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CFA Level I · CFA Level I Exam · Simulation of Financial Asset Prices and Returns

A stock is priced at 40.00. In a one-step simulation, the continuously compounded return equals 0.06 plus 0.25 times a standard normal draw. The draw is -0.80. The simulated price at the end of the step is closest to:

The simulated return is 0.06 minus 0.20, or -0.14. The price is 40 × e^(-0.14), about 34.77, so the closest option is 34.30. Using the draw-free drift would overstate the price.

  1. A34.30Correct
  2. B40.00
  3. C46.20

Explanation

Return = 0.06 + 0.25(-0.80) = -0.14. Price = 40 × e^(-0.14) = 40 × 0.86936 = 34.77, closest to 34.30 among the options. A mistake of using simple return gives 40 × 0.86 = 34.40; ignoring the draw gives 42.5, not 40.00.

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