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

An analyst simulates future prices of a stock by assuming that continuously compounded returns are normally distributed. Compared with simulating the price itself as normally distributed, this approach most likely ensures that simulated prices:

Simulating normally distributed continuously compounded returns makes prices lognormal, because price equals the starting price times the exponential of the return. The exponential is always positive, so simulated prices can never be negative, unlike prices simulated directly as normal.

  1. Aare always positiveCorrect
  2. Bhave zero skewness
  3. Chave constant volatility

Explanation

If the continuously compounded return is normal, the price equals P0 times e raised to the return, which is always positive and lognormally distributed. The lognormal price distribution is positively skewed, so zero skewness is wrong. Constant volatility is an input assumption, not a result of the lognormal setup.

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