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Will the exam provide N(d1) and N(d2) or do we need to calculate them?

Thread starter #1
In reference to R27.P1.T4.Hull_Ch13_15_19:Topic: BLACK-SCHOLES-MERTON_MODEL :-

In the exam, if we were to calculate the Call or Put Option prices using the BSM Model, would it be safe to assume that N(d1) & N(d2) would ALWAYS be provided given....?

There are formulae to calculate the d1 and d2 but not sure how we would deduce the N(d1) & N(d2) knowing the d1 & d2 in the exam...

Thanks much for any insights on this.
 

brian.field

Well-Known Member
Subscriber
#2
In reference to R27.P1.T4.Hull_Ch13_15_19:Topic: BLACK-SCHOLES-MERTON_MODEL :-

In the exam, if we were to calculate the Call or Put Option prices using the BSM Model, would it be safe to assume that N(d1) & N(d2) would ALWAYS be provided given....?

There are formulae to calculate the d1 and d2 but not sure how we would deduce the N(d1) & N(d2) knowing the d1 & d2 in the exam...

Thanks much for any insights on this.
I surgest that you review the definition N(*). It is notation for the Normal CDF and the prometric calculator is used specifically for this purpose, so you would need to be able to determine N(*) given *.
 

David Harper CFA FRM

David Harper CFA FRM
Staff member
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#3
@gargi.adhikari (as variations on this question have been asked many times in the forum, I am going to reply with an entry that hopefully is suitable for adding to our FAQ. cc @Nicole Seaman please note that I have tagged this with "n(d1), "n(d2)" and "BSM" which are highly unique. Thank you @brian.field i just learned a new vocabulary phrase, prometric caclulator!).

Question: The BSM formula is actually simple except for N(d1) and N(d2) in the case of the call, and N(-d1) and N(-d2) in the case of the put. Will the exam always provide N(d1) and N(d2) or do we need to know how to calculate them?

Answer: That's a good point that BSM is simple except for the standard normal cumulative distribution functions; aka, normal CDFs. After all, the minimum value of the call on a non-dividend paying is given by min[call] = S(0) - K*exp(-rT) which can be understood intuitively. The minimum value is the option's value if the volatility is zero, so we can imagine the addition of the N(.) functions as increasing the option's value to account for non-zero volatility. It is helpful to have a bit of an intuitive understanding of why N(d2) is the probability that a call option will expire in the money (ie, will be exercised) in the risk-neutral world; see http://trtl.bz/merton-model-summary. While it is more difficult to get an intuition of N(d1), at least memorize that N(d1) is the Greek percentage delta of a non-dividend paying stock, and please don't forget that for a dividend-paying stock call option delta is given by exp(-qT)*N(d1). With that context, let's finally answer the question...

As of 2017, authorized exam calculators include the Texas Instruments (TI) BA II Plus and Hewlett Packard (HP) 12C which do not naturally return CDFs. Therefore, you cannot be expected to retrieve N(d1) or N(d2) from scratch. The most likely scenario is that these probability values will be provided as assumptions. For example, here is a snippet from GARP's 2015 Part 1 Practice Exam, Question 11:



Another possible scenario is for the question to require you to calculate d2 or d1 and then retrieve N(d2) or N(d1) by using a provided Z-lookup table. For example, here is the provided Z lookup table in GARP's 2017 Part 2 Practice Exam:


A final possibility--although this seems unlikely--is for the (d2) or (d1) value to conveniently calculate to a recognizable quantile such as -2.33, -1.65, +1.65, +2.33 or even +/- 1.96 because if d2 is conveniently equal to 1.65 then we do not need a calculator to realize that N(1.65) equals about 95.0%.

Finally, please remember that d2 = d1 - σ*sqrt(T). Thanks!
 
Last edited:
#5
In reference to R27.P1.T4.Hull_Ch13_15_19:Topic: BLACK-SCHOLES-MERTON_MODEL :-

In the exam, if we were to calculate the Call or Put Option prices using the BSM Model, would it be safe to assume that N(d1) & N(d2) would ALWAYS be provided given....?

There are formulae to calculate the d1 and d2 but not sure how we would deduce the N(d1) & N(d2) knowing the d1 & d2 in the exam...

Thanks much for any insights on this.
Hi, it may not be given always. After calculating d1, d2, to find out the corresponding probablilities, you need to look up the z table.

Edit: my page wasn't refreshed so did not notice that question has been answered already
 
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