5. Computational Methods

Monte Carlo — Quiz

Test your understanding of monte carlo with 5 practice questions.

Practice Questions

Question 1

Which of the following describes the 'diffusion' term in a Geometric Brownian Motion model used for Monte Carlo simulations in finance?

Question 2

When using Monte Carlo simulation to price a path-dependent option, why is it necessary to simulate the entire path of the underlying asset, rather than just its terminal value?

Question 3

Consider a Monte Carlo simulation for pricing a derivative. If the simulation uses a large number of paths, say $N = 1,000,000$, and the estimated option price is $C_{MC}$, what is the approximate standard error of this estimate, assuming the standard deviation of the individual discounted payoffs is $\sigma_{payoff}$?

Question 4

Which of the following variance reduction techniques involves simulating two paths for each random number, one with the original random number and one with its negative counterpart?

Question 5

In the context of Monte Carlo simulations for financial engineering, what is the primary purpose of 'calibration'?