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PRMIA Exam 8006 Topic 5 Question 35 Discussion
Topic #: 5
[According to the PRMIA study guide for Exam 1, Simple Exotics and Convertible Bonds have been excluded from the syllabus. You may choose to ignore this question. It appears here solely because the Handbook continues to have these chapters.]
The use of numerical pricing methods over analytical methods for valuing exotic options is resorted to allow for which of the following reasons:
1. Efficient valuation
II. Allowing for stochastic volatility
III. Accommodating discontinuous asset prices
IV. Allowing for complex payoffs
Analytical methods are more 'efficient' than numerical methods in terms of computing power required, consistency of results and providing clarity on the inputs driving the results. Therefore 'efficient valuation' is not a reason to adopt numerical pricing methods over analytical methods.
It is much easier to incorporate changing stochastic volatility, discontinuous asset prices or other complex payoffs using numerical pricing methods. So these certainly represent good reasons to use numerical pricing methods for valuing exotics.
Therefore Choice 'b' is the correct answer.
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