Abstract 2

Introduction: 3

Literature Review: 4

1. Options & its characteristics 4

2. Black Scholes Pricing Model 6

Assumptions 6

I. Constant volatility 6

II. No Dividends 6

III. European exercise terms are used 6

IV. Markets are efficient 7

V. No commissions are charged 7

VI. Interest rates remain constant and known 7

VII. Returns are lognormal distributed 7

VIII. Liquidity 7

4. Inputs to the Black-Scholes Model 9

I. The underlying price 9

II. The exercise price 9

III. Time to expiration 9

IV. The risk-free rate 9

V. Volatility 9

5. Limitations of Black Scholes Model 10

6. Macro-economic Variable Effect: 12

Methodology: 13

Analysis: 14

Limitations: 19

Recommendations: 20

Conclusion: 21

References: 22

Abstract

A credit
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Black Scholes Pricing Model

In 1973, Myron Scholes and Fisher Black developed the framework on option pricing and presented the theory in their seminal paper. With reference to both approach and application the Black Scholes Model is considered to be one of the most significant concepts in modern financial theory. For valuing options the Black Sholes Model is viewed as a standard model.

Assumptions

To compute the value of a stock option the Black-Scholes Option Pricing Model is used. Both call and put option can be calculated with the help of the model. For the accurate application of the Black Scholes Pricing Model it is necessary to be familiar with its assumptions. Black and Scholes specified the following assumptions in their seminal paper (1973). (Ray, 2012)

I. Constant volatility

Volatility refers to the movement of the stock price whether upwards or downwards. The model assumes that the volatility does not change and is known to market participants. This implies that the variance of the return remains constant over the life of the option.

II. No Dividends

The model assumes that the underlying asset (stock) does not pay any dividends during the option’s life.

III. European exercise terms are

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