PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Textbook Question
Chapter 21, Problem 23PS
American options Other things equal, which of these American options are you most likely to want to exercise early?
- a. A put option on a stock with a large dividend or a call on the same stock.
- b. A put option on a stock that is selling below exercise price or a call on the same stock.
- c. A put option when the interest rate is high or the same put option when the interest rate is low.
Illustrate your answer with examples.
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Students have asked these similar questions
Part I.
Explain why an American call options on futures could be optimally exercised early while call options on the spot can not be optimally exercised. Assume that there is no dividend.
Explain how to use call options and put options to create a synthetic short position in stock.
Part II.
Indicate whether each of the following two statements below is true, false or uncertain and justify your response.
It is theoretically impossible for an out-of-money European call and an in-the-money European put to be trading at the same price. Both options are written on the same non-dividend paying stock.
A 3-month European put option on a non-dividend-paying stock is currently selling for $3.80. The stock price is $48.0, the strike price is $51, and the risk-free interest rate is 6% per annum (continuous compounding). There is no arbitrage opportunity in this scenario.
Is the Black-Scholes-Merton options pricing model well suited to pricing an American call option on a dividend paying stock?
State whether the following statements are true or false. In each case, provide a brief explanation.
a. In a risk averse world, the binomial model states that, other things being equal, the greater the probability of an up movement in the stock price, the lower the value of a European put option.
b. By observing the prices of call and put options on a stock, one can recover an estimate of the expected stock return.
c. An investor would like to purchase a European call option on an underlying stock index with a strike price of 210 and a time to maturity of 3 months, but this option is not actively traded. However, two otherwise identical call options are traded with strike prices of 200 and 220 respectively, hence the investor can replicate a call with a strike price of 210 by holding a static position in the two traded calls.
d. In a binomial world,if a stock is more likely to go up in price than to go down, an increase in volatility would increase the price of a call option and reduce…
Chapter 21 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 21 - Binomial model Over the coming year, Ragworts...Ch. 21 - Binomial model Imagine that Amazons stock price...Ch. 21 - Prob. 3PSCh. 21 - Binomial model Suppose a stock price can go up by...Ch. 21 - Prob. 6PSCh. 21 - Two-step binomial model Suppose that you have an...Ch. 21 - Prob. 8PSCh. 21 - Option delta a. Can the delta of a call option be...Ch. 21 - Option delta Suppose you construct an option hedge...Ch. 21 - BlackScholes model Use the BlackScholes formula to...
Ch. 21 - Option risk A call option is always riskier than...Ch. 21 - Option risk a. In Section 21-3, we calculated the...Ch. 21 - Prob. 16PSCh. 21 - Prob. 18PSCh. 21 - American options The price of Moria Mining stock...Ch. 21 - American options Suppose that you own an American...Ch. 21 - American options Recalculate the value of the...Ch. 21 - American options The current price of the stock of...Ch. 21 - American options Other things equal, which of...Ch. 21 - Option exercise Is it better to exercise a call...Ch. 21 - Option delta Use the put-call parity formula (see...Ch. 21 - Option delta Show how the option delta changes as...Ch. 21 - Dividends Your company has just awarded you a...Ch. 21 - Option risk Calculate and compare the risk (betas)...Ch. 21 - Option risk In Section 21-1, we used a simple...Ch. 21 - Prob. 30PS
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- Referring to put-call parity, which one of the following alternatives would allow you to create (own) a syntheticEuropean call option? Sell the stock, buy a European put option on the same stock with the same exercise price and the same maturity, invest an amount equal to thepresent value of the exercise price in a pure-discount riskless bond Buy the stock, sell a European put option on the same stock with the same exercise price and the same matunty: short an amount equal to the presentvalue of the exercise price worth of a pure-discount riskless bond Buy the stock, buy a European put option on the same stock with the same exercise price and the same maturity; short an amount equal to the presentvalue of the exercise price worth of a pure-discount riskless bondarrow_forwardUnder the assumptions of the Black-Scholes model, which value does not affect the price of a European call option: Select one: a. the interest rate r b. the spot price S c. the strike price K d. the return of the stock µ e. the volatility of the stock σarrow_forwardWhich of the following is true, select the most appropriate answer below? There is always some chance that an American call option on a stock will be exercised early when no dividends are expected An American call option on a stock should never be exercised early An American call option on a stock should never be exercised early when no dividends are expected There is always some chance that an American call option on a stock will be exercised earlyarrow_forward
- Which of the following can be used to create a long position in a European put option on a stock? Buy a call on the stock and short the stock Sell a call option on the stock and buy the stock Sell a call option on the stock and sell the stock Buy a call option on the stock and buy the stockarrow_forwardProblem 4a: State whether the following statements are true or false. In each case, provide a brief explanation. a. In a risk averse world, the binomial model states that, other things being equal, the greater the probability of an up movement in the stock price, the lower the value of a European put option.arrow_forwardWhich of the following can be used to create a long position in a European put option on a stock? A. Sell call on the stock and buy stock B. Sell call option on the stock and sell stock C. Buy call option on the stock and buy stock D. Buy call on the stock and short stock.arrow_forward
- The binomial and Black-Scholes pricing models are the "guide posts" for pricing American and European options. Investors often consider employing stock options in their portfolios to minimize risk. They are viewed as "insurance" against losses in the portfolio. What are the pros and cons of the two models when pricing options? How would you incorporate the two models in your investment strategies/plans?arrow_forwardSelect all that are true with respect to the Black Scholes Option Pricing Model (OPM) in practice): Group of answer choices BSOPM assumes that the volatility of the underlying stock returns is constant over time. BSOPM assumes that the underlying stock can be traded continuously. BSOPM assumes that there are no transaction costs. There is only one input to the BSOPM that is not observable at the time you are valuing a stock option, and that input is volatility. Implied volatility is estimated by calculating the daily volatility of the underlying stock’s return that occurred over the prior six months.arrow_forwardRequired:a)Calculate the price of a call and a put option based on the Black-Scholes option pricing model. b) Steven, an investor who owns 500,000 shares of ABC Berhad, and is expecting the upcoming general election would create greater volatility to the share price of ABC Berhad. Advise Steven on how to protect the value of his shareholding in ABC Berhad by using the option. c)Explain TWO (2) differences of hedging using options and futures with appropriate examples.d)Explain sector rotation with an appropriate example and discuss how to identify the prospects of an industry. e)Explain the term ''private equity" and discuss TWO (2) reasons why a firm needs private equity.arrow_forward
- A) Assume that you have some shares of stock in ABC Inc. Why do we say that if you also purchase a put option on the same stock, the price paid to buy the put option is like paying an insurance premium? B) We understand standard deviation of returns as a measure of risk and rational investors would like to minimize risk. Notwithstanding this, you may have read that as the standard deviation of returns of the underlying asset increases the value of an option rises. If standard deviation is a measure of risk and investors do not particularly like it, why does it lead to an increase in an option's value?arrow_forwardProblem 4d: State whether the following statements are true or false. In each case, provide a brief explanation. d. In a binomial world, if a stock is more likely to go up in price than to go down, an increase in volatility would increase the price of a call option and reduce the price of a put option. Note that a static position is a position that is chosen initially and not rebalanced through time.arrow_forward1. Consider a family of European call options on a non - dividend - paying stock, with maturity T, each option being identical except for its strike price. The current value of the call with strike price K is denoted by C(K) . There is a risk - free asset with interest rate r >= 0 (b) If you observe that the prices of the two options C( K 1) and C( K 2) satisfy K2 K 1<C(K1)-C(K2), construct a zero - cost strategy that corresponds to an arbitrage opportunity, and explain why this strategy leads to arbitrage.arrow_forward
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