Belief of Franklin about the European-style option will aim higher premium. Introduction: Option Style: According to financial terminology, the style of an option is a class or group which consists of predefined dates abut when option have to be exercised. The two types of option styles are American-style options and European style options.

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Answer 1

Question

Chapter 21, Problem 3CP

a.

Summary Introduction

To evaluate: Belief of Franklin about the European-style option will aim higher premium.

Introduction:

Option Style: According to financial terminology, the style of an option is a class or group which consists of predefined dates abut when option have to be exercised. The two types of option styles are American-style options and European style options.

b.

Summary Introduction

To determine: The European-style call option using put-call parity and the information provided in the table.

Introduction:

Put-Call parity relationship: It is a relationship defined among the amounts of European put options and European call options of the given same class. The condition implied here is that the underlying asset, strike price, and expiration dates are the same in both the options.

c.

Summary Introduction

To determine: The effect of increment short-term interest rate and stock price volatility; and decrease in time to expiration on the call option’s value.

Introduction:

Call option: It is an option that facilitates the buyer to buy the underlying assets at a fixed or agreed price irrespective of changes in market price during a specified period.

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An investor buys a European call option at a price of 7.6 yuan. The stock price is 52 yuan and the strike price is 55 yuan. Under what circumstances will the investor make a profit ? Under what circumstances will the option be executed ? Draw a diagram of the relationship between investor profitability and stock price at maturity.

State whether the following statements are true or false. In each case, provide a brief explanation. a. By observing the prices of call and put options on a stock, one can recover an estimate of the expected stock return. b. 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. c. 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.

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…

Answer 2

Question

Chapter 21, Problem 3CP

a.

Summary Introduction

To evaluate: Belief of Franklin about the European-style option will aim higher premium.

Introduction:

Option Style: According to financial terminology, the style of an option is a class or group which consists of predefined dates abut when option have to be exercised. The two types of option styles are American-style options and European style options.

b.

Summary Introduction

To determine: The European-style call option using put-call parity and the information provided in the table.

Introduction:

Put-Call parity relationship: It is a relationship defined among the amounts of European put options and European call options of the given same class. The condition implied here is that the underlying asset, strike price, and expiration dates are the same in both the options.

c.

Summary Introduction

To determine: The effect of increment short-term interest rate and stock price volatility; and decrease in time to expiration on the call option’s value.

Introduction:

Call option: It is an option that facilitates the buyer to buy the underlying assets at a fixed or agreed price irrespective of changes in market price during a specified period.

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Answer 3

Question

Chapter 21, Problem 3CP

a.

Summary Introduction

To evaluate: Belief of Franklin about the European-style option will aim higher premium.

Introduction:

Option Style: According to financial terminology, the style of an option is a class or group which consists of predefined dates abut when option have to be exercised. The two types of option styles are American-style options and European style options.

b.

Summary Introduction

To determine: The European-style call option using put-call parity and the information provided in the table.

Introduction:

Put-Call parity relationship: It is a relationship defined among the amounts of European put options and European call options of the given same class. The condition implied here is that the underlying asset, strike price, and expiration dates are the same in both the options.

c.

Summary Introduction

To determine: The effect of increment short-term interest rate and stock price volatility; and decrease in time to expiration on the call option’s value.

Introduction:

Call option: It is an option that facilitates the buyer to buy the underlying assets at a fixed or agreed price irrespective of changes in market price during a specified period.

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Answer 4

Question

Chapter 21, Problem 3CP

a.

Summary Introduction

To evaluate: Belief of Franklin about the European-style option will aim higher premium.

Introduction:

Option Style: According to financial terminology, the style of an option is a class or group which consists of predefined dates abut when option have to be exercised. The two types of option styles are American-style options and European style options.

b.

Summary Introduction

To determine: The European-style call option using put-call parity and the information provided in the table.

Introduction:

Put-Call parity relationship: It is a relationship defined among the amounts of European put options and European call options of the given same class. The condition implied here is that the underlying asset, strike price, and expiration dates are the same in both the options.

c.

Summary Introduction

To determine: The effect of increment short-term interest rate and stock price volatility; and decrease in time to expiration on the call option’s value.

Introduction:

Call option: It is an option that facilitates the buyer to buy the underlying assets at a fixed or agreed price irrespective of changes in market price during a specified period.

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Answer 5

Chapter 21, Problem 3CP

a.

Summary Introduction

To evaluate: Belief of Franklin about the European-style option will aim higher premium.

Introduction:

Option Style: According to financial terminology, the style of an option is a class or group which consists of predefined dates abut when option have to be exercised. The two types of option styles are American-style options and European style options.

b.

Summary Introduction

To determine: The European-style call option using put-call parity and the information provided in the table.

Introduction:

Put-Call parity relationship: It is a relationship defined among the amounts of European put options and European call options of the given same class. The condition implied here is that the underlying asset, strike price, and expiration dates are the same in both the options.

c.

Summary Introduction

To determine: The effect of increment short-term interest rate and stock price volatility; and decrease in time to expiration on the call option’s value.

Introduction:

Call option: It is an option that facilitates the buyer to buy the underlying assets at a fixed or agreed price irrespective of changes in market price during a specified period.

Answer 6

Chapter 21, Problem 3CP

a.

Summary Introduction

To evaluate: Belief of Franklin about the European-style option will aim higher premium.

Introduction:

Option Style: According to financial terminology, the style of an option is a class or group which consists of predefined dates abut when option have to be exercised. The two types of option styles are American-style options and European style options.

Answer 7

Chapter 21, Problem 3CP

a.

Summary Introduction

To evaluate: Belief of Franklin about the European-style option will aim higher premium.

Introduction:

Option Style: According to financial terminology, the style of an option is a class or group which consists of predefined dates abut when option have to be exercised. The two types of option styles are American-style options and European style options.

Answer 8

b.

Summary Introduction

To determine: The European-style call option using put-call parity and the information provided in the table.

Introduction:

Put-Call parity relationship: It is a relationship defined among the amounts of European put options and European call options of the given same class. The condition implied here is that the underlying asset, strike price, and expiration dates are the same in both the options.

Answer 9

b.

Summary Introduction

To determine: The European-style call option using put-call parity and the information provided in the table.

Introduction:

Put-Call parity relationship: It is a relationship defined among the amounts of European put options and European call options of the given same class. The condition implied here is that the underlying asset, strike price, and expiration dates are the same in both the options.

Answer 10

c.

Summary Introduction

To determine: The effect of increment short-term interest rate and stock price volatility; and decrease in time to expiration on the call option’s value.

Introduction:

Call option: It is an option that facilitates the buyer to buy the underlying assets at a fixed or agreed price irrespective of changes in market price during a specified period.

Answer 11

c.

Summary Introduction

To determine: The effect of increment short-term interest rate and stock price volatility; and decrease in time to expiration on the call option’s value.

Introduction:

Call option: It is an option that facilitates the buyer to buy the underlying assets at a fixed or agreed price irrespective of changes in market price during a specified period.

Answer 12

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Answer 13

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Answer 14

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Answer 15

Ch. 21 - Prob. 1PS Ch. 21 - Prob. 2PS Ch. 21 - Prob. 3PS Ch. 21 - Prob. 4PS Ch. 21 - Prob. 5PS Ch. 21 - Prob. 6PS Ch. 21 - Prob. 7PS Ch. 21 - Prob. 8PS Ch. 21 - Prob. 9PS Ch. 21 - Prob. 10PS

Solution Summary: The author evaluates Franklin's belief that the European-style option will aim higher premium. The European option is never sold for a higher amount to receive more return.

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