Learning objectives: Explain put-call parity and apply it to the valuation of European and American stock options. Explain the early exercise features of American call and put options.
Questions:
726.1. The price of a dividend-paying stock is $44.00 while the riskfree rate is 3.0%. Consider a European call option and a European put option with identical strike prices, K = $40.00, and identical times to expiration of nine months, T = 0.75 years. The call has a price of $8.95 and the put has a price of $5.36. What is the present value of the dividends expected during the life of the option?
a. Zero
b. $0.19
c. $1.30
d. $4.75
726.2. Assume an option has a strike price of $50.00 and its time to expiration is six months (0.5 years) while the stock pays a dividend. Each of the following implications is true, ceteris paribus, if the risk-free rate reduces from 3.0% to zero EXCEPT which is FALSE if the risk-free rate reduces to zero?
a. If the option is put (either American or European), its price will increase
b. If the option is a call (either American or European), its price will decrease
c. If the option is American (either a call or a put), the early exercise feature becomes relatively LESS attractive
d. If the option is European (either a call or a put), the lower bound (aka, minimum value) simplifies to the option's intrinsic value
726.3. A non-dividend-paying stock currently trades at a price of $21.00 while the risk-rate is 4.0%. The stock's is highly uncertain, with a volatility of 50.0%. Two deeply in-the-money one-year European put options on this stock are trading at the following prices:
a. No
b. Yes, and it exploited with a straddle
c. Yes, and it is exploited with a bull spread
d. Yes, and it is exploited with a bear spread
Answers here:
Questions:
726.1. The price of a dividend-paying stock is $44.00 while the riskfree rate is 3.0%. Consider a European call option and a European put option with identical strike prices, K = $40.00, and identical times to expiration of nine months, T = 0.75 years. The call has a price of $8.95 and the put has a price of $5.36. What is the present value of the dividends expected during the life of the option?
a. Zero
b. $0.19
c. $1.30
d. $4.75
726.2. Assume an option has a strike price of $50.00 and its time to expiration is six months (0.5 years) while the stock pays a dividend. Each of the following implications is true, ceteris paribus, if the risk-free rate reduces from 3.0% to zero EXCEPT which is FALSE if the risk-free rate reduces to zero?
a. If the option is put (either American or European), its price will increase
b. If the option is a call (either American or European), its price will decrease
c. If the option is American (either a call or a put), the early exercise feature becomes relatively LESS attractive
d. If the option is European (either a call or a put), the lower bound (aka, minimum value) simplifies to the option's intrinsic value
726.3. A non-dividend-paying stock currently trades at a price of $21.00 while the risk-rate is 4.0%. The stock's is highly uncertain, with a volatility of 50.0%. Two deeply in-the-money one-year European put options on this stock are trading at the following prices:
- The put with a strike price of $40.00 has a price (premium) of $18.20
- The put with a strike price of $45.00 has a price (premium) of $25.20
a. No
b. Yes, and it exploited with a straddle
c. Yes, and it is exploited with a bull spread
d. Yes, and it is exploited with a bear spread
Answers here:
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