Concept explainers
Explain the meanings of the following financial terms:
- a. Option
- b. Expiration date
- c. Strike price
- d. Call
- e. Put
a)
To discuss: The meaning of option.
Introduction:
A type of financial security whose value is derived from the value of a particular underlying asset is termed as derivative. This form of financial security consists of two or more parties who enter into an agreement to purchase or sell an asset at a specific price on a particular period. They are four types of derivative securities that are as follows:
- Forward contract
- Future contract
- Swap
- Option
Explanation of Solution
Option is a contract that involves the act of purchase a financial asset from one party and selling it to another party on an agreed price for a future date. There are two types of options. They are as follows:
- An option that buys an asset is called as call option
- An option that sells an asset is called as put option.
b)
To discuss: The meaning of expiration date.
Explanation of Solution
The last day or date, wherein the holder of a financial security has a right to exercise a particular option is termed as expiration date. In case of Country AM’s option, the right of the holder is exercised until the expiration date, whereas in Country E’s option, the option is exercised only on the expiration date.
c)
To discuss: The meaning of strike price.
Explanation of Solution
A particular price at which the option holder has the right to sell or purchase a specified asset is termed as strike price. It is also termed as exercise price.
d)
To discuss: The meaning of call option.
Explanation of Solution
The right of an individual to purchase an asset at the price that is fixed and at a specific period is the call option.
e)
To discuss: The meaning of put option.
Explanation of Solution
Put option is a contract that is made by two investors to sell or buy an underlying asset. This option is constructed to mitigate the downside risk of an underlying asset.
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