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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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.
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.
Is the Black-Scholes-Merton options pricing model well suited to pricing an American call option on a dividend paying stock?
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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Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Black-Scholes Model Assume that you have been given the following information on Purcell Industries call options: According to the Black-Scholes option pricing model, what is the option’s value?arrow_forwardConsider two put options on the same stock with the same time to maturity. The strike price of Put A is less than the strike price of Put B. Which of the following is true? O It is possible for Put A to be in the money and Put B to be out of the money. O It is possible for Put A to be out of the money and Put B to be in the money. One of the options must be in the money. All of the other answers are correct.arrow_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_forward
- What is a REIT What are the advantages and disadvantages of REITs List and Describe the different types of REITs What is an OPTION Differentiate between a PUT and a CALL OPTION List and Describe the different types of OPTIONS What is a REPO What are the advantages and disadvantages of REPOS List and Describe the different types of REPOS What is the formula for calculating REPO RATE Define (a) Market Risk (b) Interest Rate Risk (c) Commodity Risk (d) Currency Riskarrow_forwardDiscuss which of the following statements is true. O I. An American call option is more expensive than a European call option because of the time value of money. O II. An American call option is more expensive than an American put option because call options give the right to buy the stock and not to sell it. O II. An American put option is more expensive than a European put option because of the time value of money. O IV. An American call option is cheaper than a European call option because we lose the insurance value of the call if we exercise early.arrow_forwardThe 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_forward
- Explain carefully why Blacks approach to evaluating an American call option on a dividend-paying stock may give an approximate answer even when only one dividend is anticipated. Does the answer given by Blacks approach understate or overstate the true option value? Explain your answer.arrow_forwardDescribe what a stock option is. what does it means to buy a "put" or a "call" and what you are expecting the stock to do for each (ie go up or down in price). Discuss when you would make money on a put option and when you would make money on a call option.arrow_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? 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_forwardMy question is for a synthetic call option why do we need to borrow the present value of the strike price and what does it mean in a simple language explanation. Similarly why do we need to lend the present value of the stock at risk-free rate and what does it mean in simple language explanation? Please also clarify the significance of risk free rate? Why is it used in put call parity. Synthetic Call Option: If an investor believes that a call option is over-priced, then he/she can sell the call on the market and replicate a synthetic call. Borrow the present value of the strike price at the risk free rate and purchase the underlying stock and a put. Synthetic Put Option: Similar to the synthetic call option. A synthetic put can be created by re-arranging the put-call parity relationship, if the trader believes the put is overvalued. Synthetic Stock: A synthetic stock can also be created by rearranging the put-call parity identity. In this case, the investor will buy the…arrow_forwardBoth call and put options are affected by the following five factors: the exercise price, the underlying stock price, the time to expiration, the stock’s standard deviation, and the risk-free rate. However, the direction of the effects on call and put options could be different. Use the following table to identify whether each statement describes put options or call options. Statement Put Option Call Option 1. When the exercise price increases, option prices increase. 2. An option is more valuable the longer the maturity. 3. The effect of the time to maturity on the option prices is indeterminate. 4. As the risk-free rate increases, the value of the option increases.arrow_forward
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