FM12 Ch 09 Solutions Manual - Chapter 9 Financial Options...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Chapter 9 Financial Options and Applications in Corporate Finance ANSWERS TO END-OF-CHAPTER QUESTIONS 9-1 a. An option is a contract which gives its holder the right to buy or sell an asset at some predetermined price within a specified period of time. A call option allows the holder to buy the asset, while a put option allows the holder to sell the asset. b. A simple measure of an option’s value is its exercise value. The exercise value is equal to the current price of the stock (underlying the option) less the striking price of the option. The strike price is the price stated in the option contract at which the security can be bought (or sold). For example, if the underlying stock sells for $50 and the striking price is $20, the exercise value of the option would be $30. c. The Black-Scholes Option Pricing Model is widely used by option traders to value options. It is derived from the concept of a riskless hedge. By buying shares of a stock and simultaneously selling call options on that stock, the investor will create a risk-free investment position. This riskless return must equal the risk-free rate or an arbitrage opportunity would exist. People would take advantage of this opportunity until the equilibrium level estimated by the Black-Scholes model was reached. 9-2 The market value of an option is typically higher than its exercise value due to the speculative nature of the investment. Options allow investors to gain a high degree of personal leverage when buying securities. The option allows the investor to limit his or her loss but amplify his or her return. The exact amount this protection is worth is the options time value, which is the difference between the option’s price and its exercise value. 9-3 (1) An increase in stock price causes an increase in the value of a call option. (2) An increase in strike price causes a decrease in the value of a call option. (3) An increase in the time to expiration causes an increase in the value of a call option. (4) An increase in the risk-free rate causes an increase in the value of a call option. (1) An increase in the variance of stock return causes an increase in the value of a call option. Answers and Solutions: 9 - 1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
SOLUTIONS TO END-OF-CHAPTER PROBLEMS 9-1 Exercise value = Current stock price – strike price = $30 - $25 = $5. Time value = Option price – Exercise value = $7 - $5 = $2. 9-2 Option’s strike price = $15; Exercise value = $22; Time value = $5; V = ? P 0 = ? Time Value = Market price of option - Exercise value $5 = V - $22 V = $27. Exercise value = P 0 - Strike price $22 = P 0 - $15 P 0 = $37. 9-3 P = $15; X = $15; t = 0.5; r RF = 0.06; σ 2 = 0.12; d 1 = 0.24495; d 2 = 0.0000; N(d 1 ) = 0.59675; N(d 2 ) = 0.500000; V = ? Using the Black-Scholes Option Pricing Model, you calculate the option’s value as:
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 11/17/2010 for the course FI 515 FI 515 taught by Professor Senn during the Spring '10 term at Keller Graduate School of Management.

Page1 / 11

FM12 Ch 09 Solutions Manual - Chapter 9 Financial Options...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online