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Reading 75 Pricing and Valuation of Options Ans

Pricing and valuation of option

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34 views5 pages

Reading 75 Pricing and Valuation of Options Ans

Pricing and valuation of option

Uploaded by

keshav
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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CFA

Reading 75

PRICING AND VALUATION OF


OPTIONS

1. (A) be nonnegative.
Explanation
Option values can never be negative, but they can be zero or positive, and
therefore the lower and upper bounds on options is nonnegative.
The lower and upper bounds of all options include a present value calculation of
the exercise price, except when calculating the upper bound on a European call
option, which is simply the underlying asset price.
Option Minimum Value Maximum Value
European call ct ≥ Max [0, St − X (1 + Rf)–(T–t)] St
European put pt ≥ Max [0, X (1 + Rf)–(T–t) − St] X
(1 + Rf)–(T–t)
(Module 75.1, LOS 75.b)

2. (C) Only options have upper and lower no-arbitrage price bounds.
Explanation
Because options are contingent claims, the right to exercise or not to exercise
the leads to establishing both upper and lower price bounds on options. In
contrast, forward commitments represent obligations on both sides, and
therefore there are no price bounds. However, there is a lower bound in cases
where the underlying cannot have a negative value, for example, stocks. While
the forward buyer pays no cash up front, the option buyer pays a premium
upfront.
(Module 75.1, LOS 75.b)

3. (B) equal to the entire premium for an out-of-the-money option.


Explanation
The price (or premium) of an option is its intrinsic value plus its time value. An
out-of-the money option has an intrinsic value of zero, so its entire premium
consists of time value. Time value is zero at an option's expiration date. Time
value is the amount by which an option's premium exceeds its intrinsic value.
(Module 75.1, LOS 75.a)

Derivative 1 Pricing and Valuation of Options


CFA
4. (C) above the strike price, a put option is out-of-the-money.
Explanation
When the stock price is above the strike price, a put option is out-of-the-money.
When the stock price is below the strike price, a call option is out-of-the-money.
(Module 75.1, LOS 75.a)

5. (C) increase call option values and decrease put option values.
Explanation
An increase in the risk-free rate of interest will increase call option values and
decrease put option values.
(Module 75.1, LOS 75.c)

6. (A) a higher exercise price


Explanation
The value of an option at expiration is the greater of zero or its exercise value. A
higher exercise price increases the exercise value of a put option because it
gives the holder the right to sell the underlying asset for a higher price. The risk-
free interest rate and volatility of the underlying asset price only affect the time
value of options, which is zero at expiration.
(Module 75.1, LOS 75.c)

Derivative 2 Pricing and Valuation of Options


CFA

Derivative 3 Pricing and Valuation of Options


CFA

Derivative 4 Pricing and Valuation of Options


CFA

Derivative 5 Pricing and Valuation of Options

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