4. Answer all parts of this question. (a) A trader observes an American option and a European option with the samestrike price, expiration, and underlying stock. He believes that the European option will have a higher premium than the American option. Critique his belief that the European option will have a higher premium.
4. Answer all parts of this question. (a) A trader observes an American option and a European option with the samestrike price, expiration, and underlying stock. He believes that the European option will have a higher premium than the American option. Critique his belief that the European option will have a higher premium.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Please answer question 4-a
Transcribed Image Text:4. Answer all parts of this question.
(a) A trader observes an American option and a European option with the
samestrike price, expiration, and underlying stock. He believes that the
European option will have a higher premium than the American option.
Critique his belief that the European option will have a higher premium.
(b) A trader is asked to value a 1-year European call option for Facebook
Ltd.common stock, which last traded at 43 USD. He has collected the following
information: call and put option exercise price 45 USD, 1-year put option price
4 USD, 1-year Treasury bill rate 5.50% continuously compounded. Calculate
the European call option value using put-call parity.
(c) State the effect, if any, of each of the following three variables on the valueof a
call option. (No calculations required.) į. An increase in the short-term interest
rate. ii. An increase in stock price volatility. iii. A decrease in time to option
expiration.
(d) Price the European call having strike 60 GBP. Use the two-periods
binomialmodel with u = 1.1, d = 0.9 and At = 1. Assume that the risk free rate is
5%, and the current price of the underlying asset is 50 GBP.
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