Call option: It is an agreement where the buyer is entitled the right to buy a stock at a pre-specified price within a pre-specified period. The stock on which the call option is provided is called the underlying asset. Put option: It is an agreement where the buyer is entitled the right to sell a stock at a pre-specified price within a pre-specified period. The stock on which the put option is provided is called the underlying asset. Put-call parity: The put call parity provides a relationship among the stock price, strike price, call price and the put price. According to this theory, the difference between the price of a call option and put option on the same asset underlined with the same strike price and expiry date equals to the difference between the stock price and the present value of the strike price. Pr i c e o f c a l l − Pr i c e o f p u t = S t o c k p r i c e − P V o f S t r i k e p r i c e Pr i c e o f c a l l − Pr i c e o f p u t = S t o c k p r i c e − S t r i k e p r i c e × e − r i s k f r e e r a t e × t i m e t o exp i r e To determine: The impact of volatility on the option values and to provide a numerical example using put call parity relationship to support it.

Question

Crenshaw, Incorporated, is considering the purchase of a $367,000 computer with an economic life of five years. The computer will be fully depreciated over five years using the straight-line method. The market value of the computer will be $67,000 in five years. The computer will replace five office employees whose combined annual salaries are $112,000. The machine will also immediately lower the firm's required net working capital by $87,000. This amount of net working capital will need to be replaced once the machine is sold. The corporate tax rate is 22 percent. The appropriate discount rate is 15 percent. Calculate the NPV of this project. Note: Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. NPV Answer is complete but not entirely correct. S 103,141.80

Answer 1

Question

Chapter 16, Problem 4PS

Summary Introduction

Call option:

It is an agreement where the buyer is entitled the right to buy a stock at a pre-specified price within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Put option:

It is an agreement where the buyer is entitled the right to sell a stock at a pre-specified price within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Put-call parity: The put call parity provides a relationship among the stock price, strike price, call price and the put price. According to this theory, the difference between the price of a call option and put option on the same asset underlined with the same strike price and expiry date equals to the difference between the stock price and the present value of the strike price.

Price of call−Price of put=Stock price−PV of Strike pricePrice of call−Price of put=Stock price−Strike price×e−risk free rate×time to expire

To determine:

The impact of volatility on the option values and to provide a numerical example using put call parity relationship to support it.

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