Page 103 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes 6.7 Review Questions

1. Briefly discuss the factors affecting option value.
2. What are the basic principles of option valuation?

3. What do you understand by put-call parity?
4. Discuss the effect of a dividend payable on the underlying shares on the call and put
option prices.

5. What do you mean by ‘binomial’? Explain with suitable example the application of
Binomial model for the valuation of options.
6. State the basic feature and assumptions of Black-Scholes Option Valuation.

7. Explain the Black-Scholes model for the valuation of European call option. How is this
different from valuation of put option?
8. Consider the following information with regard to a call option on the stock of XYZ
Company.
Current price of the share, S0 = ` 120
Exercise price of the option, E = ` 115

Time period to expiration = 3 months. Thus, t = 0.25 years.
Standard deviation of the distribution of continuously compounded rates of return, s = 0.6
Continuously compounded risk-free interest rate, r = 0.10
Calculate the value of the call option using Black-Scholes Model.
9. Using the Black-Scholes model, calculate the value of a European call option using the
following data:
Exercise price = ` 65, Stock price- ` 60, Time to Expiration = 6 months
Continuously compounded risk-free rate of return= 15 % p.a.

Variance of rate of return is 0.25.
10. TISCO shares are currently selling at ` 75. Assume that at the end of three months, it will
be either ` 90 or ` 60. The risk-free rate of return with continuous compounding is 10% p.a.
Calculate the value of a three-month European call option on TISCO share with exercise
price of ` 70.
Answers: Self Assessment

1. European 2. Arbitrage-based pricing
3. Discounted 4. Arbitrage
5. Put-call parity 6. Price
7. Option premium 8. Stock

9. Risk-free 10. Present value
11. True 12. False
13. False 14. True
15. True

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