Lecture 16

Question 1

Intrinsic value

Answer 1

Profit that could be made if the option was immediately exercised

Question 2

Intrinsic value of call =

Answer 2

Stock price - exercise price

Question 3

Intrinsic value of put =

Answer 3

Exercise price - stock price

Question 4

Time value =

Answer 4

Difference between actual call price and intrinsic value

Question 5

Value of call option if > stock price increases

Answer 5

Increases

Question 6

Value of call option if > exercise price increases

Answer 6

Falls

Question 7

Value of call option if > volatility increases

Answer 7

Increases

Question 8

Value of call option if > time to expiration increases

Answer 8

Increases

Question 9

Value of call option if > interest rate increases

Answer 9

Increases

Question 10

Value of call option if > dividend payouts increase

Answer 10

Falls

Question 11

Black-Scholes model

Answer 11

Model of price variation over time of financial instruments such as stocks that can be used to determine the price of a European call option

Question 12

Black-Scholes model states

Answer 12

The price of heavily traded assets follows a geometric Brownian motion with constant drift and volatility

Question 13

When applied to a stock option, the Black-Scholes model incorporates

Answer 13

The constant price variation of the stock, the time value of money, the option’s strike price, and the time to the option’s expiry

Question 14

Black-Scholes model assumes (3)

Answer 14

• No dividends are paid
• Interest rate and variance rate are constant
• Stock prices are continuous

Question 15

N(d) =

Answer 15

The normal distribution of d

Question 16

If N(d) is close to 1.0

Answer 16

High probability the option will be exercised

Question 17

If N(d) is close to 0

Answer 17

The option is unlikely to be exercised > the call is worth nothing

Question 18

If N(d) is in the middle range between 0-1

Answer 18

Call value is viewed as the present value of the call’s potential payoff, adjusting for the probability of the in-the-money expiration

Question 19

Implied volatility

Answer 19

That value of the volatility of the underlying instrument which, when input in an option pricing model (such as Black–Scholes) will return a theoretical value equal to the current market price of the option.

Question 20

If actual stock standard deviation exceeds the implied volatility

Answer 20

Option is considered a good buy > fair price exceeds observed price

Question 21

Black-Scholes model with dividends

Answer 21

Replace the stock price with the dividend adjusted stock price