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Joel Franklin is a portfolio manager responsible for derivatives. Franklin observes an American-style option and a European-style

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Joel Franklin is a portfolio manager responsible for derivatives. Franklin observes an American-style option and a European-style option with the same strike price, expiration, and underlying stock. Franklin believes that the European-style option will have a higher premium than the American-style option.

a. Critique Franklin's belief that the European-style option will have a higher premium.

Franklin is asked to value a one-year European-style call option for Abaco Ltd. common stock, which last traded at $43.00. He has collected the following information:

Closing stock price ............$43.00

Call and put option exercise price ......$45.00

One-year put option price ..........$ 4.00

One-year Treasury bill rate ........ 5.50%

Time to expiration One year

b. Calculate, using put-call parity and the information provided, the European-style call option value.

c. State the effect, if any, of each of the following three variables on the value of a call option:

(1) An increase in short-term interest rate,

(2) An increase in stock price volatility,

(3) A decrease in time to option expiration.


Portfolio
A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly...
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a Critique of Belief Joel Franklins belief is incorrect There are two fundamental kinds of options A...View the full answer


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Investment Analysis and Portfolio Management

Investment Analysis and Portfolio Management

ISBN: 978-0538482387

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Authors: Frank K. Reilly, Keith C. Brown

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A put option is a financial contract that gives the owner the right, but not the obligation, to sell an underlying asset, such as a stock or a commodity, at a predetermined price, known as the strike price, on or before a specific date, known as the expiration date. Put options are used by investors as a form of insurance against a decline in the value of the underlying asset. If an investor expects the value of an asset to fall in the future, they can purchase a put option on that asset. If the value of the asset does fall, the put option will increase in value, allowing the investor to sell the asset at the higher strike price. For example, if an investor owns 100 shares of a stock that is currently trading at $50 per share, they may purchase a put option with a strike price of $45 and an expiration date three months in the future. If the stock price falls to $40 before the expiration date, the investor can exercise the put option and sell their shares for $45 each, even though the market price is only $40. This would allow the investor to limit their losses. It\'s important to note that purchasing a put option involves paying a premium to the seller of the option, and the investor can lose the entire premium if the price of the underlying asset does not decline as expected. Put options are just one type of financial derivative and should only be used by experienced investors who understand the risks involved.

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