(5) (a) Provide numerical examples of the decision rules for both a call and a put option.

(6 Marks)

(b) Describe the assumptions of Black Scholes option pricing.

(4 Marks)

Regency Mines has a current share price of 1.79 and a call option written on this share with an expiry date of 3 months has an exercise price of 150p. The risk-free rate of interest is 1.7 per cent per annum and the volatility of the returns on the share is 3.8 per cent.

Required:

(c) Use Black and Scholes option pricing to estimate the value of the call and put and explain the results.

(4 Marks)

(d) Differentiate between the intrinsic and time value by means of providing an example.

(4 Marks)

(e) Find the present value of an exercise price given that the value of the call is 31.4p, the value of the put is 4.3p and the current market price of the underlying share is 59.7p and explain the results. (2 Marks)

(f) Provide a numerical example that illustrates how a change in exercise price can have a gearing and exponential effect upon the call option price and explain in detail.