QUESTION 3

(a) To value options investors must understand the role of options and how the market works. Six primary factors influence options pricing: the underlying price, strike price, time until expiration, volatility, interest rates and dividends. Explain how underlying price and interest rates affect the call option pricing. (10 marks)

(b) Given the following information:

Stock price	S0 = 62
Exercise price	X = 60
Interest rate	r = 4%
Dividend yield	= 0
Time of expiration	T = 40 days
Standard deviation	= 32%

Calculate the value of call option using Black-Scholes formula. Justify your answer. (20 marks)

(Total: 30 marks)