1. The value of an option is determined by a number of factors and these factors relates to the value of the underlying asset and the financial market.

Required:

Critically explain five determinants of the value of an option. 6 Marks

2. A call option has a strike price of 50, which is expected to expire in two time periods, on an underlying asset whose price currently is 50. Assuming that the prevailing interest rate is 11%, use the binomial option pricing model to determine the value of the option

5 Marks

3. On March 6, 2021, Asomdwe Ltd stock was trading at $13.62. A July call option on the stock has a strike price of $15. The annualized standard deviation in Asomdwe Ltd stock price over the previous year was 81.00%. This standard deviation is estimated using weekly stock prices over the year and the resulting number was annualized as follows:

• Weekly standard deviation = 1.556%
• Annualized standard deviation =1.556%*52 = 81%

The option is expected to expire on Friday, July 20, 2021. There are 103 days to expiration. The annualized Treasury bill rate corresponding to this option life is 4.63%.

Required

1. Using the Black-Scholes model, determine the value of the call option
2. If the call option on the stock is currently valued at $2, determine whether it is overvalued or undervalued 6.5 Marks