Flashcards
Chapter 8 Exam Review
Cards in this deck (14)
- 1Optioncontract = right to buy or sell a stock
at some predetermined price
within a specified period of time - 2Call optionright to BUY a share of stock
at a fixed price (strike price, exercise price)
You exercise your option. - 3Put optionright to SELL a share of stock
at a fixed strike price. - 4Expiration datedate after which the option may not be exercised.
American - anytime before date
European - exercise only ON date - 5In-the-moneycurrent stock price>strike price
- 6Out-of-the-moneycurrent stock price
- 7Exercise valuePAYOFF EXERCISE IMMEDIATELY
the payoff from immediately exercising an option.
Max of either (current price-strike price) or zero - 8Elements of the Black-Scholes pricing model Vc, P, N(di), X, rRF, tx, SigmaVc = current value call option
P = current price underlying stock
N(di) = prob deviation - 95 factors affect call option prices P, X, tx, rRF, Sigma1. P = Current price of underlying stock
2. X = strike price of option
3. t = Time until option expires (option period)
4. rRF = risk-free interest rate
5. standard deviation - 10The current price of an underlying stock affects call option prices in thatstock price > strike price, Vc increases because it is in-the-money.
stock price < the strike price, Vc falls towards zero and loses value,
becomes more out-of-the-money. - 11The strike price affects call option prices in thatbecause a X is fixed, an increase in the stock price increases the chances that the option will be in-the-money at expiration. Vc, therefore, is relative to the difference between the stock price (may change) and the strike price (remains the same).
- 12The time to expiration affects call option prices in thatLONGER time to expiration, the GREATER value bc P HAS TIME to rise above the X by the expiration date. Inverse also true.
The payoff is > than the opportunity cost of zero if the stock price falls below the strike price. - 13The risk-free interest rate affects call option prices in thatrRF increases, Vc increases, albeit incrementally.
The increase in rRF reduces the present value of the X, which increases Vc. - 14The standard deviation affects call option prices in thatVc increases with the volatility of its sigma. A high volatility = high prob that the P rise above the X by the expiration date.
The greater the volatility, the greater the value of the option bc it helps more than it hurts.
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- Corporate Finance Flashcards on Chapter 8 Exam Review, created by L F on 24/10/2017.
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- L F
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