Suppose a European call option has an exercise price of $100 and the underlying

Question

Suppose a European call option has an exercise price of $100 and the underlying stock has a price of $100. The stock will pay no dividends over the next year. The option expires in 1 year and the continuously compounded interest rate is 6%.

(a) What is the intrinsic value of this option? (b) What will the option be worth on expiration if the stock price in 1 year is $110? What if the stock price is $90? (c) Will the value of the option be larger or smaller if the volatility of the underlying asset is higher than otherwise? (d) Will the value be larger or smaller if the option has 3 months rather than 6 months to expiration? (e) Will the value be larger or smaller if the interest rate is larger or smaller? (f) Would the value be different for an American option? Why or why not?

Explanation / Answer

Intrinsic Value stock price*(1+IR)^n A) Intrinsic Value 106 C) Higher the volatility higher the price of opn D) Small. E) Larger the Interest rate. Larger the value. F) American Option worths more. Because it gives the option to exercise at any time before expiry.But european option can be exercise on expiry date only

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