ACCA Strategic Professional · Advanced Financial Management · Application of option pricing theory in investment decisions
A European call option on the shares of Veltra plc has an exercise price of $50 and three months to expiry. All else equal, which change would increase the value of the call?
A rise in the risk-free interest rate increases the value of a European call, because the present value of the exercise price to be paid at expiry falls. Lower volatility, a higher exercise price or a lower share price would each reduce the call value.
- AA fall in the volatility of the share price
- BA rise in the exercise price
- CA rise in the risk-free interest rateCorrect
- DA fall in the current share price
Explanation
A higher risk-free rate reduces the present value of the exercise price payable, which raises the call value. Lower volatility, a higher exercise price and a lower share price all reduce the call value.
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