CFA Level I · CFA Level I Exam · Pricing and Valuation of Options
Holding all other factors constant, an increase in the risk-free interest rate will most likely:
A higher risk-free rate raises European call values and lowers European put values. The present value of the exercise price falls, so paying X later is cheaper for a call holder, while receiving X later is worth less to a put holder.
- Adecrease the value of a European call and increase the value of a European put
- Bincrease the value of a European call and decrease the value of a European putCorrect
- Cincrease the value of both a European call and a European put
Explanation
A higher risk-free rate lowers the present value of the exercise price. This makes the right to buy at X more valuable (call up) and the right to sell at X less valuable (put down). The first option reverses the effects, and the third is wrong because the two effects are opposite.
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