ACCA Strategic Professional · Advanced Financial Management · Application of option pricing theory in investment decisions
The monthly standard deviation of continuously compounded returns on a comparator company's shares is 4.0%. Assuming returns are independent between months, what annualised volatility should be used in the Black-Scholes model?
Annualised volatility is 13.86%. Volatility grows with the square root of time, so the monthly standard deviation of 4.0% is multiplied by the square root of 12, about 3.464. Multiplying by 12 would overstate it as 48%.
- A13.86%Correct
- B48.00%
- C1.15%
- D3.46%
Explanation
Volatility scales with the square root of time. Annual volatility = 4.0% x √12 = 4.0% x 3.4641 = 13.86%. Multiplying by 12 gives 48%, which wrongly scales linearly. Dividing by √12 gives 1.15%, which converts in the wrong direction.
Did you get it right without looking?
One question tells you little. A timed set on Application of option pricing theory in investment decisions shows your real accuracy, how long you take and where you lose marks.
More Application of option pricing theory in investment decisions questions
- Which of the following statements about option values is correct for options on a share that pays no dividends during the option's life?
- Under the Black-Scholes option pricing model, all other inputs remaining unchanged, which of the following changes in the share's characteri…
- Zeta Co has assets worth $100m and a single zero-coupon debt issue with a face value of $80m due in one year. Using option pricing, equity i…
- A company values a project's option to delay using the Black-Scholes model. Which of the following is a recognised limitation of applying th…
- Daily share price returns of a proxy company have a standard deviation of 1.5%. Assuming 250 trading days in a year and independent returns,…
- A share is priced at $80 and will pay a dividend before the options expire, with a present value of $3. A European put with an exercise pric…