ACCA Strategic Professional · Advanced Financial Management · Application of option pricing theory in investment decisions
Under the Black-Scholes option pricing model, all other inputs remaining unchanged, which of the following changes in the share's characteristics would increase the value of both a European call option and a European put option on that share?
A rise in the volatility of the share's returns increases the value of both calls and puts. The option holder benefits from larger upside or downside movements while the loss is capped at the premium paid. Changes in share price or interest rate move calls and puts in opposite directions.
- AA fall in the expected volatility of the share's returns
- BA rise in the expected volatility of the share's returnsCorrect
- CA rise in the current share price
- DA rise in the risk-free rate of interest
Explanation
Higher volatility widens the range of possible future share prices. The holder gains from favourable outcomes while losses are limited to the premium, so both calls and puts gain value. A higher share price raises calls but lowers puts. A higher risk-free rate raises calls but lowers puts. A fall in volatility reduces both.
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
- Zentra plc is valuing an option to expand a project using the Black-Scholes model. Which input for the underlying asset is typically the har…
- Under the option-pricing view of a company financed by equity and a single issue of zero-coupon debt, which statement is correct?
- In the Black-Scholes call valuation formula, what does the term N(d2) represent?
- Each $100 convertible bond of Linden Co converts into 20 shares. The current share price is $4. The straight-debt value of the bond is $82. …
- Using the option view of corporate capital structure, Zeta Co has assets worth $100m and zero-coupon debt with a face value of $100m due in …
- 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 wou…