Joel Franklin is a portfolio manager responsible for derivatives. Franklin observes an American-style option and a European-style option with the same strike price, expiration, and underlying stock. Franklin believes that the European-style option will have a higher premium than the American-style option.
a. Critique Franklin's belief that the European-style option will have a higher premium.
Franklin is asked to value a one-year European-style call option for Abaco Ltd. common stock, which last traded at $43.00. He has collected the following information:
Closing stock price ............ $43.00
Call and put option exercise price ...... $45.00
One-year put option price .......... $ 4.00
One-year Treasury bill rate ........ 5.50%
Time to expiration One year
b. Calculate, using put-call parity and the information provided, the European-style call option value.
c. State the effect, if any, of each of the following three variables on the value of a call option:
(1) An increase in short-term interest rate,
(2) An increase in stock price volatility,
(3) A decrease in time to option expiration.

  • CreatedDecember 17, 2014
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