You own a European call option and an American Call option, each on one share of Smart `R' Us, and each with an exercise price of $80. The current share price is $120 and it is an instant before Smart `R' Us pays dividends by an amount of $10. An instant after the ex-dividend date, the share price would fall to $110, and the two options would have one period until expiration. By expiration date the end of the period the share price can either increase to $130 or fall to $90. The riskless interest rate over this period (which starts an instant after the ex-dividend date and ends on the expiration day) is 13%.

a) Find the prices, intrinsic values and time values of the European and American call options, an instant AFTER the ex-dividend date (that is, when the stock price is $110). (3 points)

b) Should the American call be exercised an instant before the ex-dividend date? Explain. (2 points)

Answer rating: 100% (QA)

a To find the prices intrinsic values and time values of the European and American call options afte... View the full answer