Use the following information for parts A to C.

Leo buys 1,000 shares of American call options on the stock of PLU Limited. The price of the call option is $5.5 per share. The exercise price is $95 and time to maturity is 6 months.

A. If the current stock price is $94 per share, should Leo exercise the options? Explain.

B. Suppose the current stock price is $94 per share. Calculate the time value of the option.

C. If the options are European options instead of American options, would the option price be above or below $5.5 per share. Explain.

Use the following information for parts D to E.

A bank is offering the following foreign exchange investment to its customer Mr. Yeung.

Mr. Yeung has to pay HKD880,000 today (20 December 2020).

If the exchange rate of HKD and EUR is at or above HKD8.80 per EUR at 4:00 p.m. on 20 January 2021, Mr. Yeung will get his HKD880,000 back. In addition, he will receive HKD10,000. The contract will then expire.

If the exchange rate of HKD and EUR is below HKD8.80 per EUR at 4:00 p.m. on 20 January 2021, Mr. Yeung will have to buy EUR100,000 with the HKD880,000 he has paid. He will also receive an additional HKD10,000 from the bank. The contract will then expire.

Even though the product is called foreign exchange investment it is in effect an option on EUR.

D. Determine the exercise price of EUR in this option. Explain your answers.

E. Is the option on EUR a call option or put option? Is Mr. Yeung the holder or the writer of the option? Explain your answers.

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Solution Call option price premium 55 Exercise price Strike price 9500 Time to maturity 6 months A C... View the full answer