Problem 16-02

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. Franklin is asked to value a one-year European-style call option for Abaco Ltd. common stock, which last traded at $45.00. He has collected the following information:

Closing stock price	$45.00
Call and put option exercise price	$47.50
One-year put option price	$4.50
One-year Treasury bill rate	6.50%
Time to expiration	One year

1. Calculate, using put-call parity and the information provided, the European-style call option value. Do not round intermediate calculations. Round your answer to the nearest cent.

   $

2. State the effect, if any, of each of the following three variables on the value of a call option: (1) a decrease in short-term interest rate, (2) a decrease in stock price volatility, and (3) a decrease in time to option expiration.

   		Effect on Call Option's Value
   	A decrease in short-term interest rate	-Select-PositiveNegativeNo effectItem 2
   	A decrease in stock price volatility	-Select-PositiveNegativeNo effectItem 3
   	A decrease in time to option expiration	-Select-PositiveNegativeNo effectItem 4