QUESTION 7: (2 points, one point for each correct answer.)

Circle or highlight the correct answer. (If you cannot circle or highlight, write the question number and the letter of the correct answer.)

The following table describes the TIME VALUES of EUROPEAN PUT options on the S&P 500 index. The EUROPEAN PUToptions expire 2 weeks from today.

The S&P 500 index value is $4275. The index will not pay dividends over the life of these options.

EXERCISE PRICE	TIME VALUE of PUT option (Dollars per share)
4275	80
4285	70

PROVIDETWO REASONSWHY THE PUT OPTION WITH THE HIGHER EXERCISE PRICE HAS A LOWER TIME VALUE.

(TWO REASONS: ONE POINT FOR EACH CORRECT ANSWER.)

1. The value of the insurance against the possibility that the option will expire worthless is lower.
2. The interest lost from not being able to exercise the European option before its expiration day is higher.
3. Because the index will not pay any dividends, its value must increase by a greater percentage to compensate its holders. A higher the index value is associated with lower put prices.
4. The put option with the higher exercise price is-in the-money. However, because the index will not pay dividends, you will never exercise an in-the-money American put option before its expiration and its time value must be lower. In addition, when the index does not pay dividends, European and American put options are identical and they have the same time values. Therefore, the time value of the in-the-money European put option must also be lower.