Question

Black-Scholes-Merton model:

Using a spot price of $96 and strike price of $98, a risk-free rate of return of 6% and the fact that the volatility of the share price is 18%, answer following questions:

1. What is the price of an eight-month European call? [1 mark]
2. What is the price of an eight-month American call? [1 mark]
3. What is the price of an eight-month European put? [1 mark]
4. How would your result from k. change if a dividend of $1 is expected in three months? How would your result from k. change if a dividend of $1 is expected in ten months? [2 marks]

Note for calculations with the BSM model: Keep four decimal points for d1 and d2. Use the Table for N(x) with interpolation in calculating N(d1) and N(d2).

Answer 1

This is the solution for part a),b) and c)

The solution requires the use of Black Scholes model for option pricing.

a) The price of 8 month European Call is $6.66

b)The price of 8 month American Call is same as that of European Call

c)a) The price of 8 month European Put is $4.82