Question #76

Reading: Reading 31 Valuation of Contingent Claims

PDF File: Reading 31 Valuation of Contingent Claims.pdf

Page: 36

Status: Unattempted

Part of Context Group: Q76-78 First in Group
Shared Context
- Barlow notices that the stock in Exhibit 1 does not pay dividends. If the stock begins to pay a dividend, how will the price of a call option on that stock be affected? The price of the call option: A) may either increase or decrease. B) will decrease. C) will increase.
Question
Barlow calculated the value of an American call option on the stock shown in Exhibit 2. Which of the following is closest to the value of this call option?
Answer Choices:
A. $15.41
B. $14.84
C. $15.12
Explanation
The value of the American-style call option is the same as the value of the equivalent European-style call option. Since the underlying stock does not pay a dividend, it is never optimal to exercise the American option early. Hence the early-exercise option embedded in the American-style call has no value in this case. This makes the American option worth exactly the same as the European option.
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