Question #90 - Reading 31 Valuation of Contingent Claims

Reading: Reading 31 Valuation of Contingent Claims

PDF File: Reading 31 Valuation of Contingent Claims.pdf

Page: 42

Status: Unattempted

Correct Answer: A

Shared Context

- Bingly's sentiments towards the Black-Scholes-Merton (BSM) model regarding a lognormal distribution of prices and a variable risk-free rate are: A) correct for both reasons. B) correct concerning the distribution of stocks but incorrect concerning the risk-free rate. C) incorrect for both reasons.

Question

If Bingly forecasts the volatility for a stock and find that it is significantly greater than that implied by the prices of the puts and calls of the stock, he would conclude that:

Answer Choices:

A. the puts are overpriced and the calls are underpriced

B. puts and calls are underpriced

C. puts and calls are overpriced

Explanation

There is a positive relationship between the volatility of the stock and the price of both puts and calls. A higher estimate of volatility implies that the prices of both puts and calls should be higher.

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