[ 2009 FRM Sample Exam ] Market risk measurement and management Q4 between, possible, difference, continuous, management

Babul

 

4. You've been asked to verify the pricing of a 2?year European call option with a strike price of USD 45. You know that the initial stock price is USD 50, and the continuous risk?free rate is 3%. To verify the possible price range of this call, you consider using price bounds. What is the difference between the upper and lower bounds for that European call?

A. 0.00

B. 7.62

C. 42.38

D. 45.00

Babul

 

Correct answer is Cfficeffice" />

The upper bound of a European call is S0 = 50.  The lower bound of a European call is MAX[0, S0 ? Ke-rT] = MAX[0, 50?45e-0.03*2] = MAX[0, 7.62] = 7.62.  The difference is then 50 ? 7.62 = 42.38.

ffice:smarttags" />Readings: Options, Futures and Other Derivatives, John C. Hull, 5th edition, Prentice Hall, 2002, Chapter 8.

Type of Question: Market Risk