QUESTION 6 HAS TWO PARTS (A， B) FOR A TOTAL OF 8 MINUTES.

 

　　Michael Weber，CFA，is analyzing several aspects of option valuation， including the determinants of the value of an option， the characteristics of various models used to value options， and the potential for divergence of calculated option values from observed market prices.

 

　　A. State， and justify with one reason for each case， the expected effect on the value of a call option on common stock if each of the following changes occurs：

 

　　i. The volatility of the underlying stock price decreases

 

　　ii. The time to expiration of the option increases

 

　　(4 minutes)

 

　　Using the Black-Scholes option-pricing model， Weber calculates the price of a three-month call option and notices the option‘s calculated value is different from its market price. A colleague verifies that Weber’s methodology and results are correct.

 

　　B. With respect to Weber‘s use of the Black-Scholes option-pricing model， and given that his methodology and results are correct：

 

　　i. Discuss one reason why the calculated value of an out-of-the-money European option may differ from that same option’s market price.

 

　　ii. Discuss one reason why the calculated value of an American option may differ from that same option‘s market price.

 

　　(4 minutes)