ParT 2: ValuaTION, rISk aNd reTurN
IMPOrTaNT eQuaTIONS
8.1 S + P = B + C
8.2 C = SN(d 1 ) – Xe-rt N(d 2 )8.3 =
++ σ
σ
=−σdS
Xrtt
dd tIn
2
1221
8.4 Warrant value = $C(N 1 / (N 1 +N 2 ))keY TerMS
American call option, 265
at the money, 267
binomial option pricing model,
283
call option, 263
cash settlement, 266
conversion premium, 295
conversion price, 294
conversion ratio, 294
conversion value, 295
convertible bond, 294
counterparty risk, 266
derivative security, 263equity kickers, 293
European call option, 265
exercise price, 263
exercise the option, 265
expiration date, 265
hedge ratio, 285
in the money, 267
intrinsic value, 267
long position, 265
naked option position, 272
net payoff, 270
option premium, 265out of the money, 267
payoff, 269
payoff diagrams, 269
protective put, 275
put–call parity, 278
put option, 265
short position, 265
standard normal distribution,
289
strike price, 263
time value, 267
underlying asset, 263
warrants, 293SelF-TeST PrOBleMS
Answers to Self-test problems and the Concept review questions throughout the chapter appear on
CourseMate with SmartFinance Tools at http://login.cengagebrain.com.■ Calls increase in value when there is time
left before expiration, whereas the effect of
a longer expiration period on the value of a
put can be positive or negative.■ An increase in the volatility of the underlying
asset increases the values of puts and calls.
■ The binomial model uses the principle of ‘no
arbitrage’ to determine the market prices of
puts and calls.■ Beyond the pure theory of financial options,
option pricing is useful for calculating the
worth of executive compensation packages
that include share options, and for valuing
convertible bonds (which include embedded
options). It is also used more generally for
evaluating ‘real options’ (covered in Chapter
11) which are projects with embedded
choices for the investor.LO8.4LO8.5