FIN 534 Week 11 Final Guide Help Chapter 1 to 22
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An option is a contract that gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time.
The strike price is the price that must be paid for a share of common stock when it is bought by exercising a warrant.
The exercise value is the positive difference between the current price of the stock and the strike price. The exercise value is zero if the stock’s price is below the strike price.
The exercise value is also called the strike price, but this term is generally used when discussing convertibles rather than financial options.
As the price of a stock rises above the strike price, the value investors are willing to pay for a call option increases because both (1) the immediate capital gain that can be realized by exercising the option and (2) the likely exercise value of the option when it expires have both increased.
If the current price of a stock is below the strike price, then an option to buy the stock is worthless and will have a zero value.
If the market is in equilibrium, then an option must sell at a price that is exactly equal to the difference between the stock’s current price and the option’s strike price.
Since investors tend to dislike risk and like certainty, the more volatile a stock, the less valuable will be an option to purchase the stock, other things held constant.
Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.
If we define the “premium” on an option to be the difference between the price at which an option sells and the exercise value (or the difference between the stock’s current market price and the strike...