Why Does the Black Scholes Call Formula Use the Present

question 47

Multiple Choice

Why does the Black Scholes call formula use the present value of the exercise price and not merely the exercise price in the formula?

• A) All finance must use the time value of money
• B) Call options are rarely exercised early
• C) You cannot exercise an option early
• D) Because the put option uses the future value

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Definitions:

Absolute Purchasing Power Parity

The theory that, in the absence of transaction costs and other barriers, identical goods in different countries should have the same price when expressed in a common currency.

Transaction Costs

The expenses incurred when buying or selling goods and services, which may include commissions, fees, and the bid-ask spread.

Covered Interest Arbitrage

An investment strategy that involves exchanging domestic currency for a foreign currency, investing in foreign interest-bearing assets, and using forward contracts to hedge exchange rate risk.

Forward Contract

A special arrangement made between two parties to transact an asset at a pre-agreed price on a set date in the future.