In the Black-Scholes Framework, Return Volatility Is Assumed to Be

question 8

Multiple Choice

In the Black-Scholes framework, return volatility is assumed to be constant over the life of the option. This is not theoretically appropriate for pricing options on (default-risk-free) bonds because

• A) Empirically, interest rates are known to change over time, so bond volatility will change over time.
• B) Even if interest rates are constant over time, the duration of the bond will change over time, and duration is a measure of volatility.
• C) Constant return volatility on a zero-coupon bond is possible only if the bond price does not change over time.
• D) The bond price at maturity is known for certain, so volatility must go down as maturity approaches.

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Definitions:

Postconventional

Pertains to a level of moral reasoning that is beyond social conventions, where actions are judged based on ethical principles rather than societal norms or expectations.

Cognitive Development

The process of growth and change in intellectual capabilities that occurs as people age, involving learning, memory, problem-solving, and decision-making.

Formal Operational

The stage of cognitive development in Piaget’s theory characterized by the ability to think logically about abstract concepts.

Advanced Moral Reasoning

Advanced moral reasoning is a level of ethical thinking that goes beyond personal or cultural norms to consider the greater good and principles of justice, fairness, and human rights.