# FINA 410 Lecture Notes - Lecture 5: Dividend Yield, Implied Volatility, AutocorrelationPremium

3 pages85 viewsSummer 2017

This

**preview**shows half of the first page. to view the full**3 pages of the document.**CHAPTER 5 – OPTION PRICING THEORY AND MODELS

Chapter 5: pp 87- 90 and 95-99

The value of any asset is derived from the PV of CF form that asset, this is the only

exception to the rule and must have these 2 characteristics:

o 1) the assets derive their value from other assets

o 2) The CF’s o the assets are cotiget o the occurrece of specific eets

USING DCF would understate their value.

Basics of Option Pricing

Options gives you the right, not the obligation, to buy or sell underlying asset at a

predetermined (strike) price

o two positions in options: long (buyer) or short (seller)

American options can be excercised at any time, European options only at expiration

o American options more valuable but also harder to value

o The value of an option is determined by 6 variables relating to the underlying asset and

financial markets:

o 1) Current value of the underlying asset:

o underlying increases → call increases, put decreases

o 2) Volatility of the underlying asset:

o volatility increases → call and put increase

o 3)Dividends paid on the underlying asset:

o dividends increase → underlying decreases → call decreases, put increases

o 4) Strike price of the option:

o strike increases → call decreases, put increases

o 5) Time to expiration on the option:

o time decreases → call and put decrease

o 6) Riskless interest rate corresponding to life of the option:

o interest increases → PV (strike) is cheaper → call increase and put decrease

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