Black Scholes Option Pricing Model

Introduction:

Though out this paper I have motivated to find out how a decrease in the value of option price in Black Scholes option pricing model is likely change the price of a call option as well as a discussion about six factors that affected option price are: stock price, strike price, time to expired, volatility, risk free interest rate and dividend. Then though the case of UWA plc, I have discussed the relative merits for the company of the existing bonus scheme and the proposed share option scheme. After that, I evaluated that the proposed share option scheme where or not likely to be attractive to middle managers of UWA plc.

In the second part, I have discussed the case of McDonald’s corporation’s British Pound Exposure. Does the cross currency swap hedge the long term equity exposure in the foreign subsidiary? The answer would be discussed in this paper as well.

Question 1:

a) Discuss how a decrease in the value of each of the determinants of the option price in the Black Scholes option pricing model for European option is likely to change the price of a call option:

Black and Scholes propose that the option's price is determined by only two variables that are allowed to change: time and the underlying price.The other factors - the volatility, the exercise price, and the risk free rate do affect the option's price but they are not allowed to change. By forming a portfolio consisting of a long position in stock and a short position in calls, the risk of the stock is eliminated. This hedged portfolio is obtained by setting the number of shares of stock equal to the approximate change in the call price for a change in the stock price. This mix of stock and calls must be revised continuously, a process known as delta hedging.

Black and Scholes then turn to a little–known result in a specialized field of probability known as stochastic calculus. This result defines how the option price changes in terms of the change in the stock price and time to...