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The Princing of Options and Corporate Liabilities

  • Date Submitted: 10/11/2010 03:59 AM
  • Flesch-Kincaid Score: 63 
  • Words: 336
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An option is a security giving the right to buy or sell an asset ,subject to certain conditions
,within a speci ed peroid of time .An "American option" is one that can be exercised at
any time up to the maturity date. A "Europeon option" is one that can be exercised only
on a speci ed future date .the price that is paid for the asset when the option is exercised
is called the "exercise price"or "Striking price".
the last day on when the option is exercised is called "expiration date" or "maturity
date".
The simplest kind of option is one that gives right to buy a single share of a common
stock.This type of option is often called as "call option".
In general ,it seems clear that the higher the price of the stock, the greater the value
of the option. When the stock price is much greater than the exercise price, the option is
almost sure to be exercised. The current value of the option will thus be approximately
equal to the price of a pure discount bond that matures on the same date as the option,
with a face value equal to the striking price of the option.
On the other hand, if the price of the stock is much less than the exercise price, the option
is almost sure to expire without being exercised so its value will be near zero.
If the expiration date of the option is very far in future, then the price of a bond that pays
the exercise price on the maturity date will be approximately equal to the price of the stock.
On the other hand, if the expiration date is very near, the value of the option will be
approximately equal to the stock price minus the exercise price, or zero, if the stock price is
less than the exercise price. Normally the value of an option declines as its maturity date
approaches, if the value of the stock does not change.

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