Mock test

AMITAG1990
Finance Junkie
Posts: 89
Joined: Sat Sep 22, 2012 12:35 pm

Mock test

Postby AMITAG1990 » Sat Nov 10, 2012 5:00 pm

What impact will a decrease in the risk-free interest rate have on the price of an American put option with the stock price and all other variables remaining the same?
Choose one answer.
a. No impact. Incorrect
b. Negative. Incorrect
c. Positive. Correct
d. Cannot be determined. Incorrect
The correct answer is Positive.
p = c + Ke^(-rT) + S

But in 1 solution of pristine it was given that put call parity is not applicable for american option... So please give some clarity on ths.??

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content.pristine
Finance Junkie
Posts: 356
Joined: Wed Apr 11, 2012 11:26 am

Re: Mock test

Postby content.pristine » Mon Nov 12, 2012 12:55 pm

Hi Amit,

I can understand your confusion.
To break this, lets take the question in 2 steps:
1. Impact of change in interest rates for a European put option
2. How this would differ from American Options

1. The impact of decrease in risk free rate would increase the value of a put option, right? ;)

2. Now, it is true that put-call parity does not hold for American options only because of the early exercise. However, the question says "Keeping All Other Variables Constant (Ceterus Paribus)" What that means is, we are comparing the option cost before interest rates changes and after it. Hence the same logic of a European put can be applied here..

I hope my explanation helps. 8-)

AMITAG1990
Finance Junkie
Posts: 89
Joined: Sat Sep 22, 2012 12:35 pm

Re: Mock test

Postby AMITAG1990 » Mon Nov 12, 2012 5:50 pm

ya i got it..thnx


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