CHAPTER 13
The Black-Scholes-Merton Model
Problem 13.1.
What does the BlackScholesMerton stock option pricing model assume about the
probability distribution of the stock price in one year? What does it assume about the
continuously compounded rate of return on the stock during the year?
The BlackScholesMerton option pricing model assumes that the probability distribution of
the stock price in 1 year (or at any other future time) is lognormal. It assumes that the
continuously compounded rate of return on the stock during the year is normally distributed.
Problem 13.2.
The volatility of a stock price is 30% per annum. What is the standard deviation of the
percentage price change in one trading day?
The standard deviation of the percentage price change in time t is t where is the
volatility. In this problem 03 and, assuming 252 trading days in one year,
t 1 252 0004 so that t 03 0004 0019 or 1.9%.
Problem 13.3.
Calculate the price of a three-month European put option on a non-dividend-paying stock
with a strike price of $50 when the current stock price is $50, the risk-free interest rate is
10% per annum, and the volatility is 30% per annum.
In this case S0 50 , K 50 , r 01 , 03 , T 025 , and
ln(50 50) (01 009 2)025
d1
02417
03 025
d 2 d1 03 025 00917
The European put price is
50 N (00917)e 01025 50 N (02417)
or $2.37.
Problem 13.4.
What difference does it make to your calculations in Problem 13.3 if a dividend of $1.50 is
expected in two months?
In this case we must subtract the present value of the dividend from the stock price before
using BlackScholes-Merton. Hence the appropriate value of S0 is
S0 50 150e 0166701 4852
As before K 50 , r 01 , 03 , and T 025 . In this case
d1
d 2 d1 03 025 01086
The European put price is
50 N (01086)e 01025 4852 N (00414)
or $3.03.
Problem 13.5.
What is implied volatility? How can it be calculated?
The implied volatility is the volatility that makes the BlackScholes-Merton price of an
option equal to its market price. It is calculated using an iterative procedure.
Problem 13.6.
What is the price of a European call option on a non-dividend-paying stock when the stock
price is $52, the strike price is $50, the risk-free interest rate is 12% per annum, the volatility
is 30% per annum, and the time to maturity is three months?
In this case S0 52 , K 50 , r 012 , 030 and T 025 .
d1
d 2 d1 035 05 00809
The price of the European put is
70e 00505 N (00809) 69 N (01666)
70e 0025 05323 69 04338
640
or $6.40.