The current price of a stock is $50. Every month, the stock price will rise by a factor of 1.2 or fall by a factor of 0.8; and a $1 risk-free investment will be worth $1.03. Dividends are paid as a proportion of 0.02 of the stock price. What can you say about the the 49-strike, European and American six-month calls if the risk-less investment grows to $1.05 (instead of $1.03) each period, and the dividend rate increases to 0.04?
A) The European call rises in value and the American call rises in value.
B) The European call rises in value and the American call falls in value.
C) The European call falls in value and the American call rises in value.
D) The European call falls in value and the American call falls in value.

Question

Quizplus · Accepted Answer

When the risk-free rate increases, the present value of the strike price decreases, which generally decreases the value of European calls. Additionally, an increase in the dividend rate makes holding the stock less attractive, reducing the value of both European and American calls.

The Current Price of a Stock Is $50