Consider pricing an exchange option on two stocks.Assume the usual lognormal returns distributions on the stock prices as in Magrabe's formula.Which of the following input variables does NOT affect the probability of the option being in-the-money at maturity?
A)The volatility of the assets' returns.
B)The risk-free rate.
C)The correlation between the two assets' returns.
D)The time to maturity of the option.

Question

Quizplus · Accepted Answer

Magrabe's formula for pricing an exchange option, which gives the holder the right to exchange one asset for another, does not directly incorporate the risk-free rate as a determinant of the option being in-the-money. The key factors are the volatilities of the assets, their correlation, and the time to maturity, as these affect the distribution and dynamics of the assets' prices relative to each other.

Consider Pricing an Exchange Option on Two Stocks