THE CURRENT STOCK PRICE OF A COMPANY IS USD 80. A RISK MANAGER IS...
13.
The current stock price of a company is USD 80. A risk manager is monitoring call and put options on the
stock with exercise prices of USD 50 and 5 days to maturity. Which of these scenarios is most likely to occur
if the stock price falls by USD 1?
Scenario
Call Value
Put Value
A
Decrease by USD 0.94
Increase by USD 0.08
B
Decrease by USD 0.94
Increase by USD 0.89
C
Decrease by USD 0.07
Increase by USD 0.89
D
Decrease by USD 0.07
Increase by USD 0.08
a.
Scenario A
b.
Scenario B
c.
Scenario C
d.
Scenario D
Correct Answer: a
Rationale:
The call option is deep in-the-money and must have a delta close to one. The put option is deep out-of-
the-money and will have a delta close to zero. Therefore, the value of the in-the-money call will decrease by close
to USD 1, and the value of the out-of-the-money put will increase by a much smaller amount close to 0. The choice
that is closest to satisfying both conditions is A.
Section:
Valuation and Risk Models
Reference:
John Hull, Options, Futures, and Other Derivatives, 9th Edition, Chapter 19, “The Greek Letters.”
Learning Objective:
Describe the dynamic aspects of delta hedging.
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2015 Financial Risk Manager (FRM®) Practice Exam