A
Adam
Member
In Section 11.1 of Hull, it says
"
The risk-free interest rate affects the price of an option in a less clear-cut way. As interest
rates in the economy increase, the expected return required by investors from the stock
tends to increase. In addition, the present value of any future cash flow received by the
holder of the option decreases. The combined impact of these two effects is to increase the
value of call options and decrease the value of put options.
"
Can I interpret this para as follows?
"
The risk-free interest rate affects the price of an option in a less clear-cut way. As interest
rates in the economy increase, the expected return required by investors from the stock
tends to increase. In addition, the present value of any future cash flow received by the
holder of the option decreases. The combined impact of these two effects is to increase the
value of call options and decrease the value of put options.
"
Can I interpret this para as follows?
- Expected return on stock increase --> Future share price increases --> call price increases
- Interest rate increase --> discounting increases --> present value decreases --> call price decreases
- The above two are offsetting each other --> Question is then how can one be sure that the first effect is always bigger than the second effect.