What is the early exercise premium

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Reference no: EM132764398

For input values, let's assume that the underlying bond matures on 15 September, 2029 the bond's yield is y = 3.0%, the option's settlement date is 20 October, 2020, and the option's maturity date is 23 March, 2022. We'll assume that the term structure is flat with y = the bond's yield. Also, assume the (cash) exercise price is X = 100. NOTE: To get a flat term structure, set a1 = a2 = a3 = 0, a4 = y. You will need this fact when using some of the other spreadsheets below. For the bond's volatility, assume that y = 0.15 (see cell M5) and then use the formula we learned in Ch. 8: the bond's volatility, P, is given by P = yyMD. (The spreadsheet calculates this automatically in cell G5; the modified duration, MD, is calculated in cell L5. The bond's cash price is also calculated automatically once you enter the bond's coupon rate and yield.)

Problem 1: What is the price of the European call if we assume that the bond's coupon rate is 2.0%? What is the price of the American call? Is there an early exercise premium for the American call? If so, what is the early exercise premium? The European call option corresponding to which coupon payment has the maximum price? What is the Delta of the above American call option (assuming you hedge using the underlying bond)?

Reference no: EM132764398

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