Multinational Business Finance Study Set 4
Quiz 7: Foreign Currency Derivatives: Futures and Options
If the Exchange Rate's Volatility Is Rising, and Therefore the Risk
If the exchange rate's volatility is rising, and therefore the risk of the option not being exercised is decreasing, the option premium would be increasing.
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The primary problem with volatility is that it is unobservable; it is the only input into the option pricing formula that is determined subjectively by the trader pricing the option.
Historical volatility is the correct method for the calculation of the option volatility.
Traders by using the historical volatility assume that the immediate future will be the same as the recent past, and the historical volatility will equal the forward-looking volatility.
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