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5.When interest rates increase with all else remaining the same, which of the following is true?

A.Both calls and puts increase in value

B.Both calls and puts decrease in value

C.Calls increase in value while puts decrease in value

D.Puts increase in value while calls decrease in value

A.Both calls and puts increase in value

B.Both calls and puts decrease in value

C.Calls increase in value while puts decrease in value

D.Puts increase in value while calls decrease in value

Answer: C

Calls increase and puts decrease in value. As explained in the text an increase in interest rates causes the growth rate of the stock price to increase and the discount rate to increase. An increase in interest rates therefore reduces the value of puts because puts are hurt by both a discount rate increase and a growth rate increase. For calls it turns out that the growth rate increase is more important than the discount rate increase so that their values increase when interest rates increase. (Note that we are assuming all else equal and so the asset price does not change.)

Calls increase and puts decrease in value. As explained in the text an increase in interest rates causes the growth rate of the stock price to increase and the discount rate to increase. An increase in interest rates therefore reduces the value of puts because puts are hurt by both a discount rate increase and a growth rate increase. For calls it turns out that the growth rate increase is more important than the discount rate increase so that their values increase when interest rates increase. (Note that we are assuming all else equal and so the asset price does not change.)

Flashcard info:

Author: CoboCards-User

Main topic: Finance & Investment

Topic: Derivatives

Published: 27.10.2015