Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

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According to the Black-Scholes option pricing model, which of the following is NOT a variable that determines the price of an option on a non-dividend stock?

  1. Price of the underlying asset

  2. Dividend yield

  3. Time to expiration

  4. Riskless interest rate

The correct answer is: Dividend yield

The Black-Scholes option pricing model is a widely used mathematical model that estimates the price of options. It incorporates several key variables that influence the price of options on non-dividend-paying stocks. In this case, the price of the underlying asset, time to expiration, and riskless interest rate are all fundamental components of the Black-Scholes model. The price of the underlying asset directly affects the option value, as higher underlying prices generally result in higher option premiums for calls and lower premiums for puts. The time to expiration is crucial because options gain value as they approach expiration due to the time value of money and the potential for the underlying asset's price to fluctuate. The riskless interest rate is also integral, as it influences the present value of the strike price and the cost of carry for the option. However, the model specifically does not include dividend yield when pricing options on non-dividend-paying stocks. This is because the variables explicitly considered focus on the movement of the stock price, the time until expiration, and the interest rate environment, assuming that no dividends will affect the price of the underlying during its lifespan. The inclusion of dividend yield applies to options on dividend-paying stocks, but since the question pertains to non-dividend stocks, it is not