In developing the pricing model for American put options, we concluded that an American option’ s price must always be higher than that of a European option. Explain why.

a. In developing the pricing model for American put options, we concluded that an American option’ s price must always be higher than that of a European option. Explain why.

b. A company is about to issue new one-year options. Currently, an older series of one-year options is traded on the market. In pricing these options, should the company use the historical variance or the expected variance according to the previous option series currently on the market? Explain.

c. In chapter 18, we demonstrated how risk trading (e.g., currencies) is a win-win situation that inherently increases the utility of both parties to a transaction. Explain how, in capital market risk trading, option writers and option buyers are in a win-win situation even though one party’ s loss is the other’ s gain (in both cases we are ignoring speculator trading).

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