Consider American-style call options on a bond. The options expire in 60 days. The bond is currently at $1.05 per $1 par and makes no cash payments during the life of the option. The risk-free rate is 5%. Assume that the contract is on $1 face value bonds. Calculate the lower boundary of the call, if the strike price of the call is $0.9.

The correct answer is $0.158 or $0.16

Explanation:

According to the scenario, the computation of the given data are as follows:

We can calculate the lower boundary of the call by using following formula:

Lower boundary of call = Spot price - (Strike price ÷ (1 + r)^t)

Where, r = 5% for 60 days = 5% × ( 60 ÷ 360) = 0.833%

So, Let 60 days = 1 time period

By putting the value, we get

Lower boundary of call = 1.05 - ( 0.9 ÷ ( 1 + 0.833%)^1)

= 1.05 - 0.892

= $0.158 or $0.16

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