Suppose there is no uncertainty:
Suppose we know that the value of a stock at the end of
one period will be S1and suppose that the per-period risk-free
rate of interest is also known. Further suppose that we can buy a call
option on the stock with an exercise price of X. How much would we have
to pay for the call (i.e., how much is it worth) today?
Notice that this is just the lower bound that we developed
earlier, but also notice that the Black/Scholes model looks similar, but
has two additional terms.
What do N(d1) and N(d2) account
for?
When does Black/Scholes deviate the least from the certain
world case?
When does Black/Scholes deviate the most from the certain world case?