Interview Question: Interest Rate Effect

Sample Question #148 (finance – option pricing)

[I know you guys love option-pricing questions, so here’s another one!]

What happens to the price of an option when the interest rate goes to infinity?

(Comment: I don’t know why, but option pricing questions are very popular on the quant interview circuit, even when a position will not deal with options at all. Of course, if you admit up-front that you know nothing or little about options, you’ll be spared of such questions.)

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2 Responses to Interview Question: Interest Rate Effect

  1. Brett says:

    ANSWER
     
    As interest rate goes to infinity, option price tends to the stock price, all other things being equal. (Bonus question: why?) This is known as the marginal effect of interest rate.
     

  2. Wu Chao says:

    Sorry, can I think this way:when the interest rate goes to infinity, everybody will save the money in the bank. Nobody trades stocks. Option prices is zero.

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