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Black Scholes Option Pricing Model and Assumptions

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Explain the Black Scholes Option Pricing Model including the underlying assumptions.

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The solution discusses Black Scholes option pricing model and assumptions.

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The model, SN(d1)-Ke^(-rt)N(d2), is divided into two parts. SN(d1) shows hte expected benefit from obtaining the stock. You can do this by multiplying the stock price (S) by the change in the call premium in terms to a change in the underlying stock price (N(d1)). The second part, Ke^(-rt)N(d2), shows the present value of paying the exercise price on the expiration day. The fair market value of the call option is calculated by taking the difference of the two parts.

Assumptions: (take from http://bradley.bradley.edu/~arr/bsm/pg04.html)

1) The stock pays no dividends during the option's life
Most companies pay dividends to their share holders, so this might seem a serious limitation to the model considering the observation that higher dividend yields elicit lower call ...

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