Finance Questions

Question: Please explain in detail exactly how the Black-Scholes-Merton formula works with pricing of a option?

I am a finance major with a test on it. I have to use this formula that says

P = Ke^rt N(-d2) - Se ^yT N(-d1)

What is this?

S= Stock price
y= stock dividend yield
k= strike price
r= risk free rate
T= time remaining until expiration

Anyone that can explain this to me, i wuold be so gratefull

Answer: This is the Black-Scholes option pricing formula that is used to price European-style options.

N(d2) and N(d1) are taken from the normal probability distribution tables. You are missing two more formulas there. That is, there's a separate formula for d1 and d2. See here for them:http://en.wikipedia.org/wiki/Black-Scholes

Once you have all the variables, just plug them in and get your option price.

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