which is not the assumption of BSM Model?

CFA Level II Derivatives
#1

Please can some1 help with the following;

Which of the following is not an assumption underlying the black scholes merton option pricing model?

A. The underyling asset does not generate cash flows

B. Continuously compounded returns are lognormally distributed.

C. The option can be only exercised at maturity.

The ans says in Schweser is B reasoning that its asset prices (not returns) follow a lognormal distribution.

But while studying the chapter from Schweser, it says : The underlying asset price follows a geometric brownian motion proces. the return of the underlying asset follows a lognormal distribution. In other words, the logarithmic continuously compounded return is normally distributed.

Can some1 please clear this confusion. Thanks

#2

[… Deleted my previous comment …]

Under the Geometric Brownian Motion assumption, the returns are lognormally distributed.

Here’s an excerpt from the text:

“Geometric Brownian motion implies a lognormal distribution of the return, which implies that the continuously compounded return on the underlying is normally distributed.”

#3

Thanks!

#4

My pleasure. Hope that was helpful