Explanation

Under the Black-Scholes-Merton model, short selling is permitted with full use of proceeds (Option B).

This assumption is crucial because:

1. Perfect markets: The model assumes frictionless markets where short selling is allowed without restrictions

2. Full use of proceeds: When an investor sells short, they receive the full proceeds from the sale and can use these funds to invest in other assets, typically risk-free bonds

3. No-arbitrage pricing: This assumption enables the creation of riskless hedged portfolios through dynamic trading strategies that involve both long and short positions

4. Replication: The ability to short sell with full proceeds is essential for replicating option payoffs through the no-arbitrage approach

Options A and C are incorrect because:

• A: Short selling is permitted, not prohibited
• C: There are no restrictions on the use of proceeds from short sales

The model assumes markets are perfectly efficient with no transaction costs, taxes, or restrictions on short selling.