FIN 534 Week 11 Final Guide Help Chapter 1 to 22
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TRUE/FALSE
An option is a contract that gives its holder the right to buy or
sell an asset at a predetermined price within a specified period of time.
The strike price is the price that must be paid for a share of
common stock when it is bought by exercising a warrant.
The exercise value is the positive difference between the current
price of the stock and the strike price. The exercise value is zero if the
stock’s price is below the strike price.
The exercise value is also called the strike price, but this term
is generally used when discussing convertibles rather than financial options.
As the price of a stock rises above the strike price, the value
investors are willing to pay for a call option increases because both (1) the
immediate capital gain that can be realized by exercising the option and (2)
the likely exercise value of the option when it expires have both increased.
If the current price of a stock is below the strike price, then an
option to buy the stock is worthless and will have a zero value.
If the market is in equilibrium, then an option must sell at a
price that is exactly equal to the difference between the stock’s current price
and the option’s strike price.
Since investors tend to dislike risk and like certainty, the more
volatile a stock, the less valuable will be an option to purchase the stock,
other things held constant.
Because of the time value of money, the longer before an option
expires, the less valuable the option will be, other things held constant.
If we define the “premium” on an option to be the difference
between the price at which an option sells and the exercise value (or the
difference between the stock’s current market price and the strike price), then
we would expect the premium to increase as the stock price increases, other
things held constant.
Because of the put-call parity relationship, under equilibrium
conditions a put option on a stock must sell at exactly the same price as a
call option on the stock, provided the strike prices for the put and call are
the same.
If a company announces a change in its dividend policy from a zero
target payout ratio to a 100% payout policy, this action could be expected to
increase the value of long-term options (say 5-year options) on the firm’s
stock.
MULTIPLE CHOICE
An option that gives the holder the right to sell a stock at a
specified price at some future time is
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a.
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a put option.
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b.
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an out-of-the-money option.
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c.
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a naked option.
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d.
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a covered option.
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e.
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a call option.
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Other things held constant, the value of an option depends on the
stock’s price, the risk-free rate, and the
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a.
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Variability of the stock price.
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b.
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Option’s time to maturity.
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c.
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Strike price.
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d.
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All of the above.
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e.
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None of the above.
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Which of the following statements is most correct, holding other
things constant, for XYZ Corporation’s traded call options?
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a.
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The higher the strike price on XYZ’s options, the higher the
option’s price will be.
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b.
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Assuming the same strike price, an XYZ call option that expires
in one month will sell at a higher price than one that expires in three
months.
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c.
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If XYZ’s stock price stabilizes (becomes less volatile), then
the price of its options will increase.
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d.
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If XYZ pays a dividend, then its option holders will not receive
a cash payment, but the strike price of the option will be reduced by the
amount of the dividend.
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e.
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The price of these call options is likely to rise if XYZ’s stock
price rises.
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BLW Corporation is considering the terms to be set on the options
it plans to issue to its executives. Which of the following actions would decrease the
value of the options, other things held constant?
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a.
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The exercise price of the option is increased.
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b.
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The life of the option is increased, i.e., the time until it
expires is lengthened.
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c.
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The Federal Reserve takes actions that increase the risk-free
rate.
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d.
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BLW’s stock price becomes more risky (higher variance).
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e.
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BLW’s stock price suddenly increases.
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Which of the following statements is CORRECT?
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a.
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Call options give investors the right to sell a stock at a
certain strike price before a specified date.
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b.
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Options typically sell for less than their exercise value.
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c.
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LEAPS are very short-term options that were created relatively
recently and now trade in the market.
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d.
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An option holder is not entitled to receive dividends unless he
or she exercises their option before the stock goes ex dividend.
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e.
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Put options give investors the right to buy a stock at a certain
strike price before a specified date.
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An investor who writes standard call options against stock held in
his or her portfolio is said to be selling what type of options?
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a.
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Put
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b.
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Naked
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c.
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Covered
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d.
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Out-of-the-money
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e.
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In-the-money
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Cazden Motors’ stock is trading at $30 a share. Call options on
the company’s stock are also available, some with a strike price of $25 and
some with a strike price of $35. Both options expire in three months. Which of
the following best describes the value of these options?
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a.
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The options with the $25 strike price will sell for less than
the options with the $35 strike price.
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b.
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The options with the $25 strike price have an exercise value
greater than $5.
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c.
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The options with the $35 strike price have an exercise value
greater than $0.
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d.
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If Cazden’s stock price rose by $5, the exercise value of the
options with the $25 strike price would also increase by $5.
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e.
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The options with the $25 strike price will sell for $5.
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Braddock Construction Co.’s stock is trading at $20 a share. Call
options that expire in three months with a strike price of $20 sell for $1.50.
Which of the following will occur if the stock price increases 10%, to $22 a
share?
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a.
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The price of the call option will increase by more than $2.
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b.
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The price of the call option will increase by less than $2, and
the percentage increase in price will be less than 10%.
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c.
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The price of the call option will increase by less than $2, but
the percentage increase in price will be more than 10%.
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d.
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The price of the call option will increase by more than $2, but
the percentage increase in price will be less than 10%.
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e.
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The price of the call option will increase by $2.
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Which of the following statements is CORRECT?
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a.
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Call options generally sell at a price greater than their
exercise value, and the greater the exercise value, the higher the premium on
the option is likely to be.
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b.
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Call options generally sell at a price below their exercise
value, and the greater the exercise value, the lower the premium on the
option is likely to be.
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c.
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Call options generally sell at a price below their exercise
value, and the lower the exercise value, the lower the premium on the option
is likely to be.
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d.
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Because of the put-call parity relationship, under equilibrium
conditions a put option on a stock must sell at exactly the same price as a
call option on the stock.
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e.
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If the underlying stock does not pay a dividend, it does not
make good economic sense to exercise a call option prior to its expiration
date, even if this would yield an immediate profit.
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Which of the following statements is CORRECT?
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a.
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Call options generally sell at a price less than their exercise
value.
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b.
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If a stock becomes riskier (more volatile), call options on the stock
are likely to decline in value.
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c.
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Call options generally sell at prices above their exercise
value, but for an in-the-money option, the greater the exercise value in
relation to the strike price, the lower the premium on the option is likely
to be.
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d.
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Because of the put-call parity relationship, under equilibrium
conditions a put option on a stock must sell at exactly the same price as a
call option on the stock.
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e.
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If the underlying stock does not pay a dividend, it makes good
economic sense to exercise a call option as soon as the stock’s price exceeds
the strike price by about 10%, because this permits the option holder to lock
in an immediate profit.
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Which of the following statements is CORRECT?
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a.
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As the stock’s price rises, the time value portion of an option
on a stock increases because the difference between the price of the stock
and the fixed strike price increases.
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b.
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Issuing options provides companies with a low cost method of
raising capital.
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c.
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The market value of an option depends in part on the option’s
time to maturity and also on the variability of the underlying stock’s price.
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d.
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The potential loss on an option decreases as the option sells at
higher and higher prices because the profit margin gets bigger.
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e.
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An option’s value is determined by its exercise value, which is
the market price of the stock less its striking price. Thus, an option can’t
sell for more than its exercise value.
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Suppose you believe that Basso Inc.’s stock price is going to
increase from its current level of $22.50 sometime during the next 5 months.
For $3.10 you can buy a 5-month call option giving you the right to buy 1 share
at a price of $25 per share. If you buy this option for $3.10 and Basso’s stock
price actually rises to $45, what would your pre-tax net profit be?
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a.
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-$3.10
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b.
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$16.90
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c.
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$17.75
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d.
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$22.50
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e.
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$25.60
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Suppose you believe that Florio Company’s stock price is going to
decline from its current level of $82.50 sometime during the next 5 months. For
$5.10 you could buy a 5-month put option giving you the right to sell 1 share
at a price of $85 per share. If you bought this option for $5.10 and Florio’s
stock price actually dropped to $60, what would your pre-tax net profit be?
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a.
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-$5.10
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b.
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$19.90
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c.
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$20.90
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d.
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$22.50
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e.
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$27.60
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The current price of a stock is $22, and at the end of one year
its price will be either $27 or $17. The annual risk-free rate is 6.0%, based
on daily compounding. A 1-year call option on the stock, with an exercise price
of $22, is available. Based on the binomial model, what is the option’s value?
(Hint: Use daily compounding.)
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a.
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$2.43
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b.
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$2.70
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c.
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$2.99
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d.
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$3.29
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e.
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$3.62
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The current price of a stock is $50, the annual risk-free rate is
6%, and a 1-year call option with a strike price of $55 sells for $7.20. What
is the value of a put option, assuming the same strike price and expiration
date as for the call option?
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a.
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$7.33
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b.
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$7.71
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c.
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$8.12
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d.
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$8.55
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e.
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$9.00
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An analyst wants to use the Black-Scholes model to value call
options on the stock of Heath Corporation based on the following data:
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·
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The price of the stock is $40.
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·
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The strike price of the option is $40.
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·
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The option matures in 3 months (t = 0.25).
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·
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The standard deviation of the stock’s returns is 0.40, and the
variance is 0.16.
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·
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The risk-free rate is 6%.
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Given this information, the analyst then calculated the following
necessary components of the Black-Scholes model:
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·
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d1 = 0.175
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·
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d2 = -0.025
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·
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N(d1) = 0.56946
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·
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N(d2) = 0.49003
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N(d1) and N(d2) represent areas under a
standard normal distribution function. Using the Black-Scholes model, what is
the value of the call option?
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a.
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$2.81
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b.
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$3.12
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c.
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$3.47
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d.
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$3.82
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e.
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$4.20
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All Possible Questions are included with answers
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