Deck 6: Financial Options

Question 1

The current price of a stock is $22. In one year, the price will be either $27 or $17. The annual risk-free rate is 6 percent. What is the price of a call option on the stock that has an exercise price of $22 and that expires in one year, rounded to the nearest dollar? [Hint: use daily compounding.]

A) $1.00.
B) $2.00.
C) $3.00.
D) $4.00.
E) $5.00.

Answer 1

C

Question 2

The exercise price is the price that must be paid for a share of common stock when it is bought by exercising a warrant.

Answer 2

True

Question 3

Which of the following statements is most correct?

A) 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.
B) As stock 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 striking price increases.
C) Issuing options provides companies with a low cost method of raising capital.
D) The market value of an option depends in part on the option's time to maturity and on the variability of the underlying stock's price.
E) The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.

Answer 3

D

Question 4

An option which gives the holder the right to sell a stock at a specified price at some time in the future is called a(n)

A) Call option.
B) Put option.
C) Out-of-the-money option.
D) Naked option.
E) Covered option.

Question 5

As the price of a stock rises, the time value investors are willing to pay for a call option increases because of the immediate capital gain that can be realized by exercising the option, and from the possibility that the stock price could go higher.

Question 6

An investor who writes call options against stock held in his or her portfolio is said to be selling ___________ options.

A) in-the-money
B) put
C) naked
D) covered
E) out-of-the-money

Question 7

The value of an option depends on the stock's price, the risk-free rate, and the

A) Exercise price.
B) Variability of the stock price.
C) Option's time to maturity.
D) All of the above.
E) None of the above.

Question 8

The current price of a stock is $50 and the annual risk-free rate is 6 percent. A call option with an exercise price of $55 and one year until expiration has a current value of $7.20. What is the value of a put option (to the nearest dollar) written on the stock with the same exercise price and expiration date as the call option?

A) $5.00.
B) $6.00.
C) $7.00.
D) $8.00.
E) $9.00.

Question 9

An analyst is interested in using the Black-Scholes model to value call options on the stock of Ledbetter Inc. The analyst has accumulated the following information: • The price of the stock is $40.
• The strike price is $40.
• The option matures in 3 months (t = 0.25)• The standard deviation of the stock's returns is 0.40 and the variance is 0.16.
• The risk-free rate is 6 percent.
Given this information, the analyst is then able to calculate some other necessary components of the Black-Scholes model:
• d1 = 0.175
• d2 = -0.025
• N(d1)• N(d2)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?

A) $0.60
B) $3.17
C) $3.47
D) $4.20
E) $8.00

Question 10

Deeble Construction Co.'s stock is trading at $30 a share. There are also call options on the company's stock, some with an exercise price of $25 and some with an exercise price of $35. All options expire in three months. Which of the following best describes the value of these options?

A) The options with the $25 exercise price will sell for $5.
B) The options with the $25 exercise price will sell for less than the options with the $35 exercise price.
C) The options with the $25 exercise price have an exercise value greater than $5.
D) The options with the $35 exercise price have an exercise value greater than $0.
E) If Deeble's stock price rose by $5, the exercise value of the options with the $25 exercise price would also increase by $5.

Question 11

Warnes Motors' stock is trading at $20 a share. Call options that expire in three months with an exercise price of $20 have a price of $1.50. Which of the following will occur if the stock price increases 10 percent to $22 a share?

A) The price of the call option will increase by $2.
B) The price of the call option will increase by more than $2.
C) The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10 percent.
D) The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10 percent.
E) The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10 percent.

Question 12

There are call options on the common stock of XYZ Corporation. Which of the following best describes the factors affecting the value of these call options?

A) The price of the call options is likely to rise if XYZ's stock price rises.
B) The higher the strike price on the call option, the higher the call option price.
C) Assuming the same strike price, a call option which expires in one month will sell for a higher price than a call option which expires in three months.
D) All of the answers above are correct.
E) None of the answers above is correct.

Question 13

Suppose you believe that Du Pont's stock price is going to decline from its current level of $82.50 sometime during the next 5 months. For $510.25 you could buy a 5-month put option giving you the right to sell 100 shares at a price of $83.00 per share. If you bought a 100-share contract for $510.25 and Du Pont's stock price actually dropped to $63.00, you would make

A) $1,950.00
B) $1,439.75
C) $1,489.75
D) $2,000.00
E) $2,435.00

Question 14

If the current price of a stock is below the strike (exercise) price and there is still time before expiration, there will not be a time value in the market price of a call option on the stock.

Question 15

The strike price is different from the exercise price and deals with convertibles rather than with warrants.

Question 16

Which of the following statements is correct?

A) Put options give investors the right to buy a stock at a certain exercise price before a specified date.
B) Call options give investors the right to sell a stock at a certain exercise price before a specified date.
C) Options typically sell for less than their exercise value.
D) LEAPS are very short-term options which have begun trading on the exchanges in recent years.
E) Option holders are not entitled to receive dividends unless they choose to exercise their option.

Question 17

Which of the following events is likely to decrease the value of call options on the common stock of GCC Company?

A) An increase in GCC's stock price.
B) An increase in the exercise price of the option.
C) An increase in the amount of time until the option expires.
D) An increase in the risk-free rate.
E) GCC's stock price becomes more risky (higher variance).

Question 18

An option is a contract which gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time.

Question 19

Which of the following statements is most correct?

A) If the underlying asset does not pay a dividend, it does not make sense to exercise a call option prior to its expiration date.
B) Call options generally sell at a price less than their exercise value.
C) If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.
D) Answers b and c are correct.
E) None of the answers above is correct.