Deck 25: Conclusion

Question 1

What is the worst-case profitability scenario for an investor who sold a call on the firm's stock for a premium of $10 and a strike price of $100?

A)$90 per share profit
B)$10 per share profit
C)$0 per share profit (break-even)
D)Unlimited losses

Answer 1

Unlimited losses

Question 2

What is the profit per share for an investor who has purchased a share of stock and two put options with an exercise price of $40, given that the purchase price of the stock was $42, each put cost $2 per share, and the stock was valued at $30 at expiration?

A)($16)
B)($6)
C)($4)
D)$4 profit per share = value of stock at expiration + 2(value of put at expiration) - price of stock - 2(put premium)
= 30 + 2(40 - 30) - 42 - 2(2)

Answer 2

$4 profit per share = value of stock at expiration + 2(value of put at expiration) - price of stock - 2(put premium)
= 30 + 2(40 - 30) - 42 - 2(2)

Question 3

A decrease in which of the following terms will cause an increase in the call value of an option?

A)Interest rates
B)Time to maturity
C)Exercise price
D)Volatility of the stock

Answer 3

Exercise price

Question 4

Which of the following is true for an investor that owns a share of stock and has purchased a put option on the stock?

A)The investor profits when the stock decreases in value
B)Maximum loss is the price of the option premium
C)The investor is protected against upside potential
D)Increases in stock value go to the seller of the put

Question 5

Which of the following call options would command the higher premium, other things equal?

A)October 1996 expiration, $45 strike price
B)December 1996 expiration, $40 strike price
C)March 1997 expiration, $45 strike price
D)June 1997 expiration, $40 strike price

Question 6

Which of the following is true for the owner of a call option?

A)The loss potential is unlimited
B)The profit potential is unlimited
C)The premium exceeds the strike price
D)There is no expiration date, unless the option is a European call

Question 7

If you feel strongly that a stock price will move, but are unsure of the direction, you could buy the stock and:

A)Buy both a put and a call
B)Sell both a put and a call
C)Buy a put and sell a call
D)Buy two puts

Question 8

The difference between an American call option and a European call option is:

A)The European call has a final exercise date
B)The American call trades only on domestic stocks
C)The European call can be exercised only on one day
D)The American call generates profits regardless of which direction the stock moves

Question 9

What is the option buyer's total profit or loss per share if a call option is purchased for a $5 premium, has a $50 exercise price, and the stock is valued at $53 at expiration?

A)($5)
B)($2)
C)$3
D)$8 Value of call option = stock price - exercise price
Total profit of call = value of call option - premium paid
Then:
Value of call option = $53 - 50 = $3

Question 10

The option to abandon a project investing in real assets can be considered to have a strike price equal to the:

A)Historical cost of the asset
B)Market value of the asset at abandonment
C)Forgone revenues anticipated from the project
D)Forgone interest on the bonds used to finance the real assets

Question 11

The payoffs from holding a call option can be replicated by:

A)Borrowing money to buy a put option
B)Borrowing money to invest in the stock
C)Simultaneously selling a call and buying a put
D)Simultaneously buying a share and buying a put

Question 12

Which combination of positions will tend to protect the owner from downside risk?

A)Buy the stock and buy a call option
B)Sell the stock and buy a call option
C)Buy the stock and buy a put option
D)Buy the stock and sell a put option

Question 13

Calculate the profit per share for an investor that exercises a put option with a strike price of $60 when the stock is selling for $46 and the premium for the put option was $4.

A)($14)
B)($10)
C)$10
D)$18 Value of put at expiration = exercise price - stock price
= $60 - 46
= $14
Total profit = value of put option - premium paid

Question 14

A stock is currently selling for $70 per share and its call option has a $90 exercise price.What is the lower limit on the value of the call option?

A)($20)
B)0
C)$10
D)$20 Lower limit on value of call option = max [0,(stock price - exercise price)]
= max [0,(70 - 90)]

Question 15

If the owner of a call option with a strike price of $35 finds the stock to be trading for $42 at expiration, then the option:

A)Expires worthless
B)Will not be exercised
C)Is worth at least $7 per share
D)Cost too much initially

Question 16

Why is the value of a call option said to increase as the interest rate increases?

A)The stock seller must pay the call owner more interest
B)The present value of the strike price is reduced
C)As interest rates increase, stock prices increase
D)Interest rate increases reduce the option premium

Question 17

The major difference between options on real assets and options on financial assets is that options on:

A)Financial assets are costly
B)Financial assets have a higher probability of positive payoff
C)Real assets are implicit, rather than explicit
D)Real assets are not influenced by price volatility

Question 18

Owning a call option that has a high probability of being exercised is said to be equivalent to owning the stock.In which way is owning a call not equivalent to owning the stock?

A)Option holders pay no income taxes
B)Shareholders do not have capped (restricted) profits
C)Option holders do not receive dividends
D)Shareholders cannot sustain losses

Question 19

How much must the stock be worth at expiration in order for a call holder to break even if the exercise price is $50 and the call premium was $4?

A)$46
B)$50
C)$52
D)$54 profit from call = stock value - exercise price - premium
0 = stock value - 50 - 4

Question 20

Which of the following option traders receive, rather than pay, a premium?

A)Option sellers
B)Option buyers
C)Both option sellers and buyers
D)Neither buyers nor sellers receive premiums

Question 21

Under what circumstance will the buyer of a put option be asked to perform his or her obligation?

A)When the stock price has declined below the strike price
B)When the stock price has increased above the strike price
C)The put buyer has an equal obligation regardless of the relationship between stock and strike prices
D)The put buyer has no obligation whatsoever

Question 22

The payoffs from investing in options are designed so that:

A)Both buyers and sellers can profit
B)The seller's (buyer's) gain is the buyer's (seller's) loss
C)Roughly 20% of sellers and 50% of buyers profit
D)Few buyers or sellers profit; they buy "insurance"

Question 23

If a $1,000 convertible bond with a market value of $950 has a conversion ratio of 25 when the firm's stock is selling for $36 per share, then:

A)The bond will be converted immediately
B)The bond is violating its "price floor"
C)Conversion now would give the investor a profit of $900
D)The conversion value of the bond is $900

Question 24

Which of the following conditions will typically be present when a firm calls a bond prior to maturity?

A)The firm is in poor financial health
B)Interest rates have risen substantially since the bond was issued
C)Interest rates have fallen substantially since the bond was issued
D)The call option is ready to expire

Question 25

Under which condition does a call option approach its upper bound?

A)When the stock price is far above the strike price
B)When the stock price is closest to the strike price
C)When the stock price is approaching zero
D)When the option is approaching its expiration time

Question 26

Joe sold a put option on ZZZ Corp.with an exercise price of $40.The option expires tomorrow and ZZZ is currently trading at $28 per share.The option premium was $4 per share.What is Joe's profit per share if the option is exercised tomorrow?

A)($16)
B)($8)
C)$8
D)$16

Question 27

Jennifer sold a call option on XXX Corp.with an exercise price of $50.The option expires tomorrow and XXX is currently trading at $40.The option premium was $3 per share.What is Jennifer's expected profit per share at tomorrow's expiration?

A)($3)
B)$3
C)$7
D)$10

Question 28

Which of the following is correct for the owner of a June call, valued at $3, on XYZ Corp.with a strike price of $60? XYZ Corp.currently trades at $55.

A)XYZ is expected to go to $63 per share
B)The option cannot currently be exercised
C)The option owner's current profit is $3 per share
D)The option may expire without value

Question 29

What is the value of a convertible bond with a conversion ratio of 25, face value of $1,000, coupon of 10% and yield of 10 percent? Common stock of this firm is currently selling at $35.

A)$875
B)$1,000
C)$1,125
D)$1,875 Conversion value = 25 x 35 = $875
Floor value of the par bond is $1,000

Question 30

At what point on the graph of possible values for a call option does the buyer break even financially?

A)When stock price equals strike price
B)At any point on the upward-sloping segment of the graph
C)When stock price equals cost of the option plus strike price
D)At the point where the graph intercepts the y-axis

Question 31

The value of a callable bond equals the value of a straight bond:

A)Plus the value of the bondholder's call option
B)Minus the value of the bondholder's call option
C)Plus the value of the issuer's call option
D)Minus the value of the issuer's call option

Question 32

It is May 19^th and you own a June, European call on ABC Corp.with an exercise price of $50.The option trades at $40 and ABC is trading at $86.What should you do?

A)Exercise the option now and take the profits
B)Buy more options on ABC Corp
C)Sell your ABC stock before its price declines
D)Sit and wait until the June expiration

Question 33

Investors who hold warrants essentially have a:

A)Put option on the firm's bonds
B)Put option on the firm's equity
C)Call option on the firm's bonds
D)Call option on the firm's equity

Question 34

Which of the following statements is correct for an investor who has purchased "portfolio insurance," by owning the stock and buying a put option on the stock?

A)The investor profits when the stock price declines
B)Maximum profitability occurs when stock price equals strike price
C)Value per share can decline no further than the strike price less the value of the option premium
D)The option will certainly be exercised

Question 35

Stock options have been traded on exchanges since:

A)The founding of the New York Stock Exchange
B)Options were discovered in 1946
C)The early part of the 1970s
D)Just before the stock market crash in 1987

Question 36

The conversion ratio for a convertible bond equals the:

A)Ratio of bond value to stock price at conversion
B)Number of bonds necessary to convert into one share of stock
C)Number of shares of stock that can be exchanged for one bond
D)Floor value beneath which the bond price cannot fall

Question 37

Which of the following statements is correct?

A)A convertible bond will be priced less than a similar callable bond
B)A convertible bond will be priced more than a similar callable bond
C)Similar callable and convertible bonds will have the same price
D)Warrants are always priced more than convertible bonds

Question 38

If a $1,000 convertible bond has a conversion ratio of 50 and the firm's equity is currently selling for $22 per share, then the:

A)Bond should trade for $900
B)Bond should trade for $1,000
C)Bond should trade for $1,100
D)Firm will have already converted the bond

Question 39

Option buyers can have a(n) __________ of exercising their options.Options sellers can have a(n) __________ of exercising their options.

A)Obligation; obligation
B)Obligation; right
C)Right; right
D)Right; obligation

Question 40

Which of the following is correct for the owner of a September put, valued at $20, on CBA Corp.with a strike price of $80? CBA currently trades at $67.

A)The option will continue to gain value until its September expiration
B)The owner profits $13 per share by exercising now
C)Further decreases in CBA stock price will be translated directly into additional option value
D)$20 is the maximum value for this option

Question 41

A share of stock is currently priced at $20 and will change with equal likelihood to either $50 or $10.A call option with a $25 exercise price is available on the stock.How many shares of stock must be purchased to replicate the payoff from owning one call option?

A)$.50 shares
B)$.75 shares
C)$.80 shares
D)$1.25 shares Given the possible range of stock values, the option can range in price from $25 to $0.Then,

Question 42

Which of the following statements is correct concerning call options?

A)Value of a call option at expiration will be greater than the stock price
B)Value of a call option at expiration will be equal to the exercise price
C)Value of a call option at expiration will be equal to the difference between the stock price and exercise price
D)Value of a call option at expiration will be equal to zero

Question 43

When the stock price has risen above the exercise price, the value of a call option is equal to the stock price:

A)Less the value of the dividend
B)Less the value of the option
C)Less the present value of the exercise price
D)Less the exercise price

Question 44

You paid $5 a call option on a stock with an exercise price of $80.If the current stock price is $60, your net proceeds by exercising this option and selling the stock will be:

A)($25)
B)$0
C)$20
D)$60

Question 45

IBM shares are currently selling at $75.The premium on a call option on IBM shares with an exercise price of $60 will be:

A)Less than $15
B)Greater than $15
C)Equal to $15
D)Zero

Question 46

Recently you bought a call and a put option on a stock with a common exercise price of $75.The call premium was $5 and the put premium was $3.You will make money from this position if the stock price is:

A)Greater than $75, but less than $78
B)Greater than $75, but less than $80
C)Greater than $72, but less than $75
D)Less than $67, or greater than $83

Question 47

Which of the following is correct concerning callable bonds?

A)There is an upper bound on the bond's price
B)Their prices are higher than for straight bonds
C)Their attraction to the issuer increases as interest rates increase
D)The bond investor owns the call option

Question 48

When does a change in the value of a call option come the closest to matching the price change in a share of stock?

A)When the stock is priced far above the strike price
B)When the stock is priced far below the strike price
C)When the stock is priced very near the strike price
D)Changes in call value always come close to matching changes in stock price.

Question 49

At what point is the payoff from owning a call option on a stock greater than the payoff from owning the stock itself?

A)When stock price exceeds strike price at expiration
B)When strike price exceeds stock price at expiration
C)When stock price equals strike price at expiration
D)Call payoff never exceeds stock payoff.

Question 50

Three months back you bought for $4 a put option on a stock with an exercise price of $100.If the stock price at expiration of this option is $92, what is your return on investment?

A)200 percent
B)150 percent
C)100 percent
D)50 percent Proceeds = Stock price - Exercise price
100 - 92 = $8
Profits = proceeds - original investment
= 8 - 4 = $4

Question 51

You are currently holding a call option on a stock with an exercise price of $80.If the current stock price is $60, your net proceeds by exercising this option will be:

A)($20)
B)$0
C)$20
D)$60 Proceeds = Stock price - Exercise price

Question 52

If a convertible bond can be thought of as a straight bond with a call option, then the call is owned by the ___________ and the strike price is the ___________.

A)Debt issuer; stock price
B)Debt issuer; straight bond value
C)Bond investor; stock price
D)Bond investor; straight bond value

Question 53

Why should a convertible bond always be valued at more than its bond value or its conversion value up until maturity?

A)The bondholder is receiving higher interest rates
B)The conversion value does not have an upper bound
C)The conversion ratio may be decreased
D)The bond does not have to be given up to exercise the option

Question 54

Corporations that attach warrants to their bonds are hoping to:

A)Sell equity without paying flotation costs
B)Convert the bonds into stock at a later date
C)Reduce the cost of debt by increasing bond prices
D)Increase the price of their shares

Question 55

The value of a call option increases as the time to expiration increases because:

A)The exercise price continually decreases
B)Opportunity increases to surpass exercise price
C)Dividends accumulate while waiting to be paid
D)The option can be repeatedly exercised

Question 56

It has been determined that 0.5 shares of stock should be purchased with borrowed funds to replicate the payoff to one call option.What is the option's strike price if the stock could range in value from $110 to $10 at the expiration of the option?

A)$40
B)$50
C)$60
D)$70 number of shares to replicate one call =

Question 57

Stocks that have more volatile price changes have more valuable call options because call holders:

A)Capture upside potential without downside risk
B)Realize that volatility decreases the present value of the exercise price
C)Have too little variability in the exercise price
D)Have transferred all risk to put holders

Question 58

Firms spend an increasing amount of time evaluating real options, which are:

A)Options on real assets such as an option to abandon
B)Call and put options traded on organized exchanges
C)Call options such as warrants and convertible bonds
D)Put options such as held by shareholders of a firm with financial leverage

Question 59

What is the minimum value of the call option on a convertible bond with a conversion ratio of 30 if the bond offers a 9% coupon, has 10 years until maturity and market interest rates are 9% for comparable bonds? The stock is currently priced at 35.

A)$0
B)$5
C)$50
D)$65 Bond value = $1,000 because coupon rate = market rate.
Conversion value = $30 x $35 = $1,050.
Therefore, bond will sell for conversion value since it exceeds bond value.
Value of call = selling price of bond - bond value
= $1,050 - $1,000

Question 60

Of the following four put options that can be purchased on a stock, which would you expect to have the highest price?

A)September put; $65 exercise price
B)September put; $75 exercise price
C)December put; $65 exercise price
D)December put; $75 exercise price

Question 61

The lower limit on value of a call option is:

A)Zero
B)Less than zero
C)Stock price minus exercise price
D)Exercise price

Question 62

How does the price of a put option respond to an interest rate increase?

A)Increases
B)Decreases
C)Remains the same
D)Goes to zero

Question 63

An investor can create a straddle position by doing the following:

A)Buy a stock and write a call option
B)Buy a stock and buy a call option
C)Buy a stock and buy a put option
D)Buy a call option and a put option with the same exercise price

Question 64

On March 30 you are holding a call option on a stock (exercise price of $60), which will expire on March 31.The closing price of the stock on March 30 is $59.What is the value of your call option?

A)$1
B)($1)
C)Very little
D)Zero

Question 65

Which is the best definition of a put option?

A)The right to buy an asset at a fixed price during a particular time period
B)The right to sell an asset at a fixed price during a particular time period
C)A security that gives the holder the right to purchase shares of a stock at a fixed price over a period of time
D)The act of buying or selling the underlying asset via the option contract

Question 66

What is the primary difference between an American and European option?

A)The value at which the option can be exercised
B)The number of options that can be exercised
C)The time period when the option can be exercised
D)The manner options are bought or sold

Question 67

A firm is planning to issue a callable bond with 8% coupon and 10 years to maturity.A straight bond with similar coupon is priced at $1,000.If the value of the issuer's call option is estimated to be $60, what is the value of the callable bond?

A)$940
B)$970
C)$1,000
D)$1,060

Question 68

The seller of a put option is betting that the market value of the stock will decrease.

Question 69

Calculate the return on exercising a put option that was purchased for $10, with an exercise price of $85.The stock price at expiration is $81.

A)(60%)
B)60%
C)30%
D)(30%) Proceeds = exercise price - stock price
= 85 - 81 = $4
Profits = proceeds - original investment
= 4 - 10 = -$6

Question 70

A stock is selling at $85 at the expiration of an option contract.Which of the following options will most likely be exercised?

A)Buyer of a call option with exercise price of $65
B)Buyer of a put option with exercise price of $65
C)Buyer of a call option with exercise price of $80
D)Buyer of a put option with exercise price of $85

Question 71

A writer of a call option expects the stock price to:

A)Decrease
B)Increase
C)Remain unchanged
D)Cash dividends quarterly

Question 72

How does the price of a put option respond to a stock price increase?

A)Increases
B)Decreases
C)Remains the same
D)Goes to zero

Question 73

Which of the following changes will decrease the value of a call option?

A)An increase in stock price
B)An increase in strike price
C)An increase in stock price volatility
D)An increase in interest rates

Question 74

An investor who is buying a put option is expecting:

A)Stock prices to go up
B)Stock prices to go down
C)Interest rates to go up
D)Interest rates to go down

Question 75

The buyer of a call option has the obligation to buy shares at the strike price.

Question 76

A homeowner can refinance the mortgage loan on the house at a lower rate when the interest rates go down.The right to refinance at a lower rate is a(n):

A)Put option
B)Call option
C)Option to expand
D)It is not an option

Question 77

Which is the best definition of a call option?

A)The right to buy an asset at a fixed price during a particular time period
B)The right to sell an asset at a fixed price during a particular time period
C)A security that gives the holder the right to purchase shares of a stock at a fixed price over a period of time
D)The act of buying or selling the underlying asset via the option contract

Question 78

Which is the best definition of a warrant?

A)The right to buy an asset at a fixed price during a particular time period
B)The right to sell an asset at a fixed price during a particular time period
C)A security that gives the holder the right to purchase shares of a stock at a fixed price over a period of time
D)The act of buying or selling the underlying asset via the option contract

Question 79

How does the price of a put option respond to a exercise price increase?

A)Increases
B)Decreases
C)Remains the same
D)Goes to zero

Question 80

Adding warrants as a 'sweetener' to bonds will:

A)Reduce the value of the bond
B)Increase the coupon rate of the bond
C)Increase the value of the bond
D)Make the bond more risky