Deck 23: Options

Question 1

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

Answer 1

False

Question 2

The put-call parity holds only if an investor plans to hold the options to maturity.

Answer 2

True

Question 3

A callable bond gives the issuer a potentially valuable option in the case of changing interest rates.

Answer 3

True

Question 4

The value of a call option increases as the strike price increases.

Question 5

The probability that all six of an executive's stock-option grants from 1995 to 2002 were dated just before a rise in the stock price (often at the bottom of a steep drop)is as small as 1 in 300 billion.

Question 6

Stock price volatility is beneficial to option holders.

Question 7

At expiration a call option will have no value if the stock price is less than exercise price.

Question 8

Callable bonds allow the investor to redeem the bond at face value or let the bond remain outstanding until maturity.

Question 9

Warrants are long-term call options on a company's stock issued by an organized stock exchange.

Question 10

Stock options give recipients a right to buy the company stock at a set (exercise)price.The exercise price is usually the stock's 4 p.m.price on the date of the grant,an average of the day's high and low,or the 4 p.m.price the day before.

Question 11

The value of both call and put options increases as the variability of the stock price increases.

Question 12

A protective put is a costless way of eliminating the downside risk if holding stock.

Question 13

FASB's Statement 123 stipulates that companies must use an option valuation model to estimate the fair value of any option grants and then deduct this value when calculating profits.

Question 14

At expiration a put option will have no value if the stock price is greater than the exercise price.

Question 15

The price of a call option increases while its exercise price decreases.

Question 16

When the stock price is very high compared to the exercise price,the call option premium approximates the difference between the stock price and strike price.

Question 17

The longer the time until expiration of a call option,the greater the value of the option.

Question 18

The Financial Accounting Standards Board (FASB)requires that companies recognize the fact that employee stock options are valuable and therefore are an expense just like salaries and wages.

Question 19

Only at the expiration date can an investor expect to find the value of call options above their lower bound.

Question 20

In 2007 the SEC investigated a number of instances where companies had backdated the stock options that they granted to senior executives.

Question 21

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 22

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 23

Convertible bonds give the investor the option to buy the firm's stock in exchange for the value of the underlying bond.

Question 24

The floor of a convertible bond will be the value of the underlying bond.

Question 25

Unlike call options,the option to abandon a real asset project does not become more valuable as time to expiration increases.

Question 26

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

Question 27

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

Question 28

The put option that comes with the puttable bonds makes the bond more valuable.

Question 29

A callable bond will have a lower value than a straight bond with the same coupon rate and maturity.

Question 30

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 31

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 $7 per share.
D) cost too much initially.

Question 32

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%? Common stock of this firm is currently selling at $35.

A) $875
B) $1,000
C) $1,125
D) $1,875

Question 33

A warrant is a long-term call option that is "in the money" at the time of issuance.

Question 34

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

Question 35

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

Question 36

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

Question 37

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

Question 38

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 39

Callable bonds give the option to the issuing firm and hence reduce the value of the bond.

Question 40

The value of a convertible bond is less than the value of a straight bond with similar coupon and maturity.

Question 41

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 42

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 43

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 44

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 45

Under what circumstance will the buyer of a put option be asked to perform 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 46

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 47

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

A) decrease.
B) increase.
C) split.
D) produce quarterly cash dividends.

Question 48

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 49

What is the minimum value of the call option on a convertible bond (with face value of $1,000)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

Question 50

Three months ago 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%
B) 150%
C) 100%
D) 50%

Question 51

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 or loss per share if the option is exercised tomorrow?

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

Question 52

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 or loss per share at tomorrow's expiration?

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

Question 53

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%

Question 54

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 $85
D) Buyer of a put option with exercise price of $85

Question 55

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.

Question 56

It is May 19 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 57

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 share
B) .75 share
C) .80 share
D) 1.25 shares

Question 58

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 59

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 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

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 62

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 63

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 64

Owning a call option that has a high probability of being exercised is said to be almost 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) Stockholders do not have capped (restricted) profits.
C) Option holders do not receive dividends.
D) Stockholders cannot sustain losses.

Question 65

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) none of these.

Question 66

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 67

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 68

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 69

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 70

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 71

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 72

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 73

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

Question 74

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 75

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 76

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 77

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 78

It has been determined that 0.5 share 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

Question 79

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 80

Which of the following is true for an investor who 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.