Deck 20: Financial Options

Question 1

Using options to place a bet on the direction in which you believe the market is likely to move is called

A) speculation.
B) hedging.
C) a covered position.
D) a naked position.

Answer 1

speculation.

Question 2

The writer of a call option has

A) the obligation to sell a security for a given price.
B) the obligation to buy a security for a given price.
C) the right to sell a security for a given price.
D) the right to buy a security for a given price.

Answer 2

the obligation to sell a security for a given price.

Question 3

Which of the following statements is false?

A) The option buyer, also called the option holder, holds the right to exercise the option and has a long position in the contract.
B) The market price of the option is also called the exercise price.
C) If the payoff from exercising an option immediately is positive, the option is said to be in-the-money.
D) As with other financial assets, options can be bought and sold. Standard stock options are traded on organized exchanges, while more specialized options are sold through dealers.

Answer 3

The market price of the option is also called the exercise price.

Question 4

Use the table for the question(s) below.
Consider the following information on options from the CBOE for Merck:
Assume you want to buy one option contract with an exercise price closest to being at-the-money and that expires January 2009.The current price that you would have to pay for such a contract is:

A) $680
B) $380
C) $650
D) $420

Question 5

Before joining the TSX,the Montreal Exchange traded options on other products.These products were: ________.

A) stock indexes (1999), exchange-traded funds (2000), and the U.S. dollar (2005)
B) fixed income securities (1991), exchange-traded funds (2000), and the U.S. dollar (2005)
C) fixed income securities (1991), stock indexes (1999), and the U.S. dollar (2005)
D) fixed income securities (1991), stock indexes (1999), exchange-traded funds (2000), and the U.S. dollar (2005)

Question 6

Using options to reduce risk is called

A) speculation.
B) a naked position.
C) hedging.
D) a covered position.

Question 7

The Montreal Exchange was the first to trade stock options in Canada in ________.

A) 1975
B) 1973
C) 1971
D) 1972

Question 8

Montreal offers options on ________ that track the S&P TSX 60 and ________.

A) five industry sectors; exchange-traded funds (iShares)
B) exchange-traded funds (iShares); financial industry sector
C) exchange-traded funds (iShares); five industry sectors
D) financial industry sectors; exchange-traded funds (iShares)

Question 9

On the ICE Futures Canada exchange,headquartered in Winnipeg,options on ________ are traded.

A) canola, softwood, and oil
B) cattle, feed wheat, and western barley
C) beef, red spring wheat and western barley
D) canola, feed wheat, and western barley

Question 10

Use the table for the question(s) below.
Consider the following information on options from the CBOE for Merck:
The open interest for a January 2009 put option that is closest to being at-the-money is:

A) 7174
B) 982
C) 319
D) 8422

Question 11

Use the table for the question(s) below.
Consider the following information on options from the CBOE for Merck:
How many of the January 2009 put options are in-the-money?

A) 1
B) 3
C) 2
D) 4

Question 12

Which of the following statements is false?

A) A holder would not exercise an in-the-money option.
B) The option seller, also called the option writer, sells (or writes) the option and has a short position in the contract.
C) Because the long side has the option to exercise, the short side has an obligation to fulfill the contract.
D) When the exercise price of an option is equal to the current price of the stock, the option is said to be at-the-money.

Question 13

Montreal offers options on futures of ________ and 10-year ________.

A) three-month Bankers' Acceptances; Government of Canada Bonds
B) three-month Bankers' Acceptances; Canada Saving Bonds
C) three-month T-bills; Canada Saving Bonds
D) three-month T-bills; Government of Canada Bonds

Question 14

Which of the following statements is false?

A) When a holder of an option enforces the agreement and buys or sells a share of stock at the agreed-upon price, he is exercising the option.
B) European options allow their holders to exercise the option on any date up to and including a final date called the expiration date.
C) Because an option is a contract between two parties, for every owner of a financial option, there is also an option writer, the person who takes the other side of the contract.
D) The price at which the holder buys or sells the share of stock when the option is exercised is called the strike price or exercise price.

Question 15

________,options on Canadian stocks and bonds were traded on the Montreal Exchange,which was centre of the Canadian Derivatives Exchange.

A) After 1999
B) Before 1973
C) After 2008
D) Before 2008

Question 16

In Canada,the Montreal Exchange's only broad index option is ________.

A) on the S&P TSX Composite
B) on the S&P TSX 60
C) on the TSX Ventures
D) on the TSX Derivatives

Question 17

The holder of a put option has

A) the obligation to sell a security for a given price.
B) the right to buy a security for a given price.
C) the right to sell a security for a given price.
D) the obligation to buy a security for a given price.

Question 18

American options allow their holders to exercise the option ________.European options allow their holders to exercise the option ________.

A) only on the expiration date; on any date up to and including a final date
B) on any date up to but not including expiration date; on any date up to and including a final date
C) on any date up to and including a final date; only on the expiration date
D) on any date before the expiration date; on any date including the expiration date

Question 19

Which of the following statements is false?

A) A call option gives the owner the right to buy the asset.
B) A put option gives the owner the right to sell the asset.
C) A financial option contract gives the writer the right (but not the obligation) to purchase or sell an asset at a fixed price at some future date.
D) A stock option gives the holder the option to buy or sell a share of stock on or before a given date for a given price.

Question 20

Which of the following statements is false?

A) Options allow investors to speculate, or place a bet on the direction in which they believe the market is likely to move.
B) Options where the strike price and the stock price are very far apart are referred to as deep in-the-money or deep out of-the-money.
C) Call options with strike prices above the current stock price are in-the-money, as are put options with strike prices below the current stock price.
D) European options allow their holders to exercise the option only on the expiration date - holders cannot exercise before the expiration date.

Question 21

Use the table for the question(s) below.
Consider the following information on options from the CBOE for Merck:
You have decided to sell (write)5 January 2009 put options on Merck with an exercise price of $45 per share.How much money will you receive and are these contracts in- or out-of-the-money?

Question 22

The Law of One Price requires that ________ must have the same price.

A) the stock and a put or a bond and a call
B) the stock and a call or a bond and a put
C) the bond and a put or a stock and a put
D) the bond and a call or a stock and a call

Question 23

Use the figure for the question(s) below.
You are long both a put option and a call option on Rockwood stock with the same expiration date.The exercise price of the call option is $40 and the exercise price of the put option is $30.Graph the payoff of the combination of options at expiration.

Question 24

From the Law of One Price,the value of any security is determined by ________ an investor receives from owning it.Therefore,before we can assess what an option is worth,we must determine an option's ________ at the time of expiration.

A) the current cash flows ; payoff
B) the future cash flows ; price
C) the present cash flows ; price
D) the future cash flows ; payoff

Question 25

Consider the following equation: C = P + S - PV(K)- PV(Div)
In this equation the term S refers to

A) the payoff of a zero coupon bond.
B) the strike price of the option.
C) the value of the call option.
D) the stock's current price.

Question 26

Use the figure for the question(s) below.
Which of the following statements is false?

A) Because a short position in an option is the other side of a long position, the profits from a short position in an option are just the negative of the profits of a long position.
B) The deeper out-of-the-money the put option is, the less negative its beta, and the higher is its expected return.
C) Although payouts on a long position in an option contract are never negative, the profit from purchasing an option and holding it to expiration could well be negative because the payout at expiration might be less than the initial cost of the option.
D) The put position has a higher return in states with low stock prices; that is, if the stock has a positive beta, the put has a negative beta.

Question 27

The payoff to the holder of a call option is given by:

A) C = max(S - K, 0)
B) C = min(K, 0)
C) C = max(K - S, 0)
D) C = min(K - S, 0)

Question 28

Use the figure for the question(s) below.
This graph depicts the payoffs of

A) a short position in a put option at expiration.
B) a short position in a call option at expiration.
C) a long position in a put option at expiration.
D) a long position in a call option at expiration.

Question 29

Consider the following equation: C = P + S - PV(K)- PV(Div)
In this equation the term K refers to

A) the value of the call option.
B) the strike price of the option.
C) the price of a zero coupon bond.
D) the stock's current price.

Question 30

Use the figure for the question(s) below.
An option strategy in which you hold a long position in both a put and a call option with the same strike price is called

A) a strangle.
B) portfolio insurance.
C) a butterfly spread.
D) a straddle.

Question 31

Use the figure for the question(s) below.
This graph depicts the payoffs of

A) a long position in a put option at expiration.
B) a short position in a call option at expiration.
C) a short position in a put option at expiration.
D) a long position in a call option at expiration.

Question 32

Rose Industries is currently trading for $47 per share.The stock pays no dividends.A one-year European call option on Rose Industries with a strike price of $45 is currently trading for $7.45.If the risk-free interest rate is 6% per year,then calculate the price of a one-year European put option on Rose Industries with a strike price of $45.

Question 33

The time value of an option is the difference between ________.Because a(n)________ option cannot be worth less than its intrinsic value,it cannot have a negative time value.

A) the current option price and its intrinsic value; American
B) the current option price and its intrinsic value; European
C) the current option price and its present value; American
D) the current option price and its present value; European

Question 34

Use the figure for the question(s) below.
Graph the payoff at expiration of a short position in a put option with a strike price of $20.

Question 35

Use the table for the question(s) below.
Consider the following information on options from the CBOE for Merck:
You have decided to buy 10 January 2009 call options on Merck with an exercise price of $45 per share.How much will this transaction cost you and are these contracts in- or out-of-the-money?

Question 36

Use the table for the question(s) below.
Consider the following information on options from the CBOE for Merck:
How many of the January 2009 call options are in-the-money?

A) 2
B) 4
C) 1
D) 3

Question 37

Consider the following equation: C = P + S - PV(K)- PV(Div)
In this equation the term C refers to

A) the value of the call option.
B) the stock's current price.
C) the payoff of a zero coupon bond.
D) the strike price of the option.

Question 38

The payoff to the holder of a put option is given by:

A) P = max(K - S, 0)
B) P= max(S - K, 0)
C) P = min(S - K, 0)
D) P = max(K, 0)

Question 39

Use the figure for the question(s) below.
You pay $3.25 for a call option on Luther Industries that expires in three months with a strike price of $40.00.Three months later,at expiration,Luther Industries is trading at $41.00 per share.Your profit per share on this transaction is closest to?

A) -$1.00
B) $1.00
C) -$2.25
D) $2.25

Question 40

Luther Industries is currently trading for $27 per share.The stock pays no dividends.A one-year European put option on Luther with a strike price of $30 is currently trading for $2.60.If the risk-free interest rate is 6% per year,then the price of a one-year European call option on Luther with a strike price of $30 will be closest to:

A) $1.30
B) $7.10
C) $2.60
D) $1.95

Question 41

Which of the following statements is false?

A) The option price is more sensitive to changes in volatility for at-the-money options than it is for in-the-money options.
B) A share of stock can be thought of as a put option on the assets of the firm with a strike price equal to the value of debt outstanding.
C) In the context of corporate finance, equity is at-the-money when a firm is close to bankruptcy.
D) Because the price of equity is increasing with the volatility of the firm's assets, equity holders benefit from a zero-NPV project that increases the volatility of the firm's assets.

Question 42

Consider the following equation: C = S - K + dis(K)+ P - PV(Div)
In this equation,dis(K)+ P - PV(Div)tells us

A) the market value of the option.
B) the difference in the price of an American option over a European option because of dividend capture.
C) the intrinsic value of the option.
D) the time value of the option.

Question 43

Which of the following statements is false?

A) If the value of the firm's assets exceeds the required debt payment, debt holders are fully repaid.
B) Another way to view corporate debt is as a portfolio of riskless debt and a short position in a call option on the firm's assets with a strike price equal to the required debt payment.
C) Viewing debt as an option portfolio is useful as it provides insight into how credit spreads for risky debt are determined.
D) You can think of the debt holders as owning the firm and having sold a call option with a strike price equal to the required debt payment.

Question 44

Describe the conditions when it would be optimal to exercise an American Call and an American Put option prior to their expiration.

Question 45

KD Industries' stock is currently trading at $32 per share.Consider a put option on KD stock with a strike price of $30.The maximum value of this put option is:

A) $0
B) $32
C) $30
D) $2

Question 46

Which of the following statements is false?

A) The intrinsic value of an option is the value it would have if it expired immediately.
B) A European option cannot be worth less than its American counterpart.
C) Put options increase in value as the stock price falls.
D) A put option cannot be worth more than its strike price.

Question 47

Which of the following statements is false?

A) An American call on a non-dividend-paying stock has the same price as its European counterpart.
B) The price of any call option on a non-dividend-paying stock always exceeds its intrinsic value.
C) It is never optimal to exercise a call option on a dividend-paying stock early - you are always better off just selling the option.
D) If the present value of the dividend payment is large enough, the time value of a European call option can be negative, implying that its price could be less than its intrinsic value.

Question 48

KD Industries' stock is currently trading at $32 per share.Consider a put option on KD stock with a strike price of $30.The intrinsic value of this put option is:

A) $0
B) -$2
C) $2
D) $30

Question 49

Which of the following statements is false?

A) Put-call parity gives the price of a European call option in terms of the price of a European put, the underlying stock, and a zero-coupon bond.
B) For a given strike price, the value of a call option is higher if the current price of the stock is higher, as there is a greater likelihood the option will end up in-the-money.
C) The value of an otherwise identical call option is higher if the strike price the holder must pay to buy the stock is higher.
D) Because a put is the right to sell the stock, puts with a lower strike price are less valuable.

Question 50

Which of the following statements is false?

A) Because an American option cannot be worth less than its intrinsic value, it cannot have a negative time value.
B) An American option with a later exercise date cannot be worth less than an otherwise identical American option with an earlier exercise date.
C) The value of an option generally decreases with the volatility of the stock.
D) The intrinsic value is the amount by which the option is currently in-the-money or 0 if the option is out-of-the-money.

Question 51

When the firm's assets are worth ________ the required debt payment,the put is ________; the owner of the put option will therefore exercise the option and receive the difference between the required debt payment and the firm's asset value.

A) less than; in-the-money
B) more than; in-the-money
C) less than; out-of-the-money
D) more than; out-of-the-money

Question 52

Consider the following equation: C = S - K + dis(K)+ P
In this equation,S - K tells us

A) the market value of the option.
B) the time value of the option.
C) the option spread.
D) the intrinsic value of the option.

Question 53

The price of any call option on a ________ stock is always ________ its intrinsic value.

A) non-dividend-paying; greater than
B) non-dividend-paying; equal to
C) non-dividend-paying; smaller than
D) dividend-paying; greater than

Question 54

Which of the following will NOT increase the value of a put option?

A) An increase in the time to maturity
B) A decrease in the stock price
C) A decrease in the stock's volatility
D) An increase in the exercise price

Question 55

The intrinsic value of an option is the value it would have ________.

A) if it approached to its exercise price
B) if it approached to its strike price
C) if it expired immediately
D) if it approached to its fixed price

Question 56

The intrinsic value is the amount by which the option is currently ________,or 0 if the option is ________.

A) out-of-the-money; in-the-money
B) in-the-money; out-of-the-money
C) deep in-the-money; out-of-the-money
D) in-the-money; deep out-of-the-money