1. A put option is a wasting asset; i.e., its value declines with the passage of time, all else equal. Ans: True Level: Basic Subject: Option Pricing Type: Concepts
2. The minimum value of a convertible bond is given by its straight-bond value or its conversion value, whichever is greater.
Ans: True Level: Basic Subject: Convertible Bonds Type: Concepts
3. A financial contract that gives its owner the right, but not the obligation, to buy or sell a specified asset at an agreed-upon price on or before a given future date is called a(n):
A) Option contract. B) Futures contract. C) Forward contract. D) Swap contract. E) Straddle contract.
Ans: A Level: Basic Subject: Options Type: Definitions
4. The act where an owner of an option buys or sells the underlying asset, as is their right, is called _____________ the option. A) striking B) exercising C) opening D) splitting E) strangling
Ans: B Level: Basic Subject: Option Exercise Type: Definitions
5. The fixed price in an option contract at which the owner can buy or sell the underlying asset is called the option's _________________. A) opening price B) intrinsic value C) strike price D) market price E) time value
Ans: C Level: Basic Subject: Strike Price Type: Definitions
6. The last day on which an owner of an option can elect to exercise is the ___________ date. A) ex-payment
B) ex-option C) opening D) expiration E) intrinsic
7. An option that may be exercised at any time up to its expiration date is called a(n): A) Futures option. B) Asian option. C) Bermudan option. D) European option. E) American option.
Ans: E Level: Basic Subject: American Options Type: Definitions 8. An option that may be exercised only on the expiration date is called a(n):
A) European option. B) American option. C) Bermudan option. D) Futures option. E) Asian option.
Ans: A Level: Basic Subject: European Options Type: Definitions
9. A ____________ is a derivative security that gives the owner the right, but not the obligation, to buy an asset at a fixed price for a specified period of time.
A) futures contract B) call option C) put option
D) swap
E) forward contract
Ans: B Level: Basic Subject: Call Options Type: Definitions
10. A ____________ is a derivative security that gives the owner the right, but not the obligation, to sell an asset at a fixed price for a specified period of time.
A) futures contract B) call option C) put option
D) swap
E) forward contract
Ans: C Level: Basic Subject: Put Option Type: Definitions
11. A trading opportunity that offers a riskless profit is called a(n) _______________. A) put option
B) call option
C) market equilibrium D) arbitrage
E) cross-hedge
12. The value of an option if it were to immediately expire, that is, its lower pricing bound, is called an option's _________________. A) strike value B) market value C) volatility value D) time value E) intrinsic value
Ans: E Level: Basic Subject: Intrinsic Value Type: Definitions 13. The time value of an option is equal to:
A) The difference between the option's market price and its intrinsic value. B) The difference between the option's intrinsic value and its market price. C) The risk-free interest rate in the economy.
D) The net present value of the option's cash flows.
E) The net present value of the option's cash flows, discounted at the risk-free interest rate. Ans: A Level: Basic Subject: Time Value Type: Definitions
14. A security that gives the holder the right, but not the obligation, to purchase shares of stock in a firm for a fixed price over a specified period of time is called a(n):
A) Convertible bond. B) Warrant.
C) Initial public offering. D) Seasoned equity offering. E) Forward sale of equity.
Ans: B Level: Basic Subject: Warrants Type: Definitions
15. A bond that can be exchanged for a fixed number of shares of stock in a firm over a specified period of time is called a: A) Secured bond. B) Warranted bond. C) Convertible bond. D) Junk bond. E) Callable bond.
Ans: C Level: Basic Subject: Convertible Bonds Type: Definitions
16. The dollar amount of a convertible bond's par value that is exchangeable for one share of stock is the bond's _________________.
A) conversion premium B) straight bond value C) conversion value D) conversion price E) conversion ratio
17. The number of shares of stock received for each convertible bond converted into stock is called the _______________.
A) conversion premium B) straight bond value C) conversion value D) conversion price E) conversion ratio
Ans: E Level: Basic Subject: Conversion Ratio Type: Definitions
18. The difference between the conversion price of a convertible bond and the current stock price, divided by the current stock price, is called the _______________.
A) conversion premium B) straight bond value C) conversion value D) conversion price E) conversion ratio
Ans: A Level: Basic Subject: Conversion Premium Type: Definitions
19. The value a convertible bond would have if it could not be converted into common stock is called the __________________.
A) conversion premium B) straight bond value C) conversion value D) conversion price E) conversion ratio
Ans: B Level: Basic Subject: Straight Bond Value Type: Definitions
20. The value a convertible bond would have if it were to be immediately converted into common stock is called the ____________.
A) conversion premium B) straight bond value C) conversion value D) conversion price E) conversion ratio
Ans: C Level: Basic Subject: Conversion Value Type: Definitions
21. Options with payoffs in real goods, as opposed to asset prices are known as _______. A) call options
B) goods options C) managerial options D) futures options E) asset options
22. The formula C = [S][N(d1)] – [E][N(d2)]/(1+Rf)t defines:
A) Put-call parity.
B) Continuous compounding. C) The put option delta.
D) Black-Scholes option pricing model. E) The implied standard deviation.
Ans: D Level: Basic Subject: Black-Scholes Option Pricing Model Type: Definitions 23. An option that can only be exercised on the expiration date is called a(n):
A) Implied option. B) European-style option. C) Parity call option. D) American-style option. E) Put option.
Ans: B Level: Basic Subject: European Option Type: Definitions 24. The present value of the strike price can be defined as:
A) Price that represents the highest probability of the future value of the stock price. B) A T-bill with a face value equal to the strike price.
C) The price that reflects the volatility of the underlying stock.
D) The present value of a risky security discounted at the market rate of return. E) The current market value of the underlying security.
Ans: B Level: Basic Subject: Present Value Of Strike Price Type: Definitions
25. When the effective annual rate is computed using the natural logarithm, the compounding period of the interest rate is:
A) Annually. B) Quarterly. C) Daily. D) Continuously. E) Monthly.
Ans: D Level: Basic Subject: Continuous Compounding Type: Definitions
26. An option issued by an individual that gives its owner the right to buy an asset at a fixed price on or before a given date is called a(n):
A) American call option. B) American put option. C) American warrant. D) European call option. E) European put option.
27. An option that gives its owner the right to sell an asset at a fixed price on a given date is called a(n): A) American call option.
B) American put option. C) American warrant. D) European call option. E) European put option.
Ans: E Level: Easy Subject: European Put Type: Definitions
28. A security issued by a firm that gives its owner the right to purchase new shares of stock at a fixed price over a given period of time is called a(n):
A) American call option. B) American put option. C) American warrant. D) European call option. E) European put option.
Ans: C Level: Easy Subject: Warrant Type: Definitions
29. On a given day, the rights to buy 160,000 shares of stock at a stated price by a stated date were traded. The newspaper would list the volume of options traded on that day as:
A) 16.
B) 160.
C) 1,600. D) 16,000. E) 160,000.
Ans: C Level: Easy Subject: Option Listing Type: Definitions 30. If a call option is "in-the-money" on the expiration date, the:
A) Strike price is more than the market price of the stock.
B) Option is expiring unexercised that day and the seller gets to keep the option premium. C) Buyer of the option is getting a refund equal to the option premium paid.
D) Call has an intrinsic value that is equal to the stock price minus the strike price.
E) Seller of the call gets to keep the option premium without relinquishing any shares of stock. Ans: D Level: Easy Subject: In The Money Type: Definitions
31. Options that are frequently issued in conjunction with privately placed bonds are called: A) Calls.
B) Puts. C) Warrants.
D) Employee options. E) Debt options.
32. A security that can be converted into shares of common stock and has an infinite maturity date is called a: A) Convertible preferred bond.
B) Convertible preferred stock. C) Warranted bond.
D) Warranted preferred stock. E) Conversion put bond.
Ans: B Level: Easy Subject: Preferred Convertible Type: Definitions 33. Which of the following can only be exercised on the expiration date?
A) American option B) European option C) Warrant
D) Convertible bond E) Putable bond
Ans: B Level: Basic Subject: European Options Type: Concepts
34. A local retail store allows you to return the merchandise you purchase and get your money back for up to 30 days after the purchase date. The store has, in effect, provided each shopper with _______________ options. A) American call B) European call C) American put D) European put E) convertible bond
Ans: C Level: Basic Subject: American Put Options Type: Concepts
35. A ticket to a baseball game gives the holder the right, but not the obligation, to attend a specified game. Thus, a baseball ticket is effectively a(n) ________ option on the possession of a seat, which has an expiration date equal to __________.
A) American call; the end of the baseball season B) European call; the end of the baseball season C) American call; the day of the game
D) European call; the day of the game
E) Convertible bond; the end of the baseball season
Ans: D Level: Basic Subject: European Call Options Type: Concepts 36. If you sell a call option on a stock that you don't own you:
A) Have the right to force exercise of the option anytime prior to maturity. B) May be forced to buy the underlying stock at the exercise price.
C) Have a right to receive dividends on the underlying stock until exercise or maturity of the option. D) May be forced to sell the underlying stock at a fixed price if the option is exercised against you. E) May let the option expire without exercising it.
37. Three weeks ago, you sold an IBM September $110 call option for $2.25. Now, in August, IBM is selling for $117.50 per share and your call is trading for $9.75. Ignoring transactions costs, you may do which of the following?
A) Exercise the call and then sell the 100 shares of IBM stock for $117.50 per share B) Exercise the call and sell 100 shares of IBM for $110 per share
C) Forego your right to exercise the call until later D) Sell the call to net a $7.50 profit per share E) Sell an additional call option contract for $9.75
Ans: E Level: Basic Subject: Call Options Type: Concepts 38. If you exercise a put option prior to expiration you ______________.
A) sell the asset underlying the option contract at the option strike price B) must have been the "writer" of the option when it was created C) will receive less than you would if you let the option run to maturity
D) have behaved in a rational manner if the market price exceeds the strike price E) must own a European option
Ans: A Level: Basic Subject: Put Option Type: Concepts
39. In July, you purchase a September 75 put option on Keebler, Inc. common stock. You: A) Should exercise the option at expiration if the price of Keebler stock is $80.
B) Have given the seller the right to buy a share of Keebler stock at $75 sometime prior to the September expiration.
C) Have the right to buy a share of Keebler stock at $75 sometime prior to the September expiration. D) Will have a negative cash flow at the time you initiate the contract and a positive cash flow when the
option expires if the stock price is less than $75 at that time.
E) Will have a worthless option in August if the stock price is $80 at that time. Ans: D Level: Basic Subject: Put Option Type: Concepts
40. A put option you own is going to expire in one second. The current stock price is $25 and the strike price of your option is $30. Which of the following statements is NOT true?
A) Your option has intrinsic value.
B) Your option should be exercised or sold. C) You have the right to sell the stock for $30.
D) Someone other than you stands to gain $5 per share when the option is exercised. E) Your option is in-the-money.
Ans: D Level: Basic Subject: Put Option Type: Concepts 41. Which of the following statements is false?
A) Option contracts are a zero sum game.
B) If an in-the-money option is not exercised at expiration, you will lose money. C) It is possible for you to lose all of your investment in an option.
D) One advantage to buying options on a stock rather than the stock itself is that it requires a smaller initial investment.
E) As the price of a stock falls, the value of a put option on the stock also falls. Ans: E Level: Basic Subject: Options Type: Concepts
42. Which of the following is/are true regarding stock options? I. Buying a call option gives you the right to purchase shares. II. Selling a call option may give you the obligation to sell shares. III. Buying a put option gives you the right to sell shares.
IV. Selling a put option may give you the obligation to buy shares. A) None of the above
B) I and IV only C) II and III only D) I, II, and IV only E) I, II, III, and IV
Ans: E Level: Basic Subject: Options Type: Concepts
43. Based on your research, you believe that the price of Jet-Electro stock will fall by 30% by the end of the year. As a rational investor, you should:
A) Buy calls on Jet-Electro stock. B) Buy warrants on Jet-Electro stock. C) Buy puts on Jet-Electro stock. D) Buy Jet-Electro stock.
E) Buy Jet-Electro convertible bonds.
Ans: C Level: Basic Subject: Option Usage Type: Concepts
44. Based on your research, you believe that Jet-Electro stock will rise by 130% by the end of the year. As a rational investor, you could make money by doing each of the following EXCEPT:
A) Sell calls on Jet-Electro stock. B) Buy warrants on Jet-Electro stock. C) Buy Jet-Electro convertible bonds. D) Sell puts on Jet-Electro stock. E) Buy Jet-Electro stock.
Ans: A Level: Basic Subject: Option Usage Type: Concepts
45. The upper bound on the market value of a call option is the __________ and the lower bound is the ___________________.
A) exercise price; intrinsic value
B) value of the underlying asset; intrinsic value C) exercise price; value of the underlying asset D) value of the underlying asset; exercise price E) value of the risk-free asset; exercise price
Ans: B Level: Basic Subject: Option Pricing Type: Concepts 46. The intrinsic value of a call option is defined as:
A) max [S + X, 0] B) max [X – S, 0] C) min [S – X, 0] D) max [S – X, 0]
47. Which of the following correctly describe the boundary values for an American call option on stock? I. C0 <= S0 II. C0 >= 0 if (S0 – E) < 0 III. C0 >= (S0 + E) if (S0 + E) >= 0 A) I only B) III only C) I and II only D) II and III only E) I, II, and III
Ans: C Level: Basic Subject: Call Options Type: Concepts 48. Which of the following statements is true of American options?
A) The lower bound on the price of a call option on stock is the price of the stock. B) The lower bound on the price of a call option on stock could be zero.
C) To prevent arbitrage, the value of the call today must be less than the stock price minus the exercise price.
D) After expiration, an option on stock will be worth more than the option's intrinsic value. E) The upper bound on the price of a call option is its intrinsic value.
Ans: B Level: Basic Subject: Call Options Type: Concepts
49. All else the same, the value of an American call option decreases __________________. A) with increases in the underlying asset price
B) with decreases in the exercise price C) with decreases in the risk-free interest rate D) the less out-of-the-money the option becomes E) with increases in the time to expiration
Ans: C Level: Basic Subject: Call Options Type: Concepts 50. Which of the following statements is true of American options?
A) The lower the underlying share price, the higher the value of a call option. B) The lower the exercise price, the lower the value of a call option.
C) The longer the time to expiration, the lower the value of a call option. D) The greater the interest rate, the lower the value of a call option.
E) The lower the risk of the underlying security, the lower the value of a call option. Ans: E Level: Basic Subject: Call Options Type: Concepts
51. Which of the following would increase the value of an American call option? I. The exercise price is decreased
II. The value of the underlying asset increases III. The expiration date is extended
IV. The variance of the underlying asset increases A) I and III only
B) II and IV only C) II, III, and IV only D) I, II, and III only E) I, II, III, and IV
52. Which of the following would decrease the value of an American call option? I. The exercise price is decreased
II. The value of the underlying asset decreases III. The expiration date is extended
IV. The variance of the underlying asset decreases A) I and II only
B) I and III only C) I and IV only D) II and III only E) II and IV only
Ans: E Level: Basic Subject: Call Options Type: Concepts
53. Which of the following would unambiguously increase the value of an American put option? I. The exercise price is increased
II. The value of the underlying asset increases III. Market interest rates increase
IV. The variance of the underlying asset decreases A) I only
B) III only C) II and IV only D) I, II, and IV only E) I, II, III, and IV
Ans: A Level: Basic Subject: Put Option Type: Concepts
54. As the variance of the asset price decreases, the value of a call option decreases because A) downside risk is virtually eliminated
B) the possible payoffs increase
C) downside risk is virtually eliminated while the possible payoffs increase D) downside risk doesn't change but the possible payoffs decrease
E) it becomes more likely that the option will finish out of the money Ans: D Level: Basic Subject: Put Option Type: Concepts
55. Which of the following would unambiguously decrease the value of an American put option? I. The exercise price is increased
II. The value of the underlying asset increases III. Market interest rates increase
IV. The variance of the underlying asset increases A) I and II only
B) I and III only C) II and III only D) II and IV only E) I and IV only
56. Because _____________, equity in a leveraged firm can be considered a call option on the firm's assets. A) of the M&M capital structure irrelevance theorem
B) stockholders have unlimited liability for the debts of the firm
C) the possible loss on a share of common stock is limited to the initial investment D) the bondholders can elect to "walk away" leaving the stockholders holding the bag E) call options are more prevalent than put options
Ans: C Level: Basic Subject: Equity As A Call Option Type: Concepts
57. You know for certain that a common share of Mystical Inc., worth $25 today, will be worth $55 one month from now. The stock pays no dividends. Which of the following actions would maximize your return on investment (assuming no transaction costs)?
A) Purchase a call option with a strike price of $55.
B) Purchase warrants on the stock (totaling 100 shares) with a strike price of $35. C) Purchase a put option on the stock with a strike price of $30.
D) Purchase 100 shares of the stock at the current price of $25 per share. E) Purchase a call option on the stock with a strike price of $25. Ans: E Level: Basic Subject: Security Payoffs Type: Concepts 58. Which of the following statements about warrants is true?
A) Warrants are usually issued in conjunction with a security offering. B) Warrants are issued by individuals.
C) Warrant exercise will not increase the number of shares outstanding. D) Warrant exercise will increase earnings per share.
E) Warrants may not be traded separately from the security with which they were issued. Ans: A Level: Basic Subject: Warrants Type: Concepts
59. __________ are frequently offered as a sweetener by firms in combination with private placements of bonds or loans. A) Put options B) Call options C) Warrants D) Call provisions E) Put bonds
Ans: C Level: Basic Subject: Warrants Type: Concepts
60. Which of the following is a characteristic difference between a warrant and a call option? A) A call option will typically have a longer maturity than a warrant.
B) Call options are issued by individuals while warrants are issued by firms. C) Call options can be allowed to expire while warrants cannot.
D) Neither warrants nor call options affect firm value.
E) Unlike warrants, when call options are exercised, the number of shares of stock outstanding increases.
61. Which of the following is true regarding convertible bonds?
A) A convertible bond's value will exceed both the straight bond value and the conversion value unless the firm is in default or bondholders are forced to convert.
B) When a convertible bond is converted into common stock, the company receives cash for the transfer.
C) The floor price of a convertible bond is the greater of the straight bond value or the conversion value. D) The conversion value of a convertible bond is not affected by the value of the firm's underlying
common stock.
E) A distinction of convertible bonds is that the conversion privilege can be separated from the bond and sold by the owner.
Ans: C Level: Basic Subject: Convertible Bonds Type: Concepts
62. The ______________ is the current price of common stock multiplied by the number of shares of common stock that will be received upon conversion of a convertible bond.
A) conversion ratio B) conversion price C) conversion value D) conversion premium E) straight bond value
Ans: C Level: Basic Subject: Conversion Value Type: Concepts 63. Which of the following is true for a firm with positive earnings?
A) When bonds are converted into shares of stock, earnings per share increases. B) When warrants are exercised, earnings per share increases.
C) The number of shares of stock outstanding will decrease with either convertible bonds or warrants. D) Exercise of warrants and conversion of bonds will always result in a decrease in the price of the
stock.
E) Fully diluted earnings per share with either warrants or convertible bonds will be lower than earnings per share based only on shares presently outstanding.
Ans: E Level: Basic Subject: Convertible Bonds Type: Concepts
64. Which of the following present(s) an arbitrage opportunity? (Assume no transaction costs and any option can be exercised immediately. )
I. A warrant sells for $2 and allows you to buy a share of stock for $5; the current market price of the stock is $6.
II. A American call option, with an exercise price of $5, sells for $2; the stock price is $8. III. A American put option, with an exercise price of $15, sells for $7.50; the stock price is $6. IV. The conversion value of a convertible bond is $750 and the bond sells for $700.
A) I only B) II and III only C) III and IV only D) II, III, and IV only E) I, II, III, and IV
65. ______________ gives a firm the option to retire its bonds early. A) An issue of put bonds
B) A green shoe provision in the bond indenture C) A loan guarantee in the bond indenture D) A conversion privilege
E) A call provision in the bond indenture
Ans: E Level: Basic Subject: Call Provision Type: Concepts 66. Which of the following statements is correct?
A) A callable bond allows the owner to force the issuer to repurchase the bond during some fixed time period.
B) Equity in a leveraged firm is effectively a put option on the firm's assets. C) A warrant is similar to insurance.
D) A loan guaranty is similar to a call option.
E) An overallotment option is effectively a call option granted to the underwriter. Ans: E Level: Basic Subject: Implicit Options Type: Concepts
67. Which of the following securities or agreements include an implicit call option? I. Overallotment provisions
II. Convertible preferred stock III. Loan guarantees
IV. Warrants A) I and II only B) I and III only C) II and IV only D) II and III only E) I, II, and IV only
Ans: E Level: Basic Subject: Other Options Type: Concepts
68. Which of the following would decrease the value of a call option, according to the Black-Scholes model? I. The exercise price is increased
II. The risk-free rate increases III. The expiration date is extended
IV. The variance of the underlying asset decreases A) I only
B) I and III only C) I and IV only D) II and III only E) II and IV only
69. Which of the following statements are correct?
I. The strike price is the price the owner of a call pays per share to purchase shares of stock. II. The expiration date is the only date the owner of a European option can exercise the option. III. Warrants generally have longer maturity dates than options.
IV. The seller of a put agrees to purchase shares of stock if the option is exercised. A) I and II only
B) II and IV only C) I, II, and III only D) I, II, and IV only E) I, II, III, and IV
Ans: E Level: Easy Subject: Option Basics Type: Concepts
70. Lucie wants to have the option to buy 1,000 shares of stock at a set price any time up to a given date. Lucie should purchase: A) 10 calls. B) 100 calls. C) 1,000 calls. D) 100 puts. E) 1,000 puts.
Ans: A Level: Easy Subject: Call Option Type: Concepts
71. Martin owns 15,000 shares of stock that he wants to sell sometime within the next three months. Shares of this stock are currently selling for $43.24. The stock has been increasing in price but Martin is concerned the price might start to fall. He is not yet willing to sell his shares just in case the price rises some more. To guarantee that he can receive at least $42.50 a share when he does sell, Martin could purchase _____ with a strike price of $42.50. A) 1,500 warrants B) 150 calls C) 15,000 puts D) 1,500 puts E) 150 puts
Ans: E Level: Intermediate Subject: Put Option Type: Concepts 72. Sue just sold 1,500 American calls. This transaction:
A) Gives Sue the right to sell 1,500 shares at any time prior to the option expiration. B) Grants Sue the right to buy 150,000 shares at any time prior to the option expiration. C) Obligates Sue to buy 15,000 shares if the option is exercised prior to expiration.
D) Provides Sue the right to sell 150,000 shares of stock on the expiration date if she so chooses. E) Obligates Sue to sell 150,000 shares if the option is exercised by the expiration date.
73. An increase in which of the following will increase the value of a call option? I. Underlying stock price
II. Exercise price III. Time to expiration
IV. Variance of the return on the underlying asset A) III and IV only
B) I and III only C) II and IV only D) I, III, and IV E) I, II, III, and IV
Ans: D Level: Intermediate Subject: Call Value Type: Concepts 74. A decrease in which of the following will increase the value of a put option?
I. Exercise price II. Time to expiration
III. Variance of return of the underlying asset IV. Current value of the underlying security A) I only
B) IV only C) II and III only D) I and IV only E) I, II, and III only
Ans: B Level: Intermediate Subject: Put Value Type: Concepts
75. Which two of the following correctly identify the value of a call option at expiration? I. C1 = 0 if S1 - E 0
II. C1 = 0 if S1 - E >0
III. C1 = S1 - E if S1 - E > 0
IV. C1 = S1 - E if S1 - E 0
A) I and III only B) I and IV only C) II and III only D) II and IV only E) I and II only
Ans: A Level: Intermediate Subject: Expiration Value Type: Concepts
76. Which one of the following is the correct expression of the lower bound of a call option price prior to option maturity?
A) C0 = S0
B) C0 = S1 – S0
C) C0 is equal to the lesser of S1 or S0.
D) C0 is equal to the greater of (S0 – E) or zero.
E) C0 is equal to the lesser of (S0 – E) or zero.
77. The value of a call option that is expected to expire in the money can be expressed as: A) C0 = E – S0 /(1 + Rf)t. B) C0 = S0 – E/(1 + Rf)t. C) C0 = ( S/C)(C0) + S0/(1 + Rf)t. D) C0 = (S/C)(C0) – E/(1 + Rf)t. E) C0 = E – S1.
Ans: B Level: Intermediate Subject: In-The-Money Option Value Type: Concepts
78. Last week, Alfonso purchased a three-month put option on shares of DOG stock. This week DOG shares declined in price and the rate on the Canadian Treasury bill also declined. As a result of these two events, with all else constant, the value of Alfonso's options:
A) Increased in value as a result of both events. B) Decreased in value as a result of both events.
C) Increased in value due to the decline in the market value of DOG stock but was unaffected by the change in the Treasury bill rate.
D) Decreased in value due to the decline in the market value of DOG stock but increased in value from the change in the Treasury bill rate.
E) Changed in value but the direction of the change cannot be determined from the information provided.
Ans: A Level: Intermediate Subject: Option Value Type: Concepts 79. Which one of the following should decrease the value of a call option?
A) Increasing the volatility of the overall stock market
B) Increasing the range of expected returns on an underlying security C) Increasing the time period until the option expires
D) Decreasing the exercise price of the call option E) Decreasing the market value of the underlying security
Ans: E Level: Intermediate Subject: Option Value Type: Concepts
80. Fred paid $.60 to buy a put option with a $20 strike price. Edith paid $.90 to buy a put option with a $20 strike price. Fred's option is on ABC stock, which has a 52-week price range of $12 to $42. His option expires in three months. Edith's option is on XYZ stock with a 52-week price range of $14 to $21. Her option expires in six months. Which one of the following statements concerning these two options is correct assuming the underlying securities remain within their 52-week ranges?
A) Fred's option has more value than Edith's option based on the time-to-maturity.
B) Edith's option has more value than Fred's based on the variance of the underlying securities. C) Both options are certain to expire in the money.
D) If the price of XYZ stock hits its 52-week high, Edith will make a net profit of $0.10 per share. E) The maximum net profit per share than Fred can earn is $7.40.
81. When employee stock options are issued they are usually priced: A) At 10% above the market value of stock.
B) At an intrinsic value of $10. C) At the money.
D) Such that they will not go “underwater”.
E) So that they can be exercised immediately at a profit.
Ans: C Level: Intermediate Subject: Employee Stock Options Type: Concepts 82. Which of the following are true statements concerning employee stock options (ESOs)?
I. ESOs may have a vesting period of up to three years.
II. The employee may not be allowed to sell or exercise their ESOs for a period of time.
III. ESOs generally provide a guarantee that the option will be in the money prior to the expiration date. IV. ESOs generally contain a guarantee that the option will be restruck if it goes underwater.
A) I and II only B) II and IV only C) II and III only D) I, II, and IV only E) I, II, III, and IV
Ans: A Level: Intermediate Subject: Employee Stock Option Type: Concepts 83. Which of the following are correct statements concerning warrants?
I. Warrants are used to attract lenders.
II. When a warrant is exercised the earnings per share of a corporation decreases. III. Warrants can be a source of cash for a firm.
IV. A warrant is a long-term option agreement between two stockholders. A) I and II only
B) I and III only C) II and III only D) II, III, and IV only E) I, II, and III only
Ans: E Level: Intermediate Subject: Warrants Type: Concepts 84. The conversion premium for a convertible bond is computed using the formula:
A) (Current price – conversion price) / conversion price. B) (Conversion price – current price) / conversion price. C) (Current price – conversion price) / current price. D) (Conversion price - current price) / current price.
Ans: D Level: Easy Subject: Conversion Premium Type: Concepts 85. The minimum floor value of a convertible bond:
A) Is the greater of the bond's face value or the conversion value. B) Is always less than the conversion value of the bond.
C) Is equal to the straight bond value of the security.
D) Is the greater of the straight bond value or the conversion value. E) Is equal to the conversion value of the security.
86. A firm which issues put bonds is agreeing to:
A) Sell the bonds at a specific price for a specific period of time.
B) Borrow money under the condition that it can be repaid at a set price for a set period of time. C) Pay a set amount of money for a set period of time in exchange for converting the bonds into stock. D) Borrow money now and give the holder the option to lend more money at a set rate for a set period
of time.
E) Issue bonds that can be converted into equity at the option of the bondholder. Ans: B Level: Intermediate Subject: Put Bond Type: Concepts
87. The slope of the conversion value line for a convertible bond is equal to the: A) Conversion ratio.
B) Conversion premium. C) Straight bond value. D) Option value. E) Put value.
Ans: A Level: Intermediate Subject: Conversion Value Type: Concepts 88. Which of the following are factors that determine the value of an option?
I. The risk-free rate of return II. The underlying stock price III. The time to expiration IV. The strike price A) II and IV only B) I, II, and IV only C) II, III, and IV only D) I, II, and III only E) I, II, III, and IV
Ans: E Level: Intermediate Subject: Option Values Type: Concepts 89. Which one of the following statements concerning European options is correct?
A) A European call can be exercised at any time up to and including the expiration date. B) A European call is more valuable than an American call based on its characteristics. C) A European option has value only if it is in the money at expiration.
D) The value of a European call cannot be computed using the Black-Scholes model. E) The put-call parity relationship can NOT be applied to European calls.
Ans: C Level: Basic Subject: European Options Type: Concepts 90. Which one of the following will decrease the value of a put option?
A) An increase in the price of the stock B) An increase in the strike price
C) An increase in the standard deviation of the return on the stock D) A decrease in the risk-free rate of return
91. The Black-Scholes Option Pricing Model as it pertains to calls is based on: I. American style puts.
II. European options.
III. The stock price, strike price, time to maturity, standard deviation of the stock, and the price of the put.
IV. The formula C = [S][N(d1)]-[E][N(d2)]/(1+Rf)t for non-dividend paying stocks with European options.
A) I and III only B) I and IV only C) II and III only D) II and IV only E) II, III, and IV only
Ans: D Level: Intermediate Subject: Black-Scholes Option Pricing Model Type: Concepts 92. Which of the following will increase the value of a call option?
I. An increase in the T-bill rate
II. An increase in the time to expiration III. A decrease in the strike price
IV. A decrease in the standard deviation of the return on the stock A) I and II only
B) I and III only C) II and IV only D) I, II, and III only E) II, III, and IV only
Ans: D Level: Intermediate Subject: Call Options Type: Concepts 93. The seller of an American call has the:
A) Right, but not the obligation, to buy an asset at the strike price on or before the expiration date. B) Right, but not the obligation, to buy an asset only on the expiration date.
C) Right, if they so choose, to sell an asset at the strike price on of before the expiration date. D) Obligation to sell an asset on or before the expiration date, if the buyer exercises the option. E) Obligation to sell an asset at the strike price on the expiration date.
Ans: D Level: Intermediate Subject: American Call Type: Concepts 94. The buyer of a European put has the:
A) Obligation to buy an asset at the strike price on the expiration date.
B) Obligation to sell an asset on or before the expiration date if requested to do so. C) Right, but not the obligation, to sell an asset at the strike price on the expiration date.
D) Right, but not the obligation, to buy an asset at any time up to and including the expiration date. E) Right, but not the obligation, to sell an asset at the strike price at any time up to and including the
expiration date.
95. The value of a risk-free bond can be duplicated by combining a risky bond with a _____ option on the assets of the firm with a _______ maturity date and a strike price _____ to the face value of the bond. A) Put; matching; equal to
B) Call; matching; equal to C) Put; later; lower than D) Call; later; equal to E) Put; shorter; greater than
Ans: A Level: Challenge Subject: Value Of Risk-Free Bond Type: Concepts
96. A firm has a zero-coupon bond issue outstanding with a face value of $12 million, a current market value of $8 million, and a maturity date of 5 years. The risk-free rate of return is 4%. The equity in this firm is a: A) Put option with an exercise value of ($8 million)(e-.04(5)).
B) Put option with an exercise value of ($12 million)(e-.04(5)).
C) Put option with an exercise value of $8 million. D) Call option with a strike price of $12 million. E) Call option with a strike price of $8 million.
Ans: D Level: Intermediate Subject: Equity As A Call Option Type: Concepts 97. The value of a call option:
A) Decreases as the price of the underlying security increases.
B) Has a greater reaction to a change in the time to maturity than does a put option. C) Increases as the risk-free rate of return decreases.
D) Increases as the price fluctuation of the underlying security increases. E) Decreases as the time to expiration increases.
Ans: D Level: Intermediate Subject: Options Type: Concepts 98. The term N(d2) is:
A) The European put option delta. B) The European call option delta.
C) The probability of a value that is less than or equal to d2, given a standardized normally distributed
random variable.
D) The probability of a value that is greater than or equal to N(d1), given a standardized normally
distributed random variable.
E) The symbol for the measure of sensitivity of an option's value to a change in the time to expiration. Ans: C Level: Intermediate Subject: N(d2) Type: Concepts
99. A stock has a call with a strike price of $25 that expires four days from now. The current price of the stock is $23.50. Suppose the expected prices over the next fours days are $25.25, $24.50, $25.60, and $24.75, respectively. Which one of the following statements concerning the call is correct? Ignore the cost of the call and all transaction costs.
A) If the call is a European call, the maximum profit to be gained on the call is $1.60. B) If the call is an American call, the maximum profit to be gained on the call is $.25. C) If the call is a European call, then the call will never be exercised.
100. Assume the following American call option will finish in-the-money: the exercise price is $75, maturity is one year, current stock price is $72.50, and the risk-free interest rate is 6%. What is the value of the call option? A) –$6.60 B) $0.00 C) $1.75 D) $2.15 E) $2.65
Ans: C Level: Basic Subject: Call Value Type: Problems
101. A firm has stock outstanding with a current price of $35 per share. The price in one period is expected to be either $40 or $48. A call option on ONE share is available with an exercise price of $30. If the risk-free rate of interest is 6%, what would you pay for the call option?
A) $6.29 B) $6.50 C) $6.70 D) $7.09 E) $7.27
Ans: C Level: Basic Subject: Valuing A Call Type: Problems
102. You are evaluating a call option with an exercise price of $140. The underlying stock has possible prices of $135 or $160 when the option expires. If the risk-free rate is 6%, how many options do you need to buy along with the risk-free asset to replicate the stock?
A) 0.80 calls B) 1.00 calls C) 1.25 calls D) 1.75 calls E) 2.25 calls
Ans: C Level: Basic Subject: Calls Needed To Replicate Stock Type: Problems
103. Suppose a firm has a current market value of $900 and outstanding debt with a face value of $850. The risk-free rate of interest is 6%. If the firm will have a value of either $650 or $900 next period, what is the value of the equity in the firm?
A) $0.00 B) $53.70 C) $57.36 D) $67.41 E) $89.65
104. The current value of a firm is $1,400. The firm has $1,000 in pure discount debt due in one year and the risk-free rate is 6%. The firm's assets will be worth either $1,200 or $1,500 in one year. What is the current value of the firm's equity?
A) $318
B) $421
C) $457
D) $943
E) $1,400
Ans: C Level: Basic Subject: Equity As A Call Option Type: Problems
105. John and Randy form a company with assets worth $900. They each have four shares of stock. Randy gives Cheri a call option on one share of stock. The option has an exercise price of $100 and expires in one year. In one year, the firm's assets are worth $1,000 and Cheri exercises the option. What is the intrinsic value of the option at maturity?
A) $0
B) $25
C) $50
D) $150
E) $200
Ans: B Level: Basic Subject: Equity As A Call Option Type: Problems
106. Suppose a firm has a total market value of $900 and outstanding debt with a face value of $850. The risk-free rate of interest is 6%. If the firm will have a value of either $650 or $900 next period, what is the value of the debt in the firm?
A) $782.59 B) $788.92 C) $792.64 D) $800.00 E) $842.64
Ans: E Level: Basic Subject: Value Of Debt Type: Problems
107. The current value of a firm is $1,400. The firm has $1,000 in pure discount debt due in one year and the risk-free rate is 6%. The firm's assets will be worth either $1,200 or $1,500 in one year. What is the current value of the firm's debt?
A) $318
B) $421
C) $457
D) $943
E) $1,400
108. Suppose a firm has a total market value of $900 and outstanding debt with a face value of $850. The risk-free rate of interest is 6%. If the firm will have a value of either $650 or $900 next period, what is the rate of return on the firm's debt? (Assume the bond makes no coupon payments during this time period. )
A) 0.9%
B) 6.7%
C) 7.2%
D) 7.8%
E) 8.1%
Ans: A Level: Basic Subject: Return On Debt Type: Problems
109. The current value of a firm is $1,400. The firm has $1,000 in pure discount debt due in one year and the risk-free rate is 6%. The firm's assets will be worth either $1,200 or $1,500 in one year. What is the interest rate on the debt?
A) 6.0%
B) 7.0%
C) 7.5%
D) 11.0%
E) 13.0%
Ans: A Level: Basic Subject: Return On Debt Type: Problems
110. Suppose an all-equity firm has a value of $10,000 and 100 shares outstanding. The firm has issued 25 warrants, each of which may be exchanged for one share. The warrants have an exercise price of $75. If the firm will be worth $9,800 in one period (before exercise), what will the price of the shares be assuming the warrants are exercised?
A) $88.20 B) $91.60 C) $93.40 D) $96.00 E) $98.40
Ans: C Level: Basic Subject: Firm Value With Warrants Type: Problems
111. John and Randy form a company with assets worth $900. They each have two shares of stock. The firm sells Cheri a warrant for one share of stock. The warrant has an exercise price of $200 and expires in one year. In one year, the firm's assets are worth $1,200 immediately before expiration of the warrant. Should Cheri exercise the warrant?
A) No, because the option is out of the money. B) Yes, because she stands to gain $40 by exercising. C) Yes, because she stands to gain $80 by exercising. D) Yes, because she stands to gain $100 by exercising.
E) We can't tell without knowing what she paid for the warrant. Ans: C Level: Basic Subject: Warrants Type: Problems
112. The bonds of VDM, Inc. are convertible into shares of the firm's common stock at $50 per share. The current price of the common stock is $45 per share. The bonds have a $1,000 par value and currently sell for $950 apiece. What is the conversion price of these bonds?
A) $22
B) $45
C) $50
D) $55
E) $100
Ans: C Level: Basic Subject: Conversion Price Type: Problems
113. The bonds of VDM, Inc. are convertible into shares of the firm's common stock at $50 per share. The current price of the common stock is $45 per share. The bonds have a $1,000 par value and currently sell for $950 apiece. What is the conversion ratio of these bonds?
A) 20
B) 22
C) 25
D) 45
E) 50
Ans: A Level: Basic Subject: Conversion Ratio Type: Problems
114. The bonds of VDM, Inc. are convertible into shares of the firm's common stock at $50 per share. The current price of the common stock is $45 per share. The bonds have a $1,000 par value and currently sell for $950 apiece. When the bonds were issued, the market price of the common stock was $40. Thus, what was the conversion premium at issuance?
A) 10%
B) 11%
C) 20%
D) 25%
E) 33%
Ans: D Level: Basic Subject: Conversion Premium Type: Problems
115. The bonds of VDM, Inc. are convertible into shares of the firm's common stock at $50 per share. The current price of the common stock is $45 per share. The bonds have a $1,000 par value and currently sell for $950 apiece. When the bonds were issued, the market price of the common stock was $40. What is the conversion value of these bonds?
A) $ 800 B) $ 875 C) $ 900 D) $ 950 E) $1,000
116. Suppose you are evaluating a bond that can be exchanged for shares of the issuing company's stock at a conversion price of $5 per share. The bond has a $50 annual coupon, five years to maturity, and straight debt of the same risk is priced to yield 8%. The current share price for the issuing firm is $4.50. What is the minimum value for which the bond should sell?
A) $848.37 B) $880.22 C) $900.00 D) $921.12 E) $1,000.00
Ans: C Level: Basic Subject: Convertible Bond Value Type: Problems 117. If d1 = –1.52 in the Black-Scholes formula, what is the value for N(d1)?
A) –0.9357 B) –0.0643 C) 0.1985 D) 0.0643 E) 0.9357
Ans: D Level: Intermediate Subject: Appendix: Cumulative Normal Distribution Type: Problems 118. Given that d1 = 1.50 in the Black-Scholes formula, the time to expiration of a call option is two months, the
risk-free rate is 6% per year, and the standard deviation of returns on the shares underlying the call option is 20%. What is the value of d2 if the exercise price is $28 and the stock price is $31.23?
A) 1.42
B) 1.48
C) 1.50
D) 1.58
Ans: A Level: Intermediate Subject: Appendix: Black-Scholes Valuation Type: Problems
119. Given that d1 = 1.50 in the Black-Scholes formula, the time to expiration of a call option is two months, the
risk-free rate is 6% per year, and the standard deviation of returns on the shares underlying the call option is 20%. What is the value of the call if its exercise price is $28 and the stock price is $31.23?
A) $3.13 B) $3.27 C) $3.40 D) $3.57 E) $4.94
Ans: D Level: Intermediate Subject: Appendix: Black-Scholes Valuation Type: Problems 120. Determine the value of the following call option using the Black-Scholes formula:
Current stock price: $105
Exercise price: $100
Risk-free rate: 0.5% per month
Standard deviation: 2.0% per month
A) $7.50 B) $7.95 C) $8.82 D) $9.02 E) $9.10
Ans: E Level: Intermediate Subject: Appendix: Black-Scholes Valuation Type: Problems 121. Determine the value of the following call option using the Black-Scholes formula:
Current stock price: $18
Exercise price: $18
Risk-free rate: 6% per month
Standard deviation: 2.0% per month
Time to expiration: four months
A) $0.53 B) $0.55 C) $0.82 D) $1.07 E) $2.41
Ans: B Level: Intermediate Subject: Appendix: Black-Scholes Valuation Type: Problems Use the following to answer questions 122-129:
Share value Call Put
Option Strike Exp. Vol. Last Vol. Last
OutTel 20.0 Jan. 101 6 69 1
25 20.0 Feb. 79 7 54 2
25 22.5 Mar. 65 5 40 4
122. You want to purchase one February call option contract on the stock. The contract with a $20 exercise price will cost you ________. (Ignore transactions costs.)
A) $100
B) $200
C) $500
D) $600
E) $700
Ans: E Level: Basic Subject: Option Quote Type: Problems 123. What is the market value per share of the March call?
A) $4
B) $5
C) $6
D) $7
124. What is the intrinsic value per share of the January call? A) $0.00 B) $1.00 C) $5.00 D) $6.00 E) $7.00
Ans: C Level: Basic Subject: Option Quote Type: Problems 125. What is the time value per share of the January call?
A) $0.00 B) $1.00 C) $5.00 D) $6.00 E) $7.00
Ans: B Level: Basic Subject: Option Quote Type: Problems 126. What is the market value per share of the March put?
A) $1.00 B) $2.00 C) $4.00 D) $5.00 E) $6.00
Ans: C Level: Basic Subject: Option Quote Type: Problems 127. What is the intrinsic value per share of the March put?
A) $0.00 B) $1.00 C) $1.50 D) $2.00 E) $4.00
Ans: A Level: Basic Subject: Option Quote Type: Problems 128. What is the time value per share of the March put?
A) $0.00 B) $1.00 C) $1.50 D) $2.00 E) $4.00
129. Which of the options shown in the quotes are in-the-money? I. The January 20 call
II. The February 20 call III. The February 20 put IV. The March 22 1/2 put A) I and II only
B) I and III only C) I and IV only D) II and III only E) III and IV only
Ans: A Level: Basic Subject: Option Quote Type: Problems Use the following to answer questions 130-141:
Share value Call Put
Option Strike Exp. Vol. Last Vol. Last
Glaxo 45 Oct. 91 2 7/8 59 7/8 45 7/8 45 Nov. 59 4 3/8 54 2 3/8 45 7/8 47 1/2 Oct. 80 1 22 3 1/8 45 7/8 47 1/2 Nov. 42 2 3/8 20 5 1/4 45 7/8 47 1/2 Feb. 31 5 18 7 45 7/8 50 Oct. 28 3/8 15 7 1/8 45 7/8 50 Nov. 23 2 12 9
130. You want to purchase one October 45 call contract on Glaxo stock. The option contract will cost you _______________. (Ignore transactions costs.)
A) $37.50 B) $100.00 C) $287.50 D) $437.50 E) $900.00
Ans: C Level: Basic Subject: Option Quote Type: Problems 131. What is the market value per share of the November 47 1/2 call?
A) $1.875 B) $2.375 C) $2.875 D) $4.375 E) $7.000
132. What is the intrinsic value per share of the November 45 call? A) $0.875 B) $2.875 C) $3.875 D) $4.375 E) $4.500
Ans: A Level: Basic Subject: Option Quote Type: Problems 133. What is the time value per share of the November 45 call?
A) $0.875 B) $3.500 C) $3.875 D) $4.375 E) $5.250
Ans: B Level: Basic Subject: Option Quote Type: Problems 134. What is the market value per share of the November 45 put?
A) $1.875 B) $2.375 C) $2.875 D) $4.375 E) $7.000
Ans: B Level: Basic Subject: Option Quote Type: Problems 135. What is the intrinsic value per share of the November 45 put?
A) $0.000 B) $0.875 C) $1.500 D) $3.250 E) $4.500
Ans: A Level: Basic Subject: Option Quote Type: Problems 136. What is the time value per share of the February 47 1/2 put?
A) $0.000 B) $3.875 C) $5.375 D) $7.000 E) $8.625
137. Which of the options shown in the quote are in-the-money? I. The October 45 call
II. The November 50 call III. The October 45 put IV. The November 47 1/2 put A) I and II only
B) II and III only C) I and IV only D) III only E) III and IV only
Ans: C Level: Basic Subject: Option Quote Type: Problems
138. What option would you buy if you want to have the right to sell 100 shares of Glaxo stock on or before the 3rd Friday in October for $45 per share?
A) Oct 45 call B) Oct 47 1/2 call C) Oct 50 put D) Oct 45 put E) Nov 47 1/2 put
Ans: D Level: Basic Subject: Option Listing Type: Problems
139. How much would you pay for the right to buy 100 shares of Glaxo stock for $47.50 on or before the 3rd Friday in February? A) $150.00 B) $237.50 C) $500.00 D) $587.50 E) $700.00
Ans: C Level: Basic Subject: Option Listing And Prices Type: Problems
140. Suppose you bought 10 Glaxo Oct 45 call contracts. Just before the option expires, the stock is selling for $50. What is your net profit (or loss)? Ignore transaction costs.
A) –$212.50 B) $1,275.00 C) $1,625.00 D) $2,125.00 E) $5,000.00
Ans: D Level: Basic Subject: Option Payoffs Type: Problems
141. Suppose you bought 10 Glaxo Nov 50 put contracts. Just before the option expires, the stock is selling for $55. What is your net profit (or loss)? Ignore transaction costs.
A) –$14,000.00 B) –$9,000.00 C) –$2,125.00
Use the following to answer questions 142-146:
Maturity: 10 years
Face value: $1,000
Conversion price: $65
Stock price at issue: $45
Annual coupon: $80
YTM on similar nonconvertibles: 7.5%
142. What is the conversion ratio? A) 9.8
B) 12.3
C) 15.4
D) 16.7
E) 22.2
Ans: C Level: Basic Subject: Conversion Ratio Type: Problems 143. What was the conversion premium at issuance?
A) 16.67%
B) 30.80%
C) 33.33%
D) 38.25%
E) 44.44%
Ans: E Level: Basic Subject: Conversion Premium Type: Problems 144. What is the straight bond value?
A) $778.43 B) $867.39 C) $939.00 D) $983.64 E) $1,034.32
Ans: E Level: Basic Subject: Straight Bond Value Type: Problems 145. What is the conversion value if the current stock price is $69.50?
A) $778.43 B) $867.39 C) $939.00 D) $1,034.32 E) $1,070.30
146. What is the minimum value of this bond if the current stock price is $69.50 per share? A) $778.43 B) $867.39 C) $939.00 D) $1,034.32 E) $1,070.30
Ans: E Level: Basic Subject: Convertible Bond Value Type: Problems
147. ABC stock is currently priced at $31.42 a share. The three-month calls have a strike price of $30.00 and a market price of $2. If Mary purchases the call today and then exercises the option next week, how much will she have spent for each share of stock she purchased?
A) $30.00 B) $30.02 C) $31.42 D) $31.44 E) $32.00
Ans: E Level: Easy Subject: Option Pricing Type: Problems
148. ZXC stock is currently priced at $42.27 a share. The six-month puts are priced at $0.80 and have a $42.50 strike price. Fred owns 1,000 shares of ZXC stock and wants to sell it for the best possible price. Fred should:
A) Buy 10 puts and then exercise them immediately. B) Buy 1 put and then exercise it immediately. C) Sell 10 puts and then exercise them immediately. D) Sell 1 put and then exercise it immediately. E) Sell the shares directly at the market price.
Ans: E Level: Easy Subject: Puts Type: Problems
149. Angelina sold 100 puts on a stock at a price of $1.20. The strike price is $20 and the underlying security is priced at $21.00. If the option is exercised, Angelina will:
A) Receive $210,000 in exchange for her shares of stock.
B) Receive a net of $188,000 after considering the cost of the puts. C) Received $2,000 from the stock issuer.
D) Pay a net cost of $188,000 to buy her shares. E) Pay $210,000 when the option is exercised.
Ans: D Level: Intermediate Subject: Put Type: Problems
150. Peter owns ten European DFG 25 calls with an expiration date in September. Peter bought the calls at a price of $1.05. Today the 25 calls are priced at $13.40. Yesterday, June 14th, DFG stock doubled in price to $42.80 a share. Today the stock is selling for $37.30 a share. Peter wants to profit from this sudden price surge before the price falls further. Ignore commissions and trading costs. Peter should:
A) Exercise his option, sell 1,000 shares of DFG stock, and make a profit of $12,300. B) Exercise his option, sell 1,000 shares of DFG stock, and earn a net profit of $11,250. C) Sell his options and earn a net profit of $12,350.
151. Nine months ago, Zena paid $0.62 to purchase one call option on LPK stock. The stock price was $12.89 and the strike price was $13.00 at the time of her purchase. If the options expire out-of-the-money, Zena will:
A) Lose $1,238. B) Lose $62. C) Earn $62. D) Earn $1,238.
E) Cannot be determined from the information provided.
Ans: B Level: Intermediate Subject: Options Type: Problems
152. Shares of a stock are currently priced at $28. The future price is expected to be either $27 or $32. The risk-free rate of return is 5%. What is the value of a twelve-month $25 call option?
A) $3.00 B) $3.19 C) $4.00 D) $4.19 E) $8.19
Ans: D Level: Intermediate Subject: In The Money Call Price Type: Problems
153. A stock currently has a market value of $12.50. The risk-free rate of return is 3%. In one year, the stock is expected to sell for either $11.00 or $17.00. What is the value of a twelve-month call option with a strike price of $10? A) -$4.00 B) $0 C) $1.29 D) $1.82 E) $2.79
Ans: E Level: Intermediate Subject: In The Money Call Price Type: Problems
154. One year from now, a stock is expected to be priced at either $36 or $49. Currently the stock is selling for $38.20 while Treasury bills are yielding 2.5%. What is the value of a twelve-month call option with an exercise price of $40? A) $0 B) $1.44 C) $2.13 D) $3.08 E) $4.45
Ans: C Level: Intermediate Subject: Out Of The Money Call Price Type: Problems
155. Shares of a stock are currently priced at $61. The future price is estimated at either $52 or $62. The risk-free rate of return is 4%. What is the value of a twelve-month call option with a strike price of $55? A) $5.48
B) $6.00 C) $6.19 D) $7.70 E) $12.00
156. Davistown Enterprises has assets currently worth $1,600. In one year the assets will be worth either $1,400 or $1,900. The company has a zero coupon bond issue outstanding with a total face value of $1,200. The bonds are due in one year. The risk-free rate of return is 3%. What is the value of the equity in Davistown Enterprises? A) $0 B) $234.95 C) $400.00 D) $434.95 E) $734.95
Ans: D Level: Intermediate Subject: In The Money Equity Value Type: Problems 157. Mostly Right, Inc. has assets that are currently valued at $1,500. One year from now, the assets are
expected to be worth either $1,300 or $1,900. The company also has a zero coupon bond issue with a face value of $1,400 that is due in one year. The risk-free rate of return is 4%. What is the value of the equity in Mostly Right, Inc.?
A) $0
B) $48.33 C) $166.67 D) $208.33 E) $250.00
Ans: D Level: Intermediate Subject: Out Of The Money Equity Value Type: Problems
158. A $1,000 bond has a conversion value of $80 a share. The common stock is currently selling for $64.90 a share. What is the current conversion value of the bond?
A) $519.20 B) $662.25 C) $811.25 D) $1,000.00 E) $1,232.67
Ans: C Level: Intermediate Subject: Conversion Value Type: Problems
159. A $1,000 face value 7% convertible bond pays interest semi-annually and has a maturity date of five years. The conversion price is $40. The market yield on nonconvertible debentures of comparable quality is 8%. The market price of the common stock is $38.50 currently. What is the minimum price at which the convertible bond should sell?
A) $948.26 B) $959.44 C) $962.50 D) $1,000.00 E) $1,037.50
160. A 6% convertible bond has a face value of $1,000 and a 6-year maturity. The conversion ratio is 13. Nonconvertible bonds with comparable risk are yielding 7%. The common stock is selling at $76 a share. What is the value of the conversion premium?
A) 3.59%
B) 3.61%
C) 3.68%
D) 3.75%
E) 3.83%
Ans: D Level: Intermediate Subject: Conversion Premium Type: Problems
161. A $1,000 semi-annual convertible bond has a 4% coupon rate, a conversion ratio of 20, and five years to maturity. The common stock has a market price of $45. The relevant discount rate is 7%. What is the floor value of the convertible bond?
A) $708.92 B) $875.25 C) $900.00 D) $1,000.00 E) $1,124.75
Ans: C Level: Intermediate Subject: Floor Value Type: Problems
162. A $1,000 convertible bond has a discount rate of 6%. The bond pays interest annually and has 10 years to maturity. The common stock is currently selling for $18 a share. The conversion premium is 5%. What is the conversion price?
A) $17.10 B) $17.55 C) $17.90 D) $18.90 E) $18.95
Ans: D Level: Intermediate Subject: Conversion Price Type: Problems
163. A $1,000 5% annual coupon convertible bond is currently valued at $1,050. The discount rate is 5%. The conversion rate is 20. If the price of the common stock rises by $2, what is the amount of the change in the floor value of the bond?
A) $20
B) $30
C) $40
D) $50
E) $100
164. Suppose you look in the newspaper and see IBM trading at $250 per share. Calls on IBM with one month to expiration and an exercise price of $245 are trading at $6.50 each. Puts on IBM with one month to expiration and an exercise price of $255 are trading at $3.50 each. Are these prices reasonable? Explain. (Ignore transactions costs. )
Ans: The calls are okay since the intrinsic value of each is $5 and the calls are trading at a price greater than this. However, the intrinsic value of the puts is $5 but the put is trading at $3.50. Thus, you could engage in arbitrage by buying puts for $3.50 each, exercising and selling the shares at the exercise price of $255, and purchase shares to cover the sale in the market at $250 each, netting a profit of $150 per contract.
Level: Intermediate Subject: Option Quotes & Arbitrage Type: Essays
165. Suppose IBM is priced at $225 a share and a call with an exercise price of $250 and two months to expiration costs $0.125 per contract. Why do you suppose investors would be willing to purchase a call so far out-of-the-money?
Ans: Students are basically expected to discuss the impact of time to maturity on option values. They should point out, at a minimum, that with two months left to maturity, there is a chance that the option could finish in-the-money. More astute students will point out that even though investors may be willing to purchase the option, the price of the option is very low, that is, investors aren't terribly confident the price will rise that far.
Level: Basic Subject: Out Of The Money Calls Type: Essays
166. Suppose your wealthy Aunt Minnie has asked you to manage her large stock portfolio. You would like to buy and/or sell options on many of the stocks she owns. Describe the types of options you would buy or sell, as well as your rationale, given the following circumstances:
(a) Aunt Minnie owns 10,000 shares of IBM common stock. You believe it is going to fall in price, but she won't let you sell it because her late husband told her never to let it go. How do you protect her from the impending price decline?
(b) Your analysis suggests that the common stock of Jet-Electro is poised to increase in value sharply over the next year. Aunt Minnie doesn't want to buy any of the stock, but does want you to use options to profit if the price rises. What do you do?
(c) Although Aunt Minnie doesn't want you sell any of the stocks she owns, she would like you to use options to generate a little extra income. How might you do this?
Ans: (a) To profit from an expected price decline, you can offset your loss (assuming you don't wish to simply sell the stock) by either buying puts or selling (writing) calls on the stock. In this case, you would probably buy puts (and sell them before expiration) because writing calls exposes Aunt Minnie to potentially unlimited losses.
(b) In this case, the obvious solution is to buy calls and hope to sell them at a higher price later. You could also write puts, but Aunt Minnie would be forced to buy shares if you are wrong about the direction of the price change.
(c) One could sell puts on some of the stock she owns. (As noted above, writing calls would expose her to the risk that some of her stocks would be sold.)
167. What are the upper and lower bounds for an American call option? Explain what would happen in each case if the bound was violated.
Ans: The upper bound on a call is the stock price. If the call price exceeded the stock price, you would be paying more for the option to buy an asset than the asset itself costs. The lower bounds are: C >= 0 if S – E < 0 and C >= (S – E) if (S – E) >= 0. In the first case, if the call exercise price exceeds the stock price, the call is out-of-the-money and it will either be worthless or have some time value. In the second case, if the call is in-the-money, the call must be worth at least the difference between the asset's value and the exercise price. If the call was worth less than this value, rational investors would purchase calls, immediately exercise them, and then sell the stock at the current price, completing an arbitrage.
Level: Intermediate Subject: Option Pricing Bounds Type: Essays
168. List the five factors that the value of any option depends on. Briefly explain the direction of the impact and the rationale behind each as they relate to call options.
Ans: The factors are time to expiration (+), cost of the underlying asset (+), exercise price (–), risk free rate of interest (+), and volatility of the underlying asset's value (+). The rationale is
straightforward.
Level: Basic Subject: Option Price Sensitivity Type: Essays
169. Explain the rationale behind the statement that equity is a call option on the firm's assets. When would a shareholder allow the call to expire?
Ans: The analogy only works for leveraged firms. At maturity of the firm's debt, the stockholders have the option to either pay the bondholders the par value of their debt or turn the firm's assets over to them. If the firm's assets are worth less than the par value of the debt, the stockholders will not exercise their call, that is, they will let the bondholders have the assets and the firm will be liquidated.
Level: Basic Subject: Equity As A Call Option On Assets Type: Essays
170. Consider a firm that has an issue of convertible bonds outstanding. The bonds have an annual coupon rate of 8%, a face value of $1,000, and 20 years to maturity. The firm's stock price was $50 when the bonds were issued and the conversion premium was 20%. The current stock price is $55. Compute the conversion price, conversion ratio, and conversion value. Also determine the yield on similar straight bonds at which the conversion value would equal the straight bond value.
Ans: Conversion price = .250 + 50 = $60
Conversion ratio = 1,000/60 = 16.67 shares Conversion value = 16.6755 = $916.85 Break-even YTM = 8.9%
