Deck 23: Options

Question 1

Warrants do not expire.

Answer 1

False

Question 2

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

Answer 2

False

Question 3

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.

Answer 3

True

Question 4

The lower limit on a call option's value is equal to the greater of zero or the exercise price minus the stock price.

Question 5

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

Question 6

A call option is worthless if the underlying stock is worthless.

Question 7

The value of a call option increases as the exercise price decreases.

Question 8

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

Question 9

A strategy of buying the stock and selling the put is called a protective put.

Question 10

The Financial Accounting Standards Board (FASB)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 11

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

Question 12

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

Question 13

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

Question 14

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

Question 15

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

Question 16

Stock price volatility is beneficial to option holders.

Question 17

Unlike call options,the option to abandon a real asset can never be more valuable as time to expiration increases.

Question 18

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

Question 19

The VIX is an estimate of expected future market volatility.

Question 20

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

Question 21

An investor purchased a share of stock for $42 and at the same time paid $2 to purchase a put option on the stock with an exercise price of $40.What is her profit if the stock is worth $30 at expiration?

A) $6
B) −$6
C) −$4
D) $4

Question 22

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

A) −$5
B) −$2
C) $3
D) $8

Question 23

The writer of a call option hopes that the stock price will:

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

Question 24

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

Question 25

Which one of the following option traders receives the price of the option?

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

Question 26

When the stock price is very high compared with the exercise price,the value of the call option approximates the difference between the stock price and the present value of the exercise price.

Question 27

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

Question 28

If you own a call and a put on a stock with the same exercise price and exercise date,your payoffs:

A) will be positive only if the stock price rises.
B) will be positive only if the stock price declines.
C) will always be positive and will increase with the size of the stock price change.
D) will always be positive but will be larger if the stock price is relatively stable.

Question 29

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

Question 30

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

Question 31

The floor of a convertible bond is the value of the underlying bond.

Question 32

A protective put is a way to eliminate the downside risk of holding stock.

Question 33

Which combination of positions will 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 34

An increase in which one of the following will reduce the value of a call option?

A) Interest rate
B) Time to expiration
C) Volatility of stock price
D) Exercise price

Question 35

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

Question 36

Which one of the following is true for an investor who purchased a share of stock for $45 and purchased a put option on the stock with an exercise price of $45?

A) The investor profits when the stock decreases in value.
B) The minimum payoff on the position is $45.
C) The investor is protected against upside potential.
D) Increases in the value of the stock will go to the seller of the put.

Question 37

What is the difference between an American call option and a European call option?

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 38

Adding warrants as a "sweetener" to bonds will:

A) reduce the value of the bond.
B) increase the coupon rate of the bond.
C) increase the value of the package.
D) make the bond riskier.

Question 39

The maximum possible payoff to the owner of a put options is:

A) the stock price.
B) the exercise price minus the stock price.
C) the option's exercise price.
D) there is no maximum.

Question 40

Which one 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 option price exceeds the exercise price.
D) There is no expiration date, unless the option is a European call.

Question 41

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

A) $46
B) $50
C) $52
D) $54

Question 42

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

A) plus the value of the bondholder's call option.
B) minus the value of the bondholder's call option.
C) plus the value of the issuer's call option.
D) minus the value of the issuer's call option.

Question 43

The conversion ratio for a convertible bond equals the:

A) number of interest payments that must be received prior to conversion.
B) number of bonds necessary to convert into one share of stock.
C) number of shares of stock that can be exchanged for one bond.
D) floor value beneath which the bond price cannot fall.

Question 44

Put-call parity states that:

A) Price of stock + price of call = price of put + PV(exercise price)
B) Price of stock + PV(exercise price) = price of call + price of put
C) Price of stock + price of put = price of call + PV(exercise price)
D) Price of stock = price of put + price of call − exercise price

Question 45

Executive stock options are issued with the hope that the recipients will:

A) sell the shares they currently own thereby diversifying the firm's ownership.
B) work to increase the value of the firm's stock.
C) never exercise them.
D) sell their shares at the option's exercise price.

Question 46

Which one 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 about to expire.

Question 47

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

A) historical cost of the asset.
B) resale value of the asset at abandonment.
C) foregone revenues anticipated from the project.
D) foregone interest on the bonds used to finance the real assets.

Question 48

A put and a call both have the same maturity and both have an exercise price which is equal to the current stock price.The interest rate is 5%.Which option should sell for a higher price?

A) the put.
B) both should sell for the same price.
C) the call.
D) can't say without knowing the variability of the stock.

Question 49

A 10% convertible bond has a conversion ratio of 25.The firm's common stock is currently selling at $35.If the bond is about to mature,what is its value?

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

Question 50

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 at least $900.
B) bond should trade for at least $1,000.
C) bond should trade for at least $1,100.
D) firm will have already converted the bond.

Question 51

Which of the following statements is true of the holder of a call option?

A) Option holders pay no income taxes.
B) Holders of a call option have restricted profits.
C) Option holders do not receive dividends
D) Investors in call options do not have to exercise them and therefore cannot sustain losses.

Question 52

Investors who hold warrants essentially have a:

A) put option on the firm's bonds.
B) put option on the firm's equity.
C) call option on the firm's bonds.
D) call option on the firm's equity.

Question 53

Which one of the following call options would command the higher price,other things equal? (All months are within the same calendar year.)

A) October expiration, $45 exercise price
B) December expiration, $40 exercise price
C) March expiration, $45 exercise price
D) June expiration, $40 exercise price

Question 54

Why does the value of a call option increase as the interest rate increases?

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

Question 55

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

A) buy both a put and a call.
B) sell both a put and a call.
C) buy a put and sell a call.
D) buy two puts.

Question 56

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 57

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 58

What is the most an investor can lose if sells a call on the firm's stock with an exercise price of $100?

A) $100
B) $0
C) $50
D) Unlimited losses

Question 59

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

A) −$20
B) $0
C) $10
D) $20

Question 60

Which one of the following statements is correct?

A) A convertible bond will be worth less than a similar non-convertible bond.
B) A callable bond will be worth less than a similar non-callable bond.
C) A callable bond will be worth more than a similar convertible bond.
D) Warrants are always worth more than convertible bonds.

Question 61

Which of the following is not a real option?

A) If tanker rates fall, the company can lay up its fleet
B) The extra warehouse space allows the company to expand
C) The company replaces an ageing machine tool
D) If oil prices rise the company can switch to using gas

Question 62

At what point does the value of a call option lie furthest above its lower bound (that is,the maximum of zero or the stock price − exercise price)?

A) When the stock price is zero.
B) When the stock price is very high relative to the exercise price.
C) When the stock price equals the exercise price.
D) It depends on the maturity of the option.

Question 63

The buyer of a put option has a(n)_____ to sell the underlying asset and the option seller has a(n)____ to buy the underlying asset.

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

Question 64

The payoffs from investing in an option contract are designed so that:

A) both the buyer and the seller of the contract will 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) there are no profits but there are also no losses.

Question 65

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

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

Question 66

Which one of the following is correct for the owner of a June call on XYZ Corp.with an exercise price of $60? XYZ Corp.currently trades at $55 and the option at $3.

A) XYZ stock will go to $63 per share within the option period.
B) The option should be exercised now.
C) The option owner's current profit is $3 per share.
D) The option may expire without value.

Question 67

What is the lower bound on the value of a put option?

A) Maximum of zero or exercise price − stock price
B) Maximum of zero or stock price − exercise price
C) Stock price − exercise price
D) Exercise price − stock price

Question 68

Of the following four put options that can be purchased on a stock,which would you expect to have the highest price? (All option months are in the same calendar year.)

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 69

Real options are:

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

Question 70

A call option will have the highest value when the stock price is:

A) far above the exercise price.
B) closest to the exercise price.
C) approaching zero.
D) less than the exercise price.

Question 71

You own a September put on CBA Corp.with an exercise price of $80.CBA stock currently trades at $80 and the put at $5.Which of the following is definitely true?

A) The option will continue to gain value until its September expiration.
B) The owner should exercise now in order to avoid further losses.
C) Decreases in the CBA stock price will be translated directly into additional option value.
D) $20 is the maximum value for this option.

Question 72

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

A) The investor profits when the stock price declines.
B) Maximum profitability occurs when the stock price equals the exercise price.
C) The value of the position can decline no further than the option's exercise price.
D) The option will certainly be exercised.

Question 73

Maria sold a call option on XXX Corp.with an exercise price of $50.The option is about to expire and stock XXX is currently trading at $40.What is the value of Maria's position?

A) −$10
B) $0
C) $7
D) $10

Question 74

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

A) capture upside potential without additional 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 75

A share of stock is currently priced at $20 and will change with equal likelihood to either $40 or $10.A call option with a $20 exercise price is available on the stock.The interest rate is zero.Which of the following positions will provide (approximately)the same payoffs as the option?

A) Buy 0.667 shares and lend $6.67
B) Buy 0.667 shares and borrow $6.67
C) Buy 0.5 shares
D) Sell 0.667 shares and borrow $0.667

Question 76

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

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

Question 77

Under what circumstance will the buyer of a put option need to fulfill her obligation?

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

Question 78

Joe sold a put option on ZZZ Corp.with an exercise price of $40.The option is about to expire and ZZZ stock is currently trading at $28 per share.What is the value of Joe's position?

A) $12
B) −$12
C) $8
D) $16

Question 79

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

A) the exercise price continually decreases.
B) the opportunity increases for the stock price to exceed the exercise price.
C) the dividends accumulate while waiting to be paid.
D) the option can be repeatedly exercised.

Question 80

It is May and you own a June 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 the stock of ABC Corp because option traders seem to be optimistic about its prospects.
C) Sell your ABC stock before its price declines.
D) Sit and wait until the June expiration.