Question 1

option is a contract that gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time.

Accepted Answer

This is the definition of an option.

Question 2

we define the "premium" on an option to be the difference between the price at which an option sells and the exercise value (or the difference between the stock's current market price and the strike price), then we would expect the premium to increase as the stock price increases, other things held constant.

Accepted Answer

False

Question 3

strike price is the price that must be paid for a share of common stock when it is bought by exercising a warrant.

Accepted Answer

This statement correctly defines strike price, which is the price that must be paid for a share of common stock when a warrant is exercised.

Question 4

a company announces a change in its dividend policy from a zero target payout ratio to a 100% payout policy, this action could be expected to increase the value of long-term options (say 5-year options) on the firm's stock.

Accepted Answer

The answer of a company announces a change in its...

Question 5

Which of the following statements is CORRECT?

Accepted Answer

Option holders do not receive dividends unless they exercise their options before the stock goes ex-dividend.

Question 6

exercise value is the positive difference between the current price of the stock and the strike price.The exercise value is zero if the stock's price is below the strike price.

Accepted Answer

This is correct as per the definition of exercise value. It represents the profit that an investor would make if they exercise the option and buy the stock at the strike price, and then sell it at the current market price. If the current market price is lower than the strike price, there is no profit to be made and the exercise value would be zero.

Question 7

the market is in equilibrium, then an option must sell at a price that is exactly equal to the difference between the stock's current price and the option's strike price.

Accepted Answer

The price of an option is influenced by many factors beyond the stock price and strike price, such as the time left until expiration, the volatility of the stock, and current interest rates. Therefore, even in a market equilibrium, an option may sell at a price that is not exactly equal to the difference between the stock's current price and the option's strike price.

Question 8

Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock, provided the strike prices for the put and call are the same.

Accepted Answer

The put-call parity relationship does not imply that put and call options must sell at the same price, but rather it defines a specific relationship between the prices of European put and call options with the same strike price and expiration date, involving the stock price and the strike price discounted at the risk-free rate.

Question 9

Corporation is planning to issue options to its key employees, and it is now discussing the terms to be set on those options.Which of the following actions would decrease the value of the options, other things held constant?

Accepted Answer

Increasing the exercise price of the option would decrease the value of the option, as it would require the employee to pay more to purchase the stock at a later date. This would make the option less attractive to the employee. The other options would all increase the value of the option (A, D, E) or have no effect (C).

Question 10

investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?

Accepted Answer

Selling standard call options against stock held in the portfolio is known as covered call writing. The investor already owns the underlying stock, therefore the call options sold are covered by the stock held in the portfolio, making it a covered call.

Question 11

options on XYZ Corporation's common stock trade in the market.Which of the following statements is most correct, holding other things constant?

Accepted Answer

The price of call options generally increases when the underlying stock price rises, as the option becomes more valuable.

Question 12

Since investors tend to dislike risk and like certainty, the more volatile a stock, the less valuable will be an option to purchase the stock, other things held constant.

Accepted Answer

Options, particularly call options, can become more valuable with increased volatility because the potential for large price swings increases the chance of the option being in the money before expiration.

Question 13

the current price of a stock is below the strike price, then an option to buy the stock is worthless and will have a zero value.

Accepted Answer

The answer of the current price of a stock is...

Question 14

Deeble Construction Co.'s stock is trading at $30 a share.Call options on the company's stock are also available, some with a strike price of $25 and some with a strike price of $35.Both options expire in three months.Which of the following best describes the value of these options?

Accepted Answer

The answer of Deeble Construction Co.'s stock is trading at...

Question 15

the price of a stock rises above the strike price, the value investors are willing to pay for a call option increases because both (1) the immediate capital gain that can be realized by exercising the option and (2) the likely exercise value of the option when it expires have both increased.

Accepted Answer

When the price of a stock rises above the strike price, the value of the call option increases as there is a higher chance of making a profit by exercising it and the potential gains upon expiration have also increased.

Question 16

Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the

Accepted Answer

The value of an option depends on the stock price, as the option gives the holder the right to buy or sell the underlying asset at a certain price. The strike price is the price at which this transaction can occur, so it also affects the option's value. The variability of the stock price, measured by its volatility, affects the likelihood that the stock price will move above or below the strike price, thus affecting the option price. Finally, the option's time to maturity determines how long the holder has to exercise their right, which affects the probability of the stock price moving favorably for the holder. Therefore, all of these factors - stock price, strike price, stock price variability (volatility), and time to maturity - affect the value of an option.

Question 17

exercise value is also called the strike price, but this term is generally used when discussing convertibles rather than financial options.

Accepted Answer

The answer of exercise value is also called the strike...

Question 18

Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.

Accepted Answer

The time value of money principle suggests that an option with a longer time before expiration is generally more valuable because it has more time to become profitable due to potential changes in the underlying asset's price.

Question 19

Warner Motors' stock is trading at $20 a share.Call options that expire in three months with a strike price of $20 sell for $1.50.Which of the following will occur if the stock price increases 10%, to $22 a share?

Accepted Answer

The call option's intrinsic value increases as the stock price rises, but the increase in the option's price is typically less than the increase in the stock price. However, because the option is relatively cheap, the percentage increase in the option's price can be more than the percentage increase in the stock price.

Question 20

option that gives the holder the right to sell a stock at a specified price at some future time is

Accepted Answer

A put option gives the holder the right to sell a stock at a specified price (strike price) at a future time. This is useful for investors who believe that a stock's price will decrease in the future, as they can use the put option to sell the stock at a higher price than the market value.

Quiz 8: Financial Options