Question 1

The time value of an option is
I.he difference between the option's price and the value it would have if it were expiring immediately.
II.the same as the present value of the option's expected future cash flows.
III.the difference between the option's price and its expected future value.
IV.different from the usual time value of money concept.
A) I
B) I and II
C) II and III
D) II
E) I and IV

Accepted Answer

The time value of an option is the difference between the option's price and the intrinsic value if it were expiring immediately (I). It is also different from the usual time value of money concept (IV), as it relates to the potential for future gains rather than the present value of expected cash flows.

Question 2

You are evaluating a stock that is currently selling for $30 per share.Over the investment period you think that the stock price might get as low as $25 or as high as $40.There is a call option available on the stock with an exercise price of $35.Answer the following questions about hedging your position in the stock.Assume that you will hold one share.
What is the hedge ratio?
How much would you borrow to purchase the stock?
What is the amount of your net investment in the stock?
Complete the table below to show the value of your stock portfolio at the end of the holding period.

Accepted Answer

The answer of You are evaluating a stock that is...

Question 3

The Black-Scholes formula assumes that
I.the risk-free interest rate is constant over the life of the option.
II.the stock price volatility is constant over the life of the option.
III.the expected rate of return on the stock is constant over the life of the option.
IV.there will be no sudden extreme jumps in stock prices.
A) I and II
B) I and III
C) II and II
D) I,II and IV
E) I,II,III,and IV

Accepted Answer

The Black-Scholes formula only assumes that the risk-free interest rate is constant over the life of the option, the stock price volatility is constant over the life of the option, and there will be no sudden extreme jumps in stock prices. It does not assume that the expected rate of return on the stock is constant over the life of the option. Therefore, the correct choices are I (the risk-free interest rate is constant over the life of the option), II (the stock price volatility is constant over the life of the option), and IV (there will be no sudden extreme jumps in stock prices).

Question 4

As the underlying stock's price increased,the call option valuation function's slope approaches
A) zero.
B) one.
C) two times the value of the stock.
D) one-half time s the value of the stock.
E) infinity

Accepted Answer

As the stock price increases the value of the call option increases in price one for one with the stock price.The option is very likely to be exercised.

Question 5

The intrinsic value of an at-the-money put option is equal to
A) the stock price minus the exercise price.
B) the put premium.
C) zero.
D) the exercise price minus the stock price.
E) None of these is correct

Accepted Answer

The intrinsic value of a put option is the difference between the strike price and the stock price, only if the stock price is lower than the strike price. However, in the case of an at-the-money put option, the stock price is equal to the exercise price, hence the intrinsic value is zero. Therefore, the correct answer is C.

Question 6

In the table below,list the six variables that influence the value of an American call option in column one.In column two,indicate whether an increase in the value of each would cause an increase or a decrease in the value of the call.Assume all other variables remain constant in each case.In column three,give a brief explanation of why this relationship exists.

Accepted Answer

The answer of In the table below,list the six variables...

Question 7

The hedge ratio of an option is also called the option's
A) alpha
B) beta
C) sigma
D) delta
E) rho

Accepted Answer

The hedge ratio of an option is also known as delta. Delta measures the rate of change of option value in relation to underlying asset price movement.

Question 8

Which of the variables affecting option pricing is not directly observable? If this variable is estimated to be higher or lower than the variable actually is how is the option valuation affected?

Accepted Answer

The answer of Which of the variables affecting option pricing...

Question 9

Relative to non-dividend-paying European calls,otherwise identical American call options
A) are less valuable.
B) are more valuable.
C) are equal in value.
D) will always be exercised earlier.
E) none of these.

Accepted Answer

The answer of Relative to non-dividend-paying European calls,otherwise identical American...

Question 10

In volatile markets,dynamic hedging may be difficult to implement because
A) prices move too quickly for effective rebalancing.
B) as volatility increases,historical deltas are too low.
C) price quotes may be delayed so that correct hedge ratios cannot be computed.
D) volatile markets may cause trading halts.
E) all of these.

Accepted Answer

Dynamic hedging can be challenging in volatile markets due to rapid price movements, outdated historical deltas, delayed price quotes, and potential trading halts, making all the options relevant.

Question 11

Vega is defined as
A) the change in the value of an option for a dollar change in the price of the underlying asset.
B) the change in the value of the underlying asset for a dollar change in the call price.
C) the percentage change in the value of an option for a one percent change in the value of the underlying asset.
D) the change in the volatility of the underlying stock price.
E) the sensitivity of an option's price to changes in volatility.

Accepted Answer

Vega is the sensitivity of an option's price to changes in volatility. It measures the amount an option's price is expected to change for a 1% change in the volatility of the underlying asset.

Question 12

Rubinstein (1994)observed that the performance of the Black-Scholes model had deteriorated in recent years,and he attributed this to
A) investor fears of another market crash.
B) higher than normal dividend payouts.
C) early exercise of American call options.
D) decreases in transaction costs.
E) none of these.

Accepted Answer

Rubinstein (1994) noted that the Black-Scholes model's performance had worsened due to increased investor fears of another market crash, which affected market volatility and option pricing.

Question 13

Dollar movements in option prices are ________ than dollar movements in the stock price,and rate of return volatility of options is ________ than stock return volatility.
A) less,less
B) greater,greater
C) less,greater
D) greater,less
E) There is no particular pattern.

Accepted Answer

The volatility of an option is greater than the volatility of the underlying stock because the option price is affected by both the stock price and the time value of the option. The time value of an option is the value of the option that is not due to the current stock price. As the time to expiration of an option decreases, the time value of the option decreases. This means that the option price will become more volatile as the time to expiration decreases.

Question 14

What is an option hedge ratio? How does the hedge ratio for a call differ from that of a put (or are the two equivalent)? Explain.

Accepted Answer

The answer of What is an option hedge ratio? How...

Question 15

Which Excel formula is used to execute the Black-Scholes option pricing model?
A) NORMAL
B) ABNORMAL
C) NORMSDIST
D) DIST
E) NORMALDIST

Accepted Answer

The Black-Scholes option pricing model uses the cumulative standard normal distribution function, which can be calculated using the NORMSDIST formula in Excel.

Question 16

You purchased a call option for a premium of $4.The call has an exercise price of $29 and is expiring today.The current stock price is $31.What would be your best course of action?
A) Exercise the call because the stock price is greater than the exercise price.
B) Do not exercise the call because the stock price is greater than the exercise price.
C) Do not exercise the call because the difference between the exercise price and the stock price is not enough to cover the amount of the premium.
D) Exercise the call to get a positive net return on the investment.
E) Do not exercise the call to avoid a negative net return on the investment.

Accepted Answer

Since the current stock price is higher than the exercise price, exercising the call option would allow the investor to purchase the stock at a lower price than the current market price. Therefore, the best course of action would be to exercise the call option and realize the gain. The premium paid for the option would be added to the exercise price and the stock could then be sold in the market for a profit.

Question 17

Discuss the relationship between option prices and time to expiration,volatility of the underlying stocks,and the exercise price.

Accepted Answer

The answer of Discuss the relationship between option prices and...

Quiz 18: Performance Evaluation and Active Portfolio Management

As the underlying stock's price increased,the call option valuation function's slope approaches

The intrinsic value of an at-the-money put option is equal to

The hedge ratio of an option is also called the option's

Which of the variables affecting option pricing is not directly observable? If this variable is estimated to be higher or lower than the variable actually is how is the option valuation affected?

Relative to non-dividend-paying European calls,otherwise identical American call options

In volatile markets,dynamic hedging may be difficult to implement because

Vega is defined as

Rubinstein (1994) observed that the performance of the Black-Scholes model had deteriorated in recent years,and he attributed this to

Dollar movements in option prices are than dollar movements in the stock price,and rate of return volatility of options is than stock return volatility.

What is an option hedge ratio? How does the hedge ratio for a call differ from that of a put (or are the two equivalent)? Explain.

Which Excel formula is used to execute the Black-Scholes option pricing model?

You purchased a call option for a premium of $4.The call has an exercise price of $29 and is expiring today.The current stock price is $31.What would be your best course of action?

Discuss the relationship between option prices and time to expiration,volatility of the underlying stocks,and the exercise price.