Question 1

Which of the following investors would be happy to see the stock price rise sharply?
I.An investor who owns the stock and a put option;
II.An investor who has sold a put option and bought a call option;
III.An investor who owns the stock and has sold a call option;
IV.An investor who has sold a call option
A)I and II only
B)III and IV only
C)III only
D)IV only

Accepted Answer

An investor who owns the stock and a put option (I) benefits from the stock price rising because they own the stock. An investor who has sold a put option and bought a call option (II) benefits from a rise in stock price because the call option gains value and the put option they sold becomes less likely to be exercised.

Question 2

If the risk-free interest rate increases,then:
A)call option prices increase.
B)call option prices decrease.
C)call option prices remain the same.
D)call option prices can either increase,decrease,or remain the same.

Accepted Answer

The answer of If the risk-free interest rate increases,then:
A)call option...

Question 3

Suppose the underlying stock pays a dividend before the expiration of options on that stock.This will:
I.increase the value of a call option;
II.increase the value of a put option;
III.decrease the value of a call option;
IV.decrease the value of a put option
A)I and II only
B)III and IV only
C)I and IV only
D)II and III only

Accepted Answer

When a stock pays a dividend, its price typically decreases by the amount of the dividend, which decreases the value of call options (III) and increases the value of put options (II).

Question 4

Buying a call option,investing the present value of the exercise price in T-bills,and short-selling the underlying share is the same as:
A)buying a call and a put.
B)buying a put and a share.
C)buying a put.
D)selling a call.

Accepted Answer

The answer of Buying a call option,investing the present value...

Question 5

Suppose you buy a call and lend the present value of its exercise price.You could match the payoffs of this strategy by:
A)buying the underlying stock and selling a call.
B)selling a put and lending the present value of the exercise price.
C)buying the underlying stock and buying a put.
D)buying the underlying stock and selling a put.

Accepted Answer

The answer of Suppose you buy a call and lend...

Question 6

For European options,the value of a put is equal to:
A)the value of a call minus the value of a share plus the present value of the exercise price.
B)the value of a call plus the value of a share plus the present value of the exercise price.
C)the value of the share minus the value of a call plus the present value of the exercise price.
D)the value of the share minus the present value of the exercise price plus the value of a call.

Accepted Answer

This is based on the put-call parity principle for European options, which states that the value of a put option is equal to the value of a call option minus the value of the underlying share plus the present value of the exercise price.

Question 7

Consider the following data for a European option: Expiration = 6 months; Stock price = $80; Exercise price = $75; Call option price = $12; Risk-free rate = 5% per year.Using put-call parity,calculate the price of a put option having the same exercise price and expiration date.
A)$3.07
B)$5.19
C)$11.43
D)$3.42Value of put = value of call - share price + PV of exercise price

Accepted Answer

Using put-call parity, we have:

Put price + Share price = Call price + PV of exercise price
Put price + $80 = $12 + PV($75)
Put price = $5.19 (rounded to nearest cent)

Question 8

If the stock makes a dividend payment before the expiration date,then the put-call parity relation is:
A)Value of call = value of put + share price - present value (PV)of dividend - PV of exercise price.
B)Value of call = value of put - share price + PV of dividend - PV of exercise price.
C)Value of call = value of put + share price + PV of dividend + PV of exercise price.
D)Value of call = value of put + share price + PV of dividend - PV of exercise price.

Accepted Answer

The correct put-call parity relation, accounting for dividends, is: Value of call = value of put + share price - present value (PV) of dividend - PV of exercise price. This accounts for the fact that owning a call option does not entitle the holder to dividends paid during the option's life, hence the need to subtract the PV of dividends from the equation.

Question 9

All else equal,as the underlying stock price increases:
A)the call price decreases.
B)the call price increases.
C)there is no effect on call price.
D)the call price can either increase,decrease,or remain the same.

Accepted Answer

As the underlying stock price increases, the call option becomes more valuable since it gives the owner the right to buy the stock at a lower strike price. Therefore, the call price increases.

Question 10

For European options,the value of a call minus the value of a put is equal to:
A)the present value of the exercise price minus the value of a share
B)the present value of the exercise price plus the value of a share
C)the value of a share plus the present value of the exercise price
D)the value of a share minus the present value of the exercise price

Accepted Answer

This is known as Put-Call Parity and occurs because owning a call option gives the right to buy a share at the exercise price, while owning a put option gives the right to sell a share at the exercise price. Therefore, the value of the call minus the value of the put equals the difference between the value of owning a share versus the value of owning the exercise price, which is the same as the value of a share minus the present value of the exercise price.

Question 11

Which of the following features increase(s)the value of a call option?
I.A high interest rate;
II.A long time to maturity;
III.A higher volatility of the underlying stock price
A)I only
B)II only
C)III only
D)I,II,and III

Accepted Answer

All three features increase the value of a call option. A high interest rate increases the present value of the expected payoff, a long time to maturity gives the stock more time to increase in value, and higher volatility increases the potential for the stock to reach a higher price, all of which are beneficial for a call option holder.

Question 12

If the volatility of the underlying asset decreases,then the:
A)value of the put option will increase,but the value of the call option will decrease.
B)value of the put option will decrease,but the value of the call option will increase.
C)value of both the put and call option will increase.
D)value of both the put and call option will decrease.

Accepted Answer

The value of both put and call options generally decreases with a decrease in the volatility of the underlying asset because lower volatility means less chance of large price movements, making both types of options less valuable.

Question 13

Buying the stock and the put option on the stock provides the same payoff as:
A)investing the present value of the exercise price in T-bills and buying the call option on the stock.
B)short-selling the stock and buying a call option on the stock.
C)writing (selling)a put option and buying a call option on the stock.
D)a T-bill.

Accepted Answer

Both buying the stock and the put option on the stock and investing the present value of the exercise price in T-bills and buying the call option on the stock will provide the same payoff. This is because the put option will protect the downside risk of the stock, while the call option will provide the upside potential. By investing the present value of the exercise price in T-bills, the option holder can ensure that they will have the funds available to exercise the call option if necessary. Therefore, option A is the best choice. Short-selling the stock and buying a call option on the stock is not a viable strategy as short-selling involves unlimited downside risk, and the call option may not fully protect against this risk. Writing (selling) a put option and buying a call option on the stock could result in significant losses if the stock price falls below the strike price of the put option. A T-bill does not provide the same payoff as buying the stock and the put option on the stock or investing the present value of the exercise price in T-bills and buying the call option on the stock.

Question 14

Suppose an investor buys one share of stock and a put option on the stock and simultaneously sells a call option on the stock with the same exercise price.What will be the value of his investment on the final exercise date?
A)Above the exercise price if the stock price rises and below the exercise price if it falls
B)Equal to the exercise price regardless of the stock price
C)Equal to zero regardless of the stock price
D)Below the exercise price if the stock price rises and above if it falls

Accepted Answer

By buying a share of stock and a put option, the investor has the right to sell the stock at the exercise price. By selling a call option, the investor has the obligation to sell the stock at the exercise price. Since the exercise price is the same for both options, the investor's potential profit and loss are limited to the difference between the exercise price and the stock price. Therefore, the value of the investment will be equal to the exercise price regardless of the stock price on the final exercise date.

Question 15

Relative to the underlying stock,a call option always has:
A)a higher beta and a higher standard deviation of return.
B)a lower beta and a higher standard deviation of return.
C)a higher beta and a lower standard deviation of return.
D)a lower beta and a lower standard deviation of return.

Accepted Answer

Call options, due to their leveraged nature, typically exhibit both a higher beta, indicating a higher sensitivity to market movements, and a higher standard deviation of return, reflecting greater volatility compared to the underlying stock.

Question 16

Put-call parity can be used to show:
A)how valuable in-the-money put options can get.
B)how valuable in-the-money call options can get.
C)the precise relationship between put and call option prices given equal exercise prices and equal expiration dates.
D)that the value of a call option is always twice that of a put given equal exercise prices and equal expiration dates.

Accepted Answer

Put-call parity states that the price of a European call option and a European put option with the same strike price and expiration date should be equal. Moreover, the sum of the present value of the strike price and the price of the put option should be equal to the sum of the present value of the stock price and the price of the call option. This relationship helps in understanding the interdependence of put and call options and their pricing. The statement in options D is incorrect.

Question 17

Suppose an investor buys one share of stock and a put option on the stock.What will be the value of her investment on the final exercise date if the stock price is below the exercise price? (Ignore transaction costs.)
A)The value of two shares of stock.
B)The value of one share of stock plus the exercise price.
C)The exercise price.
D)The value of one share of stock minus the exercise price.

Accepted Answer

If the stock price is below the exercise price, the put option will be exercised and the investor will sell the stock at the exercise price. Therefore, the value of her investment will be equal to the exercise price.

Question 18

All else equal,as the underlying stock price increases:
A)the put price increases.
B)the put price decreases.
C)there is no effect on put price.
D)the put price can either increase,decrease,or remain the same.

Accepted Answer

When the underlying stock price increases, the probability of the stock price falling below the strike price decreases. Therefore, the option becomes less likely to be exercised and the put price decreases.

Question 19

For European options,the value of a call plus the present value of the exercise price is equal to:
A)the value of a put minus the value of a share.
B)the value of a share minus the value of a call.
C)the value of a put plus the value of a share.
D)the value of a share minus the value of a put.

Accepted Answer

By definition, the value of a European call option is the present value of the expected payoff at expiration, which is the maximum of zero and the difference between the stock price and the exercise price. Therefore, the value of a call plus the present value of the exercise price is equal to the value of the stock (i.e. the current stock price). 
On the other hand, the value of a European put option is the present value of the expected payoff at expiration, which is the maximum of zero and the difference between the exercise price and the stock price. Therefore, the value of a put plus the present value of the exercise price is equal to the strike price. 
Combining these two, we get the value of a put plus the value of a call plus the present value of the exercise price is equal to the stock price plus the strike price, which is equivalent to the value of a put plus the value of a share. Therefore, the correct choice is C.

Question 20

A call option has an exercise price of $150.At the option expiration date,the stock price could be either $100 or $200.Which investment would combine to give the same payoff as the stock?
A)Lend PV of $100 and buy two calls
B)Lend PV of $100 and sell two calls
C)Borrow $100 and buy two calls
D)Borrow $100 and sell two calls

Accepted Answer

The answer of A call option has an exercise price...

Quiz 20: Understanding Options

If the risk-free interest rate increases,then:

Suppose the underlying stock pays a dividend before the expiration of options on that stock.This will: I.increase the value of a call option; II.increase the value of a put option; III.decrease the value of a call option; IV.decrease the value of a put option

Buying a call option,investing the present value of the exercise price in T-bills,and short-selling the underlying share is the same as:

Suppose you buy a call and lend the present value of its exercise price.You could match the payoffs of this strategy by:

For European options,the value of a put is equal to:

Consider the following data for a European option: Expiration = 6 months; Stock price = $80; Exercise price = $75; Call option price = $12; Risk-free rate = 5% per year.Using put-call parity,calculate the price of a put option having the same exercise price and expiration date.

If the stock makes a dividend payment before the expiration date,then the put-call parity relation is:

All else equal,as the underlying stock price increases:

For European options,the value of a call minus the value of a put is equal to:

Which of the following features increase(s) the value of a call option? I.A high interest rate; II.A long time to maturity; III.A higher volatility of the underlying stock price

If the volatility of the underlying asset decreases,then the:

Buying the stock and the put option on the stock provides the same payoff as:

Suppose an investor buys one share of stock and a put option on the stock and simultaneously sells a call option on the stock with the same exercise price.What will be the value of his investment on the final exercise date?

Relative to the underlying stock,a call option always has:

Put-call parity can be used to show:

Suppose an investor buys one share of stock and a put option on the stock.What will be the value of her investment on the final exercise date if the stock price is below the exercise price? (Ignore transaction costs.)

All else equal,as the underlying stock price increases:

For European options,the value of a call plus the present value of the exercise price is equal to:

A call option has an exercise price of $150.At the option expiration date,the stock price could be either $100 or $200.Which investment would combine to give the same payoff as the stock?