Question 1

You purchase a call option and a put option on the shares of a company.The sticker price and expiration date for the options is equal.What is the best description of the combined payoff diagram for the combination of the two options?

Accepted Answer

The combined payoff diagram for the combination of a call option and a put option with equal sticker price and expiration date is a V-shaped diagram with the kink at the strike price of the options. This is because the call option will have a payoff that increases as the stock price increases, while the put option will have a payoff that increases as the stock price decreases. At the strike price, both options will have zero payoff, resulting in the kink in the diagram.

Question 2

You own 100 shares of a stock with a current price of $50 and you also own a put option of 100 shares of the stock with a strike price of $45.What is the minimum value of your portfolio at expiration? Ignore the original cost of the put option for your calculation.

Accepted Answer

At expiration, if the stock price falls below the strike price of $45, you can exercise the put option and sell the 100 shares of stock at $45 each, resulting in a minimum value of $4,500. If the stock price stays above $45, the put option will expire worthless but you still own the 100 shares of stock, which would have a minimum value of $5,000. Therefore, the minimum value of your portfolio at expiration is $4,500.

Question 3

Bavarian Brew issued convertible bonds with a par value of $1,000.The conversion ratio on the bonds is 12.33,the current market price of the bonds is $933.75 and the underlying stock currently sells at $45.25.What is the conversion premium?

Accepted Answer

933.75/12.33 = 75.73
(75.73-45.25)/45.25 = .6648

Question 4

You need to immediately purchase 100 shares of Stock X and you own a call option with a strike price of $32.The current price of Stock X is $25.Your best course of action is

Accepted Answer

Exercising the call option at the strike price of $32 would result in a loss as the current market price of the stock is only $25. Similarly, purchasing a new call option with a strike price of $25 and exercising it would be pointless as the current market price is already $25.

Therefore, the best course of action is to purchase the stock in the market at the current price of $25 to fulfill the requirement of owning 100 shares of Stock X.

Question 5

If you purchase the right to sell a share of IBM stock for a set price for a fixed period of time,then you have

Accepted Answer

Purchasing a put option gives the holder the right to sell a share of stock at a set price within a specified period.

Question 6

You own a put option on a stock and the strike price of the option is $30.The option has 3 weeks until expiration and the stock is currently priced at $35 per share.What is the largest payout possible for this put option? Ignore the original cost of the option for the payout calculation.

Accepted Answer

The largest payout for a put option occurs when the stock price falls to $0. In this case, the payout would be the strike price of $30 minus the stock price of $0, resulting in a $30 payout.

Question 7

A call option with a $35 strike price on Bavarian Sausage stock will expire in one year.If you know that the risk free rate is 6%,that the stock currently sells at $38 and the put on the same stock has a value of $3.85,what is the price of the call?

Accepted Answer

B = 35/1.06 =33.02
38 + 3.85 = 33.02 + C
C = 8.83

Question 8

You notice that the price of a one-year call option,with a $40 strike price,is $5.The current price of the underlying stock is also $40.What should the price of a one-year put option be with a strike price of $40? Assume that the interest rate on a one-year risk free bond is 10%.

Accepted Answer

S + P = B/(1+r)+ C
40 + P = 40/1.1 + 5 ======> P = 1.36

Question 9

One of the main reasons for the name "derivatives" is that

Accepted Answer

The term "derivative" refers to the fact that these financial instruments derive their value from the value of other instruments, such as stocks, bonds, or commodities. They are essentially based on, or derived from, the price movements of an underlying asset.

Question 10

You sold a call option on a stock and the strike price of the option is $30.The option has 3 weeks until expiration and the stock is currently priced at $35 per share.You originally sold the call option for $3.What is the largest payout possible total payout to you for this call option?

Accepted Answer

The largest total payout you can receive from selling a call option is the premium you collected when you sold the option, which in this case is $3.

Question 11

You notice that you can purchase an option for $5.The price of the underlying stock is currently $42.What is the option premium for this option?

Accepted Answer

The option premium is the price you pay to purchase the option, which in this case is $5. The current price of the underlying stock is not relevant to the option premium.

Question 12

An option that gives the holder the right to purchase an underlying security only at the end of a fixed period for a fixed price is an

Accepted Answer

A European call option gives the holder the right to purchase an underlying security at a fixed price, known as the strike price, on a specific date in the future, known as the expiration date. The holder has no obligation to exercise the option but may do so if the underlying security's market price is higher than the strike price at expiration. A European call option is exercised only at the end of its term, whereas an American call option can be exercised at any time before expiration.

Question 13

A put option with a $35 strike price on Bavarian Sausage stock will expire in one year.If you know that the risk free rate is 6%,that the stock currently sells at $38 and the call on the same stock has a value of $6.85,what is the price of the put?

Accepted Answer

B = 35/1.06 = 33.02
38 + P = 33.02 + 6.85
P = 1.87

Question 14

You find that an investor purchases a put option on shares of Company Z stock.What is the most likely reason that an investor would make such a purchase?

Accepted Answer

An investor purchasing a put option on shares of Company Z stock indicates that the investor believes that Company Z is an overvalued company and that its stock price is likely to decrease in the future. A put option gives the holder the right, but not the obligation, to sell a specific number of shares at a specific price (strike price) before the expiration date. If the stock price drops below the strike price, the holder can exercise the option and sell the shares at a profit. Therefore, buying a put option is a common strategy used by investors to protect themselves from potential losses due to a decline in the stock price.

Question 15

A put option with a $35 strike price on Bavarian Sausage stock will expire in one year.If you know that the stock currently sells at $38 that the put on the same stock has a value of $6.85,and the value of the call is $11.87,what is the implied risk free rate?

Accepted Answer

38 + 6.85 = B + 9.87
B = 32.98
35/(1+r)= 32.98
r = .0612

Question 16

Bavarian Brew issued convertible bonds with a par value of $1,000.The conversion ratio on the bonds is 12.33,the current market price of the bonds is $933.75 and the underlying stock currently sells at $35.25.What is the conversion price?

Accepted Answer

933.75/12.33 = 75.73

Question 17

You own a call option on a stock and the strike price of the option is $30.The option has 3 weeks until expiration and the stock is currently priced at $35 per share.What is the largest payout possible for this call option? Ignore the original cost of the option for the payout calculation.

Accepted Answer

A call option gives the holder the right to buy the underlying stock at the strike price. If the stock price rises above the strike price, the option holder can exercise the option and buy the stock at the lower strike price and then sell it at the higher market price for a profit. Since the stock is currently priced at $35 per share and the strike price is $30, there is potential for unlimited profit if the stock price continues to rise. Therefore, the largest payout possible for this call option is unlimited, making choice D the correct answer.

Question 18

If a company is wanting to lessen the cost of a new security by imbedding a valuable option in the security,then the company is most likely to issue

Accepted Answer

Convertible debt allows the investor to convert their debt into equity (usually common stock) at a future date. By offering a valuable conversion option, the company can entice investors to buy the debt and lower the overall cost of the security. This is a common strategy used by companies looking to raise capital while minimizing expenses. Common stock (A) and preferred stock (D) do not typically have embedded options, and issuing debt (B) without any added value would not provide any cost-saving benefits.

Question 19

Which of the following will increase in price as the value of the underlying asset decreases in price,from the option holder's perspective?

Accepted Answer

A put option gives the holder the right, but not the obligation, to sell the underlying asset at a predetermined price, known as the strike price. As the value of the underlying asset decreases, the holder of a put option can sell the asset at the higher strike price, resulting in a profit. Therefore, from the option holder's perspective, the price of a put option will increase as the value of the underlying asset decreases.

Question 20

You currently own a put option on Stock X with a strike price of $25.If the current price of Stock X is $30,then what is the in-the-money amount of the option?

Accepted Answer

A put option is in-the-money when the stock price is below the strike price. Since the stock price is $30 and the strike price is $25, the option is out-of-the-money, and the in-the-money amount is $0.

Quiz 19: Options