Question 1

Provide a definition of a straight bond value.

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Question 2

Provide a definition of a conversion value.

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Question 3

Provide a definition of a convertible bond.

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Question 4

Explain the rationale behind the statement that equity is a call option on the firm's assets. When would a shareholder allow the call to expire?

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Question 5

Suppose IBM is priced at $225 a share and a call with an exercise price of $250 and two months to expiration costs $0.125 per contract. Why do you suppose investors would be willing to purchase a call so far out-of-the-money?

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Question 6

Provide a definition of exercising the option.

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Question 7

Provide a definition of an expiration date.

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Question 8

Kevin owns a call option which will expire in one year. He believes that the call will finish in the money. What formula should Kevin use to determine the current value of his option? Briefly explain this formula.

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Question 9

Provide a definition of an employee stock option (ESO).

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Question 10

List the five factors that the value of any option depends on. Briefly explain the direction of the impact and the rationale behind each as they relate to call options.

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Question 11

Provide a definition of a European options.

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Question 12

Provide a definition of a conversion price.

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Question 13

An American option is worth more than a comparable European option. Explain in detail why this is so.

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Question 14

Based on the Black-Scholes Option Pricing Model, there are only five factors that affect the pricing of a call option. List each of these five options and explain how each one affects the price of a call option.

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Question 15

Consider a firm that has an issue of convertible bonds outstanding. The bonds have an annual coupon rate of 8%, a face value of $1,000, and 20 years to maturity. The firm's stock price was $50 when the bonds were issued and the conversion premium was 20%. The current stock price is $55. Compute the conversion price, conversion ratio, and conversion value. Also determine the yield on similar straight bonds at which the conversion value would equal the straight bond value.

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Question 16

Provide a definition of intrinsic value.

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Question 17

What are the upper and lower bounds for an American call option? Explain what would happen in each case if the bound was violated.

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Question 18

Suppose you look in the newspaper and see IBM trading at $250 per share. Calls on IBM with one month to expiration and an exercise price of $245 are trading at $6.50 each. Puts on IBM with one month to expiration and an exercise price of $255 are trading at $3.50 each. Are these prices reasonable? Explain. (Ignore transactions costs).

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Question 19

Draw a graph which depicts the value of a call option prior to expiration. Indicate both the upper and the lower bounds of the call's value. Indicate the formulas used to create the upper and lower bounds.

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Question 20

Provide a definition of a conversion ratio.

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Quiz 25: Options and Corporate Securities