Question 1

You purchased a stock for $43 a share,sold a call option with an exercise price of $40,and bought a put option with an exercise price of $45.What will be the value of your position when the options expire if the stock price is $48 a share?
A) $48
B) $46
C) $56
D) $40

Accepted Answer

Stock value = $48: call position = −$8; put position = $0

Question 2

Which one of the following is correct?
A) There is an upper bound on a callable bond's price.
B) Callable bond prices are higher than those of comparable straight bonds.
C) The attraction of callable bonds to the issuer increases as interest rates increase.
D) The investor in a callable bond owns the call option.

Accepted Answer

Callable bonds have an upper bound on their prices since the issuer has the option to call them back and retire the bond before maturity if interest rates fall. This call option limits the potential price appreciation of the bond. Option A correctly identifies this feature of callable bonds. Option B is incorrect because callable bonds often trade at a lower price than their straight bond counterparts because of the call option. Option C is incorrect because the issuer's attraction to callable bonds decreases as interest rates increase because the bond becomes less likely to be called. Option D is incorrect because the issuer, not the investor, owns the call option in a callable bond.

Question 3

An investor who sells a put option profits if:
A) stock prices go up.
B) stock prices go down.
C) the put is exercised.
D) interest rates go up.

Accepted Answer

An investor who sells a put option profits if the stock prices go up because the put option will expire worthless, allowing the seller to keep the premium received from selling the option.

Question 4

Which one of the following changes will reduce the value of a call option?
A) An increase in the stock price
B) An increase in the exercise price
C) An increase in the volatility of the stock price
D) An increase in interest rates

Accepted Answer

An increase in the exercise price (the price at which the option can be exercised) will reduce the value of a call option as it makes it less likely for the option to be exercised and the holder to make a profit. The other options listed would generally increase the value of a call option.

Question 5

You purchased a stock for $36 a share,a call option with an exercise price of $35,and a put option with an exercise price of $34.What will be the value of your position when the options expire if the stock price is $37?
A) $39
B) $37
C) $40
D) $2

Accepted Answer

Stock value = $37; call value = $2; put value = $0

Question 6

You purchased a call option with an exercise price of $50.If you exercise the option when the stock price is $60,your proceeds will be:
A) $10.
B) $0.
C) $4.
D) $16.

Accepted Answer

The proceeds from exercising a call option are the difference between the stock price and the exercise price. Here, $60 (stock price) - $50 (exercise price) = $10.

Question 7

Corporations that attach warrants to their bonds are hoping to:
A) repurchase shares of outstanding stock.
B) convert the bonds into stock at a later date.
C) increase the value of the bonds.
D) increase the price of their shares.

Accepted Answer

Attaching warrants to bonds makes them more attractive to investors, thereby increasing the value of the bonds.

Question 8

If you sell a put option,your maximum payoff is equal to:
A) The maximum of zero or the stock price − the exercise price.
B) The maximum of the exercise price − the stock price or zero.
C) zero.
D) the exercise price.

Accepted Answer

When you sell a put option, the maximum payoff is the premium received, which is fixed and does not depend on the stock price, effectively making the maximum payoff zero beyond the premium.

Question 9

A firm is planning to issue a callable bond with a coupon rate of 8% and 10 years to maturity.A straight bond with a similar coupon is priced at $1,000.If the value of the issuer's call option is $60,what is the value of the callable bond?
A) $940
B) $970
C) $1,000
D) $1,060

Accepted Answer

The value of the callable bond is the value of the straight bond minus the value of the call option. The value of the straight bond is $1,000. The value of the call option is $60. Therefore, the value of the callable bond is $1,000 - $60 = $940.

Question 10

A call option has an exercise price of $60.When the option expires,the price of the stock is exactly $60.What is the value of your call option?
A) $1
B) −$1
C) Zero
D) $60

Accepted Answer

The value of a call option is calculated by taking the difference between the stock price and the exercise price. In this case, since the stock price is exactly equal to the exercise price, the difference is zero. Therefore, the value of the call option is also zero.

Question 11

Why should a convertible bond always be valued at more than its bond value or its conversion value up until maturity?
A) The bond holder is receiving higher interest rates.
B) The holder can decide later whether to own the bond or the stock.
C) The conversion ratio may be decreased.
D) The bond does not have to be given up to exercise the option.

Accepted Answer

A convertible bond always gives the holder the option to convert the bond into a predetermined number of shares at a later date. This option to convert provides added value to the holder, which is reflected in the convertible bond's price. Until maturity, the holder can decide whether to own the bond or convert it into stock, which adds flexibility and makes the convertible bond more valuable than its bond value or conversion value alone. Therefore, option B is the correct answer. The other options do not fully explain why a convertible bond should always be valued higher than its bond or conversion value.

Question 12

If a convertible bond can be thought of as a straight bond with a call option,then the call is owned by the _____,and the exercise price is the _____.
A) debt issuer; stock price
B) debt issuer; straight bond value
C) bond investor; stock price
D) bond investor; straight bond value

Accepted Answer

The call option is owned by the bond investor, and the exercise price is the straight bond value.

Question 13

The value of a call option at expiration will be equal to the maximum of zero or the:
A) stock price.
B) exercise price.
C) stock price minus the exercise price.
D) exercise price minus the stock price.

Accepted Answer

At expiration, a call option's value is the maximum of zero or the difference between the stock price and the exercise price, as the option is only valuable if the stock price exceeds the exercise price.

Question 14

Three months ago you bought a put option with an exercise price of $100.What is the value of this option at expiration if the stock price is $110?
A) $10
B) −$110
C) $0
D) −$10

Accepted Answer

A put option gives the holder the right to sell a stock at the exercise price. If the stock price is above the exercise price at expiration, the option is worthless, so its value is $0.

Question 15

Kingston Lisle shares are currently selling at $75.The value of a call option on the company's shares with an exercise price of $60 and several months to expiration is:
A) less than $15.
B) greater than $15.
C) equal to $15.
D) zero.

Accepted Answer

The value of a call option is the difference between the current stock price and the exercise price. 
$75 - $60 = $15. Therefore, the value of the call option is greater than $15.

Question 16

A stock is selling for $85 at the expiration of an option contract.Which of the following options on the stock will most likely be exercised?
A) Call option with exercise price of $65
B) Put option with exercise price of $65
C) Call option with exercise price of $85
D) Put option with exercise price of $85

Accepted Answer

A call option with an exercise price of $65 will be exercised because the stock price ($85) is higher than the exercise price, allowing the holder to buy the stock at a lower price and potentially sell it at the current market price for a profit.

Question 17

You purchased a stock and a put option on the stock with an exercise prices of $40 a share.What will be the value of your position when the option expires if the stock price is $28 a share?
A) $40
B) $28
C) $12
D) $32

Accepted Answer

Stock value = $28: put position = $12

Question 18

The value of a put at expiration is defined as the:
A) minimum of zero or the stock price minus the exercise price.
B) minimum of zero or the exercise price minus the stock price.
C) maximum of zero or the stock price minus the exercise price.
D) maximum of zero or the exercise price minus the stock price.

Accepted Answer

The value of a put option at expiration is the maximum of zero or the exercise price minus the stock price, as the holder will only exercise the option if it is in-the-money.

Question 19

A 10-year convertible bond has a face value of $1,000,a 9% coupon,and a conversion ratio of 30.The stock is currently priced at $35.If a comparable straight bond would have a yield of 9%,what is the minimum value of the call option provided by the convertible?
A) $0
B) $5
C) $50
D) $65

Accepted Answer

Bond value = $1,000 because coupon rate = market rateConversion value = 30 × $35 = $1,050Value of call = $1,050 − 1,000 = $50

Quiz 23: Options

You purchased a stock for $43 a share,sold a call option with an exercise price of $40,and bought a put option with an exercise price of $45.What will be the value of your position when the options expire if the stock price is $48 a share?

Which one of the following is correct?

An investor who sells a put option profits if:

Which one of the following changes will reduce the value of a call option?

You purchased a stock for $36 a share,a call option with an exercise price of $35,and a put option with an exercise price of $34.What will be the value of your position when the options expire if the stock price is $37?

You purchased a call option with an exercise price of $50.If you exercise the option when the stock price is $60,your proceeds will be:

Corporations that attach warrants to their bonds are hoping to:

If you sell a put option,your maximum payoff is equal to:

A firm is planning to issue a callable bond with a coupon rate of 8% and 10 years to maturity.A straight bond with a similar coupon is priced at $1,000.If the value of the issuer's call option is $60,what is the value of the callable bond?

A call option has an exercise price of $60.When the option expires,the price of the stock is exactly $60.What is the value of your call option?

Why should a convertible bond always be valued at more than its bond value or its conversion value up until maturity?

If a convertible bond can be thought of as a straight bond with a call option,then the call is owned by the _,and the exercise price is the _.

The value of a call option at expiration will be equal to the maximum of zero or the:

Three months ago you bought a put option with an exercise price of $100.What is the value of this option at expiration if the stock price is $110?

Kingston Lisle shares are currently selling at $75.The value of a call option on the company's shares with an exercise price of $60 and several months to expiration is:

A stock is selling for $85 at the expiration of an option contract.Which of the following options on the stock will most likely be exercised?

You purchased a stock and a put option on the stock with an exercise prices of $40 a share.What will be the value of your position when the option expires if the stock price is $28 a share?

The value of a put at expiration is defined as the:

A 10-year convertible bond has a face value of $1,000,a 9% coupon,and a conversion ratio of 30.The stock is currently priced at $35.If a comparable straight bond would have a yield of 9%,what is the minimum value of the call option provided by the convertible?