Question 1

An investor is considering buying 500 shares of ABC Company at $32 per share. Analysts agree that the firm's stock price may increase to $45 per share in the next 4 months. As an alternative, the investor could purchase a 120-day call option at a striking price of $30 for $5,000. At what stock price would the investor break even?
A) $35
B) $40
C) $42
D) $45

Accepted Answer

If the investor buys 500 shares at $32 per share, the total investment cost will be:
500 shares x $32 per share = $16,000

If the stock price increases to $45 per share, the investor will make a profit of:
500 shares x ($45 - $32) per share = $6,500

Alternatively, if the investor buys a call option for $5,000, the total investment cost will be:
$5,000

To break even, the stock price needs to increase enough to cover the cost of the call option. This means the stock price needs to be at least:
$30 (strike price) + $5 (cost of option) = $35

Therefore, the investor would break even at a stock price of $35 when purchasing the call option. However, if the stock price increases to $40 or beyond, the investor would make a larger profit with the call option than by purchasing the stock outright.

Question 2

Which of the following statements about put and call options is false?
A) They are traded on organized exchanges.
B) They are a form of deferred equity financing by the firm.
C) They can be used to lock in a gain or prevent a loss on a stock holding.
D) They provide the buyer with an opportunity to earn larger returns than simply buying or selling common stock.

Accepted Answer

Put and call options are not a form of deferred equity financing by the firm. They are derivatives that give the holder the right, but not the obligation, to buy (call) or sell (put) a specific underlying asset at a pre-determined price on or before a specific date.

Question 3

A ________ option is an option to purchase a specified number of shares of a stock on or before some future date at a specified price, whereas a ________ option is an option to sell a specified number of shares of a stock on or before some future date at a specified price. ________ are purchased if the stock price is expected to fall.
A) put; call; Puts
B) call; put; Puts
C) put; call; Calls
D) call; put; Calls

Accepted Answer

A call option gives the holder the right to buy a stock at a specified price, while a put option gives the holder the right to sell a stock at a specified price. Puts are bought when a decline in the stock price is anticipated.

Question 4

Options are a special type of security that provides the holder with the right to purchase or sell specified assets at a stated price on or before a set expiration date.

Accepted Answer

This is an accurate description of options.

Question 5

If an investor buys a 100-share call option for $250 with an exercise price of $60 and the underlying price per share of the stock at expiration is $66, what is the amount of profit or loss, ignoring brokerage fees?
A) There would be a profit of $350.
B) There would be a profit of $600.
C) There would be a loss of $350.
D) There would be a loss of $250.

Accepted Answer

The profit is calculated as (Selling Price - Exercise Price) * Number of Shares - Cost of Option = ($66 - $60) * 100 - $250 = $350.

Question 6

The option buyer who expects a stock price to decline will purchase
A) a call.
B) a warrant.
C) a put.
D) a convertible bond.

Accepted Answer

An option buyer who expects a stock price to decline will purchase a put option, which gives them the right, but not the obligation, to sell the underlying stock at a predetermined price (strike price) before a certain expiration date. This allows the buyer to profit if the stock price decreases below the strike price, as they can sell the stock at a higher price than the current market value. A call option, on the other hand, is purchased by someone who expects the stock price to increase. A warrant is similar to an option, but it is typically issued by a company and gives the holder the right to purchase company stock at a certain price. A convertible bond allows the bondholder to convert their bond into a predetermined number of shares of the company's stock, which is not necessarily related to the stock's price movement.

Question 7

If an investor buys a 100-share call option for $300 with an exercise price of $30 and the underlying price per share of the stock at expiration is $32, what is the amount of profit or loss, ignoring brokerage fees?
A) There would be a profit of $200.
B) There would be a profit of $100.
C) There would be a loss of $100.
D) There would be a loss of $300.

Accepted Answer

The answer of If an investor buys a 100-share call...

Question 8

A firm can raise capital by issuing securities such as convertibles and warrants but a firm has nothing to do with the creation of options to raise capital.

Accepted Answer

Options are derivatives traded between investors in the market, and firms do not issue options to raise capital. Convertibles and warrants, on the other hand, are issued by firms directly as a means to raise funds.

Question 9

Call options are purchased with the expectation that the market price of the underlying security will rise while put options are purchased with the expectation that the market price of the underlying security will fall.

Accepted Answer

This statement is true as call options give the buyer the right to buy the underlying security at a specified price (strike price), indicating an expectation of a price increase. Conversely, put options give the buyer the right to sell the underlying security at a specified price, indicating an expectation of a price decrease.

Question 10

The dominant organized options exchange is the
A) over-the-counter exchange.
B) Chicago Board Options Exchange.
C) American Stock Exchange.
D) New York Stock Exchange.

Accepted Answer

The Chicago Board Options Exchange (CBOE) is the dominant organized options exchange, founded in 1973. It is the world's largest options market and offers trading in a wide range of options contracts on various underlying assets, including stocks, indexes, and ETFs. Currently, the CBOE is a subsidiary of Cboe Global Markets, Inc.

Question 11

The available options of the firm with an overhanging issue to finance the call include all of the following EXCEPT
A) selling additional debt resulting in a higher debt ratio.
B) using current retained earnings.
C) selling additional common equity resulting in less dilution of EPS.
D) selling additional preferred stock resulting in higher financial leverage.

Accepted Answer

Selling additional common equity would result in more dilution of EPS, not less.

Question 12

In the financial statement of the firm, puts and calls
A) determine cash management policy.
B) influence the capital structure decision.
C) affect bond quality.
D) have no influence.

Accepted Answer

Puts and calls have no influence on the financial statement of the firm, as they are generally not included in the statement.

Question 13

The dominant organized options exchange in which options are traded is the Chicago Board Options Exchange (CBOE).

Accepted Answer

The Chicago Board Options Exchange (CBOE) is indeed the dominant organized options exchange in which options are traded.

Question 14

For puts and calls, the exercise price is called
A) the expected value.
B) the market price.
C) the striking price.
D) the option price.

Accepted Answer

The exercise price is the price at which the underlying asset can be bought or sold, depending on the type of option. This price is also known as the striking price. Therefore, option C is the correct choice. The other options (expected value, market price, and option price) do not accurately describe the exercise price of an option.

Question 15

Call options are purchased with the expectation that the market price of the underlying security will fall while put options are purchased with the expectation that the market price of the underlying security will rise.

Accepted Answer

The statements in the question are incorrect. Call options are purchased with the expectation that the market price of the underlying security will rise, while put options are purchased with the expectation that the market price of the underlying security will fall.

Question 16

A firm can raise capital by issuing securities such as convertibles, warrants, calls and puts.

Accepted Answer

A firm typically raises capital by issuing securities like stocks and bonds, not options like calls and puts, which are financial derivatives.

Question 17

A call option is an option to sell a specified number of shares of a stock on or before some future date at a stated price.

Accepted Answer

A call option is an option to BUY a specified number of shares of a stock on or before some future date at a stated price.

Question 18

The option buyer who expects a stock price to decline will purchase a put option.

Accepted Answer

A put option gives the buyer the right to sell a stock at a specific price (strike price) before the option expires. If the stock price declines below the strike price, the buyer can sell the stock at a higher price than the current market price, thereby profiting from the decline in the stock price. Therefore, purchasing a put option is a way for an investor to make a profit if they expect a stock price to decline.

Question 19

An investor is considering buying 500 shares of ABC Company at $32 per share. Analysts agree that the firm's stock price may increase to $45 per share in the next four months. As an alternative, the investor could purchase a 120-day call option at a striking price of $30 for $5,000. What profit would the investor realize if the stock price increased to $42 per share?
A) $0
B) $1,000
C) $4,000
D) $6,000

Accepted Answer

If the investor buys 500 shares at $32 per share, the total investment will be 500 x $32 = $16,000.

If the stock price increases to $42 per share, the value of the shares will be 500 x $42 = $21,000. The profit will be $21,000 - $16,000 = $5,000.

If the investor buys a call option, the initial investment will be $5,000.

If the stock price increases to $42 per share, the value of the option will be (500 x ($42 - $30)) - $5,000 = $3,500.

The profit will be $3,500 - $5,000 = -$1,500. Therefore, the best choice is to buy the 500 shares of ABC Company at $32 per share as it would result in a profit of $1,000.

Question 20

All of the following are true of calls and puts EXCEPT
A) options are issued by businesses.
B) the presence of options trading in the firm's stock could, by increasing trading activity, stabilize the firm's share price in the marketplace.
C) options are not a source of funding to the corporation.
D) the financial manager of a corporation has very little need to deal with options.

Accepted Answer

Options are not issued by businesses; they are financial instruments traded on exchanges, and their existence does not involve the issuing company directly.

Quiz 17: Hybrid and Derivative Securities

Which of the following statements about put and call options is false?

Options are a special type of security that provides the holder with the right to purchase or sell specified assets at a stated price on or before a set expiration date.

If an investor buys a 100-share call option for $250 with an exercise price of $60 and the underlying price per share of the stock at expiration is $66, what is the amount of profit or loss, ignoring brokerage fees?

The option buyer who expects a stock price to decline will purchase

If an investor buys a 100-share call option for $300 with an exercise price of $30 and the underlying price per share of the stock at expiration is $32, what is the amount of profit or loss, ignoring brokerage fees?

A firm can raise capital by issuing securities such as convertibles and warrants but a firm has nothing to do with the creation of options to raise capital.

Call options are purchased with the expectation that the market price of the underlying security will rise while put options are purchased with the expectation that the market price of the underlying security will fall.

The dominant organized options exchange is the

The available options of the firm with an overhanging issue to finance the call include all of the following EXCEPT

In the financial statement of the firm, puts and calls

The dominant organized options exchange in which options are traded is the Chicago Board Options Exchange (CBOE).

For puts and calls, the exercise price is called

Call options are purchased with the expectation that the market price of the underlying security will fall while put options are purchased with the expectation that the market price of the underlying security will rise.

A firm can raise capital by issuing securities such as convertibles, warrants, calls and puts.

A call option is an option to sell a specified number of shares of a stock on or before some future date at a stated price.

The option buyer who expects a stock price to decline will purchase a put option.

All of the following are true of calls and puts EXCEPT