Question 1

A share is a ________ on the value of assets of the firm with an exercise price equal to the ________.

Accepted Answer

A share can be viewed as a call option on the firm's assets, with the exercise price being the face value of the debt outstanding. This is because shareholders have the right, but not the obligation, to "buy" the firm from the bondholders by paying off the debt, similar to how a call option gives the holder the right to buy an asset at a specified price.

Question 2

A protective put written on a portfolio (rather than a single share)is known as

Accepted Answer

A protective put written on a portfolio is a strategy known as portfolio insurance. It involves buying a put option on a portfolio to protect against a decline in its value. This strategy is commonly used by institutional investors and fund managers.

Question 3

Consider the following equation: C = P + S - PV(K)- PV(Div)
In this equation, what does the term C represent?

Accepted Answer

The term C in the equation represents the value of the call option. The other terms in the equation (P, S, PV(K), PV(Div)) represent the price of the underlying stock, the exercise price of the option, the present value of the exercise price, and the present value of the dividends, respectively. Therefore, the equation is used to calculate the value of a call option based on these inputs.

Question 4

Suppose you are looking to exploit opportunities in the options markets. The price of a call option on Massive Industries with a maturity of one year and an exercise price of $150 is $15, and the share price is $140. What should the price of a put option be to preclude profitable opportunities? The risk-free rate of interest is 5%.

Accepted Answer

According to the put-call parity, C + PV(X) = P + S, where C is the call price, PV(X) is the present value of the exercise price, P is the put price, and S is the stock price. Solving for P: P = C + PV(X) - S = $15 + ($150 / 1.05) - $140 = $17.86.

Question 5

A share can be thought of as a call option on the assets of the firm with an exercise price equal to the face value of debt outstanding.

Accepted Answer

A share can be thought of as a call option on the assets of the firm because the shareholders have the right, but not the obligation, to "buy" the firm from the creditors by paying off the debt, which acts as the exercise price. If the firm's assets are worth more than the debt, shareholders will exercise this "option" by ensuring the firm's obligations are met, effectively retaining ownership of the remaining assets.

Question 6

According to put-call parity, which of the following would cause the value of a call option to decrease?

Accepted Answer

According to put-call parity, the value of a call option is directly proportional to the put price. Therefore, a decrease in the put price would cause the value of the call option to decrease.

Question 7

Consider the following equation: C = P + S - PV(K)- PV(Div)
In this equation, what does the term S represent?

Accepted Answer

S represents the current share price in the given equation. This equation is used in financial models to calculate the value of a call option, where C is the call option value, P is the present value of the exercise price, S is the current share price, PV(K) represents the present value of the strike price, and PV(Div) represents the present value of dividends.

Question 8

Which of the following statements is FALSE?

Accepted Answer

A share is more accurately described as a call option on the assets of the firm with an exercise price equal to the value of debt outstanding, not a put option.

Question 9

Consider the following equation: C = P + S - PV(K)- PV(Div)
In this equation, what does the term K represent?

Accepted Answer

K represents the exercise price of the option. This is because PV(K) refers to the present value of the exercise price of the option, which is subtracted from the sum of P (the present value of the expected payoff from the underlying asset), S (the present value of any expected cash flows not related to the underlying asset), and PV(Div) (the present value of any expected dividends from the underlying asset). Therefore, K cannot represent the current share price, the price of a zero-coupon bond, or the value of the call option.

Question 10

A(n)________ in the volatility of assets of the firm benefits ________ at a cost to debt holders.

Accepted Answer

An increase in the volatility of assets of the firm benefits equity holders because it increases the potential upside of their investment, while increasing the risk borne by debt holders who have a fixed claim.

Question 11

Equity holders have an incentive to ________ the volatility of a firm's assets because they benefit from such an increase at a cost to ________.

Accepted Answer

Equity holders benefit from an increase in the volatility of a firm's assets as it can lead to higher potential returns for them. However, this increase in volatility can also lead to higher risk which affects the value of the firm, which will negatively impact debt holders as they have a fixed rate of return regardless of the company's performance. Thus, equity holders have an incentive to increase the volatility of the firm's assets at a cost to debt holders.

Question 12

Luther Industries is currently trading for $47 per share. The share pays no dividends. A one-year European call option on Luther with an exercise price of $45 is currently trading for $7.45. If the risk-free interest rate is 6% per year, then calculate the price of a one-year European put option on Luther with an exercise price of $45.
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Accepted Answer

The answer of Luther Industries is currently trading for $47...

Question 13

Debt holders can be thought as owning the firm but having ________ a call option on the assets of the firm with an exercise price equal to the ________.

Accepted Answer

Debt holders can be thought of as owning the firm but having sold a call option on the assets of the firm with an exercise price equal to the face value of the debt outstanding. This is because if the firm's assets exceed the debt, equity holders will "exercise" their option to take the residual value after debt is paid.

Question 14

The relationship that gives the price of a call option in terms of the price of a put option plus the price of the underlying, non-dividend paying share minus the present value of the exercise price is known as

Accepted Answer

The relationship described in the question is known as put-call parity, which states that the price of a European call option is equal to the price of a European put option plus the present value of the exercise price, minus the current price of the underlying asset. This relationship holds only for European options on non-dividend paying stocks.

Question 15

Luther Industries is currently trading for $27 per share. The share pays no dividends. A one-year European put option on Luther with an exercise price of $30 is currently trading for $2.60. If the risk-free interest rate is 6% per year, then the price of a one-year European call option on Luther with an exercise price of $30 will be closest to:

Accepted Answer

Using the put-call parity for European options: C - P = S - PV(K), where C is the call price, P is the put price, S is the stock price, and PV(K) is the present value of the strike price. Here, C - 2.60 = 27 - 30/(1.06), solving for C gives approximately $1.30.

Quiz 20: Option Applications and Corporate Finance

A share is a on the value of assets of the firm with an exercise price equal to the .

A protective put written on a portfolio (rather than a single share) is known as

Consider the following equation: C = P + S - PV(K) - PV(Div) In this equation, what does the term C represent?

A share can be thought of as a call option on the assets of the firm with an exercise price equal to the face value of debt outstanding.

According to put-call parity, which of the following would cause the value of a call option to decrease?

Consider the following equation: C = P + S - PV(K) - PV(Div) In this equation, what does the term S represent?

Which of the following statements is FALSE?

Consider the following equation: C = P + S - PV(K) - PV(Div) In this equation, what does the term K represent?

A(n) in the volatility of assets of the firm benefits at a cost to debt holders.

Equity holders have an incentive to the volatility of a firm's assets because they benefit from such an increase at a cost to .

Debt holders can be thought as owning the firm but having a call option on the assets of the firm with an exercise price equal to the .

The relationship that gives the price of a call option in terms of the price of a put option plus the price of the underlying, non-dividend paying share minus the present value of the exercise price is known as

Quiz 20: Option Applications and Corporate Finance

A share is a ________ on the value of assets of the firm with an exercise price equal to the ________.

A protective put written on a portfolio (rather than a single share) is known as

Consider the following equation: C = P + S - PV(K) - PV(Div) In this equation, what does the term C represent?

A share can be thought of as a call option on the assets of the firm with an exercise price equal to the face value of debt outstanding.

According to put-call parity, which of the following would cause the value of a call option to decrease?

Consider the following equation: C = P + S - PV(K) - PV(Div) In this equation, what does the term S represent?

Which of the following statements is FALSE?

Consider the following equation: C = P + S - PV(K) - PV(Div) In this equation, what does the term K represent?

A(n) ________ in the volatility of assets of the firm benefits ________ at a cost to debt holders.

Equity holders have an incentive to ________ the volatility of a firm's assets because they benefit from such an increase at a cost to ________.

Debt holders can be thought as owning the firm but having ________ a call option on the assets of the firm with an exercise price equal to the ________.

The relationship that gives the price of a call option in terms of the price of a put option plus the price of the underlying, non-dividend paying share minus the present value of the exercise price is known as

A share is a on the value of assets of the firm with an exercise price equal to the .

A(n) in the volatility of assets of the firm benefits at a cost to debt holders.

Equity holders have an incentive to the volatility of a firm's assets because they benefit from such an increase at a cost to .

Debt holders can be thought as owning the firm but having a call option on the assets of the firm with an exercise price equal to the .