Question 1

The most correct method to determine the current value of future payoffs would be to:
A)take the discounted expected value at the risk-free rate.
B)take the expected value using the probabilities.
C)take the discounted expected value using the risk-neutral probabilities and the risk free rate.
D)sum the payoffs discounted at the risk free rate.
E)None of the above.

Accepted Answer

The most correct method to determine the current value of future payoffs is to take the discounted expected value using the risk-neutral probabilities and the risk-free rate. This approach takes into account both the expected payoff and the degree of risk involved in the investment. It is widely used in financial derivatives pricing and is considered the most accurate method.

Question 2

By rewarding executives with large option positions,corporations:
A)cause the executives to hold highly undiversified portfolios.
B)put the firm in a risky position to pay off the options.
C)cause the value of the stock to fall because the options are theft.
D)are really valueless because most options are never exercised.
E)None of the above.

Accepted Answer

By rewarding executives with large option positions, corporations cause the executives to hold highly undiversified portfolios. This is because the executives may be incentivized to hold onto the company's stock rather than diversifying their investments, in order to maximize the value of their options. This can increase their exposure to risk, as the value of their compensation is tied to the performance of a single company rather than a diversified portfolio.

Question 3

An example of a special option is:
A)an executive stock option.
B)the embedded option in a start-up company.
C)the option in simple business contracts.
D)the option to shut down and reopen a project.
E)All of the above.

Accepted Answer

E

Question 4

Which of the following statements is true?
A)The Black Scholes model is the simplest to use and best used for complex situations.
B)The binomial model does not handle options with dividend payments prior to expiration date.
C)The Black Scholes model adequately handles the valuation of an American put.
D)The binomial model is better for complex situations and is the simplest tool to use.
E)The Black Scholes model is simpler to use,but for complex situations,the binomial model is the necessary tool.

Accepted Answer

The answer of Which of the following statements is true?
A)The...

Question 5

Rejecting an investment today forever may not be a good choice because:
A)the size of the firm will decline.
B)there are always errors in the estimation of NPVs.
C)the option value is negative.
D)the company's foregoing the future rights or option to the investment.
E)None of the above.

Accepted Answer

The answer of Rejecting an investment today forever may not...

Question 6

The volatility of interest rates can affect the value of the project by:
A)increasing the value as volatility increases.
B)increasing the value as volatility decreases.
C)decreasing the value as volatility increases.
D)interest rate volatility does not affect value.
E)None of the above.

Accepted Answer

The answer of The volatility of interest rates can affect...

Question 7

Options are granted to top corporate executives because:
A)executives will make better business decisions in line with benefiting the shareholders.
B)executive pay is at risk and linked to firm performance.
C)options are tax-efficient and taxed only when they are exercised.
D)All of the above.
E)None of the above.

Accepted Answer

Options are granted to top corporate executives for a combination of reasons. Firstly, executives are expected to make decisions that are in the best interest of the company and its shareholders, and granting them options aligns their interests with those of shareholders. Secondly, tying pay to firm performance through the use of options allows executives to have "skin in the game" and be incentivized to work towards improving the company's financial performance. Finally, options are tax-efficient as they are only taxed when exercised, making them an attractive form of compensation for both executives and shareholders.

Question 8

What are the u,the up state multiplier,and d,the down state multiplier,if there are monthly intervals and the standard deviation is .38?
A)1.1159;.8961
B).0317;31.5789
C).0317;.9683
D).2193;.7807
E)None of the above

Accepted Answer

The answer of What are the u,the up state multiplier,and...

Question 9

The NPV approach must be:
A)augmented by added analysis if there are a few embedded options.
B)augmented by added analysis if a decision has significant embedded options.
C)jettisoned if there are any embedded options.
D)computed carefully to identify the options.
E)None of the above.

Accepted Answer

The NPV approach can be used to value projects with embedded options, but if those options have a significant impact on the project's value or decision-making process, additional analysis should be conducted to fully understand their potential impact. Therefore, the NPV approach must be augmented by added analysis if a decision has significant embedded options.

Question 10

If a project has optionality:
A)the shorter the available life of the project the less valuable the project is.
B)the longer the available life of the project the less valuable the project is.
C)the shorter the available life of the project the more valuable the project is.
D)available project life does not change optionality.
E)None of the above.

Accepted Answer

The answer of If a project has optionality:
A)the shorter the...

Question 11

The call option on a dividend paying stock compared to a non-dividend paying stock is:
A)more valuable because of the extra dividend payment.
B)equal in value because cash dividends are paid on stock only.
C)less valuable because cash dividends are paid on stock only.
D)less valuable if the dividend paying stock is in-the-money while the non-dividend paying stock if out-of-the-money.
E)None of the above.

Accepted Answer

The answer of The call option on a dividend paying...

Question 12

The opportunity to defer investing to a later date may have value because:
A)the cost of capital may decline in the near future.
B)certainty may be reduced in the future.
C)investment costs fluctuate in time.
D)All of the above.
E)None of the above.

Accepted Answer

The answer of The opportunity to defer investing to a...

Question 13

The risk-neutral probabilities for an asset,with a current value equal to the present value of future payoffs are:
A)given by the probability of each state occurring.
B)given by the value of the underlying asset under good news and the risk free rate.
C)given by the value of the underlying asset under good news and bad news.
D)given by the value of the underlying asset under good news,bad news,and the risk free rate.
E)None of the above.

Accepted Answer

The answer of The risk-neutral probabilities for an asset,with a...

Question 14

A firm in the extraction industry whose major assets are cash,equipment and a closed facility may appear to have extraordinary value.This value can be primarily attributed to:
A)the potential sale of the company.
B)the low exercise price held by the shareholders.
C)the option to open the facility when prices rise dramatically.
D)All of the above.
E)None of the above.

Accepted Answer

The extraordinary value of the firm's assets can be primarily attributed to the option to open the facility when prices rise dramatically. This option increases the potential future cash flow of the firm and therefore its value. The potential sale of the company and the low exercise price held by the shareholders may contribute to the firm's value, but they are not the primary factors.

Question 15

Increasing the number of intervals in the binomial model causes the price shift parameters to change.New estimates are related to:
A)the standard deviation of the underlying asset.
B)the up state multiplier equals the standard deviation divided by root n.
C)the number of intervals in a year.
D)All of the above.
E)None of the above.

Accepted Answer

Increasing the number of intervals in the binomial model would lead to a finer partitioning of the time interval, decreasing the length of each time interval. This would effectively increase the number of compounding periods per year, and thus affect the calculation of the up and down price shift parameters. The up state multiplier is equal to the standard deviation divided by the square root of n, where n is the number of intervals. Therefore, as n increases, the up state multiplier would decrease, as the length of the time interval decreases. This means that the standard deviation of the underlying asset would also affect the new estimates. Hence, all the options A, B and C are correct.

Question 16

A financial manager who does not follow the general constraints of the NPV rule may:
A)accept a negative NPV project for fear of losing an investment opportunity.
B)accept a marginally acceptable NPV project limiting the corporation's ability to choose a competing project.
C)not consider all options available in a capital budgeting decision.
D)not take a positive NPV project even if the NPV is adequate reward to forego the option.
E)All of the above.

Accepted Answer

A financial manager who does not follow the general constraints of the NPV rule may do any of the mentioned actions. They may accept a negative NPV project for fear of losing an investment opportunity, accept a marginally acceptable NPV project limiting the corporation's ability to choose a competing project, or not consider all options available in a capital budgeting decision. Additionally, they may not take a positive NPV project even if the NPV is an adequate reward to forego the option.

Question 17

Executives cannot exercise their options for a fixed period of time.This is the:
A)investing period.
B)freeze-out period.
C)valuation period.
D)guaranteed growth period.
E)strike period.

Accepted Answer

The answer of Executives cannot exercise their options for a...

Question 18

Which of the following is not part of the Black Scholes option pricing model?
A)Standard deviation
B)Time to maturity
C)Exercise price
D)Par value of the company's stock
E)Interest rate

Accepted Answer

The Black Scholes option pricing model does not take into consideration the par value of the company's stock. It factors in standard deviation, time to maturity, exercise price, and interest rate.

Question 19

The value of the options awarded executives is much less than face value to the executives because:
A)the value to the executive depends on the stock price being greater than the exercise price.
B)the options must be held beyond the freeze-out period.
C)a highly undiversified portfolio can have a large drop in value with high variance stocks.
D)All of the above.
E)None of the above.

Accepted Answer

The answer of The value of the options awarded executives...

Question 20

The option to abandon is:
A)a real option.
B)usually of little value because of the cost associated with abandonment.
C)irrelevant in capital budgeting analysis.
D)nearly always less relevant the option to expand.
E)All of the above.

Accepted Answer

The option to abandon is a real option, meaning it provides the holder with the right to make a certain decision in the future based on market conditions. While there may be costs associated with abandonment, it is still a valid consideration in capital budgeting analysis. The relevance of the option to abandon depends on the specific project and its potential future cash flows. It may be more or less relevant than the option to expand depending on the circumstances.

Quiz 23: Options and Corporate Finance: Extensions and Applications

The most correct method to determine the current value of future payoffs would be to:

By rewarding executives with large option positions,corporations:

An example of a special option is:

Which of the following statements is true?

Rejecting an investment today forever may not be a good choice because:

The volatility of interest rates can affect the value of the project by:

Options are granted to top corporate executives because:

What are the u,the up state multiplier,and d,the down state multiplier,if there are monthly intervals and the standard deviation is .38?

The NPV approach must be:

If a project has optionality:

The call option on a dividend paying stock compared to a non-dividend paying stock is:

The opportunity to defer investing to a later date may have value because:

The risk-neutral probabilities for an asset,with a current value equal to the present value of future payoffs are:

A firm in the extraction industry whose major assets are cash,equipment and a closed facility may appear to have extraordinary value.This value can be primarily attributed to:

Increasing the number of intervals in the binomial model causes the price shift parameters to change.New estimates are related to:

A financial manager who does not follow the general constraints of the NPV rule may:

Executives cannot exercise their options for a fixed period of time.This is the:

Which of the following is not part of the Black Scholes option pricing model?

The value of the options awarded executives is much less than face value to the executives because:

The option to abandon is: