Question 1

Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock, provided the strike prices for the put and call are the same.

Accepted Answer

Recognize that if a stock is selling far above the strike price, the call option will be quite valuable, but the put option will be worth very little because the probability is low that the stock's market price will fall below the put's strike price.

Question 2

An option is a contract that gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time.

Accepted Answer

This is a correct description of an option contract.

Question 3

An option that gives the holder the right to sell a stock at a specified price at some future time is

Accepted Answer

A put option gives the holder the right to sell a stock at a specified price at some future time. Out-of-the-money options are options whose exercise price is far from the current stock price, naked options are options that are not covered by an offsetting position, and covered options are options that are covered by an offsetting position, typically the underlying stock. A call option gives the holder the right to buy a stock at a specified price at some future time. Therefore, the best choice is A) a put option, as it accurately describes the given scenario.

Question 4

An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?

Accepted Answer

Selling standard call options against stock held in a portfolio is known as covered call writing. This means that the investor is covering the option by holding the underlying asset, hence the name "covered". Option contracts that are sold without owning the underlying asset are referred to as "naked" options (choice B). Put options (choice A) give the holder the right to sell an underlying asset, while call options give the holder the right to buy an underlying asset. Out-of-the-money (OTM) and in-the-money (ITM) options (choices D and E) refer to the relationship between the strike price of the option and the current market price of the underlying asset.

Question 5

If the market is in equilibrium, then an option must sell at a price that is exactly equal to the difference between the stock's current price and the option's strike price.

Accepted Answer

While the price of an option is influenced by factors such as the underlying stock price, volatility, time to expiration, and interest rates, it does not necessarily have to sell at a price equal to the difference between the current stock price and strike price for the market to be in equilibrium. In fact, options can trade at prices above or below this theoretical value (known as intrinsic value) due to factors such as investor sentiment and supply and demand dynamics.

Question 6

Braddock Construction Co.'s stock is trading at $20 a share.Call options that expire in three months with a strike price of $20 sell for $1.50.Which of the following will occur if the stock price increases 10%, to $22 a share?

Accepted Answer

The intrinsic value of the call option increases from $0 to $2 when the stock price rises to $22. The option price will increase by less than $2 due to time value, but the percentage increase will be more than 10% because the initial option price is $1.50.

Question 7

Cazden Motors' stock is trading at $30 a share.Call options on the company's stock are also available, some with a strike price of $25 and some with a strike price of $35.Both options expire in three months.Which of the following best describes the value of these options?

Accepted Answer

The answer of Cazden Motors' stock is trading at $30...

Question 8

Which of the following statements is CORRECT?

Accepted Answer

An option holder does not have the rights of a stockholder, such as receiving dividends, unless they exercise their option to buy the stock before it goes ex-dividend.

Question 9

The exercise value is also called the strike price, but this term is generally used when discussing convertibles rather than financial options.

Accepted Answer

The statement is false. The exercise value and strike price both refer to the price at which the option can be exercised, regardless of whether it is a financial option or convertible.

Question 10

The exercise value is the positive difference between the current price of the stock and the strike price.The exercise value is zero if the stock's price is below the strike price.

Accepted Answer

This is true because if the stock's price is below the strike price, then there is no benefit to exercising the option, as the investor could simply buy the stock at its current market price instead of paying the higher strike price. Therefore, the exercise value can only be positive if the stock's price is above the strike price.

Question 11

If a company announces a change in its dividend policy from a zero target payout ratio to a 100% payout policy, this action could be expected to increase the value of long-term options (say 5-year options)on the firm's stock.

Accepted Answer

Dividends do not enter into the OPM pricing formula.We would expect the stock of a firm that retains all of its earnings to grow over time due to the reinvestment of its earnings, whereas a firm that retains zero earnings should not grow much if any.therefore, the value of the firm's long-term options should decline if it announces a change from a zero to a 100% payout policy.

Question 12

Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.

Accepted Answer

The time value of money principle suggests that an option with a longer time until expiration is generally more valuable because it has more time to become profitable due to potential changes in the underlying asset's price.

Question 13

As the price of a stock rises above the strike price, the value investors are willing to pay for a call option increases because both (1)the immediate capital gain that can be realized by exercising the option and (2)the likely exercise value of the option when it expires have both increased.

Accepted Answer

As the price of the underlying stock increases, the difference between the strike price and the market price also widens, which means that exercising the call option will result in a greater immediate capital gain. Additionally, the likelihood of the option reaching its exercise value by expiration also increases, further increasing its value. Therefore, both factors contribute to an increase in the value that investors are willing to pay for a call option as the price of the stock rises above the strike price.

Question 14

BLW Corporation is considering the terms to be set on the options it plans to issue to its executives.Which of the following actions would decrease the value of the options, other things held constant?

Accepted Answer

Increasing the exercise price of the option will decrease its value, as the option will be less likely to be profitable for the executive if the stock price does not increase enough to offset the higher exercise price. The other choices would increase the value of the option or have no effect on its value.

Question 15

Which of the following statements is most correct, holding other things constant, for XYZ Corporation's traded call options?

Accepted Answer

The price of call options will generally increase as the stock price increases. Option prices are closely tied to the underlying stock, and a rising stock price makes the option more valuable. All other choices are incorrect. A higher strike price will generally result in a lower option price, a longer expiration time typically leads to a higher option price, a stabilization of the stock price will not necessarily increase option prices, and dividend payments can affect option prices but not in the way described in choice D.

Question 16

Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the

Accepted Answer

The value of an option is determined by several factors, including the underlying stock's price, the risk-free rate, the variability of the stock price (measured by the standard deviation), the option's time to maturity, and the strike price. Therefore, all of the above factors should be considered when determining the value of an option.

Question 17

The strike price is the price that must be paid for a share of common stock when it is bought by exercising a warrant.

Accepted Answer

The strike price represents the price at which a share can be purchased when a warrant is exercised.

Question 18

If we define the "premium" on an option to be the difference between the price at which an option sells and the exercise value (or the difference between the stock's current market price and the strike price), then we would expect the premium to increase as the stock price increases, other things held constant.

Accepted Answer

See Figure 8-1, which shows that the premium becomes smaller and smaller as the price of the stock increases.One factor that produces this result is the fact that the amount of leverage inherent in the option diminishes as the stock price increases.

Question 19

If the current price of a stock is below the strike price, then an option to buy the stock is worthless and will have a zero value.

Accepted Answer

An option to buy a stock may still have some value even if the current price of the stock is below the strike price. This is because there may be some time left until the option expiration and the stock price may increase before then. Additionally, the option may have some intrinsic value if the stock price has moved close to the strike price.

Question 20

Since investors tend to dislike risk and like certainty, the more volatile a stock, the less valuable will be an option to purchase the stock, other things held constant.

Accepted Answer

Options can become more valuable with increased volatility because the potential for the stock to make large moves increases the chances of the option being in the money at expiration.

Quiz 8: Financial options and applications in corporate finance