Question 1

If the market is in equilibrium, then a call option contract 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

If the market is in equilibrium, the price of the call option will reflect not only the difference between the current stock price and the option's strike price, but also other factors such as time remaining until expiration, volatility of the stock, and interest rates. The price of the call option may be higher or lower than the difference between the stock price and strike price depending on these other factors.

Question 2

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 (a call option) may still have time value even if the current price of the stock is below the strike price, as there is potential for the stock price to rise above the strike price before the option expires.

Question 3

Which term refers to the type of options sold by an investor who writes standard call options against stock held in his or her portfolio?
A) in-the-money
B) naked
C) covered
D) out-of-the-money

Accepted Answer

Writing standard call options against stock held in one's portfolio is called "covered call writing". This means that the investor has enough shares of the underlying stock to deliver if the options are exercised. This is in contrast to "naked" call writing, where the investor sells call options without owning the underlying stock.

Question 4

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

Accepted Answer

This statement accurately describes the strike price when it is applied to warrants.

Question 5

The exercise value of a call option 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 statement is true. The exercise value of a call option is calculated by subtracting the strike price from the current price of the underlying stock. If the stock's price is lower than the strike price, the exercise value is zero.

Question 6

Deeble Construction Co.'s 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 3 months. Which statement regarding the value of these options is true?
A) The options with the $25 strike price will sell for less than the options with the $35 strike price.
B) The options with the $25 strike price have an exercise value greater than $5.
C) The options with the $35 strike price have an exercise value greater than $0.
D) If Deeble's stock price rose by $5, the exercise value of the options with the $25 strike price would also increase by $5.

Accepted Answer

The answer of Deeble Construction Co.'s stock is trading at...

Question 7

Call options on XYZ Corporation's common stock trade in the market. Which statement regarding XYZ Corporation's options is true, other things held constant?
A) The price of these call options is likely to rise if XYZ's stock price rises.
B) The higher the strike price on XYZ's options, the higher the option's price will be.
C) Assuming the same strike price, an XYZ call option that expires in 1 month will sell at a higher price than one that expires in 3 months.
D) If XYZ's stock price stabilizes (becomes less volatile), then the price of its options will increase.

Accepted Answer

Call options give the holder the right to buy the underlying stock at a fixed price (strike price) before a specified expiration date. As the stock price of XYZ Corporation rises, the call option becomes more valuable as there is a greater chance of the stock price rising above the strike price before expiration. Therefore, the price of the call options is likely to rise if XYZ's stock price rises.

Option B is incorrect because the opposite is true - the higher the strike price on an option, the lower the option's price, assuming all other factors remain constant.

Option C is incorrect because the opposite is true - assuming the same strike price, an XYZ call option that expires in 3 months will sell at a higher price than one that expires in 1 month. This is because the longer the time until expiration, the more time there is for the stock price to potentially rise above the strike price.

Option D is incorrect because the opposite is true - if XYZ's stock price stabilizes and becomes less volatile, the price of its options will decrease because there is a lower chance of the stock price moving significantly above the strike price before expiration.

Question 8

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, particularly call options, can become more valuable with increased volatility because the potential for large price swings increases the chance of the option being in the money before expiration.

Question 9

As the price of a stock rises above the strike price, the value investors are willing to pay for a call option increases because (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 a stock rises above the strike price, the potential profit from exercising a call option increases, making it more valuable to investors. Additionally, the higher stock price increases the likelihood that the option will be in the money when it expires, further increasing its value. Therefore, as the stock price goes up, the demand and price for call options tend to increase as well.

Question 10

GCC Corporation is planning to issue options to its key employees, and it is now discussing the terms to be set on those options. Which circumstance would decrease the value of the options, other things held constant?
A) GCC's stock price becomes more risky (higher variance).
B) The exercise price of the option is increased.
C) The life of the option is increased, i.e., the time until it expires is lengthened.
D) The government takes actions that increase the risk-free rate.

Accepted Answer

Increasing the exercise price of the option would decrease the value of the option since the option becomes less valuable as the exercise price becomes higher. The other options, such as an increase in stock price volatility, longer option life, or an increase in the risk-free rate, would increase the value of the option, other things held constant.

Question 11

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 the correct definition of an option. It is a type of derivative contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price within a certain time frame.

Question 12

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

The answer of If we define the "premium" on an...

Question 13

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

The put-call parity relationship does not imply that put and call options must sell at the same price, but rather it defines a specific relationship between the prices of European put and call options with the same strike price and expiration date, involving the stock price and the strike price discounted at the risk-free rate.

Question 14

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

Switching to a 100% payout policy means the company will distribute all its earnings as dividends, leaving less reinvestment in the business for growth. This could reduce the stock's future price potential, negatively affecting the value of long-term options.

Question 15

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 before expiration is generally more valuable because it has more time to become profitable due to potential changes in the underlying asset's price.

Question 16

Which term refers to an option that gives the holder the right to sell a stock at a specified price at some future time?
A) a call option
B) a put option
C) a naked option
D) a covered option

Accepted Answer

A put option gives the holder the right to sell a stock at a specified price (strike price) at some point in the future. On the other hand, a call option gives the holder the right to buy a stock at a specified price (strike price) at some point in the future. Therefore, the correct choice is B.

Question 17

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 incorrect. The term "strike price" is commonly used when discussing both financial options and convertibles.

Question 18

Warner Motors' stock is trading at $20 a share. Call options that expire in three months with a strike price of $20 sell for $1.50. What will happen if the stock price increases 10%, to $22 a share?
A) The price of the call option will increase by $2.
B) The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10%.
C) The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%.
D) The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10%.

Accepted Answer

Since the stock price has increased to $22 a share, the call option is now in the money. The price of the call option will increase but by less than $2 because the call option is not yet at the expiration date. The percentage increase in price will be more than 10% because the underlying stock has increased by 10% and the call option is now in the money.

Question 19

Which of the following does NOT affect the value of an option, other things held constant?
A) the strike price
B) the variability of the stock price
C) the option's time to maturity
D) the stock beta

Accepted Answer

The stock beta is a measure of systematic risk and does not directly affect the value of an option. The strike price, the variability of the stock price, and the option's time to maturity all have a direct impact on the value of an option.

Question 20

Which of the following statements is correct?
A) Put options give investors the right to buy a stock at a certain strike price before a specified date.
B) Call options give investors the right to sell a stock at a certain strike price before a specified date.
C) LEAPS are very short-term options that were created relatively recently and now trade in the market.
D) An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.

Accepted Answer

Option holders do not receive dividends unless they exercise their options and own the stock before the ex-dividend date.

Quiz 19: Financial Options and Applications in Corporate Finance

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

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.

Which term refers to the type of options sold by an investor who writes standard call options against stock held in his or her portfolio?

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

The exercise value of a call option 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.

Deeble Construction Co.'s 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 3 months. Which statement regarding the value of these options is true?

Call options on XYZ Corporation's common stock trade in the market. Which statement regarding XYZ Corporation's options is true, other things held constant?

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.

As the price of a stock rises above the strike price, the value investors are willing to pay for a call option increases because (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.

GCC Corporation is planning to issue options to its key employees, and it is now discussing the terms to be set on those options. Which circumstance would decrease the value of the options, other things held constant?

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.

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.

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.

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

Which term refers to an option that gives the holder the right to sell a stock at a specified price at some future time?

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

Warner Motors' stock is trading at $20 a share. Call options that expire in three months with a strike price of $20 sell for $1.50. What will happen if the stock price increases 10%, to $22 a share?

Which of the following does NOT affect the value of an option, other things held constant?

Which of the following statements is correct?