Exam 8: Financial Options and Applications in Corporate Finance

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 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.

If a stock's price is above the strike price of a call option written on the stock, then the exercise value is equal to the stock price minus the strike price.If the stock price is below the strike price, the exercise value of the call option is zero.

An analyst wants to use the Black-Scholes model to value call options on the stock of Heath Corporation based on the following data: ?The price of the stock is $40. ?The strike price of the option is $40. ?The option matures in 3 months (t = 0.25). ?The standard deviation of the stock's returns is 0.40, and the variance is 0.16. ?The risk-free rate is 6%. Given this information, the analyst then calculated the following necessary components of the Black-Scholes model: ?D₁ = 0.175 ?D₂ = ?0.025 ?N(d₁) = 0.56946 ?N(d₂) = 0.49003 N(d₁) and N(d₂) represent areas under a standard normal distribution function.Using the Black-Scholes model, what is the value of the call option?

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?

Suppose you believe that Basso Inc.'s stock price is going to increase from its current level of $22.50 sometime during the next 5 months.For $3.10 you can buy a 5-month call option giving you the right to buy 1 share at a price of $25 per share.If you buy this option for $3.10 and Basso's stock price actually rises to $45, what would your pre-tax net profit be?

Which of the following statements is CORRECT?

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.

Which of the following statements is CORRECT?

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

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.

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.

Suppose you believe that Florio Company's stock price is going to decline from its current level of $82.50 sometime during the next 5 months.For $5.10 you could buy a 5-month put option giving you the right to sell 1 share at a price of $85 per share.If you bought this option for $5.10 and Florio's stock price actually dropped to $60, what would your pre-tax net profit be?

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 of the following statements is CORRECT?

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?

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.

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.

The current price of a stock is $50, the annual risk-free rate is 6%, and a 1-year call option with a strike price of $55 sells for $7.20.What is the value of a put option, assuming the same strike price and expiration date as for the call option?

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