Exam 22: Options and Corporate Finance

Suppose XYZ is priced at $125 a share,has a call with an exercise price of $150,has two months to expiration,and costs $0.125 per contract. Why do you suppose investors would be willing to purchase a call that is so far out of the money?

Suppose your wealthy Aunt Minnie has asked you to manage her large stock portfolio. You would like to buy and/or sell options on many of the stocks she owns. Describe the types of options you would buy or sell,as well as your rationale,given the following circumstances: a. Aunt Minnie owns 10,000 shares of IBM common stock. You believe it is going to fall in price,but she won't let you sell it because her late husband told her never to let it go. How do you protect her from the impending price decline? b. Your analysis suggests that the common stock of Jet-Electro is poised to increase in value sharply over the next year. Aunt Minnie doesn't want to buy any of the stock,but does want you to use options to profit if the price rises. What do you do? c. Although Aunt Minnie doesn't want you to sell any of the stocks she owns,she would like you to use options to generate a little extra income. How might you do this? Looking at each option,we see:

The value of a call increases when: I. the time to expiration increases. II) the stock price increases. III) the risk-free rate of return increases. IV) the volatility of the price of the underlying stock increases.

If a call has a positive intrinsic value at expiration the call is said to be:

You wrote ten call option contracts on JIG stock with a strike price of $41 and an option price of $.60. What is your net gain or loss on this investment if the price of JIG is $46.05 on the option expiration date?

What is the intrinsic value of the August 25 call?

You can realize the same value as that derived from stock ownership if you:

You sold ten put option contracts on PLT stock with an exercise price of $31.20 and an option price of $1.20. Today,the option expires and the underlying stock is selling for $33 a share. Ignoring trading costs and taxes,what is your total profit or loss on this investment?

You purchased six TJH call option contracts with a strike price of $40 when the option was quoted at $2. The option expires today when the value of TJH stock is $43. Ignoring trading costs and taxes,what is your total profit or loss on your investment?

The lower bound of a call option:

GS,Inc. stock is selling for $28 a share. A 3-month call on GS stock with a strike price of $30 is priced at $1.50. Risk-free assets are currently returning 0.3% per month. What is the price of a 3-month put on GS stock with a strike price of $30?

Shareholders in a leveraged firm might wish to accept a negative net present value project if:

The market price of ABC stock has been very volatile and you think this volatility will continue for a few weeks. Thus,you decide to purchase a one-month call option contract on ABC stock with a strike price of $25 and an option price of $1.50. You also purchase a one-month put option on ABC stock with a strike price of $25 and an option price of $.70. What will be your total profit or loss on these option positions if the stock price is $24.60 on the day the options expire?

An out-of-the-money call option is one that:

What are the upper and lower bounds for an American call option? Explain what would happen in each case if the bound was violated.