Question 1

Which one of the following is correct concerning callable bonds?

Accepted Answer

A)  There is an upper bound on the bond's price. 
B)  Callable bond prices are higher than those of comparable straight bonds. 
C)  Their attraction to the issuer increases as interest rates increase. 
D) The bond investor owns the call option. 
A)  There is an upper bound on the bond's price. 
B)  Callable bond prices are higher than those of comparable straight bonds. 
C)  Their attraction to the issuer increases as interest rates increase. 
D) The bond investor owns the call option.

Question 2

A firm is planning to issue a callable bond with a coupon rate of 8% and 10 years to maturity. A straight bond with a similar coupon is priced at $1,000. If the value of the issuer's call option is estimated to be $60, what is the value of the callable bond?

Accepted Answer

A)  $940 
B)  $970 
C)  $1,000 
D) $1,060 
A)  $940 
B)  $970 
C)  $1,000 
D) $1,060

Question 3

The floor of a convertible bond will be the value of the underlying bond.

Accepted Answer

A) True 
 B)False

Question 4

Which one of the following is true for the owner of a call option?

Accepted Answer

A)  The loss potential is unlimited. 
B)  The profit potential is unlimited. 
C)  The premium exceeds the strike price. 
D) There is no expiration date, unless the option is a European call. 
A)  The loss potential is unlimited. 
B)  The profit potential is unlimited. 
C)  The premium exceeds the strike price. 
D) There is no expiration date, unless the option is a European call.

Question 5

Unlike call options, the option to abandon a real asset project does not become more valuable as time to expiration increases.

Accepted Answer

A) True 
 B)False

Question 6

On March 30 you are holding a call option with an exercise price of $60 that will expire on March 31. The closing price of the stock on March 30 is $59. What is the value of your call option?

Accepted Answer

A)  $1 
B)  -$1 
C)  Minimal value 
D) Zero 
A)  $1 
B)  -$1 
C)  Minimal value 
D) Zero

Question 7

Warrants are long-term call options on a company's stock issued by an organized stock exchange.

Accepted Answer

A) True 
 B)False

Question 8

Stock options have been traded on exchanges since:

Accepted Answer

A)  the founding of the New York Stock Exchange. 
B)  options were created in 1946. 
C)  the early part of the 1970s. 
D) just before the stock market crash in 1987. 
A)  the founding of the New York Stock Exchange. 
B)  options were created in 1946. 
C)  the early part of the 1970s. 
D) just before the stock market crash in 1987.

Question 9

What is the option buyer's total profit or loss per share if a call option is purchased for a $5 premium, has a $50 exercise price, and the stock is valued at $53 at expiration?

Accepted Answer

A)  -$5 
B)  -$2 
C)  $3 
D) $8 
A)  -$5 
B)  -$2 
C)  $3 
D) $8

Question 10

An investor who is selling a put option is expecting:

Accepted Answer

A)  stock prices to go up. 
B)  stock prices to go down. 
C)  the put to be exercised. 
D) interest rates to go up. 
A)  stock prices to go up. 
B)  stock prices to go down. 
C)  the put to be exercised. 
D) interest rates to go up.

Question 11

You own a $1,000 face value convertible bond with a coupon rate of 6% that matures in 5 years. The market rate on similar bonds is currently 7%. The conversion ratio is 15.5 and the stock is currently selling for $70 per share. What is the current value of this bond? Justify your answer.

Accepted Answer

Conversion value = 15.5 × $70 = $1,085
S

Question 12

Corporations that attach warrants to their bonds are hoping to:

Accepted Answer

A)  repurchase shares of outstanding stock. 
B)  convert the bonds into stock at a later date. 
C)  increase the value of the bonds. 
D) increase the price of their shares. 
A)  repurchase shares of outstanding stock. 
B)  convert the bonds into stock at a later date. 
C)  increase the value of the bonds. 
D) increase the price of their shares.

Question 13

Which combination of positions will tend to protect the owner from downside risk?

Accepted Answer

A)  Buy the stock and buy a call option 
B)  Sell the stock and buy a call option 
C)  Buy the stock and buy a put option 
D) Buy the stock and sell a put option 
A)  Buy the stock and buy a call option 
B)  Sell the stock and buy a call option 
C)  Buy the stock and buy a put option 
D) Buy the stock and sell a put option

Question 14

Of the following four put options that can be purchased on a stock, which would you expect to have the highest price? (All option months are in the same calendar year.)

Accepted Answer

A)  September put; $65 exercise price 
B)  September put; $75 exercise price 
C)  December put; $65 exercise price 
D) December put; $75 exercise price 
A)  September put; $65 exercise price 
B)  September put; $75 exercise price 
C)  December put; $65 exercise price 
D) December put; $75 exercise price

Question 15

The Financial Accounting Standards Board (FASB) stipulates that companies must use an option valuation model to estimate the fair value of any option grants and then deduct this value when calculating profits.

Accepted Answer

A) True 
 B)False

Question 16

The conversion ratio for a convertible bond equals the:

Accepted Answer

A)  number of interest payments that must be received prior to conversion. 
B)  number of bonds necessary to convert into one share of stock. 
C)  number of shares of stock that can be exchanged for one bond. 
D) floor value beneath which the bond price cannot fall. 
A)  number of interest payments that must be received prior to conversion. 
B)  number of bonds necessary to convert into one share of stock. 
C)  number of shares of stock that can be exchanged for one bond. 
D) floor value beneath which the bond price cannot fall.

Question 17

Under what circumstance will the buyer of a put option be asked to fulfill her obligation?

Accepted Answer

A)  When the stock price has declined below the strike price 
B)  When the stock price has increased above the strike price 
C)  The put buyer has an equal obligation regardless of the relationship between stock and strike prices. 
D) The put buyer has no obligation whatsoever. 
A)  When the stock price has declined below the strike price 
B)  When the stock price has increased above the strike price 
C)  The put buyer has an equal obligation regardless of the relationship between stock and strike prices. 
D) The put buyer has no obligation whatsoever.

Question 18

Generalize the formulas for determining the value of the following four option types: buying a call, buying a put, writing a call, writing a put.

Accepted Answer

Buying a call: Max [(stock price - exerc

Question 19

How does the price of a put option respond to the following changes, other things being equal? Does the put price go up or down?
a. Stock price increases.
b. Exercise price increases.
c. Risk-free interest rate increases.
d. Expiration date of the option is extended.
e. Volatility of the stock price falls.
f. Time passes, so the option's expiration date comes closer.

Accepted Answer

a. Decreases
b. Increases
c. D

Exam 23: Options

Which one of the following is correct concerning callable bonds?

A firm is planning to issue a callable bond with a coupon rate of 8% and 10 years to maturity. A straight bond with a similar coupon is priced at $1,000. If the value of the issuer's call option is estimated to be $60, what is the value of the callable bond?

The floor of a convertible bond will be the value of the underlying bond.

Which one of the following is true for the owner of a call option?

Unlike call options, the option to abandon a real asset project does not become more valuable as time to expiration increases.

On March 30 you are holding a call option with an exercise price of $60 that will expire on March 31. The closing price of the stock on March 30 is $59. What is the value of your call option?

Warrants are long-term call options on a company's stock issued by an organized stock exchange.

Stock options have been traded on exchanges since:

What is the option buyer's total profit or loss per share if a call option is purchased for a $5 premium, has a $50 exercise price, and the stock is valued at $53 at expiration?

An investor who is selling a put option is expecting:

You own a $1,000 face value convertible bond with a coupon rate of 6% that matures in 5 years. The market rate on similar bonds is currently 7%. The conversion ratio is 15.5 and the stock is currently selling for $70 per share. What is the current value of this bond? Justify your answer.

Corporations that attach warrants to their bonds are hoping to:

Which combination of positions will tend to protect the owner from downside risk?

Of the following four put options that can be purchased on a stock, which would you expect to have the highest price? (All option months are in the same calendar year.)

The Financial Accounting Standards Board (FASB) stipulates that companies must use an option valuation model to estimate the fair value of any option grants and then deduct this value when calculating profits.

The conversion ratio for a convertible bond equals the:

Under what circumstance will the buyer of a put option be asked to fulfill her obligation?

Generalize the formulas for determining the value of the following four option types: buying a call, buying a put, writing a call, writing a put.

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Accounting and Finance

Measuring Corporate Performance

The Time Value of Money

Valuing Bonds

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Net Present Value and Other Investment Criteria

Using Discounted Cash-Flow Analysis to Make Investment Decisions

Project Analysis

Introduction to Risk, Return, and the Opportunity Cost of Capital

Risk, Return, and Capital Budgeting

The Weighted-Average Cost of Capital and Company Valuation

Introduction to Corporate Financing

How Corporations Raise Venture Capital and Issue Securities

Debt Policy

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