Question 1

Which of the following statements regarding factors that affect call option prices is CORRECT?

Accepted Answer

A) The longer the time until the call option expires the smaller its value and the smaller its premium. 
B) An option on an extremely volatile stock is worth less than one on a very stable stock. 
C) The price of a call option increases as the risk-free rate increases. 
D) Two call options on the same stock will have the same value even if they have different strike prices. 
E) If you observe that a put option on a stock increases in value, then a call option on that same stock also increases in value. 
A) The longer the time until the call option expires the smaller its value and the smaller its premium. 
B) An option on an extremely volatile stock is worth less than one on a very stable stock. 
C) The price of a call option increases as the risk-free rate increases. 
D) Two call options on the same stock will have the same value even if they have different strike prices. 
E) If you observe that a put option on a stock increases in value, then a call option on that same stock also increases in value.

Question 2

Which of the following statements concerning risk management is NOT CORRECT?

Accepted Answer

A) Risk management can reduce the volatility of cash flows, and this decreases the probability of bankruptcy. 
B) Risk management makes sense for firms directly engaged in activities that involve commodities whose values can be hedged, but it doesn't make much sense for most other firms. 
C) Companies with volatile earnings pay more taxes than companies with more stable earnings due to the treatment of tax credits and the rules governing corporate loss carry-forwards and carry-backs. Therefore, our tax system encourages risk management to stabilize earnings. 
D) Risk management can reduce the likelihood of low cash flows, and therefore reduce the probability of financial distress. 
E) Risk management involves identifying events that could have adverse financial consequences and then taking actions to prevent and/or to minimize the damage caused by these events. 
A) Risk management can reduce the volatility of cash flows, and this decreases the probability of bankruptcy. 
B) Risk management makes sense for firms directly engaged in activities that involve commodities whose values can be hedged, but it doesn't make much sense for most other firms. 
C) Companies with volatile earnings pay more taxes than companies with more stable earnings due to the treatment of tax credits and the rules governing corporate loss carry-forwards and carry-backs. Therefore, our tax system encourages risk management to stabilize earnings. 
D) Risk management can reduce the likelihood of low cash flows, and therefore reduce the probability of financial distress. 
E) Risk management involves identifying events that could have adverse financial consequences and then taking actions to prevent and/or to minimize the damage caused by these events.

Question 3

Which of the following statements is CORRECT?

Accepted Answer

A) Put options give investors the right to buy a stock at a certain exercise price before a specified date. 
B) Call options give investors the right to sell a stock at a certain exercise price before a specified date. 
C) Options typically sell for less than their exercise value. 
D) LEAPS are very short-term options that have begun trading on the exchanges in recent years. 
E) Option holders are not entitled to receive dividends unless they choose to exercise their option. 
A) Put options give investors the right to buy a stock at a certain exercise price before a specified date. 
B) Call options give investors the right to sell a stock at a certain exercise price before a specified date. 
C) Options typically sell for less than their exercise value. 
D) LEAPS are very short-term options that have begun trading on the exchanges in recent years. 
E) Option holders are not entitled to receive dividends unless they choose to exercise their option.

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A) An option's value is determined by its exercise value, which is the market price of the stock less its strike price. Thus, an option can't sell for more than its exercise value. 
B) As a stock's price increases, the premium portion of an option on that stock increases because the difference between the stock price and the fixed strike price increases. 
C) If the company is consistently profitable, its call options will always be in the money. 
D) The market value of an option depends in part on the option's length of time until expiration and on the variability of the underlying stock's price. 
E) The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin becomes larger. 
A) An option's value is determined by its exercise value, which is the market price of the stock less its strike price. Thus, an option can't sell for more than its exercise value. 
B) As a stock's price increases, the premium portion of an option on that stock increases because the difference between the stock price and the fixed strike price increases. 
C) If the company is consistently profitable, its call options will always be in the money. 
D) The market value of an option depends in part on the option's length of time until expiration and on the variability of the underlying stock's price. 
E) The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin becomes larger.

Question 5

A 6-month put option on Makler Corp.'s stock has a strike price of $45 and sells in the market for $8.90.Makler's current stock price is $41.What is the exercise value of the option?

Accepted Answer

A) $2.62 
B) $2.92 
C) $3.24 
D) $3.60 
E) $4.00 
A) $2.62 
B) $2.92 
C) $3.24 
D) $3.60 
E) $4.00

Question 6

Looking at The Wall Street Journal you observe that the settlement price on a hypothetical 10-year,semiannual payment,6% coupon Treasury note is 105-21.If the note has a $1,000 par value,what is the implied Treasury note rate?

Accepted Answer

A) 5.27% 
B) 5.53% 
C) 5.80% 
D) 6.10% 
E) 6.40% 
A) 5.27% 
B) 5.53% 
C) 5.80% 
D) 6.10% 
E) 6.40%

Question 7

In theory,reducing the volatility of its cash flows will always increase a company's value.

Accepted Answer

A) True 
 B)False

Question 8

One objective of risk management can be to reduce the volatility of a firm's cash flows.

Accepted Answer

A) True 
 B)False

Question 9

Warnes Motors' stock is trading at $20 a share.Three-month call options with an exercise price of $20 have a price of $1.50.Which of the following will occur if the stock price increases 10% to $22 a share?

Accepted Answer

A) The price of the call option will increase by $2. 
B) The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%. 
C) The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10%. 
D) The price of the call option will increase by more than $2. 
E) The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10%. 
A) The price of the call option will increase by $2. 
B) The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%. 
C) The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10%. 
D) The price of the call option will increase by more than $2. 
E) The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10%.

Question 10

Suppose a CBOT 10-year U.S.Treasury note futures contract has a quoted price of 103-18.What is the implied annual interest rate inherent in the futures contract?

Accepted Answer

A) 4.74% 
B) 4.99% 
C) 5.25% 
D) 5.53% 
E) 5.81% 
A) 4.74% 
B) 4.99% 
C) 5.25% 
D) 5.53% 
E) 5.81%

Question 11

A commercial bank recognizes that its net income suffers whenever interest rates increase.Which of the following strategies would protect the bank against rising interest rates?

Accepted Answer

A) Buying inverse floaters. 
B) Entering into an interest rate swap where the bank receives a fixed payment stream, and in return agrees to make payments that float with market interest rates. 
C) Purchase principal only (PO) strips that decline in value whenever interest rates rise. 
D) Enter into a short hedge where the bank agrees to sell interest rate futures. 
E) Sell some of the bank's floating-rate loans and use the proceeds to make fixed-rate loans. 
A) Buying inverse floaters. 
B) Entering into an interest rate swap where the bank receives a fixed payment stream, and in return agrees to make payments that float with market interest rates. 
C) Purchase principal only (PO) strips that decline in value whenever interest rates rise. 
D) Enter into a short hedge where the bank agrees to sell interest rate futures. 
E) Sell some of the bank's floating-rate loans and use the proceeds to make fixed-rate loans.

Question 12

Lissa Co.'s stock price is currently $30.25.A 6-month call option on Lissa's stock has a strike price of $25 and has an expected volatility of 40% (i.e.,expected standard deviation = 40%).The risk-free rate is 6%.According to the Black-Scholes option pricing model,what is the value of the option?

Accepted Answer

A) $5.06 
B) $5.62 
C) $6.24 
D) $6.94 
E) $7.63 
A) $5.06 
B) $5.62 
C) $6.24 
D) $6.94 
E) $7.63

Question 13

An option that gives the holder the right to buy a stock at a specified price at some time in the future is called a(n)

Accepted Answer

A) Call option. 
B) Put option. 
C) Out-of-the-money option. 
D) Naked option. 
E) Covered option. 
A) Call option. 
B) Put option. 
C) Out-of-the-money option. 
D) Naked option. 
E) Covered option.

Question 14

A 6-month put option on Smith Corp.'s stock has a strike price of $45 and sells in the market for $8.90.Smith's current stock price is $41.What is the option premium?

Accepted Answer

A) $4.41 
B) $4.90 
C) $5.39 
D) $5.93 
E) $6.52 
A) $4.41 
B) $4.90 
C) $5.39 
D) $5.93 
E) $6.52

Question 15

A riskless hedge can best be defined as

Accepted Answer

A) A situation in which aggregate risk can be reduced by derivatives transactions between two parties. 
B) A hedge in which an investor buys a stock and simultaneously sells a call option on that stock and ends up with a riskless position. 
C) Standardized contracts that are traded on exchanges and are "marked to market" daily, but where physical delivery of the underlying asset is virtually never taken. 
D) Two parties agree to exchange obligations to make specified payment streams. 
E) Simultaneously buying and selling a call option with the same exercise price. 
A) A situation in which aggregate risk can be reduced by derivatives transactions between two parties. 
B) A hedge in which an investor buys a stock and simultaneously sells a call option on that stock and ends up with a riskless position. 
C) Standardized contracts that are traded on exchanges and are "marked to market" daily, but where physical delivery of the underlying asset is virtually never taken. 
D) Two parties agree to exchange obligations to make specified payment streams. 
E) Simultaneously buying and selling a call option with the same exercise price.

Exam 18: Derivatives and Risk Management

Which of the following statements regarding factors that affect call option prices is CORRECT?

Which of the following statements concerning risk management is NOT CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

A 6-month put option on Makler Corp.'s stock has a strike price of $45 and sells in the market for $8.90.Makler's current stock price is $41.What is the exercise value of the option?

Looking at The Wall Street Journal you observe that the settlement price on a hypothetical 10-year,semiannual payment,6% coupon Treasury note is 105-21.If the note has a $1,000 par value,what is the implied Treasury note rate?

In theory,reducing the volatility of its cash flows will always increase a company's value.

One objective of risk management can be to reduce the volatility of a firm's cash flows.

Warnes Motors' stock is trading at $20 a share.Three-month call options with an exercise price of $20 have a price of $1.50.Which of the following will occur if the stock price increases 10% to $22 a share?

Suppose a CBOT 10-year U.S.Treasury note futures contract has a quoted price of 103-18.What is the implied annual interest rate inherent in the futures contract?

A commercial bank recognizes that its net income suffers whenever interest rates increase.Which of the following strategies would protect the bank against rising interest rates?

Lissa Co.'s stock price is currently $30.25.A 6-month call option on Lissa's stock has a strike price of $25 and has an expected volatility of 40% (i.e.,expected standard deviation = 40%).The risk-free rate is 6%.According to the Black-Scholes option pricing model,what is the value of the option?

An option that gives the holder the right to buy a stock at a specified price at some time in the future is called a(n)

A 6-month put option on Smith Corp.'s stock has a strike price of $45 and sells in the market for $8.90.Smith's current stock price is $41.What is the option premium?

A riskless hedge can best be defined as

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Interest Rates

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Real Options and Other Topics in Capital Budgeting

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Multinational Financial Management

Hybrid Financing: Preferred Stock, leasing, warrants, and Convertibles

Mergers and Acquisitions

Continuous Compounding and Discounting

Zero Coupon Bonds

Bankruptcy and Reorganization

Calculating Beta Coefficients

Using the Capm to Estimate the Risk-Adjusted Cost of Capital

Techniques for Measuring Beta Risk

Degree of Leverage

Filters