Question 1

Using the binomial pricing model,calculate the price of a two-year put option on Kinston stock with a strike price of $9.

Accepted Answer

This problem requires a two period binomial tree.The solution will start by solving the value of the call option for the up and down branches as of year 1 and then solve for the final value of the option at year 0.   
Up branch
D =   
=   
= 0
B =   
=   
= 0
C = SD + B = $13(0)+ (0)= $0
Down Branch
D =   
=   
= -0.6
B =   
=   
= 6.285714
C = SD + B = $8(-0.6)+ (6.285714)= $1.49
Value at year 0
D =   
=   
= -0.298
B =   
=   
= 3.874
C = SD + B = $10(-0.298)+ 3.874 = $0.89

Question 2

The Black-Scholes value of a one-year call option on Taggart stock with a strike price of $50 is closest to:

Accepted Answer

A) $1.45 
B) $3.15 
C) $4.75 
D) $9.50 
A) $1.45 
B) $3.15 
C) $4.75 
D) $9.50 A

Question 3

Use the information for the question(s)below.
The current price of Kinston Corporation stock is $10.In each of the next two years,this stock price can either go up by $3.00 or go down by $2.00.Kinston stock pays no dividends.The one year risk-free interest rate is 5% and will remain constant.
-Using the binomial pricing model,calculate the price of a two-year call option on Kinston stock with a strike price of $9.

Accepted Answer

This problem requires a two period binomial tree.The solution will start by solving the value of the call option for the up and down branches as of year 1 and then solve for the final value of the option at year 0.   
Up branch
D =   
=   
= 1
B =   
=   
= -8.571429
C = SD + B = $13(1)+ (-8.571429)= $4.43
Down Branch
D =   
=   
= .4
B =   
=   
= -2.285714
C = SD + B = $8(.4)+ (-2.285714)= $0.91
Value at year 0
D =   
=   
= .7040
B =   
=   
= -4.497143
C = SD + B = $10(.704)+ (-4.497143)= $2.54

Question 4

Which of the following statements is FALSE?

Accepted Answer

A) A replicating portfolio is a portfolio of other securities that has exactly the same value in one period as the option. 
B) By using the Law of One Price,we are able to solve for the price of the option as long as we know the probabilities of the states in the binomial tree. 
C) The binomial tree contains all the information we currently know: the value of the stock,bond,and call options in each state in one period,as well as the price of the stock and bond today. 
D) The idea that you can replicate the option payoff by dynamically trading in a portfolio of the underlying stock and a risk-free bond was one of the most important contributions of the original Black-Scholes paper.Today,this kind of replication strategy is called a dynamic trading strategy. 
A) A replicating portfolio is a portfolio of other securities that has exactly the same value in one period as the option. 
B) By using the Law of One Price,we are able to solve for the price of the option as long as we know the probabilities of the states in the binomial tree. 
C) The binomial tree contains all the information we currently know: the value of the stock,bond,and call options in each state in one period,as well as the price of the stock and bond today. 
D) The idea that you can replicate the option payoff by dynamically trading in a portfolio of the underlying stock and a risk-free bond was one of the most important contributions of the original Black-Scholes paper.Today,this kind of replication strategy is called a dynamic trading strategy.

Question 5

Which of the following statements is FALSE?

Accepted Answer

A) For a call written on a stock with positive beta,the beta of the call always exceeds the beta of the stock. 
B) The beta of a put option written on a negative beta stock is always negative. 
C) As the stock price changes,the beta of an option will change,with its magnitude falling as the option goes in-the-money. 
D) A put option is a hedge,so its price goes up when the stock price goes down. 
A) For a call written on a stock with positive beta,the beta of the call always exceeds the beta of the stock. 
B) The beta of a put option written on a negative beta stock is always negative. 
C) As the stock price changes,the beta of an option will change,with its magnitude falling as the option goes in-the-money. 
D) A put option is a hedge,so its price goes up when the stock price goes down.

Question 6

The Black-Scholes value of a one-year,at-the-money put option on Taggart stock is closest to:

Accepted Answer

A) $1.45 
B) $3.15 
C) $4.75 
D) $9.50 
A) $1.45 
B) $3.15 
C) $4.75 
D) $9.50

Question 7

Using the binomial pricing model,the calculated price of a one-year put option on KD stock with a strike price of $20 is closest to:

Accepted Answer

A) $2.00 
B) $1.45 
C) $2.40 
D) $2.15 
A) $2.00 
B) $1.45 
C) $2.40 
D) $2.15

Question 8

Using risk neutral probabilities,the calculated price of a one-year put option on KD stock with a strike price of $20 is closest to:

Accepted Answer

A) $2.00 
B) $2.15 
C) $1.45 
D) $2.40 
A) $2.00 
B) $2.15 
C) $1.45 
D) $2.40

Question 9

Consider the following equation:
B =  
In this equation,the term B,represents:

Accepted Answer

A) the bid price for the option. 
B) the position in bonds for the replicating portfolio. 
C) the highest price at which it is advantageous to buy the option. 
D) the number of shares of stock to buy for the replicating portfolio. 
A) the bid price for the option. 
B) the position in bonds for the replicating portfolio. 
C) the highest price at which it is advantageous to buy the option. 
D) the number of shares of stock to buy for the replicating portfolio.

Question 10

The Black-Scholes Δ of a one-year,at-the-money put option on Taggart stock is closest to:

Accepted Answer

A) -0.2850 
B) 0.2850 
C) -0.3859 
D) -0.6141 
A) -0.2850 
B) 0.2850 
C) -0.3859 
D) -0.6141

Question 11

Consider the following equation:
C = S × N  
- PV(K)× N  
In this equation,the term σ represents:

Accepted Answer

A) the number of days to expiration. 
B) the number of years to expiration. 
C) the expected return on the stock. 
D) the annual volatility of the stock. 
A) the number of days to expiration. 
B) the number of years to expiration. 
C) the expected return on the stock. 
D) the annual volatility of the stock.

Question 12

Which of the following is a corporate application of option pricing?

Accepted Answer

A) Calculating the beta of risky debt 
B) Calculating the beta of risk-free debt 
C) Calculating the beta of risky equity 
D) Calculating the alpha of risky equity 
A) Calculating the beta of risky debt 
B) Calculating the beta of risk-free debt 
C) Calculating the beta of risky equity 
D) Calculating the alpha of risky equity

Question 13

Which of the following statements is FALSE?

Accepted Answer

A) After we have constructed the tree and calculated the probabilities in the risk-neutral world,we can use them to price the derivative by simply discounting its expected payoff (using the risk neutral probabilities)at the risk-free rate. 
B) By using the probabilities in the risk-neutral world we can price any derivative security - that is,any security whose payoff depends solely on the prices of other marketed assets. 
C) To ensure that all assets in the risk-neutral world have an expected return equal to the risk-free rate,relative to the true probabilities,the risk-neutral probabilities underweight the bad states and overweight the good states. 
D) In Monte Carlo simulation,the expected payoff of the derivative security is estimated by calculating its average payoff after simulating many random paths for the underlying stock price. 
A) After we have constructed the tree and calculated the probabilities in the risk-neutral world,we can use them to price the derivative by simply discounting its expected payoff (using the risk neutral probabilities)at the risk-free rate. 
B) By using the probabilities in the risk-neutral world we can price any derivative security - that is,any security whose payoff depends solely on the prices of other marketed assets. 
C) To ensure that all assets in the risk-neutral world have an expected return equal to the risk-free rate,relative to the true probabilities,the risk-neutral probabilities underweight the bad states and overweight the good states. 
D) In Monte Carlo simulation,the expected payoff of the derivative security is estimated by calculating its average payoff after simulating many random paths for the underlying stock price.

Question 14

Consider the following equation:
D =  
In this equation,the term D,represents:

Accepted Answer

A) the change in the stock price from the low state to the high state. 
B) the sensitivity of the option's value to changes in the stock price. 
C) the position in bonds for the replicating portfolio. 
D) the change in the stock price from the high state to the low state. 
A) the change in the stock price from the low state to the high state. 
B) the sensitivity of the option's value to changes in the stock price. 
C) the position in bonds for the replicating portfolio. 
D) the change in the stock price from the high state to the low state.

Question 15

Which of the following statements is FALSE?

Accepted Answer

A) N(d)is the cumulative normal distribution - that is,the probability that a normally distributed variable is greater than d. 
B) Of the five required inputs in the Black-Scholes formula,four are directly observable. 
C) The Black-Scholes formula is derived assuming that the call is a European option. 
D) The Black-Scholes Option Pricing Model can be derived from the Binomial Option Pricing Model by making the length of each period,and the movement of the stock price per period,shrink to zero and letting the number of periods grow infinitely large. 
A) N(d)is the cumulative normal distribution - that is,the probability that a normally distributed variable is greater than d. 
B) Of the five required inputs in the Black-Scholes formula,four are directly observable. 
C) The Black-Scholes formula is derived assuming that the call is a European option. 
D) The Black-Scholes Option Pricing Model can be derived from the Binomial Option Pricing Model by making the length of each period,and the movement of the stock price per period,shrink to zero and letting the number of periods grow infinitely large.

Question 16

Use the information for the question(s)below.
The current price of KD Industries stock is $20.In the next year the stock price will either go up by 20% or go down by 20%.KD pays no dividends.The one year risk-free rate is 5% and will remain constant.
-Using the binomial pricing model,the calculated price of a one-year call option on KD stock with a strike price of $20 is closest to:

Accepted Answer

A) $2.40 
B) $2.00 
C) $2.15 
D) $1.45 
A) $2.40 
B) $2.00 
C) $2.15 
D) $1.45

Question 17

Use the information for the question(s)below.
The current price of Kinston Corporation stock is $10.In each of the next two years,this stock price can either go up by $3.00 or go down by $2.00.Kinston stock pays no dividends.The one year risk-free interest rate is 5% and will remain constant.
-Using risk neutral probabilities,calculate the price of a two-year call option on Kinston stock with a strike price of $9.

Accepted Answer

p = @#IMG-DLM& 
= @#IMG-DLM&

Question 18

Use the information for the question(s)below.
The current price of KD Industries stock is $20.In the next year the stock price will either go up by 20% or go down by 20%.KD pays no dividends.The one year risk-free rate is 5% and will remain constant.
-Assuming the Beta on KD stock is 1.1,the calculated beta for a one-year call option on KD stock with a strike price of $20 is closest to:

Accepted Answer

A) -1.8 
B) 2.4 
C) -7.7 
D) 4.6 
A) -1.8 
B) 2.4 
C) -7.7 
D) 4.6

Question 19

Which of the following statements is FALSE?

Accepted Answer

A) Out-of-the-money calls have the highest expected returns and out-of-the-money puts have the lowest expected returns. 
B) The expression SΔ/(SΔ +
B) is the ratio of the amount of money in the stock position in the replicating portfolio to the value of the replicating portfolio (or the option price);it is known as the leverage ratio. 
C) The beta of a portfolio is just the weighted average beta of the constituent securities that make up the portfolio. 
D) The magnitude of the leverage ratio for options is usually very small,especially for out-of-the-money options. 
A) Out-of-the-money calls have the highest expected returns and out-of-the-money puts have the lowest expected returns. 
B) The expression SΔ/(SΔ +
B) is the ratio of the amount of money in the stock position in the replicating portfolio to the value of the replicating portfolio (or the option price);it is known as the leverage ratio. 
C) The beta of a portfolio is just the weighted average beta of the constituent securities that make up the portfolio. 
D) The magnitude of the leverage ratio for options is usually very small,especially for out-of-the-money options.

Question 20

Using risk neutral probabilities,calculate the price of a two-year put option on Kinston stock with a strike price of $9.

Accepted Answer

p = @#IMG-DLM& 
= @#IMG-DLM&

Exam 21: Option Valuation

Using the binomial pricing model,calculate the price of a two-year put option on Kinston stock with a strike price of $9.

The Black-Scholes value of a one-year call option on Taggart stock with a strike price of $50 is closest to:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

The Black-Scholes value of a one-year,at-the-money put option on Taggart stock is closest to:

Using the binomial pricing model,the calculated price of a one-year put option on KD stock with a strike price of $20 is closest to:

Using risk neutral probabilities,the calculated price of a one-year put option on KD stock with a strike price of $20 is closest to:

Consider the following equation: B = In this equation,the term B,represents:

The Black-Scholes Δ of a one-year,at-the-money put option on Taggart stock is closest to:

Consider the following equation: C = S × N - PV(K)× N In this equation,the term σ represents:

Which of the following is a corporate application of option pricing?

Which of the following statements is FALSE?

Consider the following equation: D = In this equation,the term D,represents:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Using risk neutral probabilities,calculate the price of a two-year put option on Kinston stock with a strike price of $9.

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Debt and Taxes

Financial Distress,managerial Incentives,and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modeling: a Case Study

Financial Options

Real Options

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

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