Exam 8: Financial options and applications in corporate finance

Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.

An option that gives the holder the right to sell a stock at a specified price at some future time is

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.

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: N(d?)and N(d?)represent areas under a standard normal distribution function.Using the Black-Scholes model, what is the value of the call option?

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?

The exercise value is also called the strike price, but this term is generally used when discussing convertibles rather than financial options.

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.

Which of the following statements is CORRECT?

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.

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.

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?

The exercise value is the positive difference between the current price of the stock and the strike price.The exercise value is zero if the stock's price is below the strike price.

The current price of a stock is $22, and at the end of one year its price will be either $27 or $17.The annual risk-free rate is 6.0%, based on daily compounding.A 1-year call option on the stock, with an exercise price of $22, is available.Based on the binomial model, what is the option's value? (Hint: Use daily compounding.)

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

The strike price is the price that must be paid for a share of common stock when it is bought by exercising a warrant.

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.

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?

Cazden Motors' stock is trading at $30 a share.Call options on the company's stock are also available, some with a strike price of $25 and some with a strike price of $35.Both options expire in three months.Which of the following best describes the value of these options?

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.