Question 1

Owning a call option that has a high probability of being exercised is said to be almost equivalent to owning the stock. In which way is owning a call not equivalent to owning the stock?

Accepted Answer

A)   Option holders pay no income taxes.
B)   Stockholders do not have capped (restricted)  profits.
C)   Option holders do not receive dividends.
D)  Stockholders cannot sustain losses. C

Question 2

Assume that call options on Microsoft stock with the same exercise date in October are available with exercise prices $45, $55, and $65. Also assume that the price of the middle call is the average of the other two calls. Show that if you sell two of the middle calls and use the proceeds to buy one each of the other calls, your proceeds in October may be positive but cannot be negative despite the fact that your net outlay today is zero. What can you deduce from this example about option pricing?

Accepted Answer

Notice that, if S is between 45 and 65 at option expiration, the total payoff to the portfolio is positive. Otherwise the total payoff is zero. This portfolio has only nonnegative payoffs. But it has zero cost if the price of the 55 call is equal to the average of the prices of the other two calls. This situation cannot persist. At a cost of zero, all investors will attempt to buy an unlimited amount of this portfolio. We conclude that the price of the 55 call must be greater than the average of the prices of the other two calls. In this case, the cost of establishing the portfolio is positive, which is consistent with the nonnegative payoffs to the portfolio.

Question 3

You purchased a stock for $43 a share, a call option with an exercise price of $40 and a premium of $5, and a put option with an exercise price of $45 and a premium of $4. What will be your net profit if you close out all three positions when the stock is selling for $48 a share?

Accepted Answer

A)   -$9
B)   -$4
C)   $5
D)  $4 D

Question 4

The lower limit on a call option's value is equal to the greater of zero or the exercise price minus the stock price.

Accepted Answer

A) True 
 B)False

Question 5

The price of a call option increases as the exercise price decreases.

Accepted Answer

A) True 
 B)False

Question 6

The VIX is an estimate of expected future market volatility over the next 30 calendar days.

Accepted Answer

A) True 
 B)False

Question 7

A warrant is a long-term call option that is "in the money" at the time of issuance.

Accepted Answer

A) True 
 B)False

Question 8

The value of a call option increases as the strike price increases.

Accepted Answer

A) True 
 B)False

Question 9

Assume you purchased a call option with an exercise price of $720 and a premium of $80.50. How do you compute the stock price that is required to break even on this investment? What would your percentage rate of return be if the stock price rose to $810?

Accepted Answer

The answer of Assume you purchased a call option with...

Question 10

When the stock price is very high compared to the exercise price, the call option premium approximates the difference between the stock price and the present value of the strike price.

Accepted Answer

A) True 
 B)False

Question 11

If you feel strongly that a stock price will move, but are unsure of the direction, you could buy the stock and:

Accepted Answer

A)   buy both a put and a call.
B)   sell both a put and a call.
C)   buy a put and sell a call.
D)  buy two puts.

Question 12

The longer the time until expiration of a call option, the lower the value of the option.

Accepted Answer

A) True 
 B)False

Question 13

A stock is selling at $85 at the expiration of an option contract. Which one of the following options on the stock will most likely be exercised?

Accepted Answer

A)   Call option with exercise price of $65
B)   Put option with exercise price of $65
C)   Call option with exercise price of $85
D)  Put option with exercise price of $85

Question 14

What price risk is an investor exposed to if he owns a share of stock and has purchased a put option on the stock?

Accepted Answer

The answer of What price risk is an investor exposed...

Question 15

For each of the following option and securities combinations show what the payoff would be when the option expires. Assume that each option has an exercise price of $100 and the same expiration date. Use "S" to symbolize the stock price at expiration.
a. Buy a call and invest the present value of the exercise price in a bank deposit
b. Buy a share and a put option on the share
c. Buy a share, buy a put option on the share, and sell a call option on the share
d. Buy a call option and a put option on the share

Accepted Answer

The answer of For each of the following option and...

Question 16

Stock price volatility is beneficial to option holders.

Accepted Answer

A) True 
 B)False

Question 17

Jennifer sold a call option on XXX Corp. with an exercise price of $50 and a premium of $3. The option expires today and XXX is currently trading at $40. What is Jennifer's expected profit or loss per share?

Accepted Answer

A)   -$3
B)   $3
C)   $7
D)  $10

Question 18

If a $1,000 convertible bond with a market value of $950 has a conversion ratio of 25 when the firm's stock is selling for $36 per share, then:

Accepted Answer

A)   the bond will be converted immediately.
B)   the bond is violating its price floor.
C)   conversion now would give the investor a profit of $900.
D)  the conversion value of the bond is $900.

Question 19

Which one of the following changes will decrease the value of a call option?

Accepted Answer

A)   An increase in the stock price
B)   An increase in the strike price
C)   An increase in the volatility of the stock price
D)  An increase in interest rates

Question 20

Firms spend an increasing amount of time evaluating real options, which are:

Accepted Answer

A)   options on real assets such as an option to abandon.
B)   call and put options traded on organized exchanges.
C)   call options such as warrants and convertible bonds.
D)  put options such as those held by shareholders of a firm with financial leverage.

Exam 23: Options

Owning a call option that has a high probability of being exercised is said to be almost equivalent to owning the stock. In which way is owning a call not equivalent to owning the stock?

You purchased a stock for $43 a share, a call option with an exercise price of $40 and a premium of $5, and a put option with an exercise price of $45 and a premium of $4. What will be your net profit if you close out all three positions when the stock is selling for $48 a share?

The lower limit on a call option's value is equal to the greater of zero or the exercise price minus the stock price.

The price of a call option increases as the exercise price decreases.

The VIX is an estimate of expected future market volatility over the next 30 calendar days.

A warrant is a long-term call option that is "in the money" at the time of issuance.

The value of a call option increases as the strike price increases.

Assume you purchased a call option with an exercise price of $720 and a premium of $80.50. How do you compute the stock price that is required to break even on this investment? What would your percentage rate of return be if the stock price rose to $810?

When the stock price is very high compared to the exercise price, the call option premium approximates the difference between the stock price and the present value of the strike price.

If you feel strongly that a stock price will move, but are unsure of the direction, you could buy the stock and:

The longer the time until expiration of a call option, the lower the value of the option.

A stock is selling at $85 at the expiration of an option contract. Which one of the following options on the stock will most likely be exercised?

What price risk is an investor exposed to if he owns a share of stock and has purchased a put option on the stock?

Stock price volatility is beneficial to option holders.

Jennifer sold a call option on XXX Corp. with an exercise price of $50 and a premium of $3. The option expires today and XXX is currently trading at $40. What is Jennifer's expected profit or loss per share?

If a $1,000 convertible bond with a market value of $950 has a conversion ratio of 25 when the firm's stock is selling for $36 per share, then:

Which one of the following changes will decrease the value of a call option?

Firms spend an increasing amount of time evaluating real options, which are: