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Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)
Chapter 21 Option Applications and Corporate Finance
21.1 Option Basics
1) For every owner of a call option there is also an option writer, the person who takes the
other side.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
2) Options are also called derivative assets because they derive their value solely from the
price of another asset.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
3) Standard stock options are traded and bought and sold through dealers only and cannot
be bought via an exchange.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
4) An options contract gives the owner the ________ but not the ________ to buy or sell an
asset at a ixed price at some future date.
A) obligation, right
B) right, option
C) right, obligation
D) option, right
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
1
5) A call option gives the owner the right to ________ an asset at a ixed price at some future
date.
A) sell
B) buy
C) hold
D) none of the above
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
6) A put option gives the owner the right to ________ an asset at a ixed price at some future
date.
A) sell
B) buy
C) hold
D) none of the above
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
7) When a company writes a call option on new stock in the company, it is called a ________.
A) convertible bond
B) put option
C) stock option
D) warrant
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
8) The price at which the holder of an option buys or sells a share of stock when the option
is exercised is called the ________ price.
A) strike
B) American
C) dilutive
D) none of the above
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
9) ________ options allow the holder to exercise the option on any date up to and including
the expiration date.
A) Canadian
B) American
C) European
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D) None of the above
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
10) ________ options allow the holder to exercise the option only on the expiration date.
A) Canadian
B) American
C) European
D) None of the above
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
11) The ________ side of an options contract has the option to exercise, while the ________
side has an obligation to fulill the contract.
A) long, long
B) short, long
C) long, short
D) short, short
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
3
12) The ________ is the total number of contracts of a particular option that have been
written and not yet closed.
A) mark interest
B) open interest
C) turnover
D) local turnover
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
13) When the exercise price of an option is equal to the current price of the stock, the
option is said to be ________.
A) at-the-money
B) in-the-money
C) out-of-the-money
D) none of the above
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
14) When the exercise price of a call option is higher than the current price of the stock,
the option is said to be ________.
A) at-the-money
B) in-the-money
C) out-of-the-money
D) none of the above
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
4
15) When the exercise price of a call option is lower than the current price of the stock, the
option is said to be ________.
A) at-the-money
B) in-the-money
C) out-of-the-money
D) none of the above
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
16) Using an option to reduce the risk of a portfolio is called ________, while using options
to bet on the direction of the market or an asset is called ________.
A) hedging, speculation
B) hedging, veriication
C) veriication, hedging
D) speculation, hedging
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
17) Which of the following statements is FALSE?
A) A call option gives the owner the right to buy the asset.
B) A put option gives the owner the right to sell the asset.
C) A inancial options contract gives the writer the right (but not the obligation) to
purchase or sell an asset at a ixed price at some future date.
D) A stock option gives the holder the option to buy or sell a share of stock on or before a
given date for a given price.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
5
18) Which of the following statements is FALSE?
A) When a holder of an option enforces the agreement and buys or sells a share of stock at
the agreed-upon price, he is exercising the option.
B) There are two kinds of options. European options allow their holders to exercise the
option on any date up to and including a inal date called the expiration date.
C) Because an option is a contract between two parties, for every owner of a inancial
option, there is also an option writer, the person who takes the other side of the contract.
D) The price at which the holder buys or sells the share of stock when the option is
exercised is called the strike price or exercise price.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
19) Which of the following statements is FALSE?
A) The option buyer, also called the option holder, holds the right to exercise the option and
has a long position in the contract.
B) The market price of the option is also called the exercise price.
C) If the payof from exercising an option immediately is positive, the option is said to be in-
the-money.
D) As with other inancial assets, options can be bought and sold. Standard stock options
are traded on organized exchanges, while more specialized options are sold through
dealers.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
20) Which of the following statements is FALSE?
A) A holder would not exercise an in-the-money option.
B) The option seller, also called the option writer, sells (or writes) the option and has a
short position in the contract.
C) Because the long side has the option to exercise, the short side has an obligation to
fulill the contract.
D) When the exercise price of an option is equal to the current price of the stock, the option
is said to be at-the-money.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
21) Which of the following statements is FALSE?
A) Options also allow investors to speculate, or place a bet on the direction in which they
believe the market is likely to move.
B) Options where the strike price and the stock price are very far apart are referred to as
deep in-the-money or deep out-of-the-money.
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C) Call options with strike prices above the current stock price are in-the-money, as are put
options with strike prices below the current stock price.
D) European options allow their holders to exercise the option only on the expiration date–
holders cannot exercise before the expiration date.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
22) The writer of a call option has ________.
A) the obligation to sell a security for a given price
B) the obligation to buy a security for a given price
C) the right to sell a security for a given price
D) the right to buy a security for a given price
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
23) The holder of a put option has ________.
A) the obligation to sell a security for a given price
B) the right to buy a security for a given price
C) the right to sell a security for a given price
D) the obligation to buy a security for a given price
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
7
24) Using options to reduce risk is called ________.
A) speculation
B) a naked position
C) hedging
D) a covered position
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
25) Using options to place a bet on the direction in which you believe the market is likely to
move is called ________.
A) speculation
B) hedging
C) a covered position
D) a naked position
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
8
Use the table for the question(s) below.
Consider the following information on options from the CBOE for Merck:
26) Assume you want to buy one options contract that with an exercise price closest to
being at-the-money and that expires January 2009. The current price that you would have
to pay for such a contract is ________.
A) $680
B) $380
C) $650
D) $420
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
27) The open interest for a January 2009 put option that is closest to being at-the-money is
________.
A) 7,174
B) 982
C) 319
D) 8,422
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
9
28) How many of the January 2009 put options are in-the-money?
A) 1
B) 3
C) 2
D) 4
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
29) How many of the January 2009 call options are in-the-money?
A) 2
B) 4
C) 1
D) 3
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
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