Chapter 14: Options Markets
Copyright Cengage Learning. Powered by Cognero.
Page 1
1. A ____ grants the owner the right to purchase a specified financial instrument for a specified price within a specified
period of time.
a.
call option
b.
put option
c.
sale of a futures contract
d.
purchase of a futures contract
ANSWER:
a
2. A ____ requires a premium above and beyond the price to be paid for the financial instrument.
a.
futures contract
b.
call option
c.
put option
d.
B and C
ANSWER:
d
3. A put option is “out of the money” when the
a.
market price of the security exceeds the exercise price.
b.
market price of the security equals the exercise price.
c.
market price of the security is less than the exercise price.
d.
premium on the option is less than the exercise price.
ANSWER:
a
4. When the market price of the underlying security exceeds the exercise price, a
a.
call option is in the money.
b.
put option is in the money.
c.
call option is at the money.
d.
call option is out of the money.
ANSWER:
a
5. Sellers (writers) of call options can offset their position at any point in time by
a.
selling a put option on the same stock.
b.
buying identical call options.
c.
selling additional call options on the same stock.
d.
all of the above
e.
A and B
ANSWER:
b
6. The ____ is the most important exchange for trading options.
a.
New York Stock Exchange (NYSE)
b.
Chicago Board Options Exchange (CBOE)
c.
Boston Options Exchange
d.
NYSE MKT
ANSWER:
b
7. The Options Clearing Corporation (OCC) serves as a guarantor on option contracts traded in the United States.
a.
True
Chapter 14: Options Markets
Copyright Cengage Learning. Powered by Cognero.
Page 2
b.
False
ANSWER:
True
8. ____ execute transactions desired by investors and trade stock options for their own account.
a.
Floor brokers
b.
Discount brokers
c.
Market makers
d.
none of the above
ANSWER:
c
9. A speculator buys a call option for $3, with an exercise price of $50. The stock is currently priced at $49, and rises to
$55 on the expiration date. What is the stock price at which the speculator would break even?
a.
$50
b.
$58
c.
$52
d.
$53
e.
$49
ANSWER:
d
10. A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is presently priced
at $29 and rises to $32 before the expiration date. What is the maximum profit per unit to the speculator who owned the
put option assuming he or she exercises the option at the ideal time?
a.
−$4
b.
−$3
c.
−$2
d.
$2
e.
$3
ANSWER:
b
11. A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is presently priced
at $29 and rises to $32 before the expiration date. What is the stock price at which the speculator would break even?
a.
$26
b.
$34
c.
$28
d.
$29
e.
$32
ANSWER:
a
12. The ____, the higher the call option premium, other things being equal.
a.
lower the existing price of the security relative to the exercise price
b.
lower the variability of the security’s market price
c.
longer the maturity of the option
d.
A and B
ANSWER:
c
13. The longer the time to maturity, the ____ the call option premium and the ____ the put option premium.
Chapter 14: Options Markets
Copyright Cengage Learning. Powered by Cognero.
Page 3
a.
higher; lower
b.
lower; higher
c.
higher; higher
d.
lower; lower
ANSWER:
c
14. The greater the volatility of the underlying stock, the ____ the call option premium and the ____ the put option
premium.
a.
higher; lower
b.
lower; higher
c.
higher; higher
d.
lower; lower
ANSWER:
c
15. The sale of a call option on a stock the seller already owns is referred to as
a.
a covered call.
b.
a naked call.
c.
call on futures.
d.
futures on options.
ANSWER:
a
16. Assume a pension fund purchased stock at $53. Call options at a $50 exercise price presently have a $4 premium per
share. The pension fund sells a call option on the stock it owns. If the call option is exercised when the price of the stock
is $56, what is the gain or loss per share to the pension fund (including its gain from holding the stock as well)?
a.
$4 gain
b.
$6 loss
c.
$2 loss
d.
$1 gain
e.
$0
ANSWER:
d
17. Covered call writing ____ the upside potential return and ____ the risk of an investment in stock.
a.
increases; increases
b.
increases; decreases
c.
limits; increases
d.
limits; decreases
ANSWER:
d
18. Put options are typically used to hedge when portfolio managers are mainly concerned about
a.
a permanent decline in a stock’s value.
b.
a permanent increase in a stock’s value.
c.
a temporary decline in a stock’s value.
d.
a temporary increase in a stock’s value.
ANSWER:
c
19. A speculator purchases a put option on Treasury bond futures with a September delivery date with an exercise price of
Chapter 14: Options Markets
Copyright Cengage Learning. Powered by Cognero.
Page 4
85-00. The option has a premium of 2-00. Assume that the price of the futures contract decreases to 82-00 on the
expiration date and the option is exercised at that point (if it is feasible). What is the net gain?
a.
$1,968.75
b.
$3,750.00
c.
$3,000.00
d.
−$2,000.00
e.
$1,000.00
ANSWER:
e
20. Assume an insurance company purchases a call option on an S&P 500 Index futures contract for a premium of 14,
with an exercise price of 1800. The value of an S&P 500 futures contract is 250 times the index. If the index on the
futures contract increases to 1830, what is the gain on the sale of the futures contract?
a.
$15,000
b.
$7,500
c.
$3,300
d.
$4,000
e.
$1,500
ANSWER:
d
21. Corporations involved in international business transactions can ____ to hedge future ____.
a.
sell currency call options; payables
b.
purchase currency put options; receivables
c.
purchase currency call options, receivables
d.
purchase currency put options, payables
e.
A and B
ANSWER:
b
22. If a corporation hedges payables with currency call options, it will ____ if the value of the foreign currency is ____
than the exercise price when the payables are due.
a.
exercise the option; greater
b.
exercise the option; less
c.
let the option expire; greater
d.
let the option expire; less
e.
A and D
ANSWER:
e
23. Speculators purchase currency ____ on currencies they expect to ____ against the dollar.
a.
call options; weaken
b.
put options; strengthen
c.
futures; weaken
d.
put options; weaken
ANSWER:
d
24. Speculators may be willing to write ____ options on foreign currencies they expect to ____ against the dollar.
a.
put; strengthen
b.
put; weaken
Chapter 14: Options Markets
Copyright Cengage Learning. Powered by Cognero.
Page 5
c.
call; strengthen
d.
call; weaken
e.
A and D
ANSWER:
e
25. European-style stock options
a.
are long-term options (at least one year until expiration at the time they are created).
b.
can be exercised after the expiration date.
c.
can be exercised any time until the expiration date.
d.
none of the above
ANSWER:
d
26. A speculator purchased a call option with an exercise price of $31 for a premium of $4. The option was exercised a
few days later when the stock price was $34. What was the return to the speculator?
a.
25 percent
b.
−25 percent
c.
−3.2 percent
d.
−2.9 percent
ANSWER:
b
27. The premium on an existing call option should ____ when the underlying stock price decreases.
a.
be negative
b.
decline
c.
increase
d.
be unaffected
e.
A and B
ANSWER:
b
28. The premium on an existing put option should ____ when the underlying stock price increases.
a.
be negative
b.
decline
c.
increase
d.
be unaffected
e.
A and B
ANSWER:
b
29. The premium on an existing put option should ____ when there is an increase in the expected short-term volatility of
the stock price.
a.
be negative
b.
decline
c.
increase
d.
be unaffected
e.
A and B
ANSWER:
c
Chapter 14: Options Markets
Copyright Cengage Learning. Powered by Cognero.
Page 6
30. The premium on an existing call option should ____ when there is a reduction in the expected short-term volatility of
the stock price.
a.
be negative
b.
decline
c.
increase
d.
be unaffected
e.
A and B
ANSWER:
b
31. The premium on an existing put option should ____ when there is a reduction in the expected short-term volatility of
the stock price.
a.
be negative
b.
decline
c.
increase
d.
be unaffected
e.
A and B
ANSWER:
b
32. The premium on an existing call option should ____ when there is an increase in the expected short-term volatility of
the stock price.
a.
be negative
b.
decline
c.
increase
d.
be unaffected
e.
A and B
ANSWER:
c
33. When a stock index option is exercised, the cash payment is equal to a specified dollar amount
a.
multiplied by the index level.
b.
multiplied by the exercise price.
c.
multiplied by the difference between the index level and the exercise price.
d.
multiplied by the sum of the index level and the exercise price.
ANSWER:
c
34. When stock portfolio managers use dynamic asset allocation by purchasing call options on a stock index, they ____
their exposure to stock market conditions.
a.
reduce
b.
completely eliminate
c.
have no effect on
d.
increase
ANSWER:
d
35. Options on stock indexes representing non-U.S. stocks are ____; options exchanges have been established ____.
a.
available; in numerous non-U.S. countries
b.
not available; in numerous non-U.S. countries
c.
available; only in the United States
Chapter 14: Options Markets
Copyright Cengage Learning. Powered by Cognero.
Page 7
d.
not available; only in the United States
ANSWER:
a
36. Which of the following is not a difference between purchasing an option and purchasing a futures contract?
a.
The option requires that a premium be paid in addition to the price of the financial instrument.
b.
Owners of options can choose to let the option expire on the so-called expiration date without exercising it.
c.
The fulfillment of futures contracts is regulated by exchanges, while the fulfillment of options is not.
d.
All of the above are differences between purchasing an option and purchasing a futures
ANSWER:
c
37. Marcie purchases a call option on interest rate futures with an exercise price of 92-10. The premium on the call option
is 2-24. Just before the expiration date, the price of Treasury bond futures is 97-14. At this time, Marcie decides to
exercise the option and closes out the position by selling an identical futures contract. Marcie‘s net gain from this strategy
is $____.
a.
−2,687.50
b.
2,687.50
c.
2,375.00
d.
7,437.50
e.
none of the above
ANSWER:
b
38. Reese Insurance company sold a call option on interest rate futures with an exercise price of 92-10. The premium on
the call option is 2-24. Just before the expiration date, the price of Treasury bond futures is 97-14. At this time, the option
was exercised as the buyer closed out the position by selling an identical futures contract. Reese‘s net gain from selling the
call option is $____.
a.
2,687.50
b.
−2,687.50
c.
2,375.00
d.
7,437.50
e.
none of the above
ANSWER:
b
39. Vince, a speculator, expects interest rates to increase and purchases a put option on Treasury bond futures with an
exercise price of 95-32. The premium paid for the put option is 2-36. Just prior to the expiration date, the price of the
Treasury bond futures contract is valued at 93-22. Vince exercises the option and closes out the position by purchasing an
identical futures contract. Vince’s net gain from this speculative strategy is $____.
a.
−406.25
b.
4,718.75
c.
−4,718.75
d.
−812.50
e.
none of the above
ANSWER:
a
40. Which of the following is not an assumption underlying the Black-Scholes option-pricing model?
a.
The risk-free rate is known and constant over the life of the option.
b.
The probability distribution of stock prices is lognormal.
Chapter 14: Options Markets
Copyright Cengage Learning. Powered by Cognero.
Page 8
c.
The world is risk-neutral.
d.
The variability of a stock’s return is constant.
e.
There are no transaction costs involved in trading options.
ANSWER:
c
41. Which of the following is not true with respect to market makers?
a.
They benefit from the spread.
b.
They may earn profits when they take positions in options.
c.
They are not subject to a risk of loss on their positions in options.
d.
All of the above are true with respect to market makers.
ANSWER:
c
42. Option trading is regulated by the
a.
Options Clearing Corporation.
b.
International Securities Exchange.
c.
Securities and Exchange Commission.
d.
Federal Reserve.
ANSWER:
c
43. On an exchange, option trades can be executed
a.
by a floor broker.
b.
electronically.
c.
by a market maker.
d.
all of the above
e.
A and B only
ANSWER:
d
44. When investors purchase an option that does not hedge their existing investments, the option can be referred to as
“naked.”
a.
True
b.
False
ANSWER:
True
45. Backdating occurs when CEOs (or other executives) reset the date that their options were granted to an earlier date
when the stock price was lower.
a.
True
b.
False
ANSWER:
True
46. The motive for CEOs to backdate options is that it allows them to exercise the options at a lower exercise price.
a.
True
b.
False
ANSWER:
True
47. Stock options can be used by speculators to benefit from their expectations and by financial institutions to reduce their
risk.
Chapter 14: Options Markets
Copyright Cengage Learning. Powered by Cognero.
Page 9
a.
True
b.
False
ANSWER:
True
48. The writer of a put option is obligated to provide the specified financial instrument at the price specified by the option
contract if the owner exercises the option.
a.
True
b.
False
ANSWER:
False
49. A call option is said to be at the money when the market price of the underlying security exceeds the exercise price.
a.
True
b.
False
ANSWER:
False
50. Market makers can execute stock option transactions for customers but do not trade stock options for their own
account.
a.
True
b.
False
ANSWER:
False
51. American-style stock options can be exercised only just before expiration.
a.
True
b.
False
ANSWER:
False
52. An option with a higher exercise price has a higher call option premium and a lower put option premium.
a.
True
b.
False
ANSWER:
False
53. Several call options are available for a given stock, and the risk-return potential will vary among them
a.
True
b.
False
ANSWER:
True
54. The higher the existing market price of the underlying financial instrument relative to the exercise price, the higher the
put option premium, other things being equal.
a.
True
b.
False
ANSWER:
False
55. The longer a call option’s time to maturity, the lower the call option premium, other things being equal.
a.
True
b.
False
ANSWER:
False
Chapter 14: Options Markets
Copyright Cengage Learning. Powered by Cognero.
Page 11
ANSWER:
c
64. Which of the following statements is least correct regarding corporations involved in international business
transactions?
a.
They may purchase currency put options to hedge future receivables denominated in a foreign currency.
b.
They may purchase currency call options to hedge future payables denominated in a foreign currency.
c.
They may purchase currency call options to hedge future receivables denominated in a foreign currency.
d.
They benefit from currency put options if the currency’s value declines before the expiration date of the option.
ANSWER:
c
65. The ____ is not a factor affecting the call option premium.
a.
market price of the underlying instrument (relative to the option’s exercise price)
b.
volatility of the underlying instrument
c.
current price of futures contracts on the underlying instrument
d.
time to maturity of the call option
ANSWER:
c
66. Speculators who anticipate a decline in interest rates may consider ____ a ____ option on Treasury bond futures.
a.
purchasing; put
b.
selling; call
c.
purchasing; call
d.
none of the above
ANSWER:
c
67. Brad expects interest rates to increase and purchases a put option on Treasury bond futures with an exercise price of
97-00. The premium paid for the put option is 3-00. Just prior to the expiration date, the price of the Treasury bond futures
contract is valued at 89-00. Brad exercises the option and closes out the position by purchasing an identical futures
contract. Brad’s net gain from this speculative strategy is $____, and his return on his investment is about _______
percent.
a.
b.
11,000; 27
c.
−5,000; −167
d.
e.
none of the above
ANSWER:
d
68. Which of the following statements is incorrect?
a.
Some firms allowed their CEOs to backdate options that they were granted to an earlier period when the stock
price was lower.
b.
Backdating is completely inconsistent with the idea of granting options to encourage managers to focus on
maximizing the stock price.
c.
Firms readily promote their option compensation programs and are more than willing to acknowledge that the
options are an expense.
d.
All of the above are correct.
ANSWER:
c
Chapter 14: Options Markets
Copyright Cengage Learning. Powered by Cognero.
Page 12
69. The purchaser of an American-style put option is always better off exercising the option at the expiration date than
before that date.
a.
True
b.
False
ANSWER:
False
70. Which of the following does not directly affect a call option premium?
a.
volatility of the underlying instrument
b.
market price of the underlying instrument
c.
analyst rating of the underlying instrument
d.
time to maturity of the option
ANSWER:
c
71. Options on small stocks normally have higher premiums than options on large stocks because small stocks typically
are more volatile.
a.
True
b.
False
ANSWER:
True
72. Which of the following can normally be found in quotations for stock options provided by the financial media?
a.
exercise price, expiration date, and implied volatility
b.
exercise price, expiration date, and most recently quoted premium
c.
expiration date, implied volatility, and trading volume
d.
expiration date, most recently quoted premium, and implied volatility
ANSWER:
b