Corporate Finance: Core Principles & Apps, 5e (Ross)
Chapter 17 Options and Corporate Finance
1) Which term applies to the purchase or sale of an underlying asset via an option contract?
A) Exercising the option
B) Striking the price
C) Opening the bid
D) Splitting the security
E) Expiring the option
2) The fixed price in an option contract at which the owner can buy or sell the underlying asset is
called the option’s
A) opening price.
B) intrinsic value.
C) market price.
D) strike price.
E) time value.
3) An option that can only be exercised on the expiration date is referred to as
A) an expired option.
B) an American option.
C) a struck option.
D) a European option.
E) an expiring option.
4) The difference between an American call and a European call is that the American call
A) has a fixed exercise price while the European exercise price can vary within a small range.
B) is a right to buy while a European call is an obligation to buy.
C) has an expiration date while the European call does not.
D) can be exercised at any time up to and including the expiration date while the European call can
only be exercised on the expiration date.
E) is written on 100 shares of the underlying stock while the European call is based on 10 shares of
the underlying stock.
5) A ________ is a derivative security that grants the owner the right, but not the obligation, to buy
an asset at a fixed price during a specified period of time.
A) call option
B) futures contract
C) put option
D) swap
E) forward contract
6) Which one of the following statements correctly describes your situation as the owner of an
American call option?
A) You are obligated to buy at a set price at any time up to and including the expiration date.
B) You have the right to sell at a set price at any time up to and including the expiration date.
C) You have the right to buy at a set price only on the expiration date.
D) You are obligated to sell at a set price if the option is exercised.
E) You have the right to buy at a set price at any time up to and including the expiration date.
7) Eduardo owns an option that gives him the right to purchase shares of ABC stock at a price of
$18 a share. Currently, the stock is selling for $21.60. He would like to profit on this stock but is
not permitted to exercise his option for another 2 weeks. Contrary to other investors, he believes
the stock price will decline significantly over the next 2 weeks. Given this situation, he should
A) sell his option today.
B) buy call options today that expire in 2 weeks.
C) wait for 2 weeks and then immediately exercise his option.
D) purchase shares of ABC today and then sell his option in 2 weeks.
E) just forget about it because he cannot profit from this situation.
8) The intrinsic value of a put is equal to the:
A) lesser of the stock price minus the exercise price or zero.
B) greater of the strike price minus the stock price or zero.
C) lesser of the stock price or zero.
D) lesser of the strike price or the stock price.
E) greater of the stock price minus the exercise price or zero.
9) A 35 put option on FKL stock expires today. The current price of the stock is $36. The put is
A) at the money.
B) out of the money.
C) in the money.
D) funded.
E) unfunded.
10) An ________ is a derivative security that gives the owner the right, but not the obligation, to
sell an asset at a fixed price on the expiration date.
A) American call option
B) European put option
C) American put option
D) Euro-American swap
E) European call option
11) Carie opted to exercise her May option on April 3rd and received $1,750 in exchange for her
shares. She must have owned a(n)
A) warrant.
B) American call.
C) American put.
D) European put.
E) European call.
12) The seller of a European call option has the
A) obligation to sell the underlying stock at the strike price if the option is exercised.
B) right but not the obligation to exercise the option on the expiration date.
C) obligation to buy a stock on a specified date but only at the specified price.
D) obligation to buy a stock sometime during a specified period of time at the specified price.
E) obligation to buy a stock at the lower of the exercise price or the market price on the expiration
date.
13) The seller of a call option makes the most profit when the option
A) is exercised immediately.
B) expires without being exercised.
C) is in the money.
D) is converted into shares.
E) is not exercised until the expiration date.
14) The seller of a put option on 100 shares of stock makes the most profit when the
A) option is exercised immediately.
B) stock price exceeds the exercise price throughout the option period.
C) exercise price exceeds the stock price throughout the option period.
D) option is converted into shares.
E) is not exercised until the expiration date.
15) The maximum payoff to the seller of a call is
A) zero.
B) equal to the stock price.
C) equal to the exercise price.
D) not quantifiable.
E) unlimited.
16) The minimum payoff to the seller of a put is
A) zero.
B) a loss equal to the stock price.
C) a loss equal to the exercise price.
D) equal to the exercise price minus the stock price.
E) unlimited.
17) The ticker symbol for a stock option indicates all of the following except the
A) underlying stock.
B) expiration date.
C) intrinsic value.
D) type of option.
E) strike price.
18) Stock option quotes are
A) quoted as the price for each 100-share contract.
B) quoted on a per-share basis with each contract covering 1,000 shares.
C) quoted on a per-share basis with each contract covering a single share.
D) based on a 1,000-share contract and quoted as a price per contract.
E) based on a 100-share contract with the quote stated on a per-share basis.
19) Which one of these combinations is a protective put?
A) Writing identical puts and calls on the same asset
B) Buying a put and buying the underlying asset
C) Selling a call and buying the underlying asset
D) Buying a call and selling the underlying asset
E) Selling a put and buying the underlying asset
20) Selling a covered call is equivalent to
A) selling a put and buying the underlying stock.
B) buying a put and selling a zero coupon bond.
C) selling a put and selling the underlying stock.
D) buying the underlying stock and selling a put.
E) buying a zero coupon bond and selling a put.
21) The relationship between the prices of the underlying stock, a call option, a put option, and a
riskless asset is referred to as the ________ relationship.
A) covered call
B) put-call parity
C) protective put
D) straddle
E) strangle
22) Given an exercise price, E, time to maturity, t, and European put-call parity, the present value
of the strike price plus the value of the call option on the stock is equal to the
A) price of the stock plus the price of the put option.
B) present value of the stock minus the put option.
C) price of the put option minus the market value of the stock.
D) value of risk-free security, such as a U.S. Treasury bill.
E) current market value of the stock.
23) You can realize the same value as that derived from stock ownership if you
A) sell a put option and invest at the risk-free rate of return.
B) sell a put and buy a call on the stock as well as invest at the risk-free rate of return.
C) buy a call option and write a put option on a stock and also lend out funds at the risk-free rate.
D) lend out funds at the risk-free rate of return and sell a put option on the stock.
E) borrow funds at the risk-free rate of return and invest the proceeds in equivalent amounts of put
and call options.
24) Assume you own both a June 20 put and a June 20 call on ALPO stock. Which one of the
following statements is correct concerning your option positions? Ignore taxes and transaction
costs.
A) Both a May 20 put and a May 20 call on ALPO will have higher values than your June 20
options.
B) An increase in the stock price will increase the value of your put and decrease the value of your
call.
C) A decrease in the stock price will decrease the value of both of your options.
D) If put-call parity does not hold, you can profit from your positions even if ALPO stock sells for
$20 a share.
E) The time premium on your June 20 put is equal to the time premium on a July 20 put on ALPO.
25) You own an October 12 call and an October 12 put on SC stock. If the call finishes in the
money, then the put will
A) also finish in the money.
B) finish out of the money.
C) finish at the money.
D) either finish at the money or out of the money.
E) either finish at the money or in the money.
26) If a call has a positive intrinsic value at expiration, the call is said to be
A) at the money.
B) out of the money.
C) in the money.
D) funded.
E) unfunded.
27) Which of the following statements are correct concerning option values, all else held constant?
I. The value of an in-the-money call increases as the price of the underlying stock increases.
II. The value of a call decreases as the exercise price increases.
III. The value of an in-the-money put increases as the price of the underlying stock increases.
IV. The value of a put decreases as the exercise price increases.
A) I and III only
B) II and IV only
C) I and II only
D) II and III only
E) I, II, and IV only
28) The intrinsic value of a call is
I. the value of the call if it were to expire today.
II. equal to the lower bound of a call’s value.
III. another name for the market price of a call.
IV. always equal to zero if the call is currently out of the money.
A) I and III only
B) II and IV only
C) I and II only
D) II, III, and IV only
E) I, II, and IV only
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29) The lower bound on a call’s value is the:
A) stock price minus the exercise price or zero, whichever is greater.
B) strike price or zero, whichever is greater.
C) strike price or zero, whichever is lower.
D) strike price or the stock price, whichever is lower.
E) stock price minus the exercise price or zero, whichever is lower.
30) Assuming all else equal, the value of an in-the-money call increases when the
I. time to expiration increases.
II. stock price increases.
III. risk-free rate of return increases.
IV. volatility of the price of the underlying stock increases.
A) I and III only
B) II, III, and IV only
C) I, III, and IV only
D) I, II, and III only
E) I, II, III, and IV
31) Which one of the following will cause the value of a call to decrease?
A) Lowering the risk level of the underlying security
B) Increasing the time to expiration
C) Increasing the risk-free rate
D) Lowering the exercise price
E) Increasing the stock price
32) The value of an option if it were to immediately expire is called the option’s ________ value.
A) strike
B) time
C) intrinsic
D) volatility
E) market
33) Which one of these will increase both the value of a call and the value of a put?
A) Decrease in the exercise price
B) Increase in the stock price
C) Decrease in the interest rate
D) Increase in stock volatility
E) Decrease in time to expiration
34) An increase in which one of these will decrease the value of a call option and increase the value
of a put option?
A) Stock price
B) Time to expiration
C) Stock volatility
D) Interest rate
E) Exercise price
35) The relationship between a change in the price of a stock and the related change in the price of
the call on that stock is referred to as the option
A) vega.
B) theta.
C) rho.
D) gamma.
E) delta.
36) In the Black-Scholes option pricing model, what does the variable R represent?
A) The annually compounded risk-free rate of return
B) The continuously compounded variance
C) The continuously compounded annual risk-free rate of return
D) The annually compounded market rate of return
E) The continuously compounded market rate of return
37) In the Black-Scholes option pricing formula, N(d) is the probability that a standardized,
normally distributed random variable is:
A) greater than or equal to d.
B) less than one.
C) equal to one.
D) equal to d.
E) less than or equal to d.
38) Which variable within the Black-Scholes option pricing formula is the delta?
A) S
B) e−Rt
C) N(d2)
D) N(d1)
E) E
39) Assume N(d2) = N(3.0155) = 0.9987. Given this assumption, a drawing from the standardized
normal distribution has a ________ percent probability of being less than ________.
A) 3.0155; 0.9987
B) 0.13; 3.0155
C) 99.87; 3.0155
D) 0.0013; .9987
E) 0.9987; 3.0155
40) Which one of the Black-Scholes formula parameters must be estimated?
A) Stock price
B) Interest rate
C) Time to expiration
D) Variance of the return
E) Exercise price
41) You own stock in a firm that has a pure discount loan due in 6 months. The loan has a face
value of $50,000. The assets of the firm are currently worth $62,000. The stockholders in this firm
basically own a ________ option on the assets of the firm with a strike price of ________.
A) put; $62,000.
B) call; $50,000.
C) warrant; $62,000.
D) call; $62,000.
E) put; $50,000.
42) If you consider the equity of a firm to be an option on the firm’s assets, then the act of paying
off debt is comparable to ________ on the assets of the firm.
A) purchasing a put option
B) purchasing a call option
C) exercising an in-the-money call option
D) exercising an in-the-money put option
E) selling a call option
43) If you express a firm in terms of put options, the
A) current value of the firm is the exercise price.
B) option will always be in the money.
C) stockholders will be considered as the firm’s owners.
D) bondholders determine whether or not the option will be exercised.
E) bondholders are the buyers of the put.
44) The value of a risky bond is equal to the value of
A) a call option plus the value of a default–free bond.
B) the put option plus the value of a default–free bond.
C) a default–free bond minus the value of the call option.
D) a default–free bond minus the value of the put option.
E) a default–free bond minus the value of the put plus the value of the call.
45) A government guarantee of a firm’s existing debt
A) has a cost equal to that of a put option.
B) benefits shareholders at the expense of current bondholders.
C) converts risk-free debt into risky debt.
D) is costless to taxpayers.
E) is essentially exercising a call option on the firm.
46) RTF stock is currently priced at $21.06 a share. The only options on this stock are the August
$25 call option, which is priced at $.32, and the August $25 put which is priced at $3.98. Flo would
like the option to purchase 500 shares of RTF should the price suddenly rise as she expects. Her
main concern is that the price will double after hours and she will miss out on some potential
profits. She also realizes the stock is highly risky, and she could lose her entire investment, which
she prefers not to do. What should she do to help offset her concerns?
A) Sell 500 put option contracts and receive $1,990
B) Sell five call option contracts and receive $1.60
C) Buy 500 call option contracts at a cost of $160
D) Buy five put option contracts at a cost of $19.90
E) Buy five call option contracts at a cost of $160
47) Pure Aqua stock is selling for $37.28 a share. One $37.50 call is valued at $1.02 and one $35
put is valued at $.13. What is the value of four call option contracts?
A) $4.08
B) $2.96
C) $296.00
D) $408.00
E) $0