Chapter 19—Options
MULTIPLE CHOICE
1. The option that gives the owner the right to buy an asset at a fixed price at or before a certain date is
called a
a.
put option
b.
call option
c.
parity option
d.
swaption
2. The price at which the owner of an option can buy or sell the underlying asset is called the
a.
market price
b.
liquidation value
c.
strike price
d.
intrinsic value
3. An option that gives the owner the right to buy or sell an asset at a fixed price only on the expiration
date, is called a(n)
a.
European option
b.
American option
c.
Asian option
d.
exotic option
4. According to the Black and Scholes option pricing model, which of the following will lead to an
increase in the value of a call option?
a.
the price of the underlying asset decreases
b.
the risk free rate increases
c.
the time to expiration decreases
d.
none of the above
5. When a call option’s strike price is less than the current price of the underlying asset, the call is said to
be
a.
at the money
b.
in the money
c.
out of the money
d.
worthless
6. Smith Enterprises stock currently sells for $17.50. A call option on the stock has a strike price of $15
and currently sells at $4.50. What is the intrinsic value of the option?
a.
$0
b.
$2.50
c.
$4.50
d.
$1.25
7. Smith Enterprises stock currently sells for $17.50. A put option on the stock has a strike price of $15
and currently sells at $4.50. What is the intrinsic value of the option?
a.
$0
b.
$2.50
c.
$4.50
d.
$1.25
8. Smith Enterprises stock currently sells for $17.50. A put option on the stock has a strike price of $15
and currently sells at $4.50. What is the time value of the option?
a.
$0
b.
$2.50
c.
$4.50
d.
$2.00
9. Smith Enterprises stock currently sells for $17.50. A call option on the stock has a strike price of $15
and currently sells at $4.50. What is the time value of the option?
a.
$2.50
b.
$0
c.
$2.00
d.
$4.50
10. Smith Enterprises stock currently sells for $17.50. A call option on the stock has a strike price of $20
and currently sells at $4.50. What is the intrinsic value of the option?
a.
$0
b.
$2.50
c.
$2.00
d.
$4.50
11. Smith Enterprises stock currently sells for $17.50. A call option on the stock has a strike price of $20
and currently sells at $4.50. What is the time value of the option?
a.
$0
b.
$2.50
c.
$2
d.
$4.50
12. Smith Enterprises stock currently sells for $17.50. A put option on the stock has a strike price of $20
and currently sells at $4.50. What is the time value of the option?
a.
$0
b.
$2.50
c.
$2
d.
$4.50
13. Smith Enterprises stock currently sells for $17.50. A put option on the stock has a strike price of $20
and currently sells at $4.50. What is the intrinsic value of the option?
a.
$0
b.
$2.50
c.
$2.00
d.
$4.50
14. Suppose you bought 10 Smith Enterprise call options with a strike price of $52 at $2.75 per option. If
the price of Smith stock is $50, what is your net profit (or loss)? Ignore transaction costs.
a.
$0
b.
-$27.50
c.
$27.50
d.
$500
15. Suppose you bought 10 Smith Enterprise put options with a strike price of $52 at $2.75 per option. If
the price of Smith stock is $48, what is your net profit (or loss)? Ignore transaction costs.
a.
$40
b.
$0
c.
$12.50
d.
-$27.50
16. Suppose you bought 10 Smith Enterprise put options with a strike price of $52 at $2.75 per option. If
the price of Smith stock is $56, what is your net profit (or loss)? Ignore transaction costs.
a.
$40
b.
$0
c.
-$27.50
d.
$12.50
17. Suppose you bought 10 Smith Enterprise call options with a strike price of $52 at $2.75 per option. If
the price of Smith stock is $56, what is your net profit (or loss)? Ignore transaction costs.
a.
$0
b.
$12.50
c.
-$27.50
d.
$40
18. A call option with a $50 strike price on Bavarian Sausage stock will expire in one year. If you know
that the risk free rate is 4%, that the stock currently sells at $47 and the put on the same stock has a
value of $2.75, what is the price of the call?
a.
$2.75
b.
$3.56
c.
$1.67
d.
$5.36
19. A put option with a $50 strike price on Bavarian Sausage stock will expire in one year. If you know
that the risk free rate is 4%, that the stock currently sells at $47 and the call on the same stock has a
value of $2.75, what is the price of the put?
a.
$4.67
b.
$2.75
c.
$3.83
d.
$1.56
20. A put option with a $50 strike price on Bavarian Sausage stock will expire in one year. If you know a
call on the same stock has a value of $2.75, that the price of the put is $1.26 and the stock is currently
selling at $47, what is the implied risk free rate?
a.
4.56%
b.
3.07%
c.
5.43%
d.
9.87%
21. Bavarian Brew issued convertible bonds with a par value of $1,000. The conversion ratio on the bonds
is 12.33, the current market price of the bonds is $933.75 and the underlying stock currently sells at
$35.25. What is the conversion price?
a.
$33.25
b.
$75.73
c.
$54.36
d.
$12.33
22. Bavarian Brew issued convertible bonds with a par value of $1,000. The conversion ratio on the bonds
is 12.33, the current market price of the bonds is $933.75 and the underlying stock currently sells at
$45.25. What is the conversion premium?
a.
66.48%
b.
45.25%
c.
74.67%
d.
27.58%
23. A call option with a $35 strike price on Bavarian Sausage stock will expire in one year. If you know
that the risk free rate is 6%, that the stock currently sells at $38 and the put on the same stock has a
value of $3.85, what is the price of the call?
a.
$3.85
b.
$6.26
c.
$7.34
d.
$8.83
24. A put option with a $35 strike price on Bavarian Sausage stock will expire in one year. If you know
that the risk free rate is 6%, that the stock currently sells at $38 and the call on the same stock has a
value of $6.85, what is the price of the put?
a.
$6.85
b.
$1.87
c.
$3.00
d.
$0
25. A put option with a $35 strike price on Bavarian Sausage stock will expire in one year. If you know
that the stock currently sells at $38 that the put on the same stock has a value of $6.85, and the value of
the call is $11.87, what is the implied risk free rate?
a.
3.57%
b.
5.39%
c.
8.27%
d.
6.12%
26. If a company is wanting to lessen the cost of a new security by imbedding a valuable option in the
security, then the company is most likely to issue
a.
common stock.
b.
debt.
c.
convertible debt.
d.
preferred stock.
27. One of the main reasons for the name “derivatives” is that
a.
the value of the underlying instrument derives its value from the derivative instrument.
b.
the instruments derive their value from the value of other instruments.
c.
calculus is required to convert their market price to a dollar price.
d.
none of the above.
28. If you purchase the right to sell a share of IBM stock for a set price for a fixed period of time, then you
have
a.
sold a call option.
b.
purchased a call option.
c.
purchased a put option.
d.
sold a put option.
29. You need to immediately purchase 100 shares of Stock X and you own a call option with a strike price
of $32. The current price of Stock X is $25. Your best course of action is
a.
to exercise your call option at price of $32.
b.
to purchase a new call option with a strike price of $25 and exercise it.
c.
to purchase the stock in the market at a price of $25.
d.
none of the above.
30. An option that gives the holder the right to purchase an underlying security only at the end of a fixed
period for a fixed price is an
a.
American call option.
b.
American put option.
c.
European call option.
d.
European put option.
31. Which of the following will increase in price as the value of the underlying asset decreases in price,
from the option holder’s perspective?
a.
call option
b.
put option
c.
a long future position.
d.
none of the above.
32. You notice that you can purchase an option for $5. The price of the underlying stock is currently $42.
What is the option premium for this option?
a.
$5
b.
$37
c.
$42
d.
$47
33. You currently own a put option on Stock X with a strike price of $25. If the current price of Stock X is
$30, then what is the in-the-money amount of the option?
a.
-$5
b.
$0
c.
$5
d.
none of the above
34. You own a put option on a stock and the strike price of the option is $30. The option has 3 weeks until
expiration and the stock is currently priced at $35 per share. What is the largest payout possible for this
put option? Ignore the original cost of the option for the payout calculation.
a.
$0
b.
$5
c.
$30
d.
the payout is unlimited
35. You own a call option on a stock and the strike price of the option is $30. The option has 3 weeks until
expiration and the stock is currently priced at $35 per share. What is the largest payout possible for this
call option? Ignore the original cost of the option for the payout calculation.
a.
$0
b.
$5
c.
$30
d.
there is an unlimited possible payout on this option
36. You sold a call option on a stock and the strike price of the option is $30. The option has 3 weeks until
expiration and the stock is currently priced at $35 per share. You originally sold the call option for $3.
What is the largest payout possible total payout to you for this call option?
a.
$0
b.
$3
c.
$5
d.
$30
37. You find that an investor purchases a put option on shares of Company Z stock. What is the most
likely reason that an investor would make such a purchase?
a.
the investor believes that Company Z is an undervalued company
b.
the investor believes that Company Z in an overvalued company
c.
the investor would like to speculated that Company Z’s stock price will randomly increase
d.
none of the above
38. You purchase a call option and a put option on the shares of a company. The sticker price and
expiration date for the options is equal. What is the best description of the combined payoff diagram
for the combination of the two options?
a.
an upward sloping straight line
b.
a downward sloping straight line
c.
a v-shaped diagram with the kink at the strike price of the options
d.
an upside down v-shaped diagram with the kink at the strike price of the options
39. You own 100 shares of a stock with a current price of $50 and you also own a put option of 100 shares
of the stock with a strike price of $45. What is the minimum value of your portfolio at expiration?
Ignore the original cost of the put option for your calculation.
a.
$50
b.
$45
c.
$5
d.
$0
40. You notice that the price of a one-year call option, with a $40 strike price, is $5. The current price of
the underlying stock is also $40. What should the price of a one-year put option be with a strike price
of $40? Assume that the interest rate on a one-year risk free bond is 10%.
a.
$5
b.
$0
c.
$1.36
d.
$8.63
41. You notice that the price of a one-year put option, with a $60 strike price, is $1. The current price of
the underlying stock is also $58. What should the price of a one-year call option be with a strike price
of $60? Assume that the interest rate on a one-year risk free bond is 10%.
a.
$0
b.
$2
c.
$2.45
d.
$4.45
42. Which of the following will cause a decrease in the value of the respective derivative?
a.
an increase in volatility for a call option
b.
a decrease in volatility for a call option
c.
an increase in the length to expiration for a call option
d.
an increase in the length to expiration for a put option
43. You have written a call option on 1 share of Z stock that is worth $15. You expect the price of the
stock to either move to $20 or $10 over the next year. How many shares of Z stock should you own to
perfectly hedge your position on the call option? The strike price on the option is $15.
a.
2 shares
b.
1 share
c.
.5 shares
d.
none of the above
44. You have written a call option on 1 share of Z stock that is currently worth $15. You expect the price
of the stock to either move to $20 or $10 over the next year. If the one-year risk-free interest rate is
10% and the strike price on the option is $15, what should have been the proceeds of the option?
a.
$5.45
b.
$2.95
c.
$.45
d.
$0
45. You have written a call option on 1 share of A stock that is currently worth $30. You expect the price
of the stock to either move to $40 or $20 over the next year. If the one-year risk-free interest rate is 5%
and the strike price on the option is $25, what should have been the proceeds of the option?
a.
$15.72
b.
$8.22
c.
$.72
d.
$0
46. You need to find the price of a European call option on a stock that does not pay dividends. The
current price of the shares are $50 and the strike price on the option is $50. The expiration date is 3
months from now and the risk-free rate applicable is 10% per annum. If the standard deviation of the
returns on the stock is 20%, what is the price of a single call option?
a.
$6.53
b.
$2.91
c.
$2.65
d.
$2.00
47. According to the Black-Scholes option pricing model which of the following has the effect of
decreasing the value of a call option?
a.
an increase in the stock price
b.
a higher strike price
c.
an increase in the standard deviation of the underlying asset price returns
d.
an increase in the risk-rate
48. You need to find the price of a European call option on a stock that does not pay dividends. The
current price of the shares are $100 and the strike price on the option is $80. The expiration date is 9
months from now and the risk-free rate applicable is 8% per annum. If the standard deviation on the
returns on the stock is 50%, what is the price of a single call option?
a.
$19.71
b.
$27.20
c.
$30.39
d.
$36.65
49. When managers of a firm are compensated in options, managements interests may not be aligned with
that of shareholders because
a.
managers may have incentives to increase the riskiness of the firm.
b.
managers would rather be paid in cash.
c.
the taxes that are paid on the option compensation buffer that form of compensation from
being aligned with the shareholders interests.
d.
none of the above.
50. Which of the following is issued by the firm that grants investors the right to buy shares of stock at a
fixed price, for a given period of time?
a.
stock futures
b.
put options
c.
warrants
d.
none of the above
51. An investor that purchases a call option on XYZ stock, is hoping that XYZ stock price will:
a.
be below the strike price at expiration
b.
be above the strike price at expiration
c.
be equal to the strike price at expiration
d.
none of the above
52. An investor that purchases a put option on ABC stock is hoping that ABC stock will:
a.
fall below the put strike price at expiration.
b.
rise above the put strike price at expiration.
c.
equal the put strike price at expiration.
d.
none of the above
53. An investor that writes a naked call could be considered:
a.
bullish
b.
bearish
c.
neutral
d.
risk averse
54. ABC stock is currently trading at $28. A call option on ABC with a strike price of $30 and 3 months to
expiration trades for $2.75. In order for the option to be considered in the money at expiration, ABC
stuck must:
a.
be greater than $30.75
b.
be greater than $32.75
c.
be greater than $30
d.
be less than $27.25
55. A put on United Pipeline has 1 year to maturity and a strike price of $45. If an investor purchases that
option for $3.25 then in order for the investor to break even, United Pipeline’s stock price on the
expiration date must equal
a.
$45
b.
$48.25
c.
$41.75
d.
none of the above
56. An investor purchases 2 call options on XYZ stock with a strike price of $50. The call premium is
$2.65 each. The investor will breakeven at expiration if the stock price of XYZ is:
a.
$50
b.
$47.35
c.
$55.30
d.
$52.65
57. Which of the following conditions must be met in order for put – call parity to hold.
a.
The call and put options must be on the same underlying stock
b.
The call and put options must have the same expiration date
c.
Both options should be European options
d.
All of the above