Investment Analysis and Portfolio Management 9th Edition TestBank Chapter 20

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CHAPTER 20—AN INTRODUCTION TO DERIVATIVE MARKETS AND

SECURITIES TRUE/FALSE Question: A cash or spot contract is an agreement for the

immediate delivery of an asset such as the purchase of stock on the NYSE. Answer:

Question: Forward and future contracts, as well as options, are types of derivative

securities. Answer:

Question: All features of a forward contract are standardized, except for price and number

of contracts. Answer:

Question: Forward contracts are traded over-the-counter and are generally not

standardized. Answer:

Question: The forward market has low liquidity relative to the futures market. Answer:

Question: A futures contract is an agreement between a trader and the clearinghouse of the

exchange for delivery of an asset in the future. Answer:

Question: A primary function of futures markets is to allow investors to transfer risk.

Answer:

Question: The futures market is a dealer market where all the details of the transactions are

negotiated. Answer:

Question: Futures contracts are slower to absorb new information than forward contracts.

Answer:

Question: The initial value of a future contract is the price agreed upon in the contract.

Answer:

Question: A futures contract eliminates uncertainty about the future spot price that an

individual can expect to pay for an asset at the time of delivery. Answer:

Question: Investment costs are generally higher in the derivative markets than in the

corresponding cash markets. Answer:

Question: An option buyer must exercise the option on or before the expiration date.

Answer:

Question: The minimum value of an option is zero. Answer:

Question: An option to sell an asset is referred to as a call, whereas an option to buy an

asset is called a put. Answer:

Question: If an investor wants to acquire the right to buy or sell an asset, but not the

obligation to do it, the best instrument is an option rather than a futures contract. Answer:

Question: Investors buy call options because they expect the price of the underlying stock

to increase before the expiration of the option. Answer:

Question: A call option is in the money if the current market price is above the strike price.

Answer:

Question: A put option is in the money if the current market price is above the strike price.

Answer:

Question: The price at which the stock can be acquired or sold is the exercise price.

Answer:

Question: The minimum amount that must be maintained in an account is called the

maintenance margin. Answer:

Question: A forward contract gives its holder the option to conduct a transaction involving

another security or commodity. Answer:

Question: In the forward market both parties are required to post collateral or margin.

Answer:

Question: The option premium is the price the call buyer will pay to the option seller if the

option is exercised. Answer:

Question: The payoffs to both long and short position in the forward contact are symmetric

around the contract price. Answer:

Question: Which of the following statements is false?

Answer:

Question: Derivative instruments exist because

Answer:

Question: There are a number of differences between forward and futures contracts. Which

of the following statements is false?

Answer:

Question: Futures differ from forward contracts because

Answer:

Question: The price at which a futures contract is set at the end of the day is the

Answer:

Question: Which of the following statements is true?

Answer:

Question: The CBOE brought numerous innovations to the option market. Which of the

following is not such an innovation?

Answer:

Question: Which of the following factors is not considered in the valuation of call and put

options?

Answer:

Question: Which of the following statements is a true definition of an in-the-money

option?

Answer:

Question: The value of a call option just prior to expiration is (where V is the underlying

assets market price and X is the options exercise price)

Answer:

Question: Which of the following is not a factor needed to calculate the value of an

American call option?

Answer:

Question: In the valuation of an option contract, the following statements apply except

Answer:

Question: You own a stock that has risen from $10 per share to $32 per share. You wish to

delay taking the profit but you are troubled about the short run behavior of the stock

market. An effective action on your part would be to

Answer:

Question: A vertical spread involves buying and selling call options in the same stock with

Answer:

Question: The value of a put option at expiration is

Answer:

Question: In the two state option pricing model, which of the following does not influence

the option price?

Answer:

Question: The cost of carry includes all of the following except

Answer:

Question: A call option in which the stock price is higher than the exercise price is said to

Answer:

Question: The price paid for the option contract is referred to as the

Answer:

Question: A stock currently sells for $75 per share. A call option on the stock with an

exercise price $70 currently sells for $5.50. The call option is

Answer:

Question: A stock currently sells for $150 per share. A call option on the stock with an

exercise price $155 currently sells for $2.50. The call option is

Answer:

Question: A stock currently sells for $75 per share. A put option on the stock with an

exercise price $70 currently sells for $0.50. The put option is

Answer:

Question: A stock currently sells for $15 per share. A put option on the stock with an

exercise price $15 currently sells for $1.50. The put option is

Answer:

Question: A stock currently sells for $15 per share. A put option on the stock with an

exercise price $20 currently sells for $6.50. The put option is

Answer:

Question: An equity portfolio manager can neutralize the risk of falling stock prices by

entering into a hedge position where the payoffs are

Answer:

Question: The derivative based strategy known as portfolio insurance involves

Answer:

Question: A hedge strategy known as a collar agreement involves the simultaneous

Answer:

Question: A call option differs from a put option in that

Answer:

Question: Which of the following statements is a true definition of an out-of-the-money

option?

Answer:

Question: According to put/call parity

Answer:

Question: Futures contracts are similar to forward contracts in that they both

Answer:

Question: Which of the following statements are true?

Answer:

Question: A buyer of the call option is speculating on the

Answer:

Question: Which of the following is consistent with put-call-spot parity?

Answer:

Question: Holding a put option and the underlying security at the same time is an example

Answer:

Question: A one year call option has a strike price of 50, expires in 6 months, and has a

price of $5.04. If the risk free rate is 5%, and the current stock price is $50, what should

the corresponding put be worth?

Answer:

Question: A one year call option has a strike price of 50, expires in 6 months, and has a

price of $4.74. If the risk free rate is 3%, and the current stock price is $45, what should

the corresponding put be worth?

Answer:

Question: A one year call option has a strike price of 60, expires in 6 months, and has a

price of $2.5. If the risk free rate is 7%, and the current stock price is $55, what should the

corresponding put be worth?

Answer:

Question: A one year call option has a strike price of 70, expires in 3 months, and has a

price of $7.34. If the risk free rate is 6%, and the current stock price is $62, what should

the corresponding put be worth?

Answer:

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) December

futures on the S&P 500 stock index trade at 250 times the index value of 1187.70. Your

broker requires an initial margin of 10% percent on futures contracts. The current value of

the S&P 500 stock index is 1178. NARREND Question: Refer to Exhibit 20-1. How much

must you deposit in a margin account if you wish to purchase one contract?

Answer:

Question: Refer to Exhibit 20-1. Suppose at expiration the futures contract price is 250

times the index value of 1170. Disregarding transaction costs, what is your percentage

return?

Answer:

Question: Refer to Exhibit 20-1. Calculate the return on a cash investment in the S&P 500

stock index over the same time period

Answer:

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) A futures

contract on Treasury bond futures with a December expiration date currently trade at

103:06. The face value of a Treasury bond futures contract is $100,000. Your broker

requires an initial margin of 10%. NARREND Question: Refer to Exhibit 20-2. Calculate

the current value of one contract.

Answer:

Question: Refer to Exhibit 20-2. Calculate the initial margin deposit.

Answer:

Question: Refer to Exhibit 20-2. If the futures contract is quoted at 105:08 at expiration,

calculate the percentage return.

Answer:

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) On the last

day of October, Bruce Springsteen is considering the purchase of 100 shares of Olivia

Corporation common stock selling at $37 1/2 per share and also considering an Olivia

option.

NARREND Question: Refer to Exhibit 20-3. If Bruce decides to buy a March call option

with an exercise price of 35, what is his dollar gain (loss) if he closes his position when the

stock is selling at 43 1/2?

Answer:

Question: Refer to Exhibit 20-3. If Bruce buys a March put option with an exercise price

of 40, what is his dollar gain (loss) if he closes his position when the stock is selling at 43

1/2?

Answer:

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Rick

Thompson is considering the following alternatives for investing in Davis Industries,

which is now selling for $44 per share:

NARREND Question: Refer to Exhibit 20-4. Assuming no commissions or taxes, what is

the annualized percentage gain if the stock reaches $50 in four months and a call was

purchased?

Answer:

Question: Refer to Exhibit 20-4. Assuming no commissions or taxes, what is the

annualized percentage gain if the stock is at $30 in four months and the stock was

purchased?

Answer:

Question: Tom Gettback buys 100 shares of Johnson Walker stock for $87.00 per share and

a 3-month Johnson Walker put option with an exercise price of $105.00 for $20.00. What

is his dollar gain if at expiration the stock is selling for $80.00 per share?

Answer:

Question: Tom Gettback buys 100 shares of Johnson Walker stock for $87.00 per share and

a 3-month Johnson Walker put option with an exercise price of $105.00 for $20.00. What

is Toms dollar gain/loss if at expiration the stock is selling for $105.00 per share?

Answer:

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Sarah Kling

bought a 6-month Peppy Cola put option with an exercise price of $55 for a premium of

$8.25 when Peppy was selling for $48.00 per share. NARREND Question: Refer to

Exhibit 20-5. If at expiration Peppy is selling for $42.00, what is Sarahs dollar gain or

loss?

Answer:

Question: Refer to Exhibit 20-5. What is Sarahs annualized gain/loss?

Answer:

Question: Refer to Exhibit 20-5. If at expiration Peppy is selling for $47.00, what is Sarahs

dollar gain or loss?

Answer:

Question: Refer to Exhibit 20-5. What is Sarahs annualized gain/loss?

Answer:

Question: A stock currently trades for $25. January call options with a strike price of $30

sell for $6. The appropriate risk free bond has a price of $30. Calculate the price of the

January put option.

Answer:

Question: A stock currently trades for $115. January call options with a strike price of $100

sell for $16, and January put options a strike price of $100 sell for $5. Estimate the price of

a risk free bond.

Answer:

Question: Assume that you have purchased a call option with a strike price $60 for $5. At

the same time you purchase a put option on the same stock with a strike price of $60 for

$4. If the stock is currently selling for $75 per share, calculate the dollar return on this

option strategy.

Answer:

Question: Assume that you purchased shares of a stock at a price of $35 per share. At this

time you purchased a put option with a $35 strike price of $3. The stock currently trades at

$40. Calculate the dollar return on this option strategy.

Answer:

Question: Assume that you purchased shares of a stock at a price of $35 per share. At this

time you wrote a call option with a $35 strike and received a call price of $2. The stock

currently trades at $70. Calculate the dollar return on this option strategy.

Answer:

Question: A stock currently trades at $110. June call options on the stock with a strike

price of $105 are priced at $4. Calculate the arbitrage profit that you can earn.

Answer:

Question: Datacorp stock currently trades at $50. August call options on the stock with a

strike price of $55 are priced at $5.75. October call options with a strike price of $55 are

priced at $6.25. Calculate the value of the time premium between the August and October

options.

Answer:

Question: A stock currently trades at $110. June put options on the stock with a strike price

of $100 are priced at $5.25. Calculate the dollar return on one put contract.

Answer:

Question: A stock currently trades at $110. June call options on the stock with a strike

price of $120 are priced at $5.75. Calculate the dollar return on one call contract.

Answer:

Question: Consider a stock that is currently trading at $65. Calculate the intrinsic value for

a put option that has an exercise price of $55.

Answer:

Question: Consider a stock that is currently trading at $20. Calculate the intrinsic value for

a put option that has an exercise price of $35.

Answer:

Question: Consider a stock that is currently trading at $45. Calculate the intrinsic value for

a call option that has an exercise price of $35.

Answer:

Question: Consider a stock that is currently trading at $10. Calculate the intrinsic value for

a call option that has an exercise price of $15.

Answer:

USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT QUESTION(S)

The current stock price of ABC Corporation is $53.50. ABC Corporation has the following

put and call option prices that expire 6 months from today. The risk-free rate of return is

5% and the expected return on the market is 11%.

NARREND Question: Refer to Exhibit 20-6. What should the price be of a call option that

expires 6 month from today with a exercise price of $55?

Answer:

Question: Refer to Exhibit 20-6. What is the value of a synthetic stock created with put and

call options that expire in 6 months with an expiration price of $50?

Answer:

Question: Refer to Exhibit 20-6. How could an investor create arbitrage profits?

Answer:

Question: A stock currently trades for $63. Call options with a strike price of $62 sell for

$4.00 and expire in 6 months. If the risk-free rate is 4%, what should the price of a put

option with an exercise price of $62 be worth?

Answer:

Question: You own a call option and put option that both have the same exercise price of

$50 and their respective prices are $4 and $3. The stock is currently trading at $60.

Calculate the dollar return on this strategy.

Answer: