Chapter 16 – Option Contracts
1. The Chicago Board Options Exchange has the largest share of stock option trading.
a.
True
b.
False
2. Index options are settled by delivery of the stocks that make up the index.
a.
True
b.
False
3. In index options, the aggregate market takes the place of the individual stock issues being traded, as in stock options.
a.
True
b.
False
4. Risk management is the driving force behind the futures options market.
a.
True
b.
False
5. The longer the time to expiration, the greater the value of a call option.
a.
True
b.
False
6. There is an inverse relationship between the market interest rate and the value of a call option.
a.
True
b.
False
7. Credit risk in the options market is only a concern to the option seller.
a.
True
b.
False
8. The standardization of option contracts and the creation of the Options Clearing Corporation are two important results
of the opening of the Chicago Board of Options Exchange.
a.
True
b.
False
9. Stock options expire on the Sunday following the third Saturday of the designated month.
a.
True
b.
False
10. Index options can only be settled in cash.
a.
True
b.
False
11. Unlike stock options, futures options require the holder to enter into a futures contract.
Chapter 16 – Option Contracts
a.
True
b.
False
12. The owner of a call option on a futures contract has the obligation to buy the futures contract at a predetermined strike
price during a specified time period.
a.
True
b.
False
13. Options on futures expire at the same time the futures contract expires.
a.
True
b.
False
14. The Options Clearing Corporation (OCC) acts as the guarantor of each Chicago Board Options Exchange (CBOE)
traded contract.
a.
True
b.
False
15. It is always theoretically possible to use options as a perfect hedge against fluctuations in value of the underlying
asset.
a.
True
b.
False
16. Investors should purchase market index put options if they anticipate an increase in the index value.
a.
True
b.
False
17. Risk management strategies involving interest rate agreements can be classified as forward-based or option-based.
a.
True
b.
False
18. The most important input the investor must provide in determining option values is the strike price.
a.
True
b.
False
19. A portfolio containing a share of stock and a put option will have the same value as a portfolio containing a call option
and the risk-free bond.
a.
True
b.
False
20. The binomial model is a continuous method for valuing options.
a.
True
b.
False
21. In a binomial option pricing model, the initial value of the call can be determined by working backward through the
tree and solving for each of the remaining intermediate option values.
a.
True
b.
False
22. The binomial option pricing model and the Black and Scholes model are similar because they are both discrete
models.
a.
True
b.
False
23. The delta in the Black-Scholes model is simply the slope of a line tangent to the call option price curve.
a.
True
b.
False
24. The binomial option pricing model approximates the price of an option obtained using the Black-Scholes option
pricing model as the number of subintervals increases.
a.
True
b.
False
25. European options can only be exercised on the expiration date.
a.
True
b.
False
26. The underlying stock price and the value of the put option are factors that impact the value of an American call option.
a.
True
b.
False
27. A price spread (or vertical spread) involves buying and selling an option for the same stock and expiration date but
with different exercise prices.
a.
True
b.
False
28. A strip is a call option on a stock that is written by someone who owns the stock.
a.
True
b.
False
29. The buyer of a straddle expects stock prices to move strongly in either direction.
a.
True
b.
False
30. A long-strip position indicates that an investor is bullish but conservative.
a.
True
Chapter 16 – Option Contracts
b.
False
31. It is a violation of the securities laws to combine option contracts to achieve a customized payoff.
a.
True
b.
False
32. The issuance of convertibles will ultimately lead to greater dilution than an initial issue of stock.
a.
True
b.
False
33. Convertibles provide the upside potential of common stock and the downside protection of a bond.
a.
True
b.
False
34. By attaching a convertible feature to a bond issue, a firm can often get a lower rate of interest on its debt.
a.
True
b.
False
35. The investment value of a convertible bond is the price that it would be expected to sell as a straight debt instrument.
a.
True
b.
False
36. The conversion parity price is equal to the par value of a convertible bond divided by the number of shares into which
it can be converted.
a.
True
b.
False
37. A credit default swap (CDS) is better regarded as an option-like arrangement.
a.
True
b.
False
38. The creation of the CBOE led to all the following innovations in options EXCEPT
a.
the creation of a central marketplace.
b.
the introduction of a clearing corporation.
c.
the standardization of expiration dates.
d.
the creation of a primary market.
e.
the creation of a secondary market.
39. A currency call is like being ____ in the currency futures.
a.
out–of-the-money
b.
in-the-money
c.
long
d.
short
e.
at-the-money
40. The entity that acts as the guarantor of each CBOE-traded contract is the
a.
Federal Government.
b.
Securities and Exchange Commission.
c.
CBOE.
d.
Options Clearing Corporation.
e.
Federal Reserve Bank.
41. A foreign currency option contract traded on U.S. exchanges allows for the sale or purchase of a set amount of
a.
U.S. currency at a floating exchange rate.
b.
U.S. currency at a fixed exchange rate.
c.
foreign currency at a floating exchange rate.
d.
foreign currency at a fixed exchange rate.
e.
None of these are correct.
42. Options on futures contracts are very popular because
a.
they require the holder to purchase at a future date.
b.
of their ability to create leverage.
Chapter 16 – Option Contracts
c.
the seller of the futures contract is under no obligation.
d.
the amount of the underlying commodity is negotiable.
e.
None of these are correct.
Exhibit 16.1
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Option Type
Currency
Canadian dollar
Contract Size
50000
Canadian dollars
Expiry
April
Strike
Call
Put
$0.815
$0.0118
$0.820
$0.0068
43. Refer to Exhibit 16.1. How much must an investor pay for one call option contract?
a.
$680
b.
$815
c.
$625
d.
$590
e.
$340
44. Refer to Exhibit 16.1. How much must an investor pay for one put option contract?
a.
$680
b.
$815
Chapter 16 – Option Contracts
c.
$340
d.
$625
e.
$590
45. Refer to Exhibit 16.1. If the spot rate at expiration is $0.90 and the call option was purchased, what is the dollar gain
or loss?
a.
$0
b.
$3750 gain
c.
$3660 gain
d.
$4650 loss
e.
$2680 loss
46. Refer to Exhibit 16.1. If the spot rate at expiration is $0.80 and the call option was purchased, what is the dollar gain
or loss?
a.
$123 gain
b.
$590 loss
c.
$312 gain
d.
$237 gain
e.
$0
47. Refer to Exhibit 16.1. If the spot rate at expiration is $0.85 and the put option was purchased, what is the dollar gain or
loss?
a.
$340 loss
b.
$125 gain
c.
$750 gain
d.
$750 loss
e.
$200 loss
48. Refer to Exhibit 16.1. If the spot rate at expiration is $0.75 and the put option was purchased, what is the dollar gain or
loss?
a.
$0
b.
$200 loss
c.
$200 gain
d.
$3160 gain
e.
$1187 loss
49. In the Black-Scholes option pricing model, an increase in security price (S) will cause
a.
an increase in call value and an increase in put value.
b.
an increase in call value and a decrease in put value.
Chapter 16 – Option Contracts
c.
a decrease in call value and an increase in put value.
d.
a decrease in call value and a decrease in put value.
e.
an increase in call value and an increase or decrease in put value.
50. In the Black-Scholes option pricing model, an increase in exercise price (X) will cause
a.
an increase in call value and an increase in put value.
b.
an increase in call value and a decrease in put value.
c.
a decrease in call value and an increase in put value.
d.
a decrease in call value and a decrease in put value.
e.
an increase in call value and an increase or decrease in put value.
51. In the Black-Scholes option pricing model, an increase in time to expiration (T) will cause
a.
an increase in call value and an increase in put value.
b.
an increase in call value and a decrease in put value.
c.
a decrease in call value and an increase in put value.
d.
a decrease in call value and a decrease in put value.
e.
an increase in call value and an increase or decrease in put value.
52. In the Black-Scholes option pricing model, an increase in the risk-free rate (RFR) will cause
a.
In the Black-Scholes option pricing model, an increase in the risk-free rate (RFR) will cause
b.
an increase in call value and a decrease in put value.
c.
a decrease in call value and an increase in put value.
d.
a decrease in call value and a decrease in put value.
e.
an increase in call value and an increase or decrease in put value.
53. In the Black-Scholes option pricing model, an increase in security volatility () will cause
a.
an increase in call value and an increase in put value.
b.
an increase in call value and a decrease in put value.
c.
a decrease in call value and an increase in put value.
d.
a decrease in call value and a decrease in put value.
e.
an increase in call value and an increase or decrease in put value.
54. The Black-Scholes model assumes that stock price movements can be described by
a.
geometric moving averages.
b.
arithmetic moving averages.
c.
regression towards the mean.
d.
geometric Brownian motion.
e.
stochastic time lags.
Chapter 16 – Option Contracts
55. Which of the following is not a variable required to determine an option’s value in the Black-Scholes valuation model?
a.
future security price
b.
exercise price
c.
time to expiration
d.
risk-free rate
e.
security price volatility
56. In the Black-Scholes model N(d1) represents the
a.
hedge ratio.
b.
partial derivative of the call’s value with respect to the stock price.
c.
change in the option’s value given a one dollar change in the underlying security’s price.
d.
option’s delta.
e.
All of these are correct.
57. The calculation of a weighted average of the implied volatility estimates from options on the Standard & Poor’s 500
index using a wide range of exercise prices is known as
a.
Spider.
b.
QQQ.
c.
VIX.
d.
CIN.
e.
VOL.
Exhibit 16.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The following information is provided in the context of a two-period (two six-month periods) binomial option pricing
model. A stock currently trades at $60 per share, and a call option on the stock has an exercise price of $65. The stock is
equally likely to rise by 15 percent or fall by 15 percent during each six-month period. The one-year risk free rate is 3
percent.
58. Refer to Exhibit 16.2. Calculate the possible prices of the stock at the end of one year.
a.
$69, $51, $79.35
b.
$51, $79.35, $58.65
c.
$79.35, $58.65, $43.35
d.
$58.65, $43.35, $14.35
e.
$72.65, $53.35, $17.25
59. Refer to Exhibit 16.2. Calculate the price of the call option after the stock price has already moved up in value once
(Cu).