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Fundamentals of Corporate Finance, 12e (Ross)
Chapter 25 Option Valuation
1) Travis owns a stock that is currently valued at $45.80 a share. He is concerned that the stock
price may decline so he just purchased a put option on the stock with an exercise price of $45.
Which one of the following terms applies to this strategy?
A) Put-call parity
B) Covered call
C) Protective put
D) Straddle
E) Strangle
2) According to put-call parity, the present value of the exercise price is equal to the:
A) stock price plus the call premium minus the put premium.
B) call premium plus the put premium minus the stock price.
C) stock price minus the put premium minus the call premium.
D) put premium plus the call premium minus the stock price.
E) stock price plus the put premium minus the call premium.
3) In the put-call parity formula, the present value of the exercise price is computed using the:
A) nominal market rate.
B) real market rate.
C) real inflation rate.
D) nominal inflation rate.
E) risk-free rate.
4) Which one of the following provides the option of selling a stock at a specified price on a
stated date even if the market price of the stock declines to zero?
A) American call
B) European call
C) American put
D) European put
E) Either an American or European put
5) The primary purpose of a protective put is to:
A) ensure a maximum purchase price in the future.
B) offset an equivalent call option.
C) limit the downside risk of asset ownership.
D) lock in a risk-free rate of return on a financial asset.
E) increase the upside potential return on an investment.
6) Which one of the following can be used to replicate a protective put strategy?
A) Riskless investment and stock purchase
B) Stock purchase and call option
C) Call option and riskless investment
D) Riskless investment and writing a put
E) Call option, stock purchase, and riskless investment
7) Which one of these is most equivalent to e− Rt?
A) −2.71828Rt
B) −1/2.71828Rt
C) 1/2.71828Rt
D) 1 − 2.71828Rt
E) 1/2.71828Rt
8) Under European put-call parity, the present value of the strike price is equivalent to the
present value of:
A) the current value of the stock minus the call premium.
B) the market value of the stock plus the put premium.
C) a U.S. Treasury coupon bond with a face value equal to the strike price.
D) a U.S. Treasury bill with a face value equal to the strike price.
E) any risk-free security with a face value equal to the strike price and a coupon rate equal to the
risk-free rate of return.
9) In the Black-Scholes option pricing formula, N(d1) is the probability that a standardized,
normally distributed random variable is:
A) less than or equal to N(d2).
B) less than 1.
C) equal to 1.
D) equal to d1.
E) less than or equal to d1.
10) In the Black-Scholes option pricing model, the symbol "σ" is used to represent the standard
deviation of the:
A) option premium on a call with a specified exercise price.
B) rate of return on the underlying asset.
C) volatility of the risk-free rate of return.
D) rate of return on a risk-free asset.
E) option premium on a put with a specified exercise price.
11) All of the following affect the value of a call option except the:
A) strike price.
B) stock price.
C) standard deviation of the returns on a risk-free asset.
D) continuously compounded risk-free rate.
E) time to maturity.
12) To compute the value of a put using the Black-Scholes option pricing model, you:
A) assume the equivalent call is worthless and then apply the put-call parity formula.
B) have to compute the value of the put as if it is a call and then apply the put-call parity
formula.
C) subtract the value of an equivalent call from 1.0.
D) subtract the value of an equivalent call from the market price of the stock.
E) multiply the value of an equivalent call by e−rt.
13) Which one of the following statements is correct?
A) The price of an American put is equal to the stock price minus the exercise price.
B) The value of a European call is greater than the value of a comparable American call.
C) The value of a put is equal to one minus the value of an equivalent call.
D) The value of a put minus the value of a comparable call is equal to the value of the stock
minus the exercise price.
E) The value of an American put will equal or exceed the value of a comparable European put.
14) Which one of the following cannot be either used by or calculated by the Black-Scholes
option pricing model?
A) Risk-free rate of return
B) Premium on an American call option
C) Time to maturity greater than one year
D) Underlying asset value
E) An exercise price equal to the face value of a firm's debt
15) When computing the value of a call option using the Black-Scholes option pricing model, d2
is calculated as:
A) σt .5 − 1.
B) 1 − σt .5.
C) d1 − σt .5.
D) 1 + σt .5.
E) d1 + σt .5.
16) Which one of the following statements related to options is correct?
A) American stock options can be exercised but not resold.
B) A European call is either equal to or less valuable than a comparable American call.
C) European puts can be resold but can never be exercised.
D) European options can be exercised on any dividend payment date.
E) American options are valued using the Black-Scholes option pricing model.
17) Assume all stocks are non-dividend paying. Given this assumption, which one of these
statements is correct regarding stock options?
A) European put options are more valuable than comparable American put options.
B) Exercising a well-into-the-money American put option is generally not a good idea.
C) It is never optimal to exercise an American call option early.
D) You should wait to exercise a put option if the stock price falls to zero.
E) You are better off exercising an in-the-money call option than selling it.
18) Assume the risk-free rate increases by one percent. Which one of the following measures the
effect this change will have on the value of a firm's stock options?
A) Theta
B) Vega
C) Delta
D) Rho
E) Gamma
19) Which one of the following defines the relationship between the value of an option and the
option's time to expiration?
A) Theta
B) Vega
C) Rho
D) Delta
E) Gamma
20) Assume the standard deviation of the returns on ABC stock increases. This change will
________ the value of the call options and ________ the value of the put options on ABC stock.
A) increase; decrease
B) increase; increase
C) decrease; decrease
D) decrease; increase
E) not effect; not effect
21) Assume the risk-free rate increases. This change will ________ the value of call options and
________ the value of put options on shares of stock.
A) increase; decrease
B) increase; increase
C) decrease; decrease
D) decrease; increase
E) not affect; not affect
22) The estimate of the future volatility of the returns on the underlying asset that is computed
using the Black-Scholes option pricing model is referred to as the:
A) residual error.
B) implied mean return.
C) derived case volatility.
D) forecast rho.
E) implied standard deviation.
23) The value of a call option delta is best defined as a value that is:
A) between zero and one.
B) less than zero.
C) greater than zero.
D) greater than or equal to zero.
E) less than or equal to zero.
24) Given a small change in the value of the underlying stock, the change in an option's price is
approximately equal to the change in stock value:
A) divided by delta.
B) divided by (1 − Delta).
C) divided by (1 + Delta).
D) multiplied by (1 − Delta).
E) multiplied by delta.
25) If the price of the underlying stock decreases, then the value of the call options ________
and the value of the put options ________.
A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase
E) increase; remain unchanged
26) Which one of the following statements is correct?
A) Increasing the time to maturity may not increase the value of a European put.
B) An increase in time decreases the value of a call option.
C) Exercising an American option is always more valuable than selling the option.
D) Call options tend to be less sensitive to the passage of time than are put options.
E) Vega measures the sensitivity of an option's value to the passage of time.
27) Theta measures an option's:
A) intrinsic value.
B) volatility.
C) rate of time decay.
D) sensitivity to changes in the value of the underlying asset.
E) sensitivity to changes in the risk-free rate.
28) Selling a call option is generally more valuable than exercising the option because of the
option's:
A) riskless value.
B) intrinsic value.
C) standard deviation.
D) exercise price.
E) time premium.
29) Which one of the following statements is correct?
A) The value of a call option decreases as the time to expiration increases.
B) A decrease in the risk-free rate decreases the value of a put option.
C) Increasing the risk-free rate decreases the value of a call option.
D) The value of a put option increases when the standard deviation of the returns on the
underlying stock increase.
E) Increasing the strike price decreases the value of a put option.
30) A decrease in which of the following will increase the value of a put option on a stock?
A) Strike price and standard deviation of the returns on the underlying stock
B) Stock price and risk-free rate
C) Time to expiration and strike price
D) Risk-free rate and standard deviation of the returns on the underlying stock
E) Time to expiration and stock price
31) Which one of the five factors included in the Black-Scholes option pricing model cannot be
directly observed?
A) Risk-free rate
B) Strike price
C) Standard deviation
D) Stock price
E) Life of the option
32) Which one of the following statements related to the implied standard deviation (ISD) is
correct?
A) The ISD is an estimate of the historical standard deviation of the underlying security.
B) ISD is equal to (1 − d1).
C) The ISD estimates the volatility of an option's price over the option's lifespan.
D) The value of ISD is dependent upon both the risk-free rate and the time to option expiration.
E) ISD confirms the observable volatility of the return on the underlying security.
33) The implied standard deviation used in the Black-Scholes option pricing model is:
A) based on historical performance.
B) a prediction of the volatility of the return on the underlying asset over the life of the option.
C) a measure of the time decay of an option.
D) an estimate of the future value of an option given a strike price e.
E) a measure of the historical intrinsic value of an option.
34) The value of an option is equal to the:
A) intrinsic value minus the time premium.
B) time premium plus the intrinsic value.
C) implied standard deviation plus the intrinsic value.
D) summation of the intrinsic value, the time premium, and the implied standard deviation.
E) summation of delta, theta, vega, and rho.
35) For the equity of a firm to be considered a call option on the firm's assets, the firm must:
A) be in default.
B) be leveraged.
C) pay dividends.
D) have a negative cash flow from operations.
E) have a negative cash flow from assets.
36) Paying off a firm's 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 put option
D) exercising an in-the-money call option
E) writing a put option
37) The shareholders of a firm will benefit the most from a positive net present value project
when the delta of the call option on the firm's assets is:
A) equal to one.
B) between zero and one.
C) equal to zero.
D) between zero and minus one.
E) equal to minus one.
38) The value of the risky debt of a firm is equal to the value of:
A) a call option plus the value of a risk-free bond.
B) a risk-free bond plus a put option.
C) the equity of the firm minus a put.
D) the equity of the firm plus a call option.
E) a risk-free bond minus a put option.
39) A firm has assets of $16.4 million and 2-year, zero-coupon, risky bonds with a total face
value of $7.4 million. The bonds have a total current market value of $7.1 million. The
shareholders of this firm can change these risky bonds into risk-free bonds by purchasing a
________ option with a 2-year life and a strike price of ________ million.
A) call; $7.1
B) call; $7.4
C) put; $16.4
D) put; $7.1
E) put; $7.4
40) Purely financial mergers:
A) are beneficial to stockholders.
B) are beneficial to both stockholders and bondholders.
C) are detrimental to stockholders.
D) add value to both the total assets and the total equity of a firm.
E) reduce both the total assets and the total equity of a firm.
