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Exam 6: Financial Options

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Question 1

True/False

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option is a contract that gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time.

A) True
B) False

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Question 2

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Which of the following statements is CORRECT?

A) As the stock's price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.
B) Issuing options provides companies with a low cost method of raising capital.
C) The market value of an option depends in part on the option's time to maturity and also on the variability of the underlying stock's price.
D) The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.
E) An option's value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can't sell for more than its exercise value.

F) A) and B)
G) A) and C)

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Question 3

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exercise value is also called the strike price, but this term is generally used when discussing convertibles rather than financial options.

current price of a stock is $50, the annual risk-free rate is 6%, and a 1-year call option with a strike price of $55 sells for $7.20 What is the value of a put option, assuming the same strike price and expiration date as for the call option?

Cazden Motors's stock is trading at $30 a share Call options on the company's stock are also available, some with a strike price of $25 and some with a strike price of $35 Both options expire in three months Which of the following best describes the value of these options?

Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock, provided the strike prices for the put and call are the same.

exercise value is the positive difference between the current price of the stock and the strike price The exercise value is zero if the stock's price is below the strike price.

the market is in equilibrium, then an option must sell at a price that is exactly equal to the difference between the stock's current price and the option's strike price.

Since investors tend to dislike risk and like certainty, the more volatile a stock, the less valuable will be an option to purchase the stock, other things held constant.

the current price of a stock is below the strike price, then an option to buy the stock is worthless and will have a zero value.

current price of a stock is $22, and at the end of one year its price will be either $27 or $17 The annual risk-free rate is 6.0%, based on daily compounding A 1-year call option on the stock, with an exercise price of $22, is available Based on the binominal model, what is the option's value?

Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the

a company announces a change in its dividend policy from a zero target payout ratio to a 100% payout policy, this action could be expected to increase the value of long-term options (say 5-year options) on the firm's stock.

Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.

Suppose you believe that Florio Company's stock price is going to decline from its current level of $82.50 sometime during the next 5 months For $5.10 you could buy a 5-month put option giving you the right to sell 1 share at a price of $85 per share If you bought this option for $5.10 and Florio's stock price actually dropped to $60, what would your pre-tax net profit be?

Suppose you believe that Basso Inc.'s stock price is going to increase from its current level of $22.50 sometime during the next 5 months For $3.10 you can buy a 5-month call option giving you the right to buy 1 share at a price of $25 per share If you buy this option for $3.10 and Basso's stock price actually rises to $45, what would your pre-tax net profit be?

Which of the following statements is most correct, holding other things constant, for XYZ Corporation's traded call options?

we define the "premium" on an option to be the difference between the price at which an option sells and the exercise value (or the difference between the stock's current market price and the strike price), then we would expect the premium to increase as the stock price increases, other things held constant.

the price of a stock rises above the strike price, the value investors are willing to pay for a call option increases because both (1) the immediate capital gain that can be realized by exercising the option and (2) the likely exercise value of the option when it expires have both increased.

strike price is the price that must be paid for a share of common stock when it is bought by exercising a warrant.