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Exam 5: Financial Options

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Question 1

True/False

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As 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.

A) True
B) False

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Question 2

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Which of the following statements is CORRECT?

A) call options generally sell at a price less than their exercise value.
B) if a stock becomes riskier (more volatile) , call options on the stock are likely to decline in value.
C) call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.
D) 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.
E) if the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock's price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.

F) A) and D)
G) A) and E)

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Question 3

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If 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.

BLW Corporation is considering the terms to be set on the options it plans to issue to its executives. Which of the following actions would decrease the value of the options, other things held constant?

An analyst wants to use the Black-Scholes model to value call options on the stock of Heath Corporation based on the following data: The price of the stock is $40. The strike price of the option is $40. The option matures in 3 months (t = 0.25) . The standard deviation of the stock's returns is 0.40, and the variance is 0.16. σ The risk-free rate is 6%. Given this information, the analyst then calculated the following necessary components of the Black-Scholes model: σ d1 = 0.175 σ d2 = σ0.025 σ N(d1) = 0.56946 σ N(d2) = 0.49003 N(d1) and N(d2) represent areas under a standard normal distribution function. Using the Black-Scholes model, what is the value of the call optionσ

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

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

If a stock's price is above the strike price of a call option written on the stock, then the exercise value is equal to the stock price minus the strike price. If the stock price is below the strike price, the exercise value of the call option is zero.

The 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 binomial model, what is the option's value?(Hint: Use daily compounding.)

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

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

If 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.

An option that gives the holder the right to sell a stock at a specified price at some future time is

An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?

An 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.

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.

If 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.

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 CORRECT?