Chapter 8 iClickers

Multiple Choice Identify the choice that best completes the statement or answers the question. ____ 1. An option that gives the holder the right to sell a stock at a specified price at some future time is a. a call option. b. a put option. c. an out-of-the-money option. d. a naked option. e. a covered option. 2. Call options on XYZ Corporation's common stock trade in the market. Which of the following statements is most correct, holding other things constant? a. The price of these call options is likely to rise if XYZ's stock price rises. b. The higher the strike price on XYZ's options, the higher the option's price will be. c. Assuming the same strike price, an XYZ call option that expires in one month will sell at a higher price than one that expires in three months. d. If XYZ's stock price stabilizes (becomes less volatile), then the price of its options will increase. e. If XYZ pays a dividend, then its option holders will not receive a cash payment, but the strike price of the option will be reduced by the amount of the dividend. 3. GCC Corporation is planning to issue options to its key employees, and it is now discussing the terms to be set on those options. Which of the following actions would decrease the value of the options, other things held constant? a. GCC's stock price suddenly increases. b. The exercise price of the option is increased. c. The life of the option is increased, i.e., the time until it expires is lengthened. d. The Federal Reserve takes actions that increase the risk-free rate. e. GCC's stock price becomes more risky (higher variance). 4. Which of the following statements is CORRECT? a. Put options give investors the right to buy a stock at a certain strike price before a specified date. b. Call options give investors the right to sell a stock at a certain strike price before a specified date. c. Options typically sell for less than their exercise value. d. LEAPS are very short-term options that were created relatively recently and now trade in the market. e. An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend. 5. Deeble Construction Co.'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? a. The options with the $25 strike price will sell for $5. b. The options with the $25 strike price will sell for less than the options with the $35 strike price. c. The options with the $25 strike price have an exercise value greater than $5. d. The options with the $35 strike price have an exercise value greater than $0.

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$1.862.70 c. If the underlying stock does not pay a dividend. The annual risk-free rate is 6.989. $3.25 and Johnson's stock price actually rises to $45. what would your pre-tax net profit be? a. $2.10 8.25 you could buy a 5-month put option giving you the right to sell 100 shares at a price of $85 per share. Because of the put-call parity relationship. $1. ____ 6. based on the following data: • • • • The price of the stock is $40. The option matures in 3 months (t = 0. Based on the binominal model. and the lower the exercise value.99 d. it does not make good economic sense to exercise a call option prior to its expiration date. the lower the premium on the option is likely to be. Call options generally sell at a price below their exercise value.25 b. $2.75 c. Suppose you believe that Johnson Company's stock price is going to increase from its current level of $22. under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock. For $510. e.e.24 d. $2.50 sometime during the next 5 months. The current price of a stock is $22.25 b. Which of the following statements is CORRECT? a. and the greater the exercise value.95 e. $2.25).16.75 c.774. A 1-year call option on the stock. the lower the premium on the option is likely to be.38 9. is available. d. with an exercise price of $22. Call options generally sell at a price greater than their exercise value. what would your pre-tax net profit be? a. −$310.29 e. Call options generally sell at a price below their exercise value.50 sometime during the next 5 months.43 b.303.25 and Delva's stock price actually dropped to $60. and the greater the exercise value. For $310. If you bought this option for $510. $2. based on daily compounding.089. and the variance is 0. c. what is the option's value? a. An analyst wants to use the Black-Scholes model to value call options on the stock of Ledbetter Inc.40.62 ____ ____ ____ ____ 10. The standard deviation of the stock's returns is 0. −$510. and at the end of one year its price will be either $27 or $17. even if this would yield an immediate profit.24 d.0%. $3. $1. $1. If you buy this option for $310.193. If Deeble's stock price rose by $5.689. the exercise value of the options with the $25 strike price would also increase by $5.956. 7. $2. the higher the premium on the option is likely to be. The strike price of the option is $40. . Suppose you believe that Delva Corporation's stock price is going to decline from its current level of $82. b. $1.25 you can buy a 5-month call option giving you the right to buy 100 shares at a price of $25 per share.70 e.

• The risk-free rate is 6%. $4.20 . $2. $3.82 e. Given this information. what is the value of the call option? a. Using the Black-Scholes model.49003 N(d1) and N(d2) represent areas under a standard normal distribution function.47 d. $3. the analyst then calculated the following necessary components of the Black-Scholes model: • • • • d1 = 0.025 N(d1) = 0.12 c.81 b.175 d2 = −0. $3.56946 N(d2) = 0.

of options − Cost of options = $1.25 Profit per share = Final price − Strike price = $45 − $25 or zero: $20. ANS: A PTS: 1 DIF: Medium OBJ: Comp: 8.5 | Comp: 8.00 Total profit = Profit/option × No. ANS: E PTS: 1 DIF: Easy OBJ: Comp: 8. P $22. P TOP: Option value MSC: Conceptual 6. Strike price: $85. P TOP: Option concepts MSC: Conceptual 4.Chapter 8 iClickers Answer Section MULTIPLE CHOICE 1. there will simply be a loss equal to the cost of the option.00 Final price: $60.00 Final price: $45. ANS: B The put option will be exercised only if the final price is below the strike price.1 | Comp: 8. ANS: E PTS: 1 DIF: Medium OBJ: 8. of options: 100 Option cost: $310.25 Profit per share = Strike price − Final price = $85 − $60 or zero: $25. ANS: B The call option will be exercised only if the final price is above the strike price.00 Price at end of year: .6 NAT: AACSB: C. ANS: B PTS: 1 DIF: Easy OBJ: 8. P TOP: Call options MSC: Problem 8.00 No.75 PTS: 1 DIF: Easy OBJ: 8.3 | Comp: 8.1 NAT: AACSB: C.1 NAT: AACSB: C.75 PTS: 1 TOP: Put options 9. ANS: A PTS: 1 DIF: Easy OBJ: 8. there will simply be a loss equal to the cost of the option.1 NAT: AACSB: C. P TOP: Miscellaneous option concepts MSC: Conceptual 7. P TOP: Option terms MSC: Conceptual 2. If the final price is below the strike price. Strike price: $25.1 NAT: AACSB: C.989. If the final price exceeds the strike price. of options − Cost of options = $1.4 NAT: AACSB: C. P TOP: Miscellaneous option concepts MSC: Conceptual 5.689. ANS: B PTS: 1 DIF: Easy OBJ: 8.1 NAT: AACSB: C.1 NAT: AACSB: C.00 No. of options: 100 Option cost: $510. ANS: C Current price DIF: Easy MSC: Problem OBJ: 8. P TOP: Option concepts MSC: Conceptual 3.1 | Comp: 8.00 Total profit = Profit/option × No.

Payoff range. $8.00 = Price − Exercise = 27 − 22 = (Price − Exercise) or $0 = $5 − $0 = $27.00 or 0. option: If stock is high: If stock is low: Option range: $22.005.78 − $19.5 shares of stock will be either: $13.00% Low $27. The present value of $8.Exercise price rRF Step 1. The option price is the cost of the stock purchased for the portfolio minus the PV of the payoff: V = 0.49003) = $22. stock: Payoff range.00 $ 5. PTS: 1 DIF: Medium OBJ: 8. The payoff from 0. P TOP: Option price based on binomial model MSC: Problem 10.01 = $2.00 Step 3.50 at the daily compounded risk-free rate is: PV = $8.5($22) − $8.50 The payoff from the option will be either: 5.50/(1 + (0.00 High 6.16 Risk-free rate: 6.06/365)) 365 = $8.0% The Black-Scholes model calculates the value of the call option as: V = P[N(d1)] − Xe−rt[N(d2)] = $40(0.99 Step 5.31 = $3.49003 Option maturity: 0.50 or $ 8.56946 Strike price: $40. Step 6.5 Step 4.50 regardless of which choice materializes.00 − $17.00 $ 5.00 0.2 NAT: AACSB: C. ANS: C Stock price: $40. P .00 $10.00 N(d2) = 0.00 N(d1) = 0.50 or $ 8. Step 2.47 PTS: 1 DIF: Hard TOP: Black-Scholes model OBJ: 8.50 So the portfolio's payoff is riskless. Equalize the ranges to find the number of shares of stock: Option range/Stock range = $5/$10 = shares of stock = 0.00 The portfolio's payoff will be either: $ 8.00 $17.5 MSC: Problem NAT: AACSB: C.56946) − $40e−rt(0.25 Variance of stock returns: 0.

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