Chap 024

Chapter 24 - Options and Corporate Finance
24-1
Chapter 24 Options and Corporate Finance Answer Key

Multiple Choice Questions

1. Which one of the following grants its owner the right to buy or to sell an asset at a
prespecified price at any tie during a stated period!
A. option
". forward contract
C. futures contract
#. swap
$. intrinsic contract
%efer to section 24.1

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#$%
Section: "#&%
'o(ic: O(tion

2. $li&abeth owns a call option on 1'' shares of (icrosoft stoc). *he has decided to buy those
shares. +his purchase is coonly referred to as,
A. stri)ing the asset.
". e-piring the option.
C. e-ercising the option.
#. putting the collar.
$. the collar option.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: )*ercising t+e o(tion

24-2
.. (arti owns an option that allows hi to purchase A"C stoc) at /0' a share. +he /0' price
is referred to as the,
A. opening price.
". intrinsic 1alue.
C. stri)e price.
#. ar)et price.
$. tie 1alue.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: Stri,e (rice

4. What is the final day on which an option can be e-ercised called!
A. payent date
". e--option date
C. opening date
D. e-piration date
$. intrinsic date

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: )*(iration date

24-.
0. Felicia purchased an option which she can e-ercise anytie within the ne-t si- onths.
Which type of option did she purchase!
A. ar)et-ready
". portable
C. daily
#. $uropean
E. Aerican

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: American o(tion

2. "rad purchased an option that he can only e-ercise on the final day of the option period.
Which type of option did he purchase!
A. $uropean
". Aerican
C. infle-ible
#. dated
$. pointed

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: )uro(ean o(tion

24-4
3. Which of the following grants its owner the right to purchase an asset at a stated price!
4. Aerican call
44. $uropean call
444. Aerican put
45. $uropean put
A. 4 only
B. 4 and 44 only
C. 4 and 444 only
#. 44 and 45 only
$. 444 and 45 only

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: Call o(tion

6. +he owner of a put option has the 77777 an asset at a fi-ed price during a stated period of
tie.
A. right to sell
". right to buy
C. obligation to sell
#. obligation to buy
$. obligation to trade

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: -ut o(tion

24-0
8. Which one of the following ters applies to the 1alue of an option on its e-piration date!
A. stri)e price
". upper liit
C. deadline price
#. tie 1alue
E. intrinsic 1alue

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#$"
Section: "#&"
'o(ic: .ntrinsic !alue

1'. *u&ie is the controller of +he 9rice %ite Copany. *he has been granted to the right to buy
1:''' shares of her eployer;s stoc) at /20 a share anytie within the ne-t three years.
Which one of the following has *u&ie been granted!
A. eployee stoc) option
". copany bonus option
C. eployee grant
#. eployee e-ercise option
$. copany benefits option

AACSB: N/A
Bloom's: Com(re+ension
Difficulty: Basic
Learning Obecti!e: "#$/
Section: "#&#
'o(ic: )m(loyee stoc, o(tion

24-2
11. Which one of the following ters applies to an option that has an office building as its
underlying asset!
A. financial option
". li<uid option
C. fi-ed option
D. real option
$. concrete option

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#$0
Section: "#&1
'o(ic: 2eal o(tions

12. +he in1estent tiing decision is the,
A. deterination of when an option should be e-ercised.
". decision of when to purchase an option on an underlying asset.
C. analysis of deterining when an asset should be sold.
#. deterination of when a pro=ect should be abandoned.
E. e1aluation of the optial tie to begin a pro=ect.

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Bloom's: Knowledge
Difficulty: Basic
Section: "#&1
'o(ic: .n!estment timing decision

24-3
1.. >ucas $nterprises recently opted to open a new retail outlet. 4f the outlet outperfors the
e-pectations: the anager can opt to increase the store;s si&e. 4f it underperfors: the anager
can opt to close the store. +hese choices that the anager has been gi1en are called,
A. call options.
". put options.
C. straddles.
D. anagerial options.
$. e-ecuti1e options.

AACSB: N/A
Difficulty: Basic
Section: "#&1
'o(ic: 3anagerial o(tions

14. Which one of the following considers all of the options iplicit in a pro=ect!
A. e-pansion planning
B. contingency planning
C. asset anageent re1iew
#. prospecti1e e1aluation
$. strategic e1aluation

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Bloom's: Knowledge
Difficulty: Basic
Section: "#&1
'o(ic: Contingency (lanning

24-6
10. K+ $nterprises has e-panded its operations into a new field: which is the production of
e1eryday dinnerware. 4f this pro=ect goes well: the fir has the option to e-pand its
production into fine china. What type of option is this!
A. financial
B. strategic
C. put
#. intangible
$. call

AACSB: N/A
Difficulty: Basic
Section: "#&1
'o(ic: Strategic o(tions

12. Ay is a current shareholder of #? 4ndustries. *he has been gi1en the right to purchase an
additional 20 shares of #? 4ndustries stoc) at a price of /.2 a share if she e-ercises that right
within the ne-t 12 onths. What is this security called that Ay has been gi1en!
A. con1ertible bond
B. warrant
C. straddle
#. spread
$. put

AACSB: N/A
Difficulty: Basic
Section: "#&4
'o(ic: 5arrants

24-8
13. ?eff owns a /1:''' face 1alue bond. @e can e-change that bond for 20 shares of KA?
stoc) at any tie within the ne-t 2 years. What type of bond does ?eff own!
A. secured
". warranted
C. con1ertible
#. =un)
$. callable

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: Con!ertible bonds

16. +he dollar aount of a bond;s par 1alue that is e-changeable for one share of stoc) is
called the,
A. con1ersion preiu.
". par 1alue.
C. con1ersion 1alue.
D. con1ersion price.
$. con1ersion ratio.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: Con!ersion (rice

24-1'
18. Alicia owns a /1:''' face 1alue bond that can be con1erted into 2' shares of A" >iited
stoc). Which one of the following ters refers to these 2' shares!
A. con1ersion preiu
". straight bond 1alue
C. con1ersion 1alue
#. con1ersion price
E. con1ersion ratio

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: Con!ersion ratio

2'. +he difference between the con1ersion price and the current stoc) price: di1ided by the
current stoc) price: is called the,
A. con1ersion preiu.
". straight bond 1alue.
C. con1ersion 1alue.
#. con1ersion price.
$. con1ersion ratio.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: Con!ersion (remium

24-11
21. >atetia owns a con1ertible bond. Which one of the following ters would describe the
1alue of this bond if it were not con1ertible!
A. con1ersion preiu
B. straight bond 1alue
C. con1ersion 1alue
#. in1erted 1alue
$. ar)et 1alue

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: Straig+t bond !alue

22. "rad owns a con1ertible bond. Which one of the following ters would apply to the 1alue
of this bond if he were to con1ert it into shares of stoc) today!
A. con1ersion preiu
". straight bond 1alue
C. con1ersion 1alue
#. in1erted 1alue
$. prescribed 1alue

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: Con!ersion !alue

24-12
2.. Which one of the following stateents correctly describes your situation as the holder of a
$uropean call option!
A. Bou are obligated to buy if the option is e-ercised.
". Bou ha1e a right to sell.
C. Bou ha1e a right to buy but only on the e-piration date.
#. Bou are obligated to sell if the option is e-ercised.
$. Bou ha1e a right to buy at any tie before the option e-pires.

AACSB: N/A
Difficulty: Basic
Section: "#&%

24. ?ulie opted to e-ercise her August option on ?une 2'th and as a result recei1ed /2:0'' for
the sale of her shares. Which one of the following did ?ulie own!
A. warrant
". Aerican call
C. Aerican put
#. $uropean call
$. $uropean put

AACSB: N/A
Difficulty: Basic
Section: "#&%

24-1.
20. ?osh opted to e-ercise his ?anuary option at the end of #eceber and paid /.:20' at that
tie to ac<uire 1'' shares of stoc). Which one of the following did ?osh own!
A. Aerican call
". Aerican put
C. $uropean call
#. $uropean put
$. $uropean con1ertible bond

AACSB: N/A
Difficulty: Basic
Section: "#&%

22. *te1e owns an option which grants hi the right to purchase shares of >o)ier +ool stoc)
at a price of /40 a share. Currently: the stoc) is selling for /02.4' a share. *te1e would li)e to
reali&e his profits but is not peritted to e-ercise the option for another two wee)s. Which
one of the following does *te1e own!
A. straight bond
". Aerican call
C. Aerican put
D. $uropean call
$. $uropean put

AACSB: N/A
Difficulty: Basic
Section: "#&%

24-14
23. What is the priary difference between an Aerican call option and a $uropean call
option!
A. +he Aerican call has a fi-ed stri)e price while the $uropean stri)e price 1aries o1er tie.
". An Aerican call is a right to buy while a $uropean call is an obligation to buy.
C. An Aerican call has an e-piration date while the $uropean call does not.
#. An Aerican call is written on 1'' shares of the underlying security while the $uropean
call co1ers 1:''' shares.
E. An Aerican call an be e-ercised at any tie up to the e-piration date while the $uropean
call can only be e-ercised on the e-piration date.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%

26. Bou own a ?uly /10 call on A"C stoc). Assue today is April 2' and the call has &ero
intrinsic 1alue. Which one of the following best describes this option!
A. worthless
". unfunded
C. e-pired
#. in-the-oney
E. out-of-the-oney

AACSB: N/A
Difficulty: Basic
Section: "#&"
'o(ic: Call !alue

24-10
28. A /2' put option on Wildwood stoc) e-pires today. +he current price of the stoc) is
/16.0'. Which one of the following best describes this option!
A. funded
". unfunded
C. at-the-oney
D. in-the-oney
$. out-of-the-oney

AACSB: N/A
Difficulty: Basic
Section: "#&"
'o(ic: -ut !alue

.'. Which one of the following describes the a-iu 1alue of a call option!
A. stri)e price inus the initial cost of the option
". e-ercise price plus the price of the underlying stoc)
C. stri)e price
D. ar)et price of the underlying stoc)
$. purchase price

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&"
'o(ic: Call u((er bound

24-12
.1. Which one of the following describes the lower bound of a call;s 1alue!
A. stri)e price or &ero: whiche1er is greater
B. stoc) price inus the e-ercise price or &ero: whiche1er is greater
C. stri)e price or the stoc) price: whiche1er is lower
#. stri)e price or &ero: whiche1er is lower
$. stoc) price inus the e-ercise price or &ero: whiche1er is lower

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&"
'o(ic: Call lower bound

.2. Which one of the following describes the intrinsic 1alue of a call option!
A. the call;s upper bound 1alue
B. the call;s lower bound 1alue
C. ar)et price of the underlying security
#. &ero: if the call is in-the-oney
$. negati1e aount: if the call is out-of-the-oney.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&"
'o(ic: Call intrinsic !alue

24-13
... Which one of the following describes the intrinsic 1alue of a put option!
A. lesser of the stri)e price or the stoc) price
". lesser of the stoc) price inus the e-ercise price or &ero
C. lesser of the stoc) price or &ero
D. greater of the stri)e price inus the stoc) price or &ero
$. greater of the stoc) price inus the e-ercise price or &ero

AACSB: N/A
Difficulty: Basic
Section: "#&"
'o(ic: -ut intrinsic !alue

.4. Which one of the following stateents is correct!
A. +he 1alue of a call decreases as the price of the underlying stoc) increases.
B. +he 1alue of a call increases as the e-ercise price decreases.
C. +he 1alue of a put increases as the price of the underlying stoc) increases.
#. +he 1alue of a put decreases as the e-ercise price increases.
$. +he intrinsic 1alue of a put ust be &ero on the e-piration date.

AACSB: N/A
Difficulty: Basic
Section: "#&"
'o(ic: 6actors affecting o(tion !alues

24-16
.0. An increase in which of the following will increase the 1alue of a call!
4. tie to e-piration
44. underlying stoc) price
444. ris)-free rate of return
45. price 1olatility of the underlying stoc)
A. 4 and 444 only
". 44: 444: and 45 only
C. 4: 444: and 45 only
#. 4: 44: and 444 only
E. 4: 44: 444: and 45

AACSB: N/A
Difficulty: Basic
Section: "#&"

.2. Which of the following will decrease the 1alue of a call option!
4. a decrease in the e-ercise price
44. a decrease in the 1alue of the underlying security
444. an increase in the ris)-free rate
45. an increase in the tie to e-piration
A. 44 only
". 4 and 44 only
C. 444 and 45 only
#. 4: 44: and 45 only
$. 4: 44: and 444 only

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&"

24-18
.3. (ar) owns both a (arch /2' put and a (arch /2' call on Alpha stoc). Which one of the
following stateents correctly relates to (ar);s position! 4gnore ta-es and transaction costs.
A. A price decrease in Alpha stoc) will increase the 1alue of (ar);s call option.
". A (arch /.' call is worth ore than (ar);s /2' call.
C. +he tie preiu on an April /2' put is less than the tie preiu on (ar);s put.
CAssue both puts e-pire in the sae calendar year.D
#. A price increase in Alpha stoc) fro /22 to /26 will increase the 1alue of (ar);s put.
E. 4f the intrinsic 1alue of (ar);s put increases by /1 then the intrinsic 1alue of his call ust
either decrease by /1 or e<ual &ero.

AACSB: N/A
Bloom's: Analysis
Difficulty: Basic
Section: "#&"
'o(ic: O(tion !alue

.6. +ra1is owns both a *epteber /.' call and a *epteber /.' put. 4f the call finishes at-
the-oney: then the put will,
A. also finish in-the-oney.
B. finish at-the-oney.
C. finish out-of-the-oney.
#. either finish at-the-oney or in-the-oney.
$. either finish at-the-oney or out-of-the-oney.

AACSB: N/A
Difficulty: Basic
Section: "#&"
'o(ic: O(tion !alue

24-2'
.8. Which one of the following stateents regarding eployee stoc) options C$*OsD is
correct!
A. $*Os grant an eployee the right to buy a fi-ed nuber of shares of copany stoc) at the
ar)et price.
". $ployees ust e-ercise their $*Os prior to those $*Os becoing 1ested.
C. $ployees ay forfeit their $*Os if they terinate their eployent with the issuing
fir.
#. 4f a fir issue $*Os it ust a)e the a1ailable to all eployees.
$. $ployees can sell their $*Os if they do not want to personally e-ercise the.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&#

4'. $ployee stoc) options are priarily designed to do which one of the following!
A. pro1ide eployees with put options on their shares of copany stoc)
". pro1ide an iediately 1ested benefit to )ey eployees
C. influence the actions and priorities of eployees
#. distribute e-cess cash to )ey eployees to a1oid corporate ta-ation
$. pro1ide an iediate capital gain to certain eployees

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&#

24-21
41. $ployee stoc) options,
A. usually ha1e a positi1e intrinsic 1alue when issued.
". ust be bac)dated at least si- onths to coply with *arbanes-O-ley.
C. are generally EunderwaterE when issued.
#. are fre<uently repriced if the options are in-the-oney.
E. are generally issued with a &ero intrinsic 1alue.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&#

42. +he *arbanes-O-ley Act of 2''2 re<uires firs to report $*O grants within how any
days of the grant!
A. 2 calendar days
B. 2 business days
C. 3 calendar days
#. .' business days
$. 40 calendar days

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&#
'o(ic: )SO bac,dating

24-22
4.. #elta 4porters has a pure discount loan with a face 1alue of /16':''' due in one year.
+he assets of the fir are currently worth /220:'''. +he shareholders in this fir basically
own a 77777 option on the assets of the fir with a stri)e price of 77777.
A. putF /16':'''.
". putF /220:'''.
C. warrantF /220:'''.
D. callF /16':'''.
$. callF /220:'''.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#$#
Section: "#&0
'o(ic: )7uity as a call o(tion

44. ?ac) and ?ill are house hunting. +hey find @ouse A situated on a hill. +hey really li)e the
house but want to continue searching the ar)et for one ore wee) before a)ing their final
decision to buy the house. +o a1oid ha1ing soeone else purchase @ouse A while they
continue their house hunting: they decide to place a /2:0'' deposit on @ouse A. +his deposit
will apply to the purchase price if they buy @ouse A. 4f they do not buy @ouse A: they will
forfeit the /2:0''. $ssentially: ?ac) and ?ill ha1e a 77777 on @ouse A.
A. financial put
". financial call
C. warrant
#. real put
E. real call

AACSB: N/A
Difficulty: Basic
Section: "#&1
'o(ic: 2eal o(tions

24-2.
40. +he option to wait,
4. ay be of inial 1alue if a pro=ect is dependent upon rapidly changing technology.
44. is partially dependent upon the discount rate applied to the pro=ect being e1aluated.
444. is defined as teporarily shutting down a pro=ect for a period of tie.
45. has a 1alue e<ual to the A95 of a pro=ect if it is started at a later date inus the A95 if the
pro=ect is started today.
A. 4 and 444 only
". 44 and 45 only
C. 4 and 44 only
#. 44: 444: and 45 only
E. 4: 44: and 45 only

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&1
'o(ic: O(tion to wait

42. 4gnoring which of the following will cause the A95 of a pro=ect to be underestiated!
4. option to abandon
44. option to e-pand
444. option to wait
45. option to contract
A. 4 and 444 only
". 44: 444: and 45 only
C. 4: 44: and 444 only
#. 4: 444: and 45 only
E. 4: 44: 444: and 45

AACSB: N/A
Difficulty: Basic
Section: "#&1

24-24
43. Which one of the following is an e-aple of a strategic option for a restaurant!
A. opening a new restaurant with a different loo) and an entirely different enu to see if that
type of restaurant appeals to the public
". deciding to close one hour earlier during the winter onths due to slow sales
C. abandoning a enu ite based on custoer coplaints
#. deciding to open only two new locations ne-t year instead of the fi1e that were originally
scheduled
$. deciding to create separate lunch and dinner enus rather than ha1e the cobined on one
enu

AACSB: N/A
Difficulty: Basic
Section: "#&1
'o(ic: Strategic o(tions

46. >ast onth: @ill *ide (ar)ets introduced a new board gae. Consuer deand has been
o1erwheling and appears that strong deand will e-ist o1er the long-ter as young children
absolutely lo1e the gae. Gi1en this: which one of the following options should @ill *ide
(ar)ets consider in respect to this gae!
A. suspension
B. e-pansion
C. abandonent
#. contraction
$. withdrawal

AACSB: N/A
Difficulty: Basic
Section: "#&1
'o(ic: O(tion to e*(and

24-20
48. +hree onths ago: +oy +own introduced a new toy for pre-school children. +he store
e-pected this toy to be an instant success and a fast o1ing ite. +o their surprise: children
ha1e &ero interest in this toy so sales ha1e been abysal. Which one of the following options
should +oy +own consider in respect to this toy!
A. suspension
". e-pansion
C. abandonent
#. contraction
$. re-introduction

AACSB: N/A
Difficulty: Basic
Section: "#&1
'o(ic: O(tion to abandon

0'. Which of the following are anagerial options once a pro=ect is coenced!
4. odifying the production process
44. re-pricing the product
444. re1ising the ar)eting plan
45. odifying the product;s color and shape
A. 4 and 44 only
". 444 and 45 only
C. 4: 44: and 444 only
#. 44: 444: and 45 only
E. 4: 44: 444: and 45

AACSB: N/A
Difficulty: Basic
Section: "#&1

24-22
01. Which one of the following stateents related to warrants is correct!
A. Warrants are generally issued as an attachent to publicly-issued bonds.
". Warrants are e-cluded fro trading on an organi&ed e-change.
C. Warrants are structured as long-ter put options.
#. Warrants are issued by indi1idual in1estors.
E. Warrants are generally added as an incenti1e to a pri1ate debt issue.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: 5arrants

02. Which of the following stateents are correct concerning warrants!
4. Warrants are siilar to put options.
44. Warrants are siilar to call options.
444. When a warrant is e-ercised: the issuer is not in1ol1ed in the transaction.
45. When a warrant is e-ercised: the issuer ust issue new shares of stoc).
A. 4 only
". 44 only
C. 4 and 444 only
D. 44 and 45 only
$. 4 and 45 only

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: 5arrants

24-23
0.. When warrants are e-ercised: the,
A. earnings per share decrease.
". earnings per share reain constant.
C. total e<uity in a fir reains constant.
#. total e<uity in a fir decreases.
$. nuber of bonds outstanding increases.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: 5arrants

04. Which of the following stateents are correct concerning con1ertible bonds!
4. Aew shares of stoc) are issued when a con1ertible bond is con1erted.
44. A con1ertible bond is siilar to a bond with a call option.
444. A con1ertible bond should always be worth less than a coparable straight bond.
45. A con1ertible bond can be described as ha1ing upside potential with downside protection.
A. 4 and 444 only
B. 4: 44: and 45 only
C. 4: 44: and 444 only
#. 4: 444: and 45 only
$. 44: 444: and 45 only

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4

24-26
00. +he con1ersion 1alue of a con1ertible bond is e<ual to which one of the following!
A. Con1ersion ratio *toc) price
". Con1ersion ratio Con1ersion price
C. Face 1alue of the bondHCon1ersion preiu
#. Face 1alue of the bond C1 I Con1ersion preiuD
$. *toc) price C1 I Con1ersion ratioD

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4

02. +he a-iu 1alue of a con1ertible bond is theoretically,
A. e<ual to the con1ersion 1alue inus the straight bond 1alue.
". e<ual to the face 1alue of the bond ultiplied by C1 I Con1ersion priceD.
C. liited to the a-iu straight bond 1alue.
#. liited by the face 1alue of the bond.
E. unliited.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4

24-28
03. What is the cost of two Ao1eber /20 put option contracts on #o1e stoc) gi1en the
following price <uotes!

A. /'.10
". /'..'
C. /1.0'
#. /10.''
E. /.'.''
Cost J 2 1'' /'.10 J /.'

AACSB: Analytic
Bloom's: A((lication
Difficulty: Basic
Section: "#&%
'o(ic: O(tion 7uotes

24-.'
06. What is the 1alue of fi1e August /20 call contracts on #o1e stoc)!

A. /.4
". /26
C. /.4'
#. /26'
E. /.:4''
Contract 1alue J 0 1'' /2.6' J /.:4''

AACSB: Analytic
Difficulty: Basic
Section: "#&%

24-.1
08. What is the intrinsic 1alue of the Ao1eber /20 call on #o1e stoc)!

A. -/'.86
". /'
C. /'.10
D. /2.12
$. /3.1'
4ntrinsic 1alue J /.1.12 - /20 J /2.12

AACSB: Analytic
Difficulty: Basic
Section: "#&%

2'. Bou purchased si- call option contracts on A"C stoc) with a stri)e price of /.2.0' when
the option was <uoted at /1.6'. +he option e-pires today when the 1alue of A"C stoc) is
/.4.2'. 4gnoring trading costs and ta-es: what is the net profit or loss on this in1estent!
A. /'
B. /16'
C. /21'
#. /64'
$. /1:22'
+otal profit J C/.4.2' - /.2.0' - /1.6'D 1'' 2 J /16'

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: Call (ayoff

24-.2
21. Bou sold one call option contract with a stri)e price of /00 when the option was <uoted at
/'.6'. +he option e-pires today when the 1alue of the underlying stoc) is /0..3'. 4gnoring
trading costs and ta-es: what is the net profit or loss on this in1estent!
A. -/20'
". -/6'
C. /'
#. /0'
E. /6'
+otal profit J /'.6' 1'' 1 J /6'. +he call finished out-of-the-oney.

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: Call (ayoff

22. Bou sold three /.0 call option contracts at a <uoted price of /1.4'. What is your net profit
or loss on this in1estent if the price of the underlying asset is /.2.3' on the option
e-piration date!
A. -/01'
B. -/8'
C. /8'
#. /01'
$. /8.'
+otal loss J C/1.4' I /.0 - /.2.3'D 1'' . J -/8'

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: Call (ayoff

24-..
2.. Bou wrote eight call option contracts with a stri)e price of /42.0' at a call price of /1..0
per share. What is your net gain or loss on this in1estent if the price of the underlying stoc)
is /4'..' per share on the option e-piration date!
A. -/2:64'
". -/1:32'
C. -/1:'6'
D. /1:'6'
$. /1:32'
Aet profit J /1..0 1'' 6 J /1:'6'. +he call finished out-of-the-oney.

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: Call (ayoff

24. +he ar)et price of *outhern 9ress stoc) has been relati1ely 1olatile and you thin) this
1olatility will continue for a couple ore onths. +hus: you decide to purchase a two-onth
$uropean call option on this stoc) with a stri)e price of /40 and an option price of /2.2'. Bou
also purchase a two-onth $uropean put option on the stoc) with a stri)e price of /40 and an
option price of /'..'. What will be your net profit or loss on these option positions if the
stoc) price is /46 on the day the options e-pire! 4gnore trading costs and ta-es.
A. -/.'
B. /0'
C. /6'
#. /23'
$. /..'
Aet profit J K-/2.2' I /46 - /40D 1''L I K-/'..' 1''L J /0'

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: O(tion (ayoffs

24-.4
20. *e1eral ruors concerning 5alue %ite stoc) are causing the ar)et price of the stoc) to be
<uite 1olatile. Gi1en this situation: you decide to buy both a one-onth $uropean /20 put and
a one-onth $uropean /20 call on this stoc). +he call price per share is /'.2' and the put
price per share is /2.1'. What will be your net profit or loss on these option positions if the
stoc) price is /16 on the day the options e-pire! 4gnore trading costs and ta-es.
A. -/21'
". -/10'
C. -/2'
D. /4.'
$. /48'
Aet profit J K-/'.2' 1''L I KC-/2.1' I /20 - /16D 1''L J /4.'

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: O(tion (ayoffs

22. +hree onths ago: Central *upply stoc) was selling for /01.4' a share. At that tie: you
purchased fi1e put options on the stoc) with a stri)e price of /0' per share and an option price
of /'.2' per share. +he option e-pires today when the 1alue of the stoc) is /42.3' per share.
What is your net profit or loss on this in1estent! 4gnore trading costs and ta-es.
A. -/1:.''
". -/1:'''
C. -/.''
D. /.:.0'
$. /.:20'
Aet profit J C-/'.2' - /42.3' I /0'D 1'' 0 J /.:.0'

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: -ut (ayoff

24-.0
23. Bou wrote two put options on Mylo stoc) with an e-ercise price of /.' per share and an
option price of /1.'0 per share. +oday: the contracts e-pire and the stoc) is selling for /.1.10
a share. What is your net profit or loss on this in1estent! 4gnore trading costs and ta-es.
A. -/110
". -/1'0
C. /2'
#. /1'0
E. /21'
Aet profit J /1.'0 1'' 2 J /21'. +he put finished out of the oney.

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: -ut (ayoff

26. Bou sold ten put contracts on Cross +own "an) stoc) at an option price per share of
/'.60. +he options ha1e an e-ercise price of /.3.0' per share. +he options were e-ercised
today when the stoc) price was /.4 a share. What is your net profit or loss on this in1estent
assuing that you closed out your positions at a stoc) price of /.4! 4gnore transaction costs
and ta-es.
A. -/.:0''
B. -/2:20'
C. /1:6''
#. /60'
$. /.:0''
Aet loss J C/'.60 - /.3.0' I /.4D 1'' 1' J -/2:20'

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: -ut (ayoff

24-.2
28. Bou own eight call option contracts on *wift Water +ours stoc) with a stri)e price of /10.
When you purchased the shares the option price was /'..' and the stoc) price was /10.20.
What is the total intrinsic 1alue of these options if the stoc) is currently selling for /12.'6 a
share!
A. -/6.
". -/1.'6
C. /'
#. /1'6
E. /624
4ntrinsic 1alue J C/12.'6 - /10D 1'' 6 J /624

AACSB: Analytic
Difficulty: Basic
Section: "#&"

3'. Bou recently purchased three put option contracts on Guillepsi stoc) with an e-ercise
price of /42.0'. What is the total intrinsic 1alue of these contracts if the stoc) is currently
selling for /4..3' a share!
A. -/.2'
". -/12'
C. /'
#. /12'
$. /.2'
+he intrinsic 1alue is e<ual to &ero because the puts are out-of-the-oney.

AACSB: Analytic
Difficulty: Basic
Section: "#&"

24-.3
31. >ast wee): you purchased a call option on $dgewater stoc) with a stri)e price of /4'. +he
stoc) price was /.8.6' and the option price was /'.40 at that tie. What is the intrinsic 1alue
per share if the stoc) is currently priced at /.8.1'!
A. -/8'
". -/3'
C. /'
#. /3'
$. /8'
+he intrinsic 1alue is &ero because the call is currently out-of-the-oney.

AACSB: Analytic
Difficulty: Basic
Section: "#&"

32. +hree wee)s ago: you purchased a ?une /.' put option on >eeper (etals stoc) at an
option price of /1.6'. +he ar)et price of the stoc) three wee)s ago was /.'.2'. +oday: the
stoc) is selling at /28.6' a share. What is the intrinsic 1alue of your put contract!
A. -/1''
". -/2'
C. /'
D. /2'
$. /2'
Contract intrinsic 1alue J C/.' - /28.6'D 1'' J /2'

AACSB: Analytic
Difficulty: Basic
Section: "#&"

24-.6
3.. +his orning: you purchased a call option on *choolhouse *upply Co. stoc) that e-pires
in one year. +he e-ercise price is /4'. +he current price of the stoc) is /4..4' and the ris)-
free rate of return is ..2 percent. Assue the option will finish in the oney. What is the
current 1alue of the call option!
A. /'
". /1.48
C. /..83
D. /4.38
$. /0.42
C' J /4..4' - K/4'HC1 I '.'.2DL J /4.38

AACSB: Analytic
Difficulty: Basic
Section: "#&"
'o(ic: Call !alue

34. Bou currently own a one-year call option on %ail Copany: 4nc.: stoc). +he current stoc)
price is /01.6' and the ris)-free rate of return is 4.20 percent. Bour option has a stri)e price of
/0' and you assue the option will finish in the oney. What is the current 1alue of your call
option!
A. /1.2'
". /2.08
C. /..64
#. /0.1.
$. /3.23
C' J /01.6' - K/0'HC1 I '.'420D J /..64

AACSB: Analytic
Difficulty: Basic
Section: "#&"
'o(ic: Call !alue

24-.8
30. +he coon stoc) of @a&elton %efiners is selling for /32..' a share. N.*. +reasury bills
are currently yielding 4.6 percent. What is the current 1alue of a one-year call option on this
stoc) if the e-ercise price is /3' and you assue the option will finish in the oney!
A. /'
". /1.2'
C. /..''
#. /4.2'
E. /0.01
C' J /32..' - K/3'HC1 I '.'46DL J /0.01

AACSB: Analytic
Difficulty: Basic
Section: "#&"
'o(ic: Call !alue

32. +he coon stoc) of Westo1er Foods is currently priced at /23.8' a share. One year
fro now: the stoc) price is e-pected to be either /20 or /.' a share. +he ris)-free rate of
return is 4.2 percent. What is the current 1alue of one call option on this stoc) if the e-ercise
price is /23.0'!
A. /'
B. /1.80
C. /2.''
#. /..6'
$. /4.''
Auber of options needed J C/.' - /20DHC2.0' - 'D J 2
/23.8' J 2 C' I K/20HC1 I '.'42DLF C' J /1.80

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&/
'o(ic: Call !alue

24-4'
33. Bou own one call option with an e-ercise price of /4' on *;ore Good stoc). +he stoc) is
currently selling for /41 a share but is e-pected to sell for either /.3 or /4. a share in one
year. +he ris)-free rate of return is 4.20 percent and the inflation rate is ..2 percent. What is
the current call option price if the option e-pires one year fro now!
A. /'.00
". /'.28
C. /1..3
#. /2.4.
E. /2.30
Auber of options needed J C/4. - /.3DHC. - 'D J 2
/41 J 2C' I K/.3HC1 I '.'420DLF C' J /2.30

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&/
'o(ic: Call !alue

36. +he assets of Nptown *tores are currently worth /1.2:4''. +hese assets are e-pected to
be worth either /12':''' or /10':''' one year fro now. +he copany has a pure discount
bond outstanding with a /1.':''' face 1alue and a aturity date of one year. +he ris)-free
rate is 4.. percent. What is the 1alue of the e<uity in this fir!
A. /11:82'
B. /14:2.2
C. /18:0'3
#. /21:.43
$. /22:4'6
Auber of options needed J C/10':''' - /12':'''DHC/2':''' - /'D J 1.0
/1.2:4'' J 1.0C' I C/12':'''HC1 I '.'4.DF C' J /14:2.2

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&0

24-41
38. $lectronic 4porters has a pure discount bond with a face 1alue of /20:''' that atures in
one year. +he ris)-free rate of return is ..6 percent. +he assets of the business are e-pected to
be worth either /2.:''' or /.0:''' in one year. Currently: these assets are worth /23:0''.
What is the current 1alue of the bond!
A. /13:342
". /18:2'3
C. /2':222
#. /22:048
E. /2.:'46
Auber of options needed J C/.0:''' - /2.:'''DHC/1':''' - /'D J 1.2
/23:0'' J 1.2C' I C/2.:'''HC1 I '.'.6DF C' J /4:401.23
5alue of debt J /23:0'' - /4:401.23 J /2.:'46

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&0

6'. +he Glass @ouse has total assets currently 1alued at /13:2''. +hese assets are e-pected to
increase in 1alue to either /16:''' or /21:''' by ne-t year. +he copany has a pure discount
bond outstanding with a face 1alue of /2':'''. +his bond atures in one year. Currently: N.*.
+reasury bills are yielding 0.4 percent. What is the 1alue of the e<uity in this fir!
A. -/.:'''.''
". -/8'6.''
C. /'
D. /4'.3.
$. /122.2'
Auber of options needed J C/21:''' - /16:'''DHC/1:''' - /'D J .
/13:2'' J .C' I C/16:'''HC1 I '.'04DF C' J /4'.3.

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&0

24-42
61. Bou are considering a pro=ect that has been assigned a discount rate of 14 percent. 4f you
start the pro=ect today: you will incur an initial cost of /6:0'' and will recei1e cash inflows of
/0:00' a year for two years. 4f you wait one year to start the pro=ect: the initial cost will rise to
/8:2'' and the cash flows will increase to /0:6'' a year for two years. What is the 1alue of
the option to wait!
A. -/..1.4'
". -/184.42
C. /226.01
#. /2.'.48
$. /..4.26
5alue of option to wait J /.'3.03 - /2.6.83 J -/..1.4'

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&1

24-4.
62. *outhern *hores is considering a pro=ect that has an initial cost today of /12:0''. +he
pro=ect has a two-year life with cash inflows of /3:0'' a year. *hould the fir opt to wait one
year to coence this pro=ect: the initial cost will increase by 0 percent and the cash inflows
will increase to /6:0'' a year. What is the 1alue of the option to wait if the applicable
discount rate is 14 percent!
A. /214.02
". /321.02
C. /814.22
#. /862.23
$. /1:'21.22
5alue of option to wait J /631.21 - C-/10'.'0D J /814.22

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&1

24-44
6.. Western 4ndustrial 9roducts is considering a pro=ect with a four-year life and an initial cost
of /212:'''. +he discount rate for the pro=ect is 12 percent. +he fir e-pects to sell 8:2''
units on the last day of each year. +he cash flow per unit is /0'. +he fir will ha1e the option
to abandon this pro=ect at the end of year one Cafter year one;s salesD at which tie the
pro=ect;s assets could be sold for an estiated /120:'''. +he fir should abandon the pro=ect
at the end of year one if the e-pected le1el of annual sales: starting with year 2: falls to 77777
units or less. 4gnore ta-es.
A. 1:11. units
". 1:223 units
C. 1:822 units
#. 2:'.4 units
$. 2:1'6 units

AACSB: Analytic
Bloom's: Analysis
Difficulty: .ntermediate
Section: "#&1

24-40
64. #ressler +echnologies is considering a pro=ect with a .-year life and an initial cost of
/60:'''. +he discount rate for the pro=ect is 14.0 percent. +he fir e-pects to sell 1:2'' units
on the last day of each year. +he cash flow per unit is /.2. +he fir will ha1e the option to
abandon this pro=ect at the end two years Cafter year 2 salesD at which tie the pro=ect;s assets
could be sold for an estiated /.':'''. +he fir;s anagers are interested in )nowing how
the pro=ect will perfor if the sales forecast for year . of the pro=ect is re1ised such that there
is a 0'H0' chance that the sales will be either 1:''' or 1:4'' units a year. What is the net
present 1alue of this pro=ect at tie &ero gi1en the current sales forecasts!
A. -/.:434
". -/2:022
C. /4:181
#. /2:182
$. /2:663
>e1el to abandon J /.':''' J /.2OH1.140F O J 1:'3..44 units
At 1:''' units: you will abandon the pro=ect and recei1e /.':''' at the end of year 2.
At 1:4'' units: you will continue the pro=ect and the pro=ect will ha1e a 1alue at the end of
year 2 of,
A95$nd of year 2 J C1:4'' /.2DH1.140 J /.8:122.24
+he A95 of this pro=ect today is,

AACSB: Analytic
Bloom's: Analysis
Difficulty: C+allenge
Section: "#&1

24-42
60. 9atience is re1iewing a pro=ect with pro=ected sales of 4:2'' units a year: a cash flow of
/26 a unit: and a four-year pro=ect life. Assue all operating cash flows occur on the last day
of each year. +he initial cost of the pro=ect is /243:'''. +he rele1ant discount rate is 1.
percent. 9atience has the option to abandon the pro=ect after two years at which tie she feels
she could sell the pro=ect;s assets for /11':'''. At what le1el of annual sales: starting in year
.: should she be willing to abandon this pro=ect!
A. 2:118 units
B. 2:.00 units
C. 2:.23 units
#. 2:012 units
$. 2:223 units

AACSB: Analytic
Bloom's: Analysis
Section: "#&1

62. Bou own a con1ertible bond with a face 1alue of /1:''' and a ar)et 1alue of /1:'.4.
+he bond can be con1erted into 14 shares of stoc). What is the con1ersion price!
A. /31.4.
". /32.''
C. /32.23
#. /3..62
$. /34...
Con1ersion price J /1:'''H14 J /31.4.

AACSB: Analytic
Difficulty: Basic
Section: "#&4

24-43
63. Bou own nine con1ertible bonds. +hese bonds ha1e a 3 percent coupon: a /1:''' face
1alue: and ature in 2 years. +he bonds are con1ertible into shares of coon stoc) at a
con1ersion price of /20. @ow any shares of stoc) will you recei1e if you con1ert all of your
bonds!
A. 260
". .''
C. .0'
D. .2'
$. 4''
Auber of shares J C/1:'''H/20D 8 J .2' shares

AACSB: Analytic
Difficulty: Basic
Section: "#&4

66. A con1ertible bond has a face 1alue of /0:''' and a con1ersion price of /6'. +he bond
has a 2 percent coupon: pays interest sei-annually: and atures in 12 years. *iilar bonds
are yielding 3.0 percent. +he current price of the stoc) is /41.2' per share. What is the
con1ersion 1alue of this bond!
A. /1:26'
". /2:410
C. /2:030
#. /4:201
$. /0:'''
Con1ersion 1alue J C/0:'''H/6'D /41.2' J /2:030

AACSB: Analytic
Difficulty: Basic
Section: "#&4

24-46
68. A con1ertible bond has a face 1alue of /1:''' and a con1ersion price of /12.0'. +he bond
has a 2 percent coupon: pays interest sei-annually: and atures in 12 years. *iilar bonds
are yielding 8 percent. +he current price of the stoc) is /1..4' per share. What is the straight
bond 1alue!
A. /362.03
". /361.62
C. /623.34
#. /6.2.'8
$. /64..43

AACSB: Analytic
Difficulty: Basic
Section: "#&4

24-48
8'. Kurt owns a con1ertible bond that atures in three years. +he bond has a 3.0 percent
coupon and pays interest sei-annually. +he face 1alue of the bond is /1:''' and the
con1ersion price is /20. *iilar bonds ha1e a ar)et return of 8.20 percent. +he current price
of the stoc) is /22.0' per share. What is the straight bond 1alue!
A. /846.2'
B. /800.'0
C. /832.6'
#. /863.36
$. /881.10

AACSB: Analytic
Difficulty: Basic
Section: "#&4

81. >ucinda owns a con1ertible bond that atures in si- years. +he bond has a 8 percent
coupon and pays interest annually. +he face 1alue of the bond is /1:''' and the con1ersion
price is /22. *iilar bonds ha1e a ar)et return of 6.30 percent. +he current price of the
stoc) is /21.2' per share. What is the con1ersion 1alue of this bond!
A. /6.0.2'
". /646.4'
C. /842.11
D. /861.62
$. /1:'''.''
Con1ersion 1alue J C/1:'''H/22D /21.2' J /861.62

AACSB: Analytic
Difficulty: Basic
Section: "#&4

24-0'

Essay Questions

82. Circle *tores stoc) is priced at /26 a share. A /4' call on this stoc) has fi1e onths until
e-piration and a call price of /'.10. Why would an in1estor purchase a call that is so far out of
the oney!
*tudents should discuss the ipact of tie to aturity on option 1alues. +hey should point
out that with fi1e onths left to aturity: there is a chance that the option could finish in the
oney: especially if the stoc) price is 1olatile. A low option price per share such as /'.10:
eans that an in1estent in an option contract will be <uite ine-pensi1e. @owe1er: in1estors
apparently don;t ha1e a strong feeling the stoc) will reach /4' by share by the e-piration date:
or the option price would be uch higher.
Feedbac), %efer to section 24..

AACSB: 2eflecti!e t+in,ing
Bloom's: Analysis
Difficulty: Basic
Section: "#&/
'o(ic: O(tion !alue

8.. What are the basic siilarities and basic differences between warrants and call options!
"oth warrants and call options grant their owners the right to purchase shares of stoc) at a
prespecified price. Warrants are issued by corporations while call options are issued by
in1estors. Warrants are usually attached to pri1ately placed loans or bonds. Warrants can be
detached fro the debt security and traded separately. Call options are traded separately fro
the underlying stoc).
Feedbac), %efer to section 24.3

Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#$% and "#$1
Section: "#&4
'o(ic: 5arrants8 calls8 and con!ertibles

24-01
84. What are the upper and lower bounds for an Aerican call option! $-plain what would
happen in each case if the bound was 1iolated.
+he upper bound on a call is the stoc) price. 4f the call price e-ceeded the stoc) price: you
would be paying ore for the option to buy an asset than the asset itself costs. +he lower
bounds are, C ' if * - $ P ' and C C* - $D if C* - $D '. 4n the first case: if the e-ercise
price e-ceeds the stoc) price: the call is out of the oney and it will either be worthless or
ha1e soe tie 1alue. 4n the second case: if the call is in the oney: the call ust be worth at
least the difference between the asset;s 1alue and the e-ercise price. 4f the call was worth less
than this 1alue: rational in1estors would purchase calls: iediately e-ercise the: and then
sell the stoc) at the current price: copleting an arbitrage.

Bloom's: Analysis
Section: "#&"
'o(ic: O(tion (ricing bounds

80. $-plain the rationale behind the idea that e<uity is a call option on a fir;s assets. When
would a shareholder allow this call to e-pire!
+he analogy only wor)s for le1eraged firs. At aturity of the fir;s debt: the stoc)holders
ha1e the option to either pay the creditors the face 1alue of the debt or turn the fir;s assets
o1er to the fir;s creditors. 4f the fir;s assets are worth less than the face 1alue of the debt:
the stoc)holders will not e-ercise the call: that is: they will let the creditors ha1e the assets
and the fir will be li<uidated.

Difficulty: Basic
Section: "#&0

24-02
82. Call options are fre<uently attached to bonds: a)ing the callable at the option of the
issuer. Consider a fir that =ust issued two sets of bonds, One is callable: has a 3 percent
coupon rate: 10 years to aturity: and cannot be called during the first three yearsF the second
is noncallable: has a 3 percent coupon rate: 10 years to aturity: and is identical to the first
bond in e1ery way e-cept for the call option. *uppose the noncallable bonds are sold for
/1:''' each. Will the callable bonds sell for ore or less than /1:'''! Who EpurchasesE the
option in this case and who EsellsE it!
+he callable bond will sell for less than par. +he bond issuer buys the option and the
bondholder writes it. 4f the callable bonds sell for /80' each: the call option will be worth the
difference between the two bond prices: or /0' per bond.

Difficulty: Basic
Section: "#&4
'o(ic: Callable bonds

83. $-plain how the floor and the ceiling prices for a con1ertible bond are deterined.
+he floor: or iniu: 1alue of a bond is the bond;s straight bond 1alue. +he ceiling: or
a-iu: 1alue is theoretically unliited since there is no upper liit on a bond;s con1ersion
1alue.

Bloom's: Knowledge
Difficulty: Basic
Section: "#&4

Multiple Choice Questions

24-0.
86. +-bills currently yield 2.. percent. *toc) in 9inta (anufacturing is currently selling for
/42 per share. +here is no possibility that the stoc) will be worth less than /.8 per share in
one year. What is the 1alue of a call option on this stoc) if the e-ercise price is /22 per share!
A. /21.4'
". /22.''
C. /24.''
D. /20..'
$. /20.3'
C' J /42 - K/22HC1 I '.'2.DL J /20..'

AACSB: Analytic
Difficulty: Basic
)OC 9: "#$%
Section: "#&"
'o(ic: O(tion !alue

88. +he price of +ie *<uared Corp. stoc) will be either /6' or /80 at the end of the year.
Call options are a1ailable with one year to e-piration. +-bills currently yield 2 percent and the
current price of +ie *<uared Corp. stoc) is /60. What is the 1alue of a call option if the
e-ercise price is /30 per share!
A. /14.20
". /10.'2
C. /16.36
#. /24.20
$. /20.'2
C' J /60 - K/30HC1 I '.'2DL J /14.20

AACSB: Analytic
Difficulty: Basic
)OC 9: "#$#
Section: "#&/
'o(ic: O(tion !alue

24-04
1''. +he price of #iension: 4nc. stoc) will be either /20 or /60 at the end of the year. Call
options are a1ailable with one year to e-piration. +-bills currently yield 0 percent. *uppose the
current price of #iension stoc) is /3'. What is the 1alue of the call option if the e-ercise
price is /3' per share!
A. /2.'3
". /6.46
C. /11.06
#. /10..8
$. /13.22
/3' J KC/60 - /20DHC/60 - /3'DLC' I /20HC1 I '.'0DF C' J /2.'3

AACSB: Analytic
Difficulty: Basic
)OC 9: "#$0
Section: "#&/
'o(ic: O(tion !alue

1'1. %ac)in 9inion Corporation;s assets are currently worth /1:22'. 4n one year: they will be
worth either /1:2'' of /1:21'. +he ris)-free interest rate is 0 percent. *uppose %ac)in 9inion
has an outstanding debt issue with a face 1alue of /1:2''. What is the current 1alue of the
fir;s debt!
A. /2'.''
". /114.14
C. /1:142.62
#. /1:22..18
$. /1:0'4.2'
$' J /1:22' - K/1:2''HC1 I '.'0DL J /113.14
#' J /1:22' - /113.14 J /1:142.62

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
)OC 9: "#$4
Section: "#&0
'o(ic: )7uity as an o(tion

24-00
1'2. "uc)eye 4ndustries has a bond issue with a face 1alue of /1:''' that is coing due in
one year. +he 1alue of "uc)eye;s assets is currently /1:2''. ?i +ressell: the C$O: belie1es
that the assets in the fir will be worth either /2'' or /1:3'' in a year. +he going rate on one-
year +-bills is 2 percent. What is the current 1alue of the fir;s debt!
A. /2'1.16
B. /382.03
C. /644.24
#. /636.36
$. /811.'.
/1:2'' J KC/1:3'' - /2''DHC/1:3'' - /1:'''DL $' I K/2''HC1 I '.'2DL J /4'..4.
#' J /1:2'' - /4'..4. J /382.03

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
)OC 9: "#$:
Section: "#&0
'o(ic: )7uity as an o(tion

1'.. A /1:''' con1ertible debenture has a con1ersion price for coon stoc) of /60 per
share. +he coon stoc) is selling at /82 a share. What is the con1ersion 1alue of this bond!
A. /82'.''
". /82..81
C. /1:'''.''
D. /1:'62..0
$. /1:'82.''
Con1ersion 1alue J C/1:'''H/60DC/82D J /1:'62..0

AACSB: Analytic
Difficulty: Basic
)OC 9: "#$;
Section: "#&4
'o(ic: Con!ersion !alue

24-02
1'4. A bond with 1' detachable warrants has =ust been offered for sale at /1:'''. +he bond
atures in 10 years and has an annual coupon of /6'. $ach warrant gi1es the owner the right
to purchase two shares of stoc) in the copany at /14 per share. Ordinary bonds Cwith no
warrantsD of siilar <uality are priced to yield 11 percent. What is the 1alue of one warrant!
A. /3.''
". /1..06
C. /14.''
#. /12.23
E. /21.03
+otal warrant 1alue J /1:''' - /364.23 J /210.3.
9rice per warrant J /210.3.H1' J /21.03

AACSB: Analytic
Difficulty: Basic
)OC 9: "#$%"
Section: "#&4
'o(ic: 5arrant !alues

24-03
1'0. Bour copany is deciding when to in1est in a new achine. +he new achine will
increase cash flow by /24':''' per year. Bou belie1e the technology used in the achine has
a 1'-year lifeF in other words: no atter when you purchase the achine: it will be obsolete
1' years fro today. +he achine is currently priced at /1:2'':'''. +he cost of the achine
will decline by /12':''' per year until it reaches /32':''': where it will reain. Bour
re<uired return is 6 percent. 4n which year should you purchase the achine!
A. Bear '
". Bear 1
C. Bear 2
#. Bear .
$. Bear 4
+he copany should purchase the achine today when the A95 is the highest.

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
)OC 9: "#$%/
Section: "#&1

24-06
1'2. We are e-aining a new pro=ect. We e-pect to sell 8:''' units per year at /40 net cash
flow apiece for the ne-t 2' years. 4n other words: the annual operating cash flow is pro=ected
to be /40 8:''' J /4'0:'''. +he rele1ant discount rate is 14 percent: and the initial
in1estent re<uired is /1:3.':'''. After the first year: the pro=ect can be disantled and sold
for /1:.0':'''. 4f e-pected sales are re1ised based on the first year;s perforance: it would
a)e sense to abandon the in1estent if the sales are less than which of the following nuber
of units!
A. 4:06' units
". 4:22' units
C. 4:30' units
#. 4:61' units
$. 0:'2' units
/1:.0':''' J C/40DCODC954FA14Q: 18DF O J 4:06' units
Abandon the pro=ect if O P 4:06' units because the A95 of abandoning the pro=ect is greater
than the A95 of the future cash flows.

AACSB: Analytic
Bloom's: Analysis
)OC 9: "#$%#
Section: "#&1
'o(ic: Abandonment !alue

24-08
1'3. We are e-aining a new pro=ect. We e-pect to sell 6:''' units per year at /6' net cash
flow apiece for the ne-t 10 years. 4n other words: the annual operating cash flow is pro=ected
to be /6' 6:''' J /24':'''. +he rele1ant discount rate is 12 percent: and the initial
in1estent re<uired is /2:34':'''. +he pro=ect can be disantled after the first year and sold
for /2:1.':'''. *uppose you thin) it is li)ely that e-pected sales will be re1ised upward to
8:2'' units if the first year is a success and re1ised downward to .:''' units if the first year is
not a success. *uppose the scale of the pro=ect can be doubled in one year in the sense that
twice as any units can be produced and sold. Aaturally: e-pansion would be desirable only if
the pro=ect is a success. +his iplies that if the pro=ect is a success: pro=ected sales after
e-pansion will be 18:2''. Assue that success and failure are e<ually li)ely. Aote that
abandonent is still an option if the pro=ect is a failure. What is the 1alue of the option to
e-pand!
A. /1:334:.26
B. /1:6'8:841
C. /1:626:4'2
#. /1:646:82'
$. /1:632:.12
+he gain fro the option to e-pand is the present 1alue of the cash flows fro the additional
units sold: so,
Gain fro option to e-pand J /6'C8:2''DC954FA12Q: 14D J /4:188:'22..8
We need to find the 1alue of the option to e-pand ties the li)elihood of e-pansion. We also
need to find the 1alue of the option to e-pand today: so,
Option 1alue J C'.0'DC/4:188:'22..8DH1.12 J /1:6'8:841

AACSB: Analytic
Bloom's: )!aluation
)OC 9: "#$%1
Section: "#&1
'o(ic: Abandonment and e*(ansion

24-2'

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Chapter 24 - Options and Corporate Finance

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