Derivatives Markets 3rd Edition

McDonald Test Bank

Visit to download the full and correct content document: https://testbankdeal.com/dow
nload/derivatives-markets-3rd-edition-mcdonald-test-bank/
Derivatives Markets, 3e (McDonald)
Chapter 10 Binomial Option Pricing: Basic Concepts

10.1 Multiple Choice

1) A stock is currently selling for $22.00 per share. Ignoring interest, determine the intrinsic
value of a call option should there exist equally probable stock prices of $25.00 and $23.00.
A) $0.00
B) $1.00
C) $2.00
D) $3.00
Answer: C

2) Compute Δ for the following call option. The stock is selling for $23.50. The strike price is
$25. The possible stock prices at the end of 6 months are $27.25 and $21.75.
A) 0.4091
B) 0.6822
C) 0.8433
D) 0.9216
Answer: A

3) The stock price in KMW, Inc. is $50, $54, $56, and $48 on four consecutive days of trading.
What is the continuously compounded return on the stock over this time frame?
A) -3.85 %
B) -4.00 %
C) -4.08 %
D) -4.16 %
Answer: C

4) A stock is selling for $32.70. The strike price on a call, maturing in 6 months, is $35. The
possible stock prices at the end of 6 months are $39.50 and $28.40. If interest rates are 6.0%,
what is the option price?
A) $1.90
B) $2.80
C) $3.40
D) $4.20
Answer: C

5) The monthly standard deviation for a stock is 4.2%. What is the 6 month standard deviation
for the security?
A) 4.2 %
B) 10.3 %
C) 25.2 %
D) 50.4 %
Answer: B

1
Copyright © 2013 Pearson Education, Inc.
6) A stock is selling for $18.50. The strike price on a call, maturing in 6 months, is $20. The
possible stock prices at the end of 6 months are $22.50 and $15.00. Interest rates are 6.0%. How
much money would you borrow to create an arbitrage on a call trading for $2.00?
A) $2.54
B) $4.85
C) $6.60
D) $8.85
Answer: B

7) A stock is selling for $41.60. The strike price on a call, maturing in 6 months, is $45. The
possible stock prices at the end of 6 months are $35.00 and $49.00. Interest rates are 5.0%. Given
an under-priced option, what are the short sale proceeds in an arbitrage strategy?
A) $6.36
B) $8.22
C) $10.43
D) $11.89
Answer: D

8) A stock is selling for $53.20. Interest rates are 6.0% and the returns on the stock have a
standard deviation of 24.0%. What is the forecasted up movement in the stock over a 6-month
interval?
A) $64.96
B) $69.69
C) $73.48
D) $76.96
Answer: A

9) A stock is selling for $53.20. Interest rates are 6.0% and the returns on the stock have a
standard deviation of 24.0%. What is the forecasted up movement in the stock over 6 months,
assuming two periods of 3 months each?
A) $64.96
B) $69.69
C) $73.48
D) $76.96
Answer: B

10) A stock is selling for $68.50. Interest rates are 6.0% and the returns on the stock have a
standard deviation of 32.0%. What is the forecasted price of the stock using 3-month periods at
Suudu?
A) $74.08
B) $94.24
C) $100.17
D) $111.12
Answer: C

2
Copyright © 2013 Pearson Education, Inc.
11) Using a binomial tree, what is the price of a $40 strike 6-month call option, using 3-month
intervals as the time period? Assume the following data: S = $37.90, r = 5.0%, σ = 0.35
A) $2.50
B) $2.76
C) $2.92
D) $3.08
Answer: D

12) Using a binomial tree, what is the price of a $40 strike 6-month put option, using 3-month
intervals as the time period? Assume the following data: S = $37.90, r = 5.0%, σ = 0.35
A) $3.52
B) $3.66
C) $3.84
D) $3.91
Answer: D

13) A call option has an exercise price of $30. The stock price at a point on the binomial tree is
$36.24. The calculated present value of the option at that same point is $5.86. What figure should
be used to calculate option prices at points moving toward the final price?
A) $5.86
B) $6.24
C) $6.62
D) $7.01
Answer: B

14) In the case of a 1-year option, the current stock price is $52 per share. If the stock price has
an equal chance of ending the year at either $58 or $45, what is the △ given an interest rate of
6.0% and an exercise price of $50?
A) 0.2145
B) 0.3254
C) 0.5411
D) 0.6154
Answer: D

15) For an option trading in the money, what is the likely impact on the binomial option price as
the number of binomial steps is increased?
A) The price will fall
B) The price will increase
C) The price will remain constant
D) The impact cannot be determined
Answer: A

3
Copyright © 2013 Pearson Education, Inc.
10.2 Short Answer Essay Questions

1) Draw the binomial tree listing only the option prices at each node. Assume the following data
on a 6-month call option, using 3-month intervals as the time period. K = $40, S = $37.90,
r = 5.0%, σ = 0.35
Answer:

2) Draw the binomial tree listing only the stock prices at each node. Assume the following data
on a 6-month call option, using 3-month intervals as the time period. K = $70, S = $68.50,
r = 6.0%, σ = 0.32
Answer:

4
Copyright © 2013 Pearson Education, Inc.
3) Draw the binomial tree listing only the option prices at each node. Assume the following data
on a 6-month put option, using 3-month intervals as the time period. K = $40.00, S = $37.90,
r = 5.0%, σ = 0.35
Answer:

4) Using a binomial tree explanation, explain the situation in which an American option would
alter the pricing of an option.
Answer: The value of an American option at a node is the maximum of its intrinsic value or the
discounted value of the subsequent nodes. Early exercise permits the realization of the intrinsic
value, should it be the higher number. European options may not consider this potential gain.

5) Explain the impact a constant dividend yield would have on the price of a call option.
Answer: The impact of a dividend will be to reduce the price of the option. Stocks which are ex-
dividend tend to decline in price, thus reducing the intrinsic value of call options and the
resulting option prices.

10.3 Class Discussion Question

1) Discuss options on other assets. Ask students to define currency options, futures options,
index options, and commodity options. Require that the students state which variables in the
securities listed above correspond with the binomial pricing inputs used for stock options.

5
Copyright © 2013 Pearson Education, Inc.