Financial Management - Chapter 25 Option Valuation

Chapter 25 Option Valuation

 

1.

Travis owns a stock that is currently valued at $45.80 a share. He is concerned that the stock price may decline so he just purchased a put option on the stock with an exercise price of $45. Which one of the following terms applies to the strategy Travis is using?    A.  put-call parity B.  covered call C.  protective put D.  straddle E.  strangle Refer to section 25.1

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-01 The relationship between stock prices; call prices; and put prices using put-call parity. Section: 25.1 Topic: Protective put

2.

Put-call parity is defined as the relationship between which of the following variables? I. risk-free asset II. underlying stock price III. call option IV. put option    A.  I and II only B.  II and III only C.  II, III, and IV only D.  I, II, and III only E.  I, II, III, and IV Refer to section 25.1

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-01 The relationship between stock prices; call prices; and put prices using put-call parity. Section: 25.1 Topic: Put-call parity

3.	Assume the price of Westward Co. stock increases by one percent. Which one of the following measures the effect that this change in the stock price will have on the value of the Westward Co. options?    A.  theta B.  vega C.  rho D.  delta E.  gamma Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option delta

4.	Which one of the following defines the relationship between the value of an option and the option's time to expiration?    A.  theta. B.  vega. C.  rho. D.  delta. E.  gamma. Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option theta

5.	Assume the standard deviation of the returns on ABC stock increases. The effect of this change on the value of the call options on ABC stock is measured by which one of the following?    A.  theta. B.  vega. C.  rho. D.  delta. E.  gamma. Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option vega

6.	The sensitivity of an option's value to a change in the risk-free rate is measured by which one of the following?    A.  theta. B.  vega. C.  rho. D.  delta. E.  gamma. Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option rho

7.

The implied volatility of the returns on the underlying asset that is computed using the Black-Scholes option pricing model is referred to as which one of the following?    A.  residual error B.  implied mean return C.  derived case volatility (DCV) D.  forecast rho E.  implied standard deviation (ISD) Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Implied standard deviation

8.	Amy just purchased a right to buy 100 shares of LKL stock for $35 a share on June 20, 2012. Which one of the following did Amy purchase?    A.  American delta B.  American call C.  American put D.  European put E.  European call Refer to section 25.1

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-01 The relationship between stock prices; call prices; and put prices using put-call parity. Section: 25.1 Topic: Put option

9.

Which one of the following provides the option of selling a stock anytime during the option period at a specified price even if the market price of the stock declines to zero?    A.  American call B.  European call C.  American put D.  European put E.  either an American or a European put Refer to section 25.1

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-01 The relationship between stock prices; call prices; and put prices using put-call parity. Section: 25.1 Topic: Put option

10.

Which one of the following best defines the primary purpose of a protective put?    A.  ensure a maximum purchase price in the future B.  offset an equivalent call option C.  limit the downside risk of asset ownership D.  lock in a risk-free rate of return on a financial asset E.  increase the upside potential return on an investment Refer to section 25.1

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-01 The relationship between stock prices; call prices; and put prices using put-call parity. Section: 25.1 Topic: Protective put

11.

Which one of the following acts like an insurance policy if the price of a stock you own suddenly decreases in value?    A.  sale of a European call option B.  sale of an American put option C.  purchase of a protective put D.  purchase of a protective call E.  either the sale or purchase of a put Refer to section 25.1

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 25-01 The relationship between stock prices; call prices; and put prices using put-call parity. Section: 25.1 Topic: Protective put

12.

Which one of the following can be used to replicate a protective put strategy?    A.  riskless investment and stock purchase B.  stock purchase and call option C.  call option and riskless investment D.  riskless investment E.  call option, stock purchase, and riskless investment Refer to section 25.1

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-01 The relationship between stock prices; call prices; and put prices using put-call parity. Section: 25.1 Topic: Protective put

13.

Given the (1) exercise price E, (2) time to maturity T, and (3) European put-call parity, the present value of E plus the value of the call option is equal to the:    A.  current market value of the stock. B.  present value of the stock minus the value of the put. C.  value of the put minus the market value of the stock. D.  value of a risk-free asset. E.  stock value plus the put value. Refer to section 25.1

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-01 The relationship between stock prices; call prices; and put prices using put-call parity. Section: 25.1 Topic: Put-call parity

14.

Which one of the following will provide you with the same value that you would have if you just purchased BAT stock?    A.  sell a put option on BAT stock and invest at the risk-free rate of return B.  buy both a call option and a put option on BAT stock and also lend out funds at the risk-free rate C.  sell a put and buy a call on BAT stock as well as invest at the risk-free rate of return D.  lend out funds at the risk-free rate of return and sell a put option on BAT stock E.  borrow funds at the risk-free rate of return and invest the proceeds in equivalent amounts of put and call options on BAT stock Refer to section 25.1

AACSB: Analytic Blooms: Understand Difficulty: 2 Medium Learning Objective: 25-01 The relationship between stock prices; call prices; and put prices using put-call parity. Section: 25.1 Topic: Put-call parity

15.

Under European put-call parity, the present value of the strike price is equivalent to:    A.  the current value of the stock minus the call premium. B.  the market value of the stock plus the put premium. C.  the present value of a government coupon bond with a face value equal to the strike price. D.  a U.S. Treasury bill with a face value equal to the strike price. E.  a risk-free security with a face value equal to the strike price and a coupon rate equal to the risk-free rate of return. Refer to section 25.1

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-01 The relationship between stock prices; call prices; and put prices using put-call parity. Section: 25.1 Topic: Put-call parity

16.

Traci wants to have $16,000 six years from now and wants to deposit just one lump sum amount today. The annual percentage rate applicable to her investment is 6.8 percent. Which one of the following methods of compounding interest will allow her to deposit the least amount possible today?    A.  annual B.  daily C.  quarterly D.  monthly E.  continuous Refer to section 25.1

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-01 The relationship between stock prices; call prices; and put prices using put-call parity. Section: 25.1 Topic: Continuous compounding

17.

The seller of a European call option has the:    A.  right, but not the obligation, to buy a stock at a specified price on a specified date. B.  right to buy a stock at a specified price during a specified period of time. C.  obligation to sell a stock on a specified date but only at the specified price. D.  obligation to buy a stock some time during a specified period at the specified price. E.  obligation to buy a stock at the lower of the exercise price or the market price on the expiration date. Refer to section 25.2

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-02 The famous Black-Scholes option pricing model and its uses. Section: 25.2 Topic: European call option

18.	In the Black-Scholes option pricing formula, N(d1) is the probability that a standardized, normally distributed random variable is:    A.  less than or equal to N(d2). B.  less than one. C.  equal to one. D.  equal to d1. E.  less than or equal to d1. Refer to section 25.2

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-02 The famous Black-Scholes option pricing model and its uses. Section: 25.2 Topic: Black-Scholes

19.

In the Black-Scholes model, the symbol "σ" is used to represent the standard deviation of the:    A.  option premium on a call with a specified exercise price. B.  rate of return on the underlying asset. C.  volatility of the risk-free rate of return. D.  rate of return on a risk-free asset. E.  option premium on a put with a specified exercise price. Refer to section 25.2

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-02 The famous Black-Scholes option pricing model and its uses. Section: 25.2 Topic: Black-Scholes

20.

Which of the following affect the value of a call option? I. strike price II. time to maturity III. standard deviation of the returns on a risk-free asset IV. risk-free rate    A.  I and III only B.  II and IV only C.  I, II, and IV only D.  II, III, and IV only E.  I, II, III, and IV Refer to section 25.2

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-02 The famous Black-Scholes option pricing model and its uses. Section: 25.2 Topic: Black-Scholes

21.

To compute the value of a put using the Black-Scholes option pricing model, you:    A.  first have to apply the put-call parity relationship. B.  first have to compute the value of the put as if it is a call. C.  compute the value of an equivalent call and then subtract that value from one. D.  compute the value of an equivalent call and then subtract that value from the market price of the stock. E.  compute the value of an equivalent call and then multiply that value by e-RT. Refer to section 25.2

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 25-02 The famous Black-Scholes option pricing model and its uses. Section: 25.2 Topic: Put option pricing

22.

Which one of the following statements is correct?    A.  The price of an American put is equal to the stock price minus the exercise price. B.  The value of a European call is greater than the value of a comparable American call. C.  The value of a put is equal to one minus the value of an equivalent call. D.  The value of a put minus the value of a comparable call is equal to the value of the stock minus the exercise price. E.  The value of an American put will equal or exceed the value of a comparable European put. Refer to section 25.2

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 25-02 The famous Black-Scholes option pricing model and its uses. Section: 25.2 Topic: Put option pricing

23.	The Black-Scholes option pricing model can be used for:    A.  American options but not European options. B.  European options but not American options. C.  call options but not put options. D.  put options but not call options. E.  both zero coupon bonds and coupon bonds. Refer to section 25.2

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-02 The famous Black-Scholes option pricing model and its uses. Section: 25.2 Topic: Black-Scholes

24.	Which of the following variables are included in the Black-Scholes call option pricing formula? I. put premium II. N(d1) III. exercise price IV. stock price    A.  III and IV only B.  I, II, and IV only C.  II, III, and IV only D.  I, III, and IV only E.  I, II, III, and IV Refer to section 25.2

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-02 The famous Black-Scholes option pricing model and its uses. Section: 25.2 Topic: Black-Scholes

25.

Which one of the following statements related to options is correct?    A.  American stock options can be exercised but not resold. B.  A European call is either equal to or less valuable than a comparable American call. C.  European puts can be resold but can never be exercised. D.  European options can be exercised on any dividend payment date. E.  American options are valued using the Black-Scholes option pricing model. Refer to section 25.2

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 25-02 The famous Black-Scholes option pricing model and its uses. Section: 25.2 Topic: Option features

26.	The value of a call option delta is best defined as:    A.  between zero and one. B.  less than zero. C.  greater than zero. D.  greater than or equal to zero. E.  greater than one. Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option delta

27.

Which one of the following is the correct formula for approximating the change in an option's value given a small change in the value of the underlying stock?    A.  Change in option value ≈ Change in stock value/Delta B.  Change in option value ≈ Change in stock value/(1 - Delta) C.  Change in option value ≈ Change in stock value/(1 + Delta) D.  Change in option value ≈ Change in stock value × (1 - Delta) E.  Change in option value ≈ Change in stock value × Delta Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option delta

28.

Assume the price of the underlying stock decreases. How will the values of the options respond to this change? I. call value decreases II. call value increases III. put value decreases IV. put value increases    A.  I and III only B.  I and IV only C.  II and III only D.  II and IV only E.  I only Refer to section 25.3

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option delta

29.

Which of the following statements are correct? I. Increasing the time to maturity may not increase the value of a European put. II. Vega measures the sensitivity of an option's value to the passage of time. III. Call options tend to be more sensitive to the passage of time than are put options. IV. An increase in time decreases the value of a call option.    A.  I and III only B.  II and IV only C.  II, III, and IV only D.  I, III, and IV only E.  I, II, III, and IV Refer to section 25.3

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option theta

30.	Theta measures an option's:    A.  intrinsic value. B.  volatility. C.  rate of time decay. D.  sensitivity to changes in the value of the underlying asset. E.  sensitivity to risk-free rate changes. Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option theta

31.	Selling an option is generally more valuable than exercising the option because of the option's:    A.  riskless value. B.  intrinsic value. C.  standard deviation. D.  exercise price. E.  time premium. Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option value

32.

Which of the following statements are correct? I. As the standard deviation of the returns on a stock increase, the value of a put option increases. II. The value of a call option decreases as the time to expiration increases. III. A decrease in the risk-free rate increases the value of a put option. IV. Increasing the strike price increases the value of a put option.    A.  I and III only B.  II and IV only C.  I and II only D.  I, III, and IV only E.  I, II, and III only Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option inputs

33.	A decrease in which of the following will increase the value of a put option on a stock? I. time to expiration II. stock price III. exercise price IV. risk-free rate    A.  III only B.  II and IV only C.  I and III only D.  I, II, and III only E.  II, III, and IV only Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option inputs

34.	Which one of the five factors included in the Black-Scholes model cannot be directly observed?    A.  risk-free rate B.  strike price C.  standard deviation D.  stock price E.  life of the option Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Black-Scholes

35.

Which one of the following statements related to the implied standard deviation (ISD) is correct?    A.  The ISD is an estimate of the historical standard deviation of the underlying security. B.  ISD is equal to (1 - D1). C.  The ISD estimates the volatility of an option's price over the option's lifespan. D.  The value of ISD is dependent upon both the risk-free rate and the time to option expiration. E.  ISD confirms the observable volatility of the return on the underlying security. Refer to section 25.3

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Implied standard deviation

36.

The implied standard deviation used in the Black-Scholes option pricing model is:    A.  based on historical performance. B.  a prediction of the volatility of the return on the underlying asset over the life of the option. C.  a measure of the time decay of an option. D.  an estimate of the future value of an option given a strike price (E). E.  a measure of the historical intrinsic value of an option. Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Implied standard deviation

37.

The value of an option is equal to the:    A.  intrinsic value minus the time premium. B.  time premium plus the intrinsic value. C.  implied standard deviation plus the intrinsic value. D.  summation of the intrinsic value, the time premium, and the implied standard deviation. E.  summation of delta, theta, vega, and rho. Refer to section 25.3

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-03 How the five factors in the Black-Scholes formula affect the value of an option. Section: 25.3 Topic: Option value

38.	For the equity of a firm to be considered a call option on the firm's assets, the firm must:    A.  be in default. B.  be leveraged. C.  pay dividends. D.  have a negative cash flow from operations. E.  have a negative cash flow from assets. Refer to section 25.4

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-04 How the Black-Scholes model can be used to value the debt and equity of a firm. Section: 25.4 Topic: Equity value of firm

39.	Paying off a firm's debt is comparable to _____ on the assets of the firm.    A.  purchasing a put option B.  purchasing a call option C.  exercising an in-the-money put option D.  exercising an in-the-money call option E.  selling a call option Refer to section 25.4

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 25-04 How the Black-Scholes model can be used to value the debt and equity of a firm. Section: 25.4 Topic: Equity value of firm

40.	The shareholders of a firm will benefit the most from a positive net present value project when the delta of the call option on the firm's assets is:    A.  equal to one. B.  between zero and one. C.  equal to zero. D.  between zero and minus one. E.  equal to minus one. Refer to section 25.4

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 25-04 How the Black-Scholes model can be used to value the debt and equity of a firm. Section: 25.4 Topic: Equity value of firm

41.

The value of the risky debt of a firm is equal to the value of:    A.  a call option plus the value of a risk-free bond. B.  a risk-free bond plus a put option. C.  the equity of the firm minus a put. D.  the equity of the firm plus a call option. E.  a risk-free bond minus a put option. Refer to section 25.4

AACSB: Analytic Blooms: Remember Difficulty: 1 Easy Learning Objective: 25-04 How the Black-Scholes model can be used to value the debt and equity of a firm. Section: 25.4 Topic: Value of firm debt

42.

A firm has assets of $21.8 million and a 3-year, zero-coupon, risky bonds with a total face value of $8.5 million. The bonds have a total current market value of $8.1 million. How can the shareholders of this firm change these risky bonds into risk-free bonds?    A.  purchase a call option with a 1-year life and a $8.1 million face value B.  purchase a call option with a 5-year life and a $8.5 million face value C.  purchase a put option with a 1-year life and a $21.8 million face value D.  purchase a put option with a 3-year life and a $8.1 million face value E.  purchase a put option with a 3-year life and an $8.5 million face value Refer to section 25.4

AACSB: Analytic Blooms: Understand Difficulty: 1 Easy Learning Objective: 25-04 How the Black-Scholes model can be used to value the debt and equity of a firm. Section: 25.4 Topic: Bond protective put