Finance 469 Final Exam

Bill Jones inherited 5,000 shares of stock priced at $45 per share. He does not want to sell the stock this year due to tax reasons but he is concerned the stock will drop in value before year end. Bill wants to use a collar to ensure that he minimizes his risk and doesn't incur too much cost in deferring the gain. January call options with a strike of $50 are quoted at a cost of $2 and January puts with a $40 exercise price are quoted at a cost of $3. If Bill establishes the collar and the stock price winds up at $35 in January, Bill's net position value including the option profit or loss and the stock is____________. A. $195,000 B. $220,000 C. $175,000 D. $215,000

A. $195,000 Position value = 5000 shares x $45/share = $225,000. To establish a collar you would need 5000/100 = 50 options. You would buy the 50 puts at a cost of $3(100)(50) = $15,000 and write the 50 calls, earning a premium of $2(100)(50) = $10,000. The initial cost is $15,000 - $10,000 = $5,000. If the stock price in January is $35 then profit can be found as: Profit = [Max($0,$40 - $35) - Max($0,$35 - $50)](100)(50) - $5,000 = $20,000 New Stock value = 5000 shares x $35 = $175,000 so net position value = $175,000 + $20,000 = $195,000

You write one IBM July 120 call contract for a premium of $4. You hold the option until the expiration date when IBM stock sells for $121 per share. You will realize a __________ on the investment. A. $300 profit B. $200 loss C. $600 loss D. $200 profit

A. $300 profit Short Call Profit = Min[0,($120 - $121))(100)] + $400 = $300

A put on Sanders stock with a strike price of $35 is priced at $2 per share while a call with a strike price of $35 is priced at $3.50. The maximum per share loss to the writer of an uncovered put is____________ and the maximum per share gain to the writer of an uncovered call is_______. . A. $33.00; $3.50 B. $33.00; $31.50 C. $35.00; $3.50 D. $35.00; $35.00

A. $33.00; $3.50 Maximum per share loss to put writer = (35 - 0) + 2 = 33.00 if stock price is $0 at expiration. Maximum per share gain to call writer = 3.50 if stock price is below $40 at expiration.

The value of a listed put option on a stock is lower when___________. I. the exercise price is higher II. the contract approaches maturity III. the stock decreases in value IV. a stock split occurs A. II only B. II and IV only C. I, II and III only D. I, II, III and IV

A. II only

The Black-Scholes hedge ratio for a long call option is equal to____________. A. N(d1) B. N(d2) C. N(d1) 1 D. N(d2) 1

A. N(d1)

Suppose you purchase a call and write a put on the same stock with the same exercise price and expiration. If prices are at equilibrium the value of this portfolio is________. A. S0 - Xe-rt B.S0-X -rt C.S0 +Xe D. S0 + X

A. S0 - Xe-rt

A lookback option provides its holder with _______________. A. a payoff determined by either the maximum or minimum price of the underlying stock during the life of the option B. a payoff determined by the difference between the maximum and minimum price of the underlying stock during the life of the option C. a payoff if the firm's stock price falls below some specified dollar amount during the term of the option D. a payoff based on the average price of the underlying stock over the life of the option

A. a payoff determined by either the maximum or minimum price of the underlying stock during the life of the option

The weak form of the EMH states that ________ must be reflected in the current stock price. A. all past information including security price and volume data B. all publicly available information C. all information including inside information D. all costless information

A. all past information including security price and volume data

You invest in the stock of Rayleigh Corp. and write a call option on Rayleigh Corp. This strategy is called a _________. A. covered call B. long straddle C. naked call D. money spread

A. covered call

The hedge ratio is often called the option's _______. A. delta B. gamma C. theta D. beta

A. delta

The small firm in January effect is strongest ________________. A. early in the month B. in the middle of the month C. late in the month D. in even numbered years

A. early in the month

In a recent study, Fama and French found that the return on the aggregate stock market was __________ when the dividend yield was higher. A. higher B. lower C. unaffected D. more skewed

A. higher

Investor A bought a call option and Investor B bought a put option. All else equal if the underlying stock price volatility increases the value of Investor A's position will ______ and the value of Investor B's position will _______. A. increase; increase B. increase; decrease C. decrease; increase D. decrease; decrease

A. increase; increase

The __________ is the stock price minus exercise price, or the profit that could be attained by immediate exercise of an inthe-money call option. A. intrinsic value B. time value C. stated value D. discounted value

A. intrinsic value

The tendency when the ______ performing stocks in one period are the best performers in the next and the current ________ performers are lagging the market later is called the reversal effect. A. worst; best B. worst; worst C. best; worst D. best; best

A. worst; best

Calculate the price of a call option using the Black Scholes model and the following data. Stock price = $47.30. Exercise price = $50. Time to expiration = 85 days. Risk free rate = 3.0%. Standard deviation = 35%. A. $1.11 B. $2.22 C. $3.33 D. $4.44

B. $2.22

You purchase one IBM July 120 call contract for a premium of $5. You hold the option until the expiration date when IBM stock sells for $123 per share. You will realize a ______ on the investment. A. $200 profit B. $200 loss C. $400 profit D. $400 loss

B. $200 loss

Even if the markets are efficient, professional portfolio management is still important because it provides investors with _________. I. low cost diversification II. provides a portfolio with a specified risk level III. provides better risk adjusted returns than an index A. I only B. I and II only C. II and III only D. I, II and III

B. I and II only

Which of the following is not a method employed by fundamental analysts? A. Analyzing the Fed's next interest rate move B. Relative strength analysis C. Earnings forecasting D. Estimating the economic growth rate

B. Relative strength analysis

The writer of a put option _______________ A. agrees to sell shares at a set price if the option holder desires B. agrees to buy shares at a set price if the option holder desires C. has the right to buy shares at a set price D. has the right to sell shares at a set price

B. agrees to buy shares at a set price if the option holder desires

Hedge ratios for long calls are always __________. A. between 1 and 0 B. between 0 and 1 C. 1 D. greater than 1

B. between 0 and 1

The percentage change in the stock call option price divided by the percentage change in the stock price is the_________ of the option. A. delta B. elasticity C. gamma D. theta

B. elasticity

All else equal call option values are _____ if the _____ is lower. A. higher; stock price B. higher; exercise price C. lower; dividend payout D. lower; stock volatility

B. higher; exercise price

A put option on Snapple Beverage has an exercise price of $30. The current stock price of Snapple Beverage is $24.25. The put option is_________. A. at the money B. in the money C. out of the money D. knocked out

B. in the money

Investor A bought a call option and Investor B bought a put option. All else equal if the interest rate increases the value of Investor A's position will______ and the value of Investor B's position will _______. A. increase; increase B. increase; decrease C. decrease; increase D. decrease; decrease

B. increase; decrease

You buy a call option and a put option on General Electric. Both the call option and the put option have the same exercise price and expiration date. This strategy is called a _________. A. time spread B. long straddle C. short straddle D. money spread

B. long straddle

You purchase one IBM March 120 put contract for a put premium of $10. The maximum profit that you could gain from this strategy is__________ . A. $120 B. $1,000 C. $11,000 D. $12,000

C. $11,000 Profit = 100(120 - 10) = 11,000.00

The stock price of Bravo Corp. is currently $100. The stock price a year from now will be either $160 or $60 with equal probabilities. The interest rate at which investors invest in riskless assets at is 6%. Using the binomial OPM, the value of a put option with an exercise price of $135 and an expiration date one year from now should be worth __________ today. A. $34.09 B. $37.50 C. $38.21 D. $45.45

C. $38.21

What portfolio position in stock and T-Bills will ensure you a payoff equal to the payoff that would be provided by a protective put with X = $50? A. 1⁄2 share of stock and $25 in bills B. 1 share of stock and $50 in bills C. 1⁄2 share of stock and $26.19 in bills D. 1 share of stock and $25 in bills

C. 1⁄2 share of stock and $26.19 in bills

The current stock price of Alcoa is $70 and the stock does not pay dividends. The instantaneous risk free rate of return is 6%. The instantaneous standard deviation of Alcoa's stock is 40%. A put option on this stock with an exercise price of $75 and an expiration date 30 days from now. According to the Black-Scholes OPM, you should hold __________ shares of stock per 100 put options to hedge your risk. A. 30 B. 34 C. 69 D. 74

C. 69

Which of the following is not a method employed by followers of technical analysis? A. Charting B. Relative strength analysis C. Earnings forecasting D. Trading around support and resistance levels

C. Earnings forecasting

The value of a listed call option on a stock is lower when_____________ . I. the exercise price is higher II. the contract approaches maturity III. the stock decreases in value IV. a stock split occurs A. II, III and IV only B. I, III and IV only C. I, II and III only D. I, II, III and IV

C. I, II and III only

Which of the following strategies makes a profit if the stock price stays stable? A. Long call and short put B. Long call and long put C. Short call and short put D. Short call and long put

C. Short call and short put

Insiders are able to profitably trade and earn abnormal returns prior to the announcement of positive news. This is a violation of which form of efficiency? A. Weak form efficiency B. Semistrong form efficiency C. Strong form efficiency D. Technical analysis

C. Strong form efficiency

Which of the following stock price observations would appear to contradict the weak form of the efficient market hypothesis? A. The average rate of return is significantly greater than zero. B. The correlation between the market return one week and the return the following week is zero. C. You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall. D. You could have consistently made superior returns by forecasting future earnings performance with your new Crystal Ball forecast methodology.

C. You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.

Proponents of the EMH typically advocate __________. A. a conservative investment strategy B. a liberal investment strategy C. a passive investment strategy D. an aggressive investment strategy

C. a passive investment strategy

You invest in the stock of Valleyview Corp. and purchase a put option on Valleyview Corp. This strategy is called a ___________ . A. long straddle B. naked put C. protective put D. short stroll

C. protective put

The broadest information set is included in the A. weak form efficiency argument B. semistrong form efficiency argument C. strong form efficiency argument D. technical analysis trading method

C. strong form efficiency argument

You believe that stock prices reflect all information that can be derived by examining market trading data such as the history of past stock prices, trading volume or short interest but you do not believe stock prices reflect all publicly available or inside information. You are a proponent of the____________ form of the efficient market hypothesis A. semistrong B. strong C. weak D. perfect

C. weak

A 45 put option on a stock priced at $50 is priced at $3.50. This call has an intrinsic value of ________and a time value of_______ . A. $3.50; $0 B. $5.00; $3.50 C. $3.50; $5.00 D. $0; $3.50

D. $0; $3.50 Intrinsic value = Max(0, 45-50) = $0; Time value = Call premium - Intrinsic value =$3.50 - $0 = $3.50

The stock price of Harper Corp. is $33 today. The risk-free rate of return is 6% and Harper Corp. pays no dividends. A put option on Harper Corp. stock with an exercise price of $30 and an expiration date 73 days from now is worth $0.95 today. A call option on Harper Corp. stock with an exercise price of $30 and the same expiration date should be worth __________ today. A. $2.25 B. $3.14 C. $3.99 D. $4.31

D. $4.31

A(n) ______ option can only be exercised on the expiration date. A. Mexican B.Asian C. American D. European

D. European

Important characteristic(s) of market efficiency is that _________________. I. there are no arbitrage opportunities II. security prices react quickly to new information III. active trading strategies will not consistently outperform passive strategies A. I only B. II only C. I and III only D. I, II and III

D. I, II and III

Which of the following strategies makes a profit if the stock price declines and loses money when the stock price increases? A. Long call and short put B. Long call and long put C. Short call and short put D. Short call and long put

D. Short call and long put

Which of the following beliefs would not preclude charting as a method of portfolio management? A. The market is strong form efficient. B. The market is semi-strong form efficient. C. The market is weak form efficient. D. Stock prices follow recurring patterns.

D. Stock prices follow recurring patterns.

Proponents of the EMH think technical analysts __________. A. should focus on relative strength B. should focus on resistance levels C. should focus on support levels D. are wasting their time

D. are wasting their time

A down-and-out option______________ . A. provides a payoff if the firm's stock price falls below some specified percentage of what it was at the beginning of the option term B. provides a payoff if the firm's stock price falls below some specified dollar amount during the term of the option C. expires worthless if the firm's stock price falls below some specified percentage of what it was at the beginning of the option term D. expires worthless if the firm's stock price falls below some specified dollar amount during the term of the option

D. expires worthless if the firm's stock price falls below some specified dollar amount during the term of the option

According to recent research securities markets fully adjust to earnings announcements _______. A. instantly B. in 1 day C. in 1 week D. gradually over time

D. gradually over time

Growth stocks usually exhibit ______ price-to-book ratios and ______ price-to-earnings ratios. A. low; low B. low; high C. high; low D. high; high

D. high; high

Evidence suggests that there may be _______ momentum and ________reversal patterns in stock price behavior. A. shortrun, shortrun B. longrun, longrun C. longrun, shortrun D. shortrun, long run

D. shortrun, long run

The potential loss for a writer of a naked call option on a stock is_________. A. equal to the call premium B. larger the lower the stock price C. limited D. unlimited

D. unlimited

A technical analyst is most likely to be affiliated with which investment philosophy? A. Active management B. Buy and hold C. Passive investment D. Index funds

A. Active management

You purchase one IBM July 120 put contract for a premium of $3. You hold the option until the expiration date when IBM stock sells for $123 per share. You will realize a ______ on the investment. A. $300 profit B. $300 loss C. $500 loss D. $200 profit

B. $300 loss

Each listed stock option contract gives the holder the right to buy or sell__________ shares of stock. A. 1 B. 10 C. 100 D. 1,000

C. 100

Random price movements indicate_______________ . A. irrational markets B. that prices cannot equal fundamental values C. that technical analysis to uncover trends can be quite useful D. that markets are functioning efficiently

D. that markets are functioning efficiently

The stock price of Ajax Inc. is currently $105. The stock price a year from now will be either $130 or $90 with equal probabilities. The interest rate at which investors can borrow is 10%. Using the binomial OPM, the value of a call option with an exercise price of $110 and an expiration date one year from now should be worth __________ today. A. $11.59 B. $15.00 C. $20.00 D. $40.00

A. $11.59

Suppose you purchase one Texas Instruments August 75 call contract quoted at $8.50 and write one Texas Instruments August 80 call contract quoted at $6. If, at expiration, the price of a share of Texas Instruments stock is $79, your profit would be___________ . A. $150 B. $400 C. $600 D. $1,850

A. $150 Profit = 100 [(79 - 75)] - 8.50 + 6.00] = $150

Value stocks usually exhibit ______ price-to-book ratios and ______ price-to-earnings ratios. A. low; low B. low; high C. high; low D. high; high

A. low; low

Small firms have tended to earn abnormal returns primarily in __________. A. the month of January B. the month July C. the trough of the business cycle D. the peak of the business cycle

A. the month of January

You are considering purchasing a put option on a stock with a current price of $33. The exercise price is $35, and the price of the corresponding call option is $2.25. According to the put-call parity theorem, if the risk-free rate of interest is 4%, and there are 90 days until expiration, the value of the put should be ____________. A. $2.25 B. $3.91 C. $4.05 D. $5.52

B. $3.91

Exercise prices for listed stock options usually occur in increments of__________ , and bracket the current stock price. A. $1 B. $5 C. $20 D. $25

B. $5

The current stock price of Alcoa is $70 and the stock does not pay dividends. The instantaneous risk free rate of return is 6%. The instantaneous standard deviation of Alcoa's stock is 40%. You wish to purchase a call option on this stock with an exercise price of $75 and an expiration date 30 days from now. Based on the Black-Scholes OPM, the call option's delta will be __________. A.0.28 B. 0.31 C. 0.62 D. 0.70

B. 0.31

You are convinced that a stock's price will move by at least 15% over the next three months. You are not sure which way the price will move, but you believe that the results of a patent hearing are definitely going to have a major effect on the stock price. You are somewhat more bullish than bearish however. Which one of the following options strategies best fits this scenario? A. Buy a strip B. Buy a strap C. Buy a straddle D. Write a straddle

B. Buy a strap

In an efficient market and for an investor who believes in a passive approach to investing, what is the primary duty of a portfolio manager? A. Accounting for results B. Diversification C. Identifying undervalued stocks D. No need for a portfolio manager

B. Diversification

The semi strong form of the EMH states that ________ must be reflected in the current stock price. A. all security price and volume data B. all publicly available information C. all information including inside information D. all costless information

B. all publicly available information

An Asian call option gives its holder the right to ____________. A. buy the underlying asset at the exercise price on or before the expiration date B. buy the underlying asset at a price determined by the average stock price during some specified portion of the option's life C. sell the underlying asset at the exercise price on or before the expiration date D. sell the underlying asset at a price determined by the average stock price during some specified portion of the option's life

B. buy the underlying asset at a price determined by the average stock price during some specified portion of the option's life

According to the put-call parity theorem, the payoffs associated with ownership of a call option can be replicated by ________. A. shorting the underlying stock, borrowing the present value of the exercise price, and writing a put on the same underlying stock and with the same exercise price B. buying the underlying stock, borrowing the present value of the exercise price, and buying a put on the same underlying stock and with the same exercise price C. buying the underlying stock, borrowing the present value of the exercise price, and writing a put on the same underlying stock and with the same exercise price D. shorting the underlying stock, lending the present value of the exercise price and buying a put on the same underlying stock and with the same exercise price

B. buying the underlying stock, borrowing the present value of the exercise price, and buying a put on the same underlying stock and with the same exercise price

A put option with several months until expiration has a strike price of $55 when the stock price is $50. The option has ________ intrinsic value and________ time value. A. negative; positive B. positive; positive C. zero; zero D. zero; positive

B. positive; positive

Strike prices of options are adjusted for ________ but not for_________. A. dividends; stock splits B. stock splits; cash dividends C. exercise of warrants; stock splits D. stock price movements; stock dividends

B. stock splits; cash dividends

If you believe in the __________ form of the EMH, you believe that stock prices reflect all relevant information, including information that is available only to insiders. A. semistrong B. strong C. weak D. perfect

B. strong

Choosing stocks by searching for predictable patterns in stock prices is called ________. A. fundamental analysis B. technical analysis C. index management D. random-walk investing

B. technical analysis

Joe bought a stock at $57 per share. The price promptly fell to $55. Joe held on to the stock until it again reached $57, and then he sold it once he had eliminated his loss. If other investors do the same to establish a trading pattern, this would contradict _______. A. the strong-form EMH B. the weak-form EMH C. technical analysis D. the semistrong-form EMH

B. the weak-form EMH

A stock is trading at $50. You believe there is a 60% chance the price of the stock will increase by 10% over the next three months. You believe there is a 30% chance the stock will drop by 5% and you think there is only a 10% chance of a major drop in price of 20%. At the money 3 month puts are available at a cost of $650 per contract. What is the expected dollar profit for a writer of a naked put at the end of three months? A. $300 B. $200 C. $475 D. $0

C. $475 E[Profit] = -[0.60Max($0,$50 - ($50)(1.1)) + 0.30Max($0,$50 - ($50)(0.95)) + 0.10Max($0,$50 - ($50)(0.80))](100) + $650 = - [0.6 (0) + 0.3(250) + 0.1(1000)] + 650 = $475

You sell one IBM July 90 call contract for a premium of $4 and two puts for a premium of $3 each. You hold the position until the expiration date when IBM stock sells for $95 per share. You will realize a _________ on this strip. A. $300 profit B. $100 loss C. $500 profit D. $200 profit

C. $500 profit Selling an IBM July 90 strip entails selling two IBM July 90 puts and one IBM July 90 call. Initial income = C90 + 2P90 = (4 + 2(3))(100) = $1000. If the final stock price is $95 the position value is found as Profit = [-Max($0,$95 - 90) + 2Max($0,$90 - $95)](100) + $1000 = -$500 + $1000 = $500

You buy one Hewlett Packard August 50 call contract and one Hewlett Packard August 50 put contract. The call premium is $1.25 and the put premium is $4.50. Your highest potential loss from this position is___________ . A. $125 B. $450 C. $575 D. unlimited

C. $575 Loss = 100(1.25 + 4.50) = 575.00 if stock price is $50 at expiration.

Which of the following contradicts the proposition that the stock market is weakly efficient? A. Over 25% of mutual funds outperform the market on average. B. Insiders earn abnormal trading profits. C. Every January, the stock market earns above-normal returns. D. Applications of technical trading rules fail to earn abnormal returns

C. Every January, the stock market earns above-normal returns.

A longer time to maturity will unambiguously increase the value of a call option because __________. I. the longer maturity time reduces the effect of a dividend on call price II. with a longer time to maturity the present value of the exercise price falls III. with a longer time to maturity the range of possible stock prices at expiration increases A. I only B. I and II only C. II and III only D. I, II and III

C. II and III only

The strong form of the EMH states that ________ must be reflected in the current stock price. A. all security price and volume data B. all publicly available information C. all information including inside information D. all costless information

C. all information including inside information

A one dollar increase in a stock's price would result in ____________ in the call option's value of ____________than one dollar. A. a decrease; less B. a decrease; more C. an increase; less D. an increase; more

C. an increase; less

A high dividend payout will ______ the value of a call option and ______ the value of a put option. A. increase; decrease B. increase; increase C. decrease; increase D. decrease; decrease

C. decrease; increase

A hedge ratio of 0.70 implies that a hedged portfolio should consist of__________. A. long .70 calls for each short stock B. long .70 shares for each long call C. long .70 shares for each short call D. short .70 calls for each long stock

C. long .70 shares for each short call

The primary objective of fundamental analysis is to identify __________. A. well run firms B. poorly run firms C. mis-priced stocks D. high P/E stocks

C. mispriced stocks

An implication of the efficient market hypothesis is that __________. A. high-beta stocks are consistently overpriced B. low-beta stocks are consistently overpriced C. nonzero alphas will quickly disappear D. growth stocks are better buys than value stocks

C. nonzero alphas will quickly disappear

The practice of using options or dynamic hedging strategies to provide protection against investment losses while maintaining upside potential is called _________. A. trading on gamma B. index optioning C. portfolio insurance D. index arbitrage

C. portfolio insurance

You purchase one IBM July 125 call contract for a premium of $5. You hold the option until the expiration date when IBM stock sells for $123 per share. You will realize a ______ on the investment. A. $200 profit B. $200 loss C. $500 profit D. $500 loss

D. $500 loss

You are looking to invest in one of three stocks. Stock A has high expected earnings growth, Stock B has only modest expected earnings growth and Stock C is expected to generate poor earnings growth. Which stock is likely to generate the greatest alpha for you? A. Stock A B. Stock B C. Stock C D. You cannot tell from the information given

D. You cannot tell from the information given

You buy a call option on Merritt Corp. with an exercise price of $50 and an expiration date in July and write a call option on Merritt Corp. with an exercise price of $55 with an expiration date in July. This is called a ____________ . A. time spread B. long straddle C. short straddle D. money spread

D. money spread