Ch. 13 - Practice Test

A put option you own is going to expire in one second. The current stock price is $25 and the strike price of your option is $30. Which of the following statements is false? A. You have the right to sell the stock for $30 B. Your option is in the money C. Someone other than you stands yo gain $5 per share when the option is exercised D. Your option has intrinsic value E. Your option should be exercised or sold

C. Someone other than you stands yo gain $5 per share when the option is exercised

Which of the following would decrease the value of a call option? I. The exercise price is decreased. II. The value of the underlying asset decreases. III. The expiration date is extended. IV. The variance of the underlying asset decreases. A. I and IV only B. I and III only C. II and III only D. I and II only E. II and IV only

E. II and IV only

As the variance of the asset price decreases, the value of a call option decreases as well as: A. Downside risk is virtually eliminated while the possible payoffs increase B. It becomes more likely that the option will finish out of the money C. The possible payoffs increase D. Downside risk is virtually eliminated E. The possible payoffs decrease

E. The possible payoffs decrease

Which of the following statements is true regarding call options on stock? A. When a call option is exercised it increases the shares outstanding of the firm B. When you purchase a call option on a given company's common stock, the seller is always the issuing company. C. A call option gives the owner the right to sell the stock for a specified price on or before a given date. D. A call option changes the value of the firm when it is exercised. E. When you write a call option you have an immediate cash inflow and a potential future cash outflow.

E. When you write a call option you have an immediate cash inflow and a potential future cash outflow.

You sell a put option on GM stock. As the seller, you may have the _________ to ___________ the put buyer at the exercise price. A. right; sell GM stock to B. right; purchase GM stock from C. obligation; sell GM stock to D. the obligation or the right (depending on whether it is an American or European option); buy GM stock from E. obligation; purchase GM stock from

E. obligation; purchase GM stock from

You buy a put option on Microsoft stock. As the buyer of the put, you have the ________ to ________ the put seller at the exercise price. A. the obligation or the right (depending on whether it is an American or European option); sell Microsoft stock to B. obligation; purchase Microsoft stock from C. obligation; purchase Microsoft stock from D. right; purchase Microsoft stock from E. right; sell Microsoft stock to

E. right; sell Microsoft stock to

All else the same, the value of a call option decreases ________. A. with increases in the time to expiration B. with increases in the underlying asset price C. the less out of the money the option becomes D. with decreases in the exercise price E. with decreases in the risk-free interest rate

E. with decreases in the risk-free interest rate

True or False: A November call option to buy 100 shares of IBM stock at $100 will always cost the same as a November put option to sell 100 shares of IBM stock at $100.

False

True or False: An option is American if it was purchased on an exchange located in the United States

False

True or False: The greater the variance of the underlying asset, the less a call option is worth

False

True or False: The higher the exercise price, the greater the value of a call option, all else the same

False

True or False: The higher the risk free rate of interest, the greater the value of a call option, all else the same

False

True or False: Equity can be viewed as a call option on a firm's assets

True

True or False: The Green Shoe provision that is frequently used in IPOs is one type of call option

True

True or False: The act of buying or selling the underlying asset via the option contract is called exercising the option

True

True or False: The call option seller is obligated to sell the underlying asset if the buyer exercises the option

True

True or False: The price of a share of stock impacts the value of a call option written on that stock

True

Which of the following statements is false? A. As the price of a stock falls, the value of a put option on the stock falls as well B. It is possible for you to lose all of your investment in an option C. If an in-the-money option is not exercised at expiration, you will lose money D. Option contracts are a zero sum game; that is, there is a loser for every winner E. One advantage to buying options on a stock rather than the stock itself is that it requires fewer investment dollars up front

A. As the price of a stock falls, the value of a put option on the stock falls as well

Which of the following statements are true regarding options on common stock? I. Buying a call gives you the right to purchase shares. II. Selling a call may give you the obligation to sell shares. III. Buying a put gives you the right to sell shares. IV. Selling a put may give you the obligation to buy shares. A. I, II, III, and IV B. I, II, and IV only C. None of the above D. II and III only E. I and IV only

A. I, II, III, and IV

Three weeks ago, you sold an IBM September $110 call option for $2.25. Now in August, IBM is selling for $117.50 per share and your call is trading for $9.75. Ignoring transaction costs, what can you do now? A. Sell an additional call option contract for $9.75 B. Exercise the call and then sell the 100 shares of IBM for $117.50 per share C. Forego your right to exercise the call until later D. Sell the call to net a $7.50 profit per share E. Exercise the call and then sell the 100 shares of IBM for $110 per share

A. Sell an additional call option contract for $9.75

Which of the following would unambiguously increase the value of an American put option? I. The exercise price is increased. II. The value of the underlying asset increases. III. The risk-free rate increases. IV. The variance of the underlying asset decreases A. I, II, and IV only B. I only C. I, II, III, and IV D. I and III only E. I and IV only

B. I only

Which of the following would unambiguously decrease the value of an American put option? I. The exercise price is increased. II. The value of the underlying asset increases. III. The risk-free rate increases. IV. The variance of the underlying asset increases. A. I, II, and IV only B. II and III only C. II and IV only D. I and III only E. I and II only

B. II and III only

You buy a call on Wal Mart stock. As the buyer of a call, you have the _________ to _________ the call seller at the exercise price. A. the obligation or the right (depending on whether it is an American or European option); buy Wal Mart stock from B. Right; purchase Wal Mart stock from C. right; sell Wal Mart stock to D. obligation; sell Wal Mart stock to E. obligation; purchase Wal Mart stock from

B. Right; purchase Wal Mart stock from

Which of the following statements is true? A. The lower the underlying share price, the higher the value of a call option. B. The lower the risk of the underlying security, the lower the value of a call option. C. The lower the exercise price, the lower the value of a call option. D. The greater the interest rate, the lower the value of a call option. E. The longer the time to expiration, the lower the value of a call option.

B. The lower the risk of the underlying security, the lower the value of a call option.

You know for certain that a common share of Mystical Inc., worth $25 today, will be worth $55 one month from now. The stock pays no dividends. Which of the following actions would maximize your return on investment? A. You purchase warrants on the stock (totaling 100 shares) with a strike price of $35 and an expiration of one month. B. You purchase 100 shares of the stock at the current price of $25 per share. C. You purchase a call option on the stock with a strike price of $25 that expires in one month. D. You purchase a put option on the stock with a strike price of $30 that expires in one month. E. You purchase a call option with a strike price of $55 that expires in one month.

C. You purchase a call option on the stock with a strike price of $25 that expires in one month.

Because _______, equity in a leveraged firm can be considered a call option on the firm's assets A. it is typically true that more call options than put options are written on common stocks B. stockholders have unlimited liability for the debts of the firms C. the possible loss on a share of common stock is limited to the initial investment D. the bondholders can elect to walk away, leaving the stockholders holding the bag E. Stock price can be lower than zero

C. the possible loss on a share of common stock is limited to the initial investment

If you exercise a put option prior to expiration you: A. Will always receive less than you would if you let the option run to maturity B. Have behaved in a rational manner is the market price exceeds the strike price C. Must own a European option D. Are obligated to sell the asset underlying the option contract at the option strike price E. Must have been the writer of the option when it was created

D. Are obligated to sell the asset underlying the option contract at the option strike price

Which of the following is a characteristic difference between a warrant and a call option? A. Neither warrants nor call options affect firm value B. Unlike warrants, when call options are exercised, the number of shares outstanding increases. C. A call option will typically have a longer maturity than a warrant. D. Call options are issued by individuals while warrants are issued by firms E. Call options can be allowed to expire while warrants cannot.

D. Call options are issued by individuals while warrants are issued by firms

If you sell a call option on a stock that you don't own you: A. May be forced to buy the underlying stock at the exercise price B. Have a right to receive dividends on the underlying stock until option exercise or maturity C. May be forced to sell the underlying stock at the strike price if the option is exercised D. May let the option expire without exercising it E. Have the right to force exercise of the option anytime prior to maturity

D. May let the option expire without exercising it

Which of the following statements is true regarding warrants? A. Warrant exercise will not increase the number of shares outstanding B. Warrant exercise will increase earnings per share. C. Warrants may not be traded separately from the security with which they were issued. D. Warrants are usually issued in conjunction with a security offering. E. Warrants are issued by individuals.

D. Warrants are usually issued in conjunction with a security offering.

If in July you purchase a September 75 put option on Keebler, Inc. common stock: A. You will have a worthless option in August if the stock price is $80 at that time. B. You have the right to buy a share of Keebler stock at $75 sometime prior to the September expiration C. You should exercise the option at expiration if the price of Keebler stock is $80 D. You will have a negative cash flow at the time you initiate the contract and a positive cash flow when the option expires provided that the stock price is less than $70 at that time. E. You have given the seller the right to buy a share of Keebler stock at $75 sometime prior to the September expiration

D. You will have a negative cash flow at the time you initiate the contract and a positive cash flow when the option expires provided that the stock price is less than $70 at that time.

You sell a call option on Intel stock. As the seller, you may have the ______ to ____ the call buyer at the exercise price A. right; purchase Intel stock from B. obligation; purchase Intel stock from C. the obligation or the right (depending on whether it is an American or European option); sell Intel stock to D. obligation; sell Intel stock to E. right; sell Intel stock to

D. obligation; sell Intel stock to