Ch. 24

In a two-state world, the value of a call option is equal to _____.

So-E/(1+Rf)

The opportunity to earn riskless profits is known as ______.

arbitrage

Convertible bonds are _____.

bonds that can be converted to stock

Warrants give the owner the right to ______ shares at a fixed price within a specified period.

buy

The dollar amount of a bond's par value that is exchangeable for one share of stock is called the:

conversion price

True or false: Backdating ESOs is illegal.

false

True or false: When an investment has a positive NPV, it should always be taken immediately.

false

The exercise price of a call option that expires in two weeks is $5. If the call option is in the money and the stock price increases by $1, what is the increase in the value per share of the call option?

1

How does a firm benefit from an option to delay? (Select all that apply) 1. It prevents losses from hasty business decisions. 2. It delays decision making until more information is available. 3. It allows the firm to invest in a project in stages. 4. It benefits from first-mover advantage.

1, 2, 3

Which of these exist if identical securities are listed at two different prices on two different exchanges? (Select all that apply) 1. Arbitrage 2. Inefficient markets 3. Riskless profits 4. Well-functioning financial market

1, 2, 3

A call option has an exercise price of $50. There are two potential future scenarios. Scenario 1: 50/50 chance the stock will be worth either $40 or $20; Scenario 2: 50/50 chance the stock will be worth either $60 or $0. Which scenario is more valuable for a call buyer? A. Scenario 2 is more valuable because the stock price might exceed the exercise price. B. Scenario 1 is more valuable because the stock price should not exceed the exercise price. C. Scenario 1 is more valuable because the exercise price should not exceed the stock price. D. Scenario 2 is more valuable because the exercise price might exceed the stock price.

A

Ignoring each of the following may cause the NPV of a project to be underestimated except for the option to: A. commence immediately B. expand C. wait D. abandon E. contract

A

What is the impact of arbitrage trade on option prices?. A. Arbitrage restores prices to equilibrium. B. Arbitrage reduces confidence in the options market. C. Arbitrage increases profits on option trades. D. Arbitrage drives prices even further away from the equilibrium price.

A

What is the largest organized options exchange in the USA? A. The Chicago Board Options Exchange B. The American Stock Exchange C. The New York Stock Exchange D. NASDAQ

A

Arabelle opted to exercise her March option on January 18th and, as a result, received $1,800 for the sale of her shares. Arabelle owned a(n):

American put

The greater the __________ of the return on the underlying asset, the higher the value of the call option. A. reliability B. variability C. reputation D. price

B

What is a call option? A. A call option obligates its owner to sell the asset at a fixed price by a specified date. B. A call option gives the owner the right to buy an asset at a fixed price on or before a specified date. C. A call option obligates its owner to buy the asset at a fixed price by a specified date. D. A call option gives the owner the right to sell an asset at a fixed price on or before a specified date.

B

When underwater employee stock options are exchanged, the option holder generally receives: A. a cash payment equal to the value of the options when they were originally issued. B. a smaller number of new options with a lower exercise price. C. a larger number of new options with a higher exercise price. D. the same number of options but with a higher exercise price. E. twice the number of options with an exercise price equal to half of the original exercise price.

B

The formula for determining the number of call options to buy in order to replicate the stock's payoffs in the simple two-state model is _____. A. ΔC/ΔS B. ΔC^ΔS C. ΔS/ΔC D. ΔC×ΔS

C

What is a call option? A. A call option makes the owner liable to sell the stock at a fixed price. B. A call option makes the owner liable to buy the stock at a fixed price. C. A call option gives the owner the right to buy a stock at a fixed price. D. A call option gives the owner the right to sell a stock at a fixed price.

C

Delta Importers has a pure discount loan with a face value of $180,000 due in one year. The assets of the firm are currently worth $215,000. The shareholders in this firm basically own a _____ option on the assets of the firm with a strike price of _____.

Call, 180,000

When using the formula for determining the number of call options to buy in order to replicate the stock's payoffs in the simple two-state model is the difference in the possible stock prices divided by the difference in the possible option values. When the stock is certain to finish in the money, then this formula is _____. A. always greater than 100 B. always equal to 10 C. sometimes equal to zero D. always equal to 1

D

Why is there a positive relationship between interest rates and the value of a call option? A. As interest rates rise, the stock price falls making the call option more valuable. B. As interest rates rise, the stock price rises making the call option more valuable. C. Since the exercise price is paid later by the call buyer, delayed payment is more valuable when interest rates are low. D. Since the exercise price is paid later by the call buyer, the delayed payment is more valuable when interest rates are high.

D

______ option contracts can be exercised only on the expiration date while ______ option contracts can be exercised anytime up to and including the expiration date.

European, American

A higher stock price will generally ______ the value of a call option.

increase

An executive has been awarded 5,000 stock options in his company, KJL. If KJL's stock price becomes more volatile, the value of the options will tend to _____.

increase

Investors are likely to buy call options on Bank of America when they expect the share price of Bank of America to ______.

increase

If you buy a European call option with an exercise price of $175, you will not exercise the call option if the underlying stock price is ______ than $175 on the expiration date.

less

ESO backdating occurs when companies search the past in order to find a stock price to use as the exercise price that is _____.

low

An increase in the exercise price will ______ the value of the call option.

reduce

Where is the exercise price of an employee stock option generally set when issued?

the current market price of stick

Assume you purchase one call option contract on a stock that is currently selling for $12 per share. What is the maximum amount you can lose?

the option premium per share

In a two-state world, where there are only two possible payoffs on a share of stock at the end of a year, the stock payoffs can be exactly duplicated using a combination of a call option on the stock and _____.

the risk free asset

The maximum value of a call option can never exceed the:

underlying stock price

Mega Corporation (MC) issued securities that entitled the holder to buy shares in MC within the next 2 years at a fixed price of $47. What type of security is this?

warrant

When will a call option on a stock be classified as an "underwater" call option? A. When the market price of stock is far above the exercise price. B. When the market price of stock is far below the exercise price. C. When the call premium is equal to the stock price D. When the market price of stock is equal to the exercise price.

B

Which one of the following terms applies to an option that has an office building as its underlying asset? A. Fixed option B. Real option C. Concrete option D. Financial option E. Implicit option

B

When using the simple two-state model to value a call option, suppose that in one of the states the call is "out of the money," and in the other state the call is "in the money." In order to replicate the payoffs to the underlying asset, one must purchase call options and invest the present value of the _____ price in a riskless asset. Multiple choice question. A. in-the-money stock B. exercise C. out-of-the-money stock

C

Brycen owns a $1,000 par value bond. He can exchange the bond for 40 shares of Bhandarkar, Incorporated, stock at any time within the next two years. Brycen owns a _____ bond.

Convertible

Define an option contract: A. An option contract gives the owner the right to buy or sell an asset at any price on or before a given date B. An option contract gives the seller the right to buy or sell some asset at a fixed price on or before a given date C. An option contract creates an obligation for the owner to buy or sell some asset at a fixed price on or before a given date D. An option contract gives the owner the right to buy or sell some asset at a fixed price on or before a given date

D

How do convertible bonds and bonds with warrants differ? A. The conversion feature can be detached from convertible bonds but warrants cannot be detached from bonds. B. Convertible bonds are issued by the firm while warrants are issued by individual investors. C. Convertible bonds have an active secondary market while there is no secondary market for warrants. D. Warrants can be detached from bonds but the conversion feature cannot be detached from a convertible bond.

D

What is an important drawback of traditional NPV analysis? A. It ignores the time value of money when computing the NPV. B. Standard software programs and calculators cannot compute NPV. C. It ignores the impact of the discount rate. D. It ignores embedded options in investment decisions.

D