inv 3

Put Call Parity

Consider a portfolio that is Long 1 Call and Short 1 Put -It is just like the payoff of a levered stock position (aka borrowing money and buying stock)

In what industry are investors likely to use the dividend discount model and arrive at a price close to the observed market price?

utility

A stock has an intrinsic value of $15 and an actual stock price of $13.50. You know that this stock ________.

will generate a positive alpha

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 _______.

increase; increase

The __________ is the stock price minus exercise price, or the profit that could be attained by immediate exercise of an in-the-money call option.

intrinsic value

Value stocks are more likely to have a PEG ratio _____.

less than 1

The initial maturities of most exchange-traded options are generally __________.

less than 1 year

Perfect hedge

locks in the end-of-period payout, which then can be discounted using the risk-free interest rate. •It is the ratio of shares you must hold for every call you write

Which one of the following is a common term for the market consensus value of the required return on a stock?

market capitalization rate

You purchase a call option on a stock. The profit at contract maturity of the option position is ___________, where X equals the option's strike price, ST is the stock price at contract expiration, and C0 is the original purchase price of the option.

max (-C0, ST - X - C0)

All else the same, an American-style option will be ______ valuable than a ______ style option.

more; European-

Before expiration, the time value of an out-of-the-money stock option is __________.

positive

Seller / Writer

short

Exchange-traded stock options expire on the _______________ of the expiration month.

third Friday

The _________ is the difference between the actual call price and the intrinsic value.

time value

__________ is the amount of money per common share that could be realized by breaking up the firm, selling its assets, repaying its debt, and distributing the remainder to shareholders.

Liquidation value per share

The potential loss for a writer of a naked call option on a stock is _________.

unlimited

In 1973, trading of standardized options on a national exchange started on the _________.

CBOE

The SEC requires public U.S. companies to file registration statements and periodic reports electronically through

EDGAR.

Buyer /Hold

Long

Book value

Net worth of common equity according to a firm's balance sheet.

At the Money

exercise price and asset price are equal

Implied Volatility

the standard deviation that you get from equating the Black Scholes Value to the market value. The market price implies what the market thinks true volatility is going to be Standard deviation of stock returns (standard deviation) that is consistent with an option's market value - also known as "investor fear gauge"

A stock with a current market price of $50 and a strike price of $45 has an associated call option priced at $6.50. This call has an intrinsic value of ______ and a time value of _____.

$5; $1.50

Spread

-Combination of two or more call or put options with different exercise prices and expiration dates •Long call with a certain strike price and short call on the same stock with a higher strike price. Both options have the same expiration date. •Limits the investor's upside as well as downside risk. •Reduces the initial investment (but still > $0; Why?)

Collar

An option strategy that brackets the value of a portfolio between two bounds •Long stock, long put, and short call •Limit the downside risk of a stock position at little or no cost •Forego upside potential in return for obtaining this downside protection

Black-Scholes Model

Assuming that stock prices follow a lognormal distribution, Black-Scholes develop a pricing formula for a European call option and a European put option

Time value of an option

Difference between an option's price and its intrinsic value, typically a type of "volatility value"

Market capitalization rate (k)

Market-consensus estimate of the appropriate discount rate for a firm's cash flows. This can come from CAPM or other risk-return benchmark model.

Which one of the following statements about market and book value is correct?

Most firms have a market-to-book ratio above 1, but not all.

New-economy companies generally have higher _______ than old-economy companies.

P/E multiples

intrinsic value of an option

Payoff that could be attained by immediate exercise of an in-the-money call option, i.e. stock price minus exercise price

Intrinsic value (V)

Present value of a firm's expected future net cash flows discounted by firm's market capitalization rate

Derivative

Security whose payoff is contingent on the price of another security

A company with an expected earnings growth rate which is greater than that of the typical company in the same industry most likely has _________________.

a dividend yield which is less than that of the typical company

The writer of a put option _______________.

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

A __________ is an option valuation model based on the assumption that stock prices can move to only two values over any short time period.

binomial model

American option

can be exercised on or before its expiration

European option

can be exercised only at expiration

You invest in the stock of Rayleigh Corp. and write a call option on Rayleigh Corp. This strategy is called a _________.

covered call

Generally speaking, as a firm progresses through the industry life cycle, you would expect the PVGO to ________ as a percentage of share price.

decrease

A writer of a call option will want the value of the underlying asset to __________, and a buyer of a put option will want the value of the underlying asset to _________.

decrease; decrease

The term "residual claimant" refers to

equity/shareholders.

You invest in the stock of Valleyview Corp. and purchase a put option on Valleyview Corp. This strategy is called a _________.

protective put

If you have an extremely "bullish" outlook on the stock market, you could attempt to maximize your rate of return by ________________.

purchasing out-of-the-money call options

An American put option gives its holder the right to _________.

sell the underlying asset at the exercise price on or before the expiration date

What combination of variables is likely to lead to the lowest time value?

short time to expiration and low volatility

Each of two stocks, A and B, is expected to pay a dividend of $7 in the upcoming year. The expected growth rate of dividends is 6% for both stocks. You require a return of 10% on stock A and a return of 12% on stock B. Using the constant-growth DDM, the intrinsic value of stock A _________.

will be higher than the intrinsic value of stock B

A call 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.

zero; positive

Straddle

•Long call and put with the same exercise price and expiration date •Appropriate when an investor is expecting a large move in a stock price but does not know in which direction the move will be.•e.g., the outcome of a major lawsuit involving the company is about to be announced.

Protective put

•Long stock, long put •Limited downside risk, unlimited profit potential •Like buying insurance for your stock portfolio

Covered call

•Long stock, short call •Limited upside profit potential •Generate income in addition to any dividends from shares of underlying stock owned.

P/E Ratios are a function of two primary factors

•Required Rates of Return (k) •Expected growth in Dividends

Each listed stock option contract gives the holder the right to buy or sell __________ shares of stock.

100

______ option can only be exercised on the expiration date.

A European

A high dividend payout will ______ the value of a call option and ______ the value of a put option.

decrease; increase

A firm cuts its dividend payout ratio. As a result, you know that the firm's _______.

earnings retention ratio will increase

In the Money

exercise of the option would be profitable -Call: market price>exercise price -Put: exercise price>market price

Out of the Money

exercise of the option would not be profitable Call: market price<exercise price Put: exercise price<market price

An underpriced stock provides an expected return that is ____________ the required return based on the capital asset pricing model (CAPM).

greater than

The value of Internet companies is based primarily on _____.

growth opportunities

The constant-growth dividend discount model (DDM) can be used only when the ___________.

growth rate is less than the required return

All else equal, call option values are _____ if the _____ is lower.

higher; exercise price

According to the Black-Scholes option-pricing model, two options on the same stock but with different exercise prices should always have the same _________________.

implied volatility

A put option on Dr. Pepper Snapple Group, Inc., has an exercise price of $45. The current stock price is $41. The put option is _________.

in the money

At contract maturity the value of a call option is ___________, where X equals the option's strike price and ST is the stock price at contract expiration.

max (0, ST - X)

The price-to-sales ratio is probably most useful for firms in which phase of the industry life cycle?

start-up phase

The delta of an option is __________.

the change in the dollar value of an option for a dollar change in the price of the underlying asset

Call Option

the right to buy a stock at a specified time in the future (Expiration date) at a specified price (Exercise Price)

Put Option

the right to sell a stock at a specified time in the future (Expiration date) at a specified price (Exercise Price)