FIN 510 Chpt 20

Match the term with its description for the case of a call option. 1. In the money 2. At the money 3. Out of the money Asset price < Exercise price Asset price = Exercise price Asset price > Exercise price

1. In the money: Asset price > Exercise price 2. At the money: Asset price = Exercise price 3. Out of the money: Asset price < Exercise price

Matching Question Match the correct investment strategies against the corresponding investments. 1. Purchasing call options 2. Writing call options a. Bearish strategy b. Bullish strategy

1. Purchasing call options <-> Bullish strategy 2. Writing call options <-> Bearish strategy

An option whose exercise would produce a positive payoff is said to be _____________ ____________ ____________.

In The Money

Many loan arrangements require that the borrower put up _______________ to guarantee the loan will be paid back.

collateral

The combination of buying both a call and a put on the same asset, each with the same exercise price and expiration date is a(n) ________________.

straddle

An investor expects the equity markets to experience a dramatic fall in prices during the next six months. Which of the following positions would result in the more significant losses? Writing naked calls Writing naked puts

Writing naked puts notes: Reason: Call options become more valuable when stock prices rise, so call option writers would get to keep the option premiums after a market downturn. This would result in large gains. Reason: Put options become more valuable when stock prices fall, so put option writers who do not own the stock (naked) will experience large losses in the event of a market downturn.

What is the payoff of a protective put portfolio? ST if ST ≤ X and (ST - X) if ST > X X if ST ≤ X and ST if ST > X (X - ST) if ST ≤ X and ST if ST > X ST if ST ≤ X and X if ST > X

X if ST ≤ X and ST if ST > X

An investor who regularly writes naked, deep-out-of-the-money puts on an index would be expected to earn ______ gains and ______ losses. occasional small; a series of large a series of large; occasional small a series of small; occasional large occasional large; a series of small

a series of small; occasional large notes: (the premium for a deep-out-of-the-money option is small and the losses writing naked calls vary but are often large)

The ______ of a call at expiration equals its ______ less its ______. premium; profit; payoff payoff; premium; profit profit; payoff; premium

profit; payoff; premium

The right to sell an asset at a specified exercise price on or before a specified expiration date is provided by a(n) ____________ option.

put

The equation representing the equilibrium relationship between put and call prices is given by the ___________-____________ _____________ ___________ .

put call parity theorem

A convertible bond has a higher price than a straight bond because ______. the bondholder writes the option the bondholder owns the option

the bondholder owns the option notes: 1. Reason: The issuer writes the option and receives a higher price. 2. Reason: Convertible bonds have higher prices because their prices reflect the price of a straight bond plus the cost of the convertible option.

Select all that apply For a call option on a given security with a given expiration date, the value of the call is ______ when the exercise price is ______. higher; lower higher; higher lower; lower lower; higher

higher; lower lower; higher

Taylor Winn buys a put option for $3 and a call option for $5, both written on the same stock and both with an exercise price of $50. If the stock price at expiration is $60, what is Taylor's profit?

$2 : max(st-x,0)+max(x-st,0)-C-P= 60-50+0-3-5=2 notes: 1. Reason: This is the payoff, not the profit, as it does not include the cost of the options. 2. Reason: The two options have a total cost of $8. The put expires out of the money, but the call is worth $10. The difference is $2. 3. Reason: This is the total cost of the two options.

An option that can be exercised before and up to its expiration date is called a(n) ____________ option.

American

_____________-____________ options are options with payoffs that depend on the average price of the underlying asset during at least some portion of the life of the option.

Asian style

________________ options have payoffs that depend not only on some asset price at option expiration, but also on whether the underlying asset price has crossed through some "barrier."

Barrier

___________-___________ options may be of interest to firms that wish to hedge a profit stream that depends on the average price of a commodity over some period of time.

Blank 1: Asian Blank 2: style

LEAPS stands for ____________ - ______________ ______________ __________ securities.

Blank 1: long Blank 2: term Blank 3: equity Blank 4: anticipation note: A is Antici P is Pation -_-

A _________ _________ involves the purchase of one option and the simultaneous sale of another with a different exercise price.

Blank 1: money Blank 2: spread

Select all that apply Which portfolios provide a payoff with a guaranteed minimum value and unlimited upside potential? Covered call Call and T-bills Put and T-bills Protective put

Call and T-bills Protective put

____________ options have fixed payoffs that depend on whether a condition is satisfied by the price of the underlying asset.

Digital

An option that can be exercised only on its expiration date is called a(n) ______________ option.

European

Select all that apply Which are derivative securities? Equity Futures Swaps Options Bonds

Futures Swaps Options

Suppose an investor purchased a put option with exercise price X for premium P on an asset that ends up with a terminal value of ST. The investor will at least break even at expiration if ______. (Note: assume that the time value of money is zero.) ST < X + P ST < X - P ST > X + P ST > X - P

ST < X - P

What is the payoff of a covered call portfolio? X if ST ≤ X and ST if ST > X ST if ST ≤ X and X if ST > X (X - ST) if ST ≤ X and ST if ST > X ST if ST ≤ X and (ST - X) if ST > X

ST if ST ≤ X and X if ST > X

A combination of two or more call options (or two or more puts) on the same stock with differing exercise prices or times to maturity is a(n) _______________.

Spread

Select all that apply Consider the three strategies depicted: all stocks (A), all options (B), and calls and T-bills (C). Which statements are true about them based on the figure? (Click to enlarge.) The T-bills-plus-option portfolio (C) offers the highest potential return. The T-bills-plus-option portfolio (C) has the least downside risk. The all-option portfolio (B) has the least downside risk. The all-option portfolio (B) has the greatest sensitivity to increases in the value of the underlying security.

The T-bills-plus-option portfolio (C) has the least downside risk. The all-option portfolio (B) has the greatest sensitivity to increases in the value of the underlying security. notes: 1. Reason: The T-bills that limit downside risk also limit upside potential. 3. Reason: It has a return of -100% if the stock price is less than the exercise price. 4. Reason: The slope of its value is steepest.

Select all that apply Which statements are true of options traded on exchanges? A contract provides for the right to buy or sell 10 shares of stock. They are tailored to meet the specific needs of the buyer. Their uniformity increases market depth, lowers trading costs, and increases liquidity. They are standardized by allowable expiration dates and exercise prices.

Their uniformity increases market depth, lowers trading costs, and increases liquidity. They are standardized by allowable expiration dates and exercise prices. Notes: 1. Reason: They are generally for 100 shares of stock. 2. Reason: This is true of options traded OTC.

Select all that apply If an investor believes that a share of stock is overvalued, the investor might ______. buy a put sell a call buy a call sell a put

buy a put sell a call

Matching Question Match the exotic option with its description. 1. Asian options 2. Barrier options 3. Lookback options 4. Digital options A. Payoffs depend on the average price of the underlying asset B. Payoffs depend in part on the minimum or maximum price of the underlying asset during the life of the option C. Payoffs depend not only on the underlying asset price at expiration but also on whether the asset crossed specified prices pre-expiration D. Have fixed payoffs that depend on whether a condition is satisfied by the price of the underlying asset

1. A 2. C 3. B 4. D Asian options matches Choice, Payoffs depend on the average price of the underlying asset Payoffs depend on the average price of the underlying asset Barrier options matches Choice, Payoffs depend not only on the underlying asset price at expiration but also on whether the asset crossed specified prices pre-expiration Payoffs depend not only on the underlying asset price at expiration but also on whether the asset crossed specified prices pre-expiration Lookback options matches Choice, Payoffs depend in part on the minimum or maximum price of the underlying asset during the life of the option Payoffs depend in part on the minimum or maximum price of the underlying asset during the life of the option Digital options matches Choice, Have fixed payoffs that depend on whether a condition is satisfied by the price of the underlying asset Have fixed payoffs that depend on whether a condition is satisfied by the price of the underlying asset

_____________ options have payoffs that depend in part on the minimum or maximum price of the underlying asset during the life of the option.

Lookback

What is the formula for the value of a call at expiration? Max[X - ST, 0] Max[ST - X, 0] Min[ST - X, 0] Min[X - ST, 0]

Max[ST - X, 0]

When an option holder exercises an option, the ______________ arranges for a member firm with clients who have written that option to make good on the option obligation. Listen to the complete question

OCC

The put-call parity relationship holds for which types of options? Neither American nor European Only European Both European and American Only American

Only European

The clearinghouse for options trading, known as the ___________ ___________ __________ , is jointly owned by the exchanges on which stock options are traded.

Options Clearing Corporation

A financial institution has written an option on a broad equity index that expires today and will be in the money. Which of the following is the most likely outcome at expiration? The financial institution will settle the amount owed to the option buyer in cash. The option buyer will receive all securities in the index upon expiration. The option will be allowed to expire worthless.

The financial institution will settle the amount owed to the option buyer in cash. notes: 1. Reason: Index options are settled in cash because it is much easier than delivering all securities in the index. 2. Reason: Index options are almost never settled with actual delivery because it would be too difficult to execute. 3. Reason: In-the-money options should be exercised.

Select all that apply Which statements are correct based on the figure? (Click to enlarge.) The stock portfolio outperforms the protective put portfolio when the stock price is high. The profit is the same for both strategies when the stock price equals the exercise price. The loss with a protective put portfolio is limited. The stock portfolio outperforms the protective put portfolio when the stock price is low.

The stock portfolio outperforms the protective put portfolio when the stock price is high. The loss with a protective put portfolio is limited. notes: 2. Reason: The payoff to the strategies is the same, but the profit of the protective put strategy is lower by the amount of the put premium.

Securities providing payoffs that depend on or are contingent on the values of other assets such as commodity prices, bond and stock prices, or market-index values are referred to as ______________ securities.

derivative

Securities providing payoffs that depend on or are contingent on the values of other assets such as commodity prices, bond and stock prices, or market-index values are referred to as ________________ securities.

derivative

Options that are tailor-made according to the specifications of the buyer in terms of exercise price, expiration date, and number of shares committed are traded ______. both over-the-counter and on exchanges on exchanges neither over-the-counter nor on exchanges over-the-counter

over-the-counter

Select all that apply What are the terms used for the price specified in an options contract at which the underlying asset can be bought or sold? Premium Exercise price Mark-to-market price Strike or striking price

Exercise price Strike or striking price

Match the term with its description for the case of a put option. 1. In the money 2. At the money 3. Out of the money Current price < Exercise price Current price = Exercise price Current price > Exercise price

In the money matches Current price < Exercise price At the money Current price = Exercise price Out of the money matches Current price > Exercise price

Longer-term options traded with expirations ranging up to several years are called ____________ .

LEAPS

Longer-term options traded with expirations ranging up to several years are called _________________.

LEAPS

Writing an option without an offsetting stock position is referred to as ____________ option writing.

naked

The potential gain for the buyer of a call option is ______, and the potential gain for the seller (or writer) of a call option is ______. unlimited; the call premium the call premium; the call premium unlimited; unlimited the call premium; unlimited

unlimited; the call premium

The sum of the profits for the buyer and writer of a given put equals ______. the exercise price the payoff the premium zero

zero

What is the formula for the value of a put at expiration? Max[X - ST, 0] Min[ST - X, 0] Max[ST - X, 0] Min[X - ST, 0]

Max[X - ST, 0]

Which of the following combinations of securities constitutes a protective put? Shorting the shares and buying a put option Owning the stock and buying a put option Shorting the shares and writing a put option Owning the stock and writing a put option

Owning the stock and buying a put option. notes: 1. Reason: The combination of these two positions is a double bet on falling stock prices and offers no protection. 2. Reason: Protection comes in the form of having the right to sell a share of stock that the investor already owns. 3. Reason: These positions fall when prices rise. 4. Reason: These positions benefit when prices rise.

Select all that apply Which statements are true of warrants? They are often issued in conjunction with another security. They are essentially put options issued by a firm. There is a cash flow to the firm when the warrant is exercised. Their exercise results in the creation of new shares.

They are often issued in conjunction with another security. There is a cash flow to the firm when the warrant is exercised. Their exercise results in the creation of new shares. notes: 2. Reason: They are like call options.

An option issued by the firm to purchase shares of the firm's stock is a(n) ___________.

Warrant

The owner of a convertible bond typically has the right but not the obligation to ______. sell the bonds at a premium purchase additional bonds if interest rates fall exchange the bonds for shares of stock

exchange the bonds for shares of stock notes: 1. Reason: Bondholders do not need the conversion option to sell at a premium, they can do so if interest rates fall enough. 2. Reason: The conversion option of a convertible bond allows its owner to exchange bonds for shares of stock. 3. Reason: Convertible bonds allow the owner to convert their bonds into shares of stock.

Suppose an investor paid $10 for a call option with an exercise price of $90. If the stock has a price of $95 at expiration, then it is ______ so the investor will ______ the option and have a ______ profit. out of-the-money; not exercise; negative in-the-money; exercise; negative out of-the-money; not exercise; positive in-the-money; exercise; positive

in-the-money; exercise; negative

In contrast to stock options, ______________ ______________ do not require that the call writer actually "deliver the index" upon exercise or that the put writer "Purchase the index."

index options

A bond that has a call provision is one in which the ______. issuer can change the coupon rate issuer can repurchase the bonds bondholders can buy the securities at a discount

issuer can repurchase the bonds

For a put option on a given security with a given expiration date, the value of the put is ______ when the exercise price is ______. higher; lower lower; higher lower; lower higher; higher

lower; lower higher; higher

In a ____________ loan, the lender may not sue the borrower for further payment if the collateral turns out not to be valuable enough to repay the loan

nonrecourse

In order for callable bonds to sell near par value at issuance, the borrower is most likely to ______. issue the bond with a longer maturity date offer a higher coupon rate issue a zero coupon bond

offer a higher coupon rate note: 1. Reason: longer maturity dates will add, rather than diminish the risk of the bond being called. 2. Reason: Callable bonds penalize bondholders when interest rates fall, so they demand higher coupon rates when the bonds are issued. 3. Reason: Zero coupon bonds have no need for call provisions.

An investor who regularly writes covered calls on an asset receives _______ and gives up _______. premiums; only small gains in the asset only small gains in the asset; premiums potentially large gains in the asset; premiums premiums; potentially large gains in the asset

premiums; potentially large gains in the asset notes: 1. Reason: Gains in the asset are potentially unlimited.

An option provides the ______, but not the ______, to buy or sell an underlying asset for a stated price over a stated time period. obligation; right right; obligation

right; obligation