WMgmt Final

Which of the following are logical reasons to buy a put? (1) To profit when stock prices decrease (2) To utilize leverage (3) To benefit from the income payable periodically (4) To hedge against an additional portfolio A. 1 and 3 only B. 1 and 4 only C. 1, 2, 4 only D. 2, 3, 4 only

1, 2, and 4 are reasons to buy a put. 3 is a reason to write a put

Jim began purchasing shares of the ERT stock mutual fund several years ago. He has followed a dollar cost averaging approach by investing $700 each year for 4 years. The following data depict Jim's purchases: Year Fund Price 1 $10.25 2 $20.15 3 $15.60 4 $17.35 Whats is Jim's average cost/share for this fund. A. $14.87 B. $15.23 C. $35.17 D. $44.20

A. $ investment / fund price = # of shares $2800/188.25 = 14.87

Bond A has a 6% annual coupon and is due in 2 years. its value in today's market is $900 Bond B has a 10% annual coupon and is due in 4 years. Its price to yield 12% Bond C is a 9% zero-coupon bond priced to yield 11% in 8 years Assuming that the duration of Bond A is 1.94 years, which of the following statements about the effect of a 1% decline in interest rates is true? A. Bond C, having a longer duration than Bond A, would have a larger percent increase in price than Bond A B. The percent change in price of a bond is independent of the duration of a bond C. It is not possible to determine the percent change in price of Bond A versus Bond C because the duration of Bond C is not given D. Bond A would have a greater percent change in price than Bond C because is has a shorter duration E. The percent change in the price of Bonds A and C is equal since it is not affected by duration

A. Bonds with longer durations are more volatile than bonds with shorter durations. Duration, then, does have a relationship to volatility, so B,D, and E are incorrect. C comes close to being correct, though it is possible to at least compute the percentage change in the price of Bond B.

A call option with a strike price of 110 is selling for 3.50 when the market price of the underlying stock is 108. The intrinsic value of the call is: A. 0.00 B. 1.50 C. 2.00 D. 3.50 E -2.00

A. A call option does not have any intrinsic value until it is "in the money", meaning that the price at which the call may be exercised, or the strike price of 110 in the present case, is lower than the market price of the underlying stock. In this case, the market price is 108, or less than the strike price, so the intrinsic value of the call is 0. This is a good question because it is commonly misunderstood. Intrinsic value reflects the amount, if any, by which an option is "in the money". It cannot be less than 0. "In the money" = market price - exercise price.

Campbell has a put option with a strike price of $30. The stock subject to the option is currently selling for $27. In this situation: A. The option has an intrinsic value of $3 because it is "in the money" B. The option has an intrinsic value of zero because it is "out of the money" C. The option has an intrinsic value of $3 because it is "on the money" D. The option has an intrinsic value of zero because it is "on the money" E. The option has an intrinsic value of zero because it is "in the money"

A. A put option with a stock price that exceeds the stock's market price has an intrinsic value equal to the difference. For that reason, it is said to be "in the money"

Kelly has a call option with a strike price of $30. The stock subject to the option is currently selling for $27. In this situation: A. The option has an intrinsic value of $3 because it is "in the money" B. The option has an intrinsic value of zero because it is "out of the money" C. The option has an intrinsic value of $3 because it is "on the money" D. The option has an intrinsic value of zero because it is "on the money" E. The option has an intrinsic value of zero because it is "in the money"

B. A call option has an intrinsic value only if the market price of the stock exceeds the price at which the option may be exercised. If the stock's market price is less than the exercise price in the all option, the option is said to be "out of the money"

Which of the following statements concerning the writing of a covered call options are correct? (1) Any loss on the long position in the stock will be reduced by the dollars received for the sale of the call (2) If the market price of the stock increases to 1/2 of a point above the strike price, the writer would have been better off not selling the call (3) The writer reduces his/her downside risk but gives up possible upside opportunity (4) The premium received is considered a return of capital A. 1 and 2 only B. 1 and 3 only C. 2 and 4 ony D. 3 and 4 only

B. An investor writes a call to increase income and protect the stock owned against a decrease in price in the ST. The writer gives up upside opportunity because if the call is exercised, the investor must give of the stock. (2) is incorrect b/c the writer would have been better off not writing the call only when the stock price moves up significantly. (4) is incorrect because the premium is considered income, not a return on capital.

Jasmine has a large paper profit in her Amalgamated Corporation shares, currently at 46. She is happy with the stock but realizes that a good thing cannot go on forever. If she is willing to sell at 50, what strategy could you recommend to her? A. Buy $50 call options B. Sell $50 call options C. Buy $50 put options D. Sell $50 put options

B. If she is willing to sell at 50, she should write (sell) a call option giving the buyer of the option the right to buy the stock from at that price.

A client has a cash need at the end of seven years. Which of the following investments might initially immunize the portfolio? (1) A 9-year maturity coupon bond (2) A 7-year maturity coupon Treasury-note (3) A series of Treasury Bills A. 1,2, and 3 only B. 1 only C. 2 and 3 only D. 2 only E. 1 and 2 only

B. Immunization of a portfolio involves matching the portfolio's duration with the duration of the investor's cash needs. A 7-year maturity coupon treasury note would have a duration of less than seven years. Similarly, a series of Treasury bills would have a very short duration. A 9-year maturity coupon bond, on the other hand, will have a duration of less than nine years, perhaps something in the neighborhood of seven years.

Which of the following correctly indicates a difference between puts and short sales? A. Puts are profitable when stock prices decrease; short sales are profitable when stock prices increase B. Puts provide a greater amount of leverage than short sales C. Short sales have a shorter time frame than puts D. Puts provide more potential for capital loss than short sales

B. Puts and short sales are profitable when stock prices decline. Put options have an expiration; short sales do not have an expiration date. The most investor will lose on a put investment is the cost of an option. The loss potential is unlimited in a short sale.

Which of the following statements concerning a bond's duration is not correct? A. If a bond has high coupon, its duration will be lower that a similar one with a low coupon B. If a bond has a long maturity, its duration will be lower than a similar one with a short maturity C. The duration of a zero-coupon bond is equal to its years to maturity D. For most bonds, duration is less than their years to maturity E. A bond with a low duration has a lower susceptibility to interest rate risk than a similar bond with a high duration

B. The duration of a short-maturity bond is less than that of a similar bond with a long maturity

The following set of newly issued debt instruments was purchased for a portfolio: Treasury Bond Zero Coupon Bond Corporate Bond Municipal bond The respective maturities of these investments are approximately equivalent. Which one of the investments in the preceding set would be subject to the greatest amount of price volatility if interest rates were to change quickly? A. Treasury Bond B. Zero Coupon Bond C. Corporate Bond D. Municipal bond

B. The zero-coupon bond has the longest duration (equal to its maturity), so it would have the greatest price volatility

Janet wants to write an uncovered, or naked, call. She will succeed in making income from this strategy if: A. She offsets with a covered put B. The price of the stock falls or remains unchanged C. She increase her initial margin to lessens any sharp drop in stock price D. The stock price increases beyond the cost of the premium to the buyer E. She writes another call for a stock whose price she anticipates will rise sharpely

B. This is a risky strategy, but one that will pay off, provided B occurs.

Which of the following statements concerning duration is correct? A. If interest rates increase, duration for an investor's bond portfolio will increase B. If interest rates are expected to rise, an investor should shorten duration of bond portfolio C. A zero-coupon bond will not match duration and maturity in future years D. If the coupon for a bond to be purchased is increased, the duration will increase

B. If the interest rates are expected to rise, an investor should shorten the duration of a bond portfolio. If interest rates increase, the duration for an investors bond portfolio will decrease. They are inversely related. Similarly, if the coupon for a bond to be purchased is decreased, the duration will increase. The maturity date of a zero-coupon bond will always match its duration

With the same dollar investment, which if the following strategies can cause the investor to experience the greatest loss? A. Selling a naked put option B. Selling a naked call option C. Writing a covered call D. Buying a call option E. Buying the underlying security

B. We can eliminate E as an answer quickly since the maximum possible loss is the full amount invested. Of the four options listed, naked options involve the potential for the greatest loss since the seller of a naked option does not have the underlying stock and if the option is exercised, would have to obtain stock at its market price or sell the stock at its market price in order to fulfill his or her responsibility. Selling a naked put option involves a lower loss potential than selling a naked call option. If a naked put option is sold, the max that the seller of the option can lose is the full value of the stock since the market price of the stock cannot go below 0. On the other hand, selling a naked call option presents an unlimited potential for loss since the price of the stock may rise dramatically, perhaps doubling, or more in value before the option expires.

Which of the following statements concerning the writing of a call option is (are) correct? (1) The writer expects the price of the stock subject to the option to go down (2) The primary advantage of writing a call option is the revenue produced by selling the option (3) Writing a naked call option presents a smaller loss potential than writing a covered call option A. 2 only B. 3 only C. 1 and 2 only D. 2 and 3 only E. 1, 2, and 3

C. (3) is incorrect. If the stock goes up in price, the writer pf a call option loses. But if the writer does not own the stock, as in a naked call option, the price of the stock could rise dramatically, and the writer would have to buy it in order to deliver the stock to that person exercising the option

Morgan is the owner of a well diversified portfolio of common stocks, but Morgan is concerned that the market may decline soon. He has been advised to buy a put on a market index such as the S&P 500. In this situation which of the following statements is correct? A. Morgan has been given bad advice because if the market declines, the value of his option will decline B. Morgan has been given bad advice because if the market declines, the value of his option will be zero C. Morgan has been given good advice because if the market declines, the value of his option will rise D. Morgan has been given good advice because if the market rises, the value of his option will rise

C. A market index put option gives the holder the right to sell at specified price. Therefore, if the market declines, the value of the option rises.

A client with a well diversified common stock portfolio expresses concern about a possible market decline. However he/she does not want to incur the cost of selling a portion of his/her holdings no the risk of mistiming the market. A possible strategy for this client would be: A. Buy an index call option B. Sell an index call option C. Buy an index put option D. Sell an index put option E. The client cannot protect against the decline with these options

C. A put option gives the holder the right to sell specified securities at a specified price within a specified time period. Therefore, as the price of the specified security declines, the value of a put option rises. Since the client in this question is concerned with a market decline, he or she would want a put option, rather than a call option. The appropriate type of option would be an index put option to hedge against a broad decline in the market. Therefore, A and B are incorrect. E is also incorrect because the put option provides protection against a market decline. Thus, the choices are between C and D. Since the client wants to have the right to sell, not to obtain some revenue now, she/he would need to buy a put option, not sell (write) one.

Which of the following are logical reasons for buying a call? (1) To profit when stock prices increase (2) To utilize leverage (3) To generate income in a flat market (4) To hedge against an existing short stock position A. 1 and 2 only B. 1 and 3 only C. 1, 2, and 4 only D. 2, 3, and 4 only

C. A long call will allow you to buy the stock at the lower strike price as the stock price increases. Long naked option positions always seek to utilize leverage. A long call can be used to hedge an existing short stock position since the risk with a stock short position is that the price will increase. If this occurs, the long call can be exercised, locking in a maximum purchase price for the shares. (3) is the reason to write a call.

A client asks a certified financial planner to invest $10M in two different fixed-income instruments with durations of 5.5 years and 7.4 years, respectively. The client will need all the cash from this investment in six years. In order to properly immunize this portfolio, the planner must A. Anticipate the interest rate environment at the time of the portfolios maturity B. Factor in the reinvestment income from coupon payments C. Calculate the weighted average of both bonds' duration to match the client's time horizion D. Purchase additional bonds with coupons equal to or slightly greater than six years E. Calculate the standard deviation of each bond

C. When determining duration, one must calculate a weighted time period. Matching it to the time horizon is the basis of the immunization strategy. A deals with the attempt to forecast interest rates. B & D have nothing to do with immunizing a portfolio, bu they are part of the management process. E is not responsive, as standard deviation only reveals the dispersion of each bond's returns around its average

Which of the following investments will negate the need to calculate duration? A. A 15-year bond whose call date is only four years away B. A custodial account with a mixture of equities and bond funds C. A bond fund that minimizes portfolio turnover and is tax-efficient D. A zero coupon bond that matures in eight years E. A series of bonds with no call date provisions

D. A zero coupon bond has no coupon payments during its life. All payments are made at maturity. As a result, duration = the number of years until maturity. A,B,C and E will have duration shorter than years until maturity

George Demos bought 100 shares of General Motors stock at $30 on Feb 15. On Dec 1st, the stock had risen to $38, so George wrote a 9-month call option, with an exercise price of $40, call premium of $3. The call was exercised just before it was expired. What gain will George report for income taxes?(ignore commissions) A. $1000 LT gain B. $1300 ST gain C. $300 ST gain and $1000 LT gain D. $1300 LT gain E. $300 ST gain

D. George held the stock for more than 12 months, so the gain is LT. The gain is the sale price of $40/share + the premium of $3/share, less the purchase price of $30/share. Total is $4000 + $300 - $3000 = $1300

Dan Hope has come to you asking about stock options in general. He is confused about what he has heard about puts and calls. Which of the following statements about puts and calls is not correct? A. Both call and put option writers receive premiums B. A put writer has a positive view of future market movements C. An investor who believes market prices will be stable is likely to write calls D. The seller of a call or put option forfeits the premium once the exercise price has been attained E. The buyer of a call option anticipates a stock price increase

D. The premium for the writer of either option is never forfeited and is always kept. A,B,C and E are all correct. With regard to C, many investors write calls because they believe they can earn extra income in a nonvolatile market environment

Which of the following are logical reasons to write a covered call? (1) To profit when stock prices increase (2) To utilize leverage (3) To provide additional income in a flat market (4) To provide additional gain while disposing of a long stock position A. 1 only B. 1 and 3 only C. 1, 2, and 4 only D. 3 and 4 only

D. Writing options are always income generating positions. 1 and 2 are reasons to buy a call. 4 allows the client to hold the stock for limited future gain while collecting the premium.

Which of the following correctly describes a protective put? A. A combination of a put and call on the same stock with different expiration dates and exercise prices B. A combination of a put and a call on the same stock with the same expiration dates and exercise prices C. Sale of a stock short and sale of a put D. Purchase of a stock and a put

D. A protective put involves buying a put and buying the underlying stock. Purchase of the put is a comparable to a short position in the stock, and the purchase of the stock is a long position, so the investor will in effect have offsetting positions. The offsetting positions provide protection against a declining market.

To immunize a bond portfolio over a specific investment horizon, an investor would do which of the following? A. Match the maturity of each bond to the investment horizon B. Match the duration of each bond to the investment horizon C. Match the average-weighted maturity of each bond to the investment horizon D. Match the average-weighted duration of the bond portfolio to the investment horizon

D. By definition of immunization of a portfolio.

Sarah Dunham has invested $30,000 in a bond that has a coupon of 8% and yield to maturity of 7%. The bond's duration is 12.8 years. What price change can Sarah expect from an increase of 1% in interest rates? A. +11.96% B. +11.85% C. -11.85% D. -11.96%

D. The modified duration formula will give us the change in the bond price: -(12.8) x ((0.01)/(1 + 0.07)) = -11.96%

Stanley writes a put for $8 with a strike price of $30. The stock has a current market price of $28. In the situation, which of the following statements is (are) correct? (1) Stanley's expectation is that the market price of the stock is going to plummet (2) Stanley will break even if the market price of the stock settles at $22 (3) Stanley maximum profit will occur if the market price of the stock reaches $30 or more. A. 1 only B. 2 only C. 3 only D. 1 and 2 only E. 2 and 3 only

E. (1) is incorrect because the writer of a put option expects that market price will not fall or will fall very little. (2) is correct because if stanley has to buy the staock at $30 when it is worth only $22, his $8 gain from the sale of the put is wiped out. (3) correct because at a market price of $30 or higher for the stock no portion of Stanley's $8 is sacrificed

The duration of a bond is a function of its: (1) current price (2) Time to maturity (3) Yield to maturity (4) Coupon Rate A. 1 and 3 only B. 2 and 3 only C. 2 and 4 only D. 1, 2, and 3 only E. 1,2,3,4

E. A bond's duration is affected by all four of the listed variables

XYZ stock is selling for $53/share, and a call option with 3 month expiration may be bought for $3/share, with a strike price $55. This option may be said to be: A. At the money B. In the money C. Without a time premium D. Valued at fair market E. Out of the money

E. When the strike price is greater than the current stock price, the call option is out of the money