Chapter 5 Ray

Which of the following is true? A. Volatility smile for European puts is the same as for European calls. B. Volatility smile for European puts is the same as for American puts. C. Volatility smile for European calls is the same as for American calls. D. Volatility smile for American puts is the same as for American calls.

A. Volatility smile for European puts is the same as for European calls.

A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option on the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options and one put option. The breakeven stock price above which the trader makes a profit is: A. $35 B. $40 C. $30 D. $36

A. $35

A company knows it will have to pay a certain amount of a foreign currency to one of its suppliers in the future. Which of the following is true? A. A forward contract can be used to lock in the exchange rate. B. A forward contract will always give a better outcome than an option. C. An option will always give a better outcome than a forward contract. D. An option can be used to lock in the exchange rate.

A. A forward contract can be used to lock in the exchange rate.

Which of the following options allows a corporation to manage the downside risk of a project? A. Abandonment option. B. Expansion option. C. Extension option. D. None of the above.

A. Abandonment option.

The price of a stock on February 1 is $84. A trader buys 200 put options on the stock with a strike price of $90 when the option price is $10. The options are exercised when the stock price is $85. The trader's net profit or loss is: A. Loss of $1,000 B. Loss of $2,000 C. Gain of $200 D. Gain of $1,000

A. Loss of $1,000

Which of the following best describes the term "spot price"? A. The price for immediate delivery. B. The price for delivery at a future time. C. The price of an asset that has been damaged. D. The price of renting an asset.

A. The price for immediate delivery.

Why do traders use volatility smiles for pricing options? A. To allow for non-lognormality of the probability distribution of future asset price. B. Because it is consistent with recent market moves. C. As a tool to reflect their views about extreme market moves. D. Because extreme market moves are always more likely than Black-Scholes-Merton assumes.

A. To allow for non-lognormality of the probability distribution of future asset price.

Which of the following is NOT true? A. When a CBOE call option on IBM is exercised, IBM issues more stock. B. An American option can be exercised at any time during its life. C. A call option will always be exercised at maturity if the underlying asset price is greater than the strike price. D. A put option will always be exercised at maturity if the strike price is greater than the underlying asset price.

A. When a CBOE call option on IBM is exercised, IBM issues more stock.

Which of the following best describes a central clearing party (CCP)? A. It is a trader that works for an exchange. B. It stands between two parties in the over-the-counter market. C. It is a trader that works for a bank. D. It helps facilitate futures trades.

B. It stands between two parties in the over-the-counter market.

A one-year forward contract is an agreement where: A. One side has the right to buy an asset for a certain price in one year's time. B. One side has the obligation to buy an asset for a certain price in one year's time. C. One side has the obligation to buy an asset for a certain price at some time during the next year. D. One side has the obligation to buy an asset for the market price in one year's time.

B. One side has the obligation to buy an asset for a certain price in one year's time.

A trader has a portfolio worth $5 million that mirrors the performance of a stock index. The stock index is currently 1,250. Futures contracts trade on the index with one contract being on 250 times the index. To remove market risk from the portfolio the trader should: A. Buy 16 contracts B. Sell 16 contracts C. Buy 20 contracts D. Sell 20 contracts

B. Sell 16 contracts

Which of the following is true about a long forward contract? A. The contract becomes more valuable as the price of the asset declines. B. The contract becomes more valuable as the price of the asset rises. C. The contract is worth zero if the price of the asset declines after the contract has been entered into. D. The contract is worth zero if the price of the asset rises after the contract has been entered into.

B. The contract becomes more valuable as the price of the asset rises.

An investor sells a futures contract an asset when the futures price is $1,500. Each contract is on 100 units of the asset. The contract is closed out when the futures price is $1,540. Which of the following is true? A. The investor has made a gain of $4,000. B. The investor has made a loss of $4,000. C. The investor has made a gain of $2,000. D. The investor has made a loss of $2,000.

B. The investor has made a loss of $4,000.

When using the straight NPV approach (ignoring optionality), A. a straight negative NPV project will always be rejected. B. a straight negative NPV project may be accepted based on real options. C. a straight positive NPV project should not be accepted. D. a straight positive NPV can turn negative when real options are included.

B. a straight negative NPV project may be accepted based on real options.

The valuation of real assets and options on real assets is based on the A. risk-averse valuation principle. B. risk-neutral valuation principle. C. risk-tolerant valuation principle. D. loss minimization principle.

B. risk-neutral valuation principle.

The price of a stock on July 1 is $57. A trader buys 100 call options on the stock with a strike price of $60 when the option price is $2. The options are exercised when the stock price is $65. The trader's net profit is: A. $700 B. $500 C. $300 D. $600

C. $300

A short forward contract on an asset plus a long position in a European call option on the asset with a strike price equal to the forward price is equivalent to: A. A short position in a call option. B. A short position in a put option. C. A long position in a put option. D. None of the above.

C. A long position in a put option.

hich of the following describes European options? A. Sold in Europe B. Priced in Euros C. Exercisable only at maturity D. Calls (there are no European puts)

C. Exercisable only at maturity

In order to exploit a business opportunity, which of the following options are useful? A. Contraction option. B. Abandonment option. C. Extension option. D. Deferment option.

C. Extension option.

The price of a stock on February 1 is $48. A trader sells 200 put options on the stock with a strike price of $40 when the option price is $2. The options are exercised when the stock price is $39. The trader's net profit or loss is: A. Loss of $800 B. Loss of $200 C. Gain of $200 D. Loss of $900

C. Gain of $200

Which of the following is true of a volatility smile? A. Implied volatility is on the horizontal axis and strike price is on the vertical axis. B. Historical volatility is on the horizontal axis and strike price is on the vertical axis. C. Implied volatility is on the vertical axis and strike price is on the horizontal axis. D. Historical volatility is on the vertical axis and strike price is on the horizontal axis.

C. Implied volatility is on the vertical axis and strike price is on the horizontal axis.

What does the shape of the volatility smile reveal about put options on equity? A. Options close-to-the-money have the lowest implied volatility. B. Options deep-in-the-money have a relatively high implied volatility. C. Options deep-out-of-the-money have a relatively high implied volatility. D. All of the above.

C. Options deep-out-of-the-money have a relatively high implied volatility.

Which of the following could cause the volatility smile typically seen for foreign currency options? A. Currencies are traded in different countries at different times of the day. B. Currencies tend to have low volatilities. C. The activities of central banks causes occasional jumps in the exchange rate. D. Interest rates may be different in the two countries.

C. The activities of central banks causes occasional jumps in the exchange rate.

Which of the following is NOT true? A. A call option gives the holder the right to buy an asset by a certain date for a certain price. B. A put option gives the holder the right to sell an asset by a certain date for a certain price. C. The holder of a call or put option must exercise the right to sell or buy an asset. D. The holder of a forward contract is obligated to buy or sell an asset.

C. The holder of a call or put option must exercise the right to sell or buy an asset.

Which of the following is true when the tails of a future stock price distribution are compared with those of a lognormal distribution with the same mean and standard deviation? A. The left tail and right tail are thinner. B. The left tail is thinner and the right tail is fatter. C. The right tail is thinner and the left tail is fatter. D. Both tails are fatter.

C. The right tail is thinner and the left tail is fatter.

Under the real options project evaluation approach, the A. value of the asset is the present value of its expected cash flows discounted at the CAPM risk-adjusted rate. B. value of the asset does not require a discount rate. C. value of the asset is the present value of its expected cash flows discounted at the risk-free rate. D. all of the above.

C. value of the asset is the present value of its expected cash flows discounted at the risk-free rate.

A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option on the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options and one put option. The breakeven stock price below which the trader makes a profit is: A. $25 B. $28 C. $26 D. $20

D. $20

A speculator can choose between buying 100 shares of a stock for $40 per share and buying 1000 European call options on the stock with a strike price of $45 for $4 per option. For second alternative to give a better outcome at the option maturity, the stock price must be above: A. $45 B. $46 C. $55 D. $50

D. $50

What does the shape of the volatility smile reveal about call options on a currency? A. Options close-to-the-money have the lowest implied volatility. B. Options deep-in-the-money have a relatively high implied volatility. C. Options deep-out-of-the-money have a relatively high implied volatility. D. All of the above.

D. All of the above.

Which of the following is true when the tails of a future foreign currency distribution are compared with those of a lognormal distribution with the same mean and standard deviation? A. The left tail and right tail are thinner. B. The left tail is thinner and the right tail is fatter. C. The right tail is thinner and the left tail is fatter. D. Both tails are fatter.

D. Both tails are fatter.

A business is trying to reduce its risk exposure when evaluating a project. Which of the following options would not be relevant to the analysis? A. Contraction option. B. Deferment option. C. Abandonment option. D. Extension option.

D. Extension option.

The price of a stock on February 1 is $124. A trader sells 200 put options on the stock with a strike price of $120 when the option price is $5. The options are exercised when the stock price is $110. The trader's net profit or loss is: A. Gain of $1,000 B. Loss of $2,000 C. Loss of $2,800 D. Loss of $1,000

D. Loss of $1,000

When analyzing real options, which of the following statements is FALSE? A. The Black-Scholes-Merton (BSM) model can be used for real options. B. The binomial or multinomial model (tree) can be used for real options. C. Both models, BSM and tree can be combined with time value of money. D. None of the above.

D. None of the above.

Which of the following is approximately true when size is measured in terms of the underlying principal amounts or value of the underlying assets? A. The exchange-traded market is twice as big as the over-the-counter market. B. The over-the-counter market is twice as big as the exchange-traded market. C. The exchange-traded market is about ten times as big as the over-the-counter market. D. The over-the-counter market is about ten times as big as the exchange-traded market.

D. The over-the-counter market is about ten times as big as the exchange-traded market.

Which of the following is NOT true about call and put options? A. An American option can be exercised at any time during its life. B. A European option can only be exercised only on the maturity date. C. Investors must pay an upfront price (the option premium) for an option contract. D. The price of a call option increases as the strike price increases.

D. The price of a call option increases as the strike price increases.

When evaluating a project, the best approach always is A. the NPV approach. B. the IRR approach. C. the payback period approach. D. the option model approach.

D. the option model approach.