Chapter 10 Smartbook

Assume a stock is trading at $100 per share. The binomial model assumes that the future price of the shares cannot be which of the following pairs? $120 and $100 $120 and $80

$120 and $100

Jon Fell owns an in the money call option with an exercise price of $45. The call currently sells for $3.75 and the stock sells for $47.50. Which of the following is the most likely call price if the stock prices rises by $2.00? $4.50 $1.75 $5.80

$5.80

Assume a stock is trading at $56 per share. The binomial model assumes that the future price of the shares is which of the following pairs? $60.20 and $58.90. $64.40 and $47.60

$64.40 and $47.60

Which of the following is closest: The market crash of October 19, 1987 saw the DJIA fall more than 10% 50% 100% 20%

20%

The Black-Scholes pricing formula prices a(n) _____ -style call option

European

Two call options exist on the same shares of stock and have identical terms with the exception of the exercise price. Option 1 has exercise price of $50 while Option 2 has an exercise price of $40. Which call option sells for the higher price? Option 1 Option 2

Option 2

Which of the following does NOT describe what happened during the market crash on October 19th, 1987? Put option deltas computed from historical experience were too high. The Dow Jones Industrial Average fell more than 20% Future prices traded at steep discounts to their proper levels compared to reported stock prices. Prices moved so fast that insurers could not keep up with the necessary re-balancing.

Put option deltas computed from historical experience were too high.

Jen Keys owns call options on Red Inc. If the central bank increases interest rates, it will have which of the following effect on Keys' position? The options will increase in value. The options will decrease in value.

The options will increase in value.

True or false: An option valuation model predicated on the assumption that stock prices can move to only two values over any short time period is called binomial model. True False

True

True or false: Put prices can be derived simply from the prices of calls. This is because prices of European put and call options are linked together in an equation known as the put-call parity relationship. True False

True

True or false: The difference between an option's price and its intrinsic value is called time value. True False

True

True or false: The hedge ratio is simply the slope of the value function evaluated at the current stock price. True False

True

True or false: The stock price minus exercise price, or the cash flow that could be attained by immediate exercise of an in-the-money call option is called the intrinsic value. True False

True

True or false: We can use the put-call parity relationship to value put options once we know the call option value. True False

True

A tool that enables us to summarize the overall exposure of portfolios of options with various exercise prices and times to expiration is the hedge ration. The hedge ratio is commonly called the option's _____ .

delta

Another term for dynamic heding is _____ hedging.

delta

The number of shares of stock required to hedge the price risk of holding one option is called the hedge ratio, or _____ .

delta

The constant updating of hedge positions as market conditions change is called _____ hedging.

dynamic

If actual volatility seems greater than the implied volatility, the option's fair price _____ it's observed price.

exceeds

Which of the following is NOT used in the Black-Scholes pricing formula calculation? risk-free interest rate standard deviation of the stock return stock price expected rate of return on the stock

expected rate of return on the stock

Because American option can be exercised at any time before the _____ date, it must be worth at least as much as the corresponding European option.

expiration

An investor purchases a ten-month call option on GRD Technology, a non-dividend paying stock. In two months, GRD announces that it will pay its first ever dividend of $1.00 per share in three weeks time. The announcement of the dividend will most likely cause the call price to: rise fall remain unchanged

fall

The standard deviation of stock returns that is consistent with an option's market value is known as _____ _____ .

implied volatility

Call option values _____ with the volatility of the underlying stock price.

increase

The call's value should _____ with the stock price and with _____ the exercise price.

increase decrease

Increased time to until expiration for a call option has an effect similar to increased volatility decreased volatility market efficiency higher dividend payouts

increased volatility

Portfolio strategies that limit investment losses while maintaining upside potential is called portfolio _____ .

insurance

Call option values are higher when interest rates remain constant interest rates rise interest rates fall

interest rates rise

The value of an option is based on the right to choose not to exercise if the stock price moves against the holder. Option holder cannot _____ more than the cost of the option regardless of stock price performance. (Select Lose or gain)

lose

The percentage increase in an option's value given at 1% increase in the value of the underlying security is called _____ _____ .

option or options elasticity

Jay Paul owns a call option on a share of stock with an exercise price of $225. The current stock price is $198, and five months remain until expiration. The value of Paul's option is ______. positive negative zero

positive

The firm's dividend policy affects option values -- high dividend payouts increase the growth of the stock price decrease the stock price increase the risk-free rate put a drag on the growth of the stock price.

put a drag on the growth of the stock price.

A _____ portfolio for a given asset or series of cash flows is a portfolio of assets with the same properties, especially the cash flows, as the originals.

replicating

Call options with longer times until expiration will ______. have higher exercise prices have less chance of finishing in the money sell for higher premiums

sell for higher premiums

Select all that apply The Black-Scholes formula assumes which of the following: stock prices are continuous stock prices are discrete a non-constant, continuous dividend interests rates are constant or predictable a constant, continuous dividend interest rates are unpredictable

stock prices are continuous interests rates are constant or predictable a constant, continuous dividend

If index puts are used to protect a nonindexed portfolio, _____ error can result.

tracking

Which of the following is NOT a factor that should affect the value of a call option? interest rate time to expiration stock price All four are factors exercise price

All four are factors

Most listed put option are African-style Exotic European-style American-style

American-style

Which of the following represents a replicating portfolio? Investing in both call options and the shares of stock. Writing call options and investing the proceeds in the risk-free asset. Borrowing the present value of the lower future stock price and owning the stock.

Borrowing the present value of the lower future stock price and owning the stock.

Recent stock market events have resulted in a significant increase in volatility. Which of the following effects are most likely to be felt in the options market? Put option prices have fallen. Call option prices have risen.

Call option prices have risen.

An option valuation model predicated on the assumption that stock prices can move to only two values over any short time period is called the _____ model.

binomial

The Black-Scholes formula assumes stock prices are , ruling out sudden extreme price jumps.

continuous