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Chapter Quiz
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1
The seller of a put option is betting that the market value of the stock will decrease.
A)True
B)False
2
At expiration a call option will have no value if the stock price is less than exercise price.
A)True
B)False
3
If the owner of a call option with a strike price of $35 finds the stock to be trading for $42 at expiration, then the option:
A)expires worthless.
B)will not be exercised.
C)is worth $7 per share.
D)cost too much initially.
4
Which of the following is true for the owner of a call option?
A)The loss potential is unlimited.
B)The profit potential is unlimited.
C)The premium exceeds the strike price.
D)There is no expiration date, unless the option is a European call.
5
What is the option buyer's total profit or loss per share if a call option is purchased for a $5 premium, has a $50 exercise price, and the stock is valued at $53 at expiration?
A)($5)
B)($2)
C)$3
D)$8
6
Which of the following option traders receive, rather than pay, a premium?
A)Option sellers
B)Option buyers
C)Both option sellers and buyers
D)Neither buyers nor sellers receive premiums
7
Which of the following is true for an investor that owns a share of stock and has purchased a put option on the stock?
A)The investor profits when the stock decreases in value.
B)Maximum loss is the price of the option premium.
C)The investor is protected against upside potential.
D)Increases in stock value go to the seller of the put.
8
Which combination of positions will tend to protect the owner from downside risk?
A)Buy the stock and buy a call option.
B)Sell the stock and buy a call option.
C)Buy the stock and buy a put option.
D)Buy the stock and sell a put option.
9
What is the worst-case profitability scenario for an investor who sold a call on the firm's stock for a premium of $10 and a strike price of $100?
A)$90 per share profit
B)$10 per share profit
C)$0 per share profit (break-even)
D)Unlimited losses
10
Which of the following call options would command the higher premium in September, 2002, other things equal?
A)October 2002 expiration, $45 strike price
B)December 2002 expiration, $40 strike price
C)March 2003 expiration, $45 strike price
D)June 2003 expiration, $40 strike price
11
The option to abandon a project investing in real assets can be considered to have a strike price equal to the:
A)historical cost of the asset.
B)market value of the asset at abandonment.
C)forgone revenues anticipated from the project.
D)forgone interest on the bonds used to finance the real assets.
12
The conversion ratio for a convertible bond equals the:
A)ratio of bond value to stock price at conversion.
B)number of bonds necessary to convert into one share of stock.
C)number of shares of stock that can be exchanged for one bond.
D)floor value beneath which the bond price cannot fall.
13
If a $1,000 convertible bond with a market value of $950 has a conversion ratio of 25 when the firm's stock is selling for $36 per share, then:
A)the bond will be converted immediately.
B)the bond is violating its "price floor."
C)conversion now would give the investor a profit of $900.
D)the conversion value of the bond is $900.
14
Option buyers have the _____ to exercise their options. Options sellers have a(n) _____ to fulfill the terms of the option contract.
A)obligation; obligation
B)obligation; right
C)right; right
D)right; obligation
15
The value of a call option increases as the time to expiration increases because:
A)the exercise price continually decreases.
B)opportunity increases to surpass exercise price.
C)dividends accumulate while waiting to be paid.
D)the option can be repeatedly exercised.
16
Which of the following is incorrect regarding options and the payoff to buyers and sellers of options?
a. There are two basic types of options. A call option is the right to buy an asset at a specific exercise price on or before the exercise date. A put is the right to sell an asset at a specific exercise price on or before the exercise date.
b. The payoff to a call is the value of the asset minus the exercise price if the difference is positive, and zero otherwise.
c. The payoff to a put is the exercise price minus the value of the asset if the difference is positive, and zero otherwise.
d. The payoff to the seller of an option is the negative of the payoff to the option buyer.
A)a
B)b
C)c
D)none of the above four statements is incorrect.
17
Which of the following statements is incorrect?
a. To exercise the call option you must pay the exercise price. Other things equal, the less you are obliged to pay, the better. Therefore, the value of the option is higher when the exercise price is high relative to the stock price.
b. Investors who buy the stock by way of a call option are buying on installment credit. They pay the purchase price of the option today but they do not pay the exercise price until they exercise the option. The higher the rate of interest and the longer the time to expiration, the more this "free credit" is worth.
c. No matter how far the stock price falls, the owner of the call cannot lose more than the price of the call. On the other hand, the more the stock price rises above the exercise price, the greater the profit on the call. Therefore, the option holder does not lose from increased variability if things go wrong, but gains if they go right. The value of the option increases with the variability of stock returns. Of course the longer the time to the final exercise date, the more opportunity there is for the stock price to vary.
A)a
B)b
C)c
D)none of the three statements is incorrect.
18
Which of the following is incorrect regarding the call option value?
a. No matter how far the stock price falls, the owner of the call cannot lose more than the price of the call.
b. On the other hand, the more the stock price rises above the exercise price, the greater the profit on the call.
c. The option holder loses from increased variability if things go wrong, and gains if they go right.
d. The value of the option increases with the variability of stock returns. Of course the longer the time to the final exercise date, the more opportunity there is for the stock price to vary.
A)a
B)b
C)c
D)d
19
What options may be present in capital investment proposals?
a. The importance of building flexibility into investment projects can be reformulated in the language of options. For example, many capital investments provide the flexibility to expand capacity in the future if demand turns out to be unusually buoyant. They are in effect providing the firm with a call option on the extra capacity.
b. Firms also think about alternative uses for their assets if things go wrong. The option to abandon a project is a put option; the put's exercise price is the value of the project's assets if shifted to an alternative use.
c. The ability to expand or to abandon are both present in capital investment proposals and are both examples of real options.
A)a
B)b
C)c
D)all of the three statements are correct.
20
What options may be provided in financial securities?
a. Many of the securities that firms issue contain an option. For example, a warrant is nothing but a long-term call option issued by the firm.
b. Convertible bonds give the investor the option to buy the firm's stock in exchange for the value of the underlying bond.
c. Unlike warrants and convertibles, which give an option to the investor, callable bonds give the option to the issuing firm. If interest rates decline and the value of the underlying bond rises, the firm can buy the bonds back at a specified exercise price.
A)a
B)b
C)c
D)a, b and c







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