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Exam 8: Financial Options and Applications in Corporate Finance

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Question 1

Multiple Choice

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Suppose you believe that Delva Corporation's stock price is going to decline from its current level of $82.50 sometime during the next 5 months. For $510.25 you could buy a 5-month put option giving you the right to sell 100 shares at a price of $85 per share. If you bought this option for $510.25 and Delva's stock price actually dropped to $60, what would your pre-tax net profit be?

A) -$510.25
B) $1,989.75
C) $2,089.24
D) $2,193.70
E) $2,303.38

F) A) and B)
G) D) and E)

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Question 2

Multiple Choice

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An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?

A) In-the-money
B) Put
C) Naked
D) Covered
E) Out-of-the-money

F) C) and D)
G) A) and B)

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Question 3

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The strike price is the price that must be paid for a share of common stock when it is bought by exercising a warrant.

Warner Motors’ stock is trading at $20 a share. Call options that expire in three months with a strike price of $20 sell for $1.50. Which of the following will occur if the stock price increases 10%, to $22 a share?

If a company announces a change in its dividend policy from a zero target payout ratio to a 100% payout policy, this action could be expected to increase the value of long-term options (say 5-year options) on the firm's stock.

If the market is in equilibrium, then an option must sell at a price that is exactly equal to the difference between the stock's current price and the option's strike price.

An analyst wants to use the Black-Scholes model to value call options on the stock of Ledbetter Inc. based on the following data: The price of the stock is $40. The strike price of the option is $40. The option matures in 3 months (t = 0.25) . The standard deviation of the stock's returns is 0.40, and the variance is 0.16. The risk-free rate is 6%. Given this information, the analyst then calculated the following necessary components of the Black-Scholes model: d1 = 0.175 d2 = -0.025 N(d1) = 0.56946 N(d2) = 0.49003 N(d1) and N(d2) represent areas under a standard normal distribution function. Using the Black-Scholes model, what is the value of the call option?

The exercise value is the positive difference between the current price of the stock and the strike price. The exercise value is zero if the stock's price is below the strike price.

If the current price of a stock is below the strike price, then an option to buy the stock is worthless and will have a zero value.

An option is a contract that gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time.

Since investors tend to dislike risk and like certainty, the more volatile a stock, the less valuable will be an option to purchase the stock, other things held constant.

An option that gives the holder the right to sell a stock at a specified price at some future time is

The exercise value is also called the strike price, but this term is generally used when discussing convertibles rather than financial options.

The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year call option on the stock, with an exercise price of $22, is available. Based on the binominal model, what is the option's value?

The current price of a stock is $50, the annual risk-free rate is 6%, and a 1-year call option with a strike price of $55 sells for $7.20. What is the value of a put option, assuming the same strike price and expiration date as for the call option?

Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock, provided the strike prices for the put and call are the same.

Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the

Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.

Call options on XYZ Corporation's common stock trade in the market. Which of the following statements is most correct, holding other things constant?

Suppose you believe that Johnson Company's stock price is going to increase from its current level of $22.50 sometime during the next 5 months. For $310.25 you can buy a 5-month call option giving you the right to buy 100 shares at a price of $25 per share. If you buy this option for $310.25 and Johnson's stock price actually rises to $45, what would your pre-tax net profit be?