Chap020 Text Bank(1) Solution

5/22/2018 Chap020 Text Bank(1) Solution

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Chapter 20 - Options Markets: Introduction

Chapter 20

Options Markets: Introduction

Multiple Choice Questions

1. The price that the buyer of a call option pays to acquire the option is called the.strike price!.e"ercise priceC.e"ecution price#.acquisition priceE.pre$iu$

The price that the buyer of a call option pays to acquire the option is called the pre$iu$.

Difficulty: Easy

2. The price that the %riter of a call option recei&es to sell the option is called the.strike price!.e"ercise priceC.e"ecution price#.acquisition priceE.pre$iu$

The price that the %riter of a call option recei&es to sell the option is called the pre$iu$.

Difficulty: Easy

'. The price that the buyer of a put option pays to acquire the option is called the.strike price!.e"ercise priceC.e"ecution price

#.acquisition priceE.pre$iu$

The price that the buyer of a put option pays to acquire the option is called the pre$iu$.

Difficulty: Easy

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(. The price that the %riter of a put option recei&es to sell the option is called theA.pre$iu$!.e"ercise priceC.e"ecution price#.acquisition price

).strike price

The price that the %riter of a put option recei&es to sell the option is called the pre$iu$.

Difficulty: Easy

*. The price that the buyer of a call option pays for the underlyin+ asset if she e"ecutes heroption is called the.strike price

!.e"ercise priceC.e"ecution price#. or CE. or !

The price that the buyer of a call option pays for the underlyin+ asset if she e"ecutes heroption is strike price or e"ercise price.

Difficulty: Easy

,. The price that the %riter of a call option recei&es for the underlyin+ asset if the buyere"ecutes her option is called the.strike price!.e"ercise priceC.e"ecution priceD. or !). or C

The price that the %riter of a call option recei&es for the underlyin+ asset if the buyer e"ecutes

her option is called the strike price or e"ercise price.

Difficulty: Easy

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. The price that the buyer of a put option recei&es for the underlyin+ asset if she e"ecutes heroption is called the.strike price!.e"ercise priceC.e"ecution price

#. or CE. or !

The price that the buyer of a put option recei&es for the underlyin+ asset if she e"ecutes heroption is called the strike price or e"ercise price.

Difficulty: Easy

. The price that the %riter of a put option recei&es for the underlyin+ asset if the option is

e"ercised is called the.strike price!.e"ercise priceC.e"ecution price#. or !E.none of the abo&e

The price that the %riter of a put option recei&es for the underlyin+ asset if the option ise"ercised depends on the $arket price at the ti$e.

Difficulty: Easy

/. n $erican call option allo%s the buyer to.sell the underlyin+ asset at the e"ercise price on or before the e"piration date.!.buy the underlyin+ asset at the e"ercise price on or before the e"piration date.C.sell the option in the open $arket prior to e"piration.#. and C.E.! and C.

n $erican call option $ay be e"ercised allo%in+ the holder to buy the underlyin+ asseton or before e"piration the option contract also $ay be sold prior to e"piration.

Difficulty: Easy

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10. )uropean call option allo%s the buyer to.sell the underlyin+ asset at the e"ercise price on the e"piration date.!.buy the underlyin+ asset at the e"ercise price on or before the e"piration date.C.sell the option in the open $arket prior to e"piration.#.buy the underlyin+ asset at the e"ercise price on the e"piration date.

E.C and #.

)uropean call option $ay be e"ercised allo%in+ the holder to buy the underlyin+ asset onthe e"piration date the option contract also $ay be sold prior to e"piration.

Difficulty: Easy

11. n $erican put option allo%s the holder to.buy the underlyin+ asset at the strikin+ price on or before the e"piration date.

!.sell the underlyin+ asset at the strikin+ price on or before the e"piration date.C.potentially benefit fro$ a stock price decrease %ith less risk than short sellin+ the stock.D.! and C.). and C.

n $erican put option allo%s the buyer to sell the underlyin+ asset at the strikin+ price on orbefore the e"piration date. The put option also allo%s the in&estor to benefit fro$ an e"pectedstock price decrease %hile riskin+ only the a$ount in&ested in the contract.

Difficulty: Easy

12. )uropean put option allo%s the holder to.buy the underlyin+ asset at the strikin+ price on or before the e"piration date.!.sell the underlyin+ asset at the strikin+ price on or before the e"piration date.C.potentially benefit fro$ a stock price decrease %ith less risk than short sellin+ the stock.#.sell the underlyin+ asset at the strikin+ price on the e"piration date.E.C and #.

)uropean put option allo%s the buyer to sell the underlyin+ asset at the strikin+ price on or

before the e"piration date. The put option also allo%s the in&estor to benefit fro$ an e"pectedstock price decrease %hile riskin+ only the a$ount in&ested in the contract.

Difficulty: Easy

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1'. n $erican put option can be e"ercisedA.any ti$e on or before the e"piration date.!.only on the e"piration date.C.any ti$e in the indefinite future.#.only after di&idends are paid.

).none of the abo&e.

$erican options can be e"ercised on or before e"piration date.

Difficulty: Easy

1(. n $erican call option can be e"ercisedA.any ti$e on or before the e"piration date.!.only on the e"piration date.

C.any ti$e in the indefinite future.#.only after di&idends are paid.).none of the abo&e.

$erican options can be e"ercised on or before e"piration date.

Difficulty: Easy

1*. )uropean call option can be e"ercised.any ti$e in the future.B.only on the e"piration date.C.if the price of the underlyin+ asset declines belo% the e"ercise price.#.i$$ediately after di&idends are paid.).none of the abo&e.

)uropean options can be e"ercised at e"piration only.

Difficulty: Easy

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1,. )uropean put option can be e"ercised.any ti$e in the future.B.only on the e"piration date.C.if the price of the underlyin+ asset declines belo% the e"ercise price.#.i$$ediately after di&idends are paid.


)uropean options can be e"ercised at e"piration only.

Difficulty: Easy

1. To ad3ust for stock splitsA.the e"ercise price of the option is reduced by the factor of the split and the nu$ber ofoption held is increased by that factor.

!.the e"ercise price of the option is increased by the factor of the split and the nu$ber ofoption held is reduced by that factor.C.the e"ercise price of the option is reduced by the factor of the split and the nu$ber ofoption held is reduced by that factor.#.the e"ercise price of the option is increased by the factor of the split and the nu$ber ofoption held is increased by that factor.).none of the abo&e

To ad3ust for stock splits the e"ercise price of the option is reduced by the factor of the splitand the nu$ber of option held is increased by that factor.

Difficulty: Easy

1. ll else equal4 call option &alues are lo%er.in the $onth of May.!.for lo% di&idend payout policies.C.for hi+h di&idend payout policies.#. and !.). and C.

ll else equal4 call option &alues are lo%er for hi+h di&idend payout policies.

Difficulty: Easy

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1/. ll else equal4 call option &alues are hi+her.in the $onth of May.B.for lo% di&idend payout policies.C.for hi+h di&idend payout policies.#. and !.

). and C.

ll else equal4 call option &alues are hi+her for lo% di&idend payout policies.

Difficulty: Easy

20. The current $arket price of a share of T5T stock is 6*0. If a call option on this stock hasa strike price of 6(*4 the call.is out of the $oney.

!.is in the $oney.C.sells for a hi+her price than if the $arket price of T5T stock is 6(0.#. and C.E.! and C.

If the strikin+ price on a call option is less than the $arket price4 the option is in the $oneyand sells for $ore than an out of the $oney option.

Difficulty: Easy

21. The current $arket price of a share of !oein+ stock is 6*. If a call option on this stockhas a strike price of 604 the call.is out of the $oney.!.is in the $oney.C.sells for a hi+her price than if the $arket price of !oein+ stock is 60.#. and C.E.! and C.

If the strikin+ price on a call option is less than the $arket price4 the option is in the $oney

and sells for $ore than an at the $oney option.

Difficulty: Easy

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22. The current $arket price of a share of C7CO stock is 622. If a call option on this stock hasa strike price of 6204 the call.is out of the $oney.!.is in the $oney.C.sells for a hi+her price than if the $arket price of C7CO stock is 621.

#. and C.E.! and C.

If the strikin+ price on a call option is less than the $arket price4 the option is in the $oneyand sells for $ore than a less in the $oney option.

Difficulty: Easy

2'. The current $arket price of a share of #isney stock is 6'0. If a call option on this stock

has a strike price of 6'*4 the callA.is out of the $oney.!.is in the $oney.C.can be e"ercised profitably.#. and C.).! and C.

If the strikin+ price on a call option is $ore than the $arket price4 the option is out of the$oney and cannot be e"ercised profitably.

Difficulty: Easy

2(. The current $arket price of a share of CT stock is 6,. If a call option on this stock has astrike price of 6,4 the call.is out of the $oney.!.is in the $oney.C.is at the $oney.#. and C.).! and C.

If the strikin+ price on a call option is equal to the $arket price4 the option is at the $oney.

Difficulty: Easy

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2*. put option on a stock is said to be out of the $oney if.the e"ercise price is hi+her than the stock price.B.the e"ercise price is less than the stock price.C.the e"ercise price is equal to the stock price.#.the price of the put is hi+her than the price of the call.

).the price of the call is hi+her than the price of the put.

n out of the $oney put option +i&es the o%ner the ri+ht to sell the shares for less than$arket price.

Difficulty: Easy

2,. put option on a stock is said to be in the $oney ifA.the e"ercise price is hi+her than the stock price.

!.the e"ercise price is less than the stock price.C.the e"ercise price is equal to the stock price.#.the price of the put is hi+her than the price of the call.).the price of the call is hi+her than the price of the put.

n in the $oney put option +i&es the o%ner the ri+ht to sell the shares for $ore than $arketprice.

Difficulty: Easy

2. put option on a stock is said to be at the $oney if.the e"ercise price is hi+her than the stock price.!.the e"ercise price is less than the stock price.C.the e"ercise price is equal to the stock price.#.the price of the put is hi+her than the price of the call.).the price of the call is hi+her than the price of the put.

put option on a stock is said to be at the $oney if the e"ercise price is equal to the stockprice.

Difficulty: Easy

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2. call option on a stock is said to be out of the $oney ifA.the e"ercise price is hi+her than the stock price.!.the e"ercise price is less than the stock price.C.the e"ercise price is equal to the stock price.#.the price of the put is hi+her than the price of the call.

).the price of the call is hi+her than the price of the put.

n out of the $oney call option +i&es the o%ner the ri+ht to buy the shares for $ore than$arket price.

Difficulty: Easy

2/. call option on a stock is said to be in the $oney if.the e"ercise price is hi+her than the stock price.

B.the e"ercise price is less than the stock price.C.the e"ercise price is equal to the stock price.#.the price of the put is hi+her than the price of the call.).the price of the call is hi+her than the price of the put.

n in the $oney call option +i&es the o%ner the ri+ht to buy the shares for less than $arketprice.

Difficulty: Easy

'0. call option on a stock is said to be at the $oney if.the e"ercise price is hi+her than the stock price.!.the e"ercise price is less than the stock price.C.the e"ercise price is equal to the stock price.#.the price of the put is hi+her than the price of the call.).the price of the call is hi+her than the price of the put.

call option on a stock is said to be at the $oney if the e"ercise price is equal to the stockprice.

Difficulty: Easy

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'1. The current $arket price of a share of 898 stock is 6,0. If a put option on this stock has astrike price of 6**4 the put.is in the $oney.!.is out of the $oney.C.sells for a lo%er price than if the $arket price of 898 stock is 6*0.

#. and C.E.! and C.

If the strikin+ price on a put option is less than the $arket price4 the option is out of the$oney and sells for less than an in the $oney option.

Difficulty: Easy

'2. The current $arket price of a share of a stock is 60. If a put option on this stock has a

strike price of 6*4 the put.is in the $oney.!.is out of the $oney.C.sells for a hi+her price than if the $arket price of the stock is 6*.#. and C.E.! and C.

If the strikin+ price on a put option is $ore than the $arket price4 the option is out of the$oney and sells for less than an at the $oney option.

Difficulty: Easy

''. The current $arket price of a share of a stock is 620. If a put option on this stock has astrike price of 614 the put.is out of the $oney.!.is in the $oney.C.sells for a hi+her price than if the strike price of the put option %as 62'.D. and C.).! and C.


Difficulty: Easy

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'(. The current $arket price of a share of MOT stock is 61*. If a put option on this stock hasa strike price of 6204 the putA.is out of the $oney.!.is in the $oney.C.can be e"ercised profitably.

#. and C.).! and C.

If the strikin+ price on a put option is less than the $arket price4 the option is out of the$oney.

Difficulty: Easy

'*. The current $arket price of a share of ;M stock is 6*. If a put option on this stock has

a strike price of 6/4 the put.is out of the $oney.!.is in the $oney.C.can be e"ercised profitably.#. and C.E.! and C.

If the strikin+ price on a put option is less than the $arket price4 the option is in the $oneyand can be profitably e"ercised.

Difficulty: Easy

',. The current $arket price of a share of T5T stock is 6*0. If a put option on this stock hasa strike price of 6(*4 the put.is out of the $oney.!.is in the $oney.C.sells for a lo%er price than if the $arket price of T5T stock is 6(0.D. and C.).! and C.

If the strikin+ price on a put option is $ore than the $arket price4 the option is out of the$oney and sells for less than an in the $oney option.

Difficulty: Easy

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'. The current $arket price of a share of !oein+ stock is 6*. If a put option on this stockhas a strike price of 604 the putA.is out of the $oney.!.is in the $oney.C.sells for a hi+her price than if the $arket price of !oein+ stock is 60.

#. and C.).! and C.

If the strikin+ price on a put option is $ore than the $arket price4 the option is out of the$oney and sells for less than an at the $oney option.

Difficulty: Easy

'. The current $arket price of a share of C7CO stock is 622. If a put option on this stock has

a strike price of 6204 the put.is out of the $oney.!.is in the $oney.C.sells for a hi+her price than if the strike price of the put option %as 62*.D. and C.).! and C.


Difficulty: Easy

'/. The current $arket price of a share of #isney stock is 6'0. If a put option on this stockhas a strike price of 6'*4 the putA.is out of the $oney.!.is in the $oney.C.can be e"ercised profitably.#. and C.).! and C.

If the strikin+ price on a put option is less than the $arket price4 the option is out of the$oney.

Difficulty: Easy

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(0. The current $arket price of a share of CT stock is 6,. If a put option on this stock has astrike price of 604 the put.is out of the $oney.!.is in the $oney.C.can be e"ercised profitably.

#. and C.E.! and C.

If the strikin+ price on a put option is less than the $arket price4 the option is in the $oneyand can be profitably e"ercised.

Difficulty: Easy

(1. ;ookback options ha&e payoffs that

A.ha&e payoffs that depend in part on the $ini$u$ or $a"i$u$ price of the underlyin+asset durin+ the life of the option.!.ha&e payoffs that only depend on the $ini$u$ price of the underlyin+ asset durin+ the lifeof the option.C.ha&e payoffs that only depend on the $a"i$u$ price of the underlyin+ asset durin+ the lifeof the option.#.are kno%n in ad&ance.).none of the abo&e.

;ookback options ha&e payoffs that ha&e payoffs that depend in part on the $ini$u$ or$a"i$u$ price of the underlyin+ asset durin+ the life of the option.

Difficulty: Easy

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(2. !arrier Options ha&e payoffs thatA.ha&e payoffs that only depend on the $ini$u$ price of the underlyin+ asset durin+ the lifeof the option.!.depend both on the asset


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((. !inary Options.are based on t%o possible outco$es - yes or no.!.$ay $ake a payoff of a fi"ed a$ount if a specified e&ent happens.C.$ay $ake a payoff of a fi"ed a$ount if a specified e&ent does not happen.#. and ! only.

E.,!4 and C.

!inary Options are based on t%o possible outco$es - yes or no4 $ay $ake a payoff of a fi"eda$ount if a specified e&ent happens4 and $ay $ake a payoff of a fi"ed a$ount if a specifiede&ent does not happen.

Difficulty: Easy

(*. The $a"i$u$ loss a buyer of a stock call option can suffer is equal to

.the strikin+ price $inus the stock price.!.the stock price $inus the &alue of the call.C.the call pre$iu$.#.the stock price.).none of the abo&e.

If an option e"pires %orthless all the buyer has lost is the price of the contract pre$iu$.

Difficulty: Easy

(,. The $a"i$u$ loss a buyer of a stock put option can suffer is equal to.the strikin+ price $inus the stock price.!.the stock price $inus the &alue of the call.C.the put pre$iu$.#.the stock price.).none of the abo&e.

If an option e"pires %orthless all the buyer has lost is the price of the contract pre$iu$.

Difficulty: Easy

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(. (.The lo%er bound on the $arket price of a con&ertible bond is.its strai+ht bond &alue.!.its crooked bond &alue.C.its con&ersion &alue.D. and C.

).none of the abo&e

The lo%er bound on the $arket price of a con&ertible bond is its strai+ht bond &alue or itscon&ersion &alue.

Difficulty: Easy

(. The potential loss for a %riter of a naked call option on a stock is.li$ited

B.unli$itedC.lar+er the lo%er the stock price.#.equal to the call pre$iu$.).none of the abo&e.

If the buyer of the option elects to e"ercise the option and buy the stock at the e"ercise price4the seller of the option $ust +o into the open $arket and buy the stock in order to sell thestock to the buyer of the contract at the current $arket price. Theoretically4 the $arket priceof a stock is unli$ited thus the %riter


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*0. The intrinsic &alue of an at-the-$oney call option is equal to.the call pre$iu$.B.=ero.C.the stock price plus the e"ercise price.#.the strikin+ price.


The fact that the o%ner of the option can buy the stock at a price equal to the $arket price+i&es the contract an intrinsic &alue of =ero.

Difficulty: Easy

*1. The intrinsic &alue of an in-of-the-$oney call option is equal to.the call pre$iu$.

!.=ero.C.the stock price $inus the e"ercise price.#.the strikin+ price.).none of the abo&e.

The fact that the o%ner of the option can buy the stock at a price less than the $arket price+i&es the contract a positi&e intrinsic &alue.

Difficulty: Easy

*2. The intrinsic &alue of an in-the-$oney put option is equal to.the stock price $inus the e"ercise price.!.the put pre$iu$.C.=ero.D.the e"ercise price $inus the stock price.).none of the abo&e.

The intrinsic &alue of an in-the-$oney put option contract is the strike price less the stockprice4 since the holder can buy the stock at the $arket price and sell it for the strike.

Difficulty: Moderate

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*'. The intrinsic &alue of an at-the-$oney put option is equal to.the stock price $inus the e"ercise price.!.the put pre$iu$.C.=ero.#.the e"ercise price $inus the stock price.


The intrinsic &alue of an at-the-$oney put option contract is =ero.


*(. The intrinsic &alue of an out-of-the-$oney put option is equal to.the stock price $inus the e"ercise price.!.the put pre$iu$.

C.=ero.#.the e"ercise price $inus the stock price.).none of the abo&e.

The intrinsic &alue of an out-of-the-$oney put option contract is =ero.


**. >ou %rite one 898 ?ebruary 0 put for a pre$iu$ of 6*. I+norin+ transactions costs4 %hatis the breake&en price of this [email protected],*!.6*C.6*#.60).none of the abo&e

A60 - 6* B 6,*.

Difficulty: Easy

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*,. >ou purchase one 898 * call option for a pre$iu$ of 6'. I+norin+ transaction costs4 thebreak-e&en price of the position is.6*!.62C.6'

D.6).none of the abo&e

A* A 6' B 6.

Difficulty: Easy

*. >ou %rite one T5T ?ebruary *0 put for a pre$iu$ of 6*. I+norin+ transactions costs4%hat is the breake&en price of this position@

.6*0!.6**C.6(*#.6(0).none of the abo&e

A6*0 - 6* B 6(*.

Difficulty: Easy

*. >ou purchase one I!M 0 call option for a pre$iu$ of 6,. I+norin+ transaction costs4 thebreak-e&en price of the position is.6/!.6,(C.6,#.60).none of the abo&e

A0 A 6, B 6,.

Difficulty: Easy

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*/. Call options on I!M listed stock options are.issued by I!M Corporation.!.created by in&estors.C.traded on &arious e"chan+es.#. and C.

E.! and C.

Options are $erely contracts bet%een buyer and seller and sold pri$arily on &ariousor+ani=ed e"chan+es.


,0. !uyers of call options required to post $ar+in deposits and sellers of putoptions required to post $ar+in deposits.

.are are not!.are areC.are not are#.are not are not).are al%ays are so$eti$es

!uyers of call options pose no risk as they ha&e no co$$it$ent. If the option e"pires%orthless4 the buyer $erely loses the option pre$iu$. If the option is in the $oney ate"piration and the buyer lacks funds4 there is no require$ent to e"ercise. The seller of a putoption is co$$itted to sellin+ the stock at the e"ercise price. If the seller of the option doesnot o%n the underlyin+ stock the seller $ust +o into the open $arket and buy the stock inorder to be able to sell the stock to the buyer of the contract.


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,1. !uyers of put options anticipate the &alue of the underlyin+ asset %ill andsellers of call options anticipate the &alue of the underlyin+ asset %ill ..increase increase!.decrease increaseC.increase decrease

D.decrease decrease).cannot tell %ithout further infor$ation

The buyer of the put option hopes the price %ill fall in order to e"ercise the option and sell thestock at a price hi+her than the $arket price. ;ike%ise4 the seller of the call option hopes theprice %ill decrease so the option %ill e"pire %orthless.


,2. The Option Clearin+ Corporation is o%ned by.the ?ederal Deser&e 7yste$.B.the e"chan+es on %hich stock options are traded.C.the $a3or E.7. banks.#.the ?ederal #eposit Insurance Corporation.).none of the abo&e.

The e"chan+es on %hich options are traded 3ointly o%n the Option Clearin+ Corporation inorder to facilitate option tradin+.


,'. co&ered call position is.the si$ultaneous purchase of the call and the underlyin+ asset.!.the purchase of a share of stock %ith a si$ultaneous sale of a put on that stock.C.the short sale of a share of stock %ith a si$ultaneous sale of a call on that stock.D.the purchase of a share of stock %ith a si$ultaneous sale of a call on that stock.).the si$ultaneous purchase of a call and sale of a put on the sa$e stock.

Fritin+ a co&ered call is a &ery safe strate+y4 as the %riter o%ns the underlyin+ stock. Theonly risk to the %riter is that the stock %ill be called a%ay4 thus li$itin+ the upside potential.


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,(. co&ered call position is equi&alent to a.lon+ put.B.short put.C.lon+ straddle.#.&ertical spread.


Fith a short put4 the seller of the contract $ust buy the stock if the option is e"ercisedho%e&er4 this cash outflo% is offset by the pre$iu$ inco$e as in the co&ered call scenario.


,*. ccordin+ to the put-call parity theore$4 the &alue of a )uropean put option on a non-di&idend payin+ stock is equal to:

.the call &alue plus the present &alue of the e"ercise price plus the stock price.B.the call &alue plus the present &alue of the e"ercise price $inus the stock price.C.the present &alue of the stock price $inus the e"ercise price $inus the call price.#.the present &alue of the stock price plus the e"ercise price $inus the call price.).none of the abo&e.

B C - 7O A GH A Gdi&idends4 %here 7O B the $arket price of the stock4 and H B thee"ercise price.

Difficulty: Difficult

,,. protecti&e put strate+y isA.a lon+ put plus a lon+ position in the underlyin+ asset.!.a lon+ put plus a lon+ call on the sa$e underlyin+ asset.C.a lon+ call plus a short put on the sa$e underlyin+ asset.#.a lon+ put plus a short call on the sa$e underlyin+ asset.).none of the abo&e.

If you in&est in a stock and purchase a put option on the stock you are +uaranteed a payoff

equal to the e"ercise price thus the protection of the put.


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,. 7uppose the price of a share of oo+le stock is 6*00. n pril call option on oo+lestock has a pre$iu$ of 6* and an e"ercise price of 6*00. I+norin+ co$$issions4 the holder ofthe call option %ill earn a profit if the price of the share.increases to 6*0(.!.decreases to 6(/0.

C.increases to 6*0,.#.decreases to 6(/,.).none of the abo&e.

6*00 A 6* B 6*0* !reake&en. The price of the stock $ust increase to abo&e 6*0* for theoption holder to earn a profit.


,. 7uppose the price of a share of I!M stock is 6100. n pril call option on I!M stock hasa pre$iu$ of 6* and an e"ercise price of 6100. I+norin+ co$$issions4 the holder of the calloption %ill earn a profit if the price of the share.increases to 610(.!.decreases to 6/0.C.increases to 610,.#.decreases to 6/,.).none of the abo&e.

6100 A 6* B 610* !reake&en. The price of the stock $ust increase to abo&e 610* for theoption holder to earn a profit.


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,/. >ou purchased one T5T March *0 call and sold one T5T March ** call. >our strate+yis kno%n as.a lon+ straddle.!.a hori=ontal spread.C.a &ertical spread.

#.a short straddle.).none of the abo&e.

&ertical or $oney spread in&ol&es the purchase one option and the si$ultaneous sale ofanother %ith a different e"ercise price and sa$e e"piration date.


0. >ou purchased one T5T March *0 put and sold one T5T pril *0 put. >our strate+y is

kno%n as.a &ertical spread.!.a straddle.C.a hori=ontal spread.#.a collar.).none of the abo&e.

hori=ontal or ti$e spread in&ol&es the si$ultaneous purchase and sale of options %ithdifferent e"piration dates4 sa$e e"ercise price.


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1. !efore e"piration4 the ti$e &alue of a call option is equal to.=ero.B.the actual call price $inus the intrinsic &alue of the call.C.the intrinsic &alue of the call.#.the actual call price plus the intrinsic &alue of the call.


The difference bet%een the actual call price and the intrinsic &alue is the ti$e &alue of theoption4 %hich should not be confused %ith the ti$e &alue of $oney. The option


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(. The &alue of a stock put option is positi&ely related to the follo%in+ factors except.the ti$e to e"piration.!.the strikin+ price.C.the stock price.#.all of the abo&e.


The ti$e to e"piration and strikin+ price are positi&ely related to the &alue of a put option thestock price is in&ersely related to the &alue of the option.


*. The &alue of a stock put option is positi&ely related to.the ti$e to e"piration.

!.the strikin+ price.C.the stock price.#.all of the abo&e.E. and !.

The ti$e to e"piration and strikin+ price are positi&ely related to the &alue of a put option thestock price is in&ersely related to the &alue of the option.


,. >ou purchase one 7epte$ber *0 put contract for a put pre$iu$ of 62. Fhat is the$a"i$u$ profit that you could +ain fro$ this [email protected](400!.6200C.6*4000#.6*4200).none of the abo&e

-6200 A 6*4000 B 6(400 if the stock falls to =ero.


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. >ou purchase one 8une 0 put contract for a put pre$iu$ of 6(. Fhat is the $a"i$u$profit that you could +ain fro$ this [email protected]!.6(00C.64(00

D.6,4,00).none of the abo&e

-6(00 A 64000 B 6,4,00 if the stock falls to =ero.


. >ou purchase one I!M March 100 put contract for a put pre$iu$ of 6,. Fhat is the$a"i$u$ profit that you could +ain fro$ this strate+y@

.6104000!.6104,00C.6/4(00#.6/4000).none of the abo&e

-6,00 A 6104000 B 6/4(00 if the stock falls to =ero.


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/. The follo%in+ price quotations %ere taken fro$ the Fall 7treet 8ournal.

The pre$iu$ on one ?ebruary /0 call contract is.6'.12*0!.6'1.00C.6'12.*0#.6*.00).none of the abo&e

' 1J B 6'.12* H 100 B 6'12.*0. rice quotations are per share ho%e&er4 option contracts arestandardi=ed for 100 shares of the underlyin+ stock thus4 the quoted pre$iu$s $ust be$ultiplied by 100.


0. The follo%in+ price quotations on I!M %ere taken fro$ the Fall 7treet 8ournal.

The pre$iu$ on one I!M ?ebruary /0 call contract is.6(.12*0

!.6(1.00C.6(12.*0#.61*.00).none of the abo&e

( 1J B 6(.12* H 100 B 6(12.*0. rice quotations are per share ho%e&er4 option contracts arestandardi=ed for 100 shares of the underlyin+ stock thus4 the quoted pre$iu$s $ust be$ultiplied by 100.


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1. The follo%in+ price quotations on I!M %ere taken fro$ the Fall 7treet 8ournal.

The pre$iu$ on one I!M ?ebruary * call contract is.6.*B.6.*0C.6(12.*0#.61*.00).none of the abo&e

J B 6.* H 100 B 6.*0. rice quotations are per share ho%e&er4 option contracts arestandardi=ed for 100 shares of the underlyin+ stock thus4 the quoted pre$iu$s $ust be$ultiplied by 100.


7uppose you purchase one I!M May 100 call contract at 6* and %rite one I!M May 10* callcontract at 62.

2. The $a"i$u$ potential profit of your strate+y is.6,00.

!.6*00.C.6200.#.6'00.).6100

-6100 - 6* B -610* A 62 A 610* B 610 62 " 100 B 6200.


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'. If4 at e"piration4 the price of a share of I!M stock is 610'4 your profit %ould be.6*00.!.6'00.C.=ero.#.6100.


610' - 6100 B 6' - 6* B -62 A62 60 H 100 B 60.


(. The $a"i$u$ loss you could suffer fro$ your strate+y is.6200.B.6'00.

C.=ero.#.6*00.).none of the abo&e.

-6* A 62 B -6' H 100 B -6'00.


*. Fhat is the lo%est stock price at %hich you can break e&[email protected].!.6102.C.610'.#.610(.).none of the abo&e.

" B 6100 A 6* - 62 " B 610'.


>ou buy one Hero" 8une ,0 call contract and one 8une ,0 put contract. The call pre$iu$ is6* and the put pre$iu$ is 6'.

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,. >our strate+y is called.a short straddle.B.a lon+ straddle.C.a hori=ontal straddle.#.a co&ered call.


!uyin+ both a put and a call4 each %ith the sa$e e"piration date and e"ercise price is a lon+straddle.


. >our $a"i$u$ loss fro$ this position could be.6*00.

!.6'00.C.600.#.6200.).none of the abo&e.

-6* A -6' B -6 H 100 B 600.


. t e"piration4 you break e&en if the stock price is equal to.6*2.!.6,0.C.6,.D.both and C.).none of the abo&e.

Call: -6,0 A -6* A 6' B 6, !reak e&en ut: -6' A 6,0 A -6* B 6*2 !reak e&en thus4if price increases abo&e 6, or decreases belo% 6*24 a profit is reali=ed.


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/. The put-call parity theore$.represents the proper relationship bet%een put and call prices.!.allo%s for arbitra+e opportunities if &iolated.C.$ay be &iolated by s$all a$ounts4 but not enou+h to earn arbitra+e profits4 oncetransaction costs are considered.

D.all of the abo&e.).none of the abo&e.

The put-call parity relationship depicts the relationship bet%een put and call prices4 %hich4 if&iolated4 allo%s for arbitra+e profits ho%e&er4 these profits $ay disappear once transactioncosts are considered.


/0. 7o$e $ore KtraditionalK assets ha&e option-like features so$e of these instru$entsinclude.callable bonds.!.con&ertible bonds.C.%arrants.#. and !.E.4 !4 and C.

ll of the abo&e-$entioned instru$ents ha&e option-like features.

Difficulty: Easy

/1. ?inancial en+ineerin+.is the custo$ desi+nin+ of securities or portfolios %ith desired patterns of e"posure to theprice of the underlyin+ security.!.pri$arily takes place for institutional in&estor.C.pri$arily takes places for the indi&idual in&estor.D. and !.). and C.

?inancial en+ineerin+ is the custo$i=ation of ne% securities4 pri$arily for institutionalin&estors.

Difficulty: Easy

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/2. rotecti&e puts offer an ad&anta+e o&er stop-loss orders in that.the stop-loss order %ill be e"ecuted as soon as the stock price reaches the tri++er point4%ithout allo%in+ for a subsequent rebound4 %hile the put allo%s the holder to %ait.!.the stop-loss order is costless to place.C.the stop-loss order $ay actually be e"ecuted at a price belo% the tri++er price.

#.both and ! are true.E.both and C are true.

Only ! is false - it %ould be an ad&anta+e of a stop order o&er a protecti&e put.


/'. collar %ith a net outlay of appro"i$ately =ero is an options strate+y that.co$bines a put and a call to lock in a price ran+e for a security.

!.uses the +ains fro$ sale of a call to purchase a put.C.uses the +ains fro$ sale of a put to purchase a call.D.both and !.).both and C.

The collar brackets the &alue of a portfolio bet%een t%o bounds.

Difficulty: Easy

/(. Top ?li+ht 7tock currently sells for 6*'. one-year call option %ith strike price of 6*sells for 6104 and the risk free interest rate is *.*L. Fhat is the price of a one-year put %ithstrike price of 6*@.610.00!.612.12C.61,.00D.611./).61(.1'

B 10 - *' A *J1.0*.* B 11./


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/*. i+h?lyer 7tock currently sells for 6(. one-year call option %ith strike price of 6**sells for 6/4 and the risk free interest rate is ,L. Fhat is the price of a one-year put %ith strikeprice of 6**@.6/.00B.612./

C.61,.00#.61.2).61*.,0

B / - ( A **J1.0, B 12./


/,. I9 7tock currently sells for 6'. one-year call option %ith strike price of 6(* sells for

6/4 and the risk free interest rate is (L. Fhat is the price of a one-year put %ith strike price of6(*@.6/.00!.612./C.61,.00D.61.2).61(.2,

B / - ' A (*J1.0( B 1(.2,


/. callable bond should be priced the sa$e as.a con&ertible bond.!.a strai+ht bond plus a put option.C.a strai+ht bond plus a call option.#.a strai+ht bond plus %arrants.).a strai+ht bond.

callable bond is the equi&alent of a strai+ht bond sale by the corporation and the concurrentissue of a call option by the bond buyer.


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/. sian options differ fro$ $erican and )uropean options in that.they are only sold in sian financial $arkets.!.they ne&er e"pire.C.their payoff is based on the a&era+e price of the underlyin+ asset.#.both and !.

).both and C.

sian options ha&e payoffs that depend on the a&era+e price of the underlyin+ asset durin+so$e period of ti$e.

Difficulty: Easy

//. Tradin+ in Ke"otic optionsK takes place.on the 9e% >ork 7tock )"chan+e.

B.in the o&er-the-counter $arket.C.on the $erican 7tock )"chan+e.#.in the pri$ary $arketplace.).none of the abo&e.

There is an acti&e o&er-the-counter $arket for e"otic options.


100. Currency options and currency futures options ha&e different &alues becauseA.the payoff on the currency option depends on the e"chan+e rate at $aturity4 %hile thecurrency futures option


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101. Consider a one-year $aturity call option and a one-year put option on the sa$e stock4both %ith strikin+ price 6(*. If the risk-free rate is (L4 the stock price is 6(4 and the put sellsfor 61.*04 %hat should be the price of the [email protected](.'!.6*.,0

C.6,.2'#.612.2,).none of the abo&e.

C B ( - (*J1.0( A 1.*0 C B 6,.2'.


102. Consider a one-year $aturity call option and a one-year put option on the sa$e stock4

both %ith strikin+ price 6100. If the risk-free rate is *L4 the stock price is 610'4 and the putsells for 6.*04 %hat should be the price of the [email protected].*0B.61*.2,C.610.',#.612.2,).none of the abo&e.

C B 10' - 100J1.0* A .*0 C B 61*.2,.


10'. #eri&ati&e securities are also called contin+ent clai$s because.their o%ners $ay choose %hether or not to e"ercise the$.!.a lar+e contin+ent of in&estors holds the$.C.the %riters $ay choose %hether or not to e"ercise the$.D.their payoffs depend on the prices of other assets.).contin+ency $ana+e$ent is used in addin+ the$ to portfolios.

The &alues of deri&ati&es depend on the &alues of the underlyin+ stock4 co$$odity4 inde"4etc.

Difficulty: Easy

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10(. )"chan+e-traded stock options e"pire.on the first day of the e"piration $onth.!.on the last day of the e"piration $onth.C.on the 1*thday of the e"piration $onth.#.on the first Monday of the e"piration $onth.

E.on the third ?riday of the e"piration $onth.

They e"pire on the third ?riday.

Difficulty: Easy

10*. >ou purchased a call option for 6'.(* se&enteen days a+o. The call has a strike price of6(* and the stock is no% tradin+ for 6*1. If you e"ercise the call today4 %hat %ill be yourholdin+ period return@ If you do not e"ercise the call today and it e"pires4 %hat %ill be your

holdin+ period [email protected]'./L4 -100LB.'./L4 -100LC.*.*L4 -1'./L#.'./L4 -*.*L).100L4 -100L

If the call is e"ercised the +ross profit is 6*1 - (* B 6,. The net profit is 6, - '.(* B 62.**. Theholdin+ period return is 62.**J6'.(* B .'/ './L. If the call is not e"ercised4 there is no+ross profit and the in&estor loses the full a$ount of the pre$iu$. The return is 60 - '.(*J6'.(* B -1.00 -100L.

Difficulty: Easy

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10,. n option %ith an e"ercise price equal to the underlyin+ asset


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10/. Fhat happens to an option if the underlyin+ stock has a 2-for-1 [email protected] is no chan+e in either the e"ercise price or in the nu$ber of options held.!.The e"ercise price %ill ad3ust throu+h nor$al $arket $o&e$ents the nu$ber of options%ill re$ain the sa$e.C.The e"ercise price %ould beco$e half of %hat it %as and the nu$ber of options held

%ould double.#.The e"ercise price %ould double and the nu$ber of options held %ould double.).There is no standard rule - each corporation has its o%n policy.

This is si$ilar to %hat happens to the underlyin+ stock.

Difficulty: Easy

110. Fhat happens to an option if the underlyin+ stock has a '-for-1 split@

.There is no chan+e in either the e"ercise price or in the nu$ber of options held.!.The e"ercise price %ill ad3ust throu+h nor$al $arket $o&e$ents the nu$ber of options%ill re$ain the sa$e.C.The e"ercise price %ould beco$e one third of %hat it %as and the nu$ber of options held%ould triple.#.The e"ercise price %ould triple and the nu$ber of options held %ould triple.).There is no standard rule - each corporation has its o%n policy.

This is si$ilar to %hat happens to the underlyin+ stock.

Difficulty: Easy

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111. 7uppose that you purchased a call option on the 75 100 inde". The option has ane"ercise price of ,0 and the inde" is no% at 20. Fhat %ill happen %hen you e"ercise theoption@.>ou %ill ha&e to pay 6,0.!.>ou %ill recei&e 620.

C.>ou %ill recei&e 6,0.D.>ou %ill recei&e 6(4000.).>ou %ill ha&e to pay 6(4000.

Fhen an inde" option is e"ercised the %riter of the option pays cash to the option holder. Thea$ount of cash equals the difference bet%een the e"ercise price of the option and the &alue ofthe inde". In this case4 you %ill recei&e 20 - ,0 B (0 ti$es the 6100 $ultiplier4 or 6(4000. Inother %ords4 you are i$plicitly buyin+ the inde" for ,0 and sellin+ it to the call %riter for20.


112. 7uppose that you purchased a call option on the 75 100 inde". The option has ane"ercise price of 00 and the inde" is no% at ,0. Fhat %ill happen %hen you e"ercise theoption@.>ou %ill ha&e to pay 6,4000.B.>ou %ill recei&e 6,4000.C.>ou %ill recei&e 600.#.>ou %ill recei&e 6,0.).>ou %ill ha&e to pay 64000.

Fhen an inde" option is e"ercised the %riter of the option pays cash to the option holder. Thea$ount of cash equals the difference bet%een the e"ercise price of the option and the &alue ofthe inde". In this case4 you %ill recei&e ,0 - 00 B ,0 ti$es the 6100 $ultiplier4 or 6,4000. Inother %ords4 you are i$plicitly buyin+ the inde" for 00 and sellin+ it to the call %riter for,0.


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hort Ans!er Questions

11'. Fhat is the Option Clearin+ Corporation OCC and ho% does this or+ani=ation facilitateoption tradin+@

The OCC is the other side of e&ery option transaction. s a result4 the buyers and sellers donot ha&e to be $atched %ith each other. In addition4 the OCC +uarantees their side of thetransaction.?eedback: The purpose of this question is to ascertain %hether the student understands ho%the options $arket differs fro$ the $arkets pre&iously studied in ter$s of the e"istence of theK$iddlepersonK in the options $arket.

Difficulty: Easy

11(. #escribe the protecti&e put. Fhat are the ad&anta+es of such a strate+y@

protecti&e put consists of in&estin+ in stock and si$ultaneously purchasin+ a put option onthe stock. De+ardless of %hat happens to the price of the stock4 you are +uaranteed a payoffequal to the put option e"ercise price.?eedback: The purpose of this question is to deter$ine if the student understands the$echanis$ of one the $ore co$$on and less co$ple" option strate+ies.


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11*. #iscuss the differences in %ritin+ co&ered and naked calls. re risks in&ol&ed in the t%ostrate+ies si$ilar or different@ )"plain.

Fritin+ a co&ered call is sellin+ a call on stock the in&estor o%ns. Thus4 this strate+y is &eryconser&ati&e the in&estor recei&es the pre$iu$ inco$e fro$ %ritin+ the call. If the call is

e"ercised4 the stock is called a%ay fro$ the in&estor thus the in&estor has li$ited his or herupside potential.Fritin+ a naked call is a &ery risky strate+y. The in&estor sells a call on a stock the in&estordoes not o%n. If the price of the stock increases4 the option %ill be e"ercised and the in&estor$ust +o into the open $arket and buy the stock at the pre&ailin+ $arket price.Theoretically4 the price to %hich the stock can increase is unli$ited thus4 the in&estor


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11. ;ist t%o types of e"otic options and describe their characteristics.

There are fi&e e"otic options $entioned in the te"tbook:sian Options ha&e payoffs that depend on the a&era+e price of the underlyin+ asset durin+ atleast so$e portion of the life of the option.

!arrier Options ha&e payoffs that depend both on the asset

Chap020 Text Bank(1) Solution

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Transcript of Chap020 Text Bank(1) Solution