10e Ch 20

CHAPTER 20—AN INTRODUCTION TO DERIVATIVE MARKETS AND SECURITIES TRUE/FALSE 1. A cash or spot contract is an agreement for the immediate delivery of an asset such as the purchase of stock on the NYSE. ANS: T

PTS: 1

2. Forward and future contracts, as well as options, are types of derivative securities. ANS: T

PTS: 1

3. All features of a forward contract are standardized, except for price and number of contracts. ANS: F

PTS: 1

4. Forward contracts are traded over-the-counter and are generally not standardized. ANS: T

PTS: 1

5. The forward market has low liquidity relative to the futures market. ANS: T

PTS: 1

6. A futures contract is an agreement between a trader and the clearinghouse of the exchange for delivery of an asset in the future. ANS: F

PTS: 1

7. A primary function of futures markets is to allow investors to transfer risk. ANS: T

PTS: 1

8. The futures market is a dealer market where all the details of the transactions are negotiated. ANS: F

PTS: 1

9. Futures contracts are slower to absorb new information than forward contracts. ANS: F

PTS: 1

10. The initial value of a future contract is the price agreed upon in the contract. ANS: F

PTS: 1

11. A futures contract eliminates uncertainty about the future spot price that an individual can expect to pay for an asset at the time of delivery. ANS: T

PTS: 1

12. Investment costs are generally higher in the derivative markets than in the corresponding cash markets. ANS: F

PTS: 1

13. An option buyer must exercise the option on or before the expiration date. ANS: F

PTS: 1

14. The minimum value of an option is zero. ANS: T

PTS: 1

15. An option to sell an asset is referred to as a call, whereas an option to buy an asset is called a put. ANS: F

PTS: 1

16. If an investor wants to acquire the right to buy or sell an asset, but not the obligation to do it, the best instrument is an option rather than a futures contract. ANS: T

PTS: 1

17. Investors buy call options because they expect the price of the underlying stock to increase before the expiration of the option. ANS: T

PTS: 1

18. A call option is in the money if the current market price is above the strike price. ANS: T

PTS: 1

19. A put option is in the money if the current market price is above the strike price. ANS: F

PTS: 1

20. The price at which the stock can be acquired or sold is the exercise price. ANS: T

PTS: 1

21. The minimum amount that must be maintained in an account is called the maintenance margin. ANS: T

PTS: 1

22. A forward contract gives its holder the option to conduct a transaction involving another security or commodity. ANS: F

PTS: 1

23. In the forward market both parties are required to post collateral or margin. ANS: F

PTS: 1

24. The option premium is the price the call buyer will pay to the option seller if the option is exercised. ANS: F

PTS: 1

25. The payoffs to both long and short position in the forward contact are symmetric around the contract price. ANS: T

PTS: 1

26. Forward contracts are much easier to unwind than futures contracts due to the standardization of the contracts. ANS: F

PTS: 1

27. Forward contracts do not require an upfront premium. ANS: T

PTS: 1

28. The payoffs diagrams to both long and short positions in a forward contract are asymmetrical around the contract price. ANS: F

PTS: 1

MULTIPLE CHOICE 1. Which of the following statements is false? a. Derivatives help shift risk from risk-adverse investors to risk-takers. b. Derivatives assist in forming cash prices. c. Derivatives provide additional information to the market. d. In many cases, the investment in derivatives (both commissions and required investment) is more than in the cash market. e. None of the above (that is, all are reasons) ANS: D

PTS: 1

OBJ: Multiple Choice

2. Derivative instruments exist because a. They help shift risk from risk-averse investors to risk-takers. b. They help in forming prices. c. They have lower investment costs. d. Choices a and b e. All of the above ANS: E

PTS: 1

OBJ: Multiple Choice

3. There are a number of differences between forward and futures contracts. Which of the following statements is false? a. Futures have less liquidity risk than forward contracts. b. Futures have less credit risk than forward contracts. c. Futures have more default risk than forward contracts. d. In futures, the exchange becomes the counterparty to all transactions. e. None of the above (that is, all statements are true) ANS: C

PTS: 1

OBJ: Multiple Choice

4. Futures differ from forward contracts because a. Futures have more liquidity risk. b. Futures have more credit risk.

c. Futures have more maturity risk. d. All of the above e. None of the above ANS: E

PTS: 1

OBJ: Multiple Choice

5. The price at which a futures contract is set at the end of the day is the a. Stock price. b. Strike price. c. Maintenance price. d. Settlement price. e. Parity price. ANS: D

PTS: 1

OBJ: Multiple Choice

6. Which of the following statements is true? a. The buyer of a futures contract is said to be long futures. b. The seller of a futures contract is said to be short futures. c. The seller of a futures contract is said to be long futures. d. The buyer of a futures contract is said to be short futures. e. Choices a and b ANS: E

PTS: 1

OBJ: Multiple Choice

7. The CBOE brought numerous innovations to the option market, which of the following is not such an innovation? a. Creation of a central marketplace b. Creation of a non-liquid secondary option market c. Introduction of a Clearing Corporation d. Standardization of all expiration dates e. Standardization of all exercise prices ANS: B

PTS: 1

OBJ: Multiple Choice

8. Which of the following factors is not considered in the valuation of call and put options? a. Current stock price b. Exercise price c. Market interest rate d. Volatility of underlying stock price e. none of the above (that is, all are factors which should be considered in the valuation of call and put options) ANS: E

PTS: 1

OBJ: Multiple Choice

9. Which of the following statements is a true definition of an in-the-money option? a. A call option in which the stock price exceeds the exercise price. b. A call option in which the exercise price exceeds the stock price. c. A put option in which the stock price exceeds the exercise price. d. An index option in which the exercise price exceeds the stock price. e. A call option in which the call premium exceeds the stock price. ANS: A

PTS: 1

OBJ: Multiple Choice

10. The value of a call option just prior to expiration is (where V is the underlying asset's market price and X is the option's exercise price) a. Max [0, V  X]

b. c. d. e.

Max [0, X  V] Min [0, V  X] Min [0, X  V] Max [0, V > X]

ANS: A

PTS: 1

OBJ: Multiple Choice

11. Which of the following is not a factor needed to calculate the value of an American call option? a. The price of the underlying stock. b. The exercise price. c. The price of an equivalent put option. d. The volatility of the underlying stock. e. The interest rate. ANS: C

PTS: 1

OBJ: Multiple Choice

12. In the valuation of an option contract, the following statements apply except a. The value of an option increases with its maturity. b. There is a negative relationship between the market interest rate and the value of a call option. c. The value of a call option is negatively related to its exercise price. d. The value of a call option is positively related to the volatility of the underlying asset. e. The value of a call option is positively related to the price of the underlying stock. ANS: B

PTS: 1

OBJ: Multiple Choice

13. You own a stock that has risen from $10 per share to $32 per share. You wish to delay taking the profit but you are troubled about the short run behavior of the stock market. An effective action on your part would be to a. Buy a put option on the stock. b. Write a call option on the stock. c. Purchase an index option. d. Utilize a bearish spread. e. Utilize a bullish spread. ANS: A

PTS: 1

OBJ: Multiple Choice

14. A vertical spread involves buying and selling call options in the same stock with a. The same time period and exercise price. b. The same time period but different exercise price. c. A different time period but same exercise price. d. A different time period and different price. e. Quotes in different options markets. ANS: B

PTS: 1

OBJ: Multiple Choice

15. The value of a put option at expiration is a. Max [0, S(T)  X] b. Max [0, X  S(T)] c. Min [0, S(T)  X] d. Min [0, X  S(T)] e. X ANS: B

PTS: 1

OBJ: Multiple Choice

16. In the two state option pricing model, which of the following does not influence the option price? a. Past stock price b. Up and down factors u and d c. The risk free rate d. The exercise price e. Current stock price ANS: A

PTS: 1

OBJ: Multiple Choice

17. The cost of carry includes all of the following except a. Storage costs. b. Insurance. c. Current price. d. Financing costs. e. Risk free rate. ANS: C

PTS: 1

OBJ: Multiple Choice

18. A call option in which the stock price is higher than the exercise price is said to be a. At-the-money. b. In-the-money. c. Before-the-money. d. Out-of-the-money. e. Above-the-money. ANS: B

PTS: 1

OBJ: Multiple Choice

19. The price paid for the option contract is referred to as the a. Forward price. b. Exercise price. c. Striking price. d. Option premium. e. Call price. ANS: D

PTS: 1

OBJ: Multiple Choice

20. A stock currently sells for $75 per share. A call option on the stock with an exercise price $70 currently sells for $5.50. The call option is a. At-the-money. b. In-the-money. c. Out-of-the-money. d. At breakeven. e. None of the above. ANS: B

PTS: 1

OBJ: Multiple Choice

21. A stock currently sells for $150 per share. A call option on the stock with an exercise price $155 currently sells for $2.50. The call option is a. At-the-money. b. In-the-money. c. Out-of-the-money. d. At breakeven. e. None of the above. ANS: C

PTS: 1

OBJ: Multiple Choice

22. A stock currently sells for $75 per share. A put option on the stock with an exercise price $70 currently sells for $0.50. The put option is a. At-the-money. b. In-the-money. c. Out-of-the-money. d. At breakeven. e. None of the above. ANS: C

PTS: 1

OBJ: Multiple Choice

23. A stock currently sells for $15 per share. A put option on the stock with an exercise price $15 currently sells for $1.50. The put option is a. At-the-money. b. In-the-money. c. Out-of-the-money. d. At breakeven. e. None of the above. ANS: A

PTS: 1

OBJ: Multiple Choice

24. A stock currently sells for $15 per share. A put option on the stock with an exercise price $20 currently sells for $6.50. The put option is a. At-the-money. b. In-the-money. c. Out-of-the-money. d. At breakeven. e. None of the above. ANS: B

PTS: 1

OBJ: Multiple Choice

25. An equity portfolio manager can neutralize the risk of falling stock prices by entering into a hedge position where the payoffs are a. Not correlated with the existing exposure. b. Positively correlated with the existing exposure. c. Negatively correlated with the existing exposure. d. Any of the above. e. None of the above. ANS: C

PTS: 1

OBJ: Multiple Choice

26. The derivative based strategy known as portfolio insurance involves a. The sale of a put option on the underlying security position. b. The purchase of a put on the underlying security position. c. The sale of a call on the underlying security position. d. The purchase of a call on the underlying security position. e. b and d. ANS: B

PTS: 1

OBJ: Multiple Choice

27. A hedge strategy known as a collar agreement involves the simultaneous a. Purchase of an in-the money put and purchase of an out-of-the-money call on the same underlying asset with same expiration date and market price. b. Sale of an out-of-the money put and sale of an out-of-the-money call on the same underlying asset with same expiration date and market price. c. Purchase of an in-the money put and purchase of an in-the-money call on the same

underlying asset with same expiration date and market price. d. Purchase of an out-of-the money put and sale of an out-of-the-money call on the same underlying asset with same expiration date and market price. e. Sale of an in-the money put and purchase of an in-the-money call on the same underlying asset with same expiration date and market price. ANS: D

PTS: 1

OBJ: Multiple Choice

28. A call option differs from a put option in that a. a call option obliges the investor to purchase a given number of shares in a specific common stock at a set price; a put obliges the investor to sell a certain number of shares in a common stock at a set price. b. both give the investor the opportunity to participate in stock market dealings without the risk of actual stock ownership. c. a call option gives the investor the right to purchase a given number of shares of a specified stock at a set price; a put option gives the investor the right to sell a given number of shares of a stock at a set price. d. a put option has risk, since leverage is not as great as with a call. e. none of the above ANS: C

PTS: 1

OBJ: Multiple Choice

29. Which of the following statements is a true definition of an out-of-the-money option? a. A call option in which the stock price exceeds the exercise price. b. A call option in which the exercise price exceeds the stock price. c. A call option in which the exercise price exceeds the stock price. d. A put option in which the exercise price exceeds the stock price. e. A call option in which the call premium exceeds the stock price. ANS: B

PTS: 1

OBJ: Multiple Choice

30. According to put/call parity a. Stock price + Call Price = Put Price + Risk Free Bond Price b. Stock price + Put Price = Call Price + Risk Free Bond Price c. Put price + Call Price = Stock Price + Risk Free Bond Price d. Stock price  Put Price = Call Price + Risk Free Bond Price e. Stock price + Call Price = Put Price  Risk Free Bond Price ANS: B

PTS: 1

OBJ: Multiple Choice

31. Futures contracts are similar to forward contracts in that they both a. Have volatile price movements and strong interest from buyers and sellers. b. Give the holder the option to make a transaction in the future. c. Have similar liquidity. d. Have similar credit risk. e. None of the above. ANS: A

PTS: 1

OBJ: Multiple Choice

32. Which of the following statements are true? a. Futures contracts have less liquidity risk and credit risk than forward contracts. b. Futures contract prices are strongly linked to the prevailing level of the underlying spot index. c. Futures contract decrease in price, the further forward in time the delivery date is set. d. All of the above.

e. None of the above. ANS: B

PTS: 1

OBJ: Multiple Choice

33. A buyer of the call option is speculating on the a. Direction of the price movement of the underlying investment. b. Timing of the price movement of the underlying investment. c. Leverage that a call option creates with respect to the underlying investment. d. All of the above. e. None of the above. ANS: D

PTS: 1

OBJ: Multiple Choice

34. Which of the following is consistent with put-call-spot parity? a. S + C = P + X/(1 + RFR) b. S + P = C + X/(1 + RFR) c. S  C = P + X/(1 + RFR) d. S  P = C + X/(1 + RFR) e. S = P  C + X/(1 + RFR) ANS: B

PTS: 1

OBJ: Multiple Choice

35. Holding a put option and the underlying security at the same time is an example of a. Collar b. Straddle c. Income generation d. Portfolio insurance e. None of the above ANS: D

PTS: 1

OBJ: Multiple Choice

36. Derivative securities can be used a. By investors in the same way as the underlying security b. To modify the risk and expected return characteristics of existing investment portfolios c. To duplicate cash flow patterns for arbitrage opportunities d. All of the above e. None of the above ANS: D

PTS: 1

OBJ: Multiple Choice

37. An advantage of a forward contract over a futures contract is that a. The terms of the contract are flexible b. It is more liquid c. It trades through a centralized market exchange d. It is easier to unwind due to contract homogeneity e. None of the above ANS: A

PTS: 1

OBJ: Multiple Choice

38. A forward contract is similar to an option contract because they both a. Can provide insurance against the price of the underlying stock b. Are paid for up front in the form of premiums c. Are paid for at the end of the contract in the form of premiums d. Require a future settlement payment e. None of the above

ANS: A

PTS: 1

OBJ: Multiple Choice

39. An expiration date payoff and profit diagram for forward positions illustrates a. Gains and losses are usually small b. The payoffs to both long and short positions in the forward contract are asymmetrical around the contract price c. Forward contracts are zero-sum games d. Long positions benefit from falling prices e. None of the above ANS: C

PTS: 1

OBJ: Multiple Choice

40. A one year call option has a strike price of 50, expires in 6 months, and has a price of $5.04. If the risk free rate is 5%, and the current stock price is $50, what should the corresponding put be worth? a. $3.04 b. $4.64 c. $6.08 d. $3.83 e. $0 ANS: D p(t) = $5.04  $50+ $50(1 + .05)1/2 = $3.83 PTS: 1

OBJ: Multiple Choice Problem

41. A one year call option has a strike price of 50, expires in 6 months, and has a price of $4.74. If the risk free rate is 3%, and the current stock price is $45, what should the corresponding put be worth? a. $12.74 b. $10.48 c. $5.00 d. $9.00 e. $8.30 ANS: D p(t) = $4.74  $45+ $50(1 + .03) 1/2 = $9.0 PTS: 1

OBJ: Multiple Choice Problem

42. A one year call option has a strike price of 60, expires in 6 months, and has a price of $2.5. If the risk free rate is 7%, and the current stock price is $55, what should the corresponding put be worth? a. $5.00 b. $4.56 c. $5.50 d. $7.08 e. $7.54 ANS: C p(t) = $2.5  $55+ $60(1 + .07) 1/2 = $5.50 PTS: 1

OBJ: Multiple Choice Problem

43. A one year call option has a strike price of 70, expires in 3 months, and has a price of $7.34. If the risk free rate is 6%, and the current stock price is $62, what should the corresponding put be worth? a. $5.34 b. $8.00

c. $10.68 d. $14.33 e. $13.33 ANS: D p(t) = $7.34  $62 + $70(1 + .06) 1/4 = $14.33 PTS: 1

OBJ: Multiple Choice Problem

Exhibit 20.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) December futures on the S&P 500 stock index trade at 250 times the index value of 1187.70. Your broker requires an initial margin of 10% percent on futures contracts. The current value of the S&P 500 stock index is 1178. 44. Refer to Exhibit 20.1. How much must you deposit in a margin account if you wish to purchase one contract? a. $267,232.5 b. $29,450 c. $29,692.50 d. $30,000 e. $265,050 ANS: C Margin = 0.10  250  1187.70 = $29,692.50 PTS: 1

OBJ: Multiple Choice Problem

45. Refer to Exhibit 20.1. Suppose at expiration the futures contract price is 250 times the index value of 1170. Disregarding transaction costs, what is your percentage return? a. 1.87% b. 0.68% c. 14.90% d. 10.36% e. None of the above ANS: C Purchase December contract 250  1187.7 = $296,925 Sell December contract 250  1170 = $292,500 Loss in futures = $292,500  $296,925 = $4425 Rate of return = $4425/29,692.50 = .1490 or 14.9% PTS: 1

OBJ: Multiple Choice Problem

46. Refer to Exhibit 20.1. Calculate the return on a cash investment in the S&P 500 stock index if the ending index value is 1170 over the same time period. a. 1.87%

b. c. d. e.

0.68% 14.90% 10.36% None of the above

ANS: B Return on cash investment in the index = (1170  1178)/1178 = 0.0068 or 0.68% PTS: 1

OBJ: Multiple Choice Problem

Exhibit 20.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A futures contract on Treasury bond futures with a December expiration date currently trade at 103:06. The face value of a Treasury bond futures contract is $100,000. Your broker requires an initial margin of 10%. 47. Refer to Exhibit 20.2. Calculate the current value of one contract. a. $100,000 b. $103,600.5 c. $103,187.5 d. $102,306.3 e. $104,293.5 ANS: C Current price is 103 6/32 percent of face value of $100,000 = 1.031875  100,000 = $103,187.50 PTS: 1

OBJ: Multiple Choice Problem

48. Refer to Exhibit 20.2. Calculate the initial margin deposit. a. $10,000 b. $10,360.50 c. $10,318.75 d. $10,230.63 e. $10,429.35 ANS: C Margin deposit = 0.10  103,187.5 = $10,318.75 PTS: 1

OBJ: Multiple Choice Problem

49. Refer to Exhibit 20.2. If the futures contract is quoted at 105:08 at expiration calculate the percentage return. a. 1.99% b. 19.99% c. 20.62% d. 25.37% e. 13.65% ANS: B Purchase December contract 103 6/32 percent of 100,000 = $103,187.50

Sell December contract 105 8/32 percent of $100,000 = $105,250 Gain in futures = $105,250  $103,187.50 = $2,062.50 Rate of return = 2062.5/10318.75 = 0.1999 or 19.9% PTS: 1

OBJ: Multiple Choice Problem

Exhibit 20.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) On the last day of October, Bruce Springsteen is considering the purchase of 100 shares of Olivia Corporation common stock selling at $37 1/2 per share and also considering an Olivia option. Calls Price 35 40

December 3 3/4 2 1/2

Puts March 5 3 1/2

December 1 1/4 4 1/2

March 2 4 3/4

50. Refer to Exhibit 20.3. If Bruce decides to buy a March call option with an exercise price of 35, what is his dollar gain (loss) if he closes his position when the stock is selling at 43 1/2? a. $225.00 loss b. $350.00 loss c. $225.00 gain d. $350.00 gain e. $850.00 gain ANS: D 43 1/2  35 = 8.5 8.5  5 = 3.5. $3.5/share  100 shares/contract = $350.00 PTS: 1

OBJ: Multiple Choice Problem

51. Refer to Exhibit 20.3. If Bruce buys a March put option with an exercise price of 40, what is his dollar gain (loss) if he closes his position when the stock is selling at 43 1/2? a. $825.00 loss b. $475.00 loss c. $350.00 loss d. $25.00 loss e. He has a gain ANS: B The option is worthless so he loses the $475 he paid for the contract. PTS: 1

OBJ: Multiple Choice Problem

Exhibit 20.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Rick Thompson is considering the following alternatives for investing in Davis Industries which is now selling for $44 per share: (1)

Buy 500 shares, and

(2)

Buy six month call options with an exercise price of 45 for $3.25 premium.

52. Refer to Exhibit 20.4. Assuming no commissions or taxes what is the annualized percentage gain if the stock reaches $50 in four months and a call was purchased? a. 161.54% gain b. 53.85% gain c. 161.54% loss d. 11.11% gain e. 53.85% loss ANS: A [(50  45  3.25)  3.25]  3 = 161.54% gain PTS: 1

OBJ: Multiple Choice Problem

53. Refer to Exhibit 20.4. Assuming no commissions or taxes, what is the annualized percentage gain if the stock is at $30 in four months and the stock was purchased? a. 9.54% loss b. 95.45% loss c. 0.9545% gain d. 95.45% gain e. 9.54% gain ANS: B [(30  44)  44]  3 = 95.45% loss PTS: 1

OBJ: Multiple Choice Problem

54. Tom Gettback buys 100 shares of Johnson Walker stock for $87.00 per share and a 3-month Johnson Walker put option with an exercise price of $105.00 for $20.00. What is his dollar gain if at expiration the stock is selling for $80.00 per share? a. $200 loss b. $700 loss c. $200 gain d. $700 gain e. None of the above ANS: A Profit on put = 105  80  20 = 5 5  100 = $500.00 Loss on stock = $700.00 Net loss = $700.00  500.00 = $200.00 (loss) PTS: 1

OBJ: Multiple Choice Problem

55. Tom Gettback buys 100 shares of Johnson Walker stock for $87.00 per share and a 3-month Johnson Walker put option with an exercise price of $105.00 for $20.00. What is Tom's dollar gain/loss if at expiration the stock is selling for $105.00 per share? a. $1000 gain b. $200 loss c. $1000 loss d. $200 gain

e. None of the above ANS: B Put value = 0, therefore, loss = $2,000.00 Stock (105  87)(100) = $1,800.00 Net loss = $2,000  1,800 = $200.00 (loss) PTS: 1

OBJ: Multiple Choice Problem

Exhibit 20.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Sarah Kling bought a 6-month Peppy Cola put option with an exercise price of $55 for a premium of $8.25 when Peppy was selling for $48.00 per share. 56. Refer to Exhibit 20.5. If at expiration Peppy is selling for $42.00, what is Sarah's dollar gain or loss? a. $420 gain b. $420 loss c. $475 loss d. $475 gain e. None of the above ANS: D [(55  42  8.25)  100] = $475 gain PTS: 1

OBJ: Multiple Choice Problem

57. Refer to Exhibit 20.5. What is Sarah's annualized gain/loss? a. 11.51% gain b. 115.15% gain c. 11.51% loss d. 115.15% loss e. None of the above ANS: B [(55  42  8.25)  8.25]  2 = 115.15% gain PTS: 1

OBJ: Multiple Choice Problem

58. Refer to Exhibit 20.5. If at expiration Peppy is selling for $47.00, what is Sarah's dollar gain or loss? a. $25 loss b. $250 loss c. $25 gain d. $250 gain e. None of the above ANS: A [(55  47  8.25)  100] = $25 loss PTS: 1

OBJ: Multiple Choice Problem

59. Refer to Exhibit 20.5. What is Sarah's annualized gain/loss?

a. b. c. d. e.

60.60% gain 6.06% loss 60.60% loss 6.06% gain None of the above

ANS: B [(55  47  8.25)  8.25]  2 = 6.06% loss PTS: 1

OBJ: Multiple Choice Problem

60. A stock currently trades for $25. January call options with a strike price of $30 sell for $6. The appropriate risk free bond has a price of $30. Calculate the price of the January put option. a. $11 b. $24 c. $19 d. $30 e. $25 ANS: A P = 6 + 30  25 = $11 PTS: 1

OBJ: Multiple Choice Problem

61. A stock currently trades for $115. January call options with a strike price of $100 sell for $16, and January put options a strike price of $100 sell for $5. Estimate the price of a risk free bond. a. $120 b. $15 c. $105 d. $116 e. $104 ANS: E Bond price = 115 + 5  16 = $104 PTS: 1

OBJ: Multiple Choice Problem

62. Assume that you have purchased a call option with a strike price $60 for $5. At the same time you purchase a put option on the same stock with a strike price of $60 for $4. If the stock is currently selling for $75 per share, calculate the dollar return on this option strategy. a. $10 b. $4 c. $5 d. $6 e. $15 ANS: D Profit on call = (75  60)  5 = 10 Profit on put = 4 Total = $6 PTS: 1

OBJ: Multiple Choice Problem

63. Assume that you purchased shares of a stock at a price of $35 per share. At this time you purchased a put option with a $35 strike price of $3. The stock currently trades at $40. Calculate the dollar return on this option strategy. a. $3 b. $2 c. $2 d. $3 e. $0 ANS: C Profit on stock = 40  35 = 5 Profit on put = 3 Total = $2 PTS: 1

OBJ: Multiple Choice Problem

64. Assume that you purchased shares of a stock at a price of $35 per share. At this time you wrote a call option with a $35 strike and received a call price of $2. The stock currently trades at $70. Calculate the dollar return on this option strategy. a. $25 b. $2 c. $2 d. $25 e. $0 ANS: C Profit on stock = 70  35 = 35 Profit on call = 35  70 + 2 = 23 Total = $2 PTS: 1

OBJ: Multiple Choice Problem

65. A stock currently trades at $110. June call options on the stock with a strike price of $105 are priced at $4. Calculate the arbitrage profit that you can earn. a. $0 b. $1 c. $5 d. $4 e. None of the above ANS: B Arbitrage profit = 110  105  4 = $1 PTS: 1

OBJ: Multiple Choice Problem

66. Datacorp stock currently trades at $50. August call options on the stock with a strike price of $55 are priced at $5.75. October call options with a strike price of $55 are priced at $6.25. Calculate the value of the time premium between the August and October options. a. $0.50 b. $0 c. $0.50 d. $5 e. $5

ANS: C Time premium = 6.25  5.75 = $0.50 PTS: 1

OBJ: Multiple Choice Problem

67. A stock currently trades at $110. June put options on the stock with a strike price of $100 are priced at $5.25. Calculate the dollar return on one put contract. a. $525 b. $1000 c. $0 d. $1000 e. $525 ANS: A Dollar return = (100  110  5.25)(100) = $525 PTS: 1

OBJ: Multiple Choice Problem

68. A stock currently trades at $110. June call options on the stock with a strike price of $120 are priced at $5.75. Calculate the dollar return on one call contract. a. $1000 b. $1000 c. $575 d. $575 e. $0 ANS: D Dollar return = (110  120  5.75)(100) = $575 PTS: 1

OBJ: Multiple Choice Problem

69. Consider a stock that is currently trading at $65. Calculate the intrinsic value for a put option that has an exercise price of $55. a. $10 b. $50 c. $55 d. $10 e. $0 ANS: E Put = Max[55  65, 0] = $0 PTS: 1

OBJ: Multiple Choice Problem

70. Consider a stock that is currently trading at $20. Calculate the intrinsic value for a put option that has an exercise price of $35. a. $15 b. $55 c. $35 d. $15 e. $0 ANS: A Put = Max[35  20, 0] = $15

PTS: 1

OBJ: Multiple Choice Problem

71. Consider a stock that is currently trading at $45. Calculate the intrinsic value for a call option that has an exercise price of $35. a. $25 b. $35 c. $0 d. $10 e. $10 ANS: E Call = Max[45  35, 0] = $10 PTS: 1

OBJ: Multiple Choice Problem

72. Consider a stock that is currently trading at $10. Calculate the intrinsic value for a call option that has an exercise price of $15. a. $25 b. $5 c. $0 d. $20 e. $5 ANS: C Call = Max[10  15, 0] = $0 PTS: 1

OBJ: Multiple Choice Problem

Exhibit 20.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The current stock price of ABC Corporation is $53.50. ABC Corporation has the following put and call option prices that expire 6 months from today. The risk-free rate of return is 5% and the expected return on the market is 11%. Exercise Price 50 55

Put Price $1.50 $3.25

Call Price $5.75 ---

73. Refer to Exhibit 20.6. What should the price be of a call option that expires 6 month from today with an exercise price of $55? a. $1.33 b. $3.08 c. $4.58 d. $6.07 e. $6.33 ANS: B C = P + S  X/(1 + RFR)t = 3.25 + 53.50  $55/(1.05)0.5 = 56.75  53.67 = 3.08 PTS: 1

OBJ: Multiple Choice Problem

74. Refer to Exhibit 20.6. What is the value of a synthetic stock created with put and call options that expire in 6 months with an expiration price of $50? a. $53.04 b. $53.53 c. $54.54 d. $55.03 e. $56.23 ANS: A S = C  P + X/(1 + RFR)t = 5.75  1.50 + $50/(1.05)0.5 = 4.25 + 48.79 = 53.04 PTS: 1

OBJ: Multiple Choice Problem

75. Refer to Exhibit 20.6. How could an investor create arbitrage profits? a. Sell the stock short, write a put, buy a call and invest the proceeds at the risk-free rate. b. Buy the stock, write a put, buy a call and invest the proceeds at the risk-free rate. c. Sell the stock short, buy a put, write a call and invest the proceeds at the risk-free rate. d. Buy the stock, write a put, buy a call and borrow the strike price at the risk-free rate. e. Sell the stock short, write a put, buy a call and borrow the strike price at the risk-free rate. ANS: A The stock price is $53.50 and the synthetic stock price is $53.04. The synthetic stock price is created by combining a long call, short put, and the present value of the strike price. The synthetic stock and stock price must converge. So shorting the stock (S) and going long the synthetic stock (C  P + PV(X)) will create an arbitrage profit. PTS: 1

OBJ: Multiple Choice Problem

76. A stock currently trades for $63. Call options with a strike price of $62 sell for $4.00 and expire in 6 months. If the risk-free rate is 4% what should the price of a put option with an exercise price of $62 be worth? a. $0.62 b. $0.98 c. $1.80 d. $3.00 e. $5.80 ANS: C P = C + X/(1 + RFR)t  S = $4 + $62/(1.04)0.5  $63 = $4 + $60.80  $63 = $1.80 PTS: 1

OBJ: Multiple Choice Problem

77. You own a call option and put option that both have the same exercise price of $50 and their respective prices are $4 and $3. The stock is currently trading at $60. Calculate the dollar return on this strategy. a. $1.00 b. $2.00 c. $3.00 d. $4.00 e. $5.00 ANS: C $60  $50  $7 = $3 PTS: 1

OBJ: Multiple Choice Problem

Exhibit 20.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The current stock price of Zanco Corporation is $50. Zanco Corporation has the following put and call option prices with exercise prices at $45 and $50. Exercise Price $45 $50

Put Price $1.50 $3.75

Call Price $6.75 $4.25

78. Refer to Exhibit 20.7. The time premium for the put option with a $45 exercise price is a. $0.00 b. $1.50 c. $2.75 d. $5.25 e. $6.50 ANS: B The time premium for the put option with a $45 exercise price is $1.50. The put option is out of the money so the market price is purely a time premium. PTS: 1

OBJ: Multiple Choice Problem

79. Refer to Exhibit 20.7. The intrinsic value for the put option with a $50 exercise price is a. $0.00 b. $1.50 c. $2.25 d. $3.75 e. $8.75 ANS: A The intrinsic value for the put option with a $50 exercise price is $0.00. The put option is out of the money so there is no intrinsic value. PTS: 1

OBJ: Multiple Choice Problem

80. Refer to Exhibit 20.7. The intrinsic value for the call option with a $45 exercise price is a. $0.00 b. $1.50 c. $5.00 d. $5.25 e. $6.75 ANS: C The intrinsic value for the call option with a $45 exercise price is $5.00. The call option is in the money so the difference between the current stock price of $50 and the strike price equals the intrinsic value. PTS: 1

OBJ: Multiple Choice Problem

81. Refer to Exhibit 20.7. The time premium for the call option with a $50 exercise price is a. $0.00 b. $1.50

c. $1.75 d. $4.25 e. $9.25 ANS: D The time premium for the call option with a $50 exercise price is $4.25. The call option is out of the money so the market price is purely a time premium. PTS: 1

OBJ: Multiple Choice Problem