Chapter 22

Options and Corporate Finance

Multiple Choice Questions

1. A financial contract that gives its owner the right, but not the obligation, to buy or sell
a specified asset at an agreed-upon price on or before a given future date is called
a(n) _____ contract.

A. optio
n
B. future
s
C. forwar
d
D. swa
p
E. straddl
e

2. The act where an owner of an option buys or sells the underlying asset, as is his right,
is called ______ the option.

A. strikin
g
B. exercisin
g
C. openin
g
D. splitti
ng
E. strangli
ng

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3. The fixed price in an option contract at which the owner can buy or sell the underlying
asset is called the option's:

A. opening
price.
B. intrinsic
value.
C. strike
price.
D. market
price.
E. time
value.

4. The last day on which an owner of an option can elect to exercise is the _____ date.

A. ex-
payment
B. ex-
option
C. openin
g
D. expirati
on
E. intrins
ic

5. An option that may be exercised at any time up to its expiration date is called a(n)
_____ option.

A. future
s
B. Asia
n
C. Bermuda
n
D. Europea
n
E. America
n

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6. An option that may be exercised only on the expiration date is called a(n) _____
option.

A. Europea
n
B. America
n
C. Bermuda
n
D. future
s
E. Asia
n

7. A _____ is a derivative security that gives the owner the right, but not the obligation,
to buy an asset at a fixed price for a specified period of time.

A. futures
contract
B. call
option
C. put
option
D. swa
p
E. forward
contract

8. A _____ is a derivative security that gives the owner the right, but not the obligation,
to sell an asset at a fixed price for a specified period of time.

A. futures
contract
B. call
option
C. put
option
D. swa
p
E. forward
contract

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9. A trading opportunity that offers a riskless profit is called a(n):

A. put
option.
B. call
option.
C. market
equilibrium.
D. arbitrag
e.
E. cross-
hedge.

10. The value of an option if it were to immediately expire, that is, its lower pricing bound,
is called an option's _____ value.

A. strik
e
B. mark
et
C. volatili
ty
D. tim
e
E. intrins
ic

11. The relationship between the prices of the underlying stock, a call option, a put
option, and a riskless asset is referred to as the _____ relationship.

A. put-call
parity
B. covered
call
C. protective
put
D. straddl
e
E. strangl
e

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12. The effect on an option's value of a small change in the value of the underlying asset
is called the option:

A. thet
a.
B. vega
.
C. rho
.
D. delt
a.
E. gamm
a.

13. An option that grants the right, but not the obligation, to sell shares of the underlying
asset on a particular date at a specified price is called:

A. either an American or a European

option.
B. an American
call.
C. an American
put.
D. a European
put.
E. a European
call.

14. Which one of the following provides the option of selling a stock anytime during the
option period at a specified price even if the market price of the stock declines to
zero?

A. American
call
B. European
call
C. American
put
D. European
put
E. either an American or a
European put

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15. Given an exercise price, time to maturity, and European put-call parity, the present
value of the strike price plus the call option is equal to:

A. the current market value of the

stock.
B. the present value of the stock minus a put
option.
C. a put option minus the market value of the share
of stock.
D. the value of a U.S. Treasury
bill.
E. the share of stock plus the put
option.

16. You can realize the same value as that derived from stock ownership if you:

A. sell a put option and invest at the risk-free rate

of return.
B. buy a call option and write a put option on a stock and also borrow funds at the
risk-free rate.
C. sell a put and buy a call on a stock as well as invest at the risk-free
rate of return.
D. lend out funds at the risk-free rate of return and sell a put option
on the stock.
E. borrow funds at the risk-free rate of return and invest the proceeds in equivalent
amounts of put and call options.

17. Which one of the following statements correctly describes your situation as the owner
of an American call option?

A. You are obligated to buy at a set price at any time up to and including the
expiration date.
B. You have the right to sell at a set price at any time up to and including the
expiration date.
C. You have the right to buy at a set price only on the
expiration date.
D. You are obligated to sell at a set price if the option is
exercised.
E. You have the right to buy at a set price at any time up to and including the
expiration date.

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18. Jeff opted to exercise his August option on August 10 and received $2,500 in
exchange for his shares. Jeff must have owned a(an):

A. warran
t.
B. American
call.
C. American
put.
D. European
call.
E. European
put.

19. Jillian owns an option which gives her the right to purchase shares of WAN stock at a
price of $20 a share. Currently, WAN stock is selling for $24.50. Jillian would like to
profit on this stock but is not permitted to exercise her option for another two weeks.
Which of the following statements apply to this situation?

I. Jillian must own a European call option.

II. Jillian must own an American put option.
III. Jillian should sell her option today if she feels the price of WAN stock will decline
significantly over the next two weeks.
IV. Jillian cannot profit today from the price increase in WAN stock.

A. I and III
only
B. II and IV
only
C. I and IV
only
D. II and III
only
E. I, III, and IV
only

20. The difference between an American call and a European call is that the American
call:

A. has a fixed exercise price while the European exercise price can vary within a
small range.
B. is a right to buy while a European call is an
obligation to buy.
C. has an expiration date while the European call
does not.
D. is written on 100 shares of the underlying security while the European call covers
1,000 shares.
E. can be exercised at any time up to the expiration date while the European call can
only be exercised on the expiration date.

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21. If a call has a positive intrinsic value at expiration the call is said to be:

A. funde
d.
B. unfunde
d.
C. at the
money.
D. in the
money.
E. out of the
money.

22. A put option with a $35 exercise price on ABC stock expires today. The current price
of ABC stock is $36.
The put is:

A. funde
d.
B. unfunde
d.
C. at the
money.
D. in the
money.
E. out of the
money.

23. The maximum value of a call option is equal to:

A. the strike price minus the initial cost of the

option.
B. the exercise price plus the price of the
underlying stock.
C. the strike
price.
D. the price of the underlying
stock.
E. the purchase
price.

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24. The lower bound on a call's value is either the:

A. strike price or zero, whichever is

greater.
B. stock price minus the exercise price or zero, whichever is
greater.
C. strike price or the stock price, whichever is
lower.
D. strike price or zero, whichever is
lower.
E. stock price minus the exercise price or zero, whichever
is lower.

25. The lower bound of a call option:

A. can be a negative value regardless of the stock or

exercise prices.
B. can be a negative value but only when the exercise price exceeds the
stock price.
C. can be a negative value but only when the stock price exceeds the
exercise price.
D. must be greater than
zero.
E. can be equal to
zero.

26. The intrinsic value of a call is:

I. the value of the call if it were about to expire.

II. equal to the lower bound of a call's value.
III. another name for the market price of a call.
IV. always equal to zero if the call is currently out of the money.

A. I and III
only
B. II and IV
only
C. I and II
only
D. II, III, and IV
only
E. I, II, and IV
only

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27. The intrinsic value of a put is equal to the:

A. lesser of the strike price or the stock

price.
B. lesser of the stock price minus the exercise price
or zero.
C. lesser of the stock price or
zero.
D. greater of the strike price minus the stock price
or zero.
E. greater of the stock price minus the exercise price
or zero.

28. Which of the following statements are correct concerning option values?

I. The value of a call increases as the price of the underlying stock increases.
II. The value of a call decreases as the exercise price increases.
III. The value of a put increases as the price of the underlying stock increases.
IV. The value of a put decreases as the exercise price increases.

A. I and III
only
B. II and IV
only
C. I and II
only
D. II and III
only
E. I, II, and IV
only

29. The value of a call increases when:

I. the time to expiration increases.

II. the stock price increases.
III. the risk-free rate of return increases.
IV. the volatility of the price of the underlying stock increases.

A. I and III
only
B. II, III, and IV
only
C. I, III, and IV
only
D. I, II, and III
only
E. I, II, III, and
IV

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30. Which one of the following will cause the value of a call to decrease?

A. lowering the exercise

price
B. increasing the time to
expiration
C. increasing the risk-free
rate
D. lowering the risk level of the underlying
security
E. increasing the stock
price

31. Assume that you own both a May 40 put and a May 40 call on ABC stock. Which one of
the following statements is correct concerning your option positions? Ignore taxes and
transaction costs.

A. An increase in the stock price will increase the value of your put and decrease the
value of your call.
B. Both a May 45 put and a May 45 call will have higher values than your May
40 options.
C. The time premiums on both your put and call are less than the time premiums on
equivalent June options.
D. A decrease in the stock price will decrease the value of both of
your options.
E. You cannot profit on your position as your profits on one option will be offset by
losses on the other option.

32. You own both a May 20 call and a May 20 put. If the call finishes in the money, then
the put will:

A. also finish in the

money.
B. finish at the
money.
C. finish out of the
money.
D. either finish at the money or in the
money.
E. either finish at the money or out of the
money.

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33. You own stock in a firm that has a pure discount loan due in six months. The loan has
a face value of $50,000. The assets of the firm are currently worth $62,000. The
stockholders in this firm basically own a _____ option on the assets of the firm with a
strike price of ______

A. put;
$62,000.
B. put;
$50,000.
C. warrant;
$62,000.
D. call;
$62,000.
E. call;
$50,000.

34. The owner of a call option has the:

A. right but not the obligation to buy a stock at a specified price on a

specified date.
B. right but not the obligation to buy a stock at a specified price during a specified
period of time.
C. obligation to buy a stock on a specified date but only at the
specified price.
D. obligation to buy a stock sometime during a specified period of time at the
specified price.
E. obligation to buy a stock at the lower of the exercise price or the market price on
the expiration date.

35. In the Black-Scholes option pricing formula, N(d1) is the probability that a
standardized, normally distributed random variable is:

A. less than or equal to

N(d2).
B. less than
one.
C. equal to
one.
D. equal to
d1.
E. less than or equal to
d1.

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36. To compute the value of a put using the Black-Scholes option pricing model, you:

A. first have to apply the put-call parity

relationship.
B. first have to compute the value of the put as if it
is a call.
C. compute the value of an equivalent call and then subtract that
value from one.
D. compute the value of an equivalent call and then subtract that value from the
market price of the stock.
E. compute the value of an equivalent call and then multiply that
value by e-RT.

37. If you consider the equity of a firm to be an option on the firm's assets then the act of
paying off debt is comparable to _____ on the assets of the firm.

A. purchasing a put
option
B. purchasing a call
option
C. exercising an in-the-money put
option
D. exercising an in-the-money call
option
E. selling a call
option

38. For every positive net present value project that a firm undertakes, the equity in the
firm will increase the most if the delta of the call option on the firm's assets is:

A. equal to
one.
B. between zero and
one.
C. equal to
zero.
D. between zero and minus
one.
E. equal to minus
one.

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39. Shareholders in a leveraged firm might wish to accept a negative net present value
project if:

A. it increases the standard deviation of the returns on the

firm's assets.
B. it lowers the variance of the returns on the firm's
assets.
C. it lowers the risk level of the
firm.
D. it diversifies the cash flows of the
firm.
E. it decreases the risk that a firm will default on
its debt.

40. Which of the following statements is true?

A. American options are options on securities of U.S. corporations, and the options are
traded on American exchanges. European options are options on securities of U.S.
corporations, but the options are traded on European exchanges.
B. American options are options on securities which are traded on American
exchanges. European options, also traded on American exchanges, are options on
European corporations.
C. American options give the holder the right to the dividend payment. European
options do not.
D. American options may be exercised anytime up to expiration. European options
may be exercised only at expiration.
E. None of
these.

41. An out-of-the-money call option is one that:

A. has an exercise price below the current market price of the

underlying security.
B. should not be
exercised.
C. has an exercise price above the current market price of the
underlying security.
D. Both has an exercise price below the current market price of the underlying
security; and should not be exercised.
E. Both should not be exercised; and has an exercise price above the current market
price of the underlying security.

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42. Which of the following is not true concerning call option writers?

A. Writers promise to deliver shares if exercised by

the buyer.
B. The writer has the option to sell shares but not an
obligation.
C. The writer's liability is zero if the option expires out-of-
the-money.
D. The writer receives a cash payment from the buyer at the time the option is
purchased.
E. The writer has a loss if the market price rises substantially above the
exercise price.

43. An in-the-money put option is one that:

A. has an exercise price greater than the underlying

stock price.
B. has an exercise price less than the underlying
stock price.
C. has an exercise price equal to the underlying
stock price.
D. should not be exercised at
expiration.
E. should not be exercised at any
time.

44. Which of the following statements is true?

A. At expiration the maximum price of a call is the greater of (Stock Price -

Exercise) or 0.
B. At expiration the maximum price of a call is the greater of (Exercise - Stock
Price) or 0.
C. At expiration the maximum price of a put is the greater of (Stock Price -
Exercise) or 0.
D. At expiration the maximum price of a put is the greater of (Exercise - Stock
Price) or 0.
E. Both At expiration the maximum price of a call is the greater of (Stock Price -
Exercise) or 0; and At expiration the maximum price of a put is the greater of
(Exercise - Stock Price) or 0.

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45. Put-call parity can be used to show:

A. how far in-the-money put options

can get.
B. how far in-the-money call options
can get.
C. the precise relationship between put and call prices given equal exercise prices and
equal expiration dates.
D. that the value of a call option is always twice that of a put given equal exercise
prices and equal expiration dates.
E. that the value of a call option is always half that of a put given equal exercise
prices and equal expiration dates.

46. Tele-Tech Com announces a major expansion into Internet services. This
announcement causes the price of Tele-Tech Com stock to increase, but also causes
an increase in price volatility of the stock.

Which of the following correctly identifies the impact of these changes on a call option
of Tele-Tech Com?

A. Both changes cause the price of the call option to

decrease.
B. Both changes cause the price of the call option to
increase.
C. The greater uncertainty will cause the price of the call option to decrease. The
higher price of the stock will cause the price of the call option to increase.
D. The greater uncertainty will cause the price of the call option to increase. The
higher price of the stock will cause the price of the call option to decrease.
E. The greater uncertainty has no direct effect on the price of the call option. The
higher price of the stock will cause the price of the call option to decrease.

47. Tele-Tech Com announces a major expansion into Internet services. This
announcement causes the price of Tele-Tech Com stock to increase, but also causes
an increase in price volatility of the stock.

Which of the following correctly identifies the impact of these changes on a put option
of Tele-Tech Com?

A. Both changes cause the price of the put option to

decrease.
B. Both changes cause the price of the put option to
increase.
C. The greater uncertainty will cause the price of the put option to decrease. The
higher price of the stock will cause the price of the put option to increase.
D. The greater uncertainty will cause the price of the put option to increase. The
higher price of the stock will cause the price of the put option to decrease.
E. The greater uncertainty has no direct effect on the price of the put option. The
higher price of the stock will cause the price of the put option to decrease.

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48. The delta of a call measures:

A. the change in the ending stock

value.
B. the change in the ending option
value.
C. the swing in the price of the call relative to the swing in
stock price.
D. the ratio of the change in the exercise price to the change in the
stock price.
E. None of
these.

49. The Black-Scholes option pricing model is dependent on which five parameters?

A. Stock price, exercise price, risk free rate, probability, and time
to maturity
B. Stock price, risk free rate, probability, time to maturity,
and variance
C. Stock price, risk free rate, probability, variance and
exercise price
D. Stock price, exercise price, risk free rate, variance and time
to maturity
E. Exercise price, probability, stock price, variance and time
to maturity

50. What is the cost of five November 25 call option contracts on KNJ stock given the
following price quotes?

A. $61
5
B. $66
0
C. $2,50
0
D. $3,07
5
E. $3,30
0

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51. What is the value of one November 35 put contract?

A. $7
0
B. $46
0
C. $51
0
D. $4,60
0
E. $5,10
0

52. What is the intrinsic value of the August 25 call?

A. $0.1
0
B. $5.8
6
C. $6.1
5
D. $10.0
0
E. $25.0
0

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53. You purchased six TJH call option contracts with a strike price of $40 when the option
was quoted at $1.30. The option expires today when the value of TJH stock is $41.90.
Ignoring trading costs and taxes, what is your total profit or loss on your investment?

A. $6
0
B. $32
0
C. $36
0
D. $42
0
E. $54
0

54. You purchased four WXO 30 call option contracts at a quoted price of $.34. What is
your net gain or loss on this investment if the price of WXO is $33.60 on the option
expiration date?

A. -
$1,57
6
B. -
$136
C. $1,30
4
D. $1,44
0
E. $1,57
6

55. You wrote ten call option contracts on JIG stock with a strike price of $40 and an
option price of $.40. What is your net gain or loss on this investment if the price of JIG
is $46.05 on the option expiration date?

A. -
$6,45
0
B. -
$5,65
0
C. $40
0
D. $5,65
0
E. $6,45
0

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56. The market price of ABC stock has been very volatile and you think this volatility will
continue for a few weeks. Thus, you decide to purchase a one-month call option
contract on ABC stock with a strike price of $25 and an option price of $1.30. You also
purchase a one-month put option on ABC stock with a strike price of $25 and an
option price of $.50. What will be your total profit or loss on these option positions if
the stock price is $24.60 on the day the options expire?

A. -
$180
B. -
$140
C. -
$100
D. $
0
E. $18
0

57. Several rumors concerning Wyslow, Inc. stock have started circulating. These rumors
are causing the market price of the stock to be quite volatile. Given this situation, you
decide to buy both a one-month put and a one month call option on this stock with an
exercise price of $15. You purchased the call at a quoted price of $.20 and the put at
a price of $2.10. What will be your total profit or loss on these option positions if the
stock price is $4 on the day the options expire?

A. -
$230
B. $87
0
C. $89
0
D. $91
0
E. $1,31
0

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58. Three months ago, you purchased a put option on WXX stock with a strike price of
$60 and an option price of $.60. The option expires today when the value of WXX
stock is $62.50. Ignoring trading costs and taxes, what is your total profit or loss on
your investment?

A. -
$310
B. -
$60
C. $
0
D. $6
0
E. $19
0

59. You sold ten put option contracts on PLT stock with an exercise price of $32.50 and an
option price of $1.10. Today, the option expires and the underlying stock is selling for
$34.30 a share. Ignoring trading costs and taxes, what is your total profit or loss on
this investment?

A. -
$2,90
0
B. -
$1,10
0
C. $70
0
D. $1,10
0
E. $2,90
0

60. You sold a put contract on EDF stock at an option price of $.40. The option had an
exercise price of $20. The option was exercised. Today, EDF stock is selling for $19 a
share. What is your total profit or loss on all of your transactions related to EDF stock
assuming that you close out your positions in this stock today? Ignore transaction
costs and taxes.

A. -
$140
B. -
$60
C. $4
0
D. $6
0
E. $14
0

22-21
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
61. You own two call option contracts on ABC stock with a strike price of $15. When you
purchased the contracts the option price was $1.20 and the stock price was $15.90.
What is the total intrinsic value of these options if ABC stock is currently selling for
$14.50 a share?

A. -
$280
B. -
$180
C. -
$100
D. $
0
E. $10
0

62. You own five put option contracts on XYZ stock with an exercise price of $25. What is
the total intrinsic value of these contracts if XYZ stock is currently selling for $24.50 a
share?

A. -
$250
B. -
$50
C. $
0
D. $5
0
E. $25
0

63. Last week, you purchased a call option on Denver, Inc. stock at an option price of
$1.05. The stock price last week was $28.10. The strike price is $27.50. What is the
intrinsic value per share if Denver, Inc. stock is currently priced at $29.03?

A. -
$1.0
5
B. $
0
C. $.4
8
D. $.9
3
E. $1.5
3

22-22
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
64. Three weeks ago, you purchased a July 45 put option on RPJ stock at an option price
of $3.20. The market price of RPJ stock three weeks ago was $42.70. Today, RPJ stock
is selling at $44.75 a share and the July 45 put is priced at $.80. What is the intrinsic
value of your put contract?

A. -
$295
B. -
$210
C. $
0
D. $2
5
E. $11
0

65. You own a call option on Jasper Co. stock that expires in one year. The exercise price
is $42.50. The current price of the stock is $56.00 and the risk-free rate of return is
3.5%. Assume that the option will finish in the money. What is the current value of the
call option?

A. $13.0
4
B. $13.5
0
C. $13.9
7
D. $14.9
4
E. $15.4
6

66. You currently own a one-year call option on Way-One, Inc. stock. The current stock
price is $26.50 and the risk-free rate of return is 4%. Your option has a strike price of
$20 and you assume that it will finish in the money. What is the current value of your
call option?

A. $6.2
5
B. $6.5
0
C. $6.7
6
D. $7.1
3
E. $7.2
7

22-23
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
67. The common stock of Mercury Motors is selling for $43.90 a share. U.S. Treasury bills
are currently yielding 4.5%. What is the current value of a one-year call option on
Mercury Motors stock if the exercise price is $37.50 and you assume the option will
finish in the money?

A. $6.1
2
B. $6.4
0
C. $6.6
9
D. $7.6
7
E. $8.0
1

68. The common stock of Winsson, Inc. is currently priced at $52.50 a share. One year
from now, the stock price is expected to be either $54 or $60 a share. The risk-free
rate of return is 4%. What is the value of one call option on Winsson stock with an
exercise price of $55?

A. $0.3
9
B. $0.4
1
C. $0.4
5
D. $0.4
8
E. $0.5
1

69. You own one call option with an exercise price of $30 on Nadia Interiors stock. This
stock is currently selling for $27.80 a share but is expected to increase to either $28
or $34 a share over the next year. The risk-free rate of return is 5% and the inflation
rate is 3%. What is the current value of your option if it expires in one year?

A. $0.7
6
B. $0.7
9
C. $0.8
9
D. $0.9
2
E. $0.9
5

22-24
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
70. The assets of Blue Light Specials are currently worth $2,100. These assets are
expected to be worth either $1,800 or $2,300 one year from now. The company has a
pure discount bond outstanding with a $2,000 face value and a maturity date of one
year. The risk-free rate is 5%. What is the value of the equity in this firm?

A. $166.6
7
B. $231.4
2
C. $385.7
1
D. $405.0
0
E. $714.2
9

71. Big Ed's Electrical has a pure discount bond that comes due in one year and has a
face value of $1,000. The risk-free rate of return is 4%. The assets of Big Ed's are
expected to be worth either $800 or $1,300 in one year. Currently, these assets are
worth $1,140. What is the current value of the debt of Big Ed's Electrical?

A. $222.4
6
B. $370.7
7
C. $514.2
8
D. $769.2
3
E. $917.5
4

72. Martha B's has total assets of $1,750. These assets are expected to increase in value
to either $1,800 or $2,400 by next year. The company has a pure discount bond
outstanding with a face value of $2,[Link] bond matures in one year. Currently, U.S.
Treasury bills are yielding 6%. What is the value of the equity in this firm?

A. $16.9
8
B. $34.5
9
C. $36.6
7
D. $37.0
8
E. $51.8
9

22-25
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
73. Tru-U stock is selling for $36 a share. A 3-month call on Tru-U stock with a strike price
of $40 is priced at $1. Risk-free assets are currently returning 0.25% per month. What
is the price of a 3-month put on Tru-U stock with a strike price of $40?

A. $2.9
8
B. $3.0
0
C. $4.0
3
D. $4.7
0
E. $4.9
0

74. GS, Inc. stock is selling for $28 a share. A 3-month call on GS stock with a strike price
of $30 is priced at $1.50. Risk-free assets are currently returning 0.3% per month.
What is the price of a 3-month put on GS stock with a strike price of $30?

A. $0.5
0
B. $2.0
2
C. $2.7
3
D. $3.2
3
E. $4.0
2

75. J&L, Inc. stock has a current market price of $55 a share. The one-year call on J&L
stock with a strike price of $55 is priced at $2.50 while the one-year put with a strike
price of $55 is priced at $1. What is the risk-free rate of return?

A. 2.71
%
B. 2.76
%
C. 2.80
%
D. 2.84
%
E. 2.87
%

22-26
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
76. What is the value of d2 given the following information on a stock?
Stock price $63
Exercise price $60
Time to expiration .50
Risk-free rate 6%
Standard deviation 20%
d1 .627841

A. .313
3
B. .486
4
C. .546
0
D. .686
7
E. .734
9

77. Given the following information, what is the value of d 2 as it is used in the Black-
Scholes Option Pricing Model?
Stock price $42
Time to expiration .25
Risk-free rate .055
Standard deviation .50
d1 .375161

A. .02160
8
B. .12516
1
C. .17560
8
D. .20016
1
E. .25016
1

22-27
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
78. What is the value of a 9-month call with a strike price of $45 given the Black-Scholes
Option Pricing Model and the following information?
Stock price $48
Exercise price $45
Time to expiration .75
Risk-free rate .05
N(d1) .718891
N(d2) .641713

A. $2.0
3
B. $4.8
6
C. $6.6
9
D. $8.8
1
E. $9.2
7

79. Assume that the delta of a call option on a firm's assets is .792. This means that a
$50,000 project will increase the value of equity by:

A. $27,90
2.
B. $39,60
0.
C. $43,82
0.
D. $63,13
1.
E. $89,60
0.

80. The current market value of the assets of Bigelow, Inc. is $86 million, with a standard
deviation of 15% per year. The firm has zero-coupon bonds outstanding with a total
face value of $45 million. These bonds mature in 2 years. The risk-free rate is 4% per
year compounded continuously. What is the value of d 1?

A. 3.5
4
B. 3.6
2
C. 3.6
8
D. 3.7
1
E. 3.7
5

22-28
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
81. The current market value of the assets of ABC, Inc. is $86 million. The market value of
the equity is $43.28 million. What is the market value of the firm's debt?

A. Cannot be determined from the information

given.
B. $21.36
million
C. $42.72
million
D. $64.08
million
E. $129.28
million

82. You purchased six TJH call option contracts with a strike price of $40 when the option
was quoted at $2. The option expires today when the value of TJH stock is $43.
Ignoring trading costs and taxes, what is your total profit or loss on your investment?

A. $
6
B. $60
0
C. $80
0
D. $1,20
0
E. $1,80
0

83. You purchased four WXO 32 call option contracts at a quoted price of $.34. What is
your net gain or loss on this investment if the price of WXO is $35 on the option
expiration date?

A. $26
6
B. $1,06
4
C. $1,09
3
D. $1,20
0
E. $2,12
5

22-29
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
84. You wrote ten call option contracts on JIG stock with a strike price of $41 and an
option price of $.60. What is your net gain or loss on this investment if the price of JIG
is $46.05 on the option expiration date?

A. -
$5,05
0
B. -
$4,45
0
C. $41
0
D. $4,45
0
E. $5,05
0

85. The market price of ABC stock has been very volatile and you think this volatility will
continue for a few weeks. Thus, you decide to purchase a one-month call option
contract on ABC stock with a strike price of $25 and an option price of $1.50. You also
purchase a one-month put option on ABC stock with a strike price of $25 and an
option price of $.70. What will be your total profit or loss on these option positions if
the stock price is $24.60 on the day the options expire?

A. -
$180
B. -
$140
C. -
$100
D. $
0
E. $18
0

22-30
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
86. Several rumors concerning Wyslow, Inc. stock have started circulating. These rumors
are causing the market price of the stock to be quite volatile. Given this situation, you
decide to buy both a one-month put and a one month call option on this stock with an
exercise price of $15. You purchased the call at a quoted price of $.40 and the put at
a price of $2.30. What will be your total profit or loss on these option positions if the
stock price is $4 on the day the options expire?

A. $19
0
B. $23
0
C. $83
0
D. $91
0
E. $1,50
0

87. Three months ago, you purchased a put option on WXX stock with a strike price of
$61 and an option price of $.60. The option expires today when the value of WXX
stock is $63.50. Ignoring trading costs and taxes, what is your total profit or loss on
your investment?

A. -
$310
B. -
$60
C. $
0
D. $6
0
E. $19
0

22-31
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
88. You sold ten put option contracts on PLT stock with an exercise price of $31.20 and an
option price of $1.20. Today, the option expires and the underlying stock is selling for
$33 a share. Ignoring trading costs and taxes, what is your total profit or loss on this
investment?

A. -
$3,30
0
B. -
$1,20
0
C. $12
0
D. $1,20
0
E. $3,30
0

89. You sold a put contract on EDF stock at an option price of $.50. The option had an
exercise price of $21. The option was exercised. Today, EDF stock is selling for $20 a
share. What is your total profit or loss on all of your transactions related to EDF stock
assuming that you close out your positions in this stock today? Ignore transaction
costs and taxes.

A. -
$150
B. -
$60
C. -
$50
D. $6
0
E. $15
0

Essay Questions

22-32
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
90. Suppose you look in the newspaper and see ABC trading at $50 per share. Calls on
ABC with one month to expiration and an exercise price of $45 are trading at $6.50
each. Puts on ABC with one month to expiration and an exercise price of $55 are
trading at $3.50 each. Are these prices reasonable? Explain. (Ignore transactions
costs.)

91. Suppose XYZ is priced at $125 a share, has a call with an exercise price of $150, has
two months to expiration, and costs $0.125 per contract. Why do you suppose
investors would be willing to purchase a call that is so far out of the money?

22-33
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
92. Suppose your wealthy Aunt Minnie has asked you to manage her large stock portfolio.
You would like to buy and/or sell options on many of the stocks she owns. Describe
the types of options you would buy or sell, as well as your rationale, given the
following circumstances:

a. Aunt Minnie owns 10,000 shares of IBM common stock. You believe it is going to fall
in price, but she won't let you sell it because her late husband told her never to let it
go. How do you protect her from the impending price decline?
b. Your analysis suggests that the common stock of Jet-Electro is poised to increase in
value sharply over the next year. Aunt Minnie doesn't want to buy any of the stock,
but does want you to use options to profit if the price rises. What do you do?
c. Although Aunt Minnie doesn't want you to sell any of the stocks she owns, she
would like you to use options to generate a little extra income. How might you do
this?

Looking at each option, we see:

93. What are the upper and lower bounds for an American call option? Explain what would
happen in each case if the bound was violated.

94. Explain the rationale behind the statement that equity is a call option on the firm's
assets. When would a shareholder allow the call to expire?

22-34
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
95. How do options apply to capital budgeting? Explain and give an example.

22-35
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
84. You wrote ten call option contracts on JIG stock with a strike price of $41 and an
option price of $.60. What is your net gain or loss on this investment if the price of
JIG is $46.05 on the option expiration date?

A. -
$5,05
0
B. -
$4,45
0
C. $41
0
D. $4,45
0
E. $5,05
0

Net loss = ($.60 + $41 - $46.05) × 100 × 10 = -$4,450

AACSB: Analytic
Blooms: Apply
Difficulty level: 2 Medium
Topic: Call Options

85. The market price of ABC stock has been very volatile and you think this volatility
will continue for a few weeks. Thus, you decide to purchase a one-month call option
contract on ABC stock with a strike price of $25 and an option price of $1.50. You
also purchase a one-month put option on ABC stock with a strike price of $25 and
an option price of $.70. What will be your total profit or loss on these option
positions if the stock price is $24.60 on the day the options expire?

A. -
$180
B. -
$140
C. -
$100
D. $
0
E. $18
0

Net loss = [-$1.50 × 100] + [(-$.70 + $25.00 - $24.60) × 100] = -$150 - $30 = -
$180

AACSB: Analytic
Blooms: Apply
Difficulty level: 2 Medium
Topic: Call Options

22-36
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
86. Several rumors concerning Wyslow, Inc. stock have started circulating. These
rumors are causing the market price of the stock to be quite volatile. Given this
situation, you decide to buy both a one-month put and a one month call option on
this stock with an exercise price of $15. You purchased the call at a quoted price of
$.40 and the put at a price of $2.30. What will be your total profit or loss on these
option positions if the stock price is $4 on the day the options expire?

A. $19
0
B. $23
0
C. $83
0
D. $91
0
E. $1,50
0

Net profit = [-$.40 × 100] + [(-$2.30 + $15.00 - $4.00) × 100] = -$40 + $870 =
$830

AACSB: Analytic
Blooms: Apply
Difficulty level: 2 Medium
Topic: Call Options

87. Three months ago, you purchased a put option on WXX stock with a strike price of
$61 and an option price of $.60. The option expires today when the value of WXX
stock is $63.50. Ignoring trading costs and taxes, what is your total profit or loss on
your investment?

A. -
$310
B. -
$60
C. $
0
D. $6
0
E. $19
0

Total loss = -$.60 × 100 = -$60 (loss); The option finished out of the money.

AACSB: Analytic
Blooms: Apply
Difficulty level: 2 Medium
Topic: Put Options

22-37
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
88. You sold ten put option contracts on PLT stock with an exercise price of $31.20 and
an option price of $1.20. Today, the option expires and the underlying stock is
selling for $33 a share. Ignoring trading costs and taxes, what is your total profit or
loss on this investment?

A. -
$3,30
0
B. -
$1,20
0
C. $12
0
D. $1,20
0
E. $3,30
0

Total profit = $1.20 × 100 × 10 = $1,200; The option finished out of the money.

AACSB: Analytic
Blooms: Apply
Difficulty level: 2 Medium
Topic: Put Options

89. You sold a put contract on EDF stock at an option price of $.50. The option had an
exercise price of $21. The option was exercised. Today, EDF stock is selling for $20
a share. What is your total profit or loss on all of your transactions related to EDF
stock assuming that you close out your positions in this stock today? Ignore
transaction costs and taxes.

A. -
$150
B. -
$60
C. -
$50
D. $6
0
E. $15
0

Total loss = ($.50 - $21.00 + $20.00) × 100 = -$50 (loss); When the option was
exercised, you had to buy at $20.

AACSB: Analytic
Blooms: Apply
Difficulty level: 2 Medium
Topic: Put Options

22-38
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Essay Questions

90. Suppose you look in the newspaper and see ABC trading at $50 per share. Calls on
ABC with one month to expiration and an exercise price of $45 are trading at $6.50
each. Puts on ABC with one month to expiration and an exercise price of $55 are
trading at $3.50 each. Are these prices reasonable? Explain. (Ignore transactions
costs.)

The calls are okay since the intrinsic value of each is $5 and the calls are trading at
a price greater than this. However, the intrinsic value of the puts is $5, but the put
is trading at $3.50. Thus, you could engage in arbitrage by buying puts for $3.50
each, exercising and selling the shares at the exercise price of $55, and purchasing
shares to cover the sale in the market at $50 each, netting a profit of $150 per
contract.

AACSB: Analytic
Blooms: Analyze
Difficulty level: 3 Hard
Topic: Option Quotes

91. Suppose XYZ is priced at $125 a share, has a call with an exercise price of $150,
has two months to expiration, and costs $0.125 per contract. Why do you suppose
investors would be willing to purchase a call that is so far out of the money?

Students are basically expected to discuss the impact of time to maturity on option
values. They should point out, at a minimum, that with two months left to maturity,
there is a chance that the option could finish in the money. More astute students
will point out that even though investors may be willing to purchase the option, the
price of the option is very low, that is, investors aren't terribly confident the price
will rise that far.

AACSB: Analytic
Blooms: Analyze
Difficulty level: 3 Hard
Topic: Call Options

22-39
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
92. Suppose your wealthy Aunt Minnie has asked you to manage her large stock
portfolio. You would like to buy and/or sell options on many of the stocks she owns.
Describe the types of options you would buy or sell, as well as your rationale, given
the following circumstances:

a. Aunt Minnie owns 10,000 shares of IBM common stock. You believe it is going to
fall in price, but she won't let you sell it because her late husband told her never to
let it go. How do you protect her from the impending price decline?
b. Your analysis suggests that the common stock of Jet-Electro is poised to increase
in value sharply over the next year. Aunt Minnie doesn't want to buy any of the
stock, but does want you to use options to profit if the price rises. What do you do?
c. Although Aunt Minnie doesn't want you to sell any of the stocks she owns, she
would like you to use options to generate a little extra income. How might you do
this?

Looking at each option, we see:

a. To profit from an expected price decline, you can offset your loss (assuming you
don't wish to simply sell the stock) by either buying puts or selling (writing) covered
calls on the stock. In this case, you would probably buy puts and sell them before
expiration.
b. In this case, the obvious solution is to buy calls and hope to sell them at a higher
price later. You could also write puts, but Aunt Minnie would be forced to buy
shares if you are wrong about the direction of the price change.
c. You could sell puts as long as you are willing to buy the underlying security if the
market moves against you. You do not want to sell covered calls if you are
unwilling to sell your shares if the option is exercised. You do not want to sell naked
calls as they have unlimited risk.

AACSB: Analytic
Blooms: Evaluate
Difficulty level: 3 Hard
Topic: Valuing Options

93. What are the upper and lower bounds for an American call option? Explain what
would happen in each case if the bound was violated.

The upper bound on a call is the stock price. If the call price exceeded the stock
price, you would be paying more for the option to buy an asset than the asset itself
costs. The lower bounds are: C ≥ 0 if S - E < 0 and C ≥ (S - E) if (S - E) ≥ 0. In the
first case, if the call exercise price exceeds the stock price, the call is out of the
money and it will either be worthless or have some time value. In the second case,
if the call is in the money, the call must be worth at least the difference between
the asset's value and the exercise price. If the call was worth less than this value,
rational investors would purchase calls, immediately exercise them, and then sell
the stock at the current price, completing an arbitrage.

AACSB: Analytic
Blooms: Analyze
Difficulty level: 3 Hard

22-40
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
 Topic: Valuing Options

94. Explain the rationale behind the statement that equity is a call option on the firm's
assets. When would a shareholder allow the call to expire?

The analogy only works for leveraged firms. At maturity of the firm's debt, the
stockholders have the option to either pay the bondholders the par value of their
debt or turn the firm's assets over to them. If the firm's assets are worth less than
the par value of the debt, the stockholders will not exercise their call, that is, they
will let the bondholders have the assets and the firm will be liquidated.

AACSB: Analytic
Blooms: Analyze
Difficulty level: 3 Hard
Topic: Stocks and Bonds as Options

95. How do options apply to capital budgeting? Explain and give an example.

There are many ways options apply in capital budgeting. One example goes back
to the value of the firm and the leverage in the capital structure. For a highly
leveraged firm, equity holders could prefer a lower NPV project to a higher one due
to the low level of equity interest in the firm as a whole. Options apply in capital
budgeting in many ways and future chapters discuss real options, which can
include the option to abandon a capital budgeting project, the option to wait for
investment, or the option to expand.

AACSB: Analytic
Blooms: Evaluate
Difficulty level: 3 Hard
Topic: Options and Corporate Decisions: Some Applications

22-41
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