Question 1

The stock of Edwards Homes, Inc. has a current market value of $23 a share. The 3-month call with a strike price of $20 is selling for $3.80 while the 3-month put with a strike price of $20 is priced at $0.54. What is the continuously compounded risk-free rate of return?

Accepted Answer

A)  4.43 percent
B)  4.50 percent
C)  4.68 percent
D)  5.00 percent
E)  5.23 percentF) A) and D)
G) C) and D)

Question 2

A stock is selling for $60 per share. A call option with an exercise price of $67 sells for $3.31 and expires in 4 months. The risk-free rate of interest is 2.8 percent per year, compounded continuously. What is the price of a put option with the same exercise price and expiration date?

Accepted Answer

A)  $8.99
B)  $9.23
C)  $9.47
D)  $9.69
E)  $9.94F) A) and B)
G) A) and C)

Question 3

The implied volatility of the returns on the underlying asset that is computed using the Black-Scholes option pricing model is referred to as which one of the following?

Accepted Answer

A)  residual error
B)  implied mean return
C)  derived case volatility (DCV) 
D)  forecast rho
E)  implied standard deviation (IS
D)  F) C) and D)
G) B) and C)

Question 4

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?

Accepted Answer

A)  American call
B)  European call
C)  American put
D)  European put
E)  either an American or a European putF) A) and B)
G) None of the above

Question 5

The value of the risky debt of a firm is equal to the value of:

Accepted Answer

A)  a call option plus the value of a risk-free bond.
B)  a risk-free bond plus a put option.
C)  the equity of the firm minus a put.
D)  the equity of the firm plus a call option.
E)  a risk-free bond minus a put option.F) B) and D)
G) A) and C)

Question 6

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

Accepted Answer

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.F) C) and D)
G) A) and E)

Question 7

Assume the price of Westward Co. stock increases by one percent. Which one of the following measures the effect that this change in the stock price will have on the value of the Westward Co. options?

Accepted Answer

A)  theta
B)  vega
C)  rho
D)  delta
E)  gammaF) C) and E)
G) A) and B)

Question 8

A stock is currently priced at $45. A call option with an expiration of one year has an exercise price of $60. The risk-free rate is 14 percent per year, compounded continuously, and the standard deviation of the stock's return is infinitely large. What is the price of the call option?

Accepted Answer

A)  $39.47
B)  $42.08
C)  $45.00
D)  $52.63
E)  $60.00F) A) and D)
G) B) and E)

Question 9

Selling an option is generally more valuable than exercising the option because of the option's:

Accepted Answer

A)  riskless value.
B)  intrinsic value.
C)  standard deviation.
D)  exercise price.
E)  time premium.F) A) and D)
G) B) and D)

Question 10

Which one of the following statements related to the implied standard deviation (ISD)  is correct?

Accepted Answer

A)  The ISD is an estimate of the historical standard deviation of the underlying security.
B)  ISD is equal to (1 - D1) .
C)  The ISD estimates the volatility of an option's price over the option's lifespan.
D)  The value of ISD is dependent upon both the risk-free rate and the time to option expiration.
E)  ISD confirms the observable volatility of the return on the underlying security.F) B) and E)
G) A) and B)

Question 11

The current market value of the assets of Cristopherson Supply is $46.5 million. The market value of the equity is $28.7 million. The risk-free rate is 4.75 percent and the outstanding debt matures in 4 years. What is the market value of the firm's debt?

Accepted Answer

A)  $17.80 million
B)  $19.80 million
C)  $20.23 million
D)  $22.66 million
E)  $23.01 millionF) A) and D)
G) D) and E)

Question 12

Which one of the following statements is correct?

Accepted Answer

A)  Mergers benefit shareholders but not creditors.
B)  Positive NPV projects will automatically benefit both creditors and shareholders.
C)  Shareholders might prefer a negative NPV project over a positive NPV project.
D)  Creditors prefer negative NPV projects while shareholders prefer positive NPV projects.
E)  Mergers rarely affect bondholders.F) A) and B)
G) A) and E)

Question 13

Wesleyville Markets stock is selling for $36 a share. The 9-month $40 call on this stock is selling for $2.23 while the 9-month $40 put is priced at $5.11. What is the continuously compounded risk-free rate of return?

Accepted Answer

A)  2.87 percent
B)  3.11 percent
C)  3.38 percent
D)  3.56 percent
E)  3.79 percentF) A) and D)
G) None of the above

Question 14

Which one of the following best defines the primary purpose of a protective put?

Accepted Answer

A)  ensure a maximum purchase price in the future
B)  offset an equivalent call option
C)  limit the downside risk of asset ownership
D)  lock in a risk-free rate of return on a financial asset
E)  increase the upside potential return on an investmentF) C) and D)
G) B) and E)

Question 15

A firm has assets of $21.8 million and a 3-year, zero-coupon, risky bonds with a total face value of $8.5 million. The bonds have a total current market value of $8.1 million. How can the shareholders of this firm change these risky bonds into risk-free bonds?

Accepted Answer

A)  purchase a call option with a 1-year life and a $8.1 million face value
B)  purchase a call option with a 5-year life and a $8.5 million face value
C)  purchase a put option with a 1-year life and a $21.8 million face value
D)  purchase a put option with a 3-year life and a $8.1 million face value
E)  purchase a put option with a 3-year life and an $8.5 million face valueF) B) and C)
G) A) and C)

Question 16

The delta of a call option on a firm's assets is 0.767. This means that a $50,000 project will increase the value of equity by:

Accepted Answer

A)  $21,760.
B)  $25,336.
C)  $38,350.
D)  $54,627.
E)  $65,189.F) C) and D)
G) B) and E)

Question 17

For the equity of a firm to be considered a call option on the firm's assets, the firm must:

Accepted Answer

A)  be in default.
B)  be leveraged.
C)  pay dividends.
D)  have a negative cash flow from operations.
E)  have a negative cash flow from assets.F) All of the above
G) A) and B)

Question 18

What is the value of a 6-month call with a strike price of $25 given the Black-Scholes option pricing model and the following information?

Accepted Answer

A)  $0
B)  $0.93
C)  $1.06
D)  $1.85
E)  $2.14F) C) and E)
G) A) and B)

Question 19

The value of a call option delta is best defined as:

Accepted Answer

A)  between zero and one.
B)  less than zero.
C)  greater than zero.
D)  greater than or equal to zero.
E)  greater than one.F) A) and D)
G) A) and B)

Question 20

Explain why the equity ownership of a firm is equivalent to owning a call option on the firm's assets.

Accepted Answer

Equity is equal to asset minus liabiliti...

Exam 25: Option Valuation

What is the value of a 6-month call with a strike price of $25 given the Black-Scholes option pricing model and the following information?

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Selling an option is generally more valuable than exercising the option because of the option's:

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

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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?

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The delta of a call option on a firm's assets is 0.767. This means that a $50,000 project will increase the value of equity by:

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Which one of the following statements is correct?

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The current market value of the assets of Cristopherson Supply is $46.5 million. The market value of the equity is $28.7 million. The risk-free rate is 4.75 percent and the outstanding debt matures in 4 years. What is the market value of the firm's debt?

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The value of a call option delta is best defined as:

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A firm has assets of $21.8 million and a 3-year, zero-coupon, risky bonds with a total face value of $8.5 million. The bonds have a total current market value of $8.1 million. How can the shareholders of this firm change these risky bonds into risk-free bonds?

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A stock is selling for $60 per share. A call option with an exercise price of $67 sells for $3.31 and expires in 4 months. The risk-free rate of interest is 2.8 percent per year, compounded continuously. What is the price of a put option with the same exercise price and expiration date?

Correct AnswerverifiedShow Answer

Wesleyville Markets stock is selling for $36 a share. The 9-month $40 call on this stock is selling for $2.23 while the 9-month $40 put is priced at $5.11. What is the continuously compounded risk-free rate of return?

Correct AnswerverifiedShow Answer

Which one of the following best defines the primary purpose of a protective put?

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The stock of Edwards Homes, Inc. has a current market value of $23 a share. The 3-month call with a strike price of $20 is selling for $3.80 while the 3-month put with a strike price of $20 is priced at $0.54. What is the continuously compounded risk-free rate of return?

Correct AnswerverifiedShow Answer

The value of the risky debt of a firm is equal to the value of:

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For the equity of a firm to be considered a call option on the firm's assets, the firm must:

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Explain why the equity ownership of a firm is equivalent to owning a call option on the firm's assets.

Correct AnswerverifiedEquity is equal to asset minus liabiliti...View AnswerShow Answer

A stock is currently priced at $45. A call option with an expiration of one year has an exercise price of $60. The risk-free rate is 14 percent per year, compounded continuously, and the standard deviation of the stock's return is infinitely large. What is the price of the call option?

Correct AnswerverifiedShow Answer

The implied volatility of the returns on the underlying asset that is computed using the Black-Scholes option pricing model is referred to as which one of the following?

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Which one of the following statements related to the implied standard deviation (ISD) is correct?

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Assume the price of Westward Co. stock increases by one percent. Which one of the following measures the effect that this change in the stock price will have on the value of the Westward Co. options?

Correct AnswerverifiedShow Answer

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

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Equity is equal to asset minus liabiliti...
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