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Option Valuation

1. If the Black-Scholes formula is solved to find the standard deviation consistent


with the current market call premium, that standard deviation would be called
the _______.

a.
variability

b.
volatility

c.
implied volatility

d.
deviance

2. The ___ is the stock price minus exercise price, or the profit that could be
attained by immediate exercise of an in-the-money call option.

a.
Intrinsic value

b.
Time value

c.

State value

d.
None of the above

3. The ___ is the difference between the actual call price and the intrinsic value.

a.
State value

b.
Strike value

c.
Time value

d.
None of the above

4. The ___ is the intrinsic value of the call option minus the value of the dividends
the stock will pay out before the call is exercised.

a.
State value

b.
Dividend value

c.
Interim value

d.
None of the above

5. The value of a call option will ___ as the ___ decreases.

a.
Increase, stock price

b.
Increase, exercise price

c.
Decrease, dividend payout

d.
None of the above

6. A ___ is an option valuation model predicated on the assumption that stock


prices can move to only two values over any short time period.

a.
Nominal model

b.
Binomial model

c.
Time model

d.
None of the above

7. The Black-Scholes option pricing formula was developed for ___ .

a.
American options

b.
European options

c.
Tokyo options

d.
Out-of-the-money options

8. If put-call parity is violated in the market, this may be _______.

a.

a profit opportunity

b.
due to "stale" prices

c.
too small a difference to exploit due to trading costs

d.
any of the above could be true

9. The hedge ratio is often called the option's _______.

a.
delta

b.
synthetic

c.
dynamic

d.
beta

10. Dynamic hedging is commonly _______.

a.
used in "portfolio insurance" strategies

b.
called delta hedging

c.
said to contribute to market volatility

d.
all of the above

11. The Black-Scholes formula seems to perform worst for stocks with _______
dividends.

a.
no

b.
low

c.
moderate

d.
high

12. The Black-Scholes option valuation model assumes that the _______ is constant
over the life of the option.

a.
risk free rate

b.
stock price volatility

c.
strike price

d.
all of the above

13. Relative to the Black-Scholes model, the binomial model ______.

a.
is very flexible

b.
is easy to use without a computer or calculator when trading

c.
makes more assumptions

d.
all of the above

14. The price of a stock put option is positively correlated with __________.

a.
the exercise price

b.
the stock volatility

c.
both a and b

d.
neither a nor b

15. The percentage change in the stock call option price divided by the percentage
change in the stock price is the __________ of the option.

a.
delta

b.
elasticity

c.

gamma

d.
theta

16. Before expiration the time value of an out-of-the money stock option is
__________.

a.
equal to the stock price minus the exercise price

b.
equal to zero

c.
negative

d.
positive

17. The intrinsic value of a call option is equal to _______________.

a.
the stock price minus the exercise price

b.
the exercise minus the stock price

c.
the stock price minus the exercise price plus any expected dividends

d.
the exercise price minus the stock price plus any expected dividends

18. The divergence between an option's intrinsic value and its market value is
usually greatest when ___________________.

a.
the option is deep in the money

b.
the option is approximately at the money

c.
the option is far out of the money

d.
time to expiration is very low

19. The value of a call option increases with all of the following except ___________.

a.
stock price

b.
time to maturity

c.
volatility

d.
All of the above

20. The value of a put option increases with all of the following except ___________.

a.
stock price

b.
time to maturity

c.
volatility

d.
All of the above

21. Dynamic hedging involves _______________.

a.

a smaller capital outlay than static hedging

b.
less commission expense than static hedging

c.
daily rebalancing

d.
continuous rebalancing

22. The delta of an option is __________.

a.
the change in the value of an option for a dollar change in the price of
the underlying asset

b.
the change in the value of the underlying asset for a dollar change in the call
price

c.
the percentage change in the value of an option for a one percent change in
the value of the underlying asset

d.
the percentage change in the value of the underlying asset for a one percent
change in the value of the call

23. A stock option has an intrinsic value of zero if the option is __________.

a.
in-the-money

b.
out-of-the money

c.
both a and b

d.
neither a nor b

24. Hedge ratios for calls are always __________.

a.
between -1 and 0

b.
between 0 and 1

c.
1

d.
greater than 1

25. __________ is a true statement.

a.
The actual value of a call option is greater than its intrinsic value prior
to expiration

b.
The intrinsic value of a call option is always greater than its time value prior
to expiration

c.
The intrinsic value of a call option is always positive prior to expiration

d.
The intrinsic value of a call option is greater than its actual value prior to
expiration

26. Which of the following is not a variable used in the Black-Scholes option pricing
model?

a.
price of the underlying stock

b.
exercise price of the option

c.
the risk-free rate

d.
expected dividends

27. The strike price of an option is adjusted for ____________ but not for
____________.

a.
dividends; stock splits

b.
stock splits; dividends

c.
exercise of warrants; stock splits

d.
None of the above

28. An important assumption underlying the Black-Scholes option pricing model is


________________.

a.
the stock will pay no dividends until after the option expiration date

b.
the risk-free rate of interest rate is known

c.
stock price does not exhibit any discontinuities

d.
All of the above

29. According to the Black-Scholes option pricing model, two options on the same
stock but with different expiration dates should always have the same
_________________.

a.
price

b.
expected return

c.
implied volatility

d.
None of the above

30. An option's hedge ratio is _________________.

a.
the change in the price of the option given a $1 change in the price of the
underlying stock

b.
the number of shares required to hedge the price risk associated with holding
one option

c.
sometimes called the option's delta

d.
All of the above

31. The Black-Scholes hedge ratio for a call option is equal to __________.

a.
N(d1)

b.
N(d2)

c.
N(d1)-1

d.

N(d2)-1

32. The Black-Scholes hedge ratio for a put option is equal to __________.

a.
N(d1)

b.
N(d2)

c.
N(d1)-1

d.
N(d2)-1

33. A change in any of the following except ___________ can cause a change in the
hedge ratio.

a.
stock price

b.
exercise price

c.
interest rate

d.
All of the above

34. Portfolio insurance is an investment strategy that involves ________________.

a.
a long stock position and a long position in puts

b.
a long stock position and a short position in puts

c.
a long stock position and a long position in calls

d.
a long stock position and a short position in calls

35. Which of the following has been cited as a contributing factor in the "crash" of
1987.

a.
hedging activities of individual investors

b.
institutional portfolio insurance activities

c.
speculative trading by individual investors

d.
speculative trading by mutual fund managers

36. Research suggests that option pricing models that allow for the possibility of
____________, provide more accurate pricing than does the Black-Scholes
option pricing model.

a.
stock splits

b.
early exercise

c.
mergers

d.
None of the above

37. Research suggests that the performance of the Black-Scholes option pricing
model has __________________.

a.
improved in recent years

b.
remained about the same over time

c.
deteriorated in recent years

d.
varied widely over the years since 1973

38. Research conducted by Rubinstein (1994) suggests that _______________


command a disproportionately high premium over intrinsic value.

a.
out of the money call options

b.
out of the money put options

c.
in the money call options

d.
in the money put options

39. Of the variables in the Black-Scholes OPM, the __________ is not directly
observable.

a.
price of the underlying asset

b.
risk-free rate of interest

c.
time to expiration

d.
variance of the underlying asset return

40. __________ the practice of using options or dynamic hedging strategies to


provide protection against investment losses while maintaining upside potential.

a.
Delta management is

b.
Index optioning is

c.
Portfolio insurance is

d.
None of the above are

41. The empirical study of option pricing by Geske and Roll (1984) found that the
Black-Scholes OPM __________.

a.
was accurate for both calls and puts

b.
was accurate for calls but not for puts

c.
was accurate for puts but not for calls

d.
was inaccurate in pricing options because it failed to consider the
possibility of early exercise on dividend-paying stocks

42. The elasticity of a put option on a stock is always __________.

a.
less than -1

b.
between -1 and 0

c.
between 0 and 1

d.
greater than 1

43. The price of a stock put option is __________ correlated with the stock price and
__________ correlated with the exercise price.

a.
negatively, negatively

b.
negatively, positively

c.
positively, negatively

d.
positively, positively

44. The elasticity of a call option on a stock is always __________.

a.
less than -1

b.
between -1 and 0

c.

between 0 and 1

d.
greater than 1

45. Hedge ratios for call options are __________ and hedge ratios for put options
are____________.

a.
negative, negative

b.
negative, positive

c.
positive, negative

d.
positive, positive

46. A higher dividend payout policy will have a __________ impact on the value of a
put and a __________ impact on the value of a call.

a.
negative, negative

b.

negative, positive

c.
positive, negative

d.
positive, positive

47. A one dollar increase in a call option's exercise price would result in __________
in the call option's value of __________ than one dollar.

a.
a decrease, less

b.
a decrease, more

c.
an increase, less

d.
an increase, more

48. A hedge ratio of .70 implies that a hedged portfolio should consist of __________.

a.
long .70 calls for each short stock

b.
long .70 shares for each long call

c.
long .70 shares for each short call

d.
short .70 calls for each long stock

49. If a stock price increases, the price of a put option on the stock will __________
and the price of a call option on the stock will __________.

a.
decrease, decrease

b.
decrease, increase

c.
increase, decrease

d.
increase, increase

50. The current stock price of Alcoa is $70 and the stock does not pay dividends.
The instantaneous riskfree rate of return is 6%. The instantaneous standard
deviation of Alcoa's stock is 40%. You wish to purchase a call option on this

stock with an exercise price of $75 and an expiration date 30 days from now.
Based on the Black-Scholes OPM, the call option's delta will be __________.

a.
.28

b.
.31

c.
.62

d.
.70

51. The current stock price of Alcoa is $70 and the stock does not pay dividends.
The instantaneous riskfree rate of return is 6%. The instantaneous standard
deviation of Alcoa's stock is 40%. A put option on this stock with an exercise
price of $75 and an expiration date 30 days from now. Considering BlackScholes OPM, to hedge your investment of __________ shares in stock, you
should buy 100 put options.

a.
30

b.
34

c.

69

d.
74

52. The current stock price of International Paper is $69 and the stock does not pay
dividends. The instantaneous riskfree rate of return is 10%. The instantaneous
standard deviation of International Paper's stock is 25%. You wish to purchase
a call option on this stock with an exercise price of $70 and an expiration date 73
days from now. Using the Black-Scholes OPM, the call option should be worth
__________ today.

a.
$2.50

b.
$2.94

c.
$3.16

d.
$3.50

53. The current stock price of International Paper is $69 and the stock does not pay
dividends. The instantaneous riskfree rate of return is 10%. The instantaneous
standard deviation of International Paper's stock is 25%. You wish to purchase
a put option on this stock with an exercise price of $70 and an expiration date 73
days from now. Using the Black-Scholes OPM, the put option should be worth
__________ today.

a.
$1.50

b.
$2.50

c.
$2.55

d.
$3.00

54. The current stock price of IBM is $64 and the stock does not pay dividends. The
instantaneous riskfree rate of return is 5%. The instantaneous standard
deviation of IBM's stock is 20%. You wish to purchase a call option on this stock
with an exercise price of $55 and an expiration date 73 days from now. Using the
Black-Scholes OPM, the call option should be worth __________ today.

a.
$.01

b.
$.07

c.
$9.26

d.

$9.62

55. The current stock price of IBM is $64 and the stock does not pay dividends. The
instantaneous riskfree rate of return is 5%. The instantaneous standard
deviation of IBM's stock is 20%. You wish to purchase a put option on this stock
with an exercise price of $55 and an expiration date 73 days from now. Using the
Black-Scholes OPM, the put option should be worth __________ today.

a.
$.01

b.
$.07

c.
$9.26

d.
$9.62

56. The current stock price of Oracle is $34 and the stock does not pay dividends.
The instantaneous riskfree rate of return is 5%. The instantaneous standard
deviation of Oracle's stock is 30%. You wish to purchase a call option on this
stock with an exercise price of $25 and an expiration date 73 days from now.
Using the Black-Scholes OPM, the call option should be worth __________
today.

a.
$.01

b.

$.07

c.
$9.26

d.
$9.62

57. The current stock price of Oracle is $34 and the stock does not pay dividends.
The instantaneous riskfree rate of return is 5%. The instantaneous standard
deviation of Oracle's stock is 30%. You wish to purchase a put option on this
stock with an exercise price of $25 and an expiration date 73 days from now.
Using the Black-Scholes OPM, the put option should be worth __________
today.

a.
$.01

b.
$.07

c.
$9.26

d.
$9.62

58. The stock price of Ajax Inc. is currently $105. The stock price a year from now
will be either $130 or $90 with equal probabilities. The interest rate at which
investors can borrow is 10%. Using the binomial OPM, the value of a call

option with an exercise price of $110 and an expiration date one year from now
should be worth __________ today.

a.
$11.60

b.
$15.00

c.
$20.00

d.
$40.00

59. The stock price of Bravo Corp. is currently $100. The stock price a year from
now will be either $160 or $60 with equal probabilities. The interest rate at
which investors invest in riskless assets at is 6%. Using the binomial OPM, the
value of a put option with an exercise price of $135 and an expiration date one
year from now should be worth __________ today.

a.
$34.09

b.
$37.50

c.
$38.21

d.
$45.45

60. If you have an extremely "bullish" outlook on the stock market, you could put
this view into practice by ________________.

a.
purchasing out-of-the-money call options

b.
purchasing at-the-money bull spreads

c.
purchasing convertible preferred stocks

d.
selling stock index futures

61. __________ will increase the value of a put option.

a.
A decrease in interest rates

b.
A decrease in time to expiration of the call

c.
An increase in the volatility of the underlying stock

d.
None of the above

62. The value of a call option is positively related to ______________.

a.
the risk-free interest rate

b.
the price of the underlying stock

c.
the time to maturity

d.
All of the above

63. You are considering purchasing a call option with a strike price of $35. The
price of the underlying stock is currently $27. Without any further information,
you would expect the hedge ratio for this option to be _______________.

a.
negative

b.
0

c.
positive and near 0

d.
positive and near .77

64. According to the put-call parity theorem, the payoffs associated with ownership
of a call option can be replicated by __________________.

a.
shorting the underlying stock, borrowing the present value of the exercise
price, and writing a put on the same underlying stock and with same exercise
price

b.
buying the underlying stock, borrowing the present value of the exercise
price, and buying a put on the same underlying stock and with same
exercise price

c.
buying the underlying stock, borrowing the present value of the exercise
price, and writing a put on the same underlying stock and with same exercise
price

d.
None of the above

65. You are considering purchasing a put option on a stock with a current price of
$39. The exercise price is $35, and the price of the corresponding call option is
$7. According to the put-call parity theorem, if the risk-free rate of interest is
4%, and there are 60 days until expiration, the value of the put should be
____________.

a.
$2.78

b.
$3.00

c.
$4.00

d.
$11.00

66. The stock price of Atlantis Corp. is $43 today. The risk-free rate of return is
10% and Atlantis Corp. pays no dividends. A call option on Atlantis Corp.
stock with an exercise price of $40 and an expiration date six months from now
is worth $5.00 today. A put option on Atlantis Corp. stock with an exercise
price of $40 and an expiration date six months from now should be worth
__________ today.

a.
$0

b.
$0.14

c.
$2.00

d.
$3.95

67. The stock price of Harper Corp. is $31 today. The risk-free rate of return is 6%
and Harper Corp. pays no dividends. A put option on Harper Corp. stock with
an exercise price of $30 and an expiration date six months from now is worth
$2.14 today. A call option on Harper Corp. stock with an exercise price of $30
and an expiration date six months from now should be worth __________ today.

a.
$2.25

b.
$3.14

c.
$4.00

d.
$4.84

68. A call option on Juniper Corp. stock with an exercise price of $75 and an
expiration date one year from now is worth $5.00 today. A put option on
Juniper Corp. stock with an exercise price of $75 and an expiration date one
year from now is worth $2.75 today. The risk-free rate of return is 8% and
Juniper Corp. pays no dividends. The stock should be worth __________ today.

a.
$66.25

b.
$71.69

c.
$73.12

d.
$77.25

69. You would like to be holding a protective put position on the stock of Avalon
Corporation to lock in a guaranteed minimum value of $50 at year-end. Avalon
currently sells for $50. Over the next year, the stock price will increase by 10%
or decrease by 10%. The T-bill rate is 5%. Unfortunately, no put options are
traded on Avalon Co.
Reference: 17-1

Suppose the desired put option were traded. What would be the hedge ratio for
the option?

a.
-1.0

b.
-0.5

c.

0.5

d.
1.0

70. You would like to be holding a protective put position on the stock of Avalon
Corporation to lock in a guaranteed minimum value of $50 at year-end. Avalon
currently sells for $50. Over the next year, the stock price will increase by 10%
or decrease by 10%. The T-bill rate is 5%. Unfortunately, no put options are
traded on Avalon Co.
Reference: 17-1

Suppose the desired put option were trades. How much would it cost to
purchase?

a.
$1.19

b.
$2.38

c.
$5.00

d.
None of the above

71. You would like to be holding a protective put position on the stock of Avalon
Corporation to lock in a guaranteed minimum value of $50 at year-end. Avalon
currently sells for $50. Over the next year, the stock price will increase by 10%

or decrease by 10%. The T-bill rate is 5%. Unfortunately, no put options are
traded on Avalon Co.
Reference: 17-1

What would have been the cost of a protective put portfolio?

a.
$48.81

b.
$51.19

c.
$52.38

d.
none of the above

72. You would like to be holding a protective put position on the stock of Avalon
Corporation to lock in a guaranteed minimum value of $50 at year-end. Avalon
currently sells for $50. Over the next year, the stock price will increase by 10%
or decrease by 10%. The T-bill rate is 5%. Unfortunately, no put options are
traded on Avalon Co.
Reference: 17-1

What portfolio position in stock and T-Bills will ensure you a payoff equal to the
payoff that would be provided by a protective put with X = $50?

a.

share of stock and $25 in bills

b.
1 share of stock and $50 in bills

c.
share of stock and $26.19 in bills

d.
none of the above

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