Preview Extract
Multiple Choice Questions
1. You purchase one IBM July 120 call contract for a premium of $5. You hold the option
until the expiration date, when IBM stock sells for $123 per share. You will realize a ______
on the investment.
A. $200 profit
B. $200 loss
C. $300 profit
D. $300 loss
Answer: B. $200 loss
Long call profit = Max [0, ($123 - $120)(100)] - $500 = -$200
2. You purchase one IBM July 125 call contract for a premium of $5. You hold the option
until the expiration date, when IBM stock sells for $123 per share. You will realize a ______
on the investment.
A. $200 profit
B. $200 loss
C. $500 profit
D. $500 loss
Answer: D. $500 loss
Long call profit = Max [0, ($123 - $125)(100)] - $500 = -$500
3. You purchase one IBM July 120 put contract for a premium of $3. You hold the option
until the expiration date, when IBM stock sells for $123 per share. You will realize a ______
on the investment.
A. $300 profit
B. $300 loss
C. $500 loss
D. $200 profit
Answer: B. $300 loss
Long put profit = Max [0, ($120 - $123)(100)] - $300 = -$300
4. You write one IBM July 120 call contract for a premium of $4. You hold the option until
the expiration date, when IBM stock sells for $121 per share. You will realize a ______ on the
investment.
A. $300 profit
B. $200 loss
C. $600 loss
D. $200 profit
Answer: A. $300 profit
Answer: A. $300 profit
Short call profit = Min [0, ($120 - $121)(100)] + $400 = $300
5. ______ option can only be exercised on the expiration date.
A. A Mexican
B. An Asian
C. An American
D. A European
Answer: D. A European
6. All else the same, an American style option will be ______ valuable than a ______ style
option.
A. more; EuropeanB. less; EuropeanC. more; CanadianD. less; CanadianAnswer: A. more; EuropeanAnswer: A. more; European7. At contract maturity the value of a call option is ___________, where X equals the option's
strike price and ST is the stock price at contract expiration.
A. Max (0, ST - X)
B. Min (0, ST - X)
C. Max (0, X - ST)
D. Min (0, X - ST)
Answer: A. Max (0, ST - X)
Answer: A. Max (0, ST - X)
8. At contract maturity the value of a put option is ___________, where X equals the option's
strike price and ST is the stock price at contract expiration.
A. Max (0, ST - X)
B. Min (0, ST - X)
C. Max (0, X - ST)
D. Min (0, X - ST)
Answer: C. Max (0, X - ST)
9. An American put option gives its holder the right to _________.
A. buy the underlying asset at the exercise price on or before the expiration date
B. buy the underlying asset at the exercise price only at the expiration date
C. sell the underlying asset at the exercise price on or before the expiration date
D. sell the underlying asset at the exercise price only at the expiration date
Answer: C. sell the underlying asset at the exercise price on or before the expiration date
10. An Asian call option gives its holder the right to ____________.
A. buy the underlying asset at the exercise price on or before the expiration date
B. buy the underlying asset at a price determined by the average stock price during some
specified portion of the option's life
C. sell the underlying asset at the exercise price on or before the expiration date
D. sell the underlying asset at a price determined by the average stock price during some
specified portion of the option's life
Answer: B. buy the underlying asset at a price determined by the average stock price during
some specified portion of the option's life
11. An Asian put option gives its holder the right to ____________.
A. buy the underlying asset at the exercise price on or before the expiration date
B. buy the underlying asset at a price determined by the average stock price during some
specified portion of the option's life
C. sell the underlying asset at the exercise price on or before the expiration date
D. sell the underlying asset at a price determined by the average stock price during some
specified portion of the option's life
Answer: D. sell the underlying asset at a price determined by the average stock price during
some specified portion of the option's life
12. A time spread may be executed by _____.
A. selling an option with one exercise price and buying a similar one with a different exercise
price
B. buying two options that have the same expiration dates but different strike prices
C. selling two options that have the same expiration dates but different strike prices
D. selling an option with one expiration date and buying a similar option with a different
expiration date
Answer: D. selling an option with one expiration date and buying a similar option with a
different expiration date
13. Which of the following statements about convertible bonds are true?
I. The conversion price does not change over time.
II. The associated stocks may not pay dividends as long as the bonds are outstanding.
III. Most convertibles are also callable at the discretion of the firm.
IV. They may be thought of as straight bonds plus a call option.
A. I and III only
B. I and IV only
C. I, II, and IV only
D. III and IV only
Answer: D. III and IV only
14. A quanto provides its holder with the right to ______________.
A. participate in the payoffs from a portfolio of gambling casino stocks
B. exchange a fixed amount of a foreign currency for dollars at a specified exchange rate
C. participate in the investment performance of a foreign security
D. exchange the payoff from a foreign investment for dollars at a fixed exchange rate
Answer: D. exchange the payoff from a foreign investment for dollars at a fixed exchange rate
15. You purchase a call option on a stock. The profit at contract maturity of the option
position is ___________, where X equals the option's strike price, ST is the stock price at
contract expiration, and C0 is the original purchase price of the option.
A. Max (-C0, ST - X - C0)
B. Min (-C0, ST - X - C0)
C. Max (C0, ST - X + C0)
D. Max (0, ST - X - C0)
Answer: A. Max (-C0, ST - X - C0)
Answer: A. Max (-C0, ST - X - C0)
16. Strips and straps are variations of __________.
A. straddles
B. collars
C. money spreads
D. time spreads
Answer: A. straddles
Answer: A. straddles
17. You write a put option on a stock. The profit at contract maturity of the option position is
___________, where X equals the option's strike price, ST is the stock price at contract
expiration, and P0 is the original premium of the put option.
A. Max (P0, X - ST - P0)
B. Min (-P0, X - ST - P0)
C. Min (P0, ST - X + P0)
D. Max (0, ST - X - P0)
Answer: C. Min (P0, ST - X + P0)
18. Longer-term American-style options with maturities of up to 3 years are called
__________.
A. warrants
B. LEAPS
C. GICs
D. CATs
Answer: B. LEAPS
19. The initial maturities of most exchange-traded options are generally __________.
A. less than 1 year
B. less than 2 years
C. between 1 and 2 years
D. between 1 and 3 years
Answer: A. less than 1 year
Answer: A. less than 1 year
20. A futures call option provides its holder with the right to ___________.
A. purchase a particular stock at some time in the future at a specified price
B. purchase a futures contract for the delivery of options on a particular stock
C. purchase a futures contract at a specified price for a specified period of time
D. deliver a futures contract and receive a specified price at a specific date in the future
Answer: C. purchase a futures contract at a specified price for a specified period of time
21. Exchange-traded stock options expire on the _______________ of the expiration month.
A. second Monday
B. third Wednesday
C. second Thursday
D. third Friday
Answer: D. third Friday
22. The writer of a put option _______________.
A. agrees to sell shares at a set price if the option holder desires
B. agrees to buy shares at a set price if the option holder desires
C. has the right to buy shares at a set price
D. has the right to sell shares at a set price
Answer: B. agrees to buy shares at a set price if the option holder desires
23. Advantages of exchange-traded options over OTC options include all but which one of the
following?
A. Ease and low cost of trading
B. Anonymity of participants
C. Contracts that are tailored to meet the needs of market participants
D. No concerns about counterparty credit risk
Answer: C. Contracts that are tailored to meet the needs of market participants
24. Each listed stock option contract gives the holder the right to buy or sell __________
shares of stock.
A. 1
B. 10
C. 100
D. 1,000
Answer: C. 100
25. Exercise prices for listed stock options usually occur in increments of ____ and bracket
the current stock price.
A. $1
B. $5
C. $20
D. $25
Answer: B. $5
26. You buy a call option and a put option on General Electric. Both the call option and the
put option have the same exercise price and expiration date. This strategy is called a
_________.
A. time spread
B. long straddle
C. short straddle
D. money spread
Answer: B. long straddle
27. In 1973, trading of standardized options on a national exchange started on the _________.
A. AMEX
B. CBOE
C. NYSE
D. CFTC
Answer: B. CBOE
28. An American call option gives the buyer the right to _________.
A. buy the underlying asset at the exercise price on or before the expiration date
B. buy the underlying asset at the exercise price only at the expiration date
C. sell the underlying asset at the exercise price on or before the expiration date
D. sell the underlying asset at the exercise price only at the expiration date
Answer: A. buy the underlying asset at the exercise price on or before the expiration date
Answer: A. buy the underlying asset at the exercise price on or before the expiration date
29. A put option on Dr. Pepper Snapple Group, Inc., has an exercise price of $45. The current
stock price is $41. The put option is _________.
A. at the money
B. in the money
C. out of the money
D. knocked out
Answer: B. in the money
30. You buy a call option on Merritt Corp. with an exercise price of $50 and an expiration
date in July, and you write a call option on Merritt Corp. with an exercise price of $55 and an
expiration date in July. This is called a ________.
A. time spread
B. long straddle
C. short straddle
D. money spread
Answer: D. money spread
31. A call option on Brocklehurst Corp. has an exercise price of $30. The current stock price
of Brocklehurst Corp. is $32. The call option is _________.
A. at the money
B. in the money
C. out of the money
D. knocked in
Answer: B. in the money
32. You invest in the stock of Rayleigh Corp. and write a call option on Rayleigh Corp. This
strategy is called a _________.
A. covered call
B. long straddle
C. naked call
D. money spread
Answer: A. covered call
Answer: A. covered call
33. You buy a call option on Summit Corp. with an exercise price of $40 and an expiration
date in September, and you write a call option on Summit Corp. with an exercise price of $40
and an expiration date in October. This strategy is called a _________.
A. time spread
B. long straddle
C. short straddle
D. money spread
Answer: A. time spread
Answer: A. time spread
34. A European call option gives the buyer the right to _________.
A. buy the underlying asset at the exercise price on or before the expiration date
B. buy the underlying asset at the exercise price only at the expiration date
C. sell the underlying asset at the exercise price on or before the expiration date
D. sell the underlying asset at the exercise price only at the expiration date
Answer: B. buy the underlying asset at the exercise price only at the expiration date
35. You invest in the stock of Valleyview Corp. and purchase a put option on Valleyview
Corp. This strategy is called a _________.
A. long straddle
B. naked put
C. protective put
D. short stroll
Answer: C. protective put
36. The value of a listed call option on a stock is lower when:
I. The exercise price is higher.
II. The contract approaches maturity.
III. The stock decreases in value.
IV. A stock split occurs.
A. II, III, and IV only
B. I, III, and IV only
C. I, II, and III only
D. I, II, III, and IV
Answer: C. I, II, and III only
37. The Option Clearing Corporation is owned by _________.
A. the exchanges on which stock options are traded
B. the Federal Deposit Insurance Corporation
C. the Federal Reserve System
D. major U.S. banks
Answer: A. the exchanges on which stock options are traded
Answer: A. the exchanges on which stock options are traded
38. The value of a listed put option on a stock is lower when:
I. The exercise price is higher.
II. The contract approaches maturity.
III. The stock decreases in value.
IV. A stock split occurs.
A. II only
B. II and IV only
C. I, II, and III only
D. I, II, III, and IV
Answer: A. II only
Answer: A. II only
39. The maximum loss a buyer of a stock call option can suffer is the _________.
A. call premium
B. stock price
C. stock price minus the value of the call
D. strike price minus the stock price
Answer: A. call premium
Answer: A. call premium
40. Which one of the statements about margin requirements on option positions is not correct?
A. The margin required will be higher if the option is in the money.
B. If the required margin exceeds the posted margin, the option writer will receive a margin
call.
C. A buyer of a put or call option does not have to post margin.
D. Even if the writer of a call option owns the stock, the writer will have to meet the margin
requirement in cash.
Answer: D. Even if the writer of a call option owns the stock, the writer will have to meet the
margin requirement in cash.
41. A European put option gives its holder the right to _________.
A. buy the underlying asset at the exercise price on or before the expiration date
B. buy the underlying asset at the exercise price only at the expiration date
C. sell the underlying asset at the exercise price on or before the expiration date
D. sell the underlying asset at the exercise price only at the expiration date
Answer: D. sell the underlying asset at the exercise price only at the expiration date
42. The potential loss for a writer of a naked call option on a stock is _________.
A. equal to the call premium
B. larger the lower the stock price
C. limited
D. unlimited
Answer: D. unlimited
43. A writer of a call option will want the value of the underlying asset to __________, and a
buyer of a put option will want the value of the underlying asset to _________.
A. decrease; decrease
B. decrease; increase
C. increase; decrease
D. increase; increase
Answer: A. decrease; decrease
Answer: A. decrease; decrease
44. Buyers of listed options __________ required to post margins, and writers of naked listed
options __________ required to post margins.
A. are; are not
B. are; are
C. are not; are
D. are not; are not
Answer: C. are not; are
45. An option with a payoff that depends on the average price of the underlying asset during
at least some portion of the life of the option is called ______ option.
A. an American
B. a European
C. an Asian
D. an Australian
Answer: C. an Asian
46. Which of the following expressions represents the value of a call option to its holder on
the expiration date?
A. ST - X if ST > X, 0 if ST ≤ X
B. - (ST - X) if ST > X, 0 if ST ≤ X
C. 0 if ST ≥ X, X - ST if ST < X
D. 0 if ST ≥ X, - (X - ST) if ST X, 0 if ST ≤ X
47. A "bet" option is also called a ____ option.
A. barrier
B. lookback
C. digital
D. foreign exchange
Answer: C. digital
48. Which one of the following is the ticker symbol for the CBOE option contract on the S&P
100 Index?
A. SPX
B. DJX
C. CME
D. OEX
Answer: D. OEX
49. The May 17, 2012, price quotation for a Boeing call option with a strike price of $50 due
to expire in November is $20.80, while the stock price of Boeing is $69.80. The premium on
one Boeing November 50 call contract is _________.
A. $1,980
B. $4,900
C. $5,000
D. $2,080
Answer: D. $2,080
Premium = $20.80 × 100 = $2,080
50. You purchase one IBM March 120 put contract for a put premium of $10. The maximum
profit that you could gain from this strategy is _________.
A. $120
B. $1,000
C. $11,000
D. $12,000
Answer: C. $11,000
Profit = 100(120 - 10) = 11,000
51. You buy one Hewlett Packard August 50 call contract and one Hewlett Packard August 50
put contract. The call premium is $1.25, and the put premium is $4.50. Your highest potential
loss from this position is _________.
A. $125
B. $450
C. $575
D. unlimited
Answer: C. $575
Loss = 100(1.25 + 4.50) = 575 if stock price is $50 at expiration.
52. You sell one Hewlett Packard August 50 call contract and sell one Hewlett Packard
August 50 put contract. The call premium is $1.25 and the put premium is $4.50. Your
strategy will pay off only if the stock price is __________ in August.
A. either lower than $44.25 or higher than $55.75
B. between $44.25 and $55.75
C. higher than $55.75
D. lower than $44.25
Answer: B. between $44.25 and $55.75
You have positive profit in the range $50 - ($1.25 + $4.50) and $50 + ($1.25 + $4.50).
53. Suppose you purchase one Texas Instruments August 75 call contract quoted at $8.50 and
write one Texas Instruments August 80 call contract quoted at $6. If, at expiration, the price
of a share of Texas Instruments stock is $79, your profit would be _________.
A. $150
B. $400
C. $600
D. $1,850
Answer: A. $150
Profit = 100[(79 - 75)] - 8.50 + 6] = $150
54. __________ is the most risky transaction to undertake in the stock-index option markets if
the stock market is expected to fall substantially after the transaction is completed.
A. Writing an uncovered call option
B. Writing an uncovered put option
C. Buying a call option
D. Buying a put option
Answer: B. Writing an uncovered put option
55. Which one of the following is a correct statement?
A. Exercise of warrants results in more outstanding shares of stock, while exercise of listed
call options does not.
B. A convertible bond consists of a straight bond plus a specified number of detachable
warrants.
C. Call options always have an initial maturity greater than 1 year, while warrants have an
initial maturity less than 1 year.
D. Call options may be convertible into the stock, while warrants are not convertible into the
stock.
Answer: A. Exercise of warrants results in more outstanding shares of stock, while exercise of
listed call options does not.
56. A put on Sanders stock with a strike price of $35 is priced at $2 per share, while a call
with a strike price of $35 is priced at $3.50. The maximum per-share loss to the writer of an
uncovered put is __________, and the maximum per-share gain to the writer of an uncovered
call is _________.
A. $33; $3.50
B. $33; $31.50
C. $35; $3.50
D. $35; $35
Answer: A. $33; $3.50
Maximum per-share loss to put writer = (35 - 0) + 2 = 33 if stock price is $0 at expiration.
Maximum per share gain to call writer = 3.50 if stock price is below $35 at expiration.
57. You are cautiously bullish on the common stock of the Wildwood Corporation over the
next several months. The current price of the stock is $50 per share. You want to establish a
bullish money spread to help limit the cost of your option position. You find the following
option quotes:
To establish a bull money spread with calls, you would _______________.
A. buy the 55 call and sell the 45 call
B. buy the 45 call and buy the 55 call
C. buy the 45 call and sell the 55 call
D. sell the 45 call and sell the 55 call
Answer: C. buy the 45 call and sell the 55 call
58. You are cautiously bullish on the common stock of the Wildwood Corporation over the
next several months. The current price of the stock is $50 per share. You want to establish a
bullish money spread to help limit the cost of your option position. You find the following
option quotes:
Ignoring commissions, the cost to establish the bull money spread with calls would be
_______.
A. $1,050
B. $650
C. $400
D. $400 income rather than cost
Answer: B. $650
To establish a bull money spread with calls, you would buy the 45 call at a cost of $8.50 and
write the 55 call, earning the $2 premium. The initial cost is ($2 - $8.50)(100) = -$650.
59. You are cautiously bullish on the common stock of the Wildwood Corporation over the
next several months. The current price of the stock is $50 per share. You want to establish a
bullish money spread to help limit the cost of your option position. You find the following
option quotes:
If in June the stock price is $53, your net profit on the bull money spread (buy the 45 call and
sell the 55 call) would be ________.
A. $300
B. -$400
C. $150
D. $50
Answer: C. $150
ST = $53 at contract maturity in June
Profit = C45, June - C55, June - Initial cost
Profit = [Max (0, $53 - $45) - Max (0, $53 - $55)](100) - $650 = $150
60. You are cautiously bullish on the common stock of the Wildwood Corporation over the
next several months. The current price of the stock is $50 per share. You want to establish a
bullish money spread to help limit the cost of your option position. You find the following
option quotes:
To establish a bull money spread with puts, you would _______________.
A. sell the 55 put and buy the 45 put
B. buy the 45 put and buy the 55 put
C. buy the 55 put and sell the 45 put
D. sell the 45 put and sell the 55 put
Answer: A. sell the 55 put and buy the 45 put
61. You are cautiously bullish on the common stock of the Wildwood Corporation over the
next several months. The current price of the stock is $50 per share. You want to establish a
bullish money spread to help limit the cost of your option position. You find the following
option quotes:
Suppose you establish a bullish money spread with the puts. In June the stock's price turns out
to be $52. Ignoring commissions, the net profit on your position is _______________.
A. $500
B. $700
C. $200
D. $250
Answer: D. $250
To establish a bull money spread with puts, you would buy the 45 put at a cost of $2 and write
the 55 put, earning the $7.50 premium. The initial revenue is ($7.50 - $2)(100) = $550.
ST = $52 at contract maturity in June
Profit = P45, June - P55, June + Initial revenue
Profit = [Max (0, $45 - $52) - Max (0, $55 - $52)](100) + $550 = $250.
62. The common stock of the Avalon Corporation has been trading in a narrow range around
$40 per share for months, and you believe it is going to stay in that range for the next 3
months. The price of a 3-month put option with an exercise price of $40 is $3, and a call with
the same expiration date and exercise price sells for $4.
What would be a simple options strategy using a put and a call to exploit your conviction
about the stock price's future movement?
A. Sell a call.
B. Purchase a put.
C. Sell a straddle.
D. Buy a straddle.
Answer: C. Sell a straddle.
63. The common stock of the Avalon Corporation has been trading in a narrow range around
$40 per share for months, and you believe it is going to stay in that range for the next 3
months. The price of a 3-month put option with an exercise price of $40 is $3, and a call with
the same expiration date and exercise price sells for $4.
Selling a straddle would generate total premium income of _____.
A. $300
B. $400
C. $500
D. $700
Answer: D. $700
Sell a straddle = sell a put + sell a call
Premium income for selling a straddle = (P0 + C0)100 = ($3 + $4)(100) = $700
64. The common stock of the Avalon Corporation has been trading in a narrow range around
$40 per share for months, and you believe it is going to stay in that range for the next 3
months. The price of a 3-month put option with an exercise price of $40 is $3, and a call with
the same expiration date and exercise price sells for $4.
Suppose you write a strap and the stock price winds up to be $42 at contract expiration. What
was your net profit on the strap?
A. $200
B. $300
C. $700
D. $400
Answer: C. $700
Selling a strap entails selling two calls and selling one put. Initial income = 2C0 + P0 = [(2)(4)
+ 3](100) = $1,100. If the final stock price is $42, the position profit is found as Profit = [2Max ($0, $42 - 40) + Max ($0, $40 - $42)](100) + $1,100 = $700
65. The common stock of the Avalon Corporation has been trading in a narrow range around
$40 per share for months, and you believe it is going to stay in that range for the next 3
months. The price of a 3-month put option with an exercise price of $40 is $3, and a call with
the same expiration date and exercise price sells for $4.
How can you create a position involving a put, a call, and riskless lending that would have the
same payoff structure as the stock at expiration?
A. Buy the call, sell the put; lend the present value of $40.
B. Sell the call, buy the put; lend the present value of $40.
C. Buy the call, sell the put; borrow the present value of $40.
D. Sell the call, buy the put; borrow the present value of $40.
Answer: A. Buy the call, sell the put; lend the present value of $40.
Answer: A. Buy the call, sell the put; lend the present value of $40.
66. A stock is trading at $50. You believe there is a 60% chance the price of the stock will
increase by 10% over the next 3 months. You believe there is a 30% chance the stock will
drop by 5%, and you think there is only a 10% chance of a major drop in price of 20%. Atthe-money 3-month puts are available at a cost of $650 per contract. What is the expected
dollar profit for a writer of a naked put at the end of 3 months?
A. $300
B. $200
C. $475
D. $0
Answer: C. $475
E[Profit] = -{.60Max [$0, $50 - ($50)(1.1)] + .30Max [$0, $50 - ($50)(0.95)] + .10Max [$0,
$50 - ($50)(.80)]} (100) + $650 = - [.6(0) + .3(250) + .1(1,000)] + 650 = $475
67. A covered call strategy benefits from what environment?
A. Falling interest rates
B. Price stability
C. Price volatility
D. Unexpected events
Answer: B. Price stability
68. You sell one IBM July 90 call contract for a premium of $4 and two puts for a premium of
$3 each. You hold the position until the expiration date, when IBM stock sells for $95 per
share. You will realize a ______ on this strip.
A. $300 profit
B. $100 loss
C. $500 profit
D. $200 profit
Answer: C. $500 profit
Selling an IBM July 90 strip entails selling two IBM July 90 puts and one IBM July 90 call.
Initial income = C90 + 2P90 = [4 + 2(3)](100) = $1,000. If the final stock price is $95, the
position value is found as:
Profit = [-Max ($0, $95 - 90) + 2Max ($0, $90 - $95)](100) + $1,000 = -$500 + $1,000 =
$500
69. Which strategy benefits from upside price movement and has some protection should the
price of the security fall?
A. Bull spread
B. Long put
C. Short call
D. Straddle
Answer: A. Bull spread
Answer: A. Bull spread
70. What combination of puts and calls can simulate a long stock investment?
A. Long call and short put
B. Long call and long put
C. Short call and short put
D. Short call and long put
Answer: A. Long call and short put
Answer: A. Long call and short put
71. An investor purchases a long call at a price of $2.50. The expiration price is $35. If the
current stock price is $35.10, what is the break-even point for the investor?
A. $32.50
B. $35
C. $37.50
D. $37.60
Answer: C. $37.50
Break even = 35 + 2.50 = 37.50
72. An investor is bearish on a particular stock and decided to buy a put with a strike price of
$25. Ignoring commissions, if the option was purchased for a price of $.85, what is the breakeven point for the investor?
A. $24.15
B. $25
C. $25.87
D. $27.86
Answer: A. $24.15
Answer: A. $24.15
Breakeven = 25 - .85 = 24.15
73. Which of the following strategies makes a profit if the stock price stays stable?
A. Long call and short put
B. Long call and long put
C. Short call and short put
D. Short call and long put
Answer: C. Short call and short put
74. Which of the following strategies makes a profit when the stock price declines and loses
money when the stock price increases?
A. Long call and short put
B. Long call and long put
C. Short call and short put
D. Short call and long put
Answer: D. Short call and long put
75. If you combine a long stock position with selling an at-the-money call option, the
resulting net payoff profile will resemble the payoff profile of a _______.
A. long call
B. short call
C. short put
D. long put
Answer: C. short put
76. What strategy could be considered insurance for an investment in a portfolio of stocks?
A. Covered call
B. Protective put
C. Short put
D. Straddle
Answer: B. Protective put
77. What strategy is designed to ensure a value within the bounds of two different stock
prices?
A. Collar
B. Covered Call
C. Protective put
D. Straddle
Answer: A. Collar
Answer: A. Collar
78. You are convinced that a stock's price will move by at least 15% over the next 3 months.
You are not sure which way the price will move, but you believe that the results of a patent
hearing are definitely going to have a major effect on the stock price. You are somewhat more
bullish than bearish however. Which one of the following options strategies best fits this
scenario?
A. Buy a strip.
B. Buy a strap.
C. Buy a straddle.
D. Write a straddle.
Answer: B. Buy a strap.
79. When issued, most convertible bonds are issued _____________.
A. deep in the money
B. deep out of the money
C. slightly out of the money
D. slightly in the money
Answer: B. deep out of the money
80. A convertible bond is deep in the money. This means the bond price will closely track the
__________.
A. straight debt value of the bond
B. conversion value of the bond
C. straight debt value of the bond minus the conversion value
D. straight debt value of the bond plus the conversion value
Answer: B. conversion value of the bond
81. Warrants differ from listed options in that:
I. Exercise of warrants results in dilution of a firm's earnings per share.
II. When warrants are exercised, new shares of stock must be created.
III. Warrant exercise results in cash flows to the firm, whereas exercise of listed options does
not.
A. I only
B. I and II only
C. II and III only
D. I, II, and III
Answer: D. I, II, and III
82. Suppose you find two bonds identical in all respects except that bond A is convertible to
common stock and bond B is not. Bond A is priced at $1,245, and bond B is priced at $1,120.
Bond A has a promised yield to maturity of 5.6%, and bond B has a promised yield to
maturity of 6.7%. The stock of bond A is trading at $49.80 per share. Which of the following
statements is (are) correct?
I. The value of the conversion option for bond A is $125.
II. The lower promised yield to maturity of bond A indicates that the bond is priced according
to its straight debt value rather than its conversion value.
III. If bond A can be converted into 25 shares of stock, the investor would break even at the
current prices.
A. II only
B. I and III only
C. III only
D. I, II, and III
Answer: B. I and III only
I. Value of conversion option = $1,245 - $1,120 = $125
II. The lower yield on the bond that differs only in it conversion feature indicates that the
bond is priced according to its conversion value, not its straight debt value.
III. $1,245/$49.80 = $25
83. You find digital option quotes on jobless claims. You can buy a call option with a strike
price of 300,000 jobless claims. This option pays $100 if actual claims exceed the strike price
and pays zero otherwise. The option costs $68. A second digital call with a strike price of
305,000 jobless claims is available at a cost of $53. Suppose you buy the option with the
300,000 strike and sell the option with the 305,000 strike and jobless claims actually wind up
at 303,000. Your net profit on the position is ______.
A. -$15
B. $200
C. $85
D. $185
Answer: C. $85
Initial cost = -C300 + C305 = -$68 + $53 = -$15
At actual jobless claims of 303,000, at contract maturity the C300 call is worth $100 and the
C305 call is worthless. Profit = +$100 - $0 - $15 = $85
84. Bill Jones inherited 5,000 shares of stock priced at $45 per share. He does not want to sell
the stock this year due to tax reasons, but he is concerned that the stock will drop in value
before year-end. Bill wants to use a collar to ensure that he minimizes his risk and doesn't
incur too much cost in deferring the gain. January call options with a strike of $50 are quoted
at a cost of $2, and January puts with a $40 exercise price are quoted at a cost of $3. If Bill
establishes the collar and the stock price winds up at $35 in January, Bill's net position value
including the option profit or loss and the stock is _________.
A. $195,000
B. $220,000
C. $175,000
D. $215,000
Answer: A. $195,000
Answer: A. $195,000
Position value = 5,000 shares × $45/share = $225,000. To establish a collar, you would need
5,000/100 = 50 options. You would buy the 50 puts at a cost of $3(100)(50) = $15,000 and
write the 50 calls, earning a premium of $2(100)(50) = $10,000. The initial cost is $15,000 $10,000 = $5,000. If the stock price in January is $35, then profit can be found as:
Profit = [Max ($0, $40 - $35) - Max ($0, $35 - $50)](100)(50) - $5,000 = $20,000
New stock value = 5,000 shares × $35 = $175,000, so Net position value = $175,000 +
$20,000 = $195,000
85. You own a stock portfolio worth $50,000. You are worried that stock prices may take a
dip before you are ready to sell, so you are considering purchasing either at-the-money or outof-the-money puts. If you decide to purchase the out-of-the-money puts, your maximum loss
is __________ than if you buy at-the-money puts and your maximum gain is __________.
A. greater; lower
B. greater; greater
C. lower; greater
D. lower; lower
Answer: B. greater; greater
86. You purchase one IBM July 90 call contract for a premium of $4. The stock has a 2-for-1
split prior to the expiration date. You hold the option until the expiration date, when IBM
stock sells for $48 per share. You will realize a ______ on the investment.
A. $300 profit
B. $100 loss
C. $400 loss
D. $200 profit
Answer: D. $200 profit
Long call profit = 2Max {0, [$48 - ($90/2)(100)]} - $400 = $200
87. You own $75,000 worth of stock, and you are worried the price may fall by year-end in 6
months. You are considering using either puts or calls to hedge this position. Given this,
which of the following statements is (are) correct?
I. One way to hedge your position would be to buy puts.
II. One way to hedge your position would be to write calls.
III. If major stock price declines are likely, hedging with puts is probably better than hedging
with short calls.
A. I only
B. II only
C. I and III only
D. I, II, and III
Answer: D. I, II, and III
Test Bank for Essentials of Investments
Zvi Bodie, Alex Kane, Alan Marcus
9780078034695, 9789389957877, 9781264140251, 9781260316148, 9780073382401, 9780078034695, 9781260013924, 9780077835422
