Problem Set 5

Multiple Choice Questions (0.5 points each. Fill your answers in the table below)

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1. The price that the buyer of a call option pays to acquire the option is called the
A. strike price
B. exercise price
C. execution price
D. acquisition price
E. premium

2. The price that the buyer of a call option pays for the underlying asset if she executes her option
is called the
A. strike price
B. exercise price
C. execution price
D. strike price or execution price
E. strike price or exercise price

3. An American call option allows the buyer to

A. sell the underlying asset at the exercise price on or before the expiration date.
B. buy the underlying asset at the exercise price on or before the expiration date.
C. sell the option in the open market prior to expiration.
D. sell the underlying asset at the exercise price on or before the expiration date and sell the
option in the open market prior to expiration.
E. buy the underlying asset at the exercise price on or before the expiration date and sell the
option in the open market prior to expiration.

4. A European call option can be exercised

A. any time in the future.
B. only on the expiration date.
C. if the price of the underlying asset declines below the exercise price.
D. immediately after dividends are paid.
E. None of these is correct.

5. The current market price of a share of CSCO stock is $22. If a call option on this stock has a
strike price of $20, the call
A. is out of the money.
B. is in the money.
C. sells for a higher price than if the market price of CSCO stock is $21.
D. is out of the money and sells for a higher price than if the market price of CSCO stock is $21.
E. is in the money and sells for a higher price than if the market price of CSCO stock is $21.
6. The current market price of a share of IBM stock is $80. If a call option on this stock has a strike
price of $80, the call
A. is out of the money.
B. is in the money.
C. is at the money.
D. is out of the money and is at the money.
E. is in the money and is at the money.

7. You purchase one September 50 put contract for a put premium of $2. What is the maximum
profit that you could gain from this strategy?
A. $4,800
B. $200
C. $5,000
D. $5,200
E. None of these is correct

8. The put-call parity theorem

A. represents the proper relationship between put and call prices.
B. allows for arbitrage opportunities if violated.
C. may be violated by small amounts, but not enough to earn arbitrage profits, once transaction
costs are considered.
D. All of these are correct.
E. None of these is correct.

9. Top Flight Stock currently sells for $53. A one-year call option with strike price of $58 sells for
$10, and the risk free interest rate is 5.5%. What is the price of a one-year put with strike price of
$58?
A. $10.00
B. $12.12
C. $16.00
D. $11.97
E. $14.13

10. Consider a one-year maturity call option and a one-year put option on the same stock, both
with striking price $45. If the risk-free rate is 4%, the stock price is $48, and the put sells for
$1.50, what should be the price of the call?
A. $4.38
B. $5.60
C. $6.23
D. $12.26
E. None of these is correct.
11. Before expiration, the time value of an in the money call option is always
A. equal to zero.
B. positive.
C. negative.
D. equal to the stock price minus the exercise price.
E. None of these is correct.

12. A call option has an intrinsic value of zero if the option is

A. at the money.
B. out of the money.
C. in the money.
D. at the money and in the money.
E. at the money and out of the money.

13. If the stock price increases, the price of a put option on that stock __________ and that of a call
option __________.
A. decreases, increases
B. decreases, decreases
C. increases, decreases
D. increases, increases
E. does not change, does not change

14. Other things equal, the price of a stock call option is positively correlated with the following
factors except
A. the stock price.
B. the time to expiration.
C. the stock volatility.
D. the exercise price.
E. None of these is correct.

15. All the inputs in the Black-Scholes Option Pricing Model are directly observable except
A. the price of the underlying security.
B. the risk free rate of interest.
C. the time to expiration.
D. the variance of returns of the underlying asset return.
E. None of these is correct.

16. A hedge ratio of 0.70 implies that a hedged portfolio should consist of
A. long 0.70 calls for each short stock.
B. short 0.70 calls for each long stock.
C. long 0.70 shares for each short call.
D. long 0.70 shares for each long call.
E. None of these is correct.
17. A portfolio consists of 100 shares of stock and 1500 calls on that stock. If the hedge ratio for
the call is 0.7, what would be the dollar change in the value of the portfolio in response to a one
dollar decline in the stock price?
A. +$700
B. +$500
C. -$1,150
D. -$520
E. None of these is correct

18. Which one of the following variables influence the value of call options?
I) Level of interest rates.
II) Time to expiration of the option.
III) Dividend yield of underlying stock.
IV) Stock price volatility.
A. I and IV only.
B. II and III only.
C. I, II, and IV only.
D. I, II, III, and IV.
E. I, II and III only.

19. Use the Black-Scholes Option Pricing Model for the following problem. Given: S O= $70; X =
$70; T = 70 days; r = 0.06 annually (0.0001648 daily);  = 0.020506 (daily). No dividends will be
paid before option expires. The value of the call option is _______.
A. $10.16
B. $5.16
C. $0.00
D. $2.16
E. None of these is correct

20. The intrinsic value of an at-the-money put option is equal to

A. the stock price minus the exercise price.
B. the put premium.
C. zero.
D. the exercise price minus the stock price.
E. None of these is correct.

21. A futures contract

A. is an agreement to buy or sell a specified amount of an asset at the spot price on the expiration
date of the contract.
B. is an agreement to buy or sell a specified amount of an asset at a predetermined price on the
expiration date of the contract.
C. gives the buyer the right, but not the obligation, to buy an asset some time in the future.
D. is a contract to be signed in the future by the buyer and the seller of the commodity.
E. None of these is correct.
22. You hold one long corn futures contract that expires in April. To close your position in corn
futures before the delivery date you must
A. buy one May corn futures contract.
B. buy two April corn futures contract.
C. sell one April corn futures contract.
D. sell one May corn futures contract.
E. None of these is correct.

23. An investor with a long position in Treasury notes futures will profit if
A. interest rates decline.
B. interest rate increase.
C. the prices of Treasury notes decrease.
D. the price of the long bond increases.
E. None of these is correct.

24. If you determine that the S&P 500 Index futures is overpriced relative to the spot S&P 500
Index you could make an arbitrage profit by
A. buying all the stocks in the S&P 500 and selling put options on the S&P 500 index.
B. selling short all the stocks in the S&P 500 and buying S&P Index futures.
C. selling all the stocks in the S&P 500 and buying call options on the S&P 500 index.
D. selling S&P 500 Index futures and buying all the stocks in the S&P 500.
E. None of these is correct.

25. You sold one silver future contract at $3 per ounce. What would be your profit (loss) at
maturity if the silver spot price at that time is $4.10 per ounce? Assume the contract size is 5,000
ounces and there are no transactions costs.
A. $5.50 profit
B. $5,500 profit
C. $5.50 loss
D. $5,500 loss
E. None of these is correct.

26. Given a stock index with a value of $1,500, an anticipated dividend of $62 and a risk-free rate
of 5.75%, what should be the value of one-year future contract on the index?
A. $1343.40
B. $62.00
C. $1418.44
D. $1524.25
E. None of these is correct

27. Which one of the following statements is true?

A. The maintenance margin is the amount of money you post with your broker when you buy or
sell a futures contract.
B. If the value of the margin account falls below the maintenance margin requirement, the holder
of the contract will receive a margin call.
C. A margin deposit can only be met with cash.
D. All futures contracts require the same margin deposit.
E. The maintenance margin is set by the producer of the underlying asset.
28. A trader who has a __________ position in gold futures wants the price of gold to __________ in
the future.
A. long; decrease
B. short; decrease
C. short; stay the same
D. short; increase
E. long; stay the same

29. A decrease in the basis will __________ a long hedger and __________ a short hedger.
A. hurt; benefit
B. hurt; hurt
C. benefit; hurt
D. benefit; benefit
E. benefit; have no effect upon

30. If you determine that the DAX-30 index futures is under priced relative to the spot DAX-30
index you could make an arbitrage profit by
A. buying all the stocks in the DAX-30 and selling put options on the DAX-30 index.
B. selling short DAX-30 futures and buying all the stocks in the DAX-30.
C. selling all the stocks in the DAX-30 and buying call options on the DAX-30 index.
D. buying DAX-30 index futures and selling all the stocks in the DAX-30.
E. None of these is correct.