Answer Choices:
a. The price of call options will rise if XYZ’s stock price rises.
b. The higher the strike price, the higher the call option price.
c. Assuming the same strike price, a call option that expires in 1 month will sell for a higher price than one that expires in 3 months.
d. The less volatile a stock’s price, the more valuable a call option on the stock is.
e. If the risk-free rate of interest increases, the value of call options will decrease.
Answer: a. The price of call options will rise if XYZ’s stock price rises.
Question: Which of the following is NOT an example of a derivative security?
Answer Choices:
a. Futures.
b. Options.
c. Swaps.
d. Forward contracts.
e. Preferred stock.
Answer: e. Preferred stock.
Question: Which of the following statements is most CORRECT?
Answer Choices:
a. One advantage of forward contracts is that they are default free.
b. Futures contracts generally trade on an organized exchange and are marked to market daily.
c. Goods are never delivered under forward contracts, but are almost always delivered under futures contracts.
d. Forward contracts are generally standardized instruments, whereas futures contracts are generally tailor-made for the 2 parties of the contract.
e. Essentially there are no differences between forward and futures contracts, except that forward contracts are used only for financial assets while futures contracts are used only for commodities.
Answer: b. Futures contracts generally trade on an organized exchange and are marked to market daily.
Question: A call option whose underlying stock value is less than the corresponding exercise price is an example of a(n):
Answer Choices:
a. Straddle option.
b. Put option.
c. Out-of-the-money option.
d. Naked option.
e. Covered option.
Answer: c. Out-of-the-money option.
Question: Which of the following statements concerning risk management is NOT CORRECT?
Answer Choices:
a. Risk management can reduce the volatility of cash flows, and this decreases the probability of bankruptcy.
b. Risk management makes sense for firms directly engaged in activities that involve commodities whose values can be hedged, but it doesn’t make much sense for most other firms.
c. Companies with volatile earnings pay more taxes than companies with more stable earnings due to the treatment of tax credits and the rules governing corporate loss carry-forwards and carry-backs. Therefore, our tax system encourages risk management to stabilize earnings.
d. Risk management can reduce the likelihood of low cash flows, and therefore reduce the probability of financial distress.
e. Risk management involves identifying events that could have adverse financial consequences and then taking actions to prevent and/or to minimize the damage caused by these events.
Answer: b. Risk management makes sense for firms directly engaged in activities that involve commodities whose values can be hedged, but it doesn’t make much sense for most other firms.
Question: A commercial bank recognizes that its net income suffers whenever interest rates increase. Which of the following strategies would protect the bank against rising interest rates?
Answer Choices:
a. Buying inverse floaters.
b. Entering into an interest rate swap where the bank receives a fixed payment stream, and in return agrees to make payments that float with market interest rates.
c. Purchase principal only (PO) strips that decline in value whenever interest rates rise.
d. Enter into a short hedge where the bank agrees to sell interest rate futures.
e. Sell some of the bank’s floating-rate loans and use the proceeds to make fixed-rate loans.
Answer: d. Enter into a short hedge where the bank agrees to sell interest rate futures.
Question: In theory, reducing the volatility of its cash flows will always increase a company’s value.
Answer Choices:
a. True
b. False
Answer: False
Question: An option that gives the holder the right to buy a stock at a specified price at some time in the future is called a(n):
Answer Choices:
a. Call option.
b. Put option.
c. Out-of-the-money option.
d. Naked option.
e. Covered option.
Answer: a. Call option.
Question: The value of a stock option depends on all of the following EXCEPT:
Answer Choices:
a. Exercise price.
b. Variability of the stock price.
c. Length of time until option expiration.
d. Risk-free rate of interest.
e. Bond price.
Answer: e. Bond price.
Question: Which of the following statements regarding factors that affect call option prices is CORRECT?
Answer Choices:
a. The longer the time until the call option expires the smaller its value and the smaller its premium.
b. An option on an extremely volatile stock is worth less than one on a very stable stock.
c. The price of a call option increases as the risk-free rate increases.
d. Two call options on the same stock will have the same value even if they have different strike prices.
e. If you observe that a put option on a stock increases in value, then a call option on that same stock also increases in value.
Answer: c. The price of a call option increases as the risk-free rate increases.
Question: Which of the following events is likely to decrease the value of call options on the common stock of GCC Company?
Answer Choices:
a. An increase in GCC’s stock price.
b. An increase in the exercise price of the option.
c. An increase in the amount of time until the option expires.
d. An increase in the risk-free rate.
e. GCC’s stock price becomes more risky (higher variance).
Answer: b. An increase in the exercise price of the option.
Question: An investor who “writes” a call option without the stock in his or her portfolio to back it up is selling a(n):
Answer Choices:
a. Call option.
b. Put option.
c. Out-of-the-money option.
d. Naked option.
e. Covered option.
Answer: d. Naked option.