1. Which of the following statements is CORRECT?

a. Put options give investors the right to buy a stock at a certain strike price before a specified date.

b. Call options give investors the right to sell a stock at a certain strike price before a specified date.

c. Options typically sell for less than their exercise value.

d. LEAPS are very short-term options that were created relatively recently and now trade in the market.

e. An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.

 2. Which of the following statements is CORRECT?

a. If the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock’s price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.

b. Call options generally sell at a price less than their exercise value.

c. If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.

d. Call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.

e. Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

 3. Which of the following statements is CORRECT?

a. An option's value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can't sell for more than its exercise value.

b. As the stock’s price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.

c. Issuing options provides companies with a low cost method of raising capital.

d. The market value of an option depends in part on the option's time to maturity and also on the variability of the underlying stock's price.

e. The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.

4. The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year call option on the stock, with an exercise price of $22, is available. Based on the binominal model, what is the option's value?

a. $2.43

b. $2.70

c. $2.99

d. $3.29

e. $3.62 

The stock’s range of payoffs in one year is $27 - $17 = $10. At expiration, the option will be worth $27 - $22 = $5 if the stock price is $27, and zero if the stock price $17. The range of payoffs for the stock option is $5 – 0 = $5. Equalize the range to find the number of shares of stock: Option range / Stock range = $5/$10 = 0.5. With 0.5 shares, the stock’s payoff will be either $13.5 or $8.5. The portfolio’s payoff will be $13.5 - $5 = $8.5, or $8.5 – 0 = $8.5. The present value of $8.5 at the daily compounded risk-free rate is: PV = $8.5 / (1+ (0.06/365))365 = $8.005. The option price is the current value of the stock in the portfolio minus the PV of the payoff: V = 0.5($22) - $8.005 = $3.00.

5. An analyst wants to use the Black-Scholes model to value call options on the stock of Ledbetter Inc. based on the following data:

The price of the stock is $40.

The strike price of the option is $40.

The option matures in 3 months (t = 0.25).

The standard deviation of the stock’s returns is 0.40, and the variance is 0.16.

The risk-free rate is 6%.

Given this information, the analyst then calculated the following necessary components of the Black-Scholes model:

d1 = 0.175

d2 = -0.025

N(d1) = 0.56946

N(d2) = 0.49003

N(d1) and N(d2) represent areas under a standard normal distribution function. Using the Black- Scholes model, what is the value of the call option?

a. $2.81

b. $3.12

c. $3.47

d. $3.82

e. $4.20