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Exam 19: Financial Options and Applications in Corporate Finance

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Question 21

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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) LEAPS are very short-term options that were created relatively recently and now trade in the market.
D) An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.

E) None of the above
F) B) and C)

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Question 22

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Suppose you believe that Delva Corporation's stock price is going to decline from its current level of $82.50 sometime during the next 5 months. For $510.25 you could buy a 5-month put option giving you the right to sell 100 shares at a price of $85 per share. If you bought this option for $510.25 and Delva's stock price actually dropped to $60, what would your pre-tax net profit be?

A) -$510.25
B) $1,989.75
C) $2,089.24
D) $2,193.70

E) A) and B)
F) A) and D)

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Question 23

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The exercise value is also called the strike price, but this term is generally used when discussing convertibles rather than financial options.

Since investors tend to dislike risk and like certainty, the more volatile a stock, the less valuable will be an option to purchase the stock, other things held constant.

If we define the "premium" on an option to be the difference between the price at which an option sells and the exercise value (or the difference between the stock's current market price and the strike price), then we would expect the premium to increase as the stock price increases, other things held constant.

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. What is the value of the call option?

If a company announces a change in its dividend policy from a zero target payout ratio to a 100% payout policy, this action could be expected to increase the value of long-term options (say 5-year options) on the firm's stock.

GCC Corporation is planning to issue options to its key employees, and it is now discussing the terms to be set on those options. Which of the following actions would decrease the value of the options, other things held constant?