Options Futures And Other Derivatives 10th Edition By JohnC. – Test Bank

Chapter 11: Properties of Stock Options
Multiple Choice Test Bank: Questions with Answers

1. When the stock price increases with all else remaining the same, which of the following is true?
A. Both calls and puts increase in value
B. Both calls and puts decrease in value
C. Calls increase in value while puts decrease in value
D. Puts increase in value while calls decrease in value

Answer: C

Stock price increases cause the values of calls to increase and the values of puts to decline.

2. When the strike price increases with all else remaining the same, which of the following is true?
A. Both calls and puts increase in value
B. Both calls and puts decrease in value
C. Calls increase in value while puts decrease in value
D. Puts increase in value while calls decrease in value

Answer: D

Strike price increases cause the values of puts to increase and the values of calls to decline.

3. When volatility increases with all else remaining the same, which of the following is true?
A. Both calls and puts increase in value
B. Both calls and puts decrease in value
C. Calls increase in value while puts decrease in value
D. Puts increase in value while calls decrease in value

Answer: A

Volatility increases the likelihood of a high payoff from either a call or a put option. The payoff can never be negative. It follows that as volatility increases the value of all options increase.

4. When dividends increase with all else remaining the same, which of the following is true?
A. Both calls and puts increase in value
B. Both calls and puts decrease in value
C. Calls increase in value while puts decrease in value
D. Puts increase in value while calls decrease in value

Answer: D

Dividends during the life of an option reduce the final stock price. As a result dividend increases cause puts to increase in value and calls to decrease in value.

5. When interest rates increase with all else remaining the same, which of the following is true?
A. Both calls and puts increase in value
B. Both calls and puts decrease in value
C. Calls increase in value while puts decrease in value
D. Puts increase in value while calls decrease in value

Answer: C

Calls increase and puts decrease in value. As explained in the text an increase in interest rates causes the growth rate of the stock price to increase and the discount rate to increase. An increase in interest rates therefore reduces the value of puts because puts are hurt by both a discount rate increase and a growth rate increase. For calls it turns out that the growth rate increase is more important than the discount rate increase so that their values increase when interest rates increase. (Note that we are assuming all else equal and so the asset price does not change.)

6. When the time to maturity increases with all else remaining the same, which of the following is true?
A. European options always increase in value
B. The value of European options either stays the same or increases
C. There is no effect on European option values
D. European options are liable to increase or decrease in value

Answer: D

When the time to maturity increases from X to Y, European options usually increase in value. But this is not always the case. For example, European call options can decrease in value if a big dividend is expected between X and Y.

7. The price of a stock, which pays no dividends, is $30 and the strike price of a one year European call option on the stock is $25. The risk-free rate is 4% (continuously compounded). Which of the following is a lower bound for the option such that there are arbitrage opportunities if the price is below the lower bound and no arbitrage opportunities if it is above the lower bound?
A. $5.00
B. $5.98
C. $4.98
D. $3.98

Answer: B

The lower bound in S0 − Ke-rT. In this case it is 30 – 25e-0.04×1 = $5.98.

8. A stock price (which pays no dividends) is $50 and the strike price of a two year European put option is $54. The risk-free rate is 3% (continuously compounded). Which of the following is a lower bound for the option such that there are arbitrage opportunities if the price is below the lower bound and no arbitrage opportunities if it is above the lower bound?
A. $4.00
B. $3.86
C. $2.86
D. $0.86

Answer: D

The lower bound in Ke-rT −S0 In this case it is 54e−0.03×2 – 50= $0.86.

9. Which of the following is NOT true? (Present values are calculated from the end of the life of the option to the beginning.)
A. An American put option is always worth less than the present value of the strike price
B. A European put option is always worth less than the present value of the strike price
C. A European call option is always worth less than the stock price
D. An American call option is always worth less than the stock price

Answer: A

If it is optimal to exercise an American option today and the stock price is very low the option will be worth more than the present value of the strike price

10. Which of the following best describes the intrinsic value of an option?
A. The value it would have if the owner had to exercise it immediately or not at all
B. The Black-Scholes-Merton price of the option
C. The lower bound for the option’s price
D. The amount paid for the option

Answer: A

The intrinsic value of an option is the value it would have if it were about the expire which is the same as the value in A.