Chapter 23

<p>American options may be exercised anytime up to expiration. European options may be exercised only at expiration.</p> Signup and view all the answers

<p>You have the right to buy at a set price at any time up to and including the expiration date.</p> Signup and view all the answers

<p>but not the obligation to buy an asset at a given price.</p> Signup and view all the answers

<p>Call options are issued by investors and bought by investors.</p> Signup and view all the answers

<p>is in-the-money.</p> Signup and view all the answers

<p>sell a put and buy a call on a stock as well as invest at the risk-free rate of return.</p> Signup and view all the answers

<p>greater of the strike price minus the stock price or zero.</p> Signup and view all the answers

<p>Lowering the risk level of the underlying security.</p> Signup and view all the answers

<p>hockey stick diagrams.</p> Signup and view all the answers

<p>zero, because it is a limited liability instrument.</p> Signup and view all the answers

<p>The writer has the option to sell shares but not an obligation.</p> Signup and view all the answers

<p>has an exercise price greater than the underlying stock price.</p> Signup and view all the answers

<p>a European put.</p> Signup and view all the answers

<p>American put</p> Signup and view all the answers

<p>Call options are in the money if the stock price is above the exercise price. Put options are in the money if the stock price is below the exercise price.</p> Signup and view all the answers

<p>American put.</p> Signup and view all the answers

<p>0; 0.</p> Signup and view all the answers

<p>but not the obligation to sell an asset at a given price.</p> Signup and view all the answers

<p>the mirror image of the call diagram around the exercise price.</p> Signup and view all the answers

<p>the option did not trade that day.</p> Signup and view all the answers

<p>the holder to sell shares if desired and requires the put seller to buy the shares at a fixed price.</p> Signup and view all the answers

<p>$787.50 plus brokerage fees, etc.</p> Signup and view all the answers

<p>$3,300</p> Signup and view all the answers

<p>$5.86</p> Signup and view all the answers

<p>the precise relationship between put and call prices given equal exercise prices and equal expiration dates.</p> Signup and view all the answers

<p>17.65%.</p> Signup and view all the answers

<p>$250</p> Signup and view all the answers

<p>$4</p> Signup and view all the answers

<p>$23</p> Signup and view all the answers

<p>the lower the call price.</p> Signup and view all the answers

<p>For both calls and puts an increase in the time to expiration will cause an increase in the option price.</p> Signup and view all the answers

<p>value of both the put and call option will decrease.</p> Signup and view all the answers

<p>value of both the put and call option will decrease.</p> Signup and view all the answers

<p>Both changes cause the price of the call option to increase.</p> Signup and view all the answers

<p>The greater uncertainty will cause the price of the put option to increase. The higher price of the stock will cause the price of the put option to decrease.</p> Signup and view all the answers

<p>The volatility normally will have a positive effect on the price of the call option while the lower price of the stock will cause the price of the call option to decrease.</p> Signup and view all the answers

<p>The volatility normally will have a positive effect on the price of the put option, but the lower price of the stock will cause the price of the put option to increase.</p> Signup and view all the answers

<p>The higher interest rate will cause the price of the call option to increase. The lower price of the stock will cause the price of the call option to decrease.</p> Signup and view all the answers

<p>there are only two specific outcomes in the future period.</p> Signup and view all the answers

<p>Stock price, exercise price, risk free rate, variance and time to maturity.</p> Signup and view all the answers

<p>$4.80</p> Signup and view all the answers

<p>first have to compute the value of the put as if it is a call.</p> Signup and view all the answers

<p>a call option on the firm with the exercise price equal to the promised payments to the bondholders.</p> Signup and view all the answers

<p>call; $50,000.</p> Signup and view all the answers

<p>The option is out-of-the-money, the stockholders walk away, and the bondholders receive the entire cash flow.</p> Signup and view all the answers

<p>The option is in-the-money and the stockholders earn the difference between the cash flow and the bondholder's promised payment.</p> Signup and view all the answers

<p>In addition to owning the firm, they have written a call option against the firm whose exercise price equals the promised payment.</p> Signup and view all the answers

<p>the put is out-of-the-money, is not exercised, and the stockholders retain ownership.</p> Signup and view all the answers

<p>the put is in-the-money, is exercised, and the stockholders walk away from their promise to the bondholders.</p> Signup and view all the answers

<p>the stock is a call option on the firm's assets, and risky projects increase the volatility of those assets.</p> Signup and view all the answers

<p>projects, as call options, can be more valuable if the decision to start up the project is delayed until relevant information is released.</p> Signup and view all the answers

<p>will decrease because the value of the put option will increase.</p> Signup and view all the answers

<p>Investment is $25 + $3 - $4 = $24. Guaranteed payoff = $30. Guaranteed return = ($24/$30) - 1 = 25% &gt; 20%. P-C does not hold. The put price that would guarantee a return of 20% is $4.</p> Signup and view all the answers

<p>d1 = {ln(36/35) + [.03 + (.5)(.25)] * (30/365)}/((.25)(30/365)).5 =.2854 d2 =.2854 - ((.25)(30/365)).5 =.1421 N(d1 ) =.6124; N(d1 ) =.5565 C = (36 * .6124) - 35e-(.030)(.082192) *.5565 = $2.75</p> Signup and view all the answers

<p>d1 = [ln(20/17.5) + 0.07 + (0.5*(0.1^2))<em>1]/(SQRT((0.1^2)<em>1)) = (0.133531 + 0.075)/0.1 = 2.08531 d2 = 2.08531 - 0.1 = 1.98531 N(d1) = 0.9814796 N(d2) = 0.9764452 e^(-0.07</em>1) = 0.932394 Call = (20</em>0.98148) - (17.5<em>0.932394</em>0.97645) = 3.697 or $3.70</p> Signup and view all the answers

<p>Call</p> <ul> <li>bondholders own firm</li> <li>bondholders sold call to stockholders</li> <li>stockholders exercise by paying debt amount Put</li> <li>bondholders are owed interest and principal</li> <li>bondholders sold put on the firm cash flow to stockholders</li> <li>stockholders exercise put when cash flows less than amount owed Can be resolved by Put-Call Parity. These are equivalent positions; as the value of call rises, put falls and vice-versa.</li> </ul> Signup and view all the answers

<ul> <li>Every project can be viewed as an option--to invest or not to invest. If the NPV is positive, exercise the option to add value.</li> <li>Timing of an investment can be critical to value--time is a positive factor to option value.</li> <li>lengthening time to invest, delaying the choice until more information is revealed.</li> <li>a negative NPV alternative may be clearly avoided or an alternative course of action presented.</li> <li>Instructor should determine the reasonableness of an example.</li> </ul> Signup and view all the answers

<p>Looking at each option, we see: a. To profit from an expected price decline, you can offset your loss (assuming you don't wish to simply sell the stock) by either buying puts or selling (writing) covered calls on the stock. In this case, you would probably buy puts and sell them before expiration. b. In this case, the obvious solution is to buy calls and hope to sell them at a higher price later. You could also write puts, but Aunt Minnie would be forced to buy shares if you are wrong about the direction of the price change. c. You could sell puts as long as you are willing to buy the underlying security if the market moves against you. You do not want to sell covered calls if you are unwilling to sell your shares if the option is exercised. You do not want to sell naked calls as they have unlimited risk.</p> Signup and view all the answers

<p>The analogy only works for leveraged firms. At maturity of the firm's debt, the stockholders have the option to either pay the bondholders the par value of their debt or turn the firm's assets over to them. If the firm's assets are worth less than the par value of the debt, the stockholders will not exercise their call, that is, they will let the bondholders have the assets and the firm will be liquidated</p> Signup and view all the answers

<p>The upper bound on a call is the stock price. If the call price exceeded the stock price, you would be paying more for the option to buy an asset than the asset itself costs. The lower bound: C ≥ 0 if S</p> <ul> <li>E &lt; 0 and C ≥ (S - E) if (S - E) ≥ 0. In the first case, if the call exercise price exceeds the stock price, the call is out of the money and it will either be worthless or have a time premium. In the second case, if the call is in the money, the call must be worth at least the difference between the asset's value and the exercise price. If the call was worth less than this value, rational investors would purchase calls, immediately exercise them, and then sell the stock at the current market price, completing an arbitrage. If the stock price equals the exercise price, then the call is at the money and will have a value of zero or an amount equal to the time premium.</li> </ul> Signup and view all the answers