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FIN 534 Quiz5 week 6
30 Multiple choices
Question 1
 
Which of the following statements is CORRECT?
Answer

 

If the underlying stock does not pay a dividend, it does not
make good economic sense to exercise a call option prior to its
expiration date, even if this would yield an immediate profit.

 

Call options generally sell at a price greater than their
exercise value, and the greater the exercise value, the higher the
premium on the option is likely to be.

 

Call options generally sell at a price below their exercise
value, and the greater the exercise value, the lower the premium on
the option is likely to be.

 

Call options generally sell at a price below their exercise
value, and the lower the exercise value, the lower the premium on
the option is likely to be.

 

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.

2 points  
Question 2
 
Call options on XYZ Corporation’s common stock trade in the
market.  Which of the following statements is most correct,
holding other things constant?
Answer

 

The price of these call options is likely to rise if XYZ’s stock
price rises.

 

The higher the strike price on XYZ’s options, the higher the
option’s price will be.

 

Assuming the same strike price, an XYZ call option that expires
in one month will sell at a higher price than one that expires in
three months.

 

If XYZ’s stock price stabilizes (becomes less volatile), then
the price of its options will increase.

 

If XYZ pays a dividend, then its option holders will not receive
a cash payment, but the strike price of the option will be reduced
by the amount of the dividend.
              

2 points  
Question 3
 
Which of the following statements is CORRECT?
Answer

 

If the underlying stock does not pay a dividend, it does not
make good economic sense to exercise a call option prior to its
expiration date, even if this would yield an immediate profit.

 

Call options generally sell at a price greater than their
exercise value, and the greater the exercise value, the higher the
premium on the option is likely to be.

 

Call options generally sell at a price below their exercise
value, and the greater the exercise value, the lower the premium on
the option is likely to be.

 

Call options generally sell at a price below their exercise
value, and the lower the exercise value, the lower the premium on
the option is likely to be.

 

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.

2 points  
Question 4
 
Which of the following statements is CORRECT?
Answer

 

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.

 

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.

 

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

 

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.

 

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

2 points  
Question 5
 
An option that gives the holder the right to sell a stock at a
specified price at some future time is
Answer

 

a call option.

 

a put option.

 

an out-of-the-money option.

 

a naked option.

 

a covered option.
 
              

2 points  
Question 6
 
Other things held constant, the value of an option depends on
the stock’s price, the risk-free rate, and the
Answer

 

Strike price.

 

Variability of the stock price.

 

Option’s time to maturity.

 

All of the above.

 

None of the above.
 
              

2 points  
Question 7
 
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?
 
Answer

 

-$510.25

 

$1,989.75

 

$2,089.24

 

$2,193.70

 

$2,303.38
 

2 points  
Question 8
 
Which of the following statements is CORRECT?

2 points  
Question 9
 
Deeble Construction Co.’s stock is trading at $30 a share. 
Call options on the company’s stock are also available, some with a
strike price of $25 and some with a strike price of $35.  Both
options expire in three months.  Which of the following best
describes the value of these options?

2 points  
Question 10
 
Warner Motors’ stock is trading at $20 a share.  Call
options that expire in three months with a strike price of $20 sell
for $1.50.  Which of the following will occur if the stock
price increases 10%, to $22 a share?

2 points  
Question 11
 
Which of the following statements is CORRECT?

2 points  
Question 12
 
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?
Answer
2 points  
Question 13
 
Suppose you believe that Johnson Company’s stock price is going
to increase from its current level of $22.50 sometime during
the next 5 months.  For $310.25 you can buy a 5-month call
option giving you the right to buy 100 shares at a price of $25 per
share.  If you buy this option for $310.25 and Johnson’s stock
price actually rises to $45, what would your pre-tax net profit
be?
Answer
2 points  
Question 14
 
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?
Answer
 
2 points  
Question 15
 
An investor who writes standard call options against stock held
in his or her portfolio is said to be selling what type of
options?
Question 16
 
Which of the following statements is CORRECT?

Question 17
 
Which of the following statements is CORRECT?
Answer
2 points  
Question 18
 
For a typical firm, which of the following sequences is
CORRECT?  All rates are after taxes, and assume that the firm
operates
at its target capital structure.
Answer
2 points  
Question 19
 
Which of the following statements is CORRECT?
Answer
2 points  
Question 20
 
The MacMillen Company has equal amounts of low-risk,
average-risk, and high-risk projects.  The firm’s overall WACC
is 12%.  The CFO believes that this is the correct WACC for
the company’s average-risk projects, but that a lower rate should
be used for lower-risk projects and a higher rate for higher-risk
projects.  The CEO disagrees, on the grounds that even though
projects have different risks, the WACC used to evaluate each
project should be the same because the company obtains capital for
all projects from the same sources.  If the CEO’s position is
accepted, what is likely to happen over time?

Question 21
 
Which of the following statements is CORRECT?
Answer
Question 22
 
Which of the following statements is CORRECT?  Assume that
the firm is a publicly-owned corporation and is seeking to maximize
shareholder wealth.
Answer
Question 23
 
Which of the following statements is CORRECT?
Answer
 
Question 24
 
Which of the following statements is CORRECT?
Answer
Question 25
 
Firm M’s earnings and stock price tend to move up and down with
other firms in the S&P 500, while Firm W’s earnings and stock
price move counter cyclically with M and other S&P
companies.  Both M and W estimate their costs of equity using
the CAPM, they have identical market values, their standard
deviations of returns are identical, and they both finance only
with common equity.  Which of the following statements is
CORRECT?
Answer
 
2 points  
Question 26
 
Duval Inc. uses only equity capital, and it has two
equally-sized divisions.  Division A’s cost of capital is
10.0%, Division B’s cost is 14.0%, and the corporate (composite)
WACC is 12.0%.  All of Division A’s projects are equally
risky, as are all of Division B’s projects.  However, the
projects of Division A are less risky than those of Division
B.  Which of the following projects should the firm
accept?
Answer
Question 27
 
Schalheim Sisters Inc. has always paid out all of its earnings
as dividends; hence, the firm has no retained earnings.  This
same situation is expected to persist in the future.  The
company uses the CAPM to calculate its cost of equity, and its
target capital structure consists of common stock, preferred stock,
and debt.  Which of the following events would REDUCE its
WACC?
Answer
2 points  
Question 28
 
Norris Enterprises, an all-equity firm, has a beta of 2.0. 
The chief financial officer is evaluating a project with an
expected
return of 14%, before any risk adjustment.  The risk-free rate
is 5%, and the market risk premium is 4%.  The project being
evaluated is riskier than an average project, in terms of both its
beta risk and its total risk.  Which of the following
statements is CORRECT?
Answer
2 points  
Question 29
 
For a company whose target capital structure calls for 50% debt
and 50% common equity, which of the following statements
is CORRECT?
Answer
2 points  
Question 30
 
Which of the following statements is CORRECT?
 
 

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