Chap 024

Chapter 24 - Options and Corporate Finance
Chapter 24
Options and Corporate Finance

Multiple Choice Questions

1. Which one of the following grants its owner the right to buy or to sell an asset at a
prespecified price at any time during a stated period?
. option
!. forward contract
C. futures contract
". swap
#. intrinsic contract

2. #li$abeth owns a call option on 1%% shares of &icrosoft stoc'. (he has decided to buy those
shares. )his purchase is commonly referred to as*
. stri'ing the asset.
!. e+piring the option.
C. e+ercising the option.
". putting the collar.
#. the collar option.

,. &arti owns an option that allows him to purchase !C stoc' at -.% a share. )he -.% price
is referred to as the*
. opening price.
!. intrinsic /alue.
C. stri'e price.
". mar'et price.
#. time /alue.

4. What is the final day on which an option can be e+ercised called?
. payment date
!. e+-option date
C. opening date
". e+piration date
#. intrinsic date

24-1
.. Felicia purchased an option which she can e+ercise anytime within the ne+t si+ months.
Which type of option did she purchase?
. mar'et-ready
!. portable
C. daily
". #uropean
#. merican

0. !rad purchased an option that he can only e+ercise on the final day of the option period.
Which type of option did he purchase?
. #uropean
!. merican
C. infle+ible
". dated
#. pointed

1. Which of the following grants its owner the right to purchase an asset at a stated price?
2. merican call
22. #uropean call
222. merican put
23. #uropean put
. 2 only
!. 2 and 22 only
C. 2 and 222 only
". 22 and 23 only
#. 222 and 23 only

4. )he owner of a put option has the 55555 an asset at a fi+ed price during a stated period of
time.
. right to sell
!. right to buy
C. obligation to sell
". obligation to buy
#. obligation to trade

24-2
6. Which one of the following terms applies to the /alue of an option on its e+piration date?
. stri'e price
!. upper limit
C. deadline price
". time /alue
#. intrinsic /alue

1%. (u$ie is the controller of )he 7rice 8ite Company. (he has been granted to the right to buy
19%%% shares of her employer:s stoc' at -2. a share anytime within the ne+t three years.
Which one of the following has (u$ie been granted?
. employee stoc' option
!. company bonus option
C. employee grant
". employee e+ercise option
#. company benefits option

11. Which one of the following terms applies to an option that has an office building as its
underlying asset?
. financial option
!. li;uid option
C. fi+ed option
". real option
#. concrete option

12. )he in/estment timing decision is the*
. determination of when an option should be e+ercised.
!. decision of when to purchase an option on an underlying asset.
C. analysis of determining when an asset should be sold.
". determination of when a pro<ect should be abandoned.
#. e/aluation of the optimal time to begin a pro<ect.

24-,
1,. =ucas #nterprises recently opted to open a new retail outlet. 2f the outlet outperforms the
e+pectations9 the manager can opt to increase the store:s si$e. 2f it underperforms9 the manager
can opt to close the store. )hese choices that the manager has been gi/en are called*
. call options.
!. put options.
C. straddles.
". managerial options.
#. e+ecuti/e options.

14. Which one of the following considers all of the options implicit in a pro<ect?
. e+pansion planning
!. contingency planning
C. asset management re/iew
". prospecti/e e/aluation
#. strategic e/aluation

1.. >) #nterprises has e+panded its operations into a new field9 which is the production of
e/eryday dinnerware. 2f this pro<ect goes well9 the firm has the option to e+pand its
production into fine china. What type of option is this?
. financial
!. strategic
C. put
". intangible
#. call

10. my is a current shareholder of "? 2ndustries. (he has been gi/en the right to purchase an
additional 2. shares of "? 2ndustries stoc' at a price of -,2 a share if she e+ercises that right
within the ne+t 12 months. What is this security called that my has been gi/en?
. con/ertible bond
!. warrant
C. straddle
". spread
#. put

24-4
11. ?eff owns a -19%%% face /alue bond. @e can e+change that bond for 2. shares of >A?
stoc' at any time within the ne+t 2 years. What type of bond does ?eff own?
. secured
!. warranted
C. con/ertible
". <un'
#. callable

14. )he dollar amount of a bond:s par /alue that is e+changeable for one share of stoc' is
called the*
. con/ersion premium.
!. par /alue.
C. con/ersion /alue.
". con/ersion price.
#. con/ersion ratio.

16. licia owns a -19%%% face /alue bond that can be con/erted into 2% shares of ! =imited
stoc'. Which one of the following terms refers to these 2% shares?
. con/ersion premium
!. straight bond /alue
C. con/ersion /alue
". con/ersion price
#. con/ersion ratio

2%. )he difference between the con/ersion price and the current stoc' price9 di/ided by the
current stoc' price9 is called the*
!. straight bond /alue.

24-.
21. =atetia owns a con/ertible bond. Which one of the following terms would describe the
/alue of this bond if it were not con/ertible?
C. con/ersion /alue
". in/erted /alue
#. mar'et /alue

22. !rad owns a con/ertible bond. Which one of the following terms would apply to the /alue
of this bond if he were to con/ert it into shares of stoc' today?
C. con/ersion /alue
". in/erted /alue
#. prescribed /alue

2,. Which one of the following statements correctly describes your situation as the holder of a
#uropean call option?
. Bou are obligated to buy if the option is e+ercised.
!. Bou ha/e a right to sell.
C. Bou ha/e a right to buy but only on the e+piration date.
". Bou are obligated to sell if the option is e+ercised.
#. Bou ha/e a right to buy at any time before the option e+pires.

24. ?ulie opted to e+ercise her ugust option on ?une 2%th and as a result recei/ed -29.%% for
the sale of her shares. Which one of the following did ?ulie own?
. warrant
!. merican call
C. merican put
". #uropean call
#. #uropean put

24-0
2.. ?osh opted to e+ercise his ?anuary option at the end of "ecember and paid -,92.% at that
time to ac;uire 1%% shares of stoc'. Which one of the following did ?osh own?
. merican call
!. merican put
C. #uropean call
". #uropean put
#. #uropean con/ertible bond

20. (te/e owns an option which grants him the right to purchase shares of =o'ier )ool stoc'
at a price of -4. a share. Currently9 the stoc' is selling for -.2.4% a share. (te/e would li'e to
reali$e his profits but is not permitted to e+ercise the option for another two wee's. Which
one of the following does (te/e own?
. straight bond
!. merican call
C. merican put
". #uropean call
#. #uropean put

21. What is the primary difference between an merican call option and a #uropean call
option?
. )he merican call has a fi+ed stri'e price while the #uropean stri'e price /aries o/er time.
!. n merican call is a right to buy while a #uropean call is an obligation to buy.
C. n merican call has an e+piration date while the #uropean call does not.
". n merican call is written on 1%% shares of the underlying security while the #uropean
call co/ers 19%%% shares.
#. n merican call an be e+ercised at any time up to the e+piration date while the #uropean
call can only be e+ercised on the e+piration date.

24. Bou own a ?uly -1. call on !C stoc'. ssume today is pril 2% and the call has $ero
intrinsic /alue. Which one of the following best describes this option?
. worthless
!. unfunded
C. e+pired
". in-the-money
#. out-of-the-money

24-1
26. -2% put option on Wildwood stoc' e+pires today. )he current price of the stoc' is
-14..%. Which one of the following best describes this option?
. funded
!. unfunded
C. at-the-money
". in-the-money
#. out-of-the-money

,%. Which one of the following describes the ma+imum /alue of a call option?
. stri'e price minus the initial cost of the option
!. e+ercise price plus the price of the underlying stoc'
C. stri'e price
". mar'et price of the underlying stoc'
#. purchase price

,1. Which one of the following describes the lower bound of a call:s /alue?
. stri'e price or $ero9 whiche/er is greater
!. stoc' price minus the e+ercise price or $ero9 whiche/er is greater
C. stri'e price or the stoc' price9 whiche/er is lower
". stri'e price or $ero9 whiche/er is lower
#. stoc' price minus the e+ercise price or $ero9 whiche/er is lower

,2. Which one of the following describes the intrinsic /alue of a call option?
. the call:s upper bound /alue
!. the call:s lower bound /alue
C. mar'et price of the underlying security
". $ero9 if the call is in-the-money
#. negati/e amount9 if the call is out-of-the-money.

,,. Which one of the following describes the intrinsic /alue of a put option?
. lesser of the stri'e price or the stoc' price
!. lesser of the stoc' price minus the e+ercise price or $ero
C. lesser of the stoc' price or $ero
". greater of the stri'e price minus the stoc' price or $ero
#. greater of the stoc' price minus the e+ercise price or $ero

24-4
,4. Which one of the following statements is correct?
. )he /alue of a call decreases as the price of the underlying stoc' increases.
!. )he /alue of a call increases as the e+ercise price decreases.
C. )he /alue of a put increases as the price of the underlying stoc' increases.
". )he /alue of a put decreases as the e+ercise price increases.
#. )he intrinsic /alue of a put must be $ero on the e+piration date.

,.. n increase in which of the following will increase the /alue of a call?
2. time to e+piration
22. underlying stoc' price
222. ris'-free rate of return
23. price /olatility of the underlying stoc'
. 2 and 222 only
!. 229 2229 and 23 only
C. 29 2229 and 23 only
". 29 229 and 222 only
#. 29 229 2229 and 23

,0. Which of the following will decrease the /alue of a call option?
2. a decrease in the e+ercise price
22. a decrease in the /alue of the underlying security
222. an increase in the ris'-free rate
23. an increase in the time to e+piration
. 22 only
!. 2 and 22 only
C. 222 and 23 only
". 29 229 and 23 only
#. 29 229 and 222 only

24-6
,1. &ar' owns both a &arch -2% put and a &arch -2% call on lpha stoc'. Which one of the
following statements correctly relates to &ar':s position? 2gnore ta+es and transaction costs.
. price decrease in lpha stoc' will increase the /alue of &ar':s call option.
!. &arch -,% call is worth more than &ar':s -2% call.
C. )he time premium on an pril -2% put is less than the time premium on &ar':s put.
Cssume both puts e+pire in the same calendar year.D
". price increase in lpha stoc' from -20 to -24 will increase the /alue of &ar':s put.
#. 2f the intrinsic /alue of &ar':s put increases by -1 then the intrinsic /alue of his call must
either decrease by -1 or e;ual $ero.

,4. )ra/is owns both a (eptember -,% call and a (eptember -,% put. 2f the call finishes at-
the-money9 then the put will*
. also finish in-the-money.
!. finish at-the-money.
C. finish out-of-the-money.
". either finish at-the-money or in-the-money.
#. either finish at-the-money or out-of-the-money.

,6. Which one of the following statements regarding employee stoc' options C#(OsD is
correct?
. #(Os grant an employee the right to buy a fi+ed number of shares of company stoc' at the
mar'et price.
!. #mployees must e+ercise their #(Os prior to those #(Os becoming /ested.
C. #mployees may forfeit their #(Os if they terminate their employment with the issuing
firm.
". 2f a firm issue #(Os it must ma'e them a/ailable to all employees.
#. #mployees can sell their #(Os if they do not want to personally e+ercise them.

4%. #mployee stoc' options are primarily designed to do which one of the following?
. pro/ide employees with put options on their shares of company stoc'
!. pro/ide an immediately /ested benefit to 'ey employees
C. influence the actions and priorities of employees
". distribute e+cess cash to 'ey employees to a/oid corporate ta+ation
#. pro/ide an immediate capital gain to certain employees

24-1%
41. #mployee stoc' options*
. usually ha/e a positi/e intrinsic /alue when issued.
!. must be bac'dated at least si+ months to comply with (arbanes-O+ley.
C. are generally EunderwaterE when issued.
". are fre;uently repriced if the options are in-the-money.
#. are generally issued with a $ero intrinsic /alue.

42. )he (arbanes-O+ley ct of 2%%2 re;uires firms to report #(O grants within how many
days of the grant?
. 2 calendar days
!. 2 business days
C. 1 calendar days
". ,% business days
#. 4. calendar days

4,. "elta 2mporters has a pure discount loan with a face /alue of -14%9%%% due in one year.
)he assets of the firm are currently worth -20.9%%%. )he shareholders in this firm basically
own a 55555 option on the assets of the firm with a stri'e price of 55555.
. putF -14%9%%%.
!. putF -20.9%%%.
C. warrantF -20.9%%%.
". callF -14%9%%%.
#. callF -20.9%%%.

44. ?ac' and ?ill are house hunting. )hey find @ouse situated on a hill. )hey really li'e the
house but want to continue searching the mar'et for one more wee' before ma'ing their final
decision to buy the house. )o a/oid ha/ing someone else purchase @ouse while they
continue their house hunting9 they decide to place a -29.%% deposit on @ouse . )his deposit
will apply to the purchase price if they buy @ouse . 2f they do not buy @ouse 9 they will
forfeit the -29.%%. #ssentially9 ?ac' and ?ill ha/e a 55555 on @ouse .
. financial put
!. financial call
C. warrant
". real put
#. real call

24-11
4.. )he option to wait*
2. may be of minimal /alue if a pro<ect is dependent upon rapidly changing technology.
22. is partially dependent upon the discount rate applied to the pro<ect being e/aluated.
222. is defined as temporarily shutting down a pro<ect for a period of time.
23. has a /alue e;ual to the A73 of a pro<ect if it is started at a later date minus the A73 if the
pro<ect is started today.
. 2 and 222 only
!. 22 and 23 only
C. 2 and 22 only
". 229 2229 and 23 only
#. 29 229 and 23 only

40. 2gnoring which of the following will cause the A73 of a pro<ect to be underestimated?
2. option to abandon
22. option to e+pand
222. option to wait
23. option to contract
. 2 and 222 only
!. 229 2229 and 23 only
C. 29 229 and 222 only
". 29 2229 and 23 only
#. 29 229 2229 and 23

41. Which one of the following is an e+ample of a strategic option for a restaurant?
. opening a new restaurant with a different loo' and an entirely different menu to see if that
type of restaurant appeals to the public
!. deciding to close one hour earlier during the winter months due to slow sales
C. abandoning a menu item based on customer complaints
". deciding to open only two new locations ne+t year instead of the fi/e that were originally
scheduled
#. deciding to create separate lunch and dinner menus rather than ha/e them combined on one
menu

24-12
44. =ast month9 @ill (ide &ar'ets introduced a new board game. Consumer demand has been
o/erwhelming and appears that strong demand will e+ist o/er the long-term as young children
absolutely lo/e the game. Gi/en this9 which one of the following options should @ill (ide
&ar'ets consider in respect to this game?
. suspension
!. e+pansion
C. abandonment
". contraction
#. withdrawal

46. )hree months ago9 )oy )own introduced a new toy for pre-school children. )he store
e+pected this toy to be an instant success and a fast mo/ing item. )o their surprise9 children
ha/e $ero interest in this toy so sales ha/e been abysmal. Which one of the following options
should )oy )own consider in respect to this toy?
. suspension
!. e+pansion
C. abandonment
". contraction
#. re-introduction

.%. Which of the following are managerial options once a pro<ect is commenced?
2. modifying the production process
22. re-pricing the product
222. re/ising the mar'eting plan
23. modifying the product:s color and shape
. 2 and 22 only
!. 222 and 23 only
C. 29 229 and 222 only
". 229 2229 and 23 only
#. 29 229 2229 and 23

.1. Which one of the following statements related to warrants is correct?
. Warrants are generally issued as an attachment to publicly-issued bonds.
!. Warrants are e+cluded from trading on an organi$ed e+change.
C. Warrants are structured as long-term put options.
". Warrants are issued by indi/idual in/estors.
#. Warrants are generally added as an incenti/e to a pri/ate debt issue.

24-1,
.2. Which of the following statements are correct concerning warrants?
2. Warrants are similar to put options.
22. Warrants are similar to call options.
222. When a warrant is e+ercised9 the issuer is not in/ol/ed in the transaction.
23. When a warrant is e+ercised9 the issuer must issue new shares of stoc'.
. 2 only
!. 22 only
C. 2 and 222 only
". 22 and 23 only
#. 2 and 23 only

.,. When warrants are e+ercised9 the*
. earnings per share decrease.
!. earnings per share remain constant.
C. total e;uity in a firm remains constant.
". total e;uity in a firm decreases.
#. number of bonds outstanding increases.

.4. Which of the following statements are correct concerning con/ertible bonds?
2. Aew shares of stoc' are issued when a con/ertible bond is con/erted.
22. con/ertible bond is similar to a bond with a call option.
222. con/ertible bond should always be worth less than a comparable straight bond.
23. con/ertible bond can be described as ha/ing upside potential with downside protection.
. 2 and 222 only
!. 29 229 and 23 only
C. 29 229 and 222 only
". 29 2229 and 23 only
#. 229 2229 and 23 only

... )he con/ersion /alue of a con/ertible bond is e;ual to which one of the following?
. Con/ersion ratio (toc' price
!. Con/ersion ratio Con/ersion price
C. Face /alue of the bondHCon/ersion premium
". Face /alue of the bond C1 I Con/ersion premiumD
#. (toc' price C1 I Con/ersion ratioD

24-14
.0. )he ma+imum /alue of a con/ertible bond is theoretically*
. e;ual to the con/ersion /alue minus the straight bond /alue.
!. e;ual to the face /alue of the bond multiplied by C1 I Con/ersion priceD.
C. limited to the ma+imum straight bond /alue.
". limited by the face /alue of the bond.
#. unlimited.

.1. What is the cost of two Ao/ember -2. put option contracts on "o/e stoc' gi/en the
following price ;uotes?

. -%.1.
!. -%.,%
C. -1..%
". -1..%%
#. -,%.%%

.4. What is the /alue of fi/e ugust -2. call contracts on "o/e stoc'?

. -,4
!. -04
C. -,4%
". -04%
#. -,94%%

24-1.
.6. What is the intrinsic /alue of the Ao/ember -2. call on "o/e stoc'?

. --%.64
!. -%
C. -%.1.
". -0.12
#. -1.1%

0%. Bou purchased si+ call option contracts on !C stoc' with a stri'e price of -,2..% when
the option was ;uoted at -1.4%. )he option e+pires today when the /alue of !C stoc' is
-,4.0%. 2gnoring trading costs and ta+es9 what is the net profit or loss on this in/estment?
. -%
!. -14%
C. -21%
". -44%
#. -1920%

01. Bou sold one call option contract with a stri'e price of -.. when the option was ;uoted at
-%.4%. )he option e+pires today when the /alue of the underlying stoc' is -.,.1%. 2gnoring
trading costs and ta+es9 what is the net profit or loss on this in/estment?
. --2.%
!. --4%
C. -%
". -.%
#. -4%

24-10
02. Bou sold three -,. call option contracts at a ;uoted price of -1.4%. What is your net profit
or loss on this in/estment if the price of the underlying asset is -,0.1% on the option
e+piration date?
. --.1%
!. --6%
C. -6%
". -.1%
#. -6,%

0,. Bou wrote eight call option contracts with a stri'e price of -42..% at a call price of -1.,.
per share. What is your net gain or loss on this in/estment if the price of the underlying stoc'
is -4%.,% per share on the option e+piration date?
. --2944%
!. --1910%
C. --19%4%
". -19%4%
#. -1910%

04. )he mar'et price of (outhern 7ress stoc' has been relati/ely /olatile and you thin' this
/olatility will continue for a couple more months. )hus9 you decide to purchase a two-month
#uropean call option on this stoc' with a stri'e price of -4. and an option price of -2.2%. Bou
also purchase a two-month #uropean put option on the stoc' with a stri'e price of -4. and an
option price of -%.,%. What will be your net profit or loss on these option positions if the
stoc' price is -44 on the day the options e+pire? 2gnore trading costs and ta+es.
. --,%
!. -.%
C. -4%
". -21%
#. -,,%

24-11
0.. (e/eral rumors concerning 3alue 8ite stoc' are causing the mar'et price of the stoc' to be
;uite /olatile. Gi/en this situation9 you decide to buy both a one-month #uropean -2. put and
a one-month #uropean -2. call on this stoc'. )he call price per share is -%.0% and the put
price per share is -2.1%. What will be your net profit or loss on these option positions if the
. --21%
!. --1.%
C. --0%
". -4,%
#. -46%

00. )hree months ago9 Central (upply stoc' was selling for -.1.4% a share. t that time9 you
purchased fi/e put options on the stoc' with a stri'e price of -.% per share and an option price
of -%.0% per share. )he option e+pires today when the /alue of the stoc' is -42.1% per share.
What is your net profit or loss on this in/estment? 2gnore trading costs and ta+es.
. --19,%%
!. --19%%%
C. --,%%
". -,9,.%
#. -,90.%

01. Bou wrote two put options on Jylo stoc' with an e+ercise price of -,% per share and an
option price of -1.%. per share. )oday9 the contracts e+pire and the stoc' is selling for -,1.1.
a share. What is your net profit or loss on this in/estment? 2gnore trading costs and ta+es.
. --11.
!. --1%.
C. -2%
". -1%.
#. -21%

24-14
04. Bou sold ten put contracts on Cross )own !an' stoc' at an option price per share of
-%.4.. )he options ha/e an e+ercise price of -,1..% per share. )he options were e+ercised
today when the stoc' price was -,4 a share. What is your net profit or loss on this in/estment
assuming that you closed out your positions at a stoc' price of -,4? 2gnore transaction costs
and ta+es.
. --,9.%%
!. --290.%
C. -194%%
". -4.%
#. -,9.%%

06. Bou own eight call option contracts on (wift Water )ours stoc' with a stri'e price of -1..
When you purchased the shares the option price was -%.,% and the stoc' price was -1..2..
What is the total intrinsic /alue of these options if the stoc' is currently selling for -10.%4 a
share?
. --4,
!. --1.%4
C. -%
". -1%4
#. -404

1%. Bou recently purchased three put option contracts on Guillepsi stoc' with an e+ercise
price of -42..%. What is the total intrinsic /alue of these contracts if the stoc' is currently
selling for -4,.1% a share?
. --,0%
!. --12%
C. -%
". -12%
#. -,0%

24-16
11. =ast wee'9 you purchased a call option on #dgewater stoc' with a stri'e price of -4%. )he
stoc' price was -,6.4% and the option price was -%.4. at that time. What is the intrinsic /alue
per share if the stoc' is currently priced at -,6.1%?
. --6%
!. --1%
C. -%
". -1%
#. -6%

12. )hree wee's ago9 you purchased a ?une -,% put option on =eeper &etals stoc' at an
option price of -1.4%. )he mar'et price of the stoc' three wee's ago was -,%.0%. )oday9 the
stoc' is selling at -26.4% a share. What is the intrinsic /alue of your put contract?
. --1%%
!. --2%
C. -%
". -2%
#. -0%

1,. )his morning9 you purchased a call option on (choolhouse (upply Co. stoc' that e+pires
in one year. )he e+ercise price is -4%. )he current price of the stoc' is -4,.4% and the ris'-
free rate of return is ,.0 percent. ssume the option will finish in the money. What is the
current /alue of the call option?
. -%
!. -1.46
C. -,.61
". -4.16
#. -..40

14. Bou currently own a one-year call option on 8ail Company9 2nc.9 stoc'. )he current stoc'
price is -.1.4% and the ris'-free rate of return is 4.2. percent. Bour option has a stri'e price of
-.% and you assume the option will finish in the money. What is the current /alue of your call
option?
. -1.2%
!. -2..6
C. -,.44
". -..1,
#. -1.21

24-2%
1.. )he common stoc' of @a$elton 8efiners is selling for -12.,% a share. K.(. )reasury bills
are currently yielding 4.4 percent. What is the current /alue of a one-year call option on this
stoc' if the e+ercise price is -1% and you assume the option will finish in the money?
. -%
!. -1.2%
C. -,.%%
". -4.2%
#. -...1

10. )he common stoc' of Westo/er Foods is currently priced at -21.6% a share. One year
from now9 the stoc' price is e+pected to be either -2. or -,% a share. )he ris'-free rate of
return is 4.2 percent. What is the current /alue of one call option on this stoc' if the e+ercise
price is -21..%?
. -%
!. -1.6.
C. -2.%%
". -,.4%
#. -4.%%

11. Bou own one call option with an e+ercise price of -4% on (:more Good stoc'. )he stoc' is
currently selling for -41 a share but is e+pected to sell for either -,1 or -4, a share in one
year. )he ris'-free rate of return is 4.2. percent and the inflation rate is ,.0 percent. What is
the current call option price if the option e+pires one year from now?
. -%...
!. -%.06
C. -1.,1
". -2.4,
#. -2.1.

24-21
14. )he assets of Kptown (tores are currently worth -1,094%%. )hese assets are e+pected to
be worth either -12%9%%% or -1.%9%%% one year from now. )he company has a pure discount
bond outstanding with a -1,%9%%% face /alue and a maturity date of one year. )he ris'-free
rate is 4., percent. What is the /alue of the e;uity in this firm?
. -11962%
!. -1492,2
C. -169.%1
". -219,41
#. -2094%4

16. #lectronic 2mporters has a pure discount bond with a face /alue of -2.9%%% that matures in
one year. )he ris'-free rate of return is ,.4 percent. )he assets of the business are e+pected to
be worth either -2,9%%% or -,.9%%% in one year. Currently9 these assets are worth -219.%%.
What is the current /alue of the bond?
. -119140
!. -1692%1
C. -2%9222
". -229.46
#. -2,9%44

4%. )he Glass @ouse has total assets currently /alued at -1192%%. )hese assets are e+pected to
increase in /alue to either -149%%% or -219%%% by ne+t year. )he company has a pure discount
bond outstanding with a face /alue of -2%9%%%. )his bond matures in one year. Currently9 K.(.
)reasury bills are yielding ..4 percent. What is the /alue of the e;uity in this firm?
. --,9%%%.%%
!. --6%4.%%
C. -%
". -4%.1,
#. -122.2%

24-22
41. Bou are considering a pro<ect that has been assigned a discount rate of 14 percent. 2f you
start the pro<ect today9 you will incur an initial cost of -49.%% and will recei/e cash inflows of
-.9..% a year for two years. 2f you wait one year to start the pro<ect9 the initial cost will rise to
-692%% and the cash flows will increase to -.94%% a year for two years. What is the /alue of
the option to wait?
. --,,1.4%
!. --164.40
C. -224..1
". -2,%.46
#. -,,4.04

42. (outhern (hores is considering a pro<ect that has an initial cost today of -129.%%. )he
pro<ect has a two-year life with cash inflows of -19.%% a year. (hould the firm opt to wait one
year to commence this pro<ect9 the initial cost will increase by . percent and the cash inflows
will increase to -49.%% a year. What is the /alue of the option to wait if the applicable
discount rate is 14 percent?
. -014..2
!. -121..0
C. -614.02
". -642.01
#. -19%21.00

4,. Western 2ndustrial 7roducts is considering a pro<ect with a four-year life and an initial cost
of -2129%%%. )he discount rate for the pro<ect is 10 percent. )he firm e+pects to sell 690%%
units on the last day of each year. )he cash flow per unit is -.%. )he firm will ha/e the option
to abandon this pro<ect at the end of year one Cafter year one:s salesD at which time the
pro<ect:s assets could be sold for an estimated -12.9%%%. )he firm should abandon the pro<ect
at the end of year one if the e+pected le/el of annual sales9 starting with year 29 falls to 55555
units or less. 2gnore ta+es.
. 1911, units
!. 19201 units
C. 19622 units
". 29%,4 units
#. 291%4 units

24-2,
44. "ressler )echnologies is considering a pro<ect with a ,-year life and an initial cost of
-4.9%%%. )he discount rate for the pro<ect is 14.. percent. )he firm e+pects to sell 192%% units
on the last day of each year. )he cash flow per unit is -,2. )he firm will ha/e the option to
abandon this pro<ect at the end two years Cafter year 2 salesD at which time the pro<ect:s assets
could be sold for an estimated -,%9%%%. )he firm:s managers are interested in 'nowing how
the pro<ect will perform if the sales forecast for year , of the pro<ect is re/ised such that there
is a .%H.% chance that the sales will be either 19%%% or 194%% units a year. What is the net
present /alue of this pro<ect at time $ero gi/en the current sales forecasts?
. --,9414
!. --29.20
C. -49161
". -09162
#. -09441

4.. 7atience is re/iewing a pro<ect with pro<ected sales of 492%% units a year9 a cash flow of
-24 a unit9 and a four-year pro<ect life. ssume all operating cash flows occur on the last day
of each year. )he initial cost of the pro<ect is -2419%%%. )he rele/ant discount rate is 1,
percent. 7atience has the option to abandon the pro<ect after two years at which time she feels
she could sell the pro<ect:s assets for -11%9%%%. t what le/el of annual sales9 starting in year
,9 should she be willing to abandon this pro<ect?
. 29116 units
!. 29,.. units
C. 29,01 units
". 29.10 units
#. 29001 units

40. Bou own a con/ertible bond with a face /alue of -19%%% and a mar'et /alue of -19%,4.
)he bond can be con/erted into 14 shares of stoc'. What is the con/ersion price?
. -11.4,
!. -12.%%
C. -12.01
". -1,.40
#. -14.,,

24-24
41. Bou own nine con/ertible bonds. )hese bonds ha/e a 1 percent coupon9 a -19%%% face
/alue9 and mature in 0 years. )he bonds are con/ertible into shares of common stoc' at a
con/ersion price of -2.. @ow many shares of stoc' will you recei/e if you con/ert all of your
bonds?
. 24.
!. ,%%
C. ,.%
". ,0%
#. 4%%

44. con/ertible bond has a face /alue of -.9%%% and a con/ersion price of -4%. )he bond
has a 0 percent coupon9 pays interest semi-annually9 and matures in 12 years. (imilar bonds
are yielding 1.. percent. )he current price of the stoc' is -41.2% per share. What is the
con/ersion /alue of this bond?
. -1904%
!. -2941.
C. -29.1.
". -490.1
#. -.9%%%

46. con/ertible bond has a face /alue of -19%%% and a con/ersion price of -12..%. )he bond
are yielding 6 percent. )he current price of the stoc' is -1,.4% per share. What is the straight
bond /alue?
. -142..1
!. -141.42
C. -421.14
". -4,2.%6
#. -44,.41

24-2.
6%. >urt owns a con/ertible bond that matures in three years. )he bond has a 1.. percent
coupon and pays interest semi-annually. )he face /alue of the bond is -19%%% and the
con/ersion price is -2.. (imilar bonds ha/e a mar'et return of 6.2. percent. )he current price
of the stoc' is -20..% per share. What is the straight bond /alue?
. -644.2%
!. -6...%.
C. -612.4%
". -641.14
#. -661.1.

61. =ucinda owns a con/ertible bond that matures in si+ years. )he bond has a 6 percent
coupon and pays interest annually. )he face /alue of the bond is -19%%% and the con/ersion
price is -22. (imilar bonds ha/e a mar'et return of 4.1. percent. )he current price of the
stoc' is -21.0% per share. What is the con/ersion /alue of this bond?
. -4,..0%
!. -444.4%
C. -642.11
". -641.42
#. -19%%%.%%

Essay Questions

62. Circle (tores stoc' is priced at -24 a share. -4% call on this stoc' has fi/e months until
e+piration and a call price of -%.1.. Why would an in/estor purchase a call that is so far out of
the money?

24-20
6,. What are the basic similarities and basic differences between warrants and call options?

64. What are the upper and lower bounds for an merican call option? #+plain what would
happen in each case if the bound was /iolated.

6.. #+plain the rationale behind the idea that e;uity is a call option on a firm:s assets. When
would a shareholder allow this call to e+pire?

60. Call options are fre;uently attached to bonds9 ma'ing them callable at the option of the
issuer. Consider a firm that <ust issued two sets of bonds* One is callable9 has a 1 percent
coupon rate9 1. years to maturity9 and cannot be called during the first three yearsF the second
is noncallable9 has a 1 percent coupon rate9 1. years to maturity9 and is identical to the first
bond in e/ery way e+cept for the call option. (uppose the noncallable bonds are sold for
-19%%% each. Will the callable bonds sell for more or less than -19%%%? Who EpurchasesE the
option in this case and who EsellsE it?

24-21
61. #+plain how the floor and the ceiling prices for a con/ertible bond are determined.


64. )-bills currently yield 0., percent. (toc' in 7inta &anufacturing is currently selling for
-40 per share. )here is no possibility that the stoc' will be worth less than -,6 per share in
one year. What is the /alue of a call option on this stoc' if the e+ercise price is -22 per share?
. -21.4%
!. -22.%%
C. -24.%%
". -2..,%
#. -2..1%

66. )he price of )ime (;uared Corp. stoc' will be either -4% or -6. at the end of the year.
Call options are a/ailable with one year to e+piration. )-bills currently yield 0 percent and the
current price of )ime (;uared Corp. stoc' is -4.. What is the /alue of a call option if the
e+ercise price is -1. per share?
. -14.2.
!. -1..%0
C. -14.14
". -24.2.
#. -2..%0

24-24
1%%. )he price of "imension9 2nc. stoc' will be either -0. or -4. at the end of the year. Call
options are a/ailable with one year to e+piration. )-bills currently yield . percent. (uppose the
current price of "imension stoc' is -1%. What is the /alue of the call option if the e+ercise
price is -1% per share?
. -0.%1
!. -4.44
C. -11..4
". -1..,6
#. -11.02

1%1. 8ac'in 7inion Corporation:s assets are currently worth -1920%. 2n one year9 they will be
worth either -192%% of -1901%. )he ris'-free interest rate is . percent. (uppose 8ac'in 7inion
has an outstanding debt issue with a face /alue of -192%%. What is the current /alue of the
firm:s debt?
. -0%.%%
!. -114.14
C. -19142.40
". -1920,.16
#. -19.%4.2%

1%2. !uc'eye 2ndustries has a bond issue with a face /alue of -19%%% that is coming due in
one year. )he /alue of !uc'eye:s assets is currently -192%%. ?im )ressell9 the C#O9 belie/es
that the assets in the firm will be worth either -0%% or -191%% in a year. )he going rate on one-
year )-bills is 0 percent. What is the current /alue of the firm:s debt?
. -0%1.14
!. -160..1
C. -444.24
". -414.14
#. -611.%,

1%,. -19%%% con/ertible debenture has a con/ersion price for common stoc' of -4. per
share. )he common stoc' is selling at -62 a share. What is the con/ersion /alue of this bond?
. -62%.%%
!. -62,.61
C. -19%%%.%%
". -19%42.,.
#. -19%62.%%

24-26
1%4. bond with 1% detachable warrants has <ust been offered for sale at -19%%%. )he bond
matures in 1. years and has an annual coupon of -4%. #ach warrant gi/es the owner the right
to purchase two shares of stoc' in the company at -14 per share. Ordinary bonds Cwith no
warrantsD of similar ;uality are priced to yield 11 percent. What is the /alue of one warrant?
. -1.%%
!. -1,..4
C. -14.%%
". -10.01
#. -21..1

1%.. Bour company is deciding when to in/est in a new machine. )he new machine will
increase cash flow by -24%9%%% per year. Bou belie/e the technology used in the machine has
a 1%-year lifeF in other words9 no matter when you purchase the machine9 it will be obsolete
1% years from today. )he machine is currently priced at -192%%9%%%. )he cost of the machine
will decline by -12%9%%% per year until it reaches -12%9%%%9 where it will remain. Bour
re;uired return is 4 percent. 2n which year should you purchase the machine?
. Bear %
!. Bear 1
C. Bear 2
". Bear ,
#. Bear 4

1%0. We are e+amining a new pro<ect. We e+pect to sell 69%%% units per year at -4. net cash
flow apiece for the ne+t 2% years. 2n other words9 the annual operating cash flow is pro<ected
to be -4. 69%%% L -4%.9%%%. )he rele/ant discount rate is 14 percent9 and the initial
in/estment re;uired is -191,%9%%%. fter the first year9 the pro<ect can be dismantled and sold
for -19,.%9%%%. 2f e+pected sales are re/ised based on the first year:s performance9 it would
ma'e sense to abandon the in/estment if the sales are less than which of the following number
of units?
. 49.4% units
!. 4902% units
C. 491.% units
". 4941% units
#. .9%2% units

24-,%
1%1. We are e+amining a new pro<ect. We e+pect to sell 49%%% units per year at -4% net cash
flow apiece for the ne+t 1. years. 2n other words9 the annual operating cash flow is pro<ected
to be -4% 49%%% L -04%9%%%. )he rele/ant discount rate is 10 percent9 and the initial
in/estment re;uired is -2914%9%%%. )he pro<ect can be dismantled after the first year and sold
for -291,%9%%%. (uppose you thin' it is li'ely that e+pected sales will be re/ised upward to
690%% units if the first year is a success and re/ised downward to ,9%%% units if the first year is
not a success. (uppose the scale of the pro<ect can be doubled in one year in the sense that
twice as many units can be produced and sold. Aaturally9 e+pansion would be desirable only if
the pro<ect is a success. )his implies that if the pro<ect is a success9 pro<ected sales after
e+pansion will be 1692%%. ssume that success and failure are e;ually li'ely. Aote that
abandonment is still an option if the pro<ect is a failure. What is the /alue of the option to
e+pand?
. -191149,24
!. -194%69641
C. -1942494%0
". -19444962%
#. -194129,12

24-,1
Chapter 24 Options and Corporate Finance nswer >ey


1. Which one of the following grants its owner the right to buy or to sell an asset at a
prespecified price at any time during a stated period?
A. option
!. forward contract
C. futures contract
". swap
#. intrinsic contract
8efer to section 24.1

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#$%
Section: "#&%
'o(ic: O(tion

2. #li$abeth owns a call option on 1%% shares of &icrosoft stoc'. (he has decided to buy those
shares. )his purchase is commonly referred to as*
. stri'ing the asset.
!. e+piring the option.
C. e+ercising the option.
". putting the collar.
#. the collar option.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: )*ercising t+e o(tion

24-,2
,. &arti owns an option that allows him to purchase !C stoc' at -.% a share. )he -.% price
is referred to as the*
. opening price.
!. intrinsic /alue.
C. stri'e price.
". mar'et price.
#. time /alue.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: Stri,e (rice

4. What is the final day on which an option can be e+ercised called?
. payment date
!. e+-option date
C. opening date
D. e+piration date
#. intrinsic date

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: )*(iration date

24-,,
.. Felicia purchased an option which she can e+ercise anytime within the ne+t si+ months.
Which type of option did she purchase?
. mar'et-ready
!. portable
C. daily
". #uropean
E. merican

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: American o(tion

0. !rad purchased an option that he can only e+ercise on the final day of the option period.
Which type of option did he purchase?
A. #uropean
!. merican
C. infle+ible
". dated
#. pointed

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: )uro(ean o(tion

24-,4
1. Which of the following grants its owner the right to purchase an asset at a stated price?
2. merican call
22. #uropean call
222. merican put
23. #uropean put
. 2 only
B. 2 and 22 only
C. 2 and 222 only
". 22 and 23 only
#. 222 and 23 only

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: Call o(tion

4. )he owner of a put option has the 55555 an asset at a fi+ed price during a stated period of
time.
A. right to sell
!. right to buy
C. obligation to sell
". obligation to buy
#. obligation to trade

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%
'o(ic: -ut o(tion

24-,.
6. Which one of the following terms applies to the /alue of an option on its e+piration date?
. stri'e price
!. upper limit
C. deadline price
". time /alue
E. intrinsic /alue

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#$"
Section: "#&"
'o(ic: .ntrinsic !alue

1%. (u$ie is the controller of )he 7rice 8ite Company. (he has been granted to the right to buy
19%%% shares of her employer:s stoc' at -2. a share anytime within the ne+t three years.
Which one of the following has (u$ie been granted?
A. employee stoc' option
!. company bonus option
C. employee grant
". employee e+ercise option
#. company benefits option

AACSB: N/A
Bloom's: Com(re+ension
Difficulty: Basic
Learning Obecti!e: "#$/
Section: "#&#
'o(ic: )m(loyee stoc, o(tion

24-,0
11. Which one of the following terms applies to an option that has an office building as its
underlying asset?
. financial option
!. li;uid option
C. fi+ed option
D. real option
#. concrete option

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#$0
Section: "#&1
'o(ic: 2eal o(tions

12. )he in/estment timing decision is the*
. determination of when an option should be e+ercised.
!. decision of when to purchase an option on an underlying asset.
C. analysis of determining when an asset should be sold.
". determination of when a pro<ect should be abandoned.
E. e/aluation of the optimal time to begin a pro<ect.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&1
'o(ic: .n!estment timing decision

24-,1
1,. =ucas #nterprises recently opted to open a new retail outlet. 2f the outlet outperforms the
e+pectations9 the manager can opt to increase the store:s si$e. 2f it underperforms9 the manager
can opt to close the store. )hese choices that the manager has been gi/en are called*
. call options.
!. put options.
C. straddles.
D. managerial options.
#. e+ecuti/e options.

AACSB: N/A
Difficulty: Basic
Section: "#&1
'o(ic: 3anagerial o(tions

14. Which one of the following considers all of the options implicit in a pro<ect?
. e+pansion planning
B. contingency planning
C. asset management re/iew
". prospecti/e e/aluation
#. strategic e/aluation

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&1
'o(ic: Contingency (lanning

24-,4
1.. >) #nterprises has e+panded its operations into a new field9 which is the production of
e/eryday dinnerware. 2f this pro<ect goes well9 the firm has the option to e+pand its
production into fine china. What type of option is this?
. financial
B. strategic
C. put
". intangible
#. call

AACSB: N/A
Difficulty: Basic
Section: "#&1
'o(ic: Strategic o(tions

10. my is a current shareholder of "? 2ndustries. (he has been gi/en the right to purchase an
additional 2. shares of "? 2ndustries stoc' at a price of -,2 a share if she e+ercises that right
within the ne+t 12 months. What is this security called that my has been gi/en?
. con/ertible bond
B. warrant
C. straddle
". spread
#. put

AACSB: N/A
Difficulty: Basic
Section: "#&4
'o(ic: 5arrants

24-,6
11. ?eff owns a -19%%% face /alue bond. @e can e+change that bond for 2. shares of >A?
stoc' at any time within the ne+t 2 years. What type of bond does ?eff own?
. secured
!. warranted
C. con/ertible
". <un'
#. callable

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: Con!ertible bonds

14. )he dollar amount of a bond:s par /alue that is e+changeable for one share of stoc' is
called the*
!. par /alue.
D. con/ersion price.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: Con!ersion (rice

24-4%
16. licia owns a -19%%% face /alue bond that can be con/erted into 2% shares of ! =imited
stoc'. Which one of the following terms refers to these 2% shares?
C. con/ersion /alue
". con/ersion price
E. con/ersion ratio

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: Con!ersion ratio

2%. )he difference between the con/ersion price and the current stoc' price9 di/ided by the
current stoc' price9 is called the*
A. con/ersion premium.
!. straight bond /alue.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: Con!ersion (remium

24-41
21. =atetia owns a con/ertible bond. Which one of the following terms would describe the
/alue of this bond if it were not con/ertible?
B. straight bond /alue
C. con/ersion /alue
". in/erted /alue
#. mar'et /alue

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: Straig+t bond !alue

22. !rad owns a con/ertible bond. Which one of the following terms would apply to the /alue
of this bond if he were to con/ert it into shares of stoc' today?
C. con/ersion /alue
". in/erted /alue
#. prescribed /alue

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: Con!ersion !alue

24-42
2,. Which one of the following statements correctly describes your situation as the holder of a
#uropean call option?
. Bou are obligated to buy if the option is e+ercised.
!. Bou ha/e a right to sell.
C. Bou ha/e a right to buy but only on the e+piration date.
". Bou are obligated to sell if the option is e+ercised.
#. Bou ha/e a right to buy at any time before the option e+pires.

AACSB: N/A
Difficulty: Basic
Section: "#&%

24. ?ulie opted to e+ercise her ugust option on ?une 2%th and as a result recei/ed -29.%% for
the sale of her shares. Which one of the following did ?ulie own?
. warrant
!. merican call
C. merican put
". #uropean call
#. #uropean put

AACSB: N/A
Difficulty: Basic
Section: "#&%

24-4,
2.. ?osh opted to e+ercise his ?anuary option at the end of "ecember and paid -,92.% at that
time to ac;uire 1%% shares of stoc'. Which one of the following did ?osh own?
A. merican call
!. merican put
C. #uropean call
". #uropean put
#. #uropean con/ertible bond

AACSB: N/A
Difficulty: Basic
Section: "#&%

20. (te/e owns an option which grants him the right to purchase shares of =o'ier )ool stoc'
at a price of -4. a share. Currently9 the stoc' is selling for -.2.4% a share. (te/e would li'e to
reali$e his profits but is not permitted to e+ercise the option for another two wee's. Which
one of the following does (te/e own?
. straight bond
!. merican call
C. merican put
D. #uropean call
#. #uropean put

AACSB: N/A
Difficulty: Basic
Section: "#&%

24-44
21. What is the primary difference between an merican call option and a #uropean call
option?
. )he merican call has a fi+ed stri'e price while the #uropean stri'e price /aries o/er time.
!. n merican call is a right to buy while a #uropean call is an obligation to buy.
C. n merican call has an e+piration date while the #uropean call does not.
". n merican call is written on 1%% shares of the underlying security while the #uropean
call co/ers 19%%% shares.
E. n merican call an be e+ercised at any time up to the e+piration date while the #uropean
call can only be e+ercised on the e+piration date.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&%

24. Bou own a ?uly -1. call on !C stoc'. ssume today is pril 2% and the call has $ero
intrinsic /alue. Which one of the following best describes this option?
. worthless
!. unfunded
C. e+pired
". in-the-money
E. out-of-the-money

AACSB: N/A
Difficulty: Basic
Section: "#&"
'o(ic: Call !alue

24-4.
26. -2% put option on Wildwood stoc' e+pires today. )he current price of the stoc' is
-14..%. Which one of the following best describes this option?
. funded
!. unfunded
C. at-the-money
D. in-the-money
#. out-of-the-money

AACSB: N/A
Difficulty: Basic
Section: "#&"
'o(ic: -ut !alue

,%. Which one of the following describes the ma+imum /alue of a call option?
. stri'e price minus the initial cost of the option
!. e+ercise price plus the price of the underlying stoc'
C. stri'e price
D. mar'et price of the underlying stoc'
#. purchase price

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&"
'o(ic: Call u((er bound

24-40
,1. Which one of the following describes the lower bound of a call:s /alue?
. stri'e price or $ero9 whiche/er is greater
B. stoc' price minus the e+ercise price or $ero9 whiche/er is greater
C. stri'e price or the stoc' price9 whiche/er is lower
". stri'e price or $ero9 whiche/er is lower
#. stoc' price minus the e+ercise price or $ero9 whiche/er is lower

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&"
'o(ic: Call lower bound

,2. Which one of the following describes the intrinsic /alue of a call option?
. the call:s upper bound /alue
B. the call:s lower bound /alue
C. mar'et price of the underlying security
". $ero9 if the call is in-the-money
#. negati/e amount9 if the call is out-of-the-money.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&"
'o(ic: Call intrinsic !alue

24-41
,,. Which one of the following describes the intrinsic /alue of a put option?
. lesser of the stri'e price or the stoc' price
!. lesser of the stoc' price minus the e+ercise price or $ero
C. lesser of the stoc' price or $ero
D. greater of the stri'e price minus the stoc' price or $ero
#. greater of the stoc' price minus the e+ercise price or $ero

AACSB: N/A
Difficulty: Basic
Section: "#&"
'o(ic: -ut intrinsic !alue

,4. Which one of the following statements is correct?
. )he /alue of a call decreases as the price of the underlying stoc' increases.
B. )he /alue of a call increases as the e+ercise price decreases.
C. )he /alue of a put increases as the price of the underlying stoc' increases.
". )he /alue of a put decreases as the e+ercise price increases.
#. )he intrinsic /alue of a put must be $ero on the e+piration date.

AACSB: N/A
Difficulty: Basic
Section: "#&"
'o(ic: 6actors affecting o(tion !alues

24-44
,.. n increase in which of the following will increase the /alue of a call?
2. time to e+piration
22. underlying stoc' price
222. ris'-free rate of return
23. price /olatility of the underlying stoc'
. 2 and 222 only
!. 229 2229 and 23 only
C. 29 2229 and 23 only
". 29 229 and 222 only
E. 29 229 2229 and 23

AACSB: N/A
Difficulty: Basic
Section: "#&"

,0. Which of the following will decrease the /alue of a call option?
2. a decrease in the e+ercise price
22. a decrease in the /alue of the underlying security
222. an increase in the ris'-free rate
23. an increase in the time to e+piration
A. 22 only
!. 2 and 22 only
C. 222 and 23 only
". 29 229 and 23 only
#. 29 229 and 222 only

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&"

24-46
,1. &ar' owns both a &arch -2% put and a &arch -2% call on lpha stoc'. Which one of the
following statements correctly relates to &ar':s position? 2gnore ta+es and transaction costs.
. price decrease in lpha stoc' will increase the /alue of &ar':s call option.
!. &arch -,% call is worth more than &ar':s -2% call.
C. )he time premium on an pril -2% put is less than the time premium on &ar':s put.
Cssume both puts e+pire in the same calendar year.D
". price increase in lpha stoc' from -20 to -24 will increase the /alue of &ar':s put.
E. 2f the intrinsic /alue of &ar':s put increases by -1 then the intrinsic /alue of his call must
either decrease by -1 or e;ual $ero.

AACSB: N/A
Bloom's: Analysis
Difficulty: Basic
Section: "#&"
'o(ic: O(tion !alue

,4. )ra/is owns both a (eptember -,% call and a (eptember -,% put. 2f the call finishes at-
the-money9 then the put will*
. also finish in-the-money.
B. finish at-the-money.
C. finish out-of-the-money.
". either finish at-the-money or in-the-money.
#. either finish at-the-money or out-of-the-money.

AACSB: N/A
Difficulty: Basic
Section: "#&"
'o(ic: O(tion !alue

24-.%
,6. Which one of the following statements regarding employee stoc' options C#(OsD is
correct?
. #(Os grant an employee the right to buy a fi+ed number of shares of company stoc' at the
mar'et price.
!. #mployees must e+ercise their #(Os prior to those #(Os becoming /ested.
C. #mployees may forfeit their #(Os if they terminate their employment with the issuing
firm.
". 2f a firm issue #(Os it must ma'e them a/ailable to all employees.
#. #mployees can sell their #(Os if they do not want to personally e+ercise them.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&#

4%. #mployee stoc' options are primarily designed to do which one of the following?
. pro/ide employees with put options on their shares of company stoc'
!. pro/ide an immediately /ested benefit to 'ey employees
C. influence the actions and priorities of employees
". distribute e+cess cash to 'ey employees to a/oid corporate ta+ation
#. pro/ide an immediate capital gain to certain employees

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&#

24-.1
41. #mployee stoc' options*
. usually ha/e a positi/e intrinsic /alue when issued.
!. must be bac'dated at least si+ months to comply with (arbanes-O+ley.
C. are generally EunderwaterE when issued.
". are fre;uently repriced if the options are in-the-money.
E. are generally issued with a $ero intrinsic /alue.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&#

42. )he (arbanes-O+ley ct of 2%%2 re;uires firms to report #(O grants within how many
days of the grant?
. 2 calendar days
B. 2 business days
C. 1 calendar days
". ,% business days
#. 4. calendar days

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&#
'o(ic: )SO bac,dating

24-.2
4,. "elta 2mporters has a pure discount loan with a face /alue of -14%9%%% due in one year.
)he assets of the firm are currently worth -20.9%%%. )he shareholders in this firm basically
own a 55555 option on the assets of the firm with a stri'e price of 55555.
. putF -14%9%%%.
!. putF -20.9%%%.
C. warrantF -20.9%%%.
D. callF -14%9%%%.
#. callF -20.9%%%.
8efer to section 24..

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#$#
Section: "#&0
'o(ic: )7uity as a call o(tion

44. ?ac' and ?ill are house hunting. )hey find @ouse situated on a hill. )hey really li'e the
house but want to continue searching the mar'et for one more wee' before ma'ing their final
decision to buy the house. )o a/oid ha/ing someone else purchase @ouse while they
continue their house hunting9 they decide to place a -29.%% deposit on @ouse . )his deposit
will apply to the purchase price if they buy @ouse . 2f they do not buy @ouse 9 they will
forfeit the -29.%%. #ssentially9 ?ac' and ?ill ha/e a 55555 on @ouse .
. financial put
!. financial call
C. warrant
". real put
E. real call

AACSB: N/A
Difficulty: Basic
Section: "#&1
'o(ic: 2eal o(tions

24-.,
4.. )he option to wait*
2. may be of minimal /alue if a pro<ect is dependent upon rapidly changing technology.
22. is partially dependent upon the discount rate applied to the pro<ect being e/aluated.
222. is defined as temporarily shutting down a pro<ect for a period of time.
23. has a /alue e;ual to the A73 of a pro<ect if it is started at a later date minus the A73 if the
pro<ect is started today.
. 2 and 222 only
!. 22 and 23 only
C. 2 and 22 only
". 229 2229 and 23 only
E. 29 229 and 23 only

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&1
'o(ic: O(tion to wait

40. 2gnoring which of the following will cause the A73 of a pro<ect to be underestimated?
2. option to abandon
22. option to e+pand
222. option to wait
23. option to contract
. 2 and 222 only
!. 229 2229 and 23 only
C. 29 229 and 222 only
". 29 2229 and 23 only
E. 29 229 2229 and 23

AACSB: N/A
Difficulty: Basic
Section: "#&1

24-.4
41. Which one of the following is an e+ample of a strategic option for a restaurant?
A. opening a new restaurant with a different loo' and an entirely different menu to see if that
type of restaurant appeals to the public
!. deciding to close one hour earlier during the winter months due to slow sales
C. abandoning a menu item based on customer complaints
". deciding to open only two new locations ne+t year instead of the fi/e that were originally
scheduled
#. deciding to create separate lunch and dinner menus rather than ha/e them combined on one
menu

AACSB: N/A
Difficulty: Basic
Section: "#&1
'o(ic: Strategic o(tions

44. =ast month9 @ill (ide &ar'ets introduced a new board game. Consumer demand has been
o/erwhelming and appears that strong demand will e+ist o/er the long-term as young children
absolutely lo/e the game. Gi/en this9 which one of the following options should @ill (ide
&ar'ets consider in respect to this game?
. suspension
B. e+pansion
C. abandonment
". contraction
#. withdrawal

AACSB: N/A
Difficulty: Basic
Section: "#&1
'o(ic: O(tion to e*(and

24-..
46. )hree months ago9 )oy )own introduced a new toy for pre-school children. )he store
e+pected this toy to be an instant success and a fast mo/ing item. )o their surprise9 children
ha/e $ero interest in this toy so sales ha/e been abysmal. Which one of the following options
should )oy )own consider in respect to this toy?
. suspension
!. e+pansion
C. abandonment
". contraction
#. re-introduction

AACSB: N/A
Difficulty: Basic
Section: "#&1
'o(ic: O(tion to abandon

.%. Which of the following are managerial options once a pro<ect is commenced?
2. modifying the production process
22. re-pricing the product
222. re/ising the mar'eting plan
23. modifying the product:s color and shape
. 2 and 22 only
!. 222 and 23 only
C. 29 229 and 222 only
". 229 2229 and 23 only
E. 29 229 2229 and 23

AACSB: N/A
Difficulty: Basic
Section: "#&1

24-.0
.1. Which one of the following statements related to warrants is correct?
. Warrants are generally issued as an attachment to publicly-issued bonds.
!. Warrants are e+cluded from trading on an organi$ed e+change.
C. Warrants are structured as long-term put options.
". Warrants are issued by indi/idual in/estors.
E. Warrants are generally added as an incenti/e to a pri/ate debt issue.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: 5arrants

.2. Which of the following statements are correct concerning warrants?
2. Warrants are similar to put options.
22. Warrants are similar to call options.
222. When a warrant is e+ercised9 the issuer is not in/ol/ed in the transaction.
23. When a warrant is e+ercised9 the issuer must issue new shares of stoc'.
. 2 only
!. 22 only
C. 2 and 222 only
D. 22 and 23 only
#. 2 and 23 only

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: 5arrants

24-.1
.,. When warrants are e+ercised9 the*
A. earnings per share decrease.
!. earnings per share remain constant.
C. total e;uity in a firm remains constant.
". total e;uity in a firm decreases.
#. number of bonds outstanding increases.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4
'o(ic: 5arrants

.4. Which of the following statements are correct concerning con/ertible bonds?
2. Aew shares of stoc' are issued when a con/ertible bond is con/erted.
22. con/ertible bond is similar to a bond with a call option.
222. con/ertible bond should always be worth less than a comparable straight bond.
23. con/ertible bond can be described as ha/ing upside potential with downside protection.
. 2 and 222 only
B. 29 229 and 23 only
C. 29 229 and 222 only
". 29 2229 and 23 only
#. 229 2229 and 23 only

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4

24-.4
... )he con/ersion /alue of a con/ertible bond is e;ual to which one of the following?
A. Con/ersion ratio (toc' price
!. Con/ersion ratio Con/ersion price
C. Face /alue of the bondHCon/ersion premium
". Face /alue of the bond C1 I Con/ersion premiumD
#. (toc' price C1 I Con/ersion ratioD

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4

.0. )he ma+imum /alue of a con/ertible bond is theoretically*
. e;ual to the con/ersion /alue minus the straight bond /alue.
!. e;ual to the face /alue of the bond multiplied by C1 I Con/ersion priceD.
C. limited to the ma+imum straight bond /alue.
". limited by the face /alue of the bond.
E. unlimited.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "#&4

24-.6
.1. What is the cost of two Ao/ember -2. put option contracts on "o/e stoc' gi/en the
following price ;uotes?

. -%.1.
!. -%.,%
C. -1..%
". -1..%%
E. -,%.%%
Cost L 2 1%% -%.1. L -,%

AACSB: Analytic
Bloom's: A((lication
Difficulty: Basic
Section: "#&%
'o(ic: O(tion 7uotes

24-0%
.4. What is the /alue of fi/e ugust -2. call contracts on "o/e stoc'?

. -,4
!. -04
C. -,4%
". -04%
E. -,94%%
Contract /alue L . 1%% -0.4% L -,94%%

AACSB: Analytic
Difficulty: Basic
Section: "#&%

24-01
.6. What is the intrinsic /alue of the Ao/ember -2. call on "o/e stoc'?

. --%.64
!. -%
C. -%.1.
D. -0.12
#. -1.1%
2ntrinsic /alue L -,1.12 - -2. L -0.12

AACSB: Analytic
Difficulty: Basic
Section: "#&%

0%. Bou purchased si+ call option contracts on !C stoc' with a stri'e price of -,2..% when
the option was ;uoted at -1.4%. )he option e+pires today when the /alue of !C stoc' is
-,4.0%. 2gnoring trading costs and ta+es9 what is the net profit or loss on this in/estment?
. -%
B. -14%
C. -21%
". -44%
#. -1920%
)otal profit L C-,4.0% - -,2..% - -1.4%D 1%% 0 L -14%

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: Call (ayoff

24-02
01. Bou sold one call option contract with a stri'e price of -.. when the option was ;uoted at
-%.4%. )he option e+pires today when the /alue of the underlying stoc' is -.,.1%. 2gnoring
trading costs and ta+es9 what is the net profit or loss on this in/estment?
. --2.%
!. --4%
C. -%
". -.%
E. -4%
)otal profit L -%.4% 1%% 1 L -4%. )he call finished out-of-the-money.

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: Call (ayoff

02. Bou sold three -,. call option contracts at a ;uoted price of -1.4%. What is your net profit
or loss on this in/estment if the price of the underlying asset is -,0.1% on the option
e+piration date?
. --.1%
B. --6%
C. -6%
". -.1%
#. -6,%
)otal loss L C-1.4% I -,. - -,0.1%D 1%% , L --6%

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: Call (ayoff

24-0,
0,. Bou wrote eight call option contracts with a stri'e price of -42..% at a call price of -1.,.
per share. What is your net gain or loss on this in/estment if the price of the underlying stoc'
is -4%.,% per share on the option e+piration date?
. --2944%
!. --1910%
C. --19%4%
D. -19%4%
#. -1910%
Aet profit L -1.,. 1%% 4 L -19%4%. )he call finished out-of-the-money.

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: Call (ayoff

04. )he mar'et price of (outhern 7ress stoc' has been relati/ely /olatile and you thin' this
/olatility will continue for a couple more months. )hus9 you decide to purchase a two-month
#uropean call option on this stoc' with a stri'e price of -4. and an option price of -2.2%. Bou
also purchase a two-month #uropean put option on the stoc' with a stri'e price of -4. and an
option price of -%.,%. What will be your net profit or loss on these option positions if the
. --,%
B. -.%
C. -4%
". -21%
#. -,,%
Aet profit L M--2.2% I -44 - -4.D 1%%N I M--%.,% 1%%N L -.%

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: O(tion (ayoffs

24-04
0.. (e/eral rumors concerning 3alue 8ite stoc' are causing the mar'et price of the stoc' to be
;uite /olatile. Gi/en this situation9 you decide to buy both a one-month #uropean -2. put and
a one-month #uropean -2. call on this stoc'. )he call price per share is -%.0% and the put
price per share is -2.1%. What will be your net profit or loss on these option positions if the
. --21%
!. --1.%
C. --0%
D. -4,%
#. -46%
Aet profit L M--%.0% 1%%N I MC--2.1% I -2. - -14D 1%%N L -4,%

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: O(tion (ayoffs

00. )hree months ago9 Central (upply stoc' was selling for -.1.4% a share. t that time9 you
purchased fi/e put options on the stoc' with a stri'e price of -.% per share and an option price
of -%.0% per share. )he option e+pires today when the /alue of the stoc' is -42.1% per share.
What is your net profit or loss on this in/estment? 2gnore trading costs and ta+es.
. --19,%%
!. --19%%%
C. --,%%
D. -,9,.%
#. -,90.%
Aet profit L C--%.0% - -42.1% I -.%D 1%% . L -,9,.%

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: -ut (ayoff

24-0.
01. Bou wrote two put options on Jylo stoc' with an e+ercise price of -,% per share and an
option price of -1.%. per share. )oday9 the contracts e+pire and the stoc' is selling for -,1.1.
a share. What is your net profit or loss on this in/estment? 2gnore trading costs and ta+es.
. --11.
!. --1%.
C. -2%
". -1%.
E. -21%
Aet profit L -1.%. 1%% 2 L -21%. )he put finished out of the money.

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: -ut (ayoff

04. Bou sold ten put contracts on Cross )own !an' stoc' at an option price per share of
-%.4.. )he options ha/e an e+ercise price of -,1..% per share. )he options were e+ercised
today when the stoc' price was -,4 a share. What is your net profit or loss on this in/estment
assuming that you closed out your positions at a stoc' price of -,4? 2gnore transaction costs
and ta+es.
. --,9.%%
B. --290.%
C. -194%%
". -4.%
#. -,9.%%
Aet loss L C-%.4. - -,1..% I -,4D 1%% 1% L --290.%

AACSB: Analytic
Difficulty: Basic
Section: "#&%
'o(ic: -ut (ayoff

24-00
06. Bou own eight call option contracts on (wift Water )ours stoc' with a stri'e price of -1..
When you purchased the shares the option price was -%.,% and the stoc' price was -1..2..
What is the total intrinsic /alue of these options if the stoc' is currently selling for -10.%4 a
share?
. --4,
!. --1.%4
C. -%
". -1%4
E. -404
2ntrinsic /alue L C-10.%4 - -1.D 1%% 4 L -404

AACSB: Analytic
Difficulty: Basic
Section: "#&"

1%. Bou recently purchased three put option contracts on Guillepsi stoc' with an e+ercise
price of -42..%. What is the total intrinsic /alue of these contracts if the stoc' is currently
selling for -4,.1% a share?
. --,0%
!. --12%
C. -%
". -12%
#. -,0%
)he intrinsic /alue is e;ual to $ero because the puts are out-of-the-money.

AACSB: Analytic
Difficulty: Basic
Section: "#&"

24-01
11. =ast wee'9 you purchased a call option on #dgewater stoc' with a stri'e price of -4%. )he
stoc' price was -,6.4% and the option price was -%.4. at that time. What is the intrinsic /alue
per share if the stoc' is currently priced at -,6.1%?
. --6%
!. --1%
C. -%
". -1%
#. -6%
)he intrinsic /alue is $ero because the call is currently out-of-the-money.

AACSB: Analytic
Difficulty: Basic
Section: "#&"

12. )hree wee's ago9 you purchased a ?une -,% put option on =eeper &etals stoc' at an
option price of -1.4%. )he mar'et price of the stoc' three wee's ago was -,%.0%. )oday9 the
stoc' is selling at -26.4% a share. What is the intrinsic /alue of your put contract?
. --1%%
!. --2%
C. -%
D. -2%
#. -0%
Contract intrinsic /alue L C-,% - -26.4%D 1%% L -2%

AACSB: Analytic
Difficulty: Basic
Section: "#&"

24-04
1,. )his morning9 you purchased a call option on (choolhouse (upply Co. stoc' that e+pires
in one year. )he e+ercise price is -4%. )he current price of the stoc' is -4,.4% and the ris'-
free rate of return is ,.0 percent. ssume the option will finish in the money. What is the
current /alue of the call option?
. -%
!. -1.46
C. -,.61
D. -4.16
#. -..40
C% L -4,.4% - M-4%HC1 I %.%,0DN L -4.16

AACSB: Analytic
Difficulty: Basic
Section: "#&"
'o(ic: Call !alue

14. Bou currently own a one-year call option on 8ail Company9 2nc.9 stoc'. )he current stoc'
price is -.1.4% and the ris'-free rate of return is 4.2. percent. Bour option has a stri'e price of
-.% and you assume the option will finish in the money. What is the current /alue of your call
option?
. -1.2%
!. -2..6
C. -,.44
". -..1,
#. -1.21
C% L -.1.4% - M-.%HC1 I %.%42.D L -,.44

AACSB: Analytic
Difficulty: Basic
Section: "#&"
'o(ic: Call !alue

24-06
1.. )he common stoc' of @a$elton 8efiners is selling for -12.,% a share. K.(. )reasury bills
are currently yielding 4.4 percent. What is the current /alue of a one-year call option on this
stoc' if the e+ercise price is -1% and you assume the option will finish in the money?
. -%
!. -1.2%
C. -,.%%
". -4.2%
E. -...1
C% L -12.,% - M-1%HC1 I %.%44DN L -...1

AACSB: Analytic
Difficulty: Basic
Section: "#&"
'o(ic: Call !alue

10. )he common stoc' of Westo/er Foods is currently priced at -21.6% a share. One year
from now9 the stoc' price is e+pected to be either -2. or -,% a share. )he ris'-free rate of
return is 4.2 percent. What is the current /alue of one call option on this stoc' if the e+ercise
price is -21..%?
. -%
B. -1.6.
C. -2.%%
". -,.4%
#. -4.%%
Aumber of options needed L C-,% - -2.DHC2..% - %D L 2
-21.6% L 2 C% I M-2.HC1 I %.%42DNF C% L -1.6.

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&/
'o(ic: Call !alue

24-1%
11. Bou own one call option with an e+ercise price of -4% on (:more Good stoc'. )he stoc' is
currently selling for -41 a share but is e+pected to sell for either -,1 or -4, a share in one
year. )he ris'-free rate of return is 4.2. percent and the inflation rate is ,.0 percent. What is
the current call option price if the option e+pires one year from now?
. -%...
!. -%.06
C. -1.,1
". -2.4,
E. -2.1.
Aumber of options needed L C-4, - -,1DHC, - %D L 2
-41 L 2C% I M-,1HC1 I %.%42.DNF C% L -2.1.

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&/
'o(ic: Call !alue

14. )he assets of Kptown (tores are currently worth -1,094%%. )hese assets are e+pected to
be worth either -12%9%%% or -1.%9%%% one year from now. )he company has a pure discount
bond outstanding with a -1,%9%%% face /alue and a maturity date of one year. )he ris'-free
rate is 4., percent. What is the /alue of the e;uity in this firm?
. -11962%
B. -1492,2
C. -169.%1
". -219,41
#. -2094%4
Aumber of options needed L C-1.%9%%% - -12%9%%%DHC-2%9%%% - -%D L 1..
-1,094%% L 1..C% I C-12%9%%%HC1 I %.%4,DF C% L -1492,2

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&0

24-11
16. #lectronic 2mporters has a pure discount bond with a face /alue of -2.9%%% that matures in
one year. )he ris'-free rate of return is ,.4 percent. )he assets of the business are e+pected to
be worth either -2,9%%% or -,.9%%% in one year. Currently9 these assets are worth -219.%%.
What is the current /alue of the bond?
. -119140
!. -1692%1
C. -2%9222
". -229.46
E. -2,9%44
Aumber of options needed L C-,.9%%% - -2,9%%%DHC-1%9%%% - -%D L 1.2
-219.%% L 1.2C% I C-2,9%%%HC1 I %.%,4DF C% L -494.1.01
3alue of debt L -219.%% - -494.1.01 L -2,9%44

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&0

4%. )he Glass @ouse has total assets currently /alued at -1192%%. )hese assets are e+pected to
increase in /alue to either -149%%% or -219%%% by ne+t year. )he company has a pure discount
bond outstanding with a face /alue of -2%9%%%. )his bond matures in one year. Currently9 K.(.
)reasury bills are yielding ..4 percent. What is the /alue of the e;uity in this firm?
. --,9%%%.%%
!. --6%4.%%
C. -%
D. -4%.1,
#. -122.2%
Aumber of options needed L C-219%%% - -149%%%DHC-19%%% - -%D L ,
-1192%% L ,C% I C-149%%%HC1 I %.%.4DF C% L -4%.1,

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&0

24-12
41. Bou are considering a pro<ect that has been assigned a discount rate of 14 percent. 2f you
start the pro<ect today9 you will incur an initial cost of -49.%% and will recei/e cash inflows of
-.9..% a year for two years. 2f you wait one year to start the pro<ect9 the initial cost will rise to
-692%% and the cash flows will increase to -.94%% a year for two years. What is the /alue of
the option to wait?
A. --,,1.4%
!. --164.40
C. -224..1
". -2,%.46
#. -,,4.04
3alue of option to wait L -,%1..1 - -0,4.61 L --,,1.4%

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&1

24-1,
42. (outhern (hores is considering a pro<ect that has an initial cost today of -129.%%. )he
pro<ect has a two-year life with cash inflows of -19.%% a year. (hould the firm opt to wait one
year to commence this pro<ect9 the initial cost will increase by . percent and the cash inflows
will increase to -49.%% a year. What is the /alue of the option to wait if the applicable
discount rate is 14 percent?
. -014..2
!. -121..0
C. -614.02
". -642.01
#. -19%21.00
3alue of option to wait L -411.01 - C--1.%.%.D L -614.02

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "#&1

24-14
4,. Western 2ndustrial 7roducts is considering a pro<ect with a four-year life and an initial cost
of -2129%%%. )he discount rate for the pro<ect is 10 percent. )he firm e+pects to sell 690%%
units on the last day of each year. )he cash flow per unit is -.%. )he firm will ha/e the option
to abandon this pro<ect at the end of year one Cafter year one:s salesD at which time the
pro<ect:s assets could be sold for an estimated -12.9%%%. )he firm should abandon the pro<ect
at the end of year one if the e+pected le/el of annual sales9 starting with year 29 falls to 55555
units or less. 2gnore ta+es.
A. 1911, units
!. 19201 units
C. 19622 units
". 29%,4 units
#. 291%4 units

AACSB: Analytic
Bloom's: Analysis
Difficulty: .ntermediate
Section: "#&1

24-1.
44. "ressler )echnologies is considering a pro<ect with a ,-year life and an initial cost of
-4.9%%%. )he discount rate for the pro<ect is 14.. percent. )he firm e+pects to sell 192%% units
on the last day of each year. )he cash flow per unit is -,2. )he firm will ha/e the option to
abandon this pro<ect at the end two years Cafter year 2 salesD at which time the pro<ect:s assets
could be sold for an estimated -,%9%%%. )he firm:s managers are interested in 'nowing how
the pro<ect will perform if the sales forecast for year , of the pro<ect is re/ised such that there
is a .%H.% chance that the sales will be either 19%%% or 194%% units a year. What is the net
present /alue of this pro<ect at time $ero gi/en the current sales forecasts?
. --,9414
!. --29.20
C. -49161
". -09162
#. -09441
=e/el to abandon L -,%9%%% L -,2OH1.14.F O L 19%1,.44 units
t 19%%% units9 you will abandon the pro<ect and recei/e -,%9%%% at the end of year 2.
t 194%% units9 you will continue the pro<ect and the pro<ect will ha/e a /alue at the end of
year 2 of*
A73#nd of year 2 L C194%% -,2DH1.14. L -,69120.04
)he A73 of this pro<ect today is*

AACSB: Analytic
Bloom's: Analysis
Difficulty: C+allenge
Section: "#&1

24-10
4.. 7atience is re/iewing a pro<ect with pro<ected sales of 492%% units a year9 a cash flow of
-24 a unit9 and a four-year pro<ect life. ssume all operating cash flows occur on the last day
of each year. )he initial cost of the pro<ect is -2419%%%. )he rele/ant discount rate is 1,
percent. 7atience has the option to abandon the pro<ect after two years at which time she feels
she could sell the pro<ect:s assets for -11%9%%%. t what le/el of annual sales9 starting in year
,9 should she be willing to abandon this pro<ect?
. 29116 units
B. 29,.. units
C. 29,01 units
". 29.10 units
#. 29001 units

AACSB: Analytic
Bloom's: Analysis
Section: "#&1

40. Bou own a con/ertible bond with a face /alue of -19%%% and a mar'et /alue of -19%,4.
)he bond can be con/erted into 14 shares of stoc'. What is the con/ersion price?
A. -11.4,
!. -12.%%
C. -12.01
". -1,.40
#. -14.,,
Con/ersion price L -19%%%H14 L -11.4,

AACSB: Analytic
Difficulty: Basic
Section: "#&4

24-11
41. Bou own nine con/ertible bonds. )hese bonds ha/e a 1 percent coupon9 a -19%%% face
/alue9 and mature in 0 years. )he bonds are con/ertible into shares of common stoc' at a
con/ersion price of -2.. @ow many shares of stoc' will you recei/e if you con/ert all of your
bonds?
. 24.
!. ,%%
C. ,.%
D. ,0%
#. 4%%
Aumber of shares L C-19%%%H-2.D 6 L ,0% shares

AACSB: Analytic
Difficulty: Basic
Section: "#&4

44. con/ertible bond has a face /alue of -.9%%% and a con/ersion price of -4%. )he bond
are yielding 1.. percent. )he current price of the stoc' is -41.2% per share. What is the
con/ersion /alue of this bond?
. -1904%
!. -2941.
C. -29.1.
". -490.1
#. -.9%%%
Con/ersion /alue L C-.9%%%H-4%D -41.2% L -29.1.

AACSB: Analytic
Difficulty: Basic
Section: "#&4

24-14
46. con/ertible bond has a face /alue of -19%%% and a con/ersion price of -12..%. )he bond
are yielding 6 percent. )he current price of the stoc' is -1,.4% per share. What is the straight
bond /alue?
A. -142..1
!. -141.42
C. -421.14
". -4,2.%6
#. -44,.41

AACSB: Analytic
Difficulty: Basic
Section: "#&4

24-16
6%. >urt owns a con/ertible bond that matures in three years. )he bond has a 1.. percent
coupon and pays interest semi-annually. )he face /alue of the bond is -19%%% and the
con/ersion price is -2.. (imilar bonds ha/e a mar'et return of 6.2. percent. )he current price
of the stoc' is -20..% per share. What is the straight bond /alue?
. -644.2%
B. -6...%.
C. -612.4%
". -641.14
#. -661.1.

AACSB: Analytic
Difficulty: Basic
Section: "#&4

61. =ucinda owns a con/ertible bond that matures in si+ years. )he bond has a 6 percent
coupon and pays interest annually. )he face /alue of the bond is -19%%% and the con/ersion
price is -22. (imilar bonds ha/e a mar'et return of 4.1. percent. )he current price of the
stoc' is -21.0% per share. What is the con/ersion /alue of this bond?
. -4,..0%
!. -444.4%
C. -642.11
D. -641.42
#. -19%%%.%%
Con/ersion /alue L C-19%%%H-22D -21.0% L -641.42

AACSB: Analytic
Difficulty: Basic
Section: "#&4

24-4%

Essay Questions

62. Circle (tores stoc' is priced at -24 a share. -4% call on this stoc' has fi/e months until
e+piration and a call price of -%.1.. Why would an in/estor purchase a call that is so far out of
the money?
(tudents should discuss the impact of time to maturity on option /alues. )hey should point
out that with fi/e months left to maturity9 there is a chance that the option could finish in the
money9 especially if the stoc' price is /olatile. low option price per share such as -%.1.9
means that an in/estment in an option contract will be ;uite ine+pensi/e. @owe/er9 in/estors
apparently don:t ha/e a strong feeling the stoc' will reach -4% by share by the e+piration date9
or the option price would be much higher.
Feedbac'* 8efer to section 24.,

AACSB: 2eflecti!e t+in,ing
Bloom's: Analysis
Difficulty: Basic
Section: "#&/
'o(ic: O(tion !alue

6,. What are the basic similarities and basic differences between warrants and call options?
!oth warrants and call options grant their owners the right to purchase shares of stoc' at a
prespecified price. Warrants are issued by corporations while call options are issued by
in/estors. Warrants are usually attached to pri/ately placed loans or bonds. Warrants can be
detached from the debt security and traded separately. Call options are traded separately from
the underlying stoc'.
Feedbac'* 8efer to section 24.1

Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#$% and "#$1
Section: "#&4
'o(ic: 5arrants8 calls8 and con!ertibles

24-41
64. What are the upper and lower bounds for an merican call option? #+plain what would
happen in each case if the bound was /iolated.
)he upper bound on a call is the stoc' price. 2f the call price e+ceeded the stoc' price9 you
would be paying more for the option to buy an asset than the asset itself costs. )he lower
bounds are* C % if ( - # P % and C C( - #D if C( - #D %. 2n the first case9 if the e+ercise
price e+ceeds the stoc' price9 the call is out of the money and it will either be worthless or
ha/e some time /alue. 2n the second case9 if the call is in the money9 the call must be worth at
least the difference between the asset:s /alue and the e+ercise price. 2f the call was worth less
than this /alue9 rational in/estors would purchase calls9 immediately e+ercise them9 and then
sell the stoc' at the current price9 completing an arbitrage.

Bloom's: Analysis
Section: "#&"
'o(ic: O(tion (ricing bounds

6.. #+plain the rationale behind the idea that e;uity is a call option on a firm:s assets. When
would a shareholder allow this call to e+pire?
)he analogy only wor's for le/eraged firms. t maturity of the firm:s debt9 the stoc'holders
ha/e the option to either pay the creditors the face /alue of the debt or turn the firm:s assets
o/er to the firm:s creditors. 2f the firm:s assets are worth less than the face /alue of the debt9
the stoc'holders will not e+ercise the call9 that is9 they will let the creditors ha/e the assets
and the firm will be li;uidated.
Feedbac'* 8efer to section 24..

Difficulty: Basic
Section: "#&0

24-42
60. Call options are fre;uently attached to bonds9 ma'ing them callable at the option of the
issuer. Consider a firm that <ust issued two sets of bonds* One is callable9 has a 1 percent
coupon rate9 1. years to maturity9 and cannot be called during the first three yearsF the second
is noncallable9 has a 1 percent coupon rate9 1. years to maturity9 and is identical to the first
bond in e/ery way e+cept for the call option. (uppose the noncallable bonds are sold for
-19%%% each. Will the callable bonds sell for more or less than -19%%%? Who EpurchasesE the
option in this case and who EsellsE it?
)he callable bond will sell for less than par. )he bond issuer buys the option and the
bondholder writes it. 2f the callable bonds sell for -6.% each9 the call option will be worth the
difference between the two bond prices9 or -.% per bond.

Difficulty: Basic
Section: "#&4
'o(ic: Callable bonds

61. #+plain how the floor and the ceiling prices for a con/ertible bond are determined.
)he floor9 or minimum9 /alue of a bond is the bond:s straight bond /alue. )he ceiling9 or
ma+imum9 /alue is theoretically unlimited since there is no upper limit on a bond:s con/ersion
/alue.

Bloom's: Knowledge
Difficulty: Basic
Section: "#&4


24-4,
64. )-bills currently yield 0., percent. (toc' in 7inta &anufacturing is currently selling for
-40 per share. )here is no possibility that the stoc' will be worth less than -,6 per share in
one year. What is the /alue of a call option on this stoc' if the e+ercise price is -22 per share?
. -21.4%
!. -22.%%
C. -24.%%
D. -2..,%
#. -2..1%
C% L -40 - M-22HC1 I %.%0,DN L -2..,%

AACSB: Analytic
Difficulty: Basic
)OC 9: "#$%
Section: "#&"
'o(ic: O(tion !alue

66. )he price of )ime (;uared Corp. stoc' will be either -4% or -6. at the end of the year.
Call options are a/ailable with one year to e+piration. )-bills currently yield 0 percent and the
current price of )ime (;uared Corp. stoc' is -4.. What is the /alue of a call option if the
e+ercise price is -1. per share?
A. -14.2.
!. -1..%0
C. -14.14
". -24.2.
#. -2..%0
C% L -4. - M-1.HC1 I %.%0DN L -14.2.

AACSB: Analytic
Difficulty: Basic
)OC 9: "#$#
Section: "#&/
'o(ic: O(tion !alue

24-44
1%%. )he price of "imension9 2nc. stoc' will be either -0. or -4. at the end of the year. Call
options are a/ailable with one year to e+piration. )-bills currently yield . percent. (uppose the
current price of "imension stoc' is -1%. What is the /alue of the call option if the e+ercise
price is -1% per share?
A. -0.%1
!. -4.44
C. -11..4
". -1..,6
#. -11.02
-1% L MC-4. - -0.DHC-4. - -1%DNC% I -0.HC1 I %.%.DF C% L -0.%1

AACSB: Analytic
Difficulty: Basic
)OC 9: "#$0
Section: "#&/
'o(ic: O(tion !alue

1%1. 8ac'in 7inion Corporation:s assets are currently worth -1920%. 2n one year9 they will be
worth either -192%% of -1901%. )he ris'-free interest rate is . percent. (uppose 8ac'in 7inion
has an outstanding debt issue with a face /alue of -192%%. What is the current /alue of the
firm:s debt?
. -0%.%%
!. -114.14
C. -19142.40
". -1920,.16
#. -19.%4.2%
#% L -1920% - M-192%%HC1 I %.%.DN L -111.14
"% L -1920% - -111.14 L -19142.40

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
)OC 9: "#$4
Section: "#&0
'o(ic: )7uity as an o(tion

24-4.
1%2. !uc'eye 2ndustries has a bond issue with a face /alue of -19%%% that is coming due in
one year. )he /alue of !uc'eye:s assets is currently -192%%. ?im )ressell9 the C#O9 belie/es
that the assets in the firm will be worth either -0%% or -191%% in a year. )he going rate on one-
year )-bills is 0 percent. What is the current /alue of the firm:s debt?
. -0%1.14
B. -160..1
C. -444.24
". -414.14
#. -611.%,
-192%% L MC-191%% - -0%%DHC-191%% - -19%%%DN #% I M-0%%HC1 I %.%0DN L -4%,.4,
"% L -192%% - -4%,.4, L -160..1

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
)OC 9: "#$:
Section: "#&0
'o(ic: )7uity as an o(tion

1%,. -19%%% con/ertible debenture has a con/ersion price for common stoc' of -4. per
share. )he common stoc' is selling at -62 a share. What is the con/ersion /alue of this bond?
. -62%.%%
!. -62,.61
C. -19%%%.%%
D. -19%42.,.
#. -19%62.%%
Con/ersion /alue L C-19%%%H-4.DC-62D L -19%42.,.

AACSB: Analytic
Difficulty: Basic
)OC 9: "#$;
Section: "#&4
'o(ic: Con!ersion !alue

24-40
1%4. bond with 1% detachable warrants has <ust been offered for sale at -19%%%. )he bond
matures in 1. years and has an annual coupon of -4%. #ach warrant gi/es the owner the right
to purchase two shares of stoc' in the company at -14 per share. Ordinary bonds Cwith no
warrantsD of similar ;uality are priced to yield 11 percent. What is the /alue of one warrant?
. -1.%%
!. -1,..4
C. -14.%%
". -10.01
E. -21..1
)otal warrant /alue L -19%%% - -144.21 L -21..1,
7rice per warrant L -21..1,H1% L -21..1

AACSB: Analytic
Difficulty: Basic
)OC 9: "#$%"
Section: "#&4
'o(ic: 5arrant !alues

24-41
1%.. Bour company is deciding when to in/est in a new machine. )he new machine will
increase cash flow by -24%9%%% per year. Bou belie/e the technology used in the machine has
a 1%-year lifeF in other words9 no matter when you purchase the machine9 it will be obsolete
1% years from today. )he machine is currently priced at -192%%9%%%. )he cost of the machine
will decline by -12%9%%% per year until it reaches -12%9%%%9 where it will remain. Bour
re;uired return is 4 percent. 2n which year should you purchase the machine?
A. Bear %
!. Bear 1
C. Bear 2
". Bear ,
#. Bear 4
)he company should purchase the machine today when the A73 is the highest.

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
)OC 9: "#$%/
Section: "#&1

24-44
1%0. We are e+amining a new pro<ect. We e+pect to sell 69%%% units per year at -4. net cash
flow apiece for the ne+t 2% years. 2n other words9 the annual operating cash flow is pro<ected
to be -4. 69%%% L -4%.9%%%. )he rele/ant discount rate is 14 percent9 and the initial
in/estment re;uired is -191,%9%%%. fter the first year9 the pro<ect can be dismantled and sold
for -19,.%9%%%. 2f e+pected sales are re/ised based on the first year:s performance9 it would
ma'e sense to abandon the in/estment if the sales are less than which of the following number
of units?
A. 49.4% units
!. 4902% units
C. 491.% units
". 4941% units
#. .9%2% units
-19,.%9%%% L C-4.DCODC732F14Q9 16DF O L 49.4% units
bandon the pro<ect if O P 49.4% units because the A73 of abandoning the pro<ect is greater
than the A73 of the future cash flows.

AACSB: Analytic
Bloom's: Analysis
)OC 9: "#$%#
Section: "#&1
'o(ic: Abandonment !alue

24-46
1%1. We are e+amining a new pro<ect. We e+pect to sell 49%%% units per year at -4% net cash
flow apiece for the ne+t 1. years. 2n other words9 the annual operating cash flow is pro<ected
to be -4% 49%%% L -04%9%%%. )he rele/ant discount rate is 10 percent9 and the initial
in/estment re;uired is -2914%9%%%. )he pro<ect can be dismantled after the first year and sold
for -291,%9%%%. (uppose you thin' it is li'ely that e+pected sales will be re/ised upward to
690%% units if the first year is a success and re/ised downward to ,9%%% units if the first year is
not a success. (uppose the scale of the pro<ect can be doubled in one year in the sense that
twice as many units can be produced and sold. Aaturally9 e+pansion would be desirable only if
the pro<ect is a success. )his implies that if the pro<ect is a success9 pro<ected sales after
e+pansion will be 1692%%. ssume that success and failure are e;ually li'ely. Aote that
abandonment is still an option if the pro<ect is a failure. What is the /alue of the option to
e+pand?
. -191149,24
B. -194%69641
C. -1942494%0
". -19444962%
#. -194129,12
)he gain from the option to e+pand is the present /alue of the cash flows from the additional
units sold9 so*
Gain from option to e+pand L -4%C690%%DC732F10Q9 14D L -491669%02.,6
We need to find the /alue of the option to e+pand times the li'elihood of e+pansion. We also
need to find the /alue of the option to e+pand today9 so*
Option /alue L C%..%DC-491669%02.,6DH1.10 L -194%69641

AACSB: Analytic
Bloom's: )!aluation
)OC 9: "#$%1
Section: "#&1
'o(ic: Abandonment and e*(ansion

24-6%

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Chapter 24 - Options and Corporate Finance

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