CHAPTER 8—FINANCIAL OPTIONS AND APPLICATIONS IN CORPORATE FINANCE

TRUE/FALSE 1.An option is a contract that gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time. ANS:OBJ:LOC:T LO: 8-1 TBA PTS: 1 DIF: Difficulty: Easy NAT: BUSPROG: Reflective Thinking STA: DISC: Derivatives TOP: Options KEY: Bloom’s: Knowledge 2.The strike price is the price that must be paid for a share of common stock when it is bought by exercising a warrant. ANS:OBJ:LOC:T LO: 8-1 TBA PTS: 1 DIF: Difficulty: Easy NAT: BUSPROG: Reflective Thinking STA: DISC: Derivatives TOP: Strike price KEY: Bloom’s: Knowledge 3.The exercise value is the positive difference between the current price of the stock and the strike price. The exercise value is zero if the stock's price is below the strike price. ANS:OBJ:LOC:T LO: 8-1 TBA PTS: 1 DIF: Difficulty: Easy NAT: BUSPROG: Reflective Thinking STA: DISC: Derivatives TOP: Exercise value KEY: Bloom’s: Knowledge 4.The exercise value is also called the strike price, but this term is generally used when discussing convertibles rather than financial options. ANS:OBJ:LOC:F LO: 8-1 TBA PTS: 1 DIF: Difficulty: Easy NAT: BUSPROG: Reflective Thinking STA: DISC: Derivatives TOP: Exercise value KEY: Bloom’s: Knowledge 5.As the price of a stock rises above the strike price, the value investors are willing to pay for a call option increases because both (1) the immediate capital gain that can be realized by exercising the option and (2) the likely exercise value of the option when it expires have both increased. ANS:OBJ:LOC:T LO: 8-1 TBA PTS: 1 DIF: Difficulty: Easy NAT: BUSPROG: Reflective Thinking STA: DISC: Derivatives TOP: Option time value KEY: Bloom’s: Knowledge 6.If the current price of a stock is below the strike price, then an option to buy the stock is worthless and will have a zero value. ANS:OBJ:LOC:F LO: 8-1 TBA PTS: 1 DIF: Difficulty: Easy NAT: BUSPROG: Reflective Thinking STA: DISC: Derivatives TOP: Option pricing KEY: Bloom’s: Knowledge 7.If the market is in equilibrium, then an option must sell at a price that is exactly equal to the difference between the stock's current price and the option's strike price.