Options Mcqs

CMA Exam Review - Part 2 Page 1 of 15
Test Bank Questions
Valuing Options
Question 1 (2B2-LS16)
2B2-LS16
All of the following statements about an option are correct except:
The owner of a put option has the right to sell the underlying asset at a fixed price.
The buyer of an option contract receives an up-front premium from the seller of the option
contract.
The owner of a call option has the right to buy the underlying asset from the seller.
The seller (writer) of an option contract receives an up-front premium from the owner of
the option contract.
By definition, a premium is the initial purchase price of an option and it is usually stated on
a per unit basis. The writer (seller) of an option contract receives an up-front premium from
the buyer (owner) of the option contract. This premium obligates the writer to fulfill the
contract (sell or buy the underlying asset) if the buyer chooses to exercise the option.
Question 2 (tb.val.opt.001_1711)
tb.val.opt.001_1711
The value of an option before the expiration date depends on all of the following factors except
for:
nominal rate of interest.
current price of the underlying asset.
volatility of the value of the underlying asset.
time until the option expires.
The value of an option depends on the risk-free rate of interest, not the nominal rate of
interest.
tb.val.opt.001_1805
What is the payoff for a call option with a strike price of $50 if the underlying stock price at
expiration is $85?
$35
$50
$85
https://app.efficientlearning.com/pv5/v8/5/app/cma/part2_2019.html? 9/9/2019
$135
Correct. The payoff for a call option is the stock price minus the strike price = $85 − $50 =
$35.
tb.val.opt.002_1711
The Black-Scholes model is commonly used to price options. Which of the following is not an
assumption of the Black-Scholes model?
The risk-free rate exists, is constant across the life of the option, and is the same for all
maturity dates.
There are no transaction costs, taxes, or commissions.
The stock's returns are normally distributed.
The option is not a European option.
The Black-Scholes model assumes the option is a European option.
tb.val.opt.002_1805
What is the payoff for the owner of a call option with a strike price of $35 if the underlying stock
price at expiration is $30?
$30
$(5)
$5
$0
Correct. The payoff of a call option is the underlying stock price minus the strike price = $30
− $35 = $(5). Rather than exercise the option and lose $5, the owner of the option would
choose to let it expire instead with a payoff of $0.
tb.val.opt.003_1711
The binomial model is commonly used to price options. Which of the following is not an
assumption of the binomial model?
The duration of the option is shortened.
The stock's price can remain constant.
No arbitrage is possible.
The investor is risk-neutral.
The binomial model assumes that the stock's price must either increase or decrease.
tb.val.opt.003_1805
What is the payoff for the owner of a put option with a strike price of $63 if the underlying stock
price at expiration is $43?
$106
$43
$20
$63
Correct. The payoff of a put option is the strike price minus the underlying stock price = $63
− $43 = $20.
tb.val.opt.004_1805
You own a put option on Phosfranc Inc. stock with a strike price of $50. The current stock price is
$50. In which of the following cases your benefit will increase?
If the stock price goes up.
If the stock price goes down.
If the stock price stays the same.
The benefit is indifferent to the changes in the stock price.
Correct. The payoff for a put option is the strike price minus the current stock price. As the
stock price goes down, the payoff increases.
tb.val.opt.005_1805
You have sold a call option on Ausia Co. stock with a strike price of $50. You do not intend to
make any other transactions before the options expiration date. The current stock price is $30.
Which of the following statements best describes your hopes for the stock?
You want the stock price to fall below $30.
You want the stock price to rise above $50.
You want the stock price to stay under $50.
It doesn't matter; you are indifferent to changes in the stock price.
Correct. If the holder decides to exercise the option, the seller must sell the shares to the
holder at the exercise price. If the stock price stays under $50, the holder will choose not to
exercise the option, and the seller will not sell the shares at the strike price.
tb.val.opt.006_1805
What is the payoff for a put option with a strike price of $22 if the price of the underlying stock at
expiration is $19?
$3
$19
$22
$41
Correct. The payoff for a put option is strike price minus stock price = $22 − $19 = $3.
tb.val.opt.007_1805
Pitchgent Inc. stock was trading last month at $22 per share. There were two types of options
available on the stock. Call options with a strike price of $16, which expire at the end of the
month, were trading at $6.00. Put options with a strike price of $16, which expire at the end of the
month, were trading at $1.10. Larry invested $132 in common stock. Keaty invested $132 in the
call options. Marek invested $132 in the put options. At the end of one month, the price of
Pitchgent Inc. is $25. Who made the most money off of their investment?
Larry
Keaty
Marek
Marek made the least amount of money, but did not lose any money
Correct. Keaty purchased $132 ÷ 6 = 22 options for $132. In addition, Keaty paid 22 × $16
strike price = $352, for a total cost of $484. After exercising the options, the shares were
worth 22 × $25 = $550, for a profit of $550 − $484 = $66. Larry purchased $132 ÷ 22 = 6 shares,
at the end of the month they were worth 6 × $25 = $150, for a profit of $150 − $132 = $18.
Marek's put options were not in the money at the end of the month; therefore, Marek lost
the $132 investment.
tb.val.opt.008_1805
Pitchgent Inc. is $25. How much money did Larry make from the investment?
$132
$18
$150
Larry did not make a profit
Correct. Larry purchased 6 shares at $22 dollars each, for a cost of $132. At the end of the
month, the shares were worth 6 × 25 = $150. The profit is $150 − $132 = $18.
tb.val.opt.009_1805
Pitchgent Inc. is $25. How much money did Keaty make from the investment?
$352
$66
$550
Keaty did not make any money from the investment
Correct. Keaty purchased $132 ÷ 6 = 22 options for $132. In addition, Keaty paid 22 × $16
strike price = $352, for a total cost of $484. After exercising the options, the shares were
worth 22 × $25 = $550, for a profit of $550 − $484 = $66.
tb.val.opt.010_1805
Pitchgent Inc. is $25. How much money did Marek make from the investment?
$0
Marek lost the investment amount of $132
$948
$3,000
Correct. Marek's put options were not in the money at the end of the month. Marek would
choose to let them expire, and therefore lose the $132 investment.
tb.val.opt.011_1805
Tunerecord Unit Co. stock was trading last year at $24. There were two types of options available
on the stock. Call options with a strike price of $24, which expire at the end of the year, were
trading at $9.60. Put options with a strike price of $24, which expire at the end of the year, were
trading for $2.40. Berniss invested $144 in common stock. Jewel invested $144 in the call options.
Reynardo invested $144 in the put options. At the end of one year the price of Tunerecord Unit
stock is $20.00. How did their investments compare at the end of the year?
All three investors showed a profit.
Only Jewel showed a profit.
Only Reynardo showed a profit.
Only Berniss showed a profit.
Correct. Reynardo purchase 60 options for $144, which allowed him to sell 60 shares for $24
each, or $1,440 in total. At the end of the year, Reynardo was able to purchase the 60 shares
for $1,200. Reynardo's investment of $1,200 + $144 = $1,344 was worth $1,440 at the end of
the year.
tb.val.opt.012_1805
stock is $20.00. How much money did Berniss make or lose from this investment?
$0
$24 profit
$24 loss
$120 profit
Correct. Berniss was able to purchase $144 ÷ $24 = 6 shares at a cost of $144. At the end of
the year, the shares were worth 6 × $20 = $120, for a loss of $120 − $144, or $24.
tb.val.opt.013_1805
stock is $20.00. How much money did Jewel make or lose from this investment?
$0
$144 loss
$204 loss
$204 profit
Correct. Jewel's options were not in the money at the end of the year. To avoid losing more
money, Jewel's best option is to let the options expire. Jewel would therefore lose the $144
invested in the options.
tb.val.opt.014_1805
stock is $20.00. How much money did Reynardo make or lose from this investment?
$0
$96 profit
$144 loss
$96 loss
Correct. Reynardo was able to purchase $144 ÷ $2.40 = 60 options. At the end of the year,
the options were worth 60 × ($24 − $20) = $240, minus the $144 investment equals a profit of
$96.
tb.val.opt.015_1805
The intrinsic value of call option can never be less than which of the following?
$0
$1
The strike price
The value of the underlying asset
Correct. The value of an option can never be negative. If an option is out of the money, it is
worth $0.
tb.val.opt.016_1805
Consider a corn farmer who expects to produce 55,000 bushels of corn at the end of this season.
To hedge the risk associated with corn prices, the farmer purchases put options to cover his
entire crop. The put options have a strike price of $8.50 per bushel and a premium of $0.40 per
bushel. He also sells an equal amount of call options with a strike price of $8.50 per bushel and a
premium of $0.53 a bushel. Which of the following statements is correct?
From this transaction the farmer can pocket $7,500 immediately.
If corn prices increase substantially, the farmer will earn more than the strike price.
If corn prices decrease substantially, the farmer will earn less than the strike price.
The farmer has guaranteed that he will sell his corn for $8.50 a bushel.
Correct. If at exercise date corn is worth less than $8.50 per bushel, the call options are
worthless, but the farmer can exercise the put options at $8.50 per bushel. If at exercise
date corn is worth more than $8.50 per bushel, the put options are worthless, but the holder
of the call options will exercise, and the farmer will provide the corn at the strike price.
tb.val.opt.017_1805
Consider a lease agreement recently offered by a car dealership. The agreement gives the
customer the right to use a new SUV for 4 years in exchange for payments of $650 per month. At
the end of the lease, the customer can choose to purchase the SUV for $18,000. What sort of
option does this resemble for the lessee?
The purchase of a put option on the SUV with a strike price of $18,000
The purchase of a call option on the SUV with a strike price of $18,000
The sale of a put option on the SUV with a strike price of $18,000
The sale of a call option on the SUV with a strike price of $18,000
Correct. At the end of the lease term, the lessee has the right, but not the obligation, to
purchase the SUV at the strike price.
tb.val.opt.018_1805
Consider a lease agreement recently offered by a car dealership. The agreement gives the
customer the right to use a new SUV for 4 years in exchange for payments of $650 per month. At
the end of the lease, the customer can choose to purchase the SUV for $18,000. What sort of
option does this resemble for the car dealership?
The purchase of a put option on the SUV with a strike price of $18,000
The purchase of a call option on the SUV with a strike price of $18,000
The sale of a put option on the SUV with a strike price of $18,000
The sale of a call option on the SUV with a strike price of $18,000
Correct. The lessee has the right, but not the obligation, to purchase the SUV at the end of
the lease term. If the lessee decides to purchase the SUV, the car dealership must provide it.
The car dealership is therefore selling a call option.
tb.val.opt.019_1805
Neunlay Inc. is a manufacturer of residential air conditioning equipment. Air conditioning
equipment requires a lot of copper. In six months the company will purchase its copper supply
for the next two years. Management is very concerned about the volatility of copper prices.
Assume the risk-free rate of interest is 0%. Which of the following transactions will ensure the
company does not have to pay more than $6,100 per ton of copper six months from now?
The company purchases a put option for the necessary amount of copper with a strike price
of $6,000 per ton, a premium of $100 per ton, and an expiration date six months from now.
The company purchases a call option for the necessary amount of copper with a strike price
of $6,000 per ton, a premium of $100 per ton, and an expiration date six months from now.
The company sells a put option for the necessary amount of copper with a strike price of
$6,000 per ton, a premium of $100 per ton and an expiration date six months from now.
The company sells a call option for the necessary amount of copper with a strike price of
$6,000 per ton, a premium of $100 per ton, and an expiration date six months from now.
Correct. If the price of copper is less than $6,000 per ton, Neunlay can purchase the copper
on the open market, let the options expire and lose $100 per ton. If the price of copper is
more than $6,000 per ton, Neunlay can exercise the options and purchase the copper for
$6,000 per ton, at a total cost of $6,100 per ton.
tb.val.opt.020_1805
An investor (the buyer) purchases a call option from a seller. On the expiration date of a call
option, which of the following is true?
The buyer has the obligation to buy the underlying asset and the seller has the obligation to
sell it.
The buyer has the right to buy the underlying asset and the seller has the obligation to sell
it.
The buyer has the obligation to sell the underlying asset and the seller has the right to buy
it.
The buyer has the right to sell the underlying asset and the seller has the right to buy it.
Correct. With a call option, the buyer can decide whether to purchase the underlying asset
or not. If the buyer decides to purchase the asset, the seller of the option must sell the
underlying asset to the buyer.
tb.val.opt.021_1805
An investor (the buyer) purchases a put option from a seller. On the expiration date of a put
option, which of the following is true?
The buyer has the obligation to sell the underlying asset and the seller has the right to buy
it.
The buyer has the obligation to sell the underlying asset and the seller has the obligation to
buy it.
The buyer has the right to sell the underlying asset and the seller has the obligation to buy
it.
The buyer has the right to buy the underlying asset and the seller has the right to sell it.
Correct. With a put option, the buyer has the right, but not the obligation, to sell the
underlying asset. If the buyer decides to sell the underlying asset, the seller must buy it.
tb.val.opt.022_1805
Which of the following statements is true of a call option?
The intrinsic value of a call option can never be positive.
The intrinsic value of a call option can be more than the market value of the underlying
asset.
The intrinsic value of a call option is always less than the market value of the underlying
asset.
The intrinsic value of a call option is always less than the strike price.
Correct. The intrinsic value of the call option plus the strike price is equal to the market
value of the asset.
tb.val.opt.023_1805
Which of the following statements is true of a put option?
The intrinsic value of a put option can be negative.
The intrinsic value of a put option can be worth more than the underlying asset.
The intrinsic value of a put option is the strike price plus the market value of the underlying
asset.
The intrinsic value of a put option increases when the stock price increases.
Correct. The intrinsic value of a put option plus the market value of the asset is equal to the
strike price.
tb.val.opt.024_1805
Suppose you own a call option on a stock with a strike price of $20 that expires today. The price
of the underlying stock is $15. What is your best choice?
Sell the option.
Let the option expire.
Exercise the option and immediately sell the underlying stock.
Exercise the option and hold the underlying stock.
Correct. The option has no value so you cannot sell it. If you exercise the option, you are
spending $20 to purchase an asset worth $15, so you would lose the purchase cost of the
option plus $5 per share. Letting the option expire means you only lose the purchase cost of
the option.
tb.val.opt.025_1805
Suppose you own a put option on a stock with a strike price of $35 that expires today. The price
of the underlying stock is $25. What happens if you purchase the stock and exercise the put
option?
You will earn $10 minus the cost of the option.
You will lose $10 plus the cost of the option.
You will earn $25 minus the cost of the option.
You will lose $25 plus the cost of the option.
Correct. If you purchase the stock, you spend $25 for it. When you exercise the put option,
you have the right to sell the stock for $35. You would earn $10 minus the cost of the option.
tb.val.opt.026_1805
Consider an option that gives the owner the right to buy a stock for $20 only on the third Friday of
May, next year. What is the option being described?
An American call option
A European put option
An American put option
A European call option
Correct. A European call option would give the owner the right to buy a stock during limited
points of time.
tb.val.opt.027_1805
Consider an American and a European call option on a dividend-paying stock, with otherwise
identical features (same strike price, etc.). Which of the following statements is true?
The American call option will never be worth less than the European call option.
The European call option will never be worth less than the American call option.
Both European call and American call option should always have the same value.
The American option can be exercised only on specific dates during the life of the option.
Correct. Since the European call option is more restrictive than the American call option,
the American call option is more desirable, and therefore priced higher.
tb.val.opt.028_1805
The option payoff function is the relationship between which of the following?
Between the value of an option and the value of a firm
Between the value of an option and the price of the underlying asset
Between the call premium and the value of an option
Between the call premium and the value of a firm
Correct. The option payoff is the value of the option. The payoff is the difference between
the value of the firm and the strike price. The payoff function charts the payoff at different
prices of the underlying asset.
tb.val.opt.029_1805
Which of the following changes, when considered individually, will increase the value of a call
option?
The value of the underlying asset becomes more volatile.
The price of the underlying asset goes down.
The expiration date gets closer (the passage of time).
The strike price is higher.
Correct. As the value of the underlying asset becomes more volatile, the chance of a larger
payoff increases, also increasing the value of a call option.
tb.val.opt.030_1805
Which of the following changes, when considered individually, will increase the value of a put
option?
An increase in the risk-free interest rate
Lower volatility of the price of the underlying asset
A higher strike price
The option nearing its expiration date
Correct. A higher strike price for a put option increases the payoff, and therefore the value
of a put option.
tb.val.opt.031_1805
What happens to the value of call and put options if the volatility of the price of underlying asset
decreases?
Put options will be worth more, call options will be worth less.
Put options will be worth less, call options will be worth more.
Both call and put options will be worth more.
Both call and put options will be worth less.
Correct. As the volatility of the underlying asset decreases, there is a lower chance of either
a large price increase or a large price decrease, and therefore a lower chance of a large
payoff for either option. This would make both the call and put options worth less.
tb.val.opt.032_1805
If the price of the underlying asset increases, what happens to the value of call and put options?
Put options will be worth more, call options will be worth less.
Put options will be worth less, call options will be worth more.
Correct. As the price of the underlying asset increases, the payoff of the call option
increases, but the payoff of the put option decreases. This would make the put option worth
less and the call option worth more.
tb.val.opt.033_1805
With everything else constant, as the expiration date gets closer, what happens to the value of
call and put options?
Call option will be worth more, put options will be worth less.
Call option will be worth less, put options will be worth more.
Correct. As the expiration date gets closer, there is a lower chance of either a large price
increase or a large price decrease in the underlying asset, and therefore a lower chance of a
large payoff for either the call or put option. This would make the call and put options worth
less.
tb.val.opt.034_1805
With everything else held constant, what happens to the value of call and put options if the risk-
free interest rate increases?
Call options will be worth more, put options will be worth less.
Call options will be worth less, put options will be worth more.
Correct. If the risk-free interest rate increases, stock prices will also likely increase. As stock
prices increase, the payoff of call options increases, but the payoff of put options decreases.
Therefore, this would make call options worth more and put options worth less.
tb.val.opt.035_1805
When a company issues convertible bonds with a $1,000 par value that can be converted to 20
shares of common stock, each bond includes which of the following?
A put option with an exercise price of $200 per share
A call option with an exercise price of $50 per share
A put option with an exercise price of $20 per share
A call option with an exercise price of $20 per share
Correct. A conversion option, like a call option, allows you to purchase common stock. $50
per share times 20 shares equals the $1,000 par value of the bond.

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CMA Exam Review - Part 2 Page 1 of 15

Test Bank Questions

current price of the underlying asset.

volatility of the value of the underlying asset.

time until the option expires.

The stock's returns are normally distributed.

The option is not a European option.

The Black-Scholes model assumes the option is a European option.

The stock's price can remain constant.

The investor is risk-neutral.

If the stock price goes down.

If the stock price stays the same.

The benefit is indifferent to the changes in the stock price.

You want the stock price to rise above $50.

You want the stock price to stay under $50.

It doesn't matter; you are indifferent to changes in the stock price.

Larry did not make a profit

Keaty did not make any money from the investment

Marek lost the investment amount of $132

Only Jewel showed a profit.

Only Reynardo showed a profit.

Only Berniss showed a profit.

The strike price

The value of the underlying asset

Let the option expire.

Exercise the option and immediately sell the underlying stock.

Exercise the option and hold the underlying stock.

You will lose $10 plus the cost of the option.

You will earn $25 minus the cost of the option.

You will lose $25 plus the cost of the option.

A European put option

An American put option

A European call option

Between the call premium and the value of an option

Between the call premium and the value of a firm

The price of the underlying asset goes down.

The expiration date gets closer (the passage of time).

The strike price is higher.

Lower volatility of the price of the underlying asset

A higher strike price

The option nearing its expiration date

Both call and put options will be worth more.

Both call and put options will be worth less.

Both call and put options will be worth more.

Both call and put options will be worth less.

Both call and put options will be worth more.

Both call and put options will be worth less.

Both call and put options will be worth less.

Both call and put options will be worth more.

A call option with an exercise price of $50 per share

A put option with an exercise price of $20 per share

A call option with an exercise price of $20 per share

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