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Chapter 2 New Practice Questions

1) The holder of a March call option will profit if the stock price is above $52.50 in March. The option will be exercised if the stock price is above $50. 2) The seller of a June put option will profit if the stock price is above $56 in June. The option will be exercised if the stock price is below $60. 3) The document contains sample questions and answers about option contracts, including circumstances under which options will be exercised or sold for a profit.

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99 views

Chapter 2 New Practice Questions

1) The holder of a March call option will profit if the stock price is above $52.50 in March. The option will be exercised if the stock price is above $50. 2) The seller of a June put option will profit if the stock price is above $56 in June. The option will be exercised if the stock price is below $60. 3) The document contains sample questions and answers about option contracts, including circumstances under which options will be exercised or sold for a profit.

Uploaded by

Hà Phạm Thu
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER 2 EXERCISES

Question 1: Suppose that a March call option to buy a share for $50 costs $2.50 and is
held until March. Under what circumstances will the holder of the option make a profit?
Under what circumstances will the option be exercised? Draw a diagram illustrating
how the profit from a long position in the option depends on the stock price at maturity
of the option.
20
The holder of the option will gain Profit
if the price of the stock is above 15
$52.50 in March. (This ignores the
time value of money.) The option 10

will be exercised if the price of the


5
stock is above $50.00 in March.
Stock Price
The profit as a function of the stock 0
20 30 40 50 60 70
price is shown in Figure S1.1.
-5

Question 2: Suppose that a June put option to sell a share for $60 costs $4 and is held
until June. Under what circumstances will the seller of the option (i.e., the party with
the short position) make a profit? Under what circumstances will the option be
exercised? Draw a diagram illustrating how the profit from a short position in the option
depends on the stock price at
60
maturity of the option. Profit
50
The seller of the option will lose if
40
the price of the stock is below
30
$56.00 in June. (This ignores the
time value of money.) The option 20

will be exercised if the price of the 10


Stock Price
stock is below $60.00 in June. The 0
profit as a function of the stock 0 20 40 60 80 100 120
-10
price is shown in Figure S1.2.

Figure S1.2 Profit from short position in Problem 1.14


Question 3: It is May and a trader writes a September call option with a strike price of
$20. The stock price is $18 and the option price is $2. Describe the trader’s cash flows
if the option is held until September and the stock price is $25 at that time.
The trader has an inflow of $2 in May and an outflow of $5 in September. The $2 is the
cash received from the sale of the option. The $5 is the result of the option being
exercised. The investor has to buy the stock for $25 in September and sell it to the
purchaser of the option for $20.
Question 4: A trader writes a December put option with a strike price of $30. The price
of the option is $4. Under what circumstances does the trader make a gain?
The investor makes a gain if the price of the stock is above $26 at the time of exercise.
(This ignores the time value of money.)
Question 5: A company knows that it is due to receive a certain amount of a foreign
currency in 4 months. What type of option contract is appropriate for hedging?
A long position in a four-month put option can provide insurance against the exchange
rate falling below the strike price. It ensures that the foreign currency can be sold for at
least the strike price.
Question 6: A US company expects to have to pay 1 million Canadian dollars in 6
months. Explain how the exchange rate risk can be hedged using (a) a forward contract
and (b) an option.
The company could enter into a long forward contract to buy 1 million Canadian dollars
in six months. This would have the effect of locking in an exchange rate equal to the
current forward exchange rate.
Alternatively, the company could buy a call option giving it the right (but not the
obligation) to purchase 1 million Canadian dollars at a certain exchange rate in six
months. This would provide insurance against a strong Canadian dollar in six months
while still allowing the company to benefit from a weak Canadian dollar at that time.
Question 7: On May 8, 2013, as indicated in Table 1.2, the spot offer price of Google
stock is $871.37 and the offer price of a call option with a strike price of $880 and a
maturity date of September is $41.60. A trader is considering two alternatives: buy 100
shares of the stock and buy 100 September call options. For each alternative, what is
(a) the upfront cost,
(b) the total gain if the stock price in September is $950, and
(c) the total loss if the stock price in September is $800. Assume that the option is not
exercised before September and if the stock is purchased it is sold in September.
a) The upfront cost for the stock alternative is $87,137. The upfront cost for the option
alternative is $4,160.
b) The gain from the stock alternative is $95,000−$87,137=$7,863. The total gain from
the option alternative is ($950-$880) ×100−$4,160=$2,840.
c) The loss from the stock alternative is $87,137−$80,000=$7,137. The loss from the
option alternative is $4,160.

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