Concepts Review and Critical Thinking Questions

1. Options and Expiration Dates What is the impact of lengthening the time to expiration on an option's value? Explain.

2. Options and Stock Price Volatility What is the impact of an increase in the volatility of the underlying stock's return on an option's value? Explain.

3. Options and Interest Rates How do interest rates affect option prices? Explain.

4. Protective Puts The protective put strategy we discussed in the chapter is sometimes referred to as "stock price insurance." Why?

5. Intrinsic Value What is the intrinsic value of a call option? Of a put option? How do we interpret this value?

6. Time Value What is the time value of a call option? Of a put option? What happens to the time value of a call option as the maturity increases? What about a put option?

7. Option Valuation and NPV You are CEO of Titan Industries and have just been awarded a large number of employee stock options. The company has two mutually exclusive projects available. The first project has a large NPV and will reduce the total risk of the company. The second project has a small NPV and will increase the total risk of the company. You have decided to accept the first project when you remember your employee stock options. How might this affect your decision?

8. Put-Call Parity You find a put and a call with the same exercise price and maturity. What do you know about the relative prices of the put and call? Prove your answer and provide an intuitive explanation.

9. Put-Call Parity A put and a call have the same maturity and strike price. If they have the same price, which one is in the money? Prove your answer and provide an intuitive explanation.

10. Put-Call Parity One thing put-call parity tells us is that given any three of a stock, a call, a put, and a T-bill, the fourth can be synthesized or replicated using

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VIII. Topics in Corporate Finance

24. Option Valuation

© The McGraw-Hill Companies, 2002

CHAPTER 24 Option Valuation the other three. For example, how can we replicate a share of stock using a call, a put, and a T-bill?

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