Concepts Review and Critical Thinking Questions

1. Options What is a call option? A put option? Under what circumstances might you want to buy each? Which one has greater potential profit? Why?

2. Options Complete the following sentence for each of these investors:

a. A buyer of call options b. A buyer of put options c. A seller (writer) of call options d. A seller (writer) of put options

"The (buyer/seller) of a (put/call) option (pays/receives) money for the (right/ obligation) to (buy/sell) a specified asset at a fixed price for a fixed length of time."

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

4. Put Options What is the value of a put option at maturity? Based on your answer, what is the intrinsic value of a put option?

5. Option Pricing You notice that shares of stock in the Patel Corporation are going for $50 per share. Call options with an exercise price of $35 per share are selling for $10. What's wrong here? Describe how you can take advantage of this mispricing if the option expires today.

6. Options and Stock Risk If the risk of a stock increases, what is likely to happen to the price of call options on the stock? To the price of put options? Why?

7. Option Rise True or false: The unsystematic risk of a share of stock is irrelevant in valuing the stock because it can be diversified away; therefore, it is also irrelevant for valuing a call option on the stock. Explain.

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

V. Risk and Return

14. Options and Corporate Finance

© The McGraw-Hill Companies, 2002

CHAPTER 14 Options and Corporate Finance

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