NAME:  The standard deviation of the stock’s returns is 0.

40, and the variance

is 0.16.
ID NO.:  The risk-free rate is 6%.
TRUE OR FALSE Given this information, the analyst then calculated the following necessary
components of the Black-Scholes model:
1. One objective of risk management can be to reduce the volatility of a firm’s
cash flows. T  d1 = 0.175

 d2 = -0.025
2. Interest rate swaps allow a firm to exchange fixed for floating-rate payments,
but a swap cannot reduce actual net interest expenses. F  N(d1) = 0.56946

3. Speculative risks are symmetrical in the sense that they offer the chance of a  N(d2) = 0.49003
gain as well as a loss, while pure risks are those that can only lead to losses.
T N(d1) and N(d2) represent areas under a standard normal distribution
function. Using the Black-Scholes model, what is the value of the call
option? 3.47
4. In theory, reducing the volatility of its cash flows will always increase a
company’s value. F MULTIPLE CHOICE

5. A swap involves the exchange of cash payment obligations. T 1. Which of the following statements is most CORRECT?
6. A company can swap fixed interest payments for floating interest payments. A. One advantage of forward contracts is that they are default free.
T B. Futures contracts generally trade on an organized exchange and
7. An option is a contract that gives its holder the right to buy or sell an asset at are marked to market daily.
a predetermined price within a specified period of time. T C. Goods are never delivered under forward contracts, but are almost
8. The strike price is the price that must be paid for a share of common stock always delivered under futures contracts.
when it is bought by exercising a warrant. T D. There are futures contracts for currencies but no forward contracts for
9. The exercise value is the positive difference between the current price of the currencies.
stock and the strike price. The exercise value is zero if the stock’s price is 2. A commercial bank recognizes that its net income suffers whenever interest
below the strike price. T rates increase. Which of the following strategies would protect the bank
10. If the current price of a stock is below the strike price, then an option to buy against rising interest rates?
the stock is worthless and will have a zero value. F A. Buying inverse floaters.
B. Entering into an interest rate swap where the bank receives a fixed
PROBLEMS payment stream, and in return agrees to make payments that float with
1. The current price of a stock is $22, and at the end of one year its price will be either market interest rates.
$27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1- C. Purchase principal only (PO) strips that decline in value whenever
year call option on the stock, with an exercise price of $22, is available. Based interest rates rise.
on the binominal model, what is the option's value? 2.99 D. Enter into a short hedge where the bank agrees to sell interest rate
futures.
2. Suppose you believe that Johnson Company's stock price is going to increase from 3. An option that gives the holder the right to sell a stock at a specified price at
its current level of $22.50 sometime during the next 5 months. For $310.25 you some future time is
can buy a 5-month call option giving you the right to buy 100 shares at a price of A. a call option.
$25 per share. If you buy this option for $310.25 and Johnson's stock price B. a put option
C. an out-of-the-money option.
actually rises to $45, what would your pre-tax net profit be? $1,689.75
D. a naked option.
4. Call options on XYZ Corporation’s common stock trade in the market. Which
3. An analyst wants to use the Black-Scholes model to value call options on the stock
of the following statements is most correct, holding other things constant?
of Ledbetter Inc. based on the following data: A. The price of these call options is likely to rise if XYZ’s stock price
 The price of the stock is $40.
rises.
 The strike price of the option is $40.The option matures in 3 months (t
= 0.25).
 B. The higher the strike price on XYZ’s options, the higher the option’s
price will be.
C. Assuming the same strike price, an XYZ call option that expires in one
month will sell at a higher price than one that expires in three months.
D. If XYZ’s stock price stabilizes (becomes less volatile), then the price of
its options will increase.
5. Other things held constant, the value of an option depends on the stock's
price, the risk-free rate, and the
A. Strike price.
B. Variability of the stock price.
C. Option's time to maturity.
D. All of the above.
E. None of the above.