Jenna Kiragis

5/11/2014
FIN 534 Homework Chapter 8


Directions: Answer the following five questions on a separate document. Explain how you
reached the answer or show your work if a mathematical calculation is needed, or both. Submit
your assignment using the assignment link in the course shell. Each question is worth five points
apiece for a total of 25 points for this homework assignment.


1. An investor who writes standard call options against stock held in his or her portfolio is said to
be selling what type of options?

a. Put
b. Naked
c. Covered
d. Out-of-the-money
e. In-the-money

Explanation:
In Section 8.1 of your text, we learn about options. On page 329, our text says An
investor who writes call options against stock held in his or her portfolio is said to be
selling covered options (Brigham & Ehrhardt, 2014).



2. Cazden Motors' stock is trading at $30 a share. Call options on the company's stock are also
available, some with a strike price of $25 and some with a strike price of $35. Both options expire
in three months. Which of the following best describes the value of these options?

a. The options with the $25 strike price will sell for less than the options with the
$35 strike price.
b. The options with the $25 strike price have an exercise value greater than $5.
c. The options with the $35 strike price have an exercise value greater than $0.
d. If Cazden's stock price rose by $5, the exercise value of the options with the $25
strike price would also increase by $5.
e. The options with the $25 strike price will sell for $5.

Explanation:
We learn from chapter 8 that a call option gives the owner the right to buy a share of
stock at a fixed price, which is called a strike price (which we are learn that it can
sometimes be called the exercise price because it is the price at which you exercise your
option). You would not want to exercise a option by paying more for a strike price than
what the stock is selling for. The exercise value is any profit from immediately
exercising an option can be defined by the formula Exercise Value = MAX[Current
price of the stock Strike price, 0]. By looking a the question, if Cazdens stock price
rose by $5, than the strike price would also have to rise by $5. That is why I choose
answer D (Brigham & Ehrhardt, 2014).


3. Braddock Construction Co.'s stock is trading at $20 a share. Call options that expire in three
months with a strike price of $20 sell for $1.50. Which of the following will occur if the stock price
increases 10%, to $22 a share?

a. The price of the call option will increase by more than $2.
b. The price of the call option will increase by less than $2, and the percentage
increase in price will be less than 10%.
c. The price of the call option will increase by less than $2, but the percentage
increase in price will be more than 10%.
d. The price of the call option will increase by more than $2, but the percentage
increase in price will be less than 10%.
e. The price of the call option will increase by $2.

Explanation:
This question is all about figuring out where you will end up. The main thing here is that
the percentage increase in price will be more than 10%. The only answer with that
statement in it is C (Brigham & Ehrhardt, 2014).



4. Which of the following statements is CORRECT?
a. Call options generally sell at a price greater than their exercise value, and the
greater the exercise value, the higher the premium on the option is likely to be.
b. Call options generally sell at a price below their exercise value, and the greater
the exercise value, the lower the premium on the option is likely to be.
c. Call options generally sell at a price below their exercise value, and the lower the
exercise value, the lower the premium on the option is likely to be.
d. Because of the put-call parity relationship, under equilibrium conditions a put
option on a stock must sell at exactly the same price as a call option on the
stock.
e. If the underlying stock does not pay a dividend, it does not make good economic
sense to exercise a call option prior to its expiration date, even if this would yield
an immediate profit.

Explanation:
The question circles the concept arena. Answer E seemed to be the most correct because
without a dividend from the stock, why would I exercise a call option prior to its
expiration date.



5. Which of the following statements is CORRECT?
a. Call options generally sell at a price less than their exercise value.
b. If a stock becomes riskier (more volatile), call options on the stock are likely to
decline in value.
c. Call options generally sell at prices above their exercise value, but for an in-the-
money option, the greater the exercise value in relation to the strike price, the
lower the premium on the option is likely to be.
d. Because of the put-call parity relationship, under equilibrium conditions a put
option on a stock must sell at exactly the same price as a call option on the
stock.
e. If the underlying stock does not pay a dividend, it makes good economic sense to
exercise a call option as soon as the stock's price exceeds the strike price by
about 10%, because this permits the option holder to lock in an immediate profit.

Explanation:
We learned from section 8.1 of our book that when the current stock price is greater
than the strike price, the option is in-the-money (Brigham & Ehrhardt, 2014). We also
learned that the greater the exercise value is in relation to the strike price, the lower the
premium is likely to be on that option. Answer C covered this nicely.


Brigham, E., & Ehrhardt, M. (2014). Financial management. (14th ed.). Mason, Ohio: Cengage Learning.