Sample questions test #3

(These are questions randomly drawn from the test bank. They are intended to
show you how test questions may be worded and the level of difficulty involved. It is
your responsibility to study the course material and work out the solutions of these
sample questions).

1. When dividends increase with all else remaining the same, which of the
following is true?
A. Both calls and puts increase in value
B. Both calls and puts decrease in value
C. Calls increase in value while puts decrease in value
D. Puts increase in value while calls decrease in value
Answer: D

2. Suppose S = 70, X = 65, r = 0.05, p = 0.6, Cu = 7.17, Cd = 1.22 and there is

one period left in an American call's life. What will the option be worth? Assume
non-continuous compounding.
a. 6.83
b. 0.00
c. 4.56
d. 5.00
e. none of the above
Answer: D (early exercise at c0)

3. The current price of a non-dividend-paying stock is $40. Over the next year it
is expected to rise to $42 or fall to $37. An investor buys put options with a strike
price of $41. What is the value of each option using a one-period binomial model?
The risk-free interest rate is 2% per annum. Assume non continuous compounding.
A. $3.93
B. $2.93
C. $1.93
D. $0.93
Answer: D
4. Which of the following statements about the Black-Scholes-Merton model is
not true?
a. decreasing the volatility lowers the call price
b. the expected stock price plays a role in the model
c. the risk-free rate is continuously compounded
d. the model is consistent with put-call parity
e. none of the above
ans: b

5. When the non-dividend paying stock price is $20, the strike price is $20, the
risk-free rate is 6%, the volatility is 20% and the time to maturity is 3 months which
of the following is the price of a European call option on the stock
A. 20N(0.1)-19.7N(0.2)
B. 20N(0.2)-19.7N(0.1)
C. 19.7N(0.2)-20N(0.1)
D. 19.7N(0.1)-20N(0.2)

Answer: B

6. The current price of a stock is $100. Consider the Black-Scholes model price
of a six-month call option at strike $101, given an interest rate of 2% and a dividend
rate of 1%? The volatility is 25%. What is the risk-neutral probability of the call
option ending up in the money?
(a) 0.45
(b) 0.48
(c) 0.49
(d) 0.50
Answer: A

7. Consider the following statement related to buying a put option. For a given
stock price, the ____________ the position is held, the more time value it loses and
the ___________ the profit; however, an exception can occur when the stock price is
___________. Identify the correct words for these two blanks.
a. longer, lower, low
b. longer, higher, high
c. shorter, lower, low
d. shorter, higher, high
e. longer, flatter, low

Answer: A

8. Which of the following is correct?

A. A calendar spread can be created by buying a call and selling a put when the
strike prices are the same and the times to maturity are different
B. A calendar spread can be created by buying a put and selling a call when the
strike prices are the same and the times to maturity are different
C. A calendar spread can be created by buying a call and selling a call when the
strike prices are different and the times to maturity are different
D. A calendar spread can be created by buying a call and selling a call when the
strike prices are the same and the times to maturity are different

Answer: D

9. What is a description of the trading strategy where an investor sells a 3-

month call option and buys a one-year call option, where both options have a strike
price of $100 and the underlying stock price is $75?
A. Neutral Calendar Spread
B. Bullish Calendar Spread
C. Bearish Calendar Spread
D. None of the above

Answer: B
10. A trader creates a long butterfly spread from options with strike prices $60,
$65, and $70 by trading a total of 400 options. The options are worth $11, $14, and
$18. What is the maximum net gain (after the cost of the options is taken into
account)?
A. $100
B. $200
C. $300
D. $400

Answer: D

11. The delta of a call option on a non-dividend-paying stock is 0.4. What is the
delta of the corresponding put option?
A. -0.4
B. 0.4
C. -0.6
D. 0.6
Answer: C

12. The delta of a call option is 0.6. The current price of the call is $5 and the
stock is at $100. What is the approximate price of the call if the stock price
increases to $100.50?
(a) $4.70
(b) $5.30
(c) $5.60
(d) $8.00
Answer b.

Equations to be given:
C=max(0, S-X); -C = -max(0, S-X); P = max(0, X-S); -P =-max(0, X-S);
Ce= Pe + S0 Xe^-rt ; = (Cu-Cd) / (Su-Sd) ; C0 = S0 [ (Su Cu ) / (1+rf)] ;
C0 = S0 [ (Sd Cd )/(1+rf)]; C0 = S0 (Su Cu) e^-rt ; C0 = S0 (Sd Cd) e^-rt ;
= (Pd-Pu) / (Su-Sd) ; P0 = [ (Su + Pu ) / (1+rf)] - S0 ; P0=[ (Su + Pu )e^ -rt] - S0 ;
P = (e^rt-d) / (u-d); C0 = [pCu + (1-p)Cd]/ (1+rf); C0 = [pCu + (1-p)Cd] e^-rt ;
Ce = S0*N(d1) Xe^-rt *N(d2); d1= [ln(S0/X) + (r + 2 /2)*t] / sqrt (2 *t) ;
d2 = d1 *sqrt(t); Pe= Xe^-rt * N(-d2) S0* N(-d1);
Values of gamma, theta, rho, and vega will be provided if needed.

Instructions: 150 minutes. Closed book/note. Must complete on the first attempt in one sitting.
Questions will be displayed one at a time without backtracking. In some questions, the answer
none of the above may appear before the last because answers are randomized. 2 pages of
scratch paper allowed, must destroy scratch papers after exam. Test will auto submit when time
is up.

Originally, it was planned that the 3rd test would count 31.5% of the overall grade. Due to the
constraint of the Grade Center of Blackboard, the 3rd test will now count 31% of the overall
grade. 0.5% will be added to your overall grade when I compute the overall weighted sum.