1. An option that can be exercised any time before expiration date is called:

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1 Sample Test Questions for Intermediate Business Finance Ch An option that can be exercised any time before expiration date is called: A. an European option B. an American option C. a call option D. a put option 2. The owner of a regular exchange-listed call-option on the stock: A. has the right to buy 100 shares of the underlying stock at the exercise price B. has the right to sell 100 shares of the underlying stock at the exercise price C. has the obligation to buy 100 shares of the underlying stock at the exercise price D. has the obligation to sell 100 shares of the underlying stock at the exercise price 3. The Position diagram for a put with the same exercise price and premium as the call on the same underlying asset with the same maturity is (like): A. the inverse of the call diagram along the put price B. unrelated to the call diagram no matter what the exercise price C. the mirror image of the call diagram around the exercise price D. exactly the same as the call diagram for the given exercise price 4. The writer (seller) of a regular exchange-listed call-option on the stock: A. has the right to buy 100 shares of the underlying stock at the exercise price B. has the right to sell 100 shares of the underlying stock at the exercise price C. has the obligation to buy 100 shares of the underlying stock at the exercise price D. has the obligation to sell 100 shares of the underlying stock at the exercise price 5. The value of a put option at expiration is: A. market price of the share minus the exercise price B. higher of the exercise price minus market price of the share and zero C. the exercise price 6. Figure-2 depicts the:

2 A. position diagram for the buyer of a call option B. profit diagram for the buyer of a call option C. position diagram for the buyer of a put option D. profit diagram for the buyer of a put option 7. Figure-4 depicts the: A. position diagram for the writer (seller) of a call option B. profit diagram for the writer (seller) of a call option C. position diagram for the writer (seller) of a put option D. profit diagram for the writer (seller) of a put option 8. Suppose an investor buys one share of stock and a put option on the stock. What will be the value of her investment on the final exercise date if the stock price is below the exercise price? (Ignore transaction costs) A. The value of two shares of stock B. The value of one share of stock plus the exercise price C. The exercise price D. The value of one share of stock minus the exercise price 9. Which of the following investors would be happy to see the stock price rise sharply? I) Investor who owns the stock and a put option II) Investor who has sold a put option and bought a call option III) Investor who owns the stock and has sold a call option

3 IV) Investor who has sold a call option A. I and II only B. III and IV only C. III only D. IV only 10. Buying a call option, investing the present value of the exercise price in T-bills, and short selling the underlying share is the same as: A. Buying a call and a put B. Buying a put and a share C. Buying a put D. Selling a call 11. Suppose you buy a call and lend the present value of its exercise price. You could match the payoffs of this strategy by: A. Buying the underlying stock and selling a call B. Selling a put and lending the present value of the exercise price C. Buying the underlying stock and buying a put D. Buying the underlying stock and selling a put 12. Put-call parity can be used to show: A. How far in-the-money put options can get B. How far in-the-money call options can get C. The precise relationship between put and call option prices given equal exercise prices and equal expiration dates D. That the value of a call option is always twice that of a put given equal exercise prices and equal expiration dates 13. If the underlying stock pays a dividend before the expiration of the options that will have the following effect on the price of the options: I) increase the value of the call option II) increase the value of the put option III) decrease the value of the call option IV) decrease the value of the put option A. I and II only B. III and IV only

4 C. I and IV only D. II and III only 14. Given the following data: Expiration = 6 months; Stock price = $80; exercise price = $75; call option price = $12; risk-free rate = 5% per year. Calculate the price of an equivalent put option using put-call parity: A. $3.07 B. $5.19 C. $11.43 value of put = value of call - share price + PV of exercise price = /(1.05^0.5) = = $ The higher the underlying stock price: (everything else remaining the same) A. higher the put price B. lower the put price C. has no effect on put price 16. Which of the following features increase(s) the value of a call option? A. A high interest rate B. A long time to maturity C. A higher volatility of the underlying stock price D. All of the above 17. Relative to the underlying stock, a call option always has: A. A higher beta and a higher standard deviation of return B. A lower beta and a higher standard deviation of return C. A higher beta and a lower standard deviation of return D. A lower beta and a lower standard deviation of return 18. The value of a call option is positively related to the following: I) underlying stock price II) risk-free rate III) time to expiration IV) volatility of the underlying stock price

5 A. I only B. II only C. III only D. I, II, III, and IV 19. If a put and call cost the same, how can an investor offset the cost of a buying a call? A. Borrowing money B. Sell a put C. Sell a stock D. Wait for the stock price to rise Ch If the bond has 15% probability of default and payment under default is $400, calculate the expected payment from the bond. A. $1,050 B. $400 C. $ Expected payment = 1050(0.85) + 400(0.15) = $ The interest rate on one-year risk-free bond is 5%. BAC company has issued a 5% coupon bond with a face value of $1,000, maturing in one year. If the bond is considered risk-free, what is the price of the bond? A. $1,050 B. $1,000 C. $985 Price = 1,050/1.05 = 1, If a bond with one year maturity with a coupon rate of 5% and face value of $1,000 is selling for $ Calculate the promised yield on the bond. A. 5% B. 8%

6 C % Promised yield = (1050/881.94) - 1 = 19.06% 4. The value of a corporate bond can be thought of as: A. Asset value - value of call on assets B. Asset value + value of call on assets C. Asset value + value of a default free bond D. None of the above 5. Which of the following rated bonds have the least risk? A. AAA B. AA C. A D. BBB 6. Commercial banks and several other financial institutions are not permitted to invest in bonds unless they are investment grade. What is the definition of an investment grade bond? A. One with a triple-a rating B. One with a rating of Baa or better C. One with a rating of B or better D. One with a rating of C or better 7. The three main bond rating agencies in the USA are: I) Moody's II) Standard and Poor's III) A.M. Best IV) Dominion Bond V) Fitch A. I, II and III B. I, II and IV C. I, II and V D. I, II, III, IV and V Ch 24

7 1. A "foreign" bond is a bond: A. Sold in the United States by a company in the USA B. Sold to investors in the local market issued by a company from some other country C. Sold in Europe by a company from the United States D. None of the above 2. A "samurai bond" is a bond: A. Sold by a company from Japan B. Sold in the United States by a company from Japan C. Sold in Japan by a local company D. Sold in Japan by a company from some other country 3. Very large bond issues that are marketed both internationally as well as in individual domestic markets are called: A. Eurobonds B. Foreign bonds C. Global bonds 4. In general which of the following statement(s) is (are) true: I) Bonds issued in the United States are registered II) Bonds issued in the United States are bearer bonds III) Eurobonds are registered IV) Eurobonds are bearer bonds A. I and IV only B. II only C. III only D. II and III only 5. Which of the following would not generally be included in the typical bond indenture? I) The basic terms of the bond II) Details of the protective covenants III) Sinking fund arrangements IV) Call provisions A. I only B. II only

8 C. II and III only D. I, II, III, and IV 6. The Alfa Co. has a 6% coupon bond outstanding that pays annual interest. Calculate the annual interest payment: A. $60 B. $30 C. $10 D. None of the above 7. The Alfa Co. has a 12% bond outstanding that pays interest on February 1st and July 1st. Today is March 1st and you are planning to purchase one of these bonds. How much will you pay in accrued interest? A. $10 B. $20 C. $30 D. $60 (60/180) * 30 = $10 8. Which of the following bonds is secured by assets? A. A mortgage bond B. A floating rate bond C. A debenture D. All of the above 9. The recovery rate on defaulting debt is the highest for the following type of debt: A. Bank debt B. Senior secured bonds C. Senior subordinated bonds D. Junior subordinated bonds 10. Which of the following provisions would often be included in the indenture for a firstmortgage bond? A. A limit on officer salaries B. A negative pledge clause C. A limit on new issues of subordinated debt

9 D. A limit on the amount of senior debt that can be issued 11. A sinking fund is useful to a corporation because: A. The corporation does not have to worry about paying the bondholders B. It provides the corporation with the option to buy the bonds back at the lower of face value or market price C. The payments to the sinking fund are not necessary when the firm is in financial difficulty D. They are simple and easy to monitor 12. Corporations typically have the right to repurchase a debt issue prior to maturity at a fixed price. Such debt issues are said to be: A. Indentured B. Protected C. Convertible D. Callable 13. Puttable provision in bonds allows: A. The issuer to call the bond at par on the coupon payment date B. The holder to redeem the bond at par before maturity C. The issuer to extend the maturity of the bond D. The holder to extend the maturity of the bond 14. The call policy that maximizes shareholder wealth is to call a bond issue when: A. The bond's price is above par B. The bond's price is above par, but below the call price C. The bond's price exceeds the call premium D. The bond's price equals or exceeds the call price 15. Which of the following is not an example of an affirmative (positive) covenant? A. Requirement to maintain a minimum level of working capital B. Requirement to furnish bondholders with a copy of the firm's annual accounts C. Requirement to limit dividends to net income D. Requirement to maintain a minimum level of net worth 16. The written agreement between a corporation and its bondholders contains a limitation on the dividends that the corporation can pay. This limitation is:

10 A. A non-recourse covenant B. A recourse covenant C. A positive covenant D. A negative covenant 17. The holder of a $1,000 face value bond has the right to exchange the bond anytime before maturity for shares of stock priced at $50 per share. The $50 is called the: A. Conversion price. B. Stated price. C. Exercise price. D. Striking price. 18. The holders of ZZZ Corporation's bond with a face value of $1,000 can exchange that bond for 35 shares of stock. The stock is selling for $ What is the conversion price? A. $35 B. $7.70 C. $28.57 D. None of the above 19. The holders of ZZZ Corporation's bond with a face value of $1,000 can exchange that bond for 35 shares of stock. The stock is selling for $ What is the conversion value of the bond? A. $1,000 B. $875 C. $1,200 D. None of the above Conversion value = 35 * 25 = $ A convertible bond issue by a firm can be thought of as: A. selling straight bonds B. selling straight bond and a call option C. selling put options D. selling common stock 21. Which of the following could be a sensible reason for issuing convertibles? A. Convertibles are convenient and flexible - they're usually unsecured and subordinated, and

11 cash requirements for debt service are relatively low B. Interest rates on convertible issues are significantly less than on straight debt C. Firms that need equity capital use convertibles as a roundabout way of issuing stock D. Firms prefer to issue convertibles when their shares are under-valued 22. A loan guarantee provided by the government on a corporate bond acts like what kind of derivative security for the investor? A. Long put B. Short put C. Long call D. Short call

I. Asset Valuation. The value of any asset, whether it is real or financial, is the sum of all expected future earnings produced by the asset.

I. Asset Valuation. The value of any asset, whether it is real or financial, is the sum of all expected future earnings produced by the asset. 1 I. Asset Valuation The value of any asset, whether it is real or financial, is the sum of all expected future earnings produced by the asset. 2 1 II. Bond Features and Prices Definitions Bond: a certificate