Chapter 2

Question 1

the price at which an option holder can buy or sell the underlying asset

Answer 1

strike or exercise price

Question 2

Types of options contract

Answer 2

Call option
Put Option

Question 3

grants the right to purchase a share of stock at a fixed price on or before a certain date

Answer 3

Call option

Question 4

Grants the right to sell a share of stocks at a fixed price on or before a certain date

Answer 4

Put option

Question 5

is a contract between two parties, neither of
whom need have any connection to the company
whose stock serves as the underlying asset for the
contract

Answer 5

Option

Question 6

are not necessarily issued by firms.

Answer 6

Options

Question 7

Options trade either on an

Answer 7

exchange or over the counter market

Question 8

as the price an investor would be willing to pay for the option of the instant before it expires.

Answer 8

Options payoff

Question 9

is distinct from it’s price, or premium, because the payoff only refers to the price of the option at a particular instant in time, t he expiration date.

Answer 9

Options payoff

Question 10

refers to the profit or loss an option buyer or seller makes from a trade.

Answer 10

Call option payoff

Question 11

A graph that illustrates an option’s payoff as a function of the underlying stock price.

Answer 11

Payoff Diagrams

Question 12

These diagrams are extremely useful tools for underrated how options behave and how they can be combined to form portfolios with fascinating properties.

Answer 12

Payoff Diagrams

Question 13

is the right,
but not the obligation

Answer 13

Put option

Question 14

to sell an asset at a pre specified price on, or before, a pre specified date in the future.

Answer 14

Put Option

Question 15

The concept of combining call and put options to create portfolios with unique payoff structures.

Answer 15

Payoffs for Portfolios of Options and Other Securities

Question 16

The graphs illustrate the payoff scenarios for long and short positions in both common stock and risk free, zero coupon bonds.

Answer 16

Payoff Diagrams for Stocks and Bonds

Question 17

This graph represents a portfolio that combines a long position in the underlying stock with a long position in a put option for that same stock, having a strike price of

Answer 17

Payoff from One Long Share
and One Long Put

Question 18

Is a fundamental principle in options pricing and trading.

Answer 18

Put Call Parity

Question 19

Option Pricing Models

Answer 19

The Binomial Model
The Black and Scholes Model

Question 20

It is an options valuation method developed in 1979. The model assumes that stock price have two possible movement directions at each time point up or down.

Answer 20

The Binomial Model

Question 21

Recognizes investors can combine options with shares of the underlying assets to construct a portfolio with an risk free payoff.

Answer 21

The Binomial Model

Question 22

Three steps of binomial model:

Answer 22

1. Create a risk free portfolio
2. Calculate the present value of portfolio
3. Determine the price of the option

Question 23

aka the Black Scholes Merton (BSM) model, is a differential equation widely

Answer 23

The Black Scholes model

Question 24

is a differential equation widely
used to price options contracts.

Answer 24

The Black-scholes Model

Question 25

five input variables of black scholes model

Answer 25

The Strike price of an option
The Current stock price
The Time to expiration
the risk-free rate
the volatility

Question 26

and where:
S
X
t
r
o
e
N(X)

Answer 26

S = current market price of underlying stock
X = strike price of option
t = amount of time (in years) before option expires
r = annual risk
free interest rate
o = annual standard deviation of underlying stock’s returns
e = 2.718 (approximately)
N(X) = the probability of drawing a value less than or equal to X
from the

Question 27

are essentially call options that give employees the right to buy shares in the company they work for at a fixed price.

Answer 27

Employee Stock Options

Question 28

requires firms to treat the value of employee stock options grants as an expense on the
income statement.

Answer 28

Financial accounting standards board

Question 29

are securities that are issued by firms and that grant investors the right to buy shares of stock at a fixed price, for a given period of time.

Answer 29

• Warrants

Question 30

Are contract investors who are not necessarily connected to the firm whose stock serves as the underlying asset

Answer 30

Call options

Question 31

2. When investors are exercise warrants, the number of outstanding shares
   increase and the issuing firm receives the ???? as a capital inflow.

Answer 31

strike price

Question 32

are often issued with expiration dates that are several years in the future

Answer 32

Warrants

Question 33

expire in just a few months

Answer 33

Options

Question 34

A bond that gives investors the right to convert their bonds into shares.

Answer 34

Convertible bond

Question 35

The market price of a convertible bond, divided by the number of shares of stock that bondholders receive if they convert.

Answer 35

Conversion Price

Question 36

The number of shares bondholders receive if they convert their bonds into shares.

Answer 36

Conversion Ratio

Question 37

The percentage increase in the underlying stock that must occur before it is profitable to exercise the option to convert a bond into shares.

Answer 37

Conversion Premium

Question 38

The market price of the stock, multiplied by the number of shares of stock that bondholders receive if they convert.

Answer 38

Conversion Value