Investments - Lect. 12-14

Question 1

An option is said to be in the money when:

Answer 1

Exercise today would generate a cash flow (the option currently has value)

Question 2

An option is at the money when

Answer 2

The exercise price

and asset price are equal

Question 3

An option is out of the money when

Answer 3

The asset price and exercise price are different such that the option is worthless

Question 4

A Call Option is out of the money when:

Answer 4

Exercise price is above asset price

Question 5

A Put Option is out of the money when:

Answer 5

Exercise price is below asset price

Question 6

A Put Option is out of the money when:

Answer 6

Exercise price is below asset price

Question 7

Relationships about Call Option prices?

Answer 7

(1) Price is lower when exercise price is higher. (2) Price increases as volatility in the underlying asset increases. (3) Price increases as time to expiration increases.

Question 8

Relationships about Call Option prices?

Answer 8

(1) Price is lower when exercise price is higher. (2) Price increases as volatility in the underlying asset increases. (3) Price increases as time to expiration increases.

Question 9

Buy share of stock and put option on stock. Limits ____ while allowing unlimited potential ____. Payoff function similar to ______.

Answer 9

Protective Put: Losses, Gains, Call Option

Question 10

Buy share of stock and a simultaneous short position in a call option. If exercised, ____ ____ can simply sell the share of the stock they currently own. Commonly used by ____ ____. Gain ____ ____ in most situations. Forces sale of the stock if it has ______ in value by the expiration date.

Answer 10

Covered Call Position: The short position, Institutional Investors, small premiums, dropped

Question 11

Buy a call and put option on the same stock with the same exercise price and maturity. Used when predict stock to be more _____ than the market. Selling this makes it less ____ than the market.

Answer 11

Straddle, Volatile, Volatile

Question 12

Going into a long and short position in 2 call OR 2 put options @ either different strike prices or times to maturity. Long position on a call with ____ Strike Price and short position on a call with ____ Strike Price will pay out if stock price goes ___, but has limited _____ potential

Answer 12

Spread, Lower, Higher, Up, Gain

Question 13

Puts bounds on the gain and loss potential on a share of stock. Purchase Protective Put at strike price ____ current stock price. Write call option at a strike price ____ current Strike Price. Premiums should be roughly ____.

Answer 13

Collar, Below, Above, Equal

Question 14

Give the issuing firm the option to buy back at the call price and reissue it at a lower interest rate. Higher ____ relative to identical straight ___. Limited ___ ___ potential. Cannot be exercised until after some period of ___ ___ and price may change over time.

Answer 14

Callable Bonds, Coupons, Capital Gains, Call Protection

Question 15

Give the issuing firm the option to buy back at the call price and reissue it at a lower interest rate.

Answer 15

Callable Bonds

Question 16

Puts bounds on the gain and loss potential on a share of stock.

Answer 16

Collar

Question 17

Going into a long and short position in 2 call OR 2 put options @ either different strike prices or times to maturity.

Answer 17

Spread

Question 18

Buy a call and put option on the same stock with the same exercise price and maturity.

Answer 18

Straddle

Question 19

Buy share of stock and a simultaneous short position in a call option.

Answer 19

Covered Call Position

Question 20

Buy share of stock and put option on stock.

Answer 20

Protective Put

Question 21

Buy share of stock and put option on stock.

Answer 21

Protective Put

Question 22

Forecasting earnings per share is _____ b/c it involves:

Answer 22

Very Difficult - involves lots of international, firm-specific and macroeconomic factors

Question 23

Forecasting P/E ratio is:

Answer 23

Even more difficult than forecasting earnings per share

Question 24

Forecasting P/E ratio is:

Answer 24

Even more difficult than forecasting earnings per share

Question 25

As PVGO gets larger, P/E ratio will _____

Answer 25

Increase

Question 26

As PVGO gets larger, P/E ratio will _____

Answer 26

Increase

Question 27

P/E ratio increases as ___ Increases

Answer 27

ROE

Question 28

P/E ratio increases as b increases as long as ____>____

Answer 28

ROE > k

Question 29

PEG Ratio = (Formula) - Tends to be between __ and __, if less than __ it may be undervalued relative to its growth prospects.

Answer 29

P/E Ratio / Growth Rate -

1 and 1.5, 1

Question 30

PEG Ratio = (Formula) - Tends to be between __ and __, if less than __ it may be undervalued relative to its growth prospects.

Answer 30

P/E Ratio / Growth Rate -

1 and 1.5, 1

Question 31

All else equal, as k increases (firm becomes riskier), the P/E Ratio will

Answer 31

Drop

Question 32

Small firms tend to still have very high ___ ___

Answer 32

P/E Ratios

Question 33

Problems with P/E Ratios

Answer 33

1) Earnings use accounting values, which are subject to manipulation and fluctuations due to inflation. (2) Earnings can also be affected by the business cycle. (3) Our formulas have been for P0/E1 , or next year’s earnings,
when we only actually have last year’s earnings. (4) High P/E ratios may be unsustainable in the long term; need to look at long-term trends.

Question 34

Problems with P/E Ratios

Answer 34

1) Earnings use accounting values, which are subject to manipulation and fluctuations due to inflation. (2) Earnings can also be affected by the business cycle. (3) Our formulas have been for P0/E1 , or next year’s earnings,
when we only actually have last year’s earnings. (4) High P/E ratios may be unsustainable in the long term; need to look at long-term trends.

Question 35

Comparative Valuation Ratios: ratio of price per share divided by book value per share

Answer 35

Price-to-Book Ratio

Question 36

Comparative Valuation Ratios: ratio of price to cash flow per share

Answer 36

Price-to-Cash Flow Ratio

Question 37

Comparative Valuation Ratios: the ratio of stock price to the annual sales per share

Answer 37

Price-to-Sales Ratio