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Chapter 21 Option Valuation

Multiple Choice Questions

1. Before expiration, the time value of an in the money call option is always A) equal to zero. B) positive. C) negative. D) equal to the stock price minus the exercise price. E) none of the above.

Answer: B Difficulty: Easy Rationale: The difference between the actual option price and the intrinsic value is

called the time value of the option.

2. Before expiration, the time value of an in the money put option is always A) equal to zero. B) negative. C) positive. D) equal to the stock price minus the exercise price. E) none of the above.

Answer: C Difficulty: Easy Rationale: The difference between the actual option price and the intrinsic value is

called the time value of the option.

3. Before expiration, the time value of an at the money call option is always A) positive. B) equal to zero. C) negative. D) equal to the stock price minus the exercise price. E) none of the above.

Answer: A Difficulty: Easy Rationale: The difference between the actual option price and the intrinsic value is

called the time value of the option.

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Chapter 21 Option Valuation

4. Before expiration, the time value of an at the money put option is always A) equal to zero.

B) equal to the stock price minus the exercise price. C) negative. D) positive.

E) none of the above. Answer: D Difficulty: Easy

Rationale: The difference between the actual option price and the intrinsic value is called the time value of the option.

5. A call option has an intrinsic value of zero if the option is A) at the money. B) out of the money. C) in the money. D) A and C. E) A and B.

Answer: E Difficulty: Easy

Rationale: Intrinsic value can never be negative; thus it is set equal to zero for out of the money and at the money options.

6. A put option has an intrinsic value of zero if the option is A) at the money. B) out of the money. C) in the money. D) A and C. E) A and B.

Answer: E Difficulty: Easy

Rationale: Intrinsic value can never be negative; thus it is set equal to zero for out of the money and at the money options.

7. Prior to expiration

A) the intrinsic value of a call option is greater than its actual value. B) the intrinsic value of a call option is always positive.

C) the actual value of call option is greater than the intrinsic value.

D) the intrinsic value of a call option is always greater than its time value. E) none of the above. Answer: C Difficulty: Moderate

Rationale: Prior to expiration, any option will be selling for a positive price, thus the actual value is greater than the intrinsic value.

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Chapter 21 Option Valuation

8. Prior to expiration

A) the intrinsic value of a put option is greater than its actual value. B) the intrinsic value of a put option is always positive.

C) the actual value of put option is greater than the intrinsic value.

D) the intrinsic value of a put option is always greater than its time value. E) none of the above. Answer: C Difficulty: Moderate

Rationale: Prior to expiration, any option will be selling for a positive price, thus the actual value is greater than the intrinsic value.

9. If the stock price increases, the price of a put option on that stock __________ and that of a call option __________. A) decreases, increases B) decreases, decreases C) increases, decreases D) increases, increases

E) does not change, does not change Answer: A Difficulty: Moderate

Rationale: As stock prices increases, call options become more valuable (the owner can buy the stock at a bargain price). As stock prices increase, put options become less valuable (the owner can sell the stock at a price less than market price).

10. If the stock price decreases, the price of a put option on that stock __________ and that

of a call option __________. A) decreases, increases B) decreases, decreases C) increases, decreases D) increases, increases E) does not change, does not change

Answer: C Difficulty: Moderate Rationale: As stock prices decreases, call options become less valuable (the owner can

buy the stock at a bargain price). As stock prices decreases, put options become more valuable (the owner can sell the stock at a price less than market price).

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