Question

1. One advantage of hedging with options is that there is no basis risk. (True or False)

2. The time value of an option goes to zero as the expiration date approaches. (True or False)

Answer #1

1. The statement is false.

In hedging,Basis Risk is a financial risk that does not Experience price changes in opposite directions from each other.This Correlation leads to Excess losses in the Hedging strategy which adds the Basis Risk

2. The statement is true.

As the value of an option comes closer to the Expiration date, the value of an option goes to zero as the time value and option value are related.This is because of the less time cummulative volatility. Less volatility leads to less option value.

1.) True or False. __________ The buyer of an option has
the risk of having to meet margin calls.
2.) True or False. __________The option buyer’s
financial risk is limited to the premium paid.
3.) True or False. __________An option seller must
deposit margin to cover potential losses.
4.) What is an Option? Provide a definition. (3 points)
____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________
5.) What are the two (2) types of Options? Describe or
define each briefly. (4 points)
____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________...

Which of the following is an advantage of hedging with options
instead of forward contracts?
A.
Options prices tend to be lower than forward prices.
B.
Options allow investors to purchase a forward contract at a later
date.
C.
If the price moves in the opposite direction to the one hedged
against, the hedger can decline to exercise the option and limit
the loss to what was paid for the option.
D.
If the price moves in the direction of...

1.
American put option price increase if time to expiration gets
extended.
True
or
False
2. American put option price will increase if risk free rate
decrease.
True
or
False
3. American put option price increase if volatility of
underlying stock price goes down.
True
or
False
4. For a non dividend paying underlying stocks, american call
options can be more expensive than european call options that are
equal in other terms.
True
or
False

1. “Volatility smile” is a graph that plots implied volatility
against time to expiration. (True / False)
2.Which of the Greeks is greater than zero?
a. Delta of a call option
b. Elasticity of a put option
c. Gamma of the underlying stock
c. Vega of the underlying stock
3. Trading shares of the underlying stock will affect the delta
of a portfolio. (True / False)
4. in a “volatility smile”, options have the same time to
expiration and the...

1(a). (TRUE or FALSE?) Firms cannot manage risk through hedging:
entering into a financial agreement that does not offset or guard
against risk.
1(b). (TRUE or FALSE?) An exchange rate of two currencies found
by using a common third currency is known as a currency cross
rate.
1(c). (TRUE or FALSE?) If the U.S. dollar strengthens relative
to the euro during the year, McDonald’s U.S. dollar profits will be
higher after converting the euros to dollars and repatriating the
profits...

Basis risk exists when the hedging instrument A. is likely to
increase in value over time. C. has a high level of volatility. D.
differs in value from the item being hedged.
I CHOOSE C

Which one of the following is true for in the money, out of the
money, and at the money option contracts?
a. Out of the money options are
worthless.
b. Given everything else being the
same (the underlying stock, expiration date), in the money put
options have higher strike prices than at the money put
options.
c. At the money options will always
remain at the money before expiration date.
d. None of the above.

1(a). (TRUE or FALSE?) The firm using the hedging instruments
such as a forward, futures, or swap contract insulates itself from
the foreign exchange risk.
1(b). (TRUE or FALSE?) To calculate the cost of new common
stock, we must adjust the Dividend Growth Model equation for
floatation costs of the new common shares.

Call options with an exercise price of $125 and one year to
expiration are available. The market price of the underlying stock
is currently $120, but this market price is expected to either
decrease to $110 or increase to $130 in a year's time. Assume the
risk-free rate is 6%. What is the value of the option?

Use the Black-Scholes formula to value the following
options:
a. A Call option written on a stock selling for $100 per share
with a $110 exercise price. The stock's standard deviation is 15%
per quarter. The option matures in three months. The risk free
interest is 3% per quarter.
b. A put option written on the same stock at the same time, with
the same exercise price and expiration date.
Now for each of these options find the combination of...

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