Quick Quiz 2

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1		As the variance of the asset price increases, the value of a call option increases because
			A)	downside risk is virtually eliminated.
			B)	the possible payoffs decrease.
			C)	downside risk is virtually eliminated while the possible payoffs increase.
			D)	downside risk doesn't change but the possible payoffs increase.
			E)	it becomes more likely that the option will finish out of the money.
2		Equity in a leveraged firm can be considered a call option on the assets of the firm because
			A)	of the M&M capital structure irrelevance theorem.
			B)	stockholders have unlimited liability for the debts of the firm.
			C)	it is typically true that more call options than put options are written on common stocks.
			D)	the bondholders can elect to "walk away" leaving the stockholders holding the bag.
			E)	the possible loss on a share of common stock is limited to the initial investment.
3		Which of the following is a characteristic difference between a warrant and a call option?
			A)	A call option will typically have a longer maturity than a warrant.
			B)	The corporation will receive funds when a call option is exercised but not when a warrant is exercised.
			C)	Call options can be allowed to expire while warrants cannot.
			D)	Neither warrants nor call options affect firm value.
			E)	Unlike call options, when warrants are exercised the number of outstanding shares of stock increases.
4		The __________ tells how many shares of stock will be received for each convertible bonds that is converted.
			A)	conversion premium
			B)	conversion ratio
			C)	conversion price
			D)	conversion value
			E)	straight bond value
5		A ticket to a baseball game gives the holder the right, but not the obligation, to attend a specified game. This, a baseball ticket is effectively a(n) __________ option on the possession of a seat with an expiration date of __________.
			A)	American call;the end of the baseball season
			B)	European call; the end of the baseball season
			C)	American call; the day of the game
			D)	European call; the day of the game
			E)	The baseball ticket does not represent an option of any form.
6		The bonds of van Dyke and Moore, Inc. are convertible into shares of the firm's common stock at $40 per share. The current price of the common stock is $35 per share. The bonds have a $1,000 par value and currently sell for $880 each. The conversion ratio for these bonds is __________.
			A)	25
			B)	40
			C)	22
			D)	50
			E)	100
7		A firm has stock outstanding with a current price of $13 per share. The price in one period is expected to be either $15 or $18. A call option on ONE share is available with an exercise price of $12. If the risk-free rate is 12%, what would you pay for the call option?
			A)	$2.00
			B)	$2.29
			C)	$3.29
			D)	$3.39
			E)	$5.07

Use the following information to answer the next two questions. Suppose a firm has a current total market value of $800 and outstanding debt with a face value of $800.

8		If the firm will have a value of either $650 or $900 next period, what is the value of the equity in the firm?
			A)	$0.00
			B)	$23.70
			C)	$79.26
			D)	$117.41
			E)	$219.65
9		What is the rate of return on the debt in the firm?
			A)	0.00%
			B)	3.05%
			C)	10.49%
			D)	11.00%
			E)	15.95%
10		Suppose an all equity firm has a value of $400 and 10 shares outstanding. The firm has issued 5 warrants, each of which may be exchanged for 1 share. The warrants have an exercise price of $50. If the firm will be worth $800 in one period (before exercise), what will be the price of shares, assuming the warrants are exercised?
			A)	$53
			B)	$60
			C)	$70
			D)	$96
			E)	$122