Chapters CHAPTER 20 AN INTRODUCTION TO DERIVATIVE MARKETS AND by abstraks

VIEWS: 349 PAGES: 59

									                                   CHAPTER 20

 AN INTRODUCTION TO DERIVATIVE MARKETS AND SECURITIES


                            TRUE/FALSE QUESTIONS

(t) 1    A cash or spot contract is an agreement for the immediate delivery of an asset
         such as the purchase of stock on the NYSE.

(t) 2    Forward and future contracts, as well as options, are types of derivative securities.

(f) 3    All features of a forward contract are standardized, except for price and number of
         contracts.

(t) 4    Forward contracts are traded over-the-counter and are generally not standardized.

(t) 5    The forward market has low liquidity relative to the futures market.

(f) 6    A futures contract is an agreement between a trader and the clearinghouse of the
         exchange for delivery of an asset in the future.

(t) 7    A primary function of futures markets is to allow investors to transfer risk.

(f) 8    The futures market is a dealer market where all the details of the transactions are
         negotiated.

(f) 9    Futures contracts are slower to absorb new information than forward contracts.

(f) 10   The initial value of a future contract is the price agreed upon in the contract.

(t) 11   A futures contract eliminates uncertainty about the future spot price that an
         individual can expect to pay for an asset at the time of delivery.

(f) 12   Investment costs are generally higher in the derivative markets than in the
         corresponding cash markets.

(f) 13   An option buyer must exercise the option on or before the expiration date.

(t) 14   The minimum value of an option is zero.

(f) 15   An option to sell an asset is referred to as a call, whereas an option to buy an asset
         is called a put.

(t) 16   If an investor wants to acquire the right to buy or sell an asset, but not the
         obligation to do it, the best instrument is an option rather than a futures contract.
(t) 17   Investors buy call options because they expect the price of the underlying stock to
         increase before the expiration of the option.

(t) 18   A call option is in the money if the current market price is above the strike price.

(f) 19   A put option is in the money if the current market price is above the strike price.

(t) 20   The price at which the stock can be acquired or sold is the exercise price.

(t) 21   The minimum amount that must be maintained in an account is called the
         maintenance margin.


                       MULTIPLE CHOICE QUESTIONS

(d) 1    Which of the following statements is false?
         a)    Derivatives help shift risk from risk-adverse investors to risk-takers.
         b)    Derivatives assist in forming cash prices.
         c)    Derivatives provide additional information to the market.
         d)    In many cases, the investment in derivatives (both commissions and required
               investment) is more than in the cash market.
         e)    None of the above (that is, all are reasons)

(e) 2    Derivative instruments exist because
         a)     They help shift risk from risk-averse investors to risk-takers.
         b)     They help in forming prices.
         c)     They have lower investment costs.
         d)     Choices a and b
         e)     All of the above

(c) 3    There are in number of differences between forward and futures contracts. Which
         of the following statements is false?
         a)      Futures have less liquidity risk than forward contracts.
         b)      Futures have less credit risk than forward contracts.
         c)      Futures have more default risk than forward contracts.
         d)      In futures, the exchange becomes the counterparty to all transactions.
         e)      None of the above (that is, all statements are true)
(d) 4 Futures differ from forward contracts because
             a)       Futures have more liquidity risk.
             b)       Futures have more credit risk.
             c)       Futures have more maturity risk.
             d)       None of the above
             e)       All of the above

(d) 5          The price at which a futures contract is set at the end of the day is the
               a)     Stock price.
               b)     Strike price.
               c)     Maintenance price.
               d)     Settlement price.
               e)     Parity price.

(e) 6 Which of the following statements is true?
            a)       The buyer of a futures contract is said to be long futures.
            b)       The seller of a futures contract is said to be short futures.
            c)       The seller of a futures contract is said to be long futures.
            d)       The buyer of a futures contract is said to be short futures.
            e)       Choices a and b

(b) 7          The CBOE brought numerous innovations to the option market, which of the
               following is not such an innovation?
               a)     Creation of a central marketplace
               b)     Creation of a non-liquid secondary option market
               c)     Introduction of a Clearing Corporation
               d)     Standardization of all expiration dates
               e)     Standardization of all exercise prices

(e) 8          Which of the following factors is not considered in the valuation of call and put
               options?
               a)     Current stock price
               b)     Exercise price
               c)     Market interest rate
               d)     Volatility of underlying stock price
               e)     none of the above (that is, all are factors which should be considered in the
                      valuation of call and put options)

(a) 9 Which of the following statements is a true definition of an in-the-money option?
            a)       A call option in which the stock price exceeds the exercise price.
            b)       A call option in which the exercise price exceeds the stock price.
            c)       A put option in which the stock price exceeds the exercise price.
            d)       An index option in which the exercise price exceeds the stock price.
            e)       A call option in which the call premium exceeds the stock price.
(a) 10          The value of a call option just prior to expiration is (where V is the underlying
                asset's market price and X is the option's exercise price)
                a)      Max [0, V - X]
                b)      Max [0, X - V]
                c)      Min [0, V - X]
                d)      Min [0, X - V]
                e)      Max [0, V > X]

(c) 11          Which of the following is not a factor needed to calculate the value of an American
                call option?
                a)      The price of the underlying stock.
                b)      The exercise price.
                c)      The price of an equivalent put option.
                d)      The volatility of the underlying stock.
                e)      The interest rate.

(b) 12 In the valuation of an option contract, the following statements apply except
               a)      The value of an option increases with its maturity.
               b)      There is a negative relationship between the market interest rate and the
                       value of a call option.
               c)      The value of a call option is negatively related to its exercise price.
               d)      The value of a call option is positively related to the volatility of the
                       underlying asset.
               e)      The value of a call option is positively related to the price of the underlying stock.

(a) 13          You own a stock that has risen from $10 per share to $32 per share. You wish to
                delay taking the profit but you are troubled about the short run behavior of the stock
                market. An effective action on your part would be to
                a)      Buy a put option on the stock.
                b)      Write a call option on the stock.
                c)      Purchase an index option.
                d)      Utilize a bearish spread.
                e)      Utilize a bullish spread.

(b) 14 A vertical spread involves buying and selling call options in the same stock with
               a)      The same time period and exercise price.
               b)      The same time period but different exercise price.
               c)      A different time period but same exercise price.
               d)      A different time period and different price.
               e)      Quotes in different options markets.
(b) 15   The value of a put option at expiration is
         a)     Max [0, S(T) – X]
         b)     Max [0, X - S(T)]
         c)     Min [0, S(T) – X]
         d)     Min [0, X - S(T)]
         e)     X

(a) 16   In the two state option pricing model, which of the following does not influence
         the option price?
         a)      Past stock price
         b)      Up and down factors u and d
         c)      The risk free rate
         d)      The exercise price
         e)      Current stock price

(c) 17   The cost of carry includes all of the following except
         a)     Storage costs.
         b)     Insurance.
         c)     Current price.
         d)     Financing costs.
         e)     Risk free rate.

(b) 18   A call option in which the stock price is higher than the exercise price is said to be
         a)      At-the-money.
         b)      In-the-money.
         c)      Before-the-money.
         d)      Out-of-the-money.
         e)      Above-the-money.

(d) 19   The price paid for the option contract is referred to as the
         a)     Forward price.
         b)     Exercise price.
         c)     Striking price.
         d)     Option premium.
         a)     Call price.

(b) 20           A stock currently sells for $75 per share. A call option on the stock with
         an exercise price $70 currently sells for $5.50. The call option is
         a)    At-the-money.
         b)    In-the-money.
         c)    Out-of-the-money.
         d)    At breakeven.
         e)    None of the above.
(c) 21          A stock currently sells for $150 per share. A call option on the stock with
         an exercise price $155 currently sells for $2.50. The call option is
         a)     At-the-money.
         b)     In-the-money.
         c)     Out-of-the-money.
         d)     At breakeven.
         e)     None of the above.

(c) 22          A stock currently sells for $75 per share. A put option on the stock with an
         exercise price $70 currently sells for $0.50. The put option is
         a)     At-the-money.
         b)     In-the-money.
         c)     Out-of-the-money.
         d)     At breakeven.
         e)     None of the above.

(a) 23          A stock currently sells for $15 per share. A put option on the stock with an
         exercise price $15 currently sells for $1.50. The put option is
         a)     At-the-money.
         b)     In-the-money.
         c)     Out-of-the-money.
         d)     At breakeven.
         e)     None of the above.

(b) 24           A stock currently sells for $15 per share. A put option on the stock with an
         xercise price $20 currently sells for $6.50. The put option is
         a)      At-the-money.
         b)      In-the-money.
         c)      Out-of-the-money.
         d)    At breakeven.
         e)    None of the above.

(c) 25   An equity portfolio manager can neutralize the risk of falling stock prices by
         entering into a hedge position where the payoffs are
         a)     Not correlated with the existing exposure.
         b)     Positively correlated with the existing exposure.
         c)     Negatively correlated with the existing exposure.
         d)     Any of the above.
         e)     None of the above.




(b) 26   The derivative based strategy known as portfolio insurance involves
         a)     The sale of a put option on the underlying security position.
         b)     The purchase of a put on the underlying security position.
         c)     The sale of a call on the underlying security position.
         d)     The purchase of a call on the underlying security position.
         e)     b) and d).

(d) 27   A hedge strategy known as a collar agreement involves the simultaneous
         a)    Purchase of an in-the money put and purchase of an out-of-the-money call
               on the same underlying asset with same expiration date and market price.
         b)    Sale of an out-of-the money put and sale of an out-of-the-money call on
               the same underlying asset with same expiration date and market price.
         c)    Purchase of an in-the money put and purchase of an in-the-money call on
               the same underlying asset with same expiration date and market price.
         d)    Purchase of an out-of-the money put and sale of an out-of-the-money call
               on the same underlying asset with same expiration date and market price.
         e)    Sale of an in-the money put and purchase of an in-the-money call on the
               same underlying asset with same expiration date and market price.

(c) 28   A call option differs from a put option in that
         a)      a call option obliges the investor to purchase a given number of shares in a
                 specific common stock at a set price; a put obliges the investor to sell a
                 certain number of shares in a common stock at a set price.
         b)      both give the investor the opportunity to participate in stock market
                 dealings without the risk of actual stock ownership.
         c)      a call option gives the investor the right to purchase a given number of
                 shares of a specified stock at a set price; a put option gives the investor the
                 right to sell a given number of shares of a stock at a set price.
         d)      a put option has risk, since leverage is not as great as with a call.
         e)      none of the above

(b) 29   Which of the following statements is a true definition of an out-of-the-money
         option?
         a)      A call option in which the stock price exceeds the exercise price.
         b)      A call option in which the exercise price exceeds the stock price.
         c)      A call option in which the exercise price exceeds the stock price.
         d)      A put option in which the exercise price exceeds the stock price.
         e)      A call option in which the call premium exceeds the stock price.

(b) 30   According to put/call parity
         a)    Stock price + Call Price = Put Price + Risk Free Bond Price
         b)    Stock price + Put Price = Call Price + Risk Free Bond Price
         c)    Put price + Call Price = Stock Price + Risk Free Bond Price
         d)    Stock price - Put Price = Call Price + Risk Free Bond Price
         e)    Stock price + Call Price = Put Price - Risk Free Bond Price



                        MULTIPLE CHOICE PROBLEMS
(d) 1         A one year call option has a strike price of 50, expires in 6 months, and has a
              price of $5.04. If the risk free rate is 5%, and the current stock price is $50, what
              should the corresponding put be worth?
              a)      $3.04
              b)      $4.64
              c)      $6.08
              d)      $3.83
              e)      $0

(d) 2         A one year call option has a strike price of 50, expires in 6 months, and has a
              price of $4.74. If the risk free rate is 3%, and the current stock price is $45, what
              should the corresponding put be worth?
              b)      $12.74
              a)      $10.48
              c)      $5.00
              d)      $9.00
              e)      $8.30

(c) 3         A one year call option has a strike price of 60, expires in 6 months, and has a
              price of $2.5. If the risk free rate is 7%, and the current stock price is $55, what
              should the corresponding put be worth?
              a)      $5.00
              b)      $4.56
              c)      $5.50
              d)      $7.08
              e)      $7.54

(d) 4         A one year call option has a strike price of 70, expires in 3 months, and has a
              price of $7.34. If the risk free rate is 6%, and the current stock price is $62, what
              should the corresponding put be worth?
              a)      $5.34
              b)      $8.00
              c)      $10.68
              d)      $14.33
              e)      $13.33




        USE THE FOLLOWING INFORMATION FOR THE NEXT THREE PROBLEMS

December futures on the S&P 500 stock index trade at 250 times the index value of 1187.70.
Your broker requires an initial margin of 10% percent on futures contracts. The current value of
the S&P 500 stock index is 1178.
(c) 5         How much must you deposit in a margin account if you wish to purchase one
              contract?
              a)     $267,232.5
              b)     $29,450
              c)     $29,692.50
              d)     $30,000
              e)     $265,050

(c) 6         Suppose at expiration the futures contract price is 250 times the index value of
              1170. Disregarding transaction costs, what is your percentage return?
              a)     1.87%
              b)     -0.68%
              c)     -14.90%
              d)     10.36%
              e)     None of the above

(b) 7         Calculate the return on a cash investment in the S&P 500 stock index over the
              same time period
              a)     1.87%
              b)     -0.68%
              c)     -14.90%
              d)     10.36%
              e)     None of the above

         USE THE FOLLOWING INFORMATION FOR THE NEXT THREE PROBLEMS

A futures contract on Treasury bond futures with a December expiration date currently trade at
103:06. The face value of a Treasury bond futures contract is $100,000. Your broker requires an
initial margin of 10%.

(c) 8         Calculate the current value of one contract
              a)     $100,000
              b)     $103,600.5
              c)     $103,187.5
              d)     $102,306.3
              e)     $104,293.5

(c) 9         Calculate the initial margin deposit
              a)     $10,000
              b)     $10,360.50
              c)     $10,318.75
              d)     $10,230.63
              e)     $10,429.35




(b) 10        If the futures contract is quoted at 105:08 at expiration calculate the percentage
              return
               a)   1.99%
               b)   19.99%
               c)   20.62%
               d)   25.37%
               e)   -13.65%

          USE THE FOLLOWING INFORMATION FOR THE NEXT TWO PROBLEMS
On the last day of October, Bruce Springsteen is considering the purchase of 100 shares of Olivia
Corporation common stock selling at $37 1/2 per share and also considering an Olivia option.
                          Calls                         Puts
               Price       December       March          December       March
               35            3 3/4            5            1 1/4          2
               40            2 1/2          3 1/2          4 1/2        4 3/4

(d) 11         If Bruce decides to buy a March call option with an exercise price of 35, what is his
               dollar gain (loss) if he closes his position when the stock is selling at 43 1/2?
               a)      $225.00 loss
               b)      $350.00 loss
               c)      $225.00 gain
               d)      $350.00 gain
         e)    $850.00 gain

(b) 12         If Bruce buys a March put option with an exercise price of 40, what is his dollar gain
               (loss) if he closes his position when the stock is selling at 43 1/2?
               a)       $825.00 loss
               b)       $475.00 loss
               c)       $350.00 loss
               d)       $25.00 loss
               e)       He has a gain




          USE THE FOLLOWING INFORMATION FOR THE NEXT TWO PROBLEMS

Rick Thompson is considering the following alternatives for investing in Davis Industries which is
now selling for $44 per share:
       1)       Buy 500 shares, and
       2)       Buy six month call options with an exercise price of 45 for $3.25 premium.
(a) 13        Assuming no commissions or taxes what is the annualized percentage gain if the
              stock reaches $50 in four months and a call was purchased?
              a)                                                   161.54% gain
              b)                                                   53.85% gain
              c)                                                   161.54% loss
              d)                                                   11.11% gain
              e)                                                   53.85% loss

(b) 14        Assuming no commissions or taxes, what is the annualized percentage gain if the
              stock is at $30 in four months and the stock was purchased?
              a)                                                                             9.54% loss
              b)                                                                             95.45% loss
              c)                                                                             0.9545% gain
              d)                                                                             95.45% gain
              e)                                                                             9.54% gain

(a) 15        Tom Gettback buys 100 shares of Johnson Walker stock for $87.00 per share and a
              3-month Johnson Walker put option with an exercise price of $105.00 for $20.00.
              What is his dollar gain if at expiration the stock is selling for $80.00 per share?
              a)     $200 loss
              b)     $700 loss
              c)     $200 gain
              d)     $700 gain
              e)     None of the above

(b) 16        Tom Gettback buys 100 shares of Johnson Walker stock for $87.00 per share and a
              3-month Johnson Walker put option with an exercise price of $105.00 for $20.00.
              What is Tom’s dollar gain/loss if at expiration the stock is selling for $105.00 per
              share?
              a)     $1000 gain
              b)     $200 loss
              c)     $1000 loss
              d)     $200 gain
              e)     None of the above




         USE THE FOLLOWING INFORMATION FOR THE NEXT FOUR PROBLEMS
Sarah Kling bought a 6-month Peppy Cola put option with an exercise price of $55 for a premium
of $8.25 when Peppy was selling for $48.00 per share.

(d) 17        If at expiration Peppy is selling for $42.00, what is Sarah’s dollar gain or loss?
              a)       $420 gain
              b)       $420 loss
         c)      $475 loss
         d)      $475 gain
         e)      None of the above

(b) 18   What is Sarah’s annualized gain/loss?
         a)     11.51% gain
         b)     115.15% gain
         c)     11.51% loss
         d)     115.15% loss
         e)     None of the above

(a) 19   If at expiration Peppy is selling for $47.00, what is Sarah’s dollar gain or loss?
         a)       $25 loss
         b)       $250 loss
         c)       $25 gain
         d)       $250 gain
         e)       None of the above

(b) 20   What is Sarah’s annualized gain/loss?
         a)     60.60% gain
         b)     6.06% loss
         c)     60.60% loss
         d)     6.06% gain
         a)     None of the above

(a) 21           A stock currently trades for $25. January call options with a strike price of
         $30 sell for $6. The appropriate risk free bond has a price of $30. Calculate the
         price of the January put option.
         a)      $11
         b)      $24
         c)      $19
         d)      $30
         e)      $25



(e) 22          A stock currently trades for $115. January call options with a strike price
         of $100 sell for $16, and January put options a strike price of $100 sell for $5.
         Estimate the price of a risk free bond.
         a)     $120
         b)      $15
         c)     $105
         d)     $116
         e)     $104
(d) 23           Assume that you have purchased a call option with a strike price $60 for
         $5. At the same time you purchase a put option on the same stock with a strike
         price of $60 for $4. If the stock is currently selling for $75 per share, calculate the
         dollar return on this option strategy.
         a)      $10
         b)      -$4
         c)      $5
         d)      $6
         e)      $15

(c) 24           Assume that you purchased shares of a stock at a price of $35 per share.
         At this time you purchased a put option with a $35 strike price of $3. The stock
         currently trades at $40. Calculate the dollar return on this option strategy.
         a)      $3
         b)      -$2
         c)      $2
         d)      -$3
         e)      $0

(c) 25           Assume that you purchased shares of a stock at a price of $35 per share.
         At this time you wrote a call option with a $35 strike and received a call price of
         $2. The stock currently trades at $70. Calculate the dollar return on this option
         strategy.
         a)      $25
         b)      -$2
         c)      $2
         d)      -$25
         e)      $0

(b) 26           A stock currently trades at $110. June call options on the stock with a
         strike price of $105 are priced at $4. Calculate the arbitrage profit that you can
         earn
         a)      $0
         b)      $1
         c)      $5
         d)      $4
         e)      None of the above

(c) 27           Datacorp stock currently trades at $50. August call options on the stock
         with a strike price of $55 are priced at $5.75. October call options with a strike
         price of $55 are priced at $6.25. Calculate the value of the time premium between
         the August and October options.
         a)      -$0.50
         b)      $0
         c)      $0.50
         d)      $5
         e)     -$5

(a) 28           A stock currently trades at $110. June put options on the stock with a
         strike price of $100 are priced at $5.25. Calculate the dollar return on one put
         contract.
         a)      -$525
         b)      $1000
         c)      $0
         d)      -$1000
         e)      $525

(d) 29           A stock currently trades at $110. June call options on the stock with a
         strike price of $120 are priced at $5.75. Calculate the dollar return on one call
         contract.
         a)      -$1000
         b)      $1000
         c)      $575
         d)      -$575
         e)      $0

(e) 30           Consider a stock that is currently trading at $65. Calculate the intrinsic
         value for a put option that has an exercise price of $55.
         a)      $10
         b)      $50
         c)      $55
         d)      -$10
         e)      $0

(a) 31           Consider a stock that is currently trading at $20. Calculate the intrinsic
         value for a put option that has an exercise price of $35.
         a)      $15
         b)      $55
         c)      $35
         d)      -$15
         e)      $0



(e) 32           Consider a stock that is currently trading at $45. Calculate the intrinsic
         value for a call option that has an exercise price of $35.
         a)      $25
         b)      $35
         c)      $0
         d)      -$10
         e)      $10
(c) 33           Consider a stock that is currently trading at $10. Calculate the intrinsic
         value for a call option that has an exercise price of $15.
         a)      $25
         b)      -$5
         c)      $0
         d)      $20
         e)      $5
                                  CHAPTER 20

                         ANSWERS TO PROBLEMS


1    p(t) = $5.04 - $50+ $50(1 + .05)-½ = $3.83

2    p(t) = $4.74 - $45+ $50(1 + .03)-½ = $9.0

3    p(t) = $2.5 - $55+ $60(1 + .07) -½ = $5.50

4    p(t) = $7.34 - $62+ $70(1 + .06)-1/4 = $14.33

5       Margin = 0.10 x 250 x 1187.70 = $29,692.50

6       Purchase December contract
        250 x 1187.7 = $296,925

        Sell December contract
        250 x 1170 = $292,500

        Loss in futures = $292,500 - $296,925 = -$4425

        Rate of return = -$4425/29,692.50 = -.1490 or -14.9%


7       Return on cash investment in the index = (1170 – 1178)/1178 = -0.0068 or 0.68%


8       Current price is 103 6/32 percent of face value of $100,000
        = 1.031875 x 100,000 = $103,187.50

9       Margin deposit = 0.10 x 103,187.5 = $10,318.75

10      Purchase December contract
        103 6/32 percent of 100,000 = $103,187.50

        Sell December contract
        105 8/32 percent of $100,000 = $105,250

        Gain in futures = $105,250 - $103,187.50 = $2,062.50

        Rate of return = 2062.5/10318.75 = 0.1999 or 19.9%
11   43 1/2 - 35 = 8.5
     8.5 - 5 = 3.5     $3.5/share x 100 shares/contract = $350.00

12   The option is worthless so he loses the $475 he paid for the contract.

13   [(50 - 45 - 3.25) ÷ 3.25] x 3 = 161.54% gain

14   [(30 - 44) ÷ 44] x 3 = 95.45% loss

15   Profit on put = 105 - 80 - 20 = 5
     5 x 100 = $500.00

     Loss on stock = $700.00

     Net loss = $700.00 - 500.00 = $200.00 (loss)

16   Put value = 0, therefore, loss = $2,000.00

     Stock (105 - 87)(100) = $1,800.00

     Net loss = $2,000 - 1,800 = $200.00 (loss)

17   [(55 - 42 - 8.25) x 100] = $475 gain

18   [(55 - 42 - 8.25)  8.25] x 2 = 115.15% gain

19   [(55 - 47 - 8.25) x 100] = $25 loss

20      [(55 - 47 - 8.25)  8.25] x 2 = 6.06% loss

21      P = 6 + 30 –25 = $11

22      Bond price = 115 + 5 – 16 = $104

23      Profit on call = (75 – 60) – 5 = 10
        Profit on put = -4
        Total = $6

24      Profit on stock = 40 – 35 = 5
        Profit on put = -3
        Total = $2

25      Profit on stock = 70 – 35 = 25
        Profit on call = 35 – 70 + 2 = -23
        Total = $2

26      Arbitrage profit = 110 – 105 – 4 = $1
27      Time premium = 6.25 – 5.75 = $0.50
28   Dollar return = (100 – 110 – 5.25)(100) = -$525

29   Dollar return = (110 – 120 – 5.75)(100) = -$575

30   Put = Max[55 – 65, 0] = $0

31   Put = Max[35 – 20, 0] = $15

32   Call = Max[45 – 35, 0] = $10

33   Call = Max[10 – 15, 0] = $0
                                  CHAPTER 22

                            OPTION CONTRACTS
                            TRUE/FALSE QUESTIONS

(t) 1    The Chicago Board Options Exchange has the largest share of stock option
         trading.

(f) 2    Index options are settled by delivery of the stocks that make up the index.

(t) 3    In index options, the aggregate market takes the place of the individual stock
         issues being traded, as in stock options.

(f) 4    Risk management is the driving force behind the futures options market.

(t) 5    The longer the time to expiration, the greater the value of a call option.

(f) 6    There is an inverse relationship between the market interest rate and the value of a
         call option.

(f) 7    Credit risk in the options market is only a concern to the option seller.

(t) 8    The standardization of option contracts and the creation of the Options Clearing
         Corporation are two important results of the opening of the Chicago Board of
         Options Exchange.

(f) 9    Stock options expire on the Sunday following the third Saturday of the designated
         month.

(t) 10   A price spread (or vertical spread) involves buying and selling an option for the
         same stock and expiration date but with different exercise prices.

(t) 11   A portfolio containing a share of stock and a put option will have the same value
         as a portfolio containing a call option and the risk-free discount bond.

(f) 12   A strip is a call option on a stock that is written by someone that owns the stock.

(t) 13   The buyer of a straddle expects stock prices to move strongly in either direction.

(t) 14   A long strip position indicates that an investor is bullish but conservative.

(t) 15   Index options can only be settled in cash.

(f) 16   Unlike stock options, futures options require the holder to enter into a utures
         contract.
(f) 17   It is a violation of the securities laws to combine option contracts to achieve a
         customized payoff.

(t) 18   European options can only be exercised on the expiration date.

(f) 19   The owner of a call option on a futures contract has the obligation to buy the
         futures contract at a predetermined strike price during a specified time period.

(f) 20   Options on futures expire at the same time the futures contract expires.

(f) 21   The underlying stock price and the value of the put option are factors that impact
         the value of an American call option.

(t) 22   The binomial option pricing model approximates the price of an option obtained
         using the Black-Scholes option pricing model as the number of subintervals
         increases.

(f) 23   Investors should purchase market index put options if they anticipate an increase
         in the index value.


                     MULTIPLE CHOICE QUESTIONS

(d) 1    The creation of the CBOE led to all the following innovations in options except
         a)     The creation of a central marketplace.
         b)     The introduction of a clearing corporation.
         c)     The standardization of expiration dates.
         d)     The creation of a primary market.
         e)     The creation of a secondary market.

(b) 2    A calendar spread requires the purchase and sale of two calls or two puts in the
         same stock with
         a)     The same expiration date but different exercise prices.
         b)     The same exercise price but different expiration dates.
         c)     Different exercise prices and different expiration dates.
         d)     The same exercise price and the same expiration month.
         e)     Traded in different markets.




(b) 3    In a money spread, an investor would
         a)     Buy two in-the-money call options on the same stock with different
                exercise dates.
        b)     Buy two out-of-the-money call options on the same stock with different
               exercise dates.
        c)     Sell two in-the-money call options on the same stock with different
               exercise dates.
        d)     Sell an out-of-the-money call and purchase an in-the-money call on the
               same stock with the same exercise date.
        e)     Sell two out-of-the-money call options on the same stock with different
               exercise dates.

(b) 4   A money spread involves buying and selling call options in the same stock with
        a)    The same time period and exercise price.
        b)    The same time period but different exercise price.
        c)    A different time period but same exercise price.
        d)    A different time period and different exercise price.
        e)    Options in different markets.

(b) 5   If you were to purchase an October option with an exercise price of 50 for 8 and
        simultaneously sell an October option with an exercise price of 60 for 2, you
        would be
        a)     Bullish and taking a high risk.
        b)     Bullish and conservative.
        c)     Bearish and taking a high risk.
        d)     Bearish and conservative.
        e)     Neutral.

(a) 6   You own a stock that has risen from $10 per share to $32 per share. You wish to
        delay taking the profit but you are troubled about the short run behavior of the
        stock market. An effective action on your part would be to
        a)     Purchase a put.
        b)     Purchase a call.
        c)     Purchase an index option.
        d)     Utilize a bearish spread.
        e)     Utilize a bullish spread.

(b) 7   If you were to purchase an October option with an exercise price of 50 for $8 and
        simultaneously sell an October option with an exercise price of 60 for $2, you
        would be
        a)     Bullish and taking a high risk.
        b)     Bullish and conservative.
        c)     Bearish and taking a high risk.
        d)     Bearish and conservative.
        e)     Neutral.

(b) 8   A vertical spread involves buying and selling call options in the same stock with
        a)     The same time period and price.
        b)     The same time period but different price.
         c)     A different time period but same price.
         d)     A different time period and different price.
         e)     Options in different markets.

(c) 9    Which of the following is not a factor needed to calculate the value of an
         American call option?
         a)    The stock price
         b)    The exercise price
         c)    The exchange on which the option is listed
         d)    The volatility of the underlying stock
         e)    The interest rate

(a) 10   Buying a bear spread is equivalent to
         a)    Selling a bull spread.
         b)    Buying an out-of-the-money call and selling an in-the-money call on the
               same stock with the same exercise date.
         c)    Selling an out-of-the-money call and buying an in-the-money call on the
               same stock with a different exercise price.
         d)    Choices a and b only.
         e)    None of the above

(c) 11   A currency call is like being         in the currency futures.
         a)     Out-of-the-money
         b)     In-the-money
         c)     Long
         d)     Short
         e)     At-the-money

(a) 12   A straddle is the simultaneous purchase (or sale) of a put and call option with the
         same underlying asset,
         a)     Same exercise price, and expiration date.
         b)     Same exercise price but different expiration date.
         c)     Same expiration date but different exercise price.
         d)     Either choices b or c.
         e)     None of the above.




(b) 13   In the Black-Scholes option pricing model, an increase in security price (S) will
         cause
         a)      An increase in call value and an increase in put value
         b)      An increase in call value and a decrease in put value
         c)      An decrease in call value and an increase in put value
         d)      An decrease in call value and a decrease in put value
         e)     An increase in call value and an increase or decrease in put value

(c) 14   In the Black-Scholes option pricing model, an increase in exercise price (X) will
         cause
         a)      An increase in call value and an increase in put value
         b)      An increase in call value and a decrease in put value
         c)      An decrease in call value and an increase in put value
         d)      An decrease in call value and a decrease in put value
         e)      An increase in call value and an increase or decrease in put value

(e) 15   In the Black-Scholes option pricing model, an increase in time to expiration (T)
         will cause
         a)      An increase in call value and an increase in put value
         b)      An increase in call value and a decrease in put value
         c)      An decrease in call value and an increase in put value
         d)      An decrease in call value and a decrease in put value
         e)      An increase in call value and an increase or decrease in put value

(b) 16   In the Black-Scholes option pricing model, an increase in the risk free rate (RFR)
         will cause
         a)      An increase in call value and an increase in put value
         b)      An increase in call value and a decrease in put value
         c)      An decrease in call value and an increase in put value
         d)      An decrease in call value and a decrease in put value
         e)      An increase in call value and an increase or decrease in put value

(a) 17   In the Black-Scholes option pricing model, an increase in security volatility (σ)
         will cause
         a)      An increase in call value and an increase in put value
         b)      An increase in call value and a decrease in put value
         c)      An decrease in call value and an increase in put value
         d)      An decrease in call value and a decrease in put value
         e)      An increase in call value and an increase or decrease in put value




(d) 18   The value of a call option is positively related to:
         a)   Underlying stock price.
         b)   Time to expiration
         c)   Exercise price.
         d)   a) and b)
         e)   b) and c)

(c) 19   The value of a call option is inversely related to:
             a)    Underlying stock price.
             b)    Time to expiration
             c)    Exercise price.
             d)    a) and b)
             e)    b) and c)

(b) 20       If the hedge ratio is 0.50, this indicates that the portfolio should hold
             a)     Two shares of stock for every call option written.
             b)     One share of stock for every two call options written.
             c)     Two shares of stock for every call option purchased.
             d)     One share of stock for every two call options purchased.
             e)     Two call options for every put option written.

(e) 21       Options can be used to
             a)   Modify an equity portfolio's systematic risk.
             b)   Modify an equity portfolio's unsystematic risk.
             c)   Manage currency exposures in international equity portfolios.
             d)   Change a portfolio’s exposure to a particular asset
             e) All of the above


                            MULTIPLE CHOICE PROBLEMS

         USE THE FOLLOWING INFORMATION FOR THE NEXT SIX PROBLEMS

                    Option Type               Currency    Canadian dollar
                    Contract
                    Size                      50000       Canadian dollars
                    Expiry                    April

                       Strike        Call        Put
                       $0.815      $0.0118
                       $0.820                  $0.0068

(d) 1        How much must an investor pay for one call option contract?
             a)   $680
             b)   $815
             c)   $625
             d)   $590
             e)   $340

(c) 2        How much must an investor pay for one put option contract?
             a)   $680
             b)   $815
             c)   $340
             d)   $625
             e)   $590
(c) 3   If the spot rate at expiration is $0.90 and the call option was purchased, what is
        the dollar gain or loss?
        a)      $0
        b)      $3750 gain
        c)      $3660 gain
        d)      $4650 loss
        e)      $2680 loss

(b) 4   If the spot rate at expiration is $0.80 and the call option was purchased, what is
        the dollar gain or loss?
        a)      $123 gain
        b)      $590 loss
        c)      $312 gain
        d)      $237 gain
        e)      $0

(a) 5   If the spot rate at expiration is $0.85 and the put option was purchased, what is the
        dollar gain or loss?
        a)      $340 loss
        b)      $125 gain
        c)      $750 gain
        d)      $750 loss
        e)      $200 loss

(d) 6   If the spot rate at expiration is $0.75 and the put option was purchased, what is the
        dollar gain or loss?
        a)      $0
        b)      $200 loss
        c)      $200 gain
        d)      $3160 gain
        e)      $1187 loss
         USE THE FOLLOWING INFORMATION FOR THE NEXT TEN PROBLEMS

                                        XYZ CORP
                              EXERCISE                              NYSE
                            DATE     PRICE             PRICE       CLOSE
              CALLS         OCT        85              16 3/4      101 11/16
                            OCT        90                12        101 11/16
                            OCT        95               7 5/8      101 11/16
              PUTS          OCT        85                1/8       101 11/16
                            OCT        90                3/8       101 11/16
                            OCT        95              13/16       101 11/16

(a) 7         If you establish a long straddle using the options with an 85 exercise price, what is
              your dollar gain or loss if at expiration XYZ is still trading at 101 11/16?
              a)      $18.75 loss
              b)      $18.75 gain
              c)      $1,668.75 gain
              d)      $1,668.75 loss
              e)      $1,687.50 loss

(d) 8         If you establish a long strap using the options with an 85 exercise price, what is
              your dollar gain or loss if at expiration XYZ is still trading at 101 11/16?
              a)     $1,687.50 loss
              b)     $3,362.50 loss
              c)     $3,675.50 gain
              d)     $13.00 gain
              e)     $13.00 loss

(e) 9         If you establish a long strip using the options with an 85 exercise price, what is
              your dollar gain or loss if at expiration XYZ is still trading at 101 11/16?
              a)     $1,668.75 gain
              b)     $1,700.00 gain
              c)     $1,700.00 loss
              d)     $31.25 gain
              e)     $31.25 loss

(a) 10        If you establish a long straddle using the options with an 90 exercise price, what is
              your dollar gain or loss if at expiration XYZ is still trading at 101 11/16?
              a)      $68.75 loss
              b)      $68.75 gain
              c)      $37.50 loss
              d)      $1,200.00 loss
              e)      $1,200.00 gain
(c) 11   If you establish a long strap using the options with an 90 exercise price, what is
         your dollar gain or loss if at expiration XYZ is still trading at 101 11/16?
         a)     $37.50 loss
         b)     $37.50 gain
         c)     $100.00 loss
         d)     $100.00 gain
         e)     $2,437.50 loss

(b) 12   If you establish a long strip using the options with an 90 exercise price, what is
         your dollar gain or loss if at expiration XYZ is still trading at 101 11/16?
         a)     $106.25 gain
         b)     $106.25 loss
         c)     $1,275.00 loss
         d)     $1,275.00 gain
         e)     $75.00 loss

(d) 13   If you establish a long straddle using the options with an 95 exercise price, what is
         your dollar gain or loss if at expiration XYZ is still trading at 101 11/16?
         a)      $668.75 gain
         b)      $668.75 loss
         c)      $94.56 gain
         d)      $94.56 loss
         e)      $81.25 loss

(d) 14   If you establish a long strap using the options with an 95 exercise price, what is
         your dollar gain or loss if at expiration XYZ is still trading at 101 11/16?
         a)     $81.25 loss
         b)     $1,606.25 gain
         c)     $1,606.25 loss
         d)     $268.75 loss
         e)     $268.75 gain

(a) 15   If you establish a long strip using the options with a 95 exercise price, what is
         your dollar gain or loss if at expiration XYZ is still trading at 101 11/16?
         a)     $256.25 loss
         b)     $256.25 gain
         c)     $925.00 loss
         d)     $668.75 gain
         e)     $668.75 loss




(b) 16   If XYZ were trading at $90/share and you formed a bull money spread, what is
         your profit if XYZ is trading at $110 at expiration?
               a)      $912.50 loss
               b)      $87.50 gain
               c)      $87.50 loss
               d)      $1,000.00 gain
               e)      $1,000.00 loss

         THE FOLLOWING INFORMATION IS FOR THE NEXT TWO PROBLEMS

A stock currently trades for $130 per share. Options on the stock are available with a strike price

of $125. The options expire in 10 days. The risk free rate is 3% over this time period, and the

expected volatility is 0.35.


(d) 17         Use the Black-Scholes option pricing model to calculate the price of a call option.
               a)    $5.19
               b)    $4.35
               c)    $3.93
               d)    $6.19
               e)    $8.17

(a) 18         Calculate the price of the put option.
               a)   $1.086
               b)   $0.862
               c)   $6.234
               d)   $0.623
               e)   $2.317

(a) 19                 Assume that you have just sold a stock for a loss at a price of $75, for tax
                               purposes. You still wish to maintain exposure to the sold stock.
                       Suppose that you        buy a call with a strike price of $70 and a price of
                       $6.75. Calculate the effective price paid to repurchase the stock if the price
                       after 35 days is $65.
               a)      $71.75
               b)      $76.75
               c)      $58.25
               d)      $81.75
               e)      None of the above
(d) 20                Assume that you have just sold a stock for a loss at a price of $75, for tax
                              purposes. You still wish to maintain exposure to the sold stock.
                      Suppose that you        buy a call with a strike price of $70 and a price of
                      $6.75. Calculate the effective price paid to repurchase the stock if the price
                      after 35 days is $80.
              a)      $81.75
              b)      $73.25
              c)      $86.75
              d)      $76.75
              e)      None of the above

(d) 21                Assume that you have just sold a stock for a loss at a price of $75, for tax
                              purposes. You still wish to maintain exposure to the sold stock.
                      Suppose that you        sell a put with a strike price of $80 and a price of
                      $7.25. Calculate the effective price paid to repurchase the stock if the price
                      after 35 days is $70.
              a)      $77.75
              b)      $87.25
              c)      $82.25
              d)      $72.75
              e)      None of the above

(a) 22                Assume that you have just sold a stock for a loss at a price of $75, for tax
                              purposes. You still wish to maintain exposure to the sold stock.
                      Suppose that you        sell a put with a strike price of $80 and a price of
                      $7.25. Calculate the effective price paid to repurchase the stock if the price
                      after 35 days is $85.
              a)      $77.75
              b)      $87.25
              c)      $82.25
              d)      $72.75
              e)      None of the above.

         USE THE FOLLOWING INFORMATION FOR THE NEXT 12 QUESTIONS

Consider the following information on put and call options for Citigroup

   Strike Price       Put Price              Call Price
   $32.50             $2.85          $1.65

(b) 23        Calculate the net value of a protective put position at a stock price at expiration of
              $20, and a stock price at expiration of $45.
              a)     $6.35, $18.85
              b)     $29.65, $42.15
              c)     $21.65, $34.15
              d)     $8, $8
         e)     -$8, -$8

(b) 24   A protective put is an appropriate strategy if
         a)     An investor wishes to generate additional income.
         b)     An investor wished to insure against a decline in share values.
         c)     An investor expected share prices to be volatile.
         d)     An investor expected share prices to remain in a trading range.
         e)     An investor expected share prices to be volatile, but was inclined to be
                bullish.

(c) 25   Calculate the net value of a covered call position at a stock price at expiration of
         $20, and a stock price at expiration of $45.
         a)     $6.35, $18.85
         b)     $29.65, $42.15
         c)     $21.65, $34.15
         d)     $8, $8
         e)     -$8, -$8

(a) 26   A covered call is an appropriate strategy if
         a)    An investor wishes to generate additional income.
         b)    An investor wished to insure against a decline in share values.
         c)    An investor expected share prices to be volatile.
         d)    An investor expected share prices to remain in a trading range.
         e)    An investor expected share prices to be volatile, but was inclined to be
               bullish.

(d) 27   Calculate the payoffs of a long straddle at a stock price at expiration of $20 and a
         stock price at expiration of $45.
         a)     $6.35, $18.85
         b)     $29.65, $42.15
         c)     $21.65, $34.15
         d)     $8, $8
         e)     -$8, -$8

(c) 28   A long straddle is an appropriate strategy if
         a)     An investor wishes to generate additional income.
         b)     An investor wished to insure against a decline in share values.
         c)     An investor expected share prices to be volatile.
         d)     An investor expected share prices to remain in a trading range.
         e)     An investor expected share prices to be volatile, but was inclined to be
                bullish.
(e) 29        Calculate the payoffs of a short straddle at a stock price at expiration of $20 and a
              stock price at expiration of $45.
              a)     $6.35, $18.85
              b)     $29.65, $42.15
              c)     $21.65, $34.15
              d)     $8, $8
              e)     -$8, -$8

(d) 30        A short straddle is an appropriate strategy if
              a)     An investor wishes to generate additional income.
              b)     An investor wished to insure against a decline in share values.
              c)     An investor expected share prices to be volatile.
              d)     An investor expected share prices to remain in a trading range.
              e)     An investor expected share prices to be volatile, but was inclined to be
                     bullish.

(a) 31        Calculate the payoffs of a long strap at a stock price at expiration of $20 and a
              stock price at expiration of $45.
              a)     $6.35, $18.85
              b)     $29.65, $42.15
              c)     $21.65, $34.15
              d)     $8, $8
              e)     -$8, -$8

(e) 32        A long strap is an appropriate strategy if
              a)     An investor wishes to generate additional income.
              b)     An investor wished to insure against a decline in share values.
              c)     An investor expected share prices to be volatile.
              d)     An investor expected share prices to remain in a trading range.
              e)     An investor expected share prices to be volatile, but was inclined to be
                     bullish.

USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT THREE QUESTIONS

The information provided is relevant in the context of a one period (one year) binomial option
pricing model. A stock currently trades at $50 per share, a call option on the stock has an
exercise price of $45. The stock is equally likely to rise by 25% or fall by 25%. The one-year
risk free rate is 2%.

(b) 33        Calculate the possible prices of the stock one year from today
              a)     $37.50 or $17.50.
              b)     $62.50 or $37.50.
              c)     $62.50 or $17.50.
              d)     $50 or $45.
              e)     None of the above.

(a) 34        Estimate n, the number of call options that must be written
               a)    -1.4286
               b)    -2.9286
               c)    -2.8571
               d)    -2.5714
               e)    -1.1111

(c) 35         Calculate the price of the call option today (C0)
               a)     $7.56
               b)     $17.48
               c)     $9.26
               d)     $5.0
               e)     $17.15

USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT FOUR QUESTIONS

The following information is provided in the context of a two period (two six month periods)
binomial option pricing model. A stock currently trades at $60 per share, a call option on the
stock has an exercise price of $65. The stock is equally likely to rise by 15% or fall by 15%
during each six month period. The one-year risk free rate is 3%.

(c) 36         Calculate the possible prices of the stock at the end of one year
               a)   $69, $51, $79.35
               b)   $51, $79.35, $58.65
               c)   $79.35, $58.65, $43.35
               d)   $58.65, $43.35, $14.35
               e)   None of the above

(a) 37         Calculate the price of the call option after the stock price has already moved up in
               value once (Cu)
               a)    $7.77
               b)    $14.35
               c)    $0
               d)    $4.21
               e)    $6.44

(c) 38         Calculate the price of the call option after the stock price has already moved down
               in value once (Cd)
               a)    $7.77
               b)    $14.35
               c)    $0
               d)    $4.21
               e)    $6.44




(d) 39         Calculate the price of the call option today (C0)
               a)   $7.77
b)   $14.35
c)   $0
d)   $4.21
e)   $6.44
CHAPTER 22


ANSWERS TO PROBLEMS


1       (US$/Can$)(0.0118)(50,000 Can$) = $590

2       (US$/Can$)(0.0068)(50,000 Can$) = $340

3       Cost = $590
        Net gain = (0.90 - 0.815)(50,000) -590 = $3,660

4       Cost = $590
        Payoff = (0) – 590 = -$590 (Option expires worthless)

5       Cost = $340
        Payoff = (0) – 340 = -$340 (Option expires worthless)

6       Cost = $340
        Payoff = (0.82 – 0.75)(50,000) - $340= $3160

7       Long straddle: purchase one OCT 85 put and one OCT 85 call
        Cost of one call = 16 3/4(100) =  $1,675.00
        Cost of one put = 1/8(100) =         $12.50
        Total cost =                      $1,687.50

        Payoff on one call = 100(101 11/16 - 85) = $1,668.75
        Payoff on one put = 0, expires out of the money
        Net gain/loss = $1,668.75 - $1,687.50 = $18.75 loss

8       Long strap: purchase two OCT 85 calls and one OCT 85 put

        Cost of 2 calls = 2(16.75(100) =     $3,350.00
        Cost of one put = 1/8(100) =            $12.50
        Total cost =                         $3,362.50

        Payoff on 2 calls = 2(100)(101 11/16 - 85) = $3,375.00
        Payoff on one put = 0, expires out of the money
        Net gain/loss = $3,375.50 - $3,362.50 = $13.00 gain

9       Long strip: purchase one OCT 85 call and two OCT 85 puts
        Cost of one call = 16 3/4(100) =   $1,675.00
        Cost of two puts = 2(1/8)(100) =       $25.00
     Total cost =                         $1,700.00


     Payoff on one call = 100(101 11/16 - 85) = $1,668.75
     Payoff on two puts = 0, expires out of the money
     Net gain/loss = $1,668.75 - $1,700.00 = $31.25 loss

10   Long straddle: purchase one OCT 90 put and one OCT 90 call
     Cost of one call = 12(100) =      $1,200.00
     Cost of one put = 3/8(100) =         $37.50
     Total cost =                      $1,237.50

     Payoff on one call = 100(101 11/16 - 90) = $1,168.75
     Payoff on one put = 0, expires out of the money
     Net gain/loss = $1,168.75 - $1,237.50 = $68.75 loss

11   Long strap: purchase two OCT 90 calls and one OCT 90 put

     Cost of 2 calls = 2(12.00(100) =     $2,400.00
     Cost of one put = 3/8(100) =            $37.50
     Total cost =                         $2,437.50

     Payoff on 2 calls = 2(100)(101 11/16 - 90) = $2,337.50
     Payoff on one put = 0, expires out of the money
     Net gain/loss = $2,337.50 - $2,437.50 = $100.00 loss

12   Long strip: purchase one 90 call and two OCT 90 puts
     Cost of one call = 12(100) =         $1,200.00
     Cost of two puts = 2(3/8)(100) =        $75.00
     Total cost =                         $1,275.00

     Payoff on one call = 100(101 11/16 - 90) = $1,168.75
     Payoff on two puts = 0, expires out of the money
     Net gain/loss = $1,168.75 - $1,275.00 = $106.25 loss

13   Long straddle: purchase one OCT 95 put and one OCT 95 call

     Cost of one call = 7 5/8(100) =       $762.50
     Cost of one put = 13/16(100) =         $81.25
     Total cost =                          $763.31

     Payoff on one call = 100(101 11/16 - 95) = $668.75
     Payoff on one put = 0, expires out of the money
     Net gain/loss = $668.75 - $763.31 = $94.56 loss

14   Long strap: purchase two OCT 95 calls and one OCT 95 put
         Cost of 2 calls = 2(7 5/8)(100) =   $1,525.00
         Cost of one put =      13/16(100) =    $81.25
         Total cost =                        $1,606.25

         Payoff on 2 calls = 2(100)(101 11/16 - 95) = $1,337.50
         Payoff on one put = 0, expires out of the money
         Net gain/loss = $1,337.50 - $1,606.25 = $268.75 loss

15       Long strip: purchase one 95 call and two OCT 95 puts

         Cost of one call = 7 5/8(100) =           $762.50
         Cost of two puts = 2(13/16)(100) =        $162.50
         Total cost =                              $925.00

         Payoff on one call = 100(101 11/16 - 95) = $668.75
         Payoff on two puts = 0, expires out of the money
         Net gain/loss = $668.75 - $925.00 = $256.25 loss

16       Bull money spread = buy the in-the-money call, i.e., OCT 85 and sell the out-of-
         the-money call, i.e., OCT 95

         Cost of buying OCT 85 call = 100(16 3/4) =                $1,675.00
         Proceeds from selling OCT 95 call = 100(7 5/8) =            $762.50
         Net cost                                                    $912.50

         Payoff on OCT 85 call = 100(110 - 85) = $2,500.00
         Payoff on OCT 95 call = 100(110 - 95) = ($1,500.00)
         Net payoff = $2,500.00 - 1,500.00 = $1,000.00
         Total gain/loss = $1,000.00 - 912.50 = $87.50 gain

17       Price using the B-S option pricing model

         d1 = ln(130/125) + [(.03 + 5(.352))(.0833)]/(.35(.02778.5))
         = 0.715807

         d2 = 0.715807 - (.35(.02778.5)) = 0.657474

         N(d1) = 0.762945
         N(d2) = 0.744562

         Call price = Pc = 120[0.762945– 125(e-.03(.02778))( 0.744562]
     = $6.19

18   Put price = 6.19 + 125(e-.03(.02778)) – 130 = $1.086

19       The effective price is 65 + 6.75 = $71.75
         The option expires worthless so your effective price is the current price plus the
         option premium.

20       The effective price is 70 + 6.75 = $76.75

         The option is exercised so your effective price is the strike price plus the option
         premium.

21       The effective price is 80 – 7.25 = $72.75

         The option is exercised so your effective price is the strike price less the option
         premium.

22       The effective price is 85 – 7.25 = $77.75

         The option expires worthless so your effective price is the current price less the
         option premium.

23       At S = 20
         Net value of protective put = (32.5 – 20) – 2.85 + 20 = 29.65
         At S = 45
         Net value of protective put = – 2.85 + 45 = 42.15

24       This strategy is appropriate if an investor wished to insure against a decline in
         share values.

25       At S = 20
         Net value of covered call = 1.65 + 20 = 21.65
         At S = 45
         Net value of covered call = -(45 – 32.5) + 1.65 + 45 = 34.15

26   This strategy is appropriate if an investor wished to generate additional income.

27       At S = 20
         Net payoff on a long straddle = (32.5 – 20) -1.65 – 2.85 = 8
         At S = 45
         Net payoff on a long straddle = (45 - 32.5) -1.65 – 2.85 = 8

28   This strategy is appropriate if an investor expected share prices to be volatile.

29       At S = 20
         Net payoff on a short straddle = -(32.5 – 20) + 1.65 + 2.85 = -8
         At S = 45
         Net payoff on a long straddle = -(45 - 32.5) + 1.65 + 2.85 = -8

30       This strategy is appropriate if an investor expected share prices to remain in a
         trading range.

31       At S = 20
            Net payoff on a long strap = (32.5 – 20) – (2)(1.65) – 2.85 = 6.35
            At S = 45
            Net payoff on a long straddle = (2)(45 - 32.5) – (2)(1.65) – 2.85 = 18.85

32      This strategy is appropriate if an investor expected share prices to be volatile.

33      If the stock rises the price one year for now will be = 50(1 + 0.25) = $62.50

        If the stock falls the price one year for now will be = 50(1 - 0.25) = $37.50

34   Current stock price = $50
     Exercise price = $45
     Risk free rate = 2%
     Price in one year if stock rises = 50(1.25) = $62.50
     Price in one year if stock declines = 50(1.25) = $37.50

             Intrinsic value of call option if stock rises to $62.50 = Max[0, 62.50 – 45] =
             $17.50
     Intrinsic value of call option if stock falls to $37.50 = Max[0, 37.50 – 45] = $0

     Estimate the number calls needed by setting:
            The hedge portfolio will consist of one share of stock held long plus some number
            of call options written.
            Value of hedge portfolio if stock rises = Value of hedge portfolio if stock falls

     62.50 + (17.5)(n) = 37.50 + (0)(n)

     n = -1.4286

35   Value of hedge portfolio today = 50 – (1.4286)(C0) = 37.5/(1.02)

     C0 = $9.26

36   Current stock price = $60
             Price in one year if stock rises 15% per six month period= 60(1.15)(1.15) =
             $$79.35
     Price in one year if stock rises 15%, then falls 15% = 60(1.15)(0.85) = $58.65
        Price in one year if stock declines 15% per period = 60(0.85)(0.85) = $43.35

37   Current stock price = $60
     Exercise price = $65
     Risk free rate = 3% or 1.49% per six month period = (1.03)0.5 – 1 = 0.0149
     Price in six months if stock rises 15% = 60(1.15) = $69
     Price in six month if stock falls 15% = 60(0.85) = $51
             Price in one year if stock rises 15% per six month period= 60(1.15)(1.15) =
             $79.35
     Price in one year if stock rises 15%, then falls 15% = 60(1.15)(0.85) = $58.65
     Price in one year if stock declines 15% per period = 60(0.85)(0.85) = $43.35

             Intrinsic value of call option if stock rises to $79.35 = Max[0, 79.35 – 65] =
             $14.35
     Intrinsic value of call option if stock falls to $58.65= Max[0, 58.65 – 65] = $0
     Intrinsic value of call option if stock falls to $43.35 = Max[0, 43.35 – 65] = $0

     Estimate the number calls needed by constructing a hedge portfolio.
            The hedge portfolio will consist of one share of stock held long plus some number
            of call options written.

            At the end of the first six month period:
            Value of hedge portfolio if stock rises = Value of hedge portfolio if stock falls

     79.35 + (14.35)(n) = 58.65 + (0)(n)

     n = -1.44251

            Value of hedge portfolio at the end of first six months = 69 – (1.44251)(Cu) =
            58.65/(1.0149)

     Cu = $7.7719

38          Cd = 0. Since the ending stock prices of $58.65 and $43.35 are both below the
            exercise price.

39          To solve for the value of the call today (C0), first determine the number of calls by
            constructing a hedge portfolio where:

            Right now:
            Value of hedge portfolio if stock rises = Value of hedge portfolio if stock falls

     69 + (7.7719)(n) = 51 + (0)(n)

     n = -2.31603

     Value of hedge portfolio now = 60 – (2.31603)(C0) = 51/(1.0149)

        C0 = $4.2092
                                 CHAPTER 24

               PROFESSIONAL ASSET MANAGEMENT

                           TRUE/FALSE QUESTIONS

(t) 1    Management and advisory firms can advise clients on how to structure their own
         portfolios.

(t) 2    In an investment company, the invested funds belong to many individuals.

(t) 3    The total market value of all assets of a mutual fund divided by the number of
         shares of the fund is known as the net asset value.

(f) 4           A portfolio is generally managed by the board of directors of an
         investment company.

(f) 5    A closed-end investment company is normally referred to as a mutual fund.

(f) 6    The market price of shares of a closed-end fund is typically determined by supply
         and demand.

(t) 7    An open-end investment company differs from a closed-end investment company
         by the way they operate after the initial public offering.

(t) 8    Open-end investment companies continue to sell and repurchase shares after their
         initial public offering.

(f) 9    A no-load fund imposes a substantial sales charge and sells shares at their NAV.

(t) 10   All investment firms charge annual management fees to compensate the
         professional manager of the fund.

(t) 11   Hedge funds are far less liquid than mutual fund shares.

(t) 12   The primary purpose of government regulations and voluntary standards in the
         professional asset management industry is to ensure that managers deal with all
         investors fairly and equitably and that information about investment performance
         is accurately reported.

(f) 13   Hedge funds have no limitations on when and how often capital can be
         contributed or removed from the partnership.
(f) 14        The returns received by the average individual investor on funds managed by
              investment companies will probably be superior to the average results for a
              specific U.S. or international market.

(t) 15        An investor should be cautious when selecting a fund based solely on the
              manager’s past performance, since past performance may not be repeated in the
              future.

(t) 16        Diversifying a portfolio to eliminate unsystematic risk is one of the major benefits
              of investing in mutual funds.

(f) 17               High Portfolio turnover lowers mutual fund costs.

(t)      18       The total market value of all assets of a mutual
              fund divided by the number of shares of the fund is
              known as the net asset value.

(f)      19       Income    distributions                     and        capital   gains
              distributions are the only                     source      of returns for
              mutual funds.

(t)      20       The market price of shares of a closed-end fund is
              typically determined by supply and demand.

(f)      21         Closed-end investment companies                       never      sell     at
                    discounts to their NAV.

(t)      22       Market   index funds   attempt                         to   match  the
              composition and performance of a                          specified market
              indicator series.

(f)           23   Open-end and closed-end investment companies are
              similar in that both companies will repurchase shares
              on demand.


                          MULTIPLE CHOICE QUESTIONS

(d) 1         Which of the following is an approach to asset management?
              a)    Management and advisory firms
              b)    Investment companies
              c)    Strategic management
              d)    Choices a and b only
              e)    All of the above

(b) 2         An open-end investment company is commonly referred to as a(n)
              a)    Balanced fund.
              b)    Mutual fund.
              c)    Money market fund.
        d)     Accessible fund.
        e)     Unit trust.


(a) 3   The main difference between a closed-end fund and an open-end fund is
        a)    The way each is traded after the initial public offering.
        b)    There is no significant difference.
        c)    The minimum initial investment.
        d)    The type of allowable investments.
        e)    The way in which each is regulated by the SEC.

(b) 4   Net asset value (NAV) is determined by
        a)     The total market value of all its assets multiplied by the number of fund
               shares outstanding.
        b)     The total market value of all its assets divided by the number of fund shares
               outstanding.
        c)     The total market value of all its assets divided by the number of
               shareholders.
        d)     Supply and demand for the investment company stock in the secondary market.
        e)     Supply and demand for the investment company stock in the primary market.

(a) 5   The market price of a closed-end investment company has generally been
        a)    5 to 20 percent below the NAV.
        b)    25 to 35 percent below the NAV.
        c)    Equal to the NAV (within a 2 percent range).
        d)    5 to 20 percent above the NAV.
        e)    25 to 35 percent above the NAV.

(c) 6   The closed-end fund index is
        a)     Value weighted and based on market values.
        b)     Value weighted and based on NAVs.
        c)     Price weighted and based on market values.
        d)     Price weighted and based on NAVs.
        e)     Equally weighted and based on market values.

(d) 7   Open-end mutual funds that charge a sales fee when the fund is initially offered to
        the investor are known as
        a)      12b-1.
        b)      Americus trusts.
        c)      Unit investment trusts.
        d)      Load funds.
        e)      Contingency funds.

(c) 8   A 12b-1 plan allows funds to
        a)     Charge a redemption fee.
        b)     Deduct 7 to 8 percent commission at the initial offering.
         c)     Deduct .75 percent of the average net assets per year.
         d)     Charge a contingent deferred sales load.
         e)     Switch from closed-end to open-end.


(d) 9    When the offer price and the NAV of a mutual fund are equal it is an indication that
         a)    The fund’s assets are in equilibrium.
         b)    The fund is trading at par.
         c)    It is strictly a coincidence.
         d)    The fund has no initial fee.
         e)    The fund is backloaded.

(c) 10   All investment companies charge an annual
         a)      12b-1 fee.
         b)      Marketing and distribution.
         c)      Management fee.
         d)      Maintenance fee.
         e)      Market adjustment.

(b) 11   The offering price of a load fund equals the NAV of the fund
         a)     Less an initial requirement.
         b)     Plus a sales charge.
         c)     Plus a sales charge and an administrative fee.
         d)     Less a negotiated discount.
         e)     At its stated value.

(b) 12   Funds that normally contain a combination of common stock and fixed income
         securities are known as
         a)      Section 401(k) plans.
         b)      Balanced funds.
         c)      Contractual plans.
         d)      Income funds.
         e)      Flexible funds.

(d) 13   Funds that attempt to provide current income, safety of principal and liquidity are
         known as
         a)     Balanced funds.
         b)     Flexible funds.
         c)     Income funds.
         d)     Money market funds.
         e)     Index funds.

(e) 14   A money market fund would be likely to invest in a portfolio containing all of the
         following except
         a)     Commercial paper.
         b)     Banker's acceptances.
         c)     U.S. Treasury bills.
         d)     Bank certificates of deposit.
         e)     U.S. Treasury notes.


(d) 15   A mutual fund typically performs all of the following functions, except
         a)    Provides alternative risk-return options.
         b)    Eliminates unsystematic risk.
         c)    Provides diversification.
         d)    Derives a risk-adjusted performance that is consistently superior to risk-
               adjusted net return of the aggregate market.
         e)    Administers the account, keeps records and provides timely information.

(b) 16   Mutual fund performance studies have shown that most funds
         a)     Have risks and returns that are inconsistent with their stated objectives.
         b)     Have risks and returns that are consistent with their stated objectives.
         c)     Do not have stated objectives.
         d)     Have experienced risk-adjusted returns above the market.
         e)     Have changed their objectives over time.

(c) 17   The text offers a number of suggestions for investing in mutual funds. Which of the
         following is not such a suggestion?
         a)     Choose only those mutual funds which are consistent with your objectives
                and constraints.
         b)     Invest in no-load funds whenever possible.
         c)     Avoid investing in index funds.
         d)     Use a dollar cost average strategy.
         e)     None of the above (that is, all are valid suggestions for investing in mutual
                funds)

(e) 18   The gross return of closed-end investments companies has typically been
         a)     10 - 20 percent less than their NAV.
         b)     10 - 15 percent less than their NAV.
         c)     Less than the net return.
         d)     About the same as the net return.
         e)     None of the above

(e) 19   A major question in modern finance regarding closed-end investment companies is
         a)    Why do these funds sell at discounts?
         b)    Why do the discounts differ between funds?
         c)    What are the returns available to investors from funds that sell at a large
               discount?
         d)    Choices a and b only
         e)    All of the above
(b) 20   A portfolio manager should be able to perform all of the following functions, except
         a)     Determine risk-return preferences.
         b)     Eliminate systematic risk.
         c)     Maintain diversification ensuring a stabilized risk class.
         d)     Attempt to derive a risk-adjusted performance that is superior to the market.
         e)     Administer the account, keep records and provide timely information.

(b) 21   An investment company is
         a)     A corporation that handles the administrative functions for a fund.
         b)     A corporation that has its major assets in a portfolio of securities.
         c)     A corporation that invests in financial services firms.
         d)     a) and b).
         e)     a) and c).

(a) 22   An investment management company is
         a)     A corporation that handles the administrative functions for a fund.
         b)     A corporation that has its major assets in a portfolio of securities.
         c)     A corporation that invests in financial services firms.
         d)     a) and b).
         e)     a) and c).

(d) 23   In the case of private management firms
         a)      Investors deal with a fund company and do not have separate accounts
                 tailored to their specific needs.
         b)      Investors deal with a fund company and have separate accounts tailored to
                 their specific needs.
         c)      Investors deal with an asset manager and do not have separate accounts
                 tailored to their specific needs.
         d)      Investors deal with an asset manager have separate accounts tailored to their
                 specific needs.
         e)      None of the above.

(a) 24   In the case of investment companies
         a)      Investors deal with a fund company and do not have separate accounts
                 tailored to their specific needs.
         b)      Investors deal with a fund company and have separate accounts tailored to
                 their specific needs.
         c)      Investors deal with an asset manager and do not have separate accounts
                 tailored to their specific needs.
         d)      Investors deal with an asset manager have separate accounts tailored to their
                 specific needs.
         e)      None of the above.
(e) 25   In the case of open-end investment companies, shares of the company
         a)      Trade on the secondary market.
         b)      Can be bought from or sold to the investment company at the NAV.
         c)      Are determined by supply and demand.
         d)      a) and c).
         e)      b) and c).

(d) 26   In the case of closed-end investment companies, shares of the company
         a)      Trade on the secondary market.
         b)      Can be bought from or sold to the investment company at the NAV.
         c)      Are determined by supply and demand.
         d)      a) and c).
         e)      b) and c).

(d) 27   The following are examples of mutual fund companies
         a)      Common stock funds.
         b)      Bond funds.
         c)      Hedge funds.
         d)      a) and b).
         e)      a), b) and c)

(b) 28   An example of an international fund would be one that consisted of investments in
         securities from
         a)      The U.S., Germany, and Japan.
         b)      Germany, Italy, and the U.K.
         c)      The U.S., Korea, and Argentina.
         d)      All of the above.
         e)      None of the above.

(d) 29   The Investment Company Act of 1940
         a)     Contains various anti-fraud provisions and record keeping and reporting
                requirements for fund advisors.
         b)     Regulates broker-dealers.
         c)     Requires federal registration of all public offerings of securities.
         d)     Regulates the structure and operations of mutual funds.
         e)     Contains a code of ethics and standards of professional conduct.

(c) 30   The Securities Act of 1933
         a)     Contains various anti-fraud provisions and record keeping and reporting
                requirements for fund advisors.
         b)     Regulates broker-dealers.
         c)     Requires federal registration of all public offerings of securities.
         d)     Regulates the structure and operations of mutual funds.
         e)     Contains a code of ethics and standards of professional conduct.


(b) 31   The Securities Exchange Act of 1934
         a)     Contains various anti-fraud provisions and record keeping and reporting
                requirements for fund advisors.
         b)     Regulates broker-dealers.
         c)     Requires federal registration of all public offerings of securities.
         d)     Regulates the structure and operations of mutual funds.
         e)     Contains a code of ethics and standards of professional conduct.

(a) 32   The Investment Advisors Act of 1940
         a)     Contains various anti-fraud provisions and record keeping and reporting
                requirements for fund advisors.
         b)     Regulates broker-dealers.
         c)     Requires federal registration of all public offerings of securities.
         d)     Regulates the structure and operations of mutual funds.
         e)     Contains a code of ethics and standards of professional conduct.

(d) 33   Soft dollars are generated when
         a)     A manager commits to paying a higher than normal brokerage fee in
                exchange for additional bundled services.
         b)     A manager commits to paying a higher than normal brokerage fee in
                exchange for secretarial services.
         c)     A manager commits to paying a higher than normal brokerage fee in
                exchange for office equipment.
         d)     All of the above.
         e)     None of the above.

(a) 34   Which of the following is a characteristic of hedge funds
         a)    They are generally less restricted in how and where they can make
               investments.
         b)    They are more liquid than mutual fund shares.
         c)    They have no limitations on when and how often investment capital can be
               contributed or removed.
         d)    All of the above.
         e)    None of the above.

(a) 35   In a long short-short hedge fund strategy
         a)      Managers take long positions in undervalued stocks and short positions in
                 overvalued stocks.
         b)      Managers take short positions in undervalued stocks and long positions in
                 overvalued stocks.
         c)      Managers take offsetting risk positions on the long and short side.
         d)      All of the above.
         e)     None of the above.



(b) 36   In a convertible arbitrage strategy hedge fund managers attempt to
         a)      Generate profits by taking advantage of convertible bond pricing
                 disparities caused by changing market events.
         b)      Generate profits by taking advantage of disparities in the relationship
                 between prices for convertible bonds and the underlying common stock.
         c)      Generate profits by taking advantage of disparities in the relationship
                 between prices for convertible bonds and the underlying common stock
                 option.
         d)      All of the above.
         e)      None of the above.

(d) 37   Ethical conflicts may arise as a result of
         a)      Incentive compensation schemes.
         b)      Soft dollar arrangements.
         c)      Marketing investment management services.
         d)      All of the above.
         e)      None of the above.

(d) 38   Which of the following are guiding principles for ethical behavior in the asset
         management industry as put forward by the CFA Center for Financial Market
         Integrity
         a)      The interests of investment professional come first.
         b)      The preferred method for promoting fair and efficient markets is to set up
                 a central oversight board.
         c)      Financial markets in various countries should develop high-quality
                 standards for reporting financial information that reflect local customs.
         d)      Financial statements should be reported from the perspective of firm
                 shareholders.
         e)      All of the above.

(c) 39   Which of the following are functions that a portfolio manager should perform for
         clients
         a)      Determine investment objectives and constraints, diversify the portfolio,
                 eliminate tax payments.
         b)      Determine investment objectives, diversify the portfolio, maintain ethical
                 standards and eliminate tax payments.
         c)      Determine investment objectives and constraints, diversify the portfolio,
                 and maintain ethical standards.
         d)      Determine constraints, diversify the portfolio, eliminate tax payments.
         e)      Determine investment objectives and constraints, diversify the portfolio,
                 eliminate tax payments, and achieve risk adjusted return superior to the
                 relevant benchmark.
                           MULTIPLE CHOICE PROBLEMS

        USE THE FOLLOWING INFORMATION FOR THE NEXT TWO PROBLEMS

          Suppose ABC Mutual fund owned only 4 stocks as follows:

           Stock                   Shares                       Price
           W             2500           $11
           X             2100             14
           Y             2700             23
           Z             1900             15


(b)       1       The fund originated by selling $100,000 of stock
              at $10.00 per share. What is its current NAV?
              a) $ 1.47
              b) $ 14.75
              c) $ 16.03
              d) $ 27.62
              e) $234.12


(d)       2         What is the offering price for the fund if the
              NAV   is $25.25 and a the load is 6 percent?
              a)    $26.19
              b)    $23.74
              c)    $25.25
              d)    $26.77
              e)    $24.13

(d) 3         Suppose Mega Mutual Fund owns only the 4 stocks shown below with no liabilities.
              Stock              Shares            Price
                 A                1800              15
                 B                2200              11
                 C                2300               9
                 D                1900              18
              The fund originated by selling $300,000 of stock at $30.00 per share. What is its
              current NAV?
              a)      $106.10
              b)      $12.94
              c)      $129.40
              d)      $10.61
              e)      None of the above
(a) 4   Suppose Under Mutual Fund owns only the 3 stocks shown below with no liabilities.
        Stock              Shares            Price
           A                2900              15
           B                3100              14
           C                3200              12
        The fund originated by selling $500,000 of stock at $50.00 per share. What is its
        current NAV?
        a)      $12.53
        b)      $15.29
        c)      $152.90
        d)      $125.30
        e)      None of the above

(b) 5   Suppose you consider investing $1,000 in a load fund which charges a fee of 2%,
        and you expect the fund to earn 14% over the next year. Alternatively, you could
        invest in a no-load fund with similar risk that is expected to earn 9% and charges a
        1/2 percent redemption fee. Which is better and by how much?
        a)      Funds are equal
        b)      Load fund by $32.65
        c)      Load fund by $50.55
        d)      No-load fund by $64.55
        e)      No-load fund by $44.30

(d) 6   Suppose you consider investing $1,000 in a load fund which charges a fee of 2%,
        and you expect the fund to earn 11% over the next year. Alternatively, you could
        invest in a no-load fund with similar risk that is expected to earn 7% and charges a
        1/2 percent redemption fee. Which is better and by how much?
        a)      Funds are equal
        b)      No-load fund by $36.98
        c)      Load fund by $45.25
        d)      Load fund by $23.15
        e)      No-load fund by $15.52

(b) 7   Suppose you consider investing $15,000 in a load fund from which a fee of 5% is
        deducted and you expect the fund to earn 12% over the next year. Alternatively,
        you could invest in a no load fund which is expected to earn 10% and which takes
        a 1/2 percent redemption fee. Which is better and by how much?
        a)      Load fund by $318.45
        b)      No load fund by $457.50
        c)      Funds are equal
        d)      Load fund by $415.10
        e)      No load fund by $211.51
(b) 8    Suppose you consider investing $10,000 in a load fund from which a fee of 3% is
         deducted and you expect the fund to earn 12% over the next year. Alternatively,
         you could invest in a no load fund which is expected to earn 10% and which takes
         a 0 percent redemption fee. Which is better and by how much?
         a)      Load fund by $151
         b)      No load fund by $136
         c)      Funds are equal
         d)      No load fund by $421
         e)      Load fund by $115

(b) 9    Suppose you consider investing $5,000 in a load fund from which a fee of 8% is
         deducted and you expect the fund to earn 12% over the next year. Alternatively,
         you could invest in a no load fund which is expected to earn 10% and which takes
         a 1/2 percent redemption fee. Which is better and by how much?
         a)      Load fund by $57.50
         b)      Load fund by $575.50
         c)      Funds are equal
         d)      No load fund by $575.50
         e)      No load fund by $57.50

(b) 10   On January 2, 2003, you invest $10,000 in Megabucks Mutual Fund, a load fund
         that charges a fee of 2%. The fund’s returns were 13% in 2003, 11% in 2004, 8% in
         2005. On December 31, 2005 you redeem all your shares. The dollar value is
         a)      $13,600.00
         b)      $13,275.51
         c)      $13,297.67
         d)      $13,995.75
         e)      $10,000.00

(c) 11   On January 2, 2003, you invest $50,000 in the Lizbiz Mutual Fund, a load fund that
         charges a fee of 5%. The fund’s returns were 14.6% in 2003, -6.4% in 2004, 15.2%
         in 2005. On December 31, 2005 you redeem all your shares. The dollar value is
         a)     $66,722.27
         b)     $15,200.00
         c)     $58,695.74
         d)     $33,366.25
         e)     $10,000.00
(b) 12   On January 2, 2003, you invest $100,000 in the Jeffers Mutual Fund, a load fund
         that charges a fee of 5%. The fund’s returns were -14.6% in 2003, -6.4% in 2004,
         35% in 2005. On December 31, 2005 you redeem all your shares. The dollar value
         is:
         a)      $95,600.57
         b)      $102,515.90
         c)      $83,297.75
         d)      $133,995.75
         e)      $100,000.00

(c) 13   On January 2, 2003, you invest $10,000 in the Tiger Fund, a load fund that charges a
         fee of 6%. The fund’s returns were 25% in 2003, 35% in 2004, -5% in 2005. On
         December 31, 2005 you redeem all your shares of Tiger. The dollar value is
         a)      $5,200.89
         b)      $13,345.89
         c)      $7,931.25
         d)      $15,896.34
         e)      $8,646.91

(e) 14   On January 2, 2003, you invest $10,000 in the W.O.W. Mutual Fund, a load fund
         that charges a fee of 5%. The fund’s returns were 13.6% in 2003, 12.2% in 2004,
         8.3% in 2005. On December 31, 2005 you redeem all your W.O.W. shares. The
         dollar value is
         a)      $13,600.00
         b)      $13,664.13
         c)      $10,000.00
         d)      $131,136.40
         e)      $13,113.64

(b) 15   On January 2, 2003, you invest $10,000 in the Dog Mutual Fund, a load fund that
         charges a fee of 7%. The fund’s returns were 12.8% in 2003, 13.9% in 2004, 7.9%
         in 2005. On December 31, 2005 you redeem all your shares. The dollar value is
         a)       $12,800.00
         b)       $12,892.50
         c)     $100,000.00
         d)     $128,925.00
         e)       $10,000.00
(a) 16         On January 2, 2003, you invest $50,000 in A Mutual Fund, a load fund that charges
               a fee of 7%. The fund’s returns were 12.8% in 2003, 13.9% in 2004, 7.9% in 2005.
               On December 31, 2005 you redeem all your shares in A. The dollar value is
               a)        $64,462.57
               b)      $644,625.70
               c)        $50,000.00
               d)         $6,446.25
               e)        $10,000.00

(d) 17         On January 2, 2003, you invest $100,000 in Righteous, a load fund that charges a fee
               of 7%. The fund’s returns were 12.8% in 2003, 13.9% in 2004, 7.9% in 2005. On
               December 31, 2005 you redeem all your Righteous shares. The dollar value is
               a)      $12,800.00
               b)      $12,892.50
               c)     $100,000.00
               d)     $128,925.00
               e)      $10,000.00
(b) 18         Consider the Defiance Bond Fund that consists of the 3 bonds shown below and has
               no liabilities.

Company Current Bond Value                     # Bonds
                     Komko              980              120
                     Hijack            1010              150
                     Mitsue            1200              100
If initially the value of the fund was $250,000 and the original shares were offered to the public
                  with a NAV of $25 per share, what is the current NAV of the fund?
                  a)      $25.00
                  b)      $38.91
                  c)      $39.81
                  d)      $31.98
                  e)      $39.91
(d) 19         Consider X Bond Fund which consists of the 5 bonds shown below with no liabilities.

Company Current Bond Value                     # Bonds
                Komko                    980             120
                 Hijack                 1010             150
                 Mitsue                 1200             100
                 Smitsu                  800             120
                  Jones                  600             150
               If initially the value of the fund was $1,000,000 and the original shares were offered
               to the public with a NAV of $25 per share, what is the current NAV of the fund?
               a)       $25.00
               b)       $27.68
               c)       $25.68
               d)       $28.76
              e)     $26.78

(a) 20        Consider the Compliance Bond Fund that consists of the 7 bonds shown below and
              has no liabilities.
              Company          Current Bond Value # Bonds
                 Komko                  980             120
                 Hijack                1010             150
                 Mitsue                1200             100
                 Smitsu                 800             120
                  Jones                 600             150
                 GMM                   1000             150
                  ATP                   950             150
              If initially the value of the fund was $2,500,000 and the original shares were offered
              to the public with a NAV of $25 per share, what is the current NAV of the fund?
              a)       $27.11
              b)       $25.00
              c)       $26.11
              d)       $21.67
              e)       $26.27

(b)      21       Given the following fees and expected returns
              for fund X, assuming an initial investment of $1000
              calculate the value of the investment at the end of
              5 years.

                    Investment E(Return)       Load                         12b-1              fee
                    Rear-end load   Years
                        X           10%        2.5%                         0.25%
                        0%                5 years

              a)     $1069.82
              b)     $1550.77
              c)     $1042.36
              d)     $1689.95
              e)     $1389.95
(d)      22       Given the following fees and expected returns
              for fund Y, assuming an initial investment of $1000
              calculate the value of the investment at the end of
              5 years

                    Investment E(Return)                    Load            12b-1              fee
                    Rear-end load   Years
                            Y             8%                                0%
                        0.50%       3%                      5 years

              a)     $1069.82
              b)     $1550.77
              c)     $1642.36
              d)     $1389.95
              e)     $1362.59
(c)   23       Calculate the annual rate of return for a mutual
           fund with the following fees and expected returns

                Investment E(Return)      Load   12b-1      fee
                    Years Held
                Mutual Fund          7%          4%
                    0.50%       7 years
           a)   4.95%
           b)   5.0%
           c)   5.85%
           d)   2.5%
           e)   6.55%
                                CHAPTER 24


                        ANSWERS TO PROBLEMS
1    Original number of shares = $100,000/$10 = 10,000

                              Shares Price            MV
                       W       2500   $11           $27,500
                       X       2100    14           $29,400
                       Y       2700    23           $62,100
                       Z       1900    15           $28,500
                     TOTAL                         $147,500



     NAV =    $147,500/10,000 = $14.75


2    Offering price = NAV + NAV x Load percentage

                          = $25.25 + 25.25(0.06)

                          =   $26.77

3   Original number of shares = $300,000  $30 = 10,000

    Stock      Shares    Price      Market Price
      A         1800      15           27,000
      B         2200      11           24,200
      C         2300       9           20,700
      D         1900      18           34,200
                              Total = 106,100

    NAV = $106,100  10,000 = $10.61

4   Original number of shares = $500,000  $50 = 10,000

    Stock      Shares    Price      Market Price
     AA         2900      15           43,500
     BB         3100      14           43,400
     CC         3200      12           38,400
                              Total = 125,300

    NAV = $125,300  10,000 = $12.53
5    Load Fund: $1,000 (1.00 - 0.02) (1.14) = $1117.20

     No-Load Fund: $1,000 (1.09)(1.00 - 0.005) = $1084.55

     The difference is 1117.20 - 1084.55 = $32.65

     Load fund is better.

6    Load Fund: $1,000 (1.00 - 0.02) (1.11) = $1087.80

     No-Load Fund: $1,000 (1.07)(1.00 - 0.005) = $1064.65

     The difference is $1087.80 - $1064.65= $23.15

     Load fund is better.

7    Load Fund $15,000 (1.00 - 0.05) (1.12) = $15960

     No-Load Fund $15,000 (1.10) (1.00 - .005) = $16417.50

     The difference is $16417.50 - $15960 = $457.50

     No-Load fund is better.

8    Load Fund $10,000 (1.00 - 0.03) (1.12) = $10864

     No-Load Fund $10,000 (1.10) = $11000

     The difference is $11000 - $10864 = $136

     No-Load fund is better.

9    Load Fund $5,000 (1.00 - 0.08) (1.12) = $6048.00

     No-Load Fund $5,000 (1.10) (1.00 - .005) = $5472.50

     The difference is $6048.00 - $5472.50 = $575.50

     Load fund is better.

10   Dollar value = $10,000 (1.13)(1.11)(1.08)(1.00 - 0.02) = $13275.51

11   Dollar value = $50,000 (1.146)(0.936)(1.152)(1.00 - 0.05) = $58695.74

12   Dollar value = $100,000 (0.854)(0.936)(1.35)(1.00 - 0.05) = $102515.90
13    Dollar value = $10,000 (1.25)(1.35)(0.5)(1.00 - 0.06) = $7931.25

14    Dollar value = $10,000 (1.136)(1.122)(1.083)(1.00 - 0.05) = $13,113.64

15    Dollar value = $10,000 (1.128)(1.139)(1.079)(1.00 - 0.07) = $12,892.50

16    Dollar value = $50,000 (1.128)(1.139)(1.079)(1.00 - 0.07) = $64,462.51

17    Dollar value = $100,000 (1.128)(1.139)(1.079)(1.00 - 0.07) = $128,925.02

18    Original # of shares = 250,000  25 = 10,000
      NAV = 389,000  10,000 = $38.91

19    Original # of shares = 500,000  25 = 20,000
      NAV = 575,100  20,000 = $28.76

20    Original # of shares = 800,000  25 = 32,000
      NAV = 867,600  32,000 = $27.11

21   $1000(1 - 0.025)(1 + .10)5(1 - 0.0025)5 = $1,550.77

22   $1000(1 + 0.08)5(1 - 0.005)5(1 - .03) = $1,389.95

23   $1(1 – 0.04)(1 + 0.07)7(1 - 0.005)7 = $1.4884

     Annual return = 1.48841/7 – 1 = 0.05845 = 5.85%

								
To top