Chapter 24 fundamentals of corporate finance 9th edition test bank

24
Student: ___________________________________________________________________________

1.

Which one of the following grants its owner the right to buy or to sell an asset at a prespecified price at
any time during a stated period?
A. option
B. forward contract
C. futures contract
D. swap
E. intrinsic contract

2.

Elizabeth owns a call option on 100 shares of Microsoft stock. She has decided to buy those shares. This
purchase is commonly referred to as:
A. striking the asset.
B. expiring the option.
C. exercising the option.
D. putting the collar.
E. the collar option.

3.

Marti owns an option that allows him to purchase ABC stock at $50 a share. The $50 price is referred to
as the:
A. opening price.
B. intrinsic value.
C. strike price.
D. market price.

E. time value.

4.

What is the final day on which an option can be exercised called?
A. payment date
B. ex-option date
C. opening date
D. expiration date
E. intrinsic date

5.

Felicia purchased an option which she can exercise anytime within the next six months. Which type of
option did she purchase?
A. market-ready
B. portable
C. daily
D. European
E. American

6.

Brad purchased an option that he can only exercise on the final day of the option period. Which type of
option did he purchase?
A. European
B. American
C. inflexible
D. dated
E. pointed

7.

Which of the following grants its owner the right to purchase an asset at a stated price?
I. American call
II. European call
III. American put
IV. European put
A. I only
B. I and II only
C. I and III only
D. II and IV only
E. III and IV only

8.

The owner of a put option has the _____ an asset at a fixed price during a stated period of time.
A. right to sell
B. right to buy
C. obligation to sell
D. obligation to buy
E. obligation to trade

9.

Which one of the following terms applies to the value of an option on its expiration date?
A. strike price
B. upper limit
C. deadline price

D. time value
E. intrinsic value

10. Suzie is the controller of The Price Rite Company. She has been granted to the right to buy 1,000 shares
of her employer's stock at $25 a share anytime within the next three years. Which one of the following
has Suzie been granted?
A. employee stock option
B. company bonus option
C. employee grant
D. employee exercise option
E. company benefits option
11. Which one of the following terms applies to an option that has an office building as its underlying asset?
A. financial option
B. liquid option
C. fixed option
D. real option
E. concrete option
12. The investment timing decision is the:
A. determination of when an option should be exercised.
B. decision of when to purchase an option on an underlying asset.
C. analysis of determining when an asset should be sold.
D. determination of when a project should be abandoned.
E. evaluation of the optimal time to begin a project.
13. Lucas Enterprises recently opted to open a new retail outlet. If the outlet outperforms the expectations,
the manager can opt to increase the store's size. If it underperforms, the manager can opt to close the
store. These choices that the manager has been given are called:
A. call options.
B. put options.
C. straddles.
D. managerial options.

E. executive options.


14. Which one of the following considers all of the options implicit in a project?
A. expansion planning
B. contingency planning
C. asset management review
D. prospective evaluation
E. strategic evaluation
15. KT Enterprises has expanded its operations into a new field, which is the production of everyday
dinnerware. If this project goes well, the firm has the option to expand its production into fine china.
What type of option is this?
A. financial
B. strategic
C. put
D. intangible
E. call
16. Amy is a current shareholder of DJ Industries. She has been given the right to purchase an additional
25 shares of DJ Industries stock at a price of $32 a share if she exercises that right within the next 12
months. What is this security called that Amy has been given?
A. convertible bond
B. warrant
C. straddle
D. spread
E. put
17. Jeff owns a $1,000 face value bond. He can exchange that bond for 25 shares of KNJ stock at any time
within the next 2 years. What type of bond does Jeff own?
A. secured
B. warranted
C. convertible

D. junk
E. callable
18. The dollar amount of a bond's par value that is exchangeable for one share of stock is called the:
A. conversion premium.
B. par value.
C. conversion value.
D. conversion price.
E. conversion ratio.
19. Alicia owns a $1,000 face value bond that can be converted into 20 shares of AB Limited stock. Which
one of the following terms refers to these 20 shares?
A. conversion premium
B. straight bond value
C. conversion value
D. conversion price
E. conversion ratio
20. The difference between the conversion price and the current stock price, divided by the current stock
price, is called the:
A. conversion premium.
B. straight bond value.
C. conversion value.
D. conversion price.
E. conversion ratio.


21. Latetia owns a convertible bond. Which one of the following terms would describe the value of this bond
if it were not convertible?
A. conversion premium
B. straight bond value
C. conversion value
D. inverted value

E. market value
22. Brad owns a convertible bond. Which one of the following terms would apply to the value of this bond if
he were to convert it into shares of stock today?
A. conversion premium
B. straight bond value
C. conversion value
D. inverted value
E. prescribed value
23. Which one of the following statements correctly describes your situation as the holder of a European call
option?
A. You are obligated to buy if the option is exercised.
B. You have a right to sell.
C. You have a right to buy but only on the expiration date.
D. You are obligated to sell if the option is exercised.
E. You have a right to buy at any time before the option expires.
24. Julie opted to exercise her August option on June 20th and as a result received $2,500 for the sale of her
shares. Which one of the following did Julie own?
A. warrant
B. American call
C. American put
D. European call
E. European put
25. Josh opted to exercise his January option at the end of December and paid $3,250 at that time to acquire
100 shares of stock. Which one of the following did Josh own?
A. American call
B. American put
C. European call
D. European put
E. European convertible bond
26. Steve owns an option which grants him the right to purchase shares of Lokier Tool stock at a price of $45

a share. Currently, the stock is selling for $52.40 a share. Steve would like to realize his profits but is not
permitted to exercise the option for another two weeks. Which one of the following does Steve own?
A. straight bond
B. American call
C. American put
D. European call
E. European put
27. What is the primary difference between an American call option and a European call option?
A. The American call has a fixed strike price while the European strike price varies over time.
B. An American call is a right to buy while a European call is an obligation to buy.
C. An American call has an expiration date while the European call does not.
D. An American call is written on 100 shares of the underlying security while the European call covers
1,000 shares.
E An American call an be exercised at any time up to the expiration date while the European call can only
. be exercised on the expiration date.


28. You own a July $15 call on ABC stock. Assume today is April 20 and the call has zero intrinsic value.
Which one of the following best describes this option?
A. worthless
B. unfunded
C. expired
D. in-the-money
E. out-of-the-money
29. A $20 put option on Wildwood stock expires today. The current price of the stock is $18.50. Which one
of the following best describes this option?
A. funded
B. unfunded
C. at-the-money
D. in-the-money

E. out-of-the-money
30. Which one of the following describes the maximum value of a call option?
A. strike price minus the initial cost of the option
B. exercise price plus the price of the underlying stock
C. strike price
D. market price of the underlying stock
E. purchase price
31. Which one of the following describes the lower bound of a call's value?
A. strike price or zero, whichever is greater
B. stock price minus the exercise price or zero, whichever is greater
C. strike price or the stock price, whichever is lower
D. strike price or zero, whichever is lower
E. stock price minus the exercise price or zero, whichever is lower
32. Which one of the following describes the intrinsic value of a call option?
A. the call's upper bound value
B. the call's lower bound value
C. market price of the underlying security
D. zero, if the call is in-the-money
E. negative amount, if the call is out-of-the-money.
33. Which one of the following describes the intrinsic value of a put option?
A. lesser of the strike price or the stock price
B. lesser of the stock price minus the exercise price or zero
C. lesser of the stock price or zero
D. greater of the strike price minus the stock price or zero
E. greater of the stock price minus the exercise price or zero
34. Which one of the following statements is correct?
A. The value of a call decreases as the price of the underlying stock increases.
B. The value of a call increases as the exercise price decreases.
C. The value of a put increases as the price of the underlying stock increases.
D. The value of a put decreases as the exercise price increases.

E. The intrinsic value of a put must be zero on the expiration date.


35. An increase in which of the following will increase the value of a call?
I. time to expiration
II. underlying stock price
III. risk-free rate of return
IV. price volatility of the underlying stock
A. I and III only
B. II, III, and IV only
C. I, III, and IV only
D. I, II, and III only
E. I, II, III, and IV
36. Which of the following will decrease the value of a call option?
I. a decrease in the exercise price
II. a decrease in the value of the underlying security
III. an increase in the risk-free rate
IV. an increase in the time to expiration
A. II only
B. I and II only
C. III and IV only
D. I, II, and IV only
E. I, II, and III only
37. Mark owns both a March $20 put and a March $20 call on Alpha stock. Which one of the following
statements correctly relates to Mark's position? Ignore taxes and transaction costs.
A. A price decrease in Alpha stock will increase the value of Mark's call option.
B. A March $30 call is worth more than Mark's $20 call.
C The time premium on an April $20 put is less than the time premium on Mark's put. (Assume both puts
. expire in the same calendar year.)
D. A price increase in Alpha stock from $26 to $28 will increase the value of Mark's put.

E. If the intrinsic value of Mark's put increases by $1 then the intrinsic value of his call must either
decrease by $1 or equal zero.
38. Travis owns both a September $30 call and a September $30 put. If the call finishes at-the-money, then
the put will:
A. also finish in-the-money.
B. finish at-the-money.
C. finish out-of-the-money.
D. either finish at-the-money or in-the-money.
E. either finish at-the-money or out-of-the-money.
39. Which one of the following statements regarding employee stock options (ESOs) is correct?
A. ESOs grant an employee the right to buy a fixed number of shares of company stock at the market
price.
B. Employees must exercise their ESOs prior to those ESOs becoming vested.
C. Employees may forfeit their ESOs if they terminate their employment with the issuing firm.
D. If a firm issue ESOs it must make them available to all employees.
E. Employees can sell their ESOs if they do not want to personally exercise them.
40. Employee stock options are primarily designed to do which one of the following?
A. provide employees with put options on their shares of company stock
B. provide an immediately vested benefit to key employees
C. influence the actions and priorities of employees
D. distribute excess cash to key employees to avoid corporate taxation
E. provide an immediate capital gain to certain employees


41. Employee stock options:
A. usually have a positive intrinsic value when issued.
B. must be backdated at least six months to comply with Sarbanes-Oxley.
C. are generally "underwater" when issued.
D. are frequently repriced if the options are in-the-money.
E. are generally issued with a zero intrinsic value.

42. The Sarbanes-Oxley Act of 2002 requires firms to report ESO grants within how many days of the grant?
A. 2 calendar days
B. 2 business days
C. 7 calendar days
D. 30 business days
E. 45 calendar days
43. Delta Importers has a pure discount loan with a face value of $180,000 due in one year. The assets of
the firm are currently worth $265,000. The shareholders in this firm basically own a _____ option on the
assets of the firm with a strike price of _____.
A. put; $180,000.
B. put; $265,000.
C. warrant; $265,000.
D. call; $180,000.
E. call; $265,000.
44. Jack and Jill are house hunting. They find House A situated on a hill. They really like the house but want
to continue searching the market for one more week before making their final decision to buy the house.
To avoid having someone else purchase House A while they continue their house hunting, they decide to
place a $2,500 deposit on House A. This deposit will apply to the purchase price if they buy House A. If
they do not buy House A, they will forfeit the $2,500. Essentially, Jack and Jill have a _____ on House
A.
A. financial put
B. financial call
C. warrant
D. real put
E. real call
45. The option to wait:
I. may be of minimal value if a project is dependent upon rapidly changing technology.
II. is partially dependent upon the discount rate applied to the project being evaluated.
III. is defined as temporarily shutting down a project for a period of time.
IV. has a value equal to the NPV of a project if it is started at a later date minus the NPV if the project is

started today.
A. I and III only
B. II and IV only
C. I and II only
D. II, III, and IV only
E. I, II, and IV only
46. Ignoring which of the following will cause the NPV of a project to be underestimated?
I. option to abandon
II. option to expand
III. option to wait
IV. option to contract
A. I and III only
B. II, III, and IV only
C. I, II, and III only
D. I, III, and IV only
E. I, II, III, and IV


47. Which one of the following is an example of a strategic option for a restaurant?
A.opening a new restaurant with a different look and an entirely different menu to see if that type of
restaurant appeals to the public
B. deciding to close one hour earlier during the winter months due to slow sales
C. abandoning a menu item based on customer complaints
D. deciding to open only two new locations next year instead of the five that were originally scheduled
E. deciding to create separate lunch and dinner menus rather than have them combined on one menu
48. Last month, Hill Side Markets introduced a new board game. Consumer demand has been overwhelming
and appears that strong demand will exist over the long-term as young children absolutely love the game.
Given this, which one of the following options should Hill Side Markets consider in respect to this game?
A. suspension
B. expansion

C. abandonment
D. contraction
E. withdrawal
49. Three months ago, Toy Town introduced a new toy for pre-school children. The store expected this toy to
be an instant success and a fast moving item. To their surprise, children have zero interest in this toy so
sales have been abysmal. Which one of the following options should Toy Town consider in respect to this
toy?
A. suspension
B. expansion
C. abandonment
D. contraction
E. re-introduction
50. Which of the following are managerial options once a project is commenced?
I. modifying the production process
II. re-pricing the product
III. revising the marketing plan
IV. modifying the product's color and shape
A. I and II only
B. III and IV only
C. I, II, and III only
D. II, III, and IV only
E. I, II, III, and IV
51. Which one of the following statements related to warrants is correct?
A. Warrants are generally issued as an attachment to publicly-issued bonds.
B. Warrants are excluded from trading on an organized exchange.
C. Warrants are structured as long-term put options.
D. Warrants are issued by individual investors.
E. Warrants are generally added as an incentive to a private debt issue.
52. Which of the following statements are correct concerning warrants?
I. Warrants are similar to put options.

II. Warrants are similar to call options.
III. When a warrant is exercised, the issuer is not involved in the transaction.
IV. When a warrant is exercised, the issuer must issue new shares of stock.
A. I only
B. II only
C. I and III only
D. II and IV only
E. I and IV only


53. When warrants are exercised, the:
A. earnings per share decrease.
B. earnings per share remain constant.
C. total equity in a firm remains constant.
D. total equity in a firm decreases.
E. number of bonds outstanding increases.
54. Which of the following statements are correct concerning convertible bonds?
I. New shares of stock are issued when a convertible bond is converted.
II. A convertible bond is similar to a bond with a call option.
III. A convertible bond should always be worth less than a comparable straight bond.
IV. A convertible bond can be described as having upside potential with downside protection.
A. I and III only
B. I, II, and IV only
C. I, II, and III only
D. I, III, and IV only
E. II, III, and IV only
55. The conversion value of a convertible bond is equal to which one of the following?
A. Conversion ratio × Stock price
B. Conversion ratio × Conversion price
C. Face value of the bond/Conversion premium

D. Face value of the bond × (1 + Conversion premium)
E. Stock price × (1 + Conversion ratio)
56. The maximum value of a convertible bond is theoretically:
A. equal to the conversion value minus the straight bond value.
B. equal to the face value of the bond multiplied by (1 + Conversion price).
C. limited to the maximum straight bond value.
D. limited by the face value of the bond.
E. unlimited.
57. What is the cost of two November $25 put option contracts on Dove stock given the following price
quotes?

A. $0.15
B. $0.30
C. $1.50
D. $15.00
E. $30.00
58. What is the value of five August $25 call contracts on Dove stock?

A. $34
B. $68
C. $340
D. $680
E. $3,400


59. What is the intrinsic value of the November $25 call on Dove stock?

A. -$0.98
B. $0
C. $0.15

D. $6.12
E. $7.10
60. You purchased six call option contracts on ABC stock with a strike price of $32.50 when the option was
quoted at $1.80. The option expires today when the value of ABC stock is $34.60. Ignoring trading costs
and taxes, what is the net profit or loss on this investment?
A. $0
B. $180
C. $210
D. $840
E. $1,260
61. You sold one call option contract with a strike price of $55 when the option was quoted at $0.80. The
option expires today when the value of the underlying stock is $53.70. Ignoring trading costs and taxes,
what is the net profit or loss on this investment?
A. -$250
B. -$80
C. $0
D. $50
E. $80
62. You sold three $35 call option contracts at a quoted price of $1.40. What is your net profit or loss on this
investment if the price of the underlying asset is $36.70 on the option expiration date?
A. -$510
B. -$90
C. $90
D. $510
E. $930
63. You wrote eight call option contracts with a strike price of $42.50 at a call price of $1.35 per share. What
is your net gain or loss on this investment if the price of the underlying stock is $40.30 per share on the
option expiration date?
A. -$2,840
B. -$1,760

C. -$1,080
D. $1,080
E. $1,760


64. The market price of Southern Press stock has been relatively volatile and you think this volatility will
continue for a couple more months. Thus, you decide to purchase a two-month European call option
on this stock with a strike price of $45 and an option price of $2.20. You also purchase a two-month
European put option on the stock with a strike price of $45 and an option price of $0.30. What will be
your net profit or loss on these option positions if the stock price is $48 on the day the options expire?
Ignore trading costs and taxes.
A. -$30
B. $50
C. $80
D. $270
E. $330
65. Several rumors concerning Value Rite stock are causing the market price of the stock to be quite volatile.
Given this situation, you decide to buy both a one-month European $25 put and a one-month European
$25 call on this stock. The call price per share is $0.60 and the put price per share is $2.10. What will be
your net profit or loss on these option positions if the stock price is $18 on the day the options expire?
Ignore trading costs and taxes.
A. -$210
B. -$150
C. -$60
D. $430
E. $490
66. Three months ago, Central Supply stock was selling for $51.40 a share. At that time, you purchased five
put options on the stock with a strike price of $50 per share and an option price of $0.60 per share. The
option expires today when the value of the stock is $42.70 per share. What is your net profit or loss on
this investment? Ignore trading costs and taxes.

A. -$1,300
B. -$1,000
C. -$300
D. $3,350
E. $3,650
67. You wrote two put options on Xylo stock with an exercise price of $30 per share and an option price of
$1.05 per share. Today, the contracts expire and the stock is selling for $31.15 a share. What is your net
profit or loss on this investment? Ignore trading costs and taxes.
A. -$115
B. -$105
C. $20
D. $105
E. $210
68. You sold ten put contracts on Cross Town Bank stock at an option price per share of $0.85. The options
have an exercise price of $37.50 per share. The options were exercised today when the stock price was
$34 a share. What is your net profit or loss on this investment assuming that you closed out your positions
at a stock price of $34? Ignore transaction costs and taxes.
A. -$3,500
B. -$2,650
C. $1,800
D. $850
E. $3,500


69. You own eight call option contracts on Swift Water Tours stock with a strike price of $15. When you
purchased the shares the option price was $0.30 and the stock price was $15.25. What is the total intrinsic
value of these options if the stock is currently selling for $16.08 a share?
A. -$83
B. -$1.08
C. $0

D. $108
E. $864
70. You recently purchased three put option contracts on Guillepsi stock with an exercise price of $42.50.
What is the total intrinsic value of these contracts if the stock is currently selling for $43.70 a share?
A. -$360
B. -$120
C. $0
D. $120
E. $360
71. Last week, you purchased a call option on Edgewater stock with a strike price of $40. The stock price
was $39.80 and the option price was $0.45 at that time. What is the intrinsic value per share if the stock is
currently priced at $39.10?
A. -$90
B. -$70
C. $0
D. $70
E. $90
72. Three weeks ago, you purchased a June $30 put option on Leeper Metals stock at an option price of
$1.80. The market price of the stock three weeks ago was $30.60. Today, the stock is selling at $29.80 a
share. What is the intrinsic value of your put contract?
A. -$100
B. -$20
C. $0
D. $20
E. $60
73. This morning, you purchased a call option on Schoolhouse Supply Co. stock that expires in one year.
The exercise price is $40. The current price of the stock is $43.40 and the risk-free rate of return is 3.6
percent. Assume the option will finish in the money. What is the current value of the call option?
A. $0
B. $1.49

C. $3.97
D. $4.79
E. $5.46
74. You currently own a one-year call option on Rail Company, Inc., stock. The current stock price is $51.80
and the risk-free rate of return is 4.25 percent. Your option has a strike price of $50 and you assume the
option will finish in the money. What is the current value of your call option?
A. $1.20
B. $2.59
C. $3.84
D. $5.13
E. $7.27


75. The common stock of Hazelton Refiners is selling for $72.30 a share. U.S. Treasury bills are currently
yielding 4.8 percent. What is the current value of a one-year call option on this stock if the exercise price
is $70 and you assume the option will finish in the money?
A. $0
B. $1.20
C. $3.00
D. $4.20
E. $5.51
76. The common stock of Westover Foods is currently priced at $27.90 a share. One year from now, the stock
price is expected to be either $25 or $30 a share. The risk-free rate of return is 4.2 percent. What is the
current value of one call option on this stock if the exercise price is $27.50?
A. $0
B. $1.95
C. $2.00
D. $3.80
E. $4.00
77. You own one call option with an exercise price of $40 on S'more Good stock. The stock is currently

selling for $41 a share but is expected to sell for either $37 or $43 a share in one year. The risk-free rate
of return is 4.25 percent and the inflation rate is 3.6 percent. What is the current call option price if the
option expires one year from now?
A. $0.55
B. $0.69
C. $1.37
D. $2.43
E. $2.75
78. The assets of Uptown Stores are currently worth $136,400. These assets are expected to be worth either
$120,000 or $150,000 one year from now. The company has a pure discount bond outstanding with a
$130,000 face value and a maturity date of one year. The risk-free rate is 4.3 percent. What is the value of
the equity in this firm?
A. $11,920
B. $14,232
C. $19,507
D. $21,347
E. $26,408
79. Electronic Importers has a pure discount bond with a face value of $25,000 that matures in one year. The
risk-free rate of return is 3.8 percent. The assets of the business are expected to be worth either $23,000
or $35,000 in one year. Currently, these assets are worth $27,500. What is the current value of the bond?
A. $17,746
B. $19,207
C. $20,222
D. $22,549
E. $23,048
80. The Glass House has total assets currently valued at $17,200. These assets are expected to increase in
value to either $18,000 or $21,000 by next year. The company has a pure discount bond outstanding with
a face value of $20,000. This bond matures in one year. Currently, U.S. Treasury bills are yielding 5.4
percent. What is the value of the equity in this firm?
A. -$3,000.00

B. -$908.00
C. $0
D. $40.73
E. $122.20


81. You are considering a project that has been assigned a discount rate of 14 percent. If you start the project
today, you will incur an initial cost of $8,500 and will receive cash inflows of $5,550 a year for two
years. If you wait one year to start the project, the initial cost will rise to $9,200 and the cash flows will
increase to $5,800 a year for two years. What is the value of the option to wait?
A. -$331.40
B. -$194.46
C. $228.51
D. $230.49
E. $334.68
82. Southern Shores is considering a project that has an initial cost today of $12,500. The project has a twoyear life with cash inflows of $7,500 a year. Should the firm opt to wait one year to commence this
project, the initial cost will increase by 5 percent and the cash inflows will increase to $8,500 a year.
What is the value of the option to wait if the applicable discount rate is 14 percent?
A. $614.52
B. $721.56
C. $914.62
D. $982.67
E. $1,021.66
83. Western Industrial Products is considering a project with a four-year life and an initial cost of $212,000.
The discount rate for the project is 16 percent. The firm expects to sell 9,600 units on the last day of each
year. The cash flow per unit is $50. The firm will have the option to abandon this project at the end of
year one (after year one's sales) at which time the project's assets could be sold for an estimated $125,000.
The firm should abandon the project at the end of year one if the expected level of annual sales, starting
with year 2, falls to _____ units or less. Ignore taxes.
A. 1,113 units

B. 1,267 units
C. 1,922 units
D. 2,034 units
E. 2,108 units
84. Dressler Technologies is considering a project with a 3-year life and an initial cost of $85,000. The
discount rate for the project is 14.5 percent. The firm expects to sell 1,200 units on the last day of each
year. The cash flow per unit is $32. The firm will have the option to abandon this project at the end two
years (after year 2 sales) at which time the project's assets could be sold for an estimated $30,000. The
firm's managers are interested in knowing how the project will perform if the sales forecast for year 3 of
the project is revised such that there is a 50/50 chance that the sales will be either 1,000 or 1,400 units a
year. What is the net present value of this project at time zero given the current sales forecasts?
A. -$3,474
B. -$2,526
C. $4,191
D. $6,192
E. $6,887
85. Patience is reviewing a project with projected sales of 4,200 units a year, a cash flow of $28 a unit, and a
four-year project life. Assume all operating cash flows occur on the last day of each year. The initial cost
of the project is $247,000. The relevant discount rate is 13 percent. Patience has the option to abandon
the project after two years at which time she feels she could sell the project's assets for $110,000. At what
level of annual sales, starting in year 3, should she be willing to abandon this project?
A. 2,119 units
B. 2,355 units
C. 2,367 units
D. 2,516 units
E. 2,667 units


86. You own a convertible bond with a face value of $1,000 and a market value of $1,034. The bond can be
converted into 14 shares of stock. What is the conversion price?

A. $71.43
B. $72.00
C. $72.67
D. $73.86
E. $74.33
87. You own nine convertible bonds. These bonds have a 7 percent coupon, a $1,000 face value, and mature
in 6 years. The bonds are convertible into shares of common stock at a conversion price of $25. How
many shares of stock will you receive if you convert all of your bonds?
A. 285
B. 300
C. 350
D. 360
E. 400
88. A convertible bond has a face value of $5,000 and a conversion price of $80. The bond has a 6 percent
coupon, pays interest semi-annually, and matures in 12 years. Similar bonds are yielding 7.5 percent. The
current price of the stock is $41.20 per share. What is the conversion value of this bond?
A. $1,680
B. $2,415
C. $2,575
D. $4,651
E. $5,000
89. A convertible bond has a face value of $1,000 and a conversion price of $12.50. The bond has a 6 percent
coupon, pays interest semi-annually, and matures in 12 years. Similar bonds are yielding 9 percent. The
current price of the stock is $13.40 per share. What is the straight bond value?
A. $782.57
B. $781.82
C. $827.74
D. $832.09
E. $843.47
90. Kurt owns a convertible bond that matures in three years. The bond has a 7.5 percent coupon and pays

interest semi-annually. The face value of the bond is $1,000 and the conversion price is $25. Similar
bonds have a market return of 9.25 percent. The current price of the stock is $26.50 per share. What is the
straight bond value?
A. $948.20
B. $955.05
C. $972.80
D. $987.78
E. $991.15
91. Lucinda owns a convertible bond that matures in six years. The bond has a 9 percent coupon and pays
interest annually. The face value of the bond is $1,000 and the conversion price is $22. Similar bonds
have a market return of 8.75 percent. The current price of the stock is $21.60 per share. What is the
conversion value of this bond?
A. $835.60
B. $848.40
C. $942.11
D. $981.82
E. $1,000.00


92. Circle Stores stock is priced at $28 a share. A $40 call on this stock has five months until expiration and a
call price of $0.15. Why would an investor purchase a call that is so far out of the money?

93. What are the basic similarities and basic differences between warrants and call options?

94. What are the upper and lower bounds for an American call option? Explain what would happen in each
case if the bound was violated.

95. Explain the rationale behind the idea that equity is a call option on a firm's assets. When would a
shareholder allow this call to expire?

96. Call options are frequently attached to bonds, making them callable at the option of the issuer. Consider a
firm that just issued two sets of bonds: One is callable, has a 7 percent coupon rate, 15 years to maturity,
and cannot be called during the first three years; the second is noncallable, has a 7 percent coupon rate,
15 years to maturity, and is identical to the first bond in every way except for the call option. Suppose
the noncallable bonds are sold for $1,000 each. Will the callable bonds sell for more or less than $1,000?
Who "purchases" the option in this case and who "sells" it?


97. Explain how the floor and the ceiling prices for a convertible bond are determined.

98. T-bills currently yield 6.3 percent. Stock in Pinta Manufacturing is currently selling for $46 per share.
There is no possibility that the stock will be worth less than $39 per share in one year. What is the value
of a call option on this stock if the exercise price is $22 per share?
A. $21.40
B. $22.00
C. $24.00
D. $25.30
E. $25.70
99. The price of Time Squared Corp. stock will be either $80 or $95 at the end of the year. Call options are
available with one year to expiration. T-bills currently yield 6 percent and the current price of Time
Squared Corp. stock is $85. What is the value of a call option if the exercise price is $75 per share?
A. $14.25
B. $15.06
C. $18.78
D. $24.25
E. $25.06
100.The price of Dimension, Inc. stock will be either $65 or $85 at the end of the year. Call options are
available with one year to expiration. T-bills currently yield 5 percent. Suppose the current price of
Dimension stock is $70. What is the value of the call option if the exercise price is $70 per share?
A. $6.07

B. $8.48
C. $11.58
D. $15.39
E. $17.62
101.Rackin Pinion Corporation's assets are currently worth $1,260. In one year, they will be worth either
$1,200 of $1,610. The risk-free interest rate is 5 percent. Suppose Rackin Pinion has an outstanding debt
issue with a face value of $1,200. What is the current value of the firm's debt?
A. $60.00
B. $114.14
C. $1,142.86
D. $1,263.19
E. $1,504.20
102.Buckeye Industries has a bond issue with a face value of $1,000 that is coming due in one year. The value
of Buckeye's assets is currently $1,200. Jim Tressell, the CEO, believes that the assets in the firm will be
worth either $600 or $1,700 in a year. The going rate on one-year T-bills is 6 percent. What is the current
value of the firm's debt?
A. $601.18
B. $796.57
C. $844.24
D. $878.78
E. $911.03


103.A $1,000 convertible debenture has a conversion price for common stock of $85 per share. The common
stock is selling at $92 a share. What is the conversion value of this bond?
A. $920.00
B. $923.91
C. $1,000.00
D. $1,082.35
E. $1,092.00

104.A bond with 10 detachable warrants has just been offered for sale at $1,000. The bond matures in 15
years and has an annual coupon of $80. Each warrant gives the owner the right to purchase two shares of
stock in the company at $14 per share. Ordinary bonds (with no warrants) of similar quality are priced to
yield 11 percent. What is the value of one warrant?
A. $7.00
B. $13.58
C. $14.00
D. $16.67
E. $21.57
105.Your company is deciding when to invest in a new machine. The new machine will increase cash flow by
$240,000 per year. You believe the technology used in the machine has a 10-year life; in other words, no
matter when you purchase the machine, it will be obsolete 10 years from today. The machine is currently
priced at $1,200,000. The cost of the machine will decline by $120,000 per year until it reaches $720,000,
where it will remain. Your required return is 8 percent. In which year should you purchase the machine?
A. Year 0
B. Year 1
C. Year 2
D. Year 3
E. Year 4
106.We are examining a new project. We expect to sell 9,000 units per year at $45 net cash flow apiece
for the next 20 years. In other words, the annual operating cash flow is projected to be $45 × 9,000 =
$405,000. The relevant discount rate is 14 percent, and the initial investment required is $1,730,000.
After the first year, the project can be dismantled and sold for $1,350,000. If expected sales are revised
based on the first year's performance, it would make sense to abandon the investment if the sales are less
than which of the following number of units?
A. 4,580 units
B. 4,620 units
C. 4,750 units
D. 4,810 units
E. 5,020 units

107.We are examining a new project. We expect to sell 8,000 units per year at $80 net cash flow apiece
for the next 15 years. In other words, the annual operating cash flow is projected to be $80 × 8,000 =
$640,000. The relevant discount rate is 16 percent, and the initial investment required is $2,740,000. The
project can be dismantled after the first year and sold for $2,130,000. Suppose you think it is likely that
expected sales will be revised upward to 9,600 units if the first year is a success and revised downward to
3,000 units if the first year is not a success. Suppose the scale of the project can be doubled in one year
in the sense that twice as many units can be produced and sold. Naturally, expansion would be desirable
only if the project is a success. This implies that if the project is a success, projected sales after expansion
will be 19,200. Assume that success and failure are equally likely. Note that abandonment is still an
option if the project is a failure. What is the value of the option to expand?
A. $1,774,328
B. $1,809,941
C. $1,828,406
D. $1,848,920
E. $1,872,312



24 Key
1. A
2. C
3. C
4. D
5. E
6. A
7. B
8. A
9. E
10. A
11. D

12. E
13. D
14. B
15. B
16. B
17. C
18. D
19. E
20. A
21. B
22. C
23. C
24. C
25. A
26. D
27. E
28. E
29. D
30. D
31. B
32. B
33. D
34. B
35. E
36. A


37. E
38. B
39. C

40. C
41. E
42. B
43. D
44. E
45. E
46. E
47. A
48. B
49. C
50. E
51. E
52. D
53. A
54. B
55. A
56. E
57. E
58. E
59. D
60. B
61. E
62. B
63. D
64. B
65. D
66. D
67. E
68. B
69. E

70. C
71. C
72. D
73. D
74. C


75. E
76. B
77. E
78. B
79. E
80. D
81. A
82. C
83. A
84. C
85. B
86. A
87. D
88. C
89. A
90. B
91. D
Feedback: Refer to section 24.3
92. Students should discuss the impact of time to maturity on option values. They should point out that with five months left to maturity, there is a
chance that the option could finish in the money, especially if the stock price is volatile. A low option price per share such as $0.15, means that an
investment in an option contract will be quite inexpensive. However, investors apparently don't have a strong feeling the stock will reach $40 by
share by the expiration date, or the option price would be much higher.

Feedback: Refer to section 24.7
93. Both warrants and call options grant their owners the right to purchase shares of stock at a prespecified price. Warrants are issued by
corporations while call options are issued by investors. Warrants are usually attached to privately placed loans or bonds. Warrants can be detached
from the debt security and traded separately. Call options are traded separately from the underlying stock.

Feedback: Refer to section 24.2
94. The upper bound on a call is the stock price. If the call price exceeded the stock price, you would be paying more for the option to buy an asset
than the asset itself costs. The lower bounds are: C ≥ 0 if S - E < 0 and C ≥ (S - E) if (S - E) ≥ 0. In the first case, if the exercise price exceeds
the stock price, the call is out of the money and it will either be worthless or have some time value. In the second case, if the call is in the money,
the call must be worth at least the difference between the asset's value and the exercise price. If the call was worth less than this value, rational
investors would purchase calls, immediately exercise them, and then sell the stock at the current price, completing an arbitrage.

Feedback: Refer to section 24.5
95. The analogy only works for leveraged firms. At maturity of the firm's debt, the stockholders have the option to either pay the creditors the
face value of the debt or turn the firm's assets over to the firm's creditors. If the firm's assets are worth less than the face value of the debt, the
stockholders will not exercise the call, that is, they will let the creditors have the assets and the firm will be liquidated.

Feedback: Refer to section 24.7
96. The callable bond will sell for less than par. The bond issuer buys the option and the bondholder writes it. If the callable bonds sell for $950
each, the call option will be worth the difference between the two bond prices, or $50 per bond.


Feedback: Refer to section 24.7
97. The floor, or minimum, value of a bond is the bond's straight bond value. The ceiling, or maximum, value is theoretically unlimited since there
is no upper limit on a bond's conversion value.

98. D
99. A
100. A
101. C

102. B
103. D
104. E
105. A
106. A
107. B


24 Summary
Category
AACSB: Analytic
AACSB: N/A
AACSB: Reflective thinking
Difficulty: Basic
Difficulty: Challenge
Difficulty: Intermediate
EOC #: 24-1
EOC #: 24-12
EOC #: 24-13
EOC #: 24-14
EOC #: 24-16
EOC #: 24-4
EOC #: 24-5
EOC #: 24-7
EOC #: 24-8
EOC #: 24-9
Learning Objective: 24-1
Learning Objective: 24-1 and 24-6
Learning Objective: 24-2
Learning Objective: 24-3

Learning Objective: 24-4
Learning Objective: 24-5
Learning Objective: 24-6
Ross - Chapter 24
Section: 24.1
Section: 24.2
Section: 24.3
Section: 24.4
Section: 24.5
Section: 24.6
Section: 24.7
Topic: Abandonment and expansion
Topic: Abandonment value
Topic: American option
Topic: Call intrinsic value
Topic: Call lower bound
Topic: Call option
Topic: Call payoff
Topic: Call upper bound
Topic: Call value
Topic: Callable bonds
Topic: Contingency planning
Topic: Conversion premium
Topic: Conversion price
Topic: Conversion ratio
Topic: Conversion value
Topic: Convertible bonds
Topic: Employee stock option
Topic: Equity as a call option
Topic: Equity as an option

Topic: ESO backdating
Topic: European option
Topic: Exercising the option

# of Questions
45
56
6
101
1
5
1
1
1
1
1
1
1
1
1
1
27
1
24
5
7
20
23
107
25

21
5
5
7
20
24
1
1
3
1
1
1
4
1
6
1
1
1
1
1
2
11
4
5
2
1
4
1

Topic: Expiration date

1

Topic: Factors affecting option values
Topic: Intrinsic value
Topic: Investment timing decision
Topic: Managerial options
Topic: Option
Topic: Option payoffs
Topic: Option pricing bounds
Topic: Option quotes
Topic: Option to abandon
Topic: Option to expand
Topic: Option to wait
Topic: Option value
Topic: Put intrinsic value
Topic: Put option
Topic: Put payoff
Topic: Put value
Topic: Real options
Topic: Straight bond value
Topic: Strategic options
Topic: Strike price
Topic: Warrant values
Topic: Warrants
Topic: Warrants, calls, and convertibles

3
5

1
3
1
2
1
3
4
1
4
6
1
1
3
1
2
1
2
1
1
4
1