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Fundamentals of Corporate Finance

Stephen A. Ross; Randolph W. Westerfield; Bradford D. Jordan

Chapter 24

OPTIONS AND CORPORATE FINANCE - all with Video Answers

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Chapter Questions

Problem 1

What is a call option? A put option? Under what circumstances might you want to buy each? Which one has greater potential profit? Why?

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Problem 2

Complete the following sentence for each of these investors:
a. A buyer of call options.
b. A buyer of put options.
c. A seller (writer) of call options.
d. A seller (writer) of put options.
"The (buyer/seller) of a (put/call) option (pays/receives) money for the (rightobligation) to (buy/sell) a specified asset at a fixed price for a fixed length of time."

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Problem 3

What is the intrinsic value of a call option? How do we interpret this value?

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Problem 4

What is the value of a put option at maturity? Based on your answer, what is the intrinsic value of a put option?

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Problem 5

You notice that shares of stock in the Patel Corporation are going for $$\$ 50$$ per share. Call options with an exercise price of $$\$ 35$$ per share are selling for $$\$ 10$$. What's wrong here? Describe how you can take advantage of this mispricing if the option expires today.

Rashmi Sinha
Rashmi Sinha
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Problem 6

If the risk of a stock increases, what is likely to happen to the price of call options on the stock? To the price of put options? Why?

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01:41

Problem 7

True or false: The unsystematic risk of a share of stock is irrelevant in valuing the stock because it can be diversified away; therefore, it is also irrelevant for valuing a call option on the stock. Explain.

Anitha Mary
Anitha Mary
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Problem 8

Suppose a certain stock currently sells for $$\$ 30$$ per share. If a put option and a call option are available with $$\$ 30$$ exercise prices, which do you think will sell for more, the put or the call? Explain.

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Problem 9

Suppose the interest rate on T-bills suddenly and unexpectedly rises. All other things being the same, what is the impact on call option values? On put option values?

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00:54

Problem 10

When you take out Page 823 an ordinary student loan, it is usually the case that whoever holds that loan is given a guarantee by the U.S. government, meaning that the government will make up any payments you skip. This is just one example of the many loan guarantees made by the U.S. government. Such guarantees don't show up in calculations of government spending or in official deficit figures. Why not? Should they show up?

Brenda Sanchez
Brenda Sanchez
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Problem 11

What is the option to abandon? Explain why we underestimate NPV if we ignore this option.

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Problem 12

What is the option to expand? Explain why we underestimate NPV if we ignore this option.

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Problem 13

In Chapter 10 , we discussed Porsche's launch of its new Cayenne. Suppose sales of the Cayenne go extremely well and Porsche is forced to expand output to meet demand. Porsche's action in this case would be an example of exploiting what kind of option?

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Problem 14

Natural resource extraction facilities (such as oil wells or gold mines) provide a good example of the value of the option to suspend operations. Why?

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Problem 15

You own stock in the Hendrix Guitar Company. The company has implemented a plan to award employee stock options. As a shareholder, does the plan benefit you? If so, what are the benefits?

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