# Midterm (Answers) - 1 The exercise price on a call option...

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a. Calculate the option's exercise value? Exercise value of call option = Current price of stock - Strike price Current price of stock = \$35 Less: Strike price (or exercise price) = \$30 Exercise value of call option = \$5 b. Calculate the value of the premium over and above the exercise value? Why is an investor willin The premium on the option is the sum of exercise value and the time value. Therefore, the the exercise value is called as the "time value". Option's time value = Price of the option - Exercise value Price of the option = \$5.75 Less: Exercise value of option = \$5.00 Time value \$0.75 [answer] This is the value of the p c. Is this an out-of-the money, at-the-money, or in-the-money option? Why? d. What will happen to the value of the option if the underlying stock price changes to \$30? Why? e. Is this an example of a covered call option or a naked call option? Why? 1. The exercise price on a call option is \$30 and the price of the underlying stock is \$35. The optio currently selling for \$5.75. The investor expects that the price of the underlying stock will increase more than its cu make a profit by purchasing the stock by exercising the option and then selling it at the price. Due to this reason, he is willing to pay \$5.75 for the option which has an exercise The option is in-the-money because the current stock price is greater than the exercise In-the-money: Current stock price > Exercise/ Strike price Out-the-money: Current stock price < Exercise / Strike price In this case it is in-the money because the current stock price of \$35 is greater than the The market value of the option will decrease as it a combination of exercise value and ti decreases upon decrease in the current price of the stock. Therefore, when the price of to \$30 per share, the market value of the option would decrease.

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This is an example of a covered call option. When the investor already owns the shares writes call options against the stock held in his or her portfolio, is said to be selling cove are the options sold without the stock to back them up and is very risky. Here, it is assum the shares of the underlying stock and hence is an example of a covered call option.
ng to pay more than the exercise value? e value of the premium over and above premium over and above the exercise value. on will expire in 35 days. The option is urrent price and that he can then prevailing higher market value of only \$5.00 at present. price (strike price). e exercise price of \$30. time value. The exercise value the underlying stock decreases

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of the underlying stock and ered options. Naked options med that the investor owns
Base price (\$350,000) Modification costs (\$125,000) Increase in Net working capital (\$20,000) Year 0 net cash outflow (\$495,000) b. Calculate the net operating cash flows for Years 1, 2, 3, and 4 Step 1: To compute yearly depreciation expense Depreciable cost = \$350,000 + \$125,000 ==> \$475,000 Year Cost Rate Depreciation 1 \$475,000 33.33% \$158,317.50 2 \$475,000 44.45% \$211,137.50 3 \$475,000 14.81% \$70,347.50 4 \$475,000 7.41% \$35,197.50 Please note: Depreciation rates have been rounded to 2 decimal places. If it is rounded to a whole per there would be differences in the final answer. This is an important point to note.

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