Ross. Westerfield. Jaffe. Jordan Chapter 22 Solution

Ross. Westerfield. Jaffe. Jordan Chapter 22 Solution -...

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CHAPTER 22 OPTIONS AND CORPORATE FINANCE: BASIC CONCEPTS Answers to Concept Questions 1. A call option confers the right, without the obligation, to buy an asset at a given price on or before a given date. A put option confers the right, without the obligation, to sell an asset at a given price on or before a given date. You would buy a call option if you expect the price of the asset to increase. You would buy a put option if you expect the price of the asset to decrease. A call option has unlimited potential profit, while a put option has limited potential profit; the underlying asset’s price cannot be less than zero. 2. a. The buyer of a call option pays money for the right to buy. ... b. The buyer of a put option pays money for the right to sell. ... c. The seller of a call option receives money for the obligation to sell. ... d. The seller of a put option receives money for the obligation to buy. ... 3. An American option can be exercised on any date up to and including the expiration date. A European option can only be exercised on the expiration date. Since an American option gives its owner the right to exercise on any date up to and including the expiration date, it must be worth at least as much as a European option, if not more. 4. The intrinsic value of a call is Max[S – E, 0]. The intrinsic value of a put is Max[E – S, 0]. The intrinsic value of an option is the value at expiration. 5. The call is selling for less than its intrinsic value; an arbitrage opportunity exists. Buy the call for $10, exercise the call by paying $35 in return for a share of stock, and sell the stock for $50. You’ve made a riskless $5 profit. 6. The prices of both the call and the put option should increase. The higher level of downside risk still results in an option price of zero, but the upside potential is greater since there is a higher probability that the asset will finish in the money. 7. False. The value of a call option depends on the total variance of the underlying asset, not just the systematic variance. 8. The call option will sell for more since it provides an unlimited profit opportunity, while the potential profit from the put is limited (the stock price cannot fall below zero). 9. The value of a call option will increase, and the value of a put option will decrease.
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CHAPTER 22 B- 2 10. The reason they don’t show up is that the U.S. government uses cash accounting; i.e., only actual cash inflows and outflows are counted, not contingent cash flows. From a political perspective, they would make the deficit larger, so that is another reason not to count them! Whether they should be included depends on whether we feel cash accounting is appropriate or not, but these contingent liabilities should be measured and reported. They currently are not, at least not in a systematic fashion. 11.
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This note was uploaded on 04/18/2010 for the course FINANCE 936116531 taught by Professor Wuyiling during the Spring '10 term at Nashville State Community College.

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Ross. Westerfield. Jaffe. Jordan Chapter 22 Solution -...

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