Pricing a put with the binomial model is the same procedure as pricing with a call, except that the

Pricing a put with the binomial model is the same procedure as pricing with a call, except that the

a. underlying stock must not pay dividends
b. binomial model cannot account for expiration payoffs
c. value of the underlying must be discounted back to the current time period
d. expiration payoffs reflect the fact that the option is the right to sell the underlying stock
e. none of the above

Answer: D

Which of the following statements about the binomial model is incorrect?

Which of the following statements about the binomial model is incorrect?

a. it converges to the Black-Scholes-Merton model
b. it can accommodate early exercise
c. it allows only two stock prices at expiration
d. it can be extended to a large number of time periods
e. none of the above

Answer: C

In a one-period binomial model with Su = 49.5, Sd = 40.5, p = 0.8, r = 0.06, S = 45 and X = 50, what is a European put worth?

In a one-period binomial model with Su = 49.5, Sd = 40.5, p = 0.8, r = 0.06, S = 45 and X = 50, what is a European put worth?

a. 2.17
b. 0.50
c. 9.50
d. 5.00
e. none of the above






Answer: A

Suppose S = 70, X = 65, r = 0.05, p = 0.6, Cu = 7.17, Cd = 1.22 and there is one period left in an American call's life. What will the option be worth?

Suppose S = 70, X = 65, r = 0.05, p = 0.6, Cu = 7.17, Cd = 1.22 and there is one period left in an American call's life. What will the option be worth?

a. 6.83
b. 0.00
c. 4.56
d. 5.00
e. none of the above





Answer: C

In the binomial model, if an option has no chance of expiring out-of-the-money, the hedge ratio will be

In the binomial model, if an option has no chance of expiring out-of-the-money, the hedge ratio will be

a. 0.5
b. infinite
c. 1
d. 0
e. none of the above





Answer: E

Consider a binomial world in which the current stock price of 80 can either go up by 10 percent or down by 8 percent. The risk-free rate is 4 percent. Assume a one-period world. Answer questions 12 through 15 about a call with an exercise price of 80.

Consider a binomial world in which the current stock price of 80 can either go up by 10 percent or down by 8 percent. The risk-free rate is 4 percent. Assume a one-period world. Answer questions 12 through 15 about a call with an exercise price of 80.

Question: What would be the call's price if the stock goes up?

a. 3.60
b. 8.00
c. 5.71
d. 4.39
e. none of the above


Answer: B

Question: What would be the call's price if the stock goes down?

a. 8.00
b. 3.60
c. 0.00
d. 9.00
e. none of the above


Answer: C

Question: What is the hedge ratio?

a. 0.429
b. 0.714
c. 0.571
d. 0.823
e. none of the above


Answer: E

Question: What is the theoretical value of the call?

a. 8.00
b. 4.39
c. 5.15
d. 5.36
e. none of the above


Answer: C

When the number of time periods in a binomial model is large, what happens to the binomial probability of an up move?

When the number of time periods in a binomial model is large, what happens to the binomial probability of an up move? 

a. it approaches 1.0
b. it approaches zero
c. it fluctuates without pattern
d. it converges to 0.5
e. none of the above

Answer: A

When the number of time periods in a binomial model is large, a European call option value does what?

When the number of time periods in a binomial model is large, a European call option value does what? 

a. fluctuates around its intrinsic value
b. converges to a specific value
c. increases without limit
d. converges to the European lower bound
e. none of the above




Answer: C

In a non-recombining tree, the number of paths that will occur after three periods is

In a non-recombining tree, the number of paths that will occur after three periods is 

a. three
b. four
c. ten
d. eight
e. six

Answer: D

Which of the following are not path-dependent options when the stock pays a constant dividend yield?

Which of the following are not path-dependent options when the stock pays a constant dividend yield? 

a. European calls and European puts
b. European calls and American puts
c. American puts and European puts
d. American puts and European calls
e. none of the above

Answer: E

If the binomial model is extended to multiple periods for a fixed option life, which of the following adjustments must be made?

If the binomial model is extended to multiple periods for a fixed option life, which of the following adjustments must be made? 

a. the up and down factors must be increased
b. the risk-free rate must be increased
c. the up and down factors and the risk-free rate must be decreased
d. the initial stock price must be proportionately reduced
e. none of the above





Answer: C

When puts are priced with the binomial model, which of the following is true?

When puts are priced with the binomial model, which of the following is true? 

a. the puts must be American
b. the puts cannot be properly hedged
c. the puts will violate put-call parity
d. the hedge ratio is one throughout the tree
e. none of the above

Answer: D

The values of u and d are which of the following?

The values of u and d are which of the following?

a. the return on the stock if it goes up and down, respectively
b. the inverse of the ratio of the up and down probabilities, respectively, and the risk-free rate
c. the normal probabilities of up and down movements, respectively
d. one plus the return on the stock if it goes up and down, respectively
e. none of the above




Answer: D

In a two-period binomial world, a mispriced call will lead to an arbitrage profit if

In a two-period binomial world, a mispriced call will lead to an arbitrage profit if 

a. the proper hedge ratio is maintained over the two periods
b. the hedge portfolio is terminated after one period
c. the option goes from over- to underpriced or vice versa
d. the option remains mispriced over both periods
e. none of the above

Answer: A

In a binomial model, if the call price in the market is higher than the call price given by the model, you should

In a binomial model, if the call price in the market is higher than the call price given by the model, you should 

a. sell the call and sell short the stock
b. buy the call and sell short the stock
c. buy the stock and sell the call
d. buy the call and buy the stock
e. none of the above





Answer: C

A portfolio that combines the underlying stock and a short position in an option is called

A portfolio that combines the underlying stock and a short position in an option is called

a. a risk arbitrage portfolio
b. a hedge portfolio
c. a ratio portfolio
d. a two-state portfolio
e. none of the above





Answer: B