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CHAPTER 3: PRINCIPLES OF OPTION PRICING MULTIPLE CHOICE TEST QUESTIONS 1. Consider a portfolio consisting of a long call with an exercise price of X, a short position in a non-dividend paying stock at an initial price of S0, and the purchase of riskless bonds with a face value of X and maturing when the call expires. What should such a portfolio be worth? a. C + P - X(1 + r)-T b. C - S0 c. P - X d. P + S0 - X(1 + r)-T e. none of the above 2. What is the lowest possible value of a European put? a. Max(0, X- S0) b. X(1 + r)-T c. Max[0, S0 - X(1 + r)-T] d. Max[0, X(1 + r)-T - S0)] e. none of the above 3. Another expression for intrinsic value is a. parity b. parity value c. exercise value d. all of the above e. none of the above 4. On March 2, a Treasury bill expiring on April 20 had a bid discount of 5.80, and an ask discount of 5.86. What is the best estimate of the risk-free rate as given in the text? a. 5.86 % b. 5.83 % c. 6.11 % d. 6.14 % e. none of the above 5. Suppose you use put-call parity to compute a European call price from the European put price, the stock price, and the risk-free rate. You find the market price of the call to be less than the price given by put-call parity. Ignoring transaction costs, what trades should you do? a. buy the call and the risk-free bonds and sell the put and the stock b. buy the stock and the risk-free bonds and sell the put and the call c. buy the put and the stock and sell the risk-free bonds and the call d. buy the put and the call and sell the risk-free bonds and the stock e. none of the above 6. If there are no dividends on a stock, which of the following statements is correct? a. An American call will sell for more than a European call b. A European call will sell for more than an American call c. An American call will be immediately exercised d. An American call and an American put will sell for the same price e. none of the above The following quotes were observed for options on a given stock on November 1 of a