Question

730 CHAPTER 14 Complex Financial Instruments GP P14-5. Nature and identification of financial instruments (L.O. 14-1) (Easy - 10 minutes) In relation to stock options, identify whether each of the following statements is true o True/False Item A stock option provides a right to buy but not a right to sell a share. b. An options fair value is at least as high as its intrinsic value. A stock option's fair value increases with the volatility of the underlying stock c d Astock option's exercise price is the price of the share at the time of exercise e. An option's intrinsic value cannot be negative. f. An option's intrinsic value increases with the length of time until the option matures g An in-the-money option is one in which the exercise price is higher than the market price.

Answer 1

S. No.	Item	True or False	Reason
a	A stock option provides a right to buy but not right to sell a share	FALSE	A stock option may provide either a right to buy or a right to sell the share depending on whether it is a Put or Call option.
b	An option's fair value is at least as high as its intrinsic value	TRUE	The intrinsic value of an option reflects the effective financial advantage resulting from the immediate exercise of that option. Basically, it is an option's minimum value.
c	A stock option's fair value increases with the votality of the underlying stock	TRUE	A stock option is basically priced by considering the Exercise price and the Current Market price. Hence any change in the underlying stock will affect the stock option price.
d	A stock option's exercise price is the price of the share at the time of exercise	FALSE	A stock option's exercise price is the price which was determined as the exercise price at the inception of entering into such stock option contract.
e	An option's intrinsic value cannot be negative	TRUE	An option's intrinsic value cannot be negative, because if the option is not worth anything, the option holder would not exercise it.
f	An option's intrinsic value increases with the length of time until the option matures	FALSE	An option's intrinsic value may increase with length of time if it is in-the-money. However it will decrease if it is out-of-money.
g	An in-the-money option is one where the exercise price is higher than the market price.	FALSE	An in-the-money option is one where the market price is higher than the exercise price & not the other way round.