CHAPTER 8

Test Bank

1. Consider an exchange traded put option to sell 100 shares for $20.

Give (a) the strike price and (b) the number of shares that can be sold after

(i) A 5 for 1 stock split (a) ………….(b) ……………

(ii) A 25% stock dividend (a) ……….. (b) ………….

(iii) A $5 cash dividend (a) ………. (b) ……………

2. A trader writes two naked put option contracts. The option price is $3, the strike price is $40 and the
stock price is $42. What is the initial margin? ……………..

3. Which of the following lead to IBM issuing more shares (circle three)

(a) Some executive stock options are exercised

(b) Some exchange-traded put options are exercised

(c) Some exchange-traded call options are exercised

(d) Some warrants on IBM are exercised

(e) Some of IBM's convertible debt is converted to equity.

4. Which of the following is true (circle one):

(a) The cost of employee stock options does not currently appear on a company's income statement

(b) A ten-year employee stock option is worth more than a regular ten-year over-the-counter American-
style option on the same company with the same strike price.

(c) Microsoft is currently one of the biggest issuers of employee stock options

(d) None of the above

5. Which of the following is regarded by accounting authorities as an acceptable approach to valuing
employee stock option (circle one):

(a) Use Black--Scholes with the time to maturity set equal to an estimate of expected life

(b) Set the value equal to the intrinsic value at the time of issue

(c) Set the value equal to the lowest intrinsic value observed during the month prior to issue

(d) None of the above

6. Which of the following is normally a feature of employee stock options (circle one):

(a) Can be sold by one employee to another employee

(b) Can be sold by an employee to a member of the employee's family

(c) Can be sold by an employee to anyone

(d) None of the above

7. Which of the following is not true (circle one):

(a) Employee stock options encourage executives to take decisions in the long-term interests of the
company

(b) Employee stock options give employees in start-up companies a stake in the future of the company
and encourage them to work hard.

(c) Employee stock options encourage executives to stay with the company

(d) Employee stock options can lead to executives taking decisions that are not in the best interests of
shareholders

8. On a particular day a company has 900,000 shares outstanding and the stock price is $100. Employees
decide to exercise 100,000 employee stock options that were issued four years ago and have a strike
price of $80. The impact of this decision can be expected to be (circle one):

(a) Stock price decreases to $98

(b) Stock price increases to $102

(c) Stock price is unchanged

(d) Not possible to estimate the impact

9. When a company pays no dividends which of the following is not true (circle one):

(a) A regular call option on the company's stock should never be exercised early

(b) It can be optimal for an employee to exercise an employee stock option and immediately sell the
stock

(c) It can be optimal for an employee to exercise an employee stock option and hold on to the stock in
the hope that its price will increase

(d) Options are sometimes exercised as soon as the vesting period is over.

10. Backdating became less common when (circle one):

(a) The SEC required companies to report stock option grants within two days of the grant date

(b) Employee stock options had to be expensed on the income statement

(c) The cost of employee stock options had to be reported in the notes to the accounts.

(d) Employee stock options had to be revalued at each financial year end.

11. Consider 12-year employee stock options on a non-dividend-paying stock with a two-year vesting
period. At present about 10% of the exercises of the options occur in each of years 3, 4, 5, ….., 12.
Suppose the vesting period is increased to 4 years. Which of the following describes what happens to the
calculated value of the option (circle one):

(a) It decreases or remains the same

(b) It increases

(c) It remains the same

(d) It may increase, decrease, or remain the same.

12. A company makes the decision on March 31 to issue employee stock options when the stock price is
$100. It reports them as at-the-money on March 25 of the same year, a day when the stock price was
$92. Which of the following is true (circle one):
(a) This is illegal

(b) This was legal until 2002 when the SEC took action

(c) This was illegal until 2002 when rules were changed to make it legal

(d) This is legal because the two dates are within 30 days of each other

13. The exercise multiple approach to valuation assumes (circle one):

(a) That the payoff from exercise is a certain multiple of the strike price

(b) That exercise takes place as soon as the option is in the money and the option has vested

(c) That the employee exercises as soon as the stock price is a certain multiple of the strike price and the
option has vested

(d) None of the above