Deck 17: Advanced Issues in Options

Question 1

For LEPOs,a fall in the premium results in __________ the margin writer's account and __________ the option taker's account.

Answer 1

D
Explanation: Low exercise price options (LEPOs)are physical delivery-based European-type options with an exercise price typically of one cent.LEPOs are traded on the ASX via the derivatives trading facility in the same way that standard options are traded.Similar to standard options written on shares,LEPOs generally require delivery of 1000 shares on expiry of the contract but,unlike standard options on shares,only one option is issued for each expiry,as there is only one exercise price for each expiry date.An important feature of these options is the requirement for deposit and margining of the premium on a daily basis.Thus a premium is not paid on taking the option position.Rather,the option writer and taker are liable for margin adjustments as the option premium changes over time.If the premium rises (falls),then the option writer's (taker's)margin account is reduced (increased)by the amount of the rise (fall),and the option taker's (writer's)account is increased (decreased)by the same amount.

Question 2

Warrants are not typically priced using the futures cost-of-carry model.

Answer 2

True
Explanation: An important feature of company-issued options is that new shares are issued upon exercise.Standard warrants are written over existing shares and hence,on exercise,there is a transfer of existing shares.In contrast,company-issued options involve the issue of new shares at exercise.The implication of the new issue is to create a dilution effect.Originally it was argued that the option value should be adjusted for dilution,but Handley (2002)shows that this is not required,and that arbitrage will ensure the underlying share price reflects the dilution as from the announcement of the issue,so there is no need for a dilution adjustment.Thus,options are valued as if they are ordinary options written on the firm's share once the share market is aware of the option issue.Consistent with Handley's argument,empirical evidence has shown that the Black-Scholes model without adjustment provides a reasonable approximation of company-issued option prices,except perhaps for deep out-of-the-money options (Schulz and Trautmann 1994),though this may simply reflect well-documented biases in the Black-Scholes option pricing model.

Question 3

Low exercise price options (LEPOs)are physical delivery-based __________ options with __________.

Answer 3

C
Explanation: Low exercise price options (LEPOs)are physical delivery-based European-type options with an exercise price typically of one cent.LEPOs are traded on the ASX via the derivatives trading facility in the same way that standard options are traded.Similar to standard options written on shares,LEPOs generally require delivery of 1000 shares on expiry of the contract but,unlike standard options on shares,only one option is issued for each expiry,as there is only one exercise price for each expiry date.An important feature of these options is the requirement for deposit and margining of the premium on a daily basis.Thus a premium is not paid on taking the option position.Rather,the option writer and taker are liable for margin adjustments as the option premium changes over time.If the premium rises (falls),then the option writer's (taker's)margin account is reduced (increased)by the amount of the rise (fall),and the option taker's (writer's)account is increased (decreased)by the same amount.

Question 4

Credit default swaps (CDS)transfer credit risk from the protection seller to the protection buyer.

Question 5

One way in which LEPOs are identical to standard options is that there is only one option for each exercise price.

Question 6

Convertible notes typically have a window for conversion that is unlimited.

Question 7

The premium on a LEPO tends to move similarly to that of a futures contract.

Question 8

options can be used to control interest rate risk. allows borrowers to set a maximum interest rate,while . allows investors to set a minimum interest rate earned on their investment

Question 9

The term to maturity of company-issued warrants tends to be greater than that of standard exchange-traded options.

Question 10

Given a LEPO price of $0.01,a share price of $5,time to expiry of six months,a risk-free rate of 5% p.a.and a dividend present value of $0.25,what is the value the LEPO?

Question 11

Index warrant holders are generally not protected against changes in the composition of the underlying index.

Question 12

An equity-linked deposit is a zero coupon instrument that offers to pay the face value at maturity.

Question 13

A convertible note is a security that is initially issued as equity,but can later be converted into a debt security.

Question 14

With forward start options the following applies:

Question 15

Suppose the LEPO has an exercise price of one cent,the share price of the underlying share is currently $13.25,the time to expiry is two months,the risk-free rate is 5.0% p.a.and the present value of the dividend is $0.84.What would be the price of this LEPO?

Question 16

Which of the following are limitations to the range of derivative contracts offered in over-the-counter markets?

Question 17

Which of the following provides insurance to a portfolio manager against declines in value without limiting the increase in portfolio value?

Question 18

In Australia,options that are heavily traded on the ASX 24 futures contracts include:

Question 19

The key difference between a call option written on the USD cost of the AUD and a put option written on the AUD cost of the USD is the standard deviation estimate.

Question 20

Which of the following are features of LEPOs?

Question 21

Company-issued options tend to arise because of:

Question 22

Unsecured notes issued by companies where the holder receives periodic coupon payments and an option to change the note into ordinary shares at a ratio which is pre-specified and remains constant over the life of the note are known as:

Question 23

If the futures contract is the SPI 200 futures contract and the premium is quoted as 12.5,what is the premium?

Question 24

A ___________ option could be used to pay back the initial premium where the price falls ____________________,in which case the option is sometimes called a money back option.

Question 25

______________ option pay-off is a function either of specified credit spreads or credit sensitive _______________.

Question 26

Which of the following about CDS is correct?

Question 27

Following figure 17.1,we can see that portfolio insurance on a large share portfolio is most typically performed using a strategy involving buying index put options.
A barrier option may be _________ by _____________ a complementary barrier option from a/an____________ option.

Question 28

Currency options are generally __________-traded __________ options.

Question 29

Portfolio insurance on a large share portfolio is most typically performed using a strategy involving:

Question 30

Options written on the 90-day bank bill contract have:

Question 31

If the futures contract is the SPI 200 futures contract and the premium is quoted as 25,what is the premium?

Question 32

The Garman Kohlhagen (1983)model may be used to price an European-type option where:

Question 33

You have $1250 000 invested in a property index,which has a current value of 9000.0.If a put option is available with an exercise price of 11500,standard deviation of returns is 40%,time to maturity is 9 months and risk-free rate is 8% p.a. ,how many contracts are required for an exact hedge of this index? Assume an index point value of $10.00.

Question 34

You have $500 000 invested in a property index,which has a current value of 4000.00.If a put option is available with an exercise price of 3800,standard deviation of returns is 20%,time to maturity is 6 months and risk free rate is 8% p.a. ,how many contracts are required for an exact hedge of this index? Assume an index point value of $10.00.

Question 35

In an issue of third-party warrants,the issuer is usually:

Question 36

The contingent premium in the contingent premium option may be contingent on the:

Question 37

The exercise value of a __________ option is determined by the maximum or minimum price of the underlying asset reached during the life of an option and the expiry price of the asset.

Question 38

An option that starts at some time in the future but which is paid for now is called a:

Question 39

An Asian call option gives its holder the right to ____________.

A)buy the underlying asset at the exercise price on or before the expiration date
B)buy the underlying asset at a price determined by the average stock price during some specified portion of the option's life
C)sell the underlying asset at the exercise price on or before the expiration date
D)sell the underlying asset at a price determined by the average stock price during some specified portion of the option's life

Question 40

Barrier options exist within certain: