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8. Given the CAPM model and the £o11owmg m£ormat1on, the market risk premium is closest to:
Portfolio Expected Return Beta
A 7.50% 1.25
B 11.25% 2.10
a. 1.99%

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d. 8.51%
e. None of the above

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9. Which of the following is an assumption of the CAPM?
a. Restricted borrowing and lending at risk-free interest rate
b. The average investor determines the price
c. Investors only pay limited transaction costs
d. Single period model, homogeneous expectations, and portfolio choice is based only on
vanance
e. None of the above

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10. The risk-free rate is 8% and the expected market return is 15%. A stock with a beta of 0.7 is
currently priced at $50 and will pay $1 dividend one year later. If after a year the stock will be
priced at $55. The stock currently is:
a. Overpriced, arbitragers will buy it
b. Underpriced, arbitragers will short sell it
c. Overpriced, arbitragers will short sell it
d. Underpriced, arbitragers will buy it

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e. Properly priced, arbitragers cannot make profits
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12. Supposed you sell a put and buy a call with the same exercise price. You could match the
payoffs of this strategy by
a. Lending the present value of the exercise price and buying stock
� Lending the present value of the exercise price and selling stock
(s;) Borrowing the present value of the exercise price and buying stock
d. Borrowing the present value ofthe exercise price and selling stock
e. Both B or C J
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16. If an investor sells a straddle on an underlying asset, that investor aims to profit from:
a. Volatile movements in the underlying in either direction
b. Volatile upside movements in the underlying but less volatile movements to the
downside
@Lower volatility in the underlying
cl. Higher expected market interest rates
e. Lower expected market interest rates
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17. If a one-year put option with an exercise price of $50 is trading at $4 and the risk free rate is 5%
per annum, assume the stock price is $50, the value of a one-year call option with an exercise
price of $50 on the same underlying is:

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c. $4.00
d. $3.81
e. None of the above

18. Company ABC's stock is currently trading at $22 and is forecast to either increase by 20% or
fall by 15% in 3 months. The 3-month interest rate is 1.5%. Assuming there is no active options
market, an investor wishing to buy a call option on ABC stock with an exercise price of $20
will:
a. Long 0.831 units of ABC stock and lend $15.54
b. Long 0.831 units of ABC stock and borrow $15.31
c. Long 1.203 units of ABC stock and lend $15.31
d. Long 1.203 units of ABC stock and borrow $15.54
e. None of the above
19. Which one of the following is TRUE:
a. If the risk-free rate is high enough, one may consider exercise an American call early
b. Holding everything else constant, the price of a call option is increasing with increasing
exercise price
c. Holding everything else constant, the price of a put option is increasing with increasing
,R\current stock price
'd..Jlf an investor has a short position in a stock, that investor is protected by buying a call
option on the same stock.
e. None of above

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20. Holding others equal, a lower risk-free interest rate indicates
a. A Lower premium on puts and a higher premium on calls
@ A higher premium on puts and a lower premium on calls
c. A higher premium on both puts and calls
d. A lower premium on both puts and calls
e. Risk-free interest rate has no impact on the calls and puts premiums

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21. Shares in listed companies have a real option component. This is because the law limits the total
liability of shareholders. When the company defaults on its debts, shareholders are not obligated
to use their own money to bail out the company. This option that is linked to shares can be
BEST described as:
a. A long position on a call option on the assets of the company, the exercise price being
the total value of the company's equity
b. A short position on a put option on the assets of the company, the exercise price being
r='f)the total value of the company's equity
� A long position on a call option on the assets of the company, the exercise price being
the total value of the company's liability.
d. A long position on a put option on the assets of the company, exercise price being the
total value of the company's liability

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e. None of above
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 22. Bondholders of a limited company also take a position in real option. If a company defaults on
its debt, bondholders may not be able to recover the full amount payable to them. Assume a
company has only one non-coupon bond, then its bondholders' real option position can be BEST
described as:
a. A long position on a call option on discounted future profits of the company, the
exercise price being the face value of the bond.
b. A short position on a put option on the assets of the company, the exercise price being
the market capitalisation of the company.
c. A long position on a call option on the liability of the company, the exercise price being
@ the total value of the company.
A short position on a put option on the assets of the company, the exercise price being
,,; the face value of the bond.

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e. A short position on a call option on the asset of the company, the exercise price being
the face value of the bond.
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23. lionTrade is considering inves�gi�-A �ining project �at can be sold anytime during its life for tJtA-� o�, 5
$69,000. The value of the project is $81,000 today. During each of the next two 6-month periods or:_ ell -{/)
the value of the project is expected to either increase by 30% or fall by 30%. The risk-free 8 we
interest rate is 10% per six months. What is the value of the embedded option using the risk �/tt.bt<2 h v(r}er5
neutral method?
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$3727.27
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f -;.. (24. ln :il�roducer has obtained a drilling right to extract oil from an oil reserve, which is expected
to yield 6 million barrels of oil. At the beginning of the extraction operation, the company will
incur a cost of infrastructure and equipment of $10.5 million (has no salvage value). The current
oil price is $40 per barrel; in one year's time the price could rise to $46 per barrel or fall to $36
per barrel. The variable cost of extracting oil is $39 per barrel. The company can wait for one
year and then decide whether it will extract and sell the oil or mothball the reserve. Suppose all
barrels of oil can be extracted and sold at the spot price at the beginning or at the end of the year.
What is the value of the real option in this situation (assuming a risk-free rate of 5% p.a.)?
a. $24 million
Q $18 millio;i
n
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25. A Brazilian fast food franchise is considering introducing its stores into the United States. It
plans to initially introduces its stores in a large metropolitan area to gauge potential demand. It
takes 2 years to complete this phase. If the initial introduction turns out to be successful, the
company can further expand its stores across the United States, which will take 5 years to
complete. What is the duration of the embedded real option?
a. 5 years

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d. 3 years
e. None of above

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