MBA Introduction Options 2nd Year Semester IV Question Answer

MBA Introduction Options 2nd Year Semester IV Question Answer

MBA Introduction Options 2nd Year Semester IV Question Answer

MBA Introduction Options 2nd Year Semester IV Question Answer
MBA Introduction Options 2nd Year Semester IV Question Answer

Introduction to options, Hedging with currency options, Speculation and Arbitrage with options, Pricing options, General principles of pricing, Black- Scholes option pricing model, Index options, Hedging with index options, Speculation and Arbitrage with index options, Index options market in Indian stock market, Use of different option strategies to mitigate the risk.

Section A

VERY SHORT ANSWER QUESTIONS

QUES.1. What is option?

Ans. Option is a financial derivative that represents a contract sold by one party to another party. The contract offers the buyer the right but not the obligation, to buy or sell a security or other financial  at an agreed-upon price during a certain period of time or on a specific date.

Ques.2. What is option price?

Ans. Option price is the amount per share that an option buyer pays to the seller. The premium is the price at which the contract trades. The premium is the price of the option and is paid by the buyer to the writer or seller of the option. In return, the writer of the call option is obligated to deliver the underlying security to an option buyer if the call is exercised or buy the underlying security if the put is exercised.

Ques.3. Define exercise price.

Ans. The exercise price is also called the fixed price. Strike price or just the strike is determined at the beginning of the transaction. It is the fixed price at which the holder of the call or put can buy or sell the underlying asset.

Ques.4. Give the four advantages of options.

Ans. Four advantages of options are as follows:

  1. Leverage,
  2. Risk management,
  3. Speculation,
  4. Income generation.

Ques.5. Give the two assumptions of Black and Scholes option pricing model.

Ans. Following are the assumptions of Black and Scholes model are:

  1. Returns are Normally Distributed: These assumptions suggest that returns on the underlying stock are normally distributed, which is reasonable for most assets that offer options.
  2. Markets are Efficient: This assumption suggests that people cannot consistently predict the direction of the market or an individual stock.

Ques.6. What do you know about option pay-off?

Ans. An option pay-off is defined as the price that an investor would be willing to pay for the option the instant before it expires. An option pay-off is distinct from its price or premium, because the pay-off only refers to the price of the option at a particular instant of time, the expiration date.

Ques.7. State the disadvantages of options.

Ans. The disadvantages of options are as follows:

  1. Complex Process: Understanding option trading requires from observations and maintenance.
  2. Lower Liquidity: With the wide range of prices available some will suffer from very low liquidity making the trading  difficult.

Ques.8. What is short call? 

Ans. The writer of the call has the obligation to deliver the underlying asset to the buyer at the strike price. If the call writer does not own or possess the underlying asset, he is writing naked cause. He has to deliver the goods or assets only when the market price is more than the stock price.

Ques.9. What do you understand by a caller?

Ans. A caller is an option trading strategy similar to covered call strategy but involves another leg i.e., buying a put to ensure against the fall in the price of the stock. It is a covered call with a limited risk So, a caller is buying a stock ensuring against the downside by buying a put and then financing the put by selling a call.

Ques.10. Define a cap.

Ans. A cap is essentially a strip of options. A borrower with an existing interest rate liability can protect against a rise in interest rate by purchasing a cap. If the rates rise above the cap, the borrower will be compensated by the cap payout, however if rates fall, the borrower gains from lower funding costs.

Ques.11. What are stock index options?

Ans. A stock index option provides the right to trade a specified stock index at a specified price by a specified expiration date. Call options on stock indexes allow the right to purchase the index, and put options on stock indexes allow the right to sell the index. If and when the index option is exercised, the cash payment is equal to a specified dollar amount multiplied by the difference between the index level and the exercise price.

Ques.12. Define a strip.

Ans. A strip refers to a long position with one call and to put options with the same strike price and the expiration date.

Ques.13. What is call bear spread?

Ans. A bear vertical call option spread is created by buying a call option with a high strike price and selling one with a lower strike price, both with the same expiration date. This is exactly the reverse of the vertical call option. Bullish spread where the long call is at a higher strike price and the short call is at a lower strike price.

Ques.14. Define strike price.

Ans. The price specified in the options contract is known as the strike price or the exercise price.

Ques.15. How will you define call option premium?

Ans. The premium on a call option represents the cost of having the right to buy the underlying currency at a specified risk. For MNCs that use currency call options to hedge, the premium reflects a cost of insurance or protection to the MNCs.

Ques.16. What do you mean by option premium/price?

Ans. Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium.

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