Knopman Exam Options & Issuing Securities

Front 1

An investor buys 6 DFI Feb 60 calls at 2.25 each. At the time of the purchase, DFI is trading at 59.50 per share. What price would DFI stock need to reach for the investor to break even?

A) 57.75.
B) 62.25.
C) 61.75.
D) 60.

Back 1

The correct answer was: 62.25.
The breakeven point for a call, long or short, is strike price plus premium (60 + 2.25 = 62.25).

Front 2

Rule 144A regulates:

A) the sale of restricted stock by control persons.
B) the sale of restricted stock by institutional investors.
C) personal trading by research analysts.
D) companies traded on the NASDAQ Global Select Market.

Back 2

The correct answer was: the sale of restricted stock by institutional investors.
Rule 144A regulates the trading of restricted securities by institutional investors known as qualified institutional buyers (QIBs).

Reference: 7.6.2.5 in the License Exam Manual.

Front 3

In early September, a customer buys 100 shares of MCS stock for $83 per share and simultaneously writes 1 MCS Mar 90 call for $4 per share. The customer will break even when MCS stock is at:

A) 86
B) 94
C) 79
D) 87

Back 3

The correct answer was: 79
This is a covered call writer. If the stock rises above $90, the writer will be exercised and will make $700 on the stock (buy at $83, deliver at $90) and keep the $400 received in premiums. If the stock declines, the call expires unexercised. The writer can lose $400 on the stock (the premiums earned) and still break even. This occurs at $79 ($83 − $4). Breakeven is cost of stock purchased less premiums.

Front 4

An investor who believes the U.S. dollar will strengthen against the Canadian dollar should profit from which of the following strategies?

1. Buying puts on the Canadian dollar.
2. Writing puts on the Canadian dollar.
3. Writing a straddle on the Canadian dollar.
4. Establishing a call credit spread on the Canadian dollar.

A) I and III.
B) I and IV.
C) III and IV.
D) II and IV.

Back 4

The correct answer was: I and IV.
The investor who is bearish on the Canadian dollar should buy puts, write calls, and call spreads. Short straddles pay off when the market does not move either way.

Front 5

Which of the following listed option positions is most unsuitable for a customer whose investment objectives include minimal risk?

A) Long call.
B) Short call.
C) Long put.
D) Short put.

Back 5

The correct answer was: Short call.
The sale of the call option burdens the investor with unlimited upside potential risk.

Front 6

Covered put writing is a strategy where an investor:

A) sells a put and buys a call on the same stock.
B) sells a put on a stock he has sold short.
C) sells a put on a stock that he owns.
D) sells a put and sells a call on the same stock.

Back 6

The correct answer was: sells a put on a stock he has sold short.
The customer sells the put to generate income. The short stock position provides the necessary cash should his short put be exercised, forcing him to buy the stock.

Front 7

A customer sells short 1,000 ABC at 39. ABC falls to 34 at which time the customer writes 10 ABC Nov 35 puts at 3.50. If the stock subsequently falls another point and the customer is assigned, the result is a gain of:

A) 8500.
B) 1500.
C) 7500.
D) 500.

Back 7

The correct answer was: 7500.
The investor receives $39,000 from the short sale of the stock and $3,500 from the sale of puts, for a total of $42,500. When the puts are exercised, the investor purchases 1,000 shares of the stock at $35 per share, or $35,000. ($42,500 minus $35,000 gives the investor a profit of $7,500.) The customer shorted stock at 39 which he was forced to buy back at 35 (gain of $4,000). In addition, the customer received $3,500 for writing the puts for a total gain of $7,500.

Front 8

XYZ closed at 41 and the XYZ Mar 45 puts closed at 5.25. The puts are:

A) out-of-the-money.
B) at the money.
C) at parity.
D) in-the-money.

Back 8

The correct answer was: in-the-money.
Put options are in-the-money when the market price is below the strike price. In this case, the puts are in-the-money by 4.

Front 9

The breakeven point for covered call writers is:

A) cost of stock less premiums.
B) cost of stock plus premiums .
C) strike price less premiums.
D) strike price plus premiums.

Back 9

The correct answer was: cost of stock less premiums.
The breakeven point for an investor who owns the underlying stock and writes a call is the cost of that stock less the premium received from the sale of the call.

Front 10

Who cannot trade options for his or her account?

A) A Registered options principal.
B) An order book official.
C) A specialist.
D) A market maker.

Back 10

The correct answer was: An order book official.
The order book official holds customer limit orders and, as an employee of the exchange, cannot trade for himself.

Front 11

If a customer buys 100 XYZ at 49 and writes 1 XYZ Nov 50 call, receiving $350 in premiums, the breakeven point is:

A) 53.5.
B) 52.5.
C) 45.5.
D) 46.5.

Back 11

The correct answer was: 45.5.
This is a covered call, so the investor is protected against declining stock prices to the extent of the premium received, and the breakeven is 45.50 (49 − 3.50).

Front 12

The derivative-based strategy known as portfolio insurance involves the:

A) sale of a call on the underlying security position.
B) purchase of a call on the underlying security position.
C) purchase of a put on the underlying security position.
D) sale of a put on the underlying security position.

Back 12

The correct answer was: purchase of a put on the underlying security position.
The purchase of a put option to hedge the downside risk of an underlying security holding is called a protective put position one of many derivative-based strategies collectively known as portfolio insurance.

Front 13

Which investor has the greatest potential risk if the price of QRS goes up?

A) Short 10 puts on QRS.
B) Short 10 calls on QRS.
C) Long 10 calls on QRS.
D) Long 10 puts on QRS.

Back 13

The correct answer was: Short 10 calls on QRS.
If the market is rising, the greatest potential risk that an investor can take is a short naked call because the potential loss is unlimited.

Front 14

Which of the following would best describe, "Bought 1 Jan 55 call at 3 and sold 1 Jan 60 call at 1"?

A) A bull vertical spread.
B) A bull horizontal spread.
C) A bear vertical spread.
D) A bear time spread.

Back 14

The correct answer was: A bull vertical spread.
The client paid 2 points out-of-pocket for a call spread. Break even here is 57. Your client wants the stock to go up; hence, a bull spread. Because the exercise prices are different, it is also a vertical spread.

Front 15

An investor opens the following position:

Buy 1 COD Jan 40 put at 6.50
Write 1 COD Jan 30 put at 2.10

His maximum loss is:

A) 2600.
B) 440.
C) 560.
D) 2100.

Back 15

The correct answer was: 440.
The maximum loss on a debit spread is the net debit.

Front 16

In reading the foreign currency option quotes in The Wall Street Journal, you find that the exchange rate for British pounds is listed at 148.47. What does this mean?

A) $1 equals 1.4847 pounds.
B) $1 equals 14.847 pounds.
C) One pound equals $1.4847.
D) One pound equals 14.847 U.S. cents.

Back 16

The correct answer was: One pound equals $1.4847.
The exchange rate refers to U.S. cents per British pound; 148.47 equals $1.4847.

Front 17

If a customer sells short 100 XYZ at 79 and simultaneously writes 1 XYZ Jan 80 put at 5, the maximum gain potential is:

A) 600.
B) unlimited.
C) 400.
D) 500.

Back 17

The correct answer was: 400.
Short stock combined with a short put is an income strategy that carries unlimited loss potential. Although gain will occur if the stock moves downward, the customer wrote an in-the-money put that will be exercised, forcing the customer to buy stock at 80 for a $100 loss on the stock shorted at 79. However, the customer received $500 in premiums, resulting in an overall gain of $400. Breakeven for short stock-short put is short sale price plus premium. In this case, breakeven is 84 and maximum gain is 4 points, from 84 to 80.

Front 18

Which of the following is inversely related to the length of time an investor holds an option?

A) Time value.
B) Volatility.
C) Value of the underlying stock.
D) Intrinsic value.

Back 18

The correct answer was: Time value.
An option's time value diminishes as the option nears expiration. The longer an option is held, the less time remains.

Front 19

In a rising market, all of the following strategies are appropriate EXCEPT:

A) long calls.
B) short stock/short put.
C) debit call spreads.
D) short puts.

Back 19

The correct answer was: short stock/short put.
Investors who short stock have sold borrowed shares, and profit when the market price declines.

Front 20

If a customer buys 5 ABC Jan 40 puts and writes 5 ABC Jan 45 puts, which of the following statements are TRUE?

1. The customer profits if the spread widens.
2. The customer profits if the spread narrows.
3. The customer is a bull.
4. The customer is a bear.

A) I and III.
B) I and IV.
C) II and III.
D) II and IV.

Back 20

The correct answer was: II and III.
Because a put is a right to sell, the premium on the 45 puts is higher than that of the 40 puts. The customer is writing the put with the higher premium, so this is a credit spread and the bullish investor will profit at expiration if the difference between the two premiums narrows as the contracts lose value.

Front 21

If the Swiss franc closes at 56, 1 SF 59 put is:

A) 3 points in-the-money.
B) at the money.
C) 3 points out-of-the-money.
D) without intrinsic value.

Back 21

The correct answer was: 3 points in-the-money.
The put is in-the-money when the underlying instrument's market price is below the put's strike price.

Front 22

A customer is long 10 XYZ Jan 60 calls, and XYZ declares a 20% stock dividend. On the ex-date, the customer will have:

A) 10 XYZ Jan 60 calls (100 shares per contract).
B) 10 XYZ Jan 50 calls (100 shares per contract).
C) 10 XYZ Jan 60 calls (120 shares per contract).
D) 10 XYZ Jan 50 calls (120 shares per contract).

Back 22

The correct answer was: 10 XYZ Jan 60 calls (120 shares per contract).
When adjusting options contracts, the number of contracts held and the strike price will not change for stock dividends (and fractional splits). The number of shares covered by each contract is increased (100 shares × 120%). Each adjusted contract now represents 120 shares.

Front 23

An investor buys a yield-based Sept 70 call on a 30-year T-bond for a premium of 2.50. At expiration, if the yield on the most recently issued T-bond is 7.95%, what is the investor's gain or loss?

A) $950 gain.
B) $700 gain.
C) $700 loss.
D) $950 loss

Back 23

The correct answer was: $700 gain.
A September 70 call means that the holder is buying a 7% yield. The investor can close the option at its intrinsic value: (7.95 − 7.00 = 0.95; 0.95 × 10 × $100 = $950 received upon close). Subtract $250 premium paid for a total profit of $700.

Front 24

A customer purchases 200 shares of XYZ at 17.50 and writes 2 XYZ Jan 20 calls at 1. At expiration, with the stock trading at 19, the options expire worthless. If the customer sells his long stock at the current market price, the gain is:

A) 500
B) 250
C) 350
D) 700

Back 24

The correct answer was: 500
The customer buys stock at 17.50 and sells his shares at 19 for a gain of $300. In addition, the customer keeps the $200 in premiums for an overall gain of $500.

Front 25

Which option strategy is most similar to entering a buy limit order?

A) Long in-the-money call.
B) Short out-of-the-money call.
C) Short out-of-the-money put.
D) Long in-the-money put.

Back 25

The correct answer was: Short out-of-the-money put.
A buy limit order is only executed when the market price of the stock falls to or below the limit price. An out-of-the-money put will only be exercised when the price of the underlying stock falls below the strike price. Thus, in both cases, the investor is determining the maximum purchase price of the stock.

Front 26

If XYZ Corporation intends to offer stock in a public offering, it must do all of the following EXCEPT:

A) file a registration statement.
B) register the securities with the SEC.
C) issue a prospectus.
D) publish a tombstone advertisement.

Back 26

The correct answer was: publish a tombstone advertisement.
Tombstones are advertisements often appearing in business newspapers to publicize new issues and are generally placed by a syndicate manager. They are not required.

Front 27

Which of the following positions has an unlimited dollar risk?

A) Short 1 ABC Jan 35 call; long 1 ABC Jan 40 call.
B) Short 100 shares of ABC; long 1 ABC call.
C) Short 1 ABC Jan 50 put.
D) Short 1 ABC Jan 50 put; short 100 shares of ABC.

Back 27

The correct answer was: Short 1 ABC Jan 50 put; short 100 shares of ABC.
An investor faces unlimited dollar risk when short stock, short a naked call, or when a short stock position is combined with a short put. In this position, the unlimited risk of the stock is only protected on the upside by the premium received

Front 28

What is the size of one LEAPS contract?

A) 1,000 shares.
B) More than 1,000 shares.
C) There is no standard LEAPS contract size.
D) 100 shares.

Back 28

The correct answer was: 100 shares.
Like a standard options contract, the size of a LEAPs contract is 100 shares.

Front 29

Which of the following statements regarding index options are TRUE?

1. Exercise is settled in cash.
2. Exercise settlement value is based on the value of the index at the time exercise instructions are received.
3. Exercise settlement value is based on the closing index value on the day exercise instructions are tendered.
4. Exercise settlement is regular way.

A) I and II.
B) I and III.
C) II and IV.
D) II and III.

Back 29

The correct answer was: I and III.
All index option exercises are settled in cash. The amount a writer owes the holder is known as the intrinsic value of the option, and the settlement value is based on the closing index value on the day exercise instructions are tendered. Settlement is next business day.

Front 30

A covered call could be written to:

A) do All of these.
B) lock in a profit.
C) purchase future securities.
D) improve the return on a portfolio.

Back 30

The correct answer was: improve the return on a portfolio.
Writing a call will not necessarily lock in the profit. In the form of increased cash flow, it will improve the return on the portfolio.

Front 31

If a customer purchases 60 calls and writes 70 calls at a net debit of $4 per spread, above which of the following prices will an additional dollar of gain on the 60 calls be offset by a dollar loss on the 70 calls?

A) 70.
B) 64.
C) 66.
D) 60.

Back 31

The correct answer was: 70.
As the stock rises above 70, each point represents a gain of 1 on the long 60 call, and a loss of 1 on the short 70 call, because both are in-the-money.

Front 32

Which of the following actions could affect the holding period on a long position in IBS stock?

A) Purchase of 1 IBS call.
B) Purchase of 1 IBS put.
C) Sale of 1 IBS out-of-the-money put.
D) Sale of 1 IBS out-of-the-money call.

Back 32

The correct answer was: Purchase of 1 IBS put.
The purchase of a put affects a stock's holding period when the stock has been held short term. The holding period begins anew once the put position is closed.

Front 33

Under SEC Rule 134, a tombstone advertisement includes all of the following EXCEPT:

A) names of the syndicate members.
B) net proceeds to the issuer.
C) number of shares to be sold.
D) the public offering price.

Back 33

The correct answer was: net proceeds to the issuer.
Under SEC Rule 134, a tombstone advertisement may be placed by the syndicate manager on or before the offering's effective date and is limited to the name of the issuer, type of security being offered, number of shares to be sold, public offering price, and names of the syndicate members.

Front 34

If an American exporter will be paid 25 million Japanese yen when her goods arrive in 45 days, her best hedge is to:

A) sell yen calls.
B) buy yen calls.
C) buy yen puts.
D) sell yen puts.

Back 34

The correct answer was: buy yen puts.
The exporter does not want to see the value of the yen fall. If she owns yen puts and the yen does fall, her profit on the puts would help compensate for the decrease in the value of the yen. Selling yen calls would also provide protection if the yen fell in value, but only to the extent of the premium received. Exporters buy puts in order to hedge; importers buy calls on the foreign currency to hedge.