LOS g: Discuss the effect of the underlying asset's cash flows on the price of an option.

Q1. The value of a put option will be higher if, all else equal, the:

A)   exercise price is lower.

B)   underlying asset has positive cash flows.

C)   underlying asset has less volatility.

Q2. Compared to the value of a call option on a stock with no dividends, a call option on an identical stock expected to pay a dividend during the term of the option will have a:

A)   lower value only if it is an American style option.

B)   lower value in all cases.

C)   higher value only if it is an American style option.

Q3. Dividends on a stock can be incorporated into the valuation model of an option on the stock by:

A)   adding the present value of the dividend to the current stock price.

B)   subtracting the future value of the dividend from the current stock price.

C)   subtracting the present value of the dividend from the current stock price.

LOS g: Discuss the effect of the underlying asset's cash flows on the price of an option. fficeffice" />

Q1. The value of a put option will be higher if, all else equal, the:

A)   exercise price is lower.

B)   underlying asset has positive cash flows.

C)   underlying asset has less volatility.

Correct answer is B)

Positive cash flows in the form of dividends will lower the price of the stock making it closer to being "in the money" which increases the value of the option as the stock price gets closer to the strike price.

Q2. Compared to the value of a call option on a stock with no dividends, a call option on an identical stock expected to pay a dividend during the term of the option will have a:

A)   lower value only if it is an American style option.

B)   lower value in all cases.

C)   higher value only if it is an American style option.

Correct answer is B)

An expected dividend during the term of an option will decrease the value of a call option.

Q3. Dividends on a stock can be incorporated into the valuation model of an option on the stock by:

A)   adding the present value of the dividend to the current stock price.

B)   subtracting the future value of the dividend from the current stock price.

C)   subtracting the present value of the dividend from the current stock price.

Correct answer is C)

The option pricing formulas can be adjusted for dividends by subtracting the present value of the expected dividend(s) from the current asset price.