Hull: Options, Futures, and Other Derivatives, Tenth Edition

Chapter 16: Employee Stock Options

Multiple Choice Test Bank

1. Which of the following is true?

A. An employee stock option is usually held to maturity
B. An employee stock option tends to be exercised earlier than a traded option with the
same terms
C. An employee stock options tends to be exercised later than a traded option with the
same terms
D. Employee stock options are usually exercised as early as possible

2. Which of the following is NOT usually true about employee stock options?
A. There is a vesting period
B. They can be sold to other employees
C. They are often at-the-money when issued
D. Their value is currently a charge to the income statement

3. What term is used to describe losses shareholders experience because the interests of managers
are not aligned with their own?
A. Agency costs
B. Backdating scandals
C. Dilution
D. Income statement expense

4. Which of the following are true of employee stock options?

A. They are commonly valued as though they are regular American options
B. They are commonly valued as though they are regular American options, but with a reduced
life.
C. They are commonly valued as though they are regular European option
D. They are commonly valued as though they are regular European options but with a reduced
life.

5. Which of the following was true about employee stock options prior to 1995?
A. The options never had any affect on a company’s financial statements
B. The value of options which were at-the-money when issued had to be expensed on the
income statement
C. The value of options which were at-the-money when issued had to be reported in the
notes to the financial statements
D. Options which were at-the-money when issued did not affect a company’s financial
statements
6. Which of the following was true about employee stock options between 1996 and 2004?
A. The options never had any affect on a company’s financial statements
B. The value of options which were at-the-money when issued had to be expensed on the
income statement
C. The value of options which were at-the-money when issued had to be reported in the
notes to the financial statements
D. Options which were at-the-money when issued did not affect a company’s financial
statements

7. Which of the following was true after 2005?

A. The options never had any affect on a company’s financial statements
B. The value of options which were at-the-money when issued had to be expensed on the
income statement
C. The value of options which were at-the-money when issued had to be reported in the
notes to the financial statements
D. Options which were at-the-money when issued did not affect a company’s financial
statements

8. Which of the following is true about employee stock options after they have been issued?
A. They have to be revalued every year
B. They have to be revalued every quarter
C. They have to be revalued every day like other derivatives
D. They never have to be revalued

9. Which of the following is true about the practice of backdating a stock options grant?
A. It is illegal
B. It is illegal in the majority of states in the U.S., but not all states
C. It is illegal in roughly half the states in the U.S.
D. It is unethical, but not illegal

10. A company surprises the market with an announcement that it has granted stock options to
senior executives. The options are exercised four years later. When does dilution take place?
A. Dilution takes place when the options are exercised
B. Dilution takes place on the announcement date
C. Dilution takes place gradually over the four years
D. There is no dilution

11. When an employee leaves the company which of the following is usually true?
A. All outstanding employee stock options are forfeited
B. Out-of the money employee stock options are forfeited
C. All options which have vested are forfeited
D. All options are retained

12. Which of the following defines the vesting period?

A. The period during which employee stock options can be exercised
B. The period during which the options are issued
C. The period during which the strike price of the options equals the stock price
D. The period during which employee stock options cannot be exercised
13. Which of the following is NOT true?
A. Management has an incentive to issue executive stock options after bad news
B. Management has an incentive to issue executive stock options before good news
C. Executive stock options encourage management to pursue strategies that are best for
the company in the long run
D. Management have an incentive to time the announcement of good news just before
they plan to exercise their stock options

14. Which of the following strategies makes no sense?

A. An employee exercises stock options early and sells the stock. No dividends are expected
B. An employee exercises stock options early and keeps the stock. No dividends are
expected
C. An employee exercises stock options early and sells the stock. Dividends are expected
D. An employee exercises stock options early and keeps the stock. Dividends are expected.

15. When a CEO has employee stock options, he or she is in theory motivated to do which of the
following?
A. Take more risk
B. Take less risk
C. Buy some of the company’s stock
D. None of the above

16. When an employee stock option is exercised, which of the following is usually true?
A. The employee pays the market price for the shares and the company refunds the
difference between the market price and the strike price
B. The company or the company’s agent buys stock in the market for the employee
C. The company issues more shares and sells them to the employee for the strike price
D. The employee cannot immediately sell the shares

17. Which of the following increases the expected life of employee stock options?
A. An increase in the vesting period
B. An increase in employee turnover
C. A fast growth rate for the stock price
D. A tendency for employees to exercise earlier than in the past

18. Which of the following hypotheses was supported by empirical research covering the 1995 to
2002 period?
A. The grant date for executive stock options tended to be when the stock price is high
B. The grant date for executive stock options tended to be when the stock price is low
C. The grant date for executive stock options tended to be after a growth spurt in the stock
price
D. The was no relationship between the timing of grants and the stock price

19. Which of the following ensures that managers are rewarded only when a company performs
 better than its competitors?
A. A constant strike price for executive stock options
B. A strike price that increases with time
C. A strike price that changes in line with an index of stock prices
D. A strike price that is tied to reported profit

20. Employee stock options are particularly popular with start ups because
A. They encourage employees to work hard
B. The start up cannot afford to pay high salaries
C. The risk associated with the company’s success is shared with employees.
D. All of the above