Alpha Company Purchases a Call Option to Hedge an Investment

question 4

Multiple Choice

Alpha Company purchases a call option to hedge an investment of 20,000 shares of Beta Company stock. The option agreement provides that if the prices of a share of Beta Company stock is greater than $30 on October 25, Alpha receives the difference (multiplied by 20,000 shares) . Alternatively, if the price of the stock is less than $30, the option is worthless and will be allowed to expire. Which of the following statements regarding this call option is correct?

• A) The call option effectively hedges the investment in the shares of Beta stock.
• B) The call option is an option to sell Beta Company stock at a fixed price.
• C) The call option represents a speculative option rather than a hedge.
• D) Alpha could have purchased a put option or a call option to effectively hedge the investment in the shares of Beta stock.

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