• Now assume that on December

31, Year 6, Anderson lost its

ability to significantly influence
the operating, investing, and
financing decisions for Carter
when another party obtained
sufficient shares in the open
market to obtain control over
Carter. Accordingly, the
investment in Carter was
reclassified as a FVTPL
investment. The fair value of
the Carter shares was $35 per
share on this date.
Prepare the journal entry at
December 31, Year 6, to
reclassify the investment from
significant influence to FVTPL
4-1 There are three types of misstatements:

 Factual Misstatements. These are identified misstatements about which

there is no doubt. For example, an auditor may test a sales invoice and
determine that the prices applied to the products ordered are incorrect.
Once the products are correctly priced, the amount of misstatement is
known. In such cases, the auditor knows the exact amount of the
misstatement.
  Judgmental Misstatements. These are misstatements that arise from the
judgments of management concerning accounting estimates that the
auditor considers unreasonable or the selection or application of
accounting policies that the auditor considers inappropriate.
 Projected Misstatements. These are the auditor’s best estimate of
misstatements in populations, involving the projection of misstatements
identified in an audit sample to the entire population from which the
sample was drawn.

4-2 Misstatements can result from errors or fraud. The term errors refers to
unintentional misstatements of amounts or disclosures in financial statements.
The term fraud refers to an intentional act by one or more among
management, those charged with governance, employees, or third parties,
involving the use of deception to obtain an unjust or illegal advantage. Thus,
the primary distinction between errors and fraud is whether the misstatement
was intentional or unintentional. Unfortunately, it is often difficult to
determine intent. For example, if the auditor detects a misstatement in an
account that requires an estimate, such as bad debt expense, it may be difficult
to determine whether the misstatement was intentional.

in €)

Nuñes considers the following option strategies relating to IZD:

Nuñes next reviews the following option strategies relating to QWY:

Finally, Nuñes considers two option strategies relating to XDF:

1. Strategy 1 would require Nuñes to buy:

A. shares of IZD.
B. a put option on IZD.
C. a call option on IZD
2. Based on Exhibit 1, Nuñes should expect Strategy 2 to be least profitable if the share price of
IZD at option expiration is:
A. less than €91.26.
B. between €91.26 and €95.00
C. more than €95.00.
3. Based on Exhibit 1, calculate the breakeven share price of Strategy 3.
Answer:
The current share price of IZD is €93.93, and the IZD April €97.50 call premium is €1.68. Thus,
the breakeven underlying share price for Strategy 3 is S0 – c0 = €93.93 – €1.68 = €92.25

4. Based on Exhibit 1, calculate the maximum loss per share that would be incurred by
implementing Strategy 4.
Answer:
By purchasing the €25.00 strike put option, Nuñes would be protected from losses at QWY share
prices of €25.00 or lower. Thus, the maximum loss per share from Strategy 4 would be the loss of
share value from €28.49 to €25.00 (or €3.49) plus the put premium paid for the put option of
€0.50: S0 – X + p0 = €28.49 – €25.00 + €0.50 = €3.99.

5. Strategy 5 is best described as a:

A. collar.
B. straddle.
C. bear spread.
6. Based on Exhibit 1, Strategy 5 offers:
A. unlimited upside.
B. a maximum profit of €2.48 per share.
C. protection against losses if QWY's share price falls below €28.14
7. Based on Exhibit 1, calculate the breakeven share price for Strategy 6.
Answer:
In the case of Strategy 6, the April €31.00 put option would be purchased and the April €25.00 put
option would be sold. The long put premium is €3.00 and the short put premium is €0.50, for a net
cost of €2.50. The breakeven share price is €28.50, calculated as XH – (pH – pL) = €31.00 –
(€3.00 – €0.50) = €28.50.

8. Based on Exhibit 1, the maximum gain per share that could be earned if Strategy 7 is
implemented is:
A. €5.74.
B. €5.76.
C. unlimited.
9. Based on Exhibit 1, the best explanation for Nuñes to implement Strategy 8 would be that,
between the February and December expiration dates, she expects the share price of XDF to:
A. decrease.
B. remain unchanged.
C. increase.
10. Over the past few months, Nuñes and Pereira have followed news reports on a proposed
merger between XDF and one of its competitors. A government antitrust committee is
currently reviewing the potential merger. Pereira expects the share price to move sharply
upward or downward depending on whether the committee decides to approve or reject the
merger next week. Pereira asks Nuñes to recommend an option trade that might allow the firm
to benefit from a significant move in the XDF share price regardless of the direction of the
move. The option trade that Nuñes should recommend relating to the government committee’s
decision is a:
A. Collar
B. bull spread
C. long straddle

The following information relates to Questions 11–16

Stanley Kumar Singh, CFA, is the risk manager at SKS Asset Management. He works with
individual clients to manage their investment portfolios. One client, Sherman Hopewell, is worried
about how short-term market fluctuations over the next three months might impact his equity
position in Walnut Corporation. Although Hopewell is concerned about short-term downside price
movements, he wants to remain invested in Walnut shares because he remains positive about its
long-term performance. Hopewell has asked Singh to recommend an option strategy that will keep
him invested in Walnut shares while protecting against a short-term price decline. Singh gathers
the information in Exhibit 1 to explore various strategies to address Hopewell’s concerns.

Another client, Nigel French, is a trader who does not currently own shares of Walnut
Corporation. French has told Singh that he believes that Walnut shares will experience a large
move in price after the upcoming quarterly earnings release in two weeks. French also tells Singh,
however, that he is unsure which direction the stock will move. French asks Singh to recommend
an option strategy that would allow him to profit should the share price move in either direction.
A third client, Wanda Tills, does not currently own Walnut shares and has asked Singh to explain
the profit potential of three strategies using options in Walnut: a long straddle, a bull call spread,
and a bear put spread. In addition, Tills asks Singh to explain the gamma of a call option. In
response, Singh prepares a memo to be shared with Tills that provides a discussion of gamma and
presents his analysis on three option strategies:

11. The option strategy Singh is most likely to recommend to Hopewell is a:

A. collar.
B. covered call.
C. protective put.
12. The option strategy that Singh is most likely to recommend to French is a:
A. Straddle
B. bull spread
C. collar
13. Based on Exhibit 1, calculate the share price at expiration when Strategy 1 is profitable.
Answer:
The market price for the $67.50 call option is $1.99, and the market price for the $67.50 put option
is $2.26, for an initial net cost of $4.25 per share. Thus, this straddle position requires a move
greater than $4.25 in either direction from the strike price of $67.50 to become profitable. So, the
straddle becomes profitable at $67.50 – $4.25 = $63.25 or lower, or $67.50 + $4.25 = $71.75 or
higher. At $63.00, the profit on the straddle is positive.

14. Based on Exhibit 1, calculate the maximum profit, on a per share basis, from investing in
Strategy 2.
Answer:
The purchase of the $65 strike call option costs $3.65 per share, and selling the $70 strike call
option generates an inflow of $0.91 per share, for an initial net cost of $2.74 per share. At
expiration, the maximum profit occurs when the stock price is $70 or higher, which yields a $5.00
per share payoff ($70 – $65) on the long call position. After deduction of the $2.74 per share cost
required to initiate the bull call spread, the profit is $2.26 ($5.00 – $2.74)
15. Based on Exhibit 1, and assuming the market price of Walnut’s shares at expiration is $66,
calculate the profit or loss, on a per share basis, from investing in Strategy 3.
Answer:
The initial net cost of the bear spread position is $3.70 – $1.34 = $2.36 per share. If Walnut shares
are $66 at expiration, the $70 strike put option is in the money by $4.00, and the short position in
the $65 strike put expires worthless. After deducting the cost of $2.36 to initiate the bear spread
position, the net profit is $1.64 per contract.

16. Based on the data in Exhibit 1, Singh would advise Tills that the call option with the largest
gamma would have a strike price closest to:
A. $ 55.00.
B. $ 67.50.
C. $ 80.00.

The following information relates to Questions 17–20

Anneke Ngoc is an analyst who works for an international bank, where she advises highnet-worth
clients on option strategies. Ngoc prepares for a meeting with a US-based client, Mani Ahlim.

Ngoc notes that Ahlim recently inherited an account containing a large Brazilian real (BRL) cash
balance. Ahlim intends to use the inherited funds to purchase a vacation home in the United States
with an expected purchase price of US$750,000 in six months. Ahlim is concerned that the
Brazilian real will weaken against the US dollar over the next six months. Ngoc considers
potential hedge strategies to reduce the risk of a possible adverse currency movement over this
time period.

Ahlim holds shares of Pselftarô Ltd. (PSÔL), which has a current share price of $37.41. Ahlim is
bullish on PSÔL in the long term. He would like to add to his long position but is concerned about
a moderate price decline after the quarterly earnings announcement next month, in April. Ngoc
recommends a protective put position with a strike price of $35 using May options and a $40/$50
bull call spread using December options. Ngoc gathers selected PSÔL option prices for May and
December, which are presented in Exhibit 1.

Ahlim also expresses interest in trading options on India’s NIFTY 50 (National Stock Exchange
Fifty) Index. Ngoc gathers selected one-month option prices and implied volatility data, which are
presented in Exhibit 2. India’s NIFTY 50 Index is currently trading at a level of 11,610.
Ngoc reviews a research report that includes a one-month forecast of the NIFTY 50 Index. The
report’s conclusions are presented in Exhibit 3.

Based on these conclusions, Ngoc considers various NIFTY 50 Index option strategies for Ahlim.
17. Based on Exhibit 1, calculate the maximum loss per share of Ngoc’s recommended PSÔL
protective put position.
Answer:
Maximum loss per share of protective put = S0 − X + p0 = $37.41 − $35.00 + $1.81 = $4.22

18. Based on Exhibit 1, calculate the breakeven price per share of Ngoc’s recommended PSÔL
protective put position.
Answer:
Breakeven price per share of protective put = $37.41 + $1.81 = $39.22

19. Based on Exhibit 1, calculate the maximum profit per share of Ngoc’s recommended PSÔL
bull call spread.
Answer:
Maximum profit per share of bull call spread = (XH – XL) – (cL – cH) = ($50 – $40) – ($6.50 –
$4.25) = $7.75.

20. Based on Exhibit 1, calculate the breakeven price per share of Ngoc’s recommended PSÔL
bull call spread.
Answer:
Breakeven price per share of bull call spread = XL + (cL – cH) = $40 + ($6.50 – $4.25) = $42.25.