Question

A call option on 100 shares of Generous Dynamics stock has an exercise price $130.0 per share. GD declares a stock dividend of 20.0 percent. What happens to the exercise price and the number of shares underlying the option?

a) Number of shares increases to 120.0 and the exercise price is reduced to 1040
b) Number of shares increases to 120.0 and the exercise price remains the same Nothing happens
c) Number of shares increases to 120.0 and the exercise price is reduced to 108.33

Answer 1

After a stock dividend of 20%, the option on 100 shares of Generous Dynamics will adjust to 120 shares, and the exercise price would decrease to approximately $108.33 per share to maintain the same overall value.

Step-by-step explanation:

When Generous Dynamics declares a stock dividend of 20.0 percent, this generally dilutes the share price and increases the number of shares. Specifically, if you have an option on 100 shares of Generous Dynamics at an exercise price of $130 per share, after the stock dividend, the number of shares would increase to 120 shares (100 shares + 20% = 120 shares). To maintain the overall value of the option, the exercise price would be adjusted downward to keep the total cost of exercising the option the same. The new exercise price can be calculated by dividing the old exercise price by the new number of shares (130/1.2). This results in a new exercise price of approximately $108.33 per share (rounded to two decimal places).