An option's premium is comprised of two components: intrinsic value and time value. The intrinsic value of a call option is the amount by which the underlying stock's market price is above the strike price. Here, the intrinsic value is $5 ($40 market price - $35 strike price). The time value is the portion of the premium that exceeds the intrinsic value. To find the time value, subtract the intrinsic value from the total premium. Therefore, the time value is $2 ($7 premium - $5 intrinsic value).

A. $0: Incorrect. This would only be true if the entire premium consisted of intrinsic value, which is not the case.

C. $5: Incorrect. This represents the option's intrinsic value, which is the amount the option is "in-the-money."

D. $7: Incorrect. This is the total premium of the option, which is the sum of both its intrinsic value and its time value.

1. FINRA Investor Education Foundation. "Options." FINRA.org. This official resource explains the components of an option's premium. It states, "An option's premium is its total cost. It consists of two components: intrinsic value and time value... For a call option, intrinsic value is the amount the underlying security's price is above the strike price... Time value is the amount by which the option's premium exceeds its intrinsic value." This directly supports the calculation method used.

2. Bodie, Z., Kane, A., & Marcus, A. J. (2018). Investments (11th ed.). McGraw-Hill Education. In Chapter 20, "Options Markets: Introduction," the text defines the components of an option's value. It explicitly states the formula: Time Value = Option Premium - Intrinsic Value. (See Section 20.2, "The Option Contract").

3. MIT OpenCourseWare. 15.401 Finance Theory I, Fall 2008. Lecture Notes 13: Options I. The course materials define the value of a call option at expiration as Max(ST - K, 0), which is its intrinsic value. The price of the option before expiration is shown to be the sum of this intrinsic value and a time value component (Option Price = Intrinsic Value + Time Value). This foundational academic principle confirms the relationship used to solve the problem.