Deck 24: Risk Management

Question 1

A commodity producer that uses put options to reduce the risk of a fall in commodity prices is effectively buying insurance.

Answer 1

True

Question 2

A commodity producer can place a floor on its revenues by selling put options on the commodity.

Answer 2

False

Question 3

Futures contracts are custom-tailored forward contracts.

Answer 3

False

Question 4

Mexico purchased call options to lock in the price of its oil and create a base floor for its revenue stream.

Question 5

Speculators are a necessary component of well-functioning futures markets.

Question 6

Forward contracts are marked to market.

Question 7

The majority of large companies use derivatives in some way to manage their risk.

Question 8

A producer that uses options to reduce downside risk is buying a "protective put."

Question 9

Properly managed,hedging can be a very profitable activity.

Question 10

Firms use options to speculate not to reduce risk.

Question 11

A swap is an arrangement by two counterparties to exchange one stream of cash flows for another.

Question 12

Swap contracts can be based on either interest rates or currencies.

Question 13

Insurance is often an effective way to reduce risk when the insurance company can spread its risk over many different policies.

Question 14

A firm might enter a swap contract whereby it agrees to make a series of regular payments in one currency in return for receiving a series of payments in another currency.

Question 15

Futures contracts are standardized to expire on the same day each year.

Question 16

Unless the corporation has reason to believe that the odds are stacked in its favor,it should use derivatives for speculation,not for hedging.

Question 17

A company that hedges simply passes the risk on to someone else.

Question 18

In a typical interest rate swap the two parties will exchange a series of fixed payments for a series of payments that are linked to the level of interest rates.

Question 19

Buyers of financial futures place an order to buy a financial asset at a future date.

Question 20

An oil producer would sell,rather than buy,crude oil futures to protect against falling oil prices.

Question 21

The buyer of a credit default swap:

A) gains protection against a fall in house prices.
B) gains protection against default by a pension scheme.
C) insures the seller against a fall in house prices.
D) gains insurance against default on a bond.

Question 22

Exchange traded futures contracts allow the seller to choose the place of delivery for the commodity.

Question 23

Which one of the following is not correct concerning futures contracts?

A) Futures contracts entail an obligation rather than an option.
B) The contract price is set at the beginning of the contract.
C) The contracts are exchange-traded.
D) Gains and losses are not settled until the contract expires.

Question 24

The derivatives market is characterized by:

A) shrinking activity.
B) the introduction of new contracts.
C) low turnover.
D) regular IPOs.

Question 25

Both the seller and the buyer in a futures contract are required to put up margin.

Question 26

The profit to the buyer of a futures contract is equal to the initial futures price minus the ultimate market price.

Question 27

What form of insurance would you suggest for a producer that wishes to be protected from future price decreases but wants to benefit from any future price increases?

A) Buy a call option on the asset
B) Sell a call option on the asset
C) Buy a put option on the asset
D) Sell a put option on the asset

Question 28

Unlike options,the purchase of a futures contract is a binding obligation to purchase at a fixed price at contract maturity.

Question 29

A speculator who sells a futures contract is betting that prices will _____ by the expiration of the contract.

A) decrease
B) increase
C) remain constant
D) Be unusually volatile

Question 30

Investors can hedge against a change in house prices by purchasing real estate futures contracts.

Question 31

By using options a firm can (at a cost)protect against increases in raw material prices,while continuing to benefit from price decreases.

Question 32

How might a firm such as General Mills protect itself against fluctuations in raw material prices for breakfast cereals?

A) Buy commodity futures
B) Sell commodity futures
C) Buy put options on commodities
D) Sell put options on commodities

Question 33

A bond investor who is worried about future fluctuations in interest rates could:

A) enter into a swap to pay both a fixed and a floating rate.
B) enter into a swap to pay a fixed rate and receive a floating rate.
C) enter into a swap to pay a floating rate and pay a fixed rate.
D) enter into a swap to receive both a fixed and a floating rate.

Question 34

A speculator who buys a futures contract is betting that prices will _____ by the expiration of the contract.

A) decrease
B) increase
C) remain constant
D) guarantee high profits

Question 35

Hedging may increase a company's debt capacity.

Question 36

Which one of the following futures contracts is written on an asset that cannot be delivered?

A) U.S. Treasury bills
B) Wheat
C) Standard and Poor's index
D) British pounds

Question 37

Companies should always leave investors to hedge for themselves.

Question 38

Which one of the following is not generally considered a benefit of hedging?

A) Hedging reduces business risk.
B) Hedging allows prices to be locked in ahead of time.
C) Hedging can be very profitable.
D) Hedging can stabilize profits.

Question 39

Selling a futures contract may be appropriate for someone who wishes to:

A) lock in a future sales price.
B) lock in a future purchase price.
C) speculate that future spot prices are going up.
D) have a ready market in which to sell a product.

Question 40

A farmer can avoid delivery on a futures contract by buying an offsetting futures contract.

Question 41

When a commodity futures reaches its expiration,the seller usually:

A) delivers the commodity to the futures buyer.
B) delivers the commodity to the futures exchange.
C) takes an offsetting futures position and settles in cash.
D) adds the profit or loss to his margin account and continues to trade.

Question 42

The primary purpose of financial futures is to:

A) benefit from increases in interest rates.
B) protect against swings in interest rates or prices of financial assets.
C) translate one currency into another.
D) guarantee the repayment of loan principal.

Question 43

Yesterday you sold six-month futures on the S&P index at a price of 2,100.Today the index closed at 2,050 and the future at 2,140.You get a call from your broker.Is he:

A) asking you to pay $40 times the contract size into your margin account?
B) asking you to pay $50 times the contract size into your margin account?
C) telling you that you can withdraw $40 times the contract size from your margin account?
D) telling you that you can withdraw $50 times the contract size from your margin account?

Question 44

A futures contract calls for delivery of 60,000 pounds of soybean oil.What happens to the seller of a soybean oil futures contract at 41 cents per pound if the futures price closes the next day at 42 cents per pound?

A) The contract is marked to market with a $600 loss.
B) The contract is marked to market with a $600 gain.
C) Futures contracts are voided if the price increases prior to expiration.
D) Nothing happens until the expiration of the contract.

Question 45

Which one of the following is not correct concerning forward contracts? Forward contracts:

A) are not standardized.
B) do not set the price until the end of the contract.
C) are not traded on organized exchanges.
D) are not marked to market daily.

Question 46

The basic difference between speculators and hedgers in futures contracts is that speculators:

A) will profit regardless of the direction of price change.
B) do not have an offsetting position in the underlying commodity.
C) are concerned only with long-term price movements.
D) take a position in more than one commodity at a time.

Question 47

Which one of the following is a reason for firms to engage in currency swaps?

A) They will be required to repay only the interest.
B) They can obtain more favorable terms by borrowing in a different currency.
C) The debt will not show on their balance sheets.
D) You can borrow in the currency with the lowest interest rate without taking on any currency risk.

Question 48

The purpose of a margin account for a futures contract is to:

A) guarantee a minimum margin of profit for the contract holder.
B) allow futures traders to have more than one contract simultaneously.
C) provide a cushion for the exchange against defaults on the contract.
D) hold interest payments until expiration.

Question 49

A futures contract seller is obligated to deliver 5,000 bushels of soybeans for $12.00 per bushel at expiration.If soybean futures close at $12.10 the next day,the seller:

A) has a profit of $500 thus far on the contract.
B) has a loss of $500 thus far on the contract.
C) has no profit or loss, but is still obligated to deliver 5,000 bushels at $12.00.
D) will receive a check for $500 from the buyer of the contract.

Question 50

A farmer sells corn futures for March delivery at $7.50 per bushel.In March the spot price of corn is $7.20 per bushel.Which of the following is correct?

A) The futures buyer is required to deliver corn to the farmer at $7.20.
B) The farmer has locked in an effective price of $7.50 per bushel.
C) The farmer would have been better off without the futures contract.
D) The farmer will receive $7.35 per bushel which is the average of the spot and futures prices.

Question 51

What happens to the price of a futures contract as expiration draws closer?

A) The futures price exceeds the spot price of the asset.
B) The futures price is exceeded by the spot price of the asset.
C) The futures price approaches the spot price of the asset.
D) There is no relationship between the futures price and spot price as the contract approaches expiration.

Question 52

If there is an excess of market participants who want to buy the futures as a hedge,then:

A) speculators will come into the market to sell the futures.
B) speculators will see a potential profit from also buying the futures.
C) speculators will steer clear of the futures market.
D) the market may have to close down until there is a balance of supply and demand.

Question 53

A milling company buys a futures contract that requires it to take delivery of 5,000 bushels of wheat at a price of $6.80 per bushel.At expiration the spot price of wheat is $6.68 per bushel.The miller:

A) has saved $0.12 per bushel through hedging.
B) has locked in an effective price of $6.80 per bushel.
C) can choose not to take delivery since the price declined.
D) has locked in an effective price of $6.68 per bushel.

Question 54

A milling company buys a futures contract that requires it to take delivery of 5,000 bushels of wheat at a price of $6.75 per bushel.Next day the price of the future is $6.80.The miller:

A) must pay an extra $0.05 a bushel into its margin account.
B) can withdraw $0.05 from its margin account.
C) does not need to do anything until the contract matures.
D) can't say without knowing what happened to the spot price.

Question 55

The effect of marking a futures contract to market is similar to:

A) doubling the total payments by the contract buyer.
B) doubling the total payments by the contract seller.
C) closing the current position and opening a new position daily.
D) imposing a daily fee on both buyers and sellers.

Question 56

A commodity producer who is worried about future prices can best hedge by:

A) buying a futures contract.
B) selling a futures contract.
C) buying a call option.
D) selling a call option.

Question 57

You enter into a forward contract to take delivery of 1 million euros 3 months from now.What happens to the price you will pay at expiration if the euro depreciates during the contract period?

A) Your price will increase.
B) Your price will decrease.
C) Your price was fixed at the onset of the contract.
D) Your price was fixed but you will receive correspondingly more euros due to the depreciation.

Question 58

The process of marking a futures contract to market means that:

A) the profitability of the contract is locked in from the onset of the contract.
B) the amount of commodity to be delivered changes as prices change.
C) contracts are closed out as soon as they become unprofitable.
D) profits or losses are settled daily.

Question 59

What has happened to cause a $250 loss to be marked to the margin account of a futures contract buyer?

A) The commodity futures price decreased on that day.
B) The commodity futures price increased on that day.
C) The commodity spot price decreased on that day.
D) The commodity spot price increased on that day.

Question 60

Which one of the following would not be regulated in a standardized futures contract?

A) Quantity of asset to be traded
B) Quality of asset to be traded
C) The spot price
D) Date of settlement

Question 61

The price for immediate delivery of a product is called the:

A) spot price.
B) exercise price.
C) forward price.
D) the impact price.

Question 62

Why are most futures contracts not settled through delivery of the product?

A) Most contracts are settled through the margin account.
B) Most contracts expire with neither party having an obligation to the other party.
C) Most participants cancel their futures contracts through purchase of an option contract.
D) It is easier and cheaper to settle in cash or by an offsetting futures transaction.

Question 63

A derivatives contract:

A) increases the risk of both the hedger and speculator.
B) increases the risk of the hedger and decreases the risk of the speculator.
C) reduces the risk of the hedger and increases the risk of the speculator.
D) reduces risk in both cases.

Question 64

Hershey's Chocolate is concerned about cocoa prices,which are currently $3,000 a ton.Analysts project that the cost of cocoa purchases could vary from $2,900 to $3,100 a ton.A September call option can be purchased with a $2,950 exercise price for $145.What is Hershey's worst-case scenario if it purchases these options?

A) Cocoa prices will rise to $3,100 and Hershey is protected only to a price of $2,950.
B) Cocoa prices will not change from their current level and Hershey will have wasted the cost of the option.
C) Cocoa prices will not rise above Hershey's break-even price of $3,095, which equals the sum of the exercise price plus the cost of the option.
D) Cocoa prices will fall below $2,950 and Hershey will lose the $145 cost of the option.

Question 65

ABC Corp.borrows $5 million at 10% from a bank and swaps this loan for a 12% yen loan.The spot exchange rate is JPY105 = USD1.How much does ABC pay annually to the bank?

A) ¥1.26 million
B) ¥5.71 million
C) ¥52.50 million
D) ¥63.00 million

Question 66

In an interest rate swap,borrowers typically exchange fixed-rate payments in one currency for:

A) fixed-rate payments in another currency.
B) variable-rate payments in another currency.
C) fixed-rate payments in the same currency.
D) variable-rate payments in the same currency.

Question 67

A gasoline distributor buys a gasoline futures contract to receive 42,000 gallons of gasoline at $2.94 per gallon.How is the account marked to market if gasoline futures close the next day at $2.97?

A) A loss of $1,260 is posted to the account.
B) A gain of $1,260 is posted to the account.
C) A loss of $12,600 is posted to the account.
D) A gain of $12,600 is posted to the account.

Question 68

In general,when deciding whether one needs to buy or sell futures contracts in order to hedge,the rule could be:

A) buy futures if you have the underlying asset and sell futures if you need the underlying asset.
B) sell futures if you have the underlying asset and buy futures if you need the underlying asset.
C) buy futures if you want to speculate, sell futures if you want to hedge.
D) buy futures if you are willing to have unlimited risk, sell futures if you want capped risk.

Question 69

The term derivatives refers to:

A) forwards and futures.
B) swaps and options.
C) forwards, futures, swaps, and options.
D) forwards, futures, and swaps.

Question 70

The typical sequence of cash flows in a futures contract is:

A) purchase price plus a margin account up-front, differences are settled at expiration.
B) margin account up-front, differences are posted daily and settled in cash if margin drops too low.
C) margin account up-front, all differences settled at expiration.
D) all funds are paid at expiration of the contract.

Question 71

The seller of a pork bellies futures contract at $1.41 per pound noted that the closing price of pork bellies was $1.44 today.What will happen to this contract,which requires delivery of 40,000 pounds of pork bellies at expiration?

A) A loss of $400 is posted to the account.
B) A gain of $400 is posted to the account.
C) A loss of $1,200 is posted to the account.
D) A gain of $1,200 is posted to the account.

Question 72

The seller of a copper futures contract noticed that his account was marked with a $500 gain yesterday.If the standardized contract requires delivery of 25,000 pounds of copper,what happened that day to the price of copper?

A) The price closed down $0.02 per pound.
B) The price closed up $0.02 per pound.
C) The price closed down $0.20 per pound.
D) The price closed up $0.20 per pound.

Question 73

If you sell a forward contract,you agree to:

A) deliver a product at a later date for a price set today.
B) receive a product at a later date at the price on that later date.
C) receive a product at a later date for a price set today.
D) deliver a product at a later date for a price set on that later date.

Question 74

If you buy a forward contract,you agree to buy the product:

A) at a later date at a price to be set in the future.
B) today at its current price.
C) at a later date at a price set today.
D) if and only if its price rises above its exercise price.

Question 75

When two borrowers engage in a currency swap,they agree to:

A) a one-time currency exchange equal to the principal amount borrowed.
B) make payments to each other in a different currency.
C) pay to each other any depreciation or appreciation of the currency.
D) exchange fixed-rate interest payments for variable-rate interest payments.

Question 76

One distinguishing difference between the buyer of a futures contract and the buyer of an option contract is that the futures buyer:

A) pays a much higher up-front price than option buyers.
B) has an obligation to purchase, not a choice.
C) can lose no more than the initial outlay.
D) has increased rather than reduced risk.

Question 77

Which of the following statements is correct?

A) Futures contracts and options contracts are economically similar, but vary in how they are traded.
B) Forward contracts and futures contracts are economically similar, but vary in how they are traded.
C) Forward contracts and options contracts are economically similar, but vary in how they are traded.
D) Forward contracts, futures contracts, and options contracts are all economically similar, but vary in how they are traded.

Question 78

Which of the following contracts is not a financial future?

A) eurodollar deposit futures
B) yen futures
C) orange juice futures
D) Standard & Poor's futures

Question 79

As time draws closer to contract expiration,futures prices can be expected to:

A) increase as the demand for delivery intensifies.
B) decrease as speculators resolve the uncertainty of prices.
C) move similarly to broad-based market indices, such as the S&P 500.
D) converge upon the spot price.

Question 80

If you enter into an interest rate swap,the company taking the opposite side is called:

A) The swap payer.
B) The swap counterparty.
C) The swap maker.
D) The off-taker.