Deck 23: Risk Management

Question 1

You are a financial manager with JCN,Co.and you have used a forward contract to hedge a yen 100,000,000 payment the company expects to receive in 90 days.Your contract calls for you to deliver yen at 109.75 yen per U.S.dollar.Suppose the spot rate at that time is 111.25 yen per U.S.dollar.Did you gain or lose on the hedge? How much?

A) Gain, $66,666.67
B) Loss, $66,666.67
C) Gain, $12,285.33
D) Loss, $12,285.33

Answer 1

Gain, $12,285.33

Question 2

Use the following information on CBOE 13-week T-bill rate options to answer the following question(s).

Refer to CBOE.What is the cost of the least expensive floor to protect from falling interest rates?

A) $75 per contract
B) $0.75 per contract
C) $100 per contract
D) $1.00 per contract

Answer 2

$75 per contract

Question 3

Outsource,Inc.expects a payment from a French customer in thirty days.To hedge its currency exposure,Outsource should

A) Sell euros forward thirty days.
B) Buy euros forward thirty days.
C) Sell dollars forward thirty days.
D) Do nothing as there is no foreign exchange rate exposure for a thirty day time horizon.

Answer 3

Sell euros forward thirty days.

Question 4

If the spot exchange rate is 110 yen per U.S.dollar,the "fair" forward exchange rate is 115 yen per U.S.dollar,and the risk-free borrowing rate in the United States is 2.5%,what must the risk-free borrowing rate be in Japan?

A) 7.2%
B) 5.6%
C) 3.7%
D) 0%

Question 5

A standard "fixed for floating" interest rate swap contract is effectively

A) a series of call options on the interest rate.
B) a series of put options on the interest rate.
C) a series of forward rate agreements.
D) none of the above.

Question 6

The spot rate on the British pound is 0.5491 per U.S.dollar,while the risk-free borrowing rates are 4% in Britain and 3% in the United States.What is the "fair" forward exchange rate?

A) 0.5438 pounds per dollar
B) 0.7321 pounds per dollar
C) 0.4118 pounds per dollar
D) 0.5544 pounds per dollar

Question 7

Which of the following is a (are)key difference(s)a manager should note in choosing between forward and futures contracts?

A) Exchange trading makes forward contracts more liquid.
B) Futures contracts carry standardized terms, while forward contracts can be tailored to meet specific needs.
C) Futures contracts have greater default risk than forward contracts.
D) Forward contracts require initial margin deposits and daily marking to market, while futures do not.

Question 8

Why might a financial manager prefer using option contracts instead of futures or forward contracts to hedge?

A) Futures and forwards require a premium be paid up front, while options do not.
B) Options provide protection against adverse price movements but allow the user to profit if the price of the underlying asset moves favorably.
C) Options create an obligation to perform, while futures and forwards do not.
D) Futures and forwards all have greater default risk than options.

Question 9

The MakeStuff Company's earnings stream is highly dependent on the cost of a key commodity input. Management believes taxable earnings will be $100,000 if the input price is low, taxable earnings will be $50,000 if the input price is at a moderate level, but earnings will be zero if the input price is high. Management sees these outcomes as being equally likely. The company pays a 15% tax rate on the first $50,000 of taxable earnings, and a 25% rate on all earnings above $50,000.
What is MakeStuff's tax liability if the input price is at the moderate level?

A) $7500
B) $10,000
C) $12,500
D) none of the above

Question 10

Use the following information on CBOE 13-week T-bill rate options to answer the following question(s).

Refer to CBOE.Suppose you want to construct a collar to reduce the cost of the cap by selling a floor.What is the net cost of the least expensive such collar? (Be sure the strike prices on the call and the put are NOT the same!)

A) $0.10 per contract outflow
B) $10 per contract outflow
C) $0.10 per contract inflow
D) $10 per contract inflow

Question 11

Suppose the spot exchange rate is 0.5491 pounds per U.S.dollar,while the risk-free borrowing rate is 4% in Britain.If the "fair" exchange rate is 0.5544 pounds per U.S.dollar,what is the risk-free borrowing rate in the United States?

A) 5%
B) 4%
C) 3%
D) 2%

Question 12

Use the following information on CBOE 13-week T-bill rate options to answer the following question(s).

Refer to CBOE.If you used the OCT 35 option to hedge rising rates,and the yield to maturity (YTM)on 13-week bills is 3.75 percent at the option's expiration,what is the outcome of your hedge?

A) profit of $250 per contract
B) profit of $130 per contract
C) loss of $120 per contract
D) no gain or loss, the option expires worthless

Question 13

You are a financial manager with ICN,Co.and you have used a forward contract to hedge a yen 100,000,000 payment the company expects in 90 days.Your contract calls for you to deliver yen at 111.25 yen per U.S.dollar.Suppose the spot rate at that time is 109.75 yen per U.S.dollar.Did you gain or lose on the hedge? How much?

A) Gain, $12,285.33
B) Loss, $12,285.33
C) Gain, $66,666.67
D) Loss, $66,666.67

Question 14

Which of the following is NOT a motivation for hedging?

A) Reducing the costs of financial distress
B) Enhancing the ability to evaluate managers
C) Offsetting the costs of insurance
D) Reducing the firm's expected tax liability

Question 15

Use the following information on CBOE 13-week T-bill rate options to answer the following question(s).

Refer to CBOE.Suppose you want to cap your interest rate before a planned October borrowing.What is the cost of using the OCT 35 option to hedge?

A) $110 per contract
B) $1.10 per contract
C) $120 per contract
D) $1.20 per contract

Question 16

The Exim Company has entered into a 3 month,$250 notional principal forward rate agreement (FRA)with What-a-Bank.The terms are such that Exim will pay What-a-Bank if LIBOR is above 2%,but What-a-Bank will pay Exim if LIBOR is below 2%.Based on the standard FRA formula,who will pay and how much,if LIBOR is 2.375% in three months?

A) Exim Co. pays, $1,475,614
B) Exim Co. pays, $232,992
C) What-a-Bank pays, $1,475,614
D) What-a-Bank pays, $232,992

Question 17

The Exim Company has entered into a 3 month,$250 million notional principal forward rate agreement (FRA)with What-a-Bank.The terms are such that Exim will pay What-a-Bank if LIBOR is above 2%,but What-a-Bank will pay Exim if LIBOR is below 2%.Based on the standard FRA formula,who will pay and how much,if LIBOR is 1.625% in three months?

A) Exim Company pays $1,244,942
B) Exim Company pays $233,427
C) What-a-Bank pays $1,244,924
D) What-a-Bank pays $233,427

Question 18

The MakeStuff Company's earnings stream is highly dependent on the cost of a key commodity input. Management believes taxable earnings will be $100,000 if the input price is low, taxable earnings will be $50,000 if the input price is at a moderate level, but earnings will be zero if the input price is high. Management sees these outcomes as being equally likely. The company pays a 15% tax rate on the first $50,000 of taxable earnings, and a 25% rate on all earnings above $50,000.
What is MakeStuff's after-tax earnings if it can lock in the moderate price level for sure?

A) $50,000
B) $42,500
C) $80,000
D) $40,333

Question 19

Suppose rising gas prices cut into consumer spending,and Wal-mart,Target,and other retailers experience a slow-down in sales.This slow-down is an example of

A) an economic exposure
B) a transaction exposure
C) a translation exposure
D) an alternatives exposure

Question 20

The MakeStuff Company's earnings stream is highly dependent on the cost of a key commodity input. Management believes taxable earnings will be $100,000 if the input price is low, taxable earnings will be $50,000 if the input price is at a moderate level, but earnings will be zero if the input price is high. Management sees these outcomes as being equally likely. The company pays a 15% tax rate on the first $50,000 of taxable earnings, and a 25% rate on all earnings above $50,000.
What is MakeStuff's expected after tax earnings if it remains unhedged?

A) $50,000
B) $42,500
C) $80,000
D) $40,833

Question 21

The overall impact of foreign exchange rate fluctuations on a firm's value is called

A) interest rate risk
B) transaction exposure
C) economic exposures
D) none of the above

Question 22

You plan to buy a 2 year zero coupon bond one year from today.If the risk free rate is 5.6% and the forward price for the bond is $843.25,what should be the current price of a three year zero-coupon bond?

A) $943.25
B) $893.23
C) $996.07
D) $798.53

Question 23

The average price at which a futures contract sell at the end of the trading day is called the

A) opening price
B) closing price
C) settlement price
D) lifetime price

Question 24

If the current spot exchange rate on the Euro is $1.2812/€ and the one year risk free rate for borrowing in dollars is 3% and 4% for borrowing in Euros,what should be the one year $/€ forward exchange rate?

A) 1.2812
B) 1.2689
C) 1.2936
D) 1.2469

Question 25

Exhibit 23-1
S&P 500 Index; $250 ´ index May 2004

Refer to Exhibit 23-1.For the purpose of marking to market what is the current value of the December contract?

A) $262,850.00
B) $264,837.50
C) $265,550.00
D) $238,250.00

Question 26

If the current spot exchange rate on the Euro is $1.2812/€ and the two year risk free rate for borrowing in dollars is 3% and 4% for borrowing in Euros,what should be the two year $/€ forward exchange rate?

A) 1.2689
B) 1.2812
C) 1.2567
D) 1.2469

Question 27

Exhibit 23-1
S&P 500 Index; $250 ´ index May 2004

Refer to Exhibit 23-1.What was the lowest value of the December contract on the day quoted?

A) $265,500
B) $262,750
C) $264,837
D) $271,450

Question 28

Suppose the spot price of oil is $49.50 per barrel,while the October futures price is $51.00 per barrel.For this contract,the basis is

A) $51.00
B) $49.50
C) $1.50
D) $100.50

Question 29

A call option on interest rates is called an

A) interest rate collar
B) interest rate floor
C) interest rate cap
D) interest rate swap

Question 30

Suppose the spot exchange rate is 0.5491 pounds per U.S.dollar,while the risk-free borrowing rates are 4% in Britain and 3% in the United States.If the current forward exchange rate is also 0.5491 pounds per dollar,what opportunity exists?

A) Arbitrage by borrowing in Britain today, and selling pounds forward.
B) Arbitrage by borrowing in Britain today, and selling dollars forward.
C) Arbitrage by borrowing in the United States today, and selling pounds forward.
D) Arbitrage by borrowing in the United States today and selling dollars forward.

Question 31

The minimum dollar amount required by an investor when taking a position in a futures contract is called the

A) initial margin
B) maintenance margin
C) margin account
D) none of the above

Question 32

The process of identifying firm-specific risk exposures and managing those exposures is called

A) capital management
B) risk management
C) financial management
D) none of the above

Question 33

Today,the price of an October oil futures contract closed at $49.50 per barrel.Yesterday,the contract closed at $50.25.When margin accounts are marked to market,

A) long positions will have $0.75 per barrel added.
B) long positions will have $0.75 per barrel deducted.
C) short positions will have $0.75 per barrel deducted.
D) no changes are made until the October expiration.

Question 34

Suppose Snooty Wine Importers has an order of Chateau de Snoot wines arriving from France in October,and the order will be paid in euros.If Snooty enters a contract today with a forward rate of 0.9 euros per U.S.dollar for October delivery,and the spot rate in October turns out to be euro 0.85 per U.S.dollar,what is the effect of the forward contract on Snooty?

A) Snooty Importers made $37,500
B) Snooty Importers lost $37,500
C) Snooty Importers made $637,55
D) There is no effect.

Question 35

Exhibit 23-1
S&P 500 Index; $250 ´ index May 2004

Refer to Exhibit 23-1.How many June contracts were outstanding at the end of the trading day?

A) 3,338
B) 8,621
C) 183,158
D) 125,845

Question 36

Exhibit 23-1
S&P 500 Index; $250 ´ index May 2004

Refer to Exhibit 23-1.If you are interested in purchasing a September S&P 500 index futures contract,what is the value of that contract?

A) $524,950
B) $210,569
C) $329,574
D) $262,475

Question 37

You plan to buy a 2 year zero coupon bond one year from today.If the risk free rate is 5.6% and a three year zero-coupon bond currently sells for $843.25,what should be the forward price?

A) $890.47
B) $943.25
C) $925.89
D) $1045.72

Question 38

If the current spot exchange rate on the Euro is €0.7805/$ and the one year risk free rate for borrowing in dollars is 3% and 4% for borrowing in Euros,what should be the one year $/€ forward exchange rate?

A) 1.2689
B) 0.7881
C) 1.2936
D) 0.7730

Question 39

Snooty Wine Importers has an order of exclusive Chateau de Snoot wines arriving from France in October,and the order will be paid in euros.Which of the following will hedge the importer's currency exposure?

A) buy euros forward
B) sell euros forward
C) sell dollars forward
D) sell wine futures

Question 40

Exhibit 23-1
S&P 500 Index; $250 ´ index May 2004

Refer to Exhibit 23-1.What is the highest value at which the June contract has ever been quoted?

A) $257,150
B) $207,262
C) $261,050
D) $278,695

Question 41

If the managers of a firm have a greater aversion to risk,then

A) they are less likely to hedge.
B) they are more likely to hedge.
C) they are more likely to use derivatives to speculate.
D) none of the above.

Question 42

In historical terms,although not necessarily the case now,risk management has focused on firm-specific events such as

A) currency risk.
B) interest rate risk.
C) worker's compensation claims.
D) none of the above.

Question 43

For most firms the principle reason for hedging is

A) to reduced the likelihood of financial distress.
B) to comply with SEC regulations concerning firm risk tolerances.
C) to satisfy the owners of the firm's shares.
D) to satisfy the owners of the firm's debt.

Question 44

Exhibit 23-1
S&P 500 Index; $250 ´ index May 2004

Refer to Exhibit 23-1.If you hold a long position of 20 June S&P 500 index futures contracts,how much compensation do you receive for the increase in the futures price at the end of the trading day?

A) $58,500
B) $11.70
C) $2,925
D) $234

Question 45

Exhibit 23-2
Coffee; 37,500 lbs per contract, $ per lb. May 2004

Refer to Exhibit 23-2.For purposes of marking to market,what is the current price of coffee futures for December?

A) $41,625
B) $53,625
C) $41,250
D) $43,500

Question 46

You need to purchase coal 4-months from now and would like to hedge against price movement.The spot price for coal is $50 a railroad car and the risk-free rate is 8%.What is the 4-month forward price for a railroad car of coal?

A) $48.73
B) $50.00
C) $51.30
D) $54.00

Question 47

If your firm produces a product that is used primarily by gold producers,then your firm might be subject to a risk related to the price of gold.If that risk is indirectly related to the price of gold,then this is an example of

A) transaction exposure.
B) translation exposure.
C) economic exposure.
D) none of the above.

Question 48

Exhibit 23-2
Coffee; 37,500 lbs per contract, $ per lb. May 2004

Refer to Exhibit 23-2.What was the highest contract price that the September coffee future has traded for over its lifetime?

A) $40,125
B) $56,625
C) $40,500
D) $42,375

Question 49

Which of the following has led to an increase in demand for strategies to hedge corporate risk?

A) fluctuations in interest rates
B) fluctuations in exchange rates
C) fluctuations in the price of raw materials
D) all of the above

Question 50

Exhibit 23-2
Coffee; 37,500 lbs per contract, $ per lb. May 2004

Refer to Exhibit 23-2.Suppose that yesterday you purchased one September coffee futures contract at the settle price.At the end of today's trading day what is the change in the value of your contract?

A) $3,000
B) -$3,000
C) $3,750
D) -$3,750

Question 51

You are the manager of a company that has an equal chance of earning either $20,000 or $40,000 before taxes.Your firm is subject to a 20% tax rate on the first $30,000 and 35% on all income earned beyond that point.If you are offered a costless hedge to achieve guaranteed before tax earnings of $30,000,what is the expected benefit to hedging?

A) $24,000
B) $23,250
C) $750
D) none of the above

Question 52

You need to purchase apples 1-month from now and would like to hedge against price movements in apples.The spot price for apples is $5 a bushel and the risk-free rate is 10%.What is the 1-month forward price for a bushel of apples?

A) $4.96
B) $5.00
C) $5.04
D) $5.50

Question 53

You buy 20 corn futures contracts when the futures price is $3.67 per bushel (each contract is for 5,000 bushels).If you eventually settle the contract at $3.78,what is your profit?

A) $11,000
B) $13,000
C) $9,500
D) $15,000

Question 54

Exhibit 23-2
Coffee; 37,500 lbs per contract, $ per lb. May 2004

Refer to Exhibit 23-2.If you are interested in purchasing a December futures contract,what is the price of a 37,500 lbs contract for December delivery?

A) $43,500
B) $37,500
C) $32,500
D) $47,500

Question 55

Exhibit 23-2
Coffee; 37,500 lbs per contract, $ per lb. May 2004

Refer to Exhibit 23-2.How many December coffee futures contracts were outstanding at the end of the trading day?

A) 17,832
B) 6,379
C) 1,397
D) 7,776

Question 56

What is the single most common concern among managers engaged in risk management?

A) interest rate risk
B) currency exchange risk
C) raw materials price risk
D) none of the above

Question 57

You find that the 6-month forward price for scrap steel is $15 a ton.If the 6-month risk-free rate is 10%,then what should be the spot price for scrap steel per ton?

A) $14.30
B) $15.00
C) 15.73
D) $16.50

Question 58

You sell 20 corn futures contracts when the futures price is $3.67 per bushel (each contract is for 5,000 bushels).If you eventually settle the contract at $3.78,what is your payoff?

A) $11,000
B) -$11,000
C) $13,000
D) -$13,000

Question 59

Exhibit 23-2
Coffee; 37,500 lbs per contract, $ per lb. May 2004

Refer to Exhibit 23-2.What was the lowest contract price for coffee futures for June delivery on this trading day?

A) $39,375
B) $37,500
C) $38,625
D) $42,000

Question 60

Exhibit 23-2
Coffee; 37,500 lbs per contract, $ per lb. May 2004

Refer to Exhibit 23-2.Suppose that yesterday you sold one September coffee futures contract at the settle price.At the end of today's trading day what is the change in the value of your contract?

A) $3,000
B) -$3,000
C) $3,750
D) -$3,750

Question 61

You notice that the spot price of beef loin is $30 per pound and the 9-month forward rate is $33.00 per pound.The annualized 9-month risk free rate of interest is 12%.What amount of arbitrage profits are available to you?

A) $.60
B) $.34
C) -$.34
D) -$.60

Question 62

You are looking to hedge a position and you require that the hedge that you take on be extremely liquid.Therefore you

A) look to the forward market to hedge.
B) look to the futures market to hedge.
C) both of the above are extremely liquid
D) none of the above are very liquid

Question 63

You initially entered into 6 long pork belly positions in the futures market.You subsequently went long another 3 contracts and then went short 4 contracts.Which of the following is correct? Assume that all of the contracts have the same settlement price and settlement date.

A) if you do nothing more then you must take delivery on 5 pork belly contracts
B) if you do nothing more then you must deliver 5 pork belly contracts
C) if you do nothing more then you must take delivery on 9 pork belly contracts
D) if you do nothing more then you must deliver 4 pork belly contracts

Question 64

The spot rate exchange rate for Andromedan Pixels (ANP)is 3.00ANP/$.If the risk-free rate of return in Andromeda is 20% per annum while that in the U.S.is 3%,then what should be the 1-year forward rate for ANP/$?

A) $2.57
B) $3.00
C) $3.50
D) $3.60

Question 65

The Bell Company has issued floating interest rate bonds whereby Bell pays LIBOR + 2% on $50,000,000 notional value.Bell enters into a swap agreement where Bell receives LIBOR - 3% from a bank but pays 2% to the bank,both also on a $50,000,000 notional value.What is Bell's net interest cost on the borrowing?

A) 2%
B) 5%
C) 7%
D) LIBOR - 3%

Question 66

Currently the Euro is trading at €/$ 0.7206; if the current anticipated inflations are 4% (U.S)and 2.3% (Euro)over the next year what is the fair one-year forward price? (€/$)

A) 0.709
B) 0.704
C) 0.693
D) 0.733

Question 67

You are currently borrowing $100,000,000 based upon a floating rate of LIBOR + 1%.You would like to borrow the same amount with a fixed rate of 7%.Which interest rate swap will achieve that end?

A) receive LIBOR and pay 6%
B) receive (LIBOR +2%) and pay 8%
C) receive (LIBOR +2%) and pay 9%
D) a and b above

Question 68

You notice that the spot price of beef loin is $30 per pound and the 9-month forward rate is $32.66 per pound.What is the annualized 9-month risk free rate of interest?

A) 6.58%
B) 8.87%
C) 10.00%
D) 12.00%

Question 69

Your firm has issued $100,000,000 bonds with a fixed cost of 10% to the firm.In addition,the firm has entered into a contract to pay a bank LIBOR + .5% while the bank pays the firm 8.5%,with both notional amounts also being $100,000,000.What is the total cost to your firm for the $100,000,000 borrowing?

A) LIBOR + 1%
B) LIBOR - 1%
C) LIBOR + 2%
D) LIBOR - 2%

Question 70

You are looking at the open interest on a futures contract and notice that there are 500 contracts open.If none of the holders of these contracts are willing to take delivery then what is the minimum number of contracts that must be bought or sold by the expiration date of the contract?

A) 0 contracts
B) 250 contracts
C) 500 contracts
D) 1,000 contracts

Question 71

The basis on a 1-year futures contract is 52 points.If spot prices do not move and the risk-free term structure of interest rates remains flat and also does not move,then what should be the basis 1-week before expiration?

A) 1 point
B) 7 points
C) 10 points
D) 52 points

Question 72

You have a long futures position on an asset with a settlement price of $30.00 and a contract expiration date of 6-months from now.If the settlement price of the contact is $30.08 tomorrow,then what cash flow will take place if you assume that the initial margin was zero?

A) all cash settlements will take place 6-months from now
B) you will receive $.08 per contract
C) you will pay $.08 per contract
D) there is not enough information to determine

Question 73

Currently the Brazilian Real is trading at R/$ 1.7531; if the current anticipated inflations are 4% (U.S)and 7.3% (Brazil)over the next year what is the fair one-year forward price? (R/$)

A) 1.686
B) 1.699
C) 1.809
D) 1.634

Question 74

Louis plans to buy two-month Treasury Bills in four months.Currently the price on six-month Treasury Bills is $962,456 per million.The risk-free rate is 5.2%.What is the fair forward price per $1 million?

A) $1,007,459
B) $1,042,088
C) $1,016,007
D) $995,114

Question 75

The spot rate exchange rate for Andromedan Pixels (ANP)is 3.00ANP/$.If the risk-free rate of return in Andromeda is 20% per annum while that in the U.S.is 3%,then what amount of U.S.dollars should you be able to convert 3,000,000 ANP into 1-year from now if you choose to begin hedging today?

A) $1,165,049
B) $1,000,000
C) $858,333
D) $833,333

Question 76

You are bidding on a contract in a foreign currency and you are not sure if you will win the bid.However,the analysis in your bid will be flawed if the foreign currency exchange rate changes between now and when you know whether you have won the contract.The best course of action to hedge your position is

A) long a currency futures contract.
B) short a currency futures contract.
C) purchase an option to sell foreign currency for your currency.
D) sell an option to sell foreign currency for your currency.

Question 77

Emma plans to buy four-month Treasury Bills in two months.Currently the price on six-month Treasury Bills is $975,568 per million.The risk-free rate is 5.4%.What is the fair forward price per $1 million?

A) $981,477
B) $1,038,347
C) $1,011,398
D) $993,822

Question 78

Which of the following assets would probably not lend itself to a futures contract?

A) paper
B) water
C) real estate
D) microchips

Question 79

Roxy plans to buy four-month Treasury Bills in eight months.Currently the price on twelve-month Treasury Bills is $962,456 per million.The risk-free rate is 5.2%.What is the fair forward price per $1 million?

A) $983,193
B) $995,538
C) $1,012,504
D) $1,012,504.0

Question 80

You have entered into a FRA with a notional amount of $100,000,000 which says that if 1-year LIBOR is greater than 5% then the bank will pay you and vice versa if the rate is less than 5%.At the end of the contract you find that 1-year LIBOR is 4.5%.What is the appropriate cash flow?

A) the bank pays you $500,000
B) you pay the bank $500,000
C) the bank pays you 478,469
D) you pay the bank 478,469