Question 1

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

Accepted Answer

The answer of What is the single most common concern...

Question 2

NARRBEGIN: Exhibit 17-1
Exhibit 23-1
S&P 500 Index; $250 ´ index May 2004
 
-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?

Accepted Answer

20(5000)3.67 - 20(5000)3.78 = -11,000

Question 3

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?

Accepted Answer

50 ´ (1 + .08)^4/12 = 51.29928

Question 4

For most firms the principle reason for hedging is

Accepted Answer

The principle reason for hedging for most firms is to reduce the likelihood of financial distress. Hedging helps firms avoid potential losses from fluctuations in commodity prices, interest rates, and foreign exchange rates. By hedging, firms can stabilize their cash flows, reduce their exposure to risk, and ensure that they can meet their financial obligations. This, in turn, reduces the likelihood of financial distress and ultimately benefits the owners of both shares and debt. However, hedging does not necessarily comply with SEC regulations concerning firm risk tolerances or solely satisfy the owners of the firm's shares or debt.

Question 5

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

Accepted Answer

Economic exposure refers to the risk that a company faces due to fluctuations in exchange rates or other economic factors that affect its profitability or cash flows. In this case, the firm's exposure to the price of gold is an economic exposure because it affects its revenues and profits indirectly through its customers (gold producers). Transaction exposure refers to the risk that arises from the settlement of transactions in foreign currencies, while translation exposure pertains to the risk of changes in exchange rates on the financial statements of a company with operations in foreign countries. Therefore, neither A nor B is the correct answer.

Question 6

NARRBEGIN: Exhibit 17-1
Exhibit 23-1
S&P 500 Index; $250 ´ index May 2004
 
-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?

Accepted Answer

20(5000)3.78 - 20(5000)3.67 = 11,000

Question 7

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

Accepted Answer

Fluctuations in interest rates, exchange rates, and the price of raw materials can all impact a company's financial performance and create risk. As a result, there has been an increase in demand for strategies to hedge against these risks and protect the financial stability of a company. Therefore, all of the above options have led to an increase in demand for such strategies.

Question 8

NARRBEGIN: Exhibit 17-2
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?

Accepted Answer

37,500(1.16)= 43,500

Question 9

NARRBEGIN: Exhibit 17-2
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?

Accepted Answer

1.05(37,500)= 39,375

Question 10

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

Accepted Answer

Worker's compensation claims are an example of firm-specific events that are typically addressed through risk management. While currency and interest rate risks are also important risks to manage, they are not necessarily specific to a particular firm and may require different types of risk management strategies.

Question 11

NARRBEGIN: Exhibit 17-1
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?

Accepted Answer

11.70(250)20 = 58,500

Question 12

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

Accepted Answer

Managers with a greater aversion to risk are more likely to hedge because hedging is a strategy used to reduce or eliminate financial risk.

Question 13

NARRBEGIN: Exhibit 17-2
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?

Accepted Answer

According to Exhibit 23-2, there were 1,397 open interest (outstanding) contracts for December 2004 coffee futures at the end of the trading day.

Question 14

NARRBEGIN: Exhibit 17-2
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?

Accepted Answer

37500(1.51)= 56625

Question 15

NARRBEGIN: Exhibit 17-2
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?

Accepted Answer

37500(.08)= +3,000

Question 16

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?

Accepted Answer

5(1 + .1)^1/12 = 5.03987

Question 17

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?

Accepted Answer

15 / (1 + .1)^6/12 = 14.3019

Question 18

NARRBEGIN: Exhibit 17-2
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?

Accepted Answer

37,500(-.08)= -3000

Question 19

NARRBEGIN: Exhibit 17-2
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?

Accepted Answer

37500(1.16)= 43500

Question 20

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?

Accepted Answer

Earnings before tax with hedging: 30,000
After-tax earnings by hedging: 30,000 ´ .8 = 24,000
After-tax earnings with 20,000 pre-tax earnings: 20,000 ´ .8 = 16,000
After-tax earnings with 40,000 pre-tax earnings: (30,000 ´ .8 = 24,000)+ (10,000 ´ .65 = 6,500)= 30,500
After-tax expected earnings from not hedging: .5(16,000)+ .5(30,500)= 23,250
Benefit from hedging: 24,000 - 23,250 = 750

Quiz 23: Risk Management

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

NARRBEGIN: Exhibit 17-1 Exhibit 23-1 S&P 500 Index; $250 ´ index May 2004 -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?

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?

For most firms the principle reason for hedging is

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

NARRBEGIN: Exhibit 17-1 Exhibit 23-1 S&P 500 Index; $250 ´ index May 2004 -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?

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

NARRBEGIN: Exhibit 17-2 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?

NARRBEGIN: Exhibit 17-2 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?

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

NARRBEGIN: Exhibit 17-1 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?

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

NARRBEGIN: Exhibit 17-2 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?

NARRBEGIN: Exhibit 17-2 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?

NARRBEGIN: Exhibit 17-2 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?

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?

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?

NARRBEGIN: Exhibit 17-2 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?

NARRBEGIN: Exhibit 17-2 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?