Question 1

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 2

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 specific to a particular firm and have been a focus of risk management in the past. Currency risk and interest rate risk are more generic and affect multiple firms, making them less firm-specific. Therefore, choice A and B are not the best choices.

Question 3

For most firms the principle reason for hedging is

Accepted Answer

The primary reason for most firms to hedge is to reduce the likelihood of financial distress. This is because hedging helps firms to manage their exposure to risks such as commodity price fluctuations or exchange rate fluctuations, which can have a significant impact on their financial performance. By hedging, firms can mitigate the potential losses associated with these risks, thereby reducing the likelihood of financial distress. Complying with SEC regulations, satisfying shareholders or debt owners may be other motives for firms to hedge, but they are not the primary reasons.

Question 4

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 5

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 6

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 7

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 of changes in exchange rates impacting a firm's cash flow, market share, and competitiveness. In this case, the firm's risk is related to the price of gold, which is a macroeconomic factor that can impact the demand for the firm's product and, consequently, its revenue. The risk is not directly related to foreign currency exchange rates, which rules out transaction and translation exposure.

Question 8

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 9

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 all increase uncertainty and risk for corporations. As a result, there is a greater need for strategies to manage and hedge against these risks to protect the financial health of the organization.

Question 10

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 11

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

Question 12

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 13

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 14

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 15

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

The answer of Exhibit 23-2
Coffee; 37,500 lbs per contract, $...

Question 16

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 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

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 19

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 20

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

Quiz 23: Risk Management

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

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

For most firms the principle reason for hedging is

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?

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?

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?

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

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?

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

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 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?

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?

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?

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

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?

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?

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?

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?