Question 1

What motivates users of raw materials to hedge future prices by entering into futures contracts? What is the disadvantage of this practice?

Accepted Answer

The answer of What motivates users of raw materials to...

Question 2

A purchaser of commodities who is completely hedged with forward contracts has eliminated the risk that prices will rise before the purchase is concluded.

Accepted Answer

By hedging with forward contracts, the purchaser has locked in a price for the commodities and eliminated the risk of price increases.

Question 3

A commodity such as diesel fuel for which there is no available futures contract might be satisfactorily hedged with:

Accepted Answer

Diesel fuel is a type of heating oil, so hedging with heating oil futures is the most appropriate choice. Stock index futures, interest rate futures, and electricity futures are not directly related to diesel fuel and would not provide an effective hedge.

Question 4

A purchaser of commodities who is completely hedged with forward contracts will profit if prices fall before the purchase is concluded.

Accepted Answer

If a purchaser is completely hedged with forward contracts, they have locked in the price they will pay for the commodities regardless of whether prices increase or decrease. Therefore, if prices fall before the purchase is concluded, the purchaser will not profit. They will simply pay the price they locked in through their forward contracts.

Question 5

You sold one July futures contract of pork bellies at $.59 per lb.One contract represents 40,000 lbs.of pork bellies.By the end of the day,the price had fallen to $.57 per lb.What was your profit or loss for the day?

Accepted Answer

The profit is calculated by the difference in price ($.59 - $.57 = $.02 per lb.) multiplied by the contract size (40,000 lbs.), resulting in a profit of $800.

Question 6

How is an airline that sells tickets that will be used several months in the future exposed to the risk of rising jet fuel prices? How can it manage that risk?

Accepted Answer

The answer of How is an airline that sells tickets...

Question 7

Banque de Lyon agrees to sell Golden Socks 1,000,000 euros at a price of $1.35 to the euro 6 months from today.If the spot price of the euro in six months is $1.45,

Accepted Answer

Banque de Lyon sells euros at $1.35 when the market rate is $1.45, losing $0.10 per euro on 1,000,000 euros, resulting in a loss of $100,000.

Question 8

A(n)________ gives the holder the right to buy a stated number of shares at a specified price for a limited time.

Accepted Answer

A call option gives the holder the right to buy a stated number of shares at a specified price (known as the strike price) for a limited time. This allows the holder to potentially profit if the market price of the underlying stock rises above the strike price.

Question 9

Hudson Valley Distributors wants to be sure it has 10,000 cases of Beaujolais Nouveau to sell next November.In January,they enters into an agreement to buy the wine at a price of 30 euros to the case.Payment will be due at the end of November.They expect to sell the wine to restaurants and retailers for $63 per case.Hudson Valley has hedged its foreign exchange risk by entering into a forward contract to purchase euros in November at $1.30/euro.If the spot exchange rate at the end of November is $1.50/euro,Hudson Valley's gross profit will be ________.

Accepted Answer

The answer of Hudson Valley Distributors wants to be sure...

Question 10

Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the coming winter.Customers who took advantage of the offer prepurchased 400,000 gallons of oil at $3.00 per gallon.Swenson hedged its position by contracting to purchase 400,000 gallons of oil for November delivery at a price of $2.50 per gallon.If the November spot price is $2.25 per gallon,Swenson's gross profit on the heating oil sold in June will be

Accepted Answer

Swenson has already contracted to buy 400,000 gallons of oil for November delivery at a price of $2.50 per gallon, so their cost is fixed. If the spot price in November is $2.25 per gallon, Swenson will make a gross profit of $0.25 per gallon, or $100,000 for the 400,000 gallons sold in June (since they prepurchased at $3.00 per gallon). Therefore, the answer is C, $200,000 gross profit.

Question 11

You purchased one July futures contract of pork bellies at $.59 per lb.One contract represents 40,000 lbs.of pork bellies.Initial margin on the contract was 4% of the contract price with a maintenance margin of $500.By the end of the day,the price had fallen to $.57 per lb.How much will you be required to add to your margin account to replenish your maintenance margin?

Accepted Answer

The initial value of the contract is 40,000 lbs. * $.59 = $23,600. A 4% initial margin is $23,600 * 0.04 = $944. The price drop to $.57 per lb. makes the new contract value 40,000 lbs. * $.57 = $22,800. The loss is $23,600 - $22,800 = $800. Since the maintenance margin is $500 and the loss ($800) exceeds both the initial margin and the maintenance margin, you must replenish the difference between the loss and the initial margin, which is $800 - $944 = -$144. However, since you cannot add a negative amount, you actually need to ensure the account has at least the maintenance margin. The correct calculation should consider bringing the account back up to the initial margin level or covering the loss to maintain the position, which was not accurately reflected in the initial explanation. The correct approach is to calculate how much the margin account falls below the maintenance margin after the loss. With an $800 loss, the margin account would be reduced to $144 ($944 - $800). Since the maintenance margin is $500, you need to add enough to bring the account back up to this level. Therefore, you need to add $356 ($500 - $144) to meet the maintenance margin requirement.

Question 12

Hudson Valley Distributors wants to be sure it has 10,000 cases of Beaujolais Nouveau to sell next November.In January,they enters into an agreement to buy the wine at a price of 30 euros to the case.Payment will be due at the end of November.They expect to sell the wine to restaurants and retailers for $63 per case.Hudson Valley has hedged its foreign exchange risk by entering into a forward contract to purchase euros in November at $1.30/euro.If the spot exchange rate at the end of November is $1.50/euro,the payoff to Hudson Valley for hedging is ________.

Accepted Answer

To calculate the payoff to Hudson Valley, we need to compare the cost of purchasing euros with the forward contract and the spot exchange rate at the end of November.

10,000 cases of Beaujolais Nouveau at 30 euros/case = 300,000 euros
Cost in USD at the forward rate of $1.30/euro = $390,000

If the spot exchange rate at the end of November is $1.50/euro, then the cost in USD would be:

300,000 euros x $1.50/euro = $450,000

Therefore, the savings from hedging would be:

$450,000 - $390,000 = $60,000

Since the question asks for the payoff to Hudson Valley, which refers to the savings or benefit from hedging, the answer is C) $60,000.

Question 13

You purchased one July futures contract of pork bellies at $.59 per lb.One contract represents 40,000 lbs.of pork bellies.By the end of the day,the price had fallen to $.57 per lb.How much did the value of your contract change during the day?

Accepted Answer

One contract represents 40,000 lbs of pork bellies. 
Cost of one contract = $.59 per lb x 40,000 lbs = $23,600 
At the end of the day, the price fell to $.57 per lb. 
New cost of one contract = $.57 per lb x 40,000 lbs = $22,800 
Change in value = $23,600 - $22,800 = $800 
Since the price fell, the value of the contract decreased, so the answer is C, it fell by $800.

Question 14

Which of the following is NOT an advantage of futures contracts?

Accepted Answer

Futures contracts are standardized contracts with a fixed size and expiration date, which may not perfectly match the needs of all market participants. Therefore, the size and commodity of the contract may not always be perfectly tailored to form a perfect hedge.

Question 15

Uses of future contracts include:

Accepted Answer

Future contracts can be used for all of the mentioned purposes. They can be used by producers to lock in a price for their products and eliminate uncertainty about the prices they will receive. They can be used by consumers to lock in a price for key inputs and eliminate uncertainty about the future cost of production. Finally, they can be used by speculators to bet on future price movements and make a profit.

Question 16

Forward contracts benefit only the customer due to a reduction in uncertainty.

Accepted Answer

Forward contracts benefit both the customer and the seller by reducing uncertainty and locking in prices for future transactions.

Question 17

A seller of commodities who has entered into forward contracts with customers will profit if prices fall before the purchase is concluded.

Accepted Answer

The answer of A seller of commodities who has entered...

Question 18

The objective of a prudent financial manager is to eliminate all foreign exchange risk.

Accepted Answer

It is not always possible or even desirable to eliminate all foreign exchange risk. Sometimes, taking on foreign exchange risk is necessary to achieve higher returns or to be competitive in certain markets. The objective of a prudent financial manager is to manage foreign exchange risk effectively and make informed decisions about hedging or accepting the risk.

Question 19

Bowman-Daniela-Mainland is a major producer and exporter of agricultural commodities.It has sold soy beans for future delivery to a Japanese firm and expects to receive payments of 400 million yen in 6 months and another 400 million yen in 1 year.To lock in the exchange rates on these two payments,BDM arranges forward contracts with an investment banker to sell 400 million yen at $0.0110 in 6 months and $0.0115 in 1 year.What will BDM's cash flow be in dollars from each of these transactions? How has it fixed its revenue in dollars from the soy bean sales?

Accepted Answer

The answer of Bowman-Daniela-Mainland is a major producer and exporter...

Question 20

Hudson Valley Distributors wants to be sure it has 10,000 cases of Beaujolais Nouveau to sell next November.In January,they enters into an agreement to buy the wine at a price of 30 euros to the case.Payment will be due at the end of November.They expect to sell the wine to restaurants and retailers for $63 per case.If Hudson Valley does not hedge its position and the exchange rate in November is $1.50 /euro,what is the gross profit on the wine?

Accepted Answer

The cost in dollars is 10,000 cases * 30 euros/case * $1.50/euro = $450,000. The revenue is 10,000 cases * $63/case = $630,000. The gross profit is $630,000 - $450,000 = $180,000.

Quiz 20: Corporate Risk Management