Deck 24: Risk Management

Question 1

Regarding the profitability of options,it is impossible for a producer who sells put options to lose more than the exercise price agreed on the option contract.

Answer 1

True

Question 2

Unlike options,a futures contract binds the buyer to buy the commodity at a fixed price.

Answer 2

True

Question 3

Financial futures contracts are available through the Chicago Board of Trade and guaranteed by the Federal Reserve.

Answer 3

False

Question 4

Costs of financial distress arise from disruption to normal business operations as well as from the effect that financial distress has on the firm's investment decisions.

Question 5

Engaging itself in a swap contract,a firm might agree to make a series of regular payments in one currency in return for receiving a series of payments in another currency.

Question 6

Speculation is foolish unless you have reason to believe that the odds are stacked in your favor.

Question 7

Risk policies are the same across companies.

Question 8

By using options a firm can protect against increase in raw material prices,while continuing to benefit from price decreases.

Question 9

Put options can be thought of as insurance policies for commodity producers.

Question 10

The profit from a futures contract is the difference between the initial futures price and the spot price at expiration.

Question 11

Forward contracts are equivalent to tailor-made futures contracts.

Question 12

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

Question 13

The better the risk management policies,the less chance that the firm will incur numerous costs of distress.

Question 14

As a side benefit,better risk management decreases the firm's debt capacity.

Question 15

Forward contracts are marked to market.

Question 16

Futures contracts are standardized to expire at one time each year.

Question 17

An oil producer would sell,rather than buy,crude oil futures for protection from falling prices.

Question 18

A survey of the world's 500 largest companies found that almost all the companies use derivatives in some way to manage their risk.

Question 19

The swap is the arrangement by two counterparties to exchange one stream of cash flow for another.

Question 20

Regarding the profitability of options,it is impossible for a producer who sells put options to lose more than the price of the option premium.

Question 21

The customary delivery procedure at the expiration of a commodity futures contract is:

A) delivering the commodity to the futures buyer.
B) delivering the commodity to the futures exchange.
C) offsetting the initial futures position and settling in cash.
D) adding the profit or loss to your margin account and continuing to trade.

Question 22

Which of the following futures contract is written on a nondeliverable asset?

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

Question 23

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

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

Question 24

Which 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 25

How might a firm such as General Mills use options to control raw material prices for breakfast cereals?

A) Buy call options on commodities
B) Sell call options on commodities
C) Buy put options on commodities
D) Sell put options on commodities

Question 26

A producer that is worried about the future price that will be available when the product is to be sold can hedge this price risk by:

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

Question 27

Counterparties to an interest rate swap exchange both interest payments and principal amounts.

Question 28

A number of copper producers have also found that hedging increases their debt capacity.

Question 29

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

Question 30

Which of the following is not correct concerning futures contracts?

A) They 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 or losses are recorded at contract expiration.

Question 31

All companies work hard to hedge their exposure to price fluctuations.

Question 32

Hedging is foolish unless you have reason to believe that the odds are stacked against your favor.

Question 33

Real estate futures on the Chicago Mercantile Exchange were launched in 2006 and enable participants to protect themselves against changes in house prices in 10 U.S.cities.

Question 34

The derivatives market is characterized by:

A) stability.
B) innovation.
C) riskiness.
D) private deals.

Question 35

Which of the following is a source of profit for a swap dealer?

A) Commission charged on the sale of bonds
B) Bid-ask spread
C) Margin account
D) Option premium

Question 36

If you are not better informed than the highly paid professionals in banks and other institutions,you should use derivatives for hedging,not for speculation.

Question 37

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 at once.
C) provide a cushion for the exchange against defaults on the contract.
D) hold interest payments until expiration.

Question 38

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

Question 39

What must happen to prices over the course of a contract for the seller of a futures contract to maximize benefits of the hedge?

A) Prices must decrease.
B) Prices must increase.
C) Prices must remain constant.
D) The seller will profit on the hedge regardless of the direction of price movements.

Question 40

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

Question 41

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 42

Which 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 43

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 posted to the contract daily.

Question 44

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 premium than option buyers.
B) has an obligation to purchase, not a choice.
C) can lose no more than the initial premium.
D) has increased rather than reduced risk.

Question 45

Which of the following is not correct concerning the financial futures markets?

A) One of the prominent exchanges for financial futures is the Chicago Board of Trade.
B) The contracts were first traded in 1972.
C) A major use is protection from interest rate risk.
D) Trading in commodity futures significantly exceeds trading in financial futures.

Question 46

Managers are willing to pay a price to hedge because:

A) they receive increased profits in return.
B) the returns on derivative instruments are not taxed.
C) they value the reduction in uncertainty.
D) it permits the managers to receive higher cash bonuses.

Question 47

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 48

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 offset.

Question 49

In general,when deciding whether a market participant 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 50

A cotton producer has purchased cotton futures that involve 50,000 pounds of cotton at a price of $0.60 per pound.By contract expiration the producer finds that cotton prices have declined by $0.07 per pound.As a result of the futures contracts,the producer will:

A) lose $3,500 per contract in the futures market which offsets gains in the cash market.
B) gain $3,500 per contract in the futures market which offsets losses in the cash market.
C) lose $3,500 per contract in the futures market and suffer an opportunity cost in the cash market.
D) gain $3,500 per contract in the futures market and gain $0.10 per pound in the cash market.

Question 51

Financial futures are available to protect against all of the following except:

A) interest rate risk.
B) level of equity prices.
C) currency swap risk.
D) exchange rate risk.

Question 52

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

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

Question 53

Manufacturers who are concerned about volatile commodity prices often use option contracts to alter their risks.What is the worst-case scenario for a seller of put options on corn with a strike price of $2.25 per bushel?

A) If corn prices drop below $2.25 the option premium will be lost.
B) If corn prices rise above $2.25 the option premium will be lost.
C) Losses can be unlimited if prices drop sufficiently.
D) Losses can be unlimited if prices rise sufficiently.

Question 54

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 55

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 marks depreciate during the contract?

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, and you will receive correspondingly more marks due to the depreciation.

Question 56

If the market for corn futures has more prospective sellers than buyers,then one would expect:

A) the price of corn futures to decrease.
B) the price of corn futures to increase.
C) some traders to change from seller to buyer.
D) the market to cease operations until demand is rebalanced.

Question 57

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

A) requiring daily payments from the contract buyer.
B) requiring daily payments from 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 58

If managers are rational,they will hedge only when they perceive that:

A) prices are headed in an adverse direction.
B) derivative instruments are priced lower than actual value.
C) risk reduction is preferable to higher potential profits.
D) they can increase their profitability by doing so.

Question 59

As time draws closer to contract expiration,futures contract 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 60

Which of the following statements is correct for an interest rate swap?

A) There is an exchange on principal between counterparties.
B) There is no exchange of principal between counterparties.
C) There is an exchange of currencies between counterparties.
D) There is no exchange of cash between counterparties.

Question 61

A farmer stores his fall harvest of corn and sells corn futures for March delivery at $2.50 per bushel.In March the spot price of corn is $2.20 per bushel.Which of the following is correct?

A) The farmer is obligated to deliver corn to the futures buyer at $2.20.
B) The farmer has locked in an effective price of $2.50 per bushel.
C) The farmer would have been better off without the futures contact.
D) The farmer will receive $4.70 per bushel, which more than doubles the profit obtained without futures.

Question 62

At the expiration of a futures contract,the futures price will be:

A) greater than spot price.
B) equal to the spot price.
C) less than the spot price.
D) more than the forward price.

Question 63

Which of the following characteristics is similar in both futures and forward contracts?

A) Future asset transactions are conducted at an agreed price.
B) Contracts are sold through organized exchanges.
C) Contract terms are standardized.
D) Price changes are settled daily.

Question 64

A hedger buys a futures contract that obligates the owner to take delivery of 5,000 bushels of wheat at a price of $3.30 per bushel.At expiration the spot price of wheat is $2.80 per bushel.The hedger has:

A) saved 50' per bushel through hedging.
B) gained peace of mind at a price of 50' per bushel.
C) the opportunity to avoid taking delivery, since price declined.
D) locked in an effective price of $3.05 per bushel.

Question 65

Those who invest in derivative instruments with the purpose of increasing rather than decreasing risk are known as:

A) option traders.
B) futures traders.
C) hedgers.
D) speculators.

Question 66

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

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

Question 67

What form of hedging 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 68

Why might an individual or organization be willing to swap fixed-rate loans for floating-rate loans?

A) They may perceive that interest rates are ready to increase.
B) Their cash flows may vary directly with interest rates.
C) Floating rates are not lower than fixed rates.
D) They may be able to postpone the payment of principal.

Question 69

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

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

Question 70

A firm can hedge the risk of upward movement in raw material prices by:

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

Question 71

Selling a futures contract may be appropriate for one 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 down.
D) have a ready market in which to sell product.

Question 72

Which of the following statements is correct?

A) An option seller makes more profits than an option buyer.
B) A futures seller makes more profits than a futures buyer.
C) A futures buyer's profit will be equal to the futures seller's loss.
D) Both futures buyer and seller makes profit.

Question 73

Most actively traded forward contracts are written on:

A) U.S. Treasury bills.
B) Standard and Poor's index.
C) eurodollar contracts.
D) foreign currencies.

Question 74

Which of the following futures contract holders is speculating?

A) A wheat farmer who sells wheat futures
B) A cattle rancher who buys live cattle futures
C) A candy maker who buys sugar futures
D) An oil producer who sells crude oil futures

Question 75

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

A) It reduces one or more aspects of business risk.
B) It allows prices to be locked in advance.
C) The costs of hedging are paid by the speculators.
D) It can stabilize profits.

Question 76

A farmer can hedge the risk of downward movement in the price of the produce by:

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

Question 77

The activities of speculators are necessary in the futures markets in order to:

A) prevent hedgers from trading options.
B) provide a continual stream of profit to hedgers.
C) maintain futures prices at appropriate levels.
D) understand the direction of future price changes.

Question 78

The spot price of silver closes at $7 per ounce at the expiration of an option contract.Which one of the following option positions will have value?

A) The buyer of a call with $5 strike price
B) The seller of a call with $5 strike price
C) The buyer of a put with $5 strike price
D) The seller of a put with $5 strike price

Question 79

A forward market contract to buy Japanese yen three months in the future at a price of *105/$ will:

A) insulate the buyer from changes in interest rates.
B) protect the buyer from changes in exchange rates.
C) lock in a profit based on current exchange rates.
D) require delivery of the yen at the Chicago Board of Trade.

Question 80

Which of the following is the major difference between forward and futures contracts?

A) Futures contracts are more expensive than forward contracts.
B) Forward contracts are available only for foreign currencies.
C) Futures contracts are always delivered.
D) Forward contracts are not marked to market.