Question 1

General Mills paid a premium of $0.10 per bushel to buy September call options for wheat with an exercise price of $6.80. If the price of wheat at the expiration is $6.90, what is the net cost of one bushel of wheat for General Mills?
A) $6.70
B) $6.80
C) $6.90
D)$7.00

Accepted Answer

Net cost = +$0.10 - 0.10 + 6.90 = $6.90Net cost = cost of option - option payoff + price of wheat

Question 2

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.

Accepted Answer

The activities of speculators are necessary in futures markets to maintain futures prices at appropriate levels. Speculators take on risk and are not interested in taking or making delivery of the underlying asset; rather, they trade futures contracts to make a profit from changes in the price of the asset. Their buying and selling activity helps to provide liquidity and stabilize futures prices. Without speculators, futures markets would be less efficient and less effective at transferring risk.

Question 3

A farmer hedged his risk by buying put options on wheat with an exercise price of $6.70 at a price of $0.14 per bushel. If the price of wheat at the expiration of the contract is $6.70, what is the net revenue from each bushel of wheat?
A) $6.56
B) $6.63
C) $6.70
D)$6.84

Accepted Answer

Net revenue = -$0.14 + 0 + $6.70 = $6.56Net revenue = -cost of option + option payoff + price of wheat

Question 4

A farmer can hedge the risk of downward movement in the price of his product by:
A) buying a call option.
B) selling a put option.
C) buying a put option.
D)buying a futures contract.

Accepted Answer

A put option gives the holder the right to sell an underlying asset at a predetermined price (i.e., strike price) until a specific expiration date. Therefore, if the price of the farmer's product decreases below the strike price, the farmer can exercise the put option and sell the product at the higher strike price. This will offset the losses incurred from the lower market price. Buying a put option is an effective hedging strategy for a farmer who wants to protect against a decrease in the price of their product.

Question 5

Nestlé wishes to obtain a loan denominated in Swiss francs but the U.S. market offers better credit terms. What should Nestlé do?
A) Borrow francs in Switzerland, exchange for dollars, and arrange a currency swap.
B) Borrow francs in Switzerland, exchange for dollars, and arrange an interest rate swap.
C) Borrow dollars in the United States, exchange for francs, and arrange an interest rate swap.
D)Borrow dollars in the United States, exchange for francs, and arrange a currency swap.

Accepted Answer

Nestlé should borrow dollars in the United States, exchange for francs, and arrange a currency swap. This is because the U.S. market offers better credit terms, which means that Nestlé can borrow at a lower interest rate. By borrowing in dollars and exchanging for francs, Nestlé can take advantage of these lower rates. A currency swap can then be arranged to convert the borrowed dollars back into francs, thereby avoiding exchange rate risk.

Question 6

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.

Accepted Answer

A forward market contract to buy Japanese yen three months in the future at a price of ¥105/$ will protect the buyer from changes in exchange rates. This means that if the exchange rate of yen changes, the buyer will still pay the same price of ¥105/$, thus insulating them from losses due to fluctuations in the exchange rate. It does not necessarily insulate the buyer from changes in interest rates, lock in a profit based on current exchange rates, or require delivery of the yen at the Chicago Board of Trade.

Question 7

At the expiration of a futures contract, the futures price will be:
A) greater than the spot price.
B) equal to the spot price.
C) less than the spot price.
D)greater than the forward price.

Accepted Answer

The futures price is designed to converge to the spot price at the expiration of the futures contract. This is known as convergence. Therefore, the futures price will be equal to the spot price at expiration.

Question 8

Why might an individual or organization be willing to swap their 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 may be higher than fixed rates.
D)They may be able to postpone the payment of principal.

Accepted Answer

Floating-rate loans can be advantageous for individuals or organizations whose cash flows vary with interest rates, as this can help align their income with their loan repayment obligations.

Question 9

Interest rate swaps allow both counterparties to:
A) reduce interest expenses.
B) avoid repayment of the notional principal.
C) rearrange their balance sheets.
D)pay a floating rate of interest on their debt.

Accepted Answer

The answer of Interest rate swaps allow both counterparties to:
A)...

Question 10

A producer has purchased cotton futures that involve 50,000 pounds of cotton at a price of $0.80 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 $0.07 per pound in the cash market.

Accepted Answer

Mark to market = $0.07 × 50,000 = $3,500; A buyer of a futures contract loses when the closing price declines. This loss offsets the gain in the cash market.

Question 11

Which one 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 the buyer and the seller of a futures contract earn a profit simultaneously.

Accepted Answer

Futures contracts involve a buyer and a seller agreeing to purchase/sell a particular asset at a particular price on a particular date. The buyer hopes that the price of the asset will rise before the delivery date, while the seller hopes that the price of the asset will fall. If the price of the asset rises, the buyer can buy it at the lower contracted price and sell it on the open market for a profit. The profit earned by the buyer will be equal to the loss incurred by the seller, and vice versa. Therefore, choice C is the correct statement. Choices A and B are incorrect because in both cases, one party (the seller) cannot consistently make more profits than the other party (the buyer). Choice D is incorrect because if both parties in a futures contract earn a profit simultaneously, it would imply that there was no underlying risk being hedged, and this is not the true nature of futures contracts.

Question 12

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.

Accepted Answer

Speculators invest in derivative instruments with the purpose of increasing risk and potentially earning higher profits. Option and futures traders may use derivatives for hedging purposes, while hedgers use derivatives to mitigate risk.

Question 13

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.

Accepted Answer

By buying a call option on the raw material, the firm secures the right to purchase the material at a predetermined price, thus protecting itself against potential price increases.

Question 14

A miller can hedge the price risk on wheat by:
A) buying put options on wheat.
B) selling call options on wheat.
C) buying wheat futures.
D)selling wheat futures.

Accepted Answer

By buying wheat futures, the miller locks in a price for purchasing wheat in the future, thus hedging against the risk of price increases.

Question 15

A copper producer is worried about declining copper prices. The risk of downward movement in prices can be hedged by:
A) buying call options on copper.
B) selling copper futures.
C) buying copper futures.
D)selling copper call options.

Accepted Answer

Selling copper futures allows the producer to lock in a selling price for their copper, effectively hedging against the risk of declining prices.

Question 16

Which one 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

Accepted Answer

A cattle rancher buying live cattle futures is speculating because they are purchasing futures contracts in anticipation of the price of cattle going up, which is not directly related to hedging their current production or inventory risks. The other options (A, C, D) involve producers or consumers of the commodities using futures contracts to hedge against price movements in their respective commodities, which is a risk management strategy, not speculation.

Question 17

Which one of the following is false concerning the financial futures markets?
A) One of the prominent exchanges for financial futures is the Chicago Board of Trade.
B) Financial futures contracts trade on the Chicago Mercantile Exchange.
C) A major use of financial futures is protection from interest rate risk.
D)Trading in commodity futures significantly exceeds trading in financial futures.

Accepted Answer

This statement is false. Trading in financial futures is much larger than trading in commodity futures, with interest rate futures being the largest segment within financial futures.

Question 18

Currency swaps are used to:
A) lock in an exchange rate for future delivery of a foreign currency.
B) effectively transform loans originated in one currency to a different currency.
C) transform fixed-rate loans into variable-rate loans.
D)exchange foreign currencies in amounts not possible in the foreign exchange market.

Accepted Answer

Currency swaps allow for the transformation of loans originated in one currency into a different currency. This can be helpful for companies or institutions that may want to borrow money in a different currency than their own to take advantage of better interest rates or terms.

Question 19

Which one of the following characteristics is similar in both futures and forward contracts?
A) Future asset transactions are conducted at a price agreed upon earlier.
B) Contracts are sold through organized exchanges.
C) Contract terms are standardized by type of commodity.
D)Price changes are settled daily in a process known as mark-to-market.

Accepted Answer

Both futures and forward contracts involve buying or selling an asset at a predetermined price at a specific time in the future. The key similarity is that the transaction price is agreed upon at the time the contract is entered into, regardless of the market price at the time of delivery or settlement.

Question 20

The most active trading in forward contracts is in:
A) U.S. Treasury bills.
B) the Standard and Poor's index.
C) wheat crops.
D)foreign currencies.

Accepted Answer

Forward contracts are commonly used for hedging foreign exchange risk, making foreign currencies the most active trading in forward contracts.

Quiz 24: Risk Management

General Mills paid a premium of $0.10 per bushel to buy September call options for wheat with an exercise price of $6.80. If the price of wheat at the expiration is $6.90, what is the net cost of one bushel of wheat for General Mills?

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

A farmer hedged his risk by buying put options on wheat with an exercise price of $6.70 at a price of $0.14 per bushel. If the price of wheat at the expiration of the contract is $6.70, what is the net revenue from each bushel of wheat?

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

Nestlé wishes to obtain a loan denominated in Swiss francs but the U.S. market offers better credit terms. What should Nestlé do?

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

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

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

Interest rate swaps allow both counterparties to:

A producer has purchased cotton futures that involve 50,000 pounds of cotton at a price of $0.80 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:

Which one of the following statements is correct?

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

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

A miller can hedge the price risk on wheat by:

A copper producer is worried about declining copper prices. The risk of downward movement in prices can be hedged by:

Which one of the following futures contract holders is speculating?

Which one of the following is false concerning the financial futures markets?

Currency swaps are used to:

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

The most active trading in forward contracts is in: