Question 1

A sensible corporate risk strategy needs answers to three of these questions.Which is the odd man out?

Accepted Answer

Options A, B, and D are all critical considerations when developing a corporate risk strategy. Understanding the major risks that the company faces is necessary for prioritizing risk mitigation efforts. Assessing whether the company is being adequately compensated for taking certain risks can inform decisions about risk acceptance or avoidance. Finally, considering how to reduce the probability of a bad outcome can help mitigate risks. Option C, on the other hand, is focused specifically on derivative contracts and may not be relevant for all companies or industries.

Question 2

Those who invest in derivative instruments that increase rather than reduce risk are known as:

Accepted Answer

Those who invest in derivative instruments with the intention of increasing risk instead of reducing it are known as speculators. Option and futures traders can use these instruments to either hedge or speculate, while hedgers use them solely for risk reduction purposes.

Question 3

A clothes producer hedges its future cotton purchases by buying cotton futures.The futures contract provides the producer with 50,000 pounds of cotton at a price of $0.80 per pound.By contract expiration the producer finds that cotton prices have declined to $0.73 per pound.As a result of the futures contracts,the producer will:

Accepted Answer

The producer will lose $3,500 per contract in the futures market, which will offset the gains in the cash market.

Question 4

Four investors buy sugar futures.Three are speculators and one is hedging.Which of the following is hedging?

Accepted Answer

A soft drink producer would hedge sugar futures to manage the risk of fluctuating sugar prices, as sugar is a key input in their production process.

Question 5

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

Accepted Answer

By buying a call option on raw materials, a firm can lock in a maximum price it will pay, thus hedging against the risk of price increases.

Question 6

Which of the following strategies does not reduce risk?

Accepted Answer

Increasing the proportion of the firm's costs that are fixed actually increases the risk as it makes the firm more vulnerable to changes in sales and market conditions. Higher fixed costs mean that the firm has a higher breakeven point and must generate more sales to cover its costs. The other options - building flexibility, taking out insurance, and hedging with derivative contracts - all reduce risk in some way.

Question 7

The most active trading in forward contracts is in:

Accepted Answer

Foreign currencies are the most actively traded in forward contracts as they are highly susceptible to fluctuations and are constantly traded globally for various purposes such as hedging, speculation, and arbitrage.

Question 8

Which of these statements is not true?

Accepted Answer

Transactions to reduce risk can sometimes add value, but it is not always the case. There may be situations where the cost of hedging outweighs the benefits. Therefore, statement C is not always true. A, B, and D are all true statements.

Question 9

Which one of the following futures contract holders is speculating?

Accepted Answer

The answer of Which one of the following futures contract...

Question 10

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

Accepted Answer

Zeta Corp should borrow dollars in the United States and then arrange a currency swap. This allows them to benefit from better credit terms in the US market while obtaining the loan denominated in Swiss francs. The currency swap allows them to exchange the dollars for francs at an agreed-upon exchange rate for the duration of the swap, effectively achieving their goal of obtaining a franc-denominated loan. Interest rate swaps would not be necessary in this scenario, as the goal is to obtain a loan denominated in Swiss francs, not to obtain more favorable interest rates.

Question 11

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

Accepted Answer

Speculators play a crucial role in ensuring that futures prices are at fair value by buying or selling futures contracts based on their expectations of future price movements. This helps to keep the market liquid and also provides hedgers with a counterparty for their trades. Hedgers use futures contracts to manage their price risks and ensure stable income, and without speculators, there would not be enough liquidity, which would make it harder for hedgers to execute their trades. Speculators can also help to provide valuable price discovery information to the market, which can help all participants to better understand the direction of future price changes.

Question 12

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?

Accepted Answer

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

Question 13

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

Accepted Answer

Forward contracts are private agreements and are not marked to market, whereas futures contracts are standardized and marked to market daily.

Question 14

Which one of the following statements is correct?

Accepted Answer

The profit realized by the buyer of futures will be equal to the loss incurred by the seller. This is because futures contracts are a zero-sum game, meaning that for every dollar gained by a buyer, a dollar is lost by the seller. Therefore, both parties cannot earn a profit simultaneously. Option A and B are incorrect because the profitability of an option or futures contract depends on various factors and cannot be generalized to either the buyer or seller earning more profits. Option D is also incorrect as futures contracts are a zero-sum game, and both parties cannot earn a profit simultaneously.

Question 15

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

Accepted Answer

At the expiration of a futures contract, the futures price will converge to the spot price, resulting in the futures price being equal to the spot price. This is known as the principle of convergence.

Question 16

Which one of the following is not true of the financial futures markets?

Accepted Answer

The statement "Trading in financial futures is significantly less than trading in financial futures" is contradictory and doesn't make sense. It is likely a typo or error. The other statements are true, including financial futures trading on the Chicago Mercantile Exchange, potential delivery issues upon maturity, and their usefulness for managing interest rate risk.

Question 17

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

Accepted Answer

Both futures and forward contracts involve transactions at a price agreed upon earlier, although futures are standardized and traded on exchanges, while forwards are private and customizable.

Question 18

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

Accepted Answer

The farmer can hedge the risk of downward movement in the price of his product by buying a put option. This gives him the right (but not the obligation) to sell his product at a certain price (called the strike price) in the future, even if the market price falls below that level. If the price does fall, the farmer can exercise the put option and sell his product at the higher strike price, thereby offsetting his losses.

Question 19

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

Accepted Answer

A contract to buy Japanese yen three months forward at a price of ¥105/$ will protect the buyer from changes in exchange rates. It is a type of hedging strategy where the buyer locks in a fixed exchange rate to mitigate the risk of unfavorable exchange rate movements and ensure a certain level of price certainty. The contract does not 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 Nasdaq Exchange.

Question 20

Currency swaps are used to:

Accepted Answer

Currency swaps are used to effectively transform loans originated in one currency to a different currency. This is done to take advantage of more favorable interest rates or to manage exchange rate risk.

Quiz 24: Risk Management