Ch23 Exam Questions – Introduction To Financial Risk - Corporate Finance Asia Pacific 2e Complete Test Bank by Chris Adam. DOCX document preview.
Chapter 23 – Introduction to financial risk management
MULTIPLE CHOICE
1. Why might a financial manager prefer using options contracts instead of futures or forward contracts to hedge?
a. | Futures and forwards require a premium be paid upfront, while options do not. |
b. | Options provide protection against adverse price movements but allow the user to profit if the price of the underlying asset moves favourably. |
c. | Options create an obligation to perform, while futures and forwards do not. |
d. | Futures and forwards have greater default risk than options. |
REF: 23.4 Options and Swaps NAT: Reflective thinking
LOC: understand derivative markets
2. Suppose rising petrol prices cut into consumer spending, and Woolworths, Target and other retailers experience a slowdown in sales. This slowdown is an example of:
a. | economic exposure |
b. | transactions exposure |
c. | interest rate risk |
d. | basis risk |
REF: 23.1 Overview of Risk Management NAT: Reflective thinking
LOC: acquire an understanding of risk and return
3. Which of the following is not a motivation for hedging?
a. | Reducing the costs of financial distress |
b. | Enhancing the ability to evaluate managers |
c. | Offsetting the costs of insurance |
d. | Reducing the company’s expected tax liability |
REF: 23.1 Overview of Risk Management NAT: Reflective thinking
LOC: acquire an understanding of risk and return
4. Which of the following is a key difference a manager should note in choosing between forward and futures contracts?
a. | Exchange trading makes forward contracts more liquid. |
b. | Futures contracts carry standardised terms, while forward contracts can be tailored to meet specific needs. |
c. | Futures contracts have greater default risk than forward contracts. |
d. | Forward contracts require initial margin deposits and daily marking-to-market, while futures do not. |
REF: 23.2 Forward Contracts | 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
5. A standard fixed-for-floating interest rate swap contract is effectively:
a. | a series of call options on the interest rate |
b. | a series of put options on the interest rate |
c. | a series of forward rate agreements |
d. | a series of call and put options on the interest rate |
REF: 23.4 Options and Swaps NAT: Analytic skills
LOC: understand derivative markets
6. The spot rate on the British pound is 0.5491 per US dollar, while the risk-free borrowing rates are 4% in the UK and 3% in the US. What is the fair forward exchange rate?
a. | £0.5438 per dollar |
b. | £0.7321 per dollar |
c. | £0.4118 per dollar |
d. | £0.5544 per dollar |
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
7. The Exim Company has entered into a three-month, $250 million notional principal forward rate agreement (FRA) with What-a-Bank. The terms are such that Exim will pay What-a-Bank if LIBOR is above 2%, but What-a-Bank will pay Exim if LIBOR is below 2%. Based on the standard FRA formula, how much will Exim or What-a-Bank pay if LIBOR is 1.625% in three months?
a. | Exim Company pays $1 244 942. |
b. | Exim Company pays $233 427. |
c. | What-a-Bank pays $1 244 924. |
d. | What-a-Bank pays $233 427. |
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
8. You are a financial manager with ICN Co., and you have used a forward contract to hedge a ¥100 000 000 payment the company expects in 90 days. Your contract calls for you to deliver yen at ¥111.25 per US dollar. Suppose the spot rate at that time is ¥109.75 per US dollar. Did you gain or lose on the hedge and by how much?
a. | Gain; $12 285.33 |
b. | Loss; $12 285.33 |
c. | Gain; $66 666.67 |
d. | Loss; $66 666.67 |
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
9. Outsource, Inc. expects a payment from a French customer in 30 days. To hedge its currency exposure, Outsource should:
a. | sell euros forward 30 days |
b. | buy euros forward 30 days |
c. | sell dollars forward 30 days |
d. | do nothing, as there is no foreign exchange rate exposure for a 30-day time horizon |
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: acquire an understanding of risk and return
10. You are a financial manager with JCN Co., and you have used a forward contract to hedge a ¥100 000 000 payment the company expects to receive in 90 days. Your contract calls for you to deliver yen at ¥109.75 per US dollar. Suppose the spot rate at that time is ¥111.25 per US dollar. Did you gain or lose on the hedge and by how much?
a. | Gain; $66 666.67 |
b. | Loss; $66 666.67 |
c. | Gain; $12 285.33 |
d. | Loss; $12 285.33 |
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: acquire an understanding of risk and return
11. The Exim Company has entered into a three-month, $250 notional principal forward rate agreement (FRA) with What-a-Bank. The terms are such that Exim will pay What-a-Bank if LIBOR is above 2%, but What-a-Bank will pay Exim if LIBOR is below 2%. Based on the standard FRA formula, how much will Exim or What-a-Bank pay if LIBOR is 2.375% in three months?
a. | Exim Co. pays $1 475 614. |
b. | Exim Co. pays $232 992. |
c. | What-a-Bank pays $1 475 614. |
d. | What-a-Bank pays $232 992. |
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
12. If the spot exchange rate is ¥110 per US dollar, the fair forward exchange rate is ¥115 per US dollar and the risk-free borrowing rate in the US is 2.5%, what must the risk-free borrowing rate be in Japan?
a. | 7.2% |
b. | 5.6% |
c. | 3.7% |
d. | 0% |
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
Use the following information to answer questions 13 to 15.
The MakeStuff Company’s earnings stream is highly dependent on the cost of a key commodity input. Management believes taxable earnings will be $100 000 if the input price is low, taxable earnings will be $50 000 if the input price is at a moderate level, but earnings will be zero if the input price is high. Management sees these outcomes as being equally likely. The company pays a 15% tax rate on the first $50 000 of taxable earnings and a 25% rate on all earnings above $50 000.
13. What is MakeStuff’s tax liability if the input price is at the moderate level?
a. | $7500 |
b. | $10 000 |
c. | $12 500 |
d. | $15 000 |
REF: 23.1 Overview of Risk Management NAT: Analytic skills
LOC: acquire an understanding of risk and return
14. What is MakeStuff’s expected after tax earnings if it remains unhedged?
a. | $50 000 |
b. | $42 500 |
c. | $80 000 |
d. | $40 833 |
REF: 23.1 Overview of Risk Management NAT: Analytic skills
LOC: acquire an understanding of risk and return
15. If it could lock in the moderate price level for sure, what would MakeStuff’s after-tax earnings be?
a. | $50 000 |
b. | $42 500 |
c. | $80 000 |
d. | $40 333 |
REF: 23.1 Overview of Risk Management NAT: Analytic skills
LOC: acquire an understanding of risk and return
Use the following information on Chicago Board Options Exchange (CBOE) 13-week T-bill rate options to answer questions 16 to 19.
Strike level | OCT call | OCT put |
30 | 1.50 | 0.75 |
35 | 1.20 | 1.10 |
40 | 1.00 | 1.40 |
16. Refer to CBOE. Suppose you want to cap your interest rate before a planned October borrowing. What is the cost of using the OCT 35 option to hedge?
a. | $110 per contract |
b. | $1.10 per contract |
c. | $120 per contract |
d. | $1.20 per contract |
REF: 23.4 Options and Swaps NAT: Analytic skills
LOC: understand derivative markets
17. Refer to CBOE. If you used the OCT 35 option to hedge rising rates, and the yield to maturity on 13-week bills is 3.75% at the option’s expiration, what is the outcome of your hedge?
a. | profit of $250 per contract |
b. | profit of $130 per contract |
c. | loss of $120 per contract |
d. | no gain or loss |
REF: 23.4 Options and Swaps NAT: Analytic skills
LOC: understand derivative markets
18. Refer to CBOE. What is the cost of the least expensive floor to protect from falling interest rates?
a. | $75 per contract |
b. | $0.75 per contract |
c. | $100 per contract |
d. | $1.00 per contract |
REF: 23.4 Options and Swaps NAT: Analytic skills
LOC: understand derivative markets
19. Refer to CBOE. Suppose you want to construct a collar to reduce the cost of the cap by selling a floor. What is the net cost of the least expensive such collar? (Be sure the strike prices on the call and the put are not the same!)
a. | $0.10 per contract outflow |
b. | $10 per contract outflow |
c. | $0.10 per contract inflow |
d. | $10 per contract inflow |
REF: 23.4 Options and Swaps NAT: Analytic skills
LOC: understand derivative markets
20. Suppose the spot exchange rate is £0.5491 per US dollar, while the risk-free borrowing rate is 4% in the UK. If the fair exchange rate is £0.5544 per US dollar, what is the risk-free borrowing rate in the US?
a. | 5% |
b. | 4% |
c. | 3% |
d. | 2% |
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
21. Suppose the spot exchange rate is £0.5491 per US dollar, while the risk-free borrowing rate is 4% in the UK and 3% in the US. If the current forward exchange rate is also £0.5491 per dollar, what opportunity exists?
a. | Arbitrage by borrowing in the UK today and selling pounds forward |
b. | Arbitrage by borrowing in the UK today and selling dollars forward |
c. | Arbitrage by borrowing in the US today and selling pounds forward |
d. | Arbitrage by borrowing in the US today and selling dollars forward |
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
22. Snooty Wine Importers has an order of exclusive Chateau de Snoot wines arriving from France in October, and the order will be paid in euros. Which of the following will hedge the importer’s currency exposure?
a. | buying euros forward |
b. | selling euros forward |
c. | selling dollars forward |
d. | selling wine futures |
REF: 23.1 Overview of Risk Management NAT: Reflective thinking
LOC: understand derivative markets
23. Snooty Wine Importers has an order of Chateau de Snoot wines arriving from France in October, and the order will be paid in euros. If Snooty enters a contract today with a forward rate of €0.9 per US dollar for October delivery, and the spot rate in October turns out to be €0.85 per US dollar, what is the effect of the forward contract on Snooty?
a. | Snooty Importers made $37 500. |
b. | Snooty Importers lost $37 500. |
c. | Snooty Importers made $63 755. |
d. | There is no effect. |
REF: 23.1 Overview of Risk Management NAT: Analytic skills
LOC: understand derivative markets
24. Suppose the spot price of oil is $49.50 per barrel, while the October futures price is $51.00 per barrel. For this contract, the basis is
a. | $51.00. |
b. | $49.50. |
c. | $1.50. |
d. | $100.50. |
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
25. Today, the price of an October oil futures contract closed at $49.50 per barrel. Yesterday, the contract closed at $50.25. When margin accounts are marked to market:
a. | long positions will have $0.75 per barrel added |
b. | long positions will have $0.75 per barrel deducted |
c. | short positions will have $0.75 per barrel deducted |
d. | no changes will be made until the October expiration |
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
26. The process of identifying company-specific risk exposures and managing those exposures is called:
a. | capital management |
b. | risk management |
c. | financial management |
d. | contract management |
REF: 23.1 Overview of Risk Management NAT: Analytic skills
LOC: acquire an understanding of risk and return
27. The overall impact of foreign exchange rate fluctuations on a company’s value is called:
a. | interest rate risk |
b. | transactions exposure |
c. | economic exposure |
d. | basis risk |
REF: 23.1 Overview of Risk Management NAT: Reflective thinking
LOC: acquire an understanding of risk and return
28. The average price at which a futures contract sells at the end of the trading day is called the:
a. | opening price |
b. | closing price |
c. | settlement price |
d. | lifetime price |
REF: 23.3 Futures Contracts NAT: Reflective thinking
LOC: understand derivative markets
29. The minimum dollar amount required by an investor when taking a position in a futures contract is called the:
a. | initial margin |
b. | maintenance margin |
c. | margin account |
d. | margin call |
REF: 23.3 Futures Contracts NAT: Reflective thinking
LOC: understand derivative markets
30. A call option on interest rates is called an:
a. | interest rate collar |
b. | interest rate floor |
c. | interest rate cap |
d. | interest rate swap |
REF: 23.4 Options and Swaps NAT: Reflective thinking
LOC: understand derivative markets
31. If the current spot exchange rate on the euro is $1.4812/€, and the one-year risk-free rate is 3% for borrowing in dollars and 4% for borrowing in euros, what should be the one-year $/€ forward exchange rate?
a. | $1.4812 |
b. | $1.4689 |
c. | $1.4936 |
d. | $1.4669 |
1.4812(1.03/1.04) = 1.4669
PTS: 1 DIF: M
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
32. If the current spot exchange rate on the euro is €0.8805/$, and the one-year risk-free rate is 3% for borrowing in dollars and 4% for borrowing in euros, what should be the one-year $/€ forward exchange rate?
a. | $1.2689 |
b. | $0.7881 |
c. | $1.2936 |
d. | $1.1248 |
(1/0.8805)(1.03/1.04) = 1.1248
PTS: 1 DIF: H
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
33. If the current spot exchange rate on the euro is $1.4812/€, and the two-year risk-free rate is 3% for borrowing in dollars and 4% for borrowing in euros, what should be the two-year $/€ forward exchange rate?
a. | $1.4689 |
b. | $1.4812 |
c. | $1.4567 |
d. | $1.4529 |
1.4812[(1.03)2/(1.04)2] = 1.4529
PTS: 1 DIF: M
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
Exhibit 23-1
S&P 500 Index; $250 × index May 2017
Open | High | Low | Settle | Change | Lifetime high | Lifetime low | Open interest | |
June | 1029.5 | 1044.5 | 1028.6 | 1041.35 | +11.70 | 1044.20 | 829.05 | 183 158 |
Sept | 1039.3 | 1052.8 | 1039.0 | 1048.9 | +11.75 | 1052.8 | 907.50 | 8622 |
Dec | 1051.4 | 1062.2 | 1050.5 | 1059.40 | +11.70 | 1062.20 | 953.00 | 3338 |
34. Refer to Exhibit 23-1. What is the value of a September S&P 500 Index futures contract?
a. | $524 950 |
b. | $210 569 |
c. | $329 574 |
d. | $262 225 |
1048.9(250) = 262 225
PTS: 1 DIF: E
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
35. Refer to Exhibit 23-1. What was the lowest value of the December contract on the day quoted?
a. | $265 500 |
b. | $262 750 |
c. | $262 625 |
d. | $271 450 |
1050.5(250) = 262 625
PTS: 1 DIF: E
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
36. Refer to Exhibit 23-1. What is the highest value at which the June contract has ever been quoted?
a. | $261 125 |
b. | $207 262 |
c. | $261 050 |
d. | $278 695 |
1044.5(250) = 261 125
PTS: 1 DIF: E
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
37. Refer to Exhibit 23-1. For the purpose of marking-to-market, what is the current value of the December contract?
a. | $264 850.00 |
b. | $264 837.50 |
c. | $265 550.00 |
d. | $238 250.00 |
1059.40(250) = 264 850
PTS: 1 DIF: E
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
38. Refer to Exhibit 23-1. How many June contracts were outstanding at the end of the trading day?
a. | 8622 |
b. | 8621 |
c. | 183 158 |
d. | 125 845 |
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
39. Refer to Exhibit 23-1. If you hold a long position of 21 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?
a. | $58 500 |
b. | $11.70 |
c. | $61 425 |
d. | $234 |
11.70(250)21 = 61 425
PTS: 1 DIF: E
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
40. You buy 21 corn futures contracts when the futures price is $3.67 per bushel (each contract is for 5000 bushels). If you eventually settle the contract at $3.78, what is your profit?
a. | $11 000 |
b. | $11 550 |
c. | $9500 |
d. | $15 000 |
21(5000)3.78 – 21(5000)3.67 = 11 550
PTS: 1 DIF: E
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
41. You sell 21 corn futures contracts when the futures price is $3.67 per bushel (each contract is for 5000 bushels). If you eventually settle the contract at $3.78, what is your payoff?
a. | $11 000 |
b. | –$11 550 |
c. | $13 000 |
d. | –$13 000 |
20(5000)3.67 – 20(5000)3.78 = –11 550
PTS: 1 DIF: E
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
Exhibit 23-2
Coffee; 37 400 kg per contract, $ per kg. May 2017
Open | High | Low | Settle | Change | Lifetime high | Lifetime low | Open interest | |
June | 1.05 | 1.12 | 1.05 | 1.12 | +0.10 | 1.59 | 1.03 | 17 832 |
Sept. | 1.08 | 1.13 | 1.08 | 1.13 | +0.08 | 1.51 | 1.07 | 6379 |
Dec. | 1.11 | 1.16 | 1.11 | 1.16 | +0.08 | 1.43 | 1.10 | 1397 |
42. Refer to Exhibit 23-2. If you are interested in purchasing a December futures contract, what is the price of a 37 400-kg contract for December delivery?
a. | $43 500 |
b. | $37 500 |
c. | $43 384 |
d. | $47 500 |
37 400(1.16) = 43 384
PTS: 1 DIF: E
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
43. Refer to Exhibit 23-2. What was the lowest contract price for coffee futures for June delivery on this trading day?
a. | $39 375 |
b. | $37 500 |
c. | $39 270 |
d. | $42 000 |
1.05(37 400) = 39 270
PTS: 1 DIF: E
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
44. Refer to Exhibit 23-2. What was the highest contract price at which the September coffee future has traded over its lifetime?
a. | $40 125 |
b. | $56 625 |
c. | $56 474 |
d. | $42 375 |
37 400(1.51) = 56 474
PTS: 1 DIF: E
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
45. Refer to Exhibit 23-2. For purposes of marking-to-market, what is the current price of coffee futures for December?
a. | $41 625 |
b. | $53 625 |
c. | $43 384 |
d. | $43 500 |
37 400(1.16) = 43 384
PTS: 1 DIF: E
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
46. 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?
a. | $3000 |
b. | –$3000 |
c. | $2992 |
d. | –$3750 |
37 400(0.08) = 2992
PTS: 1 DIF: E
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
47. 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?
a. | $3000 |
b. | –$2992 |
c. | $3750 |
d. | –$3750 |
37 400(–0.08) = –2992
PTS: 1 DIF: M
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
48. Refer to Exhibit 23-2. How many December coffee futures contracts were outstanding at the end of the trading day?
a. | 17 832 |
b. | 6379 |
c. | 1397 |
d. | 7776 |
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
49. In historical terms, although not necessarily the case now, risk management has focused on company-specific events such as:
a. | currency risk |
b. | interest rate risk |
c. | workers’ compensation claims |
d. | economy risk |
REF: 23.1 Overview of Risk Management NAT: Reflective thinking
LOC: acquire an understanding of risk and return
50. What is the single most common concern among managers engaged in risk management?
a. | Interest rate risk |
b. | Currency exchange risk |
c. | Raw materials price risk |
d. | Economy risk |
REF: 23.1 Overview of Risk Management NAT: Reflective thinking
LOC: acquire an understanding of risk and return
51. If your company produces a product that is used primarily by gold producers, then your company 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:
a. | transactions exposure |
b. | basis risk |
c. | economic exposure |
d. | interest rate risk |
REF: 23.1 Overview of Risk Management NAT: Reflective thinking
LOC: acquire an understanding of risk and return
52. For most companies, the principle reason for hedging is:
a. | to reduce the likelihood of financial distress |
b. | to comply with ASIC regulations concerning company risk tolerances |
c. | to satisfy the owners of the company’s shares |
d. | to satisfy the owners of the company’s debt |
REF: 23.1 Overview of Risk Management NAT: Reflective thinking
LOC: acquire an understanding of risk and return
53. You are the manager of a company that has an equal chance of earning either $20 000 or $40 000 before taxes. Your company 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?
a. | $24 000 |
b. | $23 250 |
c. | $750 |
d. | $30 500 |
Earnings before tax with hedging = 30 000
After-tax earnings by hedging = 30 000 × 0.8 = 24 000
After-tax earnings with 20 000 pre-tax earnings = 20 000 × 0.8 = 16 000
After-tax earnings with 40 000 pre-tax earnings = (30 000 × 0.8) + (10 000 × 0.65) = 30 500
After-tax expected earnings from not hedging = 0.5(16 000) + 0.5(30 500) = 23 250
Benefit from hedging = 24 000 – 23 250 = 750
PTS: 1 DIF: M
REF: 23.1 Overview of Risk Management NAT: Analytic skills
LOC: acquire an understanding of risk and return
54. If the managers of a company have a greater aversion to risk, then:
a. | they are less likely to hedge |
b. | they are more likely to hedge |
c. | they are more likely to use derivatives to speculate |
d. | they are more likely to take on risky projects |
REF: 23.1 Overview of Risk Management NAT: Reflective thinking
LOC: acquire an understanding of risk and return
55. You need to purchase apples one month from now and would like to hedge against price movements. The spot price for apples is $5 a bushel and the risk-free rate is 10%. What is the one-month forward price for a bushel of apples?
a. | $4.96 |
b. | $5.00 |
c. | $5.04 |
d. | $5.50 |
5(1 + 0.1)1/12 = 5.03987
PTS: 1 DIF: M
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
56. You need to purchase coal four 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 four-month forward price for a railroad car of coal?
a. | $48.73 |
b. | $50.00 |
c. | $51.30 |
d. | $54.00 |
50 × (1 + .08)4/12 = 51.29928
PTS: 1 DIF: M
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
57. You find that the six-month forward price for scrap steel is $15 a ton. If the six-month risk-free rate is 10%, then what should be the spot price for scrap steel per ton?
a. | $14.30 |
b. | $15.00 |
c. | $15.73 |
d. | $16.50 |
15/(1 + 0.1)6/12 = 14.3019
PTS: 1 DIF: M
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
58. You notice that the spot price of beef loin is $30 per kilogram and the nine-month forward rate is $32.66 per kilogram. What is the annualised nine-month risk-free rate of interest?
a. | 6.58% |
b. | 8.87% |
c. | 10.00% |
d. | 12.00% |
32.66 = 30 × (1 + r)9/12
r = 0.12
PTS: 1 DIF: M
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
59. You notice that the spot price of beef loin is $30 per kilogram and the nine-month forward rate is $33.00 per kilogram. The annualised nine-month risk-free rate of interest is 12%. What amount of arbitrage profits is available to you?
a. | $0.60 |
b. | $0.34 |
c. | –$0.34 |
d. | –$0.60 |
Theoretical forward = 30 × (1.12)9/12 = 32.66
Arbitrage profits = 33 – 32.66 = 0.34
PTS: 1 DIF: M
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
60. The spot rate exchange rate for Andromedan pixels (ANP) is 3ANP/$0. If the risk-free rate of return in Andromeda is 20% per annum while that in the Australia is 3%, then what should be the one-year forward rate for ANP/$?
a. | $2.57 |
b. | $3.00 |
c. | $3.50 |
d. | $3.60 |
3.00 × (1.2/1.03) = 3.4951
PTS: 1 DIF: M
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
61. You have entered into a FRA with a notional amount of $100 000 000. The FRA states that if one-year LIBOR is greater than 5%, then the bank will pay you; if the rate is less than 5%, you will pay the bank. At the end of the contract you find that one-year LIBOR is 4.5%. What is the appropriate cash flow?
a. | The bank pays you $500 000. |
b. | You pay the bank $500 000. |
c. | The bank pays you $478 469. |
d. | You pay the bank $478 469. |
100 000 000 × (0.045 – 0.05)/ (1 + 0.045) = –478 468.90
You pay the bank because interest rates fell.
PTS: 1 DIF: H
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
62. You are looking to hedge a position and you require that the hedge that you take on be extremely liquid. Therefore, you:
a. | look to the forward market to hedge |
b. | look to the futures market to hedge |
c. | look to the spot market to hedge |
d. | look to the bank exchange rate to hedge |
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
63. You are looking at the open interest on a futures contract and notice that there are 500 contracts open. If none of the holders of these contracts is willing to take delivery, then what is the minimum number of contracts that must be bought or sold by the expiration date of the contract?
a. | 0 contracts |
b. | 250 contracts |
c. | 500 contracts |
d. | 1000 contracts |
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
64. Which of the following assets would probably not lend itself to a futures contract?
a. | Paper |
b. | Water |
c. | Real estate |
d. | Microchips |
Real estate is unique and, therefore, not really a commodity.
PTS: 1 DIF: H
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
65. You have a long futures position on an asset with a settlement price of $30.00 and a contract expiration date of six-months from now. If the settlement price of the contact is $30.08 tomorrow, then what cash flow will take place if you assume that the initial margin was zero?
a. | All cash settlements will take place six months from now. |
b. | You will receive $0.08 per contract. |
c. | You will pay $0.08 per contract. |
d. | There is not enough information to answer this question. |
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
66. You initially entered into six long pork belly positions in the futures market. You subsequently went long on another three contracts and then went short on four contracts. Which of the following is correct? Assume that all of the contracts have the same settlement price and settlement date.
a. | If you do nothing more, then you must take delivery on five pork belly contracts. |
b. | If you do nothing more, then you must deliver five pork belly contracts. |
c. | If you do nothing more, then you must take delivery on nine pork belly contracts. |
d. | If you do nothing more, then you must deliver four pork belly contracts. |
REF: 23.3 Futures Contract NAT: Analytic skills
LOC: understand derivative markets
67. The basis on a one-year futures contract is 52 points. If spot prices do not move and the risk-free term structure of interest rates remains flat and also does not move, then what should be the basis one week before expiration?
a. | 1 point |
b. | 7 points |
c. | 10 points |
d. | 52 points |
If 52 points is 1 point per week, then the basis should be 1 point a week before expiration.
PTS: 1 DIF: M
REF: 23.3 Futures Contracts NAT: Analytic skills
LOC: understand derivative markets
68. You are bidding on a contract in a foreign currency and you are not sure if you will win the bid. However, the analysis in your bid will be flawed if the foreign currency exchange rate changes between now and when you know whether you have won the contract. The best course of action to hedge your position is to:
a. | long a currency futures contract |
b. | short a currency futures contract |
c. | purchase an option to sell foreign currency for your currency |
d. | sell an option to sell foreign currency for your currency |
REF: 23.4 Options and Swaps NAT: Analytic skills
LOC: understand derivative markets
69. Your company has issued $100 000 000 bonds with a fixed cost of 10% to the company. In addition, the company has entered into a contract to pay a bank LIBOR +0.5% while the bank pays the company 8.5%, with both notional amounts also being $100 000 000. What is the total cost to your company for the $100 000 000 borrowing?
a. | LIBOR +1% |
b. | LIBOR –1% |
c. | LIBOR +2% |
d. | LIBOR –2% |
–0.10 – (LIBOR + 0.005) + 0.085 = –LIBOR – 0.02 = –(LIBOR + 0.02)
PTS: 1 DIF: M
REF: 23.4 Options and Swaps NAT: Analytic skills
LOC: understand derivative markets
70. Currently, the euro is trading at €/US$0.7206. If the current anticipated inflation is 4% in the USA and 2.3% in Europe over the next year, what is the fair one-year forward price (€/US$)?
a. | €0.709 |
b. | €0.704 |
c. | €0.693 |
d. | €0.733 |
F = (S)[(1+ rfor)/(1+ rdom)]
Euro | 0.7206 |
rfor US$ | 0.04 |
rfor euro | 0.023 |
F | 0.708821 |
PTS: 1 DIF: H
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
71. Currently, the Brazilian real is trading at R/US$1.7531. If the current anticipated inflations is 4% in the USA and 7.3% in Brazil over the next year, what is the fair one-year forward price (R/US$)?
a. | R1.686 |
b. | R1.699 |
c. | R1.809 |
d. | R1.634 |
F = (S)[(1+ rfor)/(1+ rdom)]
Brazil | 1.7531 |
rfor US$ | 0.04 |
rfor R | 0.073 |
F | 1.808727 |
PTS: 1 DIF: H
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
72. Emma plans to buy four-month Treasury bills in two months. Currently, the price on six-month Treasury bills is $975 568 per million. The risk-free rate is 5.4%. What is the fair forward price per $1 million?
a. | $981 477 |
b. | $1 038 347 |
c. | $1 011 398 |
d. | $993 822 |
F = S0(1+ rf)n
PTS: 1 DIF: H
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
73. Roxy plans to buy four-month Treasury bills in eight months. Currently, the price on 12-month Treasury bills is $962 456 per million. The risk-free rate is 5.2%. What is the fair forward price per $1 million?
a. | $983 193 |
b. | $995 538 |
c. | $1 000 159 |
d. | $1 012 504 |
F = S0(1+ rf)n
PTS: 1 DIF: H
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
74. Louis plans to buy two-month Treasury bills in four months. Currently, the price on six-month Treasury bills is $962 456 per million. The risk-free rate is 5.2%. What is the fair forward price per $1 million?
a. | $1 007 459 |
b. | $1 042 088 |
c. | $1 016 007 |
d. | $995 114 |
F = S0(1+ rf)n
PTS: 1 DIF: H
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
75. Consider a forward contract to buy a 10-year bond in one year. Currently, the 11-year bond has a coupon rate of 10%, paid semiannually with a price of $1050. The current and effective risk-free rate of interest is 4%. What is the fair forward price?
a. | $991.01 |
b. | $992.04 |
c. | $1092.04 |
d. | $1009.62 |
F = (S0 – I + W)(1 + rf)n
PTS: 1 DIF: H
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
76. Consider a forward contract to buy a 10-year bond in one year. Currently, the 11-year bond has a coupon rate of 6%, paid semiannually with a price of $980. The current and effective risk-free rate of interest is 5%. What is the fair forward price?
a. | $1029.05 |
b. | $969.05 |
c. | $933.33 |
d. | $968.26 |
F = (S0 – I + W)(1 + rf)n
PTS: 1 DIF: H
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
77. Consider a forward contract to buy a 10-year bond in one year. Currently, the 11-year bond has a coupon rate of 7%, paid semiannually with a price of $1060. The current and effective risk-free rate of interest is 5%. What is the fair forward price?
a. | $1113.05 |
b. | $1042.14 |
c. | $1043.05 |
d. | $1009.52 |
F = (S0 – I + W)(1 + rf)n
PTS: 1 DIF: H
REF: 23.2 Forward Contracts NAT: Analytic skills
LOC: understand derivative markets
SHORT ANSWER
1. Distinguish between transactions exposure and economic exposure.
PTS: 1 DIF: E
REF: 23.1 Overview of Risk Management
2. What is an interest rate collar?
PTS: 1 DIF: E
REF: 23.4 Options and Swaps
3. What is the meaning of fungibility?
PTS: 1 DIF: E
REF: 23.3 Futures Contracts
4. Define arbitrage.
PTS: 1 DIF: E
REF: 23.2 Forward Contracts
5. What is financial engineering?
PTS: 1 DIF: E
REF: 23.5 Financial Engineering
6. What is financial risk management?
PTS: 1 DIF: E
REF: 23 Introduction to Financial Risk Management