Exam 26: Managing Risk

On $10 million of loans, Firm A is paying a fixed $700,000 in interest payments while Firm B is paying LIBOR plus 50 basis points. The current LIBOR rate is 6.25 percent. Firms A and B have agreed to swap interest payments. How much will be paid to which firm this year?

Briefly explain the term derivative.

The spot price of wheat is $2.90/bushel. The one-year futures price is $3/bushel. If the risk-free rate is 5 percent, calculate the net convenience yield.

If you sold a wheat futures contract for $3.75 per bushel and the contract ended at $3.60, what is your profit per bushel? (Ignore transaction costs.)

Insurance companies face the following problem(s):

The price for immediate delivery of a commodity is called the

Most of the world's largest companies use derivatives to manage risk.

A firm owns an asset A and it wants to hedge against changes in the value of A by making an offsetting sale of asset B. The firm minimizes risk by

The following are sensible reasons for a firm to engage in hedge transactions: I.to reduce the risk of financial distress; II.to reduce the fluctuations in its income; III.to mitigate agency costs

Which of the following derivative contract features does not reduce counterparty risk?

A forward interest rate contract is called a(n)

In addition to bearing risk, insurance companies also bear

First National Bank recently made a five-year $100 million fixed-rate loan at 10 percent. Annual interest payments are $10 million, and all principal will be repaid in year 5. The bank wants to swap the fixed interest payment into floating-rate payments. If the bank could borrow at a fixed rate of 8 percent for five years, what is the notional principal of the swap?

What are the four basic types of contracts or instruments used in financial risk management?

Your firm operates an oil refinery and is therefore naturally short on crude oil. You buy offsetting oil market futures to hedge your natural position. Shortly thereafter, local pipelines were damaged in a recent earthquake, leaving you with the highest local crude oil prices in decades. Simultaneously, unexpectedly high recent production from Mexico, Brazil, and the Baltic Sea has driven down the global price of crude and your financial hedge has lost you millions. You have fallen victim to what kind of risk?

The hedge ratio or delta measures the sensitivity of the value of one asset relative to the value of another asset.

If a bank is asked to quote a rate on a one-year loan one year from today and the current interest rate on a one-year loan is 7 percent and a two-year loan is 8 percent, it should quote 7.5 percent, which is the average of the two rates.

Which of the following statements about forwards, futures, and options is correct?

Four investors enter into long sugar contracts. Three are speculators and one is hedging. Which of the following is hedging?

If a bank is asked to quote a rate on a one-year loan one year from today and the current interest rate on a one-year loan is 7 percent and a two-year loan is 8 percent, it should quote 9 percent.