Question 1

A company that wishes to lock in an interest rate on future borrowing can either enter into a forward rate agreement (FRA)or it can borrow long-term funds and lend short-term.

Accepted Answer

A) True 
 B)False

Question 2

Derivative instruments are financial contracts whose value depends on the value of another asset.

Accepted Answer

A) True 
 B)False

Question 3

The seller of a forward contract agrees to

Accepted Answer

A) deliver a product at a later date for a price set today. 
B) receive a product at a later date at the price on that later date. 
C) receive a product at a later date for a price set today. 
D) deliver a product at a later date for a price set on that later date. 
A) deliver a product at a later date for a price set today. 
B) receive a product at a later date at the price on that later date. 
C) receive a product at a later date for a price set today. 
D) deliver a product at a later date for a price set on that later date.

Question 4

For commodity futures, (Futures price)× (1 + rf)^t = spot price − net convenience yield.

Accepted Answer

A) True 
 B)False

Question 5

In a "total return swap," the underlying asset(s)might be a

Accepted Answer

A) common stock and loan. 
B) common stock, loan, and commodity. 
C) common stock, loan, commodity, and market index. 
D) market index. 
A) common stock and loan. 
B) common stock, loan, and commodity. 
C) common stock, loan, commodity, and market index. 
D) market index.

Question 6

If the one-year spot interest rate is 8 percent and the two-year spot interest rate is 9 percent, calculate the one-year forward interest rate one year from today.

Accepted Answer

A) 10 percent 
B) 10.5 percent 
C) 11 percent 
D) 11.5 percent 
A) 10 percent 
B) 10.5 percent 
C) 11 percent 
D) 11.5 percent

Question 7

When a standardized forward contract is traded on an exchange, it becomes a(n)

Accepted Answer

A) forward contract. 
B) futures contract. 
C) options contract. 
D) swap contract. 
A) forward contract. 
B) futures contract. 
C) options contract. 
D) swap contract.

Question 8

A risk manager should address which of the following considerations?
I.The firm needs to understand the major risks and consequences that the company faces.
II.The firm needs to determine if it is being paid for any particular risk.
III.The firm should simply view risks as external factors beyond the firm's control.
IV.The firm should know how to control a particular risk.

Accepted Answer

A) I only 
B) I and II only 
C) I, II, and IV only 
D) III only 
A) I only 
B) I and II only 
C) I, II, and IV only 
D) III only

Question 9

In bearing risk, what disadvantages do insurance companies face?

Accepted Answer

There are three major disadvan

Question 10

A financial institution can hedge its interest rate risk by

Accepted Answer

A) matching the duration of its assets weighted by the book value of its assets to the duration of its liabilities weighted by the book value of its liabilities. 
B) setting the duration of its assets equal to half that of the duration of its liabilities. 
C) matching the duration of its assets weighted by the market value of its assets with the duration of its liabilities weighted by the market value of its liabilities. 
D) setting the duration of its assets weighted by the market value of its assets to one-half that of the duration of the liabilities weighted by the market value of the liabilities. 
A) matching the duration of its assets weighted by the book value of its assets to the duration of its liabilities weighted by the book value of its liabilities. 
B) setting the duration of its assets equal to half that of the duration of its liabilities. 
C) matching the duration of its assets weighted by the market value of its assets with the duration of its liabilities weighted by the market value of its liabilities. 
D) setting the duration of its assets weighted by the market value of its assets to one-half that of the duration of the liabilities weighted by the market value of the liabilities.

Question 11

Suppose that the current level of the Standard and Poor's Index is 950. The prospective dividend yield on S&P 500 stocks is 3 percent, and the risk-free interest rate is 5 percent. What is the value of a one-year futures contract on the index? (Assume all dividend payments occur at the end of the year.)

Accepted Answer

A) 969 
B) 998 
C) 979 
D) 1,026 
A) 969 
B) 998 
C) 979 
D) 1,026

Question 12

Suppose you borrow $95.24 for one year at 5 percent and invest $95.24 for two years at 7 percent. For the time period beginning one year from today, you have

Accepted Answer

A) borrowed at 7 percent. 
B) invested at 7 percent. 
C) borrowed at 9 percent. 
D) invested at 9 percent. 
A) borrowed at 7 percent. 
B) invested at 7 percent. 
C) borrowed at 9 percent. 
D) invested at 9 percent.

Question 13

What is the difference between hedging, speculation, and arbitrage?

Accepted Answer

Hedging consists of using financial inst

Question 14

Hedging contracts on a futures exchange eliminates

Accepted Answer

A) market risk. 
B) counterparty risk. 
C) default risk. 
D) currency risk. 
A) market risk. 
B) counterparty risk. 
C) default risk. 
D) currency risk.

Question 15

A derivative contract is transacted between a hedger and a speculator. What is the impact of the transaction on the risk profile of these two parties?

Accepted Answer

A) It increases the risk to both parties. 
B) It decreases risk in both cases. 
C) It increases risk of the hedger and decreases risk of the speculator. 
D) It reduces the risk of the hedger and increases the risk of the speculator. 
A) It increases the risk to both parties. 
B) It decreases risk in both cases. 
C) It increases risk of the hedger and decreases risk of the speculator. 
D) It reduces the risk of the hedger and increases the risk of the speculator.

Question 16

When a firm hedges a risk, it

Accepted Answer

A) eliminates the risk. 
B) transfers the risk to someone else. 
C) makes the government assume the risk. 
D) increases the risk. 
A) eliminates the risk. 
B) transfers the risk to someone else. 
C) makes the government assume the risk. 
D) increases the risk.

Question 17

Disadvantages faced by insurance companies in bearing risk include administrative costs, adverse selection, and moral hazard.

Accepted Answer

A) True 
 B)False

Question 18

If the one-year spot interest rate is 6 percent and the two-year spot interest rate is 7 percent, calculate the one-year forward interest rate one year from today.

Accepted Answer

A) 6.5 percent 
B) 7 percent 
C) 7.5 percent 
D) 8 percent 
A) 6.5 percent 
B) 7 percent 
C) 7.5 percent 
D) 8 percent

Question 19

For financial futures, Futures price = (spot price)/(1 + rf - y)^t.

Accepted Answer

A) True 
 B)False

Question 20

Suppose that you buy $1 million worth of euro currency futures contracts. You buy the contract at a price of $1.3468/€ (i.e., you commit to pay $1,000,000 × $1.3468 = $1,346,800 when the contract matures). Over the next four days the contract closes at the following prices: $1.3465/€, $1.3443/€, $1.3434/€, and $1.3534/€. What would be your payments to, or withdrawals from, the margin account?

Accepted Answer

A) −$500, −$1,800, −$1,100, +$10,000 
B) −$300, −$2,200, −$900, +$10,000 
C) +$300, +$2,200, +$900, −$10,000 
D) None of these answers are correct. 
A) −$500, −$1,800, −$1,100, +$10,000 
B) −$300, −$2,200, −$900, +$10,000 
C) +$300, +$2,200, +$900, −$10,000 
D) None of these answers are correct.

Exam 26: Managing Risk

A company that wishes to lock in an interest rate on future borrowing can either enter into a forward rate agreement (FRA)or it can borrow long-term funds and lend short-term.

Derivative instruments are financial contracts whose value depends on the value of another asset.

The seller of a forward contract agrees to

For commodity futures, (Futures price)× (1 + rf)^t = spot price − net convenience yield.

In a "total return swap," the underlying asset(s)might be a

If the one-year spot interest rate is 8 percent and the two-year spot interest rate is 9 percent, calculate the one-year forward interest rate one year from today.

When a standardized forward contract is traded on an exchange, it becomes a(n)

In bearing risk, what disadvantages do insurance companies face?

A financial institution can hedge its interest rate risk by

Suppose you borrow $95.24 for one year at 5 percent and invest $95.24 for two years at 7 percent. For the time period beginning one year from today, you have

What is the difference between hedging, speculation, and arbitrage?

Hedging contracts on a futures exchange eliminates

A derivative contract is transacted between a hedger and a speculator. What is the impact of the transaction on the risk profile of these two parties?

When a firm hedges a risk, it

Disadvantages faced by insurance companies in bearing risk include administrative costs, adverse selection, and moral hazard.

If the one-year spot interest rate is 6 percent and the two-year spot interest rate is 7 percent, calculate the one-year forward interest rate one year from today.

For financial futures, Futures price = (spot price)/(1 + rf - y)^t.

Introduction to Corporate Finance

How to Calculate Present Values

Valuing Bonds

The Value of Common Stocks

Net Present Value and Other Investment Criteria

Making Investment Decisions With the Net Present Value Rule

Introduction to Risk and Return

Portfolio Theory and the Capital Asset Pricing Model

Risk and the Cost of Capital

Project Analysis

How to Ensure That Projects Truly Have Positive Npvs

Agency Problems and Investment

Efficient Markets and Behavioral Finance

An Overview of Corporate Financing

How Corporations Issue Securities

Payout Policy

Does Debt Policy Matter

How Much Should a Corporation Borrow

Financing and Valuation

Understanding Options

Valuing Options

Real Options

Credit Risk and the Value of Corporate Debt

The Many Different Kinds of Debt

Leasing

Managing International Risks

Financial Analysis

Financial Planning

Working Capital Management

Mergers

Corporate Restructuring

Governance and Corporate Control Around the World

Filters

For commodity futures, (Futures price)× (1 + r_f)^t = spot price − net convenience yield.

For financial futures, Futures price = (spot price)/(1 + r_f - y)^t.