Exam 23: Risk Management: An Introduction to Financial Engineering

Most of the evidence to date indicates that firms with which two of the following characteristics are most apt to frequently use derivatives? I. firms with low financial distress costs II. firms with high financial distress costs III. firms with easy access to capital markets IV. firms with constrained access to capital markets

Murray's can borrow money at a fixed rate of 10.5 percent or a variable rate set at prime plus 2.25 percent. Fred's can borrow money at a variable rate of prime plus 1.5 percent or a fixed rate of 12 percent. Murray's prefers a variable rate and Fred's prefers a fixed rate. Given this information, which one of the following statements is correct?

The seller of a forward contract:

Steve recently sold an option that requires him to purchase 100 shares of Omega stock at $40 a share should the option owner decide to exercise the option. What type of option contract did Steve sell?

A firm with a variable-rate loan wants to protect itself from increases in interest rates. Which of the following would interest this firm? I. interest rate floor II. interest rate cap III. put option on an interest rate IV. call option on an interest rate

The National Bank has an agreement with The Foreign Bank to exchange 500,000 U.S. dollars for 380,000 Euros on the first day of each of the next 3 calendar quarters. This agreement is best described as a(n):

Explain how a manufacturer who has an ongoing need for silver as a raw material in the production process might use futures to hedge. What does the manufacturer hope to gain?

How much will you pay per pound for a September 130 orange juice futures call option? Orange juice - 15,000 lbs: u.S. cents per lb.

A payoff profile:

You own shares of a stock and believe the stock price will increase in the future. However, you realize the stock price could decline and want to hedge that risk. Which one of the following option positions should you take to create the desired hedge?

A bakery generally enters into a forward contract in wheat as a:

The buyer of an option contract:

A graph depicting the gains and losses a seller of a forward contract would earn at various market prices is referred to as a:

Farmer Jones raises several hundred acres of corn and would suffer a significant loss should the price of corn decline at harvest time. Which one of the following would he be doing if he purchased financial securities to offset this price risk?

An agreement that grants its owner the right, but not the obligation, to buy or sell a specific asset at a specific price for a set period of time is called a(n) _____ contract.

For years, your family has operated a business that produces lawn mowers. Over the years, the industry has progressed and new mass production techniques have been developed. However, your firm cannot afford this new technology, nor can you compete against those firms that can. Thus, the family has decided to close its facility at the end of the year. Which one of the following describes the risks to which your family's firm succumbed?

What is cross-hedging? Why do you suppose firms use this method of risk management? What are some of the drawbacks?

Which two of the following are key differences between an option contract and a forward contract? I. option contracts can be resold but forward contracts cannot II. the option price is determined at settlement while the forward price is determined when the contract is initiated III. the rights and obligations of the buyer IV. cost when contract initiated

Dog's can borrow money at either a fixed rate of 8.25 percent or a variable rate set at prime plus 0.5 percent. Cat's can borrow money at either a variable rate of prime plus 1 percent or a fixed rate of 8 percent. Dog's prefers a fixed rate and Cat's prefers a variable rate. Given this information, which one of the following statements is correct?

The value of a stock option is dependent upon the value of the underlying stock. Thus, a stock option is a: