Deck 26: Risk Management

Question 1

Counterparties to an interest rate swap exchange both interest payments and principal amounts.

Answer 1

False

Question 2

All financial futures contracts are written on a deliverable asset.

Answer 2

False

Question 3

Unlike options, a futures contract binds the buyer to buy the commodity at a fixed price.

Answer 3

True

Question 4

By using options, a firm can protect against increase in raw material prices, while continuing to benefit from price decreases.

Question 5

A farmer can reduce the quantity risk by buying a futures contract.

Question 6

Financial futures contracts are available only through the Chicago Board of Trade.

Question 7

Both the seller and the buyer in a futures contract are required to put up margins.

Question 8

Forward contracts are equivalent to tailor-made futures contracts.

Question 9

The profit from a futures contract is the difference between the initial futures price and the spot price at expiration.

Question 10

The most common use of hedging in finance is to reduce, rather than increase, risk.

Question 11

Futures contracts are standardized to expire at one time each year.

Question 12

Exchange traded futures contracts allow the seller to choose the place of delivery for the commodity.

Question 13

Regarding the profitability of options, it is impossible for a producer who sells put options to lose more than the exercise price agreed in the option contract.

Question 14

Forward contracts are marked to market.

Question 15

A farmer can avoid delivery on a futures contract by buying an offsetting futures contract.

Question 16

An oil producer would sell, rather than buy, crude oil futures for protection from falling prices.

Question 17

Regarding the profitability of options, it is impossible for a producer who sells put options to lose more than the price of the option premium.

Question 18

All options are standardized, exchange-traded financial instruments.

Question 19

Put options can be thought of as insurance policies for commodity producers.

Question 20

Hedging reduces risk, but it is seldom cost free.

Question 21

A farmer hedged his risk by buying put options on wheat with an exercise price of $2.70 at a price of $0.14 per bushel.If the price of wheat at the expiration of the contract is $2.70, what is the net revenue from each bushel of wheat?

A)$2.56
B)$2.63
C)$2.70
D)$2.84

Question 22

Which of the following futures contract holders is speculating?

A)A wheat farmer who sells wheat futures.
B)A cattle rancher who buys live cattle futures.
C)A candy maker who buys sugar futures.
D)An oil producer who sells crude oil futures.

Question 23

ABC Corp.entered into a currency swap with its bank, providing that ABC borrows $5 million at 10 percent and swaps for a 12 percent yen loan.The spot exchange rate is ¥105/$.If interest only is to be repaid on an annual basis, how much does ABC pay annually to the bank? (answer in millions)

A)¥1.26 million
B)¥5.71 million
C)¥52.50 million
D)¥63.00 million

Question 24

A firm can hedge the risk of upward movement in raw material prices by taking one of the following positions.

A)Buying a call option.
B)Selling a call option.
C)Buying a put option.
D)Selling a futures contract.

Question 25

In general, when deciding whether a market participant needs to buy or sell futures contracts in order to hedge, the rule could be:

A)buy futures if you have the underlying asset and sell futures if you need the underlying asset.
B)sell futures if you have the underlying asset and buy futures if you need the underlying asset.
C)buy futures if you want to speculate, sell futures if you want to hedge.
D)buy futures if you are willing to have unlimited risk, sell futures if you want capped risk.

Question 26

The seller of a pork bellies futures contract at $.41 per pound noted that the closing price of pork bellies was $0.44 today.What will happen to this contract, which requires delivery of 40,000 of pork bellies at expiration?

A)A loss of $400 is posted to the account
B)A gain of $400 is posted to the account
C)A loss of $1,200 is posted to the account
D)A gain of $1,200 is posted to the account

Question 27

A producer that is worried about the future price that will be available when the product is to be sold can hedge this price risk by:

A)buying a futures contract.
B)selling a futures contract.
C)buying a put option.
D)selling a call option.

Question 28

How might a firm such as General Mills use options to control raw material prices for breakfast cereals?

A)Buy call options on commodities.
B)Sell call options on commodities.
C)Buy put options on commodities.
D)Sell put options on commodities.

Question 29

Nestlé wishes to obtain a loan denominated in Swiss francs but considers the U.S.market to offer better terms.How can Nestlé accomplish this?

A)Borrow francs in Switzerland, exchange for dollars and arrange a currency swap
B)Borrow francs in Switzerland, exchange for dollars and arrange an interest-rate swap
C)Borrow dollars in U.S., exchange for francs and arrange an interest-rate swap
D)Borrow dollars in U.S., exchange for francs and arrange a currency swap

Question 30

The basic difference between speculators and hedgers in futures contracts is that speculators:

A)will profit regardless of the direction of price change.
B)are not protecting their commodity holdings through an offsetting transaction.
C)are concerned only with long-term price movements.
D)take a position in more than one commodity at a time.

Question 31

Which of the following is not correct concerning forward contracts? Forward contracts:

A)are not standardized.
B)do not set the price until the end of the contract.
C)are not traded on organized exchanges.
D)are not marked to market daily.

Question 32

Which of the following statements is correct?

A)An option seller makes more profits than an option buyer.
B)A futures seller makes more profits than a futures buyer.
C)A futures buyer's profit will be equal to the futures seller's loss.
D)Both futures buyer and seller make profit.

Question 33

What form of hedging would you suggest for a producer that wishes to be protected from future price decreases but wants to benefit from any future price increases?

A)Buy a call option on the asset.
B)Sell a call option on the asset.
C)Buy a put option on the asset.
D)Sell a put option on the asset.

Question 34

Which of the following is not correct concerning the financial futures markets?

A)One of the prominent exchanges for financial futures is the Chicago Board of Trade.
B)The contracts were first traded in 1972.
C)A major use is protection from interest-rate risk.
D)Trading in commodity futures significantly exceeds trading in financial futures.

Question 35

Speculators are a necessary component of well-functioning futures markets.

Question 36

Engaging itself in a swap contract, a firm might agree to make a series of regular payments in one currency in return for receiving a series of payments in another currency.

Question 37

General Mills bought September call options for wheat with an exercise price of $2.80 at a price of $0.10 per bushel.If the price of wheat at the expiration is $2.90, what is the cost of one bushel of wheat for General Mills?

A)$2.70
B)$2.80
C)$2.90
D)$3.00

Question 38

The swap is the arrangement by two counterparties to exchange one stream of cash flow for another.

Question 39

A speculator takes a position in the futures market without holding an offsetting position in the commodity market.

Question 40

A gasoline distributor buys a gasoline futures contract that requires acceptance of 42,000 gallons of gasoline at $0.94 per gallon.How is the account marked to market if gasoline futures close the next day at $0.97?

A)A loss of $1,260 is posted to the account.
B)A gain of $1,260 is posted to the account.
C)A loss of $12,600 is posted to the account.
D)A gain of $12,600 is posted to the account.

Question 41

The process of marking a futures contract to market means that:

A)the profitability of the contract is locked in from the onset of the contract.
B)the amount of commodity to be delivered changes as prices change.
C)contracts are closed out as soon as they become unprofitable.
D)profits or losses are posted to the contract daily.

Question 42

A miller can hedge the price risk on wheat by taking one of the following positions.

A)Buying put options on wheat.
B)Selling call options on wheat.
C)Buying wheat futures.
D)Selling wheat futures.

Question 43

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

A)greater than spot price.
B)equal to the spot price.
C)less than the spot price.
D)more than the forward price.

Question 44

Because most hedging acts to reduce risk, managers should expect that hedging will:

A)increase profits.
B)decrease profits.
C)increase the firm's stock price.
D)stabilize the firm's dividend payout.

Question 45

Hershey's Chocolate is concerned about cocoa prices prior to building inventory for Halloween sales.Analysts project that price per ton could vary from $1,250 to $1,500.A September call option can be purchased with a $1,300 strike price for a premium of $145.What is Hershey's worst-case scenario if it purchases these options?

A)Cocoa prices will rise to $1,500 and Hershey is only protected to a price of $1,300.
B)Cocoa prices will decline to $1,250 and Hershey must pay an extra $50 per ton.
C)Cocoa prices will not rise above Hershey's break-even price of $1,445, which equals the sum of the strike price plus the option premium.
D)Cocoa Prices will remain below $1,300 and Hershey will lose $145 per option contract.

Question 46

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

A)Futures contracts are more expensive than forward contracts.
B)Forward contracts are available only for foreign currencies.
C)Futures contracts are always delivered.
D)Forward contracts are not marked to market.

Question 47

In an interest rate swap, borrowers typically exchange fixed-rate payments in one currency for:

A)fixed-rate payments in another currency.
B)variable-rate payments in another currency.
C)fixed-rate payments in the same currency.
D)variable-rate payments in the same currency.

Question 48

Producers who hedge through the purchase of put options must remember that they may be:

A)reducing their profits compared to not hedging.
B)obligated to sell their product at a lower than market price.
C)increasing their overall risk.
D)facing unlimited price risk.

Question 49

Why might an individual or organization be willing to swap fixed-rate loans for floating-rate loans?

A)They may perceive that interest rates are ready to increase
B)Their cash flows may vary directly with interest rates
C)Floating rates are lower than fixed rates
D)They may be able to postpone the payment of principal

Question 50

A futures contract seller is obligated to deliver 5,000 bushels of soybeans for $5.00 per bushel at expiration.If soybean futures close at $5.10 the next day, the seller:

A)has a profit of $500 thus far on the contract.
B)has a loss of $500 thus far on the contract.
C)has no profit or loss, but is still obligated to deliver 5,000 bushels at $5.00.
D)will receive a cheque for $500 from the buyer of the contract.

Question 51

What happens to the price of a futures contract as expiration draws closer?

A)It exceeds the spot price of the asset.
B)It is exceeded by the spot price of the asset.
C)It approaches the spot price of the asset.
D)There is no relationship between futures price and spot price as the contract approaches expiration.

Question 52

A copper producer is worried about the copper prices going down.The risk of downward movement in prices can be hedged by taking one of the following positions.

A)Buying call options on copper.
B)Selling copper futures.
C)Buying copper futures.
D)Selling copper put options.

Question 53

Those who invest in derivative instruments with the purpose of increasing rather than decreasing risk are known as:

A)Option traders.
B)Futures traders.
C)Hedgers.
D)Speculators.

Question 54

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

A)Future asset transactions are conducted at an agreed price.
B)Contracts are sold through organized exchanges.
C)Contract terms are standardized.
D)Price changes are settled daily.

Question 55

A farmer can hedge the risk of downward movement in the price of the produce by taking one of the following positions.

A)Buying a call option.
B)Selling a put option.
C)Buying a put option.
D)Buying a futures contract.

Question 56

Financial futures are available to protect against all of the following except:

A)Interest-rate risk.
B)Level of equity prices.
C)Currency swap risk.
D)Exchange-rate risk.

Question 57

One distinguishing difference between the buyer of a futures contract and the buyer of an option contract is that the futures buyer:

A)pays a much higher premium than option buyers.
B)has an obligation to purchase, not a choice.
C)can lose no more than the initial premium.
D)has increased rather than reduced risk.

Question 58

The effect of marking a futures contract to market is similar to:

A)requiring daily payments from the contract buyer.
B)requiring daily payments from the contract seller.
C)closing the current position and opening a new position daily.
D)imposing a daily fee on both buyers and sellers.

Question 59

A soybean oil contract calls for delivery of 60,000 pounds.What happens to the seller of a soybean futures contract at 16 cents per pound if the futures price closes the next day at 18 cents per pound?

A)The contract is marked to market with a $1,200 loss.
B)The contract is marked to market with a $1,200 gain.
C)Futures contracts are voided if price increases before expiration.
D)Nothing happens until the expiration of the contract.

Question 60

Which of the following is not correct concerning futures contracts?

A)Entails an obligation rather than an option.
B)Contract price is set at the beginning of the contract.
C)Contracts are exchange-traded.
D)Gains or losses are recorded at contract expiration.

Question 61

When two borrowers engage in a currency swap, they agree to:

A)trade one currency for another, thus avoiding the foreign exchange market.
B)make payments on each other's borrowings in a different currency.
C)pay to each other any depreciation or appreciation of the currency.
D)exchange fixed-rate interest payments for variable-rate interest payments.

Question 62

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

A)prevent hedgers from trading options.
B)provide a continual stream of profit to hedgers.
C)maintain futures prices at appropriate levels.
D)understand the direction of future price changes.

Question 63

Interest rate swaps allow both counterparties to:

A)reduce interest expenses.
B)avoid repayment of the notional principal.
C)rearrange the balance sheet.
D)pay a floating rate of interest on their debt.

Question 64

Manufacturers who are concerned about volatile commodity prices often use option contracts to alter their risks.What is the worst-case scenario for a seller of put options on corn with a strike price of $2.25 per bushel?

A)If corn prices drop below $2.25 the option premium will be lost.
B)If corn prices rise above $2.25 the option premium will be lost.
C)Losses can be unlimited if prices drop sufficiently.
D)Losses can be unlimited if prices rise sufficiently.

Question 65

As time draws closer to contract expiration, futures contract prices can be expected to:

A)increase as the demand for delivery intensifies.
B)decrease as speculators resolve the uncertainty of prices.
C)move similarly to broad-based market indices, such as the TSX 300
D)converge upon the spot price.

Question 66

If managers are rational, they will only hedge when they perceive that:

A)prices are headed in an adverse direction.
B)derivative instruments are priced lower than actual value.
C)risk reduction is preferable to higher potential profits.
D)they can increase their profitability by doing so.

Question 67

A hedger who buys a futures contract is betting that prices will _____ at the expiration of the contract.

A)Decrease
B)Increase
C)Remain constant
D)Guarantee high profits

Question 68

How does a soybean farmer lock in a price of $5.40 per bushel when the cash price at harvest is only $4.90?

A)Profit in futures market to offset loss in cash market by selling futures contract at $5.40/bushel.
B)Break even in both markets by buying a futures contract at $5.40/bushel.
C)Profit in cash market to offset loss in futures market by buying futures contract at $5.40/bushel.
D)Break even in both markets by selling a futures contract at $5.40/bushel.

Question 69

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

A)insulate the buyer from changes in interest rates.
B)protect the buyer from changes in exchange rates.
C)lock in a profit based on current exchange rates.
D)require delivery of the yen at the Chicago Board of Trade.

Question 70

Which of the following is a source of profit for a swap dealer?

A)Commission charged on the sale of bonds.
B)Bid-ask spread.
C)Margin account.
D)Option premium.

Question 71

The typical sequence of cash flows in a futures contract is:

A)purchase price plus a margin account up front, differences are settled at expiration.
B)margin account up front, differences are posted daily and settled in cash if margin drops too low.
C)margin account up front, all differences settled at expiration.
D)all funds are paid at expiration of the contract.

Question 72

What must happen to prices over the course of a contract for the seller of a futures contract to maximize benefits of the hedge?

A)Prices must decrease.
B)Prices must increase.
C)Prices must remain constant.
D)The seller will profit on the hedge regardless of the direction of price movements.

Question 73

Why are most futures contracts not settled through delivery of the product?

A)Most contracts are settled through the margin account.
B)Most contracts expire with neither party having an obligation to the other party.
C)Most participants cancel their futures contracts through purchase of an option contract.
D)It is easier and cheaper to settle in cash or by offset.

Question 74

If the market for corn futures has more prospective sellers than buyers, then one would expect:

A)the price of corn futures to decrease.
B)the price of corn futures to increase.
C)some traders to change from seller to buyer.
D)the market to cease operations until demand is rebalanced.

Question 75

A cotton producer has purchased cotton futures that involve 50,000 pounds of cotton at a price of $0.60 per pound.By contract expiration the producer finds that cotton prices have declined by $0.07 per pound.As a result of the futures contracts, the producer will:

A)lose $3,500 per contract in the futures market which offsets gains in the cash market.
B)gain $3,500 per contract in the futures market which offsets losses in the cash market.
C)lose $3,500 per contract in the futures market and suffer an opportunity cost in the cash market.
D)gain $3,500 per contract in the futures market and gain $0.10 per pound in the cash market.

Question 76

The customary delivery procedure at the expiration of a commodity futures contract is:

A)delivering the commodity to the futures buyer.
B)delivering the commodity to the futures exchange.
C)offsetting the initial futures position and settling in cash.
D)adding the profit or loss to your margin account and continuing to trade.

Question 77

A farmer who sells a futures contract is betting that prices will _____ at the expiration of the contract.

A)Decrease
B)Increase
C)Remain constant
D)Guarantee high profits

Question 78

Which of the following is least responsible for the success of futures exchanges such as the Winnipeg Commodity Exchange?

A)Guaranteed settlement.
B)Standardized contracts.
C)Reduction of hedging costs through marking to market.
D)Variety of settlement dates.

Question 79

The derivatives market is characterized by:

A)stability.
B)innovation.
C)riskiness.
D)private deals.

Question 80

The purpose of a margin account for a futures contract is to:

A)guarantee a minimum margin of profit for the contract holder.
B)allow futures traders to have more than one contract at once.
C)provide a cushion for the exchange against defaults on the contract.
D)hold interest payments until expiration.