Deck 23: Enterprise Risk Management

Question 1

Which one of these statements related to forward contracts is correct?

A) The buyer of a forward contract on corn benefits if the price of corn increases during the contract period.
B) The buyer of a forward contract has the right, but not the obligation, to execute the contract any time up to and including the settlement date.
C) Forward contracts cannot be sold but must be executed by the original parties to the contract.
D) Forward contracts recognize profits and losses on a daily basis.
E) The price at which a forward contract closes is set equal to the closing spot price on the settlement date.

Answer 1

The buyer of a forward contract on corn benefits if the price of corn increases during the contract period.

Question 2

The first step in risk management is to:

A) purchase liability insurance.
B) create an emergency cash fund.
C) establish prevention programs.
D) eliminate all international risks.
E) identify and eliminate all strategic risks.

Answer 2

establish prevention programs.

Question 3

Which one of the following can a firm do if it effectively manages its financial risks?

A) Eliminate all of the risks faced by the firm
B) Totally eliminate all financial risks
C) Reduce the price volatility the firm faces
D) Guarantee the firm's financial success
E) Avoid all long-term financial risks

Answer 3

Reduce the price volatility the firm faces

Question 4

Which type of risk is related to damages arising from a natural disaster?

A) Financial risk
B) Strategic risk
C) Hazard risk
D) Occupational risk
E) Operational risk

Question 5

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?

A) Forward risk
B) Volatility exposure
C) Economic exposure
D) Transactions exposure
E) Translation risk

Question 6

A forward contract:

A) requires that payment be made in full when the contract is originated.
B) provides the buyer with an option to buy an asset on the settlement date at the forward price.
C) is a binding agreement on both the buyer and the seller and nets out as a zero sum game.
D) is marked to the market daily at the seller's request.
E) allows for immediate delivery at an agreed upon price which is to be paid on the settlement date.

Question 7

By hedging short-term financial risk, a firm can:

A) ensure a steady rate of return for its shareholders.
B) eliminate price changes over the long-term.
C) ensure its own economic viability.
D) gain time to adapt to changing market conditions.
E) eliminate its exposure to price increases in raw materials.

Question 8

Which one of the following will be least helpful in offsetting a company's costs from a loss event?

A) Self-insurance pool of cash
B) Insurance policy exclusion
C) Abidance with policy notification provisions
D) Currently paid insurance premiums
E) Low insurance deductible

Question 9

Which type of insurance helps replace a company's income during the time period the company is closed due to a major hurricane?

A) Business interruption insurance
B) Employer's liability insurance
C) Property insurance
D) Vehicle insurance
E) Commercial liability insurance

Question 10

The seller of a forward contract:

A) is obligated to make delivery and accept the forward price.
B) has the option of making delivery and receiving the greater of the spot price or the contract price.
C) has the option of either making delivery or accepting delivery.
D) is obligated to take delivery and pays the lower of the spot market price or the contract price.
E) is obligated to take delivery and pay the forward price.

Question 11

Which one of the following is true regarding forward contracts?

A) The upfront costs to enter a forward contract can be significant.
B) If a buyer of a forward contract earns a $200 profit, then the seller will also profit by $200.
C) The buyer wins when market prices are less than the forward price.
D) The payoff profile for the buyer of a forward contract is an upward sloping linear function.
E) If the seller of a forward contract earns a profit, then the buyer has neither a profit nor a loss.

Question 12

Long-run financial risk:

A) can frequently be hedged on a permanent basis.
B) is best hedged on a division by division basis within a conglomerate.
C) is related more to near-term transactions than to advancements in technology.
D) generally results from changes in the underlying economics of a business.
E) can generally be hedged such that the financial viability of a firm is protected.

Question 13

Farmer Mac owns a large orange grove in Florida. The value of his business is directly related to the price of oranges. Which one of the following is a graphical representation of this price-value relationship?

A) Exchange line
B) Net present value profile
C) Risk profile
D) Market line
E) Return grid

Question 14

Assume you are looking at a payoff profile for a forward contract on oil. Which one of these statements correctly describes what you are seeing?

A) From the buyer's perspective, the payoff profile is downward sloping.
B) From both the buyer's and the seller's perspectives, the payoff profile is upward sloping.
C) The vertical axis depicts changes in the price of oil.
D) From the seller's perspective, the payoff profile is downward sloping.
E) The horizontal axis represents the changes in contract value.

Question 15

A hedge between which two of the following firms is most apt to reduce each firm's financial risk exposure?

A) Wheat farmer and bakery
B) Oil producer and coal miner
C) Wheat grower and pharmaceutical firm
D) Pastry bakery and cotton farmer
E) Shoe manufacturer and coat manufacturer

Question 16

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?

A) Insuring
B) Deriving
C) Hedging
D) Forwarding
E) Manipulating

Question 17

Which type of insurance protects against the risks related to a defective manufactured product?

A) Business interruption insurance
B) Employer's liability insurance
C) Property insurance
D) Vehicle insurance
E) Commercial liability insurance

Question 18

Farmer Ted planted 200 acres in wheat this year. The weather has been perfect and he expects to harvest a record crop within the next two weeks. At present, he has no storage facilities and therefore must sell his crop as soon as it is harvested. Which one of the following risks is he facing because he must sell his crop at whatever the market price is at harvest time?

A) Futures risk
B) Volatility exposure
C) Economic exposure
D) Transactions exposure
E) Translation exposure

Question 19

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

A) forward agreement.
B) derivative security.
C) mezzanine asset.
D) contingent security.
E) junior security.

Question 20

Which one of the following statements is correct in relation to a firm's short-run financial risk?

A) Short-run financial risk results from permanent changes in prices due to new technology.
B) A financially sound firm can become financially distressed as the result of its short-run exposure to financial risk.
C) Each segment of a business entity should be responsible for hedging its own short-run financial risk.
D) Short-run financial risk is defined as changes resulting from fundamental shifts in the underlying economics of a business.
E) Thus far, hedging techniques have been unsuccessful in reducing short-run financial risk.

Question 21

The futures contract on silver is based on 5,000 troy ounces and is priced in dollars and cents per troy ounce. Assume today's report reflects these prices for the June contract: Open 19.435, High 19.450, Low 19.025, Settle 19.119, and Chg .369. What is the price per troy ounce that will be used for today's marking-to-market for this contract?

A) $19.435
B) $19.450
C) $19.025
D) $19.081
E) $19.119

Question 22

Which one of the following methods of setting prices would reduce the transactions exposure for both the buyer and seller of a commodity swap contract?

A) Setting a permanent price at which a commodity will be traded
B) Setting the price at the minimum spot price during a given period of time
C) Setting the price equal to the spot price on the delivery date
D) Using the average market price over a given period of time
E) Setting the contract price equal to some percentage, less than 100 percent, of the market price on any given day

Question 23

Which one of the following statements related to swaps is correct?

A) Brokerage firms are the dominant swap dealers in the U.S.
B) Swaps can be custom tailored to a firm's needs.
C) As of 2017, all swaps are traded on a single organized exchange.
D) Swaps contracts are limited to interest rates.
E) Swap contracts are limited to a single payment at expiration.

Question 24

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.

A) option
B) forward
C) futures
D) swap
E) spot

Question 25

Dog's can borrow money at either a fixed rate of 8.25 percent or a variable rate set at prime plus .5 percent. Cat's can borrow money at 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?

A) After a swap with Cat's, Dog's could end up paying a fixed rate of 7.8 percent.
B) Cat's should end up paying the prime rate if it agrees to an interest rate swap with Dog's.
C) Both firms will profit if they swap an 8.15 percent fixed rate for a prime plus .75 percent variable rate.
D) Dog's will end up paying no more than 7.75 percent as a fixed rate after a swap with Cat's.
E) Dog's and Cat's cannot swap interest rates in a manner that will be profitable for both firms.

Question 26

Southern Groves raises tangerines. To hedge its risk, the firm trades in the orange futures market. This process is known as:

A) secondary trading.
B) open trading.
C) open-hedging.
D) cross-hedging.
E) perfect-hedging.

Question 27

By definition, which one of the following contracts is marked to the market on a daily basis?

A) Forward contract
B) Spot contract
C) Option contract
D) Swap
E) Futures contract

Question 28

Company A can borrow money at a fixed rate of 7.5 percent or a variable rate set at prime plus 1 percent. Company B can borrow money at a variable rate of prime plus .5 percent or a fixed rate of 8 percent. Company A prefers a variable rate and Company B prefers a fixed rate. Which one of the following statements depicts the most favorable outcome of a swap between Companies A and B?

A) Company A could pay a fixed rate of 7.25 percent.
B) Company A could pay a fixed rate of 7.75 percent.
C) Company B could pay a fixed rate of 8 percent.
D) Company B could pay the variable prime rate + 1 percent.
E) Company A could pay the variable prime rate + .75 percent.

Question 29

The futures contract on silver is based on 5,000 troy ounces and is priced in dollars and cents per troy ounce. Assume today's report reflects these prices for the June contract: Open 19.435, High 19.450, Low 19.025, Settle 19.119, and Chg .369. What was the highest price per troy ounce for the silver futures contract on this day?

A) $19.435
B) $19.450
C) $19.819
D) $19.025
E) $19.119

Question 30

Interest rate swaps: 

A) are a group of option contracts with varying expiration dates.
B) are rarely used by U.S. business firms.
C) can involve exchanging one floating-rate loan for another floating-rate loan.
D) require two firms to have access to loans with equivalent terms.
E) are all based on the U.S. T-bill index.

Question 31

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?

A) After swapping interest rates with Fred's, Murray's may be able to pay prime plus 2 percent.
B) Both companies can profit in a swap that will allow Murray's to pay a variable rate of prime plus one percent.
C) Fred's will end up with a fixed rate of 10 percent.
D) Fred's has the best chance of profiting if it does a currency swap with Murray's.
E) There are no terms under which Murray's and Fred's can swap interest rates.

Question 32

A U.S. bank has an agreement with a German bank to exchange $500,000 for €397,000 on the first day of each of the next three calendar quarters. This agreement is best described as a:

A) floating exchange.
B) spot trade.
C) currency option.
D) futures contract.
E) swap contract.

Question 33

All of the following are futures exchanges except: 

A) CBT.
B) CME.
C) LIFFE.
D) NYSE.
E) NYMEX.

Question 34

A call option contract:

A) obligates both the buyer and the seller.
B) obligates the buyer but not the seller.
C) grants rights to the buyer and obligates the seller.
D) grants rights to the seller and obligates the buyer.
E) grants rights to both the buyer and the seller but does not obligate either party.

Question 35

Futures contracts:

A) are identical to forward contracts except for the size of the contract.
B) provide an option to purchase an asset at a specified price on the settlement date.
C) are marked to the market on a daily basis which helps eliminate credit risk.
D) are less popular in organized trading then are forward contracts.
E) are limited to contracts on financial assets.

Question 36

Steve has an option with a payoff profile that depicts a line that is constant at zero up until some point after which the line slopes downward. What type of action did Steve take to obtain this profile?

A) Purchased a call option
B) Purchased a put option
C) Sold a call option
D) Sold a put option
E) Purchased and simultaneously sold the same call option

Question 37

A swap dealer in the U.S.:

A) acts solely as a seller of swap contracts.
B) matches buyers to sellers.
C) only deals if its book is matched.
D) is frequently a commercial bank.
E) trades electronically via NASDAQ.

Question 38

This morning a national bakery agreed to pay a farmer $7.10 a bushel for 5,000 bushels of wheat that the farmer will deliver to the bakery four months from now. Payment will be made at the time of delivery. What is this legally binding agreement called?

A) Forward contract
B) Spot contract
C) Swap
D) Call option contract
E) Put option contract

Question 39

Browning Enterprises currently has all fixed-rate debt. The firm would like to convert part of this to floating-rate debt. Which one of the following will accomplish this for the firm?

A) Option on floating-rate bonds
B) Forward contract on U.S. Treasury bills
C) Interest rate swap
D) Currency swap
E) Interest rate call option

Question 40

Sue has a contract that grants her a right that she may or may not decide to exercise. This right increases in value as the value of the asset underlying her contract declines. Which one of these did she do to create this situation?

A) Purchased a call option
B) Purchased a put option
C) Purchased and simultaneously sold the same call option
D) Sold a call option
E) Sold a put option

Question 41

Gold futures contracts are based on 100 troy ounces and are priced in dollars per troy ounce. You own three November contracts. At the end of trading today, the market report reflected these prices: Open 1293.00, High 1295.00, Low 1286.00, and Settle 1296.10. What is the value of your contracts at the market close today?

A) $129,610
B) $259,000
C) $258,600
D) $388,830
E) $360,460

Question 42

If a firm creates an interest rate collar on a variable rate loan, then the rate the firm pays will always:

A) remain constant at the average of the floor and cap rates.
B) remain constant at the floor rate.
C) remain constant at the cap rate.
D) be higher than, or equal to, the cap but lower than, or equal to, the floor.
E) be higher than, or equal to, the floor but lower than, or equal to, the cap.

Question 43

Ethanol futures contracts are based on 29,000 gallons and are priced in dollars per gallon. Assume the end-of-day report on a contract show prices of: Open 2.220, High 2.231, Low 2.181, and Settle 2.186. What is the maximum profit that an investor could have earned by buying and selling one of these contracts on this day?

A) $1,131
B) $1,450
C) $942
D) $2,436
E) $986

Question 44

Futures contracts on palladium are based on 50 troy ounces and are priced in dollars per troy ounce. Assume today's open price on one May contract was 758.90 and the settle price was 756.10. You own three May contracts which you purchased at a quote of 749.30. What is your total profit or loss to date?

A) $1,020
B) −$1,545
C) −$420
D) −$1,020
E) $1,545

Question 45

Which one of the following statements concerning option payoffs is correct?

A) The buyer of a call profits when the exercise price exceeds the market price.
B) The buyer of a call profits when the strike price exceeds the exercise price.
C) A put will only be exercised if both the seller and the buyer can profit.
D) Both the buyer and the seller profit when a call is exercised.
E) The seller of a put incurs a loss when a put is exercised.

Question 46

Silver futures contracts are based on 5,000 troy ounces and are priced in dollars per troy ounce. Suppose a closing report displays these prices for a December contract: Open 17.435, High 17.450, Low 17.025, and Settle 17.119. What is the closing value for two December futures contracts on silver?

A) $174,350
B) $174,500
C) $170,250
D) $171,190
E) $172,770

Question 47

You would like the right to purchase an interest rate cap in the future. To obtain this right, you should purchase a:

A) floor.
B) swap.
C) caption.
D) collar.
E) hat.

Question 48

The cost to purchase an option contract is called the:

A) strike price.
B) rights price.
C) premium.
D) exercise price.
E) payoff price.

Question 49

When a futures call option on a commodity is exercised the option owner receives a futures contract on the commodity plus a cash payment equal to the difference between the:

A) current options price and the current futures price.
B) spot and forward futures prices.
C) strike price on the option and the current futures price.
D) exercise price and the current options price.
E) exercise price and the strike price.

Question 50

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) Buy a call
B) Sell a call
C) Buy a put
D) Sell a put
E) No option position will create the desired hedge.

Question 51

A firm with a variable-rate loan wants to protect itself solely from increases in interest rates. Which one of the following would be of most interest to this firm?

A) Create an interest rate collar
B) Create an interest rate floor
C) Buy a put option on interest rates
D) Enter a currency futures contract
E) Buy a put option on a bond

Question 52

The buyer of an option contract:

A) receives the option premium in exchange for an obligation to either buy or sell an underlying asset.
B) pays an option premium in exchange for a right to buy or sell an underlying asset during a specified period of time.
C) pays the strike price at the time the option is purchased and in exchange receives the right to exercise the option at any time during the option period.
D) receives the option premium in exchange for guaranteeing the purchase or sale of an underlying asset if called upon to do so.
E) pays the option premium in exchange for receiving the strike price at a later date.

Question 53

You believe the price of an asset is going to increase within the next three months. Which one of the following payoff profiles for an option on that asset will reflect a profit if your belief is correct?

A) Buying a put
B) Selling a call
C) Buying a call
D) Selling a put
E) Selling both a call and a put

Question 54

Most of the evidence to date indicates that firms with which two of the following characteristics are most apt to frequently use derivatives?

A) Low financial distress costs and constrained access to capital markets
B) Small in size and low financial distress costs
C) Easy access to capital markets and high financial distress costs
D) High financial distress costs and constrained access to capital markets
E) High financial distress costs and easy access to capital markets

Question 55

American option contracts:

A) are exercised at the discretion of the contract seller.
B) obligate the buyer but not the seller.
C) can be exercised on any day up to and including the expiration date.
D) are marked to market on a daily basis.
E) are only available on publicly traded stocks.

Question 56

Futures option quotes include an apostrophe. This apostrophe indicates the contracts are traded:

A) only at the end of day price.
B) weekly.
C) in eighths.
D) in 64ths.
E) in 32nds.

Question 57

An interest rate cap is actually a: 

A) forward contract on interest rates.
B) put option on a bond.
C) call option on an interest rate.
D) deferred interest rate swap.
E) put option on an interest rate.

Question 58

Which one of the following actions will provide you with the right, but not the obligation, to sell the underlying asset at a specified price during a specified period of time?

A) Purchase of a call option
B) Sale of a call option
C) Purchase of a put option
D) Sale of a put option
E) Swap

Question 59

In any one year, the chance that you will incur a loss of $10 million is .02 percent. Otherwise, you will have zero loss. What is your expected loss?

A) $20,000
B) $200,000
C) $2,000
D) $200
E) $2,000,000

Question 60

Which one of the following actions obligates you only on the expiration date to sell an asset at the strike price if the option is exercised?

A) Writing an American call
B) Buying an American put
C) Writing a European call
D) Buying a European put
E) Entering a European swap

Question 61

Futures contracts on gold are based on 100 troy ounces and priced in dollars per troy ounce. Assume the January gold contract settled today at 1285.10 and opened at 1284.60. The April contract settled at 1285.30 and opened at 1285. You own four of the April contracts that you purchased at 1284.70. What is your total profit or loss to date?

A) $160
B) $240
C) $40
D) $120
E) $60

Question 62

Suppose an investor buys a call option on 45,000 barrels of oil with an exercise price of $51 per barrel and simultaneously sells a put option on 45,000 barrels of oil with the same exercise price of $51 per barrel. Her net payoff per barrel on these option contracts is ________ if the market price per barrel is $49 and ________ if the price per barrel is $55.

A) −$4; $2
B) −$2; $0
C) $0; $2
D) $0; −$4
E) −$2; $4

Question 63

You decided to speculate in the market and sold six platinum futures contracts when the futures price was $1,391.20 per troy ounce. The price on the contract maturity date was $1,395. The contract size is 50 troy ounces. What was your total profit or loss on the settlement day if you had to cover your position in the spot market?

A) $190
B) $1,140
C) −$190
D) $50
E) −$1,140

Question 64

You expect to deliver 50,000 bushels of wheat to the market in July. Assume you hedged your position by selling futures contracts on half of your expected delivery at a price of 443.25. The futures contracts are based on 5,000 bushels and are priced in cents per bushel. Assume the market price turns out to be 445.75 when you actually deliver the wheat. How much more or less would you have earned if you had not bought the futures contracts?

A) $1,250 less
B) $625 less
C) $0
D) $625 more
E) $1,250 more

Question 65

You anticipate your firm will need 20,000 bushels of oats in December so you hedged your position today at the closing price when the daily price quotes were: Open 222, High 225.50, Low 223.50, and Settle 218.50. Assume the actual market quote turns out to be 228.70 on the day you actually acquire the oats. Oats futures contracts are based on 5,000 bushels and priced in cents per bushel. What was your gain or loss from hedging your position?

A) −$510
B) $2,040
C) $510
D) $1,060
E) −$2,040

Question 66

Suppose you sold three September cocoa futures contracts at a price quote of 1,696. Cocoa futures contracts are based on 10 metric tons and priced in dollars per ton. What will be your profit or loss on this contract if the price turns out to be $1,707 per metric ton at expiration?

A) $330
B) −$330
C) $110
D) −$110
E) $150

Question 67

Suppose that last month you purchased ten January crude oil futures contracts at a quoted price of 53.88. These contracts are based on 1,000 barrels and quoted in dollars per barrel. Assume the actual price per barrel is $56.20 in January. How much did you gain or lose by hedging your position?

A) $23,200
B) $2,320
C) $0
D) −$2,320
E) −$23,200

Question 68

You need 70,000 bushels of corn for your production operations next month. The futures contracts on corn are based on 5,000 bushels and are currently quoted at 371.25 cents per bushel for delivery next month. If you want to hedge your cost, you should ________ contracts at a cost of ________ per contract.

A) Buy 12; $2,570
B) Buy 14; $18,562.50
C) Buy 16; $22,570.00
D) Sell 14; $18,562.50
E) Sell 16; $22,570.00

Question 69

Suppose a novice investor buys a call option on 45,000 barrels of oil with an exercise price of $45 per barrel and simultaneously buys a put option on 45,000 barrels of oil with the same exercise price of $45 per barrel. Her net payoff per barrel on these option contracts is ________ if the market price per barrel is $43 and ________ if the price per barrel is $47.

A) −$2; $2
B) −$2; $0
C) $0; $2
D) $2; −$2
E) $2; $2