Deck 18: An Introduction to Risk Management and Derivatives

Question 1

Derivatives are the financial instruments that are:

A) financial assets, such as shares and bonds that derive their value from the value of the company that issues them.
B) financial assets whose rates of return must be derived from information published in financial pages.
C) financial assets that derive their value from underlying assets.
D) derived by investment banks, which then trade them.

Answer 1

C

Question 2

Risk exposures that may impact on the normal day-to-day running of a business are called:

A) transactional.
B) operational.
C) financial.
D) functional.

Answer 2

B

Question 3

For a company the process of risk management needs to:

A) cover financial and operational risks only.
B) cover business and operational risks only.
C) be a structured process.
D) be flexible as the nature of risk is dynamic.

Answer 3

C

Question 4

When an oil company suffers severe damage to one of its oil drilling platforms,this is an example of:

A) technological risk.
B) financial risk.
C) business risk.
D) operational risk.

Question 5

The analysis that documents each risk exposure and then tries to measure what will be the operational and financial effect should the risk event occur is called:

A) hedging analysis.
B) cost-benefit analysis.
C) business impact analysis.
D) SMART analysis.

Question 6

It is argued that effective risk management is vital to the survival of an organisation because:

A) most business organisations are exposed to a wide variety of risks.
B) many business failures can be attributed to inadequate policies.
C) most organisations are exposed to interest rate risk.
D) all of the given choices are correct.

Question 7

Which of the following statements is incorrect?

A) Part of a company's credit policy considers how much credit a customer should be granted.
B) Cost-benefit analysis can be used to evaluate an investment of a back-up computer centre or outsource the back-up to an outside centre provider.
C) After identification of all of its risk exposure an organisation must seek to remove all these risks.
D) Procedural controls of a risk management strategy documents all the products that can be used by the organisation.

Question 8

Risk management objectives and policies should be established by:

A) the chief executive officer.
B) the chief financial officer.
C) the board of directors.
D) a company's shareholders.

Question 9

Derivative markets exist in order to:

A) allow for the direct cash sale of common shares.
B) allow for the direct cash sale of corporate bonds.
C) reduce the risk of exposure to price fluctuations in cash markets.
D) overcome some of the information problems involved in trades in over-the-counter markets.

Question 10

A futures contract is an agreement that specifies the delivery of a commodity or financial security at a:

A) predetermined future date, with a price to be negotiated at the time of delivery.
B) predetermined future date, with a currently agreed-on price.
C) currently agreed-on price, with a delivery date to be negotiated later.
D) predetermined future date, with a price and delivery to be negotiated later.

Question 11

Major financial risk exposures for corporations include:

A) a change in interest rates.
B) foreign currency appreciating.
C) company with insufficient funds to pay wages.
D) all of the given choices.

Question 12

Which of the following is NOT an example of financial risk exposure for a company?

A) When interest rates increase and a larger proportion of mortgage payments are in default for a bank
B) When a local currency decreases for an exporter
C) When a company has taken out a short-term loan and floating interest rates increase
D) When interest rates increase for a highly geared company

Question 13

If a client investor is holding a large number of listed shares on the ASX,intends to sell in three months' time and wishes to protect the value of the share portfolio,they may:

A) buy a futures contract based on the S&P/ASX.
B) sell a futures contract based on the S&P/ASX.
C) write a put option based on the S&P/ASX.
D) buy a call option based on the S&P/ASX.

Question 14

One of the important first steps in a risk management strategy for a company is to:

A) establish related risk and product controls.
B) analyse the impact of the risk exposure.
C) select appropriate risk management strategies.
D) continually monitor the existing strategies.

Question 15

In relation to futures markets,which of the following regarding initial margins is false?

A) A futures trader is required to pay an initial margin to the clearinghouse.
B) The initial margin will be higher for low market volatility.
C) If the futures contract price drops below the minimum percentage, the initial margin will have to be increased.
D) In order to top up an insufficient initial margin a maintenance margin call will be made.

Question 16

A standardised agreement traded on an organised exchange for delivery of a specified security or commodity at a specified price on a predetermined date is a/an:

A) hedging contract.
B) futures contract.
C) option contract.
D) swap contract.

Question 17

According to the text there are three steps:
I)Assess the attitude of the organisation to each identified risk exposure
Ii)Analyse the impact of the risk exposures
Iii)Identify operational and financial risk exposures
Which is the correct order?

A) i, ii, iii
B) iii, ii, i
C) ii, i, iii
D) iii, i, ii

Question 18

The risk exposure when a corporation appears to have insufficient funds to meet day-to-day commitments as they fall due is known as:

A) transaction risk.
B) liquidity risk.
C) interest rate risk.
D) default risk.

Question 19

Which of the following businesses are most exposed to interest rate risk?

A) A company with a high equity to debt ratio
B) A company with a large amount of floating rate debt
C) An all-equity company
D) An investment company with an investment portfolio that matches its investment horizon

Question 20

In Australia futures contracts are traded:

A) face-to-face by market participants.
B) electronically by the ASX Trade 24.
C) over-the-counter by dealers.
D) over-the-counter by commodity and security brokers.

Question 21

The European call option gives the option buyer the right to exercise the option:

A) at any time up to the expiration date.
B) only on the expiration date.
C) if the price of the underlying asset falls below the exercise price.
D) immediately after the payment of dividends.

Question 22

For a call option,the:

A) buyer is locked into receive the underlying asset at a specified time.
B) writer is committed to handing over the specified asset if the holder of the call exercises the option.
C) writer may choose whether or not to deliver the underlying asset at a specified time.
D) buyer will choose to exercise the option only if the price of the underlying asset falls.

Question 23

An option that gives the option buyer the right to sell the commodity or financial instrument specified in the contact at the exercise price is called:

A) an American option.
B) a European option.
C) a call option.
D) a put option.

Question 24

In a put option,the:

A) writer is locked into handing over the underlying asset at a specified time.
B) buyer has the option to sell the specified asset at a specified time.
C) buyer is locked into receiving the underlying asset at a specified time.
D) seller must hand over the specified asset at a specified time.

Question 25

When a company contacts a bank and asks for a 3-month forward rate and is quoted by the bank's FX dealer AUD/USD0.9560-65 14.20,then the three month forward rate is:

A) AUD/USD0.9536-45
B) AUD/USD0.9540-51
C) AUD/USD0.9574-85
D) AUD/USD0.9580-79

Question 26

In the futures markets,a maintenance margin call refers to:

A) funds paid to the clearing house by the brokers as insurance against losses.
B) funds paid to the clearing house by each trader to cover losses.
C) realised profits paid by the clearing house to traders.
D) the difference between the futures contracts price and the underlying asset.

Question 27

If a company intends to borrow in three months' time,it can lock in its borrowing costs by:

A) buying futures contracts.
B) selling futures contracts.
C) going long on futures contracts.
D) an arbitrage position on futures contracts.

Question 28

An option buyer:

A) has a greater insurance benefit than the purchaser of a futures contract.
B) will generally incur a lower cost compared to a purchaser of a futures contract.
C) is purchasing a very risky instrument if they don't own the underlying asset as they are locked in to buying at expiration.
D) carries the risk of unfavourable price movements.

Question 29

In the futures markets,if a futures contract is marked-to-market,this refers to the:

A) interaction of the demand and supply forces in the market to determine the price of the options contract.
B) interaction of the demand and supply forces in the market to determine the price of the futures contract.
C) settlement of gains and losses on futures contracts on a daily basis.
D) settlement of gains and losses on forward contracts on a daily basis.

Question 30

In the futures markets,the price of a derivative contract for gold is based on:

A) prices of gold mining companies.
B) price of gold in the spot markets.
C) price of gold in the forward markets.
D) price of gold commodity indexes.

Question 31

A company,worried that the cost of funds might rise during the term of their short-term borrowing,can hedge this rise by:

A) buying futures contracts on bank-accepted bills.
B) selling futures contracts on bank-accepted bills.
C) buying bank-accepted bills on the spot market.
D) increasing the amount of money that has been borrowed.

Question 32

The advantage of using a forward rate agreement FRA over a futures contract is:

A) FRAs are highly standardised.
B) FRAs have only an initial margin and no ongoing maintenance margin.
C) the terms and conditions of a FRA can be negotiated.
D) FRAs have standardised maturities.

Question 33

An option that gives the option buyer the right to buy the commodity or financial instrument specified in the contact at the exercise price is called:

A) an American option.
B) a European option.
C) a call option.
D) a put option.

Question 34

A forward rate agreement (FRA)is an interest rate risk-management product,generally provided by banks over the-counter.Which of the following statements regarding forward rate agreements is correct?

A) FRAs are not standardised with regard to contract period and amount.
B) The centralised clearing house (CCH) holds the deposits and margin calls.
C) As a bank is the counterparty to the FRA, there is no credit risk.
D) All of the given answers.

Question 35

Which of the following statements relating to the use of futures contracts is incorrect?

A) Futures contracts are derivative products that derive from a physical market product.
B) The pricing of futures contracts is based on the price of the underlying market product.
C) Future physical market price changes are offset by a profit or loss in the futures market.
D) Futures contracts are generally closed out by delivery of the physical market product.

Question 36

In the futures markets,when the initial margin of a futures account is topped up daily to cover adverse futures price movements,this is called:

A) marked-to-market.
B) maintenance margin call.
C) short call.
D) closing-out.

Question 37

The market ASX Trade 24 trades in:

A) shares 24 hours.
B) shares and bonds 24 hours.
C) futures contracts.
D) forward contracts.

Question 38

If an FRA dealer quotes '6Mv9M 7.25 to 20',this means that the dealer is prepared to:

A) lend three-month money at 7.05% per annum.
B) borrow three-month money at 7.05% per annum.
C) lend three-month money at 7.25% per annum.
D) borrow three-month money at 7.25% per annum.

Question 39

In the futures markets,the funds that represent 2 to 10 per cent of the futures contract that a client pays to the futures exchange clearing house are called:

A) maintenance margin.
B) initial collateral.
C) margin call.
D) initial margin.

Question 40

The holder of an American call option has the right to:

A) buy the underlying asset at the exercise price on or before the expiration date.
B) buy the underlying asset only on the expiration date.
C) sell the underlying asset at the exercise price on or before the contract expiration date.
D) sell the underlying asset only at the expiration date.

Question 41

In relation to risk management for an organisation,discuss the procedures of identification and analysis of risk exposures.

Question 42

For a corporation,external risk management strategies include leading and lagging FX transactions.

Question 43

A commercial bank has to consider in its risk management procedures not only interest rate risk but also credit risk and liquidity risk.

Question 44

What is financial risk in relation to an organisation?

Question 45

The prime function of a futures clearing house is to bring together the buyer and seller in each futures contract.

Question 46

In the derivative markets a swap is:

A) another name for a call option.
B) another name for a put option.
C) an agreement between two or more persons to exchange cash flows over some future period.
D) the name for the exchange of a futures contract for an option contract.

Question 47

A government introducing legislation requiring carbon-emitting companies to lower their carbon emissions is an example of operational risk.

Question 48

An analysis of the costs associated with establishing and maintaining a particular risk management strategy versus the risk management benefits to be obtained is called a SMART analysis.

Question 49

In the option markets,the price specified in the contract at which the buyer of the option can buy or sell the specified commodity or financial instrument is called the:

A) call price.
B) exercise price.
C) settlement price.
D) spot price.

Question 50

In relation to risk management for an organisation,discuss the issue of acceptable risks and the appropriate management of such risks.

Question 51

The growth of the swaps market has been due to firms wanting to:

A) lower the cost of funds.
B) hedge interest rate risk.
C) lock in profit margins.
D) do all of the given choices.

Question 52

When two parties exchange the respective interest payments associated with existing debt borrowed in the capital markets,this is called a/an:

A) interest exchange.
B) financial switch.
C) swap.
D) financial transfer.

Question 53

The maintenance margin call refers to the difference between the futures market price and the futures contract.

Question 54

For the writer of a put option,if the underlying share price:

A) moves above the strike price the potential profits are unlimited.
B) drops below the strike price the potential profits are unlimited.
C) moves above the strike price, the potential profits are limited to the premium.
D) moves above the strike price, the premium is reduced by the difference.

Question 55

An agreement between two parties to exchange a series of cash flows similar to those resulting from an exchange of different types of bonds is called a/an:

A) credit swap.
B) interest rate swap.
C) yield curve swap.
D) notional spread.

Question 56

As risks for a company vary over time a flexible and robust risk management strategy is essential for an organisation no matter how large or small.

Question 57

The board of directors of a company is responsible for the implementation and monitoring of risk management strategies.

Question 58

An American put option is worth more than a European put option as it can be advantageous to exercise an American put option before expiry.

Question 59

A FRA expressed as 3Mv5M means the settlement date is in three months and the interest cover is for a five-month period.

Question 60

What is operational risk in relation to an organisation?

Question 61

Given the ever-changing business environment,discuss how this fits with risk management.