Deck 1: Derivatives and Risk Management

Question 1

In the United States,the Great Moderation refers to:

A) a 15-year-long period that began around 1900 during which the growth of real output fluctuated,inflation declined,stock market volatility was reduced,and business cycles were moderated
B) the time period between 1920 and 1933 when sale,manufacture,and transportation of alcohol was prohibited
C) a time period that began in 1955 and lasted for nearly a decade during which business cycle fluctuations declined and inflation was under control
D) a time period that began after World War II and lasted for nearly a decade during the growth of real output fluctuated,inflation declined,stock market volatility was reduced,and business cycles were moderated
E) a time period that began during the mid-1980s and lasted a little over two decades during which the growth of real output fluctuated,inflation declined,stock market volatility was reduced,and business cycles were moderated

Answer 1

E

Question 2

Procter & Gamble's balance sheet suggests that which of the following is NOT a characteristic of the company's risk exposure or risk management practice?

A) P&G manufactures and sells its products in many countries.It mainly uses forwards and options to reduce the risk that the company's financial position will be adversely affected by short-term changes in exchange rates.
B) P&G uses futures,options,and swaps to manage price volatility of raw materials.
C) P&G designates a security as a hedge of a specific underlying exposure and monitors its effectiveness in an ongoing manner.
D) P&G is exposed to significant volatility from commodity hedging activity and credit risk exposure.
E) P&G grants stock options and restricted stock awards to key managers and directors.

Answer 2

D

Question 3

Suppose regulators cap the maximum interest one can charge at 5 percent.Let the underlying market interest rate be 8 percent.Charging anything lower will drive you out of business. You devise a compensatory balance scheme: for every $100 that the customer borrows,she will have to keep a certain amount with you as a compensatory balance.What should the amount of the loan and the compensatory balance be if the customer wants to borrow $5,000?

A) $5,000 loan and $1,000 as compensatory balance
B) $5,000 loan and $1,500 as compensatory balance
C) $5,000 loan and $3,000 as compensatory balance
D) $8,000 loan and $3,000 as compensatory balance
E) $8,000 loan and $5,000 as compensatory balance

Answer 3

D

Question 4

The following is NOT a feature of current derivatives markets:

A) there is a huge variety in the number and type of derivatives contracts that are traded
B) the derivatives markets are now global and measured in trillions of dollars
C) commodity derivatives have emerged as the most popular kind of derivatives traded in the new millennium
D) colleges and universities now offer many kinds of derivative courses
E) Wall Street firms hire graduate degree holders in finance and quantitative methods for designing and trading derivatives

Question 5

Which of the following statements is INCORRECT?

A) Derivatives trade in zero net supply markets.
B) A derivatives trade is a zero-sum game in the absence of market imperfections like transaction costs.
C) Derivatives are powerful financial tools that can be used for speculation as well as hedging.
D) Derivatives have a history of always causing significant losses to any trader who trades these contracts.
E) Derivatives can help traders to reduce price risk from economic activities.

Question 6

A derivative security:

A) is useful only for speculation
B) is useful only for hedging
C) is useful only for manipulating markets
D) can be used for all of these purposes
E) is useful for none of these purposes

Question 7

In financial markets,a coupon refers to:

A) the detachable part of a stock that entitles the holder to get dividends from the company
B) the interest paid on a bond on a regular basis,typically semiannually
C) one side of a financial swap that entitles the holder to net payments
D) the discount from the principal amount at which a zero-coupon bond is sold in the market
E) a paper on whose submission a trader gets a reduction in brokerage fees

Question 8

Foreign exchange prices became volatile during the 1970s mainly because of:

A) an end of the policy of fixing interest rates by the US Federal Reserve Bank
B) the demise of the Bretton Woods system of fixed exchange rates
C) supply shocks of the 1970s
D) technology that helped us overcome the vagaries of Mother Earth
E) hedge funds manipulating exchange trades

Question 9

Who has described derivatives as "time bombs,both for the parties that deal in them and the economic system"?

A) Warren Buffett
B) Ronald Coase
C) Alan Greenspan
D) Peter Lynch
E) Merton Miller

Question 10

The International Monetary Market is:

A) an OTC market where money market instruments trade
B) a part of the World Bank that lends funds to developing countries
C) a division of the Chicago Mercantile Exchange created for trading foreign currency futures
D) a London-based market for interbank lending
E) None of these answers are correct.

Question 11

Interest rates in the United States became volatile during the late 1970s mainly due to:

A) an end of the policy of fixing interest rates by the US Federal Reserve Bank
B) the demise of the Bretton Woods system of fixed exchange rates
C) technological changes that enabled banks to modify interest rates
D) hedge funds manipulating interest rates

Question 12

The following was NOT an example cited by Nobel laureate economist Merton Miller in support of his view that "regulations and taxes cause financial innovation":

A) Eurobonds
B) Eurodollars
C) futures contracts
D) swaps
E) zero-coupon bonds

Question 13

Which of the following risks can be very difficult to hedge?

A) credit risk
B) legal risk
C) market risk
D) operations risk
E) portfolio risk

Question 14

Procter & Gamble's balance sheet suggests that which of the following is NOT a characteristic of the company's risk exposure or risk management practice?

A) P&G is exposed to currency risk,interest rate risk,and commodity price risk.
B) P&G consolidates currency risk,interest rate risk,and commodity price risk,and tries to naturally offset them.It then tries to hedge the residual risk with derivatives.
C) P&G holds some derivatives for trading purposes and trades them strategically to maximize shareholder value.
D) P&G monitors derivative positions using techniques including market value,sensitivity analysis,and value-at-risk.
E) P&G uses interest rate swaps to hedge its underlying debt obligations and enters into certain currency interest rate swaps to hedge the company's foreign net investments.

Question 15

The Basel Committee's Risk Management Guidelines for Derivatives (July 1994)did NOT list which of the following risks?

A) credit risk
B) legal risk
C) liquidity risk
D) market risk
E) value-at-risk

Question 16

Nobel Prize-winning economist Ronald Coase's view is:

A) arbitrage is the adhesive that holds financial markets together
B) derivatives destroy financial markets via excessive speculation
C) derivatives improve social welfare through better risk allocation in the economy
D) firms often appear when they can lower transaction costs
E) regulations and taxes cause financial innovation