Question 1

Which of the following is NOT a way risk management can be used to increase the value of a firm?

Accepted Answer

A)  Risk management can increase debt capacity. 
B)  Risk management can help a firm maintain its optimal capital budget. 
C)  Risk management can reduce the expected costs of financial distress. 
D)  Risk management can help firms minimize taxes. 
E)  Risk management can allow managers to defer receipt of their bonuses and thus postpone tax payments. 
A)  Risk management can increase debt capacity. 
B)  Risk management can help a firm maintain its optimal capital budget. 
C)  Risk management can reduce the expected costs of financial distress. 
D)  Risk management can help firms minimize taxes. 
E)  Risk management can allow managers to defer receipt of their bonuses and thus postpone tax payments. E

Question 2

Lissa Co.'s stock price is currently $30.25. A 6-month call option on Lissa's stock has a strike price of $25 and has an expected volatility of 40% (i.e., expected standard deviation = 40%). The risk-free rate is 6%. According to the Black-Scholes option pricing model, what is the value of the option?

Accepted Answer

A)  $5.06 
B)  $5.62 
C)  $6.24 
D)  $6.94 
E)  $7.63 
A)  $5.06 
B)  $5.62 
C)  $6.24 
D)  $6.94 
E)  $7.63 D

Question 3

A commercial bank recognizes that its net income suffers whenever interest rates increase. Which of the following strategies would protect the bank against rising interest rates?

Accepted Answer

A)  Buying inverse floaters. 
B)  Entering into an interest rate swap where the bank receives a fixed payment stream, and in return agrees to make payments that float with market interest rates. 
C)  Purchase principal only (PO) strips that decline in value whenever interest rates rise. 
D)  Enter into a short hedge where the bank agrees to sell interest rate futures. 
E)  Sell some of the bank's floating-rate loans and use the proceeds to make fixed-rate loans. 
A)  Buying inverse floaters. 
B)  Entering into an interest rate swap where the bank receives a fixed payment stream, and in return agrees to make payments that float with market interest rates. 
C)  Purchase principal only (PO) strips that decline in value whenever interest rates rise. 
D)  Enter into a short hedge where the bank agrees to sell interest rate futures. 
E)  Sell some of the bank's floating-rate loans and use the proceeds to make fixed-rate loans. D

Question 4

A call option whose underlying stock value is less than the corresponding exercise price is an example of a(n)

Accepted Answer

A)  Straddle option. 
B)  Put option. 
C)  Out-of-the-money option. 
D)  Naked option. 
E)  Covered option. 
A)  Straddle option. 
B)  Put option. 
C)  Out-of-the-money option. 
D)  Naked option. 
E)  Covered option.

Question 5

Which of the following statements concerning risk management is NOT CORRECT?

Accepted Answer

A)  Risk management can reduce the volatility of cash flows, and this decreases the probability of bankruptcy. 
B)  Risk management makes sense for firms directly engaged in activities that involve commodities whose values can be hedged, and it doesn't make much sense for most other firms. 
C)  Companies with volatile earnings pay more taxes than more stable companies due to the treatment of tax credits and the rules governing corporate loss carry-forwards and carry-backs. Therefore, our tax system encourages risk management to stabilize earnings. 
D)  Risk management can reduce the likelihood of low cash flows, and therefore reduce the probability of financial distress. 
E)  Risk management involves identifying events that could have adverse financial consequences and then taking actions to prevent and/or to minimize the damage caused by these events. 
A)  Risk management can reduce the volatility of cash flows, and this decreases the probability of bankruptcy. 
B)  Risk management makes sense for firms directly engaged in activities that involve commodities whose values can be hedged, and it doesn't make much sense for most other firms. 
C)  Companies with volatile earnings pay more taxes than more stable companies due to the treatment of tax credits and the rules governing corporate loss carry-forwards and carry-backs. Therefore, our tax system encourages risk management to stabilize earnings. 
D)  Risk management can reduce the likelihood of low cash flows, and therefore reduce the probability of financial distress. 
E)  Risk management involves identifying events that could have adverse financial consequences and then taking actions to prevent and/or to minimize the damage caused by these events.

Question 6

Which of the following is NOT an example of a derivative security?

Accepted Answer

A)  Futures. 
B)  Options. 
C)  Swaps. 
D)  Forward contracts. 
E)  Preferred stock. 
A)  Futures. 
B)  Options. 
C)  Swaps. 
D)  Forward contracts. 
E)  Preferred stock.

Question 7

Interest rate swaps allow a firm to exchange fixed for floating-rate payments, but a swap cannot reduce actual net interest expenses.

Accepted Answer

A) True 
 B)False

Question 8

Which of the following statements regarding factors that affect call option prices is CORRECT?

Accepted Answer

A)  The longer the call option has to run the smaller its value and the smaller its premium. 
B)  An option on an extremely volatile stock is worth less than one on a stable stock. 
C)  The price of a call option increases as the risk-free rate increases. 
D)  Two call options on the same stock will have the same value even if they have different strike prices. 
E)  If you observe a put option on a stock increase in value, a call option on the stock should also increase. 
A)  The longer the call option has to run the smaller its value and the smaller its premium. 
B)  An option on an extremely volatile stock is worth less than one on a stable stock. 
C)  The price of a call option increases as the risk-free rate increases. 
D)  Two call options on the same stock will have the same value even if they have different strike prices. 
E)  If you observe a put option on a stock increase in value, a call option on the stock should also increase.

Question 9

Speculative risks are symmetrical in the sense that they offer the chance of a gain as well as a loss, while pure risks are those that can only lead to losses.

Accepted Answer

A) True 
 B)False

Question 10

A 6-month put option on Smith Corp.'s stock has a strike price of $45 and sells in the market for $8.90. Smith's current stock price is $41. What is the option premium?

Accepted Answer

A)  $4.41 
B)  $4.90 
C)  $5.39 
D)  $5.93 
E)  $6.52 
A)  $4.41 
B)  $4.90 
C)  $5.39 
D)  $5.93 
E)  $6.52

Question 11

One objective of risk management can be to reduce the volatility of a firm's cash flows.

Accepted Answer

A) True 
 B)False

Question 12

An investor who sells an option to offset a stock position he/she holds is said to be selling a(n)

Accepted Answer

A)  Call option. 
B)  Put option. 
C)  Out-of-the-money option. 
D)  Naked option. 
E)  Covered option. 
A)  Call option. 
B)  Put option. 
C)  Out-of-the-money option. 
D)  Naked option. 
E)  Covered option.

Question 13

There are call options on the common stock of XYZ Corporation. Which of the following best describes the factors that affect call option values?

Accepted Answer

A)  The price of call options will rise if XYZ's stock price rises. 
B)  The higher the strike price, the higher the call option price. 
C)  Assuming the same strike price, a call option that expires in 1 month will sell for a higher price than one that expires in 3 months. 
D)  The less volatile a stock is, the more valuable a call option on the stock is. 
E)  If the risk-free rate of interest increases, the value of call options will decrease. 
A)  The price of call options will rise if XYZ's stock price rises. 
B)  The higher the strike price, the higher the call option price. 
C)  Assuming the same strike price, a call option that expires in 1 month will sell for a higher price than one that expires in 3 months. 
D)  The less volatile a stock is, the more valuable a call option on the stock is. 
E)  If the risk-free rate of interest increases, the value of call options will decrease.

Question 14

A 6-month put option on Makler Corp.'s stock has a strike price of $45 and sells in the market for $8.90. Makler's current stock price is $41. What is the exercise value of the option?

Accepted Answer

A)  $2.62 
B)  $2.92 
C)  $3.24 
D)  $3.60 
E)  $4.00 
A)  $2.62 
B)  $2.92 
C)  $3.24 
D)  $3.60 
E)  $4.00

Question 15

An option that an investor holds without holding an offsetting position in the underlying stock is called a(n)

Accepted Answer

A)  Call option. 
B)  Put option. 
C)  Out-of-the-money option. 
D)  Naked option. 
E)  Covered option. 
A)  Call option. 
B)  Put option. 
C)  Out-of-the-money option. 
D)  Naked option. 
E)  Covered option.

Question 16

A 6-month call option on Meyers Inc.'s stock has a strike price of $45 and sells in the market for $8.25. Meyers' current stock price is $48. What is the option premium?

Accepted Answer

A)  $4.25 
B)  $4.73 
C)  $5.25 
D)  $5.78 
E)  $6.35 
A)  $4.25 
B)  $4.73 
C)  $5.25 
D)  $5.78 
E)  $6.35

Question 17

An option that gives the holder the right to buy a stock at a specified price at some time in the future is called a(n)

Accepted Answer

A)  Call option. 
B)  Put option. 
C)  Out-of-the-money option. 
D)  Naked option. 
E)  Covered option. 
A)  Call option. 
B)  Put option. 
C)  Out-of-the-money option. 
D)  Naked option. 
E)  Covered option.

Question 18

Which of the following events is likely to decrease the value of call options on the common stock of GCC Company?

Accepted Answer

A)  An increase in GCC's stock price. 
B)  An increase in the exercise price of the option. 
C)  An increase in the amount of time until the option expires. 
D)  An increase in the risk-free rate. 
E)  GCC's stock price becomes more risky (higher variance). 
A)  An increase in GCC's stock price. 
B)  An increase in the exercise price of the option. 
C)  An increase in the amount of time until the option expires. 
D)  An increase in the risk-free rate. 
E)  GCC's stock price becomes more risky (higher variance).

Question 19

The value of a stock option depends on all of the following EXCEPT:

Accepted Answer

A)  Exercise price. 
B)  Variability of the stock price. 
C)  Option's time to maturity. 
D)  Risk-free rate of interest. 
E)  Bond price. 
A)  Exercise price. 
B)  Variability of the stock price. 
C)  Option's time to maturity. 
D)  Risk-free rate of interest. 
E)  Bond price.

Question 20

Which of the following statements is most CORRECT?

Accepted Answer

A)  One advantage of forward contracts is that they are default free. 
B)  Futures contracts generally trade on an organized exchange and are marked to market daily. 
C)  Goods are never delivered under forward contracts, but are almost always delivered under futures contracts. 
D)  Forward contracts are generally standardized instruments, whereas futures contracts are generally tailor-made for the 2 parties of the contract. 
E)  Essentially there are no differences between forward and futures contracts, except that forward contracts are used only for financial assets while futures contracts are used only for commodities. 
A)  One advantage of forward contracts is that they are default free. 
B)  Futures contracts generally trade on an organized exchange and are marked to market daily. 
C)  Goods are never delivered under forward contracts, but are almost always delivered under futures contracts. 
D)  Forward contracts are generally standardized instruments, whereas futures contracts are generally tailor-made for the 2 parties of the contract. 
E)  Essentially there are no differences between forward and futures contracts, except that forward contracts are used only for financial assets while futures contracts are used only for commodities.

Exam 18: Derivatives and Risk Management

Which of the following is NOT a way risk management can be used to increase the value of a firm?

A commercial bank recognizes that its net income suffers whenever interest rates increase. Which of the following strategies would protect the bank against rising interest rates?

A call option whose underlying stock value is less than the corresponding exercise price is an example of a(n)

Which of the following statements concerning risk management is NOT CORRECT?

Which of the following is NOT an example of a derivative security?

Interest rate swaps allow a firm to exchange fixed for floating-rate payments, but a swap cannot reduce actual net interest expenses.

Which of the following statements regarding factors that affect call option prices is CORRECT?

Speculative risks are symmetrical in the sense that they offer the chance of a gain as well as a loss, while pure risks are those that can only lead to losses.

A 6-month put option on Smith Corp.'s stock has a strike price of $45 and sells in the market for $8.90. Smith's current stock price is $41. What is the option premium?

One objective of risk management can be to reduce the volatility of a firm's cash flows.

An investor who sells an option to offset a stock position he/she holds is said to be selling a(n)

There are call options on the common stock of XYZ Corporation. Which of the following best describes the factors that affect call option values?

A 6-month put option on Makler Corp.'s stock has a strike price of $45 and sells in the market for $8.90. Makler's current stock price is $41. What is the exercise value of the option?

An option that an investor holds without holding an offsetting position in the underlying stock is called a(n)

A 6-month call option on Meyers Inc.'s stock has a strike price of $45 and sells in the market for $8.25. Meyers' current stock price is $48. What is the option premium?

An option that gives the holder the right to buy a stock at a specified price at some time in the future is called a(n)

Which of the following events is likely to decrease the value of call options on the common stock of GCC Company?

The value of a stock option depends on all of the following EXCEPT:

Which of the following statements is most CORRECT?

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds and Their Valuation

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Real Options and Other Topics in Capital Budgeting

Capital Structure and Leverage

Distributions to Shareholders: Dividends and

Working Capital Management

Financial Planning and Forecasting

Multinational Financial Management

Hybrid Financing: Preferred Stock, Leasing, Warrants, and Convertibles

Mergers and Acquisitions

Financial Management and Stock Equilibrium

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