Question 1

Why do companies hedge to reduce risk?

Accepted Answer

Fluctuations in commodity prices, intere

Question 2

Unlike options, the purchase of a futures contract is a binding obligation to purchase at a fixed price at contract maturity.

Accepted Answer

A) True 
 B)False

Question 3

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?

Accepted Answer

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 
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 4

Which one of the following is false concerning the financial futures markets?

Accepted Answer

A)  One of the prominent exchanges for financial futures is the Chicago Board of Trade. 
B)  Financial futures contracts trade on the Chicago Mercantile Exchange. 
C)  A major use of financial futures is protection from interest rate risk. 
D) Trading in commodity futures significantly exceeds trading in financial futures. 
A)  One of the prominent exchanges for financial futures is the Chicago Board of Trade. 
B)  Financial futures contracts trade on the Chicago Mercantile Exchange. 
C)  A major use of financial futures is protection from interest rate risk. 
D) Trading in commodity futures significantly exceeds trading in financial futures.

Question 5

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

Accepted Answer

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

Question 6

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

Accepted Answer

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. 
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 7

What is the basic difference between hedgers and speculators?

Accepted Answer

The difference between hedging and specu

Question 8

What do you think are the advantages of holding futures rather than the underlying commodity? What do you think are the disadvantages?

Accepted Answer

One advantage of holding futures is the

Question 9

If you are not better informed than the highly paid professionals in banks and other institutions, you should use derivatives for speculation, not for hedging.

Accepted Answer

A) True 
 B)False

Question 10

There is perhaps a negative connotation about the term "speculators." Discuss the essential purpose that speculators serve in providing the ability to hedge.

Accepted Answer

Although the futures exchange handles al

Question 11

A soybean farmer anticipates the harvest of 10,000 bushels but is concerned about the spot price that may exist at that time. He therefore sells two futures contracts (5,000 bushels each, @ $14.75 per bushel). Unfortunately, the farmer was overly pessimistic, and the spot price at contract expiration is $15.00 per bushel. Ignoring the premium paid, and making the simplifying assumption that the contract was only held for one day, show the farmer's financial results of hedging.

Accepted Answer

Two contracts sold represent an obligati

Question 12

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

Accepted Answer

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. 
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 13

What is an interest rate swap, and what might motivate a borrower to arrange for one with a bank?

Accepted Answer

In a typical interest rate swap, only th

Question 14

Which one of the following futures contract holders is speculating?

Accepted Answer

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 
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 15

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

Accepted Answer

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. 
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 16

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

Accepted Answer

A) True 
 B)False

Question 17

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

Accepted Answer

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

Question 18

How does a soybean farmer lock in a price of $14.40 per bushel when the cash price at harvest is only $14?

Accepted Answer

A)  Profit in futures market to offset loss in cash market by selling futures contracts at $14.40/bushel. 
B)  Break even in both markets by buying a futures contract at $14.40/bushel. 
C)  Profit in cash market to offset loss in futures market by buying futures contract at $14.40/bushel. 
D) Break even in both markets by selling a futures contract at $14.40/bushel. 
A)  Profit in futures market to offset loss in cash market by selling futures contracts at $14.40/bushel. 
B)  Break even in both markets by buying a futures contract at $14.40/bushel. 
C)  Profit in cash market to offset loss in futures market by buying futures contract at $14.40/bushel. 
D) Break even in both markets by selling a futures contract at $14.40/bushel.

Question 19

What is the basic difference in strategy between buying and selling a futures contract?

Accepted Answer

Assuming that the buyer of a futures con

Question 20

Which one of the following is not generally considered a benefit of hedging?

Accepted Answer

A)  Hedging reduces one or more aspects of business risk. 
B)  Hedging allows prices to be locked in advance. 
C)  The costs of hedging are paid by the speculators. 
D) Hedging can stabilize profits. 
A)  Hedging reduces one or more aspects of business risk. 
B)  Hedging allows prices to be locked in advance. 
C)  The costs of hedging are paid by the speculators. 
D) Hedging can stabilize profits.

Exam 24: Risk Management

Why do companies hedge to reduce risk?

Unlike options, the purchase of a futures contract is a binding obligation to purchase at a fixed price at contract maturity.

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?

Which one of the following is false concerning the financial futures markets?

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

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

What is the basic difference between hedgers and speculators?

What do you think are the advantages of holding futures rather than the underlying commodity? What do you think are the disadvantages?

If you are not better informed than the highly paid professionals in banks and other institutions, you should use derivatives for speculation, not for hedging.

There is perhaps a negative connotation about the term "speculators." Discuss the essential purpose that speculators serve in providing the ability to hedge.

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

What is an interest rate swap, and what might motivate a borrower to arrange for one with a bank?

Which one of the following futures contract holders is speculating?

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

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

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

How does a soybean farmer lock in a price of $14.40 per bushel when the cash price at harvest is only $14?

What is the basic difference in strategy between buying and selling a futures contract?

Which one of the following is not generally considered a benefit of hedging?

Goals and Governance of the Corporation

Financial Markets and Institutions

Accounting and Finance

Measuring Corporate Performance

The Time Value of Money

Valuing Bonds

Valuing Stocks

Net Present Value and Other Investment Criteria

Using Discounted Cash-Flow Analysis to Make Investment Decisions

Project Analysis

Introduction to Risk, Return, and the Opportunity Cost of Capital

Risk, Return, and Capital Budgeting

The Weighted-Average Cost of Capital and Company Valuation

Introduction to Corporate Financing

How Corporations Raise Venture Capital and Issue Securities

Debt Policy

Payout Policy

Long-Term Financial Planning

Short-Term Financial Planning

Working Capital Management

Mergers, Acquisitions, and Corporate Control

International Financial Management

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