Question 1

Which of the following statements regarding currency options is false?

Accepted Answer

A)  Firms often prefer forward contracts to currency options if the transaction they are hedging might not take place. 
B)  Currency options are another method that firms commonly use to manage exchange rate risk. Currency options, like stock options, give the holder the right-but not the obligation-to exchange currency at a given exchange rate. 
C)  Currency forward contracts allow firms to lock in a future exchange rate; currency options allow firms to insure themselves against the exchange rate moving beyond a certain level. 
D)  Many managers want the firm to benefit if the exchange rate moves in their favour, rather than being stuck paying an above-market rate. 
A)  Firms often prefer forward contracts to currency options if the transaction they are hedging might not take place. 
B)  Currency options are another method that firms commonly use to manage exchange rate risk. Currency options, like stock options, give the holder the right-but not the obligation-to exchange currency at a given exchange rate. 
C)  Currency forward contracts allow firms to lock in a future exchange rate; currency options allow firms to insure themselves against the exchange rate moving beyond a certain level. 
D)  Many managers want the firm to benefit if the exchange rate moves in their favour, rather than being stuck paying an above-market rate. A

Question 2

Which of the following statements is false?

Accepted Answer

A)  Currency options allow firms to lock in a future exchange rate; currency forward contracts allow firms to insure themselves against the exchange rate moving beyond a certain level. 
B)  Generally speaking, cash-and-carry strategies are used primarily by large banks, which can borrow easily and face low transaction costs. 
C)  Currency options, like stock options, give the holder the right-but not the obligation-to exchange currency at a given exchange rate. 
D)  Many managers want the firm to benefit if the exchange rate moves in their favour, rather than being stuck paying an above-market rate. 
A)  Currency options allow firms to lock in a future exchange rate; currency forward contracts allow firms to insure themselves against the exchange rate moving beyond a certain level. 
B)  Generally speaking, cash-and-carry strategies are used primarily by large banks, which can borrow easily and face low transaction costs. 
C)  Currency options, like stock options, give the holder the right-but not the obligation-to exchange currency at a given exchange rate. 
D)  Many managers want the firm to benefit if the exchange rate moves in their favour, rather than being stuck paying an above-market rate. A

Question 3

Use the information for the question(s) below.
Your firm faces an 8% chance of a potential loss of $50 million next year. If your firm implements new safety policies, it can reduce the chance of this loss to 3%, but the new safety policies have an upfront cost of $250,000. Suppose that the beta of the loss is 0 and the risk-free rate of interest is 5%.
-If your firm is uninsured,the NPV of implementing the new safety policies is closest to:

Accepted Answer

A)  $2.25 million 
B)  -$.25 million 
C)  $2.5 million 
D)  $2.15 million 
A)  $2.25 million 
B)  -$.25 million 
C)  $2.5 million 
D)  $2.15 million D

Question 4

The duration of a five-year bond with 8% annual coupons trading at par is closest to:

Accepted Answer

A)  2.5 Years 
B)  4.3 Years 
C)  5.0 Years 
D)  6.2 Years 
A)  2.5 Years 
B)  4.3 Years 
C)  5.0 Years 
D)  6.2 Years

Question 5

The futures prices for oil are determined in the market based on ________ for each delivery date.They depend on expectations of future oil prices,adjusted by an appropriate ________.

Accepted Answer

A)  price and cost; risk premium 
B)  price and cost; inflation premium 
C)  supply and demand; risk premium 
D)  supply and demand; inflation premium 
A)  price and cost; risk premium 
B)  price and cost; inflation premium 
C)  supply and demand; risk premium 
D)  supply and demand; inflation premium

Question 6

Common mistakes made when hedging include: the possibility of having a natural hedge; liquidity risk; and base risk.Which of the following does NOT represent one of these three possible risks?

Accepted Answer

A)  Future contracts are negotiated as agreements between parties that are not anonymous. Therefore, there is a possibility that one of the parties may default before the contract is finalized. 
B)  The hedge may not be necessary if the firm can effectively pass future cost increases on to their customers through higher prices . 
C)  In the event that price changes during the life of the contract require an increased contribution to the margin account, this may be an unanticipated cost for the firm and, if not addressed, could result in a default in the position taken in the contract. 
D)  Future contracts require the matching of the quantity and timing of future deliveries. If both parties cannot provide this matching, one party will be unable to completely hedge their future position. 
A)  Future contracts are negotiated as agreements between parties that are not anonymous. Therefore, there is a possibility that one of the parties may default before the contract is finalized. 
B)  The hedge may not be necessary if the firm can effectively pass future cost increases on to their customers through higher prices . 
C)  In the event that price changes during the life of the contract require an increased contribution to the margin account, this may be an unanticipated cost for the firm and, if not addressed, could result in a default in the position taken in the contract. 
D)  Future contracts require the matching of the quantity and timing of future deliveries. If both parties cannot provide this matching, one party will be unable to completely hedge their future position.

Question 7

The long-term storage of inventory can be a strategy employed by firms to hedge against commodity price uncertainty. Which of the following is NOT a possible outcome associated with this strategy?

Accepted Answer

A)  The cost associated with the storage of inventory can be mitigated if the firm is vertically integrated, that is it both produces and sells the commodity. 
B)  The strategy has associated with it storage costs that can be greater than the potential losses due to future commodity price changes. 
C)  The strategy can require significant up-front financing that could require external financing with associated issuance and debt servicing costs 
D)  If the inventory purchase is funded internally, this could put a strain on the firm's working capital position. 
A)  The cost associated with the storage of inventory can be mitigated if the firm is vertically integrated, that is it both produces and sells the commodity. 
B)  The strategy has associated with it storage costs that can be greater than the potential losses due to future commodity price changes. 
C)  The strategy can require significant up-front financing that could require external financing with associated issuance and debt servicing costs 
D)  If the inventory purchase is funded internally, this could put a strain on the firm's working capital position.

Question 8

The risk that the firm will not have,or be able to raise,the cash required to meet the margin calls on its hedges is called

Accepted Answer

A)  liquidity risk. 
B)  basis risk. 
C)  commodity price risk. 
D)  speculation risk. 
A)  liquidity risk. 
B)  basis risk. 
C)  commodity price risk. 
D)  speculation risk.

Question 9

Like most foreign exchange rates,the dollar/euro rate is a floating rate,which means it changes constantly depending on the quantity supplied and demanded for each currency in the market.The supply and demand for each currency is driven directly by all of the following factors EXCEPT

Accepted Answer

A)  relative inflation. 
B)  firms trading goods. 
C)  investors trading securities. 
D)  the actions of central banks in each country. 
A)  relative inflation. 
B)  firms trading goods. 
C)  investors trading securities. 
D)  the actions of central banks in each country.

Question 10

Insurance allows the firm to exchange a(n)________ future loss for a certain ________ expense.

Accepted Answer

A)  uncertain; upfront 
B)  certain; upfront 
C)  uncertain; afterward 
D)  certain; afterward 
A)  uncertain; upfront 
B)  certain; upfront 
C)  uncertain; afterward 
D)  certain; afterward

Question 11

To insure their assets against hazards such as fire,storm damage,vandalism,earthquakes,and other natural and environmental risks firms commonly purchase

Accepted Answer

A)  key personnel insurance. 
B)  business liability insurance. 
C)  business interruption insurance. 
D)  property insurance. 
A)  key personnel insurance. 
B)  business liability insurance. 
C)  business interruption insurance. 
D)  property insurance.

Question 12

A currency forward contract specifies all of the following EXCEPT

Accepted Answer

A)  the amount of currency to exchange. 
B)  the spot exchange rate. 
C)  the delivery date on which the exchange will take place. 
D)  the currencies to be exchanged. 
A)  the amount of currency to exchange. 
B)  the spot exchange rate. 
C)  the delivery date on which the exchange will take place. 
D)  the currencies to be exchanged.

Question 13

Which of the following statements is false?

Accepted Answer

A)  As interest rates change, the market values of the securities and cash flows in the portfolio change as well, which in turn alters the weights used when computing the duration as the value-weighted average maturity. 
B)  The duration of a portfolio of investments is the simple average of the durations of each investment in the portfolio. 
C)  Adjusting a portfolio to make its duration neutral is sometimes referred to as immunizing the portfolio, a term that indicates it is being protected against interest rate changes. 
D)  When the durations of a firm's assets and liabilities are significantly different, the firm has a duration mismatch. 
A)  As interest rates change, the market values of the securities and cash flows in the portfolio change as well, which in turn alters the weights used when computing the duration as the value-weighted average maturity. 
B)  The duration of a portfolio of investments is the simple average of the durations of each investment in the portfolio. 
C)  Adjusting a portfolio to make its duration neutral is sometimes referred to as immunizing the portfolio, a term that indicates it is being protected against interest rate changes. 
D)  When the durations of a firm's assets and liabilities are significantly different, the firm has a duration mismatch.

Question 14

What are some of the disadvantages of long-term supply contracts?

Accepted Answer

Such contracts have several potential di

Question 15

Which of the following statements is false?

Accepted Answer

A)  Not all insurable risks have a beta of zero. Some risks, such as hurricanes and earthquakes, create losses of tens of billions of dollars and may be difficult to diversify completely. 
B)  When a firm buys insurance, it transfers the risk of the loss to an insurance company. The insurance company charges an upfront premium to take on that risk. 
C)  By its very nature, insurance for non-diversifiable hazards is generally a positive beta asset; the insurance payment to the firm tends to be larger when total losses are low and the market portfolio is high. 
D)  Because insurance provides cash to the firm to offset losses, it can reduce the firm's need for external capital and thus reduce issuance costs. 
A)  Not all insurable risks have a beta of zero. Some risks, such as hurricanes and earthquakes, create losses of tens of billions of dollars and may be difficult to diversify completely. 
B)  When a firm buys insurance, it transfers the risk of the loss to an insurance company. The insurance company charges an upfront premium to take on that risk. 
C)  By its very nature, insurance for non-diversifiable hazards is generally a positive beta asset; the insurance payment to the firm tends to be larger when total losses are low and the market portfolio is high. 
D)  Because insurance provides cash to the firm to offset losses, it can reduce the firm's need for external capital and thus reduce issuance costs.

Question 16

In December 2005,the spot exchange rate for the British Pound was 1.7188 CAD/GBP and the one-year forward rate was 1.8675 CAD/GBP. Suppose that at the same time Luther Industries entered into a contract to purchase goods with a price of £375,000 to be delivered in one year.Simultaneously Luther entered into a one-year forward contract to purchase £375,000.What is the amount of the payment in Canadian dollars that Luther Industries will have to make in one year to pay for their goods?

Accepted Answer

Since Luther entered into a forward cont

Question 17

Use the information for the question(s) below.
Your firm faces an 8% chance of a potential loss of $50 million next year. If your firm implements new safety policies, it can reduce the chance of this loss to 3%, but the new safety policies have an upfront cost of $250,000. Suppose that the beta of the loss is 0 and the risk-free rate of interest is 5%.
-If your firm is fully insured,the NPV of implementing the new safety policies is closest to:

Accepted Answer

A)  $2.15 million 
B)  $2.5 million 
C)  $2.25 million 
D)  -$.25 million 
A)  $2.15 million 
B)  $2.5 million 
C)  $2.25 million 
D)  -$.25 million

Question 18

The most common strategies for hedging risk by making real investments in assets with offsetting risk are

Accepted Answer

A)  horizontal integration and storage. 
B)  vertical integration and storage. 
C)  vertical integration and diversification. 
D)  horizontal integration and diversification. 
A)  horizontal integration and storage. 
B)  vertical integration and storage. 
C)  vertical integration and diversification. 
D)  horizontal integration and diversification.

Question 19

The interest rate sensitivity of a single cash flow ________ with its maturity; the interest rate sensitivity of a stream of cash flows ________ with its duration.

Accepted Answer

A)  decreases; increases 
B)  increases; decreases 
C)  decreases; decreases 
D)  increases; increases 
A)  decreases; increases 
B)  increases; decreases 
C)  decreases; decreases 
D)  increases; increases

Question 20

Exchange rate risk naturally arises whenever transacting parties use ________.

Accepted Answer

A)  a fixed exchange rate 
B)  the same currency 
C)  different currencies 
D)  a floating exchange rate 
A)  a fixed exchange rate 
B)  the same currency 
C)  different currencies 
D)  a floating exchange rate

Exam 30: Risk Management

Which of the following statements regarding currency options is false?

Which of the following statements is false?

The duration of a five-year bond with 8% annual coupons trading at par is closest to:

The futures prices for oil are determined in the market based on ________ for each delivery date.They depend on expectations of future oil prices,adjusted by an appropriate ________.

Common mistakes made when hedging include: the possibility of having a natural hedge; liquidity risk; and base risk.Which of the following does NOT represent one of these three possible risks?

The long-term storage of inventory can be a strategy employed by firms to hedge against commodity price uncertainty. Which of the following is NOT a possible outcome associated with this strategy?

The risk that the firm will not have,or be able to raise,the cash required to meet the margin calls on its hedges is called

Like most foreign exchange rates,the dollar/euro rate is a floating rate,which means it changes constantly depending on the quantity supplied and demanded for each currency in the market.The supply and demand for each currency is driven directly by all of the following factors EXCEPT

Insurance allows the firm to exchange a(n)________ future loss for a certain ________ expense.

To insure their assets against hazards such as fire,storm damage,vandalism,earthquakes,and other natural and environmental risks firms commonly purchase

A currency forward contract specifies all of the following EXCEPT

Which of the following statements is false?

What are some of the disadvantages of long-term supply contracts?

Which of the following statements is false?

The most common strategies for hedging risk by making real investments in assets with offsetting risk are

The interest rate sensitivity of a single cash flow ________ with its maturity; the interest rate sensitivity of a stream of cash flows ________ with its duration.

Exchange rate risk naturally arises whenever transacting parties use ________.

The Corporation

Introduction to Financial Statement Analysis

Arbitrage and Financial Decision Making

The Time Value of Money

Interest Rates

Valuing Bonds

Valuing Stocks

Investment Decision Rules

Fundamentals of Capital Budgeting

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behaviour and Capital Market Efficiency

Financial Options

Option Valuation

Real Options

Capital Structure in a Perfect Market

Debt and Taxes

Financial Distress, managerial Incentives, and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modelling: a Case Study

The Mechanics of Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

International Corporate Finance

Filters

The futures prices for oil are determined in the market based on for each delivery date.They depend on expectations of future oil prices,adjusted by an appropriate .

Insurance allows the firm to exchange a(n) future loss for a certain expense.

The interest rate sensitivity of a single cash flow with its maturity; the interest rate sensitivity of a stream of cash flows with its duration.