BFM114 Financial Management Part II

Corporate Risk Management

Quiz 1 (Finals)
R. E. Navor

MULTIPLE CHOICE

1) The major risks assumed by firms include:

A) demand risk.
B) foreign-exchange risk.
C) operational risk.
D) all of the above.
2) Aspects of demand risk controllable by the firm include:
A) product quality.
B) interest rates.
C) entry of external competitors.
D) status of the regional and national economy.
3) An example of commodity risk would be:
A) volatile exchange rates with countries from which commodities are imported.
B) the price of copper for electrical contractors.
C) volatile exchange rates with countries to which commodities are exported.
D) raw materials that do not meet quality specifications.
4) Self insurance is the practice of:
A) holding reserves within the firm to cover potential losses.
B) CEO's holding large life insurance policies on themselves, payable to the company.
C) companies in unrelated businesses forming subsidiaries to cover their insurance
needs.
D) purchasing insurance policies directly rather than through a broker.
5) Which of the following is a consequence of transferring risk to an insurance company?
A) An increase in stock value because risk has been reduced.
B) A guaranteed small loss in exchange for protection against large losses.
C) Higher rates of return because the firm is now free to pursue high-risk projects.
D) Protection against losses at no significant cost to the firm.
6) Self-insurance would not provide adequate protection in which of the following
circumstances?
A) Unemployment insurance for a firm that rarely lays off employees.
B) Damage to the company's own vehicles.
C) Major ecological disasters resulting from oil spills.
D) Revenue lost because of bad weather during the peak shopping season.
7) Which of the following types of insurance does NOT involve a contract with an external
party?
A) Property insurance
B) Life insurance
C) Directors and officers insurance
D) Self insurance
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BFM114 Financial Management Part II

Corporate Risk Management

Quiz 1 (Finals)
R. E. Navor

8) The purpose of a hedging strategy is to:

A) avoid speculation on future prices.
B) speculate that future prices will be lower than the spot price.
C) speculate that future prices will be higher than the spot price.
D) avoid exposure to commodity rate risk.
9) A maker of breakfast cereals has contracted to buy 100,000 bushels of wheat for $8.50 a
bushel at the end of October. On the delivery date, the spot price of wheat is $8.70 per
bushel. Which of the following is true?
A) The seller of the contract has $20,000 profit.
B) The buyer of the contract has a $20,000 loss.
C) The buyer of the contract has a $20,000 profit
D) Both A and B are true
10) A large agribusiness firm has contracted to deliver 100,000 bushels of wheat for $8.50 a
bushel at the end of October. On the delivery date, the spot price of wheat is $8.70 per
bushel. Which of the following is true?
A) The seller of the contract has $20,000 loss.
B) The buyer of the contract has a $20,000 loss.
C) The buyer of the contract has a $20,000 profit
D) Both A and C are true
11) The party that agrees to sell a commodity or currency in the forward market is said to have
a:
A) long position.
B) short position
C) protected position.
D) split position.
12) Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the coming
winter. Swenson's customers who take advantage of the offer:
A) are speculating that fuel prices will be higher in the future.
B) have purchased a form of call option for heating fuel.
C) are entering into a futures contract to offset the risk of higher fuel prices during the
winter.
D) are purchasing a form of insurance against fuel shortages.
13) Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the coming
winter. If Swenson does not hedge its positions in the futures market:
A) it could make unexpected profits if fuel prices decline.
B) it could suffer large losses if the wholesale cost of fuel rises above the price it sold
the fuel for in June.
C) it will make normal profits if winter prices do not change very much from the June
spot price.
D) all of the above.

BFM114 Financial Management Part II

Corporate Risk Management

Quiz 1 (Finals)
R. E. Navor

14) Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the coming
winter. Customers who took advantage of the offer prepurchased 400,000 gallons of oil at
$3.00 per gallon. Swenson hedged its position by contracting to purchase 400,000 gallons
of oil for November delivery at a price of $2.50 per gallon. If the November spot price is
$2.75 per gallon, the payoff to Swenson is:
A) $100,000.
B) ($100,000).
C) $200,000.
D) $0.00.
15) Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the coming
winter. Customers who took advantage of the offer prepurchased 400,000 gallons of oil at
$3.00 per gallon. Swenson hedged its position by contracting to purchase 400,000 gallons
of oil for November delivery at a price of $2.50 per gallon. If the November spot price is
$2.25 per gallon, the payoff to Swenson is:
A) $100,000.
B) ($100,000).
C) $200,000.
D) $0.00.

16) Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the coming
winter. Customers who took advantage of the offer prepurchased 400,000 gallons of oil at
$3.00 per gallon. Swenson hedged its position by contracting to purchase 400,000 gallons
of oil for November delivery at a price of $2.50 per gallon. If the November spot price is
$2.25 per gallon, Swenson's gross profit on the heating oil sold in June will be
A) $100,000.
B) ($100,000).
C) $200,000.
D) $0.00.
17) Hudson Valley Distributors wants to be sure it has 10,000 cases of Beaujolais Nouveau to
sell next November. In January, they enters into an agreement to buy the wine at a price of
30 euros to the case. Payment will be due at the end of November. They expect to sell the
wine to restaurants and retailers for $63 per case. If Hudson Valley does not hedge its
position and the exchange rate in November is $1.50 /euro, what is the gross profit on the
wine?
A) $180,000
B) ($180,000)
C) $330,000
D) $150,000
18) Hudson Valley Distributors wants to be sure it has 10,000 cases of Beaujolais Nouveau to
sell next November. In January, they enters into an agreement to buy the wine at a price of
30 euros to the case. Payment will be due at the end of November. They expect to sell the
wine to restaurants and retailers for $63 per case. Hudson Valley has hedged its foreign
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BFM114 Financial Management Part II

Corporate Risk Management

Quiz 1 (Finals)
R. E. Navor

exchange risk by entering into a forward contract to purchase euros in November at

$1.30/euro. If the spot exchange rate at the end of November is $1.50/euro, the payoff to
Hudson Valley for hedging is ________.
A) $180,000
B) ($60,000)
C) $60,000
D) $240,000
19) Hudson Valley Distributors wants to be sure it has 10,000 cases of Beaujolais Nouveau to
sell next November. In January, they enters into an agreement to buy the wine at a price of
30 euros to the case. Payment will be due at the end of November. They expect to sell the
wine to restaurants and retailers for $63 per case. Hudson Valley has hedged its foreign
exchange risk by entering into a forward contract to purchase euros in November at
$1.30/euro. If the spot exchange rate at the end of November is $1.50/euro, Hudson Valley's
gross profit will be ________.
A) $180,000
B) ($60,000)
C) $60,000
D) $240,000
20) Which of the following is NOT an advantage of futures contracts?
A) They are inexpensive compared to customized forward contracts.
B) They trade on exchanges rather than over the counter.
C) Features such as contract size and expiration date are standardized.
D) The size and commodity can always be perfectly tailored to form a perfect hedge.
21) A commodity such as diesel fuel for which there is no available futures contract might be
satisfactorily hedged with:
A) stock index futures.
B) interest rate futures.
C) heating oil futures.
D) electricity futures.
22) Uses of future contracts include:
A) eliminating uncertainty about the future cost of key inputs.
B) eliminating uncertainty about the prices that will be received when a commodity is
ready for market.
C) speculating on future price movements of commodities which the speculator neither
uses nor produces.
D) all of the above.
23) You purchased one July futures contract of pork bellies at $.59 per lb. One contract
represents 40,000 lbs. of pork bellies. Initial margin on the contract was 4% of the contract
price with a maintenance margin of $500. By the end of the day, the price had fallen to $.57
per lb. How much will you be required to add to your margin account to replenish your
maintenance margin?
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BFM114 Financial Management Part II

Corporate Risk Management
A)
B)
C)
D)

Quiz 1 (Finals)
R. E. Navor

None
$356
$144
$32

24) You purchased one July futures contract of pork bellies at $.59 per lb. One contract
represents 40,000 lbs. of pork bellies. By the end of the day, the price had fallen to $.57 per
lb. How much did the value of your contract change during the day?
A) It rose by $800.
B) It fell by $356.
C) It fell by $800.
D) There is no change in value until the contract expires.
25) You sold one July futures contract of pork bellies at $.59 per lb. One contract represents
40,000 lbs. of pork bellies. By the end of the day, the price had fallen to $.57 per lb. What
was your profit or loss for the day?
A) $800 profit
B) $356 loss
C) $800 loss
D) There is no profit or loss until the contract expires.

BFM114 Financial Management Part II

Corporate Risk Management

Quiz 1 (Finals)
R. E. Navor

26) A(n) ________ gives the holder the right to buy a stated number of shares at a specified
price for a limited time.
A) stock index futures contract
B) put option
C) call option
D) interest rate futures contract
27) A(n) ________ gives the holder the right to sell a stated number of shares at a specified
price for a limited time.
A) stock index futures contract
B) put option
C) call option
D) interest rate futures contract
28) An investor would buy a ________ if he or she believes that the price of the underlying
stock or asset will fall in the near future.
A) call option
B) convertible bond
C) put option
D) futures contract to take delivery of an asset at a future date
29) The price at which the stock or asset may be purchased from (or sold to) the option writer is
referred to as:
A) intrinsic value of the option.
B) option premium.
C) open interest.
D) exercise or striking price.
30) A(n) ________ can be exercised only on the expiration date.
A) European option
B) at-the-money option
C) short option
D) American option
31) Mayspring Corporation common stock is currently selling for $72.00 per share. A call
option on Mayspring Corporation that expires in two months has an exercise price of
$72.50. This call option is said to be:
A) out-of-the-money.
B) at-the-money.
C) in-the-money.
D) covered.
32) Ahmad bought call options on Home Depot with a striking price of $34. The option
premium was $3.50. Just before the contract expired, Home Depot stock was $36 per share.
Ahmad:
A) made a profit of $2.00 per share.
B) lost $3.50 per share because the option would not be exercised.
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BFM114 Financial Management Part II

Corporate Risk Management

Quiz 1 (Finals)
R. E. Navor

C) made a profit of $3.50 per share.

D) lost $1.50 per share.
33) Ahmad bought put options on Verizon with a striking price of $32. The option premium
was $2.50. Just before the contract expired, Verizon stock 30.50 per share. Ahmad:
A) made a profit of $1.50 per share.
B) lost $2.50 per share because the option would not be exercised.
C) lost $0.50 per share.
D) lost $1.50 per share.
34) Barco Corp. common stock is currently selling for $36.50. A call option on Barco stock
costs $.75 per share on a normal contract of 100 shares. This option has an exercise price of
$39 and expires in one month. What is the minimum value of this option?
A) $2.50
B) $75
C) $0
D) $36.50
35) How can a currency futures contract be used as a hedge against a potentially dramatic
appreciation of a foreign currency that a U.S. company is expecting to convert into U.S.
dollars?
A) The U.S. company should sell the foreign currency using futures contracts.
B) The U.S. company should buy more foreign currency futures contracts than it
should sell.
C) The U.S. company should buy the foreign currency using futures contracts.
D) This is a standard business situation that would be favorable if it were to happen, so
no hedge is needed.
36) A call option on a stock is a financial instrument defined by which of the following
statements?
A) It obligates the investor holding it to sell the stock at the specified price at the stated
date in the future.
B) It obligates the investor holding it to buy the stock at the specified price at the stated
date in the future.
C) It gives the investor holding it the right, but not the obligation, to buy the stock at
the specified price at the stated date in the future.
D) It gives the investor holding it the right, but not the obligation, to sell the stock at
the specified price at the stated date in the future.
37) Futures contracts:
A) can be used by financial managers to reduce risk.
B) provide their holder with an opportunity to buy or sell an asset at some future time if
the asset's value has changed in a manner favorable to the futures contract holder.
C) sustain a small change in value when there is a small change in the price of the
underlying commodity.
D) have all of the characteristics stated above.

BFM114 Financial Management Part II

Corporate Risk Management

Quiz 1 (Finals)
R. E. Navor

38) How can a gold futures contract be used as a hedge against a potentially dramatic decrease
in the price of the gold needed as an input into the production of computer
microprocessors?
A) The computer company should sell gold futures contracts.
B) The computer company should sell more gold futures contracts than it should buy.
C) This is a standard business situation, which would be favorable if it were to happen,
so no hedge is needed.
D) The computer company should lower its finished product prices now in anticipation
of the decrease in the price of gold inputs.
39) Financial futures include:
A) Treasury bond futures, which are the most popular of all futures contracts in terms
of contracts issued.
B) interest rate futures, which have been around the longest.
C) stock index futures, which allow for either a cash settlement or a stock settlement.
D) all of the above.
40) A call option:
A) gives its owner the right to sell a given number of shares or some other asset at a
specified price over a given period.
B) purchaser makes money if the price of the underlying stock or asset decreases.
C) gives its owner the right to purchase a given number of shares of stock or some
other asset at a specified price over a given period.
D) does none of the above.
41) Which of the following statements is true?
A) A call option is said to be out-of-the-money if the underlying stock is selling above
the exercise price of the option.
B) A put option is said to be in-the-money if the underlying stock is selling below the
exercise price of the option.
C) A put option is said to be out-of-the-money if the underlying stock is selling below
the exercise price of the option.
D) A call option is said to be in-the-money if the underlying stock is selling below the
exercise price of the option.
42) The minimum value of a call option equals:
A) exercise price - the stock price.
B) stock price - exercise price.
C) call premium - (stock price - exercise price).
D) put premium - (exercise price - stock price).
43) The owner of a large, diversified stock portfolio could hedge against a steep decline in
prices by:
A) buying call options on a stock index.
B) buying put options on a stock index.
C) selling put options on a stock index.
D) buying both call and put options with the same expiration date.
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BFM114 Financial Management Part II

Corporate Risk Management

Quiz 1 (Finals)
R. E. Navor

44) A futures contract is a specialized form of a forward contract distinguished by a(n):

A) organized exchange.
B) standardized contract with unlimited price changes and margin requirements.
C) clearinghouse in each futures market.
D) both A and C.
45) The term futures margin refers to:
A) the percent of potential margin for profit associated with a futures contract.
B) the "good faith" money the purchaser puts down to ensure that the contract will be
carried out.
C) the interest-earning account associated with a futures contract.
D) the number of contracts outstanding on a particular futures contract.
46) The striking price is the:
A) price paid for the option.
B) price at which the stock or asset may be purchased from the writer.
C) minimum value of the option.
D) premium minus the exercise price.
47) The term open interest refers to the:
A) total amount of interest paid on an options margin account.
B) number of option contracts in existence at a point in time.
C) interest accumulated on a Treasury bond contract.
D) striking price of an interest rate swap.
48) The popularity of options can be explained by the use of options:
A) in writing future contracts.
B) as a type of financial insurance.
C) to expand the set of possible investment alternatives available.
D) both B and C.
E) all of the above.
49) A(n)________ is a financial instrument that can be used to eliminate the effect of both
favorable and unfavorable price movements.
A) convertible securities
B) call option
C) put option
D) futures contracts
50) A(n) ________ is a contract that requires the holder to buy or sell a stated commodity at a
specified price at a specified time in the future.
A) warrant
B) option
C) future
D) convertible contract