978-0132757089 Chapter 20 Part 2

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7) 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.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

8) 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.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

9) 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.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

10) 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

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

11) 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, the payoff to Hudson Valley for hedging is

________.

A) $180,000

B) ($60,000)

C) $60,000

D) $240,000

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) 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

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

13) Banque de Lyon agrees to sell Golden Socks 1,000,000 euros at a price of $1.35 to the euro 6

months from today. If the spot price of the euro in six months is $1.45,

A) the payoff to Banque de Lyon is $100,000.

B) the payoff to Banque de Lyon is ($100,000).

C) the payoff to Banque de Lyon is ($135,000).

D) the payoff to Golden Socks is ($100,000).

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

14) Forward contracts benefit only the customer due to a reduction in uncertainty.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

15) A purchaser of commodities who is completely hedged with forward contracts has eliminated

the risk that prices will rise before the purchase is concluded.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) A purchaser of commodities who is completely hedged with forward contracts will profit if

prices fall before the purchase is concluded.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

17) A seller of commodities who has entered into forward contracts with customers will profit if

prices fall before the purchase is concluded.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

18) The objective of a prudent financial manager is to eliminate all foreign exchange risk.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

400,000,000 = $4,600,000 in 1 year. By doing so it has protected itself against the possibility that

a weaker yen would have bought fewer dollars, thereby reducing its profit. It has also given up

potential gains from a stronger yen that would have purchased more dollars at the time of

payment.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

21) How is an airline that sells tickets that will be used several months in the future exposed to

the risk of rising jet fuel prices? How can it manage that risk?

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

1) 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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: futures contracts

Principles: Principle 2: There Is a Risk-Return Tradeoff

2) 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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

3) 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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: futures contracts

Principles: Principle 2: There Is a Risk-Return Tradeoff

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?

A) None

B) $356

C) $144

D) $32

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: futures margin

Principles: Principle 2: There Is a Risk-Return Tradeoff

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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: futures contracts

Principles: Principle 2: There Is a Risk-Return Tradeoff

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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: futures contracts

Principles: Principle 2: There Is a Risk-Return Tradeoff

7) 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

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: call and put options

Principles: Principle 2: There Is a Risk-Return Tradeoff

8) 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

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: call and put options

Principles: Principle 2: There Is a Risk-Return Tradeoff

9) 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

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: call and put options

Principles: Principle 2: There Is a Risk-Return Tradeoff

10) 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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: exercise or striking price

Principles: Principle 2: There Is a Risk-Return Tradeoff

11) A(n) ________ can be exercised only on the expiration date.

A) European option

B) at-the-money option

C) short option

D) American option

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: American and European options

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) 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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: option contract

Principles: Principle 2: There Is a Risk-Return Tradeoff

13) 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.

C) made a profit of $3.50 per share.

D) lost $1.50 per share.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: option contract

Principles: Principle 2: There Is a Risk-Return Tradeoff

14) 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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: option contract

Principles: Principle 2: There Is a Risk-Return Tradeoff

15) 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

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: option contract

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) 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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

17) 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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: call and put options

Principles: Principle 2: There Is a Risk-Return Tradeoff

18) 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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: futures contracts

Principles: Principle 2: There Is a Risk-Return Tradeoff

19) 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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

20) 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.

Topic: 20.4 Managing Risk with Exchange-Traded Financial Derivatives

Keywords: futures contracts

Principles: Principle 2: There Is a Risk-Return Tradeoff