978-0133423822 Chapter 20 Part 2

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15) (Business of Life) What guidelines should determine whether or not an individual

should buy life insurance?

Question Status: Previous edition

Objective: 20.2 Understand how insurance contracts can be used to manage risk.

Keywords: insurance

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

20.3 Managing Risk by Hedging with Forward Contracts

1) 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.

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

2) A maker of breakfast cereals has contracted to buy 100,000 bushels of wheat for $4.50 a

bushel at the end of October. On the delivery date, the spot price of wheat is $4.70 per

bushel. Which of the following is true?

A) The seller of the contract has $20,000 proit.

B) The buyer of the contract has a $20,000 loss.

C) The buyer of the contract has a $20,000 proit.

D) Both A and B are true

Question Status: Revised

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

3) A large agribusiness irm has contracted to deliver 100,000 bushels of wheat for $4.50 a

bushel at the end of October. On the delivery date, the spot price of wheat is $4.70 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 proit.

D) Both A and C are true

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

4) 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.

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

5) Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the

coming winter. Swenson’s customers who take advantage of the ofer

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 ofset the risk of higher fuel prices during the

winter.

D) are purchasing a form of insurance against fuel shortages.

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

6) 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 proits if fuel prices decline.

B) it could sufer large losses if the winter wholesale cost of fuel rises above the June retail

price.

C) it will make normal proits if winter prices do not change very much from the June spot

price.

D) all of the above.

Question Status: Revised

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

7) Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the

coming winter. Customers who took advantage of the ofer prepurchased 400,000 gallons

of oil at $3.50 per gallon. Swenson hedged its position by contracting to purchase 400,000

gallons of oil for November delivery at a price of $3.00 per gallon. If the November spot

price is $3.25 per gallon, the payof to Swenson is

A) $100,000.

B) ($100,000).

C) $200,000.

D) $0.00.

Question Status: Revised

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

8) Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the

coming winter. Customers who took advantage of the ofer prepurchased 400,000 gallons

of oil at $3.50 per gallon. Swenson hedged its position by contracting to purchase 400,000

gallons of oil for November delivery at a price of $3.00 per gallon. If the November spot

price is $2.75 per gallon, the payof to Swenson is

A) $100,000.

B) ($100,000).

C) $200,000.

D) $0.00.

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

9) Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the

coming winter. Customers who took advantage of the ofer prepurchased 400,000 gallons

of oil at $3.50 per gallon. Swenson hedged its position by contracting to purchase 400,000

gallons of oil for November delivery at a price of $3.00 per gallon. If the November spot

price is $3.85 per gallon, Swenson‘s gross proit on the heating oil sold in June will be

A) $100,000.

B) ($100,000).

C) $200,000.

D) $0.00.

Question Status: Revised

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

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 34.62 euros per 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 $1.30 /euro, what is the gross proit on the

wine? (Round to the nearest dollar.)

A) $179,940

B) ($179,940)

C) $363,692

D) $283,800

Question Status: Revised

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

11) Hudson Valley Distributors wants to be sure it has 10,000 cases of Beaujolais Nouveau

to sell next November. In January, they enter into an agreement to buy the wine at a price

of 34.62 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 $1.25/euro, the payof to

Hudson Valley for hedging is

A) $13,315.

B) $17,310.

C) ($17,310).

D) ($500).

Question Status: Revised

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

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 34.62 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 $1.35/euro, Hudson

Valley’s gross proit will be

A) $283,800.

B) $138,415.

C) $162,630.

D) $179,940.

Question Status: Revised

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

13) Banque de Lyon agrees to sell Golden Socks 1,000,000 euros at a price of $1.25 to the

euro 6 months from today. If the spot price of the euro in six months is $1.35

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

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

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

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

Question Status: Revised

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

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

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

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.

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

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

proit if prices fall before the purchase is concluded.

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

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

proit if prices fall before the purchase is concluded.

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

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

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

19) Bowman-Daniela-Mainland is a major producer and exporter of agricultural

commodities. It has sold soy beans for future delivery to a Japanese irm and expects to

receive payments of 400 million yen in 6 months and another 400 million yen in 1 year. To

lock in the exchange rates on these two payments, BDM arranges forward contracts with

an investment banker to sell 400 million yen at $0.0110 in 6 months and $0.0115 in 1 year.

What will BDM’s cash low be in dollars from each of these transactions? How has it ixed

its revenue in dollars from the soy bean sales?

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

20) What motivates users of raw materials to hedge future prices by entering into futures

contracts? What is the disadvantage of this practice?

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

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?

Question Status: Previous edition

Objective: 20.3 Use forward contracts to hedge commodity price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

20.4 Managing Risk with Exchange-Traded Financial Derivatives

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.

Question Status: Previous edition

Objective: 20.4 Understand the advantages and disadvantages of using exchange-traded futures and

options contracts to hedge price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

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.

Question Status: Previous edition

Objective: 20.4 Understand the advantages and disadvantages of using exchange-traded futures and

options contracts to hedge price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

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.

Question Status: Previous edition

Objective: 20.4 Understand the advantages and disadvantages of using exchange-traded futures and

options contracts to hedge price risk.

Keywords: hedging

Principles: Principle 2: There Is a Risk–Return Tradeof

4) 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?

A) None

B) $356

C) $144

D) $32

Question Status: Previous edition

Objective: 20.4 Understand the advantages and disadvantages of using exchange-traded futures and

options contracts to hedge price risk.

Keywords: futures contracts

Principles: Principle 2: There Is a Risk–Return Tradeof

5) 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.

Question Status: Previous edition

Objective: 20.4 Understand the advantages and disadvantages of using exchange-traded futures and

options contracts to hedge price risk.

Keywords: futures contracts

Principles: Principle 2: There Is a Risk–Return Tradeof

6) 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 proit or loss for the day?

A) $800 proit

B) $356 loss

C) $800 loss

D) There is no proit or loss until the contract expires.

Question Status: Previous edition

Objective: 20.4 Understand the advantages and disadvantages of using exchange-traded futures and

options contracts to hedge price risk.

Keywords: futures contracts

Principles: Principle 2: There Is a Risk–Return Tradeof

7) A(n) ________ gives the holder the right to buy a stated number of shares at a speciied

price for a limited time.

A) stock index futures contract

B) put option

C) call option

D) interest rate futures contract

Question Status: Previous edition

Objective: 20.4 Understand the advantages and disadvantages of using exchange-traded futures and

options contracts to hedge price risk.

Keywords: call and put options

Principles: Principle 2: There Is a Risk–Return Tradeof

8) A(n) ________ gives the holder the right to sell a stated number of shares at a speciied

price for a limited time.

A) stock index futures contract

B) put option

C) call option

D) interest rate futures contract

Question Status: Previous edition

Objective: 20.4 Understand the advantages and disadvantages of using exchange-traded futures and

options contracts to hedge price risk.

Keywords: call and put options

Principles: Principle 2: There Is a Risk–Return Tradeof

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

Question Status: Previous edition

Objective: 20.4 Understand the advantages and disadvantages of using exchange-traded futures and

options contracts to hedge price risk.

Keywords: call and put options

Principles: Principle 2: There Is a Risk–Return Tradeof