978-0133507676 Chapter 25 Part 2

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6) Which of the following statements regarding long-term supply contracts is FALSE?

A) The market value of the contract at any point in time may not be easy to determine,

making it diicult to track gains and losses.

B) Long-term supply contracts are designed to eliminate credit risk.

C) Long-term supply contracts insulate the irms from commodity price risk.

D) Long-term supply contracts are bilateral contracts negotiated by a buyer and a seller.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

7) Which of the following statements is FALSE?

A) Long-term supply contracts cannot be entered into anonymously; the buyer and seller

know each other’s identity. This lack of anonymity may have strategic disadvantages.

B) A futures contract is an agreement to trade an asset on some future date, at a price that

is locked in today.

C) An alternative to vertical integration or storage is a long-term supply contract.

D) Long-term supply contracts are unilateral contracts negotiated by a seller.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

8) Firms use all of the following for reducing their exposure to commodity price movements

EXCEPT ________.

A) horizontal integration

B) vertical integration

C) long-term storage of inventory

D) futures contracts

AACSB Objective: Analytic Skills

Author: WC

Question Status: Previous Edition

9) Which of the following is an agreement to trade an asset on some future date, at a price

that is ixed today?

A) margin

B) futures contract

C) notional contract

D) interest rate swap

AACSB Objective: Analytic Skills

Author: WC

Question Status: Previous Edition

10) A manufacturer of breakfast cereal is concerned about corn prices. The irm anticipates

needing 1 million bushels of corn in one month. The current price of corn is $6.50 per

bushel and the futures price for delivery in one month is $7.00 per bushel. The cost to store

the corn for 1 month is $100,000. What should the irm do?

A) Hedge with futures for a total cost of $7,000,000.

B) Hedge with futures for a total cost of $6,900,000.

C) Buy the corn now and store for 1 month, for a total cost of $6,500,000.

D) Buy the corn now and store for 1 month, for a total cost of $6,600,000.

AACSB Objective: Analytic Skills

Author: WC

Question Status: Previous Edition

11) A steel maker needs 5,000,000 tons of coal next year. The current market price for coal

is $70.00 per ton. At this price, the irm expects its EBIT to be $500 million. What will the

irm’s EBIT if the irm enters into a supply contract for coal for a ixed price of $72.00 per

ton?

A) $500 million

B) $510 million

C) $490 million

D) $350 million

AACSB Objective: Analytic Skills

Author: WC

Question Status: Previous Edition

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

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

13) Your oil reinery will need to buy 250,000 barrels of crude oil in one week and it is

worried about crude oil prices. Suppose you go long 250 crude oil futures contracts, each

for 1000 barrels of crude oil, at the current futures price of $68 per barrel. Suppose futures

prices change each day over the next week as follows:

Day 1 2 3 4 5

Futures

Price 65 65.5 68 67.25 70

What is the daily and cumulative marked to market proit or loss (in dollars) that you will

have on each of the next ive days?

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

25.3 Interest Rate Risk

1) Which of the following statements is FALSE?

A) We can access a irm’s sensitivity to interest rates by examining its balance sheet.

B) Just as the interest rate sensitivity of a single cash low increases with its maturity, the

interest rate sensitivity of a stream of cash lows increases with its duration.

C) By restructuring the balance sheet to increase its duration, we can hedge the irm’s

interest rate risk.

D) A irm’s market capitalization is determined by the diference in the market value of its

assets and its liabilities.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

2) Which of the following statements is FALSE?

A) The swap contract—like forward and futures contracts—is typically structured as a

“zero-cost” security.

B) An interest rate swap is a contract entered into with a bank, much like a forward

contract, in which the irm and the bank agree to exchange the coupons from two diferent

types of loans.

C) In a standard interest rate swap, one party agrees to pay coupons based on a ixed

interest rate in exchange for receiving coupons based on the prevailing market interest

rate during each coupon period.

D) If short-term interest rates were to fall while long-term rates remained stable, then

short-term securities would fall in value relative to long-term securities, despite their

shorter duration.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

3) Which of the following statements is FALSE?

A) Corporations use interest rate swaps routinely to alter their exposure to interest rate

luctuations.

B) The value of a swap, while initially zero, will luctuate over time as interest rates

change.

C) An interest rate that adjusts to current market conditions is called a loating rate.

D) When interest rates rise, the swap’s value will rise for the party receiving the ixed rate;

conversely, it will fall for the party paying the ixed rate.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

4) What is the duration of a ive-year zero-coupon bond?

A) 2.5 years

B) 1 year

C) 5 years

D) 0 years

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

5) The duration of a ive-year bond with 8% annual coupons trading at par is closest to

________.

A) 2.5 years

B) 4.3 years

C) 5.0 years

D) 6.2 years

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

6) An interest rate that adjusts to current market conditions is called a(n) ________.

A) loating rate

B) ixed rate

C) notional rate

D) arbitrage rate

AACSB Objective: Analytic Skills

Author: WC

Question Status: Previous Edition

7) An S&L owns mortgages that have a current market value of $325 million. The duration

of this portfolio of mortgages is 15.9 years. The S&L inances its mortgages by issuing CDs

and the current value of these liabilities is $275 million. The duration of these liabilities is

4.6 years. What is the initial duration of the equity for the S&L?

A) 103.25 years

B) 78.05 years

C) 25.30 years

D) 53.00 years

AACSB Objective: Analytic Skills

Author: WC

Question Status: Previous Edition

8) The Century 22 fund has invested in a portfolio of mortgage-backed securities that has a

current market value of $245 million. The duration of this portfolio of mortgaged back

securities is 14.7 years. The fund has borrowed to purchase these securities, and the

current value of its liabilities (i.e., the current value of the bonds Century 22 has issued) is

$160 million. The duration of these liabilities is 5.4 years. What is the initial duration of the

equity for the Century 22 fund?

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

9) Luther Industries needs to borrow $50 million in cash. Currently long-term AAA rates

are 9%. Luther can borrow at 9.75% given its current credit rating. Luther is expecting

interest rates to fall over the next few years, so it would prefer to borrow at the short-term

rates and reinance after rates have dropped. Luther management is afraid, however, that

its credit rating may fall which could greatly increase the spread the irm must pay on new

borrowings. How can Luther beneit from the expected decline in future interest rates

without exposure to the risk of the potential future changes to its credit ratings bring?

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition