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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
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
10
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
11
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
12
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
13
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
14
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
15
