Fundamentals of Corporate Finance, 12e (Ross)
Chapter 23 Enterprise Risk Management
1) Which type of risk is related to damages arising from a natural disaster?
A) Financial risk
B) Strategic risk
C) Hazard risk
D) Occupational risk
E) Operational risk
2) The first step in risk management is to:
A) purchase liability insurance.
B) create an emergency cash fund.
C) establish prevention programs.
D) eliminate all international risks.
E) identify and eliminate all strategic risks.
3) Which type of insurance protects against the risks related to a defective manufactured
product?
A) Business interruption insurance
B) Employer’s liability insurance
C) Property insurance
D) Vehicle insurance
E) Commercial liability insurance
4) Which type of insurance helps replace a company’s income during the time period the
company is closed due to a major hurricane?
A) Business interruption insurance
B) Employer’s liability insurance
C) Property insurance
D) Vehicle insurance
E) Commercial liability insurance
5) Which one of the following will be least helpful in offsetting a company’s costs from a loss
event?
A) Self-insurance pool of cash
B) Insurance policy exclusion
C) Abidance with policy notification provisions
D) Currently paid insurance premiums
E) Low insurance deductible
6) Farmer Jones raises several hundred acres of corn and would suffer a significant loss should
the price of corn decline at harvest time. Which one of the following would he be doing if he
purchased financial securities to offset this price risk?
A) Insuring
B) Deriving
C) Hedging
D) Forwarding
E) Manipulating
7) The value of a stock option is dependent upon the value of the underlying stock. Thus, a stock
option is a:
A) forward agreement.
B) derivative security.
C) mezzanine asset.
D) contingent security.
E) junior security.
8) Farmer Mac owns a large orange grove in Florida. The value of his business is directly related
to the price of oranges. Which one of the following is a graphical representation of this price-
value relationship?
A) Exchange line
B) Net present value profile
C) Risk profile
D) Market line
E) Return grid
9) Farmer Ted planted 200 acres in wheat this year. The weather has been perfect and he expects
to harvest a record crop within the next two weeks. At present, he has no storage facilities and
therefore must sell his crop as soon as it is harvested. Which one of the following risks is he
facing because he must sell his crop at whatever the market price is at harvest time?
A) Futures risk
B) Volatility exposure
C) Economic exposure
D) Transactions exposure
E) Translation exposure
10) For years, your family has operated a business that produces lawn mowers. Over the years,
the industry has progressed and new mass production techniques have been developed. However,
your firm cannot afford this new technology, nor can you compete against those firms that can.
Thus, the family has decided to close its facility at the end of the year. Which one of the
following describes the risks to which your family’s firm succumbed?
A) Forward risk
B) Volatility exposure
C) Economic exposure
D) Transactions exposure
E) Translation risk
11) Which one of the following can a firm do if it effectively manages its financial risks?
A) Eliminate all of the risks faced by the firm
B) Totally eliminate all financial risks
C) Reduce the price volatility the firm faces
D) Guarantee the firm’s financial success
E) Avoid all long-term financial risks
12) A hedge between which two of the following firms is most apt to reduce each firm’s financial
risk exposure?
A) Wheat farmer and bakery
B) Oil producer and coal miner
C) Wheat grower and pharmaceutical firm
D) Pastry bakery and cotton farmer
E) Shoe manufacturer and coat manufacturer
13) Which one of the following statements is correct in relation to a firm’s short-run financial
risk?
A) Short-run financial risk results from permanent changes in prices due to new technology.
B) A financially sound firm can become financially distressed as the result of its short-run
exposure to financial risk.
C) Each segment of a business entity should be responsible for hedging its own short-run
financial risk.
D) Short-run financial risk is defined as changes resulting from fundamental shifts in the
underlying economics of a business.
E) Thus far, hedging techniques have been unsuccessful in reducing short-run financial risk.
14) Long-run financial risk:
A) can frequently be hedged on a permanent basis.
B) is best hedged on a division by division basis within a conglomerate.
C) is related more to near-term transactions than to advancements in technology.
D) generally results from changes in the underlying economics of a business.
E) can generally be hedged such that the financial viability of a firm is protected.
15) By hedging short-term financial risk, a firm can:
A) ensure a steady rate of return for its shareholders.
B) eliminate price changes over the long-term.
C) ensure its own economic viability.
D) gain time to adapt to changing market conditions.
E) eliminate its exposure to price increases in raw materials.
16) The seller of a forward contract:
A) is obligated to make delivery and accept the forward price.
B) has the option of making delivery and receiving the greater of the spot price or the contract
price.
C) has the option of either making delivery or accepting delivery.
D) is obligated to take delivery and pays the lower of the spot market price or the contract price.
E) is obligated to take delivery and pay the forward price.
17) Which one of these statements related to forward contracts is correct?
A) The buyer of a forward contract on corn benefits if the price of corn increases during the
contract period.
B) The buyer of a forward contract has the right, but not the obligation, to execute the contract
any time up to and including the settlement date.
C) Forward contracts cannot be sold but must be executed by the original parties to the contract.
D) Forward contracts recognize profits and losses on a daily basis.
E) The price at which a forward contract closes is set equal to the closing spot price on the
settlement date.
18) A forward contract:
A) requires that payment be made in full when the contract is originated.
B) provides the buyer with an option to buy an asset on the settlement date at the forward price.
C) is a binding agreement on both the buyer and the seller and nets out as a zero sum game.
D) is marked to the market daily at the seller’s request.
E) allows for immediate delivery at an agreed upon price which is to be paid on the settlement
date.
19) Which one of the following is true regarding forward contracts?
A) The upfront costs to enter a forward contract can be significant.
B) If a buyer of a forward contract earns a $200 profit, then the seller will also profit by $200.
C) The buyer wins when market prices are less than the forward price.
D) The payoff profile for the buyer of a forward contract is an upward sloping linear function.
E) If the seller of a forward contract earns a profit, then the buyer has neither a profit nor a loss.
20) Assume you are looking at a payoff profile for a forward contract on oil. Which one of these
statements correctly describes what you are seeing?
A) From the buyer’s perspective, the payoff profile is downward sloping.
B) From both the buyer’s and the seller’s perspectives, the payoff profile is upward sloping.
C) The vertical axis depicts changes in the price of oil.
D) From the seller’s perspective, the payoff profile is downward sloping.
E) The horizontal axis represents the changes in contract value.
21) This morning a national bakery agreed to pay a farmer $7.10 a bushel for 5,000 bushels of
wheat that the farmer will deliver to the bakery four months from now. Payment will be made at
the time of delivery. What is this legally binding agreement called?
A) Forward contract
B) Spot contract
C) Swap
D) Call option contract
E) Put option contract
22) Futures contracts:
A) are identical to forward contracts except for the size of the contract.
B) provide an option to purchase an asset at a specified price on the settlement date.
C) are marked to the market on a daily basis which helps eliminate credit risk.
D) are less popular in organized trading then are forward contracts.
E) are limited to contracts on financial assets.
23) All of the following are futures exchanges except:
A) CBT.
B) CME.
C) LIFFE.
D) NYSE.
E) NYMEX.
24) The futures contract on silver is based on 5,000 troy ounces and is priced in dollars and cents
per troy ounce. Assume today’s report reflects these prices for the June contract: Open 19.435,
High 19.450, Low 19.025, Settle 19.119, and Chg .369. What is the price per troy ounce that will
be used for today’s marking-to-market for this contract?
A) $19.435
B) $19.450
C) $19.025
D) $19.081
E) $19.119
25) The futures contract on silver is based on 5,000 troy ounces and is priced in dollars and cents
per troy ounce. Assume today’s report reflects these prices for the June contract: Open 19.435,
High 19.450, Low 19.025, Settle 19.119, and Chg .369. What was the highest price per troy
ounce for the silver futures contract on this day?
A) $19.435
B) $19.450
C) $19.819
D) $19.025
E) $19.119
26) By definition, which one of the following contracts is marked to the market on a daily basis?
A) Forward contract
B) Spot contract
C) Option contract
D) Swap
E) Futures contract
27) Southern Groves raises tangerines. To hedge its risk, the firm trades in the orange futures
market. This process is known as:
A) secondary trading.
B) open trading.
C) open-hedging.
D) cross-hedging.
E) perfect-hedging.
28) A U.S. bank has an agreement with a German bank to exchange $500,000 for €397,000 on
the first day of each of the next three calendar quarters. This agreement is best described as a:
A) floating exchange.
B) spot trade.
C) currency option.
D) futures contract.
E) swap contract.
29) Browning Enterprises currently has all fixed-rate debt. The firm would like to convert part of
this to floating-rate debt. Which one of the following will accomplish this for the firm?
A) Option on floating-rate bonds
B) Forward contract on U.S. Treasury bills
C) Interest rate swap
D) Currency swap
E) Interest rate call option
30) Which one of the following statements related to swaps is correct?
A) Brokerage firms are the dominant swap dealers in the U.S.
B) Swaps can be custom tailored to a firm’s needs.
C) As of 2017, all swaps are traded on a single organized exchange.
D) Swaps contracts are limited to interest rates.
E) Swap contracts are limited to a single payment at expiration.
31) Interest rate swaps:
A) are a group of option contracts with varying expiration dates.
B) are rarely used by U.S. business firms.
C) can involve exchanging one floating-rate loan for another floating-rate loan.
D) require two firms to have access to loans with equivalent terms.
E) are all based on the U.S. T-bill index.
32) Which one of the following methods of setting prices would reduce the transactions exposure
for both the buyer and seller of a commodity swap contract?
A) Setting a permanent price at which a commodity will be traded
B) Setting the price at the minimum spot price during a given period of time
C) Setting the price equal to the spot price on the delivery date
D) Using the average market price over a given period of time
E) Setting the contract price equal to some percentage, less than 100 percent, of the market price
on any given day
33) A swap dealer in the U.S.:
A) acts solely as a seller of swap contracts.
B) matches buyers to sellers.
C) only deals if its book is matched.
D) is frequently a commercial bank.
E) trades electronically via NASDAQ.
34) Company A can borrow money at a fixed rate of 7.5 percent or a variable rate set at prime
plus 1 percent. Company B can borrow money at a variable rate of prime plus .5 percent or a
fixed rate of 8 percent. Company A prefers a variable rate and Company B prefers a fixed rate.
Which one of the following statements depicts the most favorable outcome of a swap between
Companies A and B?
A) Company A could pay a fixed rate of 7.25 percent.
B) Company A could pay a fixed rate of 7.75 percent.
C) Company B could pay a fixed rate of 8 percent.
D) Company B could pay the variable prime rate + 1 percent.
E) Company A could pay the variable prime rate + .75 percent.
35) Dog’s can borrow money at either a fixed rate of 8.25 percent or a variable rate set at prime
plus .5 percent. Cat’s can borrow money at a variable rate of prime plus 1 percent or a fixed rate
of 8 percent. Dog’s prefers a fixed rate and Cat’s prefers a variable rate. Given this information,
which one of the following statements is correct?
A) After a swap with Cat’s, Dog’s could end up paying a fixed rate of 7.8 percent.
B) Cat’s should end up paying the prime rate if it agrees to an interest rate swap with Dog’s.
C) Both firms will profit if they swap an 8.15 percent fixed rate for a prime plus .75 percent
variable rate.
D) Dog’s will end up paying no more than 7.75 percent as a fixed rate after a swap with Cat’s.
E) Dog’s and Cat’s cannot swap interest rates in a manner that will be profitable for both firms.
36) Murray’s can borrow money at a fixed rate of 10.5 percent or a variable rate set at prime plus
2.25 percent. Fred’s can borrow money at a variable rate of prime plus 1.5 percent or a fixed rate
of 12 percent. Murray’s prefers a variable rate and Fred’s prefers a fixed rate. Given this
information, which one of the following statements is correct?
A) After swapping interest rates with Fred’s, Murray’s may be able to pay prime plus 2 percent.
B) Both companies can profit in a swap that will allow Murray’s to pay a variable rate of prime
plus one percent.
C) Fred’s will end up with a fixed rate of 10 percent.
D) Fred’s has the best chance of profiting if it does a currency swap with Murray’s.
E) There are no terms under which Murray’s and Fred’s can swap interest rates.