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E_ch8

Financial derivatives are powerful tools that can be used by management for purposes of
A) speculation.
B) hedging.
C) human resource management.
D) A and B above.
D
A foreign currency ________ contract calls for the future delivery of a standard amount of foreign exchange at a fixed time, place, and price.
A) futures
B) forward
C) option
D) swap
A
Currency futures contracts have become standard fare and trade readily in the world money centers.
TRUE
The major difference between currency futures and forward contracts is that futures contracts are standardized for ease of trading on an exchange market whereas forward contracts are specialized and tailored to meet the needs of clients.
TRUE
Which of the following is NOT a contract specification for currency futures trading on an organized exchange?
A) size of the contract
B) maturity date
C) last trading day
D) All of the above are specified.
D
About ________ of all futures contracts are settled by physical delivery of foreign exchange between buyer and seller.
A) 0%
B) 5%
C) 50%
D) 95%
B
Futures contracts require that the purchaser deposit an initial sum as collateral. This deposit is called a
A) collateralized deposit.
B) marked market sum.
C) margin.
D) settlement.
C
A speculator in the futures market wishing to lock in a price at which they could ________ a foreign currency will ________ a futures contract.
A) buy; sell
B) sell; buy
C) buy; buy
D) none of the above
C
A speculator that has ________ a futures contract has taken a ________ position.
A) sold; long
B) purchased; short
C) sold; short
D) purchased; sold
C
Peter Simpson thinks that the U.K. pound will cost $1.43/£ in six months. A 6-month currency futures contract is available today at a rate of $1.44/£. If Peter was to speculate in the currency futures market, and his expectations are correct, which of the following strategies would earn him a profit?
A) Sell a pound currency futures contract.
B) Buy a pound currency futures contract.
C) Sell pounds today.
D) Sell pounds in six months.
A
Jack Hemmings bought a 3-month British pound futures contract for $1.4400/£ only to see the dollar appreciate to a value of $1.4250 at which time he sold the pound futures. If each pound futures contract is for an amount of £62,500, how much money did Jack gain or lose from his speculation with pound futures?
A) $937.50 loss
B) $937.50 gain
C) £937.50 loss
D) £937.50 gain
B
Which of the following statements regarding currency futures contracts and forward contracts is NOT true?
A) A futures contract is a standardized amount per currency whereas the forward contact is for any size desired.
B) A futures contract is for a fixed maturity whereas the forward contract is for any maturity you like up to one year.
C) Futures contracts trade on organized exchanges whereas forwards take place between individuals and banks with other banks via telecom linkages.
D) All of the above are true.
D
Which of the following is NOT a difference between a currency futures contract and a forward contract?
A) The futures contract is marked to market daily whereas the forward contract is only due to be settled at maturity.
B) The counterparty to the futures participant is unknown with the clearinghouse stepping into each transaction whereas the forward contract participants are in direct contact setting the forward specifications.
C) A single sales commission covers both the purchase and sale of a futures contract whereas there is no specific sales commission with a forward contract because banks earn a profit through the bid-ask spread.
D) All of the above are true.
D
A foreign currency ________ gives the purchaser the right, not the obligation, to buy a given amount of foreign exchange at a fixed price per unit for a specified period.
A) future
B) forward
C) option
D) swap
C
A foreign currency ________ option gives the holder the right to ________ a foreign currency whereas a foreign currency ________ option gives the holder the right to ________ an option.
A) call, buy, put, sell
B) call, sell, put, buy
C) put, hold, call, release
D) none of the above
A
The writer of the option is referred to as the seller, and the buyer of the option is referred to as the holder.
TRUE
The price at which an option can be exercised is called the ________.
A) premium
B) spot rate
C) strike price
D) commission
C
An ________ option can be exercised only on its expiration date, whereas an ________ option can be exercised anytime between the date of writing up to and including the exercise date.
A) American; European
B) American; British
C) Asian; American
D) European; American
D
A call option whose exercise price exceeds the spot rate is said to be ________.
A) in-the-money
B) at-the-money
C) out-of-the-money
D) over-the-spot
C
A call option whose exercise price is less than the spot rate is said to be ________.
A) in-the-money
B) at-the-money
C) out-of-the-money
D) under-the-spot
A
An option whose exercise price is equal to the spot rate is said to be ________.
A) in-the-money
B) at-the-money
C) out-of-the-money
D) on-the-spot
B
Foreign currency options are available both over-the-counter and on organized exchanges.
TRUE
The main advantage(s) of over-the-counter foreign currency options over exchange traded options is(are)
A) expiration dates tailored to the needs of the client.
B) amounts that are tailor made.
C) client desired expiration dates.
D) all of the above.
D
As a general statement, it is safe to say that businesses generally use the ________ for foreign currency option contracts, and individuals and financial institutions typically use the ________.
A) exchange markets; over-the-counter
B) over-the-counter; exchange markets
C) private; government sponsored
D) government sponsored; private
B
All exchange-traded options are settled through a clearing house but over-the-counter options are not and are thus subject to greater ________ risk.
A) exchange rate
B) country
C) counterparty
D) none of the above
C
Refer to Table 8.1. What was the closing price of the British pound on April 18, 2010?
A) $1.448/£
B) £1.448/$
C) $14.48/£
D) None of the above
A
Refer to Table 8.1. The exercise price of ________ giving the purchaser the right to sell pounds in June has a cost per pound of ________ for a total price of ________.
A) 1460; 0.68 cents; $425.00
B) 1440; 1.06 cents; $662.50
C) 1450; 1.02 cents; $637.50
D) 1440; 1.42 cents; $887.50
B
Refer to Table 8.1. The May call option on pounds with a strike price of 1440 means ________.
A) $88/£ per contract
B) $0.88/£
C) $0.0088/£
D) none of the above
C
The value of a European style call option is the sum of two components, the
A) present value plus the intrinsic value.
B) time value plus the present value.
C) intrinsic value plus the time value.
D) the intrinsic value plus the standard deviation.
C
Which of the following is NOT a factor in determining the price of a currency option?
A) the present spot rate
B) the time to maturity
C) the standard deviation of the daily spot price movement
D) All of the above are factors in determining the premium price.
D
The ________ of an option is the value if the option were to be exercised immediately. It is the options ________ value.
A) intrinsic value; maximum
B) intrinsic value; minimum
C) time value; maximum
D) time value; minimum
B
Assume that a call option has an exercise price of $1.50/³. At a spot price of $1.45/³, the call option has ________.
A) a time value of $0.04
B) a time value of $0.00
C) an intrinsic value of $0.00
D) an intrinsic value of -$0.04
C
The time value is asymmetric in value as you move away from the strike price. (i.e., the time value at two cents above the strike price is not necessarily the same as the time value two cents below the strike price.)
FALSE
Other things equal, the price of an option goes up as the volatility of the option decreases.
FALSE
The single largest interest rate risk of a firm is ________.
A) interest sensitive securities
B) debt service
C) dividend payments
D) accounts payable
B
The most widely used reference rate for standardized quotations, loan agreements, or financial derivative valuations is the ________.
A) Federal Reserve Discount rate
B) federal funds rate
C) LIBOR
D) one-year U.S. Treasury Bill
C
________ is the possibility that the borrower’s creditworthiness is reclassified by the lender at the time of renewing credit. ________ is the risk of changes in interest rates charged at the time a financial contract rate is set.
A) Credit risk; Interest rate risk
B) Repricing risk; Credit risk
C) Interest rate risk; Credit risk
D) Credit risk; Repricing risk
D
Refer to Instruction 8.1. Choosing strategy #1 will
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.
D
Refer to Instruction 8.1. Choosing strategy #2 will
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.
B
Refer to Instruction 8.1. Choosing strategy #3 will
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.
C
Refer to Instruction 8.1. Which strategy (strategies) will eliminate credit risk?
A) Strategy #1
B) Strategy #2
C) Strategy #3
D) Strategy #1 and #2
D
Refer to Instruction 8.1. If your firm felt very confident that interest rates would fall or, at worst, remain at current levels, and were very confident about the firm’s credit rating for the next 10 years, which strategy (strategies) would you likely choose? (Assume your firm is borrowing money.)
A) Strategy #3
B) Strategy #2
C) Strategy #1
D) Strategy #1, #2, or #3, you are indifferent among the choices.
A
Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #2 is (Assume your firm is borrowing money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above.
B
Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #3 is (Assume your firm is borrowing money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above.
C
Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #1? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.
A
Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #2? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.
B
Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #3? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.
C
Refer to Table 8.2. What is the all-in-cost (i.e., the internal rate of return) of the Polaris loan including the LIBOR rate, fixed spread and upfront fee?
A) 4.00%
B) 5.00%
C) 5.53%
D) 6.09%
D
Refer to Table 8.2. What portion of the cost of the loan is at risk of changing?
A) the LIBOR rate
B) the spread
C) the upfront fee
D) all of the above
A
Refer to Table 8.2. If the LIBOR rate jumps to 5.00% after the first year what will be the all-in-cost (i.e. the internal rate of return) for Polaris for the entire loan?
A) 5.25%
B) 5.50%
C) 6.09%
D) 6.58%
D
Refer to Table 8.2. If the LIBOR rate falls to 3.00% after the first year what will be the all-in-cost (i.e. the internal rate of return) for Polaris for the entire loan?
A) 4.00%
B) 4.50%
C) 5.25%
D) 5.60%
D
A/an ________ is a contract to lock in today interest rates over a given period of time.
A) forward rate agreement
B) interest rate future
C) interest rate swap
D) none of the above
B
An agreement to exchange interest payments based on a fixed payment for those based on a variable rate (or vice versa) is known as a/an ________.
A) forward rate agreement
B) interest rate future
C) interest rate swap
D) none of the above
C
An agreement to swap a fixed interest payment for a floating interest payment would be considered a/an ________.
A) currency swap
B) forward swap
C) interest rate swap
D) none of the above
C
Which of the following would be considered an example of a currency swap?
A) exchanging a dollar interest obligation for a British pound obligation
B) exchanging a eurodollar interest obligation for a dollar obligation
C) exchanging a eurodollar interest obligation for a British pound obligation
D) All of the above are example of a currency swap.
D
A firm with fixed-rate debt that expects interest rates to fall may engage in a swap agreement to
A) pay fixed-rate interest and receive floating rate interest.
B) pay floating rate and receive fixed rate.
C) pay fixed rate and receive fixed rate.
D) pay floating rate and receive floating rate.
B
A firm with variable-rate debt that expects interest rates to rise may engage in a swap agreement to
A) pay fixed-rate interest and receive floating rate interest.
B) pay floating rate and receive fixed rate.
C) pay fixed rate and receive fixed rate.
D) pay floating rate and receive floating rate.
A
A preferred interest rate swap strategy for a firm with variable-rate debt and that expects rates to go up is to
A) receive floating rate and pay fixed rate.
B) pay floating and receive fixed.
C) pay floating and pay fixed.
D) none of the above.
D
Polaris Inc. has a significant amount of bonds outstanding denominated in yen because of the attractive variable rate available to the firm in yen when the loan was made. However, Polaris does not have significant receivables in yen. Options available to Polaris to consider the risk of such a loan include which one of the following?
A) doing nothing to offset the need for yen
B) developing a currency swap of paying dollars and receiving yen
C) developing an interest rate swap of receiving a variable rate while paying a fixed rate
D) Polaris may engage in any of the strategies to a varying degree of effectiveness.
D
Which of the following would an MNE NOT want to do?
A) Pay a very low fixed rate of interest in the long term.
B) Swap into a foreign currency payment that is falling in value.
C) Swap into a floating interest rate receivable just prior to interest rates going up.
D) Swap into a fixed interest rate receivable just prior to interest rates going up.
C

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