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Chapter 12: Risk management

Multiple choice questions


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1 . Zap plc is a multinational company based in the UK that imports its raw materials
from Germany. It pays for raw materials in euros, has several peso-denominated assets financed through sterling borrowings at its Mexican subsidiary, and receives dollar payments for most of its exports. Which of the following exchange rate movements of the pound against the peso, the dollar and the euro will result in the maximum exchange rate exposure being faced by Zap?
Peso depreciates depreciates appreciates appreciates depreciates Value of the pound against the Dollar depreciates appreciates appreciates depreciates depreciates Euro appreciates depreciates depreciates depreciates depreciates

A B C D E

A B C D E

2 . Which of the following represent effective ways for a company to hedge its
exposures?
(1) A company importing components from the US leads its dollar payment because of their expectations that the pound will depreciate against the dollar (2) A bank with floating rate advances pays fixed interest on its customers' time deposits (3) A company buying a factory in Germany raises the finance for the purchase with a euro-denominated loan

(3) only

(2) and (4) (3) and (4) (1) only (1) and (3)

3 . Quicksilver plc will receive a payment of $503 342 in six months' time. It is currently
January 1st. The company is considering the choices it has in order to hedge its transaction exposure.
Exchange rates: $ Spot rate Six month $ forward rate Money market rates (annual): Money market rates (annual): US dollars Sterling Borrowing 6.0 percent 7.0 percent Depositing 4.5 percent 5.5 percent 1.5522 - 1.5591 1.5445- 1.5497

By making appropriate calculations, determine the amount of funds received in six months time if the exposure was hedged using: (1) Tthe forward market (2) The money market (1) 324 800 324 800 325 893 325 893 325 893 (2) 322 058 324 409 324 409 325 850 326 788

A B C D E

A B C D E

4 . A company is going to lend 8 million in 3 months' time for a period of 6 months.


The company is afraid interest rates will fall between now and the time the loan is

taken out and has decided to hedge its exposure using futures contracts. Given that the contract size of interest futures is 500 000 and that basis risk can be ignored, which of the following transactions will enable the company to successfully hedge its exposure? Buying 16 futures contracts Selling 16 futures contracts Selling 32 futures contracts Selling 8 futures contracts Buying 32 futures contracts

5 . Three months ago CCD plc sold four financial futures contracts at a price of 90 in
order to hedge its exposure of borrowing 1 million for 6 months now. Over the last three months interest rates have risen by 2 percent and the futures contract close out price is 88.5. What is the hedge efficiency of the transaction? 66 percent 75 percent 133 percent 100 percent 90 percent

6 . Which of the following collars in incorrectly specified?


A borrowers collar aims to keep an interest rate between an upper and lower limit by buying a put option and selling a call option A lenders collar aims to keep an interest rate between an upper and lower limit by buying a call option and selling a put option An importers collar aims to keep an exchange rate between an upper and lower limit by buying a sterling put option and selling a sterling call option

A sellers collar aims to keep an exchange rate between an upper and lower limit by buying a sterling put option and selling a sterling call option An exporters collar aims to keep an exchange rate between an upper and lower limit by buying a sterling call option and selling a sterling put option

7 . Which of the following will not help a company to successfully hedge against an
increase in interest rates? Purchasing a put option on futures contracts Swapping floating rate interest for fixed interest rate payments Selling interest rate futures contracts Splitting borrowing between fixed and floating rate loans Purchasing a bank-created floor

8 . Which of the following will increase the value of a US traded call option for sterling?
A depreciation of sterling against the dollar A decrease in the strike price of the option A decrease in the time to maturity of the option A decrease in exchange rate volatility None of the above

9 . Below is a table of the fixed and floating rates at which Igor plc and Jacob plc can
borrow. Igor plc is a large company requiring floating rate debt, while Jacob plc is a medium-sized company requiring fixed rate debt. LIBOR is not expected to fall below 5 percent.
Igor Jacob Fixed 10 percent 13 percent Floating LIBOR LIBOR + 0.6 percent

If a bank arranges an interest rate swap for a fee of 0.5 percent per party and if the

remaining benefit is split equally between Igor plc and Jacob plc, what will be the postswap interest rates paid by the two companies? Igor LIBOR LIBOR LIBOR LIBOR LIBOR Jacob 10.0 percent 10.5 percent 11.0 percent 10.7 percent 12.3 percent

A B C D E

+ 0.6 percent + 1.1 percent - 0.1 percent - 0.7 percent

B D C E A

10 Which of the following statements concerning swaps is incorrect? . If a currency swap involves exchanging fixed and floating interest rates it is
called a currency coupon swap Since swaps are arranged through the intermediation of a bank, arrangement fees will decrease the benefit derived that companies derive from the swap The most common type of swap after a plain vanilla swap is a basis swap, in which two fixed rates determined on different bases are exchanged The most common type of interest rate swap is a plain vanilla swap, where fixed interest payments are swapped with floating interest payments For a swap to proceed, both companies must want to raise funds by borrowing at the rate in which they do not possess a comparative advantage

11 Which of the following statements about derivatives is not true? . Swaps tend to be the most efficient method for hedging long term interest and
exchange rate exposures Financial futures should only be used when a company's exposure will definitely materialise

Tailor-made bank instruments are preferable to traded derivatives for nonstandard exposures Counterparty risk is a major drawback when hedging with financial futures

12 Identify which of the following is not an objective of hedging policy. . To provide a service to the company
To minimize foreign currency expense To secure a maximum interest cost To generate profits by anticipating derivative price movements To maximize the domestic value of foreign currency income

13 Which of the following is not a benefit that arises from hedging interest and . exchange rate exposure by using derivatives?
Hedging helps companies to reduce the volatility of cash flows Hedging allows companies to restructure their debt obligations without the need to redeem old securities and issue new ones Hedging may prevent companies failing by shielding them from the effect of large changes in interest and exchange rates Hedging interest rate exposure may enhance debt capacity Hedging allows treasury departments to generate funds through the buying and selling of derivatives

14 Which of the following is not a disadvantage of hedging? . The reduction in cash flow volatility arising from derivative hedges
The complicated tax and financial reporting treatments of derivatives

The risks associated with using external hedging instruments The costs associated with derivatives The complicated nature of hedging instruments

15 Which of the following should not be specifically referred to by the risk management . strategy of a company that uses derivatives to hedge risk?
The types of derivative instrument that are permitted to be used Limits on the size and maturity of forward exchange contracts Systems and procedures to prevent unauthorised dealings in traded options The requirement to calculate regularly the market value of the companys derivative positions Limits on the volume and principal amount of derivative transactions allowed

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