1

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 2

Chapter 18 Testbank

1. Corporate risk exposure is defined as:

A. the possibility that a firm’s realised cash flow may be higher or lower than the expected cash
flow as results of the firm’s exposures to the risk.
B. the deviation between actual and expected outcome as a result of risk exposure.
C. the possibility that a firm’s foreign liability increases as a result of expected changes in
exchange rate.
D. all of the given answers.

2. Which of the following statement describes about operational and financial risks?
A. Exposures that may impact on the normal commercial functions of a business
B. Operational exposure includes technological obsolescence, loss of market share and other
factors that may impact on the normal commercial functions of a business
C. Financial risks are those that result in unanticipated changes in projected cash flows or the
structure and value of balance sheet assets and liabilities
D. All of the given answers

3. It is argued that effective risk management is vital to the survival of an organisation because:
A. most business organisations are exposed to a wide variety of risks.
B. many business failures can be attributed to inadequate policies.
C. most organisations are exposed to interest rate risk.
D. all of the given answers are correct.

4. Risk exposure can be managed using derivative securities. The following is true about
derivative securities.
A. Derivatives are risk management products (tools) to mitigate possible risk exposure faced by
companies, investors and financial institutions.
B. Derivatives may be used to manage or mitigate risk exposure as a result of adverse movement
in interest rates, exchange rates, share price and commodity price.
C. There are four generic types of derivative instruments: forward contacts, futures contracts,
options contracts and swap contracts.
D. All of the given answers.

5. A forward contract is best described as:

A. a commitment to purchase at a future date a given amount of a commodity or an asset at a
price agreed on today.
B. an over-the-counter risk management product to hedge possible exposure as a result of
unexpected movement exchange rate.
C. a financial instrument primarily designed to enable the management of a specified risk.
D. all of the given answers.

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 3

6. Derivatives are the financial instruments that are:

A. financial assets, such as shares and bonds that derive their value from the value of the
company that issues them.
B. financial assets whose rates of return must be derived from information published in financial
pages.
C. financial assets that derive their value from underlying assets.
D. derived by investment banks, which then trade them.

7. Risk management objectives and policies should be established by:

A. the chief executive officer.
B. the chief financial officer.
C. the board of directors.
D. a company's shareholders.

8. Derivative markets exist in order to:

A. allow for the direct cash sale of common shares.
B. allow for the direct cash sale of corporate bonds.
C. reduce the risk of exposure to price fluctuations in cash markets.
D. overcome some of the information problems involved in trades in over-the-counter markets.

9. Risk exposures that may impact on the normal day-to-day running of a business are called:
A. transactional.
B. operational.
C. financial.
D. functional.

10. Portfolio managers try to use derivatives:

A. to gain from up market.
B. to limit the downside risk exposure.
C. to protect capital gain when markets decline.
D. all of the given answers.

11. When an oil company suffers severe damage to one of its oil drilling platforms, this is an
example of:
A. technological risk.
B. financial risk.
C. business risk.
D. operational risk.

12. Major financial risk exposures for corporations include:

A. a change in interest rates.

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 4

B. foreign currency appreciating.

C. company with insufficient funds to pay wages.
D. all of the given answers.

13. Which of the following businesses are most exposed to interest rate risk?
A. A company with a high equity to debt ratio
B. A company with a large amount of floating rate debt
C. An all-equity company
D. An investment company with an investment portfolio that matches its investment horizon

14. Which of the following is NOT an example of financial risk exposure for a company?
A. When interest rates increase and a larger proportion of mortgage payments are in default for a
bank
B. When a local currency decreases for an exporter
C. When a company has taken out a short-term loan and floating interest rates increase
D. When interest rates increase for a highly geared company

15. The risk exposure when a corporation appears to have insufficient funds to meet day-to-day
commitments as they fall due is known as:
A. transaction risk.
B. liquidity risk.
C. interest rate risk.
D. default risk.

16. For a company the process of risk management needs to:

A. cover financial and operational risks only.
B. cover business and operational risks only.
C. be a structured process.
D. be flexible as the nature of risk is dynamic.

17. One of the important first steps in a risk management strategy for a company is to:
A. establish related risk and product controls.
B. analyse the impact of the risk exposure.
C. select appropriate risk management strategies.
D. continually monitor the existing strategies.

18. The analysis that documents each risk exposure and then tries to measure what will be the
operational and financial effect should the risk event occur is called:
A. hedging analysis.
B. cost-benefit analysis.
C. business impact analysis.

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 5

D. SMART analysis.

19. According to the text there are three steps:

i. Assess the attitude of the organisation to each identified risk exposure
ii. Analyse the impact of the risk exposures
iii. Identify operational and financial risk exposures
Which is the correct order?
A. i, ii, iii
B. iii, ii, i
C. ii, i, iii
D. iii, i, ii

20. Which of the following statements is NOT correct?

A. Part of a company's credit policy considers how much credit a customer should be granted.
B. Cost-benefit analysis can be used to evaluate an investment of a back-up computer centre or
outsource the back-up to an outside centre provider.
C. After identification of all of its risk exposure an organisation must seek to remove all these
risks.
D. Procedural controls of a risk management strategy documents all the products that can be used
by the organisation.

21. A futures contract is an agreement that specifies the delivery of a commodity or financial
security at a:
A. predetermined future date, with a price to be negotiated at the time of delivery.
B. predetermined future date, with a currently agreed-on price.
C. currently agreed-on price, with a delivery date to be negotiated later.
D. predetermined future date, with a price and delivery to be negotiated later.

22. The following statements describe the major distinction between forward and futures
contracts.
A. A futures contract is a universally regulated (standardised) agreement to buy or sell a product
at a particular date in the future, at a pre-determined price.
B. A forward contract is a financial instrument primarily designed to enable the management of a
specified risk.
C. The basic feature of futures contract is that it is an exchange traded contract, traded on
organised exchange (e.g. ASX) while forward contracts are over-the-counter risk management
products.
D. All of the given answers.

23. A standardised agreement traded on an organised exchange for delivery of a specified

security or commodity at a specified price on a predetermined date is a/an:
A. hedging contract.

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 6

B. futures contract.
C. option contract.
D. swap contract.

24. In relation to futures markets, which of the following regarding initial margins is false?
A. A futures trader is required to pay an initial margin to the clearinghouse.
B. The initial margin will be higher for low market volatility.
C. If the futures contract price drops below the minimum percentage, the initial margin will have
to be increased.
D. In order to top up an insufficient initial margin a maintenance margin call will be made.

25. If a client investor is holding a large number of listed shares on the ASX, intends to sell in
three months' time and wishes to protect the value of the share portfolio, they may:
A. buy a futures contract based on the S&P/ASX.
B. sell a futures contract based on the S&P/ASX.
C. write a put option based on the S&P/ASX.
D. buy a call option based on the S&P/ASX.

26. Which of the following is NOT correct for ASX index futures?
A. They are cash settled.
B. They are traded electronically by the ASX Trade 24 trading platform.
C. The contract unit is valued at $25 per index point.
D. They are traded over the counter by commodity and security brokers.

27. Which of the following statements relating to the use of futures contracts is NOT correct?
A. Futures contracts are derivative products that derive from a physical market product.
B. The pricing of futures contracts is based on the price of the underlying market product.
C. Future physical market price changes are offset by a profit or loss in the futures market.
D. Futures contracts are generally closed out by delivery of the physical market product.

28. In the futures markets, if a futures contract is marked-to-market, this refers to the:
A. interaction of the demand and supply forces in the market to determine the price of the
options contract.
B. interaction of the demand and supply forces in the market to determine the price of the futures
contract.
C. settlement of gains and losses on futures contracts on a daily basis.
D. settlement of gains and losses on forward contracts on a daily basis.

29. In the futures markets, a maintenance margin call refers to:

A. funds paid to the clearing house by the brokers as insurance against losses.
B. funds paid to the clearing house by each trader to cover losses.

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 7

C. realised profits paid by the clearing house to traders.

D. the difference between the futures contracts price and the underlying asset.

30. A major advantage of forward contracts compared with futures contracts is that:
A. they are generally exposed to lower default risk.
B. they are considered more liquid.
C. they are highly standardised.
D. none of the given answers.

31. In the futures markets, when the initial margin of a futures account is topped up daily to
cover adverse futures price movements, this is called:
A. marked-to-market.
B. maintenance margin call.
C. short call.
D. closing-out.

32. The market ASX Trade 24 trades in:

A. shares 24 hours.
B. shares and bonds 24 hours.
C. futures contracts.
D. forward contracts.

33. Parties who have bought a futures contract are said to have taken a ____ position and parties
who have sold a futures contract are said to have taken a ____ position.
A. sell; short
B. buy; short
C. short; long
D. long; short

34. In the futures markets, the funds that represent 2 to 10 per cent of the futures contract that a
client pays to the futures exchange clearing house are called:
A. maintenance margin.
B. initial collateral.
C. margin call.
D. initial margin.

35. A company, worried that the cost of funds might rise during the term of their short-term
borrowing, can hedge this rise by:
A. buying futures contracts on bank-accepted bills.
B. selling futures contracts on bank-accepted bills.
C. buying bank-accepted bills on the spot market.

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 8

D. increasing the amount of money that has been borrowed.

36. In the futures markets, the price of a derivative contract for gold is based on:
A. prices of gold mining companies.
B. price of gold in the spot markets.
C. price of gold in the forward markets.
D. price of gold commodity indexes.

37. If a company intends to borrow in three months' time, it can lock in its borrowing costs by:
A. buying futures contracts.
B. selling futures contracts.
C. going long on futures contracts.
D. an arbitrage position on futures contracts.

38. A forward rate agreement (FRA) is an interest rate risk-management product, generally
provided by banks over the-counter. Which of the following statements regarding forward rate
agreements is correct?
A. FRAs are not standardised with regard to contract period and amount.
B. The centralised clearing house (CCH) holds the deposits and margin calls.
C. As a bank is the counterparty to the FRA, there is no credit risk.
D. All of the given answers.

39. If an FRA dealer quotes ‘6Mv9M 7.25 to 20', this means that the dealer is prepared to:
A. lend three-month money at 7.05% per annum.
B. borrow three-month money at 7.05% per annum.
C. lend three-month money at 7.25% per annum.
D. borrow three-month money at 7.25% per annum.

40. The advantage of using a forward rate agreement FRA over a futures contract is:
A. FRAs are highly standardised.
B. FRAs have only an initial margin and no ongoing maintenance margin.
C. the terms and conditions of an FRA can be negotiated.
D. FRAs have standardised maturities.

41. When a company contacts a bank and asks for a three-month forward rate and is quoted by
the bank's FX dealer AUD/USD0.9560-65 14.20, then the three-month forward rate is:
A. AUD/USD0.9536-45
B. AUD/USD0.9540-51
C. AUD/USD0.9574-85
D. AUD/USD0.9580-79

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 9

42. Which of the following statement describes an option contract and the major distinction
between a call and a put option?
A. An option is defined as the right, but not the obligation, to buy or to sell a specified amount of
a given stock, commodity, currency, index or debt, at a specified price (the strike price) for a
specified period of time.
B. A call option contract gives a buyer the right not the obligation to purchase an underlying
security at certain price specified in the call option contract.
C. A put option contract gives a buyer the right not the obligation to sell an underlying security
at certain price specified in the put option contract.
D. All of the given answers.

43. An option buyer:

A. has a greater insurance benefit than the purchaser of a futures contract.
B. will generally incur a lower cost compared to a purchaser of a futures contract.
C. is purchasing a very risky instrument if they don't own the underlying asset as they are locked
in to buying at expiration.
D. carries the risk of unfavourable price movements.

44. An option that gives the option buyer the right to buy the commodity or financial instrument
specified in the contact at the exercise price is called:
A. an American option.
B. a European option.
C. a call option.
D. a put option.

45. An option that gives the option buyer the right to sell the commodity or financial instrument
specified in the contact at the exercise price is called:
A. an American option.
B. a European option.
C. a call option.
D. a put option.

46. For a call option, the:

A. buyer is locked into receive the underlying asset at a specified time.
B. writer is committed to handing over the specified asset if the holder of the call exercises the
option.
C. writer may choose whether or not to deliver the underlying asset at a specified time.
D. buyer will choose to exercise the option only if the price of the underlying asset falls.

47. In a put option, the:

A. writer is locked into handing over the underlying asset at a specified time.
B. buyer has the option to sell the specified asset at a specified time.

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 10

C. buyer is locked into receiving the underlying asset at a specified time.

D. seller must hand over the specified asset at a specified time.

48. Which of the following statement describes about the American and European option
contract?
A. The European-type option gives the option buyer the right, not the obligation, to exercise the
option only on the contract expiration date.
B. The American-type option gives the option buyer the right, not the obligation, to exercise the
option at any time up to the contract expiration date.
C. American-type options are more flexible risk management products while European contracts
are less liquid.
D. All of the given answers.

49. The holder of an American call option has the right to:
A. buy the underlying asset at the exercise price on or before the expiration date.
B. buy the underlying asset only on the expiration date.
C. sell the underlying asset at the exercise price on or before the contract expiration date.
D. sell the underlying asset only at the expiration date.

50. The European call option gives the option buyer the right to exercise the option:
A. at any time up to the expiration date.
B. only on the expiration date.
C. if the price of the underlying asset falls below the exercise price.
D. immediately after the payment of dividends.

51. In the option markets, the price specified in the contract at which the buyer of the option can
buy or sell the specified commodity or financial instrument is called the:
A. call price.
B. exercise price.
C. settlement price.
D. spot price.

52. For the writer of a put option, if the underlying share price:
A. moves above the strike price, the potential profits are unlimited.
B. drops below the strike price, the potential profits are unlimited.
C. moves above the strike price, the potential profits are limited to the premium.
D. moves above the strike price, the premium is reduced by the difference.

53. In the derivative markets a swap is:

A. another name for a call option.
B. another name for a put option.

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 11

C. an agreement between two or more persons to exchange cash flows over some future period.
D. the name for the exchange of a futures contract for an option contract.

54. When two parties exchange the respective interest payments associated with existing debt
borrowed in the capital markets, this is called a/an:
A. interest exchange.
B. financial switch.
C. swap.
D. financial transfer.

55. An agreement between two parties to exchange a series of cash flows similar to those
resulting from an exchange of different types of bonds is called a/an:
A. credit swap.
B. interest rate swap.
C. yield curve swap.
D. notional spread.

56. The growth of the swaps market has been due to firms wanting to:
A. lower the cost of funds.
B. hedge interest rate risk.
C. lock in profit margins.
D. do all of the given answers.

57. A forward contract is _____ and a futures contract is _____.

A. an over-the-counter contract; an exchange contract
B. an over-the-counter contract; a dealer market contract
C. exchange contract; over-the-counter contract
D. exchange contract; exchange contract

58. An importer in Singapore must pay USD7 million for Dell computers in 60 days. The bank
gives the following quotation—SGD/USD.8319–22, 12:15. If the importer locks in the exchange
rate, how much SGD must be paid in 60 days?
A. SGD8 396 306
B. SGD8 402 353
C. SGD8 411 440
D. SGD8 414 473

59. A soybean farmer has paid $.40 per bushel for a put contract with a strike price of $4.50 per
bushel. The current price is $4.80. The breakeven point for the farmer is _____. The farmer will
exercise the option as long as the price falls below _____.
A. $4.10; $4.10

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 12

B. $4.50; $4.10
C. $4.10; $4.50
D. $4.50; $4.50

60. In a plain vanilla interest rate swap the following is NOT true.
A. Notional principal is used to figure the payments.
B. Interest payments and principal amounts are exchanged.
C. Only the net amount need be paid.
D. Fixed-for-variable is the main type of interest rate swap.

61. A New Zealand company issues short-term notes in the Frankfurt market raising euros. At
the same time it spends these euros to fund operations in Portugal. Based upon this information,
the major risk(s) appear to be:
A. interest rate risk only.
B. foreign currency risk only.
C. interest-rate risk and operational risk.
D. interest-rate risk and foreign currency risk.

62. Investment Manager expects to invest in Australian equities in six months but is concerned
that they may appreciate sharply in the near future. Investment Manager can hedge by:
A. buying futures contracts based on the S&P/ASX 50 index now and receiving delivery of the
equities in six months.
B. buying futures contracts based on the S&P/ASX 50 index now and closing this position in
about six months with a sell order.
C. selling futures contracts based on the S&P/ASX 50 index now and receiving delivery of the
equities in six months.
D. selling futures contracts based on the S&P/ASX 50 index now and closing this position in
about six months with a buy order.

63. The holder of an option:

A. makes a down payment called a premium which acts as a credit for adverse price movements.
B. pays a premium which constitutes a known limited loss.
C. pays a premium that is refunded if the option holder exercises.
D. must put up a maintenance margin in case the market moves adversely.

64. The reason that American options have greater value than European options is that:
A. American equity markets are larger than European equity markets.
B. European option holders will exercise on the expiry date where value tends to be the greatest.
C. prices for options tend to be higher in the US than in Europe.
D. American option holders are entitled to exercise on a greater number of days than European
option holders are allowed to exercise.

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 13

65. For a corporation, external risk management strategies include leading and lagging FX
transactions.
True False

66. A government introducing legislation requiring carbon-emitting companies to lower their

carbon emissions is an example of operational risk.
True False

67. A commercial bank has to consider in its risk management procedures not only interest rate
risk but also credit risk and liquidity risk.
True False

68. An analysis of the costs associated with establishing and maintaining a particular risk
management strategy versus the risk management benefits to be obtained is called a SMART
analysis.
True False

69. As risks for a company vary over time a flexible and robust risk management strategy is
essential for an organisation no matter how large or small.
True False

70. The prime function of a futures clearing house is to bring together the buyer and seller in
each futures contract.
True False

71. Forward contracts are less risky than futures contracts because the buyers of the contracts can
negotiate with the counterparty about the terms and conditions.
True False

72. Potential gains and losses are quite different for the buyers and writers (sellers) of call and
put options.
True False

73. The maintenance margin call refers to the difference between the futures market price and the
futures contract.
True False

74. An FRA expressed as 3Mv5M means the settlement date is in three months and the interest
cover is for a five-month period.

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 14

True False

75. An American put option is worth more than a European put option as it can be advantageous
to exercise an American put option before expiry.
True False

76. How is a swap similar to a bond?

______________________________________________________________________________

77. Discuss financial risks and their impacts on banks’ liquidity and capital adequacy position.
______________________________________________________________________________

78. What is netting and why is netting in swap payments helpful?

______________________________________________________________________________

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 15

Chapter 18 Testbank Key

1. Corporate risk exposure is defined as:

A. the possibility that a firm’s realised cash flow may be higher or lower than the expected cash
flow as results of the firm’s exposures to the risk.
B. the deviation between actual and expected outcome as a result of risk exposure.
C. the possibility that a firm’s foreign liability increases as a result of expected changes in
exchange rate.
D. all of the given answers.
Ans: D
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: Introduction
Topic: An introduction to risk management and derivatives

2. Which of the following statement describes about operational and financial risks?
A. Exposures that may impact on the normal commercial functions of a business
B. Operational exposure includes technological obsolescence, loss of market share and other
factors that may impact on the normal commercial functions of a business
C. Financial risks are those that result in unanticipated changes in projected cash flows or the
structure and value of balance sheet assets and liabilities
D. All of the given answers
Ans: D
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: Introduction
Topic: An introduction to risk management and derivatives

3. It is argued that effective risk management is vital to the survival of an organisation because:
A. most business organisations are exposed to a wide variety of risks.
B. many business failures can be attributed to inadequate policies.
C. most organisations are exposed to interest rate risk.
D. all of the given answers are correct.
Ans: D

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of McGraw-Hill Education.
 16

AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: Introduction
Topic: An introduction to risk management and derivatives

4. Risk exposure can be managed using derivative securities. The following is true about
derivative securities.
A. Derivatives are risk management products (tools) to mitigate possible risk exposure faced by
companies, investors and financial institutions.
B. Derivatives may be used to manage or mitigate risk exposure as a result of adverse movement
in interest rates, exchange rates, share price and commodity price.
C. There are four generic types of derivative instruments: forward contacts, futures contracts,
options contracts and swap contracts.
D. All of the given answers.
Ans: D
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 17.03 Explain procedures involved in the implementation of market-based hedging techniques, in particular forward
exchange contracts and money-market hedging.
Section: 18.01 Understanding risk
Topic: Understanding risk

5. A forward contract is best described as:

A. a commitment to purchase at a future date a given amount of a commodity or an asset at a
price agreed on today.
B. an over-the-counter risk management product to hedge possible exposure as a result of
unexpected movement exchange rate.
C. a financial instrument primarily designed to enable the management of a specified risk.
D. all of the given answers.
Ans: D
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 17.03 Explain procedures involved in the implementation of market-based hedging techniques, in particular forward
exchange contracts and money-market hedging.
Section: 17.03 Risk Management: market-based hedging techniques
Topic: Risk Management: market-based hedging techniques

6. Derivatives are the financial instruments that are:

A. financial assets, such as shares and bonds that derive their value from the value of the
company that issues them.

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of McGraw-Hill Education.
 17

B. financial assets whose rates of return must be derived from information published in financial
pages.
C. financial assets that derive their value from underlying assets.
D. derived by investment banks, which then trade them.
Ans: C
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: Introduction
Topic: An introduction to risk management and derivatives

7. Risk management objectives and policies should be established by:

A. the chief executive officer.
B. the chief financial officer.
C. the board of directors.
D. a company's shareholders.
Ans: C
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: Introduction
Topic: An introduction to risk management and derivatives

8. Derivative markets exist in order to:

A. allow for the direct cash sale of common shares.
B. allow for the direct cash sale of corporate bonds.
C. reduce the risk of exposure to price fluctuations in cash markets.
D. overcome some of the information problems involved in trades in over-the-counter markets.
Ans: C
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: Introduction
Topic: An introduction to risk management and derivatives

9. Risk exposures that may impact on the normal day-to-day running of a business are called:
A. transactional.
B. operational.
C. financial.
D. functional.

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of McGraw-Hill Education.
 18

Ans: B
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: 18.01 Understanding risk
Topic: Understanding risk

10. Portfolio managers try to use derivatives:

A. to gain from up market.
B. to limit the downside risk exposure.
C. to protect capital gain when markets decline.
D. all of the given answers.
Ans: D
AACSB: Communication
Bloom's: Reflection
Difficulty: Medium
Est time: <1 minute
Learning Objective: 17.03 Explain procedures involved in the implementation of market-based hedging techniques, in particular forward
exchange contracts and money-market hedging.
Section: 17.03 Risk Management: market-based hedging techniques
Topic: Risk Management: market-based hedging techniques

11. When an oil company suffers severe damage to one of its oil drilling platforms, this is an
example of:
A. technological risk.
B. financial risk.
C. business risk.
D. operational risk.
Ans: D
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: 18.01 Understanding risk
Topic: Understanding risk

12. Major financial risk exposures for corporations include:

A. a change in interest rates.
B. foreign currency appreciating.
C. company with insufficient funds to pay wages.
D. all of the given answers.
Ans: D

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of McGraw-Hill Education.
 19

AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: 18.01 Understanding risk
Topic: Understanding risk

13. Which of the following businesses are most exposed to interest rate risk?
A. A company with a high equity to debt ratio
B. A company with a large amount of floating rate debt
C. An all-equity company
D. An investment company with an investment portfolio that matches its investment horizon
Ans: D
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: 18.01 Understanding risk
Topic: Understanding risk

14. Which of the following is NOT an example of financial risk exposure for a company?
A. When interest rates increase and a larger proportion of mortgage payments are in default for a
bank
B. When a local currency decreases for an exporter
C. When a company has taken out a short-term loan and floating interest rates increase
D. When interest rates increase for a highly geared company
Ans: B
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: 18.01 Understanding risk
Topic: Understanding risk

15. The risk exposure when a corporation appears to have insufficient funds to meet day-to-day
commitments as they fall due is known as:
A. transaction risk.
B. liquidity risk.
C. interest rate risk.
D. default risk.
Ans: B

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 20

AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: 18.01 Understanding risk
Topic: Understanding risk

16. For a company the process of risk management needs to:

A. cover financial and operational risks only.
B. cover business and operational risks only.
C. be a structured process.
D. be flexible as the nature of risk is dynamic.
Ans: C
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.02 Construct and analyse a structured risk management process that includes the identification, analysis and assessment
of risk exposures, the selection of risk management strategies and products and the establishment of control, monitoring, audit and review
procedures.
Section: 18.02 The risk management process
Topic: The risk management process

17. One of the important first steps in a risk management strategy for a company is to:
A. establish related risk and product controls.
B. analyse the impact of the risk exposure.
C. select appropriate risk management strategies.
D. continually monitor the existing strategies.
Ans: B
AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.02 Construct and analyse a structured risk management process that includes the identification, analysis and assessment
of risk exposures, the selection of risk management strategies and products and the establishment of control, monitoring, audit and review
procedures.
Section: 18.02 The risk management process
Topic: The risk management process

18. The analysis that documents each risk exposure and then tries to measure what will be the
operational and financial effect should the risk event occur is called:
A. hedging analysis.
B. cost-benefit analysis.
C. business impact analysis.
D. SMART analysis.
Ans: B

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of McGraw-Hill Education.
 21

AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.02 Construct and analyse a structured risk management process that includes the identification, analysis and assessment
of risk exposures, the selection of risk management strategies and products and the establishment of control, monitoring, audit and review
procedures.
Section: 18.02 The risk management process
Topic: The risk management process

19. According to the text there are three steps:

i. Assess the attitude of the organisation to each identified risk exposure
ii. Analyse the impact of the risk exposures
iii. Identify operational and financial risk exposures
Which is the correct order?
A. i, ii, iii
B. iii, ii, i
C. ii, i, iii
D. iii, i, ii
Ans: B
AACSB: Reflective thinking
Bloom's: Synthesis
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.02 Construct and analyse a structured risk management process that includes the identification, analysis and assessment
of risk exposures, the selection of risk management strategies and products and the establishment of control, monitoring, audit and review
procedures.
Section: 18.02 The risk management process
Topic: The risk management process

20. Which of the following statements is NOT correct?

A. Part of a company's credit policy considers how much credit a customer should be granted.
B. Cost-benefit analysis can be used to evaluate an investment of a back-up computer centre or
outsource the back-up to an outside centre provider.
C. After identification of all of its risk exposure an organisation must seek to remove all these
risks.
D. Procedural controls of a risk management strategy documents all the products that can be used
by the organisation.
Ans: C
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.02 Construct and analyse a structured risk management process that includes the identification, analysis and assessment
of risk exposures, the selection of risk management strategies and products and the establishment of control, monitoring, audit and review
procedures.
Section: 18.02 The risk management process
Topic: The risk management process

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of McGraw-Hill Education.
 22

21. A futures contract is an agreement that specifies the delivery of a commodity or financial
security at a:
A. predetermined future date, with a price to be negotiated at the time of delivery.
B. predetermined future date, with a currently agreed-on price.
C. currently agreed-on price, with a delivery date to be negotiated later.
D. predetermined future date, with a price and delivery to be negotiated later.
Ans: B
AACSB: Communication
Bloom's: Comprehension
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

22. The following statements describe the major distinction between forward and futures
contracts.
A. A futures contract is a universally regulated (standardised) agreement to buy or sell a product
at a particular date in the future, at a pre-determined price.
B. A forward contract is a financial instrument primarily designed to enable the management of a
specified risk.
C. The basic feature of futures contract is that it is an exchange traded contract, traded on
organised exchange (e.g. ASX) while forward contracts are over-the-counter risk management
products.
D. All of the given answers.
Ans: D
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

23. A standardised agreement traded on an organised exchange for delivery of a specified

security or commodity at a specified price on a predetermined date is a/an:
A. hedging contract.
B. futures contract.
C. option contract.
D. swap contract.
Ans: B
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

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of McGraw-Hill Education.
 23

24. In relation to futures markets, which of the following regarding initial margins is false?
A. A futures trader is required to pay an initial margin to the clearinghouse.
B. The initial margin will be higher for low market volatility.
C. If the futures contract price drops below the minimum percentage, the initial margin will have
to be increased.
D. In order to top up an insufficient initial margin a maintenance margin call will be made.
Ans: B
AACSB: Communication
Bloom's: Comprehension
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

25. If a client investor is holding a large number of listed shares on the ASX, intends to sell in
three months' time and wishes to protect the value of the share portfolio, they may:
A. buy a futures contract based on the S&P/ASX.
B. sell a futures contract based on the S&P/ASX.
C. write a put option based on the S&P/ASX.
D. buy a call option based on the S&P/ASX.
Ans: B
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

26. Which of the following is NOT correct for ASX index futures?
A. They are cash settled.
B. They are traded electronically by the ASX Trade 24 trading platform.
C. The contract unit is valued at $25 per index point.
D. They are traded over the counter by commodity and security brokers.
Ans: D
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

27. Which of the following statements relating to the use of futures contracts is NOT correct?
A. Futures contracts are derivative products that derive from a physical market product.

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of McGraw-Hill Education.
 24

B. The pricing of futures contracts is based on the price of the underlying market product.
C. Future physical market price changes are offset by a profit or loss in the futures market.
D. Futures contracts are generally closed out by delivery of the physical market product.
Ans: D
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

28. In the futures markets, if a futures contract is marked-to-market, this refers to the:
A. interaction of the demand and supply forces in the market to determine the price of the
options contract.
B. interaction of the demand and supply forces in the market to determine the price of the futures
contract.
C. settlement of gains and losses on futures contracts on a daily basis.
D. settlement of gains and losses on forward contracts on a daily basis.
Ans: C
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

29. In the futures markets, a maintenance margin call refers to:

A. funds paid to the clearing house by the brokers as insurance against losses.
B. funds paid to the clearing house by each trader to cover losses.
C. realised profits paid by the clearing house to traders.
D. the difference between the futures contracts price and the underlying asset.
Ans: B
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

30. A major advantage of forward contracts compared with futures contracts is that:
A. they are generally exposed to lower default risk.
B. they are considered more liquid.
C. they are highly standardised.
D. none of the given answers.
Ans: D

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of McGraw-Hill Education.
 25

AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

31. In the futures markets, when the initial margin of a futures account is topped up daily to
cover adverse futures price movements, this is called:
A. marked-to-market.
B. maintenance margin call.
C. short call.
D. closing-out.
Ans: B
AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

32. The market ASX Trade 24 trades in:

A. shares 24 hours.
B. shares and bonds 24 hours.
C. futures contracts.
D. forward contracts.
Ans: B
AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

33. Parties who have bought a futures contract are said to have taken a ____ position and parties
who have sold a futures contract are said to have taken a ____ position.
A. sell; short
B. buy; short
C. short; long
D. long; short
Ans: D

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of McGraw-Hill Education.
 26

AACSB: Communication
Bloom's: Knowledge
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: Introduction
Topic: An introduction to risk management and derivatives

34. In the futures markets, the funds that represent 2 to 10 per cent of the futures contract that a
client pays to the futures exchange clearing house are called:
A. maintenance margin.
B. initial collateral.
C. margin call.
D. initial margin.
Ans: D
AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.02 Construct and analyse a structured risk management process that includes the identification, analysis and assessment
of risk exposures, the selection of risk management strategies and products and the establishment of control, monitoring, audit and review
procedures.
Section: 18.02 The risk management process
Topic: The risk management process

35. A company, worried that the cost of funds might rise during the term of their short-term
borrowing, can hedge this rise by:
A. buying futures contracts on bank-accepted bills.
B. selling futures contracts on bank-accepted bills.
C. buying bank-accepted bills on the spot market.
D. increasing the amount of money that has been borrowed.
Ans: B
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

36. In the futures markets, the price of a derivative contract for gold is based on:
A. prices of gold mining companies.
B. price of gold in the spot markets.
C. price of gold in the forward markets.
D. price of gold commodity indexes.
Ans: B

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of McGraw-Hill Education.
 27

AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

37. If a company intends to borrow in three months' time, it can lock in its borrowing costs by:
A. buying futures contracts.
B. selling futures contracts.
C. going long on futures contracts.
D. an arbitrage position on futures contracts.
Ans: B
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

38. A forward rate agreement (FRA) is an interest rate risk-management product, generally
provided by banks over the-counter. Which of the following statements regarding forward rate
agreements is correct?
A. FRAs are not standardised with regard to contract period and amount.
B. The centralised clearing house (CCH) holds the deposits and margin calls.
C. As a bank is the counterparty to the FRA, there is no credit risk.
D. All of the given answers.
Ans: A
AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.04 Review the operation of forward exchange contracts and forward rate agreements.
Section: 18.04 Forward contracts
Topic: Forward contracts

39. If an FRA dealer quotes ‘6Mv9M 7.25 to 20', this means that the dealer is prepared to:
A. lend three-month money at 7.05% per annum.
B. borrow three-month money at 7.05% per annum.
C. lend three-month money at 7.25% per annum.
D. borrow three-month money at 7.25% per annum.
Ans: C

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of McGraw-Hill Education.
 28

AACSB: Analysis
Bloom's: Application
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.04 Review the operation of forward exchange contracts and forward rate agreements.
Section: 18.04 Forward contracts
Topic: Forward contracts

40. The advantage of using a forward rate agreement FRA over a futures contract is:
A. FRAs are highly standardised.
B. FRAs have only an initial margin and no ongoing maintenance margin.
C. the terms and conditions of an FRA can be negotiated.
D. FRAs have standardised maturities.
Ans: C
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.04 Review the operation of forward exchange contracts and forward rate agreements.
Section: 18.04 Forward contracts
Topic: Forward contracts

41. When a company contacts a bank and asks for a three-month forward rate and is quoted by
the bank's FX dealer AUD/USD0.9560-65 14.20, then the three-month forward rate is:
A. AUD/USD0.9536-45
B. AUD/USD0.9540-51
C. AUD/USD0.9574-85
D. AUD/USD0.9580-79
Ans: C
AACSB: Analysis
Bloom's: Analysis
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

42. Which of the following statement describes an option contract and the major distinction
between a call and a put option?
A. An option is defined as the right, but not the obligation, to buy or to sell a specified amount of
a given stock, commodity, currency, index or debt, at a specified price (the strike price) for a
specified period of time.
B. A call option contract gives a buyer the right not the obligation to purchase an underlying
security at certain price specified in the call option contract.
C. A put option contract gives a buyer the right not the obligation to sell an underlying security
at certain price specified in the put option contract.
D. All of the given answers.
Ans: D

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of McGraw-Hill Education.
 29

AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

43. An option buyer:

A. has a greater insurance benefit than the purchaser of a futures contract.
B. will generally incur a lower cost compared to a purchaser of a futures contract.
C. is purchasing a very risky instrument if they don't own the underlying asset as they are locked
in to buying at expiration.
D. carries the risk of unfavourable price movements.
Ans: A
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

44. An option that gives the option buyer the right to buy the commodity or financial instrument
specified in the contact at the exercise price is called:
A. an American option.
B. a European option.
C. a call option.
D. a put option.
Ans: C
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

45. An option that gives the option buyer the right to sell the commodity or financial instrument
specified in the contact at the exercise price is called:
A. an American option.
B. a European option.
C. a call option.
D. a put option.
Ans: D

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of McGraw-Hill Education.
 30

AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

46. For a call option, the:

A. buyer is locked into receive the underlying asset at a specified time.
B. writer is committed to handing over the specified asset if the holder of the call exercises the
option.
C. writer may choose whether or not to deliver the underlying asset at a specified time.
D. buyer will choose to exercise the option only if the price of the underlying asset falls.
Ans: B
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

47. In a put option, the:

A. writer is locked into handing over the underlying asset at a specified time.
B. buyer has the option to sell the specified asset at a specified time.
C. buyer is locked into receiving the underlying asset at a specified time.
D. seller must hand over the specified asset at a specified time.
Ans: B
AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

48. Which of the following statement describes about the American and European option
contract?
A. The European-type option gives the option buyer the right, not the obligation, to exercise the
option only on the contract expiration date.
B. The American-type option gives the option buyer the right, not the obligation, to exercise the
option at any time up to the contract expiration date.
C. American-type options are more flexible risk management products while European contracts
are less liquid.
D. All of the given answers.
Ans: D

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of McGraw-Hill Education.
 31

AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

49. The holder of an American call option has the right to:
A. buy the underlying asset at the exercise price on or before the expiration date.
B. buy the underlying asset only on the expiration date.
C. sell the underlying asset at the exercise price on or before the contract expiration date.
D. sell the underlying asset only at the expiration date.
Ans: A
AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

50. The European call option gives the option buyer the right to exercise the option:
A. at any time up to the expiration date.
B. only on the expiration date.
C. if the price of the underlying asset falls below the exercise price.
D. immediately after the payment of dividends.
Ans: B
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

51. In the option markets, the price specified in the contract at which the buyer of the option can
buy or sell the specified commodity or financial instrument is called the:
A. call price.
B. exercise price.
C. settlement price.
D. spot price.
Ans: B

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of McGraw-Hill Education.
 32

AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

52. For the writer of a put option, if the underlying share price:
A. moves above the strike price, the potential profits are unlimited.
B. drops below the strike price, the potential profits are unlimited.
C. moves above the strike price, the potential profits are limited to the premium.
D. moves above the strike price, the premium is reduced by the difference.
Ans: C
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

53. In the derivative markets a swap is:

A. another name for a call option.
B. another name for a put option.
C. an agreement between two or more persons to exchange cash flows over some future period.
D. the name for the exchange of a futures contract for an option contract.
Ans: C
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.06 Consider the structure of an interest rate swap and a cross-currency swap.
Section: 18.06 Swap contracts
Topic: Swap contracts

54. When two parties exchange the respective interest payments associated with existing debt
borrowed in the capital markets, this is called a/an:
A. interest exchange.
B. financial switch.
C. swap.
D. financial transfer.
Ans: C

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of McGraw-Hill Education.
 33

AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.06 Consider the structure of an interest rate swap and a cross-currency swap.
Section: 18.06 Swap contracts
Topic: Swap contracts

55. An agreement between two parties to exchange a series of cash flows similar to those
resulting from an exchange of different types of bonds is called a/an:
A. credit swap.
B. interest rate swap.
C. yield curve swap.
D. notional spread.
Ans: B
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.06 Consider the structure of an interest rate swap and a cross-currency swap.
Section: 18.06 Swap contracts
Topic: Swap contracts

56. The growth of the swaps market has been due to firms wanting to:
A. lower the cost of funds.15ene
B. hedge interest rate risk.
C. lock in profit margins.
D. do all of the given answers.
Ans: D
AACSB: Analysis
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.06 Consider the structure of an interest rate swap and a cross-currency swap.
Section: 18.06 Swap contracts
Topic: Swap contracts

57. A forward contract is _____ and a futures contract is _____.

A. an over-the-counter contract; an exchange contract
B. an over-the-counter contract; a dealer market contract
C. exchange contract; over-the-counter contract
D. exchange contract; exchange contract
Ans: A

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of McGraw-Hill Education.
 34

AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Learning Objective: 18.04 Review the operation of forward exchange contracts and forward rate agreements.
Section: 18.04 Forward contracts
Topic: Forward contracts

58. An importer in Singapore must pay USD7 million for Dell computers in 60 days. The bank
gives the following quotation—SGD/USD.8319–22, 12:15. If the importer locks in the exchange
rate, how much SGD must be paid in 60 days?
A. SGD8 396 306
B. SGD8 402 353
C. SGD8 411 440
D. SGD8 414 473
Ans: B
AACSB: Analysis
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 18.04 Review the operation of forward exchange contracts and forward rate agreements.
Section: 18.04 Forward contracts
Topic: Forward contracts

59. A soybean farmer has paid $.40 per bushel for a put contract with a strike price of $4.50 per
bushel. The current price is $4.80. The breakeven point for the farmer is _____. The farmer will
exercise the option as long as the price falls below _____.
A. $4.10; $4.10
B. $4.50; $4.10
C. $4.10; $4.50
D. $4.50; $4.50
Ans: C
AACSB: Analysis
Bloom's: Analysis
Difficulty: Medium
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

60. In a plain vanilla interest rate swap the following is NOT true.
A. Notional principal is used to figure the payments.
B. Interest payments and principal amounts are exchanged.
C. Only the net amount need be paid.
D. Fixed-for-variable is the main type of interest rate swap.
Ans: B

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 35

AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.06 Consider the structure of an interest rate swap and a cross-currency swap.
Section: 18.06 Swap contracts
Topic: Swap contracts

61. A New Zealand company issues short-term notes in the Frankfurt market raising euros. At
the same time it spends these euros to fund operations in Portugal. Based upon this information,
the major risk(s) appear to be:
A. interest rate risk only.
B. foreign currency risk only.
C. interest-rate risk and operational risk.
D. interest-rate risk and foreign currency risk.
Ans: C
AACSB: Reflective thinking
Bloom's: Comprehension
Difficulty: Hard
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: 18.01 Understanding risk
Topic: Understanding risk

62. Investment Manager expects to invest in Australian equities in six months but is concerned
that they may appreciate sharply in the near future. Investment Manager can hedge by:
A. buying futures contracts based on the S&P/ASX 50 index now and receiving delivery of the
equities in six months.
B. buying futures contracts based on the S&P/ASX 50 index now and closing this position in
about six months with a sell order.
C. selling futures contracts based on the S&P/ASX 50 index now and receiving delivery of the
equities in six months.
D. selling futures contracts based on the S&P/ASX 50 index now and closing this position in
about six months with a buy order.
Ans: B
AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

63. The holder of an option:

A. makes a down payment called a premium which acts as a credit for adverse price movements.
B. pays a premium which constitutes a known limited loss.
C. pays a premium that is refunded if the option holder exercises.

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of McGraw-Hill Education.
 36

D. must put up a maintenance margin in case the market moves adversely.

Ans: B
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

64. The reason that American options have greater value than European options is that:
A. American equity markets are larger than European equity markets.
B. European option holders will exercise on the expiry date where value tends to be the greatest.
C. prices for options tend to be higher in the US than in Europe.
D. American option holders are entitled to exercise on a greater number of days than European
option holders are allowed to exercise.
Ans: D
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: Section: 18.05 Option contracts
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

65. For a corporation, external risk management strategies include leading and lagging FX
transactions.
Ans: False
Feedback: This is an internal strategy for a corporation.
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: Introduction
Topic: Introduction

66. A government introducing legislation requiring carbon-emitting companies to lower their

carbon emissions is an example of operational risk.
Ans: True
Feedback: Operational risks are those exposures that may impact on normal commercial
operations.

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of McGraw-Hill Education.
 37

AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: 18.01 Understanding risk
Topic: Understanding risk

67. A commercial bank has to consider in its risk management procedures not only interest rate
risk but also credit risk and liquidity risk.
Ans: True
Feedback: Interest rate risk can directly affect loan defaults for a bank and so lead to
consequential risks of credit risk and liquidity risk.
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: 18.01 Understanding risk
Topic: Understanding risk

68. An analysis of the costs associated with establishing and maintaining a particular risk
management strategy versus the risk management benefits to be obtained is called a SMART
analysis.
Ans: False
Feedback: When an analysis of the costs associated with establishing and maintaining a
particular risk management strategy versus the risk management benefits to be obtained is done
this analysis is called a cost-benefit analysis.
AACSB: Communication
Bloom's: Comprehension
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.02 Construct and analyse a structured risk management process that includes the identification, analysis and assessment
of risk exposures, the selection of risk management strategies and products and the establishment of control, monitoring, audit and review
procedures.
Section: 18.02 The risk management process
Topic: The risk management process

69. As risks for a company vary over time a flexible and robust risk management strategy is
essential for an organisation no matter how large or small.
Ans: True
Feedback: As well as having a structured risk management process a company must also have an
ongoing one.

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of McGraw-Hill Education.
 38

AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.02 Construct and analyse a structured risk management process that includes the identification, analysis and assessment
of risk exposures, the selection of risk management strategies and products and the establishment of control, monitoring, audit and review
procedures.
Section: 18.02 The risk management process
Topic: The risk management process

70. The prime function of a futures clearing house is to bring together the buyer and seller in
each futures contract.
Ans: False
Feedback: A clearing house records transactions and facilitates value settlement.
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

71. Forward contracts are less risky than futures contracts because the buyers of the contracts can
negotiate with the counterparty about the terms and conditions.
Ans: False
Feedback: Forward contracts are more risky because they are subject to both liquidity and default
risk as compared with futures contracts, which are more standardised and thus can be sold on
organized exchange.
AACSB: Reflective thinking
Bloom's: Synthesis
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

72. Potential gains and losses are quite different for the buyers and writers (sellers) of call and
put options.
Ans: True
Feedback: While the potential losses to a call option buyer is limited to the option premium,
losses to option writers are significant. For example, for a call option writer, maximum losses are
(ST – X + c) (where ST = spot price at expiration, X = exercise price and c = call option
premium). Any increase in the value of the underlying security (ST), increases the losses for the
call option writer.

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of McGraw-Hill Education.
 39

AACSB: Reflective thinking

Bloom's: Synthesis
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

73. The maintenance margin call refers to the difference between the futures market price and the
futures contract.
Ans: False
Feedback: It refers to the requirement for additional funds to be added to the initial margin to
cover adverse futures contract price movements.
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts.
Section: 18.03 Futures contracts
Topic: Futures contracts

74. An FRA expressed as 3Mv5M means the settlement date is in three months and the interest
cover is for a five-month period.
Ans: False
Feedback: Rather it means the settlement date is in three months and the interest cover is for a
two-month period.
AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.04 Review the operation of forward exchange contracts and forward rate agreements.
Section: 18.04 Forward contracts
Topic: Forward contracts

75. An American put option is worth more than a European put option as it can be advantageous
to exercise an American put option before expiry.
Ans: True
Feedback: Given the volatility of options a holder may replace it is worth exercising before
maturity.
AACSB: Communication
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 18.05 Understand the nature and versatility of option contracts.
Section: 18.05 Option contracts
Topic: Option contracts

76. How is a swap similar to a bond?

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of McGraw-Hill Education.
 40

Ans: The swap entails payments periodically, which resemble coupon payments. Moreover,
these payments are related to the notional amount, which resembles bond face value. Thus, you
can view a swap agreement as an exchange of bonds: first party buys a bond issued by the
second party, and second party buys a bond issued by the first party. In the case of an interest
rate swap normally they do not exchange the principal amount as the amounts would be the same
thing. However, in the case of a currency swap the exchange makes sense as the currencies are
not the same. Thus, the currency swap more closely resembles a sale and purchase of a bond, as
the purchase price of the bond is paid upfront and the principal bond payment is received at the
maturity of the bond.
AACSB: Communication
Bloom's: Comprehension
Difficulty: Hard
Est time: 2-3 minutes
Learning Objective: 18.06 Consider the structure of an interest rate swap and a cross-currency swap.
Section: 18.06 Swap contracts
Topic: Swap contracts

77. Discuss financial risks and their impacts on banks’ liquidity and capital adequacy position.
Ans: Financial risks are those risk exposures as a result of unanticipated changes in projected
cash flows or the structure and value of balance sheet assets and liabilities. For example, a
commercial bank is exposed to the risk that a larger percentage of customers will default on loan
repayments in times of increased interest rates during economic downturn. This will affect the
cash flow position of the bank as loan instalments are not received as expected. This may cause a
liquidity problem for the bank in that it will have less cash available for the planning period.
Further, the bank may need to write off the bad loans against capital (shareholder funds). This
may adversely impact on the bank’s capital adequacy position.
AACSB: Reflective thinking
Bloom's: Synthesis
Difficulty: Hard
Est time: <1 minute
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, and explain the operational and financial risk
exposures that a business must manage.
Section: Introduction
Topic: Introduction

78. What is netting and why is netting in swap payments helpful?

Ans: With netting, the party that has the greater payment to make, pays just the net amount. The
other party pays nothing. Suppose the swap is fixed-for-variable and that at a particular time for
swapping, the first party owes $400 000 and the second party owes $394 000. With netting the
first party merely remits $6000. The holdings of cash and the total transaction costs would be
less as only one party remits a small amount. Probably more significant is the counterparty risk.
Without netting each party must be concerned with the other party defaulting on its obligation to
pay $400 000 or $394 000. With netting only one party has to be concerned about a default and it
involves a very small amount.

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 41

AACSB: Communication
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute
Learning Objective: 18.06 Consider the structure of an interest rate swap and a cross-currency swap.
Section: 18.06 Swap contracts
Topic: Swap contracts

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of McGraw-Hill Education.
 42

Chapter 18 Testbank Summary

# of
Category Questions
AACSB: Analysis 5
AACSB: Communication 68
AACSB: Reflective thinking 5
Bloom's: Analysis 3
Bloom's: Application 1
Bloom's: Comprehension 23
Bloom's: Knowledge 46
Bloom's: Reflection 1
Bloom's: Synthesis 4
Difficulty: Easy 36
Difficulty: Hard 3
Difficulty: Medium 40
Est time: 2-3 minutes 1
Est time: <1 minute 75
Est time: Section: 18.05 Option contracts 1
Learning Objective: 17.03 Explain procedures involved in the implementation of market-based 3
hedging techniques, in particular forward exchange contracts and money-market hedging.
Learning Objective: 18.01 Understand the nature and importance of risk and risk management, 18
and explain the operational and financial risk exposures that a business must manage.
Learning Objective: 18.02 Construct and analyse a structured risk management process that 8
includes the identification, analysis and assessment of risk exposures, the selection of risk
management strategies and products and the establishment of control, monitoring, audit and
review procedures.
Learning Objective: 18.03 Examine the basic fundamentals of futures contracts. 21
Learning Objective: 18.04 Review the operation of forward exchange contracts and forward rate 6
agreements.
Learning Objective: 18.05 Understand the nature and versatility of option contracts. 16
Learning Objective: 18.06 Consider the structure of an interest rate swap and a cross-currency 7
swap.
Section: 17.03 Risk Management: market-based hedging techniques 2
Section: 18.01 Understanding risk 10
Section: 18.02 The risk management process 8
Section: 18.03 Futures contracts 20
Section: 18.04 Forward contracts 6
Section: 18.05 Option contracts 16
Section: 18.06 Swap contracts 7
Section: Introduction 9
Topic: An introduction to risk management and derivatives 7
Topic: Forward contracts 6
Topic: Futures contracts 20
Topic: Introduction 2
Topic: Option contracts 16
Topic: Risk Management: market-based hedging techniques 2
Topic: Swap contracts 7
Topic: The risk management process 8
Topic: Understanding risk 10

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of McGraw-Hill Education.