Risk Mangement 2

7/28/2019 Risk Mangement 2

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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 materialsfrom 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?

Value of the pound against the

Peso Dollar Euro

A depreciates depreciates appreciates

B depreciates appreciates depreciates

C appreciates appreciates depreciates

D appreciates depreciates depreciates

E depreciates depreciates depreciates

A

B

C

D

E

2 . Which of the following represent effective ways for a company to hedge itsexposures?

(1) A company importing components from the US leads its dollar payment because oftheir 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


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(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 currentlyJanuary 1st. The company is considering the choices it has in order to hedge its

transaction exposure.

Exchange rates:

$ Spot rate 1.5522 - 1.5591

Six month $ forward rate 1.5445- 1.5497

Money market rates (annual):

Money market rates (annual):

Borrowing Depositing

US dollars 6.0 percent 4.5 percent

Sterling 7.0 percent 5.5 percent

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) (2)A 324 800 322 058

B 324 800 324 409

C 325 893 324 409

D 325 893 325 850

E 325 893 326 788

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


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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



Buying 32 futures contracts

5 . Three months ago CCD plc sold four financial futures contracts at a price of 90 inorder 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


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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 anincrease 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 canborrow. 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.

Fixed Floating

Igor 10 percent LIBOR

Jacob 13 percent LIBOR + 0.6 percent

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


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remaining benefit is split equally between Igor plc and Jacob plc, what will be the post-

swap interest rates paid by the two companies?

Igor Jacob

A LIBOR + 0.6 percent 10.0 percent

B LIBOR + 1.1 percent 10.5 percent

C LIBOR 11.0 percentD LIBOR - 0.1 percent 10.7 percent

E LIBOR - 0.7 percent 12.3 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


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Tailor-made bank instruments are preferable to traded derivatives for non-

standard exposures

Counterparty risk is a major drawback when hedging with financial futures

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.

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

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.

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 theneed 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

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.

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


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The risks associated with using external hedging instruments

The costs associated with derivatives

The complicated nature of hedging instruments

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.

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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Risk Mangement 2