Question: Which of the following statements concerning risk management is NOT CORRECT? a. Risk management can reduce the volatility of cash flows, and this decreases the probability of bankruptcy. b. Risk management makes sense for firms directly engaged in activities that involve commodities whose values can be hedged, but it doesn’t make much sense for most other firms. c. Companies with volatile earnings pay more taxes than companies with more stable earnings due to the treatment of tax credits and the rules governing corporate loss carry-forwards and carry-backs. Therefore, our tax system encourages risk management to stabilize earnings. d. Risk management can reduce the likelihood of low cash flows, and therefore reduce the probability of financial distress. e. Risk management involves identifying events that could have adverse financial consequences and then taking actions to prevent and/or to minimize the damage caused by these events.

Answer:
b. Risk management makes sense for firms directly engaged in activities that involve commodities whose values can be hedged, but it doesn’t make much sense for most other firms.

Question: Speculative risks are symmetrical in the sense that they offer the chance of a gain as well as a loss, while pure risks are those that can only lead to losses. a. True b. False

Answer:
a. True

Question: Financial institutions are more diversified today than they were in the past, when federal laws kept investment banks, commercial banks, insurance companies, and similar organizations quite separate. Today the larger financial services corporations offer a variety of services, ranging from checking accounts, to insurance, to underwriting securities, to stock brokerage.

Answer Options:
a. True
b. False

Answer:
a. True

Question: Deeble Construction Co.’s stock is trading at $30 a share. There are also call options on the company’s stock, some with an exercise price of $25 and some with an exercise price of $35. All options expire in 3 months. Which of the following best describes the value of these options? a. If Deeble’s stock price rose by $5, the exercise value of the options with the $25 exercise price would also increase by $5. b. The options with the $25 exercise price will sell for less than the options with the $35 exercise price. c. The options with the $25 exercise price have an exercise value greater than $5. d. The options with the $35 exercise price have an exercise value greater than $0. e. The options with the $25 exercise price will sell for $5.

Answer:
c. The options with the $25 exercise price have an exercise value greater than $5.

Question: An investor who “writes” a call option without the stock in his or her portfolio to back it up is selling a(n) a. Call option. b. Put option. c. Out-of-the-money option. d. Naked option. e. Covered option.

Answer:
d. Naked option.

Question: Which of the following events is likely to decrease the value of call options on the common stock of GCC Company? a. An increase in GCC’s stock price. b. An increase in the exercise price of the option. c. An increase in the amount of time until the option expires. d. An increase in the risk-free rate. e. GCC’s stock price becomes more risky (higher variance).

Answer:
b. An increase in the exercise price of the option.

Question: When a corporation’s shares are owned by a few individuals who are associated with the firm’s management, we say that the stock is closely held.

Answer Options:
a. True
b. False

Answer:
a. True

Question: The two basic types of hedges involving the futures market are long hedges and short hedges, where the words “long” and “short” refer to the maturity of the hedging instrument. For example, a long hedge might use Treasury bonds, while a short hedge might use 3-month T-bills. a. True b. False

Answer:
b. False

Question: The term IPO stands for “individual purchase order,” as when an individual (as opposed to an institution) places an order to buy a stock.

Answer Options:
a. True
b. False

Answer:
b. False

Question: You recently sold 100 shares of Microsoft stock to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following best describes this transaction?

Answer Options:
a. This is an example of a direct transfer of capital.
b. This is an example of a primary market transaction.
c. This is an example of an exchange of physical assets.
d. This is an example of a money market transaction.
e. This is an example of a derivative market transaction.

Answer:
a. This is an example of a direct transfer of capital.