Answer Choices:
a. True
b. False
Answer: True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. Put options give investors the right to buy a stock at a certain exercise price before a specified date.
b. Call options give investors the right to sell a stock at a certain exercise price before a specified date.
c. Options typically sell for less than their exercise value.
d. LEAPS are very short-term options that have begun trading on the exchanges in recent years.
e. Option holders are not entitled to receive dividends unless they choose to exercise their option.
Answer: e. Option holders are not entitled to receive dividends unless they choose to exercise their option.
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.
Answer Choices:
a. True
b. False
Answer: True
Question: The first, and most critical, step in constructing a set of forecasted financial statements is the sales forecast.
Answer Choices:
a. True
b. False
Answer: True
Question: Warnes Motors’ stock is trading at $20 a share. Three-month call options with an exercise price of $20 have a price of $1.50. Which of the following will occur if the stock price increases 10% to $22 a share?
Answer Choices:
a. The price of the call option will increase by $2.
b. The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%.
c. The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10%.
d. The price of the call option will increase by more than $2.
e. The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10%.
Answer: b. The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%.
Question: Interest rate swaps allow a firm to exchange fixed for floating-rate payments, but a swap cannot reduce actual net interest costs.
Answer Choices:
a. True
b. False
Answer: True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. An option’s value is determined by its exercise value, which is the market price of the stock less its strike price. Thus, an option can’t sell for more than its exercise value.
b. As a stock’s price increases, the premium portion of an option on that stock increases because the difference between the stock price and the fixed strike price increases.
c. If the company is consistently profitable, its call options will always be in the money.
d. The market value of an option depends in part on the option’s length of time until expiration and on the variability of the underlying stock’s price.
Answer: d. The market value of an option depends in part on the option’s length of time until expiration and on the variability of the underlying stock’s price.
Question: A riskless hedge can best be defined as
Answer Choices:
a. A situation in which aggregate risk can be reduced by derivatives transactions between two parties.
b. A hedge in which an investor buys a stock and simultaneously sells a call option on that stock and ends up with a riskless position.
c. Standardized contracts that are traded on exchanges and are “marked to market” daily, but where physical delivery of the underlying asset is virtually never taken.
d. Two parties agree to exchange obligations to make specified payment streams.
e. Simultaneously buying and selling a call option with the same exercise price.
Answer: b. A hedge in which an investor buys a stock and simultaneously sells a call option on that stock and ends up with a riskless position.
Question: An investor who “writes” a call option against stock held in his or her portfolio is selling a(n):
Answer Choices:
a. Straddle option.
b. Put option.
c. Out-of-the-money option.
d. Naked option.
e. Covered option.
Answer: e. Covered option.
Question: One objective of risk management can be to reduce the volatility of a firm’s cash flows.
Answer Choices:
a. True
b. False
Answer: True
Question: A swap is a method used to reduce financial risk. Which of the following statements about swaps, if any, is NOT CORRECT?
Answer Choices:
a. A swap involves the exchange of cash payment obligations.
b. The earliest swaps were currency swaps, in which companies traded debt denominated in different currencies, say dollars and pounds.
c. Swaps are very often arranged by a financial intermediary, who may or may not take the position of one of the counterparties.
d. A problem with swaps is that no standardized contracts exist, which has prevented the development of a secondary market.
e. Swaps can involve side payments in order to get the counterparty to agree to the swap.
Answer: d. A problem with swaps is that no standardized contracts exist, which has prevented the development of a secondary market.
Question: Errors in the sales forecast can be offset by similar errors in costs and income forecasts. Thus, as long as the errors are not large, sales forecast accuracy is not critical to the firm.
Answer Choices:
a. True
b. False
Answer: False
Question: Which of the following is NOT a way risk management can be used to increase the value of a firm?
Answer Choices:
a. Risk management can increase debt capacity.
b. Risk management can help a firm maintain its optimal capital budget.
c. Risk management can reduce the expected costs of financial distress.
d. Risk management can help firms minimize taxes.
e. Risk management can allow managers to defer receipt of their bonuses and thus postpone tax payments.
Answer: e. Risk management can allow managers to defer receipt of their bonuses and thus postpone tax payments.
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.
Answer Choices:
a. True
b. False
Answer: False
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?
Answer Choices:
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: 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.