Ch 23 Enterprise Risk Management PDF

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One objective of risk management can be to reduce the volatility of a firm's cash flows. a. True b. False ANSWER:   True POINTS:   1 DIFFICULTY:   Difficulty: Easy QUESTION TYPE:   True / False HAS VARIABLES:   False LEARNING OBJECTIVE...

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Ch 23 Enterprise Risk Management 1. One objective of risk management can be to reduce the volatility of a firm's cash flows. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: Difficulty: Easy QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.01 - LO: 23-1 NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Risk management KEYWORDS: Bloom’s: Knowledge DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NP31 QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMJW-GHHS-N3TA-GFTU-KQMBGASU-NC5B-8RSU-OQDD-GOSS-KQJU-CWSU-EP3I-GFTD-OPJ1-E7JI-YT4D-JFNN4OTI-GO4W-NQNBEE 2. Which of the following are NOT ways risk management can be used to increase the value of a firm? a. Risk management can help a firm maintain its optimal capital budget. b. Risk management can reduce the expected costs of financial distress. c. Risk management can help firms minimize taxes. d. Risk management can allow managers to defer receipt of their bonuses and thus postpone tax payments. e. Risk management can increase debt capacity. ANSWER: d POINTS: 1 DIFFICULTY: Difficulty: Moderate QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.01 - LO: 23-1 NATIONAL STANDARDS: United States - BUSPROG: Analytic STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Risk management KEYWORDS: Bloom’s: Analysis OTHER: TYPE: Multiple Choice: Conceptual DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NP3T Page 1

Ch 23 Enterprise Risk Management QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMJU-CI1U-O3UR-GR4D-NPBT-CRSSEATZ-8RSS-RCB1-GOSS-GCB3-8YSU-GC5N-GIOS-KCUB-E7JI-YT4D-JFNN-4OTIGO4W-NQNBEE 3. Which of the following statements about interest rate and reinvestment rate risk is CORRECT? a. Interest rate price risk exists because fixed-rate debt securities lose value when interest rates rise, while reinvestment rate risk is the risk of earning less than expected when interest payments or debt principal are reinvested. b. Interest rate price risk can be eliminated by holding zero coupon bonds. c. Reinvestment rate risk can be eliminated by holding variable (or floating) rate bonds. d. Interest rate risk can never be reduced. e. Variable (or floating) rate securities have more interest rate (price) risk than fixed rate securities. ANSWER: a POINTS: 1 DIFFICULTY: Difficulty: Moderate QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.01 - LO: 23-1 NATIONAL STANDARDS: United States - BUSPROG: Analytic STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Interest rate and reinvestment rate risk KEYWORDS: Bloom’s: Analysis OTHER: TYPE: Multiple Choice: Conceptual DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NP3O QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMJT-GFOU-NP3U-CO3S-NPJZ-GYSURAJI-8YSU-KA3W-GOSU-EP5G-CRSS-KA5G-GTTU-NPDG-E7JI-YT4D-JFNN-4OTIGO4W-NQNBEE 4. Interest rate swaps allow a firm to exchange fixed for floating-rate payments, but a swap cannot reduce actual net interest expenses. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: Difficulty: Easy QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.07 - LO: 23-7 NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking STATE STANDARDS: United States - AK - DISC: Derivatives Page 2

Ch 23 Enterprise Risk Management LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Swaps KEYWORDS: Bloom’s: Knowledge DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NP3Z QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMMD-CEHD-ECUD-CE4S-K3JUCWSU-CPDB-CESS-C3MN-GOSU-KAJZ-8YSU-CAMN-GR4U-GC3A-E7JI-YT4D-JFNN4OTI-GO4W-NQNBEE 5. In theory, reducing the volatility of its cash flows will always increase a company's value. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: Difficulty: Easy QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.07 - LO: 23-7 NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Risk management KEYWORDS: Bloom’s: Knowledge DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NP3S QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMMR-CA5S-NCBA-GY5S-NPDDGHSS-C3DF-CRSU-RCUN-GOSU-YCBU-GESU-QCDF-GTOS-KCDR-E7JI-YT4D-JFNN4OTI-GO4W-NQNBEE 6. 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: False POINTS: 1 DIFFICULTY: Difficulty: Moderate QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.07 - LO: 23-7 NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking Page 3

Ch 23 Enterprise Risk Management STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Futures market hedging KEYWORDS: Bloom’s: Comprehension DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NP3I QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMJT-CEAD-N3J3-GA5S-R3DR-CESUNPT1-CRSU-O3UF-GOSU-GQJT-GHSS-CCUB-CP1D-YAMD-E7JI-YT4D-JFNN-4OTIGO4W-NQNBEE 7. A swap is a method used to reduce financial risk. Which of the following statements about swaps, if any, is NOT CORRECT? a. The earliest swaps were currency swaps, in which companies traded debt denominated in different currencies, say dollars and pounds. b. Swaps are very often arranged by a financial intermediary, who may or may not take the position of one of the counterparties. c. A problem with swaps is that no standardized contracts exist, which has prevented the development of a secondary market. d. A company can swap fixed interest payments for floating interest payments. e. A swap involves the exchange of cash payment obligations. ANSWER: c POINTS: 1 DIFFICULTY: Difficulty: Moderate QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.07 - LO: 23-7 NATIONAL STANDARDS: United States - BUSPROG: Analytic STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Swaps KEYWORDS: Bloom’s: Analysis OTHER: TYPE: Multiple Choice: Conceptual DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NP3W QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMMN-GTOS-CC3U-COHD-YP3UGHSS-GAMB-CRSU-1QB3-GOSS-EAUR-CESU-KCBS-C31D-13TW-E7JI-YT4D-JFNN4OTI-GO4W-NQNBEE 8. A commercial bank recognizes that its net income suffers whenever interest rates increase. Which of the following strategies would protect the bank against rising interest rates? a. Entering into an interest rate swap where the bank receives a fixed payment stream, and in return agrees to make payments that float with market interest rates. Page 4

Ch 23 Enterprise Risk Management b. Purchase principal only (PO) strips that decline in value whenever interest rates rise. c. Enter into a short hedge where the bank agrees to sell interest rate futures. d. Sell some of the bank's floating-rate loans and use the proceeds to make fixed-rate loans. e. Buying inverse floaters. ANSWER: c Given its interest rate exposure, the bank needs a strategy which is profitable whenever RATIONALE: interest rates rise. If designed correctly, the profits from this strategy can partially, or in some cases, completely offset the losses the bank realizes from its basic operations whenever rates rise. Of the 5 strategies, only the short hedge is profitable when rates rise฀ all the other strategies would make sense if the bank were looking for extra profits when rates dropped.

POINTS: 1 DIFFICULTY: Difficulty: Moderate QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.07 - LO: 23-7 NATIONAL STANDARDS: United States - BUSPROG: Analytic STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Hedging KEYWORDS: Bloom’s: Analysis OTHER: TYPE: Multiple Choice: Conceptual DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NPNN QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMMF-G71D-EP3I-GRAU-NQJO-CESSRP3A-CESU-N3UR-GOSS-GPUB-CASS-RQJI-GPUD-EAMF-E7JI-YT4D-JFNN-4OTIGO4W-NQNBEE 9. Company A can issue floating-rate debt at LIBOR + 1% and can issue fixed rate debt at 9%. Company B can issue floating-rate debt at LIBOR + 1.5% and can issue fixed-rate debt at 9.4%. Suppose A issues floating-rate debt and B issues fixed-rate debt, after which they engage in the following swap: A will make a fixed 7.95% payment to B, and B will make a floating-rate payment equal to LIBOR to A. What are the resulting net payments of A and B? a. A pays a fixed rate of 9%, B pays LIBOR + 1.5%. b. A pays a fixed rate of 8.95%, B pays LIBOR + 1.45%. c. A pays LIBOR plus 1%, B pays a fixed rate of 9.4%. d. A pays a fixed rate of 7.95%, B pays LIBOR. e. None of the above answers is correct. ANSWER: b A pays LIBOR + 1% to its lenders, receives LIBOR from B, and pays B 7.95%, for a net fixed RATIONALE: payment of 8.95%. B pays 9.4% to its lenders, pays LIBOR to A, and receives 7.95% from A, for a net payment of LIBOR + 1.45%.

POINTS: DIFFICULTY: QUESTION TYPE: HAS VARIABLES: Page 5

1 Difficulty: Moderate Multiple Choice False

Ch 23 Enterprise Risk Management LEARNING OBJECTIVES: FMTP.EHRH.17.23.07 - LO: 23-7 NATIONAL STANDARDS: United States - BUSPROG: Analytic STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Swaps–nonalgorithmic KEYWORDS: Bloom’s: Analysis OTHER: TYPE: Multiple Choice: Problem DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NPNB QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMMR-CIOU-GATT-GJ1U-NAMRCASU-1P5F-8YSS-C3MR-GOSU-Q3JO-CRSU-RQBO-CA3D-13BU-E7JI-YT4D-JFNN4OTI-GO4W-NQNBEE 10. Suppose the September CBOT Treasury bond futures contract has a quoted price of 89'09. What is the implied annual interest rate inherent in this futures contract? a. 6.32% b. 6.65% c. 7.00% d. 7.35% e. 7.72% ANSWER: c RATIONALE: Quote: 89'09 0.89 0.09 N: 40 PV = (0.89 + .09/32) ×$1,000 = −$892.8125 FV = $1,000 PMT = $30 I/YR = 3.50% Annual rate: I/YR ×2 = 7.00%

POINTS: 1 DIFFICULTY: Difficulty: Moderate QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.07 - LO: 23-7 NATIONAL STANDARDS: United States - BUSPROG: Analytic STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Treasury bond futures contracts KEYWORDS: Bloom’s: Analysis OTHER: TYPE: Multiple Choice: Problem DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NPB3 QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMJ1-GO4S-RCT1-COHG-NATA-GRSUC3UR-CRSS-CPJI-GOSU-KAMG-GCSS-KCUB-CR4U-QQBS-E7JI-YT4D-JFNN-4OTIGO4W-NQNBEE Page 6

Ch 23 Enterprise Risk Management 11. Suppose the December CBOT Treasury bond futures contract has a quoted price of 80'07. What is the implied annual interest rate inherent in the futures contract? a. 6.86% b. 7.22% c. 7.60% d. 8.00% e. 8.40% ANSWER: d RATIONALE: Quote: 80'07 0.80 0.07 N: 40 PV = (0.80 + 0.07/32) ×$1,000 = −$802.1875 FV = $1,000 PMT = $30 I/YR = 4.00% Annual rate: I/YR ×2 = 8.00%

POINTS: 1 DIFFICULTY: Difficulty: Moderate QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.07 - LO: 23-7 NATIONAL STANDARDS: United States - BUSPROG: Analytic STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Treasury bond futures contracts KEYWORDS: Bloom’s: Analysis OTHER: TYPE: Multiple Choice: Problem DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NPBA QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMJS-8R4U-YP5N-G3UD-GPDGCWSU-OC3U-CESS-EATT-GOSS-E3DF-8YSU-OAJS-CR5G-RPUN-E7JI-YT4D-JFNN4OTI-GO4W-NQNBEE 12. Suppose the December CBOT Treasury bond futures contract has a quoted price of 80'07. If annual interest rates go up by 1.00 percentage point, what is the gain or loss on the futures contract? (Assume a $1,000 par value, and round to the nearest whole dollar.) a. −$78.00 b. −$82.00 c. −$86.00 d. −$90.00 e. −$95.00 ANSWER: RATIONALE:

a

Quote:

80'07

0.80

0.07

Increase in annual rate: 0.01000 Par value: $1,000 N: 40 PMT: $30 Price = PV = (0.80 + 0.07/32) ×$1,000 = −$802.1875 Enter data to get rate = I/YR 2 = 7.9986% New rate = (Old rate + 1.0%)/2 = 4.4993% New price = −$724.08 Change in price = loss = −$78

POINTS: DIFFICULTY: Page 7

1 Difficulty: Moderate

Ch 23 Enterprise Risk Management QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.07 - LO: 23-7 NATIONAL STANDARDS: United States - BUSPROG: Analytic STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Treasury bond futures contracts KEYWORDS: Bloom’s: Analysis OTHER: TYPE: Multiple Choice: Problem DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NPNG QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMMR-CITD-CCUF-CE4G-N3JI-CESUGPBA-8YSS-EPBT-GOSS-KATZ-GESS-CQMG-GR4U-O3BI-E7JI-YT4D-JFNN-4OTIGO4W-NQNBEE 13. 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: True POINTS: 1 DIFFICULTY: Difficulty: Easy QUESTION TYPE: True / False HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.04 - LO: 23-4 NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Speculative versus pure risk KEYWORDS: Bloom’s: Knowledge DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NPNF QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMJ1-CC5G-K3B3-8R3U-QPBZ-CCSSKC33-8RSS-N3TU-GOSS-CCDN-CESU-QQDB-GR4U-EP3T-E7JI-YT4D-JFNN-4OTIGO4W-NQNBEE 14. Which of the following statements is most CORRECT? a. Futures contracts generally trade on an organized exchange and are marked to market daily. b. Goods are never delivered under forward contracts, but are almost always delivered under futures contracts. c. There are futures contracts for currencies but no forward contracts for currencies. Page 8

Ch 23 Enterprise Risk Management d. Futures contracts don't have any margin requirements but forward contracts do. e. One advantage of forward contracts is that they are default free. ANSWER: a POINTS: 1 DIFFICULTY: Difficulty: Moderate QUESTION TYPE: Multiple Choice HAS VARIABLES: False LEARNING OBJECTIVES: FMTP.EHRH.17.23.05 - LO: 23-5 NATIONAL STANDARDS: United States - BUSPROG: Analytic STATE STANDARDS: United States - AK - DISC: Derivatives LOCAL STANDARDS: United States - OH - Default City - TBA TOPICS: Forwards vs. futures KEYWORDS: Bloom’s: Analysis OTHER: TYPE: Multiple Choice: Conceptual DATE CREATED: 8/26/2015 10:47 AM DATE MODIFIED: 8/26/2015 10:47 AM QUESTION ID: JFND-GO4G-EO4R-NPNR QUESTION GLOBAL ID: GCID-E7BW-1TBP-GFOU-ECUF-C3TS-GCMF-GY41-43B1-G3O1-4PUB-GO4N-4PMFGTO1-4QMF-CJTU-OCTA-GTDI-GWN8-EPRW-EMJT-CEHD-NA5F-CCAG-CCBTCWSS-KPTW-CESS-CCDD-GOSU-K3UG-GHSS-RPDF-GW4D-YPTZ-E7JI-YT4D-JFNN4OTI-GO4W-NQNBEE

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