Finance Exam 3

Futures contracts on gold are based on 100 troy ounces and priced in dollars per troy ounce. Assume the January gold contract settled today at 1285.10 and opened at 1284.60. The April contract settled at 1285.30 and opened at 1285. You own four of the April contracts that you purchased at 1284.70. What is your total profit or loss to date?

$240

Which one of the following actions will provide you with the right, but not the obligation, to sell the underlying asset at a specified price during a specified period of time?

Purchase of a put option

Assume that an item costs $100 in the U.S. and the exchange rate between the U.S. and Canada is: $1 = C$1.27. Which one of the following concepts supports the idea that the item that sells for $100 in the U.S. is currently selling in Canada for $127?

Purchasing power parity

Relative purchasing power parity:

Relates differences in inflation rates to differences in exchange rates.

The home currency approach:

Requires an applicable exchange rate for every time period for which there is a cash flow.

Farmer Mac owns a large orange grove in Florida. The value of his business is directly related to the price of oranges. Which one of the following is a graphical representation of this price-value relationship?

Risk Profile

George and Pat just made an agreement to exchange currencies based on today's exchange rate. Settlement will occur tomorrow. Which one of the following is the exchange rate that applies to this agreement?

Spot exchange rate

Which one of the following describes the lower bound of a call's value?

Stock price - the exercise price (or zero) whichever is greater

KT Enterprises has expanded its operations into a new field, which is the production of everyday dinnerware. If this project goes well, the firm has the option to expand its production into fine china. What type of option is this?

Strategic

A U.S. bank has an agreement with a German bank to exchange $500,000 for €397,000 on the first day of each of the next three calendar quarters. This agreement is best described as a:

Swap contract

Which one of the following statements related to swaps is correct?

Swaps can be custom tailored to a firm's needs.

Which one of the following states that the current forward rate is an unbiased predictor of the future spot exchange rate?

Unbiased forward rates.

Which one of the following states that the expected percentage change in the exchange rate between two countries is equal to the difference in the countries' interest rates?

Uncovered interest parity

Which one of the following methods of setting prices would reduce the transactions exposure for both the buyer and seller of a commodity swap contract?

Using the average market price over a given period of time.

Which one of the following statements related to warrants is correct?

Warrants are generally added as an incentive to a private debt issue.

A hedge between which two of the following firms is most apt to reduce each firm's financial risk exposure?

Wheat farmer and bakery

You would like the right to purchase an interest rate cap in the future. To obtain this right, you should purchase a:

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For years, your family has operated a business that produces lawn mowers. Over the years, the industry has progressed and new mass production techniques have been developed. However, your firm cannot afford this new technology, nor can you compete against those firms that can. Thus, the family has decided to close its facility at the end of the year. Which one of the following describes the risks to which your family's firm succumbed?

economic exposure

Today, you can exchange $1 for £.5926. Last week, £1 was worth $1.6729 How much profit or loss would you now have in pounds if you had converted £100 into dollars last week and back into pounds this week?

loss of ?.86 [�100 ($1.6729 / �1) (�.5926 / $1)] - �100 = -�.86

Assume $1 can buy you either ¥102.38 or £.6027. If a TV in London costs £990, what will that identical TV cost in Tokyo if absolute purchasing power parity exists?

¥168,170 �990 ($1 / �.6027) (�102.38 / $1) = �168,170

Assume the current spot rate is C$1.1103 and the one-year forward rate is C$1.1025. The nominal risk-free rate in Canada is 3.5 percent while it is 4 percent in the U.S. Using covered interest arbitrage you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S.

$.0023

Assume $1 is currently equal to A$1.1024 in the spot market. Also assume the expected inflation rate in Australia is 2.8 percent as compared to 3.4 percent in the U.S. What is the expected exchange rate one year from now if relative purchasing power parity exists?

A$1.0958 E(S1) = A$1.1024 [1 + (.028 - .034)] = A$1.0958

Three months ago, Toy Town introduced a new toy for preschool children. The store expected this toy to be an instant success and a fast-moving item. To their surprise, children have zero interest in this toy so sales have been abysmal. Which one of the following options should Toy Town consider in respect to this toy?

Abandonment

Which one of the following statements is correct?

Accounting translation gains and losses are recorded in the equity section of the balance sheet.

An interest rate cap is actually a:

Call option on an interest rate.

Interest rate swaps:

Can involve exchanging one floating-rate loan for another floating-rate loan.

Southern Groves raises tangerines. To hedge its risk, the firm trades in the orange futures market. This process is known as:

Cross-hedging

When warrants are exercised, the:

Earnings per share decrease.

Interest rate parity:

Eliminates covered interest arbitrage opportunities.

International bonds issued in multiple countries but denominated in a single currency are called:

Eurobonds

A basic interest rate swap generally involves trading a:

Fixed rate for a variable rate

International bonds issued in a single country and denominated in that country's currency are called:

Foreign bonds

Which one of the following supports the idea that real interest rates are equal across countries?

International fisher effect

Which one of the following terms applies to the value of an option on its expiration date?

Intrinsic value

An agreement that grants its owner the right, but not the obligation, to buy or sell a specific asset at a specific price for a set period of time is called a(n) _____ contract.

Option

Which one of the following can a firm do if it effectively manages its financial risks?

Reduce the price volatility the firm faces.

Farmer Ted planted 200 acres in wheat this year. The weather has been perfect and he expects to harvest a record crop within the next two weeks. At present, he has no storage facilities and therefore must sell his crop as soon as it is harvested. Which one of the following risks is he facing because he must sell his crop at whatever the market price is at harvest time?

transactions exposure

How many euros can you get for $2,500 if one euro is worth $1.2803?

€1,952.67 2500(1/1.2803)

Suppose the current spot rate for the Norwegian krone is $1 = NKr5.5923. The expected inflation rate in Norway is 2.2 percent and in the U.S. 1.8 percent. A risk-free asset in the U.S. is yielding 3.4 percent. What approximate real rate of return should you expect on a risk-free Norwegian security?

1.6 percent

Assume the spot rate for the Japanese yen currently is ¥102.32 per $1 and the one-year forward rate is ¥102.69 per $1. A risk-free asset in Japan is currently earning 2.5 percent. If interest rate parity holds, approximately what rate can you earn on a one-year risk-free U.S. security?

2.14 percent

You own five convertible bonds that currently sell for $1,125 each. These bonds have a coupon rate of 7 percent, a $1,000 face value, pay interest annually, and mature in six years. The bonds are convertible into shares of common stock at a conversion price of $25. How many shares of stock will you receive if you convert all of your bonds?

200

You own shares of a stock and believe the stock price will increase in the future. However, you realize the stock price could decline and want to hedge that risk. Which one of the following option positions should you take to create the desired hedge?

Buy a put

On Friday, one South African rand was worth $.0953; on Monday the value was $.0962. On Friday, one Kuwaiti dinar was worth $3.56; on Monday it was worth $3.54. Given these rates, which one of the following statements must be correct?

The South African rand appreciated from Friday to Monday against the U.S. dollar.

Which one of the following is true regarding forward contracts?

The payoff profile for the buyer of a forward contract is an upward sloping linear function.

The buyer of an option contract:

Pays an option premium in exchange for a right to buy or sell an underlying asset during a specified period of time.

A graph depicting the gains and losses a seller of a forward contract would earn at various market prices is referred to as a:

Payoff profile

Assume $1 = C$1.1098 and $1 = £.6018. Also assume you can buy £55 for C$100. How much profit can you earn using triangle arbitrage if you start out with $100?

$1.43 [$100 × (C$1.1098 / $1) (£55 / C$100) ($1 / £.6018)] - $100

You sold two call option contracts with a strike price of $30 when the option was quoted at $.70. The option expires today when the value of the underlying stock is $28.80. Ignoring trading costs and taxes, what is the net profit or loss on this investment?

$140

Three weeks ago, you purchased a June $50 put option on Hi-Tech Metals stock at an option price of $.60. The market price of the stock three weeks ago was $51.20. Today, the stock is selling at $48.50 a share. What is the intrinsic value of your put contract?

$150

The futures contract on silver is based on 5,000 troy ounces and is priced in dollars and cents per troy ounce. Assume today's report reflects these prices for the June contract: Open 19.435, High 19.450, Low 19.025, Settle 19.119, and Chg -0.369. What is the price per troy ounce that will be used for today's marking-to-market for this contract?

$19.119

The market price of Northern Mills stock has been relatively volatile and you think this volatility will continue for a couple more months. Thus, you decide to purchase a two-month European call option on this stock with a strike price of $30 and an option price of $1.60. You also purchase a two-month European put option on the stock with a strike price of $30 and an option price of $.20. What will be your net profit or loss on these option positions if the stock price is $36 on the day the options expire? Ignore trading costs and taxes.

$420

You are considering a project that has been assigned a discount rate of 12.5 percent. If you start the project today, you will incur an initial cost of $7,600 and will receive cash inflows of $5,700 a year for two years. If you wait one year to start the project, the initial cost will rise to $7,800 and the cash flows will increase to $6,000 a year for two years. What is the value of the option to wait?

$51.03

You sold five put contracts on CTB stock at an option price per share of $1.90. The options have an exercise price of $45 per share. The options were exercised today when the market price was $39 a share. What is your net profit or loss on this investment? Ignore transaction costs and taxes

-$2,050

All of the following will increase the value of an American call except:

A decrease in the risk-free rate of return.

Which one of the following securities is used as a means of investing in a foreign stock that otherwise could not be traded in the United States?

American Depository Receipt

What is the primary difference between an American call option and a European call option?

An American call can be exercised at any time up to the expiration date while the European call can only be exercised on the expiration date.

A firm with a variable-rate loan wants to protect itself solely from increases in interest rates. Which one of the following would be of most interest to this firm?

Buy a put option on a bond

Assume the spot rate on the Canadian dollar is C$1.0947. The risk-free nominal rate in the U.S. is 3.8 percent while it is 4.1 percent in Canada. What one-year forward rate will create interest rate parity?

C$1.0979

Currently, $1 will buy C$1.1028 while $1.2334 will buy €1. What is the exchange rate between the Canadian dollar and the euro?

C$1.3602 = €1 (C$1.1028 / $1) ($1.2334 / €1) = C$1.3602 / €1

The conversion value of a convertible bond is equal to which one of the following?

Conversion ratio × Stock price

The value of a stock option is dependent upon the value of the underlying stock. Thus, a stock option is a:

Derivative security.

Suzie is the controller of The Price Rite Company. She has been granted the right to buy 1,000 shares of her employer's stock at $25 a share anytime within the next three years. Which one of the following has Suzie been granted?

Employee stock option

Which one of the following statements regarding employee stock options (ESOs) is correct?

Employees may forfeit their ESOs if they terminate their employment with the issuing firm.

Which one of the following is a suggested method of reducing a U.S. importer's short-run exposure to exchange rate risk?

Entering a forward exchange agreement timed to match the invoice date

U.S. dollars deposited in a bank in Switzerland are called:

Eurocurrency

Which one of the following obligates you only on the expiration date to sell an asset at the strike price if the option is exercised?

European call

The investment timing decision is the:

Evaluation of the optimal time to begin a project.

This morning a national bakery agreed to pay a farmer $7.10 a bushel for 5,000 bushels of wheat that the farmer will ship to the factory four months from now. What is this legally binding agreement called?

Forward contract

Mr. Black has agreed to a currency exchange with Mr. White. The parties have agreed to exchange C$12,500 for $10,000 with the exchange occurring four months from now. This agreed-upon exchange rate is called the:

Forward rate

By definition, which one of the following contracts is marked to the market on a daily basis?

Futures contract

Which one of the following describes the intrinsic value of a put option?

Greater of the strike price - the stock price (or zero)

The option to wait:

Has a value equal to the NPV of a project today versus its NPV at a later date.

A $20 put option on Wildwood stock expires today. The current price of the stock is $18.50. Which one of the following best describes this option?

In-the-money

Employee stock options are primarily designed to do which one of the following?

Influence the actions and priorities of employees.

The condition stating that the interest rate differential between two countries is equal to the percentage difference between the forward exchange rate and the spot exchange rate is called:

Interest rate parity

A forward contract:

Is a binding agreement on both the buyer and the seller and nets out as a zero sum game.

Triangle arbitrage:

Is a profitable situation involving three separate currency exchange transactions.

A swap dealer in the U.S.:

Is frequently a commercial bank.

The seller of a forward contract:

Is obligated to make delivery and accept the forward price.

On Friday evening, Bank A loans Bank B Eurodollars that must be repaid the following Monday morning. Which one of the following is most likely the interest rate that will be charged on this loan?

London Interbank Offer Rate. (LIBOR)

Which one of the following describes the maximum value of a call option?

Market price of the underlying stock.