FIN 350 Week 7 Quiz 6 Chapter 11 and 13 – Strayer

FIN 350 Week 7 Quiz – Strayer (All Possible Questions With Answers)

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Chapter 11—Stock Valuation and Risk

1. The price-earnings valuation method applies the ____ price-earnings ratio to ____ earnings per share in order to value the firm’s stock.
a. firm’s; industry
b. firm’s; firm’s
c. average industry; industry
d. average industry; firm’s

2. A firm is expected to generate earnings of $2.22 per share next year. The mean ratio of share price to expected earnings of competitors in the same industry is 15. Based on this information, the valuation of the firm’s shares based on the price-earnings (PE) method is
a. $2.22.
b. $6.76.
c. $33.30.
d. none of the above

3. The PE method to stock valuation may result in an inaccurate valuation for a firm if errors are made in forecasting the firm’s future earnings or in choosing the industry composite used to derive the PE ratio.
a. True
b. False

4. Bolwork Inc. is expected to pay a dividend of $5 per share next year. Bolwork’s dividends are expected to grow by 3 percent annually. The required rate of return for Bolwork stock is 15 percent. Based on the dividend discount model, a fair value for Bolwork stock is $____ per share.
a. 33.33
b. 166.67
c. 41.67
d. 60.00

5. Protsky Inc. just paid a dividend of $2.20 per share. The dividend growth rate for Protsky’s dividends is 3 percent per year. If the required rate of return on Protsky stock is 12 percent, the stock should be valued at $____ per share according to the dividend discount model.
a. 24.44
b. 25.18
c. 18.88
d. 75.53

6. The limitations of the dividend discount model are more pronounced when valuing stocks
a. that pay most of their earnings as dividends.
b. that retain most of their earnings.
c. that have a long history of dividends.
d. that have constant earnings growth.

7. Vansel Inc. retains most of its earnings. The company currently has earnings per share of $11. Vansel expects its earnings to grow at a constant rate of 2 percent per year. Furthermore, the average PE ratio of all other firms in Vansel’s industry is 12. Vansel is expected to pay dividends per share of $3.50 during each of the next three years. If investors require a 10 percent rate of return on Vansel stock, a fair price for Vansel stock today is $____.
a. 113.95
b. 111.32
c. 105.25
d. none of the above

8. When evaluating stock performance, ____ measures variability that is systematically related to market returns; ____ measures total variability of a stock’s returns.
a. beta; standard deviation
b. standard deviation; beta
c. intercept; beta
d. beta; error term

9. The ____ is commonly used as a proxy for the risk-free rate in the Capital Asset Pricing Model.
a. Treasury bond rate
b. prime rate
c. discount rate
d. federal funds rate

10. A beta of 1.8 implies that the stock has a risk premium of 1.8%.
a. True
b. False

11. Stock prices of U.S. firms primarily involved in exporting are likely to be ____ affected by a weak dollar and ____ affected by a strong dollar.
a. favorably; adversely
b. adversely; adversely
c. favorably; favorably
d. adversely; favorably

12. A weak dollar may enhance the value of a U.S. firm whose sales are dependent on the U.S. economy.
a. True
b. False

13. The January effect refers to the ____ pressure on ____ stocks in January of every year.
a. downward; large
b. upward; large
c. downward; small
d. upward; small

14. The expected acquisition of a firm typically results in ____ in the target’s stock price.
a. an increase
b. a decrease
c. no change
d. none of the above

15. The ____ index can be used to measure risk-adjusted performance of a stock while controlling for the stock’s volatility.
a. Sharpe
b. Treynor
c. arbitrage
d. margin

16. The ____ index can be used to measure risk-adjusted performance of a stock while controlling for the stock’s beta.
a. Sharpe
b. Treynor
c. arbitrage
d. margin

17. Stock price volatility increased during the credit crisis.
a. True
b. False

18. The Sharpe Index measures the
a. average return on a stock.
b. variability of stock returns per unit of return
c. stock’s beta adjusted for risk.
d. excess return above the risk-free rate per unit of risk.

19. A stock’s average return is 11 percent. The average risk-free rate is 9 percent. The stock’s beta is 1 and its standard deviation of returns is 10 percent. What is the Sharpe Index?
a. .05
b. .5
c. .1
d. .02
e. .2

20. A stock’s average return is 10 percent. The average risk-free rate is 7 percent. The standard deviation of the stock’s return is 4 percent, and the stock’s beta is 1.5. What is the Treynor Index for the stock?
a. .03
b. .75
c. 1.33
d. .02
e. 50

21. If security prices fully reflect all market-related information (such as historical price patterns) but do not fully reflect all other public information, security markets are
a. weak-form efficient.
b. semi-strong form efficient.
c. strong form efficient.
d. B and C
e. none of the above

22. If security markets are semi-strong form efficient, investors cannot solely use ____ to earn excess returns.
a. previous price movements
b. insider information
c. publicly available information
d. A and C

23. The ____ is commonly used to determine what a stock’s price should have been.
a. Capital Asset Pricing Model
b. Treynor Index
c. Sharpe Index
d. B and C

24. A stock’s beta is estimated to be 1.3. The risk-free rate is 5 percent, and the market return is expected to be 9 percent. What is the expected return on the stock based on the CAPM?
a. 5.2 percent
b. 11.7 percent
c. 16.7 percent
d. 4 percent
e. 10.2 percent

25. According to the text, other things being equal, stock prices of U.S. firms primarily involved in exporting could be ____ affected by a weak dollar. Stock prices of U.S. importing firms could be ____ affected by a weak dollar.
a. adversely; favorably
b. favorably; adversely
c. favorably; favorably
d. adversely; adversely

26. The demand by foreign investors for the stock of a U.S. firm sold on a U.S. exchange may be higher when the dollar is expected to ____, other things being equal. (Assume the firm’s operations are unaffected by the value of the dollar.)
a. strengthen
b. weaken
c. stabilize
d. B and C

27. A higher beta of an asset reflects
a. lower risk.
b. lower covariance between the asset’s returns and market returns.
c. higher covariance between the asset’s returns and the market returns.
d. none of the above

28. The “January effect” refers to a large
a. rise in the price of small stocks in January.
b. decline in the price of small stocks in January.
c. decline in the price of large stocks in January.
d. rise in the price of large stocks in January.

29. Technical analysis relies on the use of ____ to make investment decisions.
a. interest rates
b. inflationary expectations
c. industry conditions
d. recent stock price trends

30. The capital asset pricing model (CAPM) suggests that the required rate of return on a stock is directly influenced by the stock’s :
a. prevailing level of the industry competition.
b. beta.
c. liquidity.
d. size (market capitalization).

31. According to the capital asset pricing model, the required return by investors on a security is
a. inversely related to the risk-free rate.
b. inversely related to the firm’s beta.
c. inversely related to the market return.
d. none of the above

32. Boris stock has an average return of 15 percent. Its beta is 1.5. Its standard deviation of returns is 25 percent. The average risk-free rate is 6 percent. The Sharpe index for Boris stock is
a. 0.35.
b. 0.36.
c. 0.45.
d. 0.28.
e. none of the above

33. Morgan stock has an average return of 15 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Treynor index of Morgan stock is
a. 0.04.
b. 0.05.
c. 0.35.
d. 0.03.
e. none of the above

34. Zilo stock has an average return of 15 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Sharpe index of Zilo stock is
a. 0.36.
b. 0.35.
c. 0.28.
d. 0.45.
e. none of the above

35. Sorvino Co. is expected to offer a dividend of $3.2 per share per year forever. The required rate of return on Sorvino stock is 13 percent. Thus, the price of a share of Sorvino stock, according to the dividend discount model, is $____.
a. 4.06
b. 4.16
c. 40.63
d. 24.62
e. none of the above

36. Kandle stock just paid a dividend of $4.76 per share and plans to pay a dividend of $5 per share next year, which is expected to increase by 3 percent per year subsequently. The required rate of return is 15 percent. The value of Kandle stock, according to the dividend discount model, is $____.
a. 39.67
b. 41.67
c. 33.33
d. 31.73
e. none of the above

37. LeBlanc Inc. currently has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as LeBlanc Inc. is 15. LeBlanc is expected to pay a dividend of $3 per share over the next four years, and an investor in LeBlanc requires a return of 12 percent. What is the forecasted stock price of LeBlanc in four years, using the adjusted dividend discount model?
a. $150.00
b. $163.91
c. $45.00
d. $168.83
e. none of the above

38. Tarzak Inc. has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as Tarzak is 15. Tarzak is expected to pay a dividend of $3 per share over the next four years, and an investor in Tarzak requires a return of 12 percent. The estimated stock price of Tarzak today should be ____ using the adjusted dividend discount model.
a. $116.41
b. $104.91
c. $161.15
d. none of the above

39. The standard deviation of a stock’s returns is used to measure a stock’s
a. volatility.
b. beta.
c. Treynor Index.
d. risk-free rate.

40. The formula for a stock portfolio’s volatility does not contain the
a. weight (proportional investment) assigned to each stock.
b. variance (standard deviation squared) of returns of each stock.
c. correlation coefficients between returns of each stock.
d. risk-free rate.

41. If the returns of two stocks are perfectly correlated, then
a. their betas should each equal 1.0.
b. the sum of their betas should equal 1.0.
c. their correlation coefficient should equal 1.0.
d. their portfolio standard deviation should equal 1.0.

42. A stock’s beta can be measured from the estimate of the using regression analysis.
a. intercept
b. market return
c. risk-free rate
d. slope coefficient

43. A beta of 1.1 means that for a given 1 percent change in the value of the market, the is expected to change by 1.1 percent in the same direction.
a. risk-free rate
b. stock’s value
c. stock’s standard deviation
d. correlation coefficient

44. Stock X has a lower beta than Stock Y. The market return for next month is expected to be either −1 percent, +1 percent, or +2 percent with an equal probability of each scenario. The probability distribution of Stock X returns for next month is
a. the same as that of Stock Y.
b. more dispersed than that of Stock Y.
c. less dispersed than that of Stock Y.
d. zero.

45. The beta of a stock portfolio is equal to a weighted average of the
a. betas of stocks in the portfolio.
b. betas of stocks in the portfolio, plus their correlation coefficients.
c. standard deviations of stocks in the portfolio.
d. correlation coefficients between stocks in the portfolio.

46. Value at risk estimates the ____ a particular investment for a specified confidence level.
a. beta of
b. risk-free rate of
c. largest expected loss to
d. standard deviation of

47. A stock has a standard deviation of daily returns of 1 percent. It wants to determine the lower boundary of its probability distribution of returns, based on 1.65 standard deviations from the expected outcome. The stock’s expected daily return is .2 percent. The lower boundary is
a. −1.45 percent.
b. −1.85 percent.
c. 0 percent.
d. −1.65 percent.

48. A stock has a standard deviation of daily returns of 3 percent. It wants to determine the lower boundary of its probability distribution of returns, based on 1.65 standard deviations from the expected outcome. The stock’s expected daily return is .1 percent. The lower boundary is
a. −1.65 percent.
b. −3.00 percent.
c. −4.85 percent.
d. −5.05 percent.

49. Which of the following is not commonly used as the estimate of a stock’s volatility?
a. the estimate of its standard deviation of returns over a recent period
b. the trend of historical standard deviations of returns over recent periods
c. the implied volatility derived from an option pricing model
d. the estimate of its option premium derived from an option pricing model

50. The credit crisis caused major problems in the mortgage market but had no impact on the stock market.
a. True
b. False

51. When new information suggests that a firm will experience lower cash flows than previously anticipated or lower risk, investors will revalue the corresponding stock downward.
a. True
b. False

52. A relatively simple method of valuing a stock is to apply the mean price-earnings (PE) ratio of all publicly traded competitors in the respective industry to the firm’s expected earnings for the year.
a. True
b. False

53. While the previous year’s earnings are often used as a base for forecasting future earnings, the recent year’s earnings do not always provide an accurate forecast of the future.
a. True
b. False

54. If investors agree on a firm’s forecasted earnings, they will derive the same value for that firm using the PE method to value the firm’s stock.
a. True
b. False

55. The dividend discount model states that the price of a stock should reflect the present value of the stock’s future dividends.
a. True
b. False

56. The dividend discount model can be adapted to assess the value of any firm, even those that retain most or all of their earnings.
a. True
b. False

57. For firms that do not pay dividends, the free cash flow model may be more suitable than the dividend discount model.
a. True
b. False

58. The capital asset pricing model (CAPM) is based on the premise that the only important risk of a firm is unsystematic risk.
a. True
b. False

59. The prime rate is commonly used as a proxy for the risk-free rate in the capital asset pricing model (CAPM).
a. True
b. False

60. A stock with a beta of 2.3 means that for every 1 percent change in the market overall, the stock tends to change by 2.3 percent in the same direction.
a. True
b. False

61. Stocks that have relatively little trading are normally subject to less price volatility.
a. True
b. False

62. A firm’s stock price is affected not only by macroeconomic and market conditions but also by firm specific conditions.
a. True
b. False

63. Stock repurchases are commonly viewed as an unfavorable signal about the firm.
a. True
b. False

64. The main source of uncertainty in computing the return of a stock is the dividend to be received next year.
a. True
b. False

65. A stock portfolio has more volatility when its individual stock returns are uncorrelated.
a. True
b. False

66. Beta serves as a measure of risk because it can be used to derive a probability distribution of returns based on a set of market returns.
a. True
b. False

67. The value-at-risk method is intended to warn investors about the potential maximum loss that could occur.
a. True
b. False

68. Regarding the value-at-risk method, the same methods used to derive the maximum expected loss of one stock can be applied to derive the maximum expected loss of a stock portfolio for a given confidence level.
a. True
b. False

69. Portfolio managers who monitor systematic risk rather than total risk are more concerned about stock volatility than about beta.
a. True
b. False

70. Regarding the implied standard deviation, by plugging in the actual option premium paid by investors for a specific stock in the option-pricing model, it is possible to derive the anticipated volatility level.
a. True
b. False

71. A portfolio’s beta is the sum of the individual forecasted betas, weighted by the market value of each stock.
a. True
b. False

72. If beta is thought to be the appropriate measure of risk, a stock’s risk-adjusted returns should be determined by the Sharpe index.
a. True
b. False

73. The Treynor index is similar to the Sharpe index, except that is uses beta rather than standard deviation to measure the stock’s risk.
a. True
b. False

74. Fabrizio, Inc. is expected to generate earnings of $1.50 per share this year. If the mean ratio of share price to expected earnings of competitors in the same industry is 20, then the stock price per share is $____.
a. 13.33
b. 3.00
c. 20.00
d. 30.00
e. none of the above

75. Which of the following is not a reason the PE ratio method may result in an inaccurate valuation for a firm?
a. potential errors in the forecast of the firm’s beta
b. potential errors in the forecast of the firm’s future earnings
c. potential errors in the choice of the industry composite used to derive the PE ratio
d. All of the above are reasons the PE ratio method may result in an inaccurate valuation for a firm.

76. The ____ is not a measure of a stock’s risk.
a. stock’s price volatility
b. stock’s return
c. stock’s beta
d. value-at-risk method
e. All of the above are measures of a stock’s risk.

77. If the standard deviation of a stock’s returns over the last 12 quarters is 4 percent, and if there is no perceived change in volatility, there is a ____ percent probability that the stock’s returns will be within ____ percentage points of the expected outcome.
a. 68; 4
b. 68; 8
c. 95; 8
d. 95; 6
e. none of the above

78. The limitations of the dividend discount model are most pronounced for a firm that
a. has a high beta.
b. has high expected future earnings.
c. distributes most of its earnings as dividends.
d. retains all of its earnings.
e. none of the above

79. Which of the following is incorrect regarding the capital asset pricing model (CAPM)?
a. It is sometimes used to estimate the required rate of return for any firm with publicly traded stock.
b. It is based on the premise that the only important risk of a firm is systematic risk.
c. It is concerned with unsystematic risk.
d. All of the above are true.

80. The ____ is not a factor used in the capital asset pricing model (CAPM) to derive the return of an asset.
a. prevailing risk-free rate
b. dividend growth rate
c. market return
d. covariance between the asset’s returns and market returns
e. All of the above are factors used in the CAPM.

81. Steam Corp. has a beta of 1.5. The prevailing risk-free rate is 5 percent and the annual market return in recent years has been 11 percent. Based on this information, the required rate of return on Steam Corp. stock is ____ percent.
a. 21.5
b. 6.5
c. 16.5
d. 14.0
e. none of the above

82. Which of the following is not a type of factor that drives stock prices, according to your text?
a. economic factors
b. market-related factors
c. firm-specific factors
d. All of the above are factors that affect stock prices.

83. The general mood of investors represents:
a. investor sentiment.
b. beta.
c. systematic risk.
d. unsystematic risk.

84. ____ is (are) not a firm-specific factor(s) that affect(s) stock prices.
a. Exchange rates
b. Dividend policy changes
c. Stock offerings and repurchases
d. Earnings surprises
e. All of the above are firm-specific factors that affect stock prices.

85. The U.S. government’s budget deficit has a significant impact on the bond market but does not affect the stock market.
a. True
b. False

86. Investors can avoid unsystematic risk by:
a. using the capital asset pricing model.
b. investing in stocks with low PE ratios.
c. holding diversified portfolios.
d. using the free cash flow model.

87. The market risk premium is:
a. the yield on newly issued Treasury bonds.
b. the return of the market in excess of the risk-free rate.
c. the covariance between the risk-free rate and the return of the market.
d. the return of the market in excess of expected cash flows.

88. The market risk premium is stable over time and is not affected by stock market conditions.
a. True
b. False

89. Holding other factors constant, an increase in the capital gains tax rate will:
a. have more effect on the valuation of dividend-paying stocks than on stocks with high growth prospects.
b. have less effect on the valuation of dividend-paying stocks than on stocks with high growth prospects.
c. have no effect on the valuations of stocks.
d. have the same effect on the valuation of dividend-paying stocks and stocks with high growth prospects.

90. The VIX (volatility index) indicates the volatility of the bond market in general.
a. True
b. False

91. Holding other factors constant, a stock portfolio has more volatility when its individual stock volatilities are ________ and its individual stock returns have _______ correlations.
a. high; low
b. low; high
c. low; low
d. high; high

92. Emerging market stocks tend to exhibit all of the following except:
a. high political risk.
b. high exchange risk.
c. high correlation with stocks of more developed countries.
d. high volatility.

93. Even though a foreign stock that appears to be overvalued in its own country, the stock may not generate a reasonable return for a U.S. investor if the currency of that country appreciates against the U.S. dollar.
a. True
b. False

94. As a result of market integration, stock markets in emerging markets are likely to be as efficient as U.S. stock markets.
a. True
b. False

Chapter 13—Financial Futures Markets

1. A(n) ____ is a standardized agreement to deliver or receive a specified amount of a specified financial instrument at a specified price and date.
a. option contract
b. brokerage contract
c. financial futures contract
d. margin call

2. Interest rate futures are not available on
a. Treasury bonds.
b. Treasury notes.
c. Eurodollar CDs.
d. the S&P 500 index.

3. ____ take positions in futures to reduce their exposure to future movements in interest rates or stock prices.
a. Hedgers
b. Day traders
c. Position traders
d. None of the above

4. ____ trade futures contracts for their own account.
a. Commission brokers
b. Floor brokers
c. Commission traders
d. Floor traders

5. The initial margin of a futures contract is typically between ____ percent of a futures contract’s full value.
a. 0 and 2
b. 5 and 18
c. 25 and 40
d. 45 and 60

6. Futures exchanges take buy or sell positions on futures contracts.
a. True
b. False

STA: DISC.FMAI.MADU.15.03

7. If the prices of Treasury bonds ____, the value of an existing Treasury bond futures contract should ____.
a. increase; be unaffected
b. decrease; be unaffected
c. A and B
d. decrease; decrease
e. decrease; increase

8. Assume that a T-bill futures contract with a face value of $1 million is purchased at a price of $95.00 per $100 face value. At settlement, the price of T-bills is $95.50. What is the difference between the selling and purchase price of the futures contract?
a. $.50
b. $50
c. $500
d. $5,000
e. none of the above

9. If speculators believe interest rates will ____, they would consider ____ a T-bill futures contract today.
a. increase; selling
b. increase; buying
c. decrease, selling
d. decrease; purchasing a call option on

10. Financial futures contracts on U.S. securities are ____ by non-U.S. financial institutions.
a. not allowed to be traded
b. are rarely desired
c. are commonly traded
d. A and B

11. Assume that speculators had purchased a futures contract at the beginning of the year. If the price of a security represented by a futures contract ____ over the year, then these speculators would likely have purchased the futures contract for ____ than they can sell it for.
a. increased; more
b. decreased; less
c. remains the same; more
d. increased; less

12. Assume that a futures contract on Treasury bonds with a face value of $100,000 is purchased at 93-00. If the same contract is later sold at 94-18, what is the gain, ignoring transactions costs?
a. $1,180,000
b. $118
c. $11,800
d. $15,625
e. $1,562.50

13. The use of financial leverage
a. magnifies the positive returns of futures contracts.
b. magnifies losses of futures contracts.
c. both A and B
d. none of the above

14. According to the text, when a financial institution sells futures contracts on securities in order to hedge against a change in interest rates, this is referred to as
a. a long hedge.
b. a short hedge.
c. a closed out position.
d. basis trading.

15. A financial institution that maintains some Treasury bond holdings sells Treasury bond futures contracts. If interest rates increase, the market value of the bond holdings will ____ and the position in futures contracts will result in a ____.
a. increase; gain
b. increase; loss
c. decrease; gain
d. decrease; loss

16. The basis is the
a. difference between the price of a security and the price of a futures contract on the security.
b. gain or loss from hedging with futures contracts.
c. difference between a futures contract price and the initial deposit required.
d. price paid for a futures contract after accounting for transactions costs.
e. price paid for an option contract.

17. The profits of a financial institution with interest-rate sensitive liabilities and interest rate-insensitive assets are ____ with hedging than without hedging if interest rates decrease.
a. higher
b. the same
c. lower
d. higher or the same

18. Assume that a bank obtains most of its funds from large CDs with a one-year maturity. Its assets are in the form of loans with rates that adjust every six months. The bank would be ____ affected if interest rates increase. To partially hedge its position, it could ____ futures contracts.
a. adversely; purchase
b. favorably; sell
c. favorably; purchase
d. adversely; sell

19. According to the text, a futures contract on one financial instrument to protect a position in a different financial instrument is known as
a. cross-hedging.
b. ratio hedging.
c. basis hedging.
d. liquid hedging.

20. The effectiveness of a cross-hedge depends on the degree of correlation between the market values of the two financial instruments.
a. True
b. False

21. If a futures contract is more volatile than the portfolio value, the amount of principal represented by the futures contracts to hedge the portfolio is ____ the market value of the securities to be hedged.
a. smaller than
b. greater than
c. equal to
d. B and C are both possible

22. In cross-hedging, if the futures contract value is ____ volatile than the portfolio value, hedging will require a ____ amount of principal represented by the futures contracts.
a. less; greater
b. more; greater
c. more; smaller
d. none of the above

23. Municipal Bond Index (MBI) futures
a. involve a physical exchange of bonds.
b. are based on a Treasury bond index.
c. are based on actively traded corporate bonds.
d. are settled in cash.

24. Systemic risk reflects the risk that a particular event could
a. cause losses at a firm due to inadequate management control.
b. spread adverse effects among several firms or among financial markets.
c. cause a loss in value due to market conditions.
d. have a larger effect on the futures position than on the position being hedged.

25. A savings and loan association has long-term fixed-rate mortgages financed by short-term funds. It hedges by selling Treasury bond futures. If interest rates decline, and many mortgages are prepaid
a. the gain on the futures contracts offsets the loss on the mortgages.
b. the gain on the mortgages offsets the loss on the futures contracts.
c. the gain on the futures contracts more than offsets any unfavorable effects on mortgages.
d. a loss on the futures contracts more than offsets the favorable effect on the mortgage portfolio.

26. If a financial institution expects that the market value of its municipal bonds will decline because of economic conditions, it could hedge its position by ____ futures contracts on ____.
a. purchasing; Treasury bonds
b. purchasing; the S&P 500 Index
c. purchasing; a Municipal Bond Index
d. selling; a Municipal Bond Index

27. The net gain or loss on a futures contract for a stock index that is not closed out is based on the difference between the futures price when the initial position was created and the futures price at
a. the settlement date.
b. the date at which the futures price reaches its maximum.
c. the date at which the futures price reaches its minimum.
d. the date three months beyond the date when the initial position was taken.

28. The value of an S&P 500 futures contract is $500 times the index. Assume the futures price on the S&P 500 index is 1612 at the time of purchase. If the index price is $1619 when the position is closed out, the gain is
a. $700.
b. $7,000.
c. $3,190.
d. $3,120.
e. $3,500.

29. Assume that a stock mutual fund uses stock index futures as it conducts dynamic asset allocation. This means that the mutual fund
a. liquidates its stocks whenever it expects a market downturn.
b. maintains a constant buy position in stock index futures.
c. maintains a constant sell position in stock index futures.
d. none of the above

30. Companies with international trade can hedge ____ by ____ currency futures.
a. payables; selling
b. receivables; buying
c. payables; buying
d. A and B
e. B and C

31. Assume that corporate bond portfolio managers are concerned about the possibility of many bond defaults resulting from a future recession. A short position in Treasury bond futures ____ an effective hedge against the default risk. A short position in Treasury bill futures ____ an effective hedge against the default risk.
a. would be; would be
b. would be; would not be
c. would not be; would not be
d. would not be; would be

32. Which of the following statements is incorrect with respect to cross-hedging?
a. Even when the futures contract is highly correlated with the portfolio being hedged, the value of the futures contract may change by a higher or lower percentage than the portfolio’s market value.
b. If the futures contract value is more volatile than the portfolio value, hedging will require a greater amount of principal represented by the futures contracts.
c. The effectiveness of a cross-hedge depends on the degree of correlation between the market values of the two financial instruments.
d. If the price of the underlying security of the futures contract moves closely in tandem with the security hedged, the futures contract can provide an effective hedge.
e. All of the above are correct with respect to cross-hedging.

33. ____ risk is the risk that the position being hedged by a futures contract is not affected in the same manner as the instrument underlying the futures contract.
a. Market
b. Liquidity
c. Credit
d. Basis
e. None of the above

34. Trading restrictions imposed on specific stocks or stock indices are referred to as
a. index busters.
b. index options.
c. circuit breakers.
d. protective covenants.

35. Financial leverage, when used in association with a futures contract, ____ the positive returns and ____ losses.
a. magnifies; reduces
b. reduces; magnifies
c. magnifies; magnifies
d. reduces; reduces

36. Currency futures may be purchased to hedge ____ or to capitalize on the expected ____ of that currency against the dollar.
a. receivables; appreciation
b. receivables; depreciation
c. payables; depreciation
d. payables; appreciation

37. The risk that the position being hedged by a futures position is not affected in the same manner as the instrument underlying the financial futures contract, is referred to as
a. market risk.
b. liquidity risk.
c. default risk.
d. basis risk.

38. Dynamic asset allocation involves the switching between risky and low-risk investments by institutional investors over time in response to changing expectations.
a. True
b. False

39. The prices of stock index futures
a. are always the same as the prices of the stocks representing the index.
b. are always a little above the prices of the stocks representing the index.
c. are always a little below the prices of the stocks representing the index.
d. none of the above

40. The actions of numerous institutional investors to sell stock index futures instead of selling stocks to prepare for a market decline would likely cause the index futures price to be
a. equal to the prevailing stock prices.
b. below the prevailing stock prices.
c. above the prevailing stock prices.
d. negative.

41. Speculators in futures contracts that normally close out their futures positions on the same day that the positions were initiated are referred to as
a. day traders.
b. hedgers.
c. closed-end traders.
d. position traders.

42. Speculators in futures contracts that normally maintain the futures position that they initiate for extended periods of time (such as weeks or months) are referred to as
a. day traders.
b. hedgers.
c. closed-end traders.
d. position traders.

43. Which of the following is incorrect regarding organized exchanges trading financial futures contracts?
a. Organized exchanges establish and enforce rules for the trading of financial futures contracts.
b. Organized exchanges ensure that the seller of the futures contract always delivers the securities covered by the contract, whether the contract was settled prior to the settlement date or not.
c. Organized exchanges clear, settle, and guarantee all transactions that occur on their exchanges.
d. The operations of financial futures exchanges are regulated by the Commodity Futures Trading Commission (CFTC).
e. All of the above are correct.

44. Marcia buys an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Marcia’s position in the S&P 500 futures contract is ____ percent.
a. −20
b. −10
c. 25
d. 20
e. 0

45. Laura sells an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Laura’s position in the S&P 500 futures contract is ____ percent.
a. −20
b. −10
c. 25
d. 20
e. 0

46. Assume a corporation is receiving a large amount of funds in the near future. The company plans to use the funds to purchase municipal bonds. Also assume that the company is concerned that interest rates decrease before the purchase date, which would make the municipal bonds more expensive. In order to hedge against this possibility, the company should ____ MBI futures contracts. If interest rates decrease, the futures contract will generate a ____.
a. sell; loss
b. purchase; gain
c. purchase; loss
d. sell; gain
e. none of the above

47. If there are ____ traders with buy offers than sell offers for a particular contract, the futures price will ____ until this imbalance is removed.
a. more; decrease
b. more; rise
c. fewer; rise
d. none of the above

48. Which of the following statements is incorrect?
a. Circuit breakers are trading restrictions imposed on specific stocks or stock indexes.
b. Circuit breakers guarantee that prices will turn upward.
c. Circuit breakers may be able to prevent large declines in prices that would be attributed to panic selling rather than to fundamental forces.
d. Circuit breakers may allow investors to determine whether circulating rumors are true.

49. ____ risk is the risk of losses as a result of inadequate management or controls.
a. Basis
b. Systemic
c. Operational
d. Prepayment

50. Financial futures contracts on stock indexes are referred to as interest rate futures.
a. True
b. False

51. Financial futures contracts are rarely sold over the counter.
a. True
b. False

52. Brokers commonly require margin deposits from their customers above those required by the exchanges.
a. True
b. False

53. Purchasers of financial futures contracts usually know who the sellers are, and vice versa.
a. True
b. False

54. The futures price is mainly a function of the prevailing price of the underlying security plus an expected adjustment in that price by the settlement date.
a. True
b. False

55. A financial institution that hedges with interest rate futures is less sensitive to economic events than an institution that does not hedge.
a. True
b. False

56. A bond index futures contract allows for the buying, but not the selling, of a bond index for a specified price at a specified date.
a. True
b. False

57. Market participants who expect the stock market to perform poorly before the settlement date may consider selling S&P 500 index futures.
a. True
b. False

58. Stock index futures cannot be closed out before the settlement date.
a. True
b. False

59. The value of a stock index futures contract has little correlation with the value of the underlying stock index.
a. True
b. False

60. Since stock index futures prices are primarily driven by movements in the corresponding stock indexes, participants in stock index futures monitor indicators that may signal changes in the stock indexes.
a. True
b. False

61. The price of stock index futures may reflect investor expectations about the market more rapidly than stock prices.
a. True
b. False

62. Financial futures contracts on U.S. securities are commonly traded by non-U.S. financial institutions that maintain holdings of U.S. securities.
a. True
b. False

63. Purchasers of currency futures contracts are required to hold the contract until the settlement date and accept delivery of the foreign currency at that time.
a. True
b. False

64. Which of the following statements is incorrect regarding organized futures exchanges?
a. Organized exchanges establish and enforce rules for the trading of financial futures contracts.
b. Organized exchanges serve as market makers for futures contracts by taking positions in futures.
c. Organized exchanges clear, settle, and guarantee all transactions that occur on their exchanges.
d. The operations of financial futures exchanges are regulated by the Commodity Futures Trading Commission (CFTC).
e. All of the above are correct.

65. Stock index futures are priced ____ than the stock index itself.
a. higher
b. lower
c. either higher or lower
d. none of the above

66. An unexpected ____ in the consumer price index tends to create expectations of ____ interest rates and places ____ pressure on Treasury bond futures prices.
a. increase; higher; downward
b. increase; lower; downward
c. increase; higher; upward
d. decrease; higher; downward
e. none of the above

67. Bill Baher, a private investor, purchased a futures contract on Treasury bonds at a price of 102-12. Two months later, Baher sells the same futures contract in order to close out the position. At that time, the futures contract specifies 103-15. What is Baher’s nominal profit? The par value of the futures contract is $100,000.
a. $1,030.00; profit
b. $1,030.00; loss
c. $1,093.75; profit
d. $1,093.75; loss
e. none of the above

68. Clarke plans to satisfy cash needs in nine months by selling its Treasury bond holdings for $4 million. However, Clarke is concerned that interest rates might increase over the next three months. To hedge against this possibility, Clarke plans to sell Treasury bond futures. Thus, Clarke sells ____ futures contract for a price of 99-12. Assuming that the actual price of the futures contract declined to 97-20, Clarke would make a ____ of $____ from closing out the futures position.
a. 40; profit; $76,800
b. 40; loss; $76,800
c. 50; profit; $70,000
d. 40; profit; $70,000
e. none of the above

69. _________ take positions in financial futures to reduce their exposure to future movements in interest rates or stock prices; ________ commonly take the opposite position and thus serve as counterparties on many transactions.
a. Speculators; hedgers
b. Hedgers; speculators
c. Arbitrageurs; speculators
d. Hedgers; arbitrageurs

70. Some specialized futures contracts are sold over the counter, whereas standardized financial futures contracts are traded on exchanges.
a. True
b. False

71. A financial institution that wishes to reduce its exposure to the possibility of declining interest rates might use:
a. a long hedge.
b. a short hedge.
c. a day hedge.
d. index arbitrage.

72. Settlement of stock index futures contracts occurs through delivery of the underlying securities.
a. True
b. False

73. ___________ involves the buying or selling of stock index futures with a simultaneous opposite position in the stocks that the index comprises.
a. Dynamic asset allocation
b. Cross-hedging
c. Index arbitrage
d. Net hedging

74. Which of the following is not a type of risk associated with futures contracts?
a. basis risk
b. liquidity risk
c. market risk
d. postpayment risk

75. Credit risk exists for futures contracts traded on exchanges, but it is normally not a concern for over-the-counter futures transactions.
a. True
b. False

76. __________ occurs when a firm does not have adequate controls to monitor the employees responsible for its futures positions and those employees take more speculative positions than the firm desires.
a. Credit risk
b. Control risk
c. Operational risk
d. Management risk