Ch. 7 - Derivatives and Risk Management

Question 1

Financial Risks are:

Answer 1

the unexpected changes in interest rates, exchange rates and commodity prices

Question 2

Some common derivatives include:

Answer 2

1. forwards
2. swaps
3. futures
4. options

Question 3

A forward contract is:

Answer 3

an agreement between two parties for the delivery of a specified item on a specified future date at a specified price

Question 4

A future contract is:

Answer 4

a standardized contract to buy or sell an asset on or before a future date at a specified price

Question 5

An option is:

Answer 5

A contract that gives the owner the right (not the obligation) to buy (call) or sell (put) an asset

Question 6

Common reasons to use derivatives

Answer 6

1. Speculation
2. Diversification
3. Hedging

Question 7

Four Risk Management Approaches

Answer 7

1. Opportunistic
2. Passive
3. Defensive
4. Compromise

Question 8

Opportunistic Risk Management:

Answer 8

the entity actively forecasts and makes decisions based on this

Question 9

Passive Risk Management:

Answer 9

The entity ignores risk and relies on its ability to ride out fluctuations

Question 10

Defensive Risk Management:

Answer 10

The entity reacts when potential adverse changes occur

Question 11

Comprehensive Risk Management:

Answer 11

The entity develops a hedging strategy and follows it with certain exceptions