Derivatives and Corporate Risk Management

Question 1

Basic principles and concepts related to managing risks effectively.

Answer 1

Fundamentals of risk management

Question 2

Contracts for the future purchase or sale of a financial asset at a price set today.

Answer 2

Futures

Question 3

Motivations for corporations to manage risks effectively.

Answer 3

Reasons for engaging in risk management

Question 4

The price at which the security can be bought or sold in an option contract.

Answer 4

Exercise (or strike) price

Question 5

A call option with an exercise price lower than the current stock price.

Answer 5

In-the-money call

Question 6

A call option with an exercise price higher than the current stock price.

Answer 6

Out-of-the-money call

Question 7

Risks associated with a firm’s input costs.

Answer 7

Input risks

Question 7

Risks associated with environmental pollution.

Answer 7

Environmental risk

Question 8

Risk inherent in financial markets due to price fluctuations.

Answer 8

Financial risk exposure

Question 8

Exchanging cash payment obligations between parties to manage financial risk.

Answer 8

Swaps

Question 9

A security whose value is derived from other assets, used to manage financial risk exposures.

Answer 9

Derivative

Question 10

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Securities whose value is derived from an underlying asset.

Answer 10

Derivative securities

Question 11

Utilizing derivative securities in financial strategies.

Answer 11

Using derivatives

Question 12

Whether a firm’s reduction of cash flow volatility concerns stockholders.

Answer 12

Stockholders concerns

Question 13

A contract granting the holder the right to buy or sell an asset at a predetermined price within a specified time.

Answer 13

Option

Question 14

An option to buy a specified number of shares of a security in the future.

Answer 14

Call option

Question 15

The date an option matures.

Answer 15

Expiration date

Question 15

An option to sell a specified number of shares of a security in the future.

Answer 15

Put option

Question 16

The market price of an option contract.

Answer 16

Option price

Question 17

The value of an option if exercised today (Current stock price - Strike price).

Answer 17

Exercise value

Question 18

An option written against stock held in an investor’s portfolio.

Answer 18

Covered option

Question 18

An option written without the stock to back it up.

Answer 18

Naked (uncovered) option

Question 19

The price of an option over its exercise value.

Answer 19

Option premium

Question 19

Long-term Equity AnticiPation Securities, long-term options with maturities up to 2 1/2 years.

Answer 19

LEAPS

Question 20

Assumptions including no dividends, no transaction costs, known risk-free rate, and continuous time trading.

Answer 20

Black-Scholes Option Pricing Model assumptions

Question 20

Managing unpredictable events that could harm a firm’s operations.

Answer 20

Corporate risk management

Question 21

Risks offering only the prospect of a loss.

Answer 21

Pure risks

Question 21

Risks offering the potential for gain or loss.

Answer 21

Speculative risks

Question 21

Risks related to the demand for a firm’s products or services.

Answer 21

Demand risks

Question 22

Risks linked to the loss of a firm’s productive assets.

Answer 22

Property risks

Question 23

Risks arising from financial transactions.

Answer 23

Financial risks

Question 24

Risks resulting from human actions.

Answer 24

Personnel risk

Question 25

Risks connected with product, service, or employee liability.

Answer 25

Liability risks

Question 26

Risks typically covered by insurance.

Answer 26

Insurable risks

Question 26

Identifying risks, measuring their impact, and deciding how to handle each relevant risk.

Answer 26

Steps of corporate risk management

Question 26

Strategy to guard against price changes that could negatively impact profits.

Answer 26

Hedging

Question 27

Buying a futures contract to protect against price increases.

Answer 27

Long hedge

Question 27

Used to reduce input price risk by allowing future purchases at today’s price.

Answer 27

Commodity futures markets

Question 28

Selling a futures contract to protect against price declines.

Answer 28

Short hedge