Sessions 9 and 10: Long-Term Sources of Financing

1. Equity investment in start-up private companies is called:

A. venture capital.
B. mezzanine financing.
C. initial public offering (IPO).
D. seasoned equity offering (SEO).

2. Which of the following statements is generally true of venture capital (VC) firms?

A. VCs are always silent partners in the start-up company that they finance.
B. VCs always have a majority of directors in the start-up company.
C. VCs generally provide management advice and contacts in addition to capital.
D. VCs are combinations of publicly-traded companies.

3. Arrange the following in chronological order for a typical start-up firm:

I) VC financing; II) mezzanine financing; III) stage 1, 2, 3, 4, etc., financing; IV) IPO

A. I, II, III, and IV

B. I, III, II, and IV
C. IV, I, II, and III
D. III, I, II, and IV

4. Venture capitalists provide start-up companies:

A. all the money they will need up front.

B. enough money at each stage so that they can reach the next stage or major checkpoint.
C. assistance in managing the initial public offering (IPO).
D. funding intended to buy-out the company's founders.
5. The very first public equity sold by a company is referred to as:

A. a rights issue.
B. American depositing receipts (ADRs).
C. an initial public offering (IPO).
D. a seasoned equity offering (SEO).

6. A new public equity issue from a company with public equity previously outstanding is
called a(an):

A. initial public offering (IPO).

B. American depository receipt (ADR).
C. seasoned equity offering (SEO).
D. private placement.

7. What costs in an IPO generally exceed all other costs?

A. commissions
B. issues fees
C. spreads
D. underpricing

8. When a company sells an entire issue of securities to a small group of institutional

investors like life insurance companies, pension funds, etc., it is called a(an):

A. rights offering.
B. general art offering.
C. private placement.
D. unseasoned issue.
 Sessions 11 and 12: Understanding Risk and Return

1. Which of the following portfolios has the least risk?

A. A portfolio of Treasury bills

B. A portfolio of long-term government bonds
C. A portfolio of common stocks of small firms
D. A portfolio of common stocks of large firms

2. For long-term government bonds, which risk typically concerns investors the most?

A. Interest rate risk

B. Default risk
C. Market risk
D. Liquidity risk

3. Market risk is also called:

I) systematic risk; II) undiversifiable risk; III) firm-specific risk.

A. I only
B. II only
C. III only
D. I and II only

4. As the number of stocks in a portfolio is increased:

A. unique risk decreases and approaches zero

B. market risk decreases
C. unique risk decreases and becomes equal to market risk
D. total risk approaches zero
5. For a portfolio of N-stocks, the formula for portfolio variance contains:

A. N variance terms.
B. N(N - 1)/2 variance terms.
C. N2 variance terms.
D. N - 1 variance terms.

6. For a portfolio of N-stocks, the formula for portfolio variance contains:

A. N covariance terms.
B. N(N - 1)/2 different covariance terms.
C. N2 covariance terms.
D. N - 1 covariance terms.

7. For a two-stock portfolio, the maximum reduction in risk occurs when the correlation
coefficient between the two stocks equals:

A. +1.0.
B. -0.5.
C. -1.0.
D. 0.0.

8. Beta is a measure of:

A. unique risk.
B. total risk.
C. market risk.
D. liquidity risk.

9. The beta of the market portfolio is:

A. +1.0.
B. +0.5.
C. 0.
D. -1.0.
10. Which of the following portfolios will have the highest beta?

A. Portfolio of Treasury bills

B. Portfolio of government bonds
C. Portfolio containing 50% Treasury bills and 50% government bonds
D. Portfolio of common stocks

11. If the standard deviation of returns on the market is 20%, and the beta of a well-diversified
portfolio is 1.5, calculate the standard deviation of this portfolio:

A. 30%.
B. 20%.
C. 15%.
D. 10%.

All unique risk has been eliminated through diversification. Beta will measure the
remaining market risk. Standard deviation of the portfolio = (1.5) × (20) = 30%.
12. The correlation coefficient between a stock and the market portfolio is +0.6. The standard
deviation of return of the stock is 30% and that of the market portfolio is 20%. Calculate
the beta of the stock.

A. 1.1
B. 1.0
C. 0.9
D. 0.6

Cov(Rs, Rm) = (0.6)(20)(30) = 360; var(Rm) = 20^2 = 400;

Beta = [Cov(Rs, Rm)]/var(Rm) = 360/400 = 0.9.

13. The correlation coefficient between stock B and the market portfolio is 0.8. The standard
deviation of stock B is 35% and that of the market is 20%. Calculate the beta of the stock.

A. 1.0
B. 1.4
C. 0.8
D. 0.7

Cov(Rb, Rm) = (0.8)(20)(35) = 560;

Beta = 560/400 = 1.4.

14. The covariance between YOHO stock and the S&P 500 is 0.05. The standard deviation of
the stock market is 20%. What is the beta of YOHO?

A. 0.00
B. 1.00
C. 1.25
D. 1.42

Beta = .05/0.2^2 = 1.25.

15. An efficient portfolio:

I) has only unique risk;

II) provides the highest expected return for a given level of risk;
III) provides the least risk for a given level of expected return;
IV) has no risk at all

A. I only
B. II and III only
C. IV only
D. II only

16. The correlation coefficient measures the:

A. rate of return of individual stocks.

B. direction of movement of the return of individual stocks.
C. degree to which the returns of two stocks move together.
D. degree of s unique risk present in the standard deviations of a pair of stocks.

17. The Sharpe ratio is defined as:

A. (rP - rf)/σP.
B. (rP - rM)/σP.
C. (rP - rf)/βP.
D. (rP - rM)/βP.

18. The capital asset pricing model (CAPM) states which of the following:

A. The expected risk premium on an investment is proportional to its beta.

B. The expected rate of return on an investment is proportional to its beta.
C. The expected rate of return on an investment is determined entirely by the risk-free
rate and the market rate of return.
D. The expected rate of return on an investment is determined entirely by the risk-free
rate.
19. A stock return's beta measures:

A. the stock's covariance with the risk-free asset.

B. the change in the stock's return for a given change in the market return.
C. the return on the stock.
D. the standard deviation on the stock's return.

20. The security market line (SML) is the graph of:

A. expected rate of return on investment vs. variance of returns.

B. expected rate of return on investment vs. standard deviation of returns.
C. expected rate of return on investment vs. beta.
D. expected rate of return on investment vs. average returns.

21. Suppose the beta of Microsoft is 1.13, the risk-free rate is 3%, and the market risk
premium is 8%. Calculate the expected return for Microsoft.

A. 12.04%
B. 15.66%
C. 13.94%
D. 8.65%

E(R) = 3 + 1.13(8) = 12.04%.

22. Suppose the beta of Exxon-Mobil is 0.65, the risk-free rate is 4%, and the expected market
rate of return is 14%. Calculate the expected rate of return on Exxon-Mobil.

A. 12.6%
B. 10.5%
C. 13.1%
D. 6.5%

Beta = 4 + 0.65(14 - 4) = 10.5%.

 Sessions 13 and 14: Capital Structure and Cost of Capital

1. When a firm has no debt, then such a firm is known as:

I) an unlevered firm; II) a levered firm; III) an all-equity firm

A. I only
B. II only
C. III only
D. I and III only

2. The capital structure of the firm can be defined as:

I) the firm's mix of different debt securities;

II) the firm's mix of different securities used to finance assets;
III) the market imperfection that the firm's managers can exploit

A. I only
B. II only
C. III only
D. I, II, and III

3. If a firm permanently borrows $100 million at an interest rate of 8%, what is the present
value of the interest tax shield? (Assume that the marginal corporate tax rate is 30%.)

A. $8.00 million
B. $5.60 million
C. $30.00 million
D. $26.67 million

PV of interest tax shield = (0.3)(100) = $30 million.

4. In order to calculate the tax shields provided by debt, the tax rate used is the:

A. average corporate tax rate.

B. marginal corporate tax rate.
C. average of shareholders' equity tax rates.
D. average of bondholders' personal tax rates.

5. According to the trade-off theory of capital structure:

A. optimal capital structure occurs when the present value of tax savings on account of
additional borrowing just offsets the increase in the present value of costs of distress.
B. optimal capital structure occurs when the stockholders' right to default is balanced by
the bondholders' right to get interest and principal payments.
C. optimal capital structure occurs when the benefits of limited liability is just offset by
the value of the firm's lawyers' claims.
D. none of the options.

6. The company cost of capital is the appropriate discount rate for a firm's:

A. low-risk projects.
B. high-risk projects.
C. average-risk projects.
D. risk-free projects.

7. The cost of capital is the same as the cost of equity for firms that are financed:

A. entirely by debt.
B. by both debt and equity.
C. entirely by equity.
D. by 50% equity and 50% debt.
8. The cost of capital for a project depends on:

A. the company's cost of capital.

B. the use of the capital (the project).
C. the industry cost of capital.
D. the company's level of debt financing.

9. Using a company's cost of capital to evaluate a project is:

I) always correct;
II) always incorrect;
III) correct for projects that have average risk compared to the firm's other assets

A. I only
B. II only
C. III only
D. I and III only

10. The market value of Charter Cruise Company's equity is $15 million and the market value
of its debt is $5 million. If the required rate of return on the equity is 20% and that on its
debt is 8%, calculate the company's cost of capital. (Assume no taxes.)

A. 20%
B. 17%
C. 14%
D. 11%

Company cost of capital = (5/20)(8%) + (15/20)(20%) = 17%.

11. The hurdle rate for capital budgeting decisions is:

A. the cost of capital.

B. the cost of debt.
C. the cost of equity.
D. the risk-free rate.
12. The company cost of capital, when the firm has both debt and equity financing, is called
the:

A. cost of debt.
B. cost of equity.
C. the weighted average cost of capital (WACC).
D. the return on equity (ROE).

13. One calculates the after-tax weighted average cost of capital (WACC) using which of the
following formulas:

A. WACC = (rD) (D/V) + (rE) (E/V), where: V = D + E.

B. WACC = (rD) (1 - TC) (D/V) + (rE) (1 - TC) (E/V), where: V = D + E.
C. WACC = (rD) (D/E) + (rE) (E/D).
D. WACC = (rD) (1 - TC) (D/V) + (rE) (E/V), where: V = D + E.

14. The market value of equity equals:

A. (Market price) × (# of shares outstanding)

B. (Market price) × (# of treasury shares)
C. (Market price) × (# of authorized shares)
D. (Par value) × (# of shares outstanding)

15. A firm has $100 million in current liabilities, $200 million in total long-term liabilities, $300
million in stockholders' equity, and total assets of $600 million. Calculate the firm's ratio of
long-term debt to long-term debt plus equity.

A. 40%
B. 20%
C. 50%
D. 17%

Ratio = (200)/500 = 0.4, or 40%.

16. The market value of XYZ Corporation's common stock is $40 million and the market value
of its risk-free debt is $60 million. The beta of the company's common stock is 0.8, and the
expected market risk premium is 10%. If the Treasury bill rate is 6%, what is the firm's cost
of capital? (Assume no taxes.)

A. 9.2%
B. 14.0%
C. 8.1%
D. 10.8%

rE = 6 + 0.8(10) = 14%; rD = 5%; cost of capital = (60/100)(6%) + (40/100) (14%) = 9.2%.

17. A firm finances itself with 30% debt, 60% common equity, and 10% preferred stock. The
before-tax cost of debt is 5%, the firm's cost of common equity is 15%, and that of
preferred stock is 10%. The marginal tax rate is 30%. What is the firm's weighted average
cost of capital?

A. 10.05%
B. 11.05%
C. 12.50%
D. 10.75%

(0.3)(1 - 0.3)(5) + (0.6)(15) + (0.1)(10) = 11.05.

18. A firm uses $30 million of debt, $10 million of preferred stock, and $60 million of common
equity to finance its assets. If the before-tax cost of debt is 8%, cost of preferred stock is
10%, and the cost of common equity is 15%, calculate the weighted average cost of capital
for the firm assuming a tax rate of 35%.

A. 12.4%
B. 11.56%
C. 10.84%
D. 19.27%

WACC = (30/100)(1 - 0.35)(8) + (10/100)(10) + (60/100)(15) = 11.56%.

 Sessions 15 and 16: Capital Budgeting Techniques

1. Which of the following investment rules does NOT use the time value of money concept?

A. Net present value

B. Internal rate of return
C. The payback period
D. Profitability index

2. The following are measures used by firms when making capital budgeting decisions
EXCEPT:

A. payback period.
B. internal rate of return.
C. P/E ratio.
D. net present value.

3. The net present value of a project depends upon the:

A. company's choice of accounting method.

B. manager's tastes and preferences.
C. project's cash flows and opportunity cost of capital.
D. company's profitability index.

4. The payback period rule accepts all projects for which the payback period is:

A. greater than the cut-off value.

B. less than the cut-off value.
C. positive.
D. an integer.
5. The following are disadvantages of using the payback rule EXCEPT the rule:

A. ignores all cash flow after the cutoff date.

B. does not use the time value of money.
C. is easy to calculate and use.
D. does not have the value additivity property.

6. Which of the following statements regarding the discounted payback period rule is true?

A. The discounted payback rule uses the time value of money concept.
B. The discounted payback rule is better than the NPV rule.
C. The discounted payback rule considers all cash flows.
D. The discounted payback rule exhibits the value additivity property.

7. Given the following cash flows for project Z: C0 = -1,000, C1 = 600, C2 = 720, and C3 =
2,000, calculate the discounted payback period for the project at a discount rate of 20%.

A. 1 year
B. 2 years
C. 3 years
D. >3 years

1,000 = (600/1.2) + (720/1.2^2); Discounted payback = 2 years.

8. If an investment project (normal project) has an IRR equal to the cost of capital, the NPV
for that project is:

A. positive.
B. negative.
C. zero.
D. unable to determine.
9. The IRR is defined as:

A. the discount rate that makes a project's NPV equal to zero.

B. the difference between the cost of capital and the present value of the cash flows.
C. the discount rate used in the NPV method.
D. the discount rate used in the discounted payback period method.

10. Which of the following methods of evaluating capital investment projects incorporates the
time value of money concept?
I) payback period; II) discounted payback period; III) net present value (NPV); IV) internal
rate of return

A. I, II, and III only

B. II, III, and IV only
C. III and IV only
D. I, II, III, and IV

11. The following are some of the shortcomings of the IRR method except:

A. IRR is conceptually easy to communicate.

B. Projects can have multiple IRRs.
C. IRR cannot distinguish between a borrowing project and a lending project.
D. It is very cumbersome to evaluate mutually exclusive projects using the IRR method.

12. If the sign of the cash flows for a project changes two times, then the project likely has:

A. one IRR.
B. two IRRs.
C. three IRRs.
D. four IRRs.
13. Music Company is considering investing in a new project. The project will need an initial
investment of $2,400,000 and will generate $1,200,000 (after-tax) cash flows for three
years. Calculate the NPV for the project if the cost of capital is 15%.

A. $169, 935
B. $1,200,000
C. $339,870
D. $125,846

NPV = -2,400,000 + [(1,200,000)/(1.15)] + [(1,200,000/(1.15)^2] + [1,200,000/(1.15)^3] =

339,870.

14. A project will have only one internal rate of return if:

A. the net present value is positive

B. the net present value is negative
C. the cash flows decline over the life of the project
D. there is a one-sign change in the cash flows

15. Story Company is investing in a giant crane. It is expected to cost $6.0 million in initial
investment, and it is expected to generate an end-of-year after-tax cash flow of $3.0
million each year for three years. Calculate the NPV at 12%.

A. $2.4 million
B. $1.2 million
C. $0.80 million
D. $0.20 million

NPV(millions) = -6.0 + 3/1.12 + 3/(1.12^2) + 3/(1.12^3) = 1.2.

16. Given the following cash flows for project A: C0 = -3,000, C1 = +500, C2 = +1,500, and C3 =
+5,000, calculate the NPV of the project using a 15% discount rate.

A. $5,000
B. $2,352
C. $3,201
D. $1,857

NPV = -3000 + (500/1.15) + (1500/1.15^2) + (5000/1.15^3) = 1857.

17. How does modified internal rate of return (MIRR) differ from IRR?

A. MIRR does not consider cash flows occurring after the cutoff date.
B. MIRR uses NPV. IRR does not.
C. MIRR calculates the PV of cash inflows and then divides by the PV of the investment.
D. MIRR reduces the number of sign changes in a cash-flow sequence.

18. When a firm has the opportunity to add a project that will utilize excess factory capacity
(that is currently not being used), which costs should be used to help determine if the
added project should be undertaken?

A. allocated overhead costs

B. sunk costs
C. incremental costs
D. average costs

19. Money that a firm has already spent, or committed to spend regardless of whether a
project is taken, is called:

A. fixed cost.
B. opportunity cost.
C. sunk cost.
D. incremental cost.
20. The NPV value obtained by discounting nominal cash flows using the nominal discount
rate is the same as the NPV value obtained by discounting:
I) real cash flows using the real discount rate;
II) real cash flows using the nominal discount rate;
III) nominal cash flows using the real discount rate

A. I only
B. II only
C. III only
D. II and III only

21. Proper treatment of inflation in NPV calculations involves:

I) discounting nominal cash flows by the nominal discount rate;
II) discounting real cash flows by the real discount rate;
III) discounting nominal cash flows by the real discount rate

A. I only
B. II only
C. III only
D. I and II only

22. A project requires an investment of $900 today. It can generate sales of $1,100 per year
forever. Costs are $600 for the first year and will increase by 20% per year. (Assume all
sales and costs occur at year-end, i.e., costs are $600 @ t = 1.) Ignore taxes and calculate
the NPV of the project at a 12% discount rate. Assume that the project is stopped when
costs exceed the revenues.

A. $65.00
B. $57.51
C. $100.00
D. Cannot be calculated as g > r

NPV = -900 + (1,100 - 600)/1.12 + (1,100 - (600 × 1.2))/(1.12^2) + (1,100 - 600

(1.2^2))/(1.12)^3 + (1,100 - 600 (1.2^3))/(1.12^4) = $57.51). (The project is stopped in
Year 4).
23. Given the following cash flows for project A: C0 = -1,000, C1 = +600, C2 = +400, and C3 =
+1,500, calculate the payback period.

A. one year
B. two years
C. three years
D. cannot be determined

Initial investment: 1,000 = CF1 + CF2 = 600 + 400; payback period = two years.
Sessions 17 and 18: Working Capital Management Decisions; Dividend Policy Decisions

1. Net working capital is defined as:

A. the current assets in a business.

B. the difference between current assets and current liabilities.
C. the present value of all short-term cash flows.
D. the difference between total assets and total liabilities.

2. The following is the general formula for calculating the "Ending accounts receivable (AR):"

A. Ending (AR) = beginning (AR) - sales + collections.

B. Ending (AR) = beginning (AR) + sales - collections.
C. Ending (AR) = beginning (AR) + sales + collections.
D. Ending (AR) = beginning (AR) - sales - collections.

3. Accounts receivable include:

I) trade credit;
II) consumer credit;
III) inventories

A. I only
B. II only
C. III only
D. I and II only

4. If a firm grants credit with terms of 3/10, net 30, the customer:

A. must pay a penalty of 3% when payment is made in more than 10 days after the sale.
B. must pay a penalty for 10% when payment is made in more than 3 days after the sale.
C. receives a discount of 3% when payment is made in less than 10 days after the sale.
D. receives a discount of 10% when payment is made in less than 3 days after the sale.
5. The net credit period for a company with terms of 3/10, net 60 is:

A. 50 days.
B. 60 days.
C. 10 days.
D. 57 days.

60 - 10 = 50.

6. Suppose you purchase goods on terms of 1/10, net 30. Taking compounding into account,
what annual rate of interest is implied by the cash discount? (Assume a year has 365
days.)

A. 9.6%
B. 9.2%
C. 20.1%
D. 44.6%

Implied interest rate = [(1 + (1/99))^(365/20)] - 1 = 1.201 - 1 = 0.201 = 20.1%.

7. Suppose you purchase goods on terms of 3/10, net 60. Taking compounding into account,
what annual rate of interest is implied by the cash discount? (Assume a year has 365
days.)

A. 32%
B. 25%
C. 91%
D. 28.2%

Implied interest rate = [(1 + (3/97))^(365/50)] - 1 = 1.249 - 1 = 0.25 = 25%.

8. The market for short-term investments is called:

A. capital market.
B. stock market.
C. bond market.
D. money market.
9. Firms can pay out cash to their shareholders in the following ways:
I) dividends; II) share repurchases; III) interest payments

A. I only
B. II only
C. I and II only
D. III only

10. Dividend policy changes are decided by:

I) the managers of a firm; II) the government; III) the board of directors

A. I only
B. II only
C. III only
D. I and II only

11. Which of the following lists events in chronological order from earliest to latest?

A. Record date, declaration date, ex-dividend date

B. Declaration date, record date, ex-dividend date
C. Declaration date, ex-dividend date, record date
D. Record date, ex-dividend date, declaration date

12. Which of the following dividends is never in the form of cash?

I) regular dividend;
II) special dividend;
III) stock dividend;
IV) liquidating dividend

A. I only
B. II only
C. III only
D. I, II, and IV only
13. Which of the following are true?

I) Firms have long-run target dividend payout ratios.

II) Dividend changes follow shifts in long-term, sustainable earnings.
III) Managers are reluctant to make dividend changes that might have to be reversed.

A. I only
B. II only
C. III only
D. I, II, and III

14. Generally, investors interpret the announcement of an increase in dividends as:

A. bad news and the stock price drops.

B. good news and the stock price increases.
C. a nonevent and does not affect the stock price.
D. very bad news and the stock price plunges.

15. The dividend-irrelevance proposition of Miller and Modigliani depends on the following
relationship between investment policy and dividend policy:

A. Changes in investment policy will alter dividend policy.

B. Changes in dividend policy will alter investment policy.
C. Investment policy is independent of dividend policy.
D. Dividends are tax-deductible and investments are depreciable.
16. Company X has 100 shares outstanding. It earns $1,000 per year and expects to pay all of
it as dividends. If the firm expects to maintain this dividend forever, calculate the stock
price after the dividend payment. (The required rate of return is 10%.)

A. $110
B. $100
C. $90
D. $10

Dividends = 1000/100 = $10; P = 10/0.1 = $100;

Price before dividend payment = $110; Price after dividend payment = $100.

17. Company X has 100 shares outstanding. It earns $1,000 per year and announces that it will
use all $1,000 to repurchase its shares in the open market instead of paying dividends.
Calculate the number of shares outstanding at the end of year 1, after the first share
repurchase, if the required rate of return is 10%.

A. 110.0
B. 100.0
C. 90.91
D. 89.0

Share price at beginning of year = [$1000/0.1]/100 = $100 per share. Share price at end of
year, before repurchase, equals $100 × 1.10 = $110. Number of shares purchased =
$1,000/$110 = 9.09. 100 - 9.09 = 90.91 shares remain.
 Sessions 19 and 20: Introduction to Derivatives Securities and Markets

1. An option that can be exercised any time before its expiration date is called:

A. a European option.
B. an American option.
C. a call option.
D. a put option.

2. The owner of a regular exchange-listed call-option on a stock:

A. has the right to buy 100 shares of the underlying stock at the exercise price.
B. has the right to sell 100 shares of the underlying stock at the exercise price.
C. has the obligation to buy 100 shares of the underlying stock at the exercise price.
D. has the obligation to sell 100 shares of the underlying stock at the exercise price.

3. A put option gives the owner the right:

A. and the obligation to buy an asset at a given price.

B. and the obligation to sell an asset at a given price.
C. but not the obligation to buy an asset at a given price.
D. but not the obligation to sell an asset at a given price.

4. The buyer of a call option has the right to exercise the option, but the writer of the call
option has the:

A. choice to offset with a put option upon exercise.

B. obligation to deliver the shares at the exercise price.
C. choice to deliver shares or take a cash payoff.
D. obligation to deliver a put option upon exercise.
5. Suppose an investor sells (writes) a put option. What will happen if the stock price on the
exercise date exceeds the exercise price?

A. The seller will need to deliver stock to the owner of the option.
B. The seller will be obliged to buy stock from the owner of the option.
C. The owner will not exercise his option.
D. The option will extend for nine more months.

6. The value of a put option at expiration equals the:

A. market price of the share minus the exercise price.

B. higher of the exercise price minus market price of the share and zero.
C. exercise price.
D. share price.

7. Figure 1 depicts the:

A. position diagram for the buyer of a call option.

B. profit diagram for the buyer of a call option.
C. position diagram for the buyer of a put option.
D. profit diagram for the buyer of a put option.
8. Figure 2 depicts the:

A. position diagram for the buyer of a call option.

B. profit diagram for the buyer of a call option.
C. position diagram for the buyer of a put option.
D. profit diagram for the buyer of a put option.

9. Figure 3 depicts the:

A. position diagram for the writer (seller) of a call option.

B. profit diagram for the writer (seller) of a call option.
C. position diagram for the writer (seller) of a put option.
D. profit diagram for the writer (seller) of a put option.

10. All else equal, as the underlying stock price increases:

A. the call price decreases.

B. the call price increases.
C. there is no effect on call price.
D. the call price can either increase, decrease, or remain the same.
11. All else equal, as the underlying stock price increases:

A. the put price increases.

B. the put price decreases.
C. there is no effect on put price.
D. the put price can either increase, decrease, or remain the same.

12. If the volatility of the underlying asset decreases, then the:

A. value of the put option will increase, but the value of the call option will decrease.
B. value of the put option will decrease, but the value of the call option will increase.
C. value of both the put and call option will increase.
D. value of both the put and call option will decrease.

13. A derivative is a financial instrument whose value is determined by:

A. a regulatory body such as the FTC.

B. the value of an underlying asset.
C. hedging a risk.
D. speculation.

14. When a standardized forward contract is traded on an exchange, it becomes a(n):

A. forward contract.
B. futures contract.
C. options contract.
D. swap contract.

15. The seller of a forward contract agrees to:

A. deliver a product at a later date for a price set today.

B. receive a product at a later date at the price on that later date.
C. receive a product at a later date for a price set today.
D. deliver a product at a later date for a price set on that later date.
16. The term "derivatives" refers to:
I) forwards; II) futures; III) swaps; IV) options

A. I and II only
B. I, II, and III only
C. III and IV only
D. I, II, III, and IV

17. Which of the following players would require a put option in order to hedge their natural
position in the market?

A. A farmer who buys corn to feed his livestock

B. A farmer who sells peanuts to a chocolatier
C. A farmer who has financed his land with a floating rate mortgage
D. A miller who buys wheat from a farmer

18. What investment would be a hedge for a corn farmer?

A. Long corn put option

B. Long corn call option
C. Long corn futures
D. None of these answers