Financial Risk Management
Final Test Solutions
Course Introduction
Financial Risk Management explores the various types of risks that financial institutions and corporations face, including market, credit, operational, and liquidity risks. This course covers the principles and tools used to identify, measure, and manage these risks, with a strong emphasis on quantitative methods such as value-at-risk (VaR), stress testing, and scenario analysis. Students learn how to use derivatives and other hedging instruments to mitigate risk, as well as best practices in risk governance and regulatory compliance. Real-world case studies and practical applications help illustrate the importance of effective risk management in maintaining financial stability and achieving organizational objectives.
Recommended Textbook
International Financial Management 2nd Edition by Geert J Bekaert
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Chapter 1: Globalization and the Multinational Corporation
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Q1) It is the right given to firms to produce specific products in exchange for a ________ fee.
A) Joint Venture
B) Securitization
C) Licensing
D) Royalty
Answer: C
Q2) Which organization was originally designed to encourage free trade between member states by regulating and reducing tariffs on traded goods?
A) NAFTA
B) EU
C) ASEAN
D) GATT
Answer: D
Q3) Globally why are certain types of firms seeking others with poor corporate governance?
Answer: Hedge funds and private equity firms are very often looking for these poorly performing firms as potential targets for their value-enhancing activities.
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Chapter 2: The Foreign Exchange Market
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Q1) Which one of the following is not a characteristic of a liquid market?
A) Market makers stand ready to buy and sell currencies.
B) Foreign exchange dealers make transactions only with dealers.
C) It becomes easy to match buyers and sellers.
D) Transaction costs are low.
Answer: B
Q2) What is most different about the foreign exchange market versus the New York Stock Exchange?
Answer: The interbank foreign exchange market is a very large,diverse,over-the-counter market,not a physical trading place such as the New York Stock Exchange where buyers and sellers gather in a specific geographic location to agree on a price to exchange currencies.Currency traders,who are employees of financial institutions in the major financial cities around the world,deal with each other primarily over the phone or via computer,with written or formal electronic confirmations of transactions occurring only later.
Q3) Describe how an exchange rate is like a market price?
Answer: The direct quote for a currency is the local currency price (numerator)of one unit of foreign currency (denominator).
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Chapter 3: Forward Markets and Transaction Exchange Risk
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Q1) When does delivery occur on a 90-day forward contract?
A) in 90 days corresponding to two business days preceding the third Wednesday of the month
B) immediately but the contract is not closed for 90 more days
C) in 90 days corresponding to the calendar date of the spot value date
D) two business days following the spot value date
Answer: C
Q2) If the British pound is selling at a premium relative to the euro in the forward market,is the forward price of EUR/? larger or smaller than the spot price of EUR/??
Answer: When the pound is selling at a premium in the forward market,the euro price of the pound in the forward market,EUR/?,would be larger than the spot price of EUR/?.
Q3) What is the name of the exchange rate specified in the forward contract?
A) spot rate
B) forward rate
C) future exchange rate
D) cross-rate
Answer: B
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Chapter 4: The Balance of Payments
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Q1) The U.S.Department of Commerce breaks the total net change in U.S.assets abroad into transactions.Which one of the following options is not part of the three categories?
A) transactions in "U.S. official reserve assets"
B) transactions in "other U.S. governmental assets"
C) transactions in "U.S. private assets"
D) transactions in "other U.S. public assets"
Q2) Suppose the U.S.imposes import restrictions on Japanese cars.What is likely to happen to the U.S.current-account deficit?
Q3) In order to reduce its current account deficit,the United States must do which of the following?
A) reduce the federal budget deficit
B) raise national product relative to national spending
C) increase savings relative to domestic investment
D) all of the above
Q4) Tourism would show up on the A) merchandise account.
B) current account.
C) capital account.
D) A and C.
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Chapter 5: Exchange Rate Systems
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Q1) The special drawing rights of the IMF and the European currency unit are two examples of ________.
A) currency boards
B) floating exchange rates
C) target zones
D) baskets of currencies
Q2) What is the most likely outcome if a central bank suddenly prints a large amount of new money?
A) no change in the inflation rate
B) higher inflation
C) recession
D) prosperity
Q3) What is the relationship of currency risk in a floating exchange rate system to the future exchange rate changes?
Q4) Describe the Bretton Woods currency system?
Q5) What are the three major components of the official reserves account?
A) foreign exchange reserves, gold, and IMF-related reserve assets
B) foreign exchange reserves, foreign government bonds, gold
C) IMF-related reserve assets, gold, and U.S. Dollars
D) gold, IMF-related reserves assets, and government-owned land
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Chapter 6: Interest Rate Parity
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Q1) The difference between the interest rate that a bank charges on its loans and the interest rate that the banks pay their depositors is known as the
A) percent spread.
B) arbitrage opportunity.
C) bid-ask spread.
D) covered interest arbitrage opportunity.
Q2) Describe the sequence of transactions required to do a covered interest arbitrage out of British pound and into U.S.dollars.
Q3) The empirical evidence indicates that interest rate parity is the norm,especially during periods of financial market ________.
A) arbitrage
B) turbulence
C) profit-taking
D) tranquility
Q4) Identify an external currency market and how it operates?
Q5) If volatility in foreign exchange markets,what is the relationship to the bid-ask spread?
Q6) Given an example of how a money market hedge is constructed?
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Chapter 7: Speculation and Risk in the Foreign Exchange Market
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Q1) What is the market portfolio?
A) the large, well-diversified portfolio that investors should hold according to finance theory
B) the large, well-diversified portfolio without international securities
C) the portfolio that represents a global portfolio
D) the portfolio with strictly domestic securities
Q2) Regression tests of the unbiasedness hypothesis indicate that it is ________ with real life events.
A) an unbiased indicator of expected future exchange rates
B) very consistent
C) not consistent
D) has a strong correlation to the current account
Q3) To construct the uncertain yen-denominated return from investing one yen in the Swiss franc,what is your first step?
A) convert from yen into Swiss francs in the spot market
B) convert from Swiss francs into yen in the forward market
C) invest in the Swiss money market
D) convert from Swiss francs into yen at the future spot rate
Q4) What is the main determinant of the volatility of forward market returns?
Page 9
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Chapter 8: Purchasing Power Parity and Real Exchange
Rates
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Q1) When the price of one commodity is the same wherever in the world the good is being sold when denominated in a particular currency,it is said the Law of ________ prevails.
A) currency supply
B) currency demand
C) purchasing power parity
D) one price
Q2) If people expect that their future purchasing power will decline,what will happen to the exchange rate today?
Q3) What is the name of the ratio of a price level at one point in time to the price level in a designated base year?
A) bid-ask spread
B) reserve requirement
C) percent spread
D) price index
Q4) What effects do deviations from the law of one price have on absolute purchasing power parity?
Q5) Under what conditions could the law of one price be violated?
Q6) Explain what is meant by the real exchange rate?
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Chapter 9: Measuring and Managing Real Exchange Risk
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Q1) You have been asked to evaluate possible sites for an South American production facility that will manufacture your firm's products and sell them to the South American market.What real exchange rate considerations should you entertain in your evaluation?
Q2) When a currency depreciates,if the firm increases it foreign currency price to maintain its profits,it will ________.
A) gain sales from foreign rivals
B) maintain its market share
C) lose sales to foreign rivals
D) be forced to exit the market
Q3) In the face of a currency depreciation,if the firm maintains its foreign currency price,it will ________.
A) lose its market share but gain profits
B) lose its market share and lose profits
C) maintain its market share and gain profits
D) maintain its market share but lose profits
Q4) Assume foreign currencies are strong in real terms,why would this be the best time to enter the market of a foreign country as an exporter to that market?
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Chapter 10: Exchange Rate Determination and Forecasting
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Q1) All things considered,it is unlikely that equality of real interest rates across countries is a good description of reality,especially in the short run.The following options explain the reasons for this EXCEPT:
A) identical nominal returns imply very different real returns for investors in different countries.
B) returns in different currencies can have different currency risk premiums.
C) political risks or the threat of capital controls prevent investors from taking advantage of higher returns in other countries.
D) PPP deviations are not sizable and prolonged.
Q2) Why would technical analysis not be useful if the international parity conditions held?
Q3) Two of the most often used determinants of exchange rates are ________.
A) real interest rate differentials and current account balances
B) nominal interest rates and current account balances
C) real interest rate differentials and real price levels
D) nominal interest rate and inflation rate differentials
Q4) Describe three statistics you should obtain from a currency-forecasting service in order to judge the quality of its currency forecasts.
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Page 12
Chapter 11: International Debt Financing
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Q1) The hedging strategy that offsets foreign assets with foreign liabilities is known as ________ hedge.
A) an income-statement
B) balance-sheet
C) decentralized debt
D) decentralized equity
Q2) Which one of the following statements is true for the centralized debt denomination model?
A) The debts for both the parent company and its foreign subsidiaries are denominated in the home currency of the parent company.
B) The debt service payments are denominated in the currency in which the subsidiary's revenues are received.
C) The debts for both the parent company and its foreign subsidiaries are denominated in the currency of the largest subsidiary.
D) The debt service payments are denominated in the currency in which the subsidiary's revenues are received which does not balance foreign assets against foreign liabilities.
Q3) What are the major features of the proposed Basel III?
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Chapter 12: International Equity Financing
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Q1) What are the most import characteristics of foreign securities that leads to diversification benefits?
Q2) The stock markets of the least developed countries are called ________ markets.
A) emerging
B) start-up
C) frontier
D) secondary
Q3) Which one of the following is one important characteristic of a private bourse?
A) Brokers are appointed by the government.
B) A single corporation acquires a monopoly over all stock market transactions.
C) It is owned and operated by a corporation founded for the purpose of trading securities.
D) Private exchanges, in many countries, do not usually compete with one another.
Q4) What is the name given to the exchange where banks are the major,and sometimes only,security traders?
A) banker's bourses
B) banking syndicates
C) public bourses
D) private bourses
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Chapter 13: International Capital Market Equilibrium
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Q1) For the most part,stocks are ________ ________,so you ________ diversify away all of a portfolio's variance.Because the average covariance is ________,even a large portfolio of international stock will have a ________ variance.
A) negatively related, can, negative, negative
B) negatively related, cannot, positive, negative
C) positively correlated, cannot, positive, positive
D) positively correlated, can, negative, positive
Q2) Of the following G7 countries,which market returns have the highest correlation with U.S.returns?
A) Japan
B) Canada
C) France
D) U.K.
Q3) The locus of the portfolios in expected return-standard deviation space that have the minimum variance for each expected return is called
A) mean-variance efficient.
B) MVE portfolio.
C) mean standard deviation frontier.
D) efficient frontier.
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Chapter 14: Country and Political Risk
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Q1) ________ is the risk that a government action will negatively affect a company's cash flows.
A) Political risk
B) Economic risk
C) Social risk
D) Expropriation
Q2) The Baker Plan of 1985 is named for the U.S.________.
A) secretary of state
B) president
C) federal reserve chair
D) treasury secretary
Q3) The Overseas Private Investment Corporation (OPIC)offers coverage against
A) the event the importer does not pay.
B) losses due to labor strife.
C) the devaluation of a country's currency.
D) losses due to expropriation, political violence, and currency inconvertibility.
Q4) What political realities underlie a government budget deficit?
Q5) How might a government budget deficit lead to inflation?
Q6) What are some indicators of country health?
Page 16
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Chapter 15: International Capital Budgeting
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Q1) The basic principle of capital budgeting is that
A) all projects with positive adjusted cash flows should be accepted.
B) all projects with adjusted cash flows of zero or greater.
C) only projects with adjusted cash flows should be accepted.
D) only projects financed entirely with equity be accepted.
Q2) Suppose you are conducting a financial analysis of a potential acquisition target,and you have been asked to identify the firm's engine of growth.Upon which of the following would you focus your analysis?
A) accounts receivable turnover
B) capital expenditures
C) debt to equity ratio
D) the firm's overall capital structure
Q3) Suppose the parent MNC had a choice of licensing,royalties and overhead allocations to repatriate funds from its subsidiaries,which ones represent pure profit to the parent?
A) licensing and overhead allocations
B) licensing and royalties
C) royalties and overhead allocations
D) a combination of all three
Q4) How does the role of underwriting affect the issuing of securities?
Page 17
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Chapter 16: Additional Topics in International Capital Budgeting
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Q1) Another name for the reinvestment ratio is the ________ ratio.
A) acid test
B) retention
C) payout
D) plowback
Q2) Which of the following statements is true concerning a firm's financial distress?
A) During periods of financial distress, the firm's managers are more likely to invest in risky projects.
B) During periods of financial distress, the firm's managers are less likely to invest in risky projects.
C) During periods of financial distress, the firm's managers are more likely to invest in corporate acquisitions.
D) During periods of financial distress, the firm's managers are more likely to seek firms to merge with.
Q3) As an international financial analyst,you inform your superiors that the domestic currency discount rate can be used to do capital budgeting for a foreign project? Explain why.
Q4) With respect to project value,what is meant by the underinvestment problem?
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Chapter 17: Risk Management and the Foreign Currency
Hedging
Decision
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Q1) Tax benefits of hedging are greater in which one of the following?
A) when the tax code is more progressive
B) when a firm's pretax income is more stable
C) when more of the firm's income is subject to a flat rate tax
D) when the tax code is more regressive
Q2) If the tax code is convex and the forward rate equals the expected future spot rate,why would a firm prefer to pay taxes on the hedged value of a foreign currency cash flow rather than wait to pay the taxes on the realized foreign currency cash flow?
Q3) ________ are typically larger in the forward market than in the spot market for currency.
A) Contract sizes
B) Bank fees
C) The bid-ask spreads
D) Employee costs
Q4) What does it mean when a tax code is convex?
A) It is a flat tax and does not vary as taxable income varies.
B) It is regressive and taxes lower incomes more.
C) Is proportional and the rate always taxes at proportional income equivalents.
D) It imposes a higher rate on higher incomes and a lower rate on lower incomes.
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Chapter 18: Financing International Trade
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Q1) What is the most popular way for an exporter to finance its accounts receivable?
Q2) A ________ is a request for payment that is created when an importer asks its bank to write a letter to an exporter indicating that the importer's bank will honor the request.
A) draft
B) bill of lading
C) banker's acceptance
D) commercial invoice
Q3) With forfaiting,an irrevocable guarantee,known as a(n)________,may be created by the importer's government.
A) trade acceptance
B) documents against payment
C) documents against acceptance
D) aval
Q4) What are four different methods by which an exporter can accept payment from an importer? List them in increasing order of risk to the importer.
Q5) What are the advantages of a documentary credit to an exporter and an importer?
Q6) What is a banker's acceptance? How is one created? Whose liability is it?
Q7) What is the purpose of marine insurance?
Page 20
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Chapter 19: Managing Net Working Capital
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Q1) To avoid paying the higher corporate tax to a foreign government,the rule states that a multinational could set the transfer price for its goods entering the country for sale to an affiliate as ________ as possible to lower tariff payments.
A) low
B) high
C) neutral
D) proportional
Q2) For a multinational corporation with many affiliates throughout the world,________ the management of the short-term cash balances of the affiliates provides significant savings to the firm.
A) outsourcing offshore
B) arranging regionally
C) dispersing
D) centralizing
Q3) What are the determinants of leading payments between related international affiliates?
Q4) What are the constraints facing international cash management from purely domestic cash management?
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Chapter 20: Foreign Currency Futures and Options
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Q1) The last traded futures price in which case appointed traders in the pit establish the value of the futures price by consensus is know as the A) settle price.
B) maintenance margin.
C) open interest.
D) initial margin.
Q2) Suppose that XYZ International Company has purchased a Swiss francs futures contract (contact size is SFr 125,000)at a price of $0.8250 at $0.83.If the spot rate for the Swiss franc at the date of settlement is SFr = $0.8250,what is the Company's gain or loss on the contract?
Q3) The difference between the current spot price and the futures price is known as the A) spread.
B) barrier.
C) basis.
D) open interest.
Q4) Suppose that you have a foreign currency receivable (payable).What option strategy places a floor (ceiling)on your domestic currency revenue (cost)?
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Chapter 21: Interest Rates and Foreign Currency Swaps
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Q1) What are some factors that underlie the economic benefits of swaps?
Q2) In a(n)________ swap,one party pays a fixed rate calculated at the time off trade as a spread to a particular Treasury bond,and the other sides pays a floating rate.
A) currency
B) interest rate
C) coupon
D) basis
Q3) Describe how a back-to-back loan is used.
Q4) Why are swap market transactions costs lower than transaction costs in the long term forward market?
Q5) The ________ is the conceptual principal amount that controls the cash flows of an interest rate swap.
A) notional principal
B) all-in cost
C) right of offset
D) yield to call
Q6) Describe how the cash flows of swaps are similar in structure to the cash flow of bonds.
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