Financial Risk Management Derivatives and Risk Hedging

Question 1

What is the primary purpose of using derivatives for hedging?

Accepted Answer

To reduce or offset financial risk

Answer

Derivatives are used in hedging to offset potential losses in an underlying position by taking an opposite position in a related instrument.

Question 2

A company expecting to receive €5 million in 3 months wants to eliminate currency risk. Which derivative is most appropriate?

Accepted Answer

Forward contract

Answer

A forward contract locks in the exchange rate for a future date, eliminating currency risk entirely by fixing the conversion terms today.

Question 3

The 'delta' of an option represents:

Accepted Answer

The sensitivity of option price to changes in the underlying asset price

Answer

Delta measures how much an option's price changes for a $1 change in the price of the underlying asset, ranging from 0 to 1 for calls and -1 to 0 for puts.

Question 4

A long position in a crude oil futures contract is best described as:

Accepted Answer

An obligation to buy crude oil at a specified price and date

Answer

A long futures position obligates the holder to buy the underlying asset at the agreed-upon price on the delivery date, unlike options which confer a right.

Question 5

Which of the following best describes a perfect hedge?

Accepted Answer

A hedge that eliminates all potential gains and losses from the hedged position

Answer

A perfect hedge fully offsets the risk of the underlying position, eliminating both potential gains and losses, resulting in a locked-in outcome.

Financial Risk Management Practice Test

Financial Risk Management Practice Test

Financial Risk Management Derivatives and Risk Hedging