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ACCT 5341 Examination 2 (Part 1)
Dr. Jensen
Spring 2001
Students are allowed to use the following examination aids:
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Calculator
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Notes that you have written yourself
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File 1 printouts
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File 2 printouts
Students are not allowed to use the following in Part 1
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Photocopies
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Books
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Notes or any other materials written by other students other than File 1 and File 2 printouts that were
joint efforts between you and a partner.
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Part 1 (Multiple Choice)
Choose the best answer to each question when more than one answer is correct.
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Answers are to be recorded both on the question sheet and on the answer sheet.
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The term “earnings” does not include “comprehensive earnings.”
Questions 1-30 Relate to SFAS 133 Theory and Rules
1. (03 Points) What contract below is not eligible for hedge accounting under SFAS 133?
a. Embedded call option
b. Forward rate agreement
c. Covered call
d. Interest rate futures
2. (03 Points) The price of a block of 10,000 options may be different than the price of a single option if all
10,000 are sold in a block. SFAS 133 requires a fair market value blockage adjustment as follows:
a. Upward
b. Downward
c. Both answers a and b above
d. Neither answers a or b above
3. (03 Points) The price of a block of 10,000 options may be different than the price of a single option if all
10,000 are sold in a block. SFAS 133 requires a fair market value blockage adjustment as follows:
a. Upward
b. Downward
c. Both answers a and b above
d. Neither answers a or b above
4. (03 Points) Suppose that a change in the price of a lumber inventory forecasted purchase is effectively
offset by a forward cash flow hedge. The hedge may result in which of the following outcomes, relative to
having no hedge, in periods prior to the purchase of the inventory?
a. The hedge may reduce reported earnings prior to the transaction.
b. The hedge may increase reported earnings prior to the transaction.
c. Both answers a and b are possible depending upon the direction of the price movements.
d. None of the above since this hedge does not affect reported earnings prior to the purchase transaction or
dedesignation.
5. (03 Points) Suppose that a change in the price of gold inventory forecasted sale is effectively offset by a
forward contract cash flow hedge. The hedge may result in which of the following outcomes (relative to
having no hedge in periods prior to the sale of the inventory)?
a. The hedge may reduce reported earnings prior to the transaction.
b. The hedge may increase reported earnings prior to the transaction.
c. Both answers a and b are possible depending upon the direction of the price movements.
d. None of the above since gold cannot be a hedged item under SFAS 133.
6. (03 Points) Suppose that a change in the price of a lumber inventory forecasted purchase is effectively
offset by a forward cash flow hedge. The hedge may result in which of the following outcomes, relative to
having no hedge, in periods prior to the purchase of the inventory?
a. The hedge may reduce reported earnings prior to the transaction.
b. The hedge may increase reported earnings prior to the transaction.
c. Both answers a and b are possible depending upon the direction of the price movements.
d. None of the above since this hedge does not affect reported earnings prior to the purchase transaction or
dedesignation.
7. (03 Points) Suppose that a change in the price of gold inventory forecasted purchase is effectively offset by
a forward contract cash flow hedge. The hedge may result in which of the following outcomes (relative to
having no hedge in periods prior to the purchase of the inventory)?
a. The hedge may reduce reported earnings prior to the transaction.
b. The hedge may increase reported earnings prior to the transaction.
c. Both answers a and b are possible depending upon the direction of the price movements.
d. None of the above since gold cannot be a hedged item under SFAS 133.
8. (03 Points) Suppose that a change in the price of a lumber inventory forecasted purchase is hedged by a call
option designated in advance as a cash flow hedge. An ineffective hedge will result in which of the
following outcomes relative to an effective hedge in periods prior to the sale of the inventory?
a. Ineffectiveness may reduce reported earnings prior to the transaction.
b. Ineffectiveness may increase reported earnings prior to the transaction.
c. Both answers a and b are possible depending upon the direction of the hedge’s ineffectiveness.
d. None of the above since ineffectiveness does not affect reported earnings prior to the sale transaction.
9. (03 Points) Suppose that a change in the price of a lumber inventory forecasted sale is hedged by a put
option designated in advance as a cash flow hedge. An ineffective hedge will result in which of the
following outcomes relative to an effective hedge in periods prior to the sale of the inventory?
a. The hedge may reduce reported earnings prior to the transaction.
b. The hedge may increase reported earnings prior to the transaction.
c. Both answers a and b are possible depending upon the direction of the price movements.
d. None of the above since this hedge does not affect reported earnings prior to the sale transaction.
10. (03 Points) Suppose a forward contract is used as a fair value foreign currency hedge of an asset
denominated in Mexican pesos. Hedge effectiveness is judged by comparing changes in the fair value of the
forward contract with changes in the fair value of the U.S. dollar vis-à-vis the peso. What will be the impact
of hedge ineffectiveness?
a. No impact since only cash flow hedges are subject to hedge accounting that may be judged ineffective.
b. No impact if the asset is an available-for-sale security denominated in pesos.
c. No impact if the asset is a firm commitment at a future date rather than an available-for-sale asset.
d. None of the above answers are correct.
11. 03 Points) AggiesInternational Corporation faces the risk of price declines on its forecasted sales of corn,
soybeans, and rice to Japan. Sales quantities are also uncertain. As a hedge, this company enters into a
contract (with a $0 premium) to sell as much as it wants to the Shimura Company for a contracted fixed
price and contracted proportions of all three grains per ton. In other words, for a fixed price and fixed
proportions, AggiesInternational has an option to sell as much as it wants to Shimura for a period of six
months. Can this option be a cash flow hedge under SFAS 133 rules.
a. No because the notional is not fixed, and no because the forecasted transaction is a compounding of three
grains subject to varying price risks.
b. No because the notional is not fixed even though it would otherwise be yes since the forecasted
transaction contains fixed proportions of grains for which there is a single variable (portfolio) price per ton
that can be hedged.
c. Yes because the notional is fixed but no, in the final analysis, because the forecasted transaction is a
compounding of three grains subject to varying price risks.
d. Yes because the notional is fixed, and yes since the forecasted transaction contains a fixed proportion of
grains for which there is a single variable portfolio price that can be hedged.
12. (03 Points) SFAS 133 limits hedge accounting to which of the following relationships?
a. Only cash flow hedges of derivative financial instruments.
b. Cash flow hedges of derivative financial instruments and certain fair value foreign-currencydenominated nonderivative instruments.
c. Cash flow hedges and fair value hedges that reduce market risk exposures.
d. Any derivative or nonderivative financial instrument for which there is no credit risk.
13. (03 Points) The FASB’s stated long-term objective of having all derivative and nonderivative financial
instruments booked at fair value on any reporting date would have what impact on hedge accounting?
a. This would eliminate all hedge accounting treatments for financial instruments.
b. This would have no impact on SFAS 133 hedge accounting rules unless the FASB changed SFAS 133.
c. This would eliminate cash flow hedges but not foreign currency hedge accounting.
d. Irrespective of possible answers above, the FASB has never declared that its long-term objective is to
require fair value reporting of all financial instruments.
14. (03 Points) Which of the following restrictions apply to an underlying of a derivative financial instrument?
a. The underlying must always be a market price or an interest rate derived from financial markets.
b. The underlying may be most any external index including official rainfall on a given day or the outcome
of a NFL game between the Green Bay Packers versus the Minnesota Vikings.
c. The underlying may be most any index that is stated in monetary terms (thereby excluding rainfall
amounts or sports scores).
d. None of the above answers are correct.
15. (03 Points) Which of the following cannot be an underlying according to SFAS 133?
a. Sales revenue attained by one of the contracting parties.
b. Independent appraisal of a building owned by one of the contracting parties.
c. Both of the above answers are correct.
d. None of the above answers are correct.
16. (03 Points) SFAS 133 net settlement provisions call for settlement to be in cash or in assets easily
converted into cash. Which of the following does not meet the net price settlement test to qualify as a
derivative financial instrument in contract between Intel Corporation and General Electric?
a. Corn prices on the Chicago Board of Trade exchange.
b. The price of a common stock of Microsoft Corporation.
c. The price of the common stock of Intel Corporation.
d. All of the above prices qualify since they are easily converted into cash in an organized market
exchange.
17. (03 Points) Which of the following embedded derivatives serves to disqualify the derivative from SFAS
133 accounting rules?
a. A prepayment option of a mortgage loan.
b. An interest-only strip embedded derivative.
c. A principal-only strip embedded derivative.
d. All of the above answers are correct.
18. (03 Points) Which of the following types of contracts are generally excluded from SFAS 133 accounting
rules (including fair market value adjustment rules)?
a. A sales contract by Intel Corporation for microprocessors manufactured by Intel.
b. A purchase contract by Dell Corporation for microprocessors to be used in Dell computers.
c. A “regular-way” securities trade contract.
d. All of the above answers are correct.
19. (03 Points) The FASB’s Exposure Draft 162-B required that both the host contract and its embedded
derivatives be accounted for as a derivative contract. What happened to this provision in SFAS 133?
a. The provision remains the same in SFAS 133.
b. The provision is changed in SFAS 133 to allow for separate treatments of derivative versus nonderivative
components.
c. Nonderivative components are never allowed to be accounted for as hedges under SFAS 133.
d. Both Answers b and c above are correct.
20. (03 Points) The “clearly-and-closely related” provisions of SFAS 133 apply mainly to which of the
following?
a. A decision as to whether an embedded derivative is subject to SFAS 133 accounting rules.
b. A decision as to whether an embedded derivative will be accounted for separately from its host contract.
c. The degree of ineffectiveness of an interest rate swap contract.
d. The degree of ineffectiveness of a foreign currency hedging contract.
21. (03 Points) For purposes of fair value measurement, SFAS 133 relies most heavily upon which prior
standard?
a.
b.
c.
d.
SFAS 105
SFAS 107
SFAS 115
SFAS 131
22. (03 Points) SFAS 133 hedge accounting rules for fair value hedges arise primarily because of?
a. Lobbying pressure by constituents (e.g., banks) to defer some derivative gains and losses in
comprehensive income rather than having to book such fluctuations in earnings over the hedging period.
b. Pressures by the SEC to bring SFAS 133 rules more in line with existing international standards.
c. FASB intentions to incrementally move towards fair value accounting for all financial instruments, but
the FASB feels that it is too much of a shock for constituents to abruptly shift to fair value accounting for all
such instruments.
d. None of the above.
23. (03 Points) The FASB feels that differences between forecasted transactions and firm commitments are
which of the following?
a. Inconsequential and have no bearing on differences between accounting for forecasted transactions
versus firm commitments since neither appear in traditional financial statements.
b. important only in foreign currency hedge accounting differences arising from firm commitments versus
forecasted transactions.
c. important with respect to market price accounting differences arising from firm commitments versus
forecasted transactions.
d. None of the above are correct.
24. (03 Points) Under Paragraph 29c of SFAS 133, a forecasted transaction between a parent company and its
subsidiary can be accounted for as a cash flow hedge under the conditions that:
a. Less than 100% of the voting shares of the subsidiary are owned by the parent.
b. Both parties can enter into a similar transaction with a non-related entity if it is beneficial to the
consolidated entities as a whole.
c. The transaction meets certain tests as a foreign currency hedge.
d. There are no conditions in which transactions between related parties can be accounted for as a hedge
under SFAS 133.
25. (03 Points) Suppose General Electric uses the U.S. dollar as its functional currency and has a Mexican
peso debt requiring peso interest payments. Which statement below is the most correct?
a. The foreign exchange risk in pesos cannot be designated as a cash flow hedge, because the peso debt
obligation should be remeasured at current spot rates on each reporting date with changes in those spot rates
being recognized as current earnings.
b. The interest rate risk can be designated as a cash flow hedge, because the interest rate risk is not
remeasured each period.
c. Both answers above.
d. None of the answers above.
26. (03 Points) ABC loans $10 million to an oil company under terms where the bonds guarantee a coupon
payment of 10% and repayment of all principal. In addition, however, the bonds make a knock-in added
payment of 1% for each period’s average daily crude oil price in excess of $15 per barrel. The coupon
payments thus have both a 10% bond coupon payment and an embedded derivative for the knock-in
payments. Does the embedded derivative meet the clearly-and-closely related tests to be accounted with the
bonds or must this derivative be accounted for separately from its host contract?
a. The embedded derivative meets the closely and clearly related tests, but since the amounts are
speculative, the derivative cannot be viewed as a hedge.
b. The embedded derivative meets the closely and clearly related tests and can be viewed as a fair value
hedge.
c. The embedded derivative meets the closely and clearly related tests and can be viewed as a cash flow
hedge.
d. None of the above answers is a correct answer.
27. (03 Points) Creditor C loans Borrower B $10 million with an option to convert each bond into 20 shares of
Borrower B’s common stock. Assume that those shares, if acquired, would be available-for-sale and not
trading securities. Answer the following according to SFAS 133 revisions of SFAS 115 rules.
a. Creditor C has an embedded derivative that is clearly-and-closely related to the loan and the bonds
receivable and the derivative are not accounted for separately.
b. Creditor C has an embedded derivative that is not clearly-and-closely related to the loan and the bonds
receivable and the derivative are not accounted for separately.
c. Creditor C has an embedded derivative that is clearly-and-closely related to the loan and the bonds
receivable and the derivative are accounted for separately.
d. None of the above.
28. (03 Points) Creditor C loans Borrower B $10 million with an option to convert each bond into 20 shares of
Borrower B’s common stock. Assume that those shares, if acquired, would be available-for-sale and not
trading securities. Answer the following according to SFAS 133 revisions of SFAS 115 rules..
a. Borrower B has an embedded derivative that is clearly-and-closely related to the loan and the bonds
payable and the derivative are not accounted for separately.
b. Borrower B has an embedded derivative that is not clearly-and-closely related to the loan and the bonds
payable and the derivative are not accounted for separately.
c. Borrower B has an embedded derivative that is clearly-and-closely related to the loan and the bonds
payable and the derivative are accounted for separately.
d. None of the above.
29. (03 Points) Creditor C loans Borrower B $10 million with interest to be paid periodically at a fixed rate in
European Euros. The interest may thus vary when converted into U.S. dollars. Answer the following
according to SFAS 133 revisions of SFAS 52 rules.
a. Creditor C has an embedded derivative that is subject to SFAS 52 rules and the bonds receivable and the
derivative are not accounted for separately.
b. Creditor C has an embedded derivative that is not subject to SFAS 52 rules and the bonds receivable and
the derivative are not accounted for separately.
c. Creditor C has an embedded derivative that is subject to SFAS 52 rules and the bonds receivable and the
derivative are accounted for separately.
d. Creditor C has an embedded derivative that is not subject to SFAS 52 rules and the bonds receivable and
the derivative are accounted for separately.
30. (03 Points) Company S is a securitization trust that receives an unsecured variable rate of interest on a $10
million note. To securitize the note, Company S swaps its LIBOR-based variable rate of interest to its
investors in return for a fixed rate of interest. Is this interest rate swap a derivative subject to SFAS 133
rules?
a. Yes. The swap has a notional, an underlying , settles in cash, and requires no premium.
b. No. The swap has a notional, an underlying , settles in cash, and requires no premium. However, SFAS
133 explicitly prohibits securitization hedges.
c. No. The swap has a notional (the loan principal), settles in cash, and requires no premium. However, it
does not have a qualified underlying for a SFAS 133 derivative instrument.
d. No. The swap has an underlying (the loan principal), settles in cash, and requires no premium. However,
it does not have a qualified notional for a SFAS 133 derivative instrument.
Questions 31-42 Relate to Financial Risk Management
31. (03 Points) Interest-rate risk refers to:
(a) the variability in cost of goods sold.
(b) the variability in financial asset prices and financing costs associated with changes in the general level of
interest rates.
(c) the possibility that a firm’s credit rating will be lowered thereby leading to higher interest expenses.
(d) changes in the EBIT (earnings before interest and taxes of a company)
32. (03 Points) The term structure of interest rates describes the relationship between the:
(a) default risks of bonds and their yields to maturity.
(b) current yields of bonds and their yields to maturity.
(c) prices of bonds and their yields to maturity.
(d) maturities of bonds and their yields to maturity.
33. (03 Points) The term structure theory which predicts long-term interest rates will, on average, be higher
than short-term interest rates is called:
(a) the expectations theory.
(b) the preferred habitat theory.
(c) the segmented market theory.
(d) the liquidity preference theory.
34. (03 Points) The forward exchange rate locked in with a forward exchange-rate contract:
(a) will always be higher than the spot exchange rate.
(b) will always be lower than the spot exchange rate
(c) may be higher or lower than the spot exchange rate.
(d) is unrelated to the current spot exchange rate.
35. (03 Points) A forward rate agreement is:
(a) a loan commitment to borrow foreign currency.
(b) a forward contract on interest rates.
(c) a forward contract on long-dated foreign currency futures.
(d) a forward loan commitment.
36. (03 Points) The process of marking futures contracts to market has the effect of:
(a) turning the futures contract into an option contract.
(b) turning the futures contract into a one-day forward contract.
(c) understandardizing the contract’s delivery date.
(d) making the futures contract a less expensive form of hedging than the forward contract.
37. (03 Points) A person wanting to lock in an exchange rate for the payment of a foreign-currency obligation to
someone else would:
(a) sell a foreign-currency futures contract.
(b) buy a foreign-currency futures contract.
(c) sell an interest-rate futures contract
(d) buy an interest-rate futures contract.
38. (03 Points) A call option can be replicated by:
(a) lending at the risk-free interest rate and selling common stock.
(b) lending at the risk-free interest rate and buying common stock.
(c) borrowing at the risk-free interest rate and selling common stock.
(d) borrowing at the risk-free interest rate and buying common stock.
39. (03 Points) A major advantage of options over futures contracts for hedging purposes is:
(a) options are cheaper.
(b) options need not be exercised.
(c) options are more liquid.
(d) options are not legally enforceable obligations.
40. (03 Points) An expected receipt of German marks by an American exporter can be hedged best by:
(a) buying DM call options.
(b) buying DM put options.
(c) selling DM put options.
(d) buying European DM call options
41. (03 Points) To set a cap on the interest rate that a company must pay for a future loan, the treasurer can:
(a) buy interest-rate call options.
(b) buy interest-rate put options.
(c) write interest-rate put options.
(d) write interest-rate call options.
42. (03 Points) Swaptions are
(a) options on futures.
(b) options on forwards.
(c) swaps of options.
(d) options on swaps.
Part 2 (Foreign Currency)
43.
Example 6.8 --- Cross-Currency Hedge of a Foreign-Currency-Denominated Firm Commitment
Part 3 (Interest Rate Swap)
44.
Example 5.13 --- Cash Flow Hedge of A variable-Rate Loan with an Interest Rate Swap