Understanding Different Types of Market Participants and Transactions
Akihiko’s Forecasting Model
Akihiko has designed a sophisticated forecasting model, which predicts the movements in the overall stock market, in the hope of earning a return in excess of a fair return for the risk involved. He uses the predictions of the model to decide whether to buy, hold, or sell the shares of an index fund that aims to replicate the movements of the stock market. Takabe would best be characterized as an information-motivated trader.
James Beach’s Investment Strategy
James Beach is young and has substantial wealth. A significant proportion of his stock portfolio consists of emerging market stocks that offer relatively high expected returns at the cost of relatively high risk. Beach believes that investment in emerging market stocks is appropriate for him given his ability and willingness to take risk. Which of the following labels most appropriately describes Beach? Investor.
Lisa Smith’s Hedging Strategy
Lisa Smith owns a manufacturing company in the United States. Her company has sold goods to a customer in Brazil and will be paid in Brazilian real (BRL) in three months. Smith is concerned about the possibility of the BRL depreciating more than expected against the US dollar (USD). Therefore, she is planning to sell three-month futures contracts on the BRL. The seller of such contracts generally gains when the BRL depreciates against the USD. If Smith were to sell these future contracts, she would most appropriately be described as a hedger.
Functions of the Financial System
Which of the following is not a function of the financial system? To regulate arbitrageurs’ profits (excess returns).
Diversification into Real Estate
An investor primarily invests in stocks of publicly traded companies. The investor wants to increase the diversification of his portfolio. A friend has recommended investing in real estate properties. The purchase of real estate would best be characterized as a transaction in the alternative investment market.
Hedge Fund’s Cash Management
A hedge fund holds its excess cash in 90-day commercial paper and negotiable certificates of deposit. The cash management policy of the hedge fund is best described as using money market instruments.
Oil and Gas Company’s Share Offering
An oil and gas exploration and production company announces that it is offering 30 million shares to the public at $45.50 each. This transaction is most likely a sale in the primary market.
Mutual Fund’s Investment Goal
Consider a mutual fund that invests primarily in fixed-income securities that have been determined to be appropriate given the fund’s investment goal. Which of the following is least likely to be a part of this fund? Warrants.
Limitations of Forward Contracts
The usefulness of a forward contract is limited by some problems. Which of the following is most likely one of those problems? Once you have entered into a forward contract, it may be difficult to exit.
Tony Harris and Futures Contracts
Tony Harris is planning to start trading in commodities. He has heard about the use of futures contracts on commodities and is learning more about them. Which of the following is Harris least likely to find associated with a futures contract? Existence of counterparty risk.
Hedging with Currency Options
A German company that exports machinery is expecting to receive $10 million in three months. The firm converts all its foreign currency receipts into euros. The chief financial officer of the company wishes to lock in a minimum fixed rate for converting the $10 million to euro but also wants to keep the flexibility to use the future spot rate if it is favorable. What hedging transaction is most likely to achieve this objective? Buying put options.
Agreement Between a Book Publisher and a Paper Producer
A book publisher requires substantial quantities of paper. The publisher and a paper producer have entered into an agreement for the publisher to buy and the producer to supply a given quantity of paper four months later at a price agreed upon today. This agreement is a forward contract.