Question

1. In operating risk, the goal is to decrease the effect of ________ on firm cash flows. a. Nominal exchange rate moves b. Real exchange rate moves c. Interest Rate Parity d. Loan rate differentials

2. The _______ the price elasticity of demand, the _____ the incentive to hold down price and thereby expand sales. a. lower, greater b. lower, lower c. greater, lower d. greater, greater

3. The time value of an American option a. is always positive for an outofthemoney option b. is always positive for an inthemoney option c. decreases with the time that remains until the option expires d. all of the above e. none of the above

Answer 1

1. a. Operating risk involves that the cash flows of the firm should not be affected by the movement in exchange rates. And, for businesses, the real exchange rates don't matter to a large extent, it is the nominal exchnage rates that they have to deal with.

2. d.  The greater the price elasticity of demand, the greater the incentive to hold down price and thereby expand sales. This is because if the price elasticity of demand is high, and we increase price, the sales will decrease at a fast rate. Therefore, at higher elasticity it is prudent to keep the prices low and maintain the sales.

3. d. All of the above. American options have a feature that they can be exercised at any point of time till their expiry. Hence, there is always a time value of money irrespective of whether the option is in the money or out of the money. And, as the time to expiry decreases and we move closer to expiry, this time value keeps on decreasing. Therfore, all the options are correct.