Question 1

The covariance shows the risk of a single variable.

Accepted Answer

A) True 
 B)False  False

Question 2

Which of the following statements about bearing risk collectively is correct?

Accepted Answer

A)  Bearing risk collectively means that the risk is spread over a larger group. 
B)  Bearing risk collectively results in a more cost-efficient outcome. 
C)  Bearing risk collectively is an application of risk diversification. 
D)  All of the above are correct. 
A)  Bearing risk collectively means that the risk is spread over a larger group. 
B)  Bearing risk collectively results in a more cost-efficient outcome. 
C)  Bearing risk collectively is an application of risk diversification. 
D)  All of the above are correct. D

Question 3

As long as their correlation coefficient is less than 1, risk is being reduced by adding investments to the pool.

Accepted Answer

A) True 
 B)False  True

Question 4

A traded option contract creates a legal right to buy or sell assets at a set price before a certain date.

Accepted Answer

A) True 
 B)False

Question 5

Interest rate risk arises from changes in:

Accepted Answer

A)  currency discount rates 
B)  the value of fixed income securities because of changes in interest rates 
C)  interest rates caused solely by inflation 
D)  the value of currency relative to another currency 
A)  currency discount rates 
B)  the value of fixed income securities because of changes in interest rates 
C)  interest rates caused solely by inflation 
D)  the value of currency relative to another currency

Question 6

Which of the following is not an advantage of risk-bearing financial institutions?

Accepted Answer

A)  They provide diversification benefits. 
B)  The can save on investments in financial infrastructure. 
C)  They provide administrative services. 
D)  They provide professional management. 
A)  They provide diversification benefits. 
B)  The can save on investments in financial infrastructure. 
C)  They provide administrative services. 
D)  They provide professional management.

Question 7

Which of the following is not a risk that can be hedged?

Accepted Answer

A)  Flood 
B)  Commodity prices 
C)  Interest rate movements 
D)  Exchange rate movements 
A)  Flood 
B)  Commodity prices 
C)  Interest rate movements 
D)  Exchange rate movements

Question 8

What is the essential difference between an option and a futures contract?

Accepted Answer

A)  An option transaction occurs now, while a futures contract takes place in the future. 
B)  An option transaction is a right to transact for the option holder, while a futures contract is an obligation to transact in the future. 
C)  An option transaction is not standardized, while a futures contract is standardized. 
D)  An option transaction deals with financial assets, while a futures contract deals with commodities. 
A)  An option transaction occurs now, while a futures contract takes place in the future. 
B)  An option transaction is a right to transact for the option holder, while a futures contract is an obligation to transact in the future. 
C)  An option transaction is not standardized, while a futures contract is standardized. 
D)  An option transaction deals with financial assets, while a futures contract deals with commodities.

Question 9

Which of the following statements about diversification is incorrect?

Accepted Answer

A)  Risk-bearing financial institutions employ diversification. 
B)  Diversification reduces risk. 
C)  Mutual funds typically have a diversified portfolio. 
D)  Diversification requires that all investments have the same risk/return characteristics. 
A)  Risk-bearing financial institutions employ diversification. 
B)  Diversification reduces risk. 
C)  Mutual funds typically have a diversified portfolio. 
D)  Diversification requires that all investments have the same risk/return characteristics.

Question 10

From an insurance viewpoint, is a legal ruling that applies to many business owners a beneficial one?

Accepted Answer

A)  No, because it creates a higher correlation coefficient among those business owners 
B)  No, because it creates uncertainty for those business owners 
C)  Yes, as long as the ruling applies to all business owners 
D)  Yes, as long as the ruling applies to enough business owners 
A)  No, because it creates a higher correlation coefficient among those business owners 
B)  No, because it creates uncertainty for those business owners 
C)  Yes, as long as the ruling applies to all business owners 
D)  Yes, as long as the ruling applies to enough business owners

Question 11

Which of the following statements about put options is correct?

Accepted Answer

A)  If the option writer exercises the put option, the option holder has to sell the underlying asset to him or her. 
B)  If the option writer exercises the put option, the option holder has to buy the underlying asset from him or her. 
C)  If the option holder exercises the put option, the option writer has to buy the underlying asset from him or her. 
D)  If the option holder exercises the put option, the option writer has to sell the underlying asset to him or her. 
A)  If the option writer exercises the put option, the option holder has to sell the underlying asset to him or her. 
B)  If the option writer exercises the put option, the option holder has to buy the underlying asset from him or her. 
C)  If the option holder exercises the put option, the option writer has to buy the underlying asset from him or her. 
D)  If the option holder exercises the put option, the option writer has to sell the underlying asset to him or her.

Question 12

If two random variables are uncorrelated:

Accepted Answer

A)  their correlation coefficient cannot be calculated 
B)  their correlation coefficient is zero 
C)  their correlation coefficient depends on the covariance 
D)  All of the above are incorrect. 
A)  their correlation coefficient cannot be calculated 
B)  their correlation coefficient is zero 
C)  their correlation coefficient depends on the covariance 
D)  All of the above are incorrect.

Question 13

Output price risk is:

Accepted Answer

A)  when a change in the commodity market unfavorably affects the price at which a firm can buy their raw materials 
B)  when a change in the commodity market unfavorably affects the price at which a firm can sell their products 
C)  taking two positions whose gains and losses will offset each other 
D)  when a company sells its products abroad and there is an unfavorable exchange rate movement 
A)  when a change in the commodity market unfavorably affects the price at which a firm can buy their raw materials 
B)  when a change in the commodity market unfavorably affects the price at which a firm can sell their products 
C)  taking two positions whose gains and losses will offset each other 
D)  when a company sells its products abroad and there is an unfavorable exchange rate movement

Question 14

Why are derivatives effective instruments for hedging?

Accepted Answer

A)  They are negatively correlated with the firm's underlying risk. 
B)  There are so many of them. 
C)  They enhance the risk pool. 
D)  All of the above are correct. 
A)  They are negatively correlated with the firm's underlying risk. 
B)  There are so many of them. 
C)  They enhance the risk pool. 
D)  All of the above are correct.

Question 15

The correlation coefficient is calculated by taking the square root of the variance.

Accepted Answer

A) True 
 B)False

Question 16

Input price risk and output price risk are both a form of commodity price risk.

Accepted Answer

A) True 
 B)False

Question 17

Which of the following statements about the covariance is correct?

Accepted Answer

A)  The covariance measures risk. 
B)  The covariance is a number between -1 and +1. 
C)  The covariance measures how two variables move relative to each other. 
D)  All of the above are correct. 
A)  The covariance measures risk. 
B)  The covariance is a number between -1 and +1. 
C)  The covariance measures how two variables move relative to each other. 
D)  All of the above are correct.

Question 18

Which of the following statements about option contracts is not correct?

Accepted Answer

A)  The option writer has the right to exercise the option. 
B)  Option contracts can create a legal right to buy or sell a financial asset. 
C)  The option holder has the right to exercise the option. 
D)  All of the above are correct. 
A)  The option writer has the right to exercise the option. 
B)  Option contracts can create a legal right to buy or sell a financial asset. 
C)  The option holder has the right to exercise the option. 
D)  All of the above are correct.

Question 19

What is the essential difference between a call option and a put option?

Accepted Answer

A)  A call option transaction occurs now, while a put option transaction takes place in the future. 
B)  An call option transaction is the right to purchase the underlying asset, while a put option is the right to sell the underlying asset. 
C)  An call option transaction is not standardized, while put option transaction is standardized. 
D)  An call option transaction deals with financial assets, while a put option transaction deals with commodities. 
A)  A call option transaction occurs now, while a put option transaction takes place in the future. 
B)  An call option transaction is the right to purchase the underlying asset, while a put option is the right to sell the underlying asset. 
C)  An call option transaction is not standardized, while put option transaction is standardized. 
D)  An call option transaction deals with financial assets, while a put option transaction deals with commodities.

Question 20

Exchange rate losses arise when the value of the domestic currency falls relative to foreign currencies.

Accepted Answer

A) True 
 B)False

Exam 5: Risk-Handling Techniques: Diversification and Hedging

The covariance shows the risk of a single variable.

Which of the following statements about bearing risk collectively is correct?

As long as their correlation coefficient is less than 1, risk is being reduced by adding investments to the pool.

A traded option contract creates a legal right to buy or sell assets at a set price before a certain date.

Interest rate risk arises from changes in:

Which of the following is not an advantage of risk-bearing financial institutions?

Which of the following is not a risk that can be hedged?

What is the essential difference between an option and a futures contract?

Which of the following statements about diversification is incorrect?

From an insurance viewpoint, is a legal ruling that applies to many business owners a beneficial one?

Which of the following statements about put options is correct?

If two random variables are uncorrelated:

Output price risk is:

Why are derivatives effective instruments for hedging?

The correlation coefficient is calculated by taking the square root of the variance.

Input price risk and output price risk are both a form of commodity price risk.

Which of the following statements about the covariance is correct?

Which of the following statements about option contracts is not correct?

What is the essential difference between a call option and a put option?

Exchange rate losses arise when the value of the domestic currency falls relative to foreign currencies.

Introduction to Enterprise Risk Management and Insurance

Risk Identification

Risk Assessment and Pooling

Risk-Handling Techniques: Loss Control, Risk Transfer, and Loss Financing

Fundamentals of Insurance

Insurable Perils and Insuring Organizations

Insurance Functions

Insurance Markets: Economics and Issues

Insurance Regulation

Insurance Contracts

The Personal Auto Policy

Homeowners Insurance

Professional Financial Planning

Life Insurance Policies

Standard Life Insurance Contract Provisions and Options

Annuities

Health Insurance and Disability Income

Employee Benefits

Social Security

Unemployment and Workers Compensation Insurance

Commercial Property Insurance

Commercial Liability Insurance

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