Exam 21: Risk Management

What is the percentage change in a 10-year zero-coupon bond with a duration of 10 years,when interest rates increase from 3% to 4%?

________ is the sensitivity of a firm's assets and liabilities to interest rate changes.

How does insurance allow firms to increase their use of debt financing?

Use the information for the question(s) below. Your firm faces an 8% chance of a potential loss of $50 million next year. If your firm implements new safety policies, it can reduce the chance of this loss to 3%, but the new safety policies have an upfront cost of $250,000. Suppose that the beta of the loss is 0 and the risk-free rate of interest is 5%. -If your firm is fully insured,the net present value (NPV)of implementing the new safety policies is closest to:

A firm wishes to buy fire insurance at its plant.The loss in case of fire is estimated to be $30 million and the probability of occurrence is 0.5% over the next year.If claims are paid at the end of the year and the annual risk-free rate is 10%,compute the insurance premium.

What is an actuarially fair price?

________ is one of the most common methods to reduce the risks related to business liability,business interruption,or loss of key personnel.

Adverse selection is a market friction that raises the cost of insurance.

Luther Industries needs to borrow $50 million in cash.Currently long-term AAA rates are 9%.Luther can borrow at 9.75% given its current credit rating.Luther is expecting interest rates to fall over the next few years,so it would prefer to borrow at the short-term rates and refinance after rates have dropped.Luther management is afraid,however,that its credit rating may fall which could greatly increase the spread the firm must pay on new borrowings.How can Luther benefit from the expected decline in future interest rates without exposure to the risk of the potential future changes to its credit rating?

A steel maker needs 5,000,000 tons of coal next year.The current market price for coal is $70.00 per ton.At this price,the firm expects its EBIT to be $500 million.What will the firm's EBIT if the firm enters into a supply contract for coal for a fixed price of $72.00 per ton?

The ________ is the annual fee a firm pays the insurance company in exchange for compensation in the event of a random future loss.

Use the table for the question(s) below. -Suppose oil futures prices are as given in the above table (price per barrel).Suppose you sell 100 crude oil futures contracts,each for 1000 barrels of crude oil,at the current futures price of $108 per barrel on day 0.What is your cumulative profit/loss in your margin account by the end of day 5?

The ability of a firm to pass on cost increases to its customers or revenue decreases to its suppliers is known as

Which of the following is a customized agreement between two parties who are known to each other to trade an asset on some future date,at a price that is fixed today?

An interest rate that adjusts to current market conditions is called a(n)

A firm can borrow at a floating rate of LIBOR + 2.5% on short-term loans.If it swaps its short-term payments so that it receives LIBOR + 1.25% and pays a fixed rate of 3.75%,what is the rate of interest on its borrowing?

Heinz uses 2000 tons of corn syrup each year as an ingredient in its tomato ketchup products.Heinz is concerned about the increase in prices of corn-based products and purchases a fixed-price contract to buy corn syrup at $10,000 per ton.What is the impact on earnings before taxes as opposed to no hedging if the price of corn is $10,000 per ton over the next year?

What is a duration mismatch?

To cover the costs that result if some aspect of the business causes harm to a third party or someone else's property,a firm would purchase

________ is method of hedging because a firm can lock in the cost of a commodity at today's prices plus any carrying costs.