Deck 21: Risk Management and Corporate Strategy

Question 1

Which of the following is true of the financial distress of a company and hedging?

A)Firms that face high financial distress costs have greater incentives to hedge.
B)Hedging eliminates the possibility of financial distress.
C)If the cost of hedging is sufficiently large,and if hedging reduces variance very little,then hedging decreases the probability of financial distress.
D)Hedging has no impact on the cash flows of an unlevered firm and on the costs of financial distress.

Answer 1

A

Question 2

Assume that a UK enterprise has a German subsidiary.The UK enterprise is exposed to the risk of the euro weakening,and the value of the subsidiary's assets decreasing in pound sterling terms in consolidated financial statements.This risk is referred to as _____.

A)translation risk
B)reinvestment risk
C)transaction risk
D)economic risk

Answer 2

A

Question 3

Which of the following is a managerial incentive to speculate?

A)Managers anticipate an unfavourable outcome of a risky strategy
B)Managers hold a large volume of the firm's stock
C)Managers are compensated with executive equity options
D)Managers feel they possess inferior information about the firm

Answer 3

C

Question 4

Which of the following is true of factor risk?

A)It is generally diversifiable.
B)It is same as the unsystematic risk of a firm.
C)It is different for different firms in the same industry.
D)It can be hedged with financial derivatives.

Question 5

Explain a firm's hedging exposure to credit rate changes.

Question 6

Which of the following is a reason why most firms do not hedge economic risk?

A)Among the translation risk,transaction risk and economic risk; economic risk has the least influence on the total currency risk of a firm.
B)It is costly to hedge against the economic risk and also highly ineffective.
C)Whenever exchange rates change for real reasons other than purely monetary reasons,it is difficult to implement effective hedges.
D)It is difficult to estimate both the current and the long-term effects of exchange rate changes on the firm's cash flows.

Question 7

Which of the following is an example in which a firm might be indifferent between liability and risk management choices?

A)Taking a long position in the futures contract,a long position in a call option and a short position in the underlying asset
B)Taking a long position in the futures contract and a short position in the underlying asset
C)Borrowing in floating rates,enter into a floating-to-fixed interest swap and lending in floating rates
D)Borrowing foreign currency and swapping the foreign currency debt for a local currency obligation

Question 8

A UK based firm that has business in the United States takes offsetting positions in certain securities to eliminate the dollar exposure of its sales in the USThis method of risk management is referred to as _____.

A)arbitraging
B)hedging
C)speculating
D)scalping

Question 9

Which of the following is an advantage of hedging?

A)It can reduce the costs of financial distress.
B)It eliminates the risk of bankruptcy.
C)It can eliminate firm-specific risk with derivative instruments.
D)It improves the leverage of the firm.

Question 10

Which of the following is true of the Modigliani-Miller theorem in the absence of taxes and transaction costs?

A)Hedging is unlikely to improve a firm's value if it does no more than reduce the variance of its future cash flows.
B)To improve a firm's value,hedging must increase expected cash flows.
C)If hedging choices do not affect cash flows from real assets,hedging decisions do not affect firm values.
D)To improve a firm's value,hedging must decrease expected cash flows.

Question 11

Which of the following is a determinant of the economic risk?

A)Credit rating of the firm
B)The location of competitors
C)Share price of the firm
D)Current ratio

Question 12

How does hedging improve executive compensation contracts and performance evaluation?

Question 13

Explain the implications of the Modigliani-Miller theorem for hedging.

Question 14

Most risk management programmes are implemented at the corporate rather than the divisional level.Why?

Question 15

Which of the following is true of the hedging effects on stakeholders?

A)Hedging reduces volatility without increasing firm value and transfers value from debt holders to equity holders.
B)A firm's bankers and bondholders would certainly like the firm to hedge.
C)Managers who look out for the interests of their employees have no incentive to hedge.
D)The interests of most of a firm's employees are closer to the interests of equity holders than of debt holders.

Question 16

Which of the following is a component of the liability stream of a firm?

A)Inflation rate
B)Beta
C)Market risk premium
D)Default-free interest rates

Question 17

Assume that changes in interest rates reflect mainly changes in the rate of inflation.If a firm's unlevered cash flows:

A)don't change with the rate of inflation,then the firm will want its liabilities to be exposed to interest rate risk.
B)increase with the rate of inflation,then the firm will want its liabilities to be exposed to interest rate risk.
C)decrease with the rate of inflation,then the firm will want its liabilities to be exposed to interest rate risk.
D)increase with the real interest rate,then the firm will want its liabilities to be less exposed to interest rate risk.

Question 18

Which of the following is true of the impact of hedging on executive compensation contracts?

A)A well-designed compensation package will leave a risk-averse executive exposed to risk.
B)Hedging restricts the managers to take riskier but high return projects.
C)A firm will be able to evaluate its executives more accurately by implementing a hedging programme.
D)Hedging can increase risk and penalize the executives for a decline in profits of the project.

Question 19

_____ is usually associated with transactions denominated in foreign currencies.

A)Reinvestment risk
B)Translation risk
C)Transaction risk
D)Economic risk