Question 1

Which of the following best describes how moral hazard affects the price of insurance?

Accepted Answer

A)  Since insurers can acquire complete information regarding the riskiness of borrowers, they can charge actuarially fair premiums. 
B)  Since firms may have private information about how risky they are, insurers must raise premiums to compensate for the existence of this uncertainty. 
C)  Since purchasing insurance reduces the firm's incentive to avoid risk, insurers must raise premiums to compensate for the increase in risk. 
D)  Since purchasing insurance reduces the firm's risk, insurers can lower premiums to compensate for the reduction in risk. 
E)  Since high premiums will drive away the low-risk firms, insurers must lower premiums in order to attract low-risk borrowers. 
A)  Since insurers can acquire complete information regarding the riskiness of borrowers, they can charge actuarially fair premiums. 
B)  Since firms may have private information about how risky they are, insurers must raise premiums to compensate for the existence of this uncertainty. 
C)  Since purchasing insurance reduces the firm's incentive to avoid risk, insurers must raise premiums to compensate for the increase in risk. 
D)  Since purchasing insurance reduces the firm's risk, insurers can lower premiums to compensate for the reduction in risk. 
E)  Since high premiums will drive away the low-risk firms, insurers must lower premiums in order to attract low-risk borrowers.

Question 2

How might a decrease in interest rates reduce firm value?

Accepted Answer

Many firms have fixed long-term future l

Question 3

Use the table for the question(s) below.
  
-Suppose oil futures prices are as given in the above table (price per barrel).Suppose you buy 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 profit/loss in your margin account from the end of day 4 to the end of day 5?

Accepted Answer

A)  -$300,000 
B)  $300,000 
C)  $400,000 
D)  -$400,000 
E)  $0 
A)  -$300,000 
B)  $300,000 
C)  $400,000 
D)  -$400,000 
E)  $0

Question 4

Being long a futures contract is equivalent to purchasing a put option.

Accepted Answer

A) True 
 B)False

Question 5

Which of the following best describes how adverse selection affects the price of insurance?

Accepted Answer

A)  Since insurers can acquire complete information regarding the riskiness of borrowers, they can charge actuarially fair premiums. 
B)  Since firms may have private information about how risky they are, insurers must raise premiums to compensate for the existence of this uncertainty. 
C)  Since purchasing insurance reduces the firm's incentive to avoid risk, insurers must raise premiums to compensate for the increase in risk. 
D)  Since purchasing insurance reduces the firm's risk, insurers can lower premiums to compensate for the reduction in risk. 
E)  Since high premiums will drive away the low-risk firms, insurers must lower premiums in order to attract low-risk borrowers. 
A)  Since insurers can acquire complete information regarding the riskiness of borrowers, they can charge actuarially fair premiums. 
B)  Since firms may have private information about how risky they are, insurers must raise premiums to compensate for the existence of this uncertainty. 
C)  Since purchasing insurance reduces the firm's incentive to avoid risk, insurers must raise premiums to compensate for the increase in risk. 
D)  Since purchasing insurance reduces the firm's risk, insurers can lower premiums to compensate for the reduction in risk. 
E)  Since high premiums will drive away the low-risk firms, insurers must lower premiums in order to attract low-risk borrowers.

Question 6

In a perfect capital market,a company will not purchase insurance unless the NPV is positive.

Accepted Answer

A) True 
 B)False

Question 7

A firm with above-average risk is more likely to purchase insurance.This is an example of

Accepted Answer

A)  adverse selection. 
B)  moral hazard. 
C)  the insurance dilemma. 
D)  actuarial fairness. 
E)  insurance risk. 
A)  adverse selection. 
B)  moral hazard. 
C)  the insurance dilemma. 
D)  actuarial fairness. 
E)  insurance risk.

Question 8

The six-month LIBOR rate for a reference period is 10% (annualized).The fixed six-month coupon rate for the same period is 5%.Compute the payment to the floating-rate payer if the notional principal is $100 million.

Accepted Answer

A)  $0.5 million 
B)  $1 million 
C)  $0 million 
D)  $1.5 million 
E)  $0.25 million 
A)  $0.5 million 
B)  $1 million 
C)  $0 million 
D)  $1.5 million 
E)  $0.25 million

Question 9

A firm wishes to buy fire insurance at its plant.The loss in case of fire is estimated to be $50 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.

Accepted Answer

A)  $250,303 
B)  $236,109 
C)  $245,368 
D)  $227,273 
E)  $260,154 
A)  $250,303 
B)  $236,109 
C)  $245,368 
D)  $227,273 
E)  $260,154

Question 10

What is business liability insurance?

Accepted Answer

Business liability insurance c

Question 11

________ costs impose several direct and indirect costs,including agency costs,whose insurance could lead to an increase in firm value.

Accepted Answer

A)  Bankruptcy and financial distress 
B)  Market 
C)  Input 
D)  Output 
E)  Startup 
A)  Bankruptcy and financial distress 
B)  Market 
C)  Input 
D)  Output 
E)  Startup

Question 12

Firms can hedge risk by making real investments in assets with offsetting risk.

Accepted Answer

A) True 
 B)False

Question 13

A firm can borrow at a floating rate of LIBOR + 1% on short-term loans.It swaps its short-term payments so that it receives LIBOR + 2% and pays a fixed rate of 3%.If the notional principal is $50 million,what is the amount the firm pays under the swap?

Accepted Answer

A)  $1 million 
B)  $1.5 million 
C)  $2 million 
D)  $2.5 million 
E)  $3 million 
A)  $1 million 
B)  $1.5 million 
C)  $2 million 
D)  $2.5 million 
E)  $3 million

Question 14

A company has a current tax rate of 30% and faces a 15% chance that the its output prices will drop and it will lose $100,000 over the next year.The firm would then be in a 10% tax bracket if it faces a loss.Compute the net present value (NPV)from purchasing insurance if the rate of interest is 5% and the beta of the output prices is 0.

Accepted Answer

A)  $1932 
B)  $2178 
C)  $2857 
D)  $2591 
E)  $3122 
A)  $1932 
B)  $2178 
C)  $2857 
D)  $2591 
E)  $3122

Question 15

A firm estimates that the loss from a weather-related closing is $10 million and the probability of occurrence is 0.1% over the next year.If claims are paid at the end of the year,the annual risk-free rate is 5%,the market risk premium is 6%,and the beta of these losses is 0.5,compute the insurance premium.

Accepted Answer

A)  $8198 
B)  $8918 
C)  $9259 
D)  $9598 
E)  $8574 
A)  $8198 
B)  $8918 
C)  $9259 
D)  $9598 
E)  $8574

Question 16

Use the table for the question(s) below.
  
-Suppose oil futures prices are as given in the above table (price per barrel).Suppose you buy 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?

Accepted Answer

A)  -$300,000 
B)  $300,000 
C)  $400,000 
D)  -$400,000 
E)  $0 
A)  -$300,000 
B)  $300,000 
C)  $400,000 
D)  -$400,000 
E)  $0

Question 17

Because insurance provides cash to the firm to offset losses,it can reduce the firm's need for external capital and thus reduce ________ costs.

Accepted Answer

A)  labour 
B)  external 
C)  input 
D)  issuance 
E)  startup 
A)  labour 
B)  external 
C)  input 
D)  issuance 
E)  startup

Question 18

A(n)________ is a contract entered into with a bank in which the firm and the bank agree to exchange coupons from two different types of loans.

Accepted Answer

A)  interest rate swap 
B)  hedge 
C)  call 
D)  put 
E)  futures contract 
A)  interest rate swap 
B)  hedge 
C)  call 
D)  put 
E)  futures contract

Question 19

Two firms can use vertical integration to hedge risks,because an increase in price represents an increase in revenues for one firm,offsetting an increase in costs for the other firm.

Accepted Answer

A) True 
 B)False

Question 20

The risk that the firm will not have,or will not be able to raise,the cash required to meet the margin calls on its hedges is called

Accepted Answer

A)  liquidity risk. 
B)  basis risk. 
C)  commodity price risk. 
D)  speculation risk. 
E)  margin risk. 
A)  liquidity risk. 
B)  basis risk. 
C)  commodity price risk. 
D)  speculation risk. 
E)  margin risk.

Exam 21: Risk Management

Which of the following best describes how moral hazard affects the price of insurance?

How might a decrease in interest rates reduce firm value?

Being long a futures contract is equivalent to purchasing a put option.

Which of the following best describes how adverse selection affects the price of insurance?

In a perfect capital market,a company will not purchase insurance unless the NPV is positive.

A firm with above-average risk is more likely to purchase insurance.This is an example of

The six-month LIBOR rate for a reference period is 10% (annualized).The fixed six-month coupon rate for the same period is 5%.Compute the payment to the floating-rate payer if the notional principal is $100 million.

A firm wishes to buy fire insurance at its plant.The loss in case of fire is estimated to be $50 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 business liability insurance?

________ costs impose several direct and indirect costs,including agency costs,whose insurance could lead to an increase in firm value.

Firms can hedge risk by making real investments in assets with offsetting risk.

A firm can borrow at a floating rate of LIBOR + 1% on short-term loans.It swaps its short-term payments so that it receives LIBOR + 2% and pays a fixed rate of 3%.If the notional principal is $50 million,what is the amount the firm pays under the swap?

Because insurance provides cash to the firm to offset losses,it can reduce the firm's need for external capital and thus reduce ________ costs.

A(n)________ is a contract entered into with a bank in which the firm and the bank agree to exchange coupons from two different types of loans.

Two firms can use vertical integration to hedge risks,because an increase in price represents an increase in revenues for one firm,offsetting an increase in costs for the other firm.

The risk that the firm will not have,or will not be able to raise,the cash required to meet the margin calls on its hedges is called

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

The Valuation Principle: the Foundation of Financial Decision Making

The Time Value of Money

Interest Rates

Bonds

Valuing Stocks

Investment Decision Rules

Fundamentals of Capital Budgeting

Risk and Return in Capital Markets

Systematic Risk and the Equity Risk Premium

Determining the Cost of Capital

Risk and the Pricing of Options

Raising Equity Capital

Debt Financing

Capital Structure

Payout Policy

Financial Modelling and Pro Forma Analysis

Working Capital Management

Short Term Financial Planning

International Corporate Finance

Leasing

Mergers and Acquisitions

Corporate Governance

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