Exam 21: Risk Management

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 + 1.5% and pays a fixed rate of 5%.If the notional principal is $25 million,what is the amount the firm pays under the swap?

How do futures contracts eliminate credit risk?

A firm can borrow at a floating rate of LIBOR - 1% on short-term loans.If it swaps its short-term payments so that it receives LIBOR + 1.5% and pays a fixed rate of 5%,what is the rate of interest on its borrowing?

Insurance companies diversify their risks by pooling together highly correlated policies.

The change in behaviour that results from the presence of insurance is referred to as moral hazard.

The six-month LIBOR rate for a reference period is 7% (annualized).The fixed six-month coupon rate for the same period is 4%.Compute the payment to the floating-rate payer if the notional principal is $200 million.

What is the percentage change in a 7-year zero-coupon bond with a duration of 7 years,when interest rates increase from 6% to 7%?

By combining ________ with ________,firms can choose which of these sources of interest rate risk they will tolerate and which they will eliminate.

Insurance allows the firm to exchange a random future loss for a certain upfront expense.

A firm can borrow at fixed AA rates minus 1% for long-term loans.If it swaps its long-term payments so that it receives the fixed AA rate and pays a AA floating rate,what is the rate of interest on its borrowing if the floating rate is r%?

The risk that arises because the value of the futures contract will not be perfectly correlated with the firm's exposure is called

How does insurance allow firms to reduce issuance costs?

An operator of an oil well has a 0.5% chance of experiencing a catastrophic failure.This failure will cost the operator $500 million.If the risk-free rate is 2%,the expected return on the market is 8%,and the beta of the risk is -1.2,what is the actuarially fair insurance premium?

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 uninsured,the net present value (NPV)of implementing the new safety policies is closest to:

Because insurance pays off in bad times,it is generally a negative-beta asset.

What is key personnel insurance?

A provision in an insurance policy in which an initial amount of loss is not covered by the policy and must be paid by the insured is known as a

What is adverse selection?

A gold mining firm sells futures contracts worth 1000 ounces at a price of $700 per ounce for maturity one year from today.If gold futures prices increase to $752 per ounce,what is the cash flow to the producer?

If the price of insurance equals the net present value (NPV)of the expected payment,it is said to be