Exam 21: Risk Management

A firm wishes to buy fire insurance at its plant.The loss in case of fire is estimated to be $20 million and the probability of occurrence is 0.1% 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.

A firm can borrow at fixed AA rates 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% and the fixed rate is 1%?

When there is a mismatch between a firm's risk exposure and the underlying futures contract used for hedging,it referred to as basis risk.

A firm can borrow at fixed AA rates plus 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%?

A restaurant decides to insure itself against the risk of fire.The insurance company estimates that the probability of a fire is 0.1% and the expected payment should a fire occur is $10 million.If the risk-free rate is 4%,the expected return on the market is 9%,and the beta of the risk is 0,what is the actuarially fair insurance premium?

Securities whose value comes mostly from later cash flows have a shorter duration than do securities whose value comes mostly from earlier cash flows.

What is moral hazard?

________ is a method of hedging wherein a firm and its supplier merge so that an increase in the price of a commodity raises the firm's costs and the supplier's revenues.