Exam 21: Risk Management

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.

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

To protect the firm against the loss of earnings if the business operations are disrupted due to fire,accident,or some other insured peril,a firm would purchase:

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?

To insure their assets against hazards such as fire,storm damage,vandalism,earthquakes,and other natural and environmental risks,firms commonly purchase:

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?

Futures contracts minimize default risk by requiring traders to post collateral called ________ when buying or selling commodities using futures contracts.

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?

A buyer's margin account must always have a daily balance sufficient to cover at least one day's potential loss.

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

How do futures contracts eliminate credit risk?

What is key personnel 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?

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

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

The risk of fire at a car assembly plant is 0.1%.If the firm will receive a payment of $40 million in one year if there is a fire during the year,what is the net present value (NPV)of purchasing insurance if the firm will face financial distress costs of $7 million and issuance costs of $1 million in the event of a loss if the risk-free rate is 5%?

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?

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

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.

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