Exam 21: Risk Management

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

Your oil refinery will need to buy 250,000 barrels of crude oil in one week and it is worried about crude oil prices.Suppose you buy 250 crude oil futures contracts,each for 1000 barrels of crude oil,at the current futures price of $68 per barrel.Suppose futures prices change each day over the next week as follows: What is the daily and cumulative mark-to-market profit or loss (in thousands)that you will have on each of the next five days?

The value of insurance comes from its ability to reduce the cost of ________ for the firm.

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:

________ is one of the most common methods to reduce the risks related to business liability,business interruption,or loss of key personnel.

Heinz uses 1000 tons of corn syrup each year as an ingredient in its tomato ketchup products.Heinz is concerned about the increase in prices of corn-based products and purchases a fixed-price contract to buy corn syrup at $20,000 per ton.What is the impact on earnings before taxes as opposed to no hedging if the price of corn is $25,000 per ton over the next year?

A company has a current tax rate of 35% and faces a 10% chance that the its output prices will drop and it will lose 200,000 over the next year.The firm would then be in a 15% 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.

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

The ability of a firm to pass on cost increases to its customers or revenue decreases to its suppliers is known as:

________ 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.

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?

What is the percentage change in a 10-year zero-coupon bond with a duration of 10 years,when interest rates increase from 3% to 4%?

How does insurance allow firms to increase their use of debt financing?

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.

A manufacturer of breakfast cereal is concerned about corn prices.The firm anticipates needing 1 million bushels of corn in one month.The current price of corn is $6.50 per bushel and the futures price for delivery in one month is $7.00 per bushel.The cost to store the corn for 1 month is $100,000.What should the firm do?

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

What is the purpose of a deductible?

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 0,what is the actuarially fair insurance premium?

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%?

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.