Question 1

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

Accepted Answer

A) True 
 B)False

Question 2

What is business liability insurance?

Accepted Answer

Business liability insurance c

Question 3

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?

Accepted Answer

A) $2,500,000 
B) $2,637,131 
C) $2,550,000 
D) $2,753,304 
E) $2,145,000 
A) $2,500,000 
B) $2,637,131 
C) $2,550,000 
D) $2,753,304 
E) $2,145,000

Question 4

What is adverse selection?

Accepted Answer

A firm's desire to buy insuran

Question 5

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 6

________ 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) Start-up 
A) Bankruptcy and financial distress 
B) Market 
C) Input 
D) Output 
E) Start-up

Question 7

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 8

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 $702 per ounce,what is the cash flow to the producer?

Accepted Answer

A) -$2000 
B) $2000 
C) $0 
D) $700,000 
E) $702,000 
A) -$2000 
B) $2000 
C) $0 
D) $700,000 
E) $702,000

Question 9

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 10

A firm can borrow at a floating rate of LIBOR + 2.5% on short-term loans.It swaps its short-term payments so that it receives LIBOR + 1.25% and pays a fixed rate of 3.75%.If the notional principal is $100 million,what is the amount the firm pays under the swap?

Accepted Answer

A) $1.25 million 
B) $2.5 million 
C) $3.75 million 
D) $5 million 
E) $7.5 million 
A) $1.25 million 
B) $2.5 million 
C) $3.75 million 
D) $5 million 
E) $7.5 million

Question 11

The six month LIBOR rate for a reference period is 6.8% (annualized).The fixed six-month coupon rate for the same period is 3.9%.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) $1.5 million 
D) $2 million 
E) $2.5 million 
A) $0.5 million 
B) $1 million 
C) $1.5 million 
D) $2 million 
E) $2.5 million

Question 12

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 13

A(n)________ is only used to calculate coupon payments on a swap but is never actually paid.

Accepted Answer

A) standard loan 
B) floating loan 
C) amortization 
D) notional principal 
E) swap valuator 
A) standard loan 
B) floating loan 
C) amortization 
D) notional principal 
E) swap valuator

Question 14

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?

Accepted Answer

A) 4.5% 
B) 2.5% 
C) 5.0% 
D) 5.5% 
E) 7.5% 
A) 4.5% 
B) 2.5% 
C) 5.0% 
D) 5.5% 
E) 7.5%

Question 15

A provision in an insurance policy that limits the amount of loss that the policy covers regardless of the extent of the damage is known as a:

Accepted Answer

A) security deposit. 
B) coverage ceiling. 
C) policy limit. 
D) deductible. 
E) loss premium. 
A) security deposit. 
B) coverage ceiling. 
C) policy limit. 
D) deductible. 
E) loss premium.

Question 16

________ is the sensitivity of a firm's assets and liabilities to interest rate changes.

Accepted Answer

A) Asset mismatch 
B) Gamma 
C) Duration 
D) Vega 
E) Basis risk 
A) Asset mismatch 
B) Gamma 
C) Duration 
D) Vega 
E) Basis risk

Question 17

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?

Accepted Answer

A) $125,000 
B) $31,250 
C) $62,500 
D) $93,750 
E) $125,500 
A) $125,000 
B) $31,250 
C) $62,500 
D) $93,750 
E) $125,500

Question 18

What is a duration mismatch?

Accepted Answer

A duration mismatch is a signi

Question 19

How does insurance allow firms to reduce issuance costs?

Accepted Answer

When a firm experiences losses,it may ne

Question 20

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.

Exam 21: Risk Management

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

What is business liability insurance?

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?

What is adverse selection?

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

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

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.

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 $702 per ounce,what is the cash flow to the producer?

A firm can borrow at a floating rate of LIBOR + 2.5% on short-term loans.It swaps its short-term payments so that it receives LIBOR + 1.25% and pays a fixed rate of 3.75%.If the notional principal is $100 million,what is the amount the firm pays under the swap?

The six month LIBOR rate for a reference period is 6.8% (annualized).The fixed six-month coupon rate for the same period is 3.9%.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.

A(n)________ is only used to calculate coupon payments on a swap but is never actually paid.

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?

A provision in an insurance policy that limits the amount of loss that the policy covers regardless of the extent of the damage is known as a:

________ is the sensitivity of a firm's assets and liabilities to interest rate changes.

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?

What is a duration mismatch?

How does insurance allow firms to reduce issuance costs?

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

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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