Question 1

The duration of a five-year bond with 8% annual coupons trading at par is closest to ________.

Accepted Answer

A)  2.5 years 
B)  4.3 years 
C)  5.0 years 
D)  6.2 years 
A)  2.5 years 
B)  4.3 years 
C)  5.0 years 
D)  6.2 years B

Question 2

Which of the following statements is FALSE?

Accepted Answer

A)  Horizontal integration entails the merger of a firm and its supplier or a firm and its customer. 
B)  Like insurance, hedging involves contracts or transactions that provide the firm with cash flows that offset its losses from price changes. 
C)  For many firms, changes in the market prices of the raw materials they use and the goods they produce may be the most important source of risk to their profitability. 
D)  Because an increase in the price of the commodity raises the firm's costs and the supplier's revenues, these firms can offset their risks by merging. 
A)  Horizontal integration entails the merger of a firm and its supplier or a firm and its customer. 
B)  Like insurance, hedging involves contracts or transactions that provide the firm with cash flows that offset its losses from price changes. 
C)  For many firms, changes in the market prices of the raw materials they use and the goods they produce may be the most important source of risk to their profitability. 
D)  Because an increase in the price of the commodity raises the firm's costs and the supplier's revenues, these firms can offset their risks by merging. A

Question 3

Which of the following statements is FALSE?

Accepted Answer

A)  Not all insurable risks have a beta of zero. Some risks, such as hurricanes and earthquakes, create losses of tens of billions of dollars and may be difficult to diversify completely. 
B)  When a firm buys insurance, it transfers the risk of the loss to an insurance company. The insurance company charges an upfront premium to take on that risk. 
C)  By its very nature, insurance for nondiversifiable hazards is generally a positive beta asset; the insurance payment to the firm tends to be larger when total losses are low and the market portfolio is high. 
D)  Because insurance provides cash to the firm to offset losses, it can reduce the firm's need for external capital and thus reduce issuance costs. 
A)  Not all insurable risks have a beta of zero. Some risks, such as hurricanes and earthquakes, create losses of tens of billions of dollars and may be difficult to diversify completely. 
B)  When a firm buys insurance, it transfers the risk of the loss to an insurance company. The insurance company charges an upfront premium to take on that risk. 
C)  By its very nature, insurance for nondiversifiable hazards is generally a positive beta asset; the insurance payment to the firm tends to be larger when total losses are low and the market portfolio is high. 
D)  Because insurance provides cash to the firm to offset losses, it can reduce the firm's need for external capital and thus reduce issuance costs. C

Question 4

Which of the following statements is FALSE?

Accepted Answer

A)  Firms generally do not possess better information than outside investors regarding the risk of future commodity price changes, nor can they influence that risk through their actions. 
B)  Cash flows are exchanged on a monthly basis, rather than waiting until the end of the contract, through a procedure called marking to market. 
C)  The firm may speculate by entering into contracts that do not offset its actual risks. 
D)  When a firm authorizes managers to trade contracts to hedge, it opens the door to the possibility of speculation. 
A)  Firms generally do not possess better information than outside investors regarding the risk of future commodity price changes, nor can they influence that risk through their actions. 
B)  Cash flows are exchanged on a monthly basis, rather than waiting until the end of the contract, through a procedure called marking to market. 
C)  The firm may speculate by entering into contracts that do not offset its actual risks. 
D)  When a firm authorizes managers to trade contracts to hedge, it opens the door to the possibility of speculation.

Question 5

The Century 22 fund has invested in a portfolio of mortgage-backed securities that has a current market value of $245 million. The duration of this portfolio of mortgaged back securities is 14.7 years. The fund has borrowed to purchase these securities, and the current value of its liabilities (i.e., the current value of the bonds Century 22 has issued) is $160 million. The duration of these liabilities is 5.4 years. What is the initial duration of the equity for the Century 22 fund?

Accepted Answer

D_E = D_{A - L} = @#IMG-DLM&_TB1316_11 D

Question 6

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 NPV of implementing the new safety policies is closest to ________.

Accepted Answer

A)  $2.25 million 
B)  -$.25 million 
C)  $2.5 million 
D)  $2.15 million 
A)  $2.25 million 
B)  -$.25 million 
C)  $2.5 million 
D)  $2.15 million

Question 7

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 ratings bring?

Accepted Answer

Luther can borrow at the long term rate

Question 8

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 go long 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 marked to market profit or loss (in dollars) that you will have on each of the next five days?

Accepted Answer

The answer of Your oil refinery will need to buy...

Question 9

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 ________.

Accepted Answer

A)  property insurance 
B)  key personnel insurance 
C)  business liability insurance 
D)  business interruption insurance 
A)  property insurance 
B)  key personnel insurance 
C)  business liability insurance 
D)  business interruption insurance

Question 10

The risk that the firm will not have, or be able to raise, the cash required to meet the margin calls on its hedges is called ________.

Accepted Answer

A)  liquidity risk 
B)  basis risk 
C)  commodity price risk 
D)  speculation risk 
A)  liquidity risk 
B)  basis risk 
C)  commodity price risk 
D)  speculation risk

Question 11

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%.
-Assuming that your firm will purchase insurance, what is the minimum-size deductible that would leave your firm with an incentive to implement the new safety policies?

Accepted Answer

If the firm is fully insured (no deducti

Question 12

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%.
-An operator of an oil well has a 0.5% chance of experiencing a catastrophic failure over the next year. 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 
A)  $2,500,000 
B)  $2,637,131 
C)  $2,550,000 
D)  $2,753,304

Question 13

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

Accepted Answer

A)  key personnel insurance 
B)  business liability insurance 
C)  business interruption insurance 
D)  property insurance 
A)  key personnel insurance 
B)  business liability insurance 
C)  business interruption insurance 
D)  property insurance

Question 14

What is the duration of a five-year zero-coupon bond?

Accepted Answer

A)  2.5 years 
B)  1 year 
C)  5 years 
D)  0 years 
A)  2.5 years 
B)  1 year 
C)  5 years 
D)  0 years

Question 15

Which of the following statements is FALSE?

Accepted Answer

A)  The swap contract-like forward and futures contracts-is typically structured as a "zero-cost" security. 
B)  An interest rate swap is a contract entered into with a bank, much like a forward contract, in which the firm and the bank agree to exchange the coupons from two different types of loans. 
C)  In a standard interest rate swap, one party agrees to pay coupons based on a fixed interest rate in exchange for receiving coupons based on the prevailing market interest rate during each coupon period. 
D)  If short-term interest rates were to fall while long-term rates remained stable, then short-term securities would fall in value relative to long-term securities, despite their shorter duration. 
A)  The swap contract-like forward and futures contracts-is typically structured as a "zero-cost" security. 
B)  An interest rate swap is a contract entered into with a bank, much like a forward contract, in which the firm and the bank agree to exchange the coupons from two different types of loans. 
C)  In a standard interest rate swap, one party agrees to pay coupons based on a fixed interest rate in exchange for receiving coupons based on the prevailing market interest rate during each coupon period. 
D)  If short-term interest rates were to fall while long-term rates remained stable, then short-term securities would fall in value relative to long-term securities, despite their shorter duration.

Question 16

Which of the following statements is FALSE?

Accepted Answer

A)  Because insurance reduces the risk of financial distress, it can relax this tradeoff and allow the firm to increase its use of debt financing. 
B)  By lowering the volatility of the stock, insurance can discourage concentrated ownership by an outside director or investor who will monitor the firm and its management. 
C)  When a firm is subject to graduated income tax rates, insurance can produce a tax savings if the firm is in a higher tax bracket when it pays the premium than the tax bracket it is in when it receives the insurance payment in the event of a loss. 
D)  In a perfect market without other frictions, insurance companies should compete until they are just earning a fair return and the NPV from selling insurance is zero. The NPV is zero if the price of insurance equals the present value of the expected payment; in that case, we say the price is actuarially fair. 
A)  Because insurance reduces the risk of financial distress, it can relax this tradeoff and allow the firm to increase its use of debt financing. 
B)  By lowering the volatility of the stock, insurance can discourage concentrated ownership by an outside director or investor who will monitor the firm and its management. 
C)  When a firm is subject to graduated income tax rates, insurance can produce a tax savings if the firm is in a higher tax bracket when it pays the premium than the tax bracket it is in when it receives the insurance payment in the event of a loss. 
D)  In a perfect market without other frictions, insurance companies should compete until they are just earning a fair return and the NPV from selling insurance is zero. The NPV is zero if the price of insurance equals the present value of the expected payment; in that case, we say the price is actuarially fair.

Question 17

Which of the following statements is FALSE?

Accepted Answer

A)  Corporations use interest rate swaps routinely to alter their exposure to interest rate fluctuations. 
B)  The value of a swap, while initially zero, will fluctuate over time as interest rates change. 
C)  An interest rate that adjusts to current market conditions is called a floating rate. 
D)  When interest rates rise, the swap's value will rise for the party receiving the fixed rate; conversely, it will fall for the party paying the fixed rate. 
A)  Corporations use interest rate swaps routinely to alter their exposure to interest rate fluctuations. 
B)  The value of a swap, while initially zero, will fluctuate over time as interest rates change. 
C)  An interest rate that adjusts to current market conditions is called a floating rate. 
D)  When interest rates rise, the swap's value will rise for the party receiving the fixed rate; conversely, it will fall for the party paying the fixed rate.

Question 18

In reality market imperfections exist that can raise the cost of insurance above the actuarially fair price and offset some of these benefits. These insurance market imperfections include all of the following EXCEPT ________.

Accepted Answer

A)  adverse selection 
B)  agency costs 
C)  administrative and overhead costs 
D)  taxation of insurance payments 
A)  adverse selection 
B)  agency costs 
C)  administrative and overhead costs 
D)  taxation of insurance payments

Question 19

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 NPV of implementing the new safety policies is closest to ________.

Accepted Answer

A)  $2.15 million 
B)  $2.5 million 
C)  $2.25 million 
D)  -$.25 million 
A)  $2.15 million 
B)  $2.5 million 
C)  $2.25 million 
D)  -$.25 million

Question 20

Which of the following statements regarding long-term supply contracts is FALSE?

Accepted Answer

A)  The market value of the contract at any point in time may not be easy to determine, making it difficult to track gains and losses. 
B)  Long-term supply contracts are designed to eliminate credit risk. 
C)  Long-term supply contracts insulate the firms from commodity price risk. 
D)  Long-term supply contracts are bilateral contracts negotiated by a buyer and a seller. 
A)  The market value of the contract at any point in time may not be easy to determine, making it difficult to track gains and losses. 
B)  Long-term supply contracts are designed to eliminate credit risk. 
C)  Long-term supply contracts insulate the firms from commodity price risk. 
D)  Long-term supply contracts are bilateral contracts negotiated by a buyer and a seller.

The duration of a five-year bond with 8% annual coupons trading at par is closest to ________.

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

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 ________.

The risk that the firm will not have, or be able to raise, the cash required to meet the margin calls on its hedges is called ________.

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

What is the duration of a five-year zero-coupon bond?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

In reality market imperfections exist that can raise the cost of insurance above the actuarially fair price and offset some of these benefits. These insurance market imperfections include all of the following EXCEPT ________.

Which of the following statements regarding long-term supply contracts is FALSE?

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

Time Value of Money: an Introduction

Time Value of Money: Valuing Cash Flow Streams

Interest Rates

Bonds

Stock Valuation

Investment Decision Rules

Fundamentals of Capital Budgeting

Stock Valuation: a Second Look

Risk and Return in Capital Markets

Systematic Risk and the Equity Risk Premium

The Cost of Capital

Raising Equity Capital

Debt Financing

Capital Structure

Payout Policy

Financial Modeling and Pro Forma Analysis

Working Capital Management

Short-Term Financial Planning

Option Applications and Corporate Finance

Mergers and Acquisitions

International Corporate Finance

Leasing

Corporate Governance

Filters

Exam 25: Insurance and Risk Management

The duration of a five-year bond with 8% annual coupons trading at par is closest to ________.

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

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 ________.

The risk that the firm will not have, or be able to raise, the cash required to meet the margin calls on its hedges is called ________.

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

What is the duration of a five-year zero-coupon bond?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

In reality market imperfections exist that can raise the cost of insurance above the actuarially fair price and offset some of these benefits. These insurance market imperfections include all of the following EXCEPT ________.

Which of the following statements regarding long-term supply contracts is FALSE?

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

Time Value of Money: an Introduction

Time Value of Money: Valuing Cash Flow Streams

Interest Rates

Bonds

Stock Valuation

Investment Decision Rules

Fundamentals of Capital Budgeting

Stock Valuation: a Second Look

Risk and Return in Capital Markets

Systematic Risk and the Equity Risk Premium

The Cost of Capital

Raising Equity Capital

Debt Financing

Capital Structure

Payout Policy

Financial Modeling and Pro Forma Analysis

Working Capital Management

Short-Term Financial Planning

Option Applications and Corporate Finance

Mergers and Acquisitions

International Corporate Finance

Leasing

Corporate Governance

Filters