Exam 25: Insurance and Risk Management

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?

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 ________.

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?

What are some of the disadvantages of long-term supply contracts?

Which of the following statements is FALSE?

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 0, what is the actuarially fair insurance premium?

Insurance that compensates for the loss or unavoidable absence of crucial employees in the firm is called ________.

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?

An interest rate that adjusts to current market conditions is called a(n) ________.

Which of the following statements is FALSE?

Which of the following is an agreement to trade an asset on some future date, at a price that is fixed today?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

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?

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 ________.

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 ________.

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 ________.

Firms use all of the following for reducing their exposure to commodity price movements EXCEPT ________.

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