Question 1

Which of the following statements regarding futures contracts is FALSE?

Accepted Answer

A)  Both the buyer and the seller can get out of the contract at any time by selling it to a third party at the current market price. 
B)  Futures prices are not prices that are paid today. Rather, they are prices agreed to today, to be paid in the future. 
C)  Futures contracts are traded anonymously on an exchange at a publicly observed market price and are generally very illiquid. 
D)  Investors are required to post collateral, called margin, when buying or selling commodities using futures contracts. 
A)  Both the buyer and the seller can get out of the contract at any time by selling it to a third party at the current market price. 
B)  Futures prices are not prices that are paid today. Rather, they are prices agreed to today, to be paid in the future. 
C)  Futures contracts are traded anonymously on an exchange at a publicly observed market price and are generally very illiquid. 
D)  Investors are required to post collateral, called margin, when buying or selling commodities using futures contracts.

Question 2

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 3

An S&L owns mortgages that have a current market value of $325 million. The duration of this portfolio of mortgages is 15.9 years. The S&L finances its mortgages by issuing CDs and the current value of these liabilities is $275 million. The duration of these liabilities is 4.6 years. What is the initial duration of the equity for the S&L?

Accepted Answer

A)  103.25 years 
B)  78.05 years 
C)  25.30 years 
D)  53.00 years 
A)  103.25 years 
B)  78.05 years 
C)  25.30 years 
D)  53.00 years

Question 4

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%.
-Farmville Industries is a major agricultural firm and is concerned about the possibility of drought impacting corn production over the next year. In the event of a drought, Farmville Industries anticipates a loss of $75 million. Suppose the likelihood of a drought is 10% per year, and the beta associated with such a loss is 0.4. If the risk-free interest rate is 5% and the expected return on the market is 10%, then what is the actuarially fair insurance premium?

Accepted Answer

The expected loss = $75 million × .10 =

Question 5

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

Accepted Answer

A)  adverse selection 
B)  vertical integration 
C)  overhead 
D)  market imperfections 
A)  adverse selection 
B)  vertical integration 
C)  overhead 
D)  market imperfections

Question 6

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.

Question 7

To cover the costs that result if some aspect of the business causes harm to a third party or someone else's property, a firm would purchase ________.

Accepted Answer

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

Question 8

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

(.08) @#IMG-DLM& = (

Question 9

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

DE = DA - L = @#IMG-DLM& DA -

Question 10

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 11

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.

Question 12

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 13

Insurance for large risks that cannot be well diversified has a(n) ________, which increases its cost.

Accepted Answer

A)  positive beta 
B)  moral hazard clause 
C)  negative beta 
D)  actuarially-biased risk 
A)  positive beta 
B)  moral hazard clause 
C)  negative beta 
D)  actuarially-biased risk

Question 14

Which of the following statements is FALSE?

Accepted Answer

A)  We can access a firm's sensitivity to interest rates by examining its balance sheet. 
B)  Just as the interest rate sensitivity of a single cash flow increases with its maturity, the interest rate sensitivity of a stream of cash flows increases with its duration. 
C)  By restructuring the balance sheet to increase its duration, we can hedge the firm's interest rate risk. 
D)  A firm's market capitalization is determined by the difference in the market value of its assets and its liabilities. 
A)  We can access a firm's sensitivity to interest rates by examining its balance sheet. 
B)  Just as the interest rate sensitivity of a single cash flow increases with its maturity, the interest rate sensitivity of a stream of cash flows increases with its duration. 
C)  By restructuring the balance sheet to increase its duration, we can hedge the firm's interest rate risk. 
D)  A firm's market capitalization is determined by the difference in the market value of its assets and its liabilities.

Question 15

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 16

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 17

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%.
-What is the actuarially fair cost of full insurance?

Accepted Answer

Insurance Premium =

Question 18

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

Accepted Answer

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

Which of the following statements regarding futures contracts is FALSE?

Which of the following statements is FALSE?

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

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

To cover the costs that result if some aspect of the business causes harm to a third party or someone else's property, a firm would 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?

Insurance for large risks that cannot be well diversified has a(n) ________, which increases its cost.

Which of the following statements is FALSE?

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 ________.

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

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

Which of the following statements regarding futures contracts is FALSE?

Which of the following statements is FALSE?

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

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

To cover the costs that result if some aspect of the business causes harm to a third party or someone else's property, a firm would 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?

Insurance for large risks that cannot be well diversified has a(n) ________, which increases its cost.

Which of the following statements is FALSE?

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 ________.

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

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