978-0132757089 Chapter 20 Part 1

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Financial Management: Principles and Applications, 11e (Titman)

Chapter 20 Corporate Risk Management

1) The major risks assumed by firms include:

A) demand risk.

B) foreign-exchange risk.

C) operational risk.

D) all of the above.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

2) Aspects of demand risk controllable by the firm include:

A) product quality.

B) interest rates.

C) entry of external competitors.

D) status of the regional and national economy.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

3) An example of commodity risk would be:

A) volatile exchange rates with countries from which commodities are imported.

B) the price of copper for electrical contractors.

C) volatile exchange rates with countries to which commodities are exported.

D) raw materials that do not meet quality specifications.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

4) Assume that government and insurance providers pressure physicians to prescribe generic

drugs whenever possible. For the producers of branded drugs, this change represents:

A) insurable risk.

B) operational risk.

C) demand risk.

D) hedgeable risk.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

5) Eliminating all possible risk will ultimately:

A) guarantee the highest possible cash flow over the long run.

B) cancel out all profits with cost of hedging.

C) result in lower expected cash flow but the highest cash flow for the worst case scenario.

D) guarantee that the firm will not experience losses.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

6) Which of the following are part of the five step corporate risk management process?

A) Identify and understand the firm’s major risks

B) Decide how much risk to assume

C) Monitor and manage the risks the firm assumes

D) All of the above

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

7) Firms that wish to minimize risk will attempt to:

A) minimize the standard deviation of expected cash flows.

B) maximize the standard deviation of expected cash flows.

C) maximize expected cash flows.

D) balance expected cash flows with the standard deviation of expected cash flows.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

8) The optimal corporate risk management strategy is to:

A) avoid or transfer every possible risk.

B) do nothing to transfer risk.

C) transfer about half the risk.

D) there is no strategy that is optimal for all firms.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

9) Which of the following scenarios carries the least risk of NOT being able to meet required

payments (capital expenditure, dividend, interest and principal requirements) totaling $96

million?

A) Expected cash flow, $116 million, standard deviation $5 million

B) Expected cash flow, $107 million, standard deviation $5.5 million

C) Expected cash flow, $112 million, standard deviation $8 million

D) Expected cash flow, $134 million, standard deviation $38 million

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

10) Which of the following scenarios carries the greatest risk of NOT being able to meet required

payments (capital expenditure, dividend, interest and principal requirements) totaling $96

million?

A) Expected cash flow, $116 million, standard deviation $5 million

B) Expected cash flow, $107 million, standard deviation $5.5 million

C) Expected cash flow, $112 million, standard deviation $8 million

D) Expected cash flow, $134 million, standard deviation $38 million

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

11) Some risks cannot be transferred to other parties.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) Well managed firms will always seek to transfer as much risk as possible.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

13) A major factor impacting the demand for residential real estate is the availability of credit.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

14) Foreign-exchange risk can be important even for firms that have only U.S. operations.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

15) A manufacturer of breakfast cereals should always be fully hedged against both rising and

falling grain prices.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) In 2010, a deep water oil drilling rig owned by British Petroleum exploded in the Gulf of

Mexico resulting in the deaths of several crew members, one of the worst ecological disasters in

history, and major financial damage to the company. How could the five step corporate risk

management process have avoided or mitigated this disaster.

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

17) What is the general rule that firms should follow when deciding how much risk to assume?

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

18) What are some of the means by which firms can transfer risk to other parties? Should firms

always transfer risks when it is possible to do so?

Topic: 20.1 Five-Step Corporate Risk Management Process

Keywords: risk profile

Principles: Principle 2: There Is a Risk-Return Tradeoff

1) Which of the following types of risk cannot typically be transferred to an insurance company?

A) Losses due to property damage from storms.

B) Losses due to on-the job injuries suffered by employees.

C) Losses due to rising raw materials costs that cannot be passed on to customers.

D) Losses due to the untimely death of an employee in a key position.

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

2) Self insurance is the practice of:

A) holding reserves within the firm to cover potential losses.

B) CEO’s holding large life insurance policies on themselves, payable to the company.

C) companies in unrelated businesses forming subsidiaries to cover their insurance needs.

D) purchasing insurance policies directly rather than through a broker.

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: self insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

3) Which of the following is a consequence of transferring risk to an insurance company?

A) An increase in stock value because risk has been reduced.

B) A guaranteed small loss in exchange for protection against large losses.

C) Higher rates of return because the firm is now free to pursue high-risk projects.

D) Protection against losses at no significant cost to the firm.

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

4) Self-insurance would not provide adequate protection in which of the following

circumstances?

A) Unemployment insurance for a firm that rarely lays off employees.

B) Damage to the company’s own vehicles.

C) Major ecological disasters resulting from oil spills.

D) Revenue lost because of bad weather during the peak shopping season.

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: self insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

5) Which of the following types of insurance does NOT involve a contract with an external

party?

A) Property insurance

B) Life insurance

C) Directors and officers insurance

D) Self insurance

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: self insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

6) Which of the following should determine whether or not the firm should purchase insurance

from an outside party?

A) Only the frequency of incidents

B) The cost of the policy and the expected losses

C) Only the maximum size of incidents

D) Only the firms normal cash reserves

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

7) Which of the following individual situations would best justify the cost of a life insurance

policy?

A) Single income with young children.

B) Single income, no dependents.

C) Dual income, grown children.

D) Married couple, each had substantial income before retirement.

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

8) Which of the following types of insurance cannot be sold in the United States?

A) Insurance that protects against loss of revenue due to bad weather.

B) Insurance that protects a companies executives and directors from lawsuits.

C) Life insurance which pays the corporation when an employee dies.

D) All these types of insurance can be sold in the U. S.

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

9) Workers’ compensation insurance provides coverage for on-the-job injuries suffered by

employees.

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

10) Workers’ compensation insurance protects employees income in case they are laid off or

fired.

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

11) It is not legal for a corporation to hold life insurance policies on its employees.

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) Directors and officers insurance protects the company if key personnel die or leave the firm

for other opportunities.

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

13) How should corporations decide when to self insure against certain risks and when to

purchase insurance from outside parties?

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: self insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

14) (Business of Life) What guidelines should determine whether or not an individual should buy

life insurance?

Topic: 20.2 Managing Risk with Insurance Contracts

Keywords: insurance

Principles: Principle 2: There Is a Risk-Return Tradeoff

1) The purpose of a hedging strategy is to:

A) avoid speculation on future prices.

B) speculate that future prices will be lower than the spot price.

C) speculate that future prices will be higher than the spot price.

D) avoid exposure to commodity rate risk.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

2) A maker of breakfast cereals has contracted to buy 100,000 bushels of wheat for $8.50 a

bushel at the end of October. On the delivery date, the spot price of wheat is $8.70 per bushel.

Which of the following is true?

A) The seller of the contract has $20,000 profit.

B) The buyer of the contract has a $20,000 loss.

C) The buyer of the contract has a $20,000 profit

D) Both A and B are true

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: long and short positions

Principles: Principle 2: There Is a Risk-Return Tradeoff

3) A large agribusiness firm has contracted to deliver 100,000 bushels of wheat for $8.50 a

bushel at the end of October. On the delivery date, the spot price of wheat is $8.70 per bushel.

Which of the following is true?

A) The seller of the contract has $20,000 loss.

B) The buyer of the contract has a $20,000 loss.

C) The buyer of the contract has a $20,000 profit

D) Both A and C are true

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: long and short positions

Principles: Principle 2: There Is a Risk-Return Tradeoff

4) The party that agrees to sell a commodity or currency in the forward market is said to have a:

A) long position.

B) short position

C) protected position.

D) split position.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: long and short positions

Principles: Principle 2: There Is a Risk-Return Tradeoff

5) Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the coming

winter. Swenson’s customers who take advantage of the offer:

A) are speculating that fuel prices will be higher in the future.

B) have purchased a form of call option for heating fuel.

C) are entering into a futures contract to offset the risk of higher fuel prices during the winter.

D) are purchasing a form of insurance against fuel shortages.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff

6) Swenson Oil & Gas allows its customers to prepurchase heating oil in June for the coming

winter. If Swenson does not hedge its positions in the futures market:

A) it could make unexpected profits if fuel prices decline.

B) it could suffer large losses if the wholesale cost of fuel rises above the price it sold the fuel for

in June.

C) it will make normal profits if winter prices do not change very much from the June spot price.

D) all of the above.

Topic: 20.3 Managing Risk by Hedging with Forward Contracts

Keywords: hedging

Principles: Principle 2: There Is a Risk-Return Tradeoff