Financial Management, 12e (Titman/Keown/Martin)
Chapter 20 Corporate Risk Management
20.1 Five-Step Corporate Risk Management Process
1) The major risks assumed by irms include
A) demand risk.
B) foreign-exchange risk.
C) operational risk.
D) all of the above.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk-Return Tradeof
2) Aspects of demand risk controllable by the irm include
A) product quality.
B) interest rates.
C) entry of external competitors.
D) status of the regional and national economy.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk-Return Tradeof
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 speciications.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk-Return Tradeof
1
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.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
5) Eliminating all possible risk will ultimately
A) guarantee the highest possible cash low over the long run.
B) cancel out all proits with cost of hedging.
C) result in lower expected cash low but the highest cash low for the worst case scenario.
D) guarantee that the irm will not experience losses.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
6) Which of the following are part of the ive step corporate risk management process?
A) Identify and understand the irm’s major risks
B) Decide how much risk to assume
C) Monitor and manage the risks the irm assumes
D) All of the above
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
2
7) Firms that wish to minimize risk will attempt to
A) minimize the standard deviation of expected cash lows.
B) maximize the standard deviation of expected cash lows.
C) maximize expected cash lows.
D) balance expected cash lows with the standard deviation of expected cash lows.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
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 irms.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
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 low, $116 million, standard deviation $5 million
B) Expected cash low, $107 million, standard deviation $5.5 million
C) Expected cash low, $112 million, standard deviation $8 million
D) Expected cash low, $134 million, standard deviation $38 million
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
3
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 low, $116 million, standard deviation $5 million
B) Expected cash low, $107 million, standard deviation $5.5 million
C) Expected cash low, $112 million, standard deviation $8 million
D) Expected cash low, $134 million, standard deviation $38 million
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
11) Some risks cannot be transferred to other parties.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
12) Well managed irms will always seek to transfer as much risk as possible.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
13) A major factor impacting the demand for residential real estate is the availability of
credit.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
14) Foreign-exchange risk can be important even for irms that have only U.S. operations.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
4
15) A manufacturer of breakfast cereals should always be fully hedged against both rising
and falling grain prices.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
16) Political risk is only a factor when the irm is considering foreign direct investments.
Question Status: New question
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
17) 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 inancial damage to the company. How could the ive step
corporate risk management process have avoided or mitigated this disaster.
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
5
18) What is the general rule that irms should follow when deciding how much risk to
assume?
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
19) What are some of the means by which irms can transfer risk to other parties? Should
irms always transfer risks when it is possible to do so?
Question Status: Previous edition
Objective: 20.1 Deine risk management in the context of the ive-step risk-management process.
Keywords: risk management
Principles: Principle 2: There Is a Risk–Return Tradeof
6
20.2 Managing Risk with Insurance Contracts
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 sufered 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
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
2) Self insurance is the practice of
A) holding reserves within the irm 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.
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
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 irm is now free to pursue high-risk projects.
D) Protection against losses at no signiicant cost to the irm.
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
7
4) Self-insurance would not provide adequate protection in which of the following
circumstances?
A) Unemployment insurance for a irm that rarely lays of 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.
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
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 oicers insurance
D) Self insurance
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
6) Which of the following should determine whether or not the irm 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 irms normal cash reserves
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
8
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
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
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.
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
9) Workers’ compensation insurance provides coverage for on-the-job injuries sufered by
employees.
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
10) Workers’ compensation insurance protects employees income in case they are laid of
or ired.
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
9
11) It is not legal for a corporation to hold life insurance policies on its employees.
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
12) Directors and oicers insurance protects the company if key personnel die or leave the
irm for other opportunities.
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
13) The decision to purchase insurance is justiied if the cost of the contract is less than the
expected loss.
Question Status: New question
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
14) How should corporations decide when to self insure against certain risks and when to
purchase insurance from outside parties?
Question Status: Previous edition
Objective: 20.2 Understand how insurance contracts can be used to manage risk.
Keywords: insurance
Principles: Principle 2: There Is a Risk–Return Tradeof
10