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Exam 30: Risk Management

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Question 1

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Use the following information to answer the question(s) below. You are a risk manager for Security First Trust Savings and Loan (SFTSL) . SFTSL's balance sheet is as follows (in millions of dollars) : The duration of the auto loans is three years and the duration of the mortgages is eight years. Both cash reserves and checking and savings have zero duration. The CDs have a duration of two years and the long-term financing has a ten year duration. -The duration of SFTSL's equity is closest to:

A) 6 years
B) 8 years
C) 10 years
D) 14 years

E) B) and D)
F) None of the above

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Question 2

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Which of the following statements is false?

A) As interest rates change, the market values of the securities and cash flows in the portfolio change as well, which in turn alters the weights used when computing the duration as the value-weighted average maturity.
B) The duration of a portfolio of investments is the simple average of the durations of each investment in the portfolio.
C) Adjusting a portfolio to make its duration neutral is sometimes referred to as immunizing the portfolio, a term that indicates it is being protected against interest rate changes.
D) When the durations of a firm's assets and liabilities are significantly different, the firm has a duration mismatch.

E) B) and C)
F) A) and C)

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Question 3

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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

Use the following information to answer the question(s) below. Rearden Metal imports ore from South America. Rearden Metal is worried that the South American mines may enter into a long-term contract with the Chinese to sell all of their ore output to China, hence cutting off Rearden Metal's supply. In the event of such a contract with the Chinese, Rearden Metal will face much higher costs for its raw materials causing its operating profits to decline substantially and its marginal tax rate to fall from its current level of 35% down to 10%. An insurance firm has agreed to write a trade insurance policy that will pay Rearden Metal $2,500,000 in the event of the South American supply of ore being cut off. The chance of the South American supply being cut off is estimated to be 20%, with a beta of -2.0. The risk-free rate of interest is 4% and the return on the market is estimated to be 12%. -Rearden's NPV for purchasing this policy is closest to:

Use the following information to answer the question(s) below. Rearden Metal imports ore from South America. Rearden Metal is worried that the South American mines may enter into a long-term contract with the Chinese to sell all of their ore output to China, hence cutting off Rearden Metal's supply. In the event of such a contract with the Chinese, Rearden Metal will face much higher costs for its raw materials causing its operating profits to decline substantially and its marginal tax rate to fall from its current level of 35% down to 10%. An insurance firm has agreed to write a trade insurance policy that will pay Rearden Metal $2,500,000 in the event of the South American supply of ore being cut off. The chance of the South American supply being cut off is estimated to be 20%, with a beta of -2.0. The risk-free rate of interest is 4% and the return on the market is estimated to be 12%. -The actuarially fair premium for this insurance policy is closest to:

Use the following information to answer the question(s) below. You are a risk manager for Security First Trust Savings and Loan (SFTSL) . SFTSL's balance sheet is as follows (in millions of dollars) : The duration of the auto loans is three years and the duration of the mortgages is eight years. Both cash reserves and checking and savings have zero duration. The CDs have a duration of two years and the long-term financing has a ten year duration. -If interest rates are currently 5%,but fall to 4%,your estimate of the approximate change in SFTSL equity is closest to:

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?

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:

In December 2005,the spot exchange rate for the British Pound was $1.7188/£ and the one-year forward rate was $1.8675/£.Suppose that at the same time Luther Industries entered into a contract to purchase goods with a price of £375,000 to be delivered in one year.Simultaneously Luther entered into a one-year forward contract to purchase £375,000.What is the amount of the payment in U.S.dollars that Luther Industries will have to make in one year to pay for their goods?

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?

Which of the following statements is false?

Which of the following statements is false?

Which of the following statements is false?

Which of the following statements is false?

Which of the following statements 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

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 arises because the value of the futures contract will not be perfectly correlated with the firm's exposure is called

Farmville Industries is a major agricultural firm and is concerned about the possibility of drought impacting corn production.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?

Use the following information to answer the question(s) below. d'Anconia Copper expects to produce 500 million pounds of copper next year, with production costs of $0.75 per pound. Depending upon the economic conditions over the next year, d'Anconia Copper expects the price of copper next year to be either $1.40, $1.50, or $1.60 per pound, with each outcome being equally likely. d'Anconia Copper expects to sell all of its copper at the going price. -If d'Anconia Copper enters into a contract to supply copper to end users at an average price of $1.48 per pound,then d'Anconia Copper's operating profit next year will be closest to: