RISK MANAGEMENT
30-4. Your firm faces a 9% chance of a potential loss of $10 million next
year. If your firm implements new policies, it can reduce the chance of this
loss to 4%, but these new policies have an upfront cost of $100,000.
Suppose the beta of the loss is 0, and the risk-free interest rate is 5%.
a.
If the firm is uninsured, what is the NPV of implementing the new
policies?
b.
If the firm is fully insured, what is the NPV of implementing the new
policies?
c.
Given your answer to part (b), what is the actuarially fair cost of full
insurance?
d.
What is the minimum-size deductible that would leave your firm with
an incentive to implement the new policies?
e.
What is the actuarially fair price of an insurance policy with the
deductible in part (d)?
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%.
a.
What is the actuarially fair premium for this insurance policy?
b.
What is Rearden's NPV for purchasing this policy?
30-2. Genentech’s main facility is located in South San
Francisco. Suppose that Genentech would experience a
direct loss of $450 million in the event of a major
earthquake that disrupted its operations. The chance of
such an earthquake is 2% per year, with a beta of −0.5.
a. If the risk-free interest rate is 5% and the expected
return of the market is 10%, what is the actuarially
fair insurance premium required to cover
Genentech’s loss?
b. Suppose the insurance company raises the premium
by an additional 15% over the amount calculated in
part (a) to cover its administrative and overhead
costs. What amount of financial distress or issuance
costs would Genentech have to suffer if it were not
insured to justify purchasing the insurance?
ENTERPRISE RISK MANAGEMENT
In a Miller and Modigliani perfect capital
market, risk management would:
A.
Be performed by owners on their own
B.
Be approached in a silo way by
corporations
C.
Be approached with an enterprise risk
management framework by corporations
D.
Be performed partially by large investors
and partially by firms
Which of the following is NOT a dimension of
enterprise risk management?
A.
Integration
B.
Strategy
C.
D.
Risk integration essentially is
A. Focused on financial risk silos
B. Focused on a portfolio view of all the firm’s
risk
C. Focused on investors diversifying their
portfolios to manage risk instead of the
firm
D. Focused on centralization of the risk
management system
Which is NOT an important aspect of having a
chief risk officer:
A.
Centralization of the risk management
system
Production
B.
Risk governance
Governance
C.
Focus on financial risk
• What benefit(s) does ERM provide that
traditional risk management does not?
• What are examples of how firms implement
risk governance?
• Are large firms more or less likely to have
ERM? Why?
• Are highly leveraged firms more or less likely
to have ERM? Why?
CORPORATE GOVERNANCE
29-2. What are some examples of agency
problems?
29-4. What is the role of the board of directors
in corporate governance?
Which of the following is/are NOT corporate
monitors?
A) Security analysts
B) Lenders
C) Securities and Exchange Commission
D) All of the above are monitors.
Think of the principal/agent relationship. In
terms of the relationship between the
firm/owners and the creditors, who is the
principal and who is the agent?
29-7. How are lenders part of corporate
governance?