B1M4,5:Financial Risk Management

Question 1

What are the 3 risk-preferences?

Answer 1

1. Risk indifferent
2. Risk averse
3. Risk seeking

Question 2

explain the difference between risk averse and risk seeing?

Answer 2

risk averse managers require a higher rate of return to compensate for greater risk where risk seeing managers will settle for lower expected returns as the level of risk increases

Question 3

what is interest rate risk? (yield risk)

Answer 3

represents the risk of exposure of the owner of the financial instrument to fluctuations in the value od the instrument in response to changes in interest rates

Question 4

what is market (systematic) risk?

Answer 4

market risk the general risk you face when operating within the economy. It the fluctuation in value. its is a nondiversifiable risk because it is a risk that is inherent within the economy.

Question 5

what is nonmarket (unsystematic) risk?

Answer 5

these are risks that exist within a firm or industry that can be eliminated through diversification.

Question 6

Classify risk into its two broad categories? DUNS

Answer 6

Diversifiable
-Unsystematic (nonmarket/firm or industry specific)
Nondiversifiable
-Systematic (market)

Question 7

what is credit risk and who does it affect?

Answer 7

if a company cannot secure proper financing or secure favorable credit terms as a result of poor credit ratings, if credit ratings are down then lender will demand more interest. credit risk affects borrowers directly.

Question 8

Explain default risk and who does it affect?

Answer 8

creditors are exposed to default risk as long as a debtor may not repay the principal or interest due on their debt. this directly affects the creditors (lenders)

Question 9

explain liquidity risk and who it affects?

Answer 9

lenders or investors are exposed to this when they want to sell their security, but cant do it in a timely manner or if a material price concession has to be made.

Question 10

explain price risk

Answer 10

this is the risk of the decline in value of an individuals securities or portfolio

Question 11

what is the stated interest rate and how is it calculated?

Answer 11

this is the rate of interest charged before any adjustment.. no calculation is needed as this is often the rate shown in the agreement

Question 12

what is effective interest rate?

Answer 12

this represents the actual financial charge associated with borrowing after reducing for charges and fees related to loan origination.

calculated by diving the amount of interest paid based on the loan agreement by the net proceeds of the loan.

Question 13

what is APR?

Answer 13

noncompounded version of the effective annual percentage rate. required in disclosure by federal regulations

Question 14

how to calculate APR?

Answer 14

step 1: compute the effective periodic rate (principal * (stated rate % / number of periods) and divide that by the actual finds available after taxes and fees.
steps 2: multiply by the number of periods in the years as stated by the question