Chapter 5: Risk Handling Techniques

Question 1

What is essential in risk handling technique

Answer 1

bearing risk collectively as a member of group or pool

Question 2

Risk Diversification

Answer 2

reduce risk by combining individual exposure into group and sharing average loss

Question 3

Covariance

Answer 3

measures how two random variables move together

Question 4

Correlation

Answer 4

a linear relationship between random variables does not mean causation. Adjusted by dividing the covariance of random variables by their individual standard deviation

Question 5

Positive Correlation

Answer 5

Positively linear relationship (move together)

Question 6

Zero correlation

Answer 6

no linear relationship

Question 7

negative correlation and vital for?

Answer 7

negative linear relationship (move opposite), vital for risk diversification

Question 8

Hedging

Answer 8

Take two financial positions simultaneously whose gains and loses will offset each other limiting risk

Question 9

Hedging example with insurance

Answer 9

buy insurance but suffer financial loss, but gain as loss is covered by insurance.

Question 10

Hedging example with stocks

Answer 10

some go up and some go down

Question 11

Common Hedged Financial Risk

Answer 11

1. Currency
2. Interest
3. Commodity

Question 12

Currency Risk

Answer 12

loss potential caused by unfavourable fluctuation in value of domestic currency relative to foreign currency

Question 13

Interest Risk

Answer 13

loss potential caused when changes in interest rate reduce market value of fixed income securities

Question 14

Commodity Risk

Answer 14

fluctuation in price for variety of commodity products etc metals, agriculture, petroleum

Question 15

Commodity Output Price Risk

Answer 15

Changes in market price affect price at which can sell product

Question 16

Commodity Input Price Risk

Answer 16

Change in price increase or decrease in manufacturing costs

Question 17

Derivative Securities

Answer 17

Financial instrument where value derived from financial asset/commodity

Question 18

Future Contract

Answer 18

order placed by trader in advance to buy or sell asset/commodity later at specified price

Question 19

Forward contract

Answer 19

not traded on organized exchange, privately managed arrangements

Question 20

Currency Swap

Answer 20

Countries lend currency to each other

Question 21

Traded Options

Answer 21

legal right to buy or sell commodity/financial asset at agreed price for a specific period

Question 22

Option Holder

Answer 22

party with long position, right to buy or sell under agreed terms

Question 23

option writer

Answer 23

party with short position, obligated to buy or sell based on choice of option holder

Question 24

call option

Answer 24

option to buy underlying asset

Question 25

put option

Answer 25

option to sell underlying asset