Financial Risk Management (B1:M4-5)

Question 1

risk-indifferent

risk-adverse

risk-seeking

Answer 1

increase in risk does not result in an increase in required rate of return

increase in risk results in increase in required rate of return

increase in risk results in decrease in required rate of return

Question 2

what are the two broad categories of risk? DuNs

Answer 2

Diversifiable: Unsystematic/firm-specific

Nondiversifiable: Systematic/market

Question 3

what are the different risks?

Answer 3

interest rate risk.
as interest rates increase = value of fixed income (bonds) decreases

credit risk.
credit rating decreases = cost of borrowing increases
potential borrower is denied financing

default risk.
risk that debtor will not repay loan/interest

liquidity risk.
lender/investor wants to sell, but cannot do so in timely manner without making material price concessions (real estate)

price risk.
investor’s portfolio can decline in value. this risk is diversifiable

Question 4

what is the impact on exports/imports when the domestic currency depreciates/weakens?

Answer 4

exports: increase
imports: decrease
* value of FC increases

they buy more of our’s, we buy less of their’s

Question 5

what is the impact on exports/imports when the domestic currency appreciates/strengthens?

Answer 5

exports: decrease
imports: increase
* value of FC decreases

they buy less of our’s, we buy more of their’s

Question 6

what are the risk adjustments used to calculate required rate of return?

Answer 6

default risk premium

maturity/interest rate risk premium

liquidity risk premium

purchasing power/inflation risk premium
*used to calculate nominal rate of return

Question 7

what is an investor’s certainty equivalent?

Answer 7

point at which investor is indifferent to risk

Question 8

what is basically the only difference between a forward and futures contract?

Answer 8

forward contracts used for larger groups of transactions; futures hedge a specific transaction