Unit 6

Question 1

Enterprise risk management

Answer 1

the process of identifying and assessing risks and seeking to mitigate potential damage

Question 2

types of risks

Answer 2

Hazard risks (natural disasters)
Financial risks (exchange rate changes)
Operational risks (business related)
Strategic risks (competition)

Question 3

types of insurance

Answer 3

Commercial liability insurance
Business interruption insurance
Key personnel insurance
Workers’ compensation and employer’s liability insurance

Question 4

Hedging

Answer 4

a process that reduces a firm’s exposure to price or rate fluctuations

Question 5

Short-run

Answer 5

temporary changes in prices result from unforeseen events or shocks
Transactions exposure

Question 6

Longer-run

Answer 6

more permanent changes in prices result from fundamental shifts in the underlying economics of a business
Economic exposure

Question 7

Forward contract

Answer 7

a legally binding agreement between two parties calling for the sale of an asset or product in the future at a price agreed on today
Buyer: take delivery and pay
Seller: makes delivery and accept pay

Question 8

Futures contract

Answer 8

a forward contract with the feature that gains and losses are realized each day rather than only on the settlement date
Commodity futures (corn, gold)
Financial futures (bonds, stocks)

Question 9

hedging with forward contracts

Answer 9

the risk associated with an adverse price change is eliminated, but so is the potential gain from a favorable move

Question 10

Hedging with futures contracts

Answer 10

conceptually identical to hedging with forward contracts.
Only difference in hedging with futures is the firm must maintain an account with a broker so that gains and losses can be credited or debited each day as a part of the marking-to-market process

Question 11

Cross-hedging

Answer 11

hedging an asset with contracts written on a closely related, but not identical, asset

Question 12

Swap contract

Answer 12

an agreement by two parties to exchange, or swap, specified cash flows at specified intervals in the future

a portfolio, or series, of forward contracts

not traded on organized exchanges

Question 13

types of swap contracts

Answer 13

currency swap
interest rate swap
Commodity swap

Question 14

Option contract

Answer 14

an agreement that gives the owner the right, but not the obligation, to buy or sell a specific asset at a specific price for a set period of time

Question 15

Call option

Answer 15

the right to BUY an asset at a fixed price during a particular period

Question 16

Put option

Answer 16

the right to SELL an asset at a fixed price during a particular period of time

Question 17

Option VS Forwards

Answer 17

forward: both parties are obligated to transact and No money changes hands

Option: occurs only if the owner of the option chooses to