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Risk Management Essay

1633 words - 7 pages

Chapter 2

Objective of Risk Management

I. Multiple Choice

1. The fundamental objective of risk management is:

a. diversification
b. minimize the cost of risk
c. hedging
d. loss control

Answer: b
Type: K

2. If unexpected increases in losses from price risk are not offset by cash inflows from insurance contracts, hedging arrangements or other contractual risk transfers, they will result in:

a. an increased stock price
b. a reduced stock price
c. bankruptcy
d. increased diversification

Answer: b
Type: K

3. Johnson Incorporated, located in California, had a $1 million uninsured loss due to an earthquake in 1997. What impact is this likely to have on the ...view middle of the document...

c. Managers are often excessively cautious in their risk management decisions, spending too much on insurance and loss control.
d. Managers are often compensated with bonuses linked to the firm’s profitability or stock price.

Answer: d
Type: K

7. The cost of risk is equal to:

a. the value of the firm without risk minus the value of the firm with risk.
b. the value of the firm with risk minus the value of the firm without risk.
c. the cost of direct losses that will be incurred by the firm due to the risk.
d. the cost of loss control plus the cost of internal risk reduction.

Answer: a
Type: K

8. The cost of loss control for potential fire damage to a firm’s warehouses would include:

a. the cost of fire insurance.
b. the cost of damage to goods in the building.
c. the cost of installing sprinklers.
d. the potential loss of business that would occur if goods could not be shipped on time due to the fire.

Answer: c
Type: A

9. Which of the following statements is most correct.

a. The amount of loss control that minimizes the cost of risk will generally result in a total elimination of the risk of loss.
b. Increased expenditures on loss financing will also generally result in increases in direct loss costs.
c. Firms should invest in risk reduction until the probability of loss is zero.
d. Increased expenditures on insurance will reduce the cost of residual uncertainty.

Answer: d
Type: A

10. All of the following are important components of the cost of risk for a pharmaceutical company which is developing a new prescription drug for the treatment of AIDS except:

a. the cost of testing the product for safety.
b. the cost of marketing the product to doctors.
c. the cost of product liability insurance.
d. the cost of defending against and settling future liability claims.

Answer: b
Type: A

11. If the private cost of risk differs from the social cost of risk

a. government regulation will be ineffective
b. firms will tend to not maximize the value of the firm
c. an efficient level of societal risk will not exist
d. minimization of the total cost of societal risk will generally not coincide with firms maximizing their value

Answer: d
Type: K

12. By increasing spending on safety equipment Charly’s Meat Packing has reduced total worker injury costs by 15%. This is an example of the

a. tradeoff between loss control costs and loss financing
b. tradeoff between loss control costs and expected direct losses
c. tendency of business firms to spend too little on loss control
d. importance of loss control

Answer: b
Type: A

13. Which one of the following is not a determinant of value of a business firm?

a. expected magnitude of the firm’s future cash flows
b. expected timing of the firm’s future cash flows
c. expected variability of the firm’s future cash flows
d. all of the above are determinants of a firm’s value

Answer: d
Type: K

14. JoPro Inc. and Thron Company...

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