11e Exam Prep Appendix C Risk- The Basics of Risk Management - Business Foundations Changing World 11e Complete Test Bank by O. C. Ferrell. DOCX document preview.
Appendix C
True / False Questions
1. | Risk is something we only face occasionally in our lives. |
2. | You can insure against the possibility of financial risk of loss by buying casualty insurance. |
3. | Speculative risk assumes the possibility of either making a profit or incurring a loss. |
4. | The law of large numbers postulates that as a sample size grows, the mean of the sample will get further away from the mean of the total population. |
5. | One of the most common types of insurance policies is disability insurance. |
Multiple Choice Questions
6. | All of the following are examples of risks EXCEPT when
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7. | All of the following are considered to be uninsurable risks EXCEPT
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8. | Molly invests in stocks and bonds, which have the possibility of a gain or a loss. Which of the following can be used to cover her possible losses from fluctuating prices?
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9. | Taking more risk means potential for
|
10. | Allister's Auto Insurance Company adjusts its rates on automobile insurance annually. The price of the company's policies reflects all of the following EXCEPT the
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11. | Which of the following gives us an idea of why insurance companies like to insure many people?
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12. | Which of the following statements is true regarding the reserves kept by insurance companies?
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13. | All of the following are true regarding life insurance policies EXCEPT
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14. | Phil has a life insurance policy that provides a death benefit based on his age, health, and life expectancy. His policy is the simplest form of insurance and is called _____ life insurance.
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15. | Based on the Period Life Table, 2011, men are expected to live to be _____ years old.
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16. | A whole life insurance policy is
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17. | Clayton has bought an insurance policy that invests his set savings amount into financial assets without guaranteeing the return. Thus, Clayton has the opportunity to get a better return than the guaranteed rate. Which type of insurance policy does this scenario best describe?
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18. | An annuity is
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19. | All of the following scenarios are examples of annuities EXCEPT
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20. | Which of the following is true regarding annuities?
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21. | All of the following are types of property for which you can buy property casualty insurance EXCEPT
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22. | Which of the following explains why property casualty insurance is sometimes called property and liability insurance?
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23. | Barry owns a car dealership. He bought _____ insurance that will reimburse him if he loses any of the dealership's cars in the event of fire, theft, or other calamities. This insurance will also cover lost income.
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24. | _____ is the division of an insurance policy among many different insurance companies.
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25. | Jonathan lost his job and the health insurance coverage that his employer had provided. As a result of the Affordable Care Act, which of the following may he experience in getting a new policy?
|
26. | All of the following are true regarding health insurance EXCEPT
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27. | Laurel works for an accounting firm that offers dental insurance as one of its benefits. Which of the following would this policy most likely include?
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28. | Which of the following is true regarding disability insurance?
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29. | All of the following are true of Medicare EXCEPT
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30. | All of the following are types of insurance corporations must have EXCEPT
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31. | Which of the following accurately compares business risk and operating risk?
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32. | EduPub, a small educational publishing company, is struggling to keep up with its competitors and continue to grow its earnings. This company is finding that new players and technology are changing the landscape for the entire publishing industry, and its poor management and lack of forward planning is causing it to fall behind the curve. Which of the following types of risk does this scenario best describe?
|
33. | Craig's Construction Company borrowed money to buy the heavy machinery it needs to complete its construction projects. As a result, this company has high _____ risk.
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34. | Which of the following best describes currency risk?
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35. | All of the following are true regarding the interest rate risk EXCEPT
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36. | Globotech, a global technology company, invests in firms operating in foreign countries. All of the following are risks associated with this practice EXCEPT
|
37. | Which of the following is true regarding how prices of financial securities and commodities tend to behave over the long term?
|
38. | Stephanie owns a house with an acre of land. When her job relocates her to another state, she must sell her house quickly to get the cash she needs to move and buy a new house. The ability to turn her current house and land into cash quickly is called _____ risk.
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39. | It would be safe to say that anyone who _____ experiences various business, operating, financial, currency, interest rate, political, market, and liquidity risks.
|
40. | Carlos manages a portfolio composed of many different companies and asset classes such as stocks and bonds, foreign stocks, and bonds and securities in developed and emerging markets. As a result, his portfolio is considered to be
|
41. | Kim invests in the market, and thus, she is subject to market risks. By diversifying her portfolio, she can minimize price volatility or at least keep the volatility of returns equal to or less than the market in which she invests. She can use statistical measures such as the standard deviation or beta to measure her ability to minimize volatility. If Kim wants her risk to equal that of the market, she should invest in stocks with
|
42. | Investors of all kinds can resort to financial engineering to minimize risk. All of the following are sophisticated investors who use financial engineering EXCEPT
|
Essay Questions
43. | Briefly explain the difference between insurable and uninsurable risks.
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44. | Describe how the law of large numbers relates to insurance companies.
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45. | Briefly discuss the risks that cannot be insured by companies.
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Appendix C Key
True / False Questions
1. | Risk is something we only face occasionally in our lives. Risk is something we face in our everyday lives. We live in a world where uncertainty is around every corner, from a terrorist attack at a train station to an automobile accident on our way to work. |
AACSB: Analytical Thinking |
2. | You can insure against the possibility of financial risk of loss by buying casualty insurance. You can insure against the possibility of financial risk of loss due to personal injury, automobile crashes, house fires, floods, and other types of risk by buying casualty insurance. |
AACSB: Analytical Thinking |
3. | Speculative risk assumes the possibility of either making a profit or incurring a loss. Speculative risk assumes the possibility of either making a profit or incurring a loss. For example, investing in stocks, bonds, oil, farmland, gold, silver, grains, and other financial products and commodities all have a possibility of gain or loss. |
AACSB: Analytical Thinking |
4. | The law of large numbers postulates that as a sample size grows, the mean of the sample will get further away from the mean of the total population. The law of large numbers postulates that as a sample size grows, the mean of the sample will get closer to the mean of the total population. For example, if an insurance company is insuring a life against the probability of death, the more people who are insured, the higher the probability that the actual mean death rate will approximate the national mortality tables of life expectancy for men and women per age category. |
AACSB: Analytical Thinking |
5. | One of the most common types of insurance policies is disability insurance. The most common types of insurance policies are health insurance, life insurance, and property and casualty insurance. |
AACSB: Analytical Thinking |
Multiple Choice Questions
6. | All of the following are examples of risks EXCEPT when
Risks include when terrorists bomb major cities, when a person's gas stove starts leaking gas into the house, when an identity thief steals someone's credit card information and uses it to buy big ticket items, and when disgruntled students bring guns to school and shoot their classmates. While getting stuck in traffic is not considered a risk, getting in a car accident on the way to work would be considered to be a risk. |
AACSB: Reflective Thinking |
7. | All of the following are considered to be uninsurable risks EXCEPT
Risks that no insurance company will write a policy for are considered uninsurable risks. These include the risk of lost market share, currency fluctuations, interest rate risk, and the political risk of investing in a foreign country. |
AACSB: Analytical Thinking |
8. | Molly invests in stocks and bonds, which have the possibility of a gain or a loss. Which of the following can be used to cover her possible losses from fluctuating prices?
Although insurance companies do not cover losses on a speculative investment, Molly can use a product called a financial derivative, such as options and futures contracts, to cover possible losses from fluctuating prices. When used properly, an investor can hedge (offset) either all or some of the losses by using these financial derivatives. |
AACSB: Reflective Thinking |
9. | Taking more risk means potential for
Financial theory would say that in order to induce most people to take larger risks, there must be an increased possibility for return. However, taking more risk means that not only do you have the potential for higher returns, you also have the potential for higher losses. |
AACSB: Analytical Thinking |
10. | Allister's Auto Insurance Company adjusts its rates on automobile insurance annually. The price of the company's policies reflects all of the following EXCEPT the
Insurance companies, like Allister's, annually adjust their rates on automobile insurance in every state to reflect the previous year's accident experience. The price of the policy also reflects the age of the automobile, the replacement value of the automobile, and the driver's driving record. |
AACSB: Reflective Thinking |
11. | Which of the following gives us an idea of why insurance companies like to insure many people?
The law of large numbers gives us an idea as to why insurance companies like to insure a large number of people. The larger the number of lives, houses, cars, boats, and so on that the companies insure, the more closely the claims from losses will be predictable based on a normal statistical distribution. This allows insurance companies to price policies for life insurance and casualty insurance appropriately so they have a predictable return on their assets. |
AACSB: Analytical Thinking |
12. | Which of the following statements is true regarding the reserves kept by insurance companies?
Because they have guaranteed payment, insurance companies need reserves to cover unexpected losses. Reserves are kept in financial assets such as stocks, bonds, and U.S. government securities. These assets are liquid, meaning they can be sold quickly and turned into cash within a few days. Life insurance companies tend to invest more conservatively with a larger percentage of their assets invested in bonds, whereas property casualty companies tend to have a larger percentage of stocks than life insurance companies. |
AACSB: Analytical Thinking |
13. | All of the following are true regarding life insurance policies EXCEPT
A life insurance policy guarantees a payment upon death, and the price of the policy depends on how much money you want your beneficiary to receive. Policies can be purchased for $10,000 or millions of dollars. You can name anyone as your beneficiary or even have multiple beneficiaries. A beneficiary can be a person, persons, or an organization, such as a university, church, or any other charitable organization. The two most common reasons people buy life insurance is to leave money to cover debts they want paid, such as the mortgage on a house or money to educate children or grandchildren, or to leave an estate for their loved ones. Some companies provide life insurance as part of their employment contract. |
AACSB: Analytical Thinking |
14. | Phil has a life insurance policy that provides a death benefit based on his age, health, and life expectancy. His policy is the simplest form of insurance and is called _____ life insurance.
Based on this scenario, Phil has a term life insurance policy. This policy provides a death benefit based on his age, health, and life expectancy. |
AACSB: Reflective Thinking |
15. | Based on the Period Life Table, 2011, men are expected to live to be _____ years old.
Based on the Period Life Table, 2011, a male is expected to live to be 76.18, whereas a female is expected to live to be 80.95. The tables indicate that the longer you live, the longer you are expected to live. Even a 100-year-old is expected to live a couple more years. |
AACSB: Analytical Thinking |
16. | A whole life insurance policy is
An insurance policy that combines a term life policy and a savings account is called a whole life policy. This type of policy costs more than term life because the extra amount paid is invested by the insurance company and provides a guaranteed cash value to the policyholder. With this type of policy, you do not have to wait until you die to get some financial rewards. |
AACSB: Analytical Thinking |
17. | Clayton has bought an insurance policy that invests his set savings amount into financial assets without guaranteeing the return. Thus, Clayton has the opportunity to get a better return than the guaranteed rate. Which type of insurance policy does this scenario best describe?
In this scenario, Clayton has purchased a variable life insurance policy. Insurance companies have created this type of policies that invest the savings amount into financial assets without guaranteeing the return. Thus, the policyholder does not get a guaranteed rate of return but has the opportunity to get a better return than the guaranteed rate. |
AACSB: Reflective Thinking |
18. | An annuity is
An annuity is a guaranteed equal payment for a given number of periods. The word annuity might make you think it has to be an annual payment, but general interpretation is that the payments must be equally spaced, so monthly, quarterly, or annual payments all qualify as annuities. |
AACSB: Analytical Thinking |
19. | All of the following scenarios are examples of annuities EXCEPT
Mallory, Steve, Crystal, and Kate are all paying annuities, or guaranteed equal payments for a given number of periods. Monthly, quarterly, and annual payments all qualify as annuities. For example, a monthly car payment, a monthly mortgage payment, and a semi-annual bond interest payment would be annuities. |
AACSB: Reflective Thinking |
20. | Which of the following is true regarding annuities?
Insurance companies offer people the ability to buy annuities, with the insurance company guaranteeing the payments for a specific period of years, most often the life of the annuitant (the person receiving the annuity). If you retire, you wouldn't want to take a risk in the stock and bond markets, and you would like to know what your monthly income would be. If you have a retirement account worth $1 million, and the life insurance company guarantees you a 5 percent return for life, you could receive an annual payment of $83,870. Given that financial returns are volatile from one year to the next, you have exchanged variable returns for stable returns and have probably taken a lower rate of return than you could have gotten by having an investment advisor managing your money. |
AACSB: Analytical Thinking |
21. | All of the following are types of property for which you can buy property casualty insurance EXCEPT
You can buy property casualty insurance for all types of property, including houses, automobiles, and physical possessions such as paintings, pianos, stamp collections, and jewelry, to name a few. |
AACSB: Analytical Thinking |
22. | Which of the following explains why property casualty insurance is sometimes called property and liability insurance?
Property casualty insurance is sometimes called property and liability insurance because the policy includes coverage for any liability the policyholder might suffer because of damage to other people or property. The insurance protects you up to a loss limit that you specify when you buy the insurance. |
AACSB: Analytical Thinking |
23. | Barry owns a car dealership. He bought _____ insurance that will reimburse him if he loses any of the dealership's cars in the event of fire, theft, or other calamities. This insurance will also cover lost income.
In this scenario, Barry bought business interruption insurance, which will reimburse him for losses suffered due to fire, theft, or other calamities, and it will also cover lost income. |
AACSB: Reflective Thinking |
24. | _____ is the division of an insurance policy among many different insurance companies.
Sometimes, an insurance company insures a large piece of property but does not want to take on all the risk of loss, so it passes off some of the insurance to a reinsurance company. Reinsurance is the division of an insurance policy among many different insurance companies. |
AACSB: Analytical Thinking |
25. | Jonathan lost his job and the health insurance coverage that his employer had provided. As a result of the Affordable Care Act, which of the following may he experience in getting a new policy?
In this scenario, Jonathan may have to pay more for a new policy. Ever since the Affordable Care Act was passed, health care has been a topic of discussion. Politicians have criticized the Affordable Care Act, and so have people who lost their previous insurance and had to pay more for a new policy. |
AACSB: Reflective Thinking |
26. | All of the following are true regarding health insurance EXCEPT
Health insurance is expensive and generally covers the two basic areas of hospitalization and medical. Hospitalization insurance covers most hospital expenses, but in many cases, there is a co-pay or a minimum payment the insured has to pay. For example, your insurance may cover 80 percent of the hospital cost, and after the insured pays $2,000, the coverage may go up to 100 percent. This can also be true of surgical medical insurance that pays for the doctor's fee, the anesthesiologist, and surgical expenses. |
AACSB: Analytical Thinking |
27. | Laurel works for an accounting firm that offers dental insurance as one of its benefits. Which of the following would this policy most likely include?
Laurel's dental plan would most likely include two teeth-cleaning appointments per year and the partial cost of fillings and crowns up to a fixed yearly limit. |
AACSB: Reflective Thinking |
28. | Which of the following is true regarding disability insurance?
Most corporate insurance plans cover disability. Disability insurance covers a portion of your salary if you are unable to work due to an accident or illness and can include partial disability for several months or permanent disability if you are unable to ever work again. The Social Security Administration can also cover disability if the person was paying into the Social Security System prior to the accident. |
AACSB: Analytical Thinking |
29. | All of the following are true of Medicare EXCEPT
Once a person retires and receives Social Security benefits, he or she is eligible for Medicare health insurance parts A, B, and D. Medicare Part A covers hospital insurance, Part B covers doctor's fees, and Part D provides drug coverage. Medicare is not free, and the cost of health insurance is subtracted from your monthly payment. Your health insurance fees are affected by your income. The more retirement income you make, the more you pay for insurance. |
AACSB: Analytical Thinking |
30. | All of the following are types of insurance corporations must have EXCEPT
Corporations have their own unique risks, but they still need health and disability insurance for their employees and life insurance for key executives where the company is the beneficiary of the policy. Companies also need property casualty insurance and liability insurance for injuries to employees and others. One critical insurance policy is directors and officers (D&O) liability insurance to protect the board of directors from lawsuits. Without D&O insurance, companies would have a difficult time attracting qualified directors as few people would be willing to put their own wealth at risk in case of a lawsuit against the company and its directors. |
AACSB: Analytical Thinking |
31. | Which of the following accurately compares business risk and operating risk?
Sometimes, business risk and operating risk are confused, but they are not exactly the same. Business risk is related to the inability of a firm to hold its competitive position and maintain stability and growth in earnings. This occurs because the company does not keep up with its competitors due to lack of research and development, lack of forward planning, and poor management. On the other hand, operating risk focuses on the volatility of operating earnings. Given the cyclical nature of the economy and the stability of the industry, this risk can be measured by the standard deviation of operating earnings. One measure of operating risk is the ratio of sales to assets. |
AACSB: Analytical Thinking |
32. | EduPub, a small educational publishing company, is struggling to keep up with its competitors and continue to grow its earnings. This company is finding that new players and technology are changing the landscape for the entire publishing industry, and its poor management and lack of forward planning is causing it to fall behind the curve. Which of the following types of risk does this scenario best describe?
This scenario describes business risk, which is related to the inability of a firm to hold its competitive position and maintain stability and growth in earnings. Business risk occurs because the company does not keep up with its competitors due to lack of research and development, lack of forward planning, and poor management. New players and new technology can change the landscape for the whole industry, and the risk is that any company can be left behind. |
AACSB: Reflective Thinking |
33. | Craig's Construction Company borrowed money to buy the heavy machinery it needs to complete its construction projects. As a result, this company has high _____ risk.
In this scenario, Craig's Construction Company has high financial risk because it has borrowed money to buy its heavy machinery. Financial risk occurs when a company uses too much financial leverage as measured by the debt to asset ratio, the debt to equity ratio, and the times interest earned ratio. Too much debt can cause the firm to fail to pay its interest and principal on its debt obligations as they come due. |
AACSB: Reflective Thinking |
34. | Which of the following best describes currency risk?
One risk that is always present for corporations with multinational operations is currency risk or currency fluctuation. Changes in the relative value of one currency to another can cause profits denominated in U.S. dollars to go up or down depending on the exchange rate. |
AACSB: Analytical Thinking |
35. | All of the following are true regarding the interest rate risk EXCEPT
All investors are subject to the interest rate risk caused by changing interest rates. Interest rate changes can affect both an investor's income stream and the value of the assets held by that investor. Rising interest rates cause bond prices to fall, and the prices of other assets will also fall if they are purchased with borrowed money. When interest rates rise, it is also more expensive for companies to borrow money, and that can lower their returns. |
AACSB: Analytical Thinking |
36. | Globotech, a global technology company, invests in firms operating in foreign countries. All of the following are risks associated with this practice EXCEPT
Political risk is the risk associated with investing in firms operating in foreign countries. Dangers include the nationalization of foreign firms, blockage of capital flows to investors, or a violent overthrow of the political party in power, with all the associated implications. Punitive legislation against foreign firms or investors is another political risk. |
AACSB: Reflective Thinking |
37. | Which of the following is true regarding how prices of financial securities and commodities tend to behave over the long term?
Prices of financial securities and commodities fluctuate over the short term, and these price fluctuations create market risk. However, despite short-term price movements, over the long term, prices tend to follow supply and demand and trends related to gross domestic product growth rates and corporate earnings it may seem to be an anomaly, but it is easier to predict long-term trends that short-term fluctuations. |
AACSB: Analytical Thinking |
38. | Stephanie owns a house with an acre of land. When her job relocates her to another state, she must sell her house quickly to get the cash she needs to move and buy a new house. The ability to turn her current house and land into cash quickly is called _____ risk.
Stephanie's ability to turn her house and land into cash quickly is her liquidity risk. |
AACSB: Reflective Thinking |
39. | It would be safe to say that anyone who _____ experiences various business, operating, financial, currency, interest rate, political, market, and liquidity risks.
It would be safe to say that all the risks mentioned in this appendix apply to anyone who manages a portfolio of stocks, bonds, or commodities. Even if you are an investor in low-risk U.S. government securities, you are still subject to interest rate risk, but you would manage to escape the other risks associated with corporate securities. If you invest in airline stock, you will have a high degree of operating and financial risk, and if you invest in any multinational company, you have a currency risk and possibly a political risk. |
AACSB: Analytical Thinking |
40. | Carlos manages a portfolio composed of many different companies and asset classes such as stocks and bonds, foreign stocks, and bonds and securities in developed and emerging markets. As a result, his portfolio is considered to be
In this scenario, Carlos's portfolio is diversified, meaning it lacks concentration in any similar security, industry, or country. By diversifying his portfolio with different companies and different asset classes such as stocks and bonds, foreign stocks, and bonds and securities in developed and emerging markets, he is reducing the risk that one bad event will destroy his total investment. |
AACSB: Reflective Thinking |
41. | Kim invests in the market, and thus, she is subject to market risks. By diversifying her portfolio, she can minimize price volatility or at least keep the volatility of returns equal to or less than the market in which she invests. She can use statistical measures such as the standard deviation or beta to measure her ability to minimize volatility. If Kim wants her risk to equal that of the market, she should invest in stocks with
If Kim wants her risk to equal that of the market, she should invest in stocks with a beta of 1.0. Stocks with betas greater than 1.0 have more risk than the market, whereas those with betas of less than 1.0 have less risk than the market. Thus, in a diversified portfolio of common stocks, we can build a portfolio with betas greater than, equal to, or less than 1.0 depending on our risk preference. |
AACSB: Reflective Thinking |
42. | Investors of all kinds can resort to financial engineering to minimize risk. All of the following are sophisticated investors who use financial engineering EXCEPT
Investors of all kinds and especially sophisticated investors like insurance companies, hedge funds, investment banks, and commercial banks can resort to financial engineering to minimize risk. Financial engineering involves the use of derivative securities to reduce a specific risk. |
AACSB: Analytical Thinking |
Essay Questions
43. | Briefly explain the difference between insurable and uninsurable risks. Some risks are insurable, whereas others are not. We can insure against the possibility of financial risk of loss due to personal injury, automobile crashes, house fires, floods, and other types of risk by buying casualty insurance. These risks are considered insurable risks. This type of risk is also called pure risk because without insurance, you have lost a car, a house, a boat, a business, or some other physical property without the ability to replace it. Risks that no insurance company will write a policy for are considered uninsurable risks. Risks such as the economic risk of lost market share, currency fluctuations, interest rate risk, or the political risk of investing in foreign countries are considered uninsurable. |
AACSB: Reflective Thinking |
44. | Describe how the law of large numbers relates to insurance companies. The law of large numbers postulates that as a sample size grows, the mean of the sample will get closer to the mean of the total population. For an insurance company insuring a life against the possibility of death, the more people who are insured, the higher the probability that the actual mean death rate will approximate the national mortality tables of life expectancy for men and women per age category. The law of large numbers gives us an idea as to why insurance companies like to insure a large number of people. The larger the number of lives, houses, cars, boats, and so on that the companies insure, the more closely the claims from losses will be predictable based on a normal statistical distribution. This allows insurance companies to price policies for life insurance and casualty insurance appropriately so they have a predictable return on their assets. |
45. | Briefly discuss the risks that cannot be insured by companies. Risks that cannot be insured by companies include business risks, which are related to the inability of a firm to hold its competitive position and maintain stability and growth in earnings. Sometimes, business risk and operating risk are confused, but they are not exactly the same. While business risk occurs because the company does not keep up with its competitors due to lack of research and development, lack of forward planning, and poor management; operating risk focuses on the volatility of operating earnings. Given the cyclical nature of the economy and the stability of the industry, operating risk can be measured by the standard deviation of operating earnings. Further, financial risk occurs when a firm uses too much financial leverage as measured by the debt to asset ratio, the debt to equity ratio, and the times interest earned ratio. A risk that is always present for corporations with multinational operations is currency risk or currency fluctuations. Changes in the relative value of one currency to another can cause profits denominated in U.S. dollars to go up or down depending on the exchange rate. Additionally, all investors are subject to the interest rate risk caused by changing interest rates; these changes can affect both an investor's income stream and the value of that investor's assets. Political risk is associated with investing in firms operating in foreign countries. Another risk is market risk, which occurs because prices of financial securities and commodities fluctuate over the short term. The final risk is liquidity risk, which is the ability to turn assets into cash quickly. |
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Connected Book
Business Foundations Changing World 11e Complete Test Bank
By O. C. Ferrell