RM exam 1 textbook flashcards
questions with complete solutions
Corporate risk management - correct answer ✔✔the process of protecting the earnings power and the
assets of a firm from the financial losses resulting from negative events like property damage or lawsuits,
is a precursor to ERM that became popular after World War II.1 Traditionally, corporate risk managers
have protected their firms from these losses using techniques such as risk financing, which includes
insurance and noninsurance techniques; loss control, and risk transfer.
Operational managers guard against events that disrupt the normal operations of the firm, and strategic
planning officers position the firm to best compete against its rivals. Firms are increasingly recognizing
that it is not best for any of these functions to operate in disconnected "silos" that are isolated from each
other and beneath the radar of the corporate board - correct answer ✔✔We know now they should
operate together....led to ERM
Enterprise risk management (ERM) - correct answer ✔✔is thus a process that examines all these risks
collectively and elevates the analyses to the highest level in the corporation: the corporate boardroom.
Large-scale natural disasters, investment losses, and relatively minor traffic accidents are quite diverse
but share a common characteristic: - correct answer ✔✔they can all cause us financial harm and
interrupt our ability to carry out the tasks of daily life.
Methods of Classifying Risk - correct answer ✔✔risk refers to the variation in possible outcomes that can
result from an uncertain event based on chance.
Pure risks - correct answer ✔✔are loss exposures that can result in two possible financial outcomes: The
person or firm exposed to the risk suffers a financial loss, or the financial position will remain unchanged.
Pure risks offer no opportunity for financial gain. Most of the catastrophic events we discussed earlier—
terrorism, flood, or earthquakes—are examples of pure risks. Many of the events that can result in
damage to property are also pure risks, such as fires or windstorms. Employee benefits programs also
protect workers from pure risks, such as unexpected medical expenses, unemployment, and disability.
speculative risks - correct answer ✔✔are loss exposures that can result in three financial outcomes: A
person exposed to the risk will suffer a financial loss, receive a financial gain, or find his or her financial
,status unchanged. The decision to invest your money in the stock market is an example of a speculative
risk because your wealth will increase, decrease, or remain constant as a result of the investment.
Speculative risks also include the risk borne by entrepreneurs who start their own businesses or a firm
that decides to introduce a new product line. Other speculative risks result from the potential gains or
losses associated with price movements of foreign currencies, interest rate changes, or commodities
such as grains, precious metals, or oil.
Diversifiable Risk vs. Non-diversifiable Risk - correct answer ✔✔It is also helpful to classify loss exposures
based on whether the risk can be reduced through diversification. A number of risk-bearing financial
institutions, such as insurance companies and investment funds, help their clients by providing them a
way to diversify their risks with those of a large number of other clients. In its simplest form, risk
diversification is a process in which the financial losses of a few members in a group are spread across a
much larger number of people in the group who have not suffered a loss. Thus, while the owner of a
small home would be devastated financially if her $100,000 house was completely destroyed by a fire, if
that homeowner were one of the 20,000 customers protected by a fire insurance company, each
customer's share of that loss would equal the affordable sum of $5
Crucial to the success of such risk-bearing arrangements is making sure that there are a large number of
clients to share the risk, and that the risk is not likely to cause a large number of group members to
suffer a loss at the same time and thus financially overwhelm the group. In this regard, we will find it
helpful to classify risks based on whether they satisfy these diversification characteristics.
In insurance, diversification is achieved through the use of risk pooling - correct answer ✔✔also known
as the use of the law of large numbers. Most common types of insurance, such as auto and life
insurance, offer protection from risks well suited to diversification via risk pooling because the loss
usually affects only one person, not a large number of clients in the same risk pool.
non-diversifiable risks - correct answer ✔✔floods, wars, and unemployment--risks for insurers because
they often result in financial losses for a large number of people in the risk pool at the same time. Private
insurers rarely offer insurance for non-diversifiable risk, recognizing that their financial strength could be
harmed if such a catastrophic loss occurred.
Risk diversification is also used in the field of finance. - correct answer ✔✔For example, an investor who
invests all his cash in the stock of a single company will suffer a huge loss if that firm's stock price
decreases. On the other hand, that same investor is exposed to far less risk if he purchases stock from a
larger number of companies because it is much less likely that all the companies will decline in value
simultaneously. For this reason, financial advisors urge investors to hold a well-diversified portfolio of
investments because many of the speculative risks that can cause financial harm to a single firm (such as
, the failed launch of a new product or a loss of market share to a competitor) are diversifiable if the
remaining investments in the portfolio are unaffected.
Unfortunately, the impact of some types of investment risks, such as inflation or recession, is not limited
to a single firm but instead adversely affects a large number of firms in an investment portfolio or even
an entire market. These risks exhibit the characteristics of non-diversifiable risk in an investment
portfolio.4
Risk aversion - correct answer ✔✔refers to the behavioral tendency, when facing a choice between risky
alternatives, to prefer to take less risk rather than more.
is also one of the primary reasons that individuals and some firms purchase insurance and otherwise
engage in risk management activities
A policy of risk aversion may not be the best way to deal with speculative risk, however, because such a
strategy often reduces a person's ability to earn increased financial gain - correct answer ✔✔many
investments exhibit a risk-return trade-off, by which an investor can expect to receive increased financial
returns for bearing higher levels of risk.
Protection From Risk: Insurance, Employee Benefits, and Risk Management - correct answer ✔✔No
Protection
Personal Insurance Protection
Insurance is a financial agreement in which an individual pays a fee (known as a premium) to transfer the
financial consequences of his insured losses to a risk pool administered by an insurer.
Employee Benefit Plans
nonwage compensation provided by their employers, as a source of protection from a number of
personal pure risks. Several different types of personal insurance protection typically are provided,
including health insurance, life insurance, disability insurance, and a number of different types
Corporate Risk Management
Due in part to the limitations of insurance markets, many firms have become less reliant upon insurance
as a primary means of protecting themselves from loss exposures, and some have actively sought out
questions with complete solutions
Corporate risk management - correct answer ✔✔the process of protecting the earnings power and the
assets of a firm from the financial losses resulting from negative events like property damage or lawsuits,
is a precursor to ERM that became popular after World War II.1 Traditionally, corporate risk managers
have protected their firms from these losses using techniques such as risk financing, which includes
insurance and noninsurance techniques; loss control, and risk transfer.
Operational managers guard against events that disrupt the normal operations of the firm, and strategic
planning officers position the firm to best compete against its rivals. Firms are increasingly recognizing
that it is not best for any of these functions to operate in disconnected "silos" that are isolated from each
other and beneath the radar of the corporate board - correct answer ✔✔We know now they should
operate together....led to ERM
Enterprise risk management (ERM) - correct answer ✔✔is thus a process that examines all these risks
collectively and elevates the analyses to the highest level in the corporation: the corporate boardroom.
Large-scale natural disasters, investment losses, and relatively minor traffic accidents are quite diverse
but share a common characteristic: - correct answer ✔✔they can all cause us financial harm and
interrupt our ability to carry out the tasks of daily life.
Methods of Classifying Risk - correct answer ✔✔risk refers to the variation in possible outcomes that can
result from an uncertain event based on chance.
Pure risks - correct answer ✔✔are loss exposures that can result in two possible financial outcomes: The
person or firm exposed to the risk suffers a financial loss, or the financial position will remain unchanged.
Pure risks offer no opportunity for financial gain. Most of the catastrophic events we discussed earlier—
terrorism, flood, or earthquakes—are examples of pure risks. Many of the events that can result in
damage to property are also pure risks, such as fires or windstorms. Employee benefits programs also
protect workers from pure risks, such as unexpected medical expenses, unemployment, and disability.
speculative risks - correct answer ✔✔are loss exposures that can result in three financial outcomes: A
person exposed to the risk will suffer a financial loss, receive a financial gain, or find his or her financial
,status unchanged. The decision to invest your money in the stock market is an example of a speculative
risk because your wealth will increase, decrease, or remain constant as a result of the investment.
Speculative risks also include the risk borne by entrepreneurs who start their own businesses or a firm
that decides to introduce a new product line. Other speculative risks result from the potential gains or
losses associated with price movements of foreign currencies, interest rate changes, or commodities
such as grains, precious metals, or oil.
Diversifiable Risk vs. Non-diversifiable Risk - correct answer ✔✔It is also helpful to classify loss exposures
based on whether the risk can be reduced through diversification. A number of risk-bearing financial
institutions, such as insurance companies and investment funds, help their clients by providing them a
way to diversify their risks with those of a large number of other clients. In its simplest form, risk
diversification is a process in which the financial losses of a few members in a group are spread across a
much larger number of people in the group who have not suffered a loss. Thus, while the owner of a
small home would be devastated financially if her $100,000 house was completely destroyed by a fire, if
that homeowner were one of the 20,000 customers protected by a fire insurance company, each
customer's share of that loss would equal the affordable sum of $5
Crucial to the success of such risk-bearing arrangements is making sure that there are a large number of
clients to share the risk, and that the risk is not likely to cause a large number of group members to
suffer a loss at the same time and thus financially overwhelm the group. In this regard, we will find it
helpful to classify risks based on whether they satisfy these diversification characteristics.
In insurance, diversification is achieved through the use of risk pooling - correct answer ✔✔also known
as the use of the law of large numbers. Most common types of insurance, such as auto and life
insurance, offer protection from risks well suited to diversification via risk pooling because the loss
usually affects only one person, not a large number of clients in the same risk pool.
non-diversifiable risks - correct answer ✔✔floods, wars, and unemployment--risks for insurers because
they often result in financial losses for a large number of people in the risk pool at the same time. Private
insurers rarely offer insurance for non-diversifiable risk, recognizing that their financial strength could be
harmed if such a catastrophic loss occurred.
Risk diversification is also used in the field of finance. - correct answer ✔✔For example, an investor who
invests all his cash in the stock of a single company will suffer a huge loss if that firm's stock price
decreases. On the other hand, that same investor is exposed to far less risk if he purchases stock from a
larger number of companies because it is much less likely that all the companies will decline in value
simultaneously. For this reason, financial advisors urge investors to hold a well-diversified portfolio of
investments because many of the speculative risks that can cause financial harm to a single firm (such as
, the failed launch of a new product or a loss of market share to a competitor) are diversifiable if the
remaining investments in the portfolio are unaffected.
Unfortunately, the impact of some types of investment risks, such as inflation or recession, is not limited
to a single firm but instead adversely affects a large number of firms in an investment portfolio or even
an entire market. These risks exhibit the characteristics of non-diversifiable risk in an investment
portfolio.4
Risk aversion - correct answer ✔✔refers to the behavioral tendency, when facing a choice between risky
alternatives, to prefer to take less risk rather than more.
is also one of the primary reasons that individuals and some firms purchase insurance and otherwise
engage in risk management activities
A policy of risk aversion may not be the best way to deal with speculative risk, however, because such a
strategy often reduces a person's ability to earn increased financial gain - correct answer ✔✔many
investments exhibit a risk-return trade-off, by which an investor can expect to receive increased financial
returns for bearing higher levels of risk.
Protection From Risk: Insurance, Employee Benefits, and Risk Management - correct answer ✔✔No
Protection
Personal Insurance Protection
Insurance is a financial agreement in which an individual pays a fee (known as a premium) to transfer the
financial consequences of his insured losses to a risk pool administered by an insurer.
Employee Benefit Plans
nonwage compensation provided by their employers, as a source of protection from a number of
personal pure risks. Several different types of personal insurance protection typically are provided,
including health insurance, life insurance, disability insurance, and a number of different types
Corporate Risk Management
Due in part to the limitations of insurance markets, many firms have become less reliant upon insurance
as a primary means of protecting themselves from loss exposures, and some have actively sought out
