FINA 338 - EXAM 1 QUESTIONS WITH
CORRECT ANSWERS
Pure risk and related example - ANSWER Only possibility of loss or no loss
Ex. Premature death, theft
Speculative risk and related example - ANSWER Either profit or loss is possible
Ex. Gambling, investment
Overlapping example of pure and speculative risk - ANSWER Pure - eating for survival
Speculative - eating for enjoyment
Why distinguishes pure risk and speculative risk? - ANSWER Pure: insurance
Speculative: derivatives
Personal risk types - ANSWER Earnings
-Death
-Aging
Medical expenses
Liability
-Auto
-Home
Physical assets
-Auto
-Boats
Financial assets
-Stocks and bonds
Longevity
Business risk types - ANSWER Financial risk
-Price risk (market risk)
, -Credit risk
Non-financial risk
-Pure risk (all other forms of risk)
Market risk definition and examples - ANSWER Uncertainty over the magnitude of cash
flows due to possible changes in output and input prices
Ex. Commodity price risk, equity market risk, interest rate risk, etc
Interest rate risk definition - ANSWER Changes in interest rates affect value through
their effect on the PV of the firm's net cash flows, as reflected in the value of the firms
assets and liabilities
Exchange rate risk - ANSWER The risk of an appreciation or depreciation in the
exchange between two currencies
Credit risk definition and examples - ANSWER The chance that promised cash flow
from counter-parties may not be fully paid
Ex. Default on interest, principal, or both
The three components of credit risk - ANSWER Probability of default
Recovery rate
Credit exposure
Probability of default - ANSWER Probability that the counter-party will fail to make the
agreed upon payment
Recovery rate - ANSWER Fraction of the claim that is paid by the defaulting party
Ex. help of the legal system
Credit exposure - ANSWER The amount that the party with a claim will lose in case of
default
Operational risk - ANSWER Risk of loss from failures in a company's system
Ex. Computer breakdowns, human error
Model risk - ANSWER Risk that a model is incorrect or misapplied
Regulatory risk - ANSWER Risk associated with the uncertainty of how transaction will
be regulated or with the potential for regulations to change
CORRECT ANSWERS
Pure risk and related example - ANSWER Only possibility of loss or no loss
Ex. Premature death, theft
Speculative risk and related example - ANSWER Either profit or loss is possible
Ex. Gambling, investment
Overlapping example of pure and speculative risk - ANSWER Pure - eating for survival
Speculative - eating for enjoyment
Why distinguishes pure risk and speculative risk? - ANSWER Pure: insurance
Speculative: derivatives
Personal risk types - ANSWER Earnings
-Death
-Aging
Medical expenses
Liability
-Auto
-Home
Physical assets
-Auto
-Boats
Financial assets
-Stocks and bonds
Longevity
Business risk types - ANSWER Financial risk
-Price risk (market risk)
, -Credit risk
Non-financial risk
-Pure risk (all other forms of risk)
Market risk definition and examples - ANSWER Uncertainty over the magnitude of cash
flows due to possible changes in output and input prices
Ex. Commodity price risk, equity market risk, interest rate risk, etc
Interest rate risk definition - ANSWER Changes in interest rates affect value through
their effect on the PV of the firm's net cash flows, as reflected in the value of the firms
assets and liabilities
Exchange rate risk - ANSWER The risk of an appreciation or depreciation in the
exchange between two currencies
Credit risk definition and examples - ANSWER The chance that promised cash flow
from counter-parties may not be fully paid
Ex. Default on interest, principal, or both
The three components of credit risk - ANSWER Probability of default
Recovery rate
Credit exposure
Probability of default - ANSWER Probability that the counter-party will fail to make the
agreed upon payment
Recovery rate - ANSWER Fraction of the claim that is paid by the defaulting party
Ex. help of the legal system
Credit exposure - ANSWER The amount that the party with a claim will lose in case of
default
Operational risk - ANSWER Risk of loss from failures in a company's system
Ex. Computer breakdowns, human error
Model risk - ANSWER Risk that a model is incorrect or misapplied
Regulatory risk - ANSWER Risk associated with the uncertainty of how transaction will
be regulated or with the potential for regulations to change
