FIN 341 EXAM 1 HARTWIG STUDY GUIDE
Risk - Answers -1. Situation in which there is an expected loss
2. Situation in which there is variability around an expected result/value/loss
Uncertainty concerning the occurrence of a loss
Also used to identify the property or life that is being considered for insurance
Insurance v gambling - Answers -Insurance handles an already existing pure risk and is
always socially productive
Gambling creates a new speculative risk and is not socially productive (winner's gain
comes at the expense of the loser)
3 major burdens because of risk - Answers -1. Maintain large emergency funds
2. Can discourage innovation
3. Worry and fear
Pure risk - Answers -A chance of loss or no loss, but no chance of gain
Typically trying to insure against
Do not get anything for not getting an accident
Always undesirable
Neither outcome produces a gain
Speculative Risk - Answers -Example: gambling
Involves the chance of gain
Price risk: risk associated with change in the price of inputs as well as the market price
for completed outputs, futures contract for the price of aluminum (car company)
Credit risk: risk that customers and parties to whom the company has lent money delay
or fail to make promised pauments
Market risk: risk associated with change in price of financial securities (stocks and
bonds)
Interest rate risk: Change in the interest rate, Federal Funds rate
Liquidity risk: Being able to easily liquidate and investment, cannot easily liquidate a
shopping mall
Exchange rate risk: currency valuation fluctuations
Objective risk - Answers -Risk where the degree of variation in uncertain outcome scan
be measured (quantified) based on facts, data and analysis
Examples: hurricane risk (insures losses, catastrophe modeling, climate science),
mortality risk
Relative variation of actual loss from expected loss
Subjective risk - Answers -Perceived degree of risk is based on an individual or
organization's opinion
Examples: accessing risk of flying/shark/terrorism (overestimate), flood/smoking/health
(underestimate)
, Diversifiable risk - Answers -Affects only some individuals or small groups, not the
entire portfolio. Can significantly be reduced through diversification.
Non diversifiable risk - Answers -Highly correlated
Affects all or large proportion of individuals or groups
Cyclical unemployment, unexpected shocks
Systemic risk - Answers -Has the potential to severely disrupt or lead to the collapse of
an entire market, the financial system or major segments of the economy
Chance of loss - Answers -Probability that an event that causes loss will occur
Diversification - Answers -As long as risk are not perfectly correlated the firm can offset
risk
Use of hedging, financial derivatives, futures contracts
Diversify products, geography, suppliers, customers, portfolio/asset, business activities
Internal risk reduction
Uncertainty - Answers -Where such probabilities cannot be estimated, variability
Loss exposure - Answers -Any situation or circumstance in which a loss is possible
regardless of whether a loss occurs
Example: serving alcohol in a restaurant, machinery
Insurers try to minimize these
Enterprise risk - Answers -Encompass all major risks faced by a business firm
Strategic risk: can business reach financial goals?
Operational risk: firm's business operations (truck driver going on strike and now cannot
operate)
Financial risk: price of inputs increasing
Enterprise risk management - Answers -Comprehensive risk management program
that addresses all risks faced by the corporation (pure, speculative, strategic,
operational)
Combines into a single unified treatment program all major risks faced by the firm
Must be continuous and dynamic
Personal risk - Answers -Directly affect an individual or family
Possibility of a loss or reduction in income, extra expenses (premature death,
inadequate retirement income, health, unemployment)
Can be mitigated against
Handle by buying life insurance
Property risk - Answers -Possibility of losses associated with the destruction or theft of
property
Risk - Answers -1. Situation in which there is an expected loss
2. Situation in which there is variability around an expected result/value/loss
Uncertainty concerning the occurrence of a loss
Also used to identify the property or life that is being considered for insurance
Insurance v gambling - Answers -Insurance handles an already existing pure risk and is
always socially productive
Gambling creates a new speculative risk and is not socially productive (winner's gain
comes at the expense of the loser)
3 major burdens because of risk - Answers -1. Maintain large emergency funds
2. Can discourage innovation
3. Worry and fear
Pure risk - Answers -A chance of loss or no loss, but no chance of gain
Typically trying to insure against
Do not get anything for not getting an accident
Always undesirable
Neither outcome produces a gain
Speculative Risk - Answers -Example: gambling
Involves the chance of gain
Price risk: risk associated with change in the price of inputs as well as the market price
for completed outputs, futures contract for the price of aluminum (car company)
Credit risk: risk that customers and parties to whom the company has lent money delay
or fail to make promised pauments
Market risk: risk associated with change in price of financial securities (stocks and
bonds)
Interest rate risk: Change in the interest rate, Federal Funds rate
Liquidity risk: Being able to easily liquidate and investment, cannot easily liquidate a
shopping mall
Exchange rate risk: currency valuation fluctuations
Objective risk - Answers -Risk where the degree of variation in uncertain outcome scan
be measured (quantified) based on facts, data and analysis
Examples: hurricane risk (insures losses, catastrophe modeling, climate science),
mortality risk
Relative variation of actual loss from expected loss
Subjective risk - Answers -Perceived degree of risk is based on an individual or
organization's opinion
Examples: accessing risk of flying/shark/terrorism (overestimate), flood/smoking/health
(underestimate)
, Diversifiable risk - Answers -Affects only some individuals or small groups, not the
entire portfolio. Can significantly be reduced through diversification.
Non diversifiable risk - Answers -Highly correlated
Affects all or large proportion of individuals or groups
Cyclical unemployment, unexpected shocks
Systemic risk - Answers -Has the potential to severely disrupt or lead to the collapse of
an entire market, the financial system or major segments of the economy
Chance of loss - Answers -Probability that an event that causes loss will occur
Diversification - Answers -As long as risk are not perfectly correlated the firm can offset
risk
Use of hedging, financial derivatives, futures contracts
Diversify products, geography, suppliers, customers, portfolio/asset, business activities
Internal risk reduction
Uncertainty - Answers -Where such probabilities cannot be estimated, variability
Loss exposure - Answers -Any situation or circumstance in which a loss is possible
regardless of whether a loss occurs
Example: serving alcohol in a restaurant, machinery
Insurers try to minimize these
Enterprise risk - Answers -Encompass all major risks faced by a business firm
Strategic risk: can business reach financial goals?
Operational risk: firm's business operations (truck driver going on strike and now cannot
operate)
Financial risk: price of inputs increasing
Enterprise risk management - Answers -Comprehensive risk management program
that addresses all risks faced by the corporation (pure, speculative, strategic,
operational)
Combines into a single unified treatment program all major risks faced by the firm
Must be continuous and dynamic
Personal risk - Answers -Directly affect an individual or family
Possibility of a loss or reduction in income, extra expenses (premature death,
inadequate retirement income, health, unemployment)
Can be mitigated against
Handle by buying life insurance
Property risk - Answers -Possibility of losses associated with the destruction or theft of
property
