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risk management financial

Questions and Answers of Risk Management Financial

Do you think that loss adjustment would be most difficult in the field of life insurance, property insurance, or liability insurance?What training would you recommend for adjusters in each of these
“Pricing is more difficult in insurance than in other business fields, because the cost of production is not known until after the product has been delivered.” To what extent is this statement
Explain the nature of insurance company reserves?
Explain the effect of statutory accounting requirements on the indicated profitability of insurers?
Describe the types of reinsurance and discuss the purposes of reinsurance?
Describe the ways in which insurance companies are taxed?
What characteristics of the insurance business make reserves necessary?
Is the life insurance policy reserve more analogous to an unearned premium reserve or a loss reserve in the property and liability field?
Define the unearned premium reserve and briefly explain how it is calculated. Why is the unearned premium reserve often referred to as the “reinsurance reserve”?
What does it mean to say that a reserve is redundant?What type of reserves are considered to be redundant?Why?
The XYZ Insurance Company had an unearned premium reserve of $20 million at the end of 2006. During 2007, it wrote $25 million in annual premiums. At the end of 2007, its unearned premium reserve was
The XYZ Insurance Company had loss reserves of$7 million at the end of 2006. During 2007, it paid$7 million in losses, and had loss reserves in the amount of $6 million at the end of 2007. What were
The financial statements of the XYZ Property and Liability Insurance Company indicate the following:Premiums written 2007 $10,000,000 Unearned premium reserve, Dec. 2006 9,000,000 Unearned premium
Give two specific reasons for reinsurance. Distinguish between facultative and treaty reinsurance.
The Tax ReformAct of 1986 (TRA-86) introduced several new elements into the taxation of property and liability insurers. In what way did the TRA-86 deal with the mismatching of revenues and expenses
Explain two techniques that may be used to estimate the true underwriting profit or loss of a property and liability insurance company.
The primary emphasis in statutory accounting is supposedly on financial conservatism. However, some statutory techniques violate this principle. Discuss three ways in which statutory accounting is
The NAIC has staunchly defended its need to have an accounting system for insurance companies that differs from GAAP. On what basis have they argued for a different system? Do you agree or disagree
A noted insurance authority stated, “The insured should prefer to purchase insurance from a company that has a high loss ratio since this is evidence that the company is returning a high percentage
To what extent does the movement of surplus of a property and liability insurer indicate the profitability of the company’s operations? Would the same be true for a life insurer?
“In view of the relationship of surplus to premiums that may be written, a severe decline in the stock market is likely to serve as a brake on price-cutting practices.”Explain the rationale
Identify the exposures that arise in connection with an individual’s income?
Explain the concept of present value and why it is important in measuring life values
Explain the human life value concept
Describe how various lifestyles affect the risk of loss from premature death
Explain the process of needs analysis
Identify the sources of protection that may be available to an individual as protection in the event of premature death
Explain how the risk of disability differs from the risk of premature death
Explain the relationship between the risk of premature death and longevity risk
Briefly explain how the human life value approach differs from the needs approach in determining the amount of life insurance an individual should purchase.What is the relationship between the two
What, if any, are the defects in using the human life value concept in determining the amount of life insurance an individual should purchase?
The need for life insurance varies with the individual’s lifestyle. How does this need differ for single individuals, childless couples, and persons with children?
Identify the “needs” traditionally considered in determining the amount of life insurance required for a family.
Identify the sources other than life insurance that might provide resources to meet needs in the case of premature death.
One tool for dealing with the risk of outliving one’s income is a life annuity. Briefly explain how a life annuity is able to do this.
Identify the resources that might be available to address the retirement risk.
Explain why the disability needs for a particular individual are likely to be even greater than the needs in the case of premature death.
How should one deal with the dilemma created because disability resulting from sickness may extend beyond age 65, but insurers are generally unwilling to provide coverage for such disabilities beyond
Identify the resources that may be available for an individual who experiences a disability.
The changing lifestyles of many Americans have modified some of the traditional principles of insurance buying. With an increase in the number of two income families, do you think that the overall
It is often stated that one of the most neglected areas in the life insurance field is that of insurance on the homemaker spouse. In facing the risk management decision regarding life insurance for
What reasons can you suggest for providing a lifetime income to a spouse after any children have been raised? Under what circumstances would you recommend against providing such a lifetime income?
“On first consideration, it might seem that the risk of income loss resulting from premature death is universal.After all, no one lives forever. But death does not automatically result in financial
“The effect of the income loss occasioned by premature death depends on the circumstances.” Describe a combination of circumstances in which the effect of income loss occasioned by premature
How many ratings does Moody's use for companies that have not defaulted? What are they?
How many ratings does S&P use for companies that have not defaulted?What are they?
Calculate the average default intensity for B-rated companies during the first year from the data in Table 11.1.
Calculate the average default intensity for Ba-rated companies during the third year from the data in Table 11.1.
The spread between the yield on a 3-year corporate bond and the yield on a similar risk-free bond is 50 basis points. The recovery rate is 30%, Estimate the average default intensity per year over
The spread between the yield on a 5-year bond issued by a company and the yield on a similar risk-free bond is 80 basis points. Assume a recovery rate of 40%. Estimate the average default intensity
Verify (a) that the numbers in the second column of Table 11.4 are consistent with the numbers in Table 11.1 and (b) that the numbers in the fourth column of Table 11.5 are consistent with the
Suppose that in an asset swap B is the market price of the bond per dollar of principal, B* is the default-free value of the bond per dollar 01 principal, and V is the present value of the asset swap
Show that under Merton's model in Section 11.6 the credit spread on a T-year zero-coupon bond is where L = Der Vo -In[N{d2) + N(-d)/L]/T
The value of a company's equity is $2 million and the volatility of its equity is 50%. The debt that will have to be repaid in one year is$5 million. The risk-free interest rate is 4% per annum. Use
Suppose that the LIBOR/swap curve is flat at 6% with continuous compounding and a 5-year bond with a coupon of 5% (paid semiannually)sells for 90.00.How would an asset swap on the bond be structured?
Suppose a 3-year corporate bond provides a coupon of 7% per year payable semiannually and has a yield of 5% (expressed with semiannual compounding). The yields for all maturities on risk-free bonds
A company has 1- and 2-year bonds outstanding, each providing a coupon of 8% per year payable annually. The yields on the bonds(expressed with continuous compounding) are 6.0% and 6.6%,
The value of a company's equity is $4 million and the volatility of its equity is 60%. The debt that will have to be repaid in 2 years is$15 million. The risk-free interest rate is 6% per annum. Use
As explained in Section 2.3 an interest rate swap involves the exchange of a fixed rate of interest for a floating rate of interest with both being applied to the same principal. The principals are
An interest rate swap currently has a negative value to a financial institution. Is the financial institution exposed to credit risk on the transaction?Explain your answer.
Estimate the capital required under Basel I for a bank that has the following transactions with a corporation (assume no netting): (a) a 9-year interest rate swap with a notional principal of $250
What is the capital required in Problem 7.6 under Basel I assuming that the 1995 netting amendment applies?
All the contracts a bank has with a corporate client are loans to the client.What is the value to the bank of netting provisions in the loan agreement?
Explain why the final stage in the Basel II calculations for credit risk, market risk, and operational risk is to multiply by 12.5.
What is the difference between the trading book and the banking book for a bank? A bank currently has a loan of $10 million dollars to a corporate client. At the end of the life of the loan the
Under Basel I, banks do not like lending to highly creditworthy companies and prefer to help them issue debt securities. Why is this? Do you expect the banks' attitude to this type of lending to
What is regulatory arbitrage?
Equation (7.8) gives the formula for the capital required under Basel II.It involves four terms being multiplied together. Explain each of these terms.
Explain the difference between the simple and the comprehensive approach for adjusting for collateral.
Suppose that the assets of a bank consist of $200 of retail loans (not mortgages). The PD is 1% and the LGD is 70%. What is the riskweighted assets under the Basel II IRB approach? How much Tier 1
Estimate the capital required under Basel I for a bank that has the following transactions with another bank (assume no netting): (a) a 2-year forward contract on a foreign currency, currently worth
A bank has the following transaction with an AA-rated corporation:(a) a 2-year interest rate swap with a principal of $100 million worth$3 million; (b) a 9-month foreign exchange forward contract
Suppose that the assets of a bank consist of $500 million of loans to BBB-rated corporations. The PD for the corporations is estimated as 0.3%. The average maturity is 3 years and the LGD is 60%.
What is a spectral risk measure? What conditions must be satisfied by a spectral risk measure for the Subadditivity condition in Section 8.3 to be satisfied?
A fund manager announces that the fund's 1-month 95% VaR is 6% of the size of the portfolio being managed. You have an investment of$100,000 in the fund. How do you interpret the portfolio manager's
Suppose that each of two investments has a 0.9% chance of a loss of$10 million, a 99.1% of a loss of $1 million, and zero probability of a gain.The investments are independent of each other. (a) What
Suppose that the change in the value of a portfolio over a 1-day time period is normal with a mean of zero and a standard deviation of$2 million, What is (a) the 1-day 97.5% VaR, (b) the 5-day 97.5%
What difference does it make to your answers to (b) and (c) of Problem 8.6 if there is first-order daily autocorrelation with correlation parameter equal to 0.16?
Describe two ways extreme scenarios can be developed for stress testing.
Prove equation (8.3).
The back-testing rules of the Basel Committee can lead to questions about a VaR model when there are 5 or more exceptions in 250 trials. What is the chance of this if the VaR methodology is perfectly
The probability that the loss from a portfolio will be greater than$10 million in 1 month is estimated to be 5%. (a) What is the 1-month 99% VaR assuming the change in value of the portfolio is
What is the difference between economic capital and regulatory capital?
Why do AA-rated banks use a confidence level of 99.97% when calculating economic capital for a one-year time horizon?
What is included in business risk?
Suppose the credit loss in a year has a lognormal distribution. The logarithm of the loss is normal with mean 0.5 and standard deviation 4. What is the economic capital requirement if a confidence
Suppose that the economic capital estimates for two business units are as follows:The correlations are as in Table 16.3.Calculate the total economic capital for each business unit and the two
In Problem 16.6, what is the incremental effect of each business unit on the total economic capital? Use this to allocate economic capital to business units. What is the impact on the economic
A bank is considering expanding its asset management operations. The main risk is operational risk. It estimates that the expected operational risk loss from the new venture in one year is $2 million
Suppose that daily gains and losses are normally distributed with a standard deviation of (a) Estimate the minimum regulatory capital the bank is required to hold for market risk. (Assume a
Suppose that the economic capital estimates for two business units are as follows:The correlation between market risk and credit risk in the same business unit is 0.3. The correlation between credit
Explain the difference between hedging, speculation, and arbitrage.
Suppose you write a put contract with a strike price of $40 and an expiration date in three months. The current stock price is $41 and the contract is on 100 shares. What have you committed yourself
Suppose that you own 5,000 shares worth $25 each. How can put options be used to provide you with insurance against a decline in the value of your holding over the next four months?
When first issued, a stock provides funds for a company. Is the same true of a stock option? Discuss.
Suppose that a March call option to buy a share for $50 costs $2.50 and is held until March. Under what circumstances will the holder of the option make a profit? Under what circumstances will the
Suppose that a June put option to sell a share for $60 costs $4 and is held until June. Under what circumstances will the seller of the option (i.e., the party with the short position) make a profit?
A United States company expects to have to pay 1 million Canadian dollars in six months. Explain how the exchange rate risk can be hedged using (a) a forward contract and (b) an option.
Suppose that USD/GBP spot and forward exchange rates are as follows:What opportunities are open to an arbitrageur in the following situations:(a) a 180-day European call option to buy £1 for $1.57
A company has money invested at 5% for five years. It wishes to use the swap quotes in Table 2.5 to convert its investment to a floating-rate investment. Explain how it can do this.

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