Chapter 4
Advanced Topics in Risk Management
1. All of the following are financial risks which may be
faced by business organizations EXCEPT
(a) interest rate risk.
(b) commodity price risk.
(c) product liability risk.
(d) currency exchange rate risk.

2. Which of the following statements about the scope of risk
management is (are) true?
I. Traditionally, risk management was limited in scope to
speculative loss exposures.
II. In the 1990s, some businesses began to expand the scope
of risk management to include
financial risks.
(a) I only
(b) II only
(c) both I and II
(d) neither I nor II

3. Mid-States Beef is a commercial feedlot business.
Currently, the company has over 10,000 cattle in
feedlots. Mid-States is concerned that the price of corn,
the grain fed to the cattle, will increase
significantly. The risk that the price of corn may increase
and harm the profitability of Mid-States
Beefs operations is a(n)
(a) currency exchange rate risk.
(b) property risk.
(c) commodity price risk.
(d) interest rate risk.

4. An integrated risk program is a risk management program
which combines
(a) pure and speculative risks.
(b) property and liability risks.
(c) interest rate risk and currency exchange rate risk.
(d) commodity price risk and interest rate risk.
5. Regional Airline (RA) is looking for an effective way of
handling its risk exposures. The company
spends millions of dollars on jet fuel. The company also has
significant liability exposures. RA can
retain a large portion of its liability exposure if fuel
costs are low. The company can pay high fuel
costs if retained liability losses are low. RA cannot,
however, absorb both high fuel costs and high
retained liability claims. RAs insurer designed an
insurance program that pays only if both
contingencies (high fuel costs and high retained liability
claims) occur. The contract the insurer
designed is called a(n)
(a) double indemnity rider.
(b) double trigger option.
(c) multiple protection policy.
(d) other insurance provision.

6. Which statement is (are) true with respect to enterprise
risk management programs?
I. They address traditional property, liability, and
personnel loss exposures.
II. They do not address financial risks.
(a) I only
(b) II only
(c) both I and II
(d) neither I nor II

7. A comprehensive risk management plan that addresses an
organizations pure risks, speculative
risks, strategic risks, and operational risks is called a(n)
(a) risk management information system.
(b) financial risk management plan.
(c) speculative risk management plan.
(d) enterprise risk management plan.

8. The property and liability insurance industry is
characterized by a repetitive pattern of loose
underwriting standards with low premiums followed by tight
underwriting standards with high
premiums. This repetitive pattern is called the
(a) ratemaking oscillation.
(b) business cycle.
(c) underwriting cycle.
(d) claims circulation.

9. Which statement is (are) true regarding property and
liability insurance market conditions?
I. Premiums are high when the insurance market is hard.
II. Underwriting standards are tight when the insurance
market is soft.
(a) I only
(b) II only
(c) both I and II
(d) neither I nor II

10. Which of the following statements is true regarding
insurance market conditions and underwriting
results?
(a) A combined ratio greater than one (or 100 percent)
indicates profitable underwriting.
(b) In a soft insurance market, more retention is used
than in a hard insurance market.
(c) Insurance rates are high and underwriting standards are
tight when the insurance market is
hard.
(d) Property and liability insurance premiums and
underwriting standards do not fluctuate over
time.

11. The relative level of surplus in the insurance industry
is called the industrys
(a) capacity.
(b) liabilities.
(c) reserves.
(d) admitted assets.

12. Which of the following statements is (are) true
regarding investment returns and the underwriting
cycle?
I. Investment returns have no impact upon the underwriting
cycle.
II. Investment returns can lengthen the duration of a soft
market by offsetting underwriting losses.
(a) I only
(b) II only
(c) both I and II
(d) neither I nor II

13. A large property and liability insurance company merged
with a bank and then acquired a stock
brokerage company. This type of merger and acquisition
activity is categorized as
(a) insurance company consolidation.
(b) cross-industry consolidation.
(c) financial risk management.
(d) insurance brokerage consolidation.

14. A risk manager has a fleet of 200 vehicles. On average,
50 vehicles per year experience property
damage. What is the probability that any vehicle will be
damaged in any given year?
(a) 10 percent
(b) 20 percent
(c) 25 percent
(d) 50 percent

15. RST Company has production facilities in Salt Lake City
and Cleveland. The probability that in any
given year a fire will damage the production facility in
Salt Lake City is 5 percent. The probability
that in any given year a fire will damage the Cleveland
production facility is 4 percent. What is the
probability that BOTH production facilities will be damaged
by fire in any given year?
(a) 0.20 percent
(b) 2.00 percent
(c) 4.50 percent
(d) 9.00 percent

16. RST Company has production facilities in Salt Lake City
and Cleveland. The probability that in any
given year a fire will damage the production facility in
Salt Lake City is 5 percent. The probability
that in any given year a fire will damage the Cleveland
production facility is 4 percent. What is the
probability that AT LEAST ONE of the production facilities
will be damaged by fire in any given
year?
(a) 0.20 percent
(b) 2.00 percent
(c) 8.80 percent
(d) 9.00 percent

17. Some events cannot occur together because the occurrence
of one event makes the occurrence of the
second event impossible. Such events are called
(a) dependent events.
(b) independent events.
(c) conditional events.
(d) mutually exclusive events.

18. Two buildings are located close together at a production
facility. The probability that either of these
buildings will experience a fire loss is 4 percent. However,
if one building has a fire, the probability
that the second building will have a fire is 60 percent.
What is the probability that both buildings
will have a fire?
(a) 1.6 percent
(b) 2.4 percent
(c) 8.0 percent
(d) 64.0 percent

19. Which of the following statements is (are) true with
regard to probability analysis?
I. Independent events cannot occur together.
II. If events are dependent, the occurrence of one event
affects the occurrence of the second event.
(a) I only
(b) II only
(c) both I and II
(d) neither I nor II

20. Jane is risk manager of ABC Manufacturing Company. She
is trying to decide whether to self-insure
her companys workers compensation exposure or to purchase
insurance. Jane would like to use
regression analysis to predict the number of workers
compensation claims that will occur next year.
The number of claims will be the dependent variable in the
regression. All of the following would be
reasonable independent variables to use EXCEPT
(a) number of employees.
(b) number of hours worked.
(c) total assets.
(d) payroll.

21. A method of characterizing the relationship between two
or more variables and then using the
characterization to make a prediction is called
(a) loss analysis.
(b) time value of money analysis.
(c) regression analysis.
(d) capital budgeting.

22. A distribution showing losses that could occur and the
corresponding chance that each loss could
occur is called an
(a) underwriting cycle.
(b) capital budget.
(c) loss distribution.
(d) risk map.

23. Which of the following statements is (are) true with
respect to the time value of money?
I. Money received today is worth more than the same amount
of money received in the future.
II. The present value of a future amount is greater than the
future amount.
(a) I only
(b) II only
(c) both I and II
(d) neither I nor II

24. Calculating the present value of a future amount is
called
(a) interpolating.
(b) discounting.
(c) compounding.
(d) regression analysis.

25. The process of determining which set of investments in
plant and equipment to undertake is called
(a) regression analysis.
(b) loss forecasting.
(c) time value of money.
(d) capital budgeting.

26. Which of the following statements is (are) true
regarding the net present value of a capital
investment?
I. Net present value does not consider time value of money.
II. A positive net present value represents an increase in
value to the firm.
(a) I only
(b) II only
(c) both I and II
(d) neither I nor II

27. Millie is risk manager of JKL Company. She is
considering an investment in a loss control project.
The project will cost $40,000. Assuming a 10 percent
discount rate, the present value of the future
cash flows that this project will generate is $60,000. What
is the net present value (NPV) of this
project?
(a) $20,000
(b) $26,000
(c) $60,000
(d) $100,000

28. A computerized data base that permits risk managers to
store and analyze risk management data is
called a
(a) risk management information system.
(b) risk management Intranet.
(c) risk management web site.
(d) risk map.

29. A grid charting the potential frequency and severity of
losses is called a
(a) risk management information system.
(b) risk management Intranet.
(c) risk management web site.
(d) risk map.

30. Which of the following statements is (are) true with
regard to the use of technology in risk
management programs?
I. Risk management Intranets are web sites with search
capabilities designed for an internal
audience.
II. Risk management information systems can be used to store
and track workers compensation
claims data.
(a) I only
(b) II only
(c) both I and II
(d) neither I nor II

31. Terrorists attacked the World Trade Center on September
11, 2001. The attack simultaneously
created large losses for life insurers, property insurers,
workers compensation insurers, health
insurers, and liability insurers. What name is given to an
event that simultaneously creates large
losses in several lines of insurance?
(a) speculative loss
(b) clash loss
(c) retroactive loss
(d) consequential loss

32. Which of the following was a consequence of passage of
the Financial Modernization Act (GrammLeach-Bliley)?

(a) Formation of insurers was made easier because capital
requirements were reduced.
(b) It became easier for insurers to conduct business as
they were no longer required to be licensed
in each state where they operate, but only in the state
where they are domiciled.
(c) Insurers were required to prepare financial statements
using generally accepted accounting
principles (GAAP) instead of statements prepared using
statutory accounting.
(d) Depression-era barriers between underwriting risk,
depository functions, and securities
underwriting were eliminated.

33. The transfer of insurable risk to the capital markets
through the creation of a financial instrument is
called
(a) coefficient of risk.
(b) securitization of risk.
(c) financial risk management.
(d) enterprise risk management.

34. LMN Insurance Company is concerned about its exposure to
hurricane losses for property risks it
insured on the Gulf Coast. LMN borrowed money from investors
by issuing financial securities.
LMN promised to repay the money it borrowed with interest
provided hurricane losses do not
exceed a specified level. If hurricane losses exceed the
specified level, LMN will repay less than it
borrowed and use the extra money to fund hurricane losses.
The securities that LMN issued are
(a) call options.
(b) futures contracts.
(c) weather options.
(d) catastrophe bonds.

35. Hedge Fund Company offers a mutual fund to investors.
Fund managers are concerned about fund
volatility. They analyzed the fund to determine the worst
loss likely to occur in a calendar quarter,
assuming a 90 percent level of confidence. The worst
probable loss is known as the funds
(a) unrealized capital gain.
(b) value at risk.
(c) beta coefficient.
(d) surrender value.

36. Reasons to adopt an enterprise risk management plan
include all of the following EXCEPT
(a) to increase earnings volatility.
(b) to treat risks facing the business in a more holistic
way.
(c) to increase net income.
(d) to gain an advantage over competitors.

37. Which of the following statements concerning the
securitization of risk is (are) true?
I. Securitization increases the capacity of the insurance
industry.
II. Securitization can be used to protect against
catastrophic loss.
(a) I only
(b) II only
(c) both I and II
(d) neither I nor II
Chapter 4Advanced Topics in Risk Management1. All of the following are financial risks which may be
faced by business organizations EXCEPT(a) interest rate risk.(b) commodity price risk.(c) product liability risk.(d) currency exchange rate risk.2. Which of the following statements about the scope of risk
management is (are) true?I. Traditionally, risk management was limited in scope to
speculative loss exposures.II. In the 1990s, some businesses began to expand the scope
of risk management to includefinancial risks.(a) I only(b) II only(c) both I and II(d) neither I nor II3. Mid-States Beef is a commercial feedlot business.
Currently, the company has over 10,000 cattle infeedlots. Mid-States is concerned that the price of corn,
the grain fed to the cattle, will increasesignificantly. The risk that the price of corn may increase
and harm the profitability of Mid-StatesBeefs operations is a(n)(a) currency exchange rate risk.(b) property risk.(c) commodity price risk.(d) interest rate risk.4. An integrated risk program is a risk management program
which combines(a) pure and speculative risks.(b) property and liability risks.(c) interest rate risk and currency exchange rate risk.(d) commodity price risk and interest rate risk.5. Regional Airline (RA) is looking for an effective way of
handling its risk exposures. The companyspends millions of dollars on jet fuel. The company also has
significant liability exposures. RA canretain a large portion of its liability exposure if fuel
costs are low. The company can pay high fuelcosts if retained liability losses are low. RA cannot,
however, absorb both high fuel costs and highretained liability claims. RAs insurer designed an
insurance program that pays only if bothcontingencies (high fuel costs and high retained liability
claims) occur. The contract the insurerdesigned is called a(n)(a) double indemnity rider.(b) double trigger option.(c) multiple protection policy.(d) other insurance provision.6. Which statement is (are) true with respect to enterprise
risk management programs?I. They address traditional property, liability, and
personnel loss exposures.II. They do not address financial risks.(a) I only(b) II only(c) both I and II(d) neither I nor II7. A comprehensive risk management plan that addresses an
organizations pure risks, speculativerisks, strategic risks, and operational risks is called a(n)(a) risk management information system.(b) financial risk management plan.(c) speculative risk management plan.(d) enterprise risk management plan.8. The property and liability insurance industry is
characterized by a repetitive pattern of looseunderwriting standards with low premiums followed by tight
underwriting standards with highpremiums. This repetitive pattern is called the(a) ratemaking oscillation.(b) business cycle.(c) underwriting cycle.(d) claims circulation.9. Which statement is (are) true regarding property and
liability insurance market conditions?I. Premiums are high when the insurance market is hard.II. Underwriting standards are tight when the insurance
market is soft.(a) I only(b) II only(c) both I and II(d) neither I nor II10. Which of the following statements is true regarding
insurance market conditions and underwritingresults?(a) A combined ratio greater than one (or 100 percent)
indicates profitable underwriting.(b) In a soft insurance market, more retention is used
than in a hard insurance market.(c) Insurance rates are high and underwriting standards are
tight when the insurance market ishard.(d) Property and liability insurance premiums and
underwriting standards do not fluctuate overtime.11. The relative level of surplus in the insurance industry
is called the industrys(a) capacity.(b) liabilities.(c) reserves.(d) admitted assets.12. Which of the following statements is (are) true
regarding investment returns and the underwritingcycle?I. Investment returns have no impact upon the underwriting
cycle.II. Investment returns can lengthen the duration of a soft
market by offsetting underwriting losses.(a) I only(b) II only(c) both I and II(d) neither I nor II13. A large property and liability insurance company merged
with a bank and then acquired a stockbrokerage company. This type of merger and acquisition
activity is categorized as(a) insurance company consolidation.(b) cross-industry consolidation.(c) financial risk management.(d) insurance brokerage consolidation.14. A risk manager has a fleet of 200 vehicles. On average,
50 vehicles per year experience propertydamage. What is the probability that any vehicle will be
damaged in any given year?(a) 10 percent(b) 20 percent(c) 25 percent(d) 50 percent15. RST Company has production facilities in Salt Lake City
and Cleveland. The probability that in anygiven year a fire will damage the production facility in
Salt Lake City is 5 percent. The probabilitythat in any given year a fire will damage the Cleveland
production facility is 4 percent. What is theprobability that BOTH production facilities will be damaged
by fire in any given year?(a) 0.20 percent(b) 2.00 percent(c) 4.50 percent(d) 9.00 percent16. RST Company has production facilities in Salt Lake City
and Cleveland. The probability that in anygiven year a fire will damage the production facility in
Salt Lake City is 5 percent. The probabilitythat in any given year a fire will damage the Cleveland
production facility is 4 percent. What is theprobability that AT LEAST ONE of the production facilities
will be damaged by fire in any givenyear?(a) 0.20 percent(b) 2.00 percent(c) 8.80 percent(d) 9.00 percent17. Some events cannot occur together because the occurrence
of one event makes the occurrence of thesecond event impossible. Such events are called(a) dependent events.(b) independent events.(c) conditional events.(d) mutually exclusive events.18. Two buildings are located close together at a production
facility. The probability that either of thesebuildings will experience a fire loss is 4 percent. However,
if one building has a fire, the probabilitythat the second building will have a fire is 60 percent.
What is the probability that both buildingswill have a fire?(a) 1.6 percent(b) 2.4 percent(c) 8.0 percent(d) 64.0 percent19. Which of the following statements is (are) true with
regard to probability analysis?I. Independent events cannot occur together.II. If events are dependent, the occurrence of one event
affects the occurrence of the second event.(a) I only(b) II only(c) both I and II(d) neither I nor II20. Jane is risk manager of ABC Manufacturing Company. She
is trying to decide whether to self-insureher companys workers compensation exposure or to purchase
insurance. Jane would like to useregression analysis to predict the number of workers
compensation claims that will occur next year.The number of claims will be the dependent variable in the
regression. All of the following would bereasonable independent variables to use EXCEPT(a) number of employees.(b) number of hours worked.(c) total assets.(d) payroll.21. A method of characterizing the relationship between two
or more variables and then using thecharacterization to make a prediction is called(a) loss analysis.(b) time value of money analysis.(c) regression analysis.(d) capital budgeting.22. A distribution showing losses that could occur and the
corresponding chance that each loss couldoccur is called an(a) underwriting cycle.(b) capital budget.(c) loss distribution.(d) risk map.23. Which of the following statements is (are) true with
respect to the time value of money?I. Money received today is worth more than the same amount
of money received in the future.II. The present value of a future amount is greater than the
future amount.(a) I only(b) II only(c) both I and II(d) neither I nor II24. Calculating the present value of a future amount is
called(a) interpolating.(b) discounting.(c) compounding.(d) regression analysis.25. The process of determining which set of investments in
plant and equipment to undertake is called(a) regression analysis.(b) loss forecasting.(c) time value of money.(d) capital budgeting.26. Which of the following statements is (are) true
regarding the net present value of a capitalinvestment?I. Net present value does not consider time value of money.II. A positive net present value represents an increase in
value to the firm.(a) I only(b) II only(c) both I and II(d) neither I nor II27. Millie is risk manager of JKL Company. She is
considering an investment in a loss control project.The project will cost $40,000. Assuming a 10 percent
discount rate, the present value of the futurecash flows that this project will generate is $60,000. What
is the net present value (NPV) of thisproject?(a) $20,000(b) $26,000(c) $60,000(d) $100,00028. A computerized data base that permits risk managers to
store and analyze risk management data iscalled a(a) risk management information system.(b) risk management Intranet.(c) risk management web site.(d) risk map.29. A grid charting the potential frequency and severity of
losses is called a(a) risk management information system.(b) risk management Intranet.(c) risk management web site.(d) risk map.30. Which of the following statements is (are) true with
regard to the use of technology in riskmanagement programs?I. Risk management Intranets are web sites with search
capabilities designed for an internalaudience.II. Risk management information systems can be used to store
and track workers compensationclaims data.(a) I only(b) II only(c) both I and II(d) neither I nor II31. Terrorists attacked the World Trade Center on September
11, 2001. The attack simultaneouslycreated large losses for life insurers, property insurers,
workers compensation insurers, healthinsurers, and liability insurers. What name is given to an
event that simultaneously creates largelosses in several lines of insurance?(a) speculative loss(b) clash loss(c) retroactive loss(d) consequential loss32. Which of the following was a consequence of passage of
the Financial Modernization Act (GrammLeach-Bliley)?(a) Formation of insurers was made easier because capital
requirements were reduced.(b) It became easier for insurers to conduct business as
they were no longer required to be licensedin each state where they operate, but only in the state
where they are domiciled.(c) Insurers were required to prepare financial statements
using generally accepted accountingprinciples (GAAP) instead of statements prepared using
statutory accounting.(d) Depression-era barriers between underwriting risk,
depository functions, and securitiesunderwriting were eliminated.33. The transfer of insurable risk to the capital markets
through the creation of a financial instrument iscalled(a) coefficient of risk.(b) securitization of risk.(c) financial risk management.(d) enterprise risk management.34. LMN Insurance Company is concerned about its exposure to
hurricane losses for property risks itinsured on the Gulf Coast. LMN borrowed money from investors
by issuing financial securities.LMN promised to repay the money it borrowed with interest
provided hurricane losses do notexceed a specified level. If hurricane losses exceed the
specified level, LMN will repay less than itborrowed and use the extra money to fund hurricane losses.
The securities that LMN issued are(a) call options.(b) futures contracts.(c) weather options.(d) catastrophe bonds.35. Hedge Fund Company offers a mutual fund to investors.
Fund managers are concerned about fundvolatility. They analyzed the fund to determine the worst
loss likely to occur in a calendar quarter,assuming a 90 percent level of confidence. The worst
probable loss is known as the funds(a) unrealized capital gain.(b) value at risk.(c) beta coefficient.(d) surrender value.36. Reasons to adopt an enterprise risk management plan
include all of the following EXCEPT(a) to increase earnings volatility.(b) to treat risks facing the business in a more holistic
way.(c) to increase net income.(d) to gain an advantage over competitors.37. Which of the following statements concerning the
securitization of risk is (are) true?I. Securitization increases the capacity of the insurance
industry.II. Securitization can be used to protect against
catastrophic loss.(a) I only(b) II only(c) both I and II(d) neither I nor II