Risk finance exam 2 prep

In a forward contract, the buyer and seller of a commodity Select one:

D. Know its price prior to delivery

24) Statutes prohibiting particular wording in risk transfer agreements are generally Select one:

D. Very narrow.

1) Other than with catastrophe put notes, a disadvantage associated with contingent capital arrangements is that

D. Funds received are loans, not equity.

Each summer, O'Neill Heating Oil Company enters into contracts to deliver heating oil to residential customers in four New England states. The oil will be delivered in October and November, but the customers demand a firm price at which the oil will be delivered. Lacking storage, O'Neill Heating Oil Company cannot purchase oil in the summer and hold it until delivery. There is a risk that the price of oil may increase after O'Neill Heating Oil Company has entered into the contracts. The company can address this risk by using Select one:

D. Futures contracts.

1) Capital market products are traded financial instruments that Select one:

. Have emerged as tools that organizations can use to finance risk.

14) Retained property losses for the two divisions of Caste Iron Computer Company are shown below. Retained property losses this year are expected to be $60,000. Assuming that this year's retained property claims are allocated prospectively based on the prior two years' cumulative retained loss experience, which of the following statements is true? Two Years Ago Last Year Metal Fabrication $40,000 $35,000 Computer Sales/Service $10,000 $15,000 Select one:

A A. Must consider the overall credit risk of the organization.. The Metal Fabrication Division should be allocated $45,000 of expected retained property losses

1) Investors in contingent capital arrangements Select one:

C. Become creditors of the organization following a loss. .

One factor affecting the appropriate use of noninsurance risk transfers is whether the courts will require the parties to the contract to abide by the contractual terms. This factor is called

C. Enforceability.

20) A contractor's obligation under a service and maintenance contract is generally Select one:

C. Extremely broad.

A contract for noninsurance risk transfer is not enforceable if Select one:

C. The contract is unconscionable. .

19) One example of a contract that commonly includes some form of noninsurance risk transfer is Select one:

D. A sale and supply contract.

15) One way to transfer risk to the transferee's insurer is through Select one:

D. An additional insured endorsement.

When selecting an allocation basis for hazard risk management costs, the organization's accounting system can influence allocation because Select one:

D. Exposure bases often rely on data maintained in an accounting system.

Jeremy purchased some long-term corporate bonds when he retired. He plans to use the periodic interest payments from the bonds to supplement his other sources of retirement income. However, some of the companies that issued the bonds that Jeremy purchased may become insolvent and unable to make periodic interest payments. This risk that Jeremy took when he invested in the corporate bonds is called

Select one: D. Credit risk.

1) Which one of the following approaches for transferring risk provides the highest financial security and the lowest basis risk to an organization transferring risk?

Select one: D. Traditional insurance contracts

1) The organizations that use insurance-linked securities and insurance derivatives to transfer risk are concerned with the

Select one: A. Credit risk of the parties supplying the risk capital.

21) Party A and Party B have entered into a contract specifying that Party A will hold Party B harmless from claims arising from their joint fault. This is an example of which one of the following forms of a hold-harmless agreement?

Select one: A. Intermediate form

17) A Gulf Coast state would like to build a bridge to an island located half a mile off-shore. The state required construction companies that bid on the contract to be able to provide a contractual promise issued by an insurer that if the construction company failed to complete the project by a specified date or defaulted on the contract, the insurer would satisfy the obligation. This contractual promise issued by an insurer is called a

Select one: A. Surety bond.

11) One reason that having direct access to reinsurers is a benefit of using a captive insurance plan is that

A. A captive insurer captures any ceding commission on the reinsurance that would otherwise be paid to a commercial insurer.

12) Brenda, the risk management professional for United Manufacturing Company, organizes a captive insurer in the Cayman Islands. Brenda learns that the state in which United is located requires auto liability insurance and workers' compensation insurance to be written by a U.S.-based insurer. United places the coverage with a licensed domestic insurer, with the understanding that the licensed insurer will reinsure the business with United's captive insurer. In this case, the U.S.-based company operates as Select one:

A. A fronting company.

1) Which one of the following characteristics is shared by catastrophe bonds and other successful insurance securitizations?

A. A potentially large exposure

1) The catastrophe losses that trigger payment under a catastrophe bond Select one:

A. Can be based on aggregate catastrophe losses over a defined period of time or the occurrence of a single catastrophic event.

A company installed a new sprinkler system in its production area. This expenditure is an example of which one of the following types of costs that are allocated through a risk management cost allocation system?

A. Costs of risk control techniques

An advantage of insurance securitizations is that they Select one:

A. Create additional risk transfer capacity.

) A risk management professional can design an effective hazard risk mangement cost allocation system by ensuring that it accomplishes which one of the following objectives? Select one:

A. Facilitating risk retention by the organization

A sound strategy for a noninsurance risk transfer control program ensures that the organization Select one:

A. Maintains a consistent transfer strategy.

26) Which one of the following statements is true regarding statutory limitations on hold-harmless agreements?

A. Many statutes attempt to preserve fairness and foster economically appropriate allocation of loss exposures and actual loss.

If an organization directly securitized its income-producing assets without using a special purpose vehicle (SPV) as an intermediary, investors

A. Must consider the overall credit risk of the organization.

5) Which one of the following statements is true regarding group captives? Select one:

A. Owners of a group captive have more control over management of the captive than owners of a mutual insurer.

An organization allocates hazard risk management costs primarily based on potential exposures to loss and secondarily based on recent actual loss experience. The organization is using a Select one: A. Prospective cost

A. Prospective cost allocation approach.

14) In order for a captive to provide workers' compensation coverage for its parent, it will most likely operate as a

A. Reinsurer of a fronting company.

6) Federal legislation in 1986 permitted the formation of group captives to provide liability coverage to the participants. Under the law, all participants must be from the same industry. Furthermore, the group captive only needs to be licensed in one state even if it provides liability coverage to group members from several states. The group captives formed under this federal act are called Select one:

A. Risk retention groups.

3) Captive insurers Select one:

A. Usually insures medium to high severity of losses.

1) A major issue associated with insurance-linked securities and insurance derivatives is Select one:

D. Whether they can be considered insurance and regulated as such.

A result of the convergence of insurance with other financial services is Select one:

B. An expanded role for the capital markets in risk financing. .

As a basis for hazard risk management cost allocation, a system that allocates costs to departments on the basis of their exposures, regardless of their loss experience, is Select one:

B. An exposure-based system.

Mutual Fund Company operates a family of funds. In one fund, the company is able to use a variety of financial instruments to earn higher returns. One asset in the fund is 10,000 shares of XYZ common stock. XYZ currently sells for $70 per share. The fund manager does not think the price of XYZ will increase much in the next three months. She sold a financial instrument that gives the buyer the right to purchase 10,000 shares of XYZ from Mutual Fund Company at the price of $74 per share in the next three months. If the price does not increase to $74, the financial instrument will not be exercised, and Mutual Fund Company pockets the premium (price) for which it sold the financial instrument. If the price does rise, to say $76 per share, Mutual Fund Company will be obliged to sell the stock to the financial instrument owner at a price of $74 per share. The financial instrument that Mutual Fund Company sold is called a

B. Call option.

1) Catastrophe bonds Select one:

B. Can be issued for any type of catastrophic insurable risk.

To determine how to allocate hazard risk management costs, the method of calculating loss values must be selected. Under one basis, actual loss payments plus changes to loss reserves for losses reported during the accounting period are used. This is called the

B. Claims-made basis.

18) Sale and supply contracts can substantially modify the common law that distributes loss exposures between property buyers and sellers. With no modification common law indicates that risk of loss, both to the property and from the property's loss of use, Select one:

B. Moves with the property's title.

7) Which one of the following is a negative aspect of single-parent captives that reinsurers are guarding against by exercising caution when dealing with captives?

B. Pressure from parent company management

8) A single-parent (or pure) captive Select one:

B. Requires an investment of capital by its parent(s).

Under one hazard risk management cost allocation approach, estimated costs are allocated at the start of the period during which they are expected to be incurred. The costs can be reallocated one or more times during the period or at the end of the period according to changes in loss experience. This risk management cost allocation approach is called the

B. Retrospective cost allocation approach.

After an organization determines the types and amounts of its costs of hazard risk, which it may approach prospectively or retrospectively, it must determine Select one:

B. The bases on which it will allocate the costs among its departments.

Which one of the following statements is true regarding a generic model of a securitization? Select one:

B. The organization sells income-producing assets to an SPV in exchange for cash.

9) Which one of the following standards has the Internal Revenue Service applied in recent years in determining whether the premium paid by a parent company to its captive is tax deductible?

B. The third-party business test—if the captive writes enough nonparent business, the premium is tax deductible

1) Which one of the following is an advantage of insurance derivatives? Select one:

B. They are lower in cost than insurance-linked securities

22) A legal responsibility that occurs when one party is held liable for the actions of a subordinate or associate because of the relationship between the two parties is known as

B. Vicarious liability.

16) In both noninsurance risk control and noninsurance risk financing transfers, Select one:

C. A contract is usually formed before any loss occurs.

When determining a basis for allocating hazard risk management costs, once a department's claim experience has been measured by severity, its future losses and related costs can be projected using Select one:

C. Changes in payments plus loss reserves.

2) A captive insurer Select one:

C. Collects premiums, issues policies, and pays covered losses.

My Fair City is an average-size city that is concerned about equity. One day, the city's risk manager, Mr. Penny, discovers that the city's current method of allocating hazard risk management costs is not equitable. Departments with excellent loss experience are subsidizing other departments with poor loss experience. Mr. Penny wants to determine a new, equitable cost allocation system for workers compensation. In designing the workers compensation cost allocation system for My Fair City, Mr. Penny must first Select one:

C. Determine which risk management costs to allocate for workers' compensation.

1) Adding insurance-linked securities to a portfolio can increase an investor's return without increasing its risk because

C. Insurable risk does not correlate with other types of investment risk.

23) "The contractor agrees to indemnify and hold harmless the owner against claims, damages, bodily injury, or property damage arising out of the contractor's work and caused by any act of omission of the contractor, his agents, and his employees." This is an example of which one of the following forms of a hold-harmless agreement?

C. Limited form

Which one of the following is an advantage of a retrospective hazard cost allocation system when compared with a prospective hazard cost allocation system?

C. More accurately attributes costs to a period and a department

Which one of the following statements is true about balancing risk-bearing and risk-sharing in a hazard risk management cost allocation system?

C. Most risk management cost allocation systems are a combination of risk-bearing and risk-sharing systems.

) Corn Oil Company produces vegetable oil for restaurants and for sale at supermarkets. The company just opened a new plant. Given all the other uncertainties with the new plant, Corn Oil Company would like to lock-in a fixed price for 50,000 bushels of corn to be delivered to the plant every other Friday for the next 12 months. Corn Oil Company can accomplish this goal through the purchase of Select one:

C. Put options on corn.

) An option is an agreement that gives the holder the Select one:

C. Right, but not the obligation, to buy or sell an asset at a specific price over a period of time.

) The process of creating a marketable investment security based on the expected cash flows from a financial transaction is Select one:

C. Securitization.

Which one of the following is true regarding statutory limitations on hold-harmless agreements? Select one:

C. Some statutes prohibit virtually all hold-harmless agreements.

1) When insurance-linked securities (ILSs) and insurance derivatives are not deemed insurance, an organization's balance sheet is affected in which one of the following ways?

C. The outstanding losses meant to be covered must be shown as a liability on an organization's balance sheet.

4) An agency captive is owned by Select one:

D. Insurance agents or brokers.

Four Grains Cereal Company signed a contract to deliver 250,000 boxes of cereal to a national supermarket chain at a specified price per box of cereal six months from today. Between now and when the grain to make the cereal is purchased, the cost of the grain may increase. If the cost of this important ingredient increases, the profitability of the transaction will be altered. This financial risk that Four Grains faces is

D. Price risk.

1 ) A captive insurance plan often combines use of a captive with a transfer risk financing plan. What is the typical structure of such a plan?

D. The captive insurance plan is used for high frequency and low-to-medium severity losses, with the transfer plan used for higher severity losses.

1) Which one of the following statements is true regarding the value of an insurance option? Select one:

D. The value of an insurance option increases as the underlying insurable losses increase beyond the value of the strike price.

10) A captive insurer allows the insured(s) to benefit from the cash flow available on losses that are paid out over time because

D. Under a funded plan, the captive earns investment income on premium funds that have not yet been paid out for claims.

Jeffords Company has three buildings: a retail store, a production facility, and a small office building. The square footage of the buildings and the insurance rate relativities per square foot are shown below. The property insurer charged Jeffords $50,000 to insure the three buildings. Which one of the following statements about property insurance cost allocation based on the adjusted square footage is true? Building Square Feet Rate Relativities/Sq. Feet Retail store 60,000 .20 Production facility 60,000 .25 Office building 30,000 .10 Select one:

Select one: A. The production facility should be allocated one-half of the total property insurance charge.