Ch 1: Classifying and Analyzing Risk

A new computer chip that could position a company for explosive growth is an example of

Strategic risk.

Risks can be classified as pure or speculative. Which one of the following is the best example of a speculative risk?

Investing in shares of stock.

Jean is the Risk Manager for a Fortune 1000 company. Her CFO has tasked her to analyze vulnerabilities in the firm's supply chain. The adequacy of suppliers to meet an organization's needs would be an example of which one of the following types of risk?

Operational risk

Which one of the following best describes the categories of risk included in the enterprise risk management model?

Operational, strategic, financial, and hazard

Insurance deals primarily with

Pure risks

Company G is a manufacturer of high profile golf equipment. The risk management professional for Company G is concerned about loss of business related to product design. Failing to respond to changing customer demand and preferences in the design of golf clubs could cost Company G significant market share. Categorized according to the quadrants of risk, this exposure to loss is classified as

A strategic risk.

Classifying risk appropriately can help in managing risk. Which one of the following statements is correct with respect to the classifications of risk?

A pure risk is a chance of loss or no loss, but no chance of gain

Vandenberg Company retains workers compensation medical expenses. Based on this information, what are the expected workers compensation medical costs for next year?

$404,256

Magruder Company would like to estimate the number of workers compensation claims to expect next year. Magruder's risk manager ran a regression analysis in which the number of workers compensation claims was the dependent variable and the number of payroll hours worked (in thousands) was the independent variable. The y-intercept from the regression was 3.8. The slope coefficient was 1.4. The risk manager believes that next year Magruder workers will work 80,000 payroll hours. Based on this information, approximately how many workers compensation claims should the risk manager expect next year?

116

Richard's investment portfolio consists of common stock issued by five large oil companies. Adding the common stock issued by which one of the following companies would most improve the portfolio's risk-return position?

A discount retailer

Which one of the following statements regarding correlation analysis is true?

Abnormal observations and inaccurate data may skew correlation analysis

Which one of the following statements is true regarding the basic measures that apply to risk management?

Consequences measure the degree to which an occurrence could positively or negatively affect an organization.

Which one of the following statements about correlation and covariance is true?

Covariance measures the extent to which variables move together or independently

Risk can be classified as diversifiable or nondiversifiable. Which one of the following statements is true with respect to this type of risk classification?

Diversifiable risks tend not to be correlated so they can be managed through diversification or spread of risk.

Which one of the following statements about correlation is true?

If two variables are perfectly positively correlated, if one variable increases, the other will increase in direct proportion

Which one of the following statements is accurate regarding pure and speculative risks?

Every business venture involves speculative risks

Which one of the following provides a measure of the maximum potential damage associated with an occurrence?

Exposure

Fluctuations in the value of stocks or bonds due to interest rate changes is an example of

Financial risk

George works for a large company and part of his job is to monitor assets according to their liquidity. George is particularly concerned that the company fleet cars are affecting its liquidity and rising fuel prices are having an adverse effect during tight economic markets. If George's concerns were categorized as causes of loss according to the quadrants of risk, his concern most directly relates to which one of the following types of risks?

Financial risks

In remodeling the primary office location, Phil, who is a partner in his family's construction business, found asbestos in the attic of the building. He is concerned not only about the current tear-out exposure but is also aware that asbestos may have resulted in unidentified harm. In the "quadrants of risk," Phil's concern about the asbestos most likely falls into which one of the following quadrants of risk?

Hazard risks

Which one of the following types of risks can result in losses but not in any gains?

Hazard risks

The relationship between which two basic measures is critical for risk management in assessing risk and deciding whether and how to manage it?

Likelihood and consequences

Mid-State Packing Company, a meat processing company, is the largest private sector employer in Metro City. First National Bank of Metro City loans money to Mid-State Packing Company and to many of the employees of Mid-State. The problem with First National Bank of Metro City loaning money to both the business and many employees of the business is that

Loan defaults are likely to be highly correlated.

Billy owns a beach front cottage which has become his primary residence. Billy's primary concern is that his home will be hit by a hurricane and badly damaged or even destroyed. For Billy, this hurricane risk is a

Subjective risk

Jane always drives to visit her children who live one thousand miles away. She enjoys driving and feels safer in a vehicle than on an airplane because she feels she has more control of her fate. This driving versus flying decision is an example of

Subjective risk

Risk can be classified as subjective or objective. Which one of the following statements is correct with respect to these risk classifications? Choose one answer. A. Subjective risk is risk associated with individuals; objective risk is risk associated with objects or things. B. Risk managers focus on objective risk and attempt to avoid allowing subjective risk to affect their decisions. C. Subjective risk can exist even where objective risk does not. D. Individuals' subjective perception of risk in a given set of circumstances is typically much higher than the objective risk.

Subjective risk can exist even where objective risk does not.

During the past year, International Toys has undertaken four capital projects. The company has renovated and refurbished one of its aging warehouse buildings. It has purchased the most recent version of its current older processing computer software. It has added two trucks to its fleet of delivery vehicles. Lastly, it has purchased a new production machine that will allow it to launch a new product line. Which one of the following company projects is the most speculative risk?

The new production machine

Ed is investment manager of the Nellor Foundation. The purported reduction in risk occurs because

The real estate investment returns are negatively correlated with the other assets

Which one of the following statements is true with regard to linear regression analysis?

The regression line represents the "best fit" of a straight or smoothly curved line to actual historical data from prior periods

According to the law of large numbers, as the number of exposure units insured increases,

The relative accuracy of predictions about future losses increases

The focus of risk quadrants is different from the focus of risk classifications in general. While the classifications of risk focus on some aspect of the risk itself, the four quadrants of risk focus on

The source of risk and who has traditionally managed it

Regression analysis assumes that

The variable being forecast varies predictably with another variable

One enterprise risk management (ERM) approach to categorizing risks involves dividing risks into four risk quadrants. The risks categorized as hazard risks are Choose one answer. A. Traditionally managed by risk management professionals. B. Speculative risks that fall outside the operational risk category. C. Traditionally handled by the treasury function. D. Fundamental to an organization's existence and business plans.

Traditionally managed by risk management professionals.

As analysis that identifies mathematical patterns in past losses and then projects these patterns into the future is

Trend analysis

Patridge Office Supplies has a history of theft losses as follows: Based on Patridges loss history, the most appropriate forecasting technique is

Trend analysis

Widget Manufacturing Company has noticed that its loss frequency and severity has increased in the past two years as its production has increased. In order to better forecast loss frequency and severity, Widget Manufacturing Company should consider using

Trend analysis

Regression analysis assumes that the variable being forecast

varies predictably with another variable