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Flashcards in Econ 4 - Financial Risk Management Deck (70)
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Interest Rate Risk affects

both small and large organizations


Risks for small firms include

- inability to use broader capital markets
- unable to diversify operations
- inability access more suppliers


Operations Risk is

the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events


In negotiating a loan, the more favorable type of interest for the bank is _____ and the more favorable type of interest for the customer is ______

bank = compound interest
customer = simple interest


Over an extended period of time, how does interest on LT debt compare to interest on ST debt?

Interest on LT debt cost more


Effective Annual Interest Rate =

Total Interest / Obligation Amount
*be careful of the method of compounding other than yearly


Per FASB ASC 815, if an entity engages in a hedge against the exposure to variable cash flow of a forecasted transaction, the entity would

recognize the effective portion of the derivative's gain or loss initially as a component of other comprehensive income, and subsequently reclassify it into earnings when the forecasted transaction affects earnings.


Effective Rate of Interest (interest paid on a discount basis) =

Interest Paid / Usable Funds or [Loan amt - Discounted Interest - Compensating Balance]


Discount Interest is

a situation where all interest on a loan is paid at once and the interest amount is deducted from the amount the borrower will receive at the beginning of the loan


The Effective Annual Interest Rate will = Nominal or Stated Rate if compounding is done



The highest Effective Interest Rate occurs when compounding is done



The TRUE rate of interest is the same as the

Effective Rate


Financial Risk Mgmt is a component of ERM and includes risks such as:

- Business risk
- Operations risk
- Supply-chain risk
- Product liability risk
- Political and Economic risk


In the risk mgmt process, what strategies does the firm have to manage its risk?

Accept, transfer, or manage


If the dollar price of the euro rises

the dollar depreciates against the euro and the euro will buy more US goods


FV of an Investment using compound interest will always be ____ the same investment using simple interest

more than


Market Rate of Interest =

Risk Free Interest Rate + Inflation Premium


What would encourage a company to use short-term loans to retire 10-yr bonds that have 5-yrs to maturity?

Interest rates declined over the last 5 years (assuming they continue to decline, pay less interest)


Freely fluctuating (floating) exchange rates do what?

Auto-correct a lack of equilibrium in the balance of payments


When banks allow a customer to refinance a mortgage loan at any time without a prepayment penalty, they engage in

option risk

Allowing a customer to prepay a mortgage without a prepayment penalty gives the customer a call option, i.e., the right to pay the mortgage in full at any time during the mortgage term, thus changing the cash flow stream the firm receives from the mortgage.


The risk management process includes both internal and external controls and involves

- Identifying and prioritizing risks and understanding their relevance
- Understanding the stakeholder's objectives and their tolerance for risk
- Developing and implementing appropriate strategies in the context of a risk management policy


Usury Laws are

regulations governing the max amount of interest that can be charged on a loan


One negative consequence of Usury Law regulations from the borrower's perspective is

less creditworthy customers are excluded from the market


Credit Union was offering fixed rate mortgages to its members but decides it can longer afford to offer this service and instead decides to offer variable rate mortgages with the interest rate tied to an index and adjusted yearly. The interest rate risk has been

transferred (from the credit union to the member)


Key elements of Financial Risk Management include

- Interest rate risk
- Foreign currency risk
- Credit risk


Assuming a 360-day year, the current price of a $100 U.S. Treasury bill due in 180 days on a 6% discount basis is:

Price = Face amount - Interest
$97 = $100 - (100 x 0.06 x (180/360))


When a US parent company reviews the Cash Flow from its international subsidiaries, the primary considerations are

exchange rate risk and repatriation restrictions (repatriation restrictions limit the parent’s ability to receive cash from international subsidiaries)


The future value of $100 invested today for three years at an annual interest rate of 8% using the simple interest method is


Total = Principal + Interest
$124 = $100 + ($100 x 0.08 x 3)


Individuals who would be most hurt by inflation include

- those on fixed income (same $ have be stretched further)
- those who lent money on a fixed interest rate (they will be paid back in cheaper $)
- those who save cash dollars (purchase power of $ decreases)


Zoo Supply Company borrowed $100,000 from a local bank to purchase equipment. The annual interest rate on the 5-year loan was 10%. Over the 5-year period, Zoo paid $50,000 of interest. This interest was calculated as

simple interest