Dynamic Risks correct answers - Risks that result from changes in the economy correcting a misallocation of resources e.g. changes in the price level, consumer tastes, income, and output.
- Tend to benefit society in the long run, the short run may be a bit volatile
Static Risks correct answers...
BU 353 - Midterm 1 || Already Graded A+.
Dynamic Risks correct answers - Risks that result from changes in the economy correcting a
misallocation of resources e.g. changes in the price level, consumer tastes, income, and output.
- Tend to benefit society in the long run, the short run may be a bit volatile
Static Risks correct answers - Occur even if no macroeconomic changes
- Some individuals still suffer loss through accidents, theft etc
Fundamental Risks correct answers - Impersonal in origin (e.g. unemployment, earthquake, war)
- Particular risks arise from individual and personal events e.g. theft, fire
- Often protected by government social programs rather than insurance
Pure Risk correct answers - Involves a net loss to society
- Normally insurable via traditional insurance products
Speculative Risk correct answers - E.g. Gambling and investing in stock market
- Cannot be insured via traditional insurance products
Strategic Risk correct answers - Risk associated with an organizations ability to achieve their
business strategy
- These risks tend to be managed at the C-suite level of a company
Financial Risk correct answers - Refers to the uncertainty over future cash flows due to changes
in the prices, asset values, exchange rates, liquidity, and credit
Operational Risk correct answers - Encompasses losses resulting from inadequate or failed
internal processes, systems, or people
- These risks have traditionally been managed informally by line managers as part of everyday
operations
Hazard Risk correct answers - Those risks that pose a threat to life, health, property, or the
environment
- Considered a pure risk
- Examples include liability claims, damage to property due to theft or fire, losses due to natural
catastrophes
Direct Loss correct answers - Includes losses from damage, destruction or expropriation of
assets, payments to injured or ill employees and the cost of paying and defending against liability
claims
Indirect Loss correct answers - After an event, a firm may not be up and running immediately
and therefore suffers indirect losses
- Damage to assets (direct losses) can reduce cash flow that the asset would have generated if the
damage had not occurred
, Expected cost of losses correct answers - includes both direct and indirect losses
Cost of loss control correct answers - cost of additional testing and safeguards, cessation of a
product line that may be too risky
cost of loss financing correct answers - opportunity cost of money put into reserves to cover
losses, insurance loading (premium dollars to cover expected losses would be included in the
expected cost of losses), transaction costs in arranging hedging.
- does NOT include the pure premium or the expected cost of losses, since this is included in the
expected cost of losses
Cost of Internal Risk Reduction Methods correct answers - Include the cost of managing a
diversified set of activities, cost of data collection and analysis
- Previous methods of risk reduction were external, these are internal
- Diversification can be expensive if it requires such a large distribution network of if because of
diversification economies of scale are not obtained
Residual Uncertainty correct answers - Even after all measures are taken, some uncertainty with
respect to future cash flows and losses remains
- Uncertainty is expensive to risk averse individuals
- Assume that if one can eliminate monetary uncertainty the residual cost of uncertainty is also
eliminated
What is the actuarially fair value? correct answers The actuarially fair value of insurance is the
expected claim that will be paid by the insurer
How is the expected loss calculated? correct answers L and the probability of loss is p, then the
actuarially fair value is pL
Why do firms purchase insurance services? correct answers - Insurers offer related services of
claims processing and loss control
- Reduce financing costs - cost of issuing new securities to either pay for losses or to undertake
new projects
- They mandated by law
- Reduce likelihood of financial distress - bankruptcy or financial distress is expensive
- Reduce expected tax payments - insurance increases expenses which reduces taxable income
What are the factors favouring retention correct answers - Cash flow
- Premium loading charged by the insurer
- Flexibility to reallocate funds after a loss
What are the factors favouring insurance? correct answers - Ability to predict costs (and cash
flows)
- Earlier tax deduction
- Risk spreading
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