MODULE 5 (RISK MANAGEMENT) 6. Why might a large, multinational company choose to insure against common...

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MODULE 5 (RISK MANAGEMENT) 6. Why might a large, multinational company choose to insure against common events, such as vehicle accidents, but not against rare events which could cause large losses? Explain briefly. 7. "The farmer does not avoid risk by selling wheat futures. If wheat prices stay about $2.80 a bushel, then he will actually have lost by selling wheat futures at $2.50." Is this a fair comment? 8. List some of the commodity futures contracts that are traded on exchanges. Who do you think could usefully reduce risk by buying each of these contracts? Who do you think might wish to sell each contract? 9. Genentech's main facility is in South San Francisco. Suppose that Genentech would experience a direct loss of $450 million in the event of a major earthquake that disrupted its operations. The chance of such an earthquake is 2% per year, with a beta of -0.5. a) If the risk-free interest rate is 5% and the expected return of the market is 10%, what is the actuarially fair insurance premium required to cover Genentech's loss? b) Suppose the insurance company raises the premium by an additional 15% over the amount calculated in part (a) to cover its administrative and overhead costs. What amount of financial distress or issuance costs would Genentech have to suffer if it were not insured to justify purchasing the insurance? MODULE 5 (RISK MANAGEMENT) 6. Why might a large, multinational company choose to insure against common events, such as vehicle accidents, but not against rare events which could cause large losses? Explain briefly. 7. "The farmer does not avoid risk by selling wheat futures. If wheat prices stay about $2.80 a bushel, then he will actually have lost by selling wheat futures at $2.50." Is this a fair comment? 8. List some of the commodity futures contracts that are traded on exchanges. Who do you think could usefully reduce risk by buying each of these contracts? Who do you think might wish to sell each contract? 9. Genentech's main facility is in South San Francisco. Suppose that Genentech would experience a direct loss of $450 million in the event of a major earthquake that disrupted its operations. The chance of such an earthquake is 2% per year, with a beta of -0.5. a) If the risk-free interest rate is 5% and the expected return of the market is 10%, what is the actuarially fair insurance premium required to cover Genentech's loss? b) Suppose the insurance company raises the premium by an additional 15% over the amount calculated in part (a) to cover its administrative and overhead costs. What amount of financial distress or issuance costs would Genentech have to suffer if it were not insured to justify purchasing the insurance?