RISK & INSURANCE MANAGEMENT
CASE – 1
a. With regard to the fuel oil prices risk:
(1) Discuss how Juanita could use futures contracts to hedge the price risk.
Futures contracts are one of the most common derivatives used to hedge the price risk. A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price. The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price. The ultimate goal of an investor using futures contracts to hedge is to perfectly offset their risk. In real life, however, this is often impossible and, therefore, individuals attempt to neutralize risk as much as possible instead. For example, if a commodity to be hedged is not available as a futures contract, an investor will buy a futures contract in something that closely follows the movements of that commodity.
When a company knows that it will be making a purchase in the future for a particular item, it should take a long position in a futures contract to hedge its position. For example, suppose that Company X knows that in six months it will have to buy 20,000 ounces of silver to fulfill an order. Assume the spot price for silver is $12/ounce and the six-month futures price is $11/ounce. By buying the futures contract, Company X can lock in a price of $11/ounce. This reduces the company's risk because it will be able close its futures position and buy 20,000 ounces of silver for $11/ounce in six months.
(2) Discuss how a double-trigger, integrated risk management plan could be employed.
Risk management is a critical and essential measure in the world of business. Small and large companies alike face many liabilities ranging from product damage and employer safety to consumer health and natural disasters. Mitigating these risks requires a clearly outlined and comprehensive risk management plan. Plans may cover countless areas of individual risks and double-trigger possibilities. Double-trigger risks are when two risks actualize simultaneously. Implementing a double-trigger integrated risk management plan should be a consideration for any serious business policy
b. What is the net present value (NPV) of the sprinkler system project, assuming the rate of return required by GWS investors is 10 percent?
The net present value, or NPV, is one of the most common methods used to evaluate investments. At its simplest, NPV is the present value computed by using the firm's cost of capital as the discount rate of cash inflows, minus the present value of cash outflows, including the initial investment.
Cash inflows and outflows can occur at any time during the project. The NPV of the project is the sum of the present values of the net cash flows for each time period t, where t takes on the values 0 (the beginning of the project) through N (the end of the project).
This can be expressed as
Sometimes, for convenience, this can be written with the initial cash flow listed separately as
C0 is negative if there is an initial cash outflow.
Apply the perpetuity formula, rate of return at 10 percent, to calculate the PV of the annual cash inflows.
= -$1,000,000 + $150,000 / 0.1
The NPV of the sprinkler system project is $500,000.
c. How many derailments should Juanita expect next year, assuming the regression results are reliable and GWS goes ahead with the expansion plan?
In statistics, regression analysis is a statistical process for estimating the relationships among variables. It includes many techniques for modeling and analyzing several variables, when the focus is on the relationship between a dependent variable and one or more independent variables. More specifically, regression analysis helps one understand how the typical value of the...
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