[ 2009 FRM Sample Exam ] Operational and Integrated risk management Q23 management, following, principal, interest, payments

Abey

 

23. Which of the following risk management strategies of a firm which has principal payments to make on its debt in one year that substantially exceed the market value of its assets is most likely to be in the interest of the shareholders?

A. Reduction of the overall risk level of the firm

B. Increase of the overall risk level of the firm

C. Keep the same risk level

D. It is impossible to say which risk management strategy the shareholders prefer

Abey

 

Correct answer is Bfficeffice" />

Once a firm is in distress, it is not in the interests of shareholders to reduce risk.  If the firm stays in distress and eventually defaults, shareholders will end up with worthless shares. In these circumstances, management intent on maximizing shareholder value will seek out new risks.

Reference: Risk Management and Derivatives, Stulz, 2003.

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