Term
| Whats the goal of risk management? |
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Definition
| To increase the value of the firm (not to minimise or eliminate risk) |
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Term
| How can you estimate expected bankruptcy costs? |
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Definition
| = probability of filing for bankruptcy * the costs incurred |
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Term
| Can the risk of bankruptcy and financial distress be hedged by shareholders? |
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Definition
| No - thus it may be value increasing for the firm to undertake risk management to reduce or eliminate these costs. |
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Term
| Explain how risk management can create value by moving income across time and reducing taxes: |
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Definition
- if higher firm income is taxed at a higher rate than lower firm income, there is a possible reduction in total taxes from smoothing tax income through risk management.
Tax loss carrybacks or carry forwards can be used.
These make no adjustment for the time value of money. |
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Term
| Can having a large shareholder increase firm value? how? |
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Definition
Yes, by:
- having expertise in the firms business or industry (providing advice)
- monitor management
- can decrease agency costs (that result from a divergence between management incentives and shareholder wealth maximisation) |
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Term
| When is a firm said to have decreased value due to debt overhang? |
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Definition
| when the amount of debt prevents equity holders from investing in positive net present value projects because the benefit to debt holders reduces the value created for equity holders. |
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