[ 2009 FRM Sample Exam ] Operational and Integrated risk management Q24

Abey

 

24. One of your colleagues believes that risk management is driven by well-meaning regulators but it does not create economic value. Which of the following concepts would not be helpful to persuade him that risk management can create value for a firm?

A. Deadweight costs of financial distress and bankruptcy

B. Debt overhang mitigation

C. Homemade hedging for well-diversified shareholders

D. Tax rationale when income is taxed differently at different levels of income

Abey

 

Correct answer is Cfficeffice" />

C is correct.  `Well-diversified investors are relatively unaffected by firm-specific events, and therefore risk management does not provide homemade hedging.

Reference:  6.       René Stulz, Risk Management & Derivatives.  Chapter 3.

A is incorrect. Risk management creates value by reducing deadweight costs.

B is incorrect.  Risk management reduces the probability of future debt overhang which increases firm value.    

D is incorrect. Risk management reduces taxes, particularly when income is taxed differently at different levels.