Learning objectives: Describe the entities that are exposed to credit risk and explain circumstances under which exposure occurs. Discuss the motivations for managing or taking on credit risk.
Questions:
24.2.1. Tan Company, an international motorcycle distributor, is experiencing a decline in sales due to a global economic slowdown. The company seeks strategies to enhance sales volumes while minimizing additional credit risk exposure. Which of the following methods would allow Tan Company to achieve an increase in sales, taking on the least amount of credit risk?
a. Purchase insurance on their accounts receivable.
b. Set up a financing arm that helps customers secure credit from other sources.
c. Require collateral from customers.
d. Sell receivables at the end of every month.
24.2.2. Ron is a risk manager for RLA, an insurance company. Below is a conversation between Ron and his colleague Warner about credit risk.
a. Ron’s statement about emerging market debt.
b. Warner’s statement about originating new policies.
c. Ron’s statement about reinsurance.
d. Warner’s statement about reinsurance.
24.2.3. Firm A, Firm B, and Firm C are three companies in the bottled water industry. All companies have a mix of debt and equity in their capital structure. In 2022 all three companies had credit losses that lowered EBIT. Below is a summary of their financial information for the year 2022.
Given the above information, which firm has the higher return on equity (ROE)?
a. Firm C has the highest ROE due to its lower equity position.
b. Firm A had the higher ROE because of its large debt position.
c. Without credit losses, firm A would have had the highest ROE.
d. Without credit losses, firm B would have had the highest ROE.
Answers here:
Questions:
24.2.1. Tan Company, an international motorcycle distributor, is experiencing a decline in sales due to a global economic slowdown. The company seeks strategies to enhance sales volumes while minimizing additional credit risk exposure. Which of the following methods would allow Tan Company to achieve an increase in sales, taking on the least amount of credit risk?
a. Purchase insurance on their accounts receivable.
b. Set up a financing arm that helps customers secure credit from other sources.
c. Require collateral from customers.
d. Sell receivables at the end of every month.
24.2.2. Ron is a risk manager for RLA, an insurance company. Below is a conversation between Ron and his colleague Warner about credit risk.
- Ron tells Warner, “RLA faces significant credit risk in our investment portfolio. We are taking on too much risk in emerging markets debt and need to find a way to hedge this risk.”
- Warner responds, “I am more concerned about the credit risk we take on when originating new policies, in particular when we extend installment terms and grace periods to our corporate customers.”
- Ron responds, “No, Warner, what we should worry about is our emerging market credit risk and the credit risk we are taking on from buying reinsurance.”
- Warner responds, “Reinsurance? Reinsurance does not create credit risk. Reinsurance helps us mitigate our risk exposure.”
a. Ron’s statement about emerging market debt.
b. Warner’s statement about originating new policies.
c. Ron’s statement about reinsurance.
d. Warner’s statement about reinsurance.
24.2.3. Firm A, Firm B, and Firm C are three companies in the bottled water industry. All companies have a mix of debt and equity in their capital structure. In 2022 all three companies had credit losses that lowered EBIT. Below is a summary of their financial information for the year 2022.
Given the above information, which firm has the higher return on equity (ROE)?
a. Firm C has the highest ROE due to its lower equity position.
b. Firm A had the higher ROE because of its large debt position.
c. Without credit losses, firm A would have had the highest ROE.
d. Without credit losses, firm B would have had the highest ROE.
Answers here:
