Risk Management

Question 1: Corporate Value at Risk

Consider the FTZ Company as discussed in Lecture 6 on Value-at-Risk. Suppose the financial price uncertainty faced by FTZ has increased drastically for the next budget year. In particular, the annualized standard deviation of euro/dollar exchange rate has increased to 12%, the standard deviation of aluminum price to $70 and the standard deviation of interest rate is 1.3%.

a) Determine the 99% Value at Risk for FTZ by doing 1,000 simulations on its pre-tax earnings.

The 99% VaR = 168,720 – 156,979 = 11,741

b) Plot the probability distribution of FTZ’s pre-tax earnings and indicate the 99% Value-at-Risk on the graph. Explain the meaning of the 99% Value-at-Risk.

c) FTZ’s financial controller figures that next year’s cash flow will very tight and is applying for a line of credit from Nopay Bank that can cover the potential shortfall of pre-tax earnings with 99% confidence level. FTZ’s cash reserve next year is estimated to be $5 million only. Determine the size of the line of credit.

d) FTZ’s financial controller is also trying to figure the worst-case scenario that the line of credit in part (c) fails to cover the shortfall of earnings. Suppose the line of credit is indeed exhausted. Determine the additional liquidity needed in order to cover the expected shortfall in earnings.

Question 2: Assessing a Firm’s Future Financial Health

Read the Harvard Business Case on “Assessing a Firm’s Future Financial Health” and answer the following three questions.

1. What is your assessment of the performance of SciTronics in 2008 versus 2005?

2. Has SciTronics’ financial strength and access to finance improved or weakened?

3. What are the 2-3 most important questions that you would ask management as a result of your analysis?

4. What additional (and reasonably available) information would be important if a sound analysis of SciTronics’ performance is to be made?...