Individual Assignment Risk Management Question 1: (8 points) The pre-tax profit of a company is uncertain and is either EUR - 50 (a loss) or EUR 250 (a profit), both with a probability of 0.5. The corporate tax schedule is the following: in case of a loss, there are no tax payments. In case of a profit, the tax rate is 40 percent. Suppose the company can eliminate the risk of the profits (i.e. through hedging for no costs) and can instead realize a certain profit of EUR 100. By how much does risk management reduce the expected tax burden? Explain briefly the results. Do you find real life examples in which tax decisions might increase the firm value? Question 2 (8 points): Core risks A bank’s core business is trading financial derivatives e.g. interest rate swaps and fx forwards with corporate clients. The derivatives are used for hedging purposes. The following risk and return numbers for the trading portfolio are given for the last year. The return of 9 from market risk is driven by 8 from commission income and 1 by income from open position (proprietary trading). Risk Return Market Risk e.g. from basis risk 10 9 Counterparty risk e.g. from derivatives business 10 -6 Total risk in the trading portfolio after diversification 15 3 a. What is the core competence and what is the core risk of the trading department? b. Losses in counterparty risk occurred because of a couple of defaults of corporate clients. The CEO states, that this risk is core, whereas the chief trader states that it is non-core. What is your opinion? What could the bank do to mitigate this risk? Question 3 (26 points): Hedging Lufthansa needs to buy oil for US$ 10 million in three months time. Interest rate for T=0.25 years (3 months) in US $ is 0.27% and the € interest is 0.77%. The current spot FX is SFX,0=1.31. Current oil spot price is SComm,0=100. a) For a full fx hedge, what would be the appropriate forward position? Assume, so far that the commodity risk is fully hedged. b) Determine the fair forward price FFX,0 in USD/EUR in t=0? Note: 0 , 0 ) 1 ( ) 1 ( ) / ( FX T EUR T USD S r r EUR USD F × + + = c) What is the total profit & loss in T (after 3 months) of the hedged position? d) The bank takes a forward commission of 10 basispoints (1 basispoint = 0.01 %) on the forward price. What is the overall cost of the hedge? e) The company considers an option hedge as an alternative. What would be the appropriate option position? Illustrate graphically (see below) the profit and loss for the spot position, the forward, the option and the total positions (one for the forward hedge, one for the option hedge). What are the main advantages and disadvantages of an option hedge? f) What is the oil forward price FComm,0 for a convenience yield y = 6 % p.a.? What is the economic interpretation of this yield? Note: FComm,0 = (SComm,0+U ) *(1+rUSD-y)T, with U as the face value of storage costs, one year storage costs are 2 $ (paid at the end of three months). g) Luf.

1. Individual Assignment Risk Management
Question 1: (8 points)
The pre-tax profit of a company is uncertain and is either EUR -
50 (a loss) or EUR 250 (a profit), both with a probability of 0.5.
The corporate tax schedule is the following: in case of a loss,
there are no tax payments. In case of a profit, the tax rate is 40
percent. Suppose the company can eliminate the risk of the
profits (i.e. through hedging for no costs) and can instead
realize a certain profit of EUR 100. By how much does risk
management reduce the expected tax burden? Explain briefly
the results. Do you find real life examples in which tax
decisions might increase the firm value?
Question 2 (8 points): Core risks
A bank’s core business is trading financial derivatives e.g.
interest rate swaps and fx forwards with corporate clients. The
derivatives are used for hedging purposes. The following risk
and return numbers for the trading portfolio are given for the
last year. The return of 9 from market risk is driven by 8 from
commission income and 1 by income from open position
(proprietary trading).
Risk
Return
Market Risk e.g. from basis risk
10
9
Counterparty risk e.g. from derivatives business
10
-6
Total risk in the trading portfolio after diversification
15
3
a. What is the core competence and what is the core risk of the

2. trading department?
b. Losses in counterparty risk occurred because of a couple of
defaults of corporate clients. The CEO states, that this risk is
core, whereas the chief trader states that it is non-core. What is
your opinion? What could the bank do to mitigate this risk?
Question 3 (26 points): Hedging
Lufthansa needs to buy oil for US$ 10 million in three months
time. Interest rate for T=0.25 years (3 months) in US $ is 0.27%
and the € interest is 0.77%. The current spot FX is SFX,0=1.31.
Current oil spot price is SComm,0=100.
a) For a full fx hedge, what would be the appropriate forward
position? Assume, so far that the commodity risk is fully
hedged.
b) Determine the fair forward price FFX,0 in USD/EUR in t=0?
Note:
0
,
0
)
1
(
)
1
(
)
/
(
FX
T
EUR

3. T
USD
S
r
r
EUR
USD
F
×
+
+
=
c) What is the total profit & loss in T (after 3 months) of the
hedged position?
d) The bank takes a forward commission of 10 basispoints (1
basispoint = 0.01 %) on the forward price. What is the overall
cost of the hedge?
e) The company considers an option hedge as an alternative.
What would be the appropriate option position? Illustrate
graphically (see below) the profit and loss for the spot position,
the forward, the option and the total positions (one for the
forward hedge, one for the option hedge). What are the main
advantages and disadvantages of an option hedge?
f) What is the oil forward price FComm,0 for a convenience
yield y = 6 % p.a.? What is the economic interpretation of this
yield?
Note: FComm,0 = (SComm,0+U ) *(1+rUSD-y)T, with U as the
face value of storage costs, one year storage costs are 2 $ (paid
at the end of three months).
g) Lufthansa wants to hedge its kerosene risk using oil
contracts. Explain the basis risk for this strategy.
h) Lufthansa decides not to hedge the commodity risk. How
might this impact the fx hedge?

4. Question 4 (8 points): Financial Crisis
The financial crisis was caused in the beginning by liquid asset
backed securities turned illiquid. How did this risk turn into
funding problems of banks? Explain briefly the market
illiquidity problem and the funding problem of banks? How
could this impact the loan lending business of the bank?
_1428497860.unknown
APOL 104
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The Gospel Message
The Apostle Paul said, “For I am not ashamed of the gospel of
Christ, for it is the power of God
to salvation for everyone who believes, for the Jew first and
also for the Greek” (Romans 1:16).
Paul should know, since his life was radically transformed when
Jesus confronted him on the
road to Damascus (Acts 9, 26:4–18). Once he knew Jesus and
His power, nothing held him back
from telling others about the risen Christ. He shared this
gospel, the “good news,” with anyone
who would listen to him, regardless of their religion or moral
background. Paul once wrote to a
group of Christians telling them about this gospel. He said:
Moreover, brothers, I declare to you the gospel which I
preached to you, which
also you received and in which you stand, by which also you are

5. saved, if you
hold fast that word which I preached to you—unless you
believed in vain. For I
delivered to you first of all that which I also received: that
Christ died for our sins
according to the Scriptures, and that He was buried, and that He
rose again the
third day according to the Scriptures (1 Corinthians 15:1-4).
Be assured, this same gospel that changed and motivated Paul is
for you and me today. In
understanding the gospel message we find out that:
• Jesus paid the price for our sins (I Peter 3:18).
• Our sins can be forgiven (Ephesians 1:7).
• We can have eternal life by trusting in Him (John 3:15).
The word “gospel” is mentioned over 100 times in the Bible by
Jesus and His disciples. Jesus
was the source and subject of this good news. Jesus began his
ministry by sharing this central
truth, “The time is fulfilled, and the kingdom of God is at hand.
Repent, and believe in the
gospel” (Mark 1:15). Jesus personally shared the gospel with
those who listened to Him and
today He is sharing it through the Bible and those who know
and follow Him. He wants
everyone to believe this gospel. But why is the gospel needed
and how do people come to
understand clearly what it means to become a follower of Christ
and believe this gospel
message?

6. The Problem
The problem is that all people are born sinners and sin separates
them from God. “Your [sins]
have separated you from your God” (Isaiah 59:2). The problem
started in the Garden of Eden.
Adam and Eve were given clear instructions by God. They were
free to eat of any tree in the
garden except the tree of the knowledge of good and evil. God
told them, “Of the tree of the
knowledge of good and evil you shall not eat, for in the day that
you eat of it you shall surely
die" (Genesis 2:17). Being deceived by Satan (the serpent), Eve
ate the fruit of the tree and gave
the fruit to Adam, who willingly (rebelliously) ate it (Genesis
3:1-6).
So what is the big deal? This is a very serious matter. The God
of the Bible clearly states that
He cannot tolerate the least amount of sin in His presence.
Psalm 5:4 says, “You are not a God
who takes pleasure in wickedness, nor shall evil dwell with
You.”
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Also, Adam’s choice affected the entire human race. Because
of Adam’s rebellion, all people
are born sinners (Psalm 51:5) and since then everyone willingly
chooses to sin. The Apostle
Paul explained, “Just as through one man (Adam) sin entered

7. the world, and death through sin,
and thus death spread to all men, because all sinned” (Romans
5:12), and “all have sinned and
fall short of the glory of God” (Romans 3:23). Everyone is a
sinner and this sin separates each
person from a holy God (Isaiah 6:3). So, what is the solution;
how can sinful humans ever hope
to inhabit a holy heaven with a holy God?
The
Solution
Throughout human history people have attempted to solve this
problem on their own. Religions
have been developed which require people to do good works in
order to earn eternal happiness
and rewards. This “solution” is really an issue of pride.
Salvation is all about God and His
grace. Salvation is “the gift of God, not of works, lest
anyone should boast.” (Ephesians
2:9)
Salvation cannot be earned through good works. So what is the
real solution? The solution

8. comes from God Himself. God knew that humans could not
achieve heaven by good works.
That is why Jesus Christ, the Son of God came to die for our
sins (John 3:16; II Peter 3:9). The
Apostle Peter explained, “For Christ also suffered once for sins,
the just for the
unjust, that He might bring us to God” (I Peter 3:18). Even
though this sin had separated people
from God, Jesus willingly “bore our sin in His own body on the
cross that He might bring us to
God” (2 Peter 2:24). God loved us and “demonstrated His love
toward us in that while we were
still sinners, Christ died for us” (Romans 5:8). Jesus paid the
ultimate sacrifice so that mankind
could receive forgiveness of sins and have eternal life in
heaven. What a deal! Jesus paid the sin
debt that we could not pay so that we could receive His
righteousness (2 Corinthians 5:21).
The Choice
God does not force anyone to accept His Son, Jesus Christ. It is
a free choice, a gift that He
offers to everyone. “The wages of sin is death, but the gift of

9. God is eternal life in Christ Jesus
our Lord” (Romans 6:23). So what is the choice we need to
make to receive forgiveness of sins
and life eternal in heaven? Again, the Bible is clear. A person
must repent of their sins and must
believe in the Lord Jesus Christ. Jesus said, “The time is
fulfilled, and the kingdom of God is at
hand. Repent, and believe in the gospel” (Mark 1:15).
The word “repent” means to change one’s mind. A person first
needs to change his or her mind
about God. Many concepts exist about God in our world today,
but to make an informed choice
we must have a biblical understanding of God and Christ. Jesus
did not say He was a way to
God; He said He was the only way to God. Jesus excludes all
other “ways” when He says, “I am
the way, the truth, and the life. No one comes to the Father
except through Me” (John 14:6).
The disciples said the same exact thing, “Salvation is found in
no one else, for there is no other
name under heaven given to men by which we must be saved"
(Acts 4:12). Jesus is the only way
to God.

10. APOL 104
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A person also needs to change his or her mind about sin. It is
not about trying to be good person
and living life the way she or he wants to live it. Rather, it is
making a conscious choice to
become a follower of Christ and His Word. Jesus said “If
anyone desires to come after Me, let
him deny himself, and take up his cross, and follow Me”
(Matthew 16:24).
The word “believe” means “to trust or have faith in.” It also has
the idea of being persuaded.
Biblical faith is not a “blind leap”. It is based upon the Bible,
reason and evidence. “Faith is the
evidence of things not seen” (Hebrews 11:1). Thomas, one of
Jesus’ disciples did not believe
that Jesus had risen from the dead unless he was able to put his
fingers into Jesus’ nail pierced
hands and side. Jesus did not rebuke him for a lack of faith.

11. He let him feel the nail prints and
what was Thomas’ response; “Thomas answered and said to
Him, My Lord and my God!” (John
20:28).
The resurrection of Jesus Christ is an essential fact of history
and the gospel message. If Jesus
did not rise from the dead then Christianity is just another man-
made religion. The apostle Paul
understood this when he said, “If Christ is not risen, your faith
is futile; you are still in your
sins!” (I Corinthians 15:17).
What must a person believe in order to become a follower of
Christ? First, that Jesus is who He
said He was. “If you do not believe that I am He, you will die in
your sins” (John 8:24). Here,
Jesus placed our eternal well-being entirely on the issue of
getting what we believe about Him
correct. One must also believe that He died on the cross for his
or her sins; that He was buried;
and that He was raised from the dead (I Corinthians 15:1-4).
The Apostle Paul spelled it out
when he said that “if you confess with your mouth, Jesus is
Lord, and believe in your heart that

12. God raised him from the dead, you will be saved” (Romans
10:9). It is a personal choice.
Hopefully, it is your choice.
The Invitation
If after reading this gospel message you understand what it
means to be a follower of Christ and
you would like to receive Him as your Savior you can do that
today. "Whoever will call on the
name of the LORD shall be saved” (Romans 10:13). Your
personal relationship with God can
begin right now through praying a prayer from the heart. You
could pray a simple prayer like
this:
Heavenly Father, I know that You are holy and hate sin. I
know that I am a
sinner and I can’t get to heaven by my own works. I believe
that Jesus died on
the cross for my sins, was buried, and that He rose again. I
repent of my sins and
believe that Jesus alone can save me. I want to be a follower of

13. Jesus and His
Word. Come into my life and save my soul. Thank you for
saving me! In Jesus’
name, Amen.
Although this article was designed for Discussion Board Forum
2, if after reading this you
prayed to receive Christ as your Savior, please contact your
APOL 104 course instructor so they
can celebrate your decision with you.