Question 1 Managing the Risk Management Function CLO 5 (20 Marks)
a)In a survey to find the main causes of lateness in a factory’s work force a random sample of 200 employees who were late for work were asked the reason why. The Pareto chart below shows the results. Use the Pareto chart to answer the following questions:
i.How many of the latecomers said delays at the security gate caused their lateness?
(2 marks)
ii.What percentage of latecomers blamed the security gate? (2 marks)
iii.What percentage of latecomers blamed traffic congestion? (2 marks)
iv.What the main causes that account for 80% of the problems? (2 marks)
Answer a:
(i)79 of the latecomers said that they were late due to the delay at the security gate.
(ii)39.5% of the latecomers blamed the security gate.
(iii)30% of the latecomers blamed traffic congestion for the delay.
(iv)The main causes that accounted for 79.5% of the delay problem comprise of queue at the security gate, traffic congestion and train late of miss. Apart from that bus missed or late also accounted for another 5% of the problem of latecomers. Thus, more 84.5% of the staffs delayed due to the above main problems.
b)The Long Last Tire Company, as part of its inspection process, tests its tires for tread wear under simulated road conditions. Twenty samples of three tires each were selected from different shifts over the last month of operation. The tread wear is reported below in hundredths of an inch.
i.Determine the control limits for the mean and the range (5 marks)
ii.Are there any points on the mean or the range chart that are “out of control”? Comment on the chart (3 marks)
Answer:
(i)
Part (i)
1 44 41 19
2 39 31 21
3 38 16 25
4 20 33 26
5 34 33 36
6 28 23 39
7 40 15 34
8 36 36 34
9 32 29 30
10 29 38 34
11 11 33 34
12 51 34 39
13 30 16 30
14 22 21 35
15 11 28 38
16 49 25 36
17 20 31 33
18 26 18 36
19 26 47 26
20 34 29 32
Mean control limit 31 28.85 31.85
range:
Max 51 47 39
Min 11 15 19
(ii)
The following chart will be helpful in evaluating whether there was any point in the range chart that are out of control.
As cab be seen that considering it was 100th of an inch tread wear reported below hence, none of the range in the chart are out of control.
c)In the following Six Sigma example, which is considered the defect, the symptom, and the failure? (2 marks)
Flat tire
Nail in tire
Doing construction in the driveway
Answer:
Flat tire represents the symptom.
Nail in the tire represents defect and doing construction in the driveway means the failure.
d)Develop cause-and-effect diagrams for a poor exam grade (2 marks)
Answer:
Question 2 Risk Management Decision Making CLO 4 (20 Marks)
a)Draw the decision tree and show the best option. (5 marks)
Answer:
Particulars Launch Loyalty card option Cut prices
Cost of the options 5,00,000.00 3,00,000.00
Probability of high sales 0.6 0.8
Probability of low sales 0.4 0.2
result of high sales 10,00,000.00 8,00,000.00
result of low sales 7,50,000.00 5,00,000.00
Net impact on sales 9,00,000.00 7,40,000.00
Net profit / benefit 4,00,000.00 4,40,000.00
Decision tree is prepared below:
b)The following information is known about a project
i.Draw the AON network for this project. (5 marks)
ii.What is the Critical Path and Project Duration? (5 marks)
Answer to both (i) and (ii):
c)Suppose you are trying to decide between starting two types of businesses: A lemonade stand or a candy store. The candy store has the potential to earn up to $150; the lemonade stand could earn a maximum of $120. At this point, the answer is obvious.
Go with the candy store because it can earn more than the lemonade stand.
But starting a business and making a profit is never a sure thing.
The candy store has a 50 percent chance of success and a 50 percent chance of failure.
If it succeeds, you would make $150.
On the other hand, if it fails, you would lose your startup costs of $30.
However, the weather is hot and the lemonade stand has a 70 percent chance of success and a 30 percent possibility of failure. If it works, you would make $120; if not, you lose the initial investment of $20. Which business do you choose? (5 marks)
Answer:
Candy Particulars Success Failure Net
Probability 0.50 0.50
Earnings / (loss) 150.00 -30.00
Net benefit 75.00 -15.00 60.00
Lemonade Particulars Success Failure Net
Probability 0.70 0.30
Earnings / (loss) 120.00 -20.00
Net benefit 84.00 -6.00 78.00
Thus, it is clear for an investor and he must choose lemonade business as it has greater net benefit of at $78 compared to net expected benefit of $60 from Candy business.
Question 3 Risk Financing CLO 3 (20 Marks)
a)Andrew owns a gun shop in a high crime area. The store does not have a camera surveillance system. The high cost of burglary and theft insurance has substantially reduced his profits. A risk management consultant points out that several methods other than insurance can be used to handle the burglary and theft exposure.
Identify and explain two (2) non-insurance methods that could be used to deal with the burglary and theft exposure. (4 marks)
Answer:
Two non-insurance methods are as following:
I.Installation of CCTV cameras could work as a deterrent to the thieves and other anti-social elements to result in savings of millions.
II.Recruitment of security guards in the store to protect the assets and wealth of the store.
b)Suppose you sell bicycle theft insurance. If bicycle owners do not know whether they are high-risk or low-risk consumers, is there an adverse selection problem?
Explain your response. (4 marks)
Answer:
Yes, in this case there is an adverse selection problem because the bicycle owners are unaware of their own risk profiles to take proper insurance plans.
c)Are the two funds displayed below good hedges for each other? (6 marks)
Scenario Probability Stock fund Rate of Return Bond fund Rate of Return
Severe recession 0.05 -30% -11%
Mild recession 0.25 -15% 13%
Normal Growth 0.40 15% 12%
Boom 0.30 32% -7%
Answer:
No, the two funds displayed above are not good hedges because the returns of stock fund and bond funds are half of the time similar to one another hence, these two funds are not good hedge.
d)The distribution of damage loss produced by a certain natural disaster is normally distributed with a mean of $8.1millon and a standard deviation of $0.1 million.
What is the probability that losses occur under $8.0 million? (6 marks)
Answer:
The probability of losses occurring under $8 million is 50% because the standard deviation of $0.1 million with the normal distributed loss of $8.1 million.
