Question

1. Briefly explain the relationship between capital structure, insurance and strategic risk management. When do insurance and risk management add to firm value? When do they not add to firm value?

Answer 1

By the term Capital structure, we mean the proportion of sources of funds used to acquire the assets and to meet the operating needs of the firm. Capital structure is a combination of long-term debts, short-term debts, equity and preferred stocks. Capital structure must be optimal so that the overall cost of capital is low of the firm. Analysts usually uses the debt-equity ratio to analyse how risky a firm is. If capital structure depends heavily on the debt, then it is more risky. Therefore, optimal combination of debt and equity must be there so that it does not impact the overall growth of the firm as aggressive capital structure are more risky, but have higher return and vice versa.

Insurance is a guarantee of compensation provided by the company for the specified loss or damage, illness or death in exchange of a predetermined premium.

Strategic risk Management is the management of risk and deciding the tolerance level of risk associated with business strategies, it's objectives and its execution. It arises usually when firm fails to forecast the market's need in time to fulfill them.

Relationship

The common relationship among the capital structure, insurance and strategic risk management is that they all are associated with risk as a major factor. These all contribute to the firm's value and through there proper management risk can be reduced and which will reduce the overall cost of capital and eventually increase the firm's value.

Insurance and risk management adds to firm value when they are able to manage the firm's risk. If they manage the company's risk it will lower the cost of capital and will contribute to firm,s value.

They do not add to firm's value when they are unable to lower the risk that arises by the natural calamities or any of the government policies changes.