Financial Risk Manager Part 1

Settlement risk is a type of credit risk that arises when one party in a transaction fails to honor their financial obligations on the settlement date. In the context of the scenario described, BT Motors, despite being in a net loss position of $6.9 million, refuses to pay the entire amount. This refusal to fulfill their financial commitment is a clear example of settlement risk. Settlement risk is a significant concern in financial transactions, particularly in derivative contracts like the one between BT Motors and New Atlas bank. It can lead to substantial financial losses for the party that is left unpaid, in this case, New Atlas bank. Therefore, it is crucial for financial institutions to manage and mitigate settlement risk effectively to protect their financial interests.

Choice A is incorrect. Bankruptcy risk refers to the risk that a firm will be unable to meet its financial obligations due to insolvency. While BT Motors is refusing to pay, there's no information suggesting it's because they are insolvent or facing bankruptcy.

Choice B is incorrect. General market risk refers to the potential for losses due to changes in market conditions such as interest rates, exchange rates, commodity prices etc. In this case, while the derivative contract was indeed meant as a hedge against exchange rate fluctuations, the issue at hand isn't about general market risk but rather BT Motors' refusal to settle its obligations.

Choice D is incorrect. Default risk pertains to the possibility that a party will not fulfill their contractual obligations. Although BT Motors has not fulfilled its obligation by refusing payment, this situation specifically relates more closely with settlement risk which involves one party fulfilling their part of deal and other party failing/refusing to do so after conclusion of contract.