ERM 54 Quiz

Surety bonds and builders' risk coverage forms are commonly purchased by businesses in which one of the following industries?

Construction

In loss analysis, the Prouty Approach primarily involves

Loss frequency and severity

Which one of the following statements is correct with respect to continuous probability distributions?

One way of presenting a continuous probability distribution is to divide the distribution into accountable number of bins

The ultimate responsibility for an organization's risk management rests with the board of directors. Which one of the following broad categories involves risks that arise from people, processes, systems, or controls?

Operational risk

Most general liability insurance policies include coverage for which one of the following?

Product Liability

For insurance and traditional risk management purposes, loss exposures are typically divided into four types. Which one of the following lists those four types?

Property, liability, personnel, and net income

Hardware Store has been able to control its prices and inventory since it has no competitors. A new highway currently being constructed is going to allow increased competition falls into the category of

Strategic risk

The management team of a company decided that it made more sense for the organization to concentrate on critical operations and to outsource noncritical operations. Outsourcing noncritical operations is a form of

Risk Transfer

The sources and consequences of an identified risk are considered during which one of the following phases of the International Standard 31000 Risk Management Process?

Risk analysis

Which one of the following is a risk that enterprise risk management (ERM) would treat but that traditional risk management would not?

Risk of changes in economic conditions, such as growth or recession

When considering an empirical distribution, the measure of central tendency is called the mean. Which one of the following is correct with respect to the mean?

The mean is the sum of the values in a data set divided by the number of values

Which one of the following commonly used categories of operational risk includes risks associated with technology and equipment?

Systems

Which one of the following risk identification techniques helps identify the interconnectedness of risk across organizational functions?

Team approach

Marvin needs to calculate the present value of a stream of four equal payments of $10,000 to be received at the end of each of the next four years. The interest rate is 4%. What is the present value of this stream of payments?

$36,299

Which one of the following has the lowest present value?

$1,000 to be received 10 years from today, assuming a 9 percent interest rate.

Big data includes

Both structured and unstructured data

The important first step in a decision-making model is to

Define the problem

Which one of the following is a benefit to the organization from greater risk assurance?

Reduced capital costs

Which of the following risk management program goals is an essential goal for all public entities?

continuity of operations

InterMountain Railroad carries logs, lumber, plywood, and other forest products in a six-state region in the Western part of the United States. InterMountain self-insures its derailment cargo losses. The risk manager at InterMountain ran a regression using ton-miles (one ton of cargo carried one mile) as the independent variable and dollar losses as the dependent variable. The independent variable is in units per 10,000 and the dependent variable is per 1,000. The resulting regression equation is: y = 2.65 x + (−13.8) Next year, InterMountain estimates that it will record 5,000,000 ton-miles of shipments. Given a building materials shortage, projected for next year, the cargo will be more valuable, so a 12 percent increase in value factor should be applied to the dollar loss estimate. Based on this information, what are InterMountain's final expected derailment cargo losses for next year, rounded to the nearest $10?

$1,468,540

The Weaver Brothers own a large apartment building. They are trying to decide if they should make a $7,500 investment in the building's heating system to improve its efficiency. They estimate that the improved efficiency would save them $3,000 each of the first two years, $2,000 the third year, and $1,000 the fourth year. If the rate of return is 8 percent, what is the net present value of the investment? Disregard the effect of depreciation and taxes.

$173

Crude Oil Company is considering an investment of $270,000 to replace the outdated clean air system at its refinery. The new equipment will generate a savings of $70,000 per year for each year of its six-year life. Crude's cost of capital is 12 percent.What is the present value of the cash inflows from the proposed investment, ignoring income taxes?

$287,798

Stockton Manufacturing Company is considering purchase of a new facility. The following facts apply: • $200,000 initial investment • 10 year life of facility (no salvage value) • $60,000 differential cash revenues from the purchase • Annual expected flood losses to facility are $10,000 • Straight-line depreciation is used • 40 % tax rate • Minimum annual acceptable rate of return is 10% •Present value of $1 received at the end of each year for 10 years at 10% is 6.1446 What is the net present value of the purchase of the new facility?

$33495

Lerner Company is considering investment in a drill press machine that will cost $90,000. The machine will have a three year life and will be depreciated on a straight-line basis. There will be no salvage value after three years. The machine will increase cash revenues by $80,000 per year in each of the three years. Cash (nondepreciation) expenses will increase by $20,000 in Year 1, $30,000 in Year 2, and $40,000 in Year 3. Lerner pays taxes at a rate of 30 percent. What after-tax net cash flow does this project generate in Year 3?

$37000

Reliable Plumbing plans to replace its entire fleet of service vehicles. Reliable expects this investment to result in cash flow savings of $10,000 the first year, $20,000 the second year, and $15,000 the third year. At that time, they expect to have to replace the vehicles again. If the interest rate is six percent, the present value of the savings is

$39,828

Bread Basket Company (BBC) is a commercial baker in the Pacific Northwest. One order the company has to provide a major supermarket with 250,000 loaves of bread four months from today at a price of .75 cents per loaf. BBC believes it will take 5,000 bushels of wheat to make the wheat flour to complete this order. Wheat currently sells for $5.50 per bushel. The other costs of ingredients, processing, and shipping on this order will be $120,000. BBC decided to hedge the price of the wheat for the order by purchasing a call option of wheat at $5.50 per bushel. Cost of the option was $600. When BBC began production of the bread, the price of wheat had increased to $6.50 per bushel. How much money did BBC save on this bread order by being hedged?5

$4400

Garnett owns a commercial building and has a lease with a tenant which calls for rental payments to increase annually. To evaluate the lease, she wants to determine the present value of the building's income and then compare that to her costs. The first year's rent is set at $10,000, the second year is $15,000, the third year is $20,000, and the 4th year is $25,000. Payments are made on the first day of each year. Assuming a 5% interest rate, the present value of the rental income as of the date of the first payment is ?

$64021

The management team at Balsam Manufacturing is considering installing spray painting equipment in a currently unused building at the company's premises. The initial investment would cost $160,000 and the equipment would have a useful life of eight years. The expected differential cash revenues resulting from the purchase would be $50,000 annually. The company's risk manager has analyzed the differential probability of a fire resulting from the spray painting operation and has calculated an annual expected loss of $20,000. The following facts apply:•The minimum rate of return that Balsam's management team will accept is 10 percent. •The present value of an annuity of $1 per year for eight years is 5.3349. •The income tax rate is 40 percent. The net present value for the proposed spray painting equipment investment is

($21,293)

Which one of the following types of organization would most likely be affected by commodity price risk?

A manufacturer

Pacific Pine is a forest products company based in the state of Washington. Pacific Pine harvests timber on six large tracts of land they own. Most of the wood harvested is shipped to countries in the Pacific Rim. A key economic risk that Pacific Pine faces is that one or more of the Pacific Rim countries will impose a fee on imported wood to protect domestic lumber companies. Such a fee is called

A tariff

In addition to analyzing individual risks, an organization can prepare a report to depict all of the organization's risk scenarios. This analysis provides a description of the risk, lists the risk owners, specifies the risk quadrants impacted by the risk, estimates the likelihood of loss and the resulting consequences, assigns a risk level, and specifies any improvements needed. This collection of reports of the individual risk is called

An organizational risk register

Which one of the following statements is true regarding the Committee of Sponsoring Organizations (COSO 2004) risk management standard?

COSO 2004 originated with a focus on financial risk

Determining earnings-at-risk (EaR) entails modeling the influence of factors such as

Changes in the prices of products and production costs on an organization's earnings.

The committee of sponsoring Organizations of the Treadway Commission (COSO) grouped internal control objectives into three categories. One category of objectives deal with how well an organization meets numerous local, national, and international laws. This category of objectives is

Compliance objectives

A coefficient of variation is derived by

Dividing a distribution's standard deviation by its mean.

Which one of the following statements about event tree analysis is true?

Event trees analyze the consequences of accidental events

Basel I and Basel II prescribe capital requirements for

Financial institutions

The relationship between which two basic measures is critical for risk management in assessing risk and deciding whether and how to manage it?

Likelihood and consequences

Which one of the following team approaches to risk identification is primarily used to design complex, scientific systems?

HAZOP

Insurance deals primarily with which one of the following major categories of risk?

Hazard risk

Which one of the following statements regarding the scope of ISO 31000 is true

ISO 31000 may be applied to risks that can have a positive consequences.

In determining economic capital for insurers, various risks are quantified. One such risk is the potential for adverse loss experience or catastrophic losses. This risk is known as

Insurance risk

The fundamental purpose of a risk management framework is to

Integrate risk management throughout the organization

Elliott is the new risk manager of Consolidated Agriculture Products. The company has corporate farms that grow grain in six Midwestern states. The company trades futures contracts on grain and foreign currencies. In an effort to establish accountability in the enterprise risk management program Elliott is implementing, he is using financial measures to determine potential losses from property damage, liability claims, farming operations, grain futures trading, currency futures trading, and each of the other loss exposures the company faces. These metrics of potential losses are called

Key risk indicators

The president of Agricultural Products Company (APC) told the risk manager, Tom, to implement an enterprise risk management (ERM) program. Tom was a "traditional" risk manager who had managed APC's property, liability, and personnel-related risks for the last 12 years. Under the new plan, he was supposed to manage commodity price risk, currency exchange rate risk, and strategic risk. When Tom asked for assistance (hiring an outside expert, time to get up to speed on financial risk, etc.), his requests were denied. After six months, the president declared the ERM program a failure and told Tom to revert to the previous risk management plan. APC's experiment with ERM was not successful because of

Lack of commitment of resources

A branch of a classification tree that leads to a classification of a target variable ends at a

Leaf node

Which one of the following indicates the value of the target variable on a classification tree?

Leaf nodes

Which one of the following groups of individuals within an organization is responsible for establishing effective internal controls to monitor risk?

Management

There are several steps in the enterprise-wide risk management process. One step includes determining the effectiveness of controls, observing changes in the internal and external environment, and obtaining information to improve risk assessments. This step in the enterprise risk management process is

Monitor and assure

Hold-Harmless agreements, indemnity agreements, and hedging are examples of

Noninsurance risk transfers

Timing of losses is important in loss exposure analysis. Liability losses differ from property loss exposures in that liability losses

Often involve long delays between the occurrence of the adverse even and the payment for the loss

The use of risk quadrants to identify and categorize risk can provide a framework for holistic risk identification. One quadrant includes such risks as loss of production due to a key supplier not delivering raw materials or a mechanical breakdown of equipment. This risk quadrant is

Operational risk

Which one of the following best describes the categories of risk included in the enterprise risk management model?

Operational, strategic, financial, and hazard

Risk indicators such as experience and authority levels apply to which one of the following operational risk classes?

People

Fair value accounting uses the term market value surplus (MVS) for an organization's net worth. Which one of the following is the term used for an insurer's net worth under statutory accounting principles (SAP)?

Policyholders' surplus

Which one of the following measures only the positive results of a model?

Precision

Sharon wants to replace her computer in three years. She estimates that new computer will cost $2500. In order to determine the amount of money Sharon must invest today at a given rate to have $2500 at the end of three years, she must calculate the

Present value of the amount needed in the future

The risk that remains after all of the risk treatment methods have been applied is called

Residual Risk

The process of making and implementing decisions that enable an organization to optimize its level of risk is called

Risk Management

Be-Ne-Lux Insurance is an insurer operating in Belgium, the Netherlands, and Luxembourg. Be-Ne-Lux is subject to the Solvency II standards. Company mangers believed the company was adequately financed, however it was determined that the company did not have adequate assets based on the uncertainty of its operating performance. The standard that Be-Ne-Lux failed to meet is

Risk based capital

A conscious act or decision not to act that generates the funds to pay for losses or offset the variability in cash flows that may occur best defines

Risk financing

Integration of the management principles governing the organization with the risk management process is

Risk governance

A document published by a recognized authority that includes principles, criteria, and best practices for risk management is called a

Risk management standard

Insurance Company (IC) sells its coverages through independent insurance agents. Independent agents represent several insurance companies. Tom, the president of IC, has learned that the independent agent who is the highest producer for IC is considering selling his agency. IC is considering acquiring the agency since Tom is concerned that if the agency is sold, IC may lose a substantial amount of business. Tom asked IC's risk manager to analyze the prospective purchase. The analysis revealed that the acquisition would likely secure most of IC's book of business with the agency but also revealed local competitors that would try to place the business as well. In addition, the analysis revealed the opportunity for IC to move some accounts currently placed with other insurers over to IC. Also, it was learned that a competitor expressed an interest in the agency acquisition. The analysis performed by the risk manager is a form of

SWOT analysis

Which one of the following steps in the enterprise-wide risk management process includes an evaluation of how each of the organization's risk management processes aligns with its overall objectives?

Scan the environment

At each board of directors meeting at XYZ Insurance Company, each vice president gives a report on his/her area. Darlene is the Vice President of Investments. During one portion of her presentation, she reviews whether the portfolio is in compliance with each of the company's investment guidelines (e.g. no more than 15 percent of the portfolio may be invested in equities, no more than two percent of the portfolio may be invested in securities issued by the same company, all bonds must be investment grade, etc.). The reporting format that Darlene uses for this portion of her presentation is called a

Scorecard

Landon Company needs one new drill press machine. The company is considering using insurance alone to address the risk associated with the project or insurance combined with loss control. Relevant numbers for the two alternatives are provided below: Insurance Only: Cost of project is $300,000. Annual after-tax net cash flow for five years is $78,000. Insurance Plus Loss Control: Cost of project is $335,000. Annual after-tax net cash flow for five years is $87,500.Landon Company uses 8 percent as the appropriate interest rate in evaluating similar projects. The present value of $1 per year for five years is 3.993. Which one of the following is Landon's best course of action

Select the insurance plus loss control option

One category of operational risk that a business must manage is risk associated with people. One of the strategies to mitigate people risk is to use care when hiring employees. This strategy employs background checks, pre-employment tests, and checking references. This strategy is

Selection

Determining the premium for an applicant for personal auto insurance involves

Supervised learning

One benefit of risk management to the economy is the reduction of the potential for a major disruption in the functioning of financial markets and the financial system. This risk that is reduced is called

Systemic Risk

Which one of the following is correct with respect to compliance reviews?

The benefit of compliance reviews is that they can help an organization minimize or avoid liability loss exposures.

Which one of the following statements is true with regard to linear regression analysis?

The regression line represents the "best fit" to historical data from prior periods.

Which one of the following statements is true regarding probability distributions in forecasting?

The sum of the probabilities in a probability distribution must total 1.0

Which one of the following statements is true regarding the use of personal inspections to identify loss exposures?

To be effective, personal inspections should be accompanied by discussions with front-line personnel who can identify nonobvious loss exposures.

Which one of the following is a responsibility of internal auditors?

To validate that internal controls are in place, functioning, and meeting design objectives