CPA Exam (BEC B6)

Exchange Rate Exposure Categories

3 Types: 1. Transaction exposure: Exchange rate risk is defined in part by this. Transaction exposure is the potential that an org could suffer economic loss/experience economic gain upon settlement of indiv transactions as a result of changes in exchange rates. Measured in relation to currency variability or currency correlation. 2 steps to measure: (1) project foreign currency inflows (AR) and outflows (AP). Net them. (2) estimate the variability/risk associated w/ the foreign currency. 2. Economic exposure: Also defines exchange rate risk. Economic exposure is the potential that the PV of an org's CFs could incr/decr bc of changes in exchange rates. Generally defined through local currency appreciation/depreciation and measured in relation to org earnings and CFs. Currency appreciation/depreciation is strengthening/weakening of a currency in relation to others. -currency appreciation: as domestic currency becomes stronger, it's more expensive in terms of foreign currency. As it appreciates, volume of outflows tends to decr as domestic exports become more expensive. Volume of inflows tends to incr as foreign imports become less expensive. Bad if you have AR, good if you have AP. -currency depreciation: as domestic currency becomes weaker, it's less expensive in terms of foreign currency. As currency depreciates, volume of outflows tends to incr as domestic exports become less expensive. Volume of inflows tends to decr as foreign imports become more expensive. Good if you have AR, bad if you have AP. Economic exposure for appreciation/depreciation depends on net inflow/outflow of foreign currency. -if domestic currency appr, exports decr and imports incr. -if domestic currency depr, exports incr and imports decr. 3. Translation exposure: Also defines exchange rate risk. Translation exposure is risk that A, L, E, or inc of a consolidated org that incl foreign subs will change as a result of changes in exchange rates. Generally defned by degree of foreign involvemt, location of foreign subs, and accting methods used. Measured in relation to effect on org's earnings and comprehensive inc. -degree of foreign involvemt: translation exposure incr as proportion of foreign involvemt by subs incr. -location of foreign investmts: measuremts of financial results of foreign investmts often occur in foreign currency in which investee co operates. Exposure of parent co to translation risk is affected by the stability of the foreign currency compared to the parent's domestic currency. More stable exchange rate means lower translation risk, more volatile exchange rate means higher translation risk.

Executing

Activities assoc w/ completing the work specified in the proj plan and producing deliverables. Assure quality. Initial proj results may req updating proj mgmt plan, modifying expected activity durations, and making changes to resource productivity/availability. 1. Direct/manage proj by performing planned work 2. Perform quality assurance to make sure proj procedure/deliverables conform to std of quality planned 3. Assemble proj team and dist proj assignments. Make sure everyone stays on task and is team player. 4. Manage proj team w/ timely feedback and problem resolution 5. Dist relevant info to proj stakeholders 6. Manage stakeholder expectations by addressing issues as they occur 7. Conduct procurements by obtaining seller responses, selecting a seller, and awarding a contract

Models for Valuing Options - Binomial Model

Also called Cox-Ross-Rubinstein model. Variation of orig Black-Scholes model. Considers underlying security over a pd of time, as compared to one point in time under Black-Scholes. Useful for valuing American-style options, which can be exercised over a pd of time. Assumptions: -perfectly efficient stock mkt -the underlying security price will move up/down at certain points in time (called nodes) during the life of the option The result of applying the model is a tree diagram showing the possible values of the options at diff nodes. Math beyond scope of CPA exam. Benefits: -can be used for American-style options -can be used for stocks that pay divs w/o modifying the model (like needed in Black-Scholes)

Dynamics of the Balance of Power

1. Developed v emerging nations: -developed regarded as world's largest industrial economies -emerging regarded as countries not on developed list. Lead by Brazil, Russia, India, and China (BRIC). 2. Trade deficits: -developed nations have trade deficits bc their domestic consumption results in imports > exports. -emerging nations have trade surpluses bc their exports feed the consumption of developed nations. 3. Balance of power: Emerging nations, esp China, have maintained artificially low valuation of their currencies relative to those of developed nations (US dollar), to keep their goods cheap. So emerging, less wealthy countries basically finance richer countries.

Inherent Risks of International Business Operations

1. Exchange rate fluctuaton: Exchange rate/currency risks. Categories incl transaction, economic, and translation risk. 2. Foreign economies: Op in foreign ecnomy has risk of functioning w/in general health/weakness of that economy. Domestic ones might be doing well when international sufferring and dragging down cos performance. State of foreign economy in which multinational org ops is sig for risk eval. -foreign demand: consider inc of customer and purch power of currency. Multinational corp exporting to foreign country is concerned w/ demand there. Demand is directly affected by health of the economy. (1) weakening demand may cause foreign govt to implement tariffs or reg measures to reduce foreign penetration. (2) measures to reduce foreign penetration may req curtailmt of foreign ops or export of goods produced by the multinational inside the foreign country instead of selling w/in it. -int rates: higher int rates in foreign country indicate slower econ growth and reduced demand. Lower int rates indicate incr growth/demand. -inflation: higher local (econ) inflation reduces purch power, making imported goods more expensive and reducing local demand. Lower incr purch power for imported goods, so higher local demand. -exchange rates: weak local currency reduces demand for imports. Strong local currency incr it. 3. Political risk: Nonecon events/environmental conditions that are potentially disruptive to financial ops. Ultimately, political claims/actions can disrupt CFs. Expropriation of productive resources is most extreme risk, but others incl: -bureaucracies and related inefficiencies/barriers to trade -corruption -host govt's attitude towards foreign firms -attitude of consumers toward foreign firms -inconvertability of foreign currency -war

Complications of Global Sourcing

1. It anticipates multiple sources for materials: ex is plastic -RM (petroleum products) produced in middle east -refining those into plastic may be in asia -molding/assembling the plastic in China -trans/dist in US 2. It anticipates multiple exchange rates: multiple exchange rates and tariffs may exist as RM move to final product.

Specific Short-Term or Long-Term Financing Instruments

1. Working Cap Financing: Involves spontaneous financing of CA w/ trade AP and accrued liabs, w/ expectation that the maturities of CA (collections) will coincide w/ maturities of CL (disbursements). Maturity matching. 2. Letter of Credit: Reps a 3rd party guarantee, usually by a bank, of financial obligations incurred by the co. External credit enhancement used by a co issuing otherwise unsecured debt to enhance its credit. Can be req by creditor to ensure pmt. 3. Line of Credit: Reps a revolving loan w/ a bank/group of banks that's up to a specific dollar max amt, for a defined term, and is renewable on maturity date. Any oustanding balances under line of credit reduce future availability of funds that may be drawn by the co under that line. Lines of credit drawn rep bank loans. Co may have seasonal revolving credit facility that allows additional cap availability for limited time pd. Used by cos during pds of high WC needs.

Techniques for Transaction Exposure Mitigation - Forward Hedge

2. Forward hedge: Sim futures hedge bc entitles holder to purch/sell currency units of an ID'd currency for a negotiated price at a future point. Forward hedges are contracts btw businesses and commercial banks, usually larger transactions (as opposed to futures for small trans). Forward hedge anticipates co's needs to buy/sell a foreign currency at a particular point (as opposed to futures for particular transaction). -AP application: AP denominated in foreign currency rep a potential trans exposure to exchange rate risk if foreign currency strengthens. Forward hedge contract to buy the foreign currency at a specific price at the time AP are due for entire sub will mitigate risk of weakening domestic currency. -AR application: AR denominated in foreign currency rep a potential transaction exposure to exchange rate risk if domestic currency strengthens. Forward hedge contract to sell the foreign currency received in satisfaction of the AR at a specific price when the AR are due or on the monthly cycle of a particular sub will mitigate the risk of a strengthening domestic currency.

Techniques for Transaction Exposure Mitigation - Money Market Hedge

3. Money mkt hedge: Uses international money mkts to plan to meet future currency rqmts. Money mkt hedge uses domestic currency to purch foreign currency at current spot rates and invest it in securities timed to mature at same time as related payables. AP appication: -If AP and excess cash: firms w/ excess cash use mm hedges to lock in the exchange rate assoc w/ the foreign currency needed to satisfy payables when they're due. Steps: (1) determine amt of payable. (2) determine amt of int that can be earned before settling payable. (3) discount amt of payable to net investmt req. (4) purch the amt of foreign currency to equal net investmt req and deposit the proceeds in approp money mkt vehicle. -If AP and borrowed funds: firms w/o excess cash flow do same thing as those w/ it for a mm hedge on payables, except borrow funds domestically first and invest them internationally to satisfy the payable denominated in a foreign currency. Slightly more expensive. AR application: MM hedge used for AR denominated in foreign currencies effectively involves factoring receivables w/ foreign bank loans. Foreign currency amts borrowed in discounted amts that are repaid in the ultimate maturity value of the receivable denominated in foreign currency. Borrowed currency amts converted into domestic currency. So basically need cash now, borrow amt of receivable from bank and convert to US dollars for cash needs, and pay back loan to bank in foreign currency w/ AR when you get them.

Specific Short-Term or Long-Term Financing Instruments Continued - Operating v. Capital Leases

4. Leasing Options: A lease reps a contractual agreemt in which the owner of an asset (lessor) allows another party (lesee) to use the prop/asset in exchange for periodic lease pmts. -op leases: prop is rented over an insig portion of asset's useful life w/ no oblig/opportunity to assume oship of the prop. These are considered off-B/S financing for lesee, since no B/S effect of periodic rent pmts, which show up as rent exp on I/S. Cos that use op leases vs cap will have stronger financial ratios bc liabs lower (debt off-B/S) and, in eary yrs of lease, rent exp is lower than combined depr and int exp under a cap lease. -cap leases: finance leases under IFRS. Like lesee buying an asset and financing it w/ debt. Lesee records PV of min lease pmts as an asset on its B/S as well as corresponding current and LT lease obligations. Instead of recording rent exp on I/S, lesee records depr and int exp. Lesee firms desiring to report higher periodic op CFs prefer using cap leases over op bc principal portion of cap lease pmt is reported as a financing cash outflow, while the entire rent pmt under an op lease is resported as an op cash outflow. To classify a lease as cap, must meet 1 of these 4 criteria (*OWNS*). 1. *O*wnership transfer at end of lease 2. *W*ritten option for bargain purch 3. *N*inety (90%) percent of lease prop FV <= PV lease pmts 4. *S*eventy-five (75%) percent or more of the asset's economic life is committed in the lease term. If none of the criteria are met, op lease.

Specific Short-Term or Long-Term Financing Instruments Continued - Debentures and Bonds

5. Debentures and bonds: General characteristics are fixed cost and maturity date, new debt so decr creditworthiness and no new owners so incr EPS. Debentures and bonds rep LT indebtedness generally supported by formalized agreements (indentures), which specify the terms/conditions of the bond, including coupon rate/maturity date. Bonds are frequently admin by a trustee, who acts as a 3rd party rep of the bondholder. Debentures are unsecured, and bonds are often secured w/ rev/asset pledges. Debentures are unsecured obligations of the issuing co. In the event of default, holder of debenture has status of general creditor. Risks assoc w/ debentures can be mitigated by a negative-pledge clause that stops a co from pledging assets to other debt. Subordinated debentures are bond issues that are unsecured and rank behind senior creditors in the event of issuer liquidation. Command higher IRs than debentures bc of additional risk. Income bonds rep securities that pay int only upon achievemt of target inc levels. Inc bonds are risky, typically only used in reorgs. Junk bonds are characterized by high default risk and high return. Classified as noninvestmt grade bonds by major credit rating agencies given their more likely default on principal/int pmts. Frequently used to raise cap for acq and leveraged buyouts. Mortgage bonds are created when mortgages are pooled together and issued as mortgage bonds. Mortgages are loans secured by residential/commercial real prop. Bondholders of mortgage bonds are protected from default by a lien on the pooled real prop assets. Distinguishing feature of mortgage bonds is that trustees act on behalf of bondholders to foreclose on mortgage bonds in the event of default.

Specific Short-Term or Long-Term Financing Instruments Continued - Equity Financing

6. Equity financing: General characteristics are variable cost and no maturity, improved creditworthiness, and incr in owners so decr EPS. Equity financing involves issuing equity (stock) securities repping diff form of oship of the co. Distinguishing feature of equity securities is that their right to a cos assets in bankruptcy/liquidation is below both secured/unsecured bondholders. PS is a hybrid equity sec that has features sim debt and equity. Preferred shares offer/req fixed div pmt to holders, sim coupon pmts on debt. Like equity bc timing of div pmt at discretion of BOD, and div pmts not tax-deductible. Additional possible features: -cumulative divs: may req unpaid divs in arrears on PS from a prior pd be paid before dist of CS divs. -participating feature: preferred shares may participate in declared divs along w/ CS SHs to the extent that undist divs exist after satisfying both PS div rqmts and CS div rqmts at the preferred div rate. -voting rights: preferred shares rarely given voting rights. Situations where they are usually assoc w/ divs in arrears for sig pds. CS reps basic equity oship security of a corp. Incl voting rights w/ optional div pmts by issuer. Most CS issued w/ stated par value. When CS issued at a given mkt price, proceeds received by issuer are separated btw CS acct (par value x shares issued) and APIC acct. Neg feature of CS is that CS SHs have lowest claim to firm's assets in a liquidation. Summarization of debt v equity financing: -flexibility: D no, E yes -tax deductibility: D yes, E no -EPS dilution: D no, E yes -incr financial risk: D yes, E no -security issuance costs: D low, E high -investor return: D fixed, E variable

Lean Manufacturing

Also called lean production. Req use of only those resources req to meet rqmts of customers. Seeks to invest resources only in value added activities. Focus is on waste reduction/efficiency (not quality). Preserving value while expending only necessary effort. Kaizen and activity-based mgmt initiatives are waste reduction methodologies that use empirical data to measure/promote efficiencies. Kaizen refers to continuous improvemt efforts that improve efficiency/effectiveness of org through greater operational control. Kaizen occurs at mfg stage where ongoing search for cost reductions takes the form of analysis of production processes to ensure that resource usage stays w/in target costs. Process mgmt/ABM: ABC and activity-based mgmt (ABM) are compatible w/ process improvemts and TQM. ABC and ABM systems highlight costs of activities. Availability of cost data by activity makes ID of costs of quality and value-added activities more obv. Orgs w/ ABC and ABM programs more likely to have info needed for TQM. Process improvement results from a detailed process mgmt program (ABM system). -process mgmt focuses on activities performed by org. Structure of org designed around those processes. -process mgmt emphasizes continuous improvemt in efficiency of those processes. Process mgmt incorps many of the attributes of ABC, TQM, and value chain analysis.

Short-Term Financing Strategies and Factors

Although most cos have some kind of LT financing to meet cap rqmts, using ST financing is considered a viable option. Permanent working cap sources may be employed to meet co's LT needs, while temp working cap will be used to meet ST/seasonal needs. Use of LT/ST financing to meet cap needs has diff effects on co. Cos can compare choices that provide higher risk, lower cost, and incr profitability w/ choices that provide lower risk, higher cost, and decr profitability. ST financing generally classified as current and will mature w/in 1 yr. Rates assoc w/ ST financing tend to be lower than LT and presume greater liquidity on the part of the org using the ST financing. The extent to which an org uses ST financing strategies depends on amt of current assets it maintains and risk tolerance of mgmt. ST financing strategies anticipate higher levels of temp WC that req greater agility/flexibility. Advantages: -incr liquidity: ST financing presumes higher turnover of financing instruments and matching of receipts (liquidation of assets) and disbursements (liquidation of liabs) w/in a yr. -incr profitability: rapid conversion of op cycle components (inv, AR) into cash carries potential of incr profitability and improved liquidity. -decr financing cost: ST int rates generally lower than LT given the shorter duration of the financing instrumts. Disadvantages: -incr IR risk: IR may abruptly change, and given shorter maturities, may req greater financing charges than anticipated on future refinancing. -decr cap availability: lender eval of creditworthiness may change and make financing impossible or less favorable w/ incr rates and/or less favorable terms.

Models for Valuing Options - Black-Scholes Model

An option is a contract that entitles the owner/holder to buy (call option) or sell (put option) a stock/asset at a given price w/in a stated pd of time. American-style options can be exercised at any time before expiration. European-style options can be exercised only at the expiration/maturity date of the option. Option may/may not have value. Black-Scholes Model: Common method for option valuation. Calc won't be on exam, but need to understand the model. Accountants may use this method in valuing stock options when accting for share-based pmts. Since option calculators available, don't worry about the complex actual calcs of this method. Inputs into the model (determinants of option value): -current price of underlying stock (higher price = higher option value) -option exercise price -rf rate (higher rate = higher option value) -current time until expiration (longer time = higher option value) -some measure of risk for underlying stock (higher risk = higher option value) -the dividend on the optioned stock (higher div = higher option value) Assumptions: -stock prices behave randomly -rf rate and volatility of stock prices are constant over the option's life -there are no taxes or transaction costs -the stock pays no divs (but model can be adapted to div paying stock) -options are european-style (only exercise at maturity) -option may/may not have value Limitations: -bc of assumptions, results may differ from real prices -assumes instant, cost-less trading (unrealistic in todays mkts) -tends to underestimate extreme price movements -not applicable to American-style options.

Six Sigma

Anticipates the use of rigorous metrics in the eval of goal achievemt. Program is a continuous quality-improvemt program that req specialized training. Explands PDCA model of process mgmt and outlines methodologies to improve current processes and develop new ones. Existing product and bus process improvemts: *DMAIC* -*D*efine the prob: based on customer complaints, failed proj goals, or other issues, determine existence of prob. -*M*easure key aspects of the current process: collect relevant data. -*A*nalyze data: examine relationships btw data elements. -*I*mprove/omptimize current processes: use models/data to determine how process can be optimized. -*C*ontrol: develop a statistical control process to monitor results. New product or bus process developmt: *DMADV* -*D*efine design goals: define goals consistent w/ customer demands. -*M*easure critical to quality issues (CTQ): analyze value chain to determine the features that provide value to customer and the production capabilities available. -*A*nalyze design alternatives: develop diff methodologies to produce new product. -*D*esign optimization: use modeling techniques to determine optimization of the proposed process. -*V*erify the design: implement/test the plan.

Approaches, Activities, and Techniques to Process-Management-Driven Businesses

Approaches: Business process mgmt (BPM) is a mgmt approach seeking to coordinate the functions of an org toward a goal of continuous improvemt in customer satisfaction. Customers are internal/external to org. Process mgmt seeks effectiveness/efficiency through promotion of innovation, flexibility, and integration w/ tech. BPM tries to improve processes continuously. By focusing on processes, org becomes more nimble/responsive than hierarchial orgs managed by function. Activities: 5 categories. 1. Design: ID of existing processes and conceptual design of how they should function after improvement. 2. Modeling: introduces variables to conceptual design for what-if analysis. 3. Execution: design changes implemented, key indicators of success developed. 4. Monitoring: info gathered/tracked and compared to expected performance. 5. Optimization: use by process manager of monitoring data and orig design to continue to refine process. Techniques: General: -define: orig process defined as baseline for current process functioning or process improvemt. -measure: indicators that will show a change to process are determined (reduced time, incr customer contact, etc.) -analyze: sims/models used to determine targeted/optimal improvemt. -improve: improvement selected/implemented. -control: dashboards/other measuremt reports used to monitor improvemt in RT and apply the data to the model for improvemt. Process mgmt commonly peferred to as *PDCA*. -*P*lan: design planned process improvemt -*D*o: implement it -*C*heck: monitor it -*A*ct: continuously commit to process and reassess degree of improvemt

Constant (Gordan) Growth Dividend Discount Model (DDM)

Assumes div pmts are CFs of an equity security and that the intrinsic value of the co's stock is the PV of the expected future divs. If divs assumed to grow at a constant rate, DDM can be used to determine the value of the co's stock. P0= [D1/(r-g)]. D1= D0 x (1+g). To determine the req rate of return, use CAPM. re= [rf + (b x (rm - rf))]. rm-rf is mkt/equity risk premium. Assumptions: -must specify/allow for calc of divs 1 yr beyond yr determining price for -must incl req return -must incl constant g rate of divs -formula implies that stock price will grow at same rate as div, in perpetuity. -formula assumes that the req rate of return is greater than the div growth rate. Otherwise, it wouldn't work. If calcing price for yrs in future, do D0 x ((1+g)^(n+1)).

Discounted Cash Flow (DCF) Analysis

Attempts to determine the intrinsic/true value of an equity security by determining the PV of its expected FCFs. To apply this, analyst takes these steps: 1. Choose approp model. -DDM use stock's expected divs as the relevant CFs. Gordon constant growth model is an example of a simple DDM model. -Free CF models including free cash flow to the firm (FCFF) and free cash flow to equity (FCFE). These discount the CF left over by the firm after satisfying req obligs including WC needs and fixed cap investmt. -Residual inc models rep inc left over after the firm satisfies the investor's req return. 2. Forecast the security's CFs using one of the model approaches. 3. Select a discount rate methodology. CAPM is popular to estimate the req return for an equity security. 4. Estimate the discount rate and apply to the approp DCF model. 5. Calc the equity security's instrinsic value and compare to current MV. Not expected to calc on exam.

Exchange Rate Risk - Managing Economic and Translation Exposure

Bus have various methods of managing the economic and translation exposure assoc w/ exchange rate risks. Generally, the use of org-wide solutions related to the entity itself and related reporting rqmts are included here. Economic exposure is defined by the degree to which CFs of the bus can be affected by fluctuations in exchange rates. Extent to which revs/exps are denominated in diff currencies could seriously affect profitability of an org and reps economic exposure. Economic exposures usually relate to org-wide issues and can usually only be mitigated w/ org-wide approaches involving restructuring and adjustmts to the bus plan. Restructuring: econ exposure to currency fluctuations can be mitigated by restructuring the sources of inc and exp to the consolidated entity. -decr in sales: co fearful of depreciating foreign currency used by a foreign sub may elect to reduce foreign sales to preserve CFs. -incr in exp: co anticipating depreciating foreign currency might incr reliance on those suppliers to take adv of paying for RM/supplies w/ cheaper currency. Restructuring tends to be more difficult than ord hedges. Economic exposures to exchange rate fluctuations are viewed as more difficult to manage than transaction exposures.

Financial Risk Management- Exchange Rate Transaction Exposure

Businesses have various methods to manage transaction exposure assoc w/ exchange rate risks. Use of financial instruments and hedging attempts to mitigate the effect of exchange rate fluctuations on indiv trans. Measuring specific net transaction exposure: Net trans exposure is amt of G/L that might result from a favorable/unfavorable settlement of a transaction. 1. Selective hedging: hedging is a fin mgmt technique where an org seeking to mitigate the risk of fluctations in value acqs a fin instrument that behaves opposite from the hedged item. Reduces risk/uncertaintly of future value of transaction/position (A, L, inc) by actively engaging in various derivative instruments. 2. Identifying net transaction exposure: consol entities consider this prior to considering hedging activities. Net trans exposure considers effect of trans exposure on the entity as a whole rather than indiv subs. Although exchange rate probs might be bad for 1 sub, might be good for another. Net transaction exposure is aggregate exposure assoc w/ a particular foreign currency for a particular time. Computation: -accumulate the inflows (AR) and outlfows (AP) of foreign currencies by sub. -consolidate the effects on the sub by currency type (net AR and AP). -compute the net effect in total. Appropriately hedge. International cos may hedge transactions w/o complex instruments by timing the pmt for imports w/ collection from exports.

Selecting and Impementing Improvement Initiatives

Can select w/ rational/irrational methods. -irrational: intuitive/emotional. No structure/systematic eval. Based on fashion/fad/trend. May come from immediate cost reduction need or very ST POV. -rational: structured and systematic. Involve: (a) strategic gap analysis- external/environmental assessment and internal/org assessments to create strategic gap analysis. (b) review competitive priorities- review price, quality, etc. (c) review production obj- review performance rqmts. d) choose improvemt program- decide how to proceed for improvemt. Key features for successful implementation activities: 1. Internal leadership: senior mgmt must provide direction and commit resources to implementation. 2. Inspections: ongoing implementation must be monitored/measured. 3. Exec support: exec mgmt must visibly support initiative. 4. Internal process oship: indivs most deeply involved w/ process mgmt must be committed to need for process improvement and have the resources to carry it out. Accountability.

Scope

Challenge in manging this is to incl all work req to complete a proj and nothing else. Infinite no wants/needs, finite amt of resources to produce proj deliverables. Product scope must define attributes of product/service/result. Proj scope defines work to produce product/service/result defined in product scope. Can also descr work excluded from proj. Scope baseline is formal written approved stmt of proj scope and work breakdown structure (WBS), outlining both end product (product scope) and proj scope. Proj scope mgmt process: -create scope mgmt plan -collect/document proj rqmts -define scope -create WBS -validate scope -monitor/control scope (changes) Tools/techniques to help define scope: -focus groups -facilitated workshops -questionnaires/surveys -creation of prototypes -interviews -brainstorming -observations Rqmts documentation is a written document descr proj rqmts from all stakeholders. Can incl quality rqmts, acceptance criteria, and training rqmts. Rqmts mgmt plan docs how rqmts will be analyzed, documented, and managed, tracked, and reported. Also descr how changes will be approved/processed.

Performance Standards - Managing the IA Activity

Chief audit exec must effectively manage the IA activity to ensure it adds value to the org. Effective mgmt is characterized by ensuring that activities are contemplated by the IA charter and that activities conform to the definition of IA, the stds, and the code of ethics. Added value is char by objective/relevant assurance and contributions to the effectiveness/efficiency of governance, risk mgmt, and control processes. 1. Planning: chief audit exec must establish risk-based plans to determine the priorities of the IA activity, consistent w/ org goals. Should consider several factors: -org risk frameworks that define risk appetite levels set by mgmt -if no risk framework exists, chief audit exec uses their own judgemt of risk after consulting/receiving input from senior mgmt/BOD. 2. Comm and Approval: chief audit exec must comm -IA activity's plans and rqmts for staffing and resources (invl sig interim change) and obtain approval from senior mgmt/BOD. -effect (potential scope limitations/timing delays) of resource limitations 3. Policies and procs: chief audit exec must estalish these to guide the IA activity and should consider the size/complexity of audit activities when determining them. 4. Reporting to the BOD and senior mgmt: chief audit exec must report periodically to senior mgmt/BOD on IA activity's putpose, auth, responsibility, and performance relative to its plan. 5. External service provvider and org responsibility for IA: external providers of IA activities must inform mgmt that I/C are the responsibility of mgmt.

Internal Audit Standards - Implementation Standards: Consulting Activities

Consulting services are advisory in nature and are generally performed at the specific request of an engagemt client. When performing these, IA should maintain objectivity and not assume mgmt responsibility. Nature/scope of consulting engagemt subj to agreemt w/ engagemt client. Parties involved in consulting services: 1. Internal auditor: person/group offering the advice. 2. User (sponsor): person/group seeking and receiving the advice.

Cost Management

Cost baseline is cumulative amt of money expected to be spent on a proj. When graphed, is usually S curve bc little money spent at beginning/end, max in middle of proj. Project funding rqmts specify total funding rqmts and periodic funding rqmts based on cost baseline. Est/tracking costs crucial to proj mgmt. Processes used by an entity to ensure proj is completed w/in approved budget: -planning for cost mgmt -est costs necessary for proj -determining the budget -controlling proj costs Methods for est costs: 1. Judgment: managers consider combo of historical info and cost of materials/labor. 2. Parametric estimating: technique relying on statistical relationship btw historical cost and other variables (like sq footage). Exs are regression analysis and learning curve (latter assumes cost per unit decr as more work completed). 3. Analogous estimating: cost of sim sized projs in past used to est cost of current proj. This is considered less accurate bc it's a top-down approach and generally doesn't address unique qualities of current proj. 4. Work breakdown structure estimation (WBS): bottom-up analysis bc each WBS activity is est and then the costs are aggregated to form proj budget. 5. Three-point estimates: refer to range of cost estimates based on a most-likely assumption (realistic) of proj costs. -opimistic assumption: best-case scenario of proj mgmt -pessimistic assumption: assumes worst-case scenario 6. Reserve analysis: monetary padding to allow for uncertain cost estimations. 7. Proj mgmt software: these programs usually have a feature to est proj costs. 8. Vendor bid analysis: assumes vendor will bid on the work and a contract will be awarded. 9. Earned value mgmt: combines proj scope, cost, and schedule measures to help proj mgmt team measure progress/performance on proj considering these elements: -planned value (PV): amt of money proj S/B worth at a particular pt in the schedule -earned value (EV): physical work completed to date on proj and auth budget for that task -actual cost (AC): actual cost of proj to date -estimate at completion (EAC): est total cost of proj at completion -cost performance index (CPI): EV/AC. If <1, proj over budget.

Debt Covenants

Creditors use these in lending agreemts to protect their interests by limiting/prohibiting actions of debtors that may neg affect the positions of creditors. Covenants contained in a lending agreemt may be pos/neg. Pos may incl rqmt that issuer provides quarterly fin reporting info to investors. Neg may involve restriction on asset sales for a certain time frame. When issuing debt covenants, co mgmt should consider the potential effect of them on firm's solvency, as too restrictive covenants could hinder co's basic op decisions. Debt covenants vary widely. Common ones: -limits on issuing more debt -restrictions of pmt of divs -limitations on disposal of certain assets -min WC rqmts -limitations on how the borrowed money can be used -maintenance of specific financial ratios, incl: (a) min fixed charge coverage ratio (b) max debt-to-total cap ratio (debt ratio) (c) max debt-to-EBITDA ratio (CF coverage) (d) min int coverage ratio (times int earned) -providing monthly, quarterly, or annual F/S to bondholders (lenders) When debt covenants are violated, debtor is in technical default and creditor can demand repmt of entire principal. Usually, concessions are negotiated and real default (not technical) avoided. Concessions can result in violated covenants being temp/perm waived or in a change in IR or other debt terms.

Price Multiples - PEG Ratio

Shows effect of earnings growth on a co's P/E, assuming a linear relationship btw P/E and growth. Stocks w/ lower PEG ratios more attractive to investors than one w/ higher PEG ratios. PEG = [(P0/E1)/G]. So basically P/E ratio divided by exp gr. G= 100% x expected growth rate. PEG ratio calcs P/E per unit of growth. Can be multiplied by both forecasted future earnings and the growth rate to determine the current price of the stock. P0 = [PEG x E1 x G].

Summary Graph for Developing and Refining the Project Plan

Develop/refine proj plan in center. All other elements flow both to/from it. Time mgmt: 1. define activities 2. sequence them 3. est activity resources 4. est activity durations 5. develop the schedule Cost mgmt: 1. est costs 2. develop the budget Quality mgmt: 1. Plan for quality HR mgmt: 1. develop HR plan Comm mgmt: 1. Plan communications Risk mgmt: 1. plan risk mgmt 2. ID risks 3. perform qualitative risk analysis 4. perform quantitative risk analysis 5. define risk responses Procurement mgmt: 1. plan procurements Scope: 1. collect rqmts 2. define scope 3. create work breakdown sequence

Globalization

Dist of industrial and service activities across an incr no of nations. Produces deeper integration of the world's indiv national economies and makes them more interdependent. Reduced barriers have created opps to have ops in multiple countries or import/export from domestic op. Multinational corps (MC) are those that conduct bus outside the country where they are org'd. Globalization is often measured by world trade as a % of GDP. Greater %, greater globalization. Factors driving globalization: -improvements in transportation: incr efficiencies in trans enhance competitive status of importers in domestic mkts. -tech advancemts: knowledge-based products (like tech support) eliminate importance of location. -deregulation of international financial mkts: elimination of cap controls incr options for direct foreign investmt, though political/legal limits still an inherent risk. -organizational/operational options for international bus: when conducting bus internationally, org must decide whether to centralize/decentralize certain bus ops/functions. Availability of human labor, RM, or transportation channels for a bus region can affect type of production, dist, and mkting activities performed by it. Globalization promotes specialization: economies of scale larger in global economy. Multinational cos often use them in their global production, dist, and mkting networks. Specialization that leverages comparative adv is a natural outcome. Globalization imparts responsibilities on world citizenship: All corps have implied duty to: -act responsibly regarding environmental issues -promote political stability and cooperation among nations

Motivations for International Business Operations

Entities encouraged to look beyond political borders in which they were org'd to max SH value. Several econ theories support international trade being a way of improving SH value. 1. Comparative adv: specialization in production/trade of specific products produces comparative adv in relation to trading partners. Cos/countries use comparative adv to maximize the value of their efforts/resources. 2. Imperfect mkts: resource mkts imperfect. Ability to trade freely btw mkts is often limited by physical immobility of resource or reg barriers. To get resources, cos must trade outside their borders. 3. Product cycle: product mfg/delivery subj to definable cycle, starting w/ initial developmt of product to meet needs in domestic mkts. Product cycle theory predicts that domestic success results in domestic competition, encouraging exporting to meet foreign demand and maintain efficient use of capacity. Foreign success turns into foreign competition, and entity is then motivated to establish a bus outside its boundaries to better differentiate itself and compete w/ foreign bus rivals.

Relevant Factors for Globalization

Factors to assess effect of globalization of co (incl its fin reporting): 1. Political/legal influences: conducting bus internationally may involve political risks that could be disruptive to entity. Legal rqmts for conducting bus in foreign country S/B assessed. 2. Potential for asset expropriation: nations may expropriate (take) assets from international cos that own them. Must assess risk of political intervention for bus planning/fin reporting. 3. Taxes/tariffs: govts may try to control econ activity w/ these. Mitigate w/ transfer pricing. 4. Limits on asset oship or JV participation: govts may limit amt of oship or entirely restrict any oship of bus ventures w/in their borders (limiting JVs and direct investmt). 5. Content or value added limits: also called sourcing rqmts. Govts may provide tariff reductions to cos whose imports incl specified %s of material/labor in their products. NAFTA. 6. Foreign trade zones: govts may establish trade zones where tariffs waved until goods leave the zone. Creation of these affects govt's control of imports and location of import facilities. 7. Economic systems: -centrally planned economies: some centrally planned (China). Factors of production (cap, land, etc) owned by govt and subj to restriction. -mkt economies: most industrialized economies (US/Japan). Factors of production owned by indivs. -conglomerates: establishmt of integrated conglomerates (Japanese keiretsu or Korean chaebol) creates self-sustaining entities that couldn't exist in US. Fully integrated financing, mfg, and supplying orgs would violate antitrust laws. 8. Culture: diff cultures affect international bus. Culture is shared values/attitudes of a group. Issues: -individualism v collectivism: countries like US value individualism, countries (like asian ones) value collectivism. -uncertainty avoidance: some cultures have hard time w/ uncertainty. US has guarded ability to accept it, asian/south american cultures are highly averse to it. -ST v LT orientation: some cultures more traditional and adapt more slowly to change (asian countries), others are focused on immediate gratification (US). -acceptance of leadership hierarchy: cultures have varying degrees of acceptance of big diffs btw leadership and avg people. Some accept large power diffs (european monarchies), others expect more equality (US). Less-developed formerly colonial places in Asia and South America distrustful of big power diffs. -tech and infrastructure: international bus may req factoring in wide diffs in: (1) comm systems (2) transportation systems (3) power/water sources (4) staff training (5) diffs in accting practices

Evaluating Assumptions used in Valuations

Forecasting methods have many subjective elements subj to behavioral influences. Behavioral finance examines investor behavior and how it affects financial mkts. Generalized rules of thumb often used in forecasting can distort the objective eval of evidence. Include: 1. Tendency to use stereotyped characterizations: P/E and PEG ratios and DCF techniques useful, but all analytical techniques aren't equal. PEG and P/E techniques are less rigorous than the detailed analysis req for DCF. 2. Adjustmts to presumed baselines: adoption of earnings/price amt that is correct and adjusting it upward/downward for assumptions can result in errors bc adjustmts aren't usually sufficient. 3. Use of intuition rather than analysis: failure to use objective analysis in favor of beliefs/emotions can result in miscalc of values/assumptions. Behavioral biases distort judgment. Include: 1. Excessive optimism: strong belief/overestimation of positive results is a bias that can distort valuation model. 2. Conformation bias: use only data that confirms conclusions, ignore data that challenges ideas. 3. Overconfidence: strong belief that decisions/evals are correct. Can lead to investors overemphasizing their ability to process/interpret info. 4. Illusion of control: erroneous belief that the financial manager has control over valuation outcomes that really result from mkt forces. Effect of loss aversion: -losses are more distracting than gains: managers more likely to try to beat the odds to restore profitability. Riskier behavior comes when losses are higher. Prudent/analytical mgmt of gains is more likely than mgmt of losses. -managers are generally adverse to sure losses: even knowing likelihood of reversing projected losses is remote won't motivate the financial manager to take a sure loss. The chance (however remote) that losses might be reversed keeps the manager from making the logical decision to absorb a sure loss w/ no opportunity for recovery. Instead, they'll escalate the commitment in hopes that the projected results will reverse.

Internal Audit Standards - Attribute Standards

Gen stds regarding engagemt definition, auditor independence/objectivity, auditor proficiency/professional care, and quality assurance, incl continuing professional developmt. Attribute stds included under the stds: 1. Purpose, authority, responsibility: IA should document purpose, auth, and responsibility of IA function. Both assurance/consulting services S/B defined in charter. 2. Independence and objectivity: Chief IA officer of an org should have unrestricted access to senior mgmt/BOD to promote the independence req to effectively perform IA function. CIAO must be unbiased. -organizational independence: chief IA reporting line and level should promote independence/objectivity. Should report org independence of the IA function to the BOD annually. -individual objectivity: IAs must be free of conflicts of int. -impairments to indep/objectivity: Impairmts in fact/appearance S/B fully disclosed. Character of disclosure depends on impairmt. (a) IAs must refrain from assurance services that involve assessmts of specific ops for which they were responsible in the PY. (b) IAs may provide consulting services relating to ops for which they had previous responsibilities. 3. Proficiency and due professional care: engagemts must be performed w/ these. -proficiency: professional designations represent evidence of this. IAs need to understand fraud detection techniques and tech risks/controls. -due professional care: IAs must apply care/skill expected of a reasonably prudent and competent IA. Doesn't imply infallibility. 4. Quality assurance and improvemt program: chief audit exec must develop/maintain one of these that covers all aspects of the IA activity. Obj is to ensure conformity w/ the definition of IA and code of ethics. -quality program assessmts: quality assurance/improvemt program must include internal/external assessmts. (a) internal- IA entities should be tasked w/ ongoing/periodic evals of program effectiveness. (b) external- external assessmt must comm the results of the quality assurance/improvemt program to senior mgmt/BOD.

Techniques for Transaction Exposure Mitigation - Futures Hedge

Hedge trans used to mitigate exchange risk from foreign currency transaction exposure. 3 types, futures hedge, forward hedge, and money mkt hedge. 1. Futures hedge: Entitles holder to purch/sell a particular no of currency units of an identified currency for a negotiated price on a stated date. Denominated in std amts and are usually used for smaller trans. -AP application: AP denominated in foreign currency reps a potetial transaction exposure to exchange rate risk if the domestic currency weakens in relation to foreign. If it does, more domestic currency req to purch foreign, increasing cos cost of settling liab. If mgmt doesn't hedge the liab exposure, company will incur foreign exchange transaction loss. A futures hedge contract to buy the foreign currency at a specific price a the time the AP is due will mitigate the risk of weakening domestic currency. AP=loss, hedge=gain. -AR application: AR denominated in foreign currency rep a potential transaction exposure to exchange rate risk if domestic currency strengthens relative to foreign. If it does, less domestic currency (than anticipated on sale creating AR) can be purch w/ the foreign currency received. Exchange loss is the result. A futures hedge contract to sell the foreign currency received in satisfaction of the AR at a specific price at the time AR is due will mitigate the risk of strengthening domestic currency. AR=loss, hedge=gain.

Other Techniques for Transaction Exposure Mitigation - Long-Term Transactions

Hedge transactions used to mitigate exchange rate risk from transaction exposure: 1. LT forward contracts: Deal w/ same issues as other forwards. Set up to stabilize transaction exposure over long pds. LT purch contracts may be hedged w/ LT forward contracts. 2. Currency swaps: transaction exposure assoc w/ exchange rate risk for LT transactions can be mitigated w/ these. Two firms w/ coincidental needs for international currencies may agree to swap currencies collected in a future pd at a specified exchange rate. The two entities swap their currencies in an exchange negotiation completed yrs before receipt of the currencies. Financial intermediaries are contacted to broker/match firms w/ currency needs. 3. Parallel loan: 2 firms may mitigate their transaction exposure to LT exchange rate loss by exchanging/swapping their domestic currencies for a foreign currency and simultaneously agreeing to re-exchange or repurch their domestic currency later on.

Other Techniques for Transaction Exposure Mitigation - Alternative Hedging Techniques

Hedge transactions used to mitigate exchange rate risk from transaction exposure: 1. Leading and lagging: rep trans btw subs or a sub and a parent. Entity owed may bill in advance if exchange rate warrants (leading) or wait until exchange rate is favorable (lagging). 2. Cross-hedging: involves hedging one instrument's risk w/ a diff instrument by taking a position in a related derivatives contract. Often done when there's no derivatives contract for investmt being hedged or when a suitable derivatives contract exists but the mkt is highly illiquid. 3. Currency diversification: simplest hedge for LT transactions is to diversify foreign currency holdings over time. Substantial decline in value of one currency wouldn't affect overall dollar value of firm if the currrency represented only 1 of many foreign currencies.

Performance Standards - Nature of Work

IA activity must eval/contribute to the improvemt if governance, risk mgmt, and I/C processess using a systematic and disciplined approach. 1. Governance: IA activity must assess/make approp recommendations for improving the governance process in its accomplishmt of these objs: -promoting approp ethics/values w/in the org (IA activities contemplate a review of ethics and compliance programs) -ensuring effective org performance mgmt and accountability (IA activities anticipate an assessmt of adequacy of IT governance) -comm risk and control into to approp areas of the org -coordinating the activities of and comm info among the BOS, external/internal auditors, and mgmt 2. Risk mgmt: IA activity must eval effectiveness of risk mgmt processes and contribute to the improvemt of them, including assessmt of: -mgmt's alignmt of org goals and mission -mgmt's ID and assessmt of risks -risk response designs that align w/ risk appetite -timely comm of relevant risk info 3. Internal control: IA activity must assist the org in determining whether the entity has met its strategic objs, maintaining effective I/C by evaluating their effectiveness/efficiency and promoting continuous improvemt of I/C.

International Accounting Practices

IASB seeks to make stds more equivalent through issuance of IFRS to mitigate the risk of inconsistent fin reporting. Mgmt must be aware of local reporting rqmts and act accordingly. Some countries use IFRS, others don't, some hybrid. Discrepancies in reporting stds can lead to inconsistencies in accounting terminology/reporting practices that make fin reporting unclear and detract from GAAPs goal of fin reporting transparency.

Performance Standards - Communicating Results

IAs must comm the results of the engagemt. 1. Criteria for communicating: comms must include the engagemt's objs, scope, and applicable conclusions, recommendations, and action plans. Conclusions/opinions can take numerous forms, incl ratings or descriptions of results. 2. Quality of comms: must be accurate, obj, clear, concise, constructive, complete, and timely. 3. Engagemt disclosure of noncompliance w/ stds: when nonconformance w/ definition of IA, code of ethics, or stds affects an engagemt, comm of the engagemt results must disclose: -principle/rule of conduct of code of ethics or stds w/ which full conformance wasn't achieved -reasons for nonconformance -effect of noncomforance on the engagemt and the comm engagemt results. 4. Disseminating results: chief audit exec must review/approve the final engagemt comm before issuance and deciding to whom and how the comm will be disseminated. May delegate the duties, but chief audit exec maintains overall responsibility for all comm.

Performance Standards - Engagement Planning

IAs must develop and document a plan for each engagemt, incl enagagemt's objs, scope, timing, and resource allocations. 1. Planning considerations: in planning the engagemt, IAs must consider: -objs of the activity being reviewed and the means by which the activity controls its performance -sig risks to the activity, its objs, resources and ops, and the means by which the potential effect of risk is kept to an acceptable level -adequacy/effectiveness of activity's governance, risk mgmt, and control processes compared to a relevant control framework/model -opps for making sig improvemts to activity's governance, risk mgmt, and control processes 2. Engagement objs: must be est for each engagemt. -must reflect results of prelim risk assessmt performed before beginning of engagemt -must consider the probability of errors, fraud, noncompliance, or other exposures 3. Engagemt scope: establish scope must be sufficient to achieve the objs of the engagemt, incl considerations of relevant systems, records, personnel, and physical properties. 4. Engagemt resource allocation: IAs must determine if there are approp/sufficient resources to achieve the engagemt objs. 5. Enagemt work program: IAs must develop/document these to achieve the engagemt objs. Must be approved before implementation and changes must also be approved.

Performance Standards - Performing the Engagement

IAs must identify, analyze, eval, and documt sufficient info to achieve engagemt's objs. 1. Identifying info: IAs must identify sufficient, reliable, relevant, and useful info to achieve engagemt's objs. 2. Analysis and eval: IAs must base conclusions and engagemt results on approp analyses/evals. 3. Documenting info: IAs must documet relevant info to support the conclusions and engagemt results. 4. Engagemt supervision: engagemts must be properly supervised to ensure objs are achieved, quality is assured, and staff is developed.

Internal Audit Standards - Implementation Standards: Assurance Activities

Implementation stds embedded w/in attribute and performance stds and provide rqmts consistent w/ the unique issues applicable to assurance or consulting activities. Assurance services involve the IA's obj assessmt of evidence to provide an independent opinion/conclusions regarding the entity, an operation, a function, a process, a system, or something else. The nature/scope of the assurance engagemt determined by IA. 3 parties involved in assurance services: 1. Auditee: person/group directly involved w/ the entity, op, function, process, system, or other. 2. Internal auditor: person/group making assessmt. 3. User (sponsor): person/group using assessmt.

Initiating

In this phase, proj scope defined, project auth, and initial financing resources committed. Project charter is a doc that contains a bus justification to fulfill the needs/expectations of initial stakeholders by carrying out a stmt of work that will achieve the project's objs. Formally establishes pship btw requesting org and receiving org. Stakeholders are all indivs, internal bus units, and external orgs positively/negatively affected by proj. -project team -sponsors -steering committee -customers -customer coworkers who will be affected by the change in customer work practices due to new product/service -customer managers affected by modified workflows/logistics The stmt of work describes the product/services the proj must deliver at completion.

Financial Risk Management - Transfer Pricing

International businesses will likely do bus btw subs that cross political boundaries or btw domestic parent/foreign sub. Related parties. Valuation of these trans involves transfer pricing. Transfer pricing decisions minimize local taxation while remaining w/in the guidelines of foreign or other host govts. Interco transactions - relative TRs: Transfer (selling) prices in countries w/ higher tax rates will be reduced to optimum levels. Transfer selling prices in countries w/ higher TRs incr tax burden but also incr tax protection afforded to foreign subs operating in other countries, even if those subs have lower rates. Transfer prices S/B set up to maximize consol benefit, reduce inc in countries w/ higher taxes, and maximize tax shield in countries w/ lower taxes. Intercompany cash transfers are often managed through leading/lagging. -subs w/ strong cash position tend to follow leading transfer policy and pay other subs in advance. -subs w/ weak cash position tend to follow lagging transfer policy, paying richer subs long after obligations incurred to preserve cash.

International Professional Practices Framework (IPPF)

International stds for the practice of internal auditing are published by the Institute of Internal Auditors (IIA). Stds for the internal audit profession are meant to provide internationally authoritative guidance w/in the context of an international practices framework. The international professional practices framework orgs the authoritative guidance published by the IIA. Authoritative guidance is divided into 2 categories (mandatory and endorsed/strongly recommended). *Mandatory guidance*: 1. Definition of internal auditing: independent/objective assurance and consulting activity designed to add value and improve an org's ops. It adds value and helps an org accomplish its objs by bringing a systematic, disciplined approach to eval/improve the effectiveness of: -risk mgmt -I/C -governance processes 2. International stds: International Stds for the Practice of Internal Auditing (the stds) are a structured list of stds for internal auditors that incl attribute stds, performance stds, and implementation stds. Purpose is to: -define principles that rep internal audit -provide a framework for value-added activities -establish a basis for eval of int audit performance -foster improved processes and ops 3. Code of ethics: Issued as part of IPPF. Applies to indivs and entities that provide internal auditing services. Provides principles/rules of conduct under 4 headings. -integrity: internal auditors must perform work w/ honesty, diligence, and responsibility in full observation of the law and consistent w/ ethical objs of the org. -objectivity: internal auditors are to exhibit the highest level of professional objectivity in gathering, evaluating, and comm info abt the activity/process being examined. Shouldn't participate in relationships that rep conflicts of int and should disclose facts that may affect eval of their reports. -confidentiality: internal auditors respect the value/oship of info they receive and don't disclose it w/o approp authority (unless legal/professional obligation) or use info for personal gain. -competency: internal auditors apply the knowledge, skills, and experience needed in the performance in internal auditing services. *Endorsed and Strongly Recommended Guidance* 1. Position papers: assist a wide audience (incl those not in internal auditing) in understanding sig governance, risk, or I/C issues, and defining roles/responsibilities of internal auditing. Form part of the IPPF. 2. Practice Advisories: address approach, methodology, and considerations, but not detailed processes/procs. Offer guidance to assist internal auditors in applying the code of ethics and the stds and to promote good practices. 3. Practice guides: address detailed processes/procs in specific circumstances. Although International Stds for the Practice of IA are unique to IA, they're structured in a way that addresses the auditor's responsibilities in a manner sim to gen accepted auditing stds (GAAS). -attribute stds pub by IIA address lots of same issues of general stds under GAAS. Issues related to auditor independence, tech proficiency, and professional care addressed here. -performance stds published by IIA address may of the same issues as field work stds and reporting stds under GAAS. Issues related to planning/supervision of the engagemt and documentation of evidence or basis for conclusions are addresed here, plus generic reporting rqmts. -implementation stds pub by IIA embedded w/in attribute and performance stds to address the rqmts of implementing both assurance and consulting activities.

Planning

Involves all activities needed to further detail the scope of the proj, refine its objs, and define the course of action req to attain the proj objs. It's an ongoing process throughout the proj's life, bc any change subsequent to initial plan compels proj manager to assess it and maybe revise plan. Activities in planning: 1. Develop initial proj mgmt plan 2. Define/document stakeholder rqmts 3. Define scope of the proj (detailed descr of proj and rqmts when finished) 4. Create a work breakdown sequence: -subdivide proj work and deliverables into small, manageable tasks. -update proj doc to reflect work breakdown structure. 5. Define the activities that must be performed to produce deliverables -show them in an activity list -generate milestones list 6. Sequence the activities by determining relationships btw them -dependent activities can't be scheduled for completion before previous task/input completed -independent activities can be scheduled for completion whenever they make sense 7. Estimate the activity resources by listing supplies/equip needed to complete them. 8. Estimate the duration of activities 9. Develop the schedule of activities based on resource availability, event sequence, and amt of time to complete. 10. Estimate the costs of activities 11. Develop the budget 12. Define what a quality outcome is/define std of quality for the proj. List those attributes that will form benchmark against which success of proj will be measured. 13. Identify/document proj roles, responsibilities, skills, reporting relationships 14. Identify info needs of stakeholders and define a comm approach. Create a doc showing who needs to be kept informed abt proj and how they will get the info. 15. Determine how risk mgmt activities will be conducted 16. Identify risks based on cost, schedule, communications, and environmental factors. Determine/document those that could affect proj. 17. Prioritize the risks by assessing likelihood of occurence/effect on proj. 18. Numerically analyze effect of ID'd risks on proj objs 19. Develop options in the event that risks manifest themselves 20. Acq needed equip/supplies

Types of Risk

Measuremts of risk try to capture the multiple dimensions of risk. Types of risk exposures: 1. Int rate risk (yield risk): often used in context of fin instruments. Reps exposure of owner of instrument to fluctuations in the value of instrument in response to changes in IR. *IR incr, value of fixed rate bond decr*. 2. Mkt risk: exposure of security/firm to fluctuations in value from operating w/in an economy. Also called nondiversifiable risk bc it's inherent in operating w/in the economy. *Prices of indiv stocks usually incr/decr w/ overall mkt*. 3. Credit risk: affects borrowers. Exposure to this incl co's inability to secure financing or favorable credit terms bc of poor credit ratings. As credit ratings decr, IR demanded by lenders incr, collateral could be req, and terms are generally less favorable for borrower. *Risk incr, IR incr*. 4. Default risk: affects lenders. Creditors are exposed to this to the extent that it's possible that debtors may not repay the principal or int due on a timely basis. 5. Liquidity risk: affects lenders (investors). Lenders/investors exposed to this when they want to sell their security but can't in a timely manner or when material price concessions have to be made to do it.

Long-Term Financing Strategies and Factors

LT financing generally classified as noncurrent and will mature in >1 yr. Rates are higher than ST and presume less liquidity on the part of the org. The extent to which org uses LT financing strategies depends on amt of current assets it maintains and risk tolerance of mgmt. LT financing strategies anticipate higher levels of perm WC. Co mgmt may expect more volatile IRs or reduced cap availability in fin mkts. Advantages: -decr IR risk: for borrower, LT financing locks in IR over long pd, reducing exposure to rate fluctuations. -incr cap availability: securing LT debt guarantees financing over a long pd and reduces co's exposure to risk that refinancing might be denied/modified w/ worse terms. Disadvantages: -decr profitability: higher financing costs and incr time span for conversion of op cycle components into cash reduces profitability/liquidity. -decr liquidity: LT financing commits orgs to pmts over a longer pd and so reduces flexibility/liquidity. -incr financing costs: LT debt has higher IR given longer duration. (1) IR risk from lender's perspective- for lenders, higher IR charged for LT debt bc likelihood that rates will change over the pd of the loan incr as the term of the loan does. Higher financing charges comp the lender for incr IR risk. Lenders recog their exposure to IR risk w/ LT financing and charge a premium to borrower in the form of higher rates. (2) IR risk from borrower's perspective- borrowers lock themselves into LT IR to reduce their exposure to IR risk, and pay a premium to do it. Summary of ST v LT debt: -rates lower for ST, higher for LT. -adv of ST are incr liquidity and profitability -adv of LT are decr IR risk and incr cap availability -disadv of ST are incr IR risk and decr cap availability -disadv of LT are decr liquidity and profitability -ST strategy S/B used w/ higher levels of temp WC -LT strategy S/B used w/ higher levels of perm WC

Demand Flow

Manages resources using customer demand as basis for resource allocation. Pull. Contrasts w/ resource allocations based on sales forecasts or master scheduling. Sim JIT processes that focus on efficient coordination of demand for production goods w/ supply of them. Kanban systems visually coordinate demand rqmts of mfg floor w/ suppliers. They're used to coordinate demand flow. Demand flow designed to max efficiencies/reduce waste (sim lean). One-piece-flow mfg environments, where components move progressively from production function to production function, benefit from demand flow ideas.

Measures and Benefits to Process-Management-Driven Businesses

Measures/process metrics can be financial/nonfinancial and should correlate directly to the managed process. Measures compared to expectations to monitor progress. Measures: 1. Gross rev: Financial. Approp measure for sales/measures of rev volume in sales-driven orgs. 2. Customer contacts: Leads. Used in sales-driven orgs. 3. Customer satisfaction: Complaints. Orgs using relationship mkting might consider these measures. 4. Operational statistics: Time. Mfg opps might use opp stats like throughput times, delivery times, or logistical measures to determine process efficiency. First one financial, all others nonfinancial. The benefits of a studied/systematic approach to process mgmt allow co to monitor degree to which process improvemts have been achieved. Benefits: 1. Efficiency: fewer resources used to accomplish org obj. 2. Effectiveness: obj accomplished w/ greater predictability. 3. Agility: responses to change faster/more reliable.

Methods of Conducting International Business Operations

Methods of org: 1. International trade: cos/nations do this by exporting/importing products/services. 2. Licensing: provide the right to use processes/tech in exchange for a fee. 3. Franchising: franchisors are entities whose mkting service/delivery strategy provides training and related service delivery resources in exchange for a fee. 4. Joint ventures: take adv of comparative adv of one/both participants in mkting/delivering product. 5. Direct Foreign Investmt (DFI): Purchasing a foreign co as a sub or starting a sub op w/in borders of foreign country. 6. Global sourcing: synchronization of all levels of product mfg (incl R&D, production, and mkting) on an international basis. Frequently implemented through a range of org/bus arrangements (import/export ops, licensing, franchises, JVs).

Performance Standards - Monitoring Progress and Management's Acceptance of Risk

Monitoring progress: chief audit exec must establish/maintain a system to monitor the disposition of results communicated to mgmt. Mmgt's acceptance of risk: when chief audit exec concludes mgmt has accepted too high level of risk, must discuss the matter w/ senior mgmt. If matter not approp resolved, chief audit exec must comm it to the BOD.

Project Management Definitions

Operations mgmt: Pertains to ongoing production of goods/services and ensuring that a cos ops function efficiently by using the optimal resources needed to meet the sales demand of its customers. Focuses on managing the processes that transform inputs into outputs. Project: Temporary undertaking intended to produce a unique service, product, or result. Could involve an indiv, multiple indivs, single/multiple divisions, or multiple org units (operating cos) from multiple orgs. Unlike continuing ops, has beginning and end. Project ends when its objs have been achieved, it's determined they can't be met, or mgmt determines project isn't necessary anymore. Project mgmt: Consists of 5 major processes carried out by project manager tasked w/ balancing the needs/expectations of various stakeholders against org's constraints. Processes: -initiating -planning -executing -monitoring/controlling -closing These are laid out in next few notecards.

Internal Audit Standards - Performance Standards

Overarching field work stds incl planning, auditor communications, defining engagemt scope in a manner that adds value consistent w/ the definition of IA, and documenting work in a manner that supports conclusions. Performance stds composed of 7 areas: 1. Managing the IA activity 2. Nature of work 3. Engagemt planning 4. Performing the engagemt 5. Communicating the results 6. Monitoring progress 7. Mgmt's acceptance of risk

Just-in-Time (JIT)

Performance improvemt techniques/philosophies try to provide highest-quality goods/services in most efficient/effective manner possible. Methods are JIT, quality, lean mfg, demand flow, theory of constraints, and six sigma. JIT mgmt anticipates achievemt of efficiency by scheduling the deploymt of resources JIT to meet customer/production rqmts. Underlying concept is inv doesn't add value and keeping it on hand produces wasteful costs. Benefits of JIT: -synchronization of production scheduling w/ demand (pull) -arrival of supplies at reg intervals throughout production day -improved coordination/team approach w/ suppliers -more efficient flow of goods btw warehouses/production -reduced set-up time -greater efficiency in use of employees w/ multiple skills Overall reduces costs and incr quality.

Price Multiples - Other Ratios

Price-to-Sales Ratio (P/S): Sim P/E, can be used to forecast current stock price. Rationale for using it is that sales are less subj to manipulation than earnings/BVs, sales are always positive so this multiple can be used even when EPS neg, and ratio isn't as volatile as P/E (which incl affect of financial/op leverage). Studies have shows that P/S is an aprop measure to value stocks assoc w/ mature/cyclical cos. P/S ratio= [P0/S1]. S1= expected sales in 1 yr = [S0 x (1+g)]. Value of equity can be calced as: P0 = [(P0/S1) x S1]. Price-to-Cash-Flow Ratio (P/CF): May also be used to calc current stock price. Rationale for using this is that CF is harder for cos to manipulate than earnings, P/CF is a more stable measure than P/E, and research has shown that changes in a co's P/CF ratio over time are positively related to changes in a co's LT stock returns. P/CF ratio= [P0/CF1]. CF1= exp CF in a yr. Value of equity can be calced as: P0= [(P0/CF1) x CF1]. Price-to-Book Ratio (P/B): Focuses on B/S vs I/S or stmt of CFs. Rationale for using this is that a firm's BV of common equity (A-L and PS) is more stable than EPS, especially when a firm's EPS is super high/low for a given pd. Bc P/B usually pos, can be used even when a firm's EPS is neg/0. Research indicates that P/B ratio can explain a firm's avg stock returns over the LR. P/B ratio= [P0/B0]. B0= BV *common* equity (subtract PS). Vaule of equity can be calced as: P0= [(P0/B0) x B0]. Price multiple ratios have sim assumption rqmts, each of which can be infl by mgmt behaviors, incl: -future earnings -future CFs -future sales -future gr -duration of sales, earnings, or CF trends.

Financial Decisions Using Probability and Expected Value Models

Probability is the chance an event will occur. Probabilities assigned values btw 0 and 1. 0 is no chance of occuring (impossible), 1 is always will occur (certainty). 2 types of probability: 1. Objective probability: based on past outcomes. Obj probability of an event = [no of times event will occur/total no of possible outcomes]. 2. Subjective probability: based on an indiv's belief abt likelihood that a given event will occur. Est based on judgment and past experience of the likelihood of future events. Like just saying fav team has 60% chance of winning. Expected value is the weighted-avg of the probable outcomes of a variable where the weights are the probability of an outcome occurring. E(X)= sum of [probability of each outcome x its payoff]. The expected value of perfect info is the diff btw the expected payoff under certainty and the expected monetary value of the best alternative under uncertainty. Shortcomings of probability concepts and expected values: -expected value based on repetitive trials, not one trial, like many bus decisions. -expected value reps avg outcome, not actual outcome. Benefit is that expected values provide an obj framework for assessing risks and probable outcomes and are useful in decision making.

Monitoring and Controlling

Procs performed to observe proj execution so potential probs can be ID'd in a timely manner and corrective action taken to ensure proj completion. 1. Monitor/control proj work by reviewing where proj is against baseline in plan 2. Eval how actual time, cost, schedule, quality, and risk compare to variables in plan (actual v plan) 3. Prep status reports, progress measurmts, and forecasts for stakeholders 4. ID need for any changes req to keep the proj on schedule. Changes must be reviewed, approved, and evaled for effect on scope and proj deliverables. 5. Verify the scope by formalizing acceptance of completed proj deliverables 6. Control the scope by monitoring proj status and determining changes to scope baseline 7. Control the schedule by updating/documenting completion of scheduled activities 8. Control the costs by updating the proj budget to reflect the current proj status 9. Control procurement process 10. Perform QC by recording results of QC activities 11. Dist performance info like status reports, progress measuremts, and forecasts 12. Implement risk response plan, track ID'd risks, ID new ones, eval risk process effectiveness throughout proj 13. Manage vendor relationships, monitor contract performance, adj as necessary

Quality Philosophy

Product's ability to meet/exceed customer expectations. Cost of quality incl costs assoc w/ conformace w/ quality stds (prevention) and opp costs or activities assoc w/ correcting nonconformance w/ quality stds (cure). As incr conf/non-conf costs, other type will decr. Cost of quality reports display the financial result of quality. Inverse relationship exists btw conf/non-conf costs. Incr investmt in conf costs should result in decr in non-conf costs, and vice versa. Acronym to remember the diff costs is *A PIE*. Conformance costs are *A*ppraisal and *P*revention costs. *A*ppraisal: incurred to discover/remove defective parts before they're shipped to customers or next deptmt. Include: -statistical quality checks -testing -inspection -maintenance of laboratory *P*revention: incurred to prevent production of defective units. Engineering costs incl. Includes: -employee training -inspection expenses -preventative maintenance -redesign of product -redesign of processes -search for higher-quality suppliers Nonconformance costs are *I*nternal/*E*xternal costs. Hard to compute bc most of these costs are opp costs like lost sales/rep damage. *I*nternal failure: costs to cure a defect discovered before product is sent to customer. Include: -rework costs -scrap -tooling changes (find where failure in process was) -costs to dispose -cost of lost unit -downtime *E*xternal failure: costs to cure a defect discovered after product is sent to customer. Include: -warranty costs -costs of returning good -liab claims -lost customers -reengineering an external failure

Human Resources (Communication) Management

Proj manager must put together staff to work on proj, assign each team member responsibility for tasks, acq staff internally/externally as needed, and develop team members by providing feedback/guidance so team collaborates effectively. HR plan docs these planning assumptions. Influences on HR plan: -org culture -existing staff levels throughout org -condition of mkt place -established comm channels in org -industry regs/current laws -sources of additional staff Tools to enhance comm/success in HR plan: -hierarchial charts (typical org chart enhanced w/ work breakdown structures) -a matrix (responsibility assignment matrix, RAM, shows all activities assoc w/ 1 person and all ppl assoc w/ 1 activity) -task-oriented narrative descr outlining responsibility, auth, competencies, and qualifications -staffing mgmt plan to explain how/when PM will acq all proj participants -training/team building activities -recog/rewards Conflict resolution strategies: -retreat from conflict -focus on areas of agreement and ignore/de-emphasize areas of disagreement -compromise so all parties have some wants/needs met -offer a direct win-lose situation by leveraging auth (for critical conflict) -build consensus through incorp various perspectives -actively engage team to solve prob through discussion Plan for things to go wrong and ID approp response: -time orig allocated for taks might vary sig from actual -additional staff might be req, cost overruns -duration of activity may need to be modified based on team member competency levels -PM might be managing a virtual team w/ members in diff time zones

Closing

Proj mgmt process summed up: An auth proj plan is initiated, executed, monitored/controlled, and eventually ends when objs have been completed. Closing process group verifies all defined proj phases complete, closes proj, and closes procurement relationships.

Roles

Project manager: Responsible for project admin on day-to-day basis. Responsibilities: -achieve all proj objs while balancing contraints of budget, time, and resources -ID/manage internal/external stakeholder expectations -develop proj plan, implement it, monitor/control it, and close the proj when objs met -ID/procure proj team members, resolve team conflicts, provide feedback to team members -Break proj down into smaller manageable tasks, assign/delegate responsibilities to team members -Comm proj metrics to stakeholders/team members. Project members: Perform proj tasks. Roles: -carrying out work/producing deliverables defined by proj manager. Proj members can be indivs or orgs. -understanding the work that must be completed, planning the assigned activities in more detail if needed, completing the work w/in budget, time, and quality expectations, and proactively comm the status of their work to proj manager. Project sponsor: Indiv/group internal/external to proj's org. Responsible for providing resources/support to proj and enabling it's success. Role: -responsibility for overall proj delivery -participation in high-level planning and leading developmt of proj charter in project auth stage -support proj manager in resolving major issues/probs -chair steering committee -champion proj to upper mgmt and lateral executives across an org -remove/overcome org obstacles/barriers through diplomacy/negotiation -sign off on approvals req to proceed to next phase of proj work -review proj work w/ broader org goals in mind -interface btw org and proj itself -comm proj needs to steering committee Executive steering committee: Like BOD of proj. Directs but doesn't manage on daily basis. Group of exec level ppl or external orgs charged w/ reg oversight of proj and responsibility for bus issues assoc w/ proj. Should rep all significant areas of participation (deptmts/bus units) in an org so that they have auth to make binding decisions on behalf of the areas. Deptmt heads, VPs, directors. Responsibilties: -give guidance on overall strategic direction of proj to proj sponsor or proj manager -approve proj deliverables -help resolve issues/policy decisions -approve scope changes -auth proj in proj charter -approve budget strategy -monitor risk, quality, timeliness -mandate, control, empower, and make key decisions

Time Management

Proper time mgmt plays critical role in completing a proj w/in time constraints outlined in proj budget and to avoid cost overruns. Processes: -develop schedule mgmt plan -define proj activities -est req activity resources -est activity durations -develop a schedule -control the schedule

Price Multiples - P/E Ratio

Rep ratios of stock's mkt price to another measure of fundamental value per share. Investors use these to eval the price of a stock and determine if its undervalued, fairly valued, or overvalued by incorp what a share of stock buys relative to earnings, sales, CF, or another per share measure. Once an analyst calcs a set of price multiple ratios for a given co/stock, they're used as a method of comparison to the same ratios for sim cos/stocks w/in the industry sector to determine a ranking for each price multiple ratio and provide input in a particular co's stock valuation. *These are all on a per-share basis!* Price-Earnings (P/E) ratio: Most widely used multiple when valuing equity securities. Rationale for using it is that earnings is a key driver of investmt value (price). This is used a lot by investmt community and research has shown that changes in a co's P/E are tied to the LR stock performance of that co. P/E ratio = P0/E1. E1 is EPS in 1 yr. E1= E0 x (1+g). This is forward P/E since denom based on exp earnings in next yr. Once P/E calced, can be multiplied by anticipated future earnings to determine current stock price. P0 = [(P0/E1) x E1]. The numerator in the P/E is obv, since stock price for pubic cos is easy to find. Denom diff bc earnings in the P/E ratio can either be past earnings or exp future earnings. When past earnings are used (last 4 quarters or TTM), ratio is trailing P/E. When expected earnings of co next yr is used, ratio is forward P/E. Trailing P/E preferred when forecasted earnings unavailable for co. Forward preferred when co's historical earnings not representative of its future earnings. Trailing P/E = [P0/E0]. E0 is EPS for past yr.

Quality Management

Reps activites/processes performed by an entity on an ongoing basis to ensure that quality objs, policies, and procs pertaining to a proj will meet the needs/rqmts for which proj was designed. Contains 3 processes: 1. Plan quality mgmt: -ID quality rqmts/stds for proj and deliverables -document how proj will comply w/ specific quality rqmts 2. Perform quality assurance: -audit quality rqmts and results from QC measuremts -ensure proper quality stds used 3. Control quality: -monitor/record results of execution of QC activities to determine causes of poor product quality or processes -recommend process changes as necessary -validate that proj deliverables meet spec rqmts 7 quality tools used to solve quality related probs (7QC tools): -flowcharts -check sheets -cause-and-effect diagrams -histograms -pareto diagrams -scatter diagrams -control charts

Project Risk

Reps an uncertain condition or event that could have a neg/pos effect on one/several proj objs. Defined risk may have 1+ possible causes and, if it occurs, 1+ effects on proj. Overall proj risk is greater than sum of indiv proj risks bc it includes all sources of proj uncertainty and the effect that various proj outcomes have on all stakeholders. Risk is inherent in all aspects of mgmt process. To manage it, proj manager must consider WCGW in initiating, planning, execution, monitoring/control and closing processes. Risk assessment: -anticipate WCGW throughout proj plans -analyze each risk to specify how those uncertainties can affect performance of proj in time, cost, or meeting user expectations -prioritize risks and determine which must be eliminated completely (severe), which should get reg mgmt attention (sig), and immaterial risks. Common proj risks are time/cost est that are too optimistic, unclear roles/responsibilities, stakeholder input not sought, needs not prop understood, etc. Risk control: -spend money in adv to mitigate/prevent most severe risks -plan for emergencies w/ written plan in place before sig risks arise -track effects of ID'd risk in risk register by adding each risk to log, writing down what will be done if it happens, and writing what should be done to prevent it from happening. Inputs used for planning for risks: -risk mgmt plan -cost mgmt plan -schedule mgmt plan -risk register -enterprise environmental factors -org process assets: institutional lessons learned from previous projs, proj files, and org and project process controls.

Computation of Return (Yield)

Return comps investors/creditors for their assumed risk. Often stated/measured by IRs. Int can be expressed as a cost (int exp) to debtors or income (int inc) to investors. Diff computations: 1. Stated IR: nominal IR. Rate of int charged before any adj for compunding/mkt factors. It's shown in the agreement of indebtedness (bond indenture, promissory note, etc.). Just plain face value int %. 2. Effective IR: reps actual finance charge assoc w/ a borrowing after reducing loan proceeds for charges/fees related to loan origination. Effective IR= [amt of int paid based on loan agreement/net proceeds received] 3. Annual Percentage Rate (not like car commercials): reps noncompunded version of effective APR (car commercials). Rate req for disclosure by fed regs. Emphasizes amt paid relative to funds available. Don't forget to multiply by 6/12 if semiannual, etc. for periodic IR. Annual percentage rate= [effective periodic IR x # of compounding pds]. 4. Effective Annual Percentage Rate (APR, car commercials): reps state IR adj for no of compounding pds in a yr. APR= [((1+stated rate)^# compounding pds)-1]. Stated rate should be divided by no compounding pds in yr... so if 8% semiannual, 8/2= 4%. 5. Simple Interest: amt repped by int paid *only* on the orig amt of principal w/o regard to compounding. Simple int= [principal x IR x # pds]. 6. Compound Interest: amt repped by int earnings/exp based on orig principal + any unpaid int earnings/exp. Int earnings/exp compound and yield an amt higher than simple int. Compound int= [principal x ((1+IR)^# pds)]. 7. Required Rate of Return: calced by adding the following risk premiums to RF rate (real rate of return): -maturity risk premium (MRP): comp investors demand for exposure to IR risk over time. Incr w/ term to maturity. -purch power risk or inflation premium (IP): comp investors req to bear risk that price levels will change and affect asset values or purch power of invested dollars (real estate). -liquidity risk premium (LP): additional comp demanded by lenders/investors for risk that an investmt security (junk bonds) can't be sold on short notice w/o sig price concessions. Liquidity is ability to quickly convert asset to cash at FMV. default risk premium (DRP): additional comp demanded by lenders/investors for bearing risk that the issuer of the sec will fail to pay int/principal due on a timely basis. [RF rate + IP] = nominal rate of return (called nominal RF rate) + risk premium (incl MRP + LP + DRP) = req rate of return.

Analyzing the Trade-Offs between Risk and Return

Risk is the chance of financial loss. Uncertainty. Refers to variability of returns assoc w/ an asset. Return is the total G/L experienced on behalf of the owner of an asset over a given pd. Greater risk, greater return. Seller of fin secs comps buyer w/ incr opp for profit w/ higher rate of return. Risk/return are a function of mkt conditions and risk preferences of parties involved. Risk preferences: diff managers have diff attitudes toward risk. 3 types: 1. Risk-indifferent behavior: attitude toward risk in which incr in level of risk doesn't result in an incr in mgmt's required rate of return. Want the highest return, period. 2. Risk-adverse behavior: attitude toward risk where an incr in level of risk results in an incr in mgmt's req rate of return. Req higher expected returns to comp for more risk. Most common, general rule. 1 and 3 are exceptions to this. 3. Risk-seeking behavior: attitude toward risk where incr in level of risk results in decr in mgmt's req rate of return. Willing to settle for lower expected returns as risk level incr. Diversification: risk is often reduced by this, process of selecting investmts of diff/offsetting risks. *Not all risk can be managed this way*. Total risk is combo of diversifiable and nondiversifiable risk. *DUNS*. 1. *D*iversifiable risk: nonmkt, *U*nsystematic, or firm-specific risk. Portion of a single asset's risk assoc w/ random causes. Can be eliminated through diversification. Attributable to firm-specific events (unique to specific bus) like strikes, lawsuits, reg actions, or loss of key acct. 2. *N*ondiversifiable risk: mkt or *S*ystematic risk. Attributable to mkt factors that affect all firms (everyone) and can't be eliminated through diversification. War, inflation, international incidents, political events. *The only relevant risk is nondiversifiable risk*, bc investor can create portfolio that eliminates most/all diversifiable risk. So only worry abt nondiversifiable as investor.

Shared Services, Outsourcing, and Offshore Operations

Shared services means seeking out redundant services, combining them, and sharing them w/in a group/org. Creates efficiency but could cause probs: -service flow disruption: consol of work in 1 location can create waste in transition, rework, and duplication as well as incr in time to deliver a service. -failure demand: demand for a shared service caused by a failure to do something or do something right for a customer. When a task has to be done 2nd time bc done wrong 1st time. Outsourcing is contracting of services to an external provider. Payroll/call center. Contractual relationship btw bus/service provider. Increases efficiencies, but can cause risks: -quality risk: outsourced product/service C/B defective. -quality of service: poorly designed service agreemts could impede quality of service. -productivity: real productivity C/B reduced despite lower pay of service provider employees. -staff turnover: experienced/valued staff whose functions were outsourced may leave. -language skills: language barriers can reduce quality of service if outsource overseas. -security: security of info w/ 3rd party C/B compromised. -qualifications of outsourcers: credentials of service providers C/B flawed. Offshore degrees might not be same as domestic ones. -labor insecurity: increases when jobs move to external service provides or overseas. Offshore ops relate to oursourcing services/bus functions to external party in diff country. Most common types: -IT outsourcing -bus process outsourcing (Call centers, accting ops, tax compliance) -software R&D (software developmt) -knowledge process outsourcing (processes needing adv knowledge/specialized skill sets) Sim bus risks to outsourcing, but greater emphasis on lack of controls bc of proximity and language issues.

Theory of Constraints (TOC)

States that orgs are impeded from achieving objs by the existence of 1+ constraints. Org of project must be consistently op'd in a manner that either works around or leverages constraints. Constraints are anything impeding the accomplishment of an obj. Limited in total and orgs may face only one sometimes. Internal constraints: evident when mkt demands more than system can produce. -equip may be inefficient/used inefficiently -ppl may lack necessary skills/mind-set to produce req efficiencies -policies may prevent efficient use of resources External constraints: exist when system produces more than the mkt req. TOC has 5 steps: 1. ID of constraint: use of process charts/interviews results in ID of constraint that produces suboptimal performance. 2. Exploitation of constraint: planning around constraint uses capacity that is potentially wasted by making/selling wrong products, improper scheduling procs, etc. 3. Subordinate everything else to the above decisions: mgmt directs its efforts to improving the performance of the constraint. 4. Evaluate the constraint: add capacity to overcome it. 5. Return to step 1: reexamine process to optimize results. Remain cognizant that inertia can be a constraint. Concept of buffers is used throught TOC. Mgmt adds buffers before/after each constraint to ensure that enough resources to accomodate the constraint exist. Buffers eliminate the effect of the constraint on work flow.

Annuities

Traditional fin valuation is based on the formula for PV of an annuity. Somewhat complex, but it's applied in various forms throughout fin mgmt. Alternative valuation methods use variations of P/E ratio. Important to understand valuation formulas, implied assumptions of them, and effect of the behavior of fin managers on the eval of those assumptions. An annuity is a series of equal CFs to be received over a no of pds. The traditional approach to asset valuation is the PV of an annuity formula. PV of an annuity= [amt of annuity x ((1-PV factor)/r)]. PV factor= [1/((1+r)^n)]. Assumptions: -recurring amt of annuity: amt of periodic annuity must be specified. -approp discount rate: must specify discount rate. -duration of the annuity: must specify how long annuity will continue. -timing of annuity: must specify if pmt is monthly/quarterly/annually. Must also specify if annuity occurs at beginning or end of pd.

Quality Philosophy Continued- Total Quality Management (TQM) and Quality Audits and Gap Analysis

TQM reps an org commitment to customer-focused performance that emphasizes both quality and continuous improvemt. 7 critical factors: 1. Customer Focus: TQM org characterized by recognition that each function of the corp exists to satisfy the customer. Customers external/internal. -external: ultimate recipient/consumer of orgs product/service -internal: each link in value chain (and w/in value chain) reps an internal customer 2. Continuous Improvement: quality isn't an achievemt. Org constantly strives to improve product/processes. Quality is not just goal, embedded in process. 3. Workforce Involvemt (quality circles): team approaches/worker input to process developmt/improvemt. Small groups of workers using team approaches to process improvemt are quality circles. 4. Top mgmt support (delegation and empowerment): top mgmt must actively describe/demonstrate support for quality mission of the org. Mgmt can communicate support by meaningful delegation of auth to quality circles and involvemt of suppliers. 5. Objective measures: measures must be unambiguous, clearly communicated, and consistently reported. 6. Timely Recognition: acknowledgemt of TQM achievements (in comp and recog) must occur to encourage ongoing involvemt of workforce. 7. Ongoing training: TQM training should occur on recurring basis to ensure workforce understanding/involvemt. Quality audits are a technique used as part of the strategic positioning function in which mgmt assesses the quality practices of the org. Produce: -analysis that identifies strengths/weaknesses -strategic quality improvemt plan identifying improvemt steps that will produce greatest return to org in ST and LT. Gap analysis determines gap/diff btw industry best practices and current practices of org. Produces: -target areas for improvemt -common obj database from which to develop strategic quality improvemt

Business Process Reengineering (BPR)

Techniques to help orgs rethink how work is done to dramatically improve customer satisfaction/service, cut costs of ops, and incr competitiveness. Developmt of sophisticated IT systems/networks have driven this. Not same as BPM. BPM seeks incremental change, BRP radical. Basic premise of BPR is "fresh start." Mgmt wipes slate clean and reassesses how bus is done from ground up. Uses benchmarking/best practices to eval success. BPR not as popular as when it was intro'd in the 90s bc of overagressive downsizing and inability to produce benefits anticipated.

Shifts in the Economic Balance of Power

Unipolar was US dominant, multipolar is US, EU, and BRIC dominant. Multipolar now, where power dist among nations. Absolute strength of US not likely to decr, but its relative power likely to decline as other nations strengthen. Dimensions of national power: 1. Geography: land mass/strategic locations sig to power. US and China in temperate areas and have lots of land. Other nations may have worse weather. 2. Population: translates to workforce. Larger/more skilled, more power for nation. 3. Resources: nations w/ lots of natural resources could be more powerful. 4. Economy: size of nation's economy as a % of worldwide GDP is a strong measure of power. Developmt of economy and its integration w/ other global ones is also a measure of power. Larger, better developed, and integrated economies more powerful. 5. Military: size/effectiveness of military is power. 6. Diplomacy: influence of diplomats around the world affects perception of strength/weakness and by extension the power of the nation. 7. Identity: sense of identity and acceptance of global responsibilities contribute to perceived power of a nation. Multipolarity and interdependence: -functional interdependence: participation of nations in worldwide institutions like UN, WTO, and international monetary fund (IMF). -systemic interdependence: acknowledges that all members of global community share planet earth. Actions of govts adversely affecting climate or reducing safety affect all nations. -multipolarity: incr in this will req an acknowledgement of the interdependence of nations and cooperation among nations consistent w/ shifts in the balance of power. Emerging nations could side w/ developed ones (bandwagoning) or join other emerging ones in ignoring developed ones (balancing).

Currency Option Hedges

Use same principles as forwards and mm hedges, but instead of req a committment to a trans, they give the bus the option of executing the option contract or purely settling its orig negotiated trans w/o the benefit of the hedge, depending what's most favorable. Payables application: Call option (option to buy) is the currency option hedge used to mitigate transaction exposure assoc w/ exchange rate risk for payables. Sim futures and forwards, bus plans to buy foreign currency at a low rate in anticipation of it strengthening compared to domestic currency to ensure that it can settle its liab at predicted value. Bus has option to purch security at the option (strike/exercise) price. Bus evals relationship btw option price and exchange rate at settlemt date. If option price less than exchange rate at settlemt, bus will exercise. If more, bus will let it expire. Although option premiums are used to compute any net cost savings assoc w/ option transactions, they're a sunk cost and irrelevant to decision to exercise/not. Receivables application: Put option (option to sell) is currency option hedge used to mitigate transaction exposure assoc w/ exchange rate risk for AR. Sim to futures and forwards, bus plans to sell foreign currency at a higher rate in anticipation of it weakening compared to domestic, to ensure it can capitalize on receivable collections at stable/predicted value. Bus has option to sell the collected amt of foreign currency from the AR at option (strike/exercise) price. Bus evals relationship btw option price and exchange rate at settlemt date. If option price more than exchange rate at settlemt date, exercise. If less, allow option to expire. Premiums are used to compute any net preserved value assoc w/ the option trans, but they are a sunk cost and irrelevant to decision to exercise/not.

Exchange Rate Risk Factors

W/in domestic environments, single currency defines value of A, L, and op transactions. In international settings, values of those things are established in terms of 1 currency and in relation to other currencies. Exchange rate (FX) risk exists bc relationshp btw domestic/foreign currencies may be subj to volatility. Has risk factors (trade and financial) and risk exposure categories (transaction, economic, and translation exposures). Financial managers must understand these factors and mitigate the FX risk exposures. Circumstances giving rise to changes in exchange rates are divided btw trade-related factors (incl diffs in inflation, inc, and govt regs) and financial factors (incl diffs in IR and restrictions on cap movemts btw cos). Trade Factor: 3 types. 1. Relative inflation rates: when domestic inflation > foreign, holders of domestic currency motivated to purch foreign currency to maintain purch power of their money. Incr in demand for foreign currency forces value of foreign currency to incr in relation to domestic, thereby changing exchange rate. 2. Relative inc levels: as income incr in one country relative to another, exchange rates change as a result of incr demand for foreign currencies in the country where income is incr. Weakens the value of the currency in country where income is rising, since they're using it to buy another currency a lot. 3. Government controls: vs free mkt. Trade restrictions. Various trade/exchange barriers that artifically supress the natural forces of supply/demand affect exchange rates. So could use tariff to discourage purch of imports and maintain current exchange rate, etc. Financial factors: 1 type. 1. Relative interest rates and capital flows: IRs create demand for currencies by motivating domesic/foreign investmts. Forces of supply/demand create changes in exchange rate as investors seek fixed returns. Effect of IRs is directly affected by the volume of cap allowed to flow btw countries. So if IR high in X country so a bunch of people from country Y invest there, value for country X currency incr. Summary: Trade related factors impact demand for goods, financial factors impact the demand for securities. Both affect the demand/ supply of currency, which affects the exchange rate.

Perpetuities - Zero Growth Stock

When periodic CFs paid by an annuity last forever, the annuity is called a perpetuity or perpetual annuity. Traditional annuity formula simplified for perpetual CF streams, since no duration known. When co has to pay same div each pd, perpetuity formula can be used to determine the value of the co's stock. PV of a perpetuity= stock value per share = P = D/r p is price, d is div, r is req return. Assumptions: -must specify div and assume it will never change -must specify req return