Practice Exam

John is a risk management specialist for XYZ Company. John examines XYZ's financial statements on a quarterly basis. What is the the reason for this analysis

A review of the financial statements helps John to determine XYZ's insurance needs

Company G is a manufacturer of high profile golf equipment. The risk management professional for Company G is concerned about loss of business related to product design. Failing to respond to changing customer demand and preferences in the design of golf clubs could cost Company G significant market share. Categorized according to the quadrants of risk, this exposure to loss is classified as

A strategic risk.

Sixth National Bank stores all of its financial records in an electronic data base. Sixth National customers are able to access their accounts on-line with a user identification number and a password. Last weekend, a computer hacker was able to breach the firewall of the electronic data base and gain access to customer account data. This operational risk for Sixth National Bank is

A systems risk.

What is true regarding the Committee of Sponsoring Organizations' (COSO 2004) risk management standard

COSO 2004 originated with a focus on financial risk.

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework list five interrelated components of internal controls. What component forms the basis for carrying out all of the organization's other functions? .

Control environment

What is true if earnings at risk are $200,000 with 90 percent confidence

Earnings at risk are projected to be less than $200,000 10 percent of the time.

Most general liability insurance policies include coverage for

Product liability

Julie, a risk management professional, has identified automobile accidents by the sales department employees as a major loss exposure for her organization. She is in the process of examining the feasibility of various risk management techniques for this exposure. What is a risk financing technique

Purchase automobile insurance with a low deductible

If a large manufacturer has had no product liability losses for the past eight years, it should probably

Purchase product liability insurance.

Risk manager Christine is analyzing the risks faced by her company, Clear Sky Technology. She assigns a rating based on the significance of the consequences of the various risks. Her four ratings are: Low, Medium-Low, Medium-High, and High. The ratings that Christine assigns are a

Qualitative assessment.

An insurer's fair value is complicated because no ready market exists for trading in insurers. To calculate the fair value of an insurer's reserves, a present value discount is used and a

Market value margin is added

The recognition of expected accidental losses in cash flow analysis

May have a significant effect on the decision to undertake a proposal.

Risk management professionals should evaluate the internal and external environments in which the organization operates. What is a factor of an organization's internal environment

Risk appetite

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

Risk financing.

The structure that supports the organization's risk management objectives and strategies is the

Risk management framework.

A matrix of the likelihood and potential impact consequences of the organization's risks is called a

Risk map

As a best practice, a risk register should be an interactive computer system. What individuals should be responsible for continually updating risk information

Risk owner

Contractual agreements, such as hold harmless agreements, are an example of what risk treatment technique

Risk transfer

The report of management is a report to the users of financial statements, required as part of the company annual report. What is true regarding this report

The chairman of the board signs it acknowledging the integrity of the report.

Which is coefficient of variation useful for

The coefficient of variation is useful in comparing the variability of distributions that have different shapes, means, or standard deviations.

What is an objective and consistent measurement tool that can be used by organizations to conduct periodic self-assessments

The Risk Maturity Model (RMM)

Ag Products Company (APC) signed a contract to deliver 50,000 bags of its corn chips snack food to a supermarket chain is six months. The supermarket will pay APC $2.00 per bag of chips. APC will need 5,000 bushels of corn to produce the 50,000 bags of chips. It estimates the other production and shipping costs will total $62,500. Corn was selling at $5.50 per bushel when APC entered into the contract. At the time APC entered into the agreement, what was the expected net income from this deal, assuming APC does not use hedging

$10,000 The total revenue is $100,000 (50,000 × $2), and the total expenses are $90,000 ((5,000 × $5.50) + $62,500); leaving net income of $10,000.

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

$287,798 The factor for the present value of an annuity of $1 for six years is 4.1114. $70,000 x 4.1114 = $287,798

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

$36,299

Assuming an interest rate of 8 percent, the present value of $50,000 received in three years is

$39,690. 50,000 X .7938 = 39,690; Based on the factors shown above and assuming an interest rate of 8 percent, the present value of $50,000 received in three years is $39,690.

Bradley Company is considering purchase of a new facility. The following factors apply: •$200,000 initial investment •10 year life of facility (no salvage value) •$60,000 differential cash revenues of purchase •Straight-line depreciation is used •40 percent tax rate •Minimum annual acceptable rate of return is 10 percent •Present value of $1 received at the end of each year for 10 years is 6.145 Annual expected flood losses for facility are currently $10,000, but can be reduced to $5,000 with the implementation of a risk control measure, which includes regarding and installing a pump system for a cost of $10,000. The pump system has a 10-year life with no salvage value. What is the net present value of the purchase of the new facility and implementation of the risk control measure to reduce the flood losses

$44,403 60,000 - 5,000 - 13,600 taxes = 41,400 after tax NCF; 41,400 X 6.145 = 254,403; 254,403 - 210,000 = 44,403;

liable Plumbing is considering spending $350,000 today to replace its fleet of service vehicles. Reliable expects this investment to result in cash flow savings of $100,000 the first year, $200,000 the second year, and $150,000 the third year. At that time, they expect to have to replace the vehicles again. If the interest rate is six percent, the net present value of the investment is

$48,280. ($100,000 × .9434) + ($200,000 × .89) + ($150,000 × .8396); $94,340 + $178,000 + $125,940 = $398,280; $398,280 − $350,000 = $48,280. If the interest rate is six percent, the net present value of this investment is $48,280.

Freight Rail Company (FRC) operates a railroad in four Western states. The company has contracts to deliver goods six months from today. The revenues from the freight delivery will be $240,000. An important determinant of FRC's cost structure is the cost of fuel to power its train engines. It's estimated the deliveries in six months will require 10,000 gallons of fuel. Currently, the fuel sells for $4.50 per gallon. Financial managers are concerned that the price could increase significantly between now and when the fuel is purchased in six months. FRC was able to purchase call options that would allow the company to purchase 10,000 gallons of fuel at $4.50 per gallon in six months. The cost of the options was $1,200. Six months after purchasing the options, the price of the fuel was $5.25 per gallon. What was the net benefit to FRC of using call options to hedge its fuel exposure

$6,300

The most recent financial statements for Buddy's Burger Hut reveal the following: Cash $50,000 Equipment $25,000 Inventory $15,000 Accounts Receivable $2,500 Cost of Goods Sold $125,000 Marketable Securities $5,000 Current Liabilities $50,000 Based on this information, Buddy's Burger Hut's Acid-Test Ratio is

1.15.

Based on Belden Company's cost structure, a 10 percent decline in sales would create a 14 percent decline in pre-tax operating profit. If Belden Company's sales were to increase by 15 percent, by what percentage would its pre-tax operating profit increase

21.0 percent Based on the first sentence, we see that the degree of operating leverage is 1.4; so if a 15 percent change is multiplied by 1.4, it would be a 21 percent increase in operating profit.

What is true regarding key risk indicators (KRI)

A KRI must be leading, rather than lagging, to be effective.

What type of organization would most likely be affected by commodity price risk

A manufacturer

Buildings, investments, patents, and human resources are all examples of

Assets exposed to loss.

What is a positive risk for a start-up business

Attracting investor interest

What is true regarding Basal III?

Basal III was developed to address both the risk of individual organizations and systemic risk in the banking sector.

The sum of all expenses incurred by an organization because of the possibility of accidental loss is called the

Cost of risk.

A vitamin manufacturer has decided to dedicate research funding to developing products for senior citizens rather than infants. The manufacturer is responding to which type of strategic risk

Demographics

In capital budgeting decisions, the main noncash item affecting income taxes is

Depreciation of long term assets

Risk can be classified as diversifiable or nondiversifiable. What is a true statement of these types of risks

Diversifiable risks tend not to be correlated so they can be managed through diversification or spread of risk

A group of female employees at Third Federal Bank filed a lawsuit against the bank. The lawsuit alleges that the bank consistently failed to promote qualified women to senior management positions because of their gender. If the lawsuit is successful, which one of the following coverages would pay the damage award?

Employment practices liability insurance

Jo is evaluating ABC Company's financial statements and has prepared a year-to-year trend analysis of the income statement, which is shown below: 20X4-20X3 20X3-20X2 20X2-20X1 Sales -0.5% 0.5% 0.5% Cost of goods sold -0.4% 0.5% 0.2% Gross profit -0,7% 0.5% 0.9% Selling, general & admin. expense -3.7% -3.6% -3.4% Operating profit 5.3% 9.5% 11.9% Interest expense 8.3% -5.9% 2.0% Earnings before taxes 4.6% 13.4% 14.8% Income taxes 6.6% 13.6% 10.6% Net Income 3.3% 13.2% 17.7% What is accurate concerning the year-to-year trends for ABC

Even though sales have been flat for several years, ABC has been able to increase its profitability by reducing its operating expenses.

A main difference between decision trees and event trees is

Event trees analyze the consequences of accidental events rather than decisions.

A significant difference between the Basel I regulatory capital requirements and the Basel II regulatory capital requirements is that Basel II

Includes a capital requirement for operational risk that Basel I does not include.

In using the coefficient of variation when comparing two distributions, if both distributions have the same mean, then the distribution with the larger standard deviation will have

Greater variability.

Insurance deals primarily with what major category of risk

Hazard risk

A financial transaction in which one asset is held to offset the risk associated with another asset it called

Hedging.

What is a scope of ISO 31000

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

An insurance company is currently operating with a debt to equity ratio of 0.5 and they plan to increase that to 1.0 through the issue of additional debt without issuing any additional equity. Taking on additional debt rather than issuing additional equity, assuming the same increase in net income results from either choice, will

Increase the firm's return on equity as no additional equity was issued.

The fundamental purpose of a risk management framework is to

Integrate risk management throughout the organization.

Financial managers decide how to raise and spend capital within a company. All of the following are common methods of raising capital, EXCEPT:

Issuing derivatives

What is a major purpose of the statement of cash flows

It is used to assess the ability to generate positive future cash flows, its ability to meet financial obligations, and its need for additional financing. It is also used to determine the reasons for any differences between net income and associated cash receipts and disbursements.

Risk management professionals analyze loss exposures along four dimensions. What dimension analyzes the number of losses within a specific time period

Loss frequency

What is a probability distribution

It represents probability estimates for a particular set of circumstances and the probability of each possible outcome.

When compared to cash flow analysis for a proposal with no adjustment for uncertainty, a dollar amount assigned as the cost of uncertainty for the proposal will have what effect

It will decrease the after-tax net cash flow.

An appropriate measure to assess an organization's ability to satisfy its obligations as they come due is the

Liquidity ratio.

Scribner Trucking Company implemented an enterprise risk management program. The company manages the risk of fuel prices through a hedging program. The risk manager must also manage traditional hazard risk arising from the trucking company's operations. The number of accidents in which Scribner trucks are involved has been increasing at a fast rate. Accidents have been occurring at night, during adverse weather conditions, and when Scribner drivers were speeding. The number of accidents has led to increased auto, cargo and workers compensation losses. Based on these facts, what change should be implemented in the hazard risk portion of the enterprise risk management program

Modification of the impact/likelihood of the risk

What is a factor of the balance sheet

Net worth is positive whenever the value of assets exceeds the value of liabilities and negative if the value of liabilities exceeds the value of assets. Correct. Net worth is positive whenever the value of assets exceeds the value of liabilities and negative if the value of liabilities exceeds the value of assets. The balance sheet will always balance, even when net worth is negative. Liabilities and net worth indicate the source of funding

Liability entries on an organization's balance sheet are particularly useful to the risk management professional for exploring which loss exposure

Obligations such as mortgage payments

Jordan Brown is the risk manager of Bellows Company. The company has one key customer and one key supplier. Two years ago, Jordan made a change in how the company funds losses, shifting to greater use of retention and paying for retained losses through current income. Bellows Company is considering a change in its production process. The change would add greater fixed operating costs, but reduce variable costs. Based on the information presented, Jordan should be

Opposed to the change because it increases the chance of not having enough current income to pay retained losses. Increasing operating costs increases the variability of operating income, which is problematic because there is a key customer and a key supplier that could negatively impact sales.

James is the risk manager for a large manufacturing organization with six locations. Each location has a plant manager who is responsible for the operation of that location. James feels that the plant managers are in the best position to identify and measure risk at their locations. He wants them to own the risk. However, he is looking for a tool that will allow him to prioritize risk according to the potential effect on the organization. James wants an interactive tool that will adequately identify the organization's risks, and allow them to be measured based on likelihood and the level of risk to the organization. What is the most appropriate tool for James

Organizational risk register

What is true regarding the nature of probability

Probabilities deduced solely from historical data may change as new data are discovered or the environment changes.

Internal controls at an organization may be hard controls or soft controls. What is an example of a hard control

Process checklists

What is a benefit to the organization from greater risk assurance

Reduced capital costs

What requires the CEO and CFO of a publicly-traded company to certify that financial statements are correct and requires that public companies report operational risk to the company's stakeholders

The Sarbanes-Oxley Act

Under the Prouty Approach to analyzing losses, there are four categories of loss frequency and three categories of loss severity. What is a loss severity category

Significant

The four primary types of financial statements include the balance sheet, the income statement, the statement of changes in owners' equity, and the

Statement of cash flows.

What commonly used categories of operational risk includes risks associated with technology and equipment

Systems

After a month in which three employees were seriously injured at company paper mills, Ashley, the risk manager of Bright White Paper Company, wanted some answers about the causes of employee injuries. Ashley independently contacted the plant manager and foreman at each of the company's plants. She asked each person to complete a confidential questionnaire regarding safety procedures. After receiving the responses to the questionnaire, Ashley summarized the results and asked the same questions again instructing each person to consider revising their responses based on the initial questionnaire results. The analysis revealed that new workers were not being properly trained and that a lax attitude toward safety was present at the majority of the plants. The team approach to risk identification Ashley employed is called

The Delphi technique.

What is true of checklists and questionnaires to identify loss exposures

The questions included in questionnaires and checklists developed by insurers relate mainly to loss exposures for which commercial insurance is generally available.

According to the law of large numbers, as the number of exposure units insured increases

The relative accuracy of predictions about future losses increases.

What is a disadvantage of using loss histories to identify risks

They are lagging rather than leading indicators of risk.

What is a responsibility of internal auditors?

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

Sean recently started a small consulting practice. Sean is the only employee of the business and the sole generator of revenue. Sean is very concerned that in the event that he becomes disabled due to an accident or disease there will be no revenue coming into the business. What are Sean's concerns

Tolerable uncertainty and earnings stability

Control Risk Self-Assessment (CRSA) is a process generally performed by who

Unit managers

Regression analysis assumes that the variable being forecast

Varies predictably with some other variable.