12.1 Risk Management Flashcards
Organizations face several types of risk in pursuit of their strategic objectives. The risk that the treasury function will fail to adequately reconcile the organization’s bank statements is an example of
A. Hazard risk.
B. Financial risk.
C. Operational risk.
D. Strategic risk.
C. Operational risk.
Operational risks are the risks related to the enterprise’s ongoing, everyday operations. Operational risk is the risk of loss from inadequate or failed internal processes, people, and systems. These failures can relate to human resources (e.g., inadequate hiring or training practices), business processes (poor internal controls), technology, product failure (customer ill will, lawsuits), occupational safety and health incidents, environmental damage, and business continuity (power outages, natural disasters).
“Self insurance” is a synonym for
A. Risk retention.
B. Risk sharing.
C. Risk transfer.
D. Risk reduction.
A. Risk retention.
Risk retention is the acceptance of the risk of an activity by the organization. This term is becoming synonymous with “self insurance.”
A landlord owns an office building in a major floodplain. The landlord has decided to sell the building to a group of investors. The landlord has adopted a risk strategy of
A. Risk exploitation.
B. Risk transfer.
C. Risk avoidance.
D. Risk reduction.
C. Risk avoidance.
Risk avoidance is bringing to an end the activity from which the risk arises. For instance, the risk of having a pipeline sabotaged in an unstable region can be avoided by simply selling the pipeline.
A firm can mitigate the risk of financial loss from the possible on-the-job injury of one of its employees through
A. Hazard insurance.
B. Workers’ compensation insurance.
C. Key employee insurance.
D. Liability insurance.
D. Liability insurance.
Liability insurance provides an organization with financial protection against damage caused to consumers by faulty products or injury to persons suffered on the organization’s premises.
A toothbrush manufacturer has noticed a shift of customer preferences in its growing Asian sales market toward an electronic battery operated toothbrush from a manual toothbrush. This shifting of customer tastes best represents what type of risk to the toothbrush manufacturer?
A. Strategic risk.
B. Operational risk.
C. Financial risk.
D. Business risk.
A. Strategic risk.
Strategic risk includes the risk associated with shifts in customer preferences.
A large multinational company currently has its information technology department located in Germany. To reduce the risk of system failure, the company decided to split up the information technology department into two geographically separate locations and set up a new location in Singapore. The company can still face a catastrophic system failure, but the risk will be greatly reduced. The risk that remains after the company sets up the second information technology department in Singapore is best described as
A. Business Risk.
B. Residual Risk.
C. Hazard Risk.
D. Inherent Risk.
B. Residual Risk.
Residual risk is the risk of an activity remaining after the effects of any risk responses. After the company splits up the information technology department into two countries, the remaining risk is residual risk.
A farmers’ cooperative has a large amount of grain that it has gathered from its members and has stored in silos. Prices for grain are high, but none of the cooperative’s customers is prepared to purchase any for the next 3 months. In order to hedge against an unfavorable change in grain prices over the next 3 months, the cooperative will employ a financial risk management technique known as a
A. Short hedge.
B. Long hedge.
C. Naked option.
D. Interest rate swap.
A. Short hedge.
A common form of financial risk management is called hedging. Hedging is the process of using offsetting commitments to minimize or avoid the impact of adverse price movements. A person who would like to sell an asset in the future has a long position in the asset because (s)he benefits from a rise in value of the asset. To protect against a decline in value, the owner can enter into a short hedge, i.e., obtain an instrument whose value will rise if the asset’s value falls.
A manufacturing firm identified that it would have difficulty sourcing raw materials locally, so it decided to relocate its production facilities. According to COSO, this decision represents which of the following responses to the risk?
A. Risk reduction.
B. Prospect theory.
C. Risk sharing.
D. Risk acceptance.
A. Risk reduction.
Risk reduction (mitigation) reduces the risk so that it is within the target residual risk profile and risk appetite. By relocating its production facilities, the firm has reduced the risk of having difficulty sourcing materials locally.
The CFO at a manufacturer of computer equipment learned last week that the accounting department has not completed any bank reconciliations for the last 6 months due to the implementation of a new accounting software package. What type of risk has been identified?
A. Financial risk.
B. Hazard risk.
C. Operational risk.
D. Strategic risk.
C. Operational risk.
Operational risks are the risks related to the enterprise’s ongoing, everyday operations. Operational risk is the risk of loss from inadequate or failed internal processes, people, and systems. These failures can relate to human resources (e.g., inadequate hiring or training practices), business processes (poor internal controls), product failure (customer ill will, lawsuits), occupational safety and health incidents, environmental damage, and business continuity (power outages, natural disasters).
A corporation has established a risk management process to help it create, protect, and enhance shareholder value. Which of the following reflects the best order for that risk process?
A. Objective setting, event identification, risk assessment, risk response.
B. Event identification, objective setting, risk assessment, risk response.
C. Risk assessment, risk response, objective setting, event identification.
D. Risk assessment, objective setting, event identification, risk response.
A. Objective setting, event identification, risk assessment, risk response.
Objectives must first be set, and events that can affect those objectives must be identified. Once that is complete, the risks must be assessed, and then possible responses to those risks should be identified and evaluated.
One technique for quantitatively assessing the risks faced by an organization is to weight the monetary consequences of a potential event by its probability. The amount by which the maximum potential loss associated with the event exceeds this weighted amount is called the
A. Maximum expected loss.
B. Minimum expected loss.
C. Unexpected loss.
D. Expected loss.
C. Unexpected loss.
The unexpected loss, also called the maximum possible loss, is the amount of potential loss that exceeds the expected amount.
A German clothing retailer sells its products mainly online to customers worldwide. Company management believes that its primary risk relates to problems with its online website. A secondary risk is exchange rate volatility. Which one of the following best categorizes the company’s primary risk and secondary risk?
A. Operational risk, hazard risk.
B. Hazard risk, operational risk.
C. Strategic risk, financial risk.
D. Operational risk, financial risk.
D. Operational risk, financial risk.
Operational risks are related to the enterprise’s ongoing, everyday operations. Because sales are made mostly online, the problems with the online website represent a risk to ongoing, everyday operations. Additionally, financial risks encompass risks related to financial securities, currencies, and markets, including exchange-rate risk. Thus, the primary and secondary risks faced by the retailer are operational risk and financial risk, respectively.
A rice farmer has decided to protect against possible price fluctuations at the time of harvest by purchasing some rice options. What type of risk response strategy has the rice farmer engaged in?
A. Sharing.
B. Acceptance.
C. Reduction.
D. Avoidance.
A. Sharing.
Risk sharing transfers some loss potential to another party. By purchasing an option, the farmer is transferring some of the risk of price fluctuations to the seller of the options. However, the total amount of risk remains the same; it is split between multiple parties.
A company that prides itself on its innovation revised an existing popular brand without conducting sufficient market research. By taking this action, the company exposed itself to what types of risk?
A. Strategic risk and operational risk.
B. Operational risk and hazard risk.
C. Credit risk and strategic risk.
D. Hazard risk and credit risk.
A. Strategic risk and operational risk.
Strategic risks pose a threat to an entity’s ability to employ its strategy effectively and achieve its strategic objectives. Operational risks are those related to the entity’s ongoing, everyday operations. Furthermore, operational risk is the risk of loss from inadequate or failed internal processes, people, and systems. By failing to conduct sufficient market research, the company may be neglecting important information that affects strategy and everyday operations. Thus, the company has exposed itself to strategic and operational risks.
Which one of the following is considered a quantitative risk assessment technique?
A. Stress testing.
B. Self-assessment questionnaires.
C. Benchmarking.
D. Interviews.
C. Benchmarking.
Benchmarking is considered a quantitative risk assessment technique.
All of the following are potential benefits of risk management except
A. Reduced inherent risk.
B. Efficient allocation of resources.
C. Lower cost of capital.
D. Flexibility in responding to unforeseen circumstances.
A. Reduced inherent risk.
Inherent risk is the risk of an activity that arises from the activity itself. For example, uranium prospecting is inherently riskier than retailing.
