B1/B2 Flashcards
ERM
Culture, capabilities, and practices that organizations rely on to manage risk in creating, preserving, and realizing value
Cost of debt
Actual interest rate - tax savings
Nominal dollars & inflation rate
Nominal dollars are the inflation rate applied to real dollars
Ex: if you have 200K in real dollars, and inflation rate is 6%, in two years to Calc nominal dollars you need to
200* (1.06) * (1.06)
Simple interest formula
FV = PV * (1 + i) ^n
Net cost of debt formula
Effective interest rate net of tax.
Ex: interest rate is 14%, and tax is 30%,
Take (1-t)* i
Or 70% * 14% = 9.8%
Debt ratio
Total debt/ total assets
Price to earning ratio
Current market price / annual earnings per share
NPV formula
Initial investment - (cash inflows * PV factor)
Debenture & subordinated debenture
Debenture: unsecured obligation of the issuing company
Subordinated debenture: bond issue that is unsecured and ranks behind senior creditors
Working cap
Current asserts - current liabilities
Cash conversion cycle
CCC = days in inventory + days in AR - days payable outstanding
Methods to use to delay disbursements
Defer payments, drafts, line of credit, zero balance accounts
Reorder point
RO = safety stock + (lead time x sales during lead time)
Value realization
Value is realized when benefits created by the organization are received by stakeholders
Can be monetary (dividends) or non monetary
What’s ERM framework provide
It’s a framework to MANAGE risk within an organizations risk appeitite, to provide a reasonable expectation in the achievement of entity objectives
Governance, COSO, five frameworks (DOVES)
Desired culture exercises board Oversight demonstrates commitments to core Values attracts capable Employees establishes operating Structure
Strategy and objective setting compomonent of COSO, frameworks (SOAR)
evaluates alternative STRATEGIES
formulates business OBJECTIVES
ANALYZES business context
defines RISK appetite
Three risks considered by management under COSO
Inherent risk, actual residual risk, and target risidual risk
Five components of ERM (GO PRO)
Governance & culture strategy & OBJECTIVE setting PERFORMANCE Review and revision information, communication, reporting (ONGOING)
Risk sharing
INSURANCE
insuring against losses to address risk
Risk reduction
Think diversification
Not eliminating risk, but diversifying options to reduce
Risk sharing
Reduce severity of risk by bringing in an outside party
Go pro
Governance and culture, sratecgy and objective setting, performance, review/revision, information communication and reporting
Goals of ERM
achieve objectives/goals, assess risk regularly, achieve financial & reporting targets
VAPIR
Performance part of coso; Portfolio view, assess severity of risk, prioritize risk, identify risk, implement risk response
When is risk appetite exceeded
The likelihood and impact of negative events exceeds residual risk
Organizational sustainability
The ability of an entity to withstand the impact of large scale events
What is the difference between inherent and residual risk according to Coso
The difference arises because of management actions to reduce the inherent risk
Residual risk is the risk AFTER management takes actions to reduce impact of negative event
Under SOX, internal control must be evaluated when
Within 90 days PRIOR to issuer report
EAR formula
EAR = 1 + (stated rate/n)^n
How to reduce unsystematic risk
(Aka firm specific/ non-market risk)
Reduce by diversification
Forward contract
LARGE groups of transactions (think forward = for A LOT)
Cost to issue formula
Face value - price paid + transaction costs
Firm with higher degree of operating leverage compared to industry implies what
Firms profits are more sensitive to changes in sales volume
LETTER OF CREDIT
3rd party guarantee of obligations
If company is saying “we guarantee” its a LETTER of credit
Considering the SCOR model of supply chain, implementing changes in engineering falls into what key process?
MAKE
Four components of SCOR
Plan, source, make, deliver
SCOR; plan
Determining demand, planning inventory, configuring supply chain, make/buy decisions
SCOR; source
Which vendors, vendor pmts, oversee quality assurance
SCOR; Make
Manage production, manufacture product, test product, release inventory, analyze capacity
SCOR; deliver
Manage ORDERS, ship products, label products, manage AR
3 carrying costs
Insurance costs, cost of capital invested into inventory, cost of obsolescence, opportunity cost on inventory investment
What increases EOQ
Remember formula for EOQ = SQRT ( [2 * SO] / C )
S= sales quantity in units
O = cost per purchase ORDER
C = cost of carrying one unit in stock for one year
Order size will get larger as “S” or “O” gets bigger (numerator) or “C” gets smaller (denominator)
Why would a company agree to debt covenant which limits % of its long term debt
Reduce coupon rate on NEW bonds sold
Benefits of a lockbox system
Expedites cash inflows by having a bank receive pmts directly. This reduces AR outstanding
Aka:
(Minimize collection float)
If the dollar price against the euro rises,
This means the dollar is DEPRECIATING against the euro
Euro will get more expensive
What 3 things impact safety stock levels
Uncertain sales forecasts
Dissastisfaction of customers
Uncertain lead times
What 3 things impact the optimal level of inventory
Time required to receive inventory (lead time), cost per unit of inventory ( & associated carry costs), cost of placing an order for merchandise
MRP (materials requirements planning)
Inventory management technique that projects and plans inventory levels in order to control usage of raw materials in the production process
Audit committee financial expert must have experience specifically with what
Internal accounting controls
According to SOX 2002, how many years is the penalty for destroying, covering up documents under title VIII
20 years
What is the purpose of a written code of conduct, according to coso
Helps management set tone for the organization; promoting honest/ethical conduct, teamwork, compliance, appropriate disclosure
Liquidity risk
Risk associated with the ability to sell temporary investment in a short period of time without significant price concessions
Definition of Price risk, and what technique would a company use to manage it
Price risk = exposure an investor has to a decline in the value of a portfolio or individual securities
Using market value at risk analysis would help the company understand and quantify the value at risk
Types of risk (DUNS)
Diversifiable, unsystematic (non-market/firm specific), non-diversifiable, systematic
Put option
Gives the owner the option to sell a specific security at fixed conditions of price and time
*PUT an offer to sell a security later vs CALL you when I want to buy it (since call options are options to buy)
What does it mean when an investor’s certainty equivalent is greater than the value of an investment alternative?
This means the point at which the investor is indifferent about risk actually exceeds the expected return on the investment, so they are seeking lower return for higher risk
This is risk seeking behavior
Required rate of return is calculating by adding what 4 risk premiums to the risk free rate
MP+IP+LP+DRP
Maturity risk premium (MP)(from exposure to the same interest rate over time)
Purchasing power risk/inflation premium (IP)(based on risk of changing price levels)
Liquidity risk premium (LP) (risk of not being able to convert an asset to cash at FMV)
default risk premium (DRP) (risk issuer will fail to pay interest/principal)
