BAR - Deck 1 Flashcards
What is COSO?
Committee of Sponsoring Organizations of the Treadway Commission: an org that develops guidelines that companies evaluate internal controls, fraud deterance, and risk mngt
What are the types of risk responses?
Accept, avoid, pursue, reduce, share
Definition of accept risk response
no action is taken to change severity of risk
Definition of avoid risk response
remove the risk
Definition of pursue risk response
accepts increased risk to achieve improved performance
Definition of reduce risk response
Reduce the severity of the risk through risk mitigation techniques
Definition of share risk response
reduce the severity of the risk through outsourcing and insurance
Risk capacity
max amt of risk an entity can absorb in pursuit of its strategic and business objectives
value creation
benefits of value exceed the costs of resources used
value preservation
ongoing operations efficiently and effectively sustain created benefits
value erosion
faulty strategy and inefficient and/or ineffective operations cause value to decline
value realization
benefits created by the org are received by stakeholders in either monetary or nonmonetary forms
components of enterprise risk mngt (ERMs)
-managing risks so it aligns w/ risk appetite of competition
-enhancing risk response decisions
-improving the deployment of capital while taking into account potential risk
purpose of ERM framework
assessing risk severity w/ statistical risk ranking methodology, includes the likelihood of the risk occurring and the impact if it does occur
who is responsible for establishing the risk appetite of the org
management (w/ oversight from the BOD)
Risk assessment under COSO ERM framework considers…
-inherent risk - risk to an entity in the absence of any direct or focused actions by mngt to alter its severity
-actual residual risk - risk that remains after mngt has taken actions to reduce risk
-target residual risk - amt of risk an entity prefers to assume in pursuing its goals and objectives
Enterprise Risk Mngt - culture, capabilities, and practices, integrated w/ strategy-setting and performance, that orgs rely on to manage risk in creating, preserving, and realizing value
G Governance and Culture
O Strategy and Objective-Setting
P Performance
R Review and Revision
O Ongoing Information, Communication, and Reporting
formula for effective IR & net proceeds available
effective IR = interest paid / net proceeds available
net proceeds available = loan amt - compensating balance
what happens when the dollar price of the euro rises
-euro is more expensive (euro
appreciates)
-dollar is less expensive (dollar depr)
-dollar will buy fewer European goods and same amt of US goods
-euro will buy more US goods and the same amt of European goods
How to mitigate and control transaction exposure
- futures / forward hedges (entitles the holder to purchase or sell a particular number of currency units for a negotiated price on a stated date)
- money mrkt hedge
- currency option hedges
- currency swaps
- cross hedging
definitions of risk indifferent, risk averse, and risk seeking
- risk indifferent - neutral w/ regard to the return associated w/ a particular investment
- risk averse - demand lower levels of risk and accept lower levels of return
- risk seeking - willing to take on higher levels of risk in order to take advantage of potentially higher returns
broad categories of risks
D - diversifiable
U - unsystematic (non-market or firm-specific)
N - non-diversifiable
S - systematic (mrkt)
definition of portfolio theory
any times of risk that cannot be eliminated by application of portfolio theory?
Construct an investment portfolio that efficiently balances its risks w/ its rate of return. Risk typically reduced through diversification
systematic (non-diversifiable risk or market risk) cannot be eliminate w/ this theory
risk adjustments used to compute the required rate of return
- default risk prem - compensation demanded by lenders for bearing the risk that the issuer of the security will fail to pay interest or fail to repay the principal
- purchasing power risk prem - compensation investors req to bear the risk that price levels may change and affect asset values or purchasing power of invested dollars
- maturity risk premium (or IR risk) - compensation investors demand for bearing risk. This risk increases w/ the term to maturity
price risk definition
exposure an investor has to decline in the value of a portfolio or individual securities
nominal dollars
inflation rate applied to real dollars = real dollars * (1+inflation)^years
components of risk premiums
- length of maturity - longer period until maturity»_space;> higher risk associated w/ receiving CFs
- liquidity - extent to which a security can be sold w/o risking loss of principal. Higher liquidity»_space;> the risk prem decreases
- relative seniority - more senior»_space;> less risk associated w/ future CFs
mrkt rate on 1 yr US treas bill
risk free rate of interest + inflation premium
what types of securities have no default risk and what types always have some form of default risk?
US treas bonds - no default risk
Corporate bonds - always have some form of default risk
