BEC 1 - Corporate Governance and Financial Risk Management

Question 1

What is the Sarbanes Oxley Act of 2002?

Answer 1

had a major impact on financial reporting for Public Companies:

1. established the audit committee
2. enhanced financial disclosures with the financial statements, management assertions of internal controls, officer code of ethics, and the operations of the audit committee
3. outlines criminal penalties for corporate fraud

Question 2

What are the 5 components of internal control?

Answer 2

Remember the acronym “CRIME”

C - Control Environment
R - Risk Assessment
I - Information and Communication
M - Monitoring
E - (Existing) Control Activities

Question 3

Relating to Internal Control, what does the Control Environment relate to?

Answer 3

The five principles are:

1. Commitment to Ethics and Integrity
2. Board Independence and Oversight
3. Organizational Structure
4. Commitment to Competence
5. Accountability

Question 4

Relating to Internal Control, what does the Risk Assessment relate to?

Answer 4

The four principles related to risk assessment are:

1. Specify Objectives
2. Identify and Analyze Risks
3. Consider Potential Fraud
4. Identify and Assess Changes

Question 5

Relating to Internal Control, what does the Information and Communication relate to?

Answer 5

The three principles relating to information and communications:

1. Obtain and Use Information
2. Internally Communicate Information
3. Communicate with External Parties

Question 6

Relating to Internal Control, what does the Monitoring Activities relate to?

Answer 6

The two principles are:

1. Ongoing and/or Separate Evaluations
2. Communication of Deficiencies

Question 7

Relating to Internal Control, what does the Control Activities relate to?

Answer 7

The three principles are:

1. Select and Develop Control Activities
2. Select and Develop Technology Controls
3. Deployment of Policies and Procedures

Question 8

What is Enterprise Risk Management (ERM)?

Answer 8

-the framework was developed by COSO to assist organizations in developing a comprehensive responses to risk management

• ERM is the culture, capabilities, and practices, integrated with strategy setting and performance, that organizations rely on to manage risk in creating preserving and realizing value

Question 9

What is risk averse behavior?

Answer 9

an attitude toward risk in which an increase in the level of risk results in an increase in management’s required rate of return.

risk averse managers require higher expected returns to compensate for greater risk

Question 10

Which of the following are common process components of the COSO ERM framework?

Answer 10

The common process components of the COSO ERM framework are (1) strategy and objective-setting, (2) performance, and (3) review and revision.

Question 11

Which of the following components are supporting aspects of the COSO ERM framework?

Answer 11

The supporting aspect components of the COSO ERM framework are (1) governance and culture and (2) information, communication, and reporting.

Question 12

The performance component of the COSO ERM framework addresses an entity’s

Answer 12

The performance component addresses (1) risk identification, assessment, and prioritization; (2) risk responses; and (3) the development of a portfolio view of risk.

Question 13

What are the five components of ERM?

Answer 13

Think of the acronym “Go Pro”

1. Governance and culture
2. Strategy and Objective Setting
3. Performance
4. Review and Revision
5. information, communication and reporting (Ongoing)

Question 14

What are the principles for governance and culture?

Answer 14

Think of the acronym “DOVES”

1. Defines desired culture
2. exercises board Oversight
3. demonstrate commitment to core Values
4. attracts, develops, and retains capable Employees
5. establishes operating Structure

Question 15

What are the principles for strategy and Objective Setting?

Answer 15

Think of the acronym “SOAR”

S - evaluates alternative Strategies
O - formulates business Objectives
A - Analyzes business context
R - defines Risk appetite

Question 16

What are the principles for performance?

Answer 16

Think of the acronym “VAPIR”

V - develops portfolio View
A - Assesses severity of risk
P - Prioritizes risk
I - Identifies risks (events)
R - implements Risk responses

Question 17

What are the principles for review and revision?

Answer 17

Think of the acronym “SIR”

S - assesses Substantial change
I - pursues Improvement in ERM
R - Reviews risk and performance

Question 18

What are the principles for Information, Communication, and Reporting (ongoing)

Answer 18

Think of the acronym “TIP”

T - leverages information and Technology
I - communications risk Information
P - reports on risk, culture, and Performance

Question 19

What’s the difference between credit risk, default risk, and liquidity?

Answer 19

Credit risk affects borrowers, impacts a company’s ability to secure financing

default risk affects lenders, debtors may not repay creditor

liquidity risk affects lenders (investors). investors are exposed when they desire to sell security but cannot do so in a timely manner

Question 20

A $10K promissory note has a stated rate of 10% per annum and is due in one year. The bank charges a loan origination fee of $750 and the state charges a $250 documentary stamp charge. What is the stated interest rate and effective interest rate?

Answer 20

stated interest rate is 10%
effective interest rate is Interest paid $1,000 divided by net proceeds $9,000 = 11.1%

Question 21

A note has an 8% state rate of interest compounded semiannually (two times per year).

What is the effective annual percentage rate or APR?

Answer 21

Effective annual interest rate = [1 + (i/p)]^p - 1

= [1 + (.08/2)]^2 - 1
= [1 + (.04)]^2 - 1
= 1.0816 - 1
= 8.16%

Question 22

a $10K promissory note bears interest at 8% for 2 years.

What is the simple interest on this obligation?

What would the compound interest be?

Answer 22

simple interest = $10K x 8% x 2

Compound interest = $10K x (1 + .08)^2

Question 23

The four general types of business risk are

Answer 23

(1) strategic risks, (2) compliance risks, (3) reporting risks, and (4) operational risks.

Question 24

The COSO model broadly defines internal control as a

Answer 24

process, effected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories:

(1) effectiveness and efficiency of operations,
(2) reliability of financial reporting, and
(3) compliance with applicable laws and regulations.”

Question 25

The 4 essential steps of the Risk Management Process are:

Answer 25

1. Identify the risk.
2. Assess the risk.
3. Treat the risk.
4. Monitor and Report on the risk.

Question 26

To control purchasing and accounts payable, an information system must include certain source documents. For a manufacturing organization, these documents should include

A. Purchase orders, receiving reports, and vendor invoices.
B. Receiving reports and vendor invoices.
C. Purchase requisitions, purchase orders, receiving reports, and vendor invoices.
D. Purchase requisitions, purchase orders, inventory reports of goods needed, and vendor invoices.

Answer 26

C. Purchase requisitions, purchase orders, receiving reports, and vendor invoices.

Before ordering an item, the purchasing department should have on hand a purchase requisition reflecting an authorized request by a user department. Before a voucher is prepared for paying an invoice, the accounts payable department should have the purchase requisition, a purchase order (to be certain the items were indeed ordered), the vendor’s invoice, and a receiving report (to be certain the items were received).

Question 27

Which of the following are common process components of the COSO ERM framework?

A. Review and revision; governance and culture.
B. Governance and culture; performance.
C. Performance; review and revision.
D. Information, communication, and reporting; strategy and objective-setting.

Answer 27

C. Performance; review and revision.

The common process components of the COSO ERM framework are (1) strategy and objective-setting, (2) performance, and (3) review and revision.

Question 28

Which of the following components are supporting aspects of the COSO ERM framework?

A. Performance; review and revision.
B. Governance and culture; information, communication, and reporting.
C. Strategy and objective-setting; performance.
D. Governance and culture; review and revision.

Answer 28

B. Governance and culture; information, communication, and reporting.

The supporting aspect components of the COSO ERM framework are (1) governance and culture and (2) information, communication, and reporting.

Question 29

According to COSO, the difference between inherent risk and actual residual risk results because of management’s

A. Actions to alter the severity of inherent risk.
B. Inability to alter the severity of inherent risk.
C. Inability to share the actual residual risk.
D. Actions to alter the severity of actual residual risk.

Answer 29

A. Actions to alter the severity of inherent risk.

Inherent risk is the risk without management actions to alter its severity. Actual residual risk remains after management actions to alter its severity.

Question 30

The premise of enterprise resource management (ERM) is that an organization exists to provide value for its

A. Shareholders.
B. Employees.
C. Stakeholders.
D. Customers.

Answer 30

C. Stakeholders.

ERM is based on the premise that every organization exists to provide value for its stakeholders. Accordingly, ERM is defined as the culture, capabilities, and practices, integrated with strategy-setting and performance, that organizations rely on to manage risk in creating, preserving, and realizing value.

Question 31

If the central bank of a country raises interest rates sharply, the country’s currency will likely

A. Remain unchanged in value.
B. Increase in relative value.
C. Decrease in relative value.
D. Decrease sharply in value at first and then return to its initial value.

Answer 31

B. Increase in relative value.

Exchange rates fluctuate depending upon the demand for each country’s currency. If a country raises its interest rates, its currency will appreciate. The demand for investment at the higher interest rates will shift the demand curve for the currency to the right. The reverse holds true for a decrease in interest rates.

Question 32

A company considers investing $20 million in a foreign company whose local currency is under pressure. The company suspects that the exchange rate may fluctuate soon. The exchange rate at the time of the investment is 2.57 to $1.00. After the investment, the exchange rate changes to 3.15 to $1.00. What is the change in the value of the company’s investment in U.S. dollars?

A. 18.4% increase.
B. 22.6% increase.
C. 22.6% decrease.
D. 18.4% decrease.

Answer 32

D. 18.4% decrease.

The company’s investment of $20 million is worth $51.4 million in local currency ($20 million × 2.57 exchange rate). When the exchange rate changes to 3.15 to $1, the investment is worth only $16.3175 million ($51.4 million ÷ 3.15 new exchange rate). Thus, the value of the investment was decreased in U.S. dollars by 18.4% [($20 million – $16.3175 million) ÷ $20 million].

Question 33

Over the past year, Russia’s ruble supply has increased. Today’s spot rate with respect to the U.S. dollar is $1 = 30 rubles. Which one of the following statements is consistent with these facts?

A. Interest rates in the U.S. are lower than those in Russia.
B. The dollar has appreciated over the past year.
C. Interest rates in the U.S. are higher than those in Russia.
D. The Russian ruble has decreased in value.

Answer 33

D. The Russian ruble has decreased in value.

As the supply of the currency increases, its value will decrease (or depreciate). In this situation, the ruble would have depreciated over the past year.

Question 34

A U.S. company has invested in the U.K. The exchange rate at the time of investment is £2.5 to $1, but after the investment it increases to £2.7 to $1. What is the percentage change in the value of the investment in dollars?

A. 7.4% increase.
B. 8% increase.
C. 7.4% decrease.
D. 8% decrease.

Answer 34

C. 7.4% decrease.

At the time of the investment, the spot rate for the pound relative to the dollar is 0.4 dollar ($1 ÷ £2.5). After the investment, the spot rate for the pound is 0.3704 dollar ($1 ÷ £2.7). The percentage change in the exchange rate is a 7.4% decrease [(0.4 – 0.3704) ÷ 0.4].

Question 35

An American importer expects to pay a British supplier 500,000 British pounds in 3 months. Which of the following hedges is best for the importer to fix the price in dollars?

A. Selling British pound put options.
B. Buying British pound put options.
C. Buying British pound call options.
D. Selling British pound call options.

Answer 35

C. Buying British pound call options.

The importer wants to hedge the risk that the fixed amount of foreign currency it must pay in 3 months will gain purchasing power during that time. Buying a call option gives the importer the right to buy (call for) the foreign currency in 3 months at a fixed price, regardless of exchange rate fluctuations in the meantime.

Question 36

company based in West Palm Beach, Florida, is building a resort in Jamaica. The Jamaican property owners must make a progress payment of $1 million in U.S. dollars in 30 days. The spot rate for the U.S. dollar is 88 Jamaican dollars (J $), and the 30-day forward rate is J $90. The most likely hedge in response to the transaction exposure inherent in this situation is

A. The property owners will sell $1,000,000 in U.S. dollars in the 30-day forward market.
B. The contractor will sell J $90,000,000 in the 30-day forward market.
C. The property owners will purchase $1,000,000 in U.S. dollars in the 30-day forward market.
D. The contractor will purchase J $88,000,000 in the spot market.

Answer 36

C. The property owners will purchase $1,000,000 in U.S. dollars in the 30-day forward market.

This receivable or payable is denominated in the currency of the creditor. Thus, the creditor has no incentive to hedge. The debtors (the property owners) want to hedge against the possibility that their domestic currency will depreciate against the U.S. dollar in the next 30 days. The typical mitigation strategy is to purchase the amount needed to pay the debt so that funds are available when needed.

Question 37

A currency trader is willing to give 100 Japanese yen today in exchange for one U.S. dollar. After 30 days, 110 Japanese yen are required to buy a dollar. Which of the following is a correct statement?

A. Today’s forward rate for the Japanese yen is 100 yen.
B. The demand for the U.S. dollar will increase.
C. Japan is expected to lose purchasing power in 30 days.
D. The U.S. dollar is currently trading at a forward discount in relation to the Japanese yen.

Answer 37

C. Japan is expected to lose purchasing power in 30 days.

As more Japanese yen are required to exchange one U.S. dollar, the Japanese yen depreciates and the purchasing power decreases.

Question 38

What is the COSO Internal Control Integrated framework?

Answer 38

it was created to assist orgs in developing comprehensive assessments of IC effectiveness. helps with the assessment of internal control over financial reporting

Question 39

What are the 3 categories of COSO framework objectives?

Answer 39

1. Operating Objectives - effectiveness and efficiency of an entity’s operations
2. Reporting Objectives - relate to the reliability, timeliness, and transparency of an entity’s external and internal financial and non-financial reporting
3. Compliance Objectives - these are developed to ensure the entity is adhering to existing laws and regulations

Question 40

What is Enterprise Risk Management?

Answer 40

developed by COSO to assist organizations in developing a comprehensive response to risk management.

intent of ERM is to allow management to effectively deal with uncertainty, evaluate risk acceptance, and build value

ERM premise is every entity exists to provide value for stakeholders

Question 41

ERM is intended to provide management with reasonable expectation of success:

Answer 41

1. enhancement of risk response decisions
2. identification and management of multiple and cross enterprise risks
3. seizing opportunities
4. improving the deployment of capital

Question 42

Which step in the risk management process assesses the actions to manage identified risks?
A. Risk response.
B. Risk assessment.
C. Risk monitoring.
D. Risk context identification.

Answer 42

C. Risk monitoring.

Risk monitoring is the last step in the risk management process. It involves (1) tracking identified risks, (2) evaluating current risk response plans (risk management actions), (3) monitoring residual risks, and (4) identifying new risks.

Question 43

According to COSO, which of the following components addresses the need to respond in an organized manner to significant changes resulting from international exposure, acquisitions, or executive transitions?

A. Risk assessment.
B. Information and communication.
C. Monitoring activities.
D. Control activities.

Answer 43

A. Risk assessment.

Significant changes resulting from international exposure, acquisitions, or executive transitions represent potential risks to achievement of objectives. Under the risk assessment component of COSO, the organization identifies and assesses all risks to the achievement of its objectives and determines the appropriate risk response (i.e., whether to accept, avoid, reduce, or share the risk).

Question 44

Limitations of ERM arise from the following?

Answer 44

(1) faulty human judgment, (2) cost-benefit considerations, (3) simple errors or mistakes, (4) collusion, and (5) management override of ERM decisions. The failure to achieve objectives is a risk of poor enterprise risk management.

Question 45

The policies and procedures helping to ensure that management directives are executed and actions are taken to address risks to achievement of objectives are best described as

A. Risk assessments.
B. Control activities.
C. Monitoring activities.
D. Control environments.

Answer 45

B. Control activities.

The COSO model for internal control describes control activities as the policies and procedures helping to ensure that management directives are executed and actions are taken to address risks to achievement of objectives.

Question 46

Control activities do not encompass

A. Physical controls.
B. Supervisory controls.
C. Performance reviews.
D. Control revalidation.

Answer 46

D. Control revalidation.

The COSO model describes control activities as policies and procedures that help ensure that management directives are carried out. They are intended to ensure that necessary actions are taken to address risks to achieve the entity’s objectives. Control activities have various objectives and are applied at various organizational and functional levels. However, control revalidation is part of the monitoring component.

Question 47

A company has established and communicated baseline expectations for performance to all employees. The company’s action demonstrates a focus on which of the following components of the COSO Internal Control Framework?

A. Monitoring activities.
B. Information and communication.
C. Control environment.
D. Control activities.

Answer 47

C. Control environment.

The control environment is a set of standards, processes, and structures that pervasively affects the system of internal control. It is the foundation for the other four components. To hold employees accountable for their internal control responsibilities in pursuit of objectives, the company needs performance evaluations, incentives, and disciplinary action. To evaluate performance and distribute incentives, the company should first establish and communicate the standard or baseline expectations for performance to all employees.

Question 48

Management considers risk appetite for all of the following reasons except

A. Implementing risk responses.
B. Aligning with business objectives.
C. Aligning with development of strategy.
D. Setting risk capacity.

Answer 48

D. Setting risk capacity.

Risk appetite consists of the types and amount of risk the entity is willing to accept in pursuit of value. Among other things, risk appetite should be considered in

1. Aligning with development of strategy.
2. Aligning with business objectives.
3. Prioritizing risks.
4. Implementing risk responses.

Risk capacity is the maximum amount of risk an entity is able to assume. Management considers risk capacity in setting risk appetite.

Question 49

Which of the following is not a performance result that indicates deviation from a target or tolerance?

A. Improperly assessed risks.
B. Operational disruption risk.
C. Unidentified cyber risks.
D. Opportunities to accept more risk.

Answer 49

B. Operational disruption risk.

Cyber risk refers to the risk of financial loss, operational disruption, and reputational damage from the failure of digital technology. Performance results that deviate from a target or tolerance may indicate (1) unidentified cyber risks, (2) improperly assessed risks, (3) new risks, (4) opportunities to accept more risk, and (5) the need to revise a target performance or tolerance.

Question 50

In which of the following situations should a U.S.-based company consider hedging its transaction because it is in a short position?

A. One inheriting stock in a New Zealand company worth 90,000 New Zealand dollars with distribution in 180 days.
B. One exporting products to Denmark and receiving 500,000 krone in 90 days.
C. One selling its Brazilian mine and receiving 10,000,000 reals in 30 days.
D. One receiving shipments from Japan and owing 800,000,000 yen in 60 days.

Answer 50

D. One receiving shipments from Japan and owing 800,000,000 yen in 60 days.

An entity has a short position in a currency transaction when the entity benefits from a decline in the currency’s value and suffers from a rise in the currency’s value. When a U.S.-based company owes Japanese yen, it suffers from the appreciation of Japanese yen because that would result in an increase in settlement values in U.S. dollars. Thus, it has a short position in Japanese yen. To hedge against the risk of loss, the company should purchase forwards of Japanese yen to fix a definite price.