Chapter 11 - Risk Analysis and Corporate Governance

Question 1

The main classes of business risk are (4)

Answer 1

credit risk
market risk
liquidity risk
vulnerability due to concentrations

Question 2

Market risk is the possibility that

Answer 2

future changes in market prices may make the services that a company provides or the goods that it sells less valuable or more undesirable

Question 3

there are three main risk management strategies:

Answer 3

diversification
hedging
loss prevention strategies

Question 4

Loss prevention techniques are intended both to ___ and to ___

Answer 4

prevent perils
reduce the impact of the loss if a peril cannot be avoided

Question 5

Warning signs are clear and visible signs of the difficulties experienced by a business. two kinds:

Answer 5

Signs revealing that the business is insolvent
other signs indicating that its viability is threatened, although it is not yet insolvent.

Question 6

factors that can directly jeopardize a business’ solvency (6)

Answer 6

profitability of the business
ability to pay its debts
collect on its receivables
overall debt level
failure to respect loan conditions
insufficient liquidity.

Question 7

To arrange loans or obtain better interest rates, companies agree to meet certain conditions, commonly referred to
as ___ .

Answer 7

restrictive covenants

Question 8

The most common covenants require that the company maintain ___

Answer 8

certain financial ratios

Question 9

indicators related to ___ tell more about a company’s management.

Answer 9

operations

Question 10

factors that cast doubt on a company’s ability to continue operations. (6)

Answer 10

excessive growth
loss of a major supplier or customer
departure of key personnel
possible losses
unfavourable contract commitments
communication problems.

Question 11

When management relies heavily on budgets or forecasts, or other hypothetical information in drawing up plans, financial planners must ask themselves whether the underlying assumptions seem reasonable in the circumstances.
Certain points call for particular attention: (3)

Answer 11

• Key assumptions underlying financial forecasts
• Assumptions that are particularly sensitive or liable to change, or that conflict with past trends
• Items whose impact is ignored in the future-oriented financial information

Question 12

Financial planners must also study the plans drawn up by a company’s managers to improve the situation and discuss the plans with them. The plans may involve (5)

Answer 12

selling assets
borrowing or renegotiating the debt
focusing on collecting receivables
reducing or postponing certain expenses
increasing the company’s capital.

Question 13

excessive ___ is the cause of almost all bankruptcies

Answer 13

debt

Question 14

Before a business becomes over-indebted, a
financial planner must watch for these warning signs: (5)

Answer 14

• mismatch between long-term financing of short-term working capital costs
• need to explore new sources of financing, as conventional sources become more difficult to access
• Noncompliance with requirements to have enough assets to support par value of common shares
• Insufficient investment by shareholders
• Refusal by suppliers to provide normal credit terms

Question 15

Insufficient ___ on an ongoing basis is certainly the main warning sign

Answer 15

cash flow