Risk Management & Economic Analysis Flashcards
It is good to borrow in what type of inflationary environment?
highly inflationary
What is SWOT and what are the factors?
Strengths/Weaknesses = Internal Factors, Opportunities/Threats = External Factors
What are Porter’s 5 Forces?
Barriers to Entry
Market Competitiveness
Existence of Substitute Products
Bargaining Power of Customers
Bargaining Power of Suppliers
What are types of Barriers of Entry?
Regulation, capital investments, supplier access, preexisting customer preferences, economies of scale, learning curve, patents
When will new competitors enter a market?
Lower barriers of entry, high profits in the markets, risk of retaliation is low
What makes for Market Competitiveness?
Firms
* can respond to changes,
* have investment in marketing and r&d
* market growth is slower
* have alliance with suppliers
When do substitute products enter a market?
When they are readily available to customers, easy to switch, priced at or below firms prices, more choices for customers
When do customers have bargaining power?
When buyers are price sensitive, have low brand loyalty, a customer has a large volume of the sales, there are lower switching costs, substitutes are vast.
When does a Supplier have bargaining power?
When a firm cannot change suppliers, switching costs are high, supplier reputation is high, their product is superior.
What are the components of ERM from COSO
GOPRO
Governance & Culture
Objective Setting & Strategy
Performance
Review and Revision
Ongoing Information, Communication & Reporting
What is the Governance & Culture broken down into?
DOVES
Desired Culture
Oversight Exercised by Board
Values (Core) and Commitment
Employees are attracted, developed and retained
Structure for Operating is established
Risk responses are generally classified as:
Accept - no action taken to change the severity
Avoid - remove the risk
Reduce - risk mitigation techniques
Share - through outsourcing and insurance
Pursue - accepts it to achieve improved performance
The unsuccessful launch of a new product represents
Value Erosion (faulty strategy and inefficient operations)
What is the COSO definition of ERM?
The culture, capabilities, practices integrated with strategy setting and performance that organizations rely on to manage risk in creating, preserving and realizing value.
Risk appetite has been exceeded when:
the likelihood and impact of negative events significantly exceed residual risk.
What is residual risk?
The risk that remains after management has taken actions to mitigate negative events.
What is inherent risk?
Risk to an organization if management does nothing to alter the likelihood or impact of a negative event.
You didnt do anything you just inherited it.
Risk adverse behavior describes higher or lower return for risk?
Demand of a higher return as risk increases. Expectation of compensation for increased risk.
What are the broad categories of risks?
DUNS:
Diversifiable
Unsystematic (non-Market)
Non-diversifiable
Systematic (Market)
What is portfolio theory concerned with?
Construction of an investment portfolio that balances risk with its rate of return.
What is price risk?
The exposure an investor has to a decline in the value of a portfolio.
How would you calculate the effective interest rate of a loan?
Annual interest/net cash available
What is the calculation of nominal dollars?
Inflation rate to the power of the number of periods * amount of real dollars
How would you calculate the market rate of interest on a one year US Treasury Bill?
Risk free rate + Inflation premium
What risk is the difference between US Treasury and corporate bonds?
Default Risk, they should have a default risk premium when compared.
What would be an effective hedge for the risk associated with interest rate fluctuations?
An interest rate swap agreement. This could be used to convert interest payments from floating rate to fixed rate.
How do you calculate profit on a call option?
Profit on call = exchange rate at settlement - (strike rate + premium on call)
When would you use a call option?
To hedge the impact of payables in foreign currency going up due to exchange rate strengthening vs. dollar.
When would you use a put option?
To hedge the impact of receivables in foreign currency going down due to exchange rate weakening vs. the dollar.
How do you calculate breakeven on a put option?
Breakeven point = Strike rate - cost of the option
If consumers are demanding less of a product what happens to the demand curve?
The demand curve would shift left
A left shift in the demand can be caused by what?
Changes in wealth
changes in price of related goods
changes in consumer income
changes in consumer taste
changes in consumer expectation
changes in the number of buyers served by the market
An increase in the supply of a product will have what impact on demand?
Decrease in price and an increase in quantity demanded.
What direction does a perfectly inelastic supply curve go?
A perfectly inelastic supply curve is vertical. The quantity supplied will not change regardless of what happens with prices.
What is the Purchasing Power Risk Premium or Inflation Premium?
The compensation investors require to bear the risk that price levels may change and affect asset values or the purchasing power of invested dollars.
What is the Default Risk Premium?
The additional compensation demanded by lenders for bearing the risk that the issuer of the security will fail to pay interest or repay the principal.
What is Maturity Risk Premium?
Compensation investors demand for bearing the risk of increases to the term of maturity.
What is credit risk?
Credit risk is the risk that a company will have the ability to obtain credit. It is not a component of the Required Rate of Return.
What is price risk?
The exposure an investor has to a decline in the value of a portfolio or individual securities.
How do you calculate nominal dollars for an inflow?
Nominal dollars are equal to the inflation rate applied to the real dollars. Make sure to consider compounding.
What would the market rate of interest on a one year US T-bill?
The risk free rate plus an inflation premium.
How does the coefficient of price elasticity impact increases or decreases in demand when price changes?
The coefficient is multiplied by the % change in price to give the impact on demand.
How do you calculate real cost?
Apply inflation rate to initial cost then compare to actual payments or receipts for the period being reviewed.
When a company insures against losses it is know as what type of risk mitigation?
Risk sharing
When you self insure or just tolerate your risk exposure that is know as what type of risk mitigation?
Acceptance
When you diversify rather than eliminate risk this is know as what type of risk mitigation?
Risk reduction
When you dispose of a unit, product or geographic segment that is know as what type of risk mitigation?
Risk Avoidance
When a product line is unsuccessful the failure represents what type of value?
Value erosion
When ongoing operations efficiently sustain benefits what type of value is that?
Value preservation
When is value creation realized?
When the benefits exceed the cost of resources used
Insuring against losses or entering into joint ventures to address risk is known as:
Risk sharing.
The unsuccessful launch of a new product represents what type of value?
Value erosion. Value is eroded when faulty strategy and inefficient and/or ineffective operations cause value to decline.
What is the risk to an organization after management takes actions to reduce the likelihood or impact of a negative event?
Residual risk is the risk to an organization after management takes actions to reduce the likelihood or impact of a negative event. So as an equation: Residual risk = Inherent risk – Impact of management actions.
The Committee of Sponsoring Organization’s (COSO) Enterprise Risk Management (ERM) framework identifies four methods of responding to risk, what are they?
Avoidance, reduction, sharing, and acceptance.
What is the name of the ability of an entity to withstand the impact of large-scale events.
Organizational sustainability is the ability of an entity to withstand the impact of large-scale events.
What is the ability of an entity to withstand the impact of large-scale events?
Organizational sustainability
What does DUNS stand for?
Diversifiable Unsystematic, Non-diversifiable Systematic
What is another name for purchasing power risk premium?
Inflation Premium - price levels may change and affect asset values or the purchasing power of invested dollars.
In microeconomics, the distinguishing characteristic of the long run on the supply side is that:
All inputs are variable, even fixed costs become variable if the time period is long enough.
What is the formula for elasticity?
%change in Quantity/%change in Price
Use absolute values
They move in different directions
The ability of an entity to withstand the impact of large-scale events refers to:
Organizational sustainability
What does frequently cutting prices do to product demand if demand is significantly elastic?
Quantity demanded increases proportionally more than the price declines.
What is the formula for Price elasticity of demand?
Price elasticity of demand = % Change in quantity demanded/% Change in price
What is price discrimination?
The action of making different prices available to different customers in order to maximize profits
What is country risk?
Country risk encompasses the political risk, economic risk, transfer risk, sovereign risk, and exchange rate risk associated with engaging in business with foreign countries.
What is comparative advantage?
The ability of an entity to produce a good at a lower opportunity cost than another entity.
What is a sourcing requirement?
Sourcing requirements generally refer to content or value added limits on the percentage of labor or materials used in imported products. Compliance with limits may result in tariff reductions.
What are sourcing requirements?
Sourcing requirements generally refer to content or value added limits on the percentage of labor or materials used in imported products.
How is an equity carve out structured?
Under this partial disposal, a new public company is formed, shares are sold to the public through an IPO, the company receives cash, and the parent company maintains a controlling interest.
What is a horizontal merger or combination?
When a company in the same industry merge.
What is a diagonal combination?
Integrating another company that provides ancillary services.
What are some of the main differences in a spin off vs. a sell off?
Spin off shares are usually distributed to original shareholders, non cash transaction, no third party involved.
What is circular business combination?
Businesses in unrelated industries are merged. Can help diversify. Does not help with economies of scale or directly impact original core business.
What is the formula for cross elasticity?
%Change in Quantity of X/% change in Price of Y
Based on cross elasticity of demand, how do you determine if products are substitutes or complements?
If the products are substitutes CE is positive.
If the products are complements CE is negative
