CPA Australia FRM-8-esat

a.I, II and III only.

b.I, II and IV only.

c.I, III and IV only.

d.II, III and IV only.

Question 5

Which sequence of numbered activities represents the optimum segregation of duties?

I.The front office staff have initiated the transaction—normally via a deal sheet.

II.The middle office independently measures the exposure, values derivatives and measures exposures against limits in accordance with board policy to ensure that the front office is complying with

board policy.

III.The back office will verify the transaction to a third party; and confirm to ensure the transaction is valid and legally binding.

IV.The deal sheet should be passed to the back office with the front office having no further access to the recording or editing of the transaction.

a.I, II, III then IV.

b.I, III, II then IV.

c.I, IV, III then II.

d.IV, I, II then III.

Question 6

You have been asked to develop a policy and procedure for a corporate treasury operation. Which of the following aspects would you expect to be included in the policy?

I.Self-assessment of risks and controls by line management, and these to be reported monthly or quarterly.

II.An outline of the reporting framework—what is regularly reported to the board and management, both standard reporting and breach reporting.

III.The roles and responsibilities in the financial risk management function and management structure.

IV. A description of the internally derived analytical framework that quantifies the risk exposure of the company.

a.I, II and III only.

b.I, II and IV only.

c.I, III and IV only.

d.II, III and IV only.

Question 7

Under the Sarbanes–Oxley Act, controls are designed to minimise the risk of financial statement error.

The source of risk of financial statement error is due to

a.accounting principles, judgments and estimates, reality, fraud and error.

b.accounting principles, theft, reality, fraud and error.

c.accounting principles, judgments and estimates, fire, fraud and error.

d.accounting principles, judgments and estimates, poor system, fraud and error.

Question 8

What is the alternative name is given to credit risk?

a.Market risk.

b.Financial risk.

c.Liquidity risk.

d.Settlement risk.

Question 9

Which of the following are important features of credit risk control?

I.Limits placed on all credit exposures.

II.Constant monitoring of exposures against limits.

III.Determination of banking facilities to factor in short-term, worst-case funding requirements.

IV.Identification of exposure.

a.I, II and III only.

b.I, II and IV only.

c.I, III and IV only.

d.II, III and IV only.

Question 10

Assume that the front office of the organisation that you work for has identified two new financial institutions it would like to deal with. Bank A has a long-term rating of AA+ and a capital base of USD 6 billion while Bank B has a long-term rating of BBB and a capital base of USD 2 billion. The table below is your organisation’s approved credit framework to help manage counterparty risk.

Using this table, what limit would you allocate to each bank?

Capital base

(USD billion)Limits USD million

LT rating AAA AA+AA AA–A+A A–BBB+BBB BBB–

5>500450400350300300250200150100

445040035030025025020015010075 34003503002502002001501007550 2350300250200150150100505025 13002502001501001005025250

a.Bank A: 400; Bank B: 50.

b.Bank A: 450; Bank B: 75.

c.Bank A: 450; Bank B: 50.

d.Bank A: 250; Bank B: 0.

Question 11

Which of the following items would you not expect to be included in a financial risk management department’s policy document?

I.The role of the treasury department.

II.The objectives in managing risks.

III.The role of the company’s group audit committee.

IV.The role of the risk management committee.

V. A list of responsibilities for each member of staff.

VI.Delegation of authority.

VII.Authorisation limits.

VIII.Position report.

IX. A copy of bank mandates.

X. A list of mandated banks.

a.III and VIII only.

b.IX and X only.

c.I, II and VII only.

d.IV, V and VI only.

Question 12

Which of the following statements about a risk management committee are not correct?

I.It is a subcommittee of the board of directors.

II.It is responsible for statutory reporting, internal auditing and treasury operations.

III.It makes recommendations to the board in respect of risk management policies.

IV.It ensures no unrealistic profit targets are adopted that might lead to excessive risk-taking.

a.I and III only.

b.II and IV only.

c.III and IV only.

d.I, II, III and IV.

Question 13

Most corporations have documentation about their financial reporting processes. In order to ensure that the documentation of internal processes could assist in a meaningful and informed evaluation of financial reporting and controls, the documentation should be sufficient to

I.identify all the key decision points within a process.

II.confirm the alignment of risks and controls.

III.identify the financial statement accounts affected by the process being documented.

IV.confirm handover points between service providers within the company.

a.I and III only.

b.II and IV only.

c.III and IV only.

d.I, II, III and IV.

Question 14

Which of the following exposures is not a type of foreign exchange exposure?

a.Exposures resulting from conversion of long-term foreign currency assets and liabilities into AUDs.

b.Exposure resulting from movements in foreign interest rates.

c.Transaction exposures resulting from trade purchase and sales.

d.Exposures that may result from adopting a different approach to managing foreign exchange exposures

from that undertaken by the organisation’s competitors.

Question 15

What are the five interrelated components in the COSO framework (2004)?

I.External environment.

II.Control environment.

III.Risk assessment.

IV.Control activities.

https://www.360docs.net/doc/208311429.html,rmation and communication.

VI.Reporting.

VII.Monitoring.

a.I, III, V, VI and VII only.

b.II, III, IV, V and VII only.

c.II, IV, V, VI and VII only.

d.I, II, III, IV and VI only.

Question 16

Which one of the following is not included in compliance reporting?

a.Realised gains and losses for each risk area.

b.Certification that all policies have been adhered to.

c.Instances where stated policies have been breache

d.

d. A summary of deals outstanding or unconfirmed or that are in excess of total limits.

Question 17

Which sequence correctly identifies the financial risk management cycle?

a.Identify risk, develop strategies, create a policy, execute the policy, monitor compliance, report results,

reassess policy.

b.Identify risk, create a policy, develop strategies, execute the policy, monitor compliance, report results,

reassess policy.

c.Identify risk, develop strategies, create a policy, execute the policy, report results, monitor compliance,

reassess policy.

d.Identify risk, create a policy, develop strategies, execute the policy, report results, monitor compliance,

reassess policy.

Question 18

Digarigaroo, a hopeful Australian oil producer in the Cooper Basin in South Australia, is aware that oil prices are linked to the AUD/USD exchange rate as well as US oil price movements. Digarigaroo has elected to have the AUD as its functional currency and reporting currency. Digarigaroo also needs to borrow significant funds to cover drilling costs.

Digarigaroo would like to reduce its potential future exposure to the USD, but its goal is not to be subject to potentially large swings in reported profit or equity due to the need to revalue exposures under IAS 39.

What should Digarigaroo do to achieve its goal?

a.Borrow USD against the USD-related exposure to revenue flows.

b.Switch to the USD as functional and reporting currency and borrow USDs.

c.Hedge revenues by taking out AUD/USD forwards.

d.Do nothing.

Question 19

The audit and risk management committee of the board has reported back to the full board on the company’s current use of gold and currency derivatives. The board members who are not members of the audit and risk committee do not understand the complex report.

What should the full board do?

a.Delegate the issue to the chief financial officer (CFO) as he is a professional.

b.Forward the report to the external auditors to ensure they can be held responsible if anything goes

wrong. They are also professionals.

c.Suspend further use of derivatives and call in a professional to review the current situation.

d.Immediately close out all derivative positions and get professional advic

e.

Question 20

Which of the following was not an issue of financial controls that, according to the Group of Twenty, contributed to the global financial crisis (GFC)?

a.Refinancing risk.

b.Systemic effects of domestic and regulatory actions.

c.Overly stringent underwriting standards.

d.Increasingly sophisticated financial products.

Question 21

Which of the following requirements best reflects a legal responsibility of company directors?

a.Have a thorough knowledge of all available hedging techniques and be thoroughly trained in

financial products.

b.Ensure that employees have the necessary experience and training in dealing with the financial

instruments they are authorised to use.

c.Ensure that corporate treasury executives have effective succession plans.

d.Understand all of the risks faced by the company and introduce appropriate processes to manage

those risks.

Solutions

Question 1

Correct Answer: d

Principle 7 recommends that the board should require management to design and implement the internal control system to manage risk.

You can review this topic area in the study materials under the section entitled ‘Risk management framework’.

Question 2

Correct Answer: c

Internal control is broadly defined as a process, effected by a company’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories

You can review this topic area in the study materials under the section entitled ‘Internal control framework’.

Question 3

Correct Answer: a

Market risk is the risk of loss due to adverse changes in the market value (the price) of an instrument, transaction, exposure or portfolio of instruments.Option B is the definition of funding risk.Option C is the definition of liquidity risk.Option D is the definition of credit risk.

You can review this topic area in the study materials under the section entitled ‘Market risk management’.

Question 4

Correct Answer: a

Pasminco experienced a falling zinc price and had too much debt, and too many losses on exchange contracts and underperforming acquisitions.

II. compliance with applicable laws and regulations;III. effectiveness and efficiency of operations; and V. reliability of financial reporting.Whereas

I. represents one of the steps under the COSO framework (2004) risk management process; and IV.

represents the first step in the Sarbanes–Oxley Act process to identify financial risk.

Please refer to Case Study 8.1 in the study materials, which describes the cause of the demise of Pasminco. Also refer to the relevant case studies on Pasminco in Module 6.

You can review this topic area in the study materials section on the Pasminco case study.

Question 5

Correct Answer: c

Adequate segregation of duties must be maintained to minimise the risk of fraud. Transaction settlements, confirmations, reconciliation and accounting must be undertaken by staff independent of the person who transacts the deal. Hence, with a treasury operation, the following sequence would be expected.

I. The front office staff have initiated the transaction—normally via a deal sheet.

IV. The deal sheet should be passed to the back office with the front office having no further access to the recording or editing of the transaction.

III. The back office will verify the transaction to a third party; confirmation to ensure the transaction is valid and legally binding.

II. The middle office independently measures the exposure, values derivatives and measures exposures against limits in accordance with board policy to ensure that the front office is complying with board policy.

You can review this topic area in the study materials under the section entitled ‘Segregation of duties’.

Question 6

Correct Answer: d

Item I is one of a two-phase process—for a risk framework and control environment—to ensure regular testing and verification of risk management policies, processes and measurement systems, as well as data-capture systems.

Typically, a risk policy would not include this control, but would instead contain:

s the roles and responsibilities in the financial risk management function and management structure;

s a definition for risks, including market risk, credit risk, funding risks and operational risks, as well as the various limits that will be monitored (these risks were discussed in Module 1);

s the capture and use of internal exposures and the analysis of this against external market information (including the use of scenario analysis);

s the development and incorporation of internal controls and their assessments into the risk framework;

s a description of the internally derived analytical framework that quantifies the risk exposure of the company;

s an outline of the reporting framework—what is regularly reported to the board and management, both standard reporting and breach reporting;

s a discussion of the testing and verification processes and procedures; and

s provisions for regular review and approval of significant policy and procedural breaches and changes.

You can review this topic area in the study materials under the sections entitled ‘Governance framework for financial risk management’ (Purpose and scope of the policy), ‘ASX principles on internal control’,

‘Appendix 8.1’, and ‘Accounting disclosure requirements’.

Question 7

Correct Answer: a

These are the sources of risk as detailed in Table 8.1 of the study materials.

You can review this topic area in the study materials under the section entitled ‘Summary of a SOX compliance process’.

Question 8

Correct Answer: d

Settlement or delivery risk reflects the risk that there is a default by a counterparty in a settlement or delivery. This is the same as credit risk.

Option A—Market positions can be closed out relatively quickly, whilst for credit risk, the time horizon to close a position can be very long.

Option B—Financial risk is the risk of not being able to renew funding requirements efficiently when required in future periods.

Option C—Liquidity risk is the risk of not being able to efficiently settle debts as they fall due.

You can review this topic area in the study materials under the section entitled ‘Credit/counterparty risk management’.

Question 9

Correct Answer: b

Typically, the control described in item III is in place to manage liquidity risk.

You can review this topic area in the study materials under the section entitled ‘Credit/counterparty

risk management’.

Question 10

Correct Answer: c

Bank A: Horizontal USD5> (representing USD 6 billion capital base); Vertical AA+ (representing the

credit rating).

Bank B: Horizontal USD2 (representing USD 2 billion capital base); Vertical BBB (representing the credit rating).

You can review this topic area in the study materials under the section entitled ‘Financial risk management policy—Key risks and controls’.

Question 11

Correct Answer: a

All the items identified would be represented in a company’s risk management policy, with the exception of

the following:

s The role of the company’s group audit committee—the group audit committee is typically independent of the company’s financial risk management activities. Nonetheless, the committee would take a

proactive role in monitoring the activities of the department.

s Position report—the document is typically a management report which would be prepared and reviewed on a daily basis. Although the policy may state that such reports shall be prepared and reviewed daily, the structure and form of the report would not necessarily form part of the policy.

You can review this topic area in the study materials under the sections entitled ‘Accounting disclosure requirements’, ‘Governance framework for financial risk management’, and ‘ASX principles on internal controls’.

Question 12

Correct Answer: b

Most large companies have a risk management committee that is a subcommittee of the board of directors.

The role of the committee is to make recommendations to the board with respect to risk management policies including limits, delegations of authority, risk quantification and reporting methodologies, performance measurement and other risk management issues.

The role of the committee would be to consider strategies recommended by the CFO. Typically, such a committee should meet on a monthly basis to discuss a number of issues.

II.It is responsible for statutory reporting, internal auditing and treasury operations—no, these are the responsibilities of the CFO.

IV.It ensures no unrealistic profit targets that might lead to excessive risk-taking—no, these are the responsibilities of the directors.

You can review this topic area in the study materials under the section entitled ‘Establishment and functions of a risk committee’.

Question 13

Correct Answer: d

Most corporations would already have documentation about their financial reporting processes.

The ultimate objective for the documentation of an internal control process is to assist in a meaningful and informed evaluation of financial reporting risks and controls. Documentation should be sufficient to

s identify the financial statement accounts affected by the process being documented;

s provide information on how transactions are initiated, authorised, recorded, processed and reported;

s identify all key decision points within a process;

s provide information about each type of transaction and the flow of transaction activity to identify where material misstatements arising from error or fraud could occur;

s confirm the alignment of risks and controls;

s distinguish between key controls and other controls identified;

s indicate the steps to be undertaken should the controls identified detect a failure or an exception within the process;

s confirm the identification of changes to internal control processes or environment;

s provide information on the information technology (IT) systems used in the management and/or derivation of financial information (i.e. general ledger, spreadsheets, other IT applications) and clarify the interface, within the control environment between finance and IT systems; and

s confirm handover points between service providers within the company.

You can review this topic area in the study materials under the section entitled ‘Control environment’.

Question 14

Correct Answer: b

Foreign exchange exposures are of three types

s transaction exposures resulting from normal operational business activities (e.g. trade purchases and sales, short-term borrowing);

s translation exposure resulting from conversion of long-term foreign currency assets (net equity investments in foreign operations) and liabilities into AUDs; and

s competitive (or economic) exposures that may result (profitably or otherwise) from adopting a different approach to managing foreign exchange exposures from that taken by the organisation’s competitors.

You can review this topic area in the study materials under the section entitled ‘Foreign exchange risk management’.

Question 15

Correct Answer: b

The COSO framework (2004) is an extension of the risk management process explained in Module 1. Fundamental to the COSO framework is the proposition that internal control consists of five interrelated components.

These are derived from the way management runs a business, and are integrated with the management process. The components are as follows:

s Control environment—The core of any business is its people. There are attitudes, including integrity, ethical values and competence and the environment in which they operate. They are the engine that

drives the entity and the foundation on which everything rests.

s Risk assessment—The entity must be aware of and deal with the risks it faces. It must set objectives integrated with sales, production, marketing, financial and other activities so that the organisation is

operating in concert. It also must establish mechanisms to identify, analyse and manage the related risks.

s Control activities—Control policies and procedures must be established and executed to help ensure that the actions identified by management as necessary to address risks are effectively carried out.

s Information and communication—Surrounding these activities are information and communication systems. These enable the company’s people to capture and exchange the information needed to

conduct, manage and control its objectives.

s Monitoring—The entire process must be monitored, and modifications made as necessary. In this way, the system can react dynamically, changing as conditions warrant.

You can review this topic area in the study materials under the section entitled ‘US framework for control of fraudulent financial trading’.

Question 16

Correct Answer: a

Compliance reporting could include

s certification that all policies have been adhered to;

s instances where stated policies have been breached;

s reasons for the breaches and what actions, if any, have been taken to rectify the situations; and

s a summary of deals outstanding or unconfirmed or that are in excess of total limits.

Option A, realised gains and losses for each risk area, is based on figures supplied from the general ledger by staff independent of those executing the derivative transactions. These figures are included in financial results.

You can review this topic area in the study materials under the section entitled ‘Scope and content of

board reports’.

Question 17

Correct Answer: a

See Figure 8.7 ‘The financial risk management cycle’ in the study guide.

You can review this topic area in the study materials under the section entitled ‘Risk management framework’.

Question 18

Correct Answer: d

Do nothing, as Digarigaroo is a hopeful oil product and production is not highly probable.

Please note that whilst this is the correct answer to the question asked it is not a normally accepted answer to financial risk management.

Many companies do not hedge because of the accounting implications. This is a perverse result but one that needs to be understood.

To quote the ‘goal’ of Digarigaroo

Digarigaroo would like to reduce its exposure to the USD but its goal is not to be subject to potentially large swings in reported profit due to the need to revalue exposures under IAS 39.

Option A—‘Borrow USD against the USD-related exposure to revenue flows’—is incorrect as

translation exposures are now likely.

Option B—‘Switch to the US dollar as functional and reporting currency and borrow US dollars’—is incorrect as the AUD now becomes the ‘foreign’ currency and translation exposures are now likely.

Option C—‘Hedge revenues by taking out AUD/USD forwards’—is incorrect as these also need to be marked to market at the end of the financial year.

You can review this topic area in the study materials under the section entitled ‘Accounting disclosure requirements’, including ‘Limitations of SOX’.

Question 19

Correct Answer: c

Suspend further activity but do not prematurely realise and remove what will, in most cases, be effective hedges against financial risks.

Option A is incorrect as the CFO may be part of the problem (as in the case of Sons of Gwalia) and there must be a degree of independence in the board’s assessment of risk. See the section on management responsibilities, chief financial officer:

Internal audit often reports directly to the board so staff cannot be influenced by the CFO in reporting their findings. In this way they retain their independence.

Option B is incorrect as the board cannot delegate responsibility in this area.

Option D is incorrect as this would remove genuine hedges as well as potential excess cover and therefore expose the company to financial risk. This is what occurred in the case of AWA, when very large losses were realised on hedges and the company then lost further cash on adverse currency movements to the newly exposed positions.

(Note: Three of the four possible answers were actually adopted by the boards of either Centro, AWA or Sons of Gwalia. They directly or indirectly led to massive losses.)

You can review this topic area in the study materials under the section entitled ‘Responsibilities and obligations of directors’.

Question 20

Correct Answer: c

Weak or insufficiently stringent underwriting standards contributed to the GFC. Overly stringent underwriting standards therefore did not contribute. If these standards had been tighter, perhaps the impact may not have been as severe.

See the section on the impact of the global financial crisis.

... the Group of Twenty leaders in its declaration after the summit on financial markets and the world

economy provided a comprehensive list of root causes:

During a period of strong global growth, growing capital flows, and prolonged stability earlier this

decade, market participants sought higher yields without an adequate appreciation of the risks and

failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound

risk management practices, increasingly complex and opaque financial products, and consequent

excessive leverage combined to create vulnerabilities in the system.

You can review this topic area in the study materials under the section entitled ‘Impact of the global financial crisis’.