BFF5902 Introduction to Risk Management
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BFF5902 Introduction to Risk Management
Practice Exam Questions and Suggested Solutions
Note that the solutions are suggested only and are intended to provide minimum guidance. You should be capable of elaborating further in your answers.
You are to complete ALL questions.
Section A comprises 6 x True-False questions (2 marks), and explanation (3 marks).
Section B comprises 5 x Short Answer questions. A formulae sheet is provided for reference.
Section A: True-False Questions
Please answer ALL questions by typing in the text box:
1. stating if TRUE or FALSE ( 2 marks), and
2. explaining your answer (1-2 lines) (3 marks).
Q1
The principle of As Low as Reasonably Practicable (ALARP) states that management should treat risks until financial costs of the risk is minimised.
False. ALARP states that risks should be lowered until the costs of further treatment outweigh benefits.
Q2
A currency swap does not involve an exchange of principal but an interest rate swap does. False. The opposite is true.
Q3
A twice per year report that explains a company’s risk profile and provides recommendations for the Board, is a type of risk review.
True. A review is a report that contains analysis of risk information. A monitoring report only provides information and may not be read or acted upon unless needed.
Q4
A personality test, undertaken by job candidates, is a type of control that reduces human factor risk
True. An individual’s personality is one of three human factors and can influence operational risks. Screening candidates with personalities that do not match the role is a type of control.
Q5
A poll survey is a suitable method for identifying and understanding new risks.
False. A poll only asks for opinions about known issues and cannot be used to further analyse new information. It is more useful for gathering Key Risk Indicator information.
Q6
To hedge a natural long position with an option, a hedger should sell a call option.
False. Hedger should buy a put option.
Section B: Short-Answer questions
Please answer ALL questions by typing in the text box. (10-15 lines)
Q7 (4+4+4=12 marks)
Critique the following statement:
Climate change magnifies the risks that a bank is already exposed to.
In discussing this statement, answer ALL of the following:
a) Explain how climate change can increase the risks already faced by a bank.
b) Describe the consequences that might arise if a bank managed climate change related risks poorly.
c) Can transition risk provide opportunities?
Suggest Solution:
a) Correct. Increased financial risks (credit risk of borrowers, liabilities from insurance, physical asset risk). Strategic, funding and reputation risks. Climate related risks magnify and influence existing risks.
b) Direct financial losses from poor lending decisions, increased insurance payouts if the bank offers insurance products. Poor ESG rating will result in damaged reputation and higher funding costs.
c) Yes. A bank can provide new lending to its customers to fund decarbonising initiatives.
Q8 (4+4+4=12 marks)
You have been asked to evaluate the effectiveness of data security controls using Bow-Tie analysis. Currently, the only control the company has is a written procedure requiring staff not to disclose information. Testing shows it is followed fully 90% of the time, which is considered best practice in the industry for a control of this nature.
Answer the following:
a) Describe the essential features of a Bow-Tie diagram.
b) Describe the concept of control effectiveness and its relationship to residual risk.
c) According to the Three Lines of Defence risk governance model, who is accountable for a controls’ effectiveness?
Suggested Solution:
a) It is a graphical description of a risk: causes, consequences, main event and controls.
b) An effectively controlled risk changes the inherent risk to an acceptable residual risk level.
c) The first-line risk owner is accountable.
Q9 (4+4+4=12 marks)
A company is concerned about not being able to pay its suppliers on time because of delays in receiving credit sales from its customers.
Answer the following questions:
a) Identify the risks evident in this scenario.
b) Describe how the company could treat this risk by adjusting its cash flow conversion cycle.
c) Explain whether these treatments could also create risks.
Suggested Solution:
a) Credit risk and liquidity risk.
b) Take longer to pay its suppliers, ask for quicker payment from its debtors, or take less time to process the work and store stock (reduce inventory levels).
c) Each treatment has an additional risk - loss of suppliers, increased credit risk/loss of business from buyers, increased operational risk.
Q10 (4+5+5=14 marks)
In June 2020, a US transport company hedged the cost of purchasing 2,000 barrels of oil planned in November 2020 by entering into December 2020 futures contracts. The price of the futures contract in June was $40 when the spot price was $37. Each contract is for delivery of 1,000 barrels.
Answer ALL of the following questions:
a) Describe and explain the firm’s natural position with respect to the price of oil.
b) In November 2020, the futures price is $45 and the spot price is $44. Calculate the basis per barrel for June and November.
c) Calculate the hedged purchase cost per barrel.
Suggested Solution:
a) Short natural position.
b) Basis per barrel is: b 1 (June)= -$3, b2 (November) = -$1.
c) Effective cost is F1+b2 = $39 per barrel.
Q11 (5+5+5+5=20 marks)
A retail clothing manufacturer is facing increasing labour costs, which if not addressed, will cause it to fail. The CEO proposes to the Board that all manufacturing should be outsourced to a little known company in a developing country where there are less labour laws and cheaper costs. To make this change, the company will need to sack its current workforce. The company has been a major employer of local people and enjoys significant tax benefits and advertising from its local government. No other strategies have been proposed.
Answer ALL of the following questions:
a) Identify the critical stakeholders affected by this proposal.
b) Discuss the major risks facing this company.
c) Explain which cognitive biases may be present in the CEO’s proposal.
d) Describe two treatments that could reduce strategic risk.
Suggested solution:
a) Employees, local government, shareholders, community, customers.
b) Currently suffering financial risk. Strategic risk in setting a new strategy and with implementing it.
c) Excessive optimism.
d) Better decision making if second line risk managers evaluated the risks inherent in the implementation of the strategy. Consider more than one strategy proposal.
2023-06-13