CHAPTER 16: MANAGING RISK IN AN ORGANIZATION

MULTIPLE CHOICE TEST QUESTIONS

1. Derivatives activities in end users are primarily conducted by

a. the human resources group
b. the sales staff
c. the chief financial officer
d. the board of directors
e. the treasury group

2. Which of the following best describes a company that practices enterprise risk management?
a. interest rate risk and currency risk would be managed in unison
b. a single department to manage risk
c. it would manage insurance-related risks along with financial risk
d. credit risk would be managed the same way as market risk
e. operational risk would be managed

3. The front office refers to

a. the compliance office
b. the traders who engage in derivatives transactions
c. legal counsel
d. the risk management function
e. senior management

4. FAS 133 defines effective hedging as

a. a hedge with no basis risk
b. a correctly priced hedge
c. a perfect hedge
d. a hedge that reduces 80 to 125 percent of the risk
e. none of the above

5. In which of the following activities is hedge accounting prohibited?

a. hedging an overall portfolio as opposed to an individual transaction
b. using short calls to protect a long asset
c. using long puts to protect an asset
d. hedging a long position with a short futures
e. hedging a swap with a swaption

6. Which of the following organizations recommends best practices for the investment management industry?
a. PRMIA
b. Risk Standards Working Group
c. GARP
d. G-30
e. Financial Accounting Standards Board

7. Which of the following activities does senior management not do?

a. ensure that personnel are qualified
b. ensure that controls are in place
c. execute hedge transactions
d. establish policies
e. define roles and responsibilities

8. The primary distinction between FAS 133 and IAS 39 is

a. IAS 39 does not permit hedge accounting
b. IAS 39 was adopted earlier than FAS 133
9th Edition: Chapter 16 0 Test Bank
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 c. IAS 39 applies only to publicly traded corporations
d. IAS 39 applies to all financial assets and liabilities, not just derivatives
e. none of the above

9. Metalgesellschaft lost about $1.3 billion doing what?

a. hedging short-term commitments with long-term options
b. using crude oil futures options to hedge crude oil futures
c. trading futures spreads on crude oil
d. hedging fixed rate oil price commitments with swaptions
e. none of the above

10. “Independent risk management” means which of the following?

a. that risk management of a firm is independent of its overall corporate policy decisions
b. that the risk management function is provided by an outside consulting firm
c. that the risk manager cannot be influenced by the traders
d. that the risk manager is independent of the firm’s senior managers
e. none of the above

11. End users are all of the following types of organizations except?
a. investment funds
b. non-financial corporations
c. governments
d. financial institutions
e. none of the above

12. What is the primary activity of a firm’s front office?

a. risk management
b. trading
c. pricing derivative products
d. auditing
e. none of the above

13. Orange County lost $1.6 billion doing what?

a. betting that interest rates would remain stable
b. buying Treasury bond futures
c. selling Eurodollar futures
d. buying short- and intermediate-term bonds on margin
e. trading money market options

14. Risk managers should report to

a. the chief trader
b. legal counsel
c. the executive in charge of the front office
d. the executive in charge of the back office
e. none of the above

15. Prior to FAS 133, where on the financial statements were derivatives reported?
a. as contingent liabilities
b. as goodwill
c. as intangible assets
d nowhere because they were off-balance sheet items
e. in Other Comprehensive Income

16. Which of the following methods is not acceptable for disclosure under the SEC’s rules?
a. the CEO’s letter to the shareholders
b. tabular information
9th Edition: Chapter 16 1 Test Bank
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 c. sensitivity analysis
d VAR
e. none of the above

17. Ultimate authority for risk management lies with

a. legal counsel
b. the head trader
c. senior management
d. the internal auditors
e. the external auditors

18. Derivatives dealers primarily conduct derivatives transactions for which of the following reasons?
a. to enhance the returns on their other investment transactions
b. to profit off of their ability to execute trades at the right time
c. to profit off of their market making services
d. to provide services to enhance the overall attractiveness of their product line
a. none of the above

19. Which of the following methods is not permitted to satisfy the SEC’s requirements for disclosure of
derivatives activity?
a. an explanation in the chairman’s letter
b. a Value-at-Risk figure
c. a sensitivity analysis
d. a table of market values and related terms
e. none of the above

20. Hedge accounting is which of the following?

a. describing all hedges in footnotes to accounting statements
b. deferring all recording of hedge profits and losses until the hedge is over
c. associating the derivative profit or loss with the instrument being hedged
d. all of the above
e. none of the above

21. Which of the following statements is not true about fair value hedges?
a. it requires a method of determining the fair value of the derivative
b. it defers recognition of all profits and losses until the hedge is terminated
c. it will cause earnings to fluctuate if hedges are not effective
d. it requires proper documentation
e. none of the above

22. Which of the following statements is not true about fair value hedges?
a. it requires identification of the effective and ineffective parts
b. derivatives profits and losses are temporarily carried in an equity account
c. it requires proper documentation
d. only dealer firms are eligible to use it
e. none of the above

23. Barings lost $1.2 billion because of what?

a. a failure of risk controls in one of its foreign offices
b. model risk in their VAR models
c. fraudulent transactions
d. regulators shut it down because of poor risk management
e. speculating on German interest rates

24. Which of the following would not be included among typical derivatives end users in the U. S.?
a. pension funds
9th Edition: Chapter 16 2 Test Bank
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 b. corporations
c. state and local governments
d. the federal government
e. hedge funds

25. Procter and Gamble lost $157 million doing what?

a. speculating on a worldwide recession
b. failure to hedge their borrowing cost on a bond issue
c. speculating on foreign interest and exchange rates
d. speculating on a decrease in the federal budget deficit
e. mismanagement of a hedge fund in their pension fund

26. All of the following make up the financial derivatives risk management industry, except
a. end users
b. dealers
c. consultants
d. specialized software companies
e. GRAP professionals

27. Enterprise risk management includes all of the following except

a. a process in which a firm seeks to controls all of its risks in a centralized, integrated manner
b. seeks to manage traditional financial risks, such as interest rate and foreign currency risks
c. seeks to manage risk of product obsolescence risk
d. seeks also to manage nontraditional financial risks, such as insurable risks
e. all of the above

28. Hedge accounting, based on FAS 133, addresses all of the following except
a. fair value hedges
b. unfair value hedges
c. cash flow hedges
d. foreign investment hedges
e. speculation

29. Responsibilities of senior management include all of the following except

a. establish written policies
b. define roles and responsibilities
c. identify acceptable strategies
d. ensure that control systems are in place
e. all of the above

30. Hedge accounting is a method of accounting for which the

a. gains and losses from a hedge are deferred until the hedge is completed.
b. debits and credits are managed to keep the cash account stable
c. derivatives revenues and expenses are recorded so as to exactly balance
d. gains and losses on derivatives are shown before the hedge is terminated
e. none of the above

9th Edition: Chapter 16 3 Test Bank

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 CHAPTER 16: MANAGING RISK IN AN ORGANIZATION

TRUE/FALSE TEST QUESTIONS

T F 1. The United States government, in general, does not use derivatives.

T F 2. End users typically invest more resources in their derivatives operations than do dealers.

T F 3. End users differ from dealers in that the latter engage in risk management transactions for
the purpose of earning a profit off the spread between their buying and selling prices,
while the former enter into transactions to manage specific risks.

T F 4. Dealers typically have more sophisticated risk management operations than end users.

T F 5. An effective risk management system requires that the risk manager be independent of the
derivatives traders.

T F 6. A risk management system that controls risk within a single department is considered to
be centralized.

T F 7. In a derivatives operations, back office personnel are in charge of front office personnel.

T F 8. Under SEC rules, derivatives activities must be disclosed in one of three ways.

T F 9. Risk management in which risks such as financial market risk and insurance risk are
managed jointly is called enterprise risk management.

T F 10. Barings Bank failed due to excessive government regulation of their derivatives activities.

T F 11. Cash flow accounting must be used for all hedges involving cash outlays.

T F 12. The purpose of IAS 39 is to prescribe standards for derivatives accounting for foreign
currency transactions.

T F 13. A corporate risk management function is typically carried out by the treasury department.

T F 14. By speculating in derivatives, Procter and Gamble used its treasury department as a profit
center.

T F 15. Legal support for derivatives dealers is done by a compliance officer.

T F 16. Prior to FAS 133, derivatives were accounted for in Other Comprehensive Income.

T F 17. A fair value hedge is a transaction designed to protect the market value of an asset held.

T F. 18. Transactions that do not qualify as hedges must be accounting for as speculation and
marked to market each period.

T F 19. SEC disclosure requirements force companies to reveal how they manage all risks.

T F 20. Senior management should be involved in the setting of policies and procedures of a firm’s
risk management operations.

T F 21. The G-30 report recommends how institutional investors should manage risk.

T F 22. Senior management should evaluate trading performance on a risk-adjusted basis.

9th Edition: Chapter 16 4 Test Bank
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
T F 23. Under FAS 133 executive stock options must be accounted for as short call options.

T F 24. A company’s auditors are not typically trained to serve in a risk management capacity.

T F 25. The basic premise behind FAS 133 is that derivatives transactions must be marked to
market and recorded somewhere in the financial statements.

T F 26. The objectives of end users of derivatives is the same as derivatives dealers: use
derivatives to make a profit.

T F 27. There are two distinct groups of specialists at derivatives dealer institutions, sales
personnel and traders.

T F 28. A   derivatives   dealer   organization   will   engage   in   numerous   transactions   and   naturally
should practice risk management at the centralized firmwide level.

T F 29. Effective risk management requires that the front office clerical 
operations be separated from the back office trading operations.

T F 30. Enterprise risk  management  is a process  in which a firm  controls  all  of its risks in a

centralized, integrated manner.

9th Edition: Chapter 16 5 Test Bank

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.