CBS Financial & Risk Management 2 — Questions and Answers
Question 1: A company has a current ratio of 0.8. What does this indicate about its short-term financial health?
- The company has more current liabilities than current assets (Correct answer)
- The company is highly profitable
- The company has strong long-term solvency
- The company's inventory turnover is optimal
Correct answer: The company has more current liabilities than current assets
A current ratio below 1.0 means current liabilities exceed current assets, signaling potential liquidity problems.
Question 2: Which risk management strategy involves transferring the financial consequences of a risk to a third party?
- Risk avoidance
- Risk reduction
- Risk transfer (Correct answer)
- Risk retention
Correct answer: Risk transfer
Risk transfer shifts the financial burden of a risk to another party, most commonly through insurance or contractual agreements.
Question 3: In capital budgeting, the Internal Rate of Return (IRR) decision rule states a project should be accepted when:
- IRR is less than the cost of capital
- IRR equals zero
- IRR exceeds the required rate of return (Correct answer)
- IRR is negative
Correct answer: IRR exceeds the required rate of return
A project is accepted when its IRR exceeds the company's required rate of return (hurdle rate), indicating value creation.
Question 4: What is the primary purpose of a hedging strategy in financial risk management?
- Maximize speculative returns
- Eliminate all forms of business risk
- Offset potential losses in one position with gains in another (Correct answer)
- Increase exposure to favorable market movements
Correct answer: Offset potential losses in one position with gains in another
Hedging reduces risk by taking an offsetting position that gains value when the primary position loses value.
Question 5: Which financial statement best reveals whether a profitable company is generating sufficient cash to meet its obligations?
- Income statement
- Balance sheet
- Statement of cash flows (Correct answer)
- Statement of retained earnings
Correct answer: Statement of cash flows
The statement of cash flows shows actual cash generated and used, revealing liquidity even when a company reports accounting profits.
Question 6: A business strategist assessing enterprise risk would classify reputational damage from a product recall as which type of risk?
- Credit risk
- Operational risk (Correct answer)
- Market risk
- Liquidity risk
Correct answer: Operational risk
Reputational damage from operational failures like product recalls falls under operational risk, which encompasses failures in processes, people, or systems.
Question 7: The Weighted Average Cost of Capital (WACC) is used in financial management primarily to:
- Calculate tax liabilities
- Set the minimum acceptable return for investments (Correct answer)
- Determine dividend payout ratios
- Measure working capital efficiency
Correct answer: Set the minimum acceptable return for investments
WACC represents the blended cost of all capital sources and serves as the hurdle rate — the minimum return an investment must generate to create shareholder value.
CBS Financial & Risk Management 2
A company has a current ratio of 0.8.
What does this indicate about its short-term financial health?