CBS Financial & Risk Management 3 — Questions and Answers
Question 1: Which scenario best illustrates concentration risk in a business portfolio?
- A company diversifies revenue across 12 unrelated industries
- A manufacturer relies on a single supplier for 90% of critical raw materials (Correct answer)
- A firm uses both debt and equity financing
- A retailer operates in multiple geographic markets
Correct answer: A manufacturer relies on a single supplier for 90% of critical raw materials
Concentration risk occurs when excessive dependence on a single source, customer, or supplier creates vulnerability to a single point of failure.
Question 2: A company issues bonds to finance expansion. From a risk perspective, this increases:
- Equity risk only
- Financial leverage and interest rate risk (Correct answer)
- Only operational risk
- Systematic risk exclusively
Correct answer: Financial leverage and interest rate risk
Issuing bonds increases financial leverage, adding fixed interest obligations and exposing the firm to interest rate fluctuations.
Question 3: The Debt-to-Equity ratio is used to assess:
- A company's profitability relative to sales
- The proportion of financing from creditors versus shareholders (Correct answer)
- How efficiently a company manages inventory
- The return generated on total assets
Correct answer: The proportion of financing from creditors versus shareholders
The Debt-to-Equity ratio measures the relative proportions of debt and equity financing, indicating financial leverage and creditor exposure.
Question 4: In a risk register, assigning a probability and impact score to each identified risk enables management to:
- Eliminate all identified risks
- Prioritize risks for mitigation based on their significance (Correct answer)
- Transfer all risks to insurance providers
- Convert operational risks to financial risks
Correct answer: Prioritize risks for mitigation based on their significance
Probability-impact scoring creates a risk matrix that ranks risks, allowing management to focus resources on the most significant threats.
Question 5: Which capital structure theory suggests that firms have an optimal debt level where tax shields from debt are balanced against financial distress costs?
- Modigliani-Miller theorem (no taxes)
- Pecking order theory
- Trade-off theory (Correct answer)
- Signaling theory
Correct answer: Trade-off theory
Trade-off theory holds that an optimal capital structure exists where the marginal tax benefit of debt equals the marginal cost of financial distress.
Question 6: A strategic CFO notices that the company's Days Sales Outstanding (DSO) has increased from 30 to 65 days. This most likely indicates:
- Improved collection efficiency
- Customers are paying more slowly, straining cash flow (Correct answer)
- Inventory is moving faster
- The company's profit margins have improved
Correct answer: Customers are paying more slowly, straining cash flow
Rising DSO means receivables are taking longer to convert to cash, which can strain liquidity even if sales revenue appears strong.
Question 7: Value at Risk (VaR) is a statistical measure used to quantify:
- The maximum possible profit from an investment
- The potential loss in value of an asset over a defined period at a given confidence level (Correct answer)
- The average return of a diversified portfolio
- The break-even point of a capital investment
Correct answer: The potential loss in value of an asset over a defined period at a given confidence level
VaR estimates the maximum expected loss over a specified time horizon at a chosen confidence level, commonly used in financial risk management.
CBS Financial & Risk Management 3
Which scenario best illustrates concentration risk in a business portfolio?