CA Final November 2023 Suggested Answers Paper 6A Risk Management (Old Scheme)

FOR CA FINAL EXAM PREPARATION

CA Final 2023
Suggested Answers ·
Paper 6A Risk
Management (Old
Scheme)
EXAM YEAR TYPE

CA Final 2023 Suggested Answers
SUBJECT DATE

Paper 6A Risk Management (Old Scheme) November 2023

Notes · Sample Papers · Previous Year Papers · Mock Tests

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DISCLAIMER
This Suggested Answer hosted on the website do not constitute the basis for evaluation of the

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student’s answers in the examination. The answers are prepared by the Faculty of the Board

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of Studies with a view to assist the students in their education. Alternate Answers have been

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aanyg error or omission is noticed, the same may be brought to the attention of the Director of
incorporated, wherever necessary. While due care is taken in preparation of the answers, if

Board of Studies. The Council of the Institute is not in anyway responsible for the correctness

or otherwise of the answers published herein.

Further, in the Elective Papers which are Case Study based, the solutions have been worked

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out on the basis of certain assumptions/views derived from the facts g iven in the question or

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. to work out the solution to the case studies
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language used in the question. It may be possible

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in a different manner based on the assumptions

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2 FINAL EXAMINATION: NOVEMBER, 2023

PAPER – 6A – RISK MANAGEMENT

The Question Paper comprises five case study questions. The candidates are required
to answer any four case study questions out of five.
Answers in respect of Multiple-Choice Questions (MCQs) are to be marked on the OMR
Answer Sheet as given on the Cover Page of the answer book.
Answer to MCQs, if written inside the descriptive answer book, will not be evaluated.
Candidates should answer the Case Study Questions as selected by them in totality i.e. MCQ
as well as descriptive Question of the same Case Study Question.
Candidates are not permitted to answer MCQs of one Case Study Question and the
descriptive questions of another Case Study Question and vice-versa.
Candidates may use calculator.
CASE STUDY - 1

Automobile parts Manufacturing Sector
Automobile spare parts manufacturing is crucial in the automobile sector. It comprises of
manufacturing various components and accessories that ensure functionality, safety, and
performance of the vehicles. Manufactures are pivotal in supplying replacement parts,
enhancing the efficiency and reliability of the automobiles.
Famous Auto Limited (FAL)
FAL is a reputable automobile spare parts manufacturer located in Noida , Uttar Pradesh. They
manufacture and supply spare parts to various car manufactures across the country. If the
customer’s order contains spare parts that are not manufactured by FAL, they source them
from outside dealers and supply according to the specifications of such customer. They
produce 5% extra of each spare part in case a quality defect is discovered later on which
requires replacement.
There are several potential risks that need to be managed to ensure a successful
manufacturing process. FAL is manufacturing and supplying clutch plates, which is one of the
critical components to ensure the safety of a vehicle, to car manufactures. The Quality
Assurance (QA) team is responsible for making sure that the spare parts manufactured meet
the highest standards of both quality and safety.
Additional strategic Objectives Proposed
In line with the current trends of the automobile spare parts manufacturing industry, the
Managing Director (MD) proposes to include the following additional strategic objectives,
which are designed to contribute to the FAL’s overall growth, competitiveness, and ability to

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PAPER – 6A: RISK MANAGEMENT 3

adapt to industry trends and customer needs, in the existing long-term strategic objectives of
FAL:

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(i) Market Expansion – To expand into new unexplored geographic markets to increase

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market share and revenue.

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(ii) Product Innovation – To address the emerging trends in the automobile spare parts

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manufacturing industry by developing innovative spare parts that offer superior quality
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and performance.
Efficiency – To reduce production costs by improving the manufacturing processes
and better supply chain management.
Issues Highlighted
(a) During December 2022, there was liquidity crunch due to which; FAL could not pay (i) its
statutory taxes dues on time under various Acts and (ii) there was stoppage of further
consignments by its main suppliers for not making prompt payments. Normally FAL paid
its suppliers within 15 days of receipt of the supplies.

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(b) There was a sudden demand to supply a particular critical spare part (Part C) from a car

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manufacturer. FAL did not have enough stock of raw material to manufacture Part C.

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FAL’s regular suppler of the above raw material could not supply the same in time due to

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supply chains delays. The production manager decided to utilise a new and untested

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material for manufacturing Part C.
(c) M/s. R & Co., a Car manufacturer, ordered 10,000 nos. of Part K which FAL is not
manufacturing. Hence, FAL ordered Part K from one of its trusted suppliers. During
transit, the entire lot of the above part was damaged and in turn, FAL Could not supply
the part in a timely manner to M/s. R & Co.
(d) The Plant Manager, Mr. Raj submitted a project proposal for upgrading some machinery
in the Plant on urgent basis.

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To address these issues a Risk Committee (RC) was formed and directed to act in accordance

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with the terms of reference specified in writing by the Board.
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FAL is having an Investment Section. It has invested in Mutual Fund AB which

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ag The Investment Manager is analysing the risk of shares investment with a 1-day VaR of
` 2,50,000 at a 90% confidence level.

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4 FINAL EXAMINATION: NOVEMBER, 2023

Project to be taken up
FAL wants to manufacture some new spare parts. In this regard, FAL has two alternatives i.e.,
to pursue Project M or Project N. The following are the data for both the Projects with five
possible events:
Possible Project M Project N
Event Cash Flow (` 000) Probability Cash Flow (` 000) Probability
A 15,000 0.16 32,000 0.18
B 17,000 0.21 26,000 0.19
C 20,000 0.24 27,000 0.22
D 21,000 0.25 31,000 0.26
E 24,000 0.14 18,000 0.15

Based on the above, you are requested to answer the following questions:
Multiple Choice Questions
Choose the most appropriate answer from the given options.
(1.1) If the risk -free return over the time period is 6% the Sharpe Ratio (rounded off to two
digits) for Mutual Fund AB would be:
(A) 0.27
(B) 0.33
(C) 0.56
(D) 0.65
(1.2) Which one of the following is the primary risk associated with inadequate quality control
in the manufacturing of clutch plates for vehicles?
(A) Higher production costs
(B) Decreased manufacturing speed
(C) Reduced product lifespan
(D) Increased employee turnover
(1.3) In the proposal submitted by Mr. Raj, which of the following risks will be associated with
the project?
(A) Control Risks
(B) Opportunity Risks

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PAPER – 6A: RISK MANAGEMENT 5

(C) Interest Rate Risks
(D) Environmental Risks
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(1.4) In the analysis of Investment Manager, what does the VaR value represent?

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(A) The minimum potential loss the shares may experience with a 90% probability over
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the next day.
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(B) The maximum potential loss the shares may experience with a 10% probability over
the next day.

the next day.
(D) The maximum potential loss the shares may experience with a 90 % prob ability over
the next day.
(1.5) The decision by the production manager to utilise a new and untested material for
manufacturing Part C is most likely to primarily result in the emergence of which of the

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following risks?
(A) Financial risk due to increased material costs.
(B) Quality risk due to potential materialm
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sin material delivery.
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failure.

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(C) Supply chain risk due to delays
(D) Market risk due to changes (2 x 5 = 10 Marks)
Descriptive Questions
(1.6) Briefly explain the critical disruptions in business processes of FAL with examples drawn
from the Case Study. (3 Marks)
(1.7) Explain the composition and functions of the RC which was directed to act in accordance
with the terms of reference specified in writing by the Board with specific reference to

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FAL. (3 Marks)

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(1.8) You are requested to provide practical illustrations that can be considered under the

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respective additional long-term strategic objectives, as proposed to be included by the

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MD. The illustrations are meant to be aligned with the proposed additional long -term

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strategic objectives put forth by the MD.
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a suggest which Project
(3 Marks)

ag (1.9) Calculate Coefficient of variation of Project M and Project N and
should be undertaken by the FAL. Show your workings. (6 Marks)

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6 FINAL EXAMINATION: NOVEMBER, 2023

Answer
Multiple Choice Questions

1.1 (C)
1.2 (A) or (C)
1.3 (A)
1.4 (D)
1.5 (B)
Descriptive Questions
1.6 Critical disruptions in business processes of FAL:
• Raw material in process being lost or spoilt due to one of the processes being
disrupted due to system, people or process failure, i.e., operational reasons:
o M/s. R & Co., a car manufacturer, ordered 10,000 nos. of Part K which FAL is
not manufacturing. Hence, FAL ordered Part K from one of its trusted
suppliers. During transit, the entire lot of the above part was damaged and in
turn, FAL could not supply the part in a timely manner to M/s. R & Co.
• Contractual financial obligations such as repayment of loans, or vendor payments,
salaries:
o During December 2022 there was a liquidity crunch; it could not pay its main
suppliers that resulted in the stoppage of further consignments by those main
suppliers.
• Payment of taxes:
o During December 2022 there was a liquidity crunch; it could not pay its
statutory dues under various Acts.
Alternative Solution
The critical business disruptions in the case study are as follows:
1. Liquidity crunch due to which FAL could not pay its statutory dues.
2. Liquidity crunch due to which there was stoppage of consignment by its main
supplier with 15 days of receipt by its main supplier.
3. FAL’s regular supplier of raw material to manufacture Part C could not supply the
same due to supply chain delays.
4. Entire lot of Part K ordered from one of its trusted suppliers damaged in transit.

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PAPER – 6A: RISK MANAGEMENT 7

1.7 Composition and functions of the Risk Committee (RC):
Composition of RC

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1. Has a chair who is an independent director and avoids “dual-hatting” with the chair

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of the board, or any other committee.
2.
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Includes members who are independent.
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3. Includes

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1. Discusses all risk strategies on both an aggregated basis and by type of risk.
2. Reviews and approves the firm’s risk policies at least annually.
3. Oversees that management has in place processes to ensure the firm’s adherence
to the approved risk policies.
Alternative Solution

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Composition - Risk Committee shall consist of members of Board of directors.

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Functions: - The BOD shall define the roles and responsibilities of Risk Committee and

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may delegate monitoring and reviewing of risk management plan to the committee and

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such other functions as deemed fit.

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1.8 Practical illustrations that can be considered under the respective additional long -term

(i)
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objectives, as proposed to be included by the MD.
Market Expansion: Explore the possibility of entering emerging markets in Gulf
countries where the demand for automobiles is growing rapidly. To suit the specific
needs of these markets, FAL may consider establishing partnerships with
automobile companies and local distribution networks.
(ii) Product Innovation: There is a growing demand for electric vehicles (EVs) and
hybrid cars. FAL may invest in research and development to create specialized
spare parts for the above vehicles.

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(iii) Cost Efficiency: FAL may set a goal of reducing the production costs by 15% over

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the next 3 years. This may be done by analysing the manufacturing processes,
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identifying inefficiencies, and employing suitable corrections. FAL may also consider

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negotiating better terms with suppliers and explore the prospect of sourcing certain

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components from lower- cost areas without compromising the quality.

ag 1.9 Coefficient of Variation of Project M &N.
First, we shall calculate the Expected Value for Project M & N as follows: -

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8 FINAL EXAMINATION: NOVEMBER, 2023

Project M Project N
Possible Cash Probability Expected Cashflows Probability Expected
Events Flows Value (` 000) Value
(` 000) (` 000) (` 000)
A 15,000 0.16 2,400 32,000 0.18 5,760
B 17,000 0.21 3,570 26,000 0.19 4,940
C 20,000 0.24 4,800 27,000 0.22 5,940
D 21,000 0.25 5,250 31,000 0.26 8,060
E 24,000 0.14 3,360 18,000 0.15 2,700
Expected Net Cash Flow (ENCF) 19,380 27,400

Project M
Variance ( 𝜎2) = (15,000 -19,380)2 x 0.16 + (17,000 -19,380)2 x 0.21 +(20,000 – 19,380)2
x 0.24 + (21,000 – 19,380)2 x 0.25+ (24,000 – 19,380)2 x 0.14 = 79,95,600
SD= 7995600 = 2,827.65
Project N
𝜎2 = (32,000 – 27,400)2 x 0.18 + (26,000 – 27,400)2 x 0.19 +(27,000-27,400) 2 x 0.22 +
(31,000-27,400) 2 x 0.26+ (18,000-27,400)2 x 0.15 = 2,08,40,000
SD = 20840000 = 4,565.09

Project Coefficient of Variance Risk Expected Value
M 2,827.65/19,380=0.1459 Less Less
N 4,565.09/27,400=0.1666 More More
In Project M Risk per Rupee cashflow is approximately 0.15 while in Project N per Rupee
cashflow is approximately 0.17.
Therefore, Project M is better than Project N.
CASE STUDY - 2
Indian Jewellery Export Sector
The Indian Jewellery Export Sector is an important contributor to the nation's economy. With a
heritage rooted in skilled jewellery artisanship, India has risen as a global leader in jewellery
exports. Its prominent position among the world's foremost exporters is largely attributed to
the presence of unique designs and exceptional artisanship.

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PAPER – 6A: RISK MANAGEMENT 9

However, the Indian Jewellery Exporters have realised that (i) they have to constantly change
the designs in order to thrive in the market, (ii) the prices of precious metals, gemstones, and

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other materials used in jewellery manufacturing keep on changing very often (iii) the exchange

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rate fluctuations affect the pricing of the finished products and (iv) they are facing severe

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competition at the international level also.
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SGJ Exports Limited (SGJ)
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Ten years

aoutsourcing some tasks. The artisans are well trained in modern jewellery -making techniques,
Ahmedabad

design, and quality control and their skills are regularly updated through training programmes.
Business Proposals:
(i) A similar gold jewellery export manufacturer offered its entire business to be taken over
by SGJ. The Managing Director (MD) proposes to engage in leveraged buyout of that
company. The Chief Executive Officer (CEO) cautioned the MD that such buyouts

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typically took on large quantities of short-term debt, which would made SGJ vulnerable to

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financial distress in the event of a rise in interest rates. Instead, the CEO suggested to

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buy Interest-Rate Caps (IRC) to reduce the risk of financial distress.

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(ii) SGJ proposes to incorporate significant

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Department of the company is given
a of ` 60 lakhs, expecting a risk-free rate of 8%.
(iii) SGJ proposes to make an investment
Causes of concern:
• Competition from South-East Asian countries caused SGJ to experience a decline of
15% in its customer base compared to last year.
• Twenty-five key employees have left SGJ and joined competitors in the recent past.
• The profit from the customers in the American region was significantly lower compared to

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other regions as customers are very much conscious about the quality and purity of the

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jewellery purchased by them.

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growing challenges and severe competition within foreign exchange

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investors and traders require active tools to effectively choose and analyse

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from the extensively available information to aid in making informed

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organisations must engage in exchange rate forecasting to make
to hedging, short-term financing, brief investments, capital budgeting, earnings
evaluation, and long-term financing. With the afore-mentioned considerations, the MD
asked the Chief Accounts Manager (CAM) to provide a clear explanation of the diverse

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10 FINAL EXAMINATION: NOVEMBER, 2023

techniques used in Exchange Rate Forecasting (ERF) which would facilitate in making
well-informed decisions.
(iv) The auditor, Mr. Arun, during the course of the statutory audit, obtained confirmation of
balances from randomly selected receivables but he concluded that confirming recorded
receivables cannot be relied on to reveal unrecorded receivables.
Proposal to implement Enterprise Risk Management (ERM)
The Risk Manager (RM) suggested to implement ERM by SGJ and explained that ERM
represents a leading methodological approach for capably overseeing and enhancing
business occurrences that carry the potential to influence the corporate goals as well as the
vulnerabilities it might face. Adopting an ERM approach would empower SGJ to gauge the
tolerable levels of uncertainty and take risk within.
RM assured that he would help the Board to address some of the recognized barriers and
resistance points to ERM adoption. He described to the Board that SGJ can start with a simple
process and build from there using incremental steps rather than trying to make a quantum
leap to fully implement a complete ERM process.
Based on the above, you are requested to answer the following questions:
Multiple Choice Questions
Choose the most appropriate answer from the given options.
(2.1) The CEO suggested to the MD to buy IRC. An IRC is characterized by the following,
except:
(A) an interest rate benchmark say LIBOR, MIBOR, PLR etc. for typically some
specified maturity period.
(B) the period of the agreement, including payment dates and interest rate reset dates.
(C) notional interest payments upon which principal amount is based.
(D) a cap rate, which is equivalent to a strike or exercise price of an option.
(2.2) The conclusion of Mr. Arun is a :
(A) Sampling risk.
(B) Non-sampling risk.
(C) Balance risk.
(D) Control risk.

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PAPER – 6A: RISK MANAGEMENT 11

(2.3) SGJ's strategic business functions relate to the achievement of long-term strategic
objectives of the entity. They can be chiefly affected by the following except :

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(A) availability of capital.

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(B) abuse of intellectual property.

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(D)selegal and regulatory changes. l
(C) country and political risks.

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a(2.4)g The task given to the IT Department most likely would result in which of the following?
(A) change the risk associated with internal control.
(B) result in changes in supervision.
(C) affect risks in preparing financial statements.
(D) result in changes in competitive pressures.
(2.5) Which of the following is most likely to be achieved in the description of RM to the

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Board?

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(A) Start organisation's ERM effort without any specific enabling technology o r

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automated tools.

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(B) Existing functions such as internal audit, compliance, ethics, and other support
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function could be leveraged to build on the ERM blocks and activities.
(C) ERM practices, processes and information continue to evolve.
(D) Identify and implement key practices to achieve immediate, tangible results.
(2 x 5 = 10 Marks)
Descriptive Questions
(2.6) You are required to calculate the net present value of the proposal of investment under

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Certainty Equivalent Technique, given the following information:

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Year Expected Cash Flow (in `) Certainty Equivalent Coefficient

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1 16,00,000

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2 19,00,000 0.85

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3 24,00,000 0.94
4 28,00,000 0.86
Write the formula and show your workings. (3 Marks)

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12 FINAL EXAMINATION: NOVEMBER, 2023

(2.7) Explain the business performance indicators that could reveal the associated risk profile
of SGJ. (3 Marks)
(2.8) What would be the Chief Accounts Manager's response to the MD regarding ERF?
(4 Marks)
(2.9) Based on the Case Study, what are the key challenges faced by Indian jewellery
exporters in general and specific key challenges faced by SGJ? Provide your reasoned
answer. (5 Marks)
Answer
Multiple Choice Questions
2.1 (C)
2.2 (B)
2.3 (B)
2.4 (A)
2.5 (D)
Descriptive Questions
2.6 NPV is calculated as follows:
NPV =
Where,
αt = Risk-adjustment factor or the certainly equivalent coefficient
NCFt = Forecasts of net cash flow for year ‘t’ without risk-adjustment
k = Risk free rate assumed to be constant for all periods
I = Initial Investment
1600000  0.83 1900000  0.85 2400000  0.94 2800000  0.86
NPV = + + + - 60,00,000
(1.08) (1.08)2 (1.08)3 (1.08)4

= ` 12,29,630 + ` 13,84,602 + ` 17,90,886 + ` 17,69,952 – ` 60,00,000
= ` 61,75,070 – ` 60,00,000
= ` 1,75,070

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PAPER – 6A: RISK MANAGEMENT 13

2.7 Business Performance indicators that could reveal the associated risk profile of SGJ are
as follows:

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(1) % of Customer attrition

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o Competition from Southeast Asian countries caused SGJ to experience a

(2) %m
decline of 15% in its customer base in comparison to last year.
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Twenty-five Key employees have left SGJ and joined competitors in the recentag
turnover

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(3) Profitability of customer by regional segments
o The profit from customer in American region was significantly lower compared
to other regions as customers are very much conscious about the quality and
purity of Jewellery purchased by them.
2.8 There are numerous methods available for forecasting exchange rates. They can be
categorized into four general groups- technical, fundamental, market-based and mixed.

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(a) Technical Forecasting: It involves the use of historical data to predict future values.
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For example, time series models. Speculators may find the models useful for

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predicting day-to-day movements. However, since the models typically focus on the

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near future and rarely provide point or range estimates, they are of limited use to
MNCs.
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(b) Fundamental Forecasting: It is based on the fundamental relationships between
economic variables and exchange rates. For example, subjective assessments,
quantitative measurements based on regression models and sensitivity analyses.
In general, fundamental forecasting is limited by:
• the uncertain timing of the impact of the factors,

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• the need to forecast factors that have an immediate impact on exchange rates,

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• the omission of factors that are not easily quantifiable and

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• changes in the sensitivity of currency movements to each factor

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a will ensure that the
(c) Market-Based Forecasting: It uses market indicators to develop

ag current spot/forward rates are often used, since speculators
current rates reflect the market expectation of the future exchange rate.
(d) Mixed Forecasting: It refers to the use of a combination of forecasting techniques.
The actual forecast is a weighted average of the various forecasts developed.

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14 FINAL EXAMINATION: NOVEMBER, 2023

2.9 Key challenges faced by jewellery manufacturing and exporting trade in the country:
1. Market Volatility
The volatility in prices of precious metals, gemstones, and other materials used in
jewellery manufacturing can significantly impact production costs, pricing strategies,
and profit margins for exporters.
2. Exchange Rate Fluctuations
As jewellery is exported to various international markets, exchange rate fluctuations
can substantially affect the Indian jewellery export trade. Unexpected currency
movements can affect pricing and overall profitability.
3. Competition
The global jewellery market is characterised by intense competition, with various
countries engaged in jewellery production and exports. Indian exporters also face
stiff competition from other major players in the industry in the country. Competition
can affect pricing and overall profitability.
4. Have to constantly change the design in order to thrive in the market.
Specific Key Challenges faced by SGJ
1. Retaining trained jewellery making artisan
Availability and retaining of skilled artisans are a matter of concern for the company
as it is incurring heavy expenditure on training of artisans but not able to make us e
of that expenditure. New appointments require higher expenditure on training and
monitoring.
2. Quality and Purity Concerns
Ensuring consistent quality and purity standards is imperative for jewellery exports.
Any lapses in maintain quality control or purity may damage the reputation of Indian
Jewellery and could lead to legal and regulatory issues in the destination markets.
3. Competition from Southeast Asian countries
4. 25 Employees left SGJ and joined competitors.
5. American Region customers are more concerned about quality and purity of the
Jewellery purchased by them.
6. Foreign Exchange Market.

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PAPER – 6A: RISK MANAGEMENT 15

Alternative Solution
Key challenges faced by Indian jewellery exporters:

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(i) have to constantly change the design in order to thrive in the market.

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(ii) the prices of precious metals, gemstones and other material used in jewellery

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industry keep on changing very often.
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(iii) the exchange rate fluctuations affect the pricing of the finished products and
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Specific key challenges faced by SGJ.
(i) Competition from South East Asian countries
(ii) 25 Employees left SGJ and joined competitors.
(iii) Foreign Exchange Market.
(iv) American Region customers are more concerned about quality and purity of the

m
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CASE STUDY - 3
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About the Company
s em
g l a
a
SSS Limited (the company) is an MNC Company, engaged in the manufacture of fertilisers.
The Company has been carrying out business for over five decades in India, Sri Lanka and
South East Asian Countries. In India, this is one of the largest private sector company having
fertiliser manufacturing units across three states and four divisional marketing offices, and
more than 300 stock points across South India. The present turnover of the company is more
than ` 10,000 Crores.
Since 90% of the raw materials are imported, the manufacturing units are set up next to major
ports. Cyclones & storms are inherent risks and the unit is geared with emergency response

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plans. Also, since the production process involves in handling hazardous materials, the

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workmen are adequately trained and wearing of safety gear is made mandatory to all workmen

c. o Fertiliser sector in India is a regulated sector. The Central Government m
who are engaged in the production activities.

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e a ban on chemical
the

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distributional priorities and mandates all the Companies to prioritise dispatch to designated

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states, where there is a shortage of fertilisers. However, due to
a
complete

a fertilisers in Sri Lanka, the sale of chemical fertiliser was affected four years ba ck and the
Company had to launch organic fertilisers in Sri Lanka. Due to cost considerations, the off -
take of organic fertilisers was not encouraging in Sri Lanka.

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16 FINAL EXAMINATION: NOVEMBER, 2023

Exports to other South East Asian Countries mainly comprised on Speciality Nutrients and
such sales constitute 10% of the overall sales volume.
Corporate Governance
The Company's Board comprised of elite professionals from different sectors, who provide
value added guidance to the Senior Management team. The Board has an Audit Committee &
Risk Management Committee under the chairmanship of independent directors. They are
experts in the fields of finance, audit and risk management. The Internal Audit and Risk
Management functions of the Company reports to these Committees which have an oversight
over the internal controls and risk management processes respectively.
It is also ensured that the risk management is integrated with operations covering procurement
of the raw materials, production activities, marketing & collections, Corporate Governance etc.
Various digital tools and dash boards are in place for monitoring controls and risks.
The Risk Management Committee adopts various quantitative techniques to classify the risks
and ensures adequate mitigation steps are in place to respond to critical and high risks.
During the course of Risk Management Committee meeting recently there was a discussion
with regard to impact on sales in Sri Lanka, due to government regulations and country related
risks.
Important concerns highlighted
1. Major raw materials are sourced through imports. Due to prevailing political conditions in
some of the countries and continued Russia-Ukraine war, the prices of raw materials
have significantly increased, and sourcing of the same is affected. The Company hedges
only fifty percent of the imports and considered the same adequate to mitigate the risks
of foreign currency fluctuations.
2. During the year, there was an anonymous whistleblower complaint, who raised certain
bribery matters against the commercial manager. A detailed investigation was carried out
by the Internal Audit Team which concluded with identification of a fraud in the
commercial department due to certain gaps in internal controls. Two of the executives
were taking bribes from the domestic vendors, for placing raw material supply orders.
Based on the investigation report, the Board of Directors, have decided to further
strengthen the existing manual controls by making it to automated controls and advised
the Chief Risk Officer (CRO) and the IT Head to implement the same.
3. During the current year, due to erratic climatic conditions, the Company was not able to
sell the budgeted volumes of fertilisers and there was piling of inventory at the stock
points. Also, the receivables were piling up as the dealers and the large famers were not
able to meet the payment obligations. The Company was planning to levy interest
charges on the overdue. Due to huge pile up of stocks and outstanding, there was a

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stress on working capital management, due to which the Company was not able to meet
payment due dates for the import suppliers.

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Business expansion by the Company

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1. The Company is planning to launch Organic Fertilisers in India.

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2. During the year, the company acquired RST Pvt. Ltd. (RST), an entity which deals in the

s e
sale of agri-based implements. The Board saw this as a very good opportunity,
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considering the usage of this equipment in Agri sector in India. Due diligence was carried
out of RST and the Board of Directors had approved the acquisition of 100% stake in
RST for a value of ` 150 Crores. The Chief Financial Officer (CFO), had evaluated two
options for funding the acquisition of RST:
Option I - Fund the acquisition fully through internal accruals.
Option II - Fund the acquisition 50% through internal accruals and 50% with Long term
borrowings at 9% interest rate.
The Profit before Depreciation, Interest & Tax (PBDIT) for the five years has been
estimated as given in the table below:

o m
c 30 35
Year 1 2 4 3 5
.
emthe Company acquired 100% in RST and took
PBDIT ` crores 15 20 25

s
la that RST had no documented internal financial
3. Pursuant to the approval of the Board,

controls or risk managementag
control of the operations. It was observed
framework. The Board has mandated the Internal Audit
team and the Risk Management team to set up controls and extend the risk management
framework to RST.
4. Considering that the Company has no exposure to the agri-implements sector, the Board
has requested the CRO to evaluate and suggest inherent risks related to this sector. An
external firm was engaged by the CRO to carry out the study and report on the inherent
risks.

m
Based on the above, you are requested to answer the following questions:

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Multiple Choice Questions
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. co (3.1) (i)
Choose the most appropriate answer from the given options.
s e m
s em is the level of risk assuming no internal controls,
g l
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acontrols.
gla (ii) is the level of risk after considering the impact of
a
internal

a (A) (i) Operational Risk (ii) Residual Risk.
(B) (i) Inherent Risk (ii) Residual Risk.
(C) (i) Operational Risk & (ii) Inherent Risk

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18 FINAL EXAMINATION: NOVEMBER, 2023

(D) (i) Inherent Risk & (ii) Control Risk.
(3.2) A report issued with respect to internal controls and fraud investigation carried out in the
organisation and the assurance on these risks being managed within the acceptable
limits as laid down for the review of the Committees of the Board of Directors is:
(A) Risk report issued by the CRO.
(B) Compliance report issued by the Compliance officer.
(C) Internal audit report issued by the Management auditor
(D) Statutory audit report issued by the statutory auditor.
(3.3) Organisations carry out various periodic reviews of associated risks. The test step which
is tagged to each of the internal controls and the management audit function performs
that test. This exercise is denoted as:
(A) Risk evaluation
(B) Risk and Control Self-Assessment
(C) Risk Validation
(D) Risk Appetite Assessment
(3.4) Certain aspects within the organisation indicates the levels of Risk maturity, which
includes Risk appetite is well defined and communicated across the organisation, control
environment is strong etc. The two levels which indicates the Risk Maturity having the
following characteristics:
(i) Risk strategy in place and risks identified within functions and yet to be
communicated across the organisation.
(ii) Enterprise wide approach to risk management developed and functional risks
communicated across the organisation.
(A) Risk Naïve & Risk Enabled
(B) Risk Aware & Risk Enabled
(C) Risk Aware & Risk Managed
(D) Risk Defined & Risk Managed
(3.5) A monitoring tool to track the progress of risk management using qualitative assessment
of probability and impact of risk :
(A) Risk Event map
(B) Flow Charts and risk maps
(C) Risk Score cards
(D) Risk Heat maps
(2 x 5 = 10 Marks)

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PAPER – 6A: RISK MANAGEMENT 19

Descriptive Questions
(3.6) Elaborate the qualitative Risk assessment process undertaken in the manufacturing

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setup, and map few risks discussed in the case study to the risk matrix designed under

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qualitative risk assessment. (5 Marks)

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(3.7) Enumerate the types of Country risks which should have been considered by the

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Company with reference to Sri Lanka. What variables should be considered to identify

a the net cash flows from the project for the two options available to the CFO,a
(3.8)lCompute
these risks? (5 Marks)
g
g
a considering the Risk premium is expected to be 5% and the applicable tax rate at 35%.
Which option would you suggest to the CFO? (3 Marks)
(a) Which option would you suggest to the CFO to be beneficial from the cash flow
point of view, in case where there is a cash surplus of 200 crores with the company
and the company is getting only 5% interest income from depositing the same with
the bank. If the immediate cash surplus with the company stands at 80 Crores,
which option would the CFO proceed?

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(b) Also discuss the advantages and the limitations of the risk adjusted discount rate.

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0.8417 . 0.7722
Discounting Factors

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s 0.675 0.5718
9% 0.9174 0.7084 0.4972

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14% 0.8772 0.7695 0.4972
(2 Marks)
Answer
Multiple Choice Questions
3.1 (B)
3.2 (C)
3.3 (B)

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3.4 (C)

m 3.5 (D) .
c. o Descriptive Questions se
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s em 3.6 Qualitative Risk Assessment Process: Risk assessment g
a
is lthe determination of
gla quantitative or qualitative estimate of risk consequence relatedato a scenario or situation
a and an identified threat or hazard.

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20 FINAL EXAMINATION: NOVEMBER, 2023

Under the Qualitative Analysis, all the identified risks are plotted on a matrix. Each risk
item is given a position on the matrix chart. The probability of the risk occurring can be
plotted on the horizontal bar, while the impact of the risk can be noted along the vertical
bar of the axis. The probability-impact value of a risk is a product of both the values
assigned for the risk. Hence, a risk with a value of 9, where the probability and impact
rate the highest, requires immediate attention – Grid III. Those with a low rating of 1 or 2
require the least attention and may even be ignored, if insignificant - Grid VII.
The Following can be risk matrix:

Mapping Risks with Risk Matrix:
Handling of Hazardous material in a Manufacturing process Grid 3
Critical machinery failure affecting production Grid 2
Cyclones & storms Grid 6
A workman met with an accident, due to not wearing safety gear Grid 9
3.7 Following major types of Country Risks can be considered by the Company:
(A) Political Risk: This risk mainly arises out of the changes in the political scenarios
as well as adverse decisions by the ruling Government. The various types of
political risk which ultimately affect the profit of the MNCs from the operations in the
host country can be described as follows:
(i) Nationalisation or Expropriation Risk: This is the most common form of risk
wherein the host country takes over the business of MNCs without or with
inadequate compensation.

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PAPER – 6A: RISK MANAGEMENT 21

(ii) Exchange Control Risk: This form of risk prevents the MNCs to get converted
their earning from local currency to foreign currency to repatriate the same to

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home country of MNCs. Due to this restrictions even investors in MNCs

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business also suffer a lot.

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(iii) Taxes, Rule and Regulation Risk: This risk arises mainly due to a sudden or
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s
dramatic change in Rule and Regulations governing the host country. These

l a • Unanticipated increase tax rates applicable for MNCs operating in thea
sudden changes can be in any of following type of forms:
g
ag host country.
• Compulsion to hire local workforce.
• Compliances of stricter environmental standards.
(iv) Inefficient Legal System: High level of red tapism and corruption at local and
higher level pose a serious risk for MNCs operating in the host country as it
leads to uncertainty and high cost of operation.

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(v) Repudiation of Contracts: This type of risk arises on account revocation of

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earlier awarded turnkey projects by the Government of host country without

s
adequate consideration and damages. This risk is also called indirect

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expropriation risk.
(B) Financial and Economicg
a
a Risk
The main risk covered in this category is the Sovereign Risk i.e. default in
repayment of borrowing by the Government of host country.
Although Government of host country can easily repay the loan by printing more
currency notes, but it will depreciate value of its currency. The sovereign risk
hampers the reputation of the country severely from investment point of view, but it
saves a lot of foreign exchange of the Government.

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To identify such types of risk well in advance following economic variables can be

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used:

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 Ratio of country’s Import to its Official Reserve

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 Ratio of Import to its Export

ag  Balance of Payment Surplus/ Deficit on current account.
 Country’s Debt Service Ratio
 Country’s external debt to its GDP.

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22 FINAL EXAMINATION: NOVEMBER, 2023

3.8 (a) Option I
Year PBIT Interest Taxable Tax PAT PVF PV of CF
Profit
1 15.00 0 15.00 5.25 9.75 0.8772 8.553
2 20.00 0 20.00 7.00 13.00 0.7695 10.004
3 25.00 0 25.00 8.75 16.25 0.6750 10.969
4 30.00 0 30.00 10.50 19.50 0.5718 11.150
5 35.00 0 35.00 12.25 22.75 0.4972 11.311
Total 51.987
Cash Outflow 150.000
Net Cash Outflow 98.013
Option II (Interest on `75 Crores at 9% p.a. = `6.75 Crores p.a.)
Year PBIT Interest Taxable Tax PAT PVF PV of
Profit CF
1 15.00 6.75 8.25 2.8875 5.3625 0.8772 4.704
2 20.00 6.75 13.25 4.64 8.6125 0.7695 6.627
3 25.00 6.75 18.25 6.3875 11.8625 0.6750 8.007
4 30.00 6.75 23.25 8.14 15.1125 0.5718 8.641
5 35.00 6.75 28.25 9.8875 18.3625 0.4972 9.130
Total 37.109
Cash Outflow 75.000
Net Cash Outflow 37.891
Based on the computation, if there is an investible cash surplus of ` 200 Crores,
CFO should fund the acquisition through internal funding, since the incremental
benefit is higher by investing in the acquisition instead of depositing in the bank at a
return of 5%. The net cash outflow after five years would be ` 98.01 Crores. If there
is no immediate cash surplus, CFO would be advised to go for option II, wherein the
net cash outflows in the five years is only ` 37.89 Crores.
(b) Advantages of Risk-adjusted discount rate:
(1) It is easy to understand.
(2) It incorporates risk premium in the discounting factor.
Limitations of Risk-adjusted discount rate:
(1) Difficulty in finding risk premium and risk-adjusted discount rate.

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PAPER – 6A: RISK MANAGEMENT 23

(2) Though NPV can be calculated but it is not possible to calculate Standard
Deviation of a given project.

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CASE STUDY - 4

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About the Company

m . s e
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Founded in the year 1976, M/s. ECOFEN is a joint venture company (hereinafter referred as

a s
'the company') between the Indian ECO Group and Malaysia based FEN Group. The

l a g
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Company is one of the few FMCG companies which manufactures and markets household

aTheir
equipment, essential kitchen commodities and plethora of grocery products.
packaged food brands are top brands in South East Asia and are registered in many
countries. The company operates through eighteen plants across India and several south
Asian countries.
Control features established by the Company
1. The Company has a strong team to monitor internal financial controls and has
established enterprise risk management framework across all the processes and

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functions except for Research & Development.
2.
.
The Finance & Accounting functions plays a critical role in the organisations, managing

s em
the treasury risks across the countries and accounting for the hedge transactions. Since,

l a
the company operates in multiple countries; the Corporate Finance team has dev eloped

ag
a dash board to monitor the pricing movements of each foreign currency and looking for
arbitrage opportunities. They have benchmarked Indian Rupee & US Dollar as to two
currencies, with other country currencies and repatriated the surplus funds, whe never the
prices are favourable and ensured that the company accrues forex gains.
3. The Company invests heavily in the Research & Development activities, and has Centre
of Excellence (COEs) in five countries including India. The COES continues to study th e
market demand, consumer preferences, environment and sustainable products. There is
a proposal to invest `100 Crores on the R & D centres which will carry out scientific
research on evolution of human needs over next twenty years and come up with

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innovative products and services.

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4. In order to improve operational efficiencies, the Board of Directors advised the

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management, to establish a Steering Committee to evaluate the areas of cost reduction

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and identify efficiency improvement projects, besides prioritizing retention of employees.

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The Committee comprised of Operations Head, Chief Financial Officer, Chief Risk

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Officer, Human Resources Head, R & D Head & Marketing Head.
a
a Observations and suggestions by the Steering Committee
1. The Committee observed that the R & D centres are facing multiple issues like:

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24 FINAL EXAMINATION: NOVEMBER, 2023

• Lack of skilled personnel: Availability of talented resource is a serious concern.
Retention of talents is equally a concern. Due to family constraints and lucrative
salary offered in the market, retention of talented resources proves to be a bottle
neck in running R & D centres. The HR team could not fill up all the vacancies and
there is high level of attrition in the last five years.
• IPR Compliances: Intellectual property registration are in the form of patent right,
copy rights trademarks and trade secrets. Due to global presence, the Company is
finding difficult to comply with the local IPR laws of the respective countries. This
has led of leakage of revenue due to similar design packages was used by the
unorganized players. This has also had a reputational risk due to the inferior quality
of products being sold by the infiltrator.
• Long duration of Technology projects: It is imperative that R & D projects generally
consume a considerable time to study the changing market dynamics. The
Company has targeted for 45 different projects to be completed over three cycle,
however were able to complete only 15 projects, and the three year cycle is almost
getting completed.
• Information Breaches/leakages: Securing R & D data is critical. In spite of having
the state of art technology and controls, there has been data compromise in the
recent days, which impacts the development projects. The Company has also spent
on Ransomware breaches of about ` 250 Crores after which the importance of
technology and the gaps in their IT systems were understood.
2. The Committee after multiple rounds of discussions and data analysis has come up with
various suggestions which are listed below:
(a) Outsourcing the R & D Surveys to external agencies at fixed rate contracts.
(b) Modernisation of lab equipment, which would enhance quality of product analysis.
(c) Upgrade the existing IT systems, to ensure on-line monitoring of all projects initiated
by R & D Team and have adequate data protection protocols.
(d) Establish Risk Management Framework to the R & D function and ensure it is
integrated with other functions in the organisation.
Steps taken by the company on the suggestions made by the Steering Committee:
1. The Committee wanted to assess the risk maturity levels in the organization and the level
of integration of risk management with operational performance. An external firm was
appointed, to study the existing risk management practices, assess the gaps compared
to industry best practices and also advise on settling for risk framework to the R & D
Centres of Excellence.
The external firm carried out a risk maturity exercise and applied various techniques to
identify whether all related risks have been covered and adequately mitigated. They have

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PAPER – 6A: RISK MANAGEMENT 25

also carried out an independent assessment of the Governance Framework and
submitted their report after a detailed study.

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They have identified that the company has a qualitative and quantitative risk assessment

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process, based on which all risks are classified in High, Medium and Low. A step by step

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process for implementation of Enterprise Risk Management to R & D Centres was

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covered in the report, including the bottlenecks for its implementation. The report also

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included suggestions for enhancing the effectiveness of risk management across the

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functions & geographies.
Chief Risk officer advised his team of risk managers in various countries to monitor
the geo-political changes, climatic conditions, consumer preferences, regularly which
forms the basis to mitigate R & D Risks.
3. The Management has engaged third party professional firms, to carry out various
consumer preference surveys and to provide HR support respectively. The marketing
team and the R & D team would consider the survey findings. The marketing team
understands the needs of the consumers and place the products from the existing
portfolio basket. R & D team picks up the futuristic preference into their product

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development process.

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The actions taken by the Management, based on the recommendations by the Ste ering

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Committee is yielding positive results.
Multiple Choice Questions
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Choose the most appropriate answer from the given options.
(4.1) The risks which arises due to changes in the economy like fluctuations in price levels,
consumer references, distribution of income, product development, shifts in technology,
etc. They are less predictable and not insurable. Such risks can be classified as
(A) Control Risks.
(B) Technology Risks
(C) Dynamic Risks

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(D) Strategic Risks

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(4.2) Standard Operating Procedures is a set of
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(A) documents laying down controls to be instituted

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(B) document that guides the operations of the organization

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(C) procedures listing dos and don'ts a
a (D) documents laying down policies and procedures to be followed in the operati ons of
Centres of Excellence

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26 FINAL EXAMINATION: NOVEMBER, 2023

(4.3) The Delphi technique is a method which involves getting opinion on a process.
(A) From an individual
(B) From a group of individuals
(C) From regulator
(D) From whistleblower
(4.4) Risk enabled organisations use to identify potential events that can have a
significant impact on business to avoid negative surprises and to monitor the
process of risk management. Choose the appropriate to fill in the blanks.
(A) Risk Event Maps; Risk Scorecards
(B) Risk Heat Maps; Risk Scorecards
(C) Flow Charts; Risk Event Maps
(D) Risk Scorecards; Risk flags
(4.5) The theory that states the forward rate of one currency will contain a premium that is
determined by the differential in the interest rates between the two countries and as a
result covered interest arbitrage will provide a return that is no higher than a domestic
return, is known as
(A) Purchasing Power Parity
(B) International Fisher Effect
(C) Interest Rate Parity
(D) Netting (2 x 5 = 10 Marks)
Descriptive Questions
(4.6) The Company have established the Enterprise Risk Management process to the R & D
function and risk management was adopted across all the Centres of Excellence. Having
implement ERM, how in your view would help the organisation. (5 Marks)
(4.7) If you were part of the external firm who has carried out the assessment of the Risk
Governance framework, how would be carry out the assessment? (5 Marks)
(4.8) The Company is having business operations in multiple countries and transactions are
carried out in respective country currencies. The Corporate Finance team adopt
strategy/strategies to management currency risks. Can there be a single strategy
possible to manage the foreign exchange rate risk? (5 Marks)

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PAPER – 6A: RISK MANAGEMENT 27

Answer
Multiple Choice Questions

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4.1 (C)
4.2 (B)
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4.4 (A)se
4.3 (B)
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4.5 l(C) a g
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aDescriptive Questions
4.6 ERM can help organizations:
1. Identify strategic risk opportunities that, if undertaken, can facilitate achieving
organizational goals.
2. Introduce a common language within the organization where people recognize
problems and adopt a problem-solving approach by developing risk treatment

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actions.

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3. Provide senior management with the most up-to-date information regarding risk that

s
may be used in the decision-making process.

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4. Establish linkage between the ERM initiative and adherence to capital market
reporting disclosures and other corporate laws and regulations.
5. Align annual performance goals with risk identification and management.
6. Encourage and reward upstream reporting of business-risk opportunities and
challenges.
7. Align other risk monitoring initiatives such as self-appraisals, internal auditing
activities, control assessments, continuous control monitoring, to organizational
objectives.

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8. Imagining key Risk Scenarios that could potentially result in a stress on the financial

c. o m
e the financial
position of the company.

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9. Financial Risk monitoring, a part of the ERM initiative can balance

las stability equation of the company.
g
a and organisational
ag 4.7 A Risk Management Framework (RMF) sets the foundations
arrangements for designing, implementing, monitoring, reviewing and continually
improving risk management capability. Undertaking a periodic review to assess the
effectiveness of an entity’s risk management framework is necessary to ensure that the

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28 FINAL EXAMINATION: NOVEMBER, 2023

framework continues to evolve and meet the needs of the entity. The RMF should define
a policy statement on the following matters:
(i) Determining when to review the RMF and the frequency for undertaking the review.
(ii) Deciding who is responsible for the review. The RMF is generally reviewed by the
Audit Committee or a team of Directors. Once in few years the RMF can be
reviewed with external facilitation, and this would provide fresh insights and
benchmarking information to the Board.
(iii) Selecting the scope and method for a review. The scope and boundary of the RMF
review can be clearly set out along with the most suited method for review.
(iv) Manner of circulation of results.
The Board requires a periodic independent assessment of the firm’s overall risk
governance framework and provides direct oversight to the process.
The Board should assess whether the organisation has the required stature, talent, and
character needed to provide a reliable independent assessment of the firm’s risk
governance framework and internal controls and not be unduly influenced by the CEO
and other members of management.
Organisations may develop an entity level control framework on the basis of the Sound
Risk Governance Principles prescribed by the Financial Stability Board for evaluating
Governance Risks. The results and findings from the said entity level control assessment
may be submitted to the Board of the company on an annual basis and suitabl y disclosed
as part of its risk disclosures.
4.8 There can be no single strategy which is appropriate to all businesses.
Four separate strategy options are feasible for exposure management.
(1) Low Risk: Low Reward
This option involves automatic hedging of exposures in the forward market as soon
as they arise, irrespective of the attractiveness or otherwise of the forward rate. The
merits of this approach are that yields and costs of the transaction are known and
there is little risk of cash flow destabilization. Again, this option doesn't require any
investment of management time or effort. The negative side is that automatic
hedging at whatever rates are available is hardly likely to result into optimum costs.
At least some management seems to prefer this strategy on the grounds that an
active management of exposures is not really their business. In the floating rate era,
currencies outside their home countries, in terms of their exchange rate, have
assumed the characteristics of commodities. And business whose costs depend
significantly on commodity prices can hardly afford not to take views on the price of
the commodity. Hence this does not seem to be an optimum strategy.

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PAPER – 6A: RISK MANAGEMENT 29

(2) Low Risk: Reasonable Reward
This strategy requires selective hedging of exposures whenever forward rates are

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attractive but keeping exposures open whenever they are not. Successful pursuit of

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this strategy requires quantification of expectations about the future and the

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rewards would depend upon the accuracy of the prediction. This option is similar to

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an investment strategy of a combination of bonds and equities with the proportion of

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the two components depending on the attractiveness of prices. In foreign exchange

l a a
ag (3) High Risk: Low Reward
exposure terms, hedged positions are similar to bonds (known costs or yields) and
unhedged ones to equities (uncertain returns).

Perhaps the worst strategy is to leave all exposures unhedged. The risk of
destabilization of cash flows is very high. The merit is zero investment of managerial
time or effort.
(4) High Risk: High Reward
This strategy involves active trading in the currency market through continuous

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cancellations and re-bookings of forward contracts. With exchange controls relaxed

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in India in recent times, a few of the larger companies are adopting this strategy. In

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effect, this requires the trading function to become a profit centre. This strategy, if it

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has to be adopted, should be done in full consciousness of the risks.

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CASE STUDY - 5
About the Company and its New product
HealthHi Pvt Ltd (HHPL) is a Bangalore-based medical-grade equipment manufacturing
company. Dr Gaurav, one of the promoters of the Company, is a renowned ENT doctor. He
has developed 17 patents. Over five years, he has developed three medical equipment based
on his patented technology. The one product that is used for scanning by ENT doctors is
getting good acceptance in the market. The ease of operation of the equipment is the reason
why both doctors, as well as retail customers, are interested in the equipment. The product is

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linked with a centralized platform that uses Al and this helps patients in knowing about the

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status of the disease in no time. A team of doctors then remotely confirms the assessment of

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the Al which is followed by the prescription of the medicine. The same process is adopted for

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the review.
s e improving the
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machine learning so that more accurate and timely identification of thegdisease is done based
a
The Company has created a team of engineers who are working on further

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30 FINAL EXAMINATION: NOVEMBER, 2023

Fresh Investment into the company and its temporary deployment
1. After seeing the initial success of ENT scanning equipment which is very effective and is
available at a very affordable cost, a venture capital firm SKUCap has made an
investment of USD 2 million. The money received by SKUCap is temporarily parked in
certificates of deposits, mutual funds, and bank deposits.
Although the Board is concerned with this action, the Chief Finance Officer (CFO) has
assured the Board that liquidity risk and market risks arising out of the temporary
investment would be managed well. A Board member who does not have a background
in finance wants to understand liquidity risk so that a similar agenda note put up before
the Board can be examined in detail. The CFO has agreed to provide a short note on the
same.
2. Mr David, one of the friends of Dr Gaurav, also wants to make some investment in the
company but he wants to understand the role of machine learning in the medical world.
The task of explaining the functioning of machine learning has been assigned to one of
the team members, working on the machine learning and Al project.
3. The Company is also expecting another fresh investment INR 20 million investment in 5
months' time. The CFO wants to place it on a deposit for four months (120 days) before it
is utilized in the business. The CFO has got quotes for the Forward Rate Agreement
(FRA) from PTC Bank and the day count convention is actual /360-
0 x 5 : 10.09-14
0 × 4 : 10.07-12
5 x 9 : 10.30-35
Corporate Governance and Risk Mitigation
To satisfy the corporate governance requirements of the investor, the Board adopts an active
role in reviewing the Company's policies on risk oversight and management.
The Board oversees developing the Company's risk appetite, defining the risk framework, and
making sure that risk controls are included in management's operational strategy. The Audit
Committee oversees evaluating the efficacy of the existing risk management systems and
conducting an impartial examination of the risk mitigation strategies created for significant
risks. The Risk Committee meets on a monthly basis to perform a thorough evaluation of the
risk register and to make sure that management is doing an effective job of identifying and
managing risks when they come up.
Concerns expressed by the Board
1. While the Board believed the company's approach to risk management was generally
satisfactory, previous audits were regarded as superficial and had not provided it with the
degree of assurance it required.

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PAPER – 6A: RISK MANAGEMENT 31

2. The Board is not happy with the way the risk register is maintained and has directed for
an independent review of the risk register.

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3. The Board also wants a robust written risk management policy that should in detail cover

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the risk responsibilities of all the players starting from the Board.

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Action taken by the Board

s emof the expert
1. As a leading
current risk framework, strategy, and process for managing risk and to gl
in this field, Mr Lal was commissioned to conduct an independent

g a these to best practices.
lcompare
review
a
a2. The Board further requested Mr Lal for a professional opinion on the current situation of
data management and advice on any further steps that should be taken now to enhance
and improve the foundations for risk management.
Fund requirements of the company
1. Considering the growth prospect of the Company, it also has a plan to raise a loan from a
bank that has agreed to lend an unsecured loan of INR 20 million subject to a review of
the credit risk. The management wants you to help it in understanding credit risk-related

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factors that typically a bank considers.

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2. Dr Gaurav believes that HHPL should invest a substantial amount in developing a

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medical product that can ease the process of kidney dialysis. However, the Board

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believes the fund should not be diverted for the new unknown product at this stage

ag
despite the bigger opportunities as it will derail in positioning of the existing product.
Issues relating to Personal Investment by the Promoter
Dr Gaurav along with his wife controls a Company named CorpFin which deals in derivatives
and investments in equity and bond markets. There are certain matters, relating to operational
decisions made by the Investment Division of CorpFin, have come to the notice of Dr Gaurav.
He wants to take your opinion on to the following matters to ensure that investment decisions
are made based on sound principles, policies, and practices:-

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1. CorpFin made a substantial investment two years back in an unlisted company nam ed

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PPL. The performance of PPL has not been on the expected line. Last year PPL had a

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bad year and its return on assets fell from plus 10% to minus 25%. It has networking
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capital assets equal to 35% of total assets and the market value of its equity is 20% of its

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total debt. Last year's losses wiped out its retained earnings and PPL. turned over its

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2. CorpFin is exploring dealing in Credit Default Swaps (CDS).aA strong case has been
assets 1.90 times last year.

ag made by the chief of treasury, as there are opportunities to make more money by
investing in risky debt along with CDS.

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32 FINAL EXAMINATION: NOVEMBER, 2023

Multiple Choice Questions
Choose the most appropriate answer from the given options
(5.1) Which of the following combinations of factors typically represent credit risk?
(A) Default Risk and Loss Risk
(B) Loss Risk and Exposure Risk
(C) Exposure Risk and Default Risk
(D) Default Risk, Loss Risk, and Exposure Risk
(5.2) Which of the following is correct regarding the liquidity risk of the investment made by
HHPL?
(A) It is the systematic risk of the investment
(B) It is the unsystematic risk of the investment
(C) It is the total systematic and unsystematic risk of the investment
(D) It indicates the ease of exit from an investment
(5.3) Mr David wants to understand the process of machine learning, the type of algorithm that
is generally used in machine learning, and its effectiveness in the medical field. Which of
the following combinations is not correct regarding learning mode, problem, and
algorithm related to machine learning?
Learning Mode Problem Algorithm
(A) Supervised learning Classification Logistic Regression
(B) Unsupervised learning Regression Linear Regression
(C) Unsupervised learning Clustering K- means
(D) Supervised learning Classification Deep learning

(5.4) Which of the following is incorrect with respect to opportunity risk?
(A) It is the kind of risk that has the potential to improve the accomplishment of the
organization's mission.
(B) It is a risk connected to seizing business opportunities.
(C) Opportunity risks are typically linked to the development of new or modified
strategies.
(D) Opportunity risks are avoided using exchange-traded derivatives
(5.5) Which one of the following is incorrect with respect to the responsibility of Risk
Identification and Management?
(A) The Board

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PAPER – 6A: RISK MANAGEMENT 33

(B) The Chief Risk Officer
(C) The Audit Committee

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(D) Auditor (2 x 5 = 10 Marks)

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(5.6) Assuming.you are also part of the machine learning project how you would explain the e
Descriptive Questions

e m between deep learning and reinforcement learning and how it is related to las
l a s
difference
(2 Marks) g
a
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machine learning?

a Case Study.
(5.7) Examine the performance of PPL using Altman's model using the information given in the
(3 Marks)
(5.8) Based on the information given in the Case Study, answer the following questions:
(A) Which FRA and rate will be applicable to HHPL for entering an FRA? (1 Mark)
(B) What Payment will be received or made by HHPL when the MIBOR rate is settled at
12% and 9%? (2 Marks)
(5.9) In what respect CDS is different from the purchase of insurance, letters of credit, and

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guarantees and how are the types of settlement generally done in a CDS? (4 Marks)

m boot-up risk identification is required. Do you
(5.10) On the request of the Board, you have been asked to answer certain questions related
to the risk register :
s eonly
g la
(A) For a risk register to be complete,

a
agree? Explain. (1 Mark)
(B) While reviewing the risk register one of the Board members remarked "A good risk
management strategy is built around a static risk register." Is this statement, right?
Give a reasoned answer. (2 Marks)
Answer
Multiple Choice Questions
5.1 (C) or (D)

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5.2 (D)

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5.3 (B)

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5.5 (D)

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Descriptive Questions
5.6 Both deep learning and reinforcement learning are types of machine learning. Deep
learning is an autonomous, self – teaching system in which existing data is used to train
algorithms to find patterns and then the same is used to make predictions about new
data, for example, Face ID in a mobile phone. In contrast to this, reinforcement learning

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34 FINAL EXAMINATION: NOVEMBER, 2023

learns by trial and error although this also is an autonomous, self -teaching system. This
means AI is enhanced by the use of feedback. It performs actions with the ai m of
maximizing rewards that is it learns by doing in order to achieve the best outcome. A
robot learning how to walk is an example of reinforcement learning.
Alternative Solution
Machine learning uses an inductive approach to form a representation of th e world based
on the data it sees. It is able to tweak and improve its representation as new data arrive.
In that sense, the algorithm “learns” from new data inputs and gets better over time.
Techniques such as regression, support vector machines, and k-means clustering have
been in use for decades. Others, while developed previously, have become viable only
now that vast quantities of data and unprecedented processing power are available.
Deep Learning and Reinforcement learning are good examples of newly developed
machine learning techniques.
5.7 Prediction about the bankruptcy in a short-time can be done using Altman Z score as
follows:
Z = 1.2 x X 1 + 1.4 x X2 + 3.3 x X3 + 0.6 x X4 + 1.0 x X5
X1 = working capital / total assets. Measures liquid assets in relation to the size of the
company.
X2 = retained earnings / total assets. Measures profitability that reflects the company's
age and earning power.
X3 = earnings before interest and taxes / total assets. Measures operating efficiency
apart from tax and leveraging factors. It recognizes operating earnings as being
important to long-term viability.
X4 = market value of equity / book value of total liabilities. Adds market dimension that
can show up security price fluctuation as a possible red flag.
X5 = sales / total assets. Standard measure for total asset turnover (varies greatly from
industry to industry).
Z = 1.2 x 0.35 + 1.4 x 0 +3.3 x (-0.25) + 0.6 x 0.20 +1.0 x 1.90
Z = 0.42 + 0 - 0.825 + 0.12 + 1.90
Z = 1.615
This is below the solvency threshold of 1.81 and therefore the performance needs more
scrutiny. This model penalises losses and this is the major reason for low Z value. The
reason for substantive loss during loss needs further investigation as no other

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PAPER – 6A: RISK MANAGEMENT 35

information is given. However, looking at the market cap it appears that the losses would
be recovered in the future as the market cap is still substantial.

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Alternative Solution to this part of answer

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Since Z score is less than 1.81, the company has high risk of going bankrupt in short run.

s e
em settlement amount shall be computed by using the following formula:
5.8 (A) FRA for 5 x 9 will be applicable to HHPL and the rate will be 10.30%.

s g la
la = (N)(RR- FR)(dtm/DY)
(B) Final

g a
a [1 + RR(dtm/DY)]

Where,
N = the notional principal amount of the agreement
RR = Reference Rate for the maturity specified by the contract prevailing on the
contract settlement date; typically LIBOR or MIBOR
FR = Agreed-upon Forward Rate; and

o m
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. market transactions which could be 360
dtm =maturity of the forward rate, specified in days (FRA Days)

e m
DY = Day count basis applicable to money
or 365 days.

la s
g
a after 5 months happens to be 12%
Accordingly,
(1) If actual rate of interest
(` 20 Million)(0.12- 0.103)(120/360)
=
[1 + 0.12(120/360)]
= ` 1,08,974 or ` 0.1090 million
Thus, HHPL will pay PTC Bank a sum of 1,08,974 or ` 0.1090 million.
(2) If actual rate of interest after 5 months happens to be 9%

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(` 20 Million)(0.09- 0.103)(120/360)
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=

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[1 + 0.09(120/360)]

em = ` 84,142 or ` 0.08414 million
l a million. se
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a and guarantees in the
Thus, PTC Bank will pay HHPL a sum of ` 84,142 or ` 0.08414

ag 5.9 CDS is different from the purchase of insurance, letter of credit
sense that in CDS the seller of the CDS takes possession of the defaulted loan.

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36 FINAL EXAMINATION: NOVEMBER, 2023

Alternative Solution to this sub part
Difference between Credit Insurance and Credit Default Swaps
CDS contracts have obvious similarities with insurance, because the buyer pays a
premium and, in return, receives a sum of money if an adverse event occurs.
However, there are also many differences, the most important being that an insurance
contract provides an indemnity against the losses actually suffered by the policy holder
on an asset in which it holds an insurable interest. By contrast a CDS provides an equal
payout to all holders, calculated using an agreed, market-wide method. The holder does
not need to own the underlying security and does not even have to suffer a loss from the
default event. The CDS can therefore be used to speculate on debt objects.
The other differences include:
• The seller might in principle not be a regulated entity (though in practice most are
banks).
• The seller is not required to maintain reserves to cover the protection sold (this was
a principal cause of AIG's financial distress in 2008; it had insufficient res erves to
meet the "run" of expected payouts caused by the collapse of the housing bubble).
• Insurance requires the buyer to disclose all known risks, while CDSs do not (the
CDS seller can in many cases still determine potential risk, as the debt instrument
being "insured" is a market commodity available for inspection, but in the case of
certain instruments like CDOs made up of "slices" of debt packages, it can be
difficult to tell exactly what is being insured).
• Insurers manage risk primarily by setting loss reserves based on the Law of large
numbers and actuarial analysis. Dealers in CDSs manage risk primarily by means of
hedging with other CDS deals and in the underlying bond markets.
• CDS contracts are generally subject to mark-to-market accounting, introducing
income statement and balance sheet volatility while insurance contracts are not.
• To cancel the insurance contract the buyer can typically stop paying premiums,
while for CDS the contract needs to be unwound.
Solution to second sub part
If the reference entity defaults, one of two kinds of settlement can occur in CDS:
• the investor delivers a defaulted asset to Bank for payment of the par value, which
is known as physical settlement.
• Bank pays the investor the difference between the par value and the ma rket price of

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a specified debt obligation (even if reference entity defaults there is usually some
recovery, i.e., not all the investor's money is lost), which is known as cash

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settlement.

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5.10 (A) No. I do not agree. In order to guarantee that risk registers are complete, risks must

.
be identified both top-down and bottom–up from the various management levels of
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the business.

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(B) No. A good risk management strategy is built around an effective and dynamic risk
register. In fact, risk registers run the risk of turning into a static record of the
current state of risk management operations. This provides a false sense of
adequate risk management. Hence the risk register should not only record the key
controls that are already in place but also the specifics of any additional controls
that need to be implemented.

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