Unit 12: Fundamentals of Economics, Microeconomics, Macroeconomics and types of Economics
Chapter 3 - The Governance of Risk Management
1. What is the primary purpose of corporate governance?
A. Maximizing shareholder profits only
B. Reducing government intervention in businesses
C. Establishing processes to operate a business effectively
D. Increasing financial risk for shareholders
Corporate governance refers to the series of processes established to operate a business efficiently, involving shareholders, senior management, and the board of directors.
2. Which of the following corporate governance failures contributed to the development of the Sarbanes-Oxley Act (SOX) of 2002?
A. Lehman Brothers and Bear Stearns
B. Volkswagen Emissions Scandal
C. LIBOR Manipulation Scandal
D. Enron, WorldCom, Global Crossing, and Parmalat
The Sarbanes-Oxley Act (SOX) of 2002 was a response to major corporate governance failures, including Enron (2001), WorldCom (2002), Global Crossing (2002), and Parmalat (2003).
3. How does the European corporate governance model differ from the U.S. Sarbanes-Oxley Act (SOX)?
A. Europe adopted regulations stricter than SOX
B. Europe follows a “comply-or-explain” model instead of mandatory SOX-like rules
C. Europe has no corporate governance framework
D. Europe enforces corporate governance through criminal penalties only
Unlike the U.S., European regulators did not enact a SOX-like law but instead implemented a voluntary “comply-or-explain” model, allowing businesses to justify deviations from best practices.
4. Under the Sarbanes-Oxley Act (SOX), what responsibility do CFOs and CEOs have regarding financial filings?
A. They must personally verify and certify the accuracy of financial filings
B. They can delegate verification responsibility to auditors
C. They must disclose financial filings only if requested by investors
D. They are not directly responsible for financial statements
SOX mandates that CFOs and CEOs must personally verify and certify the accuracy of financial filings submitted to the SEC.
5. What is a key requirement for audit committee members under SOX?
A. They must have a law degree
B. They must be appointed by the CEO
C. They must be independent of the company
D. They must understand accounting principles and have audit experience
SOX requires audit committee members to be publicly disclosed and possess knowledge of accounting principles, financial statements, and audit experience.
6. What was the primary cause of the 2007–2009 financial crisis?
A. Excessive government intervention in financial markets
B. A sharp increase in global oil prices
C. Excessive securitization of subprime mortgage loans
D. A collapse in technology sector investments
The financial crisis was primarily caused by excessive securitization of subprime mortgage loans, leading to systemic failures when default rates increased.
7. Which financial institution was forced to stop operations due to the 2007–2009 financial crisis?
A. Goldman Sachs
B. Morgan Stanley
C. Citigroup
D. Lehman Brothers
Lehman Brothers filed for bankruptcy in 2008 as a result of massive losses linked to subprime mortgage-backed securities.
8. What was one major risk management failure that contributed to the financial crisis?
A. Excessive government regulation of financial institutions
B. Declines in underwriting standards and poor risk appraisal
C. Overuse of conservative lending policies
D. A decline in investor demand for mortgage-backed securities
Poor risk appraisal, weak underwriting standards, and a focus on short-term profits rather than long-term risk management contributed to the crisis.
9. Why was the Sarbanes-Oxley Act (SOX) insufficient in preventing the 2007–2009 financial crisis?
A. It only applied to technology companies
B. It focused exclusively on corporate fraud and not risk management
C. It was not enforced by U.S. regulators
D. It did not address the risks related to structured financial products
While SOX improved financial reporting, it did not address the risk exposure of structured financial products like mortgage-backed securities, which contributed to the crisis.
10. How did the financial crisis of 2007–2009 impact financial institutions and rating agencies?
A. It exposed weaknesses in risk appraisal and control systems
B. It led to an increase in credit ratings for risky assets
C. It resulted in stricter enforcement of the Glass-Steagall Act
D. It had minimal impact on global financial markets
The crisis exposed major weaknesses in risk appraisal and oversight at financial institutions and rating agencies, leading to systemic failures.
11. Why is stakeholder priority a challenge in risk management for banks?
A. Stakeholders in banks always have identical interests
B. Shareholders are the only important stakeholders in banks
C. Banks have diverse stakeholders with competing needs
D. Regulators and borrowers always align in risk preferences
Banks serve multiple stakeholders, such as depositors, borrowers, regulators, employees, bondholders, and shareholders, each with different and sometimes conflicting interests.
12. What was one surprising finding about board composition during the financial crisis?
A. Independent boards always performed better
B. Boards with only internal directors had better risk oversight
C. External forces were irrelevant to board effectiveness
D. No clear difference was observed between internal and external directors
The financial crisis showed that board composition (internal vs. external directors) did not significantly impact outcomes, suggesting that external forces played a dominant role.
13. Why is board risk oversight crucial in preventing financial crises?
A. Board members must be proactive and engaged in risk management
B. Board members should focus solely on short-term profitability
C. Risk oversight is the exclusive role of senior management
D. Board members should avoid getting involved in risk management
The crisis highlighted the importance of proactive board engagement in risk oversight, ensuring that risk management processes are robust and effective.
14. What role does the board play in defining a firm’s risk appetite?
A. It is determined solely by shareholders
B. The board must clearly articulate and communicate risk appetite
C. Risk appetite should be determined by frontline employees
D. There is no need for a formal risk appetite framework
The board is responsible for defining the firm's risk appetite and ensuring it is effectively communicated to stakeholders through an enterprise-level risk limit system.
15. How can compensation structures influence risk-taking behavior?
A. High short-term bonuses encourage prudent risk-taking
B. Management should receive only fixed salaries
C. Compensation structures do not impact risk behavior
D. Deferred bonuses and clawback provisions reduce excessive risk-taking
Compensation structures that include deferred bonuses and clawback provisions help ensure that executives are not incentivized to take excessive risks for short-term gains.
16. What was the primary focus of Basel I?
A. Systematic risk and stress testing
B. Market risk and disclosure requirements
C. Credit risk and minimum capital requirements
D. Liquidity risk and macroprudential regulations
Basel I, introduced in 1988, primarily focused on credit risk and set a minimum capital requirement of 8% of a bank's risk-weighted assets.
17. Which major improvement did Basel II introduce over Basel I?
A. Increased capital requirements for credit risk only
B. Focused solely on idiosyncratic (firm-specific) risks
C. Eliminated the need for regulatory supervision
D. Included both trading and lending activities in capital adequacy
Basel II, introduced in 2006, expanded Basel I by incorporating trading and lending activities into capital adequacy requirements while also strengthening disclosure and supervision standards.
18. What was the primary motivation behind the introduction of Basel III?
A. The financial crisis of 2007–2009
B. The Latin American debt crisis
C. The sovereign debt crisis of 2010
D. The Asian financial crisis of 1997
Basel III was introduced in response to the 2007–2009 financial crisis to address both firm-specific (idiosyncratic) and market-wide (systematic) risks.
19. Which of the following is NOT a key element of Basel III?
A. Higher capital requirements
B. Liquidity risk management
C. Removal of risk-weighted asset calculations
D. Consideration of both systematic and idiosyncratic risks
Basel III retained risk-weighted asset calculations but strengthened capital and liquidity requirements while considering both systemic and idiosyncratic risks.
20. Which organization is responsible for developing the Basel banking regulations?
A. International Monetary Fund (IMF)
B. Basel Committee on Banking Supervision (BCBS)
C. World Trade Organization (WTO)
D. Financial Stability Board (FSB)
The Basel Committee on Banking Supervision (BCBS) is responsible for formulating Basel regulations to enhance global banking supervision and risk management.
21. What is the main purpose of the liquidity coverage ratio (LCR) introduced in Basel III?
A. To increase leverage in banking operations
B. To ensure banks hold enough highly liquid assets to cover 30 days of cash needs
C. To eliminate the need for stress testing
D. To lower capital adequacy requirements
The Liquidity Coverage Ratio (LCR) under Basel III requires banks to maintain sufficient high-quality liquid assets to cover potential cash outflows over a 30-day period.
22. What is the minimum leverage ratio (Tier 1 capital/total consolidated assets) under Basel III?
A. 3%
B. 5%
C. 8%
D. 10%
Basel III introduced a leverage ratio requirement, setting the minimum Tier 1 capital to total assets ratio at 3% to limit excessive leverage.
23. What is the primary goal of the countercyclical capital buffer in Basel III?
A. To increase banks’ reliance on short-term funding
B. To reduce the need for common equity in Tier 1 capital
C. To increase lending during economic downturns
D. To help banks build additional capital during periods of high economic growth
The countercyclical capital buffer is designed to require banks to build extra capital in good times so they can absorb losses in downturns, reducing systemic risk.
24. How does Basel III aim to reduce counterparty risk in financial markets?
A. By eliminating all derivative trading
B. By restricting lending to systemically important financial institutions
C. By encouraging central clearing of as many trades as possible
D. By allowing banks to use their own internal risk models without oversight
Basel III encourages central clearing of financial transactions to reduce counterparty risk and enhance financial stability.
25. What role does stress testing play in Basel III's risk management framework?
A. To eliminate the need for Tier 1 capital
B. To better capture tail risk and extreme market scenarios
C. To focus only on historical risk patterns
D. To allow banks to reduce capital buffers in stable economic conditions
Basel III emphasizes stress testing to ensure banks can withstand extreme market events and unexpected financial shocks by capturing tail risks more effectively.
26. Who has the ultimate responsibility for overseeing a bank’s risk appetite, strategic objectives, and governance framework according to the BCBS 2015 guidelines?
A. Board of Directors
B. Chief Risk Officer (CRO)
C. Senior Management
D. Internal Auditors
The Board of Directors holds the ultimate responsibility for overseeing the firm's risk appetite, strategic objectives, and governance framework.
27. According to the BCBS 2015 guidelines, what is a key requirement for board members in terms of governance?
A. They must have at least 10 years of banking experience
B. They must be qualified and possess the necessary skill set for their supervisory role
C. They must come from a legal background
D. They must be independent directors
The BCBS guidelines stress that all board members should have the necessary qualifications and skills to effectively oversee risk management.
28. Who is responsible for conducting the day-to-day business operations in accordance with the strategy approved by the board?
A. Board of Directors
B. Internal Auditors
C. Senior Management
D. Compliance Officers
Senior management is responsible for executing the strategy set by the board, ensuring that operations align with risk policies.
29. According to BCBS 2015 guidelines, what is the primary role of the Chief Risk Officer (CRO)?
A. To oversee bank compensation policies
B. To approve board policies
C. To manage financial disclosures
D. To lead an independent risk management function reporting to the board
The CRO heads the independent risk management function and reports directly to the board to ensure objective risk oversight.
30. What is a key requirement for risk management in conglomerates under the BCBS 2015 guidelines?
A. The parent firm’s board must have ultimate oversight over all subsidiaries
B. Each subsidiary must operate independently without interference
C. The parent firm is not responsible for subsidiary risk management
D. Subsidiaries should report to local regulators only
In a conglomerate structure, the parent firm's board must oversee all subsidiaries to ensure uniform risk management practices.
31. What is the primary focus of risk identification, monitoring, and control under BCBS guidelines?
A. Eliminating all business risks
B. Identifying, evaluating, and deciding whether to retain, avoid, mitigate, or transfer risks
C. Delegating risk decisions to external consultants
D. Allowing each department to manage its own risks without board involvement
Risk management involves identifying risks, assessing their impact, and deciding whether to accept, mitigate, or transfer them.
32. Why is effective risk communication important in banking risk management?
A. To meet regulatory reporting requirements
B. To ensure only top management understands risk policies
C. To align risk management policies across all levels of the firm
D. To increase bank profitability
Effective risk communication ensures that risk appetite and policies are clearly understood across all levels of the organization.
33. What is the primary reason for conducting periodic internal audits in risk management?
A. To evaluate profitability
B. To determine loan pricing strategies
C. To satisfy external regulatory requirements
D. To inform the board of progress in risk management processes
Internal audits assess risk management effectiveness and provide feedback to the board on any necessary improvements.
34. What is the primary objective of the Fundamental Review of the Trading Book (FRTB) under Basel III?
A. To increase capital requirements for commercial lending
B. To eliminate derivatives trading
C. To enhance market risk assessment for trading desks
D. To reduce the importance of capital adequacy
The FRTB under Basel III aims to improve the assessment of market risk exposure in banks’ trading books, particularly in derivatives and complex financial instruments.
35. Which of the following financial instruments is NOT a key focus of the Fundamental Review of the Trading Book (FRTB)?
A. Derivatives
B. Futures contracts
C. Currency and index exposures
D. Retail bank savings accounts
The FRTB focuses on market risk associated with derivatives, futures, and complex financial assets rather than retail bank savings accounts.
36. The Glass-Steagall Act primarily aimed to:
A. Allow banks to combine commercial and investment banking
B. Separate commercial banking from investment banking
C. Promote high-frequency trading
D. Increase bank leverage limits
The Glass-Steagall Act was enacted to separate commercial banking from investment banking to protect depositors from risks associated with trading activities.
37. Which legislation repealed the Glass-Steagall Act, allowing banks to operate as financial services holding companies?
A. Graham-Leach-Bliley Act
B. Dodd-Frank Act
C. Basel III
D. Sarbanes-Oxley Act
The Graham-Leach-Bliley Act of 1999 repealed the Glass-Steagall Act, allowing banks to integrate commercial and investment banking under a single holding company.
38. What was a major consequence of repealing the Glass-Steagall Act?
A. Banks became more stable and profitable
B. The Federal Reserve gained direct control over investment banking
C. Financial institutions took on excessive risks, leading to the 2008 financial crisis
D. The number of small banks increased significantly
The repeal of the Glass-Steagall Act allowed financial institutions to take on excessive risks by combining commercial and investment banking, contributing to the 2008 financial crisis.
39. The Dodd-Frank Act was introduced primarily to:
A. Promote financial deregulation
B. Eliminate capital requirements for banks
C. Remove the need for financial stress testing
D. Strengthen financial regulation and consumer protection
The Dodd-Frank Act was enacted in response to the 2008 financial crisis to improve financial stability, enhance consumer protection, and prevent excessive risk-taking by banks.
40. Which of the following was NOT a key feature of the Dodd-Frank Act?
A. The repeal of Basel III regulations
B. The Volcker Rule restricting proprietary trading
C. Enhanced consumer financial protections
D. Increased oversight of systemically important financial institutions
The Dodd-Frank Act did not repeal Basel III; instead, it introduced additional financial regulations such as the Volcker Rule, consumer protection measures, and systemic risk oversight.
41. Under the Dodd-Frank Act, which institution was given oversight over all systemically important financial institutions (SIFIs)?
A. The Federal Reserve
B. The Consumer Financial Protection Bureau
C. The Securities and Exchange Commission
D. The Financial Stability Oversight Council
The Dodd-Frank Act strengthened the Federal Reserve’s role by giving it oversight over all systemically important financial institutions (SIFIs) with assets above $50 billion.
42. What is the primary purpose of the “Orderly Liquidation Authority” under Dodd-Frank?
A. To provide financial assistance to failing banks
B. To allow banks to merge without regulatory approval
C. To manage the failure of large financial institutions in a structured manner
D. To remove capital requirements for financial institutions
The Orderly Liquidation Authority was created under Dodd-Frank to ensure that large financial institutions can be resolved without disrupting the financial system.
43. What is the purpose of the "living will" requirement under Dodd-Frank?
A. To document a bank’s investment strategies
B. To outline plans for increasing leverage
C. To define credit risk exposure
D. To outline how a bank would be resolved in case of distress
Under Dodd-Frank, systemically important financial institutions (SIFIs) must submit a "living will" to the Fed, detailing how they can be resolved in an orderly manner in case of financial distress.
44. What is the main goal of the Volcker Rule under the Dodd-Frank Act?
A. To impose capital controls on banks
B. To prevent banks from engaging in proprietary trading
C. To eliminate all derivatives trading
D. To allow banks to invest unlimited amounts in hedge funds
The Volcker Rule prohibits banks from engaging in proprietary trading, meaning they cannot trade for their own profit using depositors’ funds.
45. Which agency was created by Dodd-Frank to regulate consumer financial products?
A. The Federal Reserve
B. The Securities and Exchange Commission (SEC)
C. The Consumer Financial Protection Bureau (CFPB)
D. The Office of the Comptroller of the Currency (OCC)
The Dodd-Frank Act established the Consumer Financial Protection Bureau (CFPB) to oversee consumer financial products such as mortgages, credit cards, and loans.
46. What is the purpose of the stress testing requirement under Dodd-Frank?
A. To evaluate a bank’s ability to withstand economic shocks
B. To eliminate reserve requirements for banks
C. To allow unlimited risk-taking by financial institutions
D. To ensure all banks follow the same business model
Dodd-Frank requires banks to conduct stress tests to assess their ability to survive economic downturns and financial shocks, ensuring overall stability.
47. What is the difference between the Dodd-Frank Act Stress Test (DFAST) and the Comprehensive Capital Analysis and Review (CCAR)?
A. DFAST is conducted for all banks, while CCAR applies only to hedge funds
B. DFAST applies to banks with assets above $10 billion, while CCAR applies to banks with assets exceeding $50 billion
C. CCAR is focused only on liquidity risk, while DFAST covers credit risk
D. Both DFAST and CCAR apply only to non-bank financial institutions
The Dodd-Frank Act Stress Test (DFAST) applies to banks with assets above $10 billion, while the Comprehensive Capital Analysis and Review (CCAR) applies to those exceeding $50 billion.
48. Why should a board of directors have a majority of independent members?
A. To ensure only shareholders’ interests are prioritized
B. To minimize the need for external audits
C. To maintain objectivity in decision-making and oversight
D. To avoid regulatory scrutiny
A board with independent members ensures unbiased decision-making and proper oversight, preventing undue influence from management.
49. How has the standard view of corporate governance evolved?
A. The board is solely responsible for increasing stock prices
B. The board should only consider shareholder interests
C. Corporate governance is only concerned with agency risk
D. The board now considers all stakeholders, not just shareholders
Modern corporate governance takes into account the interests of all stakeholders, including shareholders, employees, regulators, and society.
50. What is agency risk in corporate governance?
A. Risk that independent directors will take control of the firm
B. Risk arising from the separation of ownership and management
C. Risk that shareholders will demand too much dividend payout
D. Risk associated with external auditors
Agency risk arises because managers (agents) may have incentives to act in their own interest rather than in the best interests of shareholders (principals).
51. How can corporate boards mitigate agency risk?
A. By allowing CEOs to make all strategic decisions independently
B. By avoiding performance-based compensation
C. By designing compensation plans aligned with long-term goals
D. By eliminating board oversight in high-risk decisions
Compensation plans should align management incentives with long-term corporate goals to reduce short-term risk-taking and agency conflicts.
52. What is a clawback provision in executive compensation?
A. A bonus payment granted upon meeting short-term goals
B. A strategy to increase agency risk
C. A rule allowing CEOs to set their own compensation
D. A policy requiring executives to repay bonuses under certain conditions
Clawback provisions require executives to return performance-based compensation if it was awarded based on misleading or unsustainable financial results.
53. Why should the CEO and board chairperson roles be separate?
A. To prevent excessive concentration of power
B. To ensure the CEO has full control over corporate strategy
C. To eliminate the need for risk management
D. To remove regulatory oversight from board decisions
Separating the CEO and board chairperson roles prevents excessive power concentration and enhances board independence.
54. What lesson was learned from MF Global’s collapse?
A. Management should be allowed to make all risk decisions without oversight
B. Stock-based compensation eliminates agency risk
C. Independent board oversight and risk management are crucial
D. The CEO should also act as the board chairman
MF Global’s bankruptcy highlighted the dangers of excessive CEO power and ignoring risk management warnings, demonstrating the need for independent board oversight.
55. What is the primary role of the board of directors in a firm's risk management process?
A. To execute daily risk management decisions
B. To focus solely on accounting performance
C. To define the firm's risk appetite and ensure its communication to stakeholders
D. To delegate all risk-related responsibilities to the CEO
The board of directors plays a central role in articulating the firm's risk appetite and ensuring it is communicated effectively to stakeholders.
56. Which of the following is NOT a recommended step for the board in risk management?
A. Establishing a risk committee
B. Eliminating the role of Chief Risk Officer (CRO)
C. Connecting risk appetite with the compensation committee
D. Maintaining an independent audit committee
Basel III and corporate governance principles recommend establishing a CRO role rather than eliminating it, as the CRO plays a crucial role in risk management oversight.
57. Why should the board encourage economic performance over accounting performance?
A. To ensure financial reports always show high profits
B. To comply with tax regulations
C. To focus solely on reducing risk exposure
D. To align business decision-making with long-term strategic goals
Economic performance focuses on sustainable value creation and strategic decision-making, while accounting performance may emphasize short-term financial metrics.
58. What is the function of the risk committee in a firm’s risk management framework?
A. To assess and oversee risks faced by the firm
B. To approve daily financial transactions
C. To replace the audit committee
D. To focus only on operational risk
The risk committee is responsible for understanding and overseeing the firm's risk exposure and ensuring alignment with the firm's strategic objectives.
59. How should the board of directors validate management's risk-related decisions?
A. By relying solely on internal reports
B. By delegating risk assessment to external consultants
C. By corroborating information from multiple sources
D. By avoiding direct questioning of executives
The board should apply professional skepticism by verifying risk-related information from multiple sources to ensure sound decision-making.
60. What is the significance of linking the compensation committee with the firm’s risk appetite?
A. To ensure all executives receive the same bonuses
B. To align executive incentives with prudent risk-taking
C. To increase risk-taking without consequences
D. To reduce the role of performance-based compensation
By linking compensation to the firm’s risk appetite, executives are incentivized to take calculated risks that align with long-term business strategy.
61. What is the primary role of a risk advisory director on a firm’s board?
A. To manage the firm’s daily risk operations
B. To oversee employee compensation policies
C. To provide industry-specific risk guidance to the board
D. To replace the internal audit function
The risk advisory director is responsible for advising the board on specialized risk exposures and providing industry-specific risk insights.
62. Which board committees should the risk advisory director typically attend?
A. Compensation and nomination committees
B. Marketing and operations committees
C. Investment and finance committees
D. Risk committee and audit committee
The risk advisory director should attend risk committee and audit committee meetings to provide industry-specific risk insights.
63. Why is an independent risk advisory director beneficial for a firm's board?
A. To increase shareholder profits
B. To provide specialized risk expertise and industry knowledge
C. To handle all risk management decisions alone
D. To replace the need for external auditors
An independent risk advisory director brings specialized industry knowledge to help the board make informed risk management decisions.
64. What is one of the key responsibilities of the board of directors in risk governance?
A. Approving employee promotions
B. Setting daily operational policies
C. Reviewing and analyzing risk management policies
D. Managing IT infrastructure
The board is responsible for reviewing and analyzing the firm’s risk management policies to ensure sound governance.
65. What is one of the key aspects that the board reviews as part of risk governance?
A. The firm’s risk appetite and its impact on business strategy
B. The personal investments of board members
C. The daily activities of risk managers
D. The social media activity of employees
The board assesses the firm’s risk appetite and ensures it aligns with the overall business strategy.
66. How does the risk advisory director act as a liaison?
A. By managing all risk-related decisions for the board
B. By conducting risk audits independently
C. By handling the firm’s legal compliance
D. By bridging communication between senior management and the board
The risk advisory director meets with senior management and provides insights to the board, ensuring alignment in risk governance.
67. Why does the board review internal and external audit reports?
A. To approve financial transactions
B. To assess financial and operational risk controls
C. To conduct daily financial forecasting
D. To oversee human resource functions
Reviewing internal and external audit reports helps the board assess financial and operational risk controls.
68. What is one of the key risk management practices that the board should monitor?
A. The firm’s social media strategy
B. The pricing of individual products
C. The risk management practices of competitors and the industry
D. The daily financial transactions of employees
The board should assess risk management practices across the industry to ensure competitiveness and compliance with best practices.
69. What is the primary responsibility of the Risk Management Committee in a firm?
A. Approving all financial transactions
B. Managing day-to-day operational risks
C. Setting the firm's risk appetite and monitoring risk management
D. Determining employee salaries
The Risk Management Committee sets the firm's risk appetite, supervises risk decisions, and monitors risk management compliance.
70. In a banking context, which responsibility does the Risk Management Committee typically have?
A. Monitoring customer satisfaction levels
B. Approving credit facilities above specific limits or thresholds
C. Setting interest rates on loans
D. Managing marketing and promotional campaigns
The Risk Management Committee in banking is responsible for approving credit facilities that exceed certain thresholds.
71. What is the key function of the Compensation Committee in corporate governance?
A. Overseeing employee recruitment
B. Setting interest rates for deposits
C. Designing marketing strategies
D. Ensuring management compensation aligns with long-term risk management
The Compensation Committee ensures that management remuneration aligns with long-term company goals and does not encourage excessive risk-taking.
72. Why should the Compensation Committee avoid basing bonuses solely on short-term profits?
A. Because short-term profits can be manipulated
B. Because long-term investors prefer stock-based compensation
C. Because it leads to increased tax liabilities for the firm
D. Because it discourages employee retention
Short-term profits are relatively easy to manipulate, so basing bonuses solely on them may encourage excessive risk-taking.
73. How can the Compensation Committee ensure that management compensation reflects long-term performance?
A. By increasing base salaries instead of bonuses
B. By eliminating performance-based compensation
C. By deferring compensation until long-term results are known
D. By tying bonuses only to short-term revenue growth
Deferring compensation ensures that management decisions align with long-term company performance.
74. What is the purpose of a clawback provision in management compensation?
A. To increase annual bonuses
B. To reclaim bonuses if long-term results do not align with short-term gains
C. To provide additional incentives for risk-taking
D. To eliminate the need for performance-based compensation
Clawback provisions allow the company to recover bonuses if management's short-term performance is inconsistent with long-term results.
75. How can compensation be structured to discourage excessive risk-taking by management?
A. By providing only cash bonuses
B. By linking all compensation to short-term revenue
C. By eliminating all variable compensation
D. By using deferred compensation and performance-linked bonus bonds
Using deferred compensation and performance-linked bonus bonds ensures that management takes a long-term approach to risk management.
76. What is the primary role of the Chief Risk Officer (CRO) in an organization?
A. To approve all financial transactions
B. To oversee only credit risk
C. To supervise day-to-day risk management and ensure risk limits align with business strategy
D. To set the firm’s overall business strategy
The CRO is responsible for day-to-day risk supervision and ensures that risk appetite aligns with the firm’s business strategy, reporting to the CEO while liaising with the board.
77. How does a firm's risk appetite relate to its business strategy?
A. The firm's risk appetite should align with and support its strategic objectives
B. Risk appetite should be independent of business strategy
C. A firm should always prioritize risk minimization over growth
D. Risk appetite is determined only by market conditions
A firm’s risk appetite must be consistent with its business strategy to ensure it takes appropriate risks while pursuing its goals.
78. Who is responsible for setting the enterprise-level risk appetite?
A. The Chief Financial Officer (CFO)
B. The Chief Risk Officer (CRO)
C. The CEO alone
D. The board through the risk committee
The board, through the risk committee, sets the firm's enterprise-level risk appetite, ensuring alignment with overall strategy.
79. What happens if a business opportunity exceeds an approved risk limit?
A. The opportunity must always be rejected
B. The CRO and risk committee may approve a temporary extension
C. The frontline employees can approve it
D. The business unit head makes the final decision without oversight
The CRO and ultimately the risk committee can approve temporary extensions if they remain within the enterprise-level risk tolerance.
80. What is the purpose of stress testing and value at risk (VaR) analysis in risk management?
A. To eliminate all business risk
B. To increase profitability by taking on more risk
C. To monitor risk exposure and ensure limits are not breached
D. To approve risk limit breaches automatically
Stress testing and VaR analysis help firms assess and monitor risk exposure at different levels, ensuring that risk limits are properly enforced.
81. What is the primary objective of reforming managerial compensation structures?
A. To increase short-term profitability
B. To reduce base salaries and shift to performance-based pay
C. To align managerial incentives with the firm’s long-term risk appetite
D. To eliminate all forms of variable compensation
The reforms aim to ensure that managerial incentives align with the firm’s risk appetite, discouraging excessive risk-taking for short-term gains.
82. How do clawback provisions contribute to sound compensation practices?
A. By increasing immediate bonuses for executives
B. By allowing firms to reclaim bonuses if financial performance deteriorates
C. By guaranteeing a fixed bonus regardless of long-term performance
D. By reducing transparency in executive pay
Clawback provisions help prevent excessive risk-taking by allowing firms to recover bonuses if executives' decisions lead to financial losses.
83. According to G20 recommendations, what is the maximum incentive-based compensation allowed with shareholder approval?
A. 50% of salary
B. 100% of salary
C. 150% of salary
D. 200% of salary
G20 reforms suggest limiting incentive-based pay to 100% of salary, with an extension to 200% if shareholders approve.
84. Why is it important for compensation committees to be independent?
A. To ensure executive pay decisions are not influenced by conflicts of interest
B. To maximize short-term executive earnings
C. To reduce overall pay transparency
D. To guarantee high-risk compensation structures
Independent compensation committees ensure that executive pay aligns with long-term firm performance and risk management principles.
85. What is a “bonus bond” in executive compensation?
A. A guaranteed bonus paid regardless of firm performance
B. A fixed cash payment given annually
C. A bond that only pays out if specific performance conditions are met
D. A bonus that increases regardless of firm risk exposure
Bonus bonds link executive rewards to performance by requiring certain financial conditions, such as capital adequacy ratios, to be met.
86. What is the primary role of the risk committee in a firm's risk management framework?
A. Implement the firm's risk policies at the business unit level
B. Execute financial transactions to mitigate risk
C. Oversee the firm's overall risk management process
D. Handle daily risk management decisions independently
The risk committee is responsible for overseeing the firm's risk management framework, ensuring alignment with risk appetite, and providing guidance to senior management and the CRO.
87. What is the main responsibility of the Chief Risk Officer (CRO)?
A. Approving all risk-related business decisions
B. Setting the firm's risk appetite
C. Managing financial transactions related to risk mitigation
D. Monitoring day-to-day risk limits and ensuring compliance
The CRO is responsible for overseeing risk management policies, ensuring compliance with risk limits, and coordinating with senior management and the risk committee.
88. Which functional unit is primarily responsible for implementing the firm's approved risk policy?
A. Risk committee
B. Business units
C. Board of directors
D. External regulators
Business units are responsible for executing the firm's approved risk policies and ensuring compliance with the established risk framework.
89. How do finance and operations contribute to a firm's risk management process?
A. By executing risk mitigation transactions and ensuring compliance with risk limits
B. By setting the firm's risk appetite
C. By independently making strategic risk decisions
D. By overseeing all risk-related business decisions
The finance and operations units play a crucial role in risk management by executing risk mitigation strategies and ensuring that the firm adheres to risk limits.
90. What is the key function of senior management in risk management?
A. Conducting day-to-day monitoring of risk limits
B. Executing financial transactions related to risk mitigation
C. Setting risk appetite, overseeing policies, and evaluating risk performance
D. Clearing trades to minimize counterparty risk
Senior management, with guidance from the risk committee, sets the firm's risk appetite, supervises risk policies, and evaluates performance in relation to risk limits.
91. What is the primary responsibility of a firm’s audit committee?
A. Setting the firm's business strategy
B. Managing daily financial transactions
C. Ensuring reasonable accuracy of financial statements and regulatory compliance
D. Determining employee salaries
The audit committee is primarily responsible for overseeing the accuracy of financial statements and ensuring compliance with regulatory requirements.
92. Who do a firm’s internal auditors report to?
A. The CEO
B. The CFO
C. The risk management team
D. The audit committee
Internal auditors report to the audit committee to ensure independence and effective oversight of risk management and compliance procedures.
93. What is a key requirement for a viable audit committee?
A. Independence from the underlying business activity
B. Direct involvement in day-to-day management decisions
C. Controlling the firm’s marketing and sales strategies
D. Setting employee performance evaluations
The audit committee must remain independent from daily business activities to effectively monitor compliance and risk management.
94. Which of the following is NOT a responsibility of the audit committee?
A. Monitoring risk management procedures
B. Setting executive salaries
C. Ensuring compliance with financial regulations
D. Overseeing the internal audit function
The audit committee is responsible for financial oversight and compliance but does not determine executive salaries.
95. What is one of the responsibilities of internal auditors reporting to the audit committee?
A. Setting company-wide strategic goals
B. Determining employee compensation structures
C. Monitoring risk management procedures and compliance
D. Developing new business products
Internal auditors play a key role in ensuring compliance with risk management policies and validating risk metrics.
96. What financial knowledge must audit committee members possess?
A. Marketing strategies
B. Human resource management
C. Information technology
D. Accounting standards and internal controls
Audit committee members must understand accounting rules (e.g., U.S. GAAP, IFRS) and internal controls to effectively perform their roles.
97. Why is it important for the audit function to be independent of risk management policy implementation?
A. To allow auditors to participate in operational decision-making
B. To provide unbiased oversight and ensure compliance
C. To improve financial performance through direct involvement
D. To establish company-wide marketing guidelines
Independence ensures that the audit committee can provide objective oversight without conflicts of interest.
98. What role does the audit committee play in relation to financial reporting?
A. Preparing the firm’s financial statements
B. Setting tax policies for the company
C. Ensuring the accuracy and reliability of financial statements
D. Managing the firm’s investment portfolio
The audit committee ensures that the financial statements are accurate, comply with accounting standards, and reflect the company's financial condition.
99. What is one of the key lessons learned from the risk management failures of the 2007–2009 financial crisis?
A. Firms should focus solely on maximizing shareholder value
B. Boards of directors should play a minimal role in risk management
C. The needs of all stakeholders must be considered
D. Risk appetite should only be defined by senior management
The 2007–2009 financial crisis highlighted the importance of considering all stakeholders in risk management decisions, not just shareholders.
100. According to best practices in corporate governance, what is a crucial requirement for board leadership?
A. The CEO and Chairperson of the board should be the same person
B. The board should not interfere with risk management decisions
C. The board should be composed solely of internal members
D. The CEO and Chairperson should be separate individuals
Best practices dictate that the CEO and Chairperson should be separate individuals to ensure true accountability and oversight.
101. Who has ultimate responsibility for enterprise-level risk management in an organization?
A. The Chief Risk Officer (CRO)
B. The Board of Directors
C. The Compensation Committee
D. The Internal Audit Team
The Board of Directors holds ultimate responsibility for risk management and must ensure that adequate structures are in place to manage risks effectively.
102. What is the role of the risk management committee within a firm?
A. To execute daily risk management decisions
B. To oversee only financial risks
C. To determine risk appetite and bring discussions to the full board
D. To focus only on compliance and regulatory reporting
The risk management committee is responsible for setting the firm’s risk appetite and reporting its decisions to the full board for awareness and approval.
103. How should a firm’s risk appetite be aligned with its business strategy?
A. It should fit within the firm’s long-term objectives
B. It should be determined without considering business strategy
C. It should focus only on maximizing short-term profits
D. It should be flexible enough to allow unlimited risk-taking
A firm’s risk appetite must align with its long-term business strategy and objectives to ensure sustainable growth and risk management.
104. Why is it important for frontline managers to be involved in the risk management process?
A. They should only focus on daily operations, not risk management
B. Risk management should only be handled at the executive level
C. They do not play a significant role in identifying risks
D. They are critical in identifying and managing risks at the operational level
Frontline managers are vital in identifying and mitigating risks at the operational level since they have direct exposure to daily business activities.
105. What is one of the key responsibilities of the audit committee in risk management?
A. Setting compensation for senior executives
B. Monitoring compliance with risk management policies
C. Executing the firm’s daily risk management tasks
D. Making business strategy decisions
The audit committee supervises compliance with risk management policies and ensures that proper risk oversight is in place.
