2020/10/21 Course Outline – KnowledgEquity

FRM PRACTICE EXAM 2

Question 1 1 mark

Section A: Multiple Choice Questions – Single Option

This section has 70 questions worth 1 mark each (total of 70 marks)

Tango Ltd has a $5 million borrowing, with a floating rate of BBSW + 2.0%. The current BBSW rate is 3.5%, and the historical volatility in the the rate (per annum)
reveals a 1% standard deviation.

Assume that the BBSW rose progressively to 4.5% during the course of year.

Which of the following statements is correct?

A. Tango Ltd's interest expense for the year increased from $275,000 to $325,000.
B. Based on historical volatility, the BBSW has moved one standard deviation during the course of the year.
C. A Monte Carlo simulation of interest rate movements would reveal a mean interest expense of $175,000 p.a.
D. Assuming a normal distribution, there was an approximate 95% probability that the BBSW would range between 2.5% to 4.5% during the year.

You selected B - This is correct

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The BBSW was 3.5% and moved to 4.5%, which matches the 1.0% standard deviation.

Tango's interest rate is floating and the interest expense for the year is unlikely to have either been $275,000 or $325,000, as this assumes a fixed interest rate for
the overall period.

A Monte Carlo simulation based on the volatility of the BBSW may reveal a mean interest expense of $175,000 for the year based solely on the BBSW (i.e. $5m x
3.5% BBSW), but firstly, Tango also has a 2.0% margin that needs to be added (i.e. total of $275,000) and, secondly, such a result is not guaranteed as the
distribution would highlight the possible outcomes over a full year, which may or may not reveal the mean being based on the current rate.

A normal distribution would suggest that plus or minus 2 standard deviations equates to 95% of the outcomes. This equates to plus or minus 2% so, in this
situation, the actual BBSW range would be from 1.5% to 5.5%.

Module 1 > Assess risk > Analyse risk

Question 2 1 mark
Delta Echo Ltd issues a four-year bond with a face value of $50,000,000. The bond has a coupon of 4% per annum, which is paid annually in arrears. The current
market yield is 3.5% per annum.

What is the current price of the bond?

A. $49,092,526.
B. $50,086,368.
C. $50,831,902.
D. $50,918,270.

You selected D - This is correct

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The price of debt can be calculated using the formula:

P = C { [ 1 - (1 + Kd)^-n ] / Kd } + [ F / (1 + Kd)^n ]

In this scenario, C is $2,000,000, being the coupon cash flow each period (i.e. $50m x 4%); Kd is the current yield of 3.5%; n is the 4 years to maturity; and F is the face value
of $50m.

P = $2,000,000 { [ 1 - (1 + 3.5%)^-4 ] / 3.5% } + [ $50,000,000 / (1 + 3.5%)^4 ]

P = $50,918,270.

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Question 3 1 mark
ZYX Ltd is considering an investment in new equipment. The equipment requires a $400,000 upfront cash outlay, as well as $75,000 of incremental maintenance
costs each year (after tax). During its 3-year life, the machinery will generate annual incremental savings of $200,000 (after tax), and it will have a scrap value of
$100,000 (after tax). Assume that depreciation for tax purposes is limited to $100,000 per annum for 3 years. ZYX Ltd has a discount rate of 13% and the tax rate is
30%.

What is the net present value of the investment?

A. $35,284
B. ($34,021)
C. ($35,551)
D. ($104,856)

You selected A - This is correct

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The cash outflows are $400,000 in Year 0. There are also after-tax outflows of $75,000 for each of the 3 years.

While depreciation is a non-cash expense, it does have a tax effect which impacts the cash position. Depreciation is based on the stated amount of $100,000 per annum for
tax purposes. The tax effect of depreciation is therefore $30,000 per year (i.e. $100,000 x 30%). This is treated as a cash inflow as it reduces tax payable.

The other cash inflows include the savings of $200,000 per year (after tax), as well as the residual value of $100,000 at the end of year 3 (after tax).

Net nominal cash flows are therefore: Year 0 = ($400,000); Year 1 = $155,000; Year 2 = $155,000; Year 3 = $255,000.

These are then brought to their present values using a discount rate of 13%: Year 0 = ($400,000) / (1.13^0) = ($400,000); Year 1 = ($155,000) / (1.13^1) = $137,168; Year 2 =
($155,000) / (1.13^2) = $121,388; Year 3 = ($255,000) / (1.13^3) = $176,728.

The NPV is the summation of these present values, which equals $35,284.

Question 4 1 mark
RST Ltd is looking to purchase large capital equipment and has received the following submissions from three separate suppliers.:

– Supplier 1: an upfront payment of $3,000,000.

– Supplier 2: an upfront payment of $1,500,000 and a further payment of $1,550,000 in one years’ time.
– Supplier 3: a deferred payment of $3,150,000 in two years’ time.

Current swap rates are as follows:

– 1 year = 2.5%
– 2 year = 2.8%

Which submission should RST Ltd accept?

A. Supplier 1 as this is the lowest cost of $3,000,000.

B. Supplier 2 as this is the highest NPV of $3,012,195.
C. Supplier 3 as this is the highest price of $3,150,000.
D. Supplier 3 as this is the lowest NPV of costs of $2,980,742.

You selected D - This is correct

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D is correct because RST Ltd is purchasing equipment, and the lowest NPV of costs of $2,980,742 would provide the best outcome. This NPV of costs is
calculated as $3,150,000 / (1.028)^2).

A is incorrect because while the lowest cash outflow is $3,000,000 from Supplier 1, when comparing all payments at a common point in time (i.e. factoring in the
time value of money), this is not the lowest cost to RST Ltd.

B is incorrect because RST Ltd is purchasing equipment, and the highest NPV of costs of $3,012,195 would provide the worst outcome. This NPV of costs is
calculated as $1,500,000 + ($1,550,000 / (1.025)^1).

C is incorrect because while the highest cash outflow is $3,150,000 from Supplier 3, we want to compare all payments at a common point in time (i.e. factoring in
the time value of money).

Module 5 > Background > Yield curve and the term structure of interest rates

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Question 5 0 marks
LMN Ltd is an exporter of luxury goods and will be receiving payment in Singapore Dollars from its customer. The contract price is SGD 225,000. A foreign
exchange dealer quotes the following exchange rate: AUD/SGD 1.0520/55.

What is the AUD amount that LMN Ltd will receive?

A. AUD 213,169.
B. AUD 213,878.
C. AUD 236,700.
D. AUD 237,488.

You selected B - This is incorrect. The correct answer is A

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The exchange rate quoted by the dealer is AUD/SGD 1.0520 - 1.0555. This means that the dealer will buy AUD low, at 1.0520 and sell AUD high, at 1.0555. The
dealer is going to sell AUD to the exporter and buy SGD, so the rate of 1.0555 is applicable. The equivalent AUD amount is therefore SGD 225,000 / 1.0555 =
AUD 213,169.

Module 6 > Demystifying foreign exchange > Five key elements of FX

Question 6 0 marks
Which of the following statements is correct?

A. Under IFRS 9, the time value of options must be expensed through the profit and loss.
B. Under IFRS 9, the time value of options can be separated from an option contract and deferred to the profit and loss.
C. Under IFRS 9, the time value of options is not permitted to be separated from an option contract as the hedge instrument must be used in its entirety.
D. Under IFRS 9, the time value of options can be separated from an option contract, and the intrinsic value can then be designated in a hedge relationship.

You selected C - This is incorrect. The correct answer is D

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Under IFRS 9, the intrinsic value and time value of an option contract can be separated, with only the intrinsic value component then being designated in a hedge
relationship. This is an exception to the standard rule that the hedge instrument must be used in its entirety. Further, under IFRS 9, the change in time value of an
option contract can be deferred in OCI.

Module 7 > Eligible hedge instruments > Used in its entirety

Question 7 1 mark
A back-office staff member processed the following order into the trading system:

Date: 31/08/2016
Counterparty ID: AABB101A
Value: AUD 168,500
Type: Purchase
Account: Spot trades
Underlying: AUD gold price

The trading system updated overnight and payment was made to the counterparty. Unfortunately, the staff member had entered the date field into the value field
($31,082,016).

What type of internal control would have prevented this error?

A. Segregation of duties - separating the front-office from the back-office.

B. Reconciliations - comparing the actual order with the banking transaction.
C. Authority restrictions - ensuring transactions over a certain value are restricted to key personnel.
D. Independent verification - having policies in place that require a second staff member to verify and authorise each entered order.

You selected D - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

D is correct because a independent verification would take place prior to the order being approved and submitted to the system, and prior to the actual payment of
funds. This type of policy and process is therefore seen as a preventive control.

A is incorrect because segregation of duties is helpful, but not necessarily between front and back office in this scenario.

B is incorrect because reconciliations are a detective control and would identify the error after the fact.

C is incorrect because while authority restrictions would ensure only key personnel can transact at a higher dollar value, the risk of key-punch error still exists.
Also, we are not provided with information as to what the limit would be in this scenario.

Module 8 > Internal control framework > Controlling financial risks

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Question 8 1 mark
Delta Ford Ltd has implemented a risk management framework for its key financial risks. The treasury manager is currently attending to its interest rate risk
management strategies.

Delta Ford Ltd has a $5 million floating rate loan outstanding, with 3 years until maturity. The treasury manager has reviewed forward rates as well as a range of bank
forecasts and is confident that interest rates will stay flat or decrease over the coming periods. The treasury manager recommends to leave the loan unhedged.

Which of the following correctly describes the treatment of interest rate risk in this situation?

A. Passing the risk to a third party.

B. Removing the source of the risk.
C. Changing the consequence of the risk.
D. Retaining the risk for opportunistic gain.

You selected D - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

Risk treatment is the step in the risk management framework that aims to modify or remove the risk. However, leaving the floating rate exposure unhedged equates to
retaining the risk for opportunistic gain. This may not be appropriate in many situations, but it ultimately depends on the risk appetite of the organisation and the confidence in
the forecasts.
Module 1 > ERM framework > Treat risk

Question 9 1 mark
Oscar Tango Ltd is calculating its weighted average cost of capital (WACC) and has identified the following inputs:

– Weight of debt: 24.50%

– Cost of debt (before tax): 4.50%

– Weight of equity: 75.50%

– Cost of equity (after tax): 15.25%

Assuming a tax rate of 30%, what is Oscar Tango Ltd’s after-tax WACC under the classical taxation system?

A. 9.16%.
B. 12.29%.
C. 12.62%.
D. 17.22%.

You selected B - This is correct

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The after-tax WACC is calculated as:

(Weight of debt x Cost of debt x (1 - tax rate)) + (Weight of equity x Cost of equity)

The cost of debt is provided on a before tax basis, so we need to change this to an after tax cost by multiplying by (1 - tax rate). The cost of equity is already provided on an
after-tax basis, so no further changes are required.

[ 24.50% x 4.50% x (1 - 30%) ] + [ 75.50% x 15.25% ] = 12.29%

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Question 10 0 marks
PQR Ltd has a 3-year project which involved the following nominal cash flows:

Initial investment ($100,000)

Annual incremental cash inflows $50,000

PQR Ltd’s nominal discount rate is 10%, and the current inflation rate is 2%. The NPV of the project using nominal cash flows is $24,343.

What is the NPV of the project using real cash flows and a real discount rate?

A. $19,680.
B. $24,343.
C. $28,855.
D. $29,220.

You selected D - This is incorrect. The correct answer is B

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The NPV using real cash flows and a real discount rate will be the same as the NPV using nominal cash flows and a nominal discount rate. The real cash flows strip out the
effect of inflation, by dividing the nominal cash flow by (1 + inflation rate)^n. The real discount rate strips out the effect of inflation, by calculating [ (1 + nominal discount rate) /
(1 + inflation rate) - 1 ].

The real discount rate is therefore: (1.10 / 1.02) - 1 = 7.84%.

The real cash flows become: Year 0 = ($100,000); Year 1 = ($50,000 / (1.02)^1) = $49,020; Year 2 = ($50,000 / (1.02)^2) = $48,058; Year 3 = ($50,000 / (1.02)^3) = $47,116.
The present value of the real cash flows become: Year 0 = ($100,000); Year 1 = ($49,020 / (1.0784)^1) = $45,455; Year 2 = ($48,058 / (1.0784)^2) = $41,322; Year 3 =
($47,116 / (1.0784)^3) = $37,566.

The NPV using real cash flows and a real discount rate is therefore $24,343.

Question 11 1 mark
XYZ Ltd is assessing its interest rate sensitivities and maturity profile. In the next 12 months, it has $3 million in net rate sensitive assets maturing. Beyond 12
months, it has $6 million in net rate sensitive liabilities maturing.

Which of the following statements is correct?

A. XYZ Ltd has a negative gap for shorter maturities and a positive gap for longer maturities.
B. XYZ will lose if interest rates fall over the next 12 months, given its positive gap for shorter maturities .
C. Under a normal yield curve, XYZ Ltd will benefit by having net rate sensitive assets maturing in the shorter term.
D. Under an inverse yield curve, XYZ Ltd will benefit from having net rate sensitive assets maturing in the longer term.

You selected B - This is correct

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XYZ Ltd has a positive gap for shorter maturities, as it has net rate sensitive assets under 12 months. XYZ Ltd has a negative gap for longer maturities, as it has
net rate sensitive liabilities over 12 months. If interest rates fall, this means the returns for assets (deposits) is going to be less, meaning the organisation is 'lose' if
it has a positive gap and needs to reinvest those funds at lower rates.

Under a normal yield curve, XYZ Ltd will benefit from having a negative gap in the short term. Under an inverse yield curve, XYZ Ltd will benefit from having a
negative gap in the longer term.

Module 5 > Key steps in IRRM > Step 2: Identify exposures

Question 12 1 mark
A financial institution deals in a range of financial instruments, and also provides foreign exchange services to customers. It’s head office is in the United Kingdom,
and it has customers in Japan, United States, Australia and New Zealand

Which of the following provides a direct foreign exchange quotation?

A. JPY/GBP 0.0065
B. GBP/AUD 1.8400
C. USD/GBP 0.7000
D. EUR/NZD 1.6300

You selected C - This is correct

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A direct FX quote is where the base currency (the left hand side of the quote) is the USD. All other quotations are indirect quotes.

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Question 13 0 marks
Which of the following statements about IFRS 9 are correct?

A. IFRS 9 only permits non-derivative financial instruments as hedge instruments.

B. IFRS 9 permits the hedging of net positions even when there is no hedge instrument.
C. IFRS 9 permits an organisation to terminate a fair value hedge when the highly probable forecast transaction is no longer expected to occur.
D. IFRS 9 only permits quantitative methods to demonstrate an economic relationship between the hedge item and hedging instrument for the purposes of
assessing hedge effectiveness.

You selected C - This is incorrect. The correct answer is B

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B is correct because IFRS 9 allows hedging of net positions (even when there is no hedge instrument), such as a net position of $40, made up of an asset of $200
and a liability of $160.

A is incorrect because IFRS 9 permits financial instruments at fair value through P&L to be designated as hedging instruments, provided the credit changes on
liabilities are not recorded in OCI.

C is incorrect because fair value hedges require a recognised asset/liability or a firm commitment, rather than a forecast transaction.

D is incorrect because IFRS 9 employs both qualitative methods of assessing hedge effectiveness and quantitative methods.

Module 7 > Complex hedge topics > Nil net positions, Eligible hedge instruments

Question 14 1 mark
Which of the following key risk controls would a director be responsible for establishing in a large organisation?

A. Review of monthly cash reconciliations.

B. Police checks are mandatory on all new employees.
C. Profit targets are realistic and consistent with the level of risk that the Board is prepared to accept.
D. Confirmations are sent to counterparties within a two-day timeframe for all new derivative trades.

You selected C - This is correct

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Cash reconciliations, checking of new employees and sending of confirmations are all examples of day-to-day activities that management would be responsible
for.

Directors are responsible for ensuring risk management policies are established and operating effectively. And they need to ensure that policy settings do not
encourage excessive risk taking. Setting reasonable profit targets that do not encourage excessive risk taking is the best example of this, therefore the third
option is correct.

Module 8 > Risk management framework > Other obligations

Question 15 1 mark
When establishing the context in an organisation’s risk management framework, which of the following would be considered an external factor?

A. Risk appetite.
B. Regulatory changes.
C. Competitive advantage.
D. Organisational structure.

You selected B - This is correct

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External factors relate to considerations outside the organisation that concern industry and broader economic elements. While outside the organisation, external factors still
affect the organisation's operations and strategy. Regulatory changes is an example of an external factor. Risk appetite, competitive advantage and organisational structure
are all internal factors that are specific to the organisation.
Module 1 > Establish the context > External factors

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Question 16 1 mark
JKL Ltd has calculated its cost of equity to be 15%. The current risk free rate is 3% and the current expected market risk premium is 7%.

What is the systematic risk of JKL Ltd’s securities?

A. 1.7
B. 3.0
C. 4.5
D. 4.8

You selected A - This is correct

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The systematic risk of the security is represented by beta in the CAPM equation. The CAPM equation is: Ke = Rf + [E(Rm) - Rf] x B.

In this question, we are provided with Ke, Rf and [E(Rm) - Rf] and we need to solve for B. Rearranging the equation forms:

(Ke - Rf) / [E(Rm) - Rf] = B

We can then solve for B as follows: (15% - 3%) / 7% = 1.7.

A common error is to treat the 'expected market risk premium' [E(Rm) - Rf] as the 'expected return on the market' (E(Rm)) and then subtract the risk free rate. But note that the
expected market risk premium has already subtracted this risk free rate, so that would be duplicating the subtraction.

Question 17 1 mark
MNO Ltd has a 2-year project which returned a net present value of $9,853. The project involved an initial investment of $100,000 and annual incremental cash
inflows of $65,000.

MNO Ltd’s required rate of return is 12%.

What is the internal rate of return (IRR) for the project?

A. The IRR is 9.8%.

B. The IRR is 14.2%.
C. The IRR is 19.4%.
D. It is not possible to determine the IRR without financial spreadsheeting programs.

You selected C - This is correct

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The IRR is the rate that applies when the NPV is zero. The NPV is currently positive, so in order to reduce the NPV to zero, the IRR must be higher than the required rate of
return of 12% (i.e. the higher rate reduces the present value of future cash flows).

There are therefore only two available options to consider. We can estimate the IRR through trial and error methods. Alternatively, we can re-calculate the NPV of the project
using the rates provided. A rate of 14.2% leads to an NPV of $6,758. A rate of 19.4% leads to an NPV of $0.

($100,000) + ($65,000 / 1.194^1) + ($65,000 / 1.194^2) = $0 (rounded)

Question 18 1 mark
QRS Ltd is offered an investment rate for deposits of 4.0%. The current consumer price index (CPI) is published at 1.5% and the company tax rate is 30.0%.

What is QRS Ltd’s approximated real rate of return?

A. -0.3%
B. 1.3%
C. 1.75%
D. 2.5%

You selected B - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

The approximate real rate of return is calculated as: Nominal interest rate x (1 - Company tax rate) - Inflation rate. In this case, the approximate real rate of return
is: 4% x (1 - 30%) - 1.5% = 1.3%.

Module 5 > Background > Nominal and real rates, pre- and post-tax

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Question 19 1 mark
The total revenue for a commodity producer with foreign exchange exposure can be represented by which of the following equations?

A. Total Revenue = Price x Quantity.

B. Total Revenue = Price (commodity) x Quantity / Price (currency).
C. Total Revenue = Price (commodity) + Quantity + Price (currency).
D. Total Revenue = Price (currency) x Quantity x Price (commodity).

You selected D - This is correct

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The general economic equation for Total Revenue is Price x Quantity.

When we add in the currency element, we get:

Total Revenue = Price of the commodity x Price of the currency x Quantity.

This is the same as the last option (with the elements just in a different order).

Module 6 > FX risk > Background to FX risk management

Question 20 1 mark
Your colleague has asked you about the measurement of ineffectiveness for a cash flow hedge. Your colleague provides you with the following sample information:
Sample 1:
Change in fair value of actual derivative = $36,000
Change in fair value of hypothetical derivative = $31,500
Sample 2:
Change in fair value of actual derivative = ($31,500)
Change in fair value of hypothetical derivative = ($36,000)

Which of the following treatments of ineffectiveness are correct?

A. Sample 1 - no ineffectiveness; Sample 2 - no ineffectiveness.

B. Sample 1 - ineffectiveness of ($4,500 CR) taken to profit and loss; Sample 2 - no ineffectiveness.
C. Sample 1 - no ineffectiveness; Sample 2 - ineffectiveness of ($4,500 CR) taken to profit and loss.
D. Sample 1 - ineffectiveness of ($4,500 CR) taken to equity; Sample 2 - ineffectiveness of ($4,500 CR) taken to profit and loss.

You selected B - This is correct

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With a cash flow hedge:

- if the change in fair value of the actual derivative is more than the change in fair value of the hypothetical derivative, then there is ineffectiveness which needs to
be taken to P&L. This is the case with Sample 1, as $36,000 > $31,500. As the movement in the actual derivative is a gain, the difference of $4,500 is taken to
P&L as a credit (CR).

- if the change in fair value of the actual derivative is lower than the change in fair value of the hypothetical derivative, then there is no ineffectiveness. This is the
case with Sample 2, as ($31,500) < ($36,000).

Module 7 > Hedge accounting > How effectiveness will be assessed and measured

Question 21 1 mark
An accounts payable staff member has identified that it is possible to amend the banking payments file after it has been approved by management.

Which element of a fraud does this situation describe?

A. Acceptance.
B. Opportunity.
C. Rationalisation.
D. Pressure / motive.

You selected B - This is correct

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B is correct because the opportunity exists for the employee to manipulate the banking file in their favour.

A is incorrect because acceptance is not one of the three typical elements of a fraud. They are rationalisation; pressure or motive; opportunity.

C is incorrect because rationalisation is about how the employee justifies their actions. The question just describes the opportunity that the employee has
identified.

D is incorrect because pressure or motive is about what might drive the employee to commit a fraud. The question just describes the opportunity that the
employee has identified.

Module 8 > Culture of financial risk management

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Question 22 0 marks
Which of the following is an element of the risk management framework published by AS/NZS ISO 31000:2009?

A. Monitoring and review.

B. Continual commitment.
C. Transparent and inclusive.
D. Systematic, structured and timely.

You selected C - This is incorrect. The correct answer is A

TOTAL MARKS : 1 MARKS OBTAINED 0

The AS/NZS ISO 31000:2009 has 11 principles and 5 elements. The fourth element is 'Monitoring and review'. Other elements include 'Mandate and commitment', 'Design',
'Implementation', and 'Continual improvement'.

'Continual commitment' is therefore not an element. The remaining options represent key principles (i.e. 'Transparent and inclusive' and 'Systematic, structured and timely').

Question 23 1 mark
With regards to credit ratings, what do the abbreviations ‘POD’ and ‘LGD’ refer to?

A. Pay on Demand | Loss Given Delay.

B. Proof of Delivery | Low Grade Default.
C. Probability of Detection | Low Grade Debt.
D. Probability of Default | Loss Given Default.

You selected D - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

POD refers to probability of default, and the consequent LGD refers to loss given default. The credit ratings are based on financial and business analysis and are designed to
determine the POD and LGD.
Module 2 > Funding risk and credit risk assessment > Nature and measurement of credit risk

Question 24 0 marks
Oscar Romeo Ltd is considering an investment in a machine with an initial cost of $800,000. The machine is expected to have an economic life of 5 years, and will
be depreciated on a straight line basis, with a salvage value of $200,000. The machine is expected to generate a net profit before depreciation of $250,000 each
year. Oscar Romeo Ltd’s minimum accounting rate of return is 15%.

Using the accounting rate of return (ARR), should Oscar Romeo Ltd invest in the machine?

A. Yes, because the ARR is 16.25%, which is above the minimum rate of 15%.
B. No, because the ARR is 11.25%, which is below the minimum rate of 15%.
C. Yes, because payback will be achieved within 4 years, which is shorter than the economic life of the machine.
D. No, because the ARR method is simplistic, ignores the time value of money, and is based on a subjective acceptance benchmark.

You selected B - This is incorrect. The correct answer is A

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The accounting rate of return (ARR) is calculated by determining the average annual accounting profit (after depreciation) as a percentage return on the initial cash outlay.

The average annual accounting profit (after depreciation) is calculated as follows:

Net profit before depreciation $250,000 - Depreciation ($120,000) = $130,000

Depreciation per annum is calculated as follows:

(Initial cost $800,000 - Salvage value ($200,000) = Depreciable amount $600,000) / Economic life 5 years = $120,000

The ARR is calculated as follows:

Annual net profit $130,000 / Initial outlay $800,000 = 16.25%

This result is higher than the benchmark of 15% and so the investment should proceed.

While the payback period is under 4 years, this was not the requirement of the question. Also, while the ARR is simplistic and has a number of disadvantages, this was not the
focus of the question.

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Question 25 1 mark
RTY Ltd has an obligation to sell AUD at the exchange rate of AUD/USD 0.8000 in 2 months’ time.

Which of the following derivative positions has RTY Ltd entered?

A. Sold AUD Put Option.

B. Sold AUD Call Option.
C. Bought AUD Put Option.
D. Bought AUD Call Option.

You selected B - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

A sold AUD call option provides the obligation, but not the right, to sell AUD at the strike rate. The counterparty would have the right, but not the obligation, to buy AUD at the
strike rate.

A bought AUD call option would provide the right, but not the obligation, to buy AUD. A sold AUD put option would provide the obligation to buy AUD if the counterparty
exercised the option. A bought AUD put option would provide the right, but not the obligation, the sell AUD.

Question 26 1 mark
RST Ltd has a $10 million floating rate borrowing, with a remaining term of five years. It is concerned that rates will increase in future years, and has purchased a
three-year payer swaption which has a strike rate of 4.50% and matures in two years.

At expiry of the swaption, the swap reference rate is 5.00%. Should RST Ltd exercise the swaption and what is the hedged borrowing rate?

A. Yes, exercise the swaption; Hedged borrowing rate of 4.50%.

B. Yes, exercise the swaption; Hedged borrowing rate of 5.00%.
C. No, do not exercise the swaption; Hedged borrowing rate of 4.50%.
D. No, do not exercise the swaption; Hedged borrowing rate of 5.00%.

You selected A - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

The swap rate of 5.00% is greater than the swaption rate of 4.50%, so RST Ltd would exercise the swaption and enter the pay-fixed swap at the lower rate. The hedged
borrowing rate therefore becomes the swaption rate of 4.50%.

Question 27 1 mark
The forward price of crude oil is lower than the current spot price of crude oil. The spot price of gold is lower than the forward price of gold.

Which of the following correctly classifies these two commodity markets?

A. Crude oil - contango; Gold - contango.

B. Crude oil - contango; Gold - backwardation.
C. Crude oil - backwardation; Gold - contango.
D. Crude oil - backwardation; Gold - backwardation.

You selected C - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

Contango describes the situation where the forward price is higher than the spot price. This is the case with the gold market in this question. Backwardation describes the
situation where the forward price is lower than the spot price. This is the case with the crude oil market in this question.

Question 28 0 marks
In the event that an embedded forward exchange contract (FEC) is to be separated for accounting purposes, what is the correct accounting treatment under IFRS
9?

A. The FEC is fair valued but it cannot be used as a hedging instrument.

B. The entire contract must be fair valued but it cannot be used as a hedging instrument.
C. The FEC is fair valued and it can be used as a hedging instrument if it qualifies for hedge accounting.
D. The entire contract must be fair valued and it can be used as a hedging instrument if it qualifies for hedge accounting.

You selected B - This is incorrect. The correct answer is C

TOTAL MARKS : 1 MARKS OBTAINED 0

As an embedded FEC can be measured reliably, the accounting standards require that the derivative component be accounted for as a derivative (i.e. at fair value) and
subject to hedge accounting if it qualifies.

The entire contract would only be fair valued in the event that the embedded derivative cannot be measured. As FECs are relatively easy to value, this would not apply.

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Question 29 1 mark
Violet Ltd has an accounts payable period of 14 days, an inventory period of 3 days and an accounts receivable period of 21 days.

Which of the following statements is correct?

A. Violet Ltd has an operating cycle of 24 days.

B. Violet Ltd has a cash conversion cycle of 38 days.
C. Violet Ltd collects the cash from customers before payment is made to suppliers.
D. Violet Ltd can reduce its cash cycle to zero be reducing its accounts receivable period by 7 days.

You selected A - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

The operating cycle is calculated as Inventory days (3) plus accounts receivable days (21), which equates to 24 days.

The cash conversion cycle is calculated as Inventory days (3) plus accounts receivable days (21) less accounts payable days (14), which equates to 10 days (not
38 days). Reducing accounts receivable days by 7 would reduce the cash cycle to 3 days, not zero.

Cash payments take place on day 14 and cash collection takes place on day 24 (i.e. 3 inventory days = 21 receivable days), so cash is not received before
payments are made.

Module 2 > Working capital management > Measuring working capital requirements

Question 30 1 mark
Which of the following correctly describes the characteristics of Samurai bonds?

A. The bonds are issued by Japanese issuers, in Japanese yen, to foreign investors.
B. The bonds are issued by non-Japanese issuers, to investors in Japan, in Japanese yen.
C. The bonds are issued in Japanese yen, by non-Japanese issuers, to investors outside Japan.
D. The bonds are issued to investors in Japan, by non-Japanese issuers, in a currency other than Japanese yen.

You selected B - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

Samurai bonds are an example of Foreign bonds. They are issued by foreigners, they are denominated in Japanese yen, and they are issued to investors in Japan.

Question 31 1 mark
Which of the following describes a ‘two-month versus five-month forward rate agreement (FRA)’?

A. An agreement to lock in an interest rate for either a two-month period or a five-month period.
B. An agreement to lock in an interest rate for a five-month period beginning in two-months' time.
C. An agreement to lock in an interest rate for a three-month period beginning in two-months' time.
D. An agreement to lock in an interest rate for a three-month period beginning in five-months' time.

You selected C - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

A '2 x 5 FRA' refers to an agreement to lock in a fixed rate (e.g. for a borrowing) for a three month period starting in two months' time. The '2' refers to the starting time; the '5'
refers to the ending time. The difference between the two figures is the length of the actual interest rate period (5 - 2 = 3 months).

Question 32 1 mark
PQR Ltd has a $2 million borrowing requirement in two months’ time. It wants to protect itself against a rising interest rate, but wants to participate in some benefits
from a falling rate. PQR Ltd also doesn’t want to pay any hedging costs upfront.

Which of the following risk management strategies will meet PQR Ltd’s desired outcomes?

A. Buy an interest rate call option to protect against rising interest rates.
B. Enter a forward rate agreement to protect against rising interest rates.
C. Sell an interest rate put option to generate additional income from falling rates.
D. Buy an interest rate call option and sell an interest rate put option to limit the interest rate range.

You selected D - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

An interest rate collar arrangement can be structured for a borrower by buying a cap (call option) and selling a floor (put option). This can be structured to provide a zero cost
upfront. It allows for the cap rate to protect against unfavourable movements, and the put rate to allow some room to benefit from favourable movements.

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Question 33 0 marks
The current gold spot rate is AUD 1500 per ounce and the 12 month gold forward rate is AUD 1550 per ounce. The Australian 12-month interest rate is 5.0%.

Assuming no bank fees or margins, what is the current 12-month gold lease rate?

A. -1.50%.
B. 1.00%.
C. 1.67%.
D. 2.50%.

You selected B - This is incorrect. The correct answer is C

TOTAL MARKS : 1 MARKS OBTAINED 0

The spot price is AUD 1,500 per ounce, and the interest rate is 5%, taking the price to AUD 1,575 in one year (i.e. 1,500 x 1.05). The forward rate is AUD 1,550, so the lease
rate needs to reduce the price from AUD 1,575 to AUD 1,550. This is AUD 25, which is one third of the interest rate rise. If the interest rate was 5%, the lease rate is 1/3 x 5%
= 1.67%. We calculate the gold forward as: Spot price + Interest - Lease. We can rearrange the formula to become: Lease = Spot price + Interest - Forward price. In this
situation, AUD 1,500 + AUD 75 - AUD 1,550 = Lease of AUD 25. AUD 25 / AUD 1,500 = 1.67%.

Question 34 1 mark
JKL Ltd has a purchase contract with the following components:

– Hybrid instrument: (USD 5,000,000), being the purchase of equipment from a foreign manufacturer in USD.
– Host contract: (AUD 5,250,000), being the purchase of equipment in AUD at the current forward rate to the date of settlement.

What is the embedded derivative and its value?

A. A foreign exchange option, with a receipt of USD 5,000,000.

B. A forward exchange contract with a receipt of AUD 5,250,000 only.
C. A foreign exchange option, with a receipt of USD 5,000,000 and a payment of AUD 5,250,000.
D. A forward exchange contract with a receipt of AUD 5,250,000 and a payment of USD 5,000,000.

You selected D - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

Hybrid instrument = Host contract + Embedded derivative. So, Embedded derivative = Hybrid Instrument - Host contract. If the Hybrid instrument is (USD 5,000,000) and the
Host contract is (AUD 5,250,000), the embedded derivative is: (USD 5,000,000) - (AUD 5,250,000). This double negative for the host contract converts the AUD payment into
a receipt. The Embedded derivative must therefore be both a payment of USD 5,000,000 and a receipt of AUD 5,250,000.

Question 35 1 mark
Which of the following statements regarding Australian regulators and legislation is incorrect?

A. Directors duties and corporate regulation is overseen by ASIC.

B. All listed Australian companies must comply with the Sarbanes-Oxley Act.
C. The ASX Principles address risk management on an 'if not, why not?' basis.
D. An Australian superannuation fund would be regulated by both ASIC and APRA.

You selected B - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

B is correct because only those companies with activities in the US need to comply with the Sarbanes Oxeley Act.

A is incorrect because directors duties are contained in the Corporations Act 2001 (Cwlth), which is administered by ASIC.

C is incorrect because Principle 7 of the ASX Principles recommends that listed entities should establish a sound risk management framework.

D is incorrect because ASIC and APRA both play a role in the regulatory supervision of superannuation funds.

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Question 36 0 marks
Canyon Grand Inc. is a US-based organisation with operations in Japan. Canyon Grand’s currency exposures over the coming two periods are as follows:
USD exposure:
– Period 1: +USD 5 million
– Period 2: -USD 3 million
JPY exposure:
– Period 1: -JPY 420 million
– Period 2: +JPY 480 million

Assuming Canyon Grand Inc has the USD as its functional currency, what is its net foreign exchange exposure for the total period?

A. +USD 2 million.
B. +JPY 60 million.
C. JPY 900 million.
D. +USD 2 million and +JPY 60 million.

You selected D - This is incorrect. The correct answer is B

TOTAL MARKS : 1 MARKS OBTAINED 0

As Canyon Grand has selected the USD as its functional currency, then the JPY is the foreign currency it is exposed to. The JPY has an outflow of JPY 420 million in period 1,
followed by an inflow of JPY 480 million in period 2. The net foreign currency exposure is therefore an inflow of JPY 60 million.

Question 37 0 marks
Lima Delta Ltd has just started operations and needs funding to assist with early business growth. It requires approximately $1 million in funding in the first two (2)
years. However, Lima Delta Ltd does not need to draw down on the full amount immediately, as it only requires drawdowns of approximately $50,000 per month.

Which of the following financing types would be most appropriate for Lima Delta Ltd during this initial period?

A. Term loan.
B. Bank overdraft.
C. Promissory note.
D. Fully drawn advance.

You selected D - This is incorrect. The correct answer is B

TOTAL MARKS : 1 MARKS OBTAINED 0

Lima Delta Ltd requires funding in instalments, rather than the full $1 million immediately. As such, it's preference would be to only pay interest on the actual funding required
and actually drawn down (rather than draw down the full $1 million and pay interest on that amount from the start).

A bank overdraft permits the organisation to only drawdown the amounts they need each month, and interest is only charged on the drawndown amount. The other options
typically require the full amount to be drawn down in full immediately, and some may require repayment at various stages during the applicable term, and so would not be as
preferable.

Question 38 1 mark
FGH Ltd is an importer of fashion goods. In 6 months’ time, it is due to make a large payment to a customer in Japanese Yen and it will need to convert the funds
from AUD. The current exchange rate is AUD/JPY 80 and FGH Ltd wants to limit the amount of AUD required, but participate fully in any upside.

Which of the following derivatives would be suitable for FGH Ltd?

A. AUD Put Option to protect against a falling AUD and lock in a minimum amount.
B. Foreign Exchange Swap to convert the AUD into JPY and remove the timing mismatch.
C. AUD Collar Option to provide a floor and a cap on the AUD/JPY exchange rate, providing greater certainty.
D. Forward Exchange Contract to lock in an exchange rate and remove foreign exchange uncertainty from the transaction.

You selected A - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

A is correct because an AUD put option protects against a falling AUD, which would otherwise increase the cost to the importer. The option also provides a limit
(in the form of a floor), but allows FGH Ltd to participate in a rising AUD.

B is incorrect because while an FX swap helps to remove timing exposures, this is not the issue in this scenario.

C is incorrect because while an AUD collar option can provide a limit (in the form of a floor), it does not allow FGH Ltd to participate fully in the upside (because of
the related cap in place).

D is incorrect because an FEC will lock in a rate at the future period, and this will not allow FGH Ltd to participate in any upside.

Module 4 > The role of derivatives in financial risk management > The three main categories of derivatives

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Question 39 0 marks
Which of the following risk management strategies would provide a borrowing organisation with ‘crisis protection’?

A. Enter into a forward rate agreement to lock in borrowing rate at the organisation's target level cost.
B. Enter into an interest rate swap to convert a floating exposure to a fixed exposure at the organisation's target level cost.
C. Enter in a zero cost collar option and set the cap at the organisation's target level cost to protect against unfavourable movements.
D. Enter into an interest rate call option with a strike price above the target level cost, but below the cost where liquidity or funding risks become too great.

You selected A - This is incorrect. The correct answer is D

TOTAL MARKS : 1 MARKS OBTAINED 0

The 'out-of-the-money' call option would be used to borrow at the strike rate in a crisis situation (i.e. if rates increased well beyond that strike rate).

Note that the FRA and the swap lock in a rate, when we want to protect against a crisis situation occurring only. The collar might not lock in a rate, but the cap
strike is not protecting against 'crisis' situations, as it is set at the target level cost.

Module 5 > Key steps in IRRM > Step 4: Manage risks (treasury operations)

Question 40 1 mark
GoldSpark Ltd is a gold producer. Its functional currency is the AUD and gold sales are made in USD per ounce. GoldSpark Ltd forecasts 100,000 ounces of gold
will be sold in 3 months’ time, and wants to lock in a price to protect against commodity price risk.

The current exchange rate is AUD/USD 0.8000, and the 3-month forward exchange rate is AUD/USD 0.7900.

The current gold spot price is USD 1200 per ounce, and the 3-month gold forward price is USD 1225 per ounce.

What is the AUD amount that GoldSpark Ltd can lock in today for the sale of gold in 3 months’ time?

A. AUD 150,000,000.
B. AUD 151,898,734.
C. AUD 153,125,000.
D. AUD 155,063,291.

You selected D - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

There are 100,000 ounces of gold, and these can be hedged at the 3-month forward rate of USD 1225 per ounce, equating to USD 122,500,000. This USD value
can be hedged back to AUD at the forward rate of AUD/USD 0.7900, equating to AUD 155,063,291.

Module 6 > Commodity price risk > Introduction

Question 41 1 mark
Upon the termination of a cash flow hedge due to the forecast no longer being expected to occur, what is the accounting treatment?

A. Retain any cumulative gain/loss in the P&L.

B. Retain any cumulative gain/loss in OCI separately in equity.
C. Reclassify any cumulative gain/loss in OCI from equity to profit and loss.
D. Reclassify any cumulative gain/loss in the P&L from profit and loss to equity.

You selected C - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

Where the forecast is no longer expected to occur, any cumulative gain/loss in OCI will undergo a reclassification adjustment and be reclassified from equity to P&L.

Question 42 0 marks
In a large financial institution with a three-office structure, who would be responsible for verifying that balances in the end-of-year balance sheet can be reconciled
back to a transaction listing?

A. Back Office.
B. Middle Office.
C. Internal Audit.
D. External Audit.

You selected C - This is incorrect. The correct answer is A

TOTAL MARKS : 1 MARKS OBTAINED 0

A is correct because the back office function includes the Finance / Accounting function, and they typically would be responsible for this reconciliation.

B is incorrect because the middle office function is typically responsible for monitoring and reporting on risk, not on accounting data.

C is incorrect because internal audit would not be responsible for performing controls such as this reconciliation. Their function is to monitor compliance with risk policies, they
typically report their findings to senior management and/or the board.

D is incorrect because external audit are responsible for providing an opinion on the company's financial reports, not for performing any type of reconciliation function.

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Question 43 1 mark
Fort Knock Ltd is a gold producer. It has production costs of USD 800 per ounce, and it expects a profit margin of at least 20%. The current spot price is USD 1200
per ounce.

Fort Knock Ltd rates the volatility in the gold price as low, with daily price fluctuations being USD 12.50 per ounce.

How would Fort Knock Ltd most likely rate its commodity price risk exposure?

A. Acceptable, as the gold price has not breached either its production costs or its desired selling price.
B. Acceptable, as daily gold price movements would be unlikely to breach its target selling price within a 15-trading day period.
C. Unacceptable, as volatility is rated as low and this risk category would likely breach the organisation's risk appetite.
D. Unacceptable, as the gold price volatility suggests it could breach the target selling price within a 15-trading day period.

You selected B - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

The production costs are USD 800 per ounce, and the target margin is 20%, meaning that the target selling price is USD 1,000 per ounce (i.e. USD 800 / (1 -
20%)).

Volatility is rated as low, with USD 12.50 per ounce average daily price movements. With the current gold price at USD 1,200 per ounce, this means that the
target selling price could be breached after 16 days of average downward price movements.

In this situation, Fort Knock Ltd would likely rate the commodity price risk as Acceptable, rather than Unacceptable. Given it would not breach the target selling
price within 15 days, the second option is correct.

The fact that Fort Knock Ltd has not yet experienced a breach of either the target selling price or the production cost amounts is not a valid reason for designating
the risk as acceptable.

Module 1 > Framework for FRM > Identifying financial risk and opportunity in an organisation

Question 44 1 mark
Sierra Alpha Ltd has raised unsecured debt from a financial institution. It agrees to not raise any secured debt, or any further unsecured debt without the financial
institution’s prior permission.

What is the recognised term for this type of funding arrangement?

A. Debt seniority.
B. Unsecured note.
C. Negative pledge.
D. Debt defeasance.

You selected C - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

A negative pledge borrowing is one where the issuer is able to raise unsecured or partially secured funds while at the same time pledging to not provide a higher
ranking security to another lender. This has the effect of somewhat protecting the lender, as the lender retains its existing priority or ranking in the event of
insolvency of the borrower.

Debt defeasance is a type of debt restructuring. Unsecured notes are a type of unsecured borrowing, but they do not necessarily involve the pledge that has been
made in this situation. Debt seniority is a related concept, but it does not describe the underlying funding arrangement in this situation.

Module 3 > Sources of funds for business > Long-term debt financing

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Question 45 1 mark
Zulu Charlie Ltd purchased a gold commodity futures for cash settlement in 6 months’ time. The contract is for 100 ounces at a settlement price of USD 1,300 per
ounce. The current spot price is USD 1,250 per ounce.

The futures clearing house required an initial margin to be deposited, which represented 3% of the total contact value, based on the futures price. It also requires a
variation margin to be deposited each time the spot price moves unfavourably against the futures price, and this margin represents the full value of any price
movements.

Assuming the spot price dropped to USD 1,200 per ounce, what is the total margin that Zulu Charlie Ltd will have deposited with the futures clearing house?

A. $3,600.
B. $3,900.
C. $8,900.
D. $13,900.

You selected C - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

The initial margin to be deposited will be $3,900. This is calculated as 100 ounces x USD 1,300 per ounce futures price x 3% initial margin = $3,900.

The variation margin to be deposited will be $5,000. This is based on the USD 50 fall in the spot price from USD 1,250 per ounce to USD 1,200 per ounce and is
calculated as: 100 ounces x USD 50 per ounce fall = $5,000.

The total margin on deposit is therefore $8,900 (i.e. $3,900 + $5,000).

Module 4 > Futures > Trading process

Question 46 0 marks
BCD Ltd has a 3-year borrowing with a principal of $2 million, annual interest payments and a floating rate of BBSW + 2.5%. BCD Ltd is looking to protect against
rising rates and has decided to enter a 3-year pay fixed-receive floating interest rate swap with a notional principal of $2 million. The fixed rate under the swap is
4.5% and the floating rate under the swap is BBSW + 2.0%.

Assume that the relevant BBSW rate at the first settlement date was 2.8%. What is the overall effective borrowing rate paid by BCD Ltd?

A. 4.5%
B. 4.8%
C. 5.0%
D. 5.3%

You selected A - This is incorrect. The correct answer is C

TOTAL MARKS : 1 MARKS OBTAINED 0

BCD Ltd is currently paying BBSW + 2.5%. Under the IRS, it will receive BBSW + 2.0%. So, the BBSW payment and receipt net off. This just leaves a net outflow
of 0.5% on the floating rate portion of its exposures (as it pays 2.5% and receives 2.0%). We then add the fixed rate payment of 4.5% under the IRS, and this
totals an overall effective interest rate of 5.0%.

Module 5 > The key IRRM financial instruments--swaps and options > Interest rate swaps (IRSs)

Question 47 1 mark
FGH Ltd is an importer of electronics equipment. It has a large order that requires payment of USD 4,000,000 to its Chinese supplier in 3 months’ time.

The current exchange rate is AUD/USD 0.7500 and FGH Ltd wants to protect against a falling AUD. It decides to buy an AUD put option with a strike rate of
AUD/USD 0.7450, for a premium of 0.0125.

What is the worst-case effective exchange rate that FGH Ltd will achieve?

A. 0.7325.
B. 0.7375.
C. 0.7450.
D. 0.7575.

You selected A - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

To calculate the worst-case effective exchange rate, we subtract the premium payable (0.0125) from the strike rate (0.7450), which equals 0.7325.

Module 6 > FX risk > Step 4: Operations--implement strategies

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Question 48 0 marks
Which of the following list the specific requirements to qualify as a hedge relationship under IFRS 9?

A. A hedged item, a hedge instrument, formal documentation, and a director's declaration.

B. A hedge item, a hedge instrument, formal documentation, and a functional currency declaration.
C. Formal documentation and designation, a hedged item, hedge effectiveness, and a risk management committee authorisation.
D. A hedge relationship with only eligible hedge instruments and items, designation and documentation, and hedge effectiveness.

You selected C - This is incorrect. The correct answer is D

TOTAL MARKS : 1 MARKS OBTAINED 0

At a summarised level, there are three primary requirements for hedge accounting under IFRS 9:

(i) the hedging relationship consists only of eligible hedging instruments and eligible hedged items;
(ii) there is formal designation and documentation of the hedging relationship and the entity's risk management objective and strategy for undertaking the hedge;
(iii) the hedging relationship meets the hedge effectiveness requirements.

A director's declaration, risk management committee authorisation and functional currency declaraction are not required.

Question 49 1 mark
Which of the following statements regarding the Committee of Sponsoring Organizations of the Treadway Commission (COSO) is correct?

A. 'Escalation' is one of the five key components of the COSO cube.

B. Compliance with the COSO framework is mandatory for all ASX-listed companies.
C. Under the 2013 Framework, all five components are required to operate together in an integrated manner.
D. COSO was formed by the Treasury Department to provide recommendations on internal control settings for public companies.

You selected C - This is correct

TOTAL MARKS : 1 MARKS OBTAINED 1

C is correct because the COSO model states that each of the five components should be present and functioning, and that they are required to operate together
in an integrated manner.

A is incorrect because the five components of the COSO cube are control environment; risk assessment; control activities; information and communication;
monitoring activities

B is incorrect because compliance is not mandatory for all ASX-listed companies.

D is incorrect because COSO was formed independent of the government by the private sector.

Module 8 > Internal control framework > Committee of Sponsoring Organizations of the Treadway Commission

Question 50 0 marks
Ralpha Ltd’s financial reports for the last two years reveal the following:
20X5:
– Depreciation $100,000
– Net income $500,000
– Current assets $800,000
– Current liabilities $500,000
– Capital expenditure $175,000
20X6:
– Depreciation $150,000
– Net income $400,000
– Current assets $950,000
– Current liabilities $450,000
– Capital expenditure $190,000

What is Ralpha Ltd’s free cash flow in 20X6?

A. ($140,000).
B. $160,000.
C. $350,000.
D. $560,000.

You selected A - This is incorrect. The correct answer is B

TOTAL MARKS : 1 MARKS OBTAINED 0

Free cash flow is calculated as: Net income + Depreciation - Changes in net working capital - Capital expenditure.

Net working capital is calculated as: Current assets (year t) - Current liabilities (year t). In 20X6, this is $500,000 (i.e. $950,000 - $450,000). In 20X5, this is $300,000 (i.e.
$800,000 - $500,000).

The change in net working capital is calculated as: 'Net working capital (year t) - Net working capital (year t-1). In 20X6, this is $200,000 (i.e. $500,000 - $300,000).

Free cash flow in 20X6 is therefore: $400,000 + $150,000 - $200,000 - $190,000 = $160,000.

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Question 51 0 marks
Oscar Papa Ltd is evaluating two mutually exclusive projects with different lengths. The cash flows for each project are as follows:
Project A
– Year 0: ($400,000)
– Year 1: $500,000
Project B
– Year 0: ($300,000)
– Year 1: $150,000
– Year 2: $125,000
– Year 3: $175,000

Oscar Papa Ltd has a required rate of return of 13%.

Using the continuous replacement method, what are the respective project net present values?

A. Project A $42,478 | Project B $51,920.

B. Project A $48,000 | Project B $21,989.
C. Project A $113,335 | Project B $51,920.
D. Project A $369,231 | Project B $169,150.

You selected C - This is incorrect. The correct answer is D

TOTAL MARKS : 1 MARKS OBTAINED 0

Step 1: The 1-year NPV of Project A is $42,478. This is calculated as: -$400,000 + ($500,000 / 1.13^1). The 3-year NPV of Project B is $51,920. This is
calculated as: -$300,000 + ($150,000 / 1.13^1) + ($125,000 / 1.13^2) + ($175,000 / 1.13^3).

Step 2: The present value annuity factor of Project A is 0.884956 (i.e. (1/0.13)x(1-(1/1.13^1))). So, the Project A EAA is $48,000 (i.e. $42,478 / 0.884956). The
EAA of Project B is 2.361153 (i.e. (1/0.13)x(1-(1/1.13^3))). So, the Project B EAA is $21,989 (i.e. $51,920 / 2.361153).

Step 3: The perpetuity NPV of Project A is $369,231 (i.e. $48,000 / 13%). The perpetuity NPV of Project B is $169,150 (i.e. $21,989 / 13%).

Module 3 > Capital budgeting techniques > NPV and IRR methods compared

Question 52 0 marks
Which of the following is considered a benefit of lower risk?

A. A higher return on investments as the chance of variation in returns is reduced.

B. A lower cost of debt, reducing the trading price of an organisation's discount debt securities.
C. A higher credit rating, leading to a higher credit value adjustment for counterparty credit risk.
D. A higher share price as investors may pay more for shares in organisations that have lower volatility in earnings.

You selected B - This is incorrect. The correct answer is D

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D is correct because investors see value in more stable earnings, which can lead to more stable share prices and hence they will be willing to pay a premium for this.

A is incorrect because a lower risk typically means the lower the return.

B is incorrect because a lower cost of debt increases the trading price of discount securities (i.e. closer to their face value).

C is incorrect because a higher credit rating decreases the CVA.

Question 53 1 mark
BCD Ltd has a 3-year borrowing with a principal of $2 million, annual interest payments and a floating rate of BBSW + 2.5%. BCD Ltd is looking to protect against
rising rates and has decided to enter a 3-year pay fixed-receive floating interest rate swap with a notional principal of $2 million. The fixed rate under the swap is
4.5% and the floating rate under the swap is BBSW + 2.0%.

Assume that the relevant BBSW rate at the second settlement date was 1.8%. What is the net payment or receipt on the interest rate swap by BCD Ltd?

A. $4,000 Payment.
B. $10,000 Receipt.
C. $10,000 Payment.
D. $14,000 Payment.

You selected D - This is correct

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The IRS has a notional principal of $2 million. BCD Ltd is paying a fixed rate of 4.50% under the IRS, so the notional payment would be $90,000.

BCD Ltd is receiving BBSW + 2.0% under the IRS. With a BBSW of 1.8%, this equates to a floating rate receipt of 3.8%, with a notional receipt of $76,000.

The net payment is therefore $14,000.

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Question 54 0 marks
A colleague at your workplace states that “For an amount of USD 5,000,000, every one cent change in the AUD/USD exchange rate moves the AUD value by AUD
50,000”.

Which of the following is a correct response?

A. No, that's not correct. For every one cent change in the AUD/USD exchange rate, the movement is only AUD 5,000.
B. No, that's not correct. For each one cent move in the AUD/USD exchange rate, the AUD value can change by more or less than AUD 50,000.
C. Yes, that's correct. We divide the USD 5,000,000 by the exchange rate to obtain the AUD value, which would move by AUD 50,000 for each one cent change in
the AUD/USD.
D. Yes, that's correct. We multiply the USD 5,000,000 by the exchange rate to obtain the AUD value, which would move by AUD 50,000 for each one cent change in
the AUD/USD.

You selected C - This is incorrect. The correct answer is B

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We need to divide the USD 5,000,000 by the exchange rate to obtain the AUD value. For example, at AUD/USD 0.9800, USD 5,000,000 equates to AUD 5,102,041, and at
AUD/USD 0.99000, this equates to AUD 5,050,505, which is a difference of $51,536.

Question 55 1 mark
QRS Ltd has the AUD as its functional currency and has a contract to sell 1000 ounces of gold for USD 1200 per ounce. The relevant exchange rate is AUD/USD
0.7500.

Which of the following best describes what QRS Ltd is permitted to hedge?

A. Commodity price risk only.

B. Foreign exchange risk only.
C. Commodity price risk only or foreign exchange risk only.
D. Foreign exchange risk, commodity price risk, or all risks.

You selected D - This is correct

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For non-financial items such as commodity sales and purchases, permitted risks to hedge include foreign exchange risk only; commodity price risk only, or all
risks (commodity price risk and foreign exchange risk).

Module 7 > The nature of risk > Hedge risks

Question 56 1 mark
Top Stock Pty Ltd manufactures liquid stock products in Australia and exports them to Hong Kong. Sales are settled in the local currency, HKD. Its risk
management policy requires that all foreign exchange exposures should be hedged between 90% – 100%.

Top Stock has borrowed HKD 50,000,000, which is currently invested in a local HKD bank account. It is also expecting sales revenue of HKD 20,000,000 to be
settled in six months’ time.

The risk management policy permits the use of FX Forwards to manage FX risk.

What would be the minimum amount of HKD that Top Stock could sell forward whilst complying with its risk management policy?

A. HKD 18,000,000
B. HKD 20,000,000
C. HKD 63,000,000
D. HKD 70,000,000

You selected A - This is correct

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The HKD 50,000,000 borrowing and deposit would effectively offset each other from an FX risk perspective. So this would not require any hedging.

The HKD 20,000,000 receivable is a real exposure. To satisfy the risk management policy of 90-100% hedging, the minimum amount to sell forward would be:
HKD 20,0000,000 x 90% = HKD 18,000,000

Module 8 > Internal control framework > Committee of Sponsoring Organizations of the Treadway Commission

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Question 57 1 mark
Sierra Tango Ltd has submitted its quarterly financial report to its external funding providers. The report notes a current ratio of 1.7 and a quick ratio of 1.2.

Sierra Tango Ltd also notes the following balance sheet totals:
– Non-Current liabilities $1,250,000.
– Total Liabilities $2,000,000.

What is Sierra Tango’s current inventory balance?

A. $375,000.
B. $625,000.
C. $637,500.
D. $1,275,000.

You selected A - This is correct

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The Current Ratio is 1.7 and this is Current Assets / Current Liabilities. Current Liabilities are $750,000 (i.e. Total Liabilities of $2,000,000 less Non-Current Liabilities of
$1,250,000). Current Assets are therefore $1,275,000 (i.e. Current Ratio of 1.7 x Current Liabilities of $750,000). The Quick Ratio is 1.2 and this is (Current Assets - Inventory)
/ Current Liabilities. (Current Assets - Inventory) is therefore $900,000 (i.e. Quick Ratio of 1.2 x Current Liabilities of $750,000). We can rearrange the formula and insert the
value of Current Assets ($1,275,000), such that: -Inventory = $900,000 - $1,275,000 Inventory is therefore equal to $375,000. We can also confirm the calculation in another
way. The Current Ratio of 1.7 reduced by 0.5 to become the Quick Ratio of 1.2. The only difference in the ratios is the subtraction of inventory in the Quick Ratio. If we multiply
this 0.5 by the Current Liabilities value of $750,000, we obtain an inventory value of $375,000.
Module 2 > Liquidity management > Ratios to measure liquidity

Question 58 1 mark
Delta Romeo Ltd has recently released a rights issue to existing shareholders, being one share for every three shares currently held.

Each new share is being offered at a price of $4.50 per share and the current share price is $5.50 per share.

What is the theoretical rights value per share?

A. $0.25
B. $0.50
C. $0.75
D. $1.00

You selected C - This is correct

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The theoretical rights value is provided by the formula: R = N * (P - S) / (N + 1) In this scenario, N = 3 (existing shares required for each new share), P = $5.50 (current share
price), and S = $4.50 (new share offer price), providing: R = 3 * ($5.50 - $4.50) / (3 + 1) = $0.75.
Module 3 > Equity financing > Mechanisms for raising equity capital

Question 59 1 mark
Which of the following best describes basis risk?

A. The risk that interest rate basis points have volatile movements.
B. The risk that the price or quality of a hedging instrument does not match the underlying asset.
C. The risk that the foreign exchange forward rates are based on forecasts rather than calculations.
D. The risk that earnings and value change with adverse changes in foreign exchange rates, commodity prices and interest rates

You selected B - This is correct

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Basis risk describes the situation where the spot price (or quality) of the underlying asset varies from the hedging instrument used. For example, where futures contracts have
standardised contract terms that don't match the organisation's underlying exposure.

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Question 60 1 mark
LMN Ltd has a $50 million borrowing requirement for 90 days starting in one months’ time. LMN Ltd has purchased an interest rate call option to cap the borrowing
rate at 5.75%.

In one months’ time, at expiry of the call option and the issuing of the bank bills, the reference rate is 6.25%.

What is LMN Ltd’s effective borrowing rate and net borrowing proceeds?

A. 5.75% and $47,281,324.

B. 5.75% and $49,301,006.
C. 6.25% and $49,241,147.
D. 6.25% and $49,938,432.

You selected B - This is correct

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The effective borrowing rate is the cap rate of 5.75%. This is because the reference rate (6.25%) is higher than the cap rate (5.75%) and so LMS Ltd will exercise the option.

The net borrowing proceeds (based on 5.75%) are calculated as:

PV = $50,000,000 / (1 + (0.0575 x (90 / 365))) = $49,301,006.

Question 61 1 mark
FGH Ltd is an importer of electronics equipment. It has a large order that requires payment of USD 4,000,000 to its Chinese supplier in 3 months’ time.

The current exchange rate is AUD/USD 0.7500 and FGH Ltd wants to protect against a falling AUD. It decides to buy an AUD put option with a strike rate of
AUD/USD 0.7450, for a premium of 0.0125.

Assuming the exchange rate in 3 months’ time is AUD/USD 0.7475, what is the AUD amount required by FGH Ltd to settle the USD payment on expiry of the option?

A. AUD 5,351,171
B. AUD 5,369,128
C. AUD 5,442,177
D. AUD 5,460,751

You selected A - This is correct

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At settlement in 3 months' time, the exchange rate is AUD/USD 0.7475. This is above the put strike rate of 0.7450, so the put option would not be exercised. FGH
Ltd will transact in the spot market at AUD/USD 0.7475. USD 4,000,000 / 0.7475 = AUD 5,351,171. Note that the put option premium of 0.0125 would have been
paid upfront, and so has not been included in this final settlement amount.

Module 6 > FX risk > Step 4: Operations--implement strategies

Question 62 1 mark
Which of the following correctly matches the type of hedge with the hedged item?

A. Cash flow hedge for a variable rate borrowing.

B. Cash flow hedge for an unrecognised firm commitment.
C. Fair value hedge for a highly probable forecast transaction.
D. Fair value hedge for an unrecognised firm commitment for FX only.

You selected A - This is correct

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Cash flow hedges are for assets/liabilities, highly probable forecast transactions, unrecognised firm commitments for FX only and aggregated exposures. Fair value hedges
are for assets/liabilities, unrecognised firm commitments and aggregated exposures.

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Question 63 1 mark
Segregation of duties between back office, middle office and front office in a financial institution is an example of which type of control?

A. Existence.
B. Detective controls.
C. Corrective controls.
D. Preventative controls.

You selected D - This is correct

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D is correct because segregation of duties is about preventing the errors / breaches from occurring in the first place. That makes it a preventative control.

A is incorrect because existence is an assertion, not a type of control.

B is incorrect because detective controls are there to detect errors after they have occurred. Segregation of duties is about preventing the errors / breaches from occurring in
the first place.

C is incorrect because corrective controls are there to fix errors / breaches after they have occurred. Segregation of duties is about preventing the errors / breaches from
occurring in the first place.

Question 64 0 marks
Bravo Delta Ltd is an Australian organisation that manufactures equipment. It sells the equipment in US dollars via an online store. Buyers are located throughout
the world and they are required to make payment during the online checkout process. The online store transactions then need to be linked to Bravo Delta Ltd’s
accounting system.

Which of the following correctly matches the financial risk to the explanation of the risk in Bravo Delta Ltd’s situation?

A. Credit risk - as sales via an online store result in accounts receivable exposures that can cause loss.
B. Foreign exchange risk - as sales in a foreign currency can expose the organisation to translation risk.
C. Operational risk - as matching and reconciliations are required between the online store system and the accounting system.
D. Interest rate risk - as interest rate movements can cause interest expense and fair values of debt to fluctuate.

You selected B - This is incorrect. The correct answer is C

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C is correct because the operational risk component relates to the risk that orders are not correctly entered or that discrepancies may cause delays in orders/deliveries. It is
important for reconciliations to be undertaken and exception reports to be produced when data is shared between systems.

A is incorrect because the credit risk component would apply with payment upfront - this would only be the case where credit or extended payment terms are provided.

B is incorrect because the foreign exchange risk component would relate in transaction risk (revenues/expenses) rather than translation risk (assets/liabilities).

D is incorrect because, while the explanation of the risk is correct, there is no interest rate risk component specifically referred to in the case scenario for Bravo Delta Ltd.

Question 65 1 mark
Which of the following is not an example of short-term or intermediate-term debt financing?

A. Documentary letters of credit, which are used to facilitate international trade transactions.
B. Commercial paper, which are tradeable instruments that promise to pay the lender or bearer at a future date.
C. Debentures, which are securities issued to investors that are secured by a charge over organisational assets.
D. Negotiable certificates of deposit, which are tradeable securities issued by banks in exchange for deposits.

You selected C - This is correct

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Negotiable certificates of deposit, commercial paper and documentary letters of credit are all examples of short- or intermediate-term financing options.
Debentures typically have terms of 15-20 years and are an example of long-term debt financing.

Module 3 > Sources of funds for business > Short- and intermediate-term financing

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Question 66 0 marks
An Australian organisation has borrowed GBP 5,000,000 for a 3-year term. Interest is applied at a fixed rate and paid six-monthly in arrears. The organisation has
no natural foreign currency offsets in place.

Which type of strategy would be most effective at managing this financial risk?

A. Purchasing GBP 5,000,000 worth of floating rate bonds with semi-annual coupons to provide a commercial offset to the loan.
B. Purchase an interest rate option, to be exercised if the floating interest rate exceeds the fixed rate at each interest payment date.
C. Enter into an interest rate swap for a notional amount of GBP 5,000,000 where the organisation receives a fixed rate and pays a floating rate.
D. Enter into a series of foreign exchange forward contracts to lock in the AUD/GBP exchange rate for each interest instalment and the final principal repayment.

You selected C - This is incorrect. The correct answer is D

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D is correct because the foreign exchange exposures is the primary risk in this example and movements in the AUD/GBP can greatly increase the cost of the
borrowing and the actual AUD required to repay the borrowing. Locking in the repayments with a forward exchange contract can offset this exposure.

A is incorrect because while this may eliminate the foreign exchange exposure, the organisation is then exposed to interest rate fluctuations. In addition, it is
unlikely that the organisation has GBP 5,000,000 available to invest - otherwise they wouldn’t have borrowed the GBP 5,000,000 in the first place.

B is incorrect because this option is focusing on the loan's fixed interest rate rather than the primary risk being the foreign exchange exposure. Further, the option
structure is not required by the organisation as it already benefits if the fixed is lower than the floating rate.

C is incorrect because while receiving the fixed rate on the swap would offset the fixed interest paid on the existing borrowing, and therefore convert the exposure
to a floating rate, the primary risk is actually foreign exchange exposure.

Module 4 > Forwards > Swaps

Question 67 1 mark
The current yield curve is inversed and JKL Ltd wants to lock in a fixed rate for one year, starting in three years’ time. The current rates as per the yield curve are as
follows:

– Cash rate: 2.50%

– 1-year swap: 2.40%
– 2-year swap: 2.30%
– 3-year swap: 2.20%
– 4-year swap: 2.10%

What is the forward rate that JKL Ltd can lock in for the one year period, starting in three years’ time?

A. 1.80%
B. 1.90%
C. 2.10%
D. 2.20%

You selected A - This is correct

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The calculation for the one year forward rate which starts in three years' time is: ((1+R4)^4)/((1+R3)^3)-1. In this situation, R4 is 2.10% and R3 is 2.20%. The
calculation becomes: ((1+2.10%)^4)/((1+2.20%)^3)-1 = 1.80%.

Module 5 > Key steps in IRRM > Step 3: Appraise risks and set strategies

Question 68 1 mark
Which of the following correctly describes the pricing of a foreign exchange (FX) option?

A. When initially priced, the fair price of the FX option should be zero.
B. FX option prices are calculated as the intrinsic value less time value.
C. FX option prices reflect the premium that is payable by the option seller.
D. When initially priced, the net present value of the FX option should be zero.

You selected D - This is correct

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D is correct because the net present value of an FX option reflects the present or fair value of the option, less the amount paid as the premium (price), which
should equal zero at inception.

A is incorrect because the fair price of the FX option would likely reflect it's actual price, or premium.

B is incorrect because option prices are the combination of intrinsic value and time value.

C is incorrect because option prices reflect the premium payable by the option buyer to the option seller.

Module 6 > Demystifying FX > Five key elements of FX

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Question 69 1 mark
Which of the following does not correctly describe factors affecting the organisation’s functional currency under IAS 21?

A. The currency in which external funding is typically provided.

B. The currency of the primary economic environment of the organisation.
C. The currency in which presentations of financial reports are made in.
D. The currency that mainly influences the organisation's selling prices for goods and services.

You selected C - This is correct

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The presentation currency is not necessarily the functional currency. The functional currency is typically the currency of the primary revenues and expenses, assets and
liabilities and economic operating environment.

Question 70 1 mark
Majestic Mining is a gold miner listed on the Australian Securities Exchange (ASX). It has substantial commodity risk and FX risk which the financial risk
management policy specifies can be managed using over-the-counter derivatives. All derivatives have been traded with one institution – Big Bank Ltd.

Big Bank Ltd’s shares are suddenly placed in a trading halt due to a significant downgrade from a credit agency.

What type of risk has Majestic Mining potentially over-looked?

A. FX risk.
B. Commodity price risk.
C. Liquidity / funding risk.
D. Credit / counterparty risk.

You selected D - This is correct

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D is correct because credit / counterparty risk is the risk that another party will not be able to meet its obligations. In this instance, if Big Bank Ltd was unable to
honour the derivative contracts it had entered into, then Majestic Mining would be exposed to the FX and Commodity risks that they were trying to protect
themselves from. Dealing with multiple financial institutions would help minimise this risk.

A is incorrect because FX risk has been managed using financial derivatives.

B is incorrect because the commodity price risk has been managed using financial derivatives.

C is incorrect because liquidity risk relates to the company's ability to meet liabilities as they are due. Funding risk relates to the ability to refinance maturing debts
and/or raise new borrowings as required. There is no information in the question that suggests this type of risk has been mis-managed.

Module 8 > Governance framework for financial risk management > Financial risk management policy - key risks and controls

Total Marks 50 / 70

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