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Questions and answers

We hold events twice a year which give you the opportunity to ask an experienced tutor a question.

You can use our 'ask a tutor' events to put a syllabus topic that you are having problems with to our tutors. All you need to do is log into your My CIMA account during the advertised days and submit your question using our online form. We'll get a response to you by email as soon as possible.

Details and dates of our next event will be published here and in Velocity, our student e-magazine.

Below are some questions and answers relating to paper P3 Management Accounting Risk and Control Strategy from past events.

Question

What is the lean managment accounting system?

Answer

Lean management accounting is about relevant accounting, performance measurement and control techniques to support lean manufacturing. Its main aims include:

• using target costing to provide customers value
• setting up value streams to eliminate waste
• using pull systems rather than push
• focus on continuous improvement
• ensure reporting focuses on quality and use simplified systems such as backflush accounting
  

Question

In the solution to Q4 in the November 2006 paper, the cost of an option is given as the futures price less the put option price. How is this? What are the principles/rules explaining this?

Answer

A put option is a right (not obligation) to sell an asset by a certain date in the future for a given price. It is used when you have concerns that a foreign currency may weaken against the domestic, making a sale less profitable. If the spot rate moves the opposite way then the option can always be abandoned and the foreign currency sold at spot. For example, if the current spot rate $2 to £1 and the put option is $2.1 to £1 at a cost of $0.02 per £1 - when the real rate turns out to be $1.95 then you would abandon the option and if it turned out to be $2.2 then you would take up the option (then you would calculate the conversion of currency & deduct the cost of $0.02 per £1....you could not just convert at the favourable rate for free!).

Question

How can we compare and contrast the information strategies- IS, IT,IM - and could you please provide some examples of IS.

Answer

IS strategy determines the long-term information requirements of a company, following its business strategy. It ensures appropriate information is acquired, retained, shared and available for use in strategy implementation. Thus it incorporates the different information technologies that may exist.

IT strategy defines the specific systems that are required to satisfy the information needs of the organisation.

IM strategy concerns the methods by which information is stored and available for access.

Question

Can you please explain the logic of selecting an exercise price from several given options when setting up a currency hedge using call/put options?

Answer

Buy a put option if you are worried that the foreign currency should weaken against the domestic, making sales less profitable. If the spot rate moves in the opposite direction then the option can always be abandoned and the foreign currency sold at the spot rate. For example, the current spot rate = $1.58 to £1, put option = $1.60 to £1 at cost of $0.02 per £1. If the real rate was then $1.54 then you would abandon the option (gain more sterling) but if the real rate was $1.64 then you would take up the option.

Question

What is 'transaction based auditing' and what are its weakness if compared to 'system based auditing'?

Answer

Transaction based auditing refers to the checking of a sample of transactions against documentary evidence. Systems- based audit focuses on the functioning of the control systems rather than the individual records. Weaknesses would include the fact that it is time consuming, can have problems if sample is biased, based on specific transactions that may not be representative of whole, unable to test 'what ifs' and may not be enough if the controls are weak or where transactions are high risk.

Question

Can you please explain the process involved in arranging a swap?

Answer

Swaps are exchanges of one stream of cashflows for another, for example obtaining a cheaper financing rate. Say a company wishes to pay a floating interest rate charge rather than fixed, it pays the financial institution this floating interest and then receives from them the fixed to then pay back its original debt holders.

Question

Can you explain what is the Financial Risk ?

Answer

This relates to the monetary operation of a business - such as credit risk, liquidity risk, currency risk, interest rate risk and cash flow risk.  These can be classed as transaction, translation, economic or political risks. Although many are outside the control of an organisation, companies can take action to mitigate losses , for example by implementing credit control procedure, hedging, export insurance and so on.

Question

How would you explain the expected change in the exchange rate when the interest rate of one country increases?

Answer

Higher rate of interest creates demand for that currency (investors buy currency in order to hold currency with higher interest rates) thus increasing the spot rate. In the longer term the investors will want to convert back to their own domestic currency & take on forward contracts therefore the forward rate would decrease.

Question

What is risk managment, risk managment process and foreign exchange:risk management?

Answer

Risk management is the process of understanding and managing the risks that the organisation is subject to in attempting to achieve its corporate objectives. In other words it involves identifying upside & downside risks and dealing with them to avoid failure of the company's aims.
 
Risk management process involves establishing the company's objectives, carrying out risk assessment (risk analysis, identification, description, estimation,evaluation), complete risk reporting and carry out decisions, carry out risk treatment (or risk response) with further residual risk reporting & monitoring.
 
Foreign exchange risk management refers more specifically to techniques to respond to fluctuations in exchange rates, for example hedging methods.

Question

What is Basis Risk ? How do you control it ? How significant is it to know the microcosm of detail on these financial derivatives for the exam ?

Answer

A derivative is a financial instrument of which there are four main types: forward contracts, futures contract, option contract and swaps. These can be used for hedging (reducing/avoiding risk by passing it on to someone else), speculation (hoping to make profit by pre-judging the direction in which prices will move) or arbitrage (making profit by taking advantage of price discrepancies in different locations). These types of derivative thus represent the external hedging strategies a company could choose to use and they could also use internal techniques (netting/matching etc).
 
For the exam you need to be able to identify, evaluate and recommend the methods of risk management in particular with regard to exchange rates & inflation/interest rates.

Question

What format do the examiners wish to get responses for questions - detailed essay or sub headings with clear defined points?

Answer

The examiner would be indifferent between a long discursive essay or brief sectioned answer but most students prefer to write in bullet point format. However, this does not mean short phrases or a list. You should always use full sentences and may find that for each "bullet" or point that you raise you would need to write a small paragraph. This does depend on the requirement of the question, for example "list" would mean produce a short sentenced list but "explain" would mean definition/explanation and example to clearly make your point. Advantages of using bullet point layout include good presentation, reminder that more points may be required for the mark allocation (hence improve breadth of your answer) and so on.

If the requirement specifically requested report format, then you would be expected to comply with that layout.

It is also worth remembering that sometimes a diagram or table may aid your explanation and are acceptable within discussion answers.

Finally, sub-headings may also keep you focused on answering the exact requirements of the question which will in turn gain good marks.

Please note that the responses given are the tutors' own. They are not definitive nor do they necessarily reflect the views of CIMA.

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