Legal risk could arise when one party sues the other

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Legal risk could arise when one party sues the other party in an attempt to nullify or terminate the transaction. Regulatory risk could arise from changes in laws and regulations that are unfavorable to the entity (e.g., higher tax rates, higher compliance costs). Business risk revolves around uncertainty regarding the entity’s income statement. Revenues may be uncertain because of the uncertainty surrounding the demand for the products and/ or the price that should be set. Production and administration costs may also be uncertain. Strategic risk can be thought of in the context of large new business investments, which carry a high degree of uncertainty as to ultimate success and profitability. Alternatively, it could be thought of from the perspective of an entity changing its business strategy compared to its competitors. Reputation risk consists of two parts: (1) the general perceived trustworthiness of an entity (i.e., that the entity is able and willing to meet its obligations to its creditors and counterparties) and (2) the general perception that the entity engages in fair dealing and conducts business in an ethical manner.
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©2015 Kaplan, Inc. Page 13 Topic 1 Cross Reference to GARP Assigned Reading – Crouhy, Galai, and Mark, Chapter 1 C ONCEPT C HECKERS 1. Which of the following statements regarding risk and risk management is correct? A. Risk management is more concerned with unexpected losses versus expected losses. B. There is a relationship between the amount of risk taken and the size of the potential loss. C. The final step of the risk management process involves developing a risk mitigation strategy. D. If executed properly, the risk management process may allow for risk elimination within an economy. 2. Examining the impact of a dramatic increase in interest rates on the value of a bond investment portfolio could be performed using which of the following tools? I. Stress testing. II. Enterprise risk management. A. I only. B. II only. C. Both I and II. D. Neither I nor II. 3. Which of the following items would be associated with unexpected losses? I. Loan defaults are increasing simultaneously while recovery rates are decreasing. II. Lending losses are covered by charging a spread between the cost of funds and the lending rate. A. I only. B. II only. C. Both I and II. D. Neither I nor II. 4. In considering the major classes of risks, which risk would best describe an entity with weak internal controls that could easily be circumvented with a lack of segregation of duties? A. Business risk. B. Legal and regulatory risk. C. Operational risk. D. Strategic risk. 5. Local Bank, Inc., (LBI) has loaned funds to a private manufacturing company, named We Make It All (Make It). The current balance of the loan is $1 million and it is secured by a piece of land and the corresponding building owned by Make It. Due to an economic downturn, Make It suffered a loss for the first time in its 10- year operating history and is currently experiencing some cash flow difficulties. In addition, the land and building that is held as collateral has recently been appraised at only $800,000. Based only on the information provided, which of the following risks faced by LBI have increased?
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