CAIIB Paper 3 Module B Quiz 4

Sensitivity analysis changes one variable at a time—such as sales volume, price or cost—to see how the project outcome responds. It identifies important drivers but does not directly show the probability of outcomes.

Scenario analysis evaluates internally consistent combinations of inputs, such as a recession case with lower volume and prices and higher costs. It shows the combined impact of several variables changing together.

Simulation repeatedly draws values from specified probability distributions for uncertain inputs and calculates project outcomes. It can estimate an outcome distribution, but its usefulness depends on sound assumptions and modelling.

Decision trees map sequential decisions, uncertain events and their payoffs. They help compare strategies that can adapt as information arrives, using probabilities and appropriate discounting.

Expected monetary value = 0.6 × ₹10 lakh + 0.4 × (−₹4 lakh) = ₹6 lakh − ₹1.6 lakh = ₹4.4 lakh. This is a probability-weighted average, not a guaranteed result.

A higher-risk project generally requires a higher expected return, reflecting its risk. A risk-adjusted discount rate is one approach, though certainty-equivalent cash flows or other methods may be used.

The certainty-equivalent method reduces risky expected cash flows to amounts considered equivalent to certain cash flows, then discounts them at the risk-free rate. Risk is reflected in the cash-flow adjustment rather than solely in the discount rate.

The Hillier model is a capital-budgeting risk approach that considers the variance of project cash flows and correlations among periods to assess the variability of project value.

Coefficient of variation = standard deviation ÷ expected value. A: 2/10 = 0.20; B: 6/20 = 0.30. Project A has lower relative risk per unit of expected NPV under this measure.

Diversification can reduce firm-specific risk because adverse events affecting one asset may be offset by others. It cannot eliminate systematic risks that affect the broader market.

CAPM: Ke = Rf + β(Rm − Rf) = 6% + 1.2 × (11% − 6%) = 12%. Beta measures sensitivity to systematic market risk.

Beta measures systematic risk relative to the market. A beta of 0.7 indicates lower market sensitivity than beta 1, but it does not guarantee returns or eliminate company-specific risk.

APT relates expected returns to sensitivities to multiple systematic factors and associated risk premiums. Unlike basic CAPM, it does not rely on a single market factor.

A risk register supports structured risk management by documenting risks, their assessment, accountable owners, planned responses and monitoring status.

If the dollar weakens against the rupee, each USD converts into fewer rupees, reducing the INR value of a future dollar receipt. A forward or option hedge may help manage this exposure.

Country risk includes political, sovereign, transfer, convertibility and other country-specific factors that can impair the ability to operate, remit funds or realise expected cash flows.

Intercompany prices influence where profits and taxable income arise. Appraisal should use compliant transfer-pricing assumptions and focus on consolidated incremental cash flows after relevant taxes and restrictions.

Mitigation reduces either the likelihood or impact of a risk while the activity continues. Cancelling a project is risk avoidance; accepting risk means proceeding without additional response.

Expected NPV is an average and does not show dispersion, downside probability or tail outcomes. Variance, scenarios, simulation and risk tolerance may also be needed.

Sensitivity analysis identifies influential variables. Management should understand their drivers, improve forecasts, consider commercial mitigations and monitor early indicators rather than treating the variable as certain.