CAS Financial Risk and Rate of Return Practice Test
Financial risk and rate-of-return analysis connects corporate financing, investment valuation, and insurer solvency. Practice topics include capital structure ratios, interest coverage, present value, bond cash flows and duration, effective interest rates, holding-period returns, break-even sales, and surplus under stress. These calculations help evaluate how financing choices and changes in market conditions affect financial positions.
Exam overview
About the CAS Financial Risk and Rate of Return Exam
Useful analysis starts by identifying the relevant cash flows, timing, and rate convention. For bonds, distinguish coupon frequency from the quoted annual rate, and connect yield changes with approximate price sensitivity through duration. For investments, compare purchase and sale values with interim income when calculating holding-period return. Corporate measures such as debt-to-capital and interest coverage describe leverage and capacity to service borrowing; break-even analysis links fixed costs with contribution margin. Insurer balance-sheet questions require separating assets, liabilities, and surplus, then applying stated stress assumptions consistently. Risk measures also depend on their definitions: expected shortfall, for example, summarizes losses in a specified tail rather than the average across all outcomes. These skills support evaluation of financing risk, investment performance, and financial resilience.
Sample Practice Questions
Review a selection from this exam's published US Practice Tests practice bank.
A firm has $2 million in debt and $3 million in equity. Using debt divided by total capitalization (debt plus equity), what is its debt-to-capital ratio?
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Correct answer: BTotal capitalization is $2 million + $3 million = $5 million. Debt divided by total capitalization is $2 million / $5 million = 40%.
A company has annual operating income of $900,000 and annual interest expense of $150,000. What is its interest coverage ratio, defined as operating income divided by interest expense?
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Correct answer: CInterest coverage is operating income divided by interest expense: $900,000 / $150,000 = 6.0. This indicates operating income is six times the stated interest expense.
An insurer expects to pay a claim of $50,000 in one year. It can invest at a 4% annual effective rate. How much should it set aside today to fund the claim, assuming the rate applies for the full year?
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Correct answer: BDiscount the future payment by one year: $50,000 / 1.04 ≈ $48,076.92. Rounding gives $48,077.
A bond with a face value of $1,000 pays a 6% annual coupon in two equal payments per year. What is each coupon payment?
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Correct answer: BThe annual coupon is 6% of $1,000, or $60. With two equal payments per year, each payment is $60 / 2 = $30.
A company has fixed costs of $90,000 per year. Its contribution margin ratio, defined as sales revenue less variable costs divided by sales revenue, is 30%. What annual sales revenue is required to break even?
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Correct answer: DAt break-even, total contribution equals fixed costs. With a 30% contribution margin ratio, required sales are $90,000/0.30 = $300,000.
An investment has a nominal annual interest rate of 8%, compounded quarterly. What is its effective annual rate, approximately?
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Correct answer: CThe effective annual rate is (1 + 0.08/4)^4 − 1 = 1.02^4 − 1 ≈ 0.08243, or 8.24%.
An investor buys a bond for $980 and later sells it for $1,010, receiving $30 in coupon payments while holding it. Ignoring taxes and transaction costs, what is the holding-period return?
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Correct answer: BHolding-period return is (sale price − purchase price + income received) divided by purchase price: ($1,010 − $980 + $30)/$980 = $60/$980, approximately 6.12%.
How to use this practice test
US Practice Tests offers free practice questions for this exam. A session presents up to 20 random questions from the available bank, which contains 50 published questions, and shows results after the session. Use missed items to locate calculation errors, such as incorrect compounding, cash-flow timing, or the definition of a ratio or risk measure.
Preparation tips
- Write out numerator and denominator before calculating debt-to-capital or interest coverage, and verify that each uses the definition stated in the problem.
- For bond problems, map coupon dates and payment amounts before valuing cash flows; convert nominal rates to the matching compounding period.
- Practice present-value and effective-rate calculations with explicit time periods, then check whether the result is consistent with discounting or compounding.
- For duration estimates, convert the yield change to a decimal and apply the negative price-sensitivity relationship.
- In surplus and expected-shortfall problems, list scenario outcomes and probabilities before applying the stated stress or tail definition.