Test: Business


20 Questions MCQ Test Verbal for GMAT | Test: Business


Description
This mock test of Test: Business for GMAT helps you for every GMAT entrance exam. This contains 20 Multiple Choice Questions for GMAT Test: Business (mcq) to study with solutions a complete question bank. The solved questions answers in this Test: Business quiz give you a good mix of easy questions and tough questions. GMAT students definitely take this Test: Business exercise for a better result in the exam. You can find other Test: Business extra questions, long questions & short questions for GMAT on EduRev as well by searching above.
QUESTION: 1

Disruptive innovators can hurt successful and immensely profitable incumbents that tend to ignore the markets most susceptible to disruptive innovations.   Disruptive innovators offer technologically straightforward solutions consisting of off-the-shelf components put together in a product architecture that is often simpler, initially lower performing, and cheaper than established approaches. Considering disruptive technologies unprofitable, the executives at incumbents often ignored them at their own and companies’ peril.   In 1981, the old 8 inch drives used in mini computers were "vastly superior" and much more profitable to the new 5.25 inch drives used in desktop computers.  However, 8 inch drives were not affordable for the new desktop machines.  Slowly, the makers of 5.25 inch drives improved the performance of the drives and moved the 8 inch drive companies that did not invest in the 5.25 inch technology out of the market as the latter could not compete on price.  Similarly, digital cameras, when introduced in 1997 performed extremely poorly as compared to traditional film cameras.   Consequently, many traditional film companies such as Kodak ignored this market only to be bankrupted by the rise of digital cameras a decade later.

 

Leaders and strategists should be cautious while rejecting a technology that does not seem to be as high performing and hence not as profitable as their dominant technologies.  A technology that initially provides low performance can drastically improve over time and often exceed the performance of the dominant technology at a much lower price-point, a scenario that could potentially bankrupt the incumbents who ignored the technology at their peril. 

The passage provides information in support of which of the following assertions?

Solution:
QUESTION: 2

Disruptive innovators can hurt successful and immensely profitable incumbents that tend to ignore the markets most susceptible to disruptive innovations.   Disruptive innovators offer technologically straightforward solutions consisting of off-the-shelf components put together in a product architecture that is often simpler, initially lower performing, and cheaper than established approaches. Considering disruptive technologies unprofitable, the executives at incumbents often ignored them at their own and companies’ peril.   In 1981, the old 8 inch drives used in mini computers were "vastly superior" and much more profitable to the new 5.25 inch drives used in desktop computers.  However, 8 inch drives were not affordable for the new desktop machines.  Slowly, the makers of 5.25 inch drives improved the performance of the drives and moved the 8 inch drive companies that did not invest in the 5.25 inch technology out of the market as the latter could not compete on price.  Similarly, digital cameras, when introduced in 1997 performed extremely poorly as compared to traditional film cameras.   Consequently, many traditional film companies such as Kodak ignored this market only to be bankrupted by the rise of digital cameras a decade later.

 

Leaders and strategists should be cautious while rejecting a technology that does not seem to be as high performing and hence not as profitable as their dominant technologies.  A technology that initially provides low performance can drastically improve over time and often exceed the performance of the dominant technology at a much lower price-point, a scenario that could potentially bankrupt the incumbents who ignored the technology at their peril. 

The author of the passage would make which of the following recommendations to the managers of the incumbents. 

Solution:
QUESTION: 3

Disruptive innovators can hurt successful and immensely profitable incumbents that tend to ignore the markets most susceptible to disruptive innovations.   Disruptive innovators offer technologically straightforward solutions consisting of off-the-shelf components put together in a product architecture that is often simpler, initially lower performing, and cheaper than established approaches. Considering disruptive technologies unprofitable, the executives at incumbents often ignored them at their own and companies’ peril.   In 1981, the old 8 inch drives used in mini computers were "vastly superior" and much more profitable to the new 5.25 inch drives used in desktop computers.  However, 8 inch drives were not affordable for the new desktop machines.  Slowly, the makers of 5.25 inch drives improved the performance of the drives and moved the 8 inch drive companies that did not invest in the 5.25 inch technology out of the market as the latter could not compete on price.  Similarly, digital cameras, when introduced in 1997 performed extremely poorly as compared to traditional film cameras.   Consequently, many traditional film companies such as Kodak ignored this market only to be bankrupted by the rise of digital cameras a decade later.

Leaders and strategists should be cautious while rejecting a technology that does not seem to be as high performing and hence not as profitable as their dominant technologies.  A technology that initially provides low performance can drastically improve over time and often exceed the performance of the dominant technology at a much lower price-point, a scenario that could potentially bankrupt the incumbents who ignored the technology at their peril. 

Which of the following exemplifies a technological disruption as described in the passage through the 8 inch and 5.25 inch disc drive example?

Solution:
QUESTION: 4

As companies tend to innovate faster than their customers’ needs evolve, most organizations eventually end up producing products or services that are actually overly sophisticated, extremely expensive, and rather complicated for many customers in their market. These innovations fall under the category of sustaining innovations, innovations that simply improve existing products. Companies pursue sustaining innovations at the higher tiers of their markets because this is what has historically helped them succeed: by charging the highest prices to their most demanding and sophisticated customers at the top of the market, companies achieve the greatest profitability. However, by doing so, companies unwittingly open the door to another category of innovations - “disruptive innovations”. In contrast to sustaining innovations, disruptive innovations lie at the bottom of the market. They are made not only by harnessing new technologies but also by developing new business models and exploiting old technologies in new ways.

An innovation that is disruptive allows a whole new population of consumers at the bottom of a market access to a product or service that was historically only accessible to consumers with a lot of money or a lot of skill. Personal computers, for instance, were disruptive innovations because they created a new mass market for computers -  previously, expensive mainframe computers were sold only to big companies and research universities. Characteristics of disruptive businesses, at least in their initial stages, can include:  lower gross margins, smaller target markets, and simpler products and services that may not appear as attractive as existing solutions when compared against traditional performance metrics.  Because these lower tiers of the market offer lower gross margins, they are unattractive to other firms moving upward in the market, creating space at the bottom of the market for new disruptive competitors to emerge. 

Which of the following statements is supported by the information given in the passage?

Solution:

Passage Analysis

Summary and Main Point

Since this is a Global Inference question, we cannot pre-think on specific lines. However, we must keep in mind that four out of the five given answer choices will not follow from what is stated in the passage; these answer choices are INCORRECT. Select the answer choice that is bolstered by specific facts/ideas mentioned in the passage. 

Answer Choices

A

A disruptive business is less likely to face competition in the market than a business pursuing sustaining innovations.

Incorrect: Out of Scope

There is no information given in the passage to support any comparative analysis regarding the level of competition faced by companies pursing sustaining innovations and those pursuing disruptive ones.

B

Companies following innovations that are improvements of existing products do not knowingly leave market space for disruptive businesses to emerge.

Correct

This choice can be inferred from the following statement made in the passage:

However, by doing so, companies unwittingly open the door to “disruptive innovations” at the bottom of the market

C

Most technological innovations can be considered disruptive innovations.

Incorrect: Out of Scope

Although the author does cite the example of personal computers to explain the concept of disruptive innovations, it does not provide any basis to conclude that majority of such innovations deal with technology. 

D

It is likely that to produce products, disruptive businesses engage more in using old technologies in new ways than using new technologies. 

Incorrect: Inconsistent

All that the author states is that such businesses make use of both new technologies and old technologies in new ways. There is no information given to support which of the two is used more.

E

Companies typically pursuing sustaining innovations do not find disruptive products attractive since these products are typically not profitable. 

Incorrect: Inconsistent

We are told that such companies do not find disruptive innovations attractive because these innovations offer “lower” gross margins and not that they are not profitable at all.

QUESTION: 5

As companies tend to innovate faster than their customers’ needs evolve, most organizations eventually end up producing products or services that are actually overly sophisticated, extremely expensive, and rather complicated for many customers in their market. These innovations fall under the category of sustaining innovations, innovations that simply improve existing products. Companies pursue sustaining innovations at the higher tiers of their markets because this is what has historically helped them succeed: by charging the highest prices to their most demanding and sophisticated customers at the top of the market, companies achieve the greatest profitability. However, by doing so, companies unwittingly open the door to another category of innovations - “disruptive innovations”. In contrast to sustaining innovations, disruptive innovations lie at the bottom of the market. They are made not only by harnessing new technologies but also by developing new business models and exploiting old technologies in new ways.

An innovation that is disruptive allows a whole new population of consumers at the bottom of a market access to a product or service that was historically only accessible to consumers with a lot of money or a lot of skill. Personal computers, for instance, were disruptive innovations because they created a new mass market for computers -  previously, expensive mainframe computers were sold only to big companies and research universities. Characteristics of disruptive businesses, at least in their initial stages, can include:  lower gross margins, smaller target markets, and simpler products and services that may not appear as attractive as existing solutions when compared against traditional performance metrics.  Because these lower tiers of the market offer lower gross margins, they are unattractive to other firms moving upward in the market, creating space at the bottom of the market for new disruptive competitors to emerge. 

The author’s primarily concerned with

Solution:

Passage Analysis

Summary and Main Point

This is a Main Idea question. As seen in the summary and main point section, the first paragraph introduces the concept of sustaining and disruptive innovations. The author does so by talking about sustaining innovations and how the pursuit of such innovations leads to conditions responsible for the emergence of disruptive innovations. In the second paragraph, the author goes in to more detail on the concept of disruptive innovations. In essence, the main purpose of the passage is to explain two different kinds of innovations while focusing more on one.

With this understanding in mind, let’s take a look at the answer choices.

Answer Choices

A

differentiating between two kinds of innovations

Incorrect: Partial Scope

The author does briefly touch on a difference between SI and DI, but the whole passage is not written from the point of view of highlighting their difference.  The focus is on explaining the two kinds of innovations, particularly disruptive innovations.

B

explaining two kinds of innovations while focusing more on one

Correct

This choice matches our pre-thinking analysis.

C

explaining how different kinds of innovations roll out different kinds of products in the market

Incorrect: Out of Context

Yes, the author does mention the kind of products sustaining and disruptive innovations generate, but the purpose of the passage is not to explain this point. This information is given for achieving the broader purpose of explaining the concept of disruptive innovations.

D

describing how newer needs are created in the market even with the same old technology

Incorrect: Out of Context

The author briefly touches on how disruptive innovations grant access of historically extremely expensive or overly sophisticated (skill-wise) products and services to a wide number of bottom tier customers. The author also says that such innovations also use old technologies in new ways. However, all this discussion does not form part of a broader discussion on need-creation in the market.  

E

Highlighting the difference in the profits that companies can gain from two different kinds of innovations 

Incorrect: Partial Scope

The mention of differences in profitability is not the highlight of the passage. Yes, the author does mention it, but it is to explain the conditions conducive to the emergence of disruptive businesses.

QUESTION: 6

As companies tend to innovate faster than their customers’ needs evolve, most organizations eventually end up producing products or services that are actually overly sophisticated, extremely expensive, and rather complicated for many customers in their market. These innovations fall under the category of sustaining innovations, innovations that simply improve existing products. Companies pursue sustaining innovations at the higher tiers of their markets because this is what has historically helped them succeed: by charging the highest prices to their most demanding and sophisticated customers at the top of the market, companies achieve the greatest profitability. However, by doing so, companies unwittingly open the door to another category of innovations - “disruptive innovations”. In contrast to sustaining innovations, disruptive innovations lie at the bottom of the market. They are made not only by harnessing new technologies but also by developing new business models and exploiting old technologies in new ways.

An innovation that is disruptive allows a whole new population of consumers at the bottom of a market access to a product or service that was historically only accessible to consumers with a lot of money or a lot of skill. Personal computers, for instance, were disruptive innovations because they created a new mass market for computers -  previously, expensive mainframe computers were sold only to big companies and research universities. Characteristics of disruptive businesses, at least in their initial stages, can include:  lower gross margins, smaller target markets, and simpler products and services that may not appear as attractive as existing solutions when compared against traditional performance metrics.  Because these lower tiers of the market offer lower gross margins, they are unattractive to other firms moving upward in the market, creating space at the bottom of the market for new disruptive competitors to emerge. 

The passage supports which of the following statements about disruptive innovations?

Solution:

Passage Analysis

Summary and Main Point

Since this is a Global Inference question, we cannot pre-think on specific lines. However, we must keep in mind that four out of the five given answer choices will not follow from what is stated in the passage; these answer choices are INCORRECT. Select the answer choice that is bolstered by specific facts/ideas mentioned in the passage. 

Answer Choices

A

They are not expensive to produce.

Incorrect: Out of Scope

There is no mention of any kind of production cost in the passage.

B

They do not add as much research value as sustaining innovations do.

Incorrect: Out of Scope

There is no mention of any kind of research value added by either of the kinds of innovations.

C

Because they are targeted at smaller market, they never become mass scale products.  

Incorrect: Inconsistent

The author does state that at least initially they are targeted at smaller markets, but there is no mention of this aspect affecting their eventual scalability.

D

They make a service easier to consume for consumers who possess limited specialized knowledge in the field the innovations are made in. 

Correct

In the first sentence of the second paragraph, we are told that disruptive innovations provide access to those products and services for which one historically needed a lot of money or a lot of skill, characteristics compatible with sustaining innovations. Hence, we can infer statement given in this choice.

E

The products under them gradually move to sustaining innovations.

Incorrect: Opposite

The information given in the passage supports an inference opposite to this choice, as seen in the answer explanation for choice D.

QUESTION: 7

Marginal analysis is an important decision-making tool in the business world. Pricing decisions tend to heavily involve analysis regarding marginal contributions to revenues and costs. In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output, i.e. the marginal cost of producing the unit, is known as marginal-cost pricing. In the marginal analysis of pricing decisions, if marginal revenue, the increase in revenue from the sale of an additional unit of output, is greater than marginal cost at some level of output, marginal profit is positive, and, therefore, a greater quantity should be produced. Alternatively, if marginal revenue is less than the marginal cost, marginal profit is negative and a lesser quantity should be produced. Accordingly, firms tend to use this analysis to increase their production until marginal revenue equals marginal cost, and then charge a price which is determined by the demand curve.  For instance, businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price of $2.00, the firm selling the item might wish to lower the price to $1.10 - if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all.

Which of the following best describes the primary purpose of the author?

Solution:

Answer Choices

A

To explain how companies change prices, using the market conditions as an indicator

Incorrect: Partial Scope

The author talks about altering prices using the marginal analysis and the demand curve. However, this choice only refers to fluctuations in demand.

B

To discuss the use of a business tool in a particular context

Correct

This choice matches our pre-thinking analysis.

C

To establish the supremacy of a price-setting tool in the business world

Incorrect: Out of Scope

The author does not compare marginal analysis as a price setting tool with other such possible tools available to companies. In fact, there is no mention of other tools in the passage.

D

To advocate for the use of a business concept in determining prices

Incorrect: Out of Scope

The author never recommends that marginal analysis should be used. He/she merely states the way it is used.

E

To discuss the various tools available to a company to alter the prices of its products during lean periods

Incorrect: Inconsistent

First of all, there is only one way/tool discussed in the passage. And second of all, the talk about setting the price when demand has waned is only an example of the usage of marginal analysis. It is not that marginal analysis is only used in lean periods.

QUESTION: 8

Marginal analysis is an important decision-making tool in the business world. Pricing decisions tend to heavily involve analysis regarding marginal contributions to revenues and costs. In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output, i.e. the marginal cost of producing the unit, is known as marginal-cost pricing. In the marginal analysis of pricing decisions, if marginal revenue, the increase in revenue from the sale of an additional unit of output, is greater than marginal cost at some level of output, marginal profit is positive, and, therefore, a greater quantity should be produced. Alternatively, if marginal revenue is less than the marginal cost, marginal profit is negative and a lesser quantity should be produced. Accordingly, firms tend to use this analysis to increase their production until marginal revenue equals marginal cost, and then charge a price which is determined by the demand curve.  For instance, businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price of $2.00, the firm selling the item might wish to lower the price to $1.10 - if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all.

Which of the following is supported by the information given in the passage?

Solution:

Passage Analysis 

 

Summary and Main Point

Since this is a Global Inference question, we cannot pre-think on specific lines. However, we must keep in mind that four out of the five given answer choices will not follow from what is stated in the passage; these answer choices are INCORRECT. Select the answer choice that is bolstered by specific facts/ideas mentioned in the passage. 

Answer Choices

A

Marginal cost pricing is employed when even though the demand is on the rise, the sales are not.

Incorrect: Opposite

This choice makes a statement that goes against the information given in the passage. The passage clearly states that companies are likely to price their product close to the marginal cost in period of poor sales- when the demand has waned (declined).

B

The normal selling price of a product is not as affected by the demand of the product as the price set close to the marginal cost of the product.

Incorrect: Inconsistent

The passage states that the normal selling price is slashed down when the demand is low and is set close to the marginal cost of the product. So, this comparison is irrelevant as it is the normal price that is then set close to the marginal cost.

C

As companies realize economies of scale, the marginal cost of producing decreases with each extra unit produced. 

Incorrect: Out of Scope

There is no mention of the concept of economies of scale in the passage.

D

Companies are likely to shut down when they cannot even command a price that is identical to the marginal cost of their product.

Incorrect: Out of Scope

The author does not give us any information to predict what the companies are likely to do in the given situation

E

Setting the price close to the marginal cost is sometimes a question of relative benefit.

Correct

This information is given to us in the example given at the end of the passage. The author cites the example of a firm that slashes down its normal price from $2 to $1.10 (closer to the marginal cost) because as per the author, the incremental profit of 10 cents from the transaction is better than no sale at all.

 

QUESTION: 9

Marginal analysis is an important decision-making tool in the business world. Pricing decisions tend to heavily involve analysis regarding marginal contributions to revenues and costs. In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output, i.e. the marginal cost of producing the unit, is known as marginal-cost pricing. In the marginal analysis of pricing decisions, if marginal revenue, the increase in revenue from the sale of an additional unit of output, is greater than marginal cost at some level of output, marginal profit is positive, and, therefore, a greater quantity should be produced. Alternatively, if marginal revenue is less than the marginal cost, marginal profit is negative and a lesser quantity should be produced. Accordingly, firms tend to use this analysis to increase their production until marginal revenue equals marginal cost, and then charge a price which is determined by the demand curve.  For instance, businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price of $2.00, the firm selling the item might wish to lower the price to $1.10 - if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all.

Which of the following is stated in the passage?

Solution:

Passage Analysis 

 

Summary and Main Point

Since this is an open ended Detail question we cannot pre-think on specific terms. However, we must keep in mind that the correct answer will directly flow from what’s explicitly stated in the passage. 

Answer Choices

A

The level of output produced is sometimes determined by taking in to account the difference between marginal revenue and marginal cost

Correct

The difference between marginal revenue and marginal cost is marginal profit and the author clearly tells us how firms use this analysis to reach a level of output.

B

Marginal analysis is the most important tool through which the pricing of a product is decided.

Incorrect: Inconsistent

From the first and the second sentence of the passage, we get to know that MA is an important tool and that pricing decisions tend to heavily involve such analysis. However, there is no information stating that it is the most important tool.

C

The normal selling price of a product is usually close to the marginal cost of the product.

Incorrect: Opposite

In the example given in the passage, we see that the normal selling price is actually double the marginal cost of producing it. The author talks about setting it close to the marginal cost, when the demand has waned - a specific condition and not a general one.

D

Profit from an additional unit of output decreases with every increase in production. 

Incorrect: Out of Scope

We are given information about what should be done when the marginal profit is positive and when it’s negative; however, there is no information given to support an inverse relationship between an increase in production and a corresponding increase in production. For example, it is possible that the company draws the same marginal profit for the first ten thousand units. So, we cannot say that the marginal profit decreases with every increase in production.

E

Marginal cost pricing is a technique used in the short run rather than in the long run.

Incorrect: Out of Scope

No such comparison is given in the passage.

QUESTION: 10

To maximize profits, an employer should control his or her environment in a factory, shop, or office and make sure that examples of energy and efficiency are numerous enough to catch employee attention and establish an atmosphere of industry. In the workplace, there are instances in which it would be in the mutual interest of the employer and the employees to increase the speed of work, but conditions may limit or forbid the use of pace-setters. In construction work and in some of the industries, where there are minute subdivisions of operations and continuity of processes, this method of increasing efficiency is very commonly applied with the use of time cards and software. In many factories, however, such an effort to “speed up” production might stir resentment, even among the workers paid at a fixed rate for each unit produced or action performed, and have an effect exactly opposite to that desired. The alternative, of course, is for the employer to secure unconscious pace setting by providing incentives for the naturally ambitious men and women in the way of a premium or bonus system or other reward for above-average efficiency.

Accordingly, to take advantage of the benefits of conscious or voluntary imitation, workers must be provided with examples that appeal to them as admirable and inspire the wish to emulate them. A common application of this principle is seen in the choice of department heads, foremen, and other bosses. Invariably these people win promotion by industry, skill, and efficiency greater than that displayed by their direct peers, or by mastery of their skills that enables them to show their less efficient peers how any and all operations should be conducted. This focusing of attention upon individuals worthy of imitation has been carried much farther by various companies. Some create weekly or monthly papers published primarily for circulation within the organization to record every incident reflecting unusual skill, initiative, or personal power in an individual member of the organization. A big order closed, a difficult contract secured, a complex or delicate operation performed in less than the usual time, a new personal record in production, the invention of an unproved method or machine—whatever the achievement, it is described and glorified, its perpetrator praised and held up for emulation. This, indeed, is one of the methods by which the larger sales organizations have obtained remarkable results.

The author of the passage mentions a “big order closed, a difficult contract secured, a complex or delicate operation performed in less than the usual time,” etc., in order to

Solution:

Passage Analysis

Summary and Main Point

This is a Function question.

In order to find the answer to the question, let’s review the part in the passage that mentions these phrases. Some create weekly or monthly papers published primarily for circulation within the organization to record every incident reflecting unusual skill, initiative, or personal power in an individual member of the organization. A big order closed, a difficult contract secured, a complex or delicate operation performed in less than the usual time, a new personal record in production, the invention of an unproved method or machine—whatever the achievement, it is described and glorified, its perpetrator praised and held up for emulation. This, indeed, is one of the methods by which the larger sales organizations have obtained remarkable results.

From the analysis of this part in the last paragraph, we can say that the author mentions these phrases to list out the activities included in companies internal newsletters to motivate the workers.

Answer Choices

A

describe a list of rewards companies frequently offer high-achieving employees.

Incorrect: Out of Context

These items are not rewards but rather the achievements themselves.

B

list some examples through which companies take unconscious incentivizing to the next level.

Correct

his list appears in the middle of the second paragraph. The preceding sentence mentions how companies create internal newsletters to praise efficient work and spotlight the workers. The sentence describes each item as an "achievement" to be
"described and glorified."

C

offer praise to companies for incentivizing high productivity. 

Incorrect: Out of Context

The author objectively describes these items as things included in certain companies internal publications to incentivize workers.

D

further incentivize workers to achieve maximum productivity. 

Incorrect: Out of Context

This may be the companies' aim in publishing internal newsletters, but this is not the AUTHOR's reason for listing these achievements.

E

reflect upon the unusual skill, initiative, or personal power in the individual members of certain organizations. 

Incorrect: Out of Context

While the content of the newsletters does reflect upon unusual skill, author’s purpose of reflecting this is not to discuss the achievement but to illustrate how companies take unconscious encouragement to the next level.

QUESTION: 11

To maximize profits, an employer should control his or her environment in a factory, shop, or office and make sure that examples of energy and efficiency are numerous enough to catch employee attention and establish an atmosphere of industry. In the workplace, there are instances in which it would be in the mutual interest of the employer and the employees to increase the speed of work, but conditions may limit or forbid the use of pace-setters. In construction work and in some of the industries, where there are minute subdivisions of operations and continuity of processes, this method of increasing efficiency is very commonly applied with the use of time cards and software. In many factories, however, such an effort to “speed up” production might stir resentment, even among the workers paid at a fixed rate for each unit produced or action performed, and have an effect exactly opposite to that desired. The alternative, of course, is for the employer to secure unconscious pace setting by providing incentives for the naturally ambitious men and women in the way of a premium or bonus system or other reward for above-average efficiency.

Accordingly, to take advantage of the benefits of conscious or voluntary imitation, workers must be provided with examples that appeal to them as admirable and inspire the wish to emulate them. A common application of this principle is seen in the choice of department heads, foremen, and other bosses. Invariably these people win promotion by industry, skill, and efficiency greater than that displayed by their direct peers, or by mastery of their skills that enables them to show their less efficient peers how any and all operations should be conducted. This focusing of attention upon individuals worthy of imitation has been carried much farther by various companies. Some create weekly or monthly papers published primarily for circulation within the organization to record every incident reflecting unusual skill, initiative, or personal power in an individual member of the organization. A big order closed, a difficult contract secured, a complex or delicate operation performed in less than the usual time, a new personal record in production, the invention of an unproved method or machine—whatever the achievement, it is described and glorified, its perpetrator praised and held up for emulation. This, indeed, is one of the methods by which the larger sales organizations have obtained remarkable results.

The author is primarily concerned with

Solution:

Passage Analysis

Summary and Main Point

This is a Main Idea question. The correct answer must be broad enough to encompass all of the paragraphs of the passage without veering outside the scope as indicated in the passage analysis.

Answer Choices

A

describing situations in which company policies do not always lead to more productivity. 

Incorrect: Partial Scope

The first paragraph does mention this point briefly in its discussion of pace-setting, but the second paragraph doesn't explore the lack of productivity. Overall, the passage is concerned with what companies are successfully doing, not their missteps.

B

incentivizing workers in order to achieve maximum product output.

Incorrect: Out of Context

This is the goal of the companies described in the passage, not the goal of the passage itself. The author seems to be giving advice to companies, not to workers.

C

presenting two ways using which the companies can influence pace-setting and explaining one in greater depth

Correct

This is similar to what we came up in main point analysis. 

D

suggesting changes to company structure and policy that curtail efficiency. 

Incorrect: Out of Context

The author describes two ways of maximizing profit. He does not compare these two methods with older methods, nor does he/she complain that current policies are ineffective and curtail efficiency. The tone of the passage is not critical or negative.

E

explaining how companies can best inspire sub-producing workers to achieve their best results. 

Incorrect: Partial scope

This is the purpose of the second paragraph, not the entire passage. The first paragraph focuses on conscious pace-setting and the instances in which it can/cannot lead to more profits. 

QUESTION: 12

To maximize profits, an employer should control his or her environment in a factory, shop, or office and make sure that examples of energy and efficiency are numerous enough to catch employee attention and establish an atmosphere of industry. In the workplace, there are instances in which it would be in the mutual interest of the employer and the employees to increase the speed of work, but conditions may limit or forbid the use of pace-setters. In construction work and in some of the industries, where there are minute subdivisions of operations and continuity of processes, this method of increasing efficiency is very commonly applied with the use of time cards and software. In many factories, however, such an effort to “speed up” production might stir resentment, even among the workers paid at a fixed rate for each unit produced or action performed, and have an effect exactly opposite to that desired. The alternative, of course, is for the employer to secure unconscious pace setting by providing incentives for the naturally ambitious men and women in the way of a premium or bonus system or other reward for above-average efficiency.

Accordingly, to take advantage of the benefits of conscious or voluntary imitation, workers must be provided with examples that appeal to them as admirable and inspire the wish to emulate them. A common application of this principle is seen in the choice of department heads, foremen, and other bosses. Invariably these people win promotion by industry, skill, and efficiency greater than that displayed by their direct peers, or by mastery of their skills that enables them to show their less efficient peers how any and all operations should be conducted. This focusing of attention upon individuals worthy of imitation has been carried much farther by various companies. Some create weekly or monthly papers published primarily for circulation within the organization to record every incident reflecting unusual skill, initiative, or personal power in an individual member of the organization. A big order closed, a difficult contract secured, a complex or delicate operation performed in less than the usual time, a new personal record in production, the invention of an unproved method or machine—whatever the achievement, it is described and glorified, its perpetrator praised and held up for emulation. This, indeed, is one of the methods by which the larger sales organizations have obtained remarkable results.

With which of the following statements would the author of the passage NOT agree?

Solution:

Passage Analysis

Summary and Main Point

This is an Inference question. It is asking us to infer our understanding of the author's point of view based on what is implied in the passage. Because of the word "NOT," four out of the five answer choice WILL be statements that are very close to what is directly stated in the passage. Only ONE answer choice will be contradicted by the passage. Start by eliminating answer choices with which the author would likely agree, and finally select the statement with which the author would NOT logically agree.

Answer Choices

A

Utilizing time cards and software can sometimes lead to less profitability.

Incorrect: Can be Inferred

This IS something the author would agree with as illustrated by the discussion of conscious pace-setting and factories in the first paragraph.

B

Corporations looking to maximize profits should promote employees based on talent and skill rather than seniority. 

Incorrect: Can be Inferred

This IS something the author would agree with as mentioned in the second paragraph. The author states that, Invariably these people win promotion by industry, skill, and efficiency greater than that displayed by their direct peers, or by mastery of their skills
Since the above is cited as part of a strategy advocated by the author to maximize profits, choice B can be inferred as something that the author would agree with.

C

There is some disparity between the methods companies use to promote good examples to their employees. 

Incorrect: Can be Inferred

This IS something the author would agree with and is directly supported by the second paragraph, which states, "This focusing of attention upon individuals worthy of imitation has been carried much farther by various companies." "Various" companies create internal newsletters, so we can assume this is not a method all companies put into effect.

D

In order to maximize profitability, time cards and promotion of efficient paradigms must be used together. 

Correct: Opposite

The author introduces the strategy of promoting good examples as an alternative to use of time cards, implying that it’s not a must that they be used together.  

E

Certain employees might be averse to the idea of speeding up the production, even when there are distinct monetary benefits of doing so.

Incorrect: Can be Inferred

The author mentions in the first paragraph that

..., however, such an effort to "speed up" production might stir resentment, even among the workers paid at a fixed rate for each unit produced or action performed,...

Accordingly, it can be inferred that these workers will stand to benefit if they speed up their production work, but even then they might not be open to the idea of doing so.

QUESTION: 13

To maximize profits, an employer should control his or her environment in a factory, shop, or office and make sure that examples of energy and efficiency are numerous enough to catch employee attention and establish an atmosphere of industry. In the workplace, there are instances in which it would be in the mutual interest of the employer and the employees to increase the speed of work, but conditions may limit or forbid the use of pace-setters. In construction work and in some of the industries, where there are minute subdivisions of operations and continuity of processes, this method of increasing efficiency is very commonly applied with the use of time cards and software. In many factories, however, such an effort to “speed up” production might stir resentment, even among the workers paid at a fixed rate for each unit produced or action performed, and have an effect exactly opposite to that desired. The alternative, of course, is for the employer to secure unconscious pace setting by providing incentives for the naturally ambitious men and women in the way of a premium or bonus system or other reward for above-average efficiency.

Accordingly, to take advantage of the benefits of conscious or voluntary imitation, workers must be provided with examples that appeal to them as admirable and inspire the wish to emulate them. A common application of this principle is seen in the choice of department heads, foremen, and other bosses. Invariably these people win promotion by industry, skill, and efficiency greater than that displayed by their direct peers, or by mastery of their skills that enables them to show their less efficient peers how any and all operations should be conducted. This focusing of attention upon individuals worthy of imitation has been carried much farther by various companies. Some create weekly or monthly papers published primarily for circulation within the organization to record every incident reflecting unusual skill, initiative, or personal power in an individual member of the organization. A big order closed, a difficult contract secured, a complex or delicate operation performed in less than the usual time, a new personal record in production, the invention of an unproved method or machine—whatever the achievement, it is described and glorified, its perpetrator praised and held up for emulation. This, indeed, is one of the methods by which the larger sales organizations have obtained remarkable results.

Which of the following best illustrates an instance of successful unconscious pace-setting?

Solution:

Passage Analysis

Summary and Main Point

This is an Application question because of the phrase “best illustrates.” More specifically, this question is asking us to apply our understanding of the passage to hypothetical situations. The author describes pace-setting in the first paragraph. Let’s re-read the relevant facts, and then eliminate any hypothetical situations that are contradicted by those facts.

Answer Choices

A

A car factory sets a quota for the number of windshields installed per hour incentivizes windshield-installers to work at a faster rate. 

Incorrect: Opposite

The paragraph warns that factory workers who are given such quotas can be resentful, and that ultimately such policies can backfire, decreasing inefficiency. 

B

A military unit consisting of infantrymen cross-train with multiple weapons so they are more efficient in battle.

Incorrect: Out Of Scope

The passage does not mention workers cross-training as a way to improve efficiency. The paragraph is specifically focused on whether setting pace expectations causes more or less efficiency. 

C

A magazine regularly sets aside a column to name a specific “Employee of the Month” and award the employee for his/her dedication.

Correct

This is an example of unconscious pace setting mentioned in the passage.

D

A watch repair store requiring its employees to self-report their hours finds them to be inaccurate.

Incorrect: Out of Scope

The morality of employees is outside the scope of the paragraph. The paragraph is concerned with the situations in which pace-setting is and is not effective at improving efficiency. 

E

An accounting firm that hires specialized workers to handle simultaneous parts of its billing increases efficiency by requiring workers to clock in and out.

Incorrect: Out of Scope

There is no incentivizing mentioned here. This example is irrelevant to the passage.

QUESTION: 14

American companies may find the solution to their performance related problems in their own backyard. A recently conducted independent study shows that in the business world, social and political skills have become the real key to getting ahead in organisations, skills that successful managers use to their advantage. The study found out that successful managers, those who get promoted relatively quickly vis-à-vis effective managers, perform day to day activities that are more or less dissimilar to the ones conducted by effective managers or those who have satisfied, committed subordinates, in addition to high performing units. Accordingly, it comes as no surprise that networking, which consists of socializing or politicking and interacting with others, was one activity that, out of the core four activities among the plethora of activities performed by managers, topped the list for successful managers but was ranked the lowest in the list of activities performed by the effective ones. Indeed the findings of the study do not negate the reality that there are managers who strike a balance between the activities performed by both types of managers and hence are successful and effective at the same time, but the meagre percentage such managers formed of the study’s sample, barely ten percent, affirms the general divide between successful and effective managers.

These findings clearly belie the traditional assumption typically suggested by formal personnel policies that promotions are based purely on performance. In effect, the study’s implications affirm the cynical, yet what now seems real, view that people who are not necessarily the most accomplishing in terms of performing well in the other three key activity areas, namely communication, traditional management, and human resource management, are being promoted to the top level. Therefore, American companies looking to improve their performance and productivity need to ensure that formal rewards, especially promotions, are tied to performance. This way companies will be promoting a work-culture that turns effective managers in to successful managers and gives the currently successful managers a chance to effectively focus on productivity and not just on socializing and politicking.

Each of the following can be inferred from the passage EXCEPT

Solution:

Passage Analysis

Summary and Main Point

This is an Inference- EXCEPT question. Four out of the five given answer choices will follow closely from what is directly stated in the passage, but it may not itself be explicitly stated in the passage; these answer choices are INCORRECT. Select the answer choice that is NOT bolstered by specific facts mentioned in the passage. 

Answer Choices

A

Managers in general perform some activities that are more important than others.

Incorrect: Can be Inferred 

The author distinctly mentions in the first paragraph that there are four main (core) activities that managers perform from a plethora of activities.

B

Successful managers are inherently good at networking whereas effective managers are not. 

Correct: No information given

We don't have any information to conclude whether these managers naturally have the aptitude or lack of the same for networking. We are just told that successful managers indulge the most in networking and effective managers, the least.

C

Some managers do not fit exclusively in one of the two categories. 

Incorrect: Can be Inferred 

This information is given in the last sentence of the first paragraph. The author states:
Indeed the findings of the study do not negate the reality that there are managers who strike a balance between the activities performed by both types of managers and hence are successful and effective at the same time

D

Some company policies are inconsistent with the actual workings of the company. 

Incorrect: Can be Inferred 

This information can be derived from the first sentence of the last paragraph. The author states that:
These findings clearly belie the traditional assumption typically suggested by formal personnel policies that promotions are based purely on performance.

E

American companies looking to enhance their performance must look within their set-up for scope of improvement. 

Incorrect: Can be Inferred 

This statement is supported by the whole passage in general and especially by the first sentence and the second last sentence of the passage.

QUESTION: 15

American companies may find the solution to their performance related problems in their own backyard. A recently conducted independent study shows that in the business world, social and political skills have become the real key to getting ahead in organisations, skills that successful managers use to their advantage. The study found out that successful managers, those who get promoted relatively quickly vis-à-vis effective managers, perform day to day activities that are more or less dissimilar to the ones conducted by effective managers or those who have satisfied, committed subordinates, in addition to high performing units. Accordingly, it comes as no surprise that networking, which consists of socializing or politicking and interacting with others, was one activity that, out of the core four activities among the plethora of activities performed by managers, topped the list for successful managers but was ranked the lowest in the list of activities performed by the effective ones. Indeed the findings of the study do not negate the reality that there are managers who strike a balance between the activities performed by both types of managers and hence are successful and effective at the same time, but the meagre percentage such managers formed of the study’s sample, barely ten percent, affirms the general divide between successful and effective managers.

These findings clearly belie the traditional assumption typically suggested by formal personnel policies that promotions are based purely on performance. In effect, the study’s implications affirm the cynical, yet what now seems real, view that people who are not necessarily the most accomplishing in terms of performing well in the other three key activity areas, namely communication, traditional management, and human resource management, are being promoted to the top level. Therefore, American companies looking to improve their performance and productivity need to ensure that formal rewards, especially promotions, are tied to performance. This way companies will be promoting a work-culture that turns effective managers in to successful managers and gives the currently successful managers a chance to effectively focus on productivity and not just on socializing and politicking.

The author is primarily concerned with

Solution:

Passage Analysis

Summary and Main Point

This is a Main Idea question. The first paragraph talks about the findings of a study. The second paragraph presents the implications of the study mentioned in the first paragraph. Hence, the author of the passage is concerned with presenting the findings of a study and its implications.

Answer Choices

A

discussing a trend and its implications 

Correct

The author discusses the trend observed in American companies; the trend is that some managers (successful ones) not performing better than others (effective managers)on most of the four core activities are promoted relatively quickly. This trend is given to us in the form of the study findings.
The second paragraph talks about the implications of the findings/trend in terms of what they mean for the current situation in companies and how companies can use this information to institute measures enhancing their productivity and performance.

B

criticising some companies for an unfair practice followed by them

Incorrect: Partial Scope

Even though the author does use a slightly critical tone in the first two sentences of the last paragraph, they do not form sufficient content to make us believe that the main purpose of the author is to criticize the companies for promoting successful managers relatively quickly. Also, the use of the word "unfair" is not fully supported by the passage.

C

evaluating a situation and warning against its possible implications 

Incorrect: Partial Scope

It is correct that the author evaluates the situation uncovered by the study's findings; however, he/she does not warn us against any possible implications. Whatever the implications are, they are current.

D

describing the findings of a study 

Incorrect: Partial Scope

This choice fails to capture the essence of the passage. The author doesn't just describe the findings of the study; he/she discusses them while discussing the implications of these findings.

E

uncovering the gap between the perception and the reality of a situation 

Incorrect: Partial scope

The only place any perception is talked about is in the discussion of the formal personnel policies (first sentence- last para); however, the whole purpose of the passage is not to make the readers aware of the reality of the situation.

QUESTION: 16

American companies may find the solution to their performance related problems in their own backyard. A recently conducted independent study shows that in the business world, social and political skills have become the real key to getting ahead in organisations, skills that successful managers use to their advantage. The study found out that successful managers, those who get promoted relatively quickly vis-à-vis effective managers, perform day to day activities that are more or less dissimilar to the ones conducted by effective managers or those who have satisfied, committed subordinates, in addition to high performing units. Accordingly, it comes as no surprise that networking, which consists of socializing or politicking and interacting with others, was one activity that, out of the core four activities among the plethora of activities performed by managers, topped the list for successful managers but was ranked the lowest in the list of activities performed by the effective ones. Indeed the findings of the study do not negate the reality that there are managers who strike a balance between the activities performed by both types of managers and hence are successful and effective at the same time, but the meagre percentage such managers formed of the study’s sample, barely ten percent, affirms the general divide between successful and effective managers.

These findings clearly belie the traditional assumption typically suggested by formal personnel policies that promotions are based purely on performance. In effect, the study’s implications affirm the cynical, yet what now seems real, view that people who are not necessarily the most accomplishing in terms of performing well in the other three key activity areas, namely communication, traditional management, and human resource management, are being promoted to the top level. Therefore, American companies looking to improve their performance and productivity need to ensure that formal rewards, especially promotions, are tied to performance. This way companies will be promoting a work-culture that turns effective managers in to successful managers and gives the currently successful managers a chance to effectively focus on productivity and not just on socializing and politicking.

Which of the following is mentioned in the passage?

Solution:

Passage Analysis

Summary and Main Point

This is a Detail question. Keep crossing out answer choices that are not explicitly stated in the passage and choose the one for which you can directly refer to a portion in the passage.

Answer Choices

A

Socializing and politicking are activities not worthy of a manager's time.

Incorrect: Out of Scope

The author never comments on the worthiness of this activity. He/she suggests that other activities need to be focused on as well if companies are to improve on their performance.

B

The study's findings shed light on many unstated assumptions that are part of some of the policies followed by American companies.

Incorrect: Out of Scope

The author only talks about one assumption and not many. ( ref.: first sentence- last paragraph)

C

Out of the four core activities, it is communication in which effective managers perform the best. 

Incorrect: Out of Scope

The author gives no information regarding the performance of effective managers in terms of their individual performance on the core activities- except that networking is something that features on the bottom of their activities.

D

There is a gap between what appraisal related policies suggest and what the actual case is.

Correct

This choice directly flows from the first sentence of the last paragraph. The author says:
These findings clearly belie the traditional assumption typically suggested by formal personnel policies that promotions are based purely on performance.

E

American companies looking to improve their performance and productivity need to ensure that the most effective managers are also promoted once in a while.

Incorrect: Out of Scope

The proposed solution is not effective managers getting a promotion once in a while but that of getting it relatively faster.

QUESTION: 17

American companies may find the solution to their performance related problems in their own backyard. A recently conducted independent study shows that in the business world, social and political skills have become the real key to getting ahead in organisations, skills that successful managers use to their advantage. The study found out that successful managers, those who get promoted relatively quickly vis-à-vis effective managers, perform day to day activities that are more or less dissimilar to the ones conducted by effective managers or those who have satisfied, committed subordinates, in addition to high performing units. Accordingly, it comes as no surprise that networking, which consists of socializing or politicking and interacting with others, was one activity that, out of the core four activities among the plethora of activities performed by managers, topped the list for successful managers but was ranked the lowest in the list of activities performed by the effective ones. Indeed the findings of the study do not negate the reality that there are managers who strike a balance between the activities performed by both types of managers and hence are successful and effective at the same time, but the meagre percentage such managers formed of the study’s sample, barely ten percent, affirms the general divide between successful and effective managers.

These findings clearly belie the traditional assumption typically suggested by formal personnel policies that promotions are based purely on performance. In effect, the study’s implications affirm the cynical, yet what now seems real, view that people who are not necessarily the most accomplishing in terms of performing well in the other three key activity areas, namely communication, traditional management, and human resource management, are being promoted to the top level. Therefore, American companies looking to improve their performance and productivity need to ensure that formal rewards, especially promotions, are tied to performance. This way companies will be promoting a work-culture that turns effective managers in to successful managers and gives the currently successful managers a chance to effectively focus on productivity and not just on socializing and politicking.

Which of the following most aptly describes the function of the second paragraph?

Solution:

Passage Analysis

Summary and Main Point

This is a Function question. Per the individual paragraph summary, the second paragraph presents the implication of the study of the findings of the study mentioned in the first paragraph. 

Answer Choices

A

To criticize the false picture companies portray with respect to appraisals 

Incorrect: Partial Scope

This covers only the scope of the first two sentences of the last paragraph. The author's suggestion mentioned in the last few sentences of the passage are not mentioned in this choice.

B

To close the gap between perception and reality 

Incorrect: Partial scope

This choice too, like choice A, covers only the first two sentences of the last paragraph and not the whole scope of the paragraph.

C

To take forward the discussion on the strict measures American companies need to take

Incorrect: Out of Scope

The author does not tell us whether the measures to be taken by the company are strict or not.

D

To discuss the implications of a study 

Correct

As mentioned in the explanation for the correct choice in the main idea question, this paragraph talks about the implications of the findings/trend in terms of what they mean for the current situation in companies and how companies can use this information to institute measures enhancing their productivity and performance.

E

To motivate a kind of managers to become successful

Incorrect: Irrelevant

The author proposes a solution to the companies looking to achieve a particular goal; it does not mean that he is directly addressing the effective managers here.

QUESTION: 18

A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk.  Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.

Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.

Which of the following statements would the author most likely agree with?

Solution:

Passage Analysis

Summary and Main Point

 

This is an Inference question. Four out of the five given answer choices will not follow from what is stated in the passage; these answer choices are INCORRECT. Select the answer choice that is bolstered by specific facts mentioned in the passage.

Answer Choices

A

Even though uncertainty about a new CEO’s ability has more impact on a firm’s default risk, uncertainty about a new CFO could affect the rate at which the firm is lent money and its default risk.

Incorrect: Partial Scope

Although the author does state that uncertainty about a new CFO could affect a firm’s default risk and cost of borrowing, there is no information given to compare this effect with the impact resulting from uncertainty about a new CEO’s ability.

B

The uncertainty about a new CEO is likely to be comparably lower when an expected candidate takes over the position vis-à-vis an unexpected one.

Correct

This information can be deduced on the basis of the following information:

In particular, when the new CEO is not considered an “heir apparent” prior to getting the position… the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions.

C

Because the literature on debt pricing normally does not differentiate between the types of risks, sometimes the default risk is not calculated thoroughly.

Incorrect: Out Of Scope

The author neither states nor suggests the cause and effect relationship stated in this choice.

D

As the tenure of a new CEO progresses, the uncertainty regarding his ability decreases considerably.

Incorrect: Out Of Scope

Although it is given that the uncertainty decreases with the passage of time, the passage gives us no information to support that it decreases “considerably”.

E

By maintaining transparency in managerial policies, a firm can successfully negotiate its terms in the market.

Incorrect: Out Of Scope

There is no given information to deduce anything about a firm’s success in negotiating its term.

QUESTION: 19

A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk.  Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.

Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.

The author is primarily concerned with

Solution:

Passage Analysis

Summary and Main Point

 

This is a Main Idea question. As seen in the summary and main point section, the first paragraph deals with defining default risk and explaining how management risk affects it. The second paragraph discusses the importance of management risk with respect to decisions taken by the market and the firm. In all, if you see, both the paragraphs discuss the relevance of management risk.

Answer Choices

A

highlighting the importance of a risk factor that is normally not easily understood in the business world

Incorrect: Inconsistent

Yes, the author does highlight the importance of management related risk but there is no information to support that this risk is not easily understood.

B

discussing how a particular factor, though important, gets neglected most of the time

Incorrect: Irrelevant

The author does say the literature on debt pricing does not differentiate between risks, but the passage never delves in to discussing that the factor is ignored.

C

describing how a risk factor in the business world gets more importance in some situations than in others

Incorrect: Inconsistent

This information is given while discussing the situations in which the uncertainty about management is higher.  However, this is only a part of the entire discussion- not the main focus.

D

explaining how different risk factors need to be given importance as per their relative weightage

Incorrect: Irrelevant

There is no mention of/discussion over relative weightage of risk factors.

E

discussing the relevance of a risk factor that affects more than one aspect in the business world

Correct

As stated in the pre-thinking portion, the author discusses the relevance of management related risk and yes, the passage gives us enough information to conclude that this risk affects default risk, cost of borrowing, financial policies etc.

QUESTION: 20

A firm’s default risk, the measurement of the chances of the event in which the company will be unable to make the required payments on its debt obligations, reflects not only the likelihood that the firm will have bad luck but also the risk that the firm’s managerial decisions will lead the firm to default. Such management risk occurs because the impact of management on the firm’s value is uncertain, and this uncertainty affects the market’s perception of a firm’s risk.  Uncertainty about management is likely to be the highest when there is a new management team and should decrease over time as management’s ability becomes known more precisely. In particular, when the new CEO is not considered an “heir apparent” prior to getting the position, or when he comes from outside of the company, or when the new CEO is younger, the market is expected to perceive relatively high uncertainty about the CEO’s ability or future actions. Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure. The CEO, however, is not the only member of the management team who is relevant for decision making in the firm. Chief Financial Officers (CFOs) have a large role in financial decision-making, so uncertainty about new CFOs could also affect the firm’s default risk and cost of borrowing.

Now, a central feature of financial markets is that the interest rate a firm pays on debt increases with an increase in the market’s perception of the firm’s risk. This risk occurs because of factors that affect the value of the firm’s underlying assets and because of uncertainty about how these assets will be managed. The literature on debt pricing typically does not distinguish between these types of underlying risks. However, all risks, including those generated by uncertainty about management, affect the likelihood of default. Consequently, a rational market should incorporate managerial-generated uncertainty into its assessment of a firm’s risk when pricing its securities. Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies, the value of maintaining transparency in managerial policies and communicating them to the marketplace should be realised.

Which of the following CANNOT be inferred from the passage?

Solution:

Passage Analysis

Summary and Main Point

 

This is an Inference EXCEPT question. Four out of the five given answer choices CAN be deduced from the passage; these choice are INCORRECT. The correct answer will either be inconsistent with the given information or be something for which there is no supporting information in the passage.

Answer Choices

A

Market’s perception of firm’s risk is minimal when the new CEO is an “heir apparent” or is from within the existing management team.

Correct

First of all, a firm’s risk is a combination of management related and other risks. So, we cannot draw a sweeping statement about a firm’s risk by estimating just management related risk. Secondly, there is no given information to support that management related risk will be “minimal” under the given circumstances.

B

The uncertainty regarding a new CEO is likely to be more in the first years of his tenure than in the fourth year.

Incorrect: Can be Inferred

The author gives us enough throughout the passage to conclude the information given in this choice. For specific mention, one could refer to the following portion:

Accordingly, it comes as no surprise that the CDS spread, a measure of a firm’s expected default risk, is about 35 basis points higher when a new CEO takes office than three years into his tenure.

C

The default risk of a firm represents more than one thing about the firm.

Incorrect: Can be Inferred

This statement can be inferred from the first sentence of the passage.

D

It is unusual for a piece of literature on debt pricing to differentiate between the risk generated from the factors affecting a firm’s asset and one generated from how these assets will be managed.

Incorrect: Can be Inferred

We can infer the information given in this choice from the following portion:

The literature on debt pricing typically does not distinguish between these types of underlying risks.

E

Uncertainty about management affects a firm’s financial policies.

Incorrect: Can be Inferred

This can be deuced from the following section in the second paragraph:

Also since uncertainty about management affects firms’ costs of borrowing and consequently their financial policies

We can conclude from the above portion that the uncertainty affects the cost of borrowing, which in turn affects the financial policies of the firm.

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