Question #2 - Reading 8 Intercorporate Investments

Reading: Reading 8 Intercorporate Investments

PDF File: Reading 8 Intercorporate Investments.pdf

Page: 2

Status: Incorrect

Correct Answer: A

Your Answer: C

Shared Context

- Which of the following statements regarding special purpose entities (SPEs) is least accurate? A) An SPE can be established as one of several legal forms, such as corporations, partnerships, or trusts, but must establish separate management from that of the sponsor. B) In general, the equity investors in an SPE can expect to receive a limited rate of return on their investment in exchange for limited risk exposure. C) An SPE can be formed to isolate specific assets from the sponsor, thus lowering the cost of capital by protecting the assets of the SPE in the event the sponsor experiences financial distress.

Question

According to US GAAP, if an SPE is to be considered a variable interest entity (VIE), it must meet which of the following conditions?

Answer Choices:

A. The equity investors in the VIE must bear all of the SPE's risk up to a pre-determined level as outlined in the governing documents

B. The SPE must be consolidated by the primary beneficiary, whose status as primary beneficiary is defined by the level of the firm's percentage of voting control

C. The total at-risk equity of the SPE is not sufficient to finance the entity's activities without additional subordinated financial support

Explanation

To qualify as a VIE under US GAAP, any one of four conditions must be met, one of which is the presence of an insufficient at-risk equity investment.

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