ACCA AFM Flashcards

Personal ownership motivation of buyout team; hands-on management approach; keener decision-making on pricing/collections; savings in head office overheads; faster response to opportunities.

Option to enter into a swap on a future date. Holder has right (not obligation) to arrange swap at specified future date. Used when company expects to borrow but uncertain of need; preserves flexibility.

Wealth must be generated from legitimate trade and asset-based investment; investments must have social/ethical benefit; speculative investments and riba (interest) are forbidden.

Security combining features of both debt and equity. Examples: convertible bonds (debt with equity option), preference shares (fixed return with priority over equity). Used to optimise capital structure.

Acquire target at undervalue; realise synergies (revenue/cost/financial); gain market power; acquire dynamic management or innovative products; enter new market quickly.

Corporate restructuring enabling a company to continue in business (or orderly liquidation). Requires court permission; all creditor classes must vote in favour; transfers assets to new company in exchange for shares.

Risk that interest rates change before a future loan starts, locking the borrower into a rate differing from the prevailing market rate at the time the loan is negotiated.

Form of credit sale; customer receives goods but pays fixed later date. Fixed price (including mark-up incorporating time value of money) agreed before delivery; no interest charged.

High-risk financing for start-ups/emerging businesses through equity participation. Providers (venture capitalists) often backed by private equity; seek high returns to compensate risk.

Reducing combined company’s risk may lower insolvency risk and borrowing costs; increased asset backing bolsters borrowing capacity; exploiting tax losses sooner. Note: risk reduction does not benefit well-diversified shareholders.

Write off large debit balances in P&L, enabling future dividend payments and new finance injections; rearrange capital structure; make ordinary shares more attractive to investors.

OTC fixing of interest rate now to apply to future loan. Bank quotes fixed rate; if actual rate differs at loan start, bank and company settle difference in cash. Fixes effective interest rate.

Lease arrangement. Lessor takes back asset at end = operating lease. Lessor sells asset to lessee at end = Ijara-wa-Iqtina (finance lease). Lessor bears ownership risk (maintenance, insurance).

Financing from high-net-worth individuals investing in early-stage businesses in exchange for equity. Less formal than venture capital; often provide mentoring alongside capital.

Over-optimism regarding economies of scale; target’s share price may already anticipate synergies; competitive bidding drives up price. Management often overestimates their ability to improve target’s results.

All listed shares acquired by small group of investors; company is de-listed. Benefits: saves direct and indirect listing costs; eliminates hostile takeover risk; smaller shareholder base reduces agency problem.

OTC arrangement where bank fixes maximum interest rate on future loan. Company protected if rates rise above cap; if rates fall, company benefits. Premium paid upfront, whether or not option exercised.

Similar to equity finance or special partnership. Investor provides capital; business partner manages. Profits shared; losses fall on investor (limited to capital provided). Partner has no investment at risk.

Alternative to traditional IPO; shell company merges with operating company. Provides faster path to public listing; reduces costs; allows targets to remain private longer before going public.

Provide more information to shareholders; contest the offer; issue profit forecasts; revalue assets; find a White Knight (alternative bidder); arrange management buyout; poison pill tactics.

Transaction risk: settlement at different exchange rate than quoted. Translation risk: accounting profits/losses from converting foreign balances. Economic risk: change in PV of future cash flows from FX movements.

Futures price = 100 ? interest rate (%). Example: price 92.00 = 8% interest rate. A change of 2.00 in futures price = 2% p.a. = 0.5% for 3-month contract.

Partnership where both parties contribute capital and expertise. Profits shared per contract terms; losses shared proportional to capital contributions. Akin to venture capital arrangement.

Assess reinvestment strategy (short and long term), capital reconstruction programmes (share repurchases, new issues), timing of remittances, corporation tax regime, and transfer pricing policy.

Values based on the firm’s assets less liabilities. Three bases: book values (per statement of financial position), realisable values (sale price), replacement values (cost to buy individually).

As the amount of the first-mentioned currency equal to one unit of the second-mentioned currency. Example: $/£ 1.6250 – 1.6310 means 1.6250 is the buy rate (bank sells $), 1.6310 is sell rate (bank buys $).

Sell futures. Borrower fears rising rates. Rising rates ? falling futures prices. Selling futures now and buying back at lower price locks in profit, offsetting higher borrowing cost.

Islamic bonds; must have underlying tangible asset. Holders own proportional share of asset; receive share of revenues and eventual sale proceeds (not interest). Traded secondarily but market is small.

Share repurchase reduces free cash flow to equity available for payment. Affects reported EPS and financial position. Must consider impact on capital structure and gearing ratios.

FCFF = EBIT + Depreciation ? Increase in working capital ? Cost of new assets ? Tax, where tax is paid on EBIT. Interest and loan repayments are excluded (financing flows, not operating).

Binding agreement with a bank to buy/sell fixed foreign currency at fixed rate on future date. Once accepted, rate is locked in. Used to eliminate transaction exposure completely for specified amount and date.

Number = (Loan amount / Contract size) × (Loan period in months / 3). Scaling accounts for the fact that futures are 3-month standard contracts.

Provides alternative source of finance for organisations pursuing environmental/sustainable agendas. Growing source; rationale is ethical/social compliance alongside conventional financial objectives.

Pricing of goods/services across international borders within same group. Significant because regulators scrutinise to prevent profit shifting to low-tax jurisdictions; affects both tax and reported earnings.

Ungear the equity beta of a proxy company with similar business risk; regear using the acquiring company’s capital structure; calculate cost of equity via CAPM; calculate WACC using this cost of equity.

Premium: deduct from spot rate (currency at premium = fewer units per £ forward). Discount: add to spot rate (currency at discount = more units per £ forward).

Combination of buying a put option (cap = maximum rate) and selling a call option (floor = minimum rate). Net premium cost = premium paid for put ? premium received for call. Effective rate locked between floor and cap.

Report format with headings/structure; appropriate style/tone/presentation; clarity and effectiveness; relevance to specific requirements; adherence to any commissioning brief; appropriate use of CBE tools.

Government limits on repatriating profits from overseas investments. Managed through netting, multilateral matching, financing structures (loans instead of dividends), or alternative remittance routes.

Value the enlarged combined entity using its projected free cash flows including synergies; subtract the current value of the acquiring company; result is the maximum worth paying for acquisition.

Convert foreign currency at today’s spot rate by borrowing the foreign currency now (on strength of future receipt), converting at spot, and repaying when future cash arrives. Eliminates future FX rate uncertainty.

Agreement between parties to exchange interest payment obligations. One pays fixed, other pays floating. Used when each party has comparative advantage in different markets but different preferences (one wants fixed, other floating).

Appropriate use of data for calculations/analysis; objective appraisal of information; identifying missing data/further analysis needed; balanced evaluation of impact; reasoned, justified conclusions.

Organisational performance assessment, optimum capital mix and structure, distribution/retention policy, financial policy communication, financial planning/control, risk management, ESG/ethical considerations, stakeholder alignment.

FCFE = EBIT + Depreciation ? Increase in working capital ? Capital expenditure ? Interest paid ? Taxes ? Loans repaid. Represents cash available to equity holders; discounted at cost of equity.

Exchange-traded (not OTC) contract to buy/sell fixed currency amount at future date. Key differences: delivery dates four times yearly; traded on exchange; margin required; fixed contract sizes; can be closed before delivery.

The spread between two parties’ fixed rates must differ from the spread between their floating rates. This difference creates comparative advantage; total saving is divided between parties.

Questioning approach; challenging information/evidence/assumptions with reasoned justification (not abstract); identifying contradictory evidence; applying professional judgement; reaching properly informed decisions.

Apply the P/E ratio of a similar quoted company to the target’s earnings per share. For unquoted companies, reduce the P/E to reflect non-marketability; adjustment amount must be justified contextually.

The difference between the futures price and the mid-market spot rate. Basis converges (falls) to zero by delivery date. Used to estimate future futures prices assuming linear convergence.

S? = S? × [(1 + hc)/(1 + hb)], where S? = expected future spot, S? = current spot, hc = inflation in variable currency, hb = inflation in base currency. Percentage change in spot equals inflation differential.

Use scenario examples to illustrate points; recognise external constraints/opportunities; assess validity of organisational assumptions; account for internal constraints; ensure advice is practical and plausible.

Equity is analogous to a call option on the firm’s assets: if debt > assets, shareholders walk away (limited liability); if assets > debt, shareholders retain surplus. Inputs: asset value, debt amount, time, risk-free rate, asset volatility.

The variability in prices of two related securities in a hedge. If futures price change does not perfectly match underlying spot change, profit/loss may occur on hedged position.

Exchange rates adjust to offset inflation rate differences between countries, maintaining purchasing power parity. A country with higher inflation should see its currency weaken.

Short-term management of financial resources, longer-term maximisation of corporate value, and management of risk exposure (including forex and interest rate risks).

Early-year losses; no past results to base estimates on; inexperienced management; unlike existing businesses (difficult to find comparables). Conventional valuation methods are unreliable.

Smallest price movement in futures contract. Tick value = 0.0001 × contract size. Profit/loss = number of ticks × tick value × number of contracts.

Export from home country, overseas branch, overseas subsidiary, joint venture, licensing. Each offers different levels of control, risk, investment, and local market presence.

Exchange-traded vs OTC; standard contracts; tick sizes/margins; margin trading; basis risk. OTC contracts more flexible; exchange-traded more liquid and transparent.

European options: exercisable only on the expiry date. American options: exercisable at any time up to and including expiry date. Terms refer to exercise style only, not trading location.

Splitting a company into two or more separate businesses with existing shareholders receiving shares in each. Control is maintained throughout; no third-party transaction.

Gives right (not obligation) to convert currency at fixed rate. Preferred when rate movements expected in company’s favour; company abandons option if spot rate better, benefits from favourable movement.

Through dividends, loan interest, royalties, management charges, transfer prices, or countertrade. Transfer pricing is sensitive; regulators scrutinise to prevent profit shifting.

Delta: option price sensitivity to share price. Gamma: rate delta changes (requires continuous rehedging). Theta: option value decay over time. Together they measure hedging risks.

A right (not obligation) to change something about a project during its life, improving returns by reducing downside risk. Examples: delay, expand, abandon, redeploy.

Sell-off: at least part of business sold to third party; control lost. Unbundling: taking apart company components for separate disposal, typically at higher aggregate price. Asset stripping = unbundling after takeover.

OTC: arranged privately with bank, tailor-made to requirements, premium market-driven by negotiation. Traded: bought/sold on exchange, only major currencies, fixed strike prices/expiries/sizes, published premiums.

Risk affecting all foreign firms in a country: war, civil unrest, confiscation of assets, nationalisation, foreign ownership restrictions, import quotas, exchange controls.

Consider financial position, financial risk, and value of organisation. Sources include equity, debt, hybrids, leasing, venture capital, private equity, securitisation, Islamic finance.

Delay = call option (right to invest at future date). Expand = call option (right to invest further). Abandon/Redeploy = put options (right to cease/redirect resources).

Purchase of all or part of a business from owners by one or more of its executive managers, typically with backing from venture capitalists. Owners benefit by exiting non-strategic assets; buyout team gains ownership.

Two parties exchange principal in different currencies at spot rate, make periodic interest payments on each other’s borrowing, re-exchange principal at end. Purpose: each party borrows in its cheaper market, swaps to get preferred currency exposure.

Risk affecting only certain firms/industries: minimum wage legislation, pollution controls, product legislation, health/safety legislation. Specific to business type, not all foreign firms.

Process of converting claims on assets into negotiable certificates transferable among investors. Holder has same rights as original recipient. Allows organisations to free up capital from assets.

Acquiring managers often hold unrealistically high opinions of their own skills in improving a target’s results, leading to overpayment for the target.

Working capital cash flows are included but have no tax effects. Unless stated otherwise, all working capital invested is recovered at the end of the project.

Multi-period VaR = single-period standard deviation × ?n, where n = number of periods. This accounts for the accumulation of risk over time.

APV = Base-case NPV (all-equity financing) + PV of tax shield on debt. APV measures project gain after accounting for financing effects, particularly relevant when financing changes significantly.

The study of why investors and financial managers deviate from rational decision-making assumptions by failing to maximise utility, ignoring relevant information, or giving disproportionate weight to information confirming existing beliefs.

The discount rate at which NPV = 0 (the breakeven rate). IRR is calculated by trial and error, interpolating between two discount rates that produce positive and negative NPVs.

Market value = PV of all future interest payments + PV of redemption value, discounted at the investors’ required rate of return.

Annual tax shield = Tax rate × Interest payment. PV of tax shield = discounted value of annual tax shields over the debt’s life. For irredeemable debt: PV = Tax rate × Debt amount (permanent).

k? = [d?(1+g)]/P? + g, where d? = dividend just paid, g = growth rate, P? = ex-dividend market price. Equivalently: k? = d?/P? + g.

IRR assumes cash flows are reinvested at the IRR itself, which is often unrealistic. For high-IRR projects, this overstates the true return; for low-IRR projects, it understates the return.

The rate of return to investors (IRR) of the cash flows from a bond: the discount rate that equates the market value with the PV of future coupons and redemption value.

Issue costs (costs of raising finance) are subtracted from base-case NPV when arriving at APV because they represent real cash outflows reducing project value.

Maximise shareholders’ wealth, measured by the market value of their shares. The financial manager must consider the likely impact on share price when choosing between alternative strategies.

g = r × b, where b = retention ratio (proportion of earnings retained) and r = rate of return earned on reinvestment. Growth requires retained earnings for reinvestment.

MIRR is a return measure assuming cash flows are reinvested at the cost of capital (more realistic than IRR). It avoids the multiple-solutions problem and is usually lower than IRR.

Longer-dated bonds have more years of cash flows ahead. A higher discount rate (higher required return) has a greater cumulative effect on the present value over many periods.

The after-tax value of the subsidy (after-tax difference between normal borrowing rate and subsidised rate) is added to base-case NPV when calculating APV.

UK/USA: Focus on shareholder wealth maximisation whilst satisficing other stakeholders’ requirements. Continental Europe/Japan: Focus on maximising corporate wealth, including technical, human, and market resources.

kd(after tax) = [i(1?T)]/P?, where i = annual interest payment, P? = ex-interest market price, T = corporation tax rate. The tax relief on interest reduces the effective cost to the company.

MIRR = (PVR/PVI)^(1/n) × (1 + r?) ? 1, where PVR = PV of return phase, PVI = PV of investment phase, n = project life, r? = cost of capital.

Macaulay duration measures the average time it takes for a bond to pay its interest and principal, weighted by present value of each cash flow. Formula: Duration = ?(t × PV)/?(PV).

A share option is the right (not obligation) to buy (call) or sell (put) a share at a fixed exercise price on or before a future date. The holder pays a premium upfront.

The conflict of interest that arises when an agent (e.g. manager) acts on behalf of a principal (e.g. shareholder) but may pursue divergent objectives. Mechanisms like share options and profit-related pay can reduce conflicts.

WACC = [k? × V? + kd(after tax) × Vd]/(V? + Vd), where V? = market value of equity, Vd = market value of debt, k? = cost of equity, kd(after tax) = after-tax cost of debt.

Forecast cash flows in the foreign currency, convert to home currency using forecast exchange rates, incorporate tax effects in both host and home countries (including double taxation relief), then discount at home cost of capital.

As coupon increases, duration decreases (higher early coupons weight the average earlier). As time to maturity increases, duration increases (more cash flows further in future).

Current share price, exercise price, time to expiry, volatility of share price, and risk-free interest rate. BSOP model calculates option value given these inputs.

Goal congruence is achieved when the agent’s interests align with the principal’s interests. Share options and profit-related pay are mechanisms to achieve this, though no single scheme achieves perfect alignment.

Systematic (market) risk: arising from general economic factors affecting all companies. Unsystematic (company-specific) risk: arising from factors specific to an individual company. Only systematic risk is priced.

PV = C?/(r ? g), where C? = cash flow at end of year 1, r = cost of capital, g = constant growth rate. Used for cash flows in perpetuity growing at constant rate.

Modified duration = Macaulay duration / (1 + r). It measures the sensitivity of a bond’s market value to interest rate changes.

c = P? × N(d?) ? P? × e^(?rt) × N(d?), where P? = current share price, P? = exercise price, r = risk-free rate, t = time to expiry, N(d) = normal distribution probability, d? and d? are standard BSOP calculations.

Excessive remuneration, empire building through growth takeovers, creative accounting to boost share price, and defending against takeover bids regardless of shareholder benefit.

Beta (?) measures systematic risk relative to the market as a whole. Higher ? = greater sensitivity to market movements. ? = 1 means the security moves in line with the market.

Capital rationing occurs when a company has more worthwhile projects than available capital. Single-period rationing involves ranking by profitability index; multi-period requires linear programming formulation.

?P = ?D × ?i × P, where D = modified duration, ?i = change in interest rates, P = current market value. Negative sign indicates inverse bond price–interest rate relationship.

p = c ? P? + P? × e^(?rt), where p = put value, c = call value. A put option plus the share equals a call option plus the present value of the exercise price.

EBITDA = Earnings Before Interest, Taxes, Depreciation and Amortisation. Depreciation is excluded because it is non-cash; EBITDA approximates cash flow. However, it fails to account for required fixed asset replacement.

E(r?) = Rƒ + ??[E(r?) – Rƒ], where E(r?) = required return, Rƒ = risk-free rate, E(r?) = market return, ?? = beta of the investment.

Hard capital rationing: the company cannot borrow more capital. Soft capital rationing: the company could borrow but has chosen to limit borrowing. The LP formulation is identical for both.

Convexity is the non-linearity of the bond price–interest rate relationship. Modified duration is only reliable for small interest rate changes; larger changes produce less accurate estimates due to the curved relationship.

European-style options only; security value follows log-normal distribution; no dividends; constant volatility and risk-free rate; no transaction costs or taxes; perfect market.

Always comment on growth in turnover, profit, and share price. Assess overall trends rather than performing detailed year-by-year analysis.

Portfolio ? = weighted average of individual betas, where weights = proportion of investment in each share.

Free cash flow is the cash available for distribution to all capital providers (equity and debt). In project appraisal, it equals the net cash flow calculated each year.

Project duration measures the average time over which a project delivers its value (cash inflows), weighted by present value. Calculated like Macaulay duration; lower duration indicates lower project risk.

Delta = N(d?) = rate at which option price changes with share price. Delta range: 0 to 1 for calls. Used to construct delta hedges (protective positions combining shares and options).

Previous years for the same company, other similar companies, industry averages, and sector benchmarks.

Alpha = actual return ? theoretical (CAPM) required return. A positive alpha indicates the security outperforms CAPM predictions.

FCF = EBIT ? Tax on EBIT + Non-cash items (depreciation) ? Capital expenditure ? Working capital changes.

Project duration considers cash flows over the entire project life; payback only considers flows until initial investment is recovered. Duration is a better risk measure.

Number of options to sell = Shares held / Delta. Purpose: protects share holding against short-term price movements; falling share prices offset by profits on short call options.

ROCE = Net profit margin × Asset turnover. This identity shows how profitability depends on both margin and efficiency.

Asset (ungeared) beta measures purely the riskiness of underlying business activity, with gearing effects removed. It allows fair comparison of business risk across companies with different capital structures.

Sensitivity analysis calculates the percentage change in each variable that would reduce NPV to zero, holding all others constant. Variables with low sensitivity are most critical and may require further investigation.

Firm value is independent of capital structure. Higher gearing increases cost of equity, offsetting the greater proportion of cheaper debt, so WACC remains constant.

Gamma = rate at which delta itself changes. Important because delta is not constant; hedge ratios must be continuously reviewed and adjusted as gamma changes.

M&M argue that the level of dividend is irrelevant; only earnings matter. A large dividend leaves less for growth; smaller dividend allows more growth. Since future dividends determine share price, shareholders should be indifferent.

?? = ?? × V?/[V? + Vd(1?T)], where ?? = asset beta, ?? = equity beta, V? = market value of equity, Vd = market value of debt, T = tax rate.

A risk analysis method that assigns probability distributions to multiple variables, generates random outcomes, and repeats many times to produce a probability distribution of possible project outcomes and value at risk.

Because debt interest receives tax relief, WACC falls with higher gearing. The conclusion is that companies should raise as much debt as possible to minimise WACC.

Theta = rate at which option value changes with passage of time. Measures time decay of options; particularly important for option traders managing positions close to expiry.

If a company reduces its dividend, shareholders may interpret this as a sign of poor performance, even if the reduction reflects increased retention. This may lower expectations and adversely affect share price.

When a project has different business risk than the acquiring company. Ungear the proxy company’s equity beta to obtain asset beta, then regear using the acquiring company’s capital structure.

The significance of the simulation output and the assessment of the likelihood of project success (including project value at risk — the probability distribution of NPV outcomes).

k? = k?? + (k?? ? kd) × (Vd/V?) × (1 ? T), where k?? = ungeared cost of equity, kd = pre-tax cost of debt, Vd/V? = gearing ratio, T = tax rate.

An option allowing shareholders to choose between receiving cash dividends or new shares. This resolves the liquidity preference problem by allowing each shareholder to select whichever form best suits their circumstances.

The present value of all future cash flows from a project, discounted at the appropriate cost of capital. A positive NPV means the project adds value and should be accepted.

VaR is the maximum loss that an investment might suffer at a given confidence level. Example: VaR of $100,000 at 95% confidence means only 5% probability of losing more than $100,000.

Companies raise finance in the order of least effort: retained earnings (preferred), then debt, then new equity (last resort). No attempt to reach an optimal capital structure.

Investors may avoid financially attractive investments on ethical grounds, hold loss-making investments to avoid admitting prior mistakes, or buy shares based on herd instinct rather than rational analysis.

Consider only cash flows (not non-cash items); use future cash flows only (sunk costs are irrelevant); adjust for inflation to calculate nominal cash flows; include taxation as a cash flow with capital allowances effects.

95% confidence level = 1.645 standard deviations; 99% confidence level = 2.33 standard deviations from the mean.

Theory that WACC changes with gearing in unpredictable ways due to market imperfections. An optimum gearing level minimises WACC; companies should target and maintain it (found by trial and error).