ACCA AFM
ACCA Advanced Financial Management (AFM) Flashcards
What is the primary financial objective of a listed company in the UK/US model of corporate governance?
List five key stakeholder groups whose interests a financial manager must balance.
What are the four main types of strategic decision made by the financial manager?
How is shareholder wealth measured, and what does this imply for the financial manager's decisions?
Why does the dominance of institutional investors matter to financial managers?
Contrast the Anglo-American corporate objective with the approach common in mainland Europe and Japan.
Give an example of a conflict between long-term and short-term objectives.
In the 'maximising vs satisficing' framework, what does 'satisficing' mean?
What is an agency relationship, and why does it create conflicts in a company?
List four self-interested behaviours directors have been accused of at the expense of shareholders.
What is goal congruence?
How can share option schemes encourage goal congruence, and what is their main weakness?
What is the main drawback of profit-related pay as a way of achieving goal congruence?
What is 'creative accounting'? Give two examples.
Why might directors resist a takeover bid even when it is in shareholders' best interests?
Beyond remuneration design, what governance mechanisms help control the agency problem?
An employee is an agent of whom? A director is an agent of whom?
Distinguish strategic, tactical and operational plans.
What two components typically make up a business plan?
When assessing performance with ratios, what four areas of analysis should normally be considered?
State the formula for Return on Capital Employed (ROCE) and its two components.
How is capital employed defined for ratio purposes?
Give the formulas for the gearing ratio, interest cover and operating gearing.
What is EBITDA and why is it used?
Why should ratios never be interpreted in isolation?
From a shareholder's perspective, which growth measures matter most when reviewing performance?
Give the formulas for the P/E ratio, EPS and dividend yield.
State Modigliani and Miller's dividend irrelevance argument.
What is the 'signalling effect' of dividends?
Explain the 'clientele effect' (liquidity preference) in dividend policy.
How does taxation influence shareholders' dividend preferences?
What is M&M's counter-argument to the claim that shareholders need dividends for cash income, and why does it fail in practice?
What two dividend practices do companies commonly adopt in the real world?
What is the risk of a stated policy of constant dividend growth (e.g. +5% each year)?
What is a corporation's 'dividend capacity'?
Which factors determine a multinational's dividend capacity and policy?
What is a share repurchase (buy-back) and why might it be preferred to a one-off special dividend?
What does behavioural finance study?
State the three assumptions underlying rational financial decision-making.
Give two ways real investors violate the utility-maximisation assumption.
What is 'herd instinct' in investment behaviour?
What is confirmation bias?
How can behavioural factors cause an acquirer to overpay in a bidding contest?
Which managerial bias inflates estimates of post-acquisition improvements?
Why is behavioural finance relevant to explaining share price anomalies?
Using the dividend valuation model, how is the cost of equity calculated when dividends are constant?
State the growth-model formula for the cost of equity (rearranged Gordon growth model).
What are the two ways of estimating the dividend growth rate g?
In the exam, what assumption is made about debt if you are not told whether it is redeemable?
How are the return to investors (kd) and the cost to the company calculated for irredeemable debt?
How is the return to investors on redeemable debt calculated?
How is the cost to the company of redeemable debt calculated?
State the WACC formula and the values used for the weights.
If a share price is quoted cum div, what adjustment is needed before valuation calculations?
When is the existing WACC an appropriate discount rate for appraising a new project?
Why does tax relief make debt cheaper to the company than the return investors receive?
How is the cost of equity found where the dividend is CONSTANT (no growth)?
State the g = br approximation and explain the terms.
Why can the dividend valuation model give unreliable estimates of ke?
Distinguish systematic and unsystematic risk.
How does creating a portfolio reduce risk, and which type of risk remains?
What is a 'well-diversified investor', and why does the concept matter?
Why do companies in the same industry not all have the same total risk?
What does 'risk' mean in portfolio theory terms?
What is the examinable status of portfolio theory in AFM — calculations, or concepts only?
Sketch (in words) the relationship between portfolio diversity and risk.
Why is reducing total risk through corporate diversification of limited benefit to well-diversified shareholders?
State the CAPM formula and define each term.
What does a share's beta measure, and what do β = 1, β > 1 and β < 1 indicate?
State the CAPM formula and explain each term.
What is the beta of a portfolio of investments?
What is an alpha value?
Why is the equity (share) beta of a geared company higher than its asset beta?
State the asset beta formula and the standard exam assumption about the debt beta.
Outline the steps for finding a discount rate for a project in a different business area (no major gearing change).
When comparing two companies, what distinguishes the riskier SHARE from the riskier BUSINESS?
When a project involves a major change in gearing, what approach is preferred to a regeared-beta WACC?
List the main assumptions/limitations of CAPM.
How is a beta estimated for a project when the company has no history in that business?
How does CAPM justify appraising a project at its own required return rather than the company's WACC?
In NPV analysis, which cash flow principles must be applied to costs already incurred and to depreciation?
What is the difference between the nominal (money) approach and the real approach to inflation in DCF?
Describe the preferred way of dealing with tax-allowable depreciation in AFM NPV questions, and why.
How is working capital treated in project NPV calculations?
Define the IRR and state its main weaknesses as a decision tool.
State the MIRR formula and what PV_R and PV_I represent.
Why is MIRR usually considered superior to IRR, and how do the two typically compare in size?
Outline the approach to appraising a foreign project NPV (overseas currency cash flows).
In a foreign NPV, how is additional UK (home) tax on overseas profits computed under a double tax treaty?
How is the PV of a growing perpetuity calculated (e.g. cash flow inflating at g% forever)?
What is multi-period capital rationing, and what technique does it require?
Distinguish hard and soft capital rationing.
Define free cash flow and give the standard computation from EBIT.
In single-period capital rationing with divisible projects, how are projects ranked?
Absorbed fixed overheads appear in a project's forecasts. How are they treated in the NPV, and why?
What discount rate should be used for the project cash flows in an NPV, and when is a risk-adjusted rate needed?
What is sensitivity analysis in investment appraisal?
How is the sensitivity of NPV to a variable calculated?
What are the limitations of sensitivity analysis?
Outline the stages of a Monte Carlo simulation for a project (concept only).
What are expected values in investment appraisal, and what are their weaknesses?
Define Value at Risk (VaR).
How is annual VaR at 95% confidence calculated given a normal distribution with standard deviation σ?
How is a one-year standard deviation converted into an n-year VaR?
Why is VaR particularly useful to financial institutions?
What is a risk-adjusted discount rate?
Give two probability-based approaches to risk in NPV besides sensitivity analysis, and what each provides.
How is a Value at Risk figure calculated and how is it scaled over several periods?
How is the market value of a bond determined in theory?
What is the gross redemption yield (yield to maturity) of a bond and how is it found?
Why do long-dated bonds change in value more than short-dated bonds when interest rates change?
Define the Macaulay duration of a bond and outline its calculation.
How does Macaulay duration behave as (a) time to maturity, (b) coupon rate and (c) yield to maturity increase?
Define modified duration and its use.
What is the key limitation of duration as a measure of interest rate sensitivity?
What is project duration and what does it indicate?
What is the term structure of interest rates (yield curve)?
How is a company's cost of debt estimated using the term structure and credit spreads?
What determines a company's credit rating, and who assesses it?
How is the market value of a redeemable bond calculated?
Why does a bond trading below par with the same gross redemption yield as another bond not necessarily make investors indifferent between them?
State M&M's proposition (no taxes) on capital structure.
State M&M's proposition with corporate taxes.
State the M&M Proposition 2 (with tax) formula from the formula sheet and what it calculates.
What is static trade-off theory?
What is pecking order theory?
What are the two steps of a basic APV calculation?
In an APV, how is the tax shield on irredeemable debt valued, and at what rate is it usually discounted?
How are issue costs treated in an APV calculation?
How is a subsidised (cheap government) loan handled in an APV?
When is APV the appropriate appraisal technique?
What discount rate is used for the base-case NPV in APV, and how is it derived?
Give two advantages and two limitations of APV over NPV at a risk-adjusted WACC.
According to M&M with tax, what is the only benefit of debt finance, and what does agency/bankruptcy reality add?
How do agency effects influence capital structure decisions?
Define a call option and a put option.
List the five factors that determine the value of an option.
How does each of the five drivers affect the value of a CALL option when it increases?
State the BSOP call value formula and the d1 and d2 formulas.
How is the value of a put option obtained under BSOP?
What are the key assumptions/limitations of the BSOP model?
Define delta and state what N(d1) represents.
Define theta and gamma.
What is a delta hedge and how is the number of call options to sell determined?
Why does a delta hedge only work in the very short term?
Distinguish European and American options.
What do 'long' and 'short' positions mean in options dealing?
What is the intrinsic value of a call option exercisable immediately?
How can share options be used in managerial remuneration, and what valuation issue arises?
What is a 'real option' in investment appraisal?
Name the four archetypes of real option and classify each as a call or a put.
How are the BSOP variables mapped when valuing an option to delay a project?
Why can a project with a negative conventional NPV still be worth accepting?
Why does the ability to delay a project have value?
An option to abandon a project is valued how, and what is Pe?
What are the main practical difficulties in applying BSOP to real options?
A licence allows a second-phase investment only at year 4. Which real option is this and which BSOP style fits?
In real option valuation, does higher project uncertainty raise or lower the option value, and why is this counter-intuitive?
Give an example of an option to redeploy.
What are the two fundamental ways a takeover can increase the acquirer's shareholders' wealth?
Classify synergy into its three types with an example of each.
Why does reduced total risk from diversification NOT directly benefit well-diversified shareholders of an acquirer?
List the key financing questions ('predator issues') an acquirer must consider before bidding.
Why are target companies often over-valued in a bid situation?
To whom do most of the gains in a takeover typically accrue, and why?
List four defensive tactics available to a target company's board.
What is a 'white knight'?
What questions should the target's shareholders/board ask when evaluating an offer ('target issues')?
Give four commercial motives for acquisition under 'market power and other'.
Why do many acquisitions fail to enhance shareholder value?
Acquisitions versus organic growth — give two advantages of each.
What is the role of the competition (antitrust) authorities in a takeover?
What are the three bases for an asset-based valuation, and what does each represent?
What is the main weakness of asset-based valuations for a going concern?
Describe the free cash flow to firm method of valuing a business.
How does free cash flow to equity differ from free cash flow to firm, and how is each discounted?
Valuing an acquisition: business risk same as acquirer, gearing unchanged. What discount rate?
Valuing an acquisition in a different business but with little change in the acquirer's gearing: outline the discount rate steps.
When valuing an acquisition financed by substantial new debt (e.g. leveraged buyout), what approach applies?
How should synergies be built into an acquisition valuation?
Describe the P/E ratio valuation method and the adjustment for unquoted companies.
What is the earnings yield method of valuation?
How is the market capitalisation of a quoted target relevant to an offer price?
How can the BSOP model be used to value the equity of a (possibly distressed) company?
Give the two main reasons a share may be over-valued by the market.
Why are high-growth start-ups so difficult to value?
In a valuation report, why should several methods be used rather than one 'correct' figure?
How is a company valued by free cash flow with a growing terminal value, and how is the equity value then found?
Distinguish demergers, sell-offs, unbundling and asset stripping.
Distinguish a management buyout (MBO), a buy-in (MBI) and a buy-in/buy-out (BIMBO).
Who are the parties to an MBO?
Why might a seller favour an MBO over selling a division in the open market?
Why do buyouts often generate shareholder value?
What is 'going private' and what are its advantages?
What is a capital reconstruction scheme and when is one used?
What is the legal framework for a scheme of reconstruction?
Outline the approach to designing/evaluating a reconstruction scheme.
Why must every affected group be at least as well off under a reconstruction as in liquidation?
What form do reconstruction 'calculation' questions usually take in the exam?
Define transaction, translation and economic exposure to foreign exchange risk.
How are exchange rates quoted in the AFM exam, and which side of the quote do you use?
List the four 'internal' methods of reducing transaction exposure that need no special instruments.
What is a forward contract, and what are its main advantages and disadvantages?
A forward is quoted as a premium or discount from spot. How is each applied?
Describe the money market hedge for a future foreign currency RECEIPT.
Describe the money market hedge for a future foreign currency PAYMENT.
In a currency futures hedge, how do you decide whether to BUY or SELL futures?
What two features of futures contracts prevent a perfect hedge?
What is basis, and what standard assumption do we make about it in the exam?
What is the lock-in rate in a futures hedge and how is it calculated?
What is a 'tick' on a currency futures contract and how is the futures profit computed with ticks?
Which futures expiry month is chosen for a hedge, and what happens on the transaction date?
Give the main advantages and disadvantages of currency futures versus forwards.
What are initial margin and variation margin on futures?
Why does invoicing in the home currency not eliminate currency risk commercially?
Distinguish bilateral and multilateral netting.
When is a money market hedge preferred to a forward contract?
What is a currency option, and when is it worth the premium compared with a forward?
Distinguish OTC currency options from exchange-traded currency options.
In a traded currency options table, what do the strike price, calls/puts columns and month headings mean?
Outline the steps of a traded currency options hedge computation.
An option hedge outcome is described as a 'worst case' or floor. Why?
How do you choose between two strike prices for an options hedge?
Describe the mechanics of a currency swap.
Why might a company use a currency swap rather than borrowing directly in the foreign currency?
What is a FOREX swap (as distinct from a full currency swap)?
What is a Synthetic Foreign Exchange Agreement (SAFE)?
List the option-based, forward-based and internal instruments available for currency transaction risk, for a quick exam checklist.
Which currency hedging method is chosen in an exam recommendation, and on what basis?
What risk does a company face on a fixed-rate loan it will take out in three months' time?
What is a Forward Rate Agreement (FRA), and what does 'FRA 3-9' mean?
What is an Interest Rate Guarantee (IRG)?
How are interest rate futures quoted, and what does a price of 92.00 imply?
Should a future borrower buy or sell interest rate futures, and why?
Why are interest rate futures called '3-month' futures, and how does that affect the number of contracts?
How is the expected futures price on the loan start date estimated when it is not given?
What are exchange-traded interest rate options actually options on?
In interest rate option premium tables, what does 'points of 100%' pricing mean for the premium cost?
Outline the steps of an interest rate options hedge for a borrower.
What is an interest rate collar and why is it used?
How are the maximum and minimum effective interest rates under a COLLAR determined?
Compare FRAs, futures, IRGs/options and collars for hedging a future borrowing.
Why might a company prefer floating-rate borrowing?
What is an interest rate swap?
How does comparative advantage make an interest rate swap beneficial to both parties?
How is the total gain available from an interest rate swap identified, and where does it come from?
List the practical benefits and risks of interest rate swaps.
What role do banks play in the swaps market, and what is 'disintermediation'?
A company with floating-rate debt fears rate rises but doesn't want to refinance. Give its main alternatives.
What is a swaption in an interest-rate context?
What are the four main influences on exchange rates?
Distinguish fixed, freely floating and managed floating exchange rate systems.
State the Purchasing Power Parity (PPP) formula and what it predicts.
State the Interest Rate Parity (IRP) formula and what it determines.
State purchasing power parity and how it is applied over more than one year.
How reliable is PPP as a predictor of actual future exchange rates, and why is it still used?
What does the International Fisher Effect imply about interest differentials and expected exchange movements?
Why does a government operating a fixed exchange rate lose some policy freedom?
What was the Bretton Woods system and what replaced it?
List five forms of international operations, from lowest to highest commitment.
List the six ways of remitting income from an overseas subsidiary to the parent.
Define political risk and give four examples of macro political risk.
Give examples of micro (firm-specific) political risk.
How can a multinational manage political risk on an overseas investment?
What are exchange controls and how can companies deal with restricted remittances?
What is transfer pricing and why do tax authorities regulate it?
Give two advantages and two disadvantages of a joint venture for entering a foreign market.
Branch or subsidiary overseas — key differences?
Which international bodies affect multinationals' trade and finance environment, and how?
What core principles underlie Islamic finance?
What is riba and how do Islamic financial institutions earn returns instead?
What is Murabaha?
What is Ijara, and who bears the risks of ownership?
What is Mudaraba?
What is Musharaka, and what is it commonly compared to?
What is Sukuk, and what must underlie it?
Who manages Sukuk assets and what rights do holders have?
Match each Islamic instrument to its conventional counterpart: Murabaha, Ijara, Mudaraba, Musharaka, Sukuk.
Why is Islamic finance described as a growing source of finance, and what should companies weigh before using it?
Card 1 of 279. Question side.