Learn or revise key terms and concepts for your F5 exams using OpenTuition interactive ACCA Flashcards
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Question
Distinguish between European and American options.
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Answer
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.
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Question
Define corporate demerger.
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Answer
Splitting a company into two or more separate businesses with existing shareholders receiving shares in each. Control is maintained throughout; no third-party transaction.
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Question
What is a currency option and why is it preferred to forward contracts in certain situations?
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Answer
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.
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Question
How is income remitted from overseas investments?
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Answer
Through dividends, loan interest, royalties, management charges, transfer prices, or countertrade. Transfer pricing is sensitive; regulators scrutinise to prevent profit shifting.
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Question
What is the significance of delta, gamma, and theta in options management?
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Answer
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.
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Question
What is a real option?
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Answer
A right (not obligation) to change something about a project during its life, improving returns by reducing downside risk. Examples: delay, expand, abandon, redeploy.
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Question
Distinguish between sell-off and unbundling.
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Answer
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.
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Question
Distinguish between over-the-counter (OTC) and traded currency options.
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Answer
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.
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Question
Define macro (country-specific) political risk.
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Answer
Risk affecting all foreign firms in a country: war, civil unrest, confiscation of assets, nationalisation, foreign ownership restrictions, import quotas, exchange controls.
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Question
How does a company assess appropriateness of different finance sources?
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Answer
Consider financial position, financial risk, and value of organisation. Sources include equity, debt, hybrids, leasing, venture capital, private equity, securitisation, Islamic finance.
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Question
Classify real options into BSOP categories: delay, expand, abandon, redeploy.
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Answer
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).
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Question
Define management buyout (MBO).
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Answer
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.
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Question
What is a currency swap and what is its primary purpose?
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Answer
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.
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Question
Define micro (firm-specific) political risk.
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Answer
Risk affecting only certain firms/industries: minimum wage legislation, pollution controls, product legislation, health/safety legislation. Specific to business type, not all foreign firms.
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Question
What is asset securitisation?
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Answer
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.
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Question
How is the BSOP model applied to value an option to delay?
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Answer
Inputs: P? = current project NPV + outlay; P? = investment outlay; t = time before decision; r = risk-free rate; s = volatility of project NPV. Solve BSOP; subtract base NPV from result.
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Question
Why may MBOs generate shareholder value?
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Answer
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.
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Question
What is a swaption?
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Answer
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.
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Question
What is the fundamental principle of Islamic finance?
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Answer
Wealth must be generated from legitimate trade and asset-based investment; investments must have social/ethical benefit; speculative investments and riba (interest) are forbidden.
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Question
Define a hybrid security in capital structure.
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Answer
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.
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Question
What are the five main objectives of takeovers and mergers?
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Answer
Acquire target at undervalue; realise synergies (revenue/cost/financial); gain market power; acquire dynamic management or innovative products; enter new market quickly.
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Question
What is a capital reconstruction scheme?
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Answer
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.
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Question
Define interest rate risk on fixed-rate borrowing.
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Answer
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.
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Question
Define Murabaha in Islamic finance.
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Answer
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.
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Question
What is venture capital financing?
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Answer
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.
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Question
Define financial synergy in acquisitions.
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Answer
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.
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Question
What are typical reasons for undertaking capital reconstruction?
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Answer
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.
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Question
What is a Forward Rate Agreement (FRA) and what does it achieve?
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Answer
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.
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Question
What is Ijara in Islamic finance?
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Answer
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).
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Question
What is business angel financing?
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Answer
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.
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Question
Why are acquisitions frequently overvalued?
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Answer
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.
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Question
What is going private?
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Answer
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.
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Question
What is an Interest Rate Guarantee (IRG)?
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Answer
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.
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Question
Define Mudharaba in Islamic finance.
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Answer
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.
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Question
What are Special Purpose Acquisition Companies (SPACs)?
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Answer
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.
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Question
Name five defensive tactics a target company may employ.
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Answer
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.
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Question
Define the three types of foreign exchange risk.
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Answer
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.
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Question
How are interest rate futures quoted and what does the quote represent?
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Answer
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.
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Question
Define Musharaka in Islamic finance.
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Answer
Partnership where both parties contribute capital and expertise. Profits shared per contract terms; losses shared proportional to capital contributions. Akin to venture capital arrangement.
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Question
How does a company determine dividend capacity?
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Answer
Assess reinvestment strategy (short and long term), capital reconstruction programmes (share repurchases, new issues), timing of remittances, corporation tax regime, and transfer pricing policy.
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Question
What are asset-based valuation methods?
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Answer
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).
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Question
How are foreign exchange rates quoted?
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Answer
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 $).
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Question
What rule determines whether a borrower should buy or sell interest rate futures?
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Answer
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.
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Question
What are Sukuk in Islamic finance?
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Answer
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.
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Question
What is the impact of share repurchase on dividend policy?
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Answer
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.
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Question
State the free cash flow to firm (FCFF) calculation from operating data.
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Answer
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).
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Question
What is the forward contract and when is it used?
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Answer
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.
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Question
How is the number of interest rate futures contracts calculated?
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Answer
Number = (Loan amount / Contract size) × (Loan period in months / 3). Scaling accounts for the fact that futures are 3-month standard contracts.
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Question
What is the role of Islamic finance in organisational growth strategy?
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Answer
Provides alternative source of finance for organisations pursuing environmental/sustainable agendas. Growing source; rationale is ethical/social compliance alongside conventional financial objectives.
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Question
What is transfer pricing and why is it significant?
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Answer
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.
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Question
How is the discount rate selected when valuing an acquired business with different risk?
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Answer
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.
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Question
How are forward points (premium/discount) applied to spot rates?
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Answer
Premium: deduct from spot rate (currency at premium = fewer units per £ forward). Discount: add to spot rate (currency at discount = more units per £ forward).
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Question
What is an interest rate collar?
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Answer
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.
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Question
What does the professional skill of Communication require in AFM exams?
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Answer
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.
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Question
What is remittance restriction and how can it be managed?
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Answer
Government limits on repatriating profits from overseas investments. Managed through netting, multilateral matching, financing structures (loans instead of dividends), or alternative remittance routes.
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Question
How are synergy benefits incorporated into acquisition valuation?
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Answer
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.
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Question
Explain money market hedging principle.
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Answer
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.
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Question
What are interest rate swaps and when are they used?
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Answer
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).
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Question
What does the professional skill of Analysis and Evaluation require?
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Appropriate use of data for calculations/analysis; objective appraisal of information; identifying missing data/further analysis needed; balanced evaluation of impact; reasoned, justified conclusions.
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Question
What factors shape financial strategy formulation in multinationals?
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Organisational performance assessment, optimum capital mix and structure, distribution/retention policy, financial policy communication, financial planning/control, risk management, ESG/ethical considerations, stakeholder alignment.
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Question
Define free cash flow to equity (FCFE).
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Answer
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.
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Question
What is a currency future contract and how does it differ from a forward?
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Answer
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.
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Question
What condition must exist for an interest rate swap to create savings for both parties?
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Answer
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.
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Question
What does the professional skill of Scepticism require?
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Answer
Questioning approach; challenging information/evidence/assumptions with reasoned justification (not abstract); identifying contradictory evidence; applying professional judgement; reaching properly informed decisions.
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Question
What is the price/earnings multiple method of valuation?
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Answer
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.
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Question
What is basis in currency futures?
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Answer
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.
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Question
State the Purchasing Power Parity (PPP) formula for exchange rate movements.
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Answer
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.
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Question
What does the professional skill of Commercial Acumen require?
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Answer
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.
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Question
How can BSOP model be used to value equity?
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Answer
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.
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Question
What is basis risk in hedging?
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Answer
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.
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Question
What does PPP theory predict about exchange rates?
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Answer
Exchange rates adjust to offset inflation rate differences between countries, maintaining purchasing power parity. A country with higher inflation should see its currency weaken.
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Question
What is the purpose of the treasury function in multinationals?
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Answer
Short-term management of financial resources, longer-term maximisation of corporate value, and management of risk exposure (including forex and interest rate risks).
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Question
What challenges exist in valuing high-growth start-up businesses?
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Answer
Early-year losses; no past results to base estimates on; inexperienced management; unlike existing businesses (difficult to find comparables). Conventional valuation methods are unreliable.
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Question
What is a tick in currency futures and how is it used?
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Answer
Smallest price movement in futures contract. Tick value = 0.0001 × contract size. Profit/loss = number of ticks × tick value × number of contracts.
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Question
What are the main forms of international operations?
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Answer
Export from home country, overseas branch, overseas subsidiary, joint venture, licensing. Each offers different levels of control, risk, investment, and local market presence.
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Question
What are key operational features of derivatives markets?
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Answer
Exchange-traded vs OTC; standard contracts; tick sizes/margins; margin trading; basis risk. OTC contracts more flexible; exchange-traded more liquid and transparent.
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Question
Explain the signalling effect of dividend changes.
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Answer
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.
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Question
When should a project-specific discount rate be calculated using a proxy company's beta?
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Answer
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.
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Question
Candidates must understand simulation outputs of which two measures?
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Answer
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).
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Question
What is the M&M formula for cost of equity when gearing changes?
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Answer
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.
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Question
What is a scrip dividend?
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Answer
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.
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Question
What is net present value (NPV)?
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Answer
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.
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Question
Define Value at Risk (VaR).
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Answer
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.
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Question
What is pecking order theory?
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Answer
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.
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Question
Why do investors fail to maximise utility in practice?
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Answer
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.
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Question
What are the four key principles of NPV calculation?
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Answer
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.
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Question
What are the key normal distribution critical values for VaR?
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Answer
95% confidence level = 1.645 standard deviations; 99% confidence level = 2.33 standard deviations from the mean.
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Question
Define static trade-off theory.
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Answer
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).
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Question
How do financial managers' estimates of acquisition targets tend to be biased?
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Answer
Acquiring managers often hold unrealistically high opinions of their own skills in improving a target’s results, leading to overpayment for the target.
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Question
How is working capital treated in NPV calculations?
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Answer
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.
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Question
How is multi-period VaR calculated from single-period standard deviation?
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Answer
Multi-period VaR = single-period standard deviation × ?n, where n = number of periods. This accounts for the accumulation of risk over time.
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Question
What is Adjusted Present Value (APV)?
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Answer
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.
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Question
Define behavioural finance.
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Answer
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.
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Question
What is the Internal Rate of Return (IRR)?
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Answer
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.
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Question
What is the market value formula for a bond?
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Answer
Market value = PV of all future interest payments + PV of redemption value, discounted at the investors’ required rate of return.
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Question
How is the tax shield benefit calculated in APV?
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Answer
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).
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Question
What is the cost of equity formula using the dividend growth model?
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Answer
k? = [d?(1+g)]/P? + g, where d? = dividend just paid, g = growth rate, P? = ex-dividend market price. Equivalently: k? = d?/P? + g.
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Question
What assumption does IRR make about cash flow reinvestment and why is this problematic?
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Answer
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.
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Question
Define gross redemption yield (GRY).
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Answer
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.
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Question
When should issue costs be deducted in APV calculation?
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Answer
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.
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Question
What is the primary objective of shareholders in financial management?
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Answer
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.
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Question
How is sustainable dividend growth rate estimated using the 'rb' growth model?
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Answer
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.
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Question
Define Modified Internal Rate of Return (MIRR).
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Answer
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.
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Question
Why do longer-dated bonds suffer greater price falls when interest rates rise?
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Answer
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.
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Question
How are subsidised loans reflected in APV?
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Answer
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.
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Question
Name the two main theoretical approaches to shareholder representation globally.
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Answer
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.
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Question
What is the after-tax cost of irredeemable debt?
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Answer
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.
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Question
State the MIRR formula.
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Answer
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.
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Question
Define Macaulay duration.
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Answer
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).
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Question
Define a share option.
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Answer
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.
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Question
What is agency theory?
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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.
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State the WACC formula.
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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.
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How are foreign investment appraisals structured?
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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.
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How do coupon rate and time to maturity affect Macaulay duration?
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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).
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What are the five principal drivers of option value?
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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.
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Define goal congruence in remuneration schemes.
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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.
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What are the two sources of risk affecting share returns?
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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.
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What is the growth model formula for perpetuities?
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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.
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What is modified duration?
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Modified duration = Macaulay duration / (1 + r). It measures the sensitivity of a bond’s market value to interest rate changes.
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State the Black-Scholes call option formula.
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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.
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List four typical allegations of directors' self-serving behaviour.
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Excessive remuneration, empire building through growth takeovers, creative accounting to boost share price, and defending against takeover bids regardless of shareholder benefit.
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What is beta and what does it measure?
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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.
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What is capital rationing?
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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.
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State the modified duration price change formula.
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?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.
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What is the relationship between call and put option values (put-call parity)?
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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.
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What does EBITDA measure and why exclude depreciation?
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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.
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State the Capital Asset Pricing Model (CAPM) formula.
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E(r?) = Rƒ + ??[E(r?) – Rƒ], where E(r?) = required return, Rƒ = risk-free rate, E(r?) = market return, ?? = beta of the investment.
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Distinguish between hard and soft capital rationing.
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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.
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What is convexity and why does it limit modified duration's accuracy?
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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.
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What assumptions underlie the BSOP model?
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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.
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When assessing organisational performance, which growth metrics should always be commented on?
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Always comment on growth in turnover, profit, and share price. Assess overall trends rather than performing detailed year-by-year analysis.
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How is portfolio beta calculated when investing in multiple shares?
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Portfolio ? = weighted average of individual betas, where weights = proportion of investment in each share.
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Define free cash flow.
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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.
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Define project duration.
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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.
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What is delta in option pricing?
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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).
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What are the four main bases for comparing company ratios?
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Previous years for the same company, other similar companies, industry averages, and sector benchmarks.
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What is the alpha value of a security?
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Alpha = actual return ? theoretical (CAPM) required return. A positive alpha indicates the security outperforms CAPM predictions.
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State the free cash flow formula.
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FCF = EBIT ? Tax on EBIT + Non-cash items (depreciation) ? Capital expenditure ? Working capital changes.
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How does project duration differ from payback period?
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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.
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How is a delta hedge constructed and what is its purpose?
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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.
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State the relationship between net profit margin, asset turnover, and ROCE.
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ROCE = Net profit margin × Asset turnover. This identity shows how profitability depends on both margin and efficiency.
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Define asset beta and explain why it is useful.
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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.
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What is sensitivity analysis?
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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.
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State Modigliani and Miller Proposition I (without tax).
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Firm value is independent of capital structure. Higher gearing increases cost of equity, offsetting the greater proportion of cheaper debt, so WACC remains constant.
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What is gamma in option pricing?
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Gamma = rate at which delta itself changes. Important because delta is not constant; hedge ratios must be continuously reviewed and adjusted as gamma changes.
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What is the Modigliani and Miller dividend irrelevance theorem?
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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.
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State the formula to ungear equity beta.
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?? = ?? × V?/[V? + Vd(1?T)], where ?? = asset beta, ?? = equity beta, V? = market value of equity, Vd = market value of debt, T = tax rate.
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What is Monte Carlo simulation?
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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.
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State Modigliani and Miller Proposition II (with tax).
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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.
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What is theta in option pricing?
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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.
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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.
Inputs: P? = current project NPV + outlay; P? = investment outlay; t = time before decision; r = risk-free rate; s = volatility of project NPV. Solve BSOP; subtract base NPV from result.
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.
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).
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.
Restart deck (bring all cards back)
Deck complete!
You worked through every card. Restart to revise the deck again.
very handful summary thanks a lot open tuition team.
Do make sure you attempt the mock exam here as well 🙂
(The questions are selected at random from a bank of questions, so every time you try the test you are like to get different questions.)
The mock exams are great..but its also better if you can give a small description about how you arrived at the right answer for mock question.
If you read the page before the test properly, you will see that if you do not understand how the correct answer is arrived at then you should ask in the Ask the Tutor Forum and we will explain.
(At present the software we use does not allow us to show the workings – I appreciate that there is software that will allow it, but since we provide this free of charge we cannot afford the extra software at the moment!)
Tips:
1) Cut an A4 paper into card size. Good enough to fit in your wallet/purse.
2) Copy the passcards (handwritten, little effort won’t cause you anything). Front page for question, back is for answer.
3) Read it during your free time.
4) Be glad, it is provided for FREE.
I failed f5 twice can somebody please guide how to pass f5!!! I hate f5
don’t say that i failed f5 the 1st time and i am not giving up ,smile and try again u will make it have a firm believe in urself and 1st and foremost trust in allah and say to urself if others can make it so can i do past exam questions keep practicing
I hate F5 also, but we have to pass it!
believe yourself next time u will pass.
just like edison, he also fail 99 times only success!!
well i did fail it twice too but this time insha Allah i will pass it with the help of open tuition just study the lecture notes and view the video lectures it will help you a lot after that you have to study the exam kit twice at least.
great job
awesome!!! after failing my F5 2 times I just discover the site…I hope open tuition will help me to pass all my papers…already interested by all the things I saw here
I hope so as well.
We will try our best to help.
Did u pass in june 2014 i wrote first time and failed but am not giving up
i was asking mireille
how can i download?
The cannot be downloaded – they can only be used online.
plz tell me how to download flash cards……………………………..
They can only be used online – they cannot be downloaded.
This is just wonderful.thank you so much.
A wonderful source.. Thanks to the Opentution team..
Great revision kits to revise studies and terminology! Thanks a lot
Hello fellow ACCA students, ACCA fellows, ACCA members and Course tutors/ lectures. I salute you all. I was studying Kaplan F5 manual from January up to April. It used to confuse me, but i continued using out of confusion till it confused me more. Now I’m failing to answer questions from the Rev Kit. I’m facing real difficulties. Whenever i read a question, i don’t have where to start answering from. please help me. I’m worried. what should i really do? please assist me.
download the course notes and watch all the f5 lectures available,
after you have covered a topic – try past exam question or 2 from the kit,
and move to another topic …
How about they download for iphone.
they work fine on the iphone, just double tap (zoom in)
i mean that service will be more useful in app form
it downloads hardly any data.. so it should not cost you much when you use it on 3g network
in comparison, developing an app is expensive… to give it away.. and we don’t think many people would buy it to justify it..
OT… Would you ever consider accepting donations for the possibility of creating an app? I for one would not hesitate one bit to donate in order to help you make your services even better than they already are!
Chris, although I would not rule out the possibility of an app at some stage, we do have to consider the cost involved (and thanks for the offer of a donation, but we are determined to keep everything free of charge 🙂 )
However, as admin said, the flashcards are viewable well on a smartphone and download very little data. Even if we did have an app it would need to use data occasionally as the bank of questions is updated or increased.
Hi John, no that’s fine and i have no problem viewing them at all on a smart phone etc.
Just a thought to put it out there! Thanks for your swift reply though, much appreciated.
Enjoy the rest of your day.
Many thanks again!
very! very! nice study materials
‘The bottleneck is the operation that is limited the rate of production’
should this sentence be “The bottleneck is the operation that limited the rate of production”?
OK sorry. It should actually have said’ the bottleneck is the operation that is limiting the rate of production.
Good day, the flash cards are wonderful, will there be any for P1?
Hi, yes, there will. Unfortunately they will not be available for this session – so I hope you will never need them!
Thank you for the flash cards it’s proving to be helpful in many ways
It really useful for the course like F5&F9
its really good, but why are they not downloadable and printable.
The only way that we can keep this site free is to have them only available online.
studying on the GO! very helpful.
Its really a good approach while revision
I have fail F5 three time but with oppentuition i can see i am going to pass it
I do hope that you are successful 🙂