ICAP CAF CAF-7: Business Insights and Analysis Syllabus

What is the purpose of Tucker's 5-question model?

To evaluate whether a business decision is acceptable by testing it against profitability, legality, fairness, ethics and sustainability simultaneously.

List the seven steps of the American Accounting Association (AAA) ethical decision model.

(1) Determine the facts; (2) Identify the ethical issues; (3) Identify the norms/principles/values; (4) Identify alternative courses of action; (5) Compare values and alternatives; (6) Assess the consequences; (7) Make your decision.

How does the AAA 7-step model differ from Tucker's 5-question model?

AAA is a structured step-by-step decision process gathering facts and weighing consequences; Tucker is a quick 5-question screening test against profit, legality, fairness, ethics and sustainability.

What is the key distinguishing feature of debt finance?

It carries a fixed obligation to pay interest and repay principal, ranks ahead of equity, is usually secured, and gives lenders no ownership or voting rights; interest is tax-deductible.

What is the key distinguishing feature of equity finance?

Shareholders own the company, bear residual risk, receive dividends (not guaranteed), rank last in liquidation, and dividends are not tax-deductible.

What is the core principle that distinguishes Islamic finance from conventional finance?

The prohibition of riba (interest); returns must derive from real assets and shared risk, avoiding gharar (uncertainty) and haram activities.

What is a Sukuk in Islamic finance?

An Islamic 'bond' representing an ownership share in a tangible asset or project, earning a return from the asset's profit/rentals rather than interest.

Distinguish between Murabaha and Ijarah in Islamic finance.

Murabaha is cost-plus sale financing (bank buys an asset and sells it to the client at a marked-up price paid in instalments); Ijarah is leasing (bank owns the asset and leases it for rental payments).

What is the formula for the cost of debt (Kd) after tax on irredeemable debt?

Kd (after tax) = [Interest x (1 - tax rate)] / Market value of debt.

What is the dividend growth model formula for the cost of equity (Ke)?

Ke = [D1 / P0] + g, where D1 = next dividend, P0 = current share price (ex-div), and g = constant growth rate of dividends.

What does WACC stand for and what does it represent?

Weighted Average Cost of Capital — the average return a company must earn on its assets to satisfy all providers of finance (debt and equity), weighted by their market values.

State the WACC formula for a firm financed by equity and debt.

WACC = [Ke x (E / (E+D))] + [Kd(after tax) x (D / (E+D))], using market values of equity (E) and debt (D).

Why is the after-tax cost of debt used in WACC?

Because interest is tax-deductible, the tax relief reduces the effective cost of debt to the company.

What does the Capital Asset Pricing Model (CAPM) calculate, and what is its formula?

It calculates the required return (cost of equity) for a given level of systematic risk: Ke = Rf + β(Rm - Rf).

In CAPM, what does beta (β) measure?

Systematic (market) risk — the sensitivity of a security's returns to movements in the overall market; β = 1 moves with the market, β > 1 is more volatile, β < 1 is less volatile.

In CAPM, what is the 'market risk premium'?

The excess return of the market over the risk-free rate, (Rm - Rf), representing the extra reward investors require for bearing market risk.

Distinguish systematic risk from unsystematic risk.

Systematic (market) risk affects all firms and cannot be diversified away; unsystematic (specific) risk is company-specific and can be eliminated through diversification.

Name four common financial risk management techniques used to deal with risk.

Risk avoidance, risk reduction (mitigation), risk transfer (e.g. insurance/hedging), and risk retention (acceptance).

What is hedging in financial risk management?

Taking an offsetting position (e.g. via forwards, futures, options or swaps) to reduce or eliminate exposure to adverse movements in interest rates, exchange rates or prices.

Name three instruments used to hedge interest rate risk.

Forward Rate Agreements (FRAs), interest rate futures, interest rate options/caps/floors, and interest rate swaps.

What is an interest rate swap?

An agreement between two parties to exchange interest payment streams (typically fixed-for-floating) on a notional principal, used to manage interest rate exposure.

What is a Forward Rate Agreement (FRA)?

An over-the-counter contract that fixes an interest rate on a notional loan/deposit for a future period, with cash settlement of the difference against the actual rate.

Name four internal techniques for managing foreign exchange (transaction) risk.

Invoicing in home currency, matching receipts and payments, leading and lagging, and netting of intra-group balances.

Name three external instruments used to hedge foreign exchange risk.

Forward exchange contracts, currency futures, currency options, and currency swaps; money market hedges are also used.

How does a forward exchange contract hedge currency risk?

It locks in a fixed exchange rate today for a currency transaction settling on a future date, removing uncertainty over the future spot rate.

What is the purpose of ISO 31000?

It provides principles, a framework and a process for managing risk in any organization — guidelines (not a certifiable standard) to make risk management effective and integrated.

List the main steps of the ISO 31000 risk management PROCESS.

Establish scope/context/criteria; risk assessment (risk identification, risk analysis, risk evaluation); risk treatment; plus ongoing communication & consultation, monitoring & review, and recording & reporting.

What are the three components of 'risk assessment' under ISO 31000?

Risk identification, risk analysis, and risk evaluation.

Name three quantitative techniques used in budget preparation.

Time series analysis (trend and seasonal variations), regression/line of best fit, high-low method, learning curves, and index numbers.

In time-series analysis, what does the ADDITIVE model state? (Y = ?)

Y = T + S + C + R (Actual = Trend + Seasonal + Cyclical + Random variation); the multiplicative model is Y = T x S x C x R.

What is the high-low method used for in budgeting?

To separate a semi-variable cost into fixed and variable elements: variable cost per unit = (cost at high activity - cost at low activity) / (high units - low units).

What is working capital and how is it calculated?

Working capital = current assets - current liabilities; it represents the funds available to finance day-to-day operations.

State the formula for the cash operating cycle (working capital cycle).

Inventory days + receivables (debtor) days - payables (creditor) days = the time between paying for inputs and collecting cash from customers.

What does the Economic Order Quantity (EOQ) model determine, and what is its formula?

The order quantity that minimizes total inventory ordering and holding costs: EOQ = √(2 x Co x D / Ch), where Co = cost per order, D = annual demand, Ch = holding cost per unit per year.

Distinguish an aggressive from a conservative working capital financing policy.

An aggressive policy finances more current assets with short-term (cheaper, riskier) finance, raising return and liquidity risk; a conservative policy uses more long-term finance, lowering risk but also return.

What is the Net Present Value (NPV) investment appraisal method, and its decision rule?

NPV discounts all future cash flows to present value at the cost of capital and subtracts the initial outlay; accept the project if NPV is positive (it adds value).

What is the Internal Rate of Return (IRR)?

The discount rate at which a project's NPV equals zero; accept the project if IRR exceeds the company's cost of capital.

State the formula used to estimate IRR by interpolation between two rates.

IRR ≈ L + [NPV_L / (NPV_L - NPV_H)] x (H - L), where L and H are the lower and higher discount rates and NPV_L, NPV_H the corresponding NPVs.

What is the payback period method and its main weakness?

It measures the time taken for a project's cash inflows to recover the initial investment; its main weakness is that it ignores the time value of money and cash flows after the payback point.

What is the Accounting Rate of Return (ARR), and how is it calculated?

ARR = (average annual accounting profit / average (or initial) investment) x 100%; the project is accepted if ARR exceeds a target rate.