CA Final PAPER 2: ADVANCED FINANCIAL MANAGEMENT Flashcards

24 sample cards from the PAPER 2: ADVANCED FINANCIAL MANAGEMENT deck

Sampled from the end of the deck, so these are different cards from the ones shown on the syllabus page.

1. What is the Efficient Frontier in Portfolio Selection?

   It is the set of optimal portfolios offering the highest expected return for each level of risk (or lowest risk for each level of return). Rational investors select portfolios lying on the efficient frontier; portfolios below it are inefficient.

2. What is the Capital Market Line (CML) in Capital Market Theory?

   The CML shows the risk-return relationship for efficient portfolios combining the risk-free asset and the market portfolio. Expected Return = Rf + [(Rm − Rf)/σm] × σp, where σp is total risk (standard deviation) of the portfolio.

3. Differentiate between the Capital Market Line (CML) and the Security Market Line (SML).

   CML applies only to efficient portfolios and uses total risk (standard deviation) on the x-axis. SML applies to all securities/portfolios (efficient or not) and uses systematic risk (beta) on the x-axis to give required return via CAPM.

4. What is the difference between active and passive Portfolio Revision strategies?

   Active revision involves frequent buying/selling to outperform the market based on forecasts (higher cost). Passive revision uses simple rules like buy-and-hold or formula plans (constant rupee value, constant ratio, variable ratio) requiring minimal monitoring.

5. Name the three classic portfolio performance evaluation measures.

   Sharpe ratio = (Rp − Rf)/σp (reward per unit of total risk); Treynor ratio = (Rp − Rf)/βp (reward per unit of systematic risk); Jensen's Alpha = Rp − [Rf + βp(Rm − Rf)] (excess return over CAPM-required return).

6. What is Asset Allocation and its main types?

   Asset allocation is distributing investments across asset classes (equity, debt, cash, alternatives). Types: Strategic (long-term target mix), Tactical (short-term deviations to exploit opportunities), and Dynamic (continuous adjustment as market/portfolio value changes).

7. What characterises a Fixed Income Portfolio and its key risks?

   A portfolio of debt instruments (bonds, debentures, G-secs) providing regular interest income. Key risks: interest rate risk, credit/default risk, reinvestment risk, liquidity risk, and inflation risk. Managed using duration and immunisation techniques.

8. What are Distressed Securities and why are they considered high-risk investments?

   Securities of companies in or near financial distress/bankruptcy, often trading at deep discounts. They carry high default and liquidity risk but offer potential high returns if the company recovers or restructures successfully (high risk, high reward).

9. Define Securitization.

   Securitization is the process of pooling illiquid financial assets (such as loans/receivables) and converting them into tradable, marketable securities backed by those assets, which are then sold to investors. It converts future cash flows into immediate liquidity.

10. Who are the main participants in a securitization transaction?

    Originator (creates/sells the assets), Special Purpose Vehicle/SPV (buys assets and issues securities), Investors (buy the securities), Obligors (original borrowers), Credit Rating Agency, Credit Enhancer, and Servicer/Receiving and Paying Agent.

11. List the main benefits of Securitization to the originator.

    Improved liquidity (off-balance-sheet financing), better capital adequacy, risk transfer, additional source of funding, reduced cost of funds, and improved asset-liability management.

12. Name the principal securitization instruments.

    Pass Through Certificates (PTCs), Pay Through Certificates, Asset-Backed Securities (ABS), Mortgage-Backed Securities (MBS), and Collateralized Debt Obligations (CDOs).

13. What is Tokenization in the context of securitization?

    Tokenization is representing ownership rights in a real-world or financial asset as digital tokens recorded on a blockchain/distributed ledger, enabling fractional ownership, greater liquidity, transparency, and easier transfer of asset-backed securities.

14. Define a Mutual Fund.

    A mutual fund is a professionally managed investment vehicle that pools money from many investors to invest in a diversified portfolio of securities (equity, debt, money market). Returns/risks are shared by unit holders in proportion to their holdings, regulated by SEBI in India.

15. State the formula for Net Asset Value (NAV) per unit of a mutual fund.

    NAV per unit = (Market value of fund's assets − Liabilities) / Number of outstanding units. It represents the per-unit market worth of the fund.

16. What is a Hedge Fund and how does it differ from a mutual fund?

    A hedge fund is a lightly regulated, private pooled fund for sophisticated/HNI investors that uses aggressive strategies (leverage, short-selling, derivatives, arbitrage) to earn absolute returns. Unlike mutual funds, it has fewer disclosure requirements, high minimum investment, and charges performance-based fees.

17. Distinguish between a forward contract and a futures contract.

    Forwards are private, customised OTC contracts with counterparty/default risk, settled at maturity. Futures are standardised, exchange-traded contracts with daily mark-to-market, margin requirements, and a clearing house eliminating counterparty risk.

18. State the cost-of-carry model for pricing a stock index future.

    Future Price F = S0 × e^(r−q)×t (continuous) or F = S0(1 + r − q)^t, where S0 = spot price, r = risk-free rate, q = dividend yield, and t = time to maturity. Carry cost = interest; carry return = dividends.

19. What is the difference between a call option and a put option?

    A call option gives the holder the right (not obligation) to BUY the underlying at the strike price. A put option gives the holder the right to SELL the underlying at the strike price. Calls profit from price rises; puts profit from price falls.

20. State the Put-Call Parity relationship for European options.

    C + PV(K) = P + S0, i.e., Call price + Present value of strike (Ke^−rt) = Put price + Spot price. It links the prices of European calls and puts with the same strike and expiry.

21. What is an interest rate swap?

    An interest rate swap is an OTC agreement between two parties to exchange interest payments on a notional principal — typically one paying a fixed rate and receiving a floating rate, and vice versa — to manage interest rate risk or reduce borrowing costs.

22. What is Interest Rate Parity (IRP) in foreign exchange?

    IRP states that the forward exchange rate differential equals the interest rate differential between two countries. Forward Rate = Spot Rate × [(1 + interest rate home)/(1 + interest rate foreign)]. It prevents covered interest arbitrage.

23. What is a Special Purpose Acquisition Company (SPAC)?

    A SPAC is a 'blank cheque' shell company that raises money through an IPO with the sole purpose of acquiring or merging with an existing private company, thereby taking it public without a traditional IPO process, usually within a set time frame (e.g., 2 years).

24. What is a Unicorn, and name key components of valuing start-ups and digital platforms.

    A Unicorn is a privately held start-up valued at over US$1 billion. Start-ups/digital platforms (often loss-making with no track record) are valued using methods like the Venture Capital method, scorecard, DCF on projected cash flows, comparable transactions, and metrics like user base, network effects, GMV and burn rate rather than current earnings.

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PAPER 2: ADVANCED FINANCIAL MANAGEMENT flashcards FAQ