Chartered Global Management Accountant (CGMA) Corporate Finance, Treasury, and Financial Strategy Flashcards

24 sample cards from the Corporate Finance, Treasury, and Financial Strategy deck

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

1. What is financial gearing/leverage and how does it affect financial risk?

   Gearing is the proportion of debt in the capital structure, e.g. $\frac{D}{E}$ or $\frac{D}{D+E}$. Higher gearing increases financial risk because fixed interest commitments increase the volatility of returns to equity holders.

2. Explain pecking order theory of financing.

   Firms prefer financing in order of least information asymmetry/signaling cost: first internal funds (retained earnings), then debt, and finally new equity as a last resort. It implies no clearly defined target capital structure.

3. State the dividend irrelevancy theory of Modigliani and Miller.

   In a perfect market, dividend policy does not affect shareholder wealth; investors are indifferent because they can create 'home-made dividends' by selling shares. Value depends on investment/earnings, not the split between dividends and retentions.

4. What is the signaling effect of dividends?

   In imperfect markets with information asymmetry, dividend changes convey management's view of future prospects. A dividend increase signals confidence (raising the share price); a cut signals trouble (depressing it).

5. What is the clientele effect in dividend policy?

   Firms attract investors (clienteles) whose income/tax preferences match the firm's dividend policy. Sudden policy changes are costly because they disrupt the existing shareholder base, encouraging stable, consistent dividends.

6. What is a scrip (stock) dividend and a share buyback?

   A scrip dividend issues new shares to shareholders instead of cash, conserving cash. A share buyback (repurchase) uses cash to buy back and cancel shares, returning surplus cash and increasing earnings per share and gearing.

7. Distinguish equity, debt, and hybrid/mezzanine sources of finance.

   Equity (ordinary/preference shares) confers ownership and variable returns. Debt (loans, bonds) is a contractual fixed-return obligation, ranking ahead of equity. Hybrids (e.g. convertible bonds, warrants) combine features of both.

8. What is a rights issue, and how is the theoretical ex-rights price (TERP) calculated?

   A rights issue offers new shares to existing shareholders pro rata, usually at a discount. $$TERP = \frac{(\text{No. old shares} \times \text{old price}) + (\text{No. new shares} \times \text{issue price})}{\text{Total shares after issue}}$$

9. What are the four elements of working capital, and what is the working capital cycle?

   Elements: inventory, receivables, cash, and payables. The cash operating cycle is: $$\text{Inventory days} + \text{Receivables days} - \text{Payables days}$$ representing the time between paying suppliers and collecting from customers.

10. Explain the trade-off between profitability and liquidity in working capital, and the aggressive vs. conservative policies.

    Holding more working capital reduces risk of illiquidity but lowers profitability (idle assets). An aggressive policy holds low working capital (higher return, higher risk); a conservative policy holds high working capital (lower return, lower risk).

11. State the Economic Order Quantity (EOQ) formula for inventory management.

    $$EOQ = \sqrt{\frac{2 C_{o} D}{C_{h}}}$$ where $C_{o}$ is the cost per order, $D$ the annual demand, and $C_{h}$ the holding cost per unit per year.

12. State the Miller-Orr model for cash management.

    It sets an upper limit, lower limit, and return point for cash balances. $$\text{Spread} = 3\left(\frac{3 \times \text{transaction cost} \times \text{variance of cash flows}}{4 \times \text{interest rate}}\right)^{1/3}$$ and the return point $= \text{lower limit} + \frac{\text{spread}}{3}$.

13. What are the main roles/functions of a corporate treasury department?

    Liquidity and cash management, funding and capital markets (raising finance), banking relationships, and financial risk management (managing interest rate, foreign exchange, and commodity exposures).

14. State two methods of valuing a business and their formulas.

    Net asset (book/realizable) value: total assets minus total liabilities. Dividend valuation model: $$P_{0} = \frac{D_{0}(1+g)}{K_{e} - g}$$ Other methods include P/E ratio valuation ($\text{EPS} \times \text{P/E}$) and discounted free cash flow.

15. What is the Price/Earnings (P/E) ratio method of valuation?

    $$\text{Equity value} = \text{Earnings} \times \text{P/E ratio}$$ A suitable (often quoted-company) P/E multiple is applied to the target's earnings, typically discounted for an unquoted firm's lack of marketability.

16. Distinguish a horizontal, vertical, and conglomerate merger.

    Horizontal: firms at the same stage in the same industry. Vertical: firms at different stages of the same supply chain (e.g. supplier and customer). Conglomerate: firms in unrelated business activities.

17. What are common sources of synergy in mergers and acquisitions?

    Revenue synergy (cross-selling, market power), cost synergy (economies of scale, eliminating duplication), financial synergy (lower cost of capital, debt capacity, tax benefits), and managerial synergy (better management of underperforming assets).

18. Distinguish transaction, translation, and economic foreign exchange risk.

    Transaction risk: cash flow effect of exchange-rate changes on contracted future foreign currency transactions. Translation risk: accounting effect of restating foreign assets/liabilities. Economic risk: long-term effect of exchange-rate movements on the firm's competitive position and value.

19. State interest rate parity (IRP) and what it predicts.

    $$F_{0} = S_{0} \times \frac{1 + i_{c}}{1 + i_{b}}$$ The forward rate $F_{0}$ adjusts the spot rate $S_{0}$ by the ratio of the two countries' interest rates (counter currency $i_c$ over base $i_b$); it predicts the forward exchange rate.

20. State purchasing power parity (PPP) and what it predicts.

    $$F_{0} = S_{0} \times \frac{1 + h_{c}}{1 + h_{b}}$$ The future spot rate adjusts the current spot by the ratio of the two countries' inflation rates; the higher-inflation currency is expected to depreciate.

21. What are the main internal and external techniques for hedging foreign exchange transaction risk?

    Internal: matching, netting, leading and lagging, and invoicing in home currency. External: forward contracts, money market hedges, currency futures, currency options, and currency swaps.

22. How does a money market hedge work for a future foreign currency payment?

    Borrow domestic currency now, convert to the foreign currency at spot, and deposit it so it grows to the exact amount needed at the payment date — locking in the cost today and avoiding the future spot rate.

23. What instruments are used to manage interest rate risk?

    Forward rate agreements (FRAs), interest rate futures, interest rate options/guarantees (caps, floors, collars), and interest rate swaps. They fix or limit the effective interest rate on borrowing or lending.

24. What is an interest rate swap, and why might two firms enter one?

    A contract to exchange interest payment streams (typically fixed for floating) on a notional principal. Firms swap to obtain a preferred interest basis more cheaply, exploiting comparative advantage in different markets and sharing the gain.

What this deck covers

Corporate Finance, Treasury, and Financial Strategy flashcards FAQ