ICAP CA Business Finance Decisions Flashcards

24 sample cards from the Business Finance Decisions deck

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

1. Why are intangible assets (e.g. goodwill, brands) difficult to value, and how is goodwill often estimated?

   They lack an active market and generate uncertain future benefits. Goodwill is frequently estimated as the excess of the total business value (e.g. from earnings or DCF methods) over the fair value of identifiable net assets.

2. What is the main rationale (motive) for most acquisitions and mergers?

   To create synergy - the combined entity being worth more than the sum of the separate parts (the '2+2=5' effect) - alongside growth, market power, diversification, and access to assets or skills.

3. Distinguish between revenue synergy, cost synergy, and financial synergy in a merger.

   Revenue synergy: higher combined sales (cross-selling, market power). Cost synergy: economies of scale and removing duplicate functions. Financial synergy: lower cost of capital, tax benefits, or greater debt capacity.

4. Name three takeover defence strategies a target company's directors can use.

   Examples: 'poison pill' (e.g. issuing rights that make takeover costly), finding a 'white knight' (a friendlier rival bidder), revaluing assets/issuing favourable forecasts, paying special dividends, or referring the bid to regulators.

5. What are the three motives for holding cash according to Keynes?

   The transactions motive (to meet day-to-day payments), the precautionary motive (a buffer for unexpected needs), and the speculative motive (to exploit profitable opportunities as they arise).

6. What does the Baumol model determine in cash management?

   The optimal amount of cash to raise (by selling securities or borrowing) each time, balancing the transaction cost of replenishing cash against the interest/opportunity cost of holding it - analogous to the EOQ inventory model.

7. What is the purpose of the Miller-Orr model in cash management?

   It sets an upper and lower control limit and a return point for a cash balance that fluctuates randomly, telling management when to buy or sell securities to keep cash within a target range.

8. Define the cash operating cycle (working capital cycle).

   The time between paying for raw materials/inventory and receiving cash from customers: Inventory days + Receivables days - Payables days. A longer cycle requires more working capital financing.

9. What is factoring of receivables?

   A service where a company sells/assigns its trade receivables to a factor who provides finance (an advance, often 80%), and may also handle sales-ledger administration and offer credit protection (non-recourse factoring).

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

    EOQ = √(2 × Co × D ÷ Ch), where Co is the cost per order, D is annual demand, and Ch is the holding cost per unit per year. It minimises total ordering plus holding costs.

11. What is the aim of a Just-In-Time (JIT) inventory system?

    To minimise inventory holding by receiving goods only as they are needed in production, reducing holding costs and waste - relying on close supplier relationships and reliable, frequent deliveries.

12. Contrast aggressive, conservative, and moderate working capital financing policies.

    Aggressive: finance more of even permanent current assets with short-term funds (lower cost, higher risk). Conservative: finance most current assets with long-term funds (higher cost, lower risk). Moderate (matching): match the maturity of funding to the life of the asset.

13. What are the two main types of foreign exchange exposure besides translation exposure?

    Transaction exposure (the risk that exchange rates change between agreeing a foreign-currency transaction and settling it) and economic exposure (the effect of long-term exchange-rate movements on the present value of future cash flows and competitiveness).

14. Explain a forward exchange contract as a hedge.

    A binding contract to buy or sell a fixed amount of currency at an agreed rate on (or by) a set future date. It eliminates transaction risk by fixing the exchange rate today, removing uncertainty about the future spot rate.

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

    Borrow domestic currency now, convert it at the spot rate to the foreign currency, and deposit it to earn interest so it grows to the amount payable by the due date - locking in the cost and avoiding future spot-rate movements.

16. What is purchasing power parity (PPP) and what does it predict about exchange rates?

    PPP states that exchange rates adjust to reflect inflation differentials between countries. The currency of the country with higher inflation is expected to depreciate. Future spot = Spot × [(1 + inflation_foreign)/(1 + inflation_home)].

17. What is interest rate parity (IRP)?

    The forward exchange rate differs from the spot rate to reflect the interest-rate differential between two currencies. Forward rate = Spot × [(1 + interest_foreign)/(1 + interest_home)], preventing risk-free arbitrage.

18. What is the main source of interest rate risk for a company?

    The risk that changes in market interest rates adversely affect the company - e.g. rising rates increasing the cost of floating-rate borrowing, or falling rates reducing returns on deposits, plus the effect of rate changes on the value of fixed-rate instruments.

19. What is a forward rate agreement (FRA)?

    An over-the-counter agreement fixing the interest rate on a notional loan or deposit for a future period. The parties settle the difference between the agreed rate and the actual reference rate, hedging interest-rate movements without exchanging principal.

20. Define an interest rate swap.

    An agreement between two parties to exchange interest payment streams on a notional principal - typically swapping fixed-rate for floating-rate payments - to manage interest-rate risk or exploit differences in borrowing costs (comparative advantage).

21. What is the key difference between a forward/futures contract and an option as a hedging instrument?

    A forward or future is a binding obligation to transact at the agreed price, removing both downside risk and upside benefit. An option gives the right but not the obligation to transact, protecting against adverse moves while keeping favourable ones, in exchange for a premium.

22. Distinguish a call option from a put option.

    A call option gives the holder the right to buy the underlying asset at the exercise (strike) price. A put option gives the holder the right to sell the underlying asset at the exercise price - both before/on expiry for a premium.

23. What is the difference between exchange-traded futures and over-the-counter forwards?

    Futures are standardised, exchange-traded contracts with daily margining and a clearing house (low counterparty risk, less flexible). Forwards are customised OTC contracts negotiated between two parties (flexible amount/date but higher counterparty/default risk).

24. What is the basic principle of hedging financial risk with derivatives?

    To take a position in a derivative whose value moves in the opposite direction to the exposure, so that a loss on the underlying position is offset by a gain on the derivative (and vice versa), reducing overall volatility.

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