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Free ACCA Advanced Financial Management Practice Questions & Answers
400 exam-style Advanced Financial Management questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 331
What is 'securitisation' and how does it work?
Select an option first.
Correct answer: B — A process where illiquid assets (e.g., mortgages, auto loans, trade receivables) are pooled and used as collateral for securities issued to investors — the originating company (bank or corporate) sells the assets to a special purpose vehicle (SPV), which issues asset-backed securities (ABS) to investors. The company receives cash upfront
Explanation: B is correct. Securitisation: pool of assets → SPV → tranches of ABS (senior, mezzanine, equity). Originator benefit: off-balance-sheet financing, risk transfer, regulatory capital relief (for banks). Investor: access to diversified, specific-risk exposure. RMBS (residential mortgage), CMBS (commercial mortgage), CLO (collateralised loan obligation). 2008 crisis: mispriced risk in structured products. A is a financing type. C is equity conversion. D is unrelated.
Question 332
What is 'SONIA' (Sterling Overnight Index Average) and why has it replaced LIBOR?
Select an option first.
Correct answer: B — A risk-free overnight interest rate benchmark measuring the average rate at which banks lend to each other overnight in sterling — it replaced GBP LIBOR because LIBOR was based on submissions (not actual transactions) and was subject to manipulation (LIBOR scandal 2012). SONIA is transaction-based and more robust
Explanation: B is correct. SONIA: transaction-based, overnight, administered by the Bank of England. Replaced GBP LIBOR (end-2021) as the primary reference rate for GBP derivatives and loans. SOFR replaced USD LIBOR. Key difference from LIBOR: backward-looking (daily), no credit/term premium. Compounded SONIA in arrears is used for floating rate loans. A is not correct. C is the Bank Rate (different). D is wrong.
Question 333
What is 'scenario testing' (stress testing) in risk management and how does it differ from VaR?
Select an option first.
Correct answer: B — A technique that assesses the impact of extreme but plausible scenarios (e.g., financial crisis, sharp interest rate rise, large FX move) on the company's portfolio or cash flows — unlike VaR, it does not assign probabilities but focuses on the magnitude of loss in specific stress scenarios
Explanation: B is correct. Stress testing: regulators require banks to test 'severe but plausible' scenarios (e.g., 2008 financial crisis parameters, COVID scenarios). Reverse stress testing: find the scenario that would cause a specified loss. Complements VaR by revealing the magnitude of potential extreme losses. A is project appraisal. C and D are wrong.
Question 334
What is an 'exchange-traded fund' (ETF) and how is it used in treasury?
Select an option first.
Correct answer: B — An investment fund traded on a stock exchange that tracks an index (equities, bonds, commodities) — used by corporate treasury to manage short-term surplus cash more efficiently than holding cash, while maintaining reasonable liquidity. ETFs provide diversified exposure at low cost with intraday liquidity
Explanation: B is correct. ETF: open-ended fund tracking an index, traded like a share throughout the day. Treasury use: investing surplus cash in money market ETFs or short-duration bond ETFs — higher yield than bank deposits while maintaining near-daily liquidity. A is wrong. C describes a listed company. D is a structured note.
Question 335
What is a 'cross-default clause' in debt agreements and why does it matter?
Select an option first.
Correct answer: B — A covenant provision where a default on one debt obligation automatically triggers a default on other debt obligations — if a company defaults on one loan, all other loans with cross-default clauses immediately become repayable, potentially causing a liquidity crisis
Explanation: B is correct. Cross-default: lenders include this to prevent their position from being disadvantaged relative to other lenders if the company defaults selectively. Practical consequence: a technical default on one facility (e.g., breach of a covenant) can trigger cross-defaults, turning a manageable problem into a crisis. A is a prepayment right. C is a contingent convertible. D is a negative pledge.
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Question 336
What is a 'negative pledge' covenant in bond/loan agreements?
Select an option first.
Correct answer: B — A covenant that prevents the borrower from using the same assets as collateral for another lender without giving the same security to the original lender — protects unsecured lenders from having their priority diluted by subsequent secured borrowings
Explanation: B is correct. Negative pledge: if the borrower creates security for another lender, it must offer equivalent security (pari passu) to the existing lender — or the existing lender gets the right to accelerate repayment. Protects unsecured creditors. Common in bond indentures and syndicated loans. A is a different restriction. C is a dividend covenant. D is a liquidity covenant.
Question 337
What is the 'three lines of defence' model in risk management?
Select an option first.
Correct answer: B — A governance framework where: (1st line) business units own and manage risks; (2nd line) risk management and compliance functions provide oversight and challenge; (3rd line) internal audit provides independent assurance. Each line plays a different but complementary role in risk oversight
Explanation: B is correct. Three lines model (IIA): 1st line — frontline managers, operational controls; 2nd line — risk, compliance, legal (design standards and monitor); 3rd line — internal audit (independent assurance to the board and audit committee). Widely adopted in financial institutions and large corporates. A is a trading model. C and D are wrong.
Question 338
What is 'ISDA Master Agreement' and why is it used in derivatives?
Select an option first.
Correct answer: B — A standardised legal framework for OTC derivatives transactions between two counterparties — it sets out general terms and conditions (netting, events of default, governing law), reducing legal risk. Specific deals are governed by separate Confirmations. The netting provision is critical: on default, all positions are netted to a single amount
Explanation: B is correct. ISDA Master Agreement: industry-standard OTC derivatives documentation. Key provisions: close-out netting (sum of all derivative values netted on default), representations, events of default, termination events. Reduces legal and counterparty risk. Single transaction exposure ≠ gross exposure. A is regulatory. C is exchange clearing. D is bond documentation.
Question 339
What is 'enterprise risk management' (ERM) and how does it differ from siloed risk management?
Select an option first.
Correct answer: B — A comprehensive, integrated approach to identifying, assessing, and managing all risks (financial, operational, strategic, reputational) across an entire organisation — unlike siloed risk management (where individual departments manage their own risks independently), ERM provides a consolidated view of the firm's total risk exposure and enables better risk-return trade-offs
Explanation: B is correct. ERM (COSO framework): risk identification → risk assessment (likelihood × impact) → risk response (avoid, reduce, share, accept) → monitoring. Benefits: avoids risk concentration, captures diversification benefits across risk types, better capital allocation, and board-level risk governance. A is too narrow. C is siloed risk. D is wrong — ERM is a best practice, not universally mandatory.
Question 340
What is 'financial distress' and at what point can it affect firm value?
Select an option first.
Correct answer: B — A situation where a company's cash flows are insufficient to meet its financial obligations — it can destroy value even before formal insolvency through: management distraction, loss of customers and suppliers, inability to invest in positive NPV projects, and key talent departing. The market anticipates distress risk and raises the cost of capital
Explanation: B is correct. Financial distress: the cost of distress arises well before formal bankruptcy. Companies in distress: customers hesitant to buy (warranty concerns), suppliers demand cash upfront, banks refuse new credit, management spends time on survival vs value creation, best employees leave. These 'indirect' costs can be larger than direct bankruptcy costs (legal fees). A and D are specific events. C is a valuation measure.
Question 341
What is 'the Market for Corporate Control' and why does it help manage agency problems?
Select an option first.
Correct answer: B — The concept that poorly managed companies are potential acquisition targets — if management fails to maximise value, an acquirer can buy the firm, replace management, improve performance, and profit from the increase in value. This threat of takeover disciplines managers to act in shareholders' interests
Explanation: B is correct. Market for corporate control (Jensen and Meckling): the threat of hostile takeover serves as a disciplining mechanism. Management that underperforms invites a hostile bid (control premium = the value of improved management). This external governance mechanism supplements internal governance (board, pay). A is the equity market. C is the executive labour market. D is the bond market.
Question 342
What is 'transfer pricing' and why is it relevant to multinational treasury?
Select an option first.
Correct answer: B — The price charged for goods, services, loans, or intellectual property transferred between related entities within a multinational group — relevant to treasury because inter-company loans use transfer pricing rules (arm's length interest rates), and companies manage transfer prices to optimise tax efficiency across jurisdictions. Tax authorities require arm's length pricing
Explanation: B is correct. Transfer pricing: OECD Guidelines require arm's length pricing (prices that would be agreed between unrelated parties). Used by MNCs to: allocate profits, manage tax efficiency (shifting profits to low-tax jurisdictions). Tax authority risk: if not arm's length → adjustments and penalties. Treasury: intra-group loans must bear arm's length interest rates. A is external pricing. C is FX rate. D is external borrowing rate.
Question 343
What is systemic risk vs systematic risk?
Select an option first.
Correct answer: B — Systemic risk: the risk that the failure of one institution triggers cascading failures across the financial system (contagion) — a regulatory concern. Systematic risk (market risk): market-wide factors affecting all assets that cannot be diversified away, measured by beta in CAPM
Explanation: B is correct. Systemic: interconnectedness — one failure triggers others (Lehman Brothers 2008). Addressed by macroprudential regulation (Basel III, SIFI designation). Systematic: undiversifiable market risk, priced by CAPM. Both are system-level but at different analytical levels. A conflates them. C and D are wrong.
Question 344
What is tail risk and how is it measured?
Select an option first.
Correct answer: B — The risk of extreme, infrequent events lying far in the left tail of the return distribution — underestimated by models assuming normal distributions because financial returns have fatter tails. Measured by Expected Shortfall (CVaR = average loss beyond VaR) or stress testing
Explanation: B is correct. Tail risk: large, low-probability losses. 2008 financial crisis, COVID-19 market selloff were tail events. Normal distributions underestimate these (fat tails/kurtosis). CVaR/Expected Shortfall: better than VaR for tail risk as it captures the magnitude of losses beyond the VaR threshold. Black swan events: rare, extreme, retrospectively predictable. A is high-frequency small loss. C and D are wrong.
Question 345
What is cash flow at risk (CFaR)?
Select an option first.
Correct answer: B — A measure of the worst-case shortfall in operating cash flows at a given confidence level — analogous to VaR but applied to corporate cash flows rather than financial portfolio values. Used by non-financial corporations to assess the impact of market risk (FX, rates, commodities) on cash generation
Explanation: B is correct. CFaR: applied to corporate treasury to measure risk to operating cash flows from market variables. Useful for non-financial firms where cash flow stability matters most. A is equity-at-risk. C is a cash buffer. D is a probability of default measure.
Question 346
What is quantitative easing (QE) and how does it affect corporates?
Select an option first.
Correct answer: B — A central bank policy of purchasing financial assets (typically government bonds) to inject money into the financial system, lower long-term yields, and encourage lending and risk-taking — effects on corporates: lower borrowing costs, higher asset prices, and incentive to issue debt at attractive rates
Explanation: B is correct. QE: central bank creates reserves to buy assets → pushes yields down, asset prices up. Corporate effects: cheaper long-term debt issuance, higher equity valuations (lower discount rate), potential inflationary pressure on input costs. Used by Fed, ECB, Bank of England post-2008 and 2020. A is revenue collection. C is austerity. D is capital regulation.
Question 347
What is working capital cycle optimisation and how does it reduce financing needs?
Select an option first.
Correct answer: B — Managing the cash conversion cycle (inventory + receivable − payable days) to minimise the time cash is tied up in operations — a shorter CCC reduces the amount of external financing needed, lowering interest costs and financial risk
Explanation: B is correct. CCC optimisation: reduce inventory (lean manufacturing, JIT), reduce receivables (faster collection, factoring), extend payables (negotiate longer supplier terms). Each day improved in CCC = annual revenue/365 in freed cash. A is cost cutting. C and D are unrelated.
Question 348
What is inflation risk and how can it be managed?
Select an option first.
Correct answer: B — The risk that unexpected inflation erodes the real value of a company's cash flows and competitive position — managed through: pricing power (pass on cost increases), inflation-linked debt, natural hedges (revenues and costs both inflation-linked), and investment in real assets
Explanation: B is correct. Inflation risk: companies with strong pricing power pass inflation to customers. Companies with fixed-price contracts or high fixed costs suffer margin compression. Inflation-linked bonds: cost rises with inflation. Real assets (property, commodities) retain real value. A is an accounting issue. C is interest rate risk. D is deflation risk.
Question 349
What is a puttable bond and who benefits?
Select an option first.
Correct answer: B — A bond that gives the investor the right to sell the bond back to the issuer at a specified price before maturity — attractive when interest rates are expected to rise (investors can exit and reinvest at higher rates). Puttable bonds have a lower yield than equivalent plain bonds as investors pay for the protection
Explanation: B is correct. Puttable bond: put option in favour of investor. If rates rise: exercise put (sell back at par) and reinvest at higher rates. Investor pays for this right via accepting a lower yield. A describes a callable bond (issuer's right). C is a perpetual bond. D is a convertible.
Question 350
What is economic capital?
Select an option first.
Correct answer: B — The amount of capital a financial institution calculates internally is necessary to absorb unexpected losses at a given confidence level and time horizon — differs from regulatory capital (externally imposed by Basel III), as it reflects the firm's own risk model and assessment
Explanation: B is correct. Economic capital: firm's internal VaR-based capital calculation. Regulatory capital: externally imposed minimum (e.g., Basel III CET1). Economic capital is a risk management and internal performance measurement tool. May differ from regulatory capital due to proprietary risk models. A is regulatory capital. C is equity capital. D is book equity.
Question 351
What is the three lines of defence model in risk management?
Select an option first.
Correct answer: B — A governance framework: (1) first line — business units own and manage risks daily; (2) second line — risk management and compliance provide oversight, standards, and challenge; (3) third line — internal audit provides independent assurance to the board and audit committee
Explanation: B is correct. Three lines model (IIA): clearly delineates responsibility. First line: frontline controls. Second line: risk and compliance design standards and monitor. Third line: internal audit provides independent assurance. Widely adopted in financial institutions and large corporates. A is a trading model. C and D are wrong.
Question 352
What is a revolving credit facility (RCF) and why is it used?
Select an option first.
Correct answer: B — A flexible committed credit facility allowing a company to draw, repay, and re-draw funds up to an agreed limit over a defined period — the company pays only commitment fees on undrawn amounts plus full interest on drawn amounts. Used as a working capital and liquidity backstop
Explanation: B is correct. RCF: revolving (repayable and re-drawable), flexible (draw as needed), committed (bank obligated to lend within limit, subject to covenants). Two costs: commitment fee (on undrawn balance, typically 30–50% of margin) + interest (on drawn amount). Used by most investment-grade companies as a liquidity backstop. A is a mortgage. C is a bond. D is a government scheme.
Question 353
What is transfer pricing and why is it relevant to multinational treasury?
Select an option first.
Correct answer: B — The price charged for goods, services, loans, or intellectual property transferred between related entities within a multinational group — relevant because intra-group loans must use arm's length interest rates, and companies manage transfer prices to optimise tax efficiency across jurisdictions. OECD Guidelines require arm's length pricing
Explanation: B is correct. Transfer pricing: OECD Guidelines → arm's length standard (prices that would be agreed between unrelated parties). Used by MNCs to allocate profits across jurisdictions. Tax authority risk: adjustments and penalties if not arm's length. Treasury: intra-group loans must bear arm's length interest rates. A is external pricing. C is FX rate. D is external borrowing rate.
Question 354
What is the ISDA Master Agreement and its key provision?
Select an option first.
Correct answer: B — A standardised legal framework for OTC derivatives transactions — sets out general terms (netting, events of default, governing law). The close-out netting provision is critical: on default, all positions are netted to a single amount, reducing credit exposure from gross to net
Explanation: B is correct. ISDA Master Agreement: industry standard for OTC derivatives. Close-out netting: on default, all derivative positions netted → single net payment. Reduces bilateral counterparty risk. Specific deals governed by separate Confirmations. A is regulatory. C is exchange clearing. D is bond documentation.
Question 355
What is enterprise risk management (ERM)?
Select an option first.
Correct answer: B — A comprehensive, integrated approach to identifying, assessing, and managing all risks (financial, operational, strategic, reputational) across an entire organisation — provides a consolidated view of total risk exposure and enables better risk-return trade-offs, unlike siloed risk management
Explanation: B is correct. ERM (COSO framework): risk identification → risk assessment (likelihood × impact) → risk response (avoid, reduce, share, accept) → monitoring. Benefits: avoids risk concentration, captures diversification benefits, better capital allocation, board-level risk governance. A is too narrow. C is siloed risk. D is wrong — ERM is best practice, not universally mandatory.
Question 356
What is a negative pledge covenant and why does it protect lenders?
Select an option first.
Correct answer: B — A covenant preventing the borrower from using assets as collateral for another lender without giving equivalent security to the original lender — protects unsecured lenders from having their priority diluted by subsequent secured borrowings. Breach triggers a default
Explanation: B is correct. Negative pledge: if the borrower creates security for another lender, it must offer pari passu security to the existing lender (or the existing lender can accelerate). Protects unsecured creditors' relative position. Common in bond indentures and syndicated loans. A is a different restriction. C is a dividend covenant. D is a liquidity covenant.
Question 357
What is a cross-default clause and why is it significant?
Select an option first.
Correct answer: B — A covenant provision where a default on one debt obligation automatically triggers a default on all other debt obligations that contain the same clause — if a company defaults on one loan, all other cross-default loans immediately become repayable, potentially causing a liquidity crisis
Explanation: B is correct. Cross-default: prevents selective default. Practical consequence: a technical default on one facility (e.g., a covenant breach) can trigger cross-defaults on all other loans, turning a manageable situation into a crisis. A is a prepayment right. C is a contingent convertible. D is a negative pledge.
Question 358
What is SONIA and why did it replace LIBOR?
Select an option first.
Correct answer: B — A risk-free overnight interest rate benchmark measuring the average rate at which banks lend to each other overnight in sterling — it replaced GBP LIBOR (end-2021) because LIBOR was based on submissions (not actual transactions) and was subject to manipulation (LIBOR scandal 2012). SONIA is transaction-based and more robust
Explanation: B is correct. SONIA: transaction-based, overnight, administered by the Bank of England. Replaced GBP LIBOR. SOFR replaced USD LIBOR. Key difference from LIBOR: backward-looking (daily compounded), no credit/term premium. Compounded SONIA in arrears is the standard for GBP floating rate loans. A is wrong. C is the Bank Rate (different). D is wrong.
Question 359
What is securitisation and how does it work?
Select an option first.
Correct answer: B — Pooling illiquid assets (mortgages, trade receivables) and using them as collateral for securities issued to investors — the originator sells the assets to a special purpose vehicle (SPV), which issues tranched asset-backed securities (ABS) to investors. The originator receives cash upfront and transfers the risk
Explanation: B is correct. Securitisation: pool → SPV → tranches of ABS (senior/mezzanine/equity). Benefits: off-balance-sheet financing, risk transfer, regulatory capital relief for banks. RMBS (residential mortgage), CLO (collateralised loan obligation). 2008 crisis: mispriced risk in structured products. A is wrong. C is equity conversion. D is wrong.
Question 360
What is model risk in financial risk management?
Select an option first.
Correct answer: B — The risk that a financial model used for valuation or risk management is incorrect due to flawed assumptions, mathematical errors, or inappropriate application — can lead to mispriced derivatives, incorrect hedges, or misreported risk. Prominent in complex derivatives and VaR models
Explanation: B is correct. Model risk: prominent in complex derivatives (exotic options, CDOs), VaR calculations, credit scoring. Mitigated by: independent model validation, stress testing assumptions, using multiple models in parallel, and human oversight. LTCM failure was partly caused by model risk. A is a spreadsheet error. C and D are specific concerns.
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