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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 91
What is a zero-coupon bond and why is it useful in duration analysis?
Select an option first.
Correct answer: B — A bond that pays no periodic coupon — sold at a deep discount to par, returning only the face value at maturity. Its Macaulay duration exactly equals its maturity, making it ideal for immunisation strategies
Explanation: B is correct. Zero-coupon bond: all cash flow at maturity → duration = maturity. Perfect for cash flow matching and immunisation. Also called a 'strip'. A is wrong — no coupon, not no principal. C is a government bond (may or may not be zero-coupon). D is a convertible.
Question 92
What is a callable bond and how does it affect pricing?
Select an option first.
Correct answer: B — A bond that the issuer has the right to redeem before maturity at a specified call price. This option benefits the issuer, so callable bonds must offer a higher yield than equivalent non-callable bonds to compensate investors for the call risk
Explanation: B is correct. Callable bond: Price = Straight bond price − Value of issuer's call option. Investors demand a higher yield (spread) to compensate. When rates fall, the issuer is more likely to call and refinance cheaply — reinvestment risk for bondholders. A describes a puttable bond. C is a convertible. D is a floater.
Question 93
What is 'sum of the parts' (SOTP) valuation?
Select an option first.
Correct answer: B — A valuation methodology for diversified companies that values each division separately using the most appropriate method for each, then sums the values — reveals whether a conglomerate discount exists compared to market capitalisation
Explanation: B is correct. SOTP: value division A + B + C separately → total intrinsic value. Compare to market cap → if market cap < SOTP, a conglomerate discount exists. Activists use SOTP to argue for break-ups. A is a misapplication. C is book value. D is a simplified average.
Question 94
What is 'diluted net asset value' (NAV) in property company analysis?
Select an option first.
Correct answer: B — The estimated value per share of a property company's underlying assets at market value, less liabilities and debt — the primary valuation metric for REITs and property companies. A share price above NAV implies a premium; below implies a discount
Explanation: B is correct. NAV/DNAV: properties valued at market (independent valuers). If price > NAV/share → premium (growth expectation or scarcity). If price < NAV → discount (liquidity, management, or leverage concerns). A is book value. C is EPS. D is dividend yield.
Question 95
What is a 'football field chart' in investment banking valuation?
Select an option first.
Correct answer: B — A visual presentation of valuation ranges from multiple methodologies (DCF, comparable companies, precedent transactions, LBO) displayed as horizontal bars — each bar shows the implied valuation range from that method, allowing comparison of where ranges overlap
Explanation: B is correct. Football field chart: standard investment banking valuation presentation. Where bars overlap = convergence zone where valuation is most robust. Named after the shape (overlapping horizontal bars). Supports fairness opinions and deal pricing. A is a stock chart. C is wrong. D is a synergy analysis.
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Question 96
What are the three forms of market efficiency (EMH)?
Select an option first.
Correct answer: B — Weak form (prices reflect all past price/volume data), semi-strong form (prices reflect all publicly available information), and strong form (prices reflect all public and private information)
Explanation: B is correct. EMH (Fama): weak → technical analysis useless; semi-strong → fundamental analysis cannot generate consistent excess returns; strong → even inside information cannot generate excess returns. Implications: active management adds no value in strong-form efficient markets. A, C and D are invented classifications.
Question 97
What is Jensen's alpha?
Select an option first.
Correct answer: B — The excess return of a portfolio over the CAPM-predicted return given its beta — a positive alpha indicates the portfolio manager generated returns above what is expected for the portfolio's systematic risk
Explanation: B is correct. Jensen's alpha = Portfolio return − [Rf + β(Rm − Rf)]. Positive alpha = outperformance after risk adjustment (potentially genuine skill). Used to assess fund manager performance. A is beta. C is the Sharpe ratio. D is total risk.
Question 98
What is the Sharpe ratio?
Select an option first.
Correct answer: B — The excess return of a portfolio above the risk-free rate divided by the portfolio's standard deviation — measures return per unit of total risk. Higher = better risk-adjusted performance
Explanation: B is correct. Sharpe ratio = (Rp − Rf) / σp. Compares portfolios on a total risk basis. Useful for a standalone portfolio. Treynor ratio uses beta instead of σ (appropriate when portfolio is a sub-portfolio of a larger diversified portfolio). A lacks the risk-free deduction. C is R-squared. D is wrong.
Question 99
What is the Treynor ratio?
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Correct answer: B — The excess return of a portfolio above the risk-free rate divided by the portfolio's beta — measures return per unit of systematic risk. More appropriate than Sharpe when evaluating a portfolio that will be combined with other portfolios
Explanation: B is correct. Treynor = (Rp − Rf) / β. Uses beta (systematic risk) — appropriate for sub-portfolios where only systematic risk matters in a diversified context. Sharpe uses σ (total risk) — appropriate for the whole standalone portfolio. A and C are wrong formulas. D is wrong.
Question 100
What is the Capital Market Line (CML)?
Select an option first.
Correct answer: B — The line from the risk-free rate through the market portfolio in expected return vs standard deviation space — all efficient portfolios lie on the CML. The slope of the CML = Sharpe ratio of the market portfolio
Explanation: B is correct. CML: E(R) = Rf + [(Rm − Rf)/σm] × σp. All points on the CML dominate portfolios not on the efficient frontier. Uses total risk (σ); the SML (Security Market Line) uses systematic risk (beta). A describes the efficient frontier of risky portfolios. C is the MM propositions graph. D is the SML.
Question 101
What is the Security Market Line (SML)?
Select an option first.
Correct answer: B — The graphical representation of the CAPM — plots expected return (y-axis) against beta (x-axis). Assets above the SML are undervalued; assets below are overvalued. Slope = market risk premium
Explanation: B is correct. SML: E(R) = Rf + β × (Rm − Rf). Above SML → positive alpha (undervalued by CAPM). Below → negative alpha (overvalued). The slope = MRP. A is the yield curve. C is a time-series. D is the PEG ratio.
Question 102
What is the key insight of Markowitz portfolio theory?
Select an option first.
Correct answer: B — Combining assets with less than perfect positive correlation reduces total portfolio risk below the weighted average of individual asset risks — the core diversification benefit. Investors should construct portfolios on the efficient frontier
Explanation: B is correct. Markowitz (1952): portfolio variance < weighted average variance when correlation < 1. Efficient frontier: highest return for each level of risk. Optimal portfolio: tangency between efficient frontier and investor's indifference curve. A and C are wrong. D is EMH.
Question 103
What is unsystematic risk and how can it be eliminated?
Select an option first.
Correct answer: B — Risk specific to an individual company (management failure, product recall) — eliminated through portfolio diversification, because these company-specific risks are uncorrelated and cancel out as more assets are added to a portfolio
Explanation: B is correct. Unsystematic (diversifiable/idiosyncratic) risk: company-specific. Diversification eliminates it as portfolio size increases. CAPM only compensates for systematic (non-diversifiable) risk. A is systematic risk. C is interest rate risk. D is systematic risk.
Question 104
What is systematic risk and how is it measured?
Select an option first.
Correct answer: B — Market-wide risk that affects all assets and cannot be eliminated through diversification — measured by beta, which captures an asset's sensitivity to market-wide movements. Investors are compensated for bearing systematic risk via the risk premium in CAPM
Explanation: B is correct. Systematic (undiversifiable/market) risk: driven by macro factors. Beta measures it. CAPM: required return = Rf + β(Rm − Rf). Only systematic risk earns a premium because unsystematic risk can be diversified away. A is unsystematic. C and D are company-specific.
Question 105
What is the efficient frontier in portfolio theory?
Select an option first.
Correct answer: B — The set of optimal portfolios offering the highest expected return for each level of standard deviation — portfolios on the frontier cannot be improved without accepting more risk or sacrificing return. Combining with the risk-free asset produces the Capital Market Line
Explanation: B is correct. Efficient frontier: north-west boundary of the feasible portfolio set. Dominated portfolios lie inside the frontier. Tangency portfolio (combined with risk-free) gives the CML. A is the minimum-variance frontier. C is the entire opportunity set. D is the CML.
Question 106
What is a put option and why might an investor buy one?
Select an option first.
Correct answer: B — The right (but not the obligation) to sell shares at a fixed price (strike price) — used as portfolio insurance. If share price falls below the strike, the put holder can sell at the higher strike price, limiting downside losses
Explanation: B is correct. Put option: profits when underlying falls below strike. Protective put (long stock + long put) = portfolio insurance, creates a floor on losses. Equivalent to a call option + risk-free bond (put-call parity). A is a call option. C is an obligation to sell (forward). D is a forward contract.
Question 107
What is a covered call strategy?
Select an option first.
Correct answer: B — Selling a call option on shares you already own — generates premium income but caps the upside above the strike price. If price rises above the strike, the call is exercised and the investor must sell at the strike price, missing further gains
Explanation: B is correct. Covered call: long stock + short call. Income-enhancing strategy. Suitable when expecting moderate or flat price movement. Disadvantage: capped upside. A describes buying (not selling). C is a straddle. D is a cash-secured put.
Question 108
What is a straddle options strategy?
Select an option first.
Correct answer: B — Buying both a call and a put at the same strike price and expiry — profits when the underlying moves significantly in either direction. Maximum loss = both premiums paid (if underlying stays near the strike at expiry)
Explanation: B is correct. Long straddle: profit from large price movements (direction uncertain). Used before earnings announcements, regulatory decisions, or other binary events. A is a risk reversal. C is a strangle. D is a short straddle (opposite — profits from low volatility).
Question 109
What are the Greeks in option pricing and what does delta represent?
Select an option first.
Correct answer: B — Sensitivity measures of an option's price to underlying variables — Delta: change in option price per £1 change in asset price (0 to 1 for calls, −1 to 0 for puts). Gamma: rate of change of delta. Theta: daily time decay. Vega: sensitivity to volatility. Rho: sensitivity to interest rate
Explanation: B is correct. Greeks: Delta (direction), Gamma (convexity of delta), Theta (time decay — options lose value daily), Vega (volatility risk — options worth more with higher σ), Rho (interest rate sensitivity). Essential for option portfolio management. A, C and D are wrong.
Question 110
What is implied volatility in option pricing?
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Correct answer: B — The volatility that, when input into Black-Scholes, produces a theoretical option price equal to the current market price — the market's consensus view of future volatility. Higher implied volatility → more expensive options
Explanation: B is correct. Implied volatility (IV): derived by solving Black-Scholes backwards from the observed market option price. VIX = index of S&P 500 implied volatility. IV rises before events (earnings, elections) and falls after. A is historical/realised volatility. C is volatility of the derivative. D is historical volatility over a specific period.
Question 111
What is the volatility smile in options markets?
Select an option first.
Correct answer: B — The empirical finding that options with different strike prices (same maturity) imply different levels of volatility when using Black-Scholes — in equity markets, deep out-of-the-money puts imply higher volatility than at-the-money options. This reflects market expectations of fat-tailed, negatively skewed return distributions
Explanation: B is correct. Volatility smile/skew: contradicts Black-Scholes' constant volatility assumption. Investors pay more for crash protection (deep OTM puts) → higher implied vol at low strikes. Evidence of fat tails and negative skew in equity returns. A describes what Black-Scholes would predict. C is the volatility term structure. D is wrong.
Question 112
What is the binomial option pricing model and how does it differ from Black-Scholes?
Select an option first.
Correct answer: B — A discrete-time model that values options by building a tree of possible future prices (up or down at each step) and working backwards using risk-neutral probabilities — more flexible than Black-Scholes, handles American options and dividends, but requires more computation
Explanation: B is correct. Binomial: discrete steps, backward induction, risk-neutral pricing. Handles American options (early exercise), dividends, path-dependence. As steps → ∞, binomial → Black-Scholes. Black-Scholes: closed-form, quicker, European options only, assumes log-normal distribution. A describes Black-Scholes. C and D are wrong.
Question 113
What is the multi-stage dividend discount model and when is it used?
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Correct answer: B — A DDM that forecasts dividends explicitly during a high-growth phase, then applies the constant-growth perpetuity formula for the stable phase — total value = PV of explicit dividends + PV of terminal value. Used when a company's growth rate is expected to change over time
Explanation: B is correct. Multi-stage DDM: Stage 1 — high growth (forecast each dividend), Stage 2 — stable growth (TV = D_{n+1}/(Ke−g)). Total PV of both stages = intrinsic value. More realistic than one-stage DDM for growth companies. A restricts to constant growth only. C is wrong. D is wrong.
Question 114
What is the residual income (RI) model for equity valuation?
Select an option first.
Correct answer: B — A model that values equity as book value plus the present value of all future residual incomes — where RI = net income − (cost of equity × beginning book value). Consistent with DCF when clean-surplus accounting holds
Explanation: B is correct. RI model (Edwards-Bell-Ohlson): P = BV + Σ[RI_t / (1+Ke)^t]. RI_t = EPS_t − Ke × BV_{t-1}. Advantage: anchored to book value, adds NPV of above-normal returns. Useful for firms that don't pay dividends. A is cash flow approach. C ignores future RI. D is an earnings multiple.
Question 115
What is a sensitivity table (data table) in financial valuation?
Select an option first.
Correct answer: B — A two-dimensional table showing how a valuation metric (e.g., NPV or share price) changes across a range of two key assumptions simultaneously — commonly used to show implied value across combinations of WACC and terminal growth rate in a DCF valuation
Explanation: B is correct. Sensitivity tables: cross-tabulate two key drivers (most commonly WACC vs terminal growth for DCF). Shows the central case and a range of implied values, helping communicate valuation uncertainty. Used in investment banking fairness opinions and equity research. A is wrong. C is a yield curve. D is a financial schedule.
Question 116
What is a leveraged buyout (LBO) and what are the four main value creation levers?
Select an option first.
Correct answer: B — An acquisition funded primarily with debt — value created through: (1) financial leverage (amplifies equity returns); (2) debt tax shield; (3) operational improvement (EBITDA growth, margin expansion); (4) multiple expansion (exit at higher EV/EBITDA than entry)
Explanation: B is correct. LBO: typically 60–90% debt. Financial sponsors (PE) use leverage to amplify equity returns. Value drivers: leverage paydown (debt repaid from FCF → equity value grows), EBITDA growth, margin improvement, and multiple arbitrage. A ignores debt. C ignores debt. D is a subset (MBO is a type of LBO).
Question 117
What is asset beta (unlevered beta) and why is it used?
Select an option first.
Correct answer: B — The systematic risk of a firm's assets independent of capital structure — calculated by removing the leverage effect from the equity beta. Used in project appraisal when a proxy company has a different capital structure: unlever the proxy's equity beta → get asset beta → re-lever with the evaluating firm's structure → project-specific equity beta → CAPM → WACC
Explanation: B is correct. Asset beta (βa) = βe × E / (E + D(1−t)). Strips financial risk, leaves business risk. Enables comparison across differently-leveraged companies. A conflates with equity beta. C includes unsystematic risk (wrong). D is wrong.
Question 118
What is the information ratio in portfolio management?
Select an option first.
Correct answer: B — Active return (portfolio return minus benchmark return) divided by tracking error (standard deviation of active returns) — measures the consistency of outperformance. Higher IR = more consistent value added relative to benchmark
Explanation: B is correct. Information ratio = (Rp − Rb) / Tracking Error. Tracking error = volatility of excess returns. Used to evaluate active fund managers. A is Jensen's alpha / total risk. C is relative return without volatility adjustment. D is a risk decomposition ratio.
Question 119
What is the reverse yield gap?
Select an option first.
Correct answer: B — When the yield on equities falls below the yield on government bonds — common when investors expect strong future dividend/earnings growth that compensates for the lower current income yield. Prevalent in low-interest-rate environments
Explanation: B is correct. Reverse yield gap: equity yield < bond yield. Modern explanation: equities offer inflation-linked real growth (bonds are fixed nominal) → investors accept lower current yield. Traditional view: equities should yield more (higher risk). A is the traditional yield gap. C is credit spread inversion. D is negative real rates.
Question 120
What is Tobin's Q and what does it signal about investment?
Select an option first.
Correct answer: B — The ratio of the market value of a firm (equity + debt) to the replacement cost of its assets — Q > 1 implies the market values the firm above what it would cost to create its assets (suggesting positive NPV investments), and the firm should invest more. Q < 1 suggests the opposite
Explanation: B is correct. Tobin's Q = Market value / Replacement cost. Q > 1: invest (value created exceeds cost). Q < 1: don't invest (market values assets below their cost to create). A is earnings yield. C is EVA/equity. D is the inverse of price-to-book.
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