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Free ACCA Financial Management Practice Questions & Answers
400 exam-style 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 271
Which of the following is TRUE about the relationship between risk and return?
Select an option first.
Correct answer: B — Investors require higher expected returns as compensation for accepting higher risk
Explanation: The fundamental risk-return trade-off: investors demand a higher expected return for bearing more risk. This is the basis of CAPM, portfolio theory, and all finance. A links risk only to dividends (wrong); C and D contradict the risk-return principle.
Question 272
What is the 'risk-free rate' in finance?
Select an option first.
Correct answer: B — The theoretical return on an investment with zero risk — typically approximated by the yield on short-term government securities (e.g., Treasury bills)
Explanation: The risk-free rate (Rf) is the return earned without risk, conventionally represented by short-term government bond yields. It forms the base of CAPM (Rf + risk premium). A and D are risky rates; C is the market return (Rm).
Question 273
What is 'systematic risk' (market risk)?
Select an option first.
Correct answer: B — Risk that affects the entire market or a broad set of assets and cannot be eliminated by diversification (e.g., economic recession, inflation, interest rate changes)
Explanation: Systematic (market) risk affects all companies and cannot be diversified away. Beta (β) measures systematic risk. A is unsystematic (diversifiable) risk; C and D are types of unsystematic risk.
Question 274
What does a 'beta' (β) of 1.0 mean for a stock?
Select an option first.
Correct answer: B — The stock moves exactly in line with the market — its systematic risk is equal to the average market risk
Explanation: Beta measures a stock's sensitivity to market movements. β = 1.0: moves exactly with the market. β > 1: more volatile than market. β < 1: less volatile. β = 0: no correlation with market. A, C and D are incorrect interpretations.
Question 275
If the risk-free rate is 3%, the market return is 8%, and a stock has a beta of 1.5, what is the expected return using CAPM?
Select an option first.
Correct answer: A — 10.5%
Explanation: CAPM: ke = Rf + β × (Rm − Rf) = 3% + 1.5 × (8% − 3%) = 3% + 1.5 × 5% = 3% + 7.5% = 10.5%. B uses β × Rf; C adds β to market return; D is wrong.
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Question 276
What is 'unsystematic risk' (specific or diversifiable risk)?
Select an option first.
Correct answer: B — Company-specific or industry-specific risk that can be eliminated by holding a diversified portfolio of investments
Explanation: Unsystematic risk is unique to a company or industry (e.g., management changes, product recalls, competitor actions). It can be diversified away by holding a broad portfolio. A describes systematic risk; C and D are types of systematic risk.
Question 277
What is the dividend yield on a share?
Select an option first.
Correct answer: B — Annual dividend per share ÷ Current market price per share × 100%
Explanation: Dividend yield = (Dividend per share ÷ Share price) × 100%. It shows the income return (dividend) as a percentage of the share price. A is dividend cover inverted; C is also dividend cover; D is the P/D ratio (not standard).
Question 278
What is meant by 'financial leverage' (or financial gearing)?
Select an option first.
Correct answer: B — Using debt (borrowed capital) to increase potential returns on equity — amplifying both gains and losses
Explanation: Financial leverage means using debt to finance investments. Because debt has fixed interest costs, profits above the interest cost accrue fully to shareholders — amplifying equity returns (and losses if profits fall below interest). A is operating leverage; C is current ratio; D is asset liquidity.
Question 279
What is the 'dividend cover' ratio?
Select an option first.
Correct answer: B — Earnings per share ÷ Dividend per share
Explanation: Dividend cover = EPS ÷ DPS. It shows how many times the dividend is covered by earnings. Cover of 2 means earnings are twice the dividend — relatively safe. Cover of 1 means all earnings are paid out. A is dividend cover inverted (payout ratio); C and D are different ratios.
Question 280
Which of the following is an advantage of equity financing (issuing new shares) over debt financing?
Select an option first.
Correct answer: B — There is no obligation to pay dividends (unlike debt interest), reducing financial risk and financial distress risk
Explanation: Equity advantage: no compulsory payments — dividends are discretionary. This reduces the risk of financial distress. A is an advantage of debt (not equity); C is wrong (equity is usually more expensive due to higher risk); D is wrong (equity gives no guaranteed return).
Question 281
What is a 'rights issue'?
Select an option first.
Correct answer: B — An offer of new shares to existing shareholders in proportion to their existing holdings, usually at a discount to the market price
Explanation: A rights issue gives existing shareholders the right (but not obligation) to buy new shares pro-rata to their current holding, at a discount. A is an IPO; C is a share buyback; D is an employee share plan.
Question 282
What is a 'debenture'?
Select an option first.
Correct answer: B — A long-term debt instrument, typically secured on company assets, paying a fixed interest rate
Explanation: A debenture is a long-term loan to the company, usually secured on specific assets, with a fixed coupon. It is a form of bond/loan stock. A, C and D are incorrect.
Question 283
What is the difference between a 'fixed charge' and a 'floating charge' on company assets?
Select an option first.
Correct answer: B — A fixed charge is attached to specific identified assets (e.g., land); a floating charge 'floats' over all assets of a class until crystallisation (e.g., on default)
Explanation: Fixed charge: specific asset (cannot be sold without lender's consent). Floating charge: covers a class of assets that changes as the company trades (e.g., inventory); crystallises on default. A, C and D are incorrect.
Question 284
What is the difference between 'operating risk' and 'financial risk'?
Select an option first.
Correct answer: B — Operating risk arises from the nature of the business and its cost structure (proportion of fixed vs variable costs); financial risk arises from the use of debt financing
Explanation: Operating risk = business risk from the operating cost structure (high fixed costs → high operating leverage → more volatile operating profit). Financial risk = extra risk from using debt (fixed interest charges). B correctly distinguishes them. A, C and D are wrong.
Question 285
What is 'interest cover' and why does it matter?
Select an option first.
Correct answer: B — EBIT ÷ Interest expense; it indicates how many times a company can cover its interest payments from operating profit — a key measure of financial risk
Explanation: Interest cover = EBIT ÷ Interest. A high ratio (e.g., 5) means comfortable; a low ratio (e.g., 1.5) means the company is close to being unable to service debt. A, C and D are wrong formulas or descriptions.
Question 286
What is the effect of increasing gearing on the earnings per share (EPS) of a profitable company?
Select an option first.
Correct answer: B — If the company earns a return on invested capital exceeding the cost of debt, gearing increases EPS for ordinary shareholders
Explanation: If ROCE > cost of debt, the excess return goes to shareholders: fewer shares outstanding (if debt replaces equity) and/or higher profit per share (interest tax shield). This is the 'financial leverage effect'. A is only true if ROCE < cost of debt; C and D are wrong.
Question 287
What is a 'convertible bond'?
Select an option first.
Correct answer: B — A bond that gives the holder the right to convert it into ordinary shares of the issuing company at a specified price and within a specified period
Explanation: Convertible bonds pay interest like regular bonds but include an option for the holder to convert the bond into shares at a set conversion price. This hybrid instrument is attractive when the company's share price is expected to rise. A and C are incorrect; D describes a foreign currency bond.
Question 288
What is a 'warrant'?
Select an option first.
Correct answer: B — A derivative security giving the holder the right (but not obligation) to buy a specified number of new shares in the company at a fixed price (exercise price) within a specified period
Explanation: A warrant is an option-like instrument allowing purchase of new company shares at a fixed price. Often attached to bonds as a 'sweetener'. A, C and D are incorrect.
Question 289
What does 'market capitalisation' mean?
Select an option first.
Correct answer: B — The total market value of a company's outstanding shares (share price × number of shares)
Explanation: Market capitalisation = Share price × Number of shares in issue. It represents the equity market value of the company. A is book value; C is revenue; D is debt value.
Question 290
What is the 'cost of debt' (kd) for tax purposes?
Select an option first.
Correct answer: B — The pre-tax interest rate adjusted for the tax deductibility of interest: kd(post-tax) = kd(pre-tax) × (1 − tax rate)
Explanation: Because interest on debt is tax-deductible, the effective cost is reduced: kd = pre-tax rate × (1 − T). This makes debt cheaper than its headline rate and contributes to the tax shield benefit of gearing. A ignores tax; C and D are not the cost of debt.
Question 291
What is meant by 'business risk'?
Select an option first.
Correct answer: B — The risk inherent in the type of business and its operating leverage — the variability of operating profit relative to sales (driven by the proportion of fixed costs)
Explanation: Business risk = operational risk from the company's cost structure (high fixed costs create high operating leverage — profit is more volatile with changes in sales). A and D are specific operational risks; C is governance risk.
Question 292
What is the 'equity risk premium' (ERP)?
Select an option first.
Correct answer: B — The additional expected return over and above the risk-free rate required for investing in equity markets — compensation for bearing systematic risk
Explanation: ERP = Rm − Rf. It is the extra return equity investors demand over safe government securities for taking on market risk. A is just Rf; C and D are different premiums.
Question 293
What is a 'retained earnings' as a source of finance?
Select an option first.
Correct answer: B — Profits kept within the business rather than paid out as dividends — an internal source of equity finance
Explanation: Retained earnings are after-tax profits not distributed as dividends, reinvested in the business. They represent the largest source of equity finance for most companies. A, C and D are wrong definitions.
Question 294
Which of the following factors would INCREASE a company's WACC?
Select an option first.
Correct answer: B — A rise in the risk-free rate (Rf), which increases the required return on both equity (ke) and cost of debt (kd)
Explanation: A rise in Rf increases ke (via CAPM) and increases kd. C actually increases WACC (less tax shield) — also a valid answer, but B is most direct. A reduces WACC; D reduces WACC. B is the clearest cause of rising WACC.
Question 295
What is a 'share buyback' (repurchase)?
Select an option first.
Correct answer: B — A company purchasing its own shares from shareholders in the open market, reducing shares outstanding and returning cash to shareholders
Explanation: Share buybacks: company buys back its own shares, reducing the number in issue. This increases EPS (same earnings, fewer shares), return capital to shareholders, and can be used to adjust capital structure. A and C are unrelated; D is a takeover.
Question 296
What effect does a share buyback have on earnings per share (EPS)?
Select an option first.
Correct answer: B — EPS increases because the same total earnings are divided by a smaller number of shares outstanding
Explanation: After a buyback: fewer shares outstanding → same earnings ÷ smaller share count = higher EPS. A, C and D are incorrect (though D has partial logic — the opportunity cost affects NPV of the decision, not the mechanical EPS calculation).
Question 297
What is 'credit risk' in the context of bonds?
Select an option first.
Correct answer: B — The risk that the bond issuer defaults on interest or principal payments
Explanation: Credit risk (default risk) is the risk that the issuer fails to make promised payments. A is inflation risk; C is interest rate (market) risk; D is call risk.
Question 298
What is the Modigliani-Miller (MM) Proposition I (with tax)?
Select an option first.
Correct answer: B — The value of a geared firm equals the value of an equivalent ungeared firm plus the present value of the tax shield on debt (VL = VU + TD)
Explanation: MM with tax Prop I: VL = VU + PV(tax shield) = VU + T × D (assuming perpetual debt). The tax shield has positive value — debt creates value through tax savings. A is MM without tax; C overstates; D is incorrect.
Question 299
According to Modigliani-Miller (MM) without tax, what happens to WACC as gearing increases?
Select an option first.
Correct answer: C — WACC remains constant regardless of gearing level
Explanation: MM without tax: as gearing increases, ke rises to exactly offset the lower cost of cheaper debt, keeping WACC constant. A, B and D describe other theories (traditional view or MM with tax).
Question 300
The 'traditional view' of capital structure argues:
Select an option first.
Correct answer: B — There is an optimal capital structure that minimises WACC (and maximises firm value), after which financial distress costs outweigh the tax shield benefit
Explanation: The traditional view: initially, gearing reduces WACC (cheaper debt replaces equity), but eventually financial distress costs and rising ke cause WACC to rise — creating a U-shaped WACC curve and an optimal gearing level. A is MM (no tax); C is MM (with tax, ignoring distress); D is wrong.
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