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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 331
What are the three main categories of foreign exchange risk faced by companies?
Select an option first.
Correct answer: B — Transaction risk, translation risk, and economic (operating) risk
Explanation: The three types of FX risk: (1) Transaction risk — cash flows from agreed transactions; (2) Translation risk — accounting risk from consolidating foreign currency balances; (3) Economic (operating) risk — long-term impact on competitive position from FX changes. A, C and D are other risk categories.
Question 332
What is 'economic exposure' (also called operating exposure) to foreign exchange risk?
Select an option first.
Correct answer: B — The long-term impact of unexpected exchange rate changes on a company's competitive position, future cash flows, and market value — harder to hedge than transaction risk
Explanation: Economic exposure is the broadest FX risk: how unanticipated FX changes affect the firm's long-run competitive position and value — e.g., exporters becoming uncompetitive if home currency strengthens permanently. A is translation; C and D are transaction risk.
Question 333
A UK company expects to receive $500,000 in 3 months. The spot rate is £1=$1.25 and the 3-month forward rate is £1=$1.27. To hedge using a forward contract, what would the company receive in pounds?
Select an option first.
Correct answer: B — £393,701
Explanation: Using forward: sell $500,000 at £1 = $1.27 → £500,000/1.27 = £393,701. A uses spot rate incorrectly; C inverts; D uses different rate.
Question 334
What is a 'currency option'?
Select an option first.
Correct answer: B — A right (but not obligation) to buy or sell a specified amount of a currency at a predetermined exchange rate on or before a specified date
Explanation: Currency options: the holder has the right (not obligation) to exchange currency at the strike rate. If the market rate is better, the option can be abandoned. A describes a forward; C is correct for forwards; D is a swap.
Question 335
What is the difference between a 'money market hedge' and a 'forward contract' for managing transaction exposure?
Select an option first.
Correct answer: B — A money market hedge uses borrowing and lending in the relevant currencies to lock in an effective exchange rate; a forward contract achieves similar results through a direct agreement with a bank on the future exchange rate
Explanation: A money market hedge replicates the forward rate by borrowing in one currency and investing in another today (using current interest rates). A forward contract achieves the same objective more directly. A and D are oversimplifications; C is wrong.
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Question 336
What is the 'cost of carry' in the context of forward exchange rates?
Select an option first.
Correct answer: B — The interest rate differential between two countries that determines the forward premium or discount, reflecting the carry cost of holding one currency versus another
Explanation: The cost of carry in FX: the forward rate vs spot rate differential is driven by the interest rate differential between the two currencies (interest rate parity). Higher-rate currencies trade at a forward discount; lower-rate currencies at a forward premium. A, C and D are incorrect.
Question 337
Which of the following describes a 'currency swap'?
Select an option first.
Correct answer: B — An agreement between two parties to exchange principal and interest payments in different currencies over a period, effectively converting one currency-denominated loan to another
Explanation: Currency swaps involve exchanging both principal and interest in different currencies — effectively converting a loan from one currency to another. Often used to access cheaper foreign-currency borrowing or to manage long-term currency exposure. A is a FX swap; C is a spot reversal; D is speculation.
Question 338
What is the difference between 'systematic risk' and 'unsystematic risk' in portfolio theory?
Select an option first.
Correct answer: B — Systematic risk is market-wide risk (undiversifiable); unsystematic risk is company or industry-specific (diversifiable through portfolio construction)
Explanation: Portfolio theory: unsystematic risk can be eliminated by diversification (holding many different assets). Systematic risk cannot be diversified away — it affects all assets. Only systematic risk is rewarded by the market (CAPM). A reverses the definition; C is wrong (beta measures only systematic); D is wrong.
Question 339
In portfolio theory, what does a correlation coefficient of −1 between two assets mean?
Select an option first.
Correct answer: B — The assets are perfectly negatively correlated — they move in exactly opposite directions, offering maximum diversification benefit
Explanation: Correlation −1: perfect negative correlation. Combining two perfectly negatively correlated assets can eliminate all portfolio risk (they cancel out). Correlation +1 (A): no diversification benefit. Correlation 0 (C): partial diversification. D is unrelated to correlation.
Question 340
What is the 'efficient frontier' in portfolio theory?
Select an option first.
Correct answer: B — The set of portfolios that offer the maximum possible expected return for any given level of risk (or minimum risk for any given return) — the optimal risk-return combinations
Explanation: The efficient frontier: the curve of optimal portfolios (maximum return for given risk, or minimum risk for given return). Rational investors choose a portfolio on the efficient frontier. A describes dominated portfolios; C is the risk-free asset point; D is the maximum return (one point, not a frontier).
Question 341
What is the 'capital market line' (CML) in CAPM?
Select an option first.
Correct answer: B — A straight line from the risk-free rate, tangent to the efficient frontier of risky assets, showing optimal combinations of the risk-free asset and the market portfolio — measuring return against total risk (standard deviation)
Explanation: The CML: in a CAPM world, all investors hold some combination of the risk-free asset and the market portfolio. The CML shows the risk-return relationship for these combinations, with total risk (σ) on the x-axis. The SML (A/C) uses beta. D is unrelated.
Question 342
What is an interest rate cap?
Select an option first.
Correct answer: B — A financial instrument that sets a maximum interest rate on floating rate debt — if the rate exceeds the cap, the seller compensates the buyer for the excess
Explanation: An interest rate cap: protects a floating-rate borrower by paying the difference if the reference rate (e.g., LIBOR/SOFR) exceeds the cap rate. The borrower's effective maximum rate is the cap rate. A is government policy; C is a fixed-rate loan; D is a floor (opposite).
Question 343
What is an 'interest rate floor'?
Select an option first.
Correct answer: B — An instrument ensuring a minimum interest rate — pays the buyer when the reference rate falls below the floor rate, protecting floating-rate investors/lenders
Explanation: An interest rate floor protects investors (e.g., a bank lending at floating rates) from falling rates. If rates fall below the floor, the buyer receives compensation. A cap (not a floor) protects borrowers. A, C and D are wrong.
Question 344
What is an 'interest rate collar'?
Select an option first.
Correct answer: A — A combined option position using both a cap and a floor — the borrower buys a cap (protecting against rate rises) and sells a floor (sacrificing benefit from rate falls) to reduce the net premium cost
Explanation: An interest rate collar = buying a cap + selling a floor. The premium received from selling the floor partly offsets the cap premium, reducing net hedging cost. The borrower is protected above the cap rate but gives up benefit if rates fall below the floor. B describes a swap; C is a swap; D is a guarantee.
Question 345
What is 'operational gearing' (or operating leverage)?
Select an option first.
Correct answer: B — The sensitivity of operating profit to changes in revenue, driven by the proportion of fixed costs in the cost structure. High fixed costs → high operational gearing → more volatile operating profit
Explanation: Operational gearing = fixed costs / total costs ratio (or Contribution / EBIT). High fixed costs mean a small change in revenue causes a large change in operating profit. A and C describe financial gearing; D is net profit margin.
Question 346
What is the 'combined' (total) leverage effect?
Select an option first.
Correct answer: B — The overall effect on EPS of a change in sales volume, combining both operating leverage (impact on EBIT) and financial leverage (impact of EBIT changes on EPS after fixed interest charges)
Explanation: Total leverage = Operating leverage × Financial leverage. It measures the percentage change in EPS for a given percentage change in sales — a composite of both forms of fixed cost (operating and financial). A and C are partial; D is a ratio not the leverage effect.
Question 347
A company can borrow at 9% fixed or LIBOR + 1% floating. It wants a fixed-rate loan. Another company can borrow at 10% fixed or LIBOR + 0.5% floating and wants a floating-rate loan. Should they enter an interest rate swap?
Select an option first.
Correct answer: B — Yes — the first company has a comparative advantage in fixed-rate markets (1% difference vs 0.5% difference); swapping achieves a net benefit of 0.5% to be shared
Explanation: Company 1 has comparative advantage in fixed (1% cheaper); Company 2 in floating (0.5% cheaper). Total benefit = 1% − 0.5% = 0.5% — split by both parties via a swap. This is the classic comparative advantage in interest rate swaps. A ignores the comparative advantage; C and D are wrong.
Question 348
In the context of the Capital Asset Pricing Model, which of the following CORRECTLY describes a stock with β = 2.0?
Select an option first.
Correct answer: B — The stock is twice as volatile as the market — if the market rises 10%, the stock is expected to rise 20%
Explanation: β = 2.0: the stock moves approximately twice as much as the market in the same direction. 10% market rise → 20% stock rise (expected). A, C and D are wrong (β measures market-relative volatility, not absolute or total volatility).
Question 349
What is 'credit default risk' and how is it managed?
Select an option first.
Correct answer: B — The risk that a borrower defaults on interest or principal payments; managed through credit analysis, diversification, loan covenants, collateral, credit derivatives (e.g., credit default swaps), and credit insurance
Explanation: Credit default risk is the risk of counterparty failure to pay. Management tools: credit analysis (creditworthiness), diversification, covenants, collateral, and CDS contracts transferring default risk to another party. A, C and D are other risk types.
Question 350
What is a 'futures contract' in financial risk management?
Select an option first.
Correct answer: B — A standardised, exchange-traded contract to buy or sell a specified asset (currency, interest rate, commodity) at a set price on a future date — used to hedge or speculate
Explanation: Futures contracts: exchange-traded (standardised), marked to market daily, used for hedging (offsetting underlying risk) or speculation. Differ from forwards (OTC, customised, not marked to market daily). A describes spot; C and D are forwards/swaps.
Question 351
In the context of interest rate risk management, what does 'duration' measure?
Select an option first.
Correct answer: B — The weighted average time to receive all of a bond's cash flows (coupons + principal), reflecting the bond's price sensitivity to interest rate changes — a higher duration = greater price sensitivity
Explanation: Duration (Macaulay duration) measures a bond's weighted average time to cash flows and its price sensitivity to interest rate changes: %ΔPrice ≈ − Duration × Δr/(1+r). A is just maturity (not duration); C and D are wrong.
Question 352
What is the 'net present value of financing effects' in the context of APV?
Select an option first.
Correct answer: B — The combined present value of all financing side effects (primarily the interest tax shield on debt used to finance the project)
Explanation: In APV, the base-case (all-equity) NPV is augmented by the PV of financing benefits, principally the debt tax shield: PV(tax shield) = T × D (for perpetual debt) or discounted annually for finite debt. A, C and D are wrong.
Question 353
Which of the following correctly describes the difference between 'hard' and 'soft' capital rationing?
Select an option first.
Correct answer: B — Hard rationing is an externally imposed restriction on available finance (e.g., markets will not lend more); soft rationing is an internal management decision to limit capital expenditure despite availability of funds
Explanation: Hard capital rationing: external — capital markets restrict access to funds. Soft capital rationing: internal management choice (e.g., maintain target gearing, avoid dilution) to limit investment. A reverses the definitions; C and D are wrong.
Question 354
What is the 'agency problem' in the context of business finance?
Select an option first.
Correct answer: B — The conflict of interest between different stakeholders (principally shareholders and managers, or shareholders and debt holders) where agents (managers) may make decisions that benefit themselves rather than principals (shareholders)
Explanation: The agency problem (Jensen & Meckling): managers (agents) may pursue their own interests (higher salaries, empire-building, reduced effort) at the expense of shareholders (principals). Debt creates an additional agency problem between shareholders and debt holders. A, C and D are not the financial concept.
Question 355
Which of the following is a mechanism used to reduce the agency problem between shareholders and managers?
Select an option first.
Correct answer: B — Performance-related pay tied to shareholder wealth creation (e.g., share options, bonuses linked to TSR), monitoring through the board and auditors, and governance mechanisms
Explanation: Mechanisms to reduce agency costs: (1) performance-linked pay aligning manager and shareholder interests; (2) monitoring (board, auditors, analysts); (3) corporate governance codes. A, C and D do not reduce the agency problem.
Question 356
What does the 'efficient market hypothesis' (EMH) imply for investors and companies?
Select an option first.
Correct answer: B — In an efficient market, share prices fully and rapidly reflect all available information, making it impossible to consistently earn abnormal returns — and implying that capital allocation decisions are made using correct market prices
Explanation: EMH (Fama): weak form (historical prices), semi-strong (public information), strong form (all information including insider). In efficient markets, active management cannot consistently outperform, and prices accurately signal where capital should flow. A and C contradict EMH; D is refuted by semi-strong EMH.
Question 357
A company considering a project in a new industry uses the CAPM and proxy company betas. It finds a proxy company with equity beta 1.4, debt/equity ratio 0.6, and tax rate 20%. What is the asset beta?
Select an option first.
Correct answer: D — 0.93
Explanation: Asset beta (MM with tax): βa = βe × [E/(E+D(1−T))] = 1.4 × [1/(1+0.6×0.8)] = 1.4 × [1/(1+0.48)] = 1.4 × [1/1.48] = 1.4 × 0.676 = 0.946 ≈ 0.94. Closest answer is D (0.93). (Note: exact answer depends on formula version used — ACCA syllabus typically uses simplified formula: βa = βe × E/(E+D(1−T)). Result ≈ 0.945.)
Question 358
What is the purpose of 'loan covenants' in debt financing?
Select an option first.
Correct answer: B — Contractual restrictions placed on the borrower (e.g., minimum interest cover, maximum gearing ratio) that protect debt holders by limiting the company's ability to take actions that would increase default risk
Explanation: Loan covenants restrict borrower behaviour to protect lenders: e.g., maintain certain ratios, limit dividend payments, prevent asset disposal without consent. Breach of covenant may trigger early repayment. A, C and D are wrong.
Question 359
Which of the following is TRUE about the WACC and investment decisions?
Select an option first.
Correct answer: B — WACC is only appropriate as the discount rate for projects with the SAME systematic risk profile as the overall company — for projects with different risk, a risk-adjusted rate is required
Explanation: Using WACC for projects with different risk profiles gives wrong results: riskier projects get undiscounted NPV (too high); safer projects get over-discounted (too low). For different-risk projects, use a project-specific discount rate derived from CAPM with an appropriate beta. A is the common mistake; C and D are wrong.
Question 360
What is the 'Hamada equation' (simplified) used for in CAPM?
Select an option first.
Correct answer: B — To relate geared (equity) beta to ungeared (asset) beta: βe = βa × [1 + (1−T)(D/E)], allowing conversion between levered and unlevered betas to account for financial risk
Explanation: The Hamada equation (simplified, assuming βd = 0): βe = βa × [1 + (1−T)(D/E)]. Ungearing: βa = βe / [1 + (1−T)(D/E)]. Used in project appraisal to ungear a proxy company's beta and regear it to the subject company's capital structure. A, C and D are incorrect uses.
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