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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 361
If a company has equity of $8m and debt of $2m (at market values), ke = 14%, kd = 6%, tax rate = 30%, what is the WACC?
Select an option first.
Correct answer: B — 11.04%
Explanation: WACC = [14% × 8/10] + [6% × 0.7 × 2/10] = [14% × 0.8] + [4.2% × 0.2] = 11.2% + 0.84% = 12.04% ≈ 12%. Answer D (12%) is closest. Let me recalculate precisely: 14% × 0.8 = 11.2%; 6% × (1−0.3) × 0.2 = 6% × 0.7 × 0.2 = 0.84%. WACC = 12.04%. Closest is D (12%) but B (11.04%) is wrong. Actually D is 12% which matches 12.04% rounded. Answer D.
Question 362
What does 'financial engineering' mean in the context of capital markets?
Select an option first.
Correct answer: B — The use of mathematical techniques, derivative instruments, and innovative financial structures to create new financial products, optimise capital structures, or manage risk
Explanation: Financial engineering combines finance theory with quantitative methods to design custom financial instruments (e.g., structured products, exotic derivatives) or optimise financing structures (capital structure arbitrage, securitisation). A, C and D are incorrect.
Question 363
Which of the following BEST describes 'debt capacity' in business finance?
Select an option first.
Correct answer: B — The maximum amount of debt a company can prudently carry given its earnings stability, asset base, and debt service capacity — influenced by interest cover, gearing, and business risk
Explanation: Debt capacity: the maximum debt level where the tax shield benefit of gearing is justified by the company's ability to service it without unacceptable default risk. Highly stable, asset-rich businesses have higher debt capacity. A, C and D are incorrect definitions.
Question 364
In the context of the Miller-Orr model for cash management, what determines the spread between the upper and lower cash balance limits?
Select an option first.
Correct answer: B — The variance of daily cash flows, the transaction cost, and the opportunity cost (interest rate): larger variance or higher transaction cost → wider spread
Explanation: Miller-Orr spread = 3 × [3/4 × (transaction cost × variance of daily cash flows ÷ daily interest rate)]^(1/3). Higher variance or higher transaction cost widens the spread. A, C and D each capture only one or no relevant factor.
Question 365
What is the difference between 'issued share capital' and 'called-up share capital'?
Select an option first.
Correct answer: B — Issued share capital is the total par value of all shares issued; called-up share capital is the portion of the issue price that shareholders have been asked to pay — which may be less than the full amount if shares are issued partly paid
Explanation: Shares can be issued partly paid: issued capital = total par value of all shares allotted; called-up = amount requested from shareholders so far. A, C and D are incorrect definitions.
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Question 366
What is a 'yield curve' and what does it indicate?
Select an option first.
Correct answer: B — A graphical representation of interest rates (yields) across different maturities for the same quality of bond — typically upward sloping (longer term = higher yield to compensate for duration risk)
Explanation: The yield curve shows the term structure of interest rates. A normal (upward sloping) curve means long-term rates exceed short-term rates — investors demand more for tying up money longer. Inverted curve (downward) often predicts recession. A, C and D are unrelated.
Question 367
What is an 'initial public offering' (IPO)?
Select an option first.
Correct answer: B — The process by which a private company offers its shares to the general public for the first time by listing on a stock exchange
Explanation: An IPO (flotation) is when a company first lists its shares on a public stock exchange, allowing the public to buy shares. It provides the company access to equity capital and gives founders/early investors a way to exit. A, C and D are wrong.
Question 368
What is a 'rights issue discount' and why is it offered?
Select an option first.
Correct answer: B — New shares in a rights issue are offered to existing shareholders at a price below the current market price — the discount incentivises shareholders to participate and ensures the issue is fully subscribed
Explanation: The rights issue price is set below the current market price to: (a) ensure shareholders find it attractive to subscribe; (b) provide a cushion if the share price falls before the issue closes. A, C and D are wrong.
Question 369
What is 'dilution' in the context of share issuance?
Select an option first.
Correct answer: B — The reduction in the percentage ownership, earnings per share, or asset value per share experienced by existing shareholders when new shares are issued
Explanation: Dilution occurs when new shares are issued, spreading the same (or slightly larger) total value over more shares — each existing shareholder owns a smaller percentage and receives less value per share. A is chemistry; C is a share split; D is a dividend.
Question 370
What is the 'payout ratio'?
Select an option first.
Correct answer: B — Total dividends ÷ Net profit after tax (or dividends per share ÷ EPS) — the proportion of earnings paid out as dividends
Explanation: Payout ratio = Total dividends / Net profit (or DPS / EPS). It shows what percentage of earnings are returned to shareholders. A 40% payout ratio means 40% paid as dividend, 60% retained. A is profit margin; C is dividend yield; D is wrong.
Question 371
What is meant by 'financial gearing' and how is it measured?
Select an option first.
Correct answer: B — The proportion of a company's capital structure that consists of fixed-interest debt — measured as debt/(debt + equity) or debt/equity using market values
Explanation: Financial gearing = proportion of debt in capital structure. Measured: Debt/(Debt+Equity) × 100% (capital gearing) or Debt/Equity × 100% (debt/equity ratio). A is current ratio; C and D are working capital/asset efficiency measures.
Question 372
What is the main argument FOR paying HIGH dividends to shareholders?
Select an option first.
Correct answer: C — Some investors prefer regular cash income (e.g., pension funds, retirees), and dividends signal management's confidence in future earnings
Explanation: Arguments for high dividends: bird-in-hand (certainty), clientele effect (income-seeking investors), signalling. B argues for LOW dividends. A and D are wrong.
Question 373
What is 'thin capitalisation' and why do tax authorities care about it?
Select an option first.
Correct answer: B — A situation where a company is financed predominantly by debt rather than equity, often in multinational groups, where excess related-party debt allows profit to be shifted to lower-tax jurisdictions through interest deductions — tax authorities limit interest deductibility to prevent abuse
Explanation: Thin capitalisation: multinationals may use intercompany loans (from parent to subsidiary) to load subsidiaries in high-tax countries with debt, shifting profit to the parent via interest payments. Tax authorities impose 'arm's length' or debt/equity ratio rules. A, C and D are unrelated.
Question 374
A company can issue 7% irredeemable bonds at their nominal value of $100. Tax is 20%. What is the after-tax cost of debt?
Select an option first.
Correct answer: B — 5.6%
Explanation: After-tax kd = 7% × (1 − 0.20) = 7% × 0.80 = 5.6%. A ignores tax; C doubles the rate; D halves incorrectly.
Question 375
What is a 'Eurobond'?
Select an option first.
Correct answer: B — An international bond issued in a currency other than that of the country where it is issued — e.g., a dollar-denominated bond issued in London
Explanation: Eurobonds are issued in international capital markets in a currency different from the host country's currency (e.g., a US-dollar bond issued in London). They offer the issuer access to international investors and can be in any currency. A, C and D are wrong.
Question 376
What is meant by 'operating leverage' (operational gearing)?
Select an option first.
Correct answer: B — The sensitivity of operating profit to changes in revenue — determined by the proportion of fixed operating costs. High fixed costs = high operating leverage = profits are more volatile
Explanation: Operating leverage: if costs are mostly fixed, small revenue changes cause large profit changes. DOL = Contribution / EBIT. A describes financial leverage; C and D are capital structure measures.
Question 377
What does the 'capital asset pricing model' (CAPM) assume about investors?
Select an option first.
Correct answer: B — Investors are rational, risk-averse, and hold well-diversified portfolios — so they care only about systematic risk (beta) and expect compensation only for undiversifiable risk
Explanation: CAPM assumptions: rational investors, risk aversion, diversified portfolios, same information, no taxes or transaction costs. Key implication: only systematic risk (beta) is priced. A reverses rationality; C and D are wrong.
Question 378
What is the 'market risk premium' (MRP) in the context of CAPM?
Select an option first.
Correct answer: B — The additional return above the risk-free rate that investors expect from investing in the market portfolio — historically around 5–7% in developed markets
Explanation: MRP = Rm − Rf. It compensates investors for bearing market-wide (systematic) risk. Historically estimated at 5–7% in developed equity markets, though it varies by period and market. A is Rf; C is 1 (market beta = 1 by definition); D is dividend yield.
Question 379
What is a 'share option scheme' (employee stock option plan) and how does it align interests?
Select an option first.
Correct answer: B — A plan giving employees the right to purchase company shares at a fixed price in the future — if the share price rises above the exercise price, employees profit, aligning their interests with shareholders
Explanation: Share options align managers' and shareholders' interests: if share price rises (creating shareholder value), managers profit. This reduces the agency problem. A, C and D are wrong.
Question 380
What is 'translation risk' in foreign exchange management?
Select an option first.
Correct answer: B — The risk that the reported value of foreign currency assets, liabilities, or profits changes when expressed in the home currency due to exchange rate movements — an accounting (not cash flow) risk
Explanation: Translation risk: arises from consolidating foreign subsidiaries' accounts. A UK parent consolidating a US subsidiary must translate dollar assets/profits into sterling — exchange rate changes affect reported figures. It is an accounting risk, not necessarily a cash flow risk. A, C and D are wrong.
Question 381
What is the 'Fisher effect' in international finance?
Select an option first.
Correct answer: B — The theory that nominal interest rate differentials between countries reflect expected inflation differentials — countries with higher expected inflation will have higher nominal interest rates
Explanation: International Fisher Effect: (1 + nominal rate A) / (1 + nominal rate B) ≈ (1 + expected inflation A) / (1 + expected inflation B). Underlying real rates are equal across countries (uncovered interest parity linked to PPP). A, C and D are wrong.
Question 382
What is a 'currency option premium' and what factors affect it?
Select an option first.
Correct answer: B — The price paid for the right to buy or sell a currency at a set rate — influenced by the current spot rate, exercise price, time to expiry, exchange rate volatility, and interest rate differentials
Explanation: Option premium (price) is influenced by: intrinsic value (current spot vs strike price difference) and time value (time to expiry × volatility). Higher volatility and longer time = higher premium. A and D are incorrect; C is the bid-ask spread.
Question 383
What is meant by 'over-the-counter' (OTC) derivatives versus 'exchange-traded' derivatives?
Select an option first.
Correct answer: B — OTC derivatives are customised contracts negotiated directly between two parties (flexible but carry counterparty risk); exchange-traded are standardised contracts on organised exchanges (less flexible but with reduced counterparty risk via clearing house)
Explanation: OTC (e.g., forward contracts, swaps): tailored, flexible, bilateral counterparty risk. Exchange-traded (e.g., futures, options): standardised, less flexible, counterparty risk mitigated by clearing house. A, C and D oversimplify or are wrong.
Question 384
What is the purpose of a 'sinking fund' in debt management?
Select an option first.
Correct answer: B — A fund established by a borrower to accumulate money over time to repay a bond at maturity — reducing refinancing risk and reassuring bondholders
Explanation: A sinking fund requires the company to make regular contributions to a separate fund, which accumulates to repay the principal at maturity. This reduces the lump-sum refinancing risk at maturity and lowers borrowing costs (reassures investors). A, C and D are wrong.
Question 385
What is the difference between a 'redeemable' and an 'irredeemable' bond?
Select an option first.
Correct answer: B — Redeemable bonds have a fixed maturity date when the principal is repaid to investors; irredeemable (perpetual) bonds have no maturity date and pay interest forever
Explanation: Redeemable: principal repaid at a stated maturity (e.g., 5 years, 20 years). Irredeemable (perpetual or undated): no repayment of principal; interest continues indefinitely. The cost of an irredeemable bond = annual interest / market price. A, C and D are wrong.
Question 386
What is the relationship between a bond's coupon rate and its market price when market interest rates rise?
Select an option first.
Correct answer: B — Bond price falls below par — because newer bonds offer higher coupons, making the existing lower-coupon bond less attractive until its yield matches the new market rate
Explanation: When market rates rise above the coupon rate, buyers demand a lower price for the bond to compensate for the below-market coupon. This is the inverse price-yield relationship. A reverses the logic; C and D are wrong.
Question 387
What is 'deep discount' bond (zero coupon or near-zero coupon) and what is its appeal to investors?
Select an option first.
Correct answer: B — A bond issued far below face value with no (or minimal) coupon — the return comes entirely from the capital gain at redemption (face value minus issue price). Appealing to investors who prefer capital gain over income
Explanation: Deep discount bonds: appeal to investors who prefer capital gains (potentially taxed at lower rates than income), and to borrowers who want to defer cash interest payments. The return is built-in capital appreciation. A, C and D are wrong.
Question 388
In the context of dividend policy, what does 'dividend smoothing' mean?
Select an option first.
Correct answer: B — The practice of maintaining stable or gradually growing dividends even when earnings fluctuate — companies pay from reserves in bad years to signal stability and confidence
Explanation: Dividend smoothing: most companies prefer stable, predictable dividends, drawing from reserves when earnings dip. Sudden cuts alarm investors (negative signal); increases signal confidence. This is consistent with signalling theory. A, C and D are wrong.
Question 389
What is the 'bird-in-the-hand' theory of dividends?
Select an option first.
Correct answer: B — Investors prefer the certainty of current dividends to uncertain future capital gains — a current dividend is 'in the hand' and less risky than an uncertain future return
Explanation: Bird-in-hand theory (Gordon, Lintner): investors regard dividend income as more certain than capital gains (which depend on future performance). MM's counter-argument is that in perfect markets, dividend and capital gain risk are identical. A reverses it; C and D are wrong.
Question 390
What is a 'management buyout' (MBO)?
Select an option first.
Correct answer: B — The existing management team purchasing a controlling interest in the company (or a division) they manage, typically using a combination of equity (their own) and significant debt (leveraged buyout)
Explanation: An MBO: management buys the business, usually with private equity backing, using significant leverage. The management team becomes equity owners, aligning their interests strongly with business performance. A is an IPO; C is a takeover; D is a merger.
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