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Section A
Big investment appraisal / cost of capital calculation
Managing interest rate risk
Section B
Managing foreign exchange risk
Capital asset pricing model
Written on quantitative easing
BPP
Role and responsibility towards stakeholders:
Ethical issues continue to appear regularly as an optional discussion question, normally with practical financial issues from elsewhere in the syllabus. The discussion question is normally one of the easier optional questions.
Economic value added and ratio analysis can also be used to appraise the performance of a company.
Advanced investment appraisal:
The compulsory question often features an NPV question with an analysis of risk and/or financing; it could easily be set in the context of an overseas investment.
Cost of capital calculations are regularly tested, make sure that you are comfortable adjusting betas for differences in gearing. Real options are also a popular theme.
Acquisitions and mergers:
This exam normally contains a question involving valuations which the examiner sees as a crucial part of the syllabus; valuations questions are also likely to cover strategic and financing issues.
Corporate reconstruction:
A question could also ask you to evaluate a management buy out i.e. whether a business will be worth more if it splits itself up.
Advanced risk management:
We would expect to see a numerical risk management question featuring either interest rate or exchange rate hedging; currency hedging was tested in June 2011.
Kaplan tips
•Net Present Value – including foreign currency cash flows
•Bond yields and bond values
•Risk adjusted WACC
•Interest rate hedging – options, futures and FRAs
First Intuition
Q1 International investment appraisal techniques focusing on risk management tools such as value at risk
Q2 Impact of WACC following hedging of interest rate risk
Q3 Company valuation-based scenario, possible MBO finance structure
Q4 Adjusted present value with link to real options and Black Scholes option pricing model
Q5 Written question on credit ratings and difficulties of raising debt finance in current credit markets. This could be linked to current challenges faced by Eurozone governments attempting to raise debt capital amidst falling credit ratings
Icount
Overseas Net Present Value
Financing incorporating change in Business Risk
Black Scholes
Corporate failure
Interest rate risk management
ATC
The paper is the level of a Master’s degree in finance. Expect the exam to be academically challenging – after all this is an optional paper and builds upon the foundations set in paper F9 Financial Management. Your existing knowledge will be useful – but will not be sufficient to obtain a pass at this advanced level. From December 2010 there was a new examiner, Shishir Malde. He has stated that he will take a less mathematical approach to finance than his predecessor (Bob Ryan, examiner December 2007 – June 2010). For an idea of Shishir’s style I would recommend the following:
• His P4 sample question on ACCA website
• The December 2010 and June 2011 exams
• “Old” syllabus paper 3.7 exam papers. Shish was assessor for paper 3.7 and has referred to the style of its examiner (Scott Goddard) as relevant http://www.accaglobal.com/students/acca/exams/professional_scheme/part3/paper3_7/exam_papers_professional/standard
Key areas of the syllabus:
• Role and responsibility towards stakeholders
• Domestic and international investment decisions
• Mergers and acquisitions
• Corporate re-organisation strategies
• Advanced treasury and risk management techniques
• Impact of macro economics and international financial institutions
• Emerging issues in finance and financial management
The whole syllabus is examinable but too large and detailed to be tested in a 3-hour paper. It would be tempting to try and predict what will be tested but this would be a dangerous
strategy. Be particularly careful if you missed paper F9 – you must fill any gaps in your knowledge e.g. regarding cost of capital calculations. You don’t need to buy the F9 materials, just refer to ATC International’s P4 study system (sessions 2-4)
The two compulsory questions in section A of the exam will cover significant issues relevant to the senior financial manager and each will be set in the form of a case study and contain a mix of computational and discursive elements. Candidates may be asked to provide answers in a specified form such as a short report or board memorandum – professional marks will be available. Section B questions are designed to provide a more focused test of the syllabus. One question in section B will be wholly discursive
Candidates will be provided with a formulae sheet as well as present value, annuity and standard normal distribution tables. The normal distribution tables may be required for:
• the Black Scholes option pricing model (and variants upon it),
• estimation of the probability of default on corporate debt,
• the calculation of VaR (Value at Risk).
Candidates are advised to bring a scientific calculator – logarithms and exponential constants are required for the Black Scholes model.
Relevant articles:
• “Risk management” – in which the new examiner discusses whether firms should hedge their risks.
• “Toxic assets” – which discusses the nature of CDO’s (Collateralized Debt Obligations)
• “How lenders set their rates” – which covers structural debt models i.e. analysing the level and volatility of assets (or, even better, cash) to estimate the probability of default on corporate debt and hence to calculate the appropriate credit spread for the firm.
• “Modified Internal Rate of Return” – which addresses a limitation of traditional IRR in assuming that project returns can be reinvested at the IRR itself. MIRR makes the more realistic assumption that project returns can be reinvested at the firm’s hurdle rate i.e. cost of capital.
• “Application of option pricing to valuation of firms” – which explains how Robert Merton applies the Black Scholes Model to value the equity of firms that cannot be easily valued using traditional Free Cash Flow models e.g. high growth start-ups or firms at risk of default. Merton views equity investors as having a call option over the firm’s assets, with the exercise price and time to expiry being the redemption value and time to maturity of the firm’s liabilities.
In the traditional manufacturing sector the assets tend to be higher than liabilities and the option has significant intrinsic value – hence investors have a lot to lose and are risk averse, as assumed in traditional finance theory. However in the banking sector assets tend to be close to liabilities, hence investors have little to lose and encourage excessive risk taking by the bank’s employees (themselves driven by large potential bonuses). If the gamble pays off the assets rise above liabilities and the investors take a large gain, if the gamble fails they walk away under the protection of limited liability.
Exam Tips
• Be sure to practice calculations on the Black Scholes model – although the formulae are provided the abbreviations must be memorized and some skill is required to crunch the numbers under time pressure. Also be prepared to use the Black Scholes model to value options embedded within company projects – Real Options Pricing Theory.
• Be aware of what is going on in the world economy – read quality newspapers such as http://www.cfo.com/ and http://www.economist.com
• Be aware of the rise (and recent fall) in securitisation and credit derivatives Debt can be packaged and resold as Mortgage Backed Securities (MBS), these can then be chopped up into different “tranches” of risk known as Collateralised Debt Obligations (CDO), the holder of the CDO can then use a credit default swap (CDS) to transfer that risk onwards. Risk can be packaged, repackaged and transferred – but does not disappear, as the global financial crises has shown (although quality press such as “The Economist” had been warning for many years of the dangers of securitisation and credit derivatives, particularly when combined with a property bubble).
• One of the banker’s trusted tools was VaR (Value at Risk) – the potential loss in value of a portfolio at a given level of confidence. The financial crisis has exposed the limitations of VaR – (i) actual volatility of asset prices turned out to be much higher than during recent history (ii) in times of crisis the correlation between asset classes becomes high, reducing the benefits of diversification (iii) VaR modelling was based on the assumption that returns follow the “bell shape” of the normal distribution, in the real world returns are more likely to follow a distribution with “fat tails” i.e. large price falls (and rises) occur more frequently than predicted by the normal distribution. Calculation of VaR was examined in December 2009 – the discussion above puts it into the context of the global financial crisis.
Exam Technique:
• Do not try to pass the exam by only performing calculations (or by only making discussion). Balance your time according to the mark allocations.
• In calculations show your workings and write your assumptions. In an exam at this level there will rarely be a unique “correct” answer, particularly in subjective areas such as business valuation. The examiner and his marking team are flexible – just show them that you can make a reasonable attempt and they will be sympathetic – perfection is not expected
• When asked to comment upon your calculations do not be afraid to do so even if you think your calculations contain errors – you can still get maximum marks for comments. If you could not perform the required calculation then write an assumed result and comment upon that.
• Structure your comments using sub-headings and bullet points (but write a full sentence after each bullet). If asked for a report format then obviously be more formal i.e. introduction, main body, conclusion, appendix – but bullet points can still be used within the report to keep clarity.
• Do not throw away the professional marks available in section A
• Give real life examples where appropriate to support your comments – extra marks may be awarded
• Generous marks are often available in requirements (a), (b) for performing relatively straightforward calculations (e.g. estimating WACC) or basic discussion (e.g. suggesting various sources of debt finance). Later requirements may ask for something very complex – but only for a few marks. If you pick up the easier marks where available and at least make an attempt at the more complex parts then you will be awarded a pass.
EXP
Paper P4 December 2011 Exam Tips:The paper is very time-pressured. This means that to do well one needs to exercise good time management and to start every question in order to score marks quickly (remember, the law of diminishing returns applies to the accumulation of marks).Also make sure to answer the discursive parts of questions with full substantive answers which correspond to the questions. Read the questions carefully.The areas covered range right across the syllabus. Do not try to anticipate what will or will not be covered. Be prepared to tackle any topic. Be sure to cover qualitative topics, such as corporate governance models and an understanding of the CFO’s role in the corporation. Don’t forget environmental and ethics themes as well. Discursive answers earn marks as well!Clear presentation wins marks: Be organisedin your answer. Remember that Professional-level papers award “professional marks” which are given based on the presentational aspects of an answer (such as a report, letter or memo). Attention to such aspects can yield valuable additional marks.As a checklist of topics, make sure you are comfortable working with the following areas :
• International investment appraisal decisions: This means not only NPVand IRR(and MIRR) calculations, but also determining projected foreign exchange rates and making mangerialdecisions regarding investments based on strategic, ethical and non-financial factors);
• Capital structure: The relationship between risk and return, and expressing this via equity/asset betas, using CAPM, calculating WACCand understanding the treatment of business/financial risks –in other words, Paper F9is assumed knowledge!;
• Valuations: This means not only DCFcalculations, but also understanding the strategic/qualitative arguments behind making a bid for another company in an M&A-type situation, including financing considerations;
• Understanding Black-Scholesremains relevant, particularly in the context of using real options when analyzing projects;
• Reconstruction/Reorganisationschemes: Make sure you adhere to a standard approach in tackling such questions. It is too late to think about general approach to such questions when you are already in the exam;
• Economic Value Added: Check the ACCAwebsite for the technical article treating this subject to an exam standard;
• Financial hedging: Derivatives are almost certain to appear in some form, possibly as part of a larger question touching on different topics of the syllabus; make sure you have the “ground-rules” worked out in what hedging strategy to adopt if a company is long/short a currency or a borrower/depositor in the interest rate market.
• Also, the current crisis in finance continues to provide many possibilities for new questions. Be sure to checkout the ACCAtechnical articles written for P4during the last year.
Section A
Big investment appraisal / cost of capital calculation
Managing interest rate risk
Section B
Managing foreign exchange risk
Capital asset pricing model
Written on quantitative easing
BPP
Role and responsibility towards stakeholders:
Ethical issues continue to appear regularly as an optional discussion question, normally with practical financial issues from elsewhere in the syllabus. The discussion question is normally one of the easier optional questions.
Economic value added and ratio analysis can also be used to appraise the performance of a company.
Advanced investment appraisal:
The compulsory question often features an NPV question with an analysis of risk and/or financing; it could easily be set in the context of an overseas investment.
Cost of capital calculations are regularly tested, make sure that you are comfortable adjusting betas for differences in gearing. Real options are also a popular theme.
Acquisitions and mergers:
This exam normally contains a question involving valuations which the examiner sees as a crucial part of the syllabus; valuations questions are also likely to cover strategic and financing issues.
Corporate reconstruction:
A question could also ask you to evaluate a management buy out i.e. whether a business will be worth more if it splits itself up.
Advanced risk management:
We would expect to see a numerical risk management question featuring either interest rate or exchange rate hedging; currency hedging was tested in June 2011.
Kaplan tips
•Net Present Value – including foreign currency cash flows
•Bond yields and bond values
•Risk adjusted WACC
•Interest rate hedging – options, futures and FRAs
First Intuition
Q1 International investment appraisal techniques focusing on risk management tools such as value at risk
Q2 Impact of WACC following hedging of interest rate risk
Q3 Company valuation-based scenario, possible MBO finance structure
Q4 Adjusted present value with link to real options and Black Scholes option pricing model
Q5 Written question on credit ratings and difficulties of raising debt finance in current credit markets. This could be linked to current challenges faced by Eurozone governments attempting to raise debt capital amidst falling credit ratings
Icount
Overseas Net Present Value
Financing incorporating change in Business Risk
Black Scholes
Corporate failure
Interest rate risk management
ATC
The paper is the level of a Master’s degree in finance. Expect the exam to be academically challenging – after all this is an optional paper and builds upon the foundations set in paper F9 Financial Management. Your existing knowledge will be useful – but will not be sufficient to obtain a pass at this advanced level. From December 2010 there was a new examiner, Shishir Malde. He has stated that he will take a less mathematical approach to finance than his predecessor (Bob Ryan, examiner December 2007 – June 2010). For an idea of Shishir’s style I would recommend the following:
• His P4 sample question on ACCA website
• The December 2010 and June 2011 exams
• “Old” syllabus paper 3.7 exam papers. Shish was assessor for paper 3.7 and has referred to the style of its examiner (Scott Goddard) as relevant http://www.accaglobal.com/students/acca/exams/professional_scheme/part3/paper3_7/exam_papers_professional/standard
Key areas of the syllabus:
• Role and responsibility towards stakeholders
• Domestic and international investment decisions
• Mergers and acquisitions
• Corporate re-organisation strategies
• Advanced treasury and risk management techniques
• Impact of macro economics and international financial institutions
• Emerging issues in finance and financial management
The whole syllabus is examinable but too large and detailed to be tested in a 3-hour paper. It would be tempting to try and predict what will be tested but this would be a dangerous
strategy. Be particularly careful if you missed paper F9 – you must fill any gaps in your knowledge e.g. regarding cost of capital calculations. You don’t need to buy the F9 materials, just refer to ATC International’s P4 study system (sessions 2-4)
The two compulsory questions in section A of the exam will cover significant issues relevant to the senior financial manager and each will be set in the form of a case study and contain a mix of computational and discursive elements. Candidates may be asked to provide answers in a specified form such as a short report or board memorandum – professional marks will be available. Section B questions are designed to provide a more focused test of the syllabus. One question in section B will be wholly discursive
Candidates will be provided with a formulae sheet as well as present value, annuity and standard normal distribution tables. The normal distribution tables may be required for:
• the Black Scholes option pricing model (and variants upon it),
• estimation of the probability of default on corporate debt,
• the calculation of VaR (Value at Risk).
Candidates are advised to bring a scientific calculator – logarithms and exponential constants are required for the Black Scholes model.
Relevant articles:
• “Risk management” – in which the new examiner discusses whether firms should hedge their risks.
• “Toxic assets” – which discusses the nature of CDO’s (Collateralized Debt Obligations)
• “How lenders set their rates” – which covers structural debt models i.e. analysing the level and volatility of assets (or, even better, cash) to estimate the probability of default on corporate debt and hence to calculate the appropriate credit spread for the firm.
• “Modified Internal Rate of Return” – which addresses a limitation of traditional IRR in assuming that project returns can be reinvested at the IRR itself. MIRR makes the more realistic assumption that project returns can be reinvested at the firm’s hurdle rate i.e. cost of capital.
• “Application of option pricing to valuation of firms” – which explains how Robert Merton applies the Black Scholes Model to value the equity of firms that cannot be easily valued using traditional Free Cash Flow models e.g. high growth start-ups or firms at risk of default. Merton views equity investors as having a call option over the firm’s assets, with the exercise price and time to expiry being the redemption value and time to maturity of the firm’s liabilities.
In the traditional manufacturing sector the assets tend to be higher than liabilities and the option has significant intrinsic value – hence investors have a lot to lose and are risk averse, as assumed in traditional finance theory. However in the banking sector assets tend to be close to liabilities, hence investors have little to lose and encourage excessive risk taking by the bank’s employees (themselves driven by large potential bonuses). If the gamble pays off the assets rise above liabilities and the investors take a large gain, if the gamble fails they walk away under the protection of limited liability.
Exam Tips
• Be sure to practice calculations on the Black Scholes model – although the formulae are provided the abbreviations must be memorized and some skill is required to crunch the numbers under time pressure. Also be prepared to use the Black Scholes model to value options embedded within company projects – Real Options Pricing Theory.
• Be aware of what is going on in the world economy – read quality newspapers such as http://www.cfo.com/ and http://www.economist.com
• Be aware of the rise (and recent fall) in securitisation and credit derivatives Debt can be packaged and resold as Mortgage Backed Securities (MBS), these can then be chopped up into different “tranches” of risk known as Collateralised Debt Obligations (CDO), the holder of the CDO can then use a credit default swap (CDS) to transfer that risk onwards. Risk can be packaged, repackaged and transferred – but does not disappear, as the global financial crises has shown (although quality press such as “The Economist” had been warning for many years of the dangers of securitisation and credit derivatives, particularly when combined with a property bubble).
• One of the banker’s trusted tools was VaR (Value at Risk) – the potential loss in value of a portfolio at a given level of confidence. The financial crisis has exposed the limitations of VaR – (i) actual volatility of asset prices turned out to be much higher than during recent history (ii) in times of crisis the correlation between asset classes becomes high, reducing the benefits of diversification (iii) VaR modelling was based on the assumption that returns follow the “bell shape” of the normal distribution, in the real world returns are more likely to follow a distribution with “fat tails” i.e. large price falls (and rises) occur more frequently than predicted by the normal distribution. Calculation of VaR was examined in December 2009 – the discussion above puts it into the context of the global financial crisis.
Exam Technique:
• Do not try to pass the exam by only performing calculations (or by only making discussion). Balance your time according to the mark allocations.
• In calculations show your workings and write your assumptions. In an exam at this level there will rarely be a unique “correct” answer, particularly in subjective areas such as business valuation. The examiner and his marking team are flexible – just show them that you can make a reasonable attempt and they will be sympathetic – perfection is not expected
• When asked to comment upon your calculations do not be afraid to do so even if you think your calculations contain errors – you can still get maximum marks for comments. If you could not perform the required calculation then write an assumed result and comment upon that.
• Structure your comments using sub-headings and bullet points (but write a full sentence after each bullet). If asked for a report format then obviously be more formal i.e. introduction, main body, conclusion, appendix – but bullet points can still be used within the report to keep clarity.
• Do not throw away the professional marks available in section A
• Give real life examples where appropriate to support your comments – extra marks may be awarded
• Generous marks are often available in requirements (a), (b) for performing relatively straightforward calculations (e.g. estimating WACC) or basic discussion (e.g. suggesting various sources of debt finance). Later requirements may ask for something very complex – but only for a few marks. If you pick up the easier marks where available and at least make an attempt at the more complex parts then you will be awarded a pass.
EXP
Paper P4 December 2011 Exam Tips:The paper is very time-pressured. This means that to do well one needs to exercise good time management and to start every question in order to score marks quickly (remember, the law of diminishing returns applies to the accumulation of marks).Also make sure to answer the discursive parts of questions with full substantive answers which correspond to the questions. Read the questions carefully.The areas covered range right across the syllabus. Do not try to anticipate what will or will not be covered. Be prepared to tackle any topic. Be sure to cover qualitative topics, such as corporate governance models and an understanding of the CFO’s role in the corporation. Don’t forget environmental and ethics themes as well. Discursive answers earn marks as well!Clear presentation wins marks: Be organisedin your answer. Remember that Professional-level papers award “professional marks” which are given based on the presentational aspects of an answer (such as a report, letter or memo). Attention to such aspects can yield valuable additional marks.As a checklist of topics, make sure you are comfortable working with the following areas :
• International investment appraisal decisions: This means not only NPVand IRR(and MIRR) calculations, but also determining projected foreign exchange rates and making mangerialdecisions regarding investments based on strategic, ethical and non-financial factors);
• Capital structure: The relationship between risk and return, and expressing this via equity/asset betas, using CAPM, calculating WACCand understanding the treatment of business/financial risks –in other words, Paper F9is assumed knowledge!;
• Valuations: This means not only DCFcalculations, but also understanding the strategic/qualitative arguments behind making a bid for another company in an M&A-type situation, including financing considerations;
• Understanding Black-Scholesremains relevant, particularly in the context of using real options when analyzing projects;
• Reconstruction/Reorganisationschemes: Make sure you adhere to a standard approach in tackling such questions. It is too late to think about general approach to such questions when you are already in the exam;
• Economic Value Added: Check the ACCAwebsite for the technical article treating this subject to an exam standard;
• Financial hedging: Derivatives are almost certain to appear in some form, possibly as part of a larger question touching on different topics of the syllabus; make sure you have the “ground-rules” worked out in what hedging strategy to adopt if a company is long/short a currency or a borrower/depositor in the interest rate market.
• Also, the current crisis in finance continues to provide many possibilities for new questions. Be sure to checkout the ACCAtechnical articles written for P4during the last year.
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