AAT L4 Cash & Treasury Management 2 — Questions and Answers
Question 1: A cash flow forecast is prepared to:
- Calculate the depreciation charge for the year
- Predict future cash surpluses and deficits, enabling the business to arrange financing or invest surplus cash in advance (Correct answer)
- Prepare the statutory financial statements
- Determine the tax liability for the period
Correct answer: Predict future cash surpluses and deficits, enabling the business to arrange financing or invest surplus cash in advance
Cash flow forecasts (short-term: weekly/monthly; medium-term: quarterly/annual) predict cash inflows and outflows, enabling management to plan for shortfalls before they occur and optimise the use of surplus cash.
Question 2: Netting in treasury management refers to:
- Using a fishing net to collect physical cash from stores
- Offsetting cash flows between group companies or between a business and counterparties to reduce gross flows and currency exposure (Correct answer)
- Setting off income against expenses in the income statement
- Combining all bank accounts into one net balance for reporting
Correct answer: Offsetting cash flows between group companies or between a business and counterparties to reduce gross flows and currency exposure
Cash netting (or multilateral netting) offsets receipts and payments between group entities or trading counterparties, settling only the net balance — reducing transaction costs, currency conversion costs, and gross credit exposure.
Question 3: The main risk of holding excessive cash in a business is:
- The risk of fraud only
- An opportunity cost — cash is not deployed in value-creating investments and earns only low returns (Correct answer)
- The risk of bank failure
- A tax charge on the cash balance
Correct answer: An opportunity cost — cash is not deployed in value-creating investments and earns only low returns
Holding surplus cash above operational needs incurs an opportunity cost: cash earns minimal returns in a deposit account when it could be invested in higher-return assets or used to reduce expensive debt.
Question 4: A bank overdraft differs from a term loan in that:
- Overdrafts are always cheaper than term loans
- Overdrafts are repayable on demand and fluctuate with daily cash needs; term loans are for fixed amounts over fixed periods (Correct answer)
- Overdrafts cannot be used for working capital
- Term loans are always unsecured
Correct answer: Overdrafts are repayable on demand and fluctuate with daily cash needs; term loans are for fixed amounts over fixed periods
An overdraft is flexible and repayable on demand — it fluctuates with cash flow needs and is suitable for short-term working capital. A term loan is a fixed amount borrowed for a defined period with scheduled repayments.
Question 5: Currency risk in treasury management is managed using instruments such as:
- Interest rate swaps only
- Forward exchange contracts, currency options, and currency swaps (Correct answer)
- Equity derivatives
- Government bonds
Correct answer: Forward exchange contracts, currency options, and currency swaps
Currency (foreign exchange) risk is managed using: forward contracts (locking in a rate), currency options (right but not obligation to exchange), currency swaps (exchanging principal in different currencies), and natural hedging (matching revenues and costs in same currency).
Question 6: The liquidity ratio most focused on highly liquid assets (excluding both inventory AND receivables) is:
- Current ratio
- Quick ratio
- Cash ratio (Correct answer)
- Working capital ratio
Correct answer: Cash ratio
The cash ratio = Cash and cash equivalents / Current liabilities. It is the most stringent short-term liquidity measure, considering only the most immediately liquid assets — cash and near-cash.
AAT L4 Cash & Treasury Management 2
A cash flow forecast is prepared to: