ACCA Advanced Financial Management 2 — Questions and Answers
Question 1: A US company expects to receive GBP 500,000 in three months. To hedge this currency exposure using a forward contract, the company should:
- Buy GBP three-month forward
- Sell GBP three-month forward (Correct answer)
- Buy USD three-month forward
- Enter a GBP futures contract as a buyer
Correct answer: Sell GBP three-month forward
The company will receive GBP and needs to convert to USD, so it should lock in today's rate by selling GBP (buying USD) forward for delivery in three months.
Question 2: Which of the following best describes an interest rate swap?
- An agreement where two parties exchange fixed-rate interest obligations for floating-rate obligations on notional principal (Correct answer)
- A contract granting the right, but not the obligation, to borrow at a specified fixed rate
- A derivative instrument that pays the spread between two reference rates in cash
- A commitment to lend funds at a future date at an interest rate agreed today
Correct answer: An agreement where two parties exchange fixed-rate interest obligations for floating-rate obligations on notional principal
In a plain vanilla interest rate swap, one party pays fixed and receives floating (or vice versa) on a notional principal amount, without exchanging the principal itself.
Question 3: Interest rate futures are quoted as 100 minus the interest rate. If a futures price falls from 95.20 to 94.70, this implies:
- Interest rates have fallen by 0.50%
- Interest rates have risen by 0.50% (Correct answer)
- The hedge position has produced a profit for a borrower who sold futures
- The implied rate has moved from 5.20% to 4.70%
Correct answer: Interest rates have risen by 0.50%
A fall in the futures price from 95.20 to 94.70 means the implied interest rate rose from 4.80% to 5.30%, increasing borrowing costs.
Question 4: The 'duration' of a bond is most accurately described as:
- The number of years remaining until the bond matures
- The weighted average time to receipt of all cash flows, used to measure sensitivity to interest rate changes (Correct answer)
- The period needed to recover the bond's purchase price from coupon income alone
- The correlation coefficient between the bond's return and benchmark returns
Correct answer: The weighted average time to receipt of all cash flows, used to measure sensitivity to interest rate changes
Duration weights each cash flow by the time of receipt relative to price, giving a single measure that approximates how much a bond's price changes for a 1% change in yield.
Question 5: Which hedging instrument allows a company to benefit from a favorable exchange rate movement while still providing protection against adverse movements?
- Forward exchange contract
- Currency futures contract
- Currency option (Correct answer)
- Money market hedge
Correct answer: Currency option
A currency option gives the holder the right but not the obligation to transact at the strike rate, so if the market rate is better than the strike, the option is abandoned and the better rate is taken.
Question 6: When a company's treasury function operates as a 'profit center,' this means that:
- The treasury focuses exclusively on minimizing financing costs with no risk taken
- The treasury is authorised to take speculative positions in financial markets to generate returns beyond hedging costs (Correct answer)
- All treasury costs are directly allocated to individual business divisions
- The treasury only facilitates intercompany cash transfers within the group
Correct answer: The treasury is authorised to take speculative positions in financial markets to generate returns beyond hedging costs
A profit center treasury actively trades and takes market views to generate profits, accepting higher risk compared to a cost center treasury that simply hedges group exposures.
Question 7: Which of the following is a feature of exchange-traded derivatives that distinguishes them from over-the-counter (OTC) derivatives?
- They are tailored to the exact size and date requirements of the user
- They expose the user to significant counterparty credit risk
- They use standardized contracts traded on a regulated exchange with a central clearing house (Correct answer)
- They cannot be closed out before the contract expiry date
Correct answer: They use standardized contracts traded on a regulated exchange with a central clearing house
Exchange-traded derivatives have standardized terms (contract size, maturity dates) and are cleared through a central counterparty, virtually eliminating counterparty credit risk.
ACCA Advanced Financial Management 2
A US company expects to receive GBP 500,000 in three months.
To hedge this currency exposure using a forward contract, the company should: