CIMA Financial Management and Risk 2 — Questions and Answers
Question 1: What is 'financial leverage' in the context of corporate finance?
- The use of debt financing to amplify returns on equity (Correct answer)
- The speed at which assets can be converted to cash
- The ratio of gross profit to revenue
- The ability to negotiate favorable supplier terms
Correct answer: The use of debt financing to amplify returns on equity
Financial leverage refers to the use of debt financing; it amplifies potential returns to equity holders but also increases financial risk.
Question 2: In risk management, what does 'hedging' primarily aim to achieve?
- Maximizing profits from favorable market movements
- Reducing or offsetting exposure to financial risk (Correct answer)
- Increasing investment returns through speculation
- Transferring all risk to insurance companies
Correct answer: Reducing or offsetting exposure to financial risk
Hedging involves taking an offsetting position to reduce or eliminate exposure to a specific financial risk such as currency or interest rate risk.
Question 3: Which of the following best defines 'credit risk' for a business?
- The risk that interest rates will rise
- The risk that a counterparty will fail to meet its financial obligations (Correct answer)
- The risk of losing value through market price movements
- The risk that the company will run out of cash
Correct answer: The risk that a counterparty will fail to meet its financial obligations
Credit risk is the risk that a counterparty (such as a customer or borrower) will default or fail to meet their contractual financial obligations.
Question 4: What does a company's 'gearing ratio' measure?
- The proportion of debt to total capital or equity in the capital structure (Correct answer)
- The efficiency of asset utilization
- The ratio of fixed costs to variable costs
- The return generated on total assets employed
Correct answer: The proportion of debt to total capital or equity in the capital structure
The gearing ratio measures the proportion of a company's financing that comes from debt relative to total capital or equity.
Question 5: Which cash flow forecasting technique uses statistical analysis of historical data to predict future cash flows?
- Receipts and payments method
- Profit and loss adjustment method
- Time series analysis (Correct answer)
- Zero-based budgeting
Correct answer: Time series analysis
Time series analysis uses historical data patterns (trends, seasonality) to forecast future cash flows using statistical methods.
Question 6: A bond is trading at a discount. What does this indicate about the bond's coupon rate relative to current market interest rates?
- The coupon rate is higher than current market rates
- The coupon rate equals the current market rate
- The coupon rate is lower than current market rates (Correct answer)
- The bond is about to mature
Correct answer: The coupon rate is lower than current market rates
A bond trades at a discount when its coupon rate is lower than current market interest rates, making it less attractive than newly issued bonds.
CIMA Financial Management and Risk 2
What is 'financial leverage' in the context of corporate finance?