ACCA AFM key terms

The loss in value caused when managers pursue their own interests rather than those of shareholders, including monitoring costs, bonding costs and any residual loss that remains despite controls.

The system of rules, board structures and reporting practices by which a company is directed and controlled, designed to make managers accountable to shareholders and other stakeholders.

The view that a company should be managed in the interests of all parties affected by it, such as employees, customers, lenders and communities, not only its shareholders.

The financial objective of increasing the long-run market value of shareholders' equity, usually treated as maximising the present value of expected future cash flows to owners.

A conflict of interest that arises because a principal such as a shareholder delegates decision-making to an agent such as a director, and the two parties' incentives are not aligned.

Net present value: the sum of a project's expected cash flows discounted at the required rate of return, less the initial outlay. A positive NPV adds value to the firm.

The discount rate at which a project's net present value is zero. It is compared with the cost of capital to decide whether a project is acceptable.

A future, incremental cash flow that changes as a direct result of accepting a decision. Past costs, committed costs and allocated overheads are normally excluded from the analysis.

The value of the best alternative forgone when a resource is committed to a chosen course of action, such as lost contribution from a scarce resource used on a new project.

A valuation technique that converts expected future cash flows into a present value by applying a discount rate reflecting the time value of money and project risk.

The value of managerial flexibility to expand, delay, abandon or switch a project, which a conventional NPV analysis ignores but which can materially change the investment decision.

A technique that recalculates a project's outcome after changing one input variable at a time, showing how much a variable must change before the project becomes unacceptable.

An appraisal method that evaluates a project under several internally consistent combinations of variables, such as worst case, base case and best case, to reveal the range of possible outcomes.

The cash generated by operations after tax and after reinvestment in working capital and fixed assets, available to be paid to debt and equity providers.

The estimated value of a business or project at the end of an explicit forecast period, often calculated as a perpetuity of the final year's cash flow growing at a constant rate.

The return that ordinary shareholders require on their investment, reflecting the risk-free rate plus a premium for the systematic risk of the company's shares.

The capital asset pricing model: a method of estimating required return as the risk-free rate plus beta multiplied by the market risk premium.

A measure of how much a share's return moves relative to the market. A beta above one indicates higher systematic risk than the market average.

Risk arising from economy-wide factors such as interest rates and inflation that affects all companies and cannot be removed by holding a diversified portfolio of shares.

The weighted average cost of capital: the blended required return of a firm's debt and equity, weighted by their market values, used as the discount rate for average-risk projects.

The effective after-tax return demanded by lenders, calculated from the redemption yield on traded debt or the interest rate on new borrowing adjusted for tax relief.

The proportion of a company's capital that is funded by debt, measured either on book or market values. Higher gearing increases financial risk to shareholders.

The additional variability of returns to shareholders caused by the presence of fixed interest obligations, over and above the business risk of the underlying operations.

The risk inherent in a company's operating activities, driven by factors such as demand volatility, operating gearing and competitive pressure, independent of how the firm is financed.

The idea that firms prefer internal funds first, then debt, and issue new equity only as a last resort, because of information asymmetry and the costs of issuing securities.

A situation where one party, typically company management, knows more about the business than outsiders such as investors, which affects the price at which securities can be issued.

The use of observable actions, such as dividend changes or the choice of financing, to convey private information about a company's prospects to the market.

A privately negotiated agreement to buy or sell an asset or currency at a fixed price on a future date, binding on both parties and carrying counterparty risk.

A standardised, exchange-traded agreement to trade an underlying asset at a set price on a future date, settled through a clearing house and marked to market daily.

An agreement between two parties to exchange interest payment streams, typically fixed for floating, on a notional principal, used to manage exposure to interest rate movements.

Any arrangement, such as a forward, option or money market transaction, that reduces the uncertainty of future cash flows arising from movements in exchange rates.

Taking a position that offsets existing or expected exposure to a market variable, so that gains and losses on the hedge and the exposure tend to cancel out.

The exposure of a company's cash flows or asset values to changes in market interest rates, affecting both floating-rate borrowing costs and the value of fixed-rate debt.

The theory that exchange rates adjust over time so that identical goods cost the same in different countries, implying that inflation differentials drive long-run currency movements.

The principle that the difference between forward and spot exchange rates reflects the interest rate differential between two currencies, preventing risk-free arbitrage.

The combination of two or more companies into a single entity, typically through an exchange of shares, with the aim of creating value from synergies or market position.

The purchase of a controlling interest in another company, paid for in cash, shares or a mixture, which may be agreed with the target's board or hostile.

The extra value created when combining two businesses produces benefits greater than the sum of their separate values, for example through cost savings or revenue enhancement.

The amount by which the offer price for a target company exceeds its pre-bid market value, paid to persuade shareholders to accept and to capture a share of expected synergy gains.

The sale or disposal of a business unit, subsidiary or asset by a company, often to raise funds, focus on core activities or exit underperforming operations.

A transaction in which a company's existing management team acquires the business or a division, often backed by private equity finance and secured against the target's assets.

An acquisition financed largely by debt secured on the target's assets and cash flows, with the acquirer contributing only a small proportion of equity.

The separation of a company into two or more independent entities, distributing shares in the new companies to existing shareholders, often to unlock value or improve focus.