HKICPA QP Module 7 Financial Management key terms

The loss in value caused when managers pursue their own interests rather than those of shareholders, including monitoring costs, bonding costs and the residual loss that remains after controls are put in place.

A conflict arising when a person (the agent) makes decisions on behalf of another (the principal) whose interests differ, so the agent may act in its own interest unless incentives and controls align behaviour.

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

The financial objective of increasing the long-run market value of ordinary shares, treating the share price as a signal of expected future cash flows and their risk.

Any party with an interest in how a company performs, such as employees, lenders, customers, suppliers, government and local communities, not only the owners of shares.

A contract under which one party engages another to perform a service on its behalf and delegates decision-making authority, creating scope for divergent objectives.

The sum of a project's expected cash flows discounted at the required rate of return, less the initial outlay; a positive figure means the project adds value to the firm.

The discount rate at which a project's net present value equals zero; a project is acceptable if this rate exceeds the cost of capital, subject to the multiple-solution and ranking problems.

The present value of a project's future cash flows divided by its initial investment, used to rank projects when capital is rationed and the firm cannot fund every positive net present value project.

The time taken for cumulative cash inflows to recover the initial investment; simple to apply but ignores cash flows after the cut-off and does not discount future amounts.

The time taken for cumulative discounted cash inflows to equal the initial outlay, combining the simplicity of payback with recognition of the time value of money.

An incremental, future cash amount that changes only because the decision is taken; sunk costs, allocated fixed overheads and book depreciation are excluded while opportunity costs are included.

The value of the best alternative forgone when a resource is committed to a chosen course of action, such as contribution lost when a project uses scarce labour or space.

A situation where the firm cannot raise enough funds to accept every value-adding project, so projects must be ranked and selected within a fixed budget, either by management choice or by market constraint.

A spending limit imposed internally by management rather than by lenders or markets, for example to avoid the discipline of external finance or to keep divisional spending under control.

A technique that recalculates a project's outcome as one input varies, showing how far a variable such as sales price can change before the project ceases to be worthwhile.

An appraisal method that evaluates a project under a small number of consistent alternative futures, such as best, worst and most likely cases, capturing variables that move together.

The minimum return a firm must earn on its investments to leave the market value of its shares unchanged, reflecting the risk of the projects it finances.

The average of the after-tax costs of a firm's debt and equity, each weighted by its share of total market value, used as the discount rate for average-risk projects.

The return shareholders require on their investment in a firm's shares, commonly estimated with the dividend growth model or the capital asset pricing model using beta.

The effective return lenders require on a firm's borrowings, adjusted for tax relief on interest; for traded bonds it is derived from the yield to maturity.

A model stating that the required return on a security equals the risk-free rate plus beta multiplied by the market risk premium, rewarding only systematic risk that cannot be diversified away.

A measure of how much a security's returns move with the market; a beta above one indicates above-average systematic risk, and the asset beta strips out the effect of gearing.

The portion of a security's risk that arises from economy-wide factors such as interest rates and inflation and cannot be removed by holding a diversified portfolio.

Company-specific risk, such as a factory fire or a product failure, that affects one firm or industry and can be largely eliminated by diversifying holdings across many securities.

The mix of debt and equity a firm uses to finance its assets; under traditional and Modigliani-Miller views its effect on value depends on tax, bankruptcy costs and information asymmetry.

The proportion of a firm's capital provided by fixed-return borrowings; higher gearing raises the financial risk borne by shareholders and can amplify both profits and losses.

The internal rate of return on a bond bought at its current market price and held to redemption, reflecting coupon income, capital gain or loss and time to maturity.

The funds tied up in day-to-day operations, measured as current assets less current liabilities, and managed so that liquidity is sufficient without excessive idle investment.

The period from buying inventory through to collecting cash from customers, equal to the inventory holding period plus the receivables collection period in a trading business.

The operating cycle less the payables payment period, showing the number of days for which the firm must finance its trading activity from its own or borrowed funds.

Rapid growth in sales without matching long-term finance, so that working capital needs outstrip available funds and the firm risks a liquidity crisis despite reporting profits.

A cash management model that sets upper and lower control limits for the cash balance, buying or selling securities whenever the balance hits a limit so as to minimise total cost.

A cash management model treating cash like inventory, balancing the transaction cost of converting securities into cash against the opportunity cost of holding idle balances.

The relationship under which the difference between spot and forward exchange rates reflects the interest rate differential between two currencies, limiting arbitrage profits.

The theory that exchange rates adjust so that a basket of goods costs the same in different countries, implying that relative inflation rates drive long-run currency movements.

A binding agreement to exchange a fixed amount of currency on a future date at a rate set now, giving certainty of cash flow but no benefit if the market moves favourably.

Standardised exchange-traded contracts to buy or sell currency at a future date; they are marked to market daily and settled through a clearing house rather than with the counterparty.

The right, but not the obligation, to exchange currency at a specified rate before or on a set date, protecting against adverse moves while allowing gains from favourable ones at a premium cost.

An agreement between two parties to exchange interest payments, typically fixed for floating, on a notional principal, used to change the interest rate exposure of existing borrowings.

An option that pays the holder the excess when a reference interest rate exceeds a strike rate, limiting the cost of floating-rate borrowing while retaining benefit if rates fall.