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IAI CB3 practice questions

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Question 1CB3 (content domains not enumerated in source)

Under the CB3 framework for capital budgeting, which technique discounts all expected cash flows to present value using the project's cost of capital?

  1. Accounting rate of return
  2. Net present value (NPV) Correct answer.
  3. Payback period
  4. Internal rate of return (IRR)

Explanation

Net present value discounts every expected cash flow at the project's cost of capital and sums the results, so a positive NPV signals value creation. Payback and accounting rate of return ignore discounting, while IRR solves for the discount rate that zeroes NPV rather than discounting at the cost of capital.

Question 2CB3 (content domains not enumerated in source)

A project requires an initial outlay of 100,000 and generates 30,000 per year for five years. Using the annuity factor of 3.791 at a 10% cost of capital, what is the NPV?

  1. 13,730 Correct answer.
  2. 150,000
  3. 50,000
  4. 30,000

Explanation

The present value of the annuity is 30,000 multiplied by 3.791, which equals 113,730. Subtracting the 100,000 outlay gives an NPV of 13,730, so the project adds value at a 10% cost of capital.

Question 3CB3 (content domains not enumerated in source)

When comparing two mutually exclusive projects of different scale, which criterion is generally preferred for the investment decision?

  1. Higher net present value Correct answer.
  2. Higher accounting rate of return
  3. Higher internal rate of return
  4. Shorter payback period

Explanation

NPV measures the absolute value added and correctly ranks mutually exclusive projects because it reflects the total wealth increase to the firm. IRR can mislead when project scale differs, and payback and accounting return ignore value magnitude and timing.

Question 4CB3 (content domains not enumerated in source)

In the CB3 treatment of risk, a sensitivity analysis on a capital project is best described as which of the following?

  1. Adjusting the discount rate upward for all risky projects
  2. Comparing the project against the firm's average return
  3. Assigning probabilities to each possible outcome to compute an expected NPV
  4. Changing one input at a time to see how far it can move before NPV turns negative Correct answer.

Explanation

Sensitivity analysis isolates each variable and finds the change that would drive NPV to zero, revealing which inputs the decision is most exposed to. It does not attach probabilities, which is the role of expected-value or simulation methods.

Question 5CB3 (content domains not enumerated in source)

A firm's cost of equity is 12%, its cost of debt is 6%, and its debt-to-total-capital ratio is 40%. Ignoring tax, what is the weighted average cost of capital?

  1. 9.6% Correct answer.
  2. 10.8%
  3. 9.0%
  4. 7.2%

Explanation

WACC weights each source by its share of total capital: 0.6 times 12% plus 0.4 times 6%, giving 7.2% plus 2.4%, or 9.6%. The equity weight is the complement of the 40% debt ratio.

Question 6CB3 (content domains not enumerated in source)

The cost of equity under the dividend valuation model with constant growth is calculated as which expression?

  1. (D1 / P0) + g Correct answer.
  2. (D0 / P0) - g
  3. (D1 / P0) x g
  4. (P0 / D1) + g

Explanation

Rearranging the Gordon growth model gives the cost of equity as the expected dividend yield plus the growth rate, using the next dividend D1 rather than the current one. This reflects both the income and capital growth components of shareholder return.

Question 7CB3 (content domains not enumerated in source)

Which of the following best describes the role of working capital management in CB3?

  1. Selecting the optimal mix of long-term debt and equity
  2. Managing the balance of current assets and current liabilities to keep liquidity sound Correct answer.
  3. Deciding which capital projects to accept
  4. Setting the dividend payout ratio

Explanation

Working capital management concerns the short-term balance of inventory, receivables, payables and cash to maintain liquidity while avoiding excess idle funds. It is distinct from long-term financing and investment appraisal decisions.

Question 8CB3 (content domains not enumerated in source)

A company offers credit terms of 2/10 net 30. What does this mean for a customer?

  1. A 2% discount is available at day 30 and payment must be made within 10 days
  2. 2% interest is charged after 10 days until payment at day 30
  3. The full amount is due in 10 days and a 2% penalty applies at day 30
  4. A 2% discount is available if payment is made within 10 days, otherwise the full amount is due in 30 days Correct answer.

Explanation

In the notation 2/10 net 30, the first figure is the discount rate, the second is the discount period, and the final figure is the maximum credit period. The customer either takes the early settlement discount or pays the gross amount by day 30.

Question 9CB3 (content domains not enumerated in source)

The economic order quantity (EOQ) model balances which two costs to determine the optimal order size?

  1. Set-up costs and distribution costs
  2. Financing costs and tax costs
  3. Ordering costs and holding costs Correct answer.
  4. Purchase costs and selling costs

Explanation

EOQ minimises the combined total of ordering costs, which fall with larger orders, and holding costs, which rise with larger orders. The optimum occurs where these two marginal costs are equal.

Question 10CB3 (content domains not enumerated in source)

Which of the following is a key difference between ordinary shares and preference shares?

  1. Ordinary shareholders always receive a fixed dividend before preference shareholders
  2. Preference shareholders have guaranteed repayment of capital before all creditors
  3. Preference shareholders normally receive a fixed dividend ahead of ordinary shareholders but typically lack voting rights Correct answer.
  4. Ordinary shares carry a fixed rate of return set at issue

Explanation

Preference shares carry a fixed dividend that ranks ahead of ordinary dividends and usually have priority on winding up, but they generally forfeit voting control. Ordinary shares carry variable dividends and voting rights but rank last for payment.

Question 11CB3 (content domains not enumerated in source)

A firm issues a bond with a face value of 1,000 and a coupon of 5%, when the market yield for similar bonds is 6%. The bond will most likely trade at which of the following?

  1. A discount to face value Correct answer.
  2. A premium to face value
  3. Exactly at face value
  4. At a price unrelated to the yield

Explanation

When the coupon rate is below the market yield, investors will pay less than face value so that the total return matches prevailing yields. The bond therefore trades at a discount until its yield to maturity equals the market rate.

Question 12CB3 (content domains not enumerated in source)

In the CB3 treatment of the efficient market hypothesis, the semi-strong form asserts that prices reflect which information?

  1. Only the most recent annual report
  2. All publicly available information Correct answer.
  3. All information including private insider knowledge
  4. Only past price history

Explanation

The semi-strong form holds that prices adjust rapidly to all publicly available information, so fundamental analysis cannot earn abnormal returns. The weak form covers only historical prices, while the strong form extends to private information.

Question 13CB3 (content domains not enumerated in source)

A portfolio combines two assets with equal weights. Asset A has an expected return of 8% and asset B of 12%. If the correlation between them is negative, which statement about the portfolio is correct?

  1. The portfolio return is 8% because the lower-return asset dominates
  2. The portfolio return exceeds 12% because of diversification
  3. The portfolio return is 10% and its risk is lower than the weighted average of the assets' risks Correct answer.
  4. The portfolio return is 10% and its risk equals the weighted average of the assets' risks

Explanation

Expected portfolio return is the weighted average of the asset returns, here 10%, regardless of correlation. Negative correlation reduces portfolio risk below the weighted average of individual risks because the assets' fluctuations partly offset each other.

Question 14CB3 (content domains not enumerated in source)

According to the capital asset pricing model, the expected return on a security depends primarily on which factor?

  1. Its dividend yield
  2. Its systematic risk measured by beta Correct answer.
  3. Its total risk measured by standard deviation
  4. Its unsystematic risk measured by residual variance

Explanation

CAPM prices only systematic risk, because unsystematic risk can be diversified away by investors. Beta captures the sensitivity of the security's returns to market movements and drives the required return above the risk-free rate.

Question 15CB3 (content domains not enumerated in source)

A project has an IRR of 14% and the firm's cost of capital is 11%. What decision follows from the IRR rule?

  1. Reject the project because IRR is above the cost of capital
  2. Accept the project only if payback is under three years
  3. Accept the project because IRR exceeds the cost of capital Correct answer.
  4. The IRR rule gives no decision without the NPV

Explanation

The IRR rule accepts projects whose internal rate of return exceeds the hurdle rate, here 14% against 11%. This is consistent with a positive NPV at the cost of capital for a conventional project.

Question 16CB3 (content domains not enumerated in source)

Which of the following best explains why a company might prefer debt finance to equity finance?

  1. Debt never has to be repaid
  2. Debt holders gain voting control over the company
  3. Debt dividends must be paid before equity dividends
  4. Interest is tax-deductible, lowering the effective cost of debt Correct answer.

Explanation

Interest payments are generally allowable against tax, which reduces the after-tax cost of debt relative to equity. Debt also avoids diluting existing shareholders' control, but it increases financial risk and must be repaid.

Question 17CB3 (content domains not enumerated in source)

In the context of gearing, financial risk refers to which of the following?

  1. The risk of changes in foreign exchange rates
  2. The variability of a project's operating cash flows
  3. The additional risk borne by shareholders because of fixed interest obligations Correct answer.
  4. The risk that a customer will default on a trade receivable

Explanation

Financial risk arises from fixed financing commitments, principally interest, which magnify the variability of returns to shareholders as gearing rises. Operating risk, by contrast, stems from the fixed costs of the business itself.

Question 18CB3 (content domains not enumerated in source)

A company has earnings of 500,000 and 250,000 ordinary shares in issue. What is the earnings per share?

  1. 5.00
  2. 1.25
  3. 0.50
  4. 2.00 Correct answer.

Explanation

Earnings per share is earnings divided by the number of ordinary shares, so 500,000 divided by 250,000 equals 2.00. This measure indicates the profit attributable to each ordinary share.

Question 19CB3 (content domains not enumerated in source)

Which of the following describes the objective of managing trade payables effectively?

  1. Eliminating all trade credit from the balance sheet
  2. Maximising the cash held in the bank at all times
  3. Taking the maximum credit period available without damaging supplier relationships or losing discounts Correct answer.
  4. Paying suppliers as early as possible regardless of cost

Explanation

Trade credit is a cheap source of short-term finance, so the aim is to use the full credit period while preserving supplier goodwill and weighing any early settlement discount. Delaying payment beyond terms can harm the relationship and reputation.

Question 20CB3 (content domains not enumerated in source)

A firm's cash operating cycle is calculated as which combination of periods?

  1. Inventory days plus receivable days minus payable days Correct answer.
  2. Inventory days plus payable days minus receivable days
  3. Receivable days plus payable days plus inventory days
  4. Payable days minus inventory days minus receivable days

Explanation

The cash operating cycle measures the time between paying for materials and receiving cash from customers. It adds the inventory and receivable periods and deducts the payable period, which represents finance supplied by suppliers.

Question 21CB3 (content domains not enumerated in source)

Which of the following best describes the signalling effect of dividend policy?

  1. Dividends are irrelevant because investors can create their own income
  2. Dividends must always equal a fixed percentage of profits
  3. A dividend increase may signal management's confidence in future earnings Correct answer.
  4. Dividends are a cost of debt to the company

Explanation

Under signalling theory, managers use dividend changes to convey private information about future prospects to the market. A rise is often read as confidence, while a cut may signal expected deterioration.

Question 22CB3 (content domains not enumerated in source)

In a rights issue, what does the theoretical ex-rights price represent?

  1. The expected market price of the share after the new shares are issued Correct answer.
  2. The original price before the announcement of the issue
  3. The price at which the rights can be sold by the holder
  4. The price at which new shares are offered to existing holders

Explanation

The theoretical ex-rights price is the weighted average of the old share price and the discounted subscription price, reflecting the value of the share once the new shares are in issue. It is used to value the rights attached to existing holdings.

Question 23CB3 (content domains not enumerated in source)

Which of the following is the main advantage of a sale and leaseback arrangement to a company?

  1. It eliminates all future lease payments
  2. It releases capital tied up in property while retaining use of the asset Correct answer.
  3. It guarantees a lower cost of finance than any other source
  4. It transfers ownership and use of the asset to the buyer

Explanation

A sale and leaseback converts an illiquid fixed asset into cash while the company continues to occupy it under a lease. The trade-off is the loss of ownership benefits and the obligation to make rental payments.

Question 24CB3 (content domains not enumerated in source)

A company expects a net cash inflow of 40,000 in year one and 60,000 in year two, with an initial outlay of 80,000. Using a 10% discount factor (year 1: 0.909; year 2: 0.826), what is the NPV?

  1. 20,000
  2. 5,920 Correct answer.
  3. 16,000
  4. 100,000

Explanation

Discounting gives 40,000 times 0.909, or 36,360, plus 60,000 times 0.826, or 49,560, totalling 85,920. Deducting the 80,000 outlay leaves an NPV of 5,920.

Question 25CB3 (content domains not enumerated in source)

Which of the following best describes the purpose of a cash flow forecast in financial management?

  1. To determine the market value of the company's shares
  2. To anticipate the timing of cash shortages and surpluses so that funding can be arranged Correct answer.
  3. To record historical transactions in the ledger
  4. To calculate the company's taxable profit for the year

Explanation

A cash flow forecast projects receipts and payments over future periods to reveal when cash will be tight or surplus. Management can then arrange overdrafts, loans or short-term investments in advance.

Question 26CB3 (content domains not enumerated in source)

In the CB3 syllabus, the primary financial objective of a listed company is best described as:

  1. Maximising the company's total sales revenue
  2. Minimising the company's weighted average cost of capital
  3. Maximising the wealth of the company's ordinary shareholders Correct answer.
  4. Maximising the number of shares outstanding

Explanation

The assumed primary financial objective is to maximise shareholder wealth, usually interpreted as maximising the market value of the company's ordinary shares, because shareholders are the residual risk bearers. Revenue, share count and cost of capital are means to that end rather than the objective itself.

Question 27CB3 (content domains not enumerated in source)

Agency costs in the context of corporate finance refer to:

  1. The costs of monitoring and bonding incurred because managers may act in their own interests rather than shareholders' interests Correct answer.
  2. The costs of issuing new equity to the public
  3. The costs of trading securities on a stock exchange
  4. The costs of holding inventory to meet customer demand

Explanation

Agency costs arise from the separation of ownership and control: shareholders must monitor managers and managers may incur bonding costs to signal alignment. Issuing costs, trading costs and inventory holding costs are different categories of cost.

Question 28CB3 (content domains not enumerated in source)

Which of the following best describes the difference between systematic and unsystematic risk?

  1. Systematic risk is measured by the standard deviation of a single security, while unsystematic risk is measured by beta
  2. Systematic risk can be eliminated by holding a diversified portfolio, while unsystematic risk cannot
  3. Systematic risk affects all firms and cannot be diversified away, while unsystematic risk is firm-specific and can be reduced by diversification Correct answer.
  4. Systematic risk arises only from changes in interest rates, while unsystematic risk arises only from changes in exchange rates

Explanation

Systematic (market) risk stems from economy-wide factors and remains even in a fully diversified portfolio. Unsystematic (specific) risk relates to individual companies and is reduced as more securities are combined.

Question 29CB3 (content domains not enumerated in source)

A company has a beta of 1.4. The risk-free rate is 4% and the expected market return is 10%. Using the CAPM, what is the company's cost of equity?

  1. 10.0%
  2. 12.4% Correct answer.
  3. 8.4%
  4. 14.0%

Explanation

CAPM gives cost of equity = risk-free rate + beta × (market return − risk-free rate) = 4% + 1.4 × (10% − 4%) = 4% + 8.4% = 12.4%. The beta premium is applied to the market risk premium, not to the market return itself.

Question 30CB3 (content domains not enumerated in source)

Which of the following is the most accurate description of the weighted average cost of capital (WACC)?

  1. The average cost of the company's sources of finance, weighted by their book values
  2. The cost of the company's most recent debt issue
  3. The average cost of the company's sources of finance, weighted by their market values Correct answer.
  4. The return required by the company's largest shareholder

Explanation

WACC weights each source of finance by its market value because market values reflect the current opportunity cost of capital. Book values are historical and can distort the weights, while a single debt issue or one shareholder's required return does not represent the overall cost of capital.

Question 31CB3 (content domains not enumerated in source)

A firm has a debt-to-equity ratio of 1:3 based on market values. The cost of debt is 6% before tax, the cost of equity is 12%, and the tax rate is 25%. What is the WACC?

  1. 9.75%
  2. 10.5%
  3. 10.125% Correct answer.
  4. 11.25%

Explanation

Debt is 1/4 and equity is 3/4 of total value. After-tax cost of debt = 6% × (1 − 0.25) = 4.5%. WACC = (0.25 × 4.5%) + (0.75 × 12%) = 1.125% + 9% = 10.125%.

Question 32CB3 (content domains not enumerated in source)

Under the dividend valuation model with constant growth, the value of a share is calculated as:

  1. Next year's dividend multiplied by the required return
  2. Next year's dividend divided by the difference between the required return and the dividend growth rate Correct answer.
  3. The current dividend divided by the difference between the growth rate and the required return
  4. This year's dividend divided by the required return

Explanation

The constant growth (Gordon) model values a share as D1 / (r − g), where D1 is the dividend expected in one year, r is the required return and g is the constant growth rate. The denominator must be positive, so r must exceed g.

Question 33CB3 (content domains not enumerated in source)

A company has just paid a dividend of 0.50 per share. Dividends are expected to grow at 4% per year indefinitely, and the required return is 9%. What is the estimated share price?

  1. 13.00
  2. 10.40 Correct answer.
  3. 10.00
  4. 5.56

Explanation

D1 = 0.50 × 1.04 = 0.52. Price = D1 / (r − g) = 0.52 / (0.09 − 0.04) = 0.52 / 0.05 = 10.40.

Question 34CB3 (content domains not enumerated in source)

Which of the following best describes the concept of financial gearing?

  1. The ratio of current assets to current liabilities
  2. The ratio of operating profit to sales revenue
  3. The proportion of a company's capital financed by ordinary shares
  4. The proportion of a company's capital financed by fixed-interest debt Correct answer.

Explanation

Financial gearing measures the extent to which debt, with its fixed interest obligations, is used in the capital structure. A higher proportion of debt increases financial risk to shareholders because interest must be paid before dividends.

Question 35CB3 (content domains not enumerated in source)

According to Modigliani and Miller's theory with taxes, the value of a geared company:

  1. Exceeds that of an equivalent ungeared company by the present value of the tax shield on debt Correct answer.
  2. Equals that of an equivalent ungeared company because taxes are irrelevant
  3. Is lower than that of an ungeared company because debt increases risk
  4. Is determined solely by the company's dividend policy

Explanation

With corporate taxes and the tax deductibility of interest, M&M show that gearing increases firm value by the present value of the interest tax shield, often expressed as the corporate tax rate times the market value of debt. Without taxes, the values would be equal.

Question 36CB3 (content domains not enumerated in source)

Which of the following is the most likely consequence of a company increasing its level of gearing beyond the optimal point?

  1. The weighted average cost of capital falls continuously as more debt is added
  2. The company's tax shield becomes worthless because interest is no longer deductible
  3. The cost of equity rises because financial risk increases, and the cost of debt may also rise as default risk grows Correct answer.
  4. The company's share price rises because debt is always cheaper than equity

Explanation

Beyond the optimal gearing level, higher financial risk raises the return required by shareholders, and lenders may demand higher interest rates to compensate for greater default risk. The tax shield remains valuable but is offset by these rising costs.

Question 37CB3 (content domains not enumerated in source)

In the context of investment appraisal, which of the following is an advantage of the net present value (NPV) method over the internal rate of return (IRR) method?

  1. NPV can be calculated without estimating the cost of capital
  2. NPV uses the cost of capital as the discount rate and gives a direct measure of the change in shareholder wealth Correct answer.
  3. NPV ignores the time value of money
  4. NPV always gives the same ranking as IRR for mutually exclusive projects

Explanation

NPV discounts cash flows at the company's cost of capital and the result is the expected addition to shareholder wealth, which is the decision criterion. IRR can mislead when comparing mutually exclusive projects or when cash flows are unconventional.

Question 38CB3 (content domains not enumerated in source)

A project requires an initial investment of 100,000 and is expected to generate annual net cash inflows of 30,000 for five years. The company's cost of capital is 10%. The annuity factor for five years at 10% is 3.791. What is the NPV?

  1. 3,791
  2. 13,730 Correct answer.
  3. 50,000
  4. 30,000

Explanation

PV of inflows = 30,000 × 3.791 = 113,730. NPV = 113,730 − 100,000 = 13,730. A positive NPV indicates the project adds value.

Question 39CB3 (content domains not enumerated in source)

Which of the following best describes the payback period method of investment appraisal?

  1. The ratio of average annual profit to the average investment
  2. The time required for a project's NPV to become positive
  3. The time required for the cumulative cash inflows from a project to equal the initial investment Correct answer.
  4. The discount rate at which a project's NPV is zero

Explanation

Payback measures how long it takes to recover the initial outlay from cash inflows. It is simple and focuses on liquidity, but it ignores cash flows after the payback date and usually ignores the time value of money.

Question 40CB3 (content domains not enumerated in source)

A company has annual demand of 10,000 units for a component. The cost of placing an order is 20 and the cost of holding one unit for a year is 4. What is the economic order quantity (EOQ)?

  1. 100 units
  2. 316 units Correct answer.
  3. 1,000 units
  4. 500 units

Explanation

EOQ = √(2 × annual demand × order cost / holding cost per unit) = √(2 × 10,000 × 20 / 4) = √(400,000 / 4) = √100,000 ≈ 316 units.

Question 41CB3 (content domains not enumerated in source)

Which of the following best describes the purpose of a just-in-time (JIT) inventory system?

  1. To calculate the optimal cash balance using the Baumol model
  2. To maximise the order size so that quantity discounts are obtained
  3. To hold large buffer stocks to protect against supply interruptions
  4. To minimise inventory holding by receiving goods only as they are needed in the production process Correct answer.

Explanation

JIT aims to eliminate waste by arranging for materials to arrive just before they are required, thereby reducing holding costs and improving quality. It relies on reliable suppliers and efficient production scheduling.

Question 42CB3 (content domains not enumerated in source)

A company has an inventory holding period of 60 days, a receivables collection period of 45 days and a payables payment period of 30 days. What is the length of its cash operating cycle?

  1. 135 days
  2. 75 days Correct answer.
  3. 15 days
  4. 105 days

Explanation

The cash operating cycle = inventory days + receivables days − payables days = 60 + 45 − 30 = 75 days. It represents the time between paying for materials and receiving cash from customers.

Question 43CB3 (content domains not enumerated in source)

Which of the following is the most appropriate action for a company wishing to reduce its cash operating cycle?

  1. Reduce the inventory holding period and collect receivables more quickly Correct answer.
  2. Delay payment to suppliers beyond the agreed terms without negotiation
  3. Offer customers longer credit terms to increase sales
  4. Increase the inventory holding period to avoid stock-outs

Explanation

Shortening inventory days and receivables days reduces the cash operating cycle, releasing cash for other uses. Extending payables days also shortens the cycle, but unilateral delay damages supplier relationships and may incur penalties.

Question 44CB3 (content domains not enumerated in source)

Which of the following best describes the function of a stock exchange's primary market?

  1. It allows investors to trade existing shares among themselves
  2. It enables companies to raise new capital by issuing shares to investors Correct answer.
  3. It guarantees that share prices will not fall after listing
  4. It sets the official interest rate for the economy

Explanation

The primary market is where new securities are issued and the proceeds go to the issuing company, providing new finance. The secondary market is where existing securities are traded between investors.

Question 45CB3 (content domains not enumerated in source)

A company's current share price is 5.00. It makes a 1-for-4 rights issue at a subscription price of 4.00. What is the theoretical ex-rights price (TERP)?

  1. 5.00
  2. 4.75
  3. 4.50
  4. 4.80 Correct answer.

Explanation

Before the issue, four existing shares are worth 4 × 5.00 = 20.00. The rights issue adds one new share at 4.00, giving total value of 24.00 for five shares. TERP = 24.00 / 5 = 4.80.

Question 46CB3 (content domains not enumerated in source)

In a rights issue, the theoretical value of the right to buy one new share is calculated as:

  1. The cum-rights price minus the subscription price
  2. The theoretical ex-rights price plus the subscription price
  3. The theoretical ex-rights price minus the subscription price Correct answer.
  4. The subscription price divided by the number of shares required for one new share

Explanation

The value of a right per new share equals TERP minus the subscription price, because exercising the right allows the holder to buy at the subscription price a share worth TERP. This value can also be expressed per existing share by dividing by the number of shares needed for one new share.

Question 47CB3 (content domains not enumerated in source)

Which of the following is a key difference between a forward contract and a futures contract?

  1. Futures contracts always involve physical delivery, while forward contracts never do
  2. Futures contracts are standardised and traded on an exchange, while forward contracts are tailored and traded over the counter Correct answer.
  3. Forward contracts require daily settlement of gains and losses, while futures contracts do not
  4. Forward contracts are standardised and traded on an exchange, while futures contracts are tailored and traded over the counter

Explanation

Futures are exchange-traded, standardised contracts with daily marking to market, whereas forwards are private, customised agreements between two parties. This makes futures more liquid but less flexible.

Question 48CB3 (content domains not enumerated in source)

A UK company expects to receive 1 million US dollars in three months. To hedge against the dollar weakening, it could:

  1. Enter into a forward contract to sell US dollars for sterling at a fixed rate Correct answer.
  2. Enter into a forward contract to buy US dollars with sterling at a fixed rate
  3. Do nothing because exchange rate movements always even out
  4. Borrow sterling now and convert it to dollars at the spot rate

Explanation

A future receipt of foreign currency exposes the company to the risk that the currency falls in value. Selling the dollars forward locks in the exchange rate and removes that uncertainty. Buying dollars forward would increase the exposure.

Question 49CB3 (content domains not enumerated in source)

Which of the following best describes the role of a finance function in a large company?

  1. To record financial transactions, manage cash and provide information for planning and control Correct answer.
  2. To recruit and train operational staff
  3. To set the company's marketing strategy and pricing policy
  4. To design the company's products and services

Explanation

The finance function encompasses financial accounting and reporting, management accounting, treasury and cash management, and support for planning and decision-making. Marketing, human resources and product design belong to other functions.

Question 50CB3 (content domains not enumerated in source)

A company is considering a project that would increase its operating gearing. Which of the following best describes the effect of higher operating gearing?

  1. The company's interest payments become more variable
  2. A given change in sales volume produces a larger proportionate change in operating profit Correct answer.
  3. The company's dividend per share is fixed
  4. The company's tax rate increases

Explanation

Operating gearing measures the proportion of fixed costs in the cost structure. Higher fixed costs mean that a change in sales has a magnified effect on operating profit, increasing business risk.