CA Final AFM cheat sheet

Financial policy links capital structure, dividend, investment and liquidity decisions to the firm's stated strategy; a policy is internally consistent only if the target D/E, payout ratio and hurdle rate are mutually compatible.

Sustainable growth rate g = ROE × b, where b is the retention ratio (1 − dividend payout); growth above g without new equity or higher leverage forces a change in financial policy.

Porter's five forces (rivalry, buyer power, supplier power, new entrants, substitutes) determine industry attractiveness and hence the spread a strategy can earn over WACC.

Ansoff matrix: market penetration, market development, product development, diversification - risk rises left-to-right, so hurdle rates should rise with it.

BCG matrix: stars (high growth, high share) need investment; cash cows fund them; question marks need selective funding; dogs should be divested or harvested.

Value drivers under a strategy: revenue growth, operating margin, incremental capital intensity, and WACC; firm value = Σ FCFF/(1+WACC)^t plus terminal value.

Agency costs of equity (Jensen–Meckling) rise with free cash flow; higher debt commits cash to servicing, reducing managerial slack but adding financial distress costs.

Dividend policy irrelevance (Modigliani–Miller) holds only in frictionless markets; with taxes on dividends, clientele effects and signalling, payout choice affects value.

Value at Risk (parametric): VaR = z × σ × position value for the holding period; scale daily volatility by √t for a t-day horizon.

Expected shortfall (CVaR) = average loss beyond the VaR quantile; it is sub-additive, so it satisfies coherence while VaR does not.

Hedging with futures: optimal hedge ratio h* = ρ × (σ_spot / σ_futures); number of contracts N = h* × (exposure size / contract size).

Transaction exposure affects known foreign-currency cash flows; translation (accounting) exposure affects reported consolidated statements; economic exposure affects long-run competitiveness.

Interest rate swap value = difference between the present values of the fixed and floating legs; a payer swap gains when rates rise.

Delta measures option price sensitivity to the underlying; gamma is the change in delta; vega is sensitivity to volatility; theta is time decay; rho is sensitivity to rates.

A currency or interest rate option caps downside while retaining upside, but carries an upfront premium, unlike a forward or futures hedge which locks the rate at zero initial cost.

Credit risk mitigation tools: collateral, netting agreements, credit derivatives (CDS) and guarantees; a CDS spread widening signals deteriorating credit quality.

NPV = Σ CF_t/(1+k)^t − initial outlay; accept if NPV > 0. IRR is the rate where NPV = 0; use NPV when IRR and NPV rank projects differently (scale or timing conflicts).

Modified IRR (MIRR) assumes reinvestment at the cost of capital, avoiding the multiple-IRR problem of unconventional cash flows.

Equivalent annual annuity (EAA) = NPV / annuity factor at k over the project life; used to compare mutually exclusive projects with unequal lives.

Real options add value to NPV: option to expand, defer, abandon or switch inputs; value is higher when uncertainty and managerial flexibility are greater.

Replacement decision: compare the EAA of the old asset's remaining life against the EAA of the new asset; replace if the new EAA exceeds the old.

Capital rationing: with a single-period constraint, rank by profitability index (NPV/investment); with multi-period constraints, use linear programming.

Sensitivity analysis changes one variable at a time; scenario analysis changes several jointly; simulation assigns probability distributions to inputs to obtain an NPV distribution.

Inflation: discount nominal cash flows at the nominal rate and real cash flows at the real rate; (1 + nominal) = (1 + real)(1 + inflation).

CAPM: E(R_i) = R_f + β_i [E(R_m) − R_f]; β_i = Cov(R_i, R_m) / Var(R_m).

Portfolio variance = w₁²σ₁² + w₂²σ₂² + 2w₁w₂ρ₁₂σ₁σ₂; diversification benefit rises as ρ falls.

Sharpe ratio = (R_p − R_f)/σ_p; Treynor ratio = (R_p − R_f)/β_p; Jensen's alpha = R_p − [R_f + β_p(R_m − R_f)].

Information ratio = active return / tracking error; a higher ratio means more consistent outperformance per unit of active risk.

Fama–French three-factor model adds size (SMB) and value (HML) to market beta; the Carhart model adds momentum (WML).

Duration measures bond price sensitivity: %ΔP ≈ −D_mod × Δy; convexity adjusts for curvature: %ΔP ≈ −D_mod Δy + ½ × convexity × (Δy)².

Dividend discount model: P₀ = D₁/(k − g); the implied growth g = ROE × retention ratio, and g must be below k for the model to be valid.

Efficient market hypothesis: weak form (past prices), semi-strong (public information), strong form (all information including private); anomalies are evidence against semi-strong form.

Securitisation: pool of illiquid receivables is sold to an SPV, which issues securities backed by the pool's cash flows; the originator achieves off-balance-sheet funding and capital relief.

True sale and bankruptcy remoteness of the SPV are prerequisites; credit enhancement via subordination, over-collateralisation, excess spread or guarantees supports senior tranche ratings.

Pass-through securities distribute principal and interest proportionally; pay-through (CMO) structures allocate cash flows to tranches with different maturities and priorities.

Prepayment risk: PSA or CPR models estimate prepayments; faster prepayments shorten the weighted average life of the security and hurt premium-priced tranches.

Mutual fund NAV = (market value of assets − liabilities) / number of units outstanding; open-end funds transact at NAV, closed-end funds trade at market price, often at a discount.

Entry load reduces the amount invested; exit load is charged on redemption; the total expense ratio (TER) reduces NAV daily and compounds over the holding period.

Sharpe, Treynor and information ratio are used to evaluate fund performance; a fund with a high return but very high volatility may still rank poorly on Sharpe.

Expense ratio impact: a 1% higher TER over 20 years reduces terminal wealth by roughly 18–20% on a 10% gross return, so cost is a persistent drag.

Cost of carry / futures fair value: F = S × e^((r − q + storage)T) for continuous compounding; for equity futures F = S(1 + r)^T − FV(dividends).

Put–call parity (European, non-dividend): C + PV(K) = P + S; violations allow arbitrage by buying the cheap side and selling the dear side.

Black–Scholes: C = S·N(d₁) − K·e^(−rT)·N(d₂), where d₁ = [ln(S/K) + (r + σ²/2)T]/(σ√T) and d₂ = d₁ − σ√T.

Binomial model: risk-neutral probability p = (e^(rT) − d)/(u − d); option value = e^(−rT)[p × C_up + (1 − p) × C_down].

Intrinsic value of a call = max(S − K, 0); of a put = max(K − S, 0); time value = option price − intrinsic value, and time value decays to zero at expiry.

Interest rate parity: F/S = (1 + r_domestic)/(1 + r_foreign); forward premium or discount equals the interest rate differential.

Forward rate agreement payoff = (reference rate − agreed rate) × notional × days/365, discounted to settlement date.

Swaptions, caps and floors are options on interest rates; a cap is a series of call options on the reference rate, protecting a borrower against rate rises.

Purchasing power parity (absolute): S = P_domestic/P_foreign; relative PPP: expected spot change ≈ inflation differential.

Interest rate parity is the covered arbitrage relationship; uncovered interest parity is a hypothesis about expected spot rates and often fails empirically.

Forward rate is an unbiased predictor of future spot only if uncovered parity holds; carry trades profit when it does not.

Internal hedging: matching, netting, leads and lags, pricing in home currency; external hedging: forwards, futures, money market hedge, options, currency swaps.

Money market hedge: borrow in one currency, convert at spot, invest in the other; the effective rate should be close to the forward rate if parity holds.

Exposure measurement: transaction exposure = contractual foreign-currency cash flows; translation exposure = foreign subsidiary balance sheet translated at current rate; economic exposure = present value sensitivity to exchange rates.

Currency of invoice, leading/lagging payments and natural hedges via matching costs and revenues in the same currency reduce net exposure.

Foreign investment appraisal: discount foreign-currency cash flows at the foreign rate and translate at the spot rate, or discount home-currency cash flows at the home rate; both should agree under parity.

International Fisher effect: nominal interest differential equals expected inflation differential, so real rates are equalised across countries.

Cost of capital for a foreign project: use a proxy or country risk premium; adjust for political risk, expropriation risk and capital repatriation restrictions.

ADRs and GDRs allow foreign firms to raise capital abroad; eurobonds, foreign bonds and syndicated loans are major international debt instruments.

International diversification lowers portfolio risk because correlations across markets are below one, though correlations rise in crises.

Balance of payments: current account + capital account + financial account + errors and omissions = 0; persistent deficits pressure the currency.

Exchange rate regimes: fixed, floating, pegged with bands, and currency boards; a currency board requires 100% foreign reserve backing.

Political risk mitigation: investment guarantees, joint ventures with local partners, local borrowing to match local assets, and structuring repatriation via royalties or transfer pricing.

International cash management: multilateral netting, centralised pooling, and tax-efficient transfer pricing reduce transaction costs and exposure.

Synergy value = V_combined − (V_acquirer + V_target); the premium paid is the excess over the target's pre-bid market value.

Accretion/dilution: an acquisition is EPS-accretive if the target's earnings yield (E/P) exceeds the post-deal cost of acquisition funding.

Exchange ratio in a share swap = offer price per target share / acquirer share price; the post-merger ownership split follows the relative values contributed.

Free cash flow to firm = EBIT(1 − t) + depreciation − capex − Δworking capital; enterprise value = PV of FCFF at WACC.

Comparable company analysis uses EV/EBITDA, P/E and P/B multiples; precedent transaction analysis uses multiples paid in comparable deals and usually yields a higher value.

Defence tactics: poison pills, staggered boards, golden parachutes, white knights, greenmail and Pac-Man defence; the choice affects the premium and shareholder wealth.

Restructuring modes: divestiture, spin-off, split-off, carve-out, equity buyback, leveraged buyout, and debt restructuring; each changes ownership, control and leverage.

Regulatory framework in India: SEBI Takeover Code triggers at 25% voting rights, with an open offer for at least 26% of the target's shares.