CA Final AFM common mistakes
CA Final AFM · Understand the traps and how to avoid them.
Computing WACC using the book value of debt and equity from the balance sheet, or using the coupon rate on existing debt instead of the current yield-to-maturity/marginal cost of new debt, then discounting project cash flows at that rate.
Candidates memorise the WACC formula but treat its inputs as given numbers rather than market-based estimates; textbooks show neat book-value illustrations, and in the exam hall it is faster to lift figures from the data given than to re-derive market weights and a current cost of debt.
What to do instead
Before computing, write down the source of each input: equity at market capitalisation (price x shares), debt at market value or at the present value of contractual cash flows, cost of debt as post-tax YTM on traded debt or the rate on a comparable fresh borrowing, and cost of equity via CAPM with a re-levered beta where the project's business risk differs. State explicitly in the answer that book values are being rejected.
Quoting an unhedged net exposure as simply 'receivables minus payables' in the foreign currency, ignoring offsetting exposures in the same currency elsewhere in the group and ignoring the tax and consolidation effects, then recommending a hedge size that over- or under-covers the true economic exposure.
Transaction, translation and economic exposure are taught as separate chapters, so candidates classify each item mechanically instead of netting all same-currency cash flows across the horizon; the exam's short data set encourages treating each item in isolation.
What to do instead
Build a currency-wise exposure grid with columns for each time bucket (0-30, 31-90, 91-180 days, beyond) and rows for each exposure type, netting inflows and outflows per currency per bucket. Hedge the net figure bucket by bucket, and state separately which translation exposures are accounting-only and not hedged.
Valuing an option or a swap with the wrong day-count, wrong volatility convention (annual vs daily, percentage vs decimal) or by inserting the risk-free rate where the dividend yield belongs, and then presenting the number without a sanity check against intrinsic value and the no-arbitrage bounds.
Black-Scholes-Merton inputs look interchangeable and the formula is applied by rote; candidates also confuse continuously compounded rates with annual rates, and the time pressure discourages the extra check step.
What to do instead
Adopt a fixed input checklist before substituting: S and K in the same currency and per-share basis, T in years computed from actual days/365, sigma as a decimal, r and q continuously compounded and matched to the option's currency. After computing, verify the price lies between max(S-K,0) discounted appropriately and S (for a call), and verify put-call parity holds to the rupee.
In capital budgeting, discounting nominal cash flows at a real discount rate (or vice versa), and mixing the foreign-currency cash flow with the home-currency discount rate in international projects, producing a project that appears viable only because of the mismatch.
The Fisher relationship and the international Fisher effect are known as formulas but not applied as consistency rules; candidates focus on the NPV arithmetic and overlook that the rate and the cash flow must be in the same units and currency.
What to do instead
Write a one-line consistency statement at the top of every NPV: 'nominal INR flows at nominal INR rate' or 'real flows at real rate'. For foreign projects, either convert all flows to INR at forward rates and discount at the INR rate, or keep foreign flows and discount at the foreign rate, then convert the single NPV at the spot rate; show that both routes give the same answer.
Treating a merger accretion/dilution calculation as the whole answer, quoting EPS accretion as proof of value creation without testing the acquisition premium against the present value of synergies, and ignoring the financing mix (cash, debt, share swap) effect on the post-merger capital structure.
Accretion/dilution is easy to compute and looks decisive, so it becomes the default analysis; the harder synergy valuation and financing-effect reasoning is skipped under time pressure.
What to do instead
Structure the answer in three layers: (i) standalone values of acquirer and target, (ii) synergy value with its source and timing, discounted at an appropriate rate, (iii) price paid including premium and transaction costs. Conclude on value creation only if synergy value exceeds premium, and then show the EPS and leverage impact of each financing alternative separately.
Using a single-point NPV or a single scenario as the risk analysis for a project, instead of running sensitivity on the two or three variables that actually drive the outcome, and failing to compute the break-even or switching value of those variables.
Candidates equate 'risk analysis' with 'mention sensitivity analysis'; they list techniques (sensitivity, scenario, simulation, decision tree) without applying one numerically to the given data, because applying it takes more steps than describing it.
What to do instead
Identify the two largest contributors to NPV, vary each by a stated percentage, and report the change in NPV and the break-even value at which NPV is zero. If probabilities are given, compute expected NPV and the standard deviation or the probability of a negative NPV; if a real option exists, value it as a decision tree rather than a narrative aside.
Answering a portfolio theory question by computing expected return and standard deviation of individual securities but never combining them, or combining them with a simple average instead of the covariance-weighted formula, and then recommending a portfolio on the basis of highest return alone.
The two-asset variance formula with the correlation term is the step most often dropped; candidates also skip the Sharpe ratio comparison, so the recommendation ignores risk-adjusted performance.
What to do instead
Always compute portfolio return as weighted average, portfolio variance as w1^2 s1^2 + w2^2 s2^2 + 2 w1 w2 rho s1 s2, and then the Sharpe ratio for each candidate portfolio and the market. Recommend on risk-adjusted basis, and where relevant check whether the weights are on the efficient frontier (minimum-variance and tangency portfolios).
In mutual fund and securitisation questions, computing NAV or yield without adjusting for the exit load, expense ratio, or the difference between the fund's accounting income and distributable cash flow, and treating the pass-through certificate as if it carried no credit enhancement or prepayment risk.
These chapters are perceived as descriptive, so candidates answer with definitions and headline formulas; the small print (load structures, TER, waterfall mechanics, excess spread) is where the marks sit but is studied last.
What to do instead
For fund questions, compute NAV per unit, then the effective return net of entry/exit load and expense ratio, and compare with the benchmark on the same basis. For securitisation, lay out the cash flow waterfall explicitly (collections, servicing fee, senior tranche, mezzanine, residual) and quantify the credit enhancement (subordination percentage, excess spread, overcollateralisation) before commenting on the rating.
Recommending a derivative hedge (forward vs futures vs option vs swap) without comparing the all-in cost of each alternative at the relevant maturity, and without stating the residual risk the chosen instrument leaves with the firm.
Candidates pick the instrument they can value most easily or the one that sounds sophisticated; the comparison of outcomes across instruments at the expected rate, and the discussion of basis risk, margin calls and counterparty risk, is omitted.
What to do instead
Build a small outcome table: for the same exposure and the same expected future rate, show the rupee outcome under no hedge, forward, futures (net of basis), money-market hedge, option (net of premium) and swap. Recommend on cost and certainty, and name the residual risks (basis, liquidity, credit, marking-to-market cash flow) of the recommended route.
Writing international financial management answers that quote interest rate parity, purchasing power parity and the Fisher effect as definitions without using them to derive the expected spot rate or to test whether a covered arbitrage exists from the quoted numbers.
The parities are memorised as statements rather than as equations to be applied; candidates do not practise checking whether quoted deposit and forward rates are internally consistent, so they cannot spot or exploit the arbitrage the question embeds.
What to do instead
For every parity, write the equation first, then substitute the quoted figures and solve for the unknown. Test arbitrage by computing the covered interest differential: compare the forward premium with the interest differential; if they differ, compute the borrow-invest-repatriate cash flows and the riskless profit. State which parity is violated and why the market may not correct it immediately.