CA Final AFM flashcards

34 cards. Read the term and the definition here. The deck at the top of this page is optional.

Sustainable growth rate

The maximum rate a firm can grow using retained earnings without changing its debt-equity ratio or issuing new equity. It equals ROE multiplied by the retention ratio b.

Ansoff matrix

A two-by-two framework crossing products with markets to give penetration, market development, product development and diversification. Risk increases as a firm moves away from its existing product-market base.

Agency cost of equity

The value lost when managers owning less than 100% of the firm pursue perquisites or shirk, since they bear only a fraction of the cost. Higher managerial ownership reduces this cost.

Value at Risk

The maximum loss expected over a given holding period at a stated confidence level. Parametric VaR equals the z-score times portfolio volatility times position value, scaled by the square root of time.

Optimal hedge ratio

The proportion of a spot exposure hedged with futures that minimises variance, computed as the correlation between spot and futures prices times the ratio of their standard deviations.

Delta of an option

The change in an option's price for a one-unit change in the underlying asset price. Call deltas range from zero to one; put deltas range from minus one to zero.

Expected shortfall

The average loss conditional on the loss exceeding the VaR threshold. Unlike VaR, it is sub-additive and therefore a coherent risk measure, capturing tail severity.

Equivalent annual annuity

The constant annual cash flow over a project's life that has the same present value as the project's NPV. Used to compare mutually exclusive projects with unequal lives.

Modified internal rate of return

The discount rate that equates the present value of outflows with the present value of inflows compounded forward at the cost of capital. It avoids multiple solutions from unconventional cash flows.

Profitability index

The present value of a project's future cash inflows divided by its initial investment. Used to rank projects when capital is rationed in a single period; accept if greater than one.

Real option

A right, not an obligation, to alter a project after it starts, such as deferring, expanding, contracting or abandoning. Its value rises with uncertainty and managerial flexibility.

Security market line

The graphical form of the CAPM showing required return as a linear function of beta. Assets above the line are undervalued because they offer more return than their systematic risk requires.

Jensen's alpha

The excess return of a portfolio over the return predicted by the CAPM given its beta. A positive alpha indicates outperformance after adjusting for systematic risk.

Bond duration

The weighted average time to a bond's cash flows, also measuring price sensitivity to yield changes. Modified duration approximates the percentage price change for a small yield change.

Information ratio

Active return divided by tracking error, measuring how much excess return a manager earns per unit of deviation from the benchmark. Higher values indicate more consistent active management.

Special purpose vehicle

A bankruptcy-remote entity that purchases receivables from an originator and issues securities backed by them. It isolates the pooled assets from the originator's insolvency risk.

Credit enhancement

Structuring that improves the credit rating of securitised securities, achieved through subordination, over-collateralisation, excess spread, insurance or third-party guarantees. It lowers the cost of funding.

Net asset value

The market value of a mutual fund's assets minus liabilities, divided by units outstanding. Open-end schemes issue and redeem units at this value, adjusted for loads.

Prepayment risk

The risk that borrowers repay mortgages earlier than scheduled when interest rates fall, returning principal at an unfavourable time. It shortens the security's weighted average life.

Put-call parity

For European options on a non-dividend stock, a call plus the present value of the strike equals a put plus the stock price. Violations permit riskless arbitrage.

Risk-neutral probability

In the binomial model, the probability that makes the expected option payoff discounted at the risk-free rate equal its current price. It is not the actual probability of an up move.

Cost of carry model

Futures price equals spot price compounded at the risk-free rate, adjusted for dividends, storage and convenience yield. It defines the no-arbitrage futures price.

Interest rate cap

A series of call options on a reference interest rate that pays the borrower when the rate exceeds the strike. It protects against rising rates while retaining the benefit of falling rates.

Covered interest arbitrage

Borrowing in the low-interest currency, investing in the high-interest currency and selling the proceeds forward. It enforces interest rate parity by eliminating the arbitrage profit.

Translation exposure

The accounting effect of exchange rate changes on a parent's consolidated financial statements when foreign subsidiary assets and liabilities are translated. It affects reported net worth, not cash flow directly.

Money market hedge

Hedging a foreign currency payable or receivable by borrowing or investing in the foreign currency today and converting at spot, locking in an effective exchange rate.

Economic exposure

The sensitivity of a firm's present value and long-run competitiveness to unexpected exchange rate changes. It affects future sales volumes, prices and costs, not just contracted cash flows.

International Fisher effect

The proposition that nominal interest rate differentials between countries equal expected inflation differentials, so real interest rates tend to equalise. It links inflation and exchange rate expectations.

American depositary receipt

A negotiable certificate issued by a depositary bank representing shares of a foreign company held in custody. It lets foreign firms access US capital markets and trade in dollars.

Country risk premium

An additional return demanded for investing in a foreign country, reflecting political instability, expropriation risk, currency controls and sovereign default risk. It is added to the base cost of equity.

Synergy

The increase in combined value from an acquisition beyond the sum of the standalone values of acquirer and target. Sources include cost savings, revenue gains, tax benefits and lower cost of capital.

Exchange ratio

The number of acquirer shares offered for each target share in a stock-for-stock merger. It equals the offer price per target share divided by the acquirer's share price.

Accretion and dilution

Whether a merger increases or decreases the acquirer's post-deal earnings per share. It depends on the target's earnings yield relative to the after-tax cost of the acquisition financing.

Spin-off

A restructuring in which a parent distributes shares of a subsidiary to existing shareholders pro rata, creating a separate listed entity. No cash is raised and ownership proportions are unchanged.