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December 2014–June 2015 Edition
STUDY SYSTEM
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ACCA
Paper P4 | ADVANCED FINANCIAL
MANAGEMENT
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ACCA
ADVANCED FINANCIAL MANAGEMENT P4
STUDY SYSTEM
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December 2014–June 2015 Edition
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Paper
P4
Contents
Page
introduction ...............................................................................................v
About this Study System ............................................................................v
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Syllabus.....................................................................................................vi
ACCA Study Guide .......................................................................................x
Formulae and tables .............................................................................. xvii
Examination technique ........................................................................... xxi
Sessions
Role of Financial Strategy ..................................................... 1-1
2
Security Valuation and the Cost of Capital ............................ 2-1
3
Weighted Average Cost of Capital and Gearing ..................... 3-1
4
Portfolio theory and CAPM ................................................... 4-1
5
Basic investment Appraisal .................................................. 5-1
6
Advanced investment Appraisal ........................................... 6-1
7
Business Valuation ............................................................... 7-1
8
Mergers and Acquisitions...................................................... 8-1
9
Corporate Reconstruction and Re-organisation ..................... 9-1
10
Equity issues .......................................................................10-1
11
Debt issues .........................................................................11-1
12
Dividend Policy ....................................................................12-1
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1
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
iii
Contents
Sessions
Page
Options................................................................................13-1
14
Foreign Exchange Risk Management ....................................14-1
15
interest Rate Risk Management ...........................................15-1
16
the Economic Environment for Multinationals .....................16-1
17
international Operations .....................................................17-1
18
Financial Statement Analysis ..............................................18-1
19
Glossary ..............................................................................19-1
20
index ..................................................................................20-1
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13
iv
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
Introduction
ABOut thiS StuDy SyStEM
This Study System has been specifically written for the Association of Chartered Certified
Accountants professional level examination, Paper P4 Advanced Financial Management
It provides comprehensive coverage of the core syllabus areas and is designed to be used
both as a reference text and as an integral part of your studies to provide you with the
knowledge, skill and confidence to succeed in your ACCA examinations
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About the author: Mike Ashworth is ATC International's lead tutor in financial management
and has more than 15 years' experience in delivering ACCA exam-based training.
How to Use This Study System
You should start by reading through the syllabus, study guide and approach to examining
the syllabus provided in this introduction to familiarise yourself with the content of this
paper.
The sessions which follow include the following features:
These are the learning outcomes relevant to the session,
as published in the ACCA Study Guide.
Session Guidance
Tutor advice and strategies for approaching each session.
Visual Overview
A diagram of the concepts and the relationships addressed
in each session.
Definitions
Terms are defined as they are introduced and larger groupings of terms will
be set forth in a Terminology section.
illustrations
These are to be read as part of the text. Any solutions to numerical
Illustrations are provided.
These extracts of external content are presented to reinforce concepts and
should be read as part of the text.
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Exhibits
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Focus
Examples
These should be attempted using the pro forma solution provided (where
applicable).
Key Points
Attention is drawn to fundamental rules, underlying concepts and
principles.
Exam Advice
These tutor comments relate the content to relevance in the examination.
Commentaries
These provide additional information to reinforce content.
Session Summary
A summary of the main points of each session.
Session quiz
These quick questions are designed to test your knowledge of the technical
content. A reference to the answer is provided.
Study question
Bank
A link to recommended practice questions contained in the Study Question
Bank. At a minimum, you should work through the priority questions
after studying each session. For additional practice, you can attempt the
remaining questions (where provided).
Example Solutions
Answers to the Examples are presented at the end of each session.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
v
Session 1
Role of Financial Strategy
FOCUS
This session covers the following content from the
ACCA Study Guide.
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A. Role and Responsibility Towards Stakeholders
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1. The role and responsibility of senior financial executive/advisor
a) Develop strategies for the achievement of the company's goals in line with its agreed
policy framework.
b) Recommend strategies for the management of the financial resources of the company
such that they are utilised in an efficient, effective and transparent way.
c) Advise the board of directors of the company in setting the financial goals of the business
and in its financial policy development.
2. Financial strategy formulation
d) Explain the theoretical and practical rationale for the management of risk.
e) Assess the organisation's exposure to business and financial risk including operational,
reputational, political, economic, regulatory and fiscal risk.
f) Develop a framework for risk management comparing and contrasting risk mitigation,
hedging and diversification strategies.
3. Conflicting stakeholder interests
a) Assess the potential sources of the conflict within a given corporate governance/
stakeholder framework informed by an understanding of the alternative theories of
managerial behaviour.
b) Recommend, within specified problem domains, appropriate strategies for the resolution
of stakeholder conflict and advise on alternative approaches that may be adopted.
c) Compare the emerging governance structures and policies with respect to the roles of the
financial manager.
4. Ethical issues in financial management
a) Assess the ethical dimension within business issues and decisions and advise on best
practice in the financial management of the organisation.
b) Demonstrate an understanding of the interconnectedness of the ethics of good business
practice between all of the functional areas of the organisation.
c) Establish an ethical financial policy for the financial management of the company
which is grounded in good governance, the highest standards of probity and is fully
aligned with the ethical principles of the Association.
d) Recommend an ethical framework for the development of a company's financial
policies and a system for the assessment of their ethical impact upon the financial
management of the organisation.
e) Explore the areas within the ethical framework of the company which may be undermined
by agency effects and/or stakeholder conflicts.
5. Environmental issues and integrated reporting
a) Assess the issues which may impact upon corporate objectives and governance.
b) Assess and advise on the impact of investment and financing strategies and decisions on
the organisations' stakeholders, from an integrated reporting and governance perspective.
G. Emerging Issues in Finance and Financial Management
1. Developments in world financial markets
a) Discuss the significance to the organisation of the international regulations on money
laundering.
(see ACCA Study Guide for expanded learning objectives)
P4 Advanced Financial Management
Becker Professional Education | ACCA Study System
VISUAL OVERVIEW
Objective: To introduce the role and operating environment of the senior financial
executive.
CORPORATE
OBJECTIVES
CORPORATE
GOVERNANCE
• Definition
• Around the
World
• SarbanesOxley Act
• Cadbury
Report
• Greenbury
Code
• Combined
Code
• Turnbull
Report
ETHICS
• Ethical
Contexts
• Ethical
DecisionMaking
• DecisionMaking Models
• Stakeholder
Conflicts
RISK
MANAGEMENT
• Should Risk Be
Managed?
• Equity-Debt
Investors'
Conflicts
• Types of Risk
• Managing
Exposure
• Framework
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• In Practice
• Shareholders'
Wealth
• Integrated
Reporting
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ROLE OF SENIOR FINANCIAL
EXECUTIVE
CONFLICTS OF
INTEREST
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• Agency Theory
• Stakeholders
• Directors and
Shareholders
• Transaction
Cost Theory
• Goal
Congruence
ENVIRONMENTAL ISSUES
AND INTEGRATED
REPORTING
• Sustainability
• TBL Reporting
• Carbon Trading
Economy
• Government
Environment Agencies
• Integrated Reporting
Session 1 Guidance
Recognise the role of an organisation's chief financial executive (s.1).
Understand a company's objectives (s.2) and how these objectives may conflict within a
principal-agent relationship (s.3).
Recognise the different approaches to corporate governance around the world—and the main
legislation (e.g. US Sarbanes-Oxley Act, UK Corporate Governance Code) (s.4).
Appreciate the relevance of integrated reporting (s.6) and risk management (s.7) to corporate
governance in an ethical environment (s.5).
Read the technical article "Risk Management".
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-1
Session 1 • Role of Financial Strategy
1
P4 Advanced Financial Management
Role of the Senior Financial Executive
The role of the senior financial executive or adviser encompasses
the following:
< Advising the board of directors in setting the financial goals of
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the business and in its financial policy development. Specific
areas include:
 Investment selection and capital resource allocation
(Sessions 5, 6 and 17);
 Minimising the firm's cost of capital (Session 3);
 Distribution and retention policy (Session 12);
 Communicating financial policy and corporate goals
to internal and external stakeholders (see later in this
session);
 Financial planning and control (Sessions 8, 9 and 18);
 The management of risk (Sessions 13–15).
< Developing strategies for the achievement of the firm's goals
in line with its agreed policy framework.*
< Recommending strategies to manage the financial resources
*Clearly, before any
strategies can be
developed for the firm
its objectives must be
identified.
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of the firm such that they are utilised in an efficient, effective
and transparent way.
< Establishing an ethical financial policy for the financial
management of the firm which is grounded in good
governance, the highest standards of probity and is fully
aligned with the ethical principles of the ACCA.
< Exploring the areas within the ethical framework of the
firm which may be undermined by agency effects and/or
stakeholder conflicts and establishing strategies to deal
with them.
< Preparing advice on personal finance to individual as well as
groups of investors, covering areas such as investment and
financing.
Corporate Objectives
2.1
Corporate Objectives in Practice
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In practice, companies are likely to have a variety of different
objectives which may include a number of the following:
<
<
<
<
<
<
<
1-2
profit targets;
market share targets;
share price growth;
local and environmental concerns;
contented workforce;
meeting short-term targets; and
long-term plans.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
P4 Advanced Financial Management
Session 1 • Role of Financial Strategy
These objectives can be classified as follows:
< Profit goals—objectives which lead directly to increased
profits (e.g. cost reduction measures);
< Surrogate profit goals—objectives which lead indirectly to
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increased profits (e.g. maintaining a contented workforce);
< Constraints on profit—objectives which actually restrict
profit (e.g. ensuring that the company's operations do no
harm to the environment);
< Dysfunctional goals—objectives which do not provide
a benefit even in the long run (e.g. the pursuit of market
leadership at all costs).
A company may aim at either maximising or satisficing these
objectives:
< Maximising involves seeking the best possible outcome;
< Satisficing involves finding an adequate outcome.
2.2 Maximisation of Shareholders' Wealth
In theoretical terms a single corporate objective is assumed and
this is "the maximisation of shareholder wealth".
Shareholder wealth is the combination of dividend and share
price growth—together referred to as Total Shareholder Returns
("TSR").
The objective of maximising shareholder wealth can be justified in
the following ways:
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The company which provides the highest returns for its
investors will find it easiest to raise new finance and grow in
the future. If a company does not provide competitive returns
it will inevitably decline.
The directors of a company have a legal duty to run the
company on behalf of the shareholders. It is generally
considered a reasonable assumption that the shareholders
of listed companies (mainly institutional investors) seek to
maximise wealth.
Criticisms of the above include the following:
Maximising TSR ignores the interests of other stakeholders
such as employees, customers and arguably, society as a
whole.
In the case of unlisted companies even the shareholders
may not require maximised returns (e.g. some closely held
companies are run as "life-style firms" whose main objective is
to create prestige for the owners).
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-3
Session 1 • Role of Financial Strategy
2.3
P4 Advanced Financial Management
Integrated Reporting
< The International Integrated Reporting Council (IIRC) is a
Integrated
report—a concise
communication about
how an organisation's
strategy, governance,
performance and
prospects, in the
context of its external
environment, lead
to the creation of
value over the short,
medium and long
term.
Capitals—the
resources and
relationships used
and affected by an
organisation.
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<
*The IIRC launched a
new <IR> Framework
in December 2013.
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<
global coalition of regulators, investors, companies, standard
setters, the accounting profession and non-government
organisations. It has a vision of a business environment in
which integrated thinking is ingrained in mainstream business
practice, in both public and private sectors. This would be
facilitated by integrated reporting.*
The goals of integrated reporting are:
 to improve the quality of information available to providers
of financial capital;
 to promote a more cohesive and efficient approach to
corporate reporting;
 to enhance accountability and stewardship for all forms of
capital;
 to promote the understanding of the interdependencies
among the various capitals; and
 to support integrated thinking in decision-making and
actions which create value.
Capitals include—Definition
 Financial—The pool of funds that is:
— available for use in the production of goods or provision
of services; or
— obtained through financing.
 Manufactured—Manufactured physical objects that are
distinct from natural physical objects (e.g. buildings,
equipment and infrastructure).
 Intellectual—Organisational, knowledge-based intangibles.
 Human—People's competencies, capabilities and experience
and their motivations to innovate.
 Social and Relationship—The institutions and the
relationship within and between communities, groups of
stakeholders and other networks, and the ability to share
information to enhance individual and collective well-being.
 Natural—All renewable and non-renewable environmental
resources and processes that provide goods or services
that support the past, current or future prosperity of an
organisation.
The purpose of the <IR> Framework is to provide principles
and content elements that help:
 to shape the information provided; and
 to explain why the inclusion of the information provided is
important.
The <IR> Framework challenges an organisation to recognise
the needs of multiple stakeholders when making financial
and investment decisions. In particular, an integrated report
should enhance the transparency of an organisation.
<
<
1-4
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
P4 Advanced Financial Management
3
Session 1 • Role of Financial Strategy
Conflicts of Interest
3.1 Agency Theory
Agency theory examines the duties and conflicts that occur
between the parties in a company that have an agency
relationship.
Loan creditors
Directors
Employees
Shareholders
Generate maximum
return for
shareholders
Work to
maximum
efficiency
Minimum risk
from uses of
borrowed funds
AGENT
AGENT'S RESPONSIBILITY
Directors
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Shareholders
PRINCIPAL
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A company can be viewed as a set of contracts between each
of these various interest groups. The company will not succeed
unless all of the groups are working towards the same objectives.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-5
Session 1 • Role of Financial Strategy
3.2
P4 Advanced Financial Management
Stakeholders
Companies are made up of a variety of different interest groups or
"stakeholders", all of whom are likely to have different interests in
and objectives for the company:
• Maximum Wealth
DIRECTORS
• Remuneration
• Power
• Esteem
EMPLOYEES
• Pay and Conditions
• Job Security
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EQUITY
SHAREHOLDERS
Company
LOAN CREDITORS
• Short-Term Cash
Flow
COMMUNITY
• Environmental
Issues
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• Security
• Cash Flow
• Long-Term
prospects
TRADE
CREDITORS
While shareholders are clearly the key stakeholder, modern
corporate governance suggests that directors should take into
account the objectives of a wider range of interested parties.
Directors are therefore expected to show responsibility:
Sa
< to creditors (e.g. reasonable payment terms);
< to employees (e.g. health and safety); and ultimately
< to society as a whole (e.g. minimising pollution, investing in
social projects).*
Therefore the overall corporate objective may become "satisficing"
(i.e. producing satisfactory rather than maximum returns for
shareholders). With the rise of the "ethical investor" on world
stock markets, it appears that many shareholders are in fact
willing to accept slightly lower returns in exchange for their
companies following a wide range of both financial and nonfinancial objectives.
1-6
*This is encompassed
by corporate social
responsibility (CSR).
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
P4 Advanced Financial Management
Session 1 • Role of Financial Strategy
3.3 Directors and Shareholders
In larger companies the shareholders entrust the management
of the company to the directors—referred to as the separation
of ownership and control. The directors are managing the
company on behalf of the shareholders and should therefore
always act in the best interests of the shareholders, while taking
into account the objectives of other stakeholder groups.
This may not always be the case, as the directors may have other
personal objectives such as:
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< increasing personal remuneration levels;
< maximising bonus payments;
< empire building;
< job security.
In addition to the personal aspects shown above, a small number
of directors have been guilty of not fulfilling their fiduciary duties
by:
< creative accounting; by choosing creative accounting policies
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the directors can flatter the accounts­—known as "window
dressing".
< off balance sheet finance (e.g. via the use of "special purpose
vehicles").
< takeovers; in defending the company from takeovers some
directors have been accused of trying to protect their own jobs
rather than acting in the interests of their shareholders.
< disregard for environmental issues; directors may allow
processes which emit pollution or test products on animals.
If directors follow personal objectives which conflict with those of
their shareholders this leads to "agency costs" (i.e. lost potential
returns for shareholders). This can be referred to as "the agency
problem".
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Good corporate governance procedures should be implemented
to minimise the effect of agency costs. Unfortunately, the
implementation of corporate governance brings its own costs
(particularly in the case of the Sarbanes-Oxley Act) and hence
a cost-benefit approach should be followed to determine an
appropriate level of control over directors.
It can be argued that:
Actual return to shareholders = maximum potential return –
agency costs – costs of CSR
To some degree shareholders themselves should be more active
in monitoring the behaviour of directors. Most shares in listed
companies are held by institutional investors (e.g. pension
funds). Fund managers have often been guilty of operating in a
very passive way, for example not even using the proxy voting
rights given to them by the fund's investors. Until there is a rise
in shareholder activism it remains likely that some directors will
continue to work in their own best interest.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-7
Session 1 • Role of Financial Strategy
P4 Advanced Financial Management
3.4 Transaction Cost Theory
< Initially considered by Ronald Coase (1937), transaction
Sa
m
pl
e
costs were first defined in purely economic terms as the costs
incurred in making an "economic exchange with an external
third party". These include:
 search and information costs (e.g. determining who has
the goods and services available, terms and conditions and
prices charged by different suppliers);
 bargaining costs (e.g. negotiating prices, terms and
conditions, reaching an acceptable agreement, drawing up
contracts); and
 policing and enforcement costs (e.g. ensuring that there
is no breach of contract and seeking redress if there is).
< Coase argued that these market-based transactions (and
costs) can be eliminated in a firm. Firms should therefore
tend towards vertical integration (i.e. acquire suppliers and
distributors) as this would remove such costs and the risks
and uncertainties of dealing with external sources. Ultimately,
the market would be replaced by one firm.
< The underlying assumption made by Coase was that
managers make rational decisions for the primary aim of
profit maximisation. Further work by Cyert and March (1963),
Williamson (1966) and others considered that a firm consists
of people with differing views and objectives. They also
extended the concept of transactions from merely buying and
selling to include intangible elements (e.g. promises made and
favours owed).
< They also considered managers to behave rationally, but only
up to a certain point, as like all human beings they are also
opportunistic. As agents they take advantage of opportunities
to further their own self-interest and privileges.
< Although managers would organise transactions for the firm's
benefit, there would come a point (e.g. when it is worth
the risk and they do not expect to be caught) when certain
transactions and opportunities would be organised to the
manager's benefit.
< Consequently, principals (shareholders) need to ensure that
transactions maximise the benefit to the company while
minimising the potential for opportunism by agents.
1-8
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P4 Advanced Financial Management
3.5
Session 1 • Role of Financial Strategy
Goal Congruence
Goal congruence is when each of the parties in an organisation is
seeking to achieve personal objectives which are also in the best
interests of the company as a whole.
For example, managers should be encouraged to aim for longterm growth and prosperity rather than short-term reported
profitability.
Methods of encouraging goal congruence between directors and
shareholders:
< Executive Share Option Plans (ESOPs)—although the
<
4
pl
e
<
<
Corporate Governance
m
<
evidence is mixed regarding the success of such schemes
in motivating directors to improve performance (e.g. a
company's share price may rise due to a general rise in the
stock market rather than the quality of its management).
Long-Term Incentive Plans (LTIPs)—paying a bonus to
directors if over several years the company's performance is
good when benchmarked against that of competitors.
Transparency in corporate reporting.
Improved corporate governance (e.g. through the
appointment of truly independent non-executive directors).
Increased shareholder activism (e.g. using voting rights).
4.1
Corporate governance—the system by which companies are
directed and controlled.
Sa
The objective of corporate governance may be considered as the
reduction of agency costs to a level acceptable to shareholders.
4.2
Corporate Governance Around the World
4.2.1
UK*
<
<
<
<
Cadbury Report (see s.4.4)
Greenbury Code (see s.4.5)
Combined Code (see s.4.6)
Turnbull Report (see s.4.7)
4.2.2
US
< SEC imposes quarterly reporting requirements.
< Audit committees required for all listed companies.
< Sarbanes-Oxley Act introduced in 2002 as a response to
*Since 2010 the
provisions of
these have been
incorporated in the UK
Corporate Governance
Code ("the Code").
a series of high-profile corporate scandals (e.g. Enron,
WorldCom, Global Crossing and Tyco International).
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-9
Session 1 • Role of Financial Strategy
P4 Advanced Financial Management
4.2.3Germany
< Two-tier board system—separate management and
supervisory board.
< Banks providing credit often have long-term equity holding.
4.2.4Japan
< Traditionally, companies doing business together would hold
shares in each other although this system is now reducing.
< Three-tier board system—policy, functional and monocratic.
4.3 Sarbanes-Oxley Act
pl
e
Introduced in 2002, the Sarbanes-Oxley Act ("SOX") represents
the most significant review of US corporate governance since the
Securities Exchange Act of 1934.
SOX imposes new responsibilities on chief executive officers
(CEOs) and chief financial officers (CFOs) and exposes them to
much greater potential liability.
It applies to all companies listed on a US stock market—including
their foreign subsidiaries. Compliance is mandatory.
One of the main provisions is that the CEO and CFO should sign
off personally on company accounts. Fraudulent certification
(i.e. signing accounts known to be inaccurate) leads to criminal
penalties—fines of up to $5 million and up to 20 years in prison.
m
However, some CEOs and CFOs have tried to avoid their
responsibilities under SOX by asking divisional heads to certify
their division's accounts before they are sent to the head office.
Furthermore, the level of detail required in reporting compliance
with SOX is very high. Such high compliance costs have
discouraged many companies from listing their shares in New
York—often choosing London, where corporate governance codes
are based more upon principles than detail.
4.4 Cadbury Report
Sa
The Cadbury Committee was set up in 1991 to review aspects of
corporate governance—specifically related to financial reporting
and accountability.
The Cadbury Report was published in 1992 and the boards of all
UK listed companies had to comply with the Code of Best Practice
contained in the report.
Main provisions of the Code include:
< Board of directors:
 meet
regularly;
executive management;
 division of responsibility at head of company;
 include non-executive directors ("NEDs").
< Non-executive directors:
 bring independent judgement to matters of strategy,
performance, resources;
 should sit on remuneration committee.
 monitor
1-10
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P4 Advanced Financial Management
Session 1 • Role of Financial Strategy
< Executive directors:
 service
contracts not exceeding three years;
subject to recommendations of remuneration
committee;
 total emoluments disclosed fully and clearly.
< Audit committee:
 made up of at least three NEDs;
 liaise with external auditors;
 recommend appointment and fees of external auditor;
 review company statement on internal controls.
< Directors statements:
 must report on effectiveness of company's system of
internal control;
 should report that company is a going concern.
4.5 Greenbury Code
pl
e
 pay
The Greenbury Committee (formally known as The Study Group
on Directors' Remuneration) issued its report in 1995 covering
best practice recommendations in the realm of executive and
director compensation. Its principles have drawn far more
criticism than those drafted by Cadbury, but institutional investors
in Britain accept the main points as valuable. The Greenbury
Code includes the following key recommendations:
Sa
m
The compensation committee should be composed exclusively
of independent outsiders.
Companies should annually outline their compliance with the
Greenbury Code, including explanations if they do not comply.
The annual compensation committee report should disclose
pay details for all executive directors, including pension
provisions, incentive pay, option plans, performance
measurements, severance agreements and comparisons with
similar companies.
Executive pay should not be "excessive".
Employment contracts should extend for no longer than one
year so as to rule out multiyear golden handshake payouts in
the event an executive is dismissed or the company is taken
over.
New long-term incentive plans should replace, not
supplement, existing stock option plans.
Performance-related pay should "align the interest of directors
and shareholders", while performance criteria should be
"relevant, stretching and designed to enhance the business.
Upper limits should always be considered".
Executive stock option awards should be phased rather than
given all at once, and options should never be awarded at a
discount.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-11
Session 1 • Role of Financial Strategy
P4 Advanced Financial Management
4.6 Combined Code
The Combined Code of the Committee on Corporate Governance
was first issued in June 1998 and revised in July 2003. In many
ways it is derived from the Cadbury and Greenbury Codes.
The Combined Code is included in the Listing Rules of the London
Stock Exchange. Although compliance is not obligatory, any listed
company which does not comply with the Combined Code must
explain its reasons for non-compliance.
It sets out the following UK Principles of Good Governance:
m
pl
e
Every listed company should be headed by an effective board
which should lead and control the company.
Chairman and CEO—there should be a clear division of
responsibilities at the head of the company between running
the board and running the business; no single individual
should dominate.
The board should have a balance of executive and
independent non-executive directors.
All directors should be required to submit themselves for
re-election at least every three years.
Remuneration committees should be 100% independent
non-executive directors.
Remuneration committees should provide the packages
needed to attract, retain and motivate executive directors and
avoid paying more.
Executive service contracts should be for one year or less.
No director should be involved in setting his own
remuneration.
4.7 Turnbull Report
Issued in 1999 to give implementation guidance on aspects of the
Combined Code dealing with internal control, internal audit and
risk management.
Sa
It states that "the board should maintain a sound system of
internal control to safeguard shareholders' investment and the
company's assets".
The key objective of the Turnbull report was to reflect best
business practice by adopting a risk-based approach to designing,
operating and maintaining a sound system of internal control.
The guidance it offers is based on a framework of principles rather
than checklists. It also encourages making meaningful disclosure.
Instead of specifying particular controls for all companies, the
report requires the board of directors of listed companies to
identify those risks that are significant to the fulfilment of their
particular corporate business objectives and to implement a sound
internal control system to manage these effectively. This requires
the board to have a clear understanding of the company's longterm strategic aims.
1-12
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P4 Advanced Financial Management
Session 1 • Role of Financial Strategy
Illustration 1 Corporate
Governance
Briefly explain what is meant by corporate governance and discuss
the major differences that exist between corporate governance
practice in the UK, US and Japan.
Solution
pl
e
Corporate governance is the system by which companies are
controlled. In the UK this is the responsibility of the directors.
The function of the director is the high-level management of the
company, strategy, etc and reporting the performance of the
company to the owners. The auditors provide a check on the
accuracy of financial statements and help to satisfy the owners that
a system of corporate governance exists.
The actions of the directors of course affect all interest groups not
just the business owners. Their general behaviour is governed by
the articles of association but there exists also a body of civil and
criminal law which can restrict their actions. This body of law is
much larger in the US than in the UK; UK directors are more subject
to voluntary codes of conduct; and the Cadbury Report in the UK has
suggested that this may be the most effective way of introducing
controls. In addition to conventional laws and codes of conduct, the
behaviour of directors is also "controlled" by the stock exchanges;
again the rules of the New York exchange (SEC) are much more
comprehensive than in London.
m
As one would expect, the culture of Japan is reflected in its approach
to corporate governance. No detailed framework or system of laws
exists. Everybody is expected to work together for the good of
the company and not for the shareholders alone. The system is
therefore, in principle, more flexible and responsive.
Boards are often split into different levels, each with its own remit,
for example:
(i)
Policy boards responsible for strategy.
(ii) Functional boards where senior management discusses the main
functional responsibilities.
(iii) Monocratic boards, which tend to be symbolic and have few
actual functions.
Sa
In Japan, a close relationship exists between the banks and their
clients; banks usually have board representation and take an
active role in decision-making. The US is more of a middle ground
where creditors or other corporations may be represented. The UK
companies tend to be the most insular.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-13
Session 1 • Role of Financial Strategy
P4 Advanced Financial Management
5
Ethics
5.1
Ethical Contexts for the Financial Executive
or Adviser
5.1.1
Main Components
Act with integrity.
Be a credit to the profession.
Use independent professional judgement.
Be competent.
5.1.2
Fundamental Responsibilities
pl
e
<
<
<
<
< Know and comply with laws, regulations, ethical codes and
professional standards.
< Do not knowingly participate or assist others in any violation
of applicable regulations or ethical codes.
5.1.3
Relationship With the Profession
< Use ACCA designation with dignity.
< Do not engage in any act which adversely reflects on one's
honesty, trustworthiness or professional competence.
< Do not plagiarise.
Relationship With the Employer
m
5.1.4
Members must inform employers of their obligation to comply with
the ACCA Code of Ethics and Standards of Professional Conduct.
They must:
< Not undertake any independent practice in competition with
Sa
their employer without their employer's consent and the
consent of the client.
< Disclose to their employer all matters that could be
reasonably expected to impair their ability to render an
unbiased and objective opinion.
< Disclose to their employer all monetary and other benefits
received for services other than the usual compensation paid
by their primary employer.
5.1.5
Interaction With Clients
Members must:*
< place their client's interest before their own;
< have a reasonable and adequate basis for stating opinions;
< use reasonable judgement to include relevant facts,
distinguish between fact and opinion and use independence
and objectivity in making opinions.
1-14
*This is particularly
relevant to financial
advisers.
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P4 Advanced Financial Management
5.1.6
Session 1 • Role of Financial Strategy
Compliance With Anti–Money-Laundering Legislation
In many countries professionals, such as accountants, are
required by law to report any suspicion of money laundering. For
reference, the basic provisions of UK law are given below.
The Proceeds of Crime Act 2002 contains the UK anti-moneylaundering legislation, including provisions requiring businesses in
the "regulated sector" (banking, investment, money transmission
and professions such as accountancy) to report to the authorities
suspicions of money laundering by customers or others.
pl
e
Money laundering is defined in the UK as any handling of the
proceeds of any crime, including any process by which proceeds
of crime are concealed or disguised so that they may be made to
appear to be of legitimate origin.
Unlike certain other jurisdictions (notably the US and much of
Europe), UK money-laundering offences are not limited to the
proceeds of serious crimes, nor are there any monetary limits.
A money-laundering offence under UK legislation need not involve
money, since the legislation covers assets of any description.
Therefore any person who commits an acquisitive crime (i.e. one
from which he obtains some benefit in the form of money or an
asset of any description) in the UK will inevitably also commit a
money-laundering offence under UK legislation.
This applies also to a person who, by criminal conduct, evades
a liability (e.g. a taxation liability) as he is deemed thereby to
obtain a sum of money equal in value to the liability evaded.
5.1.7
m
The consequence of the act is that accountants who suspect that
their clients (or others) have engaged in tax evasion or other
criminal conduct are required to report their suspicions to the
authorities.
International Aspects
Specific ethical issues may arise for businesses operating
overseas. The following questions may have to be faced:
< Should "facilitation payments" be made to local officials
Sa
to overcome problems with "red tape" (e.g. for customs
clearance)?
Is it acceptable to use transfer pricing internationally to
minimise tax liabilities?
Should assets be transferred into offshore companies to shield
them from capital gains tax on disposal?
If laws overseas are more relaxed than at home (e.g.
regarding the employment of child labour) should the
company follow the more relaxed local laws or apply the
business practices of its home country?
Sensitivity to local business practices (e.g. in the Islamic
world Shariah law prohibits the payment/receipt of interest
and investing in "immoral" activities, such as alcohol and
gambling. Raising debt finance may still be possible through
the issue of sukuk Islamic bonds which claim Shariah
compliance through paying returns based on a profit share of
the underlying project, as opposed to a market-based interest
rate.)
<
<
<
<
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
There may be no
right or wrong answer
to such questions
but the examiner
expects an opinion to
be expressed in the
exam.
1-15
Session 1 • Role of Financial Strategy
5.2
P4 Advanced Financial Management
Ethical Decision-Making
There are many models and approaches for the classification and
description of moral and ethical decision-making. For example:
< Rest's four-component model;
< Albrecht's Ethical Development Model (EDM); and
< IAESB Ethics Education Framework.
5.2.1
Rest's Model
< This four-component model is as follows:
It must be recognised that there is a moral issue
involved. The decision-maker must be able to
appreciate that the selection of a particular course
of action will affect the welfare of other
interested parties.
Step 2
The decision-maker must be able to select an
appropriate action.
Step 3
The decision-maker must attach priority to moral
values, rather than, for example, acting out of
self-interest.
Step 4
The decision-maker must have sufficient moral
strength to implement the resolution identified in
the previous steps.
pl
e
Step 1
m
Based on Rest, 1986
Illustration 2 Charitable
Contributions
The decision of a company not to make a donation to a charity could
be based on prejudice or self-interest. This is not then a moral
decision.
Sa
Alternatively, it could be based on an ethical position that supporting
the charity may help the plight of those who are disadvantaged and/
or prevent others suffering similarly.
Whether a donation is made does not give insight into the motive. A
donor may give without much thought through embarrassment or a
belief that it is wrong to rebut a call for help. The decision could be
motivated by a considered ethical stance or by self-interest or some
other non-ethical position.
5.2.2
Albrecht's Ethical Development Model (EDM)
< The Ethical Development Model (EDM) is another progressive
model which sets out the life development of an ethical
perspective. Developed by Albrecht et al. it has four levels:
(1) Personal ethical
understanding
A foundation level. Appreciates the difference between
right and wrong and understands the basic principles of
integrity and empathy.
(2) Application of
ethics to business
situations
This is the first of two levels in which professional education
has a role to play in translating and applying ethics to the
business context.
1-16
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P4 Advanced Financial Management
Session 1 • Role of Financial Strategy
(3)Ethical courage
This requires individuals to develop ethical strength and
moral conviction to act appropriately in "questionable"
situations.
(4)Ethical leadership
Building on (3) this calls for "ethical leadership" and the
capacity to inspire others to develop their own ethical
awareness.
5.2.3 IAESB Ethics Education Framework
< The International Accounting Education Standards Board
v
Re
iew
i
Rev
•
Developing
Ethical Sensitivity
Maintaining an
Ongoing Commitment
to Ethical Behavior
Sa
se
•
2
3
m
Enhancing
Ethics Knowledge
e
vis
Re
1
4
pl
e
(IAESB) is an independent standard-setting board of the IFAC.
< The Ethics Education Framework as developed by the IAESB is
a four-stage learning continuum to be applied by all professional
accountants throughout their careers.
Ethical knowledge—obtaining
an understanding of the
fundamental theories and
principles of ethics, virtues and
individual moral development.
Ethical sensitivity—applying
the knowledge to the work
environment, to enable ethical
threats to be recognised.
Improving
Ethical Judgement
ew
Revi
•
•
Ethical judgement—applying
knowledge and sensitivity
to form reasoned and wellinformed decisions.
Ethical behaviour—continuous
believing in, applying and
acting on ethical principles.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-17
Session 1 • Role of Financial Strategy
P4 Advanced Financial Management
 Ethical sensitivity and ethical judgement require professional
accountants to develop:
ability to recognise an ethical threat or issue;
 an awareness of alternative courses of action leading to an
ethical solution; and
 an understanding of the effects of each alternative course of
action on stakeholders.
 Doing so improves professional judgement by sharpening
ethical decision-making skills through the application of ethical
theories, social responsibilities, codes of professional conduct
and ethical decision-making models (EDMM).
 the
5.3.1 Issues Addressed
pl
e
5.3 Ethical Decision-Making Models (EDMM)
< The two basic issues in ethics are determining:
 the
right motive; and
right action.
< EDMMs have been developed from conceptual approaches,
to provide a method of practically applying a framework to
resolve ethical dilemmas.
 the
< The role of EDMMs is to provide a more systematic analysis
enabling comprehensible judgement, clearer reasons and
a justifiable and more defensible action than would have
otherwise been the case.
m
5.3.2 American Accounting Association (AAA)
< The AAA model frames the ethical decision as a series of
answers to questions and requires the user to explicitly outline
their norms, principles and values. The model is appropriate
for use when considering professional or individual ethical
conflicts.
< The questions to be answered are:
(1) What are the facts of the case?
Sa
(2) What are the ethical issues in the case?
(3)What are the norms, principles and values related to the
case?
(4) What are the alternative courses of action?
(5)What is the best course of action that is consistent with
the norms, principles and values identified in (3) above?
(6)What are the consequences of each possible course of
action?
(7) What is the decision?
1-18
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P4 Advanced Financial Management
Example 1
Session 1 • Role of Financial Strategy
AAA Model
You are the chief executive of a company which depends heavily on government contracts. You
have been approached by the fundraiser for a political party candidate. He asks you for a large
contribution, strongly implying that if this candidate wins the election it will increase your ability
to win government contracts. You do not prefer the candidate, either personally or from a
business perspective.
Required:
Use the AAA model to determine whether the contribution should
be made.
1. What are the facts of the case?
pl
e
2. What are the ethical issues in the case?
3. What are the norms, principles and values related to the case?
4. What are the alternative courses of action?
5. What is the best course of action that is consistent with the norms,
principles and values identified in No. 3. above?
6. What are the consequences of each possible course of action?
7. What is the decision?
Sa
m
Solution
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1-19
Session 1 • Role of Financial Strategy
5.3.3
P4 Advanced Financial Management
Tucker's 5-Question Model
< Five questions about a business decision must be answered in
the affirmative to confirm that it is ethical. Is the decision:
(1) Profitable (But compared to what?)
(2)
Legal (What framework was used?)
(3)
Fair (From whose perspective? Consider stakeholders.)
(4)
Right (Based on what ethical position?)
(5)
Sustainable (Or environmentally sound?)
< Tucker's model actually creates more questions than it asks.
Example 2
Tucker's Model
pl
e
It encourages debate over conflicting ethical approaches, the
stakeholders involved and sustainability and is therefore more
appropriate to use when considering organisational problems
rather than professional or individual situations.
Your company owns a number of large properties in various major cities. The real
estate assessor in one city offers, for a fee, to underestimate the value of your
building and so you will save substantial annual taxes assessed on property value.
This is common practice in the region.
Required:
Use Tucker's model to determine whether you ought to pay the fee.
Sa
m
Solution
1-20
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P4 Advanced Financial Management
Session 1 • Role of Financial Strategy
5.3.4ACCA Ethical Conflict Resolution
 Under the ACCA's Code of Ethics and Conduct, professional
accountants should consider:
relevant facts;
 the ethical issues involved;
 related fundamental principles;
 established procedures of the firm;
 the action that can be followed and the probable outcome;
 alternative courses of action and their consequences; and
 internal and external sources of consultation available (e.g.
ethics partner, audit committee).
 If a significant conflict cannot be resolved, consulting
legal advisers and/or ACCA should be considered. Such
consultation can be taken without breaching confidentiality.
 If, after exhausting all possibilities, the ethical conflict remains
unresolved, members should, where possible, refuse to remain
associated with the matter creating the conflict.
pl
e
 the
5.3.5 Institute of Business Ethics (IBE)
 The IBE, a UK charity registered in 1986, promotes three
m
simple ethical tests for a business decision:
 Transparency:Do I mind others knowing what I have
decided?
 Effect:
Who does my decision affect or hurt?
 Fairness:
Would my decision be considered fair?
5.4 Agency Issues and Stakeholder Conflicts
The ability of an organisation's management to implement its
ethical framework can potentially be undermined by agency issues
and conflicts between stakeholder groups. Management needs to
identify and resolve conflicts quickly so as to avoid a potentially
damaging public debate about the organisation's ethics.
Sa
5.4.1 Agency Issues
Agency issues are particularly likely in the case of a quoted
company where there is significant divorce of ownership and
control. The directors (as agents) are in a quite different ethical
position compared with their shareholders (the principal) as:
 the directors' ethical performance is scrutinised by the public
and potentially by investigative journalists. Any alleged
wrongdoing can lead to serious damage to a director's
personal reputation;
 the shareholders, being separate from the running of the
business, cannot be easily held responsible for any ethical
lapses in the company. Furthermore, most shares in quoted
companies are held by institutional investors who will have
their portfolios diversified across many companies.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-21
Session 1 • Role of Financial Strategy
P4 Advanced Financial Management
Therefore, company directors (and indeed the entire workforce)
may tend to take a very cautious approach towards ethics, even
verging on paranoia, as their own reputation is very closely linked
to that of their firm. Institutional investors, on the other hand,
may take a more relaxed view of ethics as they are shielded
from personal scrutiny and, in any case, would only hold a small
percentage of their fund's wealth in the shares of one particular
company.
If the directors come under pressure from shareholders to relax
the firm's ethical guidelines then appropriate responses could
include:
< quoting relevant legislation (e.g. if the firm is US-based, the
5.4.1
Stakeholder Conflicts
pl
e
<
Foreign Corrupt Practices Act prohibits the payment of bribes
anywhere in the world);*
encouraging "ethical investment funds" to take shareholdings
in the firm, whose ethical stance is more likely to be aligned
with that of the directors.
*Large fines can
be imposed for
contravening.
Although shareholders are a firm's key stakeholder, there are also
potential conflicts with other groups:
< Consumers may boycott the firm's products if it is discovered
m
<
that the products were made in exploitative working
conditions. A strategy to mitigate this risk could be to arrange
manufacturing through a subcontractor.*
Governments may "attack" firms that use aggressive tax
avoidance schemes. For example, the UK government has
strongly criticised Google, Amazon and Starbucks for complex
schemes, such as the "double Irish with a Dutch sandwich",
that avoid taxable profits being recorded in the UK. A possible
defence is to highlight the amount of sales tax and payroll tax
that the firm collects on behalf of the government.*
*However, this is
no guarantee of
isolating the firm from
reputational risk.
*Or, as in the case of
Starbucks, making a
voluntary payment of
profit tax.
Environmental Issues and Integrated Reporting
6.1
Sustainability
Sa
6
Sustainability—"… not a fixed state of harmony, but rather a
process of change in which the exploitation of resources, the direction
of investments, the orientation of technological development and
institutional change are made consistent with future as well as present
needs."
Sustainable development—"a business approach that creates longterm shareholder value by embracing opportunities and managing
risks from economic, environmental and social developments."
Sustainable development—"development that meets the needs of
the present without compromising the ability of future generations to
meet their own needs."
1-22
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
P4 Advanced Financial Management
Session 1 • Role of Financial Strategy
Examples of sustainable development:
< Using or adapting existing facilities, rather than building "from
<
scratch".
Environmentally friendly building and design.
Minimisation of adverse effects on nearby residents.
Protection of native vegetation (e.g. forests, wetlands, fauna).
Minimisation of waste with recycling encouraged.
Minimisation of energy use (e.g. solar power).
Minimisation of pollution (or cleaning up if it exists).
Construction on "brownfield sites" (i.e. those previously used
as industrial/commercial sites)—leaving "greenfield" (i.e.
undeveloped) land untouched.
Integrated reporting emphasises the importance of financial
ability and sustainability for an organisation's success.
6.2
pl
e
<
<
<
<
<
<
<
Triple Bottom Line Reporting ("TBL" or "3BL")
< The phrase was coined by John Elkington, co-founder of
the business consultancy SustainAbility. It is an expanded
baseline for measuring performance.
< Triple bottom line accounting attempts to measure and
Advantages
m
<
report corporate performance against economic, social and
environmental benchmarks in order to show improvement or
to make more in-depth evaluation.*
It can be viewed as:
 a reporting device (e.g. information presented in annual
reports); and/or
 an approach to improving decision-making and the activities
of organisations (e.g. by providing tools and frameworks
for considering the economic, environmental and social
implications of decisions, products, operations, future
plans).
Sa
Makes transparent the organisation's
decisions that explicitly consider effects
on the environment and people, as well
as on financial capital.
More informed decision-making as
decision-makers can quantify tradeoffs between different aspects of
sustainability.
Improved relationships with key
stakeholders and improved riskmanagement through consultation.
Specific commercial advantages (e.g.
competitive advantage with customers
suppliers and providers of finance).
Enhancement of reputation and brand.
May result in attracting and retaining
employees with sustainable values.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
*There is also a move
to add governance
to the bottom line,
making "Quadruple
Bottom Line reporting".
Disadvantages
There are currently few standards for
measuring these effects.
Usefulness and comparability, as there
is a significant range of disclosure
(content and quality).
The difference between the economic
bottom line and the financial bottom line
is often blurred.
Increase in annual reporting costs
with disproportionate costs for smaller
entities.
Potential exposure to risk and liability
relating to the reliability of the report's
content (unless audit is mandatory).
Potential bias in voluntary presentation
(e.g. including only favourable
information).
1-23
P4 Advanced Financial Management
pl
e
Session 1 • Role of Financial Strategy
< Such indicators can distil complex information into a form
Sa
m
<
which is accessible to stakeholders. (Organisations report
on indicators that reflect their objectives and are relevant to
stakeholders.)
One difficulty in identifying and using indicators is consistency
in an organisation, over time and between organisations at
any point in time (important for benchmarking).
1-24
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
P4 Advanced Financial Management
Example 3
Session 1 • Role of Financial Strategy
TBL Reporting
The board of directors of Triple Tipple plc are discussing whether to adopt a triple bottom line
(TBL) reporting system, increasingly used by the firm's competitors. The board would like to
demonstrate the firm's commitment to sustainable development but is concerned that the costs
of TBL reporting would exceed the benefits, particularly as TBL reporting is not mandatory for
external reporting purposes.
Required:
(a) Explain what TBL reporting involves and how it would help demonstrate Triple
Tipple's sustainable development. Include examples of measures that can be
used in a TBL report. (8 marks)
pl
e
(b) Discuss how producing a TBL report may help management improve the financial
performance of the firm, providing examples where appropriate. (10 marks)
Solution
Sa
(b)
m
(a)
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-25
Session 1 • Role of Financial Strategy
P4 Advanced Financial Management
6.3The Carbon Trading Economy
< The carbon trading economy has emerged in which
pl
e
governments allocate each polluting firm a quota of the
number of tonnes of greenhouse gasses that it can emit. If a
firm then switches to "greener" production techniques it may
find it has a surplus of carbon credits which can then be sold
to a firm that is exceeding its quota (i.e. carbon trading).
< Economist Craig Mellow wrote in May 2008: "The combination
of global warming and growing environmental consciousness is
creating a potentially huge market in the trading of pollutionemission credits."
< 23 multinational corporations came together in the G8 Climate
Change Roundtable at the 2005 World Economic Forum. The
group included Ford, Toyota, British Airways, BP and Unilever.
The group published a statement stating that there was a
need to act on climate change and stressing the importance of
market-based solutions.
< The Kyoto Protocol created mandatory trading of carbon
dioxide emissions and London has established itself as the
centre of a market valued at $60 billion in 2007.
6.4Government Environment Agencies
< The UK Environment Agency's stated purpose is "to protect or
Sa
m
enhance the environment, taken as a whole" so as to promote
"the objective of achieving sustainable development".
< The Agency is the main regulator of discharges to air,
water and land—under the provisions of a series of acts of
Parliament. It does this through the issue of formal consents
to discharge or, in the case of large, complex or potentially
damaging industries, by means of a permit.
< Failure to comply with such a consent or permit or making a
discharge without consent can lead to criminal prosecution. If
prosecuted in the Crown Court, there is no limit on the amount
of the fine and sentences of up to five years' imprisonment
may be imposed on those responsible for the pollution or on
directors of companies causing pollution.
6.5 Integrated Reporting and the Environment
< The "environment" to be addressed in integrated reporting
includes factors affecting the external environment: the legal,
commercial, social, environmental and political contexts that
affect the organisation directly or indirectly.
< The environmental factors to be included in the integrated
report are:
= those that influence the particular organisation, the industry
or region of the organisation; and
= those affecting the global economy.
< Integrated reporting:
presents the link between a company's financial
management and its social and environmental capital, and
demonstrates to investors and other stakeholders that
business interests can only be enhanced by embracing a
sustainable future.
1-26
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
P4 Advanced Financial Management
6.5.1
Session 1 • Role of Financial Strategy
Guiding Principles
The guiding principles provide the foundation for how an
organisation should consider information to be included in the
report and how information should be presented. These include:
< Strategic focus and future orientation—insight into the
<
organisation's strategy and how it relates to the organisation's
ability to create value over time;
Materiality—information about items that significantly affect
the organisation's ability to create value over time should be
disclosed.
6.5.2
Content Elements
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The content elements are fundamentally linked to each other and
not mutually exclusive. These include:
< Organisational overview and external environment:
<
What does the organisation do and under what circumstances
does it operate?
Governance: How does the governance or leadership
structure support the organisation's ability to create value
over time?
< Business model: What is the organisation's business model?
< Risks and opportunities: What are the specific risks and
<
Exhibit 1
m
<
opportunities that affect the organisation's ability to create
value over time and how are these dealt with?
Strategy and resource allocation: Where does the
organisation want to go, and how does it intend to get there?
Outlook: What challenges and uncertainties are likely to
be encountered in pursuing the organisation's strategy and
what are the implications for the business model and future
performance?
CHIEF EXECUTIVE
OFFICER'S REVIEW
Sa
Extracts from the Chief Executive Officer's Review in Village Main Reef Integrated Annual
Report 2013. The review discusses challenge, change, curbing costs and strategic progress.
Question: In last year's report you were at pains to indicate what Village was not. Can you
tell us a bit more about what Village is, and how its strategy is evolving?
Answer: We remain about value rather than size; we aim to make smart investments,
unlock value and return it to shareholders; and to develop a diversified portfolio of assets.
But, our strategy has evolved in that we are no longer a buyer of marginal or, if you will,
"throw-away" gold mining assets. We continue to convert Village from an operator of
diversified small mines into a resources investment company. Particularly given the state
of the markets, we will rather be targeting smaller companies that can generate their
development financing needs internally.
Question: What are your views on the share price performance?
Answer: The share price fell by 70%—from 150c to 45c—over the year. The share
price performance has been disappointing, particularly as we had made special strategic
distributions to shareholders by means of a share buy-back and a 30c special dividend. Our
stated policy has been to create new value from assets that may not be attractive to others
and to distribute that value to shareholders.
That said, the travails of the platinum and gold sectors as a whole affected us too. Some
platinum juniors fell by as much as 80% to 90%, while even some of the gold majors shed
50%.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-27
Session 1 • Role of Financial Strategy
7
P4 Advanced Financial Management
Risk Management
Risk—"the variability of returns" (e.g. due to exchange rate changes).
7.1
Should Risk Be Managed?
pl
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At first glance, it may appear logical for a firm's management
to attempt to reduce the firm's risk exposures. However,
implementing a default policy of hedging all risks may not be
effective for the following reasons:
< Hedging may give short-run but not long-run protection. For
m
example, the exchange rate in derivatives contracts (e.g.
forwards, futures and swaps) will follow the same long-term
trend as the exchange rate in the spot market. In the end, if
an exporter faces an appreciating home currency it will find
its margins under pressure either with or without hedging the
exchange rate.
< Hedging incurs costs—both the transactions costs of using
derivatives, for example, and the higher salary costs of
employing specialist risk managers.
< The firm's shareholders may have already hedged many
risks—in the case of a listed company the majority of shares
are likely to be held by institutional investors who will hold
well-diversified equity portfolios (e.g. including shares in
both exporters and importers). Hence, shareholders may
have natural protection against some forms of risk, in which
case, corporate risk management will only add costs and not
benefits.
So why, in practice, do many firms engage in significant amounts
of risk management? There may be various explanations:
Sa
< In the case of privately held firms, the shareholders may
<
<
have significant amounts of their personal wealth invested in
an individual firm (i.e. the shareholders are exposed to total
risk as opposed to only systematic risk). In this case, risk
management at the corporate level may indeed reduce the
risk of the shareholders.
In the case of listed firms, although shareholders may be well
diversified and only exposed to systematic risk, the company's
management work only for that specific firm and not for a
portfolio of firms (i.e. their bonuses or share option plans are
exposed to total risk). Management may therefore become
highly risk-averse and attempt to hedge their personal risk—
incurring agency costs for their shareholders.
Progressive corporate tax systems—in many countries, the tax
rate on large profits is significantly higher than the tax rate on
lower profits. In this case, there could be a valid argument for
using risk management to "smooth" the firm's profits in order
to reduce the long-run tax burden. Care must be taken to
avoid cosmetic smoothing of reported profits (i.e. accounting
manipulation).
1-28
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
P4 Advanced Financial Management
Session 1 • Role of Financial Strategy
< Reduction in cost of capital—corporate diversification may lead
to financial synergy as smoother group cash flows may lead
to an improved credit rating and a lower cost of debt. Care
must be taken to ensure that the control premium paid on
acquisitions does not exceed the value of synergy.
< Financial distress costs—where a firm experiences cash flow
problems it can find that its costs of doing business rise (e.g.
suppliers may refuse to give credit; customers may lose
faith in any warranties given on the firm's products). Risk
management may be justified in reducing the risk of financial
distress.
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e
7.2 Conflicts Between Equity and Debt Investors
Equity investors are, of course, participating investors in that their
returns are linked to the underlying volatility of profits (i.e. they
absorb the firm's level of business risk). However, the equity
investors' downside risk is restricted to some degree by their
limited liability status (i.e. if the firm cannot pay its debts the
shareholders cannot be forced to inject more capital).
Debt investors, on the other hand, receive fixed contractual
payments of interest and principal (i.e. they are not exposed to
business risk). The main risk faced by debt investors is that the
firm cannot service the debt (i.e. default risk/credit risk).
m
The different positions of equity and debt investors can lead to
differing attitudes towards the level of risk-taking by the firm.
This is particularly the case where the value of the firm's assets is
close to the level of its liabilities:
< Shareholders may develop an "appetite for risk" and
Sa
encourage the management to take high risks. If the firm's
high-risk strategies succeed, the value of assets would "spike
up" above the level of liabilities and the equity rises in value.
If the gamble fails and the value of assets collapses then
shareholders can walk away under the protection of limited
liability. Overall, shareholders have high upside potential and
limited downside risk.
< Debt investors would be highly risk averse as any fall in asset
value would reduce the recoverability of their debt, whereas
any rise in asset value would not lead to any extra return on
the debt (i.e. debt investors have high downside risk and no
upside potential).
7.3 Types of Risk and Risk Mitigation
< Business risk—volatility of operating cash flows. This is
driven by (i) sales volatility (ii) level of operational gearing
(i.e. proportion of fixed to variable operating costs). Hence
the key strategies for reducing exposure to business risk are:
 reposition the firm's product lines into "defensive industries"
(i.e. those sectors relatively unaffected by the economic
cycle such as food, clothes and pharmaceuticals);
 convert fixed costs into variable costs (e.g. via outsourcing).
< Financial risk—the increased volatility of returns to equity due
to fixed interest payments first being paid on debt. Obviously,
this can be reduced through lowering the firm's level of
financial gearing, although this should be balanced against the
loss in tax shield.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-29
Session 1 • Role of Financial Strategy
P4 Advanced Financial Management
< Credit risk/default risk—becomes significant at high
<
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<
perceived levels of debt. Obviously, this can be reduced by a
reduction in financial gearing but alternative methods include:
 diversifying operations to smooth cash flows;
 diverting low-risk cash streams into a ring-fenced special
purpose vehicle (SPV), (protected should the firm itself
becomes bankrupt). The SPV then "securitises" its future
cash stream (i.e. issues bonds backed by the stream).
These asset-backed securities should attract an investmentgrade credit rating.
Reputational risk—damage to the brand value due to poor
corporate behaviour (e.g. environmental damage or use of
child labour). Mitigation strategies could include implementing
Corporate Social Responsibility or using a public relations
agency.
Operational risk—the risk of loss resulting from inadequate
or failed internal processes, people and systems (e.g. for an
investment bank the risk of a "rogue trader"). Mitigation could
include implementation of the Turnbull Report.
< Fiscal risk—impact of unexpected events adversely affecting
Sa
<
m
<
the government's fiscal strength and hence the business
climate (e.g. commodity exporting nations are highly exposed
to volatile commodity prices). The fiscal risk of different
countries can be assessed using reports from the IMF or the
EIU (Economist Intelligence Unit).
Regulatory risk—risk of government regulation adversely
affecting the firm (e.g. price caps on privatised natural
monopolies, compulsory compliance with corporate
governance codes, blocks or restrictions placed on mergers
and acquisitions). Regulatory risk may be managed through
political lobbying.
Project risk—the risk that project cash flows are not in line
with expectations. Project risk can be managed by:
 appointing an experienced project manager;
 carefully selecting contractors;
 appointing a steering committee to monitor deadlines and
cost levels; and
 PCA (Post Completion Audit) to review and improve the
process in the future.
Currency risk (see Session 14).
Interest rate risk (see Session 15).
Political risk (see Session 17).
<
<
<
7.4
Risk Mitigation, Hedging and
Diversification*
Risk mitigation, hedging and diversification are all strategies
designed to manage an organisation's exposure to various risks.
The nature of each of these strategies can be distinguished as
follows:
*See Sessions 14
and 15 for details on
currency and interest
rate hedging.
< Risk mitigation—involves the use of pre-emptive strategies
to prevent a particular risk from materialising. For example,
prior to setting up an overseas subsidiary political risk may
be mitigated by contacting overseas officials and seeking
agreements on matters such as repatriation of funds and the
level of transfer prices or management charges.
1-30
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
P4 Advanced Financial Management
Session 1 • Role of Financial Strategy
< Risk hedging—refers to managing a risk which has already
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e
materialised (e.g. foreign currency risk on an overseas
export).
< Risk diversification—refers to corporate diversification
either domestically into other industries ("conglomerate
diversification") or other countries ("international
diversification"). As previously explained, if the firm's
shareholders are institutional investors (e.g. fund managers)
they will have already used personal portfolio diversification
to remove almost all industry-specific unsystematic risk
and, in the case of global fund managers, country-specific
unsystematic risk. There is, therefore, an argument that if its
shareholders are diversified then the firm should specialise.
This does not, however, mean that corporate diversification is
never justified. For example:
< significant synergy may be obtained through buying
competitors, suppliers or distributors;
< diversified groups have lower financial distress risk, may
achieve an enhanced credit rating and may pay less tax in a
progressive tax system due to reporting "smoother" profits.
7.5
Developing a Framework for Risk
Management
7.5.1
Elements
m
There are many examples of risk management systems and
processes that have been developed by various organisations. In
general, a risk management process should, at the very least,
incorporate the following elements:
Sa
MONITOR
IDENTIFY
?


THREATS TO ACHIEVING
CORPORATE OBJECTIVES
ANALYSE
PLAN
APPROACH
AND ACTION
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-31
Session 1 • Role of Financial Strategy
7.5.2
P4 Advanced Financial Management
Stages in Risk Cycle Management
The IIA's Professional Briefing Note 13, Managing Risk, identifies
the following stages in risk cycle management:
Establish the context and set perspectives
Identify and document risk
Assess, quantify and classify risk
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Evaluate and model risk
Develop risk mitigation/control strategies
m
Obtain resources and assign responsibilities
Reduce, offset and/or optimise the risk
Sa
Monitor and review
1-32
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
P4 Advanced Financial Management
7.5.3
Session 1 • Role of Financial Strategy
Risk Management Standard
The Institute of Risk Managers (IRM), the Association of Insurance
and Risk Managers (AIRMIC) and the National Forum for Risk
Management in the Public Sector (ALARM) jointly published
a Risk Management Standard in 2002, within which the risk
management process was diagrammatically shown as:
pl
e
The Organisation's
Strategic Objectives
Risk Assessment
Risk Analysis
Risk Identification
Risk Description
Risk Estimation
m
Risk Evaluation
Formal
Audit
Risk Reporting
Threats and Opportunities
Sa
Decision
Risk Treatment
Residual Risk Reporting
Monitoring
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-33
Session 1 • Role of Financial Strategy
7.5.4
P4 Advanced Financial Management
COSO Framework
In September 2004, COSO expanded its internal control
framework to develop the Enterprise Risk Management Integrated
Framework.
C
GI
E
AT
R
ST
S
N
O
I
AT
O
G
IN
R
PE
RT
R
P
Sa
m
DIVISION
ENTITY LEVEL
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al Env
ironm
ent
Objec
tive S
etting
Event
Ident
ificati
on
Risk A
ssess
ment
Risk R
espon
se
Contr
ol Act
ivities
Inform
ation
& Com
munic
ation
Monit
oring
SUBSIDIARY
M
CO
A
LI
BUSINESS UNIT
Intern
CE
N
O
EP
1-34
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
Session 1
Summary
The first step in developing the objectives of financial management is to identify the
relevant stakeholders in the organisation.
<
In the corporate sector the key stakeholders are clearly the shareholders. Most traditional
finance theory is therefore built on the assumption that a company's objective is to
maximise the wealth of its shareholders.
<
However, modern CSR suggests that directors should also take into account other
stakeholders and therefore also follow a range of non-financial objectives (e.g. employee
satisfaction, reducing environmental impacts).
<
Such non-financial objectives may be in conflict with maximising shareholder wealth.
Therefore, the overall objective may be to produce satisfactory returns for shareholders,
while attempting to meet the demands of other interest groups.
<
In practice, managers may also have personal objectives which conflict with their
responsibilities as agents of the shareholders. Some managers may try to maximise
personal wealth (e.g. through manipulating bonus schemes or even theft of
company assets).
<
This creates agency costs for the shareholders. Well-designed remuneration systems and
good corporate governance should reduce these costs to an acceptable level.
<
<
One aspect of CSR involves ethical corporate behaviour—the "good corporate citizen".
<
More recently the IIRC has formulated an IR Framework that reflects developments in
financial governance, management commentary and sustainability reporting. It requires
organisations to publish material information about their strategy, governance, performance
and prospects in a clear, concise and comparable format.
pl
e
<
Sa
m
CSR also involves the creation of a sustainable business model which balances not only
financial but also social and environmental performance. Reporting these three areas of
performance can be achieved using the TBL approach.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-35
Session 1 Quiz
Estimated time: 20 minutes
State TWO arguments for and TWO arguments against the maximisation of shareholder
wealth as a corporate objective. (2.2)
2.
Define "integrated report". (2.3)
3.
Define "agency costs". (3.3)
4.
Suggest methods of improving goal congruence between directors and shareholders. (3.5)
5.
State the board structure common in German companies. (4.2)
6.
State which area of corporate governance the UK Greenbury Code focussed on. (4.5)
7.
State whether compliance with the Combined Code is obligatory for companies listed in
the UK. (4.6)
8.
List the "principles of good governance" as per the Combined Code. (4.6)
9.
State which area of corporate governance the UK Turnbull Report focussed on. (4.7)
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1.
10. List ethical issues specific to multinational companies. (5.1.7)
11. State the THREE areas of evaluation in the Triple Bottom Line (TBL) approach to
reporting. (6.2)
12. List FOUR examples of content elements in an integrated report. (6.5.1)
m
13. Provide examples of regulatory risk. (7.3)
Study Question Bank
Estimated time: 60 minutes
Priority
Q1
Estimated Time
Agency Relationships
60 minutes
Sa
Additional
Completed
Q2
1-36
Ethics (ACCA D03)
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
EXAMPLE SOLUTIONS
Solution 1—AAA Model
Sa
m
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(1) Facts—in exchange for a significant payment you may secure
government contracts in the future.
(2) Ethical issues—should you provide a contribution in what would be
in the best case an inducement and in the worst case considered
a bribe? As the CEO, you may be in breach of your fiduciary
duties and probably in breach of campaign contribution laws. As
a professional accountant, you would be in breach of your ethical
codes. However, not to do so may mean a lack of government
orders should the candidate win the election.
(3) Norms, principles, and values—government contracts should not
be awarded on the basis of favours, inducements or bribes—value
for money (VFM) would be an expected driver. CEOs, as leaders of
their companies, are expected to set the moral and ethical tone of
the organisation. Professional accountants are expected to have
integrity and objectivity.
(4) Alternative courses of action—(i) make the contribution, (ii) make a
lower contribution, or (iii) make no contribution.
(5) Best course of action—decline to make a contribution and report the
incident to an appropriate elections committee.
(6) Consequences of each possible course of action:
(i) Making the payment will incur cash flow now for which there
may be future awards of contracts if the candidate wins. The
political contribution would need to be disclosed in the financial
statements and the candidate would also need to disclose it,
as it is material. If the candidate wins and additional contracts
are awarded, there may be possible media speculation why the
company appears to be winning more contracts than normal,
which may lead to an investigation and negative consequences
for the firm and its directors.
(ii) Not making the payment (or lower than requested) and the
candidate wins, may result in future contracts not being
awarded. This would have a detrimental impact on the business
with possible going concern consequences.
(iii) The broad assumptions are that the candidate will win and that
they have control over the tendering process (i.e. awards are not
made by a separate committee).
(7) Decision—the ethical approach would be to decline making the
requested contribution.
Solution 2—Tucker's Model
This is a case of bribery. Since all five questions in this model must be
answered in the affirmative, the payment is not defensible as the evasion
of tax is illegal.
It is not fair to the wider society that the burden of evaded tax should be
borne by others in order to provide the services and facilities for which
the tax is raised. Nor can it be right (just) that others should suffer a
deterioration in, or lack of, services as a result of under-funding. That it
is considered common practice does not make it acceptable.
It is not sustainable in that a "vicious circle" is created of increasing
levies which are increasingly evaded. The environment may be harmed.
For example, vital services (e.g. the provision of clean water) may
be compromised. If charges then have to be made for services such
as waste-disposal (because there are not taxes to fund the service),
environmentally damaging practices (e.g. illegal dumping) are likely
to increase.
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-37
Solution 3—TBL Reporting
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(a) Sustainable development
The principle of TBL reporting is that a corporation's true performance
must be measured in terms of a balance between economic (profits),
environmental (planet) and social (people) factors; with no one factor
growing at the expense of the others.
A corporation's sustainable development is about how these three factors
can be combined so that the firm builds a reputation as being a good
corporate citizen. A corporation that balances the pressures of all three
factors should enhance shareholder value by addressing the needs of its
stakeholders.
However, whereas TBL reporting is a quantitative summary of the
corporation's historical performance, sustainable development tends to
be forward-looking and qualitative.
Economic impact can be measured by considering operating profits,
dependence on imports and the extent to which the local economy is
supported by purchasing locally produced goods and services.
Social impact can be measured by considering working conditions, fair
pay, using an appropriate labour force (not child labour), and the level of
ethical investments.
Environmental impact can be measured by considering the firm's
ecological footprint, emissions to air, water and soil, use of energy and
water and investments in renewable resources.
Ideally the firm's economic, social and environmental performance should
be benchmarked against that of its competitors or against the industry,
national or global leader in sustainable development.
m
(b) Financial performance
For TBL reporting to improve the firm's financial performance the benefits
that accrue from the assessment and production of a TBL report must
exceed the costs of undertaking the report.
The costs of producing the report should be relatively easy to measure
but the financial benefits may be more difficult to measure and may take
place over a longer time period.
Examples of the ways in which the firm may benefit financially:
Focusing on and reporting the company's environmental and social
impact may build and enhance reputation and long-term revenues.
Sa
Reducing the firm's environmental impact may reduce the risk of
paying fines for environmental damage.
Consideration and improvement of working standards and
consulting employees as part of this process may help in retaining
and attracting high calibre employees.
Better communication with stakeholders may result in
improvements in governance procedures. This in turn should lead to
a reduction in agency costs.
Reducing the carbon footprint may be achieved by switching from
importing materials to using local suppliers. This may reduce the
risk of stockouts and also boost the firm's reputation through
supporting the local economy.
Monitoring and reporting on the performance of employees and
managers as part of the assessment of economic and social factors
may help identify areas where work can be done more effectively
and efficiently.
1-38
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
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NOTES
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
1-39
Index
A
C
Cadbury Report ................................ 1-10
Cap ................................................ 15-4
Capital
budgeting ................................... 17-10
expenditure .................................. 18-2
market efficiency .............................2-2
market line .....................................4-8
mobility ........................................ 16-5
rationing.........................................6-8
reconstructions................................9-6
structure .............................3-16, 17-13
Carbon trading economy.................... 1-26
Cash against documents .................... 17-3
Cash budget pro forma........................5-8
Cash flow forecast ............................ 5-17
Cash flows, See Discounted cash flow;
See Free cash flow
Cash transfer mechanisms ................. 17-9
CDOs, See Collateralised debt obligations
Central banks .................................. 16-9
Chapter 11 ........................................9-6
Chepakovich model ........................... 7-19
Cheques .......................................... 17-9
Chief financial executive ......................1-2
City Code ........................................ 8-21
Clientele theory ................................ 12-2
Coase, Ronald (1937) .........................1-8
Code of Ethics and Conduct................ 1-21
Collar....................................... 13-3, 15-6
Collateralised debt obligations
(CDOs) .................................... 16-22
Combined Code ................................ 1-12
Commercial
paper ........................................... 11-4
risk .............................................. 17-2
Community Reinvestment Act (CRA) . 16-21
Competition law ............................... 8-21
Complex reconstruction .......................9-6
Compound options .......................... 14-14
Conditional events ............................ 6-19
Confirmation bias ...............................8-6
Conflicts of interest .............................1-5
Constant dividend...............................2-4
Contract futures ............................. 14-15
Controlling shareholder ..................... 10-5
Conversion premium ......................... 2-19
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AAA, See American Accounting Association
Abandonment option ....................... 13-16
ACCA Code of Ethics and Conduct ....... 1-21
Accounting rate of return (ARR)............5-3
Acid-test ratio .................................. 18-7
Acquisitions ............................... 8-2, 18-2
Addition rule .................................... 6-18
Adjusted present value (APV) ..... 6-2, 17-12
Agencies
environment ................................. 1-26
ratings ...........................................9-3
Agency theory....................................1-5
AIM, See Alternative Investment Market
Albrecht's EDM ................................. 1-16
Alpha .............................................. 4-11
Alternative Investment Market (AIM). 10-13
American Accounting Association
(AAA) ........................................ 1-18
American swaptions ........................ 15-19
Annuity .............................................5-6
APV, See Adjusted present value
Arbitrage pricing theory ..................... 4-17
ARR, See Accounting rate of return
Ask rate ........................................ 15-16
Asset-based valuation methods ............7-3
Asset betas...................................... 4-13
Autonomy ....................................... 17-6
Bootstrapping ............................ 2-25, 8-5
Brady package ............................... 16-11
Business
angels ........................................ 10-14
ethics ........................................... 1-21
risk ..................................1-29, 3-5, 8-9
valuation ........................................7-2
B
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Baker plan ..................................... 16-11
Bank
loans............................................ 11-5
overdraft ................................ 3-4, 11-3
Bank for International Settlements ..... 16-8
Bank of England ............................. 16-10
Bank of Japan ................................ 16-11
Banker's draft .................................. 17-9
Banking crisis ................................ 16-21
Basis risk ........................................ 15-2
Beta factor ...................................... 4-10
Bid rate ......................................... 15-16
Bills of exchange ....................... 11-3, 17-3
Bird-in-the-hand theory..................... 12-2
Black-Scholes model ......................... 13-8
Blair-Brown deal ............................. 16-12
Blocked remittances........................ 12-19
Bonds
deep discount................................ 11-9
duration ....................................... 2-21
valuation ...................................... 2-12
zero coupon .................................. 11-9
Bonus dividend ................................ 12-4
Book building ................................. 10-12
Book value-plus .................................7-4
P4 Advanced Financial Management
Becker Professional Education | ACCA Study System
P4 Advanced Financial Management
Session 20 • Index
Debt
analysis ...................................... 13-29
domestic markets .......................... 11-2
finance ....................................... 10-14
interest ........................................ 2-14
long-term ..................................... 11-7
redemption ................................. 12-18
Deep discount bonds ......................... 11-9
Default risk ............................. 15-14, 17-2
methods for reducing ..................... 1-30
MM theory .................................... 3-14
yield curve .................................... 2-25
Default swaps ....................... 13-31, 16-12
Delay option ......................... 13-16, 13-18
Delivery date ................................... 15-8
Delta ............................................ 13-12
Delta hedging ....................... 13-13, 14-13
Derivatives
credit ......................................... 13-31
exchange-traded ......................... 15-20
Diluted EPS ................................... 18-14
Directors ...........................................1-7
Disclosure risk ...................................8-3
Discounted cash flow (DCF) .................5-5
Discount factors .................................5-6
Discounting
FCFF ............................................ 7-14
relevant cash flows ........................ 5-13
Diversification strategies ................... 1-30
Portfolio theory.............................. 4-10
Divestment ........................................9-8
Dividend
bonus .......................................... 12-4
capacity ....................................... 12-9
domestic policy ............................. 12-2
growth .................................... 2-8, 7-8
international policy ...................... 12-18
irrelevance theory .......................... 12-3
payout ratio ................................ 18-14
valuation model (DVM) .............. 2-4, 7-8
yield ..............................................7-6
Divisible project .................................6-8
Divisional autonomy ....................... 17-14
Dual pricing ................................... 17-14
Dutch auction ................................ 10-10
DVM, See Dividend valuation model
Dysfunctional goals .............................1-3
D
E
Dark pools ..................................... 16-24
Dawn raid........................................ 8-21
DCF, See Discounted cash flow
Debentures ...................................... 11-8
Earnings yield ....................................7-5
ECGD, See Export Credits Guarantee
Department
Economic risk .................................. 14-6
Economic value added (EVA) .....7-17, 18-17
EDM, See Ethical development model
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Convertible
bonds......................................... 11-10
debentures ................................... 2-19
loan stock .......................................3-4
Corporate
bonds........................................... 2-26
governance .....................................1-9
objectives .......................................1-2
social responsibility (CSR) .................1-6
COSO Framework ............................. 1-34
Cost of debt
bond valuation .............................. 2-12
irredeemable debentures ................ 2-13
redeemable debentures .................. 2-15
Cost of equity ............................ 2-7, 4-13
Cost plus ....................................... 17-14
Costs
agency ......................................... 3-16
bargaining ......................................1-8
convertibles post-tax ...................... 2-20
flotation ....................................... 10-3
preference shares .......................... 2-11
replacement ....................................7-3
Cost synergies ...................................8-5
Counter-trade .................................. 17-4
Coupon rate ............................... 2-12, 9-7
CRA, See Community Reinvestment Act
Crawling peg.................................... 16-7
Credit default swaps .............. 13-31, 16-12
Credit derivatives ........................... 13-31
Credit forward contracts .................. 13-31
Credit options ................................ 13-31
Credit risk ...........................1-30, 8-9, 9-2
Cross-selling ......................................8-5
Crown jewels ................................... 8-22
CSR, See Corporate social responsibility
Cultural risk ..................................... 17-2
Cumulative preference dividends ........ 11-7
Currency
futures ....................................... 14-15
options ....................................... 14-10
risk ..................................... 14-5, 15-20
swaps ........................................ 14-20
Currency controls ............................. 16-6
Current ratio .................................... 18-8
Customs unions................................ 16-4
Cyert and March (1963) ......................1-8
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20-1
Session 20 • Index
P4 Advanced Financial Management
Financial distress risk...........................3-7
Financial risk......................................3-5
Financiers......................................... 9-11
Fiscal risk......................................... 1-30
Fisher
effect............................................ 14-2
formula......................................... 5-17
Fixed peg......................................... 16-7
Fixed price auction........................... 10-10
Flavoured swaps.............................. 15-19
Floating exchange rates...................... 16-7
Floor
interest rate................................... 15-5
value............................................ 2-19
Flotation................................... 9-13, 10-2
Foreign direct investment................... 16-6
Foreign exchange risk........................ 14-5
Forfaiting......................................... 17-3
Forward
contracts............................ 13-31, 14-20
exchange contracts......................... 14-8
exchange rate................................ 14-2
non-deliverable.............................. 14-9
rates........................................... 15-17
Forward rate agreement (FRA)............ 15-3
Four-way equivalence model............... 14-2
FRA, See Forward rate agreement
Free cash flow to equity (FCFE)... 7-12, 12-9
Free cash flow to the firm (FCFF)......... 7-14
Free trade........................................ 16-4
Futures
currency...................................... 14-15
hedging......................................... 15-9
interest rate................................... 15-6
options.......................................... 15-8
FX swaps........................................ 14-22
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EDMM, See Ethical decision-making models
Efficient market hypothesis (EMH).........2-2
Environment agencies........................ 1-26
Equal annual cash flows.......................5-6
Equity, See also Cost of equity
beta.............................................. 4-13
discount rate for all......................... 4-15
finance.......................................... 9-13
investors....................................... 1-29
unquoted..................................... 10-14
valuation..................................... 13-25
ESOPs, See Executive share option plans
Ethical conflict resolution.................... 1-21
Ethical decision-making...................... 1-16
Ethical decision-making models
(EDMM)...................................... 1-18
Ethical development model (EDM)....... 1-16
Eurobond market............................. 11-15
Eurocredit market............................ 11-14
Eurocurrency market....................... 11-14
Euromarkets................................... 11-14
Euronote market............................. 11-15
European call option.......................... 13-8
European Central Bank..................... 16-10
European swaptions......................... 15-19
European Union (EU)......................... 16-4
EVA, See Economic value added
Exchange rates
forecasting.................................... 14-2
systems........................................ 16-7
Exchange-traded
derivatives................................... 15-20
options.......................................... 13-2
Executive share option plans (ESOPs)....1-9
Exit routes................................ 9-13, 10-2
Expansion option.................... 13-16, 13-20
Expectations theory........................... 2-24
Expected values................................ 6-20
Export
factors.......................................... 17-3
Export Credits Guarantee Department
(ECGD)....................................... 17-3
Exposure.......................................... 15-2
Extendable swaptions....................... 15-19
External hedging........................ 14-7, 15-3
F
FCFE, See Free cash flow to equity
FCFF, See Free cash flow to the firm
Financial
contagion.................................... 16-25
distress cost................................... 1-29
distress risk.....................................3-6
gearing................................. 1-29, 18-9
intermediaries................................ 11-2
risk...................................1-29, 3-6, 8-9
synergies.........................................8-5
20-2
G
Gamma.......................................... 13-13
Gap exposure................................... 15-2
GATT, See General Agreement on Tariffs
and Trade
Gearing.............................. 3-5, 9-12, 18-9
General Agreement on Tariffs and Trade
(GATT)....................................... 16-5
Global debt..................................... 16-11
Goal congruence....................... 1-9, 17-13
Golden parachute.............................. 8-22
Gordon's growth model................ 2-10, 7-8
Greeks........................................... 13-12
Greenbury Code................................ 1-11
Gross profit percentage...................... 18-6
Gross redemption yield...................... 2-17
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
P4 Advanced Financial Management
Session 20 • Index
H
J
Hamada, Robert................................ 4-14
Hard capital rationing...........................6-8
Hedging
compound options........................ 14-15
delta.................................. 13-13, 14-13
external........................................ 14-8
futures........................................ 14-16
internal...........................................8-5
IRFs.............................................. 15-7
options.......................................... 15-9
High-growth start-ups........................ 7-19
Hostile bids....................................... 8-22
Joint venture.................................... 17-4
Kappa............................................
13-14
L
Lagging............................................ 14-7
Lambda.......................................... 13-14
Leading............................................ 14-7
Leasing............................................ 11-5
Letters of credit................................. 17-3
LIFFE, See London International Financial
Futures and Options Exchange
Linear programming.......................... 6-12
Liquidity
preference theory..................... 2-24, 5-5
project.......................................... 6-17
ratios............................................ 18-7
Listing............................................. 10-9
London International Financial Futures and
Options Exchange (LIFFE)........... 14-11
Long-term debt finance...................... 11-7
Long-term incentive plans (LTIPs)..........1-9
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IAESB Ethics Education Framework...... 1-17
IBE, See Institute of Business Ethics
IBO, See Institutional buyout
IMF, See International Monetary Fund
Import duties.................................. 17-15
Inflation........................................... 5-16
Initial public offering (IPO)............ 7-2, 9-13
Institute of Business Ethics (IBE)......... 1-21
Institutional buyout (IBO).....................9-9
Intangible assets............................. 13-22
Integrated reporting.................... 1-4, 1-26
Interest
cover...................................8-18, 18-10
floor cap........................................ 15-6
rate.............................. 2-24, 5-16, 13-7
Interest rate
futures (IRFs)................................ 15-6
parity (IRP).................................... 14-4
risk............................................... 15-2
swaps......................................... 15-12
Internal
finance.......................................... 3-15
hedging...........................................8-5
Internal rate of return (IRR).. 2-16, 5-9, 6-15
International
dividend policy............................. 12-18
Fisher effect................................... 14-5
trade...................................... 16-3, 17-2
International Monetary Fund (IMF)....... 16-8
In the money.................................... 13-4
Intrinsic value................................... 13-5
Inventory turnover.......................... 18-11
Investment
appraisal.................................. 5-2, 6-2
risk.................................................4-2
IPO, See Initial public offering
IRFs, See Interest rate futures
IRP, See Interest rate parity
IRR, See Internal rate of return
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
M
Macaulay's duration.......... 2-21, 6-17, 13-25
Managed float................................... 16-7
Management buy-in (MBI)....................9-8
Management buyout (MBO)..................9-8
Manufactured dividends...................... 12-3
Market
portfolio................................... 4-9, 6-3
price........................................... 17-14
to book ratio....................................7-7
value............................................ 2-12
value added................................... 7-17
Markowitz efficient frontier...................4-8
Matching.......................................... 14-7
MBI, See Management buy-in
MBO, See Management buyout
Mean-variance efficiency......................4-3
Medium-term finance......................... 11-5
Merger...............................................8-2
Merton's models.............................. 13-25
Mezzanine finance............................. 9-13
Modified internal rate of return
(MIRR)....................................... 6-15
Modigliani and
Miller............. 3-7, 4-14, 6-2, 12-3, 13-27
Money
laundering..................................... 1-15
market hedges............................. 14-10
markets........................................ 11-2
rates............................................. 5-16
20-3
Session 20 • Index
P4 Advanced Financial Management
N
redeployment...................... 13-16, 13-21
traded........................................... 13-2
value............................................ 13-4
Organic growth...................................8-2
Out of the money.............................. 13-4
Overseas expansion........................... 17-4
P
Par value.......................................... 2-12
Payables days................................. 18-12
Payback period....................................5-2
Payment methods.............................. 17-3
Payout ratio...................................... 12-3
P/E, See Price/earnings ratio
Pecking order theory.......................... 3-15
Perpetuities........................................5-7
Physical risk...................................... 17-2
Plain vanilla swap................... 14-21, 15-12
Poison pill......................................... 8-22
Political risk............................. 12-19, 17-2
Portfolio theory...................................4-4
Position risk.................................... 15-14
Post-completion audit........................ 6-30
PPP, See Purchasing power parity
Preference shares...................... 7-11, 11-7
cost.............................................. 2-11
redeemable.................................... 9-13
Price/earnings ratio (P/E).....................7-4
Private equity.....................................9-9
Probability analysis............................ 6-18
Proceeds of Crime Act 2002................ 1-15
Profitability index................................6-8
Project appraisal
cost of equity................................. 2-11
duration........................................ 6-17
risk............................................... 1-30
WACC........................................... 4-15
Protectionism.................................... 16-4
Protective put................................... 13-3
Purchasing power parity (PPP)............. 14-2
Put-call parity................................. 13-10
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Monitoring
post-merger................................... 8-23
project.......................................... 6-29
Monopoly power................................ 16-3
Monte Carlo method.......................... 6-26
Mortgage loan................................... 11-6
Mudaraba contract........................... 16-14
Multilateral netting............................ 16-6
Multinational corporations.......... 12-15, 16-2
Multiperiod capital rationing................ 6-11
Multiplication rule.............................. 6-18
Musharaka contract......................... 16-14
Mutually exclusive projects................. 6-10
Myopia............................................. 10-3
m
NDFs, See Non-deliverable forwards
Negotiated transfer prices................. 17-14
Net book value (NBV)..........................7-3
Net present value (NPV)
capital budgeting.......................... 17-10
investment appraisal.........................5-8
Net realisable value (NRV)....................7-3
Netting............................................ 14-7
New applicants.................................. 10-9
Nominal
interest rates................................. 5-16
value............................................ 2-12
Non-deliverable forwards (NDFs)......... 14-9
Note-issuance facilities....................... 16-8
NPV, See Net present value
NRV, See Net realisable value
O
Sa
Objectives, corporate...........................1-2
Offer
initial public.....................................7-2
share.......................................... 10-10
Open account trading......................... 17-3
Operational
gearing........................... 1-29, 9-3, 18-6
risk............................................... 1-30
Operational gearing.............................3-5
Options............................................ 13-2
abandonment............................... 13-16
collar............................................ 13-3
compound................................... 14-14
credit.......................................... 13-31
currency...................................... 14-10
delay................................. 13-16, 13-18
expansion........................... 13-16, 13-20
futures.......................................... 15-8
hedging....................................... 14-11
over-the-counter (OTC)............ 13-2, 15-4
real............................................. 13-16
20-4
Q
Quick ratio........................................ 18-7
R
Ratings agencies.................................9-3
Ratio analysis................................... 18-2
Real interest rates............................. 5-16
Receivables days............................. 18-11
Redeemable
debentures.................................... 2-15
preference shares........................... 9-13
Redeployment option.............. 13-16, 13-21
Regulatory risk............................ 1-30, 8-3
Relative based valuation.......................7-4
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
P4 Advanced Financial Management
Session 20 • Index
Shares
dividend-paying............................ 13-10
issuing.......................................... 10-9
preference............................. 2-11, 11-7
redeemable.................................... 9-13
Sharia boards................................. 16-15
Short-term finance............................ 11-3
Short-term
investments................................... 17-9
Simulation........................................ 6-26
Single-period capital rationing...............6-8
Soft capital rationing............................6-8
SOX, See Sarbanes-Oxley Act (2002)
Special purpose vehicles (SPV).......... 16-21
Spin-offs............................................9-8
Sponsor........................................... 10-6
Spot against forward........................ 14-22
Spot yield curve................................ 2-25
SPV, See Special purpose vehicles
Stagging........................................ 10-11
Stakeholders.......................................1-6
Standard deviation...................... 4-2, 6-22
Stock exchange................................. 10-3
Stress testing................................... 6-29
Strong-form efficiency..........................2-3
Structural models................................9-4
Sukuk finance................................. 16-18
Surrogate profit goals..........................1-3
Sustainability.................................... 1-22
SVA, See Shareholder value added
Swaps............................................ 15-12
credit default............................... 13-31
currency...................................... 14-20
FX.............................................. 14-22
interest rate................................. 15-12
plain vanilla........................ 14-21, 15-17
Swaptions...................................... 15-19
SWIFT............................................. 17-9
Syndication...................................... 16-8
Synergy.............................................8-4
Synthetic Agreements for Foreign
Exchange (SAFEs)........................ 14-9
Systematic risk...................................4-9
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Relevant cash flows........................... 5-13
Repatriation of funds........................ 17-15
Replacement cost................................7-3
Reputational risk......................1-30, 12-19
Residual dividend policy..................... 12-2
Rest's model..................................... 1-16
Return on capital employed
(ROCE)................................. 5-3, 18-5
Return on investment (ROI)..................5-3
Revolving underwriting facilities......... 11-15
Rho............................................... 13-15
Risk, See also Foreign exchange risk;
Interest rate risk
appetite........................................ 1-29
averse.............................................4-4
commercial.................................... 17-2
credit...................................... 1-29, 9-2
currency........................................ 14-5
default................................. 15-14, 17-2
diversification................................. 1-31
hedging......................................... 1-31
investment......................................4-2
management.................................. 1-28
mitigation...................................... 1-30
position....................................... 15-14
project.................................. 1-30, 6-18
reduction...........................4-4, 6-29, 8-5
regulatory...................................... 1-30
systematic.......................................4-9
transparency................................ 15-14
unsystematic...................................4-9
ROCE, See Return on capital employed
ROI, See Return on investment
S
Sa
SAFEs, See Synthetic Agreements for
Foreign Exchange
Sale and leaseback............................ 11-6
Sarbanes-Oxley Act (SOX) (2002)....... 1-10
Scrip dividends................................. 12-4
Securitisation......................... 11-11, 16-21
Security characteristic line.................. 4-10
Security market line........................... 4-13
Seed firms........................................ 7-19
Segmentation theory......................... 2-24
Selecting a target................................8-2
Sell-offs.............................................9-8
Semi-strong form efficiency..................2-3
Sensitivity analysis............................ 6-23
Share
buyback........................................ 12-4
incentive schemes.......................... 10-3
options.......................................... 9-13
Shareholders
agency theory..................................1-5
cost of equity...................................2-7
wealth.............................................1-3
Shareholder value added (SVA)........... 7-18
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
T
Takeovers........................... 2-3, 8-21, 10-4
Tax
cash flows..................................... 5-15
investment appraisal....................... 5-14
planning............................. 12-18, 17-14
post-tax cost of debt....................... 2-20
shield............................................ 2-14
TBL, See Triple bottom line
Tender offer............................. 10-10, 12-4
Term structure.................................. 2-24
Theta............................................. 13-14
Tick system.................................... 14-18
Time to expiry................................... 13-6
20-5
Session 20 • Index
P4 Advanced Financial Management
U
W
WACC, See Weighted average cost of
capital
Warehousing risk............................. 15-14
Warrants........................................ 11-10
Weak-form efficiency...........................2-2
Wealth maximisation............................1-3
Weighted average cost of capital
(WACC)........................................3-2
Williamson (1966)...............................1-8
Window dressing............................... 18-8
Working capital................................. 5-19
Working capital cycle....................... 18-13
World Bank....................................... 16-8
World Trade Organisation (WTO).......... 16-5
Writing down allowance...................... 5-14
Written submissions........................... 10-6
WTO, See World Trade Organisation
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Time value
money............................................5-5
option........................................... 13-6
Tobin's Q............................................7-7
Total shareholder returns (TSR).............1-3
Total shareholder return (TSR).......... 18-14
Trade
credit............................................ 11-3
creditors..........................................1-6
sale............................................ 10-13
Transaction
cost theory......................................1-8
exposure..................................... 14-21
risk............................................... 14-7
Transfer pricing............................... 17-13
Translation risk.................................. 14-5
Transparency risk............................ 15-14
Treasury function............................... 17-5
Triple bottom line (TBL)...................... 1-23
TSR, See Total shareholder return
Tucker's five-question model............... 1-20
Turnbull Report................................. 1-12
Two-asset portfolios.............................4-5
Two-part transfer prices................... 17-14
Yield
dividend..........................................7-6
earnings..........................................7-5
gross redemption............................ 2-17
Yield curve theory.............................. 2-24
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UK tax system.................................. 5-13
Unbundling.........................................9-8
Unconventional cash flows.................. 5-12
Undated debentures, See Irredeemable
debt
Unquoted equity.............................. 10-14
Unsystematic risk................................4-9
US Federal Reserve............................ 16-9
Y
Z
Zero coupon bonds............................ 11-9
Zero dividend.................................... 12-5
Sa
V
Valuation risk......................................8-3
Valuations......................................... 7-2
See also Dividend valuation model
equity......................................... 13-25
swaps................................ 14-21, 15-17
Value-added methods........................ 7-17
Value at risk (VaR)............................. 6-28
Vega.............................................. 13-14
Venture capital.................................. 10-2
Volatility........................................... 13-6
20-6
© 2014 DeVry/Becker Educational Development Corp. All rights reserved.
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Together with ATC International, Becker Professional Education
provides a single destination for candidates and professionals
looking to advance their careers and achieve success in:
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Accounting
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International Financial Reporting
•
Project Management
•
Continuing Professional Education
•
Healthcare
For more information on how Becker Professional Education can
support you in your career, visit www.becker.com.
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This ACCA Study System has been reviewed by ACCA's examining team and includes:
An introductory session containing the Syllabus and Study Guide and approach to examining the
syllabus to familiarise you with the content of this paper
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Comprehensive coverage of the entire syllabus
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Focus on learning outcomes
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Visual overviews
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Definitions of terms
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Illustrations and exhibits
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Examples with solutions
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Key points
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Exam advice
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Commentaries
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Session summaries
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End-of-session quizzes
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A bank of questions
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