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Summary CMA USA PART 2 SECTION B CORPORATE FINANCE
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Summary - CMA USA PART 2 SECTION B CORPORATE FINANCE.CONTENT WISE TABLE MANNER FLASHCARD STYLE.EASY TO GRASP IDEAS WITH SIGNIFICANT IDEAL EXAMPLE
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SECTION B – Corporate Finance (Weightage 20%)S.No Questions Answers
1. What is return? Return is income received by an investor on an investment.
2. What is the rate of return and Rate of return is the return expressed as a percentage of the
how is it calculated? principal amount invested.
Return Received for One Year’s Investment
Average Balance of Amount Invested
3. What is interest rate risk? The risk that the value of an investment will change over time
as a result of changes in the market rate of interest.
4. What is reinvestment rate risk? The risk that money invested in an instrument that matures
cannot be reinvested in another investment that will provide
the same, or a higher, level of return.
5. What is purchasing power risk? The risk that the purchasing power of a fixed amount of money
will decline as the result of an increase in the general price level
(inflation).
6. What is liquidity risk? The possibility that an investment cannot be sold (converted
into cash) for its market value.
Whenever an investment must be discounted significantly in
order to be sold, the investment has a high level of liquidity
risk.
7. What is foreign exchange risk? The risk that a transaction denominated in a foreign currency
will be impacted negatively by changes in the exchange rate.
8. What is credit risk? Credit risk, also known as default risk, is the risk that a
borrower of money will not be able to pay the interest and
repay the principal on a debt as it becomes due.
9. What is political risk? The risk that something will happen in a country that will cause
an investment’s value to change or even become worthless.
10. What are some examples of political Expropriation
risks? War
Blockage of fund transfers
Inconvertible currency
Government bureaucracy, regulations, and taxes
Corruption
Attitude of consumers
Foreign country's business culture
11. What is business risk? The variability of a firm’s earnings before interest and taxes
(EBIT).
12. What is total risk? Total risk is the risk of a single asset taken by itself and not
balanced against the risks of any other investments.
Total risk is defined as the variability of the asset’s relative
expected returns and is also sometimes called standalone risk.
From the Desk of Muhammad Zain – Founder of Zain Academy Page 15 of 66
, 13. What is unsystematic risk? Risk that is specific to a particular company or to the industry
in which the company operates.
14. What is systematic risk? Systematic risk is any risk that could affect all investments.
15. What is market risk? Market risk is risk inherent in an investment that is traded on a
market simply because it is traded on a market and is subject
to market movements. Market risk is a systematic risk.
16. What is foreign exchange risk? Foreign exchange risk is the risk that a transaction
denominated in a foreign currency will be impacted negatively
by changes in the exchange rate.
17. What is industry risk? Industry risk is risk that is specific to a particular industry.
18. What is interest rate risk? Interest rate risk (sometimes called price risk) is the risk that
the value of the investment will change over time as a result of
changes in the market rate of interest.
19. What is inventory financing? In inventory financing the creditor buys and retains title to the
inventory. The debtor then acts as his trustee in the selling of
the inventory and also assumes the risk of loss of the inventory.
20. What is industry risk? Risk that is specific to a particular industry.
21. What is the capital asset pricing The capital asset pricing model (CAPM) uses the security or
model (CAPM)? portfolio’s risk and the market rate of return to calculate the
investors’ required return. The theory behind the CAPM is
that investors will price investments so that the expected
return on a security or a portfolio will be equal to the risk-free
rate plus a risk premium proportional to the risk, or “beta,” for
that investment.
22. What is beta in the CAPM formula? A measurement of the systematic risk of a security or a
portfolio.
23. What is the capital asset pricing R = RF + β(RM − RF)
model formula? R = Investors’ required rate of return
RF = Risk-free rate of return
β = Beta coefficient
RM = Market’s required rate of return
24. What is a portfolio? A collection of assets that are managed as a group.
25. What is the idea behind Diversification combines securities in ways that reduce risk.
diversification? Different types of investments often change in market value in
opposite directions, so when one asset’s market price
decreases, another asset’s market price might increase to
offset the loss.
26. What is asset allocation? The process of selecting assets for a portfolio to achieve the
best risk/return tradeoff possible.
27. What does the coefficient of The coefficient of correlation measures the relationship
correlation measure? between two variables.
It expresses how closely connected, or correlated, the two
variables are and the extent to which a change in one variable
has historically resulted in a change in the other.
28. What are the sources 1) Long-term debt
of external funds? 2) Preferred stock
From the Desk of Muhammad Zain – Founder of Zain Academy Page 16 of 66
, 3) Common stock
29. How is the yield of a Yield of a Treasury security of the same term
debt security calculated? + Default premium
+ Liquidity premium
+/− Premium or Discount for tax status
+/− Premium or Discount for special provisions
= Yield of debt security
30. How is a yield curve prepared? By graphing the rates and terms for each security.
31. What are the shapes 1) Upsloping (normal)
of the yield curve? 2) Downsloping
3) Flat
4) Humped
32. What are the four theories 1) Pure (Unbiased) Expectations Theory
used to explain the 2) Liquidity Premium (Preference) Theory
slope of the yield curve? 3) Segmented Markets Theory
4) Preferred Habitat (Composite) Theory
33. Under the pure expectations theory, The yield curve is determined exclusively by expectations in the
what determines the yield curve? market of future short-term interest rates.
34. Under the liquidity premium theory, The yield curve is determined by:
what determines the yield curve? 1) The market’s expectations for future interest rates.
2) A liquidity premium for holding a less-liquid security.
The liquidity premium increases as the term gets
longer.
35. Under the segmented markets Because the cash needs of different groups and investors vary,
theory, what determines each group chooses securities that meet their forecasted cash
the yield curve? needs and not because of expected future interest rates.
Interest rates for each maturity term are determined by the
interplay of supply and demand for that term.
36. What is the Preferred habitat theory is a hybrid theory, or a compromise,
preferred habitat theory? that agrees with parts of the segmented markets theory and
parts of the pure expectations theory.
37. What are uses of the yield curve? 1) Forecasting interest rates
2) Forecasting recessions
3) Making investment decisions
4) Making financing decisions
38. What are the advantages of issuing The bond issuer has no loss of control or ownership.
bonds? The total cost of the bonds is limited and known
because the interest rate that is used to calculate the
cash paid for interest is constant throughout the life of
the bond.
Bonds have an advantage over stock, because the
interest that is paid on the bonds is tax-deductible as
an expense of the business.
If the bonds are callable, or otherwise can be retired
early, the company has the flexibility to eliminate the
interest payment if there is no longer a need for the
From the Desk of Muhammad Zain – Founder of Zain Academy Page 17 of 66
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