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ATC's ACCA Exam Tips (June 2010) P4ENG (Advanced Financial Management)

The examiner, Professor Bob Ryan, considers this paper to be at the level of a Master’s degree in finance.

You should expect the exam to be academically challenging – after all this is an optional paper and builds upon the foundations set in paper F9 Financial Management. Your existing knowledge will be useful – but will not be sufficient to obtain a pass at this advanced level.
. The examiner identifies seven key areas of the syllabus:
• Role and responsibility towards stakeholders
• Domestic and international investment decisions
• Mergers and acquisitions
• Corporate re-organisation strategies
• Advanced treasury and risk management techniques
• Impact of macro economics and the role of international financial institutions
• Emerging issues in finance and financial management
The whole syllabus is examinable but too large and detailed to be tested in a 3-hour paper. It would be tempting to try and predict what will be tested but extremely dangerous – the examiner claims to use a random number generator to choose topics!

Be particularly careful if you had an exemption from paper F9 - you must fill any gaps in your knowledge e.g. regarding cost of capital calculations. You don’t need to buy the F9 materials, just refer to ATC International’s P4 study system (sessions 2-4)

The two compulsory questions in section A of the exam will cover significant issues relevant to the senior financial manager and each will be set in the form of a case study and contain a mix of computational and discursive elements. A maximum of 40 marks will be allocated to either question in section A which is for a total of 60 marks.
Section B questions are designed to provide a more focused test of the syllabus. Each question will be 20 marks and candidates must choose two from three. One question in section B will be wholly discursive
Candidates may be asked to provide answers in a specified form such as a short report or board memorandum – professional marks will be available.
Candidates will be provided with a formulae sheet as well as present value, annuity and standard normal distribution tables. The normal distribution tables may be required for:
• the Black Scholes option pricing model (and variants upon it),
• estimation of the probability of default on corporate debt,
• the calculation of VaR (Value at Risk).
Candidates are advised to bring a scientific calculator – logarithms and exponential constants are required for the Black Scholes model.
It is essential to carefully work through the Pilot Paper and the December 2007 - December 2009 exams to become familiar with the style, time pressure and high level of difficulty. However be warned that the examiner does not simply recycle past questions.
The examiner has published the following articles:
• “Toxic assets” - the last section of the syllabus,”emerging issues in finance and financial management”, allows the examiner to test this, or indeed anything else that he finds of interest. I would recommend that you review his blog to see what is currently on his mind http://professorbobryan.blogspot.com/
• “How lenders set their rates” – which covers structural debt models i.e. analysing the level and volatility of assets (or, even better, cash) to estimate the probability of default on corporate debt and hence to calculate the appropriate credit spread for the firm.
• “Modified Internal Rate of Return” – which addresses a limitation of traditional IRR in assuming that project returns can be reinvested at the IRR itself. MIRR makes the more realistic assumption that project returns can be reinvested at the firm’s hurdle rate i.e. cost of capital.
• “Application of option pricing to valuation of firms” – the examiner explains how Robert Merton applies the Black Scholes Model to value the equity of firms that cannot be easily valued using traditional Free Cash Flow models e.g. high growth start-ups or firms at risk of default. Merton views equity investors as having a call option over the firm’s assets, with the exercise price and time to expiry being the redemption value and time to maturity of the firm’s liabilities.
In the traditional manufacturing sector the assets tend to be higher than liabilities and the option has significant intrinsic value – hence investors have a lot to lose and are risk averse, as assumed in traditional finance theory. However in the banking sector assets tend to be close to liabilities, hence investors have little to lose and encourage excessive risk taking by the bank's employees (themselves driven by large potential bonuses). If the gamble pays off the assets rise above liabilities and the investors take a large gain, if the gamble fails they walk away under the protection of limited liability.

By Mike Ashworth

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