ACCA FM · Chapter 2
Financial management environment MCQs with Answers
10 multiple-choice questions on Financial management environment for ACCA FM Financial Management. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Which of the following would be an example of an expansionary fiscal policy?
- A) Reducing the level of government spending
- B) Selling government bonds to reduce the money supply
- C) Increasing the central bank's base interest rate
- D) Reducing the rate of income tax
Show answer & explanation
Answer: D) Reducing the rate of income tax
Fiscal policy concerns government taxation, spending and borrowing. Cutting income tax increases households' disposable income and so boosts aggregate demand, which is expansionary. Cutting government spending is contractionary fiscal policy, while changing interest rates or the money supply is monetary policy.
Question 2
A government raises interest rates in order to reduce inflation. Which of the following is the MOST likely consequence for a company based in that country?
- A) An increase in its cost of borrowing and a fall in demand for its products
- B) A weakening of the domestic currency, making its exports cheaper
- C) A fall in the cost of its variable rate borrowing
- D) An increase in consumer spending on credit
Show answer & explanation
Answer: A) An increase in its cost of borrowing and a fall in demand for its products
Higher interest rates increase the cost of variable rate and new borrowing and discourage consumer spending financed by credit, so demand for many products falls. Higher interest rates also tend to attract foreign capital, which strengthens rather than weakens the domestic currency, making exports more expensive.
Question 3
Which of the following best describes monetary policy?
- A) Government policies designed to reduce pollution by businesses
- B) Government decisions on levels of taxation and public expenditure
- C) Government or central bank action to influence the money supply, interest rates and credit
- D) Government regulation of monopolies and mergers
Show answer & explanation
Answer: C) Government or central bank action to influence the money supply, interest rates and credit
Monetary policy operates through the money supply, interest rates, exchange rates and the availability of credit, and is often delegated to an independent central bank. Taxation and spending are fiscal policy, while regulation of monopolies (competition policy) and environmental rules are other forms of government intervention.
Question 4
Banks accept short-term deposits from savers and use the funds to make long-term loans to businesses. Which function of a financial intermediary does this describe?
- A) Maturity transformation
- B) Risk transformation
- C) Aggregation
- D) Securitisation
Show answer & explanation
Answer: A) Maturity transformation
Maturity transformation occurs when an intermediary bridges the gap between lenders who want to lend for short periods and borrowers who need long-term funds. Aggregation (pooling) refers to combining many small deposits into large loans, and risk transformation refers to spreading the risk of default across a large portfolio of loans.
Question 5
Which of the following statements about the money markets is correct?
- A) They are markets for long-term debt such as 20-year bonds
- B) They are markets that deal only in foreign currencies
- C) They are markets in which companies issue new ordinary shares
- D) They are markets for lending and borrowing for periods of less than one year
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Answer: D) They are markets for lending and borrowing for periods of less than one year
Money markets deal in short-term funds, typically with maturities of up to one year, using instruments such as treasury bills, certificates of deposit and commercial paper. Capital markets deal in long-term finance such as shares and long-dated bonds. The foreign exchange market is a separate market.
Question 6
Which money market instrument is a negotiable certificate issued by a bank, confirming that a sum has been deposited for a fixed period at a stated rate of interest?
- A) Commercial paper
- B) Banker's acceptance
- C) Certificate of deposit
- D) Treasury bill
Show answer & explanation
Answer: C) Certificate of deposit
A certificate of deposit (CD) is issued by a bank in exchange for a fixed-term deposit, and because it is negotiable the holder can sell it in the money market before maturity. Treasury bills are issued by government, commercial paper is unsecured short-term debt issued by large companies, and a banker's acceptance is a bill of exchange guaranteed by a bank.
Question 7
A 91-day treasury bill with a face value of $100 can be bought today for $98.80. What is the annualised yield on the bill, assuming a 365-day year and simple (not compound) annualisation?
- A) 1.21%
- B) 4.81%
- C) 4.87%
- D) 4.96%
Show answer & explanation
Answer: C) 4.87%
Return over 91 days = (100 - 98.80) / 98.80 = 1.20 / 98.80 = 1.2146%. Annualised simply: 1.2146% x 365 / 91 = 4.87% (rounded to 2 decimal places). Dividing the discount by the face value rather than the price paid gives the lower discount rate of 4.81%, 1.21% is the return for the 91 days only, and 4.96% uses compound rather than simple annualisation, which the question excludes.
Question 8
Which of the following describes a transaction in the secondary market?
- A) An investor buys existing shares in a listed company from another investor through the stock exchange
- B) A company raises new equity through a rights issue to existing shareholders
- C) A company issues new shares to the public for the first time
- D) A government issues new bonds to finance public spending
Show answer & explanation
Answer: A) An investor buys existing shares in a listed company from another investor through the stock exchange
The primary market is where new securities are issued and the issuer receives the funds. The secondary market is where existing securities are traded between investors, so the company receives no new finance. A liquid secondary market makes investors more willing to buy securities in the primary market.
Question 9
Which of the following best describes commercial paper?
- A) Secured long-term loan notes issued by small companies
- B) Short-term debt issued by central government to manage its cash flows
- C) A deposit with a bank that cannot be sold before it matures
- D) Unsecured short-term debt issued by large creditworthy companies, usually at a discount to face value
Show answer & explanation
Answer: D) Unsecured short-term debt issued by large creditworthy companies, usually at a discount to face value
Commercial paper is a short-term, unsecured promissory note issued by large companies with high credit ratings, usually with a maturity of under a year and sold at a discount to its face value. Government short-term debt is a treasury bill, and a bank deposit that can be traded would be a certificate of deposit.
Question 10
Which of the following is the main reason why the interest rate on an unsecured loan to a small company is usually higher than the yield on a treasury bill of the same maturity?
- A) Treasury bills are subject to higher inflation
- B) Treasury bills have a longer maturity
- C) Investors require a higher return to compensate for the higher default risk
- D) Small company loans are more liquid than treasury bills
Show answer & explanation
Answer: C) Investors require a higher return to compensate for the higher default risk
The return required by investors increases with risk. Treasury bills are backed by the government and are close to risk free, whereas an unsecured loan to a small company carries significant default risk and is less liquid, so lenders demand a higher interest rate. Both investments face the same inflation, and the question states that maturities are the same.