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PAPER NO.15 ADVANCED FINANCIAL MANAGEMENT GENERAL OBJECTIVE

This paper is intended to equip the candidate with knowledge, skills and attitudes that will enable him/her to apply advanced financial management techniques in an organisation.

LEARNING OUTCOMES

A candidate who passes this paper should be able to:

• Evaluate advanced capital budgeting decisions
• Design an optimal capital structure for an organisation
• Predict corporate failure
• Apply derivatives in financial risk management
• Apply financial management skills in the public sector
• Understand concepts of corporate restructuring and re-organisation
• Apply valuation techniques in real estate finance

CONTENT

Advanced capital budgeting decision

• Incorporating risk/uncertainty in capital investment decisions
• Nature and measurement of risk and uncertainty
• Techniques of handling risk: sensitivity analysis, scenario analysis, decision trees, simulation analysis, utility analysis, risk adjusted discounting rate(radr) and certainty equivalent method
• Incorporating capital rationing in capital investment appraisal
• Incorporating inflation in capital investment appraisal
• Evaluation of projects of unequal lives
• The real options-strategic investment option, timing option, abandonment option and the replacement option
• Common capital budgeting pitfalls

Portfolio theory and analysis:

• The modern portfolio theory: background of the theory; portfolio expected return; the actual and weighted portfolio risk; derivation of efficient sets; the capital market line (CML) model and its applications, the mean variance dominance rule; short comings of portfolio theory
• Capital Asset Pricing Model-CAPM : background of the theory; assumptions; beta estimation – beta coefficient of an individual asset and that of a portfolio and the interpretation of the result; security market line(SML) model and its applications; conceptual differences between portfolio theory and capital asset pricing model
• Shortcomings of the capital asset pricing model
• The Arbitrage pricing model (APM) and other multifactor models: background of the theory; conceptual differences between the Capital asset pricing model and the Arbitrage pricing model; application of the Arbitrage pricing model, shortcomings of Arbitrage pricing model; Pastor Stambaugh model
• Evaluation of portfolio performance: Treynor’s measure, Sharpe’s measure, Jensen’s measure, appraisal ratio measure, information ratio, Modigliani and Modigliani (M2)

Advanced financing decision

• The nature of financing decision, principle objectives of making financing decision
• Overview of cost of capital: meaning and relevance of cost of capital: the firm’s overall cost of capital; weighted average cost of capital (WACC) and weighted marginal cost of capital (WMCC) ; analysis of breakpoints in weighted marginal cost of capital schedule
• Capital structure theories: nature of capital structure and factors influencing the firm’s capital structure; traditional theories of capital structure – assumptions of the theories, Net income theory and Net operating income theory; Franco Modigliani and Merton Miller’s propositions – MM without taxes, MM with corporation taxes, MM with corporation and personal tax rates and MM with taxes and financial distress costs; other theories of capital structure; the pecking order theory and Trade-off theory determination of the firm’s optimal capital structure using the Hamada model, CAPM and WACC
• Special topics in financing decision: analysis of operating profit (EBIT)/EPS at point of indifference in firm’s earnings; establishing the range of operating profit within which each financing option; leverage and risk; operating leverage and operating risk, financial leverage and financial risk, combined leverage and total risk; quantifying leverage using the degree of operating leverage, degree of financial leverage and degree of combined leverage
• Long term financing decisions; bond refinancing decision, lease-buy evaluation and the rights issues
• Impact of financing on investment decisions – the concept of adjusted present value (APV)

Mergers and acquisitions

• Nature of mergers and acquisitions
• Reasons of mergers and acquisitions
• Acquisition and Mergers verses organic growth
• Valuation of acquisitions and mergers
• Prediction of a takeover target
• Defence tactics against hostile takeovers
• Financing of mergers and acquisitions
• Analysis of combined operating profit (EBIT) and post-acquisition earning per share at the point of indifference in firms earnings under various financing options.
• Determination of range of combined operating
• Regulatory frame work for mergers and acquisitions
• Reasons why there are failed mergers and acquisitions
• Mergers and acquisitions in a global context

Corporate restructuring and re-organisation

• Background on restructuring and re organisation
• Indicators/symptoms of restructuring
• Considerations in designing an appropriate restructuring programme
• Financial reconstruction: forms of financial reconstruction; impact of financial reconstruction on share price; impact of financial reconstruction on the weighted Average cost of capital (WACC)
• Portfolio reconstruction: various ways of unbundling a firm: divestment, de- merger, spin-off, liquidation, sell-offs, equity curve outs, strategic alliances, management buyout, leveraged buyouts and the management buy-ins.
• The relevance of the various forms of portfolio reconstruction
• Organisational reconstruction: The nature and benefits of this form of restructuring; models of predicting corporate failure; Multiple discriminant analysis (Z-Score model), Beaver failure ratio, Argenti model, Taffler’s model
• Causes of financial distress
• Forms of financial distress and solutions to financial distress

Derivatives in financial risk management

• The meaning, nature and importance of derivative instruments: futures, forwards, options and swaps
• Pricing and valuations of derivatives: futures, forwards, options and swaps
• Types of risks: operational risks, political risks, economic risks, fiscal risks, regulatory risks, currency risks and interest rate risks
• Foreign currency risk management: Types of forex risks, hedging currency risks, forward contracts, money market hedge, currency options, currency futures and currency swaps
• Interest rate risks: Term structure of interest rates, forward rate agreement, interest rate futures, interest rate swaps, interest rate options

International financial management

• International investments
• International financial markets
• International financial institutions
• Methods of financing international trade
• International parity conditions: Interest rate parity, purchasing power parity and International fisher effect
• International arbitrage: locational arbitrage, triangular arbitrage and covered interest arbitrage
• Divided policy for multinationals
• International debt instruments: International bonds (euro bond), certificate of deposits, securitisation of loans, commercial paper
• Availability and timing of remittances
• Transfer pricing: impact on taxes and dividends

Real estate finance

• Overview of real estate business – nature of real estate business, legal and economic framework and participants in real estate business in Kenya
• Valuation approaches (income, cost and sales comparison approaches)
• REITS: types; advantages and disadvantages; valuation: net asset value per share (NAVPS); use of funds from operations (FFO), adjusted funds from operations (AFFO) in REIT valuation
• Instruments of real estate financing – mortgages, lien, title, mortgage requirements and mortgage clauses
• Rights in case of debt – default and its consequence, equity of redemption, foreclosure, statutory redemptions
• Mortgage and financial markets: demand for funds in mortgage market, disintermediation effects, primary and secondary mortgage market, mortgage market and cost of money, role of central bank and the role of government in mortgage markets

• Savings and loan association – classification, state accounts, insurers. Mortgage backed bonds and services

Emerging issues and trends

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