CA Final Advanced Financial Management MCQs

Numerical AFM MCQs for Paper 2, with every wrong option traced to the error behind it.

5 full-length tests. Each has 23 questions for 30 marks in 30 minutes. MCQ 1 is free.

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Try 3 questions from MCQ 1

Work each one out, then open the answer to see why every option is right or wrong.

Question 1, 1 mark

A portfolio worth Rs. 576 lakhs has a beta of 1.25. Index futures trade at 24,000 with a lot size of 50. What position fully hedges the portfolio?

  1. Sell 48 contracts, the portfolio value being divided by the value of one futures contract to arrive at the number of contracts needed.

    Wrong. Ignoring beta leaves a portfolio of this volatility under-hedged.

  2. Buy 60 contracts, a long futures position being required to offset the risk that the value of the shares held will fall.

    Wrong direction. A long futures position would double the exposure rather than offset it.

  3. Sell 75 contracts, the beta of the portfolio being applied both to its value and to the value of a single futures contract.

    Wrong. Beta is applied once, to the portfolio value.

  4. Sell 60 contracts, the beta adjusted value of the portfolio being divided by the value of one futures contract.

    Correct answer

    Correct - sell 60 contracts.

Show answer
Why

The number of contracts is the beta adjusted portfolio value divided by the value of one contract. The portfolio's exposure is Rs. 576 lakhs x 1.25, or Rs. 720 lakhs, and one contract is worth 24,000 x 50, or Rs. 12 lakhs, so 60 contracts are needed. The holder of shares loses when the market falls, so the futures position must gain when the market falls, which means selling. Omitting beta understates the hedge whenever the portfolio is more volatile than the index.

Reference: Study Material Chapter 9, on hedging with stock index futures.

Question 2, 1 mark

A borrower buys a 3 against 6 forward rate agreement on a notional of Rs. 500 lakhs at 8%. At settlement the three month reference rate is 9.5%. What does the borrower receive?

  1. Rs. 7.50 lakhs, being the difference of 1.5 percentage points between the two rates applied to the notional principal of the agreement.

    Wrong. The rate is annual and the agreement covers three months.

  2. Rs. 1.88 lakhs, being the rate difference applied to the notional for the three month period the agreement covers, taken at the settlement date.

    Wrong. This is the undiscounted differential, which arises three months after settlement.

  3. Rs. 1.83 lakhs, being the rate difference applied to the notional for three months, discounted because settlement is made at the start of that period.

    Correct answer

    Correct - Rs. 1.83 lakhs, the discounted differential.

  4. Rs. 3.75 lakhs, being the rate difference applied to the notional for the six months that elapse between the dealing date and the end of the loan.

    Wrong. The contract period is three months; the 3 against 6 label describes when it starts and ends.

Show answer
Why

A forward rate agreement settles in cash at the beginning of the contract period, not at the end of it, so the interest differential has to be discounted back over that period at the reference rate. The differential is Rs. 500 lakhs x 1.5% x 3/12, or Rs. 1.875 lakhs, which arises at the end of the three month period. Discounted at 9.5% for three months, dividing by 1.02375, it becomes Rs. 1.83 lakhs. The borrower receives that amount, which offsets the higher interest he will pay on his actual borrowing.

Reference: Study Material Chapter 12, on forward rate agreements and their settlement.

Question 3, 1 mark

A bank reports a one day value at risk of Rs. 40 lakhs at a 99% confidence level. What does that mean?

  1. On about one trading day in a hundred the loss is expected to exceed Rs. 40 lakhs, and the measure says nothing about how large the loss might then be.

    Correct answer

    Correct - a threshold breached about one day in a hundred, with nothing said about the tail.

  2. The maximum loss the bank can suffer in a single trading day is Rs. 40 lakhs, and losses beyond that figure have been excluded by the modelling.

    Wrong. Value at risk is a quantile, not a ceiling; losses beyond it are possible.

  3. The bank expects to lose Rs. 40 lakhs on 99 trading days out of every hundred, which is the average daily loss its trading book will produce.

    Wrong. It is not an average daily loss.

  4. There is a 99% probability that the bank will lose exactly Rs. 40 lakhs on the next trading day, given the volatility observed in the recent past.

    Wrong. It is a probability of exceeding a threshold, not of realising an exact amount.

Show answer
Why

Value at risk is a threshold loss for a stated holding period and confidence level: at 99% over one day, losses are expected to exceed Rs. 40 lakhs on roughly one day in a hundred. It is not a maximum, and its central limitation is that it is silent about the size of the loss in that tail - which is why expected shortfall, the average loss given that the threshold is breached, is used alongside it. Nor is it an expected or average loss; it is a quantile of the loss distribution.

Reference: Study Material Chapter 2, on value at risk and its limitations.

That is the review you get on every question after a full test, with your marks broken down by topic, weakest first, so you know what to revise next.

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What the AFM tests cover

AFM Part I is almost entirely numerical, and most of it is linked: one case, several questions, each depending on getting the step before it right. These tests are built the same way, so you practise carrying a figure through, not just computing it once.

Every wrong option is a figure you would actually reach by a specific error: a rate applied to the wrong base, a settlement not discounted, a beta left out of the hedge ratio. When you pick one, the review names the error, so you know which step to fix rather than just that the answer was wrong.

Coverage runs across the paper: capital budgeting under risk, portfolio theory and CAPM, security valuation, mutual funds, derivatives and hedging, interest rate risk, foreign exchange, mergers, business valuation, startup finance and risk management.

The questions are new, written from the Acts, the Standards and the study material, and are not reprints of ICAI papers.

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