Accentuating the positive

May 2020

Joel Romaner reviews March’s AFM exam, which helped put a smile back on his face.

In the current climate, as we grasp to cling onto the positive, my day has just been brightened by the sight of the March 2020 AFM exam. It was sat only a few weeks ago, but for many of us that feels like a lifetime.

As a tutor I have always insisted my students start in section B, so to stay true to my preachings I did the same. I began with Q2, a classic foreign exchange risk requirement, which incorporated the hedging techniques of forward exchange contracts, foreign exchange futures and options.

A slight twist to the question came in the form of the derivative contracts being quoted in euros, while the exchange rate base currency was in dollars. This was a deliberate attempt to cause confusion, though one which could have been easily side stepped by reversing the exchange rate to ensure euros became the base currency.

I also tend to encourage students to pick up the straightforward discursive marks before becoming heavily embroiled in the computations.

Hopefully, many would have recognised the simplicity of part A, and collected marks from a discussion about the rationale behind the firm hedging, and the benefits to shareholder value if the policy is effectively communicated.

The requirement then asked which hedging technique should be recommended, in which a generous 11 marks could have been obtained from undertaking the computations and drawing a rational conclusion designed to maximise the dollar receipt.

The final requirement was to calculate and discuss the margin payments required on a day-to-day basis. Due to the infrequency of this task I would understand if some were unsure, though simple marks were possible to collect.

I next moved on to Q3, which on the surface was a standard investment appraisal requirement. Upon closer inspection, though, this was perhaps the most unusual question of the entire paper, and one which incorporated the technical article on conditional probability that was released in late 2019.

Comfort could be taken, however, from the rather pleasant NPV, which would have boosted confidence and put six marks on the board, prior to the additional considerations planted in the scenario.

Candidates had to recognise the probability of a recession and the impact this would have on the initial NPV, and then take into consideration an alternative investment, prior to deciding whether it was worth abandoning the opportunity today by selling to a competitor, or waiting a year to discover if the regulatory approval would be granted.

This complex aspect was counterbalanced by the final requirement in the shape of a discussion around the rationale for a monitoring system and undertaking a post-completion audit.

Candidates then had to apply this to two earlier projects and identify the benefit that could have been derived for the company.

I then turned my attention to section A, which was based upon the retail sector. A large out-of-town firm, Westparley, was seeking to diversify its product offering via the acquisition of an indirect competitor, Matravers.

I would have encouraged my students to be efficient and collect marks from the more digestible tasks set in parts A and C. The inclusion of the word ‘factors’ is a blessing and gives the candidate scope to be creative, thus making the ability to collect marks much more achievable. This was present in both the discussion of behavioural factors and financing methods.

Once past this point the inevitable report was required, containing a huge 36 marks. There were some altogether pleasant computations, incorporating the frequently examined PE ratio, WACC of combined entities and the free cash flow to equity, in order to establish the value to be derived from the proposed acquisition.

Once the computations had been completed, the candidate then had to take stock and engage in a discussion about the strategic and financial value of the acquisition, including a comment on the estimations and assumptions incorporated into the numbers.

The picture emerging from the computations suggested that there was value to be attained, though concern should be raised at the decision to dispose of the tech division, which while overvalued, may increase footfall and complement the other items sold by the firm.

With approximately 45 computational marks and some rather straightforward discussion tasks, I remain hopeful that this is a paper that will bring cheer to many in our global time of need, and push the pass rate back above the magical 40% barrier.

• Joel Romaner is a senior tutor at LSBF specialising in FM and AFM.