How to pass CIMA P3

P3 is a tricky paper but it is doable. Bear in mind this is at masters level, it is not meant to be easy and you only failed by about one question!

 

A common problem with P3 questions is students can try and answer questions a just by rote learning. Some of the questions are quite subtle in testing how you would apply some of the issues in a particular situation rather than have you learned the rules. 

 

A good example is this question:

 

 Many students answer this by saying the audit-committee has not had enough meeting per year because if we read the rules:

 

So, "there should be as many meetings as the audit committees roles and responsibilities require" in this case, the 2 they are having, while below the recommendation of 3, is enough.

 The logic for a question like this is the examiner doesn't just want candidates to rote learn, but to apply their knowledge.

 

The other issue facing many students who do loads of questions is that sometimes the see a similar question in the exam as they did before and miss the slight subtle differences.

 

So do as many questions as you can but take time to debrief yourself. Why is an option correct or wrong? You should be taking as long debriefing as you do taking the questions.

VaR

This is the way I teach this - This is all you need to know for the exam.

 VaR = Standard Deviation x the Z score.

The standard deviation is how much the members of a group differ from the mean (average) value for the group. You will not be required to calculate this in your exam.

To calculate the Z score of a particular confidence level we take the confidence level, in this case, 95% and takeaway 50 (this is because we are just looking at one side of the standard distribution (the amount that is over or under the average). This equals 45. So for a 95% confidence, we’re looking for a value in the body of the table of 0.45.

As you can see in the screenshot here, this will lie exactly halfway between the two values I’ve highlighted (0.4495 and 0.4505)

As these figures are in row 1.6 we get 1.645

 So assuming the standard deviation (always given) is $2m then the VaR is 1.645 × $2 million = $3.29 million.

 If we are asked to find the 8 years VaR we don't multiply the $1.72 by 8 as you would think. But we multiply it by the square root of 8.

On your calculator this is the same as (8^0.5) means the square root of eight. (i.e. the n-period VAR = the one-period VAR x n^0.5).

So for 99% VaR we get 99-50= 49. Look up .49 in the body of the table we get column 0.03 and row 2.3 so the Z score for a 99% VaR is 2.33.

How to take Objective Tests or Peter's Three Pass Technique

I have always thought that taking exams is part knowledge and part technique. In fact, during most of my teaching career, I have often said that to pass professional exams you need three skills in equal measure: Knowledge, technique and time. With the onset of objective testing has this option changed?

Well no it hasn't!

For objective tests, I believe that technique is also very important and it can make a big difference between pass and failure.

Firstly make sure the first time you take the exam isn't the first time you take it for real. In other words practice, practice, practice. What you need to do is not only practice your knowledge but also practice your exam technique as well and to time.

If you were entering for a marathon you wouldn't just turn up on the day and run. You would train. This training would consist of short runs, longer runs, trying different techniques, different paces until you find something that really worked.

This is what you need to do in the final build-up to the exam. Also, you wouldn't run a marathon in a brand new pair of trainers, would you? No! So make sure you practice questions using the calculator (from CIMA's approved list) that you would use on the day. Even practice using a single piece of paper or laminate sheet like you get in the exam.

With objective tests, a careful reading of the question is crucial. One word can change the whole meaning of the question. Watch out for double negatives and check how many answers you have been asked to select.

You have on average 90 seconds to attempt each question so with this in mind, can you really afford to read and then re-read a question a second or even third time?

So here is Peter's three pass technique.

First pass: Aim to do over 10 questions in each 15 minute period (there is a timer on the computer screen). Start at question 1 and ask yourself the question can I do it quickly? If the answer is yes do it. If the answer is no, flag the question (there's a button top right) and move on.

Second pass: Again aim to do 10 questions per 15 minute period. Start at your first flagged question and this time ask yourself the question. Do I think I can do it? If the answer is yes do it, if not leave it flagged and move on.

If a question has a long scenario, read the question (at the end, normally) first, so you know exactly what you're looking for in the scenario. Think about what type of information is needed to answer the question, and look for the information in the scenario.

Attempt the questions and remove the flag as you do it.

Third pass: Now go back again to your first flagged question work out how much time is left and try and spend equal time on the still flagged questions.

Don't leave any multiple-choice questions unanswered - if you don't know which answer is correct, exclude those which you know are wrong and make an educated guess. You have nothing to lose as there is no negative marking in the exam.

Remember:
If a question looks 'subjective', stop thinking too much. Look for what it probably says in the textbook. Try the 'simplistic' approach. It's normally the right one. If you over-analyse, you'll get even more confused.

The questions students are finding the most challenging are the 'select ALL that apply' question. Of course, you need to select the most obvious answers, but which ones? Well, it's least likely to be one or all of them, so 2/3/4 should be your 'favourites' but a much better approach is to try spotting the ones that don't apply.

If you find yourself using far too much time on a question, guess and move on. Try to attempt ALL the questions in the 90 minutes, even if you have to guess at a few.

Never go back to questions you have already answered. You'll only waste time and talk yourself out of what is probably the correct answer.

Finally, to pass exams you don't have to use my technique but at least have one. Good luck!

Corporate Governance – Who sits where?

The Board

Roles:

The roles of chairman and CEO should not be held by the same individual.

Chairman runs the Board and ensures its effectiveness. The CEO runs the company.

One NED should be the senior independent director who is directly available to shareholders, if they have concerns which cannot be dealt with through the CEO, Chairman or CFO.

Balance:

There should be a balance between Execs and NEDs: The Board should consist of half independent NEDs excluding the chair

              What makes an NED independent?

·       Not an employee in the last 5 years

·       No material relationship with the company in the last 3 years

·       No cross directorships

·       Only receive a directors fee (no share options and bonuses etc)

·       No close family ties with other directors

·       Not a shareholder

·       Has not served on the Board for more than 9 years.

Three compulsory committees

·       Audit

At least 3 independent NEDs (or two for companies outside the FTSE 350. The chairman of a smaller company may be an additional member of the committee provided he was regarded as independent when he was appointed chairman, but he should not chair the committee).

Though the auditors or FD may be invited to certain meetings, the composition of the AC is meant to be NEDs only. However, they will not have the right to attend or vote; they are only there by invitation.

The Code also says that the board should ‘satisfy itself’ that at least one member of the committee has recent and relevant financial experience. The Code is not specific about what constitutes ‘relevant experience’. Failure to satisfy this requirement is one of the more common disclosures in company reports when detailing their compliance with the Code. 

Often, the ‘expert’ will be a retired finance director from another company or a former partner of an accountancy firm. To comply with the Code’s recommendations for independence, the board should, of course, exclude its own former finance directors and auditors. In any event, it must justify its choice in the annual report.

·       Remuneration

           At least 3 independent NEDs (or two for companies outside the FTSE 350. The chairman of a smaller company may be an additional member of the committee provided he was regarded as independent when he was appointed chairman, but he should not chair the committee).

A remuneration committee will, in accordance with the Code’s provisions, commonly have delegated authority to set executive pay. Its proposals will be discussed with the chairman and/or chief executive, and there may be a broad policy on directors’ pay agreed with the board, but the responsibility will lie with the committee, not the board.

The head of HR will often be needed at remuneration and nomination committee meetings. But will not have the right to attend or vote; they are only there by invitation.

·       Nominations

Majority of members should be independent non-executive directors.

There is no ban on the chief executive being a member. The committee should be chaired by one of the independent non-executives or the company chairman, though he should stand aside when it comes to appointing his successor.

The committee makes recommendations for executive as well as non-executive appointments.

The nomination committee will usually make recommendations to the full board and leave the final decision to the board as a whole

NB Individuals who are non-executives in one company will often be executive directors in another – and vice versa. It is generally thought to be a good thing that an executive gets experience of the workings of another company and another industry. However, it is important that the demands on the individual are realistic – a major corporate dispute or a takeover can demand huge amounts of non-executive time. The Code says that the board should not agree to a full-time executive taking on more than one FTSE 100 company non-executive directorship or the chairmanship of such a company.

THE BASIC PRINCIPLES OF ISLAMIC FINANCE

The Islamic economic model has developed over time based on the rulings of Sharia on commercial and financial transactions. The Islamic finance framework is based on:

   equity, such that all parties involved in a transaction can make informed decisions without being misled or cheated

   pursuing personal economic gain but without entering into those transactions that are forbidden (for example, transactions involving alcohol, pork‐related products, armaments, gambling and other socially detrimental activities). Also, speculation is also prohibited (so options and futures are ruled out)

     the strict prohibition of interest (riba = excess).

As stated above, earning interest (riba) is not allowed.

In an Islamic bank, the money provided in the form of deposits is not loaned, but is instead channelled into an underlying investment activity, which will earn profit. The depositor is rewarded by a share in that profit, after a management fee is deducted by the bank.

A typical illustration would be how an Islamic bank may purchase a property from a seller and resell it to a buyer at a profit. The buyer will be allowed to pay in instalments. Compare this to a typical mortgage where the bank lends money to the buyer and charges interest.

Hence, returns are made from cash returns from a productive source – for example, profits from selling assets or allowing the use of an asset (rent).

In Islamic banking there are broadly two categories of financing techniques:

     ‘fixed Income’ modes of finance – murabaha, ijara, sukuk

     equity modes of finance – mudaraba, musharaka.

FIXED INCOME MODES

(a)  Murabaha

Murabaha is a form of trade credit or loan. The key distinction between a murabaha and a loan is that, with a murabaha, the bank will take actual constructive or physical ownership of the asset. The asset is then sold to the ‘borrower’ or ‘buyer’ for a profit but they are allowed to pay the bank over a set number of instalments.

The period of the repayments could be extended, but no penalties or additional mark‐up may be added by the bank. Early payment discounts are not within the contract.

(b)  Ijara

Ijara is the equivalent of lease finance. It is defined as when the use of the underlying asset or service is transferred for consideration. Under this concept, the bank makes available to the customer the use of assets or equipment such as plant or motor vehicles for a fixed period and price. Some of the specifications of an Ijara contact include:

     the use of the leased asset must be specified in the contract

     the lessor (the bank) is responsible for the major maintenance of the underlying assets (ownership costs)

     the lessee is held for maintaining the asset in proper order.

An Islamic lease is more like an operating lease, but the redemption features may be structured to make it similar to a finance lease.

(c)  Sukuk

Companies often issue bonds to enable them to raise debt finance. The bond holder receives interest and this is paid before dividends.

This is prohibited under Islamic law. Instead, Islamic bonds (or sukuk) are linked to an underlying asset, such that a sukuk holder is a partial owner in the underlying assets and profit is linked to the performance of the underlying asset. So, for example, a sukuk holder will participate in the ownership of the company issuing the sukuk and has a right to profits (but will equally bear their share of any losses).

EQUITY MODES

(a)  Mudaraba

Mudaraba is a special kind of partnership where one partner gives money to another for investing it in a commercial enterprise. The investment comes from the first partner (who is called ‘rab ul mal’), while the management and work is an exclusive responsibility of the other (who is called ‘mudarib’).

The Mudaraba (profit sharing) is a contract, with one party providing 100% of the capital and the other party providing its specialist knowledge to invest the capital and manage the investment project. Profits generated are shared between the parties according to a pre‐agreed ratio. In a Mudaraba only the lender of the money has to take losses.

This arrangement is therefore most closely aligned with equity finance.

(b)  Musharaka

Musharaka is a relationship between two or more parties that contribute capital to a business, and divide the net profit and loss pro rata. It is most closely aligned with the concept of venture capital. All

providers of capital are entitled to participate in management, but are not required to do so. The profit is distributed among the partners in pre‐agreed ratios, while the loss is borne by each partner strictly in proportion to their respective capital