ACCA Advanced Financial Management (AFM) Practice Exam

What do institutions prefer in times of financial uncertainty regarding their investments?

1. High-risk assets

2. Steady income sources

3. Diversified portfolios

4. Short-term investments

The correct answer is: Steady income sources

In times of financial uncertainty, institutions tend to prefer steady income sources because these investments provide a reliable and consistent cash flow, which helps mitigate risk. When the financial landscape is volatile, the focus shifts towards preserving capital and ensuring that cash flows remain stable. Steady income sources, such as bonds or dividend-paying stocks, are less subject to market fluctuations and therefore offer more predictability in terms of returns. This approach allows institutions to manage their risk exposure effectively, as steady income can support ongoing operations without the need to sell off risky assets in a downturn. In contrast, high-risk assets may offer the potential for higher returns, but they also bring greater variability and potential losses, which are less appealing during uncertain times. A diversified portfolio can reduce risk but does not guarantee steady income; it may still include a mix of volatile assets. Short-term investments can provide liquidity, but they might not necessarily ensure stable income, especially in turbulent markets. Thus, the preference for steady income sources reflects a strategic choice to maintain financial stability and security during challenging economic periods.