CA FINAL

STRATEGIC FINANCIAL MANAGEMENT

TEST PAPER
Time Allowed – 4 Hours 30 Minutes Maximum Marks –150

 The question paper consists of questions with serial number 1-22

 Answer all questions.
 Marks are indicated against each question.

1. A foreign institutional investor (FII) proposes to invest $10 million in an Indian security
with a beta of 1.10 and standard deviation of returns 7%. The holding period of investment will
be one year.
The current rupee – dollar exchange rate is `45.45/$. The expected depreciation of rupee
against dollar over the period is 2% with a standard deviation of 10%. The expected
return from the market portfolio in India is 12% and the correlation between the return on
security and the exchange rate is 0.50. The risk free rate of return in India is 5%.
You are required to calculate the expected return and risk for the FII.
5 Marks
2. A study by a Mutual fund revealed the following data in respect of three securities:
Security Standard deviation (%) Correlation with index
A 20 0.60
B 18 0.95
C 12 0.75
The standard deviation of market portfolio (BSE Sensex) is observed to be 15%
i. What is the sensitivity of returns (i.e Beta) of each stock with respect to the
market?
ii. What are the convariances among the various stocks ? Present your answer in a
Covariance Matrix
iii. What would be the risk of portfolio consisting of the all three stock equally ?
iv. What is the beta of the portfolio consisting of equal investment in each stock ?
v. What is the total, systematic and unsystematic risk of the portfolio in (iv)?
2 + 2 + 2 + 1 + 1 = 8 Marks
3. An exporter is a UK based company. Invoice amount is $3,50,000. Credit period is three
months. Exchange rates in London are:
Spot Rate $ 1.5865 – 1.5905 per £

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 Rates of interest in Money Market:
Deposit Loan
$ 7% 9%
£ 5% 8%
Compute the forward rates for US$ at which the exporter will be indifferent between
money market hedge and a forward contract assuming the same spread shall be continued
after 3 months.
6 Marks
4. Assuming that shares of ABC Ltd. and XYZ Ltd. are correctly priced according to Capital
Asset Pricing Model. The expected return from and Beta of these shares are as follows:
Share Beta Expected return
ABC 1.2 19.8%
XYZ 0.9 17.1%
You are required to derive Security Market Line.
6 Marks
5. The following two types of securities are available in the market for investment:
Security Return (%) Standard deviation (%)
Gilt edged security 7 0
equity 25 30
Using the above two securities, if you are planning to invest ` 100000 to construct a
portfolio with a standard deviation of 24%, what is the return of such portfolio?
5 Marks
6. Following are the covered after-tax lending and borrowing rates for three units
of a Multinational Corporation located in the United States, Singapore and India.
Lending (%) Borrowing (%)
United States 4.5 5
Singapore 3.5 4
India 4.6 5.4
Currently, the Singapore and India units owe $2 million and $ 3 million, respectively to
their US parent.
The Singapore unit also has $ 1 million in receivables from its India affiliate. The timing
of these payments can be changed by up to 60 days in either direction. If US Parent is
in deficit of funds, while both the Singapore and India subsidiaries have surplus cash
available, you are required to:
i. Determine the MNC’s optimal leading and lagging strategies
ii. Calculate the net profit impact of these adjustments
iii. Indicate the change in the MNC’s optimal strategy, if the US parent has surplus cash
available. 2 + 4 + 2 = 8 marks

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7. OJ Ltd. of UK is supplier of leather goods to retailers in the UK and other Western
European countries. The company is considering entering into a joint venture with a
manufacturer in South America. The two companies will each own 50% of the limited
liability company JV(SA) & will share profits equally. £ 450,000 of the initial capital is being
provided by OJ Ltd. and the equivalent in South American dollars (SA$) is being provided
by the foreign partner. The managers of the joint venture expect following cash flows :
SA$ 000 Forward rates of exchange to the £ Sterling [ SA$ / £]
Year 1 4,250 10
Year 2 6,500 15
Year 3 8,350 21
For tax reasons JV (SA) the company to be formed for the joint venture, will be registered in
South America. Ignore taxation in your calculations
Requirements :
Assume you are financial adviser retained by OJ Limited to advise on the proposed joint
venture.
i. Calculate NPV of the project under the two assumptions explained below.
Use a discount rate of 16% for both assumptions.
Assumption 1 : The South American country has exchange controls which prohibit
the payment of cash flows above 50% of the annual cash flows for the first three
years of the project. The accumulated balance can be repatriated at the end of the third
year.
Assumption 2 : The government of the South American country is considering
removing exchange controls and restriction on repatriation of profits. If this happens
all cash flows will be distributed to the partner companies at the end of each year.
ii. Comment briefly on whether or not the joint venture should proceed based on these
calculations.
7 + 3 = 10 Marks
8. Following information is available regarding four mutual funds :
Mutual Fund Return Risk (Beta) Risk free rate
σ Rf
P 13 16 .90 9
Q 17 23 .86 9
R 23 39 1.20 9
S 15 25 1.38 9
Evaluate performance of these mutual funds using Sharp Ratio and Treynor’s Ratio. Comment
on the evaluation after ranking the funds.
6 Marks

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9. Mr. XYZ has categorized all the available stocks in the market into the following types:
a. Small cap value stocks
b. Small cap growth stocks
c. Large cap value stocks
d. Large cap growth stocks
He has also estimated the weights of the above categories of stocks in the market index.
Further more, the sensitivity of returns on these categories of stocks to the three
important factors are estimated to be:
Weight in the Factor 1 Factor 2 Factor 3 (average
Category of stocks
market index (beta) (price/book) capitalization)
Small cap value 10% 0.90 0.75 1.25
Small cap growth 25% 0.80 1.39 1.35
Large cap value 15% 0.85 2.05 6.75
Large cap growth 50% 1.165 2.75 8.65
Risk premium 6.85% -3.5% 0.65%
The risk free rate of return is 4.5% .
Required:
i. Using Arbitrage Pricing Theory, determine the expected return on the market index.
ii. Using Capital Asset Pricing Model, determine the expected return on the market index.
iii. Mr. XYZ wants to construct a portfolio constituting only the ‘small cap value’ and
‘large cap growth’ stocks. If the target beta for the portfolio is one, determine the
composition of his portfolio.
3 + 3 + 2 = 8 marks
10. A Laptop Bag is priced at $ 105.00 at New York. The same bag is priced at `4,250 in
Kolkata. Determine Exchange Rate in Kolkata.
i. If, over the next one year, price of the bag increases by 7% in Kolkata and by 4% in New
York, determine the price of the bag at Kolkata and- New York? Also determine
the exchange rate prevailing at New York for ` 100.
ii. Determine the appreciation or depreciation in ` in one year from now.
4 + 4 = 8 Marks
11. The stock of the A Ltd. is selling for £50 per common stock. The company then issues rights to
subscribe to one new share at £40 for each five rights held.
a. What is the theoretical value of a right ?
b. What is the theoretical value of one share of stock after right issue ?
c. What is the theoretical value of a right when the stock sells ex-rights at £50?
d. John has £1,000 at the time A Ltd. goes ex-rights at £50 per common stock.
He feels that the price of the stock will rise to £60 by the time the rights expire.

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 Compute his return on his £1,000 if he
i. buys A Ltd stock at £50, or
ii. buys the rights as the price computed in part c, assuming his price expectations are
valid.
2 + 2 + 2 + 2 = 8 Marks
12. India Imports co., purchased USD 100,000 worth of machines from a firm in New York,
USA. The value of the rupee in terms of the Dollar has been decreasing. The firm in
New York offers 2/10, net 90 terms. The spot rate for the USD is ` 55; the 90 days
forward rate is ` 56.
i. Compute the Rupee cost of paying the account within the 10 days.
ii. Compute the Rupee cost of buying a forward contract to liquidate the account in 10
days.
iii. The difference between part a and part b is the result of the time value of money
(the discount for prepayment) and protection from currency value fluctuation.
Determine the magnitude of each of these components.
1 + 2 + 2 = 5 Marks
13. The stock research division of MMG Investment Ltd. Has developed ex- ante probability
distribution for the likely economic scenarios over the next one-year and estimates the
corresponding one period rates of return on stock A, Stock B and Market index as follows:
One period rate of return (%)
Economic Scenario Probability
Stock A Stock B Market
Recession 0.15 -15 -3 -10
Low growth 0.25 10 7 13
Medium growth 0.45 25 15 18
High growth 0.15 40 25 32
The expected risk-free real rate of return and the premium for inflation are 3% and 6.5% per
annum respectively.
You, as an analyst of MMG investment service Ltd. are required to:
calculate the following for Stock A and B:
i. expected return
ii. Covariance of returns with the market returns.
iii. Beta (a)
4 + 4 + 2 = 10 Marks
14. During a year the price of British Gilts (face value £100) rose from £105 to £110, while
paying a coupon of £8. At the same time the exchange rate moved from $/£ of 1.80 to
1.70. What is the total return to an investor in USA who invested in this security?
6 Marks

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15. Place the following strategies by different persons in the Exposure Management Strategies
Matrix.
Strategy 1: Kuljeet a wholesaler of imported items imports toys from China to sell them in the
domestic market to retailers. Being a sole trader, he is always so much involved in the
promotion of his trade in domestic market and negotiation with foreign supplier that he
never pays attention to hedge his payable in foreign currency and leaves his position
unhedged.
Strategy 2: Moni, is in the business of exporting and importing brasswares to USA and
European countries. In order to capture the market he invoices the customers in their home
currency. Lavi enters into forward contracts to sell the foreign exchange only if he
expects some profit out of it other-wise he leaves his position open.
Strategy 3: TSC Ltd. is in the business of software development. The company has both
receivables and payables in foreign currency. The Treasury Manager of TSC Ltd. not only enters
into forward contracts to hedge the exposure but carries out cancellation and
extension of forward contracts on regular basis to earn profit out of the same. As a
result management has started looking Treasury Department as Profit Centre.
Strategy 4: DNB Publishers Ltd. in addition to publishing books are also in the business of
importing and exporting of books. As a matter of policy the movement company invoices
the customer or receives invoice from the supplier immediately covers its position in the
Forward or Future markets and hence never leave the exposure open even for a single day.
8 Marks
16. Mr. Tamarind intends to invest in equity shares of a company the value of which depends
upon various parameters as mentioned below:
Factor Beta Expected value in % Actual value in %
GNP 1.20 7.70 7.70
Inflation 1.75 5.50 7.00
Interest rate 1.30 7.75 9.00
Stock market index 1.70 10.00 12.00
Industrial production 1.00 7.00 7.50
If the risk free rate of interest be 9.25%, how much is the return of the share under
Arbitrage Pricing Theory?
5 Marks
17. An established company is going to be demerged in two separate entities. The valuation
of the company is done by a well-known analyst. He has estimated a value of ` 5,000
lakhs, based on the expected free cash flow for next year of ` 200 lakhs and an expected growth
rate of 5%. While going through the valuation procedure, it was found that the analyst
has made the mistake of using the book values of debt and equity in his calculation.

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 While you do not know the book value weights he used, you have been provided with
the following information:
i. The market value of equity is 4 times the book value of equity, while the market
value of debt is equal to the book value of debt,
ii. Company has a cost of equity of 12%,
iii. After tax cost of debt is 6%.
You are required to advise the correct value of the company.
5 Marks
18. An exporter in U.K. is expecting to receive Euro 1 million after 3 months. He has collected the
following information from his banker.
Euro/£
Spot = 1.5778/80
3 months forward = 1.5770/72
3 months interest rate (p.a.)
Euro – 4.5% - 5%
£- 6% - 6.5%
Which of the following would you recommend for covering the exposure?
i. Forward market
ii. Money market
8 Marks
19. Spot rate 1 US $ = ` 48.0123
180 days Forward rate for 1 US $ = ` 48.8190
Annualized interest rate for 6 months – Rupee = 12%
Annualized interest rate for 6 months – US $ = 8%
Is there any arbitrage possibility? If yes how an arbitrage can take advantage of the situation, if
he is willing to borrow ` 40,00,000 or US $83,312.
6 Marks
20. An extract from exchange rate list of a Kolkata based bank is given below :
`/¥: 0· 3992: 0· 4002
i. How many Yen will it cost for a Japanese tourist visiting India to purchase `2,500 worth of
jackfruit?
ii. How much will Mr. Basu in Kolkata have to spend in rupees, to purchase a Sony
camcorder worth ¥1,25,000
2 + 3 = 5 Marks

SANJAY SARAF SIR 7

21. Consider the following information relating to Stock A and the market for the last five Years:
Year Stock A (%) Return on Market (%)
2005 29 -10
2006 31 24
2007 10 11
2008 6 -8
2009 -7 3
i. Determine the regression (Characteristics Line ) equation for the return from the stock
and the market and calculate the alpha (α), beta (β) and Unsystematic Risk.
ii. The total variance of the return from the stock A and the components of variance
that are explained by the market index i.e., Systematic Risk and not explained by the
market index i.e., Unsystematic Risk
6 + 2 = 8 Marks
22. Diva Jewellery Exporters, Chennai received orders to export diamond jewellery to USA at
the rate of one consignment every month in January, February and March, 2007. Amounts
will be received at the end of each month. The company has the option to invoice the
exports either in US $ or Euro. The value of the shipments in US$ and Euro is as under:
Particulars US$ Euro To be received at the end of
First consignment 63950 50000 January 07
Second consignment 96100 75000 February 07
Third consignment 128150 100000 March 07
You, as the Finance Manager of the Company have the following forecast for the exchange rates
at the end of the following months:
Currency January February March
$/Euro 1.2786/88 1.2806/08 1.2811/13
`/$ 45.98/46.00 46.05/07 46.07/09
The current forward rates in the market are as under:
Currency January February March
$/Euro 1.2803/05 1.2822/24 1.2828/30
`/$ 46.04/06 46.11/13 46.13/15
You are required to find out the rupee inflows and suggest the currency of invoicing for each
consignment:
i. If the exposure is hedged.
ii. If the exposure is left uncovered.
6 Marks

SANJAY SARAF SIR 8