SFM RTP

PAPER – 2: STRATEGIC FINANCIAL MANAGEMENT
QUESTIONS
Security Valuation
1. XL Ispat Ltd. has made an issue of 14 per cent non-convertible debentures on January 1,
2007. These debentures have a face value of ` 100 and is currently traded in the market
at a price of ` 90.
Interest on these NCDs will be paid through post-dated cheques dated June 30 and
December 31. Interest payments for the first 3 years will be paid in advance through post-
dated cheques while for the last 2 years post-dated cheques will be issued at the third
year. The bond is redeemable at par on December 31, 2011 at the end of 5 years.
Required:
(i) CALCULATE the current yield and YTM of the bond.
(ii) CALCULATE the duration of the NCD.
(iii) CALCULATE the realized yield on the NCD assuming that intermediate coupon
payments are, not available for reinvestment calculate.
2. SAM Ltd. has just paid a dividend of ` 2 per share and it is expected to grow @ 6% p.a.
After paying dividend, the Board declared to take up a project by retaining the next three
annual dividends. It is expected that this project is of same risk as the existing projects.
The results of this project will start coming from the 4th year onward from now. The
dividends will then be ` 2.50 per share and will grow @ 7% p.a.
An investor has 1,000 shares in SAM Ltd. and wants a receipt of at least ` 2,000 p.a. from
this investment.
Required:
(i) EVALUATE whether the market value of the share is affected by the decision of the
Board.
(ii) RECOMMEND how the investor can maintain his target receipt from the investment
for first 3 years and improved income thereafter, given that the cost of capital of the
firm is 8%.
Portfolio Management
3. Expected returns on two stocks for particular market returns are given in the following
table:
Market Return Aggressive Defensive
7% 4% 9%
25% 40% 18%
© The Institute of Chartered Accountants of India

34 FINAL (NEW) EXAMINATION: MAY, 2018
CALCULATE:
(i) The Betas of the two stocks.
(ii) Expected return of each stock, if the market return is equally likely to be 7% or 25%.
(iii) The Security Market Line (SML), if the risk free rate is 7.5% and market return is
equally likely to be 7% or 25%.
(iv) The Alphas of the two stocks.
4. Following are the details of a portfolio consisting of three shares:
Share Portfolio weight Beta Expected return in % Total variance
A 0.20 0.40 14 0.015
B 0.50 0.50 15 0.025
C 0.30 1.10 21 0.100
Standard Deviation of Market Portfolio Returns = 10%
You are given the following additional data:
Covariance (A, B) = 0.030
Covariance (A, C) = 0.020
Covariance (B, C) = 0.040
CALCULATE:
(i) The Portfolio Beta
(ii) Residual variance of each of the three shares
(iii) Portfolio variance using Sharpe Index Model
(iv) Portfolio variance (on the basis of modern portfolio theory given by Markowitz)
Mutual Funds
5. Sun Moon Mutual Fund (Approved Mutual Fund) sponsored open-ended equity oriented
scheme “Chanakya Opportunity Fund”. There were three plans viz. ‘A’ – Dividend Re-
investment Plan, ‘B’ – Bonus Plan & ‘C’ – Growth Plan.
At the time of Initial Public Offer on 1.4.2009, Mr. Anand, Mr. Bacchan & Mrs. Charu, three
investors invested ` 1,00,000 each & chosen ‘B’, ‘C’ & ‘A’ Plan respectively.
The History of the Fund is as follows:
Date Dividend % Bonus Ratio Net Asset Value per Unit (F.V. ` 10)
Plan A Plan B Plan C
28.07.2013 20 30.70 31.40 33.42

PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 35
31.03.2014 70 5:4 58.42 31.05 70.05

31.10.2017 40 42.18 25.02 56.15
15.03.2018 25 46.45 29.10 64.28
31.03.2018 1:3 42.18 20.05 60.12
24.03.2019 40 1:4 48.10 19.95 72.40
31.07.2019 53.75 22.98 82.07
On 31st July 2019 all three investors redeemed all the balance units.
CALCULATE:
(i) Annual rate of return of Mrs. Charu who has invested in ‘A’ – Dividend Re-investment
Plan.
(ii) Annual rate of return of Mr. Anand who has invested in ‘B’ – Bonus Plan.
(iii) Annual rate of return of Mr. Bacchan who has invested ‘C’ – Growth Plan.
Assumptions:
1. Long-term Capital Gain is exempt from Income tax.
2. Short-term Capital Gain is subject to 10% Income tax.
3. Security Transaction Tax 0.2 per cent only on sale/redemption of units.
4. Ignore Education Cess
Derivative Analysis and Valuation
6. The following market data is available:
Spot USD/JPY 116.00
Deposit rates p.a. USD JPY
3 months 4.50% 0.25%
6 months 5.00% 0.25%
Forward Rate Agreement (FRA) for Yen is Nil.
Required:
(i) CALCULATE 3 months FRA rate at 3 months forward?
(ii) RECOMMEND arbitrage strategy, when 6 & 12 months LIBORS are 5% & 6.5%
respectively and X Ltd. bank is quoting 6/12 USD FRA at 6.50 – 6.75%.?
7. TMC Holding Ltd. has a portfolio of shares of diversified companies valued at ` 400 crore
enters into a swap arrangement with None Bank on the terms that it will get 1.15% quarterly
on notional principal of ` 400 crore in exchange of return on portfolio which is exactly
tracking the Sensex which is presently 21600.

CALCULATE the net payment to be received/ paid at the end of each quarter if Sensex
turns out to be 21,860, 21,780, 22,080 and 21,960.
Foreign Exchange Exposure and Risk Management
8. An importer booked a forward contract with his bank on 10 th April for USD 2,00,000 due on
10th June @ ` 64.4000. The bank covered its position in the market at ` 64.2800.
The exchange rates for dollar in the interbank market on 10 th June and 20th June were:
10th June 20th June
Spot USD 1= ` 63.8000/8200 ` 63.6800/7200
Spot/June ` 63.9200/9500 ` 63.8000/8500
July ` 64.0500/0900 ` 63.9300/9900
August ` 64.3000/3500 ` 64.1800/2500
September ` 64.6000/6600 ` 64.4800/5600
Exchange Margin 0.10% and interest on outlay of funds @ 12%. The importer requested
on 20th June for extension of contract with due date on 10 th August.
Rates rounded to 4 decimal in multiples of 0.0025.
On 10th June, Bank Swaps by selling spot and buying one month forward.
CALCULATE:
(i) Cancellation rate
(ii) Amount payable on $ 2,00,000
(iii) Swap loss
(iv) Interest on outlay of funds, if any
(v) New contract rate
(vi) Total Cost
9. Your bank’s London office has surplus funds to the extent of USD 5,00,000/- for a period
of 3 months. The cost of the funds to the bank is 4% p.a. It proposes to invest these funds
in London, New York or Frankfurt and obtain the best yield, without any exchange risk to
the bank. The following rates of interest are available at the three centres for investment
of domestic funds there at for a period of 3 months.
London 5 % p.a.
New York 8% p.a.
Frankfurt 3% p.a.

The market rates in London for US dollars and Euro are as under:
London on New York
Spot 1.5350/90
1 month 15/18
2 month 30/35
3 months 80/85
London on Frankfurt
Spot 1.8260/90
1 month 60/55
2 month 95/90
3 month 145/140
RECOMMEND at which centre, the investment to be made & what will be the net gain (to
the nearest pound) to the bank on the invested funds?
International Financial Management
10. A foreign based company is planning to set up a software development unit in India.
Software developed at the Indian unit will be bought back by the foreign parent company
at a transfer price of US $10 millions. The unit will remain in existence in India for one year;
the software is expected to get developed within this time frame.
The foreign based company will be subject to corporate tax of 30 per cent and a withholding
tax of 10 per cent in India and will not be eligible for tax credit. The software developed will
be sold in the international market for US $ 12.0 millions. Other estimates are as follows:
Rent for fully furnished unit with necessary hardware in India ` 20,00,000
Man power cost (80 software professional will be working for 10 ` 540 per man hour
hours each day)
Administrative and other costs ` 16,20,000
The rupee-dollar rate is `65/$.
ADVISE the foreign company on the financial viability of the project.
Assumption: 365 days in a year.
Interest Rate Risk Management
11. Electraspace is consumer electronics wholesaler. The business of the firm is highly
seasonal in nature. In 6 months of a year, firm has a huge cash deposits and especially
near Christmas time and other 6 months firm cash crunch, leading to borrowing of money
to cover up its exposures for running the business.

It is expected that firm shall borrow a sum of €50 million for the entire period of slack
season in about 3 months.
A Bank has given the following quotations:
Spot 5.50% - 5.75%
3 × 6 FRA 5.59% - 5.82%
3 × 9 FRA 5.64% - 5.94%
3 month €50,000 future contract maturing in a period of 3 months is quoted at 94.15
(5.85%).
ADVISE:
(i) How a FRA, shall be useful if the actual interest rate after 3 months turnout to be:
(a) 4.5% (b) 6.5%
(ii) How 3 months Future contract shall be useful for company if interest rate turns out as
mentioned in part (a) above.
Corporate Valuation
12. BRS Inc deals in computer and IT hardwares and peripherals. The expected revenue for
the next 8 years is as follows:
Years Sales Revenue ($ Million)
1 8
2 10
3 15
4 22
5 30
6 26
7 23
8 20
Summarized financial position as on 31 March 2012 was as follows:
$ Million
Liabilities Amount Assets Amount
Equity Stocks 12 Fixed Assets (Net) 17
12% Bonds 8 Current Assets 3
20 20

Additional Information:
(a) Its variable expenses is 40% of sales revenue and fixed operating expenses (cash)
are estimated to be as follows:
Period Amount ($ Million)
1- 4 years 1.6
5-8 years 2
(b) An additional advertisement and sales promotion campaign shall be launched
requiring expenditure as per following details:
1 year 0.50
2-3 years 1.50
4-6 years 3.00
7-8 years 1.00
(c) Fixed assets are subject to depreciation at 15% as per WDV method.
(d) The company has planned additional capital expenditures (in the beginning of each
year) for the coming 8 years as follows:
1 0.50
2 0.80
3 2.00
4 2.50
5 3.50
6 2.50
7 1.50
8 1.00
(e) Investment in Working Capital is estimated to be 20% of Revenue.
(f) Applicable tax rate for the company is 30%.
(g) Cost of Equity is estimated to be 16%.
(h) The Free Cash Flow of the firm is expected to grow at 5% per annum after 8 years.
CALCULATE:
(i) Value of Firm
(ii) Value of Equity

Mergers, Acquisitions and Corporate Restructuring

13. T Ltd. and E Ltd. are in the same industry. The former is in negotiation for acquisition of
the latter. Important information about the two companies as per their latest financial
statements is given below:
T Ltd. E Ltd.
` 10 Equity shares outstanding 12 Lakhs 6 Lakhs
Debt:
10% Debentures (` Lakhs) 580 --
12.5% Institutional Loan (` Lakhs) -- 240
Earning before interest, depreciation and tax (EBIDAT) (` Lakhs) 400.86 115.71
Market Price/share (`) 220.00 110.00
T Ltd. plans to offer a price for E Ltd., business as a whole which will be 7 times EBIDAT
reduced by outstanding debt, to be discharged by own shares at market price.
E Ltd. is planning to seek one share in T Ltd. for every 2 shares in E Ltd. based on the
market price. Tax rate for the two companies may be assumed as 30%.
CALCULATE the following under both alternatives - T Ltd.'s offer and E Ltd.'s plan:
(i) Net consideration payable.
(ii) No. of shares to be issued by T Ltd.
(iii) EPS of T Ltd. after acquisition.
(iv) Expected market price per share of T Ltd. after acquisition.
Note: Calculations (except EPS) may be rounded off to 2 decimals in lakhs
Theoretical Questions
14. DISTINGUISH between:
(a) Banking and Non-Banking financial institutions
(b) Primary participants and secondary participants in securitization
(c) Islamic Finance and Conventional Finance
15. (a) DESCRIBE Value at Risk and its application.
(b) EXPLAIN the concept of Bootstrapping and describe the various methods of
bootstrapping used by start ups.
(c) DESCRIBE the guidelines for SME listing and its benefits.

SUGGESTED ANSWERS/HINTS
` 7 12
1. (i) Current yield = × = 0.1555 or 15.55%
` 90 6
YTM can be determined from the following equation
7 × PVIFA (YTM, 10) + 100 × PVIF (YTM, 10) = 90
Let us discount the cash flows using two discount rates 7.50% and 9% as follows:
Year Cash Flows PVF@7.50% PV@7.50% PVF@9% PV@9%
0 -90 1 -90 1 -90
1 7 0.930 6.51 0.917 6.419
2 7 0.865 6.055 0.842 5.894
3 7 0.805 5.635 0.772 5.404
4 7 0.749 5.243 0.708 4.956
5 7 0.697 4.879 0.650 4.550
6 7 0.648 4.536 0.596 4.172
7 7 0.603 4.221 0.547 3.829
8 7 0.561 3.927 0.502 3.514
9 7 0.522 3.654 0.460 3.220
10 107 0.485 51.90 0.422 45.154
6.560 -2.888
Now we use interpolation formula
6.560
7.50% + × 1.50%
6.560-(-2.888)
6.560
7.50% + × 1.50% =7.50% + 1.041%
9.448
YTM = 8.541% say 8.54%
Note: Students can also compute the YTM using rates other than 15% and 18%.
(ii) The duration can be calculated as follows:
Year Cash PVF@ PV @ Proportion of Proportion of
Flow 8.54% 8.54% NCD value NCD value × time
1 7 0.921 6.447 0.0717 0.0717
2 7 0.849 5.943 0.0661 0.1322

3 7 0.782 5.474 0.0608 0.1824

4 7 0.721 5.047 0.0561 0.2244
5 7 0.664 4.648 0.0517 0.2585
6 7 0.612 4.284 0.0476 0.2856
7 7 0.563 3.941 0.0438 0.3066
8 7 0.519 3.633 0.0404 0.3232
9 7 0.478 3.346 0.0372 0.3348
10 107 0.441 47.187 0.5246 5.2460
89.95 7.3654
Duration = 7.3654 half years i.e. 3.683 years.
(iii) Realized Yield can be calculated as follows:
(7 × 10) + 100
= 90
(1 + R)10
170
(1 + R)10 =
90
1/10
 170 
R=   - 1 = 0.06380 or 6.380% for half yearly and 12.76% annually.
 90 
D1
2. (i) Value of share at present =
ke − g
2(1.06)
= = ` 106
0.08 − 0.06
However, if the Board implement its decision, no dividend would be payable for 3
years and the dividend for year 4 would be ` 2.50 and growing at 7% p.a. The price
of the share, in this case, now would be:
2.50 1
P0 = × = ` 198.46
0.08 − 0.07 (1 + 0.08)3
So, the price of the share is expected to increase from ` 106 to ` 198.45 after the
announcement of the project. The investor can take up this situation as follows:
Expected market price after 3 years 2.50 ` 250.00
=
0.08 − 0.07

Expected market price after 2 years 2.50 1 ` 231.48

×
0.08 − 0.07 (1 + 0.08)
Expected market price after 1 years 2.50 1 ` 214.33
×
0.08 − 0.07 (1 + 0.08) 2
(ii) In order to maintain his receipt at ` 2,000 for first 3 year, he would sell
10 shares in first year @ ` 214.33 for ` 2,143.30
9 shares in second year @ ` 231.48 for ` 2,083.32
8 shares in third year @ ` 250 for ` 2,000.00
At the end of 3rd year, he would be having 973 shares valued @ ` 250 each i.e.
` 2,43,250. On these 973 shares, his dividend income for year 4 would be @ ` 2.50
i.e. ` 2,432.50.
Thus, if the project is taken up by the company, the investor would be able to maintain
his receipt of at least ` 2,000 for first three years and would be getting increased
income thereafter.
3. (i) The Betas of two stocks:
Aggressive stock - 40% - 4%/25% - 7% = 2
Defensive stock - 18% - 9%/25% - 7% = 0.50
Alternatively, it can also be solved by using the Characteristic Line Relationship as
follows:
Rs = α + βRm
Where
α = Alpha
β = Beta
Rm= Market Return
For Aggressive Stock
4% = α + β(7%)
40% = α + β(25%)
36% = β(18%)
β=2
For Defensive Stock
9% = α + β(7%)

18% = α + β(25%)
9% = β(18%)
β =0.50
(ii) Expected returns of the two stocks:-
Aggressive stock - 0.5 x 4% + 0.5 x 40% = 22%
Defensive stock - 0.5 x 9% + 0.5 x 18% = 13.5%
(iii) Expected return of market portfolio = 0.5 x 7% + 0.5% x 25% = 16%
∴ Market risk prem. = 16% - 7.5% = 8.5%
∴ SML is, required return = 7.5% + βi 8.5%
(iv) Rs = α + βRm
For Aggressive Stock
22% = αA + 2(16%)
αA = -10%
For Defensive Stock
13.5% = αD + 0.50(16%)
αD = 5.5%
4. (i) Portfolio Beta
0.20 x 0.40 + 0.50 x 0.50 + 0.30 x 1.10 = 0.66
(ii) Residual Variance
To determine Residual Variance first of all we shall compute the Systematic Risk as
follows:
β2A × σ M
2
= (0.40)2(0.01) = 0.0016
βB2 × σ M
2
= (0.50)2(0.01) = 0.0025
β2C × σ M
2
= (1.10)2(0.01) = 0.0121
Residual Variance
A 0.015 – 0.0016 = 0.0134
B 0.025 – 0.0025 = 0.0225
C 0.100 – 0.0121 = 0.0879
(iii) Portfolio variance using Sharpe Index Model
Systematic Variance of Portfolio = (0.10)2 x (0.66)2 = 0.004356

Unsystematic Variance of Portfolio = 0.0134 x (0.20)2 + 0.0225 x (0.50)2 + 0.0879 x

(0.30)2 = 0.014072
Total Variance = 0.004356 + 0.014072 = 0.018428
(iv) Portfolio variance on the basis of Markowitz Theory
2
= (wA x wAx σ A ) + (wA x wBxCovAB) + (wA x wCxCovAC) + (wB x wAxCovAB) + (wB x wBx
σ B2 ) + (wB x wCxCovBC) + (wC x wAxCovCA) + (wC x wBxCovCB) + (wC x wCx σ 2c )
= (0.20 x 0.20 x 0.015) + (0.20 x 0.50 x 0.030) + (0.20 x 0.30 x 0.020) + (0.20 x 0.50
x 0.030) + (0.50 x 0.50 x 0.025) + (0.50 x 0.30 x 0.040) + (0.30 x 0.20 x 0.020) + (0.30
x 0.50 x 0.040) + (0.30 x 0.30 x 0.10)
= 0.0006 + 0.0030 + 0.0012 + 0.0030 + 0.00625 + 0.0060 + 0.0012 + 0.0060 + 0.0090
= 0.0363
5. (i) Return of Mrs. Charu invested in Plan A (Dividend Reinvestment)
(Amount in ` )
Date Investment Dividend Dividend Re- NAV Units Closing
payout invested Unit
(%) (Closing Balance
Units X Face ∑ Units
value of ‘10
X Dividend
Payout %)
01.04.2009 1,00,000.00 10.00 10,000.00 10,000.00
28.07.2013 20 20,000.00 30.70 651.47 10,651.47
31.03.2014 70 74,560.29 58.42 1,276.28 11,927.75
31.10.2017 40 47,711.00 42.18 1,131.13 13,058.88
15.03.2018 25 32,647.20 46.45 702.85 13,761.73
24.03.2019 40 55,046.92 48.10 1,144.43 14,906.16
Redemption value 14,906.16 × 53.75 8,01,206.10
Less: Security Transaction Tax (STT) is 0.2% 1,602.41
Net amount received 7,99,603.69
Less: Short term capital gain tax @ 10% on 1,144.43 (53.64* – 634
48.10≈) = 6,340
Net of tax 7,98,969.69
Less: Investment 1,00,000.00
6,98,969.69

*(53.75 – STT @ 0.2%) ≈ This value can also be taken as zero

6,98,969.69 12
Annual average return (%) × × 100 = 67.64 %
1,00,000 124
(ii) Return of Mr. Anand invested in Plan B – (Bonus)
(Amount in `)
Date Units Bonus units Total Balance NAV per unit
01.04.2009 10,000 10,000 10
31.03.2014 12,500 22,500 31.05
31.03.2018 7,500 30,000 20.05
24.03.2019 7,500 37,500 19.95
Redemption value 37,500 × 22.98 8,61,750.00
Less: Security Transaction Tax (STT) is 0.2% 1,723.50
Less: Short term capital gain tax @ 10%
7,500 × (22.93† – 19.95) = 22,350 2,235.00
Net of tax 8,57,791.50
Net gain 7,57,791.50
†(22.98 – STT @ 0.2%)
7,57,791.50 12
1,00,000 124
(iii) Return of Mr. Bacchan invested in Plan C – (Growth)
Particulars (Amount in `)
Redemption value 10,000 × 82.07 8,20,700.00
Less: Security Transaction Tax (S.T.T) is .2% 1,641.40
Less: Short term capital gain tax @ 10% 0.00
Net of tax 8,19,058.60
Net gain 7,19,058.60
7,19,058 12
1,00,000 124

Note: Alternatively, figure of * and † can be taken as without net of Tax because, as
per Proviso 5 of Section 48 of IT Act, no deduction of STT shall be allowed in
computation of Capital Gain.
6. (i) 3 Months Interest rate is 4.50% & 6 Months Interest rate is 5% p.a.
Future Value 6 Months from now is a product of Future Value 3 Months now & 3
Months
Future Value from after 3 Months.
(1+0.05*6/12) = (1+0.045*3/12) x (1+i3,6 *3/12)
i3,6 = [(1+0.05* 6/12) /(1+0.045 *3/12) – 1] *12/3
i.e. 5.44% p.a.
(ii) To find arbitrage opportunity first we shall find out the 6 Months forward 6 month rate
as follows:
(1+0.065) = (1+0.05*6/12) x (1+i6,6 *6/12)
i6,6 = [(1+0.065/1.025) – 1] *12/6
6 Months forward 6 month rate is 7.80% p.a.
The Bank is quoting 6/12 USD FRA at 6.50 – 6.75%
Therefore, there is an arbitrage Opportunity of earning interest @ 7.80% p.a. & Paying
@ 6.75%
Strategy: Borrow for 6 months, buy an FRA & invest for 12 months
To get $ 1.065 at the end of 12 months for $ 1 invested today
To pay$ 1.060# at the end of 12 months for every $ 1 Borrowed today
Net gain $ 0.005 i.e. risk less profit for every $ borrowed
# (1+0.05/2) (1+.0675/2) = (1.05959) say 1.060
7.
Qtrs. Sensex Sensex Return (%) Amount Payable Fixed Return Net (`
(` Crore) (Receivable) Crore)
(` Crore)
(1) (2) (3) (4) (5) (5) – (4)
0 21,600 - - - -
1 21,860 1.2037 4.8148 4.6000 - 0.2148
2 21,780 -0.3660 -1.4640 4.6000 6.0640
3 22,080 1.3774 5.5096 4.6000 - 0.9096
4 21,960 -0.5435 -2.1740 4.6000 6.7740

8. (i) Cancellation Rate:

The forward sale contract shall be cancelled at Spot TT Purchase for $ prevailing on
the date of cancellation as follows:
$/ ` Market Buying Rate ` 63.6800
Less: Exchange Margin @ 0.10% ` 0.0636
` 63.6163
Rounded off to ` 63.6175
(ii) Amount payable on $ 2,00,000
Bank sells $2,00,000 @ ` 64.4000 ` 1,28,80,000
Bank buys $2,00,000 @ ` 63.6163 ` 1,27,23,260
Amount payable by customer ` 1,56,740
(iii) Swap Loss
On 10th June the bank does a swap sale of $ at market buying rate of ` 63.8300 and
forward purchase for June at market selling rate of ` 63.9500.
Bank buys at ` 63.9500
Bank sells at ` 63.8000
Amount payable by customer ` 0.1500
Swap Loss for $ 2,00,000 in ` = ` 30,000
(iv) Interest on Outlay of Funds
On 10thApril, the bank receives delivery under cover contract at ` 64.2800 and sell
spot at ` 63.8000.
Bank buys at ` 64.2800
Bank sells at ` 63.8000
Amount payable by customer ` 0.4800
Outlay for $ 2,00,000 in ` 96,000
Interest on ` 96,000 @ 12% for 10 days ` 320
(v) New Contract Rate
The contract will be extended at current rate
$/ ` Market forward selling Rate for August ` 64.2500
Add: Exchange Margin @ 0.10% ` 0.0643
` 64.3143

Rounded off to ` 64.3150

(vi) Total Cost
Cancellation Charges ` 1,56,740.00
Swap Loss ` 30,000.00
Interest ` 320.00
` 1,87,060.00
9. To determine the centre of investment by bank except New York (in whose currency the
surplus is available) Arbitrage Profit for remaining two centres shall be computed as
follows:
(a) If investment is made at London
Convert US$ 5,00,000 at Spot Rate (5,00,000/1.5390) = £ 3,24,886
Add: £ Interest for 3 months on £ 324,886 @ 5% =£ 4,061
= £ 3,28,947
Less: Amount Invested $ 5,00,000
Interest accrued thereon $ 5,000
= $ 5,05,000
Equivalent amount of £ required to pay the
above sum ($ 5,05,000/1.5430) = £ 3,27,285
Arbitrage Profit =£ 1,662
(b) If investment is made at New York
Gain $ 5,00,000 (8% - 4%) x 3/12 = $ 5,000
Equivalent amount in £ 3 months ($ 5,000/ 1.5475) £ 3,231
(c) If investment is made at Frankfurt
Convert US$ 500,000 at Spot Rate (Cross Rate) 1.8260/1.5390 = € 1.1865
Euro equivalent US$ 500,000 = € 5,93,250
Add: Interest for 3 months @ 3% =€ 4,449
= € 5,97,699
3 month Forward Rate of selling € (1/1.8150) = £ 0.5510
Sell € in Forward Market € 5,97,699 x £ 0.5510 = £ 3,29,332
Less: Amounted invested and interest thereon = £ 3,27,285
Arbitrage Profit = £ 2,047

Recommendation: Since out of three options the maximum profit is in case

investment is made in New York. Hence it shall be opted and arbitrage gain would be
£3,231.
10. Proforma profit and loss account of the Indian software development unit
` `
Revenue 65,00,00,000
Less: Costs:
Rent 20,00,000
Manpower (`540 x 80 x 10 x 365) 15,76,80,000
Administrative and other costs 16,20,000 16,13,00,000
Earnings before tax 48,87,00,000
Less: Tax 14,66,10,000
Earnings after tax 34,20,90,000
Less: Withholding tax 3,42,09,000
Repatriation amount (in rupees) 30,78,81,000
Repatriation amount (in dollars) $4.7366 million
Advise: The cost of development software in India for the foreign based company is $5.3
million. As the USA based Company is expected to sell the software in the international
market at $12.0 million, it is advised to develop the software in India.
11. (i) By entering into an FRA, firm shall effectively lock in interest rate for a specified future
in the given it is 6 months. Since, the period of 6 months is starting in 3 months, the
firm shall opt for 3 × 9 FRA locking borrowing rate at 5.94%.
In the given scenarios, the net outcome shall be as follows:
If the rate turns out to be If the rate turns out to be
4.50% 6.50%
FRA Rate 5.94% 5.94%
Actual Interest Rate 4.50% 6.50%
Loss/ (Gain) 1.44% (0.56%)
FRA Payment / (Receipts) €50 m × 1.44% × ½ = €50m × 0.56% × ½ =
€360,000 (€140,000)
Interest after 6 months on = €50m × 4.5% × ½ = € 50m × 6.5% × ½
€50 Million at actual rates = €1,125,000 = €1,625,000
Net Out Flow € 1,485,000 €1,485,000

Thus, by entering into FRA, the firm has committed itself to a rate of 5.94% shown as
follows:
€ 1,485,000 12
×100 × = 5.94%
€ 50,000,000 6
(ii) Since firm is a borrower it will like to off-set interest cost by profit on Future Contract.
Accordingly, if interest rate rises it will gain hence it should sell interest rate futures.
Amount of Borrowing Duration of Loan
No. of Contracts = ×
Contract Size 3 months
€ 50,000,000 6
= × = 2000 Contracts
€ 50,000 3
The final outcome in the given two scenarios shall be as follows:
If the interest rate If the interest rate
turns out to be 4.5% turns out to be 6.5%
Future Course Action:
Sell to open 94.15 94.15
Buy to close 95.50 (100 - 4.5) 93.50 (100 - 6.5)
Loss/ (Gain) 1.35% (0.65%)
Cash Payment (Receipt) for €50,000×2000× €50,000×2000×0.65%
Future Settlement 1.35%×3/12 × 3/12
= €337,500 = (€162,500)
Interest for 6 months on €50 €50 million × 4.5% × ½ €50 million × 6.5% × ½
million at actual rates = €11,25,000 = €16,25,000
€1,462,500 €1,462,500
Thus, the firm locked itself in interest rate of 5.85% shown as follows:
€ 1,462,500 12
× 100 × = 5.85%
€ 50,000,000 6
12. Working Notes:
(a) Determination of Weighted Average Cost of Capital
Sources of Cost (%) Proportions Weights Weighted
funds Cost
Equity Stock 16 12/20 0.60 9.60
12% Bonds 12%(1-0.30) = 8.40 8/20 0.40 3.36
12.96 say 13

(b) Schedule of Depreciation

$ Million
Year Opening Balance Addition during Total Depreciation @
of Fixed Assets the year 15%
1 17.00 0.50 17.50 2.63

2 14.87 0.80 15.67 2.35
3 13.32 2.00 15.32 2.30
4 13.02 2.50 15.52 2.33
5 13.19 3.50 16.69 2.50
6 14.19 2.50 16.69 2.50
7 14.19 1.50 15.69 2.35
8 13.34 1.00 14.34 2.15
(c) Determination of Investment
$ Million
Investment Required Existing Additional
Year For Capital CA (20% of Investment Investment
Total in CA required
Expenditure Revenue)
1 0.50 1.60 2.10 3.00 0.00
2 0.80 2.00 2.80 2.50* 0.30
3 2.00 3.00 5.00 2.00** 3.00
4 2.50 4.40 6.90 3.00 3.90
5 3.50 6.00 9.50 4.40 5.10
6 2.50 5.20 7.70 6.00 1.70
7 1.50 4.60 6.10 5.20 0.90
8 1.00 4.00 5.00 4.60 0.40
* Balance of CA in Year 1 ($3 Million) – Capital Expenditure in Year 1($ 0.50 Million)
** Similarly balance of CA in Year 2 ($2.80) – Capital Expenditure in Year 2($ 0.80
Million)
(d) Determination of Present Value of Cash Inflows
$ Million
Years
Particulars
1 2 3 4 5 6 7 8
Revenue (A) 8.00 10.00 15.00 22.00 30.00 26.00 23.00 20.00

Less: Expenses
Variable Costs 3.20 4.00 6.00 8.80 12.00 10.40 9.20 8.00
Fixed cash operating
cost 1.60 1.60 1.60 1.60 2.00 2.00 2.00 2.00
Advertisement Cost 0.50 1.50 1.50 3.00 3.00 3.00 1.00 1.00
Depreciation 2.63 2.35 2.30 2.33 2.50 2.50 2.35 2.15
Total Expenses (B) 7.93 9.45 11.40 15.73 19.50 17.90 14.55 13.15
EBIT (C) = (A) - (B) 0.07 0.55 3.60 6.27 10.50 8.10 8.45 6.85
Less: Taxes@30% (D) 0.02 0.16 1.08 1.88 3.15 2.43 2.53 2.06
NOPAT (E) = (C) - (D) 0.05 0.39 2.52 4.39 7.35 5.67 5.92 4.79
Gross Cash Flow (F) =
(E) + Dep 2.68 2.74 4.82 6.72 9.85 8.17 8.27 6.94
Less: Investment in
Capital Assets
plus Current Assets (G) 0 0.30 3.00 3.90 5.10 1.70 0.90 0.40
Free Cash Flow (H) =
(F) - (G) 2.68 2.44 1.82 2.82 4.75 6.47 7.37 6.54
PVF@13% (I) 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376
PV (H)(I) 2.371 1.911 1.261 1.729 2.579 3.106 3.132 2.46
Total present value = $ 18.549 million

(e) Determination of Present Value of Continuing Value (CV)
FCF9 $6.54 million(1.05) $6.867million
CV = = = = $85.8375 million
k-g 0.13 - 0.05 0.08
Present Value of Continuing Value (CV) = $85.8376 million X PVF13%,8 = $85.96875
million X 0.376 = $32.2749 million
(i) Value of Firm
$ Million
Present Value of cash flow during explicit period 18.5490
Present Value of Continuing Value 32.2749
Total Value 50.8239


$ Million
Total Value of Firm 50.8239
Less: Value of Debt 8.0000
Value of Equity 42.8239
13. As per T Ltd.’s Offer
` in lakhs
(i) Net Consideration Payable
7 times EBIDAT, i.e. 7 x ` 115.71 lakh 809.97
Less: Debt 240.00
569.97
(ii) No. of shares to be issued by T Ltd
` 569.97 lakh/` 220 (rounded off) (Nos.) 2,59,000
(iii) EPS of T Ltd after acquisition
Total EBIDT (` 400.86 lakh + ` 115.71 lakh) 516.57
Less: Interest (` 58 lakh + ` 30 lakh) 88.00
428.57
Less: 30% Tax 128.57
Total earnings (NPAT) 300.00
Total no. of shares outstanding 14.59 lakh

(12 lakh + 2.59 lakh)
EPS (` 300 lakh/ 14.59 lakh) ` 20.56
(iv) Expected Market Price:
` in lakhs
Pre-acquisition P/E multiple:
EBIDAT 400.86
10
Less: Interest ( 580 X ) 58.00
100
342.86
Less: 30% Tax 102.86
240.00

No. of shares (lakhs) 12.00

EPS ` 20.00
220
Hence, PE multiple 11
20
Expected market price after acquisition (` 20.56 x 11) ` 226.16
As per E Ltd’s Plan
` in lakhs
(i) Net consideration payable
6 lakhs shares x ` 110 660
(ii) No. of shares to be issued by T Ltd
` 660 lakhs ÷ ` 220 3 lakh
(iii) EPS of T Ltd after Acquisition
NPAT (as per earlier calculations) 300.00
Total no. of shares outstanding (12 lakhs + 3 lakhs) 15 lakh
Earning Per Share (EPS) ` 300 lakh/15 lakh ` 20.00
(iv) Expected Market Price (` 20 x 11) 220.00
14. (a) Distinction between Banking and Non-Banking financial institutions

Basis for Non-Banking
Banking Institutions
comparison Institutions
Meaning Bank is a financial intermediary Non-banking institutions
which provides banking services to are basically company
general people. And it requires a form of organization that
bank license for that. provides banking services
to people without holding
a banking license.
Transaction Banks provide transaction services The non-banking
Services like providing overdraft facility, institutions do not provide
issue of cheque books, travelers any transaction services.
cheque, demand draft, transfer of
funds, etc.
Money Bank deposits constitute a major The money supply of the
supply part of the national money supply. nonbanking institutions is
small.
Credit Banks create credit. Non-banking institutions
creation do not create credit.

Compliance Banks are required to comply with Non-banking institutions

some of the legal requirements like are not required to comply
Cash Reserve Ratio (CRR), with these legal
Statutory Liquidity Ratio and requirements.
Capital Adequacy Ratio (CAR).
Demand They are not accepted. They are accepted.
Deposit
Payment and Contains an integral part of the Not a part of the system.
settlement system.
system
(b) Distinction between Primary Participants and Secondary Participants in
securitization
Primary Participants: Primary Participants are main parties to this process. The
primary participants in the process of securitization are as follows:
(i) Originator: It is the initiator of deal or can be termed as securitizer. It is an entity
which sells the assets lying in its books and receives the funds generated
through the sale of such assets.
(ii) Special Purpose Vehicle: Also, called SPV is created for the purpose of
executing the deal. Since issuer originator transfers all rights in assets to SPV,
it holds the legal title of these assets. It is created especially for the purpose of
securitization only and normally could be in form of a company, a firm, a society
or a trust.
(iii) The Investors: Investors are the buyers of securitized papers which may be an
individual, an institutional investor such as mutual funds, provident funds,
insurance companies, mutual funds, Financial Institutions etc.
Secondary Participants
Besides, the primary participants, other parties involved into the securitization
process are as follows:
(i) Obligors: Actually they are the main source of the whole securitization process.
They are the parties who owe money to the firm and are assets in the Balance
Sheet of Originator.
(ii) Rating Agency: Since the securitization is based on the pools of assets rather
than the originators, the assets have to be assessed in terms of its credit quality
and credit support available and that is where the credit rating agencies come.
(iii) Receiving and Paying Agent (RPA): Also, called Servicer or Administrator, it
collects the payment due from obligor(s) and passes it to SPV. It also follow up

with defaulting borrower and if required initiate appropriate legal action against
them.
(iv) Agent or Trustee: Trustees are appointed to oversee that all parties to the deal
perform in the true spirit of terms of agreement. Normally, it takes care of interest
of investors who acquires the securities.
(v) Credit Enhancer: Since investors in securitized instruments are directly
exposed to performance of the underlying and sometime may have limited or no
recourse to the originator, they seek additional comfort in the form of credit
enhancement. In other words, they require credit rating of issued securities
which also empowers marketability of the securities.
Originator itself or a third party say a bank may provide an additional comfort
called Credit Enhancer. While originator provides his comfort in the form of over
collateralization or cash collateral, the third party provides it in form of letter of
credit or surety bonds.
(vi) Structurer: It brings together the originator, investors, credit enhancers and
other parties to the deal of securitization. Normally, these are investment
bankers also called arranger of the deal. It ensures that deal meets all legal,
regulatory, accounting and tax laws requirements.
(c) Distinction between Islamic Finance and Conventional Finance
How Islamic Finance is different from Conventional Finance
Major differences between Islamic finance and other form of finance (Conventional
Finance) are as follows:
Basis Islamic Finance Conventional Finance
Promotion Islamic Finance promotes just, Based on commercial
fair and balanced society. objectives and interest must
Hence, interest is prohibited. be paid irrespective of
outcome of business.
Ethical framework Structured on ethical and No such framework.
moral framework of Sharia.
Verses from the holy Quran
and tradition from As-Sunnah
are two divine guidance.
Speculation The financial transactions No such restrictions.
should be free from the
element of uncertainty
(Gharar) and gambling (Maisir)
Unlawful Goods Islamic Finance must not be There are no such
and Services involved in any transactions restrictions.

not involve trade not allowed

as per Islamic principles such
as alcohol, armaments, pork
and other socially detrimental
products.
15. (a) VAR is a measure of risk of investment. Given the normal market condition in a set of
period, say, one day it estimates how much an investment might lose. This investment
can be a portfolio, capital investment or foreign exchange etc., VAR answers two
basic questions -
(i) What is worst case scenario?
(ii) What will be loss?
It was first applied in 1922 in New York Stock Exchange, entered the financial world
in 1990s and become world’s most widely used measure of financial risk.
Features of VAR
Following are main features of VAR
(i) Components of Calculations: VAR calculation is based on following three
components :
(a) Time Period
(b) Confidence Level – Generally 95% and 99%
(c) Loss in percentage or in amount
(ii) Statistical Method: It is a type of statistical tool based on Standard Deviation.
(iii) Time Horizon: VAR can be applied for different time horizons say one day, one
week, one month and so on.
(iv) Probability: Assuming the values are normally attributed, probability of maximum
loss can be predicted.
(v) Control Risk: Risk can be controlled by selling limits for maximum loss.
(vi) Z Score: Z Score indicates how many standard Deviations is away from Mean
value of a population. When it is multiplied with Standard Deviation it provides
VAR.
Application of VAR
VAR can be applied
(i) to measure the maximum possible loss on any portfolio or a trading position.
(ii) as a benchmark for performance measurement of any operation or trading.
(iii) to fix limits for individuals dealing in front office of a treasury department.

(iv) to enable the management to decide the trading strategies.

(v) as a tool for Asset and Liability Management especially in banks.
(b) An individual is said to be boot strapping when he or she attempts to found and build
a company from personal finances or from the operating revenues of the new
company.
A common mistake made by most founders is that they make unnecessary expenses
towards marketing, offices and equipment they cannot really afford. So, it is true that
more money at the inception of a business leads to complacency and wasteful
expenditure. On the other hand, investment by startups from their own savings leads
to cautious approach. It curbs wasteful expenditures and enable the promoter to be
on their toes all the time.
Methods: Here are some of the methods in which a startup firm can bootstrap:
(i) Trade Credit: When a person is starting his business, suppliers are reluctant to
give trade credit. They will insist on payment of their goods supplied either by
cash or by credit card. However, a way out in this situation is to prepare a well-
crafted financial plan. The next step is to pay a visit to the supplier’s office. If the
business organization is small, the owner can be directly contacted. On the other
hand, if it is a big firm, the Chief Financial Officer can be contacted and
convinced about the financial plan.
(ii) Factoring: This is a financing method where accounts receivable of a business
organization is sold to a commercial finance company to raise capital. The factor
then got hold of the accounts receivable of a business organization and assumes
the task of collecting the receivables as well as doing what would've been the
paperwork. Factoring can be performed on a non-notification basis. It means
customers may not be told that their accounts have been sold.
(iii) Leasing: Another popular method of bootstrapping is to take the equipment on
lease rather than purchasing it. It will reduce the capital cost and also help
lessee (person who take the asset on lease) to claim tax exemption. So, it is
better to a take a photocopy machine, an automobile or a van on lease to avoid
paying out lump sum money which is not at all feasible for a startup organization.
(c) Guidelines for SME Listing
(i) Capital: The post issue face value capital should not exceed ` Twenty-five
crores.
(ii) Trading lot size
 The minimum application and trading lot size shall not be less than
` 1,00,000/-.

 The minimum depth shall be ` 1,00,000/- and at any point of time it shall not
be less than ` 1,00,000/-.
 The investors holding with less than ` 1,00,000/- shall be allowed to offer their
holding to the Market Maker in one lot.
 However in functionality the market lot will be subject to revival after a
stipulated time.
(iii) Participants: The existing Members of the Exchange shall be eligible to
participate in SME Platform.
(iv) Underwriting: The issues shall be 100% underwritten and Merchant Bankers
shall underwrite 15% in their own account.
Benefits of Listing in SME
(i) Easy access to Capital: BSE SME provides an avenue to raise capital through
equity infusion for growth oriented SME’s.
(ii) Enhanced Visibility and Prestige: The SME’s benefit by greater credibility and
enhanced financial status leading to demand in the company’s shares and
higher valuation of the company.
(iii) Encourages Growth of SMEs: Equity financing provides growth opportunities like
expansion, mergers and acquisitions thus being a cost effective and tax efficient
mode.
(iv) Ensures Tax Benefits: In case of listed securities Short Term Gains Tax is 15%
and there is absolutely no Long Term Capital Gains Tax.
(v) Enables Liquidity for Shareholders: Equity financing enables liquidity for
shareholders provides growth opportunities like expansion, mergers and
acquisitions, thus being a cost effective and tax efficient mode.
(vi) Equity financing through Venture Capital: Provides an incentive for Venture
Capital Funds by creating an Exit Route and thus reducing their lock in period.
(vii) Efficient Risk Distribution: Capital Markets ensure that the capital flows to its
best uses and those riskier activities with higher payoffs are funded.
(viii) Employee Incentives: Employee Stock Options ensures stronger employee
commitment, participation and recruitment incentive.

QUESTIONS
Security Valuation
1. ABC Limited’s shares are currently selling at ` 13 per share. There are 10,00,000 shares
outstanding. The firm is planning to raise ` 20 lakhs to Finance a new project.
(i) CALCULATE the ex-right price of shares and the value of a right, if the firm offers one
right share for every two shares held.
(ii) CALCULATE the ex-right price of shares and the value of a right, if the firm offers one
right share for every four shares held.
(iii) ANALYSE how does the shareholders’ wealth change from (i) to (ii) above and right
issue increases shareholders’ wealth?
2. Piyush Loonker and Associates presently pay a dividend of Re. 1.00 per share and has a
share price of ` 20.00.
(i) CALCULATE the firm’s expected or required return on equity using a dividend -
discount model approach if this dividend were expected to grow at a rate of 12% per
annum forever.
(ii) CALCULATE the firm’s expected, or required, return on equity if instead of this situation
in part (i), suppose that the dividends were expected to grow at a rate of 20% per
annum for 5 years and 10% per year thereafter.
3. Mr. FedUp wants to invest an amount of ` 520 lakhs and had approached his Portfolio
Manager. The Portfolio Manager had advised Mr. FedUp to invest in the following manner:
Security Moderate Better Good Very Good Best
Amount (in ` Lakhs) 60 80 100 120 160
Beta 0.5 1.00 0.80 1.20 1.50
ADVISE Mr. FedUp in regard to the following, using Capital Asset Pricing Methodology:
(i) Expected return on the portfolio, if the Government Securities are at 8% and the
NIFTY is yielding 10%.
(ii) Replacing Security 'Better' with NIFTY.
4. The following are the data on five mutual funds:
Fund Return Standard Deviation Beta
A 15 7 1.25
B 18 10 0.75

2 FINAL (NEW) EXAMINATION: NOVEMBER, 2018
C 14 5 1.40
D 12 6 0.98
E 16 9 1.50
CALCULATE Reward to Volatility Ratio and rank this portfolio using:
 Sharpe method and
 Treynor's method
assuming the risk free rate is 6%.
Mutual Fund
5. Following information is related to XYZ Regular Income Fund:
Particulars ` Crores
Listed shares at Cost (ex-dividend) 20
Cash in hand 1.23
Bonds and debentures at cost 4.3
Of these, bonds not listed and quoted 1
Other fixed interest securities at cost 4.5
Dividend accrued 0.8
Amount payable on shares 6.32
Expenditure accrued 0.75
Number of units (` 10 face value) 20 lacs
Current realizable value of fixed income securities of face value of ` 100 106.5
The listed shares were purchased when Index was 1,000
Present index is 2,300
Value of listed bonds and debentures at NAV date 8
CALCULATE the NAV of scheme on per unit basis if there has been a diminution of 20%
in unlisted bonds and debentures and Other fixed interest securities are valued at cost.
Derivatives
6. Ram holding shares of Reliance Industries Ltd. which is currently selling at ` 1000. He is
expecting that this price will further fall due to lower than expected level of profits to be
announced after one month. As on following option contract are available in Reliance
Share.
Strike Price (`) Option Premium (`)
1030 Call 40

1010 Call 35
1000 Call 30
990 Put 35
970 Put 20
950 Put 8
930 Put 5
Ram is interested in selling his stock holding as he cannot afford to lose more than 5% of
its value.
RECOMMEND a hedging strategy with option and show how his position will be protected.
7. Laxman buys 10,000 shares of X Ltd. at a price of ` 22 per share whose beta value is 1.5
and sells 5,000 shares of A Ltd. at a price of ` 40 per share having a beta value of 2. He
obtains a complete hedge by Nifty futures at ` 1,000 each. He closes out his position at
the closing price of the next day when the share of X Ltd. dropped by 2%, share of A Ltd.
appreciated by 3% and Nifty futures dropped by 1.5%.
CALCULATE the overall profit/loss to Ram?
8. On January 28, 2017 an importer customer requested a Bank to remit Singapore Dollar
(SGD) 2,500,000 under an irrevocable Letter of Credit (LC). However, due to unavoidable
factors, the Bank could effect the remittances only on February 4, 201 7. The inter-bank
market rates were as follows:
January 28, 2017 February 4, 2017
US$ 1= ` 45.85/45.90 ` 45.91/45.97
GBP £ 1 = US$ 1.7840/1.7850 US$ 1.7765/1.7775
GBP £ 1 = SGD 3.1575/3.1590 SGD 3. 1380/3.1390
The Bank wishes to retain an exchange margin of 0.125%
ANALYZE whether the customer stand to gain or lose due to the delay. (Note: Calculate
the rate in multiples of 0.0001)
9. 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.
10. A multinational company is planning to set up a subsidiary company in India (where hitherto
it was exporting) in view of growing demand for its product and competition from other
MNCs. The initial project cost (consisting of Plant and Machinery including installation) is
estimated to be US$ 500 million. The net working capital requirements are estimated at
US$ 50 million. The company follows straight line method of depreciation. Presently, the
company is exporting two million units every year at a unit price of US$ 80, its variable
cost per unit being US$ 40.
The Chief Financial Officer has estimated the following operating cost and other data in
respect of proposed project:
(i) Variable operating cost will be US $ 20 per unit of production;
(ii) Additional cash fixed cost will be US $ 30 million p.a. and project's share of allocated
fixed cost will be US $ 3 million p.a. based on principle of ability to share;
(iii) Production capacity of the proposed project in India will be 5 million units;
(iv) Expected useful life of the proposed plant is five years with no salvage value;
(v) Existing working capital investment for production & sale of two million units through
exports was US $ 15 million;
(vi) Export of the product in the coming year will decrease to 1.5 million units in case the
company does not open subsidiary company in India, in view of the presence of
competing MNCs that are in the process of setting up their subsidiaries in India;
(vii) Applicable Corporate Income Tax rate is 35%, and
(viii) Required rate of return for such project is 12%.

CALCULATE the Net Present Value (NPV) of the proposed project in India, assuming that:
(a) there will be no variation in the exchange rate of two currencies and
(b) all profits will be repatriated, as there will be no withholding tax.
Present Value Interest Factors (PVIF) @ 12% for five years is as below:
Year 1 2 3 4 5
PVIF 0.8929 0.7972 0.7118 0.6355 0.5674
11. M/s. Parker & Co. is contemplating to borrow an amount of `60 crores for a Period of 3
months in the coming 6 month's time from now. The current rate of interest is 9% p.a., but
it may go up in 6 month’s time. The company wants to hedge itself against the likely
increase in interest rate.
The Company's Bankers quoted an FRA (Forward Rate Agreement) at 9.30%p.a.
EVALUATE the effect of FRA and actual rate of interest cost to the company, if the actual
rate of interest after 6 months happens to be (i) 9.60% p.a. and (ii) 8.80% p.a.?
Corporate Valuation
12. Eagle Ltd. reported a profit of ` 77 lakhs after 30% tax for the financial year 2016-17. An
analysis of the accounts revealed that the income included extraordinary items of ` 8 lakhs
and an extraordinary loss of ` 10 lakhs. The existing operations, except for the
extraordinary items, are expected to continue in the future. In addition, the results of the
launch of a new product are expected to be as follows:
` In lakhs
Sales 70
Material costs 20
Labour costs 12
Fixed costs 10
You are required to:
(i) CALCULATE the value of the business, given that the capitalization rate is 14%.
(ii) CALCULATE the market price per equity share, assuming Eagle Ltd.‘s share capital
being comprised of 1,00,000 13% preference shares of ` 100 each and 50,00,000
equity shares of ` 10 each and the P/E ratio being 10 times.
13. Yes Ltd. wants to acquire No Ltd. and the cash flows of Yes Ltd. and the merged entity are
given below:

(` In lakhs)
Year 1 2 3 4 5
Yes Ltd. 175 200 320 340 350
Merged Entity 400 450 525 590 620
Earnings would have witnessed 5% constant growth rate without merger and 6% with
merger on account of economies of operations after 5 years in each case. The cost of
capital is 15%.
The number of shares outstanding in both the companies before the merger is the same
and the companies agree to an exchange ratio of 0.5 shares of Yes Ltd. for each share of
No Ltd.
CALCULATE:
(i) The Value of Yes Ltd. before and after merger.
(ii) Value of Acquisition and
(iii) Gain to shareholders of Yes Ltd.
Note: PV factor at 15% for years 1-5 are 0.870, 0.756; 0.658, 0.572, 0.497 respectively.
14. (a) EXPLAIN the key elements of a well-functioning financial system.
(b) DESCRIBE the various parameters to identity the currency risk.
(c) EXPLAIN the challenges to Efficient Market Theory.
15. (a) DESCRIBE the constituents of International Financial Centers (IFC)
(b) EXPLAIN Startup India Initiative
(c) LIST the ways to arrange finance for Small and Medium Enterprises.
1. (i) Number of shares to be issued: 5,00,000

Subscription price ` 20,00,000 / 5,00,000 = ` 4
` 1,30,00,000  ` 20,00,000
Ex-right Pr ice   ` 10
15,00,000
` 10 - ` 4
Value of r ight   3
2
Or = ` 10 – ` 4 = ` 6

(ii) Subscription price ` 20,00,000 / 2,50,000 = ` 8

` 1,30,00,000  ` 20,00,000
Ex-right Pr ice   ` 12
12,50,000
` 12  ` 8
Value of r ight   ` 1.
4
Or = ` 12 – ` 8 = ` 4
(iii) The effect of right issue on wealth of Shareholder’s wealth who is holding, say 100
shares.
(a) When firm offers one share for two shares held.
Value of Shares after right issue (150 X ` 10) ` 1,500
Less: Amount paid to acquire right shares (50X`4) ` 200
`1,300
(b) When firm offers one share for every four shares held.
Value of Shares after right issue (125 X ` 12) ` 1,500
Less: Amount paid to acquire right shares (25X`8) ` 200
`1,300
(c) Wealth of Shareholders before Right Issue `1,300
Thus, there will be no change in the wealth of shareholders from (i) and (ii).
2. (i) Firm’s Expected or Required Return on Equity
According to Dividend discount model approach the firm’s expected or required return
on equity is computed as follows:
D1
Ke  g
P0
Where,
Ke = Cost of equity share capital or (Firm’s expected or required
return on equity share capital)
D1 = Expected dividend at the end of year 1
P0 = Current market price of the share.
g = Expected growth rate of dividend.
Now, D1 = D0 (1 + g) or ` 1 (1 + 0.12) or ` 1.12, P0 = ` 20 and g = 12% per annum
` 1.12
Therefore, K e   12%
` 20

Or, K e = ` 17.6%
(ii) Firm’s Expected or Required Return on Equity
(If dividends were expected to grow at a rate of 20% per annum for 5 years and 10%
per year thereafter)
Since in this situation if dividends are expected to grow at a super normal growth rate
gs, for n years and thereafter, at a normal, perpetual growth rate of g n beginning in
the year n + 1, then the cost of equity can be determined by using the following
formula:
n
Div 0 (1+ gs ) t Div n + 1 1
P0 = ∑ (1+ K e ) t
+ ×
K e - gn (1+ K e )n
t =1
Where,
gs = Rate of growth in earlier years.
gn = Rate of constant growth in later years.
P0 = Discounted value of dividend stream.
Ke = Firm’s expected, required return on equity (cost of equity
capital).
Now,
gs = 20% for 5 years, g n = 10%
Therefore,
n
t
P0 = ∑ D0(1(1++K0.20)
)t
+
Div 5 + 1
×
1
K e - 0.10 (1+ K e ) t
t =1 e
1.20 1.44 1.73 2.07 2.49 2.49 (1  0.10) 1

0P 1  2  3  4  5   5
(1  K
e) (1  K
e) (1  K
e) (1  K
e) (1  K
e)
K
e- 0.10 (1  K
e)
or P 0 = ` 1.20 (PVF 1, K e) + ` 1.44 (PVF 2, K e) + ` 1.73 (PVF 3 , K e ) + ` 2.07

Rs. 2.74 (PVF5 , K e )
(PVF 4, K e) + ` 2.49 (PVF 5 , K e) +
K e - 0.10

By trial and error we are required to find out K e

Now, assume K e = 18% then we will have
P0 = ` 1.20 (0.8475) + ` 1.44 (0.7182) + ` 1.73 (0.6086) + ` 2.07 (0.5158) + `
1
2.49 (0.4371) + ` 2.74 (0.4371) 
0.18 - 0.10
= ` 1.017 + ` 1.034 + ` 1.053 + ` 1.068 + ` 1.09 + ` 14.97
= ` 20.23
Since the present value of dividend stream is more than required it indicates that Ke
is greater than 18%.
Now, assume K e = 19% we will have
P0 = ` 1.20 (0.8403) + ` 1.44 (0.7061) + ` 1.73 (0.5934) + ` 2.07 (0.4986) + `
1
2.49 (0.4190) + ` 2.74 (0.4190) 
0.19 - 0.10
= ` 1.008 + ` 1.017 + ` 1.026+ ` 1.032 + ` 1.043 + ` 12.76
= ` 17.89
Since the market price of share (expected value of dividend stream) is ` 20.
Therefore, the discount rate is closer to 18% than it is to 19%, we can get the exact
rate by interpolation by using the following formula:
NPV at LR
K e = LR + × Δr
NPV at LR - NPV at HR
Where,
LR = Lower Rate
NPV at LR = Present value of share at LR
NPV at HR = Present value of share at Higher Rate
r = Difference in rates
(` 20.23 ` 20)
K e  18%   1%
R` 20.23  ` 17.89
` 0.23
18%   1%
`2.34
= 18% + 0.10% = 18.10%
Therefore, the firm’s expected, or required, return on equity is 18.10%. At this rate
the present discounted value of dividend stream is equal to the market price of the
share.

3. (i) Computation of Expected Return from Portfolio

Security Beta Expected Return (r) Amount Weights wr
(β) as per CAPM (` Lakhs) (w)
Moderate 0.50 8%+0.50(10% - 8%) = 9% 60 0.115 1.035
Better 1.00 8%+1.00(10% - 8%) = 10% 80 0.154 1.540
Good 0.80 8%+0.80(10% - 8%) = 9.60% 100 0.192 1.843
Very Good 1.20 8%+1.20(10% - 8%) = 10.40% 120 0.231 2.402
Best 1.50 8%+1.50(10% - 8%) = 11% 160 0.308 3.388
Total 520 1 10.208
Thus Expected Return from Portfolio 10.208% say 10.21%.
Alternatively, it can be computed as follows:
60 80 100 120 160
Average β = 0.50 x + 1.00 x + 0.80 x + 1.20 x + 1.50 x = 1.104
520 520 520 520 520
As per CAPM
= 0.08 + 1.104(0.10 – 0.08) = 0.10208 i.e. 10.208%
(ii) As computed above the expected return from Better is 10% same as from Nifty, hence
there will be no difference even if the replacement of security is made. The main logic
behind this neutrality is that the beta of security ‘Better’ is 1 which clearly indicates
that this security shall yield same return as market return.
4. Sharpe Ratio S = (Rp – Rf)/σp
Treynor Ratio T = (Rp – Rf)/βp
Where,
Rp = Return on Fund
Rf = Risk-free rate
σp = Standard deviation of Fund
βp = Beta of Fund
Reward to Variability (Sharpe Ratio)
Mutual Rp Rf Rp – Rf σp Reward to Ranking
Fund Variability
A 15 6 9 7 1.285 2
B 18 6 12 10 1.20 3
C 14 6 8 5 1.60 1

D 12 6 6 6 1.00 5
E 16 6 10 9 1.11 4
Reward to Volatility (Treynor Ratio)

Mutual Rp Rf Rp – Rf βp Reward to Ranking
Fund Volatility
A 15 6 9 1.25 7.2 2
B 18 6 12 0.75 16 1
C 14 6 8 1.40 5.71 5
D 12 6 6 0.98 6.12 4
E 16 6 10 1.50 6.67 3
5.
Particulars Adjusted Values
` crores
Equity Shares 46.00
Cash in hand 1.23
Bonds and debentures not listed 0.80
Bonds and debentures listed 8.00
Dividends accrued 0.80
Fixed income securities 4.50
Sub total assets (A) 61.33
Less: Liabilities
Amount payable on shares 6.32
Expenditure accrued 0.75
Sub total liabilities (B) 7.07
Net Assets Value (A) – (B) 54.26
No. of units 20,00,000
Net Assets Value per unit (` 54.26 crore / 20,00,000) ` 271.30
6. Instead of selling the stock of Reliance Ltd., Ram must cover his Risk by buying or long
position in Put Option with appropriate strike price. Since Ram’s risk appetite is 5%, the
most suitable strike price in Put Option shall be ` 950 (` 1000 – 5% of ` 1000). If Ram
does so, the overall position will be as follows:

Spot Price after 1 month Stock Value Put Payoff Initial Cash Flow Total
S < 950 S 950 – S -8 942 - S
S > 950 S - -8 S–8
Thus, from the above, it can be seen that the value of holding of Ram shall never be less
than ` 942 as Put Option will compensate for loss below spot price of ` 950. However, this
strategy will involve a cost of ` 8.
7. No. of the Future Contract to be obtained to get a complete hedge
10000 ×`22 × 1.5 - 5000 × ` 40 × 2
=
`1000
`3,30,000 - `4,00,000
= = 70 contracts
`1000
Thus, by purchasing 70 Nifty future contracts to be long to obtain a complete hedge.
Cash Outlay
= 10000 x ` 22 – 5000 x ` 40 + 70 x ` 1,000
= ` 2,20,000 – ` 2,00,000 + ` 70,000 = ` 90,000
Cash Inflow at Close Out
= 10000 x ` 22 x 0.98 – 5000 x ` 40 x 1.03 + 70 x ` 1,000 x 0.985
= ` 2,15,600 – ` 2,06,000 + ` 68,950 = ` 78,550
Gain/ Loss
= ` 78,550 – ` 90,000 = - ` 11,450 (Loss)
8. On January 28, 2017 the importer customer requested to remit SGD 25 lakhs.
To consider sell rate for the bank:
US $ = `45.90
Pound 1 = US$ 1.7850
Pound 1 = SGD 3.1575
` 45.90 * 1.7850
Therefore, SGD 1 =
SGD 3.1575
SGD 1 = `25.9482
Add: Exchange margin (0.125%) ` 0.0324
` 25.9806
On February 4, 2017 the rates are

US $ = ` 45.97
Pound 1 = US$ 1.7775
Pound 1 = SGD 3.1380
` 45.97 * 1.7775
Therefore, SGD 1 =
SGD 3.1380
SGD 1 = ` 26.0394
Add: Exchange margin (0.125%) ` 0.0325
` 26.0719
Hence, loss to the importer
= SGD 25,00,000 (` 26.0719 – ` 25.9806) = ` 2,28,250
9. Strategy 1: This strategy is covered by High Risk: Low Reward category and worst as it
leaves all exposures unhedged. Although this strategy does not involve any time and effort,
it carries high risk.
Strategy 2: This strategy covers Low Risk: Reasonable reward category as the exposure
is covered wherever there is anticipated profit otherwise it is left.
Strategy 3: This strategy is covered by High Risk: High Reward category as to earn profit,
cancellations and extensions are carried out. Although this strategy leads to high gains but
it is also accompanied by high risk.
Strategy 4: This strategy is covered by Low Risk : Low Reward category as company plays
a very safe game.
Diagrammatically all these strategies can be depicted as follows:
High Risk
Low Strategy 1 Strategy 3 High

Reward Reward
Strategy 4 Strategy 2
Low Risk
10. Financial Analysis whether to set up the manufacturing units in India or not may be carried
using NPV technique as follows:
I. Incremental Cash Outflows
$ Million
Cost of Plant and Machinery 500.00
Working Capital 50.00
Release of existing Working Capital (15.00)
535.00

II. Incremental Cash Inflow after Tax (CFAT)

(a) Generated by investment in India for 5 years
$ Million
Sales Revenue (5 Million x $80) 400.00
Less: Costs
Variable Cost (5 Million x $20) 100.00
Fixed Cost 30.00
Depreciation ($500Million/5) 100.00
EBIT 170.00
Taxes@35% 59.50
EAT 110.50
Add: Depreciation 100.00
CFAT (1-5 years) 210.50
Cash flow at the end of the 5 years (Release of Working Capital) 35.00
(b) Cash generation by exports
$ Million
Sales Revenue (1.5 Million x $80) 120.00
Less: Variable Cost (1.5 Million x $40) 60.00
Contribution before tax 60.00
Tax@35% 21.00
CFAT (1-5 years) 39.00
(c) Additional CFAT attributable to Foreign Investment
$ Million
Through setting up subsidiary in India 210.50
Through Exports in India 39.00
CFAT (1-5 years) 171.50
III. Determination of NPV
Year CFAT ($ Million) PVF@12% PV($ Million)
1-5 171.50 3.6048 618.2232
5 35 0.5674 19.8590
638.0822
Less: Initial Outflow 535.0000
103.0822
Since NPV is positive the proposal should be accepted.

11. Final settlement amount shall be computed by using formula:

(N)(RR- FR)(dtm/DY)
=
[1+ RR(dtm/DY)]
Where,
N = the notional principal amount of the agreement;
RR = Reference Rate for the maturity specified by the contract prevailing on the
contract settlement date;
FR = Agreed-upon Forward Rate; and
dtm = maturity of the forward rate, specified in days (FRA Days)
DY = Day count basis applicable to money market transactions which could be 360 or
365 days.
Accordingly,
If actual rate of interest after 6 months happens to be 9.60%
(` 60crore) (0.096- 0.093) (3/12)
=
[1 + 0.096(3/12)]
(` 60crore)(0.00075)
= = ` 4,39,453
1.024
Thus, banker will pay Parker & Co. a sum of ` 4,39,453
If actual rate of interest after 6 months happens to be 8.80%
(` 60crore) (0.088- 0.093) (3/12)
=
[1 + 0.088(3/12)]
(` 60crore) (-0.00125)
= = - ` 7,33,855
1.022
Thus Parker & Co. will pay banker a sum of ` 7,33,855
Actual Rate 9.60% 8.80%
Interest payable
` 60 crore x 0.096 x 3/12 (` 1,44,00,000)
` 60 crore x 0.088 x 3/12 (` 1,32,00,000)
Compensation Receivable:
` 60 crore x (0.096 – 0.093) x 3/12 ` 4,50,000

Compensation Payable:
` 60 crore x (0.088 – 0.093) x 3/12 (` 7,50,000)
Interest Cost to Company (In `) ` 1,39,50,000 ` 1,39,50,000
Annual Interest Cost to Company (In %) 9.30% 9.30%
(` 1,39,50,000/ ` 60crore) x 12/3
12. (i) Computation of Business Value

(` Lakhs)
77 110
Profit before tax
1  0.30
Less: Extraordinary income (8)
Add: Extraordinary losses 10
112
Profit from new product (` Lakhs)
Sales 70
Less: Material costs 20
Labour costs 12
Fixed costs 10 (42) 28
140.00
Less: Taxes @30% 42.00
Future Maintainable Profit after taxes 98.00
Relevant Capitalisation Factor 0.14
Value of Business (`98/0.14) 700
(ii) Computation of Market Price of Equity Share
Future maintainable profits (After Tax) ` 98,00,000
Less: Preference share dividends 1,00,000 shares of ` 100 @ 13% ` 13,00,000
Earnings available for Equity Shareholders ` 85,00,000
No. of Equity Shares 50,00,000
` 85,00,000 ` 1.70
Earning per share = =
50,00,000
PE ratio 10
Market price per share ` 17

13. (i) Working Notes:

Present Value of Cash Flows (CF) upto 5 years
Year CF of Yes PVF PV of CF CF of Merged PV of CF of
End Ltd. @15% Entity Merged
Entity
(` lakhs) (` lakhs) (` lakhs) (` lakhs)
1 175 0.870 152.25 400 348.00
2 200 0.756 151.20 450 340.20
3 320 0.658 210.56 525 345.45
4 340 0.572 194.48 590 337.48
5 350 0.497 173.95 620 308.14
882.44 1679.27
PV of Cash Flows of Yes Ltd. after the forecast period
CF5 (1  g) 350(1  0.05) 367.50
TV5 = = = = ` 3675 lakhs
Ke  g 0.15  0.05 0.10
PV of TV5 = ` 3675 lakhs x 0.497 = ` 1826.475 lakhs

PV of Cash Flows of Merged Entity after the forecast period
CF5 (1  g) 620(1  0.06) 657.20
TV5 = = = = ` 7302.22 lakhs
Ke  g 0.15  0.06 0.09
PV of TV5 = ` 7302.22 lakhs x 0.497 = ` 3629.20 lakhs

Value of Yes Ltd.
Before merger (` lakhs) After merger (` lakhs)
PV of CF (1-5 years) 882.440 1679.27
Add: PV of TV 5 1826.475 3629.20
2708.915 5308.47
(ii) Value of Acquisition
= Value of Merged Entity – Value of Yes Ltd.
= ` 5308.47 lakhs – ` 2708.915 lakhs = ` 2599.555 lakhs
(iii) Gain to Shareholders of Yes Ltd.
1
Share of Yes Ltd. in merged entity = ` 5308.47 lakhs x = ` 3538.98 lakhs
1.5

Gain to shareholder = Share of Yes Ltd. in merged entity – Value of Yes Ltd. before
merger
= `3538.98 lakhs - `2708.915 = `830.065 lakhs
14. (a) Key elements of a well-functioning financial system are explained as below:
(i) A strong legal and regulatory environment – Capital market is regulated by
SEBI which acts a watchdog of the securities market. This has been ensured
through the passing of SEBI Act, Securities Contract Regulation Act and
numerous SEBI rules, regulations and guidelines. Likewise money market and
foreign exchange market is regulated by RBI and this has been ensured through
various provisions of the RBI Act, Foreign Exchange Management Act etc. Thus,
a strong legal system protects the rights and interests of investors and acts as
a most important element of a sound financial system.
(ii) Stable money – Money is an important part of an economy. Frequent
fluctuations and depreciations in the value of money lead to financial crises and
restrict the economic growth.
(iii) Sound public finances and public debt management – Sound public finances
means setting and controlling public expenditures and increase revenues to fund
these expenditures efficiently. Public debt management is the process of
establishing and executing a strategy for managing the government's debt in
order to raise the required amount of funding. It also includes developing and
maintaining an efficient market for government securities.
(iv) A central bank – A central bank supervises and regulates the operations of the
banking system. It acts as a banker to the banks and government, manager of
money market and foreign exchange market and also lender of the last resort.
The monetary policy of the Central Bank is used to keep the pace of economic
growth on a higher path.
(v) Sound banking system – A well-functioning financial system must have large
variety of banks both in the private and public sector having both domestic and
international operations with an ability to withstand adverse national and
international events. They perform varied functions such as operating the
payment and clearing system, and foreign exchange market. Banks also
undertake credit risk analysis and assess the expected risk and return of a
project before giving any loan for a proposed project.
(vi) Information System – All the participants in the financial system requires
information at some stage or the other. Proper information disclosure practices
form basis of a sound financial system for e.g. the corporates has to disclose
their financial performance in the financial statements. Similarly, at the time of
initial public offering, the companies have to disclose a host of information
disclosing their financial health and efficiency.

(vii) Well functioning securities market – A securities market facilitates the

issuance of both equity and debt. An efficient securities market helps in the
deployment of funds raised through the capital market to the required sections
of the economy, lowering the cost of capital for the firms, enhancing liquidity and
attracting foreign investment.
(b) Just like interest rate risk the currency risk is dependent on the Government action
and economic development. Some of the parameters to identity the currency risk are
as follows:
(1) Government Action: The Government action of any country has visual impact
in its currency. For example, the UK Govt. decision to divorce from European
Union i.e. Brexit brought the pound to its lowest since 1980’s.
(2) Nominal Interest Rate: As per interest rate parity (IRP) the currency exchange
rate depends on the nominal interest of that country.
(3) Inflation Rate: Purchasing power parity theory discussed in later chapters
impact the value of currency.
(4) Natural Calamities: Any natural calamity can have negative impact.
(5) War, Coup, Rebellion etc.: All these actions can have far reaching impact on
currency’s exchange rates.
(6) Change of Government: The change of government and its attitude towards
foreign investment also helps to identify the currency risk.
(c) Challenges to the Efficient Market Theory
(i) Information inadequacy – Information is neither freely available nor rapidly
transmitted to all participants in the stock market. There is a calculated attempt
by many companies to circulate misinformation.
(ii) Limited information processing capabilities – Human information processing
capabilities are sharply limited. According to Herbert Simon every human
organism lives in an environment which generates millions of new bits of
information every second but the bottle necks of the perceptual apparatus does
not admit more than thousand bits per seconds and possibly much less.
David Dreman maintained that under conditions of anxiety and uncertainty, with
a vast interacting information grid, the market can become a giant.
(iii) Irrational Behaviour – It is generally believed that investors’ rationality will
ensure a close correspondence between market prices and intrinsic values. But
in practice this is not true. J. M. Keynes argued that all sorts of consideration
enter into the market valuation which is in no way relevant to the prospective
yield. This was confirmed by L. C. Gupta who found that the market evaluation
processes work haphazardly almost like a blind man firing a gun. The market

seems to function largely on hit or miss tactics rather than on the basis of
informed beliefs about the long term prospects of individual enterprises.
(iv) Monopolistic Influence – A market is regarded as highly competitive. No single
buyer or seller is supposed to have undue influence over prices. In practice,
powerful institutions and big operators wield grate influence over the market.
The monopolistic power enjoyed by them diminishes the competitiveness of the
market.
15. (a) Although there are many constituents for IFC but some of the important constituent
are as follows:
(i) Highly developed Infrastructure: A leading edge infrastructure is prerequisite for
creating a platform to offer internationally completive financial services.
(ii) Stable Political Environment: Destabilized political environment brings country
risk investment by foreign nationals. Hence, to accelerate foreign participation
in growth of financial center, stable political environment is prerequisite.
(iii) Strategic Location: The geographical location of the finance center should be
strategic such as near to airport, seaport and should have friendly weather.
(iv) Quality Life: The quality of life at the center showed be good as center retains
highly paid professional from own country as well from outside.
(v) Rationale Regulatory Framework: Rationale legal regulatory framework is
another prerequisite of international finance center as it should be fair and
transparent.
(vi) Sustainable Economy: The economy should be sustainable and should possess
capacity to absorb all the shocks as it will boost investors’ confidence.
(b) Startup India scheme was initiated by the Government of India on 16 th of January,
2016. The definition of startup was provided which is applicable only in case of
Government Schemes. Startup means an entity, incorporated or registered in India:
❖ Not prior to five years,
❖ With annual turnover not exceeding r` 25 crore in any preceding financial
year, and
❖ Working towards innovation, development, deployment or commercialization of
new products, processes or services driven by technology or intellectual
property.
Provided that such entity is not formed by splitting up, or reconstruction, of a business
already in existence. Provided also that an entity shall cease to be a Startup if its
turnover for the previous financial years has exceeded ` 25 crore or it has completed
5 years from the date of incorporation/ registration. Provided further that a Startup

shall be eligible for tax benefits only after it has obtained certification from the Inter -
Ministerial Board, setup for such purpose.
(c) The need for finance can be classified into following types:
- Long and medium term loans
- Short term or working capital requirements
- Risk Capital
- Seed Capital/Marginal Money
- Bridge loans
Financial assistance in India for MSME units is available from a variety of institutions.
The important ones are:
(i) Commercial/Regional Rural/Co-operative Banks.
(ii) SIDBI: Small Industries Development Bank of India (refinance and direct
lending)
(iii) SFCs/SIDCs: State Financial Corporations (e.g. Delhi Financial
Corporation)/State Industrial Development Corporations.
Long and medium term loans are provided by SFCs, SIDBI and SIDCs. Banks also
finance term loans. This type of financing is needed to fund purchase of land,
construction of factory building/shed and for purchase of machinery and equipment.
The short-term loans are required for working capital requirements, which fund the
purchase of raw materials and consumables, payment of wages and other immediate
manufacturing and administrative expenses. Such loans are generally available from
commercial banks. The commercial banks also sanction composite loan comprising
of working capital and term loan up to a loan limit of ` 1 crore.

QUESTIONS
Security Valuation
1. Based on the credit rating of bonds, Mr. Z has decided to apply the following discount
rates for valuing bonds:
Credit Rating Discount Rate
AAA 364 day T bill rate + 3% spread
AA AAA + 2% spread
A AAA + 3% spread
He is considering to invest in AA rated, ` 1,000 face value bond currently selling at
` 1,025.86. The bond has five years to maturity and the coupon rate on the bond is 15%
p.a. payable annually. The next interest payment is due one year from today and the
bond is redeemable at par. (Assume the 364 day T-bill rate to be 9%).
You are required to calculate the intrinsic value of the bond for Mr. Z. Should he invests
in the bond? Also calculate the current yield and the Yield to Maturity (YTM) of the bond.
2. Seawell Corporation, a manufacturer of do-it-yourself hardware and housewares,
reported earnings per share of € 2.10 in 2013, on which it paid dividends per share of
€0.69. Earnings are expected to grow 15% a year from 2004 to 2008, during this period
the dividend payout ratio is expected to remain unchanged. After 2018, the earnings
growth rate is expected to drop to a stable rate of 6%, and the payout ratio is expected to
increase to 65% of earnings. The firm has a beta of 1.40 currently, and is expected to
have a beta of 1.10 after 2018. The market risk premium is 5.5%. The Treasury bond rate
is 6.25%.
(a) What is the expected price of the stock at the end of 2018?
(b) What is the value of the stock, using the two-stage dividend discount model?
3. An investor has decided to invest to invest ` 1,00,000 in the shares of two companies,
namely, ABC and XYZ. The projections of returns from the shares of the two companies
along with their probabilities are as follows:
Probability ABC(%) XYZ(%)
20 12 16
25 14 10
25 -7 28
30 28 -2

You are required to

(i) Comment on return and risk of investment in individual shares.
(ii) Compare the risk and return of these two shares with a Portfolio of these shares in
equal proportions.
(iii) Find out the proportion of each of the above shares to formulate a minimum risk
portfolio.
4. X Co., Ltd., invested on 1.4.2009 in certain equity shares as below:
Name of Co. No. of shares Cost (`)
M Ltd. 1,000 (` 100 each) 2,00,000
N Ltd. 500 (` 10 each) 1,50,000
In September, 2009, 10% dividend was paid out by M Ltd. and in October, 2009, 30%
dividend paid out by N Ltd. On 31.3.2010 market quotations showed a value of ` 220 and
` 290 per share for M Ltd. and N Ltd. respectively.
On 1.4.2010, investment advisors indicate (a) that the dividends from M Ltd. and N Ltd.
for the year ending 31.3.2011 are likely to be 20% and 35%, respectively and (b) that the
probabilities of market quotations on 31.3.2011 are as below:
Probability factor Price/share of M Ltd. Price/share of N Ltd.
0.2 220 290
0.5 250 310
0.3 280 330
(i) Calculate the average return from the portfolio for the year ended 31.3.2010;
(ii) Calculate the expected average return from the portfolio for the year 2010 -11; and
(iii) Advise X Co. Ltd., of the comparative risk in the two investments by calculating the
standard deviation in each case.
Mutual Fund
5. There are two Mutual Funds viz. D Mutual Fund Ltd. and K Mutual Fund Ltd. Each having
close ended equity schemes.
NAV as on 31-12-2014 of equity schemes of D Mutual Fund Ltd. is ` 70.71 (consisting
99% equity and remaining cash balance) and that of K Mutual Fund Ltd. is 62.50
(consisting 96% equity and balance in cash).

Following is the other information:

Equity Schemes
Particular
D Mutual Fund Ltd. K Mutual Fund Ltd.
Sharpe Ratio 2 3.3
Treynor Ratio 15 15
Standard deviation 11.25 5
There is no change in portfolios during the next month and annual average cost is ` 3
per unit for the schemes of both the Mutual Funds.
If Share Market goes down by 5% within a month, calculate expected NAV after a month
for the schemes of both the Mutual Funds.
For calculation, consider 12 months in a year and ignore number of days for particular
month.
Derivatives
6. The market received rumour about ABC corporation’s tie-up with a multinational
company. This has induced the market price to move up. If the rumour is false, the ABC
corporation stock price will probably fall dramatically. To protect from this an investor has
bought the call and put options.
He purchased one 3 months call with a striking price of `42 for `2 premium, and paid
Re.1 per share premium for a 3 months put with a striking price of `40.
(i) Determine the Investor’s position if the tie up offer bids the price of ABC
Corporation’s stock up to `43 in 3 months.
(ii) Determine the Investor’s ending position, if the tie up programme fails and the price
of the stocks falls to ` 36 in 3 months.
7. Indira has a fund of ` 3 lacs which she wants to invest in share market with rebalancing
target after every 10 days to start with for a period of one month from now. The present
NIFTY is 5326. The minimum NIFTY within a month can at most be 4793.4. She wants to
know as to how she should rebalance her portfolio under the following situations,
according to the theory of Constant Proportion Portfolio Insurance Policy, using "2" as
the multiplier:
(1) Immediately to start with.
(2) 10 days later-being the 1st day of rebalancing if NIFTY falls to 5122.96.
(3) 10 days further from the above date if the NIFTY touches 5539.04.
For the sake of simplicity, assume that the value of her equity component will change in
tandem with that of the NIFTY and the risk free securities in which she is going to invest
will have no Beta.


8. XYZ Ltd. is an export oriented business house based in Mumbai. The Company invoices
in customers’ currency. Its receipt of US $ 1,00,000 is due on September 1, 2009.
Market information as at June 1, 2009 is:
Exchange Rates Currency Futures
US $/` US $/` Contract size ` 4,72,000
Spot 0.02140 June 0.02126
1 Month Forward 0.02136 September 0.02118
3 Months Forward 0.02127
Initial Margin Interest Rates in India
June ` 10,000 7.50%
September ` 15,000 8.00%
On September 1, 2009 the spot rate US $Re. is 0.02133 and currency futur e rate is
0.02134. Comment which of the following methods would be most advantageous for XYZ
Ltd.
(a) Using forward contract
(b) Using currency futures
(c) Not hedging currency risks.
It may be assumed that variation in margin would be settled on the matu rity of the futures
contract.
9. 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
3-month Forward Rate ($/£) 1.6100 – 1.6140
Rates of interest in Money Market:
Deposit Loan
$ 7% 9%
£ 5% 8%
Compute and show how a money market hedge can be put in place. Compare and
contrast the outcome with a forward contract.


10. The directors of Implant Inc. wishes to make an equity issue to finance a $10 m (million)
expansion scheme which has an excepted Net Present Value of $2.2m and to re-finance
an existing $6 m 15% Bonds due for maturity in 5 years time. For early redemption of
these bonds there is a $3,50,000 penalty charges. The Co. has also obtained approval to
suspend these pre-emptive rights and make a $15 m placement of shares which will be
at a price of $0.5 per share. The floatation cost of issue will be 4% of Gross proceeds.
Any surplus funds from issue will be invested in IDRs which is currently yielding 10% per
year.
The Present capital structure of Co. is as under:
’000
Ordinary Share ($1 per share) 7,000
Share Premium 10,500
Free Reserves 25,500
43,000
15% Term Bonds 6,000
11% Debenture (2012-2020) 8,000
57,000
Current share price is $2 per share and debenture price is $ 103 per debenture. Cost of
capital of Co. is 10%. It may be further presumed that stock market is semi -strong form
efficient and no information about the proposed use of funds from the issue has been
made available to the public. You are required to calculate expected share price of
company once full details of the placement and to which the finance is to be put, are
announced.
11. XYZ Inc. issues a £ 10 million floating rate loan on July 1, 2016 with resetting of coupon
rate every 6 months equal to LIBOR + 50 bp. XYZ is interested in a collar strategy by
selling a Floor and buying a Cap. XYZ buys the 3 years Cap and sell 3 years Floor as per
the following details on July 1, 2016:
Notional Principal Amount $ 10 million
Reference Rate 6 months LIBOR
Strike Rate 4% for Floor and 7% for Cap
Premium 0*
*Since Premium paid for Cap = Premium received for Floor

Using the following data you are required to determine:

(i) Effective interest paid out at each reset date,
(ii) The average overall effective rate of interest p.a.
Reset Date LIBOR (%)
31-12-2016 6.00
30-06-2017 7.50
31-12-2017 5.00
30-06-2018 4.00
31-12-2018 3.75
30-06-2019 4.25
Corporate Valuation
12. The valuation of Hansel Limited has been done by an investment analyst. Based on an
expected free cash flow of ` 54 lakhs for the following year and an expected growth rate
of 9 percent, the analyst has estimated the value of Hansel Limited to be ` 1800 lakhs.
However, he committed a mistake of using the book values of debt and equity.
The book value weights employed by the analyst are not known, but you know that
Hansel Limited has a cost of equity of 20 percent and post tax cost of debt of 10 percent.
The value of equity is thrice its book value, whereas the market value of its debt is nine -
tenths of its book value. What is the correct value of Hansel Ltd?
13. Reliable Industries Ltd. (RIL) is considering a takeover of Sunflower Industries Ltd. (SIL).
The particulars of 2 companies are given below:
Particulars Reliable Industries Ltd Sunflower Industries
Ltd.
Earnings After Tax (EAT) ` 20,00,000 ` 10,00,000
Equity shares O/s 10,00,000 10,00,000
Earnings per share (EPS) 2 1
PE Ratio (Times) 10 5
Required:
(i) What is the market value of each Company before merger?
(ii) Assume that the management of RIL estimates that the shareholders of SIL will
accept an offer of one share of RIL for four shares of SIL. If there are no synergic
effects, what is the market value of the Post-merger RIL? What is the new price per

share? Are the shareholders of RIL better or worse off than they were before the
merger?
(iii) Due to synergic effects, the management of RIL estimates that the earnings will
increase by 20%. What are the new post-merger EPS and Price per share? Will the
shareholders be better off or worse off than before the merger?
14. (a) EXPLAIN the concept of side pocketing in mutual funds.
(b) EXPLAIN cash settlement and physical settlement in derivative contracts and their
relative advantages and disadvantages.
(c) EXPLAIN the importance of IRDA.
15. (a) EXPLAIN Co-location/Proximity Hosting.
(b) DESCRIBE the factors affecting Industry Analysis.
(c) EXPLAIN the need for finance in case of a MSME unit. Describe the process for
arrangement of finance in the case of MSME.
1. The appropriate discount rate for valuing the bond for Mr. Z is:
R = 9% + 3% + 2% = 14%
Time CF PVIF 14% PV (CF) PV (CF)
1 150 0.877 131.55
2 150 0.769 115.35
3 150 0.675 101.25
4 150 0.592 88.80
5 1150 0.519 596.85
 PV (CF) i.e. P 0 = 1033.80
Since, the current market value is less than the intrinsic value; Mr. Z should buy the
bond. Current yield = Annual Interest / Price = 150 / 1025.86 = 14.62%
The YTM of the bond is calculated as follows:
@15%
P = 150 × PVIFA 15%, 4 + 1150 × PVIF 15%, 5
= 150 × 2.855 + 1150 × 0.497 = 428.25 + 571.55 = 999.80
@14%
As found in sub part (a) P 0 = 1033.80

By interpolation we get,
7.94 7.94
= 14% + × (15% - 14% ) =14% + %
7.94 - (-26.06) 34
YTM = 14.23%
2. The expected rate of return on equity after 2018 = 0.0625 + 1.10(0.055) = 12.3%
The dividends from 2013 onwards can be estimated as:
Year 2013 2014 2015 2016 2017 2018 2019
Earnings Per Share (€) 2.1 2.415 2.78 3.19 3.67 4.22 4.48
Dividends Per Share (€) 0.69 0.794 0.913 1.048 1.206 1.387 2.91
a. The price as of 2018 = €2.91/(0.123- 0.06) = €46.19
b. The required rate of return upto 2018 = 0.0625 + 1.4(0.055) = 13.95%. The
dividends upto 2018 are discounted using this rate as follow:
Year PV of Dividend
2014 0.794/1.1395 = 0.70
2015 0.913/(1.1395)2 = 0.70
2016 1.048/(1.1395)3 = 0.70
2017 1.206/(1.1395)4 = 0.72
2018 1.387/(1.1395)5 = 0.72
Total 3.54
The current price = €3.54 + €46.19/(1.1395) 5= €27.58.
3. (i)
Probability ABC (%) XYZ (%) 1X2 (%) 1X3 (%)
(1) (2) (3) (4) (5)
0.20 12 16 2.40 3.2
0.25 14 10 3.50 2.5
0.25 -7 28 -1.75 7.0
0.30 28 -2 8.40 -0.6
Average return 12.55 12.1
Hence the expected return from ABC = 12.55% and XYZ is 12.1%

Probability (ABC- ABC ) (ABC- ABC )2 1X3 (XYZ- XYZ ) (XYZ- XYZ )2 (1)X(6)
(1) (2) (3) (4) (5) (6)

0.20 -0.55 0.3025 0.06 3.9 15.21 3.04
0.25 1.45 2.1025 0.53 -2.1 4.41 1.10
0.25 -19.55 382.2025 95.55 15.9 252.81 63.20
0.30 15.45 238.7025 71.61 -14.1 198.81 59.64
167.75 126.98
 2 ABC = 167.75(%)2 ;  ABC = 12.95%
 2 XYZ = 126.98(%)2 ;  XYZ = 11.27%
(ii) In order to find risk of portfolio of two shares, the covariance between the two is
necessary here.
Probability (ABC- ABC ) (XYZ- XYZ ) 2X3 1X4
(1) (2) (3) (4) (5)
0.20 -0.55 3.9 -2.145 -0.429
0.25 1.45 -2.1 -3.045 -0.761
0.25 -19.55 15.9 -310.845 -77.71
0.30 15.45 -14.1 -217.845 -65.35
-144.25
 2P = (0.52 x 167.75) + (0.5 2 x 126.98) + 2 x (-144.25) x 0.5 x 0.5
 2P = 41.9375 + 31.745 – 72.125
 2P = 1.5575 or 1.56(%)
 P = 1.56 = 1.25%
E (Rp) = (0.5 x 12.55) + (0.5 x 12.1) = 12.325%
Hence, the return is 12.325% with the risk of 1.25% for the portfolio. Thus the
portfolio results in the reduction of risk by the combination of two shares.
(iii) For constructing the minimum risk portfolio the condition to be satisfied is
σ X2 - rAX σ A σ X σ 2X - Cov.AX
XABC = or =
σ 2A + σ X2 - 2rAX σ A σ X σ 2A + σ 2X - 2 Cov.AX
σX = Std. Deviation of XYZ

σA = Std. Deviation of ABC

rAX= Coefficient of Correlation between XYZ and ABC

Cov.AX = Covariance between XYZ and ABC.
Therefore,
126.98 - (-144.25) 271.23
% ABC = = = 0.46 or 46%
[
126.98 + 167.75 - 2 × (-144.25) ] 583.23
% ABC = 46%, XYZ = 54%
(1 – 0.46) =0.54
4.
Calculation of return on portfolio for 2009-10 (Calculation in ` / share)
M N
Dividend received during the year 10 3
Capital gain/loss by 31.03.10
Market value by 31.03.10 220 290
Cost of investment 200 300
Gain/loss 20 (-)10
Yield 30 (-)7
Cost 200 300
% return 15% (-)2.33%
Weight in the portfolio 57 43
Weighted average return 7.55%
Calculation of estimated return for 2010-11
Expected dividend 20 3.5
Capital gain by 31.03.11
(220x0.2)+ (250x0.5)+(280x0.3) – 220=(253-220) 33 -
(290x0.2)+(310x0.5)+(330x0.3) – 290= (312 – 290) - 22
Yield 53 25.5
*Market Value 01.04.10 220 290
% return 24.09% 8.79%
*Weight in portfolio (1,000x220): (500x290) 60.3 39.7
Weighted average (Expected) return 18.02%
(*The market value on 31.03.10 is used as the base
for calculating yield for 10-11)

Calculation of Standard Deviation

M Ltd.
Exp. Exp. Exp. Exp Prob. (1) Dev. Square (2) X (3)
market gain div. Yield Factor X(2) (PM - of dev.
value (1) (2) PM ) (3)
220 0 20 20 0.2 4 -33 1089 217.80
250 30 20 50 0.5 25 -3 9 4.50
280 60 20 80 0.3 24 27 729 218.70
53 σ2M =
441.00
Standard Deviation (σ M) 21
N Ltd.
Exp. Exp. Exp. Exp. Prob. (1) X (2) Dev. Square (2) X (3)
market gain div. Yield Factor (PN- PN ) of dev.
value (1) (2) (3)
290 0 3.5 3.5 0.2 0.7 -22 484 96.80
310 20 3.5 23.5 0.5 11.75 -2 4 2.00
330 40 3.5 43.5 0.3 13.05 18 324 97.20
25.5 σ N = 196.00
2
Standard Deviation (σ N) 14
Share of company M Ltd. is more risky as the S.D. is more than company N Ltd.
5. Working Notes:
(i) Decomposition of Funds in Equity and Cash Components
NAV on 31.12.14 ` 70.71 ` 62.50
% of Equity 99% 96%
Equity element in NAV ` 70 ` 60
Cash element in NAV ` 0.71 ` 2.50
(ii) Calculation of Beta
(a) D Mutual Fund Ltd.
E(R) - R f E(R) - R f
Sharpe Ratio = 2 = =
σD 11.25

E(R) - Rf = 22.50
E(R) - R f 22.50
Treynor Ratio = 15 = =
βD βD
βD = 22.50/15= 1.50
(b) K Mutual Fund Ltd.
E(R) - R f E(R) - R f
Sharpe Ratio = 3.3 = =
σK 5
E(R) - Rf = 16.50
E(R) - R f 16.50
βK βK
βK = 16.50/15= 1.10
(iii) Decrease in the Value of Equity
Market goes down by 5.00% 5.00%
Beta 1.50 1.10
Equity component goes down 7.50% 5.50%
(iv) Balance of Cash after 1 month
Cash in Hand on 31.12.14 ` 0.71 ` 2.50
Less: Exp. Per month ` 0.25 ` 0.25
Balance after 1 month ` 0.46 ` 2.25
NAV after 1 month
Value of Equity after 1 month
70 x (1 - 0.075) ` 64.75 -
60 x (1 - 0.055) - ` 56.70
Cash Balance 0.46 2.25
65.21 58.95
6. Cost of Call and Put Options
= (` 2 per share) x (100 share call) + (` 1 per share) x (100 share put)
= ` 2 x 100 + 1 x 100

= ` 300
(i) Price increases to `43. Since the market price is higher than the strike price of the
call, the investor will exercise it.
Ending position = (- ` 300 cost of 2 option) + (` 1 per share gain on call) x 100
= - ` 300 + 100
Net Loss = - ` 200
(ii) The price of the stock falls to `36. Since the market price is lower than the strike
price, the investor may not exercise the call option.
Ending Position = (- `300 cost of 2 options) + (`4 per stock gain on put) x 100
= - `300 + 400
Gain = `100
7. Maximum decline in one month = 5326  4793.40  100 = 10%

5326
(1) Immediately to start with
Investment in equity = Multiplier x (Portfolio value – Floor value)
= 2 (3,00,000 – 2,70,000) = ` 60,000
Indira may invest ` 60,000 in equity and balance in risk free securities.
(2) After 10 days
Value of equity = 60,000 x 5122.96/5326 = ` 57,713
Value of risk free investment = ` 2,40,000
Total value of portfolio = ` 2,97,713
= 2 (2,97,713 – 2,70,000) = ` 55,426
Revised Portfolio:
Equity = ` 55,426
Risk free Securities = ` 2,97,713 – ` 55,426 = 2,42,287
(3) After another 10 days
Value of equity = 55,426 x 5539.04/5122.96 = ` 59,928

= 2 (3,02,215 – 2,70,000) = ` 64,430

Revised Portfolio:
Equity = ` 64,430
Risk Free Securities = ` 3,02,215 – ` 64,430 = ` 2,37,785
The investor should off-load ` 4502 of risk free securities and divert to Equity.
8.
Receipts using a forward contract (1,00,000/0.02127) = `47,01,457
Receipts using currency futures
The number of contracts needed is (1,00,000/0.02118)/4,72,000 = 10
Initial margin payable is 10 x `15,000 = `1,50,000
On September 1 Close at 0.02134
Receipts = US$1,00,000/0.02133 = 46,88,233
Variation Margin = [(0.02134 – 0.02118) x 10 x 472000/-]/0.02133
OR (0.00016x10x472000)/.02133 = 755.2/0.02133 35,406
47,23,639
Less: Interest Cost – 1,50,000 x 0.08 x 3/12 `3,000
Net Receipts `47,20,639
Receipts under different methods of hedging
Forward contract `47,01,457
Futures `47,20,639
No hedge
US$ 1,00,000/0.02133 `46,88,233
The most advantageous option would have been to hedge with futures.
9. Identify: Foreign currency is an asset. Amount $ 3,50,000.
Create: $ Liability.
Borrow: In $. The borrowing rate is 9% per annum or 2.25% per quarter.
Amount to be borrowed: 3,50,000 / 1.0225 = $ 3,42,298.29
Convert: Sell $ and buy £. The relevant rate is the Ask rate, namely, 1.5905 per £,
(Note: This is an indirect quote). Amount of £s received on conversion is 2,15,214.27
(3,42,298.29/1.5905).
Invest: £ 2,15,214.27 will be invested at 5% for 3 months and get £ 2,17,904.45
Settle: The liability of $3,42,298.29 at interest of 2.25 per cent quarter matures to

$3,50,000 receivable from customer.

Using forward rate, amount receivable is = 3,50,000 / 1.6140 = £2,16,852.54
Amount received through money market hedge = £2,17,904.45
Gain = 2,17,904.45 – 2,16,852.54 = £1,051.91
So, money market hedge is beneficial for the exporter
10 In semi-strong form of stock market, the share price should accurately reflect new
relevant information when it is made publicly available including Implant Inc. expansion
scheme and redemption of the term loan.
The existing Market Value $ 2 x 7,000,000 $ 14,000,000
The new investment has an expected NPV $ 2,200,000
Proceeds of New Issue $ 15,000,000
Issue Cost of ($ 600,000)
PV of Benefit of early redemption
Interest of $ 900,000 ($,6,000,000 x 15 %)x 3.791 3,411,900
PV of Repayment in 5 years $ 6,000,000 x 0.621 3,726,000
7,137,900
Redemption Cost Now (6,000,000)
Penalty charges (350,000) 787,900
Expected Total Market value 31,387,900
New No. of shares (30 Million + 7 Million) 37,00,000
Expected Share Price of Company $ 0.848
11. (a) The pay-off of each leg shall be computed as follows:

Cap Receipt
Max {0, [Notional principal x (LIBOR on Reset date – Cap Strike Rate) x
Number of days in the settlement period
}
365
Floor Pay-off
Max {0, [Notional principal x (Floor Strike Rate – LIBOR on Reset date) x
Number of days in the settlement period
}
365

Statement showing effective interest on each re-set date

Reset Date LIBOR Days Interest Cap Floor Effective
(%) Payment ($) Receipts Pay-off Interest
LIBOR+0.50% ($) ($)
31-12-2016 6.00 184 3,27,671 0 0 3,27,671
30-06-2017 7.50 181 3,96,712 24,795 0 3,71,917
31-12-2017 5.00 184 2,77,260 0 0 2,77,260
30-06-2018 4.00 181 1,98,356 0 0 1,98,356
31-12-2018 3.75 184 1,89,041 0 12,603 2,01,644
30-06-2019 4.25 182 2,36,849 0 0 2,36,849
Total 1096 16,26,094
(b) Average Annual Effective Interest Rate shall be computed as follows:
16,26,094 365
  100 = 5.42%
1,00,00,000 1096
12. Cost of capital by applying Free Cash Flow to Firm (FCFF) Model is as follows:-
FCFF1
Value of Firm = V0 =
K c  gn
Where –
FCFF1 = Expected FCFF in the year 1
Kc= Cost of capital
gn = Growth rate forever
Thus, ` 1800 lakhs = ` 54 lakhs /(Kc-g)
Since g = 9%, then K c = 12%
Now, let X be the weight of debt and given cost of equity = 20% and cost of debt = 10%,
then 20% (1 – X) + 10% X = 12%
Hence, X = 0.80, so book value weight for debt was 80%
 Correct weight should be 60 of equity and 72 of debt.
 Cost of capital = Kc = 20% (60/132) + 10% (72/132) = 14.5455% and correct firm’s
value
= ` 54 lakhs/(0.1454 – 0.09) = ` 974.73 lakhs.

13. (i) Market value of Companies before Merger

Particulars RIL SIL
EPS `2 Re.1
P/E Ratio 10 5
Market Price Per Share ` 20 `5
Equity Shares 10,00,000 10,00,000
Total Market Value 2,00,00,000 50,00,000
(ii) Post Merger Effects on RIL

`
Post merger earnings 30,00,000
Exchange Ratio (1:4)
No. of equity shares o/s (10,00,000 + 2,50,000) 12,50,000
EPS: 30,00,000/12,50,000 2.4
PE Ratio 10
Market Value 10 x 2.4 24
Total Value (12,50,000 x 24) 3,00,00,000
Gains From Merger: `
Post-Merger Market Value of the Firm 3,00,00,000
Less: Pre-Merger Market Value
RIL 2,00,00,000
SIL 50,00,000 2,50,00,000
Total gains from Merger 50,00,000
Apportionment of Gains between the Shareholders:
Particulars RIL(`) SIL(`)
Post Merger Market Value:
10,00,000 x 24 2,40,00,000 --
2,50,000 x 24 - 60,00,000
Less: Pre-Merger Market Value 2,00,00,000 50,00,000
Gains from Merger: 40,00,000 10,00,000
Thus, the shareholders of both the companies (RIL + SIL) are better off than before

(iii) Post-Merger Earnings:

Increase in Earnings by 20%
New Earnings: ` 30,00,000 x (1+0.20) ` 36,00,000
No .of equity shares outstanding: 12,50,000
EPS (` 36,00,000/12,50,000) ` 2.88
PE Ratio 10
Market Price Per Share: = `2.88 x 10 ` 28.80
Shareholders will be better-off than before the merger situation.
14. (a) In simple words, a Side Pocketing in Mutual Funds leads to separation of risky
assets from other investments and cash holdings. The purpose is to make sure that
money invested in a mutual fund, which is linked to stressed assets, gets locked,
until the fund recovers the money from the company or could avoid distress selling
of illiquid securities.
The modus operandi is simple. Whenever, the rating of a mutual fund decreases,
the fund shifts the illiquid assets into a side pocket so that current shareholders can
be benefitted from the liquid assets. Consequently, the Net Asset Value (NAV) of
the fund will then reflect the actual value of the liquid assets.
Side Pocketing is beneficial for those investors who wish to hold on to the units of
the main funds for long term. Therefore, the process of Side Pocketing ensures that
liquidity is not the problem even in the circumstances of frequent allotments and
redemptions.
Side Pocketing is quite common internationally. However, Side Pocketing has also
been resorted to bereft the investors of genuine returns.
In India recent fiasco in the Infrastructure Leasing and Financial Services (IL&FS)
has led to many discussions on the concept of side pocketing as IL&FS and its
subsidiaries have failed to fulfill its repayments obligations due to severe liquidity
crisis.
The Mutual Funds have given negative returns because they have completely
written off their exposure to IL&FS instruments.
(b) The physical settlement in case of derivative contracts means that underlying assets
are actually delivered on the specified delivery date. In other words, traders will
have to take delivery of the shares against position taken in the derivative contract.
In case of cash settlement, the seller of the derivative contract does not deliver the
underlying asset but transfers the Cash. It is similar to Index Futures where the
purchaser, who wants to settle the contract in cash, will have to pay or receive the
difference between the Spot price of the contract on the settlement date and the

Futures price decided beforehand since it is impossible to effect the physical

ownership of the underlying securities.
The main advantage of cash settlement in derivative contract is high liquidity
because of more derivative volume in cash segment. Moreover, the underlying
stocks in derivative contracts has constricted bid-ask spreads. And, trading in such
stocks can be effected at lower impact cost. If the stock is liquid, the impact cost of
bigger trades will be lower.
Further, an adverse move can be hedged. For example, the investors can take a
covered short derivative position by selling the future while still holding the
underlying security.
Also, a liquid derivative market facilitates the traders to do speculation. The
speculative trading may worry the regulators but it is also true that without
speculative trading, it will not be possible for the derivative market to stay liquid.
So, this leads to some arguments in favour of physical settlement in derivative
contract. One advantage of physical settlement is that it is not subject to
manipulation by both the parties to the derivative contract. This is so because the
entire activity is monitored by the broker and the clearing exchange.
However, one main disadvantage of physical delivery is that it is almost impossible
to short sell a stock in the Indian Market.
Therefore, in the end, it can be concluded that, though, physical settlement in
derivative contract does curb manipulation it also affects the liquidity in the
derivative segment.
(c) Importance of Insurance Regulatory and Development Authority (IRDA)
(i) Regulation of Insurance Sector: IRDA has a significant effect on the overall
regulation of Indian Insurance Sector. In order to keep the proper protection of
the policy holder’s interests, Insurance Regulatory and Development Authority
(IRDA) closely observe the different activities of insurance sector in India.
(ii) Protection of Policyholders Interests: The core objective or purpose of the
Insurance Regulatory and Development Authority is to protect the interests of
policyholders and IRDA is doing that with aplomb.
(iii) Awareness to Insurance: In order to increase the awareness of insurance in
the society, IRDA is trying to convince the prospective investors about the
transparency of the system and the effort being put by the regulator to put this
into practice.
(iv) Insurance Market: Insurance sector has grown leap and bounds due to the
concerted efforts of Insurance Regulatory and Development Authori ty with
respect to marketing of insurance products, competition & customer
awareness.

(v) Development of Insurance Product: Insurance Regulatory and Development

Authority (IRDA) has brought a revolution in the development of insurance
products. The development of ULIPs (Unit-Linked Insurance Plans) is the
result of privatization of the insurance sector.
(vi) Competition in the Insurance Sector: After the advent of privatization in the
insurance sector by inviting private players, competition in the insurance sector
has increased significantly leading to comparatively cheaper services and
greater customer satisfaction.
(vii) Saving and Investment of Individual: Insurance Regulatory and Development
Authority has made insurance a popular & profitable mode of investment and
inculcate saving habits among various sections of the society.
(viii) Government Responsibility: Insurance Regulatory and Development Authority
(IRDA) has make it sure that uniformity in the insurance sector is being
ensured by helping in constant increase in the number of insurers, increasing
competition, number of diversified products and diversification in the activities
of the insurers.
(ix) Banks and Post Offices: Insurance sector is now giving security against any
kind of uncertainty or risk, so the insurance sector has now become a popular
medium for savings & investments and is gradually diverting the flow of funds
from banks & post offices to insurance industry.
(x) Individual Life’s: Insurance Regulatory and Development Authority has helped
in developing an understanding of insurance by putting across a great
impression over the life of a common man of the society.
(xi) Stock Market: Private players in the insurance have developed ULIPs (Unit-
Linked Insurance plans) in order to attract more customers. ULIP is a
byproduct of modern insurance market. Therefore, insurance products have
made it simple for the companies to raise funds and have also attracted
various sections of the society to invest in the stock market indirectly.
(xii) Indian Economy: Insurance Regulatory and Development Authority has an
impact over the economic development of the country because money
invested by investors or individuals in various types of insurance products has
channelized the funds of a country for a non-economic activity to economic
activity & has made available to the governments of a country in order to
implement the various developmental activities in the country.
15. (a) The co-location or proximity hosting is a facility which is offered by the stock
exchanges to stock brokers and data vendors whereby their trading or data -vending
systems are allowed to be located within or at close proximity to the premises of the
stock exchanges, and are allowed to connect to the trading platfo rm of stock
exchanges through direct and private network.

Moreover, pursuant to the recommendations of the Technical Advisory Committee

(TAC) of SEBI, stock exchanges are advised to allow direct connectivity between
co-location facility of one recognized stock exchange and the colocation facility of
other recognized stock exchanges. Stock exchanges are also advised to allow
direct connectivity between servers of a stock broker placed in colocation facility of
a recognized stock exchange and servers of the same stock broker placed in
colocation facility of a different recognized stock exchange. This facility should be
available to all the co-located brokers, who are desirous to avail such connectivity,
in a fair and equitable manner.
Further, in light of the public comments received and in consultation with Technical
Advisory Committee (TAC) of SEBI and Secondary Market Advisory Committee
(SMAC) of SEBI and in order to facilitate small and medium sized Members, who
otherwise find it difficult to avail colocation facility, due to various reasons including
but not limited to high cost, lack of expertise in maintenance and troubleshooting,
etc. to avail co-location facility, SEBI has directed the stock exchanges to introduce
‘Managed Co-location Services’. Under this facility, space/rack in co-location
facility shall be allotted to eligible vendors by the stock exchange along with
provision for receiving market data for further dissemination of the same to their
client members and the facility.
(b) The following factors may particularly be kept in mind while assessing the factors
relating to an industry.
(i) Product Life-Cycle: An industry usually exhibits high profitability in the initial
and growth stages, medium but steady profitability in the maturity st age and a
sharp decline in profitability in the last stage of growth.
(ii) Demand Supply Gap: Excess supply reduces the profitability of the industry
because of the decline in the unit price realization, while insufficient supply
tends to improve the profitability because of higher unit price realization.
(iii) Barriers to Entry: Any industry with high profitability would attract fresh
investments. The potential entrants to the industry, however, face different
types of barriers to entry. Some of these barriers are innate to the product and
the technology of production, while other barriers are created by existing firms
in the industry.
(iv) Government Attitude: The attitude of the government towards an industry is a
crucial determinant of its prospects.
(v) State of Competition in the Industry: Factors to be noted are- firms with
leadership capability and the nature of competition amongst them in foreign
and domestic market, type of products manufactured viz. homogeneous or
highly differentiated, demand prospects through classification viz customer-
wise/area-wise, changes in demand patterns in the long/immediate/ short run,

type of industry the firm is placed viz. growth, cyclical, defensive or decline.
(vi) Cost Conditions and Profitability: The price of a share depends on its return,
which in turn depends on profitability of the firm. Profitability depends on the
state of competition in the industry, cost control measures adopted by its units
and growth in demand for its products.
(vii) Technology and Research: They play a vital role in the growth and survival of a
particular industry. Technology is subject to change very fast leading to
obsolescence. Industries which update themselves have a competitive
advantage over others in terms of quality, price etc.
(c) No MSME unit can take off without monetary support. This need for finance can be
classified into following types:
- Long and medium term loans
- Short term or working capital requirements
- Risk Capital
- Seed Capital/Marginal Money
- Bridge loans
Financial assistance in India for MSME units is available from a variety of
institutions. The important ones are:
(i) Commercial/Regional Rural/Co-operative Banks.
(ii) SIDBI: Small Industries Development Bank of India (refinance and direct
lending)
(iii) SFCs/SIDCs: State Financial Corporations (e.g. Delhi Financial
Corporation)/State Industrial Development Corporations.
Long and medium term loans are provided by SFCs, SIDBI and SIDCs. Banks also
finance term loans. This type of financing is needed to fund purchase of land,
construction of factory building/shed and for purchase of machinery and equipment.
The short-term loans are required for working capital requirements, which fund the
purchase of raw materials and consumables, payment of wages and other
immediate manufacturing and administrative expenses. Such loans are generally
available from commercial banks. The commercial banks also sanction composite
loan comprising of working capital and term loan up to a loan limit of Rs.1 crore.
For loans from financial institutions and commercial banks a formal application
needs to be made. The details of documentation that need to be provided with the
loan application are indicated below:
- Balance Sheet and Profit Loss Statement for last three consecutive years of
firms owned by promoters

- Income Tax Assessment Certificates of Partners/Directors

- Proof of Possession of Land/Building
- Architect’s estimate for construction cost
- Partnership deed/Memorandum and Articles of Associations of Company
- Project Report
- Budgetary Quotations of Plant and Machinery
A sanction or rejection letter is issued by bank after its assessment of the
application. After receiving a sanction letter, applicants need to indicate in writing
their acceptance of terms and conditions laid down by FI/Banks.
Subsequently, loan is disbursed according to the phased implementation of the
project. In today’s environment there are other choices apart from commercial
banks and Government owned financial institutions. These options include venture
capital funds and non-government finance companies.

QUESTIONS
Security Valuation
1. A hypothetical company ABC Ltd. issued a 10% Debenture (Face Value of ` 1000) of the
duration of 10 years is currently trading at ` 850 per debenture. The bond is convertible
into 50 equity shares being currently quoted at ` 17 per share.
If yield on equivalent comparable bond is 11.80%, then calculate the spread of yield of the
above bond from this comparable bond.
The relevant present value table is as follows.
Present t1 t2 t3 t4 t5 t6 t7 t8 t9 t10
Values
PVIF 0.11, t 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352
PVIF 0.13 t 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295
2. Mr. A is thinking of buying shares at ` 500 each having face value of ` 100. He is expecting
a bonus at the ratio of 1:5 during the fourth year. Annual expected dividend is 20% and the
same rate is expected to be maintained on the expanded capital base. He intends to sell
the shares at the end of seventh year at an expected price of ` 900 each. Incidental
expenses for purchase and sale of shares are estimated to be 5% of the market price. He
expects a minimum return of 12% per annum.
Should Mr. A buy the share? If so, what maximum price should he pay for each share?
Assume no tax on dividend income and capital gain.
3. Consider the following information on two stocks, A and B:
Year Return on A (%) Return on B (%)
2016 10 12
2017 16 18
You are required to determine:
(i) The expected return on a portfolio containing A and B in the proportion of 40% and
60% respectively.
(ii) The Standard Deviation of return from each of the two stocks.
(iii) The covariance of returns from the two stocks.
(iv) Correlation coefficient between the returns of the two stocks.

(v) The risk of a portfolio containing A and B in the proportion of 40% and 60%.
4. A company has a choice of investments between several different equity oriented mutual
funds. The company has an amount of `1 crore to invest. The details of the mutual funds
are as follows:
Mutual Fund Beta
A 1.6
B 1.0
C 0.9
D 2.0
E 0.6
Required:
(i) If the company invests 20% of its investment in each of the first two mutual funds and
an equal amount in the mutual funds C, D and E, what is the beta of the portfolio?
(ii) If the company invests 15% of its investment in C, 15% in A, 10% in E and the balance
in equal amount in the other two mutual funds, what is the beta of the portfolio?
(iii) If the expected return of market portfolio is 12% at a beta factor of 1.0, what will be
the portfolios expected return in both the situations given above?
Mutual Fund
5. On 1st April 2009 Fair Return Mutual Fund has the following assets and prices at 4.00 p.m.
Shares No. of Shares Market Price Per Share
(` )
A Ltd. 10000 19.70
B Ltd. 50000 482.60
C Ltd. 10000 264.40
D Ltd. 100000 674.90
E Ltd. 30000 25.90
No. of units of funds 8, 00,000
Please calculate:
(a) NAV of the Fund on 1st April 2009.
(b) Assuming that on 1st April 2009, Mr. X, a HNI, send a cheque of ` 50,00,000 to the
Fund and Fund Manager immediately purchases 18000 shares of C Ltd. and balance
is held in bank. Then what will be position of fund.
(c) Now suppose on 2 April 2009 at 4.00 p.m. the market price of shares is as follows:

Shares `
A Ltd. 20.30
B Ltd. 513.70
C Ltd. 290.80
D Ltd. 671.90
E Ltd. 44.20
Then what will be new NAV.
Derivatives
6. Sensex futures are traded at a multiple of 50. Consider the following quotations of Sensex
futures in the 10 trading days during February, 2009:
Day High Low Closing
4-2-09 3306.4 3290.00 3296.50
5-2-09 3298.00 3262.50 3294.40
6-2-09 3256.20 3227.00 3230.40
7-2-09 3233.00 3201.50 3212.30
10-2-09 3281.50 3256.00 3267.50
11-2-09 3283.50 3260.00 3263.80
12-2-09 3315.00 3286.30 3292.00
14-2-09 3315.00 3257.10 3309.30
17-2-09 3278.00 3249.50 3257.80
18-2-09 3118.00 3091.40 3102.60
Abhishek bought one sensex futures contract on February, 04. The average daily absolute
change in the value of contract is ` 10,000 and standard deviation of these changes is
` 2,000. The maintenance margin is 75% of initial margin.
You are required to determine the daily balances in the margin account and payment on
margin calls, if any.
7. Consider a two-year call option with a strike price of ` 50 on a stock the current price of
which is also ` 50. Assume that there are two-time periods of one year and in each year
the stock price can move up or down by equal percentage of 20%. The risk-free interest
rate is 6%. Using binominal option model, calculate the probability of price moving up and
down. Also draw a two-step binomial tree showing prices and payoffs at each node.


8. Excel Exporters are holding an Export bill in United States Dollar (USD) 1,00,000 due 60
days hence. They are worried about the falling USD value which is currently at ` 45.60 per
USD. The concerned Export Consignment has been priced on an Exchange rate of ` 45.50
per USD. The Firm’s Bankers have quoted a 60-day forward rate of ` 45.20.
Calculate:
(i) Rate of discount quoted by the Bank
(ii) The probable loss of operating profit if the forward sale is agreed to.
9. An Indian importer has to settle an import bill for $ 1, 30,000. The exporter has given the
Indian exporter two options:
(i) Pay immediately without any interest charges.
(ii) Pay after three months with interest at 5 percent per annum.
The importer's bank charges 15 percent per annum on overdrafts. The exchange rates in
the market are as follows:
Spot rate (` /$): 48.35 /48.36
3-Months forward rate (`/$): 48.81 /48.83
The importer seeks your advice. Give your advice.
10. ABC Ltd. is considering a project in US, which will involve an initial investment of US $
1,10,00,000. The project will have 5 years of life. Current spot exchange rate is ` 48 per
US $. The risk free rate in US is 8% and the same in India is 12%. Cash inflow from the
project is as follows:
Year Cash inflow
1 US $ 20,00,000
2 US $ 25,00,000
3 US $ 30,00,000
4 US $ 40,00,000
5 US $ 50,00,000
Calculate the NPV of the project using foreign currency approach. Required rate of return
on this project is 14%.


11. Two companies ABC Ltd. and XYZ Ltd. approach the DEF Bank for FRA (Forward Rate
Agreement). They want to borrow a sum of ` 100crores after 2 years for a period of 1 year.
Bank has calculated Yield Curve of both companies as follows:
Year XYZ Ltd. ABC Ltd.*
1 3.86 4.12
2 4.20 5.48
3 4.48 5.78
*The difference in yield curve is due to the lower credit rating of ABC Ltd. compared to XYZ
Ltd.
(i) You are required to calculate the rate of interest DEF Bank would quote under 2V3
FRA, using the company’s yield information as quoted above.
(ii) Suppose bank offers Interest Rate Guarantee for a premium of 0.1% of the amount
of loan, you are required to calculate the interest payable by XYZ Ltd. if interest rate
in 2 years turns out to be
(a) 4.50%
(b) 5.50%
Corporate Valuation
12. A valuation done of an established company by a well-known analyst has estimated a value
of ` 500 lakhs, based on the expected free cash flow for next year of ` 20 lakhs and an
expected growth rate of 5%.
While going through the valuation procedure, you found that the analyst has made the
mistake of using the book values of debt and equity in his calculation. While you do not
know the book value weights he used, you have been provided with the following
information:
(i) Company has a cost of equity of 12%,
(ii) After tax cost of debt is 6%,
(iii) The market value of equity is three times the book value of equity, while the market
value of debt is equal to the book value of debt.
You are required to estimate the correct value of the company.
13. Following information is provided relating to the acquiring company Mani Ltd. and the target
company Ratnam Ltd:

Mani Ltd. Ratnam Ltd.

Earnings after tax (` lakhs) 2,000 4,000
No. of shares outstanding (lakhs) 200 1,000
P/E ratio (No. of times) 10 5
Required:
(i) What is the swap ratio based on current market prices?
(ii) What is the EPS of Mani Ltd. after the acquisition?
(iii) What is the expected market price per share of Mani Ltd. after the acquisition,
assuming its P/E ratio is adversely affected by 10%?
(iv) Determine the market value of the merged Co.
(v) Calculate gain/loss for the shareholders of the two independent entities, due to the
merger.
14. (a) Briefly explain the concept of Exchange Traded Fund.
(b) Briefly discuss the concept of Purchasing Power Parity.
(c) Explain the reasons of Reverse Stock Split.
15. (a) Explain the benefits of Securitization from the point of view of originator.
(b) Explain briefly the parameters to identify the currency risk.
(c) Compare and contrast start-ups and entrepreneurship. Describe the priorities and
challenges which start-ups in India are facing.
1. Conversion Price = ` 50 x 17 = ` 850

Intrinsic Value = ` 850
Accordingly the yield (r) on the bond shall be:
` 850 = ` 100 PVAF (r, 10) + ` 1000 PVF (r, 10)
Let us discount the cash flows by 11%
850 = 100 PVAF (11%, 10) + 1000 PVF (11%, 10)
850 = 100 x 5.890 + 1000 x 0.352
= 91

Now let us discount the cash flows by 13%

850 = 100 PVAF (13%, 10) + 1000 PVF (13%, 10)
850 = 100 x 5.426 + 1000 x 0.295
= -12.40
Accordingly, IRR
90.90
11% + × (13% - 11%)
90.90 - (-12.40)
90.90
11% + × (13% - 11%)
103.30
= 12.76%
The spread from comparable bond = 12.76% - 11.80% = 0.96%
2. P.V. of dividend stream and sales proceeds
Year Dividend/Sale PVF (12%) PV (`)
1 ` 20/- 0.893 17.86
2 ` 20/- 0.797 15.94
3 ` 20/- 0.712 14.24
4 ` 24/- 0.636 15.26
5 ` 24/ 0.567 13.61
6 ` 24/ 0.507 12.17
7 ` 24/ 0.452 10.85
7 ` 1026/- (` 900 x 1.2 x 0.95) 0.452 463.75
` 563.68
Less: Cost of Share (` 500 x 1.05) ` 525.00
Net gain ` 38.68
Since Mr. A is gaining ` 38.68 per share, he should buy the share.
Maximum price Mr. A should be ready to pay is ` 563.68 which will include incidental
expenses. So the maximum price should be ` 563.68 x 100/105 = ` 536.84
3. (i) Expected return of the portfolio A and B
E (A) = (10 + 16) / 2 = 13%
E (B) = (12 + 18) / 2 = 15%

N
Rp =  X iR i  0.4(13)  0.6(15)  14.2%
i l
(ii) Stock A:
Variance = 0.5 (10 – 13)² + 0.5 (16 – 13) ² = 9
Standard deviation = = 3%
Stock B:
Variance = 0.5 (12 – 15) ² + 0.5 (18 – 15) ² = 9
Standard deviation = 3%
(iii) Covariance of stocks A and B
CovAB = 0.5 (10 – 13) (12 – 15) + 0.5 (16 – 13) (18 – 15) = 9
(iv) Correlation of coefficient
CovAB 9
rAB =  1
A B 3  3
(v) Portfolio Risk
P  X2 A2A  X2B2B  2X A XB (ABAB )
= 0.42 32  0.62 32  20.40.6331

= 1.44  3.24  4.32
= 3%
4. With 20% investment in each MF Portfolio Beta is the weighted average of the Betas of
various securities calculated as below:
(i)
Investment Beta (β) Investment Weighted Investment
(` Lacs)
A 1.6 20 32
B 1.0 20 20
C 0.9 20 18
D 2.0 20 40
E 0.6 20 12
100 122
Weighted Beta (β) = 1.22

(ii) With varied percentages of investments portfolio beta is calculated as follows:

Investment Beta (β) Investment Weighted Investment
(` Lacs)
A 1.6 15 24
B 1.0 30 30
C 0.9 15 13.5
D 2.0 30 60
E 0.6 10 6
100 133.5
Weighted Beta (β) = 1.335
(iii) Expected return of the portfolio with pattern of investment as in case (i)
= 12% × 1.22 i.e. 14.64%
Expected Return with pattern of investment as in case (ii) = 12% × 1.335 i.e., 16.02%.
5. (a) NAV of the Fund.
` 1,97,000 ` 2,41,30,000 ` 26,44,000 ` 6,74,90,000 ` 7,77,000
800000
` 9,52,38,000
= ` 119.0475 rounded to ` 119.05
800000
(b) The revised position of fund shall be as follows:
Shares No. of shares Price Amount (`)
A Ltd. 10000 19.70 1,97,000
B Ltd. 50000 482.60 2,41,30,000
C Ltd. 28000 264.40 74,03,200
D Ltd. 100000 674.90 674,90,000
E Ltd. 30000 25.90 7,77,000
Cash 2,40,800
10,02,38,000
5000000
No. of units of fund = 800000  = 8,42,000
119.0475
(c) On 2nd April 2009, the NAV of fund will be as follows:
Shares No. of shares Price Amount (`)
A Ltd. 10000 20.30 2,03,000

B Ltd. 50000 513.70 2,56,85,000

C Ltd. 28000 290.80 81,42,400
D Ltd. 100000 671.90 6,71,90,000
E Ltd. 30000 44.20 13,26,000
Cash 2,40,800
10,27,87,200
` 10,27,87,200
NAV as on 2nd April 2009 = = ` 122.075 per unit
842000
6. Initial Margin = µ + 3 
Where µ = Daily Absolute Change
 = Standard Deviation
Accordingly;
Initial Margin = ` 10,000 + ` 6,000 = ` 16,000
Maintenance margin = ` 16,000 x 0.75 = ` 12,000
Day Changes in future Values (` ) Margin A/c (` ) Call Money (`)
4/2/09 - 16000 -
5/2/09 50 x (3294.40 - 3296.50) = -105 15895 -
6/2/09 50 x (3230.40 - 3294.40) = -3200 12695 -
7/2/09 50 x (3212.30 - 3230.40) = -905 16000 4210
10/2/09 50 x (3267.50 - 3212.30) = 2760 18760 -
11/2/09 50 x (3263.80 - 3267.50) = -185 18575 -
12/2/09 50 x (3292 - 3263.80) =1410 19985 -
14/2/09 50 x (3309.30 - 3292) =865 20850 -
17/2/09 50 x (3257.80 - 3309.30) = -2575 18275 -
18/2/09 50 x (3102.60 - 3257.80) = -7760 16000 5485
7. Stock prices in the two step Binominal tree

Using the single period model, the probability of price increase is

R  d 1.06  0.80 0.26
P= = = = 0.65
ud 1.20  0.80 0.40
Therefore the p of price decrease = 1-0.65 = 0.35
The two step Binominal tree showing price and pay off
The value of an American call option at nodes D, E and F will be equal to the value of
European option at these nodes and accordingly the call values at nodes D, E and F will
be 22, 0 and 0 using the single period binomial model the value of call option at node B is
Cup  Cd(1 p) 22  0.65  0  0.35
C= = = 13.49
R 1.06
The value of option at node ‘A’ is
13.49  0.65  0  0.35
= 8.272
1.06
8. (i) Rate of discount quoted by the bank
(45.20 - 45.60) × 365 × 100
= = 5.33%
45.60 × 60
(ii) Probable loss of operating profit:
(45.20 – 45.50)  1, 00,000 = ` 30,000
9. If importer pays now, he will have to buy US$ in Spot Market by availing overdraft facility.
Accordingly, the outflow under this option will be
`
Amount required to purchase $1,30,000 [$1,30,000X`48.36] 62,86,800
Add: Overdraft Interest for 3 months @15% p.a. 2,35,755
65,22,555

If importer makes payment after 3 months then, he will have to pay interest for 3 months
@ 5% p.a. for 3 month along with the sum of import bill. Accordingly, he will have to buy $
in forward market. The outflow under this option will be as follows:
$
Amount of Bill 1,30,000
Add: Interest for 3 months @5% p.a. 1,625
1,31,625
Amount to be paid in Indian Rupee after 3 month under the forward purchase contract
` 64,27,249 (US$ 1,31,625 X ` 48.83)
Since outflow of cash is least in (ii) option, it should be opted for.
10. (1 + 0.12) (1 + Risk Premium) = (1 + 0.14)
Or, 1 + Risk Premium = 1.14/1.12 = 1.0179
Therefore, Risk adjusted dollar rate is = 1.0179 x 1.08 = 1.099 – 1 = 0.099
Calculation of NPV
Year Cash flow (Million) PV Factor at 9.9% P.V.
US$
1 2.00 0.910 1.820
2 2.50 0.828 2.070
3 3.00 0.753 2.259
4 4.00 0.686 2.744
5 5.00 0.624 3.120
12.013
Less: Investment 11.000
NPV 1.013
Therefore, Rupee NPV of the project is = ` (48 x 1.013) Million
= `48.624 Million
11. (i) DEF Bank will fix interest rate for 2V3 FRA after 2 years as follows:
XYZ Ltd.
(1+r) (1+0.0420)2 = (1+0.0448)3
(1+r) (1.0420)2 = (1.0448)3
r = 5.04%
Bank will quote 5.04% for a 2V3 FRA.

ABC Ltd.
(1+r) (1+0.0548)2 = (1+0.0578)3
(1+r) (1.0548)2 = (1.0578)3
r = 6.38%
(ii)
4.50% - Allow 5.50%-Exercise
to Lapse
Interest ` 100 crores X 4.50% ` 4.50 crores -
` 100 crores X 5.04% - ` 5.04 crores
Premium (Cost of ` 100 crores X 0.1% ` 0.10 crores ` 0.10 crores
Option)
4.60 crores 5.14 crores
12. Cost of capital by applying Free Cash Flow to Firm (FCFF) Model is as follows:-
FCFF1
Value of Firm = V0 =
K c  gn
Where –
FCFF 1 = Expected FCFF in the year 1
Kc= Cost of capital
gn = Growth rate forever
Thus, ` 500 lakhs = ` 20 lakhs /(Kc-g)
Since g = 5%, then Kc = 9%
Now, let X be the weight of debt and given cost of equity = 12% and cost of debt = 6%,
then 12% (1 – X) + 6% X = 9%
Hence, X = 0.50, so book value weight for debt was 50%
 Correct weight should be 150% of equity and 50% of debt.
 Cost of capital = Kc = 12% (0.75) + 6% (0.25) = 10.50%
and correct firm’s value = ` 20 lakhs/(0.105 – 0.05) = ` 363.64 lakhs.

13. (i) SWAP ratio based on current market prices:

EPS before acquisition:
Mani Ltd. : `2,000 lakhs / 200 lakhs: `10
Ratnam Ltd.: `4,000 lakhs / 1,000 lakhs: ` 4
Market price before acquisition:
Mani Ltd.: `10 × 10 `100
Ratnam Ltd.: `4 × 5 ` 20
SWAP ratio: 20/100 or 1/5 i.e. 0.20
(ii) EPS after acquisition:
`(2,000  4,000) Lakhs
= `15.00
(200  200) Lakhs
(iii) Market Price after acquisition:
EPS after acquisition : `15.00
P/E ratio after acquisition 10 × 0.9 9
Market price of share (` 15 X 9) `135.00
(iv) Market value of the merged Co.:
`135 × 400 lakhs shares ` 540.00 Crores
or ` 54,000 Lakhs
(v) Gain/loss per share: ` Crore
Mani Ltd. Ratnam Ltd.
Total value before Acquisition 200 200
Value after acquisition 270 270
Gain (Total) 70 70
No. of shares (pre-merger) (lakhs) 200 1,000
Gain per share (`) 35 7
14. (a) Exchange Traded Funds (ETFs) were introduced in US in 1993 and came to India
around 2002. ETF is a hybrid product that combines the features of an index mutual
fund and stock and hence, is also called index shares. These funds are listed on the
stock exchanges and their prices are linked to the underlying index. The authorized
participants act as market makers for ETFs.
ETF can be bought and sold like any other stock on stock exchange. In other words,
they can be bought or sold any time during the market hours at prices that are
expected to be closer to the NAV at the end of the day. NAV of an ETF is the value

of the underlying component of the benchmark index held by the ETF plus all accrued
dividends less accrued management fees.
There is no paper work involved for investing in an ETF. These can be bought like
any other stock by just placing an order with a broker.
Some other important features of ETF are as follows:
1. It gives an investor the benefit of investing in a commodity without physically
purchasing the commodity like gold, silver, sugar etc.
2. It is launched by an asset management company or other entity.
3. The investor does not need to physically store the commodity or bear the costs
of upkeep which is part of the administrative costs of the fund.
4. An ETF combines the valuation feature of a mutual fund or unit investment trust,
which can be bought or sold at the end of each trading day for its net asset
value, with the tradability feature of a closed-end fund, which trades throughout
the trading day at prices that may be more or less than its net asset value.
(b) Purchasing Power Parity (PPP): Purchasing Power Parity theory focuses on the
‘inflation – exchange rate’ relationship. There are two forms of PPP theory:-
The ABSOLUTE FORM, also called the ‘Law of One Price’ suggests that “prices of
similar products of two different countries should be equal when measured in a
common currency”. If a discrepancy in prices as measured by a common currency
exists, the demand should shift so that these prices should converge.
The RELATIVE FORM is an alternative version that accounts for the possibility of
market imperfections such as transportation costs, tariffs, and quotas. It suggests that
‘because of these market imperfections, prices of similar products of different countries
will not necessarily be the same when measured in a common currency.’ However, it
states that the rate of change in the prices of products should be somewhat similar
when measured in a common currency, as long as the transportation costs and trade
barriers are unchanged.
The formula for computing the forward rate using the inflation rates in domestic and
foreign countries is as follows:
(1+ iD )
F=S
(1+ iF )
Where F= Forward Rate of Foreign Currency and S= Spot Rate
iD = Domestic Inflation Rate and i F = Inflation Rate in foreign country
Thus PPP theory states that the exchange rate between two countries reflects the
relative purchasing power of the two countries i.e. the price at whic h a basket of goods
can be bought in the two countries.

(c) ‘Reverse Stock Split’ is a process whereby a company decreases the number of
shares outstanding by combining current shares into fewer or lesser number of
shares. For example, in a 5:1 reverse split, a company would take back 5 shares and
will replace them with one share.
Although, reverse stock split does not result in change in Market value or Market
Capitalization of the company but it results in increase in price per share.
Considering above mentioned ratio, if company has 100 million shares outstanding before
split up, the number of shares would be equal to 20 million after the reverse split up.
Reasons for Reverse Split Up
Generally, company carries out reverse split up due to following reasons:
(i) Avoiding delisting from stock exchange: Sometimes as per the stock exchange
regulation if the price of shares of a company goes below a limit it can be
delisted. To avoid such delisting company may resort to reverse stock split up.
(ii) Avoiding removal from constituents of Index: If company’s share its one of the
constituents of market index then to avoid their removal of scrip from this list,
the company may take reverse split up route.
(iii) To avoid the tag of “Penny Stock”: If the price of shares of a company goes below
a limit it may be called “Penny Stock”. In order to improve the image of the
company and avoiding this stage, the company may go for Reverse Stock Split.
(iv) To attract Institutional Investors and Mutual Funds: It might be possible that
institutional investors may be shying away from acquiring low value shares to attract
these investors the company may adopt the route of “Reverse Stock Split” to
increase the price per share.
15. (a) Originator (entity which sells assets collectively to Special Purpose Vehicle) achieves
the following benefits from securitization:
(i) Off – Balance Sheet Financing: When loan/receivables are securitized it
release a portion of capital tied up in these assets resulting in off Balance Sheet
financing leading to improved liquidity position which helps expanding the
business of the company.
(ii) More specialization in main business: By transferring the assets the entity
could concentrate more on core business as servicing of loan is transferred to
SPV. Further, in case of non-recourse arrangement even the burden of default
is shifted.
(iii) Helps to improve financial ratios: Especially in case of Financial Institutions
and Banks, it helps to manage Capital-To-Weighted Asset Ratio effectively.
(iv) Reduced borrowing Cost: Since securitized papers are rated due to credit
enhancement even they can also be issued at reduced rate as of debts and

hence the originator earns a spread, resulting in reduced cost of borrowings.

(b) Some of the parameters to identity the currency risk are as follows:
(i) Government Action: The Government action of any country has visual impact
in its currency. For example, the UK Govt. decision to divorce from European
Union i.e. Brexit brought the pound to its lowest since 1980’s.
(ii) Nominal Interest Rate: As per interest rate parity (IRP) the currency exchange
rate depends on the nominal interest of that country.
(iii) Inflation Rate: Purchasing power parity theory impact the value of currency.
(iv) Natural Calamities: Any natural calamity can have negative impact.
(v) War, Coup, Rebellion etc.: All these actions can have far reaching impact on
currency’s exchange rates.
(vi) Change of Government: The change of government and its attitude towards
foreign investment also helps to identify the currency risk.
(c) Differences between a start-up and entrepreneurship
Startups are different from entrepreneurship. The major differences between them
have been discussed in the following paragraphs:
(i) Start up is a part of entrepreneurship. Entrepreneurship is a broader concept
and it includes a startup firm.
(ii) The main aim of startup is to build a concern, conceptualize the idea which it
has developed into a reality and build a product or service. On the other hand,
the major objective of an already established entrepreneurship concern is to
attain opportunities with regard to the resources they currently control.
(iii) A startup generally does not have a major financial motive whereas an
established entrepreneurship concern mainly operates on financial motive.
Priorities and challenges which start-ups in India are facing
The priority is on bringing more and more smaller firms into existence. So, the focus
is on need based, instead of opportunity based entrepreneurship. Moreover, the trend
is to encourage self-employment rather than large, scalable concerns. The main
challenge with the startup firms is getting the right talent. And, paucity of skilled
workforce can hinder the chances of a startup organization’s growth and
development. Further, startups had to comply with numerous regulations which
escalate its cost. It leads to further delaying the chances of a breakeven or even
earning some amount of profit.

QUESTIONS
Security Valuation
1. Calculate the value of share from the following information:
Profit after tax of the company ` 290 crores
Equity capital of company ` 1,300 crores
Par value of share ` 40 each
Debt ratio of company (Debt/ Debt + Equity) 27%
Long run growth rate of the company 8%
Beta 0.1; risk free interest rate 8.7%
Market returns 10.3%
Capital expenditure per share ` 47
Depreciation per share ` 39
Change in Working capital ` 3.45 per share
2. M/s Agfa Industries is planning to issue a debenture series on the following terms:
Face value ` 100
Term of maturity 10 years
Yearly coupon rate
Years
1−4 9%
5−8 10%
9 − 10 14%
The current market rate on similar debentures is 15 per cent per annum. The Company
proposes to price the issue in such a manner that it can yield 16 per cent compounded rate
of return to the investors. The Company also proposes to redeem the debentures at 5 per
cent premium on maturity. Determine the issue price of the debentures.
3. The distribution of return of security ‘F’ and the market portfolio ‘P’ is given below:
Probability Return %
F P
0.30 30 -10

0.40 20 20
0.30 0 30
You are required to calculate the expected return of security ‘F’ and the market portfolio
‘P’, the covariance between the market portfolio and security and beta for the security.
4. A Portfolio Manager (PM) has the following four stocks in his portfolio:
Security No. of Shares Market Price per share (`) β
VSL 10,000 50 0.9
CSL 5,000 20 1.0
SML 8,000 25 1.5
APL 2,000 200 1.2
Compute the following:
(i) Portfolio beta.
(ii) If the PM seeks to reduce the beta to 0.8, how much risk free investment should he bring
in?
(iii) If the PM seeks to increase the beta to 1.2, how much risk free investment should he
bring in?
Mutual Fund
5. On 01-07-2016, Mr. X Invested ` 50,000/- at initial offer in Mutual Funds at a face value of
` 10 each per unit. On 31-03-2017, a dividend was paid @ 10% and annualized yield was
120%. On 31-03-2018, 20% dividend and capital gain of ` 0.60 per unit was given. Mr. X
redeemed all his 6271.98 units when his annualized yield was 71.50% over the period of
holding. Calculate NAV as on 31-03-2017, 31-03-2018 and 31-03-2019.
For calculations consider a year of 12 months.
Derivatives
6. From the following data for certain stock, find the value of a call option:
Price of stock now = ` 80
Exercise price = ` 75
Standard deviation of continuously compounded annual return = 0.40
Maturity period = 6 months
Annual interest rate = 12%

Given
Number of S.D. from Mean, (z) Area of the left or right (one tail)
0.25 0.4013
0.30 0.3821
0.55 0.2912
0.60 0.2743
e 0.12x0.5= 1.062
In 1.0667 = 0.0646
7. On January 1, 2018 an investor has a portfolio of 5 shares as given below:
Security Price No. of Shares Beta
A 349.30 5,000 1.15
B 480.50 7,000 0.40
C 593.52 8,000 0.90
D 734.70 10,000 0.95
E 824.85 2,000 0.85
The cost of capital to the investor is 10.5% per annum.
You are required to calculate:
(i) The beta of his portfolio.
(ii) The theoretical value of the NIFTY futures for February 2018.
(iii) The number of contracts of NIFTY the investor needs to sell to get a full hedge until
February for his portfolio if the current value of NIFTY is 5900 and NIFTY futures have
a minimum trade lot requirement of 200 units. Assume that the futures are trading at
their fair value.
(iv) The number of future contracts the investor should trade if he desires to reduce the
beta of his portfolios to 0.6.
No. of days in a year be treated as 365.
Given: In (1.105) = 0.0998 and e(0.015858) = 1.01598
8. Followings are the spot exchange rates quoted at three different forex markets:
USD/INR 48.30 in Mumbai
GBP/INR 77.52 in London
GBP/USD 1.6231 in New York

The arbitrageur has USD 1,00,00,000. Assuming that there are no transaction costs,
explain whether there is any arbitrage gain possible from the quoted spot exchange rates.
9. Nitrogen Ltd, a UK company is in the process of negotiating an order amounting to €4
million with a large German retailer on 6 months credit. If successful, this will be the first
time that Nitrogen Ltd has exported goods into the highly competitive German market. The
following three alternatives are being considered for managing the transaction risk before
the order is finalized.
(i) Invoice the German firm in Sterling using the current exchange rate to calculate the
invoice amount.
(ii) Alternative of invoicing the German firm in € and using a forward foreign exchange
contract to hedge the transaction risk.
(iii) Invoice the German first in € and use sufficient 6 months sterling future contracts (to
the nearly whole number) to hedge the transaction risk.
Following data is available:
Spot Rate € 1.1750 - €1.1770/£
6 months forward premium 0.55-0.60 Euro Cents
6 months future contract is currently trading at €1.1760/£
6 months future contract size is £62500
Spot rate and 6 months future rate €1.1785/£
Required:
(a) Calculate to the nearest £ the receipt for Nitrogen Ltd, under each of the three
proposals.
(b) In your opinion, which alternative would you consider to be the most appropriate and
the reason thereof.
10. XYZ Ltd., a company based in India, manufactures very high quality modem furniture and
sells to a small number of retail outlets in India and Nepal. It is facing tough competition.
Recent studies on marketability of products have clearly indicated that the customer is now
more interested in variety and choice rather than exclusivity and exceptional quality. Since
the cost of quality wood in India is very high, the company is reviewing the proposal for
import of woods in bulk from Nepalese supplier.
The estimate of net Indian (`) and Nepalese Currency (NC) cash flows in Nominal terms
for this proposal is shown below:

Net Cash Flow (in millions)

Year 0 1 2 3
NC -25.000 2.600 3.800 4.100
Indian (`) 0 2.869 4.200 4.600
The following information is relevant:
(i) XYZ Ltd. evaluates all investments by using a discount rate of 9% p.a. All Nepalese
customers are invoiced in NC. NC cash flows are converted to Indian (`) at the
forward rate and discounted at the Indian rate.
(ii) Inflation rates in Nepal and India are expected to be 9% and 8% p.a. respectively.
The current exchange rate is ` 1= NC 1.6
Assuming that you are the finance manager of XYZ Ltd., calculate the net present value
(NPV) and modified internal rate of return (MIRR) of the proposal.
You may use following values with respect to discount factor for ` 1 @ 9%.
Present Value Future Value
Year 1 0.917 1.188
Year 2 0.842 1.090
Year 3 0.772 1
11. A Inc. and B Inc. intend to borrow $200,000 and $200,000 in ¥ respectively for a time
horizon of one year. The prevalent interest rates are as follows:
Company ¥ Loan $ Loan
A Inc 5% 9%
B Inc 8% 10%
The prevalent exchange rate is $1 = ¥120.
They entered in a currency swap under which it is agreed that B Inc will pay A Inc @ 1%
over the ¥ Loan interest rate which the later will have to pay as a result of the agreed
currency swap whereas A Inc will reimburse interest to B Inc only to the extent of 9%.
Keeping the exchange rate invariant, quantify the opportunity gain or loss component of
the ultimate outcome, resulting from the designed currency swap.
Corporate Valuation
12. ABC Co. is considering a new sales strategy that will be valid for the next 4 years. They
want to know the value of the new strategy. Following information relating to the year which
has just ended, is available:

Income Statement `
Sales 20,000
Gross margin (20%) 4,000
Administration, Selling & distribution expense (10%) 2,000
PBT 2,000
Tax (30%) 600
PAT 1,400
Balance Sheet Information
Fixed Assets 8,000
Current Assets 4,000
Equity 12,000
If it adopts the new strategy, sales will grow at the rate of 20% per year for three years.
The gross margin ratio, Assets turnover ratio, the Capital structure and the income tax rate
will remain unchanged.
Depreciation would be at 10% of net fixed assets at the beginning of the year.
The Company’s target rate of return is 15%.
Determine the incremental value due to adoption of the strategy.
13. The following information relating to the acquiring Company Abhiman Ltd. and the target
Company Abhishek Ltd. are available. Both the Companies are promoted by Multinational
Company, Trident Ltd. The promoter’s holding is 50% and 60% respectively in Abhiman
Ltd. and Abhishek Ltd.:
Abhiman Ltd. Abhishek Ltd.
Share Capital (`) 200 lakh 100 lakh
Free Reserve and Surplus (`) 800 lakh 500 lakh
Paid up Value per share (`) 100 10
Free float Market Capitalisation (`) 400 lakh 128 lakh
P/E Ratio (times) 10 4
Trident Ltd. is interested to do justice to the shareholders of both the Companies. For the
swap ratio weights are assigned to different parameters by the Board of Directors as
follows:
Book Value 25%
EPS (Earning per share) 50%

Market Price 25%

(a) What is the swap ratio based on above weights?
(b) What is the Book Value, EPS and expected Market price of Abhiman Ltd. after
acquisition of Abhishek Ltd. (assuming P.E. ratio of Abhiman Ltd. remains unchanged
and all assets and liabilities of Abhishek Ltd. are taken over at book value).
(c) Calculate:
(i) Promoter’s revised holding in the Abhiman Ltd.
(ii) Free float market capitalization.
(iii) Also calculate No. of Shares, Earning per Share (EPS) and Book Value (B.V.),
if after acquisition of Abhishek Ltd., Abhiman Ltd. decided to :
(a) Issue Bonus shares in the ratio of 1 : 2; and
(b) Split the stock (share) as ` 5 each fully paid.
14. (a) How financial goals can be balanced vis-à-vis sustainable growth?
(b) What is Value at Risk? Identify its main features.
(c) Explain the factors affecting economic analysis.
15. (a) Discuss briefly the steps in securitization mechanism.
(b) What are some of the innovative ways to finance a start up?
(c) What is the difference between Management Buy Out and Leveraged Buyout? State
the purpose of a leveraged buyout with the help of an example.
` 1,300 crores
1. No. of Shares = = 32.5 Crores
` 40
PAT
EPS =
No.of shares
` 290 crores
EPS = = ` 8.923
32.5 crores
FCFE = Net income – [(1-b) (capex – dep) + (1-b) ( ΔWC )]

FCFE = 8.923 – [(1-0.27) (47-39) + (1-0.27) (3.45)]
= 8.923 – [5.84 + 2.5185] = 0.5645

Cost of Equity = Rf + ß (Rm – Rf)

= 8.7 + 0.1 (10.3 – 8.7) = 8.86%
FCFE(1 + g) 0.5645(1.08) 0.60966
Po = = = = ` 70.89
Ke − g 0.0886 − .08 0.0086
2. The issue price of the debentures will be the sum of present value of interest payments
during 10 years of its maturity and present value of redemption value of debenture.
Years Cash out flow (`) PVIF @ 16% PV
1 9 .862 7.758
2 9 .743 6.687
3 9 .641 5.769
4 9 .552 4.968
5 10 .476 4.76
6 10 .410 4.10
7 10 .354 3.54
8 10 .305 3.05
9 14 .263 3.682
10 14 + 105 = 119 .227 3.178 + 23.835
71.327
Thus the debentures should be priced at ` 71.327
3. Security F
Prob(P) Rf PxRf Deviations of F (Deviation) 2 (Deviations) 2
(Rf – ERf) of F PX
0.3 30 9 13 169 50.7
0.4 20 8 3 9 3.6
0.3 0 0 -17 289 86.7
ER f =17 Var f =141
STDEV σ f = 141 = 11.87

Market Portfolio, P
RM PM Exp. Dev. of P (Dev. of (DeV.) 2 PM (Deviatio Dev. of F x
% Return (RM -ERM ) P) 2 n of F) x Dev. of P)
RM x PM (Deviatio x P
n of P)
-10 0.3 -3 -24 576 172.8 -312 -93.6

20 0.4 8 6 36 14.4 18 7.2

30 0.3 9 16 256 76.8 -272 -81.6
ERM =14 Var M =264 =Co Var PM
σ M =16.25 =- 168
Co Var PM − 168
Beta= = = − .636
σ2 264
M
4.
Security No. of Market Price (1) × (2) % to total (w) ß (x) wx
shares of Per Share
(1) (2)
VSL 10000 50 500000 0.4167 0.9 0.375
CSL 5000 20 100000 0.0833 1 0.083
SML 8000 25 200000 0.1667 1.5 0.250
APL 2000 200 400000 0.3333 1.2 0.400
1200000 1 1.108
Portfolio beta 1.108
(i) Required Beta 0.8
It should become (0.8 / 1.108) 72.2 % of present portfolio
If ` 12,00,000 is 72.20%, the total portfolio should be
` 12,00,000 × 100/72.20 or ` 16,62,050
Additional investment in zero risk should be (` 16,62,050 – ` 12,00,000) = ` 4,62,050
Revised Portfolio will be
Security No. of Market (1) × (2) % to ß (x) wx
shares Price of Per total (w)
(1) Share (2)
VSL 10000 50 500000 0.3008 0.9 0.271
CSL 5000 20 100000 0.0602 1 0.060
SML 8000 25 200000 0.1203 1.5 0.180
APL 2000 200 400000 0.2407 1.2 0.289
Risk free asset 46205 10 462050 0.2780 0 0
1662050 1 0.800

(ii) To increase Beta to 1.2

Required beta 1.2
It should become 1.2 / 1.108 108.30% of present beta
If 1200000 is 108.30%, the total portfolio should be
1200000 × 100/108.30 or 1108033 say 1108030
Additional investment should be (-) 91967 i.e. Divest ` 91970 of Risk Free Asset
Security No. of Market (1) × (2) % to ß (x) wx
shares Price of Per total (w)
(1) Share (2)
VSL 10000 50 500000 0.4513 0.9 0.406
CSL 5000 20 100000 0.0903 1 0.090
SML 8000 25 200000 0.1805 1.5 0.271
APL 2000 200 400000 0.3610 1.2 0.433
Risk free asset -9197 10 -91970 -0.0830 0 0
1108030 1 1.20
Portfolio beta 1.20
5. Yield for 9 months (120% x 9/12) = 90%
Market value of Investments as on 31.03.2017 = ` 50,000/- + (` 50,000x 90%)= ` 95,000/-
Therefore, NAV as on 31.03.2017 = (` 95,000 - ` 5,000)/5,000 = ` 18.00
` 5,000
Since dividend was reinvested by Mr. X, additional units acquired = = 277.78 unit
` 18
Therefore, units as on 31.03.2017 = 5,000 + 277.78 = 5,277.78
Alternatively, units as on 31.03.2017 = (` 95,000/`18) = 5,277.78
Dividend as on 31.03.2018 = 5,277.78 x ` 10 x 0.2 = `10,555.56
Capital Gain (5277.78 x ` 0.60) = ` 3,166.67
= `13,722.23
Let X be the NAV on 31.03.2018, then number of new units reinvested will be
`13,722.23/X.
Accordingly, 6,271.98 units shall consist of reinvested units and 5277.78 (as on
31.03.2017).

Thus, by way of equation it can be shown as follows:

` 13,722.23
6,271.98 = + 5,277.78
X
Therefore, NAV as on 31.03.2018 = ` 13,722.23/(6,271.98 – 5,277.78) = ` 13.80
NAV as on 31.03.2019 = ` 50,000 (1+0.715x33/12)/6,271.98 = `23.656
6. Applying the Black Scholes Formula,
Value of the Call option now:
The Formula C = SN(d1 ) − Ke ( −rt) N(d2 )
In (S/K) + (r + σ 2 / 2)t
d1 =
σ t
d2 = d1 - σ t
Where,
C = Theoretical call premium
S = Current stock price
t = time until option expiration
K = option striking price
r = risk-free interest rate
N = Cumulative standard normal distribution
e = exponential term
σ = Standard deviation of continuously compounded annual return.
In = natural logarithim
In (1.0667) + (12% + 0.08)0.5
d1 =
0.40 0.5
= 0.0646 + (0.2)0.5
0.40 × 0.7071
0.1646
=
0.2828
= 0.5820
d2 = 0.5820 – 0.2828 = 0.2992

N(d1) = N (0.5820)
N(d2) = N (0.2992)
Price = SN(d1 ) − Ke ( −rt) N(d2 )
= 80 x N(d1) – (75/1.062) x N(d2)

Value of option
75
= 80 N(d1) - × N(d2 )
1.062
N(d1) = N (0.5820) = 0.7197
N(d2) = N(0.2992) = 0.6176
75
Price = 80 x 0.7197 – × 0.6176
1.062
= 57.57 – 70.62 x 0.6176
= 57.57 – 43.61
= `13.96
Teaching Notes:
Students may please note following important point:
Values of N(d1) and N(d2) have been computed by interpolating the values of areas under
respective numbers of SD from Mean (Z) given in the question.
It may also be possible that in question paper areas under Z may be mentioned otherwise
e.g. Cumulative Area or Area under Two tails. In such situation the areas of the respective
Zs given in the question will be as follows:
Cumulative Area
Number of S.D. from Mean, (z) Cumulative Area
0.25 0.5987
0.30 0.6179
0.55 0.7088
0.60 0.7257
Two tail area
Number of S.D. from Mean, (z) Area of the left and right (two tail)
0.25 0.8026
0.30 0.7642

0.55 0.5823
0.60 0.5485
7. (i) Calculation of Portfolio Beta
Security Price No. of Value Weightage Beta Weighted
of the shares wi Βi Beta
Stock
A 349.30 5,000 17,46,500 0.093 1.15 0.107
B 480.50 7,000 33,63,500 0.178 0.40 0.071
C 593.52 8,000 47,48,160 0.252 0.90 0.227
D 734.70 10,000 73,47,000 0.390 0.95 0.370
E 824.85 2,000 16,49,700 0.087 0.85 0.074
1,88,54,860 0.849
Portfolio Beta = 0.849
(ii) Calculation of Theoretical Value of Future Contract
Cost of Capital = 10.5% p.a. Accordingly, the Continuously Compounded Rate of
Interest ln (1.105) = 0.0998
For February 2013 contract, t= 58/365= 0.1589
Further F= Sert
F= ` 5,900e(0.0998)(0.1589)
F= ` 5,900e0.015858
F= ` 5,900X1.01598 = ` 5,994.28
Alternatively, it can also be taken as follows:
= ` 5900 e
0.105×58/365
= ` 5900 e
0.01668
= ` 5900 x 1.01682 = ` 5,999.24

(iii) When total portfolio is to be hedged:
Value of Spot Position requiring hedging
× Portfolio Beta
= Value of Future Contract
1,88,54,860
= × 0.849io= 13.35 contracts say 13 or 14 contracts
5994.28 × 200

(iv) When total portfolio beta is to be reduced to 0.6:

P(βP − β P' )
Number of Contracts to be sold = o
F
1,88,54,860 (0.849 - 0.600)
= io= 3.92 contracts say 4 contract
5994.28 × 200
8. The arbitrageur can proceed as stated below to realize arbitrage gains.
(i) Buy ` from USD 10,000,000 at Mumbai 48.30 × 10,000,000 = `483,000,000
` 483,000,000
(ii) Convert these ` to GBP at London ( ) = GBP 6,230,650.155
Rs. 77.52
(iii) Convert GBP to USD at New York GBP 6,230,650.155 × 1.6231 USD 10,112,968.26
There is net gain of USD 10,112968.26 less USD 10,000,000 i.e. USD 112,968.26
9. (i) Receipt under three proposals
(a) Invoicing in Sterling
€ 4 million
Invoicing in £ will produce = = £3398471
1.1770
(b) Use of Forward Contract
Forward Rate = €1.1770+0.0055 = 1.1825
€ 4 million
Using Forward Market hedge Sterling receipt would be = £ 3382664
1.1825
(c) Use of Future Contract
The equivalent sterling of the order placed based on future price (€1.1760)
€ 4.00 million
= = £ 3401360
1.1760
£3401360
Number of Contracts = = 54 Contracts (to the nearest whole number)
62,500
Thus, € amount hedged by future contract will be = 54 × £62,500 = £3375000
Buy Future at €1.1760
Sell Future at €1.1785
€0.0025
Total profit on Future Contracts = 54 × £62,500 × €0.0025 = €8438

After 6 months
Amount Received €4000000
Add: Profit on Future Contracts € 8438
€ 4008438
Sterling Receipts
€ 4008438
On sale of € at spot = = €3401305
1.1785
(ii) Proposal of option (c) is preferable because the option (a) & (b) produces least
receipts.
10. Working Notes:
(i) Computation of Forward Rates
End of Year NC NC/`
1  (1 + 0.09 ) 
NC1.60 x  1.615
 (1 + 0.08 ) 
 
2  (1 + 0.09 ) 
NC1.615 x  1.630
 (1 + 0.08 ) 
 
3  (1 + 0.09 ) 
NC1.630 x  1.645
 (1 + 0.08 ) 
 
(ii) NC Cash Flows converted in Indian Rupees

Year NC (Million) Conversion Rate ` (Million)
0 -25.00 1.600 -15.625
1 2.60 1.615 1.61
2 3.80 1.630 2.33
3 4.10 1.645 2.49
Net Present Value
(` Million)
Year Cash Flow in India Cash Flow in Nepal Total PVF PV
@ 9%
0 --- -15.625 -15.625 1.000 -15.625
1 2.869 1.61 4.479 0.917 4.107

2 4.200 2.33 6.53 0.842 5.498

3 4.600 2.49 7.09 0.772 5.473
-0.547
Modified Internal Rate of Return
Year
0 1 2 3
Cash Flow (` Million) -15.625 4.479 6.53 7.09
Year 1 Cash Inflow reinvested for 2 years 5.32
(1.188 x 4.479)
Year 2 Cash Inflow reinvested for 1 years 7.12
(1.090 x 6.53)
19.53
TerminalCashFlow 19.53
MIRR = n −1= 3 − 1 = 0.0772 say 7.72%
InitialOutlay 15.625
11.
Opportunity gain of A Inc under currency Receipt Payment Net
swap
Interest to be remitted to B. Inc in
$ 2,00,000х9%=$18,000 ¥21,60,000
Converted into ($18,000 х ¥120)
Interest to be received from B. Inc in $ ¥14,40,000 -
converted into Y (6%х$2,00,000 х ¥120)
Interest payable on Y loan - ¥12,00,000
¥14,40,000 ¥33,60,000
Net Payment ¥19,20,000 -
¥33,60,000 ¥33,60,000
$ equivalent paid ¥19,20,000 х(1/¥120) $16,000
Interest payable without swap in $ $18,000
Opportunity gain in $ $ 2,000
Opportunity gain of B Inc under currency swap Receipt Payment Net

Interest to be remitted to A Inc in ($ 2,00,000 х 6%) $12,000

Interest to be received from A. Inc in Y converted $18,000

into $ =¥21,60,000/¥120
Interest payable on $ loan@10% - $20,000
$18,000 $32,000
Net Payment $14,000 -
$32,000 $32,000
Y equivalent paid $14,000 X ¥120 ¥16,80,000
Interest payable without swap in ¥ ($2,00,000X¥120X8%) ¥19,20,000
Opportunity gain in Y ¥ 2,40,000
Alternative Solution
Cash Flows of A Inc
(i) At the time of exchange of principal amount
Transactions Cash Flows
Borrowings $2,00,000 x ¥120 + ¥240,00,000
Swap - ¥240,00,000
Swap +$2,00,000
Net Amount +$2,00,000
(ii) At the time of exchange of interest amount
Interest to the lender ¥240,00,000X5% ¥12,00,000
Interest Receipt from B Inc. ¥2,00,000X120X6% ¥14,40,000
Net Saving (in $) ¥2,40,000/¥120 $2,000
Interest to B Inc. $2,00,000X9% -$18,000
Net Interest Cost -$16,000
A Inc. used $2,00,000 at the net cost of borrowing of $16,000 i.e. 8%. If it had not
opted for swap agreement the borrowing cost would have been 9%. Thus there is
saving of 1%.
Cash Flows of B Inc
Borrowings + $2,00,000
Swap - $2,00,000

Swap $2,00,000X¥120 +¥240,00,000

Net Amount +¥240,00,000
Interest to the lender $2,00,000X10% - $20,000
Interest Receipt from A Inc. +$18,000
Net Saving (in ¥) -$2,000X¥120 - ¥2,40,000
Interest to A Inc. $2,00,000X6%X¥120 - ¥14,40,000
Net Interest Cost - ¥16,80,000
B Inc. used ¥240,00,000 at the net cost of borrowing of ¥16,80,000 i.e. 7%. If it had
not opted for swap agreement the borrowing cost would have been 8%. Thus there is
saving of 1%.
12.
Projected Balance Sheet
Year 1 Year 2 Year 3 Year 4
Fixed Assets (40% of Sales) 9,600 11,520 13,824 13,824
Current Assets (20% of Sales) 4,800 5,760 6,912 6,912
Total Assets 14,400 17,280 20,736 20,736
Equity 14,400 17,280 20,736 20,736
Projected Cash Flows:-
Year 1 Year 2 Year 3 Year 4
Sales 24,000 28,800 34,560 34,560
PBT (10% of sale) 2,400 2,880 3,456 3,456
PAT (70%) 1,680 2,016 2,419.20 2,419.20
Depreciation 800 960 1,152 1,382
Addition to Fixed Assets 2,400 2,880 3,456 1,382
Increase in Current Assets 800 960 1,152 -
Operating cash flow (FCFF) (720) (864) (1,036.80) 2,419.20
Projected Cash Flows:-
Present value of Projected Cash Flows:-
Cash Flows PVF at 15% PV
-720 0.870 -626.40

-864 0.756 -653.18

-1,036.80 0.658 -682.21
-1,961.79
Residual Value - 2419.20/0.15 = 16,128
Present value of Residual value = 16128/(1.15)3
= 16128/1.521 = 10603.55
Total shareholders’ value = 10,603.55 – 1,961.79 = 8,641.76
Pre strategy value = 1,400 / 0.15 = 9,333.33
∴ Value of strategy = 8,641.76 – 9,333.33 = – 691.57
Conclusion: The strategy is not financially viable.

13. (a) Swap Ratio
Abhiman Ltd. Abhishek Ltd.
Share Capital 200 Lakh 100 Lakh
Free Reserves 800 Lakh 500 Lakh
Total 1000 Lakh 600 Lakh
No. of Shares 2 Lakh 10 Lakh
Book Value per share ` 500 ` 60
Promoter’s holding 50% 60%
Non promoter’s holding 50% 40%
Free Float Market Cap. i.e. 400 Lakh 128 Lakh
relating to Public’s holding
Hence Total market Cap. 800 Lakh 320 Lakh
No. of Shares 2 Lakh 10 Lakh
Market Price ` 400 ` 32
P/E Ratio 10 4
EPS 40 8
Profits (` 2 X 40 lakh) ` 80 lakh -
(` 8 X 10 lakh) - ` 80 lakh
Calculation of Swap Ratio
Book Value 1 : 0.12 i.e. 0.12 x 25% 0.03

EPS 1 : 0.2 0.20 x 50% 0.10

Market Price 1 : 0.08 0.08 x 25% 0.02
Total 0.15
Swap ratio is for every one share of Abhishek Ltd., to issue 0.15 shares of Abhiman
Ltd. Hence total no. of shares to be issued
= 10 Lakh x 0.15 = 1.50 lakh shares
(b) Book Value, EPS & Market Price
Total No of Shares 2 Lakh + 1.5 Lakh = 3.5 Lakh
Total Capital ` 200 Lakh + ` 150 Lakh = ` 350 Lakh
Reserves ` 800 Lakh + ` 450 Lakh = ` 1,250 Lakh
Book Value ` 350 Lakh + ` 1,250 Lakh = ` 457.14 per share
3.5 Lakh
Total Profit ` 80 Lakh + ` 80 Lakh ` 160 Lakh
EPS = = = ` 45.71
No. of Share 3.5 Lakh 3.5
Expected Market Price EPS (` 45.71) x P/E Ratio (10) = ` 457.10
(c) (1) Promoter’s holding
Promoter’s Revised Abhiman 50% i.e. 1.00 Lakh shares
Holding Abhishek 60% i.e. 0.90 Lakh shares
Total 1.90 Lakh shares
Promoter’s % = 1.90/3.50 x 100 = 54.29%
(2) Free Float Market Capitalisation
Free Float Market = (3.5 Lakh – 1.9 Lakh) x ` 457.10
Capitalisation = ` 731.36 Lakh
(3) (i) & (ii)
Revised Capital ` 350 Lakh + ` 175 Lakh = ` 525 Lakh
No. of shares before Split (F.V ` 100) 5.25 Lakh
No. of Shares after Split (F.V. ` 5 ) 5.25 x 20 = 105 Lakh
EPS 160 Lakh / 105 Lakh = 1.523
Book Value Cap. ` 525 Lakh + ` 1075 Lakh
105 Lakh
= ` 15.238 per share

14. (a) The concept of sustainable growth can be helpful for planning healthy corporate
growth. This concept forces managers to consider the financial consequences of
sales increases and to set sales growth goals that are consistent with the operating
and financial policies of the firm. Often, a conflict can arise if growth objectives are
not consistent with the value of the organization's sustainable growth. Question
concerning right distribution of resources may take a difficult shape if we take into
consideration the rightness not for the current stakeholders but for the future
stakeholders also. To take an illustration, let us refer to fuel industry where resources
are limited in quantity and a judicial use of resources is needed to cater to the need
of the future customers along with the need of the present customers. One may have
noticed the save fuel campaign, a demarketing campaign that deviates from the usual
approach of sales growth strategy and preaches for conservation of fuel for their use
across generation. This is an example of stable growth strategy adopted by the oil
industry as a whole under resource constraints and the long run objective of survival
over years. Incremental growth strategy, profit strategy and pause strategy are other
variants of stable growth strategy.
Sustainable growth is important to enterprise long-term development. Too fast or too
slow growth will go against enterprise growth and development, so financial should
play important role in enterprise development, adopt suitable financial policy initiative
to make sure enterprise growth speed close to sustainable growth ratio and have
sustainable healthy development.
(b) VAR is a measure of risk of investment. Given the normal market condition in a set
of period, say, one day it estimates how much an investment might lose. This
investment can be a portfolio, capital investment or foreign exchange etc., VAR
answers two basic questions -
(i) What is worst case scenario?
(ii) What will be loss?
It was first applied in 1922 in New York Stock Exchange, entered the financial world
in 1990s and become world’s most widely used measure of financial risk.
Following are main features of VAR
(i) Components of Calculations: VAR calculation is based on following three
components:
(a) Time Period
(b) Confidence Level – Generally 95% and 99%
(c) Loss in percentage or in amount
(ii) Statistical Method: It is a type of statistical tool based on Standard Deviation.

(iii) Time Horizon: VAR can be applied for different time horizons say one day, one
week, one month and so on.
(iv) Probability: Assuming the values are normally attributed, probability of maximum
loss can be predicted.
(v) Control Risk: Risk can be controlled by selling limits for maximum loss.
(vi) Z Score: Z Score indicates how many standard Deviations is away from Mean
value of a population. When it is multiplied with Standard Deviation it provides
VAR.
(c) Some of the factors affecting economic analysis are discussed as under:
(i) Growth Rates of National Income and Related Measures: For most purposes,
what is important is the difference between the nominal growth rate quoted by
GDP and the ‘real’ growth after taking inflation into account. The estimated
growth rate of the economy would be a pointer to the prospects for the industrial
sector, and therefore to the returns investors can expect from investment in
shares.
(ii) Growth Rates of Industrial Sector: This can be further broken down into
growth rates of various industries or groups of industries if required. The growth
rates in various industries are estimated based on the estimated demand for its
products.
(iii) Inflation: Inflation is measured in terms of either wholesale prices (the
Wholesale Price Index or WPI) or retail prices (Consumer Price Index or CPI).
The demand in some industries, particularly the consumer products industries,
is significantly influenced by the inflation rate. Therefore, firms in these
industries make continuous assessment about inflation rates likely to prevail in
the near future so as to fine-tune their pricing, distribution and promotion policies
to the anticipated impact of inflation on demand for their products.
(iv) Monsoon: Because of the strong forward and backward linkages, monsoon is
of great concern to investors in the stock market too.
15. (a) The various steps in securitization mechanism are discussed as below:
Creation of Pool of Assets
The process of securitization begins with creation of pool of assets by segregation of
assets backed by similar type of mortgages in terms of interest rate, risk, maturity and
concentration units.
Transfer to SPV
One assets have been pooled, they are transferred to Special Purpose Vehicle (SPV)
especially created for this purpose.

Sale of Securitized Papers

SPV designs the instruments based on nature of interest, risk, tenure etc. based on
pool of assets. These instruments can be Pass Through Security or Pay Through
Certificates, (discussed later).
Administration of assets
The administration of assets in subcontracted back to originator which collects
principal and interest from underlying assets and transfer it to SPV, which works as
a conduct.
Recourse to Originator
Performance of securitized papers depends on the performance of underlying assets
and unless specified in case of default they go back to originator from SPV.
Repayment of funds
SPV will repay the funds in form of interest and principal that arises from the assets
pooled.
Credit Rating to Instruments
Sometime before the sale of securitized instruments credit rating can be done to
assess the risk of the issuer.
(b) Some of the innovative steps to finance a startup are as follows:
(i) Personal financing. It may not seem to be innovative but you may be surprised
to note that most budding entrepreneurs never thought of saving any money to
start a business. This is important because most of the investors will not put
money into a deal if they see that you have not contributed any money from your
personal sources.
(ii) Personal credit lines. One qualifies for personal credit line based on one’s
personal credit efforts. Credit cards are a good example of this. However, banks
are very cautious while granting personal credit lines. They provide this facility
only when the business has enough cash flow to repay the line of credit.
(iii) Family and friends. These are the people who generally believe in you, without
even thinking that your idea works or not. However, the loan obligations to
friends and relatives should always be in writing as a promissory note or
otherwise.
(iv) Peer-to-peer lending. In this process group of people come together and lend
money to each other. Peer to peer to lending has been there for many years.
Many small and ethnic business groups having similar faith or interest generally
support each other in their start up endeavors.

(v) Crowdfunding. Crowdfunding is the use of small amounts of capital from a large
number of individuals to finance a new business initiative. Crowdfunding makes
use of the easy accessibility of vast networks of people through social
media and crowdfunding websites to bring investors and entrepreneurs
together.
(vi) Microloans. Microloans are small loans that are given by individuals at a lower
interest to a new business ventures. These loans can be issued by a single
individual or aggregated across a number of individuals who each contribute a
portion of the total amount.
(vii) Vendor financing. Vendor financing is the form of financing in which a company
lends money to one of its customers so that he can buy products from the
company itself. Vendor financing also takes place when many manufacturers
and distributors are convinced to defer payment until the goods are sold. This
means extending the payment terms to a longer period for e.g. 30 days payment
period can be extended to 45 days or 60 days. However, this depends on one’s
credit worthiness and payment of more money.
(viii) Purchase order financing. The most common scaling problem faced by
startups is the inability to find a large new order. The reason is that they don’t
have the necessary cash to produce and deliver the product. Purchase order
financing companies often advance the required funds directly to the supplier.
This allows the transaction to complete and profit to flow up to the new business.
(ix) Factoring accounts receivables. In this method, a facility is given to the seller
who has sold the good on credit to fund his receivables till the amount is fully
received. So, when the goods are sold on credit, and the credit period (i.e. the
date upto which payment shall be made) is for example 6 months, factor will pay
most of the sold amount up front and rest of the amount later. Therefore, in this
way, a startup can meet his day to day expenses.
(c) The difference between Management Buy Outs and Leveraged Buy Outs has been
discussed as below:
Management Buy Outs
Buyouts initiated by the management team of a company are known as a
management buyout. In this type of acquisition, the company is bought by its own
management team.
MBOs are considered as a useful strategy for exiting those divisions that does not
form part of the core business of the entity.
Leveraged Buyout (LBO)
An acquisition of a company or a division of another company which is financed
entirely or partially (50% or more) using borrowed funds is termed as a leveraged

buyout. The target company no longer remains public after the leveraged buyout;
hence the transaction is also known as going private. The deal is usually secured by
the acquired firm’s physical assets.
The intention behind an LBO transaction is to improve the operational efficiency of a
firm and increase the volume of its sales, thereby increasing the cash flow of the firm.
This extra cash flow generated will be used to pay back the debt in LBO transaction.
After an, LBO the target entity is managed by private investors, which makes it easier
to have a close control of its operational activities. The LBOs do not stay permanent.
Once the LBO is successful in increasing its profit margin and improving its
operational efficiency and the debt is paid back, it will go public again. Companies
that are in a leading market position with proven demand for product, have a strong
management team, strong relationships with key customers and suppliers and steady
growth are likely to become the target for LBOs. In India the first LBO took place in
the year 2000 when Tata Tea acquired Tetley in the United Kingdom. The deal value
was ` 2135 crores out of which almost 77% was financed by the company using debt.
The intention behind this deal was to get direct access to Tetley’s international
market. The largest LBO deal in terms of deal value (7.6 Billion) by an Indian company
is the buyout of Corus by Tata Steel.

QUESTIONS
Security Valuation
1. Today being 1 st January 2019, Ram is considering to purchase an outstanding Corporate
Bond having a face value of ` 1,000 that was issued on 1st January 2017 which has 9.5%
Annual Coupon and 20 years of original maturity (i.e. maturing on 31st December 2027).
Since the bond was issued, the interest rates have been on downside and it is now
selling at a premium of ` 125.75 per bond.
Determine the prevailing interest on the similar type of Bonds if it is held till the maturity
which shall be at Par.
PV Factors:
1 2 3 4 5 6 7 8 9
6% 0.943 0.890 0.840 0.792 0.747 0.705 0.665 0.627 0.592
8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500
2. The following data is available for NNTC bond:
Face value: ` 1000
Coupon rate: 7.50%
Years to maturity = 8 years
Redemption Value: ` 1000
YTM: 8%
Calculate:
(i) The current market price, duration and volatility of the bond.
(ii) The expected market price if the decrease in required yield by 50 bps.
3. A study by a Mutual fund has revealed the following data in respect of three securities:
Security σ (%) Correlation with
Index, Pm
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 of each stock with respect to the market?
(ii) What are the covariances among the various stocks?
(iii) What would be the risk of portfolio consisting of all the three stocks 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) ?
4. Mr. Abhishek is interested in investing ` 2,00,000 for which he is considering following
three alternatives:
(i) Invest ` 2,00,000 in Mutual Fund X (MFX)
(ii) Invest ` 2,00,000 in Mutual Fund Y (MFY)
(iii) Invest ` 1,20,000 in Mutual Fund X (MFX) and ` 80,000 in Mutual Fund Y (MFY)
Average annual return earned by MFX and MFY is 15% and 14% respectively. Risk free
rate of return is 10% and market rate of return is 12%.
Covariance of returns of MFX, MFY and market portfolio Mix are as follow:
MFX MFY Mix
MFX 4.800 4.300 3.370
MFY 4.300 4.250 2.800
Mix 3.370 2.800 3.100
(i) variance of return from MFX, MFY and market return,
(ii) portfolio return, beta, portfolio variance and portfolio standard deviation,
(ill) expected return, systematic risk and unsystematic risk; and
(iv) Sharpe ratio, Treynor ratio and Alpha of MFX, MFY and Portfolio Mix
Mutual Fund
5. There are two Mutual Funds viz. D Mutual Fund Ltd. and K Mutual Fund Ltd. Each having
close ended equity schemes.
NAV as on 31-12-2019 of equity schemes of D Mutual Fund Ltd. is ` 70.71 (consisting
99% equity and remaining cash balance) and that of K Mutual Fund Ltd. is 62.50
(consisting 96% equity and balance in cash).


Equity Schemes
Particular
Sharpe Ratio 2 3.3
Treynor Ratio 15 15
There is no change in portfolios during the next month and annual average cost is ` 3
per unit for the schemes of both the Mutual Funds.
If Share Market goes down by 5% within a month, calculate expected NAV after a month
for the schemes of both the Mutual Funds.
For calculation, consider 12 months in a year and ignore number of days for particular
month.
Derivatives
6. Mr. SG sold five 4-Month Nifty Futures on 1 st February 2020 for ` 9,00,000. At the time of
closing of trading on the last Thursday of May 2020 (expiry), Index turned out to be 2100.
The contract multiplier is 75.
Based on the above information calculate:
(i) The price of one Future Contract on 1 st February 2020.
(ii) Approximate Nifty Sensex on 1 st February 2020 if the Price of Future Contract on
same date was theoretically correct. On the same day Risk Free Rate of Interest
and Dividend Yield on Index was 9% and 6% p.a. respectively.
(iii) The maximum Contango/ Backwardation.
(iv) The pay-off of the transaction.
Note: Carry out calculation on month basis.
7. A Rice Trader has planned to sell 22000 kg of Rice after 3 months from now. The spot
price of the Rice is ` 60 per kg and 3 months Future on the same is trading at ` 59 per
kg. Size of the contract is 1000 kg. The price is expected to fall as low as ` 56 per kg, 3
months hence.
Required:
(i) to interpret the position of trader in the Cash Market.
(ii) to advise the trader the trader should take in Future Market to mitigate its risk of
reduced profit.

(iii) to demonstrate effective realized price for its sale if he decides to make use of
future market and after 3 months, spot price is ₹ 57 per kg and future contract price
for closing the contract is ₹ 58 per kg.
8. Citi Bank quotes JPY/ USD 105.00 -106.50 and Honk Kong Bank quotes USD/JPY
0.0090- 0.0093.
(a) Are these quotes identical if not then how they are different?
(b) Is there a possibility of arbitrage?
(c) If there is an arbitrage opportunity, then show how would you make profit from the
given quotation in both cases if you are having JPY 1,00,000 or US$ 1,000.
9. (a) Given:
US$ 1 = ¥ 107.31
£ 1 = US$ 1.26
A$ 1 = US$ 0.70
(i) Calculate the cross rate for Pound in Yen terms
(ii) Calculate the cross rate for Australian Dollar in Yen terms
(iii) Calculate the cross rate for Pounds in Australian Dollar terms
(b) The current spot exchange rate is $1.35/£ and the three-month forward rate is
$1.30/£. According to your analysis of the exchange rate, you are quite confident
that the spot exchange rate will be $1.32/£ after 3 months.
(i) Suppose you want to speculate in the forward market then what course of
action would be required and what is the expected dollar Profit (Loss) from this
speculation?
(ii) What would be your Profit (Loss) in Dollar terms on the position taken as per
your speculation if the spot exchange rate turns out to be $1.26/£.
Assume that you would like to buy or sell £1,000,000.
10. Suppose you are a treasurer of XYZ plc in the UK. XYZ have two overseas subsidiaries,
one is based in Amsterdam and another in Switzerland. The surplus position of funds in
hand is as follows which it does not need for the next three months but will be needed at
the end of that period (91 days).
Holding Company £ 150,000
Swiss Subsidiary CHF 1,996,154
Dutch Subsidiary € 1,450,000

Exchange Rate as on date are as follows:

Spot Rate (€) £0.6858 - 0.6869
91 day Pts 0.0037 0.0040
Spot Rate (£) CHF 2.3295 - 2.3326
91 day Pts 0.0242 0.0228
91-Day Interest rates on p.a. basis on the Deposits in Money Market are as follows:
Amount of Currency £ € CHF
0 – 200,000 1.00 0.25 Nil
200,001 – 1,000,000 2.00 1.50 0.25
1,000,001 – 2,000,000 4.00 2.00 0.50
Over 2,000,000 5.38 3.00 1.00
You have been approached by your banker wherein the above-mentioned surplus was
lying, requesting you to swap the surplus lying with other two subsidiaries and place
them in deposit with them.
Determine the minimum interest rate per annuam (upto 3 decimal points) that should be
offered by the bank to your organization so that your organization is ready to undertake
such swap arrangement.
Note: Consider 360 days a year.
11. Two companies ABC Ltd. and XYZ Ltd. approach the DEF Bank for FRA (Forward Rate
Agreement). They want to borrow a sum of ` 100crores after 2 years for a period of 1
year. Bank has calculated Yield Curve of both companies as follows:
Year XYZ Ltd. ABC Ltd.*
1 3.86 4.12
2 4.20 5.48
3 4.48 5.78
*The difference in yield curve is due to the lower credit rating of ABC Ltd. compared to
XYZ Ltd.
(i) You are required to calculate the rate of interest DEF Bank would quote under 2V3
FRA, using the company’s yield information as quoted above.
(ii) Suppose bank offers Interest Rate Guarantee for a premium of 0.1% of the amount
of loan, you are required to calculate the interest payable by XYZ Ltd. if interest rate
in 2 years turns out to be

(a) 4.50%
(b) 5.50%
Corporate Valuation
12. Following information is given in respect of WXY Ltd., which is expected to grow at a rate
of 20% p.a. for the next three years, after which the growth rate will stabilize at 8% p.a.
normal level, in perpetuity.
For the year ended March 31, 2014
Revenues ` 7,500 Crores
Cost of Goods Sold (COGS) ` 3,000 Crores
Operating Expenses ` 2,250 Crores
Capital Expenditure ` 750 Crores
Depreciation (included in Operating ` 600 Crores
Expenses)
During high growth period, revenues & Earnings before Interest & Tax (EBIT) will grow at
20% p.a. and capital expenditure net of depreciation will grow at 15% p.a. From year 4
onwards, i.e. normal growth period revenues and EBIT will grow at 8% p.a. and
incremental capital expenditure will be offset by the depreciation. During both high
growth & normal growth period, net working capital requirement will be 25% of revenues.
The Weighted Average Cost of Capital (WACC) of WXY Ltd. is 15%.
Corporate Income Tax rate will be 30%.
Required:
Estimate the value of WXY Ltd. using Free Cash Flows to Firm (FCFF) & WACC
methodology.
The PVIF @ 15 % for the three years are as below:
Year t1 t2 t3
PVIF 0.8696 0.7561 0.6575
13. The following is the Balance-sheet of Grape Fruit Company Ltd as at March 31 st , 2019.
Liabilities (` in lakhs) Assets (` in lakhs)
Equity shares of ` 100 each 600 Land and Building 200
14% preference shares of 200 Plant and Machinery 300
` 100/- each
13% Debentures 200 Furniture and Fixtures 50
Debenture interest accrued 26 Inventory 150
and payable

Loan from bank 74 Sundry debtors 70

Trade creditors 340 Cash at bank 130
Preliminary expenses 10
Cost of issue of 5
debentures
Profit and Loss account 525
1440 1440
The Company did not perform well and has suffered sizable losses during the last few
years. However, it is felt that the company could be nursed back to health by proper
financial restructuring. Consequently the following scheme of reconstruction has been
drawn up :
(i) Equity shares are to be reduced to ` 25/- per share, fully paid up;
(ii) Preference shares are to be reduced (with coupon rate of 10%) to equal number of
shares of ` 50 each, fully paid up.
(iii) Debenture holders have agreed to forgo the accrued interest due to them. In the
future, the rate of interest on debentures is to be reduced to 9 percent.
(iv) Trade creditors will forego 25 percent of the amount due to them.
(v) The company issues 6 lakh of equity shares at ` 25 each and the entire sum was to
be paid on application. The entire amount was fully subscribed by promoters.
(vi) Land and Building was to be revalued at ` 450 lakhs, Plant and Machinery was to
be written down by ` 120 lakhs and a provision of `15 lakhs had to be made for bad
and doubtful debts.
Required:
(i) Show the impact of financial restructuring on the company’s activities.
(ii) Prepare the fresh balance sheet after the reconstructions is completed on the basis
of the above proposals.
14. (a) Explain key decisions that fall within the scope of financial strategy.
(b) What is Financial Risk? How it can be evaluated from point of views.
(c) Explain various “Market Indicators”.
15. (a) Discuss briefly the problems faced in the growth of Securitization of Instruments in
Indian context.
(b) Explain the methods in which a Stratup firm can bootstrap.
(c) Explain the difference between Forward and Future Contract.

1. To determine the prevailing rate of interest for the similar type of Bonds we shall compute
the YTM of this Bond using IRR method as follows:
M = ` 1000
Interest = ` 95 (0.095 x ` 1000)
n = 9 years
V0 = ` 1125.75 (` 1,000 + ` 125.75)
YTM can be determined from the following equation
` 95 × PVIFA (YTM, 9) + ` 1000 × PVIF (YTM, 9) = ` 1125.75
Let us discount the cash flows using two discount rates 8% and 10% as follows:
Year Cash Flows PVF@6% PV@6% PVF@8% PV@8%
0 -1125.75 1 -1125.75 1 -1125.75
1 95 0.943 89.59 0.926 87.97
2 95 0.890 84.55 0.857 81.42
3 95 0.840 79.80 0.794 75.43
4 95 0.792 75.24 0.735 69.83
5 95 0.747 70.97 0.681 64.70
6 95 0.705 66.98 0.630 59.85
7 95 0.665 63.18 0.583 55.39
8 95 0.627 59.57 0.540 51.30
9 1095 0.592 648.24 0.500 547.50
112.37 -32.36
Now we use interpolation formula
112.37
6.00% +  2.00%
112.37 - (- 32.36)
112.37
6.00% +  2.00% =6.00% + 1.553%
144.73
YTM = 6.553% say 6.55%
Thus, prevailing interest rate on similar type of Bonds shall be approx. 6.55%.

2. (i) Current Market Price of Bond shall be computed as follows:

Year Cash Flows PVF@ 8% PV@8%
1 75 0.926 69.45
2 75 0.857 64.28
3 75 0.794 59.55
4 75 0.735 55.13
5 75 0.681 51.08
6 75 0.630 47.25
7 75 0.583 43.73
8 1075 0.540 580.50
970.97
Thus, the current market price of the Bond shall be ` 970.97.
Alternatively, using the Short-cut method the Market Price of Bond can also be
computed as follows:
Interest+(Discount/Premium)/ Years to maturity
(Face Value + market Value)/2
Let market price be X
0.08 = 75 + (1000-X)/8
(1000+X)/2
Thus, Value of X i.e. the price of Bond shall be ` 969.70
For the duration of the bond, we have to see the future cash flow and discount them
as follows:
Year CF PV@8% DCF Proportion Prop* Time (Yrs)
1 75 0.926 69.45 0.071 0.071
2 75 0.857 64.28 0.066 0.132
3 75 0.794 59.55 0.061 0.183
4 75 0.735 55.13 0.057 0.228
5 75 0.681 51.08 0.053 0.265
6 75 0.630 47.25 0.049 0.294
7 75 0.583 43.73 0.045 0.315
8 1075 0.540 580.50 0.598 4.784
Total 970.97 1.000 6.272

Volatility of the bond = Duration / (1+ Yield) = 6.272/1.08 = 5.81

(ii) If there is decrease in required yield by 50 bps the expected market price of the
Bond shall be increased by:
= ` 970.97  0.50 (5.81/100) = ` 28.21
Hence expected market price is ` 970.97 + ` 28.21 = ` 999.18
Alternatively, this portion using Bond Price as per Short-cut method can also be
computed as follows:
= ` 969.70  0.50 (5.81/100) = ` 28.17
then the market price will be = ` 969.70 + ` 28.17 = ` 997.87
3. (i) Sensitivity of each stock with market is given by its beta.
Standard deviation of market Index = 15%
Variance of market Index = 0.0225
Beta of stocks = σ i r/ σ m
A = 20 × 0.60/15 = 0.80
B = 18 × 0.95/15 = 1.14
C = 12 × 0.75/15 = 0.60
(ii) Covariance between any 2 stocks = β1β 2 σ 2m
Covariance matrix
Stock/Beta 0.80 1.14 0.60
A 400.000 205.200 108.000
B 205.200 324.000 153.900
C 108.000 153.900 144.000
(iii) Total risk of the equally weighted portfolio (Variance) = 400(1/3) 2 + 324(1/3) 2 +
144(1/3) 2 + 2 (205.20)(1/3) 2 + 2(108.0)(1/3) 2 + 2(153.900) (1/3) 2 = 200.244
0.80  1.14  0.60
(iv) β of equally weighted portfolio = β p =  β i/N =
3
= 0.8467
(v) Systematic Risk β P2 σ m2 = (0.8467) 2 (15) 2 =161.302
Unsystematic Risk = Total Risk – Systematic Risk
= 200.244 – 161.302 = 38.942

4. (i) Variance of Returns

Cov (i, j)
Cor i,j =
σ iσ j
Accordingly, for MFX
Cov (X, X)
1=
σXσX
σ 2X = 4.800
Accordingly, for MFY
Cov (Y, Y)
1=
σYσY
σ 2Y = 4.250
Accordingly, for Market Return
Cov (M,M)
1=
σMσM
σ M2 = 3.100
(ii) Portfolio return, beta, variance and standard deviation
1,20,000
Weight of MFX in portfolio = =0.60
2,00,000
80,000
Weight of MFY in portfolio = =0.40
2,00,000
Accordingly Portfolio Return
0.60 × 15% + 0.40 × 14% = 14.60%
Beta of each Fund
Cov Fund,Market
β
Variance of Market
3.370
β  = 1.087
X 3.100
2.800
β  = 0.903
Y 3.100

Portfolio Beta
0.60 x 1.087 + 0.40 x 0.903 = 1.013
Portfolio Variance
σ 2XY = w 2X σ 2X + w 2Y σ 2Y + 2 w X w YCov X,Y
= (0.60) 2 (4.800) + (0.40) 2 (4.250) + 2(0.60) (0.40) (4.300)
= 4.472
Or Portfolio Standard Deviation
σ XY = 4.472 = 2.115
(iii) Expected Return, Systematic and Unsystematic Risk of Portfolio
Portfolio Return = 10% + 1.0134(12% - 10%) = 12.03%
MF X Return = 10% + 1.087(12% - 10%) = 12.17%
MF Y Return = 10% + 0.903(12% - 10%) = 11.81%
Systematic Risk = β 2σ2
Accordingly,
Systematic Risk of MFX = (1.087) 2 x 3.10 = 3.663
Systematic Risk of MFY = (0.903) 2 x 3.10 = 2.528
Systematic Risk of Portfolio = (1.013) 2 x 3.10 = 3.181
Unsystematic Risk = Total Risk – Systematic Risk
Accordingly,
Unsystematic Risk of MFX = 4.80 – 3.663 = 1.137
Unsystematic Risk of MFY = 4.250 – 2.528 = 1.722
Unsystematic Risk of Portfolio = 4.472 – 3.181 = 1.291
(iv) Sharpe and Treynor Ratios and Alpha
Sharpe Ratio
15% - 10%
MFX = = 2.282
4.800
14% - 10%
MFY = = 1.94
4.250

14.6% - 10%
Portfolio = = 2.175
2.115
Treynor Ratio
15% - 10%
MFX = = 4.60
1.087
14% - 10%
MFY = = 4.43
0.903
14.6% - 10%
Portfolio = = 4.54
1.0134
Alpha
MFX = 15% - 12.17% = 2.83%
MFY = 14% - 11.81% = 2.19%
Portfolio = 14.6% - 12.03% = 2.57%
5. Working Notes:
(i) Decomposition of Funds in Equity and Cash Components
NAV on 31.12.19 ` 70.71 ` 62.50
% of Equity 99% 96%
(ii) Calculation of Beta
E(R) - R f E(R) - Rf
σD 11.25
E(R) - Rf = 22.50
E(R) - R f 22.50
βD βD
βD = 22.50/15= 1.50


E(R) - R f E(R) - Rf
σK 5
E(R) - Rf = 16.50
E(R) - R f 16.50
βK βK
βK = 16.50/15= 1.10
(iii) Decrease in the Value of Equity
Beta 1.50 1.10
(iv) Balance of Cash after 1 month
Cash in Hand on 31.12.19 ` 0.71 ` 2.50
NAV after 1 month
70 x (1 - 0.075) ` 64.75 -
60 x (1 - 0.055) - ` 56.70
65.21 58.95
6. (i) The price of one Future Contract
Let X be the Price of Future Contract. Accordingly,
`9,00,000
5=
X
X (Price of One Future Contract) = ` 1,80,000

`1,80,000
(ii) Current Future price of the index = = 2400
75
Let Y be the current Nifty Index (on 1 st February 2020) then
4
Accordingly, Y + Y (0.09 - 0.06) = 2400
12
2400
and Y = = 2376.24
1.01
Hence Nifty Index on 1st February 2020 shall be approximately 2376.
(iii) To determine whether the market is in Contango/ Backwardation first we shall
compute Basis as follows:
Basis = Spot Price – Future Price
If Basis is negative the market is said to be in Contango and when it is positive the
market is said to be Backwardation.
Since current Spot Price is 2400 and Nifty Index is 2376, the Basis is negative and
hence there is Contango Market and maximum Contango shall be 24 (2400 – 2376).
(iv) Pay off on the Future transaction shall be [(2400-2100) x 375] ` 112500
The Future seller gains if the Spot Price is less than Futures Contract price as
position shall be reversed at same Spot price. Therefore, Mr. SG has gained
` 1,12,500/- on the Short position taken.
7. (i) Since trader has planned to sell after 3 months now it implies, he is in Long Position
in Cash or Spot Market.
(ii) Since the trader is in Long Position in Cash Market, he can mitigate its risk of
reduced profit by hedging his position by selling Rice Futures i.e. Short Position in
Future Market.
(iii) The gain on futures contract
= (` 59 – ` 58) x 22,000 kg. = ` 22,000
Revenue from the sale of Rice
= 22,000 x ` 57 = ` 12,54,000
Total Cash Flow = ` 12,54,000 + ` 22,000 = ` 12,76,000
` 12,76,000
Cash Flow per kg. of Rice = = ` 58
22,000

8. (a) No, while Citi Bank’s quote is a Direct Quote for JPY (i.e. for Japan) the Hong Kong
Bank quote is an Indirect Quote for USD (i.e. for USA).
(b) Since Citi Bank quote imply USD/ JPY 0.0094 - 0.0095 and both rates exceed those
offered by Hong Kong Bank, there is an arbitrage opportunity.
Alternatively, it can also be said that Hong Kong Bank quote imply JPY/ USD
107.53 – 111.11 and both rates exceed quote by Citi Bank, there is an arbitrage
opportunity.
(c) Let us how arbitrage profit can be made.
(i) Covert US$ 1,000 into JPY by buying from Hong Kong Bank JPY 1,07,530
Sell these JPY to Citi Bank at JPY/ USD 106.50
and convert in US$ US$ 1009.67
Thus, arbitrage gain (US$ 1009.67 - US$ 1000.00) US$ 9.67
(ii) Covert JPY 1,00,000 into USD by buying from
Citi Bank at JPY/ USD 106.50 US$ 938.97
Sell these US$ to Hong Kong Bank at
JPY/ USD 107.53 and convert in US$ JPY 100967.44
Thus, arbitrage gain (JPY 1,00,967.44 - JPY 1,00,000) JPY 967.44
9. (a) (i) Calculate the cross rate for Pounds in Yen terms
1£ = ? ¥
US$1 = ¥ 107.31
£ 1 = US$ 1.26
¥ $ ¥
× =
$ £ £
¥
= 107.31 x 1.26
£
£1 = ¥ 135.21
(ii) Calculate the cross rate for Australian Dollar in Yen terms
A$1 = ¥ ?
US$1 = ¥ 107.31
A$ 1 = US$ 0.70

¥ $ ¥
× =
$ A$ A$
¥
= 107.31 x 0.70
A$
A$ 1 = ¥ 75.12
(iii) Calculate the cross rate for Pounds in Australian Dollar terms
₤ 1 = A$ ?
A$1 = US$ 0.70
US $ 1 = A$ 1.4286
£1 = US$1.26
A$ $ A$
× =
$ £ £
A$
= 1.4286 x 1.26 = 1.80
£
£ 1 = A$ 1.80
(b) (i) If you believe the spot exchange rate will be $ 1.32/£ in three months, you
should buy £ 1,000,000 forward for $1.30/£ and sell at $ 1.32/£ 3 months
hence.
Your expected profit will be: £1,000,000 x ($1.32 - $1.30) = $20,000
(ii) If the spot exchange rate turns out to be $1.26/£ in three months, your loss
from the long position in Forward Market will be: -
£ 1,000,000 x ($ 1.26 - $1.30) = $ 40,000
10. XYZ plc shall be ready to undertake this swap arrangement only if it receives the interest
on the surplus funds if invested on individual basis as follows:
Interest Amt. after 91 Conversion in £
days
Holland
€ 1,450,000 x 0.02 € 7,330.56 € 1,457,330.56 £1,004,829.42
x 91/360 = (1,457,330.56 x 0.6895)
Switzerland
CHF 1,996,154 x 0.005 CHF 2,522.92 CHF 1,998,676.92 £865,303.02
x 91/360 = (1,998,676.92÷2.3098)

UK
£ 150,000 x 0.01 x 91/360 = £ 379.17 £ 150,379.17 £ 150,379.17
Total GBP at 91 days £ 2,020,511.61
Swap to Sterling
Sell € 1,450,000 (Spot at 0.6858) buy £ £ 994,410.00
Sell CHF 1,996,154 (Spot at 2.3326) buy £ £ 855,763.53
Independent GBP amount £ 150,000.00
£ 2,000,173.53
Amount accrued on Individual Basis (Principal + Interest) £ 2,020,511.61
Interest Required £ 20,338.08
Required Interest Rate on Per Annuam Basis 4.023%
20,338.08 360
× ×100
2,000,173.53 91
Thus, the minimum rate that should be offered is 4.023%.

11. (i) DEF Bank will fix interest rate for 2V3 FRA after 2 years as follows:
XYZ Ltd.
(1+r) (1+0.0420) 2 = (1+0.0448) 3
(1+r) (1.0420) 2 = (1.0448) 3
r = 5.04%
ABC Ltd.
(1+r) (1+0.0548) 2 = (1+0.0578) 3
(1+r) (1.0548) 2 = (1.0578) 3
r = 6.38%
(ii)
4.50% 5.50%
Allow to Lapse Exercise
Interest ` 100 crores X 4.50% ` 4.50 crores -
` 100 crores X 5.04% - ` 5.04 crores

Premium (Cost of ` 100 crores X 0.1% ` 0.10 crores ` 0.10 crores

Option)
4.60 crores 5.14 crores
12. Determination of forecasted Free Cash Flow of the Firm (FCFF)

(` in crores)
Yr. 1 Yr. 2 Yr 3 Terminal Year
Revenue 9000.00 10800.00 12960.00 13996.80
COGS 3600.00 4320.00 5184.00 5598.72
Operating Expenses 1980.00* 2376.00 2851.20 3079.30
Depreciation 720.00 864.00 1036.80 1119.74
EBIT 2700.00 3240.00 3888.00 4199.04
Tax @30% 810.00 972.00 1166.40 1259.71
EAT 1890.00 2268.00 2721.60 2939.33
Capital Exp. – Dep. 172.50 198.38 228.13 -
∆ Working Capital 375.00 450.00 540.00 259.20
Free Cash Flow (FCF) 1342.50 1619.62 1953.47 2680.13
*Excluding Depreciation.
Present Value (PV) of FCFF during the explicit forecast period is:
FCFF (` in crores) PVF @ 15% PV (` in crores)
1342.50 0.8696 1167.44
1619.62 0.7561 1224.59
1953.47 0.6575 1284.41
3676.44
PV of the terminal, value is:
2680.13 1
x = ` 38287.57 Crore x 0.6575 = ` 25174.08 Crore
0.15 - 0.08 (1.15)3
The value of the firm is :

` 3676.44 Crores + ` 25174.08 Crores = ` 28,850.52 Crores
13. Impact of Financial Restructuring
(i) Benefits to Grape Fruit Ltd.

(a) Reduction of liabilities payable

` in lakhs
Reduction in equity share capital (6 lakh shares x `75 per share) 450
Reduction in preference share capital (2 lakh shares x ` 50 per 100
share)
Waiver of outstanding debenture Interest 26
Waiver from trade creditors (`340 lakhs x 0.25) 85
661
(b) Revaluation of Assets
Appreciation of Land and Building (`450 lakhs - `200 lakhs) 250
Total (A) 911
(ii) Amount of `911 lakhs utilized to write off losses, fictious assets and overvalued
assets.
Writing off profit and loss account 525
Cost of issue of debentures 5
Provision for bad and doubtful debts 15
Revaluation of Plant and Machinery 120
(`300 lakhs – `180 lakhs)
Total (B) 675
Capital Reserve (A) – (B) 236
(ii) Balance sheet of Grape Fruit Ltd as at 31 st March 2019 (after re-construction)
(` in lakhs)
12 lakhs equity shares 300 Land & Building 450
of ` 25/- each
10% Preference shares 100 Plant & Machinery 180
of ` 50/- each
Capital Reserve 236 Furnitures & Fixtures 50
9% debentures 200 Inventory 150
Loan from Bank 74 Sundry debtors 70
Trade Creditors 255 Prov. for Doubtful -15 55
Debts
Cash-at-Bank 280
(Balancing figure)*
1165 1165
*Opening Balance of `130/- lakhs + Sale proceeds from issue of new equity shares
`150/- lakhs.

14. (a) The key decisions falling within the scope of financial strategy are as follows:
1. Financing decisions: These decisions deal with the mode of financing or mix
of equity capital and debt capital.
2. Investment decisions: These decisions involve the profitable utilization of
firm's funds especially in long-term projects (capital projects). Since the future
benefits associated with such projects are not known with certainty, investment
decisions necessarily involve risk. The projects are therefore evaluated in
relation to their expected return and risk.
3. Dividend decisions: These decisions determine the division of earnings
between payments to shareholders and reinvestment in the company.
4. Portfolio decisions: These decisions involve evaluation of investments based
on their contribution to the aggregate performance of the entire corporation
rather than on the isolated characteristics of the investments themselves.
(b) Financial Risk is referred as the unexpected changes in financial conditions such as
prices, exchange rate, Credit rating, and interest rate etc. Though political risk is not
a financial risk in direct sense but same can be included as any unexpected political
change in any foreign country may lead to country risk which may ultimately result
in financial loss.
The financial risk can be evaluated from different point of views as follows:
(a) From stakeholder’s point of view: Major stakeholders of a business are equity
shareholders and they view financial gearing i.e. ratio of debt in capital
structure of company as risk since in event of winding up of a company they
will be least prioritized.
Even for a lender, existing gearing is also a risk since company having high
gearing faces more risk in default of payment of interest and principal
repayment.
(b) From Company’s point of view: From company’s point of view if a company
borrows excessively or lend to someone who defaults, then it can be forced to
go into liquidation.
(c) From Government’s point of view: From Government’s point of view, the
financial risk can be viewed as failure of any bank or (like Lehman Brothers)
down grading of any financial institution leading to spread of distrust among
society at large. Even this risk also includes willful defaulters. This can also be
extended to sovereign debt crisis.
(c) The various market indicators are as follows:
(i) Breadth Index: It is an index that covers all securities traded. It is computed
by dividing the net advances or declines in the market by the number of issues
traded. The breadth index either supports or contradicts the movement of the
Dow Jones Averages. If it supports the movement of the Dow Jones Averages,

this is considered sign of technical strength and if it does not support the
averages, it is a sign of technical weakness i.e. a sign that the market will
move in a direction opposite to the Dow Jones Averages. The breadth index is
an addition to the Dow Theory and the movement of the Dow Jones Averages.
(ii) Volume of Transactions: The volume of shares traded in the market provides
useful clues on how the market would behave in the near future. A rising
index/price with increasing volume would signal buy behaviour because the
situation reflects an unsatisfied demand in the market. Similarly, a falling
market with increasing volume signals a bear market and the prices would be
expected to fall further. A rising market with decreasing volume indicates a bull
market while a falling market with dwindling volume indicates a bear market.
Thus, the volume concept is best used with another market indicator, such as
the Dow Theory.
(iii) Confidence Index: It is supposed to reveal how willing the investors are to
take a chance in the market. It is the ratio of high-grade bond yields to low-
grade bond yields. It is used by market analysts as a method of trading or
timing the purchase and sale of stock, and also, as a forecasting device to
determine the turning points of the market. A rising confidence index is
expected to precede a rising stock market, and a fall in the index is expected
to precede a drop in stock prices. A fall in the confidence index represents the
fact that low-grade bond yields are rising faster or falling more slowly than high
grade yields. The confidence index is usually, but not always a leading
indicator of the market. Therefore, it should be used in conjunction with other
market indicators.
(iv) Relative Strength Analysis: The relative strength concept suggests that the
prices of some securities rise relatively faster in a bull market or decline more
slowly in a bear market than other securities i.e. some securities exhibit
relative strength. Investors will earn higher returns by investing in securities
which have demonstrated relative strength in the past because the rela tive
strength of a security tends to remain undiminished over time.
Relative strength can be measured in several ways. Calculating rates of return
and classifying those securities with historically high average returns as
securities with high relative strength is one of them. Even ratios like security
relative to its industry and security relative to the entire market can also be
used to detect relative strength in a security or an industry.
(v) Odd - Lot Theory: This theory is a contrary - opinion theory. It assumes that
the average person is usually wrong and that a wise course of action is to
pursue strategies contrary to popular opinion. The odd-lot theory is used
primarily to predict tops in bull markets, but also to predict reversals in
individual securities.

15. (a) Following are main problems faced in growth of Securitization of instruments
especially in Indian context:
(i) Stamp Duty: Stamp Duty is one of the obstacle in India. Under Transfer of
Property Act, 1882, a mortgage debt stamp duty which even goes upto 12% in
some states of India and this impeded the growth of securitization in India. It
should be noted that since pass through certificate does not evidence any debt
only able to receivable, they are exempted from stamp duty.
Moreover, in India, recognizing the special nature of securitized instruments in
some states has reduced the stamp duty on them.
(ii) Taxation: Taxation is another area of concern in India. In the absence of any
specific provision relating to securitized instruments in Income Tax Act experts’
opinion differ a lot. Some are of opinion that SPV as a trustee is liable to be
taxed in a representative capacity then others are of view that instead of SPV,
investors will be taxed on their share of income. Clarity is also required on the
issues of capital gain implications on passing payments to the investors.
(iii) Accounting: Accounting and reporting of securitized assets in the books of
originator is another area of concern. Although securitization is slated to be an
off-balance sheet instrument but in true sense receivables are removed from
originator’s balance sheet. Problem arises especially when assets are
transferred without recourse.
(iv) Lack of standardization: Every originator following his own format for
documentation and administration having lack of standardization is another
obstacle in the growth of securitization.
(v) Inadequate Debt Market: Lack of existence of a well-developed debt market
in India is another obstacle that hinders the growth of secondary market of
securitized or asset backed securities.
(vi) Ineffective Foreclosure laws: For many years efforts are on for effective
foreclosure but still foreclosure laws are not supportive to lending institutions
and this makes securitized instruments especially mortgaged backed securities
less attractive as lenders face difficulty in transfer of property in event of
default by the borrower.
(b) Here are some of the methods in which a startup firm can bootstrap:
(i) Trade Credit: When a person is starting his business, suppliers are reluctant to
give trade credit. They will insist on payment of their goods supplied either by
cash or by credit card. However, a way out in this situation is to prepare a well -

crafted financial plan. The next step is to pay a visit to the supplier’s office. If
the business organization is small, the owner can be directly contacted. On the
other hand, if it is a big firm, the Chief Financial Officer can be contacted and
convinced about the financial plan.
Communication skills are important here. The financial plan has to be shown.
The owner or the financial officer has to be explained about the business and
the need to get the first order on credit in order to launch the venture. The
owner or financial officer may give half the order on credit and balance on
delivery. The trick here is to get the goods shipped and sell them before paying
to them. One can also borrow to pay for the good sold. But there is interest
cost also. So trade credit is one of the most important ways to reduce the
amount of working capital one needs. This is especially true in retail
operations.
(ii) Factoring: This is a financing method where accounts receivable of a business
organization is sold to a commercial finance company to raise capital. The
factor then got hold of the accounts receivable of a business organization and
assumes the task of collecting the receivables as well as doing what would've
been the paperwork. Factoring can be performed on a non-notification basis. It
means customers may not be told that their accounts have been sold.
In addition to reducing internal costs of a business, factoring also frees up
money that would otherwise be tied to receivables. This is especially true for
businesses that sell to other businesses or to government; there are often long
delays in payment that this would offset. This money can be used to generate
profit through other avenues of the company. Factoring can be a very useful
tool for raising money and keeping cash flowing.
(iii) Leasing: Another popular method of bootstrapping is to take the equipment on
lease rather than purchasing it. It will reduce the capital cost and also help
lessee (person who take the asset on lease) to claim tax exemption. So, it is
better to a take a photocopy machine, an automobile or a van on lease to
avoid paying out lump sum money which is not at all feasible for a startup
organization.
(c) Difference between forward and future contract is as follows:
S. Features Forward Futures
No.
1. Trading Forward contracts are traded Futures Contracts are traded in
on personal basis or on a competitive arena.
telephone or otherwise.

2. Size of Forward contracts are Futures contracts are

Contract individually tailored and have standardized in terms of
no standardized size quantity or amount as the case
may be
3. Organized Forward contracts are traded Futures contracts are traded on
exchanges in an over the counter organized exchanges with a
market. designated physical location.
4. Settlement Forward contracts settlement Futures contracts settlements
takes place on the date are made daily via. Exchange’s
agreed upon between the clearing house.
parties.
5. Delivery Forward contracts may be Futures contracts delivery
date delivered on the dates dates are fixed on cyclical
agreed upon and in terms of basis and hardly takes place.
actual delivery. However, it does not mean that
there is no actual delivery.
6. Transaction Cost of forward contracts is Futures contracts entail
costs based on bid – ask spread. brokerage fees for buy and sell
orders.
7. Marking to Forward contracts are not Futures contracts are subject to
market subject to marking to market marking to market in which the
loss on profit is debited or
credited in the margin account
on daily basis due to change in
price.
8. Margins Margins are not required in In futures contracts every
forward contract. participants is subject to
maintain margin as decided by
the exchange authorities
9. Credit risk In forward contract, credit In futures contracts the
risk is born by each party transaction is a two way
and, therefore, every party transaction, hence the parties
has to bother for the need not to bother for the risk.
creditworthiness.

QUESTIONS
Security Valuation
1. ABC Limited, just declared a dividend of ` 28.00 per share. Mr. A is planning to purchase
the share of ABC Limited, anticipating increase in growth rate from 8% to 9%, which will
continue for three years. He also expects the market price of this share to be ` 720.00
after three years.
(i) the maximum amount Mr. A should pay for shares, if he requires a rate of return of
13% per annum.
(ii) the maximum price Mr. A will be willing to pay for share, if he is of the opinion that
the 9% growth can be maintained indefinitely and require 13% rate of return per
annum.
(iii) the price of share at the end of three years, if 9% growth rate is achieved and
assuming other conditions remaining same as in (ii) above.
Note : Calculate rupee amount up to two decimal points and use PVF upto 3 decimal points.
2. KLM Limited has issued 90,000 equity shares of ` 10 each. KLM Limited’s shares are
currently selling at ` 72. The company has a plan to make a rights issue of one new equity
share at a price of ` 48 for every four shares held.
(a) Calculate the theoretical post-rights price per share and analyse the change
(b) Calculate the theoretical value of the right alone.
(c) Suppose Mr. A who is holding 100 shares in KLM Ltd. is not interested in subscribing
to the right issue, then advice what should he do.
3. Equity of ABC Ltd. (ABCL) is ` 500 Crores, its debt, is worth ` 290 Crores. Printer Division
segments value is attributable to 64%, which has an Asset Beta (β p) of 1.55, balance value
is applied on Spares and Consumables Division, which has an Asset Beta (β sc) of 1.40
ABCL Debt beta (β D) is 0.28.
(i) Equity Beta (β E),
(ii) Ascertain Equity Beta (β E), if ABC Ltd. decides to change its Debt Equity position by
raising further debt and buying back of equity to have its Debt to Equity Ratio at 1.50.

Assume that the present Debt Beta (β D1) is 0.45 and any further funds raised by way
of Debt will have a Beta (β D2) of 0.50.
(iii) Whether the new Equity Beta (βE) justifies increase in the value of equity on account
of leverage?
4. K Ltd. has invested in a portfolio of short-term equity investments. You are required to
calculate the risk of K Ltd.’s short-term investment portfolio relative to that of the market
from the information given below:
Investment A B C D
No. of shares 1,20,000 1,60,000 2,00,000 2,50,000
Market price per share (`) 8.58 5.84 4.34 6.28
Beta 2.32 4.56 1.80 3.00
Expected Dividend Yield 9.50% 14.00% 7.50% 16.00%
The current market return is 20% and the risk free return is 10%.
Advise whether K Ltd. should change the composition of its portfolio. If yes, then how.
Note: Make calculations upto 4 decimal points.
Mutual Fund
5. The following particulars relating to S Fund Schemes:
Particulars Value ` in Crores
1. Investment in Shares (at cost)
a. Pharmaceuticals companies 158
b. Construction Industries 62
c. Service Sector Companies 112
d. IT Companies 68
e. Real Estate Companies 20
2. Investment in Bonds (Fixed Income)
a. Listed Bonds (8000, 14% Bonds of ` 15,000 each) 24
b. Unlisted Bonds 14
3. No. of Units outstanding (crores) 8.4
4. Expenses Payable 7
5. Cash and Cash equivalents 3
6. Market expectations on listed bonds 8.842%

The fund has incurred the following expenses:

Consultancy and Management fees ` 520 Lakhs
Office Expenses ` 180 Lakhs
Advertisement Expenses ` 48 Lakhs
Particulars relating to each sector are as follows:
Sector Index on Purchase date Index on Valuation date
Pharmaceutical companies 300 500
Construction Industries 275 490
Service Sector Companies 285 500
IT Companies 270 515
Real Estate Companies 265 440
Required:
(i) Calculate the Net Asset Value of the fund
(ii) Calculate the Net Asset Value per unit
(iii) Determine the Net return (Annualized), if the period of consideration is 4 years, and
the fund has distributed ` 2 per unit per year as cash dividend during the same period.
Note: Calculate figure in ` Crore upto 3 decimal points.
Derivatives
6. The following data relate to R Ltd.'s share price:
Current price per share ` 1,900
6 months future's price/share ` 2050
Assuming it is possible to borrow money in the market for transactions in securities at 10%
per annum,
(i) advise the justified theoretical price of a 6-months forward purchase; and
(ii) evaluate any arbitrage opportunity, if available.
7. The Following data relate to A Ltd.’s Portfolio:
Shares X Ltd. Y Ltd. Z Ltd.
No. of Shares (lakh) 6 8 4
Price per share (`) 1000 1500 500
Beta 1.50 1.30 1.70

The CEO is of opinion that the portfolio is carrying a very high risk as compared to the
market risk and hence interested to reduce the portfolio’s systematic risk to 0.95. Treasury
Manager has suggested two below mentioned alternative strategies:
(i) Dispose off a part of his existing portfolio to acquire risk free securities, or
(ii) Take appropriate position on Nifty Futures, currently trading at 8250 and each Nifty
points multiplier is ` 210.
(a) Interpret the opinion of CEO, whether it is correct or not.
(b) Calculate the existing systematic risk of the portfolio,
(c) Advise the value of risk-free securities to be acquired,
(d) Advise the number of shares of each company to be disposed off,
(e) Advise the position to be taken in Nifty Futures and determine the number of Nifty
contracts to be bought/sold; and
(f) Calculate the new systematic risk of portfolio if the company has taken position in
Nifty Futures and there is 2% rise in Nifty.
Note: Make calculations in ` lakh and upto 2 decimal points.
8. Doom Ltd. is an export business house. The company prepares invoice in customers'
currency. Its debtors of US$ 48, 00,000 is due on April 1, 2020.
Market information as at January 1, 2020 is:
Exchange rates US$/INR Currency Futures US$/INR
Spot 0.014285 Contract size: ` 2,88,16,368
1-month forward 0.014184 1-month 0.014178
3-months forward 0.013889 3-month 0.013881
Initial Margin Interest rates in India

1-Month ` 27,500 5.5%
3-Months ` 32,500 9%
On April 1, 2020 the spot rate US$/INR is 0.013894 and currency future rate is 0.013893.
Recommend as to which of the following methods would be most advantageous to Doom
Ltd.
(i) Using forward contract

(ii) Using currency futures

(iii) Not hedging the currency risk
Note: Round off calculation upto zero decimal points.
9. Telereal Trillium, a UK Company is in the process of negotiating an order amounting €5.5
million with a large German retailer on 6 month’s credit. If successful, this will be first time
for Telereal Trillium has exported goods into the highly competitive German Market. The
Telereal Trillium is considering following 3 alternatives for managing the transaction risk
before the order is finalized.
(i) Mr. Grand, the Marketing head has suggested that in order to remove transaction risk
completely Telereal Trillium should invoice the German firm in Sterling using the
current €/£ average spot rate to calculate the invoice amount.
(ii) Mr. John, CE is doubtful about Mr. Grand’s proposal and suggested an alter native of
invoicing the German firm in € and using a forward exchange contract to hedge the
transaction risk.
(iii) Ms. Royce, CFO is agreed with the proposal of Mr. John to invoice the German first
in €, but she is of opinion that Telereal Trillium should use sufficient 6 month sterling
future contracts (to the nearest whole number) to hedge the transaction risk.
Following data is available
Spot Rate € 1.1980 - €1.1990/£
6 months forward points 0.60 – 0.55 Euro Cents.
6 month future contract is currently trading at € 1.1943/£
6 month future contract size is £70,500
After 6 month Spot rate and future rate € 1.1873/£
You are required to
(a) Advise the alternative you consider to be most appropriate.
(b) Interpret the proposal of Mr. Grand from non-financial point of view.
Note: Calculate (to the nearest £) the £ receipt.
10. Right Limited has proposed to expand its operations for which it requires funds of $ 30
million, net of issue expenses which amount to 4% of the issue size. It proposed to raise
the funds though a GDR issue. It considers the following factors in pricing the issue:
(i) The expected domestic market price of the share is ` 300 (Face Value of ` 10 each
share)
(ii) 4 shares underly each GDR

(iii) Underlying shares are priced at 20% discount to the market price
(iv) Expected exchange rate is ` 70/$
You are required to compute the number of GDR's to be issued and cost of GDR to Right
Limited, if 20% dividend is expected to be paid with a growth rate of 20%.
11. Espaces plc is consumer electronics wholesaler. The business of the firm is highly
seasonal in nature. In 6 months of a year, firm has a huge cash deposits and especially
near Christmas time and other 6 months firm cash crunch, leading to borrowing of money
to cover up its exposures for running the business.
It is expected that firm shall borrow a sum of £25 million for the entire period of slack
season in about 3 months.
The banker of the firm has given the following quotations for Forward Rate Agreement
(FRA):
Spot 5.50% - 5.75%
3 × 6 FRA 5.59% - 5.82%
3 × 9 FRA 5.64% - 5.94%
3-month £50,000 future contract maturing in a period of 3 months is quoted at 94.15.
(a) Advise the position to be taken in Future Market by the firm to hedge its interest rate
risk and demonstrate how 3 months Future contract shall be useful for the firm, if later
interest rate turns out to be (i) 4.5% and (ii) 6.5%
(b) Evaluate whether the interest cost to Espace plc shall be less had it adopted the route
of FRA instead of Future Contract.
Note:- Ignore the time value of money in settlement amount for future contract.
Corporate Valuation
12. Sun Ltd. recently made a profit of ` 200 crore and paid out ` 80 crore (slightly higher than
the average paid in the industry to which it pertains). The average PE ratio of this industry
is 9. The estimated beta of Sun Ltd. is 1.2. As per Balance Sheet of Sun Ltd., the
shareholder’s fund is ` 450 crore and number of shares is 10 crore. In case the company
is liquidated, building would fetch ` 200 crore more than book value and stock would
realize ` 50 crore less.
The other data for the industry is as follows:
Projected Dividend Growth 4%
Risk Free Rate of Return 6%

Market Rate of Return 11%

Calculate the valuation of Sun Ltd. using
(a) P/E Ratio
(b) Dividend Growth Model
(c) Book Value
(d) Net Realizable Value
13. ABC Ltd. is intending to acquire XYZ Ltd. by way of merger and the following information
is available in respect of these companies:
ABC Ltd. XYZ Ltd.
Total Earnings (E) (in lakh) ` 1200 `400
Number of outstanding shares (S) (in lakh) 400 200
Price earnings ratio (P/E) 8 7
(a) Determine the maximum exchange ratio acceptable to the shareholders of ABC Ltd.,
if the P/E ratio of the combined firm is expected to be 8?
(b) Determine the minimum exchange ratio acceptable to the shareholders XYZ Ltd., if
the P/E ratio of the combined firm is expected to be 10?
Note: Make calculation in lakh multiples and compute ratio upto 4 decimal points.
14. (a) Explain the traits that an organisation should have to make itself financially
sustainable.
(b) Describe the salient features of Foreign Currency Convertible Bonds.
(c) Explain how an organization interested in making investment in foreign country can
assess Country Risk and mitigate this risk.
15. (a) ‘Venture Capital Financing is a unique way of financing Startup’. Discuss.
(b) Explain the Secondary Participants involved in the process of Securitization of
Instruments.
(c) Explain how Cash flow-based approach of valuation is different from Income based
approach and also explain briefly the steps involved in this approach.

SUGGESTED ANSWERS
1. (i) Expected dividend for next 3 years.

Year 1 (D1) ` 28.00 (1.09) = ` 30.52
Year 2 (D2) ` 28.00 (1.09) 2 = ` 33.27
Year 3 (D3) ` 28.00 (1.09) 3 = ` 36.26
Required rate of return = 13% (Ke)
Market price of share after 3 years = (P 3) = ` 720
The present value of share
D1 D2 D3 P3
P0 = + + +
(1 + ke ) (1 + ke )2 (1 + ke )3 (1 + ke )3
30.52 33.27 36.26 720
P0 = + + +
(1+0.13) (1+0.13) (1+0.13) (1+0.13)3
2 3
P0 = 30.52(0.885) + 33.27(0.783) +36.26(0.693) +720(0.693)

P0 = 27.01 + 26.05 + 25.13 + 498.96
P0 = ` 577.15
(ii) If growth rate 9% is achieved for indefinite period, then maximum price of share
should Mr. A willing be to pay is
D1 ` 30.52 ` 30.52
P0 = = = = ` 763
(ke − g) 0.13-0.09 0.04
(iii) Assuming that conditions mentioned above remain same, the price expected after 3
years will be:
D4 D 3 (1.09) 36.26 x1.09 39.52
P3 = = = = = ` 988
k e − g 0.13 − 0.09 0.04 0.04
2. (a) Calculation of theoretical Post-rights (ex-right) price per share

 MN + S R 
Ex-right value =  
 N+R 
Where,
M = Market price,
N = Number of old shares for a right share

S = Subscription price
R = Right share offer
 ` 72 × 4 + ` 48 × 1 
=   = ` 67.20
 4+1
Thus, post right issue the price of share has reduced by `4.80 per share.
(b) Calculation of theoretical value of the rights alone:

= Ex-right price – Cost of rights share
= ` 67.20 – ` 48 = ` 19.20
Or
` 67.20 − ` 48
= = ` 4.80
4
(c) If Mr. A is not interested in subscribing to the right issue, he can renounce his right
eligibility @ ` 19.20 per right and can earn a gain of ` 480.
3. (i) Equity Beta
To calculate Equity Beta first we shall calculate Weighted Average of Asset Beta as
follows:
= 1.55 x 0.64 + 1.40 x 0.36
= 0.992 + 0.504 = 1.496
Now we shall compute Equity Beta using the following formula:
 E   D (1 - t) 
βAsset = βEquity   + βDebt  E+ D(1 - t) 
 E+ D(1 - t)   
Accordingly,
 500   290 
1.496 = βEquity   + βDebt  500+290 
 500 + 290   
 500   290 
1.496 = βEquity   + 0.28  790 
 790   
βEquity = 2.20

(ii) Equity Beta on change in Capital Structure

Amount of Debt to be raised:
Particulars Value (in ` Crore)
Total Value of Firm (Equity ` 500 crore + Debt ` 290 crore) 790
Desired Debt Equity Ratio 1.50 : 1.00
TotalValue x Debt Ratio 474
Desired Debt Level =
Debt Ratio+Equity Ratio
Less: Value of Existing Debt (290)
Value of Debt to be Raised 184
Equity after Repurchase = Total value of Firm – Desired Debt Value

= ` 790 Crore – ` 474 Crore
= ` 316 Crore
Weighted Average Beta of ABCL:

Source of Investment Weight Beta of the Weighted Beta
Finance (in ` Crore) Division
Equity 316 0.4 β(E = X) 0.4x
Debt – 1 290 0.367 0.45 0.165
Debt – 2 184 0.233 0.50 0.117
790 Weighted Average Beta 0.282 + (0.4x)
βABCL = 0.282 + 0.4x
1.496 = 0.282 + 0.4x
0.4x = 1.496 – 0.282
X = 1.214/0.4 = 3.035
β New Equity = 3.035
(iii) Yes, it justifies the increase as it leads to increase in the Value of Equity due to
increase in Beta.
4. (i) To determine whether K Ltd. should change composition of its portfolio first we should
determine the Beta of the Portfolio and compare it with implicit Beta as justified by
the Return on Portfolio.

Calculation of Beta of Portfolio

Invest- No. of Market Market Dividend Dividend Composition β Weighted
ment shares Price (`) Value Yield β
A 1,20,000 8.58 10,29,600 9.50% 97,812 0.2339 2.32 0.5426
B 1,60,000 5.84 9,34,400 14.00% 1,30,816 0.2123 4.56 0.9681
C 2,00,000 4.34 8,68,000 7.50% 65,100 0.1972 1.80 0.3550
D 2,50,000 6.28 15,70,000 16.00% 2,51,200 0.3566 3.00 1.0698
44,02,000 5,44,928 1.0000 2.9355
5,44,928
Return of the Portfolio =0.1238
44,02,000
Beta of Port Folio 2.9355
Market Risk implicit
0.1238 = 0.10 + β× (0.20 – 0.10)
Or, 0.10 β + 0.10 = 0.1238
0.1238 − 0.10
β= = 0.238
0.10
Market β implicit is 0.238 while the portfolio β is 2.93. Thus, the portfolio is marginally
risky compared to the market.
(ii) To decide whether K Ltd. should change the composition of its portfolio the dividen d
yield (given) should be compared with the Expected Return as per CAPM as follows:
Expected return as per CAPM is R f + (RM – Rf) β
Accordingly,
Expected Return for investment A = 0.10 + (0.20 - 0.10) 2.32
= 33.20%
Expected Return for investment B = 0.10 + (0.20 - 0.10) 4.56
= 55.60%
Expected Return for investment C = 0.10 + (0.20 - 0.10) 1.80
= 28%
For investment D, Rs = 0.10 + (0.20 - 0.10) 3
= 40%

Comparing dividend yields with the expected returns of investment as per CAPM it
can be observed that all investments are over-priced and they should be sold by the
K Ltd. and acquire new securities.
5. (i) Calculation of NAV of the Fund
(in ` Crore)
1. Value of Shares
a. Pharmaceutical Companies 500 263.333
158 
300
b. Construction Companies 490 110.473
62 
275
c. Service Sector Companies 500 196.491
112 
285
d. IT Companies 515 129.704
68 
270
e. Real Estate Companies 440 33.208
20 
265
2. Investment in Bonds
a. Listed Bonds 14 38.00
 24
8.842
b. Unlisted Bonds 14.000
3. Cash and Cash Equivalents 3.00
788.209
Less: Expense Payable 7.000
NAV of the Fund 781.209
(ii) NAV of the Fund per Unit
NAV of the Fund ` 781.209 crore
Number of Units 8.40 crore
NAV Per Unit (` 781.209 crore/ 8.40 crore) ` 93.00
(iii) Net Return
Initial Cost Per Unit
Investment in Shares ` 420 crore

Bonds ` 38 crore ` 458 crore

Number of Units 8.40 crore
Cost Per Unit ` 54.52
Return
Capital Gain (` 93.00 – ` 54.52) ` 38.48
Dividend ` 4x 2 ` 8.00
` 46.48
Annualised Return 46.48 1 21.31%

54.52 4
6. (i) The justified theoretical price of a 6 months forward contract as per cost to carry
model is as follows:
Theoretical minimum price = ` 1,900 + (` 1,900 x 10/100 x 6/12) = ` 1,995
(ii) Arbitrage Opportunity - Since current future price is `2050, yes there is an opportunity
for carrying arbitrage profit. The arbitrageur can borrow money @ 10 % for 6 months
and buy the shares at ` 1,900. At the same time he can sell the shares in the futures
market at ` 2,050. On the expiry date 6 months later, he could deliver the share and
collect ` 2,050 pay off ` 1,995 and record a risk –less profit of ` 55 (` 2,050 –
` 1,995).
7. (a) Yes, the apprehension of CEO is correct as the current portfolio is more riskier than
market as the beta (Systematic Risk) of market portfolio is as computed as follows:
Shares No. of Market Price of (1) × (2) % to ß (x) Wx
shares Per Share (2) (`) (` lakhs) total
(lakhs) (1) (w)
X Ltd. 6.00 1000.00 6000.00 0.30 1.50 0.45
Y Ltd. 8.00 1500.00 12000.00 0.60 1.30 0.78
Z Ltd. 4.00 500.00 2000.00 0.10 1.70 0.17
20000.00 1.00 1.40
(b) Since the Beta of existing portfolio is 1.40, the systematic risk of the current portfolio
is 1.40.
(c) Required Beta 0.95
Let the proportion of risk-free securities for target beta 0.95 = p
0.95 = 0 × p + 1.40 (1 – p)
p = 0.32 i.e. 32%

Shares to be disposed off to reduce beta (20000 × 32%) ` 6,400 lakh and Risk Free
securities to be acquired for the same amount.
(d) Number of shares of each company to be disposed off
Shares % to total Proportionate Market Price No. of Shares
(w) Amount (` lakhs) Per Share (`) (Lakh)
X Ltd. 0.30 1920.00 1000.00 1.92
Y Ltd. 0.60 3840.00 1500.00 2.56
Z Ltd. 0.10 640.00 500.00 1.28
(e) Since, the company is in long position in cash market it shall take short position in
Future Market.
Number of Nifty Contract to be sold
(1.40-0.95) × 20000 lakh
= 519 contracts
8,250 × 210
(f) If there is 2% rises in Nifty there will be 2.80%(2%x1.40) rise for portfoli o of shares
` Lakh
Current Value of Portfolio of Shares 20000
Value of Portfolio after rise 20560
Mark-to-Market Margin paid (8250 × 0.020 × ` 210 × 519) 179.83
Value of the portfolio after rise of Nifty 20380.17
% change in value of portfolio (20380.17 – 20000)/ 20000 1.90%
% rise in the value of Nifty 2%
New Systematic Risk (Beta) 0.95
8. Receipts using a forward contract = $ 48,00,000/0.013889 = ` 34,55,97,235
Receipts using currency futures
The number of contracts needed is ($ 48,00, 000/0.013881)/ = 12
28,816,368
Initial margin payable is 12 contracts x ` 32,500 = ` 3,90,000
On April 1, 2020 Close at 0.013893
Receipts = US$ 48,00,000/0.013894 = ` 34,54,72,866
Variation Margin
[(0.013893 – 0.013881) x 12 x 28,816,368]/0.013894

OR (0.000012 x 12 x 28,816,368)/0.013894 = = ` 2,98,658

4149.5570/0.013894
Less: Interest Cost – ` 3,90,000 x 0.09 x 3/12 ` 8,775
Net Receipts ` 34,57,62,749
Receipts under different methods of hedging

Forward contract ` 34,55,97,235
Future Contract ` 34,57,62,749
No Hedge (US$ 48,00,000/ 0.013894) ` 34,54,72,866
The most advantageous option would have been to hedge with futures as it is slightly
higher than Forward Option but comparing to no hedge option it is better proposition.
9. (a) (i) Receipt under three proposals
(a) Proposal of Mr. Grand
€5.5 million
Invoicing in £ will produce = = £ 45, 87,156
1.1990
(b) Proposal of Mr. John
Forward Rate = €1.1990 - 0.0055 = 1.1935
€5.5 million
Using Forward Market hedge Sterling receipt would be
1.1935
= £ 46,08,295
(c) Proposal of Ms. Royce
The equivalent sterling of the order placed based on future price (€1.1943)
€5.5 million
= = £ 46, 05,208 (rounded off)
1.1943
£46,05,208
Number of Contracts = = 65 Contracts (to the nearest whole
70,500
number)
Thus, € amount hedged by future contract will be = 65  £70,500
= £45,82,500
Buy Future at €1.1943
Sell Future at €1.1873
€0.0070

Total loss on Future Contracts = 65  £70,500  €0.0070 = €32,078

After 6 months
Amount Received €55, 00,000
Less: Loss on Future Contracts € 32,078
€ 54, 67,922
Sterling Receipts
€54,67,922
On sale of € at spot = = £46, 05,342
1.1873
Proposal of option (ii) is preferable because the option (i) & (iii) produces least
receipts.
(b) Further, in case of proposal (i) there must be a doubt as to whether this would be
acceptable to German firm as it is described as a competitive market and Telereal
Trillium is moving into it first time.
10. Net Issue Size = $30 million
$30 million
Gross Issue = = $31.25 million
0.96
Issue Price per GDR in ` (300 x 4 x 80%) ` 960
Issue Price per GDR in $ (` 960/ ` 70) $13.71
Dividend per GDR (D 1) (` 2 x 4) `8
Net Proceeds per GDR (` 960 x 0.96) ` 921.60
(a) Number of GDR to be issued
$31.25 million
= 2.2794 million
$13.71
(b) Cost of GDR to Right Ltd.
8
ke = + 0.20 = 20.87%
921.60
11. (a) (i) Since firm is a borrower it will like to off-set interest cost by profit on Future
Contract. Accordingly, if interest rate rises it will gain hence it should sell interest
rate futures.
Amount of Borrowing Duration of Loan
No. of Contracts = ×
Contract Size 3 months

£ 25,000,000 6
= x = 1000 Contracts
£ 50,000 3
(ii) The final outcome in the given two scenarios shall be as follows:
If the interest rate turns out If the interest rate turns out
to be 4.5% to be 6.5%
Future Course
Action :
Sell to open 94.15 94.15
Buy to close 95.50 (100 - 4.5) 93.50 (100 - 6.5)
Loss/ (Gain) 1.35% (0.65%)
Cash Payment £ 50,000×1000× 1.35%×3/12 £ 50,000×1000×0.65%×3/12
(Receipt) for = £1,68,750 = (£81,250)
Future
Settlement
Interest for 6 £ 25 million × 4.5% × ½ £ 25 million × 6.5% × ½
months on £50 = £ 5,62,500 = £ 8,12,500
million at
actual rates
£ 7,31,250 £ 7,31,250
£ 7,31,250 12
Thus, the firm locked itself in interest rate x 100 x = 5.85%
£ 25,000,000 6
(b) No, the interest cost shall not be less for Espace plc had it taken the route of FRA,
as the 3 x 9 FRA contract are available at 5.64% – 5.94% i.e. borrowing rate of 5.94%.
Hence, the interest cost under this option shall be nearby by 5.94% which is more
than interest rate under Future contract rate of 5.85%.
12. (a) ` 200 crore x 9 = ` 1800 crore
(b) Ke = 6% + 1.2 (11% - 6%) = 12%
80 crore x 1.04
= = ` 1040 crore
0.12 - 0.04
(c) ` 450 crore
(d) ` 450 crore + ` 200 crore – ` 50 crore = ` 600 crore

13. (a) Maximum exchange ratio acceptable to the shareholders of ABC Ltd.
Market Price of share of ABC Ltd. (` 3 x 8) ` 24
No. of Equity Shares 400 lakh
Market Capitalisation of ABC Ltd. (` 24 x 400 lakh) ` 9600 lakh
Combined Earnings (` 1200 + ` 400) lakh ` 1600 lakh
Combined Market Capitalisation (` 1600 lakh x 8) ` 12800 lakh
Market Capitalisation of ABC Ltd. (` 24x 400 lakh) ` 9600 lakh
Balance for XYZ Ltd. ` 3200 lakh
Let D be the no. of equity shares to be issued to XYZ Ltd. then,
` 3200 Lakh
=D
 1600 Lakh 
 ×8
 D + 400 
D = 133.333 lakh Shares
Exchange Ratio = 133.333 / 200 = 0.6666:1
(b) Minimum exchange ratio acceptable to the shareholders of XYZ Ltd.
Market Price of share of XYZ Ltd. ` 14.00
No. of Equity Shares 200 lakh
Market Capitalisation of XYZ Ltd. (` 14.00 x 200 lakh) ` 2800 lakh
Combined Earnings (` 1200 + ` 400) lakh ` 1600 lakh
Combined Market Capitalisation (` 1600 lakh x 10) ` 16000 lakh
Balance for ABC Ltd. ` 13200 lakh
Let D be the no. of equity shares to be issued to XYZ Ltd. then,
` 2800 lakh
=D
 1600 lakh 
 D + 400  ×10
 
D = 84.8485 lakh Shares
Exchange Ratio = 84.8485 / 200 = 0.4242:1
14. (a) To be financially sustainable, an organization must have following traits:

❖ have more than one source of income.
❖ have more than one way of generating income.

❖ do strategic, action and financial planning regularly.

❖ have adequate financial systems.
❖ have a good public image.
❖ be clear about its values (value clarity); and
❖ have financial autonomy.
(b) The salient features of FCCBs are as follows:
1. FCCB is a bond denominated in a foreign currency issued by an Indian company
which can be converted into shares of the Indian Company denominated in
Indian Rupees.
2. Prior permission of the Department of Economic Affairs, Government of India ,
Ministry of Finance is required for their issue
3. There will be a domestic and a foreign custodian bank involved in the issue
4. FCCB shall be issued subject to all applicable Laws relating to issue of capital
by a company.
5. Tax on FCCB shall be as per provisions of Indian Taxation Laws and Tax will be
deducted at source.
6. Conversion of bond to FCCB will not give rise to any capital gains tax in India.
(c) Organisation can assess country risk
(1) By referring political ranking published by different business magazines.
(2) By evaluating country’s macro-economic conditions.
(3) By analyzing the popularity of current government and assess their stability.
(4) By taking advises from the embassies of the home country in the host countries.
Further, following techniques can be used to mitigate this risk.
(i) Local sourcing of raw materials and labour.
(ii) Entering into joint ventures
(iii) Local financing
(iv) Prior negotiations
15. (a) Yes, Venture Capital Financing is unique manner of financing a Startup as it
possesses the following characteristics:
(i) Long time horizon: The fund would invest with a long time horizon in mind.
Minimum period of investment would be 3 years and maximum period can be 10
years.

(ii) Lack of liquidity: When VC invests, it takes into account the liquidity factor. It
assumes that there would be less liquidity on the equity it gets and accordingly
it would be investing in that format. They adjust this liquidity premium against
the price and required return.
(iii) High Risk: VC would not hesitate to take risk. It works on principle of high risk
and high return. So, high risk would not eliminate the investment choice for a
venture capital.
(iv) Equity Participation: Most of the time, VC would be investing in the form of
equity of a company. This would help the VC participate in the management and
help the company grow. Besides, a lot of board decisions can be supervised by
the VC if they participate in the equity of a company.
(b) Secondary participants involved into the securitization process are as follows:
(i) Obligors: Actually they are the main source of the whole securitization process.
They are the parties who owe money to the firm and are assets in the Balance
Sheet of Originator. The amount due from the obligor is transferred to SPV and
hence they form the basis of securitization process and their credit standing is
of paramount importance in the whole process.
(ii) Rating Agency: Since the securitization is based on the pools of assets rather
than the originators, the assets have to be assessed in terms of its credit quality
and credit support available. Rating agency assesses the following:
❖ Strength of the Cash Flow.
❖ Mechanism to ensure timely payment of interest and principle repayment.
❖ Credit quality of securities.
❖ Liquidity support.
❖ Strength of legal framework.
Although rating agency is secondary to the process of securitization but it plays
a vital role.
(iii) Receiving and Paying agent (RPA): Also, called Servicer or Administrator, it collects
the payment due from obligor(s) and passes it to SPV. It also follow up with defaulting
borrower and if required initiate appropriate legal action against them. Generally, an
originator or its affiliates acts as servicer.
(iv) Agent or Trustee: Trustees are appointed to oversee that all parties to the deal
perform in the true spirit of terms of agreement. Normally, it takes care of interest of
investors who acquires the securities.
(v) Credit Enhancer: Since investors in securitized instruments are directly exposed to
performance of the underlying and sometime may have limited or no recourse to the

originator, they seek additional comfort in the form of credit enhancement. In other
words, they require credit rating of issued securities which also empowers
marketability of the securities.
Originator itself or a third party say a bank may provide this additional context called
Credit Enhancer. While originator provides his comfort in the form of over
collateralization or cash collateral, the third party provides it in form of letter of credit
or surety bonds.
(vi) Structurer: It brings together the originator, investors, credit enhancers and other
parties to the deal of securitization. Normally, these are investment bankers also
called arranger of the deal. It ensures that deal meets all legal, regulatory, accounting
and tax laws requirements.
(c) As opposed to the asset based and income based approaches, the cash flow
approach takes into account the quantum of free cash that is available in future
periods, and discounting the same appropriately to match to the flow’s risk.
Simply speaking, if the present value arrived post application of the discount rate is
more than the current cost of investment, the valuation of the enterprise is attractive
to both stakeholders as well as externally interested parties (like stock analysts). It
attempts to overcome the problem of over-reliance on historical data.
There are essentially five steps in performing DCF based valuation:
(i) Arriving at the ‘Free Cash Flows’
(ii) Forecasting of future cash flows (also called projected future cash flows)
(iii) Determining the discount rate based on the cost of capital
(iv) Finding out the Terminal Value (TV) of the enterprise
(v) Finding out the present values of both the free cash flows and the TV, and
interpretation of the results.

QUESTIONS
Security Valuation
1. Mr. A will need ` 1,00,000 after two years for which he wants to make one time
necessary investment now. He has a choice of two types of bonds. Their details are as
below:
Bond X Bond Y
Face value ` 1,000 ` 1,000
Coupon 7% payable annually 8% payable annually
Years to maturity 1 4
Current price ` 972.73 ` 936.52
Current yield 10% 10%
Advice Mr. A whether he should invest all his money in one type of bond or he should
buy both the bonds and, if so, in which quantity? Assume that there will not be any call
risk or default risk.
2. The following data is related to 8.5% Fully Convertible (into Equity shares) Debentures
issued by JAC Ltd. at ` 1000.
Market Price of Debenture ` 900
Conversion Ratio 30
Straight Value of Debenture ` 700
Market Price of Equity share on the date of Conversion ` 25
Expected Dividend Per Share `1

(a) Conversion Value of Debenture
(b) Market Conversion Price
(c) Conversion Premium per share
(d) Ratio of Conversion Premium
(e) Premium over Straight Value of Debenture
(f) Favourable income differential per share
(g) Premium pay back period
3. Mr. A is interested to invest ` 1,00,000 in the securities market. He selected two
securities B and D for this purpose. The risk return profile of these securities are as
follows:
Security Risk (  ) Expected Return (ER)
B 10% 12%
D 18% 20%
Co-efficient of correlation between B and D is 0.15.
You are required to calculate the portfolio return of the following portfolios of B and D to
be considered by A for his investment.
(i) 100 percent investment in B only;
(ii) 50 percent of the fund in B and the rest 50 percent in D;
(iii) 75 percent of the fund in B and the rest 25 percent in D; and
(iv) 100 percent investment in D only.
Also indicate that which portfolio is best for him from risk as well as return point of view?
4. A Portfolio Manager (PM) has the following four stocks in his portfolio:
Security No. of Shares Market Price per share (`) 
VSL 10,000 50 0.9
CSL 5,000 20 1.0
SML 8,000 25 1.5
APL 2,000 200 1.2
Compute the following:
(i) Portfolio beta.
(ii) If the PM seeks to reduce the beta to 0.8, how much risk free investment should he
bring in?
(iii) If the PM seeks to increase the beta to 1.2, how much risk free investment should
he bring in?
Mutual Fund
5. Five portfolios experienced the following results during a 7- year period:
Average Annual Standard Correlation with the

Portfolio
Return (Rp) (%) Deviation (Sp) market returns (r)
A 19.0 2.5 0.840
PAPER 2: STRATEGIC FINANCIAL MANAGEMENT 3
B 15.0 2.0 0.540

C 15.0 0.8 0.975
D 17.5 2.0 0.750
E 17.1 1.8 0.600
Market Risk (σm) -- 1.2
Market rate of Return (Rm) 14.0
Risk-free Rate (Rf) 9.0
Rank the portfolios using (a) Sharpe’s method, (b) Treynor’s method and (c) Jensen’s
Alpha
Derivatives
6. A company is long on 10 MT of copper @ ` 534 per kg (spot) and intends to remain so
for the ensuing quarter. The variance of change in its spot and future prices are 16% and
36% respectively, having correlation coefficient of 0.75. The contract size of one contract
is 1,000 kgs.
Required:
(i) Calculate the Optimal Hedge Ratio for perfect hedging in Future Market.
(ii) Advice the position to be taken in Future Market for perfect hedging.
(iii) Determine the number and the amount of the copper futures to achieve a perfect
hedge.
7. Details about portfolio of shares of an investor is as below:
Shares No. of shares (Iakh) Price per share Beta
A Ltd. 3.00 ` 500 1.40
B Ltd. 4.00 ` 750 1.20
C Ltd. 2.00 ` 250 1.60
The investor thinks that the risk of portfolio is very high and wants to reduce the portfolio
beta to 0.91. He is considering two below mentioned alternative strategies:
(i) Dispose off a part of his existing portfolio to acquire risk free securities, or
(ii) Take appropriate position on Nifty Futures which are currently traded at 8125 and
each Nifty points is worth ` 200.
(a) portfolio beta,
(b) the value of risk free securities to be acquired,
(c) the number of shares of each company to be disposed off,

(d) the number of Nifty contracts to be bought/sold; and
(e) the value of portfolio beta for 2% rise in Nifty.
Foreign Exchange
8. Your bank’s London office has surplus funds to the extent of USD 5,00,000 for a period
of 3 months. The cost of the funds to the bank is 4% p.a. It proposes to invest these
funds in London, New York or Frankfurt and obtain the best yield, without any excha nge
risk to the bank. The following rates of interest are available at the three centres for
investment of domestic funds there at for a period of 3 months.
London 5% p.a.
New York 8% p.a.
Frankfurt 3% p.a.
The market rates in London for US dollars and Euro are as under:
London on New York
Spot 1.5350/90
1 month 15/18
2 month 30/35
3 months 80/85
London on Frankfurt
Spot 1.8260/90
1 month 60/55
2 month 95/90
3 month 145/140
At which centre, investment will be made & what will be the net gain (to the nearest
pound) to the bank on the invested funds?
9. XYZ Ltd. has imported goods to the extent of US$ 8 Million. The payment terms are as
under:
(a) 1% discount if full amount is paid immediately; or
(b) 60 days interest free credit. However, in case of a further delay up to 30 days,
interest at the rate of 8% p.a. will be charged for additional days after 60 days. M/s
XYZ Ltd. has ` 25 Lakh available and for remaining it has an offer from bank for a
loan up to 90 days @ 9.0% p.a.
The quotes for foreign exchange are as follows:

Spot Rate INR/ US$ (buying) ` 66.98
60 days Forward Rate INR/ US$ (buying) ` 67.16
90 days Forward Rate INR/ US$ (buying) ` 68.03
Advise which one of the following options would be better for XYZ Ltd.
(i) Pay immediately after utilizing cash available and for balance amount take 90 days
loan from bank.
(ii) Pay the supplier on 60 th day and avail bank’s loan (after utilizing cash) for 30 days.
(iii) Avail supplier offer of 90 days credit and utilize cash available.
Further presume that the cash available with XYZ Ltd. will fetch a return of 4% p.a. in
India till it is utilized.
Assume year has 360 days. Ignore Taxation.
Compute your working upto four decimals and cash flows in Crore.
10. A USA based company is planning to set up a software development unit in India.
Software developed at the Indian unit will be bought back by the US parent at a transfer
price of US $10 millions. The unit will remain in existence in India for one year; the
software is expected to get developed within this time frame.
The US based company will be subject to corporate tax of 30 per cent and a withholding
tax of 10 per cent in India and will be eligible for tax credit in India. The software
developed will be sold in the US market and many companies are ready to acquire the
same. Other estimates are as follows:
Rent for fully furnished unit with necessary hardware in India ` 18,75,000
Manpower cost (80 software professional will be working for 10 hours 500 per man
each day) hour
Advise the US Company the minimum amount it should charge from the prospective
buyer. The rupee-dollar rate is ` 60/$.
Note: Assume 365 days a year.
Interest rate Risk Management
11. Derivative Bank entered into a swap arrangement on a principal of ` 10 crores and
agreed to receive MIBOR overnight floating rate for a fixed payment on the principal. The
swap was entered into on Monday, 19 th August, 2019 and was to commence on
20th August, 2019 and run for a period of 7 days.

Respective MIBOR rates for Tuesday to Monday were: 8.15%, 7.98%, 7.95%, 8.12%,
8.15%, 7.75%.
If Fixed Rate of Interest is 8%, then evaluate
(i) the nature of this Swap arrangement.
(ii) the Net Settlement amount.
Notes:
(1) Sunday is Holiday.
(2) Work in rounded rupees and avoid decimal working.
(3) Consider 365 days in a year.
Corporate Valuation
12. STR Ltd.’s current financial year's income statement reported its net income after tax as
` 50 Crore.
Following is the capital structure of STR Ltd. at the end of current financial year:
`
Debt (Coupon rate = 11%) 80 Crore
Equity (Share Capital + Reserves & Surplus) 250 Crore
Invested Capital 330 Crore
Following data is given to estimate cost of equity capital:
Asset Beta of TSR Ltd. 1.11
Risk free Rate of Return 8.5%
Average market risk premium 9%
The applicable corporate income tax rate is 30%.
Estimate Economic Value Added (EVA) of RST Ltd. in ` lakh.
Mergers, Acquisitions & Corporate Restructuring
13. Cauliflower Limited is contemplating acquisition of Cabbage Limited. Cauliflower Limited
has 5 lakh shares having market value of ` 40 per share while Cabbage Limited has 3
lakh shares having market value of ` 25 per share. The EPS for Cabbage Limited and
Cauliflower Limited are ` 3 per share and ` 5 per share respectively. The managements
of both the companies are discussing two alternatives for exchange of shares as follows:
(i) In proportion to relative earnings per share of the two companies.
(ii) 1 share of Cauliflower Limited for two shares of Cabbage Limited.
Required:
(i) Calculate the EPS after merger under both the alternatives.
(ii) Show the impact on EPS for the shareholders of the two companies under both the
alternatives.
14. Can a company with no commercial operations raise capital via an IPO? Discuss.
15. Mr. R has completed his studies and wants to start his new online business. For a
successful online business there are various expenditure costs with regards to
advertisement & application development. To make the business successful he wants to
raise funds. Explain some of the innovative sources for funding a start-up.
1. Duration of Bond X
Year Cash flow P.V. @ 10% Proportion of Proportion of bond
bond value value x time (years)
1 1070 .909 972.63 1.000 1.000
Duration of the Bond is 1 year
Duration of Bond Y
1 80 .909 72.72 0.077 0.077
2 80 .826 66.08 0.071 0.142
3 80 .751 60.08 0.064 0.192
4 1080 .683 737.64 0.788 3.152
936.52 1.000 3.563
Duration of the Bond is 3.563 years
Let x1 be the investment in Bond X and therefore investment in Bond Y shall be (1 - x1).
Since the required duration is 2 year the proportion of investment in each of these two
securities shall be computed as follows:
2 = x1 + (1 - x1) 3.563
x1 = 0.61
Accordingly, the proportion of investment shall be 61% in Bond X and 39% in Bond Y
respectively.
Amount of investment
Bond X Bond Y
PV of ` 1,00,000 for 2 years @ 10% x 61% PV of ` 1,00,000 for 2 years @ 10% x
39%
= ` 1,00,000 (0.826) x 61% = ` 1,00,000 (0.826) x 39%
= ` 50,386 = ` 32,214
No. of Bonds to be purchased No. of Bonds to be purchased
= ` 50,386/ ` 972.73 = 51.79 i.e. approx. = ` 32,214/ `936.52 = 34.40 i.e. approx.
52 bonds 34 bonds
Note: The investor has to keep the money invested for two years. Therefore, the investor
can invest in both the bonds with the assumption that Bond X will be reinvested for
another one year on same returns.
Further, in the above computation, Modified Duration can also be used instead of
Duration.
2. (a) Conversion Value of Debenture
= Market Price of one Equity Share X Conversion Ratio
= ` 25 X 30 = 750
(b) Market Conversion Price
Market Pr ice of ConvertibleDebenture
=
ConversionRatio
` 900
= = ` 30
30
(c) Conversion Premium per share
Market Conversion Price – Market Price of Equity Share
= ` 30 – ` 25 = ` 5
(d) Ratio of Conversion Premium
Conversion premium per share `5
= = 20%
Market Price of Equity Share ` 25
(e) Premium over Straight Value of Debenture

Market Price of Convertible Bond ` 900
–1= – 1 = 28.6%
Straight Value of Bond ` 700
(f) Favourable income differential per share
Coupon Interest from Debenture - Conversion Ratio  Dividend Per Share
Conversion Ratio
` 85- 30  ` 1
= ` 1.833
30
(g) Premium pay back period
Conversion premium per share ` 5
= = 2.73 years
Favourable Income Differntial Per Share ` 1.833
3. We have E p = W1E1 + W3E3 + ………… WnEn
n n
and for standard deviation σ 2p = ∑∑ wiw jσij
i=1 j=1
n n
σ2p = ∑∑ wiw jρij σi σ j
i=1 j=1
Two asset portfolio

σ2p = w21σ21 + w22σ22 + 2 w1w2σ1σ2ρ12
Substituting the respective values we get,
(i) All funds invested in B
Ep = 12%
σp= 10%
(ii) 50% of funds in each of B & D
Ep = 0.50X12%+0.50X20%=16%
σ2p = (0.50) 2(10%)2 + (0.50)2(18%)2 +2(0.50)(0.50)(0.15)(10%)(18%)
σ2p = 25 + 81 + 13.5 = 119.50
σp= 10.93%
(iii) 75% in B and 25% in D

Ep = 0.75%X12%+0.25%X20=14%
σ2p = (0.75) 2(10%)2 + (0.25)2(18%)2 +2(0.75)(0.25)(0.15)(10%)(18%)
σ2p = 56.25 + 20.25 + 10.125 = 86.625
σp= 9.31%
(iv) All funds in D
Ep = 20%
σp= 18.0%
Portfolio (i) (ii) (iii) (iv)
Return 12 16 14 20
Σ 10 10.93 9.31 18
In the terms of return, we see that portfolio (iv) is the best portfolio. In terms of risk we
see that portfolio (iii) is the best portfolio.
4.
Security No. of shares Market Price of (1) × (2) % to ß (x) wx
(1) Per Share (2) total (w)
VSL 10000 50 500000 0.4167 0.9 0.375
CSL 5000 20 100000 0.0833 1 0.083
SML 8000 25 200000 0.1667 1.5 0.250
APL 2000 200 400000 0.3333 1.2 0.400
1200000 1 1.108
Portfolio beta 1.108
(i) Required Beta 0.8
It should become (0.8 / 1.108) 72.2 % of present portfolio
If ` 12,00,000 is 72.20%, the total portfolio should be
` 12,00,000 × 100/72.20 or ` 16,62,050
Additional investment in zero risk should be (` 16,62,050–` 12,00,000)= ` 4,62,050
Security No. of Market Price (1) × (2) % to ß (x) wx
shares of Per Share total (w)
(1) (2)
VSL 10000 50 500000 0.3008 0.9 0.271
CSL 5000 20 100000 0.0602 1 0.060

SML 8000 25 200000 0.1203 1.5 0.180
APL 2000 200 400000 0.2407 1.2 0.289
Risk free 46205 10 462050 0.2780 0 0
asset
1662050 1 0.800
(ii) To increase Beta to 1.2
Required beta 1.2
It should become 1.2 / 1.108 108.30% of present beta
If 1200000 is 108.30%, the total portfolio should be
` 1200000 × 100/108.30 or ` 1108033 say ` 1108030
Additional investment should be (-) ` 91,967 i.e. Divest ` 91970 of Risk Free Asset
Security No. of Market Price (1) × (2) % to total ß (x) wx
shares of Per Share (w)
(1) (2)
VSL 10000 50 500000 0.4513 0.9 0.406
CSL 5000 20 100000 0.0903 1 0.090
SML 8000 25 200000 0.1805 1.5 0.271
APL 2000 200 400000 0.3610 1.2 0.433
Risk free asset -9197 10 -91970 -0.0830 0 0
1108030 1 1.20
Portfolio beta 1.20
5. Let portfolio standard deviation be σ p
Market Standard Deviation = σ m
Coefficient of correlation = r
σ pr
Portfolio beta (β p) =
σm
Required portfolio return (Rp) = Rf + βp (Rm – Rf)
Portfolio Beta Return from the portfolio (Rp) (%)
A 1.75 17.75
B 0.90 13.50
C 0.65 12.25
D 1.25 15.25
E 0.90 13.50
Portfolio Sharpe Method Treynor Method Jensen's Alpha

Ratio Rank Ratio Rank Ratio Rank
A 4.00 IV 5.71 V 1.25 V
B 3.00 V 6.67 IV 1.50 IV
C 7.50 I 9.23 I 2.75 II
D 4.25 III 6.80 III 2.25 III
E 4.50 II 9.00 II 3.60 I
6. (i) The optional hedge ratio to minimize the variance of Hedger’s position is given by:
S
H= 
F
Where
σS = Standard deviation of ΔS (Change in Spot Prices)
σF =Standard deviation of ΔF (Change in Future Prices)
ρ = coefficient of correlation between ΔS and ΔF
H = Hedge Ratio
ΔS = change in Spot price.
ΔF = change in Future price.
Accordingly
Standard deviation of ΔS = 16% = 4% and
Standard deviation of ΔF = 36% = 6% and

0.04
H = 0.75 x = 0.5
0.06
(ii) Since the company is long position in Spot (Cash) Market it shall take Short Position
in Future Market.
(iii) Since contact size of one contract is 1,000 Kg,
10,000 Kgs
No. of contract to be short = × 0.50 = 5 Contracts
1,000 Kgs
Amount = ` 5000 x 534 = ` 26,70,000
7.
Shares No. of shares Market Price of × (2) % to ß (x) Wx
(lakhs) (1) Per Share (2) (` lakhs) total (w)
A Ltd. 3.00 500.00 1500.00 0.30 1.40 0.42
B Ltd. 4.00 750.00 3000.00 0.60 1.20 0.72
C Ltd. 2.00 250.00 500.00 0.10 1.60 0.16
5000.00 1.00 1.30
(a) Portfolio beta 1.30
(b) Required Beta 0.91
Let the proportion of risk free securities for target beta 0.91 = p
0.91 = 0 × p + 1.30 (1 – p)
p = 0.30 i.e. 30%
Shares to be disposed off to reduce beta (5000 × 30%) ` 1,500 lakh and Risk Free
securities to be acquired.
(c) Number of shares of each company to be disposed off
Shares % to total Proportionate Market Price No. of Shares
(w) Amount (` lakhs) Per Share ` (Lakh)
A Ltd. 0.30 450.00 500.00 0.90
B Ltd. 0.60 900.00 750.00 1.20
C Ltd. 0.10 150.00 250.00 0.60
(d) Number of Nifty Contract to be sold
(1.30-0.91) × 5000 lakh
= 120 contracts
8,125 × 200
(e) 2% rise in Nifty is accompanied by 2% x 1.30 i.e. 2.6% rise in portfolio of shares
` Lakh
Current Value of Portfolio of Shares 5000
Value of Portfolio after rise 5130
Mark-to-Market Margin paid (` 8125 × 0.020 × 200 × 120) 39
Value of the portfolio after rise of Nifty 5091

% change in value of portfolio (5091 – 5000)/ 5000 1.82%
% rise in the value of Nifty 2%
Beta 0.91
8. (i) If investment is made at London
Convert US$ 5,00,000 at Spot Rate (5,00,000/1.5390) = £ 3,24,886
Add: £ Interest for 3 months on £ 324,886 @ 5% =£ 4,061
= £ 3,28,947
Less: Amount Invested $ 5,00,000
Interest accrued thereon $ 5,000
= $ 5,05,000
Equivalent amount of £ required to pay the
above sum ($ 5,05,000/1.5430*) = £ 3,27,285
(ii) If investment is made at New York
Gain $ 5,00,000 (8% - 4%) x 3/12 = $ 5,000
Equivalent amount in £ 3 months ($ 5,000/ 1.5475) £ 3,231
(iii) If investment is made at Frankfurt
Convert US$ 500,000 at Spot Rate (Cross Rate) 1.8260/1.5390 = € 1.1865
Euro equivalent US$ 500,000 = € 5,93,250
Add: Interest for 3 months @ 3% =€ 4,449
= € 5,97,699
3 month Forward Rate of selling € (1/1.8150) = £ 0.5510
Sell € in Forward Market € 5,97,699 x £ 0.5510 = £ 3,29,332
Less: Amounted invested and interest thereon = £ 3,27,285
Since out of three options the maximum profit is in case investment is made in New
York. Hence it should be opted.
* Due to conservative outlook.
9. To evaluate which option would be better we shall compute the outflow under each
option as follows:
(i) Pay Immediately availing discount
Particulars
Spot Rate ` 66.98
Amount required in US$ [US$ 8 Million (1 – 0.01)] US$ 7.92 Million
Amount required in ` [` 66.98 x US$ 7.92 Million] ` 53.0482 Crore
Cash Available ` 0.2500 Crore
Loan required ` 52.7982 Crore
Interest for 90 days @ 9% ` 1.1880 Crore
Total Outflow ` 53.9862 Crore
(ii) Pay the supplier on 60 th day and avail bank’s loan (after utilizing cash) for 30
days.
Particulars
Applicable Forward Rate ` 67.16
Amount required in [` 67.16 x US$ 8 Million] ` 53.7280 Crore
Loan required [` 53.7280 Crore – ` 0.25 ` 53.4780 Crore
Crore]
Interest for 30 days @ 9% ` 0.4011 Crore
` 53.8791 Crore
Interest earned on Cash for ` 0.0017 Crore
60 days @ 4%
(iii) Avail supplier offer of 90 days credit and utilize cash available
Particulars
Amount Payable US$ 8 Million
Interest for 30 days @ 8% US$ 0.0533 Million
Amount required in ` US$ 8.0533 Million
Applicable Forward Rate ` 68.03
Amount required in ` [` 68.03 x US$ 8.0533 ` 54.7866 Crore
Million]
Cash Available ` 0.2500 Crore
Interest earned on Cash ` 0.0025 Crore

for 90 days @ 4%
Decision: Cash outflow is least in case of Option (ii) same should be opted for.
`
Revenue 60,00,00,000
Less: Costs:
Rent 18,75,000
Manpower (400 x 80 x 10 x 365) 14,60,00,000
Less: Withholding Tax 4,50,62,500
Earnings after Withholding tax @ 10% 40,55,62,500
Less: Corporation Tax net of Withholding Tax 9,01,25,000
Repatriation amount (in dollars) $ 52,57,292
Advise: The USA based Company should charge minimum $ 47,42,708 from prospective
buyer.
11. (i) The given swap arrangement is Plain Vanilla Overnight Index Swap (OIS).
(ii) To compute the Net Settlement amount we shall compute Interest as per floating
rate as follows:
Day Principal (`) MIBOR (%) Interest (`)
Tuesday 10,00,00,000 8.15 22,329
Wednesday 10,00,22,329 7.98 21,868
Thursday 10,00,44,197 7.95 21,790
Friday 10,00,65,987 8.12 22,261
Saturday & Sunday (*) 10,00,88,248 8.15 44,697
Monday 10,01,32,945 7.75 21,261
Total Interest @ Floating Rate (A) 1,54,206
Total Interest @ Fixed Rate (B) 1,53,425
7
10,00,00,000× 8.00% 
365
Net Settlement Amount Paid 781
12. First of all, to calculate Cost of Equity we shall compute the Equity Beta of STR Ltd. as
follows:
 E 
β a =β e  
 E+ D(1- t) 
 250 
1.11=β e  
 250+ 80(1- 0.30) 
βe = 1.36
then we shall compute the Cost of Equity as per CAPM as follows:
ke = Rf + β x Market Risk Premium
= 8.5% + 1.36 x 9%
= 8.5% + 12.24% = 20.74%
Cost of Debt (k d) = 11%(1 – 0.30) = 7.70%
E D
WACC (k o) = k ex + k dx
E+D E+D
250 80
= 20.74x + 7.70x
330 330
= 15.71 + 1.87 = 17.58%
Taxable Income = ` 50 Crore/(1 - 0.30)
= ` 7142.86 lakhs
Operating Income = Taxable Income + Interest
= ` 7142.86 lakhs + ` 880 lakhs
= ` 8022.86 lakhs
EVA = EBIT (1-Tax Rate) – WACC x Invested Capital
= ` 8022.86 lakhs (1 – 0.30) – 17.58% x ` 330 Crore
= ` 5616.00 lakhs – ` 5801.40 lakhs = - ` 185.40 lakhs
13. (i) Exchange ratio in proportion to relative EPS

(in `)
Company Existing No. of shares EPS Total earnings
Cauliflower Ltd. 5,00,000 5.00 25,00,000
Cabbage Ltd. 3,00,000 3.00 9,00,000
Total earnings 34,00,000
No. of shares after merger 5,00,000 + 1,80,000 = 6,80,000
 3.00 
Note: 1,80,000 may be calculated as =  3,00,000 × 
 5.00 
EPS for Cauliflower Ltd. after merger = 34,00,000 = 5.00

6,80,000
Impact on EPS
`
Cauliflower Ltd. ‘s shareholders
EPS before merger 5.00
EPS after merger 5.00
Increase/ Decrease in EPS 0.00
Cabbage Ltd. ‘s shareholders
EPS after the merger 5.00 x 3/5 3.00
Increase/ Decrease in EPS 0.00
(ii) Merger effect on EPS with share exchange ratio of 1 : 2
Total earnings after merger ` 34,00,000
No. of shares post merger 5,00,000 + 1,50,000 (0.5 × 3,00,000) 6,50,000
EPS (34,00,000 ÷ 6,50,000) ` 5.23
Impact on EPS
`
Cauliflower Ltd. shareholders
EPS after merger 5.23
Increase in EPS 0.23
Cabbage Ltd. Shareholders

EPS after the merger 5.23 x 0.5 2.615
Decrease in EPS 0.385
14. Although the statement “a company with no commercial operation can launch an IPO”
appears to be absurd but this is a fact that even if company does not have any business,
it can float an IPO. In recent time the concept of Special Purpose Acquisition Companies
(SPACs) has come into existence wherein an entity is set up with the objective to raise
funds through an IPO to finance a merger or acquisition of an unidentified target within a
specific time period. It is commonly known as a blank cheque company.
The main objective of SPAC is to raise money, despite having any operations or
revenues. The money raised from the public is kept in an escrow account, which can be
accessed while making the acquisition. However, in case the acquisition is not made
within stipulated period of time of the IPO, the SPAC is delisted and the money is
returned to the investors. Shareholders have the option to redeem their shares if they are
not interested in participating in the proposed merger. Finally, if the merger is approved
by shareholders, it is executed, and the target private company or companies become
public entities. Once a formal merger agreement has been executed the SPAC target is
usually publicly announced.
New investment opportunities in Indian companies have resurfaced and have set up new
platform for SPAC transactions. The implementation of SPACs might face certain
challenges since India does not have a specific regulatory framework guarding these
transactions.
The current regulatory framework in India does not support the SPAC transactions.
Further as per the Companies Act, 2013, the Registrar of Companies is authorized to
strike-off the name of companies that do not commence operation within one year of
incorporation. SPACs generally take 2 to 3 years to identify a target and performing due
diligence and before it could get operationalized its name can be stricken off and hence
enabling provisions relating to SPAC need to be inserted in the Companies Act in order
to make it functional in India.
Though, SPACs do not find acceptance under the Securities and Exchange Board of
India (SEBI) Act as it does not meet the eligibility criteria for public listing however SEBI
is planning to come out with a framework for SPACs.
The International Financial Services Centres Authority (IFSCA), being the regulatory
authority for development and regulation of financial services, financial products and
financial institutions in the Gujarat International Finance Tec-City, has recently released
a consultation paper defining critical parameters such as offer size to public, compulsory
sponsor holding, minimum application size, minimum subscription of the offer size, etc.
SPAC approach offers several advantages over traditional IPO, such as providing
companies access to capital, even when market volatility and other conditions limit
liquidity. SPACs help to lower the transaction fees as well as expedite the timeline in
becoming a public company. Raising money through a SPAC is easier as compared to
traditional IPO since the SPAC has already raised money through an IPO. This implies
the company in question only has to negotiate with a single entity, as opposed to
thousands of individual investors. This makes the process of fundraising a lot easier and
quicker than through an IPO. The involvement of skilled professionals in identifying the
target makes the investment a well thought and a well governed process.
However, the merger of a SPAC with a target company presents several challenges,
such as complex accounting and financial reporting/registration requirements , to meet a
public company readiness timeline and being ready to operate as a public company
within a period of three to five months of signing a letter of intent.
It is typically more expensive for a company to raise money through a SPAC than an
IPO. Investors’ money invested in a SPAC trust to earn a suitable return for up to two
years, could be put to better use elsewhere.
15. Every startup needs access to capital, whether for funding product development,
acquiring machinery and inventory or paying salaries to its employees. Most
entrepreneurs consider bank loans as the primary source of money, only to find out that
banks are really the least likely benefactors for startups. Thus, innovative measures
include maximizing non-bank financing.
Here are some of the sources for funding a Start-up:
(i) Personal financing: It may not seem to be innovative but you may be surprised to
note that most budding entrepreneurs never thought of saving any money to start a
business. This is important because most of the investors will not put money into a
deal if they see that you have not contributed any money from your personal
sources.
(ii) Personal credit lines: One qualifies for personal credit line based on one’s
personal credit efforts. Credit cards are a good example of this. However, banks are
very cautious while granting personal credit lines. They provide this facility only
when the business has enough cash flow to repay the line of credit.
(iii) Family and friends: These are the people who generally believe in you, without
even thinking that your idea works or not. However, the loan obligations to friends
and relatives should always be in writing as a promissory note or otherwise.
(iv) Peer-to-peer lending: In this process, group of people come together and lend
money to each other. Peer to peer lending has been there for many years. Many
small and ethnic business groups having similar faith or interest generally support
each other in their start up endeavors.
(v) Crowdfunding: Crowdfunding is the use of small amounts of capital from a large
number of individuals to finance a new business initiative. Crowdfunding makes use
of the easy accessibility of vast networks of people through social media and
crowdfunding websites to bring investors and entrepreneurs together.
(vi) Microloans: Microloans are small loans that are given by individuals at a lower
interest to a new business ventures. These loans can be issued by a single
individual or aggregated across a number of individuals who each contribute a
portion of the total amount.
(vii) Vendor financing: Vendor financing is the form of financing in which a company
lends money to one of its customers so that he can buy products from the company
itself. Vendor financing also takes place when many manufacturers and distributors
are convinced to defer payment until the goods are sold. This means extending the
payment terms to a longer period for e.g. 30 days payment period can be extended
to 45 days or 60 days. However, this depends on one’s credit worthiness.
(viii) Purchase order financing: The most common scaling problem faced by startups is
the inability to find a large new order. The reason is that they don’t have the
necessary cash to produce and deliver the product. Purchase order financing
companies often advance the required funds directly to the supplier. This allows the
completion of transaction and profit flows up to the new business.
(ix) Factoring accounts receivables: In this method, a facility is given to the seller
who has sold the good on credit to fund his receivables till the amount is fully
received. So, when the goods are sold on credit, and the credit period (i.e. the date
upto which payment shall be made) is for example 6 months, factor will pay most of
the sold amount up front and rest of the amount later. Therefore, in this way, a
startup can meet his day-to-day expenses.
Paper – 2: STRATEGIC FINANCIAL MANAGEMENT
QUESTIONS
Security Valuation
1. Mr. A is holding 1000 shares of face value of ` 100 each of M/s. ABC Ltd. He wants to
hold these shares for long term and have no intention to sell.
On 1st January 2020, M/s XYZ Ltd. has made short sales of M/s. ABC Ltd.’s shares and
approached Mr. A to lend his shares under Stock Lending Scheme with f ollowing terms:
(i) Shares to be borrowed for 3 months from 01-01-2020 to 31-03-2020,
(ii) Lending Charges/Fees of 1% to be paid every month on the closing price of the
stock quoted in Stock Exchange and
(iii) Bank Guarantee will be provided as collateral for the value as on 01-01-2020.
Other Information:
(a) Cost of Bank Guarantee is 8% per annum,
(b) On 29-02-2020 M/s ABC Ltd.’s share quoted in Stock Exchange on various dates
are as follows:
Date Share Price in Share Price in
Scenario -1 Bullish Scenario -2 Bullish
01-01-2020 1000 1000
31-01-2020 1020 980
29-02-2020 1040 960
31-03-2020 1050 940
You are required to find out:
(i) Earning of Mr. A through Stock Lending Scheme in both the scenarios,
(ii) Total Earnings of Mr. A during 01-01-2020 to 31-03-2020 in both the scenarios,
(iii) What is the Profit or loss to M/s. XYZ by shorting the shares using through Stock
Lending Scheme in both the scenarios?
2. Following is the information for the options free bond:
Face value of the bond ` 1,000
Coupon rate 7%
Terms of Maturity 7 years
Yield to Maturity 8%

2 FINAL EXAMINATION: MAY, 2022

(i) Market price of the bound and duration.
(ii) If there is an increase in yield by 35 basis points, what would be the price of bond?
Present Value t1 t2 t3 t4 t5 t6 t7
PVIF0.07,t 0.935 0.874 0.817 0.764 0.714 0.667 0.623
PVIF0.08,t 0.926 0.857 0.794 0.735 0.681 0.631 0.584
3. Mr. A is having 1 lakh shares of K Ltd. The beta of the company is 1.40.
Mr. B a financial advisor has suggested having the following portfolio:
Security Beta % holding
L 1.20 10
M 0.75 10
N 0.40 30
O 1.40 50
100
Market Return is 12%
Risk free rate is 8%
You. Are required to calculate the following for the present investment and suggested
portfolio:
(i) What is the expected return based on CAPM and also
(1) If the market goes upby 2.5%.
(2) If the market goes down by 2.5%.
(3) If the market is giving a negative return of 2.5%.
(ii) If the probability of market giving negative return is more, please advise Mr. A
whether to continue the holdings of M/s. K Ltd. or to buy the portfolio as per the
suggestion of Mr. B. If so, why?
4. Mayuri is interested to construct a Portfolio of Securities X and Y. She has collected the
following information:
X Y
Expected Return (ER) 19% 23%
Risk (  ) 14% 18%

Mayuri has 5 Portfolio options of X and Y as follows:

(i) 50% of funds in each X and Y
(ii) 75% of funds in X and 25% in Y
(iii) 25% of funds in X and 75% in Y
(iv) 60% of funds in X and 40% in Y
(v) 35% of funds in X and 65% in Y
Suppose if Co-efficient of correlation (r) between X and Y is 0.16, you are required to
calculate:
(i) Expected Return under different Portfolio Options.
(ii) Risk Factor associated with these Portfolio Options.
(iii) Which Portfolio is best from the point of view of Risk?
(iv) Which Portfolio is best from the point of view of Return?
Mutual Funds
5. On 1st April, an open ended scheme of mutual fund had 400 lakh units outstanding with
Net Assets Value (NAV) of `19. At the end of April, it issued 5 lakh units at an opening
NAV plus 2% load, adjusted for dividend equalization. At the end of May, 4 Lakh units
were repurchased at the opening NAV less 2% exit load adjusted for dividend
equilization. At the end of June, 60% of its available income was distributed.
In respect of April-June quarter, the following additional information is available:
Particulars ` in Lakhs
Portfolio value appreciation 515.67
Income of April 31.960
Income of May 46.125
Income for June 58.470
(i) Income available for distribution;
(ii) Issue price at the end of April;
(iii) Repurchase price at the end of May; and
(iv) Net Asset Value (NAV) as on 30 th June.

Derivatives Analysis & Valuation

6. Mr. P established the following spread on the Coastal Corporation’s stock:
(i) Purchased one 3-month call option with a premium of ` 6.5 and an Exercise price of
` 110.
(ii) Purchased one 3-month put option with a premium of ` 10 and an Exercise price of
` 90.
Coastal Corporation’s stock is currently selling at ` 100. Determine profit or loss, if the
price of Coastal Corporation’s stock:
(i) Remains at ` 100 after 3 months.
(ii) Falls at ` 70 after 3 months.
(iii) Rises to ` 138 after 3 months.
Assume the size of option is 1,000 shares of Coastal Corporation.
7. Following information is available for consideration:
BSE Index 25,000
Value of portfolio ` 50,50,000
Risk free interest rate 9% p.a.
Dividend yield on Index 6% p.a.
Beta of portfolio 1.5
We assume that a future contract on the BSE index with 4 months maturity is used to
hedge the value of portfolio over next 3 months. One future contract is for delivery of 50
times the index.
Based on the above information calculate:
(i) Price of future contract.
(ii) Gain on short futures position if index turns out to be 22,500 in 3 months.
Note: Daily compounding (exponential) formula is not required to be used.
Foreign Exchange Exposure & Risk Management
8. A US investor chose to invest in Sensex for a period of one year. The relevant
information is given below.
Size of investment ($) 20,00,000
Spot rate 1 year ago (`/$) 42.50/60
Spot rate now (`/$) 43.85/90

Sensex 1 year ago 3,256

Senex now 3,765
Inflation in US 5%
Inflation in India 9%
(i) Compute the nominal rate of return to the US investor.
(ii) Compute the real depreciation /appreciation of Rupee.
(iii) What should be the exchange rate if relevant purchasing power parity holds good?
(iv) What will be the real return to an Indian investor in Sensex?
9. Mr. Mammen, an Indian investor invests in a listed bond in USA. If the price of the bond
at the beginning of the year is USD 100 and it is USD 103 at the end of the year. The
coupon rate is 3% payable annually.
Find the return on investment in terms of home country currency if:
(i) USD is Flat.
(ii) USD appreciates during the year by 3%.
(iii) USD depreciates during the year by 3%.
(iv) Indian Rupee appreciates during the year by 5%.
(v) Will your answer differ if Mr. Mammen invests in the bond just before the interest
payable.
10. M/s. Raghu Ltd. is interested in expanding its operation and planning to install
manufacturing plant at US. It requires 8.82 million USD (net of issue expenses/ floatation
cost) to fund the proposed project. GDRs are proposed to be issued to finance this
project. The estimated floatation cost of GDRs is 2%.
Additional information:
(i) Expected market price of share at the time of issue of GDR is ` 360 (Face Value
` 100)
(ii) Each GDR will represent two underlying Shares.
(iii) The issue shall be priced at 10% discount to the market price.
(iv) Expected exchange rate is INR/USD 72.
(v) Dividend is expected to be paid at the rate of 20% with growth rate of 12%.
(1) You, as a financial consultant, are required to compute the number of GDRs to
be issued and cost of the GDR.

(2) What is your suggestion if the company receives an offer from a US Bank
willing to provide an equivalent loan with an interest rate of 12%?
(3) How much company can save by choosing the option as recommended by
you?
11. A textile manufacturer has taken floating interest rate loan of ` 40,00,000 on 1st April,
2012. The rate of interest at the inception of loan is 8.5% p.a. interest is to be paid every
year on 31 st March, and the duration of loan is four years.
(i) Suppose in the month of October 2012, the Central bank of the country releases
following projections about the interest rates likely to prevail in future.
Date Rate of Interest
On 31st March, 2013 8.75%
On 31st March, 2014 10.00%
On 31st March, 2015 10.50%
On 31st March, 2016 7.75%
Show how borrower can hedge the risk arising out of expected rise in the rate of
interest when he wants to peg his interest cost at 8.50% p.a.
(ii) Assume that the premium negotiated by both the parties is 0.75% to be paid on
1st October, 2012 and the actual rate of interest on the respective due dates
happens to be as follows:
Date Rate of Interest
On 31st
March, 2013 10.20%
On 31 March, 2014
st 11.50%
On 31st March, 2015 9.25%
On 31st March, 2016 8.25%
Show how the settlement will be executed on the perspective interest due dates.
Corporate Valuation
12. Herbal Box is a small but profitable producer of beauty cosmetics using the plant Aloe
Vera. Though it is not a high-tech business, yet Herbal’s earnings have averaged around
` 18.50 lakhs after tax, mainly on the strength of its patented beauty cream to remove
the pimples.
The patent has nine years to run, and Herbal Box has been offered ` 50 lakhs for the
patent rights. Herbal’s assets include ` 50 lakhs of property, plant and equipment, and
` 25 lakhs of working capital. However, the patent is not shown on the books of Herbal

Box. Assuming Herbal’s cost of capital being 14 percent, calculate its Economic Value
Added (EVA).
13. B Ltd. Wants to acquire S Ltd. and has offered a swap ratio of 2:3 (2 shares for every 3
share of S Ltd.). Following information is available:
Particulars B Ltd. S Ltd.
Profit after tax (in `) 21,00,000 4,50,000
Equity shares outstanding (Nos.) 6,00,000 1,80,000
EPS (`) 3.5 2.5
PE Ratio 10 times 7 times
Price quoting per share on BSE before the merger
announcement (`) 35.00 17.50
Required:
(i) The number of equity shares to be issued by B Ltd. for acquisition of S Ltd.
(ii) What is the EPS of B Ltd. after the acquisition?
(iii) Determine the equivalent earnings per share of S Ltd. and calculate per share gain
or loss to shareholders of S Ltd.
(iv) What is the expected market price per share of B Ltd. after the acquisition,
assuming its PE Multiple remains unchanged?
(v) Determine the market value of the merged firm.
(vi) After the announcement of merger, price of shares of S Ltd. rose by 10% on BSE.
Mr. X, an investor, having 10,000 shares of S Ltd. is having another investment
opportunity, which yields annual return of 14% is seeking your advice whether he
needs to offload the shares in the market or accept the shares from B Ltd.
14. Unrelated companies come together to form an entity. What this relationship is called?
Discuss briefly the features of this entity.
15. There exists a vast difference between Project and Parent cash flow?
What are these factors? Briefly discuss.

1. Earnings of Mr. A through stock lending scheme

Scenario 1 Scenario 2
(i) Lending fee
31-01-20 1020 x 1% and 980 x 1% 10.20 9.80
29-02-20 1040 x 1% and 960 x 1% 10.40 9.60
31-03-20 1050 x 1% and 940 x 1% 10.50 9.40
Earnings from lending per Share (A) 31.10 28.80
Total No. of Shares 1000 1000
Total Earning from Lending 31,100 28,800
(ii) Dividend income per Share (B) 25.00 25.00
Total earnings per share (A) + (B) 56.10 53.80
Total Earning 56,100 53,800
(iii) Gain on shortening the shares
(1,050 - 1,000) and (1,000 - 940) (50.00) 60.00
Lending fees paid (31.10) (28.80)
Bank guarantee charges @ 8% (20.00) (20.00)
Gain Per Share (101.10) 11.20
Total Gain on shortening the shares (1,01,100) 11,200
2. (i) (1) Market price and duration of Bond
= 70 (PVIAF 8%,7) + 1,000 (PVIF 8%,7)
= 70 (5.208) + 1,000 (0.584) = 364.56 + 584.00 = 948.56
(2) Duration of Bond
Period Cash flow (`) PVF@ 8% PV (`) (E)
(A) (B) (C) (D) = (B) x (C) = (A) x (D)
1 70 0.926 64.82 64.82
2 70 0.857 59.99 119.98
3 70 0.794 55.58 166.74
4 70 0.735 51.45 205.80

5 70 0.681 47.67 238.35

6 70 0.631 44.17 265.02
7 1,070 0.584 624.88 4374.16
948.56 5434.87
5434.87
Duration of the Bond is = 5.73 years
948.56
(ii) Price of Bond if increase in yield by 35 basis points
Period Cash flow (`) PVF@8.35% PV (`)
1 70 0.923 64.61
2 70 0.852 59.64
3 70 0.786 55.02
4 70 0.726 50.82
5 70 0.670 46.90
6 70 0.618 43.26
7 1,070 0.570 609.90
930.15
Alternatively, if the same increase in yield is linked with duration as computed in sub
part (i), then answer will be computed as follows:
Duration 5.73
Volatility of Bond = = = 5.306
1 + YTM 1+0.08
The expected market price if increase in yield is by 35 basis points.
= ` 948.56  0.35 (5.306/100) = ` 17.62
Hence expected market price is ` 948.56 – ` 17.62 = ` 930.94
Hence, the market price will decrease with increase in the yield.
3. Working Notes -
Calculation of Portfolio Beta suggested by Mr. B
Security Beta Wt. of Holding Beta x Wt. of Holding
L 1.20 0.1 0.120
M 0.75 0.1 0.075
N 0.40 0.3 0.120
O 1.40 0.5 0.700
Total 1.0 1.015

Portfolio Beta is 1.015

Calculation of Expected Return based on CAPM at present situation-
Particulars Risk Beta Market Risk Beta X Expected
Free Return Premium Risk Return
Rate (Rf) = Rm-Rf Premium
a b c d e=d-b f=cxe g=b+f
K Ltd. 8 1.400 12 4 5.600 13.60
Portfolio 8 1.015 12 4 4.060 12.06
(i) (1) Calculation of Expected Return based on CAPM if market goes up by 2.5%:
Rate (Rf) = Rm- Rf Premium
a b c d e=d-b f=cXe g=b+f
K Ltd. 8 1.400 14.5 6.5 9.100 17.10
Portfolio 8 1.015 14.5 6.5 6.598 14.60
(2) Calculation of Expected Return based on CAPM if market goes down by 2.5%:
Particular Risk Beta Market Risk Beta X Expected
s Free Return Premium Risk Return
Rate(Rf) = Rm - Rf Premium
a b c d e=d-b f=cXe g=b+f
K Ltd. 8 1.400 9.5 1.5 2.100 10.10
Portfolio 8 1.015 9.5 1.5 1.523 9.52
(3) Calculation of Expected Return based on CAPM if market gives negative
returns of 2.5%-
Rate(Rf) = Rm-Rf Premium
a b c d e=d-b f=cXe G=b+f
K Ltd. 8 1.400 -2.5 -10.5 -14.700 -6.70
Portfolio 8 1.015 -2.5 -10.5 -10.658 -2.66

(ii) If the probability of market giving negative return is more, it is advisable to Mr. A to
buy the portfolio suggested by Mr. B because Beta of the portfolio is less than of K
Ltd.
4. We have Ep = W1E1 + W3E3 + ………… WnEn
n n
and for standard deviation σ 2p = ∑∑ wiw jσij
i=1 j=1
n n
σ2p = ∑∑ wiw jρij σi σ j
i=1 j=1
Two asset portfolio

σ2p = w21σ21 + w22σ22 + 2 w1w2σ1σ2ρ12
Or
σp = √w1σ1 + w2σ2 + 2 w1w2σ1σ2ρ12
Substituting the respective values we get,
(i) 50% of funds in each of X and Y
Ep = 0.50 X 19% + 0.50 X 23%= 21%
σ2p = (0.50) 2(14%)2 + (0.50)2(18%)2 + 2(0.50)(0.50)(0.16)(14%)(18%)
σ2p = 49 + 81 + 20.16 = 150.16
σp= 12.25%
(ii) 75% in X and 25% in Y
Ep = 0.75 X 19% + 0.25 X 23% = 20%
σ2p = (0.75)2(14%)2 + (0.25)2(18%)2 + 2(0.75)(0.25)(0.16)(14%)(18%)
σ2p = 110.25 + 20.25 + 15.12 = 145.62
σp= 12.07%
(iii) 25% in X and 75% in Y
Ep = 0.25 X 19% + 0.75 X 23% =22%
σ2p = (0.25)2(14%)2 + (0.75)2(18%)2 + 2(0.25)(0.75)(0.16)(14%)(18%)
σ2p = 12.25 + 182.25 + 15.12 = 209.62
σp= 14.48%

(iv) 60% in X and 40% in Y

Ep = 0.60 X 19% + 0.40 X 23% = 20.60%
σ2p = (0.60) 2(14%)2 + (0.40)2(18%)2 +2(0.60)(0.40)(0.16)(14%)(18%)
σ2p = 70.56 + 51.84 + 19.35 = 141.75
σp= 11.91%
(v) 35% in X and 65% in Y
Ep = 0.35 X 19% + 0.65 X 23% = 21.60%
σ2p = (0.35) 2(14%)2 + (0.65)2(18%)2 +2(0.35)(0.65)(0.16)(14%)(18%)
σ2p = 24.01 + 136.89 + 18.35 = 179.25
σp= 13.39%
Portfolio (i) (ii) (iii) (iv) (v)
Return 21.00 20.00 22.00 20.60 21.60
σ 12.25 12.07 14.48 11.91 13.39
In the terms of return, we see that portfolio (iii) is the best portfolio.
In terms of risk we see that portfolio (iv) is the best portfolio.
5. Calculation of Income available for Distribution
Units Per Unit Total
(Lakh) (`) (` In lakh)
Income from April 400 0.0799 31.960
Add: Dividend equalization collected on issue 5 0.0799 0.3995
405 0.0799 32.3595
Add: Income from May 0.1139 46.125
405 0.1938 78.4845
Less: Dividend equalization paid on repurchase 4 0.1938 (0.7752)
401 0.1938 77.7093
Add: Income from June 0.1458 58.470
401 0.3396 136.1793
Less: Dividend Paid 0.2038 (81.7076)
401 0.1358 54.4717

Calculation of Issue Price at the end of April

`
Opening NAV 19.00000
Add: Entry Load 2% of ` 19 (0.38000)
19.38000
Add: Dividend Equalization paid on Issue Price 0.07999
19.45999
Or 19.46
Calculation of Repurchase Price at the end of May
`
Opening NAV 19.0000
Less: Exit Load 2% of ` 19 (0.3800)
18.6200
Add: Dividend Equalization paid on Issue Price 0.1938
18.8138
Closing NAV as on 30 th June
` (Lakh)
Opening Net Asset Value (` 19 × 400) 7,600.0000
Portfolio Value Appreciation 515.6700
Issue of Fresh Units (5 × 19.46) 97.3000
Income Received (31.960 + 46.125 + 58.470) 136.5550
8349.5250
Less: Units repurchased (4 × 18.8138) 75.2552
Income Distributed 81.7076 156.9628
Closing Net Asset Value 8,192.5622
Closing Units (400 + 5 – 4) lakh 401 lakhs
 Closing NAV as on 30 th June ` 20.4303
6. (i) Total premium paid on purchasing a call and put option

= (` 6.50 per share × 1000) + (` 10 per share × 1000).
= ` 6,500 + ` 10,000 = ` 16,500

In this case, Mr. P exercises neither the call option nor the put option as both will
result in a loss for him.
Ending value = - ` 16,500 + zero gain = - ` 16,500
i.e. Net loss = ` 16,500
(ii) Since the price of the stock is below the exercise price of the call, the call will not be
exercised. Only put is valuable and is exercised.
Total premium paid = ` 16,500
Ending value = – ` 16,500 + `[(90 – 70) × 1000] = – ` 16,500 + ` 20,000 = ` 3,500
 Net gain = ` 3,500
(iii) In this situation, the put is worthless, since the price of the stock exceeds the put’s
exercise price. Only call option is valuable and is exercised.
Total premium paid = ` 16,500
Ending value = – ` 16,500 + ` [(138 – 110) × 1000]
 Net Gain = – ` 16,500 + ` 28,000 = ` 11,500
4
7. (i) Current future price of the index = 25000 + 25000 (0.09 - 0.06)
12
= 25000 + 250 = 25250
 Price of the future contract = ` 50 х 25,250 = ` 12,62,500
50,50,000
(ii) Hedge Ratio = ×1.5 = 6 contracts
12,62,500
Index after three months turns out to be 22500
1
Future price will be = 22500 + 22500 (0.09 - 0.06) × = 22556.25
12
Therefore, Gain from the short futures position is = 6 х (25250 – 22556.25) х 50
= ` 8,08,125
8. (i) Nominal rate of return to the US investor
Size of investment ($) 20,00,000
Size of investment (`) ($ 20,00,000 x 42.50) 8,50,00,000
Sensex at T o 3,256
No. of units of Sensex that can be purchased at T o
(` 8,50,00,000/3,256) 26,105
Sensex at T 1 3,765

Sale of Sensex (26,105 x 3,765) 9,82,85,325

US$ at T 1 ` 43.90
Equivalent Amount in US$ 22,38,846
Gain in US$ [22,38,846 – 20,00,000] 2,38,846
Nominal rate to US investor 11.94%
(ii) Real Appreciation/Depreciation of Rupee
(1 + 0.05)
Real Exchange Rate (Buying) = 43.85 = 42.24
(1 + 0.09)
42.50 - 42.24
Real Appreciation of ` = x 100 = 0.61%
42.50
(iii) Exchange rate if relevant purchasing power parity holds

(1 + 0.09)
Buying Rate = 42.50 = 44.12
(1 + 0.05)
(1 + 0.09)
Selling rate = 42.60 = 44.22
(1 + 0.05)
Exchange rate = 44.12/44.22
(iv) Real return to Indian Investor in Sensex

3,765 − 3,256
Nominal Return = x 100 = 15.63%
3,256
(1.1563)
Real return = - 1 = 0.0608 or 6.08%
(1.09)
9. (i) If USD is flat

(Price at end - Price at begining)+Interest
Return =
Price at begining
(103 - 100) + 3
=
100
3+3
= = 0.06 say 6%
100

(ii) If USD appreciates by 3%

(1+0.06)(1+0.03) -1 = 1.06 X1.03 - 1 = 0.0918 i.e. 9.18%
(iii) If USD depreciates by 3%
(1+0.06)(1-0.03) -1 = 1.06 X 0.97 - 1 = 0.0282 i.e. 2.82%
(iv) If Indian Rupee is appreciated by 5%
(1+0.06)(1-0.05) -1 = 1.06 X 0.95 - 1 = 0.007 i.e. 0.7%.
(v) No, our answer will not differ even if Mr. Mammen invests in bond just before the
interest is payable.
10. Net Issue Size = $ 8.82 million
8.82
0.98
Issue Price per GDR in $ (` 648/ ` 72) $ 9.00
Dividend Per GDR (D 1) = ` 20 x 2 = ` 40
Net Proceeds Per GDR = ` 648 x 0.98 = ` 635.04
(1) (a) Number of GDR to be issued
$ 9.00 million
= 1.00 million
$9
(b) Cost of GDR
40.00
ke = + 0.12 = 18.30%
635.04
(2) If the company receives an offer from US Bank willing to provide an equivalent
amount of loan with interest rate of 12%, it should accept the offer.
(3) If the offer is accepted there will be net saving of 6.30%.
11. As borrower does not want to pay more than 8.5% p.a., on this loan where the rate of
interest is likely to rise beyond this, hence, he has to hedge the risk by entering into an
agreement to buy interest rate caps with the following parameters:
• National Principal: ` 40,00,000/-
• Strike rate: 8.5% p.a.
• Reference rate: the rate of interest applicable to this loan
• Calculation and settlement date: 31 st March every year

• Duration of the caps: till 31 st March 2016

• Premium for caps: negotiable between both the parties
To purchase the caps this borrower is required to pay the premium upfront at the time of
buying caps. The payment of such premium will entitle him with right to receive the
compensation from the seller of the caps as soon as the rate of interest on this loan rises
above 8.5%. The compensation will be at the rate of the difference between the rate of
none of the cases the cost of this loan will rise above 8.5% calculated on ` 40,00,000/-.
This implies that in none of the cases the cost of this loan will rise above 8.5%. This
hedging benefit is received at the respective interest due dates at the cost of premium to
be paid only once.
The premium to be paid on 1 st October 2012 is 30,000/- (` 40,00,000 x 0.75/100). The
payment of this premium will entitle the buyer of the caps to receive the compensation
from the seller of the caps whereas the buyer will not have obligation. The compensation
received by the buyer of caps will be as follows:
On 31st March 2013
The buyer of the caps will receive the compensation at the rate of 1.70% (10.20 - 8.50) to
be calculated on ` 40,00,000, the amount of compensation will be ` 68,000/- (40,00,000
x 1.70/100).
On 31st March 2014
The buyer of the caps will receive the compensation at the rate of 3.00% (11.50 – 8.50)
to be calculated on ` 40,00,000/-, the amount of compensation will be ` 1,20,000/-
(40,00,000 x 3.00/100).
On 31st March 2015
The buyer of the caps will receive the compensation at the rate of 0.75% (9.25 – 8.50) to
be calculated on ` 40,00,000/-, the amount of compensation will be ` 30,000 (40,00,000
x 0.75/100).
On 31st March 2016
The buyer of the caps will not receive the compensation as the actual rate of interest is
8.25% whereas strike rate of caps is 8.5%. Hence, his interest liability shall not exceed
8.50%.
Thus, by paying the premium upfront buyer of the caps gets the compensation on the
respective interest due dates without any obligations.
12. EVA = Income Earned – (Cost of Capital x Total Investment)

Total Investments
Amount (` in Lakhs)
Property, Plant & Equipments 50.00
Patent Rights 50.00
Total 125.00
EVA = Profit Earned – WACC x Invested Capital
= ` 18.50 Lakhs – 14% x ` 125 Lakhs
= ` 1.00 Lakhs
13. (i) The number of shares to be issued by B Ltd.:
The Exchange ratio is 2:3
2
So, new Shares = 1,80,000 x = 1,20,000 shares.
3
(ii) EPS of B Ltd. after acquisition:
Total Earnings (` 21,00,000 + ` 4,50,000) `25,50,000
No. of Shares (6,00,000 + 1,20,000) 7,20,000
EPS (` 25,50,000/7,20,000) ` 3.5416 or 3.54
(iii) Equivalent EPS of S Ltd. and gain/loss to shareholders:
2 ` 2.36
Equivalent EPS of S Ltd. (` 3.54 x )
3
Less: EPS before merger 2.50
Loss (0.14)
(iv) New Market Price of B Ltd. (P/E remaining unchanged):
Present P/E Ratio of B Ltd. 10 times
Expected EPS after merger ` 3.54
Expected Market Price (`3.54 x 10) ` 35.40
(v) Market Value of merged firm:

Total number of Shares 7,20,000
Expected Market Price ` 35.40
Total value (7,20,000 x 35.40) ` 2,54,88,000

(vi)
a) Equivalent EPS of S Ltd. ` 2.36
b) BSE price per share before merger announcement ` 17.50
c) After the merger announcement 10% increase in price of share ` 1.75
d) Present Market Price of share (b + c) ` 19.25
e) Return on Market Price per share (a/d) 12.26
As Mr. X is having another opportunity to earn 14% and expected return on S Ltd.’s
share is 12.26%, it is advisable to offload in market.
14. Unrelated companies come together to form an entity. Such relationship is called
conglomerate merger.
Such mergers involve firms engaged in unrelated type of business operations. In other
words, the business activities of acquirer and the target are neither related to each other
horizontally (i.e., producing the same or competing products) nor vertically (having
relationship of buyer and supplier).
Features:
❖ In a pure conglomerate merger, there are no important common factors between the
companies in production, marketing, research and development and technology.
❖ There may however be some degree of overlapping in one or more of these
common factors. Such mergers are in fact, unification of different kinds of
businesses under one flagship company.
❖ The purpose of merger remains utilization of financial resources, enlarged debt
capacity and also synergy of managerial functions.
15. There exists a big difference between the project and parent cash flows due to tax rules,
exchange controls.
Management and royalty payments are returns to the parent firm. The basis on which a
project shall be evaluated depend on one’s own cash flows, cash flows accruing to the
parent firm or both.
Evaluation of a project on the basis of own cash flows entails that the project should
compete favourably with domestic firms and earn a return higher than the local
competitors. If not, the shareholders and management of the parent company shall invest
in the equity/government bonds of domestic firms. A comparison cannot be made since
foreign projects replace imports and are not competitors with existing local firms. Project
evaluation based on local cash flows avoid currency conversion and eliminates problems
associated with fluctuating exchange rate.

For evaluation of foreign project from the parent firm’s angle, both operating and financial
cash flows actually remitted to it form the yardstick for the firm’s performance and the
basis for distribution of dividends to the shareholders and repayment of debt/interest to
lenders. An investment has to be evaluated on the basis of net after tax operating cash
flows generated by the project. As both types of cash flows (operating and financial) are
clubbed together, it is essential to see that financial cash flows are not mixed up with
operating cash flows.

QUESTIONS
Security Valuation
1. Rahul Ltd. has surplus cash of ` 100 lakhs and wants to distribute 27% of it to the
shareholders. The company decides to buy back shares. The Finance Manager of the
company estimates that its share price after re-purchase is likely to be 10% above the
buyback price-if the buyback route is taken. The number of shares outstanding at present
is 10 lakhs and the current EPS is ` 3.
(i) The price at which the shares can be re-purchased, if the market capitalization of the
company should be ` 210 lakhs after buyback,
(ii) The number of shares that can be re-purchased, and
(iii) The impact of share re-purchase on the EPS, assuming that net income is the same.
2. ABC Ltd. has ` 300 million, 12 per cent bonds outstanding with six years remaining to
maturity. Since interest rates are falling, ABC Ltd. is contemplating of refunding these
bonds with a ` 300 million issue of 6 year bonds carrying a coupon rate of 10 per cent.
Issue cost of the new bond will be ` 6 million and the call premium is 4 per cent. ` 9 million
being the unamortized portion of issue cost of old bonds can be written off no sooner the
old bonds are called off. Marginal tax rate of ABC Ltd. is 30 per cent. You are required to
analyse the bond refunding decision.
3. Amal Ltd. has been maintaining a growth rate of 12% in dividends. The company has paid
dividend @ ` 3 per share. The rate of return on market portfolio is 15% and the risk -free
rate of return in the market has been observed as10%. The beta co-efficient of the
company’s share is 1.2.
You are required to calculate the expected rate of return on the company’s shares as per
CAPM model and the equilibrium price per share by dividend growth model.
4. A Ltd. has an expected return of 22% and Standard deviation of 40%. B Ltd. has an
expected return of 24% and Standard deviation of 38%. A Ltd. has a beta of 0.86 and B
Ltd. a beta of 1.24. The correlation coefficient between the return of A Ltd. and B Ltd. is
0.72. The Standard deviation of the market return is 20%. Suggest:
(i) Is investing in B Ltd. better than investing in A Ltd.?
(ii) If you invest 30% in B Ltd. and 70% in A Ltd., what is your expected rate of return
and portfolio Standard deviation?
(iii) What is the market portfolios expected rate of return and how much is the risk -free
rate?

2 FINAL EXAMINATION: NOVEMBER, 2022
(iv) What is the beta of Portfolio if A Ltd.’s weight is 70% and B Ltd.’s weight is 30%?
Mutual Funds
5. On 1-4-2012 ABC Mutual Fund issued 20 lakh units at ` 10 per unit. Relevant initial
expenses involved were ` 12 lakhs. It invested the fund so raised in capital market
instruments to build a portfolio of ` 185 lakhs. During the month of April 2012 it disposed
off some of the instruments costing ` 60 lakhs for ` 63 lakhs and used the proceeds in
purchasing securities for ` 56 lakhs. Fund management expenses for the month of April
2012 was ` 8 lakhs of which 10% was in arrears. In April 2012 the fund earned dividends
amounting to ` 2 lakhs and it distributed 80% of the realized earnings. On 30-4-2012 the
market value of the portfolio was ` 198 lakhs.
Mr. Akash, an investor, subscribed to 100 units on 1-4-2012 and disposed off the same
at closing NAV on 30-4-2012. What was his annual rate of earning?
6. Mr. Dayal is interested in purchasing equity shares of ABC Ltd. which are currently selling
at ` 600 each. He expects that price of share may go upto ` 780 or may go down to ` 480
in three months. The chances of occurring such variations are 60% and 40% respectively.
A call option on the shares of ABC Ltd. can be exercised at the end of three months with
a strike price of ` 630.
(i) What combination of share and option should Mr. Dayal select if he wants a perfect
hedge?
(ii) What should be the value of option today (the risk free rate is 10% p.a.)?
(iii) What is the expected rate of return on the option?
7. Ram buys 10,000 shares of X Ltd. at a price of ` 22 per share whose beta value is 1.5 and
sells 5,000 shares of A Ltd. at a price of ` 40 per share having a beta value of 2. He obtains
a complete hedge by Nifty futures at ` 1,000 each. He closes out his position at the closing
price of the next day when the share of X Ltd. dropped by 2%, share of A Ltd. appreciated
by 3% and Nifty futures dropped by 1.5%.
What is the overall profit/loss to Ram?
8. A Ltd. of U.K. has imported some chemical worth of USD 3,64,897 from one of the U.S.
suppliers. The amount is payable in six months’ time. The relevant spot and forward rates
are:
Spot rate USD 1.5617-1.5673
6 months’ forward rate USD 1.5455 –1.5609
The borrowing rates in U.K. and U.S. are 7% and 6% respectively and the deposit rates
are 5.5% and 4.5% respectively.

Currency options are available under which one option contract is for GBP 12,500. The
option premium for GBP at a strike price of USD 1.70/GBP is USD 0.037 (call option) and
USD 0.096 (put option) for 6 months period.
The company has 3 choices:
(i) Forward cover
(ii) Money market cover, and
(iii) Currency option
Which of the alternatives is preferable by the company?
9. On April 3, 2016, a Bank quotes the following:
Spot exchange Rate (US $ 1) INR 66.2525 INR 67.5945
2 months’ swap points 70 90
3 months’ swap points 160 186
In a spot transaction, delivery is made after two days.
Assume spot date as April 5, 2016.
Assume 1 swap point = 0.0001,
(i) ascertain swap points for 2 months and 15 days. (For June 20, 2016),
(ii) determine foreign exchange rate for June 20, 2016, and
(iii) compute the annual rate of premium/discount of US$ on INR, on an average rate.
10. A USA based company is planning to set up a software development unit in India. Software
developed at the Indian unit will be bought back by the US parent at a transfer price of US
$10 millions. The unit will remain in existence in India for one year; the software is expected
to get developed within this time frame.
The US based company will be subject to corporate tax of 30% and additional withholding
tax of 10% in India and will not be eligible for tax credit in the US. The software developed
will be sold in the US market for US $ 12.0 millions. Other estimates are as follows:
Rent for fully furnished unit with necessary hardware in India ` 1500000
Man power cost (80 software professional will be working for ` 400 per man hour
10 hours each day)
Advise the US Company on the financial viability of the project. The rupee-dollar rate is `48/$.
Note: Assume 365 days a year.


11. XYZ Limited borrows £ 15 Million of six months LIBOR + 10.00% for a period of 24
months. The company anticipates a rise in LIBOR, hence it proposes to buy a Cap Option
from its Bankers at the strike rate of 8.00%. The lump sum premium is 1.00% for the
entire reset periods and the fixed rate of interest is 7.00% per annum. The actual position
of LIBOR during the forthcoming reset period is as under:
Reset Period LIBOR
1 9.00%
2 9.50%
3 10.00%
You are required to show how far interest rate risk is hedged through Cap Option.
For calculation, work out figures at each stage up to three decimal points and amount
nearest to £. It should be part of working notes.
Corporate Valuation
12. Delta Ltd.’s current financial year’s income statement reports its net income as
` 15,00,000. Delta’s marginal tax rate is 40% and its interest expense for the year was
` 15,00,000. The company has ` 1,00,00,000 of invested capital, of which 60% is debt. In
addition, Delta Ltd. tries to maintain a Weighted Average Cost of Capital (WACC) of 12.6%.
(i) Compute the operating income or EBIT earned by Delta Ltd. in the current year.
(ii) What is Delta Ltd.’s Economic Value Added (EVA) for the current year?
(iii) Delta Ltd. has 2,50,000 equity shares outstanding. According to the EVA you
computed in (ii), how much can Delta pay in dividend per share before the value of
the company would start to decrease? If Delta does not pay any dividends, what
would you expect to happen to the value of the company?
13. AFC Ltd. wishes to acquire BCD Ltd. The shares issued by the two companies are
10,00,000 and 5,00,000 respectively:
(i) Calculate the increase in the total value of BCD Ltd. resulting from the acquisition on
the basis of the following conditions:
Current expected growth rate of BCD Ltd. 7%
Expected growth rate under control of AFC Ltd., (without any additional 8%
capital investment and without any change in risk of operations)
Current Market price per share of AFC Ltd. ` 100

Current Market price per share of BCD Ltd. ` 20

Expected Dividend per share of BCD Ltd. ` 0.60
(ii) On the basis of aforesaid conditions calculate the gain or loss to shareholders of both
the companies, if AFC Ltd. were to offer one of its shares for every four shares of
BCD Ltd.
(iii) Calculate the gain to the shareholders of both the Companies, if AFC Ltd. pays ` 22
for each share of BCD Ltd., assuming the P/E Ratio of AFC Ltd. does not change
after the merger. EPS of AFC Ltd. is ` 8 and that of BCD is ` 2.50. It is assumed that
AFC Ltd. invests its cash to earn 10%.
14. Explain different forms of divestitures.
15. Briefly explain how a Centralized Cash Management system helps MNCs in their treasury
management.
1. (i) Let P be the buyback price decided by Rahul Ltd.

Market Capitalisation after Buyback
1.1P (Original Shares – Shares Bought Back)
 27% of 100 lakhs 
= 1.1P  10 lakhs - 
 P 
= 11 lakhs  P – 27 lakhs  1.1 = 11 lakhs P – 29.7 lakhs
Again, 11 lakhs P – 29.7 lakhs
or 11 lakhs P = 210 lakhs + 29.7 lakhs
239.7
or P = = ` 21.79 per share
11
(ii) Number of Shares to be Bought Back :-
` 27 lakhs
= 1.24 lakhs (Approx.) or 123910 share
` 21.79
(iii) New Equity Shares:-
10 lakhs – 1.24 lakhs = 8.76 lakhs or 1000000 – 123910 = 876090 shares

3  10 lakhs
EPS = = ` 3.43
8.76 lakhs
Thus, EPS of Rahul Ltd., increases to ` 3.43.
2. (i) Calculation of initial outlay:-
` (million)
a. Face value 300

Add: Call premium 12
Cost of calling old bonds 312
b. Gross proceed of new issue 300
Less: Issue costs 6
Net proceeds of new issue 294
c. Tax savings on call premium
and unamortized cost 0.30 (12 + 9) 6.3
 Initial outlay = ` 312 million – ` 294 million – ` 6.3 million = ` 11.7 million
(ii) Calculation of net present value of refunding the bond:-
Saving in annual interest expenses ` (million)
[300 x (0.12 – 0.10)] 6.00
Less:- Tax saving on interest and amortization
0.30 x [6 + (9-6)/6] 1.95
Annual net cash saving 4.05
PVIFA (7%, 6 years) 4.766
Present value of net annual cash saving ` 19.30 million
Less:- Initial outlay ` 11.70 million
Net present value of refunding the bond ` 7.60 million
Decision: The bonds should be refunded
3. Capital Asset Pricing Model (CAPM) formula for calculation of expected rate of return is
ER = Rf + β (Rm – Rf)
ER = Expected Return
β = Beta of Security
Rm = Market Return
Rf = Risk free Rate
= 10 + [1.2 (15 – 10)]

= 10 + 1.2 (5)
= 10 + 6 = 16% or 0.16
Applying dividend growth mode for the calculation of per share equilibrium price: -
D1
ER = +g
P0
3(1.12) 3.36
or 0.16 = + 0.12 or 0.16 – 0.12 =
P0 P0
3.36
or 0.04 P0 = 3.36 or P0 = = ` 84
0.04
Therefore, equilibrium price per share will be ` 84.
4. (i) A Ltd. has lower return and higher risk than B Ltd. investing in B Ltd. is better than in
A Ltd. because the returns are higher and the risk, lower. However, investing in both
will yield diversification advantage.
(ii) rAB = .22  0.7 + .24  0.3 = 22.6%
σ 2AB = 0.402 X 0.72 + 0.382 X 0.32 + 2X 0.7 X 0.3 X 0.72 X 0.40 X 0.38 = 0.1374
 AB = 2AB = .1374 = .37 = 37% *
* Answer = 37.06% is also correct and variation may occur due to approximation.
(iii) This risk-free rate will be the same for A and B Ltd. Their rates of return are given as
follows:
rA = 22 = r f + (rm – rf) 0.86
rB = 24 = r f + (rm – rf) 1.24
rA – rB = –2 = (rm – rf) (–0.38)
rm – rf = –2/–0.38 = 5.26%
rA = 22 = r f + (5.26) 0.86
rf = 17.5%*
rB = 24 = r f + (5.26) 1.24
rf = 17.5%*
rm – 17.5 = 5.26
rm = 22.76%**

*Answer = 17.47% might occur due to variation in approximation.

**Answer may show small variation due to approximation. Exact answer is 22.73%.
(iv) AB = A  WA + B  WB
= 0.86  0.7 + 1.24  0.3 = 0.974
5.
Amount in Amount in Amount in
` lakhs ` lakhs ` lakhs
Opening Bank (200 - 185 -12) 3.00
Add: Proceeds from sale of securities 63.00
Add: Dividend received 2.00 68.00
Deduct:
Cost of securities purchased 56.00
Fund management expenses paid (90% of 8) 7.20
Capital gains distributed = 80% of (63 – 60) 2.40
Dividend distributed =80% of 2.00 1.60 67.20
Closing Bank 0.80
Closing market value of portfolio 198.00
198.80
Less: Arrears of expenses 0.80
Closing Net Assets 198.00
Number of units (Lakhs) 20
Closing NAV per unit (198.00/20) 9.90
Rate of Earning (Per Unit)
Amount
Income received (` 2.40 + ` 1.60)/20 ` 0.20
Loss: Loss on disposal (` 200 - ` 198)/20 ` 0.10
Net earning ` 0.10
Initial investment ` 10.00
Rate of earning (monthly) 1%
Rate of earning (Annual) 12%

6. (i) To compute perfect hedge we shall compute Hedge Ratio (Δ) as follows:
C1 − C2 150 − 0 150
Δ= = = = 0.50
S1 − S2 780 − 480 300
Mr. Dayal should purchase 0.50 share for every 1 call option.
(ii) Value of Option today
If price of share comes out to be `780 then value of purchased share will be:
Sale Proceeds of Investment (0.50 x ` 780) ` 390
Loss on account of Short Position (` 780 – ` 630) ` 150
` 240
If price of share comes out to be ` 480 then value of purchased share will be:
Sale Proceeds of Investment (0.50 x ` 480) ` 240
Accordingly, Premium say P shall be computed as follows:

(` 300 – P) 1.025 = ` 240
P = `65.85
(iii) Expected Return on the Option
Expected Option Value = (` 780 – ` 630) × 0.60 + ` 0 × 0.40 = ` 90
90 − 65.85
Expected Rate of Return =  100 = 36.67%
65.85
7. No. of the Future Contract to be obtained to get a complete hedge
10000 ×`22 × 1.5 - 5000 × ` 40 × 2
=
`1000
`3,30,000 - `4,00,000
= = 70 contracts
`1000
Thus, by purchasing 70 Nifty future contracts to be long to obtain a complete hedge.
Cash Outlay
= 10000 x ` 22 – 5000 x ` 40 + 70 x ` 1,000
= ` 2,20,000 – ` 2,00,000 + ` 70,000 = ` 90,000
= 10000 x ` 22 x 0.98 – 5000 x ` 40 x 1.03 + 70 x ` 1,000 x 0.985

= ` 2,15,600 – ` 2,06,000 + ` 68,950 = ` 78,550

Gain/ Loss
= ` 78,550 – ` 90,000 = - ` 11,450 (Loss)
8. In the given case, the exchange rates are indirect. These can be converted into direct rates
as follows:
Spot rate
1 1
GBP = to
USD1.5617 USD1.5673
USD = GBP 0.64033 - GBP 0.63804
6 months’ forward rate
1 1
GBP = to
USD1.5455 USD1.5609
USD = GBP 0.64704 - GBP 0.64066
Payoff in 3 alternatives
i. Forward Cover
Amount payable USD 3,64,897
Forward rate GBP 0.64704
Payable in GBP GBP 2,36,103
ii. Money market Cover
1 USD 3,56,867
PV @ 4.5% for 6 months i.e. = 0.9779951
1.0225
Spot rate purchase GBP 0.64033
Borrow GBP 3,56,867 x 0.64033 GBP 2,28,512
Interest for 6 months @ 7 % 7,998
-
Payable after 6 months GBP 2,36,510
iii. Currency options
Unit in Options contract GBP 12,500
Value in USD at strike rate of 1.70 (GBP 12,500 x 1.70) USD 21,250

Number of contracts USD 3,64,897/ USD 21,250 17.17

Exposure covered USD 21,250 x 17 USD 3,61,250
Exposure to be covered by Forward (USD 3,64,897 – USD USD 3,647
3,61,250)
Options premium 17 x GBP 12,500 x 0.096 USD 20,400
Premium in GBP (USD 20,400 x 0.64033) GBP 13,063
Total payment in currency option
Payment under option (17 x 12,500) GBP 2,12,500
Premium payable GBP 13,063
Payment for forward cover (USD 3,647 x 0.64704) GBP 2,360
GBP 2,27,923
Thus, total payment in:
(i) Forward Cover 2,36,103 GBP
(ii) Money Market 2,36,510 GBP
(iii) Currency Option 2,27,923 GBP
The company should take currency option for hedging the risk.
9. (i) Swap Points for 2 months and 15 days
Bid Ask
Swap Points for 2 months (a) 70 90
Swap Points for 3 months (b) 160 186
Swap Points for 30 days (c) = (b) – (a) 90 96
Swap Points for 15 days (d) = (c)/2 45 48
Swap Points for 2 months & 15 days (e) = (a) + (d) 115 138
(ii) Foreign Exchange Rates for 20 th June 2016
Bid Ask
Spot Rate (a) 66.2525 67.5945
Swap Points for 2 months & 15 days (b) 0.0115 0.0138
66.2640 67.6083
(iii) Annual Rate of Premium
Bid Ask
Spot Rate (a) 66.2525 67.5945

Foreign Exchange Rates for 66.2640 67.6083

20th June 2016 (b)
Premium (c) 0.0115 0.0138
Total (d) = (a) + (b) 132.5165 135.2028
Average (d) / 2 66.2583 67.6014
Premium 0.0115 12 0.0138 12
 × 100  × 100
66.2583 2.5 67.6014 2.5
= 0.0833% = 0.0980%
` `
Revenue 48,00,00,000
Less: Costs:
Rent 15,00,000
Manpower (`400 x 80 x 10 x 365) 11,68,00,000
Less: Tax 10,81,50,000
Earnings after tax 25,23,50,000
Less: Withholding tax(TDS) 2,52,35,000
Repatriation amount (in dollars) $ 4.7 million
Advise: The cost of development software in India for the US based company is $5.268
million. As the USA based Company is expected to sell the software in the US at $12.0
million, it is advised to develop the software in India.
11. First of all we shall calculate premium payable to bank as follows:
rp rp
P= X A or A
 1  PVAF(3.5%,4)
(1  i) - 
 i  (1 + i)t 
Where
P = Premium
A = Principal Amount
rp = Rate of Premium

i = Fixed Rate of Interest

t = Time
0.01 0.01
= × £15,000,000 or
 1  (0.966 + 0.933 + 0.901+ 0.871)
(1/ 0.035) - 0.035  1.0354 
× £15,000,000
0.01 £150,000
= × £15,000,000 = £ 40,595 or = £ 40,861
 1  3.671
(28.571) - 0.0402 
Now we see the net payment received from bank

Reset Additional interest Amount Premium Net Amt.
Period due to rise in received from paid to bank* received from
interest rate bank bank
1 £ 75,000 £ 75,000 £ 40,861 £ 34,139
2 £ 112,500 £ 112,500 £ 40,861 £ 71,639
3 £ 150,000 £ 150,000 £ 40,861 £ 109,139
TOTAL £ 337,500 £ 337,500 £ 122,583 £ 214,917
Thus, from above it can be seen that interest rate risk amount of £ 337,500 reduced by
£ 214,917 by using of Cap option.
* Alternatively, if premium paid is considered as £ 40,595, then above figure of £ 214,917
shall be changed to £ 215,715.
12. (i) Taxable income = Net Income /(1 – 0.40)
or, Taxable income = ` 15,00,000/(1 – 0.40) = ` 25,00,000
Again, taxable income = EBIT – Interest
or, EBIT = Taxable Income + Interest
= ` 25,00,000 + ` 15,00,000 = ` 40,00,000
(ii) EVA = EBIT (1 – T) – (WACC  Invested capital)
= ` 40,00,000 (1 – 0.40) – (0.126  ` 1,00,00,000)
= ` 24,00,000 – ` 12,60,000 = ` 11,40,000
(iii) EVA Dividend = ` 11,40,000/2,50,000 = ` 4.56
If Delta Ltd. does not pay a dividend, we would expect the value of the firm to increase
because it will achieve higher growth, hence a higher level of EBIT. If EBIT is higher, then
all else equal, the value of the firm will increase.

13. (i) For BCD Ltd., before acquisition

The cost of capital of BCD Ltd. may be calculated by using the following formula:
Dividend
+ Growth %
Pr ice
Cost of Capital i.e., Ke = (0.60/20) + 0.07 = 0.10
After acquisition g (i.e. growth) becomes 0.08
Therefore, price per share after acquisition = 0.60/(0.10-0.08) = `30
The increase in value therefore is = `(30-20) x 5,00,000 = `50,00,000/-
(ii) To share holders of BCD Ltd. the immediate gain is `100 – `20x4 = `20 per share
The gain can be higher if price of shares of AFC Ltd. rise following merger which they
should undertake.
To AFC Ltd. shareholders (` (In lakhs)
Value of Company now 1,000
Value of BCD Ltd. 150
1,150
No. of shares 11.25
 Value per share 1150/11.25 = ` 102.22
Gain to shareholders of BCD Ltd. = `102.22 – `(4 x 20) = `22.22
Gain to shareholders of AFC Ltd. = `102.22 – `100.00 = `2.22
(iii) Gain to shareholders of AFC Ltd:-
Earnings of BCD Ltd. (5,00,000 x 2.50) ` 12,50,000/-
Less: Loss of earning in cash (5,00,000 x ` 22 x 0.10) ` 11,00,000/-
Net Earning ` 1,50,000/-
Number of shares 10,00,000
Net increase in earning per share 0.15
P/E ratio of AFC Ltd. = 100/8 = 12.50
Therefore, Gain per share of shareholders of AFC Ltd. = 0.15 x12.50 = ` 1.88
Gain to the shareholders of BCD Ltd. ` (22-20) = ` 2/- per share

Alternatively, it can also be computed as follows:

Post-Merger Earnings ` 81,50,000
(10,00,000 x ` 8 + 5,00,000 x ` 2.5 – 11,00,000)
 81, 50, 000  ` 8.15
EPS after Merger  
 10, 00, 000 
PE Ratio 12.50
Post Merger Price of Share (` 8.15 x 12.50) ` 101.875
Less: Price before merger ` 100.00
` 1.875
Say ` 1.88
14. Different ways of divestment or demerger or divestitures are as follows:
(a) Sell off / Partial Sell off: A sell off is the sale of an asset, factory, division, product line
or subsidiary by one entity to another for a purchase consideration payable either in
cash or in the form of securities. Partial Sell off, is a form of divestiture, wherein the
firm sells its business unit or a subsidiary to another because it deemed to be unfit
with the company’s core business strategy.
Normally, sell-offs are done because the subsidiary doesn't fit into the parent
company's core strategy. The market may be undervaluing the combined businesses
due to a lack of synergy between the parent and the subsidiary. So, the management
and the board decide that the subsidiary is better off under a different ownership.
Besides getting rid of an unwanted subsidiary, sell-offs also raise cash, which can be
used to pay off debts. In the late 1980s and early 1990s, corporate raiders use d debt
to finance acquisitions.
(b) Spin-off: In this case, a part of the business is separated and created as a separate
firm. The existing shareholders of the firm get proportionate ownership. So, there is
no change in ownership and the same shareholders continue to own the newly
created entity in the same proportion as previously in the original firm. The
management of spin-off division is however, parted with. Spin-off does not bring fresh
cash. The reasons for spin off may be:
(i) Separate identity to a part/division.
(ii) To avoid the takeover attempt by a predator by making the firm unattractive to
him since a valuable division is spun-off.
(iii) To create separate Regulated and unregulated lines of business.
(c) Split-up: This involves breaking up of the entire firm into a series of spin off (by
creating separate legal entities). The parent firm no longer legally exists and only the
newly created entities survive. For instance, a corporate firm has 4 divisions namely

A, B, C, D. All these 4 divisions shall be split-up to create 4 new corporate firms with
full autonomy and legal status. The original corporate firm is to be wound up. Since
de-merged units are relatively smaller in size, they are logistically more convenient
and manageable. Therefore, it is understood that spin-off and split-up are likely to
enhance shareholders value and bring efficiency and effectiveness.
(d) Equity Carve outs: This is like spin off, however, some shares of the new company
are sold in the market by making a public offer, so this brings cash. More and more
companies are using equity carve-outs to boost shareholder value. A parent firm
makes a subsidiary public through an initial public offering (IPO) of shares, amounting
to a partial sell-off. A new publicly listed company is created, but the parent keeps a
controlling stake in the newly traded subsidiary.
A carve-out is a strategic avenue a parent firm may take when one of its subsidiaries
is growing faster and carrying higher valuations than other businesses owned by the
parent. A carve-out generates cash because shares in the subsidiary are sold to the
public, but the issue also unlocks the value of the subsidiary unit and enhances the
parent's shareholder value.
15. A Centralized Cash Management system helps MNCs in their treasury management as
follows:
(a) To maintain minimum cash balance during the year.
(b) To manage judiciously liquidity requirements of the centre.
(c) To optimally use various hedging strategies so that MNC’s foreign exchange
exposure is minimised.
(d) To aid the centre to generate maximum returns by investing all cash resources
optimally.
(e) To aid the centre to take advantage of multinational netting so that transaction costs
and currency exposure are minimised.
(f) To make maximum utilization of transfer pricing mechanism so that the firm enhances
its profitability and growth.
(g) To exploit currency movement correlations:
(i) Payables & receivables in different currencies having positive correlations.
(ii) Payables of different currencies having negative correlations.
(iii) Pooling of funds allows for reduced holding – the variance of the total cash flows
for the entire group will be smaller than the sum of the individual variances.

QUESTIONS
Security Valuation
1. From the following information, compute the effective rate of interest per annum as well
as the total cost of funds to Nirmal Ltd., which is planning a Commercial Paper (CP)
issue:
Issue Price of CP ` 4,87,750
Face Value ` 5,00,000
Maturity Period 3 Months
Issue Expenses:
Brokerage 0.15% for 3 months
Rating Charges 0.55% p.a.
Stamp Duty 0.20% for 3 months
2. The following data are available for a bond:
Face Value ` 10,000 to be redeemed at par on maturity
Coupon rate 8.5 per cent per annum
Years to Maturity 5 years
Yield to Maturity (YTM) 10 per cent
(i) Current market price of the Bond,
(ii) Macaulay’s Duration,
(iii) Volatility of the Bond,
(iv) Convexity of the Bond,
(v) Expected market price if there is a decrease in the YTM by 200 basis points
(a) By Macaulay’s Duration based estimate
(b) By Intrinsic Value Method.
Given
Years 1 2 3 4 5
PVIF (10%, n) 0.909 0.826 0.751 0.683 0.621
PVIF (8%, n) 0.926 0.857 0.794 0.735 0.681

3. Ramesh has identified stocks of two companies A and B having good investment
potential:
Following data is available for these stocks:
Year A (Market Price per Share in `) B (Market Price per Share in
`)
2013 19.60 8.70
2014 18.75 12.80
2015 33.42 16.20
2016 42.64 18.25
2017 43.25 15.60
2018 44.60 13.25
2019 34.75 18.60
(i) The Risk and Return by investing in Stock A and B
(ii) The Risk and Return by investing in a portfolio of these Stocks if he invests in Stock
A and B in proportion of 6 : 4.
(iii) The better opportunity for investment
4. Following information is available in respect of expected dividend, market price and
market condition after one year.
Market condition Probability Market Price Dividend per share
` `
Good 0.25 115 9
Normal 0.50 107 5
Bad 0.25 97 3
The existing market price of an equity share is ` 106 (F.V. ` 1), which is cum 10% bonus
debenture of ` 6 each, per share. M/s. X Finance Company Ltd. had offered the buy-
back of debentures at face value.
Find out the expected return and variability of returns of the equity shares if buyback
offer is accepted by the investor.
And also advise-Whether to accept buy back offer?

Mutual Funds
5. M/S. Corpus an AMC, on 1.04.2015 has floated two schemes viz. Dividend Plan and
Bonus Plan. Mr. X, an investor has invested in both the schemes. The following details
(except the issue price) are available:
Date Dividend (%) Bonus Ratio NAV
Dividend Plan Bonus Plan
1.04.2015 ? ?
31.12.2016 1 :4 (One unit on 4 47 40
units held)
31.03.2017 12 48 42
31.03.2018 10 50 39
31.12.2018 1 :5 (One unit on 5 46 43
units held)
31.03.2019 15 45 42
31.03.2020 - - 49 44
Additional details
Investment (`) ` 9,20,000 ` 10,00,000
Average Profit (`) ` 27, 748.60
Average Yield (%) 6.40
You are required to calculate the issue price of both the schemes as on 1.04.2015.
6. A two year tree for a share of stock in ABC Ltd., is as follows:

Consider a two years American call option on the stock of ABC Ltd., with a strike price of
` 98. The current price of the stock is ` 100. Risk free return is 5 per cent per annum
with a continuous compounding and e 0·05 = 1.05127.
Assume two time periods of one year each.
Using the Binomial Model, calculate:
(i) The probability of price moving up and down;
(ii) Expected pay offs at each nodes i.e. N1, N2 and N3 (round off upto 2 decimal
points).
7. Shyam buys 10,000 shares of X Ltd., @ ` 25 per share and obtains a complete hedge of
shorting 400 Nifty at ` 1,100 each. He closes out his position at the closing price of the
next day when the share of X Ltd., has fallen by 4% and Nifty Future has dropped by
2.5%.
What is the overall profit or loss from this set of transaction?
8. XYZ has taken a six-month loan from its foreign collaborator for USD 2 millions. Interest
is payable on maturity @ LIBOR plus 1%. The following information is available:
Spot Rate INR/USD 68.5275
6 months Forward rate INR/USD 68.4575
6 months LIBOR for USD 2%
6 months LIBOR for INR 6%
You are required to :
(i) Calculate Rupee requirements if forward cover is taken.
(ii) Advise the company on the forward cover.
What will be your opinion if spot rate of INR/USD is 68.4275
9. M/s. A Ltd. is planning to import an equipment from Japan at a cost of 3,400 lakh yens.
The company may avail loans at 18% p.a. interest with quarterly rests with which it can
import the said equipment. The company has also an offer from Osaka branch of a n
Indian bank extending credit of 180 days at 2% p.a. against opening of an irrevocable
letter of credit (L/C).
Additional information:
Present Exchange Rate ` 100 = 340 yen
180 days forward rate ` 100 = 345 yen
Commission charges for L/C at 2% per 12 months.
Advice whether the company should accept the offer.


10. A US based company is planning to set up a subsidiary company in India (where so far it
was exporting) in view of growing demand for its product and competition from other US
based companies. The initial project cost consisting of plant and machinery including
installation is estimated to be US$ 490 million. The net working capital requirements are
estimated at US$ 60 million. The company follows straight line method of depreciation.
Currently, the company is exporting two million units every year at a unit price of US$ 90,
its variable cost per unit being US$ 50.
The CFO of the Company has estimated the following operating cost and other data in
respect of proposed project:
(i) Variable operating cost will be US $ 30 per unit of production;
(ii) Additional cash fixed cost will be US $ 30 million p.a. and project's share of
allocated fixed cost will be US $ 3 million p.a. based on principle of ability to share;
(iii) Expected useful life of the proposed plant is five years with no salvage value;
(iv) Production capacity of the proposed project in India will be 5 million units;
(v) Existing working capital investment for production and sale of two million units
through exports was US $ 25 million;
(vi) Export of the product in the coming year will decrease to 1.5 million units, provided
the company does not set up subsidiary company in India, in view of the presence
of competing other US based companies that are in the process of setting up their
subsidiaries in India;
(vii) Applicable Corporate Income Tax rate is 35%, and
(viii) Required rate of return for such project is 12%.
Assuming that there will be no variation in the exchange rate of two currencies and all
profits will be repatriated as there will be no withholding tax, Estimate Net Present Value
of the proposed project in India and give your advice. Present Value Interest Factors
(PVIF) @ 12% for five years is as below :
Year 1 2 3 4 5
PVIF 0.8929 0.7972 0.7118 0.6355 0.5674

11. P Ltd., a dealer quotes 'All-in-cost' for a generic swap at 6% against six months LIBOR
flat. If the Notional principal amount of swap is ` 8,00,000:
(i) Calculate semi-annual fixed payment.

(ii) Find the first floating rate payment for (i) above if the six month period from the
effective date of swap to the settlement date comprises 181 days and that the
corresponding LIBOR was 5% on the effective date of swap. (Consider up to three
decimal places).
(iii) In question number (ii) above, if the settlement is on 'Net' basis, how much the fixed
rate payer would pay to the floating rate payer?
Note: Generic swap is based on 30/360 days basis.
Corporate Valuation
12. Excellent Ltd., reported a profit of ` 154 lakhs after 30% tax for the financial year 2019-
20. An analysis of the accounts revealed that there is an extraordinary loss of ` 20 lakhs
and the income included extraordinary items of ` 16 lakhs. The existing operations,
except for the extraordinary items, are expected to continue in the future. In addition, the
results of the launch of a new product are expected to be as follows:
` in lakhs
Sales 140
Material costs 40
Labour costs 24
Fixed costs 20
(i) Calculate the value of the business, given that the capitalization rate is 14%.
(ii) Determine the market price per equity share, with Excellent Ltd.'s share capital
being comprised of 2,00,000 at 13% preference shares of ` 100 each and
100,00,000 equity shares of ` 10 each and the P/E ratio being 12 times. (Ignoring
Corporate Dividend Tax).
13. The following information is provided relating to the acquiring company Efficient Ltd. and
the target company Healthy Ltd.:
Particulars Efficient Ltd. Healthy Ltd.
No. of Shares (FV ` 10 each) 20 Lakhs 15 Lakhs
Market Capitalization ` 800 Lakhs ` 1,200 Lakhs
P/E Ratio (times) 10 5
Reserves and Surplus ` 400 Lakhs ` 273 Lakhs
Promoter’s Holding (No. of shares) 8.65 Lakhs 9 Lakhs

Board of Directors of both the companies have decided to give a fair deal to the
shareholders and accordingly for swap ratio the weights are decided as 45%, 20% and
35% respectively for Earning, Book Value and Market Price of share of each company.
Required:
(i) Calculate the swap ratio and also calculate Promoter’s holding % after acquisition.
(ii) What is the EPS of Efficient Ltd. after acquisition of Healthy Ltd.?
(iii) What is the expected market price per share and market capitalization of Efficient
Ltd. after acquisition, assuming P/E ratio of Efficient Ltd. remains unchanged?
(iv) Calculate free float market capitalization of the merged firm.
14. Explain Indicative Risk Matrix of each stage of funding for Venture Capital Financing.
15. "The process of securitization can be viewed as process of creation of additional financial
product of securities in the market backed by collaterals." What are the other features?
Describe.
 F − P  12
1. Nominal Interest or Bond Equivalent Yield =    100
 P  M
Where
F= Face Value
P= Issue Price
5,00,000 - 4,87,750 12
= ×  100 = 0.025115  4  100 = 10.046 = 10.05% p.a.
4,87,750 3
0.1005 4
Effective interest rate = [1+ ] – 1 = 10.435% p.a.
4
Cost of Funds to the Company
Effective Interest 10.435%
Brokerage (0.150  4) 0.60%
Rating Charge 0.55%
Stamp duty (0.20  4) 0.80%
12.385%

2. (i) Current Market Price of Bond

= ` 850 (PVIAF 10%, 5) + ` 10,000 (PVIF 10%, 5)
= ` 850 (3.79) + ` 10,000 (0.621) = ` 3,221.50 + ` 6,210 = ` 9,431.5
(ii) Macaulay’s Duration
1 850 0.909 772.65 0.082 0.082
2 850 0.826 702.10 0.074 0.148
3 850 0.751 638.35 0.068 0.204
4 850 0.683 580.55 0.062 0.248
5 10,850 0.621 6,737.85 0.714 3.57
9431.50 1.000 4.252
Duration of the Bond is 4.252 years
(iii) Volatility of Bond
Duration 4.252
Volatility of Bonds = = = 3.865
(1+ YTM) 1.10
(iv) Convexity of Bond
C*  (Y) 2  100
C* = V+ + V- - 2V0
2V0 (∆Y)2
Year Cash flow P.V. @ 8% P.V @12%
1 850 0.926 787.10 0.892 758.20
2 850 0.857 728.45 0.797 677.45
3 850 0.794 674.90 0.712 605.20
4 850 0.735 624.75 0.636 540.60
5 10,850 0.681 7388.85 0.567 6,151.95
10204.05 8,733.40
10,204.05 + 8,733.40 - 2 × 9,431.50
C* =
2 × 9,431.50 × ( 0.02 )
2

74.45
=
7.5452
= 9.867
Convexity of Bond = 9.867 x (0.02) 2 x 100 = 0.395%
(v) The expected market price if decrease in YTM by 200 basis points.
(A) By Macaulay’s duration-based estimate
= ` 9431.50 2 (3.865/100) = ` 729.05
Hence expected market price is ` 9431.50 + ` 729.05 = ` 10,160.55
Hence, the market price will increase.
(B) By Intrinsic Value method
Intrinsic Value at YTM of 10% ` 9,431.50
Intrinsic Value at YTM of 8% ` 10,204.05
Price increased by ` 772.55
Hence, expected market price is `10,204.05
3.
A B
Year Market Return Return- Squared Market Return Return - Squared
(Return - A ) x
Price Per (%) A Price Per (%) B
Share in ` Share in ` (Return - B )
2013 19.60 8.70
2014 18.75 -4.34 -18.33 335.9889 12.80 47.13 30.94 957.2836 -567.1302
2015 33.42 78.24 64.25 4128.0625 16.20 26.56 10.37 107.5369 666.2725
2016 42.64 27.59 13.60 184.9600 18.25 12.65 -3.54 12.5316 -48.1440
2017 43.25 1.43 -12.56 157.7536 15.60 -14.52 -30.71 943.1041 385.7176
2018 44.60 3.12 -10.87 118.1569 13.25 -15.06 -31.25 976.5625 339.6875
2019 34.75 -22.09 -36.08 1301.7664 18.60 40.38 24.19 585.1561 -872.7752
83.95 6226.6883 97.14 3582.1748 -96.3718
Mean ( A ) 13.99 Variance 1037.7814 Mean ( B ) 16.19 Variance 597.0291 Cov. = -16.0620
(i) Return A = 13.99% and Risk (SD) = √1037.7814= 32.2146 and Return B = 16.19%
and Risk (SD) = √597.0291= 24.4342
(ii) Return of Portfolio = 0.60 x 13.99% + 0.40 x 16.19% = 14.87%
Risk (Standard Deviation) of Portfolio = [0.602 x 1037.7814 + 0.402 x 597.0291 + 2
x 0.60 x 0.40 x (-16.0620)]½

= [373.6013 + 95.5247- 7.7098]½ = 21.4806

(iii) On the basis of Return ‘B’ is preferable and on the basis of Risk ‘Portfolio
Investment’ is preferable over the individual stocks.
4. The Expected Return of the equity share may be found as follows:
Market Condition Probability Total Return Cost (*) Net Return
Good 0.25 ` 124 ` 100 ` 24
Normal 0.50 ` 112 ` 100 ` 12
Bad 0.25 ` 100 ` 100 `0
 12 
Expected Return = (24  0.25) + (12  0.50) + (0  0.25) = 12=    100 = 12%
 100 
The variability of return can be calculated in terms of standard deviation.
V SD = 0.25 (24 – 12)2 + 0.50 (12 – 12)2 + 0.25 (0 – 12)2
= 0.25 (12) 2 + 0.50 (0) 2 + 0.25 (–12)2
= 36 + 0 + 36
SD = 72
SD = 8.485 or say 8.49
(*) The present market price of the share is ` 106 cum bonus 10% debenture of ` 6
each; hence the net cost is ` 100.
M/s X Finance company has offered the buyback of debenture at face value. There is
reasonable 10% rate of interest compared to expected return 12% from the market.
Considering the dividend rate and market price the creditworthiness of the company
seems to be very good. The decision regarding buy-back should be taken considering
the maturity period and opportunity in the market. Normally, if the maturity period is low
say up to 1 year better to wait otherwise to opt buy back option.
5. (i) Dividend Plan
(a) Average Annual gain over a period of 5 Years ` 27748.60
(b) Total gain over a period of 5 years (a*5) ` 138743
(c) Initial Investment ` 920000
(d) Total value of investment (b+c) ` 1058743
(e) NAV as on 31.3.2020 ` 49
(f) Number of units at the end of the period as on 31.03.2019 (d/e) 21607

1 2 3 4 = (2*3) 5 (1*4) 7
6=
(4+5)
Period Units Rate Unit Dividend NAV New Units* Balance
held value Units Pre
Dividend
31.03.2019 21607 0.15 10 1.5 45 697 20910
31.03.2018 20910 0.1 10 1 50 410 20500
31.03.2017 20500 0.12 10 1.2 48 500 20000
Issue Price as on 01.04.2015 Investment 920000/ Units purchased 20000 (c/i)
= ` 46
* Let the units issued be X
X = (Closing Units/NAV + Dividend) x Dividend
(ii) Bonus Plan
(a) Average Yield 0.064
(b) Investment ` 1000000
(c) Gain over a period of 5 years (a*b*5) ` 320000
(d) Market Value as on 31.03.2019 (b + c) ` 1320000
(e) NAV as on 31.03.2020 ` 44
(f) Total units as on 31.03.2020 (d/e) 30000
(g) No of units as on 31.03.2018 Pre bonus = 30000*5/ (5 + 1) 25000
(h) No of units as on 31.12.2016 Pre bonus = 25000*4/ (4 + 1) 20000
(i) Issue Price as on 01.04.2015 Investment 1000000/ Units
purchased 20000 (b/h) ` 50
6. (i) Using the single period model, the probability of price moving up is
95
1.05127 -
R−d 100 = 0.10127 = 0.779 say 0.78 i.e. 78%
P= =
u−d 108 95 0.13
-
100 100
Therefore, the probability of price moving down = 1 - 0.78 = 0.22 i.e. 22%
(ii) Expected pay-off at
Node N2
0.78 ×18.64 + 0.22 × 4.60 15.55
= = ` 14.79
1.05127 1.05127

Node N3
0.78 ×4.60 + 0.22 × 0 3.588
= = ` 3.41
1.05127 1.05127
Node N1
0.78 × 14.79 + 0.22 × 3.41 12.286
= = ` 11.69
1.05127 1.05127
7. Cash Outlay
= 10000 x ` 25 – 400 x ` 1,100
= ` 2,50,000 – ` 4,40,000 = - ` 1,90,000
= 10000 x ` 25 x 0.96 - 400 x ` 1,100 x 0.975
= ` 2,40,000 – ` 4,29,000 = - ` 1,89,000
Gain/ Loss
= ` 1,90,000 – ` 1,89,000 = ` 1,000 (Gain)
8. In (i) Rupee requirement if forward cover is taken:
6 Month Forward rate 68.4575
6
Interest amount (20,00,000 x 3%* x 12) US$ 30,000
Principal amount US$ 20,00,000
US$ 20,30,000
Rupee Requirement = INR 68.4575 X US$ 20,30,000 = INR 13,89,68,725
* LIBOR + 1%
(ii) Forward Rate as per Interest Rate Parity after 6 months is expected to be:
(1.03)
= 68.5275 x = 69.8845/US$
(1.01)
The company should take forward cover because as per Interest Rate Parity, the rate
after 6 months is expected to be higher than forward rate.
However, if spot rate is 68.4275, the expected rate as per Interest Rate Parity shall be:
(1.03)
= 68.4275 x = 69.7825/US$
(1.01)
Thus, still the company should take forward cover.

9. Option I (To finance the purchases by availing loan at 18% per annum):
Cost of equipment ` in lakhs
3400 lakh yen at `100 = 340 yen 1,000.00
Add: Interest at 4.5% I Quarter 45.00
Add: Interest at 4.5% II Quarter (on `1045 lakhs) 47.03
Total outflow in Rupees 1,092.03
Alternatively, interest may also be calculated on compounded
basis, i.e.,
`1000 × [1.045]² `1092.03
Option II (To accept the offer from foreign branch):
Cost of letter of credit
At 1 % on 3400 lakhs yen at `100 = 340 yen ` 10.00 lakhs
Add: Interest for 2 Quarters ` 0.90 lakhs
(A) ` 10.90 lakhs
Payment at the end of 180 days:
Cost 3400.00 lakhs yen
Interest at 2% p.a. [3400 × 2/100 × 180/365] 33.53 lakhs yen
3433.53 lakhs yen
Conversion at `100 = 345 yen [3433.53 / 345 ×100] (B) ` 995.23 lakhs
Total Cost: (A) + (B) ` 1006.13 lakhs
Advise: Option 2 is cheaper by (1092.03 – 1006.13) lakh or ` 85.90 lakh. Hence, the
offer may be accepted.
10. Financial Analysis whether to set up the manufacturing units in India or not may be
carried using NPV technique as follows:
I. Incremental Cash Outflows
$ Million
Cost of Plant and Machinery 490.00
Release of existing Working Capital (25.00)
525.00

II. (1) Incremental Cash Inflow after Tax (CFAT) generated by investment in India for
5 years
$ Million
Sales Revenue (5 Million x $90) 450.00
Less: Costs
Variable Cost (5 Million x $30) 150.00
Fixed Cost 30.00
Depreciation ($490 Million/5) 98.00
EBIT 172.00
Taxes @ 35% 60.20
EAT 111.80
Add: Depreciation 98.00
CFAT (1-5 years) 209.80
(2) Cash flow at the end of the 5 years (Release of Working Capital) $35.00 Million.
(3) Cash generation by exports (Opportunity Cost)
$ Million
Sales Revenue (1.5 Million x $90) 135.00
Less: Variable Cost (1.5 Million x $50) 75.00
Contribution before tax 60.00
Tax @ 35% 21.00
CFAT (1-5 years) 39.00
(4) Additional CFAT:
$ Million
Through setting up subsidiary in India 209.80
Through Exports in India 39.00
CFAT (1-5 years) 170.80
III. Determination of NPV
Year CFAT ($ Million) PVF@12% PV ($ Million)
1-5 170.80 3.6048 615.6998
5 35 0.5674 19.8590
635.5588
Less: Initial Outflow 525.0000
NPV 110.5588
Advice: Since NPV is positive the proposal should be accepted.

11. (i) Semi-annual fixed payment

= (N) (AIC) (Period)
Where N = Notional Principal amount = ` 8,00,000
AIC = All-in-cost = 6% = 0.06
 180 
= 8,00,000 × 0.06  
 360 
= 8,00,000 × 0.06 (0.5)
= 8,00,000 × 0.03 = ` 24,000
(ii) Floating Rate Payment
 dt 
= N (LIBOR)  
 360 
181
= 8,00,000 × 0.05 ×
360
= ` 8,00,000 × 0.05 (0.503)
= ` 8,00,000 × 0.02515
= ` 20,120
(iii) Net Amount
= (i) – (ii)
= ` 24,000 – ` 20,120 = ` 3,880
12. (i) Computation of Business Value
(` Lakhs)
154 220
Profit before tax
1 − 0.30
Less: Extraordinary income (16)
Add: Extraordinary losses 20
224
Profit from new product (` Lakhs)
Sales 140

Less: Material costs 40

Labour costs 24
Fixed costs 20 (84) 56
280.00
Less: Taxes @30% 84.00
Future Maintainable Profit after taxes 196.00
Relevant Capitalisation Factor 0.14
Value of Business (` 196/0.14) 1400
(ii) Determination of Market Price of Equity Share

Future maintainable profits (After Tax) ` 1,96,00,000
Less: Preference share dividends 2,00,000 shares of ` 100 ` 26,00,000
@ 13%
Earnings available for Equity Shareholders ` 1,70,00,000
No. of Equity Shares 1,00,00,000
` 170,00,000 ` 1.70
Earning per share = =
1,00,00,000
PE ratio 12
Market price per share ` 20.40
13. (i) Swap Ratio
Efficient Ltd. Healthy Ltd.
Market capitalisation 800 lakhs 1200 lakhs
No. of shares 20 lakhs 15 lakhs
Market Price per share ` 40 ` 80
P/E ratio 10 5
EPS `4 ` 16
Profit ` 80 lakh ` 240 lakh
Share capital ` 200 lakh ` 150 lakh
Reserves and surplus ` 400 lakh ` 273 lakh
Total ` 600 lakh ` 423 lakh
Book Value per share ` 30 ` 28.20

Calculation of Swap Ratio

EPS 1 : 4 i.e. 4.0  45% 1.80
Book value 1 : 0.94 i.e. 0.94  20% 0.188
Market price 1 : 2 i.e. 2.0  35% 0.70
Total 2.688
Swap ratio is for every one share of Healthy Ltd., to issue 2.688 shares of Efficient
Ltd.
Hence, total no. of shares to be issued 15 lakh  2.688 = 40.32 lakh shares
Promoter’s holding = 8.65 lakh shares + (9  2.688 = 24.192 lakh shares) = 32.842
lakh
i.e. Promoter’s holding % is (32.842 lakh/60.32 lakh)  100 = 54.45%.
Calculation of EPS, Market price, Market capitalization and free float market
capitalization.
(ii) Total No. of shares 20 lakh + 40.32 lakh = 60.32 lakh
EPS after merger Total Profit 80 lakh + 240lakh 320 lakh
= =
No. of Shares 60.32 60.32
= ` 5.305
(iii) Expected market price EPS  P/E Ratio
= ` 5.305  10 = ` 53.05
Market capitalization = ` 53.05 per share  60.32 lakh shares
= ` 3,199.98 lakh
(iv) Free float of market capitalization = ` 53.05 per share  (60.32 lakh  45.55%)
= ` 1457.59 lakh
14. Risk in each stage is different. An indicative Risk matrix is given below:
Financial Period (Funds Risk Perception Activity to be financed
Stage locked in
years)
Seed Money 7-10 Extreme For supporting a concept or
idea or R&D for product
development and involves low
level of financing.
Start Up 5-9 Very High Initializing prototypes
operations or developing
products and its marketing.

First Stage 3-7 High Started commercials production

and marketing.
Second Stage 3-5 Sufficiently high Expanding market and growing
working capital need though not
earning profit.
Third Stage 1-3 Medium Market expansion, acquisition &
product development for profit
making company. Also called
Mezzanine Financing.
Fourth Stage 1-3 Low Facilitating public issue i.e.
going public. Also called Bridge
Financing.
15. The other features of Securitization are as follows:
(i) Bundling and Unbundling – When all the assets are combined in one pool it is
bundling and when these are broken into instruments of fixed denomination it is
unbundling.
(ii) Tool of Risk Management – In case of assets are securitized on non-recourse basis,
then securitization process acts as risk management as the risk of default is shifted.
(iii) Structured Finance – In the process of securitization, financial instruments are tailor
structured to meet the risk return trade off profile of investor, and hence, these
securitized instruments are considered as best examples of structured finance.
(iv) Trenching – Portfolio of different receivable or loan or asset are split into several
parts based on risk and return they carry called ‘Trenche’. Each Trench carries a
different level of risk and return.
(v) Homogeneity – Under each tranche the securities issued are of homogenous nature
and even meant for small investors who can afford to invest in small amounts.

QUESTIONS
Security Analysis
1. The closing value of Sensex for the month of October, 2007 is given below:
Date Closing Sensex Value
1.10.07 2800
3.10.07 2780
4.10.07 2795
5.10.07 2830
8.10.07 2760
9.10.07 2790
10.10.07 2880
11.10.07 2960
12.10.07 2990
15.10.07 3200
16.10.07 3300
17.10.07 3450
19.10.07 3360
22.10.07 3290
23.10.07 3360
24.10.07 3340
25.10.07 3290
29.10.07 3240
30.10.07 3140
31.10.07 3260
You are required to test the weak form of efficient market hypothesis by applying the run
test at 5% and 10% level of significance.
Following values at 18% degrees of freedom can be used:
Value of t at 5% 2.101
Value of t at 10% 1.734

Security Valuation
2. XYZ company has current earnings of ` 3 per share with 5,00,000 shares outstanding.
The company plans to issue 40,000, 7% convertible preference shares of ` 50 each at
par. The preference shares are convertible into 2 shares for each preferenc e shares
held. The equity share has a current market price of ` 21 per share.
(i) What is preference share’s conversion value?
(ii) What is conversion premium in %?
(iii) Assuming that total earnings remain the same, calculate the effect of the issue on
the basic earning per share (a) before conversion (b) after conversion.
(iv) If profits after tax increases by ` 1 million what will be the basic EPS (a) before
conversion and (b) on a fully diluted basis?
3. A share of Tension-free Economy Ltd. is currently quoted at, a price earnings ratio of 7.5
times. The expected retained earnings per share being 37.5% is ` 3 per share. Compute:
(a) The company’s cost of equity, if investors expect annual growth rate of 12%.
(b) If anticipated growth rate is 13% p.a., calculate the indicated market price, with
same cost of capital.
(c) If the company’s cost of capital is 18% and anticipated growth rate is 15% p.a.,
calculate the market price per share, assuming other conditions remain the same.
4. John inherited the following securities on his uncle’s death:
Types of Security Nos. Annual Coupon % Maturity Years Yield %
Bond A (` 1,000) 10 9 3 12
Bond B (` 1,000) 10 10 5 12
Preference shares C (` 100) 100 11 * 13*
Preference shares D (` 100) 100 12 * 13*
*likelihood of being called at a premium over par.

Compute the current value of his uncle’s portfolio.
PVF @12%
Year 1 2 3 4 5
PVF 0.893 0.797 0.712 0.636 0.567
Note: Round Off Calculations with no decimal points

5. Ankit has a fund of ` 10 lacs which he wants to invest in share market with rebalancing
target after every 15 days to start with for a period of one month from now. The present
NIFTY is 19679. The minimum NIFTY within a month can at most be 18104.68. He wants
to know as to how he should rebalance his portfolio under the following situations,
according to the theory of Constant Proportion Portfolio Insurance Policy, using "2" as
the multiplier:
(1) Immediately to start with.
(2) 15 days later-being the 1st day of rebalancing if NIFTY falls to 19088.63.
(3) 15 days further from the above date if the NIFTY touches 20997.493.
Note: Assume that the value of his equity component will change in tandem with that of
the NIFTY.
Mutual Funds
6. On 01-07-2010, Mr. X Invested ` 50,000/- at initial offer in Mutual Funds at a face value
of ` 10 each per unit. On 31-03-2011, a dividend was paid @ 10% and annualized yield
was 120%. On 31-03-2012, 20% dividend and capital gain of ` 0.60 per unit was given.
Mr. X redeemed all his 6271.98 units when his annualized yield was 71.50% over the
period of holding. Calculate NAV as on 31-03-2011, 31-03-2012 and 31-03-2013.
Note: For calculations consider a year of 12 months.
7. A company is long on 10 MT of copper @ ` 474 per kg (spot) and intends to remain so
for the ensuing quarter. The standard deviation of changes of its spot and future prices
are 4% and 6% respectively, having correlation coefficient of 0.75.
What is its hedge ratio? What is the amount of the copper future it should short to
achieve a perfect hedge if initial margin is 8%?
8. The following table shows interest rates for the United States Dollar and French Franc.
The spot exchange rate is 7.05 Franc per Dollar. Complete the missing entries:
3 Months 6 Months 1 Year
Dollar interest rate (annually compounded) 11½% 12¼% ?
Franc interest rate (annually compounded) 19½% ? 20%
Forward Franc per Dollar ? ? 7.5200
Forward discount per Franc (percent per year) ? 6.3%

9. Suppose you are a treasurer of XYZ plc in the UK. XYZ have two overseas subsidiaries,
one based in Amsterdam and one in Switzerland. The Dutch subsidiary has surplus
Euros in the amount of 725,000 which it does not need for the next three months but
which will be needed at the end of that period (91 days). The Swiss subsidiary has a
surplus of Swiss Francs in the amount of 998,077 that, again, it will need on day 91. The
XYZ plc in UK has a net balance of £75,000 that is not needed for the foreseeable future.
Given the rates below, what is the advantage of swapping Euros and Swiss Francs into
Sterling?
Spot Rate (€) £0.6858- 0.6869
91 day Pts 0.0037 0.0040
Spot Rate (£) CHF 2.3295-2.3326
91 day Pts 0.0242 0.0228
Interest rates for the Deposits
91 day Interest Rate % pa
Amount of Currency
£ € CHF
0 – 100,000 1 ¼ 0
100,001 – 500,000 2 1½ ¼
500,001 – 1,000,000 4 2 ½
Over 1,000,000 5.375 3 1
Note: For calculation purpose use 360 Days a year.
10. Odessa Limited has proposed to expand its operations for which it requires funds of $ 15
million, net of issue expenses which amount to 2% of the issue size. It proposed to raise
the funds though a GDR issue. It considers the following factors in pricing the issue:
(i) The expected domestic market price of the share is ` 300 (Face Value ` 10 per share)
(ii) 3 shares underly each GDR
(iii) Underlying shares are priced at 10% discount to the market price
(iv) Expected exchange rate is ` 60/$
You are required to compute:
(a) the number of GDR's to be issued and
(b) cost of GDR to Odessa Limited, if 20% dividend is expected to be paid with a
growth rate of 20%.


11. The following market data is available:
Spot USD/JPY 116.00
Deposit rates p.a. USD JPY
3 months 4.50% 0.25%
6 months 5.00% 0.25%
a. Whether 3 months FRA rate at 3 months forward for Yen should be Nil or not.
b. What should be 3 months FRA rate at 3 months forward?
c. Analyse is any arbitrage opportunity available if the 6 & 12 months LIBORS for USD
are 5% & 6.5% respectively and Bank XYZ is quoting 6/12 USD FRA at
6.50 – 6.75%.?
Corporate Valuation
12. BRS Inc deals in computer and IT hardwares and peripherals. The expected re venue for
the next 8 years is as follows:
Years Sales Revenue ($ Million)
1 8
2 10
3 15
4 22
5 30
6 26
7 23
8 20
Summarized financial position as on 31 March 2012 was as follows:
$ Million

Equity Stocks 12 Fixed Assets (Net) 17
12% Bonds 8 Current Assets 3
20 20

Additional Information:
(a) Its variable expenses is 40% of sales revenue and fixed operating expenses (cash)
are estimated to be as follows:
1- 4 years 1.6
5-8 years 2
(b) An additional advertisement and sales promotion campaign shall be launched
requiring expenditure as per following details:
1 year 0.50
2-3 years 1.50
4-6 years 3.00
7-8 years 1.00
(c) Fixed assets are subject to depreciation at 15% as per WDV method.
(d) The company has planned additional capital expenditures (in the beginning of each
year) for the coming 8 years as follows:
1 0.50
2 0.80
3 2.00
4 2.50
5 3.50
6 2.50
7 1.50
8 1.00
(e) Investment in Working Capital is estimated to be 20% of Revenue.
(f) Applicable tax rate for the company is 30%.
(g) Cost of Equity is estimated to be 16%.
(h) The Free Cash Flow of the firm is expected to grow at 5% per annum after 8 years.
With above information you are required to determine the:
(i) Value of Firm


Notes: (i) PVF Table @ 13%
Year 1 2 3 4 5 6 7 8
PVF 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376
(ii) Round off calculations upto 2 decimal points.
13. The following is the Balance-sheet of GFC Ltd as at March 31 st, 2021.
Liabilities (` in lakhs) Assets (` in lakhs)
Equity shares of ` 100 each 600 Land and Building 200
14% preference shares of 200 Plant and Machinery 300
` 100/- each
13% Debentures 200 Furniture and Fixtures 50
Debenture interest accrued and 26 Inventory 150
payable
Loan from bank 74 Sundry debtors 70
Trade creditors 340 Cash at bank 130
Cost of issue of 5
debentures
Profit and Loss account 525
1440 1440
The Company did not perform well and has suffered sizable losses during the last few
years. However, it is felt that the company could be nursed back to health by proper
financial restructuring. Consequently the following scheme of reconstruction has been
drawn up:
(a) Equity shares are to be reduced to ` 25/- per share, fully paid up;
(b) Preference shares are to be reduced (with coupon rate of 10%) to equal number of
shares of ` 50 each, fully paid up.
(c) Debenture holders have agreed to forgo the accrued interest due to them. In the
future, the rate of interest on debentures is to be reduced to 9 percent.
(d) Trade creditors will forego 25 percent of the amount due to them.
(e) The company issues 6 lakh of equity shares at ` 25 each and the entire sum was to
be paid on application. The entire amount was fully subscribed by promoters.

(f) Land and Building was to be revalued at ` 450 lakhs, Plant and Machinery was to
be written down by ` 120 lakhs and a provision of ` 15 lakhs had to be made for
bad and doubtful debts.
Required:
(i) Show the impact of financial restructuring on the company’s activities.
(ii) Prepare the fresh balance sheet after the reconstructions is completed on the basis
of the above proposals.
14. As per GSR Notification dated 19th February 2019, what conditions an entity need to
satisfy to be considered as a startup?
15. Explain pricing of the securitized instruments.
1.
Date Closing Sensex Sign of Price Charge
1.10.07 2800
3.10.07 2780 -
4.10.07 2795 +
5.10.07 2830 +
8.10.07 2760 -
9.10.07 2790 +
10.10.07 2880 +
11.10.07 2960 +
12.10.07 2990 +
15.10.07 3200 +
16.10.07 3300 +
17.10.07 3450 +
19.10.07 3360 -
22.10.07 3290 -
23.10.07 3360 +
24.10.07 3340 -
25.10.07 3290 -

29.10.07 3240 -
30.10.07 3140 -
31.10.07 3260 +
Total of sign of price changes (r) = 8
No of Positive changes = n1 = 11
No. of Negative changes = n2 = 8
2n1n2
r= +1
n1 + n2
2  11 8
 = + 1 = 176/19 + 1 = 10.26
11 + 8

2n1n2 (2n1n2 − n1 − n2 )
 =
r (n1 + n2 )2 (n1 + n2 − 1)

(2  11 8) (2  11 8 − 11 − 8) 176  157
 = = = 4.252 = 2.06
r (11 + 8)2 (11 + 8 − 1) (19)2 (18)
Since too few runs in the case would indicate that the movement of prices is not random.
We employ a two- tailed test the randomness of prices.
Test at 5% level of significance at 18 degrees of freedom using t-table
The lower limit

=  – t ×  =10.26 – 2.101 × 2.06 = 5.932
r
Upper limit

=  + t ×  =10.26 + 2.101 × 2.06 = 14.588
r
At 10% level of significance at 18 degrees of freedom

Lower limit
= 10.26 – 1.734 × 2.06 = 6.688
Upper limit
= 10.26 + 1.734 × 2.06 = 13.832
As seen r lies between these limits. Hence, the market exhibits weak form of efficiency.
*For a sample of size n, the t distribution will have n-1 degrees of freedom.

2. (i) Conversion value of preference share

Conversion Ratio x Market Price
2 × ` 21 = ` 42
(ii) Conversion Premium
(` 50/ ` 42) – 1 = 19.05%
(iii) Effect of the issue on basic EPS
`
Before Conversion
Total (after tax) earnings ` 3 × 5,00,000 15,00,000
Dividend on Preference shares 1,40,000
Earnings available to equity holders 13,60,000
No. of shares 5,00,000
EPS 2.72
On Diluted Basis
Earnings 15,00,000
No of shares (5,00,000 + 80,000) 5,80,000
EPS 2.59
(iv) EPS with increase in Profit
`
Before Conversion
Earnings 25,00,000
Dividend on Pref. shares 1,40,000
Earning for equity shareholders 23,60,000
No. of equity shares 5,00,000
EPS 4.72
On Diluted Basis
Earnings 25,00,000
No. of shows 5,80,000
EPS 4.31

3. (a) Calculation of cost of capital

Retained earnings 37.5% ` 3 per share
Dividend* 62.5% ` 5 per share
EPS 100.0% ` 8 per share
P/E ratio 7.5 times
Market price is ` 7.5  8 = ` 60 per share
Cost of equity capital = (Dividend/price  100) + growth %
= (5/60  100) + 12% = 20.33%.
 `3 
*   62.5 = ` 5 
 37.5 
(b) Market price = Dividend/(cost of equity capital % − growth rate %) = 5/(20.33% −
13%) = 5/7.33% = ` 68.21 per share.
(c) Market price = Dividend/(cost of equity capital % − growth rate %) = 5/(18% − 15%)
= 5/3% = ` 166.66 per share.
4. Computation of current value of John’s portfolio
(i) 10 Nos. Bond A, ` 1,000 par value, 9% Bonds maturity 3 years:
`
Current value of interest on bond A
1-3 years: ` 900  Cumulative P.V. @ 12% (1-3 years) = ` 900  2.402 2,162
Add: Current value of amount received on maturity of Bond A
End of 3rd year: ` 1,000  10  P.V. @ 12% (3rd year) = ` 10,000 
0.712 7,120
9,282
(ii) 10 Nos. Bond B, ` 1,000 par value, 10% Bonds maturity 5 years:
Current value of interest on bond B
1-5 years: ` 1,000  Cumulative P.V. @ 12% (1-5 years) = ` 1,000  3,605
3.605
Add: Current value of amount received on maturity of Bond B
End of 5th year: ` 1,000  10  P.V. @ 12% (5 th year) = ` 10,000  0.567 5,670
9,275

(iii) 100 Preference shares C, ` 100 par value, 11% coupon

11%  100 Nos.  ` 100 1,100 8,462
=
13% 0.13
(iv) 100 Preference shares D, ` 100 par value, 12% coupon

12%  100 Nos.  ` 100 1,200
= 9,231
13% 0.13
Total current value of his portfolio [(i) + (ii) + (iii) + (iv)] 36,250
19679 − 18104.68
5. Maximum decline in one month = × 100= 8%
19679
(1) Immediately to start with
= 2 (10,00,000 – 9,20,000) = ` 1,60,000
Ankit may invest ` 1,60,000 in equity and balance in risk free securities.
(2) After 15 days
Value of equity = 1,60,000 x 19088.63 / 19679 = ` 1,55,200
= 2 (9,95,200 – 9,20,000) = ` 1,50,400
Revised Portfolio:
Equity = ` 1,50,400
Risk free Securities = ` 9,95,200 – ` 1,50,400 = ` 8,44,800
(3) After another 15 days
Value of equity = 1,50,400 x 20997.493 / 19088.63 = ` 1,65,440
= 2 (10,10,240 – 9,20,000) = ` 1,80,480
Revised Portfolio:
Equity = ` 1,80,480

Risk Free Securities = ` 10,10,240 – ` 1,80,480 = ` 8,29,760

Ankit should off-load ` 15,040 of risk free securities and divert to Equity.
6. Yield for 9 months (120% x 9/12) = 90%
Market value of Investments as on 31.03.2011= ` 50,000 + (` 50,000x 90%) = ` 95,000
Therefore, NAV as on 31.03.2011 = (` 95,000 - ` 5,000)/5,000 = ` 18.00
` 5,000
Since dividend was reinvested by Mr. X, additional units acquired = = 277.78 unit
` 18
Therefore, units as on 31.03.2011 = 5,000 + 277.78 = 5,277.78
Alternatively, units as on 31.03.2011 = (` 95,000/`18) = 5,277.78
Dividend as on 31.03.2012= 5,277.78 x ` 10 x 0.2 = `10,555.56
Capital Gain (5277.78 x ` 0.60) = ` 3,166.67
= `13,722.23
Let X be the NAV on 31.03.2012, then number of new units reinvested will be
`13,722.23/X.
Accordingly, 6,271.98 units shall consist of reinvested units and 5277.78 (as on
31.03.2011).
Thus, by way of equation it can be shown as follows:
` 13,722.23
6,271.98 = + 5,277.78
X
Therefore, NAV as on 31.03.2012 = ` 13,722.23/ (6,271.98 – 5,277.78) = ` 13.80
NAV as on 31.03.2013 = ` 50,000 (1+0.715x33/12)/6,271.98 = ` 23.65
7. The optional hedge ratio to minimize the variance of Hedger’s position is given by:
S
H= 
F
Where
σS = Standard deviation of change in Spot Prices
σF = Standard deviation of change on Future Prices
ρ = coefficient of correlation between ΔS and ΔF
H = Hedge Ratio

Accordingly
0.04
H = 0.75 x = 0.5
0.06
No. of contract to be short to achieve a perfect hedge = 10 x 0.5 = 5
Amount to be paid as initial margin= 0.50 x 10 x 1000 x ` 474 x 8% = ` 1,89,600
8. Computation of Missing Entries in the Table: For computing the missing entries in
the table we will use Interest Rates Parity (IRP) theorem
(1 + rf ) S f / d
or =
(1 + rd ) Ff / d
Where,
rf is the rate of interest of country F (say the foreign country)
rd is rate of interest of country D (say domestic country)
Sf/d is the spot rate between the two countries F and D and
Ff/d is the forward rate between the two countries F and D.
(i) 3 months
1
(1) Dollar interest rate = 11 % (annually compounded)
2
1
Franc interest rate = 19 % (annually compounded)
2
Then Forward Franc per Dollar rate would be:
 0.195 
 1+ 4   1 + 0.04875 
= 7.05   = 7.05  
0.115  1 + 0.02875 
 1+ 
 4 
= Franc 7.19 per US Dollar
(2) Further Forward discount per Franc per cent per year = Interest Differential i.e.
1 1
= 19 % - 11 % = 8%
2 2
Alternatively, more precisely it can also be computed as follows:
Spot per Franc Rate = 1 / 7.05 = US Dollar 0.142 per Franc

 1 + 0.115 
One Year Forward Rate = 0.142   = US Dollar 0.132 per Franc
 1 + 0.195 
0.142 − 0.132
Accordingly, the discount per annum will be =  100 = 7.04%
0.142
Alternatively, it can also be computed using forward rate computed above as
follows:
Forward per Franc Rate = 1/7.19 = 0.139
0.142 − 0.139 12
Accordingly, the discount per annum will be =   100 = 8.45%
0.142 3
(ii) 6 months
(1) Forward discount on Franc % per year = − 6.3% or – 3.15% for 6 months
Spot per Franc Rate = US$ 0.142
Forward per Franc Rate = US$ 0.142 × (1 − 0.0315)
= US$ 0.138
Accordingly, Forward Francs per US$ = 1/0.138 = 7.25
6 months Forward rate = 7.05/ (100% − 3.15%)
Forward Francs per Dollar = 7.28 Francs
(2) Let r be the Franc interest rate (annually compounded) then as per IRP
Theory:
 r 
 1+ 2 
7.05  = Franc 7.25 per Dollar
0.1225 
 1+ 
 2 
On solving the equation, we get the value r = 18.27% i.e. Franc Interest rate
(annually compounded)
 r 
 1+ 2 
7.05  = Franc 7.28 per Dollar
0.1225 
 1+ 
 2 

On solving the equation we get the value of r = 19.17% i.e. Franc interest rate
(annually compounded)
(iii) 1 Year
Franc interest rate = 20% (annually compounded)
Forward Franc per Dollar = 7.5200
As per Interest Rate Parity the relationship between the two countries rate and spot
rate is
 1+Franc Interest Rate 
7.52 = 7.05  
 1+Dollar Interest Rate 
1 + Dollar interest rate 7.05
i.e. = =
1 + 0.20 7.52
Accordingly, the Dollar interest rate = 1.20  0.9374 – 1 = 1.125 – 1 = 0.125 or
12.5%
The completed Table will be as follows:
3 Months 6 Months 1 Year
Dollar interest rate (annually 11½% 12¼% 12.50%
compounded)
Franc interest rate (annually 19½% 19.17% or 18.27% 20%
compounded)
Forward Franc per Dollar 7.19 7.25 or 7.28 7.5200
Forward discount per Franc percent 8% or 7.04% 6.3%
per year or 8.45%
9. Individual Basis
Interest Amt. after 91 days Conversion in £
Holland £502,414.71
€ 725,000 x 0.02 x 91/360 = € 3,665.28 € 728,665.28 (728,665.28 x 0.6895)
Switzerland £432,651.51
CHF 998,077 x 0.005 x CHF 1,261.46 CHF 999,338.46 (999,338.46÷2.3098)
91/360 =
UK
£ 75,000 x 0.01 x 91/360 = £ 189.58 £ 75,189.58 £ 75,189.58

Swap to Sterling
Sell € 7,25,000 (Spot at 0.6858) buy £ £ 4,97,205.00
Sell CHF 9,98,077(Spot at 2.3326) buy £ £ 4,27,881.76
Independent GBP amount £ 75,000.00
£ 1,000,086.76
Interest (£ 1,000,086.76 x 0.05375 x 91/360) £ 13,587.98
Less: Total GBP at 91 days as per individual basis £ 1,010,255.80
Net Gain £ 3,418.94
10. Net Issue Size = $15 million

$15 million
0.98
Issue Price per GDR in $ (` 810/ ` 60) $13.50
Dividend Per GDR (D 1) = ` 2 x 3 = `6
Net Proceeds Per GDR = ` 810 x 0.98 = ` 793.80
(a) Number of GDR to be issued
$15.306 million
= 1.1338 million
$13.50
(b) Cost of GDR to Odessa Ltd.
6.00
ke = + 0.20 = 20.76%
793.80
11. (a) The FRA on Yen shall be Nil as interest rate for both periods i.e. 3 months and 6
months are same.
(b) 3 Months Interest rate is 4.50% p.a. & 6 Months Interest rate is 5% p.a.
Future Value 6 Months from now is a product of Future Value 3 Months now & 3
Months
Future Value from after 3 Months.
(1+0.05*6/12) = (1+0.045*3/12) x (1+i 3,6 *3/12)
i3,6 = [(1+0.05* 6/12) /(1+0.045 *3/12) – 1] *12/3

i.e. 5.44% p.a.

(c) 6 Months Interest rate is 5% p.a. & 12 Month interest rate is 6.5% p.a.
Future value 12 month from now is a product of Future value 6 Months from now
and 6
Months Future value from after 6 Months.
(1+0.065) = (1+0.05*6/12) x (1+i 6,6 *6/12)
i6,6 = [(1+0.065/1.025) – 1] *12/6
6 Months forward 6 month rate is 7.80% p.a.
The Bank is quoting 6/12 USD FRA at 6.50 – 6.75%
Therefore, there is an arbitrage Opportunity of earning interest @ 7.80% p.a. &
Paying @ 6.75%
Borrow for 6 months, buy an FRA & invest for 12 months
To get $ 1.065 at the end of 12 months for $ 1 invested today
To pay $ 1.060# at the end of 12 months for every $ 1 Borrowed today
Net gain $ 0.005 i.e. risk less profit for every $ borrowed
# (1+0.05/2) (1+.0675/2) = (1.05959) say 1.060
12. Working Notes:
(a) Determination of Weighted Average Cost of Capital
Sources of funds Cost (%) Proportions Weights Weighted Cost
Equity Stock 16 12/20 0.60 9.60
12% Bonds 12% (1-0.30) = 8.40 8/20 0.40 3.36
12.96 say 13
(b) Schedule of Depreciation $ Million
Year Opening Balance Addition during Total Depreciation
of Fixed Assets the year @ 15%
1 17.00 0.50 17.50 2.63
2 14.87 0.80 15.67 2.35
3 13.32 2.00 15.32 2.30
4 13.02 2.50 15.52 2.33
5 13.19 3.50 16.69 2.50

6 14.19 2.50 16.69 2.50

7 14.19 1.50 15.69 2.35
8 13.34 1.00 14.34 2.15
(c) Determination of Investment $ Million
Investment Required Existing Additional
Year For Capital CA (20% of Investment Investment
Total in CA required
Expenditure Revenue)
1 0.50 1.60 2.10 3.00 0.00
2 0.80 2.00 2.80 2.50* 0.30
3 2.00 3.00 5.00 2.00** 3.00
4 2.50 4.40 6.90 3.00 3.90
5 3.50 6.00 9.50 4.40 5.10
6 2.50 5.20 7.70 6.00 1.70
7 1.50 4.60 6.10 5.20 0.90
8 1.00 4.00 5.00 4.60 0.40
* Balance of CA in Year 1 ($3 Million) – Capital Expenditure in Year 1($ 0.50 Million)
** Similarly balance of CA in Year 2 ($2.80) – Capital Expenditure in Year 2($ 0.80
Million)
(d) Determination of Present Value of Cash Inflows $ Million
Years
Particulars
1 2 3 4 5 6 7 8
Revenue (A) 8.00 10.00 15.00 22.00 30.00 26.00 23.00 20.00
Less: Expenses
Variable Costs 3.20 4.00 6.00 8.80 12.00 10.40 9.20 8.00
Fixed cash operating
cost 1.60 1.60 1.60 1.60 2.00 2.00 2.00 2.00
Advertisement Cost 0.50 1.50 1.50 3.00 3.00 3.00 1.00 1.00
Depreciation 2.63 2.35 2.30 2.33 2.50 2.50 2.35 2.15
Total Expenses (B) 7.93 9.45 11.40 15.73 19.50 17.90 14.55 13.15
EBIT (C) = (A) - (B) 0.07 0.55 3.60 6.27 10.50 8.10 8.45 6.85
Less: Taxes@30% (D) 0.02 0.16 1.08 1.88 3.15 2.43 2.53 2.06
NOPAT (E) = (C) - (D) 0.05 0.39 2.52 4.39 7.35 5.67 5.92 4.79

Gross Cash Flow (F) =

(E) + Dep 2.68 2.74 4.82 6.72 9.85 8.17 8.27 6.94
Less: Investment in
Capital Assets
plus Current Assets (G) 0 0.30 3.00 3.90 5.10 1.70 0.90 0.40
Free Cash Flow (H) = (F)
- (G) 2.68 2.44 1.82 2.82 4.75 6.47 7.37 6.54
PVF@13% (I) 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376
PV (H)(I) 2.37 1.91 1.26 1.73 2.58 3.11 3.13 2.46
Total present value = $ 18.549 million
(e) Determination of Present Value of Continuing Value (CV)
FCF9 $6.54million(1.05) $6.867million
CV = = = = $85.84 million
k-g 0.13- 0.05 0.08
Present Value of Continuing Value (CV) = $85.84 million X PVF 13%,8 = $85.96875
million X 0.376 = $32.27 million
(i) Value of Firm $ Million
Present Value of cash flow during explicit period 18.55
Present Value of Continuing Value 32.27
Total Value 50.82
(ii) Value of Equity $ Million
Total Value of Firm 50.82
Less: Value of Debt 8.00
Value of Equity 42.82
13. Impact of Financial Restructuring
(i) Benefits to GFC Ltd.
` in lakhs
(a) Reduction of liabilities payable
Reduction in equity share capital (6 lakh shares x ` 75 per share) 450
Reduction in preference share capital (2 lakh shares x ` 50 per share) 100
Waiver of outstanding debenture Interest 26
Waiver from trade creditors (` 340 lakhs x 0.25) 85
661

(b) Revaluation of Assets

Appreciation of Land and Building (` 450 lakhs - ` 200 lakhs) 250
Total (A) 911
(ii) Amount of ` 911 lakhs to be utilized to write off losses, fictitious assets and over-
valued assets as follows:
Writing off profit and loss account 525
Cost of issue of debentures 5
Provision for bad and doubtful debts 15
Revaluation of Plant and Machinery 120
(` 300 lakhs – ` 180 lakhs)
Total (B) 675
Capital Reserve (A) – (B) 236
(iii) Balance sheet of GFC Ltd as at 31 st March 2021 (after re-construction)

(` in lakhs)
12 lakhs equity shares of 300 Land & Building 450
` 25/- each
10% Preference shares 100 Plant & Machinery 180
of ` 50/- each
Capital Reserve 236 Furnitures & Fixtures 50
9% debentures 200 Inventory 150
Loan from Bank 74 Sundry debtors 70
Trade Creditors 255 Prov. for Doubtful -15 55
Debts
Cash-at-Bank 280
(Balancing figure)*
1165 1165
*Opening Balance of `130/- lakhs + Sale proceeds from issue of new equity shares
`150/- lakhs.

14. As per GSR Notification 127 (E) dated 19 th February 2019, an entity shall be considered
as a Startup:
i. Upto a period of ten years from the date of incorporation/ registration, if it is
incorporated as a private limited company (as defined in the Companies Act, 2013)
or registered as a partnership firm (registered under section 59 of the Partnership
Act, 1932) or a limited liability partnership (under the Limited Liability Partnership
Act, 2008) in India.
ii. Turnover of the entity for any of the financial years since incorporation/ registration
has not exceeded one hundred crore rupees.
iii. Entity is working towards innovation, development or improvement of products or
processes or services, or if it is a scalable business model with a high potential of
employment generation or wealth creation.
Provided that an entity formed by splitting up or reconstruction of an existing
business shall not be considered a ‘Startup’.
15. Pricing of securitized instruments is an important aspect of securitization. While pricing
the instruments, it is important that it should be acceptable to both originators as well as
to the investors. On the same basis pricing of securities can be divided into following two
categories:
(1) From Originator’s Angle
From originator’s point of view, the instruments can be priced at a rate at which
originator has to incur an outflow and if that outflow can be amortized over a period
of time by investing the amount raised through securitization.
(2) From Investor’s Angle
From an investor’s angle security price can be determined by discounting best
estimate of expected future cash flows using rate of yield to maturity of a security of
comparable security with respect to credit quality and average life of the securities.
This yield can also be estimated by referring the yield curve available for marketable
securities, though some adjustments is needed on account of spread points,
because of credit quality of the securitized instruments.

PAPER – 2
ADVANCED FINANCIAL
MANAGEMENT
QUESTIONS
Securitization
1. Grow More Ltd. an NBFC is in the need of funds and hence it sold its
receivables to MAC Financial Corporation (MFC) for ` 100 million. MFC
created a trust for this purpose called General Investment Trust (GIT)
through which it issued securities carrying a different level of risk and
return to the investors. Further, this structure also permits the GIT to
reinvest surplus funds for short term as per their requirement.
MFC also appointed a third party, Safeguard Pvt. Ltd. (SPL) to collect the
payment due from obligor(s) and passes it to GIT. It will also follow up
with defaulting obligor and if required initiate appropriate legal action
against them.
Based on above scenario, answer the following questions:
I. The securitized instrument issued for ` 100 million by the GIT falls
under category of ……….
(a) Pass Through certificate (PTCs)
(b) Pay Through Security (PTS)
(c) Stripped Security
(d) Debt Fund.
II. In the above scenario, the Originator is………………….
(a) Grow More Ltd.
(b) MAC Financial Corporation (MFC)

REVISION TEST PAPER
FINAL COURSE
(c) General Investment Trust (GIT)

(d) Safeguard Pvt. Ltd.
III. In the above scenario, the General Investment Trust (GIT) is
a/an………………….
(a) Obligor
(b) Originator
(c) Special Purpose Vehicle (SPV)
(d) Receiving and Paying Agent (RPA)
IV. In the above scenario, the Safeguard Pvt. Ltd. (SPL) is
a/an………………
(a) Obligor
(b) Originator
(c) Special Purpose Vehicle (SPV)
(d) Receiving and Paying Agent (RPA)
V. Which of the following statement holds true?
(a) When Yield to Maturity in market rises, prices of Principle
Only (PO) Securities tend to rise.
(b) When Yield to Maturity in market rises, prices of Principle
Only (PO) Securities tend to fall.
(c) When Yield to Maturity in market falls, prices of Principle
Only (PO) Securities tend to fall.
(d) When Yield to Maturity in market falls, prices of Principle
Only (PO) Securities remain the same.
Security Analysis
2. You are a financial analyst at a prominent investment firm and have
been tasked with empirically verifying the weak form of Efficient Market
Hypothesis (EMH) Theory for the XYZ Stock Index, a collection of diverse
stocks. You decided to conduct three different tests to assess whether
the stock market follows the principles of the weak form of EMH.
2 MAY 2024 EXAMINATION

REVISION TEST PAPER
ADVANCED FINANCIAL MANAGEMENT
Test 1
For the past five years, you collected daily price changes of the stocks in the
XYZ Stock Index. You calculated correlation coefficients for different lag
periods and analyzed whether past price changes exhibit any significant
correlation with future price changes. You considered price changes to be
serially independent. The results indicated that most auto correlation
coefficients are close to zero and statistically insignificant, suggesting those
past price changes do not predict future price changes.
Test 2
You further investigated the randomness of price changes in the XYZ
Stock Index. Analyzing the sequence of daily price changes, you count
the number of runs where price changes are consistently positive or
negative. Upon comparing the observed number of runs with the
expected number based on randomness, you find that they align closely,
supporting the idea that price changes follow a random pattern.
Test 3
To examine the efficacy of trading strategies based on historical price
trends, you implemented a simple trading rule for the XYZ Stock Index.
The rule involves buying when the price crosses a moving average of 5%
threshold and selling when it crosses another 7% threshold. Over a
period of testing, you computed the returns generated by the trading
strategy. The results revealed that the returns are not consistently better
than random chance, implying that past price trends do not reliably
predict future price movements.
Conclusion:
After conducting the three tests the evidence supports the weak form of
Efficient Market Theory for the XYZ Stock Index you concluded that past
price trends do not reliably predict future price movements.
Based on the above information answer the following questions:
I. Test 1 is …………………
(a) Serial Correlation test
(b) Filter Rules test

REVISION TEST PAPER
FINAL COURSE
(c) Run test

(d) Variance Ratio test
II. Test 2 is ………………….
(c) Run test
(d) Variance Ratio test
III. Test 3 is ………………
(c) Run test
(d) Variance Ratio test.
IV. The Filter Rule Test should not be applied for buy and hold strategy
if…………….
(a) the behavior of stock price changes is predictable.
(b) the behavior of stock price changes is dependent on past
trends.
(c) the behavior of stock price changes is correlated.
(d) the behavior of stock price changes is random.
V. Results of your studies support the……………
(a) Semi-strong EMH Theory
(b) Strong EMH Theory
(c) Random Walk Theory
(d) Markowitz Theory
Derivatives Analysis and Valuation
3. Mr. Shyam an investor is not sure about the expected price movement of
the stock of Delta Corporation’s share. His friend Adi advised him to go for
option contracts if he wants to play in the market with limited risk. Adi

REVISION TEST PAPER
advised him to follow below mentioned Strategy.

(1) Purchase one 3-month call option with a premium of ` 30 and an
exercise price of ` 550.
(2) Purchase one 3-month put option with a premium of ` 5 and an
exercise price of ` 450.
Delta Corporation’s stock is currently selling at ` 500.
Demonstrate the net pay off position of Mr. Shyam at the expiry of option
after 3-months if the price of Delta Corporation’s stock happens to be:
(i) No change in price
(ii) falls at ` 350
(iii) rises to ` 600.
Assume the option lot size is 100.
4. The price of ACC stock on 31 December 2022 was ` 220 and the Futures
price on the same stock on the same date, i.e., 31 December 2022 for
March 2023 was ` 222. Other features of the Futures contract and
related information are as follows:
Time to expiration - 3 months (0.25 year)
Borrowing rate - 15% p.a.
Annual Dividend on the stock - 25% payable before 31.03. 2023
Face Value of the Stock - ` 10
Advise the investor the course of action to be followed by him so as to
earn Risk free income if he can sell the stock short at spot price.
Business Valuation
5. The following information is given for 3 companies that are identical
except for their capital structure:
Orange Grape Apple

Total invested capital 1,00,000 1,00,000 1,00,000
Debt/assets ratio 0.8 0.5 0.2
Pre-tax cost of debt 16% 13% 15%

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FINAL COURSE
Cost of equity 26% 22% 20%

Operating Income (EBIT) 25,000 25,000 25,000
The tax rate is uniform 35% in all cases.
Required:
(i) Compute the Weighted Average Cost of Capital of each company.
(ii) Tabulate the Economic Valued Added (EVA) of each company.
(iii) If the industry PE ratio is 11x and stock prices of Orange, Grape
and Apple are ` 14.30, ` 15.95 and ` 15.73 respectively then
calculate the no. of shares issued by each company.
(iv) Advise whether same Industry PE ratio can be used to calculate
market price of share of each company.
(v) Tabulate market Capitalisation for each of the Companies.
6. JKL Ltd., an Indian company has an export exposure of JPY 10,000,000
receivable December 31, 2022. Japanese Yen (JPY) is not directly quoted
against Indian Rupee.
The current spot rates are:
INR/US $ = ` 82.22
JPY/US$ = JPY 132.34
It is estimated that Japanese Yen will depreciate to 154 against US $ and
Indian Rupee to depreciate to ` 85 against US $.
Forward rates as on date for 31 st December 2022 are as follows:
INR/US $ = ` 86.50
Required:
(i) Evaluate the expected loss based on estimated rates if the hedging
is not done.
(ii) Justify the decision to take forward cover even if actual rates on
December 31, 2022 happens to be as follows:

REVISION TEST PAPER
INR/US $ = ` 86.25
Note: Make calculation of ¥ rate in ` upto 4 decimal points.
7. A UK based exporter exported goods to USA. The Invoice amount is
$ 7,00,000 and credit period is 3 months. Exchange rates in London are
as follows: -
Spot Rate ($/£) 1.5865 – 1.5905
3-month Forward Rate ($/£) 1.6100 – 1.6140
Rates of interest in Money Market:
Deposit Loan
$ 7% 9%
£ 5% 8%
Justify your stand to choose money market hedge (including steps)

instead of Forward Contract.
Note: Make calculation upto 2 decimal points.
Advanced Capital Budgeting Decisions
8. X Ltd. is considering its new project with the following details:
Sr. No. Particulars Figures

1. Initial capital cost ` 400 Cr.
2. Annual unit sales 5 Cr.
3. Selling price per unit ` 100
4. Variable cost per unit ` 50
5. Fixed costs per year ` 50 Cr.
6. Discount Rate 6%
Required:
(i) Tabulate the NPV of the project. Does it represent the actual
outcome? Comment.

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FINAL COURSE
(ii) Examine the impact of 2.5 percent adverse variance in each of the
variables on the project’s NPV. Decide which variable is having
maximum effect?
(iii) Critically analyse the Sensitivity analysis as method of
incorporating risk in capital budgeting decisions.
Consider Life of the project as 3 years.
9. A Inc. and B Inc. intend to borrow $ 200,000 and $ 200,000 in ¥
respectively for a time horizon of one year. The prevalent interest rates
are as follows:
Company ¥ Loan $ Loan
A Inc 5% 9%
B Inc 8% 10%
The prevalent exchange rate is $ 1 = ¥ 120.
They entered in a currency swap under which it is agreed that B Inc will
pay A Inc @ 1% over the ¥ Loan interest rate which the later will have to
pay as a result of the agreed currency swap whereas A Inc will reimburse
interest to B Inc only to the extent of 9%.
Keeping the exchange rate invariant, assess and analyse the opportunity
gain or loss component of the ultimate outcome, resulting from the
designed currency swap.
Mutual Fund
10. There are two Mutual Funds viz. D Mutual Fund Ltd. and K Mutual Fund
Ltd. Each having close ended equity schemes.
NAV as on 31-12-2022 of equity schemes of D Mutual Fund Ltd. is ` 70.71
(consisting 99% equity and remaining cash balance) and that of K Mutual
Fund Ltd. is ` 62.50 (consisting 96% equity and balance in cash).

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Particular Equity Schemes

D Mutual Fund K Mutual Fund
Ltd. Ltd.
Sharpe Ratio 2 3.3
Treynor Ratio 15 15
Risk free rate of return (R f) 7%
There is no change in portfolios during the next month and annual

average cost is ` 3 per unit for the schemes of both the Mutual Funds.
Required:
(i) Tabulate the expected NAVs of both the schemes if share market
goes down by 5% within a month.
(ii) Advise which mutual fund should an investor choose from the
perspective of risk per unit of return.
Note: For calculation purpose, consider 12 months in a year and ignore
number of days for a particular month.
11. An investor has decided to invest ` 1,00,000 in the shares of two
companies, namely, ABC and XYZ. The projections of returns from the
shares of the two companies along with their probabilities are as follows:
Probability ABC (%) XYZ (%)

0.20 12 16
0.25 14 10
0.25 -7 28
0.30 28 -2
Required:
(i) Comment on return and risk of investment in individual shares.
(ii) Compare the risk and return of these two shares with a Portfolio of
these shares in equal proportions.

REVISION TEST PAPER
FINAL COURSE
(iii) Advise the proportion of each of the above shares to formulate a

minimum risk portfolio.
Security Valuation
12. Mr. Amit is happy with the investment in a company as it is paying good
dividend for the last few years. Last year it paid a dividend of ` 2 per
share. The share is currently trading at ` 150 per share. He is of view that
if he applies dividend discount model, the share is undervalued. As a
financial expert examine his view that dividend discount model
represents the fair value.
You being an expert is required to evaluate the market value of the
share of the company.
Profit after tax of the company ` 290 crores

Equity capital of company ` 1,300 crores
Par value of share ` 40 each
Debt ratio of company (Debt/ Debt + Equity) 27%
Long run growth rate of the company 8%
Beta 0.1; risk free interest rate 8.7%
Market returns 10.3%
Capital expenditure per share ` 47
Depreciation per share ` 39
Change in Working capital ` 3.45 per share
Note: Round off figures (e.g. EPS etc.) upto 2 decimal points.
International Financial management
13. Mr. Vishwas, a friend of Mr. Pramod who is one of the Directors of
Ashirwad Limited, is a citizen of Mauritius. His immediate family
members including his parents, born in India are residing in India. He
has many friends in different parts of India, due to which he happens to
visit India on frequent basis. He along with Mr. Pramod evince interest
in setting up business in India and formally incorporate a company to
commence their operations. Accordingly, a company is called “Aerious
Private Ltd.” got incorporated in Mumbai.

REVISION TEST PAPER
To start with he received a business proposal from one of his friends

Nimish a consultant. It is estimated that in equivalent terms the business
shall require an initial investment of MUR 100 Million and thereafter
MUR 2 Million each year will be needed as working capital fund.
He wished to evaluate whether the business proposal is viable or not.
The information related to exchange rate and inflation rate is as follows:
Spot Rate for 1 Mauritian Dollar (MUR) = 1.88 Indian Rupee (INR)
The inflation in India is 6% and in Mauritius is 5%.
It is expected that this inflation rate will remain unchanged for the next
4 years.
INR 8 Crore out of initial investment shall be required for setting up a
plant. The useful life of the plant is 4 years. At the end of 4 th year
estimated salvage value of this plant shall be INR 80 lakhs. Depreciation
of the plant shall be charged on the basis of straight-line method.
40 % of the investment shall be through debt funds from Mauritius at
the cost of 10% (post tax) while remaining funds shall be arranged by
him and his friends. They expect a rate of return of 12% on their funds.
Expected revenues & costs (excluding depreciation) in real term are as
under:
Year 1 2 3 4
Revenues (` Crore) 6.00 7.00 8.00 8.00
Costs (` Crore) 3.00 4.00 4.00 4.00
Assume that applicable tax rate in India is 30%. Since there is Double tax
avoidance agreement between India and Mauritius, the company is not
required to pay tax in Mauritius if tax has been paid in India.
The applicable inflation rates for revenues & costs are as follows:
Year Revenues Costs

1 10% 12%
2 9% 10%
3 8% 9%
4 7% 8%

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FINAL COURSE
He wants an expert opinion for the same investment proposal.

Demonstrate whether investment in this project is viable option or not.
Note: 1. Round off calculations upto 4 decimal points.
2. Show INR calculations in Crore and MUR calculations in
Million.
14. Succession planning is a good way for companies to ensure that
businesses are fully prepared to promote and advance all employees—
not just those who are at the management or executive levels. Explain
the above statement.
15. In the current scenario of globalization and growth in information and
communication technologies etc. the responsibilities of CFOs have been
drastically expanded. Explain.
1.
I (b)
II (b)
III (c)
IV (d)
V (b)
2.
I (a)
II (c)
III (b)
IV (d)
V (c)
3. Total premium paid on purchasing a call and put option
= (` 30 per share × 100) + (` 5 per share × 100)
= ` 3,000 + ` 500 = ` 3,500

REVISION TEST PAPER
(i) Net Pay-off if there is no change in price

In this case, Mr. Shyam exercises neither the Call option nor the
Put option as both will result in a loss for him.
Ending value = - ` 3,500 + Zero gain = - ` 3,500
i.e. Net loss is ` 3,500
(ii) Net Pay-off if price falls at ` 350
Since the price of the stock is below the exercise price of the Call,
it will not be exercised. Only Put is valuable hence it is exercised.
Ending value = – ` 3,500 + ` [(450 – 350) × 100] = – ` 3,500 +
` 10,000 = ` 6,500
 Net gain is ` 6,500
(iii) Net Pay-off if price rises to ` 600
In this situation, the put is worthless since the price of the stock
exceeds the Put’s exercise price. Only Call is valuable and hence it
is exercised.
Ending value = - ` 3,500 + ` [(600 – 550) × 100] = - ` 3,500 +
` 5,000 = ` 1,500
 Net Gain is ` 1,500
4. Based on the above information, the futures price for ACC stock on
31 December 2022 should be:
Spot price + Interest Portion – Dividend
= 220 + (220 x 0.15 x 0.25) – (0.25 x 10) = 225.75
Thus, as per the ‘cost of carry’ criteria, the Futures price is ` 225.75, which is
more than the actual price of ` 222 on 31 March 2023. This would give rise
to earn riskless arbitrage opportunity of ` 3.75 i.e. (225.75 - 222)
Advise to the Arbitrager.
1. Short sell one unit of stock at spot price for ` 220.
2. Deposit ` 220 at 15% p.a. for 3 months.
3. Buy a 3-month Futures contract for one unit of stock of ACC at
` 222.

REVISION TEST PAPER
FINAL COURSE
After 3 months
1. Take money out of the Bank.
2. Take delivery by paying ` 222 and return the unit of stock to the
party whom short sell was made along.
3. Pay the Dividend amount to the buyer whom short sell was made.
Total Inflow = 220 + (220 x 0.15 x 0.25) = ` 228.25
Total Outflow = 222 + 2.50 = ` 224.50
Net Gain to the Arbitrager = Total Inflow – Total Outflow
= ` 228.25 - ` 224.50
= ` 3.75
Thus, the arbitrager earns ` 3.75 per share without involving any risk.
5. (i) Calculation of WACC of each company
Orange Grape Apple
Total debt (`) 80,000 50,000 20,000
Post tax Cost of debt 10.40% 8.45% 9.75%
Equity Fund (`) 20,000 50,000 80,000
WACC
Orange: (10.4 x 0.8) + (26 x 0.2) = 13.52%
Grape: (8.45 x 0.5) + (22 x 0.5) = 15.225%
Apple: (9.75 x 0.2) + (20 x 0.8) = 17.95%
(ii) Economic Valued Added (EVA) of each company
Orange Grape Apple

WACC 13.52 15.225 17.95
EBIT (1-T) (A) 16,250 16,250 16,250
WACC x Invested Capital (B) 13,520 15,225 17,950
EVA [(A) – (B)] 2,730 1,025 -1,700

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Orange would be considered as the best investment since the EVA

of the company is highest and its weighted average cost of capital
is the lowest.
(iii) No. of shares issued by each company
Orange Grape Apple
EBIT (`) 25,000 25,000 25,000
Interest (`) 12,800 6,500 3,000
Taxable Income (`) 12,200 18,500 22,000
Tax 35% (`) 4,270 6,475 7,700
Net Income (`) 7,930 12,025 14,300
Stock Price (EPS x PE 14.30 15.95 15.73
Ratio) (`)
No. of shares (7930x11)/ (12025x11)/1 (14300x11)/1
14.30 5.95 5.73
= 6100 = 8293 = 10000
(iv) Since the three entities have different capital structures, they
would be exposed to different degrees of financial risk. The PE
ratio should therefore be adjusted for the risk factor.
(v) Market Capitalisation
Orange Grape Apple
Estimated Stock Price (`) 14.30 15.95 15.73
No. of shares 6,100 8,293 10,000
Estimated Market Cap (`) 87,230 1,32,273.35 1,57,300
6. Since the direct quote for ¥ and ` is not available it will be calculated by
cross exchange rate as follows:
`/$ x $/¥ = `/¥
82.22/132.34 = 0.6213
Spot rate on date of export 1 ¥ = ` 0.6213
Estimated Rate of ¥ for Dec.31, 2022 = ` 0.5519 (` 85/¥ 154)

REVISION TEST PAPER
FINAL COURSE
Forward Rate of ¥ for Dec.31, 2022 = ` 0.6163 (` 86.50/ ¥ 140.35)

(i) The expected loss without hedging
Value of export at the time of export ` 62,13,000

(` 0.6213 x ¥ 10,000,000)
Expected payment to be received on 31 st Dec. ` 55,19,000
2022 as per estimated rates (` 0.5519 x
¥ 10,000,000)
Loss ` 6,94,000
(ii) (a) Hedging of loss under Forward Cover

(` 0.6213 x ¥ 10,000,000)
Payment expected to be received under ` 61,63,000
Forward Cover
(` 0.6163 x ¥ 10,000,000)
Loss ` 50,000
Thus, by taking forward cover loss is reduced to ` 50,000
from ` 6,94,000
(b) Actual Rate of ¥ on December 2022 = ` 0.6124 (` 86.25/
¥ 140.85)

(` 0.6213 x ¥ 10,000,000)
Payment to be received on 31 st Dec. 2022 as ` 61,24,000
per actual rate (` 0.6124 x ¥ 10,000,000)
Loss ` 89,000
From the above solution, we can find that net loss in actual
situation is ` 89,000 while net loss when taken Forward Cover
is only ` 50,000. Hence, the decision to take Forward Cover is
justified even if the actual rate happens to be as prescribed.
7. Amount expected to be received under Money Market Hedge.
Identify: Foreign currency is an asset. Amount $ 7,00,000.

REVISION TEST PAPER
Create: $ Liability.
Borrow: In $. The borrowing rate is 9% per annum or 2.25% per quarter.
Amount to be borrowed: 7,00,000 / 1.0225 = $ 6,84,596.58
Convert: Sell $ and buy £. The relevant rate is the Ask rate, namely,
1.5905 per £,
(Note: This is an indirect quote).
Amount of £s received on conversion is 4,30,428.53 (6,84,596.58 /
1.5905).
Invest: £ 4,30,428.53 will be invested at 5% for 3 months and get
£ 4,35,808.89
Settle: The liability of $ 6,84,596.58 at interest of 2.25 per cent quarter
matures to $7,00,000 receivable from customer.
Using forward rate, amount receivable is = 7,00,000 / 1.6140 =
£ 4,33,705.08
Amount received through money market hedge = £ 4,35,808.89
Gain = £ 4,35,808.89– £ 4,33,705.08= £ 2103.81
Justification: By following the prescribed steps under hedging we
found the exporter receives £ 4,33,705.08 by using forward cover while
he receives £ 4,35,808.89 through money market hedge. Thus, money
market hedge helps exporter to receive £ 2103.81 more than the amount
received using Forward contract. Hence it is more beneficial.
8. (i) Calculation of Net Cash Inflow per year
Particulars Amount (`)
A Selling price per unit 100
B Variable cost per unit 50
C Contribution per unit (A - B) 50
D Number of units sold per year 5 Cr.
E Total Contribution (C × D) ` 250 Cr.
F Fixed cost per year ` 50 Cr.
G Net cash inflow per year (E - F) ` 200 Cr.

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FINAL COURSE
Calculation of Net Present Value (NPV) of the Project

Year Year Cash Flow PV factor Present Value (PV)
(` in Cr.) @ 6% (` in Cr.)
0 (400.00) 1.000 (400.00)
1 200.00 0.943 188.60
2 200.00 0.890 178.00
3 200.00 0.840 168.00
Net Present Value 134.60
Here, NPV represent the most likely outcomes and not the actual
outcomes. The actual outcome can be lower or higher than the
expected outcome.
(ii) Sensitivity Analysis considering 2.5 % Adverse Variance in each
variable
Particulars Base Initial Selling Variable Fixed Units
capital Price per Cost Per Cost Per sold per
cost Unit Unit Unit year
increased Reduced increased increased reduced
to ` 410 to ` 97.5 to to to 4.875
crore ` 51.25 ` 51.25 crore
(`) (`) (`) (`) (`) (`)
A Selling price 100 100 97.50 100 100 100
per unit
B Variable 50 50 50 51.25 50 50
cost per
unit
C Contribution 50 50 47.50 48.75 50 50
per unit
(A - B)
(` in Cr.) (` in Cr.) (` in Cr.) (` in Cr.) (` in Cr.) (` in Cr.)
D Number of 5 5 5 5 5 4.875
units sold
per year
(units in
Crores)
E Total 250 250 237.50 243.75 250 243.75

REVISION TEST PAPER
Contributio
n
(C × D)
F Fixed cost 50 50 50 50 51.25 50
per year
G Net Cash 200 200 187.50 193.75 198.75 193.75
Inflow per
year (E - F)
H PV of Net 534.60 534.60 501.19 517.89 531.26 517.89
cash Inflow
per year
(G × 2.673)
I Initial 400 410 400 400 400 400
capital cost
J NPV (H - I) 134.60 124.60 101.19 117.89 131.26 117.89
K Percentage - -7.43% -24.82% -12.41% -2.48% -12.41%
Change in
NPV
The above table shows that by changing one variable at a time by 2.5%
(adverse) while keeping the others constant, the impact in percentage
terms on the NPV of the project can be calculated. Thus, the change in
selling price has the maximum effect on the NPV by 24.82%.
Advantages of Sensitivity Analysis:
Following are the main advantages of Sensitivity Analysis:
(1) Critical Issues: This analysis identifies critical factors that impinge
on a project’s success or failure.
(2) Simplicity: It is a simple technique.
Disadvantage of Sensitivity Analysis
Following are the main disadvantages of Sensitivity Analysis:
(1) Assumption of Independence: This analysis assumes that all
variables are independent i.e. they are not related to each other,
which is unlikely in real life.

REVISION TEST PAPER
FINAL COURSE
(2) Ignore probability: This analysis does not look to the probability
of changes in the variables
9. Opportunity gain of A Inc under currency swap
Receipt Payment Net
Interest to be remitted to B. Inc
in $ 2,00,000 х 9% = $18,000 ¥21,60,000
Converted into ($18,000 х ¥120)
Interest to be received from B. ¥14,40,000 -
Inc in $ converted into Y (6% х
$2,00,000 х ¥120)
Interest payable on Y loan - ¥12,00,000
¥14,40,000 ¥33,60,000
Net Payment ¥19,20,000 -
¥33,60,000 ¥33,60,000
$ equivalent paid ¥19,20,000 х $16,000
(1/¥120)
Interest payable without swap $18,000
in $
Opportunity gain in $ $ 2,000
Opportunity gain of B inc under currency swap

Receipt Payment Net
Interest to be remitted to A. Inc in $12,000
($ 2,00,000 х 6%)
Interest to be received from A. Inc $18,000
in Y converted into $ = ¥
21,60,000/ ¥120
Interest payable on $ loan@10% - $20,000
$18,000 $32,000
Net Payment $14,000 -
$32,000 $32,000

REVISION TEST PAPER
Y equivalent paid $14,000 X ¥120 ¥16,80,000

Interest payable without swap in ¥ ¥19,20,000
($2,00,000 X ¥ 120 X 8%)
Opportunity gain in Y ¥ 2,40,000
Alternative Solution
Cash Flows of A Inc
Borrowings $2,00,000 X ¥120 + ¥240,00,000
Swap - ¥240,00,000
Swap +$2,00,000
Net Amount +$2,00,000

Interest to the lender ¥240,00,000 X 5% ¥12,00,000
Interest Receipt from B ¥2,00,000 X 120 X 6% ¥14,40,000
Inc.
Net Saving (in $) ¥2,40,000/¥120 $2,000
Interest to B Inc. $2,00,000 X 9% -$18,000
Net Interest Cost -$16,000
A Inc. used $2,00,000 at the net cost of borrowing of $16,000 i.e.,
8%. If it had not opted for swap agreement the borrowing cost
would have been 9%. Thus, there is saving of 1%.
Cash Flows of B Inc

Borrowings + $2,00,000
Swap - $2,00,000

REVISION TEST PAPER
FINAL COURSE
Swap $2,00,000 X ¥120 +¥240,00,000

Net Amount +¥240,00,000

Interest to the lender $2,00,000X10% - $20,000
Interest Receipt from A Inc. +$18,000
Net Saving (in ¥) -$2,000X¥120 - ¥2,40,000
Interest to A Inc. $2,00,000X6%X¥120 - ¥14,40,000
Net Interest Cost - ¥16,80,000
B Inc. used ¥240,00,000 at the net cost of borrowing of ¥16,80,000

i.e. 7%. If it had not opted for swap agreement the borrowing cost
would have been 8%. Thus, there is saving of 1%.
10. Working Notes:
(I) Decomposition of Funds in Equity and Cash Components
D Mutual K Mutual
Fund Ltd. Fund Ltd.
NAV on 31.12.14 ` 70.71 ` 62.50
% of Equity 99% 96%
(II) Calculation of Beta

E(R) - R f E(R) - R f
σD 11.25
E(R) - Rf = 22.50
E(R) - R f 22.50
βD βD

REVISION TEST PAPER
βD = 22.50/15 = 1.50
E(R) - R f E(R) - R f
σK 5
E(R) - Rf = 16.50
E(R) - R f 16.50
βK βK
βK = 16.50/15 = 1.10
(III) Decrease in the Value of Equity
D Mutual K Mutual
Fund Ltd. Fund Ltd.
Beta 1.50 1.10
(IV) Balance of Cash after 1 month
D Mutual K Mutual
Fund Ltd. Fund Ltd.
Cash in Hand on 31.12.14 ` 0.71 ` 2.50
(i) NAV after 1 month

D Mutual K Mutual
Fund Ltd. Fund Ltd.
70 x (1 - 0.075) ` 64.75 -
60 x (1 - 0.055) - ` 56.70
` 65.21 ` 58.95

REVISION TEST PAPER
FINAL COURSE
(ii) Computation to find out more beneficial Mutual fund:
D Mutual K Mutual
Fund Fund
E(R) - RF (a) 22.50 16.50
Risk free rate of return (b) 7 7
Expected Return (a+b) =(c) 29.50 23.50
Standard deviation (d) 11.25 5
Risk per unit Return (d/c) 0.38 0.21
Since risk per unit return of D is more than K, hence investor

shall choose K Mutual fund from the perspective of risk per
unit of return.
11. (i)
Probability ABC (%) XYZ (%) 1X2 (%) 1X3 (%)

(1) (2) (3) (4) (5)
0.20 12 16 2.40 3.20
0.25 14 10 3.50 2.50
0.25 -7 28 -1.75 7.00
0.30 28 -2 8.40 -0.60
Average return 12.55 12.10
Hence the expected return from ABC = 12.55% and XYZ is 12.10%
Probability (ABC- (ABC- 1X3 (XYZ- (XYZ- (1)X(6)

ABC ) ABC)2 XYZ) XYZ)2
(1) (2) (3) (4) (5) (6)
0.20 -0.55 0.3025 0.06 3.9 15.21 3.04
0.25 1.45 2.1025 0.53 -2.1 4.41 1.10
0.25 -19.55 382.2025 95.55 15.9 252.81 63.20
0.30 15.45 238.7025 71.61 -14.1 198.81 59.64
167.75 126.98
 2 ABC = 167.75(%) 2;  ABC = 12.95%
 2 XYZ = 126.98(%) 2;  XYZ = 11.27%

REVISION TEST PAPER
(ii) In order to find risk of portfolio of two shares, the covariance

between the two is necessary here.
Probability (ABC-ABC) (XYZ-XYZ) 2X3 1X4

(1) (2) (3) (4) (5)
0.20 -0.55 3.9 -2.145 -0.43
0.25 1.45 -2.1 -3.045 -0.76
0.25 -19.55 15.9 -310.845 -77.71
0.30 15.45 -14.1 -217.845 -65.35
-144.25
 2P = (0.52 x 167.75) + (0.5 2 x 126.98) + 2 x (-144.25) x 0.5 x 0.5
 2P = 41.9375 + 31.745 – 72.125
 2P = 1.5575 or 1.56(%)
 P = 1.56 = 1.25%
E (Rp) = (0.5 x 12.55) + (0.5 x 12.10) = 12.325%
Hence, the return is 12.325% with the risk of 1.25% for the
portfolio. Thus, the portfolio results in the reduction of risk by the
combination of two shares.
(iii) For constructing the minimum risk portfolio, the condition to be
satisfied is
σ X2 - rAX σ A σ X σ 2X - Cov.AX
XABC = or =
σ 2A + σ X2 - 2rAX σ A σ X σ 2A + σ 2X - 2 Cov.AX
σX = Std. Deviation of XYZ

σA = Std. Deviation of ABC
rAX= Coefficient of Correlation between XYZ and ABC
Cov.AX = Covariance between XYZ and ABC.
Therefore,
126.98 - (-144.25) 271.23
% ABC = = = 0.4650 or 46.50%
126.98 + 167.75 - [2 × (-144.25)] 583.23

REVISION TEST PAPER
FINAL COURSE
% ABC = 46.50%,
% XYZ = (1 – 0.4650) = 0.5350 = 53.50%
` 1,300crores
12. No. of Shares = = 32.50 Crores
` 40
PAT
EPS =
No.of shares
` 290 crores
EPS = = ` 8.92
32.5 crores
Calculation of value per share using Free Cash Flow to Equity as basis:
FCFE = Net income – [(1-b) (capex – dep) + (1-b) ( ΔWC )]
FCFE = 8.92 – [(1-0.27) (47-39) + (1-0.27) (3.45)]
= 8.92 – [5.84 + 2.52] = ` 0.564
Cost of Equity (K e)= Rf + ß (Rm – Rf)
= 8.7 + 0.1 (10.3 – 8.7) = 8.86%
FCFE(1+ g) 0.56(1.08) 0.6048

Po = = = = ` 70.33
Ke − g 0.0886 - 0.08 0.0086
Calculation of value per share using dividend discount model:

D0 (1+ g) 2(1.08) 2.16
Po = = = = ` 251.16
k e -g 0.0886-.08 0.0086
From the above we can see that value per share on the basis of dividend
discount model is more than the value per share on the basis of free
cash flow to equity model.
In the dividend discount model, the analyst considers the stream of
expected dividends to value the company’s stock. It is assumed that the
company follows a consistent dividend payout ratio which can be less
than the actual cash available with the firm.
A stock’s intrinsic value based on the dividend discount model may not
represent the fair value for the shareholders because dividends are
distributed in the form of cash from profits. In case the company is

REVISION TEST PAPER
maintaining healthy cash in its balance sheet then it means that dividend
pay-out is low which could result in undervaluation of the stock.
In the case of free cash flow to equity model a stock is valued on the
cash flow available for distribution after all the reinvestment needs of
capex and incremental working capital are met. Thus, using the free cash
flow to equity model provides a better measure for valuations in
comparison to the dividend discount model.
Thus, the view of Mr. Amit that dividend discount model represents the
fair value is incorrect. The share is not under-valued rather it is
overvalued if we take “free cash flow to equity model” into
consideration.
13. To evaluate whether investment in same project is a viable option or not,
we shall compute the NPV of the project.
Working Note:
(1) Expected Exchange Rates
End of Year INR INR/MUR

1 (1 + 0.06)
INR 1.88 x 1.8979
(1 + 0.05)
2 (1 + 0.06)
INR 1.8979 x 1.9160
(1 + 0.05)
3 (1 + 0.06)
INR 1.9160 x 1.9342
(1 + 0.05)
4 (1 + 0.06)
INR 1.9342 x 1.9526
(1 + 0.05)
(2) Initial Investment = MUR 100 Million x INR 1.88 = INR 18.80 crore
Working Capital (Year 1) = MUR 2 Millionx1.8979 = INR 0.3796 crore
(3) WACC = 40% x 10% + 60% x 12% = 11.20%
(4) Inflation adjusted Revenue

REVISION TEST PAPER
FINAL COURSE
Year Revenue (`) Revenue (Inflation Adjusted) (`)

1 6.00 crore 6.00 crore x 1.10 = 6.60 crore
2 7.00 crore 7.00 crore x 1.10 x 1.09 = 8.393 crore
3 8.00 crore 8.00 crore x 1.10 x 1.09 x 1.08 = 10.3594
crore
4 8.00 crore 8.00 crore x 1.10 x 1.09 x 1.08 x 1.07
= 11.0845 crore
(5) Inflation adjusted Cost
Year Cost (`) Cost (Inflation Adjusted) (`)

1 3.00 crore 3.00 crore x 1.12 = 3.3600 crore
2 4.00 crore 4.00 crore x 1.12 x 1.10 = 4.9280 crore
3 4.00 crore 4.00 crore x 1.12 x 1.10 x 1.09 = 5.3715 crore
4 4.00 crore 4.00 crore x 1.12 x 1.10 x 1.09 x 1.08
= 5.8012 crore
(6) Annual cash flows (` Crore)
Year 1 2 3 4
Revenue 6.600 8.393 10.3594 11.0845
Less: Cost 3.360 4.928 5.3715 5.8012
Less: Depreciation 1.800 1.800 1.800 1.800
Profit before Tax (PBT) 1.440 1.665 3.1879 3.4833
Tax @ 30% 0.432 0.4995 0.9564 1.0450
Profit after Tax 1.008 1.1655 2.2315 2.4383
Add: Depreciation 1.800 1.800 1.800 1.800
Cash Flows 2.808 2.9655 4.0315 4.2383
NPV of the Project
Year 0 1 2 3 4
Initial Investment (18.80)
(` Crore)

REVISION TEST PAPER
Working Capital - (0.3796) (0.3832) (0.3868) (0.3905)

(` Crore)
Scrap Value (` Crore) 0.8000
W.C Recovered 1.5401
(` Crore)
Annual Cash flows 2.8080 2.9655 4.0315 4.2383
Net Cash Flow (18.80) 2.4284 2.5823 3.6447 6.1879
Exchange Rate 1.88 1.8979 1.9160 1.9342 1.9526
Cash Flows (in Million (100) 12.7952 13.4776 18.8434 31.6906
MUR)
PVF@11.20% 1 0.8993 0.8087 0.7273 0.6540
Present value (in (100) 11.5067 10.8993 13.7048 20.7257
Million MUR)
Net Present Value = - MUR 43.1635 Million

Advise: Since NPV of the project is negative the proposal is not a
viable option for investment.
14. Succession planning is the process of identifying the critical positions
within an organization and developing action plans for individuals to
assume those positions. A succession plan identifies future need of
people with the skills and potential to perform leadership roles.
Taking a holistic view of current and future goals, this type of
preparation ensures that the right people are available for the right jobs
today and in the years to come. It can also provide a liquidity event,
which enables the transfer of ownership in a going concern to rising
employees.
Need for succession planning can be explained below:
❖ Risk mitigation – If existing leader quits, then searches can take
six-nine months for suitable candidate to close. Keeping an
organization without leader can invite disruption, uncertainty,
conflict and endangers future competitiveness.
❖ Cause removal – If the existing leader is culpable of gross
negligence, fraud, wilful misconduct, or material breach while
discharging duties and has been barred from undertaking further

REVISION TEST PAPER
FINAL COURSE
activities by court, arbitral tribunal, management, stakeholders or

any other agency.
❖ Talent pipeline – Succession planning keep employees motivated
and determined as it can help them obtaining more visibility around
career paths expected, which would help in retaining the knowledge
bank created by company over a period of time and leverage upon
the same.
❖ Conflict Resolution Mechanism – This planning is very helpful in
promoting open and transparent communication and settlement
of conflicts.
❖ Aligning – In family owned business succession planning helps to
align with the culture, vision, direction and values of the business.
15. Traditionally, the main role of CFO was concentrated to wealth
maximisation for shareholders by taking care of financial health of an
organization and overseeing and implementing adequate financial
controls.
However, in recent time because of globalization, growth in information
and communications, pandemic situation etc. their range of
responsibilities has been drastically expanded, driven by complexity, and
changing expectations.
Now a days in addition to fulfilling traditional role relating to
governance, compliances and controls, and business ethics as a part of
the leadership of role CFOs are also expected to contribute their support
in strategic and operational decision making.
In post-pandemic time their role has been advanced in the following
areas in addition to traditional role:
a. Risk Management: Now a days the CFOs are expected to look
after the overall functioning of the framework of Risk Management
system of an organisation.
b. Supply Chain: Post pandemic supply chain management system
has been posing the challenge for the company to maintain the
sustainable growth. Since CFOs are care takers of finance of the
company, considering the financial viability of the Supply Chain
Management their role has now become more critical.

REVISION TEST PAPER
c. Mergers, acquisitions, and Corporate Restructuring: Since in

recent period to maintain the growth and capture the market
share there has been a spate of Mergers and Acquisitions and
hence the role of CFOs has become more crucial because these are
strategic decision and any error in them can lead to collapse of the
whole business.
d. Environmental, Social and Governance (ESG) Financing: With
the evolving of the concept of ESG their role has been shifted from
traditional financing to sustainability financing.
Thus, from above discussion it can be concluded that in today’s time
CFOs are taking a leadership role in Value Creation for the organisation
and that too on sustainable basis for a longer period.

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PAPER – 2: STRATEGIC FINANCIAL MANAGEMENT

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

31.03.2014 70 5:4 58.42 31.05 70.05

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

Mergers, Acquisitions and Corporate Restructuring

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

3 7 0.782 5.474 0.0608 0.1824

© The Institute of Chartered Accountants of India

Expected market price after 2 years 2.50 1 ` 231.48

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

Unsystematic Variance of Portfolio = 0.0134 x (0.20)2 + 0.0225 x (0.50)2 + 0.0879 x

© The Institute of Chartered Accountants of India

*(53.75 – STT @ 0.2%) ≈ This value can also be taken as zero

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

8. (i) Cancellation Rate:

© The Institute of Chartered Accountants of India

Rounded off to ` 64.3150

© The Institute of Chartered Accountants of India

Recommendation: Since out of three options the maximum profit is in case

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

(b) Schedule of Depreciation

1 17.00 0.50 17.50 2.63

© The Institute of Chartered Accountants of India

Total present value = $ 18.549 million

© The Institute of Chartered Accountants of India

(ii) Value of Equity

Total no. of shares outstanding 14.59 lakh

© The Institute of Chartered Accountants of India

No. of shares (lakhs) 12.00

14. (a) Distinction between Banking and Non-Banking financial institutions

© The Institute of Chartered Accountants of India

Compliance Banks are required to comply with Non-banking institutions

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

not involve trade not allowed

© The Institute of Chartered Accountants of India

(iv) to enable the management to decide the trading strategies.

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

1. (i) Number of shares to be issued: 5,00,000

© The Institute of Chartered Accountants of India

(ii) Subscription price ` 20,00,000 / 2,50,000 = ` 8

© The Institute of Chartered Accountants of India

1.20 1.44 1.73 2.07 2.49 2.49 (1  0.10) 1

or P 0 = ` 1.20 (PVF 1, K e) + ` 1.44 (PVF 2, K e) + ` 1.73 (PVF 3 , K e ) + ` 2.07

© The Institute of Chartered Accountants of India