Question Paper

Investment Banking and Financial Services-I (261) : July 2005

Section A : Basic Concepts (30 Marks)
• • This section consists of questions with serial number 1 - 30.
• • Answer all questions.
• • Each question carries one mark.
• • Maximum time for answering Section A is 30 Minutes.

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1. Financial assets equal financial liabilities, so real assets will be financed by savings, for this Ans
relationship to exist which of the following assumptions should hold good? wer
>
I. There are no external borrowings in the system.
II. Financial liabilities include stock issued to the outsiders.
III. Surplus funds of an economic unit will either be used by the saver to purchase a real
asset or will be lent to other economic units to buy real assets.

(a) Only (I) above (b) Only (II) above

(c) Both (I) and (II) above (d) Both (II) and (III) above

(e) All (I), (II) and (III) above.

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2. Which of the following statements is/are true with respect to interest rate risk to the lenders? Ans
wer
I. In an administered rate scenario, the scope to manage this risk is very low. >
II. Cost based pricing of the loan can protect the lenders against this risk.
III. Credit risk is invariably reflected in the interest rate risk.

(a) Only (I) above (b) Only (II) above

(c) Both (I) and (II) above (d) Both (I) and (III) above

(e) All (I), (II) and (III) above.

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3. Some years back, Citibank offered a special kind of credit cards to all the members of Ans
Institute of Chartered Accountants of India. These types of cards are known as wer
>
(a) Co-branded cards (b) Branded cards (c) Affinity
cards
(d) Add-on cards (e) Levered investment cards.
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4. Which of the following statements is true with respect to Real Estate Investment Trusts Ans
(REIT)? wer
>
(a) The most prominent form of lending by REITs is the construction/developmental
lending
(b) To retain their special tax status, REITs have to distribute 50% of their income to
shareholders
(c) REITs are not allowed to raise finance through debt as they are equity investment
vehicles
(d) Indirect equity investments in REITs by investor usually lack liquidity
(e) According to the federal laws, REIT can only be infinite life trusts.
5. Which of the following statements is/are true in context of future flow securitization? <
Ans
I. In long-term contract receivables, volumes are generally pre-fixed but price may be variable. wer
II. In future flow category; receivables are subject to both, price and volume variations. >
 III. Borrower is able to secure a finer pricing and longer tenures in comparison to the terms
of other funding agencies.

(a) Only (I) above (b) Only (II) above

(c) Both (I) and (II) above (d) Both (II) and (III) above

(e) All (I), (II) and (III) above.

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6. The _____ are created by taking the cash-flows from the underlying collateral and splitting Ans
them into two or more classes that have the same maturity. wer
>
(a) Asset backed securities (b) Strip securities (c) Pay through
securities
(d) Collaterized mortgage obligations (e) Pass through securities.
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7. Discount fees involved in the transaction of forfaiting is payable by _______ to _______. Ans
wer
(a) Exporter, forfaiter (b) Forfaiter, exporter >
(c) Exporter’s bank, importer’s bank (d) Forfaiter, importer (e) Importer,
forfaiter.
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8. Which of the following forms of factoring is also known as confidential factoring? Ans
wer
(a) Advance factoring (b) Invoice discounting >
(c) Full factoring (d) Bank participation factoring
(e) Supplier guarantee factoring.
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9. SOT Ltd. is a primary dealer registered with RBI. To honour its bidding commitment in Ans
T-bills segment, it applies for liquidity support to RBI. The total bidding commitments are wer
Rs.300 crore. The liquidity support provided by the RBI will be >

(a) Rs.22.5 crore (b) Rs.30 crore (c) Rs.60 crore (d) Rs.15 crore (e)
Rs.100 crore.
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10. Which of the following is false with respect to real estate investment? Ans
wer
(a) It requires substantial outlay of funds >
(b) Transaction cost tend to be higher
(c) It is a good hedge against inflation
(d) Tax treatment is not favorable for real estate investments
(e) It is a durable investment.
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11. Banks in an economy have been maintaining SLR in excess of statutory requirements. In Ans
such a scenario, which of the situations given below will prevail? wer
>
I. An increase in SLR will not have a significant impact on the liquidity, prices and yields
of the instruments.
II. A decrease in SLR will not have a significant impact on the liquidity, prices and yields
of the instruments.
III. A decrease in SLR will bring down the prices of the instruments.
(a) Only (I) above (b) Only (II) above
(c) Both (I) and (II) above (d) Both (II) and (III) above

(e) Both (I) and (III) above.

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12. XYZ Ltd. is a primary dealer in India. As on 31.03.2005, the balance maturity of securities Ans
lying in its portfolio were as follows: wer
>
 Balance maturity in years Market value in Rs. crore
4 20
6 30
12 10
15 10 The risk weighted
value of above securities will be
(a) Rs. 20 crore (b) Rs.17.5 crore (c) Rs.25 crore (d) Rs.15 crore (e)
Rs.22.5 crore.
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13. State which of the following statements is/are true with respect to US T-bills markets? Ans
wer
I. Strip bills are package of bills requiring investors to bid for an entire series of bills >
with same maturities.
II. Cash management bills are simply the reopened issue of bills that were sold in prior
weeks.
III. The reopening of bills occurs at periodic intervals and is usually pre-decided.

(a) Only (I) above (b) Only (II) above

(c) Only (III) above (d) Both (II) and (III) above

(e) All (I), (II) and (III) above.

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14. Manoj Enterprises is coming out with an issue of commercial paper of amount Rs.100 lakh Ans
with maturity of 8 months. The rating charges payable by it shall be wer
>
(a) Rs.50,000 (b) Rs.32,500 (c) Rs.30,000 (d) Rs.25,000 (e)
Rs.20,000.
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15. Which of the following statements is/are not true with respect to reservation in the public Ans
issues of the company? wer
>
I. The reservation for the employees of the company cannot exceed 10% of the total size
of the company.
II. The reservation for group shareholders cannot exceed 10% of the total size of the
company.
III. Net offer to the public should not be less than 25% of the post issue equity capital of the
company.
IV. Total reservation for all NRIs and OCBs cannot exceed 15% of the post-issue capital as
per RBI guidelines.

(a) Only (II) above (b) Only (IV) above

(c) Both (II) and (III) above (d) Both (III) and (IV) above
(e) All (I), (II), (III) and (IV) above.
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16. The probability of the investment being confiscated is 0.2. If the cash flow when confiscation Ans
does not occur is Rs.20 lakh and the discount rate is 9%, then expected cash flow is wer
>
(a) Rs.55.00 lakh (b) Rs.55.17 lakh (c) Rs.50.01 lakh
(d) Rs.61.45 lakh (e) Rs.60.67 lakh.
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17. Can Factors Limited gives an advance of 80% against receivables worth Rs.10,00,000 Ans
purchased from Shayama Ltd. payable after 90 days. The advance carries an interest rate of wer
17% per annum compounded quarterly and the factoring commission is 1.8% of the value of >
factored receivables. Both the interest and commission are collected up-front. The amount
actually made available to Shayama Ltd. is
(a) Rs.7,28,000 (b) Rs.7,48,000 (c) Rs.7,66,000 (d) Rs.7,82,000 (e)
Rs.8,00,000.
 <
18. The following data pertains to Mathura Leasing Services Ltd: Ans
wer
P.V. of loan payments Rs.50,00,000 >
P.V. of lease payments Rs.52,00,000
P.V. of lease related tax shields Rs.25,00,000
P.V. of loan related tax shields Rs.27,00,000
P.V. of residual value Rs.2,00,000 The operating advantage
arising out of the lease transaction as per BHW model is
(a) (Rs.2,00,000) (b) (Rs.1,00,000) (c)
Nil
(d) Rs.1,00,000 (e) (Rs.4,00,000).
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19. First Hire purchase Limited, a company engaged in hire purchase earns Rs.2,00,000 as Ans
interest in the fiscal year 2004-05. The service tax (including surcharge) payable on the wer
interest earned by First Hire purchase Limited for the fiscal year 2004-05 is >

(a) Rs.20,100 (b) Rs.20,200 (c) Rs.10,200 (d) Rs.20,400 (e)

Rs.20,000.
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20. Integrated Financial Services Ltd. (IFSL) has recently structured a six year leveraged lease Ans
transaction involving an investment cost of Rs.150 crore with itself as the equity participant wer
and Syndicate Bank as the loan participant funding the investment in the ratio of 1:4. The >
loan carries an effective rate of interest of 14% and is to be repaid in the six equated annual
installments. The gross yield of IFSL is 20% per annum. The amount of loan repayment to
Syndicate bank at the end of every year for such a lease transaction is
(a) Rs.34.83 crore (b) Rs.35.41 crore (c) Rs.30.86
crore
(d) Rs.34.55 crore (e) Rs.30.86 crore.
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21. Which of the following is/are true regarding issue of debentures? Ans
wer
I. Credit rating is mandatory for an issue of debentures irrespective of the maturity period. >
II. Appointment of Debenture Trustee is mandatory if the maturity period exceeds 15
months.
III. Creation of Debenture Redemption Reserve is optional in case of debenture issue whose
maturity period is 15 months.

(a) Only (II) above (b) Only (III) above (c) Both (I) and
(III) above
(d) Both (II) and (III) above (e) All (I), (II) and (III) above.
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22. Polaki Garments Limited (PGL) made an offer of rights to its shareholders on March 21 Ans
2005. The earliest PGL can come up with a bonus issue is wer
>
(a) May 21, 2005 (b) August 21, 2005 (c) November
21, 2005
(d) March 21, 2006 (e) August 21, 2006.
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23. ABC Ltd. is a primary dealer in government securities. RBI is conducting an issue of dated Ans
securities worth Rs 1500 crore. The other particulars of ABC Ltd. are as follows: wer
>
 Particulars Rs. crore
Paid up capital 100
Free reserves 98
Share premium account 23
Revaluation reserve 12
Surplus arising out of the sale proceeds of assets 2
Accumulated loss balance 1
Book value of intangible assets 1 Ignoring the
liquidity support granted by RBI, the maximum portion of the present issue which ABC Ltd.
can offer to underwrite is
(a) Rs.1165 crore (b) Rs.1500 crore (c) Rs.450 crore
(d) Rs.1000 crore (e) Rs.1105 crore.
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24. Primary Finance Ltd. discounts the L/C backed bills of its clients at 25% p.a. The effective Ans
rate of interest per annum of such a bill of usance period 90 days (assuming 360 days a year) wer
is _______ %. >

(a) 25.00 (b) 26.37 (c) 26.67 (d) 27.44 (e)

29.45.
25. Which of the following statements correctly describe(s) the attributes of an Exchangeable? <
Ans
I. The stock issued on conversion is usually of the same company. wer
II. Conversion Terms are set at a later date after the issue. >
III. From investment perspective, these instruments are more attractive than convertible
debentures.
(a) Only (I) above (b) Only (II) above (c) Only (III)
above
(d) Both (II) and (III) above (e) All (I), (II) and (III) above.
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26. Primary Products Limited (PPL) is planning to lease machinery costing 60 lakh. It Ans
approaches First Leasing Limited (FLL). FLL evaluates the credit worthiness of lessee using wer
cash flow coverage ratio. The relevant particulars of PPL are as follows: >

PBIT Rs.100 lakh

Lease Rental Rs.15 lakh
Interest paid Rs.2.00 lakh
Depreciation Rs.10 lakh
Loan repayments Rs.15 lakh
Tax rate 33%. The cash flow coverage ratio for PPL is
(a) 4.51 (b) 5.12 (c) 3.34 (d) 3.17 (e)
3.90.
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27. Muhurat Finance Limited (MFL) has come out with an issue of public deposit of Rs.5 crore. Ans
To market the issue, it contracted Finbrooks Brokers Limited (FBL). FBL sold the issue wer
worth 2.5 crore. The brokerage quoted by FBL is Rs.6,25,000. The maximum MFL can pay to >
FSL is
(a) Rs.6,25,000 (b) Rs.5,00,000 (c) Rs.2,50,000
(d) Rs.10,00,000 (e) Rs.12,50,000.
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28. The effective rate of interest on the completed transaction will be _____ than the effective Ans
rate of interest on the original transaction if the interest rebate allowed to the hirer is wer
calculated as per the_______. >

(a) Less, rule of 78 method (b) Less, actuarial method

(c) More, actuarial method (d) Less, modified rule of 78 method
(e) More, rule of 78 method.
 <
29. Which of the following statements reflect(s) the characteristic(s) of Auction rated debt? Ans
wer
I. Company before issuing it must get credit rating of above investment grade from >
recognized credit rating agency.
II. The instrument is issued to general public like a debenture issue.
III. These are fully redeemable short-term debenture, which are generally secured.
(a) Only (I) above (b) Only (II) above (c) Only (III)
above
(d) Both (I) and (III) above (e) All (I), (II) and (III) above.
<
30. Master Leasing Limited has recently finalized a leasing deal with Param Sons Limited. The Ans
lease permits Param Sons Limited to add certain facilities regarding the leasing of fresh wer
equipments resembling line of credit. The above lease is a/an >

(a) Indexed lease (b) Swap lease (c) Upgrade

lease
(d) LC lease (e) Master lease.
END OF SECTION A
 Section B : Problems (50 Marks)
• • This section consists of questions with serial number 1 – 5.
• • Answer all questions.
• • Marks are indicated against each question.
• • Detailed workings should form part of your answer.
• • Do not spend more than 110 - 120 minutes on Section B.

1. Sandhya Breweries Limited (SBL) is in the midst of an expansion programme due to expected surge in the
demand of beer case worldwide. For the expansion programme, it has proposed to acquire machinery worth
Rs.600 lakh funded through term loan carrying an effective interest rate of 14% repayable in 6 equal annual
installments starting from the end of first year. The useful life of the asset is 10 years after which the salvage value
will be nil. The tax relevant rate of depreciation is 25%. Mr. Bisla, finance manager of the company has prepared
pro-forma income statement and balance sheet for the first year after the acquisition of the above asset as follows:
Profit & loss account for the year 2005-06
Rs in lakh
Sales 10,000
PBDT 750
Depreciation 200
Profit before tax 550
Tax @ 33% 181.50
Profit after tax 368.50 Balance sheet as on March 31, 2006
Sources of funds: Rs.lakh
Equity capital 500
Reserves and surplus 750
Secured loans 2675
Total 3925
Application of funds:
Fixed assets (Gross) 2000
Less depreciation 650
Net Block 1350
Investments 10.00
Current Assets
Inventory 1800
Sundry Debtor 5000
Cash & Bank balance 475
Other current assets 250 7525
Less current liabilities and provisions
Current liabilities 4500
Provisions for taxes 260
Other provisions 200
Net Current assets 2565
Total 3925 Maharaja Finance Limited
approaches SBL with a proposal to structure the leasing of the above machinery. The other particulars are as
follows:
• • SBL is interested in 5-year lease proposal.
• • The marginal cost of capital for SBL is 15%.
• • The marginal tax rate for SBL is 33%.
 • • SBL follows effective rate of interest method for lease transactions and equated lease installments have
to be paid quarterly in advance.
• • Effective interest rate for other borrowings is 8%.
• • Provision for taxes in the balance sheet includes current year taxes also.
You are required to
a. Determine the minimum lease rentals to be paid by SBL so that it can classify the lease as a finance lease.
b. Recast the financial statements of SBL assuming that the equipment is leased and the lease is classified as an
operating lease. Assume the lease rentals to be 10% less than that arrived in (a) above.
c. Show the impact of above operating lease on the leverage and fixed asset turnover ratio.
(3 + 6 + 2 = 11 marks) < Answer >
2. Agra Tanneries Limited (ATL) is contemplating to purchase an equipment worth Rs.50 lakh. The equipment
attracts a tax relevant rate of depreciation rate of 25% and has a salvage value of 15% of the initial amount at the
end of useful life of 5 years. ATL approaches Mathura Finance Limited (MFL) to structure a hire-purchase
arrangement for the said asset. The hire-purchase scheme offered by MFL provides for the following
arrangements:
Down payment 25%
Duration 5 years
Frequency of payments Monthly in arrears
MFL also shows interest in structuring a lease agreement for the above equipment with the same duration and
frequency of payment.
The cost of capital for the MFL is 15%. It is in the tax bracket of 35%. MFL follows the SOYD method for
recognition of finance income.
You are required to
a. Determine the minimum flat rate of interest to be charged by MFL on the above plan
b. Determine the lease rental at which MFL is indifferent between the hire purchase plan and lease plan.
Assume the hire rentals as arrived in (a) above.
(7 + 8 = 15 marks) < Answer >
3. ABC Ltd. is coming out with an issue of two series of zero coupon bonds maturing in 4 and 5 years. Face value of
both the bonds is Rs.1000. Market price of similar traded bonds is Rs.925 and Rs.900 respectively. Mr. Tiwari is
considering investing in these bonds.
You are required to calculate one year interest rates after 4 years.
(5 marks) < Answer >
4. Manoj Exports Limited has proposed to expand its operations for which it requires funds of $4.5 million, net of
issue expenses which amounts to 2% of issue size. It proposed to raise the funds through a GDR issue. The
dividends issued by the company for the past periods are as follows:
2001 2002 2003 2004 2005
Rs.1.5 Rs.1.9 Rs.2.3 Rs.10 Rs.12.5 At the end of year 2004, the company announced a
reverse stock split of 5:1. The past growth rate in dividends is expected to continue indefinitely. Other particulars
are as follows:
• • Three shares underlie each GDR.
• • Underlying shares are priced at 10% discount to the market price.
• • Expected exchange rate is Rs.45/$.
• • Current risk free rate is 6%.
• • Beta of the stock is 0.7.
 • • Risk premium is 10%.
You are required to compute
a. The number of GDRs to be issued.
b. Cost of GDRs to the company.
c. Gains/losses to the holder of 100 GDRs, if the company proposes a rights issue after the GDR issue in the
ratio of 1:3 at a subscription price of Rs.900 per share. Assume the GDR holder exercises the rights and sells
his entire holding at the prevailing GDR price, which will be at a premium of 25% to the prevailing domestic
price.
Assume the Rs/$ exchange rate at the time of rights issue and sale by GDR holder to be Rs.50/$.
(4 + 3 + 3 = 10 marks) < Answer >

5. During past one year, 5 companies came out with IPOs worth Rs.300 crore, Rs.350 crore, Rs.400 crore, Rs.235
crore and Rs.100 crore. The initial offer price and current market price (CMP) of one share of and number of
shares offered by these companies are given below:

No. of shares Value of index at the

Company Offer price CMP
offered time of offer
A Ltd. Rs.60 Rs.89 5,00,00,000 3000
B Ltd. Rs.70 Rs.75 5,00,00,000 4345
C Ltd. Rs.80 Rs.60 5,00,00,000 2465
D Ltd. Rs.45 Rs.90 5,00,00,000 4500
E Ltd. Rs.20 Rs.5 5,00,00,000 4756 The
current value of index is 6400. You are required to calculate the wealth relative and comment on the same.
(9 marks) < Answer >
END OF SECTION B

Section C : Applied Theory (20 Marks)

• • This section consists of questions with serial number 6 - 7.
• • Answer all questions.
• • Marks are indicated against each question.
• • Do not spend more than 25 -30 minutes on section C.

6. In recent years, Internet has emerged a preferred source for raising capital to the companies world over. Explain in
brief the methods companies employ to raise capital through internet. Also enumerate the benefits that accrue to
the companies when they raise capital through internet.
(10 marks) < Answer >
7. Collateralized mortgage obligations (CMOs) were created taking the features of mortgage backed bonds and pay
through securities. Explain in brief the term CMO and advantages associated with it clearly demarcating between
the advantages to issuers and to the investors.
(10 marks) < Answer >

END OF SECTION C
END OF QUESTION PAPER
 Suggested Answers
Investment Banking and Financial Services-I (261): July 2005
Section A : Basic Concepts
1. Answer: (c) <
TOP
Reason :For this relationship to exist, There should be no >

external borrowings in the system and financial

liabilities should include stock issued to the
outsiders. Statement (III) is an implication of the
said relationship. Hence (I) and (II) are true. Hence
(c) is the correct answer
2. Answer: (d) <
TOP
Reason : In an administered rate scenario, the scope to >
manage this risk is very low as regulator fixes the
interest rates leaving little to manage. Hence (I) is
true. Cost based pricing of the loan cannot protect
the lenders against this risk since in the increasing
rate scenario, the cost of loans tend to go up. Hence
(II) is not true. Credit risk is invariably reflected in
the interest rate risk as in an increasing rate
scenario; the default rate tends to go up. Hence (III)
is also true. Therefore (d) is the correct answer.
3. Answer: (d) <
TOP
Reason :These kinds of cards, where issue to members of a >
particular organisation who take pride in
associating themselves with their institution or
organisation are known as affinity cards. Hence (d)
is the correct answer.
4. Answer: (a) <
TOP
Reason :The most prominent form of lending by REITs is >
the construction/developmental lending. To retain
their special tax status, REITs have to distribute
95% of their income to shareholders. There can be
mortgage REITs. Indirect equity investments in
REITs by investor are highly liquid. REIT can be
infinite life trusts or finite life. Hence only (a) is
true.
5. Answer: (e) <
TOP
Reason :In long-term contract receivables, volumes are >
generally pre-fixed but price may be variable.
Future flow category receivables are subject to
both, price and volume variations. Due to nature of
 cash flows and other credit enhancement
techniques, borrower is able to secure a finer
pricing and longer tenures in comparison to the
terms of other funding agencies.
6. Answer : (b) <
TOP
Reason :The strip securities are created by taking the cash- >
flows from the underlying collateral and splitting
them into two or more classes that have the same
maturity. These classes are called interest only (I/O)
and principle only (P/O) portions. Hence (b) is the
correct answer.
7. Answer: (a) <
TOP
Reason: Discount fees involved in the transaction of >
forfaiting is payable by exporter to forfaiter.
Hence (a) is the correct answer.
8. Answer: (b) <
TOP
Reason: Invoice discounting is also known as confidential >
factoring.
Hence (b) is the correct answer.
9. Answer: (a) <
TOP
Reason: The liquidity support provided by the RBI shall be >
Rs.22.5 crore i.e. 7.5% of the total bidding
commitments.
10 Answer : (d) <
TOP
. Reason : Real estate investment has lot of tax benefits >
attached to it. Hence statement (d) is not true.
11. Answer: (c) <
TOP
Reason: If banks are having excess securities, then increase/ >
decrease in SLR will not have any impact on the
price and yield of the instruments. Statements (I)
and (II) are correct. Hence (c) is the correct answer.
12 Answer: (b) <
TOP
. Reason: The risk weights are applicable as follows: >

Balance term to maturity Risk-weights

(% of market value)
Up to one year 15
Over one year and up to 5 years 20
Over 5 years and upto 10 years 25
Above 10 years 30
20× 0.2 + 30× 0.25 + 10 ×0.3 +10v0.3 = Rs.17.5
 crore. Hence (b) is the correct answer.
13 Answer : (b) <
TOP
. Reason : Strip bills are package of bills requiring >
investors to bid for an entire series of bills with
differing maturities. Hence statement (I) is false.
The reopening of bills normally occurs when there
is un-expected need for the funds. Hence statement
(III) is also false. Cash management bills are simply
the reopened issue of bills that were sold in prior
weeks. Hence statement (II) IS TRUE. Therefore
(b) is the correct choice.
14 Answer: (a) <
TOP
. Reason : Since the maturity of the instrument is 8 >
months. The total issue charges shall be as follows:
Rating charges: 0.5% of the issue amount =
Rs.50,000. Hence (a) is the correct answer.
15 Answer: (b) <
TOP
. Reason : Total reservation for all NRIs and OCBs cannot >
exceed 10% of the post-issue capital as per RBI
guidelines. All other statements are true. Hence (b)
is the correct answer.
16 Answer: (b)
. Reason : It can be calculated with help of the formulae
i.e. V= CF (1-P)/re +P
V= (20×0.8)/(.09+0.2) = Rs.55.17 lakh. Hence the
answer is (b).
17 Answer : (b) <
TOP
. Reason :Receivables factored = Rs.10,00,000 × 0.8 >

= Rs.8,00,000
Less: Interest = 0.17 × 8,00,000 × ¼
= Rs. 34,000
Less: Commission = 0.018 × 10,00,000
= Rs. 18,000
Amount actually received = Rs.7,48,000
18 Answer : (e) <
TOP
. Reason :The operating advantage arising out of the lease >

transaction as per BHW model is OA (L)

= P.V. of lease related tax shields – P.V. of loan
related tax shields – P.V. of Residual value
= 25,00,000 – 27,00,000 – 2,00,000 =
 (Rs.4,00,000). Hence (e) is the answer.
19 Answer : (d) <
TOP
. Reason :The service tax plus surcharge payable on the >
interest earned by the hire purchase companies is
10.2%. Therefore, service tax payable by Meridian
for the fiscal year 2004-05 = 10.2% of Rs.200,000
=20,400. Hence (d) is the correct answer.
20 Answer : (c) <
TOP
. Reason : Loan amount = 0.8×150 = 120 crore >
Equity contribution = 30 crore
Equated annual installment =
120
= Rs.30.86 crore
PVIFA(14%, 6) .
Hence (c) is the correct answer.
21 Answer : (c) <
TOP
. Reason :According to the Clarification XXVI to the SEBI >
Guidelines for Disclosure and Investor Protection,
no public or rights of debt instruments (including
convertible securities) irrespective of their maturity
or conversion period shall be made unless credit
rating by at least one approved credit rating agency
is obtained and disclosed in the offer document.
Hence statement I is true. Appointment of
Debenture Trustee is mandatory if the maturity
period exceeds 18 months and not 15 months as
given in statement II. Hence, II is not true.
Debenture Redemption Reserve should be
compulsorily created if the maturity period of the
debentures exceeds 18 months and hence it is
optional if the maturity is 15 months. Hence, the
correct answer is (c).
<
22 Answer : (d) TOP
. Reason :As per the SEBI Guidelines, no bonus issue should >

be made within 12 months from the date of a rights

issue. Hence if PGL came up with a rights issue on
March 21, 2005, the earliest that it can come up
with a bonus issue is March 21, 2006. Hence (d) is
the correct answer.
<
23 Answer : (c) TOP
. Reason : A primary dealer can offer to underwrite an >

amount not exceeding 5 times of its net owned

funds or the balance liquidity support available
from the RBI whichever is higher. The amount so
 arrived should not exceed 30% of the notified
amount of the issue. Here the amount of net owned
funds would be = (Paid up capital + free reserves +
balance in share premium account +surplus arising
out of sale proceeds of capital) - accumulated loss
balance and book value of intangible assets
= Rs. (100 + 98 + 23 + 2 –1-1) crore
= Rs. 221 crore
Now the five times of net owned funds or tier-I
capital is = 221 × 5 = Rs. 1105 crore upper limit is
30% of the notified amount i.e. 1500× 0.3 = Rs. 450
crore.
So Rs. 450 crore is the maximum that ABC Ltd. can
offer to underwrite.
24 Answer : (e) <
TOP
. Reason : The effective rate of interest is calculated as >

Discount charge at the rate of 25% per annum

(assuming the value of the bill is Rs.100) is Rs.25 ×
90/360 = Rs.6.25
Value received by the client = 100 – 6.25 =
Rs.93.75
Effective rate of interest per quarter is 6.25/93.75 ×
100 = 6.667%
The effective rate of interest per annum is (1.0667)4
– 1 × 100 = 29.45%
25 Answer: (c) <
TOP
. Reason: The stock issued on conversion is usually of the >
different company and conversion Terms are set at
the time of the issue. Hence Statements (I) and (II)
are not correct. From investment perspective, these
instruments are more attractive than convertible
debentures. Hence Statement (III) is correct. Hence
(c) is the correct answer.
26 Answer: (d) <
TOP
. Reason: The cash flow coverage ratio can be calculated as >
follows:
100 + 15 + 10
2 + 15 + (15 / .67)
Hence Answer is 3.17.
27 Answer: (b) <
TOP
>
. Reason: The maximum payable to brokers is 2% of the
amount sold by brokers. 2% of Rs.25 crore
is Rs.5,00,000. Hence (b) is the answer.
28 Answer: (e) <
TOP
. Reason : The effective rate of interest on the completed >
transaction will be more than the effective arte of
interest on the original transaction if the interest
rebate allowed to the hirer is calculated as per the
rule of 78 method. Hence (e) is the correct answer.
29 Answer: (c ) <
TOP
. Reason: Issuance of it does not require credit rating, as >
maturity is less than 18 months. The instrument is
privately placed at competitive bids. Hence
statements (I) and (II) are not true. These are fully
redeemable short-term debenture, which are
generally secured. Hence (III) is true.Therefore (c)
is the correct answer.
30 Answer: (e) <
TOP
. Reason: Such kind of lease, where add on facility to the >
existing leased assets is provided without
negotiating fresh contract is known as Master lease.
Hence (e) is the correct choice.
 Section B : Problems
1. a. Investment cost = Rs.600 lakh
Useful life = 10 years
Cost of debt = 14%
For finance lease, the lease term should be more than 75% of the useful life of the asset or
the present value of minimum lease rental should be more than 90% of the market value of
the asset. The first condition is not satisfied here. So we try to find out the lease rentals in a
way that lease can be classified as finance lease. Hence
4L ×i/d4× PVIFA (I, 5) > 90% of 600 lakh at I=14%
4L ×1.0861 × 3.43 > 540 solving the above equation, we get
L> 36.21 lakh per quarter.
b. Interest on term loan = 0.14 × 600 = 84 lakh
Depreciation on leased asset = 150 lakh
Total interest = .08 × (2675- 600) + (0.14 × 600) = 166 + 84 = 250 lakh
Interest (250-84) = 166
Lease charges = 130.36
PBT = 653.64
Tax = 215.7
PAT = 437.94
Revised balance sheet:
Sources of funds:
Equity capital 500
Reserves and surplus (750 – 368.5 +437.94) 819.44
Secured loans (2675-600) 2075
Total 3394.44
Application of funds:
Fixed assets (Gross) (2000-600) 1400
Less depreciation (650-150) 500
Net Block 900
Investments 10.00
Current Assets
Inventory 1800
Sundry Debtor 5000
Cash & Bank balance (475 + 84 – 130.36) 428.64
Other current assets 250
Total current assets 7478.64
Less current liabilities and provisions
 Current liabilities 4500
Provisions for taxes ( 260- 181.50 + 215.70) 294.20
Other provisions 200
Total current liabilities 4994.20
Net Current assets 2484.44

Total 3394.44

(c) Leverage ratio prior to lease = 2675/1250 = 2.14

After the lease = 2075/1319.44 = 1.57
Fixed Assets turnover ratio (Prior to lease) = Sales/fixed asset = 10,000/1350 = 7.40
Fixed Assets turnover ratio (After the lease) = 10,000/900 = 11.11.
< TOP >

2. a. NPV(HP)
A. Down payment = 0.25 × 50 = Rs.12.5 lakh
Amount financed = 50 – 12.5 = Rs.37.5 lakh
Let flat rate of interest be F%.
F
37.5   5  37.5
100 1.875F  37.5

MHR = 60 = 60

At i = 15%
i

B. PV of hire rental = 12 (0.03125F + 0.625)× × PVFAi,5

12
i

= (0.375F + 7.5)1.067 × 3.352

= Rs. (1.341F + 26.824) lakhs
F
 5  1.875F
C. Unexpired Finance Income = Rs. 37.5 × 100

Interest Allocation
 Annual Rs.
Year SOYD PV
Income Lakhs
654
1.  0.357 0.669F 0.87 0.582F
1830

510 0.75
2  0.279 0.523F 0.395F
1830 6
366 0.65
3.  0.2 0.375F 0.247F
1830 8
222 0.37
4.  0.121 0.227F 0.130F
1830 2
78 0.49
5.  0.043 0.081F 0.040F
1830 7
1.394F
PV of interest tax on finance income of HP
= 1.394F × 0.35 = 0.488F
NPV (HP) = – A + B – C = –37.5 + 1.341F + 26.824 – 0.488
NPV (HP) = 0
∴ + 0.853F = 10.676
F = 12.5%
b. NPV (HP) = NPV (Lease) = 0
A. Initial investment = Rs.50 lakhs
i
12
 PVIFAi,5
B. PV of lease rentals = 12L × i
= Rs.42.919 L Lakhs
c. PV of tax on lease rentals = 12L × PVIFAi,5 × 0.35
= Rs. 14.078L lakhs
d. PV of depreciation tax shield:
= (12.5 PVIF15,1 + 9.375 PVIF15,2 + 7.031 PVIF15,3 + 5.273 PVIF15,4 + 3.955 PVIF15,5) 0.35
= Rs. 9.65 lakhs
e. PV of NSV = 0.15 × 50 PVIF 15, 5
= Rs.3.728 lakhs
Minimum lease rentals is the value of L in the following:
–A+ B – C + D + E = 0
– 50 + 42.919L – 14.078L + 9.65 + 3.728 = 0
28.841L = 36.622
L = Rs.1.27 lakhs/month.
< TOP >

3. To calculate the interest rate after 4 years, for the fifth year YTM of the bonds are to be
 calculated. The YTM of Bond A will be
(1000/925)1/4-1 = 1.97%.
YTM of Bond B = (1000/900)1/5 -1 = 2.13%.
The forwars rates in year 2 is obtained as follows:
( 1 + YTM4 year bond)4 (1 + I4,5) = (1+ YTM 5 year bond)5
1+ I4,5 = (1.0213)5/1.0197 = 2.77% app.
< TOP >

4. a. To calculate domestic price, we have to calculate expected dividends. Past growth rate after
adjusting for reverse stock-split can be calculated as follows:
7.5(1+g) = 12.5, Therefore g = 13.62%.
Dividends next period = 12.5 × 1.1362 = 14.20
Cost of equity can be calculated from CAPM as follows:
RF + β( Rm- RF) =
RF + Risk premium
6% + 10% = 16%
Using perpetual growth rate
Expected domestic price
D1/ ke – g = 14.20/ 0.16 – 0.1362 = Rs. 507.14
Price of 1 GDR = 3 × 507.14× 0.9 = Rs.1369.28
Domestic price of 1 GDR = 1369.28/45 = $30.43.
Number of GDRs to be issued
Amount of GDRs to be issued = $4.5 million/1- 0.02 = $ 4.5918 million
Number of GDRs = 4591800/30.43= 1,50,897
b. Computation of cost of GDRs
Price of 1 GDR = Rs. 1369.28
Expected dividends = 14.2 × 3 = 42.6
Growth rate = 13.62%
Cost of GDR = D1/ P0(1-f) + g = 16.79%
c. Computation of gains/loss to a holder of
Initial Investment =100 × 30.43 = $ 3043
Number of rights = 100 ×1/3 ×3 = 100
Investment in 100 rights = 100 × 900= Rs. 90,000 = 90,000/50 = $1800
Total investment = $ 4843
507.14 × 3 + 900
= Rs.605.36
Ex-rights price = 3 +1

GDR price = 605.36× 1.25 = 756.69

 (100 × 3 + 100) × 756.69
= $ 6053.52
Total value = 50

Total gains = 6053.52 -4843 = $1210.52.

<TOP>
5. To calculate the wealth relative we have to find the returns on the IPOs for the past one year
and retun on the market index as follows:
During past one year, 5 companies came out with IPOs worth Rs.300 crore, Rs350 crore, Rs.400 crore, Rs.235
crore and Rs.100 crore. The initial offer price and current market price (CMP) of one share of and number of
shares offered by these companies are given below:
Company Offer price CMP Returns Return on index
A Ltd. Rs.60 Rs.89 (89-60)/60 = 46.67% 6400-3000/3000 = 113%
B Ltd. Rs.70 Rs.75 75-70/70 =7.14% 6400-4345/4345 = 47.29%
C Ltd. Rs.80 Rs.60 60-80/80 =(25%) 6400-2465/2465 =159.63%
D Ltd. Rs.45 Rs.90 90-45/45 =100% 6400-4500/4500 = 42.22%
E Ltd. Rs.20 Rs.5 5-20/20= (75%) 6400-4756/4756 = 34.57%
Total 53.81% 396.71% Wealth realtive
n

1  1 / N  rit
i 1
n

1  1 / N  rmt
can found out by the formulae = i 1

Where N = number of IPO in the sample

rit = Returns on the IPO
rmt = Returns on the market
1  1 / 5 (53.81)
1  1 / 5 (396.71)
= = .1463. Wealth relative is less than 1. Hence IPOs have underperformed the market.
< TOP >

Section C: Applied Theory

6. The emergence of internet has created a few options to the companies for raising capital.
Notable among those are:
i. Direct public offering: In a direct public offering, shares are offered directly to prospective
investors online bypassing the traditional underwriting process. It is particularly effective
for smaller business that can-not afford to pay high underwriting fees.
ii. Online public options: The pop in the prices that was realized in the secondary markets
used to translate into lost dollars for the companies raising capital. This problem has been
cured using auction-pricing method. Under the auction-pricing model, prospective
investors submit bids for the amount they are willing to pay for the securities being
offered. After the bidding, the offering price is set at the highest price at which the entire
offering can be sold, with all investors paying the same price.
Advantages of online offerings:
The internet provides companies direct access to a huge pool of investors and prospective
 investors. It enables the companies to distribute its offerings material to the broadest possible
audience and to solicit interest in its securities without regards to its location. This has proved a
boon for new businesses without an established investors base as well as for established
corporations seeking to leverage their name recognition on a global basis.
Technology has also encouraged issuers to consider and develop new ways to present
information to prospective investors. Electronic prospectuses can, and do include video, sounds
graphics and interactivity. Some companies provide the prospective investors live chats
sessions with the officials to mitigate doubts relating to the issue.
Reduction in cost of capital: The use of electronic media has some obvious economic
advantages. It reduces the cost associated with capital formation process like printing,
distribution, advertising and promotion expenses. These electronic materials can be
supplemented and updated regularly.
< TOP >

7. To create a specialized mortgage that incorporated the mortgage backed bonds cash flow
predictability and improve the use of collateral for the issuer cash flow bonds the CMOs were
created. These were created to protect the investors from prepayment risk. A CMO involves
creation of several tranches. There could be a 5-year bond class, a 6-year bond class and so on.
Cash flows generated by the underlying collateral are used to retire bonds. Only one class or
tranche receives principal at a time. All principal payments, as stipulated by the prospectus are
made for the fastest pay tranche of bonds. Once the retirements of this class, the next tranche in
the sequence is repaid along with the principal amount. This process continues until the last
tranche of bond is repaid. CMOs innovatively uses the cash flows of long maturity, monthly
pay collateral to create securities of differing- short, intermediate and long- final maturities and
expected average lives.
Benefits of CMO
To the investor: CMOs are considered to have a high level of credit quality because of the
quality of the underlying collateral. To be assigned a high credit rating a bond should be
structured in such a way that the cash flows generated is at least sufficient to support the
amount of bonds in issue even under the most conservative pre-payment nature.
To the issuer:
• • Compared to pass-through securities, funds can be raised more cheaply due to
segmentation.
• • Wider diversification of investor base can be achieved.
More efficient use of collateralization than mortgage backed bonds.
< TOP >
< TOP OF THE DOCUMENT >