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This Theory Note Is
Applicable For
CA Final New
Course Students
Appearing On
Nov 2010 ; May 2011
& Nov 2011
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SFM
Strictly As Per New Syllabus
t HEORY bOOK
I
In the World of Darkness, Let There Be Light!
STRATEGIC FINANCIAL MANAGEMENT
“To be a star, you must shine your own light, follow your own path, and don't worry
about the darkness, for that is when the stars shine brightest”
By
The Best CA Final
CA Aaditya Jain
By
CA Aaditya Jain
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Aaditya Jain
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Surbhi Agarwal A Student Of Aditya Sir For Securing
All India First Rank in CA Final Nov 2008
Photo of prize distribution ceremony held On Sunday,the 18th January, 2009
ALL INDIA CA-TOPPER
The woods ar e lovely, dar k and deep,
But I have pr omises to keep,
And miles to go befor e I sleep,
And miles to go befor e I sleep
WISHING ALL MY STUDENTS TO Always aim high in life and proceed in the direction of realising your goals with
total determination ''Firm determination and hard work is always rewarding,''
Rise,Awake and Stop Not Until The Goal Is Achieved
Dream is not that what u see in Sleep, Dream is the thing which
does'nt allow u to Sleep"
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List Of Most Important Selected New Course
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“It’s Time To Be Busy BECAUSE Today Will Be Yesterday Very Soon ”
CA Aaditya Jain
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"Luck has a Peculiar Habit of Favor ing Those Who Don't Depend on it!!"
© Exclusive publication,distribution and promotion rights reserved with the Author
Price: Rs. 100/-
Third Edition : June, 2010
Published By: Bright Professional Pvt Ltd.1/53,1st Floor,Laxmi Nagar,New Delhi. Phones: 47665555 [30 Lines]
Every effort has been made to avoid errors or omissions in this publication.In spite of this errors may creep in. Any
mistake,error ordiscrepancy noted may be brought to our notice, which shall be taken care off in the next edition.It is
notified that neither the Author nor the Seller will be responsible for any damage or loss of action to anyone, of any kind, in
any manner,therefrom. It is suggested that to avoid any doubt the reader should cross-check all the facts, law and contents
of the publication with the Institute’s publication or notifications.
This book is primarily meant for private circulation and use by the students of class.No part of this book shall be repro-
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Acknow l edgement s
Dedicated to My Main Source Of Inspiration - Sri Rani Sati Dadi , Father ( Mr Bimal
Kumar Jain), Mother ( Mrs Sumitra Devi Jain)my Uncle (Mr. Mool Chand Jain) ,Aunty
(Mrs Sarla Devi Jain)

I will act now. I will act now. I will act now. Henceforth, I will repeat these words each hour,
each day, everyday, until the words become as much a habit as my breathing, and the action
which follows becomes as instinctive as the blinking of my eyelids. With these words I can
condition my mind to perform every action necessary for my success. I will act now. I will
repeat these words again and again and again. I will walk where failures fear to walk. I will
work when failures seek rest. I will act now for now is all I have. Tomorrow is the day reserved
for the labor of the lazy. I am not lazy. Tomorrow is the day when the failure will succeed. I am
not a failure. I will act now. Success will not wait. If I delay, success will become wed to another
and lost to me forever. This is the time. This is the place. I am the person.
If you want to be successful, it's just this simple: Know what you're doing. Love what you're
doing. And believe in what you're doing. -- Will Rogers

I wish to express my great fullness to a large number of discerning students who
offered valuable suggestions and for having spread word accross the student
community their positive opinion about the book.The wide acceptance of the
book in all parts of the country gives me boundless happiness and
satisfaction. - CA Ad i t y a J a i n

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Sometimes in life there are situations which makes you to loose your patience. The
best way to react at these situation is not to react at all. These situations are meant
just to distract you from your goal. Believe it or not a one minute involvement in
such situation will take away your 2-5 hours of precious time or sometimes even
more. When ever you encounter such situation just keep your head cool and try to
get out of the atmosphere if posssible and afterwards just relax your mind by cracking
a joke or by taking 14-15 long breathes in a single stroke.
From the desk of CA Aaditya Jain
The Importance Of Patience In CA Career
Believe me it’’ll work. So be ready to face such situations
Murphy's Law " If anything can go wrong,it will ".....Everything for the first time looks tough.
REMEMBER .....
A, B , C , D .......was also tough for you one day
Practice makes a man perfect......Follow the proper approach you will definitely succeed
Ending in this high note said by late Dhiru Bhai Ambani
" For Those Who Dare n Dream There is A Whole world to win "
Jinke honslo mein udaan hoti hai wo aasmaan ki uchayion se nahi darte
" I Welcome You as a Bright Future CA in This Amazing World of Finance "
“In Every Man There is Something of Which I May Also Learn, and in
All That He is My Teacher”
Winning isn't ever ything, neither is losing,
but the only thing is doing your best."

"All your lif e you ar e t old t he t hings you cannot do. All your lif e t hey will say
you' r e not good enough or st rong enough or t alent ed enough; t hey will say
you' r e t he wr ong height or t he wr ong weight or t he wr ong t ype t o play t his or
be t his or achieve t his. THEY WI LL TELL YOU NO, a t housand t imes no, unt il all
t he no' s become meaningless. All your lif e t hey will t ell you no, quit e f ir mly
and ver y quickly.
AND YOU WI LL TELL THEM YES. "
The only thing that will stop you from fulfilling your dreams is you
"Life is not measured by the number of breaths we take,
but by the moments that take our breath away."
I Wish All My Students to Always Aim High in Life.You have to grow
From Inside Out.None Can Teach You,None Can Make You
Spiritual.There is no Other Teacher But Your Own Soul.
Now You Can Also Dream Of Scoring Good Marks In MAFA/SFM
"Targetting 90+ In Mafa/SFM"
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MAFA-May 2010 Theory Questions [18 Marks]
SFM-Nov 2008 Theory Questions [24 Marks]
SFM-Nov 2009 Theory Questions [10 marks]
QUESTION NO. 1 What are the drawbacks of investments in Mutual Funds ? (4 Marks)
QUESTION NO. 2 Write short notes on any four of the following :
(a) Financial restructuring (b) Cross border leasing (c) Embedded derivatives (d) Arbitrage operations (e) Rolling
settlement. (4×5=20 Marks)
QUESTION NO. 1 What are the limitations of Credit Rating? (4 Marks)
QUESTION NO. 2 What is the impact of GDRs on Indian Capital Market? (6 Marks)
No Theory Question was Asked In This Attempt
SFM-May 2009 Theory Questions
QUESTION NO. 1 What is a depository ? Who are the major players of a depository system ?What advantage the
depositorysystemoffertotheclearing member ? 4 Marks
QUESTION NO. 2 What do you know about swaptions and their uses ? 4 Marks
QUESTION NO. 3 What are the reasons for stock index futures becoming more popular financial derivatives over
stock futures segment in India ? 6 Marks
QUESTION NO. 4 What is the role of Financial Advisor in PSU? 4 Marks
LIST OF ALL PAST YEARS NEW COURSE QUESTION PAPER
[All questions are incorporated in this book]
QUESTION NO. 1 List and briefly explain the main functions of an investment bank. 4 Marks
QUESTION NO. 2 How is a stock market index calculated? Indicate any two important market indices. 4 Marks
QUESTION NO. 3 Write a short note on Debt Securitisation. 4 marks
QUESTION NO. 4 Write a short note on Exchange Traded Funds (ETFs) 4 marks
QUESTION NO. 5 Explain briefly, how financial policy is linked to Strategic Management. 4 Marks
SFM-May 2010 Theory Questions [20 Marks]
SFM-Nov 2010 & May 2011 Expected Marks in Theory Questions : 20 Marks-25Marks
If I Believe I cannot do something,it makes me incapable of doing it.But when I believe I can,then I acquire
the ability to do it even if I didn't have it in the beginning.-Mahatma Gandhi
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The Following Theory Questions Are The List Of Most Important Theory Question Which Are Most Expected For
Exams.Students Who Wants To Cover Full Theory May Purchase Full Text Theory Book From Leading Book Stores.
QUESTION NO.1 Write a short note on the SENSITIVITY ANALYSIS:-(Also known as “What if” Analysis)?
Meaning : Sensitivity Analysis enables managers to assess how responsive the NPV is to changes in the variables which are
used to calculate it.
Example : Sensitivity Analysis answers questions like,
(i) What happens to the Net Present Value if inflows are, say Rs. 50,000 than the expected Rs. 80,000?
(ii) What will happen to NPV if the economic life of the project is only 3 years rather than expected 5 years?
Importance : It directs the management to pay maximum attention towards the factor where minimum percentage of adverse
change causes maximum adverse effect.
Computation : Sensitivity of a variable is calculated by using following relation : Sensitivity (%) = Change/Base x 100
Procedure:
(1) Set up relationship between the basic underlying factors (quantity sold, unit Sales Price, life of project etc.) & N.P.V. (Some
other criterion of merit).
(2) Estimate the range of variation and the most likely value of each of the basic underlying factors.
(3) Study the effect of N.P.V. of variations in the basic variables (One factor is valued at a time.)
Merits:
(1) Forces management to identify underlying variables and their inter- relationship.
(2) Shows how robust / vulnerable a project is to changes in underlying variables.
(3) Indicates the need for further work.If N.P.V. and I.R.R. is highly sensitive to changes in some variable, it is desirable to gather
further information about the variable.
Demerits:
(1) Fail to provide leads - if sensitivity analysis presents a complicated set of switching values, (switching value of a variable is
its value for which N.P.V. becomes 0.) it may not shed light on the risk characteristics of the project.
(2) Study of impact of variation in one factor at a time, holding other factors constant may not be very meaningful when
underlying factors are likely to be inter-related.What sense does it make to consider the effect of variation in price when holding
quantity (which is likely to be closely related to price) remains unchanged?
QUESTION NO.2 Write a short note on the CAPITAL BUDGETING UNDER CAPITAL RATIONING ?
Meaning : “Capital Rationing refers to a situation where a company cannot undertake all positive NPV projects it has identified
because of shortage of capital ”.
Reasons For Capital Rationing :
External Factors : Under this the firm does not have funds & it also cannot raise them from financial markets.Some reasons can
be : (i) Imperfections in capital markets (ii) Non-availability of market information (iii) Investor’s attitude (iv) Firm’s lack of
credibility in market (v) High Flotation costs
Internal Factors :Internal Capital Rationing arise due to the self-imposed restrictions imposed by management .Under this
though the funds can be arranged but firm itself impose restrictions on investment expenditure . Some reasons can be :
(i) not to take additional burden of debt funds (ii) laying down a specified minimum rate of return on each project (iii) No further
Equity Issue to prevent dilution of control (iv) Divisional Budgets used to prevent any inefficiency or wastage of funds by them
Different Situations of Capital Rationing :
(i) Single Period Capital Rationing : Funds limitation is there only for one year. Thereafter , no Financial constraints.
(ii) Multi Period Capital Rationing : Funds limitaton is there in more than one years.
(iii) Divisible Projects : These are the projects which can be accepted fully as well as in fractions. NPV is also adjusted to the
same fraction as cash outflows.
(iv) Indivisible Projects :These are the projects which can only be accepted fully, not in fractions.
Ways of Resorting Capital Rationing : There are various ways of resorting to capital rationing, some of which are :
(i) By Way of Retained Earnings : A firm may put up a ceiling when it has been financing investment proposals only by way
" Don't be upset or disappointed about something that happened; just think, will it really matter 10 years from now?"
" If you want to WIN; think that there is no TOMORROW. If you LOSE; think that there is a TOMORROW."
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of retained earnings (ploughing back of profits). Since the amount of capital expenditure in that situation cannot exceed the
amount of retained earnings, it is said to be an example of capital rationing.
(ii) By Way of Responsibility Accounting : Capital Rationing may also be introduced by following the concept of ‘responsibility
accounting’, whereby management may introduce capital rationing by authorising a particular department to make investment
only upto a specified limit, beyond which the investment decisions are to be taken by higher-ups.
(iii) By Making Full Utilization of Budget as Primary Consideration : In Capital Rationing it may also be more desirable to
accept several small investment proposals than a few large investment proposals so that there may be full utilisation of budgeted
amount. This may result in accepting relatively less profitable investment proposals if full utilisation of budget is a primary
consideration. Thus Capital Rationing does not always lead to optimum results.
QUESTION NO. 3 Write a short note on Cross Border Leasing ? (SFM Nov 2008)
Meaning : In case of cross-border or international lease, the lessor and the lessee are situated in two different countries.
Because the lease transaction takes place between parties of two or more countries, it is called cross-border lease.
It involves relationships and tax implications more complex than the domestic lease.
Cross-border leasing has been widely used in some European countries, to arbitrage the difference in the tax laws of different
countries.
Cross-border leasing have been in practice as a means of financing infrastructure development in emerging nations – such as
rail and air transport equipment, telephone and telecommunications, equipment, and assets incorporated into power generation
and distribution systems and other projects that have predictable revenue streams.
Basic Prerequisites Of Cross Border Leasing : The basic prerequisites are relatively high tax rates in the lessor’s country,
liberal depreciation rules and either very flexible or very formalistic rules governing tax ownership.
Objective Of Cross Border Leasing :A major objective of cross-border leases is to reduce the overall cost of financing
through utilization by the lessor of tax depreciation allowances to reduce its taxable income. The tax savings are passed through
to the lessee as a lower cost of finance.Other important objectives of cross border leasing include the following :
(i) The lessor is often able to utilize nonrecourse debt to finance a substantial portion of the equipment cost. The debt is secured
by among other things, a mortgage on the equipment and by an assignment of the right to receive payments under the lease.
(ii) Also, depending on the structure, in some countries the lessor can utilize very favourable “leveraged lease” financial accounting
treatment for the overall transacftion.
(iii) In some countries, it is easier for a lessor to repossess the leased equipment following a lessee default because the lessor is
an owner and not a mere secured lender.
(iv) Leasing provides the lessee with 100% financing.
Principal Players Of Cross Border Lease : The principal players are (i) one or more equity investors; (ii) a special purpose
vehicle formed to acquire and own the equipment and act as the lessor; (iii) one or more lenders, and (iv) the lessee. The lease
itself is a “triple-net lease” under which the lessee is responsible for all costs of operation,maintenance and insurance.
Benefits Of Cross Border Leasing : Cross border lease benefits are more or less the same as are available in domestic lease
viz. 100% funding off-balance sheets financing, matching of expenditure with earnings from the assets, the usual tax benefits on
leasing, etc. In addition to these benefits, the following are the more crucial aspects which are required to be looked into:
(i) appropriate currency requirements can be met easily to match the specific cash flow needs of the lessee;
(ii) funding for long period and at fixed rate which may not be available in the lessee home market may be obtained internationally;
(iii) maximum tax benefits in one or more regions could be gained by structuring the lease in a convenient fashion;
(iv) tax benefits can be shared by the lessee or lessor accordingly by pricing the lease in the most beneficial way to the parties;
(v) choice of assets for cross border lease is different than domestic lease because those assets may find here attractive bargain
which are internationally mobile , have adequate residual value and enjoy undisputed title.
QUESTION NO. 4 Write a short note on Rolling Settlement ? (SFM Nov 2008)
Meaning : A rolling settlement is that settlement cycle of the stock exchange, where all trades outstanding at end of the day
have to settled, which means that the buyer has to make payments for securities purchased and seller has to deliver the securities
sold.
" Always follow your dreams, and never let the flame in your heart burn out. The day you're born is the day
you start to die, so make every day count. Every new day bring new light and hope."
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Example : Suppose if we have T+2 settlement cycle it means that a transaction entered into on Day 1 has to be settled on the
Day 1+2 working days. For example Jan 1 Jan 2 Jan 3 Jan 4 Jan 5 Jan 6 Jan 7 Jan 8
Mon Tue Wed Thu Fri Sat Sun Mon
Stocks purchased/sold on Jan 1 should be settled on Jan 3. Stocks purchased/sold on Jan 4 should be settled on Jan 8 (Note that
Sat & Sun, being holidays are again excluded for the T+2 count).
Benefits of Rolling Settlement : (a) In rolling settlements, payments are quicker than in weekly settlements. Thus, investors
benefit from increased liquidity. (b) It keeps cash and forward markets separate. (c) Rolling settlements provide for a higher
degree of safety.(d) From an investor's perspective, rolling settlement reduces delays. This also reduces the tendency for price
trends to get exaggerated.Hence, investors not only get a better price but can also act at their leisure
Indian Scenario :Rolling settlement was first introduced in India by OTCEI.The rolling settlement prevailing in India is T+2,
implying that the outstanding positions at the end of the day ‘T’ are compulsorily settled 2 days after the trade date.
International Scenario : Internationally, most developed countries follow the rolling settlement system. For instance, both
the US and the UK follow a rolling settlement (T+3) system, while the German stock exchanges follow a (T+2) settlement cycle.
QUESTION NO. 5 Write a short note on CAPM? OR Write a short note on Assumptions of CAPM?
The Capital Assets Pricing Model was developed by Sharpe Mossin and Linter in 1960. The model explain the relationship
between the expected return, non-diversifiable risk and the valuation of security.
Under CAPM, the expected return from a Security can be expressed as :
Expected Return = Risk Free Rate + Beta of a Security (Market Return - Risk Free Rate)
CAPM only takes into account Systematic Risk. The CAPM is an economic model that describe how securities are priced in
the market place.
Assumption Of CAPM : The CAPM is based on following eight assumptions :
(i) Efficient Market : It is the first assumption of CAPM. Efficient market refers to the existence of competitive market where
financial securities and capital assets are bought and sold with full information of risk and return available to all participants.
In an efficient market, the price of individual assets will reflect a real or intrinsic value of a share as the market prices will adjust
quickly to any new situation.
(ii) Rational Investment Goals : Investors desire higher return for any acceptable level of risk or the lowest risk for any
desired level of return.
(iii) Risk aversion in efficient market is adhered to although at times risk seeking behaviour is adopted for gains.
(iv) CAPM assumes that all assets are divisible and liquid assets.
(v) Investors are able to borrow freely at a risk less rate of interest i.e. borrowings can fetch equal return by investing in safe
Government securities.
(vi) Securities can be exchanged without payment of brokerage, commissions or taxes and without any transaction cost.
(vii) Securities or capital assets face no bankruptcy or insolvency.
Security Market Line :A graphical representation of CAPM is the Security Market Line, (SML).
Advantages of CAPM : The advantages of CAPM can be listed as:
(i) Risk Adjusted Return : It provides a reasonable basis for estimating the required return on an investment which has risk in
built into it. Hence it can be used as Risk Adjusted Discount Rate in Capital Budgeting.
(ii) No Dividend Company : It is useful in computing the cost of equity of a company which does not declare dividend.
Limitations of CAPM
(a) Reliability of Beta : Statistically reliable Beta might not exist for shares of many firms. It may not be possible to determine
the cost of equity of all firms using CAPM. All shortcomings that apply to Beta value applies to CAPM too.
(b) Other Risks : By emphasing only on systematic risk it ignores unsystematic risks.Unsystematic Risks are also important to
share holders who do not possess a diversified portfolio.
(c) Information Available : It is extremely difficult to obtain important information on risk free interest rate and expected return
on market portfolio as there is multiple risk free rates for one while for another, markets being volatile it varies over time period.
QUESTION NO. 6 Write a short note on EMBEDDED DERIVATIVES ? (SFM Nov 2008)
“Let others lead small lives, but not you. Let others argue over small things, but not you. Let others cry over
small hurts, but not you. Let others leave their future in someone else’s hands, but not you.” –Jim Rohn
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Meaning : An embedded derivative is a derivative instrument that is embedded in another contract - the host contract. The host
contract might be a debt or equity instrument, a lease, an insurance contract or a sale or purchase contract.
How They Arise : An embedded derivative can arise from deliberate financial engineering and intentional shifting of certain
risks between parties. Many embedded derivatives, however, arise inadvertently through market practices and common contracting
arrangements. Even purchase and sale contracts that qualify for executory contract treatment may contain embedded derivatives.
Illustration : A coal purchase contract may include a clause that links the price of the coal to a pricing formula based on the
prevailing electricity price or a related index at the date of delivery. The coal purchase contract, which qualifies for the executory
contract exemption, is described as the host contract, and the pricing formula is the embedded derivative. The pricing formula is
an embedded derivative because it changes the price risk from the coal price to the electricity price.
When must embedded derivatives be accounted for? An embedded derivative is split from the host contract and accounted
for separately if:
(i)Its economics are not ‘closely related’ to those of the host contract;
(ii)A separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and
(iii)The entire contract is not carried at fair value through profit or loss.
Closely Related & Not Closely Related : An embedded derivative that modifies an instrument’s inherent risk (such as a fixed
to floating interest rate swap) would be considered closely related. Conversely, an embedded derivative that changes the nature
of the risks of a contract is not closely related.
Examples
Closely related- Examples of embedded derivatives that need not be separated
• A derivative embedded in a host lease contract is closely related to the host contract if the embedded derivative comprises
contingent rentals based on related sales;
• An inflation index term in a debt instrument as long as it is not leveraged and relates to the inflation index in the economic
environment in which the instrument is denominated or issued;
Not closely related- Examples of embedded derivatives that must be separated
• Equity conversion feature embedded in a debt instrument e.g. investment in convertible bonds;
• Option to extend the term of a debt instrument unless there is a concurrent adjustment of the interest rate to reflect market
prices;
Other Examples : The table below provides further examples of embedded derivatives that are closely related and those that are
not.
Not Closely Related Closely Related
Enquity conversion or ‘put’ option in dept intrument Interest-rate swap embedded in a debt instrument
Fixed -rate debt extension option Inflation-indexed lease contracts
Dept security with interest or principal linked to commodity or Cap and floor in a sale and purchase contracts
" To be where you've never been before, You have to do what you've never done before."
It is not because things are difficult that we do not dare, it is because we do not dare that things are difficult.
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equity prices
Credit derivatives embedded in the host debt instrument Prepayment option in the mortgage where the option’s
Sale or purchese not in exercise price is approximately equal to the the mortgage’s
(1) measurement currency of either party amortised cost on each exercise date
(2) currency in which products are routinely denominated in A forward foreign exchange contract that results in payments
international commerce, or in either party’s reporting currency
(3) currency commonly used in economic environment in Dual currency bonds
which the transaction takes place. Foreign currency denominated debt
QUESTION NO. 7 Write a short note on Systematic and Unsystematic Risk?
Total Risk = Systematic Risk + Unsystematic Risk
A portfolio of asset possesses two types of risk :
(a) Unsystematic risk that can be diversified out, and
(b) Systematic risk that cannot be diversified out through investment in domestic securities.
Systematic Risk or Non-Diversiable Risk or Market Risk
This risk affects all companies operating in the market.
They are beyond the control by the management of entity.
Example : Interest Rate; Inflation ; Taxation; Political Development ; Credit Policy.
Systematic Risk is also called non-diversiable risk as it cannot be reduced with the help of diversification.
Unsystematic Risk or Diversiable Risk or Specific Risk
This risk affects only a particular security / company .
They can be controlled by the management of entity.
Example : Strikes, change in management, special export order, the research & development expert of company leaves; a
formidable competitor enters the market, the company loses a big contract in a bid etc .
Unsystematic Risk are also called Diversifiable Risk as they can be eliminated through Diversification.
QUESTION NO. 8 Write a short note on Private Placement ?
Meaning : A private placement, which involves the selling of debt or equity to private investors, resembles both a public
offering and a merger. They are usually the province of small companies aiming ultimately to go public .
Difference Between Private Placements & Public Offerings :
A private placement differs little from a public offering aside from the fact that a private placement involves a firm selling stock
or equity to private investors rather than to public investors.
Also, a typical private placement deal is smaller than a public issue.
One difference is that private placements do not require any securities to be registered with the Stock Exchange, nor do they
involve a roadshow.In place of the prospectus, Investment banks draft a detailed Private Placement Memorandum (PPM) which
divulges information similar to a prospectus.
Despite these differences, the primary reason for a private placement - to raise capital - is fundamentally the same as a public
offering. Often, firms wishing to go public may be advised by investment bankers to first do a private placement, as they need to
gain critical mass or size to justify an IPO.
Role Of Investment Banker : The investment banker’s work involved in a private placement is quite similar to sell-side M&A
representation. The bankers attempt to find a buyer by writing the PPM and then contacting potential strategic or financial buyers
of the client.Investment bankers function as negotiators for the company, helping to convince the investor of the value of the
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i s j ust leavi ng you empty handed to r ecei ve somethi ng better .Thi nk of i t.
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firm.
Fees involved in private placements work are like those in public offerings. Usually they are a fixed percentage of the size of
the transaction.
Sale of shares to few selected investors:Private placement involves the sale of shares(or other securities)by a company to
few selected investors,particularly the institutional investors like the Unit Trust of India,Life Insurance Corporation of India etc.
Advantage :
(i) It is helpful to issue small amount of funds.
(ii) It is less expensive. There is a cost cutting on account of underwriting commission, expense relating to applications,
allotment of shares and the stock exchange requirements relating to contents of the prospectus and its advertisement. In the case
of public issue of securities, issue costs are very high which can be avoided through private placement.
(iii) It take less time to raise funds through private placement, say less than 3 months. Public issues involves a number of
requirements to be fulfilled and thus requires a lot of time to raise capital.
(iv) This method is generally adopted by small companies with unsatisfactory financial performances.
QUESTION NO. 9 What is a depository ? Who are.the major players of a depository system ?What advantage the
depository system offer to the clearing member ? (May 2010) 4 Marks
The term ‘Depository’ means a place where something is deposited for safe keeping; Depository system is concerned with
conversion of securities from physical to electronic form, settlement of trades in electronic segment, electronic transfer of
ownership of shares and electronic custody of securities. All securities in the depositories are identical in all respects and are thus
fungible.The system results in instant transfer as compared to six to eight weeks time under physical mode.
Physical Vis-a-Vis Dematerialised Share Trading
Physical Dematerialised
(1) Actual Delivery of Share is to be exchanged (1) No Actual Delivery of shares is needed
(2) Open Delivery can be kept (2) Not possible to keep delivery open
(3) Processing time is long (3) Processing time is less
(4) Stamp Charges @ 0.5%(approx) are levied for transfer (4) No Stamp Charges are required for transfer
(5) For sales transaction,no charges other than brokerage are levied(5) Sales transactions are also charged
(6) For buy transaction, delivery is to be sent to company (6) No need to send the document to the
for Registration company for Registration.
 Major players of a depository system: The Depository System consists of the following constituents to serve the
beneficial owners through1. Issuers or company 2. Issuer Registrar 3. Depository Participants 4. Clearing members 5.Stock
brokers 6.Clearing corporations 7.Investors
Pros And Cons Of Depository Services:The major benefits accruing to investors and other market players are as follows :
1. Securities are held in a safe and convenient manner
2. Transfer of securities is effected immediately
3. Stamp duty for transfer is eliminated and transaction costs are reduced
4. Paper work is minimized
5. Bad deliveries, fake securities and delays in transfers are eliminated.
6. Routine changes viz. change in address of one person owning securities issued by different companies can be taken care of
simultaneously for all securities with little delay.
7. Benefit accruing from issue of bonus shares, consolidation, split or merger is credited without much difficulty.
8. Payment of dividends and interest is fast by the use of electronic clearing system.
9. Securities held in electronic form can be locked in and frozen from either a sale or purchase for any definite period.
10. Securities held in electronic form can also be pledged for any credit facility. Both the lender (pledge) and the investor-
borrower (pledgor) are required to have a depository account. Once the pledgee confirms the request of the investor the
depository takes action and the pledge is in place. By a reverse process, the pledge can be released once the pledge confirms
receipt of funds.
There are however risks as well
1. Systemic failure – Input control, process control and output control being parts of computerized environment apply equally
Don't fear failure so much that you refuse to try new things. The saddest summary of a life contains three
descriptions: could have, might have, and should have.
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to the dematerialization process.Unforeseen failures, intentional or otherwise, on the part of the individuals entrusted with protecting
data integrity, could lead to chaos.
2. Additional record keeping – In built provisions for rematerialization exist to take care of the needs of individuals who wish
to hold securities in physical form. Companies will invariably need to maintain records on a continuous basis for securities held
in physical form. Periodical reconciliation between demat segment and physical segment is very much necessary.
3. Cost of Depository Participant (DP) – For transacting business, investors have to deal not only with brokers but also with
depository participant which acts as an additional tier in the series of intermediaries. A one time fee is levied by the depository
participant which small investors consider to be an avoidable cost.
4. Human Fraud – Dematerialization is not a remedy for all ills. Unlawful transfers by individuals against whom insolvency
proceedings are pending or transfers by attorney holders with specific or limited powers are possible.
QUESTION NO. 10 Write a short note on Advantages Of Mutual Fund ?
(1) Professional Management: The funds are managed by skilled and professionally experienced managers with a back up of
a Research team.
(2) Diversification: Mutual Funds offer diversification in portfolio which reduces the risk.
(3) Convenient Administration: There are no administrative risks of share transfer, as many of the Mutual Funds offer
services in a demat form which save investor’s time and delay.
(4) Higher Returns: Over a medium to long-term investment, investors always get higher returns in Mutual Funds as compared
to other avenues of investment.
(5) Low Cost of Management: No Mutual Fund can increase the cost beyond prescribed limits of 2.5% maximum and any extra
cost of management is to be borne by the AMC.
(6) Liquidity: In all the open ended funds, liquidity is provided by direct sales / repurchase by the Mutual Fund and in case of
close ended funds, the liquidity is provided by listing the units on the Stock Exchange.
(7) Transparency: The SEBI Regulations now compel all the Mutual Funds to disclose their portfolios on a half-yearly basis.
However, many Mutual Funds disclose this on a quarterly or monthly basis to their investors. The NAVs are calculated on a daily
basis in case of open ended funds and are now published through AMFI in the newspapers.
(8) Other Benefits: Mutual Funds provide regular withdrawal and systematic investment plans according to the need of the
investors. The investors can also switch from one scheme to another without any load.
(9) Highly Regulated:Mutual Funds all over the world are highly regulated and in India all Mutual Funds are registered with
SEBI and are strictly regulated as per the Mutual Fund Regulations which provide excellent investor protection.
QUESTION NO. 11 What are the limitations/drawbacks of investing in Mutual Fund? (RTP,Nov 2009)
(1) No guarantee of Return – There are three issues involved :
(a) All Mutual Funds cannot be winners. There may be some who may under perform the benchmark index i.e. it may not even
perform well as a beginner who invests in the stocks constituting the index.
(b) A mutual fund may perform better than the stock market but this does not necessarily lead to a gain for the investor. The
market may have risen and the mutual fund scheme increased in value but the investor would have got the same increase had he
invested in risk free investments than in mutual fund.
(c) Investors may forgive if the return is not adequate. But they will not do so if the principal is eroded. Mutual Fund investment
may depreciate in value.
(2) Diversification – Diversification may minimize risk but does not guarantee higher return.
(3) Selection of Proper Fund – It may be easier to select the right share rather than the right fund. For stocks, one can base his
selection on the parameters of economic,industry and company analysis. In case of mutual funds, past performance is the only
criteria to fall back upon. But past cannot predict the future.
(4) Cost Factor/ High Management Fee – Mutual Funds carry a price tag. Fund Managers are the highest paid executives.
While investing, one has to pay for entry load and when leaving he has to pay for exit load. Such costs reduce the return from
mutual fund. The fees paid to the Asset Management Company is in no way related to performance.The Management Fees
charged by the Fund reduces the return available to the investors.
What is "Faith" ? Once all the people of a village decided to pray for rain and assembled in a temple.On the day of prayer
all the people gathered but only one boy came with umnbrella.Thats Faith .
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(5) Unethical Practices – Mutual Funds may not play a fair game.There may be unethical practices e.g. diversion of Mutual
Fund amounts by Mutual Funds to their sister concerns for making gains for them.
(6) Others-
-Mutual Funds systems do not maintain the kind of transparency they should maintain
-Many MF scheme are, at times, subject to lock in period, therefore, deny the market drawn benefits
-At times, the investments are subject to different kind of hidden costs.
-Redressal of grievances, if any , is not easy
QUESTION NO. 12 Write short note on ‘Factors Influencing the selection of Mutual Fund ’?
(1) Past Performance – The Net Asset Value is the yardstick for evaluating a Mutual Fund. The higher the NAV, the better it is.
Performance is based on the growth of NAV during the referral period after taking into consideration Dividend paid.
Growth = (NAV1 – NAV0 ) + D1 / NAV0.
(2) Timing – The timing when the mutual fund is raising money from the market is vital. In a bullish market, investment in mutual
fund falls significantly in value whereas in a bearish market, it is the other way round where it registers growth. The turns in the
market need to be observed.
(3) Size of Fund – Managing a small sized fund and managing a large sized fund is not the same as it is not dependent on the
product of numbers. Purchase through large sized fund may by itself push prices up while sale may push prices down, as large
funds get squeezed both ways. So it is better to remain with medium sized funds.
(4) Age of Fund – Longevity of the fund in business needs to be determined and its performance in rising, falling and steady
markets have to be checked.
(5) Largest Holding – It is important to note where the largest holdings in mutual fund have been invested.
(6) Fund Manager – One should have an idea of the person handling the fund management.A person of repute gives confidence
to the investors.
(7) Expense Ratio – SEBI has laid down the upper ceiling for Expense Ratio. A lower Expense Ratio will give a higher return
which is better for an investor.
(8) PE Ratio – The ratio indicates the weighted average PE Ratio of the stocks that constitute the fund portfolio with weights
being given to the market value of holdings. It helps to identify the risk levels in which the mutual fund operates.
(9) Portfolio Turnover – The fund manager decides as to when he should enter or quit the market. A very low portfolio turnover
indicates that he is neither entering nor quitting the market very frequently. A high ratio, on the other hand, may suggest that too
frequent moves have lead the fund manager to miss out on the next big wave of investments. A simple average of the portfolio
turnover ratio of peer group updated by mutual fund tracking agencies may serve as a benchmark.
QUESTION NO.13 Write short note on‘Signals Highlighting The Exit Of The Investor From The Mutual Fund Scheme’
(1) When the mutual fund consistently under performs the broad based index, it is high time that it should get out of the scheme.
It would be better to invest in the index itself either by investing in the constituents of the index or by buying into an index fund.
(2) When the mutual fund consistently under performs its peer group instead of it being at the top. In such a case, it would have
to pay to get out of the scheme and then invest in the winning schemes.
(3) When the mutual fund changes its objectives e.g. instead of providing a regular income to the investor, the composition of the
portfolio has changed to a growth fund mode which is not in tune with the investor’s risk preferences.
(4) When the investor changes his objective of investing in a mutual fund which no longer is beneficial to him.
(5) When the fund manager, handling the mutual fund schemes, has been replaced by a new entrant whose image is not known.
QUESTION NO.14 Write short note on‘Exchange Traded Funds’ ? (May 2010)
Meaning : Exchange-Traded Funds (ETFs) are mutual fund schemes that are listed and traded on exchanges like any other
stocks.An Exchange Traded Fund (ETF) is a hybrid product that combines the features of an index fund.
ETFs invest in a basket of stocks and try to replicate a stock market index such as the S&P CNX Nifty or BSE Sensex
Advantage :
Never blame a day in your life.Good days give you " Happiness ".Bad days give you Experience .Both are essen-
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1.By owning an ETF, you get the diversification of an index fund as well as the ability to sell short, buy on margin and purchase
as little as one share.
2.Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund.They have very
low operating and transaction costs , since there are no loads required to purchase ETFs.
3.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.
4.A great reason to consider Exchange Traded Funds is that they simplify index and sector investing in a way that is easy to
understand. If investors feel a turnaround is around the corner, they can go long. If, however, they think ominous clouds will be
over the market for some time, they have the option of going short.
5.The combination of the instant diversification,low cost and the flexibility that Exchange Traded Funds offer makes these
instruments one of the most useful innovations and attractive pieces of financial engineering to date.
Indian Scenario: The following Exchange Traded Funds (ETFs) are being presently traded at National Stock Exchange of
India:
• S&P CNX Nifty UTI Notional Depository Receipts Scheme
• Liquid Benchmark Exchange Traded Scheme (Liquid BeES)
• Junior Nifty BeES
• Nifty BeES
• Bank BeES
History :They first came into existence in the USA in 1993. It took several years for their public interest. But once they did,
the volumes took off with a vengeance. Over the years more than $ 120 billion (as on June 2002) is invested in about 230 ETFs
on the American Stock Exchange .The most popular are QQQs (Cubes) based on the Nasdaq-100 Index, SPDRs (Spiders) based
on the Index, I SHARES based on MSCI indices and TRAHK (Tracks) based on the Hand . The average daily trading volume in
QQQ is around 89 million shares.
QUESTION NO. 15 Write a short note on Key Players of Mutual Fund ?
Mutual Fund is formed by a trust body. The business is set up by the sponsor, the money invested by the asset management
company and the operations monitored by the trustee.There are five principal constituents and three market intermediaries in the
formation and functioning of mutual fund.The five constituents are :
(1) Sponsor: A company established under the Companies Act forms a mutual fund.
(2) Asset Management Company:An entity registered under the Companies Act to manage the money invested in the mutual
fund and to operate the schemes of the mutual fund as per regulations. It carries the responsibility of investing and managing the
investors’ money.
(3) Trustee: The trust is headed by Board of Trustees. The trustee holds the property of the mutual fund in trust for the benefit
of unit holders and looks into the legal requirements of operating and functioning of the mutual fund. The trustee may also form
a limited company under the Companies Act in some situations.
(4) Unit Holder: A person/entity holding an undivided share in the assets of a mutual fund scheme.
(5) Mutual Fund: A mutual fund established under the Indian Trust Act to raise money through the sale of units to the public for
investing in the capital market. The funds thus collected are passed on to the Asset Management Company for investment. The
mutual fund has to be registered with SEBI.
The three market intermediaries are:(1) Custodian (2) Transfer Agents (3) Depository.
(1) Custodian : A custodian is a person who has been granted a Certificate of Registration to conduct the business of custodial
services under the SEBI (Custodian of Securities) Regulations 1996. Custodial services include safeguarding clients’ securities
along with incidental services provided. Maintenance of accounts of clients’ securities together with the collection of benefits /
rights accruing to a client falls within the purview of custodial service. Mutual funds require custodians so that AMC can
concentrate on areas such as investment and management of money.
(2) Transfer Agents : A transfer agent is a person who has been granted a Certificate of Registration to conduct the business of
transfer agent under SEBI (Registrars to an Issue and Share Transfer Agents) Regulations Act 1993. Transfer agents’ services
include issue and redemption of mutual fund units, preparation of transfer documents and maintenance of updated investment
records. They also record transfer of units between investors where depository does not function.
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(3) Depository : Under the Depositories 1996, a depository is body corporate who carries out the transfer of units to the unit
holder in dematerialised form and maintain records thereof.
QUESTION NO. 16 What is the difference between Capital Market and Money Market?
Basics Money Market Capital Market
(i)Tenure It is a market for lending and borrowing of short Capital markets deals in long term securi
term funds, upto one year . ties for a period beyond one year.
(ii)Well defined It is a not a well-defined market where business It is a well defined market where busi
place is done . -ness is done e.g. stock exchange.
(iii)Short Term It deals in short term financial assets e.x .interbank It deals in medium & long term financial
/Long Term call money, treasury bills,commercial paper, etc. assets e.g equity shares, debentures etc.
(iv)Classification There is no sub-division in money market . Capital Market is classified between
Primary Market and Secondary Market.
(v)Volume of The total value of transaction in money market far Capital market lag behind the total value
business exceeds the capital market .According to DFHI of transaction done in money market.
only in call money market daily volume is Rs. 6000
crores arround
(vi)No. of The number of instruments dealt in money market are The number of instruments in capital
instrument various, e.g.(a) Interbank call money (b) Notice money market are shares and debentures.
upto 14 days (c) Short term deposits upto 3 months
(d) 91 days treasury bill (e) 182 days treasury bill
(f) Commercial paper etc.
(vii)Participants The participants in money market are Bankers, RBI The participants in capital market are
and Government . general investors, brokers, merchant
bankers,registrars to issue, underwrit
ers,corporate investors,Flls & Bankers.
(viii)Liquidity The important features of money market Whereas Capital market are not as
instrument is that it is liquid. liquid as money market instrument.
(viii)Regulator It is regulated by the guidelines of RBI It is regulated by the guidelines of SEBI.
QUESTION NO. 17 Write a short note on the following topics :
A. FCCB (Foreign Currency Convertible Bonds)
A type of convertible bond issued in a currency different than the issuer’s domestic currency. In other words, the money being
raised by the issuing company is in the form of a foreign currency.A convertible bond is a mix between a debt and equity
instrument.It acts like a bond by making regular coupon and principal payments,but these bonds also give the bondholder the
option to convert the bond into stock.These types of bonds are attractive to both investors and issuers.The investors receive the
safety of guaranteed payments on the bond & are also able to take advantage of any large price appreciation in the company’s
stock.
Advantages of FCCBs
1. The convertible bond gives the investor the flexibility to convert the bond into equity at a price or redeem the bond at the end
of a specified period, normally three years if the price of the share has not met his expectations.
2. Companies prefer bonds as it defers the dilution of equity and earnings per share .
3. FCCBs are easily marketable as investors enjoys option of conversion into equity if resulting to capital appreciation. Further
investor is assured of a minimum fixed interest earnings .
Disadvantages of FCCBs
1. Exchange Risk is more in FCCBs as interest on bonds would be payable in foreign currency. Thus companies with low debt
equity ratios, large forex earnings potential only opt for FCCBs.
2. FCCBs mean creation of more debt and a forex outgo in terms of interest which is in foreign exchange.
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3. There is exchange risk on the interest payment as well as re-payment if the bonds are not converted into equity shares.
Recent Example : In the first quarter of 2007 Reliance Communications company raised $1 billion FCCB. It was one of the
biggest FCCBs from India.With the stock market bouncing back, India Inc is once again tapping the foreign currency convertible
bonds (FCCBs) for funds with nearly $3 billion in fresh issues in 2010 as against next to nothing, a year ago.However, buyers of
these bonds seem to be treading much more cautiously than they did last time. Conversion prices are now being set closer to the
current market prices and the bonds also carry higher interest rates than earlier.
Data compiled by news agency Bloomberg show total FCCB issuances for 2009-10 at $2.88 billion, a big jump compared with
the measly $24 million in 2008-09, but much lower than the 2007-08 number of $5.6 billion. Tata Motors, Tata Power, Sesa Goa,
Jaiprakash Power Ventures, Sterlite Industries and Larsen and Toubro were a few big issuers who took the FCCB route.
B. GDR (Global Depository Receipts) or Impact of GDRs on Indian Capital Market (SFM,Nov 2009)
A depository receipt is basically a negotiable certificate, denominated in US dollars, that represents a non US company’s
publicly - traded local currency (Indian rupee) equity shares.Rule 144A of the Securities and Exchange Commission of USA
permits companies from outside USA to offer their GDRs to certain institutional buyers.These are known as Qualified Institu-
tional Buyers(QIBs)
GDR are negotiable instruments issued to Overseas Depository Bank on behalf of an Indian Company to raise funds abroad.
The mechanics of a GDR issue may be described with the help of following diagram.
Company issues

Ordinary shares

Kept with Custodian/depository banks

against which GDRs are issued

to Foreign investors
Impact of GDRs on Indian Capital Market :After the globalization of the Indian economy, accessibility to vast amount of
resources was available to the domestic corporate sector. One such accessibility was in terms of raising financial resources
abroad by internationally prudent companies. Among others, GDRs were the most important source of finance from abroad at
competitive cost. Global depository receipts are basically negotiable certificates denominated in US dollars, that represent a non-
US company’s publicly traded local currency (Indian rupee) equity shares. Companies in India, through the issue of depository
receipts, have been able to tap global equity market to raise foreign currency funds by way of equity.Since the inception of
GDRs, a remarkable change in Indian capital market has been observed. Some of the changes are as follows:
(i) Indian capital market to some extent is shifting from Bombay to Luxemburg and other foreign financial centres.
(ii) There is arbitrage possibility in GDR issues. Since many Indian companies are actively trading on the London and the New
York Exchanges and due to the existence of time differences, market news, sentiments etc. at times the prices of the depository
receipts are traded at discounts or premiums to the underlying stock. This presents an arbitrage opportunity wherein the receipts
can be bought abroad and sold in India at a higher price.
(iii) Indian capital market is no longer independent from the rest of the world. This puts additional strain on the investors as they
now need to keep updated with worldwide economic events.
(iv) Indian retail investors are completely sidelined. Due to the placements of GDRs with Foreign Institutional Investor’s on the
basis free pricing, the retail investors can now no longer expect to make easy money on heavily discounted right/public issues.
(v) A considerable amount of foreign investment has found its way in the Indian market which has improved liquidity in the
capital market.
(vi) Indian capital market has started to echo by world economic changes, good or bad.
(vii) Indian capital market has not only been widened but deepened as well.
(viii) It has now become necessary for Indian capital market to adopt international practices in its working including financial
innovations.
Markets of GDR’S
(i) GDR’s are sold primarily to institutional investors.
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(ii) Demand is likely to be dominated by emerging market funds.
(iii) Switching by foreign institutional investors from ordinary shares into GDRs is likely.
(iv) Major demand is also in UK, USA, South East Asia (Hong kong, Singapore), and to some extent continental Europe (princi-
pally France and Switzerland) .
Profile of GDR investors : The following parameters have been observed in regard to GDR investors.
(i) Dedicated convertible investors
(ii) Equity investors who wish to add holdings on reduced risk or who require income enhancement.
(iii) Fixed income investors who wish to enhance returns.
(iv) Retail investors: Retail investment money normally managed by continental European banks which on an aggregate basis
provide a significant base for Euro-convertible issues.
Characteristics
(i) Holders of GDRs participate in the economic benefits of being ordinary shareholders though they do not have voting rights.
(ii) GDRs are settled through CEDEL & Euro-clear international book entry systems.
(iii) GDRs are listed on the Luxemberg stock exchange.
(iv) Trading takes place between professional market makers on an OTC (over the counter) basis.
Advantages of GDRs :
(a)The issuer has the benefit of collecting the issue proceeds in foreign currency which may be utilized for meeting the foreign
exchange component of the project cost,repayment of foreign currency / loan etc.
(b)It has been perceived that a GDR issue has been able to fetch higher prices from international investors than those that a
domestic public issue would have been able to extract from Indian investors.
(c)GDR does not entitle the holder to any voting rights,so there is no fear of loss of management and control.
(d)GDR does not involve any foreign exchange risk to the issuing company , as the shares represented by GDR are expressed in
rupees.
Indian Example :Among the Indian companies,Reliance Industries Ltd. was the first company (1992) to raise funds through
a GDR Issue.Recently Tata Motors on 9th Oct 2009 raised $375 million through a GDR issue,becoming the third company from
the Tata Empire,after Tata Steel and Tata Power.
C. Amercian Depository Receipts
Meaning : Depository receipts issued by a company in the United States of America (USA) is known as American Depository
Receipts (ADRs).In other words An American Depository Receipt (ADR) is a negotiable receipt which represents one or more
depository shares held by a US custodian bank, which in turn represent underlying shares of non-issuer held by a custodian in the
home country.
Statutory Compliance : Such receipts have to be issued in accordance with the provisions stipulated by the Securities and
Exchange Commission of USA (SEC) which are very stringent.Regulations include requirement such as minimum size of
issue,reporting to SEC,adherence to US GAAP in reporting etc.
Mechanism for ADR issue : An ADR is generally created by the deposit of the securities of a non-United States company with
a custodian bank in the country of incorporation of the issuing company. The custodian bank informs the depository in the United
States that the ADRs can be issued. ADRs are United States dollar denominated and are traded in the same way as are the
securities of United States companies.The pictorial representation of the process is given below :
Indian Company
Securities & Dividend
Domestic Depository Bank

Overseas Depository Bank

Overseas Investor
Types of ADRs : There are three types of ADRs:
Unsponsored ADRs are issued without any formal agreement between the issuing company and the depository, although the
issuing company must consent to the creation of the ADR facility. For the issuing company, they provide a relatively inexpensive
method of accessing the United States capital markets (especially because they are also exempt from most of reporting require-
Don’t open a shop unless you like to smile. And Remember that
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ments of the Securities and Exchange Commission).
Sponsored ADRs are created by a single depository which is appointed by the issuing company under rules provided in a deposit
agreement. There are two broad types of sponsored ADRs
Restricted ADRs (RADRs) These are restricted with respect to the type of buyer which is allowed and are privately placed.
They are allowed to be placed only among selected accredited investors and face restrictions on their resale. As these are not
issued to the general public, they are exempt from reporting requirements of the Securities and Exchange Commission and are
not even registered with it. Restricted ADR issues are sometimes issued by companies that seek to gain some visibility and
perhaps experience in the United States capital markets before making an unrestricted issue.
Unrestricted ADRs (URADRs) are issued to and traded by the general investing public in United States capital markets. There
are three classes of URADR, each increasingly demanding in terms of reporting requirements of the Securities and Exchange
Commission, but also increasingly attractive in terms of degree of visibility provided. The three classes of Unrestricted ADRs are
(i) Level 1 URADRs , (ii) Level II URADRs and (iii) Level III URADRs
Benefit of ADR for US investors ADR is an attractive investment to US investors willing to invest in securities of non US
issuers for following reasons
(a) ADRs provide a means to US investors to trade the non US company’s shares in US dollars.The trading in ADR effectively
means trading in underlying shares.
(b) ADRs facilitates share transfers. ADRs are negotiable and can be easily transferred among the investors like any other
negotiable instrument. The transfer of ADRs automatically transfers the underlying share.
(c)The transfer of ADRs does not involve any stamp duty.
(d)The dividends are paid to the holders of ADRs in US dollars.
Benefits of ADR Issue to Indian Company
(a) Better corporate image both in India & abroad which is useful for strengthening the business operation in the overseas
market.
(b) Exposure to international markets and hence stock prices in line with international trends.
(c) Means of raising capital abroad in foreign exchange.
(d) Use of foreign exchange proceeds for activities like overseas acquisitions, setting offices abroad & other capital expenditure.
(e) Increased recognition internationally by bankers, customers, suppliers etc.
(f) No risk of foreign exchange fluctuations as the company will be paying the interest and dividends in Indian rupees to the
domestic depository bank.
Documents used in ADRs A public offering of ADRs by a non US private issuer will require, in general, the following
documents :(a) Form F1 (b) Form F6 (c) Listing Application (d) Blue Sky Survey (e) Deposit Agreement (f) Custodian
Agreement (g) Underwritting Agreement
Example of Indian ADRs :Only few Indian companies have gone for ADRs so far.Some of which are (1) Infosys, (2) Wipro,
(3) MTNL, (4) VSNL,(5) Silverline, (6) Dr. Reddy.These are listed on two stock exchanges (i) NASDAQ (National Association
of Securities Dealers Automatic Quotes) and (ii) New York Stock Exchange, both have their head offices at New York.
No formal arrangement exists
between issuing company
and the depository. Restricted to Unrestricted
Some elements of costs are select investors, All public
borne by investor. by way of private
For issuer, a relatively placements. Exempt
inexpensive method of from the requirements Levels I, II & III
raising capital of SEC
Unsponsored
Types of ADRs
Sponsored
“ Life never seems to be the way we want it, but we live it the best way we can. There is no perfect life but we
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D. Indian Depository Receipts(IDRs)
IDR means any instrument in the form of depository receipt created by the domestic depository in India against the underlying
equity shares of the issuing foreign company .
Companies incorporated outside the country can now raise resources from the Indian capital market through the issue of
Indian Depository Receipts (IDRs).
An IDR is a financial instrument similar to a Global Depository Receipt (GDR) and American Depository Receipt (ADR), the
objective of which is to provide a platform to foreign firms to directly raise capital in India. For Indian investors, IDRs would
provide a route to invest in foreign firms.
In an IDR, foreign companies would issue shares, to an Indian Depository (say National Security Depository Limited –
NSDL), which would in turn issue depository receipts to investors in India.
Recent Example:Standard Chartered is planning to list its shares in India through an issue of Indian Depository Receipts
(IDRs).The UK bank had recently received an approval from the RBI for the issue.
Listing: These IDRs would be listed on stock exchanges in India and would be freely transferable.
Benefits to Indian Investors: IDR is an additional investment opportunity for Indian investors for overseas investment.Indian
citizens will be able to easily improve their portfolio diversification as well as a chance to sample new companies that would
otherwise not be available for investment.
QUESTION NO. 18 Write a short note on ARBITRAGE ? (SFM Nov 2008)
Meaning : Arbitrage by definition is a financial transaction that makes an immediate profit without involving any risk. Arbitrage
is a strategy to take advantage of price differential of a product in different markets.An arbitrageur makes money by buying an
asset at low price in a market and selling it in any other market at a relatively higher price.
For instance, If one can buy an asset for $5, sell it for $20 and make a profit of $15 that is arbitrage. The $15 gain represents
an arbitrage profit.
Arbitrage profits are the result of (i) the difference in exchange rates at two different exchange centres, (ii) the difference. due
to interest yield which can be earned at different exchanges. Thus depending upon the nature of deal, arbitrage may be of space
and time arbitrage. The space arbitrage is because of separation of two exchange markets due to physical dispersion wherein the
rates may vary while on the other hand in the time arbitrage an investor may gain by executing a spot and forward deal to buy and
sell a currency.
Types of Arbitrage
(i) Geographical/Space Arbitrage - It occurs when one currency sells for two prices in two different markets.
(ii) Cross - Rate Arbitrage - In a given market, exchange rates for currencies A and B and for currencies A and C imply an
exchange rate called a cross - rate between currencies B and C. If the rate implied for C does not match the actual rate between
C in some other market, an arbitrage opportunity exists.
(iii) Time Arbitrage - In time arbitrage, an investor may gain by executing a spot and forward deal to buy and sell a currency.
(iv) Covered Interest Arbitrage : This arbitrage occur when there is mismatch of interest rate between two countries .
QUESTION NO. 19 Write a short note on Financial Restructurings ? (SFM Nov 2008)
When a company cannot pay its cash obligations - for example, when it cannot meet its bond payments or its payments to
other creditors (such as vendors) - it goes bankrupt. In this situation, a company can, of course, choose to simply shut down
operations and walk away. On the other hand, it can also restructure and remain in business.
What does it Mean to Restructure? The process can be thought of as two-fold: financial restructuring and organizational
restructuring.
Restructuring from a financial viewpoint involves renegotiating payment terms on debt obligations, issuing new debt, and
restructuring payables to vendors.
From an organizational viewpoint, a restructuring can involve a change in management,strategy and focus.
Restructuring can take many forms. Some typical approaches to financial restructuring include:
(i) Vertical Restructuring ;(ii) Horizontal Restructuring ;(iii) Corporate Restructuring
Financial restructuring refers to a kind of internal changes made by the management in Assets and Liabilities of a company with
“What lies behind us and what lies before us are tiny matters compared to what lies within us.”
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the consent of its various stakeholders. This is a suitable mode of restructuring for corporate entities who have suffered from
sizeable losses over a period of time. Consequent upon losses the share capital or networth of such companies get substantially
eroded. In fact, in some cases, the accumulated losses are even more than the share capital and thus leading to negative networth,
putting the firm on the verge of liquidation. In order to revive such firms, financial restructuring is one of the technique to bring
into health such firms who are having potential and promise for better financial performance in the years to come.
To achieve this desired objective, such firms needs to re-start with a fresh balance sheet free from losses and fictitious assets
and shows share capital at its real true worth.To nurse back such firms a plan of restructuring need to be formulated involving
a number of legal formalities (which includes consent of court, and other stake-holders viz., creditors,lenders and shareholders
etc.). An attempt is made to do Refinancing and rescue financing while Restructuring. Normally equity shareholders make
maximum sacrifice by foregoing certain accrued benefits, followed by preference shareholders and debenture holders,lenders
and creditors etc. The sacrifice may be in the form of waving a part of the sum payable to various liability holders. The foregone
benefits may be in the form of new securities with lower coupon rates so as to reduce future liabilities. The sacrifice may also
lead to the conversion of debt into equity. Sometime, creditors, apart from reducing their claim, may also agree to convert their
dues into securities to avert pressure of payment.This measures will lead to better financial liquidity.
The financial restructuring leads to significant changes in the financial obligations and capital structure of corporate firm,leading
to a change in the financing pattern, ownership and control and payment of various financial changes.
In nutshell it may be said that financial restructuring (also known as internal re-construction) is aimed at reducing the debt/
payment burden of the corporate firm. This results into (i) Reduction/Waiver in the claims from various stakeholders; (ii) Real
worth of various properties/assets by revaluing them timely; (iii) utilizing profit accruing on account of appreciation of assets to
write off accumulated losses and fictitious assets (such as preliminary expenses and cost of issue of shares and debentures) and
creating provision for bad and doubtful debts.
QUESTION NO.20 You have been asked by the Board of Directors of XYZ & Co. Ltd. to submit a project feasibility
report on the introduction of a new product ‘A’ in the paint market as a Chief Finance Officer.Write a Specimen Of
Project Feasibility Report ?
To
The Board of Directors,
XYZ & Co. Ltd.
From:
The Chief Finance Officer
RE: IN DEPTH STUDY OF A PRODUCT ‘A’ BEING INTRODUCED IN THE MARKET PROPOSED.
The Company proposes to introduce a new product ‘A’ in the paint Market at Delhi. The present study is an effort to see whether
the project under consideration should be taken up or not.
COMMERCIAL VIABILITY (MARKET):
Aim in Market Share :
The in depth market study and research reveals the following facts:
Total Demand of the product ‘A’ type - 1,00,000 tonnes p.a.
Installed Capacity - 90,000 tonnes p.a.
Production - 80,000 tonnes p.a.
Potential Demand Gap - 20,000 tonnes p.a.
The company proposes to manufacture 10,000 tonnes of ‘A’ thus aiming at 10% share of the market or 50% of unfulfilled
demand.
Market Leader & Competition :
The market leader of this group of products has a share of 40% and rest of market is shared by a number of small manufacturers.
Thus company expects little competition from the market leader.
Availability of Inputs:
Raw Materials:
Raw Materials constitute a major portion of the total cost of output. In fact, 70% of value added output cost is raw material.
About 5% of petroleum by products are used as additives and these are subject to price fluctuations due to change in international
prices.Such increases are passed on to the consumers in the shape of increased prices thereby keeping contribution margin in
We are all manufacturers. Making good, making trouble, or making excuses.
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tact. As government is the sole supplier of additives there is a fear that company may have to stop production if supply is
discontinued.
Power:
As the project will require very little power it is expected that power shortage will not create a very big hazard.
Capital Cost of the Project - Rs. (lakhs)
(1) Land & Building 5.00
(2) Plant & Machinery 6.00
(3) Other Fixed Assets including Tanks 4.00
(4) Pre Operative Expenses 1.00
(5) Margin Money for Working Capital 2.00
(6) Provision for contingencies 2.00_
20.00
Financial Plan - Rs. (lakhs)
(1) Equity Shares 5.00
(2) Retained Earnings 5.00
(3) Term Loans 10.00
20.00
Technical Feasibility:
Knowhow:As the total investment in Plant & Machinery is Rs.6 (lakhs), it is presumed that complex technical know how is not
required.
Right Plant & Machinery:The company being the market leader in paints it has been able to select the right kind of plant &
Machinery at optimum cost. As per market quotations, the cost of Plant & Machinery, seems to be reasonable.
Storage Tanks:The cost that will incur if storage tanks are erected is estimated at Rs. 2 (lakhs) and the expense has been
considered very much necessary for the purpose.
New Factory/(Industrial Estate New Co.):The company is proposing to set up a factory nearer to the existing one where
locational facilities are available (Nearness to market, transport facilities, Tax Holiday Benefits,Availability of skilled labour, free
trade zone etc.)
Plant layout, Blue Print:A plant layout, blue print as per engineer’s and technician’s report has been attached with the schedule.
Financial Feasibility:
Projected Profitability and Cash Flow Statement Rs. (Lakhs)
Year Profit after Tax Depreciation Cash Flow PVF@10% PV
1 8.00 1.50 9.50 .909 8.6355
2 5.00 1.50 6.50 .826 5.369
3 5.00 1.50 6.50 .751 4.8815
4 5.00 1.50 6.50 .683 4.4395
5 5.00 1.50 6.50 .621 4.0365
6 5.00 1.50 6.50 .564 3.666
7 4.00 1.50 5.50 .513 2.8215
8 4.00 1.50 5.50 .467 2.5685
9 4.00 1.50 5.50 .424 2.332
10 5.00 1.50 6.50 .386 2.509
Total 50.00 15.00 65.00 41.259
The cash flow when discounted at the company’s cost of capital rate of 10% gives net cash flow of Rs.41.259 (lakhs) in Present
Value terms. Hence net present value of Rs.21.259 (lakhs) is available [Net Cash Flow – Capital Cost]. Thus the project seems to
be feasible.
Disposal of Waste/Effluents/Pollution Control:The production process is such that it will release very little waste & effluents
and so disposal is not a very great problem. Public health is thus not endangered. No special measures are required to be
undertaken for pollution control.
Repayment Schedule:A loan repayment schedule (Subject to negotiation) is being given herewith.
Years Repayment (Rs. in Lakhs)
1 -
Do not spoil what you have by desiring what you have not; remember that what you now have was once
among the things only hoped for.
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2 2
3 2
4 2
5 2
6 2
Total 10
S/d
Dated Chief Finance Officer
QUESTION NO.21 What are the Contents Of a Project Report ?
The following aspects need to be taken into account for a Project Report -
1. Promoters: Their experience, past records of performance form the key to their selection for the project under study.
2.Industry Analysis:The environment outside & within the country is vital for determining the type of project one should opt
for.
3. Economic Analysis: The demand and supply position of a particular type of product under consideration, competitor’s share
of the market along with their marketing strategies, export potential of the product, consumer preferences are matters requiring
proper attention in such type of analysis.
4. Cost of Project: Cost of land, site development, buildings, plant and machinery,utilities e.g. power, fuel, water, vehicles,
technical know how together with working capital margins, preliminary/pre-operative expenses, provision for contingencies
determine the total value of the project.
5. Inputs: Availability of raw materials within and outside the home country, reliability of suppliers cost escalations, transportation
charges, manpower requirements together with effluent disposal mechanisms are points to be noted.
6. Technical Analysis: Technical know-how, plant layout, production process, installed and operating capacity of plant and
machinery form the core of such analysis.
7. Financial Analysis: Estimates of production costs, revenue, tax liabilities profitability and sensitivity of profits to different
elements of costs and revenue, financial position and cash flows, working capital requirements, return on investment, promoters
contribution together with debt and equity financing are items which need to be looked into for financial viability.
8. Social Cost Benefit Analysis: Ecological matters, value additions, technology absorptions, level of import substitution form
the basis of such analysis.
9. SWOT Analysis: Liquidity/Fund constraints in capital market, limit of resources available with promoters, business/financial
risks, micro/macro economic considerations subject to government restrictions, role of Banks/Financial Institutions in project
assistance, cost of equity and debt capital in the financial plan for the project are factors which require careful examinations while
carrying out SWOT analysis.
10. Project Implementation Schedule: Date of commencement, duration of the project,trial runs, cushion for cost and time
over runs and date of completion of the project through Network Analysis have all to be properly adhered to in order to make the
project feasible.
QUESTION NO. 22 Explain the Interface of Strategic Management and Financial Policy ? or Explain briefly, how
financial policy is linked to strategic Management. (Nov 2009)(May2010)
The inter face of strategic management and financial policy will be clearly understood if we appreciate the fact that the starting
point of an organization is money and the end point of that organization is also money again. Offer of the organization is only a
vehicle that links up the starting point and the end point.No organization can run the existing business and promote a new
expansion project without a suitable internally mobilized financial base or both internally and externally mobilized financial base.
Financial policy required the resource deployments such as materials, labour etc.,whereas strategic management considers all
markets such as material, labour and capital as imperfect and changing. Strategies are developed to manage the business firm
in uncertain and imperfect market conditions and environment, for forecasting planning and formulation of financial policies, for
generation and allocation of resources, the finance manager is required to analyse changing market conditions and environment.
“Hope is always available to us. When we feel defeated, we need only
take a deep breath and say, “Yes,” and hope will reappear.”
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The strategy focuses on how to compete in a particular product-market segment or industry. For framing strategy it is
considered that the shareholders are not the only interested group in the unit. There are many other influential constituents such
as lenders, employees, customers, suppliers etc. The success of a company depends on its ability to service in the product
market environment which is possible only when the company considers to maintain and improve its product market positions.
The strategic management is multi-dimensional. It focuses on growth profitability and flow of funds rather than only on the
maximization of market value of shares. This focus helps the management to create enough corporate wealth for achieving
market dominance and the ultimate successful survival of the company.
Hence, the financial policy of a company is closed linked with its corporate strategy. The corporate strategy establishes an
efficient and effective match between its competences and opportunities and environmental risks. Financial policies of a company
should be developed in the context of its corporate strategy. Within the overall framework of a company’s strategy, there should
be consistency between financial policies- investment,
debt and dividend.
QUESTION NO.23 Write a short note on Social Cost Benefits Analysis ?
Meaning : Social Cost Benefit Analysis is a systematic evaluation of an organisation’s social performance as distinguished
from its economic performance. Social Cost Benefits Analysis is an approach for evaluation of projects.It assesses gains/losses
to society as a whole from the acceptance of a particular project.
Features
(1) It includes many economic activities having indirect effects on which there is no possibility of putting a market value.
(2) If savings are inadequate; money going into investment is regarded more valuable than money going into current consumption.
(3) Society values given quantum of additional consumption going to different sections of the population differently. So distributional
considerations are important.
(4) For society, taxes are transferred from the project in hand to government and does not involve real cost.
(5) Relative valuation placed on future consumption compared to current consumption is different for the society. Also effect of
perceived uncertainties may be different.
(6) Society may want to discourage consumption of certain goods and promote that of others.
(7) External effects exist on consumption side e.g. person getting inoculation against infectious disease will be conferring some
benefit to society by preventing the spreading over of the disease.
(8) Output from large projects has significant impact on the market for the good/services and neither pre project market price nor
expected post project market price would be correct indicators of the social value of project output. Market prices are not true
indicators of social gains/losses but can be suitably adjusted to reflect social valuations.
Limitations:
(i) Successful application depends upon reasonable accuracy and dependability of the underlying forecasts as well as assessment
of intangibles.
(ii) Technique does not indicate whether given project evaluated on socio-economic considerations is best choice to reach
national goals or whether same resources if employed in another project would yield better results.
(iii) Cost of evaluation by such technique could be enormous for smaller projects.
(iv) Social Cost Benefit Analysis takes into consideration those aspects of social costs and benefits which can be quantified.
Indian Scenario:The introduction of CNG in certain vehicles and switching of some portion of the transport demand to the
metro rail have resulted in a significant reduction of atmospheric pollution in Delhi. The Delhi Metro provides multiple benefits:
reduction in air pollution, time saving to passengers, reduction in accidents, reduction in traffic congestion and fuel savings.
There are incremental benefits and costs to a number of economic agents: government, private transporters, passengers, general
public and unskilled labour. The social cost-benefit analysis of Delhi Metro conducted tries to measure all these benefits and
costs from Phase I and Phase II projects covering a total distance of 108 kms in Delhi. Estimates of the social benefits and costs
of the project are obtained using the recently estimated shadow prices of investment, foreign exchange and unskilled labour as
well as the social time preference rate for the Indian economy for a study commissioned by the Planning Commission, Government
of India and done at the Institute of Economic Growth.
QUESTION NO. 24 Write a short note on Book Building ?
If you think education is expensive,try ignorance.- Derek Boker
The futur e depends on what we do in the pr esent. - Mahatma Gandhi
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Book-building means a process by which a demand for the securities proposed to be issued by a body corporate is elicited and
built up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by
means of notice/ circular / advertisement/ document or information memoranda or offer document.
The book-building system is part of Initial Public Offer (IPO) of Indian Capital Market. It was introduced by SEBI on
recommendations of Mr. Y.H. Malegam in October 1995.It is most practical, fast and efficient management of Mega Issues.
Book Building involves sale of securities to the public and the institutional bidders on the basis of predetermined price range.
Book Building is a price discovery mechanism and is becoming increasingly popular as a method of issuing capital. The idea
behind this process is to find a better price for the issue.
The issue price is not determined in advance.Book Building is a process wherein the issue price of a security is determined by
the demand and supply forces in the capital market.
Book building is a process used for marketing a public offer of equity shares of a company and is a common practice in most
developed countries.
Book building is called so because it refers to the collection of bids from investors, which is based on an indicative price range.
The issue price is fixed after the bid closing date.The various bids received from the investors are recorded in a book,that is why
the process is called Book Building.
Unlike international markets, India has a large number of retail investors who actively participate in Intial Public Offer (IPOs)
by companies. Internationally, the most active investors are the mutual funds and other institutional investors, hence the entire
issue is book built. But in India, 25 per cent of the issue has to be offered to the general public. Here there are two options with
the company.
An issuer company may make an issue of securities to the public through a prospectus in the following manner
• 100% of the net offer to the public through the book building process or
• 75% of the net offer to the public through the book building process and 25% at the price determined through the book building.
“ Hard work is a investment. The more you invest in terms of hard work, more is the profit you earn in terms of
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Procedure For Bidding
The bid should be open for at least five days and not more than 10 days, which may be extended to 13 days in case the price band
is revised. The advertisement should also contain the following:
• the date of opening and closing of the bidding (not less than five days);
• the name and addresses of the syndicate members as well as the bidding terminals for accepting the bids;
• the method and process of bidding;Bidding should be permitted only if an electronically linked transparent facility is used.
Advantage
(i) The book building process helps in discovery of price & demand.
(ii) The costs of the public issue are much reduced.
(iii) The time taken for the completion of the entire process is much less than that in the normal public issue.
(iv) In book building, the demand for the share is known before the issue closes. Infact, if there is not much demand, the issue
may be deferred.
(v) It inspires investors confidence leading to a large investor universe.
(vi) Issuers can choose investors by quality.
(vii) The issue price is market determined.
Disadvantage
(i) There is a possibility of price rigging on listing as promoters may try to bail out syndicate members.
(ii) The book building system works very effeciently in matured market conditions. But, such conditions are not commonly
found in practice.
(iii) It is appropriate for the mega issues only.
(iv) The company should be fundamentally strong & well known to the investors without it book building process will be
unsuccessful.
Recent Example : Recent example of a book buliding process in Indian context is the IPO of Reliance Power. The issue was
made through 100 % book building process .The price band for the the book buliding pocesss was between Rs 405 and Rs 450
with Rs 20 discount for retail investors .
QUESTION NO. 25 Write a short note on Derivatives ? What are different types of Derivative Risk ?
A derivative is a financial instrument which derives its value from some other financial price. This ‘other financial price’ is
called the underlying.
User & Purpose : Derivative serve as a method to hedge and reduce risks .
Users Purpose
(i) Corporation To hedge currency risk and inventory risk
(ii) Individual Investors For speculation, hedging and yield enhancement.
(iii) Institutional Investor For hedging asset allocation, yield enhancement and to avail arbitrage opportunities.
(iv) Dealers For hedging position taking, exploiting inefficiencies and earning dealer spreads.
Example : The most important derivatives are Futures, Options, Forward, Swaps
Types of Derivative Market : (a) Exchange Traded Derivatives (b) OTC (Over the Counter) Derivatives
Exchange-traded derivatives : Derivatives which trade on an exchange are called ‘Exchange-traded derivatives’. Trades on
an exchange generally take place with anonymity. Trades at an exchange generally go through the clearing corporation. Example
: Interest rate futures, Interest rate options, Currency futures, Currency options.
OTC derivative : A derivative contract which is privately negotiated is called an OTC derivative. OTC trades have no anonym-
ity, and they generally do not go through a clearing corporation. Example :Interest rate swaps, Currency swaps, Caps, collars,
floors, forward.
The different types of derivatives risks are:
(a) Credit risk: Credit risk is the risk of loss due to counterparty’s failure to perform on an obligation to the institution. Credit
risk in derivative products comes in two forms:
(i) Pre-Settlement Risk: It is the risk of loss due to a counterparty defaulting on a contract during the life of a transaction. The
level of exposure varies throughout the life of the contract and the extent of losses will only be known at the time of default.
In Business, the competition will bite you if you keep running, if you stand still, they will swallow you
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(ii) Settlement risk: It is the risk of loss due to the counterparty’s failure to perform on its obligation after an institution has
performed on its obligation under a contract on the settlement date. Settlement risk frequently arises in international transactions
because of time zone differences. This risk is only present in transactions that do not involve delivery versus payment and
generally exists for a very short time (less than 24 hours).
(b) Market risk: Market risk is the risk of loss due to adverse changes in the market value (the price) of an instrument or
portfolio of instruments. Such exposure occurs with respect to derivative instruments when changes occur in market factors
such as underlying interest rates, exchange rates, equity prices, and commodity prices or in the volatility of these factors.
(c) Liquidity risk: Liquidity risk is the risk of loss due to failure of an institution to meet its funding requirements or to execute
a transaction at a reasonable price. Institutions involved in derivatives activity face two types of liquidity risk : market liquidity
risk and funding liquidity risk.
(i) Market liquidity risk: It is the risk that an institution may not be able to exit or offset positions quickly, and in sufficient
quantities, at a reasonable price. This inability may be due to inadequate market depth in certain products (e.g. exotic derivatives,
longdated options), market disruption, or inability of the bank to access the market (e.g. credit down-grading of the institution or
of a major counterparty).
(ii) Funding liquidity risk: It is the potential inability of the institution to meet funding requirements, because of cash flow
mismatches, at a reasonable cost. Such funding requirements may arise from cash flow mismatches in swap books, exercise of
options,and the implementation of dynamic hedging strategies.
(d) Operational risk: Operational risk is the risk of loss occurring as a result of inadequate systems and control, deficiencies in
information systems, human error, or management failure. Derivatives activities can pose challenging operational risk issues
because of the complexity of certain products and their continual evolution.
(e) Legal risk: Legal risk is the risk of loss arising from contracts which are not legally enforceable (e.g. the counterparty does
not have the power or authority to enter into a particular type of derivatives transaction) or documented correctly.
(f) Regulatory risk: Regulatory risk is the risk of loss arising from failure to comply with regulatory or legal requirements.
(g) Reputation risk: Reputation risk is the risk of loss arising from adverse public opinion and damage to reputation.
QUESTION NO.26What are the major advantages & disadvantages of Futures Trading as compared to Stock Trading ?
The Major Advantages of Futures Trading Vs. Stock Trading: Compared to directly trading stocks, stock futures provide
several major advantages:
(i) Leverage: Compared to buying stock on margin, investing in futures is less costly.An investor can use leverage to control
more stock with a smaller cash outlay.
(ii) Ease of Shorting: Taking a short position in futures is simpler, less costly and may be executed at any time - there is no
requirement for an uptick.
(iii) Flexibility: Future investors can use the instruments to speculate, hedge, spread or for use in a large array of sophisticated
strategies.
Stock Futures also have disadvantages. These include:
(i) Risk: In a stock future contract, there is the risk of losing significantly more than the initial investment (margin deposit).
(ii)No Stockholder Privileges: The future owner has no voting rights and no rights to dividends.
(iii)Required Vigilance: Stock Futures are investments that require investors to monitor their positions more closely than many
would like to do. Because future accounts are marked to the market every business day, there is the possibility that the brokerage
firm might issue a margin call, requiring the investor to decide whether to quickly deposit additional funds or liquidate the
position.
QUESTION NO. 27 What is Green Share Option or Green Shoe Option ? Explain the working mechanism ?
Green Shoe Option (GSO) means an option available to the company issuing securities to the public to allocate shares in excess
of the public issue and operating a post-listing price stabilising mechanism through a stabilising agent.
This option acts as a safety net for the investors and is a standard global practice.
The name comes from the fact that Green Shoe Company was the first entity to use this option.
SEBI inserted a new Chapter No. VIII-A, with effect from August 14, 2003, in the SEBI (Disclosure and Investors Protection)
Practice Golden Rule 1 of management in everything you do
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Regulations, 2000 to deal with the GSO.
 The GSO is available to a company which is issuing equity shares through book-building mechanism for stabilising the post-
listing price of the shares. The following is the mechanism process of GSO :
1. The Company shall appoint one of the leading book runners as the Stabilising Agent (SA), who will be responsible for the price
stabilising process.
2. ‘The promoters of the company will enter into an agreement with SA to lend some of their shares to the latter, not exceeding
15% of the total issue size.
3. The borrowed shares shall be in the dematerialised form.These shares will be kept in a separate GSO Demat A/c.
4. In case of over subscription, the allocation of these share shall be on pro-rata basis to all applicants.
5. The money received from allotment of these shares shall also be kept in a ‘GSO Bank A/c’, distinct from the issue account ,
and the amount will be used for buying shares from the market during the stabilization period.
6. The shares bought from the market by SA for stabilization shall be credited to GSO Demat Account.
7. These shares shall be returned to the promoters within 2 days of closure of stabilisation process.
8. In order to stabilise post-listing prices, the SA shall determine the timing and quantity of shares to be bought.
9. If at the expiry of the stabilisation period, the SA does not purchase shares to the extent of over-allocated shares, then shares
to the extent of shortfall will be allotted by the company to the GSO Demat A/c multiplied by the issue price. Amount left in the
GSO Bank A/c (after meeting expenses of SA), shall be transferred to the Investors Protection Fund.
In the Indian context, green shoe option has a limited connotation. SEBI guidelines governing public issues contain appropriate
provisions for accepting over-subscriptions, subject to a ceiling, say 15% of the offer made to public. In certain situations, the
green-shoe option can even be more than 15%.
Examples of GSO issues in India
In April, 2004 the ICICI bank Ltd. became the first Indian company to offer GSO. The ICICI Bank Ltd. offered equity shares
of Rs. 3050 crores through 100% book building process to the investors. The issue was over subscribed by 5.14 times.
IDBI has also come up with their Flexi Bonds (Series 4 and 5) under GSO.
More recently Infosys Technologies has also excercised GSO for its issue. This offer initially involved 5.22 million depository
shares, representing 2.61 million domestic equity shares.
QUESTION NO. 28 Explain the concept of interest rate swap by giving appropriate examples.[Also Refer Class Register
for its practical part]
Meaning : An Interest Rate Swap is a transaction involving an exchange of one stream of interest obligations for another.In an
interest rate swap, no exchange of principal takes place but interest payments are made on the notional principal amount.
Condition : To facilitate a interest swap, the two parties must have opposite view on interest rates. One party should expect
interest rates to harden and the other should expect it to soften.
Interest payments can be exchanged between two parties to achieve changes in the calculation of interest on the principal, for
example :(a)Floating to fixed;(b)Fixed to floating;(c)LIBOR to prime - based;(d)Prime to LIBOR;
Major Players : The major players in the swap markets are banks (or other intermediaries on the one side) and medium and
large size corporates on the other. Individual borrowers generally do not perform swap.
Features of Interest Rate Swap :
(a) It is treated as an off - the balance sheet transaction.
(b) It is structured as a separate contract distinct from the underlying loan agreement.
(c) There is no exchange of principal repayment obligations.
(d) It effectively translates a floating rate borrowing into a fixed rate borrowing and vice versa.
(e) The motivation of interest rate swap is to save interest cost.
Types of Interest Rate Swaps :
You never suffer from a money problem, you always suffer from an idea problem
If you woke up breathing ...Congratulation ! You have another chance .

5% Fixed Rat e
Part y A Par t y B
5% Fixed Rat e
6-mont h LIBOR
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(a) Liability Swap - Where there is an exchange of interest obligation i.e., interest is to be paid, the swap is liability swap.
(b) Asset Swap - Where there is an exchange of interest receipts i.e., interest is to be received, the swap is asset swap.
Purpose:Interest Rate Swap is intended to hedge against the intetrest rate fluctuations to some extent through careful planning
with the help of swap dealer .
Provision of Interest Rate Swaps :Some of the provisions of IRS are as follows :
1. The notional principal value upon which the interest rate is to be applied.
2. The fixed interest rate to be exchanged for another rate.
3. Formula type of index used to determine the floating rate.
4. Frequency of payments, such as quarterly or every six months is also agreed.
5. Life time of the swap.
Examples On IRS:
Consider two companies rated AAA and BBB. AAA has higher credit rating than BBB. Hence they are rated differently by the
market and are offered loans at following rates:
Fixed Rate Floating Rate
AAA 10% LIBOR + .50
BBB 11% LIBOR+.75
Both are planning to raise loan of $1 million. AAA is interested in raising loan under floating rate. BBB is interested in raising loan
under fixed rate. An intermediary brings them on table and interest swap is arranged. The benefit of interest swap is to be shared
equally by the three parties. Find out net interest burden (%) for AAA and BBB?
Solution : If no Swap is arranged, total interest cost to both the parties if they borrow as per their plan :
AAA : LIBOR + .50
BBB : 11%
Total (A) LIBOR + 11.50%
Using the principle of comparative advantage, both parties could benefit from a swap arrangement in the following manner., AAA
should borrow on fixed basis and BBB on floating basis, total interest cost in this situation is :
AAA 10%
BBB LIBOR + .75
Total (B) LIBOR + 10.75%
Saving on Interest Cost : A – B = (LIBOR + 11.50%) – (LIBOR + 10.75%) = .75
Since Savings is to be distributed equally as per the requirement of the question we have
Saving for AAA = .25; Saving for BBB = .25; Commission for intermediary = .25.

Net Interest Burden = Cost under own choice – Share in saving.
For AAA : (LIBOR + .50) – .25 = LIBOR + .25 For BBB : 11% – .25 = 10.75 %
QUESTION NO. 29 What is the Dow Jones Theory to Portfolio Management?[Also Refer Class Register for its practical
part]
The Dow Jones Theory is probably the most popular theory regarding the behaviour of stock market prices.The theory derives
its name from Charles H. Dow, who established the Dow Jones & Co., and was the first editor of the Wall Street Journal- a
leading publication on financial and economic matters in the U.S.A.
The corporate world is highly competitive.As an ordinary employee with nothing new or exceptional to offer,you can easily
get lost in the crowd.However a CA with special knowledge of Finance could open new doors of opportunity.
10%
10%
L
I
B
O
R

+

.
5
0
11%
LIBOR + .75
LIBOR + .75
AAA
BBB
SWAP BANK
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The Dow Theory is one of the oldest and most famous technical theories.
It is a helpful tool for determining the relative strength of the stock market.
The Dow Theory is based upon the movements of two indices, constructed by Charles Dow,Dow Jones Industrial Average
(DJIA) and Dow Jones Transportation Average (DJTA).
The Dow Theory’s purpose is to determine where the market is and where is it going.
The Dow Jones theory classifies the movements of the prices on the share market into three major categories:
1. Primary Movements. 2. Secondary Movements.3. Daily Fluctuations.
1. Primary Movements : They reflect the trend of the stock market & last from one year to three years, or sometimes even
more During a bull phase, the basic trend is that of rise in prices. Graph I shows the behaviour of stock market prices in bull
phase. As can be seen from the graph that prices do not rise consisitently even in a bull phase. They rise for some time and after
each rise, they fall. However, the falls are of a lower magnitude than rise . As a result, prices reach higher levels with each rise.
Once the prices have risen very high, the bear phase in bound to start, i.e.price will start falling. Graph 2 shows the typical
behaviour of prices on the stock exchange in the case of a bear phase. It would be seen that prices are not falling consistently and,
after each fall, there is a rise in prices. However, the rise is not much as to take the prices higher than the previous peak.
Hence in Graph 1 above,Primary Trend is Rising and in Graph 2,Primary Trend is Falling
2. Secondary Movements : We have seen that even when the primary trend is upward, there are also downward movements of
prices. Similarly, even where the primary trend is downward, there is upward movements of prices also. These movements are
known as secondary movements and are shorter in duration and are opposite in direction to the primary movements. These
movements normally last from three weeks to three months and ranges from 1/3 ( 33 % ) to 2/3 (66 %) of the previous advance
in a bull market or previous fall in the bear market.
Hence in Graph 1 above,Secondary Trend is Falling and in Graph 2,Secondary Trend is Rising
3. Daily Movements : There are irregular fluctuations which occur every day in the market. These fluctuations are without any
definite trend. Thus if the daily share market price index for a few months is plotted on the graph it will show both upward and
downward fluctuations. These fluctuations are the result of speculative factors. An investment manager really is not interested in
the short run fluctuations in share prices since he is not a speculator. It may be reiterated that anyone who tries to gain from short
run fluctuations in the stock market, can make money only by sheer chance. Speculation is beyond the scope of the job of an
investment manager.
Benefit Of Dow- Jones Theory :
(a) Timings of Investments : Investor can choose the appropriate time for his investment / divestment .Investment should be
made in shares when their prices have reached the lowest level, and sell them at a time when they reached the highest peak.
(b) Identification of Trend : Using Dow-Jones theory, the correct and appropriate movement in the Market Prices can be
identified, and depending on the investors preference, decisions can be taken.
QUESTION NO. 30 Write a short note on Portfolio Rebalancing ?[Also Refer Class Register for its practical part]
Meaning :It means the value of portfolio as well as its composition.
There are three policies of portfolio rebalancing- Buy and hold policy, Constant mix policy, and Constant proportion portfolio
insurance policy (CPPI). These policies have different pay off under varying market conditions.
Purpose of Rebalancing (i) For increasing returns & (ii) Maintaining risk profile
Benefits of Portfolio Rebalancing
(i) Disciplined investing :Rebalancing is a vital part of investment policy - there can be no asset allocation target without the
discipline to preserve that target.
(ii) Reduces risk :A plan may incur higher risk if no rebalancing policy exists.
Be a life long student.The more you learn ,the more you earn and more self confidence you will have. - Brian Tracy
“Teacher s open the door , but you must enter by your self”

Bull Phase Bear Phase
Graph 1 .
Graph 2 .
Bear Phase
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(iii) Buy low, sell high : Rebalancing is a mechanism for sensible timing - the process naturally buys low and sells high. This
strategy ensures that the portfolio returns are enhanced.
(iv) A clear rebalancing policy avoids the risks of ad-hoc and costly portfolio revisions.
(a) Buy and Hold Policy:
The initial mix that is bought is held. This is basically a ‘do nothing’ policy in respect of what happens to relative values of
rebalancing if done.
The graph shows the pay off diagram for a buy and hold policy; if the initial stock: bond mix is 50:50. It illustrates the following
features of buy and hold policies :
Pay off Diagram For a Buy and Hold Policy
(i) The value of portfolio is linearly dependent to that of stock market.
(ii) While the portfolio value can’t fall below the value of initial investment in bonds it’s upside potential is unlimited.
(iii) When stock outperforms bond, the higher the initial percentage in stocks, the better is the performance of the buy and hold
policy. On the other hand, when stock underperforms bond, the higher the initial percentage in stocks the worst the performance
of the buy and hold policy.
(b) Constant Mix Policy: The constant mix policy calls for maintaining an exposure to stocks which is a constant proportion of
portfolio value. If the desired constant mix of stock and bonds is 50:50 this policy calls for rebalancing the portfolio when relative
values of its components change so that the target proportions are maintained. Thus this policy unlike the buy and hold policy is
a “do something” policy. The pay off associated with constant mix policy is show in the graph.
(c) Constant Proportion Portfolio Insurance Policy (CPPI): It takes the following form :
Investment in stocks = m (Portfolio value – Floor value) when m>1
Floor value means value which the market expects.
Illustration : If one has wealth of 100000 and Floor of 75000 and multiplier of 2 the pattern of investment associated with such
a policy may be illustrated in the following manner.

Pay Off
Stock Market Level
Constant Mix Policy
“ Hard work is a investment. The more you invest in terms of hard work, more is the profit you earn in terms
of success.”

Pay Off
Stock Market Level
100 200
100 200
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Solution
Condition I: As the initial cushion (different between portfolio value and floor) is Rs.25,000 i.e (1,00,000-75000)]. The initial
investment in stock is 50,000 i.e (twice of initial cushion 25,000 x2). So the initial portfolio means 50,000 in stocks and 50,000
in bonds.
Condition II: If the stock market falls from 100 to 80 value of stocks in the portfolio falls from 50,000 to 40,000; this means
that the value of portfolio declines to 90,000 (stock 40,000 and bond 50,000) thereby reducing the cushion to 15,000(90,000-
75,000). As per CPPI policy stock component would be 30,000 (15,000 x2). So 10,000 of stock should be sold and proceeds
invested in bonds if stock decline further more bonds should be purchased.
Condition III: If the stock market rises from 100 to 150, value of stock in portfolio jumps from 50,000 to 75,000 i.e (150/100
x 50,000) and a value of portfolio rises to 1,25,000 i.e (75,000 stock + 50,000 bond), thereby raising the cushion by 50,000
(1,25,000-75,000).As per CPPI policy stock component should go up to 1,00,000 (50,000 x 2). This calls for selling bonds
worth 25,000 and reinvesting the proceed in the stocks, if stock rises further in value more stocks should be bought and so on.
Thus the CPPI policy necessitates selling stock as they fall and buying stocks as they rise, this implies that this policy is the
opposite of constant mix policy which calls for buying stocks as they fall and selling stocks as they rise. Hence the pay off curve
is convex in nature as shown in the diagram.
Comparative Evaluation: The pay off associated with buy and hold policy constant mix policy and constant proportion
portfolio insurance policy are represented by straight line, concave and convex curve. The graph shows these pay off.
From the graph if the stock market move only in one direction the best policy is CPPI policy and the worst policy is constant mix
policy in between lies buy and hold policy.

Pay off Associated with Various Rebalancing Policies
P
a
y

O
f
f


CPPI
Constant Mix Policy
Stock Market Level
Buy & Hold
Ever y sunset gives us one day less to l ive! But ever y sunr i se give us,
One mor e to hope! So, hope for the best.Best of Luck!

Stock Market Level
100 200
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If the stock market reverses itself frequently rather then move in the same direction,constant mix policy seems to be superior to
other policies.
Consider a payoff from initial investment of 100000 when the market moves from 100 to 80 and back to 100 under three policies
(a) Buy and hold policy under which the initial stock bond mix is 50:50.
(b) Constant mix policy under which the stock bond mix is 50:50
(c) A CPPI policy which takes to form investment in stock = 2 (Portfolio value – 75000 i.e.floor value)
The portfolio compositions and their values for the three policies are tabulated as follows.
Portfolio Composition and Payoff for the Three Policies Market Level 100
Portfolio
Stock Bond Total
Buy and hold policy 50000 50000 100000
Constant mix policy 50000 50000 100000
CPPI policy 50000 50000 100000
Market level falls to 80
Portfolio Before Rebalancing Portfolio After Rebalancing
Stock Bonds Total Stock Bond Total
Buy-Hold 40000 50000 90000 40000 50000 90000
Constant-mix 40000 50000 90000 45000 45000 90000
CPPI 40000 50000 90000 30000 60000 90000
Market level again rises to 100
Portfolio Before Rebalancing Portfolio After Rebalancing
Stock Bonds Total Stock Bond Total
Buy-Hold 50000 50000 100000 50000 50000 100000
Constant-mix 56250 45000 101250 50625 50625 101250
CPPI 37500 60000 97500 45000 32500 97500
The performance feature of the three policies may be summed up as follows:
(a) Buy and Hold Policy
(i) Gives rise to a straight line pay off.
(ii) Provides a definite downside protection.
(iii) Performance between Constant mix policy and CPPI policy.
(b) Constant Mix Policy
(i) Gives rise to concave pay off drive.
(ii) Doesn’t provide much downward protection and tends to do relatively poor in the up market.
(iii) Tends to do very well in flat but fluctuating market.
(c) CPPI Policy
(i) Gives rise to a convex pay off drive.
(ii) Provides good downside protection and performance well in up market.
(iii) Tends to do very poorly in flat but in fluctuating market.
QUESTION NO. 31 Explain the Randon Walk Theory to Portfolio Management?
Many investment managers and stock market analysts believe that stock market prices can never be predicted because they are
not a result of any underlying factors but are mere statistical ups and downs. This hypothesis is known as Random Walk
hypothesis which states that the behaviour of stock market prices is unpredictable and that there is no relationship between the
present prices of the shares and their future prices. Proponents of this hypothesis argue that stock market prices are indepen-
dent. In other words, the fact that there are peaks and troughs in stock exchange prices is a mere statistical happening -
successive peaks and troughs are unconnected. In the layman’s language it may be said that prices on stock exchange behave
exactly the way a drunk would behave while walking in a blind lane i.e. up and down, with an unsteady way going in any direction
he likes, bending on the one side to other side .
The supporters of this theory put out a simple argument. It follows that:
People wi ll for get what you sai d. People wi ll for get what you di d . But people wi ll NEVER
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(a) Prices of shares in stock market can never be predicted.
(b) The reason is that the price trends are not the result of any underlying factors, but that they represent a statistical expression
of past data.
(c) There may be periodical ups or downs in share prices, but no connection can be established between two successive peaks
(high price of stocks) and troughs (low price of stocks).
QUESTION NO. 32 State the Objectives of Portfolio Management?
(i) Security/Safety of Principal The objective is to keep the capital / principal amount intact, in terms of value and in terms of
purchasing power. The capital or the principal amount invested should not erode , either in value or in terms of purchasing power.
(ii) Stability of Income so as to facilitate planning more accurately & systematically the reinvestment or consumption of
income.
(iii) Capital Growth which can be attained by reinvesting in growth securities or through purchase of growth securities.
(iv) Marketability i.e. the case with which a security can be bought or sold. This is essential for providing flexibility to
investment portfolio.
(v) Liquidity i.e. nearness to money. It is desirable for the investor so as to take advantage of attractive opportunities upcoming
in the market.
(vi) Diversification : The basic objective of building a portfolio is to reduce the risk of loss of capital and income , by investing
in various types of securities and over a wide range of industries.
(vii) Favourable Tax Status : The effective yield an investor gets from his investment depends on tax to which it is subject. By
minimising the tax burden, yield can be effectively improved.
QUESTION NO. 33 State two basic principles for effective Portfolio Management?
Basic Principles of Portfolio Management : There are two basic principles for effective portfolio management.
Effective investment planning for the investment in securities by considering the following factors :
(a) Fiscal, Financial and Monetary Policies of the Government of India and the Reserve Bank of India.
(b) Industrial and economic environment and its impact on industry prospects in terms of prospective technological changes,
competition in the market, capacity utilisation with industry and demand prospects etc.
(ii) Constant Review of Investment : Portfolio managers are required to review their investment in securities and continue
selling and purchasing their investment in more profitable avenues. For this purpose they will have to carry the following analysis:
(a) Assessment of quality of management of the companies in which investment has already been made or is proposed to be
made.
(b)Financial & trend analysis of companies balance sheet/profit&loss account to identify sound companies with optimum capital
structure & better performance & to disinvest the holding of those companies whose performance is found to be slackening.
(c) The analysis of securities market and its trend is to be done on a continuous basis.
The above analysis will help the portfolio manager to arrive at a conclusion as to whether the securities already in possession
should be disinvested and new securities be purchased. If so, the timing for investment or dis-investment is also revealed.
QUESTION NO. 34 Write a short note on Benefits of International Portfolio Management ?
International Diversification of portfolio of assets helps to obtain higher risk adjusted returns i.e. reduce risk and raise return
through international investment. Some of the benefits are listed as under:
(a) Reduce Risk & Diversification Benefits: International investment aids to diversify risk. The different sectors in an
individual economy in some way or the other are interrelated and as a whole subject to the same impact of the entire domestic
policy. The returns on investment in a domestic economy depend on the prospects of domestic activity together with the
uncertainty attached thereto. The gains from diversification within a country are therefore very much limited.Though macro
economic factors of different countries vary widely and do not follow the same phases of business cycles, different countries
have securities of different industries in their market portfolio leading to correlation of expected returns from investment in
different countries being lower than in a single country. Thus foreign investment provides diversification benefits which a
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domestic investment does not.
(b) Raise Return through better Risk – Return Trade off : International Investment aids to raise the return with a given risk
and/or aids to lower the risk with a given rate of return. This is possible due to profitable investment opportunities being available
in an enlarged situation and at the same time inter country dissimilarities reduce the quantum of risk.
QUESTION NO. 35 Write a short note on Traditional Position/Graham and Dodd Model on dividend policies ?
[Also Refer Class Register for its practical part]
According to the traditional position expounded by Graham and Dodd, the stock market places considerably more weight on
dividends than on retained earnings.
For them, the stock market is overwhelmingly in favour of liberal dividends as against niggardly dividends. Their view is
expressed quantitatively in the following valuation model:
Symbolically Po=
|
.
|

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|
+ ×
3
E
D m
Under this model the weights attached to dividend is equal to four times the weights attached to retained earnings.
Proof : Po=
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+ ×
3
E
D m
¬
Po=
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.
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\
| +
+ ×
3
R D
D m
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Po=
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The weights provided by Graham and Dodd are based on their subjective judgments and not derived from objective empirical
analysis. Notwithstanding the subjectivity of these weights, the major contention of the traditional position is that a liberal payout
policy has a favourable impact on stock prices.
QUESTION NO. 36 Write a Short Note on Repo [ Repurchase Option ] Agreement ? Briefly state the difference
between Repo & Reverse Repo? Or What is Repo and Reverse Repo .
A Repurchase Agreement (or repo) is an agreement of sale of a security with a commitment to repurchase or buy the
security back at a specified price and on a specified date .
Reverse repo is a term used to describe the opposite side of a repo transaction.Reverse Repo is a purchase of security with
a commitment to sell at a pre-determined price and date .Accordingly, there are two possible motives for entering into a
reverse repo:short-term investment of funds, or to obtain temporary use of a particular security.
Repos/Reverse Repos are used :
(i) to meet shortfall in cash position (ii) augment returns on funds held (iii) to borrow securities to meet regulatory requirement
(iv)An SLR surplus bank and a CRR deficit bank can use the Repo deals as a convenient way of adjusting CRR/SLR positions
simultaenously (v)RBI uses Repo and Reverse Repo deals as a convenient way of adjusting liquidity in the system.
The securities eligible for trading under Repo/Reverse Repo are: (i)GOI & State Govt. Securities (ii)Treasury Bills(iii)PSU
bonds, (iv)FI bonds & Corporate bonds held in Dematerialised form
Issuer : In India, only RBI, Banks and PDs are allowed to enter into Repos. Financial institutions and others specified can only
do reverse Repos.
The essential features of the Repo transaction are:
1. A financial institution places certain securities (presently restricted to Treasury Bills) with the buyer and borrows a certain
amount of money.
2. On a given date specified in advance (between 14 days to 1 year) the entire transaction is reversed.
3. The difference between the purchase and sale price is the interest or gain to the buyer. Sometimes the seller may also gain from
a transaction. This is when the buyer is in need of securities and initiates the transaction.
Coupon/Interest terms :
(a) Computation :Interest for the period of Repo is the difference between Sale Price and Purchase Price .The amount of
interest earned on funds invested in a Repo is determined as follows :
Interest earned = Funds Invested × Repo Rate × Number of Days/365
(b) Recognition : Interest should be recognized on a time -proportion basis , both in the books of the buyer and seller.
(c) Time Period : Interest to be payable on maturity and rounded-off to the nearest rupee.Interest to be calculated on an actual/
365-day year basis.
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Maturity :Repos are normally done for a minimum maturity period of one day & a maximum maturity period of fourteen days.
Minimum denomination and transaction size : Generally Repo transactions are done in market lots of Rs 5 crores.
Difference Between Repo & Reverse Repo :
Reverse repo is a term used to describe the opposite side of a repo transaction.
The term Repurchase Agreement (Repo) and Reverse Repurchase Agreement (Reverse Repo) refer to a type of transaction in
which money market participant raises funds by selling securities and simultaneously agreeing to repurchase the same after a
specified time generally at a specified price, which typically includes interest at an agreed upon rate.
Such a transaction is called a Repo when viewed from the perspective of the seller of securities (the party acquiring funds) and
Reverse Repo when described from the point of view of the supplier of funds.
Thus, whether a given agreement is termed a Repo or a Reverse Repo depends largely on which party initiated the transaction.
Under a Repo transaction, there are two counter parties : a lender and a borrower. The borrower in a Repo borrows cash and
pledges securities. The lender lends cash and purchases the securities and is said to enter into a Reverse Repo transaction. Hence
borrowing by pledging securities is a Repo transaction and lending by accepting the pledge is a Reverse Repo transaction.
Hence, essentially, there is no difference between a ‘REPO’ and a ‘REVERSE REPO’transaction excepting that the identifica-
tion is from a different point of view.Hence a transaction is a Repo for one party and a Reverse Repo for the other party.
QUESTION NO. 37 Write a short note on External Commercial Borrowings (ECB) ?
The foreign currency borrowings raised by the Indian corporates from confirmed banking sources outside India are called
“External Commercial Borrowings” (ECBs).
These Foreign Currency borrowings can be raised within ECB Policy guidelines of Govt. of India/ Reserve Bank of India
applicable from time to time.
External Commercial Borrowings (ECB) are defined to include
1. commercial bank loans,
2. buyer’s credit,
3. supplier’s credit,
4. securitised instruments such as floating rate notes, fixed rate bonds etc.,
5. credit from official export credit agencies,
6. commercial borrowings from the private sector window of multilateral financial institutions such as IFC, ADB, AFIC, CDC
etc. and
7. Investment by Foreign Institutional Investors (FIIs) in dedicated debt funds
Applicants are free to raise ECB from any internationally recognised source like banks,export credit agencies,suppliers of
equipment,foreign collaborations, foreign equity -holders, international capital markets etc. Offers from unrecognised sources
will not be entertained.
Benefits : The ECBs route is beneficial to the Indian corporates on account of following :-
1. It provides the foreign currency funds which may not be available in India.
2. The cost of funds at times works out to be cheaper as compared to the cost of rupee funds.
3. The availability of the funds from the International market is huge as compared to domestic market and corporates can raise
large amount of funds depending on the risk perception of the International market.
4. ECBs provided an additional source of funds to the Indian companies, allowing them to supplement domestically available
resources and to take advantage of lower international interest rates.
5. ECB encourage infrastructure/core and export sector financing which are crucial for overall growth of the economy.
Recent Example : About 812 companies have raised about $20.24 billion through ECBs in the April 2006-February 2007
period. That would be equivalent to about Rs 88,000 crore.The top fundraiser was Reliance Industries, which raised $700
million, followed by Reliance Communication, which raised $500 million.Units in SEZ are permitted to use ECBs under a special
window.
QUESTION NO. 38 Write a short note on Exchange Rate Forecasting ?
Meaning: The foreign exchange market has changed dramatically over the past few years.The amounts traded each day in the
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foreign exchange market are now huge. In this increasingly challenging and competitive market, investors and traders need tools
to select and analyze the right data from the vast amounts of data available to them to help them make good decisions. Corporates
need to do the exchange rate forecasting for taking decisions regarding hedging, short-term financing, short-term investment,
capital budgeting, earnings assessments and long-term financing.
Techniques Of Exchange Rate Forecasting : There are numerous methods available for forecasting exchange rates. They
can be categorized into four general groups- technical, fundamental, market-based, and mixed.
(a) Technical Forecasting: It involves the use of historical data to predict future values.For example time series models.
Speculators may find the models useful for predicting day-to-day movements. However, since the models typically focus on the
near future and rarely provide point or range estimates, they are of limited use to MNCs.
(b) Fundamental Forecasting: It is based on the fundamental relationships between economic variables and exchange rates.
For example subjective assessments,quantitative measurements based on regression models and sensitivity analyses.In general,
fundamental forecasting is limited by:
(i) the uncertain timing of the impact of the factors,
(ii)the need to forecast factors that have an immediate impact on exchange rates,
(iii)the omission of factors that are not easily quantifiable, and
(iv)changes in the sensitivity of currency movements to each factor over time.
(c) Market-Based Forecasting: It uses market indicators to develop forecasts. The current spot/forward rates are often used,
since speculators will ensure that the current rates reflect the market expectation of the future exchange rate.
(d) Mixed Forecasting: It refers to the use of a combination of forecasting techniques.The actual forecast is a weighted average
of the various forecasts developed.
QUESTION NO. 39 What is the difference between Futures & Forward Contracts ?
There major differences between the traditional forward contract and a futures contract.These are tabulated below:
Feature Forward Contract Futures Contract
Amount Flexible Standard amount
Maturity Any valid business date Standard date.Usually one delivery date such as the
agreed to by the two parties second Tuesday of every month
Currencies traded All currencies Majors
Cross rates Available in one contract;Multiple Usually requires two contracts
contracts avoided
Market-place Global network Regular markets-futures market and exchanges
Price fluctuations No daily limit in many currencies Daily price limit set by exchange
Risk Depends on counter party Minimal due to margin requirements
Honouring of contract By taking and giving delivery Mostly by a reverse transaction
Cash flow None until maturity date Initial margin plus ongoing variation margin because of
market to market rate and final payment on maturity date
Trading hours 24 hours a day 4 - 8 hours trading sessions
Other Distinction between forward and futures contracts are as follows:
1. Organised exchanges: Forward contracts are traded in over the counter market. Futures contracts are traded on organised
exchanges with a designated physical location for example : Stock Exchange .
2. Transaction costs: Cost of forward contracts is based on bid-ask spread. Futures contracts entail brokerage fees for buy and
sell orders.
3. Marking to Market: Forward contracts are not subject to marking to market. Futures contracts are subject to marking to
market in which the loss or profit is debited or credited in the margin account on daily basis due to change in price.
4. Margins: Margins are not required in forward contract. In futures contracts every participant is subject to maintain margin as
decided by the exchange authorities.
5. Liquidity : Forward contracts is exposed to the problem of liquidity whereas in futures there is no liquidity problem as they are
traded in stock exchange.
6. Disclosure : In forward contracts, price are not publicly disclosed whereas in future contracts price is transparent.
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QUESTION NO. 40 Write a short note on Buyouts ? or Write a short note on LBO ?
Meaning : A Leveraged buy-out (LBO) is an acquisition of a company in which the acquisition is substantially financed
through debt. Typically in the LBO 90% or more of the purchase price is financed with debt.
While some leveraged buyouts involve a company in its entirety most involve a buisness unit of a company. After the buyout,
the company invariably becomes a Private Company.
The success of the entire operation depends on their acquirer company’s abilty to improve the performence of the unit, curtail
its buisness risk, exercise cost controls and liquidate disposable asset. If they fail to do so, the high fixed financial costs can
jeopardize the venture.
An attractive candidate for acquisition through leveraged buyout should possess three basic attributes :
(a) If firm have a good position in its industry with a solid profit history and reasonable expectations of growth.
(b) The firm should have a relatively low level of debt and a high level of bankable assets that can be used as loan collateral.
(c) It must have a stable and predictable cash flows that are adequate to meet interest and principle payment of the debt and
provide adequate working capital.
Typical advantages of the leveraged buy-out method include:
(a)Low capital or cash requirement for the acquiring entity
(b)Synergy gains, by expanding operations outside own industry or business,
(c)Efficiency gains by eliminating the value-destroying effects of excessive diversification,
(d)Improved Leadership and Management :Sometimes managers run companies in ways that improve their authority (control
and compensation) at the expense of the companies’ owners, shareholders, and long-term strength. Takeovers weed out or
discipline such managers. Large interest and principal payments can force management to improve performance and operating
efficiency.This “discipline of debt” can force management to focus on certain initiatives such as divesting non-core
businesses, downsizing, cost cutting or investing in technological upgrades that might otherwise be postponed or rejected
outright.
(e)Leveraging: as the debt ratio increases, the equity portion of the acquisition financing shrinks to a level at which a private
equity firm can acquire a company by putting up anywhere from 20-40% of the total purchase price.
(f)Acquiring Company pay less taxes because interest payments on debt are tax-deductible
Critics of Leveraged buy-outs :
(a)The major risk of the leveraged buyout is bankruptcy of the acquired company.If the company’s cash flow and the sale of
assets are insufficient to meet the interest payments arising from its high levels of debt, the LBO is likely to fail and the company
may go bankrupt.
(b)The risk associated with a leveraged buyout is that of financial distress,and unforeseen events such as recession, litigation, or
changes in the regulatory environment can lead to difficulties meeting scheduled interest payments, technical default (the viola-
tion of the terms of a debt covenant) or outright liquidation.
(c)Leveraged buyouts can harm the long-term competitiveness of firms involved
(d)Attempting an LBO can be particularly dangerous for companies that are vulnerable to industry competition or volatility
in the overall economy.
(e)If the company does fail following an LBO, this can cause significant problems for employees and suppliers, as lenders
are usually in a better position to collect their money.
(f)Another disadvantage is that paying high interest rates on LBO debt can damage a company’s credit rating.
(g)Finally, it is possible that management may propose an LBO only for short-term personal profit.
Recent example: India has experienced a number of buyouts and leveraged buyouts . A successful example of LBO is the
acquisition of Tetley brand, the biggest tea brand of Europe by TATA Tea of India at 271 million pounds. It was one of the biggest
cross border acquisition by an Indian Company. Another recent example of a leveraged buyout is Tata Steel ( India ) acquiring
Corus ( United Kingdom ) for $11.3 billion .
QUESTION NO. 41 What is a Takeover by Reverse Bid or Reverse Takeover?
Meaning : It is the act of a smaller company gaining control over a larger one .In ordinary case, the company taken over is the
smaller company; in a ‘Reverse Takeover’, a smaller company gains control of a larger one. The concept of takeover by reverse
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bid, or of reverse merger, is thus not the usual case of amalgamation of a sick unit which is non-viable with a healthy or
prosperous unit but is a case whereby the entire undertaking of the healthy and prosperous company is to be merged and vested
in the sick company which is non viable.
Tests For Indentifying Takeover by Reverse Bid :
The three tests in a takeover by reverse bid that are required to be satisfied are, namely,
(i) the assets of the transferor company are greater than the transferee company,
(ii) equity capital to be issued by the transferee company pursuant to the acquisition exceeds its original issued capital, and
(iii) the change of control in the transferee company through the introduciton of a minority holder or group of holders.
Takeover by reverse bid could happen where already a significant percent of the shareholding is held by the transfer company, to
exploit economies of scale, to enjoy better trading advantages and other similar reasons.
Application of the concept of ‘takeover by reverse bid’ The concept of takeover by reverse bid has been successfully
employed in schemes formulated for revival and rehabilitation of sick industrial companies under the Sick Industrial Companies
(Special Provisions) Act 1985.
Indian Example: A recent example of a non-sick unit ‘reverse merger’ was that of ICICI Bank (smaller unit) merging with
ICICI Ltd. (larger unit) to form ICICI Bank Ltd. The aim was to give the company an identity of a ‘Universal Banking Company’.
QUESTION NO. 42 Explain the various types of risks to which the Swap Dealer is exposed to ? (RTP May 2010)
In the process of swap, the role of swap dealer is significant in so far as it brings together two counter-parties whose interests
are complementary to each other. For this role, it takes a small part of the interest payment flow. Since the principal amount is
large, even a small percentage of the interest payment adds considerably to its profit. But, on the other hand, the swap dealer has
to face a variety of risks. These different forms of risks as follows:
(a) Interest-rate Risk : Interest-rate risk arises when the interest rate on a particular loan fails to keep abreast of the movement
of the market interest rate. Thus it can be said that the fixed loans under the swap carry higher risk. On the contrary,floating
interest rate should not be risky because it changes with the changing profile of the money market. But it does carry risk at least
between two reset dates when the interest rate of a particular loan may not be reset despite changes in the market interest rates.
The swap dealer is faced with the interest-rate risk, especially when it has a naked position in the swap. Suppose the swap dealer
pays fixed-rate interest to the counter-party; and in exchange it receives LIBOR. If LIBOR moves to the swap dealer’s disadvantage,
it will have to pay more in form of interest. But the risk can be reduced if the swap dealer does not have a naked position and
passes on the risk to another counter-party.
(b) Exchange-rate Risk : Changes in the exchange rate are a common affair in the foreign exchange market. If the swap dealer
pays fixed rate of interest on a loan denominated in a currency which is going to depreciate, it will have to pay a greater amount
of interest to the end-user. Here it may be noted that if the swap dealer faces both the interest-rate risk and the exchange-rate risk
simultaneously, the quantum of risk will be very large. If the two risks are positively correlated, the risk will be still higher. But
if they are negatively correlated or uncorrelated, the risk will not be so high.
(c) Credit Risk : Credit risk arises when a counter-party defaults payment to the swap dealer. In such cases, the contract is
terminated. However, termination of the contract does not protect the swap dealer from loss. This is because the contract is
terminated only with one counter-party. The other needs payment which the swap dealer has to make.
(d) Mismatch Risk : There are occasions when it is difficult for the swap dealer to find a perfect match for a counter-party.
When a perfect match is not available, the swap dealer offers concessions to attract suitable counter-party. Any such concession
causes loss to it. Sometimes after giving concessions, perfect match is not available on different counts, such as notional
principal, maturity, swap coupon, reset dates,etc. The swap dealer may have to pay more interest.
(e) Sovereign Risk: Sovereign risk arises when the government of a country to which one of the two counter-party belongs,
puts restrictions on the flow of foreign exchange. This entails upon payments received by the swap dealer. It should not be called
to default risk or credit risk because the counter-party is willing to make payments. It is the governmental restriction that comes
in the way.
(f) Delivery Risk: Delivery risk arises when the two counter-parties are located in two different time zones so that the date of
maturity differs by one day. However, the swap dealer is not very much affected by it.
QUESTION NO. 43 What is the role of Financial Advisor in PSU? (May 2001) (May 2007)(May2010)
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The financial adviser occupies an important position in all public sector undertakings (PSU). He functions as the principal advisor
to the chief executive of the enterprise on all financial matters. The committee on public sector undertakings has specified the
following functions and responsibilities for a financial adviser:
(i) Determination of financial needs of the firm and the ways these needs are to be met.
(ii) Formulation of a programme to provide most effective cost-volume profit relationship.
(iii) Analysis of financial results of all operations and recommendations concerning future operations.
(iv) Examination of feasibility studies & detailed project reports from the point of view of overall economic viability of the
project.
(v) Conduct of special studies with a view to reduce costs and improve efficiency and profitability.
QUESTION NO. 44 Write a short note on CAMEL MODEL In Credit Rating ?
CAMEL Stands for Capital, Assets, Management, Earnings and Liquidity. The CAMEL model adopted by the Rating Agencies
deserves special attention, it focuses on the following aspects:
(a) Capital – Composition of Retained Earnings and External Funds raised; Fixed dividend component for preference shares and
fluctuating dividend component for equity shares and adequacy of long term funds adjusted to gearing levels; ability of issuer to
raise further borrowings.
(b) Assets – Revenue generating capacity of existing / proposed assets, fair values, technological / physical obsolescence,
linkage of asset values to turnover, consistency, appropriation of methods of depreciation and adequacy of charge to revenues.
Size, ageing and recoverability of monetary assets viz receivables and its linkage with turnover.
(c) Management – Extent of involvement of management personnel, team-work,authority, timeliness, effectiveness and
appropriateness of decision making along with directing management to achieve corporate goals.
(d) Earnings – Absolute levels, trends, stability, adaptability to cyclical fluctuations ability of the entity to service existing and
additional debts proposed.
(e) Liquidity – Effectiveness of working capital management, corporate policies for stock and creditors, management and the
ability of the corporate to meet their commitment in the short run.
These five aspects form the five core bases for estimating credit worthiness of an issuer which leads to the rating of an
instrument. Rating agencies determine the pre-dominance of positive / negative aspects under each of these five categories and
these are factored in for making the overall rating decision.
QUESTION NO. 45 What are the Advantages of Online Trading ?
1. Investors can have benefit of direct access to stock analysis.
2. They can put their trades as it gives the advantage of the real time live rates and real time transactions.
3. They can stream news and researsh, also get an advantage of viewing various charts and creating their own strategies.
4. It gives the investors a real access to the market.
5. Trade privacy is a key point which online trading offers. There is an increase in the trust and confidence of invetors, both large
and small which has resulted in increased online traders.
6. Since trading is totally internet based they get direct access to their trading platform from any place and any computer in the
world.
7. Online trading has a great speed transparency at a very low cost.
QUESTION NO. 46 Write a short note on Debit Cards ?
Meaning : Debit cards are also known as cheque cards. Debit cards look like credit cards or ATM (automated teller machine)
cards, but operate like cash or a personal cheque. When one uses a debit card his money is quickly deducted from his savings
account.Debit cards are accepted at many locations, including grocery stores, retail stores, gasoline stations, and restaurants.
One can use his card anywhere.They offer an alternative to carrying a cheque book or cash.
Difference Between Debit Cards and Credit Cards :It’s the difference between “debit” and “credit.” Debit means “subtract.”
When one uses a debit card, one is subtracting his money from his own bank account. Debit cards allow him spend only what
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is in his bank account.Debit cards are different from credit cards. While a credit card is to “pay later,” a debit card is to “pay
now.”
Benefits of Debit Cards :
(1) Obtaining a debit card is often easier than obtaining a credit card.
(2) Using a debit card instead of writing cheques saves one from showing identification or giving his personal information at the
time of the transaction.
(3) Using a debit card frees him from carrying cash or a cheque book.
(4) Using a debit card means he no longer has to stock up on traveller’s cheques or cash when he travels
(5) Debit cards may be more readily accepted by merchants than cheques, in other states or countries wherever the card brand
is accepted.
(6) The debit card is a quick, “pay now” product, giving one no grace period.
Use Of Debit Cards/Precaution to be taken while using Debit Cards :
(1) If the card is lost or stolen, report the loss immediately to the financial institution.
(2) If one suspects his card is being fraudulently used, report it immediately to his financial institution.
(3) Hold on to the receipts from debit card transactions. A thief may get name and debit card number from a receipt and order
goods by mail or over the telephone. The card does not have to be missing in order for it to be misused.
(4) If one has a PIN number, memorizing is required. Never keep PIN number with the card. Also, never choose a PIN number
that a smart thief could figure out, such as phone number or birthday date.
(5) Never give PIN number to anyone. Keep the PIN private.
(6) Always know how much money you have in your account. Don’t forget that your debit card may allow you to access money
that you have set aside to cover a cheque which has not cleared your bank yet.
(7) Keep your receipts in one place – for easy retrieval and better oversight of your bank account.
QUESTION NO. 47 Write a short note on Forward Rate Agreements?[Also Refer Class Register for its practical part]
Meaning: In finance, a forward rate agreement (FRA) is a forward contract in which one party pays a fixed interest rate,
and receives a floating interest rate and vice versa .In other words, Agreement to borrow or lend at a specified future date at an
interest rate that is fixed today.
Objective :The aim of a FRAs is to safeguard the interest charges for a future period.FRA is very popular method of hedging
interest rate risk.
Settlement On Net Basis Over Notional Basis : The payments are calculated over a notional amount over a certain period,
and netted, i.e. only the differential is paid. A forward rate agreement (FRA) is a cash-settled forward contract on a short-
term loan.A Forward Rate Agreement is an agreement between two parties to settle the difference between an agreed level of
interest(FRA Rate) and an actual future level of interest.(Reference Rate)
How It Is Quoted : FRAs are quoted in the format AxB, with (A) representing the number of months until the loan is set to begin,
and (B) representing the number of months until the loan ends. To find the length of the loan, subtract A from B.
For Example :
A 1 x 4 quote would mean a 3 month loan, set to begin 1 month in the future.
A 9 X 12 FRA has a contract period beginning nine months hence, ending 12 months hence.
Payoff formula :The netted payment made at the effective date is:
360
Days FRA or Rate ing in Underly Days
Rate Reference or LIBOR or Expiration At Rate 1
360
Days FRA or Rate ing in Underly Days
Rate) Fixed or FRA Rate Reference or LIBOR or Expiration At (Rate Loan x Of Amount Notional
× +
× ÷
Buyer Of An FRA :
The payer of the fixed interest rate is also known as the borrower or the buyer.
The buyer hedges against the risk of rising interest rates.
The buyer of an FRA agrees to pay a fixed-rate coupon payment (at the exercise/contract rate) and receive a floating-rate
payment against a notional principal amount at a specified future date.
The buyer of an FRA will receive (pay) cash when the actual interest rate at settlement is greater (less) than the exercise/
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contract rate (specified fixed-rate).
Seller Of An FRA :
The receiver of the fixed interest rate is the lender or the seller.
The seller hedges against the risk of falling interest rates.
The seller of an FRA agrees to make a floating-rate payment and receive a fixed-rate payment against a notional principal
amount at a specified future date.
The seller of an FRA will receive (pay) cash when the actual interest rate at settlement is less (greater) than the exercise rate.
Main features of the FRA : The main features of the FRA as follows:
An FRA is a simple agreement between two parties, with details confirmed directly between themselves.
An FRA achieves approximately the same result as futures or forward contracts, but offers much greater flexibility. Start
dates, interest periods and notional principal amount are agreed by the two parties to the contract. An FRA can therefore be
exactly tailored to suit a customer’s specific requirements.
The customer agrees a future rate with a bank and at the beginning of the specific period (value date), receives or pays a cash
sum representing the interest differential between the agreed rate and LIBOR. No initial or variation margins are involved.
If the customer’s view of the market changes, he can close out his FRA by taking out a reversing FRA (an equal and opposite
FRA at a new price). The price of the reversing FRA will reflect the market rate for the period at the time of closing the hedge.
FRAs are widely used by corporates, especially in historically high and volatile interest rate countries, such as the UK and
Australia, where FRAs are commonly used to hedge against the risk of rising interest rates by a company with a borrowing. In
general, FRA's are used by corporates for the following broad purposes:
To lock in the cost of borrowing on an existing floating-rate loan.
To guarantee the rate of interest a company has to pay on future draw downs.
To guarantee the interest rate earned on surplus funds for any period.
-FRAs are available in any amount, generally from Euro500,000 or the equivalent upwards,and are now available in a broad range
of currencies, including US dollars, sterling,Swiss Francs, Deutschemarks, French francs, Yen, Guilders and Australian dollars.
-FRAs are widely quoted out to two years in Europe and US. Customers can transact for any period over one month, including
‘broken’ or non-standard dates. However, a customer may have to pay a wider spread for a broken-date FRA (such as 11/2 on
41/2).
Users of FRAs :
1. FRAs are far more widely used than futures by corporates. Usually, this is because corporates, being less interest-rate sensitive
on the whole than financial institutions,do not place such a high value on the facility futures offer of being in and out of the
market in minutes. The forward rate agreement provides corporate treasurers with approximately the same hedging benefits of
futures, but with none of the technical and administrative difficulties.
2. Banks are also heavy users of the FRA market. The most common use of FRAs by banks is to iron out mismatches in the
short-term structure of their assets and liabilities.
Example:The following example illustrates the mechanics of a transaction involving an FRA.Suppose two banks enter into an
agreement specifying:
• a forward rate of 5 percent on a Eurodollar deposit with a three-month maturity;
• a $1 million notional principal; and
• settlement in one month.
Such an agreement is termed a 1x4 FRA because it fixes the interest rate for a deposit to be placed after one month and maturing
four months after the date the contract is negotiated. If the three-month LIBOR is 6 percent on the contract settlement date, the
seller would owe the buyer the difference between 6 and 5 percent interest on $1 million for a period of 90 days. Thus, if 90-day
LIBOR turns out to be 6 percent on the contract maturity date the buyer would receive
= $2,500 ÷ [1 + 0.06(90/360)] = $2,463.05
QUESTION NO. 48 What do you know about swaptions and’their uses ? ( May 2010 4 Marks)
Swaptions first came into vogue in the mid-1980s in the US on the back of structured bonds tagged with a callable option
issued by borrowers. With a callable bond, a borrower issues a fixed-rate bond which he may call at par from the investor at a
specific date(s) in the future. In return for the issuer having the right to call the bond issue at par, investors are offered an
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enhanced yield.
A swaption gives the buyer the right but not the obligation to pay (receive) a fixed rate on a given date and receive (pay) a
floating rate index. It is designed to give the holder the benefit of the agreed upon strike rate if the market rates are higher, with
the flexibility to enter into the current market swap rate if they are lower. The converse is true if the holder of the swaption
receives the fixed rate under the swap agreement. If the strike rate of the swap is more favorable than the prevailing market swap
rate then the swaption will be exercised.
Like any other option, if the swaption is not exercised by maturity it expires worthless. Swaptions fall into three main categories,
depending upon the exercise rights of the buyer: (a) European Swaptions give the buyer the right to exercise only on the maturity
date of the option. (b) American Swaptions, on the other hand, give the buyer the right to exercise at any time during the option
period. (c) Bermudan Swaptions give the buyer the right to exercise on specific dates during the option period.
There are two types of swaption contracts:
-A payer swaption gives the owner of the swaption the right to enter into a swap where they pay the fixed leg and receive the
floating leg.
-A receiver swaption gives the owner of the swaption the right to enter into a swap where they will receive the fixed leg, and pay
the floating leg.
The buyer and seller of the swaption agree on:
-the premium (price) of the swaption
-the strike rate (equal to the fixed rate of the underlying swap)
-length of the option period (which usually ends two business days prior to the start date of the underlying swap),
-the term of the underlying swap,
-notional amount,
-amortization, if any
-frequency of settlement of payments on the underlying swap
Uses Of Swaptions
Swaptions can be applied in a variety of ways for both active traders as well as for corporate treasurers.
Swap traders can use them for speculation purposes or to hedge a portion of their swap books.
The attraction of swaptions for corporate treasurers is that the forward element in all swaptions provides the attractions of the
forward-start swap,and to the owner of the put or call, also the flexibility to exercise or not, as may be considered appropriate.
It is therefore a valuable tool when a borrower has decided to do a swap but is not sure of the timing.
Swaptions have become useful tools for hedging embedded optionality which is common to the natural course of many
businesses.
Swaptions are useful to borrowers targeting an acceptable borrowing rate. By paying an upfront premium, a holder of a
payer’s swaption can guarantee to pay a maximum fixed rate on a swap, thereby hedging his floating-rate borrowings. The
borrower is therefore allowed to remain in low floating-rate funds while at the same time being assured of protection should rates
increase expectedly (i.e. when the yield curve is positive) or unexpectedly (i.e. when the yield curve is flat or negative).
Swaptions are also useful to those businesses tendering for contracts. Businesses need to settle the question whether to
commit to borrowings in the future in their own currency in terms of a tender on a future project. A business would certainly find
it useful to bid on a project with full knowledge of the borrowing rate should the contract be won.
Swaptions also provide protection on callable/putable bond issues.
Swap also provide arbitrage opportunity.The more innovative borrowers can use this arbitrage opportunity to their advantage
in order to bring down their funding cost.
QUESTION NO. 49 List and briefly explain the main functions of an investment bank. (May 2010)
Investment banking provides all the financial services to the corporate, governments and government agencies, other business
entities, non-profit organizations and high net worth individuals. They provide total financial services at one-stop shop. Their
services include:
(i)Issue of IPO/issue management – public as well right issues – equity as well debt
(a) advisory services – timing, size & composition and pricing of issue (b)preparation of offer documents with due care &
diligence and compliance of legal formalities (c) offering the securities to the public/ shareholders(d) underwriting of the
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securities(e) ensuring smooth completion of the issue (f) Post issue services – allotment, exercise of Greenshoe option
From an investment banking perspective, the IPO process consists of these three major phases: hiring the mangers, due diligence,
and marketing.
(ii)Management of buy back of shares – Buy back is used by cash rich companies to
(a) increase the value of shares(b)avoid hostile takeover(c) delisting the shares(d) optimization of the capital structure.(e)Compliance
of the provisions of Company Law and SEBI regulations(f)Smooth completion of the buy back
(iii)Loan syndication
(a) negotiation with loan provides like banks, financial institutions (b) preparation of information memorandum (c)presentation of
information memorandum (d)negotiating the terms (e) smooth completion of transaction
(iv)Private placement of equity as well debt
(a)preparation of Information Memorandum (b)legal compliances – particularly in case of listed companies (c)placement of the
securities to high net worth individuals, financial institutions and other buyers like Private equity
(v)Amalgamations and Absorptions
(a)Advisory services (b)Valuation of both the companies for deciding the swap ratio (c)Legal compliances – meetings of share
holders, filing petition with High court (d)Liaison with stock exchange(s) for listing of the securities issued as purchase consideration
and delisting of the shares of the amalgamated company (e) Ensuring completion deal
(vi)Research and develop opinions on securities, markets, and economies
(vii)Management of investment portfolios – cash rich companies place their surplus cash with the investment banks for
investing in various securities for obtaining appropriate return and maintaining the risk at affordable levels.
(viii) Trading in the securities.
(ix) Securitization Debt.
(x) Follow-on offering of stock :A company that is already publicly traded will sometimes sell stock to the public again.This
type of offering is called a follow-on offering, or a secondary offering. One reason for a follow-on offering is the same as a major
reason for the initial offering: a company may be growing rapidly, either by making acquisitions or by internal growth, and may
simply require additional capital.
(xi)Issue of Debt :
QUESTION NO. 50 Write a short on Credit Cards As A Part Of Consumer Finance ( May 2008 )
Meaning : Credit cards are primarily seen as a means of convenience in meeting ones expenses. A person who holds a credit
card need not pay in cash at the time of every expenditure. Instead, he can deposit a lump sum in the bank or the agencies of
which he holds the credit card, to meet the expenditures.Credit Cards are a good substitute for cash and the resultant safety and
convenience, the competition in this business has made credit cards a source of short-term finance also for individuals.
Parties Involved In Credit Card Transaction : Every transaction on a credit card involves three parties : (1) The credit card
issuer (2) The credit cardholder and (3) The party to whom the cardholder is supposed to pay, say the merchant outlet (MO).
Examples of MO are : a departmental store, hotel, railways, airlines etc.
Advantages & Disadvantages:
Advantages :
(i) They allow you to make purchases on credit without carrying around a lot of cash. This allows you a lot of flexibility.
(ii) They allow accurate record-keeping by consolidating purchases into a single statement.
(iii) They allow convenient remote purchasing - ordering/shopping online or by phone. They allow you to pay for large pur-
chases in small, monthly installments.
(iv) Under certain circumstances, they allow you to withhold payment for merchandise which proves defective.
(v) They are cheaper for short-term borrowing - interest is only paid on the remaining debt, not the full loan amount.
(vi) Many cards offer additional benefits such as additional insurance cover on purchases, cash back, air miles and discounts on
holidays.
(vii)Beside this, the credit-card may also expend the benefit of roll over credit, supplementary cards and travel assistance.
(viii) Credit cards enable a person to track and document all his expenses
(ix) It is safer to carry Credit Cards rather than cash as it provides 100% safety of cash against theft
Disadvantages:
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(i) You may become an impulsive buyer and tend to overspend because of the ease of using credit cards. Cards can encourage
the purchasing of goods and services you cannot really afford.
(ii) Credit cards are a relatively expensive way of obtaining credit if you don't use them carefully, especially because of the high
interest rates and other costs.
(iii) Lost or stolen cards may result in some unwanted expense and inconvenience.
(iv) The use of a large number of credit cards can get you even further into debt.
(v)Using a credit card, especially remotely, introduces an element of risk as the card details may fall into the wrong hands
resulting in fraudulent purchases on the card. Fraudulent or unauthorized charges may take months to dispute, investigate, and
resolve.
QUESTION NO. 52 Write a short note on Debt Securitisation?or What are the advantages of Debt Securitisation?OR
What is securitisation? What are its various instruments ?OR Write a short note on Asset Securitisation (May 10)
Meaning : Securitisation is a process of pooling and repackaging homogeneous illiquid financial assets into marketable
securities that can be sold to investors.Securitisation is the process by which financial assets are transformed into securities .
Process : For example a bank lends Rs. 10 lakhs each to 300 borrowers as part of its loan portfolio. The total debt thus on the
books of the bank will be Rs. 30 crores. By way of securitisation, the bank can break the entire portfolio of loan/debt of Rs. 30
crores into a paper of Rs. 300 each for instance, and market it in the secondary market to investors.
Debt Securitisation will thus provide liquidity to the instrument.
In other words Debt/Asset securitisation is a method of recycling of funds. Securitisation is a process of transformation of
illiquid assets into security, which may be traded later in the open market.
Steps involved in a Securitisation Process :
The basic debt securitisation process can be classified in the following three functions.
(i) The Origination Function : A borrower seeks a loan from a finance company, bank, housing company or a lease from a
leasing company. The creditworthiness of the borrower is evaluated and a contract is entered into with repayment schedule
structured over the life of the loan.
(ii) The Pooling Function : Similar loans or receivables are clubbed together to create an underlying pool of assets. This pool is
transferred in favour of a SPV - (Special Purpose Vehicle), which acts as a trustee for the investor. Once the assets are
transferred, they are held in the originators’ portfolios.
(iii) The Securitisation Function : It is the SPV’s job now to structure and issue the securities on the basis of the asset pool.
The securities carry a coupon and an expected maturity, which can be asset based or mortgage based. These are generally sold
to investors through merchant bankers. The investors interested in this type of securities are generally institutional investors like
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The digrame bellow illustrates the process of Scuritisation in India
Originator
(ICICI Bank)
Borrower
(Y Ltd.)
SPV
(ARCIL)
ICICI securitises loan
to SPV i.e. ARCIL
Lends money to
ARCIL pays discounted
amount to ICICI
Now SPV holds an asset i.e. recovery rights from Y. Ltd.
SPV issues bonds often referred to as Pass through certificates on this asset to general
investers or QIBs to raise money for paying the Orginator.
General Investers or QIBs
SPV receives money on bonds issue.
Later, SPV recovers loan from Y Ltd and repays bonds and interest to investors


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mutual funds, insurance companies etc.
Parties involved in Securitisation Process :
(i) The Originator : This is the entity in whose books the assets , to be securitised , originate.
(ii) Special Pupose Vehicle (SPV) : This is the entity through which the securitisation transaction is actually operated i.e who
buys the assets to be securitised & then issues marketable securities backed by those assets.
(iii) The Investor : These are the entities that are looking for investment opportunity for their surplus funds.They buy the
securities issued by SPV and get returns in the form of interest and principal repayment as per agreed schedule.
(iv) Other Parties : Obligators, Rating Agencies, Administrator, Agent and Trustee.
Instruments of Securitisation :Under this process securities issued by SPV are in the form of Pass Through Certificate
(PTC), Pay Through Securities (PTS) and Stripped Securities. Securities may be Asset Backed Securities and Mortgaged
Backed Securities .
(i) Asset Backed Securities : These are securities backed by other assets like credit card receivable , trade receivables etc .
(ii) Mortgage Backed Securities :These are the securities where the assets collaterised are mortgage loans i.e loans secured by
a mortgage of specified immovable property .
Benefits to the Originator :
1. The assets are shifted off the balance sheet, thus giving the originator recourse to off balance sheet funding.
2. It converts illiquid assets to liquid portfolio.
3. It facilitates better balance sheet management as assets are transferred off balance sheet facilitating satisfaction of capital
adequacy norms.
4. The originator’s credit rating enhances.
Benefits to the Investor :
1. For the investor securitisation opens up new investment avenues.
2. Though the investor bears the credit risk, the securities are tied up to definite assets.
3. Securitisation helps to convert a stream of cash receivables into a source of long-term finance.
4. Securities are rated by Credit Rating Agencies and it becomes easier for an investor to compare risk return profile and make an
informed choice.
Recent Scenario : In Indian context Debt Securitisation has began to take off. The ideal candidates for this are hire purchase
and leasing companies, asset finance and real estate finance companies.The first securitisation deal was structured by Citibank in
1991.National Housing Bank,Housing and Urban Development Corporation,LIC Housing and HDFC have emerged as key players
in the securitisation market .The experiment has already been initiated in India by the Housing Development Finance Corporation
(HDFC) by selling a part of its loan to the Infrastructure Leasing and Financial Services Ltd. (ILFS) and has therefore become a
pacesetter for other kinds of debt securitisation as well.The Industrial Credit and Investment Corporation of India (ICICI) as well
as other private financial companies have been trying similar deals for lease rentals.
QUESTION NO. 53 What are the methods of Venture Capital Financing(VCF)?
Meaning : The Venture Capital Financing refers to financing of new high risky ventures promoted by qualified entrepre-
neurs who lack experience & funds to give shape to their ideas.In broad sense,under venture capital financing venture capitalist
make investment to purchase equity or debt securities from inexperienced entrepreneurs who undertake highly risky ventures
with a potential of success.
Methods of Venture Capital Financing : The venture capitalist generally finance ventures which are in national priority areas
such as energy conservation, quality upgradation, etc,. Some common methods of venture capital financing are as follows:
(i) Equity Financing The venture capital undertakings generally requires funds for a longer period but may not be able to provide
returns to the investors during the initial stages. Therefore, the venture capital finance is generally provided by way of equity
share capital. The equity contribution of venture capital firm does not exceed 49% of the total equity capital of venture capital
undertakings so that the effective control and ownership remains with the entrepreneur. Hence such a mode is useful since there
is no compulsion to pay dividend or interest in initial stages.
(ii) Conditional Loan : A conditional loan is repayable in the form of a royalty after the venture is able to generate sales. No
interest is paid on such loans. In India venture capital financers charge royalty ranging between 2 and 15 per cent; actual rate
depends on factors such as gestation period, cash flow patterns, riskiness and any other factors of the enterprise. Some Venture
Being defeated is often a temporary condition. Giving up is what makes it permanent
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capital financers give a choice to the enterprise of paying a high rate of interest (which could be well above 20 per cent) instead
of royalty on sales once it becomes commercially sounds .
(iii) Income Note : It is a hybrid security which combines the features of both conventional loan and conditional loan. The
entrepreneur has to pay both interest and royalty on sales but at substantially low rates. IDBl’s VCF(Venture Capital Fund)
provides funding equal to 80 -87.5% of the projects cost for commercial application of indigenous technology.
(iv) Participating Debenture : Such security carries charges in three phases - in the start up phase, no interest is charged, next
stage a low rate of interest is charged upto a particular level of operations, after that, a high rate of interest is required to be paid.
The following are the criteria which may be applied to find out the eligibility of an undertaking for Venture Capital Financing
(i)The venture must be a technically feasible proposition(ii)It should be commercially viable(iii)The entreprenuers must be
technically competent & having manegerial skill (iv)The undertaking must have a long run competitive advantage over other units
Benefits Of Venture Capital Financing :
(i) This is the only feasible source of funds available for new enterprising projects , since bank loan & public issues are quite
difficult at start up stage .
(ii) There is flexibility in structuring the mode of finance i.e debt or equity.
(iii)Tax concessions available for VCF help in promoting and increasing the availability of venture capital .
Limitations Of Venture Capital Financing :
(i) Availability of Venture Capital is limited in practice & it depends mostly on the personal contacts of the entrepreneurs.
(ii) It is a very expensive source of finance and also dilutes managerial control of the entrepreneur.
Example of Indian Venture Capital Funds : Some of the important Indian venture capital funds are : ICICI Venture Funds
Ltd. IFCI Venture Capital Funds Limited (IVCF), SIDBI Venture Capital Limited (SVCL), Gujarat Venture Finance Limited
(GVFL).The important overseas venture capital funds operating in India are : Walden International Investment Group, SEAF
India Investment & Growth Fund, BTS India Private Equity Fund Limited.
Infosys Technologies co-founder and chairman NR Narayana Murthy recently sold company shares worth around $37 million to
set up a venture capital fund for incubating Indian start-ups.A statement issued by Infosys said the venture capital fund would
encourage and support young entrepreneurs having brilliant business ideas.The Fund will primarily invest in India and may on a
case-to-case basis consider investing overseas,” it added.This news has come as big boost for the market and especially budding
entrepreneurs.In fact, the country saw over 71% drop in Venture Investments this year. Total VC Investments in the first nine
months of 2009 is at $201 million against $709 million investment for the corresponding period last year. So, with more Venture
Funds we can see the revival of venture investments in India soon.
QUESTION NO. 54 What are the Constraints on Paying Dividends ?
(i) Legal : Under Section 205(1) of the Companies Act 1956, dividend is to be paid out of current profits or past profit after
providing for depreciation. Central Government can allow a company to pay dividend for any financial year out of profits of the
company without providing for depreciation if it is in public interest. Dividend is to be paid in cash .Capital profit may also be
distributed as dividends if articles permit.
(ii) Liquidity : Payment of dividends means outflow of cash. Ability to pay dividends depends on cash and liquidity position of
the firm. A mature company does not have much investment opportunities, nor are funds tied up in permanent working capital
and,therefore has a sound cash position. For a growth oriented company inspite of good profits, it will need funds for expanding
activities and permanent working capital. So it is not in a position to declare dividends.
(iii) Access to the Capital Market : By paying large dividends, cash position is affected. If new shares have to be issued to raise
funds for financing investment programmes and if the existing shareholder cannot buy additional shares, control is diluted.
Payment of dividends may be withheld and earning utilised for financing firm’s investment opportunities.
(iv) Investment Opportunities : If investment opportunities are inadequate, it is better to pay dividends and raise external funds
whenever necessary for such opportunities.
QUESTION NO. 55 What are the Differences between Primary & Secondary Markets?
Basis Primary Markets Secondary Markets
(a)Meaning A primary market refers to the set up The secondary market is market for subsequent
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which helps the industry to raise funds sale/purchase and trading in the securities.
by issuing different types of securities.
(b)Nature of It deals with new securities, i.e. securities It is a market for old securities which have been
Securities which were not previously available, and issued already.
are offered for the first time to the investors.
(c)Sale/ Securities are acquried from issuing Securities are purchased and sold by the investors
Purchase Companies themselves. without any involvement of the companies.
(d)Nature of It provides funds to new enterprises & also for It does not supply additional funds to the company
Financing expansion and diversification of the existing one. since the company is not involved in transaction
(e)Liquidity It does not lend any liquidity to the securities The secondary market provides facilities for the
continuous purchase and sale of securities, thus
lending liquidity and marketability to the securities.
(f)Organisati- It is not rooted in any particular spot and Secondary market has physical existence in the
onal Differe- has no geographical existence. It has form of stock exchange and are located in a
nce neither any tangible form nor any particular geographical area having an administrat-
administrative organisational set up. -ve organisation set up.
QUESTION NO. 56 What are the Similarities between Primary and Secondary Market ?
(a) Listing : One aspect of inseparable connection between them is that the securities issued in the primary market are invariably
listed on a secondary market (recognized stock exchange) for dealings in them. The practice of listing of new issues on the stock
market is of immense utility to the potential investors who can be sure that when they receive an allotment of new issues, they
will subsequently be able to dispose them off any time in the Stock Exchange.
(b) Control : The stock exchanges exercise considerable control over the organization of new issues. The new issues of
securities which seek stock quotation/listing have to comply with statutory rules as well as regulations framed by the stock
exchanges. If the new issues do not conform to the prescribed stipulations, the stock exchanges would refuse listing facilities to
them. This requirement obviously enables the stock exchange to exercise considerable control over the new issues market and is
indicative of close relationship between the two.
(c) Mutual Interdependence : The markets for new and old securities are, economically, an integral part of a single market - the
capital market. Their mutual interdependence from the economic point of view has two dimensions.
One, the behavior of the stock exchanges has a significant bearing on the level of activity in the primary market and, therefore,
its responses to new issues increase when share values are rising and vice versa.
The second dimension of the mutual interdependence of the two parts of the market is that the prices of new issues are
influenced by the price movements on the stock market. The quantitative predominance of old securities in the market usually
ensures that it is these, which set the tone of the market as a whole and govern the prices and acceptability of the new issues.
QUESTION NO. 57 What are the functions of the Stock Exchanges?
The Stock Exchange is a market place where investors buy and sell securities.Functions of the stock exchanges can be summarized
as follows:
(a) Liquidity and Marketability of Securities: The basic function of the stock market is the creation of a continuous market
for securities, enabling them to be liquidated, where investors can convert their securities into cash at any time at the prevailing
market price. It also provides investors the opportunity to change their portfolio as and when they want to change, i.e. they can
at any time sell one security and purchase another,thus giving them marketability.
(b) Fair Price Determination: This market is almost a perfectly competitive market as there are large number of buyers and
sellers. Due to nearly perfect information, active bidding take place from both sides. This ensures the fair price to be determined
by demand and supply forces.
(c) Source for Long term Funds: Corporates, Government and public bodies raise funds from the equity market. These
securities are negotiable and transferable. They are traded and change hands from one investor to the other without affecting the
long-term availability of funds to the issuing companies.
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(d) Helps in Capital Formation: They are the nexus between the savings and the investments of the community. The savings
of the community are mobilized and channeled by stock exchanges for investment into those sectors and units which are
favoured by the community at large, on the basis of such criteria as good return,appreciation of capital, and so on.
(e) Reflects the General State of Economy: The performance of the stock markets reflects the boom and depression in the
economy. It indicates the general state of the economy to all those concerned, who can take suitable steps in time. The Government
takes suitable monetary and fiscal steps depending upon the state of the economy.
QUESTION NO. 58 Write a short note on Bollinger Bands ?[Also Refer Class Register for its practical part]
Bollinger Bands are a technical analysis tool invented by John Bollinger in the 1980s. Having evolved from the concept of
trading bands, Bollinger Bands can be used to measure the highness or lowness of the price relative to previous trades.
When stock prices continually touch the upper Bollinger band, the prices are thought to be overbought; conversely, when they
continually touch the lower band, prices are thought to be oversold, triggering a buy signal.In other words The closer the prices
move to the upper band, the more overbought the market, and the closer the prices move to the lower band, the more oversold
the market.
A band is plotted two standard deviations away from a simple moving average. Because standard deviation is a measure of
volatility, bollinger bands adjust themselves to the market conditions.
When the markets become more volatile, the bands widen (move further away from the average), and during less volatile
periods, the bands contract (move closer to the average). The tightening of the bands is often used by technical traders as an
early indication that the volatility is about to increase sharply.
Standard deviation is a statistical unit of measure that provides a good assessment of a price volatility.The higher the standard
deviation, the more the security’s price fluctuates from its average price.
Bollinger Bands consist of: (i)a middle band (ii)an upper band (iii) a lower band.In other words Bollinger Bands consist of a
moving average and two standard deviations charted as one line above and one line below the moving average. The line above is
two standard deviations added to the moving average. The line below is two standard deviations subtracted from the moving
average.
Formula : The Bollinger band formula consists of the following:
BOLU = MA (TP, n) + m * SD [TP, n]
BOLD = MA (TP, n) - m * SD [TP, n]
Where,BOLU = Upper Bollinger Band ; BOLD = Lower Bollinger Band ;n = Smoothing Period ;m = Number of Standard
Deviations (SD) which is generally 2;SD = Standard Deviation over Last n Periods Typical Price (TP) = (HI + LO + CL) / 3
Note:If Typical Price is not given we can use Closing Price.
Bollinger recommends using a 20-day simple moving average for the center band and 2 standard deviations for the outer
bands.The default choice for the average is a simple moving average.
The technician can be relatively certain that almost all of the price data needed will be found between the two bands.
This goes out especially to people who don’t work hard enough to make their dreams come true and blame their fate for their
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Bollinger Bands serve two primary functions:
-To identify periods of high and low volatility
-To identify periods when prices are at extreme, and possibly unsustainable, levels.
Using Bollinger Band “Bands” To Gauge Trends: Bollinger bands are one of the most popular technical indicators for
traders in any financial market - stocks, bonds or foreign exchange (FX). Many traders use them primarily to determine overbought
and oversold levels,selling when price touches the upper bollinger band and buying when it hits the lower bollinger band. In
range-bound markets, this technique works well, as prices travel between the two bands like balls bouncing off the walls of a
racquetball court.
A Word of Caution! Bollinger bands are a useful tool - but need combining with other indicators, as with any single indicator,
they should not be used in isolation.
QUESTION NO. 59 Write a note on Arbitrage Pricing Theory(APT)?[Also Refer Class Register for its practical part]
Unlike the CAPM which is a single factor model, the APT is a multi factor model having a whole set of Beta Values – one for
each factor.
Arbitrage Pricing Theory states that the expected return on an investment is dependent upon how that investment reacts to a set
of individual macro-economic factors (degree of reaction measured by the Betas) and the risk premium associated with each of
those macro – economic factors.
The APT developed by Ross (1976) holds that there are several factors which explain the risk premium relationship of a
particular security. Several factors being identified e.g. inflation and money supply, interest rate, industrial production and
personal consumption have aspects of being inter-related.
In APT Expected Return =
4 4 3 3 2 2 1 1 f
R | ì + | ì + | ì + | ì +
1
ì ,
2
ì ,
3
ì ,
4
ì are average risk premium for each of the four factors in the model and
4 3 2 1
, , , | | | | are measures of sensitivity
of the particular security to each of the four factors.Rf is the Risk Free Rate of Return.
QUESTION NO. 60 Write a short note on Hedge Funds ?
Hedge Fund is an aggressively managed portfolio of investments that uses advanced investment strategies such as leverage,
long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in
an absolute sense or over a specified market benchmark).
In other words,A hedge fund is a fund that can take both long and short positions, use arbitrage, buy and sell undervalued
securities, trade options or bonds, and invest in almost any opportunity in any market where it foresees impressive gains at
reduced risk.
Benefits Of Hedge Funds :There are many advantages of hedge funds. Some of the important advantages are:
(a) Many hedge fund strategies have the ability to generate positive returns in both rising and falling equity and bond markets.
(b) Inclusion of hedge funds in a balanced portfolio reduces overall portfolio risk and volatility and increases returns.
(c) Huge variety of hedge fund investment styles – many uncorrelated with each other – provides investors with a wide choice
of hedge fund strategies to meet their investment objectives. Academic research proves hedge funds have higher returnsn and
lower overall risk than traditional investment funds.
(d) Hedge funds provide an ideal long-term investment solution, eliminating the need to correctly time entry and exit from
markets.
(e) Adding hedge funds to an investment portfolio provides diversification not otherwise available in traditional investing.
Main Features Of Hedge Funds :The key characteristics of hedge funds can be stated as follows:
(a) Hedge funds utilize a variety of financial instruments to reduce risk, enhance returns and minimize the correlation with equity
and bond markets. Many hedge funds are flexible in their investment options (can use short selling, leverage, derivatives such as
puts, calls,options, futures, etc.).
(b) Hedge funds vary enormously in terms of investment returns, volatility and risk. Many,but not all, hedge fund strategies tend
to hedge against downturns in the markets being traded.
(c) Many hedge funds have the ability to deliver non-market correlated returns.
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(d) Many hedge funds have as an objective consistency of returns and capital preservation rather than magnitude of returns.
(e) Most hedge funds are managed by experienced investment professionals who are generally disciplined and diligent.
(f) Pension funds, endowments, insurance companies, private banks and high net worth individuals and families invest in hedge
funds to minimize overall portfolio volatility and enhance returns.
(g) Most hedge fund managers are highly specialized and trade only within their area of expertise and competitive advantage.
(h) Hedge funds benefit by heavily weighting hedge fund managers’ remuneration towards performance incentives, thus attracting
the best brains in the investment business. In addition, hedge fund managers usually have their own money invested in their fund.
Hedging Strategies:Wide ranges of hedging strategies are available to hedge funds. For example:
(i) Selling Short : Selling shares without owning them, hoping to buy them back at a future date at a lower price in the
expectation that their price will drop.
(ii) Using Arbitrage : Seeking to exploit pricing inefficiencies between related securities -for example, can be long convertible
bonds and short the underlying issuer’s equity.
(iii) Trading Options or Derivatives : Contracts whose values are based on the performance of any underlying financial asset,
index or other investment.
(iv) Investing in Anticipation of a Specific Event : Merger transaction, hostile takeover,spin-off, exiting of bankruptcy
proceedings, etc.
(v) Investing in Deeply Discounted Securities : Of companies about to enter or exit financial distress or bankruptcy, often
below liquidation value.
(vi) Many of the strategies used by hedge funds benefit from being non-correlated to the direction of equity markets.
Hedge Funds Industry Scenario Of The World :The hedge funds industry around the world is estimated to be $300-$400
billion and is growing at about 20% per year with between 4,000 and 5,000 active hedge funds.
Reasons For Investing In a Hedge Fund : There are two basic reasons for investing in a hedge fund: to seek higher net returns
(net of management and performance fees) and/or to seek diversification.
(a) Potential for Higher Returns, Especially in a Bear Market: If your outlook is bearish, hedge funds should be an
attractive asset class compared to buy-and-hold or long-only mutual funds.
(b) Diversification Benefits: Many institutions invest in hedge funds for the diversification benefits. If you have a portfolio of
investments, adding uncorrelated (and positive-returning) assets will reduce total portfolio risk. Hedge funds employ derivatives,
short sales or non-equity investments tend to be uncorrelated with broad stock market indices.
Demerits Of Hedge Funds -
(i)Hedge fund investors are exposed to multiple risks, and each strategy has its own unique risks. For example, long/short funds
are exposed to the short-squeeze.The traditional measure of risk is volatility, that is, the annualized standard deviation of
returns.
(ii)Fat Tails Are The Problem:The problem is that hedge fund returns do not follow the symmetrical return paths implied by
traditional volatility. Instead, hedge fund returns tend to be skewed. Specifically, they tend to be negatively skewed, which means
they bear the dreaded “fat tails”, which are mostly characterized by positive returns but a few cases of extreme losses.
QUESTION NO. 61 Write a note on "Credit Rating" in India?OR Briefly explain the meaning and importance of
"Credit Rating"? Write a short note on Credit Rating Process ?
Meaning Credit Rating is an act of assigning values to credit instruments by assessing the solvency i.e. the ability of the
borrower to repay debt.Thus Credit Rating is:
(1) An expression of opinion of a rating agency.(2) The opinion is in regard to a debt instrument.(3) The opinion is as on a specific
date.(4) The opinion is dependent on risk evaluation.(5) The opinion depends on the probability of interest and principal obligations
being met timely.
What Credit Rating do not indicate It may be noted that credit rating is only an opinion and not the guarantee or protection
against default.It is not a recommendation to buy, or sell, or hold a security.Thus Credit Rating does not in any way linked with
(1) Performance Evaluation of the rated entity unless called for.(2) Investment Recommendation by the rating agency to invest
or not in the instrument to be rated.(3) Legal Compliance by the issuer-entity through audit.(4) Opinion on the holding company,
subsidiaries or associates of the issuer entity.
Credit Rating in India (i) CRISIL (Credit Rating & Information Services of India Ltd.) (ii) ICRA ( Investment Information
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and Credit Rating Agency of India )(iii) CARE (Credit Analysis and Research Limited)(iv)Fitch Ratings India (P) Ltd.
CRISIL was the first credit rating agency in India, incorporated in 1987 jointly by ICICI and the UTI. CRISIL has pioneered the
concept of Credit Rating in India.
Credit Rating Process
(1) Request from issuer and analysis – A company approaches a rating agency for rating a specific security. A team of analysts
interact with the company’s management and gathers necessary information. Areas covered are : historical performance, competitive
position, business risk profile, business strategies, financial policies and short/long term outlook of performance. The team of
analysts makes an assessment of the issuer’s prospects in the light of information available from management. Also factors such
as industry in which the issuer operates, its competitors and markets are taken into consideration.
(2) Rating Committee – On the basis of information obtained and assessment made the team of analysts present a report to the
Rating Committee. The issuer is not allowed to participate in this process as it is an internal evaluation of the rating agency. The
nature of credit evaluation depends on the type of information provided by the issuer.
(3) Communication to management and appeal – The Rating decision is communicated to the issuer and then supporting the
rating is shared with the issuer.If the issuer disagrees, an opportunity of being heard is given to him. Issuers appealing against a
rating decision are asked to submit relevant material information.The Rating Committee reviews the decision although such a
review may not alter the rating. The issuer may reject a rating and the rating score need not be disclosed to the public.
(4) Pronouncement of the rating – If the rating decision is accepted by the issuer, the rating agency makes a public announcement
of it.
(5) Monitoring of the assigned rating – The rating agencies monitor the on-going performance of the issuer and the economic
environment in which it operates. All ratings are placed under constant watch. In cases where no change in rating is required, the
rating agencies carry out an annual review with the issuer for updating of the information provided.
(6) Rating Watch – Based on the constant scrutiny carried out by the agency it may place a rated instrument on Rating Watch.
The rating may change for the better or for the worse. Rating Watch is followed by a full scale review for confirming or changing
the original rating. If a corporate which has issued a 5 year 8% debenture merges with another corporate or acquires another
corporate, it may lead to the listing of the specified debenture rating under this policy.
(7) Confidentiality of information – As the information provided by the issuers is very sensitive in nature; the rating agencies
are required to keep them strictly confidential and cannot use such information for any other purpose.
(8) Rating Credibility – The rating agencies follow a thorough and transparent evaluation so as to lend credibility to their
findings. The policies followed are
(a) Clear and Specific ideas for a rating score.(b) Rationale and Sensitiveness behind the ratings being made public.(c) Publication
of the limitations of rating, adequacy of information and validity of the rating score.(d) Limiting dependence on information from
third parties viz auditors, trustees, consultants, experts.(e) Not carrying out a rating exercise on an unsolicited basis.(f) Withdrawing
the ratings after expiration of the tenure and following a strict policy of not disclosing the rejected ratings except when required.
(9) Rating Coverage – Ratings are not limited to specific instruments. They also include public utilities; financial institutions;
transport; infrastructure and energy projects; Special Purpose Vehicles; domestic subsidiaries of foreign entities. Structured
ratings are given to MNCs based on guarantees or Letters of Comfort and Standby Letters of Credit issued by the banks. The
rating agencies have also launched Corporate Governance Ratings with emphasis on quality of disclosure standards and the
extent to which regulatory obligations have been complied with.
(10) Rating Scores – A comparative summary of Rating Score used by four rating agencies in India is given below.
Sample of Rating Scores
Debentures CRISIL ICRA CARE FITCH
Highest Safety AAA LAAA CARE AAA (L) AAA (ind)
High Safety AA LAA CARE AA (L) AA (ind)
Adequate Safety A LA CARE A (L) A (ind)
Moderate Safety BBB LBBB CARE BBB (L) BBB (ind)
Inadequate Safety BB LBB CARE BB (L) BB (ind)
High Risk B LB CARE B (L) B (ind)
Substantial Risk C LC CARE C (L) C (ind)
Default D LD CARE D (L) C (ind)
Fixed Deposits
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Highest Safety FAAA MAAA CARE AAA TAAA
High Safety FAA MAA CARE AA TAA
Adequate Safety FA MA CARE A TA
QUESTION NO. 62 Write a short note on Limitations Of Credit Rating ? (SFM Nov 2009)
(1) Rating Changes – Ratings given to instruments can change over a period of time. They have to be kept under rating watch.
Downgrading of an instrument may not be timely enough to keep investors educated over such matters.
(2) Industry Specific rather than Company Specific – Downgrades are linked to industry rather than company performance.
Agencies give importance to macro aspects and not to micro ones; over-react to existing conditions which come from optimistic
/ pessimistic views arising out of up / down turns.
(3) Cost Benefit Analysis – Rating being mandatory, it becomes a must for entities rather than carrying out Cost Benefit
Analysis. Rating should be left optional and the corporate should be free to decide that in the event of self rating, nothing has been
left out.
(4) Conflict of Interest – The rating agency collects fees from the entity it rates leading to a conflict of interest. Rating market
being competitive there is a distant possibility of such conflict entering into the rating system.
(5) Corporate Governance Issues – Special attention is paid to (a) Rating agencies getting more of its revenues from a single
service or group.(b) Rating agencies enjoying a dominant market position engaging in aggressive competitive practices by
refusing to rate a collateralized / securitized instrument or compelling an issuer to pay for services rendered.(c) Greater transparency
in the rating process viz. in the disclosure of assumptions leading to a specific public rating.
QUESTION NO. 63 Write short note on NAV (Net Asset Value)?[Also Refer Class Register for its practical part]
Meaning : It is the amount which a unit holder would receive if the mutual fund were wound up. An investor in mutual fund
is a part owner of all its assets and external liabilities.It is the basis for assessing the return that an investor has earned.
There are three aspects which need to be highlighted :
(i) It is the net value of all assets less liabilities. NAV represents the market value of total assets of the Fund less total external
liabilities attributable to those assets.
(ii) NAV changes daily. The value of assets and liabilities changes daily. NAV today will not be NAV tomorrow or day later.
(iii) NAV is computed as a value per unit of holding.
NAV Asset Valuation Rule
Nature of Asset Valuation Rule
Liquid Assets e.g. cash held As per books.
All listed and traded securities Closing Market Price
(other than those held as not for sale)
Debentures and Bonds Closing traded price or yield
Illiquid shares or debentures Last available price or book value whicheveris lower.
Estimated Market Price approach to be adopted if suitable
benchmark is available.
Fixed Income Securities Current Yield.
Netting the Asset Values :The asset values obtained from above have to be adjusted as follows :
Additions Deductions for Liabilities
Dividends and Interest accrued Expenses accrued
Other receivables considered good Liabilities towards unpaid assets
Other assets (owned assets) Other short term or long term liabilities
Computation of NAV :The funds net assets are defined as the assets less external liabilities.
Symbolically : NAV = Net asset of the scheme/Number of units outstanding
Where net assets of the scheme is defined as :Net Assets of the Scheme = Market value of investments + Receivables + Other
accrued income + other assets - Accrued Expenses - Other Payables - Other Liabilities
Example : If total assets of a scheme are Rs. 200 lacs and liabilities are Rs. 20 lacs and there are 10 lacs unit holders, the NAV
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per unit is Rs. 18
QUESTION NO. 64:Write a short note on INTER-BANK PARTICIPATION CERTIFICATE (IBPC) ?
Meaning : A IBPC is a deed of transfer through which a bank, sells or transfers to a third party (transferee) a part or all of a
loan made to its clients (borrowers).In other words The Inter Bank Participation Certificates are short term instruments to even
out the short term liquidity within the Banking system particularly when there are imbalances affecting the maturity mix of assets
in Banking Book.
Why it is called so ? : It is called a participation certificate because through it, the PC holder participates in a bank loan, and
so also in the interest, the security of the loan, and risk of default on a proportionate basis.
Objective: The primary objective is to provide some degree of flexibility in the credit portfolio of banks & to smoothen the
consortium arrangements.
Who can Issue & Subscribe: The IBPC can be issued by scheduled commercial bank and can be subscribed by any
commercial bank.
Issued against underlyng Advance : The IBPC is issued against an underlying advance, classified standard during the
currency of the participation.
Types : The participation can be issued in two types, viz. with and without risk to the lender.
While the participation without risk can be issued for a period not exceeding 90 days. Participation with risk can be issued for a
period between 91 days and 180 days.
Benefits : The scheme is beneficial both to the issuing and participating banks. The issuing bank can secure funds against
advances without actually diluting its asset-mix. A bank having the highest loans to total asset ratio and liquidity bind can square
the situation by issuing IBPCs. To the lender, it provides an opportunity to deploy the short term surplus funds in a secured and
profitable manner.The IBPC with risk can also be used for capital adequacy management.
Interest Rate:The interest rate on IBPC is freely determined in the market. The certificates are neither transferable nor
prematurely redeemable by the issuing bank.
Current Scenario : Despite its advantages, the IBPC scheme has not become a popular money market instrument.One of the
reason for this may be the prohibition against transferability as the participants are not allowed to transfer the certificates.
Secondly due to the absence of a ceiling on the interest rate the borrower bank has to pay the issuing bank a rate higher than that
agreed with the borrower.
QUESTION NO. 65 What are the reasons for stock index futures becoming more popular financial derivatives over
stock futures segment in India ? (May 2010 6 Marks)
Trading in stock index futures contracts was introduced by the Kansas City Board of Trade on February 24, 1982.In April
1982, the Chicago Mercantile Exchange (CME) began trading in futures contract based on the Standard and Poor’s Index of 500
common stocks. The introduction of both contracts was successful, especially the S&P 500 futures contract, adopted by most
institutional investors.
In India, both the NSE and the BSE have introduced index futures in the S&P CNX Nifty and the BSE Sensex.
Uses of Stock Index Futures: Investors can use stock index futures to perform myriad tasks. Some common uses are:
(i)to speculate on changes in specific markets;
(ii)to change the weightings of portfolios;
(iii)to separate market timing from market selection decisions; and
(iv)to take part in index arbitrage, whereby the investors seek to gain profits whenever a futures contract is trading out of line
with the fair price of the securities underlying it.
(v)Using Indexes to Hedge Portfolio Risk: Aside from the above uses of indexes, investors often use stock index futures to hedge
the value of their portfolios. To implement a hedge, the instruments in the cash and futures markets should have similar price
movements.
Main reasons to trade stock index futures are:
(i)Add flexibility to one’s investment portfolio. Stock index futures add flexibility to his or her portfolio as a hedging and trading
instrument.
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(ii)Create the possibility of speculative gains using leverage. Because a relatively small amount of margin money controls a large
amount of capital represented in a stock index contract, a small change in the index level might produce a profitable return on
one’s investment if he or she is right about the market’s direction.
(iii) Provide hedging or insurance protection for a stock portfolio in a falling market.
(iv)There is no time value erosion of the futures position.
(v) Maintain one’s stock portfolio during stock market corrections.
(vi)Sell as easily as one can buy. One of the major advantages of futures markets, in general, is that one can sell contracts as
readily as he or she can buy them and the amount of margin required is the same.
(vii) Transfer risk quickly and efficiently. Whether one is speculating, looking for insurance protection (hedging), or temporarily
substituting futures for a later cash transaction, most stock index futures trades can be accomplished quickly and efficiently.
Stock index futures give individual the opportunity to get into or out of a position whenever he or she wants.
QUESTION NO. 66 How is a stock market index calculated? Indicate any two important market indices.(May 2010)
[Also Refer Class Register for its practical part]
Stock Market Index is representative of the entire stock market. Movements of the index represent the average returns
obtained by investors in the stock market.A market Index acts as a barometer for market behavior.
How is the index calculated : A share price Index is used to monitor and measure the share price movements over a period of
time as compared to the base year. Share market indexes (also called as indices) are meant to capture the overall behavior of
equity markets. A stock market index is created by selecting a group of stocks that are representative of the whole market or a
specified sector. An Index is calculated with reference to a base period and a base index value.
Index calculation is based on the weighted aggregate method . The appropriate formula is :
Point Index s Yesterday'
tion Capitalisa Market s Yesterday'
tion Capitalisa Market s Today'
×
Example : If the market capitalization of 10 securities ( considered to be the index ) as at the beginning of 01.04.2008 amount to
Rs. 5 crores is taken as base and equated to 100 and at day end market capitalization amounts to Rs. 5.50 crores, then the index
at the end of 01.04.2008 will be 110 .
i.e
110
5.00
5.50
100
tion Capitaliza Market Opening
tion Capitaliza Market Closing
Index Opening = × = ×
If at the end 02.04.2008 , the market capitalization is Rs. 6.30 crores , then the index value would be 126.
126
5.50
6.30
110
tion Capitaliza Market Opening
tion Capitaliza Market Closing
Index Opening = × = ×
Two important market indices
Sensex and Nifty are two important share indices in India.
Sensex is an index number that measures the relative average change in prices of 30 shares listed in the Bombay Stock Exchange
Ltd (BSE). . The base year of SENSEX is 1978-79 and the base value is 100.. It is calculated on a free-float market capitalization
methodology.
Nifty tracks the performance of equity share of 50 important companies listed on NSE. The base of the index is the close of
prices on November 3, 1995. The base value of the index has been set at 1000.. It is also calculated on a free-float market
capitalization methodology.
QUESTION NO. 67 Highlight the importance of due diligence in M&A ?
In the past, various authors have emphasized the importance of due diligence in M&A. The concept of due diligence has many
dimensions such as:Due diligence is research, its purpose in M&A is to support the valuation process, arm negotiators, test the
accuracy of representations and warranties contained in the merger agreement, fulfill disclosure requirements to investors, and
inform the planners of post-merger integration.
It is the opposite of negligence.Weaknesses in the due diligence process may cause an M&A to fail.
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A due diligence process should focus at least on the following issues:
(i) Legal issues: These include examining documents of asset ownership and associated liabilities; and whether the target
company is in compliance with government regulations.
(ii) Financial and tax issues: These include examining accounting records and reports to determine whether the target companies
are in compliance with generally accepted accounting principles. In addition, the target company’s compliance with tax laws and
regulations should be examined.
(iii)Marketing issues: These include strengths and weaknesses of products and services provided by the target company and
their domestic and foreign competition.
(iv)Cross-border issues: These include foreign currency exchange risks, foreign laws and regulations, investment promotional
agency and investment incentives, foreign banking and credit agencies, accounting principles, and local tax rules.
(v)Cultural and ethical issues: These cover cultural differences between the acquirer and target companies and how to deal
with these differences; the degree of compliance with the acquirer’s ethical guidelines; and the exposure to liabilities and legal
proceedings on unethical conduct such as patent and copyright violations, price fixing and others.
QUESTION NO. 68 What are the various types of Foreign Exchange Risk ?
There are several types of risk that an investor should consider and pay careful attention to. Deciding the potential return while
respecting risk is the age-old decision that investors must make.
1.Financial Risk: It is the potential loss or danger due to the uncertainty in movement of foreign exchange rates, interest rates,
credit quality, liquidity position, investment price,commodity price, or equity price, as well as the unpredictability of sales price,
growth, and financing capabilities. Balance sheet and cash flow hedges as well as derivatives tools mitigate financial risks by
reducing uncertainty faced by firms.
2.Business Risk: On a micro scale, business risk involves the variability in earnings due to variation in the cash inflows and
outflows of capital investment projects undertaken. This risk, also known as investment risk, may materialize because of
forecasting errors made in market acceptance of products, future technological changes,and changes in costs related to projects.
The firm can reduce this risk, also referred to as portfolio risk, by seeking out capital projects and merger candidates that have
a low or negative correlation with its present operations.
3.Credit or Default Risk: This is the risk that a company or individual will be unable to pay the contractual interest or principal
on its debt obligations. This type of risk is of particular concern to investors who hold bonds within their portfolio. Government
bonds have the least amount of default risk and least amount of returns while corporate bonds tend to have the highest amount
of default risk but also the higher interest rates. Bonds with lower chances of default are considered to be “investment grade,”
and bonds with higher chances of default are considered to be junk bonds.
4.Country Risk: This refers to the risk that a country would not be able to honour its financial commitments. When a country
defaults it can harm the performance of all other financial instruments in that country as well as other countries it has relations
with.Country risk applies to stocks, bonds, mutual funds, options and futures that are issued within a particular country. This
type of risk is most often seen in emerging markets or countries that have a severe deficit.
5.Interest Rate Risk: It refers to the change in the interest rates. A rise in interest rates during the term of an investor’s debt
security hurts the performance of stocks and bonds.
6.Political Risk: This represents the financial risk that a country’s government will suddenly change its policies.
7.Market Risk: It is the day-to-day fluctuations in a stocks price. Also referred to as volatility. Market risk applies mainly to
stocks and options. As a whole, stocks tend to perform well during a bull market and poorly during a bear market.
8.Foreign Exchange Risk: When investing in foreign countries one must consider the fact that currency exchange rate can
change the price of the asset as well. Foreign exchange risk applies to all financial instruments that are in a currency other than
your domestic currency. As an example, if you are a resident of America and invest in some Canadian stock in Canadian dollars,
even if the share value appreciates, you may lose money if the Canadian dollar depreciates in relation to the American dollar.
QUESTION NO. 69 Write a short note on Netting ?[Also Refer Class Register for its practical part]
Meaning : Exposure Netting refers to offsetting exposures in one currency with Exposures in the same or another currency,
where exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by
Ther e's only one di ffer ence between Dr eam and Ai m.Dr eams r equi r es sound sleep to see
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gains or losses on the second currency exposure.
Objective :The objective of the exercise is to offset the likely loss in one exposure by likely gain in another.
It is a technique of optimising cash flow movements with the combined efforts of the subsidiaries thereby reducing administrative
and transaction costs resulting from currency conversion.
There is a co-ordinated international interchange of materials, finished products and parts among the different units of MNC
with many subsidiaries buying /selling from/to each other. Netting helps in minimising the total volume of inter-company fund
flow.
Advantages derived from netting system includes :
(1) Reduces the number of cross-border transactions between subsidiaries thereby decreasing the overall administrative costs of
such cash transfers
(2) Reduces the need for foreign exchange conversion and hence decreases transaction costs associated with foreign exchange
conversion.
(3) Improves cash flow forecasting since net cash transfers are made at the end of each period
(4) Gives an accurate report and settles accounts through co-ordinated efforts among all subsidiaries
There are two types of Netting :
(1) Bilateral Netting System – It involves transactions between the parent and a subsidiary or between two subsidiaries. If
subsidiary X purchases $ 20 million worth of goods from subsidiary Y and subsidiary Y in turn buy $ 30 million worth of goods
from subsidiary X, then the combined flows add up to $ 50 million. But in a bilateral netting system subsidiary X would pay
subsidiary Y only $10 million. Thus bilateral netting reduces the number of foreign exchange transactions and also the costs
associated with foreign exchange conversion. A more complex situation arises among the parent firm and several subsidiaries
paving the way to multinational netting system.
(2) Multilateral Netting System – Each affiliate nets all its inter affiliate receipts against all its disbursements. It transfers or
receives the balance on the position of it being a net receiver or a payer thereby resulting in savings in transfer / exchange costs.
For an effective multilateral netting system, these should be a centralised communication system along with disciplined subsidiaries.
This type of system calls for the consolidation of information and net cash flow positions for each pair of subsidiaries.
Subsidiary P sells $ 50 million worth of goods to Subsidiary Q, Subsidiary Q sells $ 50 million worth of goods to Subsidiary R and
Subsidiary R sells $ 50 million worth of goods to Subsidiary P. Through multilateral netting inter affiliate fund transfers are
completely eliminated.
P
Q R
Example : The netting system uses a matrix of receivables and payables to determine the net receipt / net payment position of
each affiliate at the date of clearing. A US parent company has subsidiaries in France, Germany, UK and Italy. The amounts due
to and from the affiliates is converted into a common currency viz. US dollar and entered in the following matrix.
Inter Subsidiary Payments Matrix (US $ Thousands)
Receiving affiliate Paying affiliate
France Germany UK Italy Total
France — 40 60 100 200
Germany 60 — 40 80 180
UK 80 60 — 70 210
Italy 100 30 60 — 190
Total 240 130 160 250 780
Without netting, the total payments are $ 780 Thousands. Through multinational netting these transfers will be reduced to $ 100
Thousands, a net reduction of 87%. Also currency conversion costs are significantly reduced. The transformed matrix after
consolidation and net payments in both directions convert all figures to US dollar equivalents to the below form :

$50Million
$50Million
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Netting Schedule (US $ Thousands)
Receipt Payment Net Receipt Net Payments
France 200 240 — 40
Germany 180 130 50 —
UK 210 160 50 —
Italy 190 250 —_ 60__
100 100_
QUESTION NO. 70 Write a short note on Support and Resistance Levels ?
Support and resistance is one of the most widely used concepts in trading.
When the index/price goes down from a peak, the peak becomes the resistance level.Resistance levels act like a ceiling for the
price of a stock. As the price rises up to a resistance level, it tends to stop, turn around and move lower.
When the index/price rebounds after reaching a trough subsequently, the lowest value reached becomes the support level.Support
levels are based on past pricing and act like a floor for the price of stock. As the price of a stock drops down to a support level
it tends to stop at that point, turn around and move higher. The price is then expected to move between these two levels.
Whenever the price approaches the resistance level, there is a selling pressure because all investors who failed to sell at the high
would be keen to liquidate, while whenever the price approaches the support level, there is a buying pressure as all those
investors who failed to buy at the lowest price would like to purchase the share.
Support levels indicate the price where the most of investors believe that prices will move higher. Resistance levels indicate the
price at which the most of investors feel prices will move lower.
A breach of these levels indicates a distinct departure from status quo, and an attempt to set newer levels.When a resistance
level is successfully broken through, that level becomes a support level. Similarly, when a support level is successfully broken
through, that level becomes a resistance level.Support and resistance levels can be identified by trend lines
Someti mes to r eali ze you wer e well, someone must come along and hur t you.
As a well-spent day br i ngs happy sleep, so a li fe well spent br i ngs happy death.
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QUESTION NO. 71 Write a short note on Commodity Swaps ?
Meaning: A swap where exchanged cash flows are dependent on the price of an underlying commodity. This is usually used
to hedge against the price of a commodity. The vast majority of commodity swaps involve oil.Commodity swaps are used to
lock-in the price of a commodity.Commodity swaps are becoming increasingly common in the energy and agricultural industries,
where demand and supply are both subject to considerable uncertainty.It is a swap in which at least one set of payments is based
on the price of a commodity, such as oil.
Types Of Commodity Swaps :There are two types of commodity swaps: fixed-floating or commodity-for-interest.
(a) Fixed-Floating Swaps: They are just like the fixed-floating swaps in the interest rate swap market with the exception that
both indices are commodity based indices.General market indices in the international commodities market with which many
people would be familiar include the Goldman Sachs Commodities Index (GSCI) and the Commodities Research Board Index
(CRB). These two indices place different weights on the various commodities so they will be used according to the swap agent’s
requirements.
(b) Commodity-for-Interest Swaps: are similar to the equity swap in which a total return on the commodity in question is
exchanged for some money market rate (plus or minus a spread).
Valuing Commodity Swaps :In pricing commodity swaps, we can think of the swap as a strip of forwards, each priced at
inception with zero market value (in a present value sense).Thinking of a swap as a strip of at-the-money forwards is also a
useful intuitive way of interpreting interest rate swaps or equity swaps.
Commodity swaps are characterized by some distinctive peculiarities, though.These include the following factors for which
we must account (at a minimum):
(i) The cost of hedging
(ii) The institutional structure of the particular commodity market in question
(iii) The liquidity of the underlying commodity market
(iv) Seasonality and its effects on the underlying commodity market
(v) The variability of the futures bid/offer spread
(vi) Brokerage fees
(vii) Credit risk, capital costs and administrative costs.
QUESTION NO. 72 Write a short note on Asset Allocation Strategies ?
Many portfolios containing equities also contain other asset categories, so the management factors are not limited to equities.
There are four asset allocation strategies :
(a) Integrated Asset Allocation : Under this strategy, capital market conditions and investor objectives and constraints are
examined and the allocation that best serves the investor’s needs while incorporating the capital market forecast is determined.
(b) Strategic Asset Allocation : Under this strategy, optimal portfolio mixes based on returns, risk, and co-variances is generated
using historical information and adjusted periodically to restore target allocation within the context of the investor’s objectives
and constraints.
(c) Tactical Asset Allocation : Under this strategy, investor’s risk tolerance is assumed constant and the asset allocation is
changed based on expectations about capital market conditions.
(d) Insured Asset Allocation : Under this strategy, risk exposure for changing portfolio values (wealth) is adjusted; more value
means more ability to take risk.
QUESTION NO. 73 What are the complexities involved in International Capital Budgeting ?
Complexities Involved in International Capital Budgeting :
(a) Cash flows from foreign projects have to be converted into the currency of the parent organization.
(b) Parent cash flows are quite different from project cash flows
(c) Profits remitted to the parent firm are subject to tax in the home country as well as the host country
(d) Effect of foreign exchange risk on the parent firm’s cash flow
(e) Changes in rates of inflation causing a shift in the competitive environment and thereby affecting cash flows over a specific
Wor ld’s r i chest , Softwar e Ki ng Bi ll Gates was a dr opout fr om Hawar d Uni ver si ty
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time period
(f) Restrictions imposed on cash flow distribution generated from foreign projects by the host country
(g) Initial investment in the host country to benefit from the release of blocked funds
(h) Political risk in the form of changed political events reduce the possibility of expected cash flows
(i) Concessions/benefits provided by the host country ensures the upsurge in the profitability position of the foreign project
(j) Estimation of the terminal value in multinational capital budgeting is difficult since the buyers in the parent company have
divergent views on acquisition of the project.
QUESTION NO. 74 What are the complexities involved in International Working Capital?
Complexities Involved in International Working Capital :The management of working capital in an international firm is very
much complex as compared to a domestic one. The reasons for such complexity are:
(1) A multinational firm has a wider option for financing its current assets. Host country funds can be used if needed. Funds flow
from different units of the same firm. Approach is made from the international financial market. However, domestic firms find it
difficult to avail such funds.
(2) Interest and tax rates vary from one country to the other. A manager associated with a multinational firm has to consider the
interest/ tax rate differentials while financing current assets. This is not the case for domestic firms.
(3) A multinational firm is confronted with foreign exchange risk due to the value of inflow/outflow of funds as well as the value
of import/export are influenced by exchange rate variations. Restrictions imposed by the home or host country government
towards movement of cash and inventory on account of political considerations affect the growth of MNCs. Domestic firm limit
their operations within the country and does not face such problems.
(4) With limited knowledge of the politico-economic conditions prevailing in different host countries, a multinational manager
often finds it difficult to manage working capital of different units of the firm operating in these countries. The pace of development
taking place in the communication system has to some extent eased this problem but it is still there very much.
(5) Intra flow of funds is available with multinational firms as cash positioning and cash mobilization, an important aspect of
international working capital management becomes easier to handle. This is not possible for domestic firms.
A study of International Working Capital Management requires knowledge of Multinational Cash Management, International
Inventory Management and International Receivables Management.
QUESTION NO. 75 Write a short note on Leading And Lagging ?
This technique is used by subsidiaries for optimizing cash flow movements by adjusting the timing of payments to determine
expectations about future currency movements.
 MNCs accelerate (lead) or delay (lag) the timing of foreign currency payments through adjustment of the credit terms
extended by one unit to another.
The technique helps to reduce foreign exchange exposure or to increase available working capital.
Firms accelerate payments of hard currency payables and delay payments of soft currency payables in order to reduce foreign
exchange exposure.
A MNC in the USA has subsidiaries all over the world. A subsidiary in India purchases its supplies from another subsidiary in
Japan. If the Indian subsidiary expects the rupee to fall against the yen, then it shall be the objective of that firm to accelerate the
timing of its payment before the rupee depreciates. Such a strategy is called Leading. On the other hand, if the Indian subsidiary
expects the rupee to rise against the yen then it shall be the objective of that firm to delay the timing of its payment before the
rupee appreciates. Such a strategy is called Lagging. MNCs should be aware of the government restrictions in such countries
before availing of such strategies.
The advantages associated with Leading and Lagging are :
(1) No formal recognition of indebtedness is required and the credit terms can be altered by increase / decrease of the terms on
the accounts.
(2) It helps in minimizing foreign exchange exposure and helps in transferring liquidity among affiliates by changing credit terms
and is dependent on the opportunity cost of funds to both paying and receiving units.
(3) It is an aggressive technique aimed at taking advantage of expected revaluations and devaluations of currency movements.
Li ve i n your dr eams,but dr eams may di e...donot get shater ed , never ever cr y .The wor ld i s
bi g and has lots to gi ve.Pi ck up a new dr eam,that’s the way to li ve.
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[mafabycaaadityajain] hello friends
Friday, 10 April, 2009 5:46 PM
From: “Sweta Kothari” <swetakothari@ymail.com>
To: mafabycaaadityajain@yahoogroups.com
I stay in Kolkata..I am appearing my CA finals in this June.. I have previously taken tutions for MAFA from a teacher..
Though he was good but i was always scared of MAFA..By taking classes by Aditya Jain Sir, now i am feeling very good & comfortable
in MAFA even though i am not his regular student..He makes us understand the concepts in a very easy manner.. I just want to thank
sir for removing my fear for MAFA..Before taking classes from sir i just used to target 45-50 in MAFA.. But now i am targeting much
more..
Thank you sir.. Thank you so much.. Regards.. Sweta Kothari Kolkata
THANKS FOR YOUR THEORY BOOK
Wednesday, 25 February, 2009 8:49 PM
From: “Priyanka Agarwal” <priyans26186@gmail.com>
To: ca_kumaraaditya@yahoo.co.in
This is Priyanka Agarwal from Kolkata.I have purchased ur theory book from Jayesh Sir and is extremely benefitted by it.Now I regret
that
why havenot I joined u.Actually when I did my MAFA classes I even didnot know your name.Your theory book is just marvellous.No doubt
I am getting immense knowledge from it but one more thing is there which I got from your book.The Confidence,most important thing
for gaining courage and facing the exams.I would definitely ask all my friends to join your classes.I have heard that your classes are
really awesome.I would like to request you that please give some of your valuable suggestions to me for passing the exams in all the
subjects. A very heartful thanks to you for publishing such a nice book.
Wednesday, June 3, 2009 12:20 PM
From: “Ashish Singla” <ashishsinglaca@gmail.com>
To: cafinalmafa@yahoo.com
Dear Mr. Aditya Jain,
I owe it to you, that today, I can heave a sigh of relief after my MAFA Exam. I happened to read only your Suggested Compilation for June
2009 exam during my revision time. And, Im not regretting it one bit. I dont know how you did it, but so many questions came
from your compilation (Which was obviously advantageous to me). Thanks a lot for putting in such a diligent effort to compile the same.
Regards, Ashish
P.S - I think there is not much chance that this mail shall come before your eyes because Im sending to a general id of yours BUT I
believe youve made me one of your die hard word of mouth advertisers.
Monday, 8 June, 2009 3:28 PM
From: “Rajeev Nagpal” <rajeev@investbank.ae>
To: ca_kumaraaditya@yahoo.co.in
Hello Aditya Sir,
I came across your book and I must complement you on writing an excellent book. I have never seen such a simple and
excellent presentation of any subject by any one. I am badly stuck up in Group-I of C.A. (Final). I wish I could get your complete notes.
I am sure it will prove to be extremely helpful.  
 Regards,Rajeev Nagpal,Assistant Financial Controller,Head Office Finance Control Department,Invest Bank,Sharjah,U.A.E. 
Tel : 06- 5694440 Ext. 350;Mob : 050-4996818;Fax :06-5681174
Abhishek Jakhetiya
CA Final-Roll No. 26804 MAFA Marks-74
CS Inter-Roll No.17926 Securities Market Paper-70 Marks
DOB: 12th September 1985
Email: ca.abhishekj@yahoo.com
Addres: H.N 1391, Sector-4, Gurgaon-122001
Exam Completion in CA : May 2008
Comments on your Classes: Finally Delhi has got some good MAFA classes as well. Aaditya Jain Sir has not only
made us fearless but also made us think of MAFA as a high scoring paper just as Accounts or Indirect Taxes.Your
Study material is fantastic . Thankyou
Positive Feedback About The Theory Books And Classes
NR Nar ayana Mur thy, founder of I nfosys, I ndi a’s fi r st softwar e company star ted the
company i n 1981 wi th an i ni ti al capi tal of Rs. 10,000
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And Many More.............
Sourav Goenka :80 Mks in MAFA in May2008 Roll No. 26120 with All India 16th Rank
Anjana Gupta
CA Final-Roll No. 26804, MAFA Mks-85
in Nov2008 One Of All India Highest
Congratulating Surbhi Agarwal For Securing All India Rank 1 In CA Final -Nov 2008 Exam
A Student Of Aditya Jain Sir
From the Desk Of Surbhi Agarwal-All India Rank 1
I am excited and feeling great today…I must say that hard work and dedication is the path to success.. I take this
opportunity to thank my family, friends and of course my Teachers whose guidance and support has always been with me..
“I suggest the students to study the subjects not with the intention to mug up things but to gain knowledge. Given that we
have eight subjects you cannot cram all of them so the best way out is to understand, comprehend and revise it again and
again so that it settles deep into your sub-conscious mind.”I will further like to thank Aditya Sir to make my MAFA
conceptually clear.Finally Delhi has got a good FM teacher.His notes are really excellent and updated .
-Surbhi Aggarwal,Rank Holder in PE-1,PE-2 and Final
Also Congratulating Amar Nilange Roll No. 01059 for scoring 87 Marks in
M ay 08 i n M A FA One of A l l I ndi a Hi ghest a st udent of Aaditya Jain
Securing All India Rank 1 in
ICFAI - MBA with 85 Marks in
FM Subject an all India Highest
Abhishek Kapuria
Abhishek Jakhetiya : CA Final-Roll No. 26804 MAFA Marks-74 & CS Inter-Roll No.17926 Securities Market Paper-70 Marks Rank 36
Sunny Jain-All India 27th Rank in CA-PEII Nov 08 Roll No. 23298 with 70 Marks in Cost-FM
SSTARS OF Aaditya Jain’s FM Class


Shivangi Patil -All India 10th Rank in CA-PCC Roll No.62937 with
92 Marks in Cost-FM.Also Scored Rank 1 in PE-1 Roll No.
10415.Also completed CA Final MAFA from Aaditya Sir.Final Attempt May10
Congratulating AMITA AGARWAL Roll No. 25256 For Securing 89 Marks in
MAFA One Of All India Highest In May 2009 CA Final Exam
Dimpy Jindal All India 1st Rank in CA-PCC & All India 7th Rank in
CA-CPT taking MAFA Classes From Aaditya Sir
Also Congratulating DHARMENDRA SINGHAL Roll No. 3186
For Securing 87 Marks
IAMNOWHERE
I AM NOWHERE
I AM NOW HERE
MAFA IS NOT TOUGH,ITS JUST THE APPROACH THAT MATTERS
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Yet Another Milestone Achieved By Aaditya Sir.Her Student
The Power Of Determination
Archana Jhunjhunwala
From The Desk Of Archana Jhunjhunwala...
I finally cleared my CA in Nov 2009 Exam scoring 71 Marks in MAFA.For me MAFA was always a
nightmare.My first CA Final Attempt was due in May2000 which i was unable to clear due to
MAFA.Then i got married but i always wanted to become CA.However MAFA was still a nightmare
for me.I was unable to recover from that.My husband supported me a lot and arranged lots of Books
and Notes relating to MAFA.But I was not confident.Finally i heard about Aaditya Sir and joined
him in June 2009.After taking classes from Sir ,the most important thing which i got is the
Confidence to crack the paper.He made Mafa very simple with his unique Concept Question
Approach.His main strength is his simplified notes,extensive coverage,giving proper balance to
both Concept & question,examination oriented.By taking classes I developed a special interest in
Finance.The subject which was once a nightmare for me became my strength.Now just because of
MAFA I am a CA .This is like a Dream come true.I dedicated this success to my husband,my children
and to one and only Aaditya Sir. Thank you sir from the bottom of my heart.
71 Marks In MAFA Roll No.40251
cleared her CA After 15 years of enrollment due to high score of
Mor e than 4000 year s ago in China, Confucius wr ote: "Our gr eatest glor y is not in never falling, but
in r ising ever y time we fall."
Always be solution-or iented i n your thi nki ng
"We all have dr eams. But in or der to make dr eams come into r eality, it takes an awful lot of
deter mi nation, dedication, self-discipline, and effor t."
--Aaditya Jain
There will be many times when you will want to quit, give up, and go back to doing something else,
but the one quality that will guarantee your success is the willingness to stick with it, to see it
through to the end -- to refuse to settle for anything less than your dream. The longer you hang in
there, the greater the chance that something will happen in your favor. No matter how hard it seems,
the longer you persist, the more likely your success will be.
From The Desk Of Aaditya Sir
IAMNOWHERE..........I AM NOWHERE........I AM NOW HERE
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Don't be afraid of opposition.
Remember that a kite rises against - not with - the wind.
Imagination is the highest kite that one can fly.
Live to Fly
CAs are on High Demand................Are You Ready
Its Time To Fullfill Your and Your Parents’s Dream
You were born with potential.
You were born with goodness and trust.
You were born with ideals and dreams.
You were born with greatness.
You were born with wings.
You are not meant for crawling, so don't.
You have wings.
Learn to use them and fly.
" Now is the time... if you want to make a difference in the
world, now is the time. Don't be fooled into thinking you
should wait until you are older or wiser or more secure
because it doesn't work that way. The wisdom will come.
The security will come. But first you must begin."
A second ago is gone, and a second from now might be. Now is all you've got. Go for it!
Your big opportunity may be right where you are now.
In the middle of every difficulty lies opportunity.
“The Gods cannot help those who do not seize opportunities”
" I would like to sign off with a prayer to the Almighty-"God! Give me the courage to do whatever is
possible,serenity to know what is not possible and the wisdom to know the difference"

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SFM
Strictly As Per New Syllabus
I
By

tHEORY Let There Be Light! bOOK In the World of Darkness,

“To be a star, you must shine your own light, follow your own path, and don't worry about the darkness, for that is when the stars shine brightest”

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Photo of prize distribution ceremony held On Sunday,the 18th January, 2009

ALL INDIA CA-TOPPER
The woods are lovely, dark and deep, But I have promises to keep, And miles to go before I sleep, And miles to go before I sleep

WISHING ALL MY STUDENTS TO Always aim high in life and proceed in the direction of realising your goals with total determination ''Firm determination and hard work is always rewarding,''

For Registration in CA Final:SFM/MAFA & IPCC/PCC-FMC:FM Delhi : Bright Professionals Pvt Ltd ,1st Floor,Lalita Park,Laxmi Nagar,Delhi-110092 Phone:47665555,9811136987,9811042458,9911442626 Kolkata : Aaditya Jain Academy(AJA),196B, 2nd floor,Chitaranjan Avenue,Opp:Nirmal Sarees Centre Pvt Ltd,Near:RamMandir,Between Girish Park Metro Station and M.G. Metro Station Phone :9339238834

Dream is not that what u see in Sleep, Dream is the thing which does'nt allow u to Sleep"

Rise,Awake and Stop Not Until The Goal Is Achieved

Kolkata-9339238834 Ph.Most Important New Course Theory Question Delhi-9911442626 . 9911442626 4 CA Aaditya Jain The Best CA Final MAFA/SFM List Of Most Important Selected New Course Theory Question The Best FM Faculty Of India Aaditya Jain Presented By Covering All Past Year New Course Question Paper CA Aaditya Jain Undisputed Name For MAFA/SFM Visiting Faculty Of ICAI WE ARE THE BEST Galib Auditorium.New Delhi.Oct 2009 MAFA/SFM Batch Its Time To Think Beyond 90+ In MAFA/SFM “It’s Time To Be Busy BECAUSE Today Will Be Yesterday Very Soon ” .

I will act now for now is all I have.It is notified that neither the Author nor the Seller will be responsible for any damage or loss of action to anyone. This book is primarily meant for private circulation and use by the students of class. Tomorrow is the day reserved for the labor of the lazy.error ordiscrepancy noted may be brought to our notice.No part of this book shall be reproduced or copied in any form or by any means (graphic. I will act now. in any manner. Success will not wait.Aunty (Mrs Sarla Devi Jain) I wish to express my great fullness to a large number of discerning students who offered valuable suggestions and for having spread word accross the student community their positive opinion about the book. -.or information retrieval system). With these words I can condition my mind to perform every action necessary for my success. This is the place.New Delhi. I am not a failure.perforated media or other information storage device. tape. Any The Best FM Faculty Of India mistake.Will Rogers "Luck has a Peculiar Habit of Favoring Those Who Don't Depend on it!!" . 2010 Published By: Bright Professional Pvt Ltd.or reproduced on any disk. If I delay.Sri Rani Sati Dadi . I will act now.The wide acceptance of the book in all parts of the country gives me boundless happiness and satisfaction.In spite of this errors may creep in.1st Floor. Love what you're doing. etc without the written permission of the author. 100/Third Edition : June. which shall be taken care off in the next edition. I will act now. everyday.distribution and promotion rights reserved with the Author Price: Rs. This is the time. It is suggested that to avoid any doubt the reader should cross-check all the facts. I am the person. until the words become as much a habit as my breathing. I will walk where failures fear to walk. Aaditya Jain Acknowledgements Dedicated to My Main Source Of Inspiration . it's just this simple: Know what you're doing. And believe in what you're doing.recording. each day. I will repeat these words again and again and again. including photocopying .Ph.taping. and the action which follows becomes as instinctive as the blinking of my eyelids.Laxmi Nagar. law and contents of the publication with the Institute’s publication or notifications. Phones: 47665555 [30 Lines] Every effort has been made to avoid errors or omissions in this publication.1/53. I will act now. I will repeat these words each hour.com © Exclusive publication. 9911442626 Covering 20 Marks 5 CA Aaditya Jain cafinalmafa@yahoo. electronic or mechanical. I will work when failures seek rest. -CA Aditya Jain If you want to be successful. Father ( Mr Bimal Kumar Jain). of any kind. Henceforth. Mother ( Mrs Sumitra Devi Jain)my Uncle (Mr.therefrom. Mool Chand Jain) . success will become wed to another and lost to me forever. I am not lazy. I will act now. Tomorrow is the day when the failure will succeed.

So be ready to face such situations Of India Murphy's Law " If anything can go wrong. D . "Life is not measured by the number of breaths we take.. Aaditya Jain The Best FM Faculty Believe me it’’ll work. 9911442626 6 CA Aaditya Jain From the desk of CA Aaditya Jain The Importance Of Patience In CA Career Sometimes in life there are situations which makes you to loose your patience.. AND YOU WILL TELL THEM YES.. but by the moments that take our breath away.. they will say you're the wrong height or the wrong weight or the wrong type to play this or be this or achieve this.There is no Other Teacher But Your Own Soul. When ever you encounter such situation just keep your head cool and try to get out of the atmosphere if posssible and afterwards just relax your mind by cracking a joke or by taking 14-15 long breathes in a single stroke. C .Follow the proper approach you will definitely succeed Ending in this high note said by late Dhiru Bhai Ambani " For Those Who Dare n Dream There is A Whole world to win " Jinke honslo mein udaan hoti hai wo aasmaan ki uchayion se nahi darte " I Welcome You as a Bright Future CA in This Amazing World of Finance " “In Every Man There is Something of Which I May Also Learn.Everything for the first time looks tough.You have to grow From Inside Out.. neither is losing.it will ". All your life they will tell you no." The only thing that will stop you from fulfilling your dreams is you Now You Can Also Dream Of Scoring Good Marks In MAFA/SFM "Targetting 90+ In Mafa/SFM" "All your life you are told the things you cannot do...... THEY WILL TELL YOU NO... B . The best way to react at these situation is not to react at all.. REMEMBER ." .. and in All That He is My Teacher” I Wish All My Students to Always Aim High in Life..was also tough for you one day Practice makes a man perfect.. Kolkata-9339238834 Ph.None Can Make You Spiritual. These situations are meant just to distract you from your goal.Most Important New Course Theory Question Delhi-9911442626 . A.." Winning isn't everything. Believe it or not a one minute involvement in such situation will take away your 2-5 hours of precious time or sometimes even more. a thousand times no.. until all the no's become meaningless.. quite firmly and very quickly.None Can Teach You. All your life they will say you're not good enough or strong enough or talented enough. but the only thing is doing your best.

1 What are the drawbacks of investments in Mutual Funds ? (4 Marks) QUESTION NO.Ph. QUESTION NO. how financial policy is linked to Strategic Management.then I acquire the ability to do it even if I didn't have it in the beginning. 4 Marks QUESTION NO.com [Name. 9911442626 Covering 20 Marks 7 CA Aaditya Jain cafinalmafa@yahoo. 2 What do you know about swaptions and their uses ? 4 Marks QUESTION NO. 1 List and briefly explain the main functions of an investment bank. 2 What is the impact of GDRs on Indian Capital Market? (4 Marks) (6 Marks) SFM-May 2010 Theory Questions [20 Marks] 4 Marks QUESTION NO. 4 marks 4 marks 4 Marks SFM-Nov 2010 & May 2011 Expected Marks in Theory Questions : 20 Marks-25Marks NOW YOU CAN ALSO JOIN SIR'S COMMUNITY ON FACEBOOK-NAME OF COMMUNITY : CA ADITYA JAIN SFM 90+ TARGET For Getting Last Time Important Suggestions Of Mafa/SFM Before Exams Please mail or SMS your following details at : By E-Mail:cafinalmafa@yahoo.com MAFA-May 2010 Theory Questions [18 Marks] QUESTION NO.City] By SMS:Delhi :9911442626 .Mobile No.But when I believe I can. 3 Write a short note on Debt Securitisation..-Mahatma Gandhi .E-mail Address. 2 How is a stock market index calculated? Indicate any two important market indices. 3 What are the reasons for stock index futures becoming more popular financial derivatives over stock futures segment in India ? 6 Marks QUESTION NO. (4×5=20 Marks) SFM-May 2009 Theory Questions No Theory Question was Asked In This Attempt SFM-Nov 2009 Theory Questions [10 marks] QUESTION NO. 1 What are the limitations of Credit Rating? QUESTION NO. 4 Write a short note on Exchange Traded Funds (ETFs) QUESTION NO. Kolkata:9339238834 If I Believe I cannot do something. 2 Write short notes on any four of the following : (a) Financial restructuring (b) Cross border leasing (c) Embedded derivatives (d) Arbitrage operations (e) Rolling settlement. QUESTION NO. 5 Explain briefly.Exam Due. 1 What is a depository ? Who are the major players of a depository system ?What advantage the depositorysystemoffertotheclearing member ? 4 Marks QUESTION NO.it makes me incapable of doing it. 4 What is the role of Financial Advisor in PSU? Aaditya Jain The Best FM Faculty Of India 4 Marks LIST OF ALL PAST YEARS NEW COURSE QUESTION PAPER [All questions are incorporated in this book] SFM-Nov 2008 Theory Questions [24 Marks] QUESTION NO.

2 Write a short note on the CAPITAL BUDGETING UNDER CAPITAL RATIONING ? Meaning : “Capital Rationing refers to a situation where a company cannot undertake all positive NPV projects it has identified because of shortage of capital ”.If N. (switching value of a variable is its value for which N.R. it is desirable to gather further information about the variable. not in fractions. (i) What happens to the Net Present Value if inflows are. of variations in the basic variables (One factor is valued at a time. Demerits: (1) Fail to provide leads .Under this though the funds can be arranged but firm itself impose restrictions on investment expenditure . NPV is also adjusted to the same fraction as cash outflows. think that there is a TOMORROW.) it may not shed light on the risk characteristics of the project.Some reasons can be : (i) Imperfections in capital markets (ii) Non-availability of market information (iii) Investor’s attitude (iv) Firm’s lack of credibility in market (v) High Flotation costs Internal Factors :Internal Capital Rationing arise due to the self-imposed restrictions imposed by management .) & N.V.Most Important New Course Theory Question Delhi-9911442626 .000? (ii) What will happen to NPV if the economic life of the project is only 3 years rather than expected 5 years? Importance : It directs the management to pay maximum attention towards the factor where minimum percentage of adverse change causes maximum adverse effect. (2) Estimate the range of variation and the most likely value of each of the basic underlying factors. (iii) Divisible Projects : These are the projects which can be accepted fully as well as in fractions. Reasons For Capital Rationing : External Factors : Under this the firm does not have funds & it also cannot raise them from financial markets.P. (Some other criterion of merit).1 Write a short note on the SENSITIVITY ANALYSIS:-(Also known as “What if” Analysis)? Meaning : Sensitivity Analysis enables managers to assess how responsive the NPV is to changes in the variables which are used to calculate it. (3) Study the effect of N.if sensitivity analysis presents a complicated set of switching values. life of project etc.P. (2) Shows how robust / vulnerable a project is to changes in underlying variables.V. Computation : Sensitivity of a variable is calculated by using following relation : Sensitivity (%) = Change/Base x 100 The Best FM Faculty Of India Procedure: (1) Set up relationship between the basic underlying factors (quantity sold.P.relationship. 80. some of which are : (i) By Way of Retained Earnings : A firm may put up a ceiling when it has been financing investment proposals only by way " Don't be upset or disappointed about something that happened. becomes 0.V. 50. QUESTION NO. and I.R. will it really matter 10 years from now?" " If you want to WIN. just think. think that there is no TOMORROW. 9911442626 8 CA Aaditya Jain The Following Theory Questions Are The List Of Most Important Theory Question Which Are Most Expected For Exams. say Rs. Thereafter ." .V. Kolkata-9339238834 Ph. is highly sensitive to changes in some variable. (iv) Indivisible Projects :These are the projects which can only be accepted fully.Students Who Wants To Cover Full Theory May Purchase Full Text Theory Book From Leading Book Stores. no Financial constraints. Some reasons can be : (i) not to take additional burden of debt funds (ii) laying down a specified minimum rate of return on each project (iii) No further Equity Issue to prevent dilution of control (iv) Divisional Budgets used to prevent any inefficiency or wastage of funds by them Different Situations of Capital Rationing : (i) Single Period Capital Rationing : Funds limitation is there only for one year. Ways of Resorting Capital Rationing : There are various ways of resorting to capital rationing. (3) Indicates the need for further work. (ii) Multi Period Capital Rationing : Funds limitaton is there in more than one years. holding other factors constant may not be very meaningful when underlying factors are likely to be inter-related.000 than the expected Rs. Example : Sensitivity Analysis answers questions like. (2) Study of impact of variation in one factor at a time. unit Sales Price.What sense does it make to consider the effect of variation in price when holding quantity (which is likely to be closely related to price) remains unchanged? Aaditya Jain QUESTION NO. If you LOSE.) Merits: (1) Forces management to identify underlying variables and their inter.P.

The day you're born is the day you start to die. 100% funding off-balance sheets financing. It involves relationships and tax implications more complex than the domestic lease. (v) choice of assets for cross border lease is different than domestic lease because those assets may find here attractive bargain which are internationally mobile . (iii) one or more lenders. have adequate residual value and enjoy undisputed title. depending on the structure. 4 Write a short note on Rolling Settlement ? (SFM Nov 2008) Meaning : A rolling settlement is that settlement cycle of the stock exchange. whereby management may introduce capital rationing by authorising a particular department to make investment only upto a specified limit. The debt is secured by among other things. Principal Players Of Cross Border Lease : The principal players are (i) one or more equity investors. This may result in accepting relatively less profitable investment proposals if full utilisation of budget is a primary consideration. 9911442626 Covering 20 Marks 9 CA Aaditya Jain cafinalmafa@yahoo. (ii) a special purpose vehicle formed to acquire and own the equipment and act as the lessor. etc. matching of expenditure with earnings from the assets. Cross-border leasing have been in practice as a means of financing infrastructure development in emerging nations – such as rail and air transport equipment. Cross-border leasing has been widely used in some European countries. Basic Prerequisites Of Cross Border Leasing : The basic prerequisites are relatively high tax rates in the lessor’s country. (iii) By Making Full Utilization of Budget as Primary Consideration : In Capital Rationing it may also be more desirable to accept several small investment proposals than a few large investment proposals so that there may be full utilisation of budgeted amount. and assets incorporated into power generation and distribution systems and other projects that have predictable revenue streams. 3 Write a short note on The Best FM Faculty Of India Cross Border Leasing ? (SFM Nov 2008) Meaning : In case of cross-border or international lease. Aaditya Jain QUESTION NO. and never let the flame in your heart burn out. the following are the more crucial aspects which are required to be looked into: (i) appropriate currency requirements can be met easily to match the specific cash flow needs of the lessee.maintenance and insurance. equipment. (iii) maximum tax benefits in one or more regions could be gained by structuring the lease in a convenient fashion. (iii) In some countries. Objective Of Cross Border Leasing :A major objective of cross-border leases is to reduce the overall cost of financing through utilization by the lessor of tax depreciation allowances to reduce its taxable income. so make every day count. Thus Capital Rationing does not always lead to optimum results. Because the lease transaction takes place between parties of two or more countries. where all trades outstanding at end of the day have to settled. Benefits Of Cross Border Leasing : Cross border lease benefits are more or less the same as are available in domestic lease viz." .com of retained earnings (ploughing back of profits). Since the amount of capital expenditure in that situation cannot exceed the amount of retained earnings. it is said to be an example of capital rationing. (iv) tax benefits can be shared by the lessee or lessor accordingly by pricing the lease in the most beneficial way to the parties. " Always follow your dreams. the usual tax benefits on leasing.Ph. (ii) Also. Every new day bring new light and hope. beyond which the investment decisions are to be taken by higher-ups. liberal depreciation rules and either very flexible or very formalistic rules governing tax ownership. (iv) Leasing provides the lessee with 100% financing. The lease itself is a “triple-net lease” under which the lessee is responsible for all costs of operation. a mortgage on the equipment and by an assignment of the right to receive payments under the lease. The tax savings are passed through to the lessee as a lower cost of finance.Other important objectives of cross border leasing include the following : (i) The lessor is often able to utilize nonrecourse debt to finance a substantial portion of the equipment cost. in some countries the lessor can utilize very favourable “leveraged lease” financial accounting treatment for the overall transacftion. (ii) funding for long period and at fixed rate which may not be available in the lessee home market may be obtained internationally. telephone and telecommunications. and (iv) the lessee. it is called cross-border lease. the lessor and the lessee are situated in two different countries. QUESTION NO. to arbitrage the difference in the tax laws of different countries. which means that the buyer has to make payments for securities purchased and seller has to deliver the securities sold. In addition to these benefits. it is easier for a lessor to repossess the leased equipment following a lessee default because the lessor is an owner and not a mere secured lender. (ii) By Way of Responsibility Accounting : Capital Rationing may also be introduced by following the concept of ‘responsibility accounting’.

(v) Investors are able to borrow freely at a risk less rate of interest i. rolling settlement reduces delays. Under CAPM. (ii) No Dividend Company : It is useful in computing the cost of equity of a company which does not declare dividend. Assumption Of CAPM : The CAPM is based on following eight assumptions : (i) Efficient Market : It is the first assumption of CAPM. being holidays are again excluded for the T+2 count). For instance. implying that the outstanding positions at the end of the day ‘T’ are compulsorily settled 2 days after the trade date. Advantages of CAPM : The advantages of CAPM can be listed as: (i) Risk Adjusted Return : It provides a reasonable basis for estimating the required return on an investment which has risk in built into it. In an efficient market. The model explain the relationship between the expected return. QUESTION NO.The rolling settlement prevailing in India is T+2. markets being volatile it varies over time period. (b) Other Risks : By emphasing only on systematic risk it ignores unsystematic risks. commissions or taxes and without any transaction cost.” –Jim Rohn . (iv) CAPM assumes that all assets are divisible and liquid assets. This also reduces the tendency for price trends to get exaggerated. (c) Information Available : It is extremely difficult to obtain important information on risk free interest rate and expected return on market portfolio as there is multiple risk free rates for one while for another. investors benefit from increased liquidity. It may not be possible to determine the cost of equity of all firms using CAPM. Let others argue over small things. (iii) Risk aversion in efficient market is adhered to although at times risk seeking behaviour is adopted for gains. (c) Rolling settlements provide for a higher degree of safety. Hence it can be used as Risk Adjusted Discount Rate in Capital Budgeting. Security Market Line :A graphical representation of CAPM is the Security Market Line.Unsystematic Risks are also important to share holders who do not possess a diversified portfolio. 9911442626 10 CA Aaditya Jain Example : Suppose if we have T+2 settlement cycle it means that a transaction entered into on Day 1 has to be settled on the Day 1+2 working days. Stocks purchased/sold on Jan 4 should be settled on Jan 8 (Note that Sat & Sun. investors not only get a better price but can also act at their leisure Indian Scenario :Rolling settlement was first introduced in India by OTCEI. (vii) Securities or capital assets face no bankruptcy or insolvency.e.Risk Free Rate) CAPM only takes into account Systematic Risk. International Scenario : Internationally. but not you. the expected return from a Security can be expressed as : Expected Return = Risk Free Rate + Beta of a Security (Market Return . most developed countries follow the rolling settlement system.Most Important New Course Theory Question Delhi-9911442626 . both the US and the UK follow a rolling settlement (T+3) system. 6 Write a short note on EMBEDDED DERIVATIVES ? (SFM Nov 2008) “Let others lead small lives. All shortcomings that apply to Beta value applies to CAPM too. but not you. but not you. Benefits of Rolling Settlement : (a) In rolling settlements. but not you. the price of individual assets will reflect a real or intrinsic value of a share as the market prices will adjust quickly to any new situation. payments are quicker than in weekly settlements. (b) It keeps cash and forward markets separate. borrowings can fetch equal return by investing in safe Government securities. Aaditya Jain The Best FM Faculty Of India QUESTION NO. 5 Write a short note on CAPM? OR Write a short note on Assumptions of CAPM? The Capital Assets Pricing Model was developed by Sharpe Mossin and Linter in 1960. Limitations of CAPM (a) Reliability of Beta : Statistically reliable Beta might not exist for shares of many firms. (SML). Let others leave their future in someone else’s hands. Kolkata-9339238834 Ph. Thus. For example Jan 1 Jan 2 Jan 3 Jan 4 Jan 5 Jan 6 Jan 7 Jan 8 Mon Tue Wed Thu Fri Sat Sun Mon Stocks purchased/sold on Jan 1 should be settled on Jan 3. (ii) Rational Investment Goals : Investors desire higher return for any acceptable level of risk or the lowest risk for any desired level of return. (vi) Securities can be exchanged without payment of brokerage.Hence. while the German stock exchanges follow a (T+2) settlement cycle.(d) From an investor's perspective. Let others cry over small hurts. Efficient market refers to the existence of competitive market where financial securities and capital assets are bought and sold with full information of risk and return available to all participants. The CAPM is an economic model that describe how securities are priced in the market place. non-diversifiable risk and the valuation of security.

Examples of embedded derivatives that need not be separated • A derivative embedded in a host lease contract is closely related to the host contract if the embedded derivative comprises contingent rentals based on related sales. and the pricing formula is the embedded derivative. Conversely. How They Arise : An embedded derivative can arise from deliberate financial engineering and intentional shifting of certain risks between parties. Not closely related. Examples Closely related. it is because we do not dare that things are difficult. is described as the host contract. (ii)A separate instrument with the same terms as the embedded derivative would meet the definition of a derivative. Not Closely Related Closely Related Enquity conversion or ‘put’ option in dept intrument Interest-rate swap embedded in a debt instrument Fixed -rate debt extension option Inflation-indexed lease contracts Dept security with interest or principal linked to commodity or Cap and floor in a sale and purchase contracts " To be where you've never been before. an embedded derivative that changes the nature of the risks of a contract is not closely related. The host contract might be a debt or equity instrument.Examples of embedded derivatives that must be separated • Equity conversion feature embedded in a debt instrument e. investment in convertible bonds. The coal purchase contract. The pricing formula is an embedded derivative because it changes the price risk from the coal price to the electricity price.com Meaning : An embedded derivative is a derivative instrument that is embedded in another contract . Even purchase and sale contracts that qualify for executory contract treatment may contain embedded derivatives. • Option to extend the term of a debt instrument unless there is a concurrent adjustment of the interest rate to reflect market prices. a lease. When must embedded derivatives be accounted for? An embedded derivative is split from the host contract and accounted The Best FM Faculty Of India for separately if: (i)Its economics are not ‘closely related’ to those of the host contract. 9911442626 Covering 20 Marks 11 CA Aaditya Jain cafinalmafa@yahoo. . • An inflation index term in a debt instrument as long as it is not leveraged and relates to the inflation index in the economic environment in which the instrument is denominated or issued. Many embedded derivatives. however. an insurance contract or a sale or purchase contract. Aaditya Jain Closely Related & Not Closely Related : An embedded derivative that modifies an instrument’s inherent risk (such as a fixed to floating interest rate swap) would be considered closely related. arise inadvertently through market practices and common contracting arrangements." It is not because things are difficult that we do not dare. and (iii)The entire contract is not carried at fair value through profit or loss. Other Examples : The table below provides further examples of embedded derivatives that are closely related and those that are not. You have to do what you've never done before. Illustration : A coal purchase contract may include a clause that links the price of the coal to a pricing formula based on the prevailing electricity price or a related index at the date of delivery.Ph.the host contract.g. which qualifies for the executory contract exemption.

and The Best FM Faculty Of India (b) Systematic risk that cannot be diversified out through investment in domestic securities. which involves the selling of debt or equity to private investors. Role Of Investment Banker : The investment banker’s work involved in a private placement is quite similar to sell-side M&A representation. Inflation . Difference Between Private Placements & Public Offerings : A private placement differs little from a public offering aside from the fact that a private placement involves a firm selling stock or equity to private investors rather than to public investors. the research & development expert of company leaves. a typical private placement deal is smaller than a public issue. . Investment banks draft a detailed Private Placement Memorandum (PPM) which divulges information similar to a prospectus.is fundamentally the same as a public offering. Political Development . nor do they involve a roadshow.Think of it. They can be controlled by the management of entity. Unsystematic Risk are also called Diversifiable Risk as they can be eliminated through Diversification. dont think that he is punishing you . Systematic Risk or Non-Diversiable Risk or Market Risk This risk affects all companies operating in the market. Example : Strikes. a formidable competitor enters the market. One difference is that private placements do not require any securities to be registered with the Stock Exchange. or (3) currency commonly used in economic environment in which the transaction takes place.to raise capital . helping to convince the investor of the value of the When God takes away something from your hands . Aaditya Jain QUESTION NO.Investment bankers function as negotiators for the company. He is just leaving you empty handed to receive something better. Taxation. Example : Interest Rate. Systematic Risk is also called non-diversiable risk as it cannot be reduced with the help of diversification. Credit Policy. change in management. the company loses a big contract in a bid etc .Most Important New Course Theory Question Delhi-9911442626 . 7 Write a short note on Systematic and Unsystematic Risk? Total Risk = Systematic Risk + Unsystematic Risk A portfolio of asset possesses two types of risk : (a) Unsystematic risk that can be diversified out.In place of the prospectus. Despite these differences. Unsystematic Risk or Diversiable Risk or Specific Risk This risk affects only a particular security / company . The bankers attempt to find a buyer by writing the PPM and then contacting potential strategic or financial buyers of the client. Also. 9911442626 12 CA Aaditya Jain Prepayment option in the mortgage where the option’s exercise price is approximately equal to the the mortgage’s amortised cost on each exercise date A forward foreign exchange contract that results in payments in either party’s reporting currency Dual currency bonds Foreign currency denominated debt equity prices Credit derivatives embedded in the host debt instrument Sale or purchese not in (1) measurement currency of either party (2) currency in which products are routinely denominated in international commerce. special export order. Kolkata-9339238834 Ph. QUESTION NO. They are beyond the control by the management of entity. 8 Write a short note on Private Placement ? Meaning : A private placement. firms wishing to go public may be advised by investment bankers to first do a private placement. as they need to gain critical mass or size to justify an IPO. resembles both a public offering and a merger. They are usually the province of small companies aiming ultimately to go public . the primary reason for a private placement . Often.

Issuers or company 2.Stock brokers 6. process control and output control being parts of computerized environment apply equally Don't fear failure so much that you refuse to try new things. allotment of shares and the stock exchange requirements relating to contents of the prospectus and its advertisement. Advantage : (i) It is helpful to issue small amount of funds. Securities held in electronic form can be locked in and frozen from either a sale or purchase for any definite period. consolidation. 7. Transfer of securities is effected immediately 3. Public issues involves a number of requirements to be fulfilled and thus requires a lot of time to raise capital. 9. 9 What is a depository ? Who are. delivery is to be sent to company (6) No need to send the document to the for Registration company for Registration. Stamp duty for transfer is eliminated and transaction costs are reduced 4. say less (iii) It take less time to raise funds through private FM Faculty Of India than 3 months. Routine changes viz. split or merger is credited without much difficulty. The saddest summary of a life contains three descriptions: could have. . (iv) This method is generally adopted by small companies with unsatisfactory financial performances. Sale of shares to few selected investors:Private placement involves the sale of shares(or other securities)by a company to few selected investors.com firm. Systemic failure – Input control. All securities in the depositories are identical in all respects and are thus fungible. Depository Participants 4. By a reverse process. Once the pledgee confirms the request of the investor the depository takes action and the pledge is in place.no charges other than brokerage are levied(5) Sales transactions are also charged (6) For buy transaction. Physical Vis-a-Vis Dematerialised Share Trading Physical Dematerialised (1) Actual Delivery of Share is to be exchanged (1) No Actual Delivery of shares is needed (2) Open Delivery can be kept (2) Not possible to keep delivery open (3) Processing time is long (3) Processing time is less (4) Stamp Charges @ 0. fake securities and delays in transfers are eliminated. settlement of trades in electronic segment.Investors Pros And Cons Of Depository Services:The major benefits accruing to investors and other market players are as follows : 1. Securities are held in a safe and convenient manner 2.The system results in instant transfer as compared to six to eight weeks time under physical mode. Securities held in electronic form can also be pledged for any credit facility. There is a cost cutting on account of underwriting commission.Ph. There are however risks as well 1. Usually they are a fixed percentage of the size of the transaction. Aaditya Jain QUESTION NO. Both the lender (pledge) and the investorborrower (pledgor) are required to have a depository account.Clearing corporations 7. issue costs are very high which can be avoided through private placement. 8. the pledge can be released once the pledge confirms receipt of funds. 10. Bad deliveries. The Best placement. In the case of public issue of securities. 6.Life Insurance Corporation of India etc.the major players of a depository system ?What advantage the depository system offer to the clearing member ? (May 2010) 4 Marks The term ‘Depository’ means a place where something is deposited for safe keeping. Payment of dividends and interest is fast by the use of electronic clearing system. Clearing members 5. change in address of one person owning securities issued by different companies can be taken care of simultaneously for all securities with little delay. and should have. Paper work is minimized 5. Issuer Registrar 3. Benefit accruing from issue of bonus shares. expense relating to applications.particularly the institutional investors like the Unit Trust of India. Depository system is concerned with conversion of securities from physical to electronic form. 9911442626 Covering 20 Marks 13 CA Aaditya Jain cafinalmafa@yahoo. (ii) It is less expensive.5%(approx) are levied for transfer (4) No Stamp Charges are required for transfer (5) For sales transaction. Fees involved in private placements work are like those in public offerings. might have.  Major players of a depository system: The Depository System consists of the following constituents to serve the beneficial owners through1. electronic transfer of ownership of shares and electronic custody of securities.

e. (9) Highly Regulated:Mutual Funds all over the world are highly regulated and in India all Mutual Funds are registered with SEBI and are strictly regulated as per the Mutual Fund Regulations which provide excellent investor protection. investors always get higher returns in Mutual Funds as compared to other avenues of investment. 2. What is "Faith" ? Once all the people of a village decided to pray for rain and assembled in a temple. Such costs reduce the return from mutual fund. The fees paid to the Asset Management Company is in no way related to performance. Kolkata-9339238834 Ph. Companies will invariably need to maintain records on a continuous basis for securities held in physical form.On the day of prayer all the people gathered but only one boy came with umnbrella. 4. Unlawful transfers by individuals against whom insolvency proceedings are pending or transfers by attorney holders with specific or limited powers are possible. Additional record keeping – In built provisions for rematerialization exist to take care of the needs of individuals who wish to hold securities in physical form. (b) A mutual fund may perform better than the stock market but this does not necessarily lead to a gain for the investor. 3. There may be some who may under perform the benchmark index i. one has to pay for entry load and when leaving he has to pay for exit load. intentional or otherwise. (3) Convenient Administration: There are no administrative risks of share transfer. 11 What are the limitations/drawbacks of investing in Mutual Fund? (RTP.The Management Fees charged by the Fund reduces the return available to the investors. QUESTION NO. investors have to deal not only with brokers but also with depository participant which acts as an additional tier in the series of intermediaries. (8) Other Benefits: Mutual Funds provide regular withdrawal and systematic investment plans according to the need of the investors. Periodical reconciliation between demat segment and physical segment is very much necessary. liquidity is provided by direct sales / repurchase by the Mutual Fund and in case of close ended funds. The NAVs are calculated on a daily basis in case of open ended funds and are now published through AMFI in the newspapers. Human Fraud – Dematerialization is not a remedy for all ills. In case of mutual funds. as many of the Mutual Funds offer services in a demat form which save investor’s time and delay. (4) Higher Returns: Over a medium to long-term investment. (2) Diversification – Diversification may minimize risk but does not guarantee higher return.industry and company analysis.5% maximum and any extra cost of management is to be borne by the AMC. But past cannot predict the future.Unforeseen failures. past performance is the only criteria to fall back upon. the liquidity is provided by listing the units on the Stock Exchange. (5) Low Cost of Management: No Mutual Fund can increase the cost beyond prescribed limits of 2.Thats Faith . Cost of Depository Participant (DP) – For transacting business. many Mutual Funds disclose this on a quarterly or monthly basis to their investors. Mutual Fund investment may depreciate in value. QUESTION NO. (4) Cost Factor/ High Management Fee – Mutual Funds carry a price tag. (7) Transparency: The SEBI Regulations now compel all the Mutual Funds to disclose their portfolios on a half-yearly basis. For stocks. The investors can also switch from one scheme to another without any load. But they will not do so if the principal is eroded. A one time fee is levied by the depository participant which small investors consider to be an avoidable cost. could lead to chaos.Most Important New Course Theory Question Delhi-9911442626 . it may not even perform well as a beginner who invests in the stocks constituting the index. While investing. . (2) Diversification: Mutual Funds offer diversification in portfolio which reduces the risk. 9911442626 14 CA Aaditya Jain to the dematerialization process. However. 10 Write a short note on Advantages Of Mutual Fund ? The Best FM Faculty Of India Aaditya Jain (1) Professional Management: The funds are managed by skilled and professionally experienced managers with a back up of a Research team. (c) Investors may forgive if the return is not adequate. The market may have risen and the mutual fund scheme increased in value but the investor would have got the same increase had he invested in risk free investments than in mutual fund. (3) Selection of Proper Fund – It may be easier to select the right share rather than the right fund. on the part of the individuals entrusted with protecting data integrity. Fund Managers are the highest paid executives. (6) Liquidity: In all the open ended funds.Nov 2009) (1) No guarantee of Return – There are three issues involved : (a) All Mutual Funds cannot be winners. one can base his selection on the parameters of economic.

A lower Expense Ratio will give a higher return which is better for an investor. It helps to identify the risk levels in which the mutual fund operates. The higher the NAV. at times. diversion of Mutual Fund amounts by Mutual Funds to their sister concerns for making gains for them. investment in mutual fund falls significantly in value whereas in a bearish market. subject to lock in period.Bad days give you Experience . 9911442626 Covering 20 Marks 15 CA Aaditya Jain cafinalmafa@yahoo. (4) When the investor changes his objective of investing in a mutual fund which no longer is beneficial to him.g. So it is better to remain with medium sized funds. the composition of the portfolio has changed to a growth fund mode which is not in tune with the investor’s risk preferences. The turns in the market need to be observed. (6) Others-Mutual Funds systems do not maintain the kind of transparency they should maintain -Many MF scheme are. deny the market drawn benefits -At times. Start everyday with a smile.Ph. ETFs invest in a basket of stocks and try to replicate a stock market index such as the S&P CNX Nifty or BSE Sensex Advantage : Never blame a day in your life. (7) Expense Ratio – SEBI has laid down the upper ceiling for Expense Ratio.An Exchange Traded Fund (ETF) is a hybrid product that combines the features of an index fund. A simple average of the portfolio turnover ratio of peer group updated by mutual fund tracking agencies may serve as a benchmark. (5) When the fund manager.14 Write short note on‘Exchange Traded Funds’ ? (May 2010) Meaning : Exchange-Traded Funds (ETFs) are mutual fund schemes that are listed and traded on exchanges like any other stocks. the better it is. therefore.13 Write short note on‘Signals Highlighting The Exit Of The Investor From The Mutual Fund Scheme’ (1) When the mutual fund consistently under performs the broad based index. (8) PE Ratio – The ratio indicates the weighted average PE Ratio of the stocks that constitute the fund portfolio with weights being given to the market value of holdings. (9) Portfolio Turnover – The fund manager decides as to when he should enter or quit the market. it is the other way round where it registers growth. In a bullish market. Aaditya Jain QUESTION NO.A person of repute gives confidence to the investors. the investments are subject to different kind of hidden costs.There may be unethical practices e. A high ratio. A very low portfolio turnover indicates that he is neither entering nor quitting the market very frequently.Good days give you " Happiness ". . it is high time that it should get out of the scheme. is not easy QUESTION NO. has been replaced by a new entrant whose image is not known. if any . instead of providing a regular income to the investor. -Redressal of grievances. QUESTION NO. falling and steady markets have to be checked. (3) When the mutual fund changes its objectives e.com (5) Unethical Practices – Mutual Funds may not play a fair game. (3) Size of Fund – Managing a small sized fund and managing a large sized fund is not the same as it is not dependent on the product of numbers. (4) Age of Fund – Longevity of the fund in business needs to be determined and its performance in rising. handling the mutual fund schemes. (2) Timing – The timing when the mutual fund is raising money from the market is vital.g. (6) Fund Manager – One should have an idea of the person handling the fund management. In such a case. Purchase through large sized fund may by itself push prices up while sale may push prices down. as large funds get squeezed both ways.Both are essential in life. Growth = (NAV1 – NAV0 ) + D1 / NAV0. (2) When the mutual fund consistently under performs its peer group instead of it being at the top. it would have to pay to get out of the scheme and then invest in the winning schemes. may suggest that too frequent moves have lead the fund manager to miss out on the next big wave of investments. 12 Write short note on ‘Factors Influencing the selection of Mutual Fund ’? The Best FM Faculty Of India (1) Past Performance – The Net Asset Value is the yardstick for evaluating a Mutual Fund. Performance is based on the growth of NAV during the referral period after taking into consideration Dividend paid. on the other hand. It would be better to invest in the index itself either by investing in the constituents of the index or by buying into an index fund. (5) Largest Holding – It is important to note where the largest holdings in mutual fund have been invested.

.There is no paper work involved for investing in an ETF. 3.low cost and the flexibility that Exchange Traded Funds offer makes these instruments one of the most useful innovations and attractive pieces of financial engineering to date.By owning an ETF. If investors feel a turnaround is around the corner. The funds thus collected are passed on to the Asset Management Company for investment. I SHARES based on MSCI indices and TRAHK (Tracks) based on the Hand . (1) Custodian : A custodian is a person who has been granted a Certificate of Registration to conduct the business of custodial services under the SEBI (Custodian of Securities) Regulations 1996. (5) Mutual Fund: A mutual fund established under the Indian Trust Act to raise money through the sale of units to the public for investing in the capital market. Maintenance of accounts of clients’ securities together with the collection of benefits / rights accruing to a client falls within the purview of custodial service. The average daily trading volume in QQQ is around 89 million shares. The trustee holds the property of the mutual fund in trust for the benefit of unit holders and looks into the legal requirements of operating and functioning of the mutual fund. the volumes took off with a vengeance. The business is set up by the sponsor. Indian Scenario: The following Exchange Traded Funds (ETFs) are being presently traded at National Stock Exchange of India: The Best FM Faculty Of India • S&P CNX Nifty UTI Notional Depository Receipts Scheme • Liquid Benchmark Exchange Traded Scheme (Liquid BeES) • Junior Nifty BeES • Nifty BeES • Bank BeES History :They first came into existence in the USA in 1993. Aaditya Jain QUESTION NO.The most popular are QQQs (Cubes) based on the Nasdaq-100 Index. 2. The mutual fund has to be registered with SEBI. It took several years for their public interest.But make you cry when you remember the time u laughed . 5. These can be bought like any other stock by just placing an order with a broker. They also record transfer of units between investors where depository does not function. (2) Asset Management Company:An entity registered under the Companies Act to manage the money invested in the mutual fund and to operate the schemes of the mutual fund as per regulations. Kolkata-9339238834 Ph. however. Mutual funds require custodians so that AMC can concentrate on areas such as investment and management of money. SPDRs (Spiders) based on the Index. (4) Unit Holder: A person/entity holding an undivided share in the assets of a mutual fund scheme. preparation of transfer documents and maintenance of updated investment records. they have the option of going short.. Over the years more than $ 120 billion (as on June 2002) is invested in about 230 ETFs on the American Stock Exchange . the money invested by the asset management company and the operations monitored by the trustee. The three market intermediaries are:(1) Custodian (2) Transfer Agents (3) Depository. Memories play a very confusing role. buy on margin and purchase as little as one share.Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund. If.They have very low operating and transaction costs . they can go long. since there are no loads required to purchase ETFs.A great reason to consider Exchange Traded Funds is that they simplify index and sector investing in a way that is easy to understand.The combination of the instant diversification. (2) Transfer Agents : A transfer agent is a person who has been granted a Certificate of Registration to conduct the business of transfer agent under SEBI (Registrars to an Issue and Share Transfer Agents) Regulations Act 1993.Most Important New Course Theory Question Delhi-9911442626 . you get the diversification of an index fund as well as the ability to sell short. Custodial services include safeguarding clients’ securities along with incidental services provided.The five constituents are : (1) Sponsor: A company established under the Companies Act forms a mutual fund. The trustee may also form a limited company under the Companies Act in some situations. 15 Write a short note on Key Players of Mutual Fund ? Mutual Fund is formed by a trust body.There are five principal constituents and three market intermediaries in the formation and functioning of mutual fund. 9911442626 16 CA Aaditya Jain 1.They make you laugh when u remember the time u cried. But once they did. they think ominous clouds will be over the market for some time. Transfer agents’ services include issue and redemption of mutual fund units. It carries the responsibility of investing and managing the investors’ money. (3) Trustee: The trust is headed by Board of Trustees. 4.

2. but the pockets change . the money being raised by the issuing company is in the form of a foreign currency. Disadvantages of FCCBs 1. upto one year . Aaditya Jain (vi)No. treasury bills.corporate investors. You have to put in many. brokers. It is regulated by the guidelines of SEBI. stock exchange. It is a well defined market where busi -ness is done e.g.registrars to issue. RBI and Government . many tiny efforts that nobody sees or appreciates before you achieve anything worthwhile Money is always there.It acts like a bond by making regular coupon and principal payments. e. It is regulated by the guidelines of RBI The participants in capital market are general investors. FCCBs are easily marketable as investors enjoys option of conversion into equity if resulting to capital appreciation. In other words. debentures etc.Flls & Bankers. Capital Market is classified between Primary Market and Secondary Market.According to DFHI only in call money market daily volume is Rs. a depository is body corporate who carries out the transfer of units to the unit holder in dematerialised form and maintain records thereof. FCCBs mean creation of more debt and a forex outgo in terms of interest which is in foreign exchange.These types of bonds are attractive to both investors and issuers. There is no sub-division in money market . 9911442626 Covering 20 Marks 17 CA Aaditya Jain cafinalmafa@yahoo. of instrument (vii)Participants The total value of transaction in money market far exceeds the capital market . 2.com (3) Depository : Under the Depositories 1996. QUESTION NO. 3.but these bonds also give the bondholder the option to convert the bond into stock. The convertible bond gives the investor the flexibility to convert the bond into equity at a price or redeem the bond at the end of a specified period.Ph.A convertible bond is a mix between a debt and equity instrument. Capital Market Capital markets deals in long term securi ties for a period beyond one year.commercial paper. Companies prefer bonds as it defers the dilution of equity and earnings per share .interbank It deals in short term financial assets e. Exchange Risk is more in FCCBs as interest on bonds would be payable in foreign currency. FCCB (Foreign Currency Convertible Bonds) A type of convertible bond issued in a currency different than the issuer’s domestic currency. etc. large forex earnings potential only opt for FCCBs. It is a not a well-defined market where business is done . merchant bankers. QUESTION NO. Advantages of FCCBs 1. underwrit ers. The participants in money market are Bankers. Thus companies with low debt equity ratios. normally three years if the price of the share has not met his expectations.(a) Interbank call money (b) Notice money upto 14 days (c) Short term deposits upto 3 months (d) 91 days treasury bill (e) 182 days treasury bill (f) Commercial paper etc.g. It deals in medium & long term financial assets e. Capital market lag behind the total value of transaction done in money market. 17 Write a short note on the following topics : A. Further investor is assured of a minimum fixed interest earnings . 6000 crores arround The number of instruments dealt in money market are various.g equity shares. 16 What is the difference between Capital Market and Money Market? Basics (i)Tenure (ii)Well defined place (iii)Short Term /Long Term (iv)Classification (v)Volume of business Money Market It is a market for lending and borrowing of short term funds.The investors receive the safety of guaranteed payments on the bond & are also able to take advantage of any large price appreciation in the company’s stock.xOf India call money. (viii)Liquidity (viii)Regulator The important features of money market instrument is that it is liquid. Whereas Capital market are not as liquid as money market instrument.Stein Gertrude . The number of instruments in capital market are shares and debentures. The Best FM Faculty .

Data compiled by news agency Bloomberg show total FCCB issuances for 2009-10 at $2.These are known as Qualified Institutional Buyers(QIBs) GDR are negotiable instruments issued to Overseas Depository Bank on behalf of an Indian Company to raise funds abroad. denominated in US dollars. (viii) It has now become necessary for Indian capital market to adopt international practices in its working including financial innovations. accessibility to vast amount of resources was available to the domestic corporate sector. 9911442626 18 CA Aaditya Jain 3. Since many Indian companies are actively trading on the London and the New York Exchanges and due to the existence of time differences. (v) A considerable amount of foreign investment has found its way in the Indian market which has improved liquidity in the capital market. Sterlite Industries and Larsen and Toubro were a few big issuers who took the FCCB route. Global depository receipts are basically negotiable certificates denominated in US dollars. Companies in India. GDRs were the most important source of finance from abroad at competitive cost. B. but much lower than the 2007-08 number of $5. Tata Motors. Among others.6 billion. have been able to tap global equity market to raise foreign currency funds by way of equity.Rule 144A of permits companies from outside USA to offer their GDRs to certain institutional buyers. at times the prices of the depository receipts are traded at discounts or premiums to the underlying stock. Tata Power. Kolkata-9339238834 Ph. The mechanics of a GDR issue may be described with the help of following diagram. a big jump compared with the measly $24 million in 2008-09.Benjamin Franklin Three tough words : Sacrifice. This puts additional strain on the investors as they now need to keep updated with worldwide economic events. sentiments etc. It was one of the biggest FCCBs from India. through the issue of depository receipts. This presents an arbitrage opportunity wherein the receipts can be bought abroad and sold in India at a higher price. and Patience . (vi) Indian capital market has started to echo by world economic changes. market news.Nov 2009) A depository receipt is basically a negotiable certificate. Some of the changes are as follows: (i) Indian capital market to some extent is shifting from Bombay to Luxemburg and other foreign financial centres. India Inc is once again tapping the foreign currency convertible bonds (FCCBs) for funds with nearly $3 billion in fresh issues in 2010 as against next to nothing. Jaiprakash Power Ventures. (iv) Indian retail investors are completely sidelined. Company issues  Ordinary shares  Kept with Custodian/depository banks  against which GDRs are issued  to Foreign investors Impact of GDRs on Indian Capital Market :After the globalization of the Indian economy. Discipline. There is exchange risk on the interest payment as well as re-payment if the bonds are not converted into equity shares. (vii) Indian capital market has not only been widened but deepened as well. Aaditya Jain A penny saved is a penny earned .Since the inception of GDRs. One such accessibility was in terms of raising financial resources abroad by internationally prudent companies. that represent a nonUS company’s publicly traded local currency (Indian rupee) equity shares. Conversion prices are now being set closer to the current market prices and the bonds also carry higher interest rates than earlier. Due to the placements of GDRs with Foreign Institutional Investor’s on the basis free pricing. a remarkable change in Indian capital market has been observed. Sesa Goa. (iii) Indian capital market is no longer independent from the rest of the world. a year ago. (ii) There is arbitrage possibility in GDR issues. that represents a non US company’s publicly . Markets of GDR’S (i) GDR’s are sold primarily to institutional investors. good or bad. GDR (Global Depository Receipts) or Impact of GDRs on Indian Capital Market (SFM.With the stock market bouncing back. the retail investors can now no longer expect to make easy money on heavily discounted right/public issues.88 billion.However.Most Important New Course Theory Question Delhi-9911442626 .traded local currency (Indian rupee) The Best FM Faculty Of Indiathe Securities and Exchange Commission of USA equity shares. buyers of these bonds seem to be treading much more cautiously than they did last time. Recent Example : In the first quarter of 2007 Reliance Communications company raised $1 billion FCCB.

The Best FM Faculty Of India Characteristics (i) Holders of GDRs participate in the economic benefits of being ordinary shareholders though they do not have voting rights. Aaditya Jain C. (iii) GDRs are listed on the Luxemberg stock exchange. The custodian bank informs the depository in the United States that the ADRs can be issued. South East Asia (Hong kong. For the issuing company.becoming the third company from the Tata Empire. Advantages of GDRs : (a)The issuer has the benefit of collecting the issue proceeds in foreign currency which may be utilized for meeting the foreign exchange component of the project cost. Statutory Compliance : Such receipts have to be issued in accordance with the provisions stipulated by the Securities and Exchange Commission of USA (SEC) which are very stringent. as the shares represented by GDR are expressed in rupees.repayment of foreign currency / loan etc. Indian Example :Among the Indian companies. (iii) Fixed income investors who wish to enhance returns.The pictorial representation of the process is given below : Indian Company Securities & Dividend Domestic Depository Bank  Overseas Depository Bank  Overseas Investor Types of ADRs : There are three types of ADRs: Unsponsored ADRs are issued without any formal agreement between the issuing company and the depository.com (ii) Demand is likely to be dominated by emerging market funds. (ii) GDRs are settled through CEDEL & Euro-clear international book entry systems. and the customer is satisfied”. (iii) Switching by foreign institutional investors from ordinary shares into GDRs is likely. (c)GDR does not entitle the holder to any voting rights.Reliance Industries Ltd. (iv) Trading takes place between professional market makers on an OTC (over the counter) basis. and to some extent continental Europe (principally France and Switzerland) .Regulations include requirement such as minimum size of issue. (d)GDR does not involve any foreign exchange risk to the issuing company . (b)It has been perceived that a GDR issue has been able to fetch higher prices from international investors than those that a domestic public issue would have been able to extract from Indian investors. they provide a relatively inexpensive method of accessing the United States capital markets (especially because they are also exempt from most of reporting require- Don’t open a shop unless you like to smile. 9911442626 Covering 20 Marks 19 CA Aaditya Jain cafinalmafa@yahoo. (i) Dedicated convertible investors (ii) Equity investors who wish to add holdings on reduced risk or who require income enhancement. USA.reporting to SEC. was the first company (1992) to raise funds through a GDR Issue. . ADRs are United States dollar denominated and are traded in the same way as are the securities of United States companies.In other words An American Depository Receipt (ADR) is a negotiable receipt which represents one or more depository shares held by a US custodian bank. which in turn represent underlying shares of non-issuer held by a custodian in the home country.Recently Tata Motors on 9th Oct 2009 raised $375 million through a GDR issue. Mechanism for ADR issue : An ADR is generally created by the deposit of the securities of a non-United States company with a custodian bank in the country of incorporation of the issuing company. although the issuing company must consent to the creation of the ADR facility. And Remember that “No Sale is really complete until the product is worn out.so there is no fear of loss of management and control.Ph. (iv) Major demand is also in UK. (iv) Retail investors: Retail investment money normally managed by continental European banks which on an aggregate basis provide a significant base for Euro-convertible issues. Profile of GDR investors : The following parameters have been observed in regard to GDR investors. Amercian Depository Receipts Meaning : Depository receipts issued by a company in the United States of America (USA) is known as American Depository Receipts (ADRs).after Tata Steel and Tata Power. Singapore).adherence to US GAAP in reporting etc.

(5) Silverline. Types of ADRs Aaditya Jain Sponsored Unsponsored No formal arrangement exists between issuing company and the depository.The trading in ADR effectively means trading in underlying shares. There is no perfect life but we can fill it with perfect moments. II & III Documents used in ADRs A public offering of ADRs by a non US private issuer will require. Some elements of costs are borne by investor. (b) Exposure to international markets and hence stock prices in line with international trends. by way of private placements. (c) Means of raising capital abroad in foreign exchange. The three classes of Unrestricted ADRs are (i) Level 1 URADRs . they are exempt from reporting requirements of the Securities and Exchange Commission and are not even registered with it. (d) Use of foreign exchange proceeds for activities like overseas acquisitions. There are two broad types of sponsored ADRs Restricted ADRs (RADRs) These are restricted with respect to the type of buyer which is allowed and are privately placed.These are listed on two stock exchanges (i) NASDAQ (National Association of Securities Dealers Automatic Quotes) and (ii) New York Stock Exchange. Restricted ADR issues are sometimes issued by companies that seek to gain some visibility and perhaps experience in the United States capital markets before making an unrestricted issue. (f) No risk of foreign exchange fluctuations as the company will be paying the interest and dividends in Indian rupees to the domestic depository bank. As these are not issued to the general public. in general. (b) ADRs facilitates share transfers. but we live it the best way we can. Sponsored ADRs are created by a single depository which is appointed by the issuing company under rules provided in a deposit agreement. (4) VSNL. There are three classes of URADR. (3) MTNL. customers. the following documents :(a) Form F1 (b) Form F6 (c) Listing Application (d) Blue Sky Survey (e) Deposit Agreement (f) Custodian Agreement (g) Underwritting Agreement Example of Indian ADRs :Only few Indian companies have gone for ADRs so far. Unrestricted ADRs (URADRs) are issued to and traded by the general investing public in United States capital markets. (6) Dr. each increasingly demanding in terms of reporting requirements of the Securities and Exchange Commission. a relatively inexpensive method of raising capital Restricted to select investors. “ Life never seems to be the way we want it. They are allowed to be placed only among selected accredited investors and face restrictions on their resale. 9911442626 20 CA Aaditya Jain ments of the Securities and Exchange Commission). both have their head offices at New York. Kolkata-9339238834 Ph. (c)The transfer of ADRs does not involve any stamp duty. (2) Wipro. (e) Increased recognition internationally by bankers. (ii) Level II URADRs and (iii) Level III URADRs Benefit of ADR for US investors ADR is an attractive investment to US investors willing to invest in securities of non US The Best FM Faculty Of India issuers for following reasons (a) ADRs provide a means to US investors to trade the non US company’s shares in US dollars.Most Important New Course Theory Question Delhi-9911442626 . Exempt from the requirements of SEC Unrestricted All public Levels I. The transfer of ADRs automatically transfers the underlying share. ADRs are negotiable and can be easily transferred among the investors like any other negotiable instrument. Benefits of ADR Issue to Indian Company (a) Better corporate image both in India & abroad which is useful for strengthening the business operation in the overseas market. setting offices abroad & other capital expenditure.” . Reddy. For issuer. but also increasingly attractive in terms of degree of visibility provided.Some of which are (1) Infosys. (d)The dividends are paid to the holders of ADRs in US dollars. suppliers etc.

In an IDR.rate between currencies B and C.An arbitrageur makes money by buying an asset at low price in a market and selling it in any other market at a relatively higher price. What does it Mean to Restructure? The process can be thought of as two-fold: financial restructuring and organizational restructuring. Restructuring from a financial viewpoint involves renegotiating payment terms on debt obligations. Restructuring can take many forms. For instance. In this situation. to an Indian Depository (say National Security Depository Limited – NSDL). QUESTION NO. an arbitrage opportunity exists. (ii) Cross . foreign companies would issue shares. when it cannot meet its bond payments or its payments to other creditors (such as vendors) .” “You can employ men and hire hands to work for you. On the other hand.strategy and focus. Indian Depository Receipts(IDRs) IDR means any instrument in the form of depository receipt created by the domestic depository in India against the underlying equity shares of the issuing foreign company . an investor may gain by executing a spot and forward deal to buy and sell a currency. it can also restructure and remain in business. exchange rates for currencies A and B and for currencies A and C imply an exchange rate called a cross . Thus depending upon the nature of deal. a restructuring can involve a change in management. and restructuring payables to vendors.(iii) Corporate Restructuring Financial restructuring refers to a kind of internal changes made by the management in Assets and Liabilities of a company with “What lies behind us and what lies before us are tiny matters compared to what lies within us.It occurs when one currency sells for two prices in two different markets. which would in turn issue depository receipts to investors in India.for example. If the rate implied for C does not match the actual rate between C in some other market.com D. due to interest yield which can be earned at different exchanges.Rate Arbitrage . issuing new debt. of course. choose to simply shut down operations and walk away. the objective of which is to provide a platform to foreign firms to directly raise capital in India. Companies incorporated outside the country can now raise resources from the Indian capital market through the issue of Indian Depository Receipts (IDRs). Listing: These IDRs would be listed on stock exchanges in India and would be freely transferable. An IDR is a financial instrument similar to a Global Depository Receipt (GDR) and American Depository Receipt (ADR). arbitrage may be of space and time arbitrage. Some typical approaches to financial restructuring include: (i) Vertical Restructuring . 18 Write a short note on ARBITRAGE ? (SFM Nov 2008) Meaning : Arbitrage by definition is a financial transaction that makes an immediate profit without involving any risk. but you must win their hearts to have them work for you” .(ii) Horizontal Restructuring .Indian citizens will be able to easily improve their portfolio diversification as well as a chance to sample new companies that would otherwise not be available for investment. From an organizational viewpoint. The Best FM Faculty Of India Recent Example:Standard Chartered is planning to list its shares in India through an issue of Indian Depository Receipts (IDRs). sell it for $20 and make a profit of $15 that is arbitrage. 9911442626 Covering 20 Marks 21 CA Aaditya Jain cafinalmafa@yahoo. Types of Arbitrage (i) Geographical/Space Arbitrage .In time arbitrage. 19 Write a short note on Financial Restructurings ? (SFM Nov 2008) When a company cannot pay its cash obligations . For Indian investors. Benefits to Indian Investors: IDR is an additional investment opportunity for Indian investors for overseas investment. The $15 gain represents an arbitrage profit.In a given market. (iv) Covered Interest Arbitrage : This arbitrage occur when there is mismatch of interest rate between two countries .The UK bank had recently received an approval from the RBI for the issue. (ii) the difference. a company can. IDRs would provide a route to invest in foreign firms. Aaditya Jain QUESTION NO.Ph. The space arbitrage is because of separation of two exchange markets due to physical dispersion wherein the rates may vary while on the other hand in the time arbitrage an investor may gain by executing a spot and forward deal to buy and sell a currency. Arbitrage profits are the result of (i) the difference in exchange rates at two different exchange centres. (iii) Time Arbitrage . Arbitrage is a strategy to take advantage of price differential of a product in different markets. If one can buy an asset for $5.it goes bankrupt.

000 tonnes p.000 tonnes p.lenders and creditors etc. Consequent upon losses the share capital or networth of such companies get substantially eroded. creditors.leading to a change in the financing pattern.00.000 tonnes of ‘A’ thus aiming at 10% share of the market or 50% of unfulfilled demand. In nutshell it may be said that financial restructuring (also known as internal re-construction) is aimed at reducing the debt/ payment burden of the corporate firm. About 5% of petroleum by products are used as additives and these are subject to price fluctuations due to change in international prices. Market Leader & Competition : The market leader of this group of products has a share of 40% and rest of market is shared by a number of small manufacturers. To achieve this desired objective. Normally equity shareholders make maximum sacrifice by foregoing certain accrued benefits.Most Important New Course Theory Question Delhi-9911442626 . and other stake-holders viz. Making good. Ltd. In fact. (ii) Real worth of various properties/assets by revaluing them timely. Availability of Inputs: Raw Materials: Raw Materials constitute a major portion of the total cost of output. or making excuses.20 You have been asked by the Board of Directors of XYZ & Co. The Company proposes to introduce a new product ‘A’ in the paint Market at Delhi.This measures will lead to better financial liquidity. Kolkata-9339238834 Ph.000 tonnes p. Production . apartOf India The Best FM Faculty from reducing their claim. in some cases. The present study is an effort to see whether the project under consideration should be taken up or not. the accumulated losses are even more than the share capital and thus leading to negative networth.Write a Specimen Of Project Feasibility Report ? To The Board of Directors. “Hope cannot be taken from you.a. Aaditya Jain QUESTION NO. such firms needs to re-start with a fresh balance sheet free from losses and fictitious assets and shows share capital at its real true worth.20. financial restructuring is one of the technique to bring into health such firms who are having potential and promise for better financial performance in the years to come. XYZ & Co. COMMERCIAL VIABILITY (MARKET): Aim in Market Share : The in depth market study and research reveals the following facts: Total Demand of the product ‘A’ type . 70% of value added output cost is raw material.a. The foregone benefits may be in the form of new securities with lower coupon rates so as to reduce future liabilities.90.Such increases are passed on to the consumers in the shape of increased prices thereby keeping contribution margin in We are all manufacturers.000 tonnes p.a. (iii) utilizing profit accruing on account of appreciation of assets to write off accumulated losses and fictitious assets (such as preliminary expenses and cost of issue of shares and debentures) and creating provision for bad and doubtful debts. An attempt is made to do Refinancing and rescue financing while Restructuring. creditors. The financial restructuring leads to significant changes in the financial obligations and capital structure of corporate firm. The company proposes to manufacture 10. Potential Demand Gap . may also agree to convert their dues into securities to avert pressure of payment. This results into (i) Reduction/Waiver in the claims from various stakeholders. Installed Capacity .a. putting the firm on the verge of liquidation.To nurse back such firms a plan of restructuring need to be formulated involving a number of legal formalities (which includes consent of court. Thus company expects little competition from the market leader.). From: The Chief Finance Officer RE: IN DEPTH STUDY OF A PRODUCT ‘A’ BEING INTRODUCED IN THE MARKET PROPOSED. In order to revive such firms.lenders and shareholders etc.80. you must surrender it” . The sacrifice may be in the form of waving a part of the sum payable to various liability holders. making trouble. ownership and control and payment of various financial changes. 9911442626 22 CA Aaditya Jain the consent of its various stakeholders.1. The sacrifice may also lead to the conversion of debt into equity. This is a suitable mode of restructuring for corporate entities who have suffered from sizeable losses over a period of time. followed by preference shareholders and debenture holders. Sometime. In fact. to submit a project feasibility report on the introduction of a new product ‘A’ in the paint market as a Chief Finance Officer.. Ltd.

00 20.50 5.50 .259 (lakhs) in Present Value terms.00 65. 9911442626 Covering 20 Marks 23 CA Aaditya Jain cafinalmafa@yahoo. Blue Print:A plant layout.00 1.00 1.666 7 4.50 6. Years Repayment (Rs.com tact.00 (2) Retained Earnings 5.00 15.00 1.) Plant layout. (lakhs) (1) Equity Shares 5.50 5.8815 4 5.332 10 5.424 2. (lakhs) (1) Land & Building 5. transport facilities. it is presumed that complex technical know how is not required.50 . 2 (lakhs) and the expense has been considered very much necessary for the purpose.683 4.386 2.369 3 5. (Lakhs) Year Profit after Tax Depreciation Cash Flow PVF@10% PV 1 8.50 9.00_ 20.259 (lakhs) is available [Net Cash Flow – Capital Cost].00 (2) Plant & Machinery 6.909 8. New Factory/(Industrial Estate New Co. Storage Tanks:The cost that will incur if storage tanks are erected is estimated at Rs. Public health is thus not endangered.00 1. Repayment Schedule:A loan repayment schedule (Subject to negotiation) is being given herewith.00 1. the cost of Plant & Machinery. Disposal of Waste/Effluents/Pollution Control:The production process is such that it will release very little waste & effluents and so disposal is not a very great problem.Availability of skilled labour.50 .00 1.259 The cash flow when discounted at the company’s cost of capital rate of 10% gives net cash flow of Rs.50 . No special measures are required to be undertaken for pollution control.00 (3) Other Fixed Assets including Tanks 4.50 6.50 . As per market quotations. Capital Cost of the Project Rs.00 1. Hence net present value of Rs.50 .564 3.50 6.0365 6 5.751 4. Tax Holiday Benefits.00 1.50 .00 1. Power: As the project will require very little power it is expected that power shortage will not create a very big hazard.509 Total 50.00 The Best FM Faculty Of India (6) Provision for contingencies 2.00 41. .00 Technical Feasibility: Knowhow:As the total investment in Plant & Machinery is Rs. Financial Feasibility: Projected Profitability and Cash Flow Statement Rs.00 1. seems to be reasonable. blue print as per engineer’s and technician’s report has been attached with the schedule. Thus the project seems to be feasible.467 2.826 5. As government is the sole supplier of additives there is a fear that company may have to stop production if supply is discontinued.5685 9 4.00 (3) Term Loans 10.8215 8 4.4395 5 5. free trade zone etc.50 .50 6.00 (4) Pre Operative Expenses 1.50 6.6355 2 5.41. remember that what you now have was once among the things only hoped for.50 .621 4.):The company is proposing to set up a factory nearer to the existing one where locational facilities are available (Nearness to market.21.00 Financial Plan Rs.50 5.50 .6 (lakhs).Ph. in Lakhs) 1 - Aaditya Jain Do not spoil what you have by desiring what you have not.513 2.50 6.00 (5) Margin Money for Working Capital 2. Right Plant & Machinery:The company being the market leader in paints it has been able to select the right kind of plant & Machinery at optimum cost.

technology absorptions. Financial Analysis: Estimates of production costs.” . vehicles. role of Banks/Financial Institutions in project assistance. 8. 22 Explain the Interface of Strategic Management and Financial Policy ? or Explain briefly. for forecasting planning and formulation of financial policies. return on investment. 10. “Yes.No organization can run the existing business and promote a new expansion project without a suitable internally mobilized financial base or both internally and externally mobilized financial base. we need only take a deep breath and say. Strategies are developed to manage the business firm in uncertain and imperfect market conditions and environment. Social Cost Benefit Analysis: Ecological matters. limit of resources available with promoters. export potential of the product. Financial policy required the resource deployments such as materials.Most Important New Course Theory Question Delhi-9911442626 . consumer preferences are matters requiring proper attention in such type of analysis. working capital requirements. the finance manager is required to analyse changing market conditions and environment. tax liabilities profitability and sensitivity of profits to different elements of costs and revenue. level of import substitution form the basis of such analysis. QUESTION NO. Cost of Project: Cost of land. Kolkata-9339238834 Ph. SWOT Analysis: Liquidity/Fund constraints in capital market.Industry Analysis:The environment outside & within the country is vital for determining the type of project one should opt for. labour and capital as imperfect and changing. duration of the project. Technical Analysis: Technical know-how. installed and operating capacity of plant and machinery form the core of such analysis. cushion for cost and time over runs and date of completion of the project through Network Analysis have all to be properly adhered to in order to make the project feasible. cost of equity and debt capital in the financial plan for the project are factors which require careful examinations while carrying out SWOT analysis. micro/macro economic considerations subject to government restrictions. reliability of suppliers cost escalations. site development. 3. The Best FM Faculty Of India 2. 4. 7. power. value additions. technical know how together with working capital margins. business/financial risks. labour etc. past records of performance form the key to their selection for the project under study. Inputs: Availability of raw materials within and outside the home country. plant layout. Economic Analysis: The demand and supply position of a particular type of product under consideration. preliminary/pre-operative expenses. manpower requirements together with effluent disposal mechanisms are points to be noted. When we feel defeated. financial position and cash flows.whereas strategic management considers all markets such as material. competitor’s share of the market along with their marketing strategies. for generation and allocation of resources. Project Implementation Schedule: Date of commencement. 5. 9911442626 24 CA Aaditya Jain 2 2 2 2 2 10 S/d Chief Finance Officer 2 3 4 5 6 Total Dated QUESTION NO. fuel. revenue. water.utilities e. Promoters: Their experience. production process. provision for contingencies determine the total value of the project. transportation charges. buildings. plant and machinery.” and hope will reappear.trial runs. how financial policy is linked to strategic Management. (Nov 2009)(May2010) The inter face of strategic management and financial policy will be clearly understood if we appreciate the fact that the starting point of an organization is money and the end point of that organization is also money again. promoters contribution together with debt and equity financing are items which need to be looked into for financial viability. 6. Offer of the organization is only a vehicle that links up the starting point and the end point. Aaditya Jain “Hope is always available to us..21 What are the Contents Of a Project Report ? The following aspects need to be taken into account for a Project Report 1. 9.g.

Within the overall framework of a company’s strategy. QUESTION NO. Social Cost Benefits Analysis is an approach for evaluation of projects. Indian Scenario:The introduction of CNG in certain vehicles and switching of some portion of the transport demand to the metro rail have resulted in a significant reduction of atmospheric pollution in Delhi.Mahatma Gandhi . employees. there should The Best FM be consistency between financial policies. foreign exchange and unskilled labour as well as the social time preference rate for the Indian economy for a study commissioned by the Planning Commission. The success of a company depends on its ability to service in the product market environment which is possible only when the company considers to maintain and improve its product market positions. (2) If savings are inadequate. Aaditya Jain QUESTION NO. 9911442626 Covering 20 Marks 25 CA Aaditya Jain cafinalmafa@yahoo. (8) Output from large projects has significant impact on the market for the good/services and neither pre project market price nor expected post project market price would be correct indicators of the social value of project output. The social cost-benefit analysis of Delhi Metro conducted tries to measure all these benefits and costs from Phase I and Phase II projects covering a total distance of 108 kms in Delhi. (7) External effects exist on consumption side e. The Delhi Metro provides multiple benefits: reduction in air pollution. It focuses on growth profitability and flow of funds rather than only on the maximization of market value of shares. the financial policy of a company is closed linked with its corporate strategy.investment. Estimates of the social benefits and costs of the project are obtained using the recently estimated shadow prices of investment.try ignorance.. Also effect of perceived uncertainties may be different. (iv) Social Cost Benefit Analysis takes into consideration those aspects of social costs and benefits which can be quantified.com The strategy focuses on how to compete in a particular product-market segment or industry. Market prices are not true indicators of social gains/losses but can be suitably adjusted to reflect social valuations. customers.Derek Boker The future depends on what we do in the present. The strategic management is multi-dimensional. For framing strategy it is considered that the shareholders are not the only interested group in the unit. reduction in traffic congestion and fuel savings. Features (1) It includes many economic activities having indirect effects on which there is no possibility of putting a market value. Faculty Of India debt and dividend.g. Financial policies of a company should be developed in the context of its corporate strategy. (iii) Cost of evaluation by such technique could be enormous for smaller projects. So distributional considerations are important. Hence. There are incremental benefits and costs to a number of economic agents: government.Ph. person getting inoculation against infectious disease will be conferring some benefit to society by preventing the spreading over of the disease. 24 Write a short note on Book Building ? If you think education is expensive. money going into investment is regarded more valuable than money going into current consumption. (4) For society. There are many other influential constituents such as lenders. time saving to passengers. (5) Relative valuation placed on future consumption compared to current consumption is different for the society. The corporate strategy establishes an efficient and effective match between its competences and opportunities and environmental risks. taxes are transferred from the project in hand to government and does not involve real cost. (ii) Technique does not indicate whether given project evaluated on socio-economic considerations is best choice to reach national goals or whether same resources if employed in another project would yield better results. reduction in accidents. (6) Society may want to discourage consumption of certain goods and promote that of others.It assesses gains/losses to society as a whole from the acceptance of a particular project. suppliers etc. passengers.23 Write a short note on Social Cost Benefits Analysis ? Meaning : Social Cost Benefit Analysis is a systematic evaluation of an organisation’s social performance as distinguished from its economic performance. Government of India and done at the Institute of Economic Growth. This focus helps the management to create enough corporate wealth for achieving market dominance and the ultimate successful survival of the company. Limitations: (i) Successful application depends upon reasonable accuracy and dependability of the underlying forecasts as well as assessment of intangibles. . (3) Society values given quantum of additional consumption going to different sections of the population differently. private transporters. general public and unskilled labour.

fast and efficient management of Mega Issues.Book Building is a process wherein the issue price of a security is determined by the demand and supply forces in the capital market. It was introduced by SEBI on recommendations of Mr. Aaditya Jain “ Hard work is a investment. more is the profit you earn in terms of success.that is why the process is called Book Building. Book Building is a price discovery mechanism and is becoming increasingly popular as a method of issuing capital. Y. An issuer company may make an issue of securities to the public through a prospectus in the following manner • 100% of the net offer to the public through the book building process or • 75% of the net offer to the public through the book building process and 25% at the price determined through the book building. The Best FM Faculty Of India The issue price is fixed after the bid closing date. 9911442626 26 CA Aaditya Jain Book-building means a process by which a demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by means of notice/ circular / advertisement/ document or information memoranda or offer document. The book-building system is part of Initial Public Offer (IPO) of Indian Capital Market.H.It is most practical. The issue price is not determined in advance. The more you invest in terms of hard work. the most active investors are the mutual funds and other institutional investors.” . 25 per cent of the issue has to be offered to the general public. hence the entire issue is book built. Malegam in October 1995. India has a large number of retail investors who actively participate in Intial Public Offer (IPOs) by companies. Here there are two options with the company.The various bids received from the investors are recorded in a book. Book building is called so because it refers to the collection of bids from investors. But in India. Unlike international markets. Kolkata-9339238834 Ph. The idea behind this process is to find a better price for the issue. which is based on an indicative price range. Book building is a process used for marketing a public offer of equity shares of a company and is a common practice in most developed countries. Book Building involves sale of securities to the public and the institutional bidders on the basis of predetermined price range.Most Important New Course Theory Question Delhi-9911442626 . Internationally.

(iii) It is appropriate for the mega issues only. Disadvantage (i) There is a possibility of price rigging on listing as promoters may try to bail out syndicate members. (vi) Issuers can choose investors by quality. the issue may be deferred. The advertisement should also contain the following: • the date of opening and closing of the bidding (not less than five days). Aaditya Jain QUESTION NO. User & Purpose : Derivative serve as a method to hedge and reduce risks . The issue was made through 100 % book building process . collars. Trades on an exchange generally take place with anonymity. yield enhancement and to avail arbitrage opportunities. Options. OTC trades have no anonymity. In Business. • the method and process of bidding. Infact. and they generally do not go through a clearing corporation. (ii) The book building system works very effeciently in matured market conditions. Trades at an exchange generally go through the clearing corporation. exploiting inefficiencies and earning dealer spreads.Ph.The price band for the the book buliding pocesss was between Rs 405 and Rs 450 with Rs 20 discount for retail investors . 25 Write a short note on Derivatives ? What are different types of Derivative Risk ? A derivative is a financial instrument which derives its value from some other financial price. Caps. (iii) Institutional Investor For hedging asset allocation. Example : Interest rate futures. The Best FM before Of issue (iv) In book building.Bidding should be permitted only if an electronically linked transparent facility is used. floors. Forward. the demand for the share is known Facultythe India closes. The level of exposure varies throughout the life of the contract and the extent of losses will only be known at the time of default.com Procedure For Bidding The bid should be open for at least five days and not more than 10 days. (iv) Dealers For hedging position taking. Currency swaps. • the name and addresses of the syndicate members as well as the bidding terminals for accepting the bids. Recent Example : Recent example of a book buliding process in Indian context is the IPO of Reliance Power. Advantage (i) The book building process helps in discovery of price & demand. Example :Interest rate swaps. the competition will bite you if you keep running. by all means Ask! . Example : The most important derivatives are Futures. This ‘other financial price’ is called the underlying. forward. (iii) The time taken for the completion of the entire process is much less than that in the normal public issue. Currency futures. But. (iv) The company should be fundamentally strong & well known to the investors without it book building process will be unsuccessful. Currency options. 9911442626 Covering 20 Marks 27 CA Aaditya Jain cafinalmafa@yahoo. Credit risk in derivative products comes in two forms: (i) Pre-Settlement Risk: It is the risk of loss due to a counterparty defaulting on a contract during the life of a transaction. Swaps Types of Derivative Market : (a) Exchange Traded Derivatives (b) OTC (Over the Counter) Derivatives Exchange-traded derivatives : Derivatives which trade on an exchange are called ‘Exchange-traded derivatives’. (ii) The costs of the public issue are much reduced. which may be extended to 13 days in case the price band is revised. hedging and yield enhancement. they will swallow you If there is Something to Gain and Nothing to Lose by Asking. The different types of derivatives risks are: (a) Credit risk: Credit risk is the risk of loss due to counterparty’s failure to perform on an obligation to the institution. Interest rate options. Users Purpose (i) Corporation To hedge currency risk and inventory risk (ii) Individual Investors For speculation. such conditions are not commonly found in practice. if you stand still. OTC derivative : A derivative contract which is privately negotiated is called an OTC derivative. if there is not much demand. (v) It inspires investors confidence leading to a large investor universe. (vii) The issue price is market determined.

2003. at a reasonable cost. in the SEBI (Disclosure and Investors Protection) Practice Golden Rule 1 of management in everything you do “Manage others the way you would like to be managed”. there is the possibility that the brokerage firm might issue a margin call. (g) Reputation risk: Reputation risk is the risk of loss arising from adverse public opinion and damage to reputation. because of cash flow mismatches. and in sufficient quantities. deficiencies in information systems. requiring the investor to decide whether to quickly deposit additional funds or liquidate the position. Stock Trading: Compared to directly trading stocks. or management failure. SEBI inserted a new Chapter No. Stock Futures also have disadvantages. or inability of the bank to access the market (e. longdated options). there is the risk of losing significantly more than the initial investment (margin deposit). (c) Liquidity risk: Liquidity risk is the risk of loss due to failure of an institution to meet its funding requirements or to execute a transaction at a reasonable price. (iii)Required Vigilance: Stock Futures are investments that require investors to monitor their positions more closely than many would like to do. Derivatives activities can pose challenging operational risk issues because of the complexity of certain products and their continual evolution.g. (ii) Ease of Shorting: Taking a short position in futures is simpler.there is no requirement for an uptick.g. The name comes from the fact that Green Shoe Company was the first entity to use this option.g. This risk is only present in transactions that do not involve delivery versus payment and generally exists for a very short time (less than 24 hours). and commodity prices or in the volatility of these factors. QUESTION NO. the counterparty does not have the power or authority to enter into a particular type of derivatives transaction) or documented correctly. (iii) Flexibility: Future investors can use the instruments to speculate. exercise of options. Aaditya Jain QUESTION NO. Such exposure occurs with respect to derivative instruments when changes occur in market factors such as underlying interest rates. exchange rates. human error. credit down-grading of the institution or The Best FM Faculty Of India of a major counterparty).and the implementation of dynamic hedging strategies. exotic derivatives. at a reasonable price. (ii) Funding liquidity risk: It is the potential inability of the institution to meet funding requirements. . (ii)No Stockholder Privileges: The future owner has no voting rights and no rights to dividends. less costly and may be executed at any time . spread or for use in a large array of sophisticated strategies. VIII-A.An investor can use leverage to control more stock with a smaller cash outlay. 27 What is Green Share Option or Green Shoe Option ? Explain the working mechanism ? Green Shoe Option (GSO) means an option available to the company issuing securities to the public to allocate shares in excess of the public issue and operating a post-listing price stabilising mechanism through a stabilising agent.26What are the major advantages & disadvantages of Futures Trading as compared to Stock Trading ? The Major Advantages of Futures Trading Vs. These include: (i) Risk: In a stock future contract. Because future accounts are marked to the market every business day. (i) Market liquidity risk: It is the risk that an institution may not be able to exit or offset positions quickly. hedge. 9911442626 28 CA Aaditya Jain (ii) Settlement risk: It is the risk of loss due to the counterparty’s failure to perform on its obligation after an institution has performed on its obligation under a contract on the settlement date. Settlement risk frequently arises in international transactions because of time zone differences. stock futures provide several major advantages: (i) Leverage: Compared to buying stock on margin. Kolkata-9339238834 Ph. equity prices. This inability may be due to inadequate market depth in certain products (e. Such funding requirements may arise from cash flow mismatches in swap books.Most Important New Course Theory Question Delhi-9911442626 . (f) Regulatory risk: Regulatory risk is the risk of loss arising from failure to comply with regulatory or legal requirements. (e) Legal risk: Legal risk is the risk of loss arising from contracts which are not legally enforceable (e. This option acts as a safety net for the investors and is a standard global practice. Institutions involved in derivatives activity face two types of liquidity risk : market liquidity risk and funding liquidity risk. (b) Market risk: Market risk is the risk of loss due to adverse changes in the market value (the price) of an instrument or portfolio of instruments. investing in futures is less costly. with effect from August 14. market disruption. (d) Operational risk: Operational risk is the risk of loss occurring as a result of inadequate systems and control.

In order to stabilise post-listing prices. In the Indian context.based. the green-shoe option can even be more than 15%.  The GSO is available to a company which is issuing equity shares through book-building mechanism for stabilising the postlisting price of the shares. The money received from allotment of these shares shall also be kept in a ‘GSO Bank A/c’. shall be transferred to the Investors Protection Fund. then shares to the extent of shortfall will be allotted by the company to the GSO Demat A/c multiplied by the issue price. no exchange of principal takes place but interest payments are made on the notional principal amount. This offer initially involved 5. You never suffer from a money problem. 3. 2000 to deal with the GSO. In certain situations.These shares will be kept in a separate GSO Demat A/c. Party A 5% Fixed Rate Party B 6-month LIBOR Types of Interest Rate Swaps : If you woke up breathing .(b)Fixed to floating. Amount left in the GSO Bank A/c (after meeting expenses of SA). (e) The motivation of interest rate swap is to save interest cost. 8.. In case of over subscription.. IDBI has also come up with their Flexi Bonds (Series 4 and 5) under GSO. 9911442626 Covering 20 Marks 29 CA Aaditya Jain cafinalmafa@yahoo.Congratulation ! You have another chance . One party should expect interest rates to harden and the other should expect it to soften. the SA shall determine the timing and quantity of shares to be bought. Features of Interest Rate Swap : (a) It is treated as an off .(c)LIBOR to prime . not exceeding 15% of the total issue size. If at the expiry of the stabilisation period.In an interest rate swap.61 million domestic equity shares. Individual borrowers generally do not perform swap. the two parties must have opposite view on interest rates. 4. SEBI guidelines governing public issues contain appropriate provisions for accepting over-subscriptions. (c) There is no exchange of principal repayment obligations. The borrowed shares shall be in the dematerialised form. The shares bought from the market by SA for stabilization shall be credited to GSO Demat Account. The Company shall appoint one of the leading book runners as the Stabilising Agent (SA). Major Players : The major players in the swap markets are banks (or other intermediaries on the one side) and medium and large size corporates on the other.the balance sheet transaction.14 times. (b) It is structured as a separate contract distinct from the underlying loan agreement. (d) It effectively translates a floating rate borrowing into a fixed rate borrowing and vice versa. More recently Infosys Technologies has also excercised GSO for its issue. you always suffer from an idea problem . the allocation of these share shall be on pro-rata basis to all applicants. the SA does not purchase shares to the extent of over-allocated shares. Condition : To facilitate a interest swap. 28 Explain the concept of interest rate swap by giving appropriate examples. offered equity shares of Rs. Examples of GSO issues in India In April.[Also Refer Class Register for its practical part] Meaning : An Interest Rate Swap is a transaction involving an exchange of one stream of interest obligations for another. The Best FM Faculty Of India and the amount will be used for buying shares from the market during the stabilization period. 5. representing 2. 7. Aaditya Jain QUESTION NO. Interest payments can be exchanged between two parties to achieve changes in the calculation of interest on the principal. became the first Indian company to offer GSO. for example :(a)Floating to fixed. 6. These shares shall be returned to the promoters within 2 days of closure of stabilisation process. distinct from the issue account . The ICICI Bank Ltd. ‘The promoters of the company will enter into an agreement with SA to lend some of their shares to the latter. say 15% of the offer made to public. The following is the mechanism process of GSO : 1.22 million depository shares. who will be responsible for the price stabilising process.Ph.com Regulations. The issue was over subscribed by 5. 3050 crores through 100% book building process to the investors. 2004 the ICICI bank Ltd. subject to a ceiling. 2.(d)Prime to LIBOR. green shoe option has a limited connotation. 9.

The corporate world is highly competitive.75 10% QUESTION NO.50) – .50 BBB 11% LIBOR+. total interest cost to both the parties if they borrow as per their plan : AAA : LIBOR + .75 % Aaditya Jain SWAP BANK 10% 50 +. interest is to be paid. Purpose:Interest Rate Swap is intended to hedge against the intetrest rate fluctuations to some extent through careful planning with the help of swap dealer .50 BBB : 11% Total (A) LIBOR + 11. Commission for intermediary = . 29 What is the Dow Jones Theory to Portfolio Management?[Also Refer Class Register for its practical part] The Dow Jones Theory is probably the most popular theory regarding the behaviour of stock market prices. Net Interest Burden = Cost under own choice – Share in saving. total interest cost in this situation is : AAA 10% BBB LIBOR + . 4.. AAA is interested in raising loan under floating rate. LIBOR + . The notional principal value upon which the interest rate is to be applied. An intermediary brings them on table and interest swap is arranged.50%) – (LIBOR + 10.25. both parties could benefit from a swap arrangement in the following manner.. Frequency of payments. BBB is interested in raising loan under fixed rate. Find out net interest burden (%) for AAA and BBB? Solution : If no Swap is arranged.25. . The fixed interest rate to be exchanged for another rate. Saving for BBB = .Where there is an exchange of interest receipts i.75%) = .50% Using the principle of comparative advantage.you can easily get lost in the crowd.. who established the Dow Jones & Co. The benefit of interest swap is to be shared equally by the three parties. Dow. (b) Asset Swap .However a CA with special knowledge of Finance could open new doors of opportunity..75 11% R AAA BO LI BBB LIBOR + .e. and was the first editor of the Wall Street Journal.A.75 Total (B) LIBOR + 10. interest is to be received.75% Saving on Interest Cost : A – B = (LIBOR + 11.e.Where there is an exchange of interest obligation i. AAA has higher credit rating than BBB.75 Both are planning to raise loan of $1 million. the swap is asset swap.25 = 10.25. 5.25 For BBB : 11% – . Life time of the swap.As an ordinary employee with nothing new or exceptional to offer.The theory derives its name from Charles H.  For AAA : (LIBOR + .Most Important New Course Theory Question Delhi-9911442626 . Hence they are rated differently by the market and are offered loans at following rates: The Best FM Faculty Of India Fixed Rate Floating Rate AAA 10% LIBOR + . Examples On IRS: Consider two companies rated AAA and BBB. such as quarterly or every six months is also agreed. Provision of Interest Rate Swaps :Some of the provisions of IRS are as follows : 1. 3. the swap is liability swap.75 Since Savings is to be distributed equally as per the requirement of the question we have Saving for AAA = . 2. Formula type of index used to determine the floating rate.25 = LIBOR + .S. Kolkata-9339238834 Ph.a leading publication on financial and economic matters in the U. 9911442626 30 CA Aaditya Jain (a) Liability Swap . AAA should borrow on fixed basis and BBB on floating basis.

However. the rise is not much as to take the prices higher than the previous peak. or sometimes even more During a bull phase. the falls are ofThe Best magnitude thanIndia. there is a rise in prices.Secondary Trend is Rising 3. Constant mix policy. the basic trend is that of rise in prices. It would be seen that prices are not falling consistently and. Be a life long student. and sell them at a time when they reached the highest peak. Aaditya Jain Bull Phase Bear Phase Bear Phase Graph 1 .Buy and hold policy. These fluctuations are the result of speculative factors. However. Similarly. (ii) Reduces risk :A plan may incur higher risk if no rebalancing policy exists.Investment should be made in shares when their prices have reached the lowest level. QUESTION NO. can make money only by sheer chance.Brian Tracy “Teachers open the door. These movements are known as secondary movements and are shorter in duration and are opposite in direction to the primary movements.e. Secondary Movements : We have seen that even when the primary trend is upward. Graph 2 shows the typical behaviour of prices on the stock exchange in the case of a bear phase. even where the primary trend is downward. It may be reiterated that anyone who tries to gain from short run fluctuations in the stock market. decisions can be taken. Daily Fluctuations.Ph. i. Graph I shows the behaviour of stock market prices in bull phase.there can be no asset allocation target without the discipline to preserve that target. 2.Secondary Trend is Falling and in Graph 2.Primary Trend is Falling 2. and Constant proportion portfolio insurance policy (CPPI). Graph 2 .price will start falling. 1. Purpose of Rebalancing (i) For increasing returns & (ii) Maintaining risk profile Benefits of Portfolio Rebalancing (i) Disciplined investing :Rebalancing is a vital part of investment policy . There are three policies of portfolio rebalancing.Primary Trend is Rising and in Graph 2. a lower FM Faculty Of rise Once the prices have risen very high. Secondary Movements. prices reach higher levels with each rise. It is a helpful tool for determining the relative strength of the stock market. the correct and appropriate movement in the Market Prices can be identified. Thus if the daily share market price index for a few months is plotted on the graph it will show both upward and downward fluctuations. Primary Movements : They reflect the trend of the stock market & last from one year to three years. they fall. constructed by Charles Dow.3. The Dow Theory is based upon the movements of two indices. there are also downward movements of prices. 30 Write a short note on Portfolio Rebalancing ?[Also Refer Class Register for its practical part] Meaning :It means the value of portfolio as well as its composition. Hence in Graph 1 above. there is upward movements of prices also. Benefit Of Dow. As can be seen from the graph that prices do not rise consisitently even in a bull phase.Dow Jones Industrial Average (DJIA) and Dow Jones Transportation Average (DJTA). . the bear phase in bound to start. after each fall. The Dow Theory’s purpose is to determine where the market is and where is it going. These movements normally last from three weeks to three months and ranges from 1/3 ( 33 % ) to 2/3 (66 %) of the previous advance in a bull market or previous fall in the bear market. The Dow Jones theory classifies the movements of the prices on the share market into three major categories: 1. Daily Movements : There are irregular fluctuations which occur every day in the market. but you must enter by yourself” .the more you earn and more self confidence you will have. They rise for some time and after each rise. Primary Movements. These fluctuations are without any definite trend.The more you learn . Speculation is beyond the scope of the job of an investment manager.com The Dow Theory is one of the oldest and most famous technical theories. 9911442626 Covering 20 Marks 31 CA Aaditya Jain cafinalmafa@yahoo. Hence in Graph 1 above. and depending on the investors preference. As a result. (b) Identification of Trend : Using Dow-Jones theory. These policies have different pay off under varying market conditions.Jones Theory : (a) Timings of Investments : Investor can choose the appropriate time for his investment / divestment . An investment manager really is not interested in the short run fluctuations in share prices since he is not a speculator.

Thus this policy unlike the buy and hold policy is a “do something” policy. This is basically a ‘do nothing’ policy in respect of what happens to relative values of rebalancing if done. On the other hand. the higher the initial percentage in stocks. if the initial stock: bond mix is 50:50.Most Important New Course Theory Question Delhi-9911442626 . If the desired constant mix of stock and bonds is 50:50 this policy calls for rebalancing the portfolio when relative values of its components change so that the target proportions are maintained. more is the profit you earn in terms of success. the better is the performance of the buy and hold policy. Kolkata-9339238834 Ph. 9911442626 32 CA Aaditya Jain (iii) Buy low. the higher the initial percentage in stocks the worst the performance of the buy and hold policy. This strategy ensures that the portfolio returns are enhanced. when stock underperforms bond. It illustrates the following features of buy and hold policies : Pay Off Aaditya Jain The Best FM Faculty Of India 100 200 Stock Market Level Pay off Diagram For a Buy and Hold Policy (i) The value of portfolio is linearly dependent to that of stock market. (iv) A clear rebalancing policy avoids the risks of ad-hoc and costly portfolio revisions.” . sell high : Rebalancing is a mechanism for sensible timing . The more you invest in terms of hard work. Pay Off 100 Stock Market Level 200 Constant Mix Policy (c) Constant Proportion Portfolio Insurance Policy (CPPI): It takes the following form : Investment in stocks = m (Portfolio value – Floor value) when m>1 Floor value means value which the market expects. The pay off associated with constant mix policy is show in the graph. Illustration : If one has wealth of 100000 and Floor of 75000 and multiplier of 2 the pattern of investment associated with such a policy may be illustrated in the following manner. (ii) While the portfolio value can’t fall below the value of initial investment in bonds it’s upside potential is unlimited. (a) Buy and Hold Policy: The initial mix that is bought is held.the process naturally buys low and sells high. (b) Constant Mix Policy: The constant mix policy calls for maintaining an exposure to stocks which is a constant proportion of portfolio value. “ Hard work is a investment. (iii) When stock outperforms bond. The graph shows the pay off diagram for a buy and hold policy.

Ph. As per CPPI policy stock component would be 30.e (1. hope for the best.com Solution Condition I: As the initial cushion (different between portfolio value and floor) is Rs.000-75.000 x2).000 in bonds.000 (50. thereby raising the cushion by 50. value of stock in portfolio jumps from 50.000 (stock 40.000 stock + 50.000-75000)]. This calls for selling bonds worth 25. if stock rises further in value more stocks should be bought and so on. So 10.000 i. Hence the pay off curve is convex in nature as shown in the diagram.000 of stock should be sold and proceeds invested in bonds if stock decline further more bonds should be purchased.000 The Best FM Faculty Of India (1.000 bond).00. this implies that this policy is the opposite of constant mix policy which calls for buying stocks as they fall and selling stocks as they rise.e (150/100 x 50.000 in stocks and 50. The graph shows these pay off.000).As per CPPI policy stock component should go up to 1.000 and reinvesting the proceed in the stocks. this means that the value of portfolio declines to 90. The initial investment in stock is 50.00. Condition II: If the stock market falls from 100 to 80 value of stocks in the portfolio falls from 50.00075.000 i. So the initial portfolio means 50.25. concave and convex curve. 9911442626 Covering 20 Marks 33 CA Aaditya Jain cafinalmafa@yahoo.000) thereby reducing the cushion to 15.e (twice of initial cushion 25.000 and bond 50.000 to 75.000 x 2). One more to hope! So.000. Pay Off CPPI Buy & Hold Constant Mix Policy Stock Market Level Pay off Associated with Various Rebalancing Policies Every sunset gives us one day less to live! But every sunrise give us.25.000 (15.000 to 40.000 x2).25. Aaditya Jain 100 Stock Market Level 200 Comparative Evaluation: The pay off associated with buy and hold policy constant mix policy and constant proportion portfolio insurance policy are represented by straight line.000 i.Best of Luck! . From the graph if the stock market move only in one direction the best policy is CPPI policy and the worst policy is constant mix policy in between lies buy and hold policy.e (75. Thus the CPPI policy necessitates selling stock as they fall and buying stocks as they rise.000) and a value of portfolio rises to 1. Condition III: If the stock market rises from 100 to 150.000(90.000 i.000).

This hypothesis is known as Random Walk hypothesis which states that the behaviour of stock market prices is unpredictable and that there is no relationship between the present prices of the shares and their future prices. (iii) Tends to do very poorly in flat but in fluctuating market. In the layman’s language it may be said that prices on stock exchange behave exactly the way a drunk would behave while walking in a blind lane i.e. (ii) Doesn’t provide much downward protection and tends to do relatively poor in the up market. Consider a payoff from initial investment of 100000 when the market moves from 100 to 80 and back to 100 under three policies (a) Buy and hold policy under which the initial stock bond mix is 50:50.e.constant mix policy seems to be superior to other policies. The supporters of this theory put out a simple argument. 9911442626 34 CA Aaditya Jain If the stock market reverses itself frequently rather then move in the same direction. Aaditya Jain QUESTION NO. . up and down. (iii) Tends to do very well in flat but fluctuating market. It follows that: People will forget what you said. the fact that there are peaks and troughs in stock exchange prices is a mere statistical happening successive peaks and troughs are unconnected. (ii) Provides a definite downside protection. In other words.Most Important New Course Theory Question Delhi-9911442626 . bending on the one side to other side . People will forget what you did . (ii) Provides good downside protection and performance well in up market. (b) Constant Mix Policy (i) Gives rise to concave pay off drive. with an unsteady way going in any direction he likes. Portfolio Composition and Payoff for the Three Policies Market Level 100 Portfolio Stock Bond Total Buy and hold policy 50000 50000 100000 Constant mix policy 50000 50000 100000 CPPI policy 50000 50000 100000 The Best FM Faculty Of India Market level falls to 80 Portfolio Before Rebalancing Portfolio After Rebalancing Stock Bonds Total Stock Bond Total Buy-Hold 40000 50000 90000 40000 50000 90000 Constant-mix 40000 50000 90000 45000 45000 90000 CPPI 40000 50000 90000 30000 60000 90000 Market level again rises to 100 Portfolio Before Rebalancing Portfolio After Rebalancing Stock Bonds Total Stock Bond Total Buy-Hold 50000 50000 100000 50000 50000 100000 Constant-mix 56250 45000 101250 50625 50625 101250 CPPI 37500 60000 97500 45000 32500 97500 The performance feature of the three policies may be summed up as follows: (a) Buy and Hold Policy (i) Gives rise to a straight line pay off. (iii) Performance between Constant mix policy and CPPI policy. (c) CPPI Policy (i) Gives rise to a convex pay off drive. But people will NEVER forget how you made them feel. Kolkata-9339238834 Ph. 31 Explain the Randon Walk Theory to Portfolio Management? Many investment managers and stock market analysts believe that stock market prices can never be predicted because they are not a result of any underlying factors but are mere statistical ups and downs.floor value) The portfolio compositions and their values for the three policies are tabulated as follows. (b) Constant mix policy under which the stock bond mix is 50:50 (c) A CPPI policy which takes to form investment in stock = 2 (Portfolio value – 75000 i. Proponents of this hypothesis argue that stock market prices are independent.

By minimising the tax burden. (c) There may be periodical ups or downs in share prices. The returns on investment in a domestic economy depend on the prospects of domestic activity together with the uncertainty attached thereto. It is desirable for the investor so as to take advantage of attractive opportunities upcoming in the market. (c) The analysis of securities market and its trend is to be done on a continuous basis. Thus foreign investment provides diversification benefits which a Live in your dreams.Ph. never ever cry . Pick up a new dream.. 34 Write a short note on Benefits of International Portfolio Management ? International Diversification of portfolio of assets helps to obtain higher risk adjusted returns i.Though macro economic factors of different countries vary widely and do not follow the same phases of business cycles.e. different countries have securities of different industries in their market portfolio leading to correlation of expected returns from investment in different countries being lower than in a single country.but dreams may die. (b) Industrial and economic environment and its impact on industry prospects in terms of prospective technological changes.com (a) Prices of shares in stock market can never be predicted. (vi) Diversification : The basic objective of building a portfolio is to reduce the risk of loss of capital and income .The world is big and has lots to give. (v) Liquidity i. This is essential for providing flexibility to investment portfolio. (iii) Capital Growth which can be attained by reinvesting in growth securities or through purchase of growth securities. (vii) Favourable Tax Status : The effective yield an investor gets from his investment depends on tax to which it is subject. reduce risk and raise return through international investment. 33 State two basic principles for effective Portfolio Management? Basic Principles of Portfolio Management : There are two basic principles for effective portfolio management. The above analysis will help the portfolio manager to arrive at a conclusion as to whether the securities already in possession should be disinvested and new securities be purchased. the case with which a security can be bought or sold. yield can be effectively improved.e..donot get shatered . QUESTION NO. If so. For this purpose they will have to carry the following analysis: (a) Assessment of quality of management of the companies in which investment has already been made or is proposed to be made. (iv) Marketability i. (b) The reason is that the price trends are not the result of any underlying factors. The capital or the principal amount invested should not erode . competition in the market.that’s the way to live. Some of the benefits are listed as under: (a) Reduce Risk & Diversification Benefits: International investment aids to diversify risk. nearness to money. QUESTION NO. but no connection can be established between two successive peaks (high price of stocks) and troughs (low price of stocks). by investing in various types of securities and over a wide range of industries. (ii) Stability of Income so as to facilitateThe Best FM Faculty Of India systematically the reinvestment or consumption of planning more accurately & income. (b)Financial & trend analysis of companies balance sheet/profit&loss account to identify sound companies with optimum capital structure & better performance & to disinvest the holding of those companies whose performance is found to be slackening. the timing for investment or dis-investment is also revealed. but that they represent a statistical expression of past data. The different sectors in an individual economy in some way or the other are interrelated and as a whole subject to the same impact of the entire domestic policy. 9911442626 Covering 20 Marks 35 CA Aaditya Jain cafinalmafa@yahoo. Financial and Monetary Policies of the Government of India and the Reserve Bank of India. The gains from diversification within a country are therefore very much limited. (ii) Constant Review of Investment : Portfolio managers are required to review their investment in securities and continue selling and purchasing their investment in more profitable avenues. capacity utilisation with industry and demand prospects etc. Effective investment planning for the investment in securities by considering the following factors : (a) Fiscal. in terms of value and in terms of purchasing power.e. Aaditya Jain . either in value or in terms of purchasing power. 32 State the Objectives of Portfolio Management? (i) Security/Safety of Principal The objective is to keep the capital / principal amount intact. QUESTION NO.

QUESTION NO. only RBI. (c) Time Period : Interest to be payable on maturity and rounded-off to the nearest rupee. 9911442626 36 CA Aaditya Jain domestic investment does not. Notwithstanding the subjectivity of these weights. Reverse repo is a term used to describe the opposite side of a repo transaction. or to obtain temporary use of a particular security. Repos/Reverse Repos are used : (i) to meet shortfall in cash position (ii) augment returns on funds held (iii) to borrow securities to meet regulatory requirement (iv)An SLR surplus bank and a CRR deficit bank can use the Repo deals as a convenient way of adjusting CRR/SLR positions simultaenously (v)RBI uses Repo and Reverse Repo deals as a convenient way of adjusting liquidity in the system. 2.Accordingly. think of the consequences . The difference between the purchase and sale price is the interest or gain to the buyer. Aaditya Jain QUESTION NO. This is when the buyer is in need of securities and initiates the transaction. On a given date specified in advance (between 14 days to 1 year) the entire transaction is reversed.Reverse Repo is a purchase of security with a commitment to sell at a pre-determined price and date . Securities (ii)Treasury Bills(iii)PSU bonds. Confidence comes from knowing that the best is backing you When anger rises. For them. 35 Write a short note on Traditional Position/Graham and Dodd Model on dividend policies ? [Also Refer Class Register for its practical part] According to the traditional position expounded by Graham and Dodd. (iv)FI bonds & Corporate bonds held in Dematerialised form Issuer : In India.Most Important New Course Theory Question Delhi-9911442626 . This is possible due to profitable investment opportunities being available in an enlarged situation and at the same time inter country dissimilarities reduce the quantum of risk. Kolkata-9339238834 Ph. A Repurchase Agreement (or repo) is an agreement of sale of a security with a commitment to repurchase or buy the security back at a specified price and on a specified date . Banks and PDs are allowed to enter into Repos. there are two possible motives for entering into a reverse repo:short-term investment of funds. Sometimes the seller may also gain from a transaction. Financial institutions and others specified can only do reverse Repos. Their view is expressed quantitatively in the following valuation model: E  Symbolically Po= m   D   The Best FM Faculty Of India 3  Under this model the weights attached to dividend is equal to four times the weights attached to retained earnings. both in the books of the buyer and seller. the stock market places considerably more weight on dividends than on retained earnings. Coupon/Interest terms : (a) Computation :Interest for the period of Repo is the difference between Sale Price and Purchase Price .The amount of interest earned on funds invested in a Repo is determined as follows : Interest earned = Funds Invested × Repo Rate × Number of Days/365 (b) Recognition : Interest should be recognized on a time -proportion basis . 36 Write a Short Note on Repo [ Repurchase Option ] Agreement ? Briefly state the difference between Repo & Reverse Repo? Or What is Repo and Reverse Repo . 3.Interest to be calculated on an actual/ 365-day year basis. A financial institution places certain securities (presently restricted to Treasury Bills) with the buyer and borrows a certain amount of money. E DR    4D  R   Po= m     m  Proof : Po= m   D    Po= m   D  3 3     3  3 The weights provided by Graham and Dodd are based on their subjective judgments and not derived from objective empirical analysis. The securities eligible for trading under Repo/Reverse Repo are: (i)GOI & State Govt. The essential features of the Repo transaction are: 1. the major contention of the traditional position is that a liberal payout policy has a favourable impact on stock prices. the stock market is overwhelmingly in favour of liberal dividends as against niggardly dividends. (b) Raise Return through better Risk – Return Trade off : International Investment aids to raise the return with a given risk and/or aids to lower the risk with a given rate of return.

CDC etc.foreign collaborations.. That would be equivalent to about Rs 88. Such a transaction is called a Repo when viewed from the perspective of the seller of securities (the party acquiring funds) and Reverse Repo when described from the point of view of the supplier of funds. Difference Between Repo & Reverse Repo : Reverse repo is a term used to describe the opposite side of a repo transaction. credit from official export credit agencies. there is no difference between a ‘REPO’ and a ‘REVERSE REPO’transaction excepting that the identifica- Aaditya Jain tion is from a different point of view. whether a given agreement is termed a Repo or a Reverse Repo depends largely on which party initiated the transaction. The Best FM : a lender and a Under a Repo transaction. Investment by Foreign Institutional Investors (FIIs) in dedicated debt funds Applicants are free to raise ECB from any internationally recognised source like banks. 5. commercial borrowings from the private sector window of multilateral financial institutions such as IFC. The borrower in a Repo borrows cash and pledges securities. QUESTION NO.They make you laugh when u remember the time u cried. ADB. allowing them to supplement domestically available resources and to take advantage of lower international interest rates. 2.com Maturity :Repos are normally done for a minimum maturity period of one day & a maximum maturity period of fourteen days.The top fundraiser was Reliance Industries.. 4.Units in SEZ are permitted to use ECBs under a special window. and 7. Minimum denomination and transaction size : Generally Repo transactions are done in market lots of Rs 5 crores.export credit agencies.000 crore. essentially. Recent Example : About 812 companies have raised about $20.Hence a transaction is a Repo for one party and a Reverse Repo for the other party. Thus. securitised instruments such as floating rate notes. which typically includes interest at an agreed upon rate. supplier’s credit. which raised $700 million. External Commercial Borrowings (ECB) are defined to include 1.24 billion through ECBs in the April 2006-February 2007 period. 2.Ph. followed by Reliance Communication. of India/ Reserve Bank of India applicable from time to time. The term Repurchase Agreement (Repo) and Reverse Repurchase Agreement (Reverse Repo) refer to a type of transaction in which money market participant raises funds by selling securities and simultaneously agreeing to repurchase the same after a specified time generally at a specified price. ECBs provided an additional source of funds to the Indian companies. foreign equity -holders.The amounts traded each day in the Memories play a very confusing role. fixed rate bonds etc. Offers from unrecognised sources will not be entertained. commercial bank loans. Hence borrowing by pledging securities is a Repo transaction and lending by accepting the pledge is a Reverse Repo transaction.suppliers of equipment. 37 Write a short note on External Commercial Borrowings (ECB) ? The foreign currency borrowings raised by the Indian corporates from confirmed banking sources outside India are called “External Commercial Borrowings” (ECBs). 9911442626 Covering 20 Marks 37 CA Aaditya Jain cafinalmafa@yahoo. The availability of the funds from the International market is huge as compared to domestic market and corporates can raise large amount of funds depending on the risk perception of the International market. 3. 38 Write a short note on Exchange Rate Forecasting ? Meaning: The foreign exchange market has changed dramatically over the past few years. 3. buyer’s credit. ECB encourage infrastructure/core and export sector financing which are crucial for overall growth of the economy. Benefits : The ECBs route is beneficial to the Indian corporates on account of following :1. 5. which raised $500 million.. 6. QUESTION NO. These Foreign Currency borrowings can be raised within ECB Policy guidelines of Govt. The lender lends cash and purchases the securities and is said to enter into a Reverse Repo transaction. 4. international capital markets etc. It provides the foreign currency funds which may not be available in India. there are two counter partiesFaculty Of India borrower. AFIC. The cost of funds at times works out to be cheaper as compared to the cost of rupee funds.But make you cry when you remember the time u laughed . Hence.

Usually one delivery date such as the agreed to by the two parties second Tuesday of every month Currencies traded All currencies Majors Cross rates Available in one contract. Everything has its beauty but not everyone sees it "Luck has a Peculiar Habit of Favoring Those Who Don't Depend on it!!" . (b) Fundamental Forecasting: It is based on the fundamental relationships between economic variables and exchange rates. short-term financing. Liquidity : Forward contracts is exposed to the problem of liquidity whereas in futures there is no liquidity problem as they are traded in stock exchange.quantitative measurements based on regression models and sensitivity analyses. For example subjective assessments. 3. Transaction costs: Cost of forward contracts is based on bid-ask spread. fundamental forecasting is limited by: (i) the uncertain timing of the impact of the factors. Futures contracts entail brokerage fees for buy and sell orders. 2. fundamental. Margins: Margins are not required in forward contract. (a) Technical Forecasting: It involves the use of historical data to predict future values. They can be categorized into four general groups. (d) Mixed Forecasting: It refers to the use of a combination of forecasting techniques. The current spot/forward rates are often used. 9911442626 38 CA Aaditya Jain foreign exchange market are now huge.In general.Multiple Usually requires two contracts contracts avoided Market-place Global network Regular markets-futures market and exchanges Price fluctuations No daily limit in many currencies Daily price limit set by exchange Risk Depends on counter party Minimal due to margin requirements Honouring of contract By taking and giving delivery Mostly by a reverse transaction Cash flow None until maturity date Initial margin plus ongoing variation margin because of market to market rate and final payment on maturity date Trading hours 24 hours a day 4 .The actual forecast is a weighted average of the various forecasts developed. 5. Futures contracts are traded on organised exchanges with a designated physical location for example : Stock Exchange . earnings assessments and long-term financing. However. market-based. 39 What is the difference between Futures & Forward Contracts ? There major differences between the traditional forward contract and a futures contract. since speculators will ensure that the current rates reflect the market expectation of the future exchange rate. In this increasingly challenging and competitive market. and (iv)changes in the sensitivity of currency movements to each factor over time. short-term investment. (iii)the omission of factors that are not easily quantifiable. capital budgeting.Most Important New Course Theory Question Delhi-9911442626 .These are tabulated below: Feature Forward Contract Futures Contract Amount Flexible Standard amount Maturity Any valid business date Standard date. 4. they are of limited use to MNCs. Corporates need to do the exchange rate forecasting for taking decisions regarding hedging. Aaditya Jain QUESTION NO. Speculators may find the models useful for predicting day-to-day movements. 6. price are not publicly disclosed whereas in future contracts price is transparent.For example time series models.technical. and mixed. In futures contracts every participant is subject to maintain margin as decided by the exchange authorities. Techniques Of Exchange Rate Forecasting : There are numerous methods available for forecasting exchange rates. (c) Market-Based Forecasting: It uses market indicators to develop forecasts. Marking to Market: Forward contracts are not subject to marking to market. investors and traders need tools to select and analyze the right data from the vast amounts of data available to them to help them make good decisions. Disclosure : In forward contracts. Futures contracts are subject to marking to market in which the loss or profit is debited or credited in the margin account on daily basis due to change in price. Kolkata-9339238834 Ph. Organised exchanges: Forward contracts are traded in over the counter market. since the models typically focus on the near future and rarely provide point or range estimates.8 hours trading sessions Other Distinction between forward and futures contracts are as follows: 1. The Best FM Faculty Of India (ii)the need to forecast factors that have an immediate impact on exchange rates.

the biggest tea brand of Europe by TATA Tea of India at 271 million pounds. The success of the entire operation depends on their acquirer company’s abilty to improve the performence of the unit. a smaller company gains control of a larger one. Recent example: India has experienced a number of buyouts and leveraged buyouts .In ordinary case. exercise cost controls and liquidate disposable asset. the high fixed financial costs can jeopardize the venture.3 billion . Takeovers weed out or discipline such managers.This “discipline of debt” can force management to focus on certain initiatives such as divesting non-core businesses. (e)Leveraging: as the debt ratio increases. as lenders are usually in a better position to collect their money. It was one of the biggest cross border acquisition by an Indian Company. While some leveraged buyouts involve a company in its entirety most involve a buisness unit of a company. therefore. litigation. (b)The risk associated with a leveraged buyout is that of financial distress. shareholders. (b) The firm should have a relatively low level of debt and a high level of bankable assets that can be used as loan collateral.Ph.and unforeseen events such as recession. (c) It must have a stable and predictable cash flows that are adequate to meet interest and principle payment of the debt and provide adequate working capital. Another recent example of a leveraged buyout is Tata Steel ( India ) acquiring Corus ( United Kingdom ) for $11. is not an act but a habit. this can cause significant problems for employees and suppliers. After the buyout. 40 Write a short note on Buyouts ? or Write a short note on LBO ? Meaning : A Leveraged buy-out (LBO) is an acquisition of a company in which the acquisition is substantially financed through debt. (e)If the company does fail following an LBO. technical default (the violation of the terms of a debt covenant) or outright liquidation. 9911442626 Covering 20 Marks 39 CA Aaditya Jain cafinalmafa@yahoo. in a ‘Reverse Takeover’. the LBO is likely to fail and the company may go bankrupt. (f)Acquiring Company pay less taxes because interest payments on debt are tax-deductible Critics of Leveraged buy-outs : (a)The major risk of the leveraged buyout is bankruptcy of the acquired company. (f)Another disadvantage is that paying high interest rates on LBO debt can damage a company’s credit rating. An attractive candidate for acquisition through leveraged buyout should possess three basic attributes : The Best solid profit history (a) If firm have a good position in its industry with a FM Faculty Of Indiaand reasonable expectations of growth. Large interest and principal payments can force management to improve performance and operating efficiency. A successful example of LBO is the acquisition of Tetley brand.If the company’s cash flow and the sale of assets are insufficient to meet the interest payments arising from its high levels of debt. Typical advantages of the leveraged buy-out method include: (a)Low capital or cash requirement for the acquiring entity (b)Synergy gains. Typically in the LBO 90% or more of the purchase price is financed with debt. or changes in the regulatory environment can lead to difficulties meeting scheduled interest payments. 41 What is a Takeover by Reverse Bid or Reverse Takeover? Meaning : It is the act of a smaller company gaining control over a larger one . the company invariably becomes a Private Company. (c)Leveraged buyouts can harm the long-term competitiveness of firms involved (d)Attempting an LBO can be particularly dangerous for companies that are vulnerable to industry competition or volatility in the overall economy. (g)Finally. (d)Improved Leadership and Management :Sometimes managers run companies in ways that improve their authority (control and compensation) at the expense of the companies’ owners. curtail its buisness risk. the equity portion of the acquisition financing shrinks to a level at which a private equity firm can acquire a company by putting up anywhere from 20-40% of the total purchase price. Aaditya Jain QUESTION NO. by expanding operations outside own industry or business. it is possible that management may propose an LBO only for short-term personal profit. If they fail to do so. The concept of takeover by reverse We are what we repeatedly do. Excellence. cost cutting or investing in technological upgrades that might otherwise be postponed or rejected outright. There are no gains without pains . and long-term strength. downsizing. the company taken over is the smaller company. (c)Efficiency gains by eliminating the value-destroying effects of excessive diversification.com QUESTION NO.

(d) Mismatch Risk : There are occasions when it is difficult for the swap dealer to find a perfect match for a counter-party. (e) Sovereign Risk: Sovereign risk arises when the government of a country to which one of the two counter-party belongs. But the risk can be reduced if the swap dealer does not have a naked position and passes on the risk to another counter-party. On the contrary. The swap dealer may have to pay more interest. (i) the assets of the transferor company are greater than the transferee company.etc. Aaditya Jain QUESTION NO. the risk will be still higher. maturity. the quantum of risk will be very large. These different forms of risks as follows: (a) Interest-rate Risk : Interest-rate risk arises when the interest rate on a particular loan fails to keep abreast of the movement of the market interest rate. namely. The other needs payment which the swap dealer has to make. (b) Exchange-rate Risk : Changes in the exchange rate are a common affair in the foreign exchange market. the swap dealer has to face a variety of risks. and if you have the ability to laugh at it you have the ability to enjoy it. If the swap dealer pays fixed rate of interest on a loan denominated in a currency which is going to depreciate. The aim was to give the company an identity of a ‘Universal Banking Company’. it takes a small part of the interest payment flow. Since the principal amount is large. and in exchange it receives LIBOR. termination of the contract does not protect the swap dealer from loss. It is the governmental restriction that comes in the way. reset dates. In such cases. especially when it has a naked position in the swap. (larger unit) to form ICICI Bank Ltd. For this role. But it does carry risk at least between two reset dates when the interest rate of a particular loan may not be reset despite changes in the market interest rates. This is because the contract is terminated only with one counter-party. such as notional principal. But. (ii) equity capital to be issued by the transferee company pursuant to the acquisition exceeds its original issued capital. It should not be called to default risk or credit risk because the counter-party is willing to make payments.Most Important New Course Theory Question Delhi-9911442626 . perfect match is not available on different counts. is thus not the usual case of amalgamation of a sick unit which is non-viable with a healthy or prosperous unit but is a case whereby the entire undertaking of the healthy and prosperous company is to be merged and vested in the sick company which is non viable. If LIBOR moves to the swap dealer’s disadvantage. it will have to pay a greater amount of interest to the end-user. The Best FM Faculty Of India Indian Example: A recent example of a non-sick unit ‘reverse merger’ was that of ICICI Bank (smaller unit) merging with ICICI Ltd. Life is tough. When a perfect match is not available. . 43 What is the role of Financial Advisor in PSU? (May 2001) (May 2007)(May2010) We make our own fortunes and call them fate. (f) Delivery Risk: Delivery risk arises when the two counter-parties are located in two different time zones so that the date of maturity differs by one day. to exploit economies of scale. the contract is terminated. on the other hand. it will have to pay more in form of interest. Sometimes after giving concessions. swap coupon. But if they are negatively correlated or uncorrelated. If the two risks are positively correlated. the risk will not be so high. Any such concession causes loss to it. This entails upon payments received by the swap dealer. Tests For Indentifying Takeover by Reverse Bid : The three tests in a takeover by reverse bid that are required to be satisfied are. puts restrictions on the flow of foreign exchange.floating interest rate should not be risky because it changes with the changing profile of the money market. However. Application of the concept of ‘takeover by reverse bid’ The concept of takeover by reverse bid has been successfully employed in schemes formulated for revival and rehabilitation of sick industrial companies under the Sick Industrial Companies (Special Provisions) Act 1985. Thus it can be said that the fixed loans under the swap carry higher risk. the role of swap dealer is significant in so far as it brings together two counter-parties whose interests are complementary to each other. or of reverse merger. Kolkata-9339238834 Ph. even a small percentage of the interest payment adds considerably to its profit. QUESTION NO. Here it may be noted that if the swap dealer faces both the interest-rate risk and the exchange-rate risk simultaneously. the swap dealer is not very much affected by it. However. 9911442626 40 CA Aaditya Jain bid. The swap dealer is faced with the interest-rate risk. 42 Explain the various types of risks to which the Swap Dealer is exposed to ? (RTP May 2010) In the process of swap. to enjoy better trading advantages and other similar reasons. (c) Credit Risk : Credit risk arises when a counter-party defaults payment to the swap dealer. the swap dealer offers concessions to attract suitable counter-party. and (iii) the change of control in the transferee company through the introduciton of a minority holder or group of holders. Suppose the swap dealer pays fixed-rate interest to the counter-party. Takeover by reverse bid could happen where already a significant percent of the shareholding is held by the transfer company.

It gives the investors a real access to the market. (ii) Formulation of a programme to provide most effective cost-volume profit relationship.” When one uses a debit card. Rating agencies determine the pre-dominance of positive / negative aspects under each of these five categories and these are factored in for making the overall rating decision. consistency. There is an increase in the trust and confidence of invetors. 44 Write a short note onThe Best FM FacultyIn Credit Rating ? CAMEL MODEL Of India CAMEL Stands for Capital. He functions as the principal advisor to the chief executive of the enterprise on all financial matters. but operate like cash or a personal cheque. 7. 3. team-work. (iv) Examination of feasibility studies & detailed project reports from the point of view of overall economic viability of the project. Fixed dividend component for preference shares and fluctuating dividend component for equity shares and adequacy of long term funds adjusted to gearing levels. also get an advantage of viewing various charts and creating their own strategies.Debit cards are accepted at many locations. effectiveness and appropriateness of decision making along with directing management to achieve corporate goals. They can put their trades as it gives the advantage of the real time live rates and real time transactions. linkage of asset values to turnover.com The financial adviser occupies an important position in all public sector undertakings (PSU). appropriation of methods of depreciation and adequacy of charge to revenues. timeliness. management and the ability of the corporate to meet their commitment in the short run. QUESTION NO. (c) Management – Extent of involvement of management personnel. 46 Write a short note on Debit Cards ? Meaning : Debit cards are also known as cheque cards. (b) Assets – Revenue generating capacity of existing / proposed assets. Earnings and Liquidity. Trade privacy is a key point which online trading offers. (e) Liquidity – Effectiveness of working capital management. (d) Earnings – Absolute levels. (v) Conduct of special studies with a view to reduce costs and improve efficiency and profitability.Ph. 2. QUESTION NO. fair values.” . 5. retail stores. The CAMEL model adopted by the Rating Agencies deserves special attention. 6. One can use his card anywhere. 4. adaptability to cyclical fluctuations ability of the entity to service existing and additional debts proposed. When one uses a debit card his money is quickly deducted from his savings account. gasoline stations. and I want to make it burn as brightly as possible before handing it onto future generations. technological / physical obsolescence. one is subtracting his money from his own bank account. (iii) Analysis of financial results of all operations and recommendations concerning future operations. it focuses on the following aspects: (a) Capital – Composition of Retained Earnings and External Funds raised. Online trading has a great speed transparency at a very low cost. Management. Debit cards look like credit cards or ATM (automated teller machine) cards. Debit cards allow him spend only what “Life is no brief candle to me. 9911442626 Covering 20 Marks 41 CA Aaditya Jain cafinalmafa@yahoo. These five aspects form the five core bases for estimating credit worthiness of an issuer which leads to the rating of an instrument. The committee on public sector undertakings has specified the following functions and responsibilities for a financial adviser: (i) Determination of financial needs of the firm and the ways these needs are to be met.” Debit means “subtract. They can stream news and researsh. both large and small which has resulted in increased online traders. Aaditya Jain QUESTION NO. Difference Between Debit Cards and Credit Cards :It’s the difference between “debit” and “credit. Assets. trends.authority. It is a sort of splendid torch which I have got a hold of for the moment. corporate policies for stock and creditors. ageing and recoverability of monetary assets viz receivables and its linkage with turnover. and restaurants.They offer an alternative to carrying a cheque book or cash. 45 What are the Advantages of Online Trading ? 1. Investors can have benefit of direct access to stock analysis. Size. including grocery stores. stability. Since trading is totally internet based they get direct access to their trading platform from any place and any computer in the world. ability of issuer to raise further borrowings.

(2) Using a debit card instead of writing cheques saves one from showing identification or giving his personal information at the time of the transaction. and netted." . in other states or countries wherever the card brand is accepted. (3) Hold on to the receipts from debit card transactions. A thief may get name and debit card number from a receipt and order goods by mail or over the telephone. only the differential is paid. a forward rate agreement (FRA) is a forward contract in which one party pays a fixed interest rate.In other words. Also.Debit cards are different from credit cards. A 9 X 12 FRA has a contract period beginning nine months hence.Most Important New Course Theory Question Delhi-9911442626 . with (A) representing the number of months until the loan is set to begin. To find the length of the loan. Settlement On Net Basis Over Notional Basis : The payments are calculated over a notional amount over a certain period. report the loss immediately to the financial institution.” a debit card is to “pay now. Use Of Debit Cards/Precaution to be taken while using Debit Cards : (1) If the card is lost or stolen. subtract A from B. A forward rate agreement (FRA) is a cash-settled forward contract on a shortterm loan. Objective :The aim of a FRAs is to safeguard the interest charges for a future period. The buyer of an FRA will receive (pay) cash when the actual interest rate at settlement is greater (less) than the exercise/ "Life is not measured by the number of breaths we take. Never keep PIN number with the card. set to begin 1 month in the future.(Reference Rate) How It Is Quoted : FRAs are quoted in the format AxB. Aaditya Jain QUESTION NO. memorizing is required. report it immediately to his financial institution. (6) The debit card is a quick. (4) If one has a PIN number. Don’t forget that your debit card may allow you to access money that you have set aside to cover a cheque which has not cleared your bank yet. (5) Never give PIN number to anyone. The card does not have to be missing in order for it to be misused. Payoff formula :The netted payment made at the effective date is: Notional Amount Of Loan x (Rate At Expiration or LIBOR or Reference Rate  FRA or Fixed Rate)  Days in Underly ing Rate or FRA Days 360 Days in Underly ing Rate or FRA Days 1  Rate At Expiration or LIBOR or Reference Rate  360 Buyer Of An FRA : The payer of the fixed interest rate is also known as the borrower or the buyer.A Forward Rate Agreement is an agreement between two parties to settle the difference between an agreed level of interest(FRA Rate) and an actual future level of interest. and (B) representing the number of months until the loan ends.” Benefits of Debit Cards : (1) Obtaining a debit card is often easier than obtaining a credit card. While a credit card is to “pay later. i. such as phone number or birthday date. never choose a PIN number that a smart thief could figure out. (4) Using a debit card means he no longer has to stock up on traveller’s cheques or cash when he travels (5) Debit cards may be more readily accepted by merchants than cheques. For Example : A 1 x 4 quote would mean a 3 month loan.FRA is very popular method of hedging interest rate risk. and receives a floating interest rate and vice versa . giving one no grace period.e. The buyer of an FRA agrees to pay a fixed-rate coupon payment (at the exercise/contract rate) and receive a floating-rate payment against a notional principal amount at a specified future date. but by the moments that take our breath away. “pay now” product. (7) Keep your receipts in one place – for easy retrieval and better oversight of your bank account. The buyer hedges against the risk of rising interest rates. 9911442626 42 CA Aaditya Jain is in his bank account. (6) Always know how much money you have in your account. (3) Using a debit card frees him from carrying cash or a cheque book. 47 Write a short note on Forward Rate Agreements?[Also Refer Class Register for its practical part] Meaning: In finance. Keep the PIN private. Kolkata-9339238834 Ph. Agreement to borrow or lend at a specified future date at an interest rate that is fixed today. The Best FM Faculty Of India (2) If one suspects his card is being fraudulently used. ending 12 months hence.

especially in historically high and volatile interest rate countries. generally from Euro500. Such an agreement is termed a 1x4 FRA because it fixes the interest rate for a deposit to be placed after one month and maturing four months after the date the contract is negotiated. being less interest-rate sensitive on the whole than financial institutions. but as candles to be lit. The forward rate agreement provides corporate treasurers with approximately the same hedging benefits of futures.Ph.000 or the equivalent upwards. he can close out his FRA by taking out a reversing FRA (an equal and opposite FRA at a new price). Users of FRAs : 1. FRA's are used by corporates for the following broad purposes: To lock in the cost of borrowing on an existing floating-rate loan. sterling. If the customer’s view of the market changes. 2. investors are offered an Vision is the art of seeing the invisible. To guarantee the rate of interest a company has to pay on future draw downs. Usually. Start The Best FM agreed by the two parties to the contract. An FRA can therefore be dates. . a borrower issues a fixed-rate bond which he may call at par from the investor at a specific date(s) in the future. where FRAs are commonly used to hedge against the risk of rising interest rates by a company with a borrowing. but offers much greater flexibility. The price of the reversing FRA will reflect the market rate for the period at the time of closing the hedge. French francs. In return for the issuer having the right to call the bond issue at par. With a callable bond. Customers can transact for any period over one month. An FRA achieves approximately the same result as futures or forward contracts. Guilders and Australian dollars. but with none of the technical and administrative difficulties. FRAs are far more widely used than futures by corporates. We must view young people not as empty bottles to be filled. Example:The following example illustrates the mechanics of a transaction involving an FRA. The seller of an FRA agrees to make a floating-rate payment and receive a fixed-rate payment against a notional principal amount at a specified future date. FRAs are widely used by corporates.463. • a $1 million notional principal. and • settlement in one month. -FRAs are available in any amount. However.do not place such a high value on the facility futures offer of being in and out of the market in minutes.and are now available in a broad range of currencies. The customer agrees a future rate with a bank and at the beginning of the specific period (value date).Suppose two banks enter into an agreement specifying: • a forward rate of 5 percent on a Eurodollar deposit with a three-month maturity. Deutschemarks. -FRAs are widely quoted out to two years in Europe and US. No initial or variation margins are involved. including ‘broken’ or non-standard dates. 9911442626 Covering 20 Marks 43 CA Aaditya Jain cafinalmafa@yahoo. Banks are also heavy users of the FRA market. The most common use of FRAs by banks is to iron out mismatches in the short-term structure of their assets and liabilities.com contract rate (specified fixed-rate). In general. a customer may have to pay a wider spread for a broken-date FRA (such as 11/2 on 41/2). such as the UK and Australia. if 90-day LIBOR turns out to be 6 percent on the contract maturity date the buyer would receive = $2. If the three-month LIBOR is 6 percent on the contract settlement date. with details confirmed directly between themselves.05 Aaditya Jain QUESTION NO.Swiss Francs. interest periods and notional principal amount areFaculty Of India exactly tailored to suit a customer’s specific requirements.06(90/360)] = $2. including US dollars. To guarantee the interest rate earned on surplus funds for any period. Seller Of An FRA : The receiver of the fixed interest rate is the lender or the seller. the seller would owe the buyer the difference between 6 and 5 percent interest on $1 million for a period of 90 days. The seller hedges against the risk of falling interest rates. The seller of an FRA will receive (pay) cash when the actual interest rate at settlement is less (greater) than the exercise rate. Thus.500  [1 + 0. Main features of the FRA : The main features of the FRA as follows: An FRA is a simple agreement between two parties. Yen. this is because corporates. receives or pays a cash sum representing the interest differential between the agreed rate and LIBOR. 48 What do you know about swaptions and’their uses ? ( May 2010 4 Marks) Swaptions first came into vogue in the mid-1980s in the US on the back of structured bonds tagged with a callable option issued by borrowers.

The Best FM Faculty Of India -A receiver swaption gives the owner of the swaption the right to enter into a swap where they will receive the fixed leg. if any -frequency of settlement of payments on the underlying swap Uses Of Swaptions Swaptions can be applied in a variety of ways for both active traders as well as for corporate treasurers. 9911442626 44 CA Aaditya Jain enhanced yield. . Swaptions are useful to borrowers targeting an acceptable borrowing rate. when the yield curve is flat or negative). on the other hand. A business would certainly find it useful to bid on a project with full knowledge of the borrowing rate should the contract be won.e. It is designed to give the holder the benefit of the agreed upon strike rate if the market rates are higher. Swaptions also provide protection on callable/putable bond issues. if the swaption is not exercised by maturity it expires worthless. The buyer and seller of the swaption agree on: -the premium (price) of the swaption -the strike rate (equal to the fixed rate of the underlying swap) -length of the option period (which usually ends two business days prior to the start date of the underlying swap). a holder of a payer’s swaption can guarantee to pay a maximum fixed rate on a swap. Swaptions are also useful to those businesses tendering for contracts. 49 List and briefly explain the main functions of an investment bank.and to the owner of the put or call. -the term of the underlying swap. The converse is true if the holder of the swaption receives the fixed rate under the swap agreement. A swaption gives the buyer the right but not the obligation to pay (receive) a fixed rate on a given date and receive (pay) a floating rate index. Swap traders can use them for speculation purposes or to hedge a portion of their swap books. Swap also provide arbitrage opportunity. Swaptions have become useful tools for hedging embedded optionality which is common to the natural course of many businesses.e.Most Important New Course Theory Question Delhi-9911442626 . Businesses need to settle the question whether to commit to borrowings in the future in their own currency in terms of a tender on a future project. and pay the floating leg. (b) American Swaptions. Their services include: (i)Issue of IPO/issue management – public as well right issues – equity as well debt (a) advisory services – timing.The more innovative borrowers can use this arbitrage opportunity to their advantage in order to bring down their funding cost. also the flexibility to exercise or not. They provide total financial services at one-stop shop. size & composition and pricing of issue (b)preparation of offer documents with due care & diligence and compliance of legal formalities (c) offering the securities to the public/ shareholders(d) underwriting of the Your attitude. not your aptitude. as may be considered appropriate. will determine your altitude The difference between the ordinary and the extraordinary is the little extra. other business entities. -amortization. governments and government agencies. non-profit organizations and high net worth individuals. give the buyer the right to exercise at any time during the option period. The borrower is therefore allowed to remain in low floating-rate funds while at the same time being assured of protection should rates increase expectedly (i. depending upon the exercise rights of the buyer: (a) European Swaptions give the buyer the right to exercise only on the maturity date of the option. Swaptions fall into three main categories. Aaditya Jain QUESTION NO. -notional amount. thereby hedging his floating-rate borrowings. (May 2010) Investment banking provides all the financial services to the corporate. Like any other option. when the yield curve is positive) or unexpectedly (i. The attraction of swaptions for corporate treasurers is that the forward element in all swaptions provides the attractions of the forward-start swap. There are two types of swaption contracts: -A payer swaption gives the owner of the swaption the right to enter into a swap where they pay the fixed leg and receive the floating leg. If the strike rate of the swap is more favorable than the prevailing market swap rate then the swaption will be exercised. It is therefore a valuable tool when a borrower has decided to do a swap but is not sure of the timing. (c) Bermudan Swaptions give the buyer the right to exercise on specific dates during the option period. Kolkata-9339238834 Ph. with the flexibility to enter into the current market swap rate if they are lower. By paying an upfront premium.

Parties Involved In Credit Card Transaction : Every transaction on a credit card involves three parties : (1) The credit card issuer (2) The credit cardholder and (3) The party to whom the cardholder is supposed to pay. A person who holds a credit card need not pay in cash at the time of every expenditure. due diligence.This type of offering is called a follow-on offering. and economies (vii)Management of investment portfolios – cash rich companies place their surplus cash with the investment banks for investing in various securities for obtaining appropriate return and maintaining the risk at affordable levels. Advantages & Disadvantages: Advantages : (i) They allow you to make purchases on credit without carrying around a lot of cash. (ii)Management of buy back of shares – Buy back is used by cash rich companies to (a) increase the value of shares(b)avoid hostile takeover(c) delisting the shares(d) optimization of the capital structure.but that it is too low & we reach it. (iii) They allow convenient remote purchasing . This allows you a lot of flexibility. either by making acquisitions or by internal growth. not the full loan amount. or a secondary offering. (ii) They allow accurate record-keeping by consolidating purchases into a single statement. (viii) Trading in the securities. Examples of MO are : a departmental store. supplementary cards and travel assistance. financial institutions (b) preparation of information memorandum (c)presentation of information memorandum (d)negotiating the terms (e) smooth completion of transaction (iv)Private placement of equity as well debt (a)preparation of Information MemorandumThe Best FM Faculty Of India (b)legal compliances – particularly in case of listed companies (c)placement of the securities to high net worth individuals. (xi)Issue of Debt : Aaditya Jain QUESTION NO. airlines etc. the IPO process consists of these three major phases: hiring the mangers. . hotel. to meet the expenditures. (iv) Under certain circumstances. (vi) Many cards offer additional benefits such as additional insurance cover on purchases.com securities(e) ensuring smooth completion of the issue (f) Post issue services – allotment. exercise of Greenshoe option From an investment banking perspective. 9911442626 Covering 20 Marks 45 CA Aaditya Jain cafinalmafa@yahoo. financial institutions and other buyers like Private equity (v)Amalgamations and Absorptions (a)Advisory services (b)Valuation of both the companies for deciding the swap ratio (c)Legal compliances – meetings of share holders. Instead. (ix) Securitization Debt. They allow you to pay for large purchases in small. the competition in this business has made credit cards a source of short-term finance also for individuals. air miles and discounts on holidays.(e)Compliance of the provisions of Company Law and SEBI regulations(f)Smooth completion of the buy back (iii)Loan syndication (a) negotiation with loan provides like banks.Ph. (x) Follow-on offering of stock :A company that is already publicly traded will sometimes sell stock to the public again. filing petition with High court (d)Liaison with stock exchange(s) for listing of the securities issued as purchase consideration and delisting of the shares of the amalgamated company (e) Ensuring completion deal (vi)Research and develop opinions on securities. 50 Write a short on Credit Cards As A Part Of Consumer Finance ( May 2008 ) Meaning : Credit cards are primarily seen as a means of convenience in meeting ones expenses. say the merchant outlet (MO). One reason for a follow-on offering is the same as a major reason for the initial offering: a company may be growing rapidly.ordering/shopping online or by phone. (vii)Beside this. cash back. markets. The greatest danger for most of us is not that our aim is too high & we miss it. and marketing. monthly installments. he can deposit a lump sum in the bank or the agencies of which he holds the credit card. but anyone can start today and make a new ending. railways. the credit-card may also expend the benefit of roll over credit.Credit Cards are a good substitute for cash and the resultant safety and convenience. and may simply require additional capital. (v) They are cheaper for short-term borrowing . they allow you to withhold payment for merchandise which proves defective.interest is only paid on the remaining debt. (viii) Credit cards enable a person to track and document all his expenses (ix) It is safer to carry Credit Cards rather than cash as it provides 100% safety of cash against theft Disadvantages: Nobody can go back and start a new beginning.

) ARCIL pays discounted amount to ICICI SPV (ARCIL) Now SPV holds an asset i. These are generally sold to investors through merchant bankers. 9911442626 46 CA Aaditya Jain (i) You may become an impulsive buyer and tend to overspend because of the ease of using credit cards.e. This pool is transferred in favour of a SPV . and resolve.e. investigate. By way of securitisation. The securities carry a coupon and an expected maturity. and market it in the secondary market to investors. (iv) The use of a large number of credit cards can get you even further into debt. which may be traded later in the open market. Kolkata-9339238834 Ph. The investors interested in this type of securities are generally institutional investors like And in the end. they are held in the originators’ portfolios. introduces an element of risk as the card details may fall into the wrong hands resulting in fraudulent purchases on the card. (ii) Credit cards are a relatively expensive way of obtaining credit if you don't use them carefully. In other words Debt/Asset securitisation is a method of recycling of funds. bank. SPV recovers loan from Y Ltd and repays bonds and interest to investors Steps involved in a Securitisation Process : The basic debt securitisation process can be classified in the following three functions. the bank can break the entire portfolio of loan/debt of Rs. Debt Securitisation will thus provide liquidity to the instrument. The Best FM Faculty Of India Aaditya Jain The digrame bellow illustrates the process of Scuritisation in India Originator (ICICI Bank) ICICI securitises loan to SPV i. 10 lakhs each to 300 borrowers as part of its loan portfolio. (iii) Lost or stolen cards may result in some unwanted expense and inconvenience. (i) The Origination Function : A borrower seeks a loan from a finance company. which can be asset based or mortgage based. especially because of the high interest rates and other costs.Most Important New Course Theory Question Delhi-9911442626 . 30 crores into a paper of Rs. Fraudulent or unauthorized charges may take months to dispute. It's the life in your years" -. Later. recovery rights from Y. (v)Using a credit card. SPV issues bonds often referred to as Pass through certificates on this asset to general investers or QIBs to raise money for paying the Orginator. especially remotely.Abraham Lincoln The best way to make your dreams come true is to wake up. Once the assets are transferred. The total debt thus on the books of the bank will be Rs. Process : For example a bank lends Rs.(Special Purpose Vehicle). housing company or a lease from a leasing company. (ii) The Pooling Function : Similar loans or receivables are clubbed together to create an underlying pool of assets. . Ltd. it's not the years in your life that count. 30 crores. 300 each for instance. (iii) The Securitisation Function : It is the SPV’s job now to structure and issue the securities on the basis of the asset pool. The creditworthiness of the borrower is evaluated and a contract is entered into with repayment schedule structured over the life of the loan. which acts as a trustee for the investor. ARCIL Lends money to Borrower (Y Ltd.Securitisation is the process by which financial assets are transformed into securities . 52 Write a short note on Debt Securitisation?or What are the advantages of Debt Securitisation?OR What is securitisation? What are its various instruments ?OR Write a short note on Asset Securitisation (May 10) Meaning : Securitisation is a process of pooling and repackaging homogeneous illiquid financial assets into marketable securities that can be sold to investors. 1 4 General Investers or QIBs 2 3 5 6 SPV receives money on bonds issue. QUESTION NO. Cards can encourage the purchasing of goods and services you cannot really afford. Securitisation is a process of transformation of illiquid assets into security.

riskiness and any other factors of the enterprise. Some common methods of venture capital financing are as follows: (i) Equity Financing The venture capital undertakings generally requires funds for a longer period but may not be able to provide returns to the investors during the initial stages.The Industrial Credit and Investment Corporation of India (ICICI) as well as other private financial companies have been trying similar deals for lease rentals. 2.e loans secured by a mortgage of specified immovable property . Pay Through Securities (PTS) and Stripped Securities. cash flow patterns. (iii) The Investor : These are the entities that are looking for investment opportunity for their surplus funds.Housing and Urban Development Corporation. The assets are shifted off the balance sheet. Hence such a mode is useful since there is no compulsion to pay dividend or interest in initial stages. Parties involved in Securitisation Process : (i) The Originator : This is the entity in whose books the assets .Ph. In India venture capital financers charge royalty ranging between 2 and 15 per cent. trade receivables etc . It converts illiquid assets to liquid portfolio. Though the investor bears the credit risk.They buy the securities issued by SPV and get returns in the form of interest and principal repayment as per agreed schedule. 3.The experiment has already been initiated in India by the Housing Development Finance Corporation (HDFC) by selling a part of its loan to the Infrastructure Leasing and Financial Services Ltd.com mutual funds. the venture capital finance is generally provided by way of equity share capital. Therefore.The first securitisation deal was structured by Citibank in 1991. (ILFS) and has therefore become a pacesetter for other kinds of debt securitisation as well. Benefits to the Investor : 1. (iv) Other Parties : Obligators. (ii) Mortgage Backed Securities :These are the securities where the assets collaterised are mortgage loans i. 4.LIC Housing and HDFC have emerged as key players in the securitisation market . Securitisation helps to convert a stream of cash receivables into a source of long-term finance. (i) Asset Backed Securities : These are securities backed by other assets like credit card receivable . Recent Scenario : In Indian context Debt Securitisation has began to take off.. No interest is paid on such loans.e who buys the assets to be securitised & then issues marketable securities backed by those assets. Aaditya Jain QUESTION NO. Agent and Trustee. Rating Agencies.National Housing Bank. Methods of Venture Capital Financing : The venture capitalist generally finance ventures which are in national priority areas such as energy conservation. 3. It facilitates better balance sheet management as assets are transferred off balance sheet facilitating satisfaction of capital adequacy norms. insurance companies etc. (ii) Conditional Loan : A conditional loan is repayable in the form of a royalty after the venture is able to generate sales. 4. 9911442626 Covering 20 Marks 47 CA Aaditya Jain cafinalmafa@yahoo. Instruments of Securitisation :Under this process securities issued by SPV are in the form of Pass Through Certificate (PTC).In broad sense. originate. Administrator. Securities may be Asset Backed Securities and Mortgaged The Best FM Faculty Of India Backed Securities . (ii) Special Pupose Vehicle (SPV) : This is the entity through which the securitisation transaction is actually operated i. The originator’s credit rating enhances. asset finance and real estate finance companies. Securities are rated by Credit Rating Agencies and it becomes easier for an investor to compare risk return profile and make an informed choice. the securities are tied up to definite assets. to be securitised .under venture capital financing venture capitalist make investment to purchase equity or debt securities from inexperienced entrepreneurs who undertake highly risky ventures with a potential of success. thus giving the originator recourse to off balance sheet funding. 53 What are the methods of Venture Capital Financing(VCF)? Meaning : The Venture Capital Financing refers to financing of new high risky ventures promoted by qualified entrepreneurs who lack experience & funds to give shape to their ideas. The equity contribution of venture capital firm does not exceed 49% of the total equity capital of venture capital undertakings so that the effective control and ownership remains with the entrepreneur. Some Venture Being defeated is often a temporary condition. 2. etc. actual rate depends on factors such as gestation period. Benefits to the Originator : 1. Average people talk about things. Small people talk about other people. Giving up is what makes it permanent Great people talk about ideas. For the investor securitisation opens up new investment avenues. . The ideal candidates for this are hire purchase and leasing companies. quality upgradation.

Aaditya Jain QUESTION NO.e debt or equity.Capital profit may also be distributed as dividends if articles permit. (iv) Participating Debenture : Such security carries charges in three phases . Total VC Investments in the first nine months of 2009 is at $201 million against $709 million investment for the corresponding period last year. The entrepreneur has to pay both interest and royalty on sales but at substantially low rates. it will need funds for expanding activities and permanent working capital. dividend is to be paid out of current profits or past profit after providing for depreciation. (iii) Access to the Capital Market : By paying large dividends. SEAF India Investment & Growth Fund. Limitations Of Venture Capital Financing : (i) Availability of Venture Capital is limited in practice & it depends mostly on the personal contacts of the entrepreneurs. (ii) Liquidity : Payment of dividends means outflow of cash. but remember that your education still continues . (iii) Income Note : It is a hybrid security which combines the features of both conventional loan and conditional loan. The following are the criteria which may be applied to find out the eligibility of an undertaking for Venture Capital Financing (i)The venture must be a technically feasible proposition(ii)It should be commercially viable(iii)The entreprenuers must be technically competent & having manegerial skill (iv)The undertaking must have a long run competitive advantage over other units Benefits Of Venture Capital Financing : (i) This is the only feasible source of funds available for new enterprising projects . after that.in the start up phase. a high rate of interest is required to be paid. since bank loan & public issues are quite difficult at start up stage . 54 What are the Constraints on Paying Dividends ? (i) Legal : Under Section 205(1) of the Companies Act 1956. IFCI Venture Capital Funds Limited (IVCF). (ii) It is a very expensive source of finance and also dilutes managerial control of the entrepreneur.5% of the projects cost for commercial application of indigenous technology. Central Government can allow a company to pay dividend for any financial year out of profits of the company without providing for depreciation if it is in public interest.A statement issued by Infosys said the venture capital fund would encourage and support young entrepreneurs having brilliant business ideas. cash position is affected. the country saw over 71% drop in Venture Investments this year. Infosys Technologies co-founder and chairman NR Narayana Murthy recently sold company shares worth around $37 million to set up a venture capital fund for incubating Indian start-ups. 55 What are the Differences between Primary & Secondary Markets? Basis (a)Meaning Primary Markets A primary market refers to the set up Secondary Markets The secondary market is market for subsequent Behind every great achievement is a dreamer of great dreams.The important overseas venture capital funds operating in India are : Walden International Investment Group. Your schooling may be over.” it added.Most Important New Course Theory Question Delhi-9911442626 . 9911442626 48 CA Aaditya Jain capital financers give a choice to the enterprise of paying a high rate of interest (which could be well above 20 per cent) instead of royalty on sales once it becomes commercially sounds .therefore has a sound cash position. QUESTION NO. Gujarat Venture Finance Limited (GVFL).The Fund will primarily invest in India and may on a case-to-case basis consider investing overseas. Dividend is to be paid in cash . So it is not in a position to declare dividends. next stage a low rate of interest is charged upto a particular level of operations. BTS India Private Equity Fund Limited. control is diluted.This news has come as big boost for the market and especially budding entrepreneurs. Payment of dividends may be withheld and earning utilised for financing firm’s investment opportunities. nor are funds tied up in permanent working capital and. The Best FM Faculty Of India (ii) There is flexibility in structuring the mode of finance i.In fact. So. with more Venture Funds we can see the revival of venture investments in India soon. SIDBI Venture Capital Limited (SVCL). it is better to pay dividends and raise external funds whenever necessary for such opportunities. (iv) Investment Opportunities : If investment opportunities are inadequate. Ability to pay dividends depends on cash and liquidity position of the firm. Example of Indian Venture Capital Funds : Some of the important Indian venture capital funds are : ICICI Venture Funds Ltd. Kolkata-9339238834 Ph. no interest is charged. If new shares have to be issued to raise funds for financing investment programmes and if the existing shareholder cannot buy additional shares. A mature company does not have much investment opportunities. (iii)Tax concessions available for VCF help in promoting and increasing the availability of venture capital . For a growth oriented company inspite of good profits. IDBl’s VCF(Venture Capital Fund) provides funding equal to 80 -87.

its responses to new issues increase when share values are rising and vice versa. the stock exchanges would refuse listing facilities to them. economically. An Investment in knowledge always pays the best interest. Their mutual interdependence from the economic point of view has two dimensions. and are offered for the first time to the investors. It also provides investors the opportunity to change their portfolio as and when they want to change. QUESTION NO.Functions of the stock exchanges can be summarized as follows: (a) Liquidity and Marketability of Securities: The basic function of the stock market is the creation of a continuous market for securities.Ph. If the new issues do not conform to the prescribed stipulations. i. This requirement obviously enables the stock exchange to exercise considerable control over the new issues market and is indicative of close relationship between the two. It is a market for old securities which have been issued already. enabling them to be liquidated. Due to nearly perfect information. (b)Nature of Securities (c)Sale/ Purchase (d)Nature of Financing (e)Liquidity which helps the industry to raise funds by issuing different types of securities. It has neither any tangible form nor any administrative organisational set up. These securities are negotiable and transferable.com sale/purchase and trading in the securities. they can at any time sell one security and purchase another. Government and public bodies raise funds from the equity market. thus lending liquidity and marketability to the securities. It provides funds to new enterprises & also for expansion and diversification of the existing one. Securities are purchased and sold by the investors without any involvement of the companies. i. because most of us are fighting a hard battle. (b) Fair Price Determination: This market is almost a perfectly competitive market as there are large number of buyers and sellers. Be kind to one another. The new issues of securities which seek stock quotation/listing have to comply with statutory rules as well as regulations framed by the stock exchanges. securities which were not previously available. . The quantitative predominance of old securities in the market usually ensures that it is these. (c) Mutual Interdependence : The markets for new and old securities are. They are traded and change hands from one investor to the other without affecting the long-term availability of funds to the issuing companies. the behavior of the stock exchanges has a significant bearing on the level of activity in the primary market and. 57 What are the functions of the Stock Exchanges? The Stock Exchange is a market place where investors buy and sell securities. 56 What are the Similarities between Primary and Secondary Market ? (a) Listing : One aspect of inseparable connection between them is that the securities issued in the primary market are invariably listed on a secondary market (recognized stock exchange) for dealings in them. (c) Source for Long term Funds: Corporates.thus giving them marketability. Secondary market has physical existence in the form of stock exchange and are located in a particular geographical area having an administrat-ve organisation set up. (b) Control : The stock exchanges exercise considerable control over the organization of new issues. an integral part of a single market . It does not supply additional funds to the company since the company is not involved in transaction The secondary market provides facilities for the continuous purchase and sale of securities. Securities are acquried from issuing Companies themselves. where investors can convert their securities into cash at any time at the prevailing market price.the capital market.e. It does not lend any liquidity to the securities Aaditya Jain The Best FM Faculty Of India (f)Organisational Difference It is not rooted in any particular spot and has no geographical existence. The second dimension of the mutual interdependence of the two parts of the market is that the prices of new issues are influenced by the price movements on the stock market. therefore. The practice of listing of new issues on the stock market is of immense utility to the potential investors who can be sure that when they receive an allotment of new issues. which set the tone of the market as a whole and govern the prices and acceptability of the new issues. This ensures the fair price to be determined by demand and supply forces. One. 9911442626 Covering 20 Marks 49 CA Aaditya Jain cafinalmafa@yahoo.e. active bidding take place from both sides. It deals with new securities. QUESTION NO. they will subsequently be able to dispose them off any time in the Stock Exchange.

Most Important New Course Theory Question Delhi-9911442626 ; Kolkata-9339238834

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(d) Helps in Capital Formation: They are the nexus between the savings and the investments of the community. The savings of the community are mobilized and channeled by stock exchanges for investment into those sectors and units which are favoured by the community at large, on the basis of such criteria as good return,appreciation of capital, and so on. (e) Reflects the General State of Economy: The performance of the stock markets reflects the boom and depression in the economy. It indicates the general state of the economy to all those concerned, who can take suitable steps in time. The Government takes suitable monetary and fiscal steps depending upon the state of the economy. QUESTION NO. 58 Write a short note on Bollinger Bands ?[Also Refer Class Register for its practical part] Bollinger Bands are a technical analysis tool invented by John Bollinger in the 1980s. Having evolved from the concept of trading bands, Bollinger Bands can be used to measure the highness or lowness of the price relative to previous trades. When stock prices continually touch the upper Bollinger band, the prices are thought to be overbought; conversely, when they continually touch the lower band, prices are thoughtBest FM Facultytriggering a buy signal.In other words The closer the prices The to be oversold, Of India move to the upper band, the more overbought the market, and the closer the prices move to the lower band, the more oversold the market. A band is plotted two standard deviations away from a simple moving average. Because standard deviation is a measure of volatility, bollinger bands adjust themselves to the market conditions. When the markets become more volatile, the bands widen (move further away from the average), and during less volatile periods, the bands contract (move closer to the average). The tightening of the bands is often used by technical traders as an early indication that the volatility is about to increase sharply. Standard deviation is a statistical unit of measure that provides a good assessment of a price volatility.The higher the standard deviation, the more the security’s price fluctuates from its average price. Bollinger Bands consist of: (i)a middle band (ii)an upper band (iii) a lower band.In other words Bollinger Bands consist of a moving average and two standard deviations charted as one line above and one line below the moving average. The line above is two standard deviations added to the moving average. The line below is two standard deviations subtracted from the moving average.

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Formula : The Bollinger band formula consists of the following: BOLU = MA (TP, n) + m * SD [TP, n] BOLD = MA (TP, n) - m * SD [TP, n] Where,BOLU = Upper Bollinger Band ; BOLD = Lower Bollinger Band ;n = Smoothing Period ;m = Number of Standard Deviations (SD) which is generally 2;SD = Standard Deviation over Last n Periods Typical Price (TP) = (HI + LO + CL) / 3 Note:If Typical Price is not given we can use Closing Price. Bollinger recommends using a 20-day simple moving average for the center band and 2 standard deviations for the outer bands.The default choice for the average is a simple moving average. The technician can be relatively certain that almost all of the price data needed will be found between the two bands.
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Bollinger Bands serve two primary functions: -To identify periods of high and low volatility -To identify periods when prices are at extreme, and possibly unsustainable, levels. Using Bollinger Band “Bands” To Gauge Trends: Bollinger bands are one of the most popular technical indicators for traders in any financial market - stocks, bonds or foreign exchange (FX). Many traders use them primarily to determine overbought and oversold levels,selling when price touches the upper bollinger band and buying when it hits the lower bollinger band. In range-bound markets, this technique works well, as prices travel between the two bands like balls bouncing off the walls of a racquetball court. A Word of Caution! Bollinger bands are a useful tool - but need combining with other indicators, as with any single indicator, they should not be used in isolation.

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QUESTION NO. 59 Write a note on Arbitrage Pricing Theory(APT)?[Also Refer Class Register for its practical part] Unlike the CAPM which is a single factor model, the APT is a multi factor model having a whole set of Beta Values – one for each factor. Arbitrage Pricing Theory states that the expected return on an investment is dependent upon how that investment reacts to a set of individual macro-economic factors (degree of reaction measured by the Betas) and the risk premium associated with each of those macro – economic factors. The APT developed by Ross (1976) holds that there are several factors which explain the risk premium relationship of a particular security. Several factors being identified e.g. inflation and money supply, interest rate, industrial production and personal consumption have aspects of being inter-related. In APT Expected Return = R f  11   2 2   3 3   4 4
1 ,  2 ,  3 ,  4 are average risk premium for each of the four factors in the model and 1 ,  2 ,  3 ,  4 are measures of sensitivity of the particular security to each of the four factors.Rf is the Risk Free Rate of Return.

QUESTION NO. 60 Write a short note on Hedge Funds ? Hedge Fund is an aggressively managed portfolio of investments that uses advanced investment strategies such as leverage, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark). In other words,A hedge fund is a fund that can take both long and short positions, use arbitrage, buy and sell undervalued securities, trade options or bonds, and invest in almost any opportunity in any market where it foresees impressive gains at reduced risk. Benefits Of Hedge Funds :There are many advantages of hedge funds. Some of the important advantages are: (a) Many hedge fund strategies have the ability to generate positive returns in both rising and falling equity and bond markets. (b) Inclusion of hedge funds in a balanced portfolio reduces overall portfolio risk and volatility and increases returns. (c) Huge variety of hedge fund investment styles – many uncorrelated with each other – provides investors with a wide choice of hedge fund strategies to meet their investment objectives. Academic research proves hedge funds have higher returnsn and lower overall risk than traditional investment funds. (d) Hedge funds provide an ideal long-term investment solution, eliminating the need to correctly time entry and exit from markets. (e) Adding hedge funds to an investment portfolio provides diversification not otherwise available in traditional investing. Main Features Of Hedge Funds :The key characteristics of hedge funds can be stated as follows: (a) Hedge funds utilize a variety of financial instruments to reduce risk, enhance returns and minimize the correlation with equity and bond markets. Many hedge funds are flexible in their investment options (can use short selling, leverage, derivatives such as puts, calls,options, futures, etc.). (b) Hedge funds vary enormously in terms of investment returns, volatility and risk. Many,but not all, hedge fund strategies tend to hedge against downturns in the markets being traded. (c) Many hedge funds have the ability to deliver non-market correlated returns.

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(d) Many hedge funds have as an objective consistency of returns and capital preservation rather than magnitude of returns. (e) Most hedge funds are managed by experienced investment professionals who are generally disciplined and diligent. (f) Pension funds, endowments, insurance companies, private banks and high net worth individuals and families invest in hedge funds to minimize overall portfolio volatility and enhance returns. (g) Most hedge fund managers are highly specialized and trade only within their area of expertise and competitive advantage. (h) Hedge funds benefit by heavily weighting hedge fund managers’ remuneration towards performance incentives, thus attracting the best brains in the investment business. In addition, hedge fund managers usually have their own money invested in their fund. Hedging Strategies:Wide ranges of hedging strategies are available to hedge funds. For example: (i) Selling Short : Selling shares without owning them, hoping to buy them back at a future date at a lower price in the expectation that their price will drop. (ii) Using Arbitrage : Seeking to exploit pricing inefficiencies between related securities -for example, can be long convertible bonds and short the underlying issuer’s equity. (iii) Trading Options or Derivatives : Contracts whose values are based on the performance of any underlying financial asset, The Best FM Faculty Of India index or other investment. (iv) Investing in Anticipation of a Specific Event : Merger transaction, hostile takeover,spin-off, exiting of bankruptcy proceedings, etc. (v) Investing in Deeply Discounted Securities : Of companies about to enter or exit financial distress or bankruptcy, often below liquidation value. (vi) Many of the strategies used by hedge funds benefit from being non-correlated to the direction of equity markets. Hedge Funds Industry Scenario Of The World :The hedge funds industry around the world is estimated to be $300-$400 billion and is growing at about 20% per year with between 4,000 and 5,000 active hedge funds. Reasons For Investing In a Hedge Fund : There are two basic reasons for investing in a hedge fund: to seek higher net returns (net of management and performance fees) and/or to seek diversification. (a) Potential for Higher Returns, Especially in a Bear Market: If your outlook is bearish, hedge funds should be an attractive asset class compared to buy-and-hold or long-only mutual funds. (b) Diversification Benefits: Many institutions invest in hedge funds for the diversification benefits. If you have a portfolio of investments, adding uncorrelated (and positive-returning) assets will reduce total portfolio risk. Hedge funds employ derivatives, short sales or non-equity investments tend to be uncorrelated with broad stock market indices. Demerits Of Hedge Funds (i)Hedge fund investors are exposed to multiple risks, and each strategy has its own unique risks. For example, long/short funds are exposed to the short-squeeze.The traditional measure of risk is volatility, that is, the annualized standard deviation of returns. (ii)Fat Tails Are The Problem:The problem is that hedge fund returns do not follow the symmetrical return paths implied by traditional volatility. Instead, hedge fund returns tend to be skewed. Specifically, they tend to be negatively skewed, which means they bear the dreaded “fat tails”, which are mostly characterized by positive returns but a few cases of extreme losses.

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QUESTION NO. 61 Write a note on "Credit Rating" in India?OR Briefly explain the meaning and importance of "Credit Rating"? Write a short note on Credit Rating Process ? Meaning Credit Rating is an act of assigning values to credit instruments by assessing the solvency i.e. the ability of the borrower to repay debt.Thus Credit Rating is: (1) An expression of opinion of a rating agency.(2) The opinion is in regard to a debt instrument.(3) The opinion is as on a specific date.(4) The opinion is dependent on risk evaluation.(5) The opinion depends on the probability of interest and principal obligations being met timely. What Credit Rating do not indicate It may be noted that credit rating is only an opinion and not the guarantee or protection against default.It is not a recommendation to buy, or sell, or hold a security.Thus Credit Rating does not in any way linked with (1) Performance Evaluation of the rated entity unless called for.(2) Investment Recommendation by the rating agency to invest or not in the instrument to be rated.(3) Legal Compliance by the issuer-entity through audit.(4) Opinion on the holding company, subsidiaries or associates of the issuer entity. Credit Rating in India (i) CRISIL (Credit Rating & Information Services of India Ltd.) (ii) ICRA ( Investment Information

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The rating may change for the better or for the worse. (4) Pronouncement of the rating – If the rating decision is accepted by the issuer. its competitors and markets are taken into consideration. nothing on earth can help the man with the wrong mental attitude. adequacy of information and validity of the rating score. 9911442626 Covering 20 Marks 53 CA Aaditya Jain cafinalmafa@yahoo. . (2) Rating Committee – On the basis of information obtained and assessment made the team of analysts present a report to the Rating Committee. business strategies. (7) Confidentiality of information – As the information provided by the issuers is very sensitive in nature. the rating agencies carry out an annual review with the issuer for updating of the information provided. infrastructure and energy projects.(d) Limiting dependence on information from third parties viz auditors. an opportunity of being heard is given to him. it may lead to the listing of the specified debenture rating under this policy.(b) Rationale and Sensitiveness behind the ratings being made public.If the issuer disagrees.Ph.(c) Publication of the limitations of rating. domestic subsidiaries of foreign entities. CRISIL was the first credit rating agency in India.com and Credit Rating Agency of India )(iii) CARE (Credit Analysis and Research Limited)(iv)Fitch Ratings India (P) Ltd. Structured ratings are given to MNCs based on guarantees or Letters of Comfort and Standby Letters of Credit issued by the banks. financial policies and short/long term outlook of performance. Credit Rating Process (1) Request from issuer and analysis – A company approaches a rating agency for rating a specific security. experts. Areas covered are : historical performance. transport. incorporated in 1987 jointly by ICICI and the UTI. All ratings are placed under constant watch. (10) Rating Scores – A comparative summary of Rating Score used by four rating agencies in India is given below. (8) Rating Credibility – The rating agencies follow a thorough and transparent evaluation so as to lend credibility to their findings. business risk profile. (9) Rating Coverage – Ratings are not limited to specific instruments. They also include public utilities. The issuer may reject a rating and the rating score need not be disclosed to the public. trustees.Thomas Jefferson . The policies followed are (a) Clear and Specific ideas for a rating score. Issuers appealing against a rating decision are asked to submit relevant material information. Also factors such as industry in which the issuer operates. financial institutions. the rating agencies are required to keep them strictly confidential and cannot use such information for any other purpose. The to participate in this Of India nature of credit evaluation depends on the type of information provided by the issuer. The rating agencies have also launched Corporate Governance Ratings with emphasis on quality of disclosure standards and the extent to which regulatory obligations have been complied with. competitive position. In cases where no change in rating is required. Sample of Rating Scores Debentures CRISIL ICRA CARE FITCH Highest Safety AAA LAAA CARE AAA (L) AAA (ind) High Safety A A LAA CARE AA (L) AA (ind) Adequate Safety A L A CARE A (L) A (ind) Moderate Safety BBB LBBB CARE BBB (L) BBB (ind) Inadequate Safety B B LBB CARE BB (L) BB (ind) High Risk B LB CARE B (L) B (ind) Substantial Risk C LC CARE C (L) C (ind) Default D LD CARE D (L) C (ind) Fixed Deposits Aaditya Jain Nothing can stop the man with the right mental attitude from achieving his goal. The team of analysts makes an assessment of the issuer’s prospects in the light of information available from management.(f) Withdrawing the ratings after expiration of the tenure and following a strict policy of not disclosing the rejected ratings except when required. Rating Watch is followed by a full scale review for confirming or changing the original rating. (3) Communication to management and appeal – The Rating decision is communicated to the issuer and then supporting the rating is shared with the issuer. If a corporate which has issued a 5 year 8% debenture merges with another corporate or acquires another corporate. (5) Monitoring of the assigned rating – The rating agencies monitor the on-going performance of the issuer and the economic environment in which it operates.The Rating Committee reviews the decision although such a review may not alter the rating. A team of analysts interact with the company’s management and gathers necessary information. consultants. The issuer is not allowedThe Best FM Faculty process as it is an internal evaluation of the rating agency. (6) Rating Watch – Based on the constant scrutiny carried out by the agency it may place a rated instrument on Rating Watch. Special Purpose Vehicles. the rating agency makes a public announcement of it.(e) Not carrying out a rating exercise on an unsolicited basis. CRISIL has pioneered the concept of Credit Rating in India.

Netting the Asset Values :The asset values obtained from above have to be adjusted as follows : Additions Deductions for Liabilities Dividends and Interest accrued Expenses accrued Other receivables considered good Liabilities towards unpaid assets Other assets (owned assets) Other short term or long term liabilities Computation of NAV :The funds net assets are defined as the assets less external liabilities. "You've got to get up every morning with determination if you're going to go to bed with satisfaction. Fixed Income Securities Current Yield." . There are three aspects which need to be highlighted : (i) It is the net value of all assets less liabilities. They have to be kept under rating watch. Rating should be left optional and the corporate should be free to decide that in the event of self rating.Other Liabilities Example : If total assets of a scheme are Rs. NAV represents the market value of total assets of the Fund less total external liabilities attributable to those assets. 200 lacs and liabilities are Rs. nothing has been The Best FM Faculty Of India left out. over-react to existing conditions which come from optimistic / pessimistic views arising out of up / down turns. it becomes a must for entities rather than carrying out Cost Benefit Analysis. in the disclosure of assumptions leading to a specific public rating. (5) Corporate Governance Issues – Special attention is paid to (a) Rating agencies getting more of its revenues from a single service or group. 9911442626 54 CA Aaditya Jain MAAA MAA MA CAREAAA CAREAA CAREA TAAA TAA TA (SFM Nov 2009) Highest Safety High Safety Adequate Safety FAAA FAA F A QUESTION NO. NAV today will not be NAV tomorrow or day later. Symbolically : NAV = Net asset of the scheme/Number of units outstanding Where net assets of the scheme is defined as :Net Assets of the Scheme = Market value of investments + Receivables + Other accrued income + other assets . (2) Industry Specific rather than Company Specific – Downgrades are linked to industry rather than company performance. All listed and traded securities Closing Market Price (other than those held as not for sale) Debentures and Bonds Closing traded price or yield Illiquid shares or debentures Last available price or book value whicheveris lower. the NAV Niney-nine percent of failures come from people who have the habit of making excuses. (ii) NAV changes daily.g. Aaditya Jain QUESTION NO. 63 Write short note on NAV (Net Asset Value)?[Also Refer Class Register for its practical part] Meaning : It is the amount which a unit holder would receive if the mutual fund were wound up. NAV Asset Valuation Rule Nature of Asset Valuation Rule Liquid Assets e.Accrued Expenses . Downgrading of an instrument may not be timely enough to keep investors educated over such matters. 20 lacs and there are 10 lacs unit holders.(c) Greater transparency in the rating process viz. Estimated Market Price approach to be adopted if suitable benchmark is available. (4) Conflict of Interest – The rating agency collects fees from the entity it rates leading to a conflict of interest. The value of assets and liabilities changes daily. (3) Cost Benefit Analysis – Rating being mandatory.(b) Rating agencies enjoying a dominant market position engaging in aggressive competitive practices by refusing to rate a collateralized / securitized instrument or compelling an issuer to pay for services rendered. An investor in mutual fund is a part owner of all its assets and external liabilities. Rating market being competitive there is a distant possibility of such conflict entering into the rating system. Agencies give importance to macro aspects and not to micro ones.It is the basis for assessing the return that an investor has earned.Most Important New Course Theory Question Delhi-9911442626 . cash held As per books. Kolkata-9339238834 Ph. 62 Write a short note on Limitations Of Credit Rating ? (1) Rating Changes – Ratings given to instruments can change over a period of time.Other Payables . (iii) NAV is computed as a value per unit of holding.

the IBPC scheme has not become a popular money market instrument. and so also in the interest. While the participation without risk can be issued for a period not exceeding 90 days. especially the S&P 500 futures contract. Uses of Stock Index Futures: Investors can use stock index futures to perform myriad tasks. Current Scenario : Despite its advantages. 1982. Secondly due to the absence of a ceiling on the interest rate the borrower bank has to pay the issuing bank a rate higher than that agreed with the borrower. 18 55 CA Aaditya Jain cafinalmafa@yahoo. Benefits : The scheme is beneficial both to the issuing and participating banks. To implement a hedge. 65 What are the reasons for stock index futures becoming more popular financial derivatives over stock futures segment in India ? (May 2010 6 Marks) Trading in stock index futures contracts was introduced by the Kansas City Board of Trade on February 24. sells or transfers to a third party (transferee) a part or all of a loan made to its clients (borrowers). and risk of default on a proportionate basis. (iii)to separate market timing from market selection decisions. Some common uses are: (i)to speculate on changes in specific markets.But They Remember How Well You Did It. 9911442626 Covering 20 Marks per unit is Rs. classified standard during the currency of the participation.The IBPC with risk can also be used for capital adequacy management. Types : The participation can be issued in two types. viz.In April 1982. The introduction of both contracts was successful. A bank having the highest loans to total asset ratio and liquidity bind can square the situation by issuing IBPCs. the PC holder participates in a bank loan. The Best FM Faculty flexibility Objective: The primary objective is to provide some degree ofOf India in the credit portfolio of banks & to smoothen the consortium arrangements. the Chicago Mercantile Exchange (CME) began trading in futures contract based on the Standard and Poor’s Index of 500 common stocks. the instruments in the cash and futures markets should have similar price movements. adopted by most institutional investors.In other words The Inter Bank Participation Certificates are short term instruments to even out the short term liquidity within the Banking system particularly when there are imbalances affecting the maturity mix of assets in Banking Book. The certificates are neither transferable nor prematurely redeemable by the issuing bank. (v)Using Indexes to Hedge Portfolio Risk: Aside from the above uses of indexes. In India. " Mothers are not paid for their work because it is priceless . whereby the investors seek to gain profits whenever a futures contract is trading out of line with the fair price of the securities underlying it. The issuing bank can secure funds against advances without actually diluting its asset-mix.Ph. it provides an opportunity to deploy the short term surplus funds in a secured and profitable manner. with and without risk to the lender. Why it is called so ? : It is called a participation certificate because through it. the security of the loan. Aaditya Jain QUESTION NO. Stock index futures add flexibility to his or her portfolio as a hedging and trading instrument.One of the reason for this may be the prohibition against transferability as the participants are not allowed to transfer the certificates. Who can Issue & Subscribe: The IBPC can be issued by scheduled commercial bank and can be subscribed by any commercial bank. Issued against underlyng Advance : The IBPC is issued against an underlying advance.com QUESTION NO. Interest Rate:The interest rate on IBPC is freely determined in the market. investors often use stock index futures to hedge the value of their portfolios. 64:Write a short note on INTER-BANK PARTICIPATION CERTIFICATE (IBPC) ? Meaning : A IBPC is a deed of transfer through which a bank. (ii)to change the weightings of portfolios. and (iv)to take part in index arbitrage. To the lender. " People Forgets How Fast You Did A Job . Main reasons to trade stock index futures are: (i)Add flexibility to one’s investment portfolio. Participation with risk can be issued for a period between 91 days and 180 days. both the NSE and the BSE have introduced index futures in the S&P CNX Nifty and the BSE Sensex.

Whether one is speculating. " I would like to sign off with a prayer to the Almighty-"God! Give me the courage to do whatever is possible. 67 Highlight the importance of due diligence in M&A ? In the past. Movements of the index represent the average returns obtained by investors in the stock market. (iv)There is no time value erosion of the futures position.50 Two important market indices Sensex and Nifty are two important share indices in India. various authors have emphasized the importance of due diligence in M&A. The base value of the index has been set at 1000. An Index is calculated with reference to a base period and a base index value. or temporarily substituting futures for a later cash transaction. The concept of due diligence has many dimensions such as:Due diligence is research.30 crores . It is calculated on a free-float market capitalization methodology. Sensex is an index number that measures the relative average change in prices of 30 shares listed in the Bombay Stock Exchange Ltd (BSE).A market Index acts as a barometer for market behavior. the market capitalization is Rs. is that one can sell contracts as readily as he or she can buy them and the amount of margin required is the same. Index calculation is based on the weighted aggregate method . in general. It is also calculated on a free-float market capitalization methodology. 6. Opening Index  Closing Market Capitalization 6.04. arm negotiators.Most Important New Course Theory Question Delhi-9911442626 .Weaknesses in the due diligence process may cause an M&A to fail.50 crores. a small change in the index level might produce a profitable return on one’s investment if he or she is right about the market’s direction. Aaditya Jain QUESTION NO. A stock market index is created by selecting a group of stocks that are representative of the whole market or a specified sector.2008 .2008 amount to Rs. (vi)Sell as easily as one can buy. 5. The base of the index is the close of prices on November 3. 66 How is a stock market index calculated? Indicate any two important market indices. its purpose in M&A is to support the valuation process.. and inform the planners of post-merger integration. Stock index futures give individual the opportunity to get into or out of a position whenever he or she wants. 5 crores is taken as base and equated to 100 and at day end market capitalization amounts to Rs.e Opening Index  Closing Market Capitalization 5. then the index value would be 126.30  110   126 Opening Market Capitalization 5.serenity to know what is not possible and the wisdom to know the difference" . Share market indexes (also called as indices) are meant to capture the overall behavior of equity markets.50  100   110 Opening Market Capitalization 5. (vii) Transfer risk quickly and efficiently. One of the major advantages of futures markets.00 If at the end 02. Because a relatively small amount of margin money controls a large amount of capital represented in a stock index contract. QUESTION NO. How is the index calculated : A share price Index is used to monitor and measure the share price movements over a period of time as compared to the base year. test the accuracy of representations and warranties contained in the merger agreement. It is the opposite of negligence. most stock index futures trades can be accomplished quickly and efficiently.. fulfill disclosure requirements to investors. looking for insurance protection (hedging). (v) Maintain one’s stock portfolio during stock market corrections. (iii) Provide hedging or insurance protection for a stock portfolio in a falling market. The base year of SENSEX is 1978-79 and the base value is 100.(May 2010) The Best FM Faculty Of India [Also Refer Class Register for its practical part] Stock Market Index is representative of the entire stock market.2008 will be 110 . Nifty tracks the performance of equity share of 50 important companies listed on NSE. Kolkata-9339238834 Ph.04. i. 9911442626 56 CA Aaditya Jain (ii)Create the possibility of speculative gains using leverage. 1995. then the index at the end of 01.04. The appropriate formula is : Today' s Market Capitalisation  Yesterday's Index Point Yesterday's Market Capitalisation Example : If the market capitalization of 10 securities ( considered to be the index ) as at the beginning of 01. .

and local tax rules. the target company’s compliance with tax laws and regulations should be examined. 1. A rise in interest rates during the term of an investor’s debt security hurts the performance of stocks and bonds. you may lose money if the Canadian dollar depreciates in relation to the American dollar. Market risk applies mainly to stocks and options. investment promotional agency and investment incentives. 7. investment price. business risk involves the variability in earnings due to variation in the cash inflows and outflows of capital investment projects undertaken. As an example. Balance sheet and cash flow hedges as well as derivatives tools mitigate financial risks by reducing uncertainty faced by firms.Financial Risk: It is the potential loss or danger due to the uncertainty in movement of foreign exchange rates. Deciding the potential return while respecting risk is the age-old decision that investors must make. future technological changes. Aaditya Jain QUESTION NO.Country risk applies to stocks. 2.Where as Aim requires sleepless efforts to fulfill . the degree of compliance with the acquirer’s ethical guidelines. . credit quality. The Best FM Faculty between (v)Cultural and ethical issues: These cover cultural differencesOf India the acquirer and target companies and how to deal with these differences. This risk. Foreign exchange risk applies to all financial instruments that are in a currency other than your domestic currency.Ph. and whether the target company is in compliance with government regulations.Business Risk: On a micro scale. This type of risk is most often seen in emerging markets or countries that have a severe deficit. options and futures that are issued within a particular country. (iii)Marketing issues: These include strengths and weaknesses of products and services provided by the target company and their domestic and foreign competition. 69 Write a short note on Netting ?[Also Refer Class Register for its practical part] Meaning : Exposure Netting refers to offsetting exposures in one currency with Exposures in the same or another currency.Dreams requires sound sleep to see . foreign laws and regulations. 3. may materialize because of forecasting errors made in market acceptance of products. 4.commodity price.Interest Rate Risk: It refers to the change in the interest rates. QUESTION NO. When a country defaults it can harm the performance of all other financial instruments in that country as well as other countries it has relations with. 6. and financing capabilities. by seeking out capital projects and merger candidates that have a low or negative correlation with its present operations. even if the share value appreciates. (ii) Financial and tax issues: These include examining accounting records and reports to determine whether the target companies are in compliance with generally accepted accounting principles. Government bonds have the least amount of default risk and least amount of returns while corporate bonds tend to have the highest amount of default risk but also the higher interest rates. if you are a resident of America and invest in some Canadian stock in Canadian dollars. In addition. as well as the unpredictability of sales price. or equity price. 9911442626 Covering 20 Marks 57 CA Aaditya Jain cafinalmafa@yahoo.Country Risk: This refers to the risk that a country would not be able to honour its financial commitments. foreign banking and credit agencies. interest rates. 5. bonds.Market Risk: It is the day-to-day fluctuations in a stocks price.Credit or Default Risk: This is the risk that a company or individual will be unable to pay the contractual interest or principal on its debt obligations.com A due diligence process should focus at least on the following issues: (i) Legal issues: These include examining documents of asset ownership and associated liabilities. stocks tend to perform well during a bull market and poorly during a bear market. 8. The firm can reduce this risk. (iv)Cross-border issues: These include foreign currency exchange risks. This type of risk is of particular concern to investors who hold bonds within their portfolio. accounting principles.Political Risk: This represents the financial risk that a country’s government will suddenly change its policies. As a whole. where exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by There's only one difference between Dream and Aim. 68 What are the various types of Foreign Exchange Risk ? There are several types of risk that an investor should consider and pay careful attention to. Also referred to as volatility. also known as investment risk. and the exposure to liabilities and legal proceedings on unethical conduct such as patent and copyright violations. price fixing and others. growth.Foreign Exchange Risk: When investing in foreign countries one must consider the fact that currency exchange rate can change the price of the asset as well. liquidity position.” and bonds with higher chances of default are considered to be junk bonds. also referred to as portfolio risk.and changes in costs related to projects. Bonds with lower chances of default are considered to be “investment grade. mutual funds.

the total payments are $ 780 Thousands. This type of system calls for the consolidation of information and net cash flow positions for each pair of subsidiaries. US dollar and entered in the following matrix. 9911442626 58 CA Aaditya Jain gains or losses on the second currency exposure. A more complex situation arises among the parent firm and several subsidiaries paving the way to multinational netting system. It transfers or receives the balance on the position of it being a net receiver or a payer thereby resulting in savings in transfer / exchange costs. There is a co-ordinated international interchange of materials. Inter Subsidiary Payments Matrix (US $ Thousands) Receiving affiliate Paying affiliate France Germany UK Italy Total France — 40 60 100 200 Germany 60 — 40 80 180 UK 80 60 — 70 210 Italy 100 30 60 — 190 Total 240 130 160 250 780 Without netting. UK and Italy. But in a bilateral netting system subsidiary X would pay subsidiary Y only $10 million. (2) Multilateral Netting System – Each affiliate nets all its inter affiliate receipts against all its disbursements. For an effective multilateral netting system.Most Important New Course Theory Question Delhi-9911442626 . P $50Million Aaditya Jain $50Million Q R Example : The netting system uses a matrix of receivables and payables to determine the net receipt / net payment position of each affiliate at the date of clearing.” Charles Schwab . Through multinational netting these transfers will be reduced to $ 100 Thousands. (3) Improves cash flow forecasting since net cash transfers are made at the end of each period The Best FM Faculty Of India (4) Gives an accurate report and settles accounts through co-ordinated efforts among all subsidiaries There are two types of Netting : (1) Bilateral Netting System – It involves transactions between the parent and a subsidiary or between two subsidiaries. Also currency conversion costs are significantly reduced. Netting helps in minimising the total volume of inter-company fund flow. Objective :The objective of the exercise is to offset the likely loss in one exposure by likely gain in another. Kolkata-9339238834 Ph. The amounts due to and from the affiliates is converted into a common currency viz. The transformed matrix after consolidation and net payments in both directions convert all figures to US dollar equivalents to the below form : “The best place to start is where you are with what you have. A US parent company has subsidiaries in France. these should be a centralised communication system along with disciplined subsidiaries. Subsidiary P sells $ 50 million worth of goods to Subsidiary Q. If subsidiary X purchases $ 20 million worth of goods from subsidiary Y and subsidiary Y in turn buy $ 30 million worth of goods from subsidiary X. Thus bilateral netting reduces the number of foreign exchange transactions and also the costs associated with foreign exchange conversion. finished products and parts among the different units of MNC with many subsidiaries buying /selling from/to each other. Subsidiary Q sells $ 50 million worth of goods to Subsidiary R and Subsidiary R sells $ 50 million worth of goods to Subsidiary P. Through multilateral netting inter affiliate fund transfers are completely eliminated. Germany. It is a technique of optimising cash flow movements with the combined efforts of the subsidiaries thereby reducing administrative and transaction costs resulting from currency conversion. Advantages derived from netting system includes : (1) Reduces the number of cross-border transactions between subsidiaries thereby decreasing the overall administrative costs of such cash transfers (2) Reduces the need for foreign exchange conversion and hence decreases transaction costs associated with foreign exchange conversion. then the combined flows add up to $ 50 million. a net reduction of 87%.

Support and resistance levels can be identified by trend lines Sometimes to realize you were well. there is a buying pressure as all those investors who failed to buy at the lowest price would like to purchase the share. . that level becomes a resistance level. As the price of a stock drops down to a support level it tends to stop at that point. and an attempt to set newer levels. it tends to stop. that level becomes a support level.When a resistance level is successfully broken through. there is a selling pressure because all investors who failed to sell at the high would be keen to liquidate. 9911442626 Covering 20 Marks Netting Schedule (US $ Thousands) Receipt France 200 Germany 180 UK 210 Italy 190 59 CA Aaditya Jain cafinalmafa@yahoo. 70 Write a short note on Support and Resistance Levels ? Aaditya Jain Support and resistance is one of the most The Best FM concepts inIndia widely used Faculty Of trading.Support levels are based on past pricing and act like a floor for the price of stock. while whenever the price approaches the support level. the lowest value reached becomes the support level. When the index/price rebounds after reaching a trough subsequently. As the price rises up to a resistance level. Whenever the price approaches the resistance level. turn around and move higher.com Net Receipt — 50 50 —_ 100 Net Payments 40 — — 60__ 100_ Payment 240 130 160 250 QUESTION NO. so a life well spent brings happy death. Support levels indicate the price where the most of investors believe that prices will move higher. Similarly. when a support level is successfully broken through.Ph. turn around and move lower. The price is then expected to move between these two levels.Resistance levels act like a ceiling for the price of a stock. When the index/price goes down from a peak. the peak becomes the resistance level. As a well-spent day brings happy sleep. someone must come along and hurt you. A breach of these levels indicates a distinct departure from status quo. Resistance levels indicate the price at which the most of investors feel prices will move lower.

9911442626 60 CA Aaditya Jain QUESTION NO. QUESTION NO. capital market conditions and investor objectives and constraints are examined and the allocation that best serves the investor’s needs while incorporating the capital market forecast is determined. These two indices place different weights on the various commodities so they will be used according to the swap agent’s requirements. Types Of Commodity Swaps :There are two types of commodity swaps: fixed-floating or commodity-for-interest. Aaditya Jain QUESTION NO.It is a swap in which at least one set of payments is based on the price of a commodity.General market indices in the international commodities market with which many people would be familiar include the Goldman Sachs Commodities Index (GSCI) and the Commodities Research Board Index (CRB).Commodity swaps are becoming increasingly common in the energy and agricultural industries.Most Important New Course Theory Question Delhi-9911442626 . where demand and supply are both subject to considerable uncertainty. optimal portfolio mixes based on returns. (a) Fixed-Floating Swaps: They are just like the fixed-floating swaps in the interest rate swap market with the exception that both indices are commodity based indices.These include the following factors for which we must account (at a minimum): (i) The cost of hedging (ii) The institutional structure of the particular commodity market in question (iii) The liquidity of the underlying commodity market (iv) Seasonality and its effects on the underlying commodity market (v) The variability of the futures bid/offer spread (vi) Brokerage fees (vii) Credit risk. Commodity swaps are characterized by some distinctive peculiarities. risk. Valuing Commodity Swaps :In pricing commodity swaps.Commodity swaps are used to lock-in the price of a commodity.Thinking of a swap as a strip of at-the-money forwards is also a useful intuitive way of interpreting interest rate swaps or equity swaps. (b) Strategic Asset Allocation : Under this strategy. 71 Write a short note on Commodity Swaps ? Meaning: A swap where exchanged cash flows are dependent on the price of an underlying commodity. more value means more ability to take risk. Software King Bill Gates was a dropout from Haward University . risk exposure for changing portfolio values (wealth) is adjusted. This is usually used to hedge against the price of a commodity. 73 What are the complexities involved in International Capital Budgeting ? Complexities Involved in International Capital Budgeting : (a) Cash flows from foreign projects have to be converted into the currency of the parent organization. The Best FM Faculty Of India (b) Commodity-for-Interest Swaps: are similar to the equity swap in which a total return on the commodity in question is exchanged for some money market rate (plus or minus a spread). investor’s risk tolerance is assumed constant and the asset allocation is changed based on expectations about capital market conditions. (c) Tactical Asset Allocation : Under this strategy. capital costs and administrative costs. The vast majority of commodity swaps involve oil. 72 Write a short note on Asset Allocation Strategies ? Many portfolios containing equities also contain other asset categories. so the management factors are not limited to equities. There are four asset allocation strategies : (a) Integrated Asset Allocation : Under this strategy. and co-variances is generated using historical information and adjusted periodically to restore target allocation within the context of the investor’s objectives and constraints. (b) Parent cash flows are quite different from project cash flows (c) Profits remitted to the parent firm are subject to tax in the home country as well as the host country (d) Effect of foreign exchange risk on the parent firm’s cash flow (e) Changes in rates of inflation causing a shift in the competitive environment and thereby affecting cash flows over a specific World’s richest . (d) Insured Asset Allocation : Under this strategy. Kolkata-9339238834 Ph. though. such as oil. we can think of the swap as a strip of forwards. each priced at inception with zero market value (in a present value sense).

Such a strategy is called Leading. However.that’s the way to live. 75 Write a short note on Leading And Lagging ? This technique is used by subsidiaries for optimizing cash flow movements by adjusting the timing of payments to determine expectations about future currency movements. 9911442626 Covering 20 Marks 61 CA Aaditya Jain cafinalmafa@yahoo. domestic firms find it difficult to avail such funds. (3) A multinational firm is confronted with foreign exchange risk due to the value of inflow/outflow of funds as well as the value of import/export are influenced by exchange rate variations. an important aspect of international working capital management becomes easier to handle. QUESTION NO. a multinational manager often finds it difficult to manage working capital of different units of the firm operating in these countries. 74 What are the complexities involved in International Working Capital? The Best FM Faculty management of working capital in an international firm is very Complexities Involved in International Working Capital :The Of India much complex as compared to a domestic one. MNCs should be aware of the government restrictions in such countries before availing of such strategies. Host country funds can be used if needed.com time period (f) Restrictions imposed on cash flow distribution generated from foreign projects by the host country (g) Initial investment in the host country to benefit from the release of blocked funds (h) Political risk in the form of changed political events reduce the possibility of expected cash flows (i) Concessions/benefits provided by the host country ensures the upsurge in the profitability position of the foreign project (j) Estimation of the terminal value in multinational capital budgeting is difficult since the buyers in the parent company have divergent views on acquisition of the project. Firms accelerate payments of hard currency payables and delay payments of soft currency payables in order to reduce foreign exchange exposure. (3) It is an aggressive technique aimed at taking advantage of expected revaluations and devaluations of currency movements. (2) Interest and tax rates vary from one country to the other.but dreams may die. A study of International Working Capital Management requires knowledge of Multinational Cash Management.The world is big and has lots to give. The technique helps to reduce foreign exchange exposure or to increase available working capital. .Pick up a new dream.donot get shatered . Live in your dreams. International Inventory Management and International Receivables Management. On the other hand. Funds flow from different units of the same firm. (2) It helps in minimizing foreign exchange exposure and helps in transferring liquidity among affiliates by changing credit terms and is dependent on the opportunity cost of funds to both paying and receiving units. Such a strategy is called Lagging. The reasons for such complexity are: (1) A multinational firm has a wider option for financing its current assets. if the Indian subsidiary expects the rupee to rise against the yen then it shall be the objective of that firm to delay the timing of its payment before the rupee appreciates. If the Indian subsidiary expects the rupee to fall against the yen. A MNC in the USA has subsidiaries all over the world. Restrictions imposed by the home or host country government towards movement of cash and inventory on account of political considerations affect the growth of MNCs. Approach is made from the international financial market.. never ever cry . This is not the case for domestic firms. then it shall be the objective of that firm to accelerate the timing of its payment before the rupee depreciates. (5) Intra flow of funds is available with multinational firms as cash positioning and cash mobilization. This is not possible for domestic firms..Ph. (4) With limited knowledge of the politico-economic conditions prevailing in different host countries.  MNCs accelerate (lead) or delay (lag) the timing of foreign currency payments through adjustment of the credit terms extended by one unit to another. Domestic firm limit their operations within the country and does not face such problems. The pace of development taking place in the communication system has to some extent eased this problem but it is still there very much. A subsidiary in India purchases its supplies from another subsidiary in Japan. A manager associated with a multinational firm has to consider the interest/ tax rate differentials while financing current assets. The advantages associated with Leading and Lagging are : (1) No formal recognition of indebtedness is required and the credit terms can be altered by increase / decrease of the terms on the accounts. Aaditya Jain QUESTION NO.

Your theory book is just marvellous.Most Important New Course Theory Question Delhi-9911442626 .No doubt I am getting immense knowledge from it but one more thing is there which I got from your book. Ashish P... 10 April.com> To: mafabycaaadityajain@yahoogroups. I have never seen such a simple and excellent presentation of any subject by any one.. now i am feeling very good & comfortable in MAFA even though i am not his regular student.. A very heartful thanks to you for publishing such a nice book..Your Study material is fantastic .U. Regards. I came across your book and I must complement you on writing an excellent book.He makes us understand the concepts in a very easy manner. 350.Before taking classes from sir i just used to target 45-50 in MAFA.Invest Bank.By taking classes by Aditya Jain Sir. Thank you sir.Sharjah. Kolkata-9339238834 Ph.com> To: cafinalmafa@yahoo.abhishekj@yahoo. Sector-4.Assistant Financial Controller. But now i am targeting much more. 26804 MAFA Marks-74 CS Inter-Roll No. I happened to read only your Suggested Compilation for June 2009 exam during my revision time.I would like to request you that please give some of your valuable suggestions to me for passing the exams in all the subjects.Fax :06-5681174 Wednesday. I am sure it will prove to be extremely helpful.ae> To: ca_kumaraaditya@yahoo. Thankyou Aaditya Jain NR Narayana Murthy. 2009 3:28 PM From: “Rajeev Nagpal” <rajeev@investbank. 25 February.com Addres: H. Sweta Kothari Kolkata THANKS FOR YOUR THEORY BOOK Wednesday. founder of Infosys.in This is Priyanka Agarwal from Kolkata..Rajeev Nagpal. Aditya Jain.most important thing for gaining courage and facing the exams. 2009 12:20 PM From: “Ashish Singla” <ashishsinglaca@gmail.I have heard that your classes are really awesome.com I stay in Kolkata.17926 Securities Market Paper-70 Marks DOB: 12th September 1985 Email: ca. Abhishek Jakhetiya CA Final-Roll No. India’s first software company started the company in 1981 with an initial capital of Rs.The Confidence. Im not regretting it one bit.com> To: ca_kumaraaditya@yahoo. 8 June.I have purchased ur theory book from Jayesh Sir and is extremely benefitted by it. I am badly stuck up in Group-I of C. Gurgaon-122001 Exam Completion in CA : May 2008 Comments on your Classes: Finally Delhi has got some good MAFA classes as well. that today.. I just want to thank sir for removing my fear for MAFA. Though he was good but i was always scared of MAFA. I have previously taken tutions for MAFA from a teacher.in Hello Aditya Sir.co.A.S . 9911442626 62 CA Aaditya Jain Positive Feedback About The Theory Books And Classes [mafabycaaadityajain] hello friends Friday.Mob : 050-4996818.Now I regret that why havenot I joined u. June 3.I would definitely ask all my friends to join your classes. I dont know how you did it.5694440 Ext. Thanks a lot for putting in such a diligent effort to compile the same..N 1391. 2009 5:46 PM From: “Sweta Kothari” <swetakothari@ymail. And.A.com Dear Mr.co. but so many questions came from your compilation (Which was obviously advantageous to me).I think there is not much chance that this mail shall come before your eyes because Im sending to a general id of yours BUT I believe youve made me one of your die hard word of mouth advertisers.  Tel : 06. I owe it to you.Head Office Finance Control Department.E.. Aaditya Jain Sir has not only made us fearless but also made us think of MAFA as a high scoring paper just as Accounts or Indirect Taxes. I can heave a sigh of relief after my MAFA Exam.. 2009 8:49 PM The Best FM Faculty Of India From: “Priyanka Agarwal” <priyans26186@gmail. Regards. (Final).000 . Thank you so much. Monday.    Regards..Actually when I did my MAFA classes I even didnot know your name.. I wish I could get your complete notes.I am appearing my CA finals in this June. 10.

Also Scored Rank 1 in PE-1 Roll No. 26804 MAFA Marks-74 & CS Inter-Roll No.Finally Delhi has got a good FM teacher.. Aaditya Jain -Surbhi Aggarwal.17926 Securities Market Paper-70 Marks Rank 36 Sourav Goenka :80 Mks in MAFA in May2008 Roll No. comprehend and revise it again and The Best FM mind.62937 with 92 Marks in Cost-FM..Ph.ITS JUST THE APPROACH THAT MATTERS . “I suggest the students to study the subjects not with the intention to mug up things but to gain knowledge.Final Attempt May10 Congratulating AMITA AGARWAL Roll No.His notes are really excellent and updated . 26804... MAFA Mks-85 in Nov2008 One Of All India Highest Abhishek Jakhetiya : CA Final-Roll No. Given that we have eight subjects you cannot cram all of them so the best way out is to understand.. 9911442626 Covering 20 Marks 63 CA Aaditya Jain cafinalmafa@yahoo....”I will further like to thank Aditya Sir to make my MAFA again so that it settles deep into your sub-conscious Faculty Of India conceptually clear. 01059 for scoring 87 Marks in M ay 08 i n M A FA O ne of A l l I ndi a H i ghest a st udent of Aaditya Jain Abhishek Kapuria Securing All India Rank 1 in ICFAI .MBA with 85 Marks in FM Subject an all India Highest Anjana Gupta CA Final-Roll No..Rank Holder in PE-1.. 3186 For Securing 87 Marks IAMNOWHERE And Many More. 23298 with 70 Marks in Cost-FM Shivangi Patil -All India 10th Rank in CA-PCC Roll No. 10415.com SSTARS OF Aaditya Jain’s FM Class Congratulating Surbhi Agarwal For Securing All India Rank 1 In CA Final -Nov 2008 Exam A Student Of Aditya Jain Sir From the Desk Of Surbhi Agarwal-All India Rank 1 I am excited and feeling great today…I must say that hard work and dedication is the path to success...Also completed CA Final MAFA from Aaditya Sir... 26120 with All India 16th Rank Sunny Jain-All India 27th Rank in CA-PEII Nov 08 Roll No. 25256 For Securing 89 Marks in MAFA One Of All India Highest In May 2009 CA Final Exam Dimpy Jindal All India in CA-PCC & All India 7th Rank in CA-CPT taking MAFA Classes From Aaditya Sir 1st Rank Also Congratulating DHARMENDRA SINGHAL Roll No. friends and of course my Teachers whose guidance and support has always been with me. I take this opportunity to thank my family. I AM NOWHERE I AM NOW HERE MAFA IS NOT TOUGH.PE-2 and Final Also Congratulating Amar Nilange Roll No.

. to see it through to the end -.to refuse to settle for anything less than your dream. But in order to make dreams come into reality.. The longer you hang in there. More than 4000 years ago in China..extensive coverage.I AM NOW HERE ..Her Student Archana Jhunjhunwala 15 years cleared her CA After of enrollment due to high score of 71 Marks In MAFA Roll No.My first CA Final Attempt was due in May2000 which i was unable to clear due to MAFA....I was unable to recover from that. From The Desk Of Aaditya Sir There will be many times when you will want to quit.. No matter how hard it seems. and effort.Now just because of MAFA I am a CA .I dedicated this success to my husband.examination oriented.my children and to one and only Aaditya Sir.I AM NOWHERE. it takes an awful lot of determination. give up. self-discipline. 9911442626 64 CA Aaditya Jain Yet Another Milestone Achieved By Aaditya Sir.giving proper balance to both Concept & question.By taking classes I developed a special interest in Finance. Thank you sir from the bottom of my heart..Most Important New Course Theory Question Delhi-9911442626 ..This is like a Dream come true...Finally i heard about Aaditya Sir and joined him in June 2009.The subject which was once a nightmare for me became my strength.He made Mafa very simple with his unique Concept Question Approach. Kolkata-9339238834 Ph." --Aaditya Jain IAMNOWHERE." Always be solution-oriented in your thinking "We all have dreams..But I was not confident.. but in rising every time we fall.However MAFA was still a nightmare for me.Then i got married but i always wanted to become CA. I finally cleared my CA in Nov 2009 Exam scoring 71 Marks in MAFA.His main strength is his simplified notes.. dedication. the more likely your success will be...For me MAFA was always a nightmare. the greater the chance that something will happen in your favor. the longer you persist.40251 The Power Of Determination Aaditya Jain The Best FM Faculty Of India From The Desk Of Archana Jhunjhunwala. and go back to doing something else. Confucius wrote: "Our greatest glory is not in never falling.After taking classes from Sir . but the one quality that will guarantee your success is the willingness to stick with it..My husband supported me a lot and arranged lots of Books and Notes relating to MAFA.the most important thing which i got is the Confidence to crack the paper.

You are not meant for crawling... You were born with goodness and trust. The security will come... In the middle of every difficulty lies opportunity. 9911442626 Covering 20 Marks 65 CA Aaditya Jain cafinalmafa@yahoo. now is the time." A second ago is gone..not with .. so don't..serenity to know what is not possible and the wisdom to know the difference" .. Learn to use them and fly.. But first you must begin. and a second from now might be. Go for it! Your big opportunity may be right where you are now.the wind. Remember that a kite rises against . “The Gods cannot help those who do not seize opportunities” You were born with potential. Don't be afraid of opposition. You have wings... You were born with greatness.Are You Ready Its Time To Fullfill Your and Your Parents’s Dream Aaditya Jain The Best FM Faculty Of India " Now is the time. Imagination is the highest kite that one can fly. Live to Fly " I would like to sign off with a prayer to the Almighty-"God! Give me the courage to do whatever is possible.com CAs are on High Demand.Ph.... if you want to make a difference in the world.. Don't be fooled into thinking you should wait until you are older or wiser or more secure because it doesn't work that way... Now is all you've got. The wisdom will come. You were born with wings. You were born with ideals and dreams.

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