Q1: there are two main regulators to regulate the Indian Financial System RBI

and SEBI. Explain the role of SEBI in detail. Do you think that these two agencies
can be merged to create a super regulatory body for an effective regulation of the
financial system?
Answer: (first part)
As part of economic reforms programme started in June 1991, the Government of
India initiated several capital market reforms, which included the abolition of the
office of the Controller of Capital Issues (CCI) and granting statutory recognition to
Securities Exchange Board of India (SEBI) in 1992 for:
(a) Protecting the interest of investors in securities;
(b) Promoting the development of securities market;
(c) Regulating the securities market; and
(d) Matters connected there with or incidental thereto.
Role of SEBI:
SEBI has been vested with necessary powers concerning various aspects of capital
market such as:
(i) Regulating the business in stock exchanges and any other securities market;
(ii) Registering and regulating the working of various intermediaries and mutual
funds;
(iii) Promoting and regulating self regulatory organisations;
(iv) Promoting investors education and training of intermediaries;
(v) Prohibiting insider trading and unfair trade practices;
(vi) Regulating substantial acquisition of shares and take over of companies;
(vii) Calling for information, undertaking inspection, conducting inquiries and audit
of stock exchanges, and intermediaries and self regulation organisations in the stock
market; and
(viii) Performing such functions and exercising such powers under the provisions of
the Capital Issues (Control) Act, 1947 and the Securities Contracts (Regulation) Act,
1956 as may be delegated to it by the Central Government.
(Further explanation, if required:
As part of its efforts to protect investors interests, SEBI has initiated many primary
market reforms, which include improved disclosure standards in public issue documents,
introduction of prudential norms and simplification of issue procedures.
Companies are now required to disclose all material facts and risk factors associated with
their projects while making public issue.
All issue documents are to be vetted by SEBI to ensure that the disclosures are not only
adequate but also authentic and accurate.
SEBI has also introduced a code of advertisement for public issues for ensuring fair and
truthful disclosures.
Merchant bankers and all mutual funds including UTI have been brought under the
regulatory framework of SEBI.

A code of conduct has been issued specifying a high degree of responsibility towards
investors in respect of pricing and premium fixation of issues.
To reduce cost of issue, underwriting of issues has been made optional subject to the
condition that the issue is not under-subscribed.
In case the issue is under-subscribed i.e., it was not able to collect 90% of the amount
offered to the public, the entire amount would be refunded to the investors.
The practice of preferential allotment of shares to promoters at prices unrelated to the
prevailing market prices has been stopped and private placements have been made more
restrictive.
All primary issues have now to be made through depository mode. The initial public
offers (IPOs) can go for book building for which the price band and issue size have to be
disclosed. Companies with dematerialised shares can alter the par value as and when they
so desire.
As for measures in the secondary market, it should be noted that all statutory powers to
regulate stock exchanges under the Securities Contracts (Regulation) Act have now been
vested with SEBI through the passage of securities law (Amendment) Act in 1995. SEBI
has duly notified rules and a code of conduct to regulate the activities of intermediaries in
the securities market and then registration in the securities market and then registration
with SEBI is made compulsory. It has issued guidelines for composition of the governing
bodies of stock exchanges so as to include more public representatives. Corporate
membership has also been introduced at the stock exchanges. It has notified the
regulations on insider trading to protect and preserve the integrity of stock markets and
issued guidelines for mergers and acquisitions. SEBI has constantly reviewed the
traditional trading systems of Indian stock exchanges and tried to simplify the procedure,
achieve transparency in transactions and reduce their costs. To prevent excessive
speculations and volatility in the market, it has done away with badla system, and
introduced rolling settlement and trading in derivatives. All stock exchanges have been
advised to set-up Clearing Corporation / settlement guarantee fund to ensure timely
settlements. SEBI organises training programmes for intermediaries in the securities
market and conferences for investor education all over the country from time to time.)
Answer: (2nd part): Should SEBI and RBI be merged?
In my opinion, they should not be merged and remain separate entities due to the
following reasons:
1.) SEBI is the regulator of security and capital markets whereas RBI is the regulator
of the banking industry and controls the monetary policy of India.
Both these are different realms of the financial sector, and need to be handled
independently.
2.) Officers are taken in both these institutions with specific credentials appropriate to
the job and market. Combining both the organizations would lead to shuffling of
employees and hence the candidate may not be qualified for the job allotted
3.) As keeping the institutions separate, would result in less bureaucracy and increased
efficiency.

4.) As both RBI and SEBI are autonomous, they have separate heads and divisions.
Merging, them would create less positions and could lead to internal politics
resulting in decrease of efficiency.
5.) History has shown that there could be differences of opinion among the regulators:
For example SEBI and IRDA had a spat over the ULIP issue. To avoid all these
controversies, they should stay independent.
Q2. a) Explain different ways in which a venture capitalist can finance an
investment proposal?
Answer:
A) Equity instruments:
1. Ordinary equity shares
2. Non-voting equity shares: entitled for higher dividene but carry no voting right
3. Deferred ordinary shares
4. Preferred ordinary shares
5. Equity warrants
6. Preference shares
7. Cumulative convertible preference shares
8. Participating preference shares
9. Cumulative convertible participatory preferred ordinary shares
10. Convertible cumulative redeemable preference shares
Of the types of equity-linked financial instruments, Equity warrants, Non-voting
equity shares and Cumulative convertible participatory preferred ordinary shares
can be used to structure a flexible venture capital deal.
B) Debt instruments:
To ensure that entrepreneur retains the control and venture capital investor (VCI)
receives a running yield during the early years when the equity portion is unlikely to
yield any return, debt instruments are also used by VCIs. They include, in addition
to conventional loans, income notes, non-convertible debentures, partly convertible
debentures, fully convertible debentures, zero interest bonds, secured premium
notes and deep discount bonds.

1. Conditional loans:
This is a form of loan finance without any predetermined repayment schedule or
interest rate. The suppliers of such loans recover a specified percentage of sales
towards the recovery of principal as well as revenue in a predetermined ratio,
usually 50:50. The charge on sales is known as royalty. The investor stands to gain
/lose depending on whether the actual sales are higher/lower than the projected
sales. It is a quasi- equity instrument.
2. Conventional loans:

These are modified to the requirements of venture capital financing. They carry
lower interest which increases after commercial production commences. A small
royalty is additionally charged to cover interest forgone during the initial years.
Although the repayment of principal is based on pre-stipulated schedule, VCIs
usually do not insist upon mortgage/other security.
3. Income notes:
These fall between the conventional loans and the conditional loans and carry a
uniform low rate of interest plus a royalty on sales. The principal is repaid
according to a stipulated schedule
4. Non-convertible debentures:
These carry a fixed/variable rate of interest, are redeemable at par/premium, are
secured, and can be cumulative/non- cumulative.
5. Partly convertible debentures:
The convertible portion is converted into equity shares at par/premium. The nonconvertible portion earns interest till redemption generally at par. Such instruments
are best suited for second round venture capital financing.
6. Zero interest/coupon bonds/debentures:
These can be either convertible or non-convertible with no interest rate. The nonconvertible bonds are sold at discount from their maturity value while convertible
ones are converted into equity shares at a stipulated price and time. They offer
considerable flexibility and are an appropriate instrument for later stage venture
capital financing.
7. Secured premium notes:
These are secured, redeemable at premium in lump-sum /installment, have zero
interest and carry a warrant against which equity shares can be acquired. It is
useful for later stage financing.
8. Deep discount bonds:
These are issued at large discount to their maturity value. As a long term
instrument these are not suited to venture capital investment.
Q# 2(b) What do you understand by financial derivatives? Explain in detail.
A derivative is a financial instrument whose value depends on is derived from the
value of some other financial instrument, called the underlying asset. Common examples
of underlying assets are stocks, bonds, corn, pork, wheat, rainfall, etc.
Basic purpose of derivatives
In derivatives transactions, one partys loss is always another partys gain
The main purpose of derivatives is to transfer risk from one person or firm to
another, that is, to provide insurance

If a farmer before planting can guarantee a certain price he will receive, he is

more likely to plant
Derivatives improve overall performance of the economy

Major categories of derivatives

Forwards and futures
Options
Swaps
FORWARDS
A forward, or a forward contract, is: An agreement between a buyer and a seller to
exchange a commodity or a financial instrument for a prespecified amount of cash on a
prearranged future date. Example: interest rate forwards. Forwards are highly
customized, and are much less common than the futures.
FUTURES
A future is a forward contract that has been standardized and sold through an organized
exchange.
Structure of a futures contract:
Seller (has short position) is obligated to deliver the commodity or a financial
instrument to the buyer (has long position) on a specific date
This date is called settlement, or delivery, date.
OPTIONS
A call option on a stock gives its holder the right to buy a fixed number of shares at a
given price by some future date, while a put option gives its holder the right to sell a
fixed number of shares on the same terms. The specified price is called the exercise price.
The purchase price of an option the money that changes hands on day one is called
the option premium. Options enable their holders to lever their resources, while at the
same time limiting their risk.
SWAPS
A swap is a contract to exchange cash flows over a specific period. The principal used to
compute the flows is the notional amount.
Suppose you have an adjustable-rate mortgage with principal of $200,000 and current
payments of $11,000 per year. So you can swap it for a fixed-rate mortgage for the same
principal amount of $200,000.
Q # 3(a) CREDIT RATING METHODOLOGY for a FINANCIAL INSTRUMENT

A Rating agencys rating process usually includes fundamental analysis of public

and private issuer-specific data, industry analysis, and presentations by the
issuers senior executives, statistical classification models and judgement
Typically, the rating agency is privy to the issuers short and long-range plans and
budgets
The rating methodology is divided into two independent segments:

The first segment deals with operational characteristics and the second one with
the financial characteristics
Also quantitative and objective factors; qualitative aspects, like assessment of
management capabilities play a very important role in arriving at the rating of an
instrument
The relative importance of qualitative and quantitative components of the analysis
varies with the type of issuer.
Key areas considered in a rating include the following:
o Business risk
o Financial risk
o Management evaluation
o Business environment analysis
Rating is not based on a predetermined formula, which specifies the relevant
variables as well as weights attached to each one of them
Broadly, the rating agency assures itself that there is a good congruence between
assets and liabilities of a company and downgrades the rating if the quality of
assets depreciates.

Q# 3(b) BOOK BUILDING PROCESS for IPO

Book Building is essentially a process used by companies raising capital through Public
Offerings-both Initial Public Offers (IPOs) and Follow-on Public Offers (FPOs) to aid
price and demand discovery. It is a mechanism where, during the period for which the
book for the offer is open, the bids are collected from investors at various prices, which
are within the price band specified by the issuer. The process is directed towards both the
institutional as well as the retail investors. The issue price is determined after the bid
closure based on the demand generated in the process.
The Process:

The Issuer who is planning an offer nominates lead merchant banker(s) as 'book
runners'.
The Issuer specifies the number of securities to be issued and the price band for
the bids.
The Issuer also appoints syndicate members with whom orders are to be placed by
the investors.
The syndicate members input the orders into an 'electronic book'. This process is
called 'bidding' and is similar to open auction.
The book normally remains open for a period of 5 days.
Bids have to be entered within the specified price band.
Bids can be revised by the bidders before the book closes.
On the close of the book building period, the book runners evaluate the bids on
the basis of the demand at various price levels.
The book runners and the Issuer decide the final price at which the securities shall
be issued.

Generally, the number of shares are fixed, the issue size gets frozen based on the
final price per share.
Allocation of securities is made to the successful bidders. The rest get refund
orders.

Q3.c
Revival Of Sick industrial unit:An industrial unit is considered sick when its financial position is not satisfactory and it
becomes worse year after year. It incurs losses and its capital reserves may be stretched
out in course of time. When its current liabilities are more than current assets, the
organization may not be in a position to pay its liabilities. The increasing trend in
industrial sickness touching all types of units including small, medium and large-scale
industrial sectors is of considerable concern. In India, there were 2,52,947 units found
sick and their credit outstanding was Rs.25,767 crore in large, medium and small-scale
industries at the end of March 2001. Out of this, a large number of small-scale industrial
units (2,49,630) were found sick and their outstanding bank credit was Rs.4,506 crore in
the country. The problem is assuming titanic proportion and may have added
repercussions in a country like India which cannot afford unemployment and loss of
production.
The small-scale industrial (SSI) sector is the worst hit. A number of small industries are
either born sick or stay sick. It is disturbing to note that despite sound academic
qualifications and initial zeal of the entrepreneurs and full initial backing by financial
institutions, sickness still
persists. By the end of March 2005, there were 1,688 number of SSI units found sick with
outstanding bank credit blocked with them was R s . 1 7 0 . 1 3 c r o r e a n d 2 0 , 5
4 7 n um b e r o f
employees were affected in Orissa. The reasons for sickness are of a varied nature. The
more
common are management failure, non-availability of raw materials, power cuts, labour
unrest,
marketing problems etc. Though the sickness develops gradually and not an overnight
phenomenon, the financial institutions are taken into confidence at the critical stages.
When the
problems and difficulties arise, the diagnosis and treatment would certainly be much
easier.
However, when the sickness reaches an advanced stage, it becomes difficult and takes
longer time
to diagnose the reasons and makes it more costly and expensive to bring the units back to
normal.
So, there is need to identify sickness in the initial stages and to initiate the process of
corrective
measures and revival / rehabilitation before the sickness assumes a serious proportion.

Q 3.d Functions of Investment Bank

Functions of Investment Banking:
Investment banks carry out multilateral functions. Some of the most important functions
of investment banking are as follows:
Investment banking helps public and private corporations in issuance of securities in the
primary market. They also act as intermediaries in tradingfor clients.
Investment banking provides financial advice to investors and helps them by assisting in
purchasing and trading securities as well as managing financial assets
Investment banking differs from commercial banking as investment banks don't accept
deposits neither do they grant retail loans.
Small firms which provide services of investment banking are called boutiques. They
mainly specialize in bond trading, providing technical analysis or program trading as well
as advising for mergers and acquisitions
Core activities of Investment Banking
Investment banking: is the traditional aspect of investment banks that involves helping
customers raise funds in the capital markets and advise them on mergers and acquisitions.
Investment banking can also involve subscribing investors to a security issuance,
negotiating with a merger target and coordinating with bidders.
Sales and trading: Depending on the needs of the bank and its clients, the main function
of a large investment bank is buying and selling products. In market making,
the traders will buy and sell securities or financial products with the goal of earning an
incremental amount of money on every trade. Sales is the term that is used for the sales
force, whose primary job is to call on institutional and high-net-worth investors to
suggest trading ideas and take orders.
Research: is the division of investment banks which reviews companies and makes
reports about their prospects, often with "buy" or "sell" ratings. Although the research
division generates no revenue, its resources can be used to assist traders in trading, can be
used by the sales force in suggesting ideas to the customers, and by the investment
bankers for covering their clients.
Q. 3f) Sources of Foreign Currency Finance for a company
Ans: Foreign Sources play an important part in meeting the long-term financial needs of
the business in India. These usually take the form of (1) external borrowings; (2) foreign
investments and; (3) deposits from NRIs.
1. External Borrowings: These include loans obtained at concessional rates of interest
with long maturity period and commercial borrowings. The major sources of
concessional loans have been the International Monetary Fund (IMF), Aid India
Consortium (AIC), Asian Development Bank (ADB), World Bank (International Bank
for Reconstruction and Development) and International Financial Corporation. The
World Bank grants loans for specific industrial projects of high priority and given either
directly to an industrial concern or through a government agency. The International
Finance Corporation, an affiliate of the World Bank, grants loans to industrial units for a
period of 8 to 10 years. Such loans do not require government guarantee. As for the
external commercial borrowings, their major sources has been the export credit agencies

like US Exim Bank, the Japanese Exim Bank, Export Credit and Guarantee Corporation
of U.K. and other government and multilateral agencies. The external commercial
borrowings are permitted by the government as an important source of finance for Indian
firms for the expansion investments.
2. Foreign Investments: The foreign investments in our country are generally done in
the form of foreign direct investment (FDI) or through foreign collaborations. The
foreign direct investment usually refers to the subscription by the foreigners to shares and
debentures of the Indian Companies. This is also known as portfolio investment and
covers their subscription to ADRs, GDRs and FCCBs (Foreign Currency Convertible
Bonds). Alternatively, some companies are formed with the specified purpose of
operating in India or the multinationals can set up their subsidiary or branch in India. As
for the foreign collaborations, these can be of financial collaborations involving foreign
companies participation in equity capital of an existing or new undertaking. The
technical collaborations are by way of supply of technical knowledge, patents and
machineries. To start with, the technical collaborations had been the more popular form
in the past. But during the post liberalization phase, shift from technical collaborations to
financial collaborations is noticed in our country. It may be noted that the government
has been very successful in attracting more foreign investment in the post liberalisation
era. It is because the Government of India now permits automatic approval of foreign
investment upto 51% equity in 34 industries and a special board (Foreign Investment
Promotion Board) has been set up to process cases not covered by automatic approvals.
The main advantage of foreign investment is that generally the foreign investor also
brings with him the technical expertise and the modern machinery. The disadvantage,
however, is that a large part of profits are transferred to the foreign investors.
3. Non-resident Indians (NRIs): The persons of Indian origin (PIO) living abroad
commonly known as Non-Resident Indians (NRIs) constitute an important source of
long-term finance for industries in India. The most common form of their contribution is
in the form of deposits under Foreign Currency Non-Resident Account (FCNRA) and
Non-Resident (External) Rupee Account (NRERA). However, like external borrowing,
NRI deposits are high cost source of external finance and are fair weather friends.
Hence, too much dependence on NRI deposits is not a right policy. It may be noted that
they are also permitted to subscribe to the shares and debentures of the companies in
India, and have the option of selling them and take back the amount. This constitutes an
integral part of foreign direct investment.
Ans 4:
Sales 500
Cost of RM 200
Labour cost for manufacturing 100
EBIT - 200
Interest on borrowings 60
Profit available to equity shareholders 140
a) Total market value of firm = EBIT/Ko = 200/0.125 = 1600
b) Total market value of the debt of the firm = Interest/Kd = 60/0.10 = 600

c) Total market value of the equity of the firm = Ko-Kd = 1600-600 = 1000
d) Equity capitalization rate (Ke) = Profit available to equity shareholders/Total
market value of equity = 140/1000 = 0.14 or 14%

5. A firm has sales of Rs 1000000. Variable cost is 70%, total cost is Rs 900000 &
debt of Rs 500000 at 10% rate of interest. If tax rate is 40% calculate(a) Operating Leverage
(b) Financial Leverage
(c) Combined Leverage
(d) If the firm wants to double up its earnings before interest & tax (EBIT), how
much of a raise in sales would be needed on a percentage basis?
Variable Cost = 70% of Sales = 70% of 1000000 = 7, 00,000
Fixed Cost = Total Cost Variable = 900000 700000 = 2, 00,000
EBIT = Sales Variable Cost Fixed Cost = 10, 00,000 7, 00,000 2, 00,000
= 1, 00,000
Interest = 10% of Debt = 10% of 5, 00,000 = 50,000
(a) Operating Leverage = Sales Variable Cost
EBIT
= 10, 00,000 7, 00,000
1, 00,000
= 3.0
(b) Financial Leverage =

EBIT
EBIT Interest

1, 00,000
1, 00,000 50, 000
=2
(c) Combined Leverage = Sales Variable Cost
EBIT - Interest
= 10, 00,000 7, 00,000
1, 00,000 50, 000
=6
(d) For EBIT to be Rs 2, 00,000. Following calculation required
Sales
13, 33,333
Less: Variable Cost 9, 33,333
Less: Fixed Cost
2, 00,000
EBIT
2, 00,000
If EBIT increases by 100% the Sales increases by 33.33%
Percentage increase in Sales = 3, 33,333*100

10, 00,000
= 33.33%
6. (a) ABC company Ltd is expected 10% return on total assets on Rs. 50 lakh. The
company has outstanding shares 20000. The directors of the company have decided
to pay 40% of earning as dividend. The rate of return required by shareholders is
12.5%. Rate of return expected on investment is 15%. You are required to
determine the price of the share using Walters Model.
Earnings of Company = 50, 00,000 * 10% = 5, 00,000
Earnings per share = Earnings/Number of outstanding share = 5, 00,000/20, 000 = Rs
25 per share
Dividend per share = Earnings per share*40% = Rs 10 per share
Price of the share using Walter ModelP = [D + (r/ke)*(E-D)]/ ke
P = [10 + (0.15/.125)*(25 10)]/0.125
P = 28/0.125
P = Rs. 224 per share
(b) The current market price of a share of X ltd is Rs 120 per share. The company is
considering Rs 6.4 per share as dividend. The company belongs to a risk class for
which the capitalization rate is 9.6%. Based on the M &M approach calculate the
market price of the share of the company when the dividend is declared & not
declared. What is your learning out of it?
Market price of the share at the end of year 1 (with dividend)
Po = [1/ (1 + ke)]*(D1 +P1)
120 = [1/ (1 + .096)]*(6.4 + P1)
120 = 5.84 + 0.91P1
P1 = Rs. 125.45 per share
Market price of the share at the end of year 1 (without dividend)
Po = [1/ (1 + ke)]*(D1 +P1)
120 = [1/ (1 + .096)]*(0 + P1)
120 = 0 + 0.91P1
P1 = Rs. 131.87 per share
Learnings:
The market price of the share at the end of year 1 will always be higher, if the company
does not payout dividends.

Q7
Income Statement of Modern Electronic

Net Sales
COGS

3060
-2338

GP
Selling
Admin
Deprication
Operating Income
Non operating
Surplus
EBIT
Interest
EBT
Tax@35%
EAT
Dividends
Retained Earnings

722
-223
-179
-180
140
34
174
-36
138
-48.3
89.7
-24
65.7

b) Formula for estimating external financing need= Growth in sales*Total assets

Growth in sales* CL- Net profit margin *new sales* dividend
= 595.8