Paper - 2: Strategic Financial Management Questions Security Valuation

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

(a) Conversion Value of Debenture
(b) Market Conversion Price
(c) Conversion Premium per share
(d) Ratio of Conversion Premium
(e) Premium over Straight Value of Debenture
(f) Favourable income differential per share
(g) Premium pay back period
© The Institute of Chartered Accountants of India

32 FINAL (NEW) EXAMINATION: NOVEMBER, 2021
Portfolio Management
3. Mr. A is interested to invest ` 1,00,000 in the securities market. He selected two
securities B and D for this purpose. The risk return profile of these securities are as
follows:
Security Risk (  ) Expected Return (ER)
B 10% 12%
D 18% 20%
Co-efficient of correlation between B and D is 0.15.
You are required to calculate the portfolio return of the following portfolios of B and D to
be considered by A for his investment.
(i) 100 percent investment in B only;
(ii) 50 percent of the fund in B and the rest 50 percent in D;
(iii) 75 percent of the fund in B and the rest 25 percent in D; and
(iv) 100 percent investment in D only.
Also indicate that which portfolio is best for him from risk as well as return point of view?
4. A Portfolio Manager (PM) has the following four stocks in his portfolio:
Security No. of Shares Market Price per share (`) 
VSL 10,000 50 0.9
CSL 5,000 20 1.0
SML 8,000 25 1.5
APL 2,000 200 1.2
Compute the following:
(i) Portfolio beta.
(ii) If the PM seeks to reduce the beta to 0.8, how much risk free investment should he
bring in?
(iii) If the PM seeks to increase the beta to 1.2, how much risk free investment should
he bring in?
Mutual Fund
5. Five portfolios experienced the following results during a 7- year period:
Average Annual Standard Correlation with the

Portfolio
Return (Rp) (%) Deviation (Sp) market returns (r)
A 19.0 2.5 0.840

PAPER 2: STRATEGIC FINANCIAL MANAGEMENT 33
B 15.0 2.0 0.540

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

(c) the number of shares of each company to be disposed off,

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

The quotes for foreign exchange are as follows:

Spot Rate INR/ US$ (buying) ` 66.98
60 days Forward Rate INR/ US$ (buying) ` 67.16
90 days Forward Rate INR/ US$ (buying) ` 68.03
Advise which one of the following options would be better for XYZ Ltd.
(i) Pay immediately after utilizing cash available and for balance amount take 90 days
loan from bank.
(ii) Pay the supplier on 60 th day and avail bank’s loan (after utilizing cash) for 30 days.
(iii) Avail supplier offer of 90 days credit and utilize cash available.
Further presume that the cash available with XYZ Ltd. will fetch a return of 4% p.a. in
India till it is utilized.
Assume year has 360 days. Ignore Taxation.
Compute your working upto four decimals and cash flows in Crore.
International Financial Management
10. A USA based company is planning to set up a software development unit in India.
Software developed at the Indian unit will be bought back by the US parent at a transfer
price of US $10 millions. The unit will remain in existence in India for one year; the
software is expected to get developed within this time frame.
The US based company will be subject to corporate tax of 30 per cent and a withholding
tax of 10 per cent in India and will be eligible for tax credit in India. The software
developed will be sold in the US market and many companies are ready to acquire the
same. Other estimates are as follows:
Rent for fully furnished unit with necessary hardware in India ` 18,75,000
Manpower cost (80 software professional will be working for 10 hours 500 per man
each day) hour
Administrative and other costs ` 15,00,000
Advise the US Company the minimum amount it should charge from the prospective
buyer. The rupee-dollar rate is ` 60/$.
Note: Assume 365 days a year.
Interest rate Risk Management
11. Derivative Bank entered into a swap arrangement on a principal of ` 10 crores and
agreed to receive MIBOR overnight floating rate for a fixed payment on the principal. The
swap was entered into on Monday, 19 th August, 2019 and was to commence on

20th August, 2019 and run for a period of 7 days.

Respective MIBOR rates for Tuesday to Monday were: 8.15%, 7.98%, 7.95%, 8.12%,
8.15%, 7.75%.
If Fixed Rate of Interest is 8%, then evaluate
(i) the nature of this Swap arrangement.
(ii) the Net Settlement amount.
Notes:
(1) Sunday is Holiday.
(2) Work in rounded rupees and avoid decimal working.
(3) Consider 365 days in a year.
Corporate Valuation
12. STR Ltd.’s current financial year's income statement reported its net income after tax as
` 50 Crore.
Following is the capital structure of STR Ltd. at the end of current financial year:
`
Debt (Coupon rate = 11%) 80 Crore
Equity (Share Capital + Reserves & Surplus) 250 Crore
Invested Capital 330 Crore
Following data is given to estimate cost of equity capital:
Asset Beta of TSR Ltd. 1.11
Risk free Rate of Return 8.5%
Average market risk premium 9%
The applicable corporate income tax rate is 30%.
Estimate Economic Value Added (EVA) of RST Ltd. in ` lakh.
Mergers, Acquisitions & Corporate Restructuring
13. Cauliflower Limited is contemplating acquisition of Cabbage Limited. Cauliflower Limited
has 5 lakh shares having market value of ` 40 per share while Cabbage Limited has 3
lakh shares having market value of ` 25 per share. The EPS for Cabbage Limited and
Cauliflower Limited are ` 3 per share and ` 5 per share respectively. The managements
of both the companies are discussing two alternatives for exchange of shares as follows:
(i) In proportion to relative earnings per share of the two companies.
(ii) 1 share of Cauliflower Limited for two shares of Cabbage Limited.

Required:
(i) Calculate the EPS after merger under both the alternatives.
(ii) Show the impact on EPS for the shareholders of the two companies under both the
alternatives.
Theoretical Questions
14. Can a company with no commercial operations raise capital via an IPO? Discuss.
15. Mr. R has completed his studies and wants to start his new online business. For a
successful online business there are various expenditure costs with regards to
advertisement & application development. To make the business successful he wants to
raise funds. Explain some of the innovative sources for funding a start-up.
SUGGESTED ANSWERS/HINTS
1. Duration of Bond X
Year Cash flow P.V. @ 10% Proportion of Proportion of bond
bond value value x time (years)
1 1070 .909 972.63 1.000 1.000
Duration of the Bond is 1 year
Duration of Bond Y
1 80 .909 72.72 0.077 0.077
2 80 .826 66.08 0.071 0.142
3 80 .751 60.08 0.064 0.192
4 1080 .683 737.64 0.788 3.152
936.52 1.000 3.563
Duration of the Bond is 3.563 years
Let x1 be the investment in Bond X and therefore investment in Bond Y shall be (1 - x1).
Since the required duration is 2 year the proportion of investment in each of these two
securities shall be computed as follows:
2 = x1 + (1 - x1) 3.563
x1 = 0.61

Accordingly, the proportion of investment shall be 61% in Bond X and 39% in Bond Y
respectively.
Amount of investment
Bond X Bond Y
PV of ` 1,00,000 for 2 years @ 10% x 61% PV of ` 1,00,000 for 2 years @ 10% x
39%
= ` 1,00,000 (0.826) x 61% = ` 1,00,000 (0.826) x 39%
= ` 50,386 = ` 32,214
No. of Bonds to be purchased No. of Bonds to be purchased
= ` 50,386/ ` 972.73 = 51.79 i.e. approx. = ` 32,214/ `936.52 = 34.40 i.e. approx.
52 bonds 34 bonds
Note: The investor has to keep the money invested for two years. Therefore, the investor
can invest in both the bonds with the assumption that Bond X will be reinvested for
another one year on same returns.
Further, in the above computation, Modified Duration can also be used instead of
Duration.
2. (a) Conversion Value of Debenture
= Market Price of one Equity Share X Conversion Ratio
= ` 25 X 30 = 750
(b) Market Conversion Price
Market Pr ice of ConvertibleDebenture
=
ConversionRatio
` 900
= = ` 30
30
(c) Conversion Premium per share
Market Conversion Price – Market Price of Equity Share
= ` 30 – ` 25 = ` 5
(d) Ratio of Conversion Premium
Conversion premium per share `5
= = 20%
Market Price of Equity Share ` 25

(e) Premium over Straight Value of Debenture

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

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

(iii) 75% in B and 25% in D

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

CSL 5000 20 100000 0.0602 1 0.060

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

B 0.90 13.50
C 0.65 12.25
D 1.25 15.25
E 0.90 13.50
Portfolio Sharpe Method Treynor Method Jensen's Alpha

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

0.04
H = 0.75 x = 0.5
0.06
(ii) Since the company is long position in Spot (Cash) Market it shall take Short Position
in Future Market.
(iii) Since contact size of one contract is 1,000 Kg,

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

Value of the portfolio after rise of Nifty 5091

% change in value of portfolio (5091 – 5000)/ 5000 1.82%
% rise in the value of Nifty 2%
Beta 0.91
8. (i) If investment is made at London
Convert US$ 5,00,000 at Spot Rate (5,00,000/1.5390) = £ 3,24,886
Add: £ Interest for 3 months on £ 324,886 @ 5% =£ 4,061
= £ 3,28,947
Less: Amount Invested $ 5,00,000
Interest accrued thereon $ 5,000
= $ 5,05,000
Equivalent amount of £ required to pay the
above sum ($ 5,05,000/1.5430*) = £ 3,27,285
Arbitrage Profit =£ 1,662
(ii) If investment is made at New York
Gain $ 5,00,000 (8% - 4%) x 3/12 = $ 5,000
Equivalent amount in £ 3 months ($ 5,000/ 1.5475) £ 3,231
(iii) If investment is made at Frankfurt
Convert US$ 500,000 at Spot Rate (Cross Rate) 1.8260/1.5390 = € 1.1865
Euro equivalent US$ 500,000 = € 5,93,250
Add: Interest for 3 months @ 3% =€ 4,449
= € 5,97,699
3 month Forward Rate of selling € (1/1.8150) = £ 0.5510
Sell € in Forward Market € 5,97,699 x £ 0.5510 = £ 3,29,332
Less: Amounted invested and interest thereon = £ 3,27,285
Arbitrage Profit =£ 2,047
Since out of three options the maximum profit is in case investment is made in New
York. Hence it should be opted.
* Due to conservative outlook.

9. To evaluate which option would be better we shall compute the outflow under each
option as follows:
(i) Pay Immediately availing discount
Particulars
Spot Rate ` 66.98
Amount required in US$ [US$ 8 Million (1 – 0.01)] US$ 7.92 Million
Amount required in ` [` 66.98 x US$ 7.92 Million] ` 53.0482 Crore
Cash Available ` 0.2500 Crore
Loan required ` 52.7982 Crore
Interest for 90 days @ 9% ` 1.1880 Crore
Total Outflow ` 53.9862 Crore
(ii) Pay the supplier on 60 th day and avail bank’s loan (after utilizing cash) for 30
days.
Particulars
Applicable Forward Rate ` 67.16
Amount required in [` 67.16 x US$ 8 Million] ` 53.7280 Crore
Loan required [` 53.7280 Crore – ` 0.25 ` 53.4780 Crore
Crore]
Interest for 30 days @ 9% ` 0.4011 Crore
` 53.8791 Crore
Interest earned on Cash for ` 0.0017 Crore
60 days @ 4%
(iii) Avail supplier offer of 90 days credit and utilize cash available
Particulars
Amount Payable US$ 8 Million
Interest for 30 days @ 8% US$ 0.0533 Million
Amount required in ` US$ 8.0533 Million
Applicable Forward Rate ` 68.03
Amount required in ` [` 68.03 x US$ 8.0533 ` 54.7866 Crore
Million]
Cash Available ` 0.2500 Crore

Interest earned on Cash ` 0.0025 Crore

for 90 days @ 4%
Decision: Cash outflow is least in case of Option (ii) same should be opted for.
10. Proforma profit and loss account of the Indian software development unit
`
Revenue 60,00,00,000
Less: Costs:
Rent 18,75,000
Manpower (400 x 80 x 10 x 365) 14,60,00,000
Administrative and other costs 15,00,000 14,93,75,000
Earnings before tax 45,06,25,000
Less: Withholding Tax 4,50,62,500
Earnings after Withholding tax @ 10% 40,55,62,500
Less: Corporation Tax net of Withholding Tax 9,01,25,000
Repatriation amount (in rupees) 31,54,37,500
Repatriation amount (in dollars) $ 52,57,292
Advise: The USA based Company should charge minimum $ 47,42,708 from prospective
buyer.
11. (i) The given swap arrangement is Plain Vanilla Overnight Index Swap (OIS).
(ii) To compute the Net Settlement amount we shall compute Interest as per floating
rate as follows:
Day Principal (`) MIBOR (%) Interest (`)
Tuesday 10,00,00,000 8.15 22,329
Wednesday 10,00,22,329 7.98 21,868
Thursday 10,00,44,197 7.95 21,790
Friday 10,00,65,987 8.12 22,261
Saturday & Sunday (*) 10,00,88,248 8.15 44,697
Monday 10,01,32,945 7.75 21,261
Total Interest @ Floating Rate (A) 1,54,206
Total Interest @ Fixed Rate (B) 1,53,425

7
10,00,00,000× 8.00% 
365
Net Settlement Amount Paid 781
12. First of all, to calculate Cost of Equity we shall compute the Equity Beta of STR Ltd. as
follows:
 E 
β a =β e  
 E+ D(1- t) 
 250 
1.11= β e  
 250+ 80(1- 0.30) 
βe = 1.36
then we shall compute the Cost of Equity as per CAPM as follows:
ke = Rf + β x Market Risk Premium
= 8.5% + 1.36 x 9%
= 8.5% + 12.24% = 20.74%
Cost of Debt (k d) = 11%(1 – 0.30) = 7.70%
E D
WACC (k o) = k ex + k dx
E+D E+D
250 80
= 20.74x + 7.70x
330 330
= 15.71 + 1.87 = 17.58%
Taxable Income = ` 50 Crore/(1 - 0.30)
= ` 7142.86 lakhs
Operating Income = Taxable Income + Interest
= ` 7142.86 lakhs + ` 880 lakhs
= ` 8022.86 lakhs
EVA = EBIT (1-Tax Rate) – WACC x Invested Capital
= ` 8022.86 lakhs (1 – 0.30) – 17.58% x ` 330 Crore
= ` 5616.00 lakhs – ` 5801.40 lakhs = - ` 185.40 lakhs

13. (i) Exchange ratio in proportion to relative EPS

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

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

Cabbage Ltd. Shareholders

EPS after the merger 5.23 x 0.5 2.615
Decrease in EPS 0.385
14. Although the statement “a company with no commercial operation can launch an IPO”
appears to be absurd but this is a fact that even if company does not have any business,
it can float an IPO. In recent time the concept of Special Purpose Acquisition Companies
(SPACs) has come into existence wherein an entity is set up with the objective to raise
funds through an IPO to finance a merger or acquisition of an unidentified target within a
specific time period. It is commonly known as a blank cheque company.
The main objective of SPAC is to raise money, despite having any operations or
revenues. The money raised from the public is kept in an escrow account, which can be
accessed while making the acquisition. However, in case the acquisition is not made
within stipulated period of time of the IPO, the SPAC is delisted and the money is
returned to the investors. Shareholders have the option to redeem their shares if they are
not interested in participating in the proposed merger. Finally, if the merger is approved
by shareholders, it is executed, and the target private company or companies become
public entities. Once a formal merger agreement has been executed the SPAC target is
usually publicly announced.
New investment opportunities in Indian companies have resurfaced and have set up new
platform for SPAC transactions. The implementation of SPACs might face certain
challenges since India does not have a specific regulatory framework guarding these
transactions.
The current regulatory framework in India does not support the SPAC transactions.
Further as per the Companies Act, 2013, the Registrar of Companies is authorized to
strike-off the name of companies that do not commence operation within one year of
incorporation. SPACs generally take 2 to 3 years to identify a target and performing due
diligence and before it could get operationalized its name can be stricken off and hence
enabling provisions relating to SPAC need to be inserted in the Companies Act in order
to make it functional in India.
Though, SPACs do not find acceptance under the Securities and Exchange Board of
India (SEBI) Act as it does not meet the eligibility criteria for public listing however SEBI
is planning to come out with a framework for SPACs.
The International Financial Services Centres Authority (IFSCA), being the regulatory
authority for development and regulation of financial services, financial products and
financial institutions in the Gujarat International Finance Tec-City, has recently released
a consultation paper defining critical parameters such as offer size to public, compulsory
sponsor holding, minimum application size, minimum subscription of the offer size, etc.

SPAC approach offers several advantages over traditional IPO, such as providing
companies access to capital, even when market volatility and other conditions limit
liquidity. SPACs help to lower the transaction fees as well as expedite the timeline in
becoming a public company. Raising money through a SPAC is easier as compared to
traditional IPO since the SPAC has already raised money through an IPO. This implies
the company in question only has to negotiate with a single entity, as opposed to
thousands of individual investors. This makes the process of fundraising a lot easier and
quicker than through an IPO. The involvement of skilled professionals in identifying the
target makes the investment a well thought and a well governed process.
However, the merger of a SPAC with a target company presents several challenges,
such as complex accounting and financial reporting/registration requirements , to meet a
public company readiness timeline and being ready to operate as a public company
within a period of three to five months of signing a letter of intent.
It is typically more expensive for a company to raise money through a SPAC than an
IPO. Investors’ money invested in a SPAC trust to earn a suitable return for up to two
years, could be put to better use elsewhere.
15. Every startup needs access to capital, whether for funding product development,
acquiring machinery and inventory or paying salaries to its employees. Most
entrepreneurs consider bank loans as the primary source of money, only to find out that
banks are really the least likely benefactors for startups. Thus, innovative measures
include maximizing non-bank financing.
Here are some of the sources for funding a Start-up:
(i) Personal financing: It may not seem to be innovative but you may be surprised to
note that most budding entrepreneurs never thought of saving any money to start a
business. This is important because most of the investors will not put money into a
deal if they see that you have not contributed any money from your personal
sources.
(ii) Personal credit lines: One qualifies for personal credit line based on one’s
personal credit efforts. Credit cards are a good example of this. However, banks are
very cautious while granting personal credit lines. They provide this facility only
when the business has enough cash flow to repay the line of credit.
(iii) Family and friends: These are the people who generally believe in you, without
even thinking that your idea works or not. However, the loan obligations to friends
and relatives should always be in writing as a promissory note or otherwise.
(iv) Peer-to-peer lending: In this process, group of people come together and lend
money to each other. Peer to peer lending has been there for many years. Many
small and ethnic business groups having similar faith or interest generally support
each other in their start up endeavors.

(v) Crowdfunding: Crowdfunding is the use of small amounts of capital from a large
number of individuals to finance a new business initiative. Crowdfunding makes use
of the easy accessibility of vast networks of people through social media and
crowdfunding websites to bring investors and entrepreneurs together.
(vi) Microloans: Microloans are small loans that are given by individuals at a lower
interest to a new business ventures. These loans can be issued by a single
individual or aggregated across a number of individuals who each contribute a
portion of the total amount.
(vii) Vendor financing: Vendor financing is the form of financing in which a company
lends money to one of its customers so that he can buy products from the company
itself. Vendor financing also takes place when many manufacturers and distributors
are convinced to defer payment until the goods are sold. This means extending the
payment terms to a longer period for e.g. 30 days payment period can be extended
to 45 days or 60 days. However, this depends on one’s credit worthiness.
(viii) Purchase order financing: The most common scaling problem faced by startups is
the inability to find a large new order. The reason is that they don’t have the
necessary cash to produce and deliver the product. Purchase order financing
companies often advance the required funds directly to the supplier. This allows the
completion of transaction and profit flows up to the new business.
(ix) Factoring accounts receivables: In this method, a facility is given to the seller
who has sold the good on credit to fund his receivables till the amount is fully
received. So, when the goods are sold on credit, and the credit period (i.e. the date
upto which payment shall be made) is for example 6 months, factor will pay most of
the sold amount up front and rest of the amount later. Therefore, in this way, a
startup can meet his day-to-day expenses.

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

32 FINAL (NEW) EXAMINATION: MAY, 2021
Assume that the present Debt Beta (β D1) is 0.45 and any further funds raised by way
of Debt will have a Beta (β D2) of 0.50.
(iii) Whether the new Equity Beta (βE) justifies increase in the value of equity on account
of leverage?
4. K Ltd. has invested in a portfolio of short-term equity investments. You are required to
calculate the risk of K Ltd.’s short-term investment portfolio relative to that of the market
from the information given below:
Investment A B C D
No. of shares 1,20,000 1,60,000 2,00,000 2,50,000
Market price per share (`) 8.58 5.84 4.34 6.28
Beta 2.32 4.56 1.80 3.00
Expected Dividend Yield 9.50% 14.00% 7.50% 16.00%
The current market return is 20% and the risk free return is 10%.
Advise whether K Ltd. should change the composition of its portfolio. If yes, then how.
Note: Make calculations upto 4 decimal points.
Mutual Fund
5. The following particulars relating to S Fund Schemes:
Particulars Value ` in Crores
1. Investment in Shares (at cost)
a. Pharmaceuticals companies 158
b. Construction Industries 62
c. Service Sector Companies 112
d. IT Companies 68
e. Real Estate Companies 20
2. Investment in Bonds (Fixed Income)
a. Listed Bonds (8000, 14% Bonds of ` 15,000 each) 24
b. Unlisted Bonds 14
3. No. of Units outstanding (crores) 8.4
4. Expenses Payable 7
5. Cash and Cash equivalents 3
6. Market expectations on listed bonds 8.842%

PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 33
The fund has incurred the following expenses:

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

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

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

(ii) Using currency futures

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

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

Market Rate of Return 11%

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

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

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

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

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

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

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

(ii) Equity Beta on change in Capital Structure

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

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

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

Calculation of Beta of Portfolio

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

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

Bonds ` 38 crore ` 458 crore

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

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

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

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

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

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

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

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

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

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

❖ do strategic, action and financial planning regularly.

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

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

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

QUESTIONS
Security Valuation
1. Today being 1 st January 2019, Ram is considering to purchase an outstanding Corporate
Bond having a face value of ` 1,000 that was issued on 1st January 2017 which has 9.5%
Annual Coupon and 20 years of original maturity (i.e. maturing on 31st December 2027).
Since the bond was issued, the interest rates have been on downside and it is now
selling at a premium of ` 125.75 per bond.
Determine the prevailing interest on the similar type of Bonds if it is held till the maturity
which shall be at Par.
PV Factors:
1 2 3 4 5 6 7 8 9
6% 0.943 0.890 0.840 0.792 0.747 0.705 0.665 0.627 0.592
8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500
2. The following data is available for NNTC bond:
Face value: ` 1000
Coupon rate: 7.50%
Years to maturity: 8 years
Redemption Value: ` 1000
YTM: 8%
Calculate:
(i) The current market price, duration and volatility of the bond.
(ii) The expected market price if there is a decrease in required yield by 50 bps.
3. A study by a Mutual fund has revealed the following data in respect of three securities:
Security σ (%) Correlation with
Index, Pm
A 20 0.60
B 18 0.95
C 12 0.75

The standard deviation of market portfolio (BSE Sensex) is observed to be 15%.

(i) What is the sensitivity of returns of each stock with respect to the market?
(ii) What are the covariances among the various stocks?
(iii) What would be the risk of portfolio consisting of all the three stocks equally?
(iv) What is the beta of the portfolio consisting of equal investment in each stock?
(v) What is the total, systematic and unsystematic risk of the portfolio in (iv) ?
4. Mr. Abhishek is interested in investing ` 2,00,000 for which he is considering following
three alternatives:
(i) Invest ` 2,00,000 in Mutual Fund X (MFX)
(ii) Invest ` 2,00,000 in Mutual Fund Y (MFY)
(iii) Invest ` 1,20,000 in Mutual Fund X (MFX) and ` 80,000 in Mutual Fund Y (MFY)
Average annual return earned by MFX and MFY is 15% and 14% respectively. Risk free
rate of return is 10% and market rate of return is 12%.
Covariance of returns of MFX, MFY and market portfolio Mix are as follow:
MFX MFY Mix
MFX 4.800 4.300 3.370
MFY 4.300 4.250 2.800
Mix 3.370 2.800 3.100
(i) variance of return from MFX, MFY and market return,
(ii) portfolio return, beta, portfolio variance and portfolio standard deviation,
(iii) expected return, systematic risk and unsystematic risk; and
(iv) Sharpe ratio, Treynor ratio and Alpha of MFX, MFY and Portfolio Mix
Mutual Fund
5. There are two Mutual Funds viz. D Mutual Fund Ltd. and K Mutual Fund Ltd. Each having
close ended equity schemes.
NAV as on 31-12-2019 of equity schemes of D Mutual Fund Ltd. is ` 70.71 (consisting
99% equity and remaining cash balance) and that of K Mutual Fund Ltd. is 62.50
(consisting 96% equity and balance in cash).

Following is the other information:

Equity Schemes
Particular
D Mutual Fund Ltd. K Mutual Fund Ltd.
Sharpe Ratio 2 3.3
Treynor Ratio 15 15
Standard deviation 11.25 5
There is no change in portfolios during the next month and annual average cost is ` 3
per unit for the schemes of both the Mutual Funds.
If Share Market goes down by 5% within a month, calculate expected NAV after a month
for the schemes of both the Mutual Funds.
For calculation, consider 12 months in a year and ignore number of days for particular
month.
Derivatives
6. Mr. SG sold five 4-Month Nifty Futures on 1 st February 2020 for ` 9,00,000. At the time of
closing of trading on the last Thursday of May 2020 (expiry), Index turned out to be 2100.
The contract multiplier is 75.
Based on the above information calculate:
(i) The price of one Future Contract on 1 st February 2020.
(ii) Approximate Nifty Sensex on 1 st February 2020 if the Price of Future Contract on
same date was theoretically correct. On the same day Risk Free Rate of Interest
and Dividend Yield on Index was 9% and 6% p.a. respectively.
(iii) The maximum Contango/ Backwardation.
(iv) The pay-off of the transaction.
Note: Carry out calculation on month basis.
7. A Rice Trader has planned to sell 22000 kg of Rice after 3 months from now. The spot
price of the Rice is ` 60 per kg and 3 months Future on the same is trading at ` 59 per
kg. Size of the contract is 1000 kg. The price is expected to fall as low as ` 56 per kg, 3
months hence.
Required:
(i) to interpret the position of trader in the Cash Market.
(ii) to advise the trader the trader should take in Future Market to mitigate its risk of
reduced profit.

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

Exchange Rate as on date are as follows:

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

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

Loan from bank 74 Sundry debtors 70

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

SUGGESTED ANSWERS/HINTS
1. To determine the prevailing rate of interest for the similar type of Bonds we shall compute
the YTM of this Bond using IRR method as follows:
M = ` 1000
Interest = ` 95 (0.095 x ` 1000)
n = 9 years
V0 = ` 1125.75 (` 1,000 + ` 125.75)
YTM can be determined from the following equation
` 95 × PVIFA (YTM, 9) + ` 1000 × PVIF (YTM, 9) = ` 1125.75
Let us discount the cash flows using two discount rates 8% and 10% as follows:
Year Cash Flows PVF@6% PV@6% PVF@8% PV@8%
0 -1125.75 1 -1125.75 1 -1125.75
1 95 0.943 89.59 0.926 87.97
2 95 0.890 84.55 0.857 81.42
3 95 0.840 79.80 0.794 75.43
4 95 0.792 75.24 0.735 69.83
5 95 0.747 70.97 0.681 64.70
6 95 0.705 66.98 0.630 59.85
7 95 0.665 63.18 0.583 55.39
8 95 0.627 59.57 0.540 51.30
9 1095 0.592 648.24 0.500 547.50
112.37 -32.36
Now we use interpolation formula
112.37
6.00% +  2.00%
112.37 - (- 32.36)
112.37
6.00% +  2.00% = 6.00% + 1.553%
144.73
YTM = 7.553% say 7.55%
Thus, prevailing interest rate on similar type of Bonds shall be approx. 7.55%.

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

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

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

(ii) If there is decrease in required yield by 50 bps the expected market price of the
Bond shall be increased by:
= ` 970.97  0.50 (5.81/100) = ` 28.21
Hence expected market price is ` 970.97 + ` 28.21 = ` 999.18
Alternatively, this portion using Bond Price as per Short-cut method can also be
computed as follows:
= ` 969.70  0.50 (5.81/100) = ` 28.17
then the market price will be = ` 969.70 + ` 28.17 = ` 997.87
3. (i) Sensitivity of each stock with market is given by its beta.
Standard deviation of market Index = 15%
Variance of market Index = 0.0225
Beta of stocks = σ i r/ σ m
A = 20 × 0.60/15 = 0.80
B = 18 × 0.95/15 = 1.14
C = 12 × 0.75/15 = 0.60
(ii) Covariance between any 2 stocks = β1β 2 σ 2m
Covariance matrix
Stock/Beta 0.80 1.14 0.60
A 400.000 205.200 108.000
B 205.200 324.000 153.900
C 108.000 153.900 144.000
(iii) Total risk of the equally weighted portfolio (Variance) = 400(1/3) 2 + 324(1/3) 2 +
144(1/3) 2 + 2 (205.20)(1/3) 2 + 2(108.0)(1/3) 2 + 2(153.900) (1/3) 2 = 200.244
0.80  1.14  0.60
(iv) β of equally weighted portfolio = β p =  β i/N =
3
= 0.8467
(v) Systematic Risk β P2 σ m2 = (0.8467) 2 (15) 2 =161.303
Unsystematic Risk = Total Risk – Systematic Risk
= 200.244 – 161.303 = 38.941

4. (i) Variance of Returns

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

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

14.6% - 10%
Portfolio = = 2.175
2.115
Treynor Ratio
15% - 10%
MFX = = 4.60
1.087
14% - 10%
MFY = = 4.43
0.903
14.6%  10%
Portfolio = = 4.54
1.013
Alpha
MFX = 15% - 12.17% = 2.83%
MFY = 14% - 11.81% = 2.19%
Portfolio = 14.6% - 12.03% = 2.57%
5. Working Notes:
(i) Decomposition of Funds in Equity and Cash Components
NAV on 31.12.19 ` 70.71 ` 62.50
% of Equity 99% 96%
Equity element in NAV ` 70 ` 60
Cash element in NAV ` 0.71 ` 2.50
(ii) Calculation of Beta
(a) D Mutual Fund Ltd.
E(R) - R f E(R) - Rf
Sharpe Ratio = 2 = =
σD 11.25
E(R) - Rf = 22.50
E(R) - R f 22.50
Treynor Ratio = 15 = =
βD βD
βD = 22.50/15= 1.50

(b) K Mutual Fund Ltd.

E(R) - R f E(R) - Rf
Sharpe Ratio = 3.3 = =
σK 5
E(R) - Rf = 16.50
E(R) - R f 16.50
Treynor Ratio = 15 = =
βK βK
βK = 16.50/15= 1.10
(iii) Decrease in the Value of Equity
Market goes down by 5.00% 5.00%
Beta 1.50 1.10
Equity component goes down 7.50% 5.50%
(iv) Balance of Cash after 1 month
Cash in Hand on 31.12.19 ` 0.71 ` 2.50
Less: Exp. Per month ` 0.25 ` 0.25
Balance after 1 month ` 0.46 ` 2.25
NAV after 1 month
Value of Equity after 1 month
70 x (1 - 0.075) ` 64.75 -
60 x (1 - 0.055) - ` 56.70
Cash Balance 0.46 2.25
65.21 58.95
6. (i) The price of one Future Contract
Let X be the Price of Future Contract. Accordingly,
`9,00,000
5=
X
X (Price of One Future Contract) = ` 1,80,000

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

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

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

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

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

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

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

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

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

(a) Reduction of liabilities payable

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

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

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

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

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

2. Size of Forward contracts are Futures contracts are

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

PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT
Question No.1 is compulsory.
Candidates are also required to answer any four questions from the remaining five questions.
Working notes should form part of the respective answers.
Question 1
(a) Mr. X is of the opinion that market has recently shown the Weak Form of Market
Efficiency. In order to test the validity of his impression he has collected the following
data relating to the movement of the SENSEX for the last 20 days.
Days Open High Low Close
1 33470.94 33513.79 33438.03 33453.99
2 33453.64 33478.11 33427.82 33434.83
3 33414.06 33440.29 33397.65 33431.93
4 33434.94 33446.18 33377.78 33383.41
5 33372.92 33380.27 33352.12 33370.93
6 33375.85 33389.49 33331.42 33340.75
7 33340.89 33340.89 33310.95 33330.98
8 33326.84 33340.91 33306.17 33335.08
9 33307.16 33328.22 33296.43 33301.97
10 33298.64 33318.60 33254.28 33259.03
11 33260.04 33228.85 33241.66 33251.53
12 33255.92 33289.46 33249.46 33285.89
13 33288.86 33535.67 33255.98 33329.28
14 33335.00 33346.21 33276.72 33284.17
15 33293.83 33310.86 33278.54 33298.78
16 33300.02 33337.79 33300.02 33325.38
17 33323.36 33356.34 33322.44 33329.95
18 33322.81 33345.98 33317.44 33319.67
19 33317.51 33321.18 33294.19 33302.32
20 33290.86 33324.96 33279.62 33319.61
You are required:
To test the Weak Form of Market Efficiency using Auto-Correlation test, taking time lag
of 10 days. (8 Marks)
(b) A proposed foreign investment involves creation of a plant with an annual output of 1
million units. The entire production will be exported at a selling price of USD 10 per unit.

2 FINAL (NEW) EXAMINATION: JANUARY 2021
At the current rate of exchange dollar cost of local production equals to USD 6 per unit.
Dollar is expected to decline by 10% or 15%. The change in local cost of production and
probability from the expected current level will be as follows:
Decline in value of USD (%) Reduction in local cost of Probability
production (USD/unit)
0 - 0.4
10 0.30 0.4
15 0.15 Additional reduction 0.2
The plant at the current rate of exchange will have a depreciation of USD 1 million
annually. Assume local Tax rate as 30%.
You are required to find out:
(i) Annual Cash Flow After Tax (CFAT) under all the different scenarios of exchange
rate.
(ii) Expected value of CFAT assuming no repatriation of profits.
(iii) Viability of the investment proposal assuming an initial investment of USD 25 million
on plant and working capital with a required rate of return of 11% on investment and
on the basis of CFAT arrived under option (ii). The CFAT will grow @ 3% per annum
in perpetuity. (8 Marks)
(c) As a financial strategist you will depend on certain key financial decisions. Discuss.
(4 Marks)
Answer
(a)
Period 1 Closing Prices Change Period 2 Closing Prices Change
1 33453.99 11 33251.53
2 33434.83 -19.16 12 33285.89 34.36
3 33431.93 - 2.90 13 33329.28 43.39
4 33383.41 - 48.52 14 33284.17 - 45.11
5 33370.93 - 12.48 15 33298.78 14.61
6 33340.75 - 30.18 16 33325.38 26.6
7 33330.98 -9.77 17 33329.95 4.57
8 33335.08 4.1 18 33319.67 -10.28
9 33301.97 - 33.11 19 33302.32 -17.35
10 33259.03 - 42.94 20 33319.61 17.29

X Y X2 Y2 XY
-19.16 34.36 367.11 1180.61 -658.34
-2.90 43.39 8.41 1882.69 -125.83
-48.52 -45.11 2354.19 2034.91 2188.74
-12.48 14.61 155.75 213.45 -182.33
-30.18 26.6 910.83 707.56 -802.79
-9.77 4.57 95.45 20.88 -44.65
4.1 -10.28 16.81 105.68 -42.15
-33.11 -17.35 1096.27 301.02 574.46
-42.94 17.29 1843.84 298.94 -742.43
 X = -194.96 Y =  X = 6848.66
2
Y
2
= 6745.74  XY = 164.68
68.08
X = - 21.66 Y = 7.56
∑ XY -𝑛𝑋𝑌 164.68 - 9(-21.66)(7.56)

b= = = 0.624
∑ 𝑋 2 −𝑛(𝑋)2 6848.66−9(-21.66)2
a = Y - b X = 7.56 – 0.624(-21.66) = 21.08

a Y +b XY - n (Y)2 = 21.08(68.08) + 0.624(164.68) - 9(7.56)
2
r2 =
 Y 2 - n (Y)2
2
6745.74 - 9(7.56)
r2 = 0.164
r = 0.405
There is moderate degree of correlation between the returns of two periods hence it can
be concluded that the market does not show the weak form of efficiency.
(b) (i) Calculation of Annual CFAT
Scenario 1 Scenario 2 Scenario 3
Annual Sales (in units) (A) 10,00,000 10,00,000 10,00,000
US $ US $ US $
Selling price p.u. 10.00 10.00 10.00
Cost p.u. 6.00 5.70 5.55
Profit p.u. (B) 4.00 4.30 4.45
Total Profit (A x B) 40,00,000 43,00,000 44,50,000
Less: Depreciation 10,00,000 9,00,000 8,50,000
PBT 30,00,000 34,00,000 36,00,000

Less: Tax @30% 9,00,000 10,20,000 10,80,000

PAT 21,00,000 23,80,000 25,20,000
Add: Depreciation 10,00,000 9,00,000 8,50,000
Expected CFAT (US$) 31,00,000 32,80,000 33,70,000
(ii) Expected Value of CFAT
= US$ 31,00,000 x 0.4 + US$ 32,80,000 x 0.4 + US$ 33,70,000 x 0.2
= US$ 32,26,000
(iii) Viability of proposal:
Expected CFAT = US $ 32,26,000
Expected Growth Rate = 3%
US$ 32,26,000 (1.03)
Expected Value of inflow in perpetuity =
0.11 - 0.03
33,22,780
= = US$ 4,15,34,750
0.08
US $
Value of Inflows 4,15,34,750
Less: Initial Outlay 2,50,00,000
NPV of project 1,65,34,750
Since NPV is positive, project is viable.
(c) The key decisions falling within the scope of financial strategy are the following:
1. Financing decisions: These decisions deal with the mode of financing or mix of
equity capital and debt capital.
2. Investment decisions: These decisions involve the profitable utilization of firm's
funds especially in long-term projects (capital projects). Since the future benefits
associated with such projects are not known with certainty, investment decisions
necessarily involve risk. The projects are therefore evaluated in relation to their
expected return and risk.
3. Dividend decisions: These decisions determine the division of earnings between
payments to shareholders and reinvestment in the company.
4. Portfolio decisions: These decisions involve evaluation of investments based on
their contribution to the aggregate performance of the entire corporation rather than
on the isolated characteristics of the investments themselves.

Question 2
(a) On 1st January, 2020, an open ended scheme of mutual fund had outstanding units of
300 lakhs with a NAV of ` 20.25. At the end of January 2020, it had issued 5 lakhs units
at an opening NA V plus a load of 2%, adjusted for dividend equalisation. At the end of
February 2020, it had repurchased 2.5 lakhs units at an opening NAV less 2% exit load
adjusted for dividend equalisation. At the end of March 2020, it had distributed 70 per
cent of its available income.
In respect of January - March quarter, the following additional information is available:
Value appreciation of the portfolio ` 460 lakhs
Income for January ` 24 lakhs
Income for February ` 36 lakhs
Income for March ` 47 lakhs
(i) Income available for distribution
(ii) Issue price at the end of January
(iii) Repurchase price at the end of February
(iv) Closing Value of Net Assets at the end of March. (8 Marks)
(b) X Ltd., an Indian company, is considering a proposal to make an investment of USD
1,65,00,000 in Latin America. The project will have a life of 5 years. The current spot
exchange rate is INR/USD 72. All investments and revenues will occur in USD. The USD
and INR risk free rates are 8% and 12% respectively. The following cash flow is expected
form the project.
Year Cash inflow (USD)
1 30,00,000
2 37,50,000
3 45,00,000
4 60,00,000
5 75,00,000
Assume required rate of return on the project as 14%.
(i) The viability of the project using foreign currency approach.
(ii) What will be the impact if there is a withholding tax of 10% applicable on the project.
(8 Marks)

(c) "The process of securitisation can be viewed as process of creation of additional financial
product of securities in the market backed by collaterals." What are the other features?
Describe. (4 Marks)
Answer
(a) (i) Calculation of Income Available for Distribution
Units Per Unit Total
(Lakh) (`) (` In lakh)
Income from January 300 0.0800 24.0000
Add: Dividend equalization collected on issue 5 0.0800 0.4000
305 0.0800 24.4000
Add: Income from February 0.1180 36.0000
305 0.1980 60.4000
Less: Dividend equalization paid on repurchase 2.50 0.1980 (0.4950)
302.50 0.1980 59.9050
Add: Income from March 0.1554 47.0000
302.50 0.3534 106.9050
Less: Dividend Paid 0.2474 (74.8335)
302.50 0.1060 32.0715
(ii) Calculation of Issue Price at the end of January
`
Opening NAV 20.250
Add: Entry Load 2% of ` 20.25 0.405
20.655
Add: Dividend Equalization collected on Issue Price 0.080
20.735
(iii) Calculation of Repurchase Price at the end of February
`
Opening NAV 20.250
Less: Exit Load 2% of ` 20.250 (0.405)
19.845
Add: Dividend Equalization paid on Issue Price 0.198
20.043

(iv) Closing NAV at the end of March

` (Lakh)
Opening Net Asset Value (` 20.25 × 300) 6075.000
Portfolio Value Appreciation 460.000
Issue of Fresh Units (5 × 20.735) 103.675
Income Received 107.000
(24 + 36 + 47)
6745.675
Less: Units repurchased (2.5 × 20.043) - 50.1075
Income Distributed -74.8335 (-124.941)
Closing Net Asset Value 6620.734
Closing Units (300 + 5 – 2.5) lakh 302.50 lakh
Closing NAV as on 31 st March ` 21.8867
(b) (i) Viability of the Project

(1 + 0.12) (1 + Risk Premium) = (1 + 0.14)
Or, 1 + Risk Premium = 1.14/1.12 = 1.0179
Therefore, Risk adjusted dollar rate is = 1.0179 x 1.08 = 1.099 – 1 = 0.099
Calculation of NPV
Year Cash flow (Million) US$ PV Factor at 9.9% P.V.
1 3.00 0.910 2.730
2 3.75 0.828 3.105
3 4.50 0.753 3.389
4 6.00 0.686 4.116
5 7.50 0.624 4.680
18.02
Less: Investment 16.50
NPV 1.52
Therefore, Rupee NPV of the project is = ` 72 x US$ 1.52 Million
= ` 109.44 Million
Project is viable as the NPV is positive.

(ii) If there is a withholding tax of 10%

Total PV of Cash Inflows US$ 18.02 Million
Less: Withholding Tax @ 10% US$ 1.802 Million
PV of Cash Inflow after Withholding Tax US$ 16.218 Million
Less: Initial Investment US$ 16.50 Million
NPV (US$ 0.282 Million)
Therefore, Rupee NPV of the project is = ` 72 x (US$ 0.282 Million)
= - ` 20.304 Million
Thus, if there is a withholding tax of 10% then the project will not be viable.
(c) The other features of Securitization are as follows:
(i) Bundling and Unbundling – When all the assets are combined in one pool it is
bundling and when these are broken into instruments of fixed denomination it is
unbundling.
(ii) Tool of Risk Management – In case of assets are securitized on non-recourse basis,
then securitization process acts as risk management as the risk of default is shifted.
(iii) Structured Finance – In the process of securitization, financial instruments are tailor
structured to meet the risk return trade off profile of investor, and hence, these
securitized instruments are considered as best examples of structured finance.
(iv) Trenching – Portfolio of different receivable or loan or asset are split into several
parts based on risk and return they carry called ‘Trenche’. Each Trench carries a
different level of risk and return.
(v) Homogeneity – Under each tranche the securities issued are of homogenous nature
and even meant for small investors who can afford to invest in small amounts.
Question 3
(a) The price of March Nifty Futures Contract on a particular day was 9170. The minimum
trading lot on Nifty Futures is 50. The initial margin is 8 and the maintenance margin is
6%. The index closed at the following levels on next five days:
Day 1 2 3 4 5
Settlement Price (`) 9380 9520 9100 8960 9140
(i) Mark to market cash flows and daily closing balances on account of
(a) An investor who has taken a long position at 9170
(b) An investor who has taken a short position at 9170

(ii) Net profit/ loss on each of the contracts (8 Marks)

(b) M/s. Sky products Ltd., of Mumbai, an exporter of sea foods has submitted a 60 days bill
for EUR 5,00,000 drawn under an irrevocable Letter of Credit for negotiation. The
company has desired to keep 50% of the bill amount under the Exchange Earners
Foreign Currency Account (EEFC). The rates for `/USD and USD/EUR in inter-bank
market are quoted as follows:
`/ USD USD/EUR
Spot 67.8000 - 67.8100 1.0775 - 1.8000
1 month forward 10/11 Paise 0.20/0.25 Cents
2 months forward 21/22 Paise 0.40/0.45 Cents
3 months forward 32/33 Paise 0.70/0.75 Cents
Transit Period is 20 days. Interest on post shipment credit is 8% p.a. Exchange Margin is
0.1%. Assume 365 days in a year.
(i) Exchange rate quoted to the company
(ii) Cash inflow to the company
(iii) Interest amount to be paid to bank by the company. (8 Marks)
(c) Following are the yields on Zero Coupon Bonds (ZCB) having a face value of ` 1,000
Maturity (Years) Yield to Maturity (YTM)
1 10%
2 11%
3 12%
Assume that the term structure of interest rate will remain the same.
You are required to
(i) Calculate the implied one year forward rates
(ii) Expected Yield to Maturity and prices of one year and two year Zero Coupon Bonds
at the end of the first year. (4 Marks)
Answer
(a) (i) Contract Size (` 9,170 x 50) = ` 4,58,500
Initial Margin (8% of 4,58,500) = ` 36,680
Maintenance Margin (6% of 4,58,500) = ` 27,510

(1) For investor taken Long position:

Day Change in Future value (`) Margin A/c Call Money
(`) (`)
0 ----- 36,680
1 (` 9,380 - ` 9,170) x 50 = 10,500 47,180
2 (` 9,520 - ` 9,380) x 50 = 7,000 54,180
3 (` 9,100 - ` 9,520) x 50 = - 21,000 33,180
4 (` 8,960 - ` 9,100) x 50 = - 7,000 36,680 10,500
5 (` 9,140 - ` 8,960) x 50 = 9,000 45,680
(2) For investor taken Short position:

Day Change in Future value (`) Margin A/c Call Money
(`) (`)
0 ----- 36,680
1 (` 9,170 - ` 9,380) x 50 = -10,500 36,680 10,500
2 (` 9,380 - ` 9,520) x 50 = -7,000 29,680
3 (` 9,520 - ` 9,100) x 50 = 21,000 50,680
4 (` 9,100 - ` 8,960) x 50 = 7,000 57,680
5 (` 8,960 - ` 9,140) x 50 = -9,000 48,680
(ii) Calculation of Net Profit/Loss

(1) Long Position
(`)
Ending margin 45,680
Less: Initial Margin 36,680
Profit 9,000
Less: Margin Call 10,500
Net Loss 1,500
OR, Loss = (9,140 – 9,170) x 50 = (` 1,500)
(2) Short Position
(`)
Ending margin 48,680
Less: Initial Margin 36,680

Profit 12,000
Less: Margin Call 10,500
Net Profit 1,500
OR, Profit = (9,170 – 7,040) x 50 = ` 1,500
(b) (i) Transit and usance period is 80 days. It will be rounded off to the lower of months
and @ months forward bid rate is to be taken
`/USD ` 67.8000
Add: Premium for 2 months ` 0.2100
` 68.0100
Less: Exchange margin @ 0.1% ` 0.0680
Bid rate for USD ` 67.9420
USD/EUR USD 1.0775
Add: Premium USD 0.0040
USD 1.0815
`/EUR Rate (67.942 x 1.0815) ` 73.4793
Amount of Export Bill EUR 5,00,000
Less: EEFC EUR 2,50,000
EUR 2,50,000
Exchange Rate ` 73.4793
(ii) Cash Inflow ` 1,83,69,825
(iii) Interest for 80 days @ 8% ` 3,22,101
(c) (i) Calculation of Forward Rates
Maturity YTM (%) PVIF Face value Price Forward rate
1 10 0.909 1,000 909.09
2 11 0.812 1,000 811.62 0.1201 i.e. 12.01%
3 12 0.712 1,000 711.78 0.1403 i.e. 14.03%
(ii) Calculation of Expected Prices and YTM

Maturity Forward Face Price YTM
rate value
2 0.1201 1,000 1,000
= 892.78 0.1201 i.e. 12.01%
(1+0.1201)

3 0.1403 1,000 1,000 0.1302* i.e. 13.02%

(1+0.1201)(1+0.1403)
=782.93
 1,000 
*   - 1 = 0.1302
 782.93 
Question 4
(a) The following are the financial statements of A Ltd., and B Ltd. for the financial year
ended 31st March, 2020. Both the companies are working in the same industry.
Balance Sheets (`)
Particulars A Ltd. B Ltd.
Total Current Assets 15,00,000 12,00,000
Total Net Fixed Assets 12,00,000 6,00,000
Total Assets 27,00,000 18,00,000
Equity Capital (Face Value ` 10) 10,00,000 8,00,000

Retained Earnings 3,00,000 ---
14% Long Term Debt 7,00,000 5,00,000
Total Current Liabilities 7,00,000 5,00,000
Total Liabilities 27,00,000 18,00,000
Income Statement (`)
Particulars A Ltd. B Ltd.
Net Sales 33,10,000 16,60,000
Gross Profit 6,90,000 3,40,000
Operating Expenses 2,00,000 1,00,000
Interest 98,000 70,000
EBT 3,92,000 1,70,000
Tax @ 30% 1,17,600 51,000
PAT 2,74,400 1,19,000
Additional information :
Dividend Pay-out Ratio 40% 60%
Market Price per Share 40 15


(i) Earnings Per share (EPS), Profit Earning Ratio (PER), Return on Equity (ROE) and
Book Value Per Share (BVPS) for both the firms.
(ii) Estimate future EPS growth rate for both the firms.
(iii) If on acquisition of B Ltd. by A Ltd., intrinsic value of B Ltd., will be ` 20 per share,
develop range of justifiable Exchange Ratio (ER) that can be offered by A Ltd., to
shareholders of B Ltd.
(iv) Based on your analysis in (i) and (ii) whether the negotiated ratio will be close to
upper or lower range. Justify.
(v) Post-merger EPS on an ER of 0.4: 1. What will be immediate accretion or dilution to
EPS to the shareholders of both the firms?
(vi) Post-Merger MPS on the basis of ER of 0.4 : 1 (12 Marks)
(b) Shyam buys 10,000 shares of X Ltd., @ ` 25 per share and obtains a complete hedge of
shorting 400 Nifty at ` 1,100 each. He closes out his position at the closing price of the
next day when the share of X Ltd., has fallen by 4% and Nifty Future has dropped by
2.5%.
What is the overall profit or loss from this set of transaction? (4 Marks)
(c) Venture Capital Funding passes through various stages. Discuss. (4 Marks)
Answer
(a) Market price per share (MPS) = EPS X P/E ratio or P/E ratio = MPS/EPS
(i) Determination of EPS, P/E ratio, ROE and BVPS of A Ltd. and B Ltd.
A Ltd. B Ltd.
Profit After Tax (PAT) ` 2,74,400 ` 1,19,000
No. of Shares (N) 100000 80000
EPS (PAT/N) ` 2.744 ` 1.4875
Market price per share (MPS) 40 15
P/E Ratio (MPS/EPS) 14.58 10.08
Equity Funds (EF) ` 13,00,000 ` 8,00,000
BVPS (EF/N) 13 10
ROE (EAT/EF) × 100 21.11% 14.88%

(ii) Estimation of growth rates in EPS for A Ltd. and B Ltd.

Retention Ratio (1-D/P ratio) 0.6 0.4
Growth Rate (ROE × Retention Ratio) 12.67% 5.95%
(iii) Range of Justifiable exchange ratio
(a) Intrinsic value based = `20 / `40 = 0.5:1 (upper limit)
(b) Market price based = MPSDA/MPSBA = `15 / `40 = 0.375:1(lower limit)
(iv) Since, A Ltd. has a higher EPS, ROE, P/E ratio and even higher EPS growth
expectations, the negotiable terms would be expected to be closer to the lower limit,
based on the existing share prices.
(v) Calculation of Post merger EPS and its effects
Particulars A Ltd. B Ltd. Combined
EAT (`) (i) 2,74,400 1,19,000 3,93,400
Share outstanding (ii) 100000 80000 132000*
EPS (`) (i) / (ii) 2.744 1.4875 2.980
EPS Accretion (Dilution) (`) 0.236 (0.296***)
(vi) Estimation of Post merger MPS

Particulars A Ltd. B Ltd. Combined
EPS (`) (i) 2.744 1.4875 2.980
P/E Ratio (ii) 14.58 10.08 14.58
MPS (`) (i) x (ii) 40 15 43.45
* Shares outstanding (combined) = 100000 shares + (.40 × 80000) = 132000 shares
** EPS claim per old share = `2.98 × 0.4 ` 1.192
***EPS dilution = `1.4875 – ` 1.192 ` 0.296
(b) Cash Outlay
= 10000 x ` 25 – 400 x ` 1,100
= ` 2,50,000 – ` 4,40,000 = - ` 1,90,000
Cash Inflow at Close Out
= 10000 x ` 25 x 0.96 - 400 x ` 1,100 x 0.975
= ` 2,40,000 – ` 4,29,000 = - ` 1,89,000

Gain/ Loss
= ` 1,90,000 – ` 1,89,000 = ` 1,000 (Gain)
(c) Stages of Venture Capital Funding:
The various stages of Venture Capital Funding are as follows:
1. Seed Money: Low level financing needed to prove a new idea.
2. Start-up: Early stage firms that need funding for expenses associated with
marketing and product development.
3. First-Round: Early sales and manufacturing funds.
4. Second-Round: Working capital for early stage companies that are selling product,
but not yet turning in a profit.
5. Third Round: Also called Mezzanine financing, this is expansion money for a newly
profitable company.
6. Fourth-Round: Also called bridge financing, it is intended to finance the "going
public" process.
Question 5
(a) Ramesh has identified stocks of two companies A and B having good investment
potential:
Following data is available for these stocks:
Year A (Market Price per Share in `) B (Market Price per Share in `)
2013 19.60 8.70
2014 18.75 12.80
2015 33.42 16.20
2016 42.64 18.25
2017 43.25 15.60
2018 44.60 13.25
2019 34.75 18.60
(i) The Risk and Return by investing in Stock A and B
(ii) The Risk and Return by investing in a portfolio of these Stocks if he invests in Stock
A and B in proportion of 6 : 4.
(iii) The better opportunity for investment (10 Marks)

(b) M/s. Roly Ltd. wants to acquire M/s. Poly Ltd. The following is the Balance Sheet of Poly
Ltd. as on 31st March, 2020 :
Liabilities ` Assets `
Equity Capital (` 10 per share) 10,00,000 Cash 20,000
Retained Earnings 3,00,000 Debtors 50,000
12% Debentures 3,00,000 Inventories 2,00,000
Creditors and other liability 3,20,000 Plant & Machinery 16,50,000
Total 19,20,000 Total 19,20,000
Shareholders of Poly Ltd. will get one share of Roly Ltd. at current Market price of ` 20
for every two shares. External liabilities are expected to be settled at a discount of
` 20,000. Sundry debtors and Inventories are expected to realise ` 2,00,000.
Poly Ltd. will run as an independent unit. Cash Flow After Tax is expected to be
` 4,00,000 per annum for next 6 years. Assume the disposal value of the plant after 6
years will be ` 1,50,000.
Poly Ltd. requires a return of 14%
n 1 2 3 4 5 6
PVIF (14%, n) 0.877 0.769 0.675 0.592 0.519 0.456
Advise the Board of Directors on the financial feasibility of the Proposal. (6 Marks)
(c) Non-bank Financial Sources are becoming popular to finance Start-ups. Discuss.
(4 Marks)
Answer
(a)
A B
Year Market Return Return - A Squared Market Price Return Return - B Squared
(Return - A ) x
Price Per (%) Per Share in (%)
Share in ` ` (Return - B )
2013 19.60 8.70
2014 18.75 -4.34 -18.33 335.9889 12.80 47.13 30.94 957.2836 -567.1302
2015 33.42 78.24 64.25 4128.0625 16.20 26.56 10.37 107.5369 666.2725
2016 42.64 27.59 13.60 184.9600 18.25 12.65 -3.54 12.5316 -48.1440
2017 43.25 1.43 -12.56 157.7536 15.60 -14.52 -30.71 943.1041 385.7176
2018 44.60 3.12 -10.87 118.1569 13.25 -15.06 -31.25 976.5625 339.6875
2019 34.75 -22.09 -36.08 1301.7664 18.60 40.38 24.19 585.1561 -872.7752
83.95 6226.6883 97.14 3582.1748 -96.3718
Mean ( A ) 13.99 Variance 1037.7814 Mean ( B ) 16.19 Variance 597.0291 Cov.= -16.0620

(i) Return A = 13.99% and Risk (SD) = √1037.7814 = 32.2146 and Return B
= 16.19% and Risk (SD) = √597.0291= 24.4342
(ii) Return of Portfolio = 0.60 x 13.99% + 0.40 x 16.19% = 14.87%
Risk (Standard Deviation) of Portfolio = [0.60 2 x 1037.7814 + 0.40 2 x 597.0291 + 2 x
0.60 x 0.40 x (-16.0620)]½
= [373.6013 + 95.5247- 7.7098]½ = 21.4806
(iii) On the basis of Return ‘B’ is preferable and on the basis of Risk ‘Portfolio
Investment’ is preferable over the individual stocks.
(b) Calculation of Purchase Consideration
`
Issue of Share 50000 x ` 20 10,00,000
External Liabilities settled 3,00,000
12% Debentures 3,00,000
16,00,000
Less: Realization of Debtors and Inventories 2,00,000
Cash 20,000
13,80,000
Net Present Value = PV of Cash Inflow + PV of Demerger of Roly Ltd. – Cash Outflow
= ` 4,00,000 PVAF(14%,6) + ` 1,50,000 PVF(14%, 6) – ` 13,80,000
= ` 4,00,000 x 3.888 + ` 1,50,000 x 0.456 – ` 13,80,000
= ` 15,55,200 + ` 68,400 – ` 13,80,000
= ` 2,43,600
Since NPV of the decision is positive it is advantageous to acquire Poly Ltd.
(c) Non-bank Financial Sources to finance Start-ups:
(i) Personal financing. It may not seem to be innovative but you may be surprised to
note that most budding entrepreneurs never thought of saving any money to start a
business. This is important because most of the investors will not put money into a
deal if they see that you have not contributed any money from your personal
sources.
(ii) Personal credit lines. One qualifies for personal credit line based on one’s
personal credit efforts. Credit cards are a good example of this. However, banks are

very cautious while granting personal credit lines. They provide this facility only
when the business has enough cash flow to repay the line of credit.
(iii) Family and friends. These are the people who generally believe in you, without
even thinking that your idea works or not. However, the loan obligations to friends
and relatives should always be in writing as a promissory note or otherwise.
(iv) Peer-to-peer lending. In this process group of people come together and lend
money to each other. Peer to peer to lending has been there for many years. Many
small and ethnic business groups having similar faith or interest generally support
each other in their start up endeavours.
(v) Crowdfunding. Crowdfunding is the use of small amounts of capital from a large
number of individuals to finance a new business initiative. Crowdfunding makes use
of the easy accessibility of vast networks of people through social media and
crowdfunding websites to bring investors and entrepreneurs together.
(vi) Micro Loans. Microloans are small loans that are given by individuals at a lower
interest to a new business ventures. These loans can be issued by a single
individual or aggregated across a number of individuals who each contribute a
portion of the total amount.
(vii) Vendor financing. Vendor financing is the form of financing in which a company
lends money to one of its customers so that he can buy products from the company
itself. Vendor financing also takes place when many manufacturers and distributors
are convinced to defer payment until the goods are sold. This means extending the
payment terms to a longer period for e.g. 30 days payment period can be extended
to 45 days or 60 days. However, this depends on one’s credit worthiness and
payment of more money.
(viii) Purchase order financing. The most common scaling problem faced by start-ups
is the inability to find a large new order. The reason is that they don’t have the
necessary cash to produce and deliver the product. Purchase order financing
companies often advance the required funds directly to the supplier. This allows the
transaction to complete and profit to flow up to the new business.
(ix) Factoring accounts receivables. In this method, a facility is given to the seller who
has sold the good on credit to fund his receivables till the amount is fully received.
So, when the goods are sold on credit, and the credit period (i.e. the date up to
which payment shall be made) is for example 6 months, factor will pay most of the
sold amount up front and rest of the amount later. Therefore, in this way, a start-up
can meet his day to day expenses.

Question 6
(a) The Balance Sheet of M/s. Sundry Ltd. as on 31-03-2020 is follows:
(` in lakhs)
Liabilities ` Assets `
Share Capital 300 Fixed Assets 600
Reserves 200 Inventory 500
Long Term Loan 400 Receivables 240
Short Term Loan 300 Cash 60
Payables & Provisions 200
Total 1400 Total 1400
Sales for the year was ` 600 lakhs. The sales are expected to grow by 20% during the
year. The profit margin and dividend pay-out ratio are expected to be 4% and 50%
respectively.
The company further desires that during the current year Sales to Short Term Loan and
Payables and Provision should be in the ratio of 4 : 3. Ratio of fixed assets to Long Term
Loans should be 1.5. Debt Equity Ratio should not exceed 1.5.
(i) The amount of External Fund Requirement (EFR)
(ii) The amount to be raised from Short Term, Long Term and Equity funds. (8 Marks)
(b) XYZ has taken a six-month loan from its foreign collaborator for USD 2 millions. Interest
is payable on maturity @ LIBOR plus 1%. The following information is available:
Spot Rate INR/USD 68.5275
6 months Forward rate INR/USD 68.4575
6 months LIBOR for USD 2%
6 months LIBOR for INR 6%
You are required to :
(i) Calculate Rupee requirements if forward cover is taken.
(ii) Advise the company on the forward cover.
What will be your opinion if spot rate of INR/USD is 68.4275 ? (8 Marks)
(c) Participants are required for the success of the securitisation process. Discuss their
roles. (4 Marks)
OR
Risks are inherent and integral part of the market. Discuss.

Answer
(a) (i) External Funds Requirement (EFR):
(` in lakhs)
(`)
Expected sales (` 600 + 20% of ` 600) 720.00
Profit margin @ 4% 28.80
Dividend payout ratio @ 50% 14.40
Balance to be ploughed back (A) 14.40
Additional funds required (` 1400 - ` 200*) x 0.20 (B) 240.00
Balance to be met from external source (B - A) 225.60
* As current liabilities shall also be increased proportionately with increase in sales.
(ii) Amount to be raised from different sources with following conditions:
➢ Sales to short term loans and payables & provisions 4:3
➢ Ratio of fixed assets to long term loans 1.5
➢ Debt equity ratio should not exceed 1.5
(1) Amount to be raised from short term funds:
(` in lakhs)
New amount of short-term loans and payables & provision 450
3 
 4 x 600 
 
Less: Existing Amount of short-term loans and payables & 500
provision
Amount to be raised from short term funds Nil
(2) Amount to be raised from Long term funds:

(` in lakhs)
New fixed assets (` 600 + 20% of ` 600) 720
New long-term loans (` 720/1.5) 480
Less: Existing long-term loans 400
Amount to be raised from Long term funds 80

(3) Amount to be raised from equity funds:

(` in lakhs)
Amount to be raised from external sources 225.60
Less: Amount to be raised from short term funds ----
Less: Amount to be raised from Long term funds 80.00
Balance amount to be raised from equity funds 145.60
(b) (i) Rupee requirement if forward cover is taken:

6 Month Forward rate 68.4575
6
Interest amount (20,00,000 x 3%* x 12) US$ 30,000
Principal amount US$ 20,00,000

US$ 20,30,000
Rupee Requirement = INR 68.4575 X US$ 20,30,000 = INR 13,89,68,725
* LIBOR + 1%
(ii) Forward Rate as per Interest Rate Parity after 6 months is expected to be:
(1.03)
= 68.5275 x = 69.8845/US$
(1.01)
The company should take forward cover because as per Interest Rate Parity, the
rate after 6 months is expected to be higher than forward rate.
However, if spot rate is 68.4275, the expected rate as per Interest Rate Parity shall be:
(1.03)
= 68.4275 x = 69.7825/US$
(1.01)
Thus, still the company should take forward cover.
(c) Role of various participants in the process of securitization is as follows:
(a) Originator: It is the initiator of deal or can be termed as securitizer. It is an entity
which sells the assets lying in its books and receives the funds generated through
the sale of such assets.
(b) Special Purpose Vehicle: Since issuer originator transfers all rights in assets to
SPV, it holds the legal title of these assets. It is created especially for the purpose
of securitization only and normally could be in form of a company, a firm, a society
or a trust.

(c) The Investors: Investors are the buyers of securitized papers which may be an
individual, an institutional investor such as mutual funds, provident funds, insurance
companies, mutual funds, Financial Institutions etc.
(d) Obligors: The amount due from the obligor is transferred to SPV and hence they
form the basis of securitization process and their credit standing is of paramount
importance in the whole process.
(e) Rating Agency: Since the securitization is based on the pools of assets rather than
the originators, the assets have to be assessed in terms of its credit quality and
credit support available.
(f) Receiving and Paying agent (RPA): Also, called Servicer or Administrator, it
collects the payment due from obligor(s) and passes it to SPV. It also follow up with
defaulting borrower and if required initiate appropriate legal action against them.
Generally, an originator or its affiliates acts as servicer.
(g) Agent or Trustee: Trustees are appointed to oversee that all parties to the deal
perform in the true spirit of terms of agreement. Normally, it takes care of interest of
investors who acquires the securities.
(h) Credit Enhancer: Since investors in securitized instruments are directly exposed to
performance of the underlying and sometime may have limited or no recourse to the
originator, they seek additional comfort in the form of credit enhancement.
(i) Structurer: It brings together the originator, investors, credit enhancers and other
parties to the deal of securitization. Normally, these are investment bankers also
called arranger of the deal. It ensures that deal meets all legal, regulatory,
accounting and tax laws requirements.
OR
Yes, Risk is an integral part of market and this is a type of systematic risk that affects
prices of any particular share move up or down consistently for some time periods in line
with other shares in the market. A general rise in share prices is referred to as a bullish
trend, whereas a general fall in share prices is referred to as a bearish trend. In other
words, the share market moves between the bullish phase and the bearish phase. The
market movements can be easily seen in the movement of share price indices such as
the BSE Sensitive Index, BSE National Index, NSE Index etc.

PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT (NEW COURSE)
Question No.1 is compulsory.
Candidates are required to answer any four out of the remaining five questions.
Working notes should form part of the respective answer.
Question 1
(a) ZX Ltd. has made purchases worth USD 80,000 on 1 st May 2020 for which it has to make
a payment on 1 st November 2020. The present exchange rate is INR/USD 75. The
company can purchase forward dollars at INR/USD 74. The company will have to make
an upfront premium @ 1 per cent of the forward amount purchased. The cost of funds to
ZX Ltd. is 10 per cent per annum.
The company can hedge its position with the following expected rate of USD in foreign
exchange market on 1 st May 2020:
Exchange Rate Probability
(i) INR/USD 77 0.15
(ii) INR/USD 71 0.25
(iii) INR/USD 79 0.20
(iv) INR/USD 74 0.40
You are required to advise the company for a suitable cover for risk. (8 Marks)
(b) A two year tree for a share of stock in ABC Ltd., is as follows:
Consider a two years American call option on the stock of ABC Ltd., with a strike price of
` 98. The current price of the stock is ` 100. Risk free return is 5 per cent per annum
with a continuous compounding and e 0·05 = 1.05127.
Assume two time periods of one year each.

Using the Binomial Model, calculate:

(i) The probability of price moving up and down;
(ii) Expected pay offs at each nodes i.e. N1, N2 and N3 (round off upto 2 decimal
points). (8 Marks)
(c) On Tuesday morning (before opening of the capital market) an investor, while going
through his bank statement, has observed that an amount of ` 7 lakhs is lying in his bank
account. This amount is available for use from Tuesday till Friday. The Bank requires a
minimum balance of ` 1000 all the time. The investor desires to make a maximum
possible investment where Value at Risk (VaR) should not exceed the balance lying in
his bank account. The standard deviation of market price of the security is 1.5 per cent
per day. The required confidence level is 99 per cent.
Given
Standard Normal Probabilities
z 0.00 .01 .02 .03 0.04 .05 .06 .07 .08 .09
2.2 .9861 .9864 .9868 .9871 .9875 .9878 .9881 .9884 .9887 .9890
2.3 .9893 .9896 .9998 .9901 .9904 .9906 .9909 .9911 .9913 .9916
2.4 .9918 .9920 .9922 .9923 .9925 .9929 .9931 .9932 .9934 .9936
You are required to determine the maximum possible investment. (4 Marks)
Answer
(a) (i) If ZX Ltd. does not take forward (Unhedged Position):
Expected Rate = ` 77  0.15 + ` 71  0.25 + ` 79  0.20 + ` 74  0.40
= ` 11.55 + ` 17.75 + ` 15.80 + ` 29.60 = ` 74.70
Expected Amount Payable = USD 80,000  ` 74.70 = ` 59,76,000
(ii) If the ZX Ltd. hedge its position in the forward market:
Particulars Amount (`)
If company purchases US$ 80,000 forward premium is 59,200
(80000 × 74 × 1%)
Interest on ` 59,200 for 6 months at 10% 2,960
Total hedging cost (a) 62,160
Amount to be paid for US$ 80,000 @ ` 74.00 (b) 59,20,000
Total Cost (a) + (b) 59,82,160
Advise: Since cashflow is less in case of unhedged position company should opt for the
same.

(b) (i) Using the single period model, the probability of price moving up is
95
1.05127 -
R−d 100 = 0.10127 = 0.779 say 0.78 i.e. 78%
P= =
u−d 108 95
- 0.13
100 100
Therefore, the probability of price moving down = 1 - 0.78 = 0.22 i.e. 22%
(ii) Expected pay-off at
Node N2
0.78 ×18.64 + 0.22 × 4.60 15.55
= = ` 14.79
1.05127 1.05127
Node N3
0.78 ×4.60 + 0.22 × 0 3.588
= = ` 3.41
1.05127 1.05127
Node N1
0.78 × 14.79 + 0.22 × 3.41 12.286
= = ` 11.69
1.05127 1.05127
(c)
Particulars Amount (`)

Amount available in bank account 7,00,000
Minimum balance to be kept 1,000
Available amount which can be used for potential investment for 4 6,99,000
days
Maximum Loss for 4 days at 99% level 6,99,000
Maximum Loss for 1 day at 99 % level = Maximum Loss for 4 days / 3,49,500
√No. of days = 699000/ √4
Z Score at 99% Level 2.33
Volatility in terms of Rupees (Maximum Loss/ Z Score at 99% level) 1,50,000
= 349500/ 2.33
Maximum Possible Investment (Volatility in Rupees/Std Deviation) 1,00,00,000
= 150000/.015

Question 2
(a) AB Industries has Equity Capital of ` 12 Lakhs, total Debt of ` 8 Lakhs, and annual sales
of ` 30 Lakhs. Two mutually exclusive proposals are under consideration for the next
year. The details of the proposals are as under:
Particulars Proposal Proposal
no. 1 no. 2
Target Assets to Sales Ratio 0.65 0.62
Target Net Profit Margin (%) 4 5
Target Debt Equity Ratio (DER) 2:3 4:1
Target Retention Ratio (of Earnings) (%) 75 -
Annual Dividend (` In Lakhs) - 0.30
New Equity Raised (` in Lakhs) - 1
You are required to calculate sustainable growth rate for both the proposals. (8 Marks)
(b) IB an Indian firm has its subsidiary in Japan and Zaki a Japanese firm has its subsidiary
in India and face the following interest rates:
Company IB Zaki
INR floating rate BPLR + 0.50% BPLR + 2.50%
JPY (Fixed rate) 2% 2.25%
Zaki wishes to borrow Rupee Loan at a floating rate and IB wishes to borrow JPY at a
fixed rate. The amount of loan required by both the firms is same at the current
exchange rate. A financial institution may arrange a swap and requires 25 basis points as
its commission. Gain, if any, is to be shared by the firms equally.
You are required to find out:
(i) Whether a swap can be arranged which may be beneficial to both the firms?
(ii) What rate of interest will the firms end up paying? (8 Marks)
(c) Peer – to – Peer Lending and Crowd funding are same and traditional methods of
funding. Do you agree? Justify your stand. (4 Marks)
Answer
(a) Sustainable Growth Rate under Proposal 1
Sales (Given) ` 30 Lakhs
Total Assets ` 30 Lakhs x 0.65 ` 19.50 Lakhs
Net Profit ` 30 Lakhs x 4% ` 1.20 Lakhs

Equity Multiplier Equity 12 Lakhs 0.6

=
Equity + Debt 12 Lakhs + 8 Lakhs
ROE 1.20 Lakhs 3.69%
× 0.60 x 100
19.50 Lakhs
Sustainable Growth Rate = ROE x Retention Ratio
= 3.69% x 0.75 = 2.77%
Sustainable Growth Rate under Proposal 2
New Equity = ` 12 Lakhs + ` 1 Lakh = ` 13 Lakhs
New Debt = ` 13 Lakhs x 4 = ` 52 Lakhs
Total Assets = ` 13 Lakhs + ` 52 Lakhs = ` 65 Lakhs
Target Assets to Sales Ratio (Given) 0.62
Sales ` 65 Lakhs / 0.62 ` 104.84 Lakhs
Net Profit ` 104.84 Lakhs x 5% ` 5.242 Lakhs
Equity Multiplier Equity 13 Lakhs 0.2
=
Equity + Debt 13 Lakhs + 52 Lakhs
ROE = 5.242 Lakhs X 0.20 X 100 1.613%

65 Lakhs
Retention Ratio 5.242 Lakhs - 0.30 Lakhs 0.943
5.242 Lakhs
Sustainable Growth Rate = ROE x Retention Ratio

= 1.613% x 0.943 = 1.52%
(b) Though Company IB has an advantage in both the markets but it has comparative more
advantage in the INR floating-rate market. Company Zaki has a comparative advantage
in the JPY fixed interest rate market.
However, company IB wants to borrow in the JPY fixed interest rate market and company
Zaki wants to borrow in the INR floating-rate market. This gives rise to the swap
opportunity.
IB raises INR floating rate at BPLR + 0.50% and Zaki raises JPY at 2.25%
Total Potential Gain = (INR interest differential) - (Yen rate differential)
= (BPLR + 2.50% - BPLR + 0.50%) + (2% - 2.25%) = 1.75%
Less Banker's commission (To be shared equally) = 0.25%

Net gain (To be shared equally: 0.75% each) = 1.50%

(i) Yes, a beneficial swap can be arranged
(ii) Effective cost of borrowing = pays to lenders + pays to other party -receives from
other party + banker's commission
IB = BPLR + 0.50% +1.125%* - (BPLR + 0.50%) + 0.125% = 1.25%
(* has been arrived as 2% - 0.75% - 0.125%)
Zaki = 2.25% + BPLR + 0.50% - 1.125% + 0.125% = BPLR + 1.75%
Note: Candidates can also present the above Swap arrangement in a different manner.
In such case they should be awarded due marks provided solution be ended up in correct
answer.
(c) No, I do not agree with the given statement because while peer-to-peer lending is in
existence for many years the crowd funding is contemporary source of finance for Startup
finance.
Further in peer-to-peer lending a group of people come together and lend money to each
other. Many small and ethnic business groups having similar faith or interest generally
support each other in their start up endeavors.
On the other hand, Crowdfunding is the use of small amounts of capital from a large
number of individuals to finance a new business initiative. Crowdfunding makes use of
the easy accessibility of vast networks of people through social media and crowdfunding
websites to bring investors and entrepreneurs together.
Question 3
(a) The following data are available for a bond:
Face Value ` 10,000 to be redeemed at par on maturity
Coupon rate 8.5 per cent per annum
Years to Maturity 5 years
Yield to Maturity (YTM) 10 per cent
(i) Current market price of the Bond,
(ii) Macaulay’s Duration,
(iii) Volatility of the Bond,
(iv) Convexity of the Bond,
(v) Expected market price, if there is a decrease in the YTM by 200 basis points
(a) By Macaulay’s Duration based estimate
(b) By Intrinsic Value Method.

Given
Years 1 2 3 4 5
PVIF (10%, n) 0.909 0.826 0.751 0.683 0.621
PVIF (8%, n) 0.926 0.857 0.794 0.735 0.681
(7 Marks)
(b) M/S. Corpus an AMC, on 1.04.2015 has floated two schemes viz. Dividend Plan and
Bonus Plan. Mr. X, an investor has invested in both the schemes. The following details
(except the issue price) are available:
Date Dividend (%) Bonus Ratio NAV
Dividend Plan Bonus Plan
1.04.2015 ? ?
31.12.2016 1 :4 (One unit on 4 47 40
units held)
31.03.2017 12 48 42
31.03.2018 10 50 39
31.12.2018 1 :5 (One unit on 5 46 43
units held)
31.03.2019 15 45 42
31.03.2020 - - 49 44
Additional details
Investment (`) ` 9,20,000 ` 10,00,000
Average Profit (`) ` 27, 748.60
Average Yield (%) 6.40
You are required to calculate the issue price of both the schemes as on 1.04.2015.
(10 Marks)
(c) An individual attempts to found and build a company from personal finances or from the
operating revenues of the new company. What this method is called? Discuss any two
methods. (3 Marks)
Answer
(a) (i) Current Market Price of Bond
= ` 850 (PVIAF 10%, 5) + ` 10,000 (PVIF 10%, 5)
= ` 850 (3.79) + ` 10,000 (0.621) = ` 3,221.50 + ` 6,210 = ` 9,431.5

(ii) Macaulay’s Duration

1 850 0.909 772.65 0.082 0.082
2 850 0.826 702.10 0.074 0.148
3 850 0.751 638.35 0.068 0.204
4 850 0.683 580.55 0.062 0.248
5 10,850 0.621 6,737.85 0.714 3.57
9431.50 1.000 4.252
Duration of the Bond is 4.252 years
(iii) Volatility of Bond
Duration 4.252
Volatility of Bonds = = = 3.865
(1+ YTM) 1.10
(iv) Convexity of Bond
C*  (Y) 2  100
C* = V+ + V- - 2V0
2V0 (∆Y)2
Year Cash flow P.V. @ 8% P.V @12%
1 850 0.926 787.10 0.892 758.20
2 850 0.857 728.45 0.797 677.45
3 850 0.794 674.90 0.712 605.20
4 850 0.735 624.75 0.636 540.60
5 10,850 0.681 7388.85 0.567 6,151.95
10204.05 8,733.40
10,204.05 + 8,733.40 - 2 × 9,431.50
C* =
2 × 9,431.50 × ( 0.02 )
2
74.45
=
7.5452
= 9.867
Convexity of Bond = 9.867 x (0.02) 2 x 100 = 0.395%

(v) The expected market price if decrease in YTM by 200 basis points.
(A) By Macaulay’s duration-based estimate
= ` 9431.50 2 (3.865/100) = ` 729.05
Hence expected market price is ` 9431.50 + ` 729.05 = ` 10,160.55
Hence, the market price will increase.
(B) By Intrinsic Value method
Intrinsic Value at YTM of 10% ` 9,431.50
Intrinsic Value at YTM of 8% ` 10,204.05
Price increased by ` 772.55
Hence, expected market price is ` 10,204.05
(b) (i) Dividend Plan
(a) Average Annual gain over a period of 5 Years 27748.60
(b) Total gain over a period of 5 years (a*5) 138743
(c) Initial Investment 920000
(d) Total value of investment (b+c) 1058743
(e) NAV as on 31.3.2020 49
(f) Number of units at the end of the period as on 31.03.2019 (d/e) 21607
1 2 3 4 = (2*3) 5 6 = 1/ 7
(4+5)*4
Period Units Rate Unit Dividend NAV New Balance Units
held value Units* Pre Dividend
31.03.2019 21607 0.15 10 1.5 45 697 20910
31.03.2018 20910 0.1 10 1 50 410 20500
31.03.2017 20500 0.12 10 1.2 48 500 20000
Issue Price as on 01.04.2015 Investment 920000/ Units purchased 20000 (c/i) = ` 46
* Let the units issued be X
X = (Closing Units/NAV + Dividend) x Dividend
(ii) Bonus Plan

(a) Average Yield 0.064
(b) Investment 1000000
(c) Gain over a period of 5 years (a*b*5) 320000

(d) Market Value as on 31.03.2019 (b + c) 1320000

(e) NAV as on 31.03.2020 44
(f) Total units as on 31.03.2020 (d/e) 30000
(g) No of units as on 31.03.2018 Pre bonus = 30000*5/ (5 + 1) 25000
(h) No of units as on 31.12.2016 Pre bonus = 25000*4/ (4 + 1) 20000
(i) Issue Price as on 01.04.2015 Investment 1000000/ Units
purchased 20000 (b/h) 50
(c) When an individual attempts to found and build a company from personal finances or
from the operating revenues of the new company, it is called Boot Strapping.
A common mistake made by most founders is that they make unnecessary expenses
towards marketing, offices and equipment they cannot really afford. So, it is true that
more money at the inception of a business leads to complacency and wasteful
expenditure. On the other hand, investment by startups from their own savings leads to
cautious approach. It curbs wasteful expenditures and enable the promoter to be on their
toes all the time.
Here are some of the methods in which a startup firm can bootstrap:
(a) Trade Credit: When a person is starting his business, suppliers are reluctant to give
trade credit. They will insist on payment of their goods supplied either by cash or by
credit card. However, a way out in this situation is to prepare a well -crafted financial
plan. The next step is to pay a visit to the supplier’s office. If the business
organization is small, the owner can be directly contacted. On the other hand, if it is
a big firm, the Chief Financial Officer can be contacted and convinced about the
financial plan.
The owner or financial officer may give half the order on credit, with the balance due
upon delivery. Of course, the trick here is to get the goods shipped, and sell them
before one has to pay for them. One could borrow money to pay for the inventory,
but you have to pay interest on that money. So, trade credit is one of the most
important ways to reduce the amount of working capital one needs. This is
especially true in retail operations.
(b) Factoring: This is a financing method where accounts receivable of a business
organization is sold to a commercial finance company to raise capital. The factor
then got hold of the accounts receivable of a business organization and assumes
the task of collecting the receivables as well as doing what would've been the
paperwork. It can reduce costs associated with maintaining accounts receivable
such as bookkeeping, collections and credit verifications.
In addition to reducing internal costs of a business, factoring also frees up money
that would otherwise be tied to receivables. This money can be used to generate

profit through other avenues of the company. Thus, factoring can be a very useful
tool for raising money and keeping cash flowing in a startup.
(c) Leasing: Another popular method of bootstrapping is to take the equipment on lease
rather than purchasing it. It will reduce the capital cost and also help lessee (person
who take the asset on lease) to claim tax benefit in the form of lease rentals paid by
him. So, it is better to take a photocopy machine, an automobile or a van on lease
to avoid paying out lump sum money which is not at all feasible for a startup
organization. The lessee benefits by making smaller payments and retain the ability
to walk away from the equipment at the end of the lease term.
Question 4
(a) ICL is proposing to take over SVL with an objective to diversify. ICL’s profit after tax
(PAT) has grown @ 18 per cent per annum and SVL’s PAT is grown @ 15 per cent per
annum. Both the companies pay dividend regularly. The summarised Profit & Loss
Account of both the companies are as follows:
` in Crores
Particulars ICL SVL
Net Sales 4,545 1,500
PBlT 2,980 720
Interest 750 25
Provision for Tax 1,440 445
PAT 790 250
Dividends 235 125
ICL SVL
Fixed Assets
Land & Building (Net) 720 190
Plant & Machinery (Net) 900 350
Furniture & Fixtures (Net) 30 1,650 10 550
Current Assets 775 580
Less: Current Liabilities
Creditors 230 130
Overdrafts 35 10
Provision for Tax 145 50
Provision for dividends 60 470 50 240
Net Assets 1,955 890

Paid up Share Capital ( ` 10 per share) 250 125

Reserves and Surplus 1,050 1,300 660 785
Borrowing 655 105
Capital Employed 1,955 890
Market Price Share ( `) 52 75

ICL’s Land & Buildings are stated at current prices. SVL’s Land & Buildings are revalued
three years ago. There has been an increase of 30 per cent per year in the value of Land
& Buildings.
SVL is expected to grow @ 18 per cent each year, after merger.
ICL’s Management wants to determine the premium on the shares over the current
market price which can be paid on the acquisition of SVL.
You are required to determine the premium using:
(i) Net Worth adjusted for the current value of Land & Buildings plus the estimated
average profit after tax (PAT) for the next five years.
(ii) The dividend growth formula.
(iii) ICL will push forward which method during the course of negotiations?
Period (t) 1 2 3 4 5
FVIF (30%, t) 1.300 1.690 2.197 2.856 3.713
FVIF (15%, t) 1.15 2.4725 3.9938 5.7424 7.7537
(12 Marks)
(b) USD 10,000 is lying idle in your Bank Account. You are able to get the following quotes
from the dealers:
Dealer Quote
A EUR/USD 1.1539
B EUR/GBP 0.9094
C GBP/USD 1.2752
Is there an opportunity of gain from these quotes? (4 Marks)
(c) Side Pocketing enhances the value of the Mutual Fund. Do you agree? Briefly explain
the process of side pocketing. (4 Marks)

Answer
(a) (i) Computation of Premium (Net Worth Formula): Amount ` in Crores
Total Assets (Fixed assets + Current Assets) = (550 + 580) 1130
Less: Liabilities (Current Liabilities + Borrowings) = (240 + 105) 345
Net Assets Value 785
Current Value of Land after growing for three years @ 30% = 417.43
190 X 2.197
Less: Book Value 190.00
Increase in the Value of land 227.43
Adjusted NAV (785 + 227.43) 1012.43
Current Profit after Tax (@15 % for 5 years i.e. 250 X 7.7537 1938.43
Average Profit for 1 year = 1938.43/5 387.69
Total Value of Firm (1012.43 + 387.69) 1400.12
Total Market Value = No of shares X MPS = 12.50 X 75 937.50
Premium (Total Value – Market Value) 462.62
Premium (%) = 462.62/937.50 * 100 49.35%
(ii) Computation of Premium (Dividend Growth Formula):
Existing Growth Rate 0.15
DPS= 125/12.50 10
MPS 75
Cost of Equity (D1/MP + g) = [(10 X 1.15/75) + 0.15] 0.3033
Expected growth rate after merger 0.18
Expected Market Price = 10 X [1.18 / (0.3033 - 0.18)] 95.70
Premium over current market price (95.70 - 75)/ 75 X 100 27.60%
Alternatively, if given figure of dividend is considered as D 1 then Premium over Current
Market Price shall be computed as follows:
D  10  0.2833
Cost of Equity  1 + g   75 + 0.15
P   
Expected Growth Rate after Merger 0.18
Expected Market Price 10.00 / (0.2833 – 0.18) 96.81
Premium over Current Market Price (96.81 - 75)/ 75 x 100 29.08%
(iii) During the course of negotiations, ICL will push forward valuation based on Growth
Rate Method as it will lead to least cash outflow.

(b) The arbitrageur can proceed as stated below to realize arbitrage gains.
(i) Buy € from US$ 10,000 from Dealer A (10,000/ 1.1539) € 8,666.26
(ii) Convert these € to £ by selling to Dealer B (€ 8,666.26 × 0.9094) £ 7,881.09
(iii) Convert £ to US$ by selling to Dealer C (£ 7,881.09 × 1.2752) US$ 10,049.97
There is net gain of US$ 10,049.97 less US$ 10,000 i.e. US$ 49.97 or US$ 50.00.
(c) Side Pocketing: Yes, Side Pocketing enhances the value of a mutual fund. In simple
words, a side pocketing in mutual fund leads to separation of risky assets from other
investments and cash holdings. The purpose is to make sure that money invested in a
mutual fund, which is linked to stressed assets, gets locked, until the fund recovers the
money from the company or could avoid distress selling of illiquid securities.
Process of Side Pocketing: The modus operandi is simple. Whenever, the rating of a
mutual fund decreases, the fund shifts the illiquid assets into a side pocket so that
current shareholders can be benefitted from the liquid assets. Consequently, the Net
Asset Value (NAV) of the fund will then reflect the actual value of the liquid assets.
Therefore, the process of side pocketing ensures that liquidity is not the problem even in
the circumstances of frequent allotments and redemptions.
Thus, from the above it can be said that Side Pocketing helps to enhance the value of
fund for the investors to some extent.
Question 5
(a) ICL an Indian MNC is executing a plant in Sri Lanka. It has raised ` 400 billion. Half of
the amount will be required after six months’ time. ICL is looking an opportunity to invest
this amount on 1 st April,2020 for a period of six months. It is considering two underlying
proposals:
Market Japan US
Nature of Investment Index Fund (JPY) Treasury Bills (USD)
Dividend (in billions) 25 -
Income from stock lending (in billions) 11.9276 -
Discount on initial investment at the end 2% -
Interest - 5 per cent per annum
Exchange Rate (1st April, 2020) JPY/INR 1.58 USD/INR 0.014
Exchange Rate (30 th September, 2020) JPY/INR 1.57 USD/INR 0.013
You, as an Investment Manager, is required to suggest the best course of option.
(8 Marks)

(b) The following are the details of three mutual funds of MFL:
Growth Balanced Regular Market
Fund Fund Fund
Average Return (%) 7 6 5 9
Variance 92.16 54.76 40.96 57.76
Coefficient of Determination 0.3025 0.6561 0.9604
The yield on 182 days Treasury Bill is 9 per cent per annum.
(i) Rank the funds as per Sharpe's measure.
(ii) Rank the funds as per Treynor's measure.
(iii) Compare the performance with the market. (8 Marks)
(c) In an efficient market, technical analysis may not work perfectly. However, with
imperfections, inefficiencies and irrationalities, which characterises the real world,
technical analysis may be helpful.
Critically analyse the statement. (4 Marks)
Answer
(a) Investment in JPY (in billions)
Particulars Currency INR ER Currency JPY
Available amount 200 1.58 316
Dividend Income 25
Stock Lending Income 11.9276
Investment value at the end after discount @ 2% 309.68
Amount available at the end 346.6076
Conversion as on 30-09-2020 1.57 ` 220.7692
Gain ` 20.7692
Investment in USD (in billions)
Particulars Currency INR ER Currency USD
Available amount 200 0.014 2.80
Interest for 6 months @ 5% p.a. 0.07
Amount available at the end 2.87

Conversion as on 30-09-2020 0.013 ` 220.7692

Gain ` 20.7692
The equivalent amount is same in both the options so ICL is indifferent.
However, USD is more stable, and Treasury Bills are risk free, so investment in Treasury
Bills (USD) is suggested.
(b)
Growth Fund Balanced Fund Regular Fund Market

Average Return (%) 7 6 5 9
Variance 92.16 54.76 40.96 57.76
Std. Deviation 9.60 7.40 6.40 7.60
Coefficient of 0.3025 0.6561 0.9604
Determination
Coefficient of 0.55 0.81 0.98
Correlation
Beta (β) 9.60 7.40 6.40
× 0.55 × 0.81 × 0.98
7.60 7.60 7.60
= 0.695 = 0.789 = 0.825
(i) Ranking of Funds as per Sharpe Ratio
Expected Return - Risk Free Rate of Return
Sharpe Ratio =
Standard Deviation
Growth Fund Balanced Fund Regular Fund

Sharpe Ratio 7-9 6-9 5-9
= - 0.208 = - 0.405 = - 0.625
9.60 7.40 6.40
Ranking 1 2 3
(ii) Ranking of Funds as per Treynor Ratio
Expected Return - Risk Free Rate of Return
Treynor Ratio =
Beta
Growth Fund Balanced Fund Regular Fund

Treynor Ratio 7-9 6-9 5-9
= - 2.878 = - 3.802 = - 4.84
0.695 0.789 0.825
Ranking 1 2 3

(iii) Comparison of performance with the Market

Sharpe Ratio 9-9
=0
7.60
Treynor Ratio 9-9
=0
1
Thus, the performance of funds is very poor since all values are negative as
compared to market performance.
(c) Yes, this statement is correct.
Arguments for technical analysis:
(a) Under influence of crowd psychology trend persists for some time. Technical
analysis helps in identifying these trends early which is helping decision making.
(b) Shift in demand and supply is gradual rather than instantaneous. Technical analysis
helps in detecting this shift rather early
(c) Fundamental information about a company is observed and assimilated by the
market over a period of time. Hence price movements tend to more or less in same
direction till the information is fully assimilated in the price of the stock.
Arguments against technical analysis:
(a) Technical are not able to offer a convincing explanation for tools employed by them.
(b) Empirical evidence in support of random walk hypothesis cast its shadow on it
(c) By the time trends are signaled by technical analysis, trends have already taken
place.
Question 6
(a) An investor is considering to purchase the equity shares of LX Ltd., whose current
market price (CMP) is ` 112. The company is proposing a dividend of ` 4 for the next
year. LX Ltd. is expected to grow @ 20 per cent per annum for the next four years. The
growth will decline linearly to 16 per cent per annum after first four years. Thereafter, it
will stabilise at 16 per cent per annum infinitely. The investor requires a return of 20 per
cent per annum.
You are required
(i) To calculate the intrinsic value of the share of LX Ltd.
(ii) Whether it is worth to purchase the share at this price.
Period 1 2 3 4 5 6 7
PVIF (20%, n) 0.833 0.694 0.579 0.482 0.402 0.335 0.279
(8 Marks)

(b) The Management of a multinational company TL Ltd. is engaged in construction of

Infrastructure Project. A proposal to construct a Toll Road in Nepal is under consideration
of the Management.
The following information is available:
The initial investment will be in purchase of equipment costing USD 250 lakhs. The
economic life of the equipment is 10 years. The depreciation on the equipment will be
charged on straight line method.
EBIDTA to be collected from the Toll Road is projected to be USD 33 lakhs per annum
for a period of 20 years.
To encourage investment Nepalese government is offering a 15 year term loan of USD
150 lakhs at an interest rate of 6 per cent per annum. The interest is to be paid annually.
The loan will be repaid at the end of 15 year in one tranche.
The required rate of return for the project under all equity financing is 12 per cent per
annum.
Post tax cost of debt is 5.6 per cent per annum.
Corporate Tax Rate is 30 per cent.
All cash Flows will be in USD.
Ignore inflation.
You are required to advise the management on the viability of the proposal by using
Adjusted Net Present Value method.
Given
PVIFA (12%, 10) = 5.650, PVIFA (12%, 20) = 7.469, PVIFA (8%,15) = 8.559, PVIF (8%,
15) = 0.315. (8 Marks)
(c) Distinguish between Pass Through Certificates (PTC) and Pay Through Securities (PTS).
OR
Differentiate between Economic Value Added (EVA) and Market Value Added (MVA)
(4 Marks)
Answer
(a) D1 = ` 4
D2 = ` 4 (1.20) = ` 4.80
D3 = ` 4 (1.20)2 = ` 5.76
D4 = ` 4 (1.20)3 = ` 6.91

D5 = ` 6.91 (1.19) = ` 8.22

D6 = ` 6.91 (1.19) (1.18) = ` 9.70
D7 = ` 6.91 (1.19) (1.18) (1.17) = ` 11.35
D8 = ` 6.91 (1.19) (1.18) (1.17) (1.16) = ` 13.17
D1 D2 D3 D4 D5 D6 D7 TV
P= + ++ ++ + + + +
2 3 4 5 6 7 7
(1+ k e ) (1+ k e ) (1+ k e ) (1+ k e ) (1+ k e ) (1+ k e ) (1+ k e ) (1+ k e )
D8 13.17
TV = = = ` 329.25
ke - g 0.20 - 0.16
4.00 4.80 5.76 6.91 8.22 9.70 11.35 329.25

P= + + + + + + +
2 3 4 5 6 7 7
(1+ 0.20) (1+ 0.20) (1+ 0.20) (1+ 0.20) (1+ 0.20) (1+ 0.20) (1+ 0.20) (1+ 0.20)
= 4.00 x 0.833 + 4.80 x 0.694 + 5.76 x 0.579 + 6.91 x 0.482 + 8.22 x 0.402 + 9.70 x
0.335 + 11.35 x 0.279 + 329.25 x 0.279
(i) Intrinsic Value = ` 114.91
(ii) As Intrinsic Value of the share is higher than its selling price of ` 112, it is under-
priced and can be acquired. However, other factors need to be taken into
consideration since difference is only slightly higher.
(b) (i) Net Present Value (All Equity Financed) – Base NPV
Particulars Period USD Lakhs PVF @ 12% PV (USD Lakhs)
Initial Investment 0 (250.00) 1.000 (250.000)
EBIDTA 1 to 20 33.00 7.469 246.477
Tax 1 to 20 (9.90) 7.469 (73.943)
Depreciation 1 to 10 (25.00)
Tax Saving on Dep 1 to 10 7.50 5.650 42.375
NPV (35.091)
(ii) Present Value of Impact of Financing by Debt
Particulars Period USD Lakhs PVF @ 8% PV (USD Lakhs)
Loan 0 150.00 1.000 150.000
Interest 1 to 15 (9.00) 8.559 (77.031)
Tax Saving on Interest 1 to 15 2.70 8.559 23.109
Repayment of Principal 15 (150.00) 0.315 (47.250)
NPV 48.828

Adjusted Present Value of the Project

= Base NPV + PV of Impact of Financing
= - US$ 35.091 + US $ 48.828 lakh
= US$ 13.737 lakh
Advise: Since APV is positive, TL Ltd. should accept the project.
Alternatively, if instead of PV of overall impact of Financing the PV of impact of tax
shield on Interest is considered then APV shall be computed as follows:
= Base NPV + PV of Tax Shield on Interest
= - US$ 35.091 + US $ 23.109 lakh
= - US$ 11.982 lakh
Advise: Since APV is negative, TL Ltd. should not accept the project.
(c) Pass Through Certificates (PTC) - In case of PTCs, the originator transfers the entire
receipt of cash in the form of interest or principal repayment from the asset sold. Thus,
PTC represent a direct claim of the investors on all assets securitized. Investors carry a
proportional benefit. Skewness of cash flow occurs at an early stage in case of
prepayment of principals.
Pay Through Securities (PTS) – In PTS, SPV debt securities are backed by the assets
and hence it can restructure different tranches from varying maturities of recei vables.
PTS also permits the SPV to reinvest surplus funds for short term as per there
requirement.
OR
Economic Value Added (EVA) – EVA is a holistic method of evaluating a company’s
financial performance in terms of its contribution to the society at large. The core concept
behind EVA is that a company generates ‘value’ only if there is a creation of wealth in
terms of returns in excess of its cost of capital. The formula is as below -
EVA = NOPAT – (Invested Capital * WACC)
Or
NOPAT – Capital Charge
Market Value Added (MVA) – MVA means Current Market Value of the firm minus
Invested Capital. It is an alternative way to gauge performance efficiencies of an
enterprise, albeit from a market capitalization point of view, the logic being that the
market will discount the efforts taken by the management fairly. Hence, MVA is the true
value added that is perceived by the market while EVA is a derived value added that is
for the more discerning investor.

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PAPER – 2: STRATEGIC FINANCIAL MANAGEMENT

You are required to calculate:

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Average Annual Standard Correlation with the

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B 15.0 2.0 0.540

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(c) the number of shares of each company to be disposed off,

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The quotes for foreign exchange are as follows:

60 days Forward Rate INR/ US$ (buying) ` 67.16

90 days Forward Rate INR/ US$ (buying) ` 68.03

© The Institute of Chartered Accountants of India

20th August, 2019 and run for a period of 7 days.

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

(e) Premium over Straight Value of Debenture

Two asset portfolio

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(iii) 75% in B and 25% in D

© The Institute of Chartered Accountants of India

CSL 5000 20 100000 0.0602 1 0.060

© The Institute of Chartered Accountants of India

Portfolio Sharpe Method Treynor Method Jensen's Alpha

Standard deviation of ΔF = 36% = 6% and

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© The Institute of Chartered Accountants of India

Value of the portfolio after rise of Nifty 5091

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© The Institute of Chartered Accountants of India

Interest earned on Cash ` 0.0025 Crore

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© The Institute of Chartered Accountants of India

13. (i) Exchange ratio in proportion to relative EPS

EPS for Cauliflower Ltd. after merger = 34,00,000 = 5.00

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Cabbage Ltd. Shareholders

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© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

The fund has incurred the following expenses:

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Initial Margin Interest rates in India

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(ii) Using currency futures

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© The Institute of Chartered Accountants of India

Market Rate of Return 11%

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

P0 = 30.52(0.885) + 33.27(0.783) +36.26(0.693) +720(0.693)

2. (a) Calculation of theoretical Post-rights (ex-right) price per share

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(b) Calculation of theoretical value of the rights alone:

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(ii) Equity Beta on change in Capital Structure

Value of Debt to be Raised 184

Equity after Repurchase = Total value of Firm – Desired Debt Value

Weighted Average Beta of ABCL:

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