IPCC, Financial Management

May−2008, Question Paper

[Part 3-B: Financial Management]

5. Answer any five of the following:
(i) Explain the relevance of time value of money in financial decisions.
(ii) Discuss the features of Secured Premium Notes (SPNs).
(iii) The following data relate to RT Ltd :
Rs
Earning before interest and tax (EBIT) 10,00,000
Fixed cost 20,00,000
Earning Before Tax (EBT) 8,00,000
Required : Calculate combined leverage
(iv) Explain the concept of closed and open ended lease.
(v) Discuss the advantages of preference share capital as an instrument of raising funds.
(vi) Explain the principles of “Trading on equity”.
6. The financial statement and operating results of PQR revealed the following position as on 31st
march, 2006:
−Equity share capital (Rs 10 fully paid share) Rs 20,00,000
−Working capital Rs 6,00,000
−Bank overdraft Rs 1,00,000
−Current ratio 2.5 : 1
−Liquidity ratio 1.5 : 1
−Proprietary ratio (Net assets/Proprietary Fund) .75 : 1
−Cost of sales Rs 14,40,000
−Debtors velocity 2 months
−Stock turnover based on cost of sales 4 times
−Gross profit ratio 20% of sales
−Net profit ratio 15% of sales
Closing stock was 25% higher than the opening stock. There were also free reserves brought forward
from earlier years. Current assets include stock, debtors and cash only. The current liabilities expect bank
overdraft treated as creditors.
Expenses include depreciation of Rs 90,000
The following information was collected from the records for the year ended31st March, 2007:
− Total sales for the year were 20% higher as compared to previous year.
− Balances as on 31st March, 2007 were : Stock Rs 5,20,000, Creditors Rs 4,15,000. Debtors Rs
4,95,000 and Cash balance Rs 3,10,000.
− Percentage of Gross profit on turnover has gone up from 20% to 25%and ratio of net profit to sales
from 15% to 16%.
− A portions of Fixed assets was very old (book values Rs 1,80,0000 disposed for Rs 90,000. (No
depreciations to be provided on this item).
− Long-term investments were purchased for Rs 2,96,000.
− Bank overdraft fully discharged.
− Percentage of depreciation to Fixed assets to be provided at the rate in the previous year.
Required :
(i) Prepare Balance Sheet as on 31st March, 2006 and 31st March, 2007.
(ii) Prepare the fund flow statement for the year ended 31st March, 2007.

1
7. (a) ABC Ltd wishes to raise additional finance of Rs 20 lakh for meeting its investment plans. The
company has Rs 4,00,000 in the form of retained earnings available for investment purposes. The following
are the further details :
 Debt equity ratio 25 : 75
 Cost of debt at the rate of 10 per cent (before tax) upto Rs 2,00,000 and 13% (before tax) beyond
that
 Earning per share, Rs 12.
 Dividend payout 50% of earnings.
 Expected growth rate in dividend. 10%
 Current market price per share, Rs 60.
 Company’s tax rate is 30% and shareholder’s personal tax rate is 20%.
Required:
(i) Calculate the post tax average cost of additional debt.
(ii) Calculate the cost of retained earnings and cost of equity.
(iii) Calculate the overall weighted average (after tax) cost of additional finance.
(b) C Ltd is considering investing in a project. The expected original investment in the project will be
Rs 2,00,000, the life of project will be 5 year with no salvage value. The expected net cash inflows
after depreciation but before tax during the life of the project will be as following :
Year 1 2 3 4 5
Rs 85,000 1,00,000 80,000 80,000 40,000
The project will be depreciated at the rate of 20% on original cost. The company is subjected to 30%
tax rate.
Required :
(i) Calculate pay back period and average rate of return (ARR).
(ii) Calculate net present value and net present value index, if cost of capital is 10%.
(iii) Calculate internal rate of return.
Note : The P.V. factors are :

Year P.V at 10% P.V. at 37% P.V. At 38% P.V. at 40%

1 .909 .730 .725 .714
2 .826 .533 .525 .510
3 .751 .389 .381 .364
4 .683 .284 .276 .260
5 .621 .207 .200 .186

8. Answer any three of the following :

(i) Explain the concept of Debt securitization.
(ii) Explain briefly the functions of Treasury Department.
(iv) Explain briefly the features of External Commercial Borrowings. (ECB)
(v) The Sales Manager of AB Limited suggests that if credit period is given for 1.5 months then
sales may likely to increase by Rs 1,20,000 per annum. Cost of sales amounted to 90% of
sales. The risk of non-payment is 5%. Income tax rate is 30%. The expected return on
investment is Rs 3,375 (after tax). Should the company accept the suggestion of Sale
Manager ?

November−2008
Answer all Questions

2
 [Part 3-B : Financial Management]

5. Answer any five of

(i) Write a short note on “Deep Discount Bonds”.
(ii) What is meant by ‘Venture Capital Financing’?
(iii) Discuss the concept of “Optimal Capital Structure.”
(iv) Name the various financial instruments dealt with in the international market.
(v) How is return on capital employed calculated? What is its significance?
(vi) What is quick ratio? What does it signify?

6. Balance Sheets of a company as on 31st March, 2007 and 2008 were as follows :
Liabilities 31.3.07 31.3.08 Assets 31.3.07 31.3.08
Rs Rs Rs Rs

Equity Share Capital 10,00,000 10,00,000 Goodwill 1,00,000 80,000

8% P.S. Capital 2,00,000 3,00,000 Land and Building 7,00,000 6,50,000
General Reserve 1,20,000 1,45,000 Plant and Machinery 6,00,000 6,60,000
Securities Premium − 25,000 Investments (non-trading) 2,40,000 2,20,000
Profit & Loss A/c 2,10,000 3,00,000 Stock 4,00,000 3,85,000
11% Debentures 5,00,000 3,00,000 Debtors 2,88,000 4,15,000
Creditors 1,85,000 2,15,000 Cash and Bank 88,000 93,000
Provisions for tax 80,000 1,05,000 Prepaid Expenses 15,000 11,000s
Proposed Dividend 1,36,000 1,44,000 Premium on
Redemption of Debenture −
20,000
24,31,000 25,34,000 24,31,000 25,34,000

Additional information:
1. Investments were sold during the year at a profit of Rs 15,000
2. During the year an old machine costing Rs. 80,000 was sold for Rs 36,000. Its written down value
was Rs 45,000
3. Depreciation charged on Plants and Machinery @ 20 per cent on the opening balance.
4. There was no purchase or sale of Land and Building.
5. Provision for tax made during the year was Rs 96,000.
6. Preference shares were issued for consideration of cash during the year.
You are required to prepare:
(i) Cash flow statement as per AS-3.
(ii) Schedule of changes in working capital.

7. (a) MN Ltd is commencing a new project for manufacture of electric toys. The following cost
information has been ascertained for annual production of 60,000 units at full capacity:

Amount per unit (Rs)

Raw materials 20
Direct labour 15
Manufacturing overheads:
Variable 15
Fixed 10 25
Selling and Distribution overheads:
Variable 3
Fixed 1 4
Total cost 64

3
 Profit 16
Selling price 80
In the first year of operations expected production and sales are 40,000 units and 35,000 units
respectively. To assess the need of Working capital, the following additional information is available :
(i) Stock of Raw materials 3 months consumption.
(ii) Credit allowable for debtors 1½ months.
(iii) Credit allowable by creditors 4 months.
(iv) Lag in payment of wages 1 month.
(v) Lag in payment of overheads 1/2 month.
(vi) Cash in hand and Bank is expected to Rs 60,000.
(vii) Provision for contingencies is required @ 10% of Working capital requirement
including that provision.
You are required to prepare a projected statement of Working capital requirement for the first year of
operations. Debtors are taken at cost.
(b) A company wants to invest in a machinery that would cost Rs 50,000 at the beginning of year 1.
It is estimated that the net cash inflows from operations will be Rs 18,000 per annum for 3 years,
if the company opts to service a part of the machine at the end of year 1 at Rs 10,000 and the
scrap value at the end of year 3 will be Rs 12,5000. However, of the company decides not to
services the part, it will have to be replaced at the end of year 2 at Rs 15,4000. But in this case,
the machine will work for the 4 th year also and get operational cash inflow of Rs 18,000 for the
4th year. It will have to be scrapped at the end of year 4 at Rs 9,000. Assuming cost of capital at
10% and ignoring taxes, will you recommended the purchase of this machine based on the net
present value of its cash flows.
If the supplier gives a discount of Rs 5,000 for purchase, what would be your decision? (The
present value factors at the end of years 0,1,2,3,4,5 and 6 are respectively 1, 0.9091, 0.8264,
0.7513, 0.6830, 0.6209 and 0.5644).
1. Answer any three of the following :
(i) A company offers a fixed deposit scheme whereby Rs 10,000 matures to Rs 12,625
after 2 years, on a half-yearly compounding basis. If the company wishes to amend
the scheme by compounding interest every quarter, what will be the revised maturity
value ?
(ii) A company operates at a production level of 1,000 units. The contribution is Rs 60
per unit, operating leverage is 6, combined leverage is 24. If tax rate is 30%, what
would be its earnings after tax?
(iii) What do you mean by Stock Turnover ratio and Gearing ratio?
(iv) Explain the concept of multiple Internal rate of Return.

May − 2009
Answer all Questions
[Part 3-B : Financial Management]
5. Answer any five of the following :
(i) Write a short note on functions of Treasury department.
(ii) Discuss the concept of American Depository Receipts.
(iii) How is Debt service coverage ratio calculated? What is its significance?
(iv) Discuss conflict in profit versus wealth maximization objective.
(v) Discuss the concept of Debt-Equity or EBIT-EPS indifference point, while determining the
capital structure of a company.
(vi) Discuss the benefits to the originator of Debt Securitisation.
4
 6. Balance Sheets of RST Limited as on March 31, 2008 and March 31, 2009 are as under :
Liabilities 31.3.2008 31.3.2009 Assets 31.3.2008 31.3.2009
Rs Rs Rs Rs
Equity Share Capital Land & Building 6,00,000 7,00,000
(Rs 10 face value Plant & Machinery 9,00,000 11,00,000
Per share) 10,00,000 12,00,000 Investments (Long-term) 2,50,000 2,50,000
General Reserve 3,50,000 2,00,000 Stock 3,60,000 3,50,000
9% Preference Share Debtors 3,00,000 3,90,000
Capital 3,00,000 5,00,000 Cash & Bank 1,00,000 95,000
Share Premium A/c 25,000 4,000 Prepaid Expenses 15,000 20,000
Profit & Loss A/c 2,00,000 3,00,000 Advance Tax Payment 80,000 1,05,000
8% Debentures 3,00,000 1,00,000 Preliminary Expenses 40,000 35,000
Creditors 2,05,000 3,00,000
Bills Payable 45,000 81,000
Provision for Tax 70,000 1,00,000
Proposed Dividend 1,50,000 2,60,000
26,45,000 30,45,000 26,45,000 30,45,000

Additional information:
(i) Depreciation charged on building and plant and machinery during the year 2008-09 were
Rs 50,000 and Rs 1,20,000 respectively.
(ii) During the year an old machine costing Rs 1,50,000 was sold or Rs 32,000. Its written
down value was Rs 40,000 on date of sale.
(iii) During the year, income tax for the year 2007-08 was assessed at Rs 76,000. A cheque of
Rs 4,000 was received alongwith the assessment order towards refund of income tax paid in
excess, by way of advance tax in earlier years.
(iv) Proposed dividend for 2007-08 was paid during the year 2008-09.
(v) 9% Preference share of Rs 3,00,000, which were due for redemption, were redeemed
during the year 2008-09 at a premium of 5%, out of the proceeds of fresh issue of 9%
Preference shares.
(vi) Bonus shares were issued to the existing equity shareholders at the rate of one share for
every five shares held on 31.3.2008 out of general reserves.
(vii) Debentures were redeemed at the beginning of the year at a premium of 3%.
(viii) Interim dividend paid during the year 2008-09 was Rs 50,000.
Required:
(a) Schedule of Changes in Working Capital; and
(b) Fund Flow Statement for the year ended March 31, 2009.

7. (a) The capital structure of MNP Ltd is as under :

9% Debentures Rs 2,75,000
11% Preference shares Rs 2,25,000
Equity shares (face value : Rs 10 per share) Rs 5,00,000
Rs 10,00,000

Additional information:
(i) Rs 100 per debenture redeemable at par has 2% floatation cost and 10 years of
maturity. The market price per debenture is Rs 105.
(ii) Rs 100 per preference share redeemable at par has 3% floatation cost and 10 years of
maturity. The market price per preference share is Rs106.

5
 (iii) Equity share has Rs 4 floatation cost and market price per share of Rs 24. The next
year expected dividend is Rs 2 per share with annual growth of 5%. The firm has a
practice of paying all earnings in the form of dividends.
(iv) Corporate Income-tax rate is 35%.
Required:
Calculate Weighted Average Cost of Capital (WACC) using market value weights.
(b) A company is required to choose between two machines A and B. The two machines are designed
differently, but have indentical capacity and do exactly the same job. Machine A costs Rs 6,00,000
and will last for 3 years. It costs Rs 1,20,000 per year to run.
Machine B is an ‘economy’ model costing Rs 4,00,000 but will last only for two years, and cost
Rs 1,80,000 per year to run. These are real cash flows. The costs are forecasted in Rupees of
constant purchasing power. Opportunity cost of capital is 10%. Which machine company should
buy? Ignore tax.
PVIF0.10.1 = 0.9091, PVIF0.10,2 = 0.8264, PVIF0.10.1 = 0.7513.

8. Answer any three of the following :

(i) A firm maintains a separate account for cash disbursement. Total disbursements are
Rs 2,62,500 per month. Administrative and transaction cost of transferring cash to disbursement
account is Rs 25 per transfer. Marketable securities yield is 7.5% per annum. Determine the
optimum cash balance according to William J Baumol model.
(ii) A firm has a total sales of Rs 12,00,000 and its average collection period is 90 days. The past
experience indicates that bad debt losses are 1.5% on sales. The expenditure incurred by the firm in
administering receivable collection efforts are Rs 50,000. A factor is prepared to buy the firm’s
receivables to the firm at an interest rate of 16% p.a. after withholding 10% as reserve. Calculate
effective cost of factoring to the firm. Assume 360 days in a year.
(iii) Explain the concept of discounted payback period.
(iv) Discuss the composition of Return on Equity (ROE) using the DuPont model.

November −2009
Answer all Questions

[Part 3-B: Financial Management]

5. Answer any five of the following:

(i) Explain briefly the limitations of financial ratios.
(ii) What do you understand by Business Risk and Financial Risk?
(iii) Differentiate between Factoring and Bills discounting.
(iv) Differentiate between Financial Management and Financial Accounting.
(v) Y Ltd retains Rs 7,50,000 out of its current earning. The expected rate of return to the shareholders.
If they had invested the funds elsewhere is 10%. The brokerage is 3% and the shareholders came in
30% tax bracket. Calculate the cost of retained earning.
(vi) From the informations given below calculate the amount of Fixed assets and
Proprietor's fund.
Ratio of fixed assets to proprietors fund = 0.75
Net working capital = Rs 6,00,000

6. The Balance Sheets of a Company as on 31 March 2008 and 2009 are given below:
6
 Liabilities 31.3.08 31.3.09 Assets 31.3.08 31.3.09
Rs Rs Rs Rs
Equity share capital 14,40,000 19,20,000 Fixed assets 38,40,000 45,60,000
Capital reserve - 48,000 Less depreciation 11,04,000 13,92,000
General reserve 8,16,000 9,60,000 27,36,000 31,68,000
Profit & Loss A/c 2,88,000 3,60,000 Investment 4,80,000 3,84,000
9% debentures 9,60,000 6,72,000 Sunder debtors 12,00,000 14,00,000
Sundry creditors 5,50,000 5,90,000 Stock 1,40,000 1,84,000
Bills payables 26,000 34,000 Cash in hand 4,000
Proposed dividend 1,44,000 1,72,800 Preliminary Expenses 96,000 48,000
Provision for tax 4,32,000 4,08,000
Unpaid dividend - 19,200
46,56,000 51,84,000 46,56,000 51,84,000
Additional informations:
During the year ended 31 March 2009 the company:
(i) Sold a machine for Rs 1,20,000; the cost of machine was Rs 2,40,000 and depreciation provided on
it was Rs 84,000.
(ii) Provided Rs 4,20,000 as depreciation fixed assets.
(iii) Sold some investment and profit credited to capital reserve.
(iv) Redeemed 30% of the debenture @ 105
(v) Decided to write off fixed assets costing Rs 60,000 on which deprecation amounting to Rs 48,000
has been provided.
You are required to prepare Cash Flow Statement as per AS-3.

7. (a) From the following Financial data of Company A and Company B prepare their Income statements.
Company A Company B
Rs Rs
Variable cost 56,000 60% of sales
Fixed cost 20,000 -
Interest expenses 12,000 9,000
Financial leverage 5: 1 -
Operating leverage - 4: 1
Income tax rates 30% 30%
Sales - 1,05,000

(b) A hospital is considering to purchase a diagnostic machine costing Rs 80,000. The projected life of the
machine is 8 years and has an expected salvage value of Rs 6,000 at the end of 8 years. The annual
operating cost of the machine is Rs 7,500. It is expected to generate revenues of Rs 40,000 per year for eight
years. Presently, the hospital is outsourcing the diagnostic work and is earning commission income is Rs
12,000 per annum; net of taxes.
Required: Whether it would be profitable for the hospital to purchase the machine. Give your
recommendation under:
(i) Net Present Value method
(ii) Profitability Index method. PV factors at 10% are given below:
Year l Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
0.909
0.751 0.683
0.564 0.513

8. Answer any three of the following:

(i) Explain the two basic functions of Financial Management.

7
 (ii) Explain the following terms:
(a) Ploughing back of profits
(b) Desirability factor.
(iii) What do you understand by weighted average cost of capital?
(iv) There are two firms P and Q which are identical except P does not use any debt in its capital
structure while Q has Rs. 8,00,000, 9% debentures in its capital structure. Both the firms have
earning before interest and tax of Rs. 2,60,000 p. a. and the capitalization rate is 10%.
Assuming the corporate tax of 30%, calculate the value of these firms according to MM
Hypothesis.

C.A. Final Gr. I New Course

Paper-2

November – 2008

Question No. 1 is compulsory. Answer any four question from the rest.
1. (a) Following information is available for X Company’s shares and Call option:
Current share price Rs 185
Option exercise price Rs 170
Risk free interest rate 7%
Time of the expiry of option 3 years
Standard deviation 0.18
Calculate the value of option using Black-Scholes formula.
(b) Suppose a dealer quotes ‘All-in-cost’ for a generic swap at 8% against six month libor flat. If the
notional principal amount of swap is Rs 5,00,000.
(i) Calculate semi-annual fixed payment.
(ii) Find the first floating rate payment for (i) above if the six-month period from the effective
date of swap to the settlement data comprises 181 days and that the corresponding libor was
6% on the effective date of swap.
(iii) In (ii) above, if the settlement in on ‘Net’ basis, how much the fixed rate payer would pay to
the floating rate payer?
Generic swap is based on 30/60 days basis.
(c) Consider the following information on two stocks, A and B:
Year Return on A (%) Return on B (%)
2006 10 12
2007 16 18
You are required to determine:
(i) The expected return on a portfolio containing A and B in the proportion of 40% and 60%
respectively.
(ii) The Standard deviation of return from each of the two stocks.
(iii) The covariance of returns from the two stocks.
(iv) Correlation coefficient between the returns of the two stocks.
(v) The risk of a portfolio containing A and B in the proportion of 40% and 60%.

2. (a) The following is the yield structure of AAA rated debenture:

Period Yield (%)
3 months 8.5%
6 months 9.25
8
 1 year 10.50
2 years 11.25
3 years and above 12.00
(i) Based on the expectation theory calculate the implicit one-year forward rates in year 2 and year 3.
(ii) If the interest rate increases by 50 basis points, what will be the percentage change in the price of the
bond having a maturity of 5 years? Assume that the bond is fairly priced as the moment at Rs 1,000
(b) RST Ltd has a capital of Rs 10,00,000 in equity shares of Rs 100 each. The shares are currently
quoted at par. The company proposes to declare a dividend of Rs 10 per share at the end of the
current financial year. The capitalization rate for the risk class of which the company belongs is
12%. What will be the market price of the share at the end of the year, if
(i) a dividend is not cleared?
(ii) a dividend is declared?
(iii) assuming that the company pays the dividend and has net profits of Rs 5,00,000 and makes new
investments of Rs 10,00,000 during the period, how many new shares must be issued? Use the
MM model.
(c) Mr X established the following spread on the Delta Corporation’s stock:
(i) Purchased one 3-month call option with a premium of Rs 30 and an exercise price of Rs 550.
(ii) Purchased one 3-month put option with a premium of Rs 5 and an exercise price of
Rs 450.
Delta Corporation’s stock is currently selling at Rs 500. Determine profit or loss, if the price of
Delta Corporation’s:
 remains at Rs 500 after 3 months.
 falls at Rs 350 after 3 months.
 rises to Rs 600.
Assume the size of option is 100 shares of Delta Corporation.
(d) XL Ispat Ltd has made an issue of 14 per cent non-convertible debentures on January
1, 2007. These debentures have a face value of Rs 100 and is currently traded in the market at a price
of Rs 90. Interest on these NCD will be paid through post-dated cheques dated June 30 and
December 31. Interest payments for the first 3 years will be paid in advance through post-dated
cheques while for the last 2 years, post-dated cheques will be issued at the third year. The bond is
redeemable at par on December 31, 2011 at the end of 5 years.
Required:
(i) Estimate the current yield at the YTM of the bond.
(ii) Calculate the duration of the NCD.
(iii) Assuming that intermediate coupon payments are, not available for reinvestment calculate the
realized yield on the NCD.

3. (a) A company has an old machine having book value zero, which can be sold for Rs 50,000.
The company is thinking to choose one from following two alternatives:
(i) To incur additional cost of Rs 10,00,000 to upgrade the old existing machine.
(ii) To replace old machine with a new machine costing Rs 20,00,000 plus installation cost Rs
50,000.
Both above proposals envisage useful life to be five years with salvage value to be nil.
The expected after tax profits for the above three alternatives are as under:
Year Old existing Upgrade New
Machine Machine Machine
Rs Rs Rs
1. 5,00,000 5,50,000 6,00,000
2. 5,40, 000 5,90, 000 6,40, 000
3. 5,80, 000 6,10, 000 6,90, 000

9
 4. 6,20, 000 6,50, 000 7,40, 000
5. 6,60, 000 7,00, 000 8,00, 000
The tax rate is 40 per cent.
The company follows straight line method of depreciation. Assume cost of capital to be
15 per cent.
P.V.F. of 15% = 0.870, 0.756, 0.658, 0.572 and 0.497. You are required to advise the company as to
which alternative is to be adopted.
(b) The data given below relates to a convertible bond:
Face value Rs 250
Coupon rate 12%
No. of shares per bond 20
Market price of share Rs 12
Straight value of bond Rs 235
Market price of convertible bond Rs 265
Calculate:
(i) Stock value of blood.
(ii) The percentage of downside risk.
(iii) The conversion premium
(iv) The conversion parity price of the stock.
(c) What are the drawbacks of investments in Mutual Funds?
4. (a) An exporter is a UK-based company. Invoice amount is $ 3,50,000. Credit period is three months.
Exchange rates in London are:
Spot Rate ($/£) 1.5865 − 1.5905
3-month Forward Rate ($/£) 1.6100 − 1.6140
Rates of Interest in Money Market:
Deposit Loan
$ 7% 9%
£ 5% 8%
Compute the show how a money market hedge can be put in place. Compare and contrast
the outcome with a forward contract.
(b) An Indian exporting firm, Rohit and Bros, would be cover itself against a likely
depreciation of pound sterling. The following data is given:
Receivables of Rohit and Bros: £ 5,00,000
Spot rate: Rs 56.00/£
Payment date: 3-months
3-months interest rate: India: 12 per cent per annum
UK: 5 per cent annum
What should the exporter do?
(c) The closing value of Sensex for the month of October 2007 is given below:
Date Closing Sensex Value
1.10.07 2800
3.10.07 2780
4.10.07 2795
5.10.07 2830
8.10.07 2760
9.10.07 2790
10.10.07 2880
11.10.07 2960
12.10.07 2990
15.10.07 3200
16.10.07 3300
17.10.07 3450

10
 19.10.07 3360
22.10.07 3290
23.10.07 3360
24.10.07 3340
25.10.07 3290
29.10.07 3240
30.10.07 3140
31.10.07 3260
You are required to test the weak form of efficient market hypothesis by applying the run test at
5% and 10% level of significance.
Following value can be used
Value of t at 5% is 2.101 at 18 degrees of freedom.
Value of t at 10% is 1.734 at 18 degrees of freedom.
Value of t at 5% is 2.086 at 20 degrees of freedom.
Value of t at 10% is 1.725 at 20 degrees of freedom.

5. (a) (i)
The rate of inflation in USA is likely to be 3% per annum and in India it is likely to
be 6.5%. The current spot rate of US $ in India is Rs 43.30. Find the expected rate of US $ in
India after one year and 3 years from now using purchasing power parity
theory.
(ii) On April 1, 3 months interest rate in the UK £ and US $ are 7.5% and 3.5% per
annum respectively. The UK £/US $ spot rate is .7570. What would be the forward
rate for US $ for delivery on 30 June?
(b) K. Ltd is considering acquiring N. Ltd, the following information is available:
Company Profit after Number of Market value
Tax Equity shares per share
K. Ltd 50,00,000 10,00,000 20.00
N. Ltd 15,00,000 2,50,000 160.00
Exchange of equity shares for acquisition is based on current market value as above. There is no
synergy advantage available:
(i) Find the earning per share for company K. Ltd after merger.
(ii) Find the exchange ratio so that shareholders of N. Ltd would not be at a loss.
6. Write short notes on any four of the following:
 Financial restructuring
 Cross-border leasing
 Embedded derivatives
 Arbitrage operations
 Rolling settlement.

C.A. Final Gr. I New Course

Paper-2

May – 2009

Question No. 1 is compulsory. Answer any four question from the rest.
1. (a) Consider a two-year American call option with a strike price of Rs 50 on a stock the current price
of which is also Rs 50. Assume that there are two time periods of one year and in each year the
stock price can move up or down by equal percentage of 20%. The risk free interest rate is 6%.

11
 Using binomial option model, calculate the probability of price moving up and down. Also draw
a two step binomial tree showing prices and payoffs at each node.
(b) Mr X owns a portfolio with the following characteristics:
Security A Security B Risk free security
Factor 1 sensitivity 0.80 1.50 0
Factor 2 sensitivity 0.60 1.20 0
Expected Return 15% 20% 10%
It is assumed that security returns are generated by a two factor model.
(i) If Mr X has Rs 1,00,000 to invest and sells short Rs 50,000 of security B and purchases Rs
1,50,000 of security A what is the sensitivity of Mr X’s portfolio to the two factors?
(ii) If Mr X borrows Rs 1,00,000 at the risk free rate and invests the amount he borrows along
with the original amount of Rs 1,00,000 in security A and B in the same proportion as
described in part (i), what is the sensitivity of the portfolio to the two factors?
(iii) What is the expected return premium of factor 2?
(c) The share of X Ltd is currently selling for Rs 300. Risk free interest rate is 0.8% per
month. A three-month futures contract is selling for Rs 312. Develop an arbitrage
strategy and show what riskless profit will be 3 months hence assuming that X Ltd will
not pay any dividend in the next three months.

2. (a) An investor has two portfolios known to be on minimum variance set for a population of three
securities A, B and C having below mentioned weights:
WA WB WC
Portfolio X 0.30 0.40 0.30
Portfolio Y 0.20 0.50 0.30
It is supposed that there are no restrictions on short sales.
(i) What would be the weight for each stock for a portfolio constructed by investing
Rs 5,000 in portfolio X and Rs 3,000 in portfolio Y?
(ii) Suppose the investor invests Rs 4,000 out of Rs 8,000 in security A. How will be allocate the
balance between security B and C to ensure that his portfolio is on minimum variance set?
(b) Calculate the value of share from the following information:
Profit of the company Rs 290 crore
Equity capital of company Rs 1,300 crore
Par value of share Rs 40 each
Debt ratio of company 27
Long run growth rate of the company 8%
Beta 0.1: risk free interest rate 8.7%
Market return 10.3%
Capital expenditure per share Rs 47
Depreciation per share Rs 39
Change in Working capital Rs 3.45 per share
(c) The returns on stock A and market portfolio for a period of 6 years are as follows:
Year Return on (% ) Return on market portfolio (%)
1 12 12
2 15 12
3 11 11
4 2 −4
5 10 9.5
6 −12 −2
You are required to determine:
(i) Characteristic line for stock A
(ii) The systematic and unsystematic risk of stock A.

12
3. (a) M/s Gama & Co. is planning of installing a power saving machine and are considering buying or
alternative. The machine is subject to straight-line method of depreciation. Gama & Co. can raise
debt at 14% payable in five equal annual instalments of Rs 1,78,858 each, at the beginning of the
year. In case of leasing, the company would be required to pay an annual end of year rent of 25% of
the cost of machine for 5 years.
The Company is in 40% tax bracket. The salvage value is estimated at Rs 24,998 at the end of 5
years.
Evaluate the two alternatives and advise the company by considering after-tax cost of debt
concept under both alternatives. P.V. factors 0.9225, 0.8510, 0.7851, 0.6681 respectively for 1 to 5
years.
(b) ABC Ltd has Rs 300 million, 12 per cent bonds outstanding with six years remaining to maturity.
Since interest rates are falling, ABC Ltd is contemplating of refunding these bonds with a Rs 300
million issue of 6-year bonds carrying a coupon rate of 10 per cent. Issue cost of the new bonds will
be Rs 6 million and the call premium is 4 per cent. Rs 9 million being the unamortized portion of
issue cost of old bonds can be written off no sooner the old bonds are called off. Marginal tax rate of
ABC Ltd is 30 per cent. You are required to analyse the bond refunding decision.
(c) Mr X earns 10% on his investments in equity shares. He is considering a recently floated scheme of
a Mutual Fund where the initial expenses are 6% and annual recurring expenses are expected to be
2%. How much the Mutual Fund scheme should earn to provide a return of 10% to Mr X?

4. (a) Your forex dealer had entered into a cross currency deal and had sold US $ 10,00,000
against EURO at US $ 1 = EUR 1.4400 for spot delivery.
However, later during the day, the market became volatile and the dealer in compliance
with his management’s guidelines had to square-up the position when the quotations were:
Spot US $ 1 INR 31.4300/4500
1 month margin 25/20
2 month margin 45/35
Spot US $ 1 Euro 1,4400/4450
1 month forward 1.4425/4490
2 month forward 1.4460/4530
What will be the gain or loss in the transaction?
(b) On 19 April following are the spot rates
Spot EUR/USD 1.2000 USD/INR 44.800
Following are the quotes of European Options:
Currency pair Call/Put Strike price Premium Expiry date
EUR/ISD Call 1,2000 $ 0.035 July 19
EUR/USD Put 1,2000 $ 0.04 July 19
USD/INR Call 44,8000 Rs 0.12 Sep. 19
USD/INR Put 44,8000 Rs 0.04 Sep. 19
(i) A trader sells an at-the-money spot straddle expiring at three months (July 19).
Calculate gain or loss if three months later the spot rate is EUR/USD 1,2900.
(ii) Which strategy gives a profit to the dealer if five months later (Sep. 19) expected spot rate is
USD/INR 45.00. Also calculate profit for a transaction USD 1.5 million.
(c) You have following quotes from Bank A and Bank B:
Bank A Bank B
SPOT USD/CHF 1.4650/55 USD/CHF 1.4653/60
3 months 5/10
6 months 10/15
SPOT GBP/USD 1.7645/60 GBP/USD 1.7640/50
3 months 25/20
6 months 35/25
Calculate:

13
 (i) How much minimum CHF amount you have to pay for 1 Million GBP spot?
(ii) Considering the quotes from Bank A only, for GBP/CHF what are the Implied Swap points for
Spot over 3 months?

5. The following information relating to the acquiring Company Abhiman Ltd and the target Company
Abhishek Ltd. are available. Both the companies are promoted by multinational company, Trident Ltd.
The promoter’s holding is 50% and 60% respectively in Abhiman Ltd and Abhishek Ltd:
Abhiman Ltd Abhishek Ltd
Share Capital (Rs) 200 lakh 100 lakh
Free Reserves and Surplus (Rs) 800 lakh 500 lakh
Paid up Value per share (Rs) 100 10
Free float Market Capitalisation (Rs) 400 lakh 128 lakh
P/E Ratio (times) 10 4
Trident Ltd is interested to do justice to the shareholders of both the companies. For the swap ratio
weights are assigned to different parameters by the Board of Directors as follows:
Book Value 25%
EPS (Earning per share) 50%
Market Price 25%
(i) What is the swap ratio based on above weights?
(ii) What is the Book Value, EPS and expected Market price of Abhiman Ltd after acquisition of
Abhishek Ltd (assuming P.E. ratio of Abhiman Ltd remains unchanged and all assets and
liabilities of Abhishek Ltd are taken over at book value).
Calculate:
(a) Promoter’s revised holding in the Abhiman Ltd
(b) Free float market capitalization.
(c) Also calculate No. of Shares, Earning per Share (EPS) and Book Value (B.V.), if acquisition of
Abhishek Ltd, Abhiman Ltd decided to:
(i) Issue Bonus shares in the ratio of 1: 2; and
(ii) Split the stock (share) as Rs 5 each fully paid.

6. (a) Consider two bonds, one with 5 years to maturity and the other with 20 years to maturity. Both the
bonds have a face value of Rs 1,000 and coupon rate of 8% (with annual interest payments) and
both are selling at par. Assume that the yields of both the bonds fall to 6%, whether the price of
bond will increase or decrease? What percentage of this increase/decrease comes from a change in
the present value of bond’s principal amount and what percentage of this increase/decrease comes
from a change in the present value of bond’s interest payments?
(b) Consider a bond selling at its par value of Rs 1,000, with 6 years to maturity and a 7% coupon rate
(with annual interest payment), what is bond’s duration?
(c) If the YTM of the bond in (b) above increases to 10%, how it affects the bond’s duration? And
why?
(d) Why should the duration of a coupon carrying bond always be less than the time to its
maturity?

14