SFM Formulae and Concept Revision Capsule - Bhavik Chokshi

Bhavik Chokshi ( 9082810221/7977299310) www.benchmarxacademy.
com
BENCHMARX ACADEMY
BHAVIK CHOKSHI
(CA (FINAL AIR 41), CS (CSFC AIR 21), CFA (USA)
STRATEGIC FINANCIAL MANAGEMENT REVISION –

Formulae & Concepts Capsule
CONTACT US – 9082810221/ 7977299310
WWW.BENCHMARXACADEMY .COM
1
Bhavik Chokshi ( 9082810221/7977299310) www.benchmarxacademy.com
INDEX
Sr . No Topics Page No.

1. Security Analysis & Valuation 3
2. Mergers & Acquisitions 7
3. Corporate Valuation 10
4. Portfolio Management 12
5. Mutual Funds 16
6. Risk Management 18
7. Derivatives 19
8. Interest Rates 22
9. Foreign Exchange Management 23
10. International Financial Management 33
2
1. SECURITY ANALYSIS & VALUATION
A. Valuation of Bonds
1. Valuation
I1 I2 IN
B0 =
(1 +KD ) 1 + (1 +KD ) 2 + ……………………. (1 +KD ) N
+
RVN
(1 +KD ) N
2. Yield
Interest
a. Current Yield = × 100
Price
b. Realised Yield
N ∑ (I +RV)
r= √ −1
P
c. Yield to Maturity (YTM)
RV−P
I +[ N ]
(Approximate) YTM = RV +P
[ 2 ]
(Accurate Method) YTM : Trial & Error Method (IRR Technique)

3. Forward Rates
(1 + YTM)2 = (1 + r1) (1 + r2)

(1 + YTM)3 = (1 + r1) (1 + r2) (1 + r3)
4. Macaulay Duration
∑ t ×PVCIt
D=
∑ PV of All CI
5. Modified Duration
Macaulay Duration
Modified Duration = (Volatility)
(1 +YTM)
3
6. Change in Bond Price = % Change in Interest × (-) Modified Duration
7. Immunization
DASSETS = DLIAB
8. Portfolio Duration
Dp = W ADA + W BDB + ……………………
9. Key Relationships
 Coupon Rate = YTM (Discount Rate) : Price = Face Value

 Falling Interest Rates : Buy Longer Duration Bonds
 Rising Interest Rates : Buy Shorter Duration Bonds
 Higher Duration : Higher Risk
 Interest Rate & Bond Price : Inverse Relationship
B. Valuation of Equity Shares
1. Gordon’s Formula : [Single Growth]
D1
P0 =
Ke − g
D1 = D0 × (1 + g)
g=r×b
Ke = RF + (RM + RF) × β
OR
E 1
Ke= [ ]
P PE Ratio
OR
D
Ke =
P
2. Gordon’s Formula : [Differing Growth]
P0 = PV of (D1 + D2 + …………. D5) + PV of (D6 + D7 + …………. D∞ )
Terminal Value
4
3. Firm Value [Enterprise] = Debt Value + Preference Value + Equity Value
4. F.C.F.F = PAT + DEP + INT(1 - t) - ↑ FA - ↑ WC
FCFF1
V(F) =
WACC− g
5. FCFE = PAT + DEP - ↑ FA - ↑ WC + Net Borrowings
FCFE1
V(E) =
Ke − g
In case Debt Ratio (D) given,

FCFE = PAT + DEPRE(1 - D) - ↑ FA(1 - D) - ↑ WC(1 - D)
6. Earning Yield Method
E1
P0 =
Ke − g
7. Right Shares
Ex Right Price : Weighted Average Price
Value of Right : Ex Right Price – Rights Issue Price
C. Convertibles
1. Conversion Value = Price/Share × Conversion Ratio
2. Conversion Premium = Price/Bond – Conversion Value
3. Straight Value = PV of Interest & Principal
4. Downside Risk = Price/Bond – Straight Value
Price/Bond
5. Conversion Parity Price =
Conversion Ratio
6. Income Differential : Coupon (Bond) – Dividend (Equivalent Shares)
Conversion Premium
7. Premium Payback Period =
Income Differential
D. Buyback (BB)
Post BB Price = Post BB EPS × POST BB P/E
5
E. Economic Value Added (EVA)
EVA = NOPAT* - Capital Employed × WACC
NOPAT = EBIT(1 - t) or PAT + Interest(1 - t)
Capital Employed = D + E + P (Book values)
6
2. MERGERS & ACQUISITIONS
A. Exchange Ratio
Exchange ratios would be based on core fundamental factors for both companies,
.i.e. EPS, MPS, NAV per share, intrinsic value per share, etc. These are favorable
financial factors .i.e. higher the better. In such cases the exchange ratio is calculated
as follows:
1) Based on EPS : EPS of Target
EPS of Acquirer
2) Based on market price : MP of Target

MP of Acquirer
 However, if the exchange ratio is based on an adverse financial factor, for
example, NPA ( Non performing assets), number of law suits, etc. , then the
exchange ratio is calculated as follows:
1) Based on NPA : NPA of Acquirer

NPA of Target
Exchange Ratio to Maintain a Financial Factor:
In order to maintain a fundamental factor to be the same pre and post the merger, the
exchange ratio should be based on the respective fundamental factor of both
companies. This ratio will ensure that the number of shares get adjusted in such or way
that there is no dilution / accretion (increase) in that specific fundamental factor.
For eg. , in order to maintain the same pre and post merger EPS, we should offer the
exchange ratio based on EPS.
B. Calculation of POST – MERGER MPS

Generally, we calculate the post - merger MPS based on assumption – 1 or assumption
– 2, However, in cases where a differential growth is given, on account of the merger,
we should directly calculate the post – merger MPS and not assume.
7
Assumption 1:
P/E Ratio of the acquirer remains constant.
In such a case, Post merger P/E = Pre Merger P/E
Therefore, Post merger MPS = Post merger EPS x Post Merger Shares
Assumption 2:
P/E Ratio adjusted to weighted average PE
Weighted Average P/E Ratio can be calculated taking the total earnings (PAT) as
weights.
Steps to calculate POST – MERGER MPS when different growth rates are given:
1) Calculate current Ke based on current growth using Gordon’s formula i.e.
Ke = D1 + g
Po
2) Calculate the intrinsic value of the target using the revised growth rates i.e.
Po = D1
Ke – g
In absence of information, Ke would remain the same.
3) Post – merger MPS can be calculated as follows :
Pre – merger market capital of acquirer XX

(+) Intrinsic value of the target XX
Post – merger market capital of the combined entity XX
(÷) Post – merger no. of shares XX
Post – merger MPS XX
C. EVALUATION OF MERGERS BASED ON DISCOUNTED CASH FLOW

TECHNIQUE
1) Calculate the present value of free cash flows, that will arise after the merger (from
an acquirer’s prospective)
PV of (FCF1 + FCF2 +………..FCF∞ ) XX

(+) PV of (Cost Savings / Synergies) XX
(+) PV of disposal of unrequired assets) XX
8
2) Deduct the liabilities that have to be paid or are taken over on the acquisition. This
will give us the maximum purchase price (MPP).
3) If the purchase price demanded is less than the MPP, then the proposal is
acceptable to the acquirer and if the purchase price demanded is greater than the
MPP, then the proposal is not acceptable to the acquirer.
Selection of appropriate discount rate

Order of preference
1) Discount rate of the combined entity (cash flows are evaluated post – merger and
hence discount rate should also be taken post – merger).
2) If the discount rate of the combined entity is not available, we use the discount rate of
the acquirer available, we use the discount rate of the acquirer. This is because the
target’s cash flows should satisfy the minimum required rate of return of the acquirer.
D. ALTERNATIVE VALUATION TECHNIQUES

1. Comparable Company Analysis
In this case, we try to identify comparative listed companies which have a similar
business and risk. We then try to find a valuation multiple (like P/E, firm value to sales,
etc) . We then try to find the average P/E or firm value to sales.
Our company’s value can be calculated as :
Company’s PAT x Avg. Sector P/E
2. Sum of the Parts/ Break – Up Value / Chop – shop
This method is used to value multi – divisional companies. Each division is valued
separately based on comparable industry standards and the value of the entire
company will be the aggregate value of all of its divisions.
9
3. CORPORATE VALUATION
Total Assets−Total Liabilities−PSC

1) Net Assets Method i.e.
No.of equity shares
2) Earnings Approach
PAT + Depreciation
Value of Equity =
KE
OR
PAT + Depreciation + Interest

Value of Firm =
K0
In absence of tax rate, the above number can be taken to be the same as EBITDA.
The earnings to be taken in the above calculation would be the recurring earnings
i.e. after removing the impact of extra-ordinary and non-recurring items.
3) Multiple Approach
The value (capitalisation) can be calculated by multiplying an appropriate earning
number (like PAT) with an appropriate valuation multiple (like P/E) i.e.
Value of Equity = PAT × P/E
Value of Firm + EBITDA X EV/EBITDA
4) Valuation of a Private Company
1) Find the equity beta (levered beta) for a comparable listed company.
2) Find unlevered beta for the comparable company.

D E
Unlevered Beta (Asset Beta) (βA ) = βD × + βE ×
D+E D+E
In absence of information, βD would be taken as NIL.
E
Therefore, βA = βE ×
D+E
where βE , D, E in this step should be taken for the comparable company.
In case tax rate is given, the above formula gets modified as follows:
E
βA = βE × (1−t)
D +E
3) The comparable company (listed) and our private company operate in the same
business and hence they should have the same business risk. Therefore, the unlevered
beta can be assumed to remain the same.
4) In order to find βE of our private company, we should consider both the business risk
(reflected by unlevered beta) and the financial risk (reflected by the debt to equity ratio
of our private company). Therefore, we need to relever the beta. However, this
relevering will happen at the debt to equity ratio of our private company.
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5) Keeping unlevered beta constant, relevered beta can ne found as follows :

E
βA = βE × (1−t)
D +E
From Missing Pvt. Co.

(step 2)
This formula can be re-arranged as :

D (1−t) +E
βE = βA ×
E
We can use the β as calculated in Step 4 in CAPM
5) Valuation Using Yield Method
Value per equity share can be calculated as:

Actual Yield
× Paid-up value per share
Expected Yield
where,
Yield (Profit)on equity shares
Actual Yield = × 100
Paid−up Equity Share Capital
The method of calculating yield (profit) is usually given in the question. However, in
case no method is given, Yield = Profit After Tax (PAT) – Preference Dividend.
Expected Yield (%) is usually the industry’s required rate of return.
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4. PORTFOLIO MANAGEMENT
1. RETURN – SINGLE SECURITY
P1 – P0 + D
Rx = × 100 [Single Period]
P0
Multi – Period
PN – P0 + D 12 Simple Interest
Rx = × 100 ×
P0 M
OR
PN = P0 (1 + r)N Multi- Period :

Compound Interest
2. RISK – SINGLE SECURITY

Σ (x−x̅)
σ= √ OR
N
When Probabilities are given
σ = √Σp (x − x̅)2
Σx
Where x̅ = OR x̅ = Σ p. x
N
3. PORTFOLIO RETURN [Rxy]
RXY = Wx Rx + Wy Ry
Where Weights represent Market Values at the beginning

[In case of short sales, Weights would be Negative]
4. PORTFOLIO RISK [𝛔 𝐱𝐲 ]
2 Security
σxy = √Wx2 σ2x + Wy2 σ2y + 2 Wx Wy σx σy COR xy
[Markowitz Formula] COVAR xy
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COVARIANCExy
Where : CORxy =
σx . σy
COVARIANCExy
Σ (x−x̅) (y−y
̅)
1. OR
N
2. Σ p. (x − x̅) (y − y̅) OR
3. COR xy . σx . σy OR
4. βx . βy . σ2M
3 Security
Wx2 σ2x + Wy2 σ2y + WZ2 σ2Z + 2 Wx Wy σx σy COR xy +

σxyz = √
2 Wx Wz σx σz COR xz + 2 Wy Wz σy σz COR yz
5. C.A.P.M
Expected Return [KE] : RF + (RM –RF) × β
6. BETA [𝛃]
σ
β = COR XM × σ X
M
OR
COVARIANCEXM
β=
σ2M
7. PORTFOLIO 𝛃
βxy = Wx βx + Wy βy
8. SYSTEMATIC RISK
2
a. COR2XM × σX [β Numerator − Squared]
OR
2
b. βX × σ2M
9. UNSYSTEMATIC RISK [𝐄𝐱𝟐 ] Random Error = √Unsystematic Risk
13
Ex2 = σ2x – Systematic Risk [Squared Terms]
10. Portfolio Risk [Sharpe Model] (Alternative Formula)
σxy = √β2xy × σ2M + Wx2 Ex2 + Wy2 Ey2
[Appropriate when β is given & Unsystematic Risk/Random Error given]
11. Performance Evaluation Measures
RX – RF
a. Sharpe Ratio :
σX
RX – RF
b. Treynor Ratio :
βX
c. Jensen’s Alpha : R X – K E [Using C.A.P.M]
[All the measures, higher the better]
12. Characteristic Line
Graphical Presentation of Securities

Return with Market Return X Axis : Market Return
Y Axis: Security Return
X = α + βM
̅ - βM
Where α = X ̅
13. Securities Market Line
Graphical Presentation of CAPM

K E = R F + (R M - R F ) × β X Axis : β
Y Axis : Return (%)
14. Capital Market Line
Graphical Presentation Taking Total Risk

σ
K E = R F + (R M - R F ) × X X Axis: σ
σM
Y Axis: Return
14
15. Arbitrage Pricing Theory [Multi Factor Model]
K E = R F + λF1 βF1 + λF2 βF2 + λF3 βF3 + ……………………..
Where F1,F2,F3 ………… represent Factors
λF1 = (R F1 - R F ) OR
λF1 = (Actual R F1 - Expected R F1 ) [Surprise element]

(λ Calculation based on data given)
16. Minimum Variance Portfolio
σ2y − Covariancexy
Wx =
σ2x + σ2y −2 Covariancexy
17. Sharpe’s Optimal Portfolio
RX – RF
1. Calculate
βX
2. Rank Securities in Descending Order of the above ratio
3. Cut-Off Point
R –R
σ2M ×Cumulative [ X F × β]
E 2
X
CX = β2
1 + σ2M ×Cumulative [ 2 ]
E X
4. Select Securities upto the Highest Cut-Off
5. Optimal Portfolio
ZX
WX = [For Selected Securities]
ZX +ZY +⋯
βX RX – RF
Where : ZX = ×[ - Final Cut-Off Point]
E2X βX
15
5. MUTUAL FUNDS
1. Net Asset Value (NAV):
Total Assets − Total Liabilities

(Fair Value) (Fair Value)
N.A.V. =
Number of Units
2. Dividend Re-investment Plan :

In these plans, the dividend declared in each year is reinvested by the mutual fund and
the additional units are distributed to the unit holders based on the NAV prevailing on
the date of distribution.
In cases where dividends are reinvested or bonus units are allotted, it is mandatory to
calculate the return on a total investment basis (and not on a per unit basis) i.e.
Total P1 − Total P0
[(Old + New)units × NAV1 [Old Units × NAV0 ] 12
RX = × 100 ×
Total P0 N
Total Dividend
where New units =
NAV @ dividend date
3. Calculation Of Investor’s Return
The formula for return is the same as the return for a single security in the portfolio
chapter. However, in this chapter, we should always try to calculate the annualised
12
return i.e. multiplying the return by , where N = no. of months for which the mutual
N
fund unit is held.
P1 − P0 + D 12
RX = × 100 ×
P0 N
4. Dividend Equalisation
Dividend Equalisation per unit equals income earned till date by the mutual fund divided by existing
units on that date i.e.
16
Income earned till date by MF

Dividend Equalisation/unit =
Existing units on that date
A dividend equalisation charge is added to the NAV at the time of purchase by a new
investor and is also added to the redemption value at the time of redemption by an
existing investor.
Dividend Equalisation should be applied only if it is specifically asked in the question.

This adjustment is usually done against the opening NAV unless otherwise given.
Income available for distribution = Income earned + Dividend Equalisation Adjustment
5. LOAD (TRANSACTION CHARGES)
Entity Load : This should be charged from a new investor at the time of purchase and
hence it would increase the initial purchase price.
Exit Load : This is charged at the time of exit and it would reduce the sale proceeds
received at the time of exit.
Load is levied on the NAV excluding the Dividend Equalisation levy.
17
6. RISK MANAGEMENT
Value of Risk
VAR is a measure of risk. It tries to measure that in a normal market condition, how
much is the maximum amount that an investment might lose. The components of
VAR are:
(a) Loss amount (Standard Deviation in ₹)
(b) Confidence Interval (Generally 99%)
(c) Time Period (if nothing is given, then 1 day)
VAR = Daily Standard Deviation × Confidence Interval Value × √Number of days

(in rupees)
where,
Daliy Standard Deviation = Portfolio Value (₹) × Portfolio Standard Deviation (%)
Confidence Interval (Z) Value = 2.33 for a 99% confidence.

This can be observed from the normal distribution table.
CONFIDENCE INTERVAL (Z VALUES) AT IMPORTANT VALUES
z
99% 2.33**
95% 1.65
90% 1.29
18
7. DERIVATIVES
[INDIAN CAPITAL MARKETS]
Derivatives
Forward Futures Options
Call Put
1) Forward/Futures [Equity]
1. Theoretical Futures Price [Cost of Carry]
Non Dividend Paying

F = S + Cost of Carry
Dividend Paying
F = S + Cost of Carry – PV Of Dividend
[Assumed Annual Compounding unless given]
Continuous Compounding
F = S. er.n – Non Dividend Paying
F = S. e(r− d) – Dividend Paying
Commodity Derivatives
F = S + Cost of Carry + PV of Storage Cost – PV of Convenience Yield
2. Index Futures Hedging (Nifty Futures)
Underlying Portfolio ×β
Number of Contracts =
Contract Size
19
3. Margin (Futures)
Initial Margin : Average Daily Volatility + (3 × Standard Deviation)
Maintainance Margin : % (Given) × Initial Margin
Options [Equity]
Call : Right to Buy Put : Right to Sell

Exercise : SX > xp Exercise : SX < xp
Payoff : SX - xp Payoff : xp - SX
Net Payoff : Payoff – Upfront Premium
OPTION STRATEGIES
STRADDLE STRIP STRAP

STRANGLE
[1c : 1p] [1c : 2p] [2c : 1p]
Option Valuation
Theoretical Binomial Black &

Value Model Scholes
A) Theoretical Value
Vc = S0 – PV of x
Vp = PV of x - S0
20
B) Binomial Model
1. Replicating Portfolio
Assume No. of shares (x) & Borrowing (B)
2. Risk-Less Hedge
Assume No. of shares (x)
3. Risk Neutral Probabilities

Assume Probability of Upmove : p
Downmove : (1 - p)
C) Black & Scholes Model
x
Vc = S × N (D1) - × N (D2)
lr.t
S σ2
LN [x] +(r + 2 ) ×t
D1 =
√t × σ
D2 = D1 - √t × σ
Call Put Parity Theory
Vc + PV of xp = Vp + S
Option Greeks
Delta Gamma Vega Theta Rho
Rate of
Share Price Delta Volatility (σ) Time
Interest
21
8. INTEREST RATES
1. Interest Rate Futures
Terminology : 3 Months September Future
Pricing : 100 – Rate of Interest
Strategy : Lender : Buy

Borrower : Sell
Net Settlement
N
(SP – CP)% × × Contract Size × No. of Contracts
12
Interest Futures Hedging
Amount of Borrowing/Lending Term of Borrowing/Lending

No. of Contracts = ×
Contract Size Duration of Futures
2. Forward Rate Agreement (FRA)
Terminalogy :
6× 9
Borrow/Lend For A Period Of

After 6 Months (9-6) = 3 Months
Strategy : Lender : Sell FRA

Borrower : Buy FRA
3. Forward Rates
(1 + YTM)2 = (1 + r1) (1 + r2)

4. Swaps:
Generally to Reduce Transaction Cost/Obtain Desired Exposure
Net Cost : Pay to Bank + Pay to Swap Party – Receive from Swap Party
5. Options:
CAP : CAPS the interest (Borrower)
FLOOR : Minimum interest guarantee (Lender)
22
9. FOREIGN EXCHANGE MANAGEMENT
Basic Terminology
Quotes Rates
Direct Indirect Bid Ask

eg ₹ 50/$ eg $ 0.02/₹ Bank : Buy Bank : Sell
In India In India Customer : Sell Customer : Sell
Currency Quotation : ₹ 50 / $
↓ ↓
Non Base Currency Base Currency
Cross Rates:
₹ / $ : 50.00 | $/£ : 1.50 | €/£ : 1.20 | ₹ /€ = ?
Arrange the rates in such a way that all intermediate currencies cancel [$,£] and
the the desired currency remains in the Numerator [₹] and Denominator [€]
₹ ₹ $ £
€
= $
×£×€
1
= Rs 50/$ × $ 1.50/£ ×
€ 1.20/$
= Rs 62.5/€
Cross Rates with Bid/Ask
₹/$ : 40.00 – 50.00

[$ - Bid] [$ - Ask]
Rule : Inverse of Bid is Ask &

Inverse of Ask is Bid
1 1
i e $/₹ = -
₹ 40/$ ₹ 50/$
23
= $ 0.0.25/₹ - $ 0.02/₹
[₹ Ask] [₹ Bid]
(Higher) (Lower)
Example :
₹ / $ : 40 - 50 | $/£ : 1.40 - 1.50 | €/£ : 1.20 – 1.30 |₹ /€ = ?
₹ ₹ $ £
[€] = [$] × [£] × [€]
B B B B
If quotes match with those given then directly take Bid [Lower] Rates. [₹ /$ & $/£]
If quotes don’t match, then take the inverse of the opposite rate [£/€]
Rs 1
[ ] = ₹ 40/$ × $ 1.40/£ ×
€ B € 1.30/£
= ₹ 43.0769/$
(Rs/€)A Can also be calculated by above method
Exchange Rate
Determination
Purchasing Power Relative Purchasing

Parity Theory Power Parity Theory
(Absolute) (Inflation Rate Parity)
The prices of a basket of goods Inflation changes the

should be the same if converted purchasing power of the
to a single currency basket of goods over time.
Hence Exchange Rates are

determined in such a way Hence Exchange Rates
that parity is established would change
accordingly
24
Inflation Rate Parity / Interest Rate Parity
For ₹/$ Quote :
F (1+iRs )N F [(1+ iRs × M⁄12)]

= =
S (1+i$ )N S [(1+ i$ × M⁄12)]
Rule : Rs - Non Base - iRs in Numerator

$ - Base - i$ in Denominator
Forward Premium/ Discount
Premium : A currency is at a premium if it fetches more units of the other currency

at a future date
Discount : A currency is at a discount if it fetches lesser units of the other currency

at a future date
F−S 12
Forward Premium on $ : × 100 ×
S M
[$ Base Currency]
Shortcut :
S−F 12
Forward Discount on Rs : × 100 ×
F M
[Non Base Currency]
Arbitrage
[Risk less Profit without Own Investment]
2 Point Covered Interest Arbitrage

Arbitrage [Based on Interest Rate
Parity Thoery]
Buy in Market where Compare Theoretical

cheaper & sell in market Forward Rate with Quoted
where expensive Forward Rate
25
Currency Strength/Weakness
Inflation/Interest Rates
Higher Lower
Weaker Currency Stronger Currency
Hedging Strategies
Money
Forwards Futures Options Swaps
Market
Forward Hedging
Importer/ Exporter/
Borrower Lender
Direct Quotes Indirect Quote Direct Quote Indirect Quote

given given given given
1) Convert
Buy Sell 1) Convert into
into Direct
Direct
2) Buy
2) Sell
26
Exchange Margin
[Bankers charges to be adjusted in rates]
Depends on Buying (Bid)/Selling (Ask)

Rates as quoted by the Banker
Bid [Bank Buying] Ask [Bank Selling]
[Exporters] [Importers]
Deduct from agreed rate Add to agreed rate

[Reduces proceeds for Exporter] [Increases cost for Importer]
Swap Points
[Rules]
Bid Points to Bid Restate Swap

Ascending Descending Rate/Ask Points Points in
to Ask Rate Decimals
Deduct from Based on Number of

Add to Spot Decimals in the
Spot
Exchange Rate Quote
Fate of Forwards
Cancellation Extension Early Delivery
27
A)
Cancellation
[Reverse Forward Method]
Offsetting Contract for Balance Unexpired Period
Before Due Date On Due Date
Offsetting Forward Rate for Balance

Unexpired Period Offsetting Spot Rate
B) Extension = Cancellation + New Forward Contract

[Same Process as above]
C) Early Delivery
Calculate the Following Amounts
[Banker’s Perspective]
1) Amount at Agreed Forward Rate
2) Amount at Spot Rate on Early Delivery [Cash Flow]
3) Amount for Offsetting Forward [Not Cash Flow]
A) Swap Gain/Loss : 2) – 3)
M
B) Interest on Outlay/Inflow : [1) – 2)] × Interest Rate × 12
28
Summary
Swap Gain/Loss Interest on Cash Flow

[2) & 3)] [1) & 2) × Interest%]
Exporter Impoter C.I > C.O. C.I < C.O.
Spot Sell [+] Spot Buy [-] Interest Interest

Income Cost
Forward Buy [-] Forward Sell [+]
Late Delivery/Extension/Cancellation
Cancellation Charges
Exchange Interest on
+ Swap Loss +
Difference Outlay
(Difference of Agreed Forward Difference of Spot (Difference of Spot Rate on

& Offsetting Spot Rate on Date Rate on the Original Date of Original Maturity
of Actual Cancellation Maturity Date
&
[After Exchange Margin] &
Original Forward Rate in
Offsetting Forward Interbank Market)
Rate for the Earliest
Maturity ×
× Contract Size
Contract Size ×
Interest Rate
×
Days from Original Maturity
to Date of Actual
Cancellation
(Maximum 15 Days)
29
Key Points
1. FEDAI RULE 8 : A Forward Contract that remains overdue Without Instructions
On/Before the Due Date shall be automatically cancelled on 15th Day from the
date of Original Maturity
2. Customer has to pay for the Loss but is not entitled to profits
3. Exchange Margin is applied on Cancellation Rate & Extension Rate
Money Market
Importer Exporter
Rule : Borrow Local Rule : Borrow Foreign
Rationale: Rationale:
Has a Payable in Foreign Has a Receivable (Asset) in
Currency Foreign Currency
Hence in order to Hedge, In order to Hedge, should

should create an Asset in create a Liability in Foreign
Foreign Currency Currency
Invest in Foreign Currency Borrow in Foreign Currency
Borrow in Local Currency Invest in Local Currency
Futures Hedging
Steps :
1. Strategy : Whether to Buy/Sell Future Contract
2. Maturity : Select Futures Contract which is On/After the Maturity Date & is closest
to the Maturity Date
3. Number of Contracts : Round off to the Nearest whole number
4. On Settlement Date :
Cash Inflow [+ve]/Cash Outflow [-ve] xx
[Invoice @ Spot on Settlement]
+ Gain (+ve)/Loss (-ve) on Futures xx
[(SP – CP) × Contract Size × No. of Contracts]
Effective Cash Inflow/Outflow xx
30
Scenario – 1 : Futures Contract in Same Currency as Invoice Currency

Scenario – 2 : Future Contract in a Different Currency as compared to Invoice
Currency
Futures Margin
Margin is like a Deposit in Futures & hence is not a Cost. Instead the Interest on the
Margin Money is treated as Cost
Currency Options
Call Option Put Option
Right to Buy Right to Sell

Base Currency Base Currency
[Preferred by Importer] [Preferred by Exporter]
Currency Swap
A Ltd desires $ Funding & B Ltd desires Rs Funding. A borrows in Rs & B borrows in
$ & they enter into a Swap
Rs
B Ltd.
A Ltd.
$
Rs $
Loan Loan
Bank A [Rs] Bank B [$]
Effective Cost for A :

Interest Paid to Bank of A [Rs] (xx)
Interest Received from B under Swap [Rs] xx
Net Interest [Rs] xx
× Exchange Rate [Rs/$] xx
Net Interest [$] xx
Interest paid to B under Swap [$] xx
Effective Cost under Swap [$] xx
Compare with :
31
Direct Interest Cost if A directly borrows [$] xx
Netting & Matching
Inter - Group Cash

Exporter/Importer
Management
Types of Exposures
Transaction Translation Operating

Exposure Exposure Exposure
Gain/Loss if Translation of Transaction Exposure

Transaction Financial Statements + Gain/Loss due to
remains Unhedged of Foreign Operations Change in Demand
Types of Foreign
Currency Accounts
Nostro Vostro Loro
Remit to another Bank

Our A/C with You Your A/C with Us for Credit of a Third
Bank
32
10. INTERNATIONAL FINANCIAL MANAGEMENT

Important Adjustments
1. Home currency Cash Flows to be discounted at Home Currency Discount Rate

& Foreign Currency Cash Flows at the Foreign Currency Discount Rate
2. Inflation adjusted Cash Flows (Nominal Cash Flows) are to be discounted at

Inflation adjusted Discount Rate (Nominal Cash Flows). [‘Real’ means excluding
inflation and ‘Nominal’ means including inflation]
3. Forward rates can be estimated using Inflation / Interest Rate Parity Theory if
not specifically given
4. Concept of Unlevered / Relevered Beta can be used to find the relevant Beta
(risk measure) for a foreign project
5. Working capital is invested at the beginning (Cash Outflow) and is assumed to

be fully recovered back at the end of the project (Cash Inflow). Inflation should
be adjusted in any additional investments in Working Capital
6. Impact of Domestic Tax, Remittance Tax and Tax credit should be considered
depending on the data given in the question
7. Projects with Positive NPV should be accepted and those with Negative NPV
should be rejected.
8. Salvage values should always be considered in every Project Evaluation
33

SFM Formulae and Concept Revision Capsule - Bhavik Chokshi

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Bhavik Chokshi ( 9082810221/7977299310) www.benchmarxacademy.

STRATEGIC FINANCIAL MANAGEMENT REVISION –

CONTACT US – 9082810221/ 7977299310

Sr . No Topics Page No.

1. SECURITY ANALYSIS & VALUATION

(Accurate Method) YTM : Trial & Error Method (IRR Technique)

(1 + YTM)2 = (1 + r1) (1 + r2)

6. Change in Bond Price = % Change in Interest × (-) Modified Duration

Dp = W ADA + W BDB + ……………………

 Coupon Rate = YTM (Discount Rate) : Price = Face Value

B. Valuation of Equity Shares

1. Gordon’s Formula : [Single Growth]

2. Gordon’s Formula : [Differing Growth]

P0 = PV of (D1 + D2 + …………. D5) + PV of (D6 + D7 + …………. D∞ )

3. Firm Value [Enterprise] = Debt Value + Preference Value + Equity Value

4. F.C.F.F = PAT + DEP + INT(1 - t) - ↑ FA - ↑ WC

5. FCFE = PAT + DEP - ↑ FA - ↑ WC + Net Borrowings

In case Debt Ratio (D) given,

6. Earning Yield Method

2. Conversion Premium = Price/Bond – Conversion Value

3. Straight Value = PV of Interest & Principal

4. Downside Risk = Price/Bond – Straight Value

6. Income Differential : Coupon (Bond) – Dividend (Equivalent Shares)

Post BB Price = Post BB EPS × POST BB P/E

E. Economic Value Added (EVA)

EVA = NOPAT* - Capital Employed × WACC

NOPAT = EBIT(1 - t) or PAT + Interest(1 - t)

Capital Employed = D + E + P (Book values)

2. MERGERS & ACQUISITIONS

2) Based on market price : MP of Target

1) Based on NPA : NPA of Acquirer

Exchange Ratio to Maintain a Financial Factor:

B. Calculation of POST – MERGER MPS

1) Calculate current Ke based on current growth using Gordon’s formula i.e.

3) Post – merger MPS can be calculated as follows :

Pre – merger market capital of acquirer XX

C. EVALUATION OF MERGERS BASED ON DISCOUNTED CASH FLOW

PV of (FCF1 + FCF2 +………..FCF∞ ) XX

Selection of appropriate discount rate

D. ALTERNATIVE VALUATION TECHNIQUES

Total Assets−Total Liabilities−PSC

PAT + Depreciation + Interest

4) Valuation of a Private Company

2) Find unlevered beta for the comparable company.

5) Keeping unlevered beta constant, relevered beta can ne found as follows :

From Missing Pvt. Co.

This formula can be re-arranged as :

5) Valuation Using Yield Method

Value per equity share can be calculated as:

Expected Yield (%) is usually the industry’s required rate of return.

1. RETURN – SINGLE SECURITY

PN = P0 (1 + r)N Multi- Period :

2. RISK – SINGLE SECURITY

3. PORTFOLIO RETURN [Rxy]

Where Weights represent Market Values at the beginning

σxy = √Wx2 σ2x + Wy2 σ2y + 2 Wx Wy σx σy COR xy

[Markowitz Formula] COVAR xy

Wx2 σ2x + Wy2 σ2y + WZ2 σ2Z + 2 Wx Wy σx σy COR xy +

Ex2 = σ2x – Systematic Risk [Squared Terms]

10. Portfolio Risk [Sharpe Model] (Alternative Formula)

σxy = √β2xy × σ2M + Wx2 Ex2 + Wy2 Ey2

[Appropriate when β is given & Unsystematic Risk/Random Error given]