Paper2 SFM PYP All Attempts Nov22

Strategic Financial
Management
Past Papers Compilation

CA Final
10 Attempts
3rd Edition
• Questions from May’18 to Nov ‘22
• For November 2023 Attempt
• All Questions in Chapter wise format
Naresh pasupuleti | 9959791590

Table of Contents
Sr. No Particulars Page Number
1 Financial Policy and Corporate Strategy P 1.1- P 1.4
2 Risk Management P 2.1- P 2.4
3 Security Analysis P 3.1- P 3.5
4 Security Valuation P 4.1- P 4.22
5 Portfolio Management P 5.1- P 5.17
6 Securitization P 6.1- P 6.5
7 Mutual Funds P 7.1- P 7.17
8 Derivative Analysis and Valuation P 8.1- P 8.14
9 Foreign Exchange Exposure & Risk Management P 9.1- P 9.16
10 International Financial Management P 10.1- P 10.14
11 Interest Rate Risk Management P 11.1 - P 11.10
12 Corporate Valuation P 12.1 - P 12.13
13 Mergers, Acquisitions & Corporate Restructuring P 13.1 - P 13.18
14 Start-up Finance P 14.1 - P 14.8
Strategic Financial Management Compilation includes:
10 Past Papers: May’18, Nov’18, May’19, Nov’19, Nov’20,
Jan’21, July ’21, Dec ’21, May ’22, Nov ‘22
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P 1.1
Chapter 1
Financial Policy & Corporate Strategy
Question 1
Explain the interface of Financial Policy and Strategic Management. (4 Marks May ‘18)
Answer 1
The interface of strategic management and financial policy will be clearly understood if we appreciate the
fact that the starting point of an organization is money and the end point of that organization is also
money. No organization can run an existing business and promote a new expansion project without a
suitable internally mobilized financial base or both i.e. internally and externally mobilized financial base.
Sources of finance and capital structure are the most important dimensions of a strategic plan. The need
for fund mobilization to support the expansion activity of firm is very vital for any organization. The
generation of funds may arise out of ownership capital and or borrowed capital. A company may issue
equity shares and / or preference shares for mobilizing ownership capital and debenture to raise borrowed
capital.
Policy makers should decide on the capital structure to indicate the desired mix of equity capital and debt
capital. There are some norms for debt equity ratio.
However this ratio in its ideal form varies from industry to industry. Another important dimension of
strategic management and financial policy interface is the investment and fund allocation decisions. A
planner has to frame policies for regulating investments in fixed assets and for restraining of current
assets. Investment proposals mooted by different business units may be divided into three groups. One
type of proposal will be for addition of a new product, increasing the level of operation of an existing
product and cost reduction and efficient utilization of resources through a new approach and or closer
monitoring of the different critical activities. Dividend policy is another area for making financial policy
decisions affecting the strategic performance of the company. A close interface is needed to frame the
policy to be beneficial for all. Dividend policy decision deals with the extent of earnings to be distributed
as dividend and the extent of earnings to be retained for future expansion scheme of the organization.
It may be noted from the above discussions that financial policy of a company cannot be worked out in
isolation of other functional policies. It has a wider appeal and closer link with the overall organizational
performance and direction of growth. As a result preference and patronage for the company depends
significantly on the financial policy framework. Hence, attention of the corporate planners must be drawn
while framing the financial policies not at a later stage but during the stage of corporate planning itself.
EXAMINERS’ COMMENTS ON THE PERFORMANCE OF EXAMINEES:
In this theoretical question, performance was of above average level.
Question 2
Discuss briefly the key decisions which fall within the scope of financial strategy. (4 Marks Nov ’19,
Jan’21)
Answer 2
The key decisions falling within the scope of financial strategy include 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.
Naresh pasupuleti | 9959791590 Chapter 1 Financial Policy & Corporate Strategy
P 1.2
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.
Most of the examinees attempted the theoretical question correctly and hence performance was
very good.
Question 3
State the strategy at different hierarchy levels. (4 Marks July 21)
Answer 3
Strategies at different levels are the outcomes of different planning needs.
Three levels of Strategy – Corporate level; Business unit level; and Functional or departmental level.
(1) Corporate Level Strategy: Corporate level strategy fundamentally is concerned with selection of
businesses in which a company should compete and with the development and coordination of that
portfolio of businesses.
Corporate level strategy should be able to answer three basic questions:
 Suitability: Whether the strategy would work for the accomplishment of common objective of the
company.
 Feasibility: Determines the kind and number of resources required to formulate and implement the
strategy.
 Acceptability: It is concerned with the stakeholders’ satisfaction and can be financial and non-
financial.
(2) Business Unit Level Strategy: Strategic business unit (SBO) may be any profit centre that can be
planned independently from the other business units of a corporation. At the business unit level, the
strategic issues are about practical coordination of operating units and developing and sustaining a
competitive advantage for the products and services that are produced.
(3) Functional Level Strategy: The functional level is the level of the operating divisions and
departments. The strategic issues at this level are related to functional business processes and value
chain. Functional level strategies in R&D, operations, manufacturing, marketing, finance, and human
resources involve the development and coordination of resources through which business unit level
strategies can be executed effectively and efficiently. Functional units of an organization are involved
in higher level strategies by providing input to the business unit level and corporate level strategy,
such as providing information on customer feedback or on resources and capabilities on which the
higher level strategies can be based. Once the higher - level strategy is developed, the functional units
translate them into discrete action plans that each department or division must accomplish for the
strategy to succeed.
Among the different functional activities viz production, marketing, finance, human resources and
research and development, finance assumes highest importance during the top down and bottom up
interaction of planning. Corporate strategy deals with deployment of resources and financial strategy
is mainly concerned with mobilization and effective utilization of money, the most critical resource
that a business firm likes to have under its command. Truly speaking, other resources can be easily
mobilized if the firm has adequate monetary base. To go into the details of this interface between

P 1.3
financial strategy and corporate strategy and financial planning and corporate planning let us
examine the basic issues addressed under financial planning.
Though overall above average performance has been noticed in this theoretical question but in
some cases, students have mentioned different levels instead of strategies and even headings
of strategies at different levels were correctly mentioned but explanation to these points were
very generic in nature.
Question 4
Explain the outcomes of Financial Planning. (4 Marks May ‘22)
Answer 4
Outcomes of the financial planning are:
(i) Financial Objectives: Financial objectives are to be decided at the very outset so that rest of the decisions
can be taken accordingly. The objectives need to be consistent with the corporate mission and corporate
objectives.
(ii) Financial Decision Making: Financial decision making helps in analyzing the financial problems that are
being faced by the corporate and accordingly deciding the course of action to be taken by it.
(iii) Financial Measures: The financial measures like ratio analysis, analysis of cash flow statement etc. are used
to evaluate the performance of the Company. The selection of these measures again depends upon the
corporate objective.
Question 5
What is sustainable growth rate?.
(i) What makes an Organization Sustainable?

(ii) Mr. X has submitted the following data:
Particulars (₹) in Lakhs
Total Assets 250
Total Liabilities 220
Net Income 12
Dividend Paid 4.5
Sales 100
Mr. X wants to know to what extent sales can be increased without going for additional borrowings by
using Sustainable Growth Rate (SGR) concept? (8 Marks Nov 22)
Answer 5
(i) The sustainable growth rate is a measure of how much a firm can grow without borrowing more money.
After the firm has passed this rate, it must borrow funds from another source to facilitate growth.
(ii) In order to be sustainable, an organization must:
 have a clear strategic direction;
 be able to scan its environment or context to identify opportunities for its work;
 be able to attract, manage and retain competent staff;
P 1.4
 have an adequate administrative and financial infrastructure;

 be able to demonstrate its effectiveness and impact in order to leverage further resources; and
 get community support for, and involvement in its work.
(iii)
SI. No Particulars Amount in ₹ Lakhs

(a) Total Assets 250.00
(b) Total Liabilities 220.00
(c) Net Income 12.00
(d) Dividend Paid 4.50
(e) Sales 100.00
(f) Equity (a) – (b) 30.00
(g) Return on Equity (ROE) (c) /(f) 40.00%
(h) Dividend pay-out Ratio (d) /(c) 37.50%
(i) SGR [g x (1-h)] 25.00%*
(j) Additional Sales can be achieved without 25.00
further borrowings (e) × (i)
(k) Maximum sales can be achieved without 125.00
further borrowings (e) + (j)
* Alternatively, it can also be computed as follows:
SGR = = 33.33% and then Additional Sales shall be ₹ 33.33 Lakhs and
Maximum Sales can be achieved without further borrowings shall be ₹ 133.33 Lakhs

P 2.1
Chapter 2
Risk Management
Question 1
How different stakeholders view the financial risk? (4 Marks Nov ‘18)
Answer 1
The financial risk can be viewed by different stakeholders as follows:
(i) From shareholder’s and lender’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 the event of winding up of a company they will be least be given priority.
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.
(ii) 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.
(iii) From Government’s point of view: From Government’s point of view, the financial risk can be viewed as
failure of any bank (like Lehman Brothers) or 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.
Question 2
List the main applications of Value At Risk (VAR).(4 Marks May ‘19)
Answer 2
Applications of Value at Risk (VAR)
VAR can be applied

(a) to measure the maximum possible loss on any portfolio or a trading position.
(b) as a benchmark for performance measurement of any operation or trading.
(c) to fix limits for individuals dealing in front office of a treasury department.
(d) to enable the management to decide the trading strategies.
(e) as a tool for Asset and Liability Management especially in banks.
In this question, performance was average as application of Value at Risk (VAR) was not
answered well by most of the examinees. Instead of writing application of VAR, some
examinees have written techniques of VAR.
Question 3
On Tuesday morning (before opening of the capital market) an investor, while going through his bank
statement, has observed that an amount of Rs. 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 Rs. 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
Chapter 2 Risk Management
P 2.2
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 poss ibl e investment. (4 Marks Nov ‘20)
Answer 3
Particulars Amount (Rs.)
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 4
Risks are inherent and integral part of the market. Discuss. (4 Marks Jan ‘21)
Answer 4
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.
Question 5
Which type of risk covers the default by the counterparty? List out the ways to manage this type of risk.(4
Marks Dec ‘21)
Answer 5
This risk occurs due to non-honoring of obligations by the counter party which can be failure to deliver the
goods for the payment already made or vice-versa or repayment of borrowings and interest etc. Thus, this
risk also covers the credit risk i.e. default by the counter party.
The various techniques to manage this type of risk are as follows:
(1) Carrying out Due Diligence before dealing with any third party.
(2) Do not over commit to a single entity or group or connected entities.
(3) Know your exposure limits.
(4) Review the limits and procedure for credit approval regularly.
(5) Rapid action in the event of any likelihood of defaults.
P 2.3
(6) Use of performance guarantee, insurance or other instruments.
Overall students have performed at an above average level but in some cases, students were
not able to identify type of risk asked in the question, so could not explain correct techniques.
Question 6
Briefly explain:
(a) Compliance risk and

(b) Operational risk (4 Marks May ‘22)
Answer 6
(a) Compliance Risk: Every business needs to comply with rules and regulations. For example, with the
advent of Companies Act, 2013, and continuous updating of SEBI guidelines, each business
organization has to comply with plethora of rules, regulations and guidelines. Noncompliance leads to
penalties in the form of fine and imprisonment. However, when a company ventures into a new
business line or a new geographical area, the real problem then occurs. For example, a company
pursuing cement business likely to venture into sugar business in a different state but laws applicable
to the sugar mills in that state are different. So, that poses a compliance risk. If the company fails to
comply with laws related to a new area or industry or sector, it will pose a serious threat to its survival.
(b) Operational Risk: This type of risk relates to internal risk. It also relates to failure on the part of the
company to cope with day-to-day operational problems. Operational risk relates to ‘people’ as well as
‘process’. We will take an example to illustrate this.
For example, an employee paying out ` 1,00,000 from the account of the company instead of ` 10,000.
This is a people as well as a process risk. An organization can employ another person to check the work
of that person who has mistakenly paid ` 1,00,000 or it can install an electronic system that can flag off
an unusual amount.
Question 7
Neel holds Rs. 1 crore shares of XY Ltd. whose market price standard deviation is 2% per day. Assuming
252 trading days in a year, determine maximum loss level over the period of 1 trading day and 10
trading days with 99% confidence level. Assuming share prices are normally for level of 99%, the
equivalent Z score from Normal table of Cumulative Area shall be 2.33.(4 Marks May ‘18)
Answer 7
Assuming share prices are normally distributed, for level of 99%, the equivalent Z score from Normal
table of Cumulative Area is 2.33.
Volatility in terms of rupees is: 2% of Rs. 1 Crore = Rs. 2 lakh
The maximum loss for 1 day at 99% Confidence Level is
Rs. 2 lakh x 2.33 = Rs. 4.66 lakh, and expected maximum loss for 10 trading days shall be:
√10 x Rs. 4.66 lakh = 14.73 lakhs or 14.74 lakhs
Overall performance was above average. However, some examinees could not properly
apply the required formula.
P 2.4
Question 8
Following is the information about Mr. J's portfolio:
Investment in shares of ABC Ltd. Rs. 200 lakh

Investment in shares of XYZ Ltd. Rs. 200 lakh
Daily standard deviation of both shares 1%
Co-efficient of correlation between both shares 0.3
Required:
Determine the 10 days 99% Value At Risk (VAR) for Mr. J' s portfolio. Given : The Z score from the Normal
Table at 99% confidence level is 2.33. (Show your calculations up to four decimal points).(4 Marks Nov ‘19)
Answer 8
Volatility (standard deviation) of the daily change in the investment in each share in terms of rupees-
1% of Rs. 200 lakh = Rs. 2 lakh
The variance of the portfolio’s daily change – V = 22 + 22 + 2 x 0.3 x 2 x 2 = 10.4 lakh
Standard Deviation of the portfolio’s daily change = √10.4 = Rs. 3.2249 Lakhs
The standard deviation of the 10-day change

= Rs. 3.2249 lakhs x √10 = Rs. 10.1981 lakhs
Therefore, the 10-days 99% VAR = 2.33 × Rs. 10.1981 lakhs = Rs. 23.7616 lakhs
Despite the fact the question was from ICAI Study Material, overall below average performance has
been observed in this question as calculation of Standard Deviation and 10 day VAR calculation was
not done up to the required decimal place mentioned in the question itself. Even at some places, the
examinees have even shown lack of awareness of the concept of VAR. Further, most of the examinees
were unable to calculate the variance of the portfolio’s daily change.
Question 9
Describe the main features of Value-at-Risk (VAR). (4 Marks July 21)
Answer 9
Following are main features of VAR:
(i) Components of Calculations: VAR calculation is based on following three components:
(a) Time Period
(b) Confidence Level – Generally 95% and 99%
(c) Loss in percentage or in amount
(ii) Statistical Method: It is a type of statistical tool based on Standard Deviation.
(iii) Time Horizon: VAR can be applied for different time horizons say one day, one week, one
month and so on.
(iv) Probability: Assuming the values are normally attributed, probability of maximum loss can
be predicted.
(v) Risk Control: Risk can be controlled by setting limits for maximum loss.
(vi) Z Score: Z Score indicates how many Standard Deviations is away from Mean value of
population. When it is multiplied with Standard Deviation it provides VAR.
Average performance was observed in this theoretical question as most of students not properly
mentioned the features of VaR.
P 3.1
Chapter 3
Security Analysis
Question 1
In an efficient market, technical analysis may not work perfectly. However, with imperfections,
inefficiencies and irrationalities, which characterizes the real world, technical analysis may be helpful.
Critically analyse the statement. (4 Marks, Nov ‘20)
Answer 1
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 2
Describe briefly on which principles Technical Analysis is based. (4 Marks Dec ‘21)
Answer 2
Technical analysis is based on the following three principals:
(1) The Market Discounts Everything: Although many experts criticize technical analysis because it
only considers price movements and ignores fundamental factors but the Efficient Market
Hypothesis (discussed later in detail) contradicts it according to which a company’s share price
already reflects everything that has or could affect a company and it includes fundamental
factors. So, technical analysts generally have the view that a company’s share price includes
everything including the fundamentals of a company.
(2) Price Moves in Trends: Technical analysts believe that prices move in trends. In other words, a
stock price is more likely to continue a past trend than move in a different direction.
(3) History Tends to Repeat Itself: Technical analysts believe that history tends to repeat itself.
Technical analysis uses chart patterns to analyze subsequent market movements to understand
trends. While many form of technical analysis have been used for many years, they are still
considered to be significant because they illustrate patterns in price movements that often
repeat themselves.
Lack of understanding of the concept of Technical Analysis was visible in most of the answers
to this theoretical question. Hence poor performance has been noticed in this question.

Chapter 3 Security Analysis
P 3.2
Question 3
Closing values of BSE Sensex from 6th to 17th day of the month of January of the year 200 X were as
follows:
Days Date Day Sense x
1 6 THU 29522
2 7 FRI 29925
3 8 SAT No Trading
4 9 SUN No Trading
5 10 MON 30222
6 11 TUE 31000
7 12 WED 31400
8 13 THU 32000
9 14 FRI No Trading
10 15 SAT No Trading
11 16 SUN No Trading
12 17 MON 33000
Compute Exponential Moving Average (EMA) of Sensex during the above period. The 30 days simple
moving average of Sensex can be assumed as 30,000. The value of exponent for 30 days EMA is 0.062.
Provide detailed analysis on the basis of your calculations. (8 Marks May ‘18)
Answer 3
Date 1 2 3 4 5
Sensex EMA for EMA
Previous day 1-2 3×0.062 2+4
6 29522 30000 (478) (29.636) 29970.364
7 29925 29970.364 (45.364) (2.812) 29967.55
10 30222 29967.55 254.45 15.776 29983.32
11 31000 29983.32 1016.68 63.034 30046.354
12 31400 30046.354 1353.646 83.926 30130.28
13 32000 30130.28 1869.72 115.922 30246.202
17 33000 30246.202 2753.798 170.735 30416.937
Conclusion – The market is bullish. The market is likely to remain bullish for short term to medium term if
other factors remain the same. On the basis of this indicator (EMA) the investors/brokers can take long
position.
An average performance has been observed in this question.
Question 4
Closing values of BSE Sensex from 6th to 17th day of the month of January of the year 20xx were as
follows:
Days Date Day Sensex
1 6 THU 34522
2 7 FRI 34925
3 8 SAT No Trading
P 3.3
4 9 SUN No Trading
5 10 MON 35222
6 11 TUE 36000
7 12 WED 36400
8 13 THU 37000
9 14 FRI No Trading
10 15 SAT No Trading
11 16 SUN No Trading
12 17 MON 38,000
Calculate Exponential Moving Average (EMA) of Sensex during the above period. The 30 days simple
moving average of Sensex can be assumed as 35,000. The value of exponent for 30 days EMA is 0.064.
Provide analyzed conclusion on the basis of your calculations. (Calculations should be up to three
decimal points.) (8 Marks Nov ‘19)
Answer 4
Date 1 2 3 4 5
Sensex EMA for Previous EMA 2
day 1-2 3×0.064 +4
6 34522 35000 (478) (30.592) 34969.408
7 34925 34,969.408 (44.408) (2.842) 34966.566
10 35222 34966.566 255.434 16.348 34982.914
11 36000 34982.914 1017.086 65.094 35048.008
12 36400 35048.008 1351.992 86.527 35134.535
13 37000 35134.535 1865.465 119.390 35253.925
17 38000 35253.925 2746.075 175.749 35429.674
Conclusion – The market is bullish. The market is likely to remain bullish for short term to medium term if
other factors remain the same. On the basis of this indicator (EMA) the investors/brokers can take long
position.
Average performance was observed in this question as some of the examinees failed to mention that
the market is bullish and give an analyzed conclusion at the end. Further, many examinees arrived at
EMA without considering the decimal points or calculated EMA by using two decimal points.
Question 5
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
P 3.4
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 Jan ‘21)
Answer 5
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 = 68.08 ∑ = 6848.66 ∑ = 6745.74 ∑ = 164.68
X = - 21.66 Y = 7.56
. . .
b= ∑
= = 0.624
. .
a= = 7.56-0.624(-21.66)=21.08
P 3.5
∑ ∑ . . . . .
∑
=
. .
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.
Question 6
Closing Values of NIFTY Index from 3rd to 12th day of the month of January 2022 were as follows:
Days Date Closing Values of NIFTY

Index
1 03/01/2022 17626
2 04/01/2022 17805
3 05/01/2022 17925
4 06/01/2022 17746
5 07/01/2022 17813
6 10/01/2022 18003
7 11/01/2022 18056
8 12/01/2022 18212
The simple moving average of NIFTY Index for the month of December 2021 was 17174.
You are required to calculate
(i) The value of exponent for 15 days EMA.
(ii) The exponential moving average (EMA) of NIFTY during the above period. (Calculations to be done
up to 2 decimals only)
(iii) Analyse the buy & sell signal on the basis of your calculations (8 Marks May ‘22)
Answer 6
(i) Value of Exponent for 15 days EMA
!
= " # = 0.125
(ii) EMAt = a X Pt + (1 – a) (EMA (t – 1)) Where, a = exponent, Pt = Price of today

Date 1 2 3 4 5
Sensex EMA for Previous EMA 2
day (EMA (t – 1)) 1-2 3 × 0.125 +4
03/01/2022 17626 17174 452 56.50 17230.50
04/01/2022 17805 17230.50 574.50 71.81 17302.31
05/01/2022 17925 17302.31 622.69 77.84 17380.15
06/01/2022 17746 17380.15 365.85 45.73 17425.88
07/01/2022 17813 17425.88 387.12 48.39 17474.27
10/01/2022 18003 17474.27 528.73 66.09 17540.36
11/01/2022 18056 17540.36 515.64 64.45 17604.82
12/01/2022 18212 17604.82 607.18 75.90 17680.71
(ii) A buy (bullish) signal is generated when actual price line (NIFTY in the give case) rises through the
moving average, while a sell a (bearish) signal is generated when actual NIFTY level declines through
the moving averages. In the case under consideration the price line of NIFTY never breaches the 15 -
day EMA line. In-fact it is hovering around the 15-day EMA line only.

P 4.1
Chapter 4
Security Valuation
Question 1
Sabanam Ltd. has issued convertible debentures with coupon rate 11%. Each debenture has an option
to convert to 16 equity shares at any time until the date of maturity. Debentures will be redeemed at Rs.
100 on maturity of 5 years. An investor generally requires a rate of return of 8% p.a. on a 5-year security.
As an advisor, when will you advise the investor to exercise conversion for given market prices of the
equity share of (i) Rs. 5, (ii) Rs. 6 and (iii) Rs. 7.10.
Cumulative PV factor for 8% for 5 years : 3.993
PV factor for 8% for year 5 : 0.681 (6 Marks May ‘18)
Answer 1
If Debentures are not converted its value is as under: -
PVF @ 8 % Rs.
Interest - Rs. 11 for 5 years 3.993 43.923
th
Redemption - Rs. 100 in 5 year 0.681 68.100
112.023
Value of equity shares:-
Market Price No. Total
Rs. 5 16 Rs. 80
Rs. 6 16 Rs. 96
Rs. 7.10 16 Rs. 113.60
Hence, unless the market price is Rs. 7.10 conversion should not be exercised.
Overall performance was very good.
Question 2
Tangent Ltd. is considering calling Rs. 3 crores of 30 years, Rs. 1,000 bond issued 5 years ago with a
coupon interest rate of 14 per cent. The bonds have a call price of Rs. 1,150 and had initially collected
proceeds of Rs. 2.91 crores since a discount of Rs. 30 per bond was offered. The initial floating cost
was Rs. 3,90,000. The Company intends to sell Rs. 3 crores of 12 per cent coupon rate, 25 years bonds
to raise funds for retiring the old bonds. It proposes to sell the new bonds at their par value of Rs.
1,000. The estimated floatation cost is Rs. 4,25,000. The company is paying 40% tax and its after tax
cost of debt is 8 per cent. As the new bonds must first be sold and then their proceeds to be used to
retire the old bonds, the company expects a two months period of overlapping interest during which
interest must be paid on both the old and the new bonds. You are required to evaluate the bond retiring
decision. [PVIFA 8%, 25 = 10.675] (8 Marks Nov ‘18)
Answer 2
NPV for bond refunding
Rs.
PV of annual cash flow savings (W.N. 2)
(3,49,600 X PVIFA 8%,25) i.e. 10.675 37,31,980
Less: Initial investment (W.N. 1) 31,15,000
NPV 6,16,980
Chapter 4 Security Valuation
P 4.2
Recommendation: Refunding of bonds is recommended as NPV is positive.

Working Notes:
(1) Initial investment:
(a) Call premium
Before tax (1,150 – 1,000) 30,000 45,00,000

Less tax @ 40% 18,00,000
After tax cost of call prem. 27,00,000
(b) Floatation cost 4,25,000
(c) Overlapping interest
Before tax (0.14 2/12 3 crores) 7,00,000

Less tax @ 40% 2,80,000 4,20,000
(d) Tax saving on unamortized discount on old bond (25/30 9,00,000 0.4) (3,00,000)
(e) Tax savings from unamortized floatation
Cost of old bond 25/30 3,90,000 0.4 (1,30,000)
31,15,000
(2) Annual cash flow savings:
(a) Old bond
(i) Interest cost (0.14 3 crores) 42,00,000
Less tax @ 40% 16,80,000 25,20,000
(ii) Tax savings from amortisation of discount (9,00,000/30 (12,000)
0.4)
(iii) Tax savings from amortisation of floatation
cost (3,90,000/30 0.4) (5,200)
Annual after tax cost payment under old Bond (A) 25,02,800
Question 3
Shares of Volga Ltd. are being quoted at a price-earning ratio of 8 times. The company retains 50% of its
Earnings Per Share. The Company's EPS is Rs. 10.
You are required to determine:
(1) the cost of equity to the company if the market expects a growth rate of 15% p.a.
(2) the indicative market price with the same cost of capital and if the anticipated growth rate is
16% p.a.
(3) the market price per share if the company's cost of capital is 20% p.a. and the anticipated growth
rate is 18% p.a. (8 Marks Nov ‘18)
Answer 3
(1) Cost of Capital
Retained earnings (50%) Rs. 5 per share
Dividend (50%) Rs. 5 per share
EPS (100%) Rs. 10 per share (given)
P/E Ratio 8 times (given)
P 4.3
Market price Rs. 10  8 = Rs. 80 per share Cost

of equity capital
.
100 + Growth % = .
100 100 +15% = 21.25%
(2) Market Price = % !" #$ %
.
= %&.% !&' %
= Rs.95.24 Per Share
.
(3) Market Price = % !& %
= Rs.250 Per Share
Alternatively, if candidates have assumed the given figure of EPS as of last year then answer
will be as follows:
(4) Cost of Capital

Retained earnings (50%) Rs. 5 per share
Dividend (50%) Rs. 5 per share
EPS (100%) Rs. 10 per share (given)
P/E Ratio 8 times (given)
Market price Rs. 10 8 = Rs. 80 per share Cost
of equity capital
. &.&
= 100 + Growth % = 100 +15% =22.19%
.
(5) Market Price =

% !" # $ %
. .(
= = Rs.92.89 Per Share
%%.&)!&' %
. &.&
(6) Market Price = % !& %
= Rs.295 Per Share
Question 4
The shares of G Ltd. we currently being traded at Rs. 46. The company published its results for the year
ended 31st March 2019 and declared a dividend of Rs. 5. The company made a return of 15% on its capital
and expects that to be the norm in which it operates. G Ltd. Also expects the dividends to grow at 10%
for the first three years and thereafter at 5%. (8 Marks)
You are required to advise whether the share of the company is being traded at a premium or discount.
PVIF @ 15% for the next 3 years is 0.870, 0.756 and 0.658 respectively. (8 Marks May ‘19)
Answer 4
Expected dividend for next three years
Year 1 (D1) = 5 (1.1) = 5.5

Year 2 (D2) = 5.5 (1.1) = 6.05
Year 3 (D3) = 6.05 (1.1) = 6.655
Required Rate (Ke) = 15% Present Value of
Dividends
= 5.5 (0.870) + 6.05 (0.756) + 6.655 (0.658)
P 4.4
= 4.785 + 4.574 + 4.379

= 13.74
Now, PV at growth rate of 5%
P+ ,
-. !/
'.' &. '.)

= .& ! .
= .&
= 69.88
Therefore, P0 = 69.88 x 0.658 = 45.98

Now, adding the PV of dividend at two different growth rates, we get, 13.74 + 45.98 = 59.72
Hence, it is clear that shares are being traded at discount i.e. undervalued because intrinsic
value of share is more than the market price.
In this question, overall performance of the examinees was good as it was a simple problem
and most of the examinees were able to solve this correctly. However, few examinees
wrongly calculated Terminal Value as per Growth Model.
Question 5
ABB Ltd. has a surplus cash balance of Rs. 180 lakhs and wants to distribute 50% of it to the equity
shareholders. The company decides to buyback equity shares. The company estimates that its equity share
price after re-purchase is likely to be 15% above the buyback price. if the buyback route is taken.
Other information is as under:
1. Number of equity shares outstanding at present (Face value Rs. 10 each) is Rs. 20 lakhs.
2. The current EPS is Rs. 5.
You are required to calculate the following:
I. The price at which the equity shares can be re-purchased, if market capitalization of the company
should be Rs. 400 lakhs after buy back.
II. Number of equity shares that can be re-purchased.

III. The impact of equity shares re-purchase on the EPS, assuming that the net income remains
unchanged. (8 Marks May ‘19)
Answer 5
Let P be the buyback price decided by ABB Ltd.
(I) Market Capitalization after Buyback

400 lakhs= 1.15P (Original Shares – Shares Bought Back)
% & 7 8$
= 1.15P 20Lakhs 6
= 23 lakhs P – 90 lakhs 1.15

= 23 lakhs P – 130.50 lakhs Again, 23 lakhs P – 130.50 lakhs
or 23 lakhs P = 400 lakhs + 130.50 lakhs
+.
Or P = %+ = Rs. 21.89 Per Share
(II) Number of Shares to be Bought Back :-

P 4.5
Rs. 90 lakhs/ 21.89 = 4.111 lakhs (Approx.) or 411147 shares

(III) Shares after buyback
= 20 lakhs – 4.111 lakhs = 15.889 lakhs
or 20,00,000 – 4,11,147 = 15,88,853 shares
∴ EPS = 5 x 20 lakhs/ 15.889 lakhs = Rs. 6.29 Thus, EPS of
ABB Ltd., increases to Rs. 6.29.
So, EPS of ABB Ltd. is increased by Rs. 1.29 (6.29 – 5.00)
Overall performance was satisfactory as most of the examinees have been able to solve
this question correctly. However, some of the examinees after writing the equation
correctly failed to determine the buyback price. Even some examinees could not even
construct the equation or write the formula properly.
Question 6
Following financial information’s are available of XP Ltd. for the year 2018:
Equity Share Capital (Rs. 10 each) Rs. 200 Lakh

Reserves and Surplus Rs. 600 Lakh
10% Debentures (Rs. 100 each) Rs. 350 Lakh
Total Assets Rs. 1200 Lakh
Assets Turnover Ratio 2 times
Tax Rate 30%
Operating Margin 10%
Dividend Payout Ratio 20%
Current Market Price per Equity Share Rs. 28
Required Rate of Return of Investors 18%
You are required to:
(i) Prepare Income Statement for the year 2018.

(ii) Determine its Sustainable Growth Rate.
(iii) Determine the fair price of the company's share using Dividend Discount Model.
(iv) Give your opinion on investment in the company's share at current price. (8 Marks May ‘19)
Answer 6
Workings
Asset turnover ratio = 2 times
Total Assets = Rs. 1200 lakh Turnover Rs. 1200
lakhs × 2 = Rs. 2400 lakhs
Interest on Debentures = 350 lakh x 10% = 35 lakhs Operating
Margin = 10%
Hence operating cost = (1 - 0.10) 2400 lakhs = Rs. 2160 lakhs
Dividend Payout = 20%
P 4.6
Tax rate = 30%

Income statement
(Rs. Lakhs)
Sale 2400
Operating Exp 2160
EBIT 240
Interest 35
EBT 205
Tax @ 30% 61.5
EAT 143.5
Dividend @ 20% 28.7
Retained Earnings 114.8
SGR = Return on Equity (1- Dividend Payout Ratio)
= ROE (1-b)
:;
ROE = <= and NW = Rs. 200 lakh + Rs.600 lakh = Rs.800 lakh
.&>+. 8$
ROE = 100 = 17.94%
. 7 8$
.&()> . .&>+ %
SGR = 0.1794 (1-0.20) =14.35% or &! = = 16.76%
.&()> . . '>
Calculation of fair price of share using dividend discount model

&@/
P = ?
-. !/
.% .( 7 8$
Dividends = % 7 8$
= Rs.1.435
Growth Rate = 14.35% or 16.76%

.&.>+ &@ .&>+ .&.'>
Hence P = .& ! .&>+
= . +'
= Rs.44.93 or 44.96
&.>+ &@ .&'(' .&.'('
Or = =Rs. 135.16 or 135.12
.& ! .&'(' . &%>
Since the current market price of share is Rs. 28, the share is undervalued. Hence, the
investor should invest in the company.
Problem on Security Valuation was answered well by most of the examinees and the overall
performance was above average. However, inspite of following the procedure correctly, some
examinees could not able to calculate operating expenses, hence, losing marks. Again, growth rate
was calculated without first calculating ROE. Some examinees have also made wrong application of
Asset Turnover Ratio. Also, some examinees have taken ROE as 18% which is given in the question,
but actually the figure of ROE has to be calculated which is 17.94%.
Question 7
The following data are available for a bond:
Face Value Rs. 10,000 to be redeemed at par on maturity Coupon rate 8.5 per cent per annum Years to
Maturity 5 years
Yield
Naresh pasupuleti to Maturity
| 9959791590 (YTM) 10 per cent You are required to calculate:
P 4.7
(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 Nov ‘20)
Answer 7
(i) Current Market Price of Bond
= Rs. 850 (PVIAF 10%, 5) + Rs. 10,000 (PVIF 10%, 5)
= Rs. 850 (3.79) + Rs. 10,000 (0.621) = Rs. 3,221.50 + Rs. 6,210 = Rs. 9,431.5
(ii) Macaulay’s Duration

Year Cash flow P.V. @ 10% Proportion of Proportion of
bond value bond value x time
(years)
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

A >.% %
Volatility of Bonds = = =3.865
&@B;C &.&
Convexity of Bond
C* ∆Y %
100
C* = V@ G V! -2V
2V ∆Y %
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
Naresh pasupuleti | 9959791590 5 10,850 0.681 7388.85 0.567 6,151.95
P 4.8
10204.05 8,733.40
& ,% >. @ ,(++.> !% ).>+&.
C* =
% ).>+&. . % I
(>.>
=
(. > %
= 9.867
Convexity of Bond = 9.867 0.02 %

100 =0.395%
(iv) The expected market price if decrease in YTM by 200 basis points.
(A) By Macaulay’s duration-based estimate
= Rs. 9431.50 2 (3.865/100) = Rs. 729.05
Hence expected market price is Rs. 9431.50 + Rs. 729.05 = Rs. 10,160.55 Hence,
the market price will increase.
(B) By Intrinsic Value method
Intrinsic Value at YTM of 10% Rs. 9,431.50

Intrinsic Value at YTM of 8% Rs. 10,204.05
Price increased by Rs. 772.55
Hence, expected market price is Rs. 10,204.05
Question 8
An investor is considering to purchase the equity shares of LX Ltd., whose current market price (CMP)
is Rs. 112. The company is proposing a dividend of Rs. 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 Nov ’20)
Answer 8
J&= Rs. 4
J% = Rs. 4 (1.20) = Rs. 4.80

J+ = Rs. 4 (1.20)2 = Rs. 5.76
J> = Rs. 4 (1.20)3 = Rs. 6.91
J = Rs. 6.91 (1.19) = Rs. 8.22

J' = Rs. 6.91 (1.19) (1.18) = Rs. 9.70
J( = Rs. 6.91 (1.19) (1.18) (1.17) = Rs. 11.35
J = Rs. 6.91 (1.19) (1.18) (1.17) (1.16) = Rs. 13.17
P 4.9
;P
P= K
&@-.
+ K
&@-. I
+ L
&@-. L
+ ,
&@-. ,
+ &@-M M G N
&@-. N
+ O
&@-. O
G &@-. O
.
Q &+.&(
TV = R = = Rs.329.25
S !T .% ! .&'
>. >. .(' '.)& .%% ).( &&.+ +%).%
P= + + + + + + +
&@ .% &@ .% I &@ .% L &@ .% , &@ .% M &@ .% N &@ .% O &@ .% O
= 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
(iii) Intrinsic Value = Rs. 114.91
(iv) As Intrinsic Value of the share is higher than its selling price of Rs. 112, it is under- priced
and can be acquired. However, other factors need to be taken into consideration since
difference is only slightly higher.
Question 9
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 Jan ‘21)
Answer 9
(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 0.1201 i.e.
2 0.1201 1,000 &, 12.01%
&@ .&% &
=892.78
0.1403 1,000
3
1,000 0.1302*i.e
1 G 0.1201 1 G 0.1403
*13.02%
&,
*W -1 = 0.1302
( %.)+
Question 10
Following financial data are available of RK Ltd., for the year ended on 31 -03-2020:
P 4.10
Particulars ` (in Million)

8% Debentures 125
10% Bonds 50
Equity Shares of ` 10 each 100
Reserves and Surplus 300
Total Assets 600
Assets Turnover Ratio 1.1
Effective Interest Rate 8%
Effective tax rate 40%
Operating margin 10%
Dividend pay-out ratio 16.67%
Required rate of return by investors 15%
Current market price of share ` 14
(i) Prepare the income statement of RK Ltd., for the year ended on 31-03-2020.
(ii) Calculate the sustainable growth rate.
(iii) Find out the fair price of the company's share using dividend discount model.
(iv) Advice whether the share is under- priced or overpriced. (8 Marks July 21)
Answer 10
(a) Workings:
Asset turnover ratio = 1.1
Total Assets = ` 600 million Turnover ` 600
million × 1.1 = ` 660 million
Effective interest rate = Interest / Liabilities = 8%
Liabilities = ` 125 million + ` 50 million = 175 million
Interest = ` 175 million × 0.08 = ` 14 million

Operating Margin = 10%
Hence operating cost = (1 - 0.10) ` 660 million = ` 594 million
Dividend Payout = 16.67%
Tax rate = 40%
(i) Income statement
(` Million)
Sale 660
Less: Operating Exp 594
EBIT 66
Less: Interest 14
EBT 52
Less: Tax @ 40% 20.80
EAT 31.20
Less: Dividend @ 16.67% 5.20
P 4.11
Retained Earnings 26.00

(ii) SGR = ROE (1-b)S
[\]
ROE ^_
and NW Rs. 100 million G Rs. 300 Million Rs. 400 Million
ij.kl.m noppoqr
ROE 100 7.8%
ij.stt noppoqr
t.t}~ t.~kkk
SGR 0.078 1 - 0.1667 6.5% or 6.95%
l!t.t}~ t.~kkk
(iii) Calculation of fair price of share using dividend discount model

‚ƒ &@T
€• = RS !T
Š‹. .% Œ
J„…„†‡ˆ†‰ .& Œ
= Rs. 0.52 per share
•Ž••‘ℎ “”‘‡ 6.5% or 6.95%
. % &@ . ' . + . % &@ . ') . '&
Hence €• = .& ! . '
= .
= Rs. 6.52 or .& ! . ')
= .
= Rs. 6.91
(iv) Since the current market price of share is ` 14, the share is overvalued. Hence the
investor should not invest in the company.
In this question on Security Valuation most of the students have performed well though in some
cases students could not compute effective interest rate correctly. Even in some cases ROE and
SGR were also wrongly calculated.
Question 11
The data given below relates to convertible bond of Hi-Fi Ltd.:
Face value ` 2,500

No. of shares per bond 20
Coupon rate 12%
Market price per share ` 120
Market price of convertible bond ` 2,650
Straight value of bond ` 2,350
You are required to calculate the following:
(i) Conversion value of bond.

(ii) The percentage of downside risk.
(iii) The conversion premium
(iv) Conversion parity price of the stock and also interpret the results. (8 Marks July 21)
Answer 11
(i) Stock value or conversion value of bond 120 × 20 = ` 2,400
(ii) Percentage of the downside risk

` %,' ! ` %,+ ` %,' ! ` %,+
= 0.1277 or 12.77% or = 0.1132 or 11.32%
` %,+ ` %,'
This ratio gives the percentage price decline experienced by the bond if the stock becomes
worthless.
P 4.12
(iii) Conversion Premium

C 8 ! P A
P A
100
` %,' ! ` %,>
` %,>
= 10.42
–
(iv) Conversion Parity Price
< . —$
` %,'
= ` 132.50
mt
This indicates that if the price of shares rises to ` 132.50 from ` 120 the investor will
neither gain nor lose on buying the bond and exercising it. Observe that ` 12.50 (` 132.50 –
` 120.00) is 10.42% of ` 120, the Conversion Premium.
In this question on Security Valuation overall performance was above average though
students were not able to interpretate the Conversion Parity price properly.
Question 12
SK Ltd., has a surplus cash of ` 150 lakhs and wants to distribute 30% of it to the shareholders. The
company decided to buy-back shares. The company estimates that its share price after the buy-back
is likely to be 15% above the buy-back price. The number of shares outstanding at present is 15 lakhs
and the current EPS is ` 4.
(i) The price at which the shares can be bought-back, if the market capitalization of the
company should be ` 400 lakhs after buy back.
(ii) The number of shares that can be bought-back, and
(iii) The impact of this buy-back on the EPS, assuming that the net income remains the same.
(8 Marks July 21)
Answer 12
(i) Let P be the buyback price decided by SK Ltd. Market
Capitalization after Buyback
1.15P (Original Shares – Shares Bought Back)
400 Lakhs = 1.15P
kt% Ÿ l™t š›œ•ž
˜l™ š›œ•ž 6 ¢
¡
400 Lakhs = 17.25 lakhs P – 45 lakhs 1.15 = 17.25 lakhs P – 51.75 lakhs Again, 400
Lakhs = 17.25 lakhs P – 51.75 lakhs
or 17.25 lakhs P = 400 lakhs + 51.75 lakhs
or P = 451.25 /17.25 = ` 26.19 per
(ii) Number of Shares to be Bought Back :

Š‹.> £¤¥¦
= 1.718 lakhs (approx.) or 171821 share
Š‹.%'.&)
(iii) Impact of Buy Back on the EPS:
Naresh pasupuleti | 9959791590 No. of equity shares after buy back :-

P 4.13
15 lakhs – 1.718 lakhs = 13.282 lakhs or 15,00,000 – 1,71,821 = 13,28,179 shares

> & £¤¥¦‹ > & £¤¥¦‹
∴ EPS = &+.% % £¤¥¦‹
= Rs. 4.52 or &+,% ,&()
= Rs. 4.52
Thus, EPS of SK Ltd., increases to ` 4.52 or increases by `0.52 (4.52 - 4.00)
Above average performance has been observed in this question on buy-back of shares.
Question 13
TN Ltd. has ` 600 lakh 10% bonds outstanding with 5 years remaining to maturity. Since interest rate is
falling, TN Ltd. is planning of refunding these bonds with a ` 600 Lakh issue of 5 years bonds carrying a
coupon rate of 7%. Issue cost of new bond wi ll be ` 12 Lakh and call premium is 3%. ` 18 lakh being the
unamortised portion of issue cost of old bonds can be written off. Tax Rate applicable to TN Ltd. is 30%. You
are required to analyse Bond Refunding Decision. PVF @ 7% and 4.9% for five years are as under:
Rate 1 Year 2 Year 3 Year 4 Year 5 Year Total

7% 0.935 0.873 0.816 0.763 0.713 4.100
4.90% 0.953 0.909 0.866 0.826 0.787 4.341
(8 Marks & Dec ‘21)
Answer 13
Calculation of initial outlay:-
a. Cost of Calling Old Bond
` (in Lakhs)
Face value 600
Add: Call premium 18
Cost of calling old bonds 618
b. Net Proceed from New Issue
` (in Lakhs)
Gross proceed of new issue 600
Less: Issue costs 12
Net Proceed from New Issue 588
c. Tax savings on call premium and unamortized cost = 0.30 (18 + 18) = 10.80 Initial
outlay = ` 618 Lakh – ` 588 Lakh – ` 10.80 Lakh
= ` 19.20 Lakh
2. Calculation of net present value of refunding the bond:-
` (in Lakhs)
Saving in annual interest expenses [600 x (0.10 – 0.07)] 18.00
Less: Tax saving on interest and amortization 5.76
(0.30 x [18 + (18-12)/5])
Annual net cash saving 12.24
PVIFA (4.96%, 5 years) 4.341
Present value of net annual cash saving 53.13
Less: Initial outlay 19.20
P 4.14
Net present value of refunding the bond 33.93
Decision: The bonds should be refunded

Average performance has been noticed in this question on Bond Refunding Decision. The
common mistake was in the calculation of Tax Saving on Interest and Amortization.
Question 14
Following are the details of X Ltd. and Y Ltd.:
Particulars X Ltd. Y Ltd.

Dividend per Share `4 `4
Growth Rate 10% 10%
Beta 0.9 1.2
Current Market Price per Share ` 150 ` 70
Other Information:
Risk Free Rate of Return 7%
Market Rate of Return 14%
(i) Calculate the price of shares of both the companies.
(ii) Write the comment on the valuation on the basis of price calculated and current market
price.
(iii) As an investor what course of action should be followed? (8 Marks , Dec ‘21)
Answer 14
(a) (i) Calculation of Prices of shares of both companies
X Ltd. Y Ltd.
Beta 0.9 1.20
Cost of Equity using CAPM 7% + 0.9 [14% - 7%] 7% + 1.20 [14% - 7%]
= 13.30% = 15.40%
Growth Rate 10% 10%
>§&.& >.> >§&.& >.>
Price of Share = =
.&++! .& . ++ .& >! .& . >
= ` 133.33 = ` 81.48
(ii) and (iii)

Name of Current Value of Valuation Action of the
Company Market Price the Share Investor
X Ltd. ` 150.00 ` 133.33 Overvalued/ Not to Invest/ to
overpriced be sold
Y Ltd. ` 70.00 ` 81.48 Undervalued Invest/ to
/ under- be
priced purchased
Alternatively, if the given figure of Dividend is considered as Dividend Expected (D1) then
solution will be as follows:
X Ltd. Y Ltd.
Beta 0.9 1.20
P 4.15
Cost of Equity using CAPM 7% + 0.9[14% - 7%] 7% + 1.20[14% - 7%]

= 13.30% = 15.40%
Growth Rate 10% 10%

>. >. >. >.
Price of Share = =
.&++! .& . ++ .& >! .& . >
= ` 121.21 = ` 74.07
(ii) and (iii)

Name of Current Value of Valuation Action of the
Company Market Price the Share Investor
X Ltd. ` 150.00 ` 121.21 Overvalued / Not to Invest/to
overpriced be sold
Y Ltd. ` 70.00 ` 74.07 Undervalued / Invest/to be
under-priced purchased
Good performance has been noticed in this question on Security Valuation.
Question 15
Calculate the value of share from the following Information:
Profit of the company (After tax) ` 560 crores

Equity share capital of the Company ` 1900 crores
Par value of share ` 50 each
Debt ratio (Debt/Debt + Equity) 43%
Long run growth rate of the company 7%
Beta 0.1 (Risk free Interest rate) 9.5%
Market return 12.6%
Capital expenditure per share ` 53
Depreciation per share ` 45
Increase in working capital ` 4.62 per share
(8 Marks May ‘22)
Answer 15
Š‹.&,) ¨©•©ª‹
No. of Shares = Š‹.
= 38 crores
«¬-
EPS = ®•.•¯ °¦¤©ª‹
Š‹. ' ±©•©ª‹

EPS = = Rs. 14.737
+ ¨©•©ª‹
Cost of Equity = Rf + ß (Rm – Rf)
= 9.5 + 0.1 (12.6 – 9.5) = 9.81%

FCFE = Net income – [(1-b) (capex – dep) + (1-b) ( ΔWC )]
FCFE = 14.737 – [(1-0.43) (53-45) + (1-0.43) (4.62)]
= 14.737 – [4.56 + 2.6334] = 7.5436
P 4.16
²±²³ &@T (. >+' &. ( . (&'

€= = = = Rs. 287.25
RS !T . ) &! . ( . % &
Question 16
The risk free rate of return is 5%. The expected rate of return on the market portfolio is 11%. The
expected rate of growth in dividend of X Ltd. is 8%. The last dividend paid was Rs. 2.00 per share. The beta
of X Ltd. equity stock is 1.5.
(i) What is the present price of the equity stock of X Ltd.?
(ii) How would the price change when:
 The inflation premium increases by 3%
 The expected growth rate decreases by 3% and
 The beta decreases to 1.3 (4 Marks May ‘18)
Answer 16
(i) Equilibrium price of Equity using CAPM
= 5% + 1.5(11% - 5%)
= 5% + 9%= 14%
K %. &. %.&'
P= = = =Rs.36
-. !/ .&>! . . '
(ii) New Equilibrium price of Equity using CAPM (assuming 3% on 5% is inflation increase)
= 5.15% + 1.3(11% - 5.15%)
= 5.15% + 7.61%= 12.76%
K %. &.
P= = = Rs.27.06
-. !/ .&%('! .
Alternatively, it can also be computed as follows, assuming it is 3% in addition to 5%

= 8% + 1.3(11% - 8%)
= 8% + 3.9%= 11.9%
K %. &.
P= = = Rs.30.43
-. !/ .&&)! .
Alternatively, if all the factors are taken separately then solution of this part will be as follows:
(i) Inflation Premium increase by 3%.
This raises RX to 17%. Hence, new equilibrium price will be:
%. &.
= Rs. 24
.&(! .
(ii) Expected Growth rate decrease by 3%.
Hence, revised growth rate stand at 5%:
%. &.
= Rs.23.33
.&>! .
(iii) Beta decreases to 1.3.

Hence, revised cost of equity shall be:
= 5% + 1.3(11% - 5%)
= 5% + 7.8%= 12.8%
As a result New Equilibrium price shall be:
P 4.17
K %. &.
P=
-. !/
= .&% ! .
= Rs.45
Overall performance was above average although some examinees committed errors in
answering sub-part (ii) of the question.
Question 17
The following data are available for three bonds A, B and C. These bonds are used by a bond portfolio
manager to fund an outflow scheduled in 6 years. Current yield is 9%. All bonds have face value of Rs.100
each and will be redeemed at par. Interest is payable annually.
Bond Maturity Coupon rate

(Years)
A 10 10%
B 8 11%
C 5 9%
(i) Calculate the duration of each bond.
(ii) The bond portfolio manager has been asked to keep 45% of the portfolio money in Bond
A. Calculate the percentage amount to be invested in bonds B and C that need to be
purchased to immunise the portfolio.
(iii) After the portfolio has been formulated, an interest rate change occurs, increasing the
yield to 11%. The new duration of these bonds are: Bond A = 7.15 Years, Bond B = 6.03
Years and Bond C = 4.27 years.
Is the portfolio still immunized? Why or why not?
(iv) Determine the new percentage of B and C bonds that are needed to immunize the
portfolio. Bond A remaining at 45% of the portfolio.
Present values be used as follows :
Present Values t1 t2 t3 t4 t5
PVIF0.09,t 0.917 0.842 0.772 0.708 0.650
Present Values t6 t7 t8 T9 t10

PVIF0.09,t 0.596 0.547 0.502 0.460 0.4224
(12 Marks Nov ‘18)

Answer 17
(i) Calculation of Bond Duration

Bond A
Year Cash flow P.V. @ 9% Proportion of Proportion of
bond value bond value x
time (years)
1 10 0.917 9.17 0.086 0.086
2 10 0.842 8.42 0.079 0.158
P 4.18
3 10 0.772 7.72 0.073 0.219

4 10 0.708 7.08 0.067 0.268
5 10 0.650 6.50 0.061 0.305
6 10 0.596 5.96 0.056 0.336
7 10 0.547 5.47 0.051 0.357
8 10 0.502 5.02 0.047 0.376
9 10 0.460 4.60 0.043 0.387
10 110 0.422 46.46 0.437 4.370
4
106.40 1.000 6.862
Duration of the bond is 6.862 years or 6.86 year
Bond B
Year Cash flow P.V. @ 9% Proportion of Proportion of bond

bond value value x time (years)
1 11 0.917 10.087 0.091 0.091
2 11 0.842 9.262 0.083 0.166
3 11 0.772 8.492 0.076 0.228
4 11 0.708 7.788 0.070 0.280
5 11 0.650 7.150 0.064 0.320
6 11 0.596 6.556 0.059 0.354
7 11 0.547 6.017 0.054 0.378
8 111 0.502 55.772 0.502 4.016
111.224 1.000 5.833
Duration of the bond B is 5.833 years or 5.84 years
Bond C
Year Cash P.V. @ 9% Proportion of Proportion of bond
flow bond value value x time (years)
1 9 0.917 8.253 0.082 0.082
2 9 0.842 7.578 0.076 0.152
3 9 0.772 6.948 0.069 0.207
4 9 0.708 6.372 0.064 0.256
5 109 0.650 70.850 0.709 3.545
100.00 1.000 4.242
Duration of the bond C is 4.242 years or 4.24 years

(ii) Amount of Investment required in Bond B and C
Period required to be immunized 6.000 Year

Less: Period covered from Bond A 3.087 Year
To be immunized from B and C 2.913 Year
P 4.19
Let proportion of investment in Bond B and C is b and c respectively then b + c = 0.55 (1)
5.883b + 4.242c = 2.913 (2)
On solving these equations, the value of b and c comes 0.3534 or 0.3621 and 0.1966 or
0.1879 respectively and accordingly, the % of investment of B and C is 35.34% or 36.21%
and 19.66 % or 18.79% respectively.
(iii) With revised yield the Revised Duration of Bond stands
0.45 7.15 + 0.36 x 6.03 + 0.19 x 4.27 = 6.20 year
No portfolio is not immunized as the duration of the portfolio has been increased from
6 years to 6.20 years.
(iv) New percentage of B and C bonds that are needed to immunize the portfolio.
Period required to be immunized 6.0000 Year

Less: Period covered from Bond A 3.2175 Year
To be immunized from B and C 2.7825 Year
Let proportion of investment in Bond B and C is b and c respectively, then b +
c = 0.55
6.03b + 4.27c = 2.7825 b = 0.2466
On solving these equations, the value of b and c comes 0.2466 and 0.3034
respectively and accordingly, the % of investment of B and C is 24.66% or 25% and 30.34
% or 30.00% respectively.
Question 18
AB Industries has Equity Capital of Rs. 12 Lakhs, total Debt of Rs. 8 Lakhs, and annual sales of Rs. 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 (Rs. In Lakhs) - 0.30
New Equity Raised (Rs. in Lakhs) - 1
You are required to calculate sustainable growth rate for both the proposals. (8 Marks Nov ‘20)
Answer 18
Sustainable Growth Rate under Proposal 1
Sales (Given) Rs. 30 Lakhs
Total Assets Rs. 30 Lakhs x 0.65 Rs. 19.50 Lakhs
Net Profit Rs. 30 Lakhs x 4% Rs. 1.20 Lakhs
Equity Multiplier Equity 12 Lakhs 0.6

=
Equity + Debt 12 Lakhs + 8 Lakhs
P 4.20
&.% 7 8$
ROE 3.69%
&). 7 8$ × 0.60 x 100
Sustainable Growth Rate = ROE

x Retention Ratio = 3.69% x 0.75 =
2.77%
Sustainable Growth Rate under Proposal 2
New Equity = Rs. 12 Lakhs + Rs. 1 Lakh = Rs. 13 Lakhs New

Debt = Rs. 13 Lakhs x 4 = Rs. 52 Lakhs
Total Assets = Rs. 13 Lakhs + Rs. 52 Lakhs = Rs. 65 Lakhs
Target Assets to Sales Ratio (Given) 0.62

Sales Rs. 65 Lakhs / 0.62 Rs. 104.84 Lakhs
Net Profit Rs. 104.84 Lakhs x 5% Rs. 5.242 Lakhs
´µA ¶ &+ 7 8$
Equity Multiplier ´µA ¶@ ·
= &+ 7 8$ @ % 8$
0.2
.%>% 7 8$
ROE = ' 7 8$
0.20 100 1.613%
.%>% 7 8$ ! .+ 7 8$
Retention Ratio = .%>% 7 8$
0.943
Sustainable Growth Rate = ROE x Retention Ratio

= 1.613% x 0.943 = 1.52%
Question 19
The following information was extracted from the books of M/s Murugan Ltd.:
Face Value of Bond ₹ 1000

Coupon Interest Rate 8.5%
Time Period of Maturity Remaining 4 Years
Interest Payment Annual, at the end of the year
Principal Repayment At the end of the Bond maturity
Conversion Ratio 30
(Number of shares per Bond)
Current Market Price per Share ₹ 55
Market Price of Convertible Bond ₹ 1725
It can issue plain bonds without conversion option at an Interest rate of 10.5%.
Year t1 t2 t3 t4
PVIF@10.5 0.905 0.819 0.741 0.671
%
Based on the above data, you are requested to calculate:
(i) Straight value of bonds

(ii) Conversion Value of Bond
P 4.21

(iv) Percentage of Down Turn Risk
(v) Conversion Parity Price (8 Marks Nov 22)
Answer 19
(i) Straight Value of Bond
= ₹ 85 x 0.905 + ₹ 85 x 0.819 + ₹ 85 x 0.741 + ₹ 1085 x 0.671
= ₹ 76.93 + ₹ 69.62 + ₹ 62.99 + ₹ 728.04 = ₹ 937.56
(ii) Conversion rate is 30 shares per bond. Market price of share ₹ 55 Conversion Value 30 x ₹ 55 = ₹
1,650
¸¤©¥ª¹ º©»¨ª!±•¼½ª©‹»•¼ ½¤£¾ª
X 100
±•¼½ª©‹»•¼ ½¤£¾ª
Š‹.&(% !Š‹.&'
X 100 = 4.55%
Š‹.&'
Alternatively, it can also be computed on Per Share/ Bond basis as follows:
Š‹.&(% !Š‹.&'
Š‹.+
= Rs. 2.50 per share or Rs. 1725 – Rs. 55 X 30 = Rs. 75
Š‹.&(% !Š‹.)+(.
(iv)
Š‹.)+(.
X 100 = 0.84 or 84%
Š‹.&(% !Š‹.)+(.
•Ž Š‹. &(%
X 100 = 0.4565 or 45.65%
This ratio gives the percentage price decline experienced by the bond if the stock becomes worthless.
(v) Conversion parity price

¿•¼À «©»¨ª Š‹.&(%
®•.•¯ ‹¦¤©ª‹ •¼ ±•¼½ª©‹»•¼
= +
= Rs. 57.50
Question 20
Mr. X wants to invest ₹ 1,00,000 in the 7 years 8% bonds in the market (Face Value ₹ 100) which were
issued 2 years ago.
(i) You are requested to advise him what is the maximum price for bonds to be paid in the following
scenarios:
(1) If Mr. X is expecting minimum 9% return on the bonds

(2) If Mr. X is expecting minimum 7% return on the bonds
(3) If the present rate of similar bonds issued is 8.25%
(4) If the present rate of similar bonds issued is 7.75%
(ii) If the bonds are available at par and 1% is the transaction cost, what is the effective yield?
(iii) Find the number of days required to breakeven transaction cost if the bonds are available at par and
2% is the transaction cost. (8 Marks Nov 22)
Answer 20
(i) The maximum price to be paid for Bond
(1) To have a return of 9% return on Bond.
= Rs. 100 X ) = Rs. 88.89
Naresh pasupuleti | 9959791590Answer

Alternative
P 4.22
&
= + + + +
&. ) K &. ) I &. ) L &. ) , &. ) M
= Rs. 7.34 + Rs. 6.73 + Rs. 6.18 + Rs. 5.67 + Rs. 70.19 = Rs. 96.11
(2) To have a return of 9% return on Bond.

= Rs. 100 X = Rs. 114.29
(
Alternative Answer
&
= &. ( K
+ &. ( I
+ &. ( L
+ &. ( ,
+ &. ( M
= Rs. 7.48 + Rs. 6.99 + Rs. 6.53 + Rs. 6.10 + Rs. 77.00 = Rs. 104.10
(3) If Present rate of similar bond issued is 8.25%

&
= + + + +
&. % K &. % I &. % L &. % , &. % M
= Rs. 7.39 + Rs. 6.83 + Rs. 6.31 + Rs. 5.83 + Rs. 72.66 = Rs. 99.02
Alternative Answer
~
= Rs. 100 X }.}™ = Rs. 103.23
(ii) Effective yield if transaction cost is 1% = & &

X 100 = 7.92
(iii) No. of Days required for break even

%% Á &, , %,
Q% = = 90days
&, , Á LNƒ %%.%%
Alternatively, if 365 days used in Calculation then answer will be as follows:
%% Á &, , %,
Q% = = 91.24 days say 91 Days
&, , Á LNM %&.)%

P 5.1
Chapter 5
Portfolio Management
Question 1
Consider the following information on two stocks, X and Y.
Year 2016 2017
Return on X (%) 10 16
Return on Y (%) 12 18
You are required to calculate:
(i) The expected return on a portfolio containing X and Y 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) The Correlation coefficient between the returns of the two stocks.
(v) The risk of a portfolio containing X and Y in the proportion of 40% and 60%. (10 Marks, May ‘18)
Answer 1
(i) Expected return of portfolio containing X and Y in the ratio 40%,60%
E (X) = (10 + 16) / 2 = 13%
E (Y) = (12 + 18) / 2 = 15%
RP = ∑ X R = 0.4(13) + 0.6(15) = 14.2%
(ii) Standard Deviation of X and Y
Stock X:
Variance = 0.5 10 13 0.5 16 13 =9
Standard deviation = 3% Stock Y:
Variance = 0.5 12 15 + 0.5 18 15 =9

Standard deviation = 3%
(iii) Cov = 0.5 (10 – 13) (12 – 15) + 0.5 (16 – 13) (18 – 15) = 9
, "
(iv) Correlation Coefficient = ρ = = =1
! ! "
(v) Risk of portfolio containing 40% X and 60 % Y
σp = %X σ X σ 2X X σ σ Corr.
= ( 0.4 3 0.6 3 2 0.4 0.6 3 3 1

= √1.44 3.24 4.32 = 3%
In this part of the question examinee’s performance was good as the same question has proved
a scoring question.
Question 2
Interpret the Capital Asset Pricing Model (CAPM) and its relevant assumptions. (4 Marks May ‘18)

Chapter 5 Portfolio Management
P 5.2
Answer 2
The Capital Asset Pricing Model was developed by Sharpe, Mossin and Linter in 1960. The model explains
the relationship between the expected return, non-diversifiable risk and the valuation of securities. It
considers the required rate of return of a security on the basis of its contribution to the total risk.
It is based on the premises that the diversifiable risk of a security is eliminated when more and more
securities are added to the portfolio. However, the systematic risk cannot be diversified and is or related
with that of the market portfolio.
All securities do not have same level of systematic risk. The systematic risk can be measured by beta, ß
under CAPM, the expected return from a security can be expressed as:
Expected return on security = Rf + Beta (Rm – Rf)
The model shows that the expected return of a security consists of the risk -free rate of interest and the
risk premium. The CAPM, when plotted on the graph paper is known as the Security Market Line (SML).
A major implication of CAPM is that not only every security but all portfolios too must plot on SML.
This implies that in an efficient market, all securities are having expected returns commensurate with their
riskiness, measured by ß.
Relevant Assumptions of CAPM
(i) The investor’s objective is to maximize the utility of terminal wealth;
(ii) Investors make choices on the basis of risk and return;
(iii) Investors have identical time horizon;
(iv) Investors have homogeneous expectations of risk and return;
(v) Information is freely and simultaneously available to investors;
(vi) There is risk-free asset, and investor can borrow and lend unlimited amounts at the risk-
free rate;
(vii) There are no taxes, transaction costs, restrictions on short rates or other market
imperfections;
(viii) Total asset quantity is fixed, and all assets are marketable and divisible.
Thus, CAPM provides a conceptual framework for evaluating any investment decision, where
capital is committed with a goal of producing future returns.
Overall performance in this question was average as lack of knowledge of concept and presentation
has been observed in maximum answers.
Question 3
Mr. Kapoor owns a portfolio with the following characteristics:
Security X Security Y Risk Free Security
Factor 1 sensitivity 0.75 1.50 0
Factor 2 sensitivity 0.60 1.10 0
Expected Return 15% 20% 10%
It is assumed that security returns are generated by a two factor model.
(i) If Mr. Kapoor has Rs. 1,00,000 to invest and sells short Rs. 50,000 of security Y and
purchases Rs. 1,50,000 of security X, what is the sensitivity of Mr. Kapoor's portfolio to the
two factors?
P 5.3
(ii) If Mr. Kapoor 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 X and Y 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? (8 Marks Nov ‘18)
Answer 3
(i) Mr. Kapoor’s position in the two securities is +1.50 in security X and -0.5 in security
Y. Hence the portfolio sensitivities to the two factors:-
b prop. 1 =1.50 x 0.75 + (-0.50 x 1.50) = 0.375
b prop. 2 = 1.50 x 0.60 + (-0.50 x 1.10) = 0.35
(ii) Mr. Kapoor’s current position:
Security X Rs. 3,00,000 / Rs. 1,00,000 = 3
Security Y -Rs. 1,00,000 / Rs. 1,00,000 = -1
Risk free asset -Rs. 100000 / Rs. 100000 = -1
b prop. 1 = 3.0 x 0.75 + (-1 x 1.50) + (- 1 x 0) = 0.75
b prop. 2 = 3.0 x 0.60 + (-1 x 1.10) + (-1 x 0) = 0.70
(iii) Expected Return = Risk Free Rate of Return + Risk Premium Let λ1 and λ2 are the Value Factor 1 and
Factor 2 respectively. Accordingly
15 = 10 + 0.75 λ1 + 0.60 λ2
20 = 10 + 1.50 λ1 + 1.10 λ2
On solving equation, the value of λ1 and λ2 comes 6.67 and 0 respectively.
Accordingly, the expected risk premium for the factor 2 shall be Zero and whatever be the risk the
same shall be on account of factor 1.
Alternatively, the risk premium of Securities X & Y can be calculated as follows: Security X
Total Return = 15% Risk Free Return = 10% Risk
Premium = 5% Security Y
Total Return = 20% Risk Free Return = 10% Risk
Premium = 10%
Question 4
Following are the details of a portfolio consisting of 3 shares:
Shares Portfolio Expected Total

Weight Beta Return (%) Variance
X Ltd. 0.3 0.50 15 0.020
Y Ltd. 0.5 0.60 16 0.010
Z Ltd. 0.2 1.20 20 0.120
Standard Deviation of Market Portfolio Return = 12% You are required to calculate the following:
(i) The Portfolio Beta.
(ii) Residual Variance of each of the three shares.
(iii) Portfolio Variance using Sharpe Index Model.(8 Marks May ‘19)
P 5.4
Answer 4
(i) Portfolio Beta
0.30 x 0.50 + 0.50 x 0.60 + 0.20 x 1.20
= 0.15 + 0.3 + 0.24
= 0.69
(ii) Residual Variance
To determine Residual Variance first of all we shall compute the Systematic Risk as follows:
β , σ- = 0.5 0.12 =0.0036
β , σ- = 0.6 0.12 =0.0052
β. , σ- = 1.20 0.12 =0.0207
Residual Variance = Total Variance – Systematic Risk

X 0.020 – 0.0036 = 0.0164
Y 0.010 – 0.0052 = 0.0048
Z 0.120 – 0.0207 = 0.0993
(iii)
Portfolio Variance = Systematic Risk of the Portfolio + Unsystematic Risk of the Portfolio
Systematic Variance of Portfolio = 0.12 x 0.69 = 0.006856 Unsystematic
Variance of Portfolio = 0.0164 x 0.30 + 0.0048 x 0.50 + 0.0993 x 0.20 =
0.006648
Total Variance = 0.006856+ 0.006648 = 0.013504
Overall performance of the examinees was good. Although Portfolio Beta and Residual
Variance was calculated correctly by most of the examinees, Portfolio Variance using
Sharpe Index Model was calculated correctly only by a few examinees.
Question 5
Mr. X holds the following portfolio:
Securities Cost (Rs.) Dividends Market Beta
(Rs.) Price (Rs.)
Equity shares:
A Ltd. 16,000 1,600 16,400 0.9
B Ltd. 20,000 1,600 21,000 0.8
C Ltd. 32,000 1,600 44,000 0.6
PSU Bonds 68,000 6,800 64,600 0.4
The risk-free rate of return is 12%. Calculate the following: The expected rate of return on his portfolio
using Capital Asset Pricing Model (CAPM).The average return on his portfolio. (Calculate up to two
decimal points) (8 Marks Nov ‘19)
Answer 5
Calculation of expected return on market portfolio (Rm)

P 5.5
Investment Cost (Rs.) Dividends Capital Gains

(Rs.) (Rs.)
Shares A 16,000 1600 400
Shares B 20,000 1600 1000
Shares C 32,000 1600 12,000
PSU Bonds 68,000 6800 –3,400
1,36,000 11,600 10,000
11,233413,333
R0 = , 100 =15.88%
1,52,333
Calculation of expected rate of return on individual security: Security

Shares A 12 + 0.9 (15.88 – 12.0) = 15.49%
Shares B 12 + 0.8 (15.88 – 12.0) = 15.10%
Shares C 12 + 0.6 (15.88 – 12.0) = 14.33%
PSU Bonds 12 + 0.4 (15.88 – 12.0) = 13.55%
Calculation of the Average Return of the Portfolio:

16.7"416.13417.55415.66
= 7
=14.62%
Overall above average performance was observed in this question as some examinees were not
able to calculate expected rate of return on individual security though they calculated
correctly average rate of return of the portfolio.
Question 6
Following are risk and return estimates for two stocks
Stock Expected returns (%) Beta Specific SD of expected return
(%)
A 14 0.8 35
B 18 1.2 45
The market index has a Standard Deviation (SD) of 25% and risk free rate on Treasury Bills is 6%.
You are required to calculate :
(i) The standard deviation of expected returns on A and B.
(ii) Suppose a portfolio is to be constructed with the proportions of 25%, 40% and 35% in
stock A, B and Treasury Bills respectively, what would be the expected return, standard
deviation of expected return of the portfolio? (8 Marks Nov ‘19)
Answer 6
(i) Total Risk = Systematic Risk + Unsystematic Risk
Stock A
Systematic Risk = 89 :9; = <. = 9

, 9> 9
=400
Unsystematic Risk = ?>9
Total Risk = @ = (A<< ?> 9 =√BC9> =40.31%
Stock B
P 5.6
Systematic Risk = D9 @9E = B. 9 9

, 9> 9
=900
Unsystematic Risk = A>9
Total Risk = @ = (F<< A> 9 =√9F9> = 54.08%
(ii) Expected return of the portfolio
(0.25 , 14)+(0.40, 18)+(0.35, 6)=12.8%
Total Risk = Systematic Risk + Unsystematic Risk
Systematic Risk G H IJ
G p = 0.25(0.8)+0.4(1.2)+0.35(0)= 0.2+0.48+0=0.68
Systematic Risk of Portfolio = ( 0.68 , 25 =√289
Non- Systematic Risk of Portfolio
= 0.25 35 0.40 45 0 K 76.56 324 =√400.56
Total Risk = √289 400.56 =26.26
The overall performance of the examinees in this question was not satisfactory. Only few examinees
could correctly attempt Total Risk (Standard Deviation) based on Systematic Risk and Unsystematic
Risk.
Question 7
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
The Risk and Return by investing in Stock A and B
(i) 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.
(ii) The better opportunity for investment(10 Marks Jan ‘21)
Answer 7
A B

P 5.7
Year Market Return Squared Market Return Squared N)x

(Return - M
Price Per (%) N
Return - M Price Per (%) N
Return - O N)
(Return - O
Share in ` Share in
`
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

N
Mean A Mean QR
13.99 Variance 1037.7814 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 = [0.602 x 1037.7814 + 0.402 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.
Question 8
Mr. X is having a portfolio of shares worth ` 170 lakhs at current price and cash ` 30 lakhs. The beta of
share portfolio is 1.6. After 3 months the price of shares dropped by 3.2%.
Determine:
(i) Current portfolio beta.
(ii) Portfolio beta after 3 months if Mr. X on current date goes for long position on ` 200 lakhs
Nifty futures. (8 Marks July 21)
Answer 8
(i) Current Portfolio Beta
Current Beta for share portfolio = 1.6 Beta for cash
=0
P 5.8
Current portfolio beta = 0.85 x 1.6 + 0 .15 x 0 = 1.36

(ii) Portfolio beta after 3 months:
STUVWX YV ZU[\X ]^ _]à^][Y] ]^ bTU`X

Beta for portfolio of shares = STUVWX YV cU[\X ]^ dUèXa _]à^][Y] YVfXg
3.35
1.6 = STUVWX YV cU[\X ]^ dUèXa _]à^][Y] YVfXg
Change in value of market portfolio (Index) = (0.032 / 1.6) x 100 = 2% Position

taken on 200 lakh Nifty futures : Long
Value of index after 3 months = ` 200 lakh x (1.00 - 0.02)
= ` 196 lakh
Mark-to-market paid = ` 4 lakh
Cash balance after payment of mark-to-market = ` 26 lakh

Value of portfolio after 3 months = ` 170 lakh x (1 - 0.032) + ` 26 lakh
= ` 190.56 lakh
33 [UeT 1"3.62 [UeT
Change in value of portfolio = ,100 = 4.72%
33 [UeT
Portfolio beta = 0.0472/0.02 = 2.36
Good performance has been observed in this question on Portfolio Management although in
some cases full steps were found missing in the answers. Moreover, some students also
wrongly considered the beta of cash as 1.
Question 9
A company has a choice of investments between several different equity oriented mutual funds. The
company has an amount of ` 100 lakhs to invest. The details of the mutual funds are as follows:
Mutual Funds A B C D E
Beta 1.5 1.0 0.8 2.0 0.7
PLAN I
If the company invests 20% of its investments in each of the first two mutual funds (A and B) and balance
in equal amounts in the mutual funds C, D and E, what is the beta of the portfolio?
PLAN II
If the company invests 15% of its investment in C, 15% in A, 10% in E and the balance in equal amounts in
the other two mutual funds, what is the beta of the portfolio?
If the expected return of market portfolio is 12% at a beta factor of 1.0, what will be the expected return
on' the portfolio in both the plans given above? (8 Marks July 21)
Answer 9
Plan I: Investment in A and B at 20 % each and balance in equal proportion in C, D, and E.
Mutual Proportion of Beta Proportion × Fund
P 5.9
Fund Investment beta

A 0.2 1.50 0.30
B 0.2 1.00 0.20
C 0.2 0.80 0.16
D 0.2 2.00 0.40
E 0.2 0.70 0.14
Portfolio 1.20
beta
Plan II: Investment in A at 15%, C at 15% and E at 10% and balance in equal proportion in B
and D:
Mutual Proportion of Beta Proportion × Fund beta
Fund Investment
A 0.15 1.50 0.225
B 0.30 1.00 0.300
C 0.15 0.80 0.120
D 0.30 2.00 0.600
E 0.10 0.70 0.070
Portfolio 1.315
Beta
Expected return = Market return × Portfolio Beta
Plan Return
I 12% × 1.20 = 14.40%
II 12% × 1.315 = 15.78%
Though overall good performance has been noted in this question on Portfolio Management, but
some students have got confused in calculation of expected returns under two plans.
Question 10
On 01/04/2020 Mr. K Invested in the following companies to make his portfolio:
Name of No. of Equity Face Value per Purchase Price
Company Share Purchase Equity Share per Equity Share
PK Ltd. 2000 ` 10 ` 210
KD Ltd. 1000 ` 10 ` 290
Mr. K expects that-
(i) Dividend for the financial year 2020-21 of PK Ltd. & KD Ltd. will be 40% & 50%
respectively.
(ii) Probabilities of the Market Price as on 31/03/2021 as under-
Probability Market Value per Equity Market Value per Equity
Factor Share of PK Ltd. Share of KD Ltd.
0.4 ` 200 ` 300
0.4 ` 240 ` 320
0.2 ` 260 ` 350
You are required to -
(i) Calculate the Expected Market Price of Equity Shares of both the Companies as on
31/03/2021.
P 5.10
(ii) Calculate the Expected Average Return of the Portfolio for the year 2020-21. (8 Marks Dec ‘21)
Answer 10
(i) Expected Market Price of Shares on 31/03/2021
PK Ltd. KD Ltd.
(200 x 0.4) + (240 x 0.4) + (260 x 0.2) 228.00 -
(300 x 0.4) + (320 x 0.4) + (350 x 0.2) - 318.00
(ii) Calculation of estimated return on Portfolio for 2020-21
(Calculation in ` / share)
PK Ltd. KD Ltd.
Expected dividend 4.00 5.00
Capital gain by 31.03.21 (228 – 210) = 18.00 (318 – 290) = 28.00
Yield 22.00 33.00
Market Value 01.04.20 210 290
% return 10.48% 11.38%
Weight in portfolio 59.15 40.85
(2,000 x 210) : (1000 x 290)
Weighted average (Expected) return 10.85%
(59.15 x 10.48%) + (40.85 x 11.38%)
Good performance has been noticed in this question on Portfolio management though in some
cases students skipped some steps and reached to final answer. In some cases, instead of
weighted average they used simple average.
Question 11
Buy and hold is one of the policies of portfolio rebalancing. Briefly explain other policies of portfolio
rebalancing. (4 Marks Dec ’21)
Answer 11
While one policy of rebalancing portfolio is Buy and Hold the two policies are as follows:
(i) Constant Mix Policy: Contrary to above policy this policy is a ‘Do Something Policy’. Under this
policy investor maintains an exposure to stock at a constant percentage of total portfolio. This
strategy involves periodic rebalancing to required (desired) proportion by purchasing and selling
stocks as and when their prices goes down and up respectively. In other words this plan specifies
that value of aggressive portfolio to the value of conservative portfolio will be held constant at a
predetermined ratio. However, it is important to this action is taken only there is change in the
prices of share at a predetermined percentage.
(ii) Constant Proportion Insurance Policy: Under this strategy investor sets a floor below which he
does not wish his asset to fall called floor, which is invested in some non-fluctuating assets such as
Treasury Bills, Bonds etc. The value of portfolio under this strategy shall not fall below this specified
floor under normal market conditions. This strategy performs well especially in bull market as the
value of shares purchased as cushion increases. In contrast in bearish market losses are avoided
by sale of shares. It should however be noted that this strategy performs very poorly in the market
hurt by sharp reversals. The following equation is used to determine equity allocation:
Target Investment in Shares = Multiplier (Portfolio Value – Floor Value) Multiplier is a fixed constant
whose value shall be more than 1.
P 5.11
Most of the students provided vague answers with lack of conceptual understanding hence
poor performance has been noticed in both theoretical questions on Portfolio Rebalancing
and Forward Rate Agreement.
Question 12
You have been given the following information about Sweccha Ltd.
Sweccha Ltd. Market

Year Average Share Dividend Average Dividend Return on
price per share Index Yield % Govt. bond %
2017 460 30 4060 5 5.5
2018 497 33 4320 6.5 5.5
2019 523 38 4592 4.5 5.5
2020 556 43 4780 6 5.5
2021 589 50 4968 5.5 5.5
(i) Compute the Beta value of the company as at the end of year 2021.
(ii) What is your Observation? (8 Marks May ‘22)
Answer 12
Computation of Beta Value
Calculation of Returns
hi 4 ji jk
Returns = X 100
jk
Year Returns from Sweccha Ltd. Returns from market Index

554 7"l 723 75 3 7323
×100 = 15.22% ×100 + 6.50% = 12.90%
2018 723 7323
5m4 6 5 7"l 76" 75 3

2019 7"l
×100 = 12.88% 75 3
×100 + 4.50% = 10.80%
754 662 6 5 7lm3 76"

2020 6 5
×100 = 14.53% 76"
×100 + 6.00% = 10.09%
634 6m" 662 7"2m 7lm3

2021 662
×100 = 14.93% 7lm3
×100 + 5.50% = 9.43%
Computation of Beta
Year Sweccha Ltd. (X) Market Index (Y) XY Y2

2018 15.22% 12.90% 196.34 166.41
2019 12.88% 10.80% 139.10 116.64
2020 14.53% 10.09% 146.61 101.81
2021 14.93% 9.43% 140.79 88.92
Total 57.56% 43.22% 622.84 473.78
P 5.12
6l.62
Average Return of Krishna Ltd. = 7
= 14.39%
75.
Average Market Return = 7
= 10.81%
∑ no V nRoR 2 .m7 7n17.5" n 13.m1

Beta (G) = ∑ o p V oR p
= = 0.097
7l5.lm 7 13.m1 p
(ii) Observation
Expected Return (%) Actual Return (%) Action
2017 5.5% + 0.097(12.90% - 5.5%) = 6.22% 15.22% Buy
2018 5.5% + 0.097(10.80% - 5.5%) = 6.01% 12.88% Buy
2019 5.5% + 0.097(10.09% - 5.5%) = 5.95% 14.53% Buy
2020 5.5% + 0.097(9.43% - 5.5%) = 5.88% 14.93% Buy
Question 13
Calculate the Covariance & Correlation Coefficient of the two securities, from the historical rates of
return over the past 10 years.
Years 1 2 3 4 5 6 7 8 9 10
Security 1 15 10 12 8 18 16 20 24 16 14
(Return %)
Security 2 24 20 18 14 22 26 12 28 16 15
(Return %)
(8 Marks May ‘22)
Answer 13
Calculation of Covariance
Year R1 Deviation Deviation R2 Deviation Deviation Product of
(R1 -R1) 2 (R2 -R2)2 deviations
(R1 - R1) (R2 -R2 )
1 15 -0.3 0.09 24 4.5 20.25 -1.35
2 10 -5.3 28.09 20 0.5 0.25 -2.65
3 12 -3.3 10.89 18 -1.5 2.25 4.95
4 8 -7.3 53.29 14 -5.5 30.25 40.15
5 18 2.7 7.29 22 2.5 6.25 6.75
6 16 0.7 0.49 26 6.5 42.25 4.55
7 20 4.7 22.09 12 -7.5 56.25 -35.25
8 24 8.7 75.69 28 8.5 72.25 73.95
9 16 0.7 0.49 16 -3.5 12.25 -2.45
10 14 -1.3 1.69 15 -4.5 20.25 5.85
153 Σ= 200.10 195 Σ=262.50 94.50
165
RRR
q1 = 13 = 15.30
RRR = 1"6 = 19.50

q 13
∑u RRRR RRRR
vwirsi si trsp sp t
Covariance = x
= 94.50/10 =9.45

P 5.13
Standard Deviation of Security 1

si RRRR
si p
I1 = %
x
33.13
I1 = % = √20.01
13
I1 =4.47
Standard Deviation of Security 2

sp RRRR
sp p
I =% x
2 .63
I =% 13
= √26.25
I =5.12
Alternatively, Standard Deviation of securities can also be calculated as follows:
Year R1 R12 R2 R22

1 15 225 24 576
2 10 100 20 400
3 12 144 18 324
4 8 64 14 196
5 18 324 22 484
6 16 256 26 676
7 20 400 12 144
8 24 576 28 784
9 16 256 16 256
10 14 196 15 225
153 2541 195.00 4065
Standard deviation of security 1:

x ∑ sip ∑ si p
I1 = % xp
13n 671 165 p 6713 573"

I1 = % =%
13p 133
331
I1 = % 133 = √20.01
I1 = 4.47
Standard deviation of security 2:

x ∑ spp ∑ sp p
I =% xp
13n7326 1"6 p 73263 5m3 6

I = % 13p
=% 133
2 6
I = % 133 = √26.25
P 5.14
I = 5.12s
Correction Coefficient
S]c ".76
y1 = = 7.7l n 6.1 = 0.413
z i zp
Question 14
Following is the information related to three mutual funds:
Year MF-A MF-B MF-C

2020 10% 5% 14%
2021 8% 10% 10%
2022 12% 8% 18%
Correlation between market and mutual fund:
MF-A MF-B MF-C

Correlation with market 0.45 0.25 0.65
Variance of the market is 9% and rate of return of government bond is 7%. You are required to Rank the
Mutual fund using Sharpe’s ratio and Treynor’s ratio. (8 Marks Nov 22)
Answer 14
(i) Calculation of Standard Deviation of Funds
Year MF-A Dev. Dev.2 MF-B Dev. Dev.2 MF-C De Dev.2
(%) (%) (%) v.
2020 10 - - 5 -2.67 7.13 14 - -
2021 8 -2 4 10 2.33 5.43 10 -4 16
2022 12 2 4 8 0.33 0.11 18 4 16
30 8 23 12.67 42 32
Avg. Var. Avg. Var. Avg. Var.
= 30/3 = 8/3 = 23/3 12.67/3 = 32/3 =
= 10 = 2.67 = 7.67 = 4.22 42/3 10.67
σA = σB = 2.05 = 14 σC =
1.63 3.27
(ii) Calculation of Beta of MFs
r σM σi Var. of Market βi
MF-A 0.45 3 1.63 9 0.244
MF-B 0.25 3 2.05 9 0.171
MF-C 0.65 3 3.27 9 0.709
Reward to Variability (Sharpe Ratio)

Mutual Rp Rf Rp – σp Reward to Ranking
Fund Rf Variability
MF-A 10.00 7.00 3.00 1.63 1.84 2
MF-B 7.67 7.00 0.67 2.05 0.33 3
MF-C 14.00 7.00 7.00 3.27 2.14 1
P 5.15
Reward to Volatility (Treynor Ratio)

Mutual Rp Rf Rp – βp Reward to Ranking
Fund Rf Volatility
MF-A 10.00 7.00 3.00 0.244 12.30 1
MF-B 7.67 7.00 0.67 0.171 3.92 3
MF-C 14.00 7.00 7.00 0.709 9.87 2
Question 15
M/s. Siri Ltd. Has a surplus amount of ₹ 3 crores to invest and has shortlisted the following equity shares:
Company Beta
S Ltd. 1.6
K Ltd. 1
P Ltd. -0.3
D Ltd. 2
C Ltd. 0.6
Required:
(i) If M/s. Siri Ltd. invests an equal amount in all securities, what is the beta of the portfolio?
(ii) If M/s. Siri Ltd. invests 15% of its investment in S Ltd., 15% in P Ltd., 10% in C Ltd. and the
balance in equal amount in the other two securities, what is the beta of the portfolio?
(iii) If the expected return of market portfolio is 12% at a beta factor of 1.0, what will be the
portfolios expected return in both the situations given above?
(iv) If the Company changes its policy to invest in any 3 securities with a minimum of 20% in each
of these 3 securities to diversify risk, you are requested to advise the company to have a right
mix of securities to maximize the return in the following two scenarios and also calculate the
expected return:
(1) Bull Phase: Expected Market returns 10%
(2) Bear Phase: Expected Market returns — 5% (8 Marks Nov 22)
Answer 15
(a) Beta of the Portfolio
Investment Beta Investment Weighted
(β) (₹ Lakhs) Investment
S Ltd. 1.6 60 96
K Ltd. 1.0 60 60
P Ltd. -0.3 60 -18
D Ltd. 2.0 60 120
C Ltd. 0.6 60 36
300 294
"7 [UeT
Gj = 533 [UeT
= 0.98
Alternatively, it can also be computed as follows:

1 1 1 1 1
1.6 , 6
+ 1.0 , 6
+(-0.30) , 6
+ 2, 6
+ 0.6, 6
= 0.98
With varied percentages of investments portfolio beta is calculated as follows:

P 5.16
Investment Beta Investment Weighted

(β) (₹ Lakhs) Investment
S Ltd. 1.6 45 72
K Ltd. 1.0 90 90
P Ltd. -0.3 45 -13.50
D Ltd. 2.0 90 180
C Ltd. 0.6 30 18
300 346.50
572.63
Beta = 533
= 1.155
(ii) Expected return of the portfolio with pattern of investment as in case (i) = 12% × 0.98 i.e.
11.76%
Expected Return with pattern of investment as in case (ii) = 12% × 1.155 i.e., 13.86%.
(iii) (1) Securities to be selected during Bull Phase Expected Market returns 10%
As it is bull Market Higher Beta stocks should be selected.
Shares % to be Beta Investment Weighted
invested (β) Investment
S Ltd. 20 1.6 60,00,000 96,00,000
K Ltd. 20 1 60,00,000 60,00,000
P Ltd. 0 -0.3 - -
D Ltd. 60 2 1,80,00,000 3,60,00,000
C Ltd. 0 0.6 - -
100 3,00,00,000 5,16,00,000
Portfolio or Weighted Beta (β) (5,16,00,000/ 3,00,00,000) 1.72
Portfolio Beta (β) 1.72

Market Return 10%
Expected Return 17.20%
(2) Securities to be selected During Bear Phase Expected Market returns – 5% As it is

bear market Lower Beta stocks should be selected
Shares % to be invested Beta (β) Investment Weighted
Investment
S Ltd. 0 1.6 - -
K Ltd. 20 1 60,00,000 60,00,000
P Ltd. 60 -0.3 1,80,00,000 -54,00,000
D Ltd. 0 2 - -
C Ltd. 20 0.6 60,00,000 36,00,000
100 3,00,00,000 42,00,000
Portfolio or Weighted Beta (β) (42,00,000/ 3,00,00,000) 0.14
Portfolio Beta (β) 0.14

P 5.17
Market Return -5%

Expected Return -0.70%
Question 16
Following is the information related to return on shares of three different companies :
Years A Ltd. B Ltd. C Ltd.

2018 2% 3% 5%
2019 6% 8% 7%
2020 13% 14% 15%
2021 7% 9% 11%
Required:
(i) Construct maximum number of portfolio and its return, if each portfolio consists of any two Company's
shares in proportion of 65% and 35% and suggest which portfolio provides highest return.
(ii) Calculate portfolio return and beta (β), if Mr. X invests ₹ 65,000 in A Ltd. having beta (β) of 0.45; ₹ 20,000
in B Ltd. having beta (β) of 1.15 and ₹ 15,000 in C Ltd. having beta (β) of 1.8. (8 Marks Nov 22)
Answer 16
(a) Calculation of Average Return
Year A Ltd. B Ltd. C Ltd.
2018 2% 3% 5%
2019 6% 8% 7%
2020 13% 14% 15%
2021 7% 9% 11%
Sum 28% 34% 38%
Average 7% 8.50% 9.50%
(i) (1) Combination 1 - 65% in A Ltd. & 35% B Ltd.
Return = 7% × 0.65 + 8.50% × 0.35 = 4.55% + 2.975% = 7.525% or 7.53%
(2) Combination 2 – 65% in B Ltd. & 35% in C Ltd.
Return = 8.50% × 0.65 + 9.50% × 0.35 = 5.525% + 3.325% = 8.85%
(3) Combination 3 – 65% in C Ltd. & 35% in A Ltd.
Return = 0.65 × 9.50% + 0.35 × 7.00% = 6.175% + 2.45% = 8.625% or 8.63%
(4) Combination 4 – 65% in A Ltd. & 35% in C Ltd.
Return = 0.65 × 7% + 0.35 × 9.50% = 4.55% + 3.325% = 7.875% or 7.88%
(5) Combination 5 – 35% in A Ltd. & 65% in B Ltd.
Return = 0.35 × 7% + 0.65 × 8.50% = 2.45% + 5.525% = 7.975% or 7.98%
(6) Combination 6 – 35% in B Ltd. & 65% in C Ltd.
Return = 0.35 × 8.50% + 0.65 × 9.50% = 2.975% + 6.175% = 9.15%
Since maximum return is under Combination - 6 i.e. 65% investment in C Ltd. and 35% in B
Ltd. hence it should be opted for.
(ii) Calculation of Return and Beta of Portfolio
26,333 3,333 16,333
Return of Portfolio = 7% , + 8.50% , + 9.50% , = 7.675%
1,33,333 1,33,333 1,33,333
26,333 3,333 16,333

Beta of Portfolio = 0.45, 1,33,333 + 1.15 , 1,33,333 + 1.80 X 1,33,333 = 0.7925 or 0.79
P 6.1
Chapter 6
Securitization
Question 1
Discuss briefly the steps involved in the Securitization mechanism. (4 Marks May ’18, May’19)
OR
Explain the benefits of Securitization from the perspective of both originator as well as the investor.
(4 Marks May ’18, May’22)
Answer 1
The steps involved in securitization mechanism are as follows:
Creation of Pool of Assets: The process of securitization begins with creation of pool of assets by segregation
of assets backed by similar type of mortgages in terms of interest rate, risk, maturity and concentration units.
Transfer to SPV: One assets have been pooled, they are transferred to Special Purpose Vehicle (SPV)
especially created for this purpose.
Sale of Securitized Papers: SPV designs the instruments based on nature of interest, risk, tenure etc.
based on pool of assets. These instruments can be Pass Through Security or Pay Through Certificates.
Administration of assets: The administration of assets in subcontracted back to originator which collects
principal and interest from underlying assets and transfer it to SPV, which works as a conduct.
Recourse to Originator: Performance of securitized papers depends on the performance of underlying assets
and unless specified in case of default they go back to originator from SPV.
Repayment of funds: SPV will repay the funds in form of interest and principal that arises from the assets
pooled.
Credit Rating of Instruments: Sometime before the sale of securitized instruments credit rating can be
done to assess the risk of the issuer.
The Steps on Securitization was answered well by the examinees and performance was
above average.
OR
The benefits of securitization can be viewed from the angle of various parties involved as follows:
(A) From the angle of originator: Originator (entity which sells assets collectively to Special Purpose
Vehicle) achieves the following benefits from securitization.
(i) Off – Balance Sheet Financing: When loan/receivables are securitized it release a portion
of capital tied up in these assets resulting in off Balance Sheet financing leading to improved
liquidity position which helps expanding the business of the company.
(ii) More specialization in main business: By transferring the assets the entity could
concentrate more on core business as servicing of loan is transferred to SPV. Further, in case
of non-recourse arrangement even the burden of default is shifted.
(iii) Helps to improve financial ratios: Especially in case of Financial Institutions and Banks, it
helps to manage Capital –To-Weighted Asset Ratio effectively.
(iv) Reduced borrowing Cost: Since securitized papers are rated due to credit enhancement
even they can also be issued at reduced rate as of debts and hence the originator earns a
spread, resulting in reduced cost of borrowings.
Chapter 6 Securitization
P 6.2
(B) From the angle of investor: Following benefits accrues to the investors of securitized
securities.
1. Diversification of Risk: Purchase of securities backed by different types of assets
provides the diversification of portfolio resulting in reduction of risk.
2. Regulatory requirement: Acquisition of asset backed belonging to a particular industry
say micro industry helps banks to meet regulatory requirement of investment of fund in
industry specific.
3. Protection against default: In case of recourse arrangement if there is any default by any
third party then originator shall make good the least amount. Moreover, there can be
insurance arrangement for compensation for any such default.
Overall performance was of above average level as majority of examinees tried to attempt the
question and presented the answer in general manner.
Question 2
Discuss about the Primary Participants in the process of Securitization. (4 Marks Nov ’18, Jan’21)
Answer 2
Primary Participants are main parties to the process of securitization. The primary participants in the
process of securitization are as follows:
(i) 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. The
originator transfers both legal as well as beneficial interest to the Special Purpose Vehicle.
(ii) Special Purpose Vehicle: Also, called SPV, it is created for the purpose of executing the deal.
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.
The main objective of creating SPV is to remove the asset from the Balance Sheet of Originator.
Since, SPV makes an upfront payment to the originator, it holds the key position in the overall
process of securitization. Further, it also issues the securities (called Asset Based Securities or
Mortgage Based Securities) to the investors.
(iii) 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, Financial
Institutions etc.
Since, they acquire a participating share in the total pool of assets/receivable, they receive their
money back in the form of interest and principal as per the agreed terms.
Question 3
Identify the benefits of Securitization from the angle of Originator. (4 Marks Nov ‘19)
Answer 3
Originator (entity which sells assets collectively to Special Purpose Vehicle) achieves the following
benefits from securitization:
(i) Off – Balance Sheet Financing: When loan/receivables are securitized, it releases a portion
of capital tied up in these assets resulting in off Balance Sheet financing leading to improved
liquidity position which helps expanding the business of the company.

P 6.3
(ii) More specialization in main business: By transferring the assets, the entity could
concentrate more on core business as servicing of loan is transferred to SPV. Further, in case
of non-recourse arrangement even the burden of default is shifted.
(iii) Helps to improve financial ratios: Especially in case of Financial Institutions and Banks, it
helps to manage Capital –To-Weighted Asset Ratio effectively.
(iv) Reduced borrowing Cost: Since securitized papers are rated due to credit enhancement even
they can also be issued at reduced rate in case of debts and, hence, the originator earns a
spread, resulting in reduced cost of borrowings.
Most of the examinees attempted this theoretical question well and explained the benefits of
Securitization of assets from the angle of Originator. Hence performance was very good.
Question 4
State the main problems faced in Securitization in India? (4 Marks Nov ’19, July’21)
Answer 4
Following are main problems faced in growth of Securitization of instruments especially in context:
Stamp Duty: Stamp Duty is one of the obstacles 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.
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 differs a lot. Some are of opinion that
SPV as a trustee is liable to be taxed in a representative capacity. While, 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.
Accounting: Accounting and reporting of securitized assets in the books of originator is another area of
concern. Although securitization is slated to 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.
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.
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.
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.
Most of the examinees attempted this question well stating the general problems faced for
the growth of securitization of instruments in India. Hence performance was good.

P 6.4
Question 5
Distinguish between Pass Through Certificates (PTC) and Pay Through Securities (PTS).(4 Marks Nov
‘20)
Answer 5
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 receivables. PTS also permits the SPV to
reinvest surplus funds for short term as per there requirement.
Question 6
"The process of securitization 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 Jan ‘21)
Answer 6
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 7
Explain the pricing of the securitized instruments. (4 Marks Dec ‘21)
Answer 7
Pricing of securitized instruments is an important aspect of securitization. While pricing the instruments, it is
important that it should be acceptable to both originators as well as to the investor. On the same basis pricing
of securities can be divided into fol lowing two categories:
(i) From Originator’s Angle: From originator’s point of view, the instruments can be priced at a rate
at which originator has to incur an outflow and if that outflow can be amortized over a period of
time by investing the amount raised through securitization.
(ii) From Investor’s Angle: From an investor’s angle security price can be determined by discounting
best estimate of expected future cash flows using rate of yield to maturity of a security of
comparable security with respect to credit quality and average life of the securities. This yield can
also be estimated by referring the yield curve available for marketable securities, though some
adjustments is needed on account of spread points, because of credit quality of the securitized
instruments.

P 6.5
Question 8
What are the features of Securitization? (4 Marks Nov 22)
Answer 8
The securitization has the following features:
(i) Creation of Financial Instruments – The process of securities can be viewed as process of creation of
additional financial product of securities in market backed by collaterals.
(ii) 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.
(iii) 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.
(iv) Structured Finance – In the process of securitization, financial instruments are tailor structured to meet
the risk return trade of profile of investor, and hence, these securitized instruments are considered as
best examples of structured finance.
(v) Trenching – Portfolio of different receivable or loan or asset are split into several parts based on risk and
return they carry called ‘Tranche’. Each Trench carries a different level of risk and return.
(vi) 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.

P 7.1
Chapter 7
Mutual Funds
Question 1
SG Mutual Fund Company has the following assets under it on the close of business as on:
1st August 2017 2nd August 2017
Company No. of Shares Market price per share Market price per
(Rs.) share (Rs.)
Q Ltd. 2,000 200.00 205.00
R Ltd. 30,000 312.40 360.00
S Ltd. 40,000 180.60 191.55
T Ltd. 60,000 505.10 503.90
Total No. of Units issued by the Mutual Fund is 6,00,000.
(i) Calculate Net Assets Value (NAV) of the Fund.

(ii) Following information is also given:
Assuming that Mr. Zubin, an investor, submits a cheque of Rs. 30,00,000 to the Mutual Fund and
the Fund Manager of this entity purchases 8,000 shares of R Ltd; and the balance amount is held
in Bank. In such a case, what would be the position of the Fund?
(iii) Calculate new NAV of the Fund as on 2nd August 2017. (10 Marks May ‘18)
Answer 1
(i) NAV of the Fund
. , , . , , . , , . , , ,
=
, ,
. , , ,
= = Rs.78.8366 rounded to Rs.78.84
, ,
Company 2/8/17 Value
Market Price /share
Q 205 4,10,000
R 360 108,00,000
S 191.55 76,62,000
T 503.90 302,34,000
Total 491,06,000
, , ,
NAV per unit = = 81.84
, ,
(ii) The revised position of fund shall be as follows:

Shares No. of shares Price Amount (Rs.)
Q Ltd. 2000 200 4,00,000
R Ltd. 38,000 312.40 1,18,71,200
S Ltd. 40,000 108.60 72,24,000
T Ltd. 60,000 505.10 3,03,06,000
Cash 5,00,800
5,03,02,000
, ,
No. of units of fund = 6,00,000 + = 6,38,053
.
(iii)
Naresh pasupuleti | 9959791590 On 2nd August 2017, the NAV of fund will be as follows:
Chapter 7 Mutual Funds
P 7.2
Shares No. of shares Price Amount (Rs.)

Q Ltd. 2000 205 4,10,000
R Ltd. 38,000 360.00 1,36,80,000
S Ltd. 40,000 191.55 76,62,000
T Ltd. 60,000 503.90 3,02,34,000
Cash 5,00,800
5,24,86,800
. , , ,
NAV as on 2nd August 2017= , ,
= Rs.82.26 per unit
Overall performance was above average.
Question 2
A mutual fund having 300 units has shown its NAV of Rs. 8.75 and Rs. 9.45 at the beginning and at the
end of the year respectively. The Mutual fund has given two options to the investors:
(i) Get dividend of Rs. 0.75 per unit and capital gain of Rs. 0.60 per unit, or
(ii) These distributions are to be reinvested at an average NAV of Rs. 8.65 per unit.
What difference would it make in terms of returns available and which option is preferable by the
investors? (8 Marks Nov ‘18)
Answer 2
Option 1: When Dividend and Capital Gain are paid:
Calculation of monthly return on the mutual funds:

r=
. . . . . . . .
Or, r =
.
. .
= =23.43%
.
Option 2: When Dividend and Capital Gain are reinvested:

If all dividends and capital gain are reinvested into additional units at Rs. 8.65 per unit the position would
be.
Total amount reinvested = Rs. 1.35 300 = Rs. 405
.
Additional Units added = = 46.82 Units or 47 Units
.
Value of units at the end = 346.82 units x Rs. 9.45 = Rs. 3277.45
Or = 347 units x Rs. 9.45 = Rs. 3279.15

Price paid for 300 units as at the beginning = (300 Rs. 8.75) = Rs. 2,625
Return = (Rs. 3277.45 – Rs. 2625)/ Rs.2625 = 24.86%
Or Return =
. . . .
= .
= 24.92%
From the above, it can be said that reinvestment option is better .

P 7.3
Question 3
A Mutual Fund Company introduces two schemes - Dividend Plan and Bonus Plan. The face value of the
Unit is Rs.10 on 1-4-2014. Mr. R invested Rs. 5 lakh in Dividend Plan and Rs. 10 lakh in Bonus Plan. The
NAV of Dividend Plan is Rs. 46 and NAV of Bonus Plan is Rs. 42. Both the plans matured on 31-03-2019.
The particulars of Dividend and Bonus declared over the period are as follows:
Date Dividend Bonus Ratio NAV of Dividend NAV of Bonus

% Plan Plan
(Rs.) (Rs.)
31-12-2014 12% - 47.0 42.0
30-09-2015 - 1:4 48.0 43.0
31-03-2016 15% - 49.5 41.5
30-09-2017 - 1:6 50.0 44.0
31-03-2018 10% - 48.0 43.5
31-03-2019 - - 49.0 44.0
You are required to calculate the effective yield per annum in respect of the above two plans.(8 Marks
May ‘19)
Answer 3
Dividend Plan
, ,
Unit acquired = =10869.57
Date Units held Dividend Reinvestment New Total

% Amount Rate Units Units
01.04.2014 10869.57
31.12.2014 10869.57 12 13043.48 47.0 277.52 11147.09
31.03.2016 11147.09 15 16720.64 49.5 337.79 11484.88
31.03.2018 11484.88 10 11484.88 48.0 239.27 11724.15
31.03.2019 Maturity Value (Rs. 49.0 X 11724.15) Rs. 5,74,483.35

Less: Cost of Acquisition Rs. 5,00,000.00
Total Gain Rs. 74483.35
. , .
∴ Effective Yield = . , ,
100 =2.98%
Bonus Plan
, ,
Unit Acquired = =23809.52
Date Particulars Calculation Working No. of Units NAV (Rs.)

1.4.14 Investment 23809.52 42
30.9.15 Bonus 23,809.52 / 4 = 5952.38
29761.90 43
30.9.17 " 29761.9 / 6 = 4960.32
34722.22 44
31.3.19 Maturity Value 34722.22 x Rs. 44 = 15,27,777.68
P 7.4
Less: 10,00,000.00
Investment
Gain 5,27,777.68
. , .
∴ Effective Yield = 100 =10.56 %
, ,
Problem on Mutual Fund was well attempted by most of the examinees though some
examinees calculated the Effective yield wrongly.
Question 4
Cinderella Mutual Fund, an approved mutual fund, sponsored open-ended equity oriented scheme
"Rudolf Opportunity Fund". There are three plans under the scheme viz. 'A' - Dividend Re-investment
plan, 'B' - Bonus plan and 'C' - Growth plan.
At the time of initial public offer on 1-4-2009, Mr. Amit, Mr. Ashish and Mr. Arun, three investors invested
Rs. 2,00,000 each at face value of Rs. 10 per unit and chosen plan 'B', 'C' and 'A' respectively.The
particulars of the fund over the period are as follows:
Date Dividend Bonus Net Asset Value per unit (Rs.)

% Ratio
Plan A Plan B Plan C
31.07.2013 10 - 30.70 31.20 35.40
31.03.2014 35 5:4 58.42 31.05 58.25
30.10.2017 20 - 42.18 26.45 56.45
15.03.2018 12.50 - 46.45 27.72 62.78
31.03.2018 - 1:3 45.20 20.05 67.12
25.03.2019 20 1:4 48.10 19.95 71.42
31.07.2019 - - 53.75 22.98 82.07
On 31st July, 2019, all the three investors redeemed all the balance units.
1. Consider the following:

(a) Long-term capital gain is exempt from Income-tax.
(b) Short-term capital gain is subject to 10% Income-tax.

(c) Security Transaction Tax is 0.2% only on sale/ redemption of units.
(d) Ignore Education Cess.
2. You are required:
(i) To calculate the Effective Yield per annum (annual rate of return) of each of the
investors.
(ii) To suggest the name of investor with the highest Effective Yield per annum with
the difference to his nearest investor.
(Show your calculations up to two decimal points)(10 Marks Nov ‘19)
Answer 4
(i) Calculation of effective yield per annum of each of the investors Mr. Arun Plan A
Dividend
Naresh pasupuleti | 9959791590 Reinvestment (Amount in Rs.)
P 7.5
Date Investment Dividend Dividend Re- NAV Units Closing Unit

payout invested Balance
(%) (Closing Units
X Face value of
‘10 X Dividend
Payout %)
01.04.2009 2,00,000.00 10.00 20,000.00 20,000.00

31.07.2013 10 20,000.00 30.70 651.47 20,651.47
31.03.2014 35 72,280.15 58.42 1,237.25 21,888.72
30.10.2017 20 43,777.44 42.18 1,037.87 22,926.59
15.03.2018 12.5 28,658.24 46.45 616.97 23,543.56
25.03.2019 20 47,087.12 48.10 978.94 24,522.50
Redemption value 24522.5 53.75 13,18,084.38
Less: Security Transaction Tax (STT) is 0.2% 2636.17
Net amount received 13,15,448.21
Less: Short term capital gain tax @ 10% on 978.94 542.33
(53.64* – 48.10≈) = 5423.33
Net of tax 13,14,905.88
Less: Investment 2,00,000.00
11,14,905.88
*(53.75 – STT @ 0.2%) ≈ This value can also be taken as zero

, , .
Annual average return (%) , , 100 =53.95%
Mr. Amit Plan B – Bonus

(Amount in Rs.)
Date Units Bonus units Total Balance NAV per unit

01.04.2009 20,000 20,000 10
31.03.2014 25,000 45,000 31.05
31.03.2018 15,000 60,000 20.05
25.03.2019 15,000 75,000 19.95
Redemption value 75,000 22.98 17,23,500

Less: Security Transaction Tax (STT) is 0.2% 3447
Net amount received 17,20,053
Less: Short term capital gain tax @ 10%
15,000 (22.93† – 19.95) = 44,700 4470
Net of tax 17,15,583
Less: Investment 2,00,000
Net gain 15,15,583
†(22.98 – STT @ 0.2%)
, ,
Annual average return (%) , ,
100 =73.33%

P 7.6
Mr. Ashish Plan C – Growth

Particulars (Amount in
Rs.)
Redemption value 20,000 82.07 16,41,400.00
Less: Security Transaction Tax (S.T.T) is 0.2% 3282.80
Net amount received 16,38,117.20
Less: Short term capital gain tax @ 10% 0.00
Net of tax 16,38,117.20
Less: Investment 2,00,000.00
Net gain 14,38,117.20
, , .
Annual average return (%) , ,
100 =69.59%
(ii) Mr. Amit (Bonus Plan) earns the highest effective yield per annum of 73.33% and the difference
to his nearest investor Mr. Ashish is 3.74 (73.33 – 69.59%).
Note: Alternatively, figure of * and † can be taken as without net of Tax because, as per Proviso 5 of Section
48 of IT Act, no deduction of STT shall be allowed in computation of Capital Gain.
In such case:
Mr. Arun Plan A – Short term capital gains tax would be Rs 553.10. Accordingly, Net of tax will be
Rs. 13,14,895.10 and the net gain would be Rs 11,14,895.10.
Mr. Amit Plan B – Bonus Plan – Short term capital gains tax would be Rs 4,545. Accordingly, Net
of tax will be Rs.17,15,508 and the net gain would be Rs 15,15,508.
Overall, the examinees did well in this paper. However, some examinees made some
calculations errors particularly in the calculation of no. of units, STCG Tax and Rate of Return.
Also, the redemption values of plans have not been arrived at properly in some cases. Few
examinees have also taken Security Transaction Tax @ 2% instead of 0.2% leading to wrong
calculation of subsequent steps.
Question 5
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 Bonus Plan
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
Naresh pasupuleti | 9959791590 - - 49 44
P 7.7
Additional details
Investment (Rs.) Rs. 9,20,000 Rs. 10,00,000
Average Profit (Rs.) Rs. 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 Nov ‘20)
Answer 5
(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 21607
(d/e)
1 2 3 4 = (2*3) 5 6= 7
1/
(4+5)*
4
Period Unit Rate Uni Dividend NAV New Balance Units
s t Units Pre Dividend
hel valu *
d e
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) = Rs. 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
Question 6
Side Pocketing enhances the value of the Mutual Fund. Do you agree? Briefly explain the process of
side pocketing. (4 Marks Nov ‘20)

P 7.8
Answer 6
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 7
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. You are
required to:
(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 Nov ‘20)
Answer 7
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
9.60 . .
Beta (β) 0.55 0.81 0.98
. .
7.60
= 0.695 = 0.789 = 0.825
Ranking of Funds as per Sharpe Ratio

#$%&'(&) &(+,- . / 0,&& 1(& 23 &(+,-
Sharpe Ratio = 4(1-)1,) 5&6.1(.2-

P 7.9
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
(i) Ranking of Funds as per Treynor Ratio
#$%&'(&) &(+,- . / 0,&& 1(& 23 &(+,-
Treynor Ratio =
7&(1
Growth Fund Balance Fund Regular Fund
Treynor Ratio =- -2.878 =- -3.802 =- -4.84
. . .
Ranking 1 2 3
(ii) Comparison of performance with the Market

Sharpe Ratio
.
=0
Treynor Ratio
=0
Thus, the performance of funds is very poor since all values are negative as compared to market
performance.
Question 8
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 Jan ‘21)
Answer 8
(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
P 7.10
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 31st March ` 21.8867
Question 9
Mr. K has invested in three Mutual fund schemes as per details below:
Scheme A Scheme B Scheme C

Date of Investment 01-12-2018 01-01-2019 01-03-2019
Amount of Investment ` 5,00,000 ` 10,00,000 ` 5,00,000
Net Asset Value at entry date ` 10.50 ` 10.00 ` 10.00
Dividend
Naresh pasupuleti | 9959791590 received up
P 7.11
to 31-03-2019 ` 9,500 ` 15,000 ` 5,000

NAV as at 31-3-2019 ` 10.40 ` 10.10 ` 9.80
You are required to calculate the effective yield on per annum basis in respect of each of the three
schemes to Mr. K upto 31-03-2019, taking the year consisting of 365 days.
Provide a brief comment on the course of action he should take for future period. (Calculation should
be upto three decimal places) (8 Marks July 21)
Answer 9
Calculation of effective yield on per annum basis in respect of three mutual fund schemes to Mr. K up to
31-03-2019:
Particulars Scheme A Scheme B Scheme C

(a) Investments ` 5,00,000 ` 10,00,000 ` 5,00,000
(b) Opening NAV ` 10.50 ` 10.00 ` 10.00
(c) No. of units (a/b) 47,619.048 1,00,000 50,000
(d) Unit NAV on 31-3-2019 ` 10.40 ` 10.10 ` 9.80
(e) Total NAV on 31-3-2019 (c x d) ` 4,95,238.099 ` 10,10,000 ` 4,90,000
(f) Increase / Decrease of NAV (e - a) (` 4,761.901) ` 10,000 (` 10,000)
(g) Dividend Received ` 9,500 ` 15,000 ` 5,000
(h) Total yield (f + g) ` 4,738.099 ` 25,000 (` 5,000)
(i) Number of Days 121 90 31
(j) Effective yield p.a. (h/a x 365/i x 2.859% 10.139% (-) 11.774%
100)
Comments: Since the Effective Yield in Scheme C is negative and that of Scheme A is much lower
than Scheme B, it is advised that Mr. K should redeem the investments in Scheme A and Scheme
C and the proceeds should be invested in Scheme B in the next period.
Overall, above average performance has been noticed in this question on Mutual Funds.
Though in some cases students not carried out calculations upto 3 decimals as mentioned in
the question. Even some students considered months instead of days. It seems that students
have ignored the instructions given in the question and hence losing marks unnecessarily.
Question 10
Describe Tracking error. List the reasons for it. (4 Marks July 21)
Answer 10
Tracking error can be defined as the divergence or deviation of a fund’s return from the benchmarks
return it is following.
The passive fund managers closely follow or track the benchmark index. Although they design their
investment strategy on the same index but often it may not exactly replicate the index return. In such
situation, there is possibility of deviation between the returns. The tracking error can be calculated on
the basis of corresponding benchmark return vis a vis quarterly or monthly average NAVs.

P 7.12
Reasons of Tracking Error:

Higher the tracking error higher is the risk profile of the fund. Whether the funds outperform or
underperform their benchmark indices; it clearly indicates that fund managers are not following the
benchmark indices properly. In addition to the same other reasons for tracking error are as follows:
 Transaction cost
 Fees charged by AMCs
 Fund expenses
 Cash holdings
 Sampling biasness
Thus, from above it can be said that to replicate the return to any benchmark index the tracking
error should be near to zero.
Question 11
Following are the details of closed ended equity schemes of two mutual funds as on 31/08/2021:
Particulars AJ Mutual Fund RP Mutual Fund

NAV (p.u.) ` 80 (consisting 95% ` 61(consisting ` 60
equity & remaining cash equity & remaining cash
balance) balance)
Sharpe Ratio 1.5 3
Treynor Ratio 1.2 10
Standard Deviation 10 6
There is no change in portfolios during the September month. Monthly cost is ` 0.50 per unit for each
mutual fund scheme. Share market rose by 2% in the month of September. You are required to calculate
Expected NAV p.u. as on 30/09/2021 for both the schemes. (8 Marks Dec ‘21)
Answer 11
(a) Working Notes:
(i) Decomposition of Funds in Equity and Cash Components
AJ Mutual Fund RP Mutual Fund
NAV on 31.08.21 ` 80.00 ` 61.00
% of Equity 95% 98.36%
Equity element in NAV ` 76.00 ` 60.00
Cash element in NAV ` 4.00 ` 1.00
(ii) Calculation of Beta
(a) AJ Mutual Fund
8 9 9: 8 9 9:
Sharpe Ratio = 1.5 = ;<=
=
E(R) - Rf = 15
8 9 9: .
Treynor Ratio = 12 = =
><= ><=
?@A = 15.00/12 = 1.25
(b) RP Mutual Fund
8 9 9: 8 9 9:
Sharpe Ratio = 3 = ;BC
=
Naresh pasupuleti | 9959791590 E(R) - Rf = 18
P 7.13
8 9 9:
Treynor Ratio = 10 = >BC
=
>BC
?D = 18/10 = 1.80
(iii) Increase in the Value of Equity
Market rose by 2.00% 2.00%
Beta 1.25 1.80
Equity component goes up 2.50% 3.60%
(iv) Balance of Cash after 1 month
Cash in Hand on 30.09.21 ` 4.00 ` 1.00
Less: Exp. Per month ` 0.50 ` 0.50
Balance after 1 month ` 3.50 ` 0.50
NAV after 1 month
Value of Equity after 1
month
76 x (1 + 0.025) ` 77.90 -
60 x (1 + 0.036) - ` 62.16
Cash Balance ` 3.50 ` 0.50
NAV ` 81.40 ` 62.66
Overall students have performed well in this question on Mutual Fund. Most common mistake
was missing out position of cash after one month. In some cases even students committed
mistake in considering the equity portion mentioned in percentage form.
Question 12
Mr. D had invested in three mutual funds (MF) as per the following details:
Particulars MF ‘A’ MF ‘B’ MF ‘C’

Amount of Investment 2,00,000 5,00,000 4,00,000
NAV at the time of purchase 10.00 25.00 20.00
Dividend Yield up to 31.03.2022 3% 5% 4%
NAV as on 31.03.2022 10.50 22.80 20.80
Annualized Yield as on 9.733% - 11.185% 15%
31.03.2022
Assume 1 Year = 365 Days.
Mr. D has misplaced the documents of his investments. You are

required to help Mr. D to find out the following:
(i) Number of units allotted in each scheme,

(ii) Value of his investments as on 31.03.2022,
P 7.14
(iii) Holding period of his investments in number of days as on 31.03.2022

(iv) Dates of original investments
(v) Total Return on investments,
(vi) Assuming past performance of all three schemes will continue for next one year, what action the
investor should take? What will be the expected return for the next one year after the above action?
(vii) Will your answer as above point no. (vi) changes if the Mutual fund charges exit load of 5% if the
investment is redeemed within one year? If so, advise the investor what and when the action to be
taken to optimise the returns. (8 Marks May ‘22)
Answer 12
(i) Number of Units in each Scheme
MF ‘A’ ` 2,00,000
= 20,000
` 10.00
MF ‘B’ ` 5,00,000
= 20,000
` 25.00
MF ‘C’ ` 4,00,000
= 20,000
` 20.00
(ii) Value of Investment on 31.03.2022
MF ‘A’ = 20,000 x ` 10.50 ` 2,10,000
MF ‘B’ = 20,000 x ` 22.80 ` 4,56,000
MF ‘C’ = 20,000 x ` 20.80 ` 4,16,000
Total ` 10,82,000
(iii) Yield on each Fund

Capital Yield Dividend Yield Total Yield (%)
MF ‘A’ ` 2,10,000 - ` 2,00,000 ` 6,000 ` 16,000.00 8.00
= ` 10,000
MF ‘B’ ` 4,56,000 - ` 5,00,000 ` 25,000 - ` 19,000.00 -3.80
= - ` 44,000
MF ‘C’ ` 4,16,000 - ` 4,00,000 ` 16,000 ` 32,000.00 8.00
= ` 16,000
Total ` 29,000.00
No. of Days Investment Held
MF ‘A’ MF ‘B’ MF ‘C’

Period of Holding
(Days) 8.00 G3.80 8.00
365 365 365
9.733 G11.185 15.00
= 300 Days = 124 Days = 195 Days
(iv) Date of Original Investment 04.06.21 27.11.21 17.09.21
9I. , .
(v) Total Yield = 9I. , ,
X 100 =2.636%
P 7.15
(vi) If past of all three schemes will continue for next one year, the investor should redeem the units
of MFs ‘A’ and ‘B’ and invest the proceeds in MF ‘C’. The expected return next will be 15%.
(vii) If the Mutual funds are charging exit load of 5%, if investment is redeemed within one year,
then investor should get redeemed units of MF ‘B’ now and units of MF ‘A’ after 65 days.
Question 13
A mutual fund made an issue of New Fund Offer (NFO) on 01/01/2021 of 10.00 Lakh Units of ` 10 each.
No entry load was charged. It made the following investments:
Particulars (`)
25,000 Equity Shares of XYZ Ltd., ` 100 each @ ` 320 80,00,000
5% Government Securities 4,00,000
10% NCDs Unlisted 5,00,000
8% Listed Debentures 10,00,000
During the year, dividends of ` 8.00 lakhs were received on equity shares. Interest on all types of debt
securities were received. On 31st December 2021 equity shares were appreciated by 15% while listed
debentures were quoted at 20% premium. XYZ Ltd., on 15th December 2021 in its AGM declared the
interim dividend of 10% and bonus shares at 1:10 with the record date of 28th December 2021.
(i) Find out the NAV per unit as on 31st December given that the operating expenses paid during the year
amounting to ` 3,00,000.
(ii) Find out the NAV, if the MF had distributed a dividend of, ` 0.50 per unit during the year to the investors.
(iii) If you are the investor, find out what is the annualised return you have got. (8 Marks May ‘22)
Answer 13
In order to find out the NAV, the cash balance at the end of the year is calculated as follows-
Particulars `
Cash balance in the beginning
(` 100 lakhs – ` 99 lakhs) 1,00,000
Dividend Received 8,00,000
Interest on 5% Govt. Securities 20,000
Interest on 10% NCDs 50,000
Interest on 8% Debentures 80,000
Interim Dividend 2,50,000
13,00,000
(-) Operating expenses 3,00,000
Net cash balance at the end 10,00,000
Calculation of NAV `
Cash Balance 10,00,000
5% Govt. Securities (at par) 4,00,000
27,500 equity shares @ ` 368 each 1,01,20,000
10% NCDs (Unlisted) at cost 5,00,000
8% Debentures @ 120% 12,00,000
Total Assets 1,32,20,000
No. of Units 10,00,000
P 7.16
NAV per Unit ` 13.22

(ii) Calculation of NAV, if dividend of ` 0.50 is paid –
Net Assets (` 1,32,20,000 – ` 5,00,000) ` 1,27,20,000
No. of Units 10,00,000
NAV per unit ` 12.72
(iii) Annualized Return

. .
= .
×100 = 32.20%
Or
J . . K .
= .
X 100 = 32.20%
Question 14
Ms. Sreenidhi is learning the portfolio management techniques and wants to test one of the techniques
she has developed on KIFS Equity Fund and compare the gains and losses from the technique with those
from a passive buy and hold strategy.
The KIFS Equity Fund consists of equities only and the ending NAVs of the fund she constructed for the
last 10 months are given below:
Month Ending NAV (₹/unit)

Jan-22 100
Feb-22 78
Mar-22 92
Apr-22 86
May-22 102
Jun-22 98
Jul-22 100
Aug-22 102
Sep-22 118
Oct-22 120
Assume
(i) Sreenidhi had invested a notional amount of ₹ 5 lakhs equally in the equity fund and a conservative
portfolio (of bonds) in the beginning of January 2022 and the total portfolio was being rebalanced
each time the NAV of the fund increased or decreased by 15% compared to the NAV of previous
month.
(ii) There is no income earned from the conservative portfolio during the period.
(iii) There is no taxation and entry/exit loads.
(i) Value of the portfolio for each level of NAV following the Constant Ratio Plan.
(ii) Whether there are any errors in the technique developed by Sreenidhi? If so briefly explain.
(8 Marks Nov 22)

P 7.17
Answer 14
(i) Constant Ratio Plan:
Stock Value of Value of Total value of Revaluation Total No. of
Portfolio Conservative aggressive Constant Action units in
NAV Portfolio Portfolio Ratio Plan aggressive
(₹) (₹) (₹) (₹) portfolio
100 2,50,000.00 2,50,000.00 5,00,000.00 - 2500
78 2,50,000.00 1,95,000.00 4,45,000.00 - 2500
2,22,500.00 2,22,500.00 4,45,000.00 Buy 352.56 2852.56
units
92 2,22,500.00 2,62,435.52 4,84,935.52 - 2852.56
2,42,467.76 2,42,467.76 4,84,935.52 Sell 217.04 2635.52
units
86 2,42,467.76 2,26,654.72 4,69,122.48 - 2635.52
102 2,42,467.76 2,68,823.04 5,11,290.80 - 2635.52
2,55,645.40 2,55,646.40 5,11,290.80 Sell 129.19 2506.33
units
98 2,55,645.40 2,45,620.34 5,01,265.74 - 2506.33
100 2,55,645.40 2,50,633.00 5,06,278.40 - 2506.33
102 2,55,645.40 2,55,645.66 5,11,291.06 - 2506.33
118 2,55,645.40 2,95,746.94 5,51,392.34 - 2506.33
2,75,696.17 2,75,696.17 5,51,392.34 Sell 169.92 2336.41
units
120 2,75,696.17 2,80,369.20 5,56,065.37 - 2336.41
Hence, the ending value of the mechanical strategy is ₹ 5,56,065.37 and buy & hold strategy is
(₹2,50,000+ 2,500 X ₹120 = ₹5,50,000)
(ii) Though the value of portfolio as per technique is lesser than Buy & Hold Strategy but there is no error
as if market has been bearish then the value of much lesser under Buy & Hold Strategy.

P 8.1
Chapter 8
Derivative Analysis and Valuation
Question 1
Discuss what you understand about Embedded Derivatives. (5 Marks May ‘18)
Answer 1
Embedded Derivatives: A derivative is defined as a contract that has all the following characteristics:
 Its value changes in response to a specified underlying, e.g. an exchange rate, interest rate or
share price;
 It requires little or no initial net investment;
 It is settled at a future date;
 The most common derivatives are currency forwards, futures, options, interest rate swaps
etc.
An embedded derivative is a derivative instrument that is embedded in another contract - the host contract.
The host contract might be a debt or equity instrument, a lease, an insurance contract or a sale or purchase
contract.
Derivatives require to be marked-to-market through the income statement, other than qualifying
hedging instruments. This requirement on embedded derivatives are designed to ensure that mark-to-
market through the income statement cannot be avoided by including - embedding - a derivative in
another contract or financial instrument that is not marked-to market through the income statement.
An embedded derivative can arise from deliberate financial engineering and intentional shifting of certain
risks between parties. Many embedded derivatives, however, arise inadvertently through market practices
and common contracting arrangements. Even purchase and sale contracts that qualify for executory
contract treatment may contain embedded derivatives. An embedded derivative causes modification to a
contract's cash flow, based on changes in a specified variable.
Overall performance was of average level as most of the examinees have shown lack of conceptual
clarity.
Question 2
Mr. KK purchased a 3-month call option for 100 shares in PQR Ltd. at a premium of Rs. 40 per
share, with an exercise price of Rs. 560. He also purchased a 3-month put option for 100 shares of the
same company at a premium of Rs. 10 per share with an exercise price of Rs. 460. The market price of
the share on the date of Mr. KK's purchase of options, is Rs. 500. Compute the profit or loss that Mr.
KK would make assuming that the market price falls to Rs. 360 at the end of 3 months. (4 Marks
May ‘18)
Answer 2
Since the market price at the end of 3 months falls to Rs. 360 which is below the exercise price under
the call option, the call option will not be exercised. Only put option becomes viable.
Rs.
The gain will be:
Gain per share (Rs.460 – Rs. 360) 100
Total gain per 100 shares 10,000
Cost or premium paid (Rs. 40 x 100) + (Rs. 10 x 100) 5,000
Chapter 8 Derivative Analysis & Valuation
P 8.2
Net gain 5,000
In this question overall performance was above average and proved to be scoring.
Question 3
The equity share of SSC Ltd. is quoted at Rs. 310. A three month call option is available at a premium of
Rs. 8 per share and a three month put option is available at a premium of Rs. 7 per share.
Ascertain the net payoffs to the option holder of a call option and a put option, considering that:
(i) the strike price in both cases is Rs. 320; and

(ii) the share price on the exercise day is Rs. 300, 310, 320, 330 and 340.
Also indicate the price range at which the call and the put options may be gainfully exercised.(8 Marks
Nov ‘18)
Answer 3
Net payoff for the holder of the call option
(Rs.)
Share price on exercise day 300 310 320 330 340
Option exercise No No No Yes Yes
Outflow (Strike price) Nil Nil Nil 320 320
Out flow (premium) 8 8 8 8 8
Total Outflow 8 8 8 328 328
Less inflow (Sales proceeds) - - - 330 340
Net payoff -8 -8 -8 2 12
Net payoff for the holder of the put option
Share price on exercise day 300 310 320 330 340

Option exercise Yes Yes No No No
Inflow (strike price) 320 320 Nil Nil Nil
Less outflow (purchase price) 300 310 - - -
Less outflow (premium) 7 7 7 7 7
Net Payoff 13 3 -7 -7 -7
The Call Option can be exercised gainfully for any price above Rs. 328 and Put Option for any Price below
Rs. 313.
Question 4
Mr. John established the following spread on the TTK Ltd.'s stock:
1. Purchased one 3-month put option with a premium of Rs. 15 and an exercise price of Rs. 900.
2. Purchased one 3-month call option with a premium of Rs. 90 and an exercise price of Rs. 1100.
TTK Ltd.'s stock is currently selling) at Rs. 1000. Calculate gain or loss, if the price of stock of
TTK Ltd. –
(i) Remains at Rs. 1000 after 3 months.

P 8.3
(ii) Falls to Rs. 700 after 3 months.

(iii) Raises to Rs. 1200 after 3 months.
Assume the size of option is 200 shares of T T K Ltd. (8 Marks May ‘19)
Answer 4
(i) Total premium paid on purchasing a call and put option
= (Rs. 15 per share × 200) + (Rs. 90 per share × 200).
= Rs. 3,000 + Rs. 18,000 = Rs. 21000
In this case, Mr. John exercises neither the call option nor the put option as both will result
in a loss for him.
Ending value = – Rs. 21000 + zero gain = - Rs. 21000
i.e. Net loss = Rs. 21000
(ii) Since the price of the stock is below the exercise price of the call, the call will not be
exercised. Only put is valuable and is exercised.
Net Gain = (Exercise Price – Current Price) x No of Shares – Premium Paid Total
premium paid = Rs. 21000
Ending value = – Rs. 21000 + Rs. [(900 – 700) × 200] = Rs. 19,000
∴ Net gain = Rs. 19,000
(iii) In this situation, the put is worthless, since the price of the stock exceeds the put’s
exercise price. Only call option is valuable and is exercised. Total
premium paid = Rs. 21000
Ending value = – Rs. 21000 + Rs. [(1200 – 1100) × 200] = -Rs. 1000
Net Loss = Rs. 1,000
Overall performance of the examinees was very good as it was well attempted by most
of the examinees. Though some examinees calculated the profit/loss on Call/Put
separately and ignored the fact that it is a combination.
Question 5
A Rice Trader has planned to sell 22000 kg of Rice after 3 months from now. The spot price of the Rice
is Rs. 60 per kg and 3 months future on the same is trading at Rs. 59 per kg. Size of the contract is
1000 kg. The price is expected to fall as low as Rs. 56 per kg, 3 months hence. What the trader can do to
mitigate its risk of reduced profit? If he decides to make use of future market, what would be the
effective realized price for its sale when after 3 months, spot price is Rs. 57 per kg and future contract
price for 3 months is Rs. 58 per kg? (8 Marks May ‘19)
Answer 5
In order to hedge its position trader would go short on future at current future price of Rs. 59/kg. This will
help the trade to realize sure Rs. 59 per kg. after 3 months.
Particulars
(a) Quantity of Rice to be hedged 22000 kg.
(b) Contract Size 1000 kg.
(c) No. of Contracts to be sold (a/b) 22
(d) Future Price Rs. 59/kg.
P 8.4
(e) Exposure in the future market (a x d) Rs. 12,98,000

After 3 months, trader would cancel its position in the future by buying a future contract of same
quantity and will sell Rice in the spot market and position shall be as follows:
Particulars Rs.
(a) Price of Future Contract 58/kg.
(b) Amount bought = 22000 x 58 12,76,000
(c) Gain(Loss) on future position (12,98,000 – 12,76,000) 22,000
(d) Spot Price 57/kg
(e) Amount realized by selling in the spot market (22000 x 57) 12,54,000
(f) Effective Selling Amount (c + e) 12,76,000
(g) Effective Selling Price (12,76,000/22000) 58/kg.
Question on derivatives were solved by a good number of examinees and their

performance was above average. However, some examinees were unable to understand
the difference between Spot market & Futures market.
Question 6
A future contract is available on R Ltd. that pays an annual dividend of Rs. 4 and whose stock is currently
priced at Rs. 125. Each future contract calls for delivery of 1,000 shares to stock in one year, daily
marking to market. The corporate treasury bill rate is 8%.
Required:
(i) Given the above information, what should the price of one future contract be ?
(ii) If the company stock price decreases by 6%, what will be the price of one futures contract ?
(iii) As a result of the company stock price decrease, will an investor that has a long position in one
futures contract of R Ltd. realizes a gain or loss ? What will be the amount of his gain or loss ?
(Ignore margin and taxation, if any) (6 Marks Nov ‘19)
Answer 6
(i) Future Price = Spot + Cost of Carry – Dividend
= Rs. 125 + (Rs. 125 x 0.08) – 4 = Rs. 131
Price of one future contract = 1000 share x Rs. 131 = Rs. 1,31,000
(ii) Price decrease by 6 %
Market Price = 125 x 94% = 117.50 Then, price
of one future contract
= Rs. 117.50 + (Rs. 117.50 x 0.08) – 4 = Rs. 122.90
= Rs. 122.90 x 1000 = Rs. 1,22,900
(iii) If the investor has taken a long position, decrease in price will result in loss for the investor.
Amount of loss will be:
Rs. 1, 31,000 - Rs. 1,22,900 = Rs. 8,100
Average performance was observed in this question due to lack of clarity about how to approach
the question and committed mistakes
Chapter 8inDerivative
the calculations.
Analysis & Valuation
P 8.5
Question 7
AB Ltd.'s equity shares are presently selling at a price of Rs. 500 each. An investor is interested in
purchasing AB Ltd.'s shares. The investor expects that there is a 70% chance that the price will go up to
Rs. 650 or a 30% chance that it will go down to Rs. 450, three months from now. There is a call option
on the shares of the firm that can be exercised only at the end of three months at an exercise price of
Rs. 550.
Calculate the following:
(i) If the investor wants a perfect hedge, what combination of the share and option should he
select ?
(ii) Explain how the investor will be able to maintain identical position regardless of the share
price.
(iii) If the risk-free rate of return is 5% for the three months period, what is the value of the option
at the beginning of the period ?
(iv) What is the expected return on the option? (8 Marks Nov ‘19)
Answer 7
(i) To compute perfect hedge we shall compute Hedge Ratio (∆) as follows:
∆= = = =0.50
The investor should purchase 0.50 share for every 1 call option Or, the
investor should purchase 1 share for eve ry 2 Call Option.
(ii) How the investor will be able to maintain his position if he purchase 0.50 share for 1 call
option written.
(a) If price of share goes upto Rs. 650 then value of purchased share will be:
Sale Proceeds of Investment (0.50 x Rs. 650) Rs. 325

Loss on account of Short Position (Rs. 650 – Rs. 550) Rs. 100
Rs. 225
(b) If price of share comes down to Rs. 450 then value of purchased share will be:
Sale Proceeds of Investment (0.50 x Rs. 450) Rs. 225
(iii) The Value of Option, say, P at the beginning of the period shall be computed as follows:
(Rs. 250 – P) 1.05 = Rs. 225
Rs. 262.50 – 1.05P = Rs. 225
Rs. 37.5 = 1.05P P = Rs. 35.71
(iv) Expected Return on the Option
Expected Option Value = (Rs. 650 – Rs. 550) × 0.70 + Rs. 0 × 0.30 = Rs.70
.
Expected Rate of Return = .
100 = 96.02%
In this question overall performance was below average as majority of examinees could not arrive
at the correct value of option and hence failed to calculate expected returns. However, most of
them examinees have correctly arrived at the estimated option value.

P 8.6
Question 8
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 Rs. 98. The
current price of the stock is Rs. 100. Risk free return is 5 per cent per annum with a continuous
compounding and e0·05 = 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 Nov ‘20)
Answer 8
(i) Using the single period model, the probability of price moving up is
. .
P= = = = 0.779 say 0.78 i.e. 78%
.
Therefore, the probability of price moving down = 1 - 0.78 = 0.22 i.e. 22%
(ii) Expected pay-off at Node N2
. . . . .
.
= .
= Rs.14.79
Node N3
. . . .
.
= .
= Rs.3.41
Node N1
. . . . .
.
= .
= Rs.11.69
Question 9
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:

P 8.7
Day 1 2 3 4 5
Settlement Price (Rs.) 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 Jan ‘21)
Answer 9
(i) Contract Size (Rs. 9,170 x 50) = Rs. 4,58,500
Initial Margin (8% of 4,58,500) = Rs. 36,680
Maintenance Margin (6% of 4,58,500) = Rs. 27,510
(1) For investor taken Long position:
Day Change in Future value (Rs.) Margin Call
A/c Money
(Rs.) (Rs.)
0 ----- 36,680
1 (Rs. 9,380 - Rs. 9,170) x 50 = 10,500 47,180
2 (Rs. 9,520 - Rs. 9,380) x 50 = 7,000 54,180
3 (Rs. 9,100 - Rs. 9,520) x 50 = - 21,000 33,180
4 (Rs. 8,960 - Rs. 9,100) x 50 = - 7,000 36,680
10,500
5 (Rs. 9,140 - Rs. 8,960) x 50 = 9,000 45,680
(2) For investor taken Short position:
Day Change in Future value (Rs.) Margin Call
A/c Money
(Rs.) (Rs.)
0 ----- 36,680
1 (Rs. 9,170 - Rs. 9,380) x 50 = - 36,680 10,500
10,500
2 (Rs. 9,380 - Rs. 9,520) x 50 = -7,000 29,680
3 (Rs. 9,520 - Rs. 9,100) x 50 = 21,000 50,680
4 (Rs. 9,100 - Rs. 8,960) x 50 = 7,000 57,680
5 (Rs. 8,960 - Rs. 9,140) x 50 = -9,000 48,680
(ii) Calculation of Net Profit/Loss

(1) Long Position
(Rs.)
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 = (Rs. 1,500)

P 8.8
(2) Short Position

(Rs.)
Ending margin 48,680
Less: Initial Margin 36,680
Profit 12,000
Net Profit 1,500
OR, Profit = (9,170 – 7,040) x 50 = Rs. 1,500
Question 10
Shyam buys 10,000 shares of X Ltd., @ Rs. 25 per share and obtains a complete hedge of shorting 400
Nifty at Rs. 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 Jan ‘21)
Answer 10
Cash Outlay
= 10000 x Rs. 25 – 400 x Rs. 1,100
= Rs. 2,50,000 – Rs. 4,40,000 = - Rs. 1,90,000
Cash Inflow at Close Out
= 10000 x Rs. 25 x 0.96 - 400 x Rs. 1,100 x 0.975

= Rs. 2,40,000 – Rs. 4,29,000 = - Rs. 1,89,000
Gain/ Loss
= Rs. 1,90,000 – Rs. 1,89,000 = Rs. 1,000 (Gain)
Question 11
Following information is available for consideration:
BSE Index 25,000
Value of Portfolio ₹ 50,50,000
Risk Free Interest Rate 9% p.a.
Dividend yield on Index 6% p.a.
Beta of portfolio 1.5
We assume that a future contract on the BSE Index with 4 months maturity is used to hedge the value
of portfolio over next 3 months. One future contract is for delivery of 50 times the index.
Based on the above information, calculate:
(i) Price of future contract.

(ii) The gain on short futures position if index turns out to be 22,500 in three months.
(8 Marks July 21)

P 8.9
Answer 11
(i) Current future price of the index = 25,000 + 25,000 (0.09 - 0.06) 4 / 1 2
= 25,000 + 250 = ₹ 25,250

∴ Price of the future contract = ₹ 50 х 25,250 = ₹ 12,62,500
(ii) Hedge ratio = 50,50,000 / 12,62,500 X 1.50 = 6 contracts
Index after three months turns out to be 22,500
Future price will be = 22,500 + 22,500 (0.09-0.06) × 1/12 = 22,556.25
Therefore, gain from the short futures position is = 6 х (25,250 – 22,556.25) х 50
= ₹ 8,08,125
Alternative Solution: If daily compounding (exponential) formula is used.
Current future price of the index = 25,000 x e (0.09-0.06) x (4/12)
= 25,000 x 1.010050 = 25,251.25

∴ Price of the future contract = ₹ 50 х 25,251.25 = ₹ 12,62,562.50
(ii) Hedge ratio = 50,50,000 / 12,62,562.50 1.50 = 6 contracts

Index after three months turns out to be 22,500
Future price will be = 22,500 x e (0.09-0.06) x (1/12) = 22,500 x 1.002503 = 22,556.32
Therefore, Gain from the short futures position is = 6 х (25,251.25 – 22,556.32) х 50

= ₹ 8,08,479
Average performance has been observed in this question based on Index Futures as mistakes
have been noticed in the calculation of Future Price and number of contracts required to
hedge the value of the Portfolio.
Question 12
On 31/08/2021 Mr. R has taken a Long position of Two lots of Nifty Futures at 17300. One lot of Nifty
future is 50 units. Initial Margin required is 10% of Contract Value. Maintenance Margin required is 80%
of Initial Margin. The closing price of 5 days are given below-
Date Closing Price of Nifty Future
01/09/2021 17340
02/09/2021 17180
03/09/2021 16990
06/09/2021 16900
P 8.10
07/09/2021 17120
You are required to-
(i) Prepare a statement showing the daily balances in the margin account & payment on
margin calls, if any.
(ii) Compute the Gain or Loss of Mr. R, if contract squared off on 07/09/2021 .
(iii) What would be the Gain or Loss if Mr. R, had taken the short position?(8 Marks Dec ‘21)
Answer 12
Contract Size (₹ 17,300 x 50 x 2) = ₹ 17,30,000

Initial Margin (10% of 17,30,000) = ₹ 1,73,000
Maintenance Margin (80% of 1,73,000) = ₹ 1,38,400
Statement showing the daily balances in Margin A/c and margin call if any,
Day Change in Future value (₹) Margin A/c Call Money
(₹) (₹)
31/08/21 ----- 1,73,000 -----
01/09/21 (₹ 17,340 - ₹ 17,300) x 50 x 2 = 4,000 1,77,000 -----
02/09/21 (₹ 17,180 - ₹ 17,340) x 50 x 2 = -16,000 1,61,000 -----
03/09/21 (₹ 16,990 - ₹ 17,180) x 50 x 2 = - 19,000 1,42,000 -----
06/09/21 (₹ 16,900 - ₹ 16,990) x 50 x 2 = - 9,000 1,73,000 40,000
07/09/21 (₹ 17,120 - ₹ 16,900) x 50 x 2 = 22,000 1,95,000 -----
(ii) Gain or Loss of Mr. R squared off position on 07/09/21
(₹)
Ending margin 1,95,000
Less: Initial Margin 1,73,000
Profit 22,000
Net Loss (18,000)
(iii) Gain/ Loss if Mr. R has taken Short Position
Day Change in Future value (₹) Margin A/c Call Money
(₹) (₹)
31/08/21 ----- 1,73,000 -----
01/09/21 (₹ 17,300 - ₹ 17,340) x 50 x 2 = - 4,000 1,69,000 -----
02/09/21 (₹ 17,340 - ₹ 17,180) x 50 x 2 = 16,000 1,85,000 -----
03/09/21 (₹ 17,180 - ₹ 16,990) x 50 x 2 = 19,000 2,04,000 -----
06/09/21 (₹ 16,990 - ₹ 16,900) x 50 x 2 = 9,000 2,13,000 -----
07/09/21 (₹ 16,900 - ₹ 17,120) x 50 x 2 = - 22,000 1,91,000 -----
Profit or Loss on Short Position
(₹)
Ending margin 1,91,000
Less: Initial Margin 1,73,000
Profit 18,000

P 8.11
While above average performance has been observed in this question on Index Futures but only
some students could compute call money correctly. Even some students could not show
calculation of Margin Call properly. Further some student even ignored existence two lots in
their calculation.
Question 13
On 1st July 2021 Mr. P has made the following investment:
Name of No. of Equity Beta Purchase Price per
Company Share Value Equity Share
ML Ltd 1000 1.25 ₹ 700
He wants to hold the investment till end of September 2021 with an expectation of huge dividends to
be announced in the AGM. On the date of investment, September Nifty Futures are quoting at 175000
and tradeable with lot size of 50 for each contract.
You are the Investment advisor to Mr. P,
(i) Please advise Mr. P how to hedge his market exposure using the available data.
(ii) Calculate the profit or loss of Mr. P during the expiry of September 2021 futures in
following situation:
(a) Nifty Future rise by 10%
(b) ML Ltd. falls by 5%
(iii) Is it possible stock as well as nifty to raise or fall at the same percentage? Please state
the reason. (8 Marks Dec ‘21)
Answer 13
(i) To hedge his market exposure Mr. P should take short position in the Nifty Futures.
No. of Contract of Nifty Future to be Short = 1.25 × Rs. 700 × 1,000 / 17,500 × 50 = 1
(ii) a. Profit or loss of Mr. P during the expiry of September 2021 Futures:
Particulars If Nifty rises by 10%
Loss on Nifty Futures (17,500 x 50 x 0.10) ₹ 87,500
Gain on Stock of ML Ltd. (1.25 x 0.10 x ₹ ₹ 87,500
7,00,000)
Net Gain/ (Loss) Nil
b. Profit or loss of Mr. P during the expiry of September 2021 Futures:
Particulars If ML Ltd. falls by 5%
Gain on Nifty Futures (17,500 x 50 x 0.05)/1.25 ₹ 35,000
Gain on Stock of ML Ltd. (0.05 x ₹ 7,00,000) ₹ 35,000
Net Gain/ (Loss) Nil
(iii) Normally it is not possible that Nifty to rise or fall by same percentage because of
systematic risk i.e. Beta may not be the same as of market.
Average performance has been observed in this question on Derivatives as most of the students
have committed error in computing final part of the answer.
P 8.12
Question 14
You had purchased a 3 month call option on the Equity shares of Satya Ltd for a premium of ₹ 30 each,
the current market price of the share is ₹ 560 and the exercise price is ₹ 590. You expect the price range
between ₹ 540 to ₹ 640.
The expected share price of Satya Ltd and related probability is given below:
Expected price (₹) 540 560 580 600 620 640

Probability 0.10 0.15 0.05 0.35 0.20 0.15
Compute the followings:
(i) Expected share price at the end of 3 months,
(ii) Value of call option at the end of 3 months, if the exercise price prevails,
(iii) In case the option is held to its maturity, what will be the expected value of the call option?
(iv) Find out the price of the shares quoted at the stock exchange to get the value of the call option
as computed in (iii) above. (8 Marks May ‘22)
Answer 14
(i) Expected Share Price
= ₹ 540 X 0.10 + ₹ 560 X 0.15 + ₹ 580 X 0.05 + ₹ 600 X 0.35 + ₹ 620 X 0.20 + ₹ 640 X 0.15
= ₹ 54 + ₹ 84 + ₹ 29 + ₹ 210 + ₹ 124 + ₹ 96 = ₹ 597
(ii) Value of Call Option
= ₹ 590 - ₹ 590 = Nil
(iii) If the option is held till maturity the expected Value of Call Option
Expected Value of call (C) Probability (P) Expected Value of
price (X) Option
₹ 540 0 0.10 0
₹ 560 0 0.15 0
₹ 580 0 0.05 0
₹ 600 ₹ 10 0.35 ₹ 3.50
₹ 620 ₹ 30 0.20 ₹ 6.00
₹ 640 ₹ 50 0.15 ₹ 7.50
Total ₹ 17.00
Alternatively, it can also be calculated as follows:
Expected price Exercise price (E) Probability (P) Expected Value of Option CP
(X) (X – E) X P
₹ 540 ₹ 590 0.10 Not Exercised*
₹ 560 ₹ 590 0.15 Not Exercised*
₹ 580 ₹ 590 0.05 Not Exercised*
₹ 600 ₹ 590 0.35 ₹ 3.50
₹ 620 ₹ 590 0.20 ₹ 6.00
₹ 640 ₹ 590 0.15 ₹ 7.50
Total ₹ 17.00
* If the stock price goes below ₹ 590, option is not exercised at all.
(iv) Price to be quoted at the stock exchange to get the value of the call option
P 8.13
₹ 590 + ₹ 17 = ₹ 607
Question 15
Details about long term portfolio of shares of an investor is as below:
Shares No. of shares Market Price per Beta

(Lakh) share
K Ltd. 6 250 1.4
L Ltd. 8 375 1.2
M Ltd. 4 125 1.6
The investor thinks that the risk of portfolio is very high and wants to reduce the portfolio beta to 0.91.
He is considering below mentioned alternative strategies:
(i) Dispose a part of his existing portfolio to acquire risk free securities, or
(ii) Take appropriate position on Nifty Futures which are currently traded at 16250 and each Nifty
points is worth ₹100.
(i) portfolio beta,

(ii) the value of risk-free securities to be acquired,
(iii) the number of shares of each company to be disposed off,
(iv) the number of Nifty contracts to be bought/sold,
(v) the value of portfolio beta for 1% rise in Nifty. (8 Marks Nov 22)
Answer 15
Shares No. of shares Market (1)× (2) % to ß (x) w*x

(lakhs) (1) Price of Per (₹ lakhs) total
Share (2) (w)
K Ltd. 6.00 250.00 1,500.00 0.30 1.40 0.42

L Ltd. 8.00 375.00 3,000.00 0.60 1.20 0.72
M Ltd. 4.00 125.00 500.00 0.10 1.60 0.16
5,000.00 1.00 1.30
(i) Portfolio beta 1.30
(ii) 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.
(iii) Number of shares of each company to be disposed off
Shares % to Proportionate Market Price No. of Shares to be
total (w) Amount (₹ lakhs) Per Share (b) disposed off (Lakh)
(a) (a/b)
K Ltd. 0.30 450.00 250.00 1.80
P 8.14
L Ltd. 0.60 900.00 375.00 2.40

M Ltd. 0.10 150.00 125.00 1.20
(iv) Number of Nifty Contract to be sold
. . !"
,
= 120 contracts
(v) 1% rises in Nifty is accompanied by 1% x 1.30 i.e. 1.30% rise for portfolio of shares
₹ Lakh
Current Value of Portfolio of Shares 5,000
Value of Portfolio after rise 5,065
Mark-to-Market Margin paid (16250 × 0.01 × ₹ 100 × 120) 19.50
Value of the portfolio after rise of Nifty 5,045.50
% change in value of portfolio (5,045.50 – 5,000)/ 5,000 0.91%
% rise in the value of Nifty 1%
Beta 0.91

P 9.1
Chapter 9
Foreign Exchange Exposure & Risk Management
Question 1
Following information is given:
Exchange rates: Canadian dollar 0.666 per DM (spot) Canadian dollar 0.671 per DM (3-months) Interest
rates: DM 7.5% p.a. Canadian Dollar - 9.5% p.a. To take the possible arbitrage gains, what operations
would be carried out? (8 Marks May ‘18)
Answer 1
In this case, DM is at a premium against the Can$.
Premium = [(0.671 – 0.666) /0.666] x (12/3) x 100 = 3.00 per cent
Interest rate differential = 9.5% - 7.5% = 2 per cent.
Since the interest rate differential is smaller than the premium, it will be profitable to place money in
Deutschmarks the currency whose 3-months interest is lower.
The following operations are carried out:
(i) Borrow Can$ 1000 at 9.5 per cent for 3- months;
(ii) Change this sum into DM at the spot rate to obtain DM
= (1000/0.666) = 1501.50
(iii) Place DM 1501.50 in the money market for 3 months to obtain a sum of DM Principal:
1501.50
Add: Interest @ 7.5% for 3 months = 28.15
Total 1529.65
(iv) Sell DM at 3-months forward to obtain Can$= (1529.65x0.671) = 1026.40
(v) Refund the debt taken in Can$ with the interest due on it, i.e.,
Can$
Principal 1000.00
Add: Interest @ 9.5% for 3 months 23.75
Total 1023.75
Net arbitrage gain = 1026.40 – 1023.75 = Can$ 2.65
Note: The students may use any quantity of currency to arrive at the arbitrage gain since no
specific amount is mentioned in the question.
Overall performance was above average although some examinees could not understand the
question properly.
Question 2
A dealer in foreign exchange has the following position in Swiss Francs on 31 st January, 2018:
(Swiss Francs)
Balance in the Nostro A/c Credit 1,00,000
Opening Position Overbought 50,000
Chapter 9 Foreign Exchange Exposure & Risk Management
P 9.2
Purchased a bill on Zurich 70,000

Sold forward TT 49,000
Forward purchase contract cancelled 41,000
Remitted by TT 75,000
Draft on Zurich cancelled 40,000
Examine what steps would the dealer take, if he is required to maintain a credit balance of
Swiss Francs 30,000 in the Nostro A/c and keep as overbought position on Swiss Francs
10,000?(8 Marks Nov ‘18 )
Answer 2
New bond
(i) Interest cost before tax (0.12 3 crores) 36,00,000

Less tax @ 40% 14,40,000
After tax interest 21,60,000
(ii) Tax savings from amortisation of
floatation cost (0.4 4,25,000/25) (6,800)
Annual after tax payment under new Bond 21,53,200

(B)
Annual Cash Flow Saving (A) – (B) 3,49,600
(a) Exchange Position:
Particulars Purchase Sw. Fcs. Sale Sw. Fcs.
Opening Balance Overbought 50,000
Bill on Zurich 70,000
Forward Sales – TT 49,000
Cancellation of Forward Contract 41,000
TT Sales 75,000
Draft on Zurich cancelled 40,000 —
1,60,000 1,65,000
Closing Balance Oversold 5,000 —
1,65,000 1,65,000
Cash Position (Nostro A/c)
Credit Debit
Opening balance credit 1,00,000 —
TT sales — 75,000
1,00,000 75,000
Closing balance (credit) — 25,000
1,00,000 1,00,000
The Bank has to buy spot TT Sw. Fcs. 5,000 to increase the balance in Nostro account to Sw. Fcs. 30,000.
This would bring down the oversold position on Sw. Fcs. as Nil.
Since the bank requires an overbought position of Sw. Fcs. 10,000, it has to buy forward Sw. Fcs.
10,000.
P 9.3
Question 3
On 19th January, Bank A entered into forward contract with a customer for a forward sale of US $
7,000, delivery 20th March at Rs. 46.67. On the same day, it covered its position by buying forward
from the market due 19th March, at the rate of Rs. 46.655. On 19th February, the customer
approaches the bank and requests for early delivery of US $. Rates prevailing in the interbank markets
on that date are as under:
Spot (Rs./$) 46.5725/5800
March 46.3550/3650
Interest on outflow of funds is 16% and on inflow of funds is 12%. Flat charges for early delivery are
Rs. 100.
What is the amount that would be recovered from the customer on the transaction?
Note: Calculation should be made on months basis than on days basis. (8 Marks Nov ‘18)
Answer 3
The bank would sell US $ to its customer at the agreed rate under the contract. However, it would
recover loss from the customer for early delivery.
On 19th February bank would buy US$ 7000 from market and shall sell to customer. Further, Bank would
enter into one month forward contract to sell the US $ acquired under the cover deal.
(i) Swap Difference
Bank sells at Rs. 46.3550

Bank buys at Rs. 46.5800
Swap loss per US $ 0.225
Swap loss for US $ 7000 Rs. 1,575
(ii) Interest on Outlay of Funds
On 19th February, Bank sell to customer Rs. 46.67

It buys from spot Market Rs. 46.58
Inflow of funds per US $ Rs. 0.09
Inflow of funds for US $ 7000 is Rs. 630
Interest on Rs. 630 at 12% for one month Rs. 6.30
(iii) Charges for early delivery
Swap loss Rs. 1,575.00

Flat charges Rs. 100.00
Less: Interest on outflow of funds Rs. 6.30
Rs. 1,668.70
Total amount to be recovered from the customer
Amount as per Forward Contract Rs. 46.67 x 7000 Rs. 3,26,690.00

Add: Charges for early delivery Rs. 1,668.70
Rs. 3,28,358.70

P 9.4
Question 4
On 1st January 2019 Global Ltd., an exporter entered into a forward contract with BBC Bank to sell US$
2,00,000 on 31st March 2019 at Rs. 71.50/$. However, due to the request of the importer, Global Ltd.
received the amount on 28 February 2019. Global Ltd. requested the Bank to take delivery of the
remittance on 2nd March 2019. The Inter- banking rates on 28th February were as follows:
Spot Rate Rs. 71.20/71.25

One month premium 5/10
If Bank agrees to take early delivery then what will be the net inflow to Global Ltd. assuming that the
prevailing prime lending rate is 15%. Assume 365 days in a year.(8 Marks May ‘19)
Answer 4
On 28th February 2019 bank would purchase form the exporter US$ 200000 at the agreed rate i.e. Rs.
71.50/$. However, bank will charge for this early delivery consisting of Swap Difference and Interest on
outlay of funds.
(i) Swap Difference

Bank sells at Rs. 71.20
It buys at Rs. 71.35
Swap loss per US$ Rs. 0.15 Swap loss for $
200000 is Rs. 30,000
(ii) Interest on Outlay of funds
On February Bank sell $ in Market Rs. 71.20 Bank buys from
customer Rs. 71.50
Outlay per US $ Rs. 0.30
Outlay of funds for US$ 200000 Rs. 60,000
Interest of outlay of funds on Rs. 60,000 for 31 days (1st March 2019 to 31st March 2019)
at 15% p.a. i.e. Rs. 764
(iii) Charges for early delivery
Swap Loss Rs. 30,000
Interest on Outlay of Funds Rs. 764
Rs. 30,764
(iv) Net Inflow to Global Ltd.
Proceed of US $ 200000@Rs. 71.50 Rs. 1,43,00,000
Less: Charges for early delivery Rs. 30,764
Net Inflow Rs. 1,42,69,236

Problem of Forex was solved well and performance of the examinees was above average in
this question. However, some examinees got confused in Sell and Buy rate. Further, many
examinees could not calculate the swap loss and the bank buy/sale rates properly. Also, the
examinees exhibit lack of knowledge about the question on early delivery. Therefore, only few
examinees could calculate the net inflow to Global Ltd. after calculating Swap difference and
interest on outlay of Funds.
P 9.5
Question 5
Sun Limited, an Indian company will need $ 5,00,000 in 90 days. In this connection, following
information is given below:
Spot Rate - $1 = Rs. 71
90 days forward rate of $1 as of today = Rs. 73

Interest Rates are as follows:
Particulars US India
90 days Deposit Rate 2.50% 4.00%
90 days Borrowing Rate 4.00% 6.00%
A call option on $ that expires in 90 days has an exercise price of Rs. 74 and a premium of
Re. 0.10. Sun Limited has forecasted the spot rates for 90 days as below:
Future Rate Probability

Rs. 72.50 25%
Rs. 73.00 50%
Rs. 74.50 25%
Which of the following strategies would be the most preferable to Sun Limited:
(i) A Forward Contract;

(ii) A Money Market hedge;
(iii) An Option Contract;
(iv) No Hedging.
Show your calculations in each case. (8 Marks May ‘19)
Answer 5
(i) Forward contract:
Rupees needed in 90 days = $5,00,000 x Rs. 73 = Rs. 3,65,00,000

(ii) Money market hedge:
Amount in $ to be invested = 5,00,000/1.0250 = Rs. 4,87,805
Amount of Rs. needed to convert into $ = 4,87,805 x 71 = Rs. 3,46,34,155 Interest
and principal on Rs. loan after 90 days
= Rs. 3,46,34,155 x 1.06 = Rs. 3,67,12,204
(iii) Call option:
Expected Prem./unit Exercise Total Total price Prob. Pi Pixi (5) x (6)
Spot rate Option price per for
(1) (2) (3) unit (4) $5,00,000 x (6) (7)
(4)
= (5)
72.50 0.10 No 72.60 3,63,00,000 0.25 90,75,000
73.00 0.10 No 73.10 3,65,50,000 0.50 1,82,75,000
74.50 0.10 Yes 74.10* 3,70,50,000 0.25 92,62,500
P 9.6
3,66,12,500
Add: Interest on Premium @ 6% (50,000 x 6%) 3,000
* (Rs. 74 + Rs. 0.10)
(iv) No hedge option:
Expected Future spot Rs. needed Prob. Pi Pi xi
rate Xi
72.50 3,62,50,000 0.25 90,62,500
73.00 3,65,00,000 0.50 1,82,50,000
74.50 3,72,50,000 0.25 93,12,500
3,66,25,000
Decision: Forward Contract Strategy is most preferable strategy because it requires the
least amount to arrange $5,00,000.
Problem of hedging in Forex was correctly solved by most of the examinees. But, Call Option could
not be calculated by many examinees.
Question 6
Following information relates to M/s A Lt d. which is a manufacturing-cum-exporting unit. It is
exporting some electronic components to Japan, USA and Europe on 90 days credit terms:
Cost and Sales Information:
Japan USA Europe

Variable cost per unit Rs. 225 Rs. 395 Rs. 510
Export sale price per unit Yen 650 $ 10.23 Euro 11.99
Receipts from sale due in Yen 78,00,000 $ 1,02,300 Euro 95920
90 days
Foreign exchange rate
information
Japan USA Europe
Yen/Re $/Re Euro/Re
Spot market 2.417-2.437 0.0214-0.0217 0.0177-0.0180
3 months forward 2.397-2.427 0.0213-0.0216 0.0176-0.0178
3 months spot 2.423-2.459 0.02144-0.02156 0.0177-0.0179
Advice the company by calculating average contribution to sales ratio whether it should hedge its
currency risk or not.(8 Marks Nov ‘19)
Answer 6
If foreign exchange risk is hedged
Total
(Rs.)
Sum due Yen 78,00,000 US$1,02,300 Euro 95,920
Unit input price Yen 650 US$10.23 Euro 11.99
Unit sold 12000 10000 8000
Variable cost per unit Rs. 225/- Rs. 395 Rs. 510
P 9.7
Variable cost Rs. 27,00,000 Rs. 39,50,000 Rs. 40,80,000 1,07,30,000

Three months forward 2.427 0.0216 0.0178
rate for selling
Rupee value of receipts Rs. 32,13,844 Rs. 47,36,111 Rs. 53,88,764 1,33,38,719
Contribution Rs. 5,13,844 Rs. 7,86,111 Rs. 13,08,764 26,08,719
Average contribution to 19.56%
sale ratio
If risk is not hedged
Rupee value of receipt Rs. 31,72,021 Rs. 47,44,898 Rs. 53,58,659 1,32,75,578
Variable cost Total 1,07,30,000
contribution 25,45,578
Average contribution to 19.17%
sale ratio
Decision: A Ltd. is advised to hedge its foreign currency exchange risk.
The overall performance of the examinees in this question has been above average. However, some
examinees made mistakes while calculating average contribution to sales. Further, few of the
examinees were unable to calculate the correct currency rates. Also, the conversion to INR was not
done properly with the result that examinees failed to arrive at rupee value of receipts,
contribution and the contribution ratio properly.
Question 7
ZX Ltd. has made purchases worth USD 80,000 on 1st May 2020 for which it has to make a payment on
1st 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 1st 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 Nov ‘20)
Answer 7
(i) If ZX Ltd. does not take forward (Unhedged Position):
Expected Rate = Rs. 77 0.15 + Rs. 71 0.25 + Rs. 79 0.20 + Rs. 74 0.40
= Rs. 11.55 + Rs. 17.75 + Rs. 15.80 + Rs. 29.60 = Rs. 74.70
Expected Amount Payable = USD 80,000 Rs. 74.70 = Rs. 59,76,000
(ii) If the ZX Ltd. hedge its position in the forward market:
Particulars Amount (Rs.)
P 9.8
If company purchases US$ 80,000 forward premium is 59,200

(80000 × 74 × 1%)
Interest on Rs. 59,200 for 6 months at 10% 2,960
Total hedging cost (a) 62,160
Amount to be paid for US$ 80,000 @ Rs. 74.00 (b) 59,20,000
Total Cost (a) + (b) 59,82,160
Advise: Since cash flow is less in case of unhedged position company should opt for the same.
Question 8
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 Nov ‘20)
Answer 8
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.
Question 9
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
Rs./USD and USD/EUR in inter-bank market are quoted as follows:
Rs./ 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 Jan ‘21)
Answer 9
P 9.9
(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
Rs./USD Rs. 67.8000
Add: Premium for 2 months Rs. 0.2100
Rs. 68.0100
Less: Exchange margin @ 0.1% Rs. 0.0680
Bid rate for USD Rs. 67.9420
USD/EUR USD 1.0775
Add: Premium USD 0.0040
USD 1.0815
Rs./EUR Rate (67.942 x 1.0815) Rs. 73.4793
Amount of Export Bill EUR 5,00,000
Less: EEFC EUR 2,50,000
EUR 2,50,000
Exchange Rate Rs. 73.4793
(ii) Cash Inflow Rs. 1,83,69,825
(iii) Interest for 80 days @ 8% Rs. 3,22,101
Question 10
XP Pharma Ltd., has acquired an export order for ` 10 million for formulations to a European company.
The Company has also planned to import bulk drugs worth ` 5 million from a company in UK. The
proceeds of exports will be realized in 3 months from now and the payments for imports will be due
after 6 months from now. The invoicing of these exports and imports can be done in any currency i.e.
Dollar, Euro or Pounds sterling at company's choice. The following market quotes are available.
Spot Rate Annualised Premium

`/$ 67.10/67.20 $ - 7%
` /Euro 63.15/63.20 Euro - 6%
` /Pound 88.65/88.75 Pound - 5%
Advice XP Pharma Ltd. about invoicing in which currency. (Calculation should be upto three decimal
places). (8 Marks July 21)
Answer 10
(i) Proceeds of Exports in INR = ` 10 Million
Position of Inflow under three currencies will be as follows:
Currency Invoice at Spot Rate Expected Rate after Conversion in INR after 3-
3-months months
$ ` 100,00,000/ ` 67.10 ` 67.10 (1 + 0.07/4) ` 68.27 x $ 149031.297
= $ 149031.297 = ` 68.27 = ` 1,01,74,367
€ ` 100,00,000/ ` 63.15 ` 63.15 (1 + 0.06/4) ` 64.10 x € 1,58,353.127
= € 1,58,353.127 = ` 64.10 = ` 1,01,50,435
£ ` 100,00,000/ ` 88.65 ` 88.65 (1 + 0.05/4) ` 89.76 x £ 1,12,803.158
= £ 1,12,803.158 = ` 89.76 = ` 1,01,25,211
(ii) Payment of Import in INR = ` 5 Million
Position of outflow under three currencies will be as follows:
P 9.10
Currency Invoice at Spot Rate Expected Rate after Conversion in INR after
6-months 6-months
$ ` 50,00,000/ ` 67.20 ` 67.20 (1 + 0.07/2) ` 69.55 x $ 74404.762
= $ 74404.762 = ` 69.55 = ` 51,74,851
€ ` 50,00,000/ ` 63.20 ` 63.20 (1 + 0.06/2) ` 65.10 x € 79,113.924
= € 79,113.924 = ` 65.10 = ` 51,50,316
£ ` 50,00,000/ ` 88.75 ` 88.75 (1 + 0.05/2) ` 90.97 x £ 56,338.028
= £ 56,338.028 = ` 90.97 = ` 51,25,070
Advice: Since cash inflow is highest (1,01,74,367) in case of $ hence invoicing for Export should be in $.
However, cash outflow is least (51,25,070) in case of £ the invoicing for import should be in
Below average performance has been observed in this question on Foreign Exchange Exposure
and Risk Management. Following common mistakes have been noticed in most of the answers:
(i) Despite the clear-cut instructions given in the question students have not calculated
rates upto 3 decimal points.
(ii) Confusion between Spot Rates and Forwards Rates.
(iii) Some students ignored difference in the timings of payment for Import bill and
realization of Export proceeds rather merged both and advised based on netting.
Question 11
A Japanese Company effected sales to X Ltd., an Indian Company, the payment being due after 3 months.
The invoice amount is JPY 216 lakhs, at today’s spot rate it is equalent to ` 50 lakhs. It is anticipated that
exchange rate will decline by 8% over the 3 months period and in order to protect the JPY payments, the
importer proposes to take appropriate action in the foreign exchange market. The 3 months forward rate
is presently quoted as JPY 4.12 per rupee. You are required to calculate the expected loss and show how
it can be hedged by a forward contract (8 Marks Dec ‘21)
Answer 11
Spot rate of ` 1 against yen = JPY 216 lakhs/ ` 50 lakhs = JPY 4.32 3 months
forward rate of Re. 1 against JPY = JPY 4.12 Anticipated
decline in Exchange rate = 8%.
Expected spot rate after 3 months = JPY 4.32 – 8% of 4.32
= JPY 4.32 – JPY 0.35
= JPY 3.97 per rupee
` (in Lakhs)
Present cost of JPY 216 Lakhs 50.00
Cost after 3 months: JPY 216 Lakhs / JPY 3.97 54.41
Expected exchange loss 4.41
If the expected exchange rate risk is hedged by a Forward contract:
` (in Lakhs)
Present cost of JPY 216 Lakhs 50.00
P 9.11
Cost after 3 months if forward contract is taken JPY 216 lakhs / 52.43
JPY 4.12
Expected exchange loss 2.43
Suggestion: If the exchange rate risk is not covered with forward contract, the expected exchange
loss is ` 4.41 Lakhs. This could be reduced to ` 2.43 Lakhs if it is covered with Forward contract.
Hence, taking forward contract is suggested.
Good performance has been noticed in this question on Forex. However, some students didn’t
carry out the required calculation and gave their suggestion based on rates. Even in some cases
initial step involving calculation of expected exchange rate was correct but after that they went
wrong.
Question 12
TT Ltd. is planning to hedge its foreign exchange risk. It has made a purchase on 1st April 2021 for which it
has to make a payment of US $ 1 Lakh on 30/09/2021. The present exchange rate is 1US $ - ` 73. It can
purchase forward 1US $ at ` 74. TT Ltd. will have to make an upfront premium @ 1% of the forward amount
purchased. The cost of the funds to the company is 10% p.a. In the following situations, compute the
Gain/(Loss) of the TT Ltd. will make if they hedge with exchange rate on 30/09/2021 as:
(i) ` 76/US $
(ii) ` 70/US $
(iii) ` 79/US $
Note: Calculation to be done on monthly basis. (8 Marks Dec ‘21)
Answer 12
(`)
Present Exchange Rate ` 73 = 1 US$
If company purchases US$ 100,000 forward premium is
100,000 × 74 × 1% 74,000
Interest on ` 74,000 for 6 months at 10% 3,700
Total hedging cost 77,700
If exchange rate is ` 76
Then gain (` 76 – ` 74) for US$ 100,000 2,00,000
Less: Hedging cost 77,700
Net gain 1,22,300
If US$ = ` 70
Then loss (` 70 – ` 74) for US$ 100,000 4,00,000
Add: Hedging Cost 77,700
Total Loss 4,77,700
If US$ = ` 79
Then Gain (` 79 – ` 74) for US$ 100,000 5,00,000
Less: Hedging Cost 77,700
Total Gain 4,22,300

Though above average performance has been noticed in this question on Forex but some
P 9.12
Question 13
M/s. Daksh Ltd is planning to import multipurpose machine from USA at a cost of $15000. The company
can avail loans at 19% Interest per annum with quarterly rests with which it can import the machine.
However, there is an offer from New York branch of an Indian based bank extending credit of 180 days at
2% per annum against opening of an irrevocable letter of credit.
Other Information:
Spot rate US$ 1 = ` 75
180 days forward rate US $ 1 = ` 77
Commission charges for letter of credit at 2% per 12 months.
(i) Justify why the offer from the foreign branch should be accepted?
(ii) Based on the present market condition company is not interested to take the risk of currency
fluctuations and wanted to hedge with an additional expenses of ` 30,000, if so, what is your advise to
the company?
Assume 360 days in the year. (8 Marks May ‘22)
Answer 13
Option I (To finance the purchases by availing loan at 19% per annum):
Amount
Cost of equipment ($ 15,000 at US$ 1 = ` 75) ` 11,25,000
Add: Interest at 4.75% I Quarter 53,438
Add: Interest at 4.75% II Quarter (on ` 11,78,438) 55,976
Total outflow in Rupees 12,34,414
Alternatively, interest may also be calculated on
compounded basis, i.e., ` 1,12,5000 × [1.0475]2 ` 12,34,413
Option II (To accept the offer from foreign branch):
Amount
Cost of letter of credit at 1 % on US$ 15,000 at US$ 1 = ` 75 ` 11,250
Add: Interest for 180 days (` 11,250 × 19% x 180/360) ` 1,069
(A) ` 12,319
Payment at the end of 180 days:
Cost US$ 15,000
Interest at 2% p.a. [15000 × 2/100 × 180/360] US$ 150
US$ 15,150
Conversion at US$ 1 = ` 77 [15150 x ` 77] (B) ` 11,66,550
Total Cost: (A) + (B) ` 11,78,869
Advise: Option 2 is cheaper by (` 12,34,413 – ` 11,78,869) lakh or ` 55,544. Hence, the offer may be
accepted.
(ii) If company is not interested to take the risk of currency fluctuations and wanted to hedge with an
additional expense of ` 30,000 then it can do so because even taking forward position is resulting in
increased cash outflow by the same amount.
Question 14
P 9.13
ICL an Indian MNC is executing a plant in Sri Lanka. It has raised Rs. 400 billion. Half of the amount
will be required after six months’ time. ICL is looking an opportunity to invest this amount on 1st
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 11.9276 -
billions)
Discount on initial investment at the 2% -
end
Interest - 5 per cent per
annum
Exchange Rate (1st April, 2020) JPY/INR 1.58 USD/INR 0.014
Exchange Rate (30th September, JPY/INR 1.57 USD/INR 0.013
2020)
You, as an Investment Manager, is required to suggest the best course of option. (8 Marks Nov ‘20)
Answer 14
(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 Rs. 220.7692
Gain Rs. 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 Rs. 220.7692

Gain Rs. 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.

P 9.14
Question 15
An Indian company obtains the following quotes (Rs./$)
Spot: 35.90/36.10
3 - Months forward 36.00/36.25
rate:
6 - Months forward 36.10/36.40
rate:
The company needs $ funds for six months. Determine whether the company should
borrow in $ or Rs. Interest rates are :
3 - Months interest rate : Rs. : 12%, $ : 6%
6 - Months interest rate : Rs. : 11.50%, $ : 5.5%
Also determine what should be the rate of interest after 3-months to make the company
indifferent between 3-months borrowing and 6-months borrowing in the case of:
(i) Rupee borrowing

(ii) Dollar borrowing
Note: For the purpose of calculation you can take the units of dollar and rupee as 100 each.(8
Marks Nov ‘18)
Answer 15
(i) If company borrows in $ then outflow would be as follows:
Let company borrows $ 100 $ 100.00
Add: Interest for 6 months @ 5.5% $ 2.75
Amount Repayable after 6 months $ 102.75 Applicable
6 month forward rate 36.40
Amount of Cash outflow in Indian Rupees Rs. 3,740.10
If company borrows equivalent amount in Indian Rupee, then outflow would be as follows:
Equivalent Rs. amount Rs. 36.10 x 100 Rs. 3,610.00
Add: Interest @11.50% Rs. 207.58
Rs. 3817.58
Since cash outflow is more in Rs. borrowing then borrowing should be made in $.
(ii) (a) Let ’ be the interest rate of Rs. borrowing make indifferent between 3 months borrowings and
6 months borrowing then
(1 + 0.03) (1 + ) = (1 + 0.0575)
= 2.67% or 10.68% (on annualized basis)
(b) Let ‘id’ be the interest rate of $ borrowing after 3 months to make indifference between 3
months borrowings and 6 months borrowings. Then,
(1 + 0.015) (1 + ) = (1 + 0.0275)
= 1.232% or 4.93% (on annualized basis)

P 9.15
Question 16
Briefly explain Asset and Liability Management (ALM). (4 Marks Nov 22)
Answer 16
Asset-Liability Management (ALM) is one of the important tools of risk management in commercial banks
of India. Indian banking industry is exposed to a number of risks prevailing in the market such as market
risk, financial risk, interest rate risk etc. The net income of the banks is very sensitive to these factors or
risks.
ALM is a comprehensive and dynamic framework for measuring, monitoring and managing the market
risk of a bank. It is the management of structure of Balance Sheet (liabilities and assets) in such a way that
the net earnings from interest are maximized within the overall risk preference (present and future) of
the institutions. The ALM functions extend to liquidly risk management, management of market risk,
trading risk management, funding and capital planning and profit planning and growth projection.
Banks and other financial institutions provide services which expose them to various kinds of risks like
credit risk, interest risk, and liquidity risk. Asset liability management is an approach that provides
institutions with protection that makes such risk acceptable. Asset-liability management models enable
institutions to measure and monitor risk, and provide suitable strategies for their management.
It is therefore appropriate for institutions (banks, finance companies, leasing companies, insurance
companies, and others) to focus on asset-liability management when they face financial risks of different
types. Asset-liability management includes not only a formalization of this understanding, but also a way
to quantify and manage these risks.
In a sense, the various aspects of balance sheet management deal with planning as well as direction and
control of the levels, changes and mixes of assets, liabilities, and capital.
Question 17
The following 2-way quotes appear in the foreign exchange market:
Spot 2-months spread

₹/US $ 74.00/74.25 1.00/1.25
(i) You are required to calculate:
(a) 2 months forward rates.
(b) How many US dollars should the firm sell to get ₹ 10 lakhs in the spot market and after 2 months?
(c) How many Rupees is the firm required to pay to obtain US $ 80,000 in the spot market and after 2
months?
(ii) Assume the firm has US $ 27,600 in current account earning no interest. ROI on Rupee investment is
10% p.a. Should the firm encash the US $ now or after 2 months? (8 Marks Nov 22)
Answer 17
(i) (a) Two Month Forward Rates:
Buying Rate ₹ 74.00 + ₹ 1.00 = ₹ 75.00 Selling Rate ₹
74.25 + ₹ 1.25 = ₹ 75.50
(b) (1) To get ₹ 10 lakh at Spot Market the firm should sell
= ₹ 10,00,000/ ₹ 74.00 = US $ 13,513.51
(2) To get ₹ 10 lakh after 2 month the firm should sell
P 9.16
= ₹ 10,00,000/ ₹ 75.00 = US $ 13,333.33

(c) (1) Rupees required to obtain US $ 80,000 in Spot Market: US $
80,000 × ₹ 74.25 = ₹ 59,40,000
(2) Rupees required to obtain US $ 80,000 after 2 months:
US $ 80,000 × ₹ 75.50 = ₹ 60,40,000
(ii) If US$ are converted in ₹ now and get invested in India, then fund position after 2 months will be
as follows:
US$ 27,600 × ₹ 74.00 ₹ 20,42,400

ROI @ 10% p.a. for 2 month ₹ 34,040
Amount after 2 months ₹ 20,76,440
If US$ are converted after 2 month, then fund position will be:
$ 27,600 × ₹ 75.00 = ₹ 20,70,000
Thus, it is better to get converted US$ into ₹ now and get them invested in India. Alternatively,
this sub part can also be answered as follows:
Computation of Annual Premium on US $ = (1.00/74.00) × (12/2) × 100 = 8.108% or 8.11%
Since, the premium on US $ in lesser than ROI on Indian ₹, it is better to convert US $ in Indian ₹
now and get them invested in India.
Question 18
Write a short note on Money Market Hedging. (4 Marks Nov 22)
Answer 18
At its simplest, a money market hedge is an agreement to exchange a certain amount of one currency for
a fixed amount of another currency, at a particular date. For example, suppose a business owner in India
expects to receive 1 Million USD in six months. This Owner could create an agreement now (today) to
exchange 1Million USD for INR at roughly the current exchange rate. Thus, if the USD dropped in value by
the time the business owner got the payment, he would still be able to exchange the payment for the
original quantity of U.S. dollars specified.
Advantages of Money Market Hedging
(i) Fixes the future rate, thus eliminating downside risk exposure.
(ii) Flexibility with regard to the amount to be covered.
(iii) Money market hedges may be feasible as a way of hedging for currencies where forward contracts
are not available.
Disadvantages of Money Market Hedging
(i) More complicated to organize than a forward contract.
(ii) Fixes the future rate - no opportunity to benefit from favorable movements in exchange rates.

P 10.1
Chapter 10
International Financial Management
Question 1
Omega Ltd. is interested in expanding its operation and planning to install manufacturing plant at US.
For the proposed project, it requires a fund of $10 million (net of issue expenses or floatation cost). The
estimated floatation cost is 2%. To finance this project, it proposes to issue GDRs.
As a financial consultant, you are requested to compute the number of GDRs to be issued and cost of the
GDR with the help of following additional information:
(i) Expected market price of share at the time of issue of GDR is Rs. 250 (Face Value being Rs.
100)
(ii) 2 shares shall underlay each GDR and shall be priced at 4% discount to market price.
(iii) Expected exchange rate Rs. 64/$
(iv) Dividend expected to be paid is 15% with growth rate 12%. (8 Marks May ‘18)
Answer 1
Net Issue Size = $10 million
.
Gross Issue = = $ 10.2041 million
.
Issue Price per GDR in Rs. (250 x 2 x 96%) Rs. 480

Issue Price per GDR in $ (Rs. 480/ Rs. 64) $7.50
Dividend Per GDR (D1) = Rs. 15 x 2 = Rs. 30
Net Proceeds Per GDR = Rs. 480 x 0.98 = Rs. 470.40
(i) Number of GDR to be issued
$ .
= 1.360547 million
$ .
(ii) Cost od GDR to Omega Ltd.

K = +0.12 =18.378%
.
Overall performance in this question was of above average level as many examinees have
committed errors in calculation of cost of GDR.
Question 2
TG Ltd., a multinational company is planning to set up a subsidiary company in India (where hitherto
it was exporting) in view of growing demand for its product and competition from other MNCs. The
initial project cost (consisting of plant and machinery including installation) is estimated to be US $ 500
million. The net working capital requirements are estimated at US $ 100 million. The company follows
straight line method of depreciation. Presently, the company is exporting 2 million units every year at
a unit price of US $ 100, its variable cost per unit being US $ 50.
The Chief Financial Officer has estimated the following operating cost and other data in respect of the
proposed project:
(a) Variable operating cost will be US $ 25 per unit of production.
(b) Additional cash fixed cost will be US $ 40 million per annum.
(c) Production and Sales capacity of the proposed project in India will be 5 million units.
(d) Expected useful life of the proposed plant is 5 years with no salvage value.
Chapter 10 International Financial Management
P 10.2
(e) Existing working capital investment for production and sale of 2 million units through
exports was US $ 20 million.
(f) Export of the product in the coming year will decrease to 1.5 million units in case the
company does not open subsidiary company in India, in view of the presence of
competing MNCs that are in the process of setting up their subsidiaries in India.
(g) Applicable Corporate Income Tax rate is 30%.
(h) Required rate of return for such project is 12%.
Assume that there will be no variation in the exchange rate of two countries, all profits will be
repatriated and there will be no withholding tax.
Estimate the Net Present Value (NPV) of the proposed project in India. Present Value Interest Factors
(PVIF) @ 12% for 5 years are as under:
Year: 1 2 3 4 5
PVIF: 0.8929 0.7972 0.7118 0.6355 0.5674
(Compute your workings to 4 decimals) (8 Marks Nov ‘19)
Answer 2
Financial Analysis whether to set up the manufacturing units in India or not may be carried using NPV
technique as follows:
I. Incremental Cash Outflows
$ Million
Cost of Plant and Machinery 500.00
Working Capital 100.00
Saving of existing Working Capital employed in Export (20.00)
Business
580.00
II. Incremental Cash Inflow after Tax (CFAT)
(a) Generated by investment in India for 5 years
$ Million
Sales Revenue (5 Million x $100) 500.00
Less: Costs
Variable Cost (5 Million x $25) 125.00
Fixed Cost 40.00
Depreciation ($500Million/5) 100.00
EBIT 235.00
Taxes@30% 70.50
EAT 164.50
Add: Depreciation 100.00
CFAT (1-5 years) 264.50
Cash flow at the end of the 5 years (Release of Working 80.00
Capital)
(b) Cash generation by exports
$ Million
Sales Revenue (1.5 Million x $100) 150.00
Less: Variable Cost (1.5 Million x $50) 75.00
Contribution before tax 75.00
P 10.3
Tax @ 30% 22.50

CFAT (1-5 years) 52.50
(c) Additional CFAT attributable to Foreign Investment

$ Million
Through setting up subsidiary in India 264.50
Through Exports in India 52.50
CFAT (1-5 years) 212.00
III. Determination of NPV
Year CFAT ($ PVF@12% PV ($
Million) Million)
1-5 212 3.6048 764.2176
5 80 0.5674 45.3920
809.6096
Less: Initial Outflow 580.0000
229.6096
Decision: Since NPV is positive the proposal should be accepted
Average performance was observed in this question as the examinees depicted lack of conceptual
clarity on the concept of incremental cash flows. Therefore, NPV has been calculated incorrectly
by majority of the examinees.
Question 3
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 Nov ‘20)
Answer 3
(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)
P 10.4
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.
Question 4
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.
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 Probabilit
(%) of production y
(USD/unit)
0 - 0.4
10 0.3 0.4
0
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 Jan ‘21)
P 10.5
Answer 4
(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%
Expected Value of inflow in perpetuity =

$32,26,000 1.03
0.11 ! 0.03
, ,
= =US$ 4,15,34,750
.
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.
Question 5
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
P 10.6
4 60,00,000
5 75,00,000
Assume required rate of return on the project as 14%. You are
required to calculate:
(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
Jan ‘21)
Answer 5
(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) PV Factor at P.V.
US$ 9.9%
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 = Rs. 72 x US$ 1.52 Million
= Rs. 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 = Rs. 72 x (US$ 0.282 Million)
= - Rs. 20.304 Million
Thus, if there is a withholding tax of 10% then the project will not be viable.
Question 6
A US based company is planning to set up a subsidiary company in India (where so far it was exporting)
in view of growing demand for its product and competition from other US based companies. The initial
project cost consisting of plant and machinery including installation is estimated to be US$ 490 million.
P 10.7
The net working capital requirements are estimated at US$ 60 million. The company follows straight
line method of depreciation. Currently, the company is exporting two million units every year at a unit
price of US$ 90, its variable cost per unit being US$ 50.
The CFO of the Company has estimated the following operating cost and other data in respect of
proposed project:
(i) Variable operating cost will be US $ 30 per unit of production;
(ii) Additional cash fixed cost will be US $ 30 million p.a. and project's share of allocated
fixed cost will be US $ 3 million p.a. based on principle of ability to share;
(iii) Expected useful life of the proposed plant is five years with no salvage value;
(iv) Production capacity of the proposed project in India will be 5 million units;
(v) Existing working capital investment for production and sale of two million units through
exports was US $ 25 million;
(vi) Export of the product in the coming year will decrease to 1.5 million units, provided the
company does not set up subsidiary company in India, in view of the presence of
competing other US based companies that are in the process of setting up their
subsidiaries in India;
(vii) Applicable Corporate Income Tax rate is 35%, and
(viii) Required rate of return for such project is 12%.
Assuming that there will be no variation in the exchange rate of two currencies and all profits will be
repatriated as there will be no withholding tax, Estimate Net Present Value of the proposed project
in India and give your advice. Present Value Interest Factors (PVIF) @ 12% for five years is as below :
Year 1 2 3 4 5
PVIF 0.8929 0.7972 0.7118 0.6355 0.5674
(8 Marks July 21)
Answer 6
Financial Analysis whether to set up the manufacturing units in India or not may be carried using NPV
technique as follows:
I. Incremental Cash Outflows
$ Million
Cost of Plant and Machinery 490.00
Working Capital 60.00
Release of existing Working Capital (25.00)
525.00
II. (1) Incremental Cash Inflow after Tax (CFAT) generated by investment in India for 5
years
$ Million
Sales Revenue (5 Million x $90) 450.00
Less: Costs
Variable Cost (5 Million x $30) 150.00
Fixed Cost 30.00
Depreciation ($490Million/5) 98.00
EBIT 172.00
P 10.8
Taxes @ 35% 60.20

EAT 111.80
Add: Depreciation 98.00
CFAT (1-5 years) 209.80
(2) Cash flow at the end of the 5 years (Release of Working Capital) $35.00 Million
(3) Cash generation by exports (Opportunity Cost)
$ Million
Sales Revenue (1.5 Million x $90) 135.00
Less: Variable Cost (1.5 Million x $50) 75.00
Contribution before tax 60.00
Tax @ 35% 21.00
CFAT (1-5 years) 39.00
(4) Additional CFAT:
$ Million
Through setting up subsidiary in India 209.80
Through Exports in India 39.00
CFAT (1-5 years) 170.80
III. Determination of NPV
Year CFAT ($ PVF@12% PV ($
Million) Million)
1-5 170.80 3.6048 615.6998
5 35 0.5674 19.8590
635.5588
Less: Initial Outflow 525.0000
NPV 110.5588
Advice: Since NPV is positive the proposal should be accepted.
Overall performance of students in this question on International Capital Budgeting was below
average due to poor conceptual knowledge especially in case of treatment of opportunity cost and
additional fixed cost and hence could not compute the correct CFAT resulting in wrong answer.
Question 7
A US company wants to setup a manufacturing plant in India which requires an initial outlay of ` 8 Million.
It is expected to have a useful life of 5 years with a salvage of ` 2 Million. The company follows straight line
method of depreciation. To support additional level of activity, investment would require one time
additional working capital of ` 1 Million.
Since the cost of production lower in India, the variable cost of production would be ` 30 per unit. Additional
fixed cost per annum is estimated at ` 0.5 Million. The company is projecting its annual sales to 80000 units
at the price of ` 100 per unit. Applicable tax rate to the company is 34% and its cost of capital is 8%. Inflation
rates in US and India are expected to be 8% and 9% respectively. The current exchange rate is ` 72 per US
Dollar.
P 10.9
Assuming that all profit will be repatriated every year and there will be no withholding taxes, estimate the
net present value of the proposed project in India and evaluate its feasibility.
PVF @ 8% for the five years are as under:
Rate 1 Year 2 Year 3 Year 4 Year 5 Year

8% 0.926 0.857 0.794 0.735 0.681
(8 Marks Dec ‘21)
Answer 7
Working Notes:
(i) Initial Investment in US$

Particulars Amount
Initial Outlay ` 80,00,000
Additional Working Capital ` 10,00,000
Total ` 90,00,000
Exchange Rate ` 72/US$
Initial Investment in US$ US$ 1,25,000
(ii) Expected Exchange Rates
Year ` /USD
1 ` 72.00 x (1+0.09) / (1+0.08)
72.67
2 ` 72.67 x (1+0.09)/ (1+0.08)

73.34
3 ` 73.34 x (1+0.09)/ (1+0.08)

74.02
4 ` 74.02 x (1+0.09)/ (1+0.08)

74.71
5 ` 74.71 x (1+0.09)/ (1+0.08)

75.40
(iii) Annual Cash Inflows

Particulars Amount (`)
Sales (80000 X ` 100) 80,00,000
Less: Variable Cost (80000 x ` 30) 24,00,000
Additional Fixed Cost 5,00,000
Depreciation (` 80,00,000 - ` 20,00,000) / 5 12,00,000
Profit Before Tax (PBT) 39,00,000

Less: Tax @ 34% 13,26,000
25,74,000
Add: Depreciation 12,00,000
37,74,000
(iv) Amount repatriated each year in US$
Year in ` Expected Exchange in US$
Rate (`/ US$)
1 Annual Cash Flow 37,74,000 72.67 51,933.40
P 10.10
2 ---do---- 37,74,000 73.34 51,458.96

3 ---do---- 37,74,000 74.02 50,986.22
4 ---do---- 37,74,000 74.71 50,513.33
5 ---do---- 37,74,000 75.40 50,053.05
(v) Release of Working Capital in US$ at the end (` 10,00,000/ ` 75.40) =
US$ 13,262.60
(vi) Salvage Value of Project in US$ (` 20,00,000/ / ` 75.40) = US$ 26,525.20
NPV of the proposed project
Particulars Period Cash Flows PVF @ 8% PV ($)
($)
Initial Outlay 0 (1,25,000.00) 1.000 (1,25,000.00)
Annual Cash Flow 1 51,933.40 0.926 48,090.33
---do---- 2 51,458.96 0.857 44,100.33
---do---- 3 50,986.22 0.794 40,483.06
---do---- 4 50,513.33 0.735 37,127.30
---do---- 5 50,053.05 0.681 34,086.13
Release of 5 13,262.60 0.681 9,031.83
Working
Capital
Salvage Value of the 5 26,525.20 0.681 18,063.66
Project
1,05,982.64
Since the NPV of the project is positive, it is feasible.
Though overall above average performance has been noticed in this question on International
Capital Budgeting however while some students committed mistake in computing cash flows
and exchange rates other have solved it ignoring exchange rate impact.
Question 8
DD Ltd. a company based in India manufactures good quality of leather bags and sells to retail outlets in
India and USA. The cost of quality leather in India is very high, the company is reviewing the proposal of
importing of leather in bulk from USA supplier. The estimate of net US $ and Indian ` Currency Cash Flows
in nominal terms for this proposal is given below:
Net Cash Flow (in Lakh)

Year 0 1 2 3
In US $ (25) 5 7 8
In ` 0 60 80 90
If not imported cost of leather to be 400 450 500 600
purchased in India (in `)
Other information:
(i) DD Ltd. evaluates all investments by using discount rate of 9% p.a.

(ii) All US customers are invoiced in US $. US $ Cash flows converted into ` at the forward rate
and discounted at Indian Rate.
(iii) Inflation in USA and India are expected to be 9% and 8% respectively.
P 10.11
(iv) The current exchange rate 1 US $ = ` 74

(v) You are required to Calculate Net Present Value and recommend the decision. Present
value factor @ 9% are as under:
1 Year 2 Year 3 Year
0.917 0.842 0.772
Note: Calculation to be made up to 2 decimal points. (8 Marks Dec ‘21)

Answer 8
Expected Forward Exchange Rates
Year ` /USD
1 ` 74.00 x (1+0.08)/ (1+0.09)
73.32
2 ` 73.32 x (1+0.08)/ (1+0.09)

72.65
3 ` 72.65 x (1+0.08)/ (1+0.09)

71.98
NPV of the proposal if leather is imported from US

0 1 2 3
Cash Flow is US$ (Lakh) (25) 5 7 8
Expected Forward Rates `/ US$ 74.00 73.32 72.65 71.98
Cash Flows in ` Lakh (1,850.00) 366.60 508.55 575.84
Cost of leather if not imported (400.00) (450.00) (500.00) (600.00)
Cash Flows in ` Lakh ---- 60.00 80.00 90.00
Total Cash Flow ` Lakh (2,250.00) (23.40) 88.55 65.84
PVF @ 9% 1.000 0.917 0.842 0.772
PV in ` Lakh (2,250.00) (21.46) 74.56 50.83
NPV (2,146.07)
Decision: Proposal should not be accepted as NPV is negative.
Overall, above average performance has been observed in this question on

International Capital Budgeting.
Question 9
Skylark Systems Ltd. is interested to expand its operations in US for which it requires funds of $ 20
million, net of issue expenses and floatation costs etc., which amounts to 3% of the issue size. To
finance this project it proposes to issue GDR.
Following factors are considered in pricing the issue:
(i) Expected market price of share at the time of issue of GDR is ` 300 (FV ` 10)
(ii) 3 shares shall underlay each GDR and shall be priced at 10% discount to market price.
(iii) Expected exchange rate is ` 75/$
(iv) 20%| 9959791590
Naresh pasupuleti Dividend is expected to be paid for next year with growth rate of 15%
P 10.12
You are required to compute the number of GDRs to be issued and cost of GDR to Skylark Systems Ltd.
If the company is able to raise the funds in US at the rate of 4% p.a. and the company is able to repay
the loan along with interest from revenues generated from the operations of US, what is your advise to
the company? (8 Marks May ‘22)
Answer 9
Working Notes:
Net Issue Size = $ 20 million
.
Gross Issue = .
= $ 20.619 million
Issue Price per GDR in ` (300 x 3 x 90%) ` 810
Issue Price per GDR in $ (` 810/ ` 75) $ 10.80
Dividend Per GDR (D1) = ` 2 x 3 = ` 6.00
Net Proceeds Per GDR = ` 810 x 0.97 = ` 785.70
Number of GDR to be issued
$ ."
$ .
= 1.9092 million
Cost of GDR
%.&&
#$ = '().'& + 0.15 = 15.76%
If the company receives an offer from US Bank willing to provide an equivalent amount of loan with
interest rate of 4%, it should accept the offer.
Question 10
What are Foreign Currency Convertible Bonds? What are their advantages?(4 Marks May ‘22)
Answer 10
A type of convertible bond issued in a currency different than the issuer's domestic currency. In other
words, the money being raised by the issuing company is in the form of a foreign currency. A convertible
bond is a mix between a debt and equity instrument. It acts like a bond by making regular coupon and
principal payments, but these bonds also give the bondholder the option to convert the bond into stock.
Advantages of FCCBs
(i) The convertible bond gives the investor the flexibility to convert the bond into equity at a price or redeem
the bond at the end of a specified period, normally three years if the price of the share has not met his
expectations.
(ii) Companies prefer bonds as it leads to delayed sdilution of equity and allows company to avoid any current
dilution in earnings per share that a further issuance of equity would cause.
(iii) FCCBs are easily marketable as investors enjoys option of conversion into equity if resulting to capital
appreciation. Further investor is assured of a minimum fixed interest earnings.
Question 11
List the main objectives of International Cash Management. (4 Marks Nov ’19)

P 10.13
Answer 11
The main objectives of an effective system of international cash management are:
(1) To minimise currency exposure risk.
(2) To minimise overall cash requirements of the company as a whole without disturbing smooth
operations of the subsidiary or its affiliate.
(3) To minimise transaction costs.
(4) To minimise country’s political risk.
(5) To take advantage of economies of scale as well as reap benefits of superior knowledge.
The objectives are conflicting in nature as minimizing of transaction costs require cash balance to be kept
in the currency in which they are received thereby contradicting both currency and political exposure
requirements.
Question 12
MNO Ltd., a company based in India, manufactures very high quality modern furniture and sells them
to a small number of retail outlets in India and Nepal. It is facing tough competition. Recent studies on
marketability of product have clearly indicated that the customers are now more interested in variety
and choice rather than exclusivity and exceptional quality. Since the cost of quality wood in India is very
high, the company is reviewing the proposal for import of wood in bulk from Nepalese supplier.
The estimate of net India (₹) and Nepalese Currency (NC) cash flow in nominal terms for this proposal
is shown below:
Net cash flow (in Millions)

Years NC India (₹)
0 —38 0
1 1.8 1.9
2 3.2 3.5
3 4.1 4.4
4 5.4 5.8
5 6.5 6.9
The following information is relevant :
(1) MNO Ltd. evaluates all investment by using a discount rate of 11% p.a. All Nepalese customers are
invoiced in NC. NC cash flows are converted to Indian ₹ at the forward rate and discounted at the Indian
rate.
(2) Inflation rate in Nepal and India are expected to be 11% and 10% p.a. respectively.
(3) The current exchange rate is ₹ 1 = NC 1.65
You are required to calculate Net Present value of the proposal. (8 Marks Nov 22)
Answer 12
Working Notes:
(i) Computation of Forward Rates

End of Year NC NC/₹
+ .
NC 1.65 X * ,
1 1.665
+ .
P 10.14
+ .
NC 1.665 X * ,
2 1.680
+ .
+ .
NC 1.680 X * ,
3
+ . 1.695
4 1.710
+ .
NC 1.695 X * ,
+ .
5 1.726
+ .
NC 1.710 X * + .
,
(ii) NC Cash Flows converted in Indian Rupees

Year NC Conversion ₹
(Million) Rate (Million)
0 -38.00 1.650 -23.03
1 1.80 1.665 1.081
2 3.20 1.680 1.905
3 4.10 1.695 2.419
4 5.40 1.710 3.158
5 6.50 1.726 3.766
Net Present Value
Year Cash Flow in Cash Flow in Total PVF PV

India Nepal Cash Flow @
11%
0 --- -23.030 -23.030 1.000 -23.030
1 1.900 1.081 2.981 0.901 2.686
2 3.500 1.905 5.405 0.812 4.389
3 4.400 2.419 6.819 0.731 4.985
4 5.800 3.158 8.958 0.659 5.903
5 6.900 3.766 10.666 0.593 6.325
1.258

P 11.1
Chapter 11
Interest Rate Risk Management
Question 1
Punjab Bank has entered into a plain vanilla swap through on Overnight Index Swap (OIS) on a principal
of Rs. 2 crore and agreed to receive MIBOR overnight floating rate for a fixed payment on the principal.
The swap was entered into on Monday, 24th July, 2017 and was to commence on 25th July, 2017 and run
for a period of 7 days.
Respective MIBOR rates for Tuesday to Monday were:
8.70%, 9.10%, 9.12%, 8.95%, 8.98% and 9.10%.
If Punjab Bank received Rs. 507 net on settlement, calculate Fixed rate and interest under both legs.
Notes:
(i) Sunday is a Holiday.

(ii) Workout in rounded rupees and avoid decimal working.
(iii) Consider a year consists of 365 days. (8 Marks May ‘18)
Answer 1
Day Principal (Rs.) MIBOR (%) Interest (Rs.)
Tuesday 2,00,00,000 8.70 4,767
Wednesday 2,00,04,767 9.10 4,987
Thursday 2,00,09,754 9.12 5,000
Friday 2,00,14,754 8.95 4,908
Saturday & Sunday (*) 2,00,19,662 8.98 9,851
Monday 2,00,29,513 9.10 4,994
Total Interest @ Floating 34,507
Less: Net Received 507
Expected Interest @ fixed 34,000
Thus Fixed Rate of Interest 0.0886428
Approx. 8.86%
(*) i.e. interest for two days.
Overall performance was above average. However, some examinees lost marks due to chain
error.
Question 2
K Ltd. currently operates from 4 different buildings and wants to consolidate its operations into one
building which is expected to cost Rs. 90 crores. The Board of K Ltd. had approved the above plan and to
fund the above cost, agreed to avail an External Commercial Borrowing (ECB) of GBP 10 m from G Bank Ltd.
on the following conditions:
 The Loan will be availed on 1st April, 2019 with interest payable on half yearly rest.
 Average Loan Maturity life will be 3.4 years with an overall tenure of 5 years.
 Upfront Fee of 1.20%.
 Interest Cost is GBP 6 months LIBOR + Margin of 2.50%.
Chapter 11 Interest Rate Risk Management
P 11.2
 The 6 month LIBOR is expected to be 1.05%.

K Ltd. also entered into a GBP-INR hedge at 1 GBP = INR 90 to cover the exposure on account
of the above ECB Loan and the cost of the hedge is coming to 4.00% p.a.
As a Finance Manager, given the above information and taking the 1 GBP = INR 90:
(i) Calculate the overall cost both in percentage and rupee terms on an annual basis.
(ii) What is the cost of hedging in rupee terms?
(iii) If K Ltd. wants to pursue an aggressive approach, what would be the net gain/loss for K
Ltd. if the INR depreciates/appreciates against GBP by 10% at the end of the 5 years
assuming that the loan is repaid in GBP at the end of 5 years?
Ignore time value and taxes and calculate to two decimals. (8 Marks May ‘19)
Answer 3
Calculation of Overall Cost
Upfront Fee (GBP 10 M @ 1.20%) Rs. 1,20,000
Interest Payment (GBP 10 M x 3.55% x 3.4) Rs. 12,07,000
Hedging Cost (GBP 10 M x 4% x 3.4) Rs. 13,60,000
Total Rs. 26,87,000
Or Rs. 2.687 million
.
Overall cost in % terms on Annual Basis = , , , , , .
.
= . .
100 =8%
.
Overall Cost in Rupee terms@ GBP 1 = Rs 90 100 = Rs.711.26 lakhs
.
OR
.
Overall cost in % terms on Annual Basis = , , . .
.
= . .
100 =7.9%
Overall Cost in Rupee terms@ GBP 1 = 10,000,000 X 7.90% X 90

= Rs. 71,100,000
OR
Calculation of overall cost
Interest & Margin (A) = 3.55%

Hedging cost (B) = 4% 7.55%
Onetime fee = 1.20%
Average loan maturity = 3.4 years
Per annum cost 1.2/3.4 (C) = 0.35%
Annual overall cost in % terms (A+B+C) = 7.9%

Overall Cost in Rupee terms@ GBP 1 = 10,000,000 X 7.90% X 90
= Rs. 71,100,000
(ii) Cost of Hedging in terms of Rupees
P 11.3
Rs. 13,60,000 x 90 = Rs. 12,24,00,000 = Rs. 12.24 crores in Total

OR
GBP10,000,000 X 90 X 4% = Rs. 3,60,00,000 on Annual Basis
(iii) If K Ltd. pursues an aggressive approach then Gain/Loss in INR Depreciation/ Appreciation
shall be computed as follows:
(a) If INR depreciates by 10%
Re. loss per GBP = 90 x 10% = Rs. 9
Total Losses GBP10M = Rs. 90 Million
Less: Cost of Hedging = Rs. 36 Million
Net Loss = Rs. 54 million
(b) If INR appreciates by 10%
Rs. Gains per GBP = Rs. 90 x 10% = Rs. 9
Total Gain on Repayment of loan = 90 Million Add: Saving
in Cost of Hedging = 36 Million Net Gain
=126 Million
Candidate’s performance in this question was very poor as many examinees did not attempt
this question. Those who attempted could not calculate the overall cost of ECB Loan. Even
some examinees were unable to understand that average maturity life will be 3.4 years.
Question 4
P Ltd. is contemplating to borrow an amount of Rs. 50 crores for a period of 3 months in the coming 6
months time from now. The current rate of interest is 8% per annum but it may go up in 6 months time.
The company wants to hedge itself against the likely increase in interest rate.
The Company's Bankers quoted an FRA (Forward Rate Agreement) at 8.30% per annum. Compute the
effect of FRA and actual rate of interest cost to the company, if the actual rate of interest during
consideration period happens to be (i) 8.60% p.a., or (ii) 7.80% p.a. (Show your workings on the basis
of months) (8 Marks Nov ‘19)
Answer 4
Final settlement amount shall be computed by using formula:
=
!
Where,
N = the notional principal amount of the agreement;

RR = Reference Rate for the maturity specified by the contract prevailing on the contract settlement date;
FR = Agreed-upon Forward Rate; and

dtm = maturity of the forward rate, specified in Months DY = Applicable
basis of months
Accordingly,
P 11.4
If actual rate of interest after 6 months happens to be 8.60%

'
".# $% %& . .
()
= '
! . *
()
".# $% %& . . # , #,
= = =Rs.3,67,107
. # . #
Thus, banker will pay a sum of Rs. 3,67,107 to P Ltd. and actual interest rate for P Ltd. shall be
as follows:
Interest on loan @ 8.60% for 3 months Rs. 1,07,50,000
Less: Amount Received from the bank Rs. 3,67,107
Net Amount Rs. 1,03,82,893
Effective Interest Rate 8.31%
(Rs. 1,03,82,893/ Rs. 50 crore x 12/3 x 100)
If actual rate of interest after 6 months happens to be 7.80%
'
".# $% %& . .
()
= '
! . *
()
".# $% %& . # . # , #,
=
. #
= . #
=Rs.6,13,046
Thus P Ltd. will pay banker a sum of Rs. 6,13,046 and actual interest rate for P Ltd. shall be
as follows:
Interest on loan @7.80% for 3 months Rs. 97,50,000
Add: Amount paid to bank Rs. 6,13,046
Net Amount Rs. 1,03,63,046
Effective Interest Rate 8.29%
(Rs. 1,03,63,046/50 crore x 12/3 x 100)
Overall performance in this question was average.
Question 5
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 Nov ‘20)
Answer 5

P 11.5
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.
Question 6
Peer – to – Peer Lending and Crowd funding are same and traditional methods of funding. Do you agree?
Justify your stand.(4 Marks Nov ‘20)
Answer 6
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 fai th 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 7
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 Jan ‘21)

P 11.6
Answer 7
(i) Rupee requirement if forward cover is taken:
6 Month Forward rate 68.4575
Interest amount (20,00,000 x 3%* 6/12 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:
.
= 68.5275 x .
= 69.8845/US$
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:
.
= 68.4275 x = 69.7825/US$
.
Thus, still the company should take forward cover.
Question 8
What is Net interest position risk and Price risk? (4 Marks May ‘22)
Answer 8
Net Interest Position Risk: The size of non-paying liabilities is one of the significant factors contributing
towards profitability of banks. Where banks have more earning assets than paying liabilities, interest rate
risk arises when the market interest rates adjust downwards. Thus, banks with positive net interest
positions will experience a reduction in NII as the market interest rate declines and increases when
interest rate rises. Thus, large float is a natural hedge against the variations in interest rates.
Price Risk: Price risk occurs when assets are sold before their stated maturities. In the financial market,
bond prices and yields are inversely related. The price risk is closely associated with the trading book,
which is created for making profit out of short -term movements in interest rates.
Banks which have an active trading book should, therefore, formulate policies to limit the portfolio size,
holding period, duration, defeasance period, stop loss limits, marking to market, etc.
Question 9
MPD Ltd. issues a ` 50 Million Floating Rate Loan on July 1, 2018 with resetting of coupon rate every 6
Months equal to LIBOR + 50 bps.
MPD is interested in an Interest rate Collar Strategy of selling a Floor and buying a cap.
MPD buys the 3 years cap and sell 3 years Floor as per the following details on July 1, 2018:
Principal Amount ` 50 Million

Strike Rate 5% for Floor & 8% for Cap
Reference Rate 6 months LIBOR
Premium NIL, since premium paid for cap = premium received for
P 11.7
Floor
The Reset dates & Interest rates p.a., on that dates are:
Reset Date 31/12/2018 30/06/2019 31/12/2019 30/06/2020 31/12/2020 30/06/2021

LIBOR (%) 7.00 8.00 6.00 4.75 4.25 5.25
Using the above data, you are required to determine:
(i) Effective Interest paid out at each six reset dates, (Round off to the nearest rupee)
(ii) Average overall effective rate of interest p.a. (round off to 2 decimals) (8 Marks May ‘22)
Answer 9
The pay-off of each leg shall be computed as follows:
Cap Receipt
Max {0, [Notional principal x (LIBOR on Reset date – Cap Strike Rate) x (No. of days in settlement period/
365)}
Floor Pay-off
Max {0, [Notional principal x (Floor Strike Rate – LIBOR on Reset date) x (No. of days in settlement period/
365)}
Statement showing effective interest on each payment date
Reset Date LIBOR Date of Days Interest Cap Floor Effective

(%) Payment Payment (`) Receipts Pay-off Interest
LIBOR+0.50% (`) (`)
31-12-2018 7.00 30-06-2019 181 18,59,589 0 0 18,59,589
30-06-2019 8.00 31-12-2019 184 21,42,466 0 0 21,42,466
31-12-2019 6.00 30-06-2020 182 16,16,120 0 0 16,16,120
30-06-2020 4.75 31-12-2020 184 13,19,672 0 62,842 13,82,514
31-12-2020 4.25 30-06-2021 181 11,77,740 0 1,85,959 13,63,699
30-06-2021 5.25 31-12-2021 184 14,49,315 0 0 14,49,315
Total 1096 98,13,703
Question 10
A dealer quotes 'All-in-cost' for a generic swap at 6% against six month LIBOR flat. If the notional principal
amount of swap is Rs. 8,00,000:
(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 date comprises 181 days and that the corresponding LIBOR was 5% on
the effective date of swap.
(iii) In (ii) above, if the settlement is on 'Net' basis, how much the fixed rate payer would pay to the
floating rate payer? Generic swap is based on 30/360 days basis.(8 Marks July’21)(4 Marks
Nov’18)
Answer 10
(i) Semi-annual fixed payment
= (N) (AIC) (Period)
P 11.8
Where N = Notional Principal amount = Rs.8,00,000 AIC = All-in-cost = 6% = 0.06
= 8,00,000 0.06
= 8,00,000 0.06(0.5)
=Rs.24,000
(ii) Floating Rate Payment

/0
=N (LIBOR)
= 8,00,000 0.05
=Rs.20,111 or Rs.20,120
(iii) Net Amount
= (i)-(ii)
= Rs.24,000 –Rs.20,111 =Rs.3889
OR = Rs. 24,000 –Rs.20,120 =Rs.3880
Overall, above average performance has been noted in this question on interest Rate Swap.
Most common mistake was not following 180/360 days convention. Further, despite the
instruction in question to consider up to 3 decimals many students ignored the same
resulting in loss of marks unnecessarily.
Question 11
Define Interest Rate Swaption. State its principal features. (4 Marks July 21)
Answer 11
An interest rate swaption is simply an option on an interest rate swap. It gives the holder the right but not
the obligation to enter into an interest rate swap at a specific date in the future, at a particular fixed rate
and for a specified term.
There are two types of swaption contracts: -

 A fixed rate payer swaption (also called Call Swaption).
 A fixed rate receiver swaption (also called Put Swaption).
Principal Features of Swaptions
A. A swaption is effectively an option on a forward-start IRS, where exact terms such as the
fixed rate of interest, the floating reference interest rate and the tenor of the IRS are
established upon conclusion of the swaption contract.
B. A 3-month into 5-year swaption would therefore be seen as an option to enter into a 5-
year IRS, 3 months from now.
C. The 'option period' refers to the time which elapses between the transaction date and
the expiry date.
D. The swaption premium is expressed as basis points.
E. Swaptions can be cash-settled; therefore, at expiry they are marked to market off the
Naresh pasupuleti | 9959791590 applicable forward curve at that time and the difference is settled in cash.
P 11.9
Poor performance has been observed in these theoretical questions as students have
exhibited lack of knowledge of the concepts of Swaption and Tracking Error.
Question 12
What are the main features of Forward Rate Agreements (FRA)? (4 Marks Dec ‘21)
Answer 12
A Forward Rate Agreement (FRA) is an agreement between two parties through which a borrower/ lender
protects itself from the unfavourable changes to the interest rate. Unlike futures FRAs are not traded on an
exchange thus are called OTC product. Following are main features of FRA.
 Normally it is used by banks to fix interest costs on anticipated future deposits or interest revenues
on variable-rate loans indexed to Benchmark Interest Rate e.g. LIBOR, MIBOR etc.
 It is an off-Balance Sheet instrument.
 It does not involve any transfer of principal. The principal amount of the agreement is termed
"notional" because, while it determines the amount of the payment, actual exchange of the
principal never takes place.
 It is settled at maturity in cash representing the profit or loss. A bank that sells an FRA agrees to
pay the buyer the increased interest cost on some "notional" principal amount if Reference Rate
of some specified maturity is above a stipulated "Forward Interest Rate" on the contract maturity
or settlement date. Conversely, the buyer agrees to pay the seller any decrease in interest cost if
Reference Rate fall below the forward rate.
Question 13
Explain various methods of hedging of interest rate risk. (4 Marks Nov 22)
Answer 13
Methods of Hedging of Interest Rate Risk can be broadly divided into following two categories:
(A) Traditional Methods: These methods can further be classified in following categories:
(i) Asset and Liability Management (ALM): ALM is a comprehensive and dynamic framework for
measuring, monitoring and managing the market risk of a bank. It is the management of
structure of Balance Sheet (liabilities and assets) in such a way that the net earnings from
interest are maximized within the overall risk preference (present and future) of the
institutions.
(ii) Forward Rate Agreement (FRA): Normally it is used by banks to fix interest costs on anticipated
future deposits or interest revenues on variable-rate loans indexed to Benchmark Interest Rate
e.g. LIBOR, MIBOR etc. A bank that sells an FRA agrees to pay the buyer the increased interest
cost on some "notional" principal amount if Reference Rate of some specified maturity is above
a stipulated "Forward Interest Rate" on the contract maturity or settlement date. Conversely,
the buyer agrees to pay the seller any decrease in interest cost if Reference Rate fall below the
forward rate.
(B) Modern Methods: These methods can further be classified in following categories:
(i) Interest Rate Futures (IRF): An interest rate future is a contract between the buyer and
seller agreeing to the future delivery of any interest-bearing asset. The interest rate future
P 11.10
allows the buyer and seller to lock in the price of the interest-bearing asset for a future date.
(ii) Interest Rate Options (IRO): Also known as Interest Rate Guarantee (IRG) as option is a right
not an obligation and acts as insurance by allowing businesses to protect themselves against
adverse interest rate movements while allowing them to benefit from favourable
movements.
It should be noted that the IRO is basically a series of FRAs which are exercisable at
predetermined bench marked interest rates on each period say 3 months, 6 months etc.
(iii) Interest Rate Swaps: In an interest rate swap, the parties to the agreement, termed the
swap counterparties, agree to exchange payments indexed to two different interest rates.
Total payments are determined by the specified notional principal amount of the swap,
which is never actually exchanged.
(iv) Swaptions: An interest rate swaption is simply an option on an interest rate swap. It gives
the holder the right but not the obligation to enter into an interest rate swap at a specific
date in the future, at a particular f ixed rate and for a specified term.
Question 14
What are the applications of Value At Risk (VAR) ? (4 Marks Nov 22)
Answer 14
VAR can be applied
a. to measure the maximum possible loss on any portfolio or a trading position.
b. as a benchmark for performance measurement of any operation or trading.
c. to fix limits for individuals dealing in front office of a treasury department.
d. to enable the management to decide the trading strategies.
e. as a tool for Asset and Liability Management especially in banks.

P 12.1
Chapter 12
Corporate Valuation
Question 1
Herbal World is a small, but profitable producer of beauty cosmetics using the plant Aloe Vera. Though
it is not a high-tech business, yet Herbal's earnings have averaged around
Rs. 18.5 lakh after tax, mainly on the strength of its patented beauty cream to remove the pimples.
The patent has nine years to run, and Herbal has been offered Rs. 50 lakhs for the patent rights.
Herbal's assets include Rs. 50 lakhs of property, plant and equipment and Rs. 25 lakhs of working
capital. However, the patent is not shown in the books of Herbal World. Assuming Herbal's cost of
capital being 14 percent, calculate its Economic Value Added (EVA). (5 Marks May ‘18)
Answer 1
EVA = NOPAT – WACC x Capital Employed.
Capital Employed: Rs. lacs
Property, etc. 50
Working Capital 25
Patent Value 50
Effective or Invested Capital 125
WACC x CE = 14% x Rs. 125 lacs= Rs. 17.5 lacs
EVA = Rs. 18.5 lacs – Rs. 17.5 lacs = Rs. 1 lac
Overall performance in this question was good though some errors have been committed in the
calculation of effective capital and not taking the patent value into consideration.
Question 2
An established company is going to be de merged in two separate entities. The valuation of the
company is done by a well-known analyst. He has estimated a value of Rs. 5,000 lakhs, based on the
expected free cash flow for next year of Rs. 200 lakhs and an expected growth rate of 5%. While going
through the valuation procedure, it was found that the analyst has made the mistake of using the
book values of debt and equity in his calculation. While you do not know the book value weights he used,
you have been provided with the following information:
(i) The market value of equity is 4 times the book value of equity, while the market value of
debt is equal to the book value of debt,
(ii) Company has a cost of equity of 12%,
(iii) After tax cost of debt is 6%.
You are required to advise the correct value of the company. (8 Marks May ‘18)
Answer 2
Value of the Company = ,where Kc = weighted average cost of Capital.
Value of the Company = 5000 =

Kc – 5 = 200/5000 = 4%
Kc = 4% + 5% = 9%
We do not know the weights the analyst had taken for arriving at the cost of capital. Let w be
the proportion of equity. Then, (1-w) will be the proportion of debt.
Chapter 12 Corporate Valuation
P 12.2
Kc = 9 = w x 12 + (1-w) x 6
9 = 6 + 6w
6w = 3.
Hence w = 3/ 6 = 0.5 = 50 % or 1:1
The weights are equal i.e. 1:1 for equity and debt.
The correct weights should be market value of equity : market value of debts.
i.e. 4 times book value of equity : book value of debts. i.e. 4:1 equity : debt
Revised Kc = 4/5 x 12 + 1/5 x 6= 10.8 %
Revised value of the company = = 200/5.8 % =3448.28 lacs

.
In this question on derivative, overall performance was good.
Question 3
Following details are available for X Ltd. Income Statement for the year ended 31st March, 2018
Particulars Amount
Sales 40,000
Gross Profit 12,000
Administrative Expenses 6,000
Profit Before tax 6,000
Tax @ 30% 1,800
Profit After Tax 4,200
Balance sheet as on 31st March, 2018
Particulars Amount
Fixed Assets 10,000
Current Assets 6,000
Total Assets 16,000
Equity Share Capital 15,000
Sundry Creditors 1,000
Total Liabilities 16,000
The Company is contemplating for new sales strategy as follows :
(i) Sales to grow at 30% per year for next four years.
(ii) Assets turnover ratio, net profit ratio and tax rate will remain the same.
(iii) Depreciation will be 15% of value of net fixed assets at the beginning of the year.
(iv) Required rate of return for the company is 15%
Evaluate the viability of new strategy. (12 Marks Nov ‘18)

P 12.3
Answer 3
Projected Balance Sheet
Year 1 Year 2 Year 3 Year 4 Year 5
Fixed Assets (25% of Sales) 13,000 16,900 21,970 28,561.00 28,561.00
Current Assets (15% of Sales) 7,800 10,140 13,182 17,136.60 17,136.60
Total Assets 20,800 27,040 35,152 45,697.60 45,697.60

Equity (37.5% of sales) 19,500 25,350 32,955 42,841.50 42,841.50
Sundry Creditors (2.5% of Sales) 1,300 1,690 2,197 2,856.10 2,856.10
Total Liabilities 20,800 27,040 35,152 45,697.60 45,697.60
Projected Cash Flows:
Year 1 Year 2 Year 3 Year 4 Year 5

Sales 52,000 67,600 87,880.00 1,14,244.00 1,14,244.00
PBT (15% of sales) 7,800 10,140 13,182.00 17,136.60 17,136.60
PAT (10.5% of sales) 5,460 7,098 9,227.40 11,995.62 11,995.62
Depreciation 1,500 1,950 2,535.00 3,295.50 4,284.15
Addition to Fixed 4,500 5,850 7,605.00 9,886.50 4,284.15
Assets
Increase in Net Current 1,500 1,950 2,535.00 3,295.50 -
Assets
Operating cash flow 960 1,248 1,622.40 2,109.12 11,995.62
Projected Cash Flows:

Cash Flows PVF at 15% PV
960 0.870 835.20
1248 0.756 943.49
1622.40 0.658 1067.54
2109.12 0.572 1206.42
4,052.65
Present value of Projected Cash Flows:-

Residual Value = 11,995.62/0.15 = 79,970.80
Present value of Residual value = 79,970.80 x PVF (15%, 4)

= 79,970.80 x 0.572 = 45,743.30
Total shareholders’ value = 45743.30 + 4052.65 = 49795.95
Pre-strategy value = 4200 / 0.15 = 28,000
∴ Value of strategy = 49795.95 – 28,000 = 21795.95
Conclusion: The strategy is financially viable.

P 12.4
Question 4
Compute Economic Value Added (EVA) of Good luck Ltd. from the following information:
Profit & Loss Statement

Particulars (Rs. in Lakh)
(a) Income -
Revenue from Operations 2000
(b) Expenses -
Direct Expenses 800
Indirect Expenses 400
(c) Profit before interest & tax(a-b) 800
(d) Interest 30
(e) Profit before tax (c - d) 770
(f) Tax 231
(g) Profit after tax (e - f) 539
Balance Sheet
Particulars (Rs. in Lakh)

Equity and Liabilities :
(a) Shareholder's Fund -
Equity Share Capital 1000
Reserve and Surplus 600
(b) Non- Current Liabilities -
Long Term Borrowings 200
(c) Current Liabilities 800
Total 2600
Assets :
(a) Non - Current Assets 2000
(b) Current Assets 600
Total 2600
Other Information:
(1) Cost of Debts is 15%.

(2) Cost of Equity (i.e. shareholders' expected return) is 12%.
(3) Tax Rate is 30%.
(4) Bad Debts Provision of Rs. 40 lakhs is included in indirect expenses and Rs. 40 lakhs
reduced from receivables in current assets. (8 Marks May ‘19)
Answer 4
EVA = NOPAT – (Invested Capital x WACC) NOPAT
= EBIT – Tax + Non-Cash Expenses
= 800 lakhs – 231 lakhs + 40 lakhs
= Rs. 609 lakh

P 12.5
(OR)
Operating Income = Taxable Income + Interest + Non-cash Expenses
= 539 +30+40 = Rs. 609 lakh
Invested Capital = 1000 + 600 + 200 = 1800
= 1800 + 40 (Non-cash expenses)
= Rs. 1840 lakhs
WACC = 12% + 15% (1-0.3)
= 10.67% + 1.17% = 11.84%

Now, EVA = 609 – (1840 x 11.84%)
= 609 – 217.86
= Rs. 391.14 lakhs
OR
WACC = 12% + 15% (1-0.3)
= 10.00% + 1.75% = 11.75%

Now, EVA = 609 – (1840 x 11.75%)
= 609 – 216.20
= Rs. 392.80 lakhs
The performance of the examinees was of average level. However, some of the examinees
could not calculate NOPAT. Further, some examinees made wrong calculation of WACC
and capital employed due to adjustment of Bad Debts Provision. This made them unable
Question 5
Mr. X, a financial analyst, intends to value the business of PQR Ltd. in terms of the future cash
generating capacity. He has projected the following after tax cash flows :
Year : 1 2 3 4 5
Cash flows (Rs. in lakh) 1,760 480 640 860 1,170
It is further estimated that beyond 5th year, cash flows will perpetuate at a constant growth rate of 8%
per annum, mainly on account of inflation. The perpetual cash flow is estimated to be Rs. 10,260 lakh
at the end of the 5th year.
Required:
(i) What is the value of the firm in terms of expected future cash flows, if the cost of capital of the
firm is 20%.
(ii) The firm has outstanding debts of Rs. 3,620 lakh and cash/bank balance of Rs. 2,710 lakh.
Calculate the shareholder value per share if the number of outstanding shares is 151.50 lakh.
(iii) The firm has received a takeover bid from XYZ ltd. of Rs. 225 per share. Is it a good offer?
[Given: PVIF at 20% for year 1 to Year 5: 0.833, 0.694, 0.579, 0.482, 0.402](8 Marks Nov ‘19)

P 12.6
Answer 5
Value of Firm
Year Cash Flow PVF PV
(Rs. in lakhs) (Rs. in
lakhs)
1 1760 0.833 1466.08
2 480 0.694 333.12
3 640 0.579 370.56
4 860 0.482 414.52
5 1170 0.402 470.34
PV of Cash flows upto year 5 3054.62
If PV of Terminal Value is considered with the growth rate (at the end of 5 th year)
, " # . $ , ,
= = =Rs.92,340 lakh
. . .
Now, PV (at the beginning of the year)
= Rs.92,340 x 0.402 = Rs.37,120.68 Lakhs

So, Present Value of the firm = Rs.3054.62 + Rs.37120.68 = Rs.40175.30 Lakhs
(ii) Value per share

= Value of Firm – Value of Debt / No of shares
= (40175.30 – 3620)/151.50 = Rs. 241.29
(iii) Takeover bid of Rs. 225 per share seems to be not a good offer as it is lesser than the
intrinsic value i.e. value per share of Rs. 241.29.
Poor performance was observed in this question as many examinees have failed to calculate the
terminal value with growth @8% per annum against perpetual cash flow. Further, many examinees
wrongly added Cash/Bank Balance to the value arrived at after deducting the value of debt from the
value of firm to calculate value per share. Further, majority of the examinees considered existing PBIT
ignoring enhanced return on additional capital.
Question 6
Differentiate between Economic Value Added (EVA) and Market Value Added (MVA) (4 Marks Nov ‘20)
Answer 6
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
P 12.7
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.
Question 7
The Balance Sheet of M/s. Sundry Ltd. as on 31-03-2020 is follows: (Rs. in lakhs)
Liabilities Rs. Assets Rs.
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 Rs. 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 Jan ‘21)
Answer 7
(i) External Funds Requirement (EFR):(Rs. in lakhs)
(Rs.)
Expected sales (Rs. 600 + 20% of Rs. 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 (Rs. 1400 - Rs. 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:

(Rs. in lakhs)
New amount of short-term loans and payables & provision 450
&
%' 600*
Less: Existing Amount of short-term loans and 500

payables & provision
P 12.8
Amount to be raised from short term funds Nil

(2) Amount to be raised from Long term funds:
(Rs. in lakhs)
New fixed assets (Rs. 600 + 20% of Rs. 600) 720
New long-term loans (Rs. 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:
(Rs. 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
Question 8
Excellent Ltd. reported a profit of ` 154 lakhs after 30% tax for the financial year 2019- 20. An analysis of
the accounts revealed that there is an extraordinary loss of ` 20 lakhs and the income included
extraordinary items of ` 16 lakhs. The existing operations, except for the extraordinary items, are
expected to continue in the future. In addition, the results of the launch of a new product are expected
to be as follows:
` in lakhs
Sales 140
Material costs 40
Labour costs 24
Fixed costs 20
(i) Calculate the value of the business, given that the capitalization rate is 14%.
(ii) Determine the market price per equity share, with Excellent Ltd.'s share capital being
comprised of 2,00,000 at 13% preference shares of ` 100 each and 100,00,000 equity shares of
` 10 each and the P/E ratio being 12 times. (Ignoring Corporate Dividend Tax). (8 Marks
July 21)
Answer 8
(i) Computation of Business Value
(` Lakhs)
+ 220
Profit before tax .,
Less: Extraordinary income (16)

Add: Extraordinary losses 20
224
Profit from new product (` Lakhs)
Sales 140
Less: Material costs 40
Labour costs 24
P 12.9
Fixed costs 20 (84) 56

280.00
Less: Taxes @30% 84.00
Future Maintainable Profit after taxes 196.00
Relevant Capitalisation Factor 0.14
Value of Business (` 196/0.14) 1400
(ii) Determination of Market Price of Equity Share
Future maintainable profits (After Tax) ` 1,96,00,000

Less: Preference share dividends 2,00,000 shares of ` ` 26,00,000
100 @ 13%
Earnings available for Equity Shareholders ` 1,70,00,000
No. of Equity Shares 1,00,00,000
Earning per share = ` 1.70
Rs. 170,00,000
1,00,00,000
PE ratio 12
Market price per share ` 20.40
In this question on Valuation good performance has been observed though some students
could not compute market price of equity share correctly.
Question 9
Following is the information of M/s. DY Ltd. for the year ending 31/03/2021:
Particulars
Sales ` 1000 Lakh
Operating Expenses Including Interest ` 620 Lakh
8% Debentures ` 250 Lakh
Equity Share Capital (Face value of ` 10 each) ` 250 Lakh
Reserves and Surplus ` 250 Lakh
Market Value of DY Ltd ` 900 Lakh
Corporate Tax Rate 30%
Risk free Rate of Return 7%
Market Rate of Return 12%
Equity Beta 1.4
You are required to-
i. Calculate Weighted Average Cost of Capital of DY Ltd.

ii. Calculate Economic Value Added
iii. Calculate Market Value Added (8 Marks Dec ‘21)

P 12.10
Answer 9
(i) Weighted Average Cost of Capital of DY Ltd.
Cost of Equity as per CAPM
ke = Rf + β x Market Risk Premium
= 7% + 1.4 x [12% - 7%]
= 7% + 7% = 14%
Cost of Debt kd = 8% (1 – 0.30) = 5.60%
3 4
WACC (ko) = 12 3#4
+ 15
3#4
= 14.00 X500/750 +5.60X 250/750
= 9.33% + 1.87% = 11.20%

(ii) Economic Value Added (EVA) of DY Ltd.
` Lakhs
Sales ` 1,000
Operating Expenses (excluding interest) ` 620
` 20 ` 600
` 400
Less: Tax @ 30% ` 120
Net Operating Profit after Tax (NOPAT) ` 280
Calculation of Capital Employed

` Lakhs
Equity Share Capital 250
Reserves & Surplus 250
8% Debentures 250
Total Capital Employed 750
EVA = NOPAT – (WACC X Total Capital) EVA = ` 280 Lakh
– 0.1120 X ` 750 lakhs EVA = 196.00 lakhs
(iii) Determination of Market Value Added (MVA)
` Lakh
Market value of Equity Stock [` 900 Lakh - ` 250 Lakh] 650
Equity Fund [` 250 Lakh + ` 250 Lakh] 500
Market Value Added 150
` Lakh
Market value of DY Ltd. 900
Capital employed [` 250 Lakh + ` 250 Lakh + ` 250 Lakh] 750
Market Value Added 150
In this question on Corporate Valuation overall above average performance has been observed.
Though some students were not aware about the technical concept of the question especially
in context of Market Value Added. Chapter 12 Corporate Valuation
P 12.11
Question 10
Following information is available pertaining to ABC Ltd. which is expected to grow at a higher rate for 3
years after which growth rate will stabilize at a lower level.
Base year information is -
Revenues EBIT Capital Depreciation

(After Depreciation) Expenditure
` 1,000 Cr. ` 150 Cr. ` 140 Cr. ` 100 Cr.
Information for high growth and stable growth period are as follows:
Stable Growth
Particulars High Growth Stable Growth
Growth in Revenue & EBIT 20% 10%
Growth in Capital Expenditure 20% Capital Expenditure are offset by
and Depreciation Depreciation
Risk free rate 10% 9%
Equity Beta 1.15 1.00
Market Risk Premium 6% 5%
PreTax cost of Debt 13% 12.86%
Debt Equity Ratio 1:1 2:3
Working capital is 25% of Revenue for all time. Corporate Tax Rate is 30%.
You are requested to find out the value of ABC Ltd. (8 Marks May ‘22)
Answer 10
High growth phase: Stable growth phase:
ke 0.10 + 1.15 x 0.06 = 0.169 or 0.09 + 1.0 x 0.05 = 0.14 or
16.9%. 14%.
kd 0.13 x (1 - 0.3) = 0.091 or 0.1286 x (1 - 0.3) = 0.09 or
9.1%. 9%.
Cost of capital 0.5 x 0.169 + 0.5 x 0.091 = 0.6 x 0.14 + 0.4 x 0.09 =
0.13 or 13%. 0.12 or 12%.
Determination of forecasted Free Cash Flow of the Firm (FCFF)
(` in crores)
Yr. 1 Yr. 2 Yr. 3 Terminal Year
Revenue 1200.00 1440.00 1728.00 1900.80
EBIT 180.00 216.00 259.20 285.12
EAT 126.00 151.20 181.44 199.58
Capital Expenditure 48.00 57.60 69.12 -
Less Depreciation
∆ Working Capital 50.00 60.00 72.00 43.20
Free Cash Flow (FCF) 28.00 33.60 40.32 156.38
(` in crores)
Revenue 1200.00 1440.00 1728.00 1900.80
P 12.12
EBIT 180.00 216.00 259.20 235.12

EAT 126.00 151.20 181.44 199.58
Add: Depreciation 120.00 144.00 172.80 190.08
246.00 295.20 354.24 389.66
Less: Capital Exp. 168.00 201.60 241.92 190.08
∆ WC 50.00 60.00 72.00 43.20
28.00 33.60 40.32 156.38
Present Value (PV) of FCFF during the explicit forecast period is:
FCFF (` in crores) PVF @ 13% PV (` in crores)
28.00 0.885 24.78
33.60 0.783 26.31
40.32 0.693 27.94
` 79.03
.&
Terminal Value of Cash Flow = = Rs. 7819 Crore
. .
PV of the terminal, value is = Rs. 7819 Crore x " . &$6
= Rs.7819 Crore x 0.693 = Rs. 5418.57 Crore

The value of the firm is = ` 79.03 Crores + ` 5418.57 Crores = ` 5497.60 Crores
Question 11
Mantra Ltd. is planning to buy Alay Ltd. Following information is given in respect of Alay Ltd. which is
expected to grow at a rate of 18% p.a. for the next three years, after which the growth rate will stabilize
at 8% p.a. normal level, in perpetuity:
Particulars For the year ended March 31, 2022

Revenues ₹ 6,800 Crores
Cost Of Goods Sold (COGS) ₹ 2,800 Crores
Operating Expenses ₹ 2,100 Crores
Capital Expenditure ₹ 750 Crores
Depreciation (included in Operating ₹ 600 Crores
Exp.)
During high growth period, Revenues & Earnings Before Interest & Tax (EBIT) will grow at 18% p.a. and
capital expenditure net of depreciation will grow at 12% p.a. From 4th year 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.
Corporate Income Tax rate is 30%.
The Weighted Average Cost of Capital (WACC) for both the companies is 15%.
You are required to estimate the value of Alay Ltd. using Free Cash Flows to Firm (FCFF) & WACC
methodology.
The PVIF for the three years are as below:
Year t1 t2 t3
PVIF @ 15% 0.870 0.756 0.658
P 12.13
(8 Marks Nov 22)

Answer 11
Determination of forecasted Free Cash Flow of the Firm (FCFF) (₹ in crores)

Revenue 8,024.00 9,468.32 11,172.62 12,066.43
COGS 3,304.00 3,898.72 4,600.49 4,968.53
Operating Expenses* 1,770.00 2,088.60 2,464.55 2,661.71
(*Excluding Depreciation)
Depreciation 708.00 835.44 985.82 1,064.68
EBIT 2,242.00 2,645.56 3,121.76 3,371.51
Tax @30% 672.60 793.67 936.53 1,011.45
EAT 1,569.40 1,851.89 2,185.23 2,360.06
Capital Exp. – Dep. 168.00 188.16 210.74 -----
∆ Working Capital 306.00 361.08 426.07 223.45
Free Cash Flow (FCF) 1,095.40 1,302.65 1,548.42 2,136.61
Terminal value is:
& .
= Rs . 30,523 Crore
. .
Present Value (PV) of FCFF:
FCFF (₹ in crores) PVF @ 15% PV (₹ in crores)
1,095.40 0.870 953.00
1,302.65 0.756 984.80
1,548.42 0.658 1,018.86
30,523 0.658 20,084.13
23,040.79
The value of the firm is ₹ 23,040.79 Crores
Note: The answer may vary due to rounding off difference.

P 13.1
Chapter 13
Mergers, Acquisitions & Corporate Restructuring
Question 1
Tatu Ltd. wants to takeover Mantu Ltd. and has offered a swap ratio of 1:2 (0.5 shares for everyone
share of Mantu Ltd.). Following information is provided
Tatu Ltd. Mantu Ltd.
Profit after tax Rs. 24,00,000 Rs. 4,80,000
Equity shares outstanding (Nos.) 8,00,000 2,40,000
EPS Rs. 3 Rs. 2
PE Ratio 10 times 7 times
Market price per share Rs.30 Rs. 14
(i) The number of equity shares to be issued by Tatu Ltd. for acquisition of Mantu Ltd.
(ii) What is the EPS of Tatu Ltd. after the acquisition?
(iii) Determine the equivalent earnings per share of Mantu Ltd.
(iv) What is the expected market price per share of Tatu Ltd. after the acquisition, assuming its PE
multiple remains unchanged?
(v) Determine the market value of the merged firm. (8 Marks May ‘18)
Answer 1
(i) The number of shares to be issued by Tatu Ltd.:
The Exchange ratio is 0.5
So, new Shares = 2,40,000 x 0.5 = 1,20,000 shares.
(ii) EPS of Tatu Ltd. after acquisition:
Total Earnings (Rs. 24,00,000 + Rs. 4,80,000) Rs.28,80,000
No. of Shares (8,00,000 + 1,20,000) 9,20,000
EPS (Rs. 28,80,000)/ 9,20,000) Rs.3.13
(iii) Equivalent EPS of Mantu Ltd.:
No. of new Shares 0.5
EPS Rs.3.13
Equivalent EPS (Rs. 3.13 x 0.5) Rs.1.57
(iv) New Market Price of Tatu Ltd. (P/E remaining unchanged)
Present P/E Ratio of A Ltd. 10 times
Expected EPS after merger Rs.3.13
Expected Market Price (Rs.3.13 x 10) Rs.31.30
(v) Market Value of merged firm:
Total number of Shares 9,20,000
Expected Market Price Rs.31.30
Total value (9,20,000 x 31.30) Rs.2,87,96,000
Overall performance was good as most of the examinees attempted the question in right direction.
Chapter 13 Mergers, Acquisitions & Corporate Restructuring
P 13.2
Question 2
TK Ltd. and SK Ltd. are both in the same industry. The former is in negotiation for acquisition of the
latter. Information about the two companies as per their latest financial statements are given below:
TK Ltd. SK Ltd.
Rs. 10 Equity shares outstanding 24 Lakhs 12 Lakhs
Debt:
10% Debentures (Rs. Lakhs) 1160 -
12.5% Institutional Loan (Rs. Lakhs) - 480
Earnings before interest, depreciation and
800.00 230.00
tax (EBIDAT) (Rs. Lakhs)
Market Price/Share (Rs.) 220.00 110.00
TK Ltd. plans to offer a price for SK Ltd. business, as a whole, which will be 7 times of EBIDAT as reduced
by outstanding debt and to be discharged by own shares at market price.
SK Ltd. is planning to seek one share in TK Ltd. for every 2 shares in SK Ltd. based on the market price.
Tax rate for the two companies may be assumed as 30%.
Calculate and show the following under both alternatives -TK Ltd.'s offer and SK Ltd.' s plan :
(i) Net consideration payable.

(ii) No. of shares to be issued by TK Ltd.
(iii) EPS of TK Ltd. after acquisition.
(iv) Expected market price per share of TK Ltd. after acquisition.
(v) State briefly the advantages to TK Ltd. from the acquisition.
Calculations may be rounded off to two decimals points. (12 Marks Nov ‘18)
Answer 2
As per TK Ltd.’s Offer
Rs. in lakhs
(i) Net Consideration Payable
7 times EBIDAT, i.e. 7 x Rs. 230 lakh 1610
Less: Debt 480
1130
(ii) No. of shares to be issued by TK Ltd
Rs. 1130 lakh/Rs. 220 (rounded off) (Nos.) 5,13,600
(iii) EPS of TK Ltd after acquisition
Total EBIDT (Rs. 800 lakh + Rs. 230 lakh) 1030.00
Less: Interest (Rs. 116 lakh + Rs. 60 lakh) 176.00
854.00
Less: 30% Tax 256.20
Total earnings (NPAT) 597.80
Total No. of shares outstanding 29,13,600
(24 lakh + 5,13,600)
EPS (Rs. 597.80 lakh/ 29,13,600) Rs. 20.52

P 13.3
Expected Market Price:
Rs. in lakhs
Pre-acquisition P/E multiple:
800.00
EBIDAT
Less: Interest ( 1160 X 10/100) 116.00
684.00
Less: 30% Tax 205.20
478.80
No. of shares (lakhs) 24
EPS Rs. 19.95
Hence, PE multiple (220/19.95) 11.03
Expected market price after acquisition (Rs. 20.52 x 11.03) Rs. 226.34
As per SK Ltd.’s Offer

Rs. in lakhs
(i) Net consideration payable
12 lakhs shares x Rs. 110 1320
(ii) No. of shares to be issued by TK Ltd
Rs. 1320 lakhs ÷ Rs. 220 6 lakh
(iii) EPS of T Ltd after Acquisition
NPAT (as per earlier calculations) 597.80
Total no. of shares outstanding (24 lakhs + 6 lakhs) 30 lakh
Earning Per Share (EPS) Rs. 597.8/30 lakh Rs. 19.93
(iv) Expected Market Price (Rs. 19.93 x 11) 219.23
Advantages of Acquisition to TK Ltd.
Since the two companies are in the same industry, the following advantages could accrue:
- Synergy, cost reduction and operating efficiency.
- Better market share.
- Avoidance of competition
Question 3
Given is the following information:
Day Ltd. Night Ltd.
Net Earnings Rs. 5 crores Rs. 3.5
crores
No. of Equity Shares 10,00,000 7,00,000
The shares of Day Ltd. and Night Ltd. trade at 20 and 15 times their respective P/E ratios. Day Ltd. considers
taking over Night Ltd. By paying Rs. 55 crores considering that the market price of Night Ltd. reflects its true
value. It is considering both the following options:
I. Takeover is funded entirely in cash.

II. Takeover is funded entirely in stock.
P 13.4
You are required to calculate the cost of the takeover and advise Day Ltd. on the best alternative. (8 Marks
May ‘19)
Answer 3
Working Notes:
Day Ltd. Night Ltd.

Net Earnings Rs. 5 crores Rs. 3.5 crores
No. of Equity Shares 10,00,000 7,00,000
EPS 50 50
P/E 20 times 15 times
MPS Rs. 1000 Rs. 750
Market Value 1,00,00,00,000 52,50,00,000
(i) If takeover is funded by Cash
Since Market Price of Night Ltd. reflects its full value, cost of takeover to Day Ltd is 55
crore – 52.50 crore = Rs. 2.5 crore.
(ii) If the takeover is funded by stock
Number of shares to be issued to Night Ltd.
= Rs. 55 Crore/ Rs. 1000 = 550000 Lakhs
Market Value of Merged Firm = Rs. 1,00,00,00,000 + Rs. 52,50,00,000
= Rs. 1,52,50,00,000 i.e. Rs. 152.50 Crore
Proportion that Night Ltd.’s shareholders get in Day Ltd.’s Capital Structure will be:
.
= = 0.3548
.
True Cost of Merger = Rs. 152.50 Crore x 0.3548 – Rs. 55 Crore

= -Rs. 0.893 Crore
Since true cost is negative in case of funding from stock, Day Ltd. would better off by funding the takeover
by stock.
The performance of the examinees on takeover problem was average. Some examinees could not
calculate market value of acquired firm and proportion of shareholding by its shareholders in merged
firm correctly. Further, cost of takeover in stock has not been calculated correctly by many examinees.
Question 4
A Ltd., a listed company, is considering merger of B Ltd. which is also a listed company, with itself by
means of a stock swap (exchange). B Ltd. has agreed to a plan under which A Ltd. will offer the current
market value of B Ltd.'s shares.
Additional Information:
Particulars A Ltd. B Ltd.

Earnings after tax (Rs.) 10,00,000 2,50,000
Number of shares outstanding 4,00,000 2,00,000
Current market price (Rs.) per share 50 20
P 13.5
On the basis of above information, you are required to calculate the following:
(i) What is the pre-merger Earnings per Share (EPS) and P/E ratio of both the companies?
(ii) If B Ltd.'s P/E is 10, what is its current market price per share? What is the exchange ratio?
What will A Ltd.'s post-merger EPS be?
(iii) What must the exchange ratio be for A Ltd.'s Pre-merger and Post-merger EPS to be the same?(8
Marks Nov ‘19)
Answer 4
(i) Before Merger
A Ltd. B Ltd.
Earning after tax (Rs.) 10,00,000 2,50,000
No. of shares outstanding 4,00,000 2,00,000
EPS Rs. 2.50 Rs. 1.25
Current Market Price/Share Rs. 50 Rs. 20
P/E Ratio 20 16
(ii) If B Ltd.’s P/E Ratio is 10
Then, it’s Current Market Price = 10 x Rs. 1.25 = Rs. 12.50
Exchange Ratio = 12.50 : 50 i.e. 1 share of A Ltd. for every 4 shares of B Ltd. No. of
shares to be issued = 50,000
A Ltd. Post-Merger EPS
Post-Merger Earning (10,00,000 + 2,50,000) Rs. 12,50,000
No. of Equity Shares after Merger (4,00,000 + 50,000) 4,50,000
EPS Rs. 2.78
(iii) Calculation of Exchange Ratio for A Ltd.’s pre-merger and post-merger EPS to be the same
= Total earnings/Pre-merger EPS of A Ltd.
= Rs.12,50,000/Rs. 2.50 = 5,00,000 shares
Now, number of shares to be issue to B Ltd. = 5,00,000 – 4,00,000 = 1,00,000 shares Therefore, the share
exchange ratio is 1,00,000 : 2,00,000 or 1:2. It means for every two shares in B Ltd., one share should be
issued from A Ltd.
Overall, the examinees did well in this paper. However, some of the examinees have given no. of
equity shares and EPS after merger incorrectly. Also, few of the examinees ignored the stipulation
of PE Ratio 10 for B Ltd. for sub-question (ii) and wrongly attempted the answer as per the existing
PE Ratio i.e. 20 and 16 for A Ltd. and B Ltd. respectively.
Question 5
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:Rs. in
Crores

P 13.6
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 (Rs. 10 per 250 125
share)
Reserves and Surplus 1,050 1,300 660 785
Borrowing 655 105
Capital Employed 1,955 890
Market Price Share (Rs.) 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
P 13.7
(12 Marks Nov ‘20)

Answer 5
(i) Computation of Premium (Net Worth Formula): Amount Rs. 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 @ 417.43
30% = 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 D1 then Premium over Current Market
Price shall be computed as follows:
Cost of Equity 0.2833
10
g 0.15
75
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 29.08%
100
During the course of negotiations, ICL will push forward valuation based on Growth Rate
Method as it will lead to least cash outflow.
Question 6
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 (Rs.)
P 13.8
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 Rs. 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
(Rs.)
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 Rs. 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 Jan ‘21)
Answer 6
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) Rs. 2,74,400 Rs. 1,19,000
No. of Shares (N) 100000 80000
EPS (PAT/N) Rs. 2.744 Rs. 1.4875
Market price per share (MPS) 40 15
P 13.9
P/E Ratio (MPS/EPS) 14.58 10.08

Equity Funds (EF) Rs. 13,00,000 Rs. 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 = Rs.20 / = 0.5:1 (upper limit)
Rs.40
(b) Market price based = = Rs.15 / = 0.375:1(lower
MPSDA/MPSBA Rs.40 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 (Rs.) (i) 2,74,400 1,19,000 3,93,400
Share outstanding (ii) 100000 80000 132000*
EPS (Rs.) (i) / (ii) 2.744 1.4875 2.980
EPS Accretion (Dilution) (Rs.) 0.236 (0.296***)
(vi) Estimation of Post-merger MPS

Particulars A Ltd. B Ltd. Combined
EPS (Rs.) (i) 2.744 1.4875 2.980
P/E Ratio (ii) 14.58 10.08 14.58
MPS (Rs.) (i) x (ii) 40 15 43.45
* Shares outstanding (combined) = 100000 shares + (.40 × 80000) = 132000 shares
** EPS claim per old share = Rs.2.98 × 0.4 Rs. 1.192
***EPS dilution = Rs.1.4875 – Rs. 1.192 Rs. 0.296
Question 7
Long Ltd., is planning to acquire Tall Ltd., with the following data available for both the companies:
Long Ltd. Tall Ltd.
Expected EPS ` 12 `5
Expected DPS ` 10 `3
No. of Shares 30,00,000 18,00,000
Current Market Price of Share ` 180 ` 50
As per an estimate Tall Ltd., is expected to have steady growth of earnings and dividends to the tune of
6% per annum. However, under the new management the growth rate is likely to be enhanced to 8%
per annum without additional investment.
P 13.10
(i) Calculate the net cost of acquisition by Long Ltd., if ` 60 is paid for each share of Tall Ltd.
(ii) If the agreed exchange ratio is one share of Long Ltd., for every three shares of Tall Ltd.,
in lieu of the cash acquisition as per (i) above, what will be the net cost of acquisition?
(iii) Calculate Gain from acquisition. (8 Marks July 21)
Answer 7
(i) Net cost of acquisition shall be computed as follows:
Cash Paid for the shares of Tall Ltd. (` 60 × 18,00,000) ` 10,80,00,000

Less: Value of Tall Ltd., as a separate entity (18,00,000 × ` ` 9,00,00,000
50)
Net Cost of acquisition of Tall Ltd. ` 1,80,00,000
(ii) Net Cost of acquisition in case of exchange of shares:
Exchange ratio = 1 share of long Ltd for every 3 shares of Tall Ltd.
Number of shares to be issued in Long Ltd. = 6,00,000 shares

(18,00,000/3) = 36,00,000
Total no. of shares in Long Ltd. after
merger (30,00,000 + 6,00,000)
Calculation of cost of Equity of Tall Ltd. = D1/P0 +g

Growth rate under new management after = ` 3/50 + 0.06 = 12%
acquisition
Value of Merged company assuming perpetual = 8%
growth
Value of merged company
(` 180 x 30,00,000) + (` 3/ (0.12 - 0.08) x 18,00,000 = ` 67,50,00,000
= 54,00,00,000 + (75 X 18,00,000)
Value per share of merged = ` 187.50 per share
company
(67,50,00,000/36,00,000)
Calculation of net cost of acquisition

Gross cost of acquisition (6,00,000 x 187.50) 11,25,00,000
Less: CMP (18,00,000 x 50) 9,00,00,000
Net Cost of acquisition 2,25,00,000
Alternatively, Net Cost of Acquisition can also be computed as follows:
No. of shares issued to shareholders of Tall Ltd. in the ratio 6,00,000

of 1:3
Existing price of one share of Long Ltd. ` 180
Value of consideration paid for acquisition of Tall Ltd. ` 10,80,00,000
Less: Existing Value of Tall Ltd., as a separate entity ` 9,00,00,000
Net Cost of acquisition of Tall Ltd. ` 1,80,00,000
(iii) Calculation of gain from acquisition:

P 13.11
Total Earnings of Long Ltd. (` 12 x 30,00,000) ` 3,60,00,000

Total Earnings of Tall Ltd. (` 5 x 18,00,000) ` 90,00,000
Combined Earnings ` 4,50,00,000
PE Ratio of Long Ltd. (180/12) 15
Value of Long Ltd. after acquisition ` 67,50,00,000
Less: Value of two companies separately
Long Ltd. (` 180 x 30,00,000) `
54,00,00,000 Tall Ltd. (` 50 x 18,00,000) ` 63,00,00,000
` 9,00,00,000
Gain from Acquisition ` 4,50,00,000
In this question on Mergers and Acquisitions, average performance has been noticed as
many students have calculated gain from acquisition wrongly.
Question 8
M/s KPMS Ltd. wants to purchase M/s. BRB Ltd., by exchanging 0.7 of its share for each share of M/s
BRB Ltd., relevant financial data are as follows:
M/s KPMS Ltd. M/s BRB Ltd.
Equity shares outstanding 20,00,000 8,00,000
EPS (`) 40 28
Market price per Share (`) 250 160
(i) Illustrate the impact of merger on EPS of both companies
(ii) The management of M/s. BRB Ltd., has quoted share exchange ratio of 1:1 for the merger.
Assuming that P/E ratio of M/s. KPMS Ltd. will remain unchanged after the merger, what
will be gain from merger for M/s. BRB Ltd.?
(iii) Find out the gain/loss to the shareholders of M/s. KPMS Ltd. if the exchange ratio is 1:1?
(iv) Determine the maximum exchange ratio acceptable to shareholders of M/s/ KPMS Ltd. (8
Marks Dec ‘21)
Answer 8
Working Notes:
(1) Market Price Per Share
KPMS Ltd. BRB Ltd.
EPS ` 40 ` 28
Profit ` 800,00,000 ` 224,00,000
P/E Ratio 6.25 5.71
Market price per share ` 250 ` 160
(2) EPS after merger
No. of shares to be issued (8,00,000 x 0.70) 5,60,000
Exiting Equity shares outstanding 20,00,000
P 13.12
Equity shares outstanding after merger 25,60,000

Total Profit (` 800,00,000 + ` 224,00,000) ` 1024,00,000
EPS ` 40
(i) Impact of merger on EPS of both the companies
KPMS Ltd. BRB Ltd.
EPS after Merger ` 40 ` 28
EPS before Merger ` 40 (`40 x 0.70) = ` 28
Nil Nil
(ii) Gain from the Merger if exchange ratio is 1 : 1
No. of shares to be issued 8,00,000
Exiting Equity shares outstanding 20,00,000
Equity shares outstanding after merger 28,00,000
Total Profit (` 800,00,000 + ` 224,00,000) ` 1024,00,000
EPS ` 36.57
Market Price of Share (` 36.57 x 6.25) ` 228.56
Market Price of Share before Merger ` 160.00
Impact (Increase/ Gain) ` 68.56
(iii) Gain/ loss from the Merger to the shareholders of KPMS Ltd.
Market Price of Share ` 228.56
Market Price of Share before Merger ` 250.00
Loss from the merger (per share) ` 21.44
(iv) Maximum Exchange Ratio acceptable to KPMS Ltd. shareholders

` Lakhs
Market Value of Merged Entity (` 228.56 x 2800000) 6,399.68
Less: Value acceptable to shareholders of KPMS Ltd. 5,000.00
Value of merged entity available to shareholders of BRB 1,399.68
Ltd.
Market Price Per Share ` 250
No. of shares to be issued to the shareholders of BRB Ltd. ` 5.60
(lakhs)
Thus maximum ratio of issue shall be 5.60 : 8.00 or 0.70 share of KPMS Ltd. for one share of
BRB Ltd.
` Lakhs
Earning after Merger (40 x 2000000 + 28 x 800000) ` 1,024
P/E Ratio of KPMS Ltd. 6.25
Market Value of Firm after Merger (1024 x 6.25) ` 6,400
Existing Value of Shareholders of KPMS Ltd. ` 5,000
Value of Merged entity available to Shareholders of BRB Ltd. ` 1,400
Market Price per Share ` 250
Total No. of shares to be issued 5.60
Thus, maximum acceptable ratio shall be 5.60 : 8.00 i.e. 0.70 share of KPMS Ltd. for one share
of BRB Ltd.
P 13.13
Good performance has been observed in this question on Mergers & Acquisitions though some
students committed mistakes in calculating exchange ratio in the last step.
Question 9
M/s. Vasavi Ltd. is considering the takeover of M/s. SKPD Ltd. by the exchange of five new shares in
M/s. Vasavi Ltd. for every eight shares in M/s. SKPD Ltd. The relevant financial details of the two
companies prior to merger announcement are as follows:
Particulars M/s. Vasavi Ltd. M/s. SKPD Ltd.

Profit before tax (` crore) 18 20.8
No. of shares (in crore) 20 18
P/E ratio 11 8
Corporate tax rate 30%.
a. Market value of both the companies

b. Value of original share holders
c. Price per share after merger

d. Effect on share price of both the companies. If the directors of Vasavi Ltd. expect their
own pre-merger P/E ratio to be applied to the combined earnings. (8 Marks May ‘22)
Answer 9
M/s Vasavi Ltd. M/s SKPD Ltd.
Profit before Tax (` in crore) 18.00 20.80
Tax 30% (` in crore) 5.40 6.24
Profit after Tax (` in crore) 12.60 14.56
Earnings per Share 12.60/ 20 = ` 0.63 14.56/18 = ` 0.81
Price per Share before Merger (EPS ` 0.63 x 11 = ` 6.93 ` 0.81 x 8 = ` 6.48
x P/E Ratio)
a. Market Value of company

M/s Vasavi Ltd. = ` 6.93 x 20 Crore = ` 138.60 crore M/s SKPD
Ltd. = ` 6.48 x 18 Crore = ` 116.64 crore
b. Value of Original Shareholders
After Merger
M/s Vasavi Ltd. M/s SKPD Ltd.
No. of Shares 20 crores 18 x 5 /8 = 11.25 crores
Combined 31.25 crores

% of Combined Equity Owned 20 / 31.25 ×100 = 11.25/31.25 ×100 =
64.00% 36.00%
Value of Original Shareholders ` 255.24 crore x 64.00% ` 255.24 crore x 36%

P 13.14
= ` 163.35 crores = ` 91.89 crores
c. Price per Share after Merger
. . ! "
EPS = # . ! "
= Rs. 0.87 per Share
P/E Ratio = 11
Market Value Per Share = ` 0.87 X 11 = ` 9.57

d. Effect on Share Price
M/s Vasavi Ltd.
Gain/loss (-) per share = ` 9.57 – ` 6.93 = ` 2.64
$. % .$#
i.e. ×100 = 0.381 or 38.10%
.$#
∴ Share price would increase by 38.10% M/s SKPD Ltd.
9.57 x '
= ` 5.98
Gain/loss (-) per share = ` 5.97 – ` 6.48 = (` 0.51)
.$ % .('
i.e. X 100 = (0.0787) or (-7.87%)
.('
∴ Share Price would decrease by 7.87%.
Question 10
Following information is available of M/s. TS Ltd.
(Rs. in crores)
PBIT 5.00
Less : Interest on Debt (10%) 1.00
PBT 4.00
Less: Tax @ 25% 1.00
PAT 3.00
No. of outstanding shares of Rs. 10 each 40 lakh
EPS (Rs.) 7.5
Market price of share (Rs.) 75
P/E ratio 10 Times
TS Ltd. has an undistributed reserves of Rs. 8 crores. The company requires Rs. 3 crores for the
purpose of expansion which is expected to earn the same rate of return on capital employed as
present. However, if the debt to capital employed ratio is higher than 35%, then P/E ratio is expected
to decline to 8 Times and rise in the cost of additional debt to 14%. Given this data which of the
following options the company would prefer, and why?
Option (i) : If the required amount is raised through debt, and
Option (ii) : If the required amount is raised through equity and the new shares will be issued at a
price of Rs. 25 each.(8 Marks Nov ‘19)

P 13.15
Answer 10
Working Notes
(1) Calculation of Return on Capital Employed (ROCE)
(Rs. in crores)
Capital Employed:
Share Capital (Rs. 10 x 40 lakhs) 4
Reserves 8
Debt (Rs. 1 cr. x 100/10) 10
22
PBIT 5
ROCE 22.73%
(2) Revised PBIT
Existing Capital Employed 22
Additional 3
ROI 22.73%
Revised PBIT 5.6825
(3) New Debt/Equity
Existing Debt 10
Additional Under Option (i) 3
Total Debt 13
Total Equity 12
#
New Debt to Capital Employed Ratio = =0.52
So, P/E Ratio to be reduced to 8 times

(4) Debt to Capital Employed Ratio in Option (ii)
= =0.40
So, P/E Ratio to be reduced to 8 times in this case also
(5) Number of additional shares to be issued in case of Option (ii) Funds to be

raised Rs. 3 crore
Price per share Rs. 25
No. of additional shares to be issued Rs. 3 crore/ Rs. 25 = 12 lakhs
Particulars Option (i) Option (ii)

PBIT (Revised) (Rs. Crore) 5.6825 5.6825
Less: Interest on Debt 1.42 1.00
PBT (Rs. Crore) 4.2625 4.6825
Tax @ 25% (Rs. Crore) 1.0656 1.1706
PAT (Rs. Crore) 3.1969 3.5119
No. of shares outstanding 40 lakhs 52 lakhs
EPS Rs. 7.99 Rs. 6.75

P 13.16
P/E Ratio 8 8
New Share Price Rs. 63.92 Rs. 54.00
Decision:
Since the MPS is expected to be more in the case of additional financing done through debt
(Option – I) Option – I is preferred.
Overall performance in this question was below average as the majority of the examinees have
not been able to appreciate the impact of increase in Capital Employed either by Debt or Equity
on increase in Profitability (PBIT) and on expected P/E Ratio depending on the proportion of
Debt to Capital Employed.
Question 11
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 Rs. Assets Rs.
Equity Capital (Rs. 10 per 10,00,000 Cash 20,000
share)
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 Rs. 20 for every
two shares. External liabilities are expected to be settled at a discount of
Rs. 20,000. Sundry debtors and Inventories are expected to realise Rs. 2,00,000.
Poly Ltd. will run as an independent unit. Cash Flow After Tax is expected to be
Rs. 4,00,000 per annum for next 6 years. Assume the disposal value of the plant after 6 years will be
Rs. 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 Jan ‘21)
Answer 11
Calculation of Purchase Consideration
Rs.
Issue of Share 50000 x Rs. 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
P 13.17
13,80,000
Net Present Value = PV of Cash Inflow + PV of Demerger of Roly Ltd. – Cash Outflow
= Rs. 4,00,000 PVAF(14%,6) + Rs. 1,50,000 PVF(14%, 6) – Rs. 13,80,000
= Rs. 4,00,000 x 3.888 + Rs. 1,50,000 x 0.456 – Rs. 13,80,000
= Rs. 15,55,200 + Rs. 68,400 – Rs. 13,80,000
= Rs. 2,43,600
Since NPV of the decision is positive it is advantageous to acquire Poly Ltd.
Question 12
Alfa Ltd. wants to acquire Beta Ltd. and has offered a swap ratio of 1 : 2 (0.5 shares for every one share
of Beta Ltd.). Following information is provided:
Alfa Ltd. Beta Ltd.

Profit after tax (₹) 18,00,000 3,60,000
EPS (₹) 3 2
PE Ratio 10 times 7 times
Market price per share (₹) 30 14
(i) You are required to determine:
(a) the number of equity shares to be issued by Alfa Ltd. for acquisition of Beta Ltd.
(b) the EPS of Alfa Ltd. after the acquisition.
(c) the equivalent earnings per share of Beta Ltd.
(d) the expected market price per share of Alfa Ltd.* after the acquisition, if PE increases to
12 times.
(e) the market value of the merged firm.
(ii) If you are the shareholder of Beta Ltd and holding 100 shares, will you be interested to sell
your stake ? Why? (8 Marks Nov 22)
* Mistakenly got typed as A Ltd.
Answer 12
(i)
(a) The number of shares to be issued by Alfa Ltd.:
The Exchange ratio is 0.5
So, new Shares = 1,80,000 x 0.5 = 90,000 shares.
(b) EPS of Alfa Ltd. after acquisition:
Total Earnings (₹ 18,00,000 + ₹ 3,60,000) ₹ 21,60,000
No. of Shares (6,00,000 + 90,000) 6,90,000
EPS (₹ 21,60,000)/6,90,000) ₹ 3.13
(c) Equivalent EPS of Beta Ltd.:
No. of new Shares 0.5

P 13.18
EPS ₹ 3.13
Equivalent EPS (₹ 3.13 x 0.5) ₹ 1.57 or ₹ 1.56
(d) New Market Price of Alfa Ltd. (P/E = 12):
Revised P/E Ratio of Alfa Ltd. 12 times
Expected EPS after merger ₹ 3.13
Expected Market Price (₹ 3.13 x 12) ₹ 37.56
(e) Market Value of merged firm:
Total number of Shares 6,90,000
Expected Market Price ₹ 37.56
Total value (6,90,000 x 37.56) ₹ 2,59,16,400
(ii) Present market Value of share of Beta Ltd. (100 x ₹ 14) ₹ 1,400
Revised market price of each share of Alfa Ltd. after Merger ₹ 37.56
Equivalent No. of Alfa Ltd. share in exchange of Beta Ltd. (0.50 x 100) 50
Equivalent Value of Alfa Ltd. share in exchange of Beta Ltd. ₹ 1,878

(100x 0.50 x ₹ 37.56)
Increase in Market Value (₹ 1,878 - ₹ 1,400) ₹ 478
No, I am not agreed to sell the stake as there is increase in market value.

P 14.1
Chapter 14
Startup Finance
Question 1
Explain the advantages of bringing venture capital in the company. (4 Marks May ‘18)
Answer 1
Advantages of bringing VC in the company:
 It injects long- term equity finance which provides a solid capital base for future growth.
 The venture capitalist is a business partner, sharing both the risks and rewards. Venture
capitalists are rewarded with business success and capital gain.
 The venture capitalist is able to provide practical advice and assistance to the company based
on past experience with other companies which were in similar situations.
 The venture capitalist also has a network of contacts in many areas that can add value to the
company.
 The venture capitalist may be capable of providing additional rounds of funding should it be
required to finance growth.
 Venture capitalists are experienced in the process of preparing a company for an initial public
offering (IPO) of its shares onto the stock exchanges or overseas stock exchange such as
NASDAQ.
 They can also facilitate a trade sale.
Overall performance was above average.
Question 2
Explain Angel Investors. (4 Marks Nov ‘18)
Answer 2
Angel investors invest in small startups or entrepreneurs. Often, angel investors are
entrepreneur's family and friends. The capital angel investors provide may be a one-time
investment to help the business propel or an ongoing injection of money to support and carry
the company through its difficult early stages.
Angel investors provide more favorable terms compared to other lenders, since they usually
invest in the entrepreneur starting the business rather than the viability of the business. Angel
investors are focused on helping startups take their first steps, rather than the possible profit
they may get from the business. Essentially, angel investors are the opposite of venture
capitalists.
Angel investors are also called informal investors, angel funders, private investors, seed investors
or business angels. These are affluent individuals who inject capital for startups in exchange
for ownership equity or convertible debt. Some angel investors invest through crowdfunding
platforms online or build angel investor networks to pool in capital.
Angel investors typically use their own money, unlike venture capitalists who take care of pooled
money from many other investors and place them in a strategically managed fund.Though
angel investors usually represent individuals, the entity that actually provides the fund may be a
limited liability company, a business, a trust or an investment fund, among many other kinds of
vehicles.
Angel investors who seed startups that fail during their early stages lose their investments
completely. This is why professional angel investors look for opportunities for a defined exit
strategy, acquisitions or initial public offerings (IPOs).
Chapter 14 Startup Finance
P 14.2
Question 3
Explain briefly the sources for funding a Start-up. (4 Marks May ‘19)
Answer 3
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 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 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 dependson one’s credit
worthiness and payment of more money.
(viii) Purchase order financing: The most common scaling problem faced by startups is the inability
to find a large new order. The reasonis 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 upfront and rest of the amount
later. Therefore, in this way, a startup can meet his day to day expenses.
Sources of Funding a Startup were answered well by the examinees and performance was
above average.
Question 4
State briefly the basic characteristics of venture capital financing? (4 Marks Nov ’19, Dec’21)
Answer 4
Basic characteristics of Venture Capital Financing:

P 14.3
(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.
This theoretical question on the concept of Venture Capital Financing was attempted well
by majority of examinees.
Question 5
What is a startup to avail the benefits of government scheme ? (4 Marks Nov ‘19)
Answer 5
Startup India scheme was initiated by the Government of India on 16 th of January, 2016. The
definition of startup was provided which is applicable only in case of Government Schemes.
 Startup means an entity, incorporated or registered in India (at the date of initiation of the
scheme):
 Not prior to five years (as per amendment 10 years),
 With annual turnover not exceeding Rs.25 crore (as per amendment Rs 100 crores) in
any preceding financial year, and
 Working towards innovation, development, deployment or commercialization of new
products, processes or services driven by technology or intellectual property.
Provided that such entity is not formed by splitting up, or reconstruction, of a business already
in existence. Provided also that an entity shall cease to be a Startup if its turnover for the
previous financial years has exceeded Rs. 25 crore or it has completed 5 years from the date
of incorporation/ registration. Provided further that a Startup shall be eligible for tax benefits
only after it has obtained certification from the Inter - Ministerial Board, setup for such
purpose.
Most of the examinees answered well in theoretical question on meaning of start up to

avail the benefits of government scheme.
Question 6
Peer – to – Peer Lending and Crowd funding are same and traditional methods of funding. Do you
agree? Justify your stand.(4 Marks Nov ‘20)
Answer 6
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
P 14.4
small and ethnic business groups having similar fai th 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 7
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 Nov
‘20)(4 Marks Dec’21)
Answer 7
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.
Though overall good performance has been noticed in this theoretical question on Startup
Finance but in some cases, student mentioned headings with no explanation.

P 14.5
Question 8
Venture Capital Funding passes through various stages. Discuss. (4 Marks Jan ‘21)
Answer 8
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 9
Non-bank Financial Sources are becoming popular to finance Start-ups. Discuss. (4 Marks Jan ‘21)
Answer 9
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
P 14.6
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 10
Explain Indicative Risk Matrix of each stages of funding for Venture Capital Financing. (4 Marks
July 21)
Answer 10
Risk in each stage is different. An indicative Risk matrix is given below:
Financial Stage Period (Funds Risk Perception Activity to be financed
locked in
years)
Seed Money 7-10 Extreme For supporting a concept or idea or
R&D for product development and
involves low level of financing.
Start Up 5-9 Very High Initializing prototypes operations or

developing products and its
marketing.
First Stage 3-7 High Started commercials production and
marketing.
Second Stage 3-5 Sufficiently high Expanding market and growing
working capital need though not
earning profit.
Third Stage 1-3 Medium Market expansion, acquisition &
product development for profit
making company. Also called
Mezzanine Financing.
Fourth Stage 1-3 Low Facilitating public issue i.e. going
public. Also called Bridge Financing.
Overall performance in this theoretical question was average as most of the students have
not correctly mentioned the elements of Period and Risk Perceptions in the Risk Matrix table.
Question 11
Explain Pitch Presentation. List the methods for approaching a Pitch Presentation. (4 Marks July 21)
Answer 11
Pitch Presentation is a short and brief presentation (not more than 20 minutes) to investors explaining
P 14.7
about the prospects of the company and why they should invest into the startup business. So, pitch deck
presentation is a brief presentation basically using PowerPoint to provide a quick overview of business
plan and convincing the investors to put some money into the business. Pitch presentation can be made
either during face-to-face meetings or online meetings with potential investors, customers, partners,
and co-founders. Some of the methods as how to approach a pitch presentation are as follows:
(i) Introduction: Introduction of the start up and a brief account of yourself.
(ii) Team: What sort of team is working with the startup and their core competence need to be
highlighted.
(iii) Problem: The promoter should be able to explain the problem he is going to solve and
solutions emerging from it.
(iv) Solution: It is very important to describe in the pitch presentation as to how the company is
planning to solve the problem.
(v) Marketing/Sales: This is a very important part where investors will be deeply interested. The
market size of the product must be communicated to the investors. The promoter can brief
the investors about the growth and forecast future revenue.
(vi) Projections or Milestones: Both financial and physical projections can be made. Some
projected statements may be presented like, Income Statement, Cash Flow Statement,
Balance Sheet etc.
(vii) Competition: Every business organization has competition even if the product or service
offered is new and unique. It is necessary to highlight in the pitch presentation as to how
the products or services are different from their competitors.
(viii) Business Model: The term business model is a wide term denoting core aspects of a business
including purpose, business process, target customers, offerings, strategies, infrastructure,
organizational structures, sourcing, trading practices, and operational processes and policies
including culture.
(ix) Financing: If a startup business firm has raised money, it is preferable to talk about how much
money has already been raised, who invested money into the business and what they did
about it.
Good performance has been observed in this theoretical question on Stratup Finance though in
some cases students mentioned lesser points and, in some cases, only headings have been
mentioned hence losing the marks unnecessarily.
Question 12
Average Annual Effective Interest Rate shall be computed as follows:
Define Angle Investors, are these only individuals? If not, list the entities. (4 Marks May ‘22)
OR
Enlist the criteria for an entity to be classified as a Startup entity under the Startup India Scheme
initiated by the Government of India. (4 Marks May ‘22)
Answer 12
Despite being a country of many cultures and communities traditionally inclined to business and
entrepreneurship, India still ranks low on comparative ratings across entrepreneurship, innovation and
ease of doing business. The reasons are obvious. These in clude our old and outdated draconian rules
and regulations which provides a hindrance to our business environment for a long time. Other reasons
are red-tapism, our time-consuming procedures, and lack of general support for entrepreneurship. Off
course, things are changing in recent times.
P 14.8
Angle Investors invest in small startups or entrepreneurs. Often angle investors are among the
entrepreneur’s family and friends.
Though angel investors usually represent individuals, the entity that actually provides th e fund may be
a limited liability company, a business, a trust or an investment fund, among many other kinds of
vehicles.
OR
As per Government Notification, an entity shall be considered as a Startup:
i. Upto a period of ten years from the date of incorporation/ registration, if it is incorporated as a
private limited company (as defined in the Companies Act, 2013) or registered as a partnership
firm (registered under section 59 of the Partnership Act, 1932) or a limited liability partnership
(under the Limited Liability Partnership Act, 2008) in India.
ii. Turnover of the entity for any of the financial years since incorporation/ registration has not
exceeded one hundred crore rupees.
iii. Entity is working towards innovation, development or improvement of products or processes or
services, or if it is a scalable business model with a high potential of employment generation or
wealth creation.
Provided that an entity formed by splitting up or reconstruction of an existing business shall snot be
considered a ‘Startup’.
Question 13
What do you mean by Bootstrapping? Explain the method of Trade Credit used by the startup firms in
bootstrapping. (4 Marks Nov 22)
Answer 13
An individual is said to be boot strapping when he or she attempts to found and build a company from
personal finances or from the operating revenues of the new company. 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 way to reduce the amount of working capital one needs.
This is especially true in retail operations.
Question 14
Write a short note on Venture Capital Fund. (4 Marks Nov 22)
Answer 14
Venture Capital Fund means investment vehicle that manage funds of investors seeking to invest in
startup firms and small businesses with exceptional growth potential. Venture capital is money
provided by professionals who alongside management invest in young, rapidly growing companies
that have the potential to develop into significant economic contributors.
Venture Capitalists generally
 Finance new and rapidly growing companies
 Purchase equity securities
 Assist in the development of new products or services
 Add value to the company through active participation.


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Strategic Financial

Past Papers Compilation

Naresh pasupuleti | 9959791590

EXAMINERS’ COMMENTS ON THE PERFORMANCE OF EXAMINEES:

In this theoretical question, performance was of above average level.

Naresh pasupuleti | 9959791590 Chapter 1 Financial Policy & Corporate Strategy

EXAMINERS’ COMMENTS ON THE PERFORMANCE OF EXAMINEES:

(i) What makes an Organization Sustainable?

 have an adequate administrative and financial infrastructure;

SI. No Particulars Amount in ₹ Lakhs

Naresh pasupuleti | 9959791590 Chapter 1 Financial Policy & Corporate Strategy

VAR can be applied

EXAMINERS’ COMMENTS ON THE PERFORMANCE OF EXAMINEES:

(6) Use of performance guarantee, insurance or other instruments.

EXAMINERS’ COMMENTS ON THE PERFORMANCE OF EXAMINEES:

(a) Compliance risk and

EXAMINERS’ COMMENTS ON THE PERFORMANCE OF EXAMINEES:

Investment in shares of ABC Ltd. Rs. 200 lakh

The standard deviation of the 10-day change

Naresh pasupuleti | 9959791590

An average performance has been observed in this question.

EXAMINERS’ COMMENTS ON THE PERFORMANCE OF EXAMINEES:

Days Open High Low Close

8 33326.84 33340.91 33306.17 33335.08

Days Date Closing Values of NIFTY

(ii) EMAt = a X Pt + (1 – a) (EMA (t – 1)) Where, a = exponent, Pt = Price of today

Naresh pasupuleti | 9959791590

PV factor for 8% for year 5 : 0.681 (6 Marks May ‘18)

Overall performance was very good.

Recommendation: Refunding of bonds is recommended as NPV is positive.

Before tax (1,150 – 1,000) 30,000 45,00,000

Before tax (0.14 2/12 3 crores) 7,00,000

Market price Rs. 10  8 = Rs. 80 per share Cost

(2) Market Price = % !" #$ %

(4) Cost of Capital

(5) Market Price =

Year 1 (D1) = 5 (1.1) = 5.5

= 4.785 + 4.574 + 4.379

'.' &. '.)

Therefore, P0 = 69.88 x 0.658 = 45.98

EXAMINERS’ COMMENTS ON THE PERFORMANCE OF EXAMINEES:

II. Number of equity shares that can be re-purchased.

(I) Market Capitalization after Buyback

= 23 lakhs P – 90 lakhs 1.15

(II) Number of Shares to be Bought Back :-

Rs. 90 lakhs/ 21.89 = 4.111 lakhs (Approx.) or 411147 shares

EXAMINERS’ COMMENTS ON THE PERFORMANCE OF EXAMINEES:

Equity Share Capital (Rs. 10 each) Rs. 200 Lakh

(i) Prepare Income Statement for the year 2018.

Tax rate = 30%

Calculation of fair price of share using dividend discount model

Growth Rate = 14.35% or 16.76%

EXAMINERS’ COMMENTS ON THE PERFORMANCE OF EXAMINEES:

The following data are available for a bond:

(i) Current market price of the Bond,

(ii) Macaulay’s Duration

Duration of the Bond is 4.252 years

(iii) Volatility of Bond