Question Paper Investment Banking and Financial Services – I (261) : July 2002 Part A : Basic Concepts (30 Points) • • • • 1.
This part consists of questions with serial number 1 - 30. Answer all questions. Each question carries one point. Maximum time for answering Part A is 30 Minutes.
Which of the following is/are true regarding Participation Certificates? I. They are issued by banks to other banks to share the credit assets of the banks. II. They provide long term funds while they are also used for risk reduction. III. The rate of these instruments is negotiable. a. b. c. d. e.
2.
Only (I) above Only (III) above Both (I) and (II) above Both (I) and (III) above All (I), (II) and (III) above.
Which of the following is/are true regarding reverse repos? I.
Simultaneous buying and selling of same security at a predetermined future date and predetermined price is referred to as reverse repo II. NBFCs cannot enter into reverse repos III. The minimum maturity for repo transaction is 1 day. a. b. c. d. e. 3.
The maximum intra-day trading limit for a broker, as set by SEBI, is a. b. c. d. e.
4.
Only (I) above Only (II) above Only (III) above Both (I) and (II) above Both (I) and (III) above.
33.33% of the base minimum capital 33.33% of the base minimum capital and additional capital Equal to base minimum capital and additional capital 33.33 times the base minimum capital 33.33 times the base minimum capital and additional capital.
Which of the following is/are true regarding Bankers to the Issue? I. A scheduled bank can be a banker to the issue. II. Registration with SEBI to act as banker to the issue is not mandatory III. There are no restrictions on the number of banks that can be associated with an issue. a. b. c. d. e.
Only (II) above Only (III) above Both (II) and (III) above Both (I) and (II) above Both (I) and (III) above.
1
5.
Which of the following is/are true regarding financial and operating leases? a.
b. c. d. e. 6.
According to FASB, if the present value of lease payments exceed 75 per cent of the fair market value of the asset at the inception of the lease, then the lease is termed as financial lease. In operating leases, the leases fully amortize over the lease period. In an operating lease if the lessee bears the cost of insuring, maintaining , then the lease is referred to as dry lease. The lessee enjoys the right to terminate the lease at short notice without significant penalty in case of financial leases. Operating leases are generally structured for leasing investment intensive assets.
Easy Finance offers hire purchase plan for its corporate borrowers on the following terms: Flat rate of interest 10 per cent Repayment period 4 years Frequency of payment Quarterly in advance Down payment 25 per cent The annual percentage rate using the approximation formula is a. 28.4% b. 26.7% c. 21.3% d. 18.8% e. 16.0%.
7.
Which of the following is/are true regarding Mortgage Backed securitization? I. Mortgage has to exist necessarily at the time of securitization II. It is backed by movable and easily traceable immovable property III. It gives high yields to the investor compared to asset backed securitization a. b. c. d. e.
8.
Recently, RBI issued a tender notification for 91-day treasury bills of Rs.100 each for Rs.500 crores. Mr.X, one of the competitive bidders who responded to the notification has submitted the tender quoting a price of Rs.98.95. If the cut-off price was determined as Rs.98.45 and the tender of Mr.X was accepted, the yield that would be earned by Mr.X will be a. b. c. d. e.
9.
Only (I) above Only (II) above Both (I) and (II) above Both (II) and (III) above All (I), (II) and (III) above.
3.95% 3.97% 4.26% 5.21% 6.31%.
Appointment of which of the following intermediaries is/are mandatory for an issue? a. b. c. d. e.
Brokers to the issue Underwriters to the issue Legal advisor Bankers to the issue Both (a) and (d) above.
2
10. Which of the following is/are true regarding Pledged-account Mortgages (PAMs)? I.
The repayments under PAMs resemble graduated payment mortgages from the borrower’s point of view II. Under PAMs, a pledged account is created by the seller out of his profits in order that additional amounts required may be drawn and paid along with the mortgage payments III. PAMs are used by borrowers who have sufficient cash on hand, but face an income or cash flow shortage for the first few years. a. b. c. d. e.
Only (I) above Only (II) above Both (I) and (II) above Both (I) and (III) above All (I), (II) and (III) above.
11. In which of the following forms of factoring, service elements of factoring are not carried by the factor? a. b. c. d. e.
Invoice Discounting Supplier Guarantee Factoring Bulk Factoring Old Line Factoring Both (a) and (c) above.
12. Which of the following conditions should a company fulfill to raise capital through ADR level -III issue? a. b. c. d. e.
The company has to comply with the US GAAP The company has to be registered with SEC The company has to comply with listing requirements of AMEX/ NYSE Both (a) and (b) above All (a), (b) and (c) above.
13. Consider the following information regarding a finance scheme offered by Flexi Finance Ltd.: Repayment Period Equated monthly Installment Deposit Cost of the asset
60 months Rs. 3,500 Rs. 10,000 Rs.1,25,000.
The flat rate of interest of the above scheme is a. b. c. d. e.
11.1% 12.0% 13.6% 15.2% 16.5%
14. The US dollar denominated bond issued by foreign borrowers in the US market is known as a. b. c. d. e.
Alpine bonds Bulldog bonds Samurai bonds Shibosai bonds Yankee bonds.
3
15. Which of the following is/are true regarding Commercial Papers (CPs)? I. Primary dealers are not allowed to raise funds through CPs II. Foreign institutional investors are allowed to invest in CPs III. Issuers are allowed to buy-back their own CPs. a. b. c. d. e.
Only (II) above Both (I) and (II) above Both (I) and (III) above Both (II) and (III) above All (I), (II) and (III) above.
16. XYZ Ltd. has accepted public deposits amounting to Rs.25 lakhs that are payable after 15 months. The maximum amount of brokerage payable for soliciting these deposits is a. b. c. d. e.
Rs.25,000 Rs.30,000 Rs.37,500 Rs.50,000 Rs.62,500.
17. Rights issue should be kept open for a minimum period of a. b. c. d. e.
15 days 30 days 40 days 45 days 60 days.
18. Vani Agro Products Ltd has leased an equipment costing Rs.100 lakhs at an annual lease rental of Rs.36 ptpm for a period of 3 years. The cost of capital and cost of pre-tax debt of the company is 9 per cent and 15 per cent respectively. If the effective tax rate of the company is 25%, according to Bower Model the amount of debt which will be raised in lieu of lease will be equal to a. b. c. d. e.
Rs. 98.63 lakhs Rs.100.00 lakhs Rs.113.42 lakhs Rs.125.54 lakhs Rs.130.60 lakhs.
19. Which of the following forms of real estate loans advanced by savings and loan associations in addition to the bank construction loan enables the developer to obtain 100% financing for the real estate development without the need to bring in personal funds? a. b. c. d. e.
Mini-perms Gap loans Bow-tie arrangement Both (a) and (b) above None of the above.
4
20. Which of the following is/are true regarding hire purchase contract? I.
a. b. c. d. e.
On early repayment, if interest rebate is calculated as per Rule of 78, the effective rate of interest on completed transaction will be lower than the effective interest rate of original transaction 2 t II. Interest rebate calculated as per Hire purchase Act, 1972 (i.e. × × D will be 3 n lower than the interest rebate as per Rule of 78 if the number of unpaid and notdue installments exceed 2/3 × (number of installments – 1) III. Interest rebate calculated as per Modified Rule of 78 will be zero if not-due and outstanding installments is less than or equal to the deferment period Only (II) above Only (III) above Both (I) and (II) above Both (II) and (III) above All (I), (II) and (III) above.
21. The maximum reservation in a proposed public issue to the employees of the issuer company is a. b. c. d. e.
3% 5% 10% 20% 25%
22. If a bank issued a Certificate of Deposit of face value of Rs.5 lakhs with maturity period of 91 days and at a discount rate of 9 per cent per annum, the discounted value of the deposit is a. b. c. d. e.
Rs.4,89,027 Rs.4,58,716 Rs.4,57,422 Rs.2,85,321 Rs.3,63,750.
23. Second Factors Ltd. has agreed to advance a sum of Rs.75 lakhs against the receivables purchased from ABC Ltd. The factoring agreement provides for an advance payment of 75% of value of the factored receivables and for guaranteed payment after 3 months from the date of purchasing the receivables. The advance carries a rate of interest of 16% p.a. compounded quarterly and the factoring commission is 1 percent of the value of the factored receivables. Both the interest and commission are collected upfront. The per annum effective cost of funds made available to ABC Ltd. is a. b. c. d. e.
16.92% 17.74% 18.02% 23.10% 24.49%.
24. Consider the following information: Aggregate value of the house Land component Progress of construction Borrower’s contribution Cumulative disbursement made
Rs.12,00,000 30% 75% Rs.2,00,000 Rs.4,00,000
The amount of disbursement that will be made by the housing finance company is a. b. c. d. e.
Rs.2,41,000 Rs.3,90,000 Rs.5,90,000 Rs.7,90,000 Rs.9,60,000. 5
25. Which of the following is/are true regarding rights issue by listed companies? I. If the rights issue exceeds Rs.40 lakhs, appointment of SEBI registered merchant banker is mandatory II. If the company does not receive atleast 90% of the issue amount (including devolvement from underwriters) within 42 days from the date of closing the issue, the amount received should be refunded. III. No bonus issue should be made within 1 year from the date of issue. a. b. c. d. e.
Only (I) above Only (II) above Both (I) and (II) above Both (II) and (III) above All (I), (II) and (III) above.
26. In which of the following types of plastic money, revolving credit payment is available to the user? a. b. c. d. e.
Credit card Debit card Charge card Both (a) and (c) above None of the above.
27. Which of the following is false with respect to credit rating? a. b. c. d. e.
A credit rating reflects borrower’s accountability A credit rating reflects the borrower’s expected capability and interest to pay the interest and principal amount on time A credit rating is a general purpose evaluation of the issuer A credit rating is not an extensive audit of the issuing company A credit rating involves issue specific evaluation.
28. Videsh Electronics Limited has leased an equipment costing Rs.70 lakhs from Perfect Leases Limited for a period of 4 years at a lease rental of Rs.350 ptpa payable annually in advance. If the marginal cost of debt and marginal cost of capital of Videsh is16 per cent and 12 per cent respectively, of Perfect Leases Ltd. is 12 percent and 10 percent respectively, the asset should be capitalized at (Assume negligible salvage value of the asset). a. b. c. d. e.
Rs.70.00 lakhs in the books of Videsh Electronics Ltd. Rs.70.00 lakhs in the books of Perfect Leases Ltd. Rs.74.41 lakhs in the books of Perfect Leases Ltd. Rs.79.52 lakhs in the books of Videsh Electronics Ltd. Rs.79.52 lakhs in the books of Perfect Leases Ltd.
29. ABC Finance Ltd. had share underwriting obligations worth Rs.5 lakhs in its off balance sheet items. The risk adjusted value of the item while calculating the capital adequacy ratio is a. b. c. d. e.
Rs.1.25 lakhs Rs.2.50 lakhs Rs.3.75 lakhs Rs.5.00 lakhs Rs.7.50 lakhs.
30. Quasi-equity instruments for funding venture companies entailing a minimum obligation at reasonably low levels of performance and an upside sharing component a. b. c. d. e.
Are the least preferred financial instruments by the venture companies Involve payments during the growth phase of the investee company May carry with them a number of protective covenants Cannot be structured Both (b) and (c) above. END OF PART A 6
Part B : Problems (50 Points) • • • • • 1.
2.
This part consists of questions with serial number 1 – 5. Answer all questions. Points are indicated against each question. Detailed workings should form part of your answer. Do not spend more than 110 - 120 minutes on Part B.
Zed Pharma Ltd. (ZPL) requires a plant costing Rs.20 crore for its expansion program. The inflows from the expansion are estimated to begin from the end of one year. The life of the required plant is 5 years and the salvage value at the end of 5 years is estimated to be negligible. The tax relevant rate of depreciation of the plant is 25%. ZPL has approached Siti Financial Services Ltd. (SFSL) to fund its investment through leasing. SFSL offers leasing, hire purchase and bill discounting facilities to its customers. SFSL, under leasing structures flexible lease transactions so that it earns a gross yield of 24% p.a. To match with its inflows ZPL has requested SFSL to structure the lease transaction in such a way that the lease payments would begin from the end of one year and increase at the rate of 4% p.a. for a period of 4 years. SFSL requires quarterly in advance lease payments. However, assume the lease payments during a year are equal. SFSL, alternatively, has offered the hire purchase facility for a period of 5 years under which it charges a flat rate of interest of 14%. Under hire purchase, SFSL requires quarterly in advance hire payments. The marginal cost of debt and capital of ZPL is 16% and 12% respectively and its marginal tax rate is 35%. The allocation of interest is based on SOYD method. Assume that under hire purchase, SFSL will agree for deferment of the first four quarter payments to be paid along with the fifth quarter payment without any substantial penalty from ZPL. You are required to a. Determine the lease rentals payable by ZPL. b. Compare lease and hire purchase facilities from the view point of ZPL and choose the best alternative of funding its investment. (4 + 11 = 15 points) Raj Techno Park, a newly built techno park, proposed to raise a foreign currency loan worth Euro 10 million for further expansion. A foreign bank has given a proposal of extending the loan in Euro on the following terms and conditions: Draw down Coupon Commitment fee Management fee Guarantee fee Agency fee Underwriting fee Amortization
Euro 6 million on August 01, 2002 and Euro 4 million on August 01, 2003 Paid annually at 250 BPs over LIBOR 50 BPs per annum payable at the end of the year 40 BPs payable upfront 60 BPs per annum payable at the beginning of the year 0.05 percent of the loan amount sanctioned, payable at the end of every year 15 BPs payable upfront Euro 5 million payable on July 31, 2007 Euro 5 million payable on July 31, 2008
The following LIBOR rates and the exchange rates as on the payment day during the year are predicted by Raj Techno Park: Year 2002 2003 2004 2005 2006 2007 2008
LIBOR (%) 3.0 3.5 3.8 4.2 4.6 4.4 4.3 7
Rs./Euro 46 48 50 48 47 46 45
Assume the foreign bank will release the loan in Euro which will be converted in to rupees by the borrower and the borrower will repay the loan in Euro to the foreign bank at the prevailing exchange rate as predicted above. You are required to determine whether Raj Techno Park should avail the loan or not if the maximum effective cost of loan to Raj Techno Park is 6%. (9 points) 3.
The following balance sheet pertains to Geekay Ltd. for the year ending March 31, 2002: Liabilities Share Capital Authorized Share capital (4 cr shares of Rs.10 each) Issued and Paid up (1.cr. shares of Rs.8 each) Reserves General reserve Capital redemption reserve Capital reserve Revaluation reserve Share Premium 16% FCDs Secured Loans Current liabilities & Provisions
Amount 40.00 8.00
5.00 1.50 0.75 0.50 1.00
Assets Net Fixed Assets
(Rs. Crore) Amount 14.75
Investments
2.50
Current Assets
6.00
8.75 2.00 3.00 1.50 23.25
23.25
The following information is extracted from the books of Geekay Ltd. i. Capital reserve consists of Rs.50 lakhs profit realized on sale of some old machinery during the year. ii. Geekay Ltd. purchased some valuable patents from Beekay Ltd. The purchase consideration of Rs.60 lakhs being settled by allotting 6 lakh equity shares of Geekay Ltd. iii. FCDs of face value of Rs.150 each is due to be converted to 3 equity shares of Rs.50 each on October 2002. iv. Revaluation reserves consists of Rs.40 lakhs which was realized on a machinery that was revalued earlier and sold during the year 2001-2002 at its revalued amount. The Board of directors of Geekay Ltd. are intending to utilize the reserves to make the partly paid shares fully paid up and declare bonus issue at its AGM to be held during July 2002. You are required to a. Compute the maximum permissible bonus ratio. b. State the latest by which date, Geekay Ltd. has to implement this proposal of bonus issue. 4.
(7 + 1 = 8 points) First Venture Biotechnics Ltd. (FVBL) has projected their next year sales at Rs.400 crores. The finance manager of FVBL has developed an analysis on their management as follows: Terms of credit
1/15, net 30 th
Proportion of customers paying on 15 day
20%
Proportion of customers paying on 30th day
50%
Proportion of customers paying on 50th day
30%
Bad-debts to sales ratio
0.01
Jai Hind Bank finances 70% of receivables at 20% p.a. and the balance 30% is financed through own funds at a pre-tax cost of 26%. The finance manager of FVBL was approached by Best Factor Services Ltd. and was offered the following factoring arrangement. 8
a. b. c.
Factor’s commission of 2.5% will be charged Factor shall advance 75% of the face value of receivables 50% of the factor reserves will be provided by National Bank Ltd. at the rate of 22% p.a. and the balance of money will be remitted on 30th day of sales d. The factoring is of non-recourse type. The finance manager of FVBL estimates to avoid the following costs if factoring is availed: i. Cost of accounting and collection of receivables of Rs.1 crores ii. Loss of sales of Rs.20 crores on account of using the sales force on collection of receivables. The gross profit margin on sales is 23.25%. Assume 360 days in a year. You are required to find out the maximum interest rate that can be payable by FVBL on the factor advances so that factoring is beneficial when compared to the in-house management of receivables. 5.
(9 points) Mega Financial Services Ltd. (MFSL) offers finance to individuals to purchase four wheelers on the following terms: i. Deposit of 20% of the cost of the asset should be made at the inception of the transaction. ii. 48 EMIs have to be made each at the beginning of every month iii. Front end service charge of 2% should be made. Deposit carries an interest of 12% p.a. compounded monthly and would be repaid on the payment of the last installment. You are required to: a. Calculate the maximum monthly payments to be made by a borrower if his effective cost of fund is 20% p.a. and cost of the asset is Rs.3 lakhs. b. Calculate the flat rate of interest of the above transaction. Assume the EMIs as obtained in (a) above. c. Calculate the effective interest rate on the completed transaction if the borrower would like to make the prepayment at the end of 36 months. The company offers an interest rebate calculated in accordance with the Rule of 78 method. Assume the EMIs as obtained in (a) above. (4 + 1 + 4 = 9 points) END OF PART B
Part C : Applied Theory (20 Points) • • • • 6.
7.
This part consists of questions with serial number 6 - 7. Answer all questions. Points are indicated against each question. Do not spend more than 25 -30 minutes on Part C.
The Indian venture capital industry has attempted to maintain the risk-reward sharing nature of the relationship through a variety of innovative instruments for structuring the investment. Discuss the various categories of investments in the Indian venture capital industry. (10 points) RBI has introduced Commercial Papers (CPs) with a view to enable highly rated corporate borrowers to diversify their sources of short-term borrowings and also providing an additional instrument to investors. (a) Discuss the issuing procedure of CPs and (b) state the various reasons for the underdevelopment of CPs. (7 + 3 = 10 points) END OF PART C END OF QUESTION PAPER
9
Suggested Answers Investment Banking and Financial Services – I (261) : July 2002 Part A : Basic Concepts 1.
Answer : (d) Reason : Statement I is “true” because the major activity of a bank is credit accommodation, which places the bank in a tight liquidity position. In order to ease their liquidity position. The banks can share their credit risk with other banks by issuing participation certificates. Statement III is also “true”. The rate at which the participation certificates are issued is negotiable and depends upon the interest rate scenario. Statement II is “False” because the participation certificates can be used for providing short-term funds and also for risk reduction. Therefore (d) is the correct alternative.
2.
Answer : (e) Reason : Statement I is “true”; Reverse repos are forward deals or agreements involving buying of a security with an undertaking to sell the same security at a predetermined price and time in future. Hence it involves a simultaneous buying and selling. Statement (III) is true; From 10th October 2000, the minimum maturity for repo transactions is reduced to 1 day following the recommendations of Narasimham Committee. Statement II is “false” because NBFCs are permitted to enter into both repo and reverse repo transactions. Therefore ‘e’ is correct alternative.
3.
Answer : (e) Reason : As a part of the capital adequacy norms for the brokers, SEBI had directed that the intra-day trading limits for a broker would be 33 1/3 times the sum of their base minimum capital and additional capital.
4.
Answer : (e) Reason : Statement I is “true”; it is one of pre-conditions that the banker to issue should be a scheduled bank before SEBI grants a Certificate of Registration as banker to issue. Statement III is also “true”; there are no restrictions on the number of banks that can be associated with an issue. Each bank designates one particular branch as the controlling branch. Statement II is “False” because registration with SEBI is mandatory for offering services as Banker to an issue. Therefore ‘e’ is the right answer. Answer : (c) Reason : Statement ‘c’ is true; an operating lease where the lessee bears the costs of insuring and maintaining the leased equipment is called a ‘dry lease’. Statement ‘a’ is not true. According to the FASB definition, if the lease term exceeds 75% of the useful life of the asset or if the present value of the minimum lease payments exceeds 90% of the fair market value of the asset at the inception of the lease, it is termed as finance lease. Statement ‘b’ is not true because in operating leases, the lease is not fully amortised. Statement ‘d’ is false because the lessee enjoys the right to terminate the lease at short notice without any significant penalty in a operating lease (and not in finance lease). Statement ‘e’ is not true because finance leases are structured for leasing investment intensive assets and operating leases are generally structured in Sunrise Industries which are characterized by high degree of technological risk. Therefore ‘c’ is the right answer.
5.
6.
Answer : (c) Reason : Given that the payments are made in advance, according to Approximation Formula, n × 2.F Iapp = n −1 N = no. of payments = 4 × 4 = 16 F = 10% ∴ Iapp =
16
× 2 × 0.1 15 = 21.33% 10
7.
Answer : (c) Reason : Statement (I) and (II) are true; In Mortgage Backed Securitization, (MBS) mortgage has to exist necessarily at the time of securitization and it is backed by easily traceable immovable property like real estate. Statement (III) is false; MBS gives low yields to the investors compared to the Asset Backed Securitization. Therefore, ‘c’ is the right answer.
8.
Answer : (c) 365 FaceValue −1 × Price No. of days to maturity
Reason : Yield in Treasury Bills = F. value Price Days to maturity
100 365 − 1 × = 0.04256 = 91 98.95 = 4.26% The cut-off price is immaterial for the calculation of yield to the investor as auction of T-Bills are done according to English Auction. Answer : (d) Reason : Only the appointment of Bankers to the issue is mandatory for an issue. Appointment of other intermediaries like Brokers, Underwriters and legal advisor to the issue is optional and not mandatory. ∴
9.
= 100 = 98.95 = 91
Yield
10. Answer : (d) Reason : Statements (I) and (III) are true. Pledged – Account Mortgages (PAMs) are structured such that the repayments resemble traditional mortgages from the lender’s point of view and the repayments resemble Graduated Payment Mortgages (GPMs) from the borrower’s point of view. Also PAMs are used by borrowers who have sufficient cash on hand, but face an income or cash flow shortage for first few years. Statement (II) is untrue because it is under Buy Down Loans (and not PAMs) that a pledged account is created by the seller out of his profits in order that additional amounts required may be drawn and paid along with mortgage payments done by the borrower. Therefore ‘d’ is the correct alternative. 11. Answer : (e) Reason : Invoice Discounting a form of factoring in which the factor provides pre-payment but does not carry the service elements of factoring. If the invoice discounting facility is not confidential, the customers of the client are advised to make payment directly to the factor. In such a case Invoice Discounting is referred to as ‘Bulk Factoring’. In supplier Guarantee Factoring, the factor offers services like following up with the customer, etc and in old-line factoring the factor provides the entire spectrum of services. Therefore (e) is the correct alternative. 12. Answer : (e) Reason : ADRs are divided into 3 levels based on the regulation and privilege of each company’s issue. ADR Level-III is used for raising fresh capital through public offering in the US capital markets. The company has to be registered with the SEC and comply with the listing requirements of MAEX/NYSE while following the US-GAAP. Thus company should fulfill all the conditions. Hence, ‘e’ is the correct alternative. 13. Answer : (c) Reason : Loan amount Repayment period Total charge for credit ∴
Annual charge
∴ Flat rate of interest
= = = =
Rs.1,25,000 60 months. (3500 × 60) – 1,25,000 Rs.85,000 85,000 = = Rs.17,000 5 Annual charge = ×100 = Loan amount = 13.6% 11
17,000 ×100 1,25,000
14. Answer : (e) Reason : Yankee bonds are the US dollar denominated issues by foreign borrowers (usually foreign governments or entities, supranational and highly rated corporate borrowers) in the US bond markets. Bulldog bonds are sterling denominated foreign bonds which are raised in the UK domestic securities market. Samurai bonds are bonds issued by non-Japanese borrowers in the domestic Japanese markets. Shibosai bonds are privately placed bonds issued in the Japanese markets. Hence ‘e’ is the right answer. 15. Answer : (d) Reason : Statements (II) and (III) are true; Recently SEBI has permitted foreign institutional investors (FIIs) to invest in Commercial Papers (CPs) within a ceiling of $ 1.5 billion of total FII inflows for debt funds set down by RBI. Unlike in Certificate of Deposits (CDs), the issuer can buy-back its own CPs. Statement (I) is wrong; Since any private sector company, public sector unit, nonbanking company, Primary Dealers (PDs), Satellite Dealers (SDs), etc. can raise funds through CPs. Hence (d) is the right alternative. 16. Answer : (c) Reason : Brokerage is 1.5% of the amount of public deposits raised if the tenure of the deposit is between one and two years. ∴ Brokerage
=
25,00,000 × 0.015
=
37,500.
17. Answer : (d) Reason : According to SEBI guidelines a rights issue should be kept open for a minimum of 30 days and a maximum of 60 days. Hence, (b) is the correct answer. 18. Answer : (b) Reason : According to Bower’s model, the amount of debt raised in lieu of lease is equal to the cost of leased equipment i.e. Rs.100 lakhs. 19. Answer : (c) Reason : Gap loans are lent by both larger and smaller savings and loan associations to the developer to cover the gap between the bank construction loan and the total cost of the project. They provide 100% financing to the developer without the need to bring in personal funds or to form a partnership. Also the developer is entitled to usual percentage of profits. Alternatives (a) and (b) are not correct because Bow-ties and Mini perms protect the borrowers from volatile interest rates. They provide short-term loans as a bridge finance until the developer can obtain financing of a permanent nature. 20. Answer : (b) Reason : Statements (II) and (III) are true. If ‘t’ (number of installments unpaid and not-due) exceeds 2 × (n – 1), the Rule of 78 will provide an interest rebate higher than the amount calculated as 3 2 t × × D. According to the Modified Rule of 78, if the number of unpaid per the formula 3 n and not-due installments are less than the deferment period, interest rebate will be Zero. Statement (I) is false; if the hirer opts for an early repayment and gets interest rebate according to Rule of 78, then he will pay an effective rate of interest higher than that implied by original transaction. 21. Answer : (c) Reason : According to SEBI Guidelines, the maximum reservation in a public issue for the employees of the issuer company is 10%.
12
22. Answer : (a) Reason : Discounted value (DR) =
F Ix N 1 + 100 x 365
F – Face Value – Rs.5,00,000 I – discount rate – 9% N – Days to Maturity – 91 days DR =
5,00,000
9 x 91 1+ 100 x 365
= Rs.4,89,027
23. Answer : (c) Reason : Funds made available to ABC Ltd. : Maximum permissible Advance Less: Commission @ 1% on factored 75 receivables × 0.01 0.75
75 lakhs 1 lakhs
74 lakhs Less: Discount @ 16% = 75 × 0.16 ×
90
3 lakhs
360
∴ Funds available to ABC Ltd.
71 lakhs
Discount charge expressed as percentage of funds available =
3 ×100 = 4.23% 71
Effective cost of funds per annum = [(1.0423)4 – 1] × 100 = 18.02%. 24. Answer : (b) Reason : Amount of disbursement (RD) is calculated as follows: Given Aggregate value (AV)
=
Rs.12,00,000
Land component (LC)
=
30%
à Cost of construction (CC)
=
70%
Progress of construction (PC)
=
75%
Borrower’s contribution (BC)
=
Rs.2,00,000
Cumulative Disbursement made (CM) =
Rs.4,00,000
∴
RD =
AV × CC/100 × PC/100 + AV × LC/100 – BC – CM
=
12,00,000 ×
=
Rs.3,90,000
70 75 30 × + 12,00,000 × 100 100 100
– 2,00,000 – 4,00,000
25. Answer : (d) Reason : Statements (II) and (III) are true; If the company does not receive at least 90% of the issued amount (including accepted devolvement from underwrites), within 42 days from the date of closing the issue, the amount of subscription received is required to be refunded. No bonus issue is to be made within 12 months from the date of issue. Statement (I) is wrong; when issue of shares by way of rights by a listed company does not exceed Rs.50 lakhs, appointment of a merchant banker is not mandatory.
13
26. Answer : (a) Reason : Revolving credit facility on amount of payment is available to credit card holders. In case of charge card, amount of payment is 100% of the purchase and in case of debt card, the holder is required to open a deposit account and on every purchase, the amount of purchase is directly debited to his account. 27. Answer : (c) Reason : Credit rating is not done to evaluate the issuer. Rating reflects the borrower’s accountability, expected capability and inclination to pay interest and principal in a timely manner. It involves issue-specific evaluation. Rating is not an extensive audit of the issuing company. 28. Answer : (a) Reason : According to the new ICAI guidelines, the leased asset should be capitalized in the books of lessee at the fair market value or the present value of the minimum payments, whichever is lower. i.
Fair Market Value of the equipment – Rs.70 lakhs
ii.
Present value of the minimum lease payments for Videsh is: =
350 70 x × PVIFA(16,4) × 1.16 1000
=
(70 x 0.35) × 2.798 × 1.16
=
Rs.79.52 lakhs
As the present value of the minimum lease payments is more than the fair market value, the asset should be capitalized at Rs.70 lakhs in Videsh Electronics Ltd. Perfect Leases Ltd. should record the present value of lease rentals as part of current assets. 29. Answer : (b) Reason : The risk adjusted value of any off-balance sheet item is calculated by multiplying the face value of each of the balance sheet items by the “credit conversion factor” (in percent) For the shares/debenture underwriting obligations, conversion factor is 50% ∴ If ABC Finance Ltd. had share underwriting obligations worth Rs.5 lakhs in its off-balance sheet items, risk adjusted value = 5 × 0.5 = Rs.2.5 lakhs 30. Answer : (e) Reason : Quasi-equity instruments come in the form of a loan on which there is a minimum obligation contracted at reasonably low levels irrespective of performance and an upside sharing component. Sometimes they come with a number of protective covenants including option to appoint nominee(s) and occasionally an option to convert the loan into equity shares in the investee company. They also involve cash pay-outs from the investee company during its growth phase, when the company needs to conserve case. Hence, (b) and (c) are true. Term loans are generally least preferred financial instruments.
14
Part B : Problems 1.
a.
b.
Let the lease rentals payable by ZPL be Rs.x crores per quarter in the second year. Then, PV of lease rentals = [4x × i/d4 PVIF24,1 + 4x(1.04)PVIF 24,2 i/d4 + 4x (1.04)2 PVIF 24, 3 i/d4 + 4x(1.04)3 PVIF 24,4 i/d4] PVIF 24,1 = 4x × i/d4 [PVIF 24,1 + 1.04 PVIF 24,2 + (1.04)2 PVIF 24,3 + (1.04)3 PVIF 24,4] PVIF 24,1 = 4x × 1.146 [0.806 + 1.04 × 0.65 + (1.04)2 0.524 + (1.04)3 0.423] × 0.806 = 11.573x × 0.806 = Rs.9.328x At the gross yield of 24% p.a., PV of lease rentals = Investment cost ⇒ 9.328x = 20 20 = Rs.2.144 crores. x = 9.328 Cost of leasing i. PV of lease rentals at pre-tax cost of debt of 16% = 4x × i/d4 [PVIF16,1 + 1.04 PVIF16,2 + (1.04)2 PVIF16,3 + (1.04)3 PVIF16,4] PVIF16,1 = 4.392x [0.862 + 0.773 + 0.693 + 0.621] 0.862 = 11.165x = 11.165 × 2.144 = Rs.23.938 crores ii. PV of tax shield on lease payments = PVIF12,1 × 4 x 2.14 + [PVIF12,1 + 1.04 PVIF12,2 + (1.04)2 PVIF12,3 + (1.04)3 PVIF12,4] 0.35 = 0.893 × 4 × 2.144 [0.893 + 0.797 × 1.04 + 0.712 + 1.042 + 0.636 × 1.043] 0.35 = 7.658 [3.207] 0.35 = Rs.8.596 crores Cost of leasing = (i) – (ii) = 23.938 – 8.596 = Rs.15.342 Cost of Hire Purchase: 20 × 0.14 × 5 + 20 Quarterly hire installments = = Rs.1.7 crores 5× 4 iii.
= 4 × 1.7 PVIF16,1 + 4 × 1.7 PVIFA16,4 PVIF16,1 × i/d4 = 5.862 + 18.010 = Rs.23.872 crores Total charge for credit = 20 × 0. 14 × 5 = Rs.14 crores Allocation of total charge based on SOYD method PV of hire rentals
(Rs. crores) Year 1 2 3 4 5 iv. v.
SOYD Factor (20 + 19 + 18 + 17)/1+---+20 (16 + 15 + 14 + 13)/1+---+20 (12 + 11 + 10 + 9)/1+----+20 (8 + 7 + 6 + 5)/1+----+20 (4 + 3 + 2 + 1)/1+----+20
Charge = = = = =
74/210 58/210 42/210 26/210 10/210
4.933 3.867 2.800 1.733 0.667
PVIF factor @ 12% 0.893 0.797 0.712 0.636 0.568
PV 4.405 3.082 1.994 1.102 0.379 10.962
PV of tax shield on charge for credit = 10.962 × 0.35 = Rs.3.837 crores PV of depreciation tax shield = [5 PVIF12,1 + 3.75 PVIF12,2 + 2.81 PVIF12,3 + 2.11PVIF12,4 + 1.58 PVIF12,5] 0.35 = 11.694 × 0.35 = Rs.4.093 crores. COHP = (iii) – (iv) – (v) = 23.872 – 3.837 – 4.093 = Rs.15.942 crores Since COL < COHP, leasing should be preferred. 15
2.
(million Euros)
A. (Inflow) Outflows : Coupon Commitment fee Management fee Guarantee fee Agency fee Underwriting fee Amortization Net cashflow in Euros Ex Rate Rs/Euro NCF in Rs. PV @ 6%
August 2002 (6.000)
August 2003 (4.000)
– 0.360 – 0.020 0.040 – 0.036 0.060 – 0.005 0.015 – – – (5.909) (3.555) 46 48 (271.814) (170.64) (271.814) (160.981)
August 2004
August 2005
August 2006
August 2007
August 2008
0.630 – – 0.060 0.005 – – 0.695 50 34.75 30.927
0.670 – – 0.060 0.005 – – 0.735 48 35.28 29.622
0.710 – – 0.060 0.005 – – 0.775 47 36.425 28.852
0.690 – – 0.030 0.005 – 5.000 5.725 46 263.35 196.79
0.340 – – – 0.005 – 5.000 5.345 45 240.525 169.561
Raj Techno Park will avail the loan if the PV of inflows is more than the PV of outflows at the cost of 6% (or) the net cash outflow is less than zero As the net cash outflow at 6% is Rs.22.958 million, the company should not avail the loan. 3.
a.
Computation of eligible reserves; Rs. Crores 0.88 5.00 1.50 0.50 0.40 8.28 Less: Required to make partly paid shares fully paid 2.00 Amount left for bonus issue 6.28 Computation of number of shares entitled to receive bonus shares: Share premium (1.00 – 0.12) General Reserve Capital Redemption Reserve Capital Reserve Revaluation Reserve
Shares issued and paid up Shares arising out of conversion =
b.
2 crore ×3 150
Crores 1.00 0.04
1.04 6.28 Number of shares that can be issued as bonus = = 0.628 crores 10 0.628 Bonus ratio = = 0.604 i.e. for every share a bonus share of 0.604 is received. 1.04 Working Notes: Rs. 60 lakhs Share premium received in kind : = Rs.10 per share 6 lakh Paid up value/share = Rs.8 per share Total amount in kind = 2 × 6 = Rs.12 lakhs According to SEBI guidelines, a company which announces its bonus issue after the approval of the Board of Directors must implement the proposal within a period of six months from the date of such approval and shall not have the option of changing the decision. Therefore, since the Board of Directors have taken the decision in July 2002, the company has to implement the proposal of bonus issue before December 2002.
16
4.
Cost of in-house management of receivables: i.
Cash discount
= 0.2 × 400 × 0.01
Average collection period
= 0.2 × 15 + 0.5 × 30 + 0.3 × 50
=
Rs.0.8 crores
= 33 days ii.
= 0.01 × 400
Bad debts
=
Rs.4 crores
iii. Costs of accounting and collection of receivables
=
Rs.1 crores
iv.
Contribution forgone on lost sales
=
20 × 0.2325 = Rs.4.65 crores
v.
Cost of funds =
400 × 0.7 × 0.2 ×
33 33 + 400 × 0.3 × 0.26 × = Rs.7.99 crores 360 360
Total costs of in house management = i + ii + iii + iv + v = 0.8 + 4 + 1 + 4.65 + 7.99 = Rs.18.44 crores Cost of factoring vi.
Factor’s commission
vii. Cost of funds
=
0.025 × 420 =Rs.10.5 crores
=
420 × 0.75 × x ×
=
Rs.26.25x + 2.1 crores
30 30 + 420 × 0.25 × 0.5 × 0.22 × 360 360 30 + 420 × 0.25 × 0.5 × 0.26 × 360
The maximum interest rate that is payable by FVBL on the factor advance is the value of x in the following: vi + vii = i + ii + iii + iv + v = 10.5 + 2.1 + 26.25x = Rs.18.44 crores x
=
5.84 = 22.25% 26.25
Interest on factor advances should be maximum 22.25% p.a. 5.
a.
i.
Cost
ii.
Deposit = 3 × 0.2 = Rs.0.6 lakhs Let Monthly Installment be = Rs.M lakhs PV of Installments = 12M × i/d12 PVIFA 20%,4 = Rs.34.339M lakhs Service charge = 3 × 0.02 = Rs.0.06 lakhs Accumulated value of deposit = 0.6 FVIF 1%, 48 = Rs.0.967 lakhs PV of deposit to be collected at the end = 0.967 PVIF 20%, 4 = Rs.0.466 lakhs EMI is ‘M’ in the following: i – ii – iii – iv + v = 0 = +3 – 0.6 – 34.339M – 0.06 + 0.466 = 0 2.806 = Rs.0.0817 lakhs ∴ M = 34.339
iii. iv. v.
b.
=
Rs.3 lakhs
Flat rate of interest: Total charge for credit
= 0.0817 × 48 – 3 = Rs.0.9216 lakhs
Flat rate
=
0.9216 4×3
= 7.68%
17
c.
Total charge for credit
=
Interest rebate as per Rule of 78 = =
Rs.0.9216 lakhs 12 ×13 × 0.9216 lakhs 48 × 49 Rs.0.06 lakhs
Amount payable on early settlement =
0.0817 × 12 – 0.06 = Rs.0.9204 lakhs
Accumulated value of deposit by the end of 36 months = 0.6 FVIF1%, 36 = Rs.0.859 lakhs Monthly effective interest is ‘i’ is the following. 3 – 0.6 – 0.0817 × 12 × PVIFAi,3 × i/d12 – 0.06 – 0.9204 PVIFi,3 + 0.859 PVIFi,3 = 0 At
i
=
20%, LHS
= 0.023
At
i
=
18%, LHS
= –0.030
By interpolation, i
=
18 +
− 0.030 × 2 = 19.09%. − 0.030 − 0.0.023
Part C: Applied Theory 6.
The Indian VC industry has attempted to maintain the risk-reward sharing nature of the relationship through a variety of innovative instruments for structuring the investment. Essentially these could be classified into three broad categories with individual tweaks and twists to the basic forms. These are: i. Equity investments ii. Quasi equity forms of hybridized debt iii. Normal loan. Equity Investments Almost all VC funds/companies appear to prefer a minority position in the investee company. When its risky the equity investment usually carries with it a number of protective covenants (especially in situations where the VC investor is a significant stockholder) including several standard ones such as the right to appoint nominee(s) on the Board of Directors, authority to examine books of accounts, carry out concurrent audit and sometimes even power to veto decisions on a set of issues that may be agreed upon with the company’s management/promoters. The timing of the disinvestment, though, will be at the VC investors’ option. The VC investor also requires the investee, through the agreement, to have the company’s stock listed on one or more stock exchange(s) as desired by the VC investor. The pricing of the sale-back of the equity to the promoters/management is often linked either to the market price upon listing of the scrip or some formula. The equity investments also carry ‘a first right of refusal in favor of the promoter’. A number of models with various terms and conditions obtain in the industry presently on this issue. What needs to be noted is that most VC funds/investors provide the buyback ‘comfort’. It may not be inaccurate to conclude that this provision is also in response to the Indian entrepreneur’s tendency to maximize his share holding in the company over a period of time. Quasi Equity Investments Most quasi equity investments, as mentioned earlier, have evolved in response to the regulatory framework as also to the reluctance of the average Indian entrepreneur to permit external participation in ‘his’ company’s equity. The quasi equity loans come in two broad types. i. A loan whose servicing is linked entirely to the company’s/project’s performance and thus participate totally in the downside and significantly in the upside in a manner agreed upon upfront. ii. A loan on which there is a minimum obligation (be it of interest or principal) contracted at reasonably low levels irrespective of performance and an upside sharing component.
18
In the former type the servicing is through a percentage charge on sales that is contracted upfront taking into account the future sales and profitability of the project/company and the servicing capacity available in the company’s cash flow. The charge is fixed at a level that would provide a discounted rate of return (on the loan) commensurate with a high-risk equity investment. The charge payment period is normally coterminus with the maturity of the venture fund. Interestingly these also carry, occasionally, some collateral cover as well such as a charge on the company’s assets. The rate of return on a reasonable set of revenue and profitability expectations would be comparable to that achievable on equity investments. Sometimes the charge on sales payable is subject to a cap on the total amount payable. In the latter type again two models obtain. The VC investor either stipulates a fixed repayment schedule for the loan and a variable rate of charge in lieu of interest; or a fixed repayment schedule, a fixed floor rate of interest and a variable premium to share the upsides. This type of quasi equity loans also carry collateral. The quasi-equity investments also come with a number of protective covenants including option to appoint nominee(s) and occasionally an option to convert the loan into equity shares in the investee company in the event of consecutive, willful default or non-achievement of some agreed upon performance milestones. The intent in such situations is to be able to obtain control of the company and effect restructuring plans, if any required. Quasi-equity instruments such as the above suffer from a number of apparent shortcomings. Firstly, they involve cash pay-outs from the investee company during the growth phase, when the company needs to conserve cash most. A second shortcoming is from the investor’s standpoint: that of tracking and accounting the payments and ensuring the accuracy of the sales accounting by the investee company. This latter is also a point of potential abuse. The quasi-equity loan will perhaps continue to be a necessary evil till such time as the pricing regime for equity issues permits equity shares to be the instrument for sharing risk and reward equitably and providing financial incentives to the participants that matter. Normal loans: Of all the financial instruments mentioned above, it may be safely stated that the normal (term) loan is the least preferred alternative. The reason, presumably and understandably, is that it is not ideally suited for VC situations where the cash flows of the firm cannot be predicted with even a reasonable degree of certainty to be able to contract fixed repayment and interest obligations. The limited normal loans that VCs provide appear to be to meet short-term/medium-term requirements of portfolio companies to help them tide over temporary cash shortages. These are short-term maturities (ranging from six to eighteen months) and carry interest at a rate equal to (or slightly higher) then the lending rate of commercial banks. 7.
a.
A corporate planning to issue CP requires to fulfill the eligibility criteria prescribed by RBI, then it needs to select a merchant banker and an Issuing and Paying Agent (IPA) (mandatory) and obtain a resolution from the company board for issue of commercial paper. After the resolution is passed, the company needs to get the CP credit rated by one of the approved credit rating agencies like CRISIL/ICRA/CARE/DCR, as prescribed by RBI. The company then has to approach its principal banker with a proposal (in the form of schedule-II given in the appendix) along with the credit rating certificate for approval. The banker will then scrutinize the same and verifies whether all conditions stipulated by RBI are met, and forwards the application to the RBI for intimation (as the approval from RBI is no more required). On the other hand, the Merchant Banker or Issuing and Paying Agent (at times, company appoints IPA as a dealer) will locate the clients and get their quotes for different maturity periods as discussed above. Then the company and merchant banker/IPA take a decision on the maturity, discount rate and the quantum of the issue. A company can opt for various maturity periods within the stipulated span i.e. if a company plans to issue a CP for a span of 6 months, it can raise the money in tranche with different maturity periods of either 1 month, 2 months or 3 months, etc. based on the market quotes. If a company decides on a 2 months CP, it can raise the finance within a period of 2 weeks from the date on which the proposal is taken on record by the bank and it can issue paper on a single day or in parts on different dates (but the whole issue should be redeemed on the same date). The issue proposed should be completed within a span of 2 weeks and the company should intimate the banker to reduce the working capital limit to the extent of the amount raised. The company should pay the applicable stamp duty based on the maturity. After the issue is completed, within 3 days, the company needs to intimate the RBI the actual amount raised through CPs. The CP is not allowed to be underwritten. On maturity the holder of the CP presents the instrument to the paying agent, who arranges the payment. The agent will receive the amount and brokerage for the services provided (the brokerage fee charged by them is given below). There is no grace period allowed for the repayment of the paper. If the maturity date is a holiday, the issuer is supposed to make the payment on the following working 19
b.
If the maturity date is a holiday, the issuer is supposed to make the payment on the following working day. Every issue of CP is treated as a fresh issue (including roll over) and the issuer needs to intimate RBI while doing so. The following are the reasons of underdevelopment: • One of the reasons for the non-development of primary market for CPs is the restricted entry of corporates into this market. The stringent conditions laid down by the RBI has made entry difficult to good but small companies. • A company is prompted to issue a CP if the cost of funds is lower when compared to the PLR of the banks which is usually the rate the top class companies will be obtaining. Since the cost of CP includes rating charges, stamp duty, IPAs’ fee in addition, to the discount, the effective cost should be lower than the PLR. Otherwise, it will not be prudent for a corporate to issue CP. All these costs have to be incurred each time a company issues a CP thus increasing the effective cost. Hence, a company may not be able to come out with a CP issue if the difference in the effective cost and PLR is marginal. • The minimum size of investment for an individual investor is too high, there are no tax benefits. Hence, the individuals and other small investors are away from this market. • The financial institutions such as LIC, GIC and UTI, etc. are not permitted to park their funds in CPs, as per specific investment patterns, which are laid by the government. This, however, is changing now.
20