Question Paper Investment Banking and Financial Services-I (261) : July 2005 Section A : Basic Concepts (30 Marks)
1.
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This section consists of questions with serial number 1 - 30.
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Answer all questions. Each question carries one mark.
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Maximum time for answering Section A is 30 Minutes.
Financial assets equal financial liabilities, so real assets will be financed by savings, for this relationship to exist which of the following assumptions should hold good? I. There are no external borrowings in the system. II. Financial liabilities include stock issued to the outsiders. III. Surplus funds of an economic unit will either be used by the saver to purchase a real asset or will be lent to other economic units to buy real assets. (a) Only (I) above (c) Both (I) and (II) above
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(b) Only (II) above (d) Both (II) and (III) above
(e) All (I), (II) and (III) above. 2.
Which of the following statements is/are true with respect to interest rate risk to the lenders? I. In an administered rate scenario, the scope to manage this risk is very low. II. Cost based pricing of the loan can protect the lenders against this risk. III. Credit risk is invariably reflected in the interest rate risk. (a) Only (I) above (c) Both (I) and (II) above
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(b) Only (II) above (d) Both (I) and (III) above
(e) All (I), (II) and (III) above. 3.
Some years back, Citibank offered a special kind of credit cards to all the members of Institute of Chartered Accountants of India. These types of cards are known as (a) Co-branded cards cards (d) Add-on cards
4.
(b) Branded cards
(c) Affinity
(e) Levered investment cards.
Which of the following statements is true with respect to Real Estate Investment Trusts (REIT)? (a)
5.
The most prominent form of lending by REITs is the construction/developmental lending (b) To retain their special tax status, REITs have to distribute 50% of their income to shareholders (c) REITs are not allowed to raise finance through debt as they are equity investment vehicles (d) Indirect equity investments in REITs by investor usually lack liquidity (e) According to the federal laws, REIT can only be infinite life trusts. Which of the following statements is/are true in context of future flow securitization? I. II.
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In long-term contract receivables, volumes are generally pre-fixed but price may be variable. In future flow category; receivables are subject to both, price and volume variations.
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III. Borrower is able to secure a finer pricing and longer tenures in comparison to the terms of other funding agencies. (a) Only (I) above (c) Both (I) and (II) above
(b) Only (II) above (d) Both (II) and (III) above
(e) All (I), (II) and (III) above. 6.
The _____ are created by taking the cash-flows from the underlying collateral and splitting them into two or more classes that have the same maturity. (a) Asset backed securities securities (d) Collaterized mortgage obligations
7.
(b) Forfaiter, exporter (d) Forfaiter, importer (e) Importer,
(b) Invoice discounting (d) Bank participation factoring
SOT Ltd. is a primary dealer registered with RBI. To honour its bidding commitment in T-bills segment, it applies for liquidity support to RBI. The total bidding commitments are Rs.300 crore. The liquidity support provided by the RBI will be (a) Rs.22.5 crore Rs.100 crore.
(b) Rs.30 crore
(c) Rs.60 crore
(d) Rs.15 crore
It requires substantial outlay of funds Transaction cost tend to be higher It is a good hedge against inflation Tax treatment is not favorable for real estate investments It is a durable investment.
11. Banks in an economy have been maintaining SLR in excess of statutory requirements. In such a scenario, which of the situations given below will prevail? I. II. III. (a) (c)
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(e)
10. Which of the following is false with respect to real estate investment? (a) (b) (c) (d) (e)
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Which of the following forms of factoring is also known as confidential factoring? (a) Advance factoring (c) Full factoring (e) Supplier guarantee factoring.
9.
(e) Pass through securities.
Discount fees involved in the transaction of forfaiting is payable by _______ to _______. (a) Exporter, forfaiter (c) Exporter’s bank, importer’s bank forfaiter.
8.
(b) Strip securities (c) Pay through
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An increase in SLR will not have a significant impact on the liquidity, prices and yields of the instruments. A decrease in SLR will not have a significant impact on the liquidity, prices and yields of the instruments. A decrease in SLR will bring down the prices of the instruments. Only (I) above (b) Only (II) above Both (I) and (II) above (d) Both (II) and (III) above
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(e) Both (I) and (III) above. 12. XYZ Ltd. is a primary dealer in India. As on 31.03.2005, the balance maturity of securities lying in its portfolio were as follows:
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Balance maturity in years 4 6 12 15 value of above securities will be (a) Rs. 20 crore Rs.22.5 crore.
Market value in Rs. crore 20 30 10 10
(b) Rs.17.5 crore
The
risk
(c) Rs.25 crore (d) Rs.15 crore
weighted (e)
13. State which of the following statements is/are true with respect to US T-bills markets? I.
Strip bills are package of bills requiring investors to bid for an entire series of bills with same maturities. II. Cash management bills are simply the reopened issue of bills that were sold in prior weeks. III. The reopening of bills occurs at periodic intervals and is usually pre-decided. (a) Only (I) above (c) Only (III) above
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(b) Only (II) above (d) Both (II) and (III) above
(e) All (I), (II) and (III) above. 14. Manoj Enterprises is coming out with an issue of commercial paper of amount Rs.100 lakh with maturity of 8 months. The rating charges payable by it shall be (a) Rs.50,000 Rs.20,000.
(b) Rs.32,500
(c) Rs.30,000
(d) Rs.25,000
(e)
15. Which of the following statements is/are not true with respect to reservation in the public issues of the company? I.
The reservation for the employees of the company cannot exceed 10% of the total size of the company. II. The reservation for group shareholders cannot exceed 10% of the total size of the company. III. Net offer to the public should not be less than 25% of the post issue equity capital of the company. IV. Total reservation for all NRIs and OCBs cannot exceed 15% of the post-issue capital as per RBI guidelines. (a) Only (II) above (c) Both (II) and (III) above (e) All (I), (II), (III) and (IV) above.
(b) Rs.55.17 lakh (e) Rs.60.67 lakh.
(c) Rs.50.01 lakh
17. Can Factors Limited gives an advance of 80% against receivables worth Rs.10,00,000 purchased from Shayama Ltd. payable after 90 days. The advance carries an interest rate of 17% per annum compounded quarterly and the factoring commission is 1.8% of the value of factored receivables. Both the interest and commission are collected up-front. The amount actually made available to Shayama Ltd. is (a) Rs.7,28,000 Rs.8,00,000.
(b) Rs.7,48,000
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(b) Only (IV) above (d) Both (III) and (IV) above
16. The probability of the investment being confiscated is 0.2. If the cash flow when confiscation does not occur is Rs.20 lakh and the discount rate is 9%, then expected cash flow is (a) Rs.55.00 lakh (d) Rs.61.45 lakh
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(c) Rs.7,66,000
(d) Rs.7,82,000
(e)
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18. The following data pertains to Mathura Leasing Services Ltd: P.V. of loan payments Rs.50,00,000 P.V. of lease payments Rs.52,00,000 P.V. of lease related tax shields Rs.25,00,000 P.V. of loan related tax shields Rs.27,00,000 P.V. of residual value Rs.2,00,000 arising out of the lease transaction as per BHW model is (a) (Rs.2,00,000) Nil (d) Rs.1,00,000
The
operating
advantage
(b) (Rs.1,00,000)
(c)
(e) (Rs.4,00,000).
19. First Hire purchase Limited, a company engaged in hire purchase earns Rs.2,00,000 as interest in the fiscal year 2004-05. The service tax (including surcharge) payable on the interest earned by First Hire purchase Limited for the fiscal year 2004-05 is (a) Rs.20,100 Rs.20,000.
(b) Rs.20,200
(c) Rs.10,200
(d) Rs.20,400
(e)
20. Integrated Financial Services Ltd. (IFSL) has recently structured a six year leveraged lease transaction involving an investment cost of Rs.150 crore with itself as the equity participant and Syndicate Bank as the loan participant funding the investment in the ratio of 1:4. The loan carries an effective rate of interest of 14% and is to be repaid in the six equated annual installments. The gross yield of IFSL is 20% per annum. The amount of loan repayment to Syndicate bank at the end of every year for such a lease transaction is (a) Rs.34.83 crore crore (d) Rs.34.55 crore
(b) Rs.35.41 crore (e) Rs.30.86 crore.
I. II.
Credit rating is mandatory for an issue of debentures irrespective of the maturity period. Appointment of Debenture Trustee is mandatory if the maturity period exceeds 15 months. III. Creation of Debenture Redemption Reserve is optional in case of debenture issue whose maturity period is 15 months. (b) Only (III) above
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(c) Both (I) and
(e) All (I), (II) and (III) above.
22. Polaki Garments Limited (PGL) made an offer of rights to its shareholders on March 21 2005. The earliest PGL can come up with a bonus issue is (a) May 21, 2005 21, 2005 (d) March 21, 2006
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(c) Rs.30.86
21. Which of the following is/are true regarding issue of debentures?
(a) Only (II) above (III) above (d) Both (II) and (III) above
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(b) August 21, 2005
(c) November
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(e) August 21, 2006.
23. ABC Ltd. is a primary dealer in government securities. RBI is conducting an issue of dated securities worth Rs 1500 crore. The other particulars of ABC Ltd. are as follows:
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Particulars Rs. crore Paid up capital 100 Free reserves 98 Share premium account 23 Revaluation reserve 12 Surplus arising out of the sale proceeds of assets 2 Accumulated loss balance 1 Book value of intangible assets 1 Ignoring the liquidity support granted by RBI, the maximum portion of the present issue which ABC Ltd. can offer to underwrite is (a) Rs.1165 crore (d) Rs.1000 crore
(b) Rs.1500 crore (e) Rs.1105 crore.
(c) Rs.450 crore
24. Primary Finance Ltd. discounts the L/C backed bills of its clients at 25% p.a. The effective rate of interest per annum of such a bill of usance period 90 days (assuming 360 days a year) is _______ %. (a) 25.00 (b) 26.37 (c) 26.67 (d) 27.44 (e) 29.45. 25. Which of the following statements correctly describe(s) the attributes of an Exchangeable? I. The stock issued on conversion is usually of the same company. II. Conversion Terms are set at a later date after the issue. III. From investment perspective, these instruments are more attractive than convertible debentures. (a) Only (I) above (b) Only (II) above (c) Only (III) above (d) Both (II) and (III) above (e) All (I), (II) and (III) above. 26. Primary Products Limited (PPL) is planning to lease machinery costing 60 lakh. It approaches First Leasing Limited (FLL). FLL evaluates the credit worthiness of lessee using cash flow coverage ratio. The relevant particulars of PPL are as follows: PBIT Lease Rental Interest paid Depreciation Loan repayments Tax rate (a) 4.51 3.90.
Rs.100 lakh Rs.15 lakh Rs.2.00 lakh Rs.10 lakh Rs.15 lakh 33%. (b) 5.12
(c) 3.34
(d) 3.17
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(e)
(b) Rs.5,00,000 (e) Rs.12,50,000.
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(c) Rs.2,50,000
28. The effective rate of interest on the completed transaction will be _____ than the effective rate of interest on the original transaction if the interest rebate allowed to the hirer is calculated as per the_______. (a) Less, rule of 78 method (c) More, actuarial method (e) More, rule of 78 method.
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The cash flow coverage ratio for PPL is
27. Muhurat Finance Limited (MFL) has come out with an issue of public deposit of Rs.5 crore. To market the issue, it contracted Finbrooks Brokers Limited (FBL). FBL sold the issue worth 2.5 crore. The brokerage quoted by FBL is Rs.6,25,000. The maximum MFL can pay to FSL is (a) Rs.6,25,000 (d) Rs.10,00,000
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(b) Less, actuarial method (d) Less, modified rule of 78 method
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29. Which of the following statements reflect(s) the characteristic(s) of Auction rated debt? I.
Company before issuing it must get credit rating of above investment grade from recognized credit rating agency. II. The instrument is issued to general public like a debenture issue. III. These are fully redeemable short-term debenture, which are generally secured. (a) Only (I) above above (d) Both (I) and (III) above
(b) Only (II) above
(c) Only (III)
(e) All (I), (II) and (III) above.
30. Master Leasing Limited has recently finalized a leasing deal with Param Sons Limited. The lease permits Param Sons Limited to add certain facilities regarding the leasing of fresh equipments resembling line of credit. The above lease is a/an (a) Indexed lease lease (d) LC lease
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(b) Swap lease (e) Master lease. END OF SECTION A
(c) Upgrade
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Section B : Problems (50 Marks)
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This section consists of questions with serial number 1 – 5.
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Answer all questions. Marks are indicated against each question.
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Detailed workings should form part of your answer. Do not spend more than 110 - 120 minutes on Section B.
Sandhya Breweries Limited (SBL) is in the midst of an expansion programme due to expected surge in the demand of beer case worldwide. For the expansion programme, it has proposed to acquire machinery worth Rs.600 lakh funded through term loan carrying an effective interest rate of 14% repayable in 6 equal annual installments starting from the end of first year. The useful life of the asset is 10 years after which the salvage value will be nil. The tax relevant rate of depreciation is 25%. Mr. Bisla, finance manager of the company has prepared pro-forma income statement and balance sheet for the first year after the acquisition of the above asset as follows: Profit & loss account for the year 2005-06 Rs in lakh Sales PBDT Depreciation Profit before tax Tax @ 33% Profit after tax
10,000 750 200 550 181.50 368.50
Balance sheet as on March 31, 2006
Sources of funds: Equity capital Reserves and surplus Secured loans Total Application of funds: Fixed assets (Gross) Less depreciation Net Block Investments Current Assets Inventory Sundry Debtor Cash & Bank balance Other current assets Less current liabilities and provisions Current liabilities Provisions for taxes Other provisions Net Current assets Total approaches SBL with a proposal to structure the leasing follows: •
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SBL is interested in 5-year lease proposal.
•
•
The marginal cost of capital for SBL is 15%.
•
•
The marginal tax rate for SBL is 33%.
Rs.lakh 500 750 2675 3925 2000 650 1350 10.00 1800 5000 475 250
7525
4500 260 200 2565 3925 Maharaja Finance Limited of the above machinery. The other particulars are as
•
• SBL follows effective rate of interest method for lease transactions and equated lease installments have to be paid quarterly in advance.
•
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Effective interest rate for other borrowings is 8%.
•
•
Provision for taxes in the balance sheet includes current year taxes also.
You are required to a.
Determine the minimum lease rentals to be paid by SBL so that it can classify the lease as a finance lease.
b.
Recast the financial statements of SBL assuming that the equipment is leased and the lease is classified as an operating lease. Assume the lease rentals to be 10% less than that arrived in (a) above.
c.
Show the impact of above operating lease on the leverage and fixed asset turnover ratio. (3 + 6 + 2 = 11 marks) < Answer >
2.
Agra Tanneries Limited (ATL) is contemplating to purchase an equipment worth Rs.50 lakh. The equipment attracts a tax relevant rate of depreciation rate of 25% and has a salvage value of 15% of the initial amount at the end of useful life of 5 years. ATL approaches Mathura Finance Limited (MFL) to structure a hire-purchase arrangement for the said asset. The hire-purchase scheme offered by MFL provides for the following arrangements: Down payment
25%
Duration
5 years
Frequency of payments
Monthly in arrears
MFL also shows interest in structuring a lease agreement for the above equipment with the same duration and frequency of payment. The cost of capital for the MFL is 15%. It is in the tax bracket of 35%. MFL follows the SOYD method for recognition of finance income. You are required to
3.
4.
a.
Determine the minimum flat rate of interest to be charged by MFL on the above plan
b.
Determine the lease rental at which MFL is indifferent between the hire purchase plan and lease plan. Assume the hire rentals as arrived in (a) above.
(7 + 8 = 15 marks) < Answer > ABC Ltd. is coming out with an issue of two series of zero coupon bonds maturing in 4 and 5 years. Face value of both the bonds is Rs.1000. Market price of similar traded bonds is Rs.925 and Rs.900 respectively. Mr. Tiwari is considering investing in these bonds. You are required to calculate one year interest rates after 4 years. (5 marks) < Answer > Manoj Exports Limited has proposed to expand its operations for which it requires funds of $4.5 million, net of issue expenses which amounts to 2% of issue size. It proposed to raise the funds through a GDR issue. The dividends issued by the company for the past periods are as follows: 2001 2002 2003 2004 2005 Rs.1.5 Rs.1.9 Rs.2.3 Rs.10 Rs.12.5 At the end of year 2004, the company announced a reverse stock split of 5:1. The past growth rate in dividends is expected to continue indefinitely. Other particulars are as follows: • • • • •
• • • • •
Three shares underlie each GDR. Underlying shares are priced at 10% discount to the market price. Expected exchange rate is Rs.45/$. Current risk free rate is 6%. Beta of the stock is 0.7.
•
•
Risk premium is 10%.
You are required to compute a.
The number of GDRs to be issued.
b.
Cost of GDRs to the company.
c.
Gains/losses to the holder of 100 GDRs, if the company proposes a rights issue after the GDR issue in the ratio of 1:3 at a subscription price of Rs.900 per share. Assume the GDR holder exercises the rights and sells his entire holding at the prevailing GDR price, which will be at a premium of 25% to the prevailing domestic price.
Assume the Rs/$ exchange rate at the time of rights issue and sale by GDR holder to be Rs.50/$. (4 + 3 + 3 = 10 marks) < Answer > 5.
During past one year, 5 companies came out with IPOs worth Rs.300 crore, Rs.350 crore, Rs.400 crore, Rs.235 crore and Rs.100 crore. The initial offer price and current market price (CMP) of one share of and number of shares offered by these companies are given below: Company
Offer price
CMP
No. of shares offered
Value of index at the time of offer
A Ltd. Rs.60 Rs.89 5,00,00,000 3000 B Ltd. Rs.70 Rs.75 5,00,00,000 4345 C Ltd. Rs.80 Rs.60 5,00,00,000 2465 D Ltd. Rs.45 Rs.90 5,00,00,000 4500 E Ltd. Rs.20 Rs.5 5,00,00,000 4756 The current value of index is 6400. You are required to calculate the wealth relative and comment on the same. (9 marks) < Answer > END OF SECTION B
Section C : Applied Theory (20 Marks)
6.
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This section consists of questions with serial number 6 - 7.
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Answer all questions. Marks are indicated against each question.
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Do not spend more than 25 -30 minutes on section C.
In recent years, Internet has emerged a preferred source for raising capital to the companies world over. Explain in brief the methods companies employ to raise capital through internet. Also enumerate the benefits that accrue to the companies when they raise capital through internet. (10 marks) < Answer >
7.
Collateralized mortgage obligations (CMOs) were created taking the features of mortgage backed bonds and pay through securities. Explain in brief the term CMO and advantages associated with it clearly demarcating between the advantages to issuers and to the investors. (10 marks) < Answer >
END OF SECTION C
END OF QUESTION PAPER
Suggested Answers Investment Banking and Financial Services-I (261): July 2005 Section A : Basic Concepts 1.
Answer: (c) Reason :For this relationship to exist, There should be no external borrowings in the system and financial liabilities should include stock issued to the outsiders. Statement (III) is an implication of the said relationship. Hence (I) and (II) are true. Hence (c) is the correct answer
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2.
Answer: Reason :
(d) In an administered rate scenario, the scope to manage this risk is very low as regulator fixes the interest rates leaving little to manage. Hence (I) is true. Cost based pricing of the loan cannot protect the lenders against this risk since in the increasing rate scenario, the cost of loans tend to go up. Hence (II) is not true. Credit risk is invariably reflected in the interest rate risk as in an increasing rate scenario; the default rate tends to go up. Hence (III) is also true. Therefore (d) is the correct answer.
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3.
Answer: (d) Reason :These kinds of cards, where issue to members of a particular organisation who take pride in associating themselves with their institution or organisation are known as affinity cards. Hence (d) is the correct answer.
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4.
Answer: (a) Reason :The most prominent form of lending by REITs is the construction/developmental lending. To retain their special tax status, REITs have to distribute 95% of their income to shareholders. There can be mortgage REITs. Indirect equity investments in REITs by investor are highly liquid. REIT can be infinite life trusts or finite life. Hence only (a) is true.
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5.
Answer: (e) Reason :In long-term contract receivables, volumes are generally pre-fixed but price may be variable. Future flow category receivables are subject to both, price and volume variations. Due to nature of
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cash flows and other credit enhancement techniques, borrower is able to secure a finer pricing and longer tenures in comparison to the terms of other funding agencies. 6.
Answer : (b) Reason :The strip securities are created by taking the cashflows from the underlying collateral and splitting them into two or more classes that have the same maturity. These classes are called interest only (I/O) and principle only (P/O) portions. Hence (b) is the correct answer.
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7.
Answer: (a) Reason: Discount fees involved in the transaction of forfaiting is payable by exporter to forfaiter. Hence (a) is the correct answer.
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8.
Answer: (b) Reason: Invoice discounting is also known as confidential factoring. Hence (b) is the correct answer.
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9.
Answer: (a) Reason: The liquidity support provided by the RBI shall be Rs.22.5 crore i.e. 7.5% of the total bidding commitments.
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10 Answer : (d) . Reason : Real estate investment has lot of tax benefits attached to it. Hence statement (d) is not true.
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11. Answer: (c) Reason: If banks are having excess securities, then increase/ decrease in SLR will not have any impact on the price and yield of the instruments. Statements (I) and (II) are correct. Hence (c) is the correct answer.
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12 Answer: (b) . Reason: The risk weights are applicable as follows: Balance term to maturity Risk-weights (% of market value) Up to one year 15 Over one year and up to 5 years 20 Over 5 years and upto 10 years 25 Above 10 years 30 20× 0.2 + 30× 0.25 + 10 ×0.3 +10v0.3 = Rs.17.5
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crore. Hence (b) is the correct
answer.
13 Answer : (b) . Reason : Strip bills are package of bills requiring investors to bid for an entire series of bills with differing maturities. Hence statement (I) is false. The reopening of bills normally occurs when there is un-expected need for the funds. Hence statement (III) is also false. Cash management bills are simply the reopened issue of bills that were sold in prior weeks. Hence statement (II) IS TRUE. Therefore (b) is the correct choice.
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14 Answer: (a) . Reason : Since the maturity of the instrument is 8 months. The total issue charges shall be as follows: Rating charges: 0.5% of the issue amount = Rs.50,000. Hence (a) is the correct answer.
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15 Answer: (b) . Reason : Total reservation for all NRIs and OCBs cannot exceed 10% of the post-issue capital as per RBI guidelines. All other statements are true. Hence (b) is the correct answer.
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16 Answer: (b) . Reason : It can be calculated with help of the formulae i.e. V= CF (1-P)/re +P V= (20×0.8)/(.09+0.2) = Rs.55.17 lakh. Hence the answer is (b). 17 Answer : (b) . Reason :Receivables factored = Rs.10,00,000 × 0.8 = Rs.8,00,000 Less: Interest = 0.17 × 8,00,000 × ¼ = Rs. 34,000 Less: Commission = 0.018 × 10,00,000 = Rs. 18,000 Amount actually received = Rs.7,48,000
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18 Answer : (e) . Reason :The operating advantage arising out of the lease transaction as per BHW model is OA (L) = P.V. of lease related tax shields – P.V. of loan related tax shields – P.V. of Residual value = 25,00,000 – 27,00,000 – 2,00,000 =
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(Rs.4,00,000). Hence (e) is the answer. 19 Answer : (d) . Reason :The service tax plus surcharge payable on the interest earned by the hire purchase companies is 10.2%. Therefore, service tax payable by Meridian for the fiscal year 2004-05 = 10.2% of Rs.200,000 =20,400. Hence (d) is the correct answer.
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20 Answer : (c) . Reason : Loan amount = 0.8×150 = 120 crore
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Equity contribution = 30 crore Equated annual installment = 120 = Rs.30.86 crore PVIFA(14%, 6) . Hence (c) is the correct answer.
21 Answer : (c) . Reason :According to the Clarification XXVI to the SEBI Guidelines for Disclosure and Investor Protection, no public or rights of debt instruments (including convertible securities) irrespective of their maturity or conversion period shall be made unless credit rating by at least one approved credit rating agency is obtained and disclosed in the offer document. Hence statement I is true. Appointment of Debenture Trustee is mandatory if the maturity period exceeds 18 months and not 15 months as given in statement II. Hence, II is not true. Debenture Redemption Reserve should be compulsorily created if the maturity period of the debentures exceeds 18 months and hence it is optional if the maturity is 15 months. Hence, the correct answer is (c).
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22 Answer : (d) . Reason :As per the SEBI Guidelines, no bonus issue should be made within 12 months from the date of a rights issue. Hence if PGL came up with a rights issue on March 21, 2005, the earliest that it can come up with a bonus issue is March 21, 2006. Hence (d) is the correct answer.
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23 Answer : (c) . Reason : A primary dealer can offer to underwrite an amount not exceeding 5 times of its net owned funds or the balance liquidity support available from the RBI whichever is higher. The amount so
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arrived should not exceed 30% of the notified amount of the issue. Here the amount of net owned funds would be = (Paid up capital + free reserves + balance in share premium account +surplus arising out of sale proceeds of capital) - accumulated loss balance and book value of intangible assets = Rs. (100 + 98 + 23 + 2 –1-1) crore = Rs. 221 crore Now the five times of net owned funds or tier-I capital is = 221 × 5 = Rs. 1105 crore upper limit is 30% of the notified amount i.e. 1500× 0.3 = Rs. 450 crore. So Rs. 450 crore is the maximum that ABC Ltd. can offer to underwrite. 24 Answer : (e) . Reason : The effective rate of interest is calculated as Discount charge at the rate of 25% per annum (assuming the value of the bill is Rs.100) is Rs.25 × 90/360 = Rs.6.25 Value received by the client = 100 – 6.25 = Rs.93.75 Effective rate of interest per quarter is 6.25/93.75 × 100 = 6.667% The effective rate of interest per annum is (1.0667)4 – 1 × 100 = 29.45%
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25 Answer: (c) . Reason: The stock issued on conversion is usually of the different company and conversion Terms are set at the time of the issue. Hence Statements (I) and (II) are not correct. From investment perspective, these instruments are more attractive than convertible debentures. Hence Statement (III) is correct. Hence (c) is the correct answer.
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26 Answer: (d) . Reason: The cash flow coverage ratio can be calculated as follows:
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100 + 15 + 10 2 + 15 + (15 / .67)
Hence Answer is 3.17. 27 Answer: (b)
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.
Reason: The maximum payable to brokers is 2% of the amount sold by brokers. 2% of Rs.25 crore is Rs.5,00,000. Hence (b) is the answer.
28 Answer: (e) . Reason : The effective rate of interest on the completed transaction will be more than the effective arte of interest on the original transaction if the interest rebate allowed to the hirer is calculated as per the rule of 78 method. Hence (e) is the correct answer.
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29 Answer: (c ) . Reason: Issuance of it does not require credit rating, as maturity is less than 18 months. The instrument is privately placed at competitive bids. Hence statements (I) and (II) are not true. These are fully redeemable short-term debenture, which are generally secured. Hence (III) is true.Therefore (c) is the correct answer.
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30 Answer: (e) . Reason: Such kind of lease, where add on facility to the existing leased assets is provided without negotiating fresh contract is known as Master lease. Hence (e) is the correct choice.
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Section B : Problems 1.
a.
b.
Investment cost = Rs.600 lakh Useful life = 10 years Cost of debt = 14% For finance lease, the lease term should be more than 75% of the useful life of the asset or the present value of minimum lease rental should be more than 90% of the market value of the asset. The first condition is not satisfied here. So we try to find out the lease rentals in a way that lease can be classified as finance lease. Hence 4L ×i/d4× PVIFA (I, 5) > 90% of 600 lakh at I=14% 4L ×1.0861 × 3.43 > 540 solving the above equation, we get L> 36.21 lakh per quarter. Interest on term loan = 0.14 × 600 = 84 lakh Depreciation on leased asset = 150 lakh Total interest = .08 × (2675- 600) + (0.14 × 600) = 166 + 84 = 250 lakh Interest (250-84) = 166 Lease charges = 130.36 PBT = 653.64 Tax = 215.7 PAT = 437.94 Revised balance sheet: Sources of funds: Equity capital 500 Reserves and surplus (750 – 368.5 +437.94) 819.44 Secured loans (2675-600) 2075 Total 3394.44 Application of funds: Fixed assets (Gross) (2000-600) 1400 Less depreciation (650-150) 500 Net Block 900 Investments 10.00 Current Assets Inventory 1800 Sundry Debtor 5000 Cash & Bank balance (475 + 84 – 130.36) 428.64 Other current assets 250 Total current assets 7478.64 Less current liabilities and provisions
Current liabilities Provisions for taxes ( 260- 181.50 + 215.70) Other provisions Total current liabilities Net Current assets
4500 294.20 200
Total
3394.44
4994.20 2484.44
(c) Leverage ratio prior to lease = 2675/1250 = 2.14 After the lease = 2075/1319.44 = 1.57 Fixed Assets turnover ratio (Prior to lease) = Sales/fixed asset = 10,000/1350 = 7.40 Fixed Assets turnover ratio (After the lease) = 10,000/900 = 11.11. < TOP >
2.
a.
NPV(HP) A. Down payment = 0.25 × 50 = Rs.12.5 lakh Amount financed = 50 – 12.5 = Rs.37.5 lakh Let flat rate of interest be F%. 37.5
MHR = At i = 15%
F 100
5 37.5
60
1.875F 37.5
=
60
i
B. PV of hire rental = 12 (0.03125F + 0.625)× = (0.375F + 7.5)1.067 × 3.352 = Rs. (1.341F + 26.824) lakhs F
i
12
× PVFAi,5
5 1.875F
C. Unexpired Finance Income = Rs. 37.5 × Interest Allocation 100
Year 1. 2 3. 4. 5.
Annual Income
PV
0.357
0.669F
0.87 0.582F
0.279
0.523F
0.75 0.395F 6
0.2
0.375F
0.65 0.247F 8
0.121
0.227F
0.37 0.130F 2
0.043
0.081F
0.49 0.040F 7
SOYD 654 1830 510 1830 366 1830 222 1830 78 1830
Rs. Lakhs
1.394F
b.
= 1.394F × 0.35 = 0.488F NPV (HP) = – A + B – C = –37.5 + 1.341F + 26.824 – 0.488 NPV (HP) = 0 ∴ + 0.853F = 10.676 F = 12.5% NPV (HP) = NPV (Lease) = 0 A. Initial investment = Rs.50 lakhs i 12
c. d.
e.
PV of interest tax on finance income of HP
PVIFAi,5
B. PV of lease rentals = 12L × i = Rs.42.919 L Lakhs PV of tax on lease rentals = 12L × PVIFAi,5 × 0.35 = Rs. 14.078L lakhs PV of depreciation tax shield: = (12.5 PVIF15,1 + 9.375 PVIF15,2 + 7.031 PVIF15,3 + 5.273 PVIF15,4 + 3.955 PVIF15,5) 0.35 = Rs. 9.65 lakhs PV of NSV = 0.15 × 50 PVIF 15, 5 = Rs.3.728 lakhs Minimum lease rentals is the value of L in the following: –A+ B – C + D + E = 0 – 50 + 42.919L – 14.078L + 9.65 + 3.728 = 0 28.841L = 36.622 L = Rs.1.27 lakhs/month. < TOP >
3.
To calculate the interest rate after 4 years, for the fifth year YTM of the bonds are to be
calculated. The YTM of Bond A will be (1000/925)1/4-1 = 1.97%. YTM of Bond B = (1000/900)1/5 -1 = 2.13%. The forwars rates in year 2 is obtained as follows: ( 1 + YTM4 year bond)4 (1 + I4,5) = (1+ YTM 5 year bond)5 1+ I4,5 = (1.0213)5/1.0197 = 2.77% app. < TOP >
4.
a.
b.
c.
To calculate domestic price, we have to calculate expected dividends. Past growth rate after adjusting for reverse stock-split can be calculated as follows: 7.5(1+g) = 12.5, Therefore g = 13.62%. Dividends next period = 12.5 × 1.1362 = 14.20 Cost of equity can be calculated from CAPM as follows: RF + β( Rm- RF) = RF + Risk premium 6% + 10% = 16% Using perpetual growth rate Expected domestic price D1/ ke – g = 14.20/ 0.16 – 0.1362 = Rs. 507.14 Price of 1 GDR = 3 × 507.14× 0.9 = Rs.1369.28 Domestic price of 1 GDR = 1369.28/45 = $30.43. Number of GDRs to be issued Amount of GDRs to be issued = $4.5 million/1- 0.02 = $ 4.5918 million Number of GDRs = 4591800/30.43= 1,50,897 Computation of cost of GDRs Price of 1 GDR = Rs. 1369.28 Expected dividends = 14.2 × 3 = 42.6 Growth rate = 13.62% Cost of GDR = D1/ P0(1-f) + g = 16.79% Computation of gains/loss to a holder of Initial Investment =100 × 30.43 = $ 3043 Number of rights = 100 ×1/3 ×3 = 100 Investment in 100 rights = 100 × 900= Rs. 90,000 = 90,000/50 = $1800 Total investment = $ 4843 507.14 × 3 + 900
= Rs.605.36
3 +1 Ex-rights price = GDR price = 605.36× 1.25 = 756.69
(100 × 3 + 100) × 756.69 50
Total value =
= $ 6053.52
Total gains = 6053.52 -4843 = $1210.52.
5.
To calculate the wealth relative we have to find the returns on the IPOs for the past one year and retun on the market index as follows: During past one year, 5 companies came out with IPOs worth Rs.300 crore, Rs350 crore, Rs.400 crore, Rs.235 crore and Rs.100 crore. The initial offer price and current market price (CMP) of one share of and number of shares offered by these companies are given below: Company A Ltd. B Ltd. C Ltd. D Ltd. E Ltd. Total
Offer price Rs.60 Rs.70 Rs.80 Rs.45 Rs.20
CMP Rs.89 Rs.75 Rs.60 Rs.90 Rs.5
Returns (89-60)/60 = 46.67% 75-70/70 =7.14% 60-80/80 =(25%) 90-45/45 =100% 5-20/20= (75%) 53.81%
Return on index 6400-3000/3000 = 113% 6400-4345/4345 = 47.29% 6400-2465/2465 =159.63% 6400-4500/4500 = 42.22% 6400-4756/4756 = 34.57% 396.71%
Wealth realtive
n
1 1 / N rit i 1 n
can found out by the formulae =
1 1 / N rmt i 1
Where N = number of IPO in the sample rit = Returns on the IPO rmt = Returns on the market 1 1 / 5 (53.81)
=
1 1 / 5 (396.71)
= .1463. Wealth relative is less than 1. Hence IPOs have underperformed the market. < TOP >
Section C: Applied Theory 6.
The emergence of internet has created a few options to the companies for raising capital. Notable among those are: i. Direct public offering: In a direct public offering, shares are offered directly to prospective investors online bypassing the traditional underwriting process. It is particularly effective for smaller business that can-not afford to pay high underwriting fees. ii. Online public options: The pop in the prices that was realized in the secondary markets used to translate into lost dollars for the companies raising capital. This problem has been cured using auction-pricing method. Under the auction-pricing model, prospective investors submit bids for the amount they are willing to pay for the securities being offered. After the bidding, the offering price is set at the highest price at which the entire offering can be sold, with all investors paying the same price. Advantages of online offerings: The internet provides companies direct access to a huge pool of investors and prospective
investors. It enables the companies to distribute its offerings material to the broadest possible audience and to solicit interest in its securities without regards to its location. This has proved a boon for new businesses without an established investors base as well as for established corporations seeking to leverage their name recognition on a global basis. Technology has also encouraged issuers to consider and develop new ways to present information to prospective investors. Electronic prospectuses can, and do include video, sounds graphics and interactivity. Some companies provide the prospective investors live chats sessions with the officials to mitigate doubts relating to the issue. Reduction in cost of capital: The use of electronic media has some obvious economic advantages. It reduces the cost associated with capital formation process like printing, distribution, advertising and promotion expenses. These electronic materials can be supplemented and updated regularly. < TOP >
7.
To create a specialized mortgage that incorporated the mortgage backed bonds cash flow predictability and improve the use of collateral for the issuer cash flow bonds the CMOs were created. These were created to protect the investors from prepayment risk. A CMO involves creation of several tranches. There could be a 5-year bond class, a 6-year bond class and so on. Cash flows generated by the underlying collateral are used to retire bonds. Only one class or tranche receives principal at a time. All principal payments, as stipulated by the prospectus are made for the fastest pay tranche of bonds. Once the retirements of this class, the next tranche in the sequence is repaid along with the principal amount. This process continues until the last tranche of bond is repaid. CMOs innovatively uses the cash flows of long maturity, monthly pay collateral to create securities of differing- short, intermediate and long- final maturities and expected average lives. Benefits of CMO To the investor: CMOs are considered to have a high level of credit quality because of the quality of the underlying collateral. To be assigned a high credit rating a bond should be structured in such a way that the cash flows generated is at least sufficient to support the amount of bonds in issue even under the most conservative pre-payment nature. To the issuer: • • Compared to pass-through securities, funds can be raised more cheaply due to segmentation. • • Wider diversification of investor base can be achieved. More efficient use of collateralization than mortgage backed bonds. < TOP > < TOP OF THE DOCUMENT >