261-1002

  • November 2019
  • PDF

This document was uploaded by user and they confirmed that they have the permission to share it. If you are author or own the copyright of this book, please report to us by using this DMCA report form. Report DMCA


Overview

Download & View 261-1002 as PDF for free.

More details

  • Words: 9,469
  • Pages: 23
Question Paper Investment Banking and Financial Services –I (261) : Oct 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 statements is/are true regarding auction of Treasury Bills in India? I.

a. b. c. d. e. 2.

Currently, the settlement in the Indian stock exchanges is done on a a. b. c. d. e.

3.

T + 3 system T + 5 system 7-day settlement cycle 14-day settlement cycle 30-day settlement cycle.

According to the capital adequacy norms applicable to NBFCs, which of the following offbalance sheet exposures carry a credit conversion factor of 50% ? a. b. c. d. e.

4.

Non-competitive bids are accepted at the weighted average of the successful bids if the notified amount is not fully subscribed to II. Auction of T-Bills is an example of Dutch auction III. In auction of T-Bills there is always a possibility of winner’s curse. Only (I) above Only (II) above Both (I) and (II) above Both (I) and (III) above All (I), (II) and (III) above.

Underwriting obligations with respect to shares and debentures Lease contracts entered into but yet to be executed Bills discounted/rediscounted with banks Both (a) and (b) of the above Both (b) and (c) of the above.

Which of the following is/are true regarding cross border factoring? I.

The client assigns the export receivables to the export factor who in turn assigns to the import factor. II. The import factor carries out the tasks of credit checking, sales ledgering and collection. III. The client is required to deal with both the import factor and export factor. a. b. c. d. e. 5.

Only (II) above Only (III) above Both (I) and (II) above Both (II) and (III) above All (I), (II) and (III) above.

ASMA Ltd., a manufacturing company has a paid up capital of Rs.24 crore and free reserves of Rs.16 crore. The maximum amount of public deposits that ASMA can raise from the public (excluding its shareholders) is a. b. c. d. e.

Rs. 6.0 crore Rs. 8.4 crore Rs.10.0 crore Rs.14.0 crore Rs.16.0 crore. 1

6.

Which of the following is true regarding cumulative convertible preference shares (CCPS)? I.

a. b. c. d. e. 7.

The minimum denomination and maturity of the American CDs is _______ and _______ days respectively. a. b. c. d. e.

8.

$50000, 15 $50000, 30 $100000, 10 $100000, 15 $100000, 30.

Niagara Distilled Water Ltd. issues 9 months CPs of face value of Rs.1000000 at Rs.956555. The stamp duty payable on each CP is a. b. c. d. e.

9.

CCPS helps companies to maintain EPS and increase the leveraging capacity of the company II. CCPS can be considered as a part of the net worth of the company even before its conversion III. CCPS cannot be issued with warrants. Only (I) above Only (II) above Both (I) and (II) above Both (II) and (III) above All (I), (II) and (III) above.

Rs.2391.40 by the issuer Rs.2500.00 by the investor Rs.3587.08 by the issuer Rs.3587.08 by the investor Rs.3750.00 by the issuer.

For an underwritten issue, the minimum underwriting that has to be committed by the Lead Manager to the issue is a. b. c. d. e.

Rs.20 lakhs Rs.25 lakhs 5% of the issue size 5% of the issue size or Rs.25 lakhs, whichever is less Underwriting by Lead Manager is not mandatory.

10. Divine Divas Ltd. comes up with an IPO of Rs.1000 crore. The registration fee payable to SEBI is _______. a. b. c. d. e.

Rs. 25,000 Rs. 50,000 Rs.1,00,000 Rs.2,50,000 Rs.5,00,000.

11. Exotic Resorts Ltd. is coming up with an issue of Rs.200 crore of 8000000 equity shares of face value Rs.5 at a premium of Rs.245. The market lot of the issue would be a. b. c. d. e.

10 shares 25 shares 40 shares 50 shares 100 shares.

12. An instrument is rated MA from ICRA. The instrument rated is a/an a. b. c. d. e.

Bond Commercial paper Equity Fixed deposit Preference share. 2

13. In which of the following stages, sales tax affects a lease transaction? I. When the asset is purchased by the lessor for the purpose of leasing II. When the right to use the asset is transferred to the lessee for a valuable consideration III. When the asset is sold by the lessor at the end of the lease period. 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.

14. While evaluating a hire purchase proposal, under which of the following situations, replacement cost is the appropriate measure of valuation?

a. b. c. d. e.

I. Realisation value > Economic value > Replacement cost II. Economic value > Replacement cost > Realisation value III. Economic value > Realisation value > Replacement cost Only (I) above Only (II) above Both (II) and (III) above Both (I) and (III) above All (I), (II) and (III) above.

15. In a hire purchase agreement the borrower is to pay 48 installments of Rs.1,000 each for an asset costing Rs.46,750. Immediately after paying the 30th installment, he wishes to repay the outstanding loan and purchase the equipment. The interest rebate as per Rule of 78 Method is a. b. c. d. e.

Rs. 84.44 Rs.162.63 Rs.169.55 Rs.181.76 Rs.189.49.

16. The equated monthly installment (EMI) for a consumer loan of Rs.25000 is Rs.2400 for 12 months. The annual effective rate of interest (by trial and error method) charged by the finance company is a. b. c. d. e.

15.00% 15.20% 15.82% 26.04% 30.67%.

17. Under which of the following aspects, factoring differs from bills discounting? I.

In a bill discounting arrangement, the financial intermediary does not assume the responsibilities of sales ledger administration and collection of debts, which the factor does under the factoring arrangement II. Unlike bill discounting, no notice of assignment is provided to the customers of the client under the factoring arrangement III. The bill discounting arrangement is recourse to the client whereas a factoring arrangement can be with or without recourse. a. b. c. d. e.

Only (I) above Both (I) and (II) above Both (I) and (III) above All of the above None of the above.

3

18. Which of the following is true regarding charge cards? a. b. c. d. e.

The payment period is revolving credit payment period – normally within 45 days of purchase 2.5% to 3% interest is charged on the outstanding balance Only annual payment is charged Amount of payment to be made is atleast 5% of the purchase There is no preset spending limit.

19. Consider the following data of a company: EBIT Lease payments per period Depreciation Interest charges Loan repayment per period Marginal tax rate The cash flow coverage ratio of the company is a. b. c. d. e.

Rs.2,50,000 Rs.50,000 Rs.25,000 Rs.30,000 Rs. 5,000 30%

2.00 2.15 2.48 3.73 4.00.

20. Before roll over of NCDs or the non convertible portion of PCDs, fresh credit rating shall be obtained within a period of ______ months prior to the date of redemption and communicated to debenture holders before roll over. a. b. c. d. e.

2 3 6 9 12.

21. In case of mortgages, while assessing the credit worthiness of a borrower which of the following is/are true regarding Loan-To-Value ratio (LTV)? I. It indicates the percentage of down payment required by lenders II. It will increase as the mortgage balance decreases III. It will be quoted high in times of lower interest rates. 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.

22. Which of the following forms of loan will hedge against interest rate risk? a. b. c. d. e.

Bow ties Gap loans Mini-perms Buy down loans Both (a) and (b) of the above.

23. Which of the following is/are true with regard to the call money market?

a. b. c. d. e.

I. The call rates are calculated on a weekly basis II. The call rates are highly volatile III. Low call rates indicate lack of liquidity in the financial system Only (II) above Only (III) above Both (I) and (II) above Both (I) and (III) above Both (II) and (III) above. 4

24. Which of the following is not true with regard to repo transactions?

a. b. c. d. e.

I. These involve borrowings of unsecured nature II. State government securities are not eligible for repo transactions III. The interest rate on the borrowing is negotiated between the borrower and the lender. Only (I) above Only (II) above Both (I) and (II) above Both (I) and (III) above None of the above.

25. Which of the following is not true with regard to depositories? a. b. c. d. e.

The securities are held in an electronic form Securities are transferred by book entries Stamp duty is payable on transfer of securities, though at a lesser rate than physical transfer of securities There is no risk of bad deliveries All corporate actions are handled by depositories.

26. Allease Ltd. leases an equipment costing Rs.10 lakhs to Best Ltd. for a period of 3 years. The lease rentals are payable yearly in advance at the rate of Rs.110 ptpq. If the lease rentals attract a sales tax of 4% and marginal cost of debt of Best Ltd. is 14%, the present value of lease payments for Best Ltd. is a. b. c. d. e.

Rs.12.11 lakhs Rs.11.65 lakhs Rs.11.20 lakhs Rs.10.63 lakhs Rs.10.22 lakhs

27. Which of the following statements is/are true about Real Estate Investment Trusts (REITs)? I.

a. b. c. d. e.

REITs can be viewed as mutual funds that invest in real estate properties and/or mortgages. II. REITs are permitted to issue only shares of beneficial interest and cannot raise funds by way of bank borrowings. III. Many REITs list their shares on the stock exchanges or their shares are traded in the OTC markets. Only (I) above Both (I) and (II) above Both (I) and (III) above Both (II) and (III) above All (I), (II) and (III) above.

28. Vijay Limited is planning a rights issue of equity shares in the ratio of 1 right share for every 5 shares held. If the current market price of the share is Rs.45 and ex-rights price should not fall below Rs.43, subscription price should be more than or equal to a. b. c. d. e.

Rs.10 Rs.30 Rs.33 Rs.42 Rs.44.

29. The required amount of successful bids by a primary dealer who participated in the bidding of treasury bills is Rs.400 crores. The commitment to aggregate bidding would have been a. b. c. d. e.

Rs.1,000 crores Rs.1,200 crores Rs.1,400 crores Rs.1,600 crores Rs.2,000 crores.

5

30. Not more than ____% of the Foreign Currency Convertible Bonds raised by an Indian company should be used for general corporate restructuring including working capital requirements. a. b. c. d. e.

10 15 20 25 30. END OF PART A

6

Part B : Problems (50 Points) • • • • •

1.

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.

I@Dreams Entertainment Ltd. is a leading producer of entertainment software. I@Dreams intend to expand its production expertise to meet the growing demand in the domestic and the international entertainment market. For this it wants to finance its expansion mainly through the ECB route. The company has received the following offer from the Bank of Tokyo. AMEX has agreed to provide guarantee cover on this loan. The terms and conditions of the loan are as follows: Amount

40 billion Yen

Maturity

8 years

Draw down

20 billion Yen on January 01, 2003 20 billion Yen on January 01, 2004

Interest

125 BP over Yen LIMEAN, payable annually

Management fee

20 BP

Underwriting fee

30 BP

Commitment fee

15 BP (payable at the beginning of the year)

Agency fee

30 million Yen per annum (payable at the beginning of the year)

Guarantee fee

60 BP (payable at the end of the year)

Amortization

4 equal installments at the end of 5th, 6th, 7th and 8th year

The expected Yen LIBOR and LIBID, as per a survey conducted by Japanese Bond Research Institute (JBRI), are as follows: Year

LIBOR (%)

LIBID (%)

2003

1.50

1.40

2004

2.00

1.85

2005

3.00

2.75

2006

2.75

2.55

2007

2.85

2.50

2008

2.10

2.00

2009

2.05

1.85

2010

2.00

1.75

2011

1.80

1.50

You are required to a. Compute the effective cost of the loan to I@Dreams Entertainment Ltd. b. State the provisions regarding the end use of ECBs as per the Guidelines on Policies & Procedures for External Commercial Borrowings for 1999-2000. (7 + 2 = 9 points)

7

2.

Best Financial Services Ltd. (BFSL) is a financial service company offering leasing, hire purchase and other financial services to its customers. Recently, Fitwell Fabrics Ltd. (FFL) has approached BFSL for funding its investment in a machinery costing Rs.100 lakhs for its expansion program. The machinery is estimated to have a life of 5 years and a salvage value of Rs.10 lakhs at the end of 5 years. The tax relevant rate of depreciation is 30%. FFL expects to generate cash flow from the second year and requests BFSL to structure the lease rentals in such a way that the lease rentals payments match the cash flow of FFL. After careful analysis, FFL and BFSL agreed for the following pattern of lease payments over the lease period of 5 years: Year

Lease Rentals

1

Nil

2

Nil

3–5

Rs.120 ptpq payable quarterly in advance

BFSL has suggested the alternate mode of financing i.e. hire purchase. Under hire purchase BFSL requires 20% of the cost of asset as down payment and payment to be made quarterly in arrears over a period of 5 years. BFSL allocates interest on SOYD basis. BFSL falls in the tax bracket of 30%. Ignore interest tax. Your are required to: a. Determine the flat rate of interest under hire purchase facility so that BFSL is indifferent between leasing and hire purchase. b. Show the accounting treatment of the hire purchase transaction in the books of BFSL for the first two years. 3.

(13 + 4 = 17 points) Mr. S plans to purchase a vehicle worth Rs.75,000. He approaches Citywide Financial Services to finance the purchase of vehicle under its Express Cash Personal Loans Scheme. The following details are provided by the finance company: Monthly outgoings are: Monthly Installment (Rs.)

Loan Amount (Rs.)

12 months

24 months

36 months

25,000

2,417

1,375

1,033

50,000

4,833

2,750

2,066

75,000

7,250

4,125

3,099



2% processing fee (minimum Rs.300) to be paid upfront.



No prepayment charges.



On the day of prepayment the borrower has to pay only the balance of capital. Interest is allocated to the installments on a straight line basis. You are required to: a. Calculate the flat rate and effective rate of interest that would be charged on the loan granted to Mr. S by the finance company for a loan period of 36 months. b. Calculate the effective rate of interest assuming Mr. S prepays the loan at the end of the 30th month under the finance scheme. (3 + 3 = 6 points)

8

4.

5.

First Finance Corporation, a leading US private equity fund has recently started its operations in the Indian market by way of providing equity and mezzanine finance to corporates desiring public offering of their equity. Sri Sai Balaji Food Processing Pvt. Ltd. is a fast growing Hyderabad based food processing company. It intends to acquire some advanced food processing machines from Germany. The Managing Director of Sri Sai Balaji approaches First Finance Corporation Ltd. to make an equity investment of Rs.15 crore. The current EPS of Sri Sai Balaji is Rs.9 and the expected growth rate of EPS as estimated by the company for the coming year is as follows: Growth rate in EPS (%) Probability (%) 10 20 20 50 30 30 The forecast of the Financial Analyst of First Finance regarding the P/E ratio for the Indian Food Processing industry is as follows: P/E ratio Probability (%) 15 30 22 45 30 25 The salient features of investment policies of First Finance Corporation Ltd. are as follows: • The time horizon of all investments made is 1 year • The target return should be 40% • The probability of achieving the target return should be at least 72% • Divestment is priced at industry P/E ratio. You are required to use the normal distribution table and compute the price per share at which First Finance Corporation Ltd. should invest in Sri Sai Balaji Food Processing Pvt. Ltd. (10 points) Paribus Factors, a subsidiary of BNP Paribus offers recourse factoring on the following terms: Facility Recourse Factoring I. Discount charge (payable up-front) 18% p.a. II. Reserve 21% III. Commission 2.5% The Finance Manager of Fabulous Furnishings Ltd, a dealer in home furnishings has approached Paribus Factors to factor its receivables. After intricate analysis of the sales documents of Fabulous Furnishings Ltd, Paribus Factors offered a guaranteed payment period of 45 days. The following information about the credit policy and trends of Fabulous Furnishings Ltd is available: Fabulous Furnishings sells on terms 2/10 net 45. On an average 50% of the customers pay on the 10th day and avail the discount. Again on an average the remaining customers pay 80 days after the invoice date The bad debts and losses amount to 1% of the sales invoices The sales personnel are responsible for following up collections and by and large the Fabulous Furnishings can increase its annual sales by Rs.25 lakhs if the sales people are relieved from collection jobs. The gross margin on sales is 28% and the estimated sales turnover for the following year without considering the increase in sales is Rs.300 lakhs By offloading sales ledger administration and credit monitoring, Fabulous Furnishings can save overheads to the extent of Rs.1.50 lakhs per annum Currently, Fabulous Furnishings is financing its investments through a mix of bank finance and long-term funds in the ratio of 3:2. The effective rate on bank finance is 17% and the pre-tax cost of long-term funds is 21%. Your are required to: a. Perform cost-benefit analysis of recourse factoring and advise Fabulous Furnishings whether to accept the factoring proposal or not. b. Find out the maximum rate of factoring commission Fabulous Furnishings can pay if it wishes to relieve the cost of bad debts and be indifferent between recourse and non-recourse factoring. (6 + 2 = 8 points) END OF PART B 9

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 National Housing and Habitat Policy outlined the urgency of development of mortgage market in the country. In this context, discuss four different forms of non-traditional mortgages. (10 points) Credit rating has emerged as one of the very important financial services. Discuss the various steps in credit rating. How does a shadow rating vary from a formal rating? (10 points)

END OF PART C END OF QUESTION PAPER

10

Suggested Answers Investment Banking and Financial Services –I (261) : Oct 2002 Part A : Basic Concepts 1.

2.

Answer : (d) Reason : In the auction of T-Bills in India, successful competitive bids will be accepted upto the minimum discounted price called ‘cut-off’ price determined at the auction. The bids above the cut-off price are accepted completely and bids at offer prices below cut-off price are rejected. If the notified amount is not fully subscribed to, the non-competitive bids are accepted at the weighted average of the successful bids. Hence (I) is true. Dutch auction is an auction in which all the successful bidders pay the price of the lowest accepted bid. English auction is an auction where the successful bidders pay the price at which they have bided. As all the successful bidders will be allotted the T-Bills at the respective prices at which the bids have been made, it is an example of English auction. Hence, (II) is not true. Winner’s curse is a situation where the bids are accepted but the bidder may make a loss. As in auction of T-Bills, all the successful bidders pay the price at which they have bided there is always a chance of the bidder bidding too high. Hence winner’s curse can happen in a T-Bills auction. Hence (III) is true. Hence, (d) is correct answer. Answer : (a) Reason : Currently the settlement in the Indian stock exchanges is done on a T+3 system. Hence (a) is the correct answer.

3.

Answer : (a) Reason : According to capital adequacy norms applicable to NBFCs, underwriting obligations with respect to shares and debentures carry a credit conversion factor of 50%.

4.

Answer : (a) Reason : Cross border factoring also referred to as an international factoring is similar to domestic factoring except that there are usually four parties to the transaction – exporter, importer, export factor and import factor. Under this system, the exporter enters into a factoring agreement with the export factor who in turn enters into an arrangement with a factor based in the country where the importer resides and contracts out the tasks of credit checking etc. Hence, (II) is true and the answer is (a). In this factoring arrangement, the client assigns the export receivables to the export factor but the export factor does not assign the same to the import factor. Hence, (I) is incorrect. Although cross border factoring employs the two factor system, the exporter is required to deal with only one factor residing in his country. Hence, (III) is also incorrect. Answer : (c) Reason : The total amount of public deposits (other than that from the share holders) that can be outstanding at any point of time cannot exceed 25% of the aggregate of paid-up capital and free reserves. Hence the maximum amount of public deposit that ASMA can raise from the public (except its shareholders) = 25% of aggregate of paid-up capital and free reserves = 25% of (24 + 16) = 25% of Rs.40 crores = Rs.10 crores. Hence (c) is the correct answer.

5.

6.

Answer : (c) Reason : CCPS are similar to convertible bonds i.e. they are eventually converted to equity. CCPS pays fixed dividend. CCPS helps companies to maintain EPS and increase the leveraging capacity of the company as they are considered as part of owner’s capital. Hence, (I) is true. CCPS can be considered as a part of the net worth of the company even before its conversion. Hence, (II) is also true. CCPS can be issued with warrants. Hence (III) is incorrect.

7.

Answer : (e) Reason : The minimum denomination and maturity of the American CDs is $100000 and 30 days respectively. Hence (e) is the correct answer.

11

8.

Answer : (e) Reason : The stamp duty payable on a 9 months CP is 0.375% on the face value. And stamp duty is always payable by the issuer. Hence stamp duty payable on a 9 months CP of Rs.1000000 is 0.375% of Rs.1000000 = Rs.3750, and this is payable by the issuer. Hence (e) is the correct answer.

9.

Answer : (d) Reason : For an underwritten issue, the minimum underwriting that has to be committed by the Lead Manager to the issue is 5% of the issue size or Rs.25 lakhs, whichever is less. Hence (d) is the correct answer. 10. Answer : (e) Reason : The registration fee payable to SEBI for an issue of size above Rs.500 crore is Rs.5,00,000. Hence the registration fee payable to SEBI by Divine Divas for an IPO of Rs.1,000 crore is Rs.5,00,000. Hence (e) is the correct answer. 11. Answer : (d) Reason : For an issue price of Rs.100 to Rs.400, the market lot is 50 shares. Thus for an issue price of Rs.250 (5 + 245), the market lot would be 50 shares. Hence (d) is the correct answer. 12. Answer : (d) Reason : An instrument, which is rated MA from ICRA is a Fixed Deposit. Hence (d) is the correct answer. 13. Answer : (e) Reason : In all of the following stages, sales tax affects a lease transaction: •

When the asset is purchased by the lessor for the purpose of leasing

• When the right to use the asset is transferred to the lessee for a valuable consideration • When the asset is sold by the lessor at the end of the lease period Hence (e) is the correct answer. 14. Answer : (e) Reason : In (I), as the realization value exceeds economic value, it appears that the firm should disinvest and therefore RV is the most appropriate measure. But applying the criterion of “loss suffered on deprivation”, it is clear that the replacement cost is the most appropriate measure. In (II) and (III), the loss suffered by the firm on deprivation is the replacement cost. Hence replacement cost is the most appropriate measure under all the situations. Hence (e) is the correct answer. 15. Answer : (d) Reason : Interest rebate, R = [t(t + 1)/n(n + 1)] x D, Where, t = number of level installments that are not due and outstanding = 48 – 30 = 18. And n = total number of level installments = 48 D = total charge of credit = Rs.48 × 1,000 – 46,750 = Rs.1,250 Hence R =

18 ×19 × Rs.1,250 = Rs.181.76 48 × 49

Hence (d) is the correct answer. 16. Answer : (e) Reason : Effective rate of interest is value of ‘r’ in the following: 2,400 PVIFAr,12

=

25,000

PVIFAr,12

=

10.417

Looking at the interest tables and by interpolation r = 30.67%.

12

17. Answer : (c) Reason : Factoring differs from bills discounting in the following respects • •

In a bill discounting arrangement, the financial intermediary does not assume the responsibilities of sales ledger administration and collection of debts, which the factor does under the factoring arrangement. Hence, I is true. The bill discounting arrangement is recourse to the client whereas a factoring arrangement can be with or without recourse. Hence, III is true.



Unlike factoring, no notice of assignment is provided to the customers of the client under the bill discounting arrangement. Hence, II is not true. Hence (c) is the correct answer. 18. Answer : (e) Reason : Charge cards, is a variation of plastic money where the entire payment is normally paid within 30 days of purchase. Hence (a) is not true. Interest is not charged as there is no extension of payment period. Hence (b) is not true. Both annual payment and commission is charged in case of charge card. Hence, (c) is not true. Amount of payment to be made is 100% of the purchase. Hence, (d) is also not true. Unlike credit cards, as the entire payment is made there is no present spending limit. Hence, (e) is true. 19. Answer : (d) Reason : Cash flow coverage ratio = [EBILT + D]/[I + L + {LR/(1 – t)}] = [250000 + 50000 + 25000]/[30000 + 50000 + {5000 / (1 – 0.3)}] = 3.73. Hence (d) is the correct answer. 20. Answer : (c) Reason : Before roll over of NCDs or the non convertible portion of PCDs, fresh credit rating shall be obtained within a period of 6 months prior to the date of redemption and communicated to debenture holders before roll over. Hence (c) is the correct answer. 21. Answer : (d) Reason : LTV is used by the lenders to indicate the percentage of down payment required by them. High LTVs are quoted only for newer, readily marketable properties and in times of lower interest rates. Hence (I) and (III) are true and (d) is the correct answer. However, as the mortgage balance declines, LTV also declines. Hence, (II) is not true. 22. Answer : (a) Reason : A bow tie protects both the lender and the borrower against the volatility in the interest rates. If the market rates of interest exceed the ceiling rate agreed upon the documentation, an additional amount may have to be added as a balloon payment to the principal at maturity. Hence (a) is the correct answer. Mini-Perm is a short-term loan extended at the time of completion of the project to provide bridge finance until the developer can obtain financing of a more permanent nature. It has no relevance to the interest rate risk. Gap loan are extended to the developer to cover the difference or gap between the bank construction loan and the total cost of the project. Gap loans also have no relevance to the interest rate risk. Buy down loans are similar to pledged a/c mortgages where the seller of the property places cash in a segregated account in order that additional amounts required may be drawn and paid along with the mortgage payments done by the borrower. Interest rate risk has no relevance in case of buy down loans. Hence, (b), (c), (d) and (e) are not true. 23. Answer : (a) Reason : Call money market is a part of the money markets, where, day-to-day surplus funds, mostly of banks are traded. The interest paid on call loans are known as the call rates. Call rates are expected to freely reflect the day-to-day market scarcities or lack of funds. These rates vary very often and are considered as very volatile. Hence, (II) is true & (a) is the answer. Call rates are calculated on a daily basis. Hence, (I) is incorrect. High rates indicate a tightness of liquidity while low rates indicate an easy liquidity position in the market. Hence, (III) is also incorrect.

13

24. Answer : (c) Reason : Repo (Ready Forward Deal) is an agreement, which involves a sale of a security with an undertaking to buy-back the same security at a predetermined price at a future date. If a bank borrows amount through a repo, the lender will receive a security duly transferred which will be held in his name till the reversal of the transaction takes place. Though very unlikely, in the event of the reversal not taking place, the lender does not suffer any loss since the transaction tantamounts to an outright purchase of a security. Hence, the borrowing under Repo is a secured borrowing. Hence, (I) is not true. RBI announces the nature of securities eligible for Repo transactions as a part of development of the repo market. Even State Government Securities have been made eligible for undertaking repos. Hence, (II) is also not true and statement is the answer. The interest rate on the borrowing will be mutually negotiated depending on the term, amount and the prevailing call money and term money rates. Hence, (III) is true. 25. Answer : statement Reason : A depository is an entity which holds the securities in electronic form on behalf of the investor. Dematerialization is a process by which physical certificates of the investor are destroyed and an equivalent number of securities are credited to the account of the investor. This also enables transfer of securities by book entries. The risk of bad deliveries is also eliminated. Further the depository also handles all the corporate actions like exercising for rights, collection of dividends, credit for bonus, exercising of warrants, conversion option, etc. on behalf of the investor. Transfer of securities through depository does not attract stamp duty. Hence, statement is the answer. 26. Answer : (a) Reason : Present value of lease payments to Best Ltd. at the marginal cost of debt of 14% is 27. Answer : Reason :

28. Answer : Reason :

0.11 × 10 × 4 PVIFA14%,3 × 1.04 × 1.14 = Statement12.11 lakhs. statement The indirect real estate equity investment is done predominantly through equity real estate investment trusts (REITs). In a loose sense, REITs can be viewed as mutual funds that invest in real estate properties and/or mortgages instead of securities such as bonds and shares. Hence, (I) is true. REITs list their shares on the stock exchanges or their shares are traded in the over-thecounter markets. Hence, (III) is true and statement is the answer. REITs raise the funds required for investment in properties through issue of shares of beneficial interest (analogous to equity shares), borrowings from institutions such as banks and insurance companies and issue of a variety of debt instruments. Hence, (II) is not true. statement Ex-rights price ≥ Statement43 NPO + S ≥ 43 N +1 Where N is the number of share required for 1 right share = 5 P0 is the current market price = 45 S is the subscription price 5× 45 + S Therefore, ≥ 43 5+1 S

≥ ≥

43 × 6 – 5 × 45 Statement33.

29. Answer : (a) Reason : The minimum success ratio for primary dealers is 33.33% for government securities and 40% for treasury bills. If the required amount of successful bids in the bidding of treasury bills is 400 Statement400 crores, commitment to aggregate bidding is = Statement1,000 crores. 0.4 30. Answer : (d) Reason : According to the guidelines issued for FCCBs and Euro issue, not more than 25% of the FCCB issue proceeds may be used for general corporate restructuring including working capital requirements. Hence, (d) is the answer. 14

(261)

Part B : Problems 1.

a. Year

LIBOR

LIBID

LIMEAN

Interest rate

2003

1.50%

1.40%

1.45%

2.70%

2004

2.00%

1.85%

1.93%

3.18%

2005

3.00%

2.75%

2.88%

4.13%

2006

2.75%

2.55%

2.65%

3.90%

2007

2.85%

2.50%

2.68%

3.93%

2008

2.10%

2.00%

2.05%

3.30%

2009

2.05%

1.85%

1.95%

3.20%

2010

2.00%

1.75%

1.88%

3.13%

2011

1.80%

1.50%

1.65%

2.90% (Amount in billion Yens)

Upfront

31.12.03

31.12.04

31.12.05

31.12.06

31.12.07

31.12.08

31.12.09

31.12.10

20.0000

20.0000

0.0000

0.0000

0.0000

0.0000

0.0000

0.0000

0.0000

Amortization

0.0000

0.0000

0.0000

0.0000

0.0000

10.0000

10.0000

10.0000

10.0000

Interest

0.0000

0.5400

1.2720

1.6520

1.5600

1.5720

0.9900

0.6400

0.3130

Management fee

0.0800

0.0000

0.0000

0.0000

0.0000

0.0000

0.0000

0.0000

0.0000

Underwriting fee

0.1200

0.0000

0.0000

0.0000

0.0000

0.0000

0.0000

0.0000

0.0000

Commitment fee

0.0300

0.0000

0.0000

0.0000

0.0000

0.0000

0.0000

0.0000

0.0000

Agency fee

0.0300

0.0300

0.0300

0.0300

0.0300

0.0300

0.0300

0.0300

0.0000

Guarantee fee

0.0000

0.1200

0.2400

0.2400

0.2400

0.2400

0.1800

0.1200

0.0600

Net Cash Flow

19.7400

19.3100

-1.5420

-1.9220

-1.8300

-11.8420

-11.2000

-10.7900

-10.3730

Drawdown

b.

Effective cost of borrowing to Entertainment Ltd. is the IRR of the above cash flow = 4.3773% A. External commercial loans are to be utilized for import of capital goods and services (on FOB or CIF basis) and for project related expenditure in all sectors subject to following conditions: a. ECB raised for project-related rupee expenditure must be brought into the country immediately. b. ECB raised for import of capital goods and services should be utilized at the earliest and corporates should strictly comply with RBI’s extant guidelines on parking ECBs outside till actual imports. RBI would be monitoring ECB proceeds parked outside. c. ECB raised is not permitted for investment in stock market or in real estate. B. Corporate borrowers will be permitted to raise ECB to acquire ships/vessels from Indian shipyards. C. Under no circumstances, ECB proceeds will be tilized for i. Investment in stock market; and ii. Speculation in real estate.

15

2.

If BFSL has to be indifferent between leasing and hire purchase, the IRR on both the transactions should be same. IRR on the lease transaction is the discounting rate in the following: – Investment cost + PV of lease rentals – PV of tax on lease rentals + PV of DTS + PV of salvage value =0 a. Investment cost = Statement100 lakh r r b. PV of lease rentals = 0.12 x 100 x 4 4 x PVIFAr,3 PVIFr,2 = Statement48 4 PVIFAr,3 PVIFr,2 d d lakhs c. PV of tax on lease rentals = 0.120 x 100 x 4 x PVIFAr,3 PVIFr,2 x 0.3 = Statement14.4 PVIFAr,3 PVIFr,2 lakhs d. Depreciation tax shield: (Statement lakhs) Year 1 2 3 4 5 e.

Depreciation 30.000 21.000 14.700 10.290 7.203

Depreciation Tax Shield 9.000 6.300 4.410 3.087 2.161

PV of DTS = (Statement9PVIFr,1 + 6.3 PVIFr,2 + 4.41PVIFr,3 + 3.087 PVIFr,4 + 2.161PVIFr,5) PV of salvage value = Statement10PVIFr,5 lakhs IRR is the value of r in the following r –100 + 48 4 PVIFAr,3 PVIFr,2 – 14.4PVIFAr,3 PVIFr,2 + 9PVIFr,1 + 6.3PVIFr,2 + 4.41PVIFr,3 d + 3.087 PVIFr,4 + 2.161PVIFr,5 + 10PVIFr,5 = 0 At r = 12% – 100 + 48 × 1.0739 × 2.402 × 0.797 – 14.4 × 2.402 × 0.797 + 9 × 0.893 + 6.3 × 0.797 + 4.41 × 0.712 + 3.087 × 0.636 + 2.161 × 0.567 + 10 × 0.567 = –100 + 98.682 – 27.567 +8.037 + 5.02 +3.140 + 1.963 + 1.225 + 5.67 = Statement–3.829. At r = 10%

– 100 + 48 × 1.0618 × 2.487 × 0.826 – 14.4 × 2.487 × 0.826 + 9 × 0.909 + 6.3 × 0.826 + 4.41 × 0.751 + 3.087 × 0.683 + 2.161 × 0.621 + 10 × 0.621 = – 100 + 104.698 – 29.581 + 8.181 + 5.204 + 3.312 + 2.108 + 1.342 + 6.21 = Statement1,474. By interpolation 1.474 r = 10 + x2 1.474 + 3.829 = 10.56% = 11% (approx) HP Transaction: Let the value of hire payments be Statement H lakhs per quarter. A. Loan amount = 100 x 0.8 = Statement80 lakhs. i B. PV of hire payments = 4H PVIFA11%,5 x 4 = 4H × 3.696 × 1.0404 i = Statement15.381H lakhs. C.

PV of the tax on finance changes: Total charge for credit = 4H × 5 – 80 = 20 H – 80 = Statement20 (H – 4) lakhs

16

(Statement in lakhs) Year

S0YD factor

Interest

PVIF at 11%

PV

1

20 + 19 + 18 + 17 74 = 20 + ......... + 1 210

7.048 (H– 4)

0.901

6.350 (H – 4)

2

16 +15 + 14 +13 58 = 20 + .........+ 1 210

5.524 (H– 4)

0.812

4.485 (H – 4)

3

12 + 11 + 10 + 9 42 = 20 + .........+ 1 210

4 (H– 4)

0.731

2.924 (H – 4)

4

8+7+ 6+5 26 = 20 + .........+ 1 210

2.476 (H– 4)

0.659

1.632 (H – 4)

5

4 + 3 + 2 +1 10 = 20 + .........+ 1 210

0.952 (H– 4)

0.593

0.565 (H – 4) 15.956 (H – 4)

PV of tax on finance charges

= 15.956 (H – 4) x 0.3 = Statement4.787 (H – 4) lakhs Hire payments is the value of H in the following: – A + B – C =0 – 80 + 15.381 H – 4.787 (H – 4) = 0 10.594H = 60.852 H = 5.744 lakhs. Flat rate =

5.744 × 4 × 5 − 80 ×100 = 8.72% 80 × 5

b.

Accounting treatment: Annual hire payment = 5.744 x 4 = Statement22.976 lakhs Allocation of total charge for credit Statement lakhs Year

Interest

Capital content

1

12.292

10.684

2

9.634

13.342

3

6.976

16.000

4

4.318

18.658

5

1.660

21.316

Income Statement (Rs. in lakhs) Year 1

Year 2 Hire Finance income

Year 1

Year 2

12.292

9.634

Year 1

Year 2

91.904

68.928

Balance Sheet

Current liabilities: Unmatured Finance Income

Year 1

Year 2

22.588

12.954

Stock on Hire

17

3.

a.

Loan

=

Rs.75,000

EMI

=

Rs.3,099

Flat rate of interest =

3099 × 36 − 75,000 = 16.25% 3 × 75,000

Effective rate of interest is ‘i’ in the following: 3099 PVIFAi,36 + 1500 – 75,000 = 0 ‘i’ is approximately 2.456% p.m. = 33.8% p.a. b.

75,000 × 0.1625 = Rs.1015.63 12 As interest is charged on straight-line basis each EMI has an interest portion of Rs.1016 and a principal portion of Rs.2083.37. ∴ Capital repaid upto 30th installment = Rs.62,501 Balance principal to be repaid = Rs.12,499. Effective rate of interest is ‘i’ in the following: 3099 PVIFAi,30 + 1500 + 12499PVIFi,30 – 75,000 = 0 Interest per month on straight line basis =

‘i’ is approximately 2.25% p.m. = 30.6% p.a. 4. Growth rate in EPS (1) 0.10 0.20 0.30 0.10 0.20 0.30 0.10 0.20 0.30

P/E ratio

Exp. EPS

(2) 15 15 15 22 22 22 30 30 30

(Rs.) (3) 9.9 10.8 11.7 9.9 10.8 11.7 9.9 10.8 11.7 Average Price

Exp. Price (Rs.) (4) 148.5 162.0 175.5 217.8 237.6 257.4 297.0 324.0 351.0

(Expected price – Expected (Expected price – price – Average Price)2 × 2 Average Price) Average price Prob.

Joint Prob. % (5) 0.06 0.15 0.09 0.09 0.225 0.135 0.05 0.125 0.075

238.49

(6) – 89.99 – 76.49 – 62.99 – 20.69 – 0.89 18.91 58.51 85.51 112.51

7 = (6)2 8098.20 5850.72 3967.74 428.08 0.7921 357.59 3423.42 7311.96 12658.5

8 = (5) x (7) 485.89 877.61 357.10 38.53 0.18 48.27 171.17 914.00 949.39 3842.14 ó P = 3842.14 = 61.98

Probability of divestment price should be more than 72% Let x be the divestment price ∴

Value of Z should be – 0.58

Z

=

x -ì = − 0.58 ó

x − 238.49 = − 0.58 61.98 x = Rs.202.54. Target return = 40% 18

i.e.

202.54 − P = 0.4 P

P=

202.54 = Rs.144.67 1.4

Hence, First Finance should invest at Rs.144.67/share. 5.

a.

b.

The relevant costs associated with in-house management of receivables and recourse factoring are listed below: Relevant costs of in-house management of receivables A. Cash discount = 300 × 0.02 × 0.50 = Rs. 3.0000 Lakhs Average collection period = (10 × 0.50) + (80 × 0.50) = 45 days Cost of bank finance = (300 × 3/5) × (45/360) × 0.17 = Rs.3.8250 lakhs Cost of long-term funds = (300 × 2/5) × (45/360) × 0.21 = Rs. 3.1500 lakhs B. Cost of funds invested in receivables = Rs.6.9750 lakhs C. Bad debt losses = 300 × 0.01 = Rs.3 lakhs D. Contribution lost on foregone sales = 25 × 0.28 = Rs.7.0000 lakhs E. Avoidable cost of sales ledger administration & credit monitoring = Rs.1.5000 lakhs Relevant costs of recourse factoring F. Factoring commission = 325 × 0.025 = Rs.8.1250 lakhs G. Discount charge = 325 × 0.79 × 0.18 × (45/360) = Rs.5.7769 lakhs H. Cost of long term funds invested in receivables = 325 × 0.21 × 0.21 × (45/360) = Rs.1.7916 lakhs Cost-benefit analysis of recourse factoring I. Benefit associated with recourse factoring = A + B + D + E = Rs.18.4750 lakhs J. Cost associated with recourse factoring = F + G + H = Rs.15.6935 lakhs K. Net benefit = I – J = Rs.2.7816 lakhs As the net benefit associated with recourse factoring, is positive Fabulous Furnishings is advised to opt for recourse factoring. As the net benefit should be same and as benefit of non-recourse factoring is increased by the amount of bad debt losses i.e. Rs.3 lakhs, non-recourse factoring commission can be higher than recourse factoring by Rs.3 lakhs. ∴ Non-recourse factoring commission = 8.125 + 3 = Rs.11.125 lakhs. Rate =

11.125 = 3.42% 325

19

Part C: Applied Theory 6.

The features of some of the popular forms of non-traditional mortgages are discussed below Graduated-Payment Mortgages (GPMs) The payments on GPMs unlike the payments on traditional mortgages are not equal. The payments under GPMs start at a relatively low level and rise for a specified number of years and then become equal after the specified number of years. The level of steps of increase and the specified number of years after which the payments become equal depend upon the plan indicated in the mortgage agreement. The terms of five popular plans are given in the table below: Graduated-Payment Mortgages Plan I II III IV V

Term to Maturity (in years) 30 30 30 30 30

Years that Payments Rise 5 5 5 10 10

Percentage Increase per year 2.5% 5.0% 7.5% 2.0% 3.0%

The comparison between monthly payments under a GPM based on Plan III and those under a traditional mortgage for a loan of $100,000 at 10% interest is given below: Year(s) 1 2 3 4 5 6-30

Monthly Payment under GPM $ 667.04 717.06 770.84 828.66 890.80 957.62

Monthly Payments under Traditional Mortgage $ 877.58 877.58 877.58 877.58 877.58 877.58

GPMs are preferred by young first-home buyers whose current income is not sufficient to take on a large loan, but whose income is expected to increase rapidly in the near future. As GPMs have smaller initial payments than the traditional mortgages, they do not pay down their mortgage balances as quickly. Another feature of GPMs is that the mortgage balance increases for a short period of time because smaller payments in the initial years do not even cover the interest and the short fall is added back to the mortgage balance. However, with the increase in the monthly payments gradually mortgage balance decreases and eventually reaches zero by the end of the term. Figure 1 shows the mortgage balance for a traditional and a plan III GPM. Under plan III GPM mortgage balances increase for a period of about 4 years and starts declining from then.

Figure 1: Comparison between Plan III GPM and a Traditional Mortgage Pledged-Account Mortgages (PAMs) PAMs are so structured that the repayments resemble traditional mortgages from the lender’s point of view and the repayments resemble GPMs from the borrower’s point of view. This is achieved as follows: Under PAMs some portion of the down payment as required under a traditional mortgage is deposited in a savings account. 20

The borrower then pays installments which are lower than those under traditional mortgage. These installments are increased at a specified percentage for a definite number of years and thereafter the borrower pays equal installments. Thus, for the borrower the payments resemble a GPM. The lender is however, paid equated monthly installments by drawing the difference between the installment paid by the borrower and the installment due from the pledged savings account. Buy Down Loans The buy down loan is similar to the PAM; however, it is the seller of the property and not the buyer/borrower who places cash in a segregated account in order that additional amounts required may be drawn and paid along with the mortgage payments done by the borrower. The pledged account is created by the seller out of his profits as in the absence of such pledged account, the borrower may not be eligible for any kind of loan. The amount that the seller pledges is a direct reduction of the sale proceeds for him and the borrower uses the seller’s money without himself having to repay this amount to the seller. Though, theoretically this cost incurred by the seller may be inbuilt in the price by increasing it, the mortgage lender may not allow it. Buy down loans are arranged by sellers who are anxious to sell their property. Adjustable-Rate Mortgages (ARMs) Many different kinds of ARMs have originated with their own features with the result that not all ARMs are even referred to as ARMs. Terms such as VRM (variable-rate mortgage), ROM (roll over mortgage), RRM (renegotiated-rate mortgage) and the like are used to refer to ARMs. ARMs have a number of complex features:

• •

ARMs can have maturities that vary as well as interest rates. It is impossible to calculate in advance the exact amortization schedule for an ARM. ARMs can have a provision that in any period, the interest cannot change beyond a specified basis points is referred to as a `periodic cap’. It can also have a provision that the mortgage interest rate may not rise above 2.5 percent (250 basis points) during the term of the maturity and is referred to as life time cap.



Another provision found on many ARMs is negative amortization. The borrower may be allowed to maintain a constant monthly payment after an interest rate increase by opting to add any interest shortfall to the outstanding mortgage balance. This process is allowed to continue until the mortgage balance reaches a maximum amount at which time payments must rise. With all these complexities, the ARM became popular due to the following reasons: i. ARM reduces interest rate risk for the lender. Hence, for thrift institutions such as the S & Ls, ARMs, in spite of the life time caps, offer obvious advantages. ii. Borrowers accept ARMs because the lenders by offering lower initial rates express their preference for ARMs. Depending on the competition and aggressiveness of the lender the initial interest rate on ARM could be 1/2 percent to 2 percentage points or more below the rates being quoted for fixed-rate mortgages. ARMs tend to be most popular when interest rates are highest and buyers are hunting for arrangements that could lower initial outflows. The disadvantage of ARMs is that they are difficult to be sold in pooled or security form as there are no standard clauses. It is difficult to find large quantities of any one kind of ARM, as there are diversities in initial interest rates, index, interest rate reset frequency, periodic or life time caps and so on. Share-Appreciation Mortgages (SAMs) High interest rates in the early 1980s brought about this innovative mortgage arrangement. SAMs use inflation as a way of paying for the property. The lender agrees to charge a very low level of interest on the funds and in turn, the borrower agrees to share part of the increase in the property value with the lender when the loan matures, or when the property is sold or at some other specified time. When SAMs came into existence, a one-third participation was popular; the lender would agree to decrease the interest charged by about a third of the prevailing rate in return for one third of the appreciation in the property value. For the borrower SAMs are attractive as he can purchase an otherwise unaffordable home. The lender has the potentially lucrative equity kicker, depending on the rate of inflation. However, the disadvantage with SAMs is that they are not standardized and hence cannot be pooled, packaged into units and sold as securities. Mortgage Pass Through Securities When mortgages are pooled together and undivided interests in the pool are sold, pass-through securities are created. The term `undivided’ in the context of pass-through securities means that each holder of the security has a proportionate interest in each cash flow generated in the pool. When a pass-through security 21

is sold, it is to be construed as a sale of assets and not as an issuance of debt obligations of the originator of the mortgages. That is, the obligation to pay continues to be that of the borrowers collectively and the originator has no obligation to pay. The pass-through securities promise that the cash flow from the underlying mortgages would be `passed through’ to the holders of the securities in the form of monthly payments of interest, principal and prepayments. When the holder of an individual mortgage prepays the whole or part of the principal before the scheduled date, prepayments are said to occur. Mortgage-backed Bonds The mortgage-backed bonds, another form of asset securitization, were evolved to address a weakness inherent in a mortgage pass-through security, namely, lack of call protection and poor predictability of cash flow. A mortgage-backed bond is a collateralized term-debt offering. It is secured by mortgages which have a market value of 110 to 200 percent of the principal amount of the bond. Unlike the pass-through certificates, the mortgages are not sold to the holder of the security, but are used only as collaterals for the bonds which are issued to raise finance. The terms of these bonds are like the bonds floated in the capital market – semi-annual or quarterly payments of interest at a fixed rate or floating rate and final bullet payment of principal. Collateralized Mortgage Obligations (CMOs) CMOs retain many of the yield and credit quality advantages of passthroughs, while eliminating some of the less desirable elements of the traditional mortgage-backed security. CMOs are bonds or debt obligations issued by mortgage originators by offering whole loan mortgages or mortgage passthrough securities as collateral. The cash flows generated by the assets in the collateral pool are first used to pay interest and then pay principal to the CMO bondholders. The major difference between traditional passthroughs and CMOs lies in the principal payment process. In the case of passthrough securities, each investor receives a pro rata distribution of any principal and interest payments (net of servicing fees) made by the homeowner. Since mortgages are self-liquidating assets, the holder of a passthrough receives some return of principal each month. Until all the mortgages in the pool are finally retired, complete return of principal and the final maturity of the passthrough does not occur. Thus, a large difference between average life and final maturity is created and there is a great deal of uncertainty with regard to timing of principal return under a passthrough security. 7.

The various steps in credit rating: 1. The rating process commences when a client approaches the credit rating agency to analyze and provide a rating symbol/report to a security/individual/borrower, etc. 2. The rating agency then assimilates all the necessary information required for this by meeting the management of the company/borrower. The information provided for rating process will be highly confidential and will not be used for any other purpose. 3. Based on the analyses of the report, the rating will be decided. 4. The rating will then be communicated to the client along with the reasons supporting the rating. If this rating is not agreeable, the client may appeal for reviewing the rating for which additional/new information will have to be provided. 5. If the rating is accepted by the client it will then be declared to the public by the credit rating agency. 6. Since rating is not a one time process, there will be a continuous monitoring of the client’s performance and its operational environment. Based on this information the rating may be affirmed, upgraded or downgraded. Any changes will, however, be informed to the public. Types of Ratings The rating services in the international markets can be classified into Shadow Rating and Formal Rating. The basic distinction between these two types of ratings is that the shadow rating is an indicative rating and will give the issuer an idea of its formal rating and suggests if it would be beneficial to go for a formal rating. Shadow Rating: The issuer will not have to disclose the rating to the public. The firm can, either independently or with the help of its investment banker, assess its shadow rating by proceeding in the following manner: 1. After collecting the relevant information, various financial ratios used by rating agencies can be computed. 2. Identify companies with similar projects having published ratings. The financial ratios of these companies can be used for comparison. 22

3.

Apart from these financial ratios, assess the management quality, performance of parent/group companies. 4. Give more weightage to those factors/ information that have a major impact on the performance of the company. Based on this also identify the strengths and limitations of the firm. 5. Use the ratings of the industry averages, other companies with similar projects and assign an indicative rating. 6. To this indicative rating apply the sovereign limitations to get the final indicative rating. This rating should preferably be in the form of a range and not as a specific rating. Formal Rating: The issuer will have to announce the rating assigned in Formal Rating to the public. The process involved in formal rating will be more detailed than the shadow rating process, since there will be a need for more disclosures, and sometimes even plant visits may be involved in it. Further, the shadow rating will not require any annual fee and meetings. While on the other hand, since formal rating will involve monitoring, there will be an annual fee for such ratings. In addition to this there will also be annual meetings.

23