CA Ipcc Fm Guess Questions Theory

8/18/2019 CA Ipcc Fm Guess Questions Theory

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CA-IPCC Costing and FM Guess questions – May 2016(Theory)

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FINANCIAL MANAGEMENT

+!o,e and ./e!ties o Finan!ia Manage3ent

4uestion 1 5,ain as to ho7 the 7eath 3ai3i8ation o./e!tie is su,erior to

the ,roit 3ai3i8ation o./e!ties.

Ans7er#

A firm's financial management may often have the following as their objectives:

(i)

The maximization of firm's profit.

(ii)

The maximization of firm's value wealth.

The maximization of profit is often consi!ere! as an implie! objective of a firm. To achieve

the aforesai! objective various type of financing !ecisions may be ta"en. #ptions resulting

into maximization of profit may be selecte! by the firm's !ecision ma"ers. They even

sometime may a!opt policies yiel!ing exorbitant profits in short run which may prove to

be unhealthy for the growth$ survival an! overall interests of the firm. The profit of the

firm in this case is measure! in terms of its total accounting profit available to its

sharehol!ers.

The valuewealth of a firm is !efine! as the mar"et price of the firm's stoc". The mar"etprice of a firm's stoc" represents the focal ju!gment of all mar"et participants as to what

the value of the particular firm is. %t ta"es into account present an! prospective future

earnings per share$ the timing an! ris" of these earnings$ the !ivi!en! policy of the firm

an! many other factors that bear upon the mar"et price of the stoc".

The value maximization objective of a firm is superior to its profit maximization objective

!ue to following reasons.

&.

The value maximization objective of a firm consi!ers all future cash flows$ !ivi!en!s$

earning per share$ ris" of a !ecision etc. whereas profit maximization objective !oes notconsi!er the effect of $ !ivi!en! pai! or any other returns to sharehol!ers or the wealth

of the sharehol!er.

*. A firm that wishes to maximize the sharehol!ers wealth may pay regular !ivi!en!s whereas

a firm with the objective of profit maximization may refrain from !ivi!en! payment to its

sharehol!ers.


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+. harehol!ers woul! prefer an increase in the firm's wealth against its generation of

increasing flow of profits.

,. The mar"et price of a share reflects the sharehol!ers expecte! return$ consi!ering the long-

term prospects of the firm$ reflects the !ifferences in timings of the returns$ consi!ers ris"an! recognizes the importance of !istribution of returns.

The maximization of a firm's value as reflecte! in the mar"et price of a share is viewe! as

a proper goal of a firm. The profit maximization can be consi!ere! as a part of the wealth

maximization strategy.

4uestion 2 9is!uss the !oni!ts in Proit ersus 7eath 3ai3i8ation ,rin!i,e o the ir3

Ans7er

Coni!t in Proit ersus :eath Mai3i8ation Prin!i,e o the Fir3# rofit

maximization is a short-term objective an! cannot be the sole objective of a company. %t is

at best a limite! objective. %f profit is given un!ue importance$ a number of problems can

arise li"e the term profit is vague$ profit maximization has to be attempte! with a realization

of ris"s involve!$ it !oes not ta"e into account the time pattern of returns an! as an objective

it is too narrow.

hereas$ on the other han!$ wealth maximization$ as an objective$ means that the company

is using its resources in a goo! manner. %f the share value is to stay high$ the company has

to re!uce its costs an! use the resources properly. %f the company follows the goal of wealth

maximization$ it means that the company will promote only those policies that will lea! to

an efficient allocation of resources.

4uestion % 5,ain the roe o Finan!e Manager in the !hanging s!enarioo inan!ia 3anage3ent in India;

Ans7er#

/ole of 0inance 1anager in the 2hanging cenario of 0inancial 1anagement in%n!ia: %n the mo!ern enterprise$ the finance manager occupies a "ey position an!his role is becoming more an! more pervasive an! significant in solving thefinance problems. The tra!itional role of the finance manager was confine! justto raising of fun!s from a number of sources$ but the recent !evelopment in thesocio-economic an! political scenario throughout the worl! has place! him in acentral position in the business organisation. 3e is now responsible for shapingthe fortunes of the enterprise$ an! is involve! in the most vital !ecision ofallocation of capital li"e mergers$ ac4uisitions$ etc. 3e is wor"ing in a challengingenvironment which changes continuously.


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mergence of financial service sector an! !evelopment of internet in the fiel! of

information technology has also brought new challenges before the %n!ian

finance managers. 5evelopment of new financial tools$ techni4ues$ instruments

an! pro!ucts an! emphasis on public sector un!erta"ing to be self-supporting

an! their !epen!ence on capital mar"et for fun! re4uirements have all change!

the role of a finance manager. 3is role$ especially$ assumes significance in the

present !ay context of liberalization$ !eregulation an! globalization.

4uestion * 9is!uss the un!tions o a Chie Finan!ia i!er;

Ans7er#

Fun!tions o a Chie Finan!ia i!er: The twin aspects viz procurement an!effective utilization of fun!s are the crucial tas"s$ which the 20# faces. The 2hief

0inance #fficer is re4uire! to loo" into financial implications of any !ecision inthe firm. Thus all !ecisions involving management of fun!s comes un!er thepurview of finance manager. These are namely

&.

stimating re4uirement of fun!s*.

5ecision regar!ing capital structure+. %nvestment !ecisions,. 5ivi!en!- !ecision6.

2ash management7.

valuating financial performance8. 0inancial negotiation

9.

eeping touch with stoc" exchange 4uotations ; behavior of share prices.


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Ca,ita @udgeting

4uestion 1 5,ain the !on!e,t o Muti,e I>> and Modiied I>>

Ans7er#

Muti,e Interna >ate o >eturn#

• %n cases where project cash flows change signs or reverse !uring the life of a

project e.g. an initial cash outflow is followe! by cash inflows an! subse4uently

followe! by a major cash outflow$ there may be more than one %//.

• %n such situations$ 7f the cost of capital is less than the two %//s$ a !ecision can

be ma!e easy. #therwise$ the %// !ecision rule may turn out to be mislea!ing as

the project shoul! only be investe! if the cost of capital is between %//-& an!

%//-*

• To un!erstan! the concept of multiple %//s it is necessary to un!erstan! the

assumption of implicit reinvestment rate in both FG an! %// techni4ues.

Modiied Interna >ate o >eturn (MI>>)#

H

As mentione! earlier$ there are several limitations attache! with the concept of

conventional %//.

H

1%// a!!resses some of these !eficiencies$ it eliminates multiple %// ratesI it

a!!resses the reinvestment rate issue an! results which are consistent with the

FG metho!.

H Jn!er this metho!$ all cash flows$ the initial investment$ are brought to the

terminal value using an appropriate$ rate (usually) the 2ost of 2apital). This results

in a single stream of cash inflows terminal year.

H 1%// is obtaine! by assuming a sing e outflow in year zero an! the terminal cash

inflows as mentione! above.

H The !iscount rate which e4uates the present value of terminal cash inflows to the

Keroth year outflow is calle! 1%//

4uestion 2# :rite a short note o interna rate o return

• Interna >ate o >eturn# %t is that rate at which !iscounte! cash inflows are e4ual to the

!iscounte! cash outflows. %n other wor!s$ it is the rate which !iscounts the cash flows to

zero. %t can be state! in the form of a ratio as follows:

I>> Cash ino7sB Cash outo7s


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• This rate is to be foun! by trial an! error metho!. This rate is use! in the evaluation of

investment proposals. %n this metho!$ the !iscount rate is not "nown but the cash outflows an! cash inflows are "nown.

•

%n evaluating investment proposals$ internal rate of return is compare! with a re4uire! rateof return$ "nown as cut-off rate. %f it is more than cut-off rate the project is treate! asacceptableI otherwise project is rejecte!.

4uestion % :rite a short note on Cut - o >ateD;

Cut - o >ate# %t is the minimum rate which the management wishes to have from any project.

Jsually this is base! upon the cost of capital. The management gains only if a project gives

return of more than the cut - off rate. Therefore$ the cut - off rate can be use! as the !iscount

rate or the opportunity cost rate.

4uestion *; "P< and I>> 3ay gie !oni!ting resuts in the eauation

o dierent ,ro/e!tsE !o33ent; (or) :rite the su,eriority o "P< oer I>>

in ,ro/e!t eauation;

Ans7er

Causes or Coni!t# Lenerally$ the higher the FG$ higher will be the %//.

3owever$ FG an! %// may give conflicting results in the evaluation of !ifferent

projects$ in the following situations-

a)

%nitial %nvestment 5isparity - i.e. !ifferent project sizes$

b)

roject Mife 5isparity - i.e. !ifference in project lives$

c)

#utflow patterns - i.e. when 2ash #utflows arise at !ifferent points of time

!uring the roject Mife$ rather than as %nitial %nvestment (Time C) only$

!)

2ash 0low 5isparity - when there is a huge !ifference between initial 20AT an!

later year's 20AT. A project with heavy initial 20AT than compare! to later years

will have higher %// an! vice-versa.

+u,eriority o "P


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c) FG ai!s !ecision-ma"ing by itself i.e.$ projects with positive FG are accepte!$

%// by itself !oes not ai! !ecision

!) %// presumes that interme!iate cash inflows will be reinveste! at that rate (%//)$

whereas in the case of FG metho!$ interme!iate cash inflows are presume! to

be reinveste! at the cut-off rate. The latter presumption viz. /einvestment at the

2ut-#ff rate$ is more realistic than reinvestment at %//.

e)

There may be projects with negative %// 1ultiple %// etc. if cash outflows

arise at !ifferent points of time. This lea!s to !ifficulty in interpretation. FG

!oes not pose such interpretation problems.

4uestion &. 9is!uss the need or so!ia !ost .eneit anaysis;

Ans7er#

&.

everal hun!re! crores of rupees are committe! every year to various publicprojects Analysis of such projects has to be !one with reference to social costs

an! benefits. They cannot be expecte! to yiel! an a!e4uate commercial return on

the fun!s employe!$ at least !uring the short run.

*.

ocial cost benefit analysis is important for the private corporations also who

have a moral responsibility to un!erta"e social benefit projects.

+.

The nee! for social cost benefit arises !ue to the following:

a. The mar"et prices use! to measure costs ; benefits in project analysis$ may not

represent social values !ue to mar"et imperfections.

b.

1onetary cost benefit analysis fails to consi!er the external positive ; negativeeffects of a project

c.

The re!istribution benefits because of project nee!s to be capture!.


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Cost o Ca,ita

4uestion 1 :hy de.t unds are !hea,er than equity= r Adantages o

de.t inan!ing=

Ans7er#

0inancing a business through 5ebt is cheaper than 4uity !ue to the following

reasons:

1; >is >eturn# The higher the ris"$ the higher the return expectations. Men!ers

5ebenture hol!ers have prior claim on interest an! principal repayment$

whereas 4uity harehol!ers are entitle! to /esi!ual arnings only. 3ence$ the

expectations of 4uity harehol!ers are higher than that of 5ebt hol!ers an!

reference harehol!ers.2; Ta 5e!t# %nterest on 5ebt can be !e!ucte! for computing the taxable income.

3ence$ use of !ebt re!uces the corporate tax payment. Thus$ 5ebt is cheaper

than 4uity$' !ue to the Tax-hiel!.

%;

Issue Costs# %ssuing an! Transaction costs associate! with raising an! servicing

5ebts are generally less than that of e4uity shares.

4uestion 2 9is!uss the diidend-,ri!e a,,roa!h and earnings ,ri!e

a,,roa!h to esti3ate !ost o equity !a,ita.

Ans7er# %n !ivi!en! price approach$ cost of e4uity capital is compute! by!ivi!ing the current !ivi!en! by average mar"et price per share. This ratio

expresses the cost of e4uity capital in relation to what yiel! the company shoul!

pay to attract investors. %t is compute! as:

? 5&C

here$ 5& ? 5ivi!en! per share in perio! &

o ? 1ar"et price per share to!ay

hereas$ on the other han!$ the a!vocates of earnings price approach co-relate

the earnings of the company with the mar"et price of its share. Accor!ingly$ the

cost of or!inary share capital woul! be base! upon the expecte! rate of earnings

of a company. This approach is similar to !ivi!en! price approach$ only it see"s

to nullify the effect of changes in !ivi!en! policy.


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4uestion % :rite a short note on Ca,ita Asset Pri!ing Mode (CAPM)

and state its assu3,tion=

Ans7er#

&.

2A1 was !evelope! by sharp 1ossin an! Minter in &N7C.

*. Main Contention o CAPM# The /e4uire! /ate of /eturn on a security is e4ual

to a >is Free >ate ,us the >is Pre3iu3.

+. >is Free >ate is the rate of return on ris" - free security. The ris" - free security

is the security which has no ris" of !efault or which has zero variance or stan!ar!

!eviation. 0or example$ Lovernment Treasury Oills or Oon!s are usually

consi!ere! ris" < free securities because normally they !o not have ris" of

!efault.

,. As !iversifiable ris" can be eliminate! by an investor through !iversification$ the

non- !iversifiable ris" in the only element ris"$ therefore a business shoul! be

concerne! as per 2A1 metho!$ solely with non-!iversifiable ris". The non-

!iversifiable ris"s are assesse! in terms of beta coefficient (b or p) through fitting

regression e4uation between return of a security an! the return on a mar"et

portfolio.

&;

>is Pre3iu3#

a.

/is" remium is the premium for systematic ris".

b. ystematic ris" (or mar"et ris" or non-!iversifiable ris") is the ris" which cannot

be eliminate! through investing in well-!iversifie! mar"et portfolio.c. ystematic ris" is measure! by beta (b)

!.

Oeta (b) is a measure of volatility of an in!ivi!ual security return relative to the

returns of a broa! base! mar"et portfolio. %t in!icates < how much in!ivi!ual

security's return will change for a unit change in the mar"et return.

e.

/is" remium ? Oeta x xpecte! rate of mar"et returns - /is" 0ree /ate of

return ? @b(/ m-/ f .)

f.

The value of Oeta (b) can be zero or more than & or less than &.

Galue of Oeta %nterpretation

Oeta e4ual to& Oeta e4ual to & in!icates that systematic ris" is e4ual to theaggregate mar"et ris". %t means that the security's returnsfluctuate e4ual to mar"et returns.

Oeta Lreater than & Oeta greater than & in!icates that systematic ris" is greater thanthe aggregate mar"et ris". %t means that the security's returnsfluctuate more than the mar"et returns.


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Oeta less than & Oeta less than & in!icates that systematic ris" is less than theaggregate mar"et ris". %t means that the security's returnsfluctuate less than the mar"et returns.

Kero Oeta Kero Oeta in!icates no volatility.

6; Therefore$ /ate of /eturn on ecurities (e) ? /is" free rate /is" remium

'. Assu3,tions o CAPM# The 2A1 is base! on the following eight

assumptions

a. 1aximization #bjective: The investor objective is to maximize the utility of

terminal wealthI

b. /is" Averse: %nvestors are ris" averse. %nvestors ma"e choices on the basis of ris"

an! returnI

c.

3omogenous xpectations: %nvestors have homogenous expectations of ris" an!

returnI!.

%!entical Time 3orizon: %nvestors have i!entical time horizonI

e. 0ree %nformation: %nformation is freely an! simultaneously available to investors

f.

Fo Taxes etc.: There are no taxes$ transaction costs$ restrictions on short rates or

other mar"et imperfections


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Ca,ita +tru!ture

4uestion 1; :hat is 3eant .y !a,ita stru!ture= :hat is o,ti3u3 !a,ita

stru!ture=

Ans7er#

&.

Ca,ita +tru!ture# 2apital structure refers to the mix of source from where$ the

long -term fun!s re4uire! in a business may be raise!. %t refers to the proportion

of 5ebt$ reference 2apital an! 4uity.

*. 2apital tructure refers to the combination of !ebt an! e4uity which a company

uses to finance its long-term operations. %t is the permanent financing of the

company representing long-term sources of capital %. e. owner's e4uity an! long-

term !ebts but exclu!es current liabilities. #n the other han!$ 0inancial tructure

is the entire left-han! si!e of the balance sheet which represents all the long-term

an! short,erm sources of capital. Thus$ capital structure is only a part of financial

structureI

+.

,ti3u3 Ca,ita +tru!ture# #ne of the basic objectives of financial

management is to maximize the value or wealth of the firm. 2apital structure is

optimum when the firm has a combination of 4uity an! 5ebt so that the wealth

of the firm is maximum. At this level$ cost of capital is minimum an! 1ar"et

price per share is maximum.

4uestion 2 9is!uss the 3a/or !onsiderations in !a,ita stru!ture ,anning

Ans7er# The + major consi!erations in 2apital structure planning are - (&) /is"

(*) 2ost ; (+) 2ontrol. These !iffer for various components of 2apital i.e.$ #wn

0un!s ; Moans 0un!s. A comparative analysis is given below:

Ty,e >is Cost Contro4uity 2apital Mow /is"- Fo

4uestion of repaymentof capital except whenthe company is Jn!erli4ui!ation. 3encebest from ris" pointof view.

1ost expensive

5ilution of controlsince because!ivi!en!expectations ofsharehol!ers arehigher than interestrates. Also$

The capital base

might be expan!e!an! newsharehol!ers public are involve!.


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!ivi!en!s are nottax !e!uctible.

reference 2apital /is" is slightly higher when compare! to

4uity 2apitalbecause principal isre!eemable after acertain perio! even if!ivi!en! payment isbase! on profits.

lightly cheaperthan 4uity but

higher than intereston loan fun!s./ather$ reference5ivi!en! is not tax!e!uctible.

Fo !ilution ofcontrol since voting

has are restricte! topreferencesharehol!ers.

Moan 0un!s /is" is high sincecapital shoul! berepai! as peragreement an!

interest shoul! bepai! irrespective #fprofits.

2omparativelycheaper sinceprevailing interestrates are consi!ere!

only to the extentof after tax impact.

Fo !ilution ofcontrol but somefinancialinstitutions may

insist onnomination of theirrepresentatives inthe Ooar! of5irectors.

4uestion % :hat are the genera assu3,tions in !a,ita stru!ture

theories=

Ans7er#&. There are only two sources of fun!s viz. 5ebt an! 4uity. (Fo reference share

capital).

*. The Total assets of the firm an! its 2apital mploye! are constant. (Fo 2hange

in 2apital mploye!). 3owever$ !ebt e4uity mix can be change!. This can be

!one by

a. ither by borrowing !ebt to repurchase (re!eem 4uity shares) or

b.

Oy raising 4uity 2apital to retire (repay) !ebt

+. All resi!ual earnings are !istribute! to 4uity sharehol!ers. (Fo retaine!

earnings).,.

The firm earns operating profits an! it is expecte! to grow. (Fo losses)

6. The Ousiness /is" is assume! to be constant an! is not affecte! by the financing

mix !ecision. (Fo change in fixe! costs operating ris"s).

7. There are no corporate or personal taxes. (Fo taxation).

8.

2ost of 5ebt ! (referre! to as 5ebt 2apitalisation /ate) is less than 2ost of

4uity e (referre! to as e4uity capitalisation rate).


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4uestion *;:hat is "et ,erating In!o3e ("I) theory o !a,ita

stru!ture= 5,ain the assu3,tions o "et ,erating In!o3e a,,roa!h

theory o !a,ita stru!ture.

Ans7er# Accor!ing to F#% approach$ there is no relationship between the cost

of capital an! value of the firm i.e. the value of the firm is in!epen!ent of the

capital structure of the firm.

Assu3,tions

(a)

The corporate income taxes !o not exist.

(b) The mar"et capitalizes the value of the firm as whole. Thus the split between !ebt

an! e4uity is not important.(c) The increase in proportion of !ebt in capital structure lea!s to change in ris"

perception of the sharehol!ers.

(!) The overall cost of capital (o) remains constant for all !egrees of !ebt e4uity

mix.

4uestion & 5,ain in .rie the assu3,tions o Modigiani-Mier theory;

Ans7er# Assumptions of 1o!igliani-1iller Theory

a)

2apital mar"ets are perfect. All information is freely available an! there is no

transaction cost.

b) All investors are rational.

c)

Fo existence of corporate taxes.

!)

0irms can be groupe! into P4uivalent ris" classesP on the basis of their business

ris".

4uestion 6 9is!uss the ,ro,osition 3ade in Modigiani and Mier

a,,roa!h in !a,ita stru!ture theory;

Ans7er# Three Oasic ropositions ma!e in 1o!igliani an! 1iller Approach in

2apital tructure theory

(i) The total mar"et value of a firm an! its cost of capital are in!epen!ent of

its capital structure. The total mar"et value of the firm is given by capitalizing the

expecte! stream of operating earnings at a !iscount rate consi!ere! appropriate

for its ris" class.


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(ii) The cost of e4uity (e) is e4ual to capitalization rate of pure e4uity

stream plus a premium for financial ris". The financial ris" increases with more

!ebt content in the capital structure. As a result$ e increases in a manner to

offset exactly the use of less expensive source of fun!s.

(iii) The cut-off rate for investment purposes is completely .in!epen!ent of the

way in which the investment is finance!.

(iv) This proposition along with the first implies a complete separation of the

investment an! financing !ecisions of the firm.

4uestion ' :hat is er Ca,itaisation= +tate its !auses and

Consequen!es

Ans7er# er!a,itai8ation and its Causes and Consequen!es

%t is a situation where a firm has more capital than it nee!s or in other wor!s

assets are worth less than its issue! share capital$ an! earnings are insufficient to

pay !ivi!en! an! interest. 2auses of #ver 2apitalization

er-!a,itaisation arises due to oo7ing reasons#

(i) /aising more money through issue of shares or !ebentures than company can

employ profitably.

(ii) Oorrowing huge amount at higher rate than rate at which company can earn.

(iii)

xcessive payment for the ac4uisition of fictitious assets such as goo!will etc(iv)

%mproper provision for !epreciation$ replacement of assets an! !istribution of

!ivi!en!s at a higher rate.

(v)

rong estimation of earnings an! capitalization.

Consequen!es o er-Ca,itaisation

(i)

2onsi!erable re!uction in the rate of !ivi!en! an! interest payments.

(ii) /e!uction in the mar"et price of shares.

(iii)

/esorting to Pwin!ow !ressingP.

(iv)

ome companies may opt for reorganization. 3owever$ sometimes the mattergets worse an! the company may go into li4ui!ation.


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Heerages

4uestion 1 9ierentiate .et7een @usiness ris and Finan!ia ris;

Ans7er# @usiness >is and Finan!ia >is

Ousiness ris" refers to the ris" associate! with the firm's operations. %t is an

unavoi!able ris" because of the environment in which the firm has to

operate an! the business ris" is represente! by the variability of earnings

before interest an! tax (O%T). The variability in turn is influence! by revenues

an! expenses. /evenues an! expenses are affecte! by !eman! of firm's pro!ucts$

variations in prices an! proportion of fixe! cost in total cost.

hereas$ 0inancial ris" refers to the a!!itional ris" place! on firm's sharehol!ers

as a result of !ebt use in financing. 2ompanies that issue more !ebt

instruments woul! have higher financial ris" than companies finance! mostly

by e4uity. 0inancial ris" can be measure! by ratios such as firm's financial

leverage multiplier$ total !ebt to assets ratio etc.

4uestion 2 E,erating ris is asso!iated 7ith !ost stru!ture 7hereas

inan!ia ris is asso!iated 7ith !a,ita stru!ture o a .usiness !on!ern;E

Criti!ay ea3ine this state3ent;

Ans7er#P#perating ris" is associate! with cost structure whereas financial ris"

is associate! with capital structure of a business concernP.

#perating ris" refers to the ris" associate! with the firm's operations. %t is

represente! by the variability of earnings before interest an! tax (O%T). The

variability in turn is influence! by revenues an! expenses$ which are affecte! by

!eman! of firm's pro!ucts$ variations in prices an! proportion of fixe! cost in

total cost. %f there is no fixe! cost$ there woul! be no operating ris". hereas

financial ris" refers to the a!!itional ris" place! on firm's sharehol!ers as a result

of !ebt an! preference shares use! in the capital structure of the concern.

2ompanies that issue more !ebt instruments woul! have higher financial ris"

than companies finance! mostly by e4uity.


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4uestion % 5,ain the !on!e,t o eeraged ease

Ans7er#

&. Meverage! lease involves lessor$ lessee an! financier

*.

%n leverage! lease$ the lessor ma"e a substantial borrowing$ even upto 9C D

of the assets purchase price. 3e provi!es remaining amount- about *CD or

so-as e4uity to become the owner

+. The lessor claims all tax benefits relate! to the ownership of the assets.

,.

Men!ers$ generally large financial institutions$ provi!e loans on a non-recourse

basis to the lessor. Their !ebt is serve! exclusively out of lease procee!s.

6. To secure the loan provi!e! by the len!ers$ the lessor also agrees to give them a

mortgage on the asset.

7. Meverage! lease is calle! so because the high non-recourse !ebt creates a high

!egree of leverage.


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:oring Ca,ita Manage3ent

4uestion 1 :hat is Treasury 3anage3ent= :hat are its Fun!tions or

>es,onsi.iities=

Ans7er# Treasury management refers to efficient management of li4ui!ity an!

financial ris" in business. The responsibilities of Treasury 1anagement %nclu!e-

&.

1anagement of 2ash$ hile obtaining the optimum return from urplus fun!s

*. 1anagement of 0oreign exchange rate ris"s in accor!ance with the 2ompany

policy

+. rovi!ing long term an! short term fun!s as re4uire! by the business$ at the

minimum cost.

,.

1aintaining goo! relationship an! liaison with financiers$ Men!ers$ Oan"ers an!

investors (sharehol!ers)

6.

A!vising on various issues of corporate finance li"e capital structure$ buy-bac"$

mergers$ ac4uisitions.

4uestion 2 +tate the adantage o 5e!troni! Cash Manage3ent +yste3;

Ans7er# A!vantages of lectronic 2ash 1anagement ystem

(i) ignificant saving in time.

(ii)

5ecrease in interest costs.

(iii)

Mess paper wor".(iv)

Lreater accounting accuracy.

(v) upports electronic payments.

(vi)

0aster transfer of fun!s from one location to another$ where re4uire!

(vii)

1a"ing available fun!s wherever re4uire!$ whenever re4uire!.

(viii) %t ma"es inter-ban" balancing of fun!s much easier.

(ix)

/e!uces the number of che4ues issue!.

4uestion % :hat is


18/44



Mower cost of han!ling a transaction.

The increase! spee! of response to customer re4uirements.

The lower cost of operating branch networ" along with re!uce! staff costs lea!s

to cost efficiency.

Girtual ban"ing allows the possibility of improve! an! a range of services being

ma!e available to the customer rapi!ly$ accurately an! at his convenience.

4uestion * :rite short note on dierent inds i oat 7ith reeren!e to

3anage3ent o !ash

Ans7er# 9ierent inds o oat 7ith reeren!e to 3anage3ent o !ash# The

term float is use! to refer to the perio!s that effect cash as it moves through the

!ifferent stages of the collection process four "in!s of float can be i!entifie!:1; @iing Foat: An invoice is the formal !ocument that a seller prepares an!

sen!s to the purchaser as the payment re4uest for goo!s sol! or services

provi!e!. The time between the sale an! the mailing of the invoice is the billing

float.

2; Mai Foat# This is the time when a che4ue is being processe! by post office$

messenger service or other means of !elivery.

%;

Cheque ,ro!essing oat# This is the time re4uire! for the seller to sort$

recor! an! !eposit the che4ue after it has been receive! by the company.

*;

@an ,ro!essing oat# This is the time from the !eposit of the che4ue to thecre!iting of fun!s in the seller's account.

4uestion & 9es!ri.e the three ,rin!i,es reating to see!tion o

3areta.e se!urities.

Ans7er# Three rinciples /elating to election of 1ar"etable ecurities

The three principles relating to selection of mar"etable securities are:

(i)

+aety# /eturn an! ris" go han!-in-han!. As the objective in this investment is

ensuring li4ui!ity$ minimum ris" is the criterion of selection.

(ii)

Maturity# 1atching of maturity an! forecaste! cash nee!s is essential. rices of

longQ term securities fluctuate more with changes in interest rates an! are$

therefore$ ris"ier.


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(iii) Mareta.iity# %t refers to the convenience$ spee! an! cost at which a security

can be converte! into cash. %f the security can be sol! 4uic"ly without loss of time

an! price$ it is highly li4ui! or mar"etable.

4uestion 6 Manage3ent o 3areta.e se!urities is an integra ,art o

inest3ent o !ashD Co33ent;

Ans7er# Manage3ent o 3areta.e se!urities is an integra ,art o

inest o !ashD

1anagement of mar"etable securities is an integral part of investment of cash as it

serves both the purpose of li4ui!ity an! cash $ provi!e! choice of investment is

ma!e correctly. As the wor"ing capital nee!s are fluctuating$ it is possible to

invest excess fun!s in short term securities$ which can be li4ui!ate! when nee!for cash is felt. The selection of securities shoul! be gui!e! by three principles

namely safety$ maturity$ mar"etability.

4uestion ' 9is!uss Mier-rr !ash 3anage3ent 3ode

Accor!ing to this mo!el the net cash flow is completely stochastic. hen changes in cash balance occur ran!omly$ the application of control theory serves a useful purpose. The 1iller

R #rr mo!el is one of such control limit mo!els. This mo!el is !esigne! to !etermine the

time an! size of transfers between an investment account an! cash account. %n this mo!el

control limits are set for cash balances. These limits may consist of Sh as upper limit$ Sz asthe return point an! zero as the lower limit.

hen the cash balance reaches the upper limit$ the transfer of cash e4ual to Sh R z is

investe! in mar"etable securities account. hen it touches the lower limit$ a transfer frommar"etable securities account to cash account is ma!e. 5uring the perio! when cash

balance stays between (h$ z) an! (z$ C) i.e. high an! low limits$ no transactionsbetween cash an! mar"etable securities account is ma!e. The high an! low limits of cashbalance are set up on the basis of fixe! cost associate! with the securities transaction$ the

opportunities cost of hol!ing cash an! !egree of li"ely fluctuations in cash balances.

These limits satisfy the !eman!s for cash at the lowest possible total costs.

4uestion ; :rite short notes on syste3s o !ash 3anage3ent;

Ans7er# Con!entration @aning#

Pro!edure# This metho! of collection from customers operates as un!er:


20/44



a. %!entify locations or places where major customers are places$ i.e$ a company with

hea! office at 2hennai an! customers base! in 5elhi$ ol"ata an! 1umbai

#pen a local ban" account in each of these locations i.e$ 5elhi$ ol"ata an!

1umbai

c.

#pen a local collection centre for receiving che4ues from these customers at the

respective places. A branch office or even an agent can perform the role of

collection centre.

!. 2ollect remittances from customers locally$ either in person$or through post.

e.

5eposit the che4ues receive! in the local ban" account for clearing.

f. Transfer the fun!s to hea! office ban" account$ upon realisation of 2he4ues.

Adantages#

a. >edu!tion in Maiing Foat# ince remittances from customers are collecte!

locally either in person or by local post courier$ mailing float is re!uce!

substantially.

b. >edu!tion in @aning Pro!essing Foat: 2he4ues are cleare! locally$ an!

the fun!s are ma!e$ available faster. There nee! not be any waiting time for

clearance of outstation che4ues

c.

. Centraised Cash Manage3ent: As surplus fun!s are transferre! to hea!

office concentration ban" account$ i!le fun!s in various locations are avoi!e!.

2entralise! cash management ensures optimum use of fun!s available to the

company an! enables payment planning.

Ho! @o +yste3#

Pro!edure: This metho! of collection from customers operates as un!er:

a.

%!entify locations or places where major customers are places$ i.e. a company with

hea! office at 2hennai an! customers base! in 5elhi$ ol"ata an! 1umbai.

b.

#pen a local ban" account in each of these locations i.e. 5elhi$ ol"ata an!

1umbai.

c.

%nstruct customers to mail their payments to the local ban".

!.

Authorise the ban" to pic" up remittances from the post box ; encash them.

e. Transfer the fun!s to hea! office ban" account$ upon realization of che4ues.

Adantages#


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a. >edu!tion in Maiing Foat# since remittances from customers are collecte!

locally either in person or by local post courier$ mailing float is re!uce!

substantially.

b.

>edu!tion in Cheque ,ro!essing Foat# The Oan" woul! prepare a list

of remittances receive! an! forwar! it to the company as a cre!it a!vice. This

saves che4ue processing float at the company's office$ prior to collection.

c.

>edu!tion in @aning ,ro!essing Foat# ince che4ues are cleare! locally$

the fun!s are ma!e available faster. There is no !elay in collection of outstation

che4ues.

!. Centraised Cash Manage3ent# ince surplus fun!s are transferre! to 3ea!

office Oan" account$ i!le fun!s in various locations are avoi!e!. 2entralise!

2ash 1anagement ensures optimum use of fun!s available to the company an!

enables payment planning.


22/44



>atio Anaysis

4uestion1. 9is!uss the inan!ia ratios or eauating !o3,any ,eror3an!e

on o,erating ei!ien!y and iquidity ,osition as,e!ts=

Ans7er# 0inancial ratios for evaluating performance on operational efficiency an!

li4ui!ity position aspects are !iscusse! as:

,erating 5i!ien!y# /atio analysis throws light on the !egree of efficiency in the

management an! utilization of its assets. The various activity ratios (such as turnover

ratios) measure this "in! of operational efficiency. These ratios are employe! toevaluate the efficiency with which the firm manages an! utilises its assets. These ratios

usually in!icate the fre4uency of sales with respect to its assets. These assets may be

capital assets or wor"ing capital or average inventory. %n fact$ the solvency of a firm is$

in the ultimate analysis$ !epen!ent upon the sales revenues generate! by use of its

assets - total as well as its components.

Hiquidity Position# ith the help of ratio analysis$ one can !raw conclusions

regar!ing li4ui!ity position of a firm. The li4ui!ity position of a firm woul! be

satisfactory$ if it is able to meet its current obligations when they become !ue.%nability to pay-off short-term liabilities affects its cre!ibility as well as its cre!it

rating. 2ontinuous !efault on the part of the business lea!s to commercial

ban"ruptcy. ventually such commercial ban"ruptcy may lea! to its sic"ness an!

!issolution. Mi4ui!ity ratios are current ratio$ li4ui! ratio an! cash to current liability

ratio. These ratios are particularly useful in cre!it analysis by ban"s an! other suppliers

of short-term loans.

4uestion 2 9is!uss any three ratios !o3,uted or inest3ent anaysis=

Three ratios compute! for investment analysis are as follows:

&. arnings er hare ? arnings Available to 4uity harehol!ers

Fumber of e4uity shares outstan!ing

*. 5ivi!en! Uiel! ratio ? 4uity !ivi!en! per share1V&CC+. /eturn on capital employe! ? (Fet rofit Oefore %nterest an! Tax (O%T) V &CC

2apital mploye!


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4uestion;% o7 is 9e.t seri!e !oerage ratio !a!uated= :hat is its

signii!an!e= Ans7er# Ca!uation o 9e.t +eri!e Coerage >atio (+C>) and its

+ignii!an!e

The !ebt service coverage ratio can be calculate! as un!er:

5ebt service coverage ratio?earnings available for !ebt(interestinstallments)

5ebt coverage ratio?O%T5AW%nterest @principle repayment !ue(&Tc)BX

5ebt service coverage ratio in!icates the capacity of a firm to service a particular levelof !ebt i.e. repayment of principal an! interest. 3igh cre!it rating firms target 52/

to be greater than * in its entire loan life. 3igh 52/ facilitates the firm to borrow at

the most competitive rates.

4uestion * 9is!uss the !o3,osition o >eturn on 5quity (>5) using the

9uPont 3ode;

Ans7er# Co3,osition o >eturn on 5quity using the 9uPont Mode# There

are three components in the calculation of return on e4uity using the tra!itional5uont mo!el- the net profit margin$ asset turnover$ an! the e4uity multiplier. Oy

examining each input in!ivi!ually$ the sources of a company's return on e4uity can be

!iscovere! an! compare! to its competitors

a) "et Proit Margin# The net profit margin is simply the after-tax profit a

company generates for each rupee of revenue.

Fet profit margin ? Fet lncome B /evenue

Fet profit margin is a safety cushionI the lower the margin$ lesser the room for error.

(.) Asset Turnoer# The asset turnover ratio is a measure of how effectively a

company converts its assets into sales. %t is calculate! as follows

Asset Turnover ? /evenue B Assets


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The asset turnover ratio ten!s to be inversely relate! to the net profit marginI i.e.$

the higher the net profit margin$ the lower the asset turnover.

(! ) 5quity Muti,ier# %t is possible for a company with terrible sales an! margins

to ta"e on excessive !ebt an! artificially increase its return on e4uity. The e4uity

multiplier$ a measure of financial leverage$ allows the investor to see what portion

of the return on e4uity is the result of !ebt. The e4uity multiplier is calculate! as

follows:

4uity 1ultiplier ? Assets B harehol!ers' 4uity.

Ca!uation o >eturn on 5quity

To calculate the return on e4uity using the 5uont mo!el$ simply multiplythe three components (net profit margin$ asset turnover$ an! e4uity multiplier.)

/eturn on 4uity ? Fet profit margin x Asset turnover x 4uity multiplier

4uestion & 5,ain .riey the i3itations o Finan!ia ratios

Ans7er# Hi3itations o Finan!ia >atios

The i3itations o inan!ia ratios are isted .eo7#

a) 5iversifie! pro!uct lines: 1any businesses operate a large number of !ivisions in

4uite !ifferent in!ustries. %n such cases$ ratios calculate! on the basis of

aggregate !ata cannot be use! for inter-firm comparisons.

b) 0inancial !ata are ba!ly !istorte! by inflation: 3istorical cost values may be

substantially !ifferent from true values. uch !istortions of financial !ata are

also carrie! in the financial ratios.

c) easonal factors may also influence financial !ata.

!)

To give a goo! shape to the popularly use! financial ratios (li"e current ratio$ !ebt-e4uity ratios$ etc.): The business may ma"e some year-en! a!justments. uch win!ow

!ressing can change the character of financial ratios which woul! be !ifferent ha!

there been no such change.

e) 5ifferences in accounting policies an! accounting perio!: %t can ma"e the

accounting !ata of two firms non-comparable as also the accounting ratios.


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f) There is no stan!ar! set of ratios against which a firm's ratios can be

compare!: ometimes a firm's ratios are compare! with the in!ustry average. Out if a

firm !esires to be above the average$ then in!ustry average becomes a low stan!ar!.

#n the other han!$ for a below average firm$ in!ustry averages become toohigh a stan!ar! to achieve.


26/44



Cash Fo7 and Funds Fo7 +tate3ent

4uestion 1 9istinguish .et7een Cash Fo7 and Fund Fo7 state3ent;

Ans7er# The ,oints o distin!tion .et7een !ash o7 and unds o7 state3ent

are as .eo7#

Cash Fo7 state3ent Fund Fo7 +tate3ent

&.%t ascertains the charges in balanceof cash in han! an! ban"

&.%t ascertains the charges in 0inancialposition between two Accounting erio!s.

*. %t analyses the reasons forcharges in balance of cash in han!an! ban"

*.%t analyses the reasons for change infinancial position between two balance

+. %t shows the inflows an!outflows of cash

+. %t reveals the sources an! application offin!s.

,.%t is an important tool for shortterm analysis

,.%t helps to test whether wor"ing capitalhas been effectively use! or not


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+our!e o inan!e

4uestion 1 :hat do you 3ean .y .ridge inan!e=

Ans7er#

1; Meaning# Ori!ge 0inance refers to loan by a company usually from commercial

ban"s$ for a short perio!$ pen!ing !isbursement of loans sanctione! by 0inancial

%nstitutions.

2; +an!tion#

a. hen a promoter or an enterprise approaches a financial institution for a long-term

loan$ there may be some normal time !elays in project evaluation$ a!ministrative;proce!ural formalities an! final sanction.

b. ince the project commencement cannot be !elaye!$ the promoter may start his

activities after receiving Pin-principleP approval from the len!ing institution.

c. To meet his temporary fun! re4uirements for starting the project$ the promoter

may arrange short-term loans from commercial ban"s or from the len!ing institution

itself.

!. uch temporary finance$ pen!ing sanction of the loan$ is calle! as POri!ge 0inanceP.

e. This Ori!ge 0inance may be use! for - (i) aying a!vance for factory lan!

1achinery ac4uisition$ (ii) urchase of 4uipments$ etc.

%; Ter3s#

a) Interest# The interest rate on Ori!ge 0inance is higher when compare! to term loans.

b) >e,ay3ent: These are repai! or a!juste! out of the term loans as an! when the loan

is !isburse! by the concerne! institutions.

c)

+e!urity# These are secure! by hypothecating movable assets$ personal guarantees;romissory notes.


28/44



4uestion 2; :hat are the dierent ty,es o eases=

&. ales an! lease bac":

A. Jn!er this type of lease$ the owner of an asset sells the asset to a party$ who in turnlease bac" the same asset to the owner in consi!eration of lease rentals.

O. Jn!er this arrangement$ the asset is not physically exchange! but it all happens in

recor!s only.

2. The main a!vantage of this metho! is that the lessee can satisfy himself completely

regar!ing the 4uality of asset an! after possession of the asset convert the sale into a

lease agreement.

5. Jn!er this transaction$ the seller assumes the role of lessee an! the buyer assumes

the role of lessor. The seller gets the agree! selling price an! the buyer gets the agree!

lease rentals.

*. Meverage! lease:

A. Jn!er this lease$ a thir! party is involve! besi!es lessor an! lessee.

O. The lessor borrows a part of the purchase cost (say 9CD) of the asset from a thir!party(len!er) an! asset so purchase! is hel! as security against the loan

2. The len!er is pai! off from the lease rentals !irectly by the lessee an! the surplus

after meeting the claims of the len!er goes to the lessor.

5. The lessor is entitle! to claim !epreciation allowance.

+. ales-Ai! lease:

A. Jn!er this lease contract$ the lessor enters into a tie up with the manufacturer formar"eting the latters pro!uct through his own leasing operations.

O. %n consi!eration of the ai! in sales$ the manufacturer may grant either cre!it$ or a

commission to the lessor. Thus$ the lessor earns from both the sources i.e. from lessee

as well as from manufacturer.


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,. 2lose en!e! an! open en!e! leases

A. %n the close en!e! lease$ the assets gets transferre! to the lessor at the en! of lease

an! the ris" of obsolescence$ resi!ual value etc.$ remain with the lessor being the legal

owner of the asset.

O. %n the open en!e! leases$ the lessee has the option of purchasing the asset at the

en! of the lease perio!.

4uestion %# :rite short note on ,re-shi,3ent inan!e or e,ort (Pa!ing

!redit a!iity)

Meaning# ac"ing cre!it is an a!vance exten!e! by ban"s to an exporter for the

purpose of buying$ manufacturing$ processing$ pac"ing an! shipping goo!s to

overseas buyers.

A,,i!a.iity#

A. %f an exporter has a firm export or!er place! with him by his foreign customer or

an irrevocable letter of cre!it opene! in his favour$ he can approach a ban" for

pac"ing cre!it facility.

O. The letter of cre!its an! firm sale contracts serve as an evi!ence of a !efinite

arrangement for realization of export procee!s an! also in!icate the amount of

finance re4uire! by exporter.

2. %n the case of long stan!ing customers$ pac"ing cre!it may also be grante! against

firm contracts entere! by them with overseas buyer.

5. An a!vance so ta"en by an exporter is re4uire! to be settle! within &9C !ays from

the !ate of its commencement by negotiation of export bills or receipt of export

procee!s in an approve! manner.

. Thus pac"ing cre!it is essentially a short term a!vance.

Ty,es#

Cean ,a!ing !redit:


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• There is no charge or control over raw material or finishe! goo!s that constitute thesupply.

• The ban" ta"es into consi!eration tra!e re4uirements$ cre!it worthiness of exporter

an! its margin.• The ban" shoul! obtain xport 2re!it Luarantee 2orporation (2L2) insurance

cover.

Pa!ing !redit against hy,othe!ation o goods#

• Loo!s which constitute the supply are hypothecate! to the ban" as security$ with thestipulate! margin.

• The goo!s are exporte! by the borrower. The ban" !oes not have any effective

possession of the same.• The exporter has to submit stoc" statements at the time of sanction an! also

perio!ically or whenever there is any movement of stoc"s.

Pa!ing !redit against ,edge o goods#

• The goo!s which constitute the supply are ple!ge! to the ban" as security$ with in thestipulate! margin.

• The goo!s shall be han!e! over to approve! cleaning agents who ship the same from

time to time re4uire! by the exporter.• The effective possession of the goo!s so ple!ge! lies with the ban" an! is "ey un!er

its loc"

4uestion * :rite short notes on go.a de,ository re!ei,ts (G9>J+)

Ans7er# Go.a 9e,ository >e!ei,ts# (G9>Js)#

a) A 5epository /eceipt (5/) is basically a negotiable certificate$ !enominate! in

J 5ollars that represents a s ublicly tra!e local currency (ay non < J company%n!ian /upee) 4uity hares.

b) 5/'s are create! when the local currency shares of an %n!ian 2ompany are

!elivere! to the !epository's local custo!ian ban"$ against which the 5epository Oan"

issues 5/'s in J 5ollars.


31/44



c) These 5/'s may be freely tra!e! in the overseas mar"ets li"e any other 5ollar

!enominate! security through either a 0oreign toc" xchange or through #ver The

2ounter(#T2) mar"et or among a restricte! group li"e Eualifie! %nstitutional

Ouyers(E%O's)

!) L5/ with arrants are more attractive than plain L5/s !ue to a!!itional

Galue of attache! warrants.

Chara!teristi!s o G9>s#

a. 3ol!ers of L5/'s participate in the economic benefits of being or!inary

sharehol!ers$ though they !o not have voting rights.b. L5/s are settle! through uro-2lear %nternational boo" entry systems.

c. L5/s are liste! on the Muxemburg stoc" exchange. (uropean 1ar"et)

!. Tra!ing ta"es place between professional mar"et ma"ers on an #T2 (#ver The

2ounter) basis.

e; As far as the case of li4ui!ation of L5/s is concerne!$ an investor may get the L5/

cancelle! any time after a cooling perio! of ,6 !ays;

4uestion :rite short notes on A3eri!an de,ository re!ei,ts (A9>+)=

Ans7er#

Meaning: 5epository /eceipts issue! by a company in the Jnite! tates of America

(JA) is "nown as American 5epositary /eceipts(A5/s). uch receipts have to be

issue! in accor!ance with the provisions of the ecurities an! xchange 2ommission

of JA (2) which are very stringent.

Chara!teristi!s o A9>s#

a.

An A5/ is generally create! by !eposit of the securities of a Fon-Jnite! tatescompany with a custo!ian ban" in the country of incorporation of the issuing

company.

b. A5/s are J !ollar !enominate! an! are tra!e! in the same way as are the securities

of Jnite! tates companies.


32/44



c. The A5/ hol!er is entitle! to the same rights an! a!vantages as owners of un!erlying

securities in the home country':

!. everal variations of A5/s have !evelope! over time to meet more specialize!

!eman!s in !ifferent mar"ets.e. #ne such variations is the L5/s which are i!entical in structure to an A5/$ the only

!ifference being that they can be tra!e! in more than one currency an! within as well

as outsi!e the unite! states.

Adantages o A9>s#

a) The major a!vantage of A5/s to the investor is that !ivi!en!s are pai! promptly an!

in American !ollars.

b)

The facilities are registere! in the Jnite! states so that some assurances is provi!e! tothe investor with respect to the protection of ownership rights.

c) These instruments also obviate the nee! to transport physically securities between

mar"ets.

!) %n general$ A5/s increase access to Jnite! states capital mar"ets by lowering the cost

of investing in the securities of Fon-Jnite! states companies an! by provi!ing the

benefits of a convenient$ familiar$ an! well-regulate! tra!ing environment.

e) %ssues of A5/s can increase the-li4ui!ity of an emerging mar"et issuer's shares$ an!

can potentially lower the future cost of raising e4uity capital by raising the company's

visibility-an! international familiarity with the company's name$ an! by increasing 'thesize of the potential investor base.

9isadantages o A9>s#

a) 3igh costs of meeting the partial or full reporting re4uirements of the ecurities an!

xchange 2ommission: Mi"e the cost of preparing an! filling J LAA account$

legal fee for un!erwriting.

b) The initial ecurities xchange 2ommission registration fees which are base! on a

percentage of the issue size as well as 'blue s"y' registration costs are re4uire! to bemet.

c) %t has further been observe! that while implie! legal responsibility lies on a company's

!irectors for the information containe! in the offering !ocument as re4uire! by any

stoc" exchange.

!) The J is wi!ely recognize! as the 'most litigious mar"et in the worl!


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4uestion 6; :hat are the other ty,es o internationa issuesB Hist so3e

Finan!ia Instru3ents in Internationa Maret =

Ans7er#

1; Foreign 5uro @onds# %n !omestic capital mar"ets of various countries the Oon!

issues referre! to above are "nown by !ifferent names e.g. Uan"ee Oon!s in the J$

wiss 0inance in witzerlan!$ amurai Oon!s in To"yo an! Oull!ogs in J.

2; 5uro Conerti.e @onds#

a. %t is a uro-Oon!$ a !ebt instrument which gives the bon! hol!ers an option to

convert them into a pre-!etermine! number of e4uity shares of the company.

b. Jsually the price of the e4uity shares at the the time of conversion will have a

premium element.

c. These bon!s carry a fixe! rate of interest

!. These bon!s may inclu!e a call option where the issuer company has the option of

calling buying the bon!s for re!emption prior to the maturity !ate) or a ut #ption

(which gives the hol!er the option to put sell his bon!s to the issuer company at a

pre-!etermine! !ate an! price)

%. Pain 5uro @onds# lain uro Oon!s are mere !ebt instruments. These are not

very attractive for an investor who !esires to have valuable a!!itions to his

investment.

*; 5uro Conerti.e Kero @onds# These bon!s are structure! as a convertible bon!.

Fo interest is payable on the bon!s. Out conversion of bon!s ta"es place on maturity

at a pre-!etermine! price. Jsually there is a five years maturity perio! an! they are

treate! as a !eferre! e4uity issue.

&; 5uro @onds 7ith 5quity :arrants# These bon!s carry a coupon rate !etermine!by mar"et rates. The warrants are !etachable. ure bon!s are tra!e! at a !iscount.

0ixe! income fun!s may li"e to invest for the purpose of earning regular income

cash flow.


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4uestion ' :hat are the arious or3s o .an !redit to7ards 7oring !a,ita

needs o a .usiness=

Ans7er: Oan" cre!it towar!s wor"ing capital may be in the following forms:

1;Cash Credit# This facility will be given by the ban" to the customer by giving

certain amount of cre!it facility on continuous basis. The borrower will not be

allowe! to excee! the limits sanctione! by the ban". 2ash 2re!it facility generally

grante! against primary security of ple!ging of stoc"s.

2;@an erdrat# %t is a short-term borrowing facility ma!e available to the

companies in case of urgent nee! of fun!s. Oan"s will impose limits on the amount

lent. hen the borrowe! fun!s are no longer re4uire! they can 4uic"ly an! easily be

repai!. Oan"s grant over!rafts with a right to call them in a short notice.

%; @is A!!e,tan!e: To obtain fin un!er this type of arrangement$ a company may

!raw a Oill of xchange on the ban". The Oan" accepts the bill thereby promising to

pay out the amount of the bill at some specifie! future !ate.

*; Hine o Credit# Mine of cre!it is a commitment by a Oan" to len! a certain amount

of fun!s on !eman! specifying the maximum amount.

&; Hetter o Credit# %t is an arrangement by which the issuing Oan" on the instruction

of a customer or on its own behalf un!erta"es to pay or accept or negotiate or

authorizes another Oan" to !o so against stipulate! !ocuments subject to compliance

with specifie! terms an! con!itions.

6; @an Guarantees# Oan" Luarantees may be provi!e! by commercial ban"s on

behalf of their clients borrowers in favour of thir! parties$ who will be the

beneficiaries of the guarantees.

4uestion ; Hist the a!iities etended .y .ans to e,orters in addition to

,re ,ost shi,3ent inan!e;

Ans7er#

1; Hetters o Credit# #n behalf of approve! exporters$ ban"s establish letters of

cre!it on their overseas or up country suppliers.


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2; Guarantees# Luarantees for waiver of excise !uty$ !ue performance of contracts$

bon! in lieu of cash $security !eposit$ guarantees for a!vance payments$ etc.$ are also

issue! by ban"s to approve! clients.

%; 9eerred Pay3ent Finan!e# Oan"s provi!e finance to approve! clients

un!erta"ing exports on !eferre! payment terms.

*; Credit >e,orts# Oan"s also try to secure for their exporter--customers$ status

reports of their buyers an! tra!e information on various commo!ities through

correspon!ents

&; Genera inor3ation# Oan"s may also provi!e economic intelligence on various

countries$ currencies$ etc$ to their exporter clients$ on nee! basis

4uestion $ :rite short notes on inter !or,orate 9e,osits (IC9Ls) Pu.i!

9e,osits !ertii!ate de,osits (C9Js)=

Ans7er: 1;Inter Cor,orate 9e,osits# (IC9J+)

a. 2ompanies can borrow fun!s for a short perio!$ for example 7 months or less$ from

other companies which have surplus li4ui!ity.

b. uch 5eposits ma!e by one company in another are calle! %nter-2orporate 5eposits

(%25's) an! are subject to the provisions of the companies Act$ &N67.

c.

The rate of interest on %25's varies !epen!ing upon the amount involve! an! time

perio!.

2; Pu.i! 9e,osits#

a. ublic !eposits are a very important source for short-term an! me!ium term

finance.

b. A company can accept public !eposits from members of the public an!

sharehol!ers$ subject to the stipulations lai! !own by /O% from time to time.c. The maximum amounts that can be raise! by way of ublic 5eposits$ maturity

perio!$ proce!ural compliance$ etc. are lai! !own by /O%$ from time to time.


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!. These !eposits are unsecure! loans an! are use! for wor"ing capital

re4uirements. They shoul! not be use! for ac4uiring fixe! assets since they are to be

repai! within a perio! of + years.

e.Merits o Pu.i! 9e,osits Fro3 Co3,anyJs Point o


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!) The !ifference between the initial investment an! the maturity value$ constitutes the

income of the investor.

e) 5a3,e# A company issue a 2ommercial aper each having maturity value of

/s.6$CC$CCC. The investor pays (say) /s.,$9*$96C at the time of his investment. #nmaturity$ the company pays /s.6$CC$CCC (maturity value or re!emption value) to the

investor. The commercial paper is sai! to be issue! at a !iscount of /s.6$CC$CCC-

/s.,$9*$96C ? /s.&8$&6C. This constitutes the interest income of the investor.

)

Adantages#

a.

+i3,i!ity# 5ocumentation involve! in issue of 2ommercial aper is simple an!minimum.

b. Cash o7 3anage3ent# The issuer company can issue 2ommercial $aper with

suitable maturity perio!s (not excee!ing one year)$ tailore! to match the cash flows of

the company.

c. Aternatie or .an inan!e# A well-rate! company can !iversify its source of

finance from ban"s to short-term money mar"ets$ at relatively cheaper cost.

!. >eturns to inestors# 2's provi!e investors with higher returns than the ban"ing

system.

e.

In!entie or inan!ia strength# 2ompanies which raise fun!s through 2 becomes well-"nows in the financial worl! for their strengths. They are place! in a more

favorable position for raising long-term capital also.

4uestion 11 9is!uss the eigi.iity !riteria or use o !o33er!ia ,a,er=

Ans7er: 2ompanies satisfying the following con!itions are eligible to issue

commercial paper.

a)

The tangible net worth of the company is /s.6 crores or more as per the au!ite!

balance sheet of the company.

b) The fun! base wor"ing capital limit is not less than /s.6 crores.

c) The company is re4uire! to obtain the necessary cre!it rating from the rating

agencies) such as 2/%%M$ %2/A$ etc.


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!) The issuers shoul! ensure that the cre!it rating at the time of applying to /O% shoul!

not be more than two months ol!.

e) The minimum current ratio shoul! &.++:& base! on the classification of current assets

an! liabilities.f) 0or public sector companies there are no listing re4uirements but for companies

other than public sector$ the same shoul! be liste! in one or more stoc" exchanges.

g) All issue expenses shall be borne by the company issuing commercial paper.

4uestion 12 :rite short notes on the oo7ing

a) +eed Ca,ita Assistan!e .) 9ee, 9is!ount @onds( 99@Ls)

!) +e!ured Pre3iu3 "otes (+P"Ls) d) Kero Cou,on @onds

e) 9ou.e ,tion @onds ) Indian 9e,ository >e!ei,ts (I9>Ls)

g) Ination @onds h) Foating >ate @onds

Ans7er#

(a) +eed Ca,ita Assistan!e

i. A,,i!a.iity# ee! capital assistance scheme is !esigne! by %5O% for professionally

or technically 4ualifie! entrepreneurs an! or persons possessing relevant experience$

s"ills an! entrepreneurial traits. All the projects eligible for financial assistance from

%5O% !irectly or in!irectly through refinance are eligible un!er the scheme.

ii. A3ount o inan!e# The project cost shoul! not excee! /s.* crores. The maximum

assistance un!er the scheme will be-

a. 6CD of the re4uire! romoter's contribution$ or

b.

/s.l6la"hs$ whichever is lower.iii. Interest and !harges: The assistance is initially interest free but carries a charge of

&D p.a for the first five years an! at increasing rate thereafter. hen the financial

position an! profitability is favorableI %5O% may charge interest at a suitable rate even

!uring the currency of the loan.


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iv. >e,ay3ent# The repayment sche!ule is fixe! !epen!ing upon the repaying

capacity of the unit with an initial moratorium of upto five years.

v. ther agen!ies# %n case of existing profit ma"ing companies$ which un!erta"e an

expansion or !iversification program$ the surplus generate! from operation aftermeeting all the contractual$ statutory wor"ing re4uirement of fun!s is available for

financing capital expen!iture.

(.) 9ee, 9is!ount @onds

i. 5eep 5iscount Oon! is a form of Kero-%nterest Oon!$ which are sol! at a !iscounte!

value (i.e. below par) an! on maturity the face value is pai! to investors.

ii. 0or example$ a bon! of a face value of /s.& la"h may be issue! for /s.*$8CC initially.

The investor pays /s.*$8CC at first. 3e gets the maturity value of /s.&%a"h at the en!of the hol!ing perio!$ say *6years.

iii. ometimes$ the issuing company may give options for re!emption at perio!ical

intervals say$ after 6 years$ &C years$ &6 years$ *C years$ etc.

iv. There is no interest payment !uring the loc"-in hol!ing perio!.

v. These bon!s can be tra!e! in the mar"et.

vi. 3ence$ the investor can also sell the bon!s in stoc" mar"et an! realize the !ifference

between face value an! mar"et price as capital gains.

(!;) +e!ured Pre3iu3 "otes (+P"Js)#

i. ecure! remium Fotes are issue! along with a !etachable warrant an! is

re!eemable after a specifie! perio!$ say , to 8 years.

ii. There is an option to convert the F's into e4uity shares.

iii. The conversion of !etachable warrant into e4uity shares will have to be !one

within the time perio! specifie! by the company.

(d) Kero Cou,on @onds#

i. Kero coupon bon!s !o not carry any interest.


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ii. %t is sol! by the issuing company at a !iscount. The !ifference between the !iscounte!

value an! maturing or face value represents the interest to be earne! by the investor

on such bon!s.

iii.

%t operates in the same manner as a 55O$ but the loc"-in perio! is comparatively less.

(e;)9ou.e ,tion @onds#

i. These were first issue! by the %5O%.

ii. The face value of each bon! is /s.6$CCC. The bon! carries interest at &6D p.a.

compoun!e! half-yearly from the !ate of allotment.

iii. The bon! has a maturity perio! of &C years.

iv. ach bon! has two parts in the form of two separate certificates$ one for principal

of /s.6$CCC an! other for interest (inclu!ing re!emption premium) of /s.&7$6CC. both

these certificates are liste! on all major stoc" exchanges.

v) The investor has the facility of selling either one or both parts at anytime he wishes

so.

( ) Indian 9e,ository >e!ei,ts

i. The concept of the !epository receipt mechanism which is use! to raise fun!s in

foreign currency has been applie! in the %n!ian capital mar"et through the issue of

%n!ian !epository /eceipts (%5/s).

ii. %5/s are similar to A5/s L5/s in the sense that foreign companies can issue

%5/s to raise fun!s from the %n!ian capital mar"et in the same lines as an %n!ian

company uses A5/s L5/s to raise foreign capital.

iii. The %5/s are liste! an! tra!e! in %n!ia in the same way as other %n!ian securities

are tra!e!.

(g) Ination @onds#

i. %nflation bon!s are bon!s in which interest rate is a!juste! for inflation.

ii. Thus$ the investor gets an interest free from the effects of inflation.


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iii .0or example$ if the interest rate is &&D an! the inflation is +D$ the investor will

earn &,D meaning thereby that the investors protecte! against inflation.

(h) Foating rate .onds#

i. %n this type of bon!$ the interest rate is not fixe! an! is allowe! to float !epen!ing

upon the mar"et con!itions.

ii. This is an instrument use! by issuing companies to he!ge themselves against the

volatility in the interest rates.

iv. 0inancial institutions li"e %5O%$%2%2%$ etc. have raise! fun!s from these bon!s.

4uestion 1% 9ierentiate .et7een Fa!toring and @is dis!ounting;

Ans7er# 9ierentiation .et7een Fa!toring and @is 9is!ounting

The !ifferences between 0actoring an! Oills !iscounting are:

a. 0actoring is calle! as ''%nvoice 0actoring' whereas Oills !iscounting is "nown as

'%nvoice !iscounting.

b. %n 0actoring$ the parties are "nown as the client$ factor an! !ebtor whereas in Oills

!iscounting$ they are "nown as !rawer$ !rawee an! payee.

c.

0actoring is a sort of management of boo" !ebts whereas bills !iscounting is asort of borrowing from commercial ban"s.

!. 0or factoring there is no specific Act$ whereas in the case of bills !iscounting$ the

Fegotiable %nstruments Act is applicable.

4uestion 1* :hat is a!toring= 5nu3erate the 3ain adantages o a!toring;

Ans7er: Con!e,t o Fa!toring and its Main Adantages#

0actoring involves provision of specialize! services relating to cre!it investigation$

sales le!ger management purchase an! collection of !ebts$ cre!it protection as well asprovision of finance against receivables an! ris" hearing. %n factoring$ accounts

receivables are generally sol! to a financial institution (a subsi!iary of commercial

ban" - calle! PfactorP)$ who charges commission an! bears the cre!it ris"s associate!

with the accounts receivables purchase! by it.


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Adantages o Fa!toring

The main a!vantages of factoring are

&. The firm can convert accounts receivables into cash without bothering aboutrepayment.

*. 0actoring ensures a !efinite pattern of cash inflows.

+. 2ontinuous factoring virtually eliminates the nee! for the cre!it !epartment.

0actoring is gaining popularity as useful source of financing short-term fun!s

re4uirement of business enterprises because of the inherent a!vantage of flexibility it

affor!s to the borrowing firm. The seller firm may continue to finance its receivables

on a more or less automatic basis. %f sales expan! or contract it can vary the financingproportionally.

,. Jnli"e an unsecure! loan$ compensating balances are not re4uire! in this case.

Another a!vantage consists of relieving the borrowing firm of substantially cre!it an!

collection costs an! from a consi!erable part of cash management.

4uestions 1& 7hat do you understand .y Assests +e!uriti8ationB 9e.t

+e!riti8ation=

Asset +e!uriti8ationB9e.t +e!uriti8ation#

ecuritization is the process by which financial assets such as loan receivables$ lease

receivables$ hire purchase !ebtors$ Tra!e !ebtors etc$ are transforme! into securities.

Jn!er this process$ assets generating stea!y cash flows are

pac"age! together an! against this asset pool$ securities can be issue!.

Parties to Asset +e!uriti8ation#

The following are the parties involve! in Asset ecuritization process. They are:

a)

riginatorB7ner# #wner#riginator is the person who grants a loan or

un!erta"es a transaction that gives rise to a financial asset.


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.)

.igor# #bligor is the person who receives the loan or enters into a transaction with

the owner that gives rise to a financial asset.

!)

+,e!ia Pur,ose


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b) The realizations from securitize! assets in excess of the value for which it is

securitize!.

c) %n case the realizations from securitize! assets not being sufficient resource can be

ha! to him.!) The owner may ta"e upon himself the assets securitize!.

Remember…

“No one can separate the best pair in this world – ardwor! and s"ccess#

All the very best………..

Urs Krish…,

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