Investment Banking and

Financial Services

Workbook

The ICFAI University

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 Contents

Brief Summaries of Chapters 1

Part I : Questions and Answers on Basic Concepts (with Explanatory Notes) 31

Frequently used Formulae 132

Part II : Problems and Solutions 136

Part III : Applied Theory Questions and Answers 327

Part IV : Case Studies Problems and Solutions 368

Part V : Caselets Questions and Answers 534

Part VI : Model Question Papers (with Suggested Answers) 593

 Preface
The ICFAI University has been upgrading the study material so that it is amenable for self study
by the Distance Learning Students.
We are delighted to publish a Workbook for the benefit of the students preparing for the
examinations. The workbook is divided into six parts.

Brief Summaries of Chapters

A brief summary of all the chapters in the textbook are given here for easy recollection of the
topics studied.

Part I: Questions and Answers on Basic Concpets (with Explanatory Notes)

Students are advised to go through the relevant textbook carefully and understand the subject
thoroughly before attempting Part I. Under no circumstances the students should attempt Part I
without fully grasping the material included in the textbook.

Frequently used Formulae

Similarly the formulae used in the various topics have been given here for easy recollection while
working out the problems.

Part II: Problems and Solutions

The students should attempt Part II only after carefully going through all the solved illustrations in
the textbook. A few repetitive problems are provided for the students to have sufficient practice.

Part III: Applied Theory: Questions and Answers

All theory questions are applied in nature. Having understood the basics in the textbook, the
students are expected to apply their knowledge to certain real life situations and develop relevant
answers. To be able to answer the applied theory questions satisfactorily all the students are
advised to follow regularly the Analyst magazine, business magazines and financial dailies.

Part IV: Case Studies: Problems and Solutions

A case study attempts to test the cognitive skills of the student in integrating various concepts
covered in the subject with focus on quantitative aspects. Hence, students should attempt them
only after they are thorough with the entire subject.

Part V: Caselets: Questions and Answers

A caselet also tests the cognitive skills of the student in integrating various concepts but with focus
on qualitative aspects. Students are advised to try to answer the questions given at the end of the
articles in the ICFAI Analyst to develop their skills further. The caselets given in this part also
help students gain the adequate exposure on how current events of interest can be analyzed and
interpreted.

Part VI: Model Question Papers (with Suggested Answers)

The students should attempt all model question papers under simulated examination conditions.
They should self score their answers by comparing them with the model answers.
Please remember that the ICFAI University examinations are quite rigorous and demanding. The
student has to prepare well for each examination. There are no short-cuts to success. We hope that
the students will find this workbook useful in preparing for the ICFAI University examinations.
Work Hard. Work Smart. Work Regularly. You have a good chance to succeed. All the best.
 Brief Summaries of Chapters
INVESTMENT BANKING, FINANCIAL SYSTEMS AND FINANCIAL
MARKETS
Investment Banking Industry
• Investment banking is a very vast area in the field of banking and finance.
• It includes raising and managing funds, advising clients about investments and marketing
financial products.
• The main activities under investment banking are: Advisory functions, administrative
functions, underwriting functions, distribution functions, investment management
functions, mergers & acquisitions and other finance related activities.
• Investment banking in the US is a very old industry and the top investment banking firms
have become MNCs with presence in most of the countries across the globe.
Financial Systems and Financial Markets
• The economic development of a country depends on the progress of its various economic
units, namely the corporate sector, government sector and the household sector.
• The role of the financial sector can be broadly classified into the savings function, policy
function and credit function.
• The main types of financial markets are: Money market, capital market, forex market and
credit market.
• The financial markets are further sub-divided into the primary market and the secondary
market.
• A market is considered perfect if all the players are price takers, there are no significant
regulations on the transfer of funds and transaction costs, if any, are very low.
• The accounting equation ASSETS = LIABILITIES, can be altered as FINANCIAL
ASSETS + REAL ASSETS = FINANCIAL LIABILITIES + SAVINGS.
• The main types of financial assets are deposits, stocks and debt.
• While designing a financial instrument, the issuer must keep the following in mind: Cash
flows required, taxation rules, leverage expected, dilution of control facts, transaction costs
to be incurred, quantum of funds sought, maturity of plan required, prevalent market
conditions, investor profile targeted, past performance of issues, cost of funds to be borne,
regulatory aspects to abide by.
• While investing in a financial instrument, the investor must keep in mind the following:
Risk involved, liquidity of the instrument, returns expected, possible tax planning, cash
flows required and simplicity of investment.
• Various financial intermediaries came into existence to facilitate a proper channel for
investment. The main ones are: Stock exchanges, investment bankers, underwriters,
registrars, depositories, custodians, primary dealers, satellite dealers and forex dealers.
CREDIT MARKET
• Banks, financial institutions and non-bank finance companies providing credit for varying
consumer requirements and corporate sectors of the economy are said to be the
intermediaries of the credit market.
• Consumer loans are auto-finance loans, credit card loans, housing loans and loans to
acquire consumer durables. Most of these loans are provided against financial or real assets.
• Credit extended to consumers is usually for short- or medium-term, except for housing
loans which tend to be medium- and long-term loans.
• Corporate loans are extended for project finance or for expansion/modernization/
diversification (purposes). Working capital loans are extended for short-term requirements
like day-to-day operational requirements and for maintaining adequate level of current
assets.
• Project loans are usually known as term loans and working capital loans are in the form of
cash credit, overdraft facility or bill financing.
• In countries like India, 40% of the loanable funds are to be given to the priority sector, in
order to ensure proper use of institutional credit.
• Credit extended to the project finance and priority sector is usually for medium- and long-
term while working capital loans are usually for short-term periods only.
• Intermediaries base their lending rates on three factors: Their cost of funds, transaction
costs and required spreads. They also give due consideration to risk exposure that the loan
may be subject to.
• The main sources of funds to the intermediaries are public deposits and other financial
markets.
• Transaction costs depend on the efficiency with which transfer of funds takes place. It
includes all the costs in the decision-making process while approving the client’s proposal
and the documentation costs.
• Spread cost is the margin of profitability levied by the banks over the cost of borrowing and
transaction costs incurred in order to make a profit.
• Risk exposures also add a certain margin to the lending rate in order to cover the credit
risks and interest rate risks perceived by the bank at the time of lending.
• Generally, short-term loans have fixed rate and long-term loans have a floating rate.
• LIBOR is used as a reference rate for Euroloans while the Bank Rate (BR) and the Prime
Lending Rate (PLR) are used in India.
• Borrowers prefer the following features in their borrowings: Low rate of interest, minimum
lead (processing) time, easy access to funds, minimum terms and conditions on usage of
funds, minimum monitoring and interference of the lender and freedom of time to repay.
• Lenders prefer the following features in their lendings: Maximum spreads, adequate
coverage for risks, satisfaction of statutory reserve requirements and capital adequacy
norms.
• The following measures have been taken to enhance the Indian credit market: Withdrawal
of government funds as a source of funds to financial institutions, restriction of dependence
of NBFCs on public money, prudential norms for intermediaries, allowing private banks to
operate in new areas, widening the scope of financial institutions, adoption of new
technology, permitting the access to overseas funds and offshore banking.
MONEY MARKET
Introduction to Money Market
• Liquidity mismatch happens often in the short run as cash inflows and outflows rarely
synchronize.
• It is important to manage the same carefully, to avoid liquidity crisis in case of deficit and idle
funds that do not bear interest in case of surplus.
• The money market is a formal financial market that deals with short-term fund
management.

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• The money market involves high volumes and is dominated by a relatively small number of
players, namely: Government of the country, central bank, banks, financial institutions,
corporates, mutual funds, foreign institutional investors, discount houses, acceptance
houses and market makers (primary and satellite dealers).
• The main money market instruments are: Government and Quasi-Government securities,
banking sector securities and private sector securities.
• Government and Quasi-Government securities include Treasury bills and Government
dated securities or Gilt-edged securities.
• Banking sector securities include Call and notice money market securities, Term money
market securities, Certificates of deposit and Participation certificates.
• Private sector securities include Commercial paper, Bills of exchange, Inter-corporate
deposits/Investments and Money market mutual funds.
• Repo transactions are popular mechanisms to deploy/borrow short-term funds in the money
market, by selling securities to another party with an agreement to buy back the same at a
later date.
• The main risks associated with money market instruments/investments are: Market risk,
interest rate risk, reinvestment risk, default risk, inflation risk, currency risk and political
risk.
• The main money market securities in the US market are: Government securities (T-bills),
Municipal notes, Federal agency securities, Call loan market, Repos and reverses,
Certificates of deposit, Eurodollar deposits and Eurodollar CDs, Yankee CDs, Loan
participations, Bankers’ acceptances, Commercial papers, Euro commercial papers in
Europe and commercial bills.
• The main objectives of the monetary policy are: Price stability and economic growth.
• The most critical factors in a monetary policy are: Money supply, interest rate stability and
exchange rate stability.
• Monetary contraction can be resorted to control inflation, by adopting one of the following
measures: Increase the statutory reserves (CRR and SLR), undertake repo transactions or go
in for open market operations.
• The RBI controls the money market in India by adopting the following measures: Changes
in CRR, changes in SLR, open market operations, reduction in bank and repo rates.
• There are two types of dealers in the Indian money markets, namely, primary dealers and
satellite dealers.
• The main objectives of the primary dealers are: Enhance liquidity of the money market,
become underwriters and market makers for government securities, activate the secondary
market for government securities and aid the RBI in open market operations.
• Subsidiaries of nationalized banks, FIs and security business companies can become
primary dealers, if they have a minimum of Rs.50 crore as net owned funds. Subsidiaries of
FIIs can become primary dealers subject to permission from the FIPB.
• The RBI extends the following support to the PDs: Liquidity support, permission to borrow
and lend in the market, access to current and subsidiary general ledger accounts, repos and
refinance, permission to raise funds through commercial papers and permission to transfer
funds from one center to the other.
• Satellite dealers support the functions of the primary dealers.
• The main objectives of the satellite dealers are: Further increase the depth of the secondary
market of government securities; enhance the liquidity of the same and provide a retail
outlet to the government securities due to their wide branch network.
• Subsidiaries of nationalized banks, FIs and security business companies can become
satellite dealers, if they have a minimum of Rs.5 crore as net owned funds.

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• The RBI extends the following support to the SDs: Access to current and subsidiary general
ledger accounts, permission to borrow and lend funds in the money market and recommend
the government of India to enter into ready forward transactions in securities with eligible
institutions.
Call Money
• The call money market is the part of the money market where the surplus funds of the
banks are traded on a daily basis. Borrowers use funds to match short-term mismatches of
assets and liabilities and to match the CRR requirements. This market is a measure of the
liquidity of the overall money market.
• Maturity period varies from 1 to 14 days.
• Money that is lent for a day is called overnight money.
• All private sector, public sector and co-operative banks, term lending institutions, insurance
companies and mutual funds participate in this market. Primary dealers, DFHI and STCI
can participate only in the local call money markets.
• Interest paid on call loans is known as call rates and is calculated on a daily basis.
• Call money markets are located in the cities that have the major stock exchanges in India,
namely Mumbai, Kolkata, Delhi, Chennai and Ahmedabad. Mumbai has the largest market
in India.
• The RBI acts as a regulator of the call money market, but neither borrows from nor lends to
it. It uses repos and open market operations to control the market.
• An efficient call money market should be less volatile and provide an opportunity to the
players to transact at comparatively stable rates of interest.
Treasury Bills
• Treasury bills are issued by the government to raise short-term funds in the money market.
They are a major portion of the borrowings of the Government of India.
• The RBI acts as the banker to the Government of India to issue the T-bills.
• The main investors in T-bills include: Banks (to meet their SLR requirements), primary
dealers, financial institutions (for primary cash management), insurance companies,
provident funds (as per the investment guidelines), non-banking finance companies,
corporations, FIIs, state governments and individuals (to a very minor extent).
• T-bills are issued in the form of promissory notes or credited to the SGL account. They are
for a minimum of Rs.25,000 and multiples thereof, issued at a discount and redeemed at par
and do not carry any yield.
• At present there are five types of T-bills in India: 14-day, 28-day, 91-day, 182-day and 364-
day, out of which the 28-day T-bills have not yet been launched. The bills are available in
paper as well as in scripless form.
• Ad hoc T-bills are issued in favor of the RBI when the government needs to replenish the
cash balances and to provide temporary surpluses to state governments and foreign central
banks. These are not available to the public.
• On tap T-bills were issued by the RBI to investors on any day and with no limit on
investment. They were for a minimum of 91 days and the discount rate was around 4.6%
redeemable at par. They were discontinued from April 1, 1997.
• 14-day and 91-day T-bills are auctioned weekly on Fridays and payment in respect to the
allotments is made on Saturdays.
• The auction for 182-day and 364-day is held weekly on Wednesdays and payment in
respect to the allotments is made on Thursdays.
• T-bills are important market instruments in the US, where the minimum denomination
is $10,000 and in multiples of $5,000 thereof. The American T-bills are mainly
classified as ‘regular-series T-bills’ and ‘irregular-series T-bills’.

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• Regular-series of 13-week, 26-week and 52-week maturities are issued weekly or monthly
while irregular-series are issued for a special cash need of the treasury.
• The US T-bills are sold in auctions and issued at a discount to face value.
Commercial Paper (CP)
• Commercial Papers (CPs) are a short-term unsecured usance promissory notes issued at a
discount to face value by reputed corporates with high credit rating and strong financial
background.
• CPs are open to individuals, corporates, NRIs and banks, but the NRIs can invest on non-
repatriable/non-refundable basis. FIIs have also been allowed to invest their short-term
funds in CPs.
• The features of CPs are: They do not originate from specific trade transactions like commercial
bills. They are unsecured, involve much less paper work and have very high liquidity.
• CPs have a minimum maturity of 15 days and a maximum maturity of 1 year. They are
available in denomination of Rs.5 lakh and multiples of Rs.5 lakh and the minimum
investment is Rs.5 lakh per investor.
• CPs can be direct paper if issued directly to the investors by the corporate or dealer paper if
issued through an intermediary/merchant banker. CPs are usually placed with the investors
by issuing and paying agents.
• Secondary market trading takes place in lots of Rs.5 lakh each usually by the banks. The
transfer is done by endorsement and delivery.
• The main reasons for poor development of the CPs market are: Restricted entry of
corporates, tendency to issue CPs only if the total cost is lower than the PLR of banks, high
minimum investment of individual investors and no tax benefits.
• In the US markets, CPs are defined as short-term, unsecured usance promissory notes
issued at a discount to face value with fixed maturity by financially strong companies with
high credit ratings.
• The main purpose of issuing CPs in the US is to finance current assets.
• The main features are: High liquidity and safety, high quality instruments negotiable by
endorsement and delivery, issued in multiples of $1,000 as bearer documents at a discount
to the face value. They are unsecured by nature and tailored to the user requirement as far
as maturity period is concerned.
• There are also two types of CPs in the US: Direct paper (issued directly by the corporates
and large banks) and dealer paper (issued by the dealers on behalf of their corporate
clients).
• The innovations in the American CP market are: Master note (financial paper issued by
finance companies to bank trust departments with interest pooled by the investors),
medium-term notes (unsecured obligation papers with maturity of 9-10 months issued by
investment grade corporations at fixed rate) and asset-backed commercial papers (packages
of pooled loans or credit receivables with lower rates of interest and placed with a special
purpose entity).
Certificate of Deposits (CDs)
• Certificate of Deposits (CDs) is a usance promissory note, negotiable and in marketable
form bearing a specified face value and number. Scheduled commercial banks and the
major financial institutions can issue CDs.
• Individuals, corporates, trusts and NRIs are the main investors on CDs (on non-repatriable
basis).

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• The features of CDs are: It is a title document to a time deposit, riskless, liquid and highly
marketable, issued at a discount to face value, being part of the time liabilities of banks,
either in registered or bearer form, freely transferable by endorsement and delivery. It does
attract stamp duty.
• The benefits of issuing CDs to the banks are: Interest can be determined on a case to case
basis, there is no early maturity of a CD, rates are more sensitive to call rates.
• To the investors the benefits of subscribing to CDs are: It is a better way of deploying
short-term funds as higher yield is offered, secondary market liquidity is available and
repayment of interest and principal is assured.
• CDs are issued for a period of 15 days to one year (normally one to three years by the
financial institutions) at a minimum amount of Rs.5 lakh and in multiples of 1 lakh
thereafter with no upper limit.
• There is no specific procedure to issue the CDs. It is available, on tap, with the bankers.
• CDs are the largest money market instruments traded in dollars. They are also issued by
either banks or depository institutions, mostly in bearer form enabling trading in the
secondary market.
• Individuals, corporates and other bodies also buy the CDs in the US.
• The features of American CDs are: They are bearer instruments, negotiable, with a
minimum denomination of $100,000, maturity of 30 days to 5 years. CDs with more than
one year maturity are known as term CDs.
• CDs have undergone various innovations: Asian dollar CDs, jumbo CDs, yankee CDs,
brokered CDs, bear and bull CDs, installment CDs, rising rate CDs and foreign index CDs,
all with different features. Many more innovations are expected in this uprising market.
Bill Financing
• Monetary policy refers to the use of the official instruments under the control of the central
bank of the country to regulate the availability, cost and use of money and credit.
• The bank standard rate is the rate at which the bank is prepared to buy or rediscount bills of
exchange or other commercial paper eligible for purchases.
• A bill of exchange has been defined as an instrument in writing containing an unconditional
order, signed by the maker, directing a certain person to pay a certain sum of money only
to, or to the order of, a certain person or to the bearer of the instrument.
• The specific features of a negotiable instrument are: There must be three parties to the
exchange, namely drawer, drawee and payee, the instrument must be in writing, containing an
order (not a request) to a certain person to pay, unconditionally, a certain sum of tender legal
money, duly signed by the drawer and presented to the drawee for acceptance. It should also
have date, number, place and other considerations found in the bills of exchange.
• Bills of exchange can be classified as demand or usance bills, documentary or clean bills,
D/A or D/P bills, inland or foreign bills, supply bills or government bills or accommodation
bills.
• Bills can also be classified as traders bills, bills with co-acceptance, bills accompanied by
letter of credit and drawee bills.
• Originally discounted bills can be rediscounted by banks for their corporate clients with
financial institutions, as long as such bills arise out of genuine trade transactions.

• The RBI has instructed banks to restrain from rediscounting bills outside the consortium of
banks and initially discounted by finance companies and merchant bankers. Further
discounting should be only for the purpose of working capital/credit limits and for the
purchase of raw materials/inventory. Accommodation bills are not to be discounted under
any circumstances.

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DEBT MARKET
Gilt-Edged Securities Market
• Gilt-edged securities mean securities of the best quality, where the repayment of principal
and interest is secured by the government. They are risk-free investments.
• Government securities are issued by central and state governments, semi-government
authorities and government financial institutions.
• Individuals, corporates, other bodies, state governments, provident funds and trusts are
allowed to invest in government securities.
• Government securities play a vital role in the open market operations conducted by the
central bank of the country.
• The minimum investment is Rs.10,000 and multiples thereof and they can be long-
dated, medium-dated and short-dated, with maturities of 10-20 years, 5-10 years and
less than 5 years respectively.
• In the primary market, government securities can be issued through auctions, pre-
announced coupon rates, as floating rate bonds, as zero-coupon bonds, as stock on tap, as
stock for which payment is to be made in installments or as stock on conversion of
maturing treasury bills/dated securities.
• There is a huge demand for government securities in the secondary market as they are the
first choice of banks to comply with the SLR requirements.
• The RBI usually undertakes the following transactions with banks: Open market operations,
repo transactions and switch deals.
Repurchase Agreements (REPOs)
• Repos are ready forward deals or agreements involving sale of a security with an
undertaking to buy-back the same security at a predetermined price and time in future. To
the seller, it is known as a repo and to the buyer it is known as a reverse repo.
• The market participants in repos are: Banks, DFHI, financial institutions, non-banking
entities like mutual funds that hold current and SGL accounts with the RBI.
• The operational aspects of a repo depend on: Size of the loan, selection of security, interest
rate and settlement system.
• The procedure to issue repos involves the acceptance of tenders, announcement of auction
results and the payment.
Public Deposits
• Corporates prefer public deposits to bank loans because as they are unsecured debts and the
funds can be deployed at the discretion of the company.
• Non-banking finance companies have been defined as loan companies or hire purchase
finance companies or investment companies or equipment leasing companies or mutual
benefit financial companies, while non-banking non-financial companies are those involved
in manufacturing, trading or service sector.
• Public deposit is any money borrowed by a company, but does not include advances,
guarantees from any government, bank borrowings, security deposits, funds from the
promoters or directors, share capital or debentures funds.
• Public deposits should be of 12 to 60 months tenure.
• The maximum rate of interest is decided by the RBI and the brokerage paid to the agents
depends on the duration of the deposit. The maximum amount of deposits cannot exceed
25% of the paid-up capital and free reserves. In addition, the company can accept deposits
from shareholders up to 10% of the paid-up capital and free reserves.

7
• The company must maintain liquid assets to the extent of 15% of the deposits maturing by
the end of the financial year (March 31). The liquid assets can be deposits with scheduled
banks without any lien, unencumbered securities of central and state governments, other
unencumbered securities or bonds of HDFC. The liquid amount can never fall below 10%
of the maturing deposits.
• Receipts of deposit must be issued within 8 weeks of acceptance and premature deposits are
allowed after a period of 3 months from the date of deposit, subject to the penalty for early
withdrawals.
• Every company accepting deposits should maintain a register of deposits at the registered
head office with the basic details of each depositholder, for a period of 8 years from the
financial year in which the latest entry is made.
• A company inviting public deposits must advertise the details of the company and the
profitability in an English and a local language newspaper.
• In order to market its public deposits successfully, a company has to develop a mix of the
following factors: Product differentiation, pricing, promotion, quality service and distribution.

Financial Guarantees
• A guarantee is a contract to perform or to discharge the liability of a third person in case of
his default. There are three parties involved in a guarantee: The lender, the borrower and
the guarantor.
• There are three major types of guarantees: Personal, governmental and institutional (usually
by financial institutions, banks, insurance companies, etc.).
• The government of India has also set-up two specialized public guarantee institutions:
Deposit Insurance and Credit Guarantee Corporation (DICGC) and Export Credit and
Guarantee Corporation (ECGC).
• While DICGC undertakes insurance of deposits on banks, guarantee for credit extended by
banks to priority sector and guarantee for credit extended to small scale industries, ECGC
offers cover to exporters against commercial risks and political risks.
• The main services offered by ECGC are: Standard policy, small exporters policy, specific
policy, guarantees to banks and special schemes (transfer guarantee, overseas investment
insurance and exchange rate fluctuation risk).
CAPITAL MARKET
An Overview of the Capital Market
• Of late the following broad trends like disintermediation, institutionalization, globalization
and modernization are being observed in the capital markets in India.
• The primary markets in India have observed the following major changes: Free pricing of
instruments, introduction of entry norms, improvement in the quality of disclosures,
introduction of the book building process to price new share issues, streamlining all the
procedures and registration of intermediaries like merchant bankers, registrars and share
transfer agents, brokers to issue, bankers to issue and debenture trustees.
• The secondary markets in India have observed the following major changes: Computerized
trading system, depository participants and dematerialization of issues, settlement of
clearing corporations for the stock exchanges, change in the settlement system, banning of
carry forward system, introduction of the margin system, minimum capital norms for
brokers, implementation of a vibrant secondary market for debt issues, review of the share
indices, strict regulations to maintain integrity of the markets, introduction of derivatives
and latest introduction of the daily rolling settlement process.

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Regulation of the Capital Market
• SEBI was instituted by the Government of India to perform disciplinary (disincentives and
penalties for errant and unfair behavior) and developmental (incentives for constructive
activities) roles.
• The main objectives of SEBI are: Protection of the interests of investors in securities,
development of the securities markets in India and regulation of the securities markets.
• The activities of SEBI are divided into: Primary market department, issue management and
intermediaries department, secondary market department, institutional investment
department, investigation department and legal department.
• The major steps initiated by SEBI include: Registration of intermediaries, redressal of
investors’ grievances, improvement in the functioning of primary and secondary markets,
regulation of takeovers, emergence of institutional investors and entry of private mutual
funds in the markets, maintenance of fairness and integrity of the markets.
• The main objectives of the International Organization of Securities Commissions (IOSCO)
are: Promotion of high standards of regulations, exchange information on past experiences,
establishment of standards of conduct and provision of mutual assistance for promotion of
integrity.
• IOSCO has three types of members: Ordinary members, associate members and affiliate
members and various committees that meet every year to discuss important issues relating
to international securities and futures markets.
MERCHANT BANKING
An Overview of Merchant Banking
• Merchant bankers act as intermediaries between the issuers of capital and the ultimate
investors who purchase the securities. Merchant banker means a person who is engaged in
the business of issue management either by making arrangements regarding selling, buying
or subscribing to securities as manager, consultant, advisor or rendering corporate advisory
services in relation to such issue management.
• The scope of merchant banking in India covers: Management of debt and equity issues,
placement and distribution of investment proposals, corporate advisory services, project
advisory services, loan syndication, venture capital and mezzanine financing, mergers and
acquisitions, divestitures of assets, takeover defense activities and financial engineering.
• Merchant banking mushroomed in India in the ‘80s and ‘90s when the entry barriers were
low and many issues by dubious promoters were being floated.
• In order to control this trend, SEBI came up with stricter guidelines, like making the same
rules for all classes of merchant bankers, increasing the net worth requirements and the fee
structure. This resulted in some control over the mushrooming trend of fly-by-night
operators in the capital markets.
• Entry barriers in the merchant banking business are still low; competition is high; pressure
from substitute options is fast growing; bargaining power of buyers (clients) is very high;
and the bargaining power of suppliers (merchant bankers) is very low.
Management of Public Issues, Initial Public Offerings and Pricing of Various
Instruments
• An Initial Public Offering (IPO) is the first public offer of equity shares by a company since
its inception.
• An IPO is used as a financing strategy (to raise funds) or as an exit strategy (to offload
holding to the general public).
• There are various advantages and disadvantages of going public. It is to be noted that
despite so many issues hit the Indian markets, most of them get subscribed.

9
• The eligibility norms for IPO are: The company should be in existence for the last 5 years
with dividend payment for at least 3 years or the project for which funds are required
should be appraised by a bank or financial institution who should invest in at least 10% of
the equity or debt capital of the company. The issue size does not exceed 5 times the pre-
issue net worth.
• The company has to appoint various intermediaries like: Merchant bankers, registrars and
share transfer agents, bankers to the issue, debenture trustees (if applicable), advertising
agency and printers of stationery, underwriters to the issue, brokers to the issue, auditors
and legal advisor to the issue.
• The contribution of the promoter should be 20% of the post-issue equity capital. The
percentage of holding for a new company coming out with an issue at a premium depends
on the size of the issue. The lock-in requirement for the promoters’ holdings is 3 years.
• Contribution of the promoters should not include: Shares issued within one year of filing
prospectus with SEBI if the price is below the issue price; bonus shares out of revaluation
reserves; shares issued in consideration other than cash.
• SEBI has made some special mandatory provisions for debenture issues: Mandatory credit
rating; appointment of SEBI registered debenture trustee; creation of debenture redemption
reserve; option of redemption in case of roll-over of NCD/PCD; optional conversion of
debentures above 18 months; availability of optional conversion of debentures after 18
months or before 36 months for debentureholders; no issue of FCD for more than 3 years
without optional conversion with put and call option facility.
• The marketing of a public issue depends on: Timing of the issue, retail distribution
network, reservation portion in the issue and advertising campaign for the issue.
• The allotment of shares in case of oversubscription should be tilted towards the small
investors (those with applications up to 1000 shares) in order to avoid concentration of
power in few hands. There ought to be at least 5 investors per Rs.1 lakh of equity capital.
• In case of undersubscription of less than 90% of the issue size, the company must refund
the proceeds to the investors. In order to avoid refunds, the company can take the help of
underwriters who have to subscribe to the balance shares as per their pre-decided
commitments.
• While designing the capital structure of a company, the following points must be kept in
mind: Type of asset being financed, nature of the industry in which operating, degree of
competition, obsolescence of one’s products, product life cycle, financial policy and
past/current capital structure.
• While deciding about the financial instrument, the following points must be kept in mind:
Purpose of the offer, debt servicing, tax considerations, credit rating, asset cover and
dilution of ownership.
• The Indian capital markets have seen the following innovative financial instruments in the
recent past: Zero-coupon bonds, secured premium notes, deep discount bonds, optional
convertible bonds, third party convertible bonds, zero coupon convertible notes, tax saving
bonds, cumulative convertible preference shares, non-convertible debentures with equity
warrants, floating rate instruments, auction rated debt, zero-coupon bonds with equity
warrants, among others.
• New companies should price their issues at par, but private companies with profitability
track record can price their issues at a premium and listed companies can price their issues
freely. At present, 10% of the issue has to be made by the book building method.
• There are various alternatives to price an issue: Dividend discount model, yield expectation
of the public, book value of share, current market price, past price behavior, Japanese
auction pricing, book building method, brand equity of the company, etc.
• Indian companies tend to justify their premiums through qualitative as well as quantitative
factors.

10
• The pricing of an IPO in the Indian capital market is as follows: Estimation of the
preliminary price, deciding on the price band and determining the actual offer price.
• An issue could be overpriced, rightly priced or underpriced. The factors underlying
underpricing are: Asymmetric information, early fixation of offer price, interest rate float,
liquidity premium, building shareholders loyalty, rewarding the favored clients of the
merchant bankers and to attract the financial institutions.
• The factors responsible for persistent underpricing in the market are: The Winner’s curse,
information disclosure in the pre-selling period, informational cascades, avoidance of
litigation (not in India), signaling for a future issue, information asymmetry between firms
and investment bankers, regulatory constraints, political goals and market incompleteness.
Rights Issues, Bonus Issues, Private Placements and Bought-out Deals
• Rights shares are shares offered to the existing shareholders as a matter of legal right.
• The objectives of Sec. 81 are: Equitable distribution of shares, voting rights not to be
affected, shareholders interest in reserves/net worth not to be impaired.
• SEBI has come out with detailed guidelines for rights issues as well as the action plan on
how to go about a rights issue.
• A rights issue affects the wealth of those shareholders who renounce adversely, but does
not change the wealth of those who exercise their rights or sell the rights to someone else.
• The advantages of a rights issue are: It enables existing shareholders to retain their
proportionate ownership of the company, the company can also concentrate on the existing
shareholders without increasing the shareholder base and its cost of making is lower than
that of a public issue.
• The main disadvantage of a rights issue is that it takes a long time to complete the
transaction.
• Bonus issue is the process of capitalizing reserves to convert the quasi-capital into equity
capital, generally to bring the paid-up capital in line with the capital employed.
• A bonus issue does not affect the wealth of a shareholder.
• SEBI has also come up with a regulatory framework for bonus issues.
• A private placement is a method to raise funds under which companies directly sell their
securities to a limited number of sophisticated and discerning investors.
• The main features of a private placement are: No entry barriers, no need of registration with
SEBI, terms are negotiable between the parties, company has a choice of investors,
transaction costs are low, credit rating is optional and the time lag is shorter.
• Mutual funds, FIs, banks, insurance companies, FIIs, rich individuals and private equity
funds are the players in the placement market.
• The main issuers are: Listed companies, FIs, unlisted companies, closely-held companies,
PSUs and government companies.
• The merits of private placement are: Accessibility, speed, flexibility, lower transaction
costs and confidentiality.
• A buy-out is a process whereby an investor buys a significant portion of the equity of a
company with a view to make it public within an agreed time-frame. It is also known as a
wholesome investment.
• The main reasons for bought-out deals are: Funds requirement in adverse market
conditions, funds requirement when the company is not entitled to an IPO, when the
company cannot go for an IPO at a premium and when the offer of an investor is more
lucrative than an IPO.
• The advantages of a bought-out deal as compared to a public offer are: Price privilege,
quick fix, cost advantage and time to realize the funds.

11
INTERNATIONAL MARKETS
• The Indian companies have many opportunities to raise funds in the international equity
markets for the right kind of usage.
• There are various types of instruments in the international markets like: Yankee bonds,
Samurai bonds, Bulldog bonds, Euro bonds, etc., as well as ADR/GDR/IDRs for equity
issues.
• The major players in the international markets are: Borrowers/issuers, lenders/investors and
intermediaries. The institutional investors can be classified as: Market specific investors,
time specific investors and industry specific investors.
• Intermediaries are mainly: Lead and co-managers, underwriters, agents and trustees,
lawyers and auditors, listing agents and stock exchanges, depository banks, custodians and
lastly, printers.
• Resource mobilization depends on the following factors: Currency requirements, pricing of
the issue, investment, depth of the market, international positioning, regulatory aspects,
disclosure requirements and investment climate.
• The issuance of GDRs requires the following steps: Approval of the shareholders,
appointment of lead manager, finalization of the structure, documentation (prospectus,
depository agreement, underwriting agreement, subscription agreement, custodian
agreement, trust deed, paying and conversion agreement, listing agreement), the launching
of the GDR, marketing and road shows, pricing and finally closing.
• Eurodollars are liabilities denominated in US dollars, but not subject to US banking
regulations. Mostly banks located outside the US issue Eurodollar deposits.
• There are various advantages of Eurodollar deposits, the main being, lesser regulatory
impediments, lower cost of deposit intermediation and less intense supervisory scrutiny by
the authorities.
• The main instruments in the Eurodollar market are: Eurodollar Certificate of Deposits
(CDs), Eurodollar Floating Rate CDs (FRCDs), Eurodollar Floating Rate Notes (FRNs),
Note Issuance Facilities (NIFs) and EuroCommercial Papers (CPs).
• The three basic risks with Eurodollar deposits are: Chances of interference of transfer of
funds by the host country government, potential jurisdiction of international disputes and
soundness of deposits of banking offices of foreign countries with relation to the US.
• Most of the Euroloans are today sourced through a syndicate of banks or lenders. The
process is almost similar to the process of syndication of loans from internal sources.
• The advantages of syndicated loans are: Size of the loan, speed and certainty of funds,
maturity profile of the loan, flexibility in repayment, lower cost of funds, diversity of
currency, simpler banking relationships and possibility of renegotiation.
• The costs associated with the Euroloan are periodic costs (interest charges and commitment
charges on the indrawn portion) and upfront costs (management fees, out of pocket
expenses and agency costs). The largest portion of the management fee retained by the lead
bank is known as ‘praecipicium’.
• Multi-currency loans are loans denominated in one currency with an option to borrow in
one or more currencies. They are basically an expansion of the Eurodollar loans. The
documentation of multi-currency loans is similar to the Eurodollar loans.
• The following are the main types of multi-currency loans: Term loan, revolving credit
facility, evergreen facility, back-stop facility and swingline.
• The fee charged for the multi-currency loans is almost similar to the fee charged on the
Eurodollar loans.

12
• External Commercial Borrowings (ECBs) are borrowings of Indian corporates made
outside India. The advantages of ECBs are: Longer maturity, low borrowing cost, useful in
infrastructure projects and export financing.
• The Government of India has recently liberalized the regulations for ECBs in order to
attract more foreign investment in the country. However, the uses of ECB funds for
investment in the stock market and speculation in real estate is still restricted.
• After analyzing the performance of the Indian issuers, the following factors are identified
for successful international equity/convertible issues: The fundamentals of the company,
the experience of the lead manager, the size of the issue, the innovative packaging of the
instrument, the timing of the issue, the care taken in the pricing, the effectiveness of the
marketing/salesmanship, the after market services and up to date information about the
developments in the global market.
• The sources to raise forex finance in the international markets are: Official channels and
Commercial channels (for equity and debt).
• Corporate finance managers must first ascertain the resource requirements and define the
borrowing criteria and then identify the right sources to borrow funds.
• Foreign Institutional Investors (FIIs) including mutual funds, pension funds, investment
trusts, endowment funds, insurance funds, university funds, charitable societies, etc., can
invest in the Indian stock markets subject to the RBI and SEBI regulations.
• Foreign Direct Investment (FDI) takes place when an investor based in one country
acquires an asset in another country with the intention of managing it. Except arms and
ammunition, atomic energy, mineral oils, atomic energy minerals and railway transport,
FDIs are allowed to invest in most of the industries.
• The Foreign Investment Promotion Board (FIPB) has been set-up specially to: Promote FDI
investments in India, grant speedy clearance to new projects and promote transparency in
the rules and regulations for FDI deposits.
• The Non-Resident Indians (NRIs) are persons of Indian origin, even if born and brought up
abroad, with or without Indian passport, including HUFs, AOPs, partnership firms,
companies, societies, trusts and Overseas Corporate Bodies (OCBs) who maintain accounts
with authorized dealers.
• The NRIs can open savings accounts, current accounts and term deposit accounts (fixed
deposit, recurring deposit and reinvestment deposit).
• The NRIs can open NRO, NRNR, NRE, FCNR and NRSR accounts in India. These
accounts have various features like repatriation of interest, non-taxability of interest and
higher interest rates.
CREDIT RATING
• Ratings serve as a benchmark to the risk involved in a particular instrument of investors. A
good rating can help a company raise money at a relatively lower cost and from a larger
body of individuals, leading to a broader investor base.
• Till recently, ratings were mostly concentrated in the area of debentures, fixed deposits and
other short-term instruments. The changing economic environment has thrown open new
areas like equity rating, individual rating, mutual fund scheme rating, chit funds rating,
country risk rating and a plethora of other new areas.
• There are three factors to be considered while conducting a rating review: One, the
performance of the industry; Two, the performance of the company; Three, the
performance of the stock market of the country.
• While companies sign a mandatory letter from the rating agency wherein they undertake to
provide information regularly, not all do so. While the good ones are more than pleased to
approach their raters with the required information, the rating agencies have to run after the
bad ones to seek information.

13
• Another problem is of rating convenience. A company that is not satisfied with the rating
assigned to its instrument by a rating agency can approach another rating agency for a fresh
rating, and disclose only the second rating to the public, if it proves to be favorable. The
company is free not to disclose the first rating or the fact that it went for a second rating. Unless
a mechanism of transparency is thrown open, rating will lose its charm.
• Today, CRISIL, ICRA and CARE are the main raters in the Indian market, while
STANDARD AND POOR’S and MOODY’S are the main players in the international
markets.
• Rating has become innovative: ONICRA has even started rating individuals in India and
even the banks rate the individuals that come to them for loans. Banks and financial
institutions are also coming forward to being rated; equities are being graded and a bunch
of other players and instruments are being rated.
EVOLUTION OF FINANCIAL SERVICES
• The term Financial Services encompasses all those services that have money as the raw
material.
• Financial Services include:
– Leasing
– Hire Purchase
– Consumer Finance and Installment Credit
– Plastic Money Cards
– Insurance
– Housing Finance
– Venture Capital
– Mutual Funds
– Portfolio Management Schemes
– Credit Rating
– Capital Issue Management
– Factoring and Forfaiting
– Plantation Schemes.
• Leasing and Hire purchase have been the oldest kind of financial services both in India and
around the world. Some of the financial services in India such as venture capital and credit
rating are relatively of recent origin.
• Financial services has been mostly regulated by the Securities and Exchange Board of
India. Some of the services such as banking are regulated by the Reserve Bank of India.
• A few of the financial services such as Insurance, Housing Finance and Mutual Fund are
witnessing better times due to various factors:
• Insurance industry has been opened to private sector participation and the Insurance
Regulatory Authority has been given statutory powers.
• Housing Finance will see increased importance due to changes in the National
Housing Bank Act and changes in the tax treatment for housing loans.
• Mutual Funds industry has witnessed ups and downs. With the savings rate
going up and a capricious equity market, 1997-98 was the best year for mutual
funds.

14
AN INTRODUCTION TO EQUIPMENT LEASING
• While leasing has a history spanning over more than 5000 years, equipment leasing is of a
recent origin. It is said that the practice of equipment leasing began when the rail road
companies in the USA. and Europe resorted to leasing of rail cars and locomotives to
expand their operations. By the mid-sixties, equipment leasing came into popular use in the
developed countries. Today equipment leasing is confined not just to leasing of equipments,
but to large infrastructural facilities, power plants and other capital-intensive projects as
well.
• In concept, an equipment lease is a contractual arrangement under which the owner (lessor)
transfers the right to use the equipment to the user (lessee) for an agreed period of time in
return for rent. At the end of the lease period the asset reverts to the lessor. It is important to
note that in the Indian context a lease cannot be structured with a provision for transfer of
ownership or with a feature of purchase option. Introducing any one of these features can
result in the lease being classified as hire purchase transaction which has a different set of
accounting and tax implications.
• The features of an equipment lease transaction can vary along the following dimensions:
Extent to which risks and rewards of ownership are transferred, number of parties to
the transaction, domiciles of the equipment manufacturer, the lessor, and the lessee.
Based on these dimensions, the following classifications are possible:
– Finance Lease and Operating Lease
– Sale Lease and Operating Lease
– Single Investor Lease and Leveraged Lease
– Domestic Lease and International Lease.
• Of the aforesaid classifications, the classification in terms of finance lease and operating
lease is of fundamental importance to the financial analysis and accounting of leases. The
distinction is drawn on the basis of the risks and rewards of ownership transferred from the
lessor to the lessee. If a lease transfers a substantial part of the risks and rewards it is
classified as a finance lease; otherwise, it is called an operating lease. The Financial
Accounting Standards Board (FASB) of the USA was the first professional body to evolve
the criteria for this classification and these criteria with some minor modifications have
been adopted by the International Accounting Standards Committee (IASC).
• There are various factors which influence the decision to lease. The important ones are:
– Flexibility
– User-Orientation
– Tax Based Advantages
– Convenience
– Expeditious Disbursement of Funds
– Hundred Percent Financing
– Better Utilization of Own Funds.
• A lease is often marketed on the strength of a dubious advantage called the “Off-Balance
Sheet Financing” which purports that a liability off the balance sheet does not affect the
debt capacity of a firm. It must be noted that a finance lease whether on or off the balance
sheet affects the borrowing capacity and increases the financial risk.
• There are of course, deterrents to leasing. These deterrents include the restrictive convenants on
the usage of the asset, the non-cancelable feature of a finance lease which restricts the
flexibility to disinvest, threat to real borrowing capacity and the high cost of lease finance vis-
á-vis most forms of borrowing.

15
LEASING IN INDIAN CONTEXT
• The equipment leasing industry in India came into being in 1973 but did not come of age
until the early eighties.
• The leasing boom of the early eighties propelled a large number of private sector finance
companies, commercial banks and financial institutions into this industry. The Banking
Regulation Act, 1949 was amended in 1983 to permit commercial banks to undertake
equipment leasing operations through the subsidiary route. These subsidiaries have been
recently permitted to undertake hire purchase operations.
• The entry of financial institutions and subsidiaries of commercial banks made the lease rates
more competitive. The fall in the lease rates coupled with high cost of funding and imposition
of sales tax on lease rentals forced many private sector finance companies to close down or
resort to concentric and conglomerate diversification. Today the dominant players in the
industry are the subsidiaries of commercial banks like SBI Caps and Canfina; Financial
Institutions like ICICI and IFCI; and about twenty private sector finance companies like
First Leasing Company of India, Twentieth Century Finance Corporation and Sundaram
Finance. The commercial banks and State Financial Corporations have been recently
permitted to directly enter the business of leasing and hire purchase.
• The equipment leasing industry has grown almost at the rate of 50 percent per annum
during the eighties and is poised to achieve a comparable growth rate in the nineties. The
recent measures of liberalization must accelerate the process of capital formation in the
country, and leasing has a major role to play in the process.
• The business of equipment leasing is not subject to any dedicated legislation. By and large, the
obligations of the lessor and the lessee are governed by the provisions of bailment contained in
the Indian Contract Act, 1872. The Hire Purchase Act which was introduced in 1972 and later
amended in 1989 is yet to be made operational.
• Funding of finance companies is subject to the RBI (Non-Banking Financial Companies)
Directions, 1977. These directions have been considerably revised recently and financial
companies are not required to adhere to the capital adequacy norms similar to those
applicable to commercial banks.
• The conventional sources of funding a financial company include equity, debentures, term
loans, bank borrowings, public deposits, intercorporate deposits and commercial paper. Of
late these companies have been toying with the idea to securitize the lease and hire
purchase receivables.
LEGAL ASPECTS OF LEASING
• In the Indian context, there is no legislation that exclusively relates to equipment lease
transactions. Since the features of an equipment lease transaction closely resemble the
features of bailment, the provisions of the Indian Contract Act, 1872 which govern
contracts of bailment are applied to equipment lease transactions. This enactment defines
the implied obligations of the bailor and the bailee.
• Since the lessor plays the role of a financier in a typical equipment lease transaction, the
implied obligation of the bailor relating to the fitness of the bailed goods is expressly
negated by the lease agreement.
• The lease agreement provides the lessee with a number of obligations which do not form a
part of his implied obligations under the Indian Contract Act. Usually the lessor and the
lessee enter into a Master Lease Agreement which enables the lessee to add on leased
equipment up to a predetermined limit in terms of value. Registration of an equipment lease
agreement is optional under the Indian Registration Act, 1908.
• The lease documentation process is fairly simple. It starts with the submission of a proposal
by the lessee. On approval, the lessor issues a letter of offer detailing the terms and
conditions of the lease. The letter of offer is accepted by the lessee by passing a Board
resolution. This is followed by the lessor and lessee entering into a formal lease agreement.

16
• There are a number of legal issues to be considered before drafting the lease agreement.
Some of these issues are (a) legal relationship between the equipment supplier, the lessor
and the lessee, (b) insurance, (c) usage and maintenance, (d) sub-lease, (e) set-off
provisions and (f) defaults and remedies.
TAX ASPECTS OF LEASING
• The tax aspects of leasing can be divided into two parts – the income tax aspects and the
sales tax aspects.

• The income tax aspects of leasing are primarily concerned with (a) lessor’s claim for
depreciation tax shields on the leased assets; (b) lessee’s claim for lease rentals and to
treat the operating costs of the leased assets as tax-deductible expenses; and (c) tax liability
on rental income in the hands of the lessor.

• The Income Tax Act, 1961 does not explicitly provide for the lessor’s eligibility to claim
depreciation allowance on the leased assets. But this eligibility can be deduced from the
Tribunal and Court judgments on the subject.

• To date, no capital allowances (like investment allowance) have been directly linked to
investment in plant and machinery. Hence, the lessor does not derive any investment related
tax shield other than depreciation tax shields.

• The rental income derived by the lessor is included under the head ‘Profits and Gains of
Business or Profession’ for the purpose of assessing the income tax liability.

• From the lessee’s angle, the rental expense can be treated as a tax-deductible expense. The
costs incurred to insure and maintain the leased asset are also tax-deductible.

• By virtue of a circular issued by the Central Board of Direct Taxes (CBDT) in 1943, the
lease agreement must not provide for a transfer of ownership of the leased asset or a
bargain purchase option to the lessee. Inclusion of either of these provisions will result in
the lease transaction being treated as a hire purchase transaction. The tax implications of a
hire purchase transaction are not the same as those of a lease transaction.

• Leasing can be used as a tax planning device by (a) exploiting the flexibility in
structuring lease rentals; (b) transferring the investment related tax shields from a firm
which has a low appetite for such tax shields to a lessor who can absorb them. The firm
transferring the tax shields can benefit through a reduction in the lease rentals.

• Sales tax affects a lease transaction at the following stages: (a) when the asset is purchased
by the lessor for the purpose of leasing; and (b) when the right to use the asset is
transferred to the lessee for a valuable consideration; and (c) when the asset is sold by the lessor
at the end of the lease period.

• The lessor is at a disadvantage with regard to interstate purchase of equipment because the
concessional rate of Central Sales Tax which applies to such transactions (on fulfillment of
certain prescribed criteria) is not made available to an equipment supplier supplying
equipments to a lessor.

• The Constitution (Forty-Sixth Amendment) Act, 1981 provides for sales tax on the
“transfer of the right to use any goods for any purpose (whether or not for a specified
period) for cash, deferred payment or other valuable consideration”. After this enactment
several states amended their sales tax laws to provide for sales tax on lease rentals.

• The validity of the provision to levy sales tax on lease transactions and the other related
aspects have been challenged by the leasing companies and stay orders have been obtained
from different state High Courts. Consequently, the lessor’s liability to pay sales tax on
rental income remains a contingent liability.

17
LEASE EVALUATION: THE LESSEE’S ANGLE
• A finance lease can be evaluated either as an investment alternative or as a financing
alternative depending upon the a priori information available about the financial
desirability of a capital investment. In the absence of any a priori information about the
financial desirability, ‘Leasing’ and ‘Buying’ are evaluated as two mutually exclusive
investment alternatives. Given prior knowledge of the financial desirability or need for a
capital investment, ‘Leasing’ is evaluated as one of the financing alternatives.

• There are a number of financial models available to evaluate a ‘lease’ and there is no
consensus till date on the most appropriate model. The following four financial models
represent the spectrum of views on this issue reasonably well:

– Weingartner Model

– Equivalent Loan Model

– Bower-Herringer-Williamson Model

– Bower Model.

Barring the first model, the other three models evaluate leasing as a financing alternative.

• The application of the Weingartner Model to evaluate a ‘lease’ as an investment alternative

involves the following steps:

a. Compute the NPVs of the ‘lease’ and ‘buy’ alternatives.

b. Select the alternative with the higher positive NPV.

• The application of the Weingartner Model for evaluating a ‘lease’ as a “financing

alternative” involves the following steps:

a. Compute Net Advantage of Leasing (NAL) defined as:

Initial Investment – P.V. (Lease Rentals) – Management Fee + P.V. (Tax Shield on
Lease Rentals) + P.V. (Tax Shield on Management Fee) – P.V. (Tax Shield on
Depreciation) – P.V. (Net Salvage Value).

b. Lease the equipment if NAL is positive. Buy the equipment if NAL is negative.

The discount rate employed is the marginal cost of capital based on the mix of debt and
equity in the target capital structure. The model assumes that debt includes present and
future lease obligations as well.

• The Equivalent Loan Model, the BHW Model and the Bower Model view ‘Leasing’ as a
financing alternative and is based on the premise that every rupee of lease finance displaces
an equal amount of long-term debt. In other words, these models assume that the debt
component in the target capital structure does not include present and future lease
obligations. So, these models consider the interest tax shields on the displaced debt as an
explicit cash flow in the computation of NAL. The models, however, differ from one
another in terms of the discount rates applied to the components of NAL viz., lease

18
 payments, tax shields (shelters) and net salvage value. The following table provides the
different discount rates employed by these models.
Components of
Equivalent Loan Model BHW Model Bower Model
NAL
Lease Payments Pre-tax Cost of Debt Pre-tax Cost of Debt Pre-tax Cost of Debt
Marginal Cost of To be Specified by
Tax Shields* Post-tax Cost of Debt
Capital the Decision-Maker
Net Salvage Marginal Cost of
-do- -do-
Value Capital
* The tax shields include the tax shields on lease payments, management fees,
depreciation and interest on displaced debt.
• We believe the risks that characterize the lease payments on the one hand and the
realization of the tax shelters and net salvage value on the other, are different. Hence,
different discount rates have to be used to discount the two sets of cash flows. For reasons
stated in the current chapter we also believe that the debt-displacement effect of leasing
must be explicitly recognized, and we define NAL as follows:
NAL = Investment Cost – P.V. (Lease Payments discounted at Kd) + P.V. (Tax
Shields on Lease Payments discounted at K) – Management Fees + P.V. (Tax
Shield on Management Fees discounted at K) – P.V. (Depreciation Tax
Shields discounted at K) – P.V. (Interest Tax Shields discounted at K) – P.V.
(Residual Value discounted at K)
Where,
Kd = Pre-tax cost of debt
K = Marginal cost of capital.

Setting NAL to zero and solving the unknown rental value provides the break even rental
from the lessee’s point of view – The maximum lease rental acceptable to the lessee.

• In practice, the decision to lease is significantly influenced by several non-tax based factors
like
– Simple Documentation.
– Expeditious Sanction.
– Absence of Restrictive Financial Covenants in the Lease Agreement.
– No Requirement for Detailed Post-sanction Reporting.
– Flexibility in terms of Structuring Lease Rentals.
– Off-Balance Sheet feature of Finance Lease (which helps maintain the apparent
borrowing capacity of the firm).

• Given the long-term relationship envisaged by a finance lease, the unlimited innovative
ways to structure a lease and the legal and tax complexities that go with such structuring
and selecting the right type of lessor assume special significance. The following factors
must be taken into account while selecting the lessor:
– Role of the Lessor as a Financier
– Financial position of the Lessor
– Experience of the Lessor
– Product Range.

19
LEASE EVALUATION: THE LESSOR’S ANGLE
• The Net Advantage of Leasing (NAL) from the lessor’s point of view can be defined as
follows:
NAL = – Initial Investment + P.V (Lease Payments) – P.V. (Tax on Lease Payments) +
P.V. (Management Fee) – P.V. (Tax on Management Fee) + P.V. (Tax shields on
Depreciation) + P.V. (Net Salvage Value) – P.V. (Initial Direct Costs) + P.V. (Tax
Shield on Initial Direct Costs).
The discount rate to be used is the marginal cost of capital based on the debt/equity mix in
the target capital structure of the lessor. The lease rental for which the NAL is equal to zero
is defined as the break even rental of the lessor – the minimum lease rental the lessor will
charge.

• The bargaining area or the range within which the rentals can be negotiated between the
lessor and the lessee is determined by the break even rentals of the lessor and the lessee.
The upper limit is determined by the break even rental of the lessee and the lower limit is
set by the break even rental of the lessor. Clearly, no negotiable range will exist if the break
even rental of the lessor exceeds that of the lessee.

• Lessors who use the gross-yield approach to price the lease define the gross yield as that
rate of interest which equates the present value of the lease rentals plus the present value of
the residual value of the investment cost.

• The flat rate of interest applicable to a lease is called the add-on yield. The assumption
underlying the computation of “add-on yield” is that the investment in the lease remains
constant over the lease period, which is untrue. The add-on yield is always less than the
(effective) gross yield defined above.

• The Internal Rate Of Return (IRR) on a lease is that rate of interest for which the NAL is
equal to zero. The lease proposal is accepted if and only if IRR is greater than the marginal
cost of capital.

• The total risk of a lease portfolio can be divided into the following types of risk:
– Default Risk
– Residual Value Risk
– Interest Rate Risk
– Purchasing Power Risk
– Political Risk
– Currency and Cross-border Risk.

• The relevant and dominant risk characterizing a finance lease is the default risk. The default
risk is a function of the creditworthiness of the lessee which is influenced by the character
and capacity of the lessee and the collateral value of the asset.

• The overall credit rating of the lessee based on the relevant factors can be determined through
the Explicit Judgemental Approach and the Statistical Approach. These approaches primarily
help in discriminating between the good and the bad lessee accounts and also help in
developing a risk classification table.

• The credit risk can be managed by altering one or more of the lease structuring variables like
lease rentals, lease term or pattern of payment. The lessor can also seek protection against
credit risk by insisting on personal and bank guarantees.

• The relevant risk in the case of an operating lease is the product risk or the risk inherent in
realizing the expected salvage value. In countries like the USA and the UK, insurance
companies offer the residual value of the insurance policies to cover such risks.

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LEASE ACCOUNTING AND REPORTING
• The first accounting standard for lease accounting was issued by the Financial Accounting
Standards Board (FASB) of the US (FASB Statement 13: Accounting of Leases). Drawing
largely on this standard, the International Accounting Standards Committee (IASC) issued
the IAS:17 on Accounting for Leases. In 1988, the Institute of Chartered Accountants of
India (ICAI) issued a Guidance Note on this subject which favored the adoption of IAS:17
in the long run and recommended a set of accounting guidelines for the interim period
keeping in view the state of the leasing industry in India and the tax framework.

• The IAS:17 requires a finance lease to be reflected in the balance sheet of a lessee as an
asset and as a liability in order to properly account the economic resources and the level of
obligations of the lessee firm. The guidelines require (a) the asset and liability to be
recorded at the inception of the lease at an amount equal to the fair market value of the
asset or, if lower, at the present value of the minimum lease payments; (b) the rentals to be
apportioned into interest and capital contents using the effective rate of interest (actuarial)
method or any other acceptable approximation; (c) expense the interest (finance) charge
and (d) depreciate the asset in line with the depreciation policy pursued in respect of the
assets owned. The leased asset must be fully depreciated over the shorter of the lease term
or its useful life.

• The ICAI guidelines require the lessee to expense the lease rentals payable under the
finance lease on an accrual basis and disclose the details concerning the leased asset and the
unexpired commitments for lease payments, as on the balance sheet date, by way of a note
in the balance sheet.

• The IAS:17 requires a finance lease to be recorded as a receivable in the books of the lessor
at an amount equal to the net investment in lease i.e., gross investment in lease less
unearned finance income. This accounting standard recommends the use of the effective
rate of interest method to allocate the unexpired finance income to the relevant accounting
period.

• The ICAI guidelines for the interim period provide for the disclosure of leased assets in
the balance sheet of the lessor as “fixed assets”. These guidelines require the lessor to
(a) allocate the unearned finance income over the primary lease period on some systematic
basis; (b) depreciate the leased assets over its primary lease period; and (c) disclose the
policies pursued with regard to income recognition and depreciation.

• The accounting standards prescribed by IASC and ICAI are more or less similar to an
operating lease. The lessee is required to allocate the aggregate rental over the lease period
on the straight line basis or on any other systematic basis which is more representative of
the time pattern of the user’s benefit.

• Lease of land where the title is not transferred from the lessor to the lessee on expiry of the
lease term is accounted for as an operating issue. Likewise long-term lease of buildings
where there is a provision to revise rentals periodically must be accounted for as an
operating lease.

• An exploratory survey conducted to assess the reaction of the leasing industry to introduce
accounting standards has revealed that lessors are not opposed to the idea of disclosing the
lease commitments by way of notes in the balance sheet of the lessee. Infact, fifty percent
of the respondents have favored capitalization of lease in the books of the lessee provided
there is a tacit assurance from the income tax authorities that the tax treatment will not be
linked to the accounting treatment.

21
HIRE PURCHASE
• Hire purchase can be defined as a contractual arrangement under which the owner lets his
goods on hire to the hirer and offers an option to the hirer to purchase the goods in
accordance with the terms of the contract. The two distinct features of a hire purchase
transaction are: (i) the option provided to the hirer to purchase the goods at any time during
the term of the agreement; and (ii) the right available to the hirer to terminate the agreement
at any time before the payment of the last installment. Hire purchase plans can be of two
types: (i) Down Payment Plan and (ii) Deposit Linked Plan.
• The rate of interest quoted on a hire purchase transaction is always a flat rate. To convert
the flat rate (F) into the effective rate (i) under a Down Payment Plan we can use the
following approximation formula:
n
i= .2F where n denotes the number of repayments.
n +1
• If the installments are payable at the beginning of each period, the relationship between
i and F is given by the formula:
n
i= .2F
n −1

• In the case of a deposit-linked plan, the effective rate of interest is calculated as follows:
(a) The cash flows over the relevant periods are defined. (b) The rate of interest which
equates the P.V. of the cash inflows to the P.V. of cash outflows is calculated. This rate of
interest reflects the effective rate of interest implicit in the plan.
• If the hirer exercises the purchase option before the payment of the last installment, then the
amount to be paid by him will be equal to the aggregate amount of the outstanding hire
purchase installments less an interest rebate. The true interest rebate can be calculated using
the Effective Rate of Interest Method. Alternatively, it can be calculated as per the Rule of
78 given by the formula:
t(t + 1)
R = xD
n(n + 1)
Where,
R = interest rebate
t = number of installments outstanding
n = total number of installments and
D = total charge for credit.
• The interest rebate calculated under the Rule of 78 will be always less than the true interest
rebate.
• As far as the legal aspects are concerned, the Hire Purchase Act, 1972 provides a
comprehensive coverage. But since this Act has not been made operational, the legal
aspects of hire purchase transactions are governed by the provisions of the Indian Contract
Act, 1872, Sale of Goods Act, 30 and the judgments pronounced by the English and the
Indian Courts from time to time.
• The income tax aspects of hire purchase transactions are governed by the provisions of a
circular issued by the Central Board of Direct Taxes in 1943. According to this circular, the
hirer is entitled to the tax shields on (i) depreciation calculated with reference to the cash
purchase price of the asset; and (ii) the ‘consideration for hire’ or the finance charge
component of the hire purchase installments. The circular provides for an even allocation of
the total finance charge over the term of the hire purchase agreement.
• As per the 46th Amendment to the Constitution, the hire purchase transactions are eligible
to sales tax. However, there are court rulings which state that hire purchase transactions
structured by finance companies (not dealing in the class of goods let on hire) are in
essence financing transactions and therefore not liable to sales tax.

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• The Finance Act, 1991 reintroduced the Interest Tax Act, 1974 which provides for an
interest tax at 3 percent on the interest income implicit in hire purchase transactions.

• From the hirer’s standpoint the financial evaluation of a hire purchase vis-á-vis a lease is
done by comparing the costs of hire purchase and cost of the lease. The Costs Of Hire
Purchase (COHP) and Lease (COL) are defined as follows:

COHP = Down Payment + Documentation & Service Charges + P.V. (Hire purchase
installments discounted at Kd) – P.V. (Depreciation Tax Shields discounted at kc)
– P.V. (Net Salvage Value discounted at kc) – P.V. (Interest Tax Shields
discounted at kc) – P.V. (Tax Shield on documentation & Service charges
discounted at kc)

Where

kd = Pre-tax marginal cost of debt

kc = Post-tax marginal cost of capital.

COL = P.V. (Lease payments discounted at kd) – P.V. (Tax shields on lease payments
discounted at kc)

If COHP exceeds COL, the asset must be leased; otherwise it can be acquired under the hire
purchase plan.

• From the finance company’s point of view, the financial evaluation will involve comparing
the Net Present Values (NPV) of the two asset-based financing plans. These NPVs are
defined as follows:

NPV (Finance Lease) = – Initial Investment – Initial Direct Costs + Lease Management
Fee + P.V. (Lease Rentals) – P.V. (Tax on Rental Income) –
P.V. (Tax on Lease Management Fee) + P.V. (Tax Shield on
Direct Costs) + P.V. (Tax Shields on Depreciation) + P.V. (Net
Salvage Value)

NPV (Hire Purchase) = – Loan Amount – Initial Direct Costs + Documentation &
Service Fee + P.V. (Tax Shield on Direct Costs) – P.V. (Tax on
Documentation & Service Fee) + P.V. (Hire Purchase
Installments) – P.V. (Income Tax on Finance Income) – P.V.
(Interest Tax on Finance Income) + P.V. (Tax Shield on Interest Tax)
The discount rate used is the marginal cost of capital of the company. If NPV (Finance
Lease) exceeds NPV (Hire Purchase) the finance company must have a product mix
weighted in favor of leasing; otherwise the product mix must be slanted in favor of hire
purchase. In practice NPV (Hire Purchase) tends to exceed NPV (Lease).
• A hire purchase transaction is reflected in the books of accounts of the hirer as follows:
(a) The cash purchase price of the asset is capitalized and an amount equal to the cash
purchase price less downpayment is recorded as a liability. (b) Depreciation is charged on
the cash purchase price in line with the depreciation policy pursued by the hirer for similar
owned assets. (c) The total charge for credit is spread over the accounting periods
(constituting the hire term) based on one of the following methods: (1) Effective Rate of
Interest Method (2) Sum of the Years Digits Method or (3) Straight Line Method.
• In the books of the finance company, the hire purchase installments receivable is shown as
a current asset under the head ‘Stock on Hire’ and the (unearned) finance income
component of these installments is shown as a current liability under the head ‘Unmatured
Finance Charges’. The unearned finance income is spread over the accounting periods
using one of the methods listed above. The direct costs associated with the transaction is
either expensed immediately or suitably amortized over the relevant accounting periods.

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CONSUMER CREDIT
• The term consumer credit encompasses all types of asset based financing plans offered
primarily to acquire consumer durables. A typical credit transaction is one where the
customer pays a small fraction of the cash purchase price on delivery of the goods and
agrees to pay the balance with interest over a specified period of time.

• The consumer credit industry in India grew at a phenomenal rate in the late eighties, thanks
to the efforts of Citibank and other multinational banks in creating a widespread awareness
of the concept. Consumer credit is made available for cars, two-wheelers, personal
computers and high-value household gadgets like TVs, VCRs, washing machines,
refrigerators, food processors, etc.

• The financing institution screens individual credit applicants on the criteria of gross annual
income, take-home salary and tenure of employment with the present employer. In the case
of business organizations, it looks for a profitable track-record and a minimum level of
sales, net worth, and cash profit.

• The consumer loans usually carry a flat rate of interest that varies between 13%–15% and a
repayment period that varies between 12 and 60 months. The repayment is required to be
made by issuing post-dated cheques at the time of availing the loan. The loan is secured by
a first charge on the asset concerned and is also guaranteed by a guarantor.

• The consumer finance schemes can be of the down-payment type or of the deposit-linked
type. In the deposit-linked schemes, the term to maturity of the deposit is matched with the
credit period. The deposit earns a nominal rate of interest not exceeding 15 percent.

• Consumer credit is not regulated by separate legislation in India. But in most countries
where the practice is in popular use, it is subject to a detailed legislative framework which,
inter alia, seeks to (a) make the customer more aware of the true cost of credit implicit in a
lending scheme; and (b) protect the customer against the unscrupulous ones as soon as the
agreement is made. Examples of such legislations are the Consumer Credit Act, 1974 of the
UK and the Consumer Credit Protection Act, 1968 of the US.

• One of the important steps to manage a consumer credit portfolio is to streamline the
procedure evaluating credit applicants. To pre-screen the credit applicants, mechanical
credit-scoring system can be used. These systems can be developed using sophisticated
statistical techniques like the Multiple Discriminant Analysis (MDA).

• Managing a Consumer Credit Portfolio effectively calls for accounting records that are
accurate and consistent and persistent collective efforts.

FACTORING AND FORFAITING

• Factoring can be defined as the sale of book debts by a firm (client) to a financial
intermediary (factor) on the understanding that the factor will pay for the debts purchased
as and when they are collected or on the guaranteed payment date fixed in relation to the
maturity dates of the debts purchased. So, the factor basically manages the collection of
debts on behalf of the client and maintains the sales-ledger. To render these services, he
charges a commission which is expressed as a percentage of the value of debts purchased.

• The factor often provides a prepayment (advance payment) up to a specified percentage of

the debts purchased and charges interest on the prepayment for the period between the date
of prepayment to the date of collection or the guaranteed payment date. This arrangement is
referred to as the advance factoring arrangement. If the factor provides credit protection to
the client, the factor assumes the risk of bad debt loss – the arrangement is referred to as
Non-Recourse Factoring. A factoring arrangement which provides the services of
collection, sales-ledgering, finance and credit protection is referred to as Full factoring or Old
line factoring.

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• Factoring differs from bill discounting in the following respects: (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 factoring, no notice of assignment is provided to the customers
of the client under the bill discounting arrangement. (iii) The bill discounting arrangement
is with recourse to the client whereas a factoring arrangement can be without recourse.
• The legal relationship between the factor and the client is governed by the provisions of the
factoring agreement. Under this agreement, the client (i) warranties that the debts sold are
valid, enforceable, undisputed and recoverable; (ii) undertakes to settle problems of dispute,
damages and deductions in relation to the bills assigned to the factor; and (iii) provides
copies of all relevant credit sales invoices along with proof of dispatch to the factor. As
between the factor and the customer, the legal status of the factor is that of an assignee.
Once the notice of assignment is served to the customer, he is under a legal obligation to
pay the factor.
• From the client’s angle, factoring offers the following advantages: (i) Factoring reduces
the uncertainty associated with collections thereby reducing the cash float and
improving the velocity of current assets turnover ratio. (ii) Since the factor assumes the
responsibility to collect and credit administration, the firm can sharply focus on market
development. (iii) Unlike other forms of financing, advance factoring does not impair the
current ratio of the firm. In fact, through a judicious use of the funds made available by the
factor, the client can improve the current ratio. Although factoring offers a number of
advantages, a firm which has been managing its receivables must necessarily do a cost-
benefit analysis before resorting to factoring.
• In the Indian context, factoring is still in the pioneering state. Based on the
recommendations made by the High Powered Committee under the Chairmanship of Shri
C S Kalyanasundaram, the Reserve Bank of India has permitted commercial banks to
promote factoring subsidiaries. At the time of writing, the two factoring companies in
operation are the SBI Factors & Commercial Services Limited and the Canbank Factors
Limited. Both these companies offer recourse factoring facility with respect to inland
receivables with a provision for prepayment up to 80 percent of the value of the
receivables. The commission charged varies between 1-2 percent of the value of receivables
and the discount charge varies between 19-22 percent per annum.
• While factoring has a large market to cater, there are some operational problems to be
sorted out before factoring can graduate to the rapid growth stage. First there is a need for
credit information services that will provide reliable credit information for a large number
of business firms. Without this service, the factor will find it extremely difficult to evaluate
the credit quality of his client’s receivable portfolio.
• Second, the funding norms applicable to factoring companies must be clearly spelt out and
these companies must be placed on par with leasing and hire purchase companies in terms
of the eligibility to raise debt. Finally, factoring transactions must be exempted from the
levy of stamp duty (which is now applicable to assignment of any form of debt) so that the
transaction costs are reduced.
SECURITIZATION
• Securitization is the process of selling assets by the person holding them to an intermediary
who in turn will break such assets into marketable securities. Any resource that has a
predictable cash flow can be securitized. The person holding the assets is called the
originator and the entity specially created for the purpose of transfer of assets is called
Special Purpose Vehicle (SPV). The underlying assets should preferably be homogenous in
nature and of same quality, in terms of the risk associated with them or their maturity
periods. The marketable securities are called Pay or Pass through Certificates and the
investors may be banks, mutual funds, government, etc.
• If the process of securitization is backed by assets, it is called Asset-Backed Securitization
(ABS). If the deal is backed by mortgage it is called Mortgage-Backed Securitization
(MBS).

25
• All credit rating agencies rate securitization deals and consider only those assets that are to
be securitized in the balance sheet of the originator. Such ratings will have a ‘SO’ suffixed
to the deal to indicate the instrument is a ‘Structured Obligation’ and has met all the
parameters of credit rating.
• Longer maturity loans can be converted into short-term marketable securities in whole loan
securitization and the rights and responsibilities are transferred to the purchaser. In such a
case, the seller may retain the right to service the loans and also the right to initiate
foreclosure proceedings in case of default.
• Mortgage Participation Certificates are designed to reduce the amount of loan by loan
review that is needed to be performed by a purchaser of a pool of loans.
• Mortgage Pass-Through Certificates are created when mortgages are pooled together and
the undivided interest in the pool is sold. The originator of these certificates can either issue
a private pass-through security or a pass-through security backed by a guarantor.
• Mortgage-Backed Bond is a collateralized term-debt offering, secured by mortgages with a
market value that is far more than the principal amount of the bond. The mortgages are not
sold to the holder of the security, but are used as collaterals for the bonds which are used to
raise finance.
• Advantage of securitization: Securitization provides liquidity to the originators. Securitized
debt is cheaper and with this deal the originator can beat the rating given by the rating
agencies and diversify the credit risk. NBFCs can plan their capital adequacy requirements
by using securitization to reduce the risk weighted assets.
• The concept of securitization has not picked up in India yet due to the absence of an active
secondary market, heavy stamp duties, strict foreclosure norms and other legal and
regulatory aspects.

MORTGAGES AND MORTGAGE INSTRUMENTS

• Mortgage is the pledge of property to secure payment of a debt. If the mortgagor fails to
pay to the lender, then the lender can foreclose the loan, seize the property and sell in order
to realize his dues.
i. Mortgage verifies the amounts outstanding on any other loans taken by the borrower;
ii. The net worth and the monthly/annual income of the borrower from all sources.
• The two basic rules to assess the repaying capacity of the borrower are:
i. Total mortgage payment should not exceed 25% of the borrower’s total income less
any obligations.
ii. Total mortgage payments plus other housing expenses should not exceed 33% of
the borrowers total income less all payments due to other obligations.
• Originator (original lender) services the mortgage loan of the borrower.
• Originator continues to service the loan even if the mortgage loan is sold to some one.
• The Loan-To-Value (LTV) ratio indicates the percentage of down payment required by the
lenders from the borrower, it creates a margin of safety for the lender in case of any default
by the borrower or short fall in realization. A loan to value ratio of 80% means that the
down payment is 20%.
• Morgtages are classified into traditional and non-traditional mortgages.
• In the traditional mortgage the interest is charged on the loan for the entire term and the
loan is to be repaid in equated monthly installments which contain both principal and
interest components.

26
• The amount of principal outstanding at any time is called mortgage balance. The difference
between the current market value of the home and the mortgage balance is called
homeowner’s equity.
• The non-traditional mortgages are also called Alternative Mortgage Instruments (AMI).
They do not have monthly installments and the repayment structure is different.
• In Graduated-Payment Mortgages (GPM), the payments start at a low level, rise for a
specified number of years and then become equal after a specified number of years as per
the mortgage agreement.
• In Pledged-Account Mortgages (PAM) the borrower deposits the portion of the down
payment in a savings account. Hence, the repayment of installments will be structured such
that PAMs appear as GPMs from the borrower’s point of view and traditional mortgages
from the lender’s perspective.
• A Buy Down loan is arranged by the seller of the property. The seller places cash in a
separate account and indirectly fulfills the down payment requirement of the borrower. The
mortgage lender may not allow the inbuilt high cost of the property.
• Adjustable Rate Mortgage has complex features. They can have maturities as well as
interest rates. The mortgage interest rate is based on index rate. Periodic gap and lifetime
gap are two distinct common features of ARMs. The major disadvantage of ARMs is that
they cannot be sold in pooled or security form as there are no standard clauses in ARMs.
• In Share-Application Mortgages the borrower pays a very low interest on the funds but
shares a part of the increase in the property value with the lender when the property is sold
or the loan matures.
• Mortgage Pass-Through Certificates are created when mortgages are pooled together and
the undivided interest in the pool is sold. The originator of these certificates can either issue
a private pass-through security or a pass-through security backed by a guarantor.
• The Collateralized Mortgage Obligations (CMO) are the bonds or debt obligations issued
by mortgage originators by offering whole loan mortgages or mortgage pass-through
certificates as collateral. The cash flows generated by the assets in the collateral pool are
first used to pay interest and then the principal to the CMO bondholders.
REAL ESTATE FINANCING: RISK AND RETURN
• Real Estate Financing is predominant in the West which is done in the form of asset-based
financing.
• A real estate transaction is tripartite involving exchange of economic resources between a
seller, buyer and in most of the cases, a financial entity.
• Three types of properties exist for financing. They are: (a) Property occupied by the
purchaser (b) Property developed to provide for continuous income and (c) Property
developed for sale.
• Real estate differs from other assets in many ways.
• Some of the aspects of real estate are: (a) Durability (b) Require substantial outlay of
funds (c) Transaction cost tend to be higher (d) Takes a large physical space (e) Value of the
real estate depends on various parameters concerning local and regional economic
conditions (f) A good hedge against inflation and (g) Tax treatment is favorable for real
estate investments.
• Real Estate Financing may be done essentially in three broad segments: (a) Acquisition
development or improvement financing (b) Construction financing and (c) Permanent
financing.
• Prominent sources of real estate financing in US are: (a) Commercial Banks (b) Savings
and Loan Associations (c) Life Insurance Companies (d) Pension Funds (e) Real Estate
Investment Trusts (f) Foreign Investors (g) Mortgage Companies.

27
HOUSING FINANCE IN INDIA
• The Indian housing finance industry comprises Housing and Urban Development
Corporation (HUDCO), the National Housing Bank (NHB), co- operative housing finance
societies, insurance companies, commercial banks, co-operative banks and 26 companies
approved by the NHB, the apex financial institution in India for housing loans.
• NHB was formed as a subsidiary of the RBI when the National Housing Policy was
announced in 1988 to regulate housing finance industry in India. The NHB Act stipulates
various norms for other housing finance companies. The NHB provides refinance facilities to
Housing Finance Companies (HFC).
• The NHB prescribes regulatory guidelines for various HFCs relating to the capital
adequacy norms, income recognition norms, loans/lending norms, interest rate ceilings for
loans of various maturities and the procedures to conduct general business.
• HFCs insist on two guarantors as sureties for the proposed loan. HFCs should consider
lending to sound, healthy and viable proposals which satisfy all the eligibility criteria
prescribed by the NHB.
• The loan application will be appraised in three steps – Credit appraisal, Legal appraisal and
Technical appraisal.
• Objective of credit appraisal is to assess the applicant’s sustained repayment capacity over
the loan period.
• In legal appraisal the HFC will scrutinize the documents to confirm that the title to the
property is clean and the applicant can create a charge (mortgage) in favor of the HFC.
• In technical appraisal HFC will verify all the information, records, approvals, clearances,
certificates etc., submitted by the applicant.
• The NHB guidelines prescribe a maximum permissible loan of 70% of the cost proposed
including land cost. The difference between the property cost and the maximum loan
permissible is called the margin or own contribution and it is to be met by the applicant.
• The loan repayment shall be in Equated Monthly Installments (EMI), which cover both
principal and interest components.
• After the appraisals and fixation of loan amount, the HFC accords sanction of the loan.
• The NHB launched the Home Loan Account Scheme to individuals on 1 July, 1989 and the
same is being offered by 28 public sector banks, 24 private banks and select state co-
operative banks and urban co-operative banks.
• The HDFC is the leading HFC in India and offers various housing loans to individuals and
NRIs. HDFC also offers Line of Credit (LOC) to the corporate employees for their homes
in two methods. In LOC ‘Thru’ the employees nominated by the company are the
borrowers. In LOC ‘TO’ the company itself takes the loan and later disburses it among its
employees.
• The LIC Housing Finance is another premier housing finance company in India offering
various housing loan schemes.
• The government is taking various steps to facilitate the growth of housing sector in India.
The housing sector has been accorded the infrastructure status and many concessions exist
in the Income Tax and Wealth Tax Acts for individuals and companies engaged in this
business. The Income Tax Act allows deduction of interest on the borrowed capital meant
for housing purposes of individuals.
• HDFC has securitized housing loans worth Rs.50 crore through IL & FS but securitization
of housing loans has certain constraints such as stamp duty.
• NHB has come out with Pass Through Certificate mechanism for securitization.
• The RBI has relaxed certain conditions in sanctions of housing loans by banks.

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PLASTIC MONEY
• A credit card (or plastic money) is a payment mechanism which allows the cardholders to
purchase goods/services without paying money immediately. The payment could be made
up-front or over several installments after a specified period of time by availing credit from
the issuer of the card.

• There are four parties to a credit card transaction (i) card issuer, (ii) customer, (iii) member
establishment and (iv) franchiser of the credit card.

• The principal issuers of credit cards are the banks; the customers can be the salaried
individuals, business people and companies. The Member Establishment (ME) is any firm
or outlet that is enlisted by the credit card issuer to accept credit card for the goods
purchased or the services rendered. The franchisers are those that permit the use of their
brand name and act as clearing agencies. Master Card and Visa Card are the major
franchisers in the world.

• Sometimes there would be Member Affiliates (MA) who enter into a tie-up with the issuer
so that they can issue their own cards which are similar to those of the issuer except that the
MA’s name and logo will also appear on the card apart from the issuer’s.

• The principal source of income to a credit card issuer is the percentage commission
collected from the MEs on the goods/services sold through credit cards. The issuer charges
interest on the balance unpaid by the customer for the period beyond the expiry of the credit
period.

• The debit card is a ‘Pay Now’ mechanism whereby the account of the customer will be
debited immediately to the extent of the transaction value.

• Issuers will issue credit cards to the customers after due evaluation of his/her
creditworthiness.

• The credit limit and the payment terms will be determined by the issuer. While issuing the
card, entrance fee and annual service charge are collected. The card becomes operational as
soon as it is issued. When a customer presents it to a ME, the retailer checks the
authenticity of the card by tallying the signature of the customer with the one on the card.
The ME approaches the issuer bank periodically with the sales vouchers and the purchase
statement. The bank pays the amount after deducting a fixed commission on the amount.

• The credit card industry in India is growing fast. To cope with the increasing competition in
the credit card industry, banks in India are offering additional facilities to their cardholders
such as free personal accident insurance, cash withdrawal facility, temporary increase in
credit lines, add-on facility to dependents who are majors, leveraged investment facility, etc.

SOURCES OF FINANCE AND REGULATORY ENVIRONMENT OF

FINANCIAL SERVICES
• NBFCs are companies involved in providing financial services in India. They perform
various activities like leasing, hire purchase, bill discounting, etc.
• The RBI has set-up certain rules for acceptance of deposits by NBFCs, including a
minimum credit rating, limit for public deposits and the procedure for acceptance of public
deposits.
• There are regulations for premature withdrawal of deposits, brokerage payment, etc.
• The income of an NBFC should be recognized as: Term loans beyond one year, lease
rentals/hire purchase installments, bills purchased/discounted and other credit facilities.

29
• Similarly, assets of an NBFC are classified as: Standard assets, sub-standard assets,
doubtful assets and loss assets.

• The capital adequacy norms for NBFCs depend on risk weighted capital ratio, preference
shares, revaluation reserves, general provisions and loss reserves, hybrid capital
instruments, subordinated debt, minimum capital funds requirement and risk weighted
assets and off-balance sheet items.

• The capital of the NBFC is divided into Tier I and Tier II capital.

30
 Part I: Questions On Basic Concepts
INVESTMENT BANKING, FINANCIAL SYSTEMS AND FINANCIAL
MARKETS
1. Which of the following is/are not the function(s) of the financial system?
a. Mobilize savings to provide a potentially profitable and low risk outlet.
b. Ensure smooth flow of funds from savings into investments.
c. Ensure that savings will transform into the necessary credit for investment and
spending purposes.
d. Both (b) and (c) above.
e. None of the above.
2. Who among the following are the player(s) in the money market?
a. Banks.
b. The Government.
c. Individuals.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
3. Which of the following is/are example(s) of open market?
a. A bought out deal.
b. A car loan.
c. Public issue of securities.
d. Housing finance.
e. Both (a) and (c) above.
4. Financial Markets are said to be perfect when
a. All the information relating to the security is available to all the players in the
market
b. The market price of the security reflects all the available information
c. The participants in the markets have homogenous expectations
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.
5. Who among the following is/are the intermediary(ies) in the Capital Market?
a. Underwriters.
b. Primary Dealers.
c. Investment Bankers.
d. Registrars.
e. All of (a), (c) and (d) above.
6. Which of the following is/are consequence(s) of the presence of intermediaries in the
financial markets?
a. Intermediaries ease the funds flow process taking place in the financial markets.
b. The cost of lending and borrowing may rise due to the presence of intermediaries.
c. The presence of intermediaries in a market that is not well regulated increases the
risks to the investors.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
 Investment Banking and Financial Services

7. Which of the following is not an important consideration of the issuer while designing an
instrument?
a. Minimizing the cost of funds.
b. Minimizing tax liability.
c. The repayment schedule of the instrument.
d. Market conditions.
e. None of the above.
8. Which of the following is/are characteristic(s) of the money market?
a. It is a wholesale debt market.
b. Only highly liquid and short-term instruments are dealt in the money market.
c. The instruments dealt in the money market constitute high risk.
d. Both (a) and (b) above.
e. Both (a) and (c) above.
9. Which of the following is/are true of the primary market?
a. It is a place for issue of fresh (new) securities.
b. The primary market provides liquidity to the investors.
c. The transactions taking place in the primary market outnumber the transactions
taking place in the secondary market.
d. The securities issued in the primary market will necessarily have to be listed on the
stock exchanges to enable trading activity.
e. Both (a) and (d) above.
CREDIT MARKET
10. The Indian credit market is dominated by which of the following players?
a. Corporates.
b. Mutual Funds.
c. Banks.
d. Individuals.
e. Government.
11. The credit market
a. Operates in a disintermediation stage
b. Allows funds to flow to an intermediary which invests in the securities issued by the
corporates
c. Operates in an intermediate stage due to lack of infrastructural support for direct
flow of funds to take place
d. Both (b) and (c) above
e. None of the above.
12. Which of the following statements is/are true?
a. The overdraft facility is provided to corporates to finance their long-term requirements.
b. In the overdraft facility, the bank will allow the firm to overdraw from its current
account to a predetermined level of credit.
c. Under the overdraft facility, the credit limit is sanctioned against the security of
commodity stocks.
d. Both (a) and (b) above.
e. Both (b) and (c) above.

32
 Part I

13. In India, priority sector lending constitutes about ____ percentage of the total funds
provided as loans by banks in that particular year.
a. 10
b. 20
c. 30
d. 40
e. 50.
14. Which of the following statements is/are true?
a. Consortium lending helps banks to minimize their risk by diversifying their term
loan portfolio.
b. When consortium lending is resorted to, banks have joint appraisal and subsequent
follow-up of projects for which loans are given.
c. In consortium lending, one bank meets the short-term requirements of the corporate
while another bank meets the long-term requirements.
d. Both (a) and (b) above.
e. Both (b) and (c) above.
15. Which of the following statements is/are false regarding cash credit facility?
a. It is provided by banks for financing working capital needs of corporates.
b. It is an unsecured advance.
c. It is repayable on demand.
d. Interest on this facility is charged on the credit limit sanctioned.
e. Both (b) and (d) above.
16. Intermediaries base their lending rate decisions on which of the following criteria?
a. Cost of funds.
b. Transaction costs.
c. Required spreads.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.
17. Indus Financial Institution has received a loan proposal from a client. Given the following
information what should be its lending rate?
Transaction costs – 1.5 percent
Bank rate – 10 percent
a. 10 percent.
b. 14.5 percent.
c. Bank rate plus required spread.
d. Bank rate plus transaction costs.
e. Minimum of (a) and (b) above.

MONEY MARKET
Introduction to Money Market
18. For its proposed project of constructing a national highway, which of the following
instruments can be used by the Government to raise funds from the money market?
a. 91-day treasury bill.
b. 182-day treasury bill.
c. 364-day treasury bill.
d. Government dated securities.
e. Both (c) and (d) above.

33
 Investment Banking and Financial Services

19. Which of the following instruments is/are considered to be risk-free instrument(s)?

a. Treasury bills.
b. Government dated securities.
c. Commercial paper.
d. Certificate of deposits.
e. Both (a) and (b) above.
20. Which of the following features is/are characteristic(s) of money market mutual funds?
a. Low liquidity.
b. Low risk.
c. High returns.
d. Both (a) and (c) above.
e. Both (b) and (c) above.
21. Which of the following statements is/are true?
a. The interest rate risk/market risk is minimum in the money market.
b. In a declining interest rate scenario, investors of money market instruments are
exposed to reinvestment risk.
c. Government securities are considered as risk-free securities due to the absence of
default risk.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
22. Monetary contraction can be made possible by
a. Decreasing the CRR
b. Increasing the SLR
c. Resorting to open market purchases
d. Both (b) and (c) above
e. All of (a), (b) and (c) above.
23. Primary dealers are required to have net owned funds of a minimum of Rs. _____.
a. 30 crore
b. 40 crore
c. 50 crore
d. 60 crore
e. 70 crore.
24. Which of the following instruments has the highest risk levels?
a. Treasury Bills.
b. Certificate of Deposits.
c. Commercial Paper.
d. Promissory Note.
e. Both (c) and (d) above.
25. The required amount of successful bids by a primary dealer who participated in the bidding
for government securities is Rs.540 crore. The commitment to aggregate bidding would
have been
a. Rs.1,350 crore
b. Rs.1,620 crore
c. Rs.2,000 crore
d. Rs.2,050 crore
e. Rs.2,200 crore.

34
 Part I

26. Which of the following best describes the objective of the Statutory Liquidity Ratio?
a. It restricts the expansion of bank credit.
b. It augments the investment of the banks in government securities.
c. It ensures solvency of the banks.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
27. Which of the following statements relating to short-term fund management is/are true?
a. A financial institution need not be concerned about short-term fund management
since it deals only in large amounts.
b. Banks can manage their short-term deficits by diverting their long-term funds.
c. Government actively participates in lending short-term funds.
d. Short-term fund management of the households affects the liquidity in the system.
e. All the above.
28. For a forthcoming project on public transportation, the government is planning to raise
funds. Which of the following instruments can be used to raise the funds in the money
market?
a. 364/91-day T-Bills.
b. 182-day T-Bills.
c. Dated securities.
d. Both (a) or (c) above.
e. None of the above.
29. Royal Steels Ltd., a highly rated company, requires on an average Rs.5 cr for the next
15 days after which it expects sufficient cash inflows. To meet this short-term deficit, it
plans to issue CPs. The treasurer is against the issue of CPs. Which of the following
statements best argues his case?
a. The maturity period of CPs will reduce the cost of funds for the company.
b. It can raise cheaper funds for 15 days by way of ICDs.
c. It can borrow from the call market on each day as per the requirement as it will
reduce its costs and risks.
d. It can raise a term loan from bank.
e. None of the above.
30. The yields of the money market instruments are closely linked to each other. If CD rates are
ranging between 11-13% and if the bank PLRs are ranging between 14-16%, which of the
following range of rates will hold good for CPs?
a. CP rates will range between 11-16%.
b. CP rates will range between 13-16%.
c. CP rates will range between 11-14%.
d. The floor for the CP rates will generally be set by the PLRs.
e. The ceiling for the CP rates will generally be set by the CDs.
31. Swift Gilts Ltd., a primary dealer in the Indian money market, participated in the T-Bills
auction during the year. If the successful bids to be maintained by Swift Gilts Ltd. is given
as Rs.420 cr., then its commitment to aggregate bidding would have been
a. Rs.1,260 cr.
b. Rs.1,050 cr.
c. Rs.168 cr.
d. Rs.140 cr.
e. None of the above.

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 Investment Banking and Financial Services

32. Swift Gilts Ltd. had tendered bids of Rs.500 cr. in the auction T-bills which were accepted.
Using the information given in question (31) above, state which of the following statements
is/are true?
a. Swift Gilts Ltd. has adhered to its commitments and successful bids.
b. Swift Gilts Ltd. has adhered to its commitments only.
c. Swift Gilts Ltd. has adhered to its successful bids only.
d. Swift Gilts Ltd. has neither adhered to its commitments nor the successful bids.
e. Insufficient data.
33. Which of the following can be expected in a rising interest rate scenario?
a. Monetary restrictions can be imposed in order to contain the interest rate rise.
b. The RBI may enter into reverse repo transactions.
c. The RBI can conduct open market purchases of G-Secs to lower the interest rates.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
34. Which of the following statements can be true for a system having excess liquidity?
a. There may be a rise in the call rates.
b. Banks would prefer to enter into repo transactions to ease the situation.
c. There may be a rise in the statutory reserve requirements.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
35. Which of the following statements will be true, if there is a cut in the bank rate?
a. There may be a fall in the interest rates on CP.
b. There may be a fall in the Prime Lending Rates (PLR).
c. There may be a fall in the interest rates on IBPs.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
36. Market risk in money market investments arises in which of the following cases?
a. If the interest rates are declining at the time of redemption of the money market
investments.
b. If the change in the average prices results in decreasing the purchasing power of the
investor.
c. If there are fluctuations in the rates of instruments in the money market.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.

Call Money
37. Who among the following can act only as a lender in the call market?
a. Banking Companies.
b. Financial Institutions.
c. DFHI.
d. STCI.
e. Both (c) and (d) above.

36
 Part I

38. Which of the following is/are true?

a. Call money is lent mainly to even out the short-term mismatches of assets and
liabilities.
b. Call money is used to meet CRR requirements of banks.
c. Money is borrowed in the call market for short periods for discounting commercial
bills.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
39. Which of the following is/are the characteristics of the Indian call money market?
a. Call loans have a maturity of more than a fortnight in India.
b. Call loans are unsecured in India.
c. Transactions in the Indian call money market are characterized by seasonal
variations.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
40. ‘Term Money’ is the money that is
a. Lent for one day
b. Lent for a period varying from 1 to 14 days
c. Lent for a period varying from 2 to 15 days
d. Lent for more than 14 days
e. None of the above.
41. Notice money refers to the money
a. Lent in the call market for less than 14 days
b. Lent in the call market, and a notice is served for making the payment before the
due date
c. Lent in the call market for more than 14 days
d. Both (a) and (b) above
e. All of the above.
42. Intermediaries like DFHI and STCI in call money market can
a. Only lend in the call market
b. Only borrow in the call market
c. Lend and borrow in the call market
d. Can borrow in specific instances
e. Can lend if they find an arbitrage opportunity.
43. Money is lent/borrowed in call money market
a. For evening out the short-term mismatches of assets and liabilities of banks
b. For earning interest on short-term funds that are available to the banks as surplus
c. For discounting the commercial bills in the market
d. For meeting statutory requirements of the bank
e. All of the above.
44. Call loans in US are
a. Extended by banks to security brokers for buying common stock
b. Extended by banks to dealers in government securities
c. Borrowed to meet the reserve requirements of banks
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.

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 Investment Banking and Financial Services

Treasury Bills
45. Which among the following is/are the characteristic(s) of a treasury bill?
a. Eligibility for inclusion in SLR.
b. Assured yield.
c. Low liquidity.
d. Negligible capital depreciation.
e. All of (a), (b) and (d) above.
46. Treasury bills are issued for a minimum of ____ days and a maximum of ____ days.
a. 14 and 28
b. 14 and 91
c. 14 and 182
d. 14 and 364
e. 14 and 365.
47. The face value of a 364-day T-bill is Rs.100. If the purchase price is Rs.86, then the yield
on such a bill is
a. 12.45%
b. 13.36%
c. 16.32%
d. 16.56%
e. 17.13%.
48. Which of the following is a characteristic feature of ad hoc treasury bills?
a. They are issued and made available to the public.
b. These bills serve the purpose of replenishing cash balances of the Central
Government.
c. These bills have maturity period of 364 days.
d. They carry a discount of 6.4 percent.
e. They can be extinguished only on maturity.
49. The 182-day treasury bills cannot be purchased by
a. State Governments
b. Provident Funds
c. Individuals Resident in India
d. Both (a) and (b) above
e. Both (b) and (c) above.
50. Which of the following statements is/are true?
a. Treasury bills carry a coupon rate.
b. Treasury bills are issued at a discount.
c. The yields on treasury bills is higher when compared to other money market
instruments.
d. The yields on T-bills are considered as a representative of interest rates in the
economy in general.
e. Both (b) and (d) above.

38
 Part I

51. Which of the following statements is/are false?

a. Treasury bills are issued by both the Central and State Governments.
b. Though the tender for treasury bills is invited for competitive bids, bids will be
allotted to both competitive and non-competitive bids.
c. The purchases and sales of treasury bills is effected through the Subsidiary General
Ledger (SGL) account maintained by the RBI for the investors.
d. Both (a) and (b) above.
e. Both (b) and (c) above.
52. In the US markets, non-competitive bids are submitted by
a. Large investors
b. Banks
c. Securities dealers
d. Small investors
e. Both (a) and (b) above.
53. Treasury bills are raised by the
a. Banks to meet their short-term liabilities
b. Corporates to meet their short-term liabilities
c. The RBI to meet short-term liabilities
d. The RBI to meet government requirements
e. Both (c) and (d) above.
54. Which of the following instruments has highest liquidity?
a. Certificate of Deposit.
b. Dated Securities.
c. Treasury Bills.
d. Commercial Paper.
e. Commercial Bills.
55. Distinctive features of treasury bills are
a. Zero default risk
b. High liquidity
c. High coupon rates
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.
56. T-bills are in the form of
a. Promissory notes
b. Finance bills
c. Discounted bills
d. Credit to SGL accounts
e. All of (a), (b) and (d) above.
57. Which of the following statement/s is/are true in case of non-competitive bidders?
a. They submit the tenders giving price and amount.
b. State Governments, PFs, FIs, Insurance Companies, Nepal Rastra Bank come under
the category of non-competitive bidders.
c. They can submit multiple bids.
d. Their bids are accepted at the weighted average price of successful competitive
bidders.
e. All of the above.

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 Investment Banking and Financial Services

58. Which of the following statements is/are true in case of 364-day T-bill?
a. They are auctioned on a monthly basis.
b. The RBI does not notify the amount in advance i.e. during notification.
c. The RBI does not interfere in the auction of these bills.
d. They are not rediscounted by the RBI.
e. Both (b) and (c) above.
59. Ad hoc T-bills are issued to
a. The RBI
b. FIs and Banks
c. Non-competitive bidders
d. General public
e. Both (a) and (c) above.
60. The treasury bills that are available for investment now are
a. Ad hoc T-bills
b. On tap T-bills
c. Auction T-bills
d. Both (b) and (c) above
e. All of the above.
61. Which of the following statements is false?
a. Treasury bills are issued by the RBI to facilitate government borrowing.
b. Treasury bills help in OMO of the RBI.
c. Treasury bills serve as a medium for short-term investments.
d. Yields on T-bills are considered as a benchmark for other short-term investments.
e. None of the above.
62. In the US, the strip bills form a part of
a. Irregular series bills
b. Regular series bills
c. Cash management bills
d. Both (a) and (c) above
e. None of the above.
Commercial Paper (CP)
63. Which of the following statements is true regarding commercial paper?
a. Companies raising funds through commercial paper have to satisfy the eligibility
criteria prescribed by SEBI.
b. A commercial paper is a long-term, secured promissory note issued by companies
for raising funds.
c. NRIs can invest in commercial paper only on a non-repatriable and non-transferable
basis.
d. Commercial paper has a maximum maturity of 180 days.
e. The minimum size of each commercial paper issue is Rs.20 lakh.
64. Commercial paper
a. Originates from a specific trade transaction
b. Does not originate from a specific self-liquidating transaction
c. Issued to the investors through intermediaries is called dealer paper
d. Both (a) and (c) above
e. Both (b) and (c) above.

40
 Part I

65. Commercial paper

a. Constitutes a cheap source of funds to corporates when compared to bank finance
b. Provides returns to investors that are lower when compared to the banking system
c. Is highly liquid as it is a negotiable/ transferable instrument
d. Is not backed by any assets and hence it is unsecured
e. All of (a), (c) and (d) above.
66. The brokerage charged on commercial paper having a maturity period of 6 months is _____
of the issue amount.
a. 0.025%
b. 0.050%
c. 0.100%
d. 0.125%
e. 0.250%.
67. A company planning to raise money through issue of commercial paper should
a. Have a tangible net worth of not less than Rs.10 crore as per the latest audited
statement
b. Company has been sanctioned working capital limit by banks or All India Financial
Institutions
c. Have a minimum current ratio of 1.33:1 as per the latest audited balance sheet
d. Both (b) and (c) above
e. All of (a), (b) and (c) above.
68. Identify the reasons that can be attributed to the underdevelopment of the CP market.
a. Restricted entry of corporates
b. High effective cost of issuing commercial paper
c. Absence of tax benefits
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.
69. X purchased a commercial paper of Sterling Inc., issued for 90 days in the market for
9,84,840 dollars. The company issued the commercial paper with a face value of 10,00,000
dollars. The rate of return which X earns is
a. 6%
b. 6.15%
c. 6.24%
d. 6.56%
e. 7.05%.
70. The credit rating obtained by companies tapping the commercial paper market
a. Should not be more than one month old
b. Should not be more than two months old
c. Should not be more than three months old
d. Should not be more than four months old
e. Should not be more than five months old.

41
 Investment Banking and Financial Services

71. Which of the following statements is/are true?

a. Only listed companies are eligible to issue commercial paper.
b. The aggregate amount that can be raised by issuing commercial paper can be
more than the fund based working capital limit sanctioned by banks to the issuer
company.
c. A company issuing commercial paper should acquire a minimum credit rating of P2
from CRISIL.
d. A single investor willing to enter the CP market needs to invest Rs.50 lakh as
minimum investment.
e. All of (a), (b), (c) and (d) above.
72. Which of the following statements is/are false?
a. CP is issued in the form of unsecured usance promissory note.
b. CP arises out of self-liquidating transactions like commercial bills.
c. CPs are generally backed by fixed assets.
d. CPs provide a cheaper source of finance to companies.
e. Both (b) and (c) above.
73. The maturity period of CP ranges from
a. Three months to six months
b. Fifteen days to one year
c. One month to one year
d. Thirty days to one year
e. Thirty days to ninety days.
74. Corporates prefer CPs due to
a. Less paperwork and other formalities
b. High liquidity
c. Lower interest rates
d. Free transferability
e. Both (a) and (c) above.
75. The minimum investment required for a single investor in CP market is:
a. 50 lakh
b. 25 lakh
c. 5 lakh
d. 1 lakh
e. No stipulated amount.
76. Which of the following is not a condition for issuing CP?
a. The company should be listed on one of the SEs.
b. The fund based working capital limit of company should not be less than Rs.4 crore.
c. The tangible net worth of the company should not be less than Rs.4 crore.
d. The company should reduce the working capital limits by the amount of CP issue.
e. The company needs to obtain specified rating.

42
 Part I

Certificate of Deposits (CDs)

77. Which of the following is/are false regarding Certificate of Deposits (CDs)?
a. They are issued by corporates in the form of usance promissory notes.
b. They are available for subscription by non-resident Indians on a repatriable basis.
c. They are negotiable as they are payable either to the bearer or to the order of the
depositor.
d. They are also known as negotiable certificates of deposits because of their
negotiable nature.
e. Both (c) and (d) above.
78. Issuers of CDs are benefited as
a. All investors will be paid the same rate of interest
b. Availability of funds is assured for a specific period
c. Interest will be determined on a case to case basis
d. Both (a) and (b) above
e. Both (b) and (c) above.
79. CDs issued by a financial institution will have a minimum maturity period of
a. 3 months
b. 6 months
c. 12 months
d. 24 months
e. 36 months.
80. Identify the statements which is/are true?
a. Banks are not permitted to buy-back their CDs prematurely.
b. Banks are allowed to grant loans against CDs.
c. CDs are freely transferable by endorsement and delivery after a lock-in period of
15 days and can be traded in the secondary market from the date of issue.
d. Both (a) and (c) above.
e. None of the above.
81. DFHI which was set-up to activate the secondary market for money market instruments has
not been successful. In the case of CDs the reasons (for this) are:
a. Investors tend to hold CDs till maturity because of the high yield
b. Lack of information among investors regarding facilities available with DFHI
c. Reluctance of banks to issue CDs when they have high liquid funds at their disposal
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.
82. Jumbo CDs
a. Are issued by foreign banks in the US
b. Are issued by savings and loan associations in large volumes such as 1,00,000
dollars and above
c. Are CDs whose returns are linked to stock market performance
d. Are sold through brokers or dealers in denominations of 1,00,000 dollars to qualify
for federal deposit insurance
e. Offer a return linked to fluctuations in foreign currency values and economic
developments abroad.

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 Investment Banking and Financial Services

83. Certificate of Deposits are issued in the form of

a. Bill of Exchange
b. Demand Promissory Notes
c. Usance Promissory Notes
d. Usance Bill of Exchange
e. Term deposits.
84. Which of the following statements is false?
a. Certificate of Deposits are maturity dated obligations.
b. CDs attract stamp duty.
c. CDs are issued at a discount to face value.
d. CDs form a part of time liabilities.
e. None of the above.
85. Banks prefer to issue CDs as
a. Funds would be available to them for specific period
b. They have control over cost of funds
c. CDs are not subjected to reserve requirements
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.
86. The minimum maturity period of CD is
a. One year to three years
b. Thirty days to one year
c. Three months to three years
d. 15 days
e. Thirty days to three years.
87. Which of the following is not considered while determining the issue price for a CD?
a. The amount of funds available.
b. Maturity of the CD.
c. Relationship with the customer.
d. Prevailing call money rates.
e. None of the above.
88. Which of the following statements is/are false?
a. Banks are permitted to buy-back CDs prematurely.
b. Banks are allowed to grant loan against CDs.
c. Banks can avail grace period while making payments.
d. Banks may or may not issue CDs at a discount to face value.
e. All of the above.
89. CDs are similar to conventional term deposits. Except that which of the following is a
unique feature?
a. CDs are traded in secondary market, after a lock-in-period.
b. CDs are available on tap.
c. CDs (only) have a specified time period.
d. CDs form a part of NDT liabilities.
e. All of the above.

44
 Part I

90. Which of the following statements is true?

a. There is no ceiling on the amount that can be raised by means of CDs by banks.
b. CDs are not subjected to stamp duty.
c. CDs can be transferred immediately after issue.
d. CDs are issued in multiples of 25 lakh.
e. CDs are not subjected to usual reserve requirements.

Bill Financing
91. A demand bill
a. Is a bill in which no time for payment is specified
b. Is payable immediately ‘at sight’ or ‘on presentment’ to the drawee
c. Is a bill that is payable at a specified later date
d. Both (a) and (b) above
e. None of the above.
92. An inland bill
a. Is a bill drawn or made in India, and payable in India
b. Is drawn on any person resident in India
c. May be endorsed in a foreign country and remain in circulation there
d. Is a bill drawn in India and made payable outside India
e. Both (a) and (b) above.
93. Which of the following is/are true with regard to a negotiable instrument?
a. A negotiable instrument need not be in writing.
b. A negotiable instrument must contain an order to pay and not a request.
c. In some cases, the drawer and the payee of a negotiable instrument may be the same
person.
d. Both (a) and (c) above.
e. Both (b) and (c) above.
94. Under the Bill market scheme introduced in 1952
a. Advances were granted to scheduled banks by way of demand loans on the security
of eligible usance bills
b. The lodgement of bills with the RBI was for the purpose of rediscounting
c. Export bills were not eligible for credit facilities
d. Both (b) and (c) above
e. None of the above.
95. Which of the following is a feature of the Bill Rediscounting Scheme, 1970?
a. Under this scheme only genuine bills were eligible for rediscounting with the
RBI.
b. The aim of the scheme was to provide bill finance in such a way that it does not
undermine the selective control policy of the RBI.
c. To provide bill finance throughout the year and not just to meet seasonal
stringency.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.

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 Investment Banking and Financial Services

96. The measure(s) introduced by the RBI based on the Vaghul Committee Recommendations
in order to promote and develop bill culture in India are:
a. Approaching the Central Government for remission of stamp duty on bills of
exchanges
b. Permitting a larger number of financial institutions to rediscount bills
c. Setting up the DFHI for the development of money market including the market for
commercial bills
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.
97. Which of the following is/are the factor(s) responsible for underdevelopment of the bill
market in India?
a. Other cheaper sources of finance.
b. Domination of the bill market by indigenous bankers.
c. Decrease in the quantum of supply bills.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
98. Which of the following is/are characteristic(s) of a well developed bill market?
a. The supply of bills should be continuous and quite large.
b. Commercial bank’s preference to use a bill of exchange as an instrument for
providing credit to their customers.
c. The number of times a bill changes hands will be higher.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
99. Which of the following is/are the recommendation(s) of the Chore Committee in order to
promote bill culture in India?
a. Making it compulsory for banks to extend at least 50% of the cash credit limit
against raw materials to manufacturing units by way of drawee bills.
b. Setting up the DFHI as a major financial institution for the development of the
money market including the market for commercial bills.
c. Remission of stamp duty on bills of exchange.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
100. The rate at which the RBI rediscounts eligible bills from commercial banks is the
a. Bank rate
b. Hundi rate
c. Bazar bill rate
d. SBI discount rate
e. None of the above.
101. Which of the following is the characteristic of the bills rediscounting scheme of IDBI?
a. The scheme covers bills arising out of the sales and purchases of imported capital
equipment.
b. The bills to be eligible for rediscounting by IDBI should be drawn, made, accepted
or endorsed by an industrial concern as defined by the IDBI Act, 1964.
c. The period of maturity of the bill should not be less than 3 months.
d. The minimum amount of a transaction covering a set of bills eligible for
rediscounting has been fixed at Rs.25,000.
e. Payment from the acceptor is obtained by IDBI on the due date.

46
 Part I

102. Which of the following statements is/are true?

a. The structures of market interest rates are indirectly influenced by the discount rate
used by the central bank to refinance the bills of exchange.
b. Bill market scheme was introduced by the RBI in the year 1970.
c. Darshani Hundi, which is similar to bills of exchange of today, originated and
operated within the local limits.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
103. Which of the following is/are specific features of negotiable instrument?
a. A negotiable instrument should contain either an order or a request to pay.
b. It must be signed by the drawee and presented to the drawer for the acceptance.
c. The holder of a negotiable instrument can endorse it.
d. Sometimes the drawee and payee of the negotiable instrument may be the same
person.
e. None of the above.
104. Which of the following statements is/are true?
a. Usance bills are to be paid on presentation.
b. Clean bills should possess the documents of title to goods.
c. A D/A bill in which documents are deliverable just against acceptance, becomes a
clean bill immediately after the delivery of documents.
d. When a bill is accepted by drawee without having received any consideration then it
is known as accommodation bill.
e. Both (c) and (d) above.
105. Which of the following statements is/are true?
a. The mechanism of ‘Bills with acceptance’ involves the discounting of the bill by the
buyers bank for the account of the buyer.
b. In ‘post-shipment finance’ the banker runs the risk of dealing only with the
documents and not in goods.
c. Banks cannot rediscount the bills which were originally discounted with them by
their corporate clients.
d. Based on the Daheja Committee recommendations the government of India has
set-up the Discount and Finance House of India.
e. None of the above.
106. Which of the following is/are true with respect to bill rediscounting by banks?
a. Banks can rediscount the bills that were discounted by finance companies.
b. Banks can rediscount the bills arising out of share transactions.
c. Banks can rediscount the bills arising out of the genuine trade transactions and
originally discounted by the banks.
d. Banks can rediscount the accommodation bills.
e. Both (a) and (c) above.
107. As per the Bill Market Scheme 1952,
a. Licensed Scheduled commercial banks having deposits of 20 crore rupees or more
are eligible under this scheme.
b. Eligible Banks can avail the demand loans against the security of usance promissory
notes to the extent of Rs.50 lakh.
c. Under this scheme the banks can withdraw any number of bills lodged.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.

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 Investment Banking and Financial Services

108. Which of the following statements is/are true?

a. Since November, 1973 scheme banks are required to lodge all the eligible bills with
the Reserve Bank under Bill Rediscounting Scheme.
b. Since 1975 banks are allowed to rediscount bills with all the other financial
institutions.
c. The draw back of Bill Market Scheme 1952 was that it permitted the conversion of
cash credits/overdrafts into usance promissory notes.
d. Bill Finance Scheme of 1970 will not provide Bill Finance through out the year, it is
mainly meant to meet the seasonal stringency of the funds.
e. All of the above.
109. Which of the following is/are true regarding the Vaghul Committee?
a. The committee recommended that banks have to extend at least 50% of the cash
credit limit against raw materials to manufacturing units by way of drawee bills.
b. On its recommendations the Central Government has notified remission of the stamp
duty on bills of exchange.
c. The RBI has set-up the DFHI as a major financial institution for the development of
the Money Market based on the committee’s recommendation.
d. Both (a) and (b) above.
e. Both (b) and (c) above.
110. Which of the following is/are true with respect to bills rediscounting scheme of IDBI?
a. The period of the maturity of the bill should not be more than one year.
b. The supplier gets the bills discounted by his bank and the sellers bank in turn gets
the bill rediscounted with the DFHI.
c. IDBI receives payments directly from the buyer.
d. The scheme does not cover the bills/promissory notes arising out of the purchase of
imported capital equipment and machinery.
e. Both (b) and (d) above.

DEBT MARKET
Gilt-Edged Securities Market
111. Which of the following statements is/are true?
a. Government of India securities are debt obligations of the Central Government.
b. GoI securities are debt obligations of the State Governments.
c. GoI securities are debt obligations of financial institutions owned by the Central and
State Governments.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
112. Which of the following is false regarding a gilt-edged security?
a. It is an unsecured financial instrument.
b. The rate of interest on these securities is relatively low when compared to other
money market instruments.
c. The minimum amount of investment in government securities for a single investor is
Rs.10,000 and in multiples thereof.
d. Both (a) and (b) above.
e. Both (a) and (c) above.

48
 Part I

113. Who among the following are not eligible to invest in Government Securities?
a. Non-Resident Indians.
b. Overseas Corporate Bodies.
c. Foreign Institutional Investors registered with SEBI.
d. Provident Funds.
e. None of the above.
114. Short dated Government Securities are those securities which mature within
a. 1 year
b. 2 years
c. 4 years
d. 5 years
e. 6 years.
115. Which of the following is/are true?
a. The issue of Government securities helps in implementing the fiscal policy of the
Government.
b. Financial institutions like commercial banks are required to maintain their Statutory
Liquidity Reserve in the form of Government securities.
c. From April 1995, the Reserve Bank has begun auctioning Government Securities
competitively and since then interest rates have been increasingly set at market
determined levels.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
116. Which of the following statements is/are true?
a. There is no prescribed settlement period in case of debt market as is found in the
capital market.
b. Stock on tap is issued by the RBI with predetermined price, maturity and coupon
with no aggregate amount indicated in the notification.
c. The secondary market in Government Securities is also known as Telephone
market.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
117. Which of the following statements is/are true?
a. In case of floating rate bonds, the stock will carry a coupon rate which will vary
according to the change in the base rate to which it is related.
b. No interest is paid on zero-coupon bonds before maturity.
c. When the RBI undertakes Repo transactions it will be buying the securities in the
first leg and sell them back later.
d. Both (a) and (b) above.
e. Both (b) and (c) above.

Repurchase Agreements (REPOs)

118. Which of the following statements is/are true?
a. A repo transaction essentially involves borrowing money at a price like other money
market instruments.
b. A repo transaction will be viewed as a reverse repo from the point of seller of security.
c. The purpose of introducing repo transactions was to even out interest rates in the call
money market.
d. Both (a) and (c) above.
e. Both (b) and (c) above.

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 Investment Banking and Financial Services

119. Who among the following are not eligible to participate in Repo transactions?
a. DFHI.
b. State Government.
c. Banks.
d. Financial institutions which maintain SGL and current account with the RBI.
e. None of the above.
120. Which of the following statements is/are true?
a. NBFCs are permitted to enter into repo as well as reverse repo transactions.
b. When RBI enters into reverse repos with banks, it sucks out liquidity from the
system.
c. Repo is an avenue of NBFCs to deploy short-term surplus funds, but not to raise
funds.
d. Both (b) and (c) above.
e. None of the above.
121. Which of the following statements is/are false?
a. Repo Transactions may also be undertaken on the NSE Wholesale Debt Market.
b. Interest rate on repo transactions is usually higher than the rate prevailing in the call
money market.
c. All GoI securities and treasury bills in demat form are eligible for Repo
transactions subject to the condition that the transaction takes place at Mumbai.
d. Provident Funds are not eligible to participate in Repo auctions.
e. Both (c) and (d) above.

Public Deposits
122. Non-banking non-finance companies include
a. An equipment leasing company
b. A hire purchase company
c. Companies engaged in the services sector
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.
123. As per the Companies (Acceptance of Deposit) Rules 1975, which of the following is not a
public deposit?
a. Advance received for supply of goods or services.
b. Any amount received by a company from any other company.
c. Any amount received as a loan from any of the notified financial institutions.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
124. The minimum tenure for which public deposits can be accepted or renewed is
a. 3 months provided such deposits do not exceed 10% of the paid-up capital and free
reserves of the company
b. 6 months
c. 12 months
d. 18 months
e. Either (a) or (c) above.

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 Part I

125. The maximum maturity period for public deposits cannot exceed
a. 12 months
b. 24 months
c. 36 months
d. 48 months
e. 60 months.
126. Which of the following statements is/are true?
a. Deposits repayable on demand or on notice can be accepted by a company.
b. The interest payable on public deposits cannot exceed 16% per annum.
c. The interest payable on public deposits cannot be compounded for periods shorter
than quarterly rests.
d. Any security deposit received by the company from an employee or an agent falls
under the category of public deposit.
e. Both (b) and (d) above.
127. The maximum brokerage payable on a deposit having a tenure between one and two years is
a. 1%
b. 1.5%
c. 2%
d. 2.5%
e. 3%.
128. Which of the following statements is/are false?
a. Payment of brokerage on public deposits is on a one-time basis.
b. The total amount of public deposits that can be outstanding at any point of time
cannot exceed 25% of the aggregate of paid-up capital and free reserves.
c. A company accepting public deposits is required to maintain liquid assets to the
extent of 10% of the deposits maturing during the financial year ending March 31,
next.
d. The liquid assets required to be held by a company accepting public deposits can be
in the form of deposits held with a scheduled bank, free from lien or charge.
e. The amount held in liquid assets can be used only for the purpose of repayment of
deposits.
129. Which of the following statements is/are true?
a. The company shall, on acceptance or renewal of deposit, furnish a receipt within a
period of 8 weeks to the depositor.
b. The deposit receipt issued by a company is negotiable and can be transferred to
another person by endorsement or delivery.
c. When a company makes premature repayment, the rate of interest payable by the
company on such deposits shall be reduced by 1.5% from the rate which the
company would have paid if the deposit had been accepted for the period for which
it had run.
d. The deposit receipt need not contain the address of the depositor.
e. Both (a) and (b) above.

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 Investment Banking and Financial Services

130. Which of the following statements is/are false?

a. Every company accepting deposits shall file a return of deposits with the Registrar
of Companies on or before 31st March every year.
b. It is enough if every company intending to invite deposits issues an
advertisement about the same in a leading English newspaper.
c. Any advertisement issued by a company about the acceptance of public deposits will
be valid up to a period of 6 months from the closure of the financial year for which it
was issued.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
131. Every company accepting public deposits is required to maintain a certain level of liquid
assets. Which of the following is/are not permitted as investments in this regard?
a. Unencumbered securities of Central or State Government.
b. Unencumbered securities approved under Indian Trusts Act, 1882.
c. Unencumbered bonds issued by Housing Development Finance Corporation
Limited.
d. All (a), (b) and (c) above.
e. None of the above.
132. Which of the following statements is/are false?
a. Every company accepting deposits is also required to file a return of deposits with
SEBI.
b. Fixed deposit is an intangible financial product.
c. The scope for innovation is limited when it comes to the pricing aspect of fixed
deposits.
d. The amount held in liquid assets shall not, at any point of time, fall below 10% of
the amount of outstanding deposits maturing before 31st March next.
e. Both (b) and (c) above.

Financial Guarantees
133. The volume of personal guarantees in the organized sector has decreased over time because of
a. Abolition of the managing agency system
b. Rise of a new entrepreneurial class
c. Professionalization of managerial cadres
d. Improvement in the financial and technical appraisal of proposals
e. All of the above.
134. An endorser of a bill is liable as a guarantor to pay the holder with respect to the debt
represented by the instrument. This is a case of:
a. Secured Guarantee
b. Implicit Guarantee
c. Continuous Guarantee
d. Explicit Guarantee
e. Performance Guarantee.
135. Which of the following statements is/are true?
a. There are two parties accompanied by a guarantee in a loan transaction.
b. The purpose of seeking guarantee is to reduce the risk of default.
c. A guarantee cannot be oral.
d. A guarantee can be treated as a perfect substitute for tangible security.
e. Both (b) and (d) above.

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 Part I

136. Which of the following guarantees is usually extended by insurance companies?

a. Guarantees extended to non-financial contracts.
b. Guarantees on behalf of hire purchase companies to banks and other institutions.
c. Guarantees to cover short-term loans from banks.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
137. The premium payable by banks for insurance of deposits with DICGC is
a. 0.25% per half year
b. 0.25% per year
c. 0.5% per half year
d. 0.5% per year
e. 0.75% per half year.
138. Which of the following activity is not undertaken by DICGC?
a. Guarantee for credit extended by banks to priority sector.
b. Guarantee for credit extended by banks to small scale industries.
c. Improving exporters financial standing.
d. Insurance of deposits of banks.
e. Both (b) and (c) above.
139. Which of the following is/are true with regard to the SSI scheme?
a. All the loans which are eligible for guarantee will have to be covered and there is no
choice to the bank to selectively cover the loan accounts.
b. The bank cannot make a claim for a minimum period of 5 years.
c. The prescribed claim forms have to be submitted to DICGC only when the borrower
defaults.
d. Both (a) and (b) above.
e. Both (a) and (c) above.
140. Which of the following risks are not covered by the export credit and guarantee
corporation?
a. Insolvency of the Buyer.
b. War, Civil War, revolution or civil disturbances in the buyer’s country.
c. Fluctuations in the exchange rate.
d. Cancelation of valid import license.
e. Imposition of restrictions by the Government of the buyer’s country.
141. Standard policy is designed to cover risks in respect of goods exported on credit not
exceeding more than _____.
a. 90 days
b. 150 days
c. 180 days
d. 280 days
e. 360 days.
142. Which of the following statements is/are true?
a. Transfer guarantee is issued at the option of the bank to cover only political risks.
b. Export finance guarantee covers post-shipment advances granted by banks to
exporters against export incentives receivable in the form of cash assistance.
c. The risks of war, expropriation and restriction on remittances are covered under the
overseas investment insurance scheme of ECGC.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.

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 Investment Banking and Financial Services

CAPITAL MARKET
An Overview of Capital Market
143. Which of the following statements is/are true?
a. The abolition of the Control on Capital Issues has given a big boost to the process of
disintermediation in the capital market.
b. The institutionalization of the market has had a negative effect on the quality of
intermediation services and on disclosure standards.
c. The process of globalization of the Indian capital markets started with the opening
of these markets for foreign portfolio investment.
d. Both (a) and (b) above.
e. Both (a) and (c) above.
144. The Malegam Committee was appointed to deal with which of the following areas?
a. Mutual Fund Regulations.
b. Suggest measures to increase the levels of disclosures by Indian Issuers.
c. Problems relating to transfer of shares by companies.
d. Modalities of short selling in Indian stock market.
e. Revamp of securities laws.
145. Which was the first exchange to introduce screen based trading in India?
a. The National Stock Exchange.
b. The Bombay Stock Exchange.
c. Over the Counter Exchange of India.
d. The Calcutta Stock Exchange.
e. The Madras Stock Exchange.
146. Which of the following statements is false regarding dematerialization?
a. Dematerialization enables transfer of securities by book entries.
b. The risk of bad deliveries increases as a result of dematerialization.
c. Transfer of securities through depository does not attract stamp duty.
d. The depository handles all corporate actions like exercising for rights, collection of
dividends, credit for bonus, etc., on behalf of the investor.
e. Both (b) and (c) above.
147. Which was the first stock exchange to set-up a clearing corporation?
a. The National Stock Exchange.
b. The Bombay Stock Exchange.
c. Over the Counter Stock Exchange.
d. The Hyderabad Stock Exchange.
e. The Madras Stock Exchange.
148. Which of the following statements is/are true?
a. In case of trading in dematerialized securities, rolling settlement has been
introduced.
b. Trading on the National Stock Exchange commences every Tuesday and concludes
on the following Wednesday.
c. Trading weeks which are not uniform give rise to arbitrage opportunities.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.

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 Part I

149. Which of the following committees was constituted to work out the modalities for
reintroduction of the carry forward system with proper cheques and balances?
a. The J R Varma Committee.
b. The L C Gupta Committee.
c. The G S Patel Committee.
d. The Chandratre Committee.
e. The Bhave Committee.
150. The Committee which recommended introduction of derivatives in India is
a. The Chandratre Committee
b. The Malegam Committee
c. The L C Gupta Committee
d. The J R Varma Committee
e. The Bhave Committee.
151. The system of margining whereby the difference between the current closing price and the
transaction price is collected from the trading member is called as
a. Concentration Margin
b. Initial Margin
c. Carry Forward Margin
d. Mark to Market Margin
e. Special Margin.
152. The trading cycle on The National Stock Exchange operates from
a. Monday to Friday
b. Wednesday to Tuesday
c. Thursday to Wednesday
d. T + 3 rolling basis
e. T + 5 rolling basis.
153. The office of The Controller of Capital Issue was abolished in the year
a. 1986
b. 1989
c. 1991
d. 1992
e. 1994.
154. The G S Patel Committee was constituted to look into
a. Reintroduction of the badla system
b. Disclosure norms in offer documents
c. Book building
d. Redrafting of The Companies Act, 1956
e. Uniform norms for bad delivery.

Regulation of the Capital Market

155. Which of the following have not yet been brought within the registration framework by
SEBI?
a. Portfolio Managers.
b. Depositories.
c. Credit Rating Agencies.
d. Mutual Funds.
e. Venture Capital Funds.

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 Investment Banking and Financial Services

156. It is mandatory for all issuers to deposit _____ of the size of the issue as security deposit
with the regional stock exchange.
a. 0.5%
b. 1%
c. 1.5%
d. 1.75%
e. 2%.
157. The maximum time period for allotment has been reduced by SEBI to _____ days from the
closure of the issue.
a. 20 days
b. 25 days
c. 30 days
d. 35 days
e. 40 days.
158. The task of vetting the offer document lies with
a. The Lead Manager
b. SEBI
c. Bankers to the issue
d. Underwriters
e. Either (a) or (b) above.
159. Issues below Rs. _____ in size are permitted to be listed only on the OTCEI.
a. 2 crore
b. 3 crore
c. 4 crore
d. 5 crore
e. 6 crore.
160. Which of the following statements is/are false?
a. Trading in dematerialized securities takes place on T+2 basis.
b. Setting up of Trade Guarantee Fund is to ensure timely completion of settlement in
the event of defaults by member brokers.
c. SEBI has introduced the stock lending scheme to facilitate timely delivery of
securities.
d. The limits for listing on regular stock exchanges has been raised to 5 crore by SEBI.
e. Both (a) and (d) above.
161. The upper limit for gross exposure for brokers has been fixed by SEBI at
a. 20 times the base minimum capital
b. 20 times the base minimum capital and additional capital
c. 33.33 times the base capital
d. 33.33 times the base minimum capital and additional capital
e. 50 times the base capital and additional capital.
162. The takeover code is triggered when an acquirer obtains ____ equity stake in a company.
a. 10%
b. 15%
c. 20%
d. 25%
e. 30%.

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 Part I

163. Which of the following Self Regulatory Organizations have been formed in India?
a. Association of Merchant Bankers of India.
b. Association of Mutual Funds of India.
c. Registrars Association of India.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
164. Which of the following intermediaries is not required to be registered with SEBI?
a. Debenture Trustees.
b. Portfolio Managers.
c. Foreign Institutional Investors.
d. Depository.
e. Advertising Agency to the Issue.
165. The maximum intra-day trading limit for a broker, as set by SEBI, is
a. 20 times the base capital
b. 20 times the base capital and additional capital
c. 33.33 times the base capital
d. 33.33 times the base capital and additional capital
e. 50 times the base capital and additional capital.
166. The regulatory body for the securities market of UK is
a. Securities Exchange Commission
b. Securities and Exchange Board
c. Securities Regulatory Commission
d. Securities Investment Board
e. Securities Regulatory Board.
167. The minimum paid-up capital required to enable a company to obtain listing on stock
exchanges was raised by SEBI to
a. Rs.1 cr
b. Rs.3 cr
c. Rs.5 cr
d. Rs.7 cr
e. Rs.10 cr.
168. To enable the process of price discovery, SEBI has introduced the system of
a. Screen based trading
b. Book building in securities
c. Underwriting
d. Vetting of premium issues
e. Dematerialization.

MERCHANT BANKING
An Overview of Merchant Banking
169. Which of the following conditions needs to be satisfied for a listed security to be classified
as a Group A security?
a. The shares should be fully paid-up equity shares.
b. The shares must not be shares of banking companies.
c. The shares must have been admitted to dealings for at least two years on the given
exchange.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.

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170. Which was the first financial institution in India to offer merchant banking services?
a. IFCI.
b. IDBI.
c. ICICI.
d. IRBI.
e. ECGC.
171. A merchant banker is not permitted to carry on which of the following activities?
a. Underwriting.
b. Advisory services.
c. Bills discounting.
d. Mergers and Acquisitions.
e. Venture Capital Placements.
172. Merchant Bankers in India are classified under which of the following categories?
a. I, II, III, IV and V.
b. I, II III and IV.
c. I, II and III.
d. I and II.
e. Multiple categories of merchant bankers have been abolished.
173. Which of the following statements is/are true?
a. Registration with SEBI is mandatory for carrying on the business of merchant
banking in India.
b. An applicant desiring to carry on the business of merchant banking should be a body
corporate.
c. The norm that a merchant banker should not carry on any business other than those
connected with the securities market is not applicable to banks and financial
institutions.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.
174. The minimum net worth required for an applicant to carry on the business of merchant
banking is
a. Rs.3 crore
b. Rs.4 crore
c. Rs.5 crore
d. Rs.6 crore
e. Rs.10 crore.
175. The certificate of registration issued to merchant bankers by SEBI is valid for a period of
a. 1 year
b. 2 years
c. 3 years
d. 4 years
e. 5 years.
176. Which of the following is a characteristic of the merchant banking industry in India?
a. High entry barriers.
b. Low competition.
c. High bargaining power of customers.
d. Both (a), (b) and (c) above.
e. Both (b) and (c) above.

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 Part I

177. Which of the following statements is/are false?

a. In the Merchant Banking Industry there are no switching costs to the customers.
b. The minimum net worth required for merchant bankers has been increased from one
crore so as to make it an effective entry barrier.
c. The concept of bought out deal was introduced for the first time by JM Financial.
d. Both (a) and (b) above.
e. None of the above.

Management of Public Issues, Initial Public Offerings and Pricing of Various

Instruments
178. A company intending to make an IPO should fulfill which of the following eligibility
norms?
a. The issuer company should have been in existence for the past three years.
b. The issuer company should have been in existence for the past five years.
c. The project appraising body should have participated in the financing of the
project to the extent of at least 15% of the project cost.
d. The participation of the project appraising body can be only in the form of debt.
e. The company should have paid dividends in the form of cash in any two of the three
years of its existence.
179. Which of the following statements is/are false?
a. The number of co-managers cannot exceed the number of lead managers appointed
for a particular public issue.
b. The maximum number of advisors/consultants to an issue is 2.
c. An associate company of the issuer company can be appointed as underwriter or
advisor/consultant to the issue.
d. Both (b) and (c) above.
e. None of the above.
180. When the size of the issue is between Rs.100 crore to Rs.200 crore the maximum number
of lead managers who can be associated with the issue is
a. 2
b. 3
c. 4
d. 5
e. No limit but subject to SEBI approval.
181. A category I registrar can act
a. As a registrar to the issue and as a share transfer agent
b. Either as a registrar to the issue or as a share transfer agent
c. Only as a registrar to the issue
d. Either as a registrar to the issue or as a share transfer agent (to be specified at the
time of registration with SEBI)
e. Can act as Registrar and Underwriter to the issue.
182. The minimum net worth requirement for a category II registrar is
a. 2 lakh
b. 3 lakh
c. 4 lakh
d. 5 lakh
e. 6 lakh.

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 Investment Banking and Financial Services

183. Which of the following is not a function of the Registrar to the issue?
a. Assist the Lead Manager in selection of the bankers to the issue and the collection
centers.
b. Collection of daily subscription figures from collecting branches and reporting the
same to the company and the lead manager.
c. Refund of application money to unsuccessful applicants.
d. Assisting the company in listing of the security on stock exchanges.
e. Redressal of investor grievances.
184. Which of the following is applicable to a banker to a public issue?
a. Issue banking falls under the regulatory ambit of the RBI.
b. It is necessary that a banker to a public issue is a scheduled bank.
c. The maximum number of banks which can be associated with a public issue is 5.
d. Every banker to an issue shall enter into an agreement with the body corporate for
whom it is acting as banker to an issue.
e. Both (b) and (d) above.
185. The total outstanding underwriting obligation of an underwriter at any point of time cannot
exceed ______ times his net worth.
a. 10
b. 15
c. 20
d. 25
e. 30.
186. Which of the following statements is/are false?
a. Underwriters are paid underwriting commission for assuming the risk of
undersubscription.
b. Underwriting commission is paid on the face value of the security.
c. Underwriting an issue is optional and not mandatory.
d. In case of underwritten issues, the minimum underwriting commitment of the lead
manager shall be to the extent of 5% of the size of the offer or Rs.25 lakh, whichever
is more.
e. Both (b) and (d) above.
187. The minimum net worth which an underwriter should have is
a. 5 lakh
b. 10 lakh
c. 15 lakh
d. 20 lakh
e. 25 lakh.
188. Which of the following statements is/are true?
a. It is not mandatory for brokers to be registered with SEBI.
b. Any member of any recognized stock exchange can be appointed as broker to the
issue.
c. Appointment of brokers to the issue is not mandatory as per SEBI guidelines.
d. Both (a) and (b) above.
e. Both (b) and (c) above.

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 Part I

189. Which of the following statements is/are false?

a. 15 copies of the draft prospectus have to be filed with SEBI.
b. Even though SEBI has given up vetting of draft prospectuses, it reserves the
right to order any amendments to the draft prospectus.
c. If no observations are received from SEBI within a stipulated period of 20 days, the
offer document will be deemed to have been cleared by SEBI.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.
190. The draft prospectus filed with SEBI need not be accompanied by which of the following
documents?
a. Statement of inter se allocation of responsibilities.
b. Due diligence certificate from the lead manager.
c. Copy of MOU between the company and the lead manager(s).
d. Both (a) and (c) above.
e. None of the above.
191. The registration fee payable to SEBI for an issue of the size of Rs.55 crore is
a. Rs.15,000
b. Rs.25,000
c. Rs.50,000
d. Rs.2,50,000
e. Rs.5,00,000.
192. Where the issue size exceeds Rs.100 crore, the minimum promoter’s contribution is
a. 10% of the post-issue equity capital
b. 15% of the post-issue equity capital
c. 20% of the post-issue equity capital
d. 25% of the post-issue equity capital
e. 30% of the post-issue equity capital.
193. Which of the following shares will be considered as ineligible for the purpose of
computation of promoter’s contribution?
a. Shares issued during the 12-month period preceding the filing of prospectus
with SEBI at a price lower than the issue price.
b. Bonus shares issued out of revaluation reserves or from any other reserve created
without the accrual of cash, during the preceding 2 accounting years.
c. Shares issued for consideration other than cash wherein the transaction involves
revaluation of assets or capitalization of intangible assets, during the preceding
5 accounting years.
d. Both (b) and (c) above.
e. None of the above.
194. Which of the following statements is/are true?
a. Promoters contribution in excess of the minimum specified contribution will not
attract any lock-in.
b. Promoters have the option of bringing in their contribution before or after the
opening of the issue.
c. Shares under promoters quota can also be offered for subscription to the relatives,
friends and associates of the promoters.
d. The entire promoters contribution shall be locked in for a period of 5 years.
e. The lock-in period for minimum promoters contribution will commence from the
date of allotment or from the date of commencement of commercial production
whichever is earlier.

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 Investment Banking and Financial Services

195. An issue of the size of Rs.15 crore will be required to have

a. At least 10 mandatory collection centers
b. 20 mandatory collection centers
c. At least 30 mandatory collection centers
d. Below 30 mandatory collection centers
e. 35 mandatory collection centers.
196. The minimum and maximum period for which an issue should be kept open is
a. 2 and 8 days respectively
b. 3 and 10 days respectively
c. 4 and 10 days respectively
d. 5 and 12 days respectively
e. 5 and 15 days respectively.
197. An applicant is required to quote his Permanent Account Number in the application form if
the size of the application
a. Is Rs.40,000
b. Exceeds Rs.40,000
c. Is Rs.50,000
d. Exceeds Rs.50,000
e. Either (c) or (d) above.
198. The minimum amount of application money should not be less than ____ of the issue price.
a. 10%
b. 15%
c. 20%
d. 25%
e. 30%.
199. The minimum subscription required for an issue is _____.
a. 50%
b. 70%
c. 75%
d. 90%
e. 95%.
200. Which of the following provisions are applicable for issue of debentures?
a. Where the redemption/conversion period of any debenture issue exceeds 12 months,
credit rating is mandatory.
b. If the maturity period of the debenture exceeds 18 months, appointment of SEBI
registered debenture trustee is mandatory.
c. A company should compulsorily create debenture redemption reserve if the maturity
period of the debenture is less than 18 months.
d. Both (a) and (b) above.
e. Both (b) and (c) above.
201. Which of the following statements is/are false?
a. A company issuing FCDs having conversion period exceeding 18 months can make
such an issue only if conversion is made optional with put and call options .
b. In case the non-convertible portion of a NCD is to be rolled over, a compulsory
option is to be given to the debenture holders to redeem and encash their debentures.
c. In case the issuer company fails to get the minimum subscription, excluding
devolvement on the underwriters, the entire issue amount should be refunded to the
investors.
d. Both (a) and (b) above.
e. Both (a) and (c) above.

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 Part I

202. The market lot depends upon the issue price of the share. For an issue price of Rs.300 the
market lot will be
a. 10 shares
b. 50 shares
c. 100 shares
d. 150 shares
e. 200 shares.
203. An overseas corporate body is a foreign firm where
a. At least 50% of the ownership stake is held directly or indirectly by Resident Indians
b. At least 50% of the ownership stake is held directly or indirectly by Non-Resident
Indians
c. At least 60% of the ownership stake is held directly by Resident Indians
d. At least 60% of the ownership stake is held directly or indirectly by Non-Resident
Indians
e. At least 75% of the ownership stake is held directly or indirectly by Non-Resident
Indians.
204. Alpha Ltd. plans a public issue of Rs.140 cr. Which of the following statements are correct
with reference to this issue?
i. The company can appoint a maximum of 4 Lead Managers
ii. The number of Co-Managers cannot exceed the number of Lead Managers
appointed for the issue
iii. The issue can have only one Advisor.
a. (i) only
b. (ii) only
c. (iii) only
d. All of the above
e. None of the above.
205. Which of the following statements is false?
a. Reservation made to a particular class of investors is called as firm reservation.
b. When reservation on firm basis is undersubscribed, the amount will be added to the net
offer to the public.
c. The class of investors to whom reservations can be made in an issue includes
employees and group shareholders.
d. Both (a) and (b) above.
e. Both (b) and (c) above.
206. Which of the following statements is/are true?
a. The issue announcement advertisement should be issued at least 5 days before the
opening of the issue.
b. The issue announcement advertisement should be issued at least 10 days before the
opening of the issue.
c. The issue announcement advertisement should be issued at least 12 days before the
opening of the issue.
d. The issue announcement advertisement should be issued at least 15 days before the
opening of the issue.
e. The issue announcement advertisement should be issued at least 20 days before the
opening of the issue.

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 Investment Banking and Financial Services

207. Which of the following guidelines have to be observed with regard to issue advertisement?
a. It is not necessary to highlight the risk factors associated with the issue in the
advertisement.
b. During the period when the issue is open for subscription, no advertisement stating
that the issue is fully subscribed or oversubscribed will be issued.
c. No announcement about the closing of the issue will be made, except on the date of
closure of the issue.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
208. The reservation for employees in a public issue cannot exceed
a. 200 shares per employee
b. 500 shares per employee
c. 1000 shares per employee
d. 5% of the size of the issue
e. 10% of the size of the issue.
209. A new company can price its issue at a premium, only if
i. The promoter company has a 5-year record of consistent profitability.
ii. The promoters contribution is 50%.
iii. The Lead Manager gives a safety net to the investors.
a. (i) only
b. (ii) only
c. (iii) only
d. Both (i) and (ii) above
e. All of the above.
210. Which of the following are important determinants in designing capital structure?
a. Nature of industry.
b. Type of asset financed.
c. Degree of competition.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.
211. Which of the following statements is/are true?
a. Short-term liabilities should be used to create short-term assets and long-term
liabilities for long-term assets.
b. In non-seasonal businesses, investment in current assets assume the characteristics
of fixed assets and hence needs to be financed by long-term liabilities.
c. The risk of financial leverage increases for businesses subject to large cyclical
variation.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
212. Which of the following statements is/are false?
a. A business characterized by low level of competition and high entry barriers
decreases the volatility of the earnings stream.
b. A low leverage limits the firm’s ability to respond to an obsolescence crisis.
c. When a business reaches maturation stage, leverage is likely to decline as cash flows
accelerate.
d. Both (b) and (c) above.
e. None of the above.

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 Part I

213. The profit earned by selling a security will be treated as short-term capital gain if the
holding period is
a. Less than 12 months
b. Less than 24 months
c. Less than 36 months
d. More than 36 months but less than 48 months
e. Less than 48 months.
214. Which of the following statements is/are true?
a. A new company which is promoted by an existing company with a 3-year record of
consistent profitability can freely price its issue.
b. An existing private or closely held public company can freely price its issue, if it
has a 3-year record of consistent profitability.
c. A new company can price its shares either at par or at premium.
d. Both (a) and (b) above.
e. Both (b) and (c) above.
215. Which of the following statements is/are false?
a. Underpricing an IPO deprives the promoter or the company of an opportunity to
raise more funds.
b. Underpricing helps in giving shareholders good returns as an IPO is mainly intended
as a long-term financing strategy.
c. Underpricing could result in a lower net worth on an increased equity, which might
make dividend pay-outs or future investments difficult.
d. All of (a), (b) and (c) above.
e. None of the above.
216. Zero-coupon bonds are:
a. Issued at face value and do not carry any interest
b. Issued at a discount to their face value and are redeemed at par on expiry of their
tenure
c. Debt instruments with warrants allowing the investors to subscribe to the equity of
another company at a predetermined price
d. Redeemed by repayment in a series of installments at a premium over the face
value
e. Convertible into equity of the issuer at a price set at the time of issuance.
217. Which of the following is a feature of auction rated debt?
a. These are convertible short-term debentures.
b. Auction rated debts are fully redeemable non-convertible short-term debentures.
c. Auction rated debt is usually unsecured in nature.
d. Auction rated debt is redeemed at regular intervals and then re-auctioned.
e. Both (b) and (d) above.
218. Which of the following companies was the pioneer in introducing auction rated debt in
India?
a. TISCO.
b. Vadilal Dairy International Limited.
c. Ashok Leyland.
d. Jindal Photofilms.
e. Reliance Petrochemicals Limited.

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219. Which of the following is not used by the Malegam Committee to justify the pricing of a
share?
a. Dividend Discount Model.
b. Earnings Per Share.
c. Price Earnings Multiple.
d. Return on Net Worth.
e. Net Asset Value.
220. Which of the following statements is/are true?
i. A zero coupon bond is issued at a discount to its face value and is redeemed at par
on maturity.
ii. A debenture with a warrant entitling the holder to acquire the shares of another company
is called as third party convertible debenture.
iii. Lyons are zero coupon convertible notes.
a. (i) only
b. (ii) only
c. (iii) only
d. All of the above
e. None of the above.
221. Which of the following statements is/are false?
i. Preference shares cannot carry dividend rate higher than 16%.
ii. Preference shares cannot be irredeemable.
iii. Cumulative preference shares cannot be issued in India.
a. (i) only
b. (iii) only
c. Both (i) and (iii) above
d. Both (ii) and (iii) above
e. Both (i) and (ii) above.

Rights Issues, Bonus Issues, Private Placements and Bought-out Deals

222. In which of the following circumstances, a company need not offer further issue of shares
to the existing shareholders?
a. Where the company is a private company.
b. In case of an issue or allotment of shares within 2 years of the formation of a
company or within one year after the first allotment, whichever event occurs earlier.
c. Where a special resolution is passed in the general meeting providing that the shares
need not be offered to the existing equity shareholders.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.
223. Which of the following statement(s) is/are true?
a. A rights issue should be compulsorily underwritten.
b. Where the rights issue of listed companies does not exceed Rs.50 lakh, appointment
of a merchant banker is not mandatory.
c. A rights issue should not be kept open for more than 60 days.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.

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 Part I

224. In case of a rights issue, if the company does not receive at least 90% of the issued amount
including accepted devolvement from underwriters, within _____ days from the date of
closing of the issue, the amount of subscription received is required to be refunded.
a. 30
b. 35
c. 42
d. 51
e. 63.
225. Which of the following is/are true?
a. The letter of offer pertaining to rights issue should be vetted by SEBI.
b. The rights issue should not dilute the value or rights of the fully or partly convertible
debenture holders.
c. Companies are permitted to retain the oversubscription amount in a rights issue.
d. Along with the rights issue, preferential allotment can be made as well.
e. Both (c) and (d) above.
226. Sri Limited is planning a rights issue of equity shares in the ratio of 1 rights share for every
3 shares held. The rights issue is being priced at Rs.16 per share. The current market price
of the share is Rs.25. The value of the rights is
a. Rs.2.20
b. Rs.2.25
c. Rs.2.27
d. Rs.2.30
e. Rs.2.52.
227. Vijay Limited is planning a rights issue of equity shares in the ratio of 1 right share for
every 5 shares held. The current market price of the share is Rs.45, while the rights issue is
being priced at Rs.30. The expected market price of the share after the rights issue is
a. Rs.40
b. Rs.40.5
c. Rs.41
d. Rs.42.5
e. Rs.45.
228. Beta Limited has tapped the markets with rights issue priced at Rs.60 per share. The rights
is being offered in the ratio of 1 share for every 2 shares held. The shares are currently
quoting at Rs.90 in the market. Murthy is currently holding 500 shares of the company. The
change in the wealth of Murthy if he allows his rights to expire is
a. –5,000
b. –10,000
c. +15,000
d. –20,000
e. –25,000.
229. Which of the following guidelines are applicable to bonus issues by companies?
a. Pending conversion of FCDs/PCDs, no company shall issue any shares by way of
bonus unless similar benefit is extended to the holders of such PCDs or FCDs.
b. Bonus shares can be issued out of share premium collected in cash and revaluation
reserves.
c. An issue of bonus shares cannot be made unless the partly paid shares are made
fully paid-up.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.

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 Investment Banking and Financial Services

230. Which of the following statements is/are true regarding bonus shares?
a. Bonus shares are always fully paid.
b. Bonus shares are issued to the existing members free of charge.
c. Similar to rights shares, bonus shares may be renounced by a member in favor of his
nominee.
d. Both (a) and (b) above.
e. Both (a) and (c) above.
231. In a composite issue, the gap between the closure dates of the rights issue and public issue
should not exceed
a. 7 days
b. 15 days
c. 21 days
d. 30 days
e. 60 days.
232. The maximum time period for which a rights issue can be kept open for subscription is
a. 10 days
b. 21 days
c. 30 days
d. 45 days
e. 60 days.
233. Which of the following reserve(s) are not eligible for issuing bonus?
a. Revaluation reserve.
b. General reserve.
c. Capital reserve.
d. Share premium.
e. Both revaluation reserve and capital reserve.
234. Which of the following are essential features of the private placement market?
a. The private placement market is characterized by high entry barriers.
b. The company tapping the private placement market has a choice of investors.
c. The transaction costs in the private placement market are very high.
d. Credit rating of debt instruments is compulsory in case of private placement.
e. Both (a) and (b) above.
235. Which of the following statements is/are true?
a. The issue of shares on a preferential basis can be made at a price not less than the
average of the weekly high and low of the closing prices on a stock exchange during
the six months or two weeks preceding 30 days prior to the general body meeting of
shareholders, whichever is lower.
b. The issue of shares on a preferential basis can be made at a price not less than the
average of the weekly high and low of the closing prices on a stock exchange during
the six months or two weeks preceding 30 days prior to the general body meeting of
shareholders, whichever is higher.
c. The issue of shares on a preferential basis can be made at a price not more than the
average of the weekly high and low of the closing prices on a stock exchange during
the six months or two weeks preceding 30 days prior to the general body meeting of
shareholders, whichever is lower.
d. The issue of shares on a preferential basis can be made at a price not more than the
average of the weekly high and low of the closing prices on a stock exchange during
the six months or one week preceding 30 days prior to the general body meeting of
shareholders, whichever is lower.
e. The issue of shares on a preferential basis can be made at a price not more than the
average of the weekly high and low of the closing prices on a stock exchange during
the six months or two weeks preceding 60 days prior to the general body meeting of
shareholders, whichever is lower.

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 Part I

236. The lock-in period for shares of a listed company privately placed with the promoters is
a. 2 years
b. 3 years
c. 5 years
d. There is no lock-in period
e. The lock-in period will be decided by the issuer company.
237. The lock-in period for shares of a listed company privately placed with investors other than
the existing promoters is
a. 2 years
b. 3 years
c. 5 years
d. There is no lock-in period
e. The lock-in period will be decided by the issuer company.
238. Which of the following statements is/are true?
a. Buy-outs are nothing but wholesale investments.
b. Buy-outs happen when the company needs money fast and market conditions are
adverse.
c. Buy-outs happen when an investor group makes an offer to a company which is
more lucrative.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
239. Which of the following can be considered as an advantage of bought out deals?
a. Price is not subject to the vagaries of the market place.
b. Funds can be obtained at a minimal cost without fear of undersubscription.
c. The intermediary usually earns a higher return on a bought out deal when compared
to the fee earned on conventional merchant banking services.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
240. In case of warrants on private placement basis, the amount payable upfront should be at
least
a. 1% of the exercise price
b. 2.5% of the exercise price
c. 5% of the exercise price
d. 7.5% of the exercise price
e. 10% of the exercise price.

INTERNATIONAL MARKETS
241. Which of the following statements is/are true?
a. In the ADR Level I issue, there are no disclosures required.
b. In the ADR Level I issue, ADRs can be traded only on the US-OTC market.
c. In the ADR Level I issue, the company need not comply with the US-GAAP.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.

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 Investment Banking and Financial Services

242. In a depository receipts issue, which of the following will be the role(s) played by the
custodian?
a. To hold the shares underlying the DRs on behalf of the depository.
b. To collect rupee dividends on the underlying shares.
c. To disseminate information from the issuer to the DR holder.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
243. Which of the following statements is/are true regarding the foreign bonds issued in the
international bond markets?
a. Yankee bonds are pound denominated bonds issued in the UK by non-UK firms.
b. Samurai bonds are yen denominated bonds issued in the Japanese market by non-
Japanese firms.
c. Bulldog bonds are dollar denominated bonds issued in the UK by domestic
companies.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
244. Belgian dentist is a term used to describe
a. An institutional investor who makes market specific investments
b. An institutional investor who makes market and industry specific investments
c. An institutional investor who makes time specific investments
d. A high net worth individual investor in bonds/DRs to ensure safety for the surplus
funds
e. Both (b) and (c) above.
245. Which of the following statements describes the Gensaki rate?
a. It is the short-term benchmarket rate used in Japanese markets.
b. It is the benchmark rate used to price the Samurai bonds.
c. It is the long-term prime rate used in the Swiss markets.
d. It is the treasury rate used in the US markets.
e. None of the above.
246. Which of the following statements is/are true in the case of Eurodollar deposits?
a. Eurodollar deposits cannot be owned by individuals.
b. Eurodollars are not subject to US banking regulations.
c. Eurodollar volume is not measured as the dollar denominated deposit liabilities of
banks located outside the US.
d. The sum of a few dollar-denominated liabilities of banks outside the United States
measures the gross size of the Eurodollar market.
e. The net size of the Eurodollar market is constructed by netting all the deposits
owned by individuals.
247. The reserve requirements on the transaction deposits have been reduced from _____ to
_____.
a. 10%, 9%
b. 11%, 9%
c. 12%, 10%
d. 12%, 11%
e. 12%, 10.5%.

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 Part I

248. Which of the following is/are features of Eurodollar Certificate of Deposits (CDs)?
a. It is a negotiable receipt for a dollar deposit at a bank outside the United States.
b. The investors sell the Eurodollar CDs only after they mature.
c. Tranche deposits are issued in very small denominations.
d. They pay a fixed, competitively determined rate of return.
e. Secondary market makers’ spreads for short-term fixed rate CDs have been 5 basis
points for European bank dollar CDs.
249. Which of the following is false in the case of Eurodollar Floating Rate Notes (FRNs)?
a. They are issued by banks and sovereign governments.
b. They are negotiable bearer papers.
c. The coupon or interest rate is set above the LIBOR for sovereign borrowers and
below the LIBOR for US banks.
d. Yields on Eurodollar FRNs range from 1/8 percent under LIBID up to LIBOR.
e. The spread quoted on FRNs in the secondary market is 10 cents per $100 face value
for the liquid sovereign issues.
250. Which of the following is a source of risk not associated with Eurodollar deposits?
a. The interference of the authorities in the movement or repatriation of the principal of
the deposit or the interest paid on it.
b. Blockage of the deposits of the foreign residents by the US Government.
c. The potential for international jurisdictional disputes.
d. Soundness of deposits at banking offices in foreign countries relative to banking
offices located in the United States.
e. Lesser cost of evaluating foreign investments than the local investments.
251. Which of the following is true in case of loan syndication?
a. In direct loan syndication, there is a principal-agent kind of relationship among the
participant banks.
b. The managing banks provide assistance and suggestions to the lead manager in
managing the loan.
c. The lead manager never plays the role of an agent bank in the syndicate.
d. Syndication can be done only on a best effort basis.
e. Merchant banker cannot act as a lead manager.
252. Which of the following is an upfront cost associated with pricing of Eurodollar loans?
a. Out of pocket costs.
b. Commitment charge on the undrawn portion.
c. Interest charges on loan amount.
d. Agency cost.
e. Interest on the undrawn portion of the loan.
253. Which of the following is true in case of multicurrency loans?
a. Multicurrency loans represent a natural expansion of the use of eurodollar loans.
b. Multicurrency loans do not carry any currency risk.
c. “Business day” is any working day.
d. Interest rate for multicurrency loans is based on the LIBOR.
e. None of the above.

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254. Which of the following is not considered as a provision to loan agreement?

a. Currencies.
b. Legality.
c. Exchange rate.
d. Increased costs.
e. Multilender considerations.
255. Which of the following gives the borrower more flexibility about the outstanding principal
during the loan’s life?
a. Swingline.
b. Evergreen facility.
c. Revolving credit facility.
d. Back-stop facility.
e. Term loan.
256. Which of the following is not an advantage of syndicated loans?
a. Uncertainty of funds.
b. Diversity of currency.
c. Simpler banking relationship.
d. Possibility of renegotiation.
e. Lower cost of funds.
257. Which of the following is not an objective of ECB guidelines?
a. Keep borrowing costs low.
b. Keep borrowing maturities long.
c. Encourage infrastructure.
d. Export sector financing.
e. Earn profits.
258. Which of the following statements is false?
a. The “all-in-cost ceilings” for normal projects is 300 basis points over six months
LIBOR.
b. The “all-in-cost ceilings” for infrastructure projects is 300 basis points over six
months LIBOR.
c. The “all-in-cost ceilings” for long-term ECBs is 450 basis points over six months
LIBOR.
d. Corporates having foreign exchange earnings are permitted to raise ECB up to three
times the average amount of annual exports during the previous three years.
e. In case of structured obligations, if default takes place, the default should be the
foreign exchange equivalent amount of principal and interest outstanding should be
calculated.
259. Which of the following is true in case of foreign direct investment?
a. It decreases the efficiency with which the world’s scarce resources are used.
b. It provides stimulus to economic growth.
c. It is viewed as an obstacle that could slowdown the pace of integration in the world
economy.
d. In home countries, the FDI exports jobs and puts downward pressure on wages.
e. In host countries the balance of payments are affected.

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260. “Mergers and Acquisitions” and “Greenfield” Investments are part of which form of FDI?
a. Reinvested earnings.
b. Equity capital.
c. Long-term borrowing.
d. Short-term borrowing.
e. Term loans.
261. Which of the following is true in case of a vertical spillover?
a. It occurs when the affiliate has a new technology that is subsequently copied or
learned by competing firms.
b. It occurs when the affiliate transfers free of charge technology to firms supplying
inputs or servicing “downstream” operations.
c. It occurs when technology is licensed by the affiliate to a domestic firm.
d. It benefits the MNC bringing in the technology.
e. It is a kind of diffusion of technology for firms in the host country.
262. Which of the following is false with respect to FDI in India?
a. FDI is in the form of investment from Non- Resident Indians (NRIs) and Overseas
Corporate Bodies(OCBs).
b. FDI is not allowed in the services sector.
c. The automatic route for FDI is not available to those who have joint venture or
technology transfer/trademark agreement in India.
d. Same rules apply to existing companies and new ventures.
e. FERA rules the FDIs in India.
263. Which of the following is not an objective of Foreign Investment Promotion Board?
a. To undertake investment in India and abroad.
b. To facilitate investment in the country through international companies,
Non-Resident Indians and other foreign investors.
c. To delay clearance of proposals submitted to it.
d. To review policy and put in place appropriate rules and procedures for investment
promotion and approvals.
e. To deal in the matters related to FDI.
264. In which of the following forms of bank account is the deposit amount payable on the
maturity date?
a. Reinvestment Deposit.
b. Fixed Deposit Account.
c. Recurring Deposits.
d. Savings Account.
e. Current Account.
265. Which of the following is not a characteristic of Non-Resident Non-Repatriable Rupee
account (NRNR)?
a. Low rate of interest.
b. Exempted from all taxes.
c. Interest income is repatriable.
d. Loan can be availed against deposit.
e. High rate of interest.

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CREDIT RATING
266. Fine Steels Limited is planning to raise funds by issue of CPs and gets the security rated.
The rating given by the credit rating agency will indicate
a. The general evaluation of Fine Steels Limited
b. The possibility of repayment of the principal and interest by Fine Steels Limited
c. The credit risk involved in making long-term investments with Fine Steels Limited
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.
267. Which of the following aspects is not involved in technical analysis of credit evaluation?
a. Operat ive efficiency of plant.
b. Availability of quality sources for major inputs.
c. Need for modernization.
d. In-house expertise.
e. None of the above.
268. First Invest Limited is an institutional investor and approaches a credit rating agency to
analyze the equity assessment of JP Pharmaceuticals Limited. Which of the following
statements refer to equity assessment process?
a. It is an analysis done upon the request of the investor and the company.
b. It is for the specific purpose of the investor who has requested for the assessment.
c. Instead of a credit rating symbol, there will be a report on the analysis.
d. Both (b) and (c) above.
e. Both (a) and (c) above.
269. Which of the following indicates the steps involved in the explicit judgmental approach
used in sovereign rating?
a. Factors relevant for rating the entity are defined and weights are attached to them for
quantitative assessment.
b. A score is obtained on the basis of the weights.
c. A score is obtained on the basis of quantitative assessment.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.
270. HK Limited is an institutional investor assessing the risks that may arise by making direct
investments in overseas companies. Which of the following risks will the overseas investor
be exposed to?
a. Political risks of confiscation.
b. Political risks of expropriation.
c. Risks due to depreciation methods.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
271. In the absence of confiscation, the cash flows to an overseas investor are expected to be
Rs.12 lakh. If the probability of confiscation is 0.05 for the investment period of 5 years,
then the expected cash flow in year 5 after adjusting for this probability will be
a. Rs.0.60 lakh
b. Rs.3 lakh
c. Rs.9.29 lakh
d. Rs.11.40 lakh
e. Rs.11.32 lakh.

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272. Real Finance Limited is a consumer finance company planning to get individual credit
rating for its borrowers. Which of the following aspects should be analyzed?
a. Duration of stay in present place of residence.
b. Future job prospects.
c. Financial assets.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
273. Which of the following ratios are used while rating a CP?
a. Total debt/capitalization including short-term debt.
b. Long-term debt/capitalization.
c. Pre-tax return on average long-term capital employed.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.
274. If the probability of the firm being confiscated is 0.05, then assess the expected cash flows
for the investment of Rs.12 lakh. Discounted rate is 10%.
a. Rs.6.33 lakh
b. Rs.76 lakh
c. Rs.10.9 lakh
d. Rs.120 lakh
e. None of the above.
275. Which of the following statements is/are true?
a. Shadow rating need not be disclosed to the public.
b. Formal rating will need considerably lesser information than shadow rating.
c. If the shadow rating indicates a good rating, then there would be no need for formal rating.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.
EVOLUTION OF FINANCIAL SERVICES
276. Which of the following statements is/are true?
a. 20th century Leasing Ltd. is the first leasing company in India which came into
existence in 1973.
b. Normally equipment leasing carries the convertibility clause that can result in
dilution of ownership and control.
c. Equipment leasing provides hundred percent finance.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
277. Which of the following statements is/are true?
a. SBI capital markets limited was set-up by SBI, which is the first commercial bank to
set-up a financial services subsidiary.
b. As per the RBI guidelines banks are allowed to provide hire purchase and leasing
services through a subsidiary only.
c. In installment credit, the ownership of the product is transferred to the user after
paying the last installment.
d. The interest rates quoted for consumer finance are based on the effective rate of
interest.
e. None of the above.

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278. Which of the following statements is/are true?

a. A lease contract should essentially consist of the transfer of ownership from the
lessor to lessee at the end of the lease period.
b. In hire purchase, ownership of the equipment is transferred only after the user
exercises his option to purchase it.
c. Hire purchase facility is not available for the consumer goods like television, audio,
systems, refrigerators etc.
d. Both (a) and (c) above.
e. None of the above.
279. Which of the following statements is/are true in respect of credit cards?
a. The largest share in the market of credit cards goes to CitiBank.
b. Credit cards were first introduced in India as Diners cards in 1962.
c. Master and Visa cards were first launched by CitiBank.
d. The mode of payment in this mechanism is through the usage of ‘plastic cards’.
e. All of the above.
280. Which of the following statements is/are true with respect to housing finance?
a. National housing bank is a fully owned subsidiary of the RBI.
b. All the housing finance companies in India, are registered with National Housing
Bank.
c. Commercial banks capture the largest market share in this market.
d. Both (b) and (c) above
e. None of the above.
281. Which of the following statements is/are true?
a. The largest of the private sector mutual funds is Kothari mutual fund.
b. Portfolio management schemes provide investor participation in non-discretionary
portfolios whereas mutual funds do not allow the direct involvement of the investors
in the investment process.
c. Credit rating in India started with the establishment of Investor Information and
Capital Credit Rating agency in 1988.
d. The minimum net worth of credit rating agency should be at least two crore, as per
SEBI regulations.
e. All of the above.

AN INTRODUCTION TO EQUIPMENT LEASING

282. As per the FASB specifications which of the following is/are termed as finance lease?
a. Lease term 5 years; useful life 10 years.
b. Lease term 5 years; useful life 8 years.
c. Lease term 5 years; useful life 6 years.
d. Lease term 5 years; useful life 12 years.
e. All of the above.
283. Given that the fair market value of the equipment is Rs.400 lakh at the time of inception of
lease and based on the present value of lease rentals given below, which of the following
can be categorized as a finance lease as per FASB specifications?
a. Rs.300 lakh.
b. Rs.250 lakh.
c. Rs.50 lakh.
d. Rs.380 lakh.
e. Rs.200 lakh.

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284. A fully pay-out lease means that

a. The lessor should take the responsibility for repairs, maintenance and insurance of
the asset
b. The lessee should bear the cost for repairs, maintenance and insurance of the asset
c. The lessee has to pay lease rentals irrespective of the condition or suitability of the
asset
d. The lease operates over the entire economic life of the asset
e. The present value of the lease rentals should be equal to the cost of the equipment.
285. In a leveraged lease transaction
a. There are only two parties to the transaction
b. The debt funds raised by the leasing company are with recourse to the lessee
c. Lender generally receives the debt service component of annual lease rental through
a trustee
d. The lessor cannot claim tax shields on depreciation and other capital allowances on
the entire investment cost
e. Both (b) and (c) above.
286. Which of the following statements is/are true?
a. In a finance lease, the lessee generally has to undertake the ‘hell or high water’
obligation.
b. A ‘wet lease’ is a variant of finance lease.
c. A ‘sale and leaseback’ transaction is a direct lease.
d. In a ‘swap lease’ the lessor happens to be the equipment supplier.
e. Both (a) and (d) above.
287. Which of the following are the characteristics of an operating lease?
a. All the equipment related business and technological risks are shifted from the lessor
to the lessee.
b. The present value of minimum lease payments is equal to the fair market value of
the asset at the time of inception of the lease.
c. The ownership of the asset is transferred to the lessee at the end of the lease period.
d. The lease can be generally terminated by the lessee at short notice without any
significant penalty.
e. Both (a) and (d) above.
288. In a perfectly competitive financial market,
a. The cost of leasing is more than the cost of other forms of borrowing
b. The cost of leasing is less than the cost of other forms of borrowing
c. The cost of leasing is equal to the cost of other forms of borrowing
d. The cost of leasing is significantly different from the cost of other forms of
borrowing, but whether it is high or low depends on other specific factors
e. The cost of leasing is generally lower than the yield on 5-year GoI securities.
289. Which of the following statements is/are true?
a. Upgrade lease and swap lease are variants of operating lease.
b. Upgrade lease helps in hedging the risk of obsolescence.
c. All operating leases are generally bipartite leases.
d. Double dip or multiple dip advantages are associated with cross-border leases.
e. All of the above.

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290. Which of the following statements is true?

a. In a single investor lease, there are always one equity participant and one debt
participant.
b. A leveraged lease transaction entitles the lessee to claim the capital allowances on
the entire investment cost.
c. A leveraged lease transaction is routed through a trustee who looks after the interest
of the lender and the lessee.
d. In a leveraged lease transaction, the leasing company invests in the equipment by
borrowing a large chunk of the investment with full recourse to itself and no
recourse to the lessee.
e. In a leveraged lease transaction, the leasing company invests in the equipment by
borrowing a large chunk of the investment with full recourse to the lessee and no
recourse to itself.
291. A walk-away lease is the same as
a. An open-ended lease
b. A closed-ended lease
c. Sale and leaseback
d. A leveraged lease
e. A cross-border lease.
292. Which of the following is/are features of an ‘equipment leasing’?
a. The lessor transfers the right to use the equipment to the lessee.
b. If the end of the lease period is over the asset automatically goes into the possession
of the lessee.
c. The lessor usually bears the costs of insuring and maintaining the asset.
d. Both (a) and (b) above.
e. All of (a), (b), and (c) above.
293. Which of the following statements is/are true?
a. The features of a finance lease transaction are similar to that of a hire purchase
transaction.
b. The features of an operating lease transaction are similar to that of conditional sales
agreement.
c. An operating lease transaction cannot provide transfer of ownership from the lessor
to lessee.
d. Any asset based financing plan will normally carry the feature of transfer of
ownership from lessor to lessee.
e. None of the above.
294. As per the ‘International Accounting Standards Committee’
a. The finance lease transaction is more or less similar to that of a hire purchase
transaction.
b. The term of the lease covers the major part of the useful life of the asset, if it were to
be a finance lease.
c. The present value of the minimum lease payments should be greater than or equal to
the fair market value of the asset at the inception of the financial lease.
d. Both (b) and (c) above.
e. All of (a), (b), and (c) above.

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295. Which of the following features is/are borne by a financial lease in the Indian context?
a. By the end of the lease term the ownership of the asset will be transferred to the
lessee.
b. The lease term is for a major part of the useful life of the asset.
c. The lease transaction is almost similar to that of the conditional sales agreement.
d. The present value of the lease payments is substantially less than the fair market
value of the asset at the inception of the lease.
e. All of the above.
296. According to the Financial Accounting Standard Board of the US, for a financial lease, the
lease term should exceed
a. 90% of the useful life of the asset
b. 75% of the useful life of the asset
c. 95% of the useful life of the asset
d. At least 50% of the useful life of the asset
e. None of the above.
297. The discount rate to be used by the lessee for the purpose of determining the present value
of the asset in a financial lease is
a. The rate of interest implicit in the lease
b. The rate at which lessee can borrow funds
c. The incremental rate of borrowing
d. The lessee’s weighted average cost of capital
e. None of the above.
298. “Hell or High water” clause means
a. The commitment of the lessor to replace the asset in the face of any event affecting
the usage of the asset
b. The operation of the asset by the lessee over the entire life of the equipment
c. The lessor should take responsibility for repair and maintenance and should pay
insurance
d. The unconditional obligation of the lessee to pay rentals over the entire life of the
asset
e. None of the above.
299. “A fully pay-out lease” is
a. A lease in which a substantial part of the payments are made at the front end of the
transaction
b. A finance lease which operates over the entire economic life of the equipment
c. A lease in which the title would be passed automatically from the seller to the buyer
at the end of lease period
d. Both (a) and (c) above
e. None of the above.
300. Which of the following features characterize an operating lease?
a. Lease term is significantly shorter than the economic life of the equipment.
b. The lease contract can be terminated by the lessor at short notice.
c. The present value of the lease rentals should be greater than or equal to the fair
market value of the asset at the inception of the lease.
d. Both (a) and (b) above.
e. All of (a), (b), and (c) above.

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301. A “wet lease”

a. Is an operating lease
b. Will provide the operating know-how, suppliers and the related services to the
lessee.
c. Characterized by the lessor’s responsibility of insuring and maintaining the
equipment
d. Both (a) and (b) above.
e. All of (a), (b), and (c) above.
302. State which of the following statements is/are true.
a. In a “dry lease” the lessor bears the costs of insuring and maintaining the leased
equipment.
b. An operating lease transfers the equipment related business and technological risks
from the lessor to the lessee.
c. The lessor while structuring a financial lease largely depends upon the realization of
a substantial resale value.
d. An operating lease calls for an in-depth knowledge of the equipments and a
secondary market for such equipments.
e. The operating leases are most popular in India.
303. Which of the following is/are true about the sale and lease back transaction?
a. The lease back arrangement should be in the form of finance lease only.
b. It enjoys the uninterrupted use of the asset.
c. It unlocks the firm’s investment in low income yielding assets.
d. Both (b) and (c) above.
e. All of (a), (b), and (c) above.
304. State which of the following statements is/are true.
a. A sale and lease back transaction can be considered as a direct lease.
b. A direct lease should essentially consist of three different parties – the equipment
supplier, the lessor and the lessee.
c. The sale and lease back arrangement can be in the form of a “finance lease” or an
“operating lease”.
d. In a finance lease the lessor is responsible for repair, maintenance and insurance of
the asset.
e. “Hell or high water” obligation applies to the lessee in operating leases only.
305. “Sales-aid-lease”
a. Is essentially a tripartite lease
b. Is a transaction catalyzed by the equipment supplier
c. Is a transaction that confers the discounted lease rentals to the leasing company
d. Is supported by a recourse to the supplier in the event of default by the lessee
e. All of the above.
306. In a leveraged lease transaction
a. The number of parties to the transaction are two
b. Lessor is the loan participant
c. The debt portion is invested in the equipment without recourse to the lessee
d. The lender obtains a first mortgage on the leased asset
e. The lessee has to pay the lease rentals directly to the lender.

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307. State which of the following statements is/are true.

a. In a domestic lease the lessor and the lessee should be domiciled in the same country
where as the domicile of the equipment supplier is immaterial.
b. Domestic lease is exposed to country risk whereas the international lease is exposed
to the currency risk.
c. Import lease transactions cannot be considered as International lease transactions.
d. A cross-border lease is invariably a big ticket leveraged lease
e. None of the above.
308. Which of the following statements is/are false?
a. In a cross-border lease transaction the domicile of the supplier is immaterial.
b. In import lease transaction the lessor is domiciled in a country different from that of
the lessee.
c. Cross-border lease transaction is prepared to take higher residual value exposure.
d. The lease rentals in cross-border lease transactions are cheaper.
e. None of the above.
309. Which of the following leases hedges the risk of obsolence?
a. Finance lease.
b. Operating lease.
c. Upgrade lease.
d. Leveraged lease.
e. Swap lease.
310. Which of the following is/are the advantages of leasing?
a. Leasing decreases the financial risk of a firm.
b. Leasing is highly beneficial in a perfectly competitive financial market.
c. For a firm which does not have the capacity to absorb the tax shelters associated
with the investments, leasing becomes more sensible.
d. Leasing is always cheaper than debt financing.
e. Both (a) and (c) above.
311. The non-capitalization of a finance lease in the lessee’s balance sheet results in
a. Under statement of the assets turnover ratio
b. Overstatement of the return on investment
c. Understatement of gearing ratio
d. Both (a) and (b) above
e. Both (b) and (c) above.
LEASING IN INDIAN CONTEXT
312. Which of the following statements is true?
a. The lease rental payable during the primary period is called the ‘pepper-corn’
consideration.
b. Equipment leasing may result in dilution of control because of the convertibility
clause associated with it.
c. The Standard Chartered Bank was the first foreign bank to participate in the equity
of a leasing company.
d. The Industrial Development Bank of India was the first financial institution to enter
into equipment leasing industry.
e. None of the above.

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313. Which of the following restrictions are applicable to a finance company intending to tap the
intercorporate market?
a. The maximum maturity period of the ICD should not be more than 15 months.
b. The total amount that can be raised by way of intercorporate deposits cannot exceed
two times the free reserves of the company.
c. A minimum liquidity reserve of 15% of the intercorporate deposits is required to be
maintained by the company planning to tap the ICD market.
d. Both (a) and (b) above.
e. Both (b) and (c) above.
314. The issue price (rounded off to nearest rupee) of a cash certificate of face value Rs.3,000,
which is to be redeemed at par after 12 months so as to yield 15% p.a. is
a. Rs.1,492
b. Rs.445
c. Rs.895
d. Rs.1,490
e. Rs.2,609.
315. Which of the following statements is/are true with respect to public deposits?
a. The true yield of a public deposit is influenced by the term to maturity of the
deposit.
b. A leasing company can use the entire finance raised through public deposits for
lease investments.
c. The true yield on a public deposit is always less than the simple interest yield.
d. The compounded yield on a public deposit is always higher than the simple interest
yield.
e. Both (a) and (d) above.
316. A leasing company can raise bank borrowings up to
a. 10 times net owned funds
b. 4 times net owned funds
c. 3 times net owned funds
d. 2 times net owned funds
e. None of the above.
317. Which of the following is not included within the definition of deemed deposits?
a. Intercorporate deposits.
b. Borrowings and monies received from the shareholders of private limited
companies.
c. Borrowings and monies received from the directors of private limited companies.
d. Monies raised through debentures and bonds secured by immovable properties.
e. Funds raised through unsecured non-convertible debentures.
318. There is a ceiling on the interest rate or discount rate given by the leasing companies if they
raise the finance through
a. Public deposits
b. Intercorporate deposits
c. Commercial paper
d. Both (b) and (c) above
e. All of (a), (b) and (c) above.

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319. The maturity mismatch is more pronounced for leasing companies in the case of
a. Public deposits
b. Bank borrowings
c. Intercorporate deposits
d. Commercial paper
e. Both (c) and (d) above.
320. Which of the following is true regarding bank lending to a finance company?
a. It can be in the form of cash credit only and should not exceed 4 times the NOF.
b. It can be in the form of term loan only and should not exceed 6 times the NOF.
c. It can be in the form of bill discounting only and should not exceed 4 times the
NOF.
d. It can be in the form of cash credit only and should not exceed 6 times the NOF.
e. None of the above.
321. Which of the following statements is/are true?
a. The implicit cost of the deemed deposits is more than their explicit cost.
b. An exchangeable bond is a combination of debt of one company which is converted
into equity of another company.
c. The provisions of the Indian Contract Act, 1872 governing bailment prohibit the
lessee from entering a sub-lease.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
322. Mr Anand deposited Rs.7,000 under the cumulative deposit scheme of Garg Finance
Limited. The tenure of the deposit is 12 months and the rate of interest is 15% p.a.
(compounded monthly). The annual yield on this deposit is
a. 15%
b. 16.08%
c. 17.52%
d. 18%
e. 18.15%.
323. Kavya deposits Rs.2,000 in a deposit scheme of Sneha Finance Company. The nominal rate
of interest on this deposit is 15% p.a. compounded monthly. If the tenure of the deposit is
12 months, the amount receivable by Kavya on maturity is
a. 2,240
b. 2,300
c. 2,322
d. 2,400
e. None of the above.
324. As per SEBI guidelines, a finance company issuing non-convertible debentures will have to
get the issue rated by an approved rating agency, if the initial term to maturity exceeds
______ months.
a 12
b. 15
c. 18
d. 24
e. 36.

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325. Securitization is advantageous because

a. It enables the originator to unlock its investment in certain illiquid assets
b. It provides funds with maturity comparable to the maturity of the assets securitized
c. It involves very low development costs
d. The time and effort required to co-ordinate an issue is low
e. Both (a) and (b) above.
326. As per the prudential norms for non-banking financial companies, sub-standard assets are
those assets which have remained NPA for a period
a. Not exceeding six months
b. Not exceeding one year
c. Not exceeding two years
d. Exceeding two years
e. None of the above.
327. A cash certificate of Rs.2,000 is issued at a discount and redeemed at par after 12 months.
Given that the yield is 15%, the issue price will be
a. Rs.1,550
b. Rs.1,579
c. Rs.1,739
d. Rs.1,790
e. None of the above.
328. In the credit rating symbols given by CRISIL, adequate safety of timely payment of interest
and principal is indicated by:
a. BB
b. B
c. A
d. AA
e. AAA.

LEGAL ASPECTS OF LEASING

329. The implied obligations of lessor and lessee in an equipment lease transaction can be
understood from the
a. Transfer of Property Act, 1882
b. Indian Contract Act, 1872
c. Hire Purchase Act, 1972
d. Indian Registration Act, 1899
e. None of the above.
330. Which of the following statements is/are true with respect to the ‘process of lease
documentation’?
a. A ‘letter of offer’ is prepared by the lessee indicating the acceptable terms and
conditions of the lease proposal.
b. In master lease agreement the lease facility is offered to the lessee in the form of a
lease line.
c. Equipment lease agreement should be registered as per the Indian Registration Act,
1908.
d. The warranties in respect of the equipment can be availed by the lessee.
e. Both (b) and (d) above.

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 Part I

331. The denial of lessor’s responsibility for any defects in the equipment is defined in which of
the following clauses?
a. Description clause.
b. Ownership clause.
c. Exemption clause.
d. Repairs and alterations clause.
e. Default clause.
332. Which of the following is/are true regarding a contract of bailment?
a. Bailment does not commence until the goods are delivered to the bailee.
b. The bailee has an implied obligation not to act in a manner inconsistent with the
terms of the bailment.
c. The bailor need not disclose to the bailee any faults in the goods bailed of which the
bailor is aware.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
333. In a lease agreement, the clause which specifies that upon expiry of the lease term the
lessee must deliver the equipment to the lessor is referred to as:
a. Exemption clause
b. Ownership clause
c. Equipment delivery clause
d. Surrender clause
e. None of the above.
334. The clause in a lease agreement which states that no right, title or interest in the leased
asset shall pass to the lessee is called the
a. Description clause
b. Exemption clause
c. Ownership clause
d. Default clause
e. Surrender clause.
335. Which of the following statements is/are false?
a. The definition of ‘bailment’ under The Indian Contract Act, 1872 closely resembles
the equipment lease transaction.
b. Bailor ‘can be taken as counterpart of the lessor’ and the ‘bailee’ can be taken as the
counterpart of the lessee.
c. The commencement of ‘bailment’ requires the delivery of the goods.
d. If the goods are destroyed, bailee is not liable to indemnify the bailor for loss.
e. The goods must be delivered to the bailor on the expiry of fixed time.
336. The differences between the bailment and the equipment leasing is/are
a. Equipment lease in the Indian context contains a purchase option whereas bailment
does not
b. Bailor has to supply the goods to the bailee according to his specifications
c. ‘Equipment lease’ requires the equipment supplier sometimes whereas the
‘bailment’ transaction does not require
d. Creditors of the bailor can take by law possession of the ‘bailed goods’ from bailee
which is not possible in lease transaction
e. None of the above.

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337. ‘Process of lease documentation’ contains

a. A ‘letter of offer’ which is to be sent to lessee specifying the terms and conditions
b. A ‘letter of offer’ which should be passed by the board of leasing company because
it is required statutorily
c. Registration of the equipment lease transaction which is essential
d. ‘Tripartite agreement’ under which the lessor is to select the equipment supplier
e. Both (a) and (d) above.
338. Which of the following statements is true?
a. The implied obligations of the lessor and the lessee in an equipment lease
transaction are defined by the Transfer of Property Act, 1882.
b. Bailment, by definition includes a lease with a purchase option.
c. A contract of bailment is similar to a hire purchase contract in the sense that it
provides an option to the bailee to purchase the goods concerned as per the terms
and conditions of the contract.
d. There is no uniform format for lease agreement.
e. None of the above.
339. Which of the following statements is/are true?
a. The change of location of the equipment by the lessee sometimes requires the prior
permission of the lessor.
b. The lessor owns no responsibility for any defect in the equipment.
c. Lessee is not entitled to avail the benefits of the warranties provided by the
manufacturer.
d. Both (a) and (b) above.
e. Both (b) and (c) above.
340. Which of the following statements is/are false?
a. Lessor should take the responsibility of delivering the equipment on the specified
date.
b. Any improvements made to the equipment by the lessee will belong to the lessee.
c. A sale and lease back transaction is an example of bailment involving constructive
delivery.
d. A tripartite lease is a leveraged lease transaction involving three parties, the loan
participant, the equity participant (lessor) and lessee.
e. Both (a) and (c) above.
341. Which of the following statements is/are true?
a. In a tripartite commercial agreement, the supplier recognizes the interests of the
lessor.
b. The Hire Purchase Act, 1972 defines the implied obligations of the lessee and the
lessor.
c. The letter of offer is usually made by the lessee wherein it indicates the acceptable
terms and conditions of the lease.
d. A finance lease agreement invariably requires the lessee to insure the equipment.
e. All of the above.
342. ‘Set-off provisions’
a. Are primarily meant to protect the interests of the ‘lessee’
b. Are primarily meant to protect the interests of the ‘lessor’
c. Include hell or high water clause
d. Both (a) and (c) above
e. Both (b) and (c) above.

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 Part I

TAX ASPECTS OF LEASING

343. Which of the following statements is/are true?
a. As per the new accounting standard AS-19 lessee can claim depreciation tax shields.
b. The lessee can claim depreciation allowance on leased assets like furniture and
fixtures because any asset used in the assessee’s trade is eligible for depreciation.
c. The lessor can claim depreciation tax shield.
d. Depreciation on leased assets cannot be claimed by lessor or the lessee.
e. Both (a) and (b) above.
344. As per Income Tax Act, 1961
a. The rental expense on leased assets can be treated as a tax deductible expense in the
accounts of lessee
b. The expenses incurred by lessee towards insuring and maintaining the equipment are
not allowed as tax deductible expenses
c. If the lessor has acquired the asset for commercial purpose and let it on lease or hire,
the rental income must be assessed under the head ‘Income from Other Sources’
d. If it is alleged that the main purpose of a sale and leaseback transaction is to reduce
the lessor’s liability to income tax, the onus of proof is on the assessing officer
e. Both (a) and (d) above.
345. The annual tax shield associated with leasing an equipment costing Rs.300 lakh for an
annual lease rental of Rs.44.3 ptpm, if the marginal tax rate is 46%, is
a. Rs.130.9 lakh
b. Rs.132.9 lakh
c. Rs.140 lakh
d. Rs.61.13 lakh
e. Rs.66.45 lakh.
346. Alankar Ltd. is evaluating the leasing alternative of the equipment whose cost is Rs.80 lakh
(exclusive of sales tax) from Evan Leasing Company. What would be the cost of equipment
inclusive of sales tax to ELC and to Alankar Ltd., if it were to purchase the equipment?
a. Rs.88 lakh and Rs.83.2 lakh
b. Rs.83.2 lakh and Rs.88 lakh
c. Rs.88 lakh and Rs.88 lakh
d. Rs.83.2 lakh and Rs.83.2 lakh
e. None of the above.
347. Which of the following statements is/are true?
a. An equipment supplier for leasing transactions cannot claim the concessional rate of
sales tax.
b. If a leasing company buys an equipment from a supplier within the same state and
leases it to a lessee within the same state, the equipment is exempted from second
levy of sales tax.
c. Clause 29A of 46th amendment states that the tax on purchase or sale of goods
includes a tax on the transfer of the right to use the goods for any purpose for cash
deferred payment or other valuable consideration.
d. Both (a) and (c) above.
e. Both (b) and (c) above.

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348. The cost of a capital equipment exclusive of sales tax is Rs.60 lakh. The quote of leasing
company on a five-year lease is Rs.27.5 ptpm payable at the end of every month excluding
sales tax. The leasing company is required to pay sales tax at 5 percent on the quoted lease
rental. The lease rental to be collected is
a. Rs.1.92 lakh
b. Rs.1.906 lakh
c. Rs.1.737 lakh
d. Rs.1.815 lakh
e. Rs.1.65 lakh.
349. As per the Income Tax Act, 1961, depreciation is calculated
a. On WDV method only at the rates given in the Act
b. On WDV method or SLM method at the rates given in the Act
c. On blocks of assets by clubbing all the assets of same rate of depreciation together
d. On individual assets
e. Both (a) and (c) above.
350. Which of the following is not considered as a sale under the CST Act?
a. Transfer of property in goods for deferred payment.
b. Hire purchase.
c. Hypothecation.
d. Pledge.
e. Both (c) and (d) above.
351. Depreciation allowance on leased assets
a. Is claimed by the lessor
b. Is claimed by the lessee
c. Is claimed by both lessee and lessor in the case of cross-border lease
d. Both (a) and (c) above
e. Both (b) and (c) above.
352. As per the Income Tax Act, 1961
a. Lessee can claim the depreciation tax shields on leased assets
b. Lessee can claim the maintenance costs of the leased assets
c. In a sale and leaseback transaction, the lessee cannot claim depreciation on a cost
which is higher than the book value of the asset as on the date of transsfer
d. A lease where more than ninety percent of the cost of the asset is recovered over the
non-cancellable term is not regarded as a “true lease”
e. Both (b) and (d) above.
353. As per the Section 32 of Income Tax Act, 1961
a. Depreciation is allowed as a tax-deductible expense if the asset is used by the
assessee for the purpose of business
b. Depreciation is computed with reference to the actual cost of the asset
c. WDV method is used for plant and machinery and SLM method is used for the rest
of the items
d. Depreciation is charged not on an individual asset but on a block of asset
e. All of the above.

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 Part I

354. Which of the following statements is/are true?

a. The lessor can claim the depreciaton tax shields as the leased assets are deemed to
be used in the lessors business of leasing and hire purchase.
b. Any asset used in the assessee’s leasing and hire purchase business is treated as a
plant.
c. The lessor cannot claim the depreciation tax shields as he transfers the right to use
the asset to the lessee.
d. Both (a) and (b) above.
e. Both (b) and (c) above.
355. Which of the following statements is/are true?
a. IT Act, 1961 does not distinguish between an operating lease and finance lease to
determine the allowable tax deductions for both the lessor and lessee.
b. As per the provisions of CBDT circular issued in 1943 an open-ended lease will
qualify as a hire purchase transaction.
c. A lease transaction which covers a short period of the life of the asset and
substantially recovers the investment cost is treated as hire purchase transaction for
the income tax purpose.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.
356. Which of the following statements is/are false?
a. A purely tax driven rental structure is not allowed by the Income Tax authorities.
b. Lessee can reduce the tax liability by using flexibility in structuring lease rentals.
c. Lessee can obtain the benefit of unabsorbed capital allowances in the form of lower
lease rentals.
d. A 100% EOU company cannot avail the acquisition-related tax shields but can avail
the lease related tax shelters.
e. None of the above.
357. A lease transaction attracts sales tax
i. When the asset is sold by the lessor at the end of the lease period.
ii. When the asset is purchased by the lessor for the purpose of leasing.
iii. When the right to use the asset is transferred to the lessee for valuable consideration.
a. (i) only
b. All (i), (ii) and (iii) above
c. (ii) only
d. (iii) only
e. (i) and (iii).
358. Levy of Sales Tax
a. Is governed by the Central Sales Tax Act, 1957
b. Is governed by the Sales Tax Laws enacted by the state legislatures
c. Depends upon the nature of the sale
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.
359. A sale or purchase which takes place in the course of Export or Import
a. Attracts Central Sales Tax
b. Attracts State Sales Tax
c. Attracts both Central and State Sales Tax
d. Attracts concessions from the Central Sales Tax
e. None of the above.

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360. Sales Tax on interstate purchase of equipment

a. Will attract the Section 8 of the CST Act
b. Will include the Sales Tax at the rate of 4% or at the rate applicable within the
appropriate state
c. If it is for the purpose of resale cannot avail the concessional rate of sales tax
d. Both (a) and (b) above
e. None of the above.
361. Sales Tax at a concessional rate of 4% cannot be availed in which of the following cases?
a. When the equipment is purchased for the purpose of leasing.
b. When the equipment is purchased for the purpose of resale.
c. When the equipment is purchased for the manufacturing process.
d. Both (a) and (b) above.
e. Both (b) and (c) above.
362. Which of the following statements is/are false?
a. As per the Central Sales Tax Act lease is not a form of sale.
b. Value of lease rentals is always less than the cost of equipment if purchased directly.
c. Concessional sales tax is not applicable when equipment is purchased for the
purpose of leasing.
d. The cost of equipment is always greater to the lessor than to lessee due to the
different rates of CST.
e. None of the above.
363. Which of the following statements is/are true?
a. An equipment lease which transfers the right to use an equipment for a very short
period of time is not deemed a sale under Article 366 (29A) of the Constitution.
b. The Sales Tax Law of a state cannot levy Sales Tax on a lease transaction which
transfers the right to use goods for domestic purposes.
c. Article 366 (29A) of the Constitution does not provide for a tax on the transfer of the
right to use goods not supported by a valuable consideration.
d. 46th Amendment is made to the constitution to levy tax on non-conventional sales
or purchases.
e. Both (c) and (d) above.
364. State which of the following statements is/are false.
a. An equipment lease transaction suffers a multipoint levy irrespective of the goods
covered by the transaction
b. Section 3(a) of CST Act gives the definition for interstate lease
c. As per the Article 286 of the constitution, an interstate sale is outside the taxing
powers of the state
d. The lessee should pay the additional Central Sales Tax suffered by the lessor and
bear the sales tax on lease rentals
e. None of the above.
365. State which of the following statements is/are true.
a. A hire purchase transaction is not a deemed sale under the Central Sales Tax Act.
b. Article 286 of the constitution imposes certain restrictions on the taxing powers of
the states.
c. The taxable rent for the purpose of levying Sales Tax on lease rentals is the transfer
of the right to use.
d. Both (a) and (b) above.
e. Both (a) and (c) above.

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 Part I

366. Unexpired finance charge is the

a. Present value of the lease payments
b. Difference between the present value of the lease payments and fair market value of
the asset
c. Sum of the lease payments over the entire lease period
d. Difference between the sum of the lease payments over the entire lease period and
present value of the lease payments
e. None of the above.
367. As per IAS 17
a. The lessor has to charge the depreciation on leased equipment to profit and loss
account
b. The lessor has to capitalize the minimum of fair market value of the equipment or
present value of the minimum lease payments
c. The lessee has to debit the finance charges to profit and loss account
d. The lessor has to disclose the leased equipment as fixed assets in his balance sheet
e. All of the above.
368. As per IAS 17 requirements the unexpired finance charge can be allocated as per
a. Actuarial Method
b. Straight Line Method
c. Sum of Digits Method
d. At the discretion of the lessee
e. Both (a) and (c) above.
369. Which of the following statements is/are true?
a. ICAI guidelines require the lessee to capitalize the leased asset.
b. The SOYD method is also known as Rule of 78 method.
c. Lease rentals should be charged to the P&L account by the lessee, as per IAS-17.
d. As per IAS 17, the finance charge and depreciation charge for each accounting
period should be equal.
e. Both (c) and (d) above.

LEASE EVALUATION: THE LESSEE’S ANGLE

370. As per the Weingartner’s model the equipment should be leased if
a. NPV(L) > 0
b. NPV(L) < NPV (B)
c. NPV(L) > NPV (B)
d. NPV(L) > NPV (B) > 0
e. NPV(L) < NPV (B) < 0.
371. Weingartner’s model assumes that the target capital structure is a mix of
a. Debt and equity
b. Replaced debt and equity
c. Debt, lease finance and equity
d. Lease finance and equity
e. Debt and lease finance.

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372. The discount rate to be used as per Weingartner’s model is/are

a. Marginal cost of capital
b. Pre-tax marginal cost of debt
c. Post-tax marginal cost of debt
d. Multiple discount rates
e. None of the above.
373. Which of the following model assumes that the debt which will be raised in lieu of the lease
will be equal to the initial investment?
a. Equivalent Loan Model.
b. Bower-Herringer-Williamson Model.
c. Weingartner’s Model.
d. Bower’s Model.
e. Both (b) and (d) above.
374. Which of the following statements is/are false?
a. Financial advantage of lease is given by cash flow stream related to tax shields and
residual value.
b. Under Bower’s Model the discount rate to be used for tax shields is at the discretion
of decision maker.
c. BHW Model assumes that the risk characterizing the lease tax shields is equal to the
risk complexion of the firm.
d. Equivalent Loan Model uses the pre-tax marginal cost of debt as risk adjusted
discount rate.
e. All of the above.
375. Break even lease rental for the lessee
a. Reflects the minimum rental which the lessee is willing to pay
b. Decreases if the upfront payment is larger
c. Decreases with a higher tax relevant rate of depreciation
d. Increases with a longer primary lease period
e. Increases with a higher net salvage value.
376. In a Back-to-Back short-term lease arrangement
a. Each short-term lease is a cancellable lease
b. The cost of the asset is fully amortized over one short-term lease
c. The lessor enjoys the right of cancelation after each short period
d. The lease rates at which the future leases will be renewed are to be determined at the
inception of the lease
e. None of the above.

LEASE EVALUATION: THE LESSOR’S ANGLE

377. The break even lease rental
a. Is a floor price of a lease to the lessee
b. Is the maximum lease rental that a lessor can expect
c. For the lessor can be obtained by equating the net value of lease from the lessor’s
point of view to zero
d. Both (a) and (c) above
e. All of (a), (b) and (c) above.

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 Part I

378. If the tax relevant rate of depreciation is 100% and the lease transaction is set-up at the end
of the financial year
a. The lessor can claim 100% of the first year depreciation as tax deductible expense
b. The lessor can claim 50% of the first year depreciation as tax deductible expense
c. The lessor cannot claim the first year depreciation as tax deductible expense
d. The lessor can claim 25% of the first year depreciation as tax deductible expense
e. None of the above.
379. Negotiation of lease rentals is possible only
a. When the break even rental of the lessor is less than that of the lessee
b. When the break even rental of the lessor exceeds the break even rental of the lessee
c. When the net advantage of lease is positive for the lessor only
d. When the net advantage of lease is positive for the lessee only
e. Both (a) and (d) above.
380. Which of the following will influence the gross yield on a lease proposal from the point of
view of the lessor?
a. Tax shield on depreciation.
b. Tax payable on lease rentals.
c. Residual value of the equipment.
d. Tax shield on displaced debt.
e. All of the above.
381. Add-on yield
a. Is a true measure of the interest rate implicit in a lease transaction
b. Is more or less similar to the effective rate of interest
c. Does not recognize the fact that every lease rental paid under the finance lease has a
capital content and an interest content
d. Is always higher than the gross yield of a lease
e. Both (b) and (d) above.
382. Calculate the add-on yield for the Sumitra Leasing Company which is proposing to give an
equipment costing Rs.36 lakh for lease with a monthly rental of Rs.25 ptpm payable in
advance for 5 years?
a. 10%
b. 12%
c. 15%
d. 19.53%
e. 20%.
383. The hurdle rate for the gross yield is given by
a. Marginal cost of capital
b. Marginal cost of debt
c. Post-tax marginal cost of debt plus a profit margin
d. Pre-tax cost of funds plus a profit margin
e. None of the above.
384. In the explicit judgmental approach to credit rating
a. ‘Zero’ refers to the most favorable assessment
b. The weights assigned to the various factors are subjectively determined
c. Highly complex procedure is involved
d. Rating is based on qualitative analysis only
e. Techniques of statistical analysis are employed to identify the set of factors deemed
relevant for credit rating.

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LEASE ACCOUNTING AND REPORTING

385. Which of the following statements is/are true?
a. There is no difference of opinion between the IASC and leasing industry about the
accounting aspects of operating lease.
b. As per IAS 17 the finance lease transactions have to be revealed in the lessee’s
balance sheet.
c. As per IAS 17 the lessor has to record the present value of the lease rentals over the
lease term as a part of current assets.
d. Capitalization debate is the disagreement that is existing between the leasing
industry and the accounting bodies.
e. All of the above.
386. Which of the following statements is/are false?
a. As per the actuarial method of allocation of the unexpired finance charge, the
interest component in lease payments decreases in the later periods.
b. IAS 17 requires the effective rate of interest method to allocate the unexpired
finance charge to each accounting period.
c. The unexpired finance charge is the difference between sum of the lease payments
over the entire lease period and present value of the lease payments.
d. Actuarial method is also known as the flat rate of interest method.
e. All of the above.
387. As per AS-19 guidelines, in an operating lease
a. The aggregate lease rentals must be spread over the relevant account periods on a
straight line basis
b. The prepaid rental will appear as a current liability in the books of the lessee
c. The lessor should normally recognize the rental income on a straight-line basis
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.
388. Long-term leases of land and buildings
a. Should be treated as finance leases
b. Should be treated as operating leases
c. Will transfer substantial risks and rewards associated with ownership to the lessee
d. Both (a) and (c) above
e. Both (b) and (c) above.

HIRE PURCHASE
389. The ownership is transferred in a hire purchase transaction
a. When the hirer pays the first installment
b. When the hirer pays the last installment
c. When the hirer exercises the option to purchase
d. Both (b) and (c) above
e. None of the above.
390. Hire purchase transaction entails the hirer
a. The right to cancel the agreement at any time before the payment of last installment
b. The right to purchase the asset at any time before the payment of last installment
c. The right to own the asset after the payment of the last installment
d. Both (b) and (c) above
e. All of (a), (b) and (c) above.

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 Part I

391. The ownership on the asset will be transferred to the buyer on the payment of first
installment in
a. Hire purchase transaction
b. Installment sale
c. Lease transaction
d. Both (b) and (c) above
e. All of (a), (b) and (c) above.
392. Which of the following statements is/are true?
a. In a hire purchase transaction the buyer is committed to pay the full price.
b. The interest component of each hire purchase installment is always calculated on the
basis of effective rate of interest.
c. A common feature of hire purchase option and conditional sale is the transfer of
ownership on the asset on payment of the first installment.
d. A lease with purchase option can be considered as hire purchase transaction.
e. None of the above.
393. Which of the following statements is/are true?
a. Effective rate of interest ignores the fact that the original amount of loan is repaid in
installments over the term of loan.
b. For a given effective rate of interest, the equivalent flat rate of interest is always
higher.
n
c. The approximation formula i = . 2f is used to determine the effective rate of
n +1
interest in a hire purchase transaction when hire payments are in arrears.
n
d. The approximation formula i = . 2f is used to determine the effective rate of
n −1
interest in a hire purchase transaction when the hire payments are in advance.
e. Both (c) and (d) above.
394. Given the rate of interest of 14% flat, repayment period 4 years, frequency of payment
being monthly in advance, which of the following will reflect the annual percentage rate?
a. 28.6%
b. 14%
c. 27.42%
d. 20.0%
e. 16%.
395. Which of the following statements is/are true?
a. Change in profile of monthly payments from ‘advance’ to ‘arrears’ will always
increase the effective rate of interest.
b. Flat rate of interest in a hire purchase transaction will reflect the effective cost of
funds.
n(n + 1)
c. The approximation formula i = . 2f assumes that the payments are in arrears.
n
d. The effective rate of interest implied by a down payment plan is generally less than
the effective rate of interest implied by deposit linked plan.
e. Both (c) and (d) above.

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396. Which of the following statements is/are true?

a. The effective rate of interest charged by finance companies is not subject to any
regulations.
b. Interest rebate to the borrower can be obtained by applying the effective rate of
interest method only according to the Hire Purchase Act.
c. If a deferment period is applied while calculating interest rebate, the rebate will
decrease.
d. Both (a) and (c) above.
e. All of (a), (b) and (c) above.
397. Given that the charge for credit is Rs.300 and repayment period is 36 months, calculate the
interest rebate using sum of years digits method if the borrower wishes to repay the
outstanding loan after the payment of 24th installment?
a. Rs.35.14
b. Rs.67.45
c. Rs.50.42
d. Rs.30.12
e. Rs.60.12.
398. Given the total credit charge as Rs.318, repayment period 3 years, calculate the interest
rebate if the borrower wishes to repay the outstanding amount after the payment of 24th
installment using the modified Rule of 78 method using the deferment period of 2 months?
a. Rs.25.00
b. Rs.26.26
c. Rs.37.24
d. Rs.30.12
e. Rs.25.23.
399. The interest rebate calculated by
a. Effective rate of interest method is more accurate than interest rebate calculated by
other methods
b. Sum of years digit method is greater than the interest rebate calculated by modified
Rule of 78 method
c. Rule of 78 method is greater than the interest rebate calculated by effective rate of
interest method
d. Both (a) and (b) above
e. Both (b) and (c) above.
400. Which of the following statements is/are true regarding hire purchase?
a. The title to the goods should be transferred to the hirer at the time of delivering the
goods.
b. The possession of goods by the hirer should not be hampered by the acts of third
parties.
c. The effective rate of interest on the completed transaction is less than the effective
rate of interest on the original transaction if the interest rebate is calculated as per the
Rule of 78 method.
d. Some occasional delays in payment over the hire period empower the owner to
terminate the contract.
e. Both (b) and (d) above.

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401. Which of the following statements is/are true?

a. As per the Hire Purchase Act, 1972, the lessor is required to arrange for a
comprehensive insurance cover for the goods hired.
b. A hire purchase agreement provides for the right of the hirer to determine the hire
purchase contract at any time before the final payment.
c. A hire purchase transaction establishes a direct contractual relationship between the
hirer and the equipment supplier.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
402. Legal aspects of hire purchase transaction are governed by
a. Hire Purchase Act, 1972
b. Indian Contract Act, 1872
c. Sale of Goods Act, 1930
d. Judgments pronounced by the English and Indian Courts from time to time
e. All of the above.
403. Which of the following statements is/are true?
a. The cash purchase price less the down payment is capitalized in the books of hirer.
b. Depreciation is charged on the cash purchase price of the asset.
c. Unmatured finance income is shown as a current liability in the books of the finance
company.
d. Both (a) and (b) above.
e. Both (b) and (c) above.

CONSUMER CREDIT
404. Mr. Gopal purchased a Videocon Color Television set with a consumer loan of Rs.14,000.
He pays an EMI of Rs.780 each for a period of 24 months. Calculate the flat interest
charged from him.
a. 9.50%
b. 16.85%
c. 11.25%
d. 12.00%
e. None of the above.
405. State which of the following statement(s) are false, with respect to Consumer Credit Act,
1974 of the UK.
a. The Act allows borrower to pause and reflect over his decision after signing the
agreement under certain circumstances.
b. It permits the borrower to opt for early repayment.
c. It defines the types of ancillary charges to be included for the purpose of
determining the total charge for credit.
d. It does not insist on a license for the intermediary which provides consumer credit.
e. Both (a) and (d) above.
406. A consumer credit transaction is not structured in the form of
a. Hire purchase
b. Conditional sale
c. Credit sale
d. Lease with an option to purchase
e. None of the above.

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407. Which of the following criteria is not considered while extending consumer loans to
individuals?
a. Minimum level of annual emoluments.
b. Minimum take-home salary.
c. Net worth of employing company.
d. Number of years in the present employment.
e. None of the above.
408. Which of the following statements is/are true?
a. The difference between the consumer credit and hire purchase is that the hire
purchase is secured through a first charge on the asset while the consumer credit is
not.
b. Consumer credit transaction is always a tripartite transaction.
c. In a conditional sale contract, the ownership is transferred to the customer on
payment of the first installment.
d. ‘Consumer credit’ encompasses all asset-based financing plans.
e. All of the above.
409. Consumer Credit
a. Is asset-based financial plan
b. Allows customer to pay in installments to acquire the asset
c. Is a financing plan offered primarily to buyers of consumer durables
d. Allows customers to choose the repayment schedule based on their convenience
e. All of (a), (b) and (c) above.
410. Effective rate of interest is given by
n
a. 2f, if payments are in advance
n +1
n
b. 2f, if payments are in arrears
n −1
c. The rate of interest which equates the present value of all the cash flows in the
transaction to zero
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.

FACTORING AND FORFAITING

411. Which of the following is not a function of a factor?
a. Credit rating.
b. Collection of receivables.
c. Maintaining sales ledger.
d. Credit protection.
e. None of the above.
412. In which of the following types of factoring does the factor purchase the receivables on the
condition that the loss arising on account of irrecoverable receivables are transferred to the
client?
a. Advance factoring.
b. Recourse factoring.
c. Non-recourse factoring.
d. Maturity factoring.
e. Full factoring.

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413. Which of the following is true with respect to cross-border factoring?

a. The export factor collects the dues directly from the importer.
b. The export receivables are always factored on a recourse basis.
c. The import factor collects the receivables and directly remits to the exporter.
d. It is known as the four-factor system.
e. Export factor enters into a contract with an import factor, who carries out the work
of credit checking, sales ledger administration and collection.
414. Which of the following is/are not (a) form(s) of factoring?
a. Invoice discounting.
b. Bill discounting.
c. Supplier guarantee factoring.
d. Forfaiting.
e. Both (b) and (d) above.
415. Which of the following statements is/are true?
a. The exporter sells the goods to the importer on a deferred payment basis spread over
15-20 years.
b. In credit insurance, insurance company not only helps in collection of receivables,
but also settles the claims of insured accounts.
c. A factor charges delcredere commission in credit granting process under non-
recourse factoring.
d. In full factoring, factor extends services like credit protection, collection, and short-
term finance.
e. Both (c) and (d) above.
416. Under which of the following types the factor does not make any advance payment to the
client?
a. Bank participation factoring.
b. Full factoring.
c. Non-recourse factoring.
d. Maturity factoring.
e. Recourse factoring.
417. Which of the following statements is false?
a. Delcredere commission is not charged by factor in recourse factoring.
b. The factor provides advance payment in case of full factoring.
c. In supplier guarantee factoring, the supplier or dealer makes arrangements for
shipping the supplies directly to the customer on approval.
d. Maturity factoring is also known as ‘confidential factoring’.
e. Cross-border factoring is referred as two-factor system of factoring.
418. In which type of factoring does the factor guarantee payment to the supplier in respect of a
specific shipment?
a. Cross-border factoring.
b. Supplier guarantee factoring.
c. Forfaiting.
d. Invoice discounting.
e. Confidential factoring.

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419. Which of the following is false with respect to forfaiting?

a. The importer draws a series of promissory notes in favor of exporter for the
payments to be made exclusive of interest charges.
b. The promissory notes are guaranteed by a reputed international bank or importer’s
bank.
c. The exporter sells the availed notes to a forfaiter at a discount without recourse.
d. The forfaiter may hold these notes till maturity or sell these notes to groups of
investors.
e. None of the above.
420. In which of the following forms of factoring does the factor extend all the related services
to his client?
a. Maturity factoring.
b. Advance factoring.
c. Full factoring.
d. Bank participation factoring.
e. Recourse factoring.
421. Mohita Factors Ltd. extends an advance of Rs.14 lakh to its client Naidu Pharma Ltd. at an
interest rate of 4.75% per quarter. What is the effective annualized rate of interest paid by
NPL?
a. 18.11%
b. 20.40%
c. 19.23%
d. 21.11%
e. 19.86%.

SECURITIZATION
422. Which of the following statements is/are true?
a. Any resource with predictable cash flows can be securitized.
b. Securitization means selling old debts in the form of securities.
c. Securitization helps an institution in raising funds out of its debt portfolio.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
423. ‘Special Purpose Vehicle’
a. Originates the assets through receivables, leases, housing loan or any other form of
debt
b. Will issue debt and purchase receivables from the originator
c. Will obtain an investment credit rating and make the transaction attractive to the
investors
d. Is intended to manage the issue of the securities
e. All of the above.
424. Which of the following statements is/are not true?
a. Securitization transforms an illiquid asset on the balance sheet into cash.
b. In a whole loan sale all rights and responsibilities connected with a mortgage loan
are transferred to the purchasers.
c. Whole loan requires the loan-by-loan review by the purchaser.
d. A whole loan sale is always with recourse to the seller.
e. None of the above.

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425. Which of the following is a collateralized term-debt offering?

a. Mortgage-backed bond.
b. Mortgage pass-through securities.
c. Collateralized mortgage obligation.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
426. Which of the following statements is/are true?
a. The average life of mortgage pass-throughs depends on prepayment experience of
underlying mortgages.
b. The pattern of cash flows is highly uncertain in CMO’s.
c. The returns to the investors of interest only and principal only securities move in
opposite direction.
d. Both (a) and (b) above.
e. Both (a) and (c) above.
427. Which of the following is/are features of asset-backed securities?
a. The installment contract asset-backed securities investor will have an ‘undivided’
interest in a trust formed by the issuer.
b. The revolving credit asset-backed securities are usually backed by credit card
receivables.
c. The asset-backed security market is dominated by securities backed by automobile
loans and credit receivables.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
428. Which of the following is not an advantage of securitization?
a. The loan originators can raise money as soon as they originate loans.
b. Securitization deals help the originator beat the credit rating given to the company.
c. It enables the originator to take advantage of more profitable investment
opportunities.
d. It enables raising of funds without altering the capital adequacy ratio.
e. None of the above.
429. STRIPs are
a. Securitized Trade Related Investment Proposals
b. Securities Tranche Investment and Principal
c. Separate Tranche Interest and Principal
d. Separate Trading of Registered Interest and Principal Securities
e. Both (c) and (d) above.
430. Which of the following is false with respect to whole loans?
a. A whole loan sale is always without recourse to the seller.
b. A seller may retain the right to service the loans.
c. The loan documents and trust deeds are transferred to the buyer with a proper
assignment deed.
d. Whole loans are not of much use as a medium of liquidity.
e. Both (a) and (d) above.

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431. Which of the following factors are considered as impediments with respect to development
of securitization in India?
a. Levy of high stamp duty.
b. Restrictions on transfer of property without intervention of the court of law.
c. Strict capital adequacy norms.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
432. The mortgage pass-through securities were designed to serve the following purpose
a. To enhance the creditworthiness of the sale of mortgage loans
b. To create a security that would be more freely tradeable and transferable
c. To create a security that would not necessarily involve the inspection of each loan as
done in case of whole loan sales
d. Both (b) and (c) above
e. All of (a), (b) and (c) above.

MORTGAGES AND MORTGAGE INSTRUMENTS

433. An adjustable rate mortgage is the same as:
a. CMO
b. Roll over mortgage
c. Buy down loan
d. SAM
e. PAM.
434. Which of the following statements is false?
a. Mortgage-backed bonds are debt obligations of mortgage originator.
b. CMOs retain many of the yield and credit quality advantages of pass-throughs,
while eliminating some of less desirable elements of the traditional mortgage-backed
security.
c. SAMs use inflation as a way of paying for the property.
d. GPMs have equal installments unlike traditional mortgages.
e. In pledged amount mortgages the borrower pays a variable amount of installment
while the lender receives an equated amount.
435. Which of the following is not a feature of ARM?
a. The mortgage interest may change only once in six months period and may not be
changed at all during the first six months.
b. The mortgage interest in the US is based on the weighted average cost of savings
index published by the Federal Home Loan Bank of San Francisco.
c. The mortgage interest rate may not rise beyond a predetermined level irrespective of
the rise in the index.
d. Whenever the mortgage rate is increased to a rate higher than its initial level, the
borrower may opt to keep his monthly payment constant by extending the maturity
of the mortgage.
e. Decrease in the mortgage rate is optional on the part of the lender, but an increase is
mandatory.
436. The Loan To Value ratio or LTV
a. Will increase as the mortgage balance decreases
b. Indicates the percentage of down payment required by lenders
c. Will be quoted high in times of lower interest rates
d. Both (a) and (b) above
e. Both (b) and (c) above.

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437. A Loan To Value (LTV) ratio of 85% means

a. The borrower can be sanctioned a loan equal to 15% of the value of the property on
which the mortgage is taken
b. The borrower can be sanctioned a loan which can be repaid with 15% of his net
income
c. The borrower has to make a down payment of 15% of the value of the property
d. The borrower has to provide a security deposit of 15% of the value of the property
e. None of the above.
438. A traditional mortgage is characterized by
a. Floating rate of interest
b. The payment of equated monthly installments
c. The payment of interest on monthly basis and the payment of principal after a
stipulated period
d. The interest payment every month and equal portions of principal every month
e. None of the above.
439. Which of the following statements is/are true?
a. As the mortgage balance decreases, in a traditional mortgage the homeowner’s
equity rises.
b. Mortgage balance at any time is the outstanding amount of principal and interest up
to that point of time.
c. The difference between the current market value of the home and the mortgage
balance equals the homeowner’s equity.
d. Both (a) and (b) above.
e. Both (a) and (c) above.
440. Which of the following statements is/are true with respect to Graduated Payment
Mortgages?
a. Graduated Payment Mortgage is a traditional form of mortgage.
b. These are characterized by the higher initial payments than the traditional
mortgages.
c. Sometimes the initial payments are so low that they do not even cover the interest.
d. Mortgage balance may increase with increase in time in the initial years.
e. Both (c) and (d) above.
441. Which of the following statements regarding Pledged Account Mortgages is/are true?
a. The lender receives equated monthly installments.
b. The lender is paid low level installments in the initial years and equated monthly
installments after the specified number of years.
c. The borrower pays low level installments in the initial years and equated monthly
installments after the specified number of years.
d. Both (a) and (b) above.
e. Both (a) and (c) above.
442. Which of the following statements is/are true?
a. In graduated payment mortgages the initial payments made by the borrower may
cover only the interest.
b. In ‘traditional mortgages’ a fixed rate of interest is charged on the loan for its entire term.
c. For a borrower under pledged account mortgages the payments resemble a
traditional mortgage payments.
d. The borrower under graduated payment mortgages is required to deposit some
amount at the beginning.
e. Both (a) and (b) above.

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REAL ESTATE FINANCING: RISK AND RETURN

443. A ‘Mini-perm’ loan is
a. Intended to protect both the borrower and the lender against volatile interest rates
b. Designed to provide long-term finance to the real estate investors
c. A medium-term loan and provides bridge finance till the real estate developer
obtains the financing of a more permanent nature
d. Covers the difference between the bank loan for construction and total cost of the
project
e. None of the above.
444. Which of the following will provide the developer the margin that he would have otherwise
invested from his own funds?
a. Gap loans.
b. Bow ties.
c. Mini-perms.
d. Direct Development and Syndications.
e. None of the above.
445. Which of the following forms of loan will hedge against interest rate risk?
a. Gap loans.
b. Bow ties.
c. Mini-perms.
d. Both (a) and (b) above.
e. All of the above.
446. Which of the following is/are features of the Real Estate Investment Trusts (REIT)?
a. These can be viewed as mutual funds.
b. They are exempt from tax.
c. The income received by the shareholders of REIT is subject to the double taxation.
d. Both (a) and (b) above.
e. All of the above.
447. Which of the following is not a feature of real estate?
a. Its value depends on local and regional economic conditions.
b. It is a durable asset with a long economic life.
c. Though there are very few buyers, the market is very active, and hence, it is easy to
assess the value of assets.
d. Transaction costs are higher when compared to other fixed assets.
e. None of the above.
448. Which one of the following is/are not active in real estate financing?
a. LIC.
b. HDFC.
c. Commercial Banks.
d. HUDCO.
e. NBFCs.

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449. Which of the following statements is/are false regarding real estate financing?
a. A bow tie arrangement is designed to protect both borrower and the lender against
volatile interest rate.
b. Some large savings and loan associations enter into land acquisition and
construction loans with the developers.
c. S&Ls also lend to cover the difference or gap between the bank construction loan
and total project cost.
d. S&L will not fund real estate development through joint ventures.
e. Both (b) and (d) above.

HOUSING FINANCE IN INDIA

450. Mr. Manish obtained a housing loan of Rs.3,50,000 for his flat @14.5% for 20 years from
HDFC. Calculate the monthly EMI that he has to pay to HDFC? (Calculate assuming that
interest is compounded monthly.)
a. Rs.4,525.
b. Rs.4,586.
c. Rs.4,356.
d. Rs.4,480.
e. Rs.4,624.
451. Which of the following document is not essential while applying for housing finance for
self-construction from a HFC?
a. Approved plan.
b. Non-encumbrance certificate.
c. Lay-out plan.
d. Clearance under ULC.
e. None of the above.

PLASTIC MONEY
452. Which of the following is false with respect to a credit card?
a. It enables the holder of the card to purchase goods without parting with cash
immediately.
b. There is a provision for spreading the payment over several installments.
c. The card is generally issued by business houses.
d. The interest charged on the credit allowed after the initial no-interest period is
generally much higher than interest on loans.
e. None of the above.
453. Which of the following statements regarding credit card and debit card is/are false?
a. The former is a ‘pay later’ product and latter is a ‘pay now’ product.
b. The former provides a credit for 35-50 days, while the latter does not.
c. In former, sometimes it is essential to open a bank account, whereas it is not
necessary to the latter.
d. In the former, sophisticated telecom network is essential, whereas such network is
not required by the latter.
e. Both (c) and (d) above.

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454. Which of the following statements regarding the difference between charge cards and credit
cards is false?
a. The former is issued mainly on the basis of account designated for charge and the
latter is always based on the creditworthiness of the applicant.
b. The former provides a credit period of 30 days after purchase, whereas the latter
extends a revolving credit of 45 days.
c. The former entails an interest rate of 2.5%-3%, whereas the latter does not call for
any interest.
d. Both annual service charges and commission are charged on the former, whereas
only annual service charges are levied on the latter.
e. None of the above.
455. Which of the following is a ‘pay before’ card?
a. Charge cards.
b. Credit cards.
c. Merchant cards.
d. Travel and Entertainment cards.
e. Traveller’s cheques.
456. Which of the following is a ‘pay now’ card?
a. Charge card.
b. Credit card.
c. Merchant cards.
d. Debit card.
e. Travel and Entertainment card.
457. Which of the following is a ‘pay later’ card?
a. Charge card.
b. Traveller’s cheques.
c. Merchant card.
d. Debit cards.
e. None of the above.
458. Which of the following is/are the features of a credit card?
a. This is built around the revolving credit concept.
b. The card does not have any pre-set limit for spending.
c. The holder has to pay 75% of the outstanding value of the purchase at the end of the
month.
d. The balance outstanding at the end of a month carries a rate of interest of not more
than 18% per annum.
e. Both (a) and (d) above.
459. Which of the following is/are the features of a charge card?
a. There are no interest charges collected by the issuer from the holder.
b. The discount collected from the member establishments is the principle source of
income for the issuer.
c. The cardholder has to make a consolidated payment to the issuer for all purchases
effected during a specified period.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.

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460. Which of the following is not a feature of ‘debit card’?

a. Both merchant establishment and cardholder should open the bank account.
b. It is highly capital-intensive.
c. It requires a computer terminal known as ‘point of sale’ terminal at every point of
sale.
d. Holder does not require to have any amount in his account.
e. None of the above.
461. Which of the following statements is/are true?
a. The less expensive route to avail a share in the credit cards market is to become an
affiliate to the principal issuer.
b. Gold Standard visa card is issued by ‘Standard Chartered Bank’.
c. Master Card International is a clearing agency.
d. Both (a) and (b) above.
e. Both (a) and (c) above.

SOURCES OF FINANCE AND REGULATORY ENVIRONMENT OF

FINANCIAL SERVICES
462. Which of the following is not undertaken in India by NBFCs?
a. Leasing.
b. Housing finance.
c. Bill discounting.
d. Credit rating.
e. Both (b) and (d) above.
463. Which of the following should not be treated as ‘NPA’ by NBFC?
a. If the interest amount remains ‘past due’ for six months, on a term loan.
b. If the interest and entire outstanding loan is overdue and unpaid for more than six
months.
c. If a bill remains overdue and unpaid for six months.
d. If lease rentals/hire purchase installments are past due for more than three months,
but less than six months.
e. Any credit facility of short-term nature if any payment that is due is not received for
past six months.
464. An asset which remains an NPA for more than two years should be classified as
a. Standard asset
b. Substandard asset
c. Doubtful asset
d. Loss asset
e. None of the above.
465. If a NBFC offers an interest rate of 16% per annum at monthly rests, what is the effective
rate of interest per annum?
a. 17.23%
b. 16.32%
c. 17.65%
d. 16.23%
e. 26.12%.

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466. Which of the following the RBI recognized credit rating agencies rate domestic NBFCs?
a. Duff & Phelps, CARE, ICRA, CRISIL and MDRA.
b. Duff & Phelps, CARE, ICRA, CRISIL and Department of Supervision at RBI.
c. CARE, ICRA, CRISIL and MDRA.
d. CARE, ICRA, CRISIL and Department of Supervision at RBI.
e. None of the above.
467. A financial services company is involved in the activity which can be simply said to be of
the nature of pooling money from the members every month to give to the neediest person
of the lot at the cost of foregoing his right to claim the money in future. Such a company is
regulated by:
a. The RBI under the Section 24 of the RBI Act
b. The RBI under Non-Banking Finance Companies, 1972 Act
c. SEBI under the SEBI Act
d. Company Law Board under Section 56B of the Companies Act
e. None of the above.
468. What is/are the profitable option(s) available to a depositor who holds a FD at a NBFC at a
lower rate than the rate that is being offered by the NBFC now?
a. Prematurely withdraw the deposit and redeposit it at a higher rate for the remaining
maturity.
b. Allow the fixed deposit to mature and deposit the matured amount at a higher rate.
c. Ask the NBFC under Section 54B (ii) through form 15I to appropriately adjust the
rate.
d. Renew the deposit for a longer maturity through prescribed form.
e. None of the above.
469. The minimum maturity for a deposit at a NBFC is:
a. 1 year and 1 day
b. 2 years
c. 1 year
d. 364 days
e. 365 days.
470. General Provisions and Loss Reserves of a NBFC are Rs.150 crore. What is the
contribution from this head towards the Tier II capital if the risk-weighted assets of a bank
are Rs.240 crore?
a. Rs.1.875 crore.
b. Rs.450 crore.
c. Rs.3 crore.
d. Rs.4.5 crore.
e. Rs.4.875 crore.
471. I deposited Rs.10,000 at Aarti Financial Services that is offering 15% per annum as interest
rate calculated at monthly rests on 31st December, 20x0. If I approach the NBFC for a loan
on 4th April, 20x1, which of the following may be said by Aarti Financial Services?
a. Eligible for a maximum of Rs.7,000 with an interest of 15%.
b. Eligible for a maximum of Rs.7,500 with an interest of 17%.
c. Eligible for a maximum of Rs.7,500 with an interest of 15%.
d. Eligible for a maximum of Rs.10,000 with an interest of 16%.
e. Not eligible for a loan before 30th June, 20x1.

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 Part I: Answers to Questions on Basic Concepts
INVESTMENT BANKING, FINANCIAL SYSTEMS AND FINANCIAL
MARKETS
1. (e) The financial system, through the savings function, policy function and credit function
aims at mobilizing resources from the surplus sections of the society and re-distributing the
same to the deficit sectors of society.
2. (e) The money market comprises of banks, government and financial institutions, as well
as individual investors.
3. (c) In the open market, the securities will be offered to a large number of investors who can
buy and sell them any number of times. A public issue mobilizes funds from a vast number
of investors through the open market system.
4. (e) A financial market is said to be perfect when options (a), (b) and (c) are satisfied.
5. (e) The role played by investment bankers in the capital market is to provide corporate
advisory services, issue of securities. Underwriters provide subscription to unsubscribed
portion of securities. Registrars handle issue securities to the investors on behalf of the
company and the share allotment and transfer activity.
6. (e) Financial intermediaries ensure the smooth transfer of funds from the lenders to the
borrowers, but their presence may increase the risk to the investors, who may invest in
risky securities on their advice and they definitely increase the costs of lending and
borrowing.
7. (e) Issuers ensure that the cost of raising funds should be minimized. Instrument is designed
in such a manner by the issuer to get certain tax incentives for the company and to the
investors.
8. (d) The money market is a wholesale debt market for low-risk, highly liquid, short-term
instruments. Funds are available in this market for periods ranging from a single day up to a
year.
9. (e) The primary market is a place for the issue of fresh securities. Corporates, banks, FIs
and government can issue new securities and raise funds for investment and pending
purposes from the primary market.

CREDIT MARKET
10. (c) Banks play a critical role in the Indian credit market by mobilizing the small savings
and routing them for corporate investment.
11. (c) The credit market operates in an intermediation stage to fulfill the credit requirements of
the different sectors of the economy as the lenders and borrowers are not directly connected
to each other.
12. (b) In the overdraft facility, the bank will allow the firm to overdraw from its current
account to a predetermined level of credit. The credit limit should be set based on the
security offered by the firm. Credit facility will generally be short-term in nature not
exceeding a year, and need not be only based on commodity stocks as security.
13. (d) For a developing economy such selective credit control becomes essential to ensure the
proper use of institutional credit since a major portion of the savings lie with these
intermediaries as loanable funds.
14. (d) Where the project is very large and the funds cannot be provided by a single institution
consortium lending will be resorted to. Two or more intermediaries will join together to
finance large project proposals.
15. (e) The interest charged will be on the daily outstanding in this account and will generally
be paid on a quarterly basis. The CC limit is usually secured on stocks and book debts of
the company.
 Investment Banking and Financial Services

16. (e) The sources of funds will determine the cost of funds for the intermediaries. Transaction
costs will depend mostly on the efficiency with which the transfer of funds is enabled. The
lending rate fixed by the intermediaries will also include a certain percentage as a spread
for making the lending activity profitable.
17. (b) The bank will decide its lending rate based on the cost of funds + transaction costs + its
required spread (margin). So, in this case, the lending rate is 11 + 1.5 + 2 = 14.5%.

MONEY MARKET
Introduction to Money Market
18. (d) These are medium to long-term government securities and carry a coupon rate. These
instruments set a benchmark for long-term interest rate. The other instruments are too short
for such a huge project.
19. (e) As these instruments are issued by the RBI on behalf of the government.
20. (e) As the investment done by MMMF will generally be in high quality securities
i.e., government/banks/highly rated corporates, which carry low risk and high rate of return.
21. (d) Investors who park their funds in short-term instruments will, at the time of redemption,
have to reinvest these funds at lower rate of interest. Default risk is non-existent in
government securities.
22. (b) This will reduce the liquidity of banks since there will be transfer of assets in the form
of cash into securities and lead to monetary contraction.
23. (c) The Primary Dealers should have net owned funds of a minimum of Rs.50 crore. Net
owned funds are owned funds, represented by paid-up capital, free reserves, balance in
share premium account and capital reserves, less accumulated loss balance and book value
of intangible assets, if any.
24. (e) As both are issued by corporates.
25. (b) The minimum success ratio for the PDs should be 33.33% for G-secs.
26. (e) SLR objective is to maintain a certain level of liquidity.
27. (d) The short-term fund requirements of the corporates and other borrowers are initially met
by short time lenders and short-term depositors of funds into the financial system.
28. (c) Dated securities carry a coupon rate unlike the T-bills which are issued at a discount and
they are long-term instruments. These instruments set a benchmark for the long-term
interest rates.
29. (a) CP is basically issued by highly rated corporates and it is cheaper than the bank interest
rate and so that cost of funds can be reduced.
30. (a) CP rate will be between the rate of CD and bank PLRs. Rate of interest on CD and CP
will be alike, rate of interest on CP will be lower than the PLRs.
31. (b) The minimum success ratio for the PDs should be 40% for T-Bills.
32. (c) Only the successful bids will be included in final bidding.
33. (c) The RBI may alter the interest rate structure by using open market operations and
through proper pricing of the OMOs, by purchasing G-secs.
34. (c) By increasing the statutory reserves, banks will have to transfer their loanable funds into
cash reserves for meeting the CRR or convert it into SLR securities. Both these actions will
reduce the extent of liquidity in the system.
35. (e) As all the money market instruments are interlinked, any changes in any one will lead
the changes to whole equation. Reduction in one will lead to reduction in all.
36. (c) Arising due to the fluctuations in the rates of the instruments, this type of risk should be
of prime concern in money market investments. This is a result of large volumes of funds
and the speed of the transactions taking place.

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Call Money
37. (b) Financial institutions (and mutual funds) can only lend in the Call Market, but cannot
borrow.
38. (e) All the three options given under (a), (b) and (c) speak about the main objectives of the
Call Money Market.
39. (d) Call loans are unsecured and demand varies according to seasonal demand.
40. (d) Term loan is lent for more than 14 days.
41. (b) The funds borrowings for a period of one day up to a fortnight but they do not have a
specified repayment date when the deal is entered. The lender will simply issue a notice to
the borrower 2–3 days before the funds are to be repaid.
42. (c) Intermediaries like DFHI and STCI have been permitted to operate both as borrowers
and lenders in the call money market.
43. (e) The call money market is the most liquid of all short-term money market segments and
the maturity period of call loans vary from 1-14 days.
44. (d) Borrowers of federal funds include securities dealers, corporations and government.
This is a unique market that performs the functions listed in (a) and (b).

Treasury Bills
45. (e) These instruments have distinct features like zero default risk, assured yield, low
transactions cost, negligible capital depreciation, high liquidity and are eligible for
inclusion in SLR.
46. (d) Treasury bills are issued for minimum of 14 days and maximum of 364 days.
⎛ 100 ⎞ 365
47. (c) Yield = ⎜ − 1⎟ x = 16.32%.
⎝ 86 ⎠ 364
48. (b) It serves to replenish cash balances of the central government, and to provide a medium
of investment for temporary surplus funds of the state governments.
49. (d) The state governments and provident funds were not allowed to participate in these
auctions.
50. (e) Treasury bills are issued at a discount and yields on T-bills are considered as a
representative of interest rates in economy.
51. (a) Tenders were invited for competitive bids, bids will be allotted to both competitive and
non-competitive bids. But T-bills are issued by the RBI on behalf of GoI only.
52. (d) In US non-competitive bids are submitted by small investors, and their bidding amount
is limited to $1 million or less.
53. (d) T-bills constitute a major portion of short-term borrowings by the Government of India.
54. (c) T-bills are supposed to be high liquid as they are backed by the Government of India.
55. (d) T-bills have distinct features like zero default risk and high liquidity.
56. (e) T-bills are issued in the form of promissory notes or finance bills, through credit to the
SGL account.
57. (d) The bids are accepted at the weighted average of the successful bids if the notified
amount is not fully subscribed to.
58. (e) The RBI neither discounts these bills nor participates in the auction, and does not notify
the amount in advance.
59. (a) Ad hoc T-bills are issued in favor of the RBI when the government needs cash.
60. (c) These T-bills are issued through auctions conducted by the RBI on every Friday for a
notified amount.

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61. (e) T-bills are issued by the RBI to facilitate government borrowing, when the government
needs money, to help in OMOs, as a medium for short-term investment of temporary state
government funds, and the yield of these bills is a benchmark for the rates of other short-
term investments.
62. (a) Strip bills are a package of bills requiring investors to bid for an entire series of bills
with different maturities.

Commercial Paper (CP)

63. (c) NRIs can only invest on a non-repatriable and non-transferable basis.
64. (e) CP does not originate from a specific self-liquidating transactions like normal
commercial bills which generally arise out of specific trade transactions. If issued through a
dealer it is known as a dealer paper.
65. (e) CPs are backed by the liquidity and earning power of the issuer, corporates prefer this
mode of finance as they can determine the cost and maturity and the liquidity is high
because it can be transferred by endorsement and delivery.
66. (b) The brokerage charged on period of 6 months is 0.050%.
67. (b) A corporate would be eligible to issue CP provided (a) the tangible net worth of the
company, as per the latest audited balance sheet, is Rs.4 crore, (b) the company has been
sanctioned working capital limit by bank/s or All India Financial Institutions, and (c) the
borrowal account of the company is classified as a Standard Asset by Financing bank/s or
institutions.
68. (e) The stringent conditions laid by the RBI has made entry difficult. The cost of CP
includes rating charges, stamp duty, IPA’s fee. All these costs have to be incurred each time
a company issues a CP thus increasing the effective cost.
69. (c) 6.24%
70. (b) The RBI insists a fresh rating and the rating should not be more than 2 months old.
71. (c) The minimum credit rating is P2 of CRISIL or an equivalent rating by other agencies.
72. (e) Commercial paper does not originate from a specific self-liquidating transaction like
normal commercial bills which generally arise out of specific trade transactions. CPs are
backed by the liquidity and earning power of the issuer. They are unsecured, as they are not
backed by any charge on fixed assets.
73. (c) CP has a minimum maturity period of 30 days and a maximum of 364 days.
74. (e) Issuing a CP involves less of paper work/formalities and high liquidity.
75. (d) CP can be issued in denominations of Rs.5 lakh or multiples. Amount invested by single
investor should not be less than Rs.5 lakh (face value).
76. (a) Any company can issue a CP, whether private or public.

Certificate of Deposits (CDs)

77. (b) They are available for subscription to NRIs also, but only on non-repatriable basis.
78. (e) CDs offer assured availability of funds for specific period and interest is determined on
a case to case basis.
79. (c) CDs issued by a financial institution will have minimum maturity period of 12 months
and maximum of 36 months.
80. (d) The minimum lock-in period for transfer is 15 days, and there is no premature buy-
back. To sell CDs, investors must approach the secondary market.
81. (e) Certain impediments in the way of DFHI, the yield on CDs being high, the investors
hold the instrument till the end of maturity to gain the maximum benefit and the banks have
high liquid funds at their disposal due to high interest rate to be paid on CDs.
82. (b) Jumbo CDs are issued by savings and loan associations in large volumes such as
$1,000,000 and at higher yields.

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83. (c) CDs are issued in the form of usance promissory notes and due to their negotiable
nature, they are also known as negotiable certificate of deposits.
84. (e) All the features mentioned above are features of CDs.
85. (d) Being time deposits, banks have control over the amounts invested with them and can
lend the same for specified periods. This is basically control over the funds.
86. (d) The minimum maturity period for a certificate of deposit is 15 days.
87. (e) All the features mentioned above are true for CDs.
88. (e) All the characteristics mentioned above are false for CDs. CDs are always issued at
discount to face value, no premature buy-back is allowed, no loans can be granted on them
and no grace period is allowed on repayment.
89. (a) CDs are traded in the secondary market, after the lock-in period of 15/30 days from the
date of issue, unlike fixed deposits, which cannot be traded in the secondary market.
90. (a) The ceiling on amount raised on CDs has not been fixed, as CDs have been developed
to deploy short-term surplus funds.

Bill Financing
91. (b) A demand bill is a bill payable ‘at sight’ or ‘on presentment’ to the drawee.
92. (e) An inland bill must be drawn or made in India and must be payable in India or drawn on
any person resident in India.
93. (e) A negotiable instrument must contain an order (and not a request) to pay and the drawee
and payee may be the same person.
94. (a) Under the Bill Market Scheme, 1952, the RBI made demand loans to eligible schedule
banks against the security of usance promissory notes of their constituents.
95. (e) The Bill Rediscounting Scheme, 1970 was started to bring out some control on the bill
rediscounting system. Points (a), (b) and (c) are the main features of the scheme.
96. (e) The features mentioned under (a), (b) and (c) are some of the measures introduced in the
bill discounting market based on the Vaghul Committee recommendations.
97. (d) The bill market is not organized in India and is mostly dominated by indigenous
bankers with limited resources. Also, cash credit and bank overdraft are cheaper sources of
finance.
98. (e) All the options mentioned above are the characteristics of a well developed bill market.
99. (d) Chore Committee stressed the importance of increasing the share of bank credit granted
in the form of bill finance, particularly drawee bills by making it compulsory for banks to
extend at least 50% of the cash credit limit against raw materials to manufacturing units by
way of drawee bills.
100. (a) Bank rate is the standard rate recognised by the RBI for discounting bills.
101. (b) The scheme of bill rediscounting scheme introduced by IDBI in April, 1965 has the
main condition as mentioned in point (b).
102. (a) The bank rate or the discount rate, is the standard rate at which the bank is prepared to
buy or rediscount bills of exchange.
103. (c) The drawee or payee who is in possession of the bill is called the holder of the bill and
can endorse it.
104. (e) DA are bills on the basis of whether the documents are deliverable just against
acceptance and become a clear bill immediately after for delivery of documents. When a
bill is accepted by the drawee without receiving consideration it becomes an
accommodation bill.
105. (b) In post-shipment finance, all documents of export should be routed through an
authorized foreign exchange dealer within 1 day of shipment of goods. Even a minor detail
unnoticed/ignored while scrutinizing the documents will entail heavy penalty.
106. (c) Banks can rediscount the bills arising out of genuine trade transactions, which were
originally discounted with them by their corporate clients.

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107. (c) The borrowing banks under this scheme had the facility to withdraw any number of the
bills lodged as also to replace them by other eligible bills.
108. (b) From January 1975 banks were allowed to rediscount bills with other financial
institutions and commercial banks.
109. (e) Remission of stamp duty and setting up of DHFI were two of the major achievements of
the Vaghul Committee recommendations.
110. (d) The scheme covers bills/promissory notes arising out of the sales and purchases of
indigenous capital equipment and machinery only.

DEBT MARKET
Gilt-Edged Securities Market
111. (e) In India, Government of India Securities (GOI Secs) include debt obligations of the
central government, state government and other financial institutions owned by Central and
State Governments. Gilt-edged security means ‘security of the best quality’.
112. (a) It is absolutely secured financial instrument which guarantees the capital as well as the
income.
113. (e) All are eligible to invest in the Government Securities.
114. (d) Short-dated securities are those which mature within 5 years.
115. (d) These instruments facilitate implementation of the fiscal policy of the Government. The
major investors such as commercial banks, NBFCs, insurance companies hold GOI
securities for meeting their statutory requirements. In spite of low yields, they are bound to
invest in these bonds.
116. (d) There is no prescribed settlement period in case of debt market as is found in the capital
market. Hence, the deals may be entered for settlement on the same day or 1 or 2 days after
the date of trading.
117. (d) In floating rate bonds, the stock will carry a coupon rate which will vary according to
the change in the base rate to which it is related. Zero-coupon bonds are issued at discount
and redeemed at par, thus implying no payment of interest till maturity.

Repurchase Agreements (REPOs)

118. (d) Government introduced REPOs in order to manage the excess of liquidity in the system
and also to even out interest rates in the call/notice money market.
119. (b) Banks, DFHI, Financial Institutions and other non-bank entities (including mutual
funds) holding both current and SGL account with the RBI Mumbai, can participate in
REPO transactions only.
120. (c) NBFC can buy securities in the first leg and then reverse the transaction in the second
leg, but they can now enter into REPOs. REPOs is an avenue to NBFCs for development of
short-term surplus funds, but not an avenue to raise funds.
121. (b) Borrowing under REPO is a secured borrowing. Hence, the interest rate is likely to be
lower than the rate prevailing in call.

Public Deposits
122. (c) These include all manufacturing companies, trading companies and companies engaged
in the services sector.
123. (e) As per the definition of the Companies (Acceptance of Deposit) Rules 1975, options
(a), (b) and (c) are not termed as public deposits.
124. (b) The minimum tenure for which public deposits can be accepted or renewed is
12 months, or 3 months if such deposit do not exceed 10% of the aggregate of paid-up
capital and reserves.
125. (e) The maximum maturity period for the deposits cannot exceed 60 months.
126. (b) NBFCs cannot pay more than 16% per annum.

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127. (b) The maximum amount of brokerage payable for soliciting public deposits between one
and two years is 1.5%.
128. (c) The company shall maintain liquid assets to the extent of 15% of the deposits maturing
during the financial year ending 31st March next. The amount held in liquid assets shall not
at any point of time fall below 10% of the amount of outstanding deposits maturing before
31st March next.
129. (a) The company shall on acceptance or renewal of deposit, furnish to the depositors a
receipt within a period of 8 weeks.
130. (d) Every company shall file a return of deposits with the Registrar of Companies, on or
before 30th June every year. A copy of the return shall be simultaneously filed with RBI.
Every company intending to invite deposits shall issue an advertisement in a leading
English and a vernacular newspaper circulating in the state in which the registered office of
the company is situated.
131. (e) All the options are permitted investment for the company in Public Deposits to contain
liquid assets.
132. (a) Every company shall file a return of deposits with the Registrar of Companies and one
copy with the RBI.

Financial Guarantees
133. (e) The abolition of the managing agency system led to the disappearance of reputed,
creditworthy guarantees, risk of new entrepreneurial and professional appraisal of the
project by the managerial cadre reduced the need for personal guarantees.
134. (b) The Lender seeks a guarantee, a form of security demanded by the creditor to reduce the
default risk.
135. (b) As per the Indian Contract Act, Sec. 126, ‘a guarantee is a contract to perform or to
discharge the liability of the third person in case of his default’.
136. (d) Insurance companies issue generally guarantees extended to non-financial contracts,
and extend guarantees on behalf of hire purchase companies to banks and other institutions.
137. (a) The premium payable for the insurance is at the rate of 2.5 paise per half-year for every
100 rupees.
138. (c) DICGC undertakes: Insurance of deposits of banks, guarantee for credit extended by
banks to priority sector, guarantee for credit extended by banks to small scale industries.
139. (e) These are some of the regulations regarding the SSI Scheme of DICGC.
140. (c) ECGC does not cover the risk of exchange rate fluctuations.
141. (c) Standard policy which is also known as shipments policy, is designed to cover risks in
respect of goods exported on short-term credit not more than 180 days.
142. (d) Banks extended post-shipment finance to exporters through purchase, negotiation or
discount of export bills or advances against such bills qualifying for guarantee.

CAPITAL MARKET
An Overview of Capital Market
143. (e) In the year 1992 abolition of the control on capital issues lead corporate sector access
the market and as due to globalization of Indian capital market, process of foreign portfolio
investment started.
144. (b) Malegam Committee was appointed to suggest measures to increase the levels of
disclosure by Indian issuer, an attempt is being made to bring out disclosure norms in
conformity with global standards.
145. (c) Over The Counter Exchange of India (OTCEI) was the first exchange to introduce
screen based trading in India.
146. (b) Due to the dematerialization, risk of bad deliveries is totally eliminated.

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147. (a) NSE was the first stock exchange to set-up clearing corporation named as NATIONAL
SECURITIES CLEARING CORPORATION. It assumes the counterparty risk in all
trading deals made on the exchange.
148. (d) Rolling settlement has been introduced in demat stocks and the settlement week has
been changed in the NSE from Wednesday–Tuesday to Monday–Friday to match the
settlement week of BSE and avoid wide arbitrage opportunities.
149. (c) G S Patel Committee was set-up to work out the modalities for reintroduction of the
carry forward system.
150. (c) The L C Gupta Committee recommended the introduction of options and futures in the
Indian Markets.
151. (d) Mark to Market Margin is the difference between the current closing price and the
transaction price and is collected from trading member.
152. (a) Trading period starts from Monday to Friday.
153. (d) 1992.
154. (a) To work-out the modalities for reintroduction of the system with proper checks and
balances.

Regulation of the Capital Market

155. (c) Credit rating agencies are not brought under the registration framework of SEBI.
156. (b) SEBI has now made it mandatory for all issuers to deposit 1% of the size of the issue
as security deposit with the regional stock exchange.
157. (c) SEBI has also reduced the maximum time period for allotment to 30 days from the
closure of the issue in order to prevent fraudulent encashment of refund orders, and interest
loss to the investors on delayed refunds.
158. (a) SEBI has now delegated the task of vetting the offer document to the Lead Manager.
The Lead Manager is required to exercise due diligence with regard to the accuracy and
adequacy of the disclosures made in the offer document.
159. (d) Issues below Rs.5 crore in size are permitted to be listed only on OTCEI.
160. (a) Trading in demat securities takes place on T + 2 basis.
161. (b) SEBI has directed that the upper limit for gross exposure would be fixed at 20 times the
sum of their base minimum capital and additional capital.
162. (b) The takeover code is triggered when an acquirer obtains 15% equity stake in a
company.
163. (e) All these organizations have been formed in India are self-regulatory.
164. (e) It does not come under the jurisdiction of SEBI.
165. (d) SEBI has introduced capital adequacy norms for brokers. SEBI has directed that the
upper limit for gross exposure would be fixed at 20 times the sum of their base minimum
capital and additional capital. The intra day trading limits of 33⅓ times the sum of their
base minimum capital and additional capital.
166. (d) The equivalent of SEBI in UK is the Securities Investment Board.
167. (c) The minimum limit for listing on regular stock exchanges was raised by SEBI to Rs.5
crore.
168. (b) Book building facilitates the process of price discovery and also reduces transaction
costs.

MERCHANT BANKING
An Overview of Merchant Banking
169. (d) The fully paid equity shares and security should not be of banking sector shares.
170. (c) In 1973 ICICI started providing Merchant Banking services.

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171. (c) Main area - instrument designing, pricing the issue, registration of the offer document,
underwriting support, marketing of the issue, allotment, refund and listing on stock
exchange.
172. (e) There is a single uniform category – Merchant Banker, following the abolition of
multiple types.
173. (e) For merchant banking, permission and registration with SEBI is mandatory and it
should be a corporate body, no other business except merchant banking can be conducted
and it excludes banks and FIs as they are connected to securities market, and thus can carry
on other activities too.
174. (c) The applicant should have a minimum net worth of Rs.5 crore.
175. (c) SEBI will grant the certificate of Registration and it is valid for a period of 3 years.
176. (d) Merchant banking industry in India is characterized by low entry barriers, high
competition, and high bargaining power of customers.
177. (c) Videocon Leasing and Industrial Finance Ltd. introduced the concept of Bought-Out
Deal for the first time for raising capital for Patheja Forgings Ltd.

Management of Public Issues, Initial Public Offerings and Pricing of Various

Instruments
178. (b) The issuer company should be in existence for the past five years.
179. (b) There can be only one Advisor/Consultant to the issue.
180. (c) If the size of the issue is between 100 crore to 200 crore maximum number of Lead
Managers will be 4.
181. (a) A category I Registrar can act as both Registrar to the issue and as a Share Transfer
Agent.
182. (b) The minimum net worth requirement for a Category II Registrar is Rs.3 lakh.
183. (d) Assisting the company in listing of the security on stock exchanges.
184. (b) The Banker to the issue must be a scheduled bank.
185. (c) The total outstanding underwriting obligation of an underwriter at any point of time
cannot exceed 20 times the underwriter’s net worth.
186. (e) The underwriting commission is payable on the issue price of the security i.e., face
value plus premium underwritten on the issue. The minimum underwriting commitment of
the Lead Manager shall be to the extent of 5% of the size of the offer or Rs.25 lakh,
whichever is less.
187. (d) An underwriter should have a minimum net worth of Rs.20 lakh and the total
outstanding underwriting obligation at any point of time cannot exceed 20 times the
underwriter’s net worth.
188. (e) Any member of any recognized stock exchange can be appointed as a broker to the issue
and their appointment is not mandatory by SEBI.
189. (d) SEBI would make the observations within 21 days from the date of filing. In case no
observations are received from SEBI within the stipulated period of 21 days, the offer
document is deemed to have been cleared by SEBI. Ten copies of draft are to be filed with
SEBI.
190. (e) All the mentioned documents must accompany the draft prospectus filed with SEBI.
191. (c) The registration fee payable to SEBI if size of the issue lies between Rs.50 crore to
Rs.100 crore, then the fees will be Rs.50,000.
192. (c) The minimum promoter’s contribution is 20% of the post-issue equity capital for issue
size up to Rs.100 crore and 20% of the post-issue equity capital for issue size exceeding
Rs.100 crore.

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193. (c) Shares issued for consideration other than cash wherein the transaction involved
revaluation of assets or capitalization of intangible assets, during the preceding
3 accounting years, are not eligible.
194. (c) Promoters can invite their friends and relatives to subscribe the promoters’ quota.
195. (c) In case of issues above Rs.10 crore there should be at least 30 mandatory collection
centers.
196. (b) An issue should be kept open for a minimum period of 3 days and maximum period of
10 days.
197. (d) The applicant is required to quote his Permanent Account Number (PAN) in the
application form if the size of the application exceeds Rs.50,000.
198. (d) The minimum amount of application money should not be less than 25% of the issue
price.
199. (d) The minimum subscription required for an issue is 90% or the entire collection is to be
refunded.
200. (b) Appointment of SEBI registered Debenture trustee is mandatory if the maturity period
of the instrument exceeds 18 months.
201. (e) No issue of FCDs having conversion period exceeding 36 months unless conversion is
made optional with put and call options is allowed and in case the issuer company fails to
get the minimum subscription, including devolvements on the underwriters, the entire issue
amount should be refunded to the investors.
202. (b) For an issue price between Rs.100 to Rs.400 the market lot is 50 shares.
203. (d) An overseas corporate body is a foreign firm where at least 60% of the ownership stake
is held directly or indirectly by Non-Resident Indians or an overseas trust in which at least
60% of the beneficial interest is irrevocably held by such persons.
204. (d) All the options given are applicable.
205. (d) If the reservation is made for a particular class of investors, it is called reservation on
competitive basis and in case of undersubscription of the portion reserved on firm basis, the
amount has to be brought in by the promoters with 3-year lock-in period.
206. (b) Issue announcement advertisement must be published at least 10 days before opening of
the issue. This advertisement contains an abridged version of the prospectus.
207. (d) No advertisement stating that the issue is fully subscribed or oversubscribed will be
issued during the period when the issue is open for subscription, nor about the date of
closure, except on the date of closure.
208. (e) The reservations for employees of the issuer company cannot exceed 10% of the total
size of the issue.
209. (d) The promoter company must have a 5 year track record of profitability and the
promoters’ contribution must be 50% of the issue.
210. (e) The nature of industry specifies the need of capital and the capital structure is decided
according to the nature of business.
211. (e) Capital structure is to be designed so as to integrate well with the financial goals at the
corporate level and all the factors mentioned in (a), (b) and (c) should be considered.
212. (b) Excessive leverage can limit the firm’s ability to respond to such crisis.
213. (a) The holding period is less than 12 months, it will be treated as short-term capital gains.
214. (b) As per SEBI clarifications, the company should have made profits after providing for
interest, depreciation and tax as per the audited accounts in 3 of the preceding 5 years with
profits in the last 2 years prior to the issue.
215. (e) Underpricing can be related to timing of the issue and prevailing market conditions
particularly in the secondary market. As a result of underpricing the promoter or the
company loses the opportunity to raise more funds.
216. (b) These bonds are issued at discount to their face value and are redeemed at par on expiry
of their tenure. There is no payment of interests on these instruments.

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217. (e) They are fully redeemable non-convertible short-term debentures, secured by specific
movable and immovable assets of the company. It is redeemed at regular intervals and then
reauctioned. Interest rate will be determined by the market.
218. (c) Ashok Leyland is the pioneer in launching this investment in India.
219. (a) Dividend discount model is not used by Malegam Committee to justify the pricing of a
share.
220. (d) LYONS are convertible into equity of the issuer at a price set at the time of issuance. If
the investors choose to convert the notes into equity they forego all interest.
221. (b) Cumulative preference shares can be issued in India.

Right Issues, Bonus Issues, Private Placements and Bought-out Deals

222. (d) According to rule laid down in Section 81(A), the further issue of shares to existing
equity shareholders does not apply to a private company.
223. (d) Where issue of shares by way of rights by a listed company does not exceed Rs.50 lakh,
appointment of merchant banker is not mandatory. Rights issue open for a maximum period
of 60 days from the date of opening of issue.
224. (c) Within 42 days from the date of closing of the issue.
225. (b) The proposed rights issue should not dilute the value or rights of the fully or partly
convertible debentureholders.
P −S 25 − 16 9
r
226. (b) Formula to be used – R = = = = 2.25
N +1 3 +1 4
227. (d) Formula applied here:
Pe = Pr – R
P −S 45 − 30 15
r
R= = = = 2.2
N +1 5 +1 6
∴Pe = 45 – 2.5
∴Pe = 42.5
228. (c) If he allows his rights to expire Market value of original shareholding at the rate of
Rs.90 = 90 x 500 = 45,000.
Market value of 1,000 shares held after the right issues at the rate of Rs.60
= 60 x 1,000 = 60,000
Change in wealth = Rs. (60,000 – 45,000) = Rs.15,000.
229. (d) No company should be pending conversion of FCDs/PCDs issue any shares by way of
bonus unless similar benefit is extended to the holders of such PCDs/FCDs and the bonus
issue should not be made unless the partly paid shares are made fully paid-up.
230. (d) This is done by issuing fully paid shares representing the increased capital. The
shareholders to whom the shares are allotted, do not have to pay anything to acquire the
share.
231. (d) 30 days.
232. (e) 60 days.
233. (a) Bonus shares cannot be issued out of revaluation reserves.
234. (b) These are no entry barriers for the private placement market. The transaction costs are
low. Credit rating is optional in case of debt instruments.
235. (b) The issue of shares on a preferential basis can be made at a price not less than the
higher of the following: The average of the weekly high and low of the closing prices of the
related shares quoted on the stock exchange during the six months preceding the relevant
date or the average of weekly high and low of the closing prices of the related shares quoted
on a stock exchange during the two weeks preceding the relevant date. Relevant date for
this purpose means the date 30 days prior to the date on which the meeting of general body
of shareholders is convened to consider the proposed issue.

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236. (b) SEBI has issued a clarification according to which the lock-in period will not be
applicable to preferential issues except in those cases where preferential issues are made to
the promoters and even in such cases lock-in period is for 3 years.
237. (d) There is no lock-in period.
238. (e) A buy-out is a process whereby an investor or a group of investors buys-out significant
portion of the equity of an unlisted company with a view to make it public within an agreed
time frame. It is nothing but wholesome investment.
239. (e) For the issuer with a good project, it means obtaining funds upfront at a minimal cost
without the fear of undersubscription in a depressed market.
240. (e) An amount equivalent to at least 10% of the price fixed would become payable for the
warrants on the date of their allotment.

INTERNATIONAL MARKETS
241. (d) In this instrument only minimum disclosure is required to the SEC and the issuer need
not comply with US GAAP. This type of instrument is traded in the US OTC market.
242. (d) In a depository receipt issue the roles played by the custodian is to hold the shares
underlying the DRs on behalf of the depository and to collect rupee dividends on the
underlying shares.
243. (b) These are bonds issued by non-Japanese borrowers in the domestic Japanese markets.
244. (d) Belgian dentist is a term used to describe a high net worth individual investor in
bonds/DRs to ensure safety for the surplus funds.
245. (a) Gensaki rate is short-term benchmark rate used in Japanese markets.
246. (b) Eurodollars are bank deposit liabilities denominated in US dollars but are not subject to
US banking regulations.
247. (c) Recently reserve requirements have been eliminated on all time deposits in the United
States and have been reduced from 12 to 10 percent on transaction deposits.
248. (a) The Eurodollar Certificate of Deposit is an important Eurodollar instrument and it is a
negotiable receipt for a dollar deposit at a bank located outside the United States or in a US
IBF (International Banking Facility).
249. (c) The coupon or interest rate is set below the LIBOR for sovereign borrowers and below
LIBOR for US banks.
250. (e) Owing to the risk factors, the cost of evaluating foreign investments is greater than the
cost of evaluating the domestic investments.
251. (b) Since the managing banks provide a larger share than the other participating banks, their
share is also larger.
252. (d) Only agency cost is an upfront cost. The reimbursement of out of pocket costs is an
upfront charge but not out of pocket costs. The remaining two costs are periodic costs.
253. (a) Multicurrency loans are used to take advantage of the growing international economy
and a part of them are a natural expansion to the use of Eurodollar loans.
254. (b) Legality is not one of the provisions. Illegality is considered as one of the provisions. It
is intended to address the possibility that the bank’s lending office in foreign country may
restrict the branch from accepting the deposits required to the loan or from making the loan.
255. (c) Revolving credit facility gives the borrower more flexibility about the outstanding
principal during the loan’s life.
256. (a) The speed and certainty of funds is one of the advantages of syndicated loans.
257. (e) Earning profits is not the objective of External Commercial Borrowings.
258. (b) The “all-in-cost ceilings’’ for infrastructure projects is 400 basis points over six months
LIBOR.
259. (b) The main objective of the Foreign Direct Investment is to stimulate economic growth in
many of the world’s poorest countries because of the expected continued decline in the role
of development assistance and the resulting search for alternative sources of foreign capital.

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 Part I

260. (b) The equity capital category of FDI includes both “mergers and acquisitions’’ and
“greenfield’’ investments, which are the latest facilities available.
261. (b) A vertical spillover occurs when the affiliate transfers free of charge technology to firms
supplying inputs or servicing “downstream’’ operations like distribution and retailing.
262. (b) FDI is freely allowed in all sectors including the services sector, except where the
existing and the notified sectorial policy does not permit FDI beyond a ceiling.
263. (c) Early delivery of proposals submitted to it through purposeful negotiation and
discussion with potential investors.
264. (b) In fixed deposit account, the interest is payable every quarter and the deposit amount is
payable on the maturity date.
265. (a) Low interest rate is not a characteristic of NRNR.

CREDIT RATING
266. (e) All the characteristics listed are the benefits of credit rating.
267. (b) Except (b) all options are taken into consideration while doing the Technical Evaluation
in Credit Rating.
268. (d) The equity assessment process commences at the request of an investor and the consent
of the company being assessed. The end result is not in the form of a symbol but an
assessment report specific to the investor’s need.
269. (e) The set of factors, deemed relevant for rating purposes is clearly defined. The weight
assigned to these factors are specified. A quantitative assessment is made of the rated entity
on each of the factors. A numerical credit score or index is arrived at on the basis of the
weights and quantitative assessments.
270. (d) The overseas investors are exposed to the political risks of confiscation and
expropriation.
271. (c) Probability of Non-confiscation is:
(1 – p) t CFt = (1 – 0.05)5 x 12 lakh = (0.95)5 x 12 lakh = 9.29 lakh.
272. (e) The borrower’s years of residence in present place, future prospects in his current jobs
and his financial assets will be examined.
273. (e) The key ratios – Pre-tax interest coverage, pre-tax interest and full rental coverage, cash
flow/long-term debt (%), cash flow/total debt (%), pre-tax return on average long-term
capital employed (%).
CF(1 − P) 12(1 − 0.05)
274. (b) Probability of Non-Confiscation is V = = = 76 lakh.
(re + P) (0.05 + 0.10)
275. (a) The issuer will not have to disclose the rating to the public.

EVOLUTION OF FINANCIAL SERVICES

276. (c) It is the only advantage of the “equipment leasing’’.
277. (a) This is in accordance with the Banking Regulation Act, 1949.
278. (b) It is one of the conditions of hire purchase.
279. (e) All the statements given are facts.
280. (a) Alternative (b) is not true because out of 350 housing finance corporations in India,
only 23 are registered with the National Housing bank. Alternative (c) is not true because
housing finance in India is provided by both governmental and non-governmental
organizations.
281. (b) Alternative (a) is wrong because Kothari Mutual Fund is the first private sector fund in
India, but not the largest. Alternative (c) is wrong because the credit rating in India started
with CRISIL. Alternative (d) is wrong because minimum net worth should be Rs.50 lakh.

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 Investment Banking and Financial Services

AN INTRODUCTION TO EQUIPMENT LEASING

282. (c) According to FASB definition, if the lease term exceeds seventy five percent of the
useful life of the asset, the lease is classified as a financial lease i.e. 75% of 6 years.
283. (d) According to FASB definition, if the present value of the minimum lease payments
exceeds ninety percent of the fair market value of the asset at the inception of the lease, the
lease is classified as a financial lease i.e., 90% of 400 lakh.
284. (d) A finance lease, which operates over the entire economic life of the asset, is called a
“full pay-out lease’’.
285. (e) In a leveraged lease transaction, the leasing company in the investments by borrowing a
large chunk of investments with full recourse to the lessee and without recourse to the
lessor. The lessor obtains an assignment of lease and rentals to be paid by the lessee and the
transaction is routed through a trustee who looks after the interests of the lessor and lessee.
286. (e) The alternative (b) is wrong because, a ‘wet lease’ is a variant of operating lease.
Alternative (c) is wrong because a direct lease is that, which is not a ‘sale and leaseback’
transaction.
287. (d) Alternative (a) is wrong because, in this type of lease, the equipment related and
technological risks cannot be shifted from lessor to lessee. Alternatives (b) and (c) are also
not the characteristics of an operating lease.
288. (c) In a perfectly competitive financial market, the cost of leasing tends to be equal to the
costs of other forms of borrowing. In such a market, a borrower (lessee) can afford to be
indifferent between the options of leasing and borrowing.
289. (e) All are true. The first three alternatives come under the Bipartite lease and the fourth
alternative comes under the international lease.
290. (e) In a single investor lease, there are two parties to the transaction. Alternatives (b) and
(c) are not the characteristics of a leveraged lease.
291. (b) A walk-away lease is same as a close-ended lease.
292. (a) At the end of the lease period, the asset goes back to the possession of the lessor. The
lessee bears the costs of insuring and maintaining the asset.
293. (c) In an operating lease transfer of ownership does not take place.
294. (e) All the alternatives are true according to the “International Accounting Standards’
Committee’’.
295. (b) In a finance lease, the lease term is for a period exceeding 75% of the life of the asset.
296. (b) In a finance lease, the lease term is for a period exceeding 75% of the life of the asset.
297. (c) The incremental borrowing rate is used by the lessee to determine the present value of
the asset in the financial lease.
298. (d) It is an obligation for the lessee to pay rentals regardless of the condition or the
suitability of the asset.
299. (b) A finance lease, which operates over the entire economic life of the equipment is called
a “full pay-out lease’’.
300. (d) Only alternatives (a) and (b) are the characteristics of operating lease.
301. (e) All the alternatives are true in case of a ‘wet lease’.
302. (d) In a dry lease, the lessee bears the costs of insuring and maintaining the leased
equipment. An operating lease does not transfer the equipment related business and
technological risks from the lessor to the lessee. The lessor while structuring an operating
lease largely depends upon the realization of a substantial resale value.
303. (d) The alternative (a) is false because leaseback arrangement in the transaction can be in
the form of a finance lease or an operating lease.
304. (c) Alternative (a) is wrong because a sale and leaseback transaction cannot be considered
as a direct lease. Alternative (b) is wrong because a direct lease consists of only two parties.
Alternative (d) is wrong because in a financial lease, the lessor does not take up repairing,
insuring and maintenance of the assets. Alternative (e) is wrong because “Hell or high
water’’ obligation applies to the lessee in a financial lease.

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 Part I

305. (e) All the alternatives are true in case of a “Sales-aid-lease’’.

306. (d) The lender/loan participant obtains an assignment of the lease and the rentals to be paid
by the lessee and a first mortgage on the leased asset. There are three participants in a
leveraged lease. The lender is a loan participant. The debt portion is invested with recourse
to the lessee. The lessee has to pay the lease rentals to the lessor.
307. (d) Alternative (a) is wrong because the lessor, lessee and the equipment supplier should be
domiciled in the same country. Alternative (b) is wrong because the international lease is
exposed to both country risk and currency risk. Alternative (c) is wrong because an import
lease is very much an international lease transaction.
308. (b) In an import lease transaction, the lessor and lessee are from the same country and the
equipment supplier from a different country.
309. (c) An upgrade lease is used to upgrade the equipment or make additions to the original
equipment configuration, which effectively hedges the risk of obsolescence.
310. (e) Leasing decreases the financial risk of the firm, as it is an off-balance sheet item: For
financially weak firms which cannot absorb tax shelters like depreciation, leasing is a way
of reducing the cash outflow that would be there in case of purchase.
311. (e) If the lease is not capitalized in the balance sheet, the fixed assets and total assets figure
will be less by that much, thus resulting in a better ROI and Gearing Ratio figure.

LEASING IN INDIAN CONTEXT

312. (c) Standard Chartered was the first foreign bank to venture into Indian leasing.

313. (c) The alternatives (a) and (b) are wrong because the maximum maturity period of the
intercorporate deposit should not exceed 12 months and the total amount that can be raised
cannot exceed two times the net owned funds. Only (c) is correct.

3, 000 3, 000
314. (e) The issue price is (Face value)/FVIF(k, t)= = = 2068.69 i.e., (app) 2069.
FVIF 1.15
(15%,1)

315. (c) The true yield is the compound yield. It is always lesser than the simple yield. So,
alternative (d) is wrong. Alternative (b) is wrong because a firm cannot use hundred percent
of finance raised through public deposits for lease investments. Alternative (a) is wrong
because a true yield is influenced by the maturity value of the deposit, initial amount of the
deposit and number of months to maturity.

316. (b) The maximum amount that can be lent by a bank to a leasing company cannot exceed
four times the net owned funds of the company.

317. (e) Deemed deposits do not include funds raised through unsecured non-convertible
debentures.

318. (a) If the leasing companies raise finance through public deposits, there is a ceiling on the
interest rate or the discount rate given by them.

319. (c) The maturity mismatch is more pronounced when lease and hire purchase investments
are funded via intercorporate deposits because the deposits have a shorter maturity than the
underlying assets being financed, thereby leading to the refinancing before the maturity of
the assets.

320. (a) The bank lending to a leasing company can be only in the form of cash credit facility
and should not exceed four times the Net Owned Funds (NOFs).

321. (d) Only alternatives (a) and (b) are correct.

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 Investment Banking and Financial Services

322. (b) The yield that can be calculated from the given data would be a simple yield. If
compounded monthly, you get compound annual yield.
The relationship between the effective annual rate of interest (r) and the nominal rate of
interest (i) per annum compounded “m’’ times a year would be
(1 + r) = (1 + i/m)m
i = 15%, m = 12
(1 + r) = (1 + 0.15/12)12
r = 16.08%
323. (c) Calculate r in the same manner as above. After one year, she would be getting 2000
(1 + 0.1608) = 2321.6. i.e., (app) Rs.2,322.
324. (c) The SEBI guidelines permit a finance company to issue non-convertible debentures at a
rate of interest freely determined by the issuer for any desired maturity period. However,
the debentures must be rated by an approved rating agency if the initial term to maturity
exceeds 18 months.
325. (e) Only alternatives (a) and (b) are advantages of securitization.
326. (c) According to prudential norms for NBFCs, all loans and advances, which have
remained as NPAs for a period not exceeding two years are classified as sub-standard
assets.
327. (c) Issue price = 2000/FVIF (15%,1) = 2000/0.8696 = Rs.1,739.
328. (c) According to credit rating symbols given by CRISIL, adequate safety of timely
payment of interest and principal is indicated by the symbol ‘A’.

LEGAL ASPECTS OF LEASING

329. (b) The definition of equipment lease transaction resembles the definition provided for
‘bailment’ under the Indian Contract Act, 1872.
330. (e) Alternative (a) is wrong because a ‘letter of offer’ is prepared by the lessor and
alternative (c) is wrong because the registration of the equipment lease is optional.
331. (c) Through the exemption clause, the lessor expressly denies any obligation as to the
fitness or merchantability of the equipment, and disowns responsibility for any defects in
the equipment or the operations thereof.
332. (d) Only alternatives (a) and (b) are correct. Alternative (c) is wrong because the bailor has
to disclose to the bailee any faults in the goods bailed, of which the bailor is aware.
333. (d) The surrender clause states that upon expiry of the lease term or earlier termination of
the lease, the lessee must deliver the equipment to the lessor at the place where it is to be
located in good working order and condition.
334. (c) The ownership clause states that no right, title or interest in the equipment shall pass to
the lessee and the lessee shall at no time, contest or challenge the lessor’s sole and
exclusive right, title and interest in the equipment.
335. (d) The bailee is bound to take responsible care of the leased asset. He is liable for his own
negligible acts and for those of his employees and agents. However, if the goods are
damaged or destroyed through no fault of the bailee then in the absence of a provision to
the contrary, the bailee is not liable to indemnify the bailor for the loss.
336. (c) In equipment leasing, the lessor is only a financial intermediary whose role is limited to
purchasing the equipment from the supplier and delivering it to the lessee. The equipment
supplier is identified by the lessee and the equipment specifications and the terms and
conditions relating to its performance are negotiated by the lessee.
337. (a) A ‘letter of offer’ that contains the acceptable terms and conditions.
338. (d) There is no uniform format for a lease agreement and the clauses included in the
agreement vary from one lease agreement to another.
339. (d) Only alternatives (a) and (b) are correct and alternative (c) is wrong because the lessee
is entitled to avail the benefits of the warranties provided by the manufacturer.

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340. (a) The responsibility of taking delivery of the equipment solely lies on the lessee.
341. (d) A finance lease agreement invariably requires the lessee to insure the equipment. The
description clause provides the description of the lessor, the lessee, the equipment and the
locations where the equipment is to be installed. The lessor usually stipulates that the
equipment shall not be removed from the described location without its prior permission.
342. (e) They do not protect the rights of lessee.

TAX ASPECTS OF LEASING

343. (e) As per the new accounting standard, lessee gets a right to claim depreciation.
344. (e) Alternative (b) is wrong because the expenses incurred by lessee towards insuring and
maintaining the equipment are tax deductible expenses and alternative (c) is also wrong
because if the lessor has acquired the asset for commercial purpose, then the rental income
should be put under the head “Profits and Gains of Business or Profession’’.
345. (d) Lease rentals = 0.443 x 300 = 132.9
Tax shield = 132.9 x 0.46 = 61.13
346. (b) Cost of the equipment to ELC = Rs.80 lakh x 1.04 = Rs.83.2 lakh.
Cost of the equipment to Alankar Ltd. = Rs.80 lakh x 1.1 = Rs.88 lakh.
347. (d) Alternative (d) is correct because when the lessor purchases the equipment with the
intention of leasing it, then CST does not recognize it as a sale. Therefore, the equipment
supplier cannot claim concession on the sales tax. Alternative (a) is the clause (29 A) of the
46th Amendment.
348. (e) Lease rental = cost of capital equipment x quote of leasing company payable at the end
of every month excluding the sales tax i.e., 60 x 27.5/1000 = 60 x 0.0275 = 1.65 lakh.
349. (c) The Act specifies rates of depreciation for different block of assets. Generally,
depreciation is applied to block of assets rather than individual assets.
350. (e) Hypothecation and pledge are not considered as a sale under CST.
351. (a) Lessees claim for depreciation tax shields on the leased assets.
352. (b) Lessee can claim for lease rentals, maintenance and insurance costs of the leased asset.
353. (e) All the alternatives given are true.
354. (d) The alternative (c) is wrong because the lessor can claim the depreciation tax shield.
355. (d) Alternative (b) is not correct because for a transaction to be treated as a hire purchase
transaction, the lease agreement must not provide for a transfer of ownership of the leased
asset. But an open-ended lease provides for a transfer of ownership.
356. (d) A hundred percent EOU company can neither avail of the lease related tax shelters nor
avail of the acquisition related tax shelters.
357. (b) All the statements are correct.
358. (e) All the statements are true.
359. (e) A sale or purchase which takes place in the course of export or import does not attract
either the central sales tax or the states sales tax.
360. (a) When a lessor purchases equipment from a supplier in another state (the purchase
results in the movement of the equipment from one state to another), the transaction will
attract central sales tax.
361. (a) Leasing is not included in the purposes for which the dealer selling the goods can pay
sales tax at a concessional rate of 4% of the sales price.
362. (e) All the statements are true.
363. (e) Alternatives (a) and (b) come under the purview of Sales Tax Act.
364. (b) Section 3(a) of CST defines the interstate sale of goods and not interstate lease.
365. (c) The appropriate state will be the state where the taxable rent takes place and in the case
of equipment lease, the taxable rent is the transfer of the right to use the equipment.

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 Investment Banking and Financial Services

366. (d) The method for allocating the unexpired finance charge is known as the Effective Rate
of Interest Method or the Actuarial Method.
367. (c) The lessee treats the lease rental payable over the lease term as a charge to the profit
and loss account. IAS 17 states that the lease rentals must be allocated to each accounting
period in a manner that is representative of the time pattern of the user’s benefit.
368. (e) Allocating the unexpired finance charge is known as Effective Rate of Interest Method
or the Acturial Method. There are two other methods for allocating the unexpired finance
charge and they are the sum of years – Digit Method and Straight Line Method.
369. (b) Sum of Digits Method also known as Rule of 78.

LEASE EVALUATION: THE LESSEE’S ANGLE

370. (d) The net present value of the lease alternative and the net present value of the buy
alternative are compared and the equipment should be only when the condition is satisfied.
371. (c) The model assumes that the target capital structure consists of a mix of debt, lease
finance and equity and that each investment is deemed to be financed using this mix.
372. (a) The discount rate (k) to be used for calculating the net present values is the marginal
cost of capital including the marginal cost of debt and marginal cost of equity.
373. (b) Bower-Herringer-Williamson (BHW) model assumes that the debt which will be raised
in lieu of the lease will be equal to the present value of the lease payments.
374. (a) Under the BHW model, the lease related cash flow stream is divided into two parts:
The part relating to financing per se and the part relating to tax shields and residual value.
The cash flow stream related to financing is called financial advantage of leasing.
375. (c) A higher tax relevant rate of depreciation decreases the rental. A larger upfront
payment and a higher cost of capital increases the break even rental. The break even rental
decreases with a longer primary lease period and a higher net salvage value.
376. (c) The disadvantages of short-term arrangement are: Lease runs the risk if being deprived
because the lessor enjoys the right of cancelation; the lease rentals for the short-term leases
beyond the initial one are not specified at the inception of the arrangement.

LEASE EVALUATION: THE LESSOR’S ANGLE

377. (c) To determine the break even rental from the lessor’s point of view, the present value of
the lessor’s cash flow stream is set to zero to solve for the lease rental.
378. (b) From A.Y. 1992-93, if an asset is put to use for less than 180 days in the year of
acquisition (including asset given on lease), the depreciation allowed will be at 50% of the
rates allowed for normal depreciation on the said type of asset.
379. (a) The difference LB – LB’ is the spread between the break even rentals of the lessor and
lessee. Here, LB is the break even rental of lessee and LB’ is the break even rental of the
lessor. For the rental to remain within the range the break even rental of lessor should be
less than that of lessee.
380. (c) Residual value of the equipment has considerable influence in the calculation of gross
yield. The other factor which influences the gross yield is the payment profile.
381. (c) The ‘add-on-yield’ is similar to the ‘flat rate of interest’, which assumes that the
investment in the lease remains constant over the lease period. It does not recognize that
every lease rental paid under the finance lease has a capital content and an interest content.
It is not a true measure of the interest rate implicit in a lease.
382. (a) Cost of equipment = Rs.36 lakh
Aggregate lease rentals = (0.025 x 36 x 60)= Rs.54 lakh
Aggregate interest charge for the lease over the lease period = Rs.(54 – 36) = Rs.18 lakh
3.6
Add-on yield = x100 = 10%
36

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 Part I

383. (d) The cut-off rate or the hurdle rate is determined as the pre-tax cost of funds plus a profit
margin, the latter being a subjectively determined figure.
384. (b) An explicit approach is to define the subjective probability distribution for the residual
values and use the expected value of the probability distribution as the input for computing
the gross yield.

LEASE ACCOUNTING AND REPORTING

385. (c) The lessee acquires the economic benefits of the use of the leased asset for the major
part of its useful life in return for entering into an obligation to pay for that right.
386. (d) Actuarial method is also known as the Effective Rate of Interest Method.
387. (c) As per AS-19, lease payment under operating lease should be recognized as an expense
in the profit and loss statement on a straight line basis over the lease term.
388. (b) Lease of land where the title is not transferred from the lessor to the lessee on expiry of
the lease term is accounted for as an operating issue. Likewise long-term lease of buildings
where there is a provision for revising rentals periodically must be accounted for as an
operating lease.

HIRE PURCHASE
389. (d) In a hire purchase transaction, the ownership is transferred to the hirer only when he
exercises the option to purchase or on payment of last installment.
390. (e) All the alternatives are correct.
391. (b) In an installment sale, the ownership of the asset is transferred to the buyer on the
payment of first installment.
392. (e) A buyer is committed to pay full price in a conditional sale. The interest component of
hire purchase installment is calculated on the basis of flat rate of interest. In hire purchase,
ownership is transferred on the payment of last installment. A lease contract with a (call)
purchase option is considered as a hire purchase contract.
393. (e) The approximation formula is used to calculate the effective rate of interest per annum
as an alternative to the trial and error method. But the formula used is different when the
payments are in arrears and in advance.
n
394. (a) x 2F ⇒ n = 48(12 x 4)
n −1
48
∴ iapp = x 2 x 0.14 = 28.59 ≈ 28.6%
47
395. (d) Because in a deposit linked plan, the rate of interest reflects the effective rate of interest
implicit in the plan.
t(t + 1)
396. (d) Interest rebate to the borrower can be x D obtained by applying ‘Rule of 78’
n(n + 1)
method.
t(t + 1) 12 x13
397. (a) xD= x 300 = 35.14
n(n + 1 36 x37
(t − α) (t − α + 1) (12 − 2)(12 − 2 + 1)
398. (b) xD= x 318 = 26.26.
n(n + 1) 36 x 37
399. (d) Alternative (c) is wrong because the rebate calculated using the ‘Rule of 78’ is less than
the rebate calculated using the effective rate of interest method. Modified ‘Rule of 78’
includes the deferments also.
400. (b) If there is a third party, then a contractual relationship exists between the hirer and the
dealer. Thus, the hire purchase contract is hampered.
401. (b) It is one of the rights provided to the hirer by the hire purchase agreement.

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 Investment Banking and Financial Services

402. (e) Apart from the provisions of HP Act, 1972, legal aspects of the HP transaction have to
be ascertained from the provisions of the Indian Contract Act, 1872, Sale of Goods Act
(1930) and the judgments pronounced by the courts on the issues related to such contracts.
403. (e) Depreciation is charged on the cash purchase price of the asset and the unearned
finance components of the installments or the unmatured finance income is shown as a
current liability in the books of the finance company.

CONSUMER CREDIT
404. (b) Repayment period = 24 months.
Total charge for credit = (780 x 24) – 14000 = 4720
Annual charge = 4720/2 = 2360
2,360
Flat rate of interest = x100 = 16.85%
14, 00
405. (d) The Act requires every intermediary, which provides consumer credit or acts as a credit
reference agency, debt collector or credit broker to obtain a license from the Office of Fair
Trading (OFT) to carry on business.
406. (d) A consumer credit transaction can be structured in the form of hire purchase,
conditional sale or credit sale transaction.
407. (c) The eligibility criteria for individual borrowers include a minimum level of annual
emoluments, minimum no. of years in the present employment and minimum take-home
salary. For partnership firms and companies, the criteria include a profitable track-record,
minimum levels of sales and net worth.
408. (d) The term ‘consumer credit’ encompasses all types of asset based financing plans
offered primarily for acquiring consumer durables.
409. (e) The alternatives (a), (b) and (c) are true. The alternative (d) is not exactly true because
in most cases the consumer finance schemes may be of two types: Down-payment type or
of the deposit-linked type.
410. (c) The effective rate of interest implied by the deposit schemes will be that rate of interest,
which equals the present value of the cash flow stream to zero.

FACTORING AND FORFAITING

411. (a) A factor offers one or more of the following functions: Collection, sales ledger
administration/maintenance, credit protection, short-term funding, advisory services.
412. (b) Under recourse factoring, the factor purchases the receivables on the condition that the
loss arising on account of irrecoverable receivables will be borne by the client (or) the
factor has recourse to the client if the debt purchased turns out to be irrecoverable.
413. (c) The export factor enters into a contract with an import factor and contracts out certain
tasks to him for an agreed fee. The debt is usually not assigned to the import factor.
414. (e) Both bill discounting and forfaiting are not forms of factoring.
415. (e) Alternative (b) is wrong because in credit insurance the insurance company does not
help in collection of receivables. Alternative (a) is wrong because the exporter sells goods
to the importer on a deferred payment basis spread over 3-5 years.
416. (d) Under maturity factoring arrangement, the factor does not make any advance payment,
he pays the client either on a guaranteed payment date or on the date of collection.
417. (d) Invoice discounting is referred to as ‘confidential factoring’.
418. (b) In supplier guarantee factoring, the factor guarantees payment to the foreign supplier in
respect of specific shipment. Upon shipment, he credits the account of the distributor and
debits the account.
419. (a) The importer draws a series of promissory notes in favor of the exporter for the
payments to be made inclusive of interest charges.

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 Part I

420. (c) Under full factoring, the factor provides the entire spectrum of services – collection,
credit protection, sales-ledger administration and short-term finance.
4
421. (b) = [(1 + 0.0475 – 1] x 100
∴annualized interest rate = 20.397%
(or) approximately 20.40%.

SECURITIZATION
422. (e) All the options are true.
423. (b) Transfer of assets by the originator to a person specially created SPV. SPV is a separate
entity.
424. (d) A whole loan may be with or without recourse to the seller.
425. (a) A mortgage-backed bond is a collateralized term-debt offering.
426. (e) The average life of mortgage pass-throughs and mortgage-backed bonds depends on the
prepayment experience of underlying mortgages, while in the case of collaterized mortgage
obligations, the prepayment is more predictable for fast pay bonds.
427. (e) The revolving credit asset-backed securities are usually backed by credit card
receivables for specified period. Those ABS do not amortize principal. These ABS offer
investors an undivided interest in a trust formed by the issuer. All the loans on automobiles
of credit card are pooled to create the trust.
428. (d) By Securitization, the capital adequacy ratio can be improved. A NBFC may increase
its capital adequacy ratio by securitizing some of its homogeneous assets, thus decreasing
the risk weightage of the assets while fulfilling the regulatory guidelines.
429. (e) STRIP security is created by taking the cash flows from the underlying collateral and
splitting them into two or more classes that have the same maturity as the underlying
collateral.
430. (a) A whole loan sale may be with recourse or without recourse to the seller.
431. (d) Any asset securitization deal will have to pay hefty stamp duties thereby increasing the
overall cost of the deal process and foreclosure norms that restrict the transfer of property
without the intervention of court of law.
432. (e) The mortgage pass-through securities were also thought to be made more attractive to
capital market investors by subjecting these securities to credit rating.

MORTGAGES AND MORTGAGE INSTRUMENTS

433. (b) Many different kinds of ARMS have originated with their own features are even
referred to as ARMS. Terms such as VRM, ROM, RRM.
434. (d) The payments on GPMs unlike the payments on traditional mortgages are not equal.
435. (e) Increases in the mortgage rate are optional on the part of the lender, but decreases are
mandatory.
436. (e) 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 rate.
437. (c) The borrower would have to make a down payment of 15% of the value of the property.
438. (b) Loan is repaid in equated monthly installments consisting of both principal and interest.
439. (e) The difference between the current market value of the home and the mortgage balance
equals the homeowner’s equity and as the mortgage balance declines the equity rises.
440. (e) The mortgage balance increases for a short period of time because smaller payments in
the initial years do not even cover the interest.
441. (e) 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.

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 Investment Banking and Financial Services

442. (e) A feature of GPM is that mortgage balance increases for a short period of time because
smaller payments in the initial years do not even cover the interest.

REAL ESTATE FINANCING: RISK AND RETURN

443. (c) It is a medium-term stop gap arrangement to the borrower till he finds a more
permanent source of finance.
444. (a) The main benefit of a gap loan is that 100% financing is provided without the need to
bring in the margin money. The rate of interest on gap loans is much higher than the PLR.
445. (b) A bow tie protects both the lender and the borrower against the volatility in interest
rates. If the market rates of interest exceed the ceiling rate agreed upon on the
documentation, an additional amount may have to be added as a balloon payment to the
principal at maturity.
446. (a) REITs work on the principle of pooling the capital of a large number of individual
investors and issues of debt and then either invest the capital in the ownership of real estate
or lend the capital to real estate borrowers on the security of mortgages. This is akin to
mutual funds that pool the funds of many investors and invest the same in the equity or debt
markets.
447. (c) Unless there is a considerable number of buyers, the market will not be active and the
assessment of the value of a property will not be done properly. After all, the value of a
property depends on the perceived value of buyers and sellers in the market.
448. (e) NBFCs are not allowed to operate in the real estate markets.
449. (d) S&Ls offer real estate financing through direct joint ventures too.

HOUSING FINANCE IN INDIA

⎡ ⎛ 0.145) ⎞ ⎤
240

⎢ 350000 x 0.145 ⎜ 1 + ⎟ ⎥
1 ⎢ ⎝ 12 ⎠ ⎥
450. (d) = Rs.4,480.
12 ⎢ ⎛ 0.145 ⎞
240
⎥
⎢ ⎜1 + ⎟ −1 ⎥
⎣ ⎝ 12 ⎠ ⎦
451. (e) All the options mentioned are essential while applying for housing finance for self-
construction from a HFC.

PLASTIC MONEY
452. (c) The card is generally issued by banks as they are called principal issuers.
453. (c) For debit card you have to open an account and no need to open a bank account in
credit card.
454. (c) There is no charge or interest on charge cards and for credit card interest is between
2.5%-3%.
455. (e) All other cards are ‘buy now pay later’.
456. (d) It debits the bank account directly.
457. (c) Merchant Card, which is a kind of credit card.
458. (a) Credit cards offer the benefit of revolving credit. This facility permits the cardholder to
choose the manner in which he wants to pay for the amount due at the end of a billing
cycle.
459. (e) No interest charge, commission or annual payment and whatsoever be the amount will
have to pay at the end of month otherwise penalty will be imposed.
460. (d) If cardholder wants to purchase anything and he uses his card before that he should
have so much of balance otherwise transaction will be declined, as his account will be
debited directly.
461. (c) As the banks are principal issuer of credit cards and have a pact with clearing agency
like Master Card International.

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 Part I

SOURCES OF FINANCE AND REGULATORY ENVIRONMENT OF

FINANCIAL SERVICES
462. (e) As they are not entitled to do so.
463. (d) Where lease rentals/hire purchase installments are past due for six months the entire
dues from the lessee/hirer should be treated as NPA.
464. (c) A doubtful asset is one which has remained NPA for a period exceeding two years.
465. (a) The interest of 16% per annum compounded at monthly rates would be equal to an
effective rate of 17.23% p.a.
466. (e) The RBI has no such directive towards NBFCs.
467. (e) It is not legal to do so in India.
468. (d) If the depositor renews his deposit for a period longer than the remaining period of the
original contract and the interest on the expired period of deposit is reduced by one
percentage point from the contracted rate.
469. (a) 1 year and 1 day.
470. (c) 3 crore → whichever is less in actual and 1.25% of RWA will be taken → 1.25% of
RWA = 3 crore.
471. (b) After 3 months from the date of deposit, NBFCs can grant loans to the depositor up to
75% of the amount of public deposit kept by the depositor. Interest rate that can be charged
by the NBFC can be minimum of 2%, above the interest rate payable on the deposit.

131
 Frequently Used Formulae
MONEY MARKET
Introduction to Money Market
1. Annual Turnover of Primary Dealer/Satellite Dealer
Total Purchases and Sales during the year*
=
Average month-end stocks during the year
* Purchases include primary market purchases and sales include redemption of maturities.
Treasury Bills
⎛ Face Value ⎞ 365
1. Yield on T-bill = ⎜ − 1⎟ x
⎝ Price ⎠ Days to Maturity
Commercial Paper (CP)
F
1. P=
(I x N)
1+
100 x 365
Where,
P = Issue Price
I = Effective interest rate p.a.
F = Face/Maturity in days
N = Usance period in days.
Par Value − Purchase Price 360
2. Rate of Return = x
Par Value Days to Maturity

Certificate of Deposits (CDs)

F
1. DR =
(I x N)
1+
100 x 365
Where,
DR = Discount value
N = Issuance period
F = Face value
I = Effective interest rate p.a.
MERCHANT BANKING
Management of Public Issues, Initial Public Offerings and Pricing of Various
Instruments
1. Dividend Discount Model
D0 (1+g)
P0 =
r−g
Where,
P0 = Price of share
D0 = Current dividend per share
g = Expected growth rate in dividends
r = Expected return by the investor.
2. Return on Stock i (Underpriced/Overpriced)
⎛P ⎞
R it = ⎜⎜ it − 1⎟⎟ x100
⎝ io
P ⎠
Where,
Rit = Returns on stock i in period t in %
Pit = Price of stock i in period t
Pio = Offer price of stock i.
3. Return on Market Index
⎛P ⎞
R mt = ⎜ mt − 1⎟ x100
⎝ Pmo ⎠
Where,
Rmt = Returns on market index in period t in %
Pmt = Value of market index in period t
Pmo = Value of market index on date of offer of stock.
4. Adjusting the Return on Stock to Return on Market
ARit = Rit – Rmt
Where,
ARit = Adjusted returns to market index.
5. Wealth Relative
I n
1+∑ rit
WR it = N i=1
I n
1+ ∑ rmt
N t=1
Rights Issues, Bonus Issues, Private Placements and Bought-out Deals
NP0 +S
1. Value of a Share after the Rights Issue =
N +1
Where,
N = Number of existing shares for the rights issue
P0 = Cum-rights market price per share
S = Subscription price at which the rights shares are issued.
Pr − S
2. Value of a Right = R =
N +1
Where,
R = Value of a right
Pr = Market value of share trading with rights on
S = Strike price
N = Number of rights to purchase a new share.
3. Share Price Ex-Rights
Pe = Pr – R
Where,
Pe = Price of share ex-rights.

133
4. Market Value of each Right after the Rights Issue
Pe − S
R=
N
5. Value of shareholding after subscription = NP0 + S.
LEASE EVALUATION: THE LESSOR’S ANGLE
1. Cost of funds to lessor:
⎛ E ⎞ ⎛D ⎞
K′ = Ke x ⎜ ⎟ K d (1 − T) x ⎜ +E⎟
⎝ D+E ⎠ ⎝ D ⎠
Where,
K′ = Marginal cost of funds
Ke = Marginal cost of equity
Kd = Marginal cost of debt
D:E = Debt-equity ratio of the lessor
T = Tax rate.
2. Present value of rental stream:
⎛ (1+ j) ⎞
PV = L x ⎜ ⎟ + PVIFA (j,n)
⎝ (1+ i) ⎠
Where,
PV = Present value of rental stream where rentals increase/decrease at constant rate p.a.
L = Lease rental per period
n = Duration of lease in years
j = [(i – g)/(1 + g)]
i = Pre-tax yield p.a.
g = Constant rate of increase/decrease p.a.
3. IRR based pricing:
i = iF + ie + id
Where,
i = Adjusted rate of return
iF = Risk-free rate of return
ie = Premium for the risk characterizing the existing lease investments
id = Premium for the differential risk characterizing the lease investment under review.
CONSUMER CREDIT
1. Index of Creditworthiness:
Z = aX1 + bX2
Where,
Z = Index of creidtworthiness
X1 = Take-home monthly income (in Rs.)
X2 = No. of years spent in the current job.

134
HOUSING FINANCE IN INDIA
1. Disbursement Amount:
CC PC LC
RD = AV x AV x + AVx − BC − CM
100 100 100
Where,
RD = Recommendation for Disbursement in Rs.
AV = Aggregate Value = LC + CC
PC = Progress of Construction in % points
LC = Land Component
CC = Cost of Construction + Overheads + Profits
BC = Borrower’s Contribution
CM = Cumulative Disbursement Made.
2. Equated Monthly Installements:
1 ⎛ Lr(1+ r)n ⎞
⎜ ⎟
12 ⎝ (1+ r) n − 1 ⎠
Where,
L = Loan
r = Rate of interest in decimals
n = Period.

135
 Part II: Problems
MONEY MARKET
Introduction to Money Market
1. a. TRQ Ltd. and XYZ Ltd. are primary dealers operating in the Indian money markets.
The commitment of TRQ Ltd. and XYZ Ltd. for the aggregate bidding for G-Secs
is Rs.1,000 crore and Rs.1,200 crore respectively. What would be the required
amount of successful bids for each of these PDs for the year?
b. If the tendered and accepted bids for an auction of G-Secs by each of these PDs are
given below, then would they be meeting the requirements for their commitments
and successful bids?
(Rs. crore)
TRQ Ltd. XYZ Ltd.
Tendered bids 800 1,400
Accepted bids 700 1,000
2. The required amount of successful bids for STL Ltd. in a T-bills auction was assessed
at Rs.315 crore. What should be the minimum amount of tendered and accepted bids
that this PD should maintain if it has to adhere to the requirements?
3. The notified bid amounts for G-Secs and T-Bills were Rs.3,700 crore and Rs.2,200 crore
respectively. Sterling Gilts Ltd. which is participating in this auction has an underwriting
commitment with the RBI to an extent of 10% of the shortfall in case of G-Secs and 5% of
the shortfall in case of T-bills. If the bids received and bids accepted are as given below,
then assess devolvements on all PDs, RBI and on Sterling Gilts Ltd.
(Rs. crore)
Bids received:
G-Secs 4,000
T-Bills 2,700
Bids accepted at cut-off price
G-Secs 3,100
T-Bills 1,800
4. The commitment for aggregate bidding for G-Secs and Auction T-Bills of 4 PDs are as
follows:
(Rs. crore.)
P Ltd. Q Ltd. R Ltd. S Ltd.
G-Secs: 800 900 600 400
Auction T-Bills 900 1,200 1,500 1,700
The bids tendered and accepted are as given below:
(Rs. cr.)
P Ltd. Q Ltd. R Ltd. S Ltd.
G-Secs:
Tendered 850 1,000 500 600
Accepted 300 250 150 300
Auction T-Bills:
Tendered 1,000 700 1,700 1,900
Accepted 300 250 620 750
 Part II

Based on the data provided above, answer the following:

i. Assess the required amount of successful bids for the year for these PDs in each of
the instruments.
ii. State whether the PDs have adhered to the commitments for aggregative bidding and
achieving the acquired amount of successful bids during the year.
5. Ross Ltd. is a primary dealer in government securities. During the auction of dated
securities and 91-day T-Bills made by the RBI, Ross Ltd. has, in agreement with the RBI,
given an underwriting commitment of 15% of the shortfall in case of government dated
securities and 10% of the shortfall in case of 91-day T-Bills. The amounts notified for the
bids were Rs.600 crore for the dated securities and Rs.200 crore for the 91-day T-Bills.
From the various cases given below, identify those cases where devolvement has occurred
and assess the amount devolved on (a) All PDs; (b) Ross Ltd. and (c) the RBI.
(Rs. crore.)
Bids received Competitive bids accepted at cut-off
price
G-Secs 91-day G-Secs 91-day T-Bills
T-Bills
Case 1 900 400 600 200
Case 2 900 400 500* 150*
(* includes non-competitive bids.)
6. The commitment for aggregative bidding for Government Securities and Auction Treasury
Bills of four primary dealers is as follows:
(All figures in Rs. crore)
Particulars PNB Gilts Ltd. SBI Gilts Ltd. Gilts Securities ICICI Securities
Trading and Finance
Corporation Company Ltd.
Government 900 1,000 800 700
securities
Auction treasury 1,300 1,500 1,100 1,800
bills
The bids tendered and accepted are as given below:
(All figures in Rs. crore)
Particulars PNB Gilts SBI Gilts Ltd. Gilts Securities ICICI Securities and
Ltd. Trading Corporation Finance Company Ltd.
Government
securities:
Tendered 1,000 900 1,100 650
Accepted 400 350 412 200
Auction treasury bills:
Tendered 1,500 1,400 1,200 1,600
Accepted 500 450 350 500
You are required to
a. Assess the required amount of successful bids for the year for these primary dealers
in each of these instruments.
b. State whether these primary dealers have adhered to the commitments for
aggregative bidding and achieving the required amount of successful bids during the
year.

137
 Investment Banking and Financial Services

Treasury Bills
7. The RBI offers 91-day T-Bills to raise Rs.5,000 crore. The following bids have been
received.
Bidder Bid rate Amount
(Rs. crore)
A 98.95 1800
B 98.93 700
C 98.92 1,000
D 98.90 1,200
E 98.90 600
F 98.87 200
G 98.85 350
H 98.85 150
Who are the winning bidders and how much of the security will be allocated to each
winning bidder?
Calculate the yield for each of the winning bidders.
If this auction is a single price auction, what is the price to be paid by the winning
bidders?
8. If the face value of a 364-day T-Bill is Rs.100 and if the purchase price is Rs.91.35 for a
treasury bill, what is the yield on such a bill?
9. Sun Limited has offered the following bond for subscription.
Face Value – Rs.10,000
Tenure – 6 years
Each bond would be paid Rs.2,750 for the first 5 years from the date of allotment. The
amount of Rs.2,750 would consist of both interest and principal portion. The amount
would be first adjusted towards the interest on principal outstanding at the time and
the balance towards principal. The last payment would be made at the end of year 6 towards
the interest and the balance principal outstanding.
The interest would be computed at a mark up of 3% over the yield on 364-day treasury bill.
According to CMIE, the yield on 364-day T-bills is expected to be as follows:
Probability
0.3 0.5 0.2
Year
1 11.0 11.5 12.5
2 10.0 10.5 11.5
3 10.5 9.5 10
4 9 9 10.5
5 8.5 9.5 11
6 8.0 8 9.5
If the yield is in fraction of a percentage, it should be rounded off to the nearest half
percentage (i.e. in multiplies of 50 basis points only). The minimum interest rate is
11.5% and the maximum interest is 14.5% during the entire tenure of the bond.
You are required to compute the cost of the bond to Sun Ltd. if its average tax rate is
17.5%.

138
 Part II

10. On November 2, the RBI issued a tender notification for 182-day T-Bills for Rs.600
crore. There were 4 competitive bidders – A, B, C and D – who responded to the
notification of T-Bills. Based on the data given below you are required to determine the
successful bidders and the amount of T-Bills allotted to them. Also calculate the
weighted average yield for the issue as well as the average yield for each successful
bidder.
Sl. Name of Price Amount Cumulative
No. bidder (Rs.) (Rs. in cr.) amount
(Rs. in cr.)
1 B 98.93 50 50
2 A 98.91 100 150
3 B 98.90 120 270
4 A 98.89 180 450
5 C 98.85 300 750
6 A 98.85 200 950
7 A 98.70 100 1,050
8 B 98.65 150 1,200
9 C 98.50 100 1,300
10 D 98.45 200 1,500
11 C 98.43 250 1,750
12 D 98.41 300 2,050
11. What should you pay for a $1 million, 5-year zero coupon bond, now assuming the
appropriate interest rate to be 8%?
12. If the face value of a 182-day T-bill is Rs.100 and if the purchase price is Rs.92.05 for
treasury bill, then what is the yield on such a bill?
13. A 2-year zero coupon bond with a face value of $10,000 is selling for $9022.87. What
interest rate would you earn if you held it to maturity?
14. What is the yield to maturity of a 8%, 5-year bond with face value of $1000, with semi-annual
coupons if its market price is $850.75?
Commercial Paper (CP)
15. Mr. Anil purchased a commercial paper of Zenith Inc. issued for 6 months in the market for
$9,61,000. The company issued the CP with a face value of $10,00,000. Determine the rate
of return which Mr. Anil earns.
16. Star Ltd. is planning a CP issue of Rs.25 lakh. Given the following details, you are required
to calculate the issue price of commercial paper.
Face Value = Rs.25 lakh
Maturity period = 3 months
Effective interest p.a. = 10.5%.
17. Given the following details you are required to calculate the effective interest p.a. as well as
the total cost of funds to Rajdeep Textiles Ltd. which is planning a CP issue.
Issue price of C.P. = Rs.98,250
Face value = Rs.1,00,000
Maturity period = 3 months
Issue Expenses:
Brokerage 0.025% of issue amount (for 3 months)
Rating charges 0.5% p.a.
Stamp duty 0.125% (for 3 months).

139
 Investment Banking and Financial Services

18. The maturity value of a 45-day CP is Rs.5 crore. The effective interest per annum is 14%.
a. At what price should the CP be issued?
b. What would be the stamp duty chargeable on this issue?
c. What can be the maximum permissible brokerage on this issue?
d. If the issuer pays the maximum permissible brokerage and he pays rating charges @ 0.5%
per annum, what is the effective cost of the CP to the issuer?
Certificate of Deposits (CDs)
19. Suppose a bank offers a 6-month CD at an Annual Percentage Rate (APR) of 11.5%
compounded monthly and a 1-year CD with an APR of 11.3% compounded weekly.
You are required to find out which of them offers a higher rate of interest.
20. Given the following details, you are required to compute the cost of funds to Secunderabad
Bank Ltd.
Face value of CD – Rs.15 lakh
Issue price – Rs.14,45,000
Tenure – 5 months
Stamp duty – 0.25% of face value.
Bill Financing
21. Naveen Financiers Ltd. discounts the bills of its clients at the following rates.
Clean bill – 25% p.a.
Usance bill – 23% p.a.
Calculate the effective rates of interest implied by a clean bill with a usance period of 60
days.
22. Rajeev Finance Ltd. discounts the L/C backed bill of its clients at the rate of 23% p.a.
Calculate the effective rate of interest implied by an L/C backed bill with a usance period of
90 days.
MERCHANT BANKING
Management of Public Issues, Initial Public Offerings and Pricing of Various
Instruments
23. Surety Venture Fund is a leading American Venture Capital Fund. The fund has
specialized in providing finance mezzanine to companies planning public offering of
their equity. The time horizon of all the investments made by this fund is 1 year. The
fund has recently opened a branch office in Mumbai. The fund has received an
investment proposal from Redmond Ltd. The company is an existing profit making,
dividend paying company. The company proposes to increase its capacity by 30% by
adding certain balancing equipment. The company has requested the fund to finance
the program with an equity of Rs.3.5 crore. The current EPS of the company is Rs.7. The
expected growth in EPS for the next year is as follows:
Growth in EPS Probability
(in percent)
0 0.15
10 0.25
20 0.20
30 0.30
40 0.10

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 Part II

Based on the study of Indian capital markets, the research wing of the fund has forecasted
the P/E ratio for the industry in which Redmond operates as follows:
P/E ratio Probability
6 0.15
8 0.25
10 0.40
12 0.20
The fund is expected to price its divestment at the industry P/E ratio. The target return on
any investment made by the fund is 35%. The fund invests only in those proposals where
the probability of getting the target return is at least 0.74. What should be the price at which
the venture fund would make the investment in Redmond Ltd.? Clearly state your
assumptions.
24. Digital Software has been set up by a team of young technocrats. The team has developed a
new software package. The estimated project cost is Rs.2 crore. The team is able to invest
only a sum of Rs.80 lakh as equity at a face value of Rs.10 each. The balance is proposed to
be financed through venture capital. The company offers two alternative investment
packages to the VC firm.
a. Straight equity investment
b. Fully convertible debentures with a coupon of 18%. At the end of 4 years the
FCD would be converted into equity. The conversion would take place at a P/E
ratio of 11 on the weighted average EPS of the preceding 3 years with weights 1,
2 and 3 for the EPS of 2nd, 3rd and 4th year respectively.
The company plans to tap the capital market with an IPO at the beginning of the 6th
year. The IPO is expected to be priced at a P/E multiple of 12.5 on the EPS of the 5th
year. The VC firm intends to divest its holding at the time of the IPO.
The company proposed to maintain a dividend pay-out of 10% for all the 5 years.
The expected EBIT for the 5 years is
Probability 0.2 0.3 0.5
(Rs. in crore.)
Year 1 1.2 1.35 1.02
Year 2 1.4 1.70 1.30
Year 3 1.7 1.75 1.45
Year 4 1.8 1.85 1.50
Year 5 2.5 2.60 2.80
Ignore taxes.
You are required to choose the alternative investment to be made by the VC firm if its
required rate of return is 15%.
25. Lavanya Textiles Ltd. proposes to go for a backward integration project at a cost of 36 crore
which is entirely financed by equity capital.
Total capital structuring is as follows:
(Rs. crore)
Total size of the issue 36
Less: Subscription by promoters 10.5
Offer through prospectus 25.5
Reservation for FIIs (competitive basis) 3
Reservation for mutual funds 4.5
(firm basis)
Reservation for Banks 1.5

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The issue is priced at par value of Rs.10.

The subscription pattern is as follows:
Banks – 1.5 crore
FIIs – 1.5 crore
Mutual Funds – 3 crore
The public portion in the issue is subscribed as follows:
No. of shares No. of applications
200 35,000
300 27,000
500 20,000
800 13,000
1,000 8,000
4,000 2,500
10,000 1,000
25,000 400
1,00,000 50
You are required to compute the basis of allotment giving the following details:
a. The number of shares available for allotment to each category;
b. The number of successful applicants in each category;
c. The number of shares allotted per applicant in each category.
Note: SEBI permits retention of 10% over subscription for the purpose of rounding off to
market lots.
26. Midland Ltd. tapped the capital market with an IPO of Rs.42 crore. The company complies
with SEBI guidelines on pricing and has priced its IPO at Rs.50 per share (i.e. Rs.40 premium).
The following are the details of the reservation in the issue:
Category Type of No. of shares
reservation reserved
FIIs Firm 7 lakh
Mutual funds Competitive 7 lakh
Banks/FIs Firm 3.5 lakh
The response to the issue was as follows:
Category No. of Applications
100 75,000
200 35,000
500 27,000
1000 12,000
2500 7,000
5000 1,500
10,000 800
The response in the reserved category was as follows:
FIIs 7 lakh shares
Mutual Funds 3.5 lakh shares
Banks/FIs Nil
Required:
Compute the detailed basis of allotment for the above issue.

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27. Care Bank Ltd. recently tapped the primary market with an IPO of Rs.160 crore. The
IPO was priced at par because of the moribund state of the capital markets. The low
pricing created a lot of interest in the issue and the issue was oversubscribed.
The following reservations were made in the issue.
Category Type of reservation No. of shares No. of shares applied
reserved
Mutual Firm 1,00,00,000 90,00,000
funds
NRIs Competitive 50,00,000 30,00,000
FIIs Firm 2,00,00,000 2,00,00,000
Banks Firm 1,00,00,000 60,00,000
Employees Competitive 1,00,000 Nil
The subscription pattern in the issue was as follows:
Category No. of
applications
200 4,40,000
500 2,20,000
800 1,00,000
1000 1,00,000
2000 60,000
5000 10,000
10,000 2000
You are required to
Compute the detailed basis of allotment showing the number of applicants in each category.
28. Premier Automobile Ltd. enters the capital market with a public issue of 260 lakh of shares
of Rs.10 each at a premium of Rs.30 per share. The company has the following reservations
in the issue.
• 24 lakh shares reserved for mutual funds on competitive basis.
• 18 lakh shares reserved for FIIs on competitive basis.
After the closure of the issue, the Registrar to the issue collected the following subscription
figures.
Reserved Portion
Category No. of applications Total no. of shares
Mutual funds 8 16,00,000
FIIs 14 4,00,000
Public portion (applications for below 1000 shares)
Size of the application No. of applications
(Shares)
200 40,000
400 20,000
600 15,000
800 10,000
1000 8,000

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On the basis of the above statement, draw a detailed basis of allotment statement giving the
following information.
a. The number of shares available for allotment to each category;
b. The number of successful applicants in each category; and
c. The number of shares allotted per applicant for each category.
29. Excel Ltd. has made a public issue of 220 lakh equity shares at par. The subscriptions
received for 1000 and less shares are as given below. Calculate the number of proportionate
shares available to each category of 1000 shares or less and number of successful applicants
and the number of shares allotted per applicant. The issue was oversubscribed 6 times.
Category Applications received
200 30,000
300 25,100
400 20,000
500 15,000
600 11,000
700 9,200
800 3,700
900 2,600
1000 2,000
1,18,600
30. Consider the following information in respect of a public issue of equity shares, through
prospectus, of Rs.10 each for cash at par to Indian public.
Particulars No. of shares Face Value Issue Price
(Rs.) (Rs.)
Net offer to the resident Indian public 10,70,000 10 10
Add: Unsubscribed portion reserved for mutual 1,09,000 10 10
funds on competitive basis
Net shares available to Indian public 11,79,000 10 10
Total number of shares applied for against the 2,50,81,600 10 10
total public offer
The following details are also available to you in respect of applications for 1000 shares
and below.
Sl. No. of shares No. of applications % of total
No. applied for received
1 500 1397 12.59
2 600 418 3.77
3 700 220 1.98
4 800 395 3.56
5 900 682 6.15
6 1000 7980 71.94
11,072 100.00
Based on the information provided above you are required to draw up the following
schedule for the basis of allotment.

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31. PI Ltd. has made a public issue by prospectus of equity shares of Rs.10 each for cash at a
premium of Rs.40 per share. The following information was collected by KC Ltd., the
Registrars to the issue, for the purposes of determining the basis of allotment.
No.of shares offered through prospectus 5,00,00,000
No.of shares subscribed and allotted to IDBI, 1,00,00,000
UTI, MFs and FIIs on firm basis
No.of shares subscribed and allotted to the 1,00,00,000
employees of PI Ltd. and other group companies
No.of shares subscribed and allotted to NRIs on 50,00,000
repatriation basis
Subscription as multiple of the entire net offer to 6000 times
public
For the category of applicants who have applied for 1000 shares or less, the following
information is available:
No. of shares applied for No. of
(category-wise) applicants
100 1,60,000
200 1,00,000
300 50,000
400 25,000
500 22,950
600 12,000
700 8,000
800 7,000
900 6,500
1000 6,000
From the information given above, you are required to calculate
a. The number of proportionate shares available to each category of 1000 shares or
less, and
b. The number of shares that could be allotted to each allottee in each of the applicant
category of 1000 shares or less.
32. Power Mats Private Ltd. has made an Initial Public Offer (IPO) of 25,00,000 equity
shares of Rs.10 each at par. The issue was underwritten by MB Financial, ICI Finance
and Global Bank for 30%, 30% and 40% respectively. Applications for a total of
23,00,000 equity shares were received. The marked applications received for the three
underwriters were 3,50,000 shares, 4,00,000 shares and 13,50,000 shares respectively.
Prepare a statement showing the underwriters’ liability to the IPO of Power Mats
Private Ltd.
33. Excel Fabrics Limited has made a public issue of Rs.100 crore by prospectus of equity shares
of Rs.10 each for cash at a premium of Rs.40 per share. Of the issue the following
reservations were made:
Mutual funds 25%
Financial institutions 15%
Employees 5%

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The total applications received for 1000 shares or less categories are as follows:
No. of shares No. of applicants
applied for
200 30,000
300 25,100
400 20,000
500 15,000
600 11,000
700 9,200
800 3,700
900 2,600
1,000 2,000
From the information given, you are required to calculate the number of successful
applicants and number of shares that could be allotted to each successful applicant in each
category of 1,000 or less shares.
34. Meena Automobiles Ltd. enters the capital market with a public issue of 220 lacs of shares
of Rs.10 each at a premium of Rs.40 per share. The company has the following reservations
in the issue:
20 lacs shares reserved for Mutual Funds on competitive basis; and
15 lacs shares reserved for FIIs on competitive basis.
After the closure of the issue, the Registrar to the issue collected the following subscription
figures:
Reserved Portion
Category No. of Applications Total No. of Shares
Mutual Funds 6 12,00,000
FIIs 17 3,00,000
Public Portion (applications for below 1000 shares)
Size of the Application No. of Applications
200 Shares 50,000
400 Shares 25,000
600 Shares 20,000
800 Shares 10,000
1000 Shares 10,000
On the basis of the above statement, draw a detailed Basis of Allotment statement giving
the following information:
a. The number of shares available for allotment to each category;
b. The number of successful applicants in each category; and
c. The number of shares allotted per applicant for each category.
35. Prompt Service Bank Ltd. recently tapped the primary market with an IPO of Rs.144 crore.
The IPO was priced at par because of the moribund state of the capital markets. The low
pricing created a lot of interest in the market and the issue was oversubscribed.

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The following reservations were made in the issue.

Category Type of No. of shares No. of shares
Reservation reserved applied
Mutual Funds Firm 1,00,00,000 80,00,000
NRIs Competitive 50,00,000 40,00,000
FIIs Firm 2,00,00,000 2,00,00,000
Banks Firm 1,00,00,000 50,00,000
Employees Competitive 1,00,000 Nil
The subscription pattern in the issue was as follows:
Category No. of shares No. of Applications
200 4,00,000
500 2,00,000
800 1,50,000
1,000 1,00,000
2,000 50,000
5,000 20,000
10,000 5,000
You are required to
a. Compute the detailed basis of allotment showing the number of applicants in each category.
b. State whether it is mandatory for this company to associate a SEBI nominated public
representative to oversee the process of allotment. Give reasons.
36. Reshma Floritech Ltd. is engaged in the business of floriculture. The products of the company
are well accepted in the international markets. The company is planning an expansion program
and proposes to fund it through an IPO of Rs.17 crore at par.
The company entered the market in June, 20x0 and the details of the same are as follows:
Type of Reservation Shares Shares
Reserved Applied
Mutual Funds 20,00,000 10,00,000
(firm basis)
FIIs (competitive basis) 20,00,000 10,00,000
The response to the issue was as follows:
Category No. of Applicants
200 75,000
300 40,000
700 25,000
1,000 18,000
2,000 12,500
4,000 7,000
5,000 2,000
Compute the detailed Basis of Allotment as per SEBI guidelines.
37. Chimanbhai Popatlal & Sons, a century old firm, is a leading stock broker operating on
both the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). The firm is
actively engaged in inter-exchange arbitrage and is, therefore, required to take very large
positions in select counters. Though this is a very profitable business, the firm requires
large amount of funds for margins and to settle their positions, as the trading cycles are
different in both the exchanges. At present the firm is losing some good arbitrage

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opportunities due to shortage of capital. To overcome this problem, the firm has decided to
corporatize itself and make a public offering of its shares. The firm intends to have a post-issue
paid-up capital of Rs.25 crore. The current proprietor Mr. Totharam intends to hold 40%
stake in the company after the public issue. Taking advantage of the latest SEBI Guidelines,
the company decides that its shares will have a face value of Rs.5 and will be offered at par.
The firm made the following reservations in its IPO:
Category Type of No. of shares
Reservation reserved
Mutual Funds Firm 25,00,000
NRIs Competitive 50,00,000
The response to its IPO is as follows:
Category No. of applications
400 shares 10,000
500 shares 8,000
800 shares 5,000
1,000 shares 5,000
2,000 shares 1,000
10,000 shares 500
20,000 shares 200
50,000 shares 100
The response in the reserved category is as follows:
Mutual Funds 20,00,000 shares
NRIs 25,00,000 shares
You are required to compute the basis of allotment as per the current SEBI Guidelines.
Rights Issues, Bonus Issues, Private Placements and Bought-out Deals
38. Stanford Export Ltd. has proposed to expand its operations for which it requires funds of
$3.75 million, net of issue expenses which amounts to 2.5% of the issue size. It proposed to
raise the funds through a GDR issue. It considers the following factors in pricing the issue.
i. The expected domestic market price of the share is Rs.250.
ii. 4 shares underlie each GDR.
iii. Underlying shares are priced at 15% discount to the market price.
iv. Expected exchange rate is Rs.40/$.
You are required to compute
a. The number of GDRs to be issued.
b. Cost of GDR to the company if the dividend expected to be paid is 15% with a
growth rate of 10% p.a.
c. Gain/loss to a holder of 100 GDRs, if the company proposes a rights issue after the
GDR issue in the ratio of 1:2 at a subscription price of Rs.150 per share. Assume the
GDR holder exercises the rights and sells his entire holdings at the prevailing GDR
price which will be at a premium of 20% to the prevailing domestic price.
Assume the Rs./$ exchange rate at the time of rights issue and sale by GDR holder to be
Rs.48/$.

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39. Ravi Cements decides to capitalize its reserves. The details of the same on March 31, 20x1 are
as follows:
Rs. crore
Authorized Capital
2,00,00,000 shares of Rs.10 each 20,00,00,000
Paid-up Capital
90,00,000 shares of Rs.10 each 9,00,00,000
Reserves & Surplus
General reserve 17,00,00,000
Share premium 7,00,00,000
Revaluation reserve 7,00,00,000 31,00,00,000
The company had allotted 15 lakh 15% FCDs of Rs.150 each on March 31, 20x1. The
terms of the issue were as follows:
• Part A of Rs.30 would be converted into 2 equity shares of Rs.15 per share, 12 months
from the date of allotment.
• Part B of Rs.120 would be converted into 3 equity shares of Rs.40 per share, 24 months
from allotment.
The company had purchased plant and machinery worth Rs.4 crore during April 20x1. The
purchase consideration was paid in the form of allotment of 12,00,000 equity shares to the
vendor.
You are required to
a. Compute the maximum permissible bonus ratio as per current SEBI guidelines.
b. Discuss further specific measures which this company would require to take.
40. The balance sheet of M/s Machine Tools Ltd. as on 31.3.20x1 is as follows:
Liabilities Rs. in crore Assets Rs. in crore
Authorized capital 20.00 Land 6.00
2 crore at Rs.10 face value
Issued and Paid-up Capital Building 4.00
0.5 crore fully paid-up 5.00 Plant and Machinery 27.00
0.3 crore – Rs.5 per Miscellaneous
share paid-up 1.50 6.50 Fixed Assets 10.00
Reserves and Surplus Investments 5.00
General Reserve 4.00
Contingency Reserve 2.50 Current Assets 20.50
Capital Reserve 1.50
Share Premium 9.00
Dividend Equalization 1.00
Reserve
Revaluation Reserve 17.00 35.00
Term Loan 17.00
Current Liabilities 14.00
72.50 72.50
The finance director of the company has given the following additional information.
i. The company had purchased a machinery worth Rs.7 crore in May 20x1. The entire
purchase consideration was paid in the form of allotment of 15 lakh equity shares to
the vendor. The vendor had sold 5 lakh equity shares in September 20x1 and 6 lakh
equity shares in January 20x2 to other investors through the secondary market. The
vendor currently holds only the balance of 4 lakh shares originally allotted to him.

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ii. The finance director also informs you that the company has secret reserves of
Rs.10 crore, which is not currently disclosed in the balance sheet. The company
follows extremely conservative accounting policies and had created secret reserves as
a buffer to meet any unforeseen eventualities.
iii. The finance director also informs that the company is not interested to make any call
on the partly paid-up shares but is interested in capitalizing its huge reserves.
You are required to
a. Compute the maximum permissible bonus ratio as per the current SEBI guidelines.
b. Discuss the specific measures the company has to take.
c. i. Explain the concept of secret reserve and how it can be created.
ii. It is the contention of the finance director that secret reserves can be treated as
eligible reserves for computation of bonus ratio, if the company discloses the
same through an advertisement in a newspaper. Do you agree with the
finance director? Give reasons.
41. The balance sheet of Megha Ltd. is as follows:
(Rs. in lakh)
Liabilities Assets
Share Capital 35 Land 20
General Reserve 20 Buildings 25
Share Premium 15 Plant & Machinery 48
Revaluation Reserve 35 Misc. Fixed Assets 20
Capital Reserve 14 84 Closing Stock 43
16% Debentures 25 Receivables 27
Current Liabilities 47 Cash 8
191 191
The company intends to declare a bonus issue. Compute the maximum permissible bonus
ratio.
42. The balance sheet of M/s Aryan Ltd. as on 31.3.20x1 is as under:
(Rs. in crore)
Liabilities Amount Assets Amount
Share Capital 6.00 Land 8.00
Reserves & Surplus Buildings 12.00
General Reserves 20.00 Plant & Machinery 24.00
Share Premium 9.00 Misc. Fixed Assets 7.00
Contingency Reserve 4.00 Investments 1.50
Capital Reserves 3.00 Inventory 8.50
Revaluation Reserves 10.00 46.00 Sundry Debtors 12.00
12.5% Convertible 2.00 Cash 3.00
Debentures
T. Loan 12.00
Current Liabilities 10.00
76.00 76.00
The following information is provided.
a. The company had issued 12.5% FCDs (Face value = Rs.10) on 1st July, 20x0. The
debentures would be converted into equity at par, after 12 months from the date of
allotment.

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b. The company purchased a building worth Rs.3.5 crore during 20x0-x1. The
purchase consideration was paid by allotting 10 lakh equity shares.
(You may assume that the face value of each share is Rs.10.)
Required to compute:
The maximum permissible bonus ratio as per SEBI guidelines.
43. The balance sheet of Panama Chemicals Ltd. as on 31st March, 20x1 is as follows:
(Rs. crore)
Liabilities Assets
Share Capital (Face value Rs.10) 15.00 Land & Buildings 19.00
Reserves & Surplus 75.00 Plant & Machinery 52.00
Debentures 26.00 Misc. Fixed Assets 20.00
Current Liabilities 35.00 Current Assets 60.00
151.00 151. 00
The profit after tax for 20x0-x1 is Rs.9 crore. The EPS is expected to increase by 40%
during 20x1-x2. The market discounts the share at 22 times its expected earnings.
The company proposes to set up a Heavy Chemicals Plant involving a project outlay of
Rs.490 crore. The project is proposed to be financed by term loan of 291.84 crore from
IDBI, Rs.60 crore through private placement of NCDs, Rs.55 crore from internal accruals
and the balance through a rights issue. The rights issue is proposed to be priced at 75% of
its current market price.
The company had issued 10,00,000, 16% PCDs of Rs.150 each in June 20x1. Part A of
Rs.100 will be converted into 6 shares, 15 months from the date of allotment. The balance
will be redeemed at the end of 5 years.
The company had raised a sum of $9 million by issue of 7,50,000 GDRs in March 20x1.
The paid-up capital of Rs.15 crore includes 30,00,000 shares underlying the GDRs.
You are required to compute:
a. The ratio for issue of rights shares and the pricing.
b. The value of the rights.
c. The gain or loss, in dollars, to a GDR holder who holds 100 GDRs, exercises the
rights and sells his entire holding at the prevailing GDR price.
Assume the GDRs are quoting at 25% premium to their domestic price and the Rs./$
exchange rate to be as follows:
• At the time of issue of GDRs – Rs.38/$
• At the time of rights and sale by GDR holder – Rs.42/$.
44. Megasoft Ltd. plans to expand its operations and estimates the total cost of the expansion to
be Rs.24 crore. The same is proposed to be financed by internal accruals of Rs.9 crore and
the balance through a rights issue. The current share capital of the company is Rs.2.40
crore. The shares of the company are currently quoting at Rs.345. The company proposes to
price the rights at Rs.250.
Based on the above information
a. Compute the ratio of the rights.
b. Calculate the value of the rights.
c. Determine the gain/loss of a shareholder, if he
i. Exercises his rights in the rights issue
ii. Allows his rights to expire
iii. Sells his rights.

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45. The financial data of Godavari Papers is as follows:

Paid-up capital (Rs.2 crore. shares) Rs.20 crore
Reserves & Surplus Rs.120 crore
Profit after Tax Rs.15 crore
The shares of the company are listed and are currently quoting at P/E multiple of 9.
The company has taken up an expansion project at a cost of Rs.280 crore. It proposes to
fund it with a term loan of Rs.140 crore from IDBI, Rs.60 crore from internal accruals and
balance by a rights issue. The right will be priced at Rs.40 per share (30 premium).
You are required to compute
a. The value of the rights;
b. The market capitalization of the company after the rights issue; and
c. The net asset value of the shares after the rights issue.
46. Consider the following information with respect to Coromandel Construction Ltd. (CCL):
Paid-up Capital (18,00,000 shares of Rs.10 each) Rs.1,80,00,000
Reserves and Surplus Rs.2,40,00,000
Profit after Taxes Rs.1,80,00,000
Market Price per share Rs.80
Some of the additional information with respect to the company are also available as given
below:
i. The profits before taxes have grown at the rate of 20% every year for the first 5 years.
ii. Corporate tax rate of 40% is applicable to CCL.
Based on the information provided above, you are required to consider two independent
situations as mentioned in (a) and (b) below, respectively, and answer the question(s)
contained therein.
a. CCL wishes to capitalize its large base of Reserves and Surplus by issuing bonus
shares to its shareholders. What is the maximum permissible bonus ratio that
could be adopted by CCL as per the regulatory requirements?
b. CCL is planning to tap the opportunity of developing a prime property in Hyderabad
and is considering a rights issue of equity shares amounting to 4.5 lakh shares at a
subscription price of Rs.50 each. Calculate the impact of this rights issue on the
wealth of a shareholder, who already holds 100 shares in CCL, under the following
situations:
i. the shareholder exercises his rights in full, and
ii. the shareholder sells his rights in its entirety.
What conclusions do you draw from your calculations?
47. Present capital structure of Prince Constructions Limited, a company listed on BSE, is as
follows.
Rs. lakh
Authorized capital
50 lakh equity shares of Rs.10 each 500
Issued, subscribed and paid-up
45 lakh equity shares of Rs.8 each paid 360
Reserves and Surplus
Free reserves 220
Revaluation Reserves 45 265
Term loans and other debt 500

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Free reserves of Rs.220 lakh include share premium of Rs.80 lakh, half of which was
collected in cash.
The company is planning to capitalize a part of its reserves.
Keeping the existing SEBI guidelines in view, you are required to
a. Calculate the maximum ratio at which the company can issue bonus shares, and
b. State whether the company can go ahead with bonus issue? Give reasons. If not,
what is the additional provision it has to comply with to issue bonus shares?
State assumptions, if any made.
48. Sriram Industries Limited, a listed company at National Stock Exchange is currently
trading at Rs.80. The management is contemplating a rights issue of 2:5 to revamp the
operations and fund their increased working capital requirement. The paid-up capital of the
company is Rs.10 crore. The company plans to price the rights issue at Rs.65 per share.
a. Find the value per share after the rights issue.
b. What is the value of rights?
49. Consider the following information with respect to Wright Constructions Limited (WCL).
Equity capital: Rs.
Issued and fully paid
(10,00,000 shares of Rs.10 each) 1,00,00,000
Reserves & surplus 1,80,00,000
Long-term debt 3,50,00,000
Market price per share Rs.20
Earnings per share Rs.4
Effective corporate tax rate 33%
Out of the total long-term debt of Rs.3,50,00,000 the company wishes to redeem a loan of
Rs.30,00,000 carrying an interest rate of 10% by making a rights issue.
You are required to calculate
a. The number of right shares, rights ratio and dilution in EPS if the shareholders
expect the subscription price to be 20% below the existing market price.
b. Calculate the ex-rights price of the shares and the corresponding P/E ratio if rights
issue is made based on (a) above.
c. Calculate the change in wealth of a shareholder who owns 1000 shares in WCL
i. if he sells his rights
ii. if he allows his rights to expire.
Comment on the above.
50. Unique Graphics Limited is currently trading on the stock exchange at Rs.80 per share of
Rs.10 face value. During the year 20x1-x2 it proposed to expand by increasing its existing
capacity of production with an estimated cost of Rs.90 lakh. The capital and reserves and
surplus of the company as at the end of March 20x2 (estimated) are as follows:
(Rs. lakh)
Issue, Subscribed and paid-up 90
(9 lakh equity shares of Rs.10 each)
Reserves and surplus 110
3 lakh of Partly Convertible Debentures 300
of Rs.100 each
Rs.80 of each PCD which are issued during March 20x2 are convertible into 1 equity share
of face value of Rs.10 at a premium of Rs.70 each at the end of March 20x3.

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Its estimated earnings per share for the year 20x1-x2 is Rs.3. Due to expansion it expects its
post-tax earnings to increase by 20% for the year 20x2-x3. To reduce the issue expenses it
proposes to raise the funds for expansion through rights issue during 20x2-x3. In pricing
the issue it had the following objective:
– The dilution in EPS should not be more than 20%.
Assuming that the price of the share would be around Rs.80 before rights issue
Calculate
i. The minimum subscription price of right shares and the maximum ratio of rights
ii. Change in the wealth of a shareholder who owns 1000 shares if he allows his rights
to lapse.
51. Dawn Ltd. had entered the market with an IPO in June 19x9 and its shares are currently
trading at Rs.78. The company intends to finance one of its new ventures with a rights issue
of 3 shares for every 1 share held. The rights shares are to be priced at Rs.65 per share.
You are required to compute
a. The value of the rights
b. The expected ex-rights price of the share
c. The gain/loss to Mr. Karan holding 100 shares if he
– exercises his rights
– allows his rights to lapse
– sells his rights.
52. The financial data of Excellent Paper is as follows:
Paid-up Capital (4 crore. shares) Rs.40 crore
Reserves & Surplus Rs.160 crore
Profit After Tax Rs.18 crore
The shares of the company are listed and are currently quoting at P/E multiple of 12.
The company has taken up an expansion project at a cost of Rs.355 crore. It proposes to
fund it with a term loan of Rs.155 crore. from ICICI, Rs.80 crore. from internal accruals
and the balance by a rights issue. The right will be priced at Rs.40 per share (Rs.30
premium).
You are required to compute
a. The value of the rights;
b. The market capitalization of the company after the rights issue; and
c. The Net Asset Value of the share after the rights issue.
53. Minco Steel decides to capitalize its reserves. The details of the same on 31/03/20x0
are as follows:
Authorized Capital Rs.
1,50,00,000 shares of Rs.10 each 15,00,00,000
Paid-up Capital
70,00,000 shares of Rs.10 each 7,00,00,000
Reserves & Surplus
General Reserve 15,00,00,000
Share Premium 9,00,00,000
Revaluation Reserve 4,00,00,000 28,00,00,000

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The company had allotted 10 lacs 16.5% FCDs of Rs.170 each on 13/11/19x8. The terms of
the issue were as follows:
• Part A of Rs.50 would be converted into 2 equity shares @ Rs.25 per share, 12
months from allotment.
• Part B of Rs.120 would be converted into 3 equity shares @ Rs.40 per share, 24 months
from allotment.
The company had purchased Plant and Machinery worth Rs.5 crore during April, 19x9. The
purchase consideration was paid in the form of allotment of 10,00,000 equity shares to the
vendor.
You are required to:
a. Compute the maximum permissible bonus ratio as per current SEBI guidelines.
b. Discuss further specific measures which this company would require to take.
54. The Balance Sheet of Ujwala Chemicals Ltd. as on 31st March, 20x0 is as follows:
(Rs. crore)

Liabilities Assets

Share Capital (Face Value Rs.10) 10.00 Land & Buildings 16.00

Reserves & Surplus 68.00 Plant & Machinery 47.00

Debentures 30.00 Miscellaneous Fixed 24.00

Assets

Current Liabilities 32.00 Current Assets 53.00

140.00 140.00
The Profit After Tax for 19x9-20x0 is Rs.6 cr. The EPS is targeted to increase by 25%
during 20x0-x1. The market discounts the share at 20 times its expected earnings.
The company proposes to set up a heavy chemicals plant involving a project outlay of
Rs.465 crore. The project is proposed to be financed by term loan of Rs.255 crore.
from ICICI, Rs.80 crore. through private placement of NCDs, Rs.40 crore. from
internal accruals and the balance through a rights issue. The rights issue is proposed to
be priced at 80% of its current market price.
The company had issued 10,00,000 17% PCDs of Rs.120 each in July, 19x9. Part A of
Rs.100 will be converted into 4 shares, 15 months from the date of allotment. The balance
will be redeemed at the end of 5 years.
The company had raised a sum of $8.75 million by issue of 6,25,000 GDRs in March,
19x9. The paid-up capital of Rs.10 crore. includes 25,00,000 shares underlying the GDRs.
You are required to compute:
a. The ratio for issue of rights shares and the pricing
b. The value of the rights
c. The gain or loss, in dollars, to a GDR holder who holds 100 GDRs, exercises the
rights and sells his entire holdings at the prevailing GDR price.
Assume the GDRs are quoting at 20% premium to their domestic price and the Rs./$
exchange rate to be as follows:
At the time of issue of GDRs Rs.36/$
At the time of rights issue
and sale by GDR holder Rs.42/$

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55. Mathura Engineering Works Ltd. is a component supplier to several manufacturers of

automobile and earth moving equipments. The balance sheet of the company as on 31st
March, 20x0 is as follows:

Liabilities (Rs. in crore.) Assets (Rs. in

crore)
Authorized capital: Land 4.00
1.4 crore. at Rs.10 face value 14.00 Buildings 9.00
Issued and paid-up capital Plant and Machinery 22.00
0.3 crore. fully paid-up 3.00 Miscellaneous Fixed Assets 7.00
0.2 crore. - Rs.5 per share paid- 1.00 4.00 Investments 3.00
up
Reserves & Surplus Current Assets 15.00
General Reserve 3.00
Contingency Reserve 2.75
Capital Reserve 1.25
Share Premium 7.00
Dividend Equalization Reserve 1.00
Revaluation Reserve 15.00 30.00
Term Loan 14.00
Current Liabilities 12.00
60.00 60.00
The Finance Director of the company has given the following additional information:
1. The company had purchased a machinery worth Rs.4 crore. in May, 19x9. The
entire purchase consideration was paid in the form of allotment of 10 lakh equity
shares to the vendor. The vendor had sold 2 lakh shares in August, 19x9 and 3.5 lakh
shares in February, 20x0 to other investors through the secondary market. The
vendor currently holds only the balance of 4.5 lakh shares originally allotted to him.
2. The Finance Director also informs you that the company has secret reserves of
Rs.8 crore, which is not currently disclosed in the balance sheet. The company
follows extremely conservative accounting policies and had created secret
reserves as a buffer to meet any unforeseen eventualities.
3. The Finance Director also informs that the company is not interested to make any
call on the partly-paid up shares but is interested in capitalizing its huge reserves.
You are required to
i. Compute the maximum permissible bonus ratio as per the current SEBI guidelines.
ii. Discuss the specific measures the company has to take.
iii. a. Explain the concept of ‘Secret Reserve’ and how it can be created.
b. It is the contention of the Finance Director that Secret Reserves can be treated as
eligible reserves for computation of bonus ratio if the company discloses the same
through an advertisement in a newspaper. Do you agree with the Finance
Director? Give reasons.

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56. The Balance Sheet of Ashwini Plastics Ltd. as on 31st March, 20x0 is as follows:
(Rs. in crore.)
Liabilities Amount Assets Amount
Share Capital 20,00,000 shares of Freehold Land 1.00
Rs.10 each fully paid-up
2.00
Buildings 3.50
Plant & Machinery 17.50
Reserves & Surplus: Misc. Fixed Assets 0.50
Share Premium 2.25 Inventory 5.50
General Reserve 2.50 Sundry Debtors 3.50
Dividend Equalization Reserve 1.25 Cash 0.50
Special Reserve 1.50
Contingency Reserve 0.50 8.00
14% Fully Convertible 1.50
Debentures (98 series)
Term Loans 14.00
Sundry Creditors 6.50
32.00 32.00
a. The company, on July 8, 20x0, had issued 2,50,000 14% Fully Convertible
Debentures of Rs.60 each. Each FCD will be converted into 2 equity shares of Rs.10
each, at a premium of Rs.20 per share, 12 months from the date of allotment.
b. The existing share capital includes 2,00,000 shares which were issued as purchase
consideration to a machinery supplier. The cost of the machinery was Rs.70 lakh
and the entire purchase consideration was paid only in the form of shares.
Compute the maximum permissible bonus ratio as per the current SEBI guidelines.
57. The Balance Sheet of Rathi Electrocastings Ltd. as on March 31, 20x1 is as under:
(Rs. in crore)
Liabilities Assets
Share Capital Land 14.00
(5,00,00,000 shares of 50.00 Building 31.00
Rs.10 each)
Reserves & Surplus Plant & Machinery 57.00
Capital Reserve 18.00 Miscellaneous Fixed Assets 23.00
Contingency Reserve 13.00 Patents 8.00
Dividend Equalization Reserve 9.00 Current Assets 113.00
General Reserve 15.00
Revaluation Reserve 42.00
Share Premium 12.00
109.00
11% FCDs 25.00
Current Liabilities 62.00
246.00 246.00

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The following information is also provided:

i. The patents were purchased in December, 19x9 from an American scientist Mr. Jimmy
Hilton. He was paid the entire purchase consideration in the form of allotment of
10,00,000 equity shares.
ii. The 11% FCDs with a face value of Rs.100 each are due for conversion in
September, 20x0. Each FCD will be converted into 1 equity share.
iii. Revaluation reserves includes an amount of Rs.12 crore calculated on a fixed asset
which was revalued upwards is sold during the year at its book value.
You are required to answer the following:
a. Compute the maximum permissible bonus ratio as per the current SEBI Guidelines.
b. Alternatively, the company is examining the possibility of a stock-split. Determine
the maximum permissible stock-split ratio as per current SEBI Guidelines.
Note: The two alternatives are mutually exclusive events.
58. Zuari Industries Ltd. wants to raise an equity capital of Rs.110 crore. The company wants
to raise the maximum possible amount through the book building process. The promoters
do not intend to invest more than the minimum requirement. The following bids are
received from the investors through the syndicate members:
Price (Rs.) Number of shares applied
52.00 101,03,000
53.00 85,90,400
54.50 72,11,300
55.25 58,97,600
57.00 41,83,700
58.00 36,55,300
59.00 17,99,400
60.00 8,32,200
61.00 5,00,100
62.00 1,75,700
63.00 82,800
64.00 25,500
a. Compute the amount of capital that
i. Can be raised through book building
ii. Can be raised through fixed public offer
iii. The promoters have to bring in.
b. Based on the information given above compute the allotment of shares by the book
building process and the cut-off rate.
c. Within the book building portion, is there any need to reserve any share for small
investors?
59. Milton Telecom Ltd. has licenses to offer cellular service in four telecom circles. The
company proposes to part finance the project with a Level III ADR issue. The company
proposes to raise $150 m net of issue expenses of 4%. The share will be offered at a
premium of 20% to its domestic market price of Rs.600 (face value Rs.5).
Each ADR will have 4 underlying shares. The current exchange rate is $1 = Rs.47.65. The
company pays a dividend of 50%.
You are required to compute
a. Number of ADRs required to be issued.
b. The cost of the ADR to the company if the growth rate is 15% p.a.

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c. Merrill Lynch Telecom Fund invests in 25000 ADRs. At the end of 1 year the
company makes a right issue of 1 share for every 4 shares held. The rights is priced
at Rs.600 per share, when the prevailing domestic price is Rs.1000 per share. The
fund exercises the rights and immediately exits from the investment. The ADRs are
quoting at a premium of 30% over the ex-rights price in the domestic market. The
exchange rate is $1 = Rs.50 at the time of the rights issue as well as the divestment.
Compute the gain/loss to Merrill Lynch Telecom Fund on this transaction.
60. Rockwood Ltd. is a closely held existing profit making company. The company proposes to
expand its capacity to meet the growing demand for its product. The cost of the project is
estimated at Rs.25 crore. The project will be financed by term loans of Rs.10 crore and the
balance through a public issue. The company appoints Emerald Capital Company (ECC) as
their Merchant Bankers. ECC advises them against tapping the market. Instead they suggest
a bought out deal on the following terms:
i. ECC will buy out the entire issue at Rs.62.5 per share.
ii. ECC will offload the shares through an offer for sale at the end of 3 years.
iii. ECC will be assured an IRR of 22% on their investments. In case the divestment
takes place at a lesser price, the promoters would compensate ECC for the
differential amount.
iv. In case, ECC offloads at a price which gives them an IRR of over 22%, the surplus
would be shared equally by the promoters and ECC.
The current EPS is Rs.10 and is expected to grow by 20% annually over the next 3 years.
The company proposes to declare dividend at 15%, 20%, 25% for the next three years
respectively.
The divestment takes place at a P/E multiple of 8.
You are required to
a. Compute the divestment price of the share;
b. The total post-issue returns to ECC on their investment; and
c. The amount of cash outflow/inflow to the promoters on divestment.
INTERNATIONAL MARKETS
61. SK Steel Limited has proposed to expand its operations for which it requires funds of $4.02
crore net of issue expenses. It proposed to raise the required funds through a GDR issue. It
considers the following factors in pricing the issue:
i. The expected market price of the company’s equity share in the domestic market is
Rs.180.
ii. 6 shares should underlie each GDR.
iii. The underlying shares are priced at a discount of 10% to the market price.
iv. The expected exchange rate is Rs.42/$.
v. Dividend expected on the equity share is 15% with a growth of 8% p.a. forever.
vi. The issue costs amount to 2% of the issue size.
You are required to
a. Compute the number of GDRs that have to be issued and also the cost of GDR to the
company.
b. Discuss the factors that the company should consider to choose between domestic
and international market.

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62. Rockland Engineering Ltd. has awarded HSBC Bank a syndication mandate for US$ 200
million, 5-year facility. The Bank underwrites US$ 100 million and two other banks
underwrite US$ 50 million each.
The company agrees on the following terms:
Tenure : 5 years
Repayment : Bullet payment
Spread : Payable annually at 100 basis points over LIBOR
Facility fee : 35 basis points per annum
Management fee : 25 basis points payable upfront as under:
– 10 basis points on amount of loan
– 15 basis points on amount underwritten
Each underwriter retains US$ 25 million and there are 10 participant banks with US$ 12.5
million each. Citibank is the appointed agent bank with annual fee of US$ 15,000.
You are required to calculate the
a. Cost of the loan facility for Rockland Engineering Ltd. if LIBOR remains constant
at 5%.
b. Fees earned by HSBC on this transaction.
63. Fine Apparels Ltd. is a leading Hyderabad based garment manufacturer. The company
intends to raise ECBs in the international market. The company has received the following
offer from Citi bank:
Amount – 200 million Euros
Maturity – 6 years
Drawdown – 100 million Euros (1st July, 20x0)
– 100 million Euros (1st July, 20x1)
Interest – Paid annually at 130 BP over Euribor
Management Fee – 50 BP
Commitment Fee – 30 BP per annum
Underwriting Fee – 60 BP
Agency Fee – 30,000 Euros per annum
Guarantee Fee – 80 BP per annum
Amortization – 2 equal installments at the end of 5th and 6th year.
The terms of agreement state that the agency fee is paid at the end of each year while
commitment fee (wherever applicable) and guarantee fee are to be paid at the beginning of each
year. The expected EURIBOR as per a study conducted is as follows:
July 20x0 – June 20x1 3.5%
July 20x1 – June 20x2 3.25%
July 20x2 – June 20x3 4.5%
July 20x3 – June 20x4 3.75%
July 20x4 – June 20x5 3.25%
July 20x5 – June 20x6 3.00%
Required:
Compute the effective cost of borrowing to the company.

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64. Sequel Information Technologies Ltd. is a leading software company engaged in

developing banking software and system integration. The company intends to takeover a
software company in the USA. The company proposes to finance the acquisition by the
ECB route. The company has approached Chase Manhattan Bank for the same. The Bank
has agreed for the loan on the following conditions.
Amount $100,000,000
Maturity 6 years from the date of loan agreement
Grace period 2 years
Amortization Equal half-yearly installments after the grace period
Drawdown 50% immediate
50% at the beginning of the 2nd year
Interest 100 basis points over LIMEAN
Management Fee 60 basis points payable upfront
Commitment Fee 20 basis points per annum payable half-yearly on undrawn
balances
Underwriting Fee 25 basis points payable upfront
Agency Fee $6500 per annum at the end of each year
Security Guarantee of commercial bank
BNP-Paribas has offered to provide the bank guarantee. The guarantee fee is 40 basis points
per annum payable half-yearly on the outstanding balances. The fee is payable at the
beginning of the period. The loan agreement is proposed to be signed on 1st January, 20x0.
The expected interest rates are as follows:
Particulars LIBOR LIBID
January-June 20x0 5.25 5.10
June-December 20x0 5.15 4.95
January-June 20x1 5.30 5.10
June-December 20x1 5.20 5.10
January-June 20x2 5.10 5.00
June-December 20x2 5.15 4.95
January-June 20x3 5.10 4.90
June-December 20x3 5.35 5.20
January-June 20x4 6.10 5.90
June-December 20x4 6.20 5.95
January-June 20x5 4.65 4.50
June-December 20x5 5.20 5.10
Advise the company on its effective cost if it accepts the offer.
65. Mayur Steel Industries Ltd. is planning a backward integration project, the estimated cost
of which works out to Rs.2,400 crore. The company plans to finance the project, inter alia,
with a syndicated loan of $400 million. The company has received an offer from ABN
Amro Bank with the following terms.
Amount $400 million
Maturity 7 years
Drawdown $150 million – immediate
$150 million – 1.1.20x1
$100 million – 1.1.20x2

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Grace period – 3 years

Amortization – Equal annual installments payable on
31.12.20x3 – I installment
31.12.20x4 – II installment
31.12.20x5 – III installment
31.12.20x6 – IV installment
Interest rate – Paid annually in arrears at 120 BP over LIBOR
Management Fee – 60 BP
Commitment Fee – 80 BP per annum
Underwriting Fee – 50 BP
Agency Fee – $15,000 per annum
Guarantee Fee – 75 BP per annum
The following additional information is provided.
i. The effective date of the loan agreement is 1.1.20x0.
ii. Commitment fee and agency fee are payable at the end of each year, while guarantee
fee is payable at the beginning of each year.
The LIBOR may be assumed as follows:
20x0 6%
20x1 4%
20x2 5%
20x3 7%
20x4 6%
20x5 8%
20x6 7%
Compute the effective cost of borrowings to the company.
66. Avis Engg. Ltd. has awarded National Westminster Bank a syndication mandate for US
$300 million, 5 year facility. The Bank underwrites US $100 million and 4 other Banks
underwrite US $50 million each.
The company agrees on the following terms:
Tenure 5 years
Repayment Bullet Payment
Spread Payable annually at 100 Basis Points over LIBOR
Facility Fee 25 Basis Points per annum
Arrangement Fee 50 Basis Points payable upfront as under:
– 15 Basis Points on amount of loan
– 25 Basis Points on amount underwritten
– 10 Basis Points on amount of commitment.
Each underwriter retains US $30 million and there are 15 participant banks with US $10
million each.
British Bank of Middle East is appointed Agent Bank with annual fee of US $10,000.
You are required to calculate the
a. Cost of the loan facility for Avis Engg. if LIBOR remains constant at 5%.
b. Fees earned by National Westminster on this transaction.

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67. Microhard Information Technologies Ltd. is a leading software company engaged in

developing banking software and systems integration. The company intends to takeover a
software company in USA. The company proposes to finance the acquisition by the ECB
route. The company has approached Chase Manhattan Bank for the same. The Bank has
agreed for the loan on the following conditions:

Amount $200,000,000

Maturity 6 years from the date of loan agreement

Grace Period 2 years

Amortization Equal half-yearly installments after the grace period

Drawdown 50% immediate

50% at the beginning of 2nd year

Interest 150 basis points over LIMEAN

Management Fee 75 basis points payable upfront

Commitment Fee 25 basis points per annum payable half-yearly on undrawn balances

Underwriting Fee 25 basis points payable upfront

Agency Fee $5000 per annum payable at the end of each year

Security Guarantee of Commercial Bank

BNP-Paribas has offered to provide the Bank guarantee. The guarantee fee is 50 basis
points per annum payable half-yearly on the outstanding balances. The fee is payable at the
beginning of the period.
The loan agreement is proposed to be signed on 1st January, 20x0. The expected interest
rates are as follows:

Particulars LIBOR LIBID

January - June, 20x0 5.10 4.90

June - December, 20x0 5.30 5.20

January - June, 20x1 5.25 4.75

June - December, 20x1 5.20 4.80

January - June, 20x2 6.10 5.90

June - December, 20x2 6.20 5.80

January - June, 20x3 4.60 4.40

June - December, 20x3 5.30 5.10

January - June, 20x4 5.60 5.40

June - December, 20x4 5.10 4.90

January - June, 20x5 5.35 5.15

June - December, 20x5 5.65 5.35

Advise the company on its effective cost if it accepts the offer.

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68. Shruthi Steel Industries Ltd. is a leading producer of Cold Rolled Coils (CR coils). The
company is planning a backward integration project to produce 1.7 million ton of Hot
Rolled Coils (HR Coils). The project cost is estimated at Rs.2,400 crore. The company
plans to finance the project, inter alia, with a syndicated loan of $400 million. The
company has received an offer from ABN Amro Bank with the following terms:
Amount $ 400 millions
Maturity 7 years
Drawdown $ 100 mn. - immediate
$ 150 mn. - 1/1/20x1
$ 150 mn. - 1/1/20x2
Grace Period 3 years
Amortization Equal annual installments payable on
31/12/20x3 - I Installment
31/12/20x4 - II Installment
31/12/20x5 - III Installment
31/12/20x6 - IV Installment
Interest Rate Paid annually in arrears at 100 BP over LIBOR
Management Fee 50 BP
Commitment Fee 75 BP per annum
Underwriting Fee 40 BP
Agency Fee $ 10,000 per annum
Guarantee Fee 60 BP per annum
The following additional information is provided.
1. The effective date of the loan agreement is 1/1/20x0.
2. Commitment fee and agency fee are payable at the end of each year while
guarantee fee is payable at the beginning of each year.
The LIBOR may be assumed as follows:
20x0 6%
20x1 5%
20x2 6%
20x3 4%
20x4 7%
20x5 8%
20x6 6%
Compute the effective cost of borrowings to the company.
69. Naveen Industries Ltd. is a leading producer of consumer electronics. The company plans
to expand its production facilities to meet the growing demand for its product. The
company intends to finance its expansion primarily through ECB. The company has
received the following offer from Bank of Tokyo – Mitsubishi.
Amount – 20 billion Yen
Maturity – 8 years
Drawdown – 10 billion Yen on 1/1/20x1
10 billion Yen on 1/1/20x2
Interest – 100 BP over Yen LIBOR payable annually
Management Fee – 15 BP
Underwriting Fee – 25 BP
Commitment Fee – 10 BP
Agency Fee – 25 million Yen per annum
Amortization – 4 equal installments at the end of 5th, 6th, 7th and 8th year.

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Bank of America has agreed to provide guarantee cover on this loan. The guarantee fee
payable is 50 BP per annum. The guarantee fee is payable at the end of each year.
Commitment Fee is payable at the beginning of the year. Agency Fee is also charged at the
beginning of the year.
The expected Yen LIBOR, as per a survey conducted by Japanese Bond Research Institute
(JBRI), is as follows:
Year Yen LIBOR (%)
20x0 1.50
20x1 1.00
20x2 1.25
20x3 1.50
20x4 2.00
20x5 3.00
20x6 2.50
20x7 2.00
20x8 1.50
Compute the effective cost of the loan to Naveen Industries Ltd.
70. Rashtriya Mills Ltd. is a major player in the textile industry. The company is currently a
market leader in both cotton textile segment as well as in manmade fabrics. The company
has been in existence for almost eight decades. Some of the existing plants were set up in
the sixties and are over 30 years old. The company is planning a comprehensive
modernization and technological upgradation program at an estimated cost of Rs.800 crore.
The company proposes to part finance this project with an ECB. The company has received
the following offer from UBS Bank, Zurich for a syndicated loan:
Amount CHF 100 million
Maturity 8 years
Drawdown CHF 40m (1/1/20x0)
CHF 40m (1/1/20x1)
CHF 20m (1/1/20x2)
Interest 80 BPs over CHF LIMEAN payable on December 31, each year
Amortization 2 equal installments at the end of 7th and 8th year
Management Fee 30 BPs
Underwriting Fee 40 BPs
Commitment Fee 30 BPs payable at the end of the year
Guarantee Fee 50 BPs payable at the beginning of the year
Agency Fee CHF 100,000 per annum payable at the end of the year.
Kotak Mahindra Capital Corp. is the regular investment banker to the company. As per
their research, the expected interest rates are as follows:
Year CHF LIBID CHF LIBOR
20x0 4.90% 5.10%
20x1 4.45% 4.55%
20x2 5.30% 5.40%
20x3 6.10% 6.20%
20x4 5.70% 5.90%
20x5 5.60% 5.80%
20x6 4.95% 5.05%
20x7 4.20% 4.30%
20x8 4.55% 4.60%
20x9 4.35% 4.42%
201x 4.80% 4.90%

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You are required to:

Calculate the effective cost of borrowings to the company.
Note: Compute the solution up to two decimal points only.
AN INTRODUCTION TO EQUIPMENT LEASING
71. XYZ Limited has recently leased equipment costing Rs.350 lakh for three years. The terms
and conditions of the lease are as follows:
– Lease rentals: Rs.435 per thousand per annum
– Frequency of payment: Annually in arrears
The incremental borrowing rate for XYZ Limited is 20% p.a. You are required to determine
if the above transaction can be classified as a finance lease according to the FASB, given
the following information:
a. The useful life of the asset is 5 years.
b. The useful life of the asset is 8 years.
72. Genius Finance Co. Limited has recently structured a leveraged lease transaction involving
an investment cost of Rs.65 crore. The investment is funded in the following manner:
Genius Finance Co. Limited being the equity participant is to invest 30% of the total cost.
The balance is to be raised by means of debt from Sterling Bank which is the loan
participant. The rate of interest on the loan component is 16% p.a. and the repayment is to
be made in 5 equated annual installments. You are required to calculate the annual lease
rental, assuming that the required rate of return of Genius Finance Co. Limited is 20% p.a.
73. With the help of the given data, you are required to determine the annual lease rentals to be
charged under the following rental structures.
a. Equated
b. Deferred (Assuming a deferment of 1 year)
• Investment cost Rs.45.00 lakh
• Pre-tax required rate of return 22.00%
• Primary lease period 5.00 years
• Residual value after the primary period Nil
74. From the following data given by Raj Limited, you are required to determine the lease
rentals as per the stepped (increase of 10% p.a.) and ballooned (annual rental for years one
to four is Rs.3 lakh) rental structures.
• Cost of the asset Rs.80 lakh
• Lessor’s required pre-tax rate of return 20.5%
• Lease period 5 years
• Residual value of the primary lease Nil
75. The summarized income statement and balance sheet of Lakshmi Textiles Limited is given
below:
Income Statement for the year ended
March 31, 20x1
Rs. in lakh
Net Sales 9,000
Cost of Goods Sold 4,500
General Expenses 1,590
Interest Charges 675
Depreciation 660
Profit before Tax 1,575
Tax 630
Profit after Tax 945

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Balance Sheet as on March 31, 20x1

Sources of Funds
A: Shareholder’s Funds
Share Capital 450.00
Reserves and Surplus 1,250.00
1,700.00
B: Loan Funds
10% Debentures 1,460.00
Term Loans 872.00
Cash Credit 1,068.00
3,400.00
C: Total (A + B) 5,100.00
Application of Funds
D: Fixed Assets
Original Cost 5,000.00
Less: Accumulated Depreciation 1,500.00
Net Block 3,500.00
Add: Capital work-in-progress 500.00
E: Investments 500.00
F: Current Assets
Cash and Bank Balances 500.00
Receivables 750.00
Inventory 1,000.00
Other Current Assets 200.00
2,450.00
G: Less: Current Liabilities
Accounts Payable 1,000.00
Provisions 850.00
1,850.00
H: Net Current Assets (F – G) 600.00
I: Total 5,100.00
The following additional information is available:
• At the beginning of the year, the company had acquired plant and machinery costing
Rs.950 lakh through a term loan carrying a rate of interest of 18.5% p.a. The term
loan is repayable in 5 equal annual installments, the first installment falling due at
the end of the first year, i.e. March 31, 20x1.
• The company could have leased plant and machinery on a 5-year non-cancelable
lease at a rate of Rs.375 per thousand payable annually in arrears.
• The depreciation policy of the company requires plant and machinery to be
1
depreciated at the rate of 33 % p.a. on the WDV method.
3

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You are required to compute:

a. Leverage ratio, the fixed assets turnover ratio and the return on investment based on
the given financial statements.
b. Recast the financial statements assuming that the assets have been leased as per the
aforesaid terms and compute the leverage, assets turnover and the ROI ratios based
on these statements.
76. Global Products Limited has recently leased equipments worth Rs.670 lakh from Capital
Leasing Limited. The lease period is seven years of which the primary lease period is 5 years.
The lease rates are as follows:
• Lease rentals during the primary lease period: Rs.22 per thousand per month.
• Lease rentals during the secondary lease period: Re.1 per thousand per month.
• The incremental borrowing rate for Global Products Limited compounded monthly
is 18% p.a. The lease rentals are payable monthly in advance.
a. If the average economic life of the equipment is 10 years, will you classify the lease
as a finance lease? Give reasons.
b. You are further informed that the physical life of the equipment is 12 years, the
technological life is 8 years and the product market life is 9 years. Will you still
classify the lease as a finance lease? Substantiate.
77. Rhombus Technologies Ltd. (RTL) is planning to lease certain equipment which costs
Rs.50 lakh. When the equipment becomes operational, the EBDIT of the company will be
higher by Rs.20 lakh for five years. The company approached Scientific Leasing Ltd.
(SLL), a finance company that specializes in leasing out equipment of this kind. But, SLL
is quoting a lease rental of Rs.35 ptpm, payable quarterly in advance, which RTL thinks is
too high. The alternative that RTL is evaluating is a loan from a bank at an interest of 14%,
repayable in five equal annual installments including interest. The cost of equity capital of
RTL is 22% and the company generally maintains a debt-equity ratio of 2:1. The equipment
is eligible for depreciation at 25% on WDV basis and the tax rate applicable to RTL is
35%. The salvage value of the equipment is expected to be twice its book value at the end
of the fifth year.
You are required to advise the company, with necessary workings, on whether
a. It should acquire the equipment at all
b. If it should acquire, whether it should be through leasing or buying.
LEASING IN INDIAN CONTEXT
78. Allsip Finance Ltd. is planning to issue bonds with a face value of Rs.100 and carrying
coupon payments at five percent above the inflation rate of the year. The company wants to
price the bond in such a way that investors get a return on 18% on it. The expected rates of
inflation during the five-year tenure of the bond are as follows:
Year Rate of Inflation (%)
1 5.0
2 4.5
3 5.0
4 6.0
5 7.5
What is the price at which the bond can be issued?

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79. The most recent audited summarized balance sheet of M/s Aryan Financial Services
Limited is given below:
Balance Sheet as on March 31, 20x1
Liabilities Rs. in million Assets Rs. in million
Equity share Fixed assets:
capital 45.00 Assets on lease 300.00
Reserves & Surplus (Original cost: 450 million)
95.00
Term loan from IDBI 56.00 Other fixed assets 40.00
Public 120.00 Investments (in wholly 15.00
deposits owned subsidiaries)
Bank borrowings Current Assets:
85.00 Stock on hire 60.00
ICDs 60.00 Receivables 25.00
180-day commercial paper 40.00 Other current assets 25.00
Miscellaneous. expenditure 36.00
(not written off)
501.00 501.00
a. You are required to calculate the net owned funds of the company as on March 31,
20x1.
b. The company intends to enhance its investments in the lease portfolio by Rs.450
million and for this purpose it plans to raise funds by way of bank borrowings and
term loans from financial institutions in that order. Determine the financing mix.
80. A company has issued PTCs backed by a pool of property receivables aggregating to
Rs.235 lakh. The equated monthly payments to be made to the PTC holder are as
follows:
During the first 12 months Rs.11 lakh p.m.
During the next 12 months Rs.9 lakh p.m.
During the next 6 months Rs.7 lakh p.m.
Calculate the promised rate of return to the investor.
81. The following financial data has been extracted from the books of Sarita Leasing Limited
for the year 20x0-x1.
Rs. in crore
– Equity share capital 140.00
– Share premium 56.00
– General reserve 126.40
– Revaluation reserves 96.80
– Profit on sale of assets 54.70
– Intangible assets (at book value) 33.60
– Investments in shares and debentures
of subsidiary companies 32.92
– Loans and advances to group
companies 21.98
– Deposits with subsidiary companies 15.64
Calculate the amount of owned funds and net owned funds.

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82. The audited Balance Sheet of Rockland Leasing Company as on March 31, 20x1 is
presented below:
Balance Sheet as on March 31, 20x1
Liabilities Rs. in lakh Assets Rs. in lakh
Paid-up Share Capital 150 Fixed Assets 1,700
Reserves & Surplus Investments in wholly owned
– Capital Reserves 100 subsidiaries
Current Assets 140
– Free Reserves 310 – Stock on Hire 750
Secured Loans Miscellaneous Expenses 85
– Term Loans 90 (to the extent not written off)
– Bank Borrowings 705
Unsecured Loans
– Public Deposits 720
Current Liabilities 600
Total 2,675 Total 2,675
70% of the revenue earned by the company is derived from equipment leasing and hire
purchase.
a. Calculate the net owned funds of the company.
b. Calculate the maximum permissible level of debt and the additional amount of debt
that can be raised.
83. Reality Financial Services is contemplating a bond issue (Face value Rs.100) with a
stepped up coupon interest structure, the step up rate being 12% p.a. The bonds will carry a
coupon rate of interest of 10% p.a. for the first year and will be redeemed at 110 percent of
the face value after seven years from the date of issue. The bond issue is to be priced so as
to yield a pre-tax redemption yield of 18.5% to the investor. Calculate the issue price.
84. Based on the data given below, you are required to develop a Cash Certificate Scheme.
Period Minimum Rate of Maturity Value Annual
(in months) Amount (Rs.) Interest*(%) Yield
13 5000 14.5% 5,845 15.60%
36 5000 14.5% 7,705 18.03%
48 5000 14.5% 8,899 19.49%
60 5000 14.5% 10,279 21.11%
* Interest is compounded monthly.
TAX ASPECTS OF LEASING
85. The following data is available on the portfolio of leased assets of Stallion Leasing Ltd. for
a given financial year.
Block Rate of WDV at the beginning Additions during the year
depreciation (Rs. in lakh) (Rs. in lakh)
A 25% 224 100
Sale of assets during the year have been Rs.13 lakh.
a. Calculate the tax relevant depreciation charge for the year.
b. It is expected that fresh investments to the tune of Rs.40 lakh will be made during
the following financial year.
The disinvestment proceeds are likely to be around Rs.22 lakh.
50% of the fresh investment will be made before September 30 of the financial year.
Calculate the projected depreciation charge for the following year.

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86. Vindhya Ltd. plans to acquire capital equipment from Samastha Ltd. based at Cochin. The
cost of the equipment exclusive of sales tax is Rs.67 lakh and the rate of CST payable is
4%. Vindhya Ltd. is considering to lease the equipment from Malathi Financial Services.
The quote on a 3-year lease is Rs.55.28 per thousand per month payable at the end of every
month. Calculate the lease rentals payable by Vindhya Limited.
87. The following data is available on the portfolio of leased assets of Radial Leasing Ltd. for
the year 20x0-x1.
Block Rate of depreciation WDV at the beginning Additions during the year
(Rs. in lakh) (Rs. in lakh)
A 25% 186 200
B 40% 125 56
Sale of assets during the year have been Rs.25 lakh and Rs.44 lakh in respect of block A &
B respectively.
a. Calculate the tax relevant depreciation charge for the year 20x0-x1.
b. It is expected that fresh investments to the tune of Rs.85 lakh will be made during
the year 20x1-x2 as follows:
Block Amount of Investment
(Rs. in lakh)
A 60
B 25
The disinvestment proceeds are likely to be around Rs.25 lakh with the following
break up
Sale proceeds
(Rs. in lakh)
A 10
B 15
It is expected that about 50% of the fresh investments will be made before
September 30 of the financial year and the rates of depreciation applicable to Blocks
A and B will be 25% and 40% respectively. Calculate the projected depreciation
charge for the following years.
88. Highway Industries is contemplating a capital investment of Rs.415 lakh during the current
year. There are two ways of funding the investment; The company can finance the
investment by debt carrying a rate of interest of 16.5% p.a. repayable in 5 equal annual
installments (principal repayable in equal installments). Alternatively, it can lease the assets
on the following terms.
• Lease Rental : Rs.310 per thousand per annum
• Lease Period : 5 years
• Frequency of Payment : Annually in arrears
The tax relevant rate of depreciation is 25% and the marginal tax rate is 46%. The company
anticipates substantial tax liabilities during the current year and in the following year.
Given that the objective of the company is to reduce the tax liability, which of the two
alternatives will you recommend?
89. Radhika Spinning Mills Ltd. (RSML) is a 100% export-oriented unit engaged in
manufacturing textiles. It is finalizing a modernization plan at a cost of Rs.65 lakh. It is
planning to lease the required plant and machinery from Sumeet Leasing Ltd. Sumeet
Leasing Ltd. has offered to structure a 7-year non-cancelable finance lease with rentals
payable on an equated annual basis in arrears. If the marginal cost of debt of Radhika
Spinning Mills Ltd. is 17.5%, calculate the maximum lease rental p.a. Radhika Spinning
Mills Ltd. will be willing to pay. Assume no salvage value for the equipment at the end
of 7 years.

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90. Innovative Ltd. based at Hyderabad is contemplating purchase of some capital equipment
from Rohit Ltd. based at Chennai. The cost of the capital equipment exclusive of sales tax
is Rs.115 lakh and the rate of CST is 4%. Innovative Ltd. is considering whether it will be
better off by leasing the equipment from Digital Leasing Ltd. (DLL). The quote of DLL on
a 5-year lease is Rs.24.5 per thousand per month payable at the end of every month.
Calculate the lease rentals payable by Innovative Ltd.
LEASE EVALUATION: THE LESSEE’S ANGLE
91. Indusway Limited is considering investment in capital equipment for which the following
information is available:
Cost of the equipment (inclusive of CST @ 4%) : Rs.21.4 lakh
Tax relevant rate of depreciation : 25%
Useful life : 5 years
Net salvage value at the end of 5 years : 35% of the book value
after 5 years
The company can either purchase the equipment under the bill rediscounting scheme of
IDBI or acquire it on a finance lease. The effective interest rate under the IDBI bill
rediscounting scheme is 17.5% p.a. The company has received an offer from Nova Leasing Ltd.
to structure a finance lease for a 5-year term at a rental of Rs.28.5 per thousand per month
payable annually in arrears. The lease rental has to be calculated on the cost of the
equipment to the lessor which will include CST @ 10%.
The target debt-equity ratio of Indusway Ltd. is 2:1 and the cost of debt and equity are
17.5% and 22% respectively. The corporate tax rate is 46%. The investment is likely to
generate an incremental EBDIT of Rs.20 lakh per annum for the first 3 years and Rs.17
lakh for the last 2 years of the project life.
You are required to advise Indusway Ltd. as to whether it should buy or lease the
equipment. Also calculate the break even rental for Indusway Ltd.
92. Ramon Tiles Ltd. is considering investment in a balancing equipment, regarding which the
following information is available:
• The cost of the equipment is Rs.62.8 lakh inclusive of CST @ 4%.
• The acquisition will be funded through a mix of term loan and own funds in the ratio
of 4:1. The loan carries interest at 18.5% p.a. and is repayable in 5 equal annual
installments.
• The planning horizon for such investments is 5 years. After 5 years, the equipment
is expected to fetch a net salvage value of Rs.7.5 lakh.
• The tax relevant rate of depreciation is 25%.
• The investment is expected to generate an EBDIT of Rs.46 lakh in year 1, Rs.37
lakh in year 2 and Rs.24 lakh in year 3, through 5.
The commercial bank which has agreed to finance the investment has recently informed the
company that the loan can be disbursed only after 3 months. Since the equipment is
urgently required, the following alternatives are being considered by the company.
– Finance the acquisition through a 3-month intercorporate loan at a cost of 6% per
quarter and liquidate the liability utilizing the bank loan made available 3 months
later.
– Lease the equipment.

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The company has received an offer from Empire Leasing Ltd., the terms of which are as
follows:
Primary lease period : 5 years
Secondary lease period : 2 years
Management fee : 1% of investment cost
Annual rental
During primary period : Rs.310 per thousand
During secondary period : Rs.30 per thousand
The lease rentals are payable annually in arrears, but the management fee is payable
immediately on signing the lease. The leasing company is not entitled to the concessional
CST and has to pay sales tax @ 10% on the cost of the equipment.
Ramon Tiles has an explicitly stated target debt- equity ratio of 2:1. The marginal costs of
debt and equity are 18.5% and 22% respectively. The marginal rate of tax is 46% including
surcharge. Based on economic considerations, which alternative would you recommend?
93. Pavan Agro Tech Ltd. is contemplating investment in equipment costing Rs.47 lakh. The
company can purchase the equipment by raising additional debt at a cost of 16.5% p.a.
Alternatively, the company can take the equipment on a finance lease with a 5-year primary
lease period at the rate of Rs.325 per thousand per annum payable annually in arrears. The
marginal tax rate is 46% and the tax relevant rate of depreciation is 25%. The salvage value
of the equipment after 5 years is negligible. Calculate the net value of the lease. Should the
company lease the equipment?
94. Resin Ltd. is contemplating investment in equipment worth Rs.56 lakh and one of the
alternative being considered is a finance lease offered by Shruti Leasing Ltd. at a rental of
Rs.315 per thousand payable annually in arrears over a non-cancelable period of 5 years.
The tax relevant rate of depreciation is 25% and the marginal rate of tax (inclusive of
surcharge) is 46%. The marginal cost of debt is 16% (pre-tax) and the marginal cost of
capital is 13.5%. Assume that the net salvage value of the equipment after 5 years is Rs.2
lakh.
Answer the following questions based on the equivalent loan model.
a. Calculate the amount of borrowing displaced by the finance lease.
b. Compute the present value of the interest tax shields on the displaced debt.
c. Should the company accept the lease proposal? Give reasons.
95. Rajdeep industries is contemplating investment in equipment about which the following
particulars are available:
Investment cost Rs.72 lakh
Tax relevant rate of depreciation 25%
Useful life 5 years
Estimated salvage value after 5 years Rs.8 lakh
The company can either borrow and buy the equipment or lease the equipment. Its cost of
capital is 13% p.a. and the marginal rate of tax is 46%. The cost of debt is 16% p.a. The
company has received a quote from Midas Leasing which has offered to structure a 5-year
full pay-out lease at the rate of Rs.315 per thousand payable annually in arrears. Compute
the NAL.
96. Surya (Private) Ltd. is planning to invest in equipments worth Rs.54 lakh and one of the
alternatives being considered is a finance lease offered by Never Lease Ltd. at a rental of
Rs.333 per thousand payable annually in arrears over a non-cancelable period of 5 years.
The tax relevant rate of depreciation is 40% and the marginal rate of tax (inclusive of
surcharge) is 46%. The marginal cost of debt is 17% (pre-tax) and the marginal cost of
capital is 12%. Assume that the net salvage value of the equipments after 5 years is Rs.5 lakh.

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Answer the following questions based on the BHW model.

a. What is the amount of borrowing displaced by the finance lease?
b. Compute the present value of the interest tax shields on the displaced debt.
c. Should the company accept the lease proposal? Explain.
97. Remington Ltd. is planning to invest in certain equipment, the particulars of which are as
follows:
Cost of the equipment Rs.25 lakh
Tax relevant rate of depreciation 40% p.a.
Useful life 3 years
Salvage value after 3 years Rs.1.5 lakh
The company has an option to either buy or lease the equipment. The cost of capital is 14% p.a.
and the tax rate is 46%. Cost of debt is 19% p.a.
The company has received a lease quote from Everlasting Leasing Ltd. at the rate of
Rs.38.6 per thousand per month payable monthly in advance. Calculate the net advantage
of leasing for Remington.
98. Haryana Mills Ltd. (HML), promoted by the Adayar Group, is a cotton yarn spinning unit
with a capacity of 56,000 spindles. The company has approached Mandakini Financial
Services Ltd. (MFSL) for arranging lease of machinery worth Rs.225 lakh. MFSL has
proposed the following terms:
Primary lease period : 5 years
Lease rental : Rs.26 per thousand per month
payable quarterly in advance
The cost of the equipment includes 4% central sales tax on outright purchase but, the rate of
central sales tax for MFSL is 10%. Further, lease rentals also attract a local sales tax of
4.5%. HML’s pre-tax cost of debt and equity are 15% and 24% respectively. The marginal
tax rate is 42% and long-term debt-equity ratio is 2. The tax relevant depreciation rate applicable
1
to the machinery is 33 % (WDV). The asset is expected to fetch a residual value of Rs.25 lakh
3
at the end of 5 years.
You are required to calculate net advantage of leasing using
a. Equivalent loan model and give your recommendations.
b. Suggested model and give your recommendations.
99. Provided here below are the details of lease quotes received from M/s Implease Ltd. and
other relevant details of Steel Alloys Ltd. which is intending to purchase certain essential
equipments:
Cost of equipment Rs.100 lakh
If purchased, the equipment will be funded by a term
loan bearing an interest rate of 18% and repayable in
equal installments of principal over 5 years
Primary lease period 5 years
Management fee 1% of the cost
Rentals are payable annually in arrears
Applicable rate of depreciation (WDV) 25%
Tax rate applicable 43%
Estimated salvage value Rs.10 lakh
Target debt-equity ratio 2:1
Marginal cost of debt 18%
Marginal cost of equity 24%
Lease rental, Proposal A Rs.320 per Rs.1000
Lease rental, Proposal B Rs.400 per Rs.1000

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You are consulted to evaluate these lease proposals using both suggested model and
Weingartner’s model. Comment on the strengths and weaknesses of these models.
Elaborate on how these models react to a given change in lease rentals. (Round off the
interest rates).
100. ACC Construction Company has decided to acquire a crane which costs Rs.10 crore. The
useful life of the crane is four years. If the company acquires the crane, its EBDIT will
increase by Rs.5 crore. The company is in a dilemma on whether to buy or lease the crane.
If it leases the crane, it will have to pay rentals at the rate of Rs.32 ptpm quarterly in
advance and an upfront processing fee of 0.5% of the cost of the asset. For tax purposes, the
crane can be depreciated at 25% and the tax rate applicable to the company is 30%. The
salvage value is expected to be 10% of the cost. The company’s marginal cost of equity and
debt are 20.5% and 14% respectively and it generally maintains a debt equity ratio of 1.5.
You are required to suggest, with the necessary calculations, whether the equipment
should be purchased or leased based on the Weingartner’s model.
LEASE EVALUATION: THE LESSOR’S ANGLE
101. Evergreen Ltd. typically writes 5-year leases with rentals payable annually in arrears. The
following information is available about a lease under review:
Equipment cost : Rs.47 lakh (Inclusive of CST @ 10%)
Salvage value after 5 years : 5% of the original cost
Initial direct cost : Rs.0.5 lakh (front ended)
Management fee : Rs.0.75 lakh (front ended)
The marginal cost of capital to Evergreen Ltd. is 16% and the marginal rate of tax is 46%.
Calculate the break even rental for Evergreen Ltd. assuming a tax relevant rate of
depreciation of (i) 25% (ii) 40% (iii) 100%
102. Starlight Financial Services writes the following types of lease contracts
Type Duration of primary Tax relevant rate of RV. as % of original
lease period depreciation cost
I 3 25% 5%
II 5 40% 3%
The marginal tax rate applicable to the company is 46% and the post-tax cost of funds is
16% p.a. On interstate purchases of capital equipment the company is required to pay CST
@ 10% on the basic price.
a. You are required to calculate the minimum rental which the company should quote
under the two types of lease contracts. Assume that the company collects lease
rentals on a monthly basis in advance.
b. Calculate the minimum monthly rental to be charged on a 5-year non-cancelable lease
proposal which involves leasing an equipment costing Rs.75 lakh (exclusive of CST).
103. Riverside Manufacturing Co. Ltd. (RMCL) has decided to invest in an equipment for which
the following particulars are available:
a. Cost of the equipment : Rs.42 lakh
b. Tax relevant rate of depreciation : 25%
c. Useful life : 3 years
d. Estimated net salvage value after 3 years : Negligible
The company has received a lease proposal from Rainbow Leasing Ltd. (RLL) to structure
a finance lease at a rental of Rs.47.50 per thousand per month payable at the beginning of
every month for three years.

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The marginal cost of debt and marginal cost of capital for RMCL are 16% (pre-tax) and
15% respectively. You have been informed that Rainbow Leasing Ltd. requires a minimum
return of 14% on its lease portfolio.
a. Determine the break even rentals for RMCL and RLL.
b. Comment on the spread available between the two break even rentals.
104. Rohit Varma, the Managing Director of Rohit Financial Services estimates the pre-tax cost
of funding leases to be 23% p.a. Based on this estimate, he believes that all lease
investments of his company must provide a gross yield of 25% p.a. after taking into
account the salvage value at 10% of the original cost. He has two alternate structures in
mind which are detailed below:
Structure I:
Equated monthly pattern under which rentals are collected at the beginning of every month
from the first month to the sixtieth month.
Structure II:
Ballooned pattern under which 10% of the monthly rental calculated under Structure I is
collected at the beginning of every month for the first 48 months and ballooned level
(equal) rentals are calculated at the beginning of every month for the next 12 months.
Required:
a. Calculate the monthly rentals under Structures I and II assuming an investment of
Rs.1,000.
b. Calculate the add-on yield on the five-year lease transaction, under both structures.
105. Alpha Industries is negotiating a lease proposal with Beta Leasing Limited for an imported
energy conservation equipment costing Rs.360 lakh which carries a (tax relevant)
depreciation rate of 100%. The useful life of the equipment is three years after which the
net salvage value of the equipment is expected to be 20% of its book value at that point of
time (assuming a book depreciation rate of 30% p.a. under written down value method).
Given its cash flow profile and estimated tax liability for the next three years, the company
wants a back-ended lease to be structured as follows:
Months Lease rental per month
1 – 12 L
13 – 24 1.5L
25 – 36 2.0L
The marginal cost of capital and the pre-tax cost of debt for the company are 14% and 18%
respectively.
Beta Leasing requires a post-tax return of 14% p.a. on all its lease investments. As a matter
of policy, the residual value of any leased equipment is taken at 5% of its original cost for
the purpose of pricing a lease. The initial direct costs are estimated to be 0.2% of the
investment cost. The company does not follow the practice of collecting an upfront
management fee.
The marginal tax rate applicable to both the companies is 45%. Ignore surcharge. Assume
that lease rentals are payable at the beginning of every month.
Required:
a. Calculate the maximum value of L from the point of view of Alpha Industries.
b. Calculate the minimum value of L from the point of view of Beta Leasing.
c. Comment on the spread available between the values obtained in (a) and (b).
106. Foremost Financial Services Limited (FFSL) has recently structured a five-year non-cancelable
leveraged lease transaction involving an investment cost of Rs.120 crore with Bhatt Commercial
Bank (BCB) as the loan participant. FFSL has financed 20% of the investment cost. The
remaining 80% was funded by BCB. If the (pre-tax) gross yield required by FFSL is 24%
per annum, calculate the annual lease rental to be charged. Assume that the loan funds
provided by BCB carry an interest of 18% p.a. and is to be amortized in five equated annual
installments. The corporate tax rate is 43%.

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107. Chinni Cement Company Limited (CCCL) is contemplating a sale and leaseback
arrangement in respect of its plant and machinery costing Rs.120 lakh. The plant and
machinery was acquired about two years back and the written down value of this asset as
on date is Rs.70 lakh. The company has received a quotation from the State Financial
Corporation (SFC) under which the SFC is prepared to buy it for a price of Rs.80 lakh and
lease it back on the following terms:
Lease period – 5 years
Lease rental (payable monthly in – Rs.25.5 per thousand per month
advance) during primary period
The tax relevant rate of depreciation is 25%. The estimated salvage value after five years is
expected to be negligible.
Required:
a. On economic considerations, will you recommend the ‘sale and leaseback’
arrangement to CCCL? You are informed that CCCL is a profit making company. Its
marginal cost of debt is 16% and post-tax cost of capital is 12%. The marginal tax
rate is 43%.
b. You are informed that the marginal cost of funds to the SFC is 12% and its marginal
tax rate is 26%. Given this information, will you recommend the proposed
investment to the SFC? Show all calculations that are required to support your
recommendation.
c. Is it possible to structure a mutually advantageous lease proposal? Answer this
question with reference to the results obtained in (a) and (b).
State the assumptions, if any.
108. Navyug Industries is contemplating import lease as one of the alternative for importing
capital goods worth Rs.128 lakh (inclusive of duty) from Smith Plc based at England. It
has approached Clarity Leasing Co. of India (CLC) for designing an import lease with
a rental structure tailored to suit its cash flows position over the next 5 years. After a
careful analysis of the projected pattern of cash flows for the next 5 years, the marketing
manager of CLC has proposed a deferred cum stepped structure of lease rentals as follows:
Profile of Lease Rentals
(Payable annually in Arrear)
Year 1 2 3 4 5
Lease Rental – L 1.15L 1.3225L 1.5208L
You are provided with the following additional information.
• The tax relevant rate of depreciation is 40% p.a.
• The marginal rate of tax (inclusive of surcharge) is 46%.
• The marginal costs of debt and equity are 16% and 18% respectively and the target
debt-equity mix is 2:1.
• The lease rentals are payable annually in arrears.
• The salvage value of the capital goods may be taken as 10% of cost.
a. Calculate the net advantage of the finance lease.
b. Determine the equated annual break even rental.
Assume that the lease rentals have been worked out by CLC based on a pre-tax yield of
20% p.a. You can make some additional assumptions if necessary.

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109. The finance manager of Minerva Ltd. evaluates lease proposals in terms of the risk adjusted
gross yield. For this purpose, he has developed the following risk classification table which
provides information on the risk adjusted pre-tax yields required for different default risk
classifications.
Risk class Required yield (%)
A 20
B 22
C 25
D 26
The finance manager is currently reviewing a proposed lease transaction with Navaratan
Ltd. about which the following details are available:
Investment Rs.22 lakh
Primary lease period 4 years
Secondary lease period 3 years
Monthly rental during primary period Rs.28.3 per thousand
Monthly rental during secondary period Rs.1 per thousand
You are required to calculate the add-on-yield.
110. The General Manager of Indotech Finance Ltd. evaluates lease proposals in terms of the
risk adjusted gross yield. For this purpose, he has developed the following risk
classification table which provides information on the risk adjusted pre-tax yields required
for different default risk classifications.
Risk class Required yield (%)
A 18
B 20
C 23
A proposed lease transaction with Macro Works Ltd. is being evaluated by the General
Manager. Information regarding the said transaction is as follows:
Primary lease period : 4 years
Lease rentals payable in advance : Rs.31.25 per thousand per month
The credit risk evaluation exercise undertaken by him puts the lease in ‘C’ category of risk.
a. Should the general manager recommend the proposal?
b. Assume that the lessee is prepared to pay 4 months rental in advance, of which 3 months
rental will be maintained as an interest free security deposit and adjusted against the
payments due for the last 3 months of the primary lease period. Does this alter your
answer to (a)?
111. The management of Rocky Leasing Ltd. is evaluating a lease proposal from Rivet
Manufacturing Ltd, information available regarding which is as follows:
Primary lease period 3 years
Secondary lease period 2 years
Monthly lease rental during the primary Rs.35.06 per thousand
lease period
Monthly rental during secondary period Rs.1 per thousand
The target debt-equity ratio of Rocky Leasing Ltd. is 3:1 and the marginal cost of debt and
equity are 19% and 22% respectively. The marginal rate of tax inclusive of surcharge is
46%. The tax relevant rate of depreciation is 40%.
The salvage value after the third year is insignificant. Based on the IRR of the lease
proposal, determine whether the proposal should be accepted or not.

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112. Leasewell Ltd. has a client who wants to lease an equipment worth Rs.100 lakh. Leasewell
Ltd. is facing a liquidity crunch and is looking for a loan participant for the lease deal who
can finance it to the extent of Rs.30 lakh. The equipment has a useful life of 5 years
and its salvage value is expected to be Rs.5 lakh. It can be depreciated at 30% on WDV
basis. The company contacted Wellfin Ltd., which agreed to participate in the lease. The
terms quoted by Wellfin Ltd. are an interest of 16% and repayments in equal quarterly
installments including interest over five years. If the Leasewell Ltd. expects a gross yield of
at least 30%, what is the minimum quarterly lease rental that should be quoted to the client?
Lease rentals are to be paid in arrears.
Leasewell Ltd. is thinking of offering a hire purchase plan to the client if he is willing to
make a down payment of Rs.30 lakh. The company wants the hire rentals to be paid
monthly in arrears. What is the minimum flat rate of interest that should be quoted
to the client if Leasewell Ltd. should not lose on this transaction compared to the above
lease transaction? Ignore interest tax. The income tax rate applicable to the company is
30%.
113. Shubhlabh Financial Services Ltd. (SFSL) has a client who wants to lease an equipment
that costs Rs.50 lakh. The current lease rate applicable to such leases is Rs.35 ptpm payable
annually in arrears. The company is at present not in a position to finance the lease entirely
by itself. It is therefore looking for a loan participant to finance at least Rs.10 lakh. The
supplier of the equipment is willing to finance it through its finance subsidiary and wants
the amount to be repaid over five years with interest at 16%, in equal annual installments
(including interest). SFSL wants a gross yield of 25% on this transaction.
You are required to advise SFSL whether it should go ahead with this transaction or not.
(Support your answer with suitable workings).
LEASE ACCOUNTING AND REPORTING
114. Anand Petro Chemicals Limited (APCL) has recently signed a lease agreement for
acquiring machinery costing Rs.450 lakh on a five-year non-cancelable lease at a rate of
Rs.312 per thousand payable at the end of every year. The salvage value of the machinery
after five years is estimated to be negligible. The other relevant information is as follows:
Marginal cost of capital 12%
Pre-tax marginal cost of debt 18%
Marginal tax rate (inclusive of surcharge) 51.75%
Rate of depreciation 30%
Required:
Based on the guidelines issued by the International Accounting Standards Committee
(IASC) for lease accounting and reporting, answer the following questions:
i. Calculate the present value of the minimum lease payments.
ii. Determine the value at which the machinery must be capitalized in the balance sheet of
APCL.
iii. Calculate the unexpired finance charge at the inception of the lease.
iv. Prepare a schedule showing the allocation of the unexpired finance charge using the
actuarial method.
v. Prepare the schedule required in (iv) using the sum of the digits method. Do the
IASC guidelines recognize this method of allocation? Explain.
vi. Prepare the schedule required in (iv) using the straight line method. Is this method
conceptually flawed? Explain.
vii. Show how the transaction will be reflected in the financial statements of APCL
at the end of the first year of the lease period. The problem has been solved
according to IAS:17 and AS:19 (Indian Standards).

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115. Jumbo Industries is contemplating an import lease for acquiring equipments costing Rs.72 lakh.
The lease terms require Jumbo Industries to pay a lease rental of Rs.105 ptpq, quarterly in
arrear over a non-cancelable period of 3 years. The marginal cost of debt is 18% p.a. and
the marginal rate of tax applicable to the company is 43%. The tax relevant rate of
depreciation is 25%.
Assume that the lease has to be capitalized in the books of the lessee as per the guidelines
of IAS:17 and AS:19 Show how the transaction will be reflected in the financial statements
of Jumbo Industries prepared at the end of each year of the lease period. The company
follows the effective rate of interest method (the actuarial method) for spreading over the
unexpired finance charge. Ignore salvage value.
116. Run Industries is contemplating to lease an industrial equipment costing Rs.65 lakh. The
lease terms require Run Industries to pay a lease rental of Rs.25.50 per thousand per month
payable monthly in advance over a period of 5 years. Its marginal cost of debt and equity
are 16% and 22% respectively. The long-term debt-equity ratio is 2 : 1. The tax relevant
depreciation and effective tax rate are 30% (WDV) and 34% respectively.
According to the IAS:17/AS:19 show how the transaction is reflected in the financial
statements of Run Industries during the lease period. Assume that the salvage value for the
asset is nil and interest allocation is made by the company using effective rate of interest
method.
117. Layman Ltd. has recently signed a lease for an equipment costing Rs.47 lakh. The lease is
for a non-cancelable period of 3 years and the lease rentals are payable at the rate of Rs.456
per thousand annually in arrear. The company depreciates the equipment @ 25% p.a. as per
the WDV method. Its incremental borrowing rate and the marginal rate of tax are 18% and
46% respectively.
a. Determine the capitalized value of the equipment.
b. Prepare a schedule showing the allocation of the unexpired finance charge.
c. Prepare all relevant ledger accounts for the 3 years of the lease in the books of lessee
and show how the ledger balances will be reflected in the financial statements for
these periods.
You may answer the above questions according to IAS:17/AS:19.
118. Creative Finance Limited has signed a lease agreement for equipment costing Rs.87 lakh.
The lease is non-cancelable for a period of 5 years and the lease rentals receivable are
312/1000 annually in arrears. Creative Finance Ltd. depreciates the equipment at the rate of
25% p.a. as per the WDV method. The incremental borrowing rate and marginal tax rate are
17% and 46% respectively. The residual value after 5 years is expected to be Rs.8.5 lakh. The
initial direct cost of the lease transactions is Rs.0.5 lakh.
a. Prepare a schedule showing the allocation of unearned finance income.
b. Prepare all relevant ledger accounts for the first 3 years of the lease and show how
these ledger balances will be reflected in the financial statements for the respective
periods.
You may follow IAS:17/AS:19 for answering this question.
119. Cordial Systems Ltd. is a dealer (lessor) in pollution control equipment. The products of the
company are sold either on hire purchase basis or on a 5-year non-cancelable lease.
The cash price of the equipment is Rs.20 lakh which includes a profit margin of 20% on
cost. The lease rate is 26.5 per thousand per month and the lease rentals are payable
annually in advance. The estimated unguaranteed residual value of the equipment at the end
of the lease period is 3% of the initial cash price. The prevailing market rate of interest for
medium-term loans is 16.5% per annum.
a. Determine the sales revenue to be recognized under the finance lease plan.
b. Prepare a schedule showing the allocation of financial income over the lease period.
c. Prepare the relevant ledger accounts in the books of Cordial Systems Ltd. for the
first year of the lease period. Also show how the transaction will be reflected in the
financial statements prepared at the end of the first year of the lease period.
You may follow IAS:17/AS:19 to answer this question.

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HIRE PURCHASE
120. Tristar Chemicals has recently acquired some equipments costing Rs.100 lakh under the
industrial hire purchase scheme of Synergy Finance. The company is required to pay a hire
purchase installment of Rs.3,94,440 per month for a period of 36 months.
a. Calculate the flat rate of interest charged by Synergy Finance.
b. Calculate the effective rate of interest p.a. implicit in the scheme. Assume that the
hire purchase installments are payable at the end of every month.
c. Tristar Chemicals follows the sum of the digits method for allocating the interest
charged over the 3-year period. Calculate the interest allocated to each year by
Tristar Chemicals.
Note:
PVIFA(1%, 36 months) = 30.108
PVIFA(1%, 35 months) = 29.409
PVIFA(2%, 36 months) = 25.489
PVIFA(2%, 35 months) = 24.999
PVIFA(3%, 36 months) = 21.832
PVIFA(3%, 35 months) = 21.487
121. Finex Financial Services company is evaluating the financial flexibility of the following
hire purchase plan:
Cost of asset : Rs.30,000
Down payment : 25%
Rate of interest : 12% p.a. flat
Duration : 3 years
Frequency of payment : Monthly in arrears
The asset is entitled to a tax relevant rate of depreciation of 25% and the net salvage value
after 3 years is estimated to be 10% of the original cost.
The D/E ratio of the company is 4 : 1. Its pre-tax cost of debt is 20% and expected
return on equity is 24%. The company attracts a tax rate of 43%.
Given the above information, you are required to
a. Calculate the NPV of the hire purchase plan, assuming FFS company follows the
SOYD method for spreading the total charge for credit. Ignore Interest Tax.
b. Calculate the effective rate of interest using the approximation formula.
122. Monopoly Financial Services Ltd. is offering equipment finance under the following schemes:
Hire Purchase
Down payment 20%
Flat rate of interest 15%
Duration 3 years
Repayment Monthly in advance
Lease
Primary lease period 5 years
Lease rental 27 ptpm
Frequency of lease rentals Monthly in advance
Pratibha Steels Corporation (PSC) has considered a modernization program for which it
requires to invest in an equipment worth Rs.280 lakh.
The company has given the following information.
a. Tax rate applicable is 30%
b. Debt-equity ratio 3 : 1

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c. Cost of debt 16%

d. Cost of equity 28%
e. Tax relevant depreciation for the assets is 25%.
Assume that the salvage value is insignificant and interest allocation is according to the
SOYD method. Ignore Interest Tax.
You are required to recommend which scheme should PSC opt for.
State assumptions made, if any.
123. Rama Financial Services (RFS) offers both lease and hire purchase plans to its corporate
clientele. The salient features of these plans are as follows:
A. Lease Plan
Primary period 5 years
Lease rate Rs.28 per thousand per month (per thousand per month)
Frequency of payment Monthly in advance
B. Hire Purchase Plan
Hire period 3 years
Rate of interest 16% p.a. flat
Frequency of payment Monthly in arrear
Down payment 20%
Sowmya Industrial Corporation (SIC) which is contemplating a capital expenditure of
Rs.360 lakh on modernization and technology upgradation is evaluating the financial
desirability of the two plans.
The following information is available:
Useful life of plant and machinery 5 years
Residual value after 5 years Rs.45 lakh
Tax relevant rate of depreciation 25%
Marginal rate of tax 51.75%
Marginal cost of capital 16%
Marginal (pre-tax) cost of debt 20%
SIC follows the sum of the years digits method for spreading over the total charge for credit
(unexpired finance charge) under the HP Plan.
Based on a financial evaluation, which plan will you recommend? Ignore interest tax.
124. The Bank of Cauvery, a private sector bank of a long standing in Southern India, is
planning to offer fund-based services such as leasing and hire purchase. A study
commissioned by the bank has revealed that the corporate clients who opt for leasing prefer
non-cancelable five-year finance leases with rentals payable quarterly in arrear. Those
corporate clients who are interested in industrial hire purchase plans prefer three-year plans
with hire charges payable quarterly in arrear.
The bank is keen to determine the break even rental and hire charges for its lease and hire
purchase plans taking into account the preferences of the corporate clients regarding tenure,
frequency and profile of payments.
The bank wants to ascertain the break even lease rental for equipments carrying a tax
relevant depreciation rate of 25% and is willing to assume a residual value exposure of 5%
of the original cost after five years. Likewise the bank wants to determine the minimum
hire charges to be collected assuming a down payment of 25% of the asset cost under the
hire purchase plan.
The marginal tax rate applicable to the bank is 30% and the post-tax cost of funds is 10% p.a.

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Required:
a. Calculate the minimum lease rental to be quoted on an asset cost of Rs.1,000. Ignore sales
tax.
b. Calculate the minimum hire charges to be quoted on an asset cost of Rs.1,000.
Assume that the bank recognizes finance income under the SOYD (Sum of Years
Digits) Method. Ignore sales tax and interest tax.
c. Calculate the add-on yield implied by the lease rental determined in (a) and the
effective rate of interest (approximate rate of interest) implied by the hire charges
determined in (b)).
125. PTS Chemicals Limited manufactures a wide range of speciality chemicals which find
applications in a number of industries such as detergents, cosmetics, leather, textiles,
pharmaceuticals and pesticides industries. In order to step up its capacity, the company has
incurred a capital expenditure of Rs.1,200 lakh of which equipments costing Rs.600 lakh
have been acquired under a hire purchase plan on the following terms:
Rate of interest – 16% flat
Frequency of payments – Annually in arrear
Pattern of payment – Equated
Down payment – 25%
Period – 4 years
The company follows the straight line method of depreciation and charges depreciation at
the rate of 12% p.a. for similar equipments.
a. Prepare tables showing the year-wise allocation of finance charge using (i) the
effective rate of interest method (ii) the SOYD method and (iii) the straight line
method.
b. Show how the transaction will be reflected in the financial statements of PTS
Chemicals at the end of the first year of the hire period.
126. Sindhiya Finance offers a hire purchase plan for its borrowers on the following terms.
Rate of interest : 13.5% flat
Repayment period : 4 years
Frequency of payment : Monthly in arrear
Down payment : 25%
Calculate the effective rate of interest per annum or the annual percentage rate (APR) using
(a) the trial and error approach and (b) the approximation formula.
127. Sahadev Financial Service offers a hire purchase plan under which the hirer is provided
with 100% finance in the following terms:
Rate of interest = 14%
Repayment period = 4 years
Frequency of payment = Monthly in arrear.
The hirer is required to invest 25% of the investment cost in the cumulative fixed deposit
scheme of the company for a period of 4 years. The company offers a rate of interest of
15% p.a. compounded monthly.
Calculate the APR of the scheme.
128. Sunanda Finance offers a hire purchase plan for its corporate borrowers on the following
terms:
• Rate of Interest : 13.5%
• Repayment period : 4 years
• Frequency of payment : Monthly in arrear
Immediately after paying the 26th monthly installment the borrower wishes to repay the
outstanding loan and purchase the equipment. Calculate the interest rebate according to the
effective rate of interest method.

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129. Srivani Finance offers a hire purchase plan for its borrower. Details of the plan are as
follows:
Rate of interest – 14% flat
Repayment period – 3 years
Frequency of payment – Monthly in arrear
Down payment – 25%
Immediately after paying the 24th monthly installment, the borrower works to repay the
outstanding loan and purchase the equipment. Calculate the interest rebate that can be
allowed to him according to the rule of 78.
130. Sujan Financial Services offers both leasing and hire purchase plans to its clientele. The
salient features of these plans are as follows:
A. Lease Plan
Primary period : 5 years
Lease rate : Rs.26.5 per thousand per month
Frequency of payment : Monthly in advance
B. Hire Purchase Plan
Hire period : 3 years
Rate of interest : 15.5% flat
Frequency of payment : Monthly in advance
Down payment : 25%
Sriven Industrial Corporation (SIC) is contemplating a capital expenditure of Rs.270 lakh.
Given the following information, evaluate the two plans for SIC:
A. Tax rate of depreciation : 40%
B. Marginal rate of tax : 46%
C. Marginal cost of capital : 17%
D. Marginal cost of debt : 20%
Assume that Sriven follows the SOYD method to spread the total charge for credit under
the hire purchase plan. The planning horizon is 5 years. The net salvage value of the plant and
machinery after 5 years is expected to be Rs.32 lakh.
131. Consider the following data about a hire purchase plan available to Mathur Industries Ltd.
for purchase of factory equipment.
Investment Rs.378 lakh
Hire period 3 years
Flat rate of interest 13.5% p.a.
Frequency of payment Monthly in advance
Amount of finance provided 100%
Initial deposit requirement (interest free) 25%
Term of deposit 3 years
Tax relevant rate of depreciation 25%
Marginal rate of tax 46%
Marginal cost of capital 14.5%
Marginal cost of debt 16%
Show how the transaction will be reflected in the financial statements over the hire
purchase period. The company follows the SOYD method for allocating the total charge for
credit.

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132. A commercial bank has recently diversified into industrial hire purchase business. The bank
proposes to offer a down payment plan with the following features:
Down payment (as a % of investment cost) : 20
Repayment Period : 3 years
Frequency of Payment : Quarterly in advance
The bank is required to pay interest tax at the rate of 3% on the finance income and income
tax at the rate of 26%. The bank follows the SOYD method to allocate the unexpired
finance charge.
Required:
If the average cost of capital for the bank is 9%, is a flat rate of 14% profitable to it?
Support your answer with necessary workings.
133. Zeta Financial Services Ltd. (ZFSL) offers finance to individuals to purchase four wheelers
on the following terms:
• Deposit of 20% of the cost of the asset should be made at the inception of the
transaction.
• 48 EMIs have to be made each at the beginning of every month.
• Front end service charge of 2% should be made.
• Deposit carrying an interest of 12% p.a. compounded monthly would be repaid at
the end of 48 months.
You are required to:
a. Calculate the maximum monthly payments to be made by a borrower if his
opportunity cost of funds is 18% p.a. and cost of the asset is Rs.4 lakh.
b. Calculate the effective interest rate on the completed transaction if the borrower
would like to make the prepayment at the end of 36 months after paying 36
installments. Deposit would be repaid at the end of 36 months. The company offers
an interest rebate calculated in accordance with the Rule of 78 Method. Assume the
EMIs as obtained in (a) above.
134. Brick-well Construction Limited has proposed to acquire a machinery costing Rs.100 crore.
The equipment has a life of 7 years. The tax relevant rate of depreciation is 25%. The target
debt-equity ratio is 2:1. The cost of debt and equity are 15% and 18% respectively.
Alternatively, the company can lease the equipment or take it on hire. It had approached
Vibrant Financial Services which offers both lease and hire purchase to corporates. The
lease terms are as follows:
Lease rentals during primary 32 ptpm payable monthly in
lease period of 4 years advance
Lease rentals during secondary 2 ptpq payable yearly in advance
period of 3 years
The hire terms of the company are as follows:
Flat rate of interest 13%
Structure Payable monthly in advance
Hire period 4 years
The marginal tax rate of BCL is 30%. BCL follows SOYD method of interest allocation.
The planning horizon is 4 years.
Assume negligible salvage value at the end of 4 years.
You are required to
a. Choose the best alternative between lease and hire purchase from BCL point of view
b. Choose the best alternative between purchase and the alternative obtained in (a) above.

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135. Fair Finance Ltd (FFL) offers the following finance scheme to its customers:
Amount (Rs.) 4,00,000
Repayment Period (Mths) 48
Equated Monthly Installment (Rs.) 9,250
(Payable at the beginning of every month)
Down Payment 25%
The company levies a service fee of Rs.2000 and offers a prompt payment bonus of Rs.8
per Rs.10,000 per month on expiry of the repayment period.
After paying 36 installments (at the end of 3 years) one of the borrower opts for an early
settlement. The company allows the prompt payment bonus in respect of the installment
paid and offers an interest rebate in accordance with the Rule of 78 method.
You are required to calculate the effective rate of interest on the completed transaction.
136. The following information relates to the loans and advances, hire purchase receivables and
lease assets of A to Z Finance Ltd., a non-banking finance company.
Loans and Advances
Category of loans and Amount at the beginning Recovery during the year
advances of the year leading to closure
(Rs. lakh) of accounts
Standard 180 —
Sub-standard 50 25%
Doubtful
Up to 1 year 12 20%
1-3 years 8 10%
More than 3 years 7 5%
Loss 25 5%
Loans and advances extended during the year amount to Rs.30 lakh, which remained as
a standard asset. Of the sub-standard assets, Rs.5 lakh became doubtful while Rs.10
lakh worth of assets were upgraded. Out of the doubtful assets, Rs.3 lakh were
upgraded. The entire amount of outstanding doubtful debts is fully secured.
Hire Purchase Assets
(Rs. lakh)
Current year Previous year
Total dues (Stock on hire) 95 88
Unmatured finance charges 20 18
Original cost of the assets 75 70
Amount realizable 95 88
Accumulated depreciation 29 14

Net Book Values of HP and Lease Assets (Rs. lakh)

Overdue for HP Assets Lease Assets
Up to 12 months 30 40
12-24 months 15 24
24-36 months 5 10
More than 36 months 3 10
In the 12-24 months category of HP assets and 24-36 months category of Lease assets,
amounts of Rs.5 lakh and Rs.3 lakh respectively are outstanding for more than 12 months
after the due date of the last payment.
Required:
Calculate the provisions to be made by the company on the above assets.

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137. Zaveri Finance Company (ZFC) offers hire purchase schemes on the following terms:
Down payment 20%
Duration 5 years
Frequency of payment Monthly in arrears.
Mohan Industries Ltd. (MIL) is contemplating an investment of Rs.75 lakh for purchase of
a plant. The plant attracts a tax relevant depreciation rate of 25% and has a salvage value of
10% of initial cost.
MIL has approached ZFC to avail the above hire purchase plan. ZFC’s cost of capital is
12%. It is in the tax bracket of 30%. Assume ZFC recognizes finance income on the basis
of the SOYD method and attracts an interest tax of 2%.
You are required to
a. Determine the minimum flat rate of interest to be charged by ZFC on the above HP plan.
b. Reflect the above hire purchase transaction in the books of ZFC for the first three
years of HP term. Assume the flat rate of interest as arrived at in (a) above.
138. Mr. Gangaram, one of the partners of M/s Gangaram and Brothers intends to purchase a car
costing Rs.5,60,000 on monthly installments for his personal use. Standard Finance Ltd.
(SFL) offered the following finance scheme to him:
Deposit (to be made at the beginning) 20% of the cost of the car
Interest earned on the deposit (at monthly rests) 6% p.a.
Flat rate of interest charged 11% p.a.
Repayment period 36 months
Payment structure At the beginning of every month
SFL levies a front ended documentation and service fee of 0.5% of the cost and offers a
prompt payment bonus of Rs.18 per Rs.20,000 per month on the expiry of the repayment
period. The deposit is refunded at the end of 36 months along with accumulated interest.
Realizable value at the end of 3 years is estimated to be negligible and the tax rate applicable to
Mr. Gangaram is 30%.
Assuming that all installments have been paid on the due date, you are required to
determine:
a. The effective rate of interest per annum implied in the above financing scheme.
b. The effective rate of interest per annum assuming M/s Gangaram and Brothers
purchased the car. The firm is in the tax bracket of 20%. Its pre-tax cost of debt is
14%, and weighted average cost of capital is 20%. The car can be depreciated at the rate
of 30% on WDV basis.
139. Aditya Steels (P) Ltd. (ASL) is contemplating to modernize its operations for which it
requires a new plant costing Rs.800 lakh inclusive of CST @ 4%. It estimates the economic
life of the plant to be 5 years after which it is estimated to realize Rs.12 lakh. The tax
relevant rate of depreciation is 30%.
The finance manager of ASL has approached Kavya Financial Services (KFS) to finance its
modernization program either through leasing or hire purchase. KFS forwarded the
following details to ASL:
Leasing
Lease rentals : Rs.25 ptpm
Payment : Quarterly in arrears
Lease period : 5 years
Hire Purchase
Down payment : 25%
Flat rate of interest : 12%
Payment : Monthly in advance
Hire period : 5 years.
The marginal cost of debt and marginal cost of capital of ASL are 14% and 16%
respectively. ASL is in the tax bracket of 35% and it allocates interest on SOYD basis.

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You are required to

a. Suggest the mode of financing suitable to ASL.
b. Determine the flat rate of interest under hire purchase option at which ASL is
indifferent between leasing and hire purchase.
140. Jumbo Financial Services (JFS) offers car loans for a maximum period of 4 years. The
details of the same are as follows:
Loan Amount 80% of the cost of asset
Flat rate of interest 12% p.a.
Payment pattern Monthly in arrears
Processing fee 1% of the amount financed
Mr. Abishek, considering to purchase a car worth Rs.3,75,000 applies for a loan for a
period of 3 years.
You are required to calculate the effective rate of interest on the completed transaction if
Mr. Abishek opts for a early settlement after paying the 24th installment. Assume JFS
calculates the interest rebate according to the Rule of 78 method.
CONSUMER CREDIT
141. Esanda Finanz has a number of schemes offered to a variety of cars:
Vehicle Model Price (Rs.)
Maruti 800 2,12,050
Maruti Zen 3,54,000
Ambassador 3,17,000
Cielo 6,50,000
Opel Astra 7,01,000
Ford Escort 7,68,000
Pal Peugeot 4,50,000
Fiat Uno 4,01,000
These schemes cover a period of 12 months to 48 months as under:
a. Down payment scheme (15% down payment)
Tenure in months 12 24 36 48
Interest flat rate (p.a.) 12.47 12.40 12.66 13.46
b. One EMI in advance scheme
Tenure in months 12 24 36 48
Interest flat rate (p.a.) 12.51 12.39 12.62 13.43
c. 100% Finance with advance EMI scheme
Tenure in months 12 24 36 48
Interest flat rate (p.a.) 12.58 12.37 12.56 13.32
Variable rates are given for the higher value vehicles and repeat customers get a benefit of
0.5% reduction in interest rates.
Calculate the equated monthly installment and the effective rate of interest per annum
or the annual percentage rate, if you opt to repay in 24 months under scheme (a) and
buy Pal Peugeot?

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142. Epsilon Finance Company offers the following type of Deposit Linked Scheme for
acquiring cars.
Deposit Scheme 25% Deposit
Amount (Rs.) 1,00,000.00
Repayment Period (in months) 36
Equated Monthly Installment (Rs.) (Payable at the end of every 3,835.00
month)
Accumulated Interest on Deposit (after 36 months) – interest is 13,886.40
cumulated with quarterly rests
The company levies a front-ended documentation and service fee of Rs.2,000 and offers a
prompt payment bonus of Rs.10 per Rs.10,000 per month on expiry of the repayment
period. The EMI is payable at the end of every month.
After 24 months, one of the borrowers (who has borrowed Rs.1,00,000) under the scheme
opts for an early settlement. The company levies a service charge of 2% on the principal
outstanding on the date of settlement. It offers an interest rebate calculated in accordance
with the Rule of 78 method. Calculate the effective rate of interest on the completed
transaction.
143. Premier Financial Services (PFS) offers car loans for a maximum period of 4 years. The
company finances up to 80% of the cost of the cars and its repayment schedule for loan
amount of Rs.1,00,000 is as follows:
Loan Tenure (in months) 12 24 36 48 60
Equated Monthly Installment (Rs.) 9,260 5,173 3,835 3,183 2,807
The company charges processing fee of 1% of the amount financed. Mr. Avinash applied
for the loan to finance the purchase of a car costing Rs.4,20,000.
Required:
a. Calculate the flat rate of interest if Mr. Avinash opts for a loan tenure of 3 years.
b. Calculate the effective rate of interest on the completed transaction if he opts for an early
settlement after paying the 24th installment. Assume PFS calculates the interest rebate
according to the Rule of 78 method.
144. Mrs Laxmi is contemplating to purchase a Maruthi Zen costing Rs.3.50 lakh by availing a
consumer finance of Rs.2.50 lakh. She is considering the following schemes:
Citi Bank scheme calls for 15% down payment on the cost price of the car and their rate of
interest is 16% flat. The loan is repayable in 36 equal monthly installments payable in
arrears. The bank also permits 3 months as deferment period at the beginning of the
transaction. The bank charges Rs.2,500 as processing fee and in case of a prepayment the
bank allows interest rebate equal to 80% of interest rebate as calculated according to
effective rate of interest method.
You are required to:
a. Calculate the EMI assuming that the actual amount financed is Rs.2.50 lakh.
b. If Mrs. Laxmi opts for an early repayment after completion of 18 months from the
beginning of the repayments, calculate the effective rate of interest on the completed
transaction.
145. A consumer loan of Rs.40,000 is repayable in 36 monthly installments (in arrear) of
Rs.1,500. Calculate the APR of the transaction.
146. A washing machine which costs Rs.19,000 can be purchased by 52 weekly installments of
Rs.380, payable in arrear. What is the APR of this transaction?
147. The car finance scheme of Meridian Finance Company permits a self-employed
professional to borrow up to Rs.2.75 lakh repayable in 12 monthly installments in arrear
calculated at a flat rate of interest of 13% p.a.
Calculate the monthly repayment on a loan amount of Rs.2 lakh and find the APR of
the transaction.

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148. Mr. Anil plans to purchase a car worth Rs.4,25,000. The finance company whom Anil
approached has offered him the following scheme:
The loan requires a down payment of 25% and the loan period is 20 years. It carries an
interest of 12.5% p.a. compounded monthly.
Calculate the equated monthly installment which is to be paid by Anil under the scheme.
Also, calculate the EMIs, if the loan does not require the down payment.
149. Sahitya Finance Company offers a credit plan under which a loan amount P is to be
repaid by a single installment of amount (P + D) after n (> 0) years. Under the credit
plan offered by the company, a customer availed a loan of Rs.75,000 on July 10, 20x0 to be
repaid one year later by a single installment of 80,000. On December 10, 20x0, he opted
for an early settlement.
In respect of loan repayable by a single installment, the Consumer Credit regulation
requires that the interest rebate should be proportional from the settlement date to the
originally specified repayment date. The regulation, however, permits the lender to take the
settlement date on the actual date of the early settlement deferred by 2 months for a loan of
an original term of 5 years or less.
Determine the sum paid by the borrower on early settlement and the APR on the completed
transaction.
150. The equated monthly installments for a consumer loan of Rs.54,000 under these repayment
options are as follows.
Repayment period EMI (Rs.)
(in months)
12 5,062.5
24 2,835.0
36 2,107.5
Calculate the flat and the effective rates of interest for each option.
151. Rehana Finance Company offers the following types of deposit linked schemes to acquire cars.
Deposit scheme Zero Deposit 25% deposit
Amount (Rs.) 90,000 90,000
Repayment period in months 36 36
Equated monthly installment 3,475 3,300
Bullet installment at the end (Rs.) 7,200 –
Accumulated interest on deposit (after 36 months) 11,720
The company levies a front ended documentation and service fee of Rs.1,500 and offers a
prompt payment bonus of Re.1 per thousand per month on expiry of the repayment period.
The EMI is payable at the end of every month.
Calculate the effective rates of interest implied by the two schemes.
152. Under the car finance plan of Meridian Finance Company a self-employed professional can
borrow up to Rs.1.10 lakh repayable in 12 monthly installments in arrears calculated at a
flat rate of interest of 12.5% p.a.
After making the sixth monthly repayment, the borrower pays off the outstanding loan. The
company calculates the amount required for early settlement by using the modified rule of
78 with α = 1. Determine the amount payable by the borrower and the effective rate on the
completed transaction.
153. Zeta Finance Company offers 20% deposit and 20% down payment schemes for acquiring
consumer durables. Prabhat approached the company to finance a washing machine costing
Rs.25,000 under 20% deposit scheme. The flat rate of interest charged is 10% p.a. Prabhat
is required to pay 24 equal monthly installments in arrears and keep the deposit at the
beginning of the contract which would be repaid on the day of payment of the last
installment with interest @ 15% p.a. compounded monthly.

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You are required to

a. Calculate the effective rate of interest for the above transaction.
b. Assume Prabhat availed 20% down payment scheme, recalculate (a) State the
reasons for the difference, if any, in the effective rates of interest.
154. Citi Bank provides car finance on second hand cars up to 70% of the value of the car, if the
car is not older than 4 years. Mr. Raghunadhan who wanted to purchase a second hand
Maruthi car for Rs.1,70,000 is falling short of Rs.1,00,000 and approached Citi Bank.
Citi Bank has appraised his creditworthiness and agreed to finance the car at a flat rate of
interest of 16%, repayable in 36 equal monthly installments in arrears. Processing fee
payable is Rs.2,000.
You are required to
a. Find EMI payable by Mr. Raghunadhan
b. If Mr. Raghunadhan repays the entire loan after 20 months and city bank provides
interest rebate under Rule of 78 and charges 2% of the outstanding principal on
prepayments, find the effective rate of interest to Mr. Raghunadhan for the complete
transaction.
FACTORING AND FORFAITING
155. Precision Instruments is a unit manufacturing clinical instruments in the Thane district of
Maharashtra. The company offers its dealers a 3 percent discount on cash and carry
transactions. Its credit terms are 2/10 net 45. The company has been plagued by a bad debt
problem averaging 2 percent of credit sales for the past several years. Dealers representing
approximately 10 percent of total sales opt for the cash and carry offer. On an average 50%
of the receivables are paid at the end of ten days thus availing the 2% discount. The rest of
the receivables are usually paid 50 days after sales.
The company has been financing 50% of its receivables from Bank of India at a cost of
22 percent p.a. The remaining half is financed through own funds whose notional cost is
estimated at 24 percent p.a. The costs associated with credit administration totals Rs.8 lakh.
Imfacs, a factoring company, has approached Precision Instruments with a factoring
proposal. The details are given below:
Type of contract Non-recourse, Advance Factoring
Interest on advances 22.5% p.a. payable in advance
Factoring commission 3.5% of the face value of factored receivables
Factor reserve 20% (percentage applied on receivables net of
commission payable)
Average maturity period 30 days
The credit administration costs can be totally avoided when the receivables are factored.
Assuming that all figures mentioned hold good for the year 20x1-20x2 and if
projected sales for the same year is Rs.800 lakh, would you recommend that
Precision Instruments go in for a factoring arrangement? Your recommendation
must be based on a cost-benefit analysis, assuming 360 days to a year and ignoring
taxes.
156. Challenge Biotechnics Ltd. has completed their final accounts and found that their sales
stand at Rs.450 crore. They have projected their next year sales at Rs.600 crore. Mr.
Ranganathan, the finance manager, has developed an analysis on their receivables
management.
The particulars are as under:
Terms of credit 2/10 net 30
Proportion of customers paying on 10th day 25%
Proportion of customers paying on 30th day 50%
Proportion of customers paying on 50th day 25%

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Present financing plan of receivables is as under:

Citibank finances 75% of receivables @ 22% and the remaining 25% is financed through
own sources at a pre-tax cost of 28%.
Additional costs for the company on account of receivables management are as under:
a. Cost of accounting and collection of receivables is Rs.3 crore p.a.
b. Loss of sales on account of using the sales force on collection of receivables is Rs.80
crore p.a. The gross profit margin on sales is 23.25%.
c. 2% of sales are expected to become bad debts.
Mr. Ranganathan was approached by Mr. David of Margarett Factor Services Ltd. and
offered the following factoring arrangement.
a. Factor’s commission 2% on the face value of all factored receivables.
b. Factor shall advance 90% of face value of factored receivables @ 20% p.a.
c. Factor shall remit balance of money on 30th day of sales whether the collection is
made or not at their end.
d. The factoring is on non-recourse basis.
You are required to
Evaluate the factoring alternative and suggest whether to go for factoring or not.
157. Given below is the Balance Sheet as on 31.03.20x0 of M/s Factors Client Ltd. who intends to
avail factoring line from a factoring company which keeps a margin of 20%. A bank is
also willing to finance the receivables on a similar margin.
Balance Sheet as on March 31, 20x0
Rs. in lakh
Liabilities Assets
Net worth 90 Fixed assets 60
Long-term debt 30 Inventory 50
Current liabilities 90 Receivables 90
Cash 10
210 210
You are required to
a. Find out the impact of Advance Factoring and Bank Overdraft and recast the
balance sheet.
b. Recast the balance sheet if M/s Factors utilizes the additional cash received through
factoring or bank to reduce its current liabilities by Rs.36 lakh.
c. Comment on the impact on liquidity ratios in (a) and (b) above.
158. Under an advance factoring arrangement, Sandeep Factors Ltd. has agreed to advance a
sum of Rs.22 lakh against the receivables purchased from Saket Traders Ltd. The
factoring agreement provides an advance payment of 75% of the value of factored
receivables for guaranteed payment after 3 months from the date of purchasing the
receivables.
The advance carries a rate of interest of 16.5% p.a. compounded quarterly and the factoring
commission is 1.25% of the value of factored receivables. Both the interest and commission
are collected upfront.
a. Compute the amount actually made available to Saket Ltd.
b. Calculate the effective cost of funds made available to Saket Ltd.
c. Assume that the interest is collected in arrears and the commission is collected in
advance. Calculate the effective cost of funds made available to Saket Ltd.

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159. Penguin Factors, the subsidiary of Meridian Bank offers the following fund-based facilities:
Facility Recourse Non-Recourse
Factoring Factoring
A Discount charge (payable upfront) 19.5% p.a. 19.5% p.a.
B Reserve 20% p.a. 20% p.a.
C Commission 2% 3%
The finance manager of Sameer Textiles has recently approached Penguin Factors to factor
the receivables. After a careful analysis of the sales ledger of Sameer Textiles, the Vice-
President (Operations) of Penguin Factors agrees to a guaranteed payment period of 60 days.
The finance manager of Sameer Textiles is not clear about the type of factoring he should
opt for and seeks your help in this regard. He provides you with the following additional
information.
a. The firm sells on terms 2/10 net 60. On an average 50% of the customers pay on the
10th day and avail the discount. On an average the remaining customers pay 90 days
after the invoice date.
b. The bad debts and losses amount to 2% of the sales invoices.
c. The sales executives are responsible for following up collectors and on an average,
spend 25% of their time on collection efforts. Subjective assessment is that the firm
can increase its annual sales by Rs.15 lakh if the sales executives are relieved from
collection responsibilities. The gross margin on sales is 25% and the projected sales
turnover for the following year (without considering the increase of Rs.15 lakh) is
Rs.260 lakh.
d. By hiving off sales ledger administration and credit monitoring, the firm can save
administrative overheads to the time of Rs.1.25 lakh per annum.
e. As of now, the firm has been financing its investment in receivables through a mix
of bank finance and long-term funds in the ratio of 2:1. The effective rate of interest
on bank finance is 18.5% p.a. and the cost of long-term funds is around 23% p.a.
(pre-tax).
160. Thirumalai Chemicals Limited (TCL) involved in petrochemicals has an annual turnover of
Rs.800 lakh, about 20% of which is cash sale. The company has an average collection
period of 45 days. The gross margin on sale is 20%. The cost of long-term funds (pre-tax)
for TCL is 20% and banks interest rate is 16% p.a. The bank finance to long-term funds
ratio is 2:1. Annual expenditure on maintaining and collecting accounts is about Rs.10 lakh.
The bad debt averages around 1% of the credit sale.
Wipro Factors Limited (WFL) recently approached the management of TCL and offered
factoring services under the following terms:
Non-recourse Factoring
Discount charges (Upfront) 19% p.a.
Commission charges (Upfront) 2.0%
Reserve 25.0%
There is a possibility that WFL would agree for 40 days collection period. TCL is expected to
avoid 75% of expenses incurred in maintaining and collecting accounts, if it avails factoring
services.
Is factoring a better way to manage receivables than the current practice? Show all
calculations.
Make suitable assumptions.

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161. Duncan Bearings is a medium-scale unit engaged in the manufacture of roller bearings. The
principal customers of the company include the major manufacturers of two-wheelers and
commercial vehicles. The firm sells on credit and the present terms are 1/10 net 60. A
recent analysis of the outstanding receivables using the Ageing Schedule revealed the
following position:
Age group Standard Percentage of Actual Percentage of
(in days) Receivable Receivables
0 - 03 35 20
31 - 45 60 40
46 - 90 5 30
> 90 – 6
The adverse changes in the pattern of payment as revealed by the Ageing Schedule
prompted the firm to review its practices relating to receivables management. The finance
manager of the firm found that:
a. The average collection period is 66 days on an annual sales turnover of Rs.780 lakh.
b. The proportion of sales on which customers currently take discount is 0.3.
c. The bad debts to sales ratio is 0.01. The average cost of funds is 16% p.a. To
expedite collection of receivables and reduce the collection period, the finance
manager has proposed the following alternatives:
i. Factoring: The firm can opt for either Recourse Advance Factoring or Non-
Recourse Advance Factoring on the following terms:
Recourse Non- Recourse
Factoring Factoring
Interest rate on advance 18% 18%
Commission (as a % of 0.5% 1%
invoice value)
The firm can negotiate for a fixed maturity period of 50 days and the firm can
save about Rs.3.4 lakh in terms of administrative overheads associated with
collection of debts.
ii. Change in Credit Policy: The firm can relax its discount terms to 2/10 net
45. Such a relaxation coupled with vigorous collection efforts can reduce the
average collection period to 36 days and increase the proportion of discount
sales to 0.6.
Based on economic considerations, which one of the alternatives will you
recommend? Show all calculations that are relevant for supporting your
recommendations.
162. Swan Silk Mills Limited (SSML) is a medium sized, composite textile and silk mill based
at Hyderabad. The company is producing pure and artificial silk fabrics, sarees, cushions,
etc. During the year 20x0-x1 it had a sales turnover of Rs.48 crore and expects it to increase
by 10% during 20x1-x2.
Currently, the company follows credit terms of 1/10 net 45 days. 20% of the customers pay
within 10 days and the balance accepts the bills drawn by the company with a usance
period of 45 days. However, only 80% of the bills receivable would be honored within the
45 days and the balance pay within 70 days. The company has a policy to avail short-term
bank finance at an interest rate of 18% p.a. to fund 80% of the receivables and the rest is
sourced from the company’s own funds at an effective cost (in pre-tax terms) of 21% p.a.
The company spends around Rs.0.6 crore for the purpose of collecting dues, ledger
administration and credit monitoring.

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The finance manager of the firm has been approached by Swift Factors Limited (SFL)
which provides advance non-recourse factoring for working capital finance to small and
medium sized companies. The terms and conditions of factoring are as follows:
• Discount charge is 19% p.a.
• Commission is 1.5%
• Advance payment as proportion of factored receivables is 80%.
• Agreed payment time is 30 days.
If factoring is availed the administration expenses can be avoided.
Assume 360 days in a year.
You are required to:
Suggest the alternative of working capital finance to the finance manager of SSML.
163. Siddi Prints is a medium-sized, composite textile mill based at Hyderabad. During the year
20x0-x1 it has a sales turnover of Rs.80 lakh and expects it to increase by 10% during
20x1-x2.
The company currently follows credit terms of 2/10 net 60 days. 30% of the customers are
expected to pay within 10 days and avail the discount. The balance 70% accepts the bills
drawn by the company, on the day of sale, with a usance period of 60 days. However, only
90% of the bills receivable would be honored within 60 days and the remaining are paid
within 90 days. The company has a policy to avail short-term bank finance at an
interest rate of 16% p.a. to fund 75% of the receivables and the rest is sourced from the
company’s own funds at an effective cost (in pre-tax terms) of 24% p.a. The
company spends around Rs.0.8 lakh for the purpose of collecting dues, ledger
administration and credit monitoring. Bad debts amount to 1% of the credit sales.
The finance manager of the firm has been approached by Swift Factors Limited which
offers bill discounting and advance non-recourse factoring for working capital finance to
small and medium-sized companies.
The terms and conditions under bill discounting option are as follows:
i. Discount charge is 20% p.a.
ii. On the 60th day, the payment day of the bills, the bank agrees to extend the time of
unpaid bills to 90 days charging an interest of 3% which the company would be
collecting from the customers.
The terms of factoring are as follows:
i. Discount charge is 19% p.a. and commission is 2%.
ii. Advance payment as proportion of factored receivables is 85%.
iii. Agreed payment time is 50 days.
While the finance manager was assured by Swift Factors that any of the above alternatives
would be better than the existing in-house management of receivables, he is unable to
decide among the three.
You are required to evaluate the cost benefit analysis of bill discounting and factoring and
suggest the alternative of working capital finance to the finance manager of the company.
(Assume 360 days in a year and administration expenses can be avoided if factoring is
availed).
164. Sri Chemicals Limited (SCL) is presently managing its accounts receivables internally
through its credit department. Sales for the current year are Rs.360 lakh. Its credit terms are
1/15 net 40. On an average 20% of the customers avail the discount while the remaining
pay within 45 days. Its bad debts to sales ratio is 0.015 and its contribution margin is 20%.
The firm currently is financing its receivables by a mix of bank finance and own funds in
the ratio of 3:2. The rate of interest on bank finance is 20% whereas its pre-tax cost of own
funds is 24%.

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SCL has received a proposal from Charan Factors Limited (CFL) to factor its receivables
under a bank participation factoring arrangement with Sind Bank providing an advance of
60 percent of factor reserves at an interest of 22%. CFL has agreed for advance payment of
80% of receivables at a guaranteed payment of 40 days. The interest (payable upfront) and
the commission charged by CFL is 20% and 3% respectively. The factoring arrangement is
without recourse to SCL.
SCL has projected its sales for the next year to increase by 10% without a factoring
arrangement and by 20% with factoring arrangement. The collection expenses are expected
to be reduced by Rs.1.5 lakh due to the factoring arrangement.
(Assume 365 days in a year).
You are required to suggest whether or not SCL should go for the factoring arrangement.
Support your answer with detailed workings.
165. Sritex Ltd. (SL) is a medium-sized, composite textile mill based at Kakinada. During the
year 20x0-x1 it had a sales turnover of Rs.250 lakh and expects it to increase by 10%
during the year 20x1-x2.
The credit terms of SL are 1/15 net 60 days. 20% of the customers pay within 15 days and
avail the discount. The remaining customers accept the bills drawn by the company for a period
of 60 days. However, the past records show that on an average 80% of the bills accepted are
honored on the due date while the remaining 20% of the bills are dishonored and the payment of
the same is made within 80 days.
SL has a policy to avail short-term bank finance from Finex Bank (FB) to fund 70% of
receivables at an interest of 18% p.a.
The cost of SL’s own funds is 24% p.a. (in pre-tax terms). The cost of sales ledger maintenance
and receivables collection is estimated to be Rs.0.6 lakh.
FB has recently started offering non-recourse factoring services and has also approached
SL for the same. The terms of factoring are
Discount charge 22% p.a.
Commission 2.5%
Advance payment 80% of factored receivables
Agreed payment time 40 days
SL has opted for factoring since SL expects to avoid the administration expenses and increase
its sales revenue. The SL’s variable to sales ratio is 0.7.
Assume 365 days in a year.
You are required to determine the minimum increment in sales at which factoring is better
than bank financing.
166. Sujana Industries Ltd. offers credit to its customers at 2/10, net 45. At present, about 25%
of the customers pay on the 45th day, 50% pay on the 55th day and the rest pay on the 75th
day. Bad debts generally amount to 2% of sales. The company now finances 50% of its
receivables through a bank loan at 16% and the rest through own funds. It is planning to
factor its receivables with Fairfacts Ltd. which agreed to factor the receivables at a
commission of 2%. The factor will also provide an advance of 75% of the receivables at an
interest of 15% and pay the balance at the end of the 50th day. The cost of the company’s
own funds is 20%. The sales of the company are at present Rs.500 crore and are expected
to increase to Rs.575 crore if the sales force is relieved from the collection efforts. The
variable costs generally form 75% of the sales. Further, a saving of Rs.5 lakh is expected
annually due to the accounting services provided by the factoring company.
You are required to advise the company whether factoring is desirable or not.
(Support your answer with suitable workings. Assume 360 days in a year).

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MORTGAGES AND MORTGAGE INSTRUMENTS

167. Reviera Finance Company has offered the following scheme to Sunil who had approached
the company for a loan to purchase a house. The amount of the loan is Rs.2,25,000. Other
details of the scheme are as follows:
The borrower is required to deposit an amount of Rs.15,000 in a pledged savings payment
which earns an interest of 10.5%.
The loan carries an interest of 11% p.a. compounded monthly and the loan period is 25 years.
The borrower would make graduated payments for 5 years increasing at a rate of 6% every
year and thereafter payments would be as equated monthly installments.
You are required to work out the equated monthly installment, graduated monthly
payment made by the borrower and the amount to be drawn from the savings account
as the lender receives the equated monthly installment throughout the scheme.
168. Savita is intending to own a house worth Rs.3,75,000. She wishes to finance the investment
with a mortgage. She is sanctioned 75% of the cost of the house. You are required to
calculate:
a. EMIs assuming that the loan is to be repaid at an interest of 15% p.a. [compounded
monthly] in 20 years.
b. Monthly payments under graduated payment mortgage scheme in which
payments are expected to rise by 4% per year for the first 4 years and then
become equal through 20 years. The interest is same as given above.
HOUSING FINANCE IN INDIA
169. Calculate the recommendations for disbursing a loan of Rs.4,25,000 on a flat. Its cost of
construction is Rs.3,75,000, and progress of construction is 50%. Aggregate value is
Rs.4,75,000 and borrower’s contribution is Rs.1,10,500 and the cumulative disbursement
made is Rs.85,000.
170. Mr. Rajesh has approached HDFC to get a housing loan of Rs.3,60,000 for a period of 20
years. The rate of interest on the loan is 16%. Calculate the equated monthly installment
required to be paid by Rajesh.
171. Calculate the monthly installment for a loan given by the HDFC on the following terms:
Loan amount Rs.15,00,000
Period 15 years
Rate of interest 15% p.a.
172. HFC Ltd., a housing finance company, has been approached by Mr. & Mrs. X for a
housing loan for a flat. As per HFC’s policies, housing loans are given subject to:
a. A maximum of 75% of the cost of the house/flat.
b. The EMI not exceeding one-third of the take-home per month salary of the
borrower(s).
c. The maximum tenure of the loan is 15 years.
d. The interest rates applied by HFC are given below:
Amount of Loan Interest rate
0 – 1,00,000 15% p.a.
1,00,000 – 3,00,000 16% p.a.
3,00,000 – 10,00,000 17% p.a.
10,00,000 and above 18% p.a.
You are also provided the following information about the salary income of Mr. &
Mrs. X.

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Mr. X Mrs. X
Rs. p.m. Rs. p.m.
Salary 20,000 12,000
Provident fund 800 600
Vehicle loan deduction 600 600
Income tax 4,000 2,000
You are now required to advice HFC the maximum amount of loan which can be
given to Mr. & Mrs. X and the maximum value of the flat which the couple can
consider buying?
SOURCES OF FINANCE AND REGULATORY ENVIRONMENT OF
FINANCIAL SERVICES
173. The summarized Balance Sheet of Apt Finance Ltd. (AFL) as at 31st March, 20x0 is as
follows:
(Rs. lakh)
Capital and Liabilities Amount Assets Amount
Shareholders’ Fund: Fixed Assets (Net)
– Subscribed and called – Own Assets 3,246.58
upEquity Capital
5567.31
Less: Call money – Leased Assets 18,952.75
receivable 0.42 5,566.89 – Capital Work-in-progress 18,027.62
– Cumulative Preference Investments
Shares of Rs.100 each to
be converted to equity at
the end of 31st March, 200.00
2001
– Capital Reserve 514.33 – Investments in Government 5,790.27
(represented by surplus securities
on sale of assets)
– General Reserve 3,612.19 – Investment in Subsidiary 2,220.00
Companies
– Share Premium Account 14,131.02 – Trade Investments 5,316.83
– Revaluation Reserves 2,517.00 Current Assets, Loans & Advances
– Debenture Redemption 4,100.00 – Stock on hire 45,487.00
Reserve
Secured Loans – Sundry Debtors 3,559.01
– Banks 27,378.03 – Cash & Bank Balance 3,844.76
– Secured Redeemable 14,198.03 – Loans and Advances
Non-convertible
Debentures
Unsecured loans – To subsidiaries 2,421.51
– Loans and Advances 480.05 – Others 10,026.03
– Public Fixed Deposits 37,299.39
Current Liabilities and
Provisions
– Sundry Creditors 1,949.85
– Unmatured Finance 656.42
Charges
– Others 5,088.06
– Provisions 1,201.10
1,18,892.36 1,18,892.36

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Notes to accounts include the following contingent liabilities:

Rs. lakh
i. Guarantees issued and outstanding 1,694.79
ii. Pending appeals under sales tax laws 10.77
iii. Partly paid-up shares and debentures 24.53
You are required to calculate the capital adequacy ratio of the company and compare it with
the minimum prescribed by the RBI.

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MONEY MARKET
Introduction to Money Market
1. a. The success rate that is to be maintained by the PDs for G-Secs is 33.33% of the
commitment.
(Rs. crore)
Commitment for aggregate bidding for G-Secs by TRQ Ltd. 1000
Commitment for aggregate bidding for G-Secs by XYZ Ltd. 1200
Required amount of successful bids for TRQ Ltd. (1000 x 33.33%) 333.3
Required amount of successful bids for XYZ Ltd. (1200 x 33.33%) 399.96
b. For the PDs to meet the requirements of their commitments, the tendered bids should be
greater than their commitments. Similarly, the bids accepted by them should be greater than
the successful bids for them to meet the requirements.
Adherence to Commitments
(Rs. crore)
Bids Tendered Commitments (Y/N) Adhered (Y/N)
TRQ Ltd. 800 < 1000 N
XYZ Ltd. 1400 > 1200 Y
Adherence to Successful Bids
(Rs. crore)
Bids Accepted Required Commitment AdherenceY/N
TRQ Ltd. 700 > 333.3 Y
XYZ Ltd. 1000 > 399.96 Y
From the table given above it can be observed that though TRQ Ltd. has adhered to the
successful bids, it does not adhere to the commitments. XYZ Ltd. has, however, adhered to
both its commitments and the successful bids.
2. The success ratio to be maintained by PDs while bidding for a T-bills auction is 40%.
Hence the commitment of aggregate bidding by STL Ltd. would have been
315 x 100/40 = Rs.787.5 crore.
For a PD to adhere to the commitments, the bids tendered should be greater than their
commitment for aggregate bidding. And for a PD to adhere to the successful bids, the bids
accepted should be greater than the required amount of successful bids. The minimum
amounts of tendered and accepted bids for STL Ltd. in order to adhere to the requirements
will be Rs.787.5 crore and Rs.315 crore respectively.
3. (Rs. crore)
G-Secs T-Bills
Notified Amount 3700 2200
Bids Accepted 3100 1800
Due to the amount of accepted bids falling below the notified amounts for g-secs and
T-Bills, both the issues will devolve on the PDs and the RBI.
(Rs. crore)
Total devolvement in the G-Secs issue 600
Total devolvement in the T-Bills issue 400
The devolved amount will have to be shared by all PDs, RBI and Sterling in the following
manner.
 Part II

Devolvement in G-Secs
(Rs. crore)
Amounts devolved on all PDs = 600 x 0.25 = 150
Amount devolved on RBI = 600 x 0.75 = 450
Amount devolved on Sterling = 150 x 0.10 = 15
Devolvement in T-Bills
Amount devolved on all PDs = 400 x 0.20 = 80
Amount devolved on RBI = 400 x 0.80 = 320
Amount devolved on Sterling = 80 x 0.05 = 4
In case of devolvement, the collectively underwritten portion by all PD’s will be fixed at a
level not exceeding 25% of an issue in the case of dated securities and 20% in case of
T-Bills. The RBI will underwrite the remaining 75% and 80% respectively.
4. i. The success ratio to be maintained by PDs in G-Secs = 33.33%
The success ratio to be maintained by PDs in Auction T-Bills = 40%
(Rs. crore)
P Ltd. Q Ltd. R Ltd. S Ltd.
G-Secs (commitment x 33.33%) 267 300 200 133
Auction T-Bills (commitment x 40%) 360 480 600 680
ii. G-Secs
Adherence to commitments Adherence to successful bids
Bids Commit- Adhered Bids accepted Required Adhered
tendered ments Y/N commitments Y/N
P Ltd. 850 > 800 Y 300 > 267 Y
Q Ltd. 1,000 > 900 Y 250 < 300 N
R Ltd. 500 < 600 N 150 < 200 N
S Ltd. 600 > 400 Y 300 > 133 Y
From the above table it can be observed that R Ltd. did not adhere to the commitment on
aggregative bidding or on the required amount of successful bids.
Q Ltd. has adhered only to their commitment on aggregative bidding but not to the required
amount of successful bids.
Auction T-Bills
(Rs. crore)
Adherence to commitments Adherence to successful bids
Bids Commitments Adhered Bids Required Adhered
tendered Y/N accepted commitment Y/N
P Ltd. 1000 > 900 Y 300 < 360 N
Q Ltd. 700 < 1200 N 250 < 480 N
R Ltd. 1700 > 1500 Y 620 > 600 Y
S Ltd. 1900 > 1700 Y 750 > 680 Y
It can be observed that Q Ltd. has not adhered to either to the commitment on aggregative
bidding or to the required amount of successful bids while P Ltd. has not adhered to the
required amount of successful bids.

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 Investment Banking and Financial Services

5. Case 1
(Rs. crore)
G-Secs 91-day
T-Bills
Notified amount 600 200
Bids accepted 600 200
There is no shortfall in the subscription of G-Secs and 91-day T-Bills since the bids
received for G-Secs and the T-Bills are equal to the notified amount. Hence, there is no
devolvement.
Case 2
(Rs. crore)
G-Secs 91-day
T-Bills
Notified amount 600 200
Bids accepted 500 150
It can be observed that the bids accepted for the G-Secs and 91-day T-Bills fall short of the
notified amount by Rs.100 crore and Rs.50 crore respectively. Hence there is a devolvement in
the issues. The devolvement on PDs, Ross Ltd. and RBI will be assessed based on the
following:
Devolvement on RBI in case of G-Secs = 75% of the devolvement
Devolvement on RBI in case of T-Bills = 80% of the devolvement
Devolvement on PDs in case of G-Secs = 25% of the devolvement
Devolvement on PDs in case of T-Bills = 20% of the devolvement
Devolvement on Ross Ltd. in case of G-Secs = 15% of the amount devolved on PDs
Devolvement on Ross Ltd. in case of T-Bills = 10% of the amount devolved on PDs
(Rs. crore)
G-Secs 91-day T-Bills
Amount of shortfall 100 50
a. Devolvement on PDs 100 x 0.25 = 25.00 50 x 0.20 = 10.00
b. Devolvement on Ross Ltd. 25 x 0.15 = 3.75 10 x 0.10 = 1.00
c. Devolvement on RBI 100 x 0.75 = 75.00 50 x 0.80 = 40.00

6. a. The success ratio to be maintained by the primary dealers in

Government securities = 33.33%.

And, the success ratio to be maintained by the primary dealers in Auction T-Bills = 40%

Required Amount of Successful bids for each Primary Dealer

(All figures in Rs. crore)
Particulars PNB Gilts Ltd. SBI Gilts Ltd. Gilts Securities ICICI Securities
Trading and Finance
Corporation Company Ltd.
Government 300 333 267 233
Securities
Auction T-Bills 520 600 440 720

202
 Part II

b.
Government Securities
(All figures in Rs. crore)
Particulars Adherence to commitments Adherence to successful bids
Bids Commit- Adhered Bids Required Adhered
tendered ments (Y/N) accepted commitment (Y/N)
PNB Gilts Ltd. 1,000 > 900 Y 400 > 300 Y
SBI Gilts Ltd. 900 < 1,000 N 350 > 333 Y
Gilts 1,100 > 800 Y 412 > 267 Y
Securities
Trading
Corporation
ICICI 650 < 700 N 200 < 233 N
Securities and
Finance
Company Ltd.
From the above table it can be observed that ICICI Securities and Finance Company Ltd.
has not adhered to the commitment on aggregative bidding or on the required amount of
successful bids and SBI Gilts Ltd. has not adhered to the commitment on aggregative
bidding.

Auction T-Bills
(All figures in Rs. crore)
Particulars Adherence to commitments Adherence to successful bids
Bids Commit- Adhered Bids Required Adhered
tendered ments (Y/N) accepted commitment (Y/N)
PNB Gilts Ltd. 1,500 > 1,300 Y 500 < 520 N
SBI Gilts Ltd. 1,400 < 1,500 N 450 < 600 N
Gilts Securities 1,200 > 1,100 Y 350 < 440 N
Trading
Corporation
ICICI 1,600 < 1,800 N 500 < 720 N
Securities and
Finance
Company Ltd.
From the above table it can be observed that only PNB Gilts Ltd. and Gilts Securities
Trading Corporation has adhered to the commitment on aggregative bidding but none of the
primary dealers have adhered to the amount of successful bids.

Treasury Bills
7. Fully accepted bids will be as follows:
Bidder Price Quoted Approved Amount (Rs. cr.)
A 98.95 1800
B 98.93 700
C 98.92 1000
Total 3500

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 Investment Banking and Financial Services

D and E will be allotted proportionately in the following manner:

Bidder Price Amount Proportionate amount
allotted (Rs. crore)
D 98.90 1200 1000
E 98.90 600 500
1800 1500
⎡ Face value ⎤ 365
⎢ Pr ice − 1⎥ x Days to maturity
Yield = ⎣ ⎦

⎡ 100 ⎤ 365
A =⎢ − 1⎥ x = 4.26%
⎣ 98.95 ⎦ 91
⎡ 100 ⎤ 365
B = ⎢ − 1⎥ x = 4.34%
⎣ 98.93 ⎦ 91
⎡ 100 ⎤ 365
C = ⎢ − 1⎥ x = 4.38%
⎣ 98.92 ⎦ 91
⎡ 100 ⎤ 365
D and E = ⎢ − 1⎥ x = 4.46%
⎣ 98.90 ⎦ 91
If this auction is a single price auction, the price to be paid by the winning bidder would be
Rs.98.90.
⎡ Face Value ⎤ 365
8. Yield = ⎢ ⎥ −1x
⎣ Pr ice ⎦ Days to maturity

⎡ 100 ⎤ 365
= ⎢ − 1⎥ x
⎣ 91.35 ⎦ 364
= 9.495%.
9. a. The interest rate for each of the 6 years is
Year T-Bill yield Mark up of 3% Coupon for each year
1 11.55* 14.55 14.5%
2 10.55 13.55 13.5%
3 9.90 12.90 13.0%
4 9.30 12.30 12.5%
5 9.50 12.50 12.5%
6 8.30 11.30 11.5%

Year Coupon Payment (Rs.) Interest (Rs.) Principal (Rs.)

1 14.50% 2750.00 1450.00 1300.00
2 13.50% 2750.00 1174.50 1575.50
3 13.00% 2750.00 926.19 1823.83
4 12.50% 2750.00 662.59 2087.41
5 12.50% 2750.00 401.66 2348.34
6 11.50% 964.40 99.47 864.93

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 Part II

b. The post-tax cash flow

Year Pre-tax interest Post-tax interest @ Principal Cash flow
17.5%
0 –10000.00

1 1450.00 1196.25 1300.00 –2496

2 1174.50 968.96 1575.50 –2544

3 926.19 764.10 1823.82 –2588

4 662.59 546.63 2087.41 –2634

5 401.66 331.37 2348.34 –2680

6 99.47 82.06 864.93 –947

11.14%
The post-tax cost to the company is (i) in the following:
2, 496 2,544 2,588 2, 634 2, 680 947
10,000 = + + + + +
(1 + i) (1 + i) 2
(1 + i) 3
(1 + i) 4
(1 + i) 5
(1 + i)6
Solving,
By i = 11.14%.
* T–Bill Yield for year 1
(11.0 x 0.3) + (11.5 x 0.5) + (12.5 x 0.2) = 11.5.
Similarly you can calculate for the remaining years also.
10. The optimal cut-off price is Rs.98.85. Below this point the amount of bids is short by
Rs.150 crore and at this point, it has a surplus of Rs.350 crore. The first 4 bids given by
A and B are accepted completely and the next quote given by the 2 bidders being the
same RBI allots them proportionately. The fully accepted bids are
(Rs. crore)
Name of the bidder Price Quoted Approval Amount
A 98.91 100
A 98.89 180
B 98.93 50
B 98.90 120
Total 450
The RBI allots the 2 bidders proportionately in the following manner.
Name of the bidder Price Amount Proportionate
Amount Allotted
(Rs. crore)
A 98.85 200 60
C 98.85 300 90
500 150
⎡ Face Value ⎤ 365
Yield = ⎢ − 1⎥ x
⎣ Pr ice ⎦ Days to maurity

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 Investment Banking and Financial Services

Weighted average yield for the issue

Name of Price Amount Proportion Weight x Price Yield Weight
The Bidder (i) (ii) (ii)/600 = (iii) (i x iii = iv) (v) Yield
(vi)
A 98.91 100 0.17 16.485 0.0221 0.00368
98.89 180 0.30 29.667 0.0225 0.00675
98.85 60 0.10 9.885 0.0233 0.00233
B 98.93 50 0.08 8.244 0.0217 0.00181
98.90 120 0.20 19.780 0.0223 0.00446
C 98.85 90 0.15 14.828 0.0233 0.00350
600 1.00 98.889 0.02254
Yield for each of the bidders
A: Average yield for A

⎡ 100 ⎤ ⎡ 180 ⎤ ⎡ 60 ⎤
⎢98.91 x *⎥
+ ⎢98.89 x *⎥
+ ⎢98.85 x ⎥ = 98.89
⎣ 340 ⎦ ⎣ 340 ⎦ ⎣ 340* ⎦

* (100 + 180 + 60 = 340)

⎡ 100 ⎤ 365
Yield = ⎢ 98.89 − 1⎥ x 182 = 2.25%
⎣ ⎦

B: Average yield for B

⎛ 50 ⎞ ⎛ 120 ⎞
= ⎜ 98.93 x + 98.90 x
* ⎟ ⎜ ⎟
⎝ 170 ⎠ ⎝ 170* ⎠

= 98.91
* (50 + 120 = 170)

⎡ 100 ⎤ 365
Yield = ⎢ − 1⎥ x = 2.21%
⎣ 98.91 ⎦ 182

⎡ 100 ⎤ 365
C= ⎢ − 1⎥ x = 2.33%
⎣ 98.85 ⎦ 182

$10, 00, 000

11. P= = $680583
(1.08)5

⎡ Face Value ⎤ 365

12. Yield = ⎢ − 1⎥ x
⎣ Pr ice ⎦ days to maturity

⎡ 100 ⎤ 365
⎢ 92.05 − 1⎥ x 182 = 17.32%
⎣ ⎦

1/ t
⎛A⎞
13. i =⎜ ⎟ −1
⎝P⎠
$10, 000
i= − 1 = 5.28%
$9022.87

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 Part II

14. The bond pays $40 semi-annual coupons and there are ten 6-month periods to maturity. The
6-month periodic rate is the value of i that satisfies
$40 $40 $40
$850.75 = + + …… +
1+ i (1 + i) 2
(1 + i)10
i = 6.03% which must be converted into an effective annual rate
(1 + i) = (1.0603)2
i = 12.43%
* (Effective annual rate ⇒ i = (1+ nominal rate)n – n → no. of compoundings.)
Commercial Paper (CP)
Par value − P urchase price 12
15. Rate of return = x
Purchase price No. of months to maturity
$10, 00, 000 − $9, 61, 000 12 $39, 000 12
= x = x = 8.11%
$9, 61, 000 6 $9, 61, 000 6
F
16. Issue price =
⎛ I N ⎞
1+ ⎜ x ⎟
⎝ 100 365 ⎠
where,
F = Face value
I = Effective interest p.a.
N = Usance period
25, 00, 000
= = Rs.24,36,907.46
⎛ 10.5 90 ⎞
1+ ⎜ x ⎟
⎝ 100 365 ⎠
Face Value
17. Effective interest Issue price =
⎛ i N ⎞
1+ ⎜ x ⎟
⎝ 100 365 ⎠
1, 00, 000
98,250 =
⎛ 90 ⎞
1 + ⎜i x
⎝ 365 ⎟⎠
i = 7.22%
Cost of funds to the company
Effective interest rate = 7.22%
Brokerage (0.025 x 4) = 0.1%
Rating charges (0.125 x 4) = 0.5%
Stamp duty = 0.5%
8.32% p.a.
F
18. a. P=
IxN
1+
100 x 365
where,
P = Issue price
F = Face value or maturity value

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 Investment Banking and Financial Services

I = Effective interest rate per annum

N = Usance period i.e. number of days.
Therefore, the issue price,
5, 00, 00, 000
P =
14 x 45
1+
100 x 365
= Rs.4,91,51,630 (Approximated)
b. Stamp Duty
As the tenure of the CP is less than 3 months, the stamp duty chargeable
= 0.125% of Rs.5 crore
= Rs.62,500
c. Maximum Permissible Brokerage
For a CP is less than 90 days (the tenure here is 45 days), maximum permissible
brokerage
= 0.025% of Rs.5 crore
= Rs.12,500
d. Computation of the Effective Cost to the Issuer
Particulars Amount (Rs.)
Interest = Rs.50,000,000 – Rs.49,151,630 = 8,48,370
Rating charges = (0.5% of Rs.50,000,000) x 45/365 = 30,822
Stamp duty 62,500
Brokerage 12,500
9,54,192
Cost to the issuer = (9,54,192/50,000,000) x 100 = 1.908%
∴ Annualized cost to the issuer = [(1.01908)365/45 – 1] x 100 = 16.57%

Certificate of Deposits (CDs)

19. Effective annual interest rate on the 6-month CD.

11.5%
Monthly interest rate = = 0.958%
12

1000 x (1.00958)12 = 1121.214

1121.214 − 1000
x 100 = 12.12%
1000

11.3%
For the 2nd CD, the periodic rate = 0.217%
52
Since, it is compounded weekly, at the end of the year, we would have
52
1000 x (1.00217) = 1119.315
1119.315 − 1000
= 11.93% = 11.93%
1000
The effective annual interest rate on the 2nd CD is lower than that of the first CD.

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 Part II

Face value
20. Issue price =
⎛ i N ⎞
1+ ⎜ x ⎟
⎝ 100 365 ⎠
15, 00, 000
14,45,000 =
⎛ i 150 ⎞
1+ ⎜ x ⎟
⎝ 100 165 ⎠
i = 9.26%
Cost of funds to the Bank = Effective interest rate + Stamp duty
= 9.26% + 0.25%
= 9.51%
Bill Financing
60
21. Discount charge = 100 x 0.25 x = Rs.4.17
360
For every Rs.100 worth of bills discounted the bimonthly interest rate
4.17
= = 4.35%
100 − 4.17
Effective rate = (1.0435)6 – 1 = 29.12%
22. Value of the L/C backed bill = Rs.1,000
90
Discount charge = 1,000 x 0.23 x = Rs.57.5
360
Value received by the client = Rs.942.5 (1000 – 57.5)
57.5
Effective rate of interest per quarter = x 100 = 6.1007%.
942.5
Effective rate of interest per annum = [(1.061007) 4 – 1] x 100 = 26.72%.

MERCHANT BANKING
Management of Public Issues, Initial Public Offerings and Pricing of Various
Instruments
23. Probability of getting the target return should be equal to or more than 0.74.
Growth in EPS P/E ratio (in percent) Estimated price Joint probability
EPS (1+g) x P/E
0 6 42.0 0.0225
10 6 46.2 0.0375
20 6 50.4 0.0300
30 6 54.6 0.0450
40 6 58.8 0.0150
0 8 56.0 0.0375
10 8 61.6 0.0625
20 8 67.2 0.0500
30 8 72.8 0.0750
40 8 78.4 0.0250
0 10 70.0 0.0600
10 10 77.0 0.1000
20 10 84.0 0.0800

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 Investment Banking and Financial Services

Growth in EPS P/E ratio (in percent) Estimated price Joint probability
EPS (1+g) x P/E
30 10 91.0 0.1200
40 10 98.0 0.0400
0 12 84.0 0.0300
10 12 92.4 0.0500
20 12 100.8 0.0400
30 12 109.2 0.0600
40 12 117.6 0.0200

Estimated price Joint probability Cumulative probability

42.0 0.0225 0.0225
46.2 0.0375 0.0600
50.4 0.0300 0.0900
54.6 0.0450 0.1350
56.0 0.0375 0.1725
58.8 0.0150 0.1875
61.6 0.0625 0.2500
67.2 0.0500 0.300
70.0 0.0600 0.3600
72.8 0.0750 0.4350
77.0 0.1000 0.5350
78.4 0.0250 0.5600
84.0 0.0800 0.6400
84.0 0.0300 0.6700
91.0 0.1200 0.7900
92.4 0.0500 0.8400
98.0 0.0400 0.8800
100.8 0.0400 0.9200
109.2 0.0600 0.9800
117.6 0.0200 1.0000
From the table it is seen that the probability of the divestment price being Rs.61.6 or less is
0.25. Hence, the probability of divestment price being Rs.67.2 and above is 0.75 which is
greater than the specified limit of 0.74. Hence, the minimum divestment price can be taken
as Rs.67.2.
The company should earn a target return of 35%.
Hence, the purchase price (P) should be
67.2 − P
x 100 = 35
P
(67.2 – P) x 100 = 35P
6720 – 100P = 35P
6720 = 65P
P = Rs.49.78
Hence, the fund should invest in Redmond Ltd. at a price of Rs.49.78 per share.
24. The EBIT for the 5 years is (the EBIT multiplied by the probabilities)

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 Part II

Year Rs. in crore

1 0.24 + 0.405 + 0.51 = 1.155
2 0.28 + 0.51 + 0.65 = 1.440
3 0.34 + 0.525 + 0.725 = 1.590
4 0.36 + 0.555 + 0.75 = 1.665
5 0.5 + 0.78 + 1.4 = 2.680
a. In case of equity investment of Rs.120 lakh (2 crore – 80 lakh) by the VCF.
The dividend for the 5 years
(Rs. in lakh)
Year EBIT 10% Dividend pay-out Dividend inflow to
(Rs. in lakh) (Rs. in lakh) VCF

1 115.5 11.55 6.93

2 144.0 14.40 8.64
3 159.0 15.90 9.54
4 166.5 16.65 9.99
5 268.0 26.80 16.08
PAT Rs.268 lakhs
The EPS for the 5th year is = = = Rs.13.4
No. of shares Rs. 20 lakhs

Hence the divestment price will be 13.4 x 12.5 = Rs.167.5

Cash flow from divestment = Rs.167.5 x 12 = Rs.2,010 lakh
The NPV for the investment will be
Year Cash flow (Rs.) Present value (Rs.) @ 15%
0 (120,00,000) –120,00,000
1 6,93,000 6,02,910
2 8,64,000 6,53,184
3 9,54,000 6,27,732
4 9,99,000 5,71,428
5 20,26,08,000 10,06,96,176
9,11,51,430
b. Investment in FCDs
Year EBIT Interest EBT EPS
(Rs. in lakh) (120 L x 0.18)
1 115.5 21.6 93.9 11.74
2 144.0 21.6 122.4 15.30
3 159.0 21.6 137.4 17.18
4 166.5 21.6 144.9 18.11
Conversion Price

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Investment Banking and Financial Services

EPS Weights Weighted EPS

15.30 1 15.30
17.18 2 34.36
18.11 3 54.33
103.99

103.99
Weighted EPS = = 17.33
6

The P/E multiple for conversion is 11.

Conversion price = 17.33 x 11 = Rs.190.63

Rounded off to Rs.191.

Hence the FCDs of 120 lakh would be converted into 62,827 shares.

EPS during the 5th year = (268 – 0)/(8 + 0.62827) = Rs.31.06

The divestment price = 31.06 x 12.5 = Rs.388.25

The NPV of the investment is

Year Cash flow PV factor Present value

0 (120,00,000) 1.000 –120,00,000

1 21,60,000 0.870 18,79,200
2 21,60,000 0.756 16,32,960
3 21,60,000 0.658 14,21,280
4 21,60,000 0.572 12,35,520
5 2,45,87,723 0.497 1,22,20,098

63,89,05,800
(62,827 x 3.106) + (388.25 x 62,827)
= 1,95,140.66 + 2,43,92,583 = 2,45,87,723
Alternative (a) is to be chosen.

25. Particulars No. of shares

Net offer to public (Rs.25.5 crore – 9 crore)/10 1,65,00,000

Add:

Unsubscribed reserved portion under competitive basis 15,00,000

Revised net offer to public 1,80,00,000

Unsubscribed portion of reserved category under firm allotment should be brought in by

promoters and the unsubscribed portion of reserved category under competitive basis
should be added to the net offer to public.
Applications above 1000 shares
Shares per allottee

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 Part II

Category No. of No. of shares Proportionate Before After No. of

applicants applied Shares Rounding Rounding Allottees
available for off off (after
allotment
adjustment)
(1) (2) (3) (4) = (5) =
(3) ÷ 3.89* (4) ÷ (2)

4,000 2,500 100,00,000 25,71,428 1,029 1,000 2,410

10,000 1,000 100,00,000 25,71,428 2,571 2,600 1,000

25,000 400 100,00,000 25,71,428 6,429 6,400 400

1,00,000 50 50,00,000 12,85,716 25,714 25,700 50

350,00,000 90,00,000
350, 00, 000
Oversubscription ratio = ~ 3.89
90, 00, 000
Note: * (3.8888....9). In col. (4), the figure taken is the original oversubscription ratio
figure and not the rounded off figure).
* 50% of 1,80,00,000 shares reserved for investors below 1000 shares.
4,35, 00, 000
Oversubscription rate = = 4.83
90, 00, 000
Applications below 1000 shares
Category No. of No. of Proportionate Shares per No. of
applicati shares shares allottee allottees
on applied available for (after
allotment adjustments)
Before After
rounding rounding
off off
1 2 (3) = (1) x (2) (4) = (3) ÷ (5) (6) (7)
4.83*

200 35,000 70,00,000 14,48,276 41 100 14,483

300 27,000 81,00,000 16,75,862 62 100 16,759

500 20,000 100,00,000 20,68,966 103 100 20,000

800 13,000 104,00,000 21,51,724 166 200 11,380

1000 8,000 8,00,000 16,55,172 207 200 8,000

4,35,00,000 90,00,000

26. Basis of allotment for below 1000 shares

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 Investment Banking and Financial Services

Size No. of Share % of Shares Shares per R/o No. of Adjustments Final no. of
Appli- Applied total available application allottees allottees
cations
100 75,000 75,00,000 18.75% 6,56,250 8.75 100 6,563 0 6,563
200 35,000 70,00,000 17.50% 6,12,500 17.50 100 6,125 0 6,125
500 27,000 135,00,00 33.75% 11,81,250 43.75 100 11,813 0 11,813
1000 12,000 120,00,00 30.00% 10,50,000 87.50 100 10,500 0 10,500
4,00,00,000 35,00,000
O/S Ratio = 11.43
Basis of allotment for above 1000 shares
Size No. of Shares % of total Share Shares per R/o No. of Adjust
applications applied vailable application allottees Final No.
of allottees
2,500 7,000 1,75,00,000 53.03% 18,56,061 265 300 6,187 6,199
5,000 1,500 75,00,000 22.73% 7,95,455 530 500 1,591 1,500
10,000 800 80,00,000 24.24% 8,48,485 1061 1,100 771 800
3,30,00,000 35,00,001
O/S Ratio = 9.43
Working Notes:
Rs. 42 crore
Number of shares to be issued = = 84,00,000
Rs. 50
Computation of Net Offer to Public
Total shares offered 84,00,000
Less: Reservations
– FII’s 7,00,000
– Mutual funds 7,00,000
– Banks/FIS 3,50,000 17,50,000
66,50,000
Add: Unsubscribed portion mutual funds 3,50,000
70,00,000
27. Computation of Net Offer to Public
(Figures in crore)
Total shares offered 16.00
Less: Reservations
Mutual funds 1.00
NRIs 0.50
FIIs 2.00
Banks 1.00
Employees 0.01 4.51
11.49
Add: Unsubscribed portion*
NRI 0.20
Employees 0.01 0.21
0.21 11.70
*Unsubscribed portion of reservation on firm basis will be bought in by the promoters with

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 Part II

3-year lock in period and unsubscribed portion of reservation on competitive basis will be
added to the public portion.
50% of the net public offer is reserved for applicants who applied for 1000 or less shares.
Thus, the oversubscription rate for the category = Total number of shares applied ÿ 50% of
11.70 crore
37,80, 00, 000
= 6.46
5,85, 00, 000
19, 00, 00, 000
Oversubscription rate = = 3.25
5,85, 00, 000
Basis of Allotment for below 1000 Shares
Size No. of Total shares applied Pro- Shares per applicant No. of Adjust. of Final
applications portionate shares allottees surplus No. of allottees
available
Before After rounding
rounding
1 2 3 4 = (Col.3 6.46) 5 6 7 8 9
200 4,40,000 8,80,00,000 1,36,19,048 31 100 1,36,190 1,36,190
500 2,20,000 11,00,00,000 1,70,23,810 77 100 1,70,238 1,70,238
800 1,00,000 8,00,00,000 1,23,80,952 124 100 1,23,810 23,810 1,00,000
1,000 1,00,000 10,00,00,000 1,54,76,190 155 200 77,381 89,286
37,80,00,000 5,85,00,000
Basis of Allotment for above 1000 Shares
Size No. of Total shares Proportionate Shares per applicant No. of Adjust. Final no.
applications applied share allottees of of
available surplus allottees
Before After
rounding rounding

1 2 3 4 5 6 7 8 9

2,000 60,000 12,00,00,000 3,69,47,368 616 600 61,579 1,579 60,000

5,000 10,000 5,00,00,000 1,53,94,737 1539 1,500 10,263 263 10,000

10,000 2,000 2,00,00,000 61,57,895 3079 3,100 1,986 – 2,000

19,00,00,000 5,85,00,000

28. As per the prospectus the issue pattern is as follows:

Offer in terms of prospectus 260 lakh shares

Less: Reservation for mutual funds 24 lakh shares
Reservation for FIIs 18 lakdh shares
218 lakh shares
Subscription on Reservation
(Shares in lakh)
Category Reservation Subscription Surplus/
Deficit
Mutual funds 24 16 +8
FIIs 18 4 +14
Net surplus in reserved category = 22 lakh shares.
This is to be added to the net offer to public.
∴ Offer to public = 218 + 22 = 240 lakh shares.
Application for Below 1000 Shares

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Category No. of No. of shares Shares Share per applicant No. of

applications applied allotted (3) ÷ allottees
3402
Before After
rounding rounding
1 2 3 4 5 6 7
200 40,000 80,00,000 23,41,463 59 100 26,000
400 20,000 80,00,000 23,41,463 117 100 20,000
600 15,000 90,00,000 26,34,146 176 200 15,000
800 10,000 80,00,000 23,41,463 234 200 10,000
1,000 8,000 80,00,000 23,41,463 293 300 8,000
4,10,00,000 1,20,00,000
Total no. of shares applied
Oversubscription rate =
50% of net offer to public
4,10, 00, 000 4,10, 00, 000
= = = 3.417
[(240) ÷ 2] lakh 1, 20, 00, 000
29.
Category Applications Total Proportionate Shares per Rounded No. of Surplus
received received Shares applicant off Success applications
available Full
applicants
200 30,000 60,00,000 13,36,844 44.56 100 13,368
300 25,100 75,30,000 16,77,740 66.84 100 16,777
400 20,000 80,00,000 17,82,459 89.12 100 17,825
500 15,000 75,00,000 16,71,055 111.40 100 16,711 1,711
600 11,000 66,00,000 14,70,529 133.68 100 14,705 3,705
700 9,200 64,40,000 14,34,879 155.97 200 7,174
800 3,700 29,60,000 6,59,510 178.25 200 3,298
900 2,600 23,40,000 5,21,369 200.53 200 2,607 7
1,000 2,000 20,00,000 4,45,615 222.81 200 2,228 228
4,93,70,000 1,10,00,000

Category No. of applicants after adjustments

200 13,368
300 16,777
400 18,854
500 15,000
600 11,000
700 9,200
800 3,700
900 2,600
1,000 2,000

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 Part II

4,93, 70, 000

Oversubscription rate = = 4.488
1,10, 00, 000
2, 20, 00, 000
50% of net offer to public = = 1,10,00,000
2
30.
Category Applications Total Proportionate Shares per Rounded No. of
received received Shares applicant off successful
available applicants
500 1,397 6,98,500 41,123 29.44 100 411
600 418 2,50,800 14,765 35.32 100 148
700 220 1,54,000 9,066 41.21 100 91
800 395 3,16,000 18,604 47.10 100 186
900 682 6,13,800 36,136 52.99 100 361
1,000 7,980 79,80,000 4,69,806 58.87 100 4,698
1,00,13,100
1, 00,13,100
Oversubscription ratio = = 16.986
5,89,500
11, 79, 000
50% of net offer to public = = 5,89,500
2
Category Surplus applications No. of applicants after adjustments

500 – 411
600 – 148
700 – 91
800 – 186
900 – 361
1000 – 4,698
31.

Net offer to public

No. of shares offered through prospectus 5,00,00,000

Less: No. of shares subscribed and allotted to IDBI, UTI, 1,00,00,000

MFs and FIIs on firm basis

Less: No. of shares subscribed and allotted to the 1,00,00,000

employees of PI Ltd. and other group companies

Less: No. of shares subscribed and allotted to NRIs on 50,00,000

repatriation basis

Net offer to public 2,50,00,000

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 Investment Banking and Financial Services

Category No. of No. of Proportioate Shares per allottee No. of

applications Shares shares allottees after
applied available for adjustment
allotment
Before After rounding
rounding
100 1,60,000 1,60,00,000 19,46,946 12.17 100 19,469
200 1,00,000 2,00,00,000 24,33,682 24.34 100 24,337
300 50,000 1,50,00,000 18,25,262 36.51 100 18,253
400 25,000 1,00,00,000 12,16,841 48.67 100 12,168
500 22,950 1,14,75,000 13,96,325 60.84 100 13,963
600 12,000 72,00,000 8,76,126 73.01 100 9,309
700 8,000 56,00,000 6,81,431 85.18 100 8,000
800 7,000 56,00,000 6,81,431 97.35 100 7,000
900 6,500 58,50,000 7,11,852 109.52 100 6,500
1000 6,000 60,00,000 7,30,105 121.68 100 6,000
10,27,25,000 1,25,00,000
100, 00, 00, 000
Oversubscription ratio = = 8.218
50
50% of net offer to public = 50% of 2,50,00,000
= 1,25,00,000
32. Statement of Underwriter’s Liability
MB Financial ICI Finance Global Total
30% 30% Bank 40%
Gross liability 7,50,000 7,50,000 10,00,000 25,00,000
Less: Unmarked applications 60,000 60,000 80,000 2,00,000
(23,00,000 – 21,00,000)
(21,00,000 = 3,50,000 +
4,00,000 + 13,50,000)
6,90,000 6,90,000 9,20,000 23,00,000
Less: Marked applications 3,50,000 4,00,000 13,50,000 21,00,000

3,40,000 2,90,000 –4,30,000 2,00,000

Excess of Global B/k to MB – 2,15,000 – 2,15,000 +4,30,000 –
and ICI in the ratio of 1:1
1,25,000 75,000 – 2,00,000
33. Public issue of Rs.100 crore of equity shares of Rs.10 each for cash at a premium of Rs.40
per share.
100, 00, 00, 000
No. of shares =
50
= 2,00,00,000
Less: Reservations

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 Part II

Mutual funds 25% = 50,00,000

Financial institutions 15% = 30,00,000
Employees 5% 10,00,000
Net offer to public = 1,10,00,000
50% of net offer to public = 55,00,000

Category No. of No. of shares Proportionate Shares per allottee No. of

applications applied shares vailable Allottees
for allotment After
adjustment
Before After
rounding rounding
200 30,000 60,00,000 6,68,422 22.28 100 6,689

300 25,100 75,30,000 8,38,870 33.42 100 8,389

400 20,000 80,00,000 8,91,229 44.56 100 8,912

500 15,000 75,00,000 8,35,528 55.70 100 8,355

600 11,000 66,00,000 7,35,264 66.84 100 7,353

700 9,200 64,40,000 7,17,440 77.98 100 7,174

800 3,700 29,60,000 3,29,755 89.12 100 3,532

900 2,600 23,40,000 2,60,685 100.26 100 2,600

1,000 2,000 20,00,000 2,22,807 111.40 100 2,000

4,93,70,000 55,00,000
4,93, 70, 000
Oversubscription ratio = = 8.976.
55, 00, 000
34. As per the prospectus, the issue pattern is as follows:
Offer in terms of prospectus – 220 lakh shares
Less:
Reservation for Mutual Funds – 20 lakh shares
Reservation for FIIs – 15 lakh shares
Net offer to public – 185 lakh shares

Subscription in Reservation
(Shares in lakh)
Category Reservation Subscription Surplus/Deficit
Mutual Funds 20 12 +8
FIIs 15 3 +12

Net surplus in Reserved Category – 20 lakh shares.

This is to be added to net offer to public.

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 Investment Banking and Financial Services

Application Below 1000 Shares

Category No. of app. No. of shares Shares Share per No. of
applied allotted applicant allottees
(1) (2) (3) (4) = (3) (5) = (1) Rounded (7)
(3) ÷ 4.878** (1) ÷ 4.878 off to = (4) ÷ (6)
nearest
100 (6)
200 50,000 100,00,000 20,50,021 41 100 20,500 +
4,600 + 500*

400 25,000 100,00,000 20,50,021 82 100 20,500

600 20,000 120,00,000 24,60,025 123 100 20,000

800 10,000 80,00,000 16,40,016 164 200 8,200

1000 10,000 100,00,000 20,50,021 205 200 10,000

500,00,000 102,50,104

* The surplus in 600 & 1000 shares category adjusted to the 200 shares category. Surplus in
600 shares category = (24,60,025 – 20,00,000) = 4,60,025. Surplus in 1,000 shares category
= 20,50,021 – 2,00,000 = 50,021. Additional shares to 200 shares category = 5,10,046.
Hence, additional successful applicants = 5,100.
Total number of shares applied
**Oversubscription rate =
50% of net offer to public
5, 00, 00, 000
= = 4.878
[(185 + 20) ÷ 2] lakh
35. a. Computation of Net Offer to Public
(Figures in crore)
Total shares offered 14.40
Less: Reservations
Mutual funds 1.00
NRIs 0.50
FIIs 2.00
Banks 1.00
Employees 0.01 4.51
9.89
Add: Unsubscribed Portion*
NRI 0.10
Employees 0.01 0.11
Net Public Offer 10.00
*Unsubscribed portion of reservation on firm basis will be brought in by the promoters with
3 year lock-in period and unsubscribed portion of reservation on competitive basis will be
added to the public portion.

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 Part II

Basis of Allotment Below 1000 Shares

Size No. of Total Pro- Shares per No. of Adjustment Final
Applications shares portionate Applicant allottees of surplus no. of
applied Shares allottees
available
Before After
rounding rounding

(1) (2) (3) (4) = (3) 8* (5) = (1) 8* (6) (7) (8) (9) = (7) + (8)

200 400000 80000000 10000000 25.0 100 100000 25000** 125000

500 200000 100000000 12500000 62.5 100 125000 0 125000

800 150000 120000000 15000000 100.0 100 150000 0 150000

1000 100000 100000000 12500000 125.0 100 125000 –25000** 100000

400000000 50000000
*50% of the net public offer is reserved for applicants who applied for 1000 or less shares.
Thus, the oversubscription rate for the category = Total number of shares applied 50% of
10 crore = 8.
** Number of allottees is more than the number of applications in 1000 size category and
hence excess adjusted to the minimum number of shares category.
Basis of Allotment Above 1000 Shares
Size No. of Total shares Proportionate Shares per No. of Adjustment Final
applications applied shares Applicant allottees of surplus no.of
available allottees
Before After
rounding rounding
(1) (2) (3) (4) (5) (6) (7) (8) (9)
= (3) ÷ 5* = (1) ÷ 5* = (7) +(8)

2000 50000 100000000 20000000 400 400 50000 — 50000

5000 20000 100000000 20000000 1000 1000 20000 — 20000
10000 5000 50000000 10000000 2000 2000 5000 — 5000

250000000 50000000

25 crore
*Oversubscription rate = =5
5 crore
b. According to SEBI guidelines a SEBI nominated public representative should oversee
the process of allotment if a par issue is oversubscribed by 5 or more times. Being a par
issue and oversubscribed by more than 5 times, a SEBI nominated public representative
should oversee the allotment process.
36. Basis of Allotment Below 1000 Shares
Size Number of Shares Applied % of Shares Available Share per Rounded Number of Adjustment Final
Applications Total (4) x 70 lakh Application Off Allottees of Surplus Number of
(5) ÷
(2) (5) ÷ (7) Allottees

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

200 75,000 1,50,00,000 24.0 16,80,000 22.4 100 16800 +216000 18960

300 40,000 1,20,00,000 19.2 13,44,000 33.6 100 13440 – 13440

700 25,000 1,75,00,000 28.0 19,60,000 78.4 100 19600 – 19600

1000 18,000 1,80,00,000 28.8 20,16,000 112.0 100 18000 –216000 18000

6,25,00,000 70,00,000

O/S Ratio = 8.92857

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Basis of Allotment Above 1000 Shares

Size Number of Shares % of Total Shares Share per Rounded Number of Adjustment Final
Applications Applied Available Application Off Allottees of Surplus Number
(4) x 70 (5) ÷ (2) (5) ÷ (7) [{(7) x (8)}– of
lakh (5)] Allottees
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
2000 12500 2,50,00,000 39.7 27,77,778 222.22 200 12500 –2,77,778 12500
4000 7000 2,80,00,000 44.4 31,11,111 444.44 500 7000 +3,88,889 7000
5000 2000 1,00,00,000 15.9 11,11,111 555.55 500 2000 –1,11,111 2000
6,30,00,000 70,00,000
O/S Ratio = 9

Working Notes:
i. Shares available for public offer:
Initial shares available for public offer
17, 00, 00, 000 1,30,00,000
= = – 40,00,000
10
Undersubscription of FIIs 10,00,000
Shares available for public offer 1,40,00,000
The undersubscription in reservations for FIIs (10,00,000 shares) has been added
back to public offer as the reservation was on a competitive basis.
The undersubscription in the Mutual Fund portion has to be brought in by the
promoters as the same was on a firm basis. 50% of shares available to public offer
i.e. 70,00,000 shares should be reserved to the small investor.
ii. While alloting to `1000 shares’ category, the number of applicants are 18000.
Therefore, number of allottees are 18000. The surplus of [2016000 – 18000 x 100]
i.e. 216000 shares are allotted to the ‘200’ category.
37. Basis of Allotment Below 1000 Shares
Size Number Shares % of Total Shares Share per Rounded Number of Surplus Adjustment Final
of applied available application off allottees number of
Applications allottees
400 10000 4000000 23.52 2941176 294.12 300 9804 –24 58824 10000
500 8000 4000000 23.52 2941176 367.65 400 7353 –24 118024 7648
800 5000 4000000 23.52 2941176 588.24 600 4902 –24 24 4902
1000 5000 5000000 29.41 3676471 735.29 700 5000 176471 –176471 5000
17000000 12500000
Oversubscription ratio = 1.36
Basis of Allotment Above 1000 Shares
Number Shares % of Total Shares Share per Rounded Number of Surplus Adjustment Final
Size of applied available application off allottees number of
Applications allottees
2000 1000 2000000 12.50 1562500 1562.50 1600 977 –700 7100 981
10000 500 5000000 31.25 3906250 7812.50 7800 500 6250 –6250 500
20000 200 4000000 25.00 3125000 15625.00 15600 200 5000 –5000 200
50000 100 5000000 31.25 3906250 39062.50 39100 100 –3750 3750 100
16000000 12500000
Working Notes:
Over Subscription Ratio = 1.28
Initial shares available for public offer
60% of (25, 00, 00, 000
= − (25, 00, 000 + 50, 00, 000)
5

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 Part II

= 3,00,00,000 – 75,00,000 = 2,25,00,000

Add: Undersubscription
of NRIs = 25,00,000
Shares available for public offer = 2,50,00,000
Shares reserved for 1000 below shares = 50% of 250 lakh
= 125 lakh
170
∴ Oversubscription ratio = = 1.36
125
Rights Issues, Bonus Issues, Private Placements and Bought-out Deals
38. a. Shares are priced at 15% discount to domestic market price
Domestic Market Price = Rs.250
15% discount to market price = Rs.212.5
Price of each GDR = 212.5 x 4
= Rs.850
850
Price of GDR in $ = = $21.25
40
Total amount to be raised through
$3.75 million
GDR issue =
0.975
= $3.85 million
$3.85 m
No. of GDRs to be issued =
21.25
= 1,81,200
(rounded off)
D1 6
b. +g= + 0.1 = 10.72% = 10.72%
P(1 − f ) 850(0.975)
Where, f = issue cost
c. Rights issue ratio = 1:2
Subscription price of rights = Rs.150 per share
N Pr + S
Ex-rights price of the share =
N +1
(2 x 250) + 150 650
= = = Rs.217
2 +1 3
Shares are sold by the GDR holder at 20% premium to the then market price
= 217 x 1.20 = Rs.260.4
No. of rights shares offered and subscribed by GDR holder holding 100 GDR
1
= x 100 x 4 = 200
2
Gain/loss made by the GDR holder
Purchase cost of 100 GDRs = $2125
200 x 150
Investment in rights issue = = $625
48
$2750

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 Investment Banking and Financial Services

(100 x 4 + 200) x 260.4

Sale of GDRs at 20% premium = = $3255
48
Profit = $505
39. a. Part B of the 15% FCDs is convertible into equity within 1 year of bonus issue.
Hence any bonus decision will affect the FCD holders.
The conversion of Part B would result in additional 45,00,000 shares. Hence these
have to be taken into consideration while computing the bonus ratio.
The reserves eligible for capitalizing are
(Rs. crore)
General Reserves 17,00,00,000
Share Premium* (Rs.2,80,00,000 premium not 4,20,00,000
collected in cash excluded)
21,20,00,000

The shares eligible for bonus are

Equity shares 90,00,000
Shares arising from conversion of 15% FCDs 45,00,000
1,35,00,000
Hence the maximum permissible bonus ratio is 1.57.
* Share premium not collected in cash is not eligible for bonus issue and is therefore
excluded. Premium not collected in cash =
Cost of Plant and Machinery purchased less face value of shares issued to the vendor
in lien of payment = 4crore– (12,00,000 x 10)
= Rs.2,80,00,000.
b. After bonus and conversion the increased capital of Rs.36.20 crore would be more
than the authorized capital of Rs.20 crore. Hence the company has to pass a specified
resolution to give effect to the increased authorized capital.
40. a. All reserves in the balance sheet of the company except revaluation reserves are
eligible reserves for bonus issue. However, share premium given in the balance
sheet includes premium not collected in cash which has to be excluded from eligible
reserves for bonus issue. Share premium not collected in cash is equal to the difference
between the payment to the vendor and the face value of the shares allotted. Hence it is
equal to Rs.7 crore – 15 lakh x 10 = Rs.5.5 crore.*
The eligible reserves for computation of bonus are
General Reserves 4.00
Contingency Reserves 2.50
Capital Reserves 1.50
Share Premium (Rs.9 – Rs.5.5* Crore) 3.50
Dividend Equalization Reserves 1.00
Total Eligible Reserves 12.50
The finance managers contention that there would not be any calls and reserves can
be capitalized is not justified as the equity capital consists of both fully paid and
partly paid shares. Utilization of reserves for making partly paid shares to make fully
paid shares would result in injustice to the fully paid shareholders. Thus, assuming
that the company calls up the partly paid shares and all the shareholders pay up in
full, the maximum bonus ratio can be worked out as under:

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 Part II

The maximum number of bonus shares that can be issued from eligible reserves
Rs.12.5 crore
= = 1.25 crore shares.
Rs.10 per share
No. of existing shares = 0.8
Hence the maximum permissible bonus ratio
1.25
= = 1.5625
0.8
b. The partly paid shares should be made fully paid-up before the bonus issue.
The total paid-up capital after bonus issue would be equal to Rs.8 crore + Rs.12.5
crore = Rs.20.5 crore.
As the paid-up capital would be exceeding the authorized capital of Rs.20 crore, the
company has to pass a special resolution to increase its authorized capital.
c. i. Secret reserve is a hidden financial strength of the company. It is not
disclosed in the balance sheet of the company. Companies build secret
reserves to meet any unforeseen eventualities. Normally secret reserves are
created by the following means:
• Making excess provisions than is required
• Showing contingent liabilities as firm liabilities
• Undervaluing intangibles like goodwill, etc.
ii. Secret reserve is an undisclosed financial strength and not in the nature of an
accounting reserve. Hence it cannot be capitalized. Disclosing the same
through newspaper advertisement does not entitle the company to declare
bonus from it.
41. Computation of maximum permissible bonus ratio.
Eligible Reserve Rs. in lakh
General Reserve 20.00
Share Premium 15.00
Capital Reserve 14.00
49.00
Hence a maximum of 4,90,000 shares can be issued as bonus shares.
The maximum permissible bonus ratio would be
4,90,000 : 3,50,000 = 7:5
7 bonus shares against every 5 existing shares.
42. Computation of Eligible Reserves:
Rs. crore
General Reserves 20.00
Share Premium 6.50
Contingency Reserve 4.00
Capital Reserve 3.00
Eligible Reserve 33.50
Rs.2.5 crore was accrued to the share premium account on account of notional premium
charged to the seller of the building. As this premium account was not collected in cash, the
same is not included in computation of eligible reserves.

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 Investment Banking and Financial Services

Shares entitled to receive Bonus Shares:

Shares issued and paid-up 60,00,000
Shares arising out of conversion of 12.5% convertible 20,00,000
debentures
Number of shares entitled to receive bonus 80,00,000
3,35,00,000 shares can be issued by capitalizing the eligible reserves of Rs.3.35 crore.
Hence, the maximum permissible bonus ratio is 4.1875. (3.35/0.8)
43. a. Size of the rights issue = 490 – (291.84 + 60 + 55) = 83.16 crore
9
EPS for 20x1-20x2 = EPS during 20x1 x 1.40 = x 1.40 = Rs.8.40
1.5
Current market price = 8.40 x 22 = Rs.184.8
Pricing of the rights = Rs.184.8 x 0.75 = Rs.138.6
83.16 cr.
Number of rights shares to be offered = = 60,00,000
138.6
As PCDs are converted into equity shares within 1 year of rights issue, the PCD
holders are also eligible for right shares in proportion to their holdings. Thus the
number of shares which are entitled to rights share are
Existing equity shares 150 lakh
Shares arising out of conversion of PCDs (10,00,000 x 6) 60 lakh
210 lakh
60, 00, 000 6
Rights ratio = =
2,10, 00, 000 21
The rights will be issued in the ratio of 6 shares for every 21 shares held.
8,57,143 rights shares will be offered to GDR holders in the ratio of 6 rights shares
for every 5.25 GDRs held.
Pr − S
b. Value of the rights (R) =
N −1
where,
Pr is the current market price
S is the subscription price and
N is the number of shares required for 1 rights share
184.8 − 138.6
R= = Rs.10.27
21
+1
6
30, 00, 000
c. No. of shares per GDR = =4
7,50, 000
90, 00, 000
Issue price per GDR = = $12
7,50, 000
N Pr + S
Ex-rights Price of the Share =
N +1
21
x 184.8 + 138.6
Ex-rights price of the share = 6 = Rs.174.53
21
+1
6

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 Part II

Shares are sold by GDR holder at 25% premium to the then market price
= 174.53 x 1.25 = Rs.218.17
Number of rights shares offered and subscribed by GDR holder holding 100 GDRs
6
= x 100 x 4 = 114
21
Gain/loss made by the GDR holder holding 100 GDRs is calculated as follows:
Purchase cost of 100 GDRs = $ 1200
114 x 138.6
Investment in rights issue = $ 376
42
Total investment = $ 1576
(100 x 4 + 114) x 218.17
Sale of GDRs at 25% premium = = $ 2670
42
Therefore,
Profit = $ 1094
44. a. Total size of the project outlay = Rs.24 crore
Less: Internal accruals = 9 crore
Size of the proposed rights issue = 15 crore
Pricing of the rights – Rs. per share 250 per share
(15 crore/250) (2.4 crore/10)
Number of right shares = 6,00,000
Existing capital = 24,00,000 shares
Hence, the rights ratio is 1 rights share for every 4 shares held.
b. Computation of the value of rights
Pr − S
R=
N +1
Where,
R is the value of the rights
S is the strike price of the rights share
Pr is the market value of share
N is the number of existing shares required to get 1 rights share.
345 − 250
R = = Rs.19
4 +1
c. Gain/Loss to a shareholder
N Pr + S
i. The ex-rights price of the share is expected to be
N +1
(4 x 345) + 250
=
4 +1
= Rs.326
Assume X holds 100 shares.
If the invests in the rights issue
Existing wealth = 100 x 345 = Rs.34,500
Subscription in rights issue = 25 x 250 = 6,250
Total = 40,750

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 Investment Banking and Financial Services

Expected post-rights market value of his portfolio

= 125 @ Rs.326 = Rs.40,750
No gain/loss to the shareholder.
ii. Allows the rights to expire:
Existing wealth = Rs.34,500
Post-rights market
value of his holdings (100 x 326) = Rs.32,600
Loss in the wealth of shareholder = Rs. 1,900
iii. Sells his rights
Existing wealth = Rs.34,500
Amount realized by sale of rights (100 x 19) = Rs.1,900
Post-rights market value of the holding (100 x 326)= 32,600
Nil
There will be no change in the wealth of the shareholder if he sells the rights.
45. The amount to be raised by rights issue
= Rs.280 – (140 + 60) = 80 crore
Subscription price/rights share = Rs.40
No. of rights shares on offer = 2,00,00,000
Hence ratio of rights is 1 share for every share held.
EPS = Rs.7.50
P/E =9
Market price = Rs.67.5
P0 − S
a. Value of the rights R =
N +1
Where,
Po = Market price before rights issue
S = Subscription price
N = Number of shares required
for 1 rights share
67.5 − 40
= = Rs.13.75
1+1
NP + S 1 x 67.5 + 40
b. Market value after the rights issue = 0
=
N +1 1+1

= Rs.53.75
No. of shares outstanding after rights issue = Existing + Rights shares

= 2 + 2 = 4 crore
Market capitalization = Ex-rights price x No. of outstanding shares
= 53.75 x 4 = Rs.215 crore

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 Part II

c. NAV per share after the issue

Paid-up capital Rs.40 crore
Reserves and Surplus:
Existing 120
Premium on rights issue 60 180 crore
Net worth of the company 220 crore
No. of shares 4 crore
NAV per share Rs.220 crore
= Rs.55
4 crore
46. Computation of maximum permissible bonus ratio
a. Reserves and surplus Rs.2,40,00,000
Shares entitled to receive bonus shares
Paid-up capital Rs.1,80,00,000
Rs.18,00,000 shares of Rs.10 each
24,00,000 shares can be issued by capitalizing the eligible reserves of Rs.2,40,00,000.
Hence the maximum permissible bonus ratio is 1.33:1. (2,40,00,000/1,80,00,000 = 1.33)
i.e. 4 bonus shares for every 3 shares held.
b. No. of the right shares = 4.5 lakh shares
Pricing of the rights issue = Rs.50 each
No. of shares = 18,00,000 shares
Hence the rights ratio is 1 rights share for every 4 existing shares held.
Impact of rights issue on the wealth of a shareholder, who already holds 100 shares
in CCL.
i. If the shareholder exercises his rights in full
Rs.
Existing wealth = 100 x 80 = 8,000
Subscription in rights issue = 25 x 50 = 1,250
9,250
Ex-rights price of share is Value of rights
NP + S (4 x 80) + 50 P −J
= r
= R = r
N +1 4 +1 N +1
= Rs.74 80 − 50
=
5
= Rs.6
Expected post rights market value of his portfolio
= 125 shares @ 74 = Rs.9,250
No gain/loss to the shareholder.
ii. If the shareholder sells his rights in its entirety
Existing wealth = 100 x Rs.80 = Rs.8,000
Amount realized by sale of rights = (100 rights @ 6) = Rs.600
Post rights market value of the holding = 100 x 74 = Rs.7,400
There will be no change in the wealth of the shareholder if he sells the rights
in its entirety.

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 Investment Banking and Financial Services

47. Partly paid-up shares should be made fully paid-up before the bonus issue.
Eligible reserves for computation of bonus are
Free reserves 220 lakh
Less: Share premium not collected in cash 40 lakh
180 lakh
The maximum number of bonus shares that can be issued from eligible reserves
Rs.180 lakh
= = 18 lakh shares
Rs.10 per share
Number of existing shares = 45 lakh shares
2 18
Hence the maximum permissible bonus ratio = (i.e. )
5 45
2 bonus shares for every 5 equity shares held.
Share capital after the bonus issue would be equal to Rs.180 lakh + Rs.450 lakh = Rs.630
lakh.
Which is more than the authorized capital of Rs.500 lakh.
The company will thus have to pass a special resolution to increase its authorized capital.
48. Current market price of the scrip = Rs.80
Rights issue in the ratio of 2 right shares for every 5 equity shares held
Paid-up capital of the company = Rs.10 crore
Pricing of the rights issue = Rs.65 per share.
a. Value per share after the rights issue
NP + S
0
=
N +1
Where,
N = Number of existing shares required for a rights share
P0 = Cum-rights market price per share
S = Subscription price at which the rights shares are issued
2.5 x 80 + 65
= = Rs.75.71.
2.5 + 1
b. Value of rights
P −S 80 − 65
r
R = =
N +1 2.5 + 1
15
= = 4.29
3.5
49. a. Market price per share = Rs.20
Earnings per share = Rs.4
Subscription price = 20% below the
existing market
price
= Rs.16
Number of right shares = 30, 00, 000
16
= 1,87,500

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 Part II

Rights ratio
Existing shares = 10,00,000
Number of additional = 1,87,500
equity shares proposed
to be issued as rights
shares
3 rights shares for every 16 shares held.
Dilution in EPS:
EPS = Rs.4
PAT PAT
EPS = =4=
No. of shares 10, 00, 000

PAT = 40,00,000
Effect of rights issue on EPS
PAT = 40,00,000
PBT = 59,70,149
Add: Interest saved as a result of redemption of loan = 3,00,000
62,70,149
Less: 33% Tax = 20,69,149
42,01,000
PAT
EPS =
Number of shares
42, 01, 000
= = Rs.3.54.
10, 00, 000 + 1,87,500
b. Ex-rights price of the share
NP + S
0
=
N +1
N = Number of existing shares required for a rights share
P0 = Cum-rights market price per share

S2 = Subscription price at which rights shares are issued.

⎛ 16 ⎞
⎜ x 20 ⎟ + 16
⎝ 3 ⎠ = Rs.19.37 = Rs.19.37
⎛ 16 ⎞
⎜ + 1⎟
⎝ 3 ⎠
Market price 19.37
P/E ratio = = = 5.47
EPS 3.54
c. i. If a shareholder who owns 1000 shares sells his rights.
Market value of original shareholding @ Rs.20 = 1000 x 20 = 20,000
P −S
0
Value realized from the sale of rights R =
N +1

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 Investment Banking and Financial Services

20 − 16
= = 0.6315
⎛ 16 ⎞
⎜ + 1⎟
⎝ 3 ⎠

1000 x 0.6315 = 631.57

Post-rights market value of the holding 1000 x 19.37 = 19,370.00

20,001.57
ii. If he allows his rights to expire
Current market value of the investment = 1,000 x 20 = 20,000
Market value after the rights issue @ 1,000 x 19.37 = 19,370
Change in Wealth = 630
50. i. Proposed amount of rights issue = Rs.90 lakh
EPS for 20x1-x2 = Rs.3
PAT PAT
EPS = =3=
No. of shares 9 lakh
PAT = 27 lakh for 20x1-x2
Post-tax earnings for year 20x2-x3 to increase by 20% = 27 lakh x 1.20
= Rs.32.4 lakh
Dilution in EPS should not be more than 20%.
EPS cannot be less than Rs.2.4
Minimum subscription price of right shares
32.4 lakh
2.4 =
12 lakh + X
X = 1.5 lakh
X = No. of rights shares to be issued
Total amount of rights issue proposed = 90 lakh
90 lakh
Minimum subscription price of right shares = = Rs. 60
1.5 lakh
12, 00, 000
Ratio of rights = = 8 :1
1,50, 000
1 rights share for every 8 shares held.
ii. If a shareholder who holds 1000 shares allows his rights to lapse, then
Rs.
Current market value of investment = 1000 x 80 80,000
Market value after the rights issue = 1000 x 77.78 77,778
Change in wealth 2,222
Ex-rights price of the share
NP + S
0
=
N +1
(8 x 80) + 60
=
8 +1
640 + 60 700
= = = Rs.77.78
9 9

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51. a. Value of the rights

Pr − S 78 − 65
R= = = Rs.9.75
N +1 1.33

⎛ 1 ⎞
⎜ N = = 0.33 ⎟
⎝ 3 ⎠
b. Expected ex-rights price of the share
NP + S (0.33 x 78) + 65
= 0
=
N +1 1.33
90.74
= = Rs.68.25
1.33
c. Gain/Loss if the shareholder exercises his rights:
Market value of original shareholding at the rate= Rs.7,800
of 78 per share (100 x 78)
Additional subscription price paid for 300 right= Rs.19,500
shares @ Rs.65 per share
Total Investment = Rs.27,300
Market value of 400 shares @ Rs.68.25 per share = Rs.27,300
If the rights are allowed to lapse:
Market value of original shareholding @ Rs.78 per share = Rs.7,800
Market value of 100 shares held after the rights issue @ Rs.68.25 per share = Rs.6,825
Change in wealth (Rs.6825 – Rs.7800) = Rs.(975)
If the rights are sold:
Market value of original shares @ 78 per share = Rs.7,800
Value realized from sale of 100 rights at Rs.9.75 = Rs.975
Market value of 100 shares held after rights issue = Rs.6,825
Change in Wealth (Rs. 6825 – Rs. 7800) = Rs.(975)
52. The amount to be raised by rights issue = Rs.355 – (155 + 80) = Rs.120 crore.
Subscription price/rights share = Rs.40.
No. of right shares on offer = 300,00,000.
Hence ratio of rights is 3 shares for every 4 shares held 3 : 4.
EPS – Rs.4.50
MPS
P/E – 12 since = 12
EPS
Market Price – Rs.54
P −S
0
a. Value of the rights R=
N +1
Where,
P0 = Market price before rights issue
S = Subscription price
N = Number of shares required for 1 rights share
54 − 40
= = Rs.6.
1.33 + 1
Rights ratio = 0.75

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 Investment Banking and Financial Services

NPo + S
b. Market value after the rights issue =
N +1
(1.33 x 54) + 40
=
1.33 + 1
71.82 + 40
=
2.33
= Rs.48
No. of shares outstanding after rights issue = Existing + Rights shares
= 4 + 3 = 7 crore
Market capitalization = Ex. Rights price x No. of outstanding shares
= 48 x 7
= Rs.336 crore
c. NAV per share after the issue:
Paid up capital Rs.70 cr.
Reserves & surplus:
Existing 160
Premium on rights issue + 90 Rs.250crore
Net worth of the company Rs.320crore
No. of shares 7crore
NAV per share = Rs.45.71
53. a. Part B of the 16.5% FCD is convertible into equity within one year of bonus issue.
Hence any bonus decision will affect the FCD holders.
The conversion of Part B, would result in additional 30,00,000 shares. Hence these
have to be taken into consideration while computing the bonus ratio.
The reserves eligible for capitalizing are
General Reserves Rs.15,00,00,000
Share Premium (Rs.4,00,00,000 premium not Rs.5,00,00,000
collected in cash excluded)*
Rs.20,00,00,000
The shares eligible for bonus are:
Equity shares 70,00,000
Shares arising from conversion of 16.5% 30,00,000
FCDs
1,00,00,000
Hence, the maximum permissible bonus ratio is 2 bonus shares for every share held.
(20crore /1crore x 10)
* Share premium not collected in cash are not eligible for bonus issue and as such
are excluded. Premium not collected in cash = Cost of plant & machinery purchased
less face value of shares issued to the vendor in lieu of payment = 5 cr. – 10,00,000 x 10 =
Rs.4crore.
b. After bonus, the increased capital of Rs.27crore would be more than the authorized
capital of Rs.15crore. Hence, the company has to pass a special resolution to give
effect to the increased authorized capital.
54. a. Size of the rights issue= 465 – (255 + 80 + 40) = Rs.90crore.
6
EPS for 20x0-x1 = EPS during 19x9-20x0 x 1.25 = x 1.25 = Rs.7.5
1
Current market price = 7.5 x 20 = Rs.150

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 Part II

Pricing of the rights = Rs.150 x 0.8 = Rs.120

90 crore
No. of rights shares offered = = 75,00,000
120
As PCDs are converted to equity shares within one year of rights issue, the PCD
holders are also eligible for right shares in proportion to their holdings. Thus, the
member of shares which are entitled to rights shares are:
Existing equity shares 100 lakh
Shares arising out of conversion of PCDs 40 lakh
(10,00,000 x 4)
140 lakh
75 15
Rights ratio = =
140 28
The rights will be offered in the ratio of 15 shares for every 28 shares held by
existing shareholders. The rights will be offered to the debentureholders in the ratio
of 15 shares for every 7 debentures held. 13,39,286 rights shares will be offered to
GDR holders in the ratio of 15 rights shares for every 7 GDRs held.
P −S
r
b. Value of the rights (R) =
N +1
Where
Pr is the current market price;
S is the subscription price; and
N is the number of shares required for 1 rights share
150 − 120
R= = Rs.10.47
28
+1
15

25, 00, 000

c. No. of shares per GDR = =4
6, 25, 000

87,50, 000
Issue price of GDR = = $14
6, 25, 000

NP + S
r
Ex-rights price of the share =
N +1
28
x 150 + 120
= 15 = Rs.139.53
28
+1
15

Shares are sold by GDR holder at 20% premium to the then market price = 139.53 x 1.2

= Rs.167.44

Number of rights shares offered and subscribed by GDR holder holding 100 GDRs

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 Investment Banking and Financial Services

15
= x 100 x 4 = 214
28

Gain/loss made by the GDR holder, holding 100 GDRs is calculated as follows:
Purchase cost of 100 GDRs (14 x 100) = $1400
214 x 120
Investment in rights issue = = $611
42
Total cost = $2011
(100 x 4 + 214) x 167.44
Sales of GDRs at 20% premium = = $2448
42
Therefore, Profit = $437
55. i. All reserves given in the balance sheet of the company except revaluation reserves
are eligible reserves for bonus issue. However, share premium given in the balance
sheet includes premium not collected in cash which has to be excluded from eligible
reserves for bonus issue.
Share premium not collected in cash is equal to the difference between the payment
to the vendor and the face value of the shares allotted. Hence, it is equal to Rs.4crore
– 10lakh x 10 = Rs.3crore.
The eligible reserves for computation of the bonus are:
General Reserves 3.00
Contingency Reserves 2.75
Capital Reserves 1.25
Share Premium (Rs.7crore – 3 crore) 4.00
Dividend Equalization Reserve 1.00
Total eligible reserves 12.00
The finance manager’s contention that there would not be any calls and reserves that
can be capitalized is not justified as the equity capital consists of both fully paid
shares and partly paid shares. Utilization of reserves for making partly paid shares to
make fully paid shares would result in injustice to the fully paid shareholders. Thus,
assuming that the company call-up the partly paid shares and all the shareholders
pay up in full the maximum bonus ratio can be worked out as under.
The maximum number of bonus shares that can be issued from eligible reserves:
Rs.12 crore
= 1.2 crore shares
Rs.10 per share
No. of existing shares = 0.5
1.2
Hence, the maximum permissible bonus ratio = = 2.4 i.e. for every 5 shares
10.5
held 11 bonus shares can be issued.
ii. a. The partly paid shares should be made fully paid up before the bonus issue.
b. The total paid up capital after bonus issue would be equal to Rs.5crore + Rs.11 crore
= Rs.16 crore.
As the paid up capital would be exceeding the authorized capital of Rs.14
crore, the company has to pass a special resolution to increase its authorized
capital.
iii. a. Secret reserve is a hidden financial strength of the company. It is not
disclosed in the balance sheet of the company. Companies build secret
reserves to meet any unforeseen eventualities. Normally secret reserves are
created by the following means:

236
 Part II

– Making excess provisions than is required

– Showing contingent liabilities as firm liabilities
– Undervaluing intangibles like goodwill, etc.
b. Secret reserve is an undisclosed financial strength and not in the nature of an
accounting reserve. Hence, it cannot be capitalized. Disclosing the same
through newspaper advertisement does not entitle the company to declare
bonus from it.
56. Computation of Maximum Permissible Bonus Ratio
Computation of Eligible Reserves
Particulars Rs. cr.
Share Premium 1.75
General Reserves 2.50
Dividend Equalization Reserve 1.25
Special Reserve 1.50
Contingency Reserve 0.50
Eligible Reserve 7.5
Note: Rs.0.5 crore was accrued to the share premium account on account of notional
premium charged to the machinery supplier. As this premium amount was not collected in
cash, the same is not included in the computation of eligible reserves.
Computation of Number of Shares Entitled to Receive Bonus Shares
Shares issued & paid up 20,00,000
Shares arising out of the conversion of 14%
Fully Convertible Debentures – 2,50,000 x 2 5,00,000
25,00,000
Par value of each share = Rs.10
Number of shares that can be issued to capitalize the Eligible Reserves of Rs.7.5 crore
7,50, 00, 000
= = 75,00,000
10
Hence the maximum permissible bonus ratio as per current SEBI guidelines is 3:1 (3 bonus
shares per every existing share held).
57. a. Computation of maximum possible bonus ratio.
Computation of Eligible Reserves
Particulars Rs. crore
Contingency reserve 13.00
Dividend equalization reserve 9.00
General reserve 15.00
Share premium 5.00
Capital reserve 18.00
Revaluation reserve 12.00
Eligible reserves 72.00
Note: Rs.7 crore was accrued to the share premium account in notional premium
charged to the American scientist. As this premium amount is not collected in cash,
the same is not included in the computation of eligible reserves.
Computation of Number of Shares Entitled to Receive Bonus Shares
Shares issued and paid-up 5,00,00,000
Shares arising out of the conversion of 11% fully 25,00,000
convertible debentures
5,25,00,000
Par value of each share = Rs.10

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 Investment Banking and Financial Services

Number of shares that can be issued to capitalize the eligible reserves of

Rs.72,00,00,000.
72, 00, 00, 000
= = 7, 20, 00, 000
10
Hence the maximum permissible bonus ratio = 14.4:10.5 (rounded off to 14 bonus
shares for every 10 existing shares held)
b. As per the latest guidelines of SEBI, the par value concept of a share is abolished.
The value of share can be Re.1 or in multiples of Re.1. Hence as the present book
value of each share is Rs.10, in case of a stock split, the maximum permissible
stock-split ratio will be 1:10 i.e. one existing share can be split to 10 shares of Re.1
each.
58. a. Amount to be raised by Zuari Industries = Rs.110 crore
As per the SEBI Guidelines the promoters’ contribution shall not be less than 20%
of the post-issue capital.
It is given that the promoters do not intend to invest more than the minimum
requirement.
∴ Promoters’ contribution should be 20% of Rs.110 crore = Rs.22 crore.
Hence, amount to be raised through the book building process and fixed price public
offer = Rs.110 crore – Rs.22 crore = Rs.88 crore.
Let the amount to be offered by book building = Rs.x crore.
Allocation to individual investors applying not through the syndicate members but
during the time when the issue is open should be 10% of the issue size offered to the
public through the prospectus i.e. 10% of x = x/10
Thus, x + x/10 = 88
⇒ x = Rs.80 crore.
⇒ 10% of x = Rs.8 crore.
∴ Amount raised through book building is Rs.80 crore ... (i)
Amount raised through fixed price public offer is Rs.8 crore ... (ii)
Promoters will bring in Rs.22 crore ... (iii)
b. Computation of the Allotment of Shares by Book Building and the Cut-off Rate
Price (Rs.) (1) Number of shares Cumulative shares (4)
applied (2) (3) (1) x (3)
(Rs.)
64.00 25,500 25,500 16,32,000
63.00 82,800 1,08,300 68,22,900
62.00 1,75,700 2,84,000 1,76,08,000
61.00 5,00,100 7,84,100 4,78,30,100
60.00 8,32,200 16,16,300 9,69,78,000
59.00 17,99,400 34,15,700 20,15,26,300
58.00 36,55,300 70,71,000 41,01,18,000
57.00 41,83,700 1,12,54,700 64,15,17,900
55.25 58,97,600 1,71,52,300 94,76,64,575
54.50 72,11,300 2,43,63,600 1,32,78,16,200
53.00 85,90,400 3,29,54,000 1,74,65,62,000

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 Part II

Price (Rs.) (1) Number of shares Cumulative shares (4)

applied (2) (3) (1) x (3)
(Rs.)
52.00 1,01,03,000 4,30,57,000 2,23,89,64,000
From the table above we can infer that Rs.55.25 is the cut-off rate.
All the applications for shares at Rs.57 or higher will get full allotment @ Rs.55.25.
Total amount to be raised through book building = Rs.80 crore
Amount that can be raised from the applications at Rs.57 or more = Rs.64,15,17,900
∴ Amount to be raised from applications at Rs.55.25
= Rs.80,00,00,000 – Rs.64,15,17,900
= Rs.15,84,82,100
Number of shares to be issued in the category of Rs.55.25 = 15,84,82,100/55.25
= 28,68,454 shares
Number of shares applied for in the category of Rs.55.25 = 58,97,600 shares
In the category of Rs.55.25 for every 206 shares applied, 1 share would be allotted
subject to the allotment being in market lots.
c. Yes, within the book building portion, at least 15% of the issue size shall be
reserved for allocation to individual investors applying up to 10 market lots through
the syndicate members. This is in adherence to the latest SEBI Guidelines.
$150 million
59. a. Gross amount to be raised = = $156.25 million
0.96
600 x 1.2 x 4
Price of each ADR = = $60.42
47.65
156.25
Number of ADRs required = = 2.58 million
60.42
b. Current dividend per share = 50% x 5 = Rs.2.5
D1 = Rs.2.5 x 1.15 = 2.875
Price of ADR (in Rupees) = (600 x 1.2 x 4) = Rs.2,880
Dividend expected on one ADR = Rs.2.875 x 4 = Rs.11.5
D
1
Cost of ADR (k) =
P (1 − f )
0

11.5
= + 0.15 = 15.4%
2,880 x 0.96
D
⎛ 11.5
1
+g ⎞
⎜ 2,880 + 0.15 ⎟
P
Cost of ADR can also be calculated as o =⎝ ⎠ = 16%
1− f 0.96
NP + S 4 x 1, 000 + 600
o
c. Domestic ex-right price = = = Rs.920
N +1 5
920 x 4 x 1.3
Ex-rights price of an ADR = = $95.68
50
Initial investment = 25,000 x 60.42
= $15,10,500
25, 000
Number of ADRs bought under rights issue = = 6,250 ADRs
4

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 Investment Banking and Financial Services

6, 250 x (600 x 4)
Investment in rights issue = = $3,00,000
50
Total investment = $18,10,500
Divestment proceeds = (25,000 + 6,250) x $95.68
= $29,90,000
Profit to MLTF = $11,79,500.
60. a. Divestment Price:
EPS for 3 years
Year 1 12.00
Year 2 14.40
Year 3 17.28
The divestment takes plakhe at P/E of 8 and this is equal to Rs.17.28 x 8
= Rs.138.24
b. Required IRR of ECC = 22%
15crore
No. of shares invested by ECC = = 24 lakh
62.5
Let the minimum value of divestment be X. Thus the cash flow to ECC will be
(Rs. in lakh)
Year 0 Investment value –1,500
Year 1 Dividend 24 x 10 x 0.15 36
Year 2 Dividend 24 x 10 x 0.2 48
Year 3 (Dividend + Divestment) (60 + X)
(24 x 10 x 0.25) + X
The discounted cash flow @ 22% is
Year 0 –1500 x 1 = –1500
Year 1 36 x 0.820 = 29.51
Year 2 48 x 0.672 = 32.25
Year 3 (60 + X) x 0.551 = 33.042 + 0.551X
1,500 = 29.51 + 32.25 + 33.042 + 0.551X
Rs. 2,550.268
Hence the divestment price = = Rs.106.26
24 lakh shares
The cash flows to ECC from divestment would be
= 24,00,000 x
⎡ 50 ⎤
⎢ Rs.106.26 + (Rs.138.24 − Rs.106.26) x 100 ⎥
⎣ ⎦
= 24,00,000 x 122.25 = Rs.29,34,00,000

The IRR to ECC on their investment is

Year 0 –15,00,00,000
Year 1 36,00,000
Year 2 48,00,000
Year 3 29,34,00,000
IRR is 27.57%
c. The amount of cash inflow to the promoters is
50
= 24,00,000 x (138.24 – 106.26) x = Rs.3,83,76,000
100

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 Part II

INTERNATIONAL MARKETS
$4.02 crore
61. Total issue amount = = $4.102 crore
0.98
= 4.102 x 42 = Rs.172.2857 crore

Price of each GDR = 180 x 0.9 x 6 = Rs.972

Rs.172.2857
No. of GDRs issued = = 0.177249 crore
Rs.972
Cost of GDRs is computed as follows:
Current market price of GDR (Po) = Rs.972

Dividend expected on each GDR (D1) = 10 x 0.15 x 6 = Rs.9

Growth rate (g) = 8% p.a.
D1
Cost of GDR (k) = +g
Po (1 − f)
9
where f is the issue cost = + 008 = 8.945%
972 x (1 − 0.02)

62. The cash flow in the zero year is

Loan $200.0 million
Less: Arrangement Fee $0.5 million
$199.5 million
Annual cash outflows:
in $ million
Interest 12.000
Facility Fee 0.700
Agent Fee 0.015
12.715
The annual cash flows are as follows:

Year Cash flow (million $)

0 + 199.5

1 –12.715

2 –12.715

3 –12.715

4 –12.715

5 –212.715

Cost of loan is the value of (i) in the following equation

−12.715 −12.715 −12.715 −12.715 −212.715

199.5 = i
+ 2
+ 3
+ 4
+
(1 + i) (1 + i) (1 + i) (1+ i) (1 + i)5

i = 6.42% (by trial and error)

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 Investment Banking and Financial Services

Fees earned by HSBC $ million

10 BP on amount of loan i.e. $200 million 0.20
15 BP on amount underwritten i.e. $100 million 0.15
0.35
The total fees earned by HSBC is $0.35 million.
63. Amount in million crore
Upfront 30.06.20x1 30.6.20x2 30.06.20x3 30.06.20x4 30.06.20x5 30.06.20x6

Interest 0.000 4.800 9.1 11.6 10.1 9.1 4.3

Amortization 0.000 0.00 0 0 0 100 100

Management Fee 1.000 0.00 0 0 0 0 0

Underwriting Fee 1.200 0.00 0 0 0 0 0

Commitment Fee 0.300 0.00 0 0 0 0 0

Agency Fee 0.000 0.03 0.03 0.03 0.03 0.03 0.03

Guarantee Fee 0.800 1.6 1.6 1.6 1.6 0.8 0

Total 3.300 6.43 10.73 13.23 11.73 109.93 104.33

Computation of Effective Cost of Borrowings

Year Cash flows
0 +96.70
1 +93.57
2 –10.73
3 –13.23
4 –11.73
5 –109.93
6 –104.33
IRR = 6.08%
64.
(in million $)
1 2 3 4 5 6 7 8 9

Half-Year Loan o/s at LIMEAN* Annual Interest Paid Guarantee Agency Fee Principal Cash
Ended the Interest (2 x 4) ÷ 2 Fee and repaid outflow =
beginning Rate (%) Commitment 5+6+7
+8

June 20x0 50 5.175 6.175 1.544 0.10 0.05 (C) – 1.6940

Dec. 20x0 50 5.05 6.05 1.512 0.20 0.0565(A) – 1.7685

June 20x1 100 5.20 6.20 3.1 0.20 – – 3.3000

Dec. 20x1 100 5.15 6.15 3.075 0.20 0.0065(A) – 3.2815

June 20x2 100 5.05 6.05 3.025 0.18 – 12.5 15.*05

Dec. 20x2 87.5 5.05 6.05 2.647 0.15 0.0065(A) 12.5 15.3040

June 20x3 75 5 6 2.25 0.13 – 12.5 14.8800

Dec. 20x3 62.5 5.275 6.275 1.961 0.10 0.0065(A) 12.5 14.5680

June 20x4 50.0 6 7 1.75 0.08 – 12.5 14.3300

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 Part II

Dec. 20x4 37.5 6.075 7.075 1.327 0.05 0.0065(A) 12.5 13.8840

June 20x5 25.0 4.575 5.575 0.697 0.03 - 12.5 13.2270

Dec. 20x5 12.5 5.15 6.15 0.384 0 0.0065(A) 12.5 12.8910

* LIMEAN is the average of LIBOR and LIBID.

Upfront costs in January 20x0
$ millions
Management Fee (100 x 0.6%) 0.6
Underwriting Fee (100 x 0.25%) 0.25
Commitment Fee (Jan. – June 20x0 (50 x 0.2%)/2 0.05
Guarantee Fee (50 x 0.4%)/2 0.10
The effective cost to the company is the value of k which equates
50 1.444 1.520 12.828
50 + =1+ + 2
+ ...... +
1 + k) (1 + k) (1 + k) (1 + K)12

By solving k = 2.76%
Annual effective cost = (1 + k) 2 – 1
= (1 + 0.0276)2 – 1
= 5.60%
Assumptions:
i. Commitment fee is paid at the beginning of the half-year period.
ii. Repayment starts from the end of the half year after the grace period i.e. from the
end of June 20x2.
65. The payment towards interest and various fees in respect of the syndicated loan are as
follows:
(in $ million)
Upfront 31.12.20x0 31.12.20x1 31.12.20x2 31.12.20x3 31.12.20x4 31.12.20x5 31.12.20x6

Opening Balance of Loan 150.00 300.00 400.00 400.0 300.0 200.0 100.0
Interest 0.00 10.80 15.60 24.80 32.8 21.6 18.4 8.2
Amortization 0.00 100.0 100.0 100.0 100.0
Management Fee 2.4 0 0 0 0 0 0 0
Underwriting Fee 2.0 0 0 0 0 0 0 0
Commitment Fee 0.0 02.00 0.800
Agency Fee 0.0 0.015 0.015 0.015 0.015 0.015 0.015 0.015
Guarantee Fee 1.125 2.25 3.00 3.00 2.25 1.50 0.75 0
Total Payment 5.525 15.065 19.415 27.815 135.065 123.115 119.165 108.215

Working Notes:

i. Management fee is payable upfront on the entire syndicated loan. It is equal to $400
million x 0.6% = $2.4 million.

ii. Underwriting fee is also payable upfront on the entire loan.

It is equal to $400 million x 0.5% = $2 million.

iii. Commitment fee is calculated on undrawn balances at 0.8% p.a. It is calculated as

follows:

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 Investment Banking and Financial Services

I year : $250 million x 0.8% = $2 million

II year : $100 million x 0.8% = $0.8 million

iv. Guarantee fee payable in advance = 0.75% on outstanding balances

0th year $150 million x 0.75% $1.125 million

I year $300 million x 0.75% $2.25 million

II year $400 million x 0.75% $3 million

III year $400 million x 0.75% $3 million

IV year $300 million x 0.75% $2.25 million

V year $200 million x 0.75% $1.5 million

VI year $100 million x 0.75% $0.75 million

The net cash flow during each year is calculated as follows:
Year Cash Inflow Cash Outflow Net Cash flow
0 + 150 –5.525 144.475
1 + 150 –15.065 134.935
2 + 100 – 19.415 80.585
3 –27.815 –27.815
4 –135.065 –135.065
5 –123.115 –123.115
6 –119.165 –119.165
7 –108.215 –108.215
The effective cost of the loan is the value of `r’ in the following:
134.935 90.585 27.815 135.065 108.215
0 = –144.475 − − + + +
1+ r (1 + r) 2 (1 + r)3 (1 + r)4 (1 + r)7
= 8.35%
66. The cash inflow in the 0th year is
Loan – $300.0 mln.
Less: Arrangement Fee – $ 1.5 mln.
$298.5 mln.
Annual cash outflow
Interest – $ 18.00 mln.
Facility Fee – $ 0.75 mln.
Agent Fee – $ 0.01 mln.
$ 18.76 mln.
The annual cash flows are as follows:
Year Cash flow (million $)
0 +298.50
1 –18.76
2 –18.76

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 Part II

3 –18.76
4 –18.76
5 –317.26
Cost of loan is value of `i’ in the following:

18.76 18.76 18.76 18.76 317.26

= 298.5 – - - - -
1 + i (1 + i) (1 + i) (1 + i) 4 (1 + i)5
2 3

At i = 6%, the above is equal to –4.31

At i = 7%, it is equal to 7.68
Hence, ‘i’ lies between 6% and 7%
By interpolation i = 6.35%
Fees earned by National Westminster Bank:
15 BP on amount of loan i.e. $300 million 0.45
25 BP on amount underwritten i.e. $100 million 0.25
10 BP on amount of commitment i.e. $30 million 0.03
0.73
The total fees earned by National Westminster Bank is $1 million.
67.
(in million $)
Half-year Loan o/s LIMEAN* Annual Interest Guarantee Agency Fee & Principal Cash
ended at the Interest Paid Fee Commitment Repaid outflow
beginning Rate (%)
(1.5% over
limean)
(1) (2) (3) (4) (5) = (2) x (4) 6 7 8 (9)=(5)+
÷ 2 (6)+(7)+(8)

June, 20x0 100 5-00 5.075 2.5375 0.2500 0.125(C) — 2.9125

Dec., 20x0 100 5-25 5.329 2.664 0.2500 0.005(A) — 2.9190
June, 20x1 200 5-00 5.075 5.075 0.5000 — — 5.5750
Dec., 20x1 200 5-00 5.075 5.075 0.5000 0.005(A) — 5.5800
June, 20x2 200 6-00 6.09 6.09 0.5000 — 25 6.5900
Dec., 20x2 175 6-00 6.09 5.329 0.4375 0.005(A) 25 30.7720
June, 20x3 150 4-50 4.568 3.426 0.3750 — 25 28.8010
Dec., 20x3 125 5-20 5.278 3.299 0.3125 0.005(A) 25 28.6170
June, 20x4 100 5-50 5.583 2.792 0.2500 — 25 28.0420
Dec., 20x4 75 5-00 5.075 1.903 0.1875 0.005(A) 25 27.0960
June, 20x5 50 5-25 5.329 1.332 0.1250 — 25 26.4570
Dec., 20x5 25 5-50 5.5825 0.698 0.0625 0.005(A) 25 25.7660
* LIMEAN is the average of LIBOR and LIBID.
Upfront costs in January, 20x0
$ millions
1. Management Fee (200 x 0.75%) 1.500
2. Underwriting Fee (200 x 0.25%) 0.500
3. Commitment Fee (Jan. - June, 20x0 – 100 x 0.25% 0.125
Invalid EQN syntax: symbol ÿ 2)
4. Guarantee Fee (100 x 0.5% ÷ 2) 0.250

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 Investment Banking and Financial Services

2.375
The effective cost to the company is the value of k which equates –

100 2.9125 2.919 25.766

100 + = 2.375 + + 2
+ ............. +
(1 + k) (1 + k) (1 + k) (1 + k)12

97.088 3.88 25.88

0 = – 97.625 – + 2
+ ............... +
(1 + k) (1 + k) (1 + k)12

Assumptions:
i. Commitment fee is paid at the beginning of the half-year period.
ii. Repayment starts from the end of the half-year after the grace period i.e. from the end of
June, 2001.
68. The payment towards interest and various fees in respect of the syndicated loan are as
follows:
(in $ millions)
Up-front 31.12.20x0 31.12.20x1 31.12.20x2 31.12.20x3 31.12.20x4 31.12.20x5 31.12.20x6

Opening Balance of loan 100.00 250.00 400.00 400.00 300.00 200.00 100.00

Interest 0.00 7.00 15.00 28.00 20.00 24.00 18.00 7.00

Amortization 0.00 0.00 0.00 0.00 100.00 100.00 100.00 100.00

Management fee (W.N. i) 2.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Underwriting Fee (W.N. ii) 1.60 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Commitment Fee (W.N. iii) 0.00 2.25 1.13 0.00 0.00 0.00 0.00 0.00

Agency Fee 0.00 0.01 0.01 0.01 0.01 0.01 0.01 0.01

Guarantee Fee (W.N. iv) 0.60 1.50 2.40 2.40 1.80 1.20 0.60

Total payment 3.60 9.86 17.64 30.41 122.41 125.81 119.21 107.61

Working Notes:

i. Management fee is payable upfront on the entire syndicated loan. It is equal to $400
million x 0.5% = $ 2 million.

ii. Underwriting fee is also payable upfront on the entire loan. It is equal to $400
million x 0.4% = $1.6 million.

iii. Commitment fee is calculated on undrawn balances at 0.75% p.a. It is calculated as

follows:

I Year $300 million x 0.75% = $2.25 million.

II Year $150 million x 0.75% = $1.13 million.

iv. Guarantee fee payable in advance = 0.6% on outstanding balances
0th Year $100 million x 0.6% $0.6 million
I Year $250 million x 0.6% $1.5 million
II Year $400 million x 0.6% $2.4 million
III Year $400 million x 0.6% $2.4 million
IV Year $300 million x 0.6% $1.8 million

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 Part II

V Year $200 million x 0.6% $1.2 million

VI Year $100 million x 0.6% $0.6 million
The net cash flow during each year is calculated as follows:
Year Cash Cash outflow Net cash flow
inflow
0 +100 –3.6 +96.40
1 +150 –9.86 +140.14
2 +150 –17.64 +132.36
3 – –30.41 –30.41
4 – –122.41 –122.41
5 – –125.81 –125.81
6 – –119.21 –119.21
7 – –107.61 –107.61
The effective cost of the loan (IRR) is the value of `r’ in the following:

140.14 132.36 30.41 122.41 125.81 119.21 107.61

0 = –96.4 – - + + + + + r = 7.84%
1 + r (1 + r) 2
(1 + r) 3
(1 + r) 4 (1 + r)5 (1 + r)6 (1 + r)7
69.
(Amount in billion Yens)
Upfront 31.12.20x0 31.12.20x1 31.12.20x2 31.12.20x3 31.12.20x4 31.12.20x5 31.12.20x6 31.12.20x7

Interest 0.000 0.250 0.400 0.450 0.500 0.600 0.600 0.350 0.150
Amortization 0.000 0.000 0.000 0.000 0.000 5.000 5.000 5.000 5.000
Management 0.030 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
Fee
Underwriting 0.050 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
Fee
Commitment 0.010 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
Fee
Agency Fee 0.025 0.025 0.025 0.025 0.025 0.025 0.025 0.025 0.000
Guarantee Fee 0.000 0.050 0.100 0.100 0.100 0.100 0.075 0.050 0.025

Total 0.115 0.325 0.525 0.575 0.625 5.725 5.700 5.425 5.175
Computation of Effective Cost of Borrowings
Year Cash flows
0 10 – 0.115 = 9.885
1 10 – 0.325 = 9.675
2 –0.525
3 –0.575
4 –0.625
5 –5.725
6 –5.700
7 –5.425
8 –5.175

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 Investment Banking and Financial Services

Year Cash flows

IRR 3.47%
∴ Effective cost of loan to Naveen Industries Ltd. is 3.47%.
70.
Particulars Upfront 31.12.x0 31.12.x1 31.12.x2 31.12.x3 31.12.x4 31.12.x5 31.12.x6 31.12.x7

Interest 0.00 2.32 4.24 6.15 6.95 6.60 6.50 5.80 2.53

Amortization 0.00 0.00 0.00 0.00 0.00 0.00 0.00 50.00 50.00

Management fee 0.30 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Underwriting fee 0.40 0.00 0.00 0.00 0.00 0000 0.00 0.00 0.00

Commitment fee 0.00 0.18 0.06 0.00 0.00 0000 0.00 0.00 0.00

Agency fee 0.00 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10

Guarantee fee 0.20 0.40 0.50 0.50 0.50 0.50 0.50 0.25 0.00

Total 0.90 3.00 4.90 6.75 7.55 7.20 7.10 56.15 52.63

Computation of Effective Cost of Borrowings

Year Cash flows
Year 0 39.10
Year 1 37.00
Year 2 15.10
Year 3 –6.75
Year 4 –7.55
Year 5 –7.20
Year 6 –7.10
Year 7 –56.15
Year 8 –52.63
IRR 6.97%
Working Notes:
Computation of CHF Limean

Year CHF LIBID (%) CHF LIBOR CHF Limean

(%) (%)

2000 4.90 5.10 5.00

2001 4.45 4.55 4.50

2002 5.30 5.40 5.35

2003 6.10 6.20 6.15

2004 5.70 5.90 5.80

2005 5.60 5.81 5.70

2006 4.95 5.05 5.00

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 Part II

2007 4.20 4.30 4.25

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AN INTRODUCTION TO EQUIPMENT LEASING

71. a. i. Lease term 3 years
ii. Useful life of the asset 5 years
iii. (i) as a percentage of (ii) 60.00%
* Since the lease term does not exceed 75% of the useful life of the asset, it
cannot be classified as a finance lease.
Present value of minimum lease payments = 0.435 x 350 = 152.25
= 152.25 x PVIFA(20,3)
= 152.25 x 2.106
= 320.64
Fair market value of the asset at the time of = Rs.350.00 lakh
inception of the lease
Present value as a percentage of the fair ⎛ 320.64 ⎞
market value = Rs.91.61% ⎜ ⎟
⎝ 350.00 ⎠
** As the present value of minimum lease payments exceeds 90% of the fair
market value of the asset, the lease can be classified as a finance lease.
b. i. Useful life of the asset 8 years
ii. Lease term 3 years
iii. (ii) as a percentage of (i) 37.50%
As the lease term does not exceed 75% of the useful life of the asset, it
cannot be classified as a finance lease. However, considering the fact that the
present value of minimum lease payments exceeds 90% of the fair market
value of the asset at the time of inception, the transaction can be classified as
a finance lease.
* For a lease to be classified as a financial lease, the lease term should exceed
75% of the useful life of the asset.
** For a lease to be classified as a finance lease, the PV of minimum lease
payment should exceed 90% of the fair market value of the asset.
72.
Loan component 65.00 x 0.70 crore 45.50 crore
Equity component 19.50 crore (65 x 0.3)
Equated annual installment 45.50 /PVIFA(16,5)
45.50/3.274 13.89 crore
Denote the annual rental as Y
Then (Y – 13.89) x PVIFA(20,5) = Rs.19.5 crore
(Y – 13.89) x 2.991 = Rs.19.5 crore
Y – 13.89 = Rs.6.52 crore
Y = Rs.20.41 crore
In terms of the standard quote, the lease rental works out to be 20.41 x 1,000/65
314.00/1,000 per annum i.e. 314 per thousand per annum.
73. a. Let the Equated Rental be denoted by ‘L’.
L x PVIFA(22,5) = 45 lakh
L x 2.86 = 45
L = 15.73 lakh

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 Part II

b. When the lease rental is deferred for 1 year, the rental structure will be as follows:
Year Rental PV factor @ 22% axb
(a) (b)
1 0 0.819 L(0)
2 L 0.672 L(0.672)
3 L 0.551 L(0.551)
4 L 0.451 L(0.451)
5 L 0.370 L(0.370)
L(2.044)
L x 2.044 = 45 lakh
L = 45/2.044 = 22.02
The deferred lease rental will thus be
Year Lease Rental
1 0.00
2 22.02
3 22.02
4 22.02
5 22.02
74. The lessor will have to price his lease so as to obtain a gross pre-tax return of 20.5% p.a.
Lease Rental under the Stepped Rental Structure:
Assume the lease rental to be charged is L, and the lease rental increases by 10% p.a.
L x PVIF(20.5,1) + 1.10L x PVIF(20.5,2) + 1.21L x PVIF(20.5,3) + 1.33L x PVIF(20.5,4)
+ 1.46L x PVIF(20.5,5) = Rs.80 lakh
(L x .830) + (1.10L x .689) + (1.21L x 0.572) + (1.33L x .474) + (1.46L x .394) = Rs.80 lakh
L(0.83) + L(0.76) + L(0.69) + L(0.63) + L(0.58) = Rs.80 lakh
L(3.49) = Rs.80.00 lakh
L = 80/3.48 = Rs.22.92 lakh
Lease rentals
Year Rs. in lakh
1 22.92
2 (22.92 x 1.1) = 25.21
3 (25.21 x 1.1) = 27.73
4 (27.73 x 1.1) = 30.51
5 (30.51 x 1.1) = 33.56
Ballooned Rental Structure:

3 x PVIF(20.5,1) + 3 x PVIF(20.5,2) + 3 x PVIF(20.5,3) + 3 x PVIF(20.5,4) + L x PVIF(20.5,5)

= Rs.80 lakh

(3 x 0.830) + (3 x 0.689) + (3 x 0.572) + (3 x 0.474) + (L x 0.394) = Rs.80 lakh

2.49 + 2.07 + 1.72 + 1.42 + L(0.39) = Rs.80.00 lakh

L(0.39) = Rs.80.00 – 7.70

L = Rs.185.39 lakh

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The ballooned payment to be made in the fifth year is Rs.185.39 lakh. Therefore, the lease
rental structure will be
Year Lease Rental
(Rs. in lakh)
1 3.00
2 3.00
3 3.00
4 3.00
5 185.39
75. a. Leverage Ratio
Total Debt Long − term Debt
= or
Net Worth Net Worth
Total Debt/Net Worth
Loan Funds + Current + Liabilities
=
Net Worth
3, 400 + 1,850
= = 3.09
1, 700
Long-Term Debt/ Net Worth
Loan Funds − Cash Credit
=
Net Worth
3, 400 − 1, 068
= = 1.37
1, 700
Fixed Assets Turnover Ratio
Net Sales
=
Net Fixed Assets
9, 000
= = 2.57
3,500
Return on Investment
PBIT
= x100
Total Assets
2, 250
= x 100 = 32.37
6,950
b. The revised financial statements will be as follows:
Income Statement for the Year Ended March 31, 1999
Rs. in lakh
Net sales 9,000
Cost of goods sold 4,500
General expenses 1,590
Lease rental (950 x 0.375) 356.25
Interest charges (675 – 175.75) 499.25
Depreciation 660 – (950 x 0.333) 343.65
Profit before tax 1,710.85
Tax @ 40% 684.34
Profit after tax 1,026.51

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 Part II

Balance Sheet as on March 31, 1999

Sources of Funds:
A: Shareholders’ Funds
Share Capital 450
Reserves and Surplus 1,332
(1250 – 945 + 1026.51) 1,782
B: Loan Funds
10% Debentures 1,460
Term Loans 112
(872 + 190 – 950)
Cash Credit 1,068 2,640

C: Total (A + B) 4,422
Application of Funds:
D: Fixed Assets
Original Cost (5000 – 950) 4,050
Less: Acc. Depreciation (1500 – 316.35) 1,183
Net Block 2,867
Add: Capital Work-in-progress 500

3,367
E: Investments 500
F: Current Assets
Cash and Bank Balances 510
(500 + 190 + 175.75 – 356.25)
Receivables 750
Inventory 1,000
Other Current Assets 200
2,460
G: Less: Current Liabilities
Accounts Payable 1,000
Provisions 904
(850 – 630 + 684.34)
1,904
H: Net Current Assets (F – G) 556
I: Total 4,423
Total Debt 2, 640
Leverage Ratio = = = 1.48
Net Worth 1, 782.2
or
Loan Funds − Cash Credit 1,572
= = 0.88
Net Worth 1, 782
Fixed Assets Turnover Ratio
Net Sales 9, 000
= = 3.14
Net Fixed Assets 2,867
PBIT 2, 210
ROI = x100 = x100 = 34.94%
Total Assets 6,327

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 Investment Banking and Financial Services

18
76. a. Borrowing rate per month = = 1.50
12
Present value of monthly lease rentals = 0.022 (1 + 1.5%) x 670 x
payable at the beginning of every month PVIFA(1.5,60)
= 14.74 x (1 + 1.5%) x
PVIFA(1.5, 60)
= 14.74 x 1.015 x PVIFA(1.5,60)
= 14.74 x 1.015 x 39.38
= Rs.589.17 lakh
i. Cost of the asset = Rs.670.00 lakh
ii. PV of monthly lease payments = Rs.589.17 lakh
(ii) as a percentage of (i) 87.94%
As the present value of monthly lease payments does not exceed 90% of the asset
cost at the time of inception of the lease the transaction is not a finance lease.
i. Economic life of the asset 10 years
ii. Lease term (ii) 7 years
as a percentage of (i) 70%
As the percentage does not exceed 75%, it cannot be classified as a finance lease.
b. In case of (b), the economic life is 8 years being least of the physical life,
technological life and the product market life
Lease term = 7 years
Lease term as a percentage of the economic life = 7/8 x 100
= 87.50
As the percentage exceeds 75%, the transaction can be treated as a finance lease.
2 1
77. a. Cost of capital = 14 x x 0.65 + 22 x = 13.4%
3 2
NPV (Buy)
i. Present value of EBDIT (1 – T):
EBDIT =Rs.20 lakh
Tax rate = 35%
EBDIT (1 – T)
= 20(1 – 0.35) = Rs.13.00 lakh
Present value
= 13.00 x PVIFA(13.4,5)
= 13.00 x 3.483 = Rs.45.28 lakh
ii. Present value of depreciation tax shields:
Year Depreciation PVIF(13.4, i) Present
@ 25% value
1 12.50 0.882 11.03
2 9.38 0.778 7.30
3 7.03 0.686 4.82
4 5.28 0.605 3.19
5 3.96 0.533 2.11
38.15 28.45
Tax shield = 28.45 x 0.35 = Rs.9.96 lakh.

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 Part II

iii. Present value of interest tax shield:

As the evaluation is based on suggested framework the amount replaced by leasing
is assumed to be the PV of lease rentals.
PV of lease rentals = 50 x 0.035 x 3 x i/d4 x 4 x PVIFA(14,5) = Rs.78.30 lakh
78.30
Equated Annual Installment = = Rs.22.808 lakh
PVIFA
(14, 5)

Actual annual lease payment = 50 x 0.035 x 12 = Rs.21 lakh

Adjustment factor = 22.808 – 21 = Rs1.808 lakh.
Adjusted interest = Interest – Adjustment factor.
Interest Amortization Schedule
(Rs. lakh)
Year Loan amount Interest Capital Equated annual Adjusted PV
outstanding @ 14% content installment interest @ 13.4%
1 78.300 10.962 11.846 22.808 9.154 8.073
2 66.454 9.304 13.504 22.808 7.496 5.832
3 52.950 7.413 15.395 22.808 5.605 3.845
4 37.555 5.258 17.550 22.808 3.450 2.088
5 20.005 2.801 20.007 22.808 0.993 0.529
20.367
PV of interest tax shield = 20.367 x 0.35 = Rs.7.13 lakh.
iv. Present value of salvage value:
Book value at the end of fifth year = 50 – 38.15 = Rs.11.85 lakh
Salvage value = 2 x 11.85 = Rs.23.70 lakh
Present value of salvage value = 23.7 PVIF(13.4,5) = Rs.12.63 lakh
v. NPV (Buy) = – Initial investment + PV of EBDIT (1 – T) + PV of depreciation tax
shields + PV of interest tax shield + PV of salvage value
= –50 + 45.28 + 9.96 + 7.13 + 12.63 = Rs.25.00 lakh
vi. Present value of lease rentals (already calculated) = Rs.78.03 lakh
vii. Present value of tax shield on lease rentals
= 50 x 0.035 x 12 x 0.35 x PVIFA(13.4,5)
= 21 x 0.35 x 3.483 = Rs.25.60 lakh
viii. NPV (Lease) = Present value of EBDIT(1 – T) – PV of lease rentals
+ PV of tax shield on lease rentals
= 45.28 – 78.30 + 25.60 = – Rs.7.42 lakh
The company should acquire the equipment as the NPV of buy is positive.
b. As the NPV (Buy) is positive and greater than NPV (Lease), the company should
buy the equipment.
LEASING IN INDIAN CONTEXT
78. The coupon payments will be at the following rates:
Year Coupon rate (%) = Inflation rate + 5%
1 10.0
2 9.5
3 10.0
4 11.0
5 12.5
The price at which the bond can be issued
= 10 x PVIF(18,1) + 9.5 x PVIF(18,2) + 10 x PVIF(18,3) + 11 x PVIF(18,4) + 112.5 x PVIF(18,5)

= 10 x 0.847 + 9.5 x 0.718 + 10 x 0.609 + 11 x 0.516 + 112.5 x 0.437 = Rs.76.22

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 Investment Banking and Financial Services

79. a. Net owned funds of the company as on March 31, 1999

= Equity share capital + Reserves and surplus – Investments in wholly owned
subsidiaries – Miscellaneous expenditure (not written off)
= 140 – 15 – 36 = Rs.89.00 million
b. Maximum debt capacity = 89 x 10 = Rs.890.00 million
Outstanding amount of debt= Rs.261.00 million (56 + 120 + 85)
Amount of debt that can be raised
= Rs.629.00 million
Additional amount of bank borrowings that can be raised
= 89 x 4 – 85 = Rs.271.00 million
Since the company wants to raise 450 million, the desired financing mix will be as
follows:
Bank borrowings Rs.271.00 million
Term loan Rs.179.00 million
80. Define im as the monthly rate of return implied by the cash flow stream. im can be calculated
as:
235 = 11x PVIFA + 9 x PVIFA x PVIF + 7 x PVIFA x PVIF
(i ,12) (i ,12) (i ,12) (i ,6) (i , 24)
m m m m m

Assuming im = 1%
= 11 x 11.255 + 9 x 11.255 x 0.887 + 7 x 5.795 x 0.787
= 123.805 + 89.84 + 31.92 = 245.565
Assuming im = 2%
= 11 x 10.575 + 9 x 10.575 x 0.788 + 7 x 5.601 x 0.621
= 116.325 + 74.99 + 24.31 = 215.625
Since the required value of aggregate receivables lies between the two values 245.565 @
1% and 215.625 @ 2%, the value of im lies between 1% and 2%. By interpolating,
245.565 − 235.00 10.565
0.01 + x1 = 1% + x 1 = 1 + 0.35 = 1.35%
245.565 − 215.625 29.94
im = 1.35%
i = (1 + im)12 – 1 = (1.0135)12 – 1
= 1.1745 – 1 = 0.1745 = 17.45%
81. Rs. in crore
Equity share capital 140.00
Share premium 56.00
General reserve 126.40
Profit on sale of assets 54.70
377.10
Less: Intangible assets 33.60
Owned funds 343.50(A)
Investments in shares and debentures of subsidiary companies 32.92
Loans and advances to group companies 21.98
Deposits with subsidiary companies 15.64
70.54(B)
Excess of B over 10% of owned funds 36.19(C)
Net owned funds (A – C) 307.31

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 Part II

82. a. Net owned funds = Paid-up Share Capital + Free Reserves – Miscellaneous
Expenses – Investments in wholly owned subsidiaries
= 150 + 310 – 85 – 140
= 460 – 225 = Rs.235 lakh

b. Maximum permissible borrowings

= 235 x 10 = Rs.2,350 lakh
(10 times of NOF)
Existing level of borrowings = Term loans + Bank borrowings
+ Public deposits
= 90 + 705 + 720 = Rs.1,515 lakh
Additional amount of debt that can be raised = 2,350 – 1,515 = Rs.835 lakh
Working Notes:
i. It is assumed that current liabilities do not include deemed deposits like Inter
Corporate Deposits.
If ICDs are included in current liabilities, then borrowings as defined above will
include inter corporate deposits.
ii. Net owned funds has been computed using the formula provided by the Non-
Banking Financial Companies (Reserve Bank) Directions, 1977.
83. 10 x PVIF(18.5,1) + 11.2 x PVIF(18.5,2) + 12.54 x PVIF(18.5,3) + 14.05 x PVIF(18.5,4) +
15.74 x PVIF(18.5,5) + 17.62 x PVIF(18.5,6) + 19.74 x PVIF(18.5,7) + 110 x PVIF(18.5,7)
= 10 x 0.844 + 11.2 x 0.712 + 12.54 x 0.601 + 14.05 x 0.507 + 15.74 x 0.428
+ 17.62 x 0.361 + 19.74 x 0.305 + 110 x 0.305
= 8.438 + 7.975 + 7.538 + 7.124 + 6.734 + 6.364 + 6.015 + 33.524 = Rs.83.7
84. True Yield*
Maturity period True Yield
(in months) (%)
13 15.50%
36 15.50%
48 15.50%
60 15.50%
Under the cash certificate scheme, a cash certificate of face value Rs.5,000 will be issued at
a discount and redeemed at par after 13 months so as to yield 15.50% p.a.
Issue price will, therefore, be
5, 000
= = Rs.4227.5
FVIF
(15.50, 1.083)

Note: 13/2 = 1.083

The issue price for other maturities can be calculated similarly (but the value of ‘m’
changes accordingly).
Cash Certificate Scheme
Period Issue price Maturity value True yield Simple
(in months) (Rs.) (Rs.) (%) interest yield (%)
13 4,278 5000 15.5% 15.6%
36 3,245 5000 15.5% 18.03%
48 2,809 5000 15.5% 19.49%
60 2,433 5000 15.5% 21.11%
* The relationship between the effective annual rate of interest (r) and the nominal rate of
interest (i) per annum compounded ‘m’ times a year is given by the formula:

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 Investment Banking and Financial Services

1 + r = (1 + i/m)m
i = 14.5%
m = 12
12
⎛ 0.145 ⎞
Therefore, 1 + r = ⎜1 + ⎟
⎝ 12 ⎠
⇒ r = 15.5%

TAX ASPECTS OF LEASING

85. a. Depreciation charge for the current financial year
Rs.
WDV at the beginning of the year 224.00
Add: Cost of assets acquired during the year 100.00
324.00
Less: Proceeds on sale of assets during the year 13.00
311.00
Written down value for charging depreciation 311.00
Depreciation allowance for the year 77.75
233.25
Written down value at the end of the year 233.25
b. Depreciation charge for the following financial year
Rs.
Written down value as at the beginning of the year 233.25
Add: Cost of assets to be acquired during the year 40.00
273.25
Less: Proceeds on sale of assets likely to be realized 22.00
during the year 251.25
Depreciation allowance for the year 60.31
190.94
Working Notes: Rs.
Normal depreciation allowance 62.81
Less: Depreciation allowance inadmissible in respect
of assets acquired after September 30
20* x 0.25 x 0.5 2.5
Admissible allowance 60.31
* 50% of the fresh investment.
86.
A. Cost of the equipment to Vindya Ltd = 67 x 1.04
= Rs.69.68 lakh
B. Cost of the equipment to Malathi Financial Services = 67 x 1.10*
= Rs.73.7 lakh
Lease rentals to be paid by
Vindhya Ltd. = 73.7 x 0.05528 = Rs.4.07 lakh per month.
* The lessor bears the impact of sales tax at the normal rate of 10%.

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87. a. Depreciation charge for the current financial year

Block Rate of depreciation (%) A B
25 40
A. WDV at the beginning of the year 186 125
Add B. Cost of assets acquired during the year 200 56
A+B 386 181
Less Proceeds on sale of assets during the year 25 44
361 137
D. WDV for reckoning depreciation 361 137
E. Depreciation allowance for the year 90.25 54.8
F. WDV as at the end of the year 270.75 82.2
b. Depreciation charge for the following financial year
Block Rate of depreciation (%) A B
25 40
A. WDV at the beginning of the year 270.75 82.20
Add: B. Cost of assets to be acquired during the year 60.00 25.00
A+B 330.75 107.20
Less: C. Proceeds on sale of assets expected to be 10.00 15.00
realized during the year (see note 2)
D. WDV for reckoning depreciation 320.75 92.20
E. Depreciation allowance for the year 76.43 34.38
F. WDV as at the end of the year 244.31 57.82
Notes:
1. Block (Rs. in lakh) (Rs. in lakh)
A B
Normal depreciation allowance 80.19 36.88
Less: Depreciation allowance 30 x 0.25 x 0.5 12.5 x 0.40 x 0.5
in-admissible in respect (50% of the
of assets acquired after fresh investment 2.5
September 30th of the year
3.75
Admissible allowance 76.43 34.38
2. Where the entire block of assets have been sold during a year for an amount
higher than (A + B) or where the sale proceeds on the part of the block that
has been sold is higher than (A + B), the difference will be treated as short-
term capital gain and taxed at the marginal rate of tax; in the case of widely
held companies, where the entire block of assets has been sold for an amount
less than (A + B), the difference will be treated as Short-term Capital Loss
and the assessee will be entitled to a tax shield at the marginal rate of tax.
88. Alternative I: Debt Financing
Year 1 Year 2
(Rs. in lakh) (Rs. in lakh)
Tax deductible expense Interest on long-term debt (415 x 0.165) [(415 – 103.75) x 0.25]
68.475 54.78
Depreciation 103.750 77.81
Total (A) 172.225 132.59
Tax shield (A x 0.46) 79.220 60.99

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Alternative II: Finance Lease

Tax deductible expenses (415 x 0.310) (415 x 0.310)
Lease Rentals (B) 128.65 128.65
Tax Shield (B x 0.46) 59.179 59.179
Alternative I is recommended as it generates a higher amount of tax shield.
Working Notes:
1. Debt Repayment Schedule:
Rs. in lakh Rs. in lakh
Year 1 2
Loan outstanding at the beginning 415.00 332.00
Interest @ 16.5% p.a. 68.48 54.78
Loan installment 83.00 83.00
Loan outstanding at the end 332.00 249.00

2. Depreciation Schedule
Year 1 2
Opening WDV 415.00 (415 – 103.75) = 311.2500
Depreciation 103.75 77.8120
Closing WDV 311.25 233.4375
89. Being a 100% EOU, the company can neither avail of the lease related tax shelters nor avail
of the acquisition related tax shelters.
Therefore, the company will not be willing to accept a rental stream whose present value
exceeds Rs.65 lakh; Put differently, if ‘L’ denotes the maximum annual lease rental RSML
is willing to pay, the value of L can be determined from the equation
L x PVIFA(17.5,7) = 65
3.866L = 65
L = 16.81
If the annual lease rental charged by Sumeet Leasing Ltd. is less than 16.81, RSML will
find it worthwhile to lease the equipments.
Cost of the equipment to Innovative Ltd. including
90. = 115 x 1.04 = Rs.119.6 lakh
sales tax
Cost of the equipment to DLL = 115 x 1.10* = Rs.126.5 lakh
Lease rentals to be paid to DLL = 126.5 x 0.0245 = Rs.3.099 lakh p.m.
By opting for a lease, Innovative Ltd. is able to avert the initial outflow of Rs.119.6 lakh.
But then, it ends up paying lease rentals on an enhanced investment cost because the lessor
bears the impact of sales tax at the normal rate of 10%. So other things being equal, the
present value of the lease rentals paid by Innovative Ltd. will be higher than Rs.119.6 lakh.
LEASE EVALUATION: THE LESSEE’S ANGLE
91. a. In order to determine as to whether Indusway should lease or buy the equipment; the
NPV(L) and the NPV(B) should be calculated.
NPV(L) = PV[EBDIT (1 – T)] – PV (LR) + PV (Tax shield on lease rental
– Management Fee) + PV (Tax Shield on Management Fee)
Discount rate to be applied is the marginal cost of capital which is calculated as
under
D E
K= x K D x (1 − T ) + x KE
D+E D+E
⎡2 ⎤ ⎡1 ⎤
= ⎢ x 17.5 x 0.54⎥ + ⎢ x 22⎥ = 6.33 + 7.33 = 13.63%
⎣ 3 ⎦ ⎣ 3 ⎦

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 Part II

PV [EBDIT (1 – T)]
= [20 x 0.54 x PVIFA (13.63,3)] + [17 x 0.54 x PVIFA(13.63,2) x PVIF(13.63,3)]
= (20 x 0.54 x 2.336) + (17 x 0.54 x 1.654 x 0.682)
= 25.23 + 10.36
= Rs.35.59 lakh
PV of Lease Rentals
21.40
= x1.10 x 12 x 0.0285 x PVIFA(13.63, 5)
1.04
= 22.63 x 12 x 0.0285 x 3.463 = 26.80
PV(LRT) = PV(LR) x 0.46
= 26.80 x 0.46 = Rs.12.32 lakh
NPV(L) = 35.59 – 26.80 + 12.32 = Rs.21.11 lakh
NPV(B) = – A + PV [EBDIT (1 – T)] + PV(DT) + PV(RV)
A = Acquisition cost = Rs.21.4 lakh
PV[EBDIT (1 – T)]
= Rs.35.59 lakh
PV[DT] = [*5.35 x PVIF(13.63,1) + 4.01 x PVIF(13.63,2) + 3.01 x
PVIF(13.63,3) + 2.26 x PVIF(13.63,4) + 1.69 x PVIF(13.63,5)] x 0.46
= [(5.35 x 0.88) + (4.01 x 0.77) + (3.01 x 0.68) + 2.26 x 0.599
+ 1.69 x 0.5279] x 0.46
= [4.708 + 3.108 + 2.051 + 1.354 + 0.894] x 0.46
= 12.11445 x 0.46 = Rs.5.57 lakh
PV(RV) = 1.78** x PVIF(13.63,5)
= 1.78 x 0.5279 = Rs.0.94 lakh
NPV(B) = –21.4 + 35.59 + 5.57 + 0.94 = Rs.20.70 lakh
As NPV (L) is greater than NPV (B), leasing is recommended.
b. Let us denote the annual break even rental as L. The value of L can be obtained by
solving for L in the equation
NPV(L) – NPV(B) = 0

= –3.463L + (0.46 x 3.463)L + 21.4 – 5.572 – 0.94 = 0

= –3.463L + 1.593L = –21.4 + 5.572 + 0.94 = –1.87L = –14.89

14.89
L = = Rs.7.96 lakh.
1.87

* 21.4 x 0.25 = 5.35

5.35 – (5.35 x 0.25) = 4.0125
4.0125 – (4.0125 x 0.25) = 3.01
3.01 – (3.01 x 0.25) = 2.26
2.26 – (2.26 x 0.25) = 1.69

**21.4 – (5.35 + 4.01 + 3.01 + 2.26 + 1.69) = 5.08

Net salvage value / Residual value
= 5.08 x 0.35 = 1.778 ~ 1.78
92. Marginal cost of capital
2 1
= x 0.185 x (1 – 0.46) + x 0.22
3 3
= 0.0666 + 0.0733 = 13.99% or say 14%

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The present value of the net cash flow stream associated with the purchase option can be
defined as:
NPV(B)
= – Initial investment + PV of [EBDIT stream (1 – Tax Rate)] + PV of [Tax shields
on depreciation] + PV of [Net salvage value]
PV of [EBDIT stream (1 – Tax Rate)]
= 46 x [PVIF(14,1)] + 37 x PVIF(14,2) + 24 x [PVIF(14,3) + PVIF(14,4) + PVIF(14,5)] x 0.54
= (46 x 0.877) + (37 x 0.770) + 24 [0.675 + 0.592 + 0.519] x 0.54
[40.35 + 28.48 + 1.24 x (1.786)] x 0.54
= [40.35 + 28.48 + 42.88] 0.54
111.71 x 0.54
= Rs.60.32 lakh.
PV of (Tax shields on depreciation)
= [*15.70 x PVIF(14,1) + 11.78 x PVIF(14,2) + 8.83 x PVIF(14,3) + 6.62
x PVIF(14,4) + 4.97 x PVIF(14,5)] x 0.46
= [15.70 x 0.877) + (11.78 x 0.770) + (8.83 x 0.675) + (6.62 x 0.592) + (4.97 x 0.520)]
x 0.46
= (13.773 + 9.062 + 5.962 + 3.923 + 2.581) x 0.46 = 35.30173 x 0.46
= 16.23879 = Rs.16.24 lakh
PV of Interest on Intercorporate Borrowings
4
= (0.06 x 62.8 x ) x PVIF(14,0.25)
5
= 3.0144 x 0.968 = Rs.2.92 lakh
PV of (Interest tax shield on Intercorporate Borrowings)
= 3.0144 x 0.46 x [PVIF(14,1)]
= 3.0144 x 0.46 x 0.877 = Rs.1.216 lakh
PV of (Net salvage value)
= 7.5 x PVIF(14,5)
= 7.5 x 0.519 = Rs.3.90 lakh
NPV of purchase option
= –62.8 + 60.32 + 16.24 – 2.92 + 1.216 + 3.90 = Rs.15.86 lakh
The present value of the cash flow stream associated with the lease option is defined as
follows:
NPV(L)
= –PV (Lease rentals) + PV[(EBDIT stream) x (1 – Tax Rate)] + PV (Tax shield on
lease rentals) – Management fee + PV (Tax shield on Management fee)
Lease Rentals
62.8
= x 1.10 x 0.310 = Rs.20.59 lakh
1.04
PV of lease rentals
= 20.59 x PVIFA(14,5)
= 20.59 x 3.433 = Rs.70.69 lakh
PV [EBDIT stream (1 – Tax Rate)]
= Rs.60.32 lakh
PV (Tax shield on Lease rentals)
= 20.59 x 0.46 x PVIFA(14,5)
= 20.59 x 0.46 x 3.433 = Rs.32.52 lakh

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 Part II

Management fee
= 66.42 x 0.01 = Rs.0.66 lakh
PV (Tax shield on Management fee)
= 0.66 x 0.46 x PVIF(14,1)
= 0.66 x 0.46 x 0.877 = Rs.0.26 lakh
NPV(L)
= –70.69 + 60.32 + 32.52 – 0.66 + 0.26
= Rs.21.75 lakh.
NPV(L) > NPV(B) > 0
Therefore, the equipment must be leased.
*62.8 x 0.25 = 15.7
47.1 x 0.25 = 11.78
35.32 x 0.25 = 8.83
26.49 x 0.25 = 6.62
19.87 x 0.25 = 4.97
93. Kd = 16.5 (1 – 0.46) = 16.5 x 0.54 = 8.91%
a. Initial investment = Rs.47 lakh
b. Present value of lease 325
payments = 47 x x PVIFA(16.5%,5)
1000
= 15.275 x 3.236 = Rs.49.436 lakh
c. PV of tax shield on lease = 15.275 x 0.46 x PVIFA(8.91,5)
payments
= 15.275 x 0.46 x 3.898 = Rs.27.39 lakh
d. PV of depreciation tax shields = [11.75 x PVIF(8.91,1) + 8.81 x PVIF(8.91,2)
+ 6.61PVIF(8.91,3) + 4.96 x PVIF(8.91,4)
+ 3.72 x PVIF(8.91,5)] x 0.46
= [(11.75 x 0.918) + (8.81 x 0.843) + (6.61 x 0.774)
+ (4.96 x 0.711) + (3.72 x 0.653)] x 0.46
= (10.789 + 7.427 + 5.117 + 3.525 + 2.428) x 0.46
= 29.286 x 0.46 = 13.471
e. Present value of interest tax = [*8.157 x PVIF(8.91,1) +6.982 x PVIF(8.91, 2)
shields + 5.614 x PVIF(8.91, 3) + 4.020 x PVIF(8.91, 4)
+ 2.163 x PVIF(8.91, 5)] x 0.46
= (7.490 + 5.887 + 4.346 + 2.857 + 1.412) x 0.46
= 21.991 x 0.46 = Rs.10.116 lakh
Amortization Schedule for Equivalent Debt
Year Amount of Capital Interest content Debt service
outstanding loan content @ 16.5% p.a charge
1 49.436 7.118 8.157 15.275
2 42.318 8.293 6.982 15.275
3 34.025 9.661 5.614 15.275
4 24.365 11.255 4.020 15.275
5 13.110 13.11 2.163 15.275
Net value of lease
47 – 49.436 + 27.39 – 13.471 – 10.116 = 1.367
Since NVL is positive the equipment should be leased.

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 Investment Banking and Financial Services

* Additional debt = P.V. of lease payments = 49.436 L

In the year I, P.V. of lease payments (debt O/S) = Rs.49.436 L
Interest content @ 16.5% p.a. = Rs.8.157
Now, the lease rental (debt service charge) = 15.275 i.e. (47 x 0.325)
Therefore, capital content in the P.V. of lease payment = 15.275 – 8.157 = 7.118 L
In the year II, debt O/S = 49.436 – 7.118 = 42.318.
The interest and capital contents are calculated as above. This is continued for all the years.
94. a. Amount of borrowing displaced by lease
= 56 x 0.315 x [PVIFA(16.0,5)]
= 56 x 0.315 x 3.274 = Rs.57.75 lakh
b. The amortization schedule for displaced borrowing is as follows:
Year Debt Interest Capital Debt service
outstanding @ 16% p.a. charge
1 57.75 9.240 8.400 17.64
2 49.35 7.890 9.740 17.64
3 39.60 6.330 11.303 17.64
4 28.30 4.520 13.112 17.64
5 15.19 2.430 15.209 17.64
Post-tax cost of debt = 16 x 0.54 = 8.64%
PV of Interest tax shields discounted at 8.64%
= 9.24 x PVIF(8.64,1) + 7.89 x PVIF(8.64,2) + 6.33 x PVIF(8.64,3) + 4.52 x PVIF(8.64,4)
+ 2.43 x PVIF(8.64,5)
= [(9.24 x 0.920) + (7.89 x 0.847) + (6.33 x 0.78) + (4.52 x 0.718) + (2.43 x 0.661)]
x 0.46 = 24.99 x 0.46 = Rs.11.49 lakh
c. To decide whether or not the company must accept the lease proposal, the NVL has
to be evaluated.
A. Investment cost = Rs.56 lakh
B. PV of lease = 57.75 lakh
rentals
C. PV (Tax shield = 17.64 x 0.46 x PVIFA(8.64, 5)
on lease rentals) = 17.64 x 0.46 x 3.926 = 31.85
D. PV (Dep. tax = *14 x PVIF(8.64,1) + 10.5 x [(PVIF(8.64, 2) + 7.88 x PVIF(8.64, 3)
shields + 5.91 x PVIF(8.64, 4) + 4.43 x PVIF(8.64,5) ] x 0.46
discounted
@ 8.64%)
= (12.89 + 8.90 + 6.14 + 4.24 + 2.93) x 0.46
= 35.09 x 0.46 = Rs.16.14 lakh
E. PV (Residual = 2 x PVIF(8.64,5) = 2 x 0.661 = 1.32 lakh
Value)
F. NVL = 56 – 57.75 + 31.85 – 16.14 – 1.32 – 11.497 = Rs.1.143 lakh
As NVL is positive lease is recommended.
* 56 x 0.25 = 14
42 x 0.25 = 10.5
31.5 x 0.25 = 7.875
23.625 x 0.25 = 5.90625
17.719 x 0.25 = 4.429

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 Part II

95. A. Initial investment = Rs.72 lakh

B. PV of lease = (0.315 x 72) x PVIFA(16, 5) = 22.68 x 3.274 = Rs.74.25 lakh
rentals
C. PV of tax shield = (72 x 0.46 x 0.315) x PVIFA(13, 5)
on lease rentals
= 10.4328 x 3.517 = Rs.36.69 lakh
D. PV of tax shields = [18 x PVIF(13,1) + 13.5 x PVIF(13,2) + 10.13 x PVIF(13,3)
on depreciation + 7.59 x PVIF(13,4) + 5.70 x PVIF(13,5) ] x 0.46
= Rs.18.99 lakh
E. PV of interest tax = [11.88 x PVIF(13, 1) + 10.15 x PVIF(13, 2) + 8.15 x PVIF(13,3)
shield on + 5.82 x PVIF(13, 4) + 3.13 x PVIF(13, 5)] x 0.46
displaced debt
= [(11.88 x 0.885) + (10.15 x 0.783) + (8.15 x 0.693) +
(5.82 x 0.613) + (3.13 x 0.543)] x 0.46
= 29.381 x 0.46 = Rs.13.515 lakh
F. PV of net salvage = 8 x PVIF(13, 5) = 8 x 0.543 = Rs.4.342 lakh
value
G. Net advantage of = A – B + C – D – E – F
leasing = 72 – 74.25 + 36.69 – 18.99 – 13.515 – 4.342 = –Rs.2.41 lakh
Since NAL is negative leasing is not recommended.
Displaced Debt Amortization Schedule
Year Loan Outstanding Interest content Capital Rental
at the beginning @ 16% content
1. 74.25 11.88 10.80 22.68
2. 63.45 10.15 12.52 22.68
3. 50.93 8.15 14.53 22.68
4. 36.40 5.82 16.85 22.68
5. 19.55 3.13 19.55 22.68
96. a. Amounts of borrowing displaced by the lease = Investment cost = Rs.54 lakh.
b. Debt service charge associated with the displaced debt of Rs.54 lakh at the rate of
interest of 17%.
54 54
= = = Rs.16.87 lakh
PVIFA (17,5) 3.199
The amortization schedule associated with the displaced debt is as follows:
Year Debt outstanding Interest @17% Principal Debt service charge
1 54.00 9.18 7.69 16.87
2 46.31 7.87 9.00 16.87
3 37.31 6.34 10.53 16.87
4 26.79 4.55 12.32 16.87
5 14.47 2.46 14.41 16.87

PV of interest tax = PVIF(12,1) and likewise

shield discounted
@12%
[(9.18 x 0.893) + (7.87 x 0.797) + (6.34 x 0.712)
+ (4.55 x 0.636) + (2.46 x 0.567)] x 0.46
= Rs.10.71 lakh
c. i. Financial Advantage = PV (Debt service payments) – PV (Lease payments)
of Leasing (FAL) = 54 – [54 x 0.333 x PVIFA(17,5)]
= 54 – [54 x 0.333 x 3.199] = –Rs.3.52 lakh

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Investment Banking and Financial Services

ii. PV (Depreciation tax shields) = [*(21.6 x 0.893) + (12.96 x 0.797)

discounted @ 12% + (7.78 x 0.712) + (4.67 x 0.636)
+ (2.80 x 0.567)] x 0.46
= 39.706 x 0.46 = Rs.18.26 lakh
iii. PV of interest tax shields = Rs.10.71 lakh
@ 12%
iv. PV of (RV) @ 12% = 5 x PVIF(12, 5)
= 5 x 0.567 = Rs.2.84 lakh
v. PV of tax shield on = (54 x 0.333 x 0.46) x PVIFA(12, 5)
lease rental
= 8.271 x 3.604 = Rs.29.82 lakh
OAL = v – ii – iii – iv
= 29.82 – 18.26 – 10.71 – 2.84 = –Rs.1.99 lakh
NAL = FAL + OAL
= –3.52 + (–1.99) = –Rs.5.51 lakh
Since NAL is negative leasing is not recommended.
*54 x 0.4 = 21.6
32.4 x 0.4 = 12.96
19.44 x 0.4 = 7.776
11.664 x 0.4 = 4.67
6.994 x 0.4 = 2.7976
97. A. Initial investment = Rs.25 lakh
B. PV of lease rentals = (25 x 0.0386 x 12) x PVIFA m (19, 3)
1
= 11.58 x x PVIFA(19, 3)
d12
= 11.58 x 1.1002 x 2.140 = Rs.27.26 lakh
C. PV of tax shield on lease payments = (25 x 0.0386 x 12) x PVIFA(14, 3) x 0.46
= 11.58 x 2.322 x 0.46 = Rs.12.36 lakh
D. PV of tax shields on depreciation = [10 x PVIF(14, 1) + 6 x PVIF(14, 2)
+ 3.6 x PVIF(14, 3)] x 0.46
= (10 x 0.877 + 6 x 0.769 + 3.6 x 0.675) x 0.46
= 15.819 x 0.46 = Rs.7.276 lakh
E. PV of interest tax shields on = [4.02 x PVIF(14, 1) + 2.58 x PVIF(14, 2)
displaced debt of Rs.27.26 lakh + 0.87 x PVIF(14.3)] x 0.46 = Rs.2.81 lakh
F. PV of Salvage Value = 1.5 x PVIF(14, 3) = 1.5 x 0.675 = Rs.1.012 lakh
Debt Amortization Schedule
Year Debt outstanding Capital Interest Repayment
at the beginning
1 27.26 7.56 4.02 11.58
2 19.70 9.00 2.58 11.58
3 10.70 10.71 0.87 11.58
NAL = A – B + C – D – E – F
= 25 – 27.26 + 12.36 – 7.276 –2.81– 1.012 = –Rs.1.00 lakh
As NAL is negative leasing is not recommended.

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98. a. Equivalent Loan Model

225
Lease rental per quarter = Rs. x 1.10 x 0.026 x 1.045 x 3 = Rs.19.40 lakh
1.04
Kd = 15% Kdq = (1.15)1/4 – 1 = 3.56%
Post-tax cost of debt = 15 (1 – 0.42) = 8.7%
Cost of the asset = Rs.225 lakh
PV of lease rentals = 19.40 x PVIFA (3.56, 20) x (1.0356)
= 19.40 x 14.124 x 1.0356 = Rs.283.76 lakh
PV of tax shield on = 19.40 x 4 x 0.42 x PVIFA(8.7,5)
lease rentals = Rs.127.76 lakh
PV of depreciation tax shields =
⎡ 75 50 33.33 22.22 14.81 ⎤
⎢ + + + +
5⎥
2 3 4
0.42
⎣1.087 (1.087) (1.087) (1.087) (1.087) ⎦
= Rs.68.43 lakh
PV of salvage value = 25 x PVIF(8.7,5) = Rs.16.47 lakh
Interest allocation
Effective installment per annum = 19.4 FVIFA(3.56,4) x (1.0356) = Rs.84.76 lakh
Actual installment = 19.40 x 4 = Rs.77.60 lakh
Year Balance Eff. Int Principal Adjusted PVIF(8.7) Present Value
outstanding @ 15% Interest * (Rs.)
1 283.76 42.56 42.19 35.40 0.920 32.56
2 241.57 36.23 48.52 29.08 0.846 24.60
3 193.05 28.95 55.81 21.79 0.778 16.95
4 137.24 20.58 64.17 13.42 0.716 9.60
5 73.07 10.96 73.80 3.80 0.659 2.50
86.21
Tax shield on interest
= 86.21 x 0.42 = 36.21
NAL = 225 – 283.76 + 127.76 – 68.43 – 36.21 – 16.47
= –Rs.52.09 lakh
Since NAL is negative leasing is not recommended.
b. Suggested Model
i. Cost of capital
2 1
= 15(1 – 0.42) + x 24 = 5.8 + 8 = 13.8%
3 3
ii. Cost of the asset = Rs.225 lakh
iii. PV of lease rentals = 19.4 x PVIFA(3.56, 20) x (1.0356) = Rs.283.76 lakh
iv. Tax shield on lease rental = 19.4 x 4 x 0.42 x PVIFA(13.8,5) = Rs.112.43 lakh
v. Tax shield on depreciation = Rs.62.22 lakh
vi. PV of salvage value = 25 PVIF(13.8,5) = Rs.13.10 lakh
vii. Interest calculated as above
Year 1 2 3 4 5
Interest 35.400 29.080 21.790 13.420 3.800
PVIF(13.8,t) 0.878 0.772 0.679 0.596 0.524
PV of Interest 31.080 22.450 14.800 7.990 1.990
Total = 78.31

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 Investment Banking and Financial Services

Tax shield on interest = 78.31 x 0.42 = Rs.32.89 lakh

NAL = 225 – 283.76 + 112.43 – 62.22 – 32.89 – 13.10 = –Rs.54.54
Since NAL is negative leasing is not recommended according to the suggested
model also.
Adjusted interest = Actual installment – Principal
Principal = Effective installment per annum – Effective interest @ 15%.
99. Steel Alloys Ltd’s evaluation of lease using Weingartner model and Suggested model
A: lease rental = Rs.320 per thousand
B: lease rental = Rs.400 per thousand
Weingartner Model Suggested Model
Cash flows Sign
A B A B
Initial payment + 100.0 100.0 100.0 100.0
PV lease rentals – 108.60 135.78 100.1 125.1
PV net salvage value – 5.0 5.0 5.0 5.0
PV tax shield on:
LRs + 46.3 57.9 46.3 57.9
Dep – 23.8 23.8 23.8 23.8
Interest – – – 18.6 23.3
Management Fee + 0.4 0.4 0.4 0.4
Management Fee – 1.0 1.0 1.0 1.0
Net Advantage of Leasing 8.3 (7.2) (1.8) (19.9)
Change in NAL (A–B) 15.5 18.1
Discussion:
In general, it can be seen that the salvage value, management fee, and tax shield on it and
even the tax shield on depreciation do not cause much differences among the two models
considered.
Major differences arise from PV of lease rentals, tax shield on lease rentals and tax shield
on interest on displaced debt. These cause difference because of their size and the different
discounting rates used to find the PVs.
Weingartner’s model evaluates the proposal A as positive because the effect of displaced
debt is ignored by the model. This result strongly points to the necessity to explicitly
consider the debt displacement effect.
100. Cost of capital
1.5 1
= x 0.14 x 0.7 + x 0.205
2.5 2.5
= 0.0588 + 0.0820 = 14.08% or say 14%
PV(EBDIT Stream)
= EBDIT(1 – T) x PVIFA(14, 4)
= 5(1 – 0.3) x 2.914 = Rs.10.20 crore
Processing fee = 10 x 0.005 = Rs.0.05 crore
32
PV(Lease rentals) = x 3 x 4 x 1.0861 x 2.914 x 10 = Rs.12.15 crore
1000
PV(TS on Processing fee)

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 Part II

1
= 0.05 x 0.30 x = Rs.0.0132 crore
1.14
PV(TS on LR)
32
= x 10 x 12 x 0.30 x PVIFA(14,4) = Rs.3.36 crore
1000
PV(DTS):
(Rs. crore)
Year Depreciation TS PV @ 14%
1 2.50 0.75 0.66
2 1.88 0.56 0.43
3 1.41 0.42 0.28
4 1.06 0.32 0.19
1.56
PV(Salvage value)
= 10 x 0.10 x PVIF(14, 4) = Rs.0.59 crore
NPV(B)
= – Initial investment + PV(EBDIT) + PV(DTS) + PV(NSV)
= –10 + 10.20 + 1.56 + 0.59 = Rs.2.35 crore
NPV(L)= –PV(LR) + PV(TS on LR) + PV(EBDIT) – Processing fee + PV(TS on rocessing fee)
= –12.15 + 3.36 + 10.20 – 0.05 + 0.0132 = Rs.1.3732 crore
As the NPV(B) is higher, the company should buy the equipment.

LEASE EVALUATION: THE LESSOR’S ANGLE

101. Define L as the annual break even rental for Evergreen; the components of NPV(L) to
Evergreen can be computed as follows:
a. Equipment cost = Rs.47 lakh
b. Present value of lease payments = L x PVIFA(16, 5) = 3.274L
c. PV of tax on lease rentals = 0.46 x L x PVIFA(16, 5)
= 0.46 x L x 3.274 = 1.506L
d. i. PV of tax shield on = 11.75 x PVIF(16, 1) + 8.81 x PVIF(16,2) + 6.61 x
depreciation @ 25% p.a. PVIF(16,3) + 4.96 x PVIF(16,4) + 3.72 x PVIF(16, 5)]
x 0.46
= [(11.75 x 0.862) + (8.81 x 0.743) + (6.61 x
0.641) + (4.96 x 0.552) + (3.72 x 0.476)] x 0.46
= 25.42 x 0.46 = Rs.11.69 lakh
ii. PV of tax shield on = [18.80 x PVIF(16,1) + 11.28 x PVIF(16,2)
depreciation @ 40% p.a. + 6.77 x PVIF(16,3 ) + 4.06 x PVIF (16, 4)
+ 2.44 x PVIF(16, 5)] x 0.46
= [(18.80 x 0.862) + (11.28 x 0.743) + (6.77 x 0.641)
+ (4.06 x 0.552) + (2.44 x 0.476)] x 0.46
= 32.32 x 0.46 = Rs.14.87 lakh
iii. PV of tax shield on = 47 x PVIF(16,1) x 0.46 = 47 x 0.862 x 0.46
depreciation @100% = Rs.18.63 lakh
e. PV of initial direct costs = Rs.0.5 lakh
f. PV of management fee = Rs.0.75 lakh
g. PV of tax shield on initial direct= 0.5 x 0.46 x PVIF(16, 1)
cost = 0.5 x 0.46 x 0.862 = Rs.0.198 lakh

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 Investment Banking and Financial Services

h. PV of tax on management fee = 0.46 x 0.75 x PVIF(16, 1)

= 0.46 x 0.75 x 0.862 = Rs.0.297 lakh
i. PV of salvage value = 2.35 x PVIF(16, 5)
= 2.35 x 0.476 = Rs.1.12 lakh
Given a tax relevant depreciation rate of 25% p.a., L can be obtained from the equation
–47 + 3.274L – 1.506L + 11.69 – 0.5 + 0.75 + 0.198 – 0.297 + 1.12 = 0
1.768L = 34.04
34.04
L= = Rs.19.25 lakh
1.768
Where the tax relevant depreciation rate is 40% p.a., L is equal to
–47 + 3.274L – 1.506L + 14.87 – 0.5 + 0.75 + 0.198 – 0.297 + 1.12 = 0
= 1.768L – 30.85 =0
1.768L = 30.85
30.85
L = = Rs.17.45 lakh
1.768
Where rate of depreciation is 100%
L = –47 + 3.274L – 1.506L + 18.63 – 0.5 + 0.75 + 0.198 – 0.297 + 1.12 = 0
11.768L – 27.10 =0
1.768L = 27.10
27.10
L = = Rs.15.33 lakh
1.768
102. a. Assuming that the investment cost is Rs.1,000, the monthly break even rentals for
the two types of lease contracts can be denoted as L1 and L2 respectively.
To determine L1 we must set the NPV(L) equation involving L1 to zero.
For this purpose we must determine the following:
i. Investment cost = Rs.1,000
ii. PV of lease rentals = 12L1 x PVIFA
M (16, 3)

= i
12L1 x x PVIFA(16, 3) where i = 16%
d12
= 12L1 x 1.0847 x 2.246 = 29.23L1
iii. PV of tax on lease rentals = 12L1 x PVIFA(16, 3) x 0.46
= 12L1 x 2.246 x 0.46 = 12.39L1
iv. PV of tax shields on = [250 x PVIF(16,1) + 187.50 x PVIF(16,2)
depreciation + 140.63 x PVIF(16, 3)] x 0.46
= [(250 x 0.862) + (187.5 x 0.743)
+ (140.63 x 0.641)] x 0.46
= (215.52 + 139.34 + 90.09) x 0.46 = 204.6
v. PV of residual value = 1,000 x 0.05 x PVIF(16, 3)
= 1,000 x 0.05 x 0.641 = 32.05
Setting the NPV(L) equation to zero, we get
–1,000 + 29.23L1 – 12.39L1 + 204.6 + 32.05 = 0
= 16.84L1 – 763.35 = 0

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 Part II

16.84L1 = 763.35
763.35
L1 = = 45.32.
16.84
Therefore, the minimum lease rental Starlight must charge for writing a lease
contract will be Rs.45.32 ptpm.
The break even rental for a type II contract will be
i. Investment Cost = Rs.1,000
ii. PV of lease rentals = 12L1 x PVIFA
m (16 ,5 )

= i
12L1 x x PVIFA(16, 5)
d12
= 12L1 x 1.0847 x 3.274
= 12L1 x 1.0847 x 3.274
= 42.61L1
iii. PV of tax on lease rental = 12L1 x PVIFA(16, 5) x 0.46
= 12L1 x 3.274 x 0.46 = 18.07L1
iv. PV of tax shields = [400 x PVIF(16, 1) + 240 x PVIF(16, 2) + 144
on depreciation x PVIF(16,3) + 86.40 x PVIF(16,4) + 51.84
x PVIF(16, 5)] x 0.46
= [(400 x 0.862) + (240 x 0.743) + (144 x 0.641)
+ (86.4 x 0.552) + (51.84 x 0.476)] x 0.46
= 316.40
PV of residual value = 1,000 x 0.05 x PVIF(16,5)
= 1,000 x 0.05 x 0.476 = 23.8
–1,000 + 42.61L1 – 18.07L1 + 316.40 + 23.8 = 0
L2 = 26.88 ptpm.
b. Minimum monthly rental for the given lease proposal will be
75 x 1.10 x 0.02688 = Rs.2.22 lakh.
103. a. Let us work out with an amount of Rs.1,000. The break even rental for RMCL can
be calculated as follows:
A. Investment cost = Rs.1000
B. PV of lease rentals = 12LB x PVIFA M (16, 3)
i
= 12LB x x PVIFA(16, 3)
(d ) P
i
= 12LB x x PVIFA(16, 3)
(d)12
= 12LB x 1.0743 x 2.322 = 29.23
C. PV of tax shield on lease = 12LB x PVIFA(15,3) x 0.46 =12LB x 2.28 x
rentals 0.46
= 12.58LB
D. PV of tax shields forgone = [250 x PVIF(15, 1) + 187.50 x PVIF(15 , 2)
on depreciation + 140.63 x PVIF(15, 3)] x 0.46
= [(250 x 0.870) + (187.5 x 0.756)
+ (140.63 x 0.658)] x 0.46
= 451.63 x 0.46 = 207.75
E. PV of interest tax shields = [3.67 x PVIF(15,1) + 2.33 x PVIF(15, 2)
on displaced debt + 0.79 x PVIF(15, 3)] x 0.46
= [(3.67 x 0.870) + (2.33 x 0.756)
+ (0.79 x 0.658)] x 0.46 = 2.516LB

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 Investment Banking and Financial Services

Debt Repayment Schedule

Year Amount outstanding Capital content Investment Installment
at the beginning content adjusted
1 29.23LB 8.33LB 3.67LB 12LB
2 20.90LB 9.66LB 2.33LB 12LB
3 11.23LB 11.21LB 0.79LB 12LB
Setting the NAL of the lease proposal equal to zero, we get
A–B+C–D–E=0
1000 – 29.23LB + 12.58LB – 207.75 – 2.516LB = 0
–19.16LB + 792.25 = 0
LB = 41.34
Break even rental = Rs.41.34 ptpm
The break even rental of RLL is as follows:
F. Initial Investment = 1,000
G. PV of lease receipts = 12 LB′ x PVIFA M (14, 3)
i
= 12 LB′ x x PVIFA(14,3)
(12 )
d
= 12 LB′ x 1.0743 x 2.322 = 29.93
H. PV of the tax liability on lease = 12 LB′ x 0.46 x PVIFA(14,3)
receipts = 12 LB′ x 0.46 x 2.322 = 12.81 LB′
I. PV of depreciation tax shields = [250 x PVIF(14,1) + 187.5 x PVIF(14,2)
+ 140.63 x PVIF(14,3)] x 0.46
= [(250 x 0.877) + (187.5 x 0.769)
+ (140.63 x 0.675)] x 0.46 = 210.907
Break Even Lease Rental
=–F+G–H+I=0
= – 1,000 + 29.93 LB – 12.81 LB + 210.907 = 0
= – 789.09 + 17.12 = 0
LB′ = 46.09 ptpm
b. The maximum lease rental that RMCL can pay (Rs.41.34 ptpm) is less than the
minimum that RLL can accept (Rs.46.09 ptpm). Therefore, it is not possible to strike
a deal for the two.
104. a. i. Let the cost of the asset = Rs.1,000
Define L as the monthly lease rental. The value of L can be determined from
the equation:
i
Lx x 12 x PVIFA(25,5) + 100 x PVIF(25,5) = 1,000
d12
i.e. 36.493L + (100 x 0.328) = 1,000
i.e. 36.493L = 967.2
or L = Rs.26.50 per thousand per month
ii. Define L as the equated ballooned rental collected from months 49-60 in
advance. The value of L can be obtained from the equation:
(0.1 x 26.5 x 1.0188 x PVIFA(1.88,48))
+ (L x 1.0188 x PVIFA(1.88,12) x PVIF(25,4)) + (100 x PVIF(25,5) )= 1,000
i.e. (2.65 x 32.047) + (L x 10.856 x 0.410) + (100 x 0.328)
i.e. 4.451L + 117.72 = 1,000

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 Part II

i.e. L = Rs.198.22 per thousand per month

Therefore, the lease rental for the first 48 months is Rs.26.5 ptpm and for the
next 12 months it is Rs.198.22 ptpm.
b. Structure I Structure II
Initial investment = Rs.1,000 1,000
cost
Gross investment in lease = (26.5 x 12 x 5) + 100 2,605.84
= 1,690
Unexpired finance charge = Rs.690 1,605.84
Average annual finance charge = Rs.138 321.17
Add-on yield = 13.8% 32.12%
105. a. Maximum value of L from the point of view of Alpha Industries can be calculated
as follows:
A. Acquisition cost = Rs.360 lakh
B. PV of Lease Rentals @ 18% p.a.
i i i
= 12L x (12) x PVIF(i, 1) + 18L x (12) x PVIF(i, 2) + 24L x (12) x PVIF(i, 3)
d d d
where,
i = 0.18 or 18%
= 12L x 1.095 x 0.847 + 18L x 1.095 x 0.718 + 24L x 1.095 x 0.609
= 41.29L
C. PV of tax shields on lease rentals @ 14% p.a.
= [12L x PVIF(14,1) + 18L x PVIF(14,2) + 24L x PVIF(14,3)] x 0.45
= [(12L x 0.877) + 18L x 0.769) + 24L x 0.675)] x 0.45 = 18.25L
D. PV of tax shield on depreciation @ 14%
= 360 x 0.877 x 0.45 = 142.07
E. PV of residual value @ 14%
= 24.70 x PVIF (14,3) = 24.7 x 0.675 = 16.67
F. PV of interest tax shields @ 14%
(Refer displaced debt amortization schedule given below)
= [6.29L x PVIF(14,1) + 4.69L x PVIF(14,2) + 1.73L x PVIF(14,3)] x 0.45
= [(6.29L x 0.877) + (4.69L x 0.769) + (1.73L x 0.675)] x 0.45
= 4.63L
Displaced Debt Amortization Schedule
Year Outstanding Int. Content Cap. Content Repay Adj. Int.
Debt @ 18% p.a.
1 41.29L 7.43L 5.71L 13.14L 6.29L
2 35.58L 6.40L 13.31L 19.71L 4.69L
3 22.27L 4.01L 22.27L 26.28L 1.73L
The maximum value of L can be obtained from the equation:
A–B+C–D–E–F=0
i.e. 360 – 41.29L + 18.25L – 142.07 – 16.67 – 4.63L = 0
i.e. 201.26 – 27.67L = 0
i.e. 27.67L = 201.26
i.e. L = Rs.7.27 lakh

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 Investment Banking and Financial Services

b. Minimum value of L from the point of view of Beta leasing can be obtained as
follows:
A. Initial outlay = Rs.360 lakh
B. PV of lease receipts
i i i
= 12L x (12) x PVIF(i,1) + 18L x (12) x PVIF(i,2) + 24L x (12) x PVIF(i,3)
d d d
where
i = 0.14 or 14%
= 12L x 1.0743 x 0.877 + 18L x 1.0743 x 0.769 + 24L x 1.0743 x 0.675
= 43.58L
C. PV of tax liability on lease receipts
= [12L x PVIF(14,1) + 18L x PVIF(14,2) + 24L x PVIF(14,3)] x 0.45
= [(12L x 0.877) + (18L x 0.769) + (24L x 0.675)] x 0.45 = 18.25L
D. Initial direct costs = 0.002 x 360 = 0.72
E. PV of tax shield on initial direct cost
= 0.72 x PVIF(14,1) x 0.45
= 0.72 x 0.877 x 0.45 = 0.28
F. PV of tax shield on depreciation
= 360 x 0.45 x PVIF(14, 1)
= 360 x 0.45 x 0.877 = 142.07
G. PV of tax shield on residual value
= 360 x 0.05 x PVIF(14,3) = 18 x 0.675 = 12.15
H. The minimum value of L can be obtained from the equation:
–A+B–C–D+E+F+G=0
i.e. – 360 + 43.58L – 18.25L – 0.72 + 0.28 + 142.07 + 12.15 = 0
i.e. – 206.22 + 25.33L = 0
i.e. L = Rs.8.14 lakh
106. Investment cost = Rs.120 crore
Equity component = Rs.24 crore (120 x 0.2)
Debt component = Rs.96 crore (120 x 0.8)
Equity-related cash flow is given by the equation and is denoted by E
E x PVIFA(24,5) = 24
24
E = = Rs.8.74 crore
2.745
Annual debt service charge is given by the equation in which debt repayment is denoted as
D.
D x PVIFA(18,5) = 96
96
D = = Rs.30.70 crore
3.127
Annual lease rental = Rs.39.44 crore
107. a. NAL for the lessee
A. Initial Investment = Rs.80 lakh
B. PV[LR] @ 16% i
= 80 x 0.0255 x 12 x (12 )
x PVIFA(i,5) where i = 16%
d
= 80 x 0.0255 x 12 x 1.0847 x 3.274 = Rs.86.94 lakh

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C. PV[TS on LR] = 80 x 0.0255 x 12 x 0.43 x PVIFA(12,5)

@ 12%
= 80 x 0.0255 x 12 x 0.43 x 3.605 = Rs.37.95 lakh
D. PV[DTS] @ 12% = [17.5 x 0.893 + 13.12 x 0.797 + 9.84 x 0.712
+ 7.38 x 0.636 + 5.54 x 0.567] x 0.43
= Rs.17.60 lakh

Amortization Schedule
(Rs. in lakh)
Year Lease initial Interest Capital Lease rental Adjusted
investment outstanding content interest
1 86.94 13.91 12.64 26.55 11.84
2 74.30 11.89 14.66 26.55 9.82
3 59.64 9.54 17.01 26.55 7.47
4 42.63 6.82 19.73 26.55 4.75
5 22.90 3.66 22.90 26.56 1.59
PV [Interest tax shields]
= [11.84 x 0.893 + 9.82 x 0.797 + 7.47 x 0.712 + 4.75 x 0.636 + 1.59 x 0.567] x 0.43
= Rs.11.89
NAL = 80 – 86.94 + 37.95 – 17.60 – 11.89
= Rs.1.52
b. NAL from lessor’s angle
Initial Investment = Rs.80 lakh
PV[LR] i
= 80 x 0.0255 x 12 x x PVIFA(i,5) where i = 12%
d (12)
= 80 x 0.0255 x 12 x 1.0639 x 3.605 = Rs.93.89 lakh
PV[Tax on LR] = 80 x 0.0255 x 12 x 0.26 x PVIFA(12,5)
= 80 x 0.0255 x 12 x 0.26 x 3.605 = Rs.22.95 lakh
PV[DTS] 17.60
= x 0.26 = Rs.10.64 lakh
0.43
NAL = – 80 + 93.89 – 22.95 + 10.64 = Rs.1.58 lakh
c. Since NAL for both the lessor and the lessee are positive it is possible to structure a
mutually advantageous lease transaction.
108. a. The value of L can be obtained by solving the equation
= [L x PVIF(20,2) + 1.15L x PVIF(20,3) + 1.3225L x PVIF(20,4) + 1.5208L x PVIF(20,5)]
= Rs.128 lakh
= (L x 0.694) + 1.15L x 0.579 + 1.3225L x 0.482 + 1.5208L x 0.402) = 128
= 0.694L + 0.666L + 0.637L + 0.611L = 128
2.608L = 128
L = Rs.49.07 lakh
Marginal cost of capital
⎛2 ⎞ ⎛1 ⎞
= ⎜ x 16 x 0.54 ⎟ + ⎜ x 18 ⎟ = 11.76% .
⎝ 3 ⎠ ⎝ 3 ⎠

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The net advantage of leasing will be as follows:

A. Initial investment = Rs.128 lakh
B. PV (Lease rentals) = 49.06 x PVIF(16, 2) + (1.15 x 49.06) x PVIF(16, 3)
+ (1.3225 x 49.06) x PVIF(16, 4) + 1.5208 x 49.06
x PVIF(16,5)
= (49.06 x 0.743) + (1.15 x 49.06) x 0.641 +
(1.3225 x 49.06) x 0.552 + (1.5208 x 49.06) x 0.476
= 36.46 + 36.15 + 35.83 + 35.52 = Rs.143.96 lakh
C. PV of tax shield on = 49.06 x PVIF(11.76, 2) x 0.46 + 56.42 x PVIF(11.76, 3)
lease rentals x 0.46 + 64.88 x PVIF(11.76,4) x 0.46 + 74.61
x PVIF(11.76,5) x 0.46
= (49.06 x 0.801 x 0.46) + (56.42 x 0.716 x 0.46)
+ (64.88 x 0.645 x 0.46) + (74.61 x 0.46 x 0.574)
= Rs.75.48 lakh
D. PV (tax shields on = [(51.20 x 0.895) + (30.72 x 0.801) + (18.43 x 0.716)
depreciation) @ 11.76 + (11.06 x 0.641) + (6.64 x 0.574)] x 0.46
= 94.506 x 0.46 = Rs.43.47 lakh
E. PV (Residual value) = 12.8 x PVIF(11.76, 5)
at 10% = 12.8 x 0.574 = Rs.7.34 lakh
The amortizaton schedule for the displaced debt is as follows:
(Rs. in lakh)
Year Debt outstanding Interest @ 16% Principal DSC
1 143.96 23.03 –23.03 –
2 166.99 26.72 22.34 49.06
3 144.65 23.14 33.28 56.42
4 111.38 17.82 47.06 64.88
5 64.32 10.29 64.32 74.61

F. PV of Interest tax shields = [23.03 x PVIF(11.76, 1) + 26.72 x PVIF(11.76, 2)

discounted @11.76% + 23.14 x PVIF(11.76, 3) + 17.82 x PVIF(11.76, 4)
+ 10.29 x PVIF(11.76,5) ] x 0.46
= [(23.03 x 0.895) + (26.72 x 0.801) + (23.14 x 0.716)
+ (17.82 x 0.641) + (10.29 x 0.574)] x 0.46
= 75.907 x 0.46 = Rs.34.917 lakh
G. NAL = A–B+C–D–E–F
= 128 – 143.96 + 75.48 – 43.47 – 7.34 – 34.917
= –Rs.26.21 lakh
As NAL is negative leasing is not recommended.
b. Define L′ as the break even rental payable annually in arrear
PV (Lease rentals) = L′ x PVIFA(16,5) = Rs.3.274 L′ lakh
PV (tax shield on lease rentals)
= 0.46 L′ PVIFA(11.76, 5) = 0.46 L′ x 3.626 = Rs.1.668 L′ lakh.

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The amortization schedule associated with the displaced debt will be as follows:
Year Debt outstanding Interest Principal Debt Service Charge
1 3.274 L′ 0.524 L′ 0.476 L′ L′
2 2.798 L′ 0.448 L′ 0.552 L′ L′
3 2.245 L′ 0.359 L′ 0.641 L′ L′
4 1.605 L′ 0.257 L′ 0.743 L′ L′
5 0.862 L′ 0.138 L′ 0.862 L′ L′
PV of interest tax shields discounted @ 11.76% = Rs.0.61 L′ lakh
L′ can be found from the following equation
128 – 3.274 L′ + 1.668 L′ –43.47–7.34 – 0.61 L′ =0
= 77.19 – 2.216 L′ = 0
77.19
L′ = = Rs.34.83 lakh
2.216
109. Initial Investment = Rs.22 lakh
Aggregate lease rentals payable under the lease during = 0.0283 x 22 x 48
the primary period = Rs.29.88 lakh
Aggregate interest charge for the lease period = Rs.7.88 lakh
Average annual interest charge 7.88
= Rs. = Rs.1.97 lakh
4
Add-on-yield 1.97
= x 100
22
= 8.96%
110. a. Define ‘i’ as the annual pre-tax yield implied by the lease transaction. The value of
i can be obtained from the equation:
= (31.25 x 12) x PVIFA m (i , 4) = 1,000
i
= 375 x x PVIFA(i, 4) = 1,000
(d)12
i 1000
= 12
x PVIFA(i,4) =
(d ) 375
i
= x PVIFA(i,4) = 2.667
(d)12
at i = 24%, LHS of the equation
= 1.1257 x 2.404 = 2.706
at i = 26%, LHS of the equation
= 1.1359 x 2.320 = 2.635
Interpolating the range we get
⎡ 2.667 − 2.706 ⎤
= 0.24 + ⎢0.02 x = 25.09%
⎣ 2.635 − 2.706 ⎥⎦
As the gross yield is more than required yield, the proposal can be recommended.
b. The value of ‘i’ can be determined from the following equation:
31.25 x 3 + 31.25 + 31.25 x PVIFA(i,44) = 1,000
i = 2.20% (monthly gross yield)
Annualized gross yield = (1.022)12 – 1 = 0.2986 or 29.86%
Since the gross yield is higher than the required yield, the proposal can be
recommended.
111. The marginal cost of capital

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 Investment Banking and Financial Services

⎛3 ⎞ 1
= ⎜ x 0.19 x 0.54 ⎟ + x 0.22 = 13.19%
⎝ 4 ⎠ 4
Define ‘i’ as the IRR of the proposal.
The various components of NAL valued at `i’ will be as follows:
A. Initial investment = Rs.1,000
B. PV of lease payments = 35.06 x 12 x PVIFA
M ( i , 3)

= i
420.72 x x PVIFA(i, 3)
d12
C. PV of tax liability on lease = 35.06 x 12 x 0.46 x PVIFA(i, 3)
payments = 193.53 x PVIFA(i, 3)
D. PV of tax shields on depreciation = (400 x PVIF(i, 1) + 240 x PVIF(i, 2)
+ 144 x PVIF(i, 3)) x 0.46
NAL = – A + B – C + D = 0
i
– 1000 + 420.72 x x PVIFA(i,3) – 193.53 x PVIFA(i,3) + 400 x PVIF(i,1)
d12
+ 240 x PVIF(i,2) + 144 x PVIF(i,3) x 0.46
NAL = –1,000 + (420.72 x 1.0162 x 2.829) – (193.53 x 2.829) + 343.32 = 5.32
at i = 4%
– 1,000 + (420.72 x 1.0215 x 2.775) – (193.53 x 2.775) + 337.88 = –6.56
i = 3.45%
Since IRR is less than the marginal cost of capital, the transaction cannot be accepted.
30 30
112. Loan repayment = = = Rs. 2.21 lakh
PVIFA ( 4%, 20) 13.590
The lease rental to be collected can be calculated as follows:
i
Xx x 4 x PVIFA(30, 5) + 5 x PVIF(30, 5) = 100 – 30
i4
where X is the lease rental required by Leasewell Ltd. after paying the loan installment.
X x 1.1064 x 4 x 2.436 + 5 x 0.269 = 70
X x 10.78 + 1.35 = 70
70 − 1.35
X= = 6.37
10.78
Lease rental to be quoted = 6.37 + 2.21 = Rs.8.58 lakh
8.58 1
or x 1000 x = Rs. 28.60 ptpm
100 3
If Leasewell should not loose on HP transaction, the IRR on hire transaction should be
equal to the IRR on the lease transaction.
IRR on lease transaction is `i’ in the following:
i
–70 + 6.37 x x 4 x PVIFAi, 5 – 6.37 x 4 x 0.3 x PVIFAi, 5 + [9PVIFi, 1 + 6.3 PVIFi, 2 +
i4
4.41PVIFi, 3 + 3.09PVIFi, 4 + 2.19PVIFi, 5 ] + 5 PVIFi, 5 = 0
Let i be 26%, LHS will be equal to
–70 + 25.48 x 1.0928 x 2.635 – 7.64 x 2.636 + [9 x 0.794 + 6.3 x 0.63 + 4.41 x 0.5
+ 3.09 x 0.397 + 2.19 x 0.315] + 5 x 0.315 = 0.043
Let i be 28%, LHS will be equal to

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–70 + 25.48 x 1.0996 x 2.532 – 7.64 x 2.532 + [9 x 0.781 + 6.3 x 0.61

+ 4.41 x 0.497 + 3.09 x 0.373 + 2.19 x 0.291] + 5 x 0.291 = –2.095
By interpolation,
0.043 − 0
i = 26 + x 2 = 26.04%
0.043 + 2.095
As Leasewell should not loose on HP transaction, the IRR required by it on the hire
transaction should be 26.04% or say 26%.
Let required flat rate be F%.
F
70 + 70 x x5
100 70 + 3.5F
EMI = = = 1.167 + 0.058F
60 60
Total charge for credit = 3.5F
Allocation of Finance charge on SOYD method
(Rs. crore)
Year SOYD Factor Interest PV at 26%
1 654/1830 1.251F 0.993F
2 510/1830 0.975F 0.614F
3 366/1830 0.700F 0.350F
4 222/1830 0.425F 0.169F
5 78/1830 0.149F 0.047F
2.173F
As required IRR is 26%, NPV (HP) at 26% should be equal to zero.
Hence,
– Initial Investment + PV of hire rentals – PV of tax on finance income = 0
–70 + (1.167 + 0.058F) 12 x 1.1142 x 2.635 – 2.173F x 0.3 = 0
–70 + 41.115 + 2.043F – 0.652F = 0
1.391F = 28.885
F = 20.77%
Flat rate to be charged on the HP transaction is 20.77%.
113. A. Initial investment = Rs.50 – 10 = Rs.40 lakh
B. PV of lease rentals at gross yield of 25%
= 0.035 x 12 x 50 x PVIFA(25%,5) = Rs.56.469 lakh
C. PV of loan repayment installments:
Loan repayment installment
Rs.10 lakhs 10
= = = Rs.3.054 lakh
PVIFA (16,5) 3.274
Therefore, PV of loan repayment installments = 3.054 x PVIFA(25%,5) = Rs.8.212 lakh.
NPV of the lease transaction = –A + B – C
= –40 + 56.469 – 8.212 = Rs.8.257 lakh
As the NPV is positive, SFSL can go ahead with the lease transaction.
Alternatively, the solution can be worked out by finding out the IRR of the lease
transaction. IRR is the rate at which the following equation is equal to zero.
–A+B–C=0
– 40 + 21PVIFA(i%,5) – 3.054PVIFA(i%,5) = 0

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– 40 + 17.946 PVIFA(i%,5) = 0
40
PVIFA(i%,5) = = 2.229
17.946
At i = 32%, PVIFA(32%,5) = 2.345
At i = 36%, PVIFA(36%,5) = 2.181
Hence, i is between 32% and 36% and by interpolation,
2.345 − 2.229
i = 32 + (36 – 32) x
2.345 − 2.189

0.116
= 32 + 4 x = 34.9%
0.164
As the IRR is greater than the required gross yield of 25%, SFSL can go ahead with the
transaction.
LEASE ACCOUNTING AND REPORTING
114. i. Present value of minimum lease payments
= 450 x 0.312 x PVIFA (18, 5) = Rs.439.03 lakh.
ii. The machinery must be capitalized at the present value of the minimum lease
payments or at the fair market value whichever is less. Since the present value of
minimum lease payments is less than the fair market value in this case, the
machinery must be capitalized at the value of Rs.439.03 lakh – the present value of
minimum lease payments.
iii. Unexpired finance charge at the inception of the lease
= (450 x 0.312 x 5) – 439.03 = Rs.262.97 lakh
iv. Allocation of unexpired Finance Charge (Actuarial Method)
Year Net amount Finance charge Capital content Lease payment
outstanding (@ 18%)
1 439.03 79.02 61.38 140.40 *
2 377.65 67.98 72.42 140.40
3 305.23 54.94 85.46 140.40
4 219.77 39.56 100.84 140.40
5 118.93 21.41 118.93 140.34
v. Allocation of Unexpired Finance Charge (Based on sum of the Years Digits
Method)
Year Factor Finance charge
(A) (B) (C) = 262.97 x (B)
1 5/15 87.66
2 4/15 70.19
3 3/15 52.59
4 2/15 35.06
5 1/15 17.53
The IASC states that the Actuarial Method or some form of approximation of this
method can be applied for allocating the unexpired finance charge. Since the Sum-
of-years Digits Method produces an allocation which is close to what is obtained
under the Actuarial Method, we can say that this method is acceptable to the IASC.

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vi. Allocation of Unexpired Finance Charge (Based on Straight Line Method)

Year Finance Charge
[= 262.97/5]
1 52.61
2 52.59
3 52.59
4 52.59
5 52.59
The method is conceptually flawed because it does not produce an allocation that
results in a constant periodic rate of interest on the remaining balance of the lease
liability during each period.
vii. Disclosure in the Financial Statements
Finance charge allocated by actuarial method.
Year 1
Income Statement
(Rs. in lakh)
Depreciation (439.03 x 0.30) 131.71
Finance Charge 79.02

Balance Sheet
Liabilities (Rs. Assets (Rs.
in lakh) in lakh)
Assets on Lease 439.03
Less: Depreciation 131.71 307.32
Secured loans
Lease Liability 305.23
Current Liabilities & Provisions
Lease Liability 72.42
* Lease payment = (P.V. of minimum lease payments + Unexpired finance charge at the
inception of the lease)/5

= (439.03 + 262.97)/5 = 140.4

115. A. PV[LR] = 72 x 0.105 x 4 x 1.0652 x 2.174 = 70.03

FMV = 72

Since, PV[LR] < FMV the equipments need to be capitalized at Rs.70.03 lakh.

B. Amortization Schedule

Year PV(LR) Cap. Int. LR Adj. Int

1 70.03 19.61 12.60 32.21 10.63
2 50.41 23.14 9.07 32.21 7.10
3 27.27 27.27 4.91 32.18 2.94

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C. Disclosure in Financial Statements

Year 1
Profit & Loss Account
(Rs. in lakh)
Depreciation 17.51
Interest component of LR 10.63
Balance Sheet
(Rs. in lakh)
Liabilities Assets
Fixed Assets
Secured Loans - Assets on lease
- Lease liability 27.27 - Gross Block 70.02
- Less. Depreciation 17.51
- Net Block 52.51
Current Liabilities
- Lease liability 23.14
Year 2
Profit and Loss Account
Depreciation
- Leased Assets 13.13
Interest component of lease rental 7.10
Balance Sheet
Liabilities Assets
Secured loans Fixed Assets
- Lease liability Nil - Assets on lease
- Gross Block 52.51
- Less: Acc. Dep. 13.13
- Net Block 39.38
Current liabilities
- Lease liability 27.27
Year 3
Profit and Loss Account
Depreciation
- Leased Assets 9.85
Interest component of lease rental 2.94
Balance Sheet
Liabilities Assets
Fixed Assets
- Assets on lease
- Gross Block 39.38
Less: Accumulated Depreciation 9.85

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- Net Block 29.54

25.50
116. Lease rental = Rs. x 65 = Rs.1.66 lakh
1000
Present value of lease rental
= 1.66 PVIFA(1.25, 60) x (1.0125)
= 1.66 x 42.095 x 1.0125 = Rs.70.75 lakh
Since the present value is more than the FMV, the asset will be capitalized at Rs.65 lakh.
Effective rate of interest
1.66 x PVIFA (km 60) (1 + km)= 65
PVIFA (km, 60) (1 + km) = 39.156
km = 1.5%, LHS = 39.971
km = 1.75, LHS = 37.611
∴ km = 1.59%
∴ k = (1.0159)12 – 1 = 20.84%
Effective installment p.a. = 1.66 x 1.0159 x FVIFA(1.59,12) = Rs.22.10 lakh
Actual Installment p.a. = Rs.19.92 lakh.
Interest adjustment = 22.10 – 19.92 = 2.18
Interest Allocation
Year Balance o/s. Interest @20.84 Principal Adjusted Interest
1 65.00 13.55 8.55 11.37
2 56.45 11.76 10.33 9.58
3 46.12 9.61 12.49 7.43
4 33.63 7.00 15.10 4.82
5 18.53 3.86 18.53 1.39
Lease Equipment Account
Year Year
1 To Lease payable 65 1 By Balance c/d 65
2 To Balance b/d 65 2 By Balance c/d 65
3 To Balance b/d 65 3 By Balance c/d 65
4 To Balance b/d 65 4 By Balance c/d 65
5 To Balance b/d 65 5 By Balance c/d 65
Lease Payable Account
1 To Lease rental 8.55 1 By Lease equipment 65.00
To balance c/d 56.45
65.00 65.00
2 To Lease rental 10.33 2 By Balance b/d 56.45
To Balance c/d 46.12
56.45 56.45
3 To Lease rental 12.49 3 By Balance b/d 46.12
To Balance c/d 33.63
46.12 46.12
4 To Lease rental 15.10 4 By Balance b/d 33.63
To Balance c/d 18.53
33.63 33.63

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Investment Banking and Financial Services

5 To Lease rental 18.53 5 By Balance b/d 18.53

18.53 18.53

Lease Rental Account

1 To Bank 19.92 1 By Lease payable 8.55
By Finance charges 11.37
19.92 19.92
2 To Bank 19.92 2 By Lease payable 10.33
By Finance charges 9.58
19.92 19.92
3 To Bank 19.92 3 By Lease payable 12.49
By Finance charges 7.43
19.92 19.92
4 To Bank 19.92 4 By Lease payable 15.10
By Finance charges 4.82
19.92 19.92
5 To Bank 19.92 5 By Lease payable 18.53
By Finance charges 1.39
19.92 19.92
Accumulated Depreciation
1 To Balance c/d. 19.50 1. By Depreciation 19.50
2. By Balance b/d 19.50
2 To Balance c/d 33.15 By Depreciation 13.65
33.15 33.15
3. By Balance b/d 33.15
3 To Balance c/d 42.70 By Depreciation 9.55
42.70 42.70
4. By Balance b/d 42.70
4 To Balance c/d 49.39 By Depreciation 6.69
49.39 49.39
5. By Balance b/d 49.39
5 To Balance c/d 54.07 By Depreciation 4.68
54.07 54.07

Profit and Loss Account

Year
1 To Finance Charges 11.37
To Depreciation 19.50
2 To Finance charges 9.58
To Depreciation 13.65
3 To Finance charges 7.43
To Depreciation 9.55
4 To Finance charges 4.82
To Depreciation 6.69
5 To Finance charges 1.39
To Depreciation 4.68

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 Part II

Balance Sheet
1 Secured Loan 1 Fixed Assets
Lease payable 46.12 Gross lease equipment 65.00
Current Liabilities Less: Acc. Depreciation 19.50
Lease payable 10.33 Net block 45.50
2 Secured Loan 2 Fixed Assets
Lease payable 33.63 Gross lease equipment 65.00
Current Liabilities Less: Acc. Depreciation 33.15
Lease payable 12.49 Net block 31.85
3 Secured Loans 3 Fixed Assets
Lease payable 18.53 Gross lease equipment 65.00
Current Liabilities Less: Acc. Depreciation 42.70
Lease payable 15.10 Net block 22.30
4 Secured Loan 4 Fixed Assets
Lease payable – Gross lease equipment 65.00
Current Liabilities Less: Acc. Depreciation 49.39
Lease payable 18.53 Net block 15.61
5 Secured Loans 5 Fixed Assets
Lease payable – Gross Lease equipment 65.00
Current Liabilities Less: Acc. Depreciation 54.07
Lease payable – Net block 10.93
117. i. Fair market value of the equipment = Rs.47 lakh
ii. PV of minimum lease payment
= (47 x 0.456) x PVIFA (18,3)
= 21.432 x 2.174 = Rs.46.59 lakh
The asset must be capitalized at Rs.46.59 lakh as it is less than fair market value.
The journal entry for capitalization will be
Leased Equipment a/c Dr 46.59
To lease payable a/c 46.59
The unexpired finance charge is equal to
(47 x 0.456 x 3) – 46.59 = Rs.17.70 lakh.
Allocation of Unexpired Finance Charge
(Rs. in lakh)
Year Outstanding Rate of Interest Principal Lease
lease liability interest charge amount payment
1 46.59 0.18 8.386 13.046 21.432
2 33.544 0.18 6.038 15.394 21.432
3 18.150 0.18 3.267 18.165 21.432
Ledger Accounts
Leased Equipment Account
Year Amount Year Amount
(Rs. in lakh) (Rs. in lakh)
1 To Lease payable a/c 46.59 1 By Balance c/d 46.59

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2 To Balance b/d 46.59 2 By Balance c/d 46.59

3 To Balance b/d 46.59 3 By Balance c/d 46.59

Accumulated Depreciation a/c

(On the Lease Equipment)
Year Amount Year Amount
in lakh in lakh
1 To Balance c/d 11.648 1 By Depreciation 11.648
2 To Balance c/d 20.383 2 By Balance b/d 11.648
By Depreciation a/c 8.736
20.383
3 To Balance c/d 26.93 3 By Balance b/d 20.383
By Depreciation 6.552
26.934 26.934
Depreciation a/c
(On the Leased Equipment)
Year Amount Year Amount
in lakh in lakh
1. To Accumulated depreciation a/c 11.648 1 By P & L a/c 11.648
2. To Accumulated depreciation a/c 8.736 2 By P & L a/c 8.736
3. To Accumulated depreciation a/c 6.552 3 By P & L a/c 6.552
Lease Rentals a/c
Year Amount Year Amount
in lakh in lakh
1 To Bank a/c 21.432 1 By Lease payable 13.046
By Finance charges 8.386
21.432
2 To Bank a/c 21.432 2 By Lease payable 15.394
By Finance charges 6.038
21.432
3 To Bank a/c 21.432 3 By Lease payable 18.165
By Finance charges 3.267
21.432
Finance Charges a/c
Year Amount in lakh Year Amount in lakh
1 To Lease rental a/c 8.386 1 By P & L a/c 8.386
2 To Lease rental a/c 6.038 2 By P & L a/c 6.038
3 To Lease rental a/c 3.267 3 By P & L a/c 3.267
Lease Payable a/c
Year Amount Year Amount
in lakh in lakh
1. To Lease rental a/c 13.046 1 By Leased equipment a/c 46.59
To Balance c/d 33.544
46.59 46.59
2. To Lease rental 15.394 2 By Balance b/d 33.544
To Balance c/d 18.150

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33.544 33.544
3. To Lease rental a/c 18.165 3 By Balance b/d 18.150

Disclosure in Financial Statements

Year 1
Profit and Loss a/c
Amount in lakh Amount in lakh
Finance charge 8.386
Depreciation 11.648
Balance Sheet
Liabilities Amount Assets Amount
in lakh in lakh
Secured loans Fixed Assets
Lease payable 15.394 Leased Equipment: Gross block 46.59
Current liabilities Less: Accumulated Depreciation 11.648
Lease payable 18.150 34.942
Year 2
Profit and Loss a/c
Dr. Cr.
Amount Amount
(Rs. In lakh) (Rs. in lakh)
Finance charges 6.038
Depreciation 8.736
Balance Sheet
Liabilities Amount Assets Amount
(Rs. in lakh) (Rs. in lakh)
Secured Loans
Lease payable 18.150
Current Liabilities
Lease payable —
Year 3
Profit and Loss a/c
Dr. Cr.
Amount in lakh Amount in lakh
To Finance charges 3.267
To Depreciation 6.552

118. The interest rate implicit in the lease transaction is given by the equation
(87 x 0.312) x PVIFA(r, 5) + 8.5 x PVIF(r, 5) = 87
At r = 18%, LHS of equation is equal to:
(27.144 x 3.127) + (8.5 x 0.437) = 88.599
At r = 19%, LHS of the equation is equal to
= (27.144 x 3.058) + (8.5 x 0.419) = 96.558
⎛ 1% x 87 − 88.599 ⎞
r = 18% + ⎜ − 88.579 ⎟ = 18.78%
⎝ 86.558 ⎠

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Investment Banking and Financial Services

Unearned Finance Income at the beginning:

= Rs.[(87 x 0.312 x 5) + 8.5 – 87) lakh
= Rs.(135.72 + 8.5 – 87) lakh = Rs.57.22 lakh
The allocation of the unearned financial income is given as under.
Allocation of Unearned Finance Income
Year O/s investment Interest Capital Lease
at the beginning content content receipt
1 87.00 16.339 10.805 27.144
2 76.195 14.309 12.835 27.144
3 63.360 11.899 15.245 27.144
4 48.115 9.036 18.108 27.144
5 30.007 5.635 30.007 35.642
Ledger Accounts
Gross Investment in Lease a/c
Dr. Cr.
Year Amount Year Amount
(Rs. in lakh) (Rs. in lakh)
1 To Inventory 87.00 1 By Bank a/c 27.144
To Unearned finance income 57.22 By Balance c/d 117.076
144.22 144.22
2 To Balance b/d 117.076 2 By Bank a/c 27.144
By Balance c/d 89.932
117.076 117.076
3 To Balance b/d 89.932 3 By Bank a/c 27.144
By Balance c/d 62.788
89.932 89.932
Unearned Finance Income a/c
Dr. Cr.
Amount Amount
(Rs. in lakh) (Rs. in lakh)
To Finance income a/c 16.339 By Gross Investment in lease 57.22
To Balance c/d 40.881
57.22 57.22
To Finance income A/c 14.309 By Balance b/d 40.881
To Balance c/d 26.572
40.881 40.881
To Finance income a/c 11.899 By Balance b/d 26.572
To Balance c/d 14.673
26.572 26.572
Finance Income a/c
Dr. Cr.
Year Amount Amount
(Rs. in lakh) (Rs. in lakh)
1 To Profit & Loss a/c 16.339 1 By Unearned finance income a/c 16.339
2 To Profit & Loss a /c 14.309 2 By Unearned finance income a/c 14.309
3 To Profit & Loss a/c 11.899 3 By Unearned finance income a/c 11.899
Initial Direct Costs a/c

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 Part II

Dr. Cr.
Year Amount Year Amount
(Rs. in lakh) (Rs. in lakh)
1 To Bank a/c 0.5 1 By Profit & Loss a/c 0.5
Disclosure in Financial Statements
Year 1
Profit & Loss a/c
Dr. Cr.
Expenses Amount Income Amount
(Rs. in lakh) (Rs. in lakh)
Initial direct cost 0.5 Finance income 16.339
Balance Sheet
Dr. Cr.
Liabilities Amount Assets Amount
(Rs. in lakh) (Rs. in lakh)
Current Assets
Net investment in lease 76.195
(144.22 – 57.22 – 10.805)
Year 2
Profit & Loss a/c
Dr. Cr.
Expenses Amount Income Amount
(Rs. in lakh) (Rs. in lakh)
Finance Income 14.309

Balance Sheet
Dr. Cr.
Liabilities Amount Assets Amount
(Rs. in lakh) (Rs. in lakh)
Current Assets
Net investment in lease 63.36
(76.195 – 12.835)
Year 3
Profit & Loss a/c
Dr. Cr.
Expenses Amount Income Amount
(Rs. in lakh) (Rs. in lakh)
Finance Income 11.899
Balance Sheet
Liabilities Amount Assets Amount
(Rs. in lakh) (Rs. in lakh)
Current Assets
Net Investment in lease 48.115
(63.36 – 15.245)

119. a. i. Annual lease rental = 20 x 0.0265 x 12 = Rs.6.36 lakh

Present value of the annual lease rental (receivable in advance) plus the

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 Investment Banking and Financial Services

unguaranteed residual value discounted @ 16.5% per annum is equal to

= 6.36 x PVIFA(16.5, 5) x 1.165 + 0.6 x PVIF(16.5, 5) = Rs.24.26 lakh

Cost of Goods Sold a/c

Dr. Cr.
Year Amount Year Amount
(Rs. in lakh) (Rs. in lakh)
1 To Inventory a/c (20 x 0.83) 16.6 1 By profit & loss a/c 16.6
ii. Fair Market Value = Rs.20 lakh
Since (ii) < (i), the sales revenue should be recorded at Rs.20 lakh.
b. The rate of interest implicit in the proposal (r) is given by the equation
= 6.36 x PVIFA(r, 5) + 0.6 x PVIF(r, 5) = 20
= 6.36 x PVIFA(r, 5) x (1 + r) + 0.6 x PVIF(r,5) = 20
= 31.28%.
Unearned Finance Income = [(6.36 x 5) + 0.6)] – 20 = Rs.12.4 lakh.
Allocation of Unearned Finance Income (Rs. in lakh)
Year Investment outstanding Interest content Capital content Lease related receipt
at the beginning
1 20.00 4.27 2.09 6.36
2 17.91 3.61 2.75 6.36
3 15.16 2.75 3.61 6.36
4 11.55 1.62 4.74 6.36
5 6.81 0.14 6.81 6.95

Dr. Finance Income a/c Cr.

Year Amount Year Amount
(Rs. in lakh) (Rs. in lakh)
1 To Profit & Loss a/c 4.27 1 By Unearned 4.27
finance income
Disclosure in the Financial Statements
Dr. Profit & Loss a/c Cr.
Amount Amount
(Rs. in lakh) (Rs. in lakh)
Cost of goods sold 16.6 Sales 20.00
Finance income 4.27
Balance Sheet
Liabilities Amount Assets Amount
(Rs. in lakh) (Rs. in lakh)
Current Assets
Net Investment in lease 20 – 2.09 17.91
HIRE PURCHASE
120. a. Cash price of equipments = Rs.100 lakh
Monthly installments payable = Rs.3,94,440

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 Part II

Total hire purchase price = 3,94,440 x 36 = Rs.141,99,840

1, 41, 99, 840 − 1, 00, 00, 000 1
Flat rate of interest = x 100 x = 13.9% ~ 14%
1, 00, 00, 000 3

b. Rate of interest implicit in the scheme is that rate which would equate the present
value of rentals to the cash price.
3,94,440 x PVIFA(k,36) = 100,00,000
100,00,000
PVIFA(k,36) = = 25.3524
3,94,440
From the additional information given,
PVIFA(2%,36) = 25.489
PVIFA(3%,36) = 21.832
25.489 − 25.3524
k=2+ = 2.04%
25.489 − 21.832
The implicit rate of interest per annum = (1 + 0.0204)12 – 1 = 27.42%
c. The sum-of-the-years digits would be,
36 + 35 + 34 + ....... + 3 + 2 + 1 = 666
Total interest payable for the three-year period = Rs.41,99,840.
Year Interest Allocation Rs.

1 ** 366 x 41,99,840 = 23,08,020

666
222
2 x 41,99,840 = 13,99,947
666
78
3 x 41,99,840 = 4,91,873
666
Since the interest rate is charged over a three year period.

** = 36 + 35 + .... + 25 = 366
36 + 35 + .... + 1 666
24 + 23 + .... + 13 222
= =
36 + 35 + .... + 1 666
12 + 11 + .... + 1 78
= =
36 + 35 + .... + 1 666
4 1
121. a. Cost of Capital = 20 (1 − 0.43) x + 24 x
5 5
9.12 + 4.8 = 14 (approx.)
Loan amount = 30,000 x 0.75 = Rs.22,500
22,500 + 22,500 x 0.12 x 3
Monthly HP = = Rs.850
36
i
PV of HP = 12 x 850 x PVIFA(14,3) x *
i12
= 10,200 x 2.322 x 1.0626 = Rs.25,167
* i = Effective rate of interest implied by the completed transaction
i/i12 can be found out from the Table 1 at the end of the textbook.

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 Investment Banking and Financial Services

For i = 0.14, i/i12 = 1.0626

Total charge for credit = 22,500 x 0.12 x 3 = 8,100

Year SOYD Annual Financial Income (Rs.)

1 366/666 x 8100 4,451
2 222/666 x 8100 2,700
3 78/666 x 8100 949
PV of tax on finance charge
= [4,451 PVIF(14,1) + 2,700 PVIF(14,2) + 949 PVIF(14,3)] x 0.43
= (4,451 x 0.877 + 2,700 x 0.769 + 949 x 0.675) x 0.43 = Rs.2847.3
NPV = –22,500 + PV of HP – PV of tax on finance charge
= –22,500 + 25,167 – 2847.3 = – Rs.180.3
b. Effective rate of interest
n 36
= (2F) = x 2 x 12 = 23.35
n +1 37

122. 3 1
Cost of capital = x 16 x 0.7 + x 28 = 15.4
4 4
Cost of Leasing
A. PV of Lease Rentals
i *
= 0.027 x 280 x 12 x x PVIFA(16%,5) = 322.17
d12
B. PV of TS on Lease Rentals
= 280 x 0.027 x 12 x PVIFA(15.4%,5) x 0.3 = 90.384
COL = A – B = 231.79
Cost of Hire Purchase
224 + 224 x 0.15 x 3
C. EMI = = 9.02
36
i
D. PV of Hire payments = 9.02 x 12 x PVIFA(16%,3) x = 263.70
d12
Total charge for credit = 224 x 0.15 x 3 = 100.8
Interest Allocation
Year SOYD Factor Interest Allocation
1 366/666 55.39
2 222/666 33.60
3 78/666 11.81
E. PV of TS on charge for credit
= [55.39 PVIF(15.4,1) + 33.6 PVIF(15.4,2) + 11.81 PVIF(15.4,3)] 0.3=Rs.24.28
F. PV of DTS
= [70 PVIF(15.4,1) + 52.5 PVIF(15.4,2) + 39.38 PVIF(15.4,3) + 29.53(15.4,4)
PVIF(15.4,4)
+ 22.15 PVIF(15.4,5)] 0.3 = Rs.45.97 lakh
COHP = C+D–E–F
= 56 + 263.7 – 24.28 – 45.97 = Rs.249.45 lakh
COHP > COL, leasing is recommended.

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 Part II

i
* For i = 0.16, d12 = 0.1475 ⇒ = 1.0847
d12
(From Table A.1 (Relationship between Nominal and Effective Rates of Interest and
Discount) from the textbook.)
123. Cost of leasing can be determined as follows:
A. Present value of lease payments
i
= 360 x 0.028 x (12 )
* x 12 x PVIFA(20,5)
d
= 360 x 0.028 x 1.1053 x 12 x 2.991 = Rs.339.88 lakh
B. Present value of tax shield on lease payments
= 360 x 0.028 x 12 x 0.5175 x PVIFA(16,5) = 62.6 x 3.274 = Rs.204.94 lakh
Cost of hire purchase can be determined as follows:
C. Down Payment = 360 x 0.2 = Rs.72 lakh
D. Monthly hire purchase installment
360 x 0.8 (1 + 0.16 x 3)
= = Rs.11.84 lakh
36
E. Present value of monthly HP installments
i
= 11.84 x (12 )
** x 12 x PVIFA(20,3)
i
= 11.84 x 1.0887 x 12 x 2.107 = Rs.325.92 lakh
F. Unexpired finance charge at the inception of the HP transaction
= 360 x 0.8 x 0.16 x 3 = Rs.138.24 lakh
Allocation of the unexpired finance charge over the lease period based on the SOYD
method will be as follows:
Year Factor Finance charge
1 36 + 35 + .... + 25 366 366
= 138.24 x = 75.97
36 + 35 + .... + 1 666 666
2 24 + 23 + .... + 13 222 222
= 138.24 x = 46.08
36 + 35 + .... + 1 666 666
3 12 + 11 + .... + 1 78 78
= 138.24 x = 16.19
36 + 35 + .... + 1 666 666
G. Present value of tax shield on finance charge
= [(75.97 x PVIF(16,1) + 46.08 x PVIF(16,2) + 16.19 x PVIF(16,3)] x 0.5175
= [(75.97 x 0.862 + 46.08 x 0.748 + 16.19 x 0.641)] x 0.5175 = Rs.56.98 lakh
H. Present value of depreciation tax shields
= [(90 x PVIF(16,1) + 67.5 x PVIF(16,2) + 50.62 x PVIF(16,3) + 37.97 x PVIF(16,4)
+ 28.48 x PVIF(16,5)] x 0.5175
= [(90 x 0.862) + (67.5 x 0.743) + (50.62 x 0.6,41) + (37.97 x 0.552)
+ (28.48 x 0.476)] x 0.5175 = Rs.100.75 lakh
I. Present value of net salvage value
= 45 x PVIF(16,5)
= 45 x 0.476 = Rs.21.42 lakh
J. Cost of Leasing = A – B = Rs.194.94 lakh
K. Cost of HP = C + E – H – I – G = Rs.218.67 lakh
Since cost of leasing is less than the cost of hire purchase leasing is recommended.

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 Investment Banking and Financial Services

i
* For i = 20% = 0.20, = 1.1053 (From Table A.1)
d12
i
**For i = 20% = 0.20, 12
= 1.0887 (From Table A.1)
i
124. a. The first step is to calculate the break even rental for the lessor. Define L as the
break even rental payable quarterly in arrear on an asset cost of Rs.1,000
A. Initial Investment = Rs.1,000
i
B. PV of lease rentals = 4L x ( 4)
* x PVIFA (10,5)
i
= 4L x 1.0368 x 3.791 = 15.721L
C. PV of Tax on lease rentals = 4L x 0.3 x PVIFA(10,5)
= 4L x 0.3 x 3.791 = 4.549L
D. PV of Depreciation tax shields
= [250x0.909 + 187.5x0.826 + 140.63 x 0.751 + 105.47 x 0.683
+ 79.10x0.621] x 0.3 = 182.67
E. PV of residual value = 50 x 0.621 = 31.05
F. L can be obtained from the equation
–1,000 + 15.721L – 4.549L + 182.67 + 31.05 = 0
i.e 11.172L = 786.28
L = Rs. 70.38 ptpq
b. Define F as the flat rate of interest associated with the hire purchase plan.
750 + (750 x F x 3)
Quarterly installment = = (62.5 + 187.5F)
12
i
PV of quarterly installments = (62.5 + 187.5F) x 4 x ( 4) x PVIFA(i,3)
i
where i = 10%
= (62.5 + 187.5F) x 4 x 1.0367 x 2.487
= 644.57 + 1933.70F
Unexpired Finance Income = 750 x F x 3 = 2,250F
Allocation of unexpired finance income under SOYD method will be as follows:
Year SOYD Factor Finance Income
1 42/78 x 2,250F 1,211.54F
2 26/78 x 2,250F 750.00F
3 10/78 x 2,250F 288.46F
PV of Tax on Finance Income
= [1211.54F x 0.909 + 750.00F x 0.826 + 288.46F x 0.751] x 0.3 = 581.23F
The value of F can be obtained from the equation:
644.57 + 1,933.70F – 581.23F = 750
i.e. 1,352.47F = 105.43 or F = 7.8%
Minimum Quarterly Installment
⎡ 750 + (750 x 0.078 x 3) ⎤
=⎢ ⎥ = Rs.77.125
⎣ 12 ⎦
c. i. Total lease rentals = 70.38 x 4 x 5 = 1407.6
Cost of asset = 1000

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 Part II

Total interest charge = 407.6

Average annual interest charge
407.6
= = 81.52
5
81.52
Add-on yield = x 100 = 8.15%
1000
⎛ n ⎞
ii. Effective Rate of Interest implied by hire charges = 2F ⎜ ⎟
⎝ n +1 ⎠
12
= 2 x 0.078 x = 14.4%
13
i
* For i = 10%, 12
= 1.0368 (from table A.1 at the end of the textbook)
i
125. a. Loan amount = 600 x 0.75 = Rs.450 lakh
Total charge for credit = 450 x 0.16 x 4 = Rs.288 lakh
450 + 288
Equated annual installment = = Rs.184.5 lakh
4
The effective rate of interest (r) can be computed from the following equation of
value.
184.5 x PVIFA(r,4) = 450
PVIFA(r,4) = 2.439
r = 23% PVIFA(23,4) = 2.448
r = 24% PVIFA(24,4) = 2.404
Interpolating in the range of (23%, 24%) we get
⎛ 0.009 ⎞
r = 23 + ⎜ x 1⎟ = 23.2%
⎝ 0.044 ⎠
Year-wise allocation of Total Charge for Credit (unexpired finance charge).
i. Effective Rate of Interest Method
(Rs. lakh)
Year Investment Interest Principal Equated
Outstanding (23.2%) Annual Installment
1 450.00 104.40 80.10 184.50
2 369.90 85.82 98.68 184.50
3 271.22 62.92 121.58 184.50
4 149.64 34.71 149.64 184.35
ii. Sum of Years Digits Method
(Rs. lakh)
Year SOYD Factor Interest Charge
4 4
1 = 0.4 x 288 = 115.20
1 + 2 + 3 + 4 10
3
2 0.3 x 288 = 86.40
10
2
3 0.2 x 288 = 57.60
10

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 Investment Banking and Financial Services

1
4 0.1 x 288 = 28.80
10

288
iii. Year-wise allocation under the straight line method =
4
= Rs.72 lakh for all years
b. We will assume allocation of unexpired finance charge using effective rate of
interest method.
Income Statement
(Rs. lakh)
Expenses Incomes
Depreciation related to equipments acquired under HP plan 72.00
Finance charge 104.40
Balance Sheet
(Rs. lakh)
Liabilities Assets
Fixed assets
Secured loans Assets acquired under HP plan
HP outstandings 271.22 Gross block 600
Current liabilities Less: Acc. Depreciation 72
HP outstandings 98.680 Net Block 528.00
126. a. We will work with an amount of Rs.1,000.
Amount of loan = 0.75 x 1,000 = Rs.750
Total charge for credit = 750 x 0.135 x 4 = 405
Monthly installment = (750 + 405)/48 = Rs.24.06
Define (i) as the effective rate of interest per annum or the APR. The value of i can
be obtained from the equation:

= (24.06 x 12) x PVIFA m (i , 4) = 750

i
= 288.75 x x PVIFA(i,4) = 750
i (12)
i
= (12 )
x PVIFA(i, 4) = 2.597
i
i = 25.64%
b. Using the approximation formula, ‘i’ can be calculated as follows:
n 48
x 2F = x 2 x 13.5 = 26.45%
n +1 49
127. We will work with an amount of Rs.1,000.
The charge for credit = (1,000 x 0.14 x 4) = Rs.560
Monthly installment 1560
= = Rs.32.5
48

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 Part II

Amount of deposit at time 0 = Rs.250

48
⎡ 0.15 ⎤
Accumulated value of deposit after 4 years = 250 ⎢1 + = Rs.453.83.
⎣ 12 ⎥⎦

Monthly Cash Flows

Month Loan Initial Investment Accumulated Net cash flow
amount deposit amount value of deposit
1 2 3 4 5 6 – (2) – (3) – (4) + (5)

0 1,000 250 750.0

1 32.5 –32.5
2 32.5 –32.5
–
–
–
47 32.5 –32.5
48 32.5 453.83 +421.338
Setting the present value of the cash outflows equal to the present value of the cash inflows
at the rate of interest (i) we get 32.5 x 12 x PVIFA(m) [I, 4]
= 750 + 453.83 x PVIF(i, 4)
i
or 390 x (12 )
x PVIFA(i, 4)
i
= 750 + 453.83 x PVIF(i, 4)
at i = 0.36, LHS – RHS = 3.62
at i = 0.38, LHS – RHS = –9.81
⎡ 3.62 ⎤
i = ⎢0.36 + 0.02 x = 36.005 = 36%
⎣ 13.35 ⎥⎦
128. Let the amount of finance be Rs.1,000.
Monthly hire charge
1000 x 0.135 x 4 + 1000
= = Rs.32.08
48
Effective rate of interest if all the payments are made on the due date:
= 1,000 – 32.08 x PVIFA(i,48) = 0
i = 1.92%
Payment value of the payments not yet due = 32.08 x PVIFA(1.92,22*)
= 32.08 x 17.81 = Rs.571.35.
Total amount payable = 32.08 x 22 = Rs.705.76
Rebate = 705.76 – 571.35 = Rs.134.41
* Since 22 installments are yet to be paid
(48 – 26) = 22

129. Total charge for credit: 750 x 0.14 x 3 = Rs.315

12 x 13
Interest rebate: x 315 = Rs.36.89.
36 x 37

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130. Cost of Leasing

A. Present value of lease payments
i
= 270 x 0.0265 x 12 x (12 )
x PVIFA(i, 5)
d
where i = 20%
= 270 x 0.0265 x 12 x 1.1053 x 2.991 = Rs.283.85 lakh
B. Present value of tax shield on lease payments @ 17%
= 270 x 0.0265 x 12 x PVIFA(17, 5) x 0.46
= 270 x 0.0265 x 12 x 3.199 x 0.46 = Rs.126.34 lakh
C. Cost of leasing = 283.77 – 126.34 = Rs.157.43 lakh
Cost of Hire Purchase
D. Total charge for credit = 270 x 0.75 x 0.155 x 3 = Rs.94.1625 lakh
The allocation of total charge for credit based on the SOYD method is presented in
the following table:
Year SOYD Charge for credit
Factor (Rs. in lakh)
366
1 51.746
666
222
2 31.387
666
78
3 11.028
666
E. Present value of tax shield on charge for credit
[(51.746 x 0.855) + (31.387 x 0.731) + (11.028 x 0.624)] x 0.46 = Rs.39.07 lakh
F. Down payment = Rs.67.5 lakh (270 x 0.25)
G. Monthly hire purchase installment
(270 x 0.75) + (202.5 x 0.155 x3)
= = Rs.8.24 lakh
36
H. Present value of HP installment
i
= 8.24 x 12 x (12 )
x PVIFA(20, 3)
d
= 8.24 x 12 x 1.1053 x 2.991 = Rs.326.89 lakh
I. Present value of depreciation tax shields @ 17%
= [108 x PVIF(17,1) + 64.80 x PVIF(17,2) + 38.88 x PVIF(17,3)
+ 23.33 x PVIF(17,4) + 14 x PVIF(17,5)] x 0.46
= [92.308 + 47.337 + 24.276 + 12.449 + 6.384] x 0.46 = Rs.84.06 lakh
J. Present value of net salvage value
= 32 x PVIF(17, 5) = Rs.14.59 lakh
K. COHP = F + H – D – I – J = Rs.261.67 lakh
Since the cost of leasing is less than the cost of hire purchase, the assets are to be acquired
under the lease plan.
131. Year Depreciation
1 94.50 (378 x 0.25)
2 70.88 (283.5 x 0.25)

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 Part II

3 53.16 (212.62 x 0.25)

378 x 0.75 x 0.135 x 3 + 378 x 0.75
Monthly hire rental = = Rs.11.06 lakh
36
Total charge for credit: 378 x 0.75 x 0.135 x 3 = Rs.114.82
Allocation of Finance Charge
(Rs. lakh)
Year SOYD factor Interest allocation Hire rentals paid Principal

366
1 x 114.82 63.10 132.72 69.62
666

222
2 x 114.82 38.27 132.72 94.45
666

78
3 x 114.82 13.45 132.72 119.27
666
Year 1
Income Statement

Year 1 To Depreciation 94.50

To Finance charge 63.10
Year 2 To Depreciation 70.88
To Finance charge 38.27
Year 3 To Depreciation 53.16
To Finance charge 13.45
Balance Sheet

Year Liabilities Year Assets

1 Secured Loans 1 Fixed Assets: Equipment }
Hire purchase outstandings 119.27 on HP Gross Block 378.00
Current Liabilities Less: Depreciation 94.50
Hire Purchase outstandings 94.45 283.50
2 Secured loans 2 Fixed Assets: Equipment 378.00
Hire purchase outstandings – on HP Gross Block
Current Liabilities Less: Depreciation 165.38 212.62
Hire purchase outstandings 94.45 (94.50 + 70.88)
3 Secured loans 3 Fixed Assets: Equipment 378.00
Hire purchase outstandings – on HP Gross Block
Current liabilities Less: Depreciation 218.54 159.46
Hire purchase outstandings – (94.50+70.88+53.16)
132. Let us work out NPV (HP) for Rs.1,000.
a. Down payment = Rs.200
b. Quarterly rental = 800 x 0.14 x 3 + 800 = (0.42 + 1) 800

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 Investment Banking and Financial Services

c. Total charge for credit = 800 x 0.14 x 3 = Rs.336

i
d. Present value of hire rentals = 94.67 x x 4 x PVIFA(9,3)
d4

= 94.67 x 1.0556 x 4 x 2.531 = Rs.1012.69

e. Interest tax and income tax on interest income
Year SOYD Interest Interest tax Income PVIF(9,n)
factor allocation tax
42
1 x 336 180.92 5.43* 45.63 0.917
78
26
2 x 336 112.00 3.36 28.25 0.842
78
10
3 x 336 43.08 1.29 10.87 0.772
78
PV (Interest tax) = Rs.8.80**
PV (Income tax) = Rs.74.01***
Rs.82.82
NPV (HP) = – Loan amount + PV (Hire payments) – PV (Interest tax)
– PV (Income tax)
= – 800 + 1012.69 – 82.82 = Rs.129.87
* Interest tax @ 3% on interest allocation
∴ 3% on 180.92 = 5.43
Now income tax = (180.92 – 5.43) x 0.26 = 45.63
** 5.43 x 0.917 + 3.36 x 0.842 + 1.29 x 0.772 = 8.80
***45.63 x 0.917 + 28.25 x 0.842 + 10.87 x 0.772 = 74.02
133. a. A. Cost = Rs.4 lakh
B. Deposit = Rs.0.8 lakh
Let Monthly Installment be = Rs.M lakh
12
C. PV of Installments = 12M x i/d PVIFA18%, 4 = Rs.35.347M lakh
D. Service charge = 4 x 0.02 = Rs.0.08 lakh
Accumulated value of deposit = 0.8 FVIF1%, 48 = Rs.1.29 lakh
E. PV of deposit to be collected at the end 1.29 PVIF18%, 4 = Rs.0.666 lakh
EMI is ‘M’ in the following: A – B – C – D + E = 0
= +4 – 0.8 – 35.347M – 0.08 + 0.666 lakh = 0
3.786
M= = 0.107 lakh
35.347
b. Total charge for credit = 0.107 x 48 – 4 = 1.136 lakh
12 x 13
Interest rebate as per Rule of 78 = x 1.136 lakh = Rs.0.075 lakh
48 x 49
Amount payable on early settlement
= 0.107 x 12 – 0.082 = Rs.1.209 lakh
Accumulated value of deposit by the end of 36th month = 0.8 FVIF1%, 36 =
Rs.1.145 lakh
Monthly effective interest is ‘i’ is the following:

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 Part II

4 – 0.8 – 0.107 x 12 x PVIFAi,3 x i/d12 – 0.08 – 1.202 PVIFi,3 + 1.145 PVIFi,3 = 0

At i = 18%,
RHS = 4 – 0.08 – 1.284 x 1.0950 x 2.174 – 0.08 – 1.209 x 0.609 + 1.145 x 0.609 =
0.024
At i = 16% RHS = –0.049
By interpolation,
0.049
i = 16 + = 16.67%
0.073
134. a. Cost of lease to BCL:
Investment cost = Rs.100 crore
A. PV of lease rentals
= 0.032 x 100 x 12 x i/d12 x PVIFA15%,4
= 0.032 x 100 x 12 x 1.0795 x 2.855 = Rs.118.347 crore
Cost of capital
2 1
= x 0.15 x 0.7 + x 0.18 = 0.13 = 13%
3 3
B. PV of tax shield on lease rentals
= 0.032 x 100 x 12 x PVIFA13%,4 x 0.3
= 0.032 x 100 x 12 x 2.974 x 0.3 = Rs.34.260 crore
Cost of lease = A – B = 118.347 – 34.260 = Rs.83.74 crore
Cost of Hire Purchase to BCL:
Equated monthly installments
100 x 0.13 x 4 + 100
=
48
= Rs.3.167 crore
C. PV of hire rentals = 3.167 x 12 x i/d12 x PVIFA15%,4
= Rs.117.12 crore
PV of depreciation tax shield (DTS):
(Rs. crore)
Year Depreciation PV @ 13%
1 25.000 22.125
2 18.750 14.681
3 14.063 9.746
4 10.547 6.465
53.017
D. PV of DTS = 53.017 x 0.3 = Rs.15.905 crore
E. PV of interest tax shield:
Total amount of charge = 100 x 0.13 x 4 = Rs.52 crore
(Rs. crore)
Year SOYD factor Interest PV @ 13%
48 + ....... + 37 510
1 = 22.551 19.958
48 + ........ + 1 1176
36 + ....... + 25 366
2 = 16.184 12.672
48 + ........ + 1 1176

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 Investment Banking and Financial Services

24 + ....... + 13 222
3 = 9.816 6.802
48 + ........ + 1 1176
12 + ....... + 1 78
4 = 3.449 2.114
48 + ........ + 1 1176
41.546
F. PV of tax shield on finance charge of hire rentals
= 41.546 x 0.3 = Rs.12.464 crore
Cost of hire purchase = C – D – E
= 117.12 – 15.905 – 12.464 = Rs.88.75 crore
As COL < COHP, lease should be opted by BCL.
b. Comparison of purchase with lease can be done by calculating the net advantage of
lease (NAL).
If NAL > 0, lease should be opted and if NAL < 0, purchase would be preferable.
NAL = Investment cost – PV of lease rentals + PV of tax shield on lease rentals
– PV of depreciation tax shield – PV of interest tax shield
PV of interest tax shield:
Total charge for credit = 12 x 0.032 x 100 x 4 – 100 = Rs.53.6 crore
(Rs. crore)
Year SOYD factor Interest PV @ 13%
1 510/1176 23.245 20.572
2 366/1176 16.682 13.062
3 222/1176 10.118 7.012
4 78/1176 3.555 2.179
42.825
PV of interest tax shield = 42.825 x 0.3 = Rs.12.848 crore
NAL = 100 – 118.347 + 34.26 – 15.905 – 12.848 = –Rs.12.84 crore
As NAL is (–)ve, purchase alternative should be opted by BCL.
135. A. Loan Amount
= 4,00,000 x 0.75 = Rs.3,00,000
B. PV of installments paid
= 9250 x 12 x i/d12 x PVIFAi,3
= 1,11,000 x i/d12 x PVIFAi,3
C. Service fee = Rs.2,000
D. PV of amount payable on early settlement:
Total charge for credit
= 9250 x 12 x 4 – 3,00,000 = Rs.1,44,000
t ( t + 1)
Interest rebate as per rule 78 = xD
n (n + 1)
where,
t = Installments not due and unpaid;
n = Total number of installments; and
D = Total charge for credit

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12 x 13
= x 1,44,000 = Rs.9,551
48 x 49
Rebate for prompt payment
8
= x 9250 x 36 = Rs.266.40
10,000
Amount payable on early settlement
= (9250 x 12) – 9551 – 266.40 = Rs.1,01,183
PV of the amount = 1,01,183 x PVIFi,3
Effective rate of interest is ‘i’ in the following equation:
3,00,000 – 1,11,000 x i/d12 x PVIFAi,3 – 2000 – 1,01,183 x PVIFi,3 = 0

At i = 24%, LHS = –2551.191

At i = 28%, LHS = 12114.901
‘i’ is between 24% and 28%. By interpolation,
−2551.191 − 0
i = 24% + 4 x = 24.7%
− 2551.191 − 12114.901
136. Loans and Advances
Assuming that the Rs.3 lakh of upgraded assets belong to doubtful assets of less than one
year, the following workings can be made:
(Rs. lakh)
Asset Opening Increase Decrease Closing Provision
Standard 180 30 + 10 — 220.00 —
Sub-standard 50 3 12.5 + 5 + 10 25.50 10% 2.55
Doubtful
< 1 year 12 5 2.4 + 3 11.60 20% 2.32
1 - 3 years 8 — 0.80 7.20 30% 2.16
> 3 years 7 — 0.35 6.65 50% 3.33
Loss 25 — 1.25 23.75 100% 23.75
34.11
Hire Purchase Assets
Basic provisioning: Rs. lakh
Total dues 95
Less: Unmatured finance charges 20
Depreciated value 46
Realizable value 95
Less: Lower of the two 46
29
Additional provision: (Rs. lakh)
Time period Amount o/s Rate of provision Amount of provision
< 12 months 30 — —
12 - 24 months 15 - 5* = 10 10% 1.0
24 - 36 months 5 50% 2.5
> 36 months 3 100% 3.0
6.5
Additional provision on HP assets = 6.5 + 5* = 11.50
Total provision on HP assets = 29 + 11.50 = Rs.40.50 lakh

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 Investment Banking and Financial Services

Lease Assets
(Rs. lakh)
Amount o/s Rate of provision Amount
< 12 months 40 — —
12 - 24 months 24 10% 2.4
24 - 36 months 10 - 3* = 7 50% 3.5
> 36 months 10 100% 10.0
15.9
Provision on leased assets = 15.9 + 3.0* = 18.90
Total provision = 34.11 + 29 + 40.50 + 15.90 = Rs.119.51 lakh
*As 12 months have expired after the due date of the last payment, entire net book value
has to be provided for.
137. a. Down payment
= Rs.75 x 0.2 = Rs.15 lakh
A. Amount of loan
= Rs.75 – Rs.15 = Rs.60 lakh
B. Let the flat rate of interest be F%
F
Rs.60 x x 5 + Rs.60
EMI = 100
12 x 5
= Rs. (0.05F + 1) lakh
C. PV of hire payment
i
= Rs.(0.05F + 1) 12 PVIFA12%, 5 x 12
i
= Rs.(0.05F + 1) 12 x 3.605 x 1.0539
= Rs. (2.28F + 45.592) lakh
F
D. Unmatured finance charges = Rs.60 x x 5 = Rs.3F lakh
100
Allocation of unmatured finance charges
(Rs. lakh)
Year SOYD Finance Interest Net PV @ 12% PV @ 12%
factor income tax interest of net of
(Rs.) @ 2% (Rs.) interest interest tax
(Rs.) (Rs.) (Rs.)
1 654/1830 1.072F 0.021F 1.051F 0.938F 0.01875F
2 510/1830 0.836F 0.017F 0.819F 0.653F 0.01355F
3 366/1830 0.600F 0.012F 0.588F 0.419F 0.00854F
4 222/1830 0.364F 0.0073F 0.357F 0.227F 0.00464F
5 78/1830 0.128F 0.0026F 0.125F 0.071F 0.00148F
2.308F 0.04696F
or 0.047F
E. PV of interest tax = Rs.0.047F lakh
F. PV of income tax on net interest income = Rs.2.308F x 0.3 = Rs.0.692F lakh
NPV(HP)
=–A+C–E–F=0
= – 60 + 2.28F + 45.592 – 0.047F – 0.692F = 0
or, 1.541F = 14.408

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Rs.14,408
or, F= = 9.35%
Rs.1,541
b. Monthly hire installment
= 0.05F + 1
= Rs.(0.05 x 9.35) + 1= Rs.1.468 lakh
Equated yearly payment
= Rs.1.468 x 12 = Rs.17.616 lakh

Amortization Schedule
(Rs. lakh)
Year Installment Interest Capital content Interest tax
(Rs.) (Rs.) (Rs.) @ 2% (Rs.)
1 17.616 10.023 7.593 0.196
2 17.616 7.817 9.799 0.159
3 17.616 5.610 12.006 0.112
4 17.616 3.403 14.213 0.068
5 17.616 1.197 16.419 0.024
88.080
Profit and Loss Account
(Rs. lakh)
Year 1 Year 2 Year 3 Year 1 Year 2 Year 3
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
Interest tax 0.196 0.159 0.112 Finance 10.023 7.817 5.61
income

Balance Sheet
(Rs. lakh)
Year 1 Year 2 Year 3 Year 1 Year 2 Year 3
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
Unmatured 18.027 10.210 4.600 Current 70.464 52.848 35.232
finance (7.817 + (5.61 + (3.403 + assets (88.08 – (70.464 – (52.848
income 5.61 + 3.403 + 1.197) 17.616) 17.616) –17.616)
3.403 + 1.197)
1.197)
138. a. A. Cost of car = Rs.5,60,000
B. Deposit = 5,60,000 x 0.2 = Rs.1,12,000
5,60,000 x 0.11 x 3 + 5,60,000
C. EMI = = Rs.20,689
36
D. PV of EMIs = 20,689 PVIFAi, 36 (1 + i)
E. Documentation fee = 0.005 x 5,60,000 = Rs.2,800
F. Deposit with interest refunded = 1,12,000 FVIF0.5%, 36 = Rs.1,34,028
PV of deposit refunded = 1,34,028 PVIFi, 36
18
G. Prompt payment rebate = x 20,689 x 36 = Rs.670
20,000
PV of rebate = 670 PVIFi, 36

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H. PV of tax on interest from the deposit

= (1,34,028 – 1,12,000) x 0.30 x PVIF(i, 36) = 6608 x PVIFi, 36
Effective rate of interest is value of i in the following:
A–B–D–E+F+G–H =0
5,60,000 – 1,12,000 – 20,689 PVIFAi, 36 (1 + i) – 2800 + (1,34,028 + 670 – 6608)
PVIFi, 36 = 0
20,689PVIFAi, 36 (1 + i) – 1,28,090
PVIFi, 36 = 4,45,200
At i = 2%
LHS = 20,689 x 25.489 x 1.02 – 1,28,090 x 0.49 = 4,75,125
At i = 3%
LHS = 20,689 x 21.832 x 1.03 – 1,28,090 x 0.345 = 4,21,042
By interpolation,
Effective rate of interest
4, 75,125 − 4, 45, 200
= 2+
4, 75,125 − 4, 21, 042
29,925
= 2+ = 2.55%
54,083
Yearly rate = 35.3%
b. As the finance scheme is in the form of hire purchase transaction and the car is used
for business purposes, depreciation and interest tax shield can be claimed.
I. PV of depreciation tax shield
(Rs.)
Year Depreciation
1 1,68,000
2 1,17,600
3 82,320
PV = Rs.[1,68,000 PVIFi, 12 + 1,17,600 PVIFi, 24 + 82,320 PVIFi, 36] x 0.2
J. PV of tax on interest from deposit
= (134028 – 112000) 0.2 PVIFi, 36 = Rs.4406 PVIFi, 36
K. Total charge for credit
= 20,689 x 36 – 5,60,000 = Rs.1,84,804
SOYD Method of Interest Allocation
Year SOYD factor Interest
1 366/666 101554
2 222/666 61604
3 78/666 21644
PV of ITS = 20311 PVIFi, 12 + 12321 PVIFi, 24 + 4328 PVIFi, 36
L. PV of TS on documentation fees
= 2800 x 0.2 PVIFi, 12
= Rs.560 PVIFi, 2
Effective cost is i in the following:
A–B–D–E+F+G+I–J+K+L=0

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 Part II

5,60,000 – 1,12,000 – 20,689 PVIFAi, 36 (1 + i) – 2800 + 1,34,028 PVIFi, 36 + 670

PVIFi, 36 – 4406 PVIFi, 36 + 33,600 PVIFi, 12 + 23,520 PVIFi, 24 + 16,464 PVIFi, 36 +
20,311 PVIFi, 12 + 12,321 PVIFi, 24 + 4328 PVIFi, 36 + 560 PVIFi, 12 = 0

4,45,200–20,689 (1 + i) PVIFAi, 36+54,472 PVIFi, 12+35,840 PVIFi, 24 + 1,51,085

PVIFi, 36=0

At i = 1%, LHS is equal to

4,45,200 – 20,689 (1.01) 30.108 + 54,472 x 0.887 + 35,840 x 0.788
+ 1,51,085 x 0.699 = –1,766
At i = 2%, LHS is equal to
4,45,000 – 20,689 (1.02) 25.489 + 54,472 x 0.788 + 35,840 x 0.622
+ 1,51,085 x 0.490 = 46,559
i is between 1% and 2%
−1766
By interpolation, i = 1+
− 1766 − 46559
= 1 + 0.03 = 1.03% p.m.
= (1.0103)12 = 13.08% p.a.
139. a. Leasing
Cost of the asset to the finance company as the lessor is not eligible to the
800
concessional rate of sales tax of 4% = x 1.1 = Rs.846 lakh
1.04
Lease rentals are charged on Rs.846 lakh
Cost of lease = PV of Lease Rentals (LR) – PV of Tax Shield (TS) on lease rentals
i
PV of LR = 0.025 x 12 x 846 x PVIFA14%,5 x = Rs.915.82 lakh.
i4
PV of TS on LR = 0.025 x 12 x 846 x PVIFA16%,5 x 0.35 = Rs.290.86 lakh
COL = 915.82 – 290.86 = Rs.624.96 lakh.
Hire Purchase
As hire purchase is equivalent to sale, the cost of asset to the finance company will
be same as Rs.800 lakh
Down payment = 0.25 x 800 = Rs.200 lakh
600 x 0.12 x 5 + 600
Monthly Hire Installment = = Rs.16 lakh
60
i
PV of Hire Installment = 16 x 12 PVIFA14%,5 x
d12
= 16 x 12 x 3.433 x 1.0743 = Rs.708.11 lakh
PV of Depreciation Tax Shield (DTS)
(Rs. in lakh)
Year Depreciation PVIF@16% PV
1 240.00 0.862 206.88
2 168.00 0.743 124.82
3 117.60 0.641 75.38

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4 82.32 0.552 45.44

5 57.62 0.476 27.43
479.95
PV of DTS = 479.95 x 0.35 = Rs.167.98 lakh
PV of Net Salvage Value (NSV) = 12 PVIF16%,5 = Rs.5.712 lakh.
PV of Interest Tax Shield (ITS):
Total charge for credit = 16 x 60 – 600 = Rs.360 lakh
Year SOYD factor Interest charge PVIF
1 654/1830 128.66 0.862 110.90
2 510/1830 100.33 0.743 74.55
3 366/1830 72.00 0.641 46.15
4 222/1830 43.67 0.552 24.11
5 78/1830 15.34 0.476 7.30
263.01
PV of ITS = 263.01 x 0.35 = Rs.92.05
Cost of Hire Purchase (COHP)
= Down Payment + PV of hire installments – PV of tax shield on finance changes of
hire installments – PV of depreciation
TS – PV of NSV = 200 + 708.11 – 92.05 – 167.98 – 5.712 = Rs.642.37
As COL < COHP, leasing should be opted.
b. Let EMIs be Rs.F lakh at which COL = COHP
COHP

PV of EMIs = 12 x F x PVIFA14%,5 x i = Rs.44.257F.

d12
Total charge for credit
= F x 12 x 5 – 600 = 60 (F – 10)
Year SOYD Factor Interest PV
1 654/1830 21.44F - 214.43 18.48F - 184.84
2 510/1830 16.72F - 167.21 12.42F - 124.24
3 366/1830 12.00F - 120.00 7.69F - 76.92
4 222/1830 7.28F - 72.79 4.02F - 40.18
5 78/1830 2.56F - 25.57 1.22F - 12.17
43.83F - 438.35
PV of ITS = [43.83F – 438.35] x 0.35 = 15.34F – 153.42
COHP: 200 + 44.26F
– 167.98 – 5.71 – 15.34F + 153.42 = 28.92F + 179.73
COHP = COL
i.e. 28.92F + 179.73 = 624.96
28.92F = 445.23
F = 15.40
(15.40 x 60) − 600
Flat rate of interest = = 10.8%
600 x 5
∴ The flat rate of interest should be 10.8% for ASL to be indifferent between leasing
and hire purchase.

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 Part II

140. Loan amount = Rs.3,75,000 x 0.8 = Rs.3,00,000

3,00,000 x 0.12 x 3 + 3,00,000
EMI = = Rs.11,333
36
PV of EMI’s = 11,333 PVIFAim,36
Processing fee = 0.01 x 3,00,000 = Rs.3,000
Total charge of credit (D) = 3,00,000 x 0.12 x 3 = Rs.1,08,000
Installments not due (t) = 12
t ( t + 1)
Interest rebate according to Rule of 78 = xD
n (n + 1)
12 x 13
= x 1,08,000 = Rs.12,649
36 x 37
Payment on early settlement = 11,333 x 12 – 12,649 = Rs.1,23,347
Monthly effective rate of interest is im in the following:
–3,00,000 + 11,333PVIFAim,24 + 3,000 + 1,23,347 PVIFim,24 = 0.
At 1%, LHS = 40,895.20
At 2%, LHS = –5961
40,895.20
i = 1+ = 1.87
40,895.23 + 5,961
Yearly effective rate = (1.0187)12 – 1 = 24.90%

CONSUMER CREDIT
141. Initial investment cost = Rs. 4,50,000
Amount of loan = 0.85 x 4,50,000 = 3,82,500
Total charge for credit = 3,82,500 x 0.1240 x 2 = 94,860
Monthly installment = (3,82,500 + 94,860) /24 = 19,890
Employing the approximation formula
n
i = x 2F
n +1
24
x 2 x 0.1240 = 23.81
25
Using the IRR Method:
19,890 x PVIFA(km, 24) = 3,82,500
km = 1.85%
Annual percentage rate = (1.0185)12 – 1 = 0.245 or 24.6%
142. Let flat rate = E
EMI
1,00,000 x E x 3 + 1,00,000
(3835) =
36
3,835 x 36 − 1,00,000
E = = 12.69%
3,00,000
A. Loan = 4,20,000 x 0.8 = Rs.3,36,000

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 Investment Banking and Financial Services

EMI = 0.03835 x 3,36,000 = Rs.12,886

B. PV of EMI = 12 x 12,886 PVIFA(i,2) x i/i12
C. Processing fee = 0.01 x 3,36,000 = 3,360
D. Total charge for credit = 1,27,896
12 x 13
Interest rebate = x 1,27,896 = Rs.14,979
36 x 37

E. Amount payable on early settlement

= 12,886 x 12 – 14,979 = 1,39,653
PV = 1,39,653 PVIF(i,2)
F. Service charge @ 2% on principal
= (1,54,632 – 14,979) x 0.02 = 2,793
Effective rate of interest is i in the following
A–B–C–E=0
3,36,000 – 1,54,632 PVIFA(i,2) x i/i12 – 3,360 – 1,39,653 PVIF(i,2) + 2,793 PVIF(i,2)
By trial and error i = 23.21%

⎛ 3, 835 x 36 ⎞
⎜ 1, 00, 000 x 3, 36, 000 ⎟ − 3, 36, 000
143. a.
⎝ ⎠ = 12.69%
3, 36, 000 x 3
Note: 4,20,000 x 0.8 = 3,36,000
b. Calculation of effective rate of interest:
Amount financed: 4,20,000 x 0.80 = 3,36,000
3,835
EMI = x 3,36,000 = 12,886
1,00,000
Processing fee = 3,36,000 x 0.01 = 3,360
Amount payable as on the date of prepayment
Total interest = 12,886 x 36 – 3,36,000 = 127,896
12 x 13
Rebate = x 1,27,896 = 14979
36 x 37
Amount payable = 12,886 x 12 –14,979 = 1,39,653
The effective rate of interest is ‘i’ in the following equation.
i
3,36,000 – 3,360 – 12,886 x 12
x PVIFA(i,2) = 0
i
– 1,39,653 x PVIF(i,2) = 0
By trial and error, i = 23.66%.
144. a. Flat rate = 16%
36
Effective rate = x 2 x 16 = 31.14%
37
Monthly interest = (1.3114)1/12 – 1 = 2.284%
PVIFA(2.284, 36) = 24.369
2,50,000
EMI = = Rs.10,259
24,369
Alternatively

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 Part II

2,50,000 +2,50,000 x 0.16 x 3

EMI = = 10,278
36
b. Balance of installments due = 10,259 x 18 = Rs.1,84,662
As bank permits 3 months deferment period, Mrs. Laxmi would, in effect, be
making the prepayment at the end of 21 months and prepays 18 installments.
PV of installments due
= 10,259 PVIFA(2.284,18) = Rs.1,50,031
Interest rebate
= 1,84,662 – 1,50,031 = Rs.34,631
Interest rebate according to the scheme = 0.8 x 34,631 = Rs.27,705
Net repayment after 21 months
= 1,84,662 – 27,705 = Rs.1,56,957
If km is the monthly effective rate in the following equation, then
250,000 – 2,500 – 10,259 PVIFA ( k m ,18 )
PVIFA ( k m , 3)
– 1,56,957 ( k m , 21)
=0

i = 2.03% p.m. or 27.27% p.a.

145. Define ‘i’ as the Annual Percentage Rate (APR) implied by the consumer loan scheme. The
value of i can be obtained from the equation
i
1,500 x 12 x (12 )
PVIFA (i,3) = 40,000
i
i 40,000
(12 )
x PVIFA(i,3) =
i 18,000
i
x PVIFA(i,3) = 2.222
i (12)
at i = 22%, LHS = 2.240
at i = 24%, LHS = 2.190
By interpolation i = 22.72%
146. Define ‘i’ as the APR of the transactions.
The value of i can be obtained from the equation
i
380 x 52 x x PVIFA(i,1) = 19,000
i 52
i
x PVIFA(i,1) = 0.9615
i (52)
At i = 7.95%, LHS = 0.9615
∴ The APR of the transaction is 7.95% (approx.)
2 + (2 x 0.13) lakh
147. Monthly installment = = Rs.18,833
12
i
The APR of the transaction is given by 12 x 18,833 x (12 )
x PVIFA(i,1) = 2,00,000
i
i
(12 )
x PVIF(i,1) = 0.885
i
i
x PVIFA(i,1) = 0.885
i12

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 Investment Banking and Financial Services

at i = 28%, RHS = 1.1226 x 0.781 = 0.877

i = 24%, RHS = 1.1057 x 0.806 = 0.891
0.891 − 0.885
i = 24 + 4 x = 25.71%
0.891 − 0.877

4,25,000 − 1,06,250 *
148. EMI = n = 20, i = 12.5
PVIFA[1 / 12, n x 12]

3,18,750 x 0.0104 x [1.0104]240

= = Rs.3,616.95
[(1.0104) 240 − 1]
* 1,06,250 = 4,25,000 x 0.25
Loan Amount
EMI =
PVIFA [i / 12, n x12 ]
EMI if the loan does not carry the down payment requirement
4, 25, 000
EMI = = Rs.4,822.60
PVIFA (1.04, 240)

149. Since there is a deferment period of 2 months, the settlement date is taken as
February 10, 1999.
The total charge for credit is 5,000, and the interest rebate allowed for an early settlement
5
= 5,000 x = Rs.2,083.
12
Amount payable on early settlement
= 80,000 – 2,083 = Rs.77,917
The rate of interest (i) implied by the completed transaction is given by the equation:
75,000 (1 + i)5/12 = Rs.77,917
⎡ 12
⎤
⎢ ⎛ 77,917 ⎞ 5
i = ⎜⎜ ⎟⎟ − 1⎥ = 9.58%
⎢⎝ 75,000 ⎠ ⎥
⎣⎢ ⎥⎦
The APR(i) associated with the original transaction is 75,000 (1 + i) = 80,000 i = 6.67%
150. i. Repayment period = 12 months
Total charge for credit = (5,062.5 x 12) – 54,000 = 6,750
6,750
Flat rate of interest = x 100 = 12.5%
54,000
n
Effective rate of interest = x 2F
n +1
12
= x 25 = 23.07%
13
ii. Repayment period = 24 months
Total charge for credit = (2,835 x 24) – 54,000 = 14,040
Annual charge = 7,020
7,020
Flat rate of interest = x 100 = 13%
54,000

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 Part II

24
Effective rate of interest = x 2 x 13 = 24.96%
25
iii. Repayment period = 36 months
Total charge for credit = (2107.5 x 36) – 54,000 = 21,870
Annual charge = 7,290
7,290
Flat rate of interest = x 100 = 13.5%
54,000
36
Effective rate of interest = x 27 = 26.27%
37
151. a. The effective rate of interest implied by the deposit scheme will be that rate of
interest which equates the present value of the following cash flow stream to zero.
i.e. Loan Amount – PV (Installment paid) – Service fee + (PV (Accumulated value
of Deposit) + PV (Prompt payment bonus) = 0
(Loan amount = 90,000 x 0.25 = 22,500)
Accumulated value of 25% deposit = 22,500 + 11,720 = 34,220 (after 36 months)
3,475
Prompt payment bonus under zero deposit plan = x 1 x 36 = 125.1
1,000
3,300
Prompt payment bonus under 25% deposit plan = x 1 x 36
1,000
= Rs.118.8 = Rs.119
We will define i1, and i2 as the effective rates of interest implied by the zero deposit
scheme and the 25% deposit scheme respectively.
The value of i1 can be obtained from the equation:
i
90,000 – 1,500 – [3,475 x 12 x (12) x PVIFA(i,3)] – [7,200 x PVIF(i,3)]
i
+ [125.1 x PVIF(i,3)]=0
i = 28.71%
The value of i2 can be obtained from the equation:
i
67,500 – 1,500 – [3,300 x 12 x (12)
x PVIFA(i,3)] + 34,220 x PVIF(i,3)
i
+ [119 x PVIF (i,3)] = 0
at 28%, LHS = – 687.257
at 30%, LHS = 290.6
By interpolation i = 29.40%
Therefore, the effective rate of interest implied by the two schemes are 28.71%
and 29.40% respectively.
1.10 + (1.10 x 0.125)
152. Monthly installment = = Rs.10,312
12
Total charge for credit at the inception of the transaction
= (1,10,000 x 1.125) – 1,10,000 = Rs.13,750
Interest rebate as per the modified rule of 78
(6 − 1) (7 − 1)
= 13,750 x = Rs.2,644
12 x 13
Amount repayable on early settlement
= (10,312 x 6) – 2,644 = Rs.59,228

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 Investment Banking and Financial Services

Define im as the monthly rate of interest implied by the completed transaction. The value of
im can be obtained from the equation:
10,312 x PVIFA[i ( m ) ,8 ]
+ 59,228 x PVIFA[i m ,6]
= 1,10,000

i = 2.1%;
Annualized effective rate of interest = [(10.210)12– 1] x 100 = 28.32%
153. a. 20% deposit scheme
A. Investment = Rs.25,000

20
B. Deposit =
x 25,000 = Rs.5000
100
Equated monthly installment (EMI)
25,000 x 0.1 x 2 + 25,000
= = Rs.1250
24
C. PV of EMIs = 1250 x 12 x i/i12 x PVIFAi,2 = 15,000 x i/i12 x PVIFAi,2
Future value of deposit = (1.0125)24
5000 = Rs.6736.755
D. PV of deposit = 6736.755 PVIFi,2
Effective rate of interest is ‘i’ in the following:
A–B–C+D=0
25,000 – 5000 – 15,000 x i/i12 x PVIFAi, 2 + 6736.755 x PVIFi,2 = 0
Let i = 24%
LHS= 25,000 – 5000 – 15,000 x 1.1057 x 1.457 + 6736.755 x 0.65
= Rs.213.817 lakh
Let i = 20%
LHS = 25,000 – 5000 –15,000 x 1.0887 x 1.528 + 6736.755 x 0.694
= –Rs.277.696 lakh
Therefore, i lies between 20% and 24%
By interpolation,
−277.696 − 0
i = 20% + (24 – 20)
− 277.696 − 213.817
= 20% + 2.26% = 22.26%
b. 20% down payment scheme
A. Investment cost = Rs.25,000
B. Down payment = 25,000 x 0.2 = Rs.5000
Equated monthly installment
20,000 x 0.1 x 2 + 20,000
= = Rs.1,000
24
C. PV of EMIs = 1,000 x 12 x PVIFAi,2 x i/i12
Effective rate of interest is i in the following:
A–B–C=0
25,000 – 5000 – 12,000 x PVIFAi,2 x i/i12 = 0
Let i = 20%, LHS = 25000 – 5000 – 12,000 x 1.0887 x 1.528 = 37.597

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 Part II

Let i = 18%, LHS = 25000 – 5000 – 12,000 x 1.08 x 1.566= – 295.36

+295.36
Therefore, by interpolation, i =018 + 2 x = 19.77%
332.957
As the down payment reduces the investment cost, effective interest in down
payment scheme is less than in deposit scheme.
1,00,000 + 1,00,000 x 0.16 x 3
154. a. EMI = = 4,111
36
b. i. Amount payable in the balance period
= 4,111 x 16 = 65,776
Total interest payable (D) = 48,000
ii. Interest rebate
16 x 17
= 48,000 x = 9,802
36 x 37
Capital outstanding after 20 months
= 65,776 – 9,802 = 55,974
iii. Service charges payable
= 55,974 x 0.02 = 1,119
iv. Amount payable
= 55,974 + 1,119 = 57,093
4111 PVIFA (km, 20) + 57093 PVIFA ( k m , 20) = 98,000

km =2 PVIFA(2,20) = 16.351 PVIF(2,20) = 0.673

∴ LHS = 1,05,642
km = 2.5 PVIFA(2.5,20) = 16.351 PVIF(2.5,20) = 0.610
∴ LHS = 98,913
km = 2.7 PVIF(2.7,20) = 15.29 PVIF(2.7,20) = 0.587
∴ LHS = 96,407
913
∴ km = 2.5 + 0.02 = 2.507
2506
∴ Effective rate of interest = (1.02507)12 – 1 = 34.6%

FACTORING AND FORFAITING

155. The projected sales are
Rs. in lakh
Cash Sales (10% of total sales) 80
Credit sales 720
800
The benefits associated with factoring are
a. Savings in bad debt losses
= 2% x 720 = Rs.14.4 lakh
b. Savings in terms of cash discount not incurred
= 2% x [50% x 720] = Rs.7.2 lakh
c. Savings in credit administration costs
= Rs.8 lakh
d. Savings in interest cost

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 Investment Banking and Financial Services

30 30 30
= [720 x 23%* x ] – [(720 – 25.2) x 0.8** x 22.5% x + 164.16 x 24% x ]
360 360 360
= Rs.(13.80 – 13.70) lakh = Rs.0.10 lakh
* 23% is the average cost of owned funds 24% and borrowings 22%
** only 80% of receivables net commission will be available as advance.
So total benefit of the factoring option
= 14.4 + 7.2 + 8.0 + 0.10 = Rs.29.7 lakh

The costs associated with factoring are

Factoring commission = 3.5% x 720 = Rs.25.2 lakh
So the net benefit of the factoring option = 29.7 – 25.2 = Rs.4.5 lakh
As the benefits from factoring outweigh the costs, factoring is recommended.
Note:
Average collection period = (50% x 10 days) + (50% x 50 days) = 30 days.
156. Costs Associated with In-house Management
a. Cash discount = 0.25 x 600 x 0.02 = Rs.3 crore.
b. Cost of funds
ACP = 0.25 x 10 + 0.50 x 30 + 0.25 x 50
= 2.5 + 15 + 12.5 = 30 days
Cost of bank finance
30
= 600 x x 0.75 x 0.22 = Rs.8.25 crore
360
Cost of own funds
30
= 600 x x 0.25 x 0.28 = Rs.3.50 crore
360
Total cost = Rs.11.75 crore
c. Cost of collection = Rs.3.00 crore
d. Cost of bad debts = 0.02 x 600 = Rs.12.00 crore
e. Contribution lost on foregone sales = 80 x 0.2325 = 18.6
Total cost = 3 + 11.75 + 3 + 12 + 18.6 = 48.35.
Costs Associated with Factoring

a. Factor commission 600 x 0.02 = Rs. 12.00 crore

b. Discount charge 30
600 x 0.9 x 0.2 x = Rs. 9.00 crore
360
c. Cost of own funds 30
600 x 0.1 x 0.28 x = Rs. 1.40 crore
360
Total cost = Rs. 22.40 crore
As the costs associated with factoring are lower, factoring is preferable.
157. a. Advance Factoring
Balance Sheet as on 31.03.20x0 Rs. in lakh
Liabilities Rs. Assets Rs.

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 Part II

Net worth 90 Fixed assets 60

Long-term debt 30 Inventory 50
Current liabilities 90 Factoring reserve (1) 18
Cash (2) 82
210 210

1. Factoring reserve = Factor margin

= 0.2 x 90 = Rs.18 lakh
2. Cash = Opening balance + Advance factoring received
= 10 + 0.8 x 90 = Rs.82 lakh
Current assets 50 + 18 + 82
Current ratio = = = 1.67
Current liabilities 90

50 + 90 + 10
Current ratio (before factoring) = = 1.67
90

Bank Overdraft

Balance Sheet as on 31-03-20x0 Rs. in lakh

Liabilities Rs. Assets Rs.
Net worth 90 Fixed assets 60
Long-term debt 30 Inventory 50
Current liabilities 90 Receivables 90
Bank overdraft 72 Cash (1) 82
282 282
1. Cash = Opening balance + Bank overdraft received
= 10 + 72 = Rs.82 lakh
Current ratio (Bank overdraft)
50 + 90 + 82
= = 1.37
90 + 72
b. Advance Factoring
Balance Sheet as on 31.03.20x0 Rs. in lakh
Liabilities Rs. Assets Rs.
Net worth 90 Fixed assets 60
Long-term debt 30 Inventory 50
Current liabilities 54 Factoring reserve 18
Cash (1) 46
174 174
1. Cash = Opening balance + Factoring receipt + Repayment of current liabilities
= 10 + 72 – 36 = Rs.46
50 + 18 + 46
Current ratio after factoring = = Rs.2.11 lakh
54
Bank Overdraft
Balance Sheet as on 31.03.20x0 Rs. in lakh

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 Investment Banking and Financial Services

Liabilities Rs. Assets Rs.

Net worth 90 Fixed assets 60
Long-term debt 30 Inventory 50
Current liabilities 54 Receivables 90
Bank overdraft 72 Cash (1) 46
246 246
1. Cash = Opening Balance + Bank Overdraft – Current Liabilities
= 10 + 72 – 36 = Rs.46 lakh
Current ratio after (Bank overdraft)
50 + 46 + 90
= = 1.48
54 + 72
c. Due to the factoring facility the current ratio in (a) is not affected but it has reduced
from 1.67 to 1.37 due to the use of bank overdraft facility.
Hence, it can be said that use of factoring facility improves the liquidity ratios of the
firm.
Further if the factoring facility is used to pay-out the current liability, the current
ratio is increased to 2.11; 1.418 in case of bank overdraft. Still less than original
current ratio. Thus, the liquidity position is further strengthened.
Thus factoring facility is more advantageous for the company.
158. (Rs. in lakh)
a. ⎛ 22 ⎞ 29.33
Value of factored receivables ⎜ ⎟
⎝ 0.75 ⎠
Maximum permissible advance 22.00
Less: Commission @ 1.25% = (29.33 x 0.0125) 0.37
21.63
Less: Discount charge (22 x 0.165 x 90/360) 0.91
Funds made available to Saket Ltd. 20.72
b. Discount charge expressed as a percentage of funds made available to Saket Ltd.
0.91
x 100 = 4.39%
20.72
Therefore, the effective rate of interest is 4.39% per quarter.
The annualized rate of interest [(1.0439)4 – 1)] x 100 = 18.75%
Put differently the annualized cost of funds made available to Saket Ltd. is 18.75%.
c. Maximum permissible advance 22.00
Less: Commission payable up front = (29.33 x 0.0125) 0.36
Funds made available to Saket Ltd. 21.64
Interest charge collected in arrears [22 x 0.165 x 90/360] 0.90
Interest charge expressed on a percentage of funds made available
0.90
= x 100 = 4.158%.
21.64
Annualized interest cost = [(1.0415)4 – 1] x 100 = 17.66%
159. The relevant costs associated with in-house management of receivables and the alternative
forms of factoring are listed below:

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 Part II

Relevant Costs of In-house Management of Receivables

A. Cash discount = 260 x 0.02 x 0.5 = Rs.2.6 lakh
Average collection period = (10 x 0.5) + (90 x 0.5) = 50 days
2 50
Cost of bank finance = (260 x )x x 0.185 = Rs.4.45 lakh
3 360
1 50
Cost of long-term funds = 260 x x x 0.23 = Rs.2.77 lakh
3 360
B. Cost of funds invested in = Rs.7.22 lakh
receivables
C. Bad debt losses = 260 x 0.02 = Rs.5.2 lakh
D. Contribution lost on = Rs.15 x 0.25 = Rs. 3.75 lakh
foregone sales
E. Avoidable costs of sales = Rs.1.25 lakh
ledger administration and
credit monitoring
Relevant Costs of Recourse Factoring
F. Factoring commission = 275 x 0.02 = Rs.5.5 lakh
60
G. Discount charge = 275 x 0.8 x 0.195 x = Rs.7.15 lakh
360
Cost of long-term funds 60
H. = 0.2 x 275 x 0.23 x = Rs.2.10 lakh
invested in receivables 360
Relevant Costs of Non-Recourse Factoring
I. Factoring commission = 275 x 0.03 = Rs.8.25 lakh
60
J. Discount charge = 0.8 x 275 x 0.195 x = Rs. 7.15 lakh
360
Cost of long-term funds 60
K. = 0.2 x 275 x 0.23 x = Rs.2.10 lakh
invested in receivables 360
Cost-benefit Analysis of Recourse Factoring
L. Benefit associated with = A+B+D+E
recourse factoring = Rs.14.82 lakh
M. Costs associated with = F + G + H = Rs.14.75 lakh
recourse factoring
N. Net benefit = L – M = Rs.0.07 lakh
Cost-benefit Analysis for Non-Recourse Factoring
O. Benefits associated with = A + B + C + D + E = Rs.20.02 lakh
non-recourse factoring
P. Costs associated with non- = I + J + K = Rs.17.5 lakh
recourse factoring
Q. Net benefit = O–P = Rs.2.52 lakh
Since the net benefit associated with non-recourse factoring is higher than that of recourse
factoring, the firm is advised to opt for non-recourse factoring.
160. Assumptions:
a. Cost Associated with present Credit Policy of TCL:
Credit sales = 80% of sales
A. Cost of in-house financing receivables:

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 Investment Banking and Financial Services

45 1
Cost of long-term own funds = 800 x 0.8 x x 0.2 x = Rs.5.33 lakh
360 3
45 2
Cost of bank finance = 800 x 0.8 x x 0.16 x = Rs.8.53 lakh
360 3
B. Cost of bad debt loss = 800 x 0.8 x = Rs.6.4 lakh
C. Cost of maintaining and = Rs.10 lakh
collecting accounts
Cost of Non-Recourse Factoring:
D. Factoring commission = 800 x 0.8 x 0.02 = Rs.12.8 lakh
40
E. Discount charges = 800 x 0.8 x 0.75 x 0.19 x
360
= Rs.10.13 lakh
40
F. Cost of own funds = 800 x 0.8 x 0.25 x 0.2 x =Rs.3.56 lakh
360
G. Cost of maintaining and = Rs.2.5 lakh
collecting accounts
Net benefit of non-recourse factoring
A + B + C – (D + E + F + G) = 30.26 – 28.89 = Rs.1.37 lakh
The benefits outweigh the cost incurred. Hence TCL should go for factoring.
161. Relevant Costs of Existing Credit Policy:
A. Cash discount = 780 x 0.3 x 0.01 = Rs.2.34 lakh
B. Cost of funds invested in receivables
66
= 780 x x 0.16 = Rs.22.88 lakh
360
C. Bad debts = 780 x 0.01 = Rs.7.80 lakh
D. Administrative costs = Rs.3.40 lakh
Relevant Costs of Proposed Credit Policy:
E. Cash discount = 780 x 0.6 x 0.02 = Rs.9.36 lakh
F. Cost of funds invested in receivables
36
= 780 x x 0.16 = Rs.12.48 lakh
360
G. Bad debts = 780 x 0.01 = Rs.7.8 lakh
H. Administrative costs = Rs.3.4 lakh
Relevant Costs Associated with recourse Advance Factoring:
I. Commission = 780 x 0.005 = Rs.3.9 lakh
50
J. Interest cost = 780 x x 0.18 = Rs.19.50 lakh
360
K. Bad debts = Rs.7.8 lakh
Relevant Costs Associated with Bon-recourse Advance Factoring:
L. Commission = 780 x 0.01 = Rs.7.8 lakh
M. Interest cost = Rs.19.50 lakh
Cost-benefit analysis of proposed credit policy:
Net benefits = (E + F + G + H) – (A + B + C + D)
= Rs.3.38 lakh (benefit)
Cost-benefit analysis of recourse advance factoring:
Net benefit = (I + J + K) – (A + B + C + D)

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 Part II

= Rs.5.22 lakh (benefit)

Cost-benefit analysis of non-recourse advance factoring:
Net benefit = (L + M) – (A + B + C + D)
= Rs.9.12 lakh (benefit)
Recommendation:
Based on the net benefit criterion non-recourse advance factoring is recommended.
162. Sales turnover in 20x1-x2 = 48 x 1.1 = 52.8 crore
Relevants Costs of In-house Management:
A. Cash discount = 52.8 x 0.01 x 0.2 = Rs.0.1056 crore.
ACP = 0.2 x 10 + 0.8 [0.8 x 45 + 0.2 x 70]
= 42 days
42
B. Cost of bank finance = 0.8 x 52.8 x 0.18 x = Rs.0.887 crore
360
42
C. Cost of own funds = 0.2 x 52.8 x 0.21 x = Rs.0.259 crore
360
D. Administration expenses = Rs.0.6 crore
Total costs = A + B + C + D = Rs.1.85 crore.
Relevant Costs of Factoring:
M. Factoring commission = 52.8 x 0.015
= Rs.0.792 crore
30
N. Discount charge = 52.8 x 0.8 x 0.19 x
360
= Rs.0.669 crore
30
O. Cost of own funds = 52.8 x 0.2 x 0.21 x
360
= Rs.0.185 crore.
Total Costs = M + N + O = Rs.1.646 crore
As total costs are lower, factoring should be preferred.
163. Total Sales = 80 x 1.1 = Rs.88 lakh
Costs of Bill Discounting
bill discounting is another way of financing debts in the form of bills. As management of
bills receivable is maintained by the company all the costs other than cost of funds
associated with the in-house management have to be borne apart from the discount charge
of bill discounting. Thus, costs of bill discounting includes:
A. Cash discount = 0.02 x 0.3 x 88 = Rs.0.528 lakh
B. Bad debts = 0.01 x 88 = Rs.0.88 lakh
C. Administration expenses = Rs.0.8 lakh
60
D. Discount charge = 0.20 x 0.7 x 88 x = Rs.2.053 lakh
360
Total costs of bill discounting = A + B + C + D = Rs.4.261 lakh
Costs of Factoring
E. Commission = 0.02 x 88 = Rs.1.76 lakh
50
F. Discount = 0.19 x x 88 x 0.85 = Rs.1.974 lakh
360

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 Investment Banking and Financial Services

50
G. Cost of own funds = 0.24 x x 88 x 0.15 = Rs.0.44 lakh
360
Total costs of factoring = Rs.4.174 lakh
As factoring costs are less than bill discounting costs, factoring should be preferred.
164. Relevant Costs of In-house Management:
Expected sales = Rs.360 x 1.1 = Rs.396 lakh
A. Cash discount = Rs.396 x 0.2 x 0.01 = Rs.0.792 lakh
Average collection period = 0.2 x 15 + 0.8 x 45 = 39 days
B. Cost of funds:
3 39
Costs of bank finance = Rs.396 x x 0.2 x = Rs.5.077 lakh
5 365
2 39
Costs of own funds = Rs.396 x x 0.24 x = Rs.4.062 lakh
5 365
Total cost of funds = Rs.9.139 lakh
C. Bad debts = Rs.396 x 0.015 = Rs.5.94 lakh
D. Loss of profit due to foregone sales = Rs.36 x 0.20 = Rs.7.2 lakh
E. Avoidable administrative expenses = Rs.1.5 lakh
Total costs of in-house management =A+B+C+D+E
= Rs.0.792 + Rs.9.139 + Rs.5.94 + Rs.7.2 + Rs.1.5 = Rs.24.571 lakh.
Relevant costs of bank Participating Factoring:
Expected sales = Rs.360 x 1.2 = Rs.432 lakh
F. Commission = Rs.432 x 0.03 = Rs.12.96 lakhs
G. Cost of funds:
40
Discount charges = Rs.432 x 0.8 x 0.2 x = Rs.7.575 lakh
365
40
Interest to Sind Bank = Rs.432 x 0.2 x 0.6 x 0.22 x = Rs.1.25 lakh
365
40
Cost of own funds = Rs.432 x 0.2 x 0.4 x 0.24 x = Rs.0.9095 lakh
365
Total cost of funds = Rs.9.734 lakh
Total cost of bank participating factoring
= Cost of funds + Commission = Rs.9.734 + Rs12.96 = Rs.22.694 lakh
As costs of bank participating factoring are less than costs of in-house management
SCL should opt for the factoring arrangement.
165. Cost and Benefit Analysis of Factoring:
Benefits of factoring:
(Assuming that the 10% increment in sales is irrespective of the method of financing
receivables).
New sales = 250 x 1.1 = Rs.275 lakh
A. Cash discount = 275 x 0.2 x 0.01 = Rs.0.55 lakh
Average collection period: 0.2 x 15 + 0.8 [0.8 x 60 + 0.2 x 80] = 54.2 days
54.2
B. Cost of own funds = 275 x x 0.3 x 0.24 = Rs.2.94 lakh
365

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 Part II

54.2
C. Cost of bank finance = 275 x x 0.7 x 0.18 = Rs.5.15 lakh
365
D. Avoidable administration expenses = Rs.0.6 lakh
E. Let the increment in sales because of factoring over and above Rs.275 lakh be Rs.X
lakh.
Contribution gained on increased sales = X x 0.3 = Rs.0.3X lakh
Total benefit of factoring =A+B+C+D+E
= 0.55 + 2.94 + 5.15 + 0.6 + 0.3X = (9.24 + 0.3X) lakh
Costs of factoring:
Sales under factoring option are Rs.(275 + X) lakh.
40
F. Discount charge = (275 + X) 0.8 x x 0.22 = Rs.5.30 + 0.019X lakh
365
G. Commission = (275 + X) 0.025 = Rs.6.88 + 0.025X lakh
40
H. Cost of own funds = (275 + X) 0.2 x x 0.24 = Rs.1.45 + 0.005X lakh
365
Total costs = F + G + H = Rs.13.63 + 0.049X lakhs
Minimum increment in sales is the value of ‘X’ in the following:
9.24 + 0.3X = 13.63 + 0.049X
X = Rs.17.49 lakh.
166. Costs of In-house Management of Receivables
A. Bad debts = 0.02 x 500 = Rs.10 crore
(assuming non-recourse factoring)
B. Average collection period = 0.25 x 45 + 0.5 x 55 + 0.25 x 75 = 57.5 days
57.5
Cost of bank finance = 500 x 0.5 x x 0.16 = Rs.6.39 crore
360
57.5
Cost of own funds = 500 x 0.5 x x 0.2 = Rs.7.99 crore
360
Cost of financing receivables = Rs.14.38 crore
C. Savings in administration expenses = Rs.0.05 crore
D. Contribution foregone on increased sales = 75 x 0.25 = Rs.18.75 crore
Total costs = A + B + C + D = 10 + 14.38 + 0.05 + 18.75 = Rs.43.18 crore.
Cost of Factoring
E. Commission = 575 x 0.02 = Rs.11.5 crore
50
F. Discount charge = 575 x 0.75 x 0.15 x = Rs.8.98 crore
360
50
G. Cost of own funds = 575 x 0.25 x 0.2 x = Rs.3.99 crore
360
Total costs of factoring = E + F + G = 11.5 + 8.98 + 3.99 = Rs.24.47 crore
As total costs of factoring are lower than the total costs of in-house management,
factoring can be considered.
However, if we assume that the factoring is with recourse, the total costs of in-house
management of receivables remain unchanged at Rs.43.18 crore whereas costs of
factoring increases by Rs.11.5 crore (i.e 575 x 0.02 crore) to Rs.35.97 crore. Even
recourse factoring, is desirable, as its costs are lower than the costs of in-house
management.

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 Investment Banking and Financial Services

MORTGAGES AND MORTGAGE INSTRUMENTS

2,25,000
167. EMI = ; i = 0.11
i
PVIFA[ ; n x 12]
12
2,25,000 x [1.009166]12 x 25 x 0.009166
= = Rs.2205.124
[1 + 0.009166]12 x 25 − 1

Year Graduated monthly payment Amount to be drawn Payment made

made by the borrower (Rs.) from savings account (Rs.) to lender (Rs.)
1 1,746.66 458.46 2,205.124
2 1,851.46 353.66 2,205.124
3 1,962.55 242.57 2,205.124
4 2,080.31 124.82 2,205.124
5-25 2,205.12 0 2,205.124
168. a. Amount of loan = 3,75,000 x 0.75 = Rs.2,81,250
Rate of interest = 15%
Period of loan = 20 years
2,81,250
EMI =
i
PVIFA[ , n x 12]
12
2,81,250 x 0.0125 x [1.0125]240
= = Rs.3,703.47
[1.0125 240 − 1]
b. Year GPM
1 3165.74
2 3,292.37
3 3,424.06
4 3,561.02
5-20 3,703.47
HOUSING FINANCE IN INDIA
169. Progress of construction (PC) = 50%
Land component (LC) = Aggregate value – Cost of construction
= 4,75,000 – 3,75,000
= 1,00,000
1,00,000
= x 100
4,75,000
= 21.05%
3,75,000
Construction Cost (CC) = = 78.95%
4,75,000
Cumulative disbursement made (CM) = 85,000
Borrowers Contribution (BC) = 1,10,500
Recommendation for disbursement (RD) is given by

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CC PC LC
= AV x x + AV x − BC − CM
100 100 100
78.95 x 50 21.05
= 4,75,000 x + 4,75,000 x – 1,10,500 – 85,000 = Rs.91,993.75
100 x100 100

170. Amount of Loan = Rs.3,60,000

Period of Loan = 20 years
Rate of Interest = 16%
⎡ ⎛ 1 + r ⎞12 n ⎤
⎢ Lr ⎜ ⎟ ⎥
1 ⎡ Lr(1 + r ) n ⎤ 1 ⎢ ⎝ 12 ⎠ ⎥
EMI = ⎢ ⎥ =
2 ⎣ (1 + r ) n − 1 ⎦ 12 ⎢ ⎛ 1 + r ⎞12 n −1 ⎥
⎢⎜ ⎟ ⎥
⎣⎢ ⎝ 12 ⎠ ⎦⎥
⎡ ⎛ 1 + 0.16 ⎞ ⎤
240

⎢ 3,60,000 x 0.16 ⎜ ⎟ ⎥
= ⎢
1 ⎝ 12 ⎠ ⎥ = Rs.5,008.5
12 ⎢ ⎛ 1 + 0.16 ⎞
240 −1 ⎥
⎢ ⎜ ⎟ ⎥
⎣⎢ ⎝ 12 ⎠ ⎦⎥
171. The approximate amount of installment can be calculated as follows:
15,00,000 1
x = Rs.21,377
PVIFA (15,15) 12

The amount of installment can be calculated accurately as follows:

15,00,000
= Rs.20,994
PVIFA (1.25,180)

172. Maximum EMI permissible

1
= ([20,000 – 800 – 600 – 4,000] + [12,000 – 600 – 600 – 2,000]) = Rs.7,800 p.m.
3
1 ⎡ Lr(1 + r ) n ⎤
EMI = ⎢ ⎥
12 ⎣ (1 + r ) n − 1 ⎦
Applying 17% interest, the loan amount can be calculated as follows:
1 ⎡ L 0.17(1.17)15 ⎤ 1 ⎡ L 0.17(10.539) ⎤
7,800 = ⎢ ⎥=
12 ⎣ (1.17)15 − 1 ⎦ 12 ⎢⎣ 10.539 − 1 ⎥⎦

1.79163
or 96,000 = L
9.539
or L = Rs.4,98,344
Maximum value of the flat = Rs.6,64,459.

SOURCES OF FINANCE AND REGULATORY ENVIRONMENT OF

FINANCIAL SERVICES
173.
(Rs. lakh)
Tier I Capital
Paid-up equity capital 5566.89
Preference capital 200.00

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Investment Banking and Financial Services

Free Reserves 3612.19

Share Premium 14131.02
Capital Reserve 514.33
Debenture redemption reserve 4100.00
Owned funds 28124.43
Less: Investment in subsidiaries 2220.00
Loans and Advances to subsidiaries 2421.51
4641.51
Less: 10% of owned funds 2812.44 1829.07
Tier I Capital 26295.35
Tier II Capital
Revaluation reserves (discounted by 55%
= 2517 x 0.45) 1132.65
Tier II capital 1132.65
Total capital funds = Tier I + Tier II capital
= 26295.35 + 1132.65
= Rs.27428 lakh
Risk Weighted Assets
(Rs. lakh)
Book Value Risk Factor Risk Weighted
(%) Value
Fixed Assets:
Own Assets 3246.58 100 3246.58
Leased Assets 18952.75 100 18952.75
Capital work-in-progress 18027.62 100 18027.62
Investments:
Investment in government securities 5790.27 0 0
Investment in subsidiaries 2220.00
Less: Amount deducted from
Own Funds 874.83
⎛ 1829.07 ⎞ 1345.17 100 1345.17
⎜= x 2220 ⎟
⎝ 4641 .51 ⎠
Trade investments 5316.83 100 5316.83
Current Assets:
Stock on hire (net of finance charges) 44830.58 100 44830.58
Sundry debtors 3559.01 100 3559.01
Loans and Advances to subsidiaries 2421.51
Less: Amount deducted from
OFs – 954.24
⎛ 1829.07 ⎞
⎜= x 2421.51⎟ 1467.27
⎝ 4641 . 51 ⎠ 100 1467.27
Loans and Advances to others 10026.03 100 10026.03
Cash and Bank balance 3844.76 0 0
Total Weighted Assets 106771.84
Off-Balance Sheet Exposure (Rs. lakh)

Book value Credit conversion Risk weight Risk adjusted

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factor (%) (%) value

Guarantees issued 1694.79 100 100 1694.79
Pending appeals 10.77 50 100 5.39
Partly paid shares 24.53 100 100 24.53
1724.71
Total risk weighted assets = 106771.84 + 1724.71 = Rs.108496.55 lakh

% of capital funds to risk weighted assets

26295.35
Tier I capital = x 100 = 24.24%
108496.55
1132.65
Tier II capital = x 100 = 1.04%
108496.55
27428
Total = x 100 = 25.28%
108496.55
Minimum Prescribed by RBI = 10%
AFL has a capital adequacy ratio of 25.28% which is well above the minimum of 10%
required for the year ended March, 1998.

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Part III: Applied Theory (Questions)

1. Prior to April 1997 the budget deficit was monetized through the creation of Ad hoc
T-Bills. It was phased out by paving the way to a new system of Ways and Means of
Advances. What are Ad hoc T-Bills? Describe how Ad hoc T-Bills were issued earlier, and
how WMA is different from Ad hoc T-Bills.
2. In the recent past, instruments were designed to cater various financial requirements of
lenders and borrowers. Discuss the various types of short-term financial instruments that
were seen in the recent past.
3. The Reserve Bank issues treasury bills on competitive and non-competitive basis. It invites
tenders and allocates T-bills on the basis of multiple price auction method. Explain the
procedure involved with an illustration and also calculate yields for successful bidders.
4. Vemoplast Ltd. is a leading manufacturer of aluminum foils. Currently, it requires short-
term funds, and Mr. Pai, the Finance Manager is thinking of various alternatives to raise
funds. Kartik Mundae, Vice President (finance), suggested to Mr. Pai, to raise funds by
issuing Commercial Paper. Help Mr. Pai to list out the requirements to be fulfilled by
Vemoplast before issuing the CP.
5. Certificate of Deposit is a money market instrument issued by banks to mobilize short-term
funds apart from their usual deposits. List out the guidelines given by the Reserve Bank to
be fulfilled by banks before issuing CDs.
6. Government securities are referred to as ‘gilt-edged securities’, as they are absolutely
secured. The RBI, being the banker to the Government, issues different types of paper on
behalf of the latter, to cater various requirements. Discuss the various types of Government
securities that are issued by the RBI.
7. Satellite Dealers (SDs) undertake a supporting function in the operations of Primary
Dealers (PDs). They are required to have a standing arrangement with the RBI, undertaking
certain obligations. What are the obligations that a SD needs to fulfill while undertaking its
responsibilities?
8. The prevalence of obsolete systems and antiquated practices were the main drawbacks of
the Indian capital markets till the early ‘90s. The government had initiated reforms to
modernize the capital markets. What are the major recent changes in the primary capital
markets in India?
9. Recently Indian markets witnessed lot of restructuring in the cement industry. Gujarat
Ambuja acquiring a substantial stake in ACC and Lafarge’s acquisition of the cement
division of TISCO are two examples. As a merchant banker, what are the aspects that you
would examine, while advising a client to divest a business operation?
10. A sound regulatory framework in regulating capital markets is expected to provide
transparency, maintain market integrity, fairness and ensure investor protection. However,
lack of adequate regulations can lead to manipulations which endanger the integrity of the
market and damage the confidence of investors. What are the regulatory measures taken by
SEBI to ensure the confidence of investors and market participants in India?
11. FACIT is a company manufacturing PCs and printers. The company has an existing equity
base of Rs.20 cr, 8% preference of 18 cr. and 10% debentures of 15 cr. in its capital
structure in the last audited statement. Observing the recent innovations in financial
instruments in the country, the company is planning to expand its business by
manufacturing other accessories and I/O devices. Mr. Ganguli, VP Finance is planning to
raise long-term funds, and he has approached a merchant banker. What are the options that
a merchant banker can suggest to Mr. Ganguli?
12. While floating an IPO, promoters may not disclose certain information or they may mislead
the investing public through window dressing. Such activities are common to overprice a
scrip. While pricing an IPO, the role of a lead manager or a merchant banker to the issue is
to exercise due diligence. What are the aspects that a merchant banker or a lead manager
needs to look into, in course of a due diligence exercise in this regard?

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13. Omega Plastics is planning to raise capital. Mr. Goutam Parekh, MD, is thinking that it
is wise to raise funds through private placement rather than from the public. List out the
features and merits of private placements to Mr. Parekh.
14. Mulchand Electronics Limited are small scale manufacturers of electronic equipments. The
company has a turnover of Rs.5 cr. It is contemplating to expand its capacity and needs
funds immediately. The Finance Manager, Mahinder Singh is of the opinion that he may
not be able to get the right price for the shares if he opts for an IPO. But, he still wants his
company to be listed. Is there any way out to raise funds without going public? If so,
discuss the distinctive advantages of the same over a public offering.
15. The prime function of a rating agency is to provide investors with authentic information
about the creditworthiness of issuers. Standard & Poor’s rating agency is considered as one
of the best credit rating agencies in the world. In this context, discuss the rating obligations
(both long-term and short-term) of S&Ps.
16. The concept of free pricing rests on the premise that “market knows best”. Both underpricing and
overpricing have negative consequences. Explain whether SEBI guidelines are adequate to ensure
proper pricing.
17. Most of the developing nations are tapping foreign investments to accelerate their economic
development, but the investors need to assess the country’s economic, social, political and
financial position through a reliable credit rating agency for investing their funds. S&P does
sovereign rating for nations all over the world. Discuss the key factors considered by S & P
while rating local currency debt.
18. The responsibilities of intermediaries form a crucial role in international capital
markets. In this regard, discuss briefly the role of various intermediaries in international
capital markets.
19. Till the early ‘90s, investors faced liquidity problems, risk of bad deliveries, lack of
transparency, etc., in secondary markets for equity. What are the major changes that have
been initiated in the secondary market to address the above problem?
20. Ranj Kunj Petrochem Ltd. is into extracting petro products for the last 25 years. It is
planning forward integration for which it needs huge funds which cannot be catered by the
Indian investors; hence it is planning to issue ADRs. Discuss the various levels of ADR.
21. Arnica Chemicals and Extracts Ltd. is planning to diversify into related areas. It plans to
raise finance by accepting public deposits rather than approach any financial institution.
Discuss various factors that Arnica Chemicals needs to consider while marketing its public
deposits.
22. The call money market is referred to as the most sensitive barometer measuring the
liquidity conditions prevailing in financial markets. What are the various purposes for
which call money is lent in India?
23. Manjari Publishers is a good market player in publishing journals, textbooks and also
undertakes bulk screen printing work. It has recently, come out with its public issue, and
when it was listed on BSE, it was underpriced. What do you think are the probable factors
for underpricing in case of the Manjari Publishers?
24. XYZ Ltd. is a company involved in the leasing business. It had applied for registration with
the RBI and is still awaiting its approval. What are the parameters of XYZ Ltd. that will be
considered by the RBI before granting the certificate of registration?
25. A NBFC with over Rs.25 lakh paid-up capital has recently received its auditors’ comment
stating that the mix of Tier I capital and Tier II capital is disproportionate compared to the
stipulated norms for the calculation of the CAR. Where do you think the NBFC must have
gone wrong? State the methodology of calculating Tier I capital.
26. The management of the Avenue Finance Ltd., a new company, was quite relieved to receive
a communication from the RBI granting it the certificate of registration. They now propose
to accept fixed deposits as per the RBI guidelines so as to provide funds to their principal
area of business leasing. What are the various regulations concerning maintenance of a
register, advertisement for deposits, nominations and loans, that have to be followed by the
management with regard to acceptance of fixed deposits?

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27. The NPAs of Path Financial Services are at a very high level of 10%. The consultant of the
company says that the company needs to make more provisions because of its asset mix
being skewed towards leasing and hire purchase rather than loans and advances.
What are the provisions that has to be done in case of loans, advances and other credit
facilities and in case of Lease and Hire Purchase of assets?
28. “Though the lease rental is a bit on the higher side, in view of the high rate of technological
obsolescence in the industry, we better go for an operating lease for the equipment, rather
than a finance lease”, said Mr Avadhani, Director (Technical) of Prudent Technologies Ltd.
to the Manager (Finance) during a meeting called to finalize the mode of acquisition of the
latest brand of balancing equipment. The Director (Marketing), who was also present, could
not understand what it meant. Explain to him the distinction between a finance lease and an
operating lease to him.
29. Leasing is widely known to be an off-balance sheet form of financing. But, is it the only
advantage of leasing? Explain the advantages of leasing.
30. “Though leasing appears to be a highly flexible form of finance, the finance lease contract
being non-cancellable makes it somewhat unattractive” says the Finance Manager of
Duraplastic Ltd. Do you agree with him? Explain the shortcomings of leasing as a form of
finance.
31. Tax treatment of lease rentals and leased assets and their representation in financial
statements were controversial issues for quite some time. But now, there is a general
agreement on the issue – mostly due to various circulars and notes issued by government
agencies and bodies. Briefly explain the tax and accounting aspects of leasing.
32. Purchase of consumer durables, particularly through consumer credit has gained a lot of
momentum in India in the last five years. Explain the characteristic features of consumer credit
transactions.
33. Mr Ramchandani wants to buy a color television costing Rs.20,000 on installment basis and
approaches Rajkamal Electronics Ltd., a big distributor of consumer goods. Rajkamal
Electronics Ltd. has a financing arrangement with World Wide Consumer Finance Ltd. for
financing purchases made from it. Explain how Mr Ramchandani will be evaluated by
the company to decide whether or not he should be granted the installment payment
facility.
34. Financial markets always create new instruments to overcome the difficulties associated
with instruments already in use. The same phenomenon can be seen in the mortgage-backed
securitized instruments. The innovative instruments are generally referred to as non-
traditional instruments. Describe any four of them.
35 Housing finance being a long-term finance, the possibility of steep changes in interest rates
has always been a matter of concern for both borrowers and lenders. To address the
concerns of the two, floating rate loans have been introduced. The HDFC has recently (in
June, 1999) announced plans to provide floating rate loans. In the West, a more
sophisticated instrument called the Adjusted Rate Mortgage (ARM) is in use. Explain what
is meant by an ARM and its advantages.
36. Real estate, for long, has been known for providing good returns. Though the real estate
market in some cities has seen a slump in the recent past (second half of 1998), investment
interest in real estate is still very strong. What are the characteristic features of real estate
that make it a good investment? What are the aspects that should be kept in view while
selecting and managing real estate?
37. Credit rating is always helpful in selling an issue of debt. But is credit rating necessary for
securitizing the receivables of a company? Explain.
38. In hire purchase, the hirer is allowed to claim depreciation on the hired assets from the year
the assets are taken on hire. But, the ownership is said to be passed on only at the time of
exercise of option to buy/payment of the last hire rental. In such a situation, when should
the transaction be subjected to sales tax, if at all? Explain the sales tax provisions relating to
hire purchase.

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39. The finance manager of Grindwell Manufacturing Co. Ltd. is seriously thinking of using
factoring to reduce the company’s funds that are blocked in accounts receivable. But, he
wants to know about factoring in detail before taking any concrete steps in that direction.
Explain the mechanism of factoring to him.
40. The process of factoring involves some legal complications as it involves the assignment of
the right to collect a debt from the client company to the factor company. Explain the legal
aspects of factoring in detail.
41. A part of the working capital finance given by banks is generally in the form of a bill
discounting limit for discounting the bills of exchange received in the course of business.
What are bills of exchange? Explain their features.
42. Just as physical assets are depreciated, finance companies also write-off their assets. The
write-off is not based on the passage of time, but on the quality of the asset as evidenced by
the receipt of the interest payments and principal payments. Explain the provisions required
for loans and advances made by NBFCs.
43. Bills of exchange are used very frequently while trading with parties in far-off locations.
Mr Raja Ram, the manager of a newly set-up trading concern, M/s Ranvir Trading Co, is
not very sure of how bills of exchange come into existence and how they are useful in
transacting with other parties. Explain the same with reference to different types of bills to
him.
44. Though Indian exporters want to reduce the lag between the export of goods and receipt of
proceeds, they are looking up to the government to provide them finance at lower rates of
interest rather than use services such as cross-border factoring and forfaiting. The reasons
appear to be lack of awareness regarding forfaiting and presence of very few companies offering
the service of forfaiting. Explain the process of forfaiting.
45. The use of credit cards has increased phenomenally in the last few years. This has induced
many banks to come out with credit cards. The competition among banks is increasing.
Explain the advantages of credit cards to all the parties involved.

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Part III: Applied Theory (Answers)

1. Ad hoc T-bills are issued in favor of the RBI when the Government needs cash. They are
neither issued nor available to the public. These bills are purchased by the RBI on tap and
they are held in its Issue Department. The RBI issues currency notes against these bills to
the Government if required, and bills are renewed at maturity.
Ad hoc T-bills are issued to serve two purposes. Firstly, to replenish cash balances of the
Central Government and secondly, to provide a medium of investment for temporary
surpluses to State Governments, semi-government departments and foreign central banks.
The RBI acts as banker to the Central Government, hence, the Government needs to
maintain a minimum balance of Rs.50 crore on Fridays and Rs.4 crore on other days free of
obligation to pay interest thereon and further whenever the balance in the account of the
Government falls below the minimum agreed amount, the account will be replenished by
the creation of ad hoc treasury bills in favor of the bank. Ad hocs have a maturity period of
91-days and carry a discount rate of 4.6 percent. These bills can be redeemed before
maturity.
The maximum incremental outstanding limit of T-bills at the end of the year should be
Rs.5,000 crore and within the year, the incremental ad hoc T-bills cannot exceed Rs.9,000
crore for a period greater than ten consecutive days. In case this is not adhered to, the RBI
would automatically reduce the level of ad hoc T-bills by auctioning them or selling fresh
Government of India dated securities in the market thereby, bringing down the level of ad
hocs to the maximum level permitted. This is essentially an arrangement between the
Central Government and the RBI and the actual operational aspects may vary from time to
time. It is adequate to state that this is essentially a mechanism through which the Central
Bank (RBI) funds the government.
T-bills have to be repaid by the government when it has adequate cash flows. However,
there was no compulsion that they have to be repaid. When they were outstanding for more
than 90 days, the RBI converts them into dated securities. As the expenditure of the
government always exceeded its income, some amount of T-bills remain unpaid at the end
of the year thus becoming a permanent source to finance the budget deficit, which could
lead to fiscal indiscipline resulting in serious imbalances in the economy. As there was no
limit on the amount that can be raised by the government on its own, the government itself
decided to put a cap on it.
Subsequently an agreement was signed in March 1997, bringing into existence the new
system of Ways and Means Advances (WMA) – replacing the old system of ad hoc
treasury bills.
WMA is not a permanent source of financing government deficit. But, this is likely to
provide greater autonomy to the RBI in conducting the monetary policy. According to the
agreement, the RBI will no more monetize the fiscal deficit and the government should
borrow from the market to finance the fiscal deficit. But, the RBI will extend the advances
to the Central and State Governments to tide over temporary or short-term finance
requirements which need to be repaid in three months. Withdrawals in excess of the WMA
limit will be allowed for a maximum of ten consecutive days. The RBI allows for three
types of Ways and Means Advances: The clean WMAs (unsecured), the secured WMAs
(which are secured against central government securities) and the special WMAs which are
allowed in exceptional circumstances against the pledge of government securities.
The system of WMA broadly works as follows:
– The limit of WMA is decided in terms of mutual consultations between the RBI and the
central government.
– The interest charged up to the WMA limit would be three percent less than the average
implicit yield at the cut-off prices of 91-day T-bills in the previous quarter and for the
amount in excess of the WMA limit, it is two percent more than the normal rate.
– The interest rate is decided on, and can be altered by mutual agreement between the RBI
and the government.

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 Part III

The outstanding balance of WMA at the end of the year should be repaid by the central
government (it should be brought down to zero). If the balance remains unpaid for more
than two weeks after the end of the year, the RBI converts the amount into dated securities
at the market rate of interest.
If 75 percent of the limit is utilized, the RBI should initiate a fresh floatation of central
government securities.
2. Short-term liquidity being the main purpose of the money market, various instruments have
developed to suit short-term requirements. For instance, the requirement of funds by banks
to meet their statutory reserves will vary from one day to a fortnight. Similarly, corporates
may require funds for their working capital purpose for any period up to a year. Given
below is a broad classification of the money market instruments depending upon the type of
issuer and the requirements they meet.
Government and Quasi-Government Securities
• Treasury Bills (T-Bills)
• Government Dated Securities/Gilt-Edged Securities
Banking Sector Securities
• Call and Notice Money Market
• Term Money Market
• Certificate of Deposit
• Participation Certificates
Private Sector Securities
• Commercial Paper
• Bills of Exchange (commercial and trade bills/factorization bills)
• Inter-corporate Deposits/Investments
• Money Market Mutual Funds.
Except for their debt nature, the securities listed above differ from each other in their
characteristics relating to maturity, issuer, type of investors, the risk-return profile,
liquidity, marketability, negotiability, transferability, etc. Money market instruments,
however, do not include any equities.
Government Securities
Treasury Bills: T-Bills are issued to enable the government to tide over short-term
liquidity requirements with maturities varying from a fortnight up to a year. These
instruments are issued at a discount to the face value. Being issued by the government they
are considered to be risk-free. Due to this, they are highly marketable. Investors in T-Bills
generally include banks, other institutional investors and individuals.
Government Dated Securities: These are medium- to long-term government securities.
Unlike the T-Bills which are issued at a discount, these securities carry a coupon rate. In
spite of being long-term instruments, these government securities form a part of the money
market due to their liquidity. These instruments set a benchmark for the long-term interest
rates. Issuers will clearly be the central/state government and other quasi-governmental
bodies while the investors will be banks, FIs, other institutional investors and individuals.
Government securities have fairly high liquidity compared to other money market
instruments.
Banking Sector Securities
The banking sector has a very vital and active role in the money market. The short-term
requirements of banks vary from a single day up to a year for meeting reserve requirements
and credit accommodation purposes. Based on this requirement, various instruments/
markets with differing maturities have developed.

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Investment Banking and Financial Services

Call and Notice Money: These funds represent borrowings made for a period of one day
up to a fortnight. However, there exists a difference in the mechanism adopted for lending
funds between the call and the notice money markets. In the call money market, funds are
lent for a predetermined maturity period that can range from a single day to a fortnight.
However, with identical range for maturity period, the funds lent in the notice money
market do not have a specified repayment date when the deal is entered into. The lender
will simply issue a notice to the borrower 2-3 days before the funds are to be repaid. On
receipt of this notice, the borrower will have to repay the funds within the given time.
While both these funds serve the general purpose of meeting reserve requirements, the
reliance of the banks, however, is mostly on the call money market. It is here that it raises
overnight money, i.e. funds for a single day.
Term Money: Short-term funds having a maturity of 15 days and over are categorized as
term money. Banks access this term money route for the purpose of bringing greater
stability to their short-term deficits. While making a forecast of the funds requirement,
banks will be in a position to assess the likely surplus and deficit balances that are to occur
during the forecasted period. In view of such a forecast, banks assess the amount that needs
to be borrowed/lent in order to prevent any severe liquidity mismatch.
Certificate of Deposits (CDs): Banks issue CDs to raise short-term funds having a
maturity of 3 months to 1 year. These instruments are issued for deposits of
individuals/corporates/institutions, etc. These are usance promissory notes which require
the holder to establish his identity before redeeming the amount. Being negotiable
instruments they are easily transferable. They are issued at a discount to face value. The
funds raised through certificates of deposit form a part of the deposits and hence attract
reserve requirements.
Participation Certificates (PCs): The major activity of a bank is credit accommodation.
This service of the banks, apart from increasing the risks, may place the banks in a tight
liquidity position. To ease their liquidity, banks have the option of sharing their credit
asset(s) with other banks by issuing Participation Certificates. These certificates are also
known as InterBank Participations (IBPs). With this participation approach, banks and FIs
come together either on a risk sharing or non-risk sharing basis. Thus, while providing
short-term funds, PCs can also be used for risk reduction. The rate at which these PCs can
be issued will be negotiable and depends on the interest rate scenario. Like CDs, PCs are
also issued by banks for similar maturity periods i.e. 3 months to 1 year.
Private Sector Securities
Commercial Papers (CPs): CPs are promissory notes with fixed maturity, issued by
highly rated corporates. This source of short-term finance is used by corporates as an
alternative to the bank finance for working capital. Corporates prefer to raise funds through
this route when the interest rate on working capital charged by banks is higher than the rate
at which funds can be raised through CP. The maturity period ranges from 30 days to 364
days.
Bills of Exchange: It is a financial instrument that facilitates funding of a trade transaction.
It is a negotiable instrument and hence is easily transferable. Further, depending on the
repayment period and the documents attached, these bills of exchange are classified into
different types. The period for which these bills are drawn generally ranges between 1 – 6
months.
Factorization Bills: This is an instrument arising due to the factoring of the bills of
exchange. Factors, who are generally banks or FIs, purchase the bills from the creditors
with or without a recourse facility and collect the dues from the debtors. The market for
factorization of bills depends on the level of activity in the bill market.
Inter Corporate Investments/Deposits (ICDs): In the ICD market, the borrowers and
issuers are the corporates. The interest rates of these instruments are generally higher than
the other short-term sources since the risk is higher.

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Money Market Mutual Funds (MMMFs): The Money Market Mutual Funds provide an
avenue for the retail investor to invest in the money market. Retail investors normally deposits
short-term surplus funds into a savings bank account, the returns from which are relatively low.
By investing in the money market through MMMFs the returns earned will be higher than
what is obtained by depositing in a bank. Further, this also provides adequate liquidity and
the investor can plan for short-term deployment of funds. The safety level of these funds
will also be high since the investments will generally be in high quality securities,
i.e., government/bank/highly rated corporate securities. Thus, MMMFs represent a low-risk
and high-returns avenue to the retail investors in the money market.
3. Auction Procedure
The process of T-Bill is explained through an illustration. Say on 2nd November, the RBI
issued a tender notification for 91-day T-bill for Rs.500 crore. There were 4 competitive
bidders namely, A, B, C and D who responded to the notification of T-bills, and submitted
sealed tenders to the RBI. The overall amount quoted through the tender is Rs.1,900 crore.
A General Manager of the Public Debt Office (Mumbai) opened the tenders, and compiled
the following information for the sake of determining the cut-off point.
Sl. No. Name of the Bidder Price Amount Cumulative Amount
(Rs.) (Rs. in cr.) (Rs. in cr.)
1 B 98.95 50 50
2 A 98.90 40 90
3 A 98.80 60 150
4 C 98.80 80 230
5 B 98.75 50 280
6 C 98.65 120 400
7 C 98.50 200 600
8 A 98.50 100 700
9 B 98.50 100 800
10 A 98.45 200 1000
11 B 98.40 120 1120
12 C 98.35 280 1400
13 D 98.45 70 1470
14 D 98.35 120 1590
15 D 98.30 150 1740
16 D 98.25 160 1900
Based on the above information, the GM needs to decide the cut-off price and allocate the
T-bills to bidders at respective rates. The GM decides the optimal cut-off price as Rs.98.50.
Below this point, amount of bids is short by Rs.100 crore and at this point, it has a surplus
of Rs.300 crore. The first six bids given by A, B and C are accepted completely, and the
next quote given by the three bidders being the same, the RBI allots T-bills proportionately.
The fully accepted bids are:
Name of the Price Quoted Approved Amount
Bidder
A 98.90 40
A 98.80 60
B 98.95 50
B 98.75 50
C 98.80 80
C 98.65 120
Total 400
The RBI allots the three bidders proportionately in the following manner:
Name of the Proportionate Amount
Price Amount
Bidder Allotted (cr)
A 98.50 100 25
B 98.50 100 25
C 98.50 200 50
400 100

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100
x 100 = 25. Thus, a proportionate allotment is done to three bidders.
400
The yield is calculated by the following formula:
⎡ Face Value ⎤ 365
Yield = ⎢ − 1⎥ x
⎣ Price ⎦ Days to Maturity
Weighted Average Yield for the Issue
Name of Price Amount Proportion Wt. Price Yield Wt.Yield
the Bidder (i) (ii) (iii) (i x iii = iv) (v) (vi)
= (iii*v)
A 98.90 40 0.08 7.904 0.0446 0.00356
98.80 60 0.12 11.856 0.0487 0.00584
98.50 25 0.05 4.925 0.0610 0.00305
B 98.95 50 0.10 9.895 0.0425 0.00425
98.75 50 0.10 9.875 0.0507 0.05078
98.50 25 0.05 4.925 0.0610 0.00305
C 98.80 80 0.16 15.808 0.0487 0.00779
98.65 120 0.24 23.676 0.0548 0.00131
98.50 50 0.10 19.700 0.0610 0.00610
1.00 98.722 0.051876
The non-competitive bidders would have to pay weighted average cut-off price which is
obtained by taking the average of prices, which works out to be 98.722 in this particular
issue. The non-competitive bidders would get an yield of 5.1876 percent.
Let us calculate the yield based on the above inputs for each of the bidders:
A. Average Yield for A:
(98.90 x 40/125 + 98.80 x 60/125 + 98.50 x 25/125) = 98.77
⎡ 100 ⎤ 365
Yield = ⎢ −1⎥ x = 4.99%
⎣ 98.77 ⎦ 91
or
(0.0446 x 40/125 + 0.0487 x 60/125 + 0.0610 x 25/125) = 4.984%
B. Average Yield for B:
(98.95 x 50/125 + 98.75 x 50/125 + 98.50 x 25/125) = 98.78
⎡ 100 ⎤ 365
Yield = ⎢ −1⎥ x = 4.95%
⎣ 98.78 ⎦ 91
(0.0425 x 50/125 + 0.0507 x 50/125 + 0.0610 x 25/125) = 4.948%
C. Average Yield for C:
(98.80 x 80/250 + 98.65 x 120/250 + 98.50 x 50/250) = 98.668
⎡ 100 ⎤ 365
Yield = ⎢ −1⎥ x = 5.414%
⎣ 98.668 ⎦ 91
or
(0.0487 x 80/250 + 0.0548 x 120/250 + 0.0610 x 50/250) = 5.41%

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4. Vemoplast can raise Commercial Paper (CP) by fulfilling the following conditions:
• The tangible net worth of Vemoplast should not be less than Rs.4 crore as per the
latest audited statement (tangible net worth will comprise of paid-up capital plus free
reserves less accumulated balance of losses, balances of deferred revenue
expenditure and also other intangible assets).
• Its fund-based working capital limit should not be less than Rs.4 crore.
• The minimum credit rating required from the approved agencies should be P2 from
Credit Rating Information Services of India Ltd. (CRISIL), A2 from Investment
Information and Credit Rating Agency of India (ICRA) and PR2 from Credit
Analysis and Research Ltd. (CARE) which should not be more than two months old.
• Vemoplast should have a minimum current ratio of 1.33:1 as per the latest audited
balance sheet.
• The aggregate amount to be raised by issuance of commercial paper should not
exceed the working capital (fund-based) limit sanctioned by bank/banks to the issuer
company i.e., CP can be raised to the extent of 100 percent of the working capital
limit.
• The working capital limit of Vemoplast should be correspondingly reduced by the
banking system. As the CP will be carved out of the working capital (fund-based)
limits of the company, by issuance of CP there should not be any increase in the
level of short-term borrowing facilities.
• A Board resolution authorizing Vemoplast Ltd. for issue of CP is essential.
5. The RBI guidelines relating to CDs are as follows:
• All scheduled banks, other than Regional Rural Banks and Scheduled Co-operative
Banks are eligible to issue CDs, and there is no limit to the total amount raised.
• CDs should be issued in the form of usance promissory notes with a fixed maturity
date without any grace period.
• The size of the issue should be in multiples of Rs.1 lakh subject to the minimum size
of each issue being Rs.5 lakh.
• The banks can issue CDs ranging from 3 months to 1 year whereas financial
institutions can issue CDs ranging from 1 year to 3 years.
• CDs become freely transferable by endorsement and delivery but only after a lock-in
period of 30 days.
• All CDs are subjected to the usual CRR and SLR requirements.
• CDs are subject to stamp duty.
• Premature payment or loans against CDs by the issuer is not allowed.
6. The Reserve Bank on behalf of issuers may issue different types of stocks from time to time
depending on their requirements:
Types of Government Stocks
i. Issue of Stock through Auction: The RBI, on behalf of the government, issues
notification for auctioning of government securities, stating the amount and time. An
applicant may submit more than one bid at different yields through separate
applications for each bid. The aggregate amount of bids submitted by a person
should not exceed the aggregate amount of Government Stock offered for sale. On
the basis of the bids received, the Reserve Bank of India will determine the cut-off
rate of yield, at which point, offers for the purchase of Government Stock will be
accepted at the auction depending upon the notified amount. The coupon of the
stock is decided in an auction. The successful bids offered at the cut-off rate of yield
as determined by the RBI will be accepted at par. Other bids tendered at rates lower

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than the cut-off rate of yield determined by the RBI will be accepted at cut-off rates
as quoted in the bid. The bidders will be issued these securities at a premium which
will be determined in such a way that yield-to-maturity to the bidder will be equal to
the rates at which they have bid. Bids quoted at rates higher than the cut-off rate of
yield determined by the RBI will be rejected. The stock carries the same coupon till
maturity.
ii. Issue of Stock with Pre-announced Coupon Rates: The RBI also announces the
coupon on stock before the date of floatation and the stock is issued at par. The
interested bidders need to submit the application form to the RBI. If the total
subscription exceeds the aggregate amount offered for sale in respect of a fixed
coupon stock, the RBI will make partial allotment to all the applicants.
iii. Stock with Variable Coupon Rates, viz., Floating Rate Bonds, etc.: In case of
floating rate bonds, the stock will carry a coupon rate which will vary according to
the change in the base rate to which it is related. The description of the base rate and
the manner in which the coupon rate is linked to the base rate, floor and cap to the
coupon rate, if any, will be announced by the RBI at the time of issue. The
procedure for issuance is similar to pre-announced coupon rates.
iv. Zero-coupon Bonds: Zero-coupon bonds are issued at a discount and redeemed at
par. No interest is paid on such bonds before maturity. Zero-coupon bonds are
issued by means of auction, with a face value of say Rs.100. The bidders need to
clearly specify the purchase price expressed up to two decimal points in the
application. An applicant needs to submit more than one bid at different prices
through separate applications for each bid (but the aggregate amount of bids
submitted by a person should not exceed the aggregate amount of bonds offered for
sale).
The RBI will determine the cut-off price at which tenders for purchase of
zero- coupon bonds will be accepted at the auction.
All the bids at prices higher than the cut-off price will receive full allotment, while
the bids at prices lower than the cut-off price will be rejected. The bids at the cut-off
price may receive full or partial allotment depending on the total amount of bids and
the notified amount.
v. Stock on Tap: Stock on tap is issued by the RBI with predetermined price, maturity
and coupon with no aggregate amount indicated in the notification. Sale of such
stock will be kept open so long as the RBI desires. The sale may be closed at any
time at the discretion of the RBI.
vi. Stock for which the payment is made in installments: The stock is issued either
by auction or by pre-announcing a coupon rate. The special feature of the stock is
that the payment can be made by the investors in installments. It means that the
stock will be initially issued as partly paid stock which will become fully paid at the
end of the last installment. The total amount is usually paid in four installments. The
interest is paid on the paid-up value of the stock.
vii. Issue of Government Stock in conversion of Maturing Treasury Bills/Dated
Securities: In this mode, the RBI gives an option to the holders of the Treasury Bills
of certain specified maturities, to convert the respective treasury bills at specified
prices into a new stock offered for sale. The conversion prices are predetermined by
the RBI depending on the remaining term to maturity of the respective treasury bills.
7. The SD will be required to have a standing arrangement with the RBI based on the
execution of an undertaking. The registration letter issued by the RBI covers the following
aspects.
Role and Obligations of SDs
i. A satellite dealer should commit to generate outright turnover of the Central
Government securities including T-Bills of not less than Rs.30 crore in a year.

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ii. The annual turnover including repos of the SD should not be less than five times in
government securities including T-Bills. Of the total turnover, turnover in respect of
outright transactions should not be less than three times. The turnover will be
Total purchases and sales during the year*
calculated as under:
Average month end stocks during the year
* Purchases are inclusive of primary market purchases and sales are inclusive of
redemption of maturities.
iii. A satellite dealer should achieve a portfolio of not less than 20 percent in
government securities in relation to total assets before the end of the first year of
operations after registration.
iv. A satellite dealer should maintain the minimum capital standards at all points of
time.
v. A satellite dealer should have adequate organizational structure with good
distribution channels across the country and in terms of office computing equipment,
communication facilities like telex/fax, telephone, etc. and skilled manpower for
efficient marketing and to provide advice and education to investors.
vi. A satellite dealer should have an efficient internal control system for fair conduct of
business and settlement of trades and maintenance of accounts.
vii. A satellite dealer should meet such registration and other requirements stipulated by
the Securities Exchange Board of India (SEBI) including operations on the Stock
Exchanges.
viii. A satellite dealer should subject itself to all prudential and regulatory guidelines
issued by the RBI.
ix. A satellite dealer should submit periodic returns as specified by the RBI.
8. Major changes in the primary market that had taken place in recent past are:
i. Free Pricing: The abolition of the office of the Controller of Capital Issues resulted
in the emergence of a new era in the primary markets. All controls on the pricing,
designing and tenure of the instruments were abolished. A wide variety of
instruments were designed to meet the specific requirements of the issuers and the
investors. The issuers were also given the freedom to price the instruments. It was
left to the market forces to decide the appropriateness of the pricing.
ii. Entry Norms: Hitherto there were no restrictions for a company to tap the capital
markets. This resulted in a massive surge of small cap issues. Many of the
companies were promoted by persons with dubious credentials. Most of these shares
were not even traded in the secondary markets after listing. Several investors lost
heavily by investing in these shares. The need for transparent entry barriers was felt.
SEBI introduced eligibility norms in the form of track record of divisible profits for
existing companies and compulsory appraisal of their projects for new companies.
iii. Disclosures: The quality of disclosures in the offer documents was extremely poor.
Several vital pieces of adverse information were not disclosed in the offer document.
SEBI has introduced stringent disclosure norms. The Malegam Committee was
appointed to suggest measures to increase the levels of disclosure by Indian issuers.
Most of the recommendations of the Committee have been implemented. An attempt
is being made to bring our disclosure norms in conformity with global standards.
iv. Book Building: Book Building is the process of price discovery. One of the
drawbacks of free pricing was the pricing mechanism. The issue price had to be
decided around 60-70 days before the opening of the issue. Further, the issuer has no
clear idea about the market perception of the price determined. Introduction of book
building helps in overcoming this limitation and results in market driven pricing of
securities.
v. Streamlining the Procedures: All the procedural formalities were streamlined.
Many of the operational aspects were hitherto unregulated and different practices
were being followed. SEBI issued guidelines to ensure uniform procedures. Many
aspects of the operations have been made more transparent.

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vi. Registration of Intermediaries: SEBI started the process of registration of some of

the intermediaries associated with the process of issue management. This is done to
ensure professionalization of the intermediaries and to curb the malpractices
indulged by some of the intermediaries. Registration has been made mandatory for
the following primary market intermediaries:

• Merchant Bankers
• Registrars and Share Transfer Agents

• Brokers to the Issue

• Bankers to the Issue

• Debenture Trustees.
9. Merchant bankers have a vital role to play in the divestiture process. Divestitures involve
sale of assets or business entities. The assets may be tangible like manufacturing unit,
product line, etc., or intangible assets like brand, distribution network, etc. Sometimes the
business entity as a whole may be sold to a third party. The reasons for divestitures can be
broadly classified as:
Planned: A company may plan for the sale of a particular asset/business. The reasons may
be varied:
• Strategic decision to exit from a certain industry.
• Poor business fit with other operations of the company.
• Severe competition.
• Technological factors.
• Continuous losses in a particular line of activity.
• Shrinking margins.
Opportunistic: In such cases, the vendor company has no intentions to divest in the normal
course. However, the management is tempted by the buyer with a very high bid. If the
company feels that the price offered is substantially more than the worth of the
asset/business, it may divest. The reason for the sale is solely profit motive.
Forced: The reason for the sale is the prevalence of circumstances beyond the control of
the company. The company may be facing a severe liquidity crunch and the only solution to
raise cash may be through divestiture. Sometimes the asset/business may be sold to avoid a
takeover or to make a takeover bid unattractive. Sometimes a divestiture may be a part of a
rehabilitation package for the turnaround of a sick company.
10. The SEBI is a regulatory body established to provide transparency, maintain market
integrity and ensure investor protection.
According to the SEBI Act, 1992, the main functions performed by SEBI to meet its
objectives are:
i. Regulating the securities market.
ii. Recognition and regulation of the Stock Exchanges.
iii. Registering and regulating the working of various intermediaries including
Merchant Bankers, Registrars, Share Transfer Agents, Stock Brokers, Sub-brokers,
Debenture Trustees, Bankers to the Issue, Underwriters, Portfolio Managers, etc.
iv. Registering and regulating the functioning of Depositories, Custodians and
Depository Participants.
v. Registration of Foreign Institutional Investors.
vi. Registering and regulating the working of Venture Capital Funds, Mutual Funds and
other collective investment schemes including plantation schemes.

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vii. Promotion and regulation of Self-Regulatory Organizations.

viii. Prohibiting fraudulent and unfair trade practices relating to securities market.
ix. Prohibiting insider trading in securities.
x. Regulating substantial acquisition of shares and takeover of companies.
xi. Promoting investor education and training of intermediaries.
xii. Conducting research relating to securities market.
11. In the recent past, the Indian capital market has witnessed innovations in the financial
instruments owing mainly to the liberalization measures.
Zero-coupon Bonds: These bonds are issued at discount to their face value and are
redeemed at par on expiry of their tenure. There is no payment of interest on these
instruments. The yield on these bonds can be computed from the difference between the
issue price and the redemption price adjusted for time factor.
Secured Premium Notes: SPNs are issued at face value and do not carry any interest.
They are redeemed by repayment in a series of installments at a premium over the face
value. The premium amount is distributed equally over the period of maturity of the
installment. SPNs may also be issued with a detachable warrant which may be converted
into share(s) for cash after a certain period. They are secured by mortgage on all immovable
properties of the company.
Deep Discount Bonds: These bonds are sold at a large discount on their face value and
mature at par value. There are no interest payments and investors obtain their return as
accretion to the par value of the instrument over its life. The advantage to the issuer is that
it does not entail any cash outflow till the time of redemption.
This instrument is similar to ZCBs described above. However, the term of this instrument is
usually around 20 to 25 years and it provides an option to the investor to exit say at the end
of 5 years, 10 years, etc.
Optionally Convertible Debentures: These debentures carry a predetermined coupon and
have a stated tenure. The debenture can either be redeemed or be converted into equity
shares on its maturity. The option for conversion or redemption is vested with the investor.
Third Party Convertible Debentures: These are debt instruments with warrants allowing
the investor to subscribe to the equity of another company at a certain price. This is a
convenient means of fund raising for companies which do not have a track record, but have
strong companies in the group whose stock can be offered.
Zero Coupon Convertible Note or LYONS: This is convertible into equity of the issuer at
a price set at the time of issuance. If the investors choose to convert the notes into equity
they forego all interest.
Tax Saving Bonds: The investor in these bonds is entitled to certain tax shields. The issuer
can, therefore, offer lesser coupon on these bonds. The issue of such bonds require the prior
approval of Central Board of Direct Taxes (CBDT). For example, the interest earned on
these bonds may be deductible under Sec. 80L. Some bonds provide for exemption
from Capital Gains Tax under Sec. 54EA and Sec. 54EB, if such amount is invested in
these approved bonds.
Cumulative Convertible Preference Shares (CCPS): CCPS are similar to convertible
bonds excepting that CCPS pays fixed dividend and cumulative deposits attract interest till
conversion. The major advantage of CCPS is that it is considered as part of net worth even
before its conversion.
This instrument is suitable for companies which want the equity component to remain low,
maintain its EPS without becoming overcapitalized, increase the leveraging capacity of the
company as it is considered owners’ capital. This, in turn, increases the net worth of the
company and allows the issuer to go in for more debt.

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One inherent advantage presented by this instrument is that promoter’s stake does not get
diluted during the public issue.
12. The lead manager exercises his due diligence by checking all the important aspects of the
company going public. Along with this exercise, he compares the company with other
companies whose shares are being publicly traded and develops his own forecast of prices
at which the scrip would be traded. The price band is agreed upon after negotiations
between the issuing company and the merchant banker. Usually, the merchant banker
approves the price band based on the following indicators about the company:
• Past track record of performance.
• Comparison of issuing company with other similar companies with respect to future
earnings, cash flow from operations and fundamental asset values.
• SWOT analysis of the issuing company.
• Half-yearly or quarterly earnings of the company during the current year and its
expectations in the next quarter.
• Information on retail and institutional interest in the proposed offering and an
indication of buying at different levels.
• Information on the overall trend in the IPO market and the success rate of similar
issues during the period.
• Taking into account the shareholding pattern before and after the issue and
identifying the potential selling shareholders upon listing the stock.
• Taking into account, the part of the issue which has to be underwritten and finding
out market-making to the issue.
• Feasibility of perceptions about the company’s management from the brokers and
prospective investor from road shows and investor conferences.
• Products and services of the company and what the future holds for them.
• The company’s accounting methods and whether there had been any changes in
recent years and reasons behind the changes.
13. Private placement of securities is one of the most popular avenues of raising capital. Private
placement is a method of raising capital in which companies directly sell their securities to
a limited number of ‘sophisticated and discerning’ investors.
The distinct features of private placement are:
i. There are no entry barriers for the private placement market.
ii. There is no need for registration of the offer document with SEBI. The procedural
formalities are simple.
iii. The terms of the issue can be negotiated between the issuers and the investors.
iv. The company has a choice of investors.
v. The transaction costs are low.
vi. Credit rating is optional in case of debt instruments.
vii. The execution of the deal is faster.
Merits of Private Placement
The private placement market has witnessed an exponential growth during the last 3 years.
The inherent advantages of private placement as an efficient route for raising capital and
profitable avenue for investments makes it acceptable to both the issuers and the investors.
i. Accessibility: There are no entry barriers for a company to access the private
placement market. Unlike the public issue market, an existing company does not
require a track record of divisible profits for 3 years nor does a greenfield project
require mandatory appraisal and funding by a Bank/Financial Institution. This route
is also available to unlisted and closely held public companies. Further, public
offering may not be viable if the amount proposed to be raised is very small.

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ii. Speed: A private placement deal can be executed successfully and much faster than
a public offering. The procedural formalities for a private placement transaction are
minimal. The time-frame required to plan and complete a public offering ranges
between 4 to 6 months (or even more in some cases). On the other hand, a private
placement deal can be successfully closed in 4 to 6 weeks. This results in substantial
saving of time and energy for the issuer.
iii. Flexibility: In a private placement, there is greater flexibility in working out the
terms of the issue. In addition to greater flexibility at the time of structuring the issue
initially, there may be more latitude to renegotiate the terms of the issue
subsequently and even roll-over the debt. This is because the issuer has to deal with
only a few institutional investors in the Private Placement Market (PPM).
Besides, one of the most attractive features of PPM is that it can be tailored to the
needs of first generation entrepreneurs who are comparatively less known to the
public which makes their public issue less attractive. It also satisfies investors who
want large holdings, but whose needs cannot obviously be met in case of public
issue. Thus, for large investors, stocks will be available in the quantity they desire at
reasonable transaction cost compared to secondary market buying.
iv. Lower Transaction Cost: A public issue entails several statutory and non-statutory
expenses associated with underwriting, brokerage, printing, mailing,
announcements, promotion and so on. In the absence of advertisement and
prospectus, the issue expense in case of private placement is as low as 2% of the
total issue amount as compared to 10 to 12% in case of public issues.
v. Confidentiality: Private placements also have the advantage of confidentiality of
information. In a competitive environment, keeping strategic business secrets
pertaining to a firm is of crucial importance.
14. A buy-out is a process whereby an investor or a group of investors buys out a significant
portion of the equity of an unlisted company with a view to make it public within an agreed
time-frame. To put it simply, buy-outs are nothing but wholesale investments.
Distinctive competitive advantages of a bought-out deal in comparison to a public offer.
• The price privilege: One of the main advantages in a bought-out deal as compared
to a run-of-mill public issue is that the price is not subject to the vagaries of the
market place as the buyer of the stock is sophisticated enough to gauge the future
earnings capacity of a company without the help of imperfect signals from the stock
market. While this price may not necessarily reflect a company’s earning potential
to the fullest extent, the discount is the price the issuing company has to pay to get
the money upfront.
• The quick fix: The small investor, who had lost money in the primary market due to
companies with dubious record, has a general mood of skepticism to all new issues.
Often a promoter cannot convince the lay public about the merits of a project,
especially if it is an unknown company or a greenfield project. In such a case,
selected investors in the form of one or several investment bankers are easier to
convince about a projects’ future earnings capacity. So, some companies will find it
easier to go in for a bought-out deal.
• The cost advantage: If the size of an issue is small, it sometimes makes sense for
companies to avoid a public issue. The support for this contention is based on the
fact that the fixed costs of a retail capital offering like mandatory advertisements,
printing of forms, underwriting and the like are rising steadily. Merchant bankers
estimate that for a small issue of Rs.1.5-2 crore, costs may be as high as 15-20% of
the issue size. This cost advantage has already made its presence felt as a catalyst for
private placements. A bought-out deal takes the argument to its logical culmination.
• Time is money: For a company, public issue translates into a six months ordeal of
convincing merchant bankers, regulatory body and investors. In a bought-out deal, a
company normally saves that amount of time. For an entrepreneur, valuable time is
wasted in raising money especially when he should be concentrating on the usage of
funds. The possible results are faster implementation of projects and fewer chances
of cost overruns.

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15. Standard & Poor’s specialize in credit rating both long-term as well as short-term
obligations. They rate all public corporate bonds and preferred stock issues of $10 million
or above with or without a request of the issuer. Presently, they have confined their rating
operations to the following types:
Rating Obligations
a. Long-term obligations:
i. US market long-term obligations.
ii. Non-US market long-term obligations.
iii. Euro-bond rating.
b. Short-term obligations:
i. Commercial paper (maturity of not more than 365 days) of US and Non-US
issuers upon request.
c. Sovereign rating.
d. Rating criteria.
Debt instruments covered under the above heading are described below.
a. Long-term Obligations
i. US market long-term obligations: Standard & Poor’s rates the following
US Capital market long-term obligations upon request of issuer and have the
publication right of the rating assigned to these obligations:
• Private placements of debt instruments.
• Mortgage-related financing such as mortgage backed bonds and pass-
through certificates of banks, and thrift institutions.
• Insured Certificates of Deposit of US Banks.
• Uninsured Certificates of Deposit of US Banks.
ii. Non-US market long-term obligations: Long-term obligations in the non-
US capital market are rated on issuers’ request in the overseas markets. Such
rating reflects an assessment of the probability of timely repayment of
principal and interest in the currency of denomination of the issuer. There is
no assessment of foreign exchange risk taken by the investor while opting to
make the investment. The overseas market issues for which S&P rate the debt
obligations includes Euro-currency bonds, domestic Pound Sterling, French
Francs, Swiss Francs, and Deutsche Marks issues.
iii. Euro-bond rating: Euro-bond rating of both US and Non-US entities has
been undertaken by S&P with the internationalization of the world’s capital
market.
Since mid-1982, the rating is done on request or without request of the issuer.
No fee is charged by S&P’s where rating is unrequested. The main advantage
of rating on Euro-bond obligation is that the issuer can have access to the US
capital market, under the US Securities and Exchange Commission’s Rules.
b. Rating of Short-term Obligations
S&P undertakes rating on request by the US or non-US issuers of short-term
obligations, such as commercial paper (having an original maturity of not more
than 365 days). Issuers retain the initial publication right of the rating, but once
the rating has been published, S&P’s can publish the revised rating.
16. The guidelines issued by SEBI for pricing of issues are on follows:
i. A new company can price its shares only at par. A new company has been defined
as one which has not completed 12 months of commercial operations and its audited
operative results are not available and where it is set-up by enterpreneurs without
track record.

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ii. A new company, which is promoted by an existing company with a 5 year track-
record of consistent profitability can freely price its issue. In such case the minimum
promoter contribution should be 50%. The term ‘consistent profitability’ should
not be construed as continuous profitability. SEBI has clarified that the promoter
companies should have profits after providing for interest, depreciation and tax
as per the audited accounts, in 5 of the 7 preceding years with profits during the last
2 years, prior to the issue.
iii. An existing private or closely held public company can freely price its issue, if it has
a 3-year track of consistent profitability. As per SEBI clarifications, the company
should have made profits after providing for interest, depreciation and tax as per the
audited accounts in 3 of the preceding 5 years with profits in the last 2 years prior to
the issue.
iv. An existing listed company is allowed to raise capital by freely pricing the issue.
The premium will be fixed by the issuer in consultation with the lead manager(s) to
the issue.
17. Different variables need to be considered while rating a government’s local and foreign
currency debt. The key economic and political risk factors considered by Standard and
Poor’s while rating local currency debt are as follows:
Stability of Political Institutions: The decision-making relating to the various economic
policies aimed to bring about progress depend on the stability and the level of participation
of the government in the economic progress.
Economic Structure: This factor is essential since a free market economy enables
decentralized decision-making where the market forces play a key role, while in a closely
regulated economy, the government will be playing a key role in various economic factors
viz., interest rates, etc.
Fiscal and Monetary Policies: The purpose and the magnitude of the public sector
borrowings and its implication on inflation are the aspects related to fiscal policy that may
have a major influence on the government’s ability to service public debt. Government may
further, with its monetary powers, mobilize funds for deficit financing. However, heavy
monetization of budget deficits will increase the public debt burden of the government
which may adversely affect its sovereign creditworthiness.
Inflation: Apart from affecting economic progress, price rise may also lead to political
problems/instability. To evaluate the inflationary pressures, S&P’s assesses the inflation
using the past behavior. Other factors that are considered here are total borrowings of the
government, the maturity structure of public debt, future borrowing programs and the
ability of the Central Bank to check fiscal imbalances.
Apart from the above mentioned factors, the performance of the country’s financial markets are
also examined by S&P while conducting local currency debt-rating.
While rating the foreign currency debt obligations of a country, S&P’s considers most of
the factors used while rating local currency debt. Other than these, it also focuses on the
following:
Balance of Payments (BoP): A nation’s BoP situation should be adequate and should
sustain any risk that might arise so as to enable the government to service its debt. Changes
in domestic and foreign environments influence the BoP. To prevent any adverse impact on
the BoP situation, timely and appropriate measures need to be taken. Current account
vulnerability to any changes in the environment depends on the structure of the trade and
service, the exports and imports, international competitiveness, etc. On the other hand,
flexibility to the BoP position can be obtained by ensuring greater capital inflows by way of
direct investment in equity and other assets. Capital inflows by way of debt will expose the
country to interest rate, exchange rate and liquidity risks. S&P’s studies the past data on the
BoP situation and based on the likely policy measures, forecasts the future trend.
External Financial Position: S&P’s focuses on the burden of external public debt,
contingent liabilities and the ability of the country’s reserves to service the debt.

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The factors affecting external financial position are as follows:

• Net public/private external debt – Total public/private debt less public/private sector
financial assets.
• The invisible assets/liabilities, which have one way movement.
• Direct and portfolio equity investments.
• Net debt service capacity of the economy.
Other considerations involved while examining the external financial position include the
policies relating to currency convertibility, exchange rates and the accessibility to
concessional/market related foreign credit.
Economic and Political Prospects: The debt servicing ability of a nation is strongly
influenced by its economic and political prospects. The economic plans of a nation are
reviewed in the light of the various constraints, both internal and external. The future
borrowing requirements of the nation are assessed by forecasting the economic scenario.
18. The intermediaries involved in the International Capital Markets include Lead
Managers/Co-lead managers, Underwriters, Agents and Trustees, Lawyers and Auditors,
Listing Agents and Stock Exchanges, Depository Banks and Custodians. An overview of
the functions performed by each of them is given below:
i. Lead and Co-managers: The responsibilities of a Lead Manager include
undertaking due diligence and preparing the offer circular, marketing the issues
including arranging the roadshows. Lead manager, sometimes in consultation with
the issuer, can choose to invite a syndicate of investment banks to buy some of the
bonds/DRs and help sell the remainder to other investors. ‘Co-managers’ are thus
invited to join the deal, each of whom agrees to take a substantial portion of the
issue to sell to their investor clients. Usually, there will be more than one lead
manager as mandates are sometimes jointly won, or the investment bank which
actually won the mandate from the issuer may decide that it needs another institution
to ensure a successful launch.
ii. Underwriters: The lead managers and co-managers act as underwriters for the
issue, taking on the risk of interest rates/markets moving against them before they
have placed bonds/DRs. Lead managers may also invite additional investment banks
to act as sub-underwriters, thus forming a larger underwriting group. A third group
of investment banks may also be invited to join the issue as members of the selling
group, but these institutions only receive a commission in respect of any bonds/DRs
sold and do not act as underwriters. The co-managers and the underwriters are also
members of the selling group.
iii. Agents and Trustees: These intermediaries are involved in the issue of
bonds/convertibles. The issuer of bonds/convertibles, in association with the lead
manager, must appoint ‘paying agents’ in different financial centers, who will
arrange for the payment of interest and principal due to investors under the terms of
the issue. These paying agents will be banks.
iv. Lawyers and Auditors: The lead manager will appoint a prominent firm of
solicitors to draw up documentations in evidence of the bond/DRs issue. The various
draft documents will be scrutinized by lawyers acting for the issuer and in due
course by the co-managers and any other party signing a document related to the
issue. Auditors or reporting accountants will become involved as well, supplying
financial information, summaries and an audit report which will be incorporated into
the ‘offering circular’. The auditors provide comfort letters to the lead manager on
the financial health of the issuer.
v. Listing Agents and Stock Exchanges: The listing agent helps facilitate the
documentation and listing process for listing on the stock exchanges and keeps on
file information regarding the issuer such as annual reports, articles of association,
the depository agreement, etc.

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The Stock Exchange (Luxembourg/London/AMEX/NYSE as the case may be)

reviews the issuers application for listing of the bonds/DRs and provides comments
on offering circular prior to accepting the securities for listing.
vi. Depository Bank: The depository bank is involved only in the issue of DRs. It is
responsible for issuing the actual DRs, disseminating information from the issuer to
the DR holders, paying any dividends or other distributions and facilitating the
exchange of DRs into underlying shares when presented for redemption.
vii. Custodian: The custodian holds the shares underlying DRs on behalf of the
Depository and is responsible for collecting rupee dividends on the underlying
shares and repatriation of the same to the Depository in US dollars/foreign currency.
viii. Printers: The printers are responsible for the printing and delivery of the
preliminary and final offering circulars as well as the DRs/bond certificates.
19. The major changes initiated in secondary markets are on follows:
i. Trading System: Trading on all the stock exchanges was being carried out by
‘public outcry’ in the trading ring. This was an inefficient system and also resulted
in lack of transparency in the trades. The Over The Counter Exchange of India
(OTCEI) was the first exchange to introduce screen based trading in India. Listing
on OTCEI was restricted to small and midcap companies. Screen based trading
received a big boost with the setting up of the National Stock Exchange. The NSE
provided nationwide access to investors by setting up trading terminals all over the
country. These terminals were networked through satellite links. The fully
automated trading system enabled market participants to log in orders, execute deals
and receive on-line market information. The competition from the NSE forced the
regional stock exchanges including the BSE to switch over to screen based trading.
The NSE trading system is order driven while the OTCEI system is quote driven. In
an order driven environment, the system captures all the orders and matches the
orders with each other to execute the transaction. A quote driven system is based on
market making concept (dealer giving two way quotes) and the order logged in is
matched against the best quote given by the market maker. The BSE On-line
Trading (BOLT) is a mixture of both quote driven and order driven system as the
system permits both jobbing and direct matching of orders.
ii. Depository: One of the major drawbacks was/is that the securities were/are held in
the form of certificates. This led to the problems in physical storage and transfer of
securities. There was also the risk of bad delivery for the buyer. The transaction
costs were also higher due to physical movement of paper and the incidence of
stamp duty. The National Securities Depository Ltd. (NSDL) was set-up in 1996 as
India’s first depository. A depository is an entity which holds the securities in
electronic form on behalf of the investor. This is done through dematerialization of
holdings at the request 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. The
transaction costs are also reduced due to less flow of paper and transfer of securities
through depository does not attract stamp duty. 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.
iii. Clearing Mechanism: The clearing houses attached to the stock exchanges were
functioning only as conduits to delivery of securities and money. The default risk by
the counterparty in the transaction continued. The NSE was the first stock exchange
to set-up a clearing corporation. The National Securities Clearing Corporation
(NSCC) assumes the counterparty risk in all trading deals made on the exchange.
The NSCC acts as the counterparty for all the trades and the default risk in the deal
is borne by it. The NSE has created a special Trade Guarantee Fund for this purpose
and loss due to defaults will be met by drawing from its corpus.

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iv. Settlement System: The exchange followed the calendar system of settlement. For
example, in case of A group shares on the BSE, the trading cycle was for 14 days.
Trading in equities internationally is done on the basis of rolling settlement. The
settlement is done on either T+3 or T+5 system (i.e. the trade will be settled on the
3rd/5th day from the date of execution of the transaction). SEBI has encouraged the
stock exchanges to shorten their settlement cycle. The exchanges currently follow a
7 day settlement cycle. However, the trading week is not uniform giving rise to
arbitrage opportunities. In case of trading in dematerialized securities, the rolling
settlement has been introduced. Further, with the availability of the facility of
electronic funds transfer, the Delivery Versus Payment (DVP) system is being
introduced.
The trading on the NSE commences every Wednesday and concludes on the
following Tuesday and thus a month normally has four trading periods. With the
introduction of rolling settlement from July 2, 2001, the settlement is to be done on
daily basis and the NSE period will also be from Monday to Friday.
v. Carry Forward System: The Indian Stock Exchanges have been an amalgam of
cash market and forward market. The prices of the scrips on the exchange did not
reflect their ‘true’ price in the underlying cash market. Further there was
indiscriminate and rampant speculation in the market. Defaults were common and
other members were forced to “accommodate” the defaulting member. Often, the
defaults had a snowballing effect and the entire market would be in the throes of a
major payment crisis. This resulted in frequent closure of the exchanges for a few
days. In order to curb the prevailing malpractices, SEBI banned carry forward
transactions on all the stock exchanges. A modified carry forward system was
introduced and the badla procedure was also streamlined. Now, with the rolling
settlement system, modified carry forward and badla have been banned.
vi. Margin System: The role of the margin system for smooth running of any stock
exchange cannot be overemphasized. The margin system was dysfunctional in most
of the stock exchanges. The lack of stringent margin requirements and the laxity in
collection of the margins resulted in utter chaos, whenever there was a default. The
margin system has now been streamlined. SEBI has introduced the concept of mark
to market margin. In addition to this, other margins like initial margin, concentration
margin, etc., have been introduced.
vii. Capital Adequacy: Most of the brokers in the stock exchanges operated on a small
capital base. They were, therefore, unable to bear the risks associated with the
business. The result was a high incidence of defaults in the Stock Exchange. SEBI
has now introduced minimum capital norms for all brokers. Further, the capacity of
a broker to assume a position in the market would be a function of his capital.
viii. Liquidity for Debt: An important feature of a good capital market is the existence
of a vibrant secondary debt market. Indian markets were characterized by lack of
liquidity for corporate debt. This called for widening and deepening of the debt
market. The NSE set-up a separate trading system called the wholesale debt segment
for trading in all debt instruments. This has provided nationwide trading access to
debt investors. Market making would further enhance the liquidity in the debt
market.
ix. Indices: An index is an important tool to measure the price behavior of the overall
market. The return on the index provides a benchmark for portfolio risk-return
analysis. Several new indices have been constructed based on various parameters.
The 30 share BSE Sensex and the 50 share S&P CNX Nifty are the popular sensitive
indices to measure the daily market volatility. Some of the new indices like BSE
Dollex and NSE Defty are denominated in dollars. The S&P CNX 500 is a more
broad based index covering a larger portion of the total market capitalization. Apart
from these indices some industry specific indices have also been constructed to
reflect the price volatility of the shares of the companies in a particular industry. The
construction and maintenance of well-designed and responsive indices has become
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x. Regulation: SEBI has taken a number of steps to maintain the integrity of the
markets and to ensure investor protection. Insider trading has been declared as a
criminal offense and prosecutions have been initiated in cases violating of the
insider trading regulations. SEBI has also started investigating into instances of price
rigging and penal action is taken against the guilty. SEBI has also attempted to bring
transparency into broker-client relationships. The system of circuit breakers has
been introduced to prevent excessive volatility in price movements.
xi. Derivatives: Derivatives are important tools for portfolio management. The
introduction of derivatives resulted in a paradigm shift in the investment strategies
of the Indian investors. The L C Gupta committee had recommended the
introduction of options and futures in India. In the light of the experience gained,
options were introduced at a later stage. While trading in options and futures has
started, the market has not yet witnessed high volumes, as the investors are not very
comfortable with these instruments.
20. Level one: There is a formal agreement between the issuer and one depository bank. Like
the unsponsored ADR, Form F-6 is filed seeking exemption under Rule 12g3-2(b) of the
SEC from the full reporting requirements. The company does not have to comply with the
US Generally Accepted Accounting Principles (GAAP).
Level one ADRs cannot be listed on the national stock exchanges but can be traded at over
the counter market and listed in the pink sheets. Over The Counter Bulletin Board will no
longer be available for Level one ADRs although pink sheets would still be available. Pink
sheets contain wholesale price quotes and are distributed by the National Quotation Bureau
of Brokers and Dealers. This can support a Rule 144A ADR facility but cannot be used for
raising capital. Level One ADRs allow the company to enjoy the benefit of a traded
security without complying with the reporting requirements.
In the US, in addition to federal laws and regulations, state level ‘blue sky’ regulations
govern the offer and sale of securities. These regulations require state registration
before intrastate offering can be made.
Issuers who establish an unlisted ADR can publish certain financial data in a
recognized security manual to provide adequate source of investment information. This
eliminates the need to individually list securities in fifty states in the US.
Level two: As in level 1 the issuer initiates the program and there is a formal
agreement with the depository bank. In addition to filing Form F-6, the issuer is also
required to file Form 20-F and comply with other disclosure rules, including partial
reconcilation of the financial statements as per the US GAAP, to the extent there are
differences in major line items in the balance sheet and income statement.
Financial statements for individual business segments need not be reconciled to the
GAAP. Listing of securities exempts foreign issuers from complying with the ‘blue
sky’ regulations.
This program may be used to fund the ESOP (Employee Stock Ownership Plan) and
management compensation plans. This ADR is more expensive and time consuming
because of elaborate reporting requirements and higher legal and listing costs. It cannot
be used for raising capital through the listing process.
Level three: It is identical to level two. In addition, the issuer is required to file Form
F-1. This is similar to Form S-1 for the US companies. The issuer is required to have
the securities registered and fully reconcile the financial statement to the US GAAP.
The offering can be used for various purposes including funding ESOPs or raising
capital for the US acquisition. The issuer also selects an investment banker to advise,
underwrite, and market the offering. Infosys, Rediff, Silverline ICICI Bank, ICICI and
Satyam Info have raised capital in the international market by issuing level 3 ADRs.
21. Arnica Chemicals needs to develop a mix of factors like product differentiation,
pricing, promotion, service and distribution to successfully market their public deposit
schemes.

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Product Differentiation: Fixed deposit is an intangible financial product. The needs of

the potential depositors have to be kept in mind while designing the product. Generally,
the target market is the middle class household. They normally look for safety and
security of their savings. The safety factor can be projected by highlighting the credit
rating. Different saving schemes may be developed to suit varying financial needs.
Some of the popular schemes include regular income schemes where interest is paid at
monthly, quarterly, half-yearly or annual intervals, cumulative deposits where the
interest alongwith the principal is paid on maturity and recurring deposit schemes
where a fixed amount is invested regularly and a lump sum is paid on maturity. Some
company deposit schemes have sweeteners like free accident insurance cover for their
depositors.
Pricing: The pricing aspect is regulated by the Government and the maximum coupon
is capped at 15% p.a. Hence, scope for innovation is limited. However, it can design
schemes with various maturities and differential interest rates can be offered subject to
the statutory ceiling.
Promotion: Arnica Chemicals should first identify the segment of the market that it
would like to tap. This strategy enables it to focus on specific target segments instead
of scattering their marketing efforts.
At any point of time, potential depositors are in different stages of readiness – some are
unaware, some aware, some informed, some interested, some curious and some
intending to invest. Thus, the promotion effort should aim at building high awareness
through advertising. The promotional campaign can be carried through various media
like the print media, audio-visual media, outdoor displays like hoardings and posters,
direct mailers, novelties like calendars and key chains, catalogues and brochures,
circulars, etc.
Arnica needs informational advertising to build primary demand. The use of a catchy
message or slogan could be a good tool for communication. The advertisement has to
put the message across in a way that captures the attention and interest of the potential
investors. The message has to be exclusive, desirable and believable to create the
necessary impact. Some companies have attempted to create an identity for their public
deposits by providing them with brand names.
Quality Service: Good and courteous service helps in earning the goodwill of the
depositors. The depositors are provided with post-dated interest warrants payable at
par, prompt repayment on maturity, loans against deposits, etc. A mechanism for
prompt redressal of depositor grievances should also be created. Personalized and
prompt service will have a self-propelling effect and can bring in more depositors by
word of mouth. It acts as pseudo-marketing.
Distribution: It should decide on the geographical areas that it needs to focus on.
However, careful attention should be paid to variations in geographical needs and
preferences.
Arnica Chemicals can practice direct marketing of their deposits. The company staff
directly contacts the potential depositors and explains to them the salient features of
their schemes. It can also canvass by holding depositor meets and make presentation
about the company and its deposit products, for which it needs to have a clearly
defined target segment e.g. pensioners, double income households, young managers,
etc.
22. In India, call money is lent mainly to even out the short-term mismatches of assets and
liabilities and to meet CRR requirements of banks. Some banks may borrow and lend
simultaneously from the market if they find an opportunity to arbitrage.
Firstly, the short-term mismatches arise due to variation in maturities i.e., the deposits
mobilized are deployed by the bank at a longer maturity to earn more returns and the
duration of withdrawal of deposits by customers varies (since it is effectively a demand
liability). Thus, banks borrow from call money markets to meet short-term maturity
mismatches such as large payments and remittances.

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Secondly, the banks borrow from this market to meet the Cash Reserve Ratio (CRR)
requirements which they should maintain with the RBI every fortnight. Cash Reserve
Ratio (CRR) represents the balances to be maintained by banks with the RBI which is
computed as a percentage of the Net Demand and Time Liabilities (NDTL).
Thirdly, the money is borrowed in the call/notice market for short periods for
discounting commercial bills. The volume of call loans for serving this purpose is very
small in India, this is due to the underdeveloped bill markets. Thus, the utility of the call
money for meeting short-term mismatches form a significant volume when compared to the
other purposes.
23. The generic factors responsible for underpricing of IPOs are:
i. Asymmetric information: The most basic problem of the IPO process is the
presence of both ‘good’ and ‘bad’ firms going public, coupled with asymmetric
information between firms and investors. Firms know themselves reasonably well
but investors do not. When information and analysis is costly, it is optimal for
investors not to learn about a firm thoroughly.
Superior information disclosures can reduce this asymmetry and should help reduce
underpricing.
ii. Fixing the offer price early: The firm sets the offer price at time 0 and the issue
opens at time T. Firms are likely to be risk-averse with respect to the prospects of
the issues failing. Hence they underprice to forestall this possibility.
The delay between choosing an offer price and the issue date has diminished in
some sense with the current SEBI policy allowing firms to choose a price band at
the time of vetting the prospectus instead of a precise price.
iii. Interest rate float: The issuing company controls the application money for a
month. Even if stock-invests are widely used, the interest rate on stock-invests is
quite low. At equilibrium, markets would compensate investors for this low rate of
return, through underpricing.
This problem can be solved if issuing firms and merchant bankers become more
efficient and shorten the lags between the issue date and the listing date.
iv. Liquidity premium: Investors who apply for public issues lose liquidity on the
amount paid at issue price. Usually at equilibrium, the markets would compensate
them for this by paying a liquidity premium, which would show up in IPO
underpricing.
v. Building loyal shareholders: Firms may have an incentive to underprice when they
expect to return to the capital market to raise further resources at a later date, via a
rights issue or a public issue.
vi. Merchant banker rewarding favored clients: The interaction between the
merchant banker and the company going public is typically a one shot interaction,
but the merchant banker is in a repeated game with many of his clients, especially
the large institutional investors. In this situation the merchant banker has an
incentive to underprice to retain his established clients.
24. XYZ Ltd. is a leasing company. The RBI has issued directives to all the leasing, hire
purchase and other non-banking finance companies to apply for registration by July, 1998.
With XYZ Ltd. applying for registration, it has in-principle approval from the RBI to carry
on its business until the RBI scrutinizes the application in detail and either grants or cancels
the certificate of registration to the company. XYZ Ltd. can operate as usual until the RBI
responds to the application of registration.
A non-banking financial company can commence business after 8th January, 1997 or an
existing NBFC, like XYZ Ltd. can carry on the business of a NBFC only after:
i. Obtaining a certificate of registration from the RBI, and
ii. Having minimum net owned funds of Rs.25 lakh.
However, if XYZ Ltd. does not have a Net Owned Funds (NOF) of Rs.25 lakh, the
company should either register itself by enhancing the NOF or cease operations as it is
unable to be registered.

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The following factors concerning XYZ Ltd. will be evaluated by the RBI prior to the
granting of the certificate of registration:
a. XYZ Ltd. should be in a position to pay its present or future depositors in full and
when their claims accrue.
b. The affairs of XYZ Ltd. should not be in a manner detrimental to the interests of its
present or future depositors.
c. The general character of the management or the proposed management of XYZ Ltd.
should not be prejudicial to the public interest or the interests of the depositors.
d. Whether XYZ Ltd. has adequate capital structure and earning prospects.
e. The grant of certificate of registration should not be prejudicial to the operation and
consolidation of the financial sector consistent with monetary stability and economic
growth considering such other relevant factors.
f. Any other condition, fulfillment of which in the opinion of the RBI, should be
necessary to ensure that the commencement of, or carrying on of the business in
India by XYZ Ltd. should not be prejudicial to the public interest or in the interest of
the depositors.
25. The NBFC must have proportionately maintained the stipulated ratio of Tier I capital and
Tier II capital. The total of Tier II elements should be limited to a maximum of 100% of the
total of Tier I capital for the purpose of calculation of Capital Adequacy Ratio (CAR).
Tier I capital consists of paid-up capital, preference shares which are compulsorily
convertible into equity, free reserves, balance in share premium account and capital
reserves representing surplus arising out of sale proceeds of assets but excluding reserves
created by revaluation of assets.
From the total of these items, accumulated loss balance, deferred revenue expenditure and
book value of intangible assets, if any, are deducted to arrive at the owned funds.
From the resultant sum, the aggregate of:
• Investment in shares of other NBFCs
• Investment in shares, debentures and bonds of subsidiaries and
• Loans and advances to subsidiaries and companies of the same group are reduced, to
the extent it is more than 10% of net owned funds.
That is:
Owned funds = (Paid-up equity capital) + (Preference shares to be compulsorily convertible
into equity) + (Free reserves which may include any or all of General
Reserves, Share Premium, Capital Reserves, Debenture Redemption
Reserve, Capital Redemption Reserve, Credit Balance in P&L account or
other specified free reserves) – (Accumulated balance of loss) – (Deferred
Revenue Expenditure) – (Other Intangible Assets)
Tier I capital will be = Net owned funds + [Total of the deductions specified below –
10% of the Net owned funds; or Nil, whichever is higher]
Deductions are:
i. Investments in shares of subsidiaries, companies in the same group, other non-
banking companies.
ii. The book value of debentures, bonds, outstanding loans and advances in subsidiaries
and companies in the same group.
26. Every NBFC has to follow a set of procedures for accepting fixed deposits. The procedures
have been put in place to ensure transparency in operations of the NBFC and also to ensure
easy supervision and genuineness of the operations.

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Maintenance of Register: Avenue Finance Ltd. (AFL) is accepting fixed deposits and
therefore, has to maintain a set of registers in respect of all the deposits that contain specific
details of each of the depositors. The details should include
i. Name and address of the depositor,
ii. Date and amount of each deposit,
iii. Duration and the due date of each deposit,
iv. Date and amount of accrued interest or premium on each deposit,
v. Date of claim made by the depositor,
vi. The reasons for delay in repayment beyond five working days, and
vii. Any other particulars relating to the deposit.
These registers should be kept at the registered office of the company and should be
maintained for the next 8 calendar years following the financial year.
Advertisement for Deposits: Regulations concerning raising of deposits by NBFCs
stipulate that these entities should not accept deposits without issuance of advertisement
inviting them in the first place.
The advertisement must be issued in a leading English newspaper and one vernacular
newspaper circulating in the state in which the registered office of the AFL is situated, after
approval from the RBI. Such advertisement will be valid till the expiry of six months from
the date of closure of the financial year in which the advertisement is so issued or until the
date on which the balance sheet is laid before the company in the general meeting. The
same procedure is applicable for renewal of deposits also.
If AFL proposes to accept public deposits without inviting or allowing or causing any other
person to invite such deposit, then it must prepare a statement in lieu of advertisement
containing the prescribed particulars.
Nomination by Depositors: Any depositor or all the depositors together have a right to
nominate one person to whom the amount of deposit may be returned by AFL in the
event of death of the sole depositor or the death of all the depositors. Upon the death of
the sole depositor/all depositors, the nominee will be entitled to receive the deposit
from AFL and to all the rights of the depositor(s) in relation to such deposits, to the
exclusion of other persons. This right of the nominee against AFL supersedes any other
law or testament (will).
Loans to Depositor: After 3 months from the date of deposit, AFL can grant loans to the
depositor up to 75% of the amount of public deposit kept by the depositor. Interest rate that
can be charged by AFL can be a minimum of 2% above the interest rate payable on the
deposit.
27. The provisions for Path Financial Services in respect of loans, advances and other credit
facilities including bills purchased and discounted are as under:
a. Sub-standard Assets: A general provision of 10% of total outstandings must be
made.
b. Doubtful Assets:
i. 100% provision must be made to the extent of the unsecured portion.
ii. Additional provision: In addition to (i) above, depending upon the period for
which the asset has remained doubtful, provision to the extent of 20% to 50%
of the secured portion must be made on the following basis:
Period for which the asset has % of provision
been considered as doubtful
Up to 1 year 20%
1-3 years 30%
More than 3 years 50%

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c. Loss Assets: The entire loss asset must be written off. If the asset continues to
remain in the books for any reason, 100% of the outstanding amount should be
provided for.
Provisions for Lease and Hire Purchase Assets:
Basic Provisions
The total provision required to be made is broken up into basic provision and additional
provisions. The basic provision is required to be made only in respect of hire purchase
transactions and not in respect of lease transactions, and is required to be made once an
asset becomes a NPA. The basic provision is not linked to the number of months (beyond
12 months) for which the installments are overdue, whereas the additional provisions are
linked.
Hire Purchase Assets
The basic provision is 100% of the following:
• Total dues (overdue and future installments taken together, whether shown as stock-
in-trade or as receivables in the balance sheet).
• As reduced by the finance charges not credited to the profit and loss account and
carried forward as unmatured finance charges.
• As further reduced by the depreciated value or net realizable value, whichever is
lower.
The depreciated value for this purpose must be notionally computed at the original cost of
the asset as reduced by the Straight Line Method (SLM) of depreciation at 20% p.a. As the
SLM rate of depreciation is at 20% per annum, in case the asset is used for a part of a year,
pro rata depreciation has to be calculated.
Additional Provisions
Hire Purchase/Lease Assets
The additional provision is dependent on the number of months for which the hire
charges/lease rentals are overdue, and is calculated as a percentage of the net book value of
the hire purchase/lease asset.
The additional provision required is as under:
Overdue hire charges/lease rentals Provisions required
Percentage of net book value
Up to 12 months Nil
More than 12 months but up to 24 months 10%
More than 24 months but up to 36 months 50%
More than 36 months 100%
Net book value is defined in para 2(1)(xi) of the RBI Regulations:
a. In the case of hire purchase assets, the aggregate of overdue and future installments
receivable as reduced by the balance of unmatured finance charges and further
reduced by the provisions made as per paragraph 8(2)(i) of these directions.
b. In the case of leased asset, the aggregate of the capital portion of overdue lease
rentals accounted as receivables and the depreciated book value of the leased asset
as adjusted by the balance of the lease adjustment account.
The amount of caution money/margin money or value of any other security to which the
NBFC has valid recourse can be deducted against the additional provision (but not against
the basic provision made for overdues) and only the balance additional provision needs to
be made.

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Provision after the last due date has passed

On the expiry of 12 months after the due date of the last hire purchase installment/lease
rental, the entire net book value must be provided for. This provision requirement overrides
the additional provision requirements. In other words, once the overdues are for more than
12 months after the due date of the last hire purchase installment/lease rental, 100% of the
net book value must be provided for and the benefit of additional provision at
10%/50%/100% depending upon the period of overdues will not apply.
Also, in such a case, the benefit of deducting the amount of caution money/margin money
or value of any other security from the additional provision will not be available.
28. The distinction between a finance lease and an operating lease is of fundamental
importance in the financial evaluation and accounting of leases. The distinction is based on
the extent to which the risks and the rewards of ownership are transferred from the lessor to
the lessee.
Finance Lease
A lease is defined as finance lease if it transfers a substantial part of the risks and rewards
associated with ownership from the lessor to the lessee. According to the International
Accounting Standards Committee (IASC), there is a transfer of a substantial part of the
ownership related risks and rewards if:
i. The lease transfers ownership of the asset to the lessee by the end of the lease term;
(or)
ii. The lessee has the option to purchase the asset at a price which is expected to be
sufficiently lower than the fair market value at the date the option becomes
exercisable and, at the inception of the lease, it is reasonably certain that the option
will be exercised; (or)
iii. The lease term is for a major part of the useful life of the asset. The title may or may
not eventually be transferred; (or)
iv. The present value of the minimum lease payments is greater than or substantially
equal to the fair market value of the asset at the inception of the lease. The title may
or may not be eventually transferred.
The aforementioned criteria are largely based on the criteria evolved by the Financial
Accounting Standards Board of the US. The FASB has in fact defined certain cut-off points
for criteria (iii) and (iv). According to the FASB definition of a finance lease, if the lease
term exceeds seventy five percent of the useful life of the asset or if the present value of the
minimum lease payments exceeds ninety percent of the fair market value of the asset at the
inception of the lease, the lease will be classified as a finance lease.
For the purpose of determining the present value, the discount rate to be used by the lessor
will be the rate of interest implicit in the lease and the discount rate to be used by the lessee
will be its incremental borrowing rate.
In the Indian context, conditions (i) and (ii) are inapplicable because inclusion of any of
these conditions in the lease agreement will result in the agreement being treated as a hire
purchase agreement. Therefore, a lease is to be classified as a finance lease if one of the
conditions (iii) or (iv) is satisfied.
Operating Lease
The International Accounting Standards Committee defines an operating lease as ‘any lease
other than a finance lease’.
An operating lease has the following characteristics:
a. The lease term is significantly less than the economic life of the equipment.
b. The lessee enjoys the right to terminate the lease at a short notice without any
significant penalty.

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c. The lessor usually provides the operating know-how, suppliers, the related services
and undertakes the responsibility of insuring and maintaining the equipment in
which case an operating lease is called a wet lease. An operating lease where the
lessee bears the costs of insuring and maintaining the leased equipment is called a
dry lease.
An operating lease does not shift the equipment related business and technological risks
from the lessor to the lessee. The lessor structuring an operating lease transaction has to
depend upon multiple leases or on the realization of a substantial resale value (on expiry of
the first lease) to recover the investment cost plus a reasonable rate of return thereon.
Therefore, specializing in operating leases calls for an indepth knowledge of the
equipments per se and the secondary (resale) market for such equipments. Of course, the
prerequisite is the existence of a resale market. Given the fact that the resale market for
most of the used capital equipments in our country lacks breadth, operating leases are not in
popular use. But then this form of lease ideally suits the requirements of firms operating in
the sunrise industries characterized by a high degree of technological risk.
29. The advantages of leasing are:
Flexibility
Equipment leasing is a flexible financing arrangement in the sense that the lease rentals can
be structured in a manner that squares with the cash flow pattern anticipated by the lessee.
If the lessee expects a constant net cash flow stream from the project in which the leased
assets are employed, the lease rentals can be evenly spread over the lease term. On the other
hand, if the lessee anticipates a steadily increasing stream of cash flows, the lease rentals
can be stepped up gradually. If the lease finance is availed for a project with a gestation
period, the lease rentals can be structured with a deferment period.
User-Oriented Variants
There are several variants of a lease transaction which are designed to meet the specific
requirements of the lessee. Examples of such innovative variants are the Upgrade Lease,
which helps in hedging the risk of obsolescence or the cross-border lease which reduces the
cost of the lease from the lessee’s point of view. There are also leases which provide all
services related to the usage and maintenance of the asset. For example, in a full service car
lease, the lessee pays a predetermined charge for the use of a car or a fleet of cars and he
gets the entire spectrum of services ranging from the provision of chauffeurs to breakdown
maintenance.
Less Paperwork and Expeditious Disbursement
Compared to the term loan arrangement, a lease arrangement requires (a) less of paperwork
to be done by the lessee and (b) involves a shorter lead time between the date of submitting
the proposal and the date of disbursement of funds.
Convenience
Convenience determines the decision to lease when a firm intends using an asset for a very
short period of time. For example, a firm which requires the use of a fleet of cars for a week
will find it easier to rent the fleet for a week than to buy it on Monday morning and sell it
on Saturday evening. Apart from convenience, it is also a financially sensible proposition
because the transaction costs associated with buying and selling like search costs, legal
charges, selling commissions, etc., will outweigh the rentals to be paid for the short-term
lease.
Hundred Percent Financing
The proponents of leasing often emphasize this feature of leasing as an advantage not
available with the other forms of equipment financing. For example, the Equipment
Finance Scheme of IFCI requires a borrower’s contribution of 25% of the equipment
cost. Most of the other financing plans including hire purchase call for down payments
varying between 15 to 25 percent. While it is true that equipment leasing does not call
for as high a margin as other financing schemes, the fact remains that where lease
rentals are payable say monthly in advance, the first installment amounts to a down
payment. For example, a lease contract which requires lease rentals to be paid at the
rate of Rs.25 ptpm (per thousand rupees per month) in advance can be viewed as a
contract which requires a down payment of 2.5% of the asset cost.

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Better Utilization of Own Funds

The proponents argue that leasing is the sensible route for acquiring non-income
generating assets like air-conditioners, office equipments and vehicles. The firm can
deploy its own funds in more productive channels.
Off-Balance Sheet Financing
From our discussion of the characteristics of finance lease, it is clear that this form of
lease with its non-cancellable and full pay-out features is like a secured loan to be repaid
over a period of time. We are also aware that secured loans and the assets acquired out of
these loans are reflected in the balance sheet of the borrower. But surprisingly neither the
financial commitments nor the value of the assets acquired under a finance lease needs to
be disclosed in the balance sheet of the lessee. This phenomenon which goes by the name
of ‘Off-Balance Sheet Financing’ is projected as a unique advantage of leasing over other
forms of financing.
Other Firm-Specific Advantages
A small-scale unit which is on the verge of losing its SSI (Small Scale Industry) status by
virtue of its investment exceeding the prescribed investment limit can postpone the
inevitable for sometime by taking care of its immediate investment requirements through
leasing. Likewise closely-held companies are likely to find leasing to be a convenient
method of equipment financing because it does not result in dilution of control.
30. Yes, the finance manager is right. Lease financing suffers from the following shortcomings:
a. Given the fact that most of the equipment lease transactions are structured as finance
leases, the flexibility of the lessee to disinvest is seriously undermined. The non-
cancellable feature is a serious disadvantage particularly where the equipments
leased have uncertain technological and/or product-market lives.
b. Propelled by the dubious advantage of “Off-Balance Sheet Financing” no firm can
afford to increase its exposure to leasing beyond reasonable limits. Firms which are
highly geared (with a high debt-equity ratio) and firms which are subject to a high
degree of business risk must be particularly wary about leasing because it reduces
the debt capacity of such firms and increases the financial risk.
c. In a perfectly competitive financial market, the cost of leasing tends to be equal to
the costs of other forms of borrowing. Therefore, in this market a borrower (lessee)
can afford to be indifferent between the options of leasing and borrowing. But in an
imperfect financial market where the tax shields associated with leasing and owning
are different, where some long-term interest rates are regulated, etc., the costs of
leasing and borrowing can be significantly different. More often than not leasing
turns out to be costlier than most forms of borrowing. So, the lessee has to
necessarily evaluate the costs of leasing and borrowing before choosing to lease or
buy.
31. Tax Aspects of Leasing
Leasing as a Tax Shelter
Even though we have an elaborate literature on taxation practices in India, the procedures
relating to the treatment of tax for lease services India is far from sufficient. This is due to
the reason that our tax rules do not present clear-cut guidelines as to the identification of
appropriate lease transaction (true lease transaction) for the purposes of calculation of taxes.
In case of instance of a financial lease, the recovery of the asset by the lessor from the
lessee is considered in a dual way: One part as real income and the other part as the
realization of the capital by the lessor. In a strict sense, the later is not an income, if
presented for tax calculations. Only a part of the whole realized by the lessor is accounted
as real income i.e., the sum received as lease rental. This allows the lessee to incur a tax
gain whereas the lessor suffers a tax loss. In the absence of any definite rules for

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distinguishing a true lease and financial lease, the treatment of tax laws have necessitated a
further look at the lease transaction because
• Several NBFCs of national repute and a number of financial institutions have
resorted to leasing as a tool for tax shelter.
• A lot of other players had joined the leasing, as there was no restriction on the
utilization of leasing against other income. This prompted companies to get into
leasing to avail these taxation benefits.
• The main purpose for the companies to get into the leasing to avail tax benefit is due
to the financial management decisions by the companies, which provides a better
look to the balance sheet of the company. For example, the tax shield earned by the
company can be shown as an income for that year, thus giving a better EPS,
dividend and net worth projections of the company for that year.
Sales Tax on Lease Transactions
Apart from the income tax, the lease transactions attract sales tax for the transactions entered
into by them. This fact is the greatest irritant of the leasing industry in India. Leasing is a
business which follows a ‘singularly revenue driven approach’ whereas the sales tax is
accompanied by a multi-point levy. This theoretical distinction itself is a sufficient justification
as to why there should not be any sales taxes on the lease transactions. Due to the presence of
sales tax, the players are tempted to underprice their transactions. There are some taxing
anomalies with respect to the leasing transactions. Many lease transactions are of interstate in
nature, and of course fall outside the tax laws for computation of sales taxes. But in practice,
such transactions are actually charged by the states. These non-clarity of the tax laws allows the
states to take advantage and the leasing companies tend to suffer.
Accounting Aspects of Leasing
The ICAI guideline 19 deals with the accounting treatment of the leasing transaction for
companies in India. However, internationally, companies were following the standard 17 of
the International Accounting Standard. The Indian companies are free to follow any of the
two directives depending on their expertise. Besides, there is hardly any difference between
the objective and accounting treatment as recommended by ICAI 19 and IAS 17. The
Institute of Chartered Accountants of India (ICAI) has issued Accounting Standard no.19
(AS 19) on accounting for leases which has been taken in response to the long-standing
demands of the leasing industry to the authorities to give a re-look at the existing
accounting standards. The apex institute in tax practices in India has finalized and released
the standards and made it applicable for all the assets leased during the accounting period
commencing from 1st April, 2001. Being an accounting standard, the new guideline is
applicable to all the lessors and their lessees; irrespective of the fact of their legal status viz.
they may be banks, NBFCs, companies or individuals. The law treats all the parties
uniformly. Since there is hardly anything to distinguish between a lease and a hire purchase
transaction, both practically and theoretically, the new guideline rightly makes it binding
for the hire purchase companies to adhere to the guidelines with equal honesty. To give
example of a significant shift in the policy for the hire purchase financiers the hire purchase
financiers traditionally had been following the straightline methods of depreciation in their
books of accounts. The new tax rule has made that method unnecessary; hence the hire
purchase financiers would not be able to recognize the revenue evenly or equally
throughout. They now have to charge the depreciation on the diminishing balance. The
accounting standard 19 states in detail as to the treatment of specific lease transactions in
the books of the lessor and the lessee.
32. The salient features of consumer credit transactions are as follows:
Number of Parties to the Transaction
The transaction can be either a bipartite one involving the dealer-cum-financier and the
borrower/customer or a tripartite one where the dealer and the financier are two distinct
entities. The tripartite transaction can be of the sales-aid type where the dealer arranges for
finance and does the necessary paperwork on behalf of the borrower. Under such
transactions, the credit granting decision lies with the dealer, of course subject to the
eligibility criteria stipulated by the finance company. Such transactions are structured with
recourse to the dealer. On the other hand, a tripartite transaction can be of the conventional
type where the customer approaches the finance company to avail the credit facility.

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Structure of the Transaction

A consumer credit transaction can be structured in the form of hire purchase, conditional
sale or credit sale transaction. As we have discussed earlier a hire purchase is a contract of
hire with the option to purchase. The customer, while having the option to purchase, need
not do so and can terminate the agreement and return the goods at any time subject to the
terms and conditions of the agreement. In a conditional sale contract, the ownership is not
transferred to the customer until the total purchase price (including the charge for credit) is
paid and the customer cannot terminate the agreement before the purchase price is paid. In
a credit sale contract the ownership is transferred to the buyer on payment of the first
installment. The customer, however, cannot cancel the agreement before the total purchase
price is paid. Most of the tripartite consumer finance transactions are of the hire purchase
type.
Down Payment
Consumer Finance Schemes can be broadly classified under two categories: Down Payment
Schemes and Deposit Linked Schemes. The down payment varies between 20% and 25%
of the value of the consumer durable. Likewise the security deposit under the Deposit
Linked Scheme varies between 15-25 percent of the amount financed (which is equal to the
investment outlay). The deposit is of cumulative nature carrying interest at a prescribed rate
(which at the time of writing cannot exceed 15% compounded monthly). Some finance
companies also offer Zero Deposit Scheme under which the Equated Installment (EMI) is
higher than the EMI under the 15% and 25% deposit schemes.
Repayment Period and Rate of Interest
The repayment schedule is drawn on the basis of monthly installments over a period
varying between 12 months and 60 months. The borrower is permitted to choose the most
convenient repayment period from the given range of options. While the rate of interest is
typically expressed as a flat rate, some financial intermediaries like Citibank disclose the
effective rate of interest. In recent times many finance companies have dispensed with the
practice of disclosing the rate of interest. Instead they disclose the equated monthly
installments associated with the different repayment periods and require the borrower to
figure out the effective rate of interest for himself.
The repayment is required to be made through post-dated cheques. In respect of
institutional consumer credit schemes where the finance is routed through the organization
which employs the borrower, the organization concerned is required to deduct EMI at
source and transmit the payments to the finance company. Most of the schemes provide for
early repayment of the loan subject to certain conditions. They also provide for either a
rebate for prompt payment (prompt payment bonus) or for a delayed payment charge.
Security
The consumer credit is secured through a first charge on the asset concerned and the
borrower is prohibited from selling or pledging or hypothecating the asset during the credit
period.
33. The first step in the streamlining process is to define and articulate a clear-cut procedure for
evaluating customers. This is an onerous and difficult task. It is onerous because the
number of customers to be credit rated is quite large. It is difficult because there are no hard
data on the past payment record or on the financial position of the borrower (like the
audited financial statements) to judge the willingness and the ability to repay.
In some countries credit reference bureaus do provide a large part of information required
for evaluating the credit applicant. The typical data stored on the individual file include:
• Record of all registered county court judgments and decrees in the last six years.
• Information supplied by other traders with regard to bad debts, slow paying accounts
and repossessions.
• Records of bankruptcies and administration orders.
• Voters roll information.

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Some credit bureaus also file details of all satisfactory credit transactions reported to them
by other users.
In the Indian context, there are no credit bureaus to aid the credit-granting decision. For the
credit evaluation of an individual borrower, the finance company calls for a copy of the
salary certificate and the name and address of the employer. For the credit evaluation of
business entities like sole proprietorships and partnerships, the finance company looks for
the financial statements for the last two years duly certified by a chartered accountant and
the addresses of the bankers with whom the business entity has credit facility. Thus,
checking with the employer and the banker seem to be the only ways of obtaining
independent reference information in India.
Since a finance company engaged in offering consumer credit has to assess the
creditworthiness of a large number of individual borrowers, it makes a lot of sense to use a
mechanical scoring system for a preliminary evaluation of the credit applicants.
A perusal of the below given questionnaire reveals that what we are trying to obtain is an
overall risk index for the loan applicant. The way to do it is to add-up the relevant
probabilities of default in different categories. In the example given in the question, if Mr.
Ramchandani gives the most unfavorable response to each question he will have a risk
index of 28 and if he gives all favorable responses he will have a risk index of 3. To
discriminate between the good and the bad risks, the finance company will have to define
its own acceptable risk index. For instance, it may decide that all loan applicants with a
credit risk index of more than 10 will be rejected.
Questionnaire for Evaluation of Loan Applicants with Default Rates
1. Do you have a telephone at residence?
Yes (0.7)
No (1.0)
2. Do you:
Own Your Home (0.7)
Rent a House (2.4)
Rent a Room (6.5)
3. How long have yoUSpent in your present job?
Less than 6 months (8.4)
7 to 24 months (3.2)
More than 24 months (0.2)
4. What is your take-home monthly pay?
Less than Rs.2,500 (8.8)
Between Rs.2,500 to Rs.4,500 (3.3)
Above Rs.4,500 (0.4)
5. How many members are there in your family?
One to Two (0.2)
Three to Five (0.7)
More than Five (2.0)
6. For how long do you require the loan?
12 months or less (1.3)
More than 12 months (0.8)
The reader must have observed that the method employed for separating the sheep from the
goats is conceptually weak because adding up the probabilities ignores the interactions
between the different factors. As an alternative, we can use the information provided by the
questionnaire to identify the factors relevant for credit rating and combine them using the

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statistical technique of Multiple Discriminant Analysis. If only two such factors are
considered, one can also use the graphical approach. For example, if we consider the take-
home pay and the number of months spent on the present job as two relevant factors, then
the credit index can be defined as follows:
Z = aX1 + bX2
Where,
Z = index of creditworthiness
X1 = take-home monthly income (in rupees)
X2 = number of years spent on the present job.
Based on a sample drawn from the past data (consisting of both defaulters and non-
defaulters) a scatter diagram is plotted as shown below.

In this diagram Os represent the customers who have defaulted and Xs denote the customers
who have paid on time. A visual inspection of the scatter of points reveals a discriminating line
intercepting the X1-axis at 3.2 and X2-axis at 2.4 such that the two groups – the defaulters
and non-defaulters – are kept as far apart as possible. The equation is therefore
Z = 3X1 + 4X2
or Index = 3 (Take-home monthly pay in thousands of rupees) + 4 (Number of months spent on
the current job expressed as a fraction of the year)
Credit applicants with an index1 of 9.6 or more will be accepted and applicants with an index of
less than 9.6 will be rejected.
34. There are various forms of non-traditional mortgages, also known as Alternative Mortgage
Instruments (AMIs). Some of the popular forms of non-traditional mortgages are:
a. Graduated Payment Mortgages
The payments under Graduated Payment Mortgages (GPM) are not equal, with
payments starting at a relatively low level and rising for a specified number of years
and then become equal after the specified number of years. The frequency of
quantum of increase and the specified number of years after which the payment
becomes equal depends upon the plan indicated in the mortgage instrument.
GPMs are preferred by those whose current income is not sufficient to take a large
loan, but whose income is expected to increase rapidly in the near future. Since the
smaller payments in the initial years do not even cover the interest, initially the
mortgage balance increases for a short period. However, with the increase in
monthly payments, the mortgage balance decreases and eventually reaches zero by
the end of the term.

1
Note that the equation of the line is X1/3.2 + X2/2.4 = 1 or 3X1 + 4X2 = 9.6.

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b. Pledged Account Mortgages (PAM)

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.
Under PAM, some portion of the down payment as required in traditional mortgage
is deposited in the savings account.
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.
c. 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.
d. 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.
35. 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.
To understand the complex features of an ARM, the structure of a VRM used by a savings
and loan association is given below:
i. The mortgage interest is based on the weighted average cost of savings index
published by the Federal Home Loan Bank of San Francisco. In general, the spread
between the mortgage rate and the index rate is held constant; that is, when the index
changes, there is an equal change in the VRM interest rates. However, there are
other provisions which may prevent such equal changes taking place all the time.
ii. The mortgage interest may change (up or down) only once in any six-month period
and may not be changed at all during the first six months.
iii. The mortgage interest may not change (up or down) more than 0.25 percent
(25 basis points) at a time, no matter how much the index changes. Combined with
provision (ii) above, this means that the mortgage interest may not change more than
0.5 percent per year.
iv. The mortgage interest rate must change at least 0.1 percent (10 basis points) at a
time, except to bring the rate to a level previously impossible because of the 25-
basis points limitation. For instance, if the index rises 5 basis points from the
original level, the VRM rate would not rise. However, if the index rises 30 basis
points from the original level, the VRM rate will rise by 25 basis points (the agreed
upon maximum) after six months, and by the other 5 basis points in another six
months.

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v. The mortgage interest rate may not rise more than 2.5 percent (250 basis points)
higher than its initial level, no matter how much the index rises.
vi. Increases in the mortgage rate are optional on the part of the lender, but decreases
are mandatory.
vii. Within 90 days of any time the mortgage rate is increased, or at any time the
mortgage rate exceeds its initial level, the borrower may prepay the loan in whole or
in part without prepayment penalty.
viii. Whenever the mortgage rate is increased to a rate higher than its initial level, the
borrower may opt to keep his monthly payment constant by extending the maturity
of the mortgage. However, there is usually a limit up to which the extension of the
maturity period will be allowed. For example, a 30-year mortgage may give the
option to the borrower to extend the term by 10 years, which means that the total
term to maturity of the mortgage cannot exceed 40 years.
In spite of 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 high and buyers hunt for arrangements that could
lower initial outflows.
36. Real estate transactions involve exchange of economic resources between a seller, buyer,
and normally, a financial entity. Investment in real estate is always found to be reliable in
hedging against inflation. Returns from real estate are not highly correlated with the returns
from shares and bonds. Therefore, by including real estate in the diversified portfolio of
investment, a diversification of risk and hence enhancing the risk-return characteristics,
may be achieved.
• Direct investment in real estate entails tax benefits through deductibility of
depreciation (on buildings). Also, any debt financing used could lead to tax losses
(as per US tax laws), which would be used to shelter other income;
• Real estate assets offer attractive total returns. Apart from the income stream of
rental, the prospects for growth in both rental and value are attractive when
compared to expected returns from financial assets.
Real Estate: Selection and Management
Office buildings, industrial warehouses and shopping centers are the three types of real
estate included in most institutional portfolios. In selecting a real estate one should take
care to analyze and inspect the property before making the purchase. A good real estate
manager is one who has the expertise to distinguish between a good and mediocre property.
Once the real estate is acquired, the management of the property becomes very important.
An important objective of property management is inflation hedging. Short-term leases are
probably ideal for investor protection. Another important property management objective is
to maximize a property’s current income. To add to the rentability and value of the real
estate, capital improvements should be made which make the building attractive and get the
highest possible rent. Professional property management is increasingly being recognized
by institutional owners of real estate.
37. Credit rating forms an integral part of the securitization deal. After identifying the
homogeneous pool of assets that are to constitute a securitization deal, rating is sought by
the originator to rate the securitization deal based on the tentative parameters on other parts
of the deal. The credit rating agency considers that part of assets that are to be securitized
without considering the assets in the balance sheet. By this, as mentioned above, there
exists a possibility of securitized assets having a higher rating than the rating of the
company itself. All the credit rating agencies rate securitized instruments. CRISIL, Duff

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and Phelps, CARE and ICRA have rated securitized deals. All such ratings will have a ‘SO’
suffixed to the deal to indicate that the rated instrument is a ‘Structured Obligation’, which
essentially means that the deal has met all the parameters of credit rating and has been
structured for the purpose of credit rating and marketing of the instruments.
Credit rating helps the investors to gauge the risk of investing in the deal. It also helps the
originator to beat its own company’s rating thereby enabling it to borrow funds at a cheaper
rate. These companies may securitize their pool of hire purchase receivables or any other
assets that have a stream of future cash flows which will give them a better rating for the
deal, thereby achieving liquidity and enabling cheaper borrowing.
The parameters considered by the credit rating agency while rating a securitized deal are
similar to the parameters used for rating any other similar borrowing instrument like the
fixed deposits. The variance will be in consideration with the pool of assets.
38. The sales tax aspects of hire purchase contracts have to be gleaned from the provisions of
the Constitution (Forty-Sixth Amendment) Act, 1982 and a maze of High Court and
Supreme Court rulings on the subject. The salient sales tax aspects are as follows:
a. Hire purchase transactions per se are liable to sales tax. The Forty-Sixth Amendment
Act clearly states that the “tax on the sale or purchase of goods includes a tax on the
delivery of goods on hire purchase or any other system of payment by installments”.
b. For the purpose of levying sales tax a sale is deemed to take place only when the
hirer exercises the option to purchase.
c. The amount of sales tax must be determined with reference to the depreciated value
of the goods at the time when the hirer exercises the purchase option. The
appropriate method for computing the depreciated value is to be determined by the
sales tax authorities.
d. The state in which the goods have been ‘delivered’ (to the hirer) is the state entitled
to levy and collect sales tax.
e. Sales tax on hire purchase will not be levied if the state in which the goods are
‘delivered’ has a single point levy system in respect of such goods and if the owner
(finance company) had purchased the goods within the same state.
f. Sales tax cannot be levied on hire purchase transactions structured by finance
companies provided these companies are not dealers in the class of goods let on hire.
g. There is no uniform rate of sales tax applicable to hire purchase transactions. The
rate varies from state to state.
h. Does the Central Sales Tax (CST) apply to hire purchase transactions?
As per Section 2(g) of the CST Act, transfer of goods on hire purchase or any other
system of payment by installments is included within the definition of ‘Sale’. But
then the statement of objects and reasons to the 46th Amendment Act clearly states
that a ‘Sale’ is deemed to take place only at the time of exercising the purchase
option. Since the interstate movement of goods would have occurred before the hirer
exercises the option to buy, no hire purchase transaction is likely to be subject to
central sales tax.
39. Factoring basically involves transfer of the collection of receivables and their related
bookkeeping functions from firm to a financial intermediary called the factor. In addition,
the factor often extends a line of credit against the receivables of the firm. Thus, factoring
provides the firm with a source of financing its receivables and facilitates the process of
collecting the receivables. Usually the factor immediately makes a part-payment to provide
liquidity to the client.
For rendering the services of collection and maintenance of sales ledger, the factor charges
commission up front. The factor charges interest at a rate that is marginally higher than the
rate of interest charged by banks on working capital advance for making an immediate part-
payment against the debts purchased. The interest charge is calculated for the period
between the date of advance payment and date of collection or the guaranteed payment
date.

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40. The legal relationship between a factor and the client is governed by the provisions of the
factoring agreement or the master agreement. Some of the salient features of the agreement
are as follows:
a. The client gives an undertaking to sell its receivables and the factor agrees to
purchase the same subject to the terms and conditions mentioned in the agreement.
b. The client warranties that the debts are valid, enforceable, undisputed and
recoverable. The client also undertakes to settle problems of dispute, damage and
deductions relating to the bills assigned to the factor.
c. The client agrees that the bills purchased by the factor on a non-recourse basis
(called approved bills) will arise only from transactions specifically approved by the
factor or those falling within the credit limits authorized by the factor.
d. The client agrees to serve a notice of assignment in the prescribed form to all
customers whose receivables have been factored.
e. The client agrees to provide copies of all invoices, credit notes, etc., relating to the
factored accounts to the factor and to remit monies received by the client against the
factored invoices to the client.
f. The factor acquires the power of attorney to further assign the debts and to draw
negotiable instruments in respect of such debts.
g. The time-frame for the agreement and the mode of termination are specified.
As between the factor and the customer, the legal status of the factor is that of an assignee.
Therefore, the customer has the same set of defences against the factor as he would have
against the client. The customer whose account has been factored and has been notified of
the assignment is under a legal obligation to remit the money due directly to the factor.
Consequently, a customer who continues to make such payments directly to the client is not
discharged from his obligation to pay the factor until and unless the client remits the
amount to the factor.
41. The origin and concept of bill can be traced back to the 4th century B.C. when the Greeks
made use of bills. From times immemorial, banks and business houses have been using
‘Hundi’, the indigenous kind of bills of exchange. There were two kinds of hundis which
were in vogue. Of the two, ‘darshani hundi’ is similar to the bill of exchange of today with
respect to the purpose for which it is drawn. Its place of origin may be quite different from
the place of operation. The ‘muddati hundi’ is quite different. It is confined to local limits
in which it is drawn.
Section 5 of the Negotiable Instruments Act, 1881, defines Bill of Exchange as ‘an
instrument in writing containing an unconditional order, signed by the maker, directing a
certain person to pay a certain sum of money only to, or to the order of, a certain person or
to the bearer of the instrument’.
A bill attains the character of negotiability only if it contains the features of negotiable
instruments. The specific features of a negotiable instrument are as follows:
a. Parties to a bill of exchange – drawer, drawee and payee. The maker of the
instrument who directs to pay is the drawer, the person to whom the direction is
given is the drawee (when he accepts the bill, he becomes the acceptor) and the
person to whom payment is to be made is the payee. In some cases the drawer and
the payee may be the same person.
The drawer or the payee who is in possession of the bill is called the holder. When
the holder endorses it, he is called the endorser. The person to whom it is endorsed is
called the endorsee. When in the bill or any endorsement thereon the name of any
person is given in addition to the drawee (to be resorted to in case of need), such
person is called a drawee in case of need. Drawee in case of need can be resorted to
only when the bill is dishonored by non-acceptance or non-payment.
b. The instrument must be in writing.
c. It must contain an order to pay and not a request.
d. A bill of exchange cannot be drawn so as to be payable conditionally.

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e. The sum payable must be certain.

f. The person to whom the direction is given or to whom the payment is to be made
must be certain.
g. It must be signed by the drawer and presented to the drawee for acceptance.
h. The order to pay should be in legal tender money.
i. All other formalities like date, number, place and consideration are usually found in
bills though not essentially required by law.
42. Taking into account the time-lag between an account becoming doubtful of recovery, its
recognition the realization of the security and the erosion over time in the value of security
charged, it has been decided that NBFCs should make a provision against sub-standard
assets, doubtful assets and loss assets as given below.
The provisions in respect of loans, advances and other credit facilities including bills
purchased and discounted are as under:
a. Sub-standard Assets: A general provision of 10% of total outstandings must be
made.
b. Doubtful Assets:
i. 100% provision must be made to the extent of the unsecured portion.
ii. Additional provision: In addition to (i) above, depending upon the period for
which the asset has remained doubtful, provision to the extent of 20% to 50%
of the secured portion must be made on the following basis:
Period for which the asset has been % provision
considered as doubtful
Up to 1 year 20%
1-3 years 30%
More than 3 years 50%
c. Loss Assets: The entire loss asset must be written off. If the asset continues to
remain in the books for any reason, 100% of the outstanding amount should be
provided for.
43. The concept of bill of exchange can be explained as follows:
Suppose seller A sells goods to the buyer B. In most cases A would want to have money
immediately but B would like to make payment only after sometime, say, when he resells
the goods he has purchased. To solve the difficulty, A draws a bill of given maturity on B.
A, the creditor, is known as the drawer of the bill, and B, the debtor, is known as the drawee
of the bill. A then sends the bill to B who acknowledges his responsibility for the payment
of the amount on terms mentioned on the bill by writing his ‘acceptance’on the bill. When
B has ‘accepted’ the bill, he has closed the transaction for the time being. A can now take
the ‘accepted bill’ to a bank and hand it over in exchange for ready money. This act of
handing over of the endorsed bill in exchange for ready money is called ‘discounting the
bill of exchange’. The margin between the ready money paid and the face value of the bill
is called the ‘discount’ and is calculated at a rate percent per annum on the maturity value.
The act of discounting is not to be interpreted as borrowing on the security of the bill, it is
an act of selling the bill. In India, however, in almost all cases, even of ‘bills purchased’ by
banks, they hold the bills only as a security for the advances.
There are four types of procedures while dealing with trade finance bills. The steps
involved are as follows:
a. Trader’s Bill: (a) A seller supplies goods and submits the bill to the buyer for the
value of goods supplied, (b) the buyer accepts the bill along with the goods supplied,
(c) the seller receives the accepted bill from the buyer and discounts the bill with the
seller’s bank, and (d) the buyer makes the payment on due date.
b. Bills with Co-acceptance: (a) A seller supplies goods and submits the bill to the
buyer for the value of goods supplied, (b) the buyer accepts the bill along with the
goods supplied, (c) the buyer’s bank also co-accepts the bill, and (d) the seller
receives the bill accepted by the buyer and co-accepted by the buyer’s bank and
discounts it the seller’s bank.

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c. Bills Accompanied with Letter of Credit (LC): (a) A seller supplies goods and
submits the bill to the buyer for the value of goods supplied, (b) the buyer accepts
the bill along with the goods supplied, (c) the buyer’s bank opens the LC in favor of
the seller, and (d) the seller receives the accepted bill along with the LC opened by
the buyer’s bank in favor of the seller and discounts the same with the seller’s bank.
d. Drawee Bills: (a) A seller supplies goods and submits the bill to the buyer for the
value of goods supplied, (b) the buyer accepts the bill along with the goods supplied,
and (c) the buyer’s bank discounts the bill for the account of the buyer.
44. In international trade transactions, forfaiting is a common form of financing export-related
receivables. Under this arrangement:
• The exporter sells the goods to the importer on a deferred payment basis spread over
3-5 years.
• The importer draws a series of promissory notes in favor of the exporter for the
payments to be made inclusive of interest charges.
• The promissory notes are avalled or guaranteed by a reputed international bank
which can also be the importer’s banker. (An aval is an endorsement on the
promissory notes by the guaranteeing bank that it covers any default of payment by
the buyer.)
• The exporter sells the avalled notes to a forfaiter (which can be the exporter’s
banker) at a discount and without recourse. The discount rate applied by the forfaiter
will depend upon the terms of the promissory notes, the currencies in which they are
denominated, the credit rating of the avalling bank, the country risk of the importer,
and the prevailing market rate of interest on medium-term loans.
• The forfaiter may hold these notes till maturity or sell them to groups of investors
interested in taking up such high-yielding unsecured paper.
The mechanics of forfaiting is graphically presented below.

Mechanics of Forfaiting
A. Promissory notes sent for avalling to the importer’s bank
B. Avalled notes returned to the importer
C. Avalled notes sent to exporter
D. Avalled notes sold at a discount to a fortfaiter on a non-recourse basis
E. Exporter obtains finance
F. Fortfaiter holds the notes till maturity or securitizes these notes and sells the short-
term paper either to a group of investors or to investors at large in the secondary
market.
45. Credit Cards: The Concept
This is the age of credit cards. People prefer credit cards to paper currency. The culture of
plastic money seems to be fast catching up in the country with more banks offering credit
card facility, more establishments willing to accept them in place of cash and more
consumers finding the concept a more convenient mode of making payments.

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Credit cards enable its holders to make purchases/avail the services at various designated
Member Establishments (MEs) like departmental stores, shops, star hotels, airlines,
railways, etc., who accept all valid credit cards in lieu of cash payment. As such, the
cardholder can avoid the risk of carrying cash.
The concept of the credit card was pioneered in the country by foreign banks like Citibank
who continues to be the biggest player both in the domestic and the international market.
Indian banks, though not far behind, have been less aggressive compared to the foreign
banks.
Credit cards are also issued to non-individual entities like corporate bodies and non-
corporate establishments. For instance, the Cancards issued to corporate bodies are called
Corporate cards and those issued to the non-corporate business establishments are called
Business Cards.
Uses of Credit Cards
Credit cards can be used for:
a. Cash withdrawals at any of the branches or ATMs of the issuer/member affiliate of
the issuer and
b. Purchasing/availing of the services at any of the MEs.
Cash Withdrawal Facility: Credit cardholders are normally permitted to draw cash at any
of the branches/offices of the issuer and at any branches/offices of member affiliates.
Usually the maximum amount that can be drawn on each occasion is fixed with reference to
the overall ceiling limit under the credit card. Usually there is a service charge for cash
withdrawals to cover the cost of funds drawn. And now with the advent of the ATM,
potential customers are being lured even more.
Automatic Teller Machines: The ATM makes standing in queues and spending time
unnecessarily at the banks, things of the past. By simply inserting a card into an ATM, the
cardholder can withdraw crisp new notes at anytime of the day or night.
Added Advantages of Credit Cards to Cardholders: In addition to the above uses, the cards
provide certain added privileges to the cardholders. Cancard-Visa issuer Canara Bank bears
premium for insurance cover of the cardholder to meet unforeseen circumstances.
Overdraft Facility: Some card issuers like Citibank provide overdraft facility whereby a
cardholder can spend more than he is entitled to. The amount depends on the individual
cardholder’s credit rating.
Benefits to Issuer/Affiliate and MEs: The reason for more and more banks jumping into
the bandwagon is the high profitability that the business of credit card offers. For instance,
banks charge a 2.5 percent commission from establishments selling goods and services
through credit cards. There are instances of banks charging as much as 7 percent for high
margin MEs like antique shops. Banks offer a credit period of 30 to 45 days to the
customers but charge about 2.5 percent on all outstandings. Thus, a single purchase
transaction through the credit card, assuming the customer does not pay within the
stipulated credit period, will fetch a commission of five percent to the bank which works
out at as much as 60 percent per annum, miles ahead of the prime lending rate of many
banks.
Benefits accrue to the member establishments from the larger number of customers that the
card brings. There is a general feeling that a credit card tempts one to over spend. Even the
MEs, especially the retail outlets, agree that a person with a credit card ends up spending
more than required, since he does not feel the pinch at the time of purchase.
Given the multiple advantages and conveniences of the plastic money, to all concerned,
fueled by aggressive marketing, the popularity of credit cards is growing and will
continue to grow by leaps and bounds in the future. Competition is going to hot up not
only amongst issuers but even amongst the member establishments.
From August 2001, all the charges levied by credit card companies in India will attract 5%
service tax, which will simply increase the costs to the cardholders.

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Part IV: Case Studies (Problems)

Case Study 1
Read the case carefully and answer the following questions.
1. Identify the various alternatives available to an investor in this issue considering the
multiple options available on warrants and the non-convertible portion. (Hint: For
example, an investor who is allotted shares in this issue, could decide to exercise the
warrants and retain the non-convertible portion also).
2. What are the net cash inflows (post-tax) and outflows from the investors’ perspective in
each of the above alternatives?
3. Calculate the effective return to the investor to the nearest percentage (using time value of
money) in any two of the above alternatives.
a. The CAMPBELL CORPORATION LTD. (CCL) was incorporated on 1st November, 20x0.
It began commercial production of cables and wires in February, 20x1 at its factory at
Andheri, Mumbai. Promoted by two well-known industrial houses from Mumbai, the
Rajputs and the Thackereys and two renowned companies from Germany, Bosch & Folten,
the Company secured technical collaboration from Bosch and was among the first to
manufacture PVC insulated cables. The Company now plans to set up a new unit to
manufacture power and control cables and expand and modernize an existing plant at
Andheri. The Company is approaching the capital markets to part finance the project.
b. The Issue is scheduled to open on 17th February, 20x2 and close on 27th February, 20x2.
The CCL is making a public issue of 33,75,000 16% Secured Redeemable Partly
Convertible Debentures of Rs.140 each for cash at par aggregating Rs.4,725.00 lakh with
detachable warrants.
The PCD will be converted into one equity share of Rs.70 on allotment. The remaining
non-convertible portion of Rs.70 shall carry a coupon of 16% p.a. payable annually and
shall be redeemed in the 4th (Rs.20), 5th (Rs.20) and 6th year (Rs.30). Warrants are
exercisable between 6 and 24 months at 40% discount to the market price subject to a
minimum of Rs.70 and a maximum price of Rs.90.
The project is being part financed to the extent of Rs.3,150 lakh through warrants at a base
price of Rs.70 each. The Promoters have undertaken to subscribe to equity shares in
exchange of warrants to the extent of Rs.787.50 lakh. In the event of warrants for the
balance amount of Rs.2,362.5 lakh, not being exercised, the Company proposes to meet the
shortfall, if any, through internal accruals and/or by liquidating its investments.
c. Terms of the Issue
Principal Terms of Debentures
Face Value
Each debenture will have a face value of Rs.140 and shall consist of two parts.
i. Convertible Part A of Rs.70, and
ii. Non-Convertible Part B of Rs.70 but the Warrant by itself will not have any face
value.
Terms of Appropriation of Payment
For all applicants (except for NRIs/OCBs/FIIs and firm allottees)
Appropriation
Part A Part B
Equity (Rs.) NCD (Rs.)
Total Paid-up Share
(Rs.) Capital Premium
On Application 35.0 5.0 20.5 9.5
On Allotment 105.0 5.0 39.5 60.5

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d. Conversion
Part A of each debenture of face value of Rs.70 will be automatically and compulsorily
converted into one equity share of Rs.10 at a premium of Rs.60, on allotment of the
debentures.
Thus for every Part A of Rs.70 there will be a constructive receipt of Rs.70 by the
Company and constructive payment of the same amount by the debentureholder to the
Company towards the price of one fully paid-up equity share. Upon such conversion, the
face value of Part A of the debenture will be reduced to NIL.
e. Interest
Debentures will carry interest at the rate of 16% per annum on the outstanding principal
amount from time to time, payable annually, subject to deduction of income tax at source,
in accordance with the provisions of the Income Tax Act, 1961 and the Rules made
thereunder or any statutory modifications or re-enactments thereof. The first payment of
interest will be made 12 months after the date the issue closes.
f. Redemption
Part B of the debentures of face value Rs.70 will be redeemed in 3 installments of Rs.20,
Rs.20 and Rs.30 per debenture at the end of the 4th, 5th and 6th year respectively, from the
date the issue closes.
g. Arrangement for the Purchase of the Non-Convertible Portion of the Debenture. (Hereby
called the portion.)
The Company has finalized a scheme for buy-back of Part B of the debentures with the
Unit Trust of India, Life Insurance Corporation of India, LIC Mutual Fund, IDBI Mutual
Fund and National Insurance Corporation, for the benefit of allottees (the offer is also open
to NRIs/OCBs/FIIs, subject to RBI approval) who may not wish to retain the portion. The
Scheme has been confirmed vide their letters dated 20.12.20x1, 12.01.20x2, 10.01.20x2,
15.01.20x2, 01.01.20x2 respectively, whereby they have agreed to buy the Non-Convertible
Portion up to Rs.28.65 crore.
The principal terms and conditions of the Offer are as follows:
i. Applicants are entitled to offer for buy-back the portion relating to the debentures
allotted to them. The option to offer the portion for buy-back must be exercised for
ALL the debentures applied for by the applicants. In no event can the applicants
exercise this option for only a part of the debentures applied for.
ii. The non-convertible portion of the face value of Rs.70 each should be offered for sale
at a price of Rs.60.50 per portion (on fully paid-up basis and accrued interest, if any, is
included in the sale price). The above purchase price is no indication of the price at
which the portion will be quoted and traded on the floor of the Stock Exchange.
iii. The persons exercising the option to sell the portion will be doing so at an upfront
discount of Rs.9.50 on the face value of the portion. As a result, the effective cost
per equity share would be Rs.79.50 for the convertible Part A of each debenture
applied for and allotted. The sale will be on cum interest basis.
iv. Under the terms of the Issue, an amount of Rs.9.50 out of the amount payable on
application towards the debentures is appropriated towards the face value of the non-
convertible portion. The balance amount of Rs.60.50 towards the face value of the
portion would be paid as per the `Terms of Payment’ mentioned elsewhere in the
prospectus. In the event of the applicant opting to sell the portion, his liability to pay
the amount on allotment/call(s) towards the portion will stand reduced to nil as the
purchaser would arrange to make the payment of the balance amount to the company.
h. Principal Terms of Warrants
Each debenture will have one detachable warrant which can be freely and separately traded.
The warrant holder will have the right to apply for and seek allotment of one equity share of
Rs.10 for each warrant at 40% discount to the average of the daily high and low prices of
three months before exercise. The warrants, however, will be exercised at a minimum price
of Rs.70 per share, and a maximum price of Rs.90 per share.

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The warrant would be exercisable between the 6th month and the 24th month from
the date of allotment of the debentures. The warrant will come into existence only
on the allotment of the debenture. The Company has made applications to have the
warrants listed on the Mumbai, Ahmedabad and Delhi Stock Exchanges, where the
existing shares are listed.
i. Arrangement for Buy-back of Warrants
This is applicable to all investors including body corporates (excluding firm allottees).
For the benefit of the prospective investors in this issue, the Company has finalized
arrangements for the sale of the detachable tradeable warrants by the successful
allottees if they so wish. M/s Kartik Finance Limited (KFL), Mumbai and M/s Namco
Finance Limited (NFL), Mumbai have agreed to purchase the same at Rs.9.50 per warrant
vide their letters dated January 10, 20x2.
The scheme for disposal of warrants in particular, will work as under:
i. The offer for sale is purely voluntary in nature. The warrantholders are free to make
any other arrangement for disposal of the warrants.
ii. The above purchase price of Rs.9.50 is no indication of the price at which the
warrant will be quoted and traded on the floor of the Stock Exchange.
iii. The option to offer warrants for buy-back must be exercised for all the warrants
entitled to the applicants. In no event can the applicants exercise this option for only
a part of the warrants entitled to.
iv. The offer for sale of warrants is only exercisable at the time of making an
application in the issue.
v. The amount of Rs.9.50 received from M/s KFL or NFL under this scheme will be
deemed to have been paid by the warrantholder and appropriated towards moneys
due on allotment.
j. Under Section 48 of the Income Tax Act, the Long-term Capital Gains arising out of sale of
shares will be computed by deducting the indexed cost of acquisition/improvements from
the full value of the consideration. The Long-term Capital Gains would be charged to tax at
the flat rates, as under, plus surcharge if any:
Assessee Rate of Tax
Individuals 20% + 10% surcharge
Others 30% + 10% surcharge
k. Projected Profitability Statement
The projected financials of the Company have not been appraised and are in-house
estimates of the company. The following table gives the projected profitability based on
exercise of warrants in the FY20x3.
(Rs. crore)
Year ended 03/20x2 03/20x3 03/20x4
Turnover (inclusive of excise) 227.35 282.92 364.22
Other Income (including extraordinary items) 20.54 2.42 2.42
Profit before Interest, Depreciation and Tax 52.26 47.21 63.25
Interest 8.40 10.32 9.45
Depreciation 4.50 7.96 12.42
Profit Before Tax 39.36 28.93 41.38
Provision for Taxation 11.84 9.57 15.75
Profit After Tax 27.52 19.36 25.63
Paid-up Equity Capital 9.00 18.00 18.00
Reserves and Surplus 91.52 159.03 177.46
Earning per Share (Rs.) 30.57* 13.24** 14.24
Book Value (Rs.) 109.85 96.79 107.21
Dividend (%) 40 40 40
* Including extraordinary items
** On weighted average basis

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l. Stock Market Data

The high and low prices recorded in each of the last three financial years (FY) as was
recorded at the Mumbai Stock Exchange are given below:
Year High Low Average (Rs.)
(Rs.) (Rs.)
19x8 225.00 120.00 175.50
19x9 300.00 220.00 260.00
20x0 180.00 86.00 133.00
m. Past Performance
09/19x8 03/19x9 03/20x0
Turnover (Rs. crore) 101.51 180.81 166.53
PAT (Rs. crore) 20.02 7.76 11.32
EPS (Rs.) 22.30 8.60 12.60
Book Value (Rs.) 105.70 82.20 76.30
n. Price/Earnings Ratio of the Industry
The offer price of Rs.70 per share after conversion of the debentures, discounts the
projected earnings per share (EPS) of FY19x8, FY19x9 and FY20x0 of Rs.30.57, Rs.13.24,
Rs.14.24 by 2.29, 5.29 and 4.92 times respectively. The industry average for the power
cable industry is 8.2.
Assumptions
You may make the following assumptions to answer the questions given at the beginning of this
case:
a. Interest income is also exempt from income tax.
b. The shares will quote at the industry P/E in future (based on expected EPS).
c. All shares held by the investor will be sold only in March 20x1 at a brokerage of 2%.
d. Warrants will be exerciseable in February 20x0.
e. The indexing of securities for capital gains purposes will be done at an 8% increase p.a.
f. The warrants are likely to trade at 8-10% of the prevailing market price per share.
g. The non-convertible portion is likely to trade between the repurchase price and the
redemption value in the secondary market.
h. Round off your calculations to the nearest 5 paise.
i. Ignore the time lag between Application and Allotment.
Case Study 2
Read the case carefully and answer the following questions.
1. Briefly describe the procedure adopted by IDCC for the issue under Book Building.
2. i. Yield for Deep Discount Bond under both Option I and Option II assuming that the
bond is held up to maturity. Consider pre-tax returns for your calculations.
ii. Yield for Deep Discount Bond for each of the Early Redemption period from the
deemed date of allotment (as given in Exhibit I). Consider pre-tax returns for your
calculations.
3. Provide (as a merchant banker to the issue) a write up on “Management Discussion and
Analysis of Results of Operations and Financial Condition” which could be included in the
prospectus in consonance with the SEBI guidelines. Consider only a comparison of the
significant items of income and expenditure between six months ended 30th September, 20x2
and six months ended 30th September, 20x1.

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GENERAL INFORMATION
Offer of Bonds
IDCC is offering the following categories of Unsecured Redeemable Bonds in the nature of
Promissory Notes for public subscription.
1. Deep Discount Bonds
2. Monthly Income Bonds
3. Money Back Plus Bonds
4. Regular Return Bonds.
Authority to issue
This issue of Bonds is being made pursuant to the Resolutions at the Board of Directors of IDCC,
passed at their meetings held on January 19, 20x5, July 17, 20x5 and March 13, 20x6 and Resolution
of the Committee of Directors of IDCC passed at their meeting held on March 23, 20x5. This is
within the overall borrowing limit set out in the Resolution passed under Section 293 (1)(d) of the
Act at the General Meeting of the Members of IDCC held on September 17, 20x3.
The Company has made an application to The Reserve Bank of India (RBI) vide its letter No.
RES/31394 dated January 4, 20x5 seeking approval that the present issue of Bonds is covered
under its exemption order DFC (COC) No.073.186.00-01 dated February 15, 20x4.
The present issue of the bonds is being made in accordance with the terms of the DFI Guidelines
and in accordance with terms prescribed in Clarification No. XIII regarding the Guidelines relating
to Book Building Process dated October 12, 1995 issued by SEBI to the extent applicable to DFIs.
Deep Discount Bond
The investor can choose either of the following options:
Option I
Each Deep Discount Bond of the face value of Rs.2,00,000 will be issued at a discounted price of
Rs.5,200 and will be redeemed at its face value of Rs.2,00,000 at the end of the 25th year from the
Deemed Date of Allotment.
Option II
A set of five Deep Discount Bonds of the face value of Rs.40,000 each (aggregating Rs.2,00,000)
will be issued at a discounted price of Rs.1,040 each (aggregating Rs.5,200 per set). Each Bond in
the set will be separately redeemed at its their face value at the end of 23rd, 24th, 25th, 26th and
27th year from the Deemed Date of Allotment. An application can be made for a minimum of one
set or in multiples thereof and no application can be made for an individual bond. Further, each
set will be listed and traded only as a set till the end of the 20th year from the Deemed Date of
Allotment. Thereafter (after the end of the 20th year from the Deemed Date of Allotment) each
bond under the set will be separately listed and traded.
Exercise of Option
The investors will have to clearly indicate their option at the time of making the application and no
change of option will be permitted.
Early Redemption at the Option of the Bondholders/ the Company
A Bondholder or the Company will have a right to exercise the option of Early Redemption of
Bonds (in case of Option I) or a set of Bonds (in case of Option II) at their deemed face value as
follows:
Exhibit I
Early Redemption period from the Deemed Face Value (in Rs.) for Option I &
Deemed Date of Allotment Option II*
5 years 11,000
10 years 24,000
15 years 50,000
20 years 1,00,000
* as a set of bonds

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Procedure for Early Redemption by Bondholders

Bondholders desirous of exercising the option for Early Redemption of the Deep Discount Bond
(Option I) or a set of Deep Discount Bonds (Option II) on any of the above dates, should submit
their requests, in writing, to IDCC/Registrars or to such persons at such addresses as may be
notified by the Company from time to time, along with the Bond Certificate(s), duly discharged by
Sole/all the Joint holders {signed at the reverse of the Bond Certificate(s)}, not more than 6
months and not less than 3 months prior to the relevant date. The Bondholder will be entitled to
receive the applicable deemed face value only if the request is received in writing within the
specified time. In case of option II the entire set of five bonds must be offered for early redemption
and individual bonds will not be eligible for early redemption.
Procedure for Early Redemption by the Company
In case IDCC decides for an early redemption of bonds, it will announce its intention to do so at
least 6 months prior to the relevant date.
Operational & Financial Performance of the Company Operating Results Data
(in Rs. crore, except per share data)
Six Months Ended 30th September
20x4 20x5
Income from Operation (1)
Project loans (2) 765.91 961.09
Financial services (3) 216.95 247.48
Debenture interest 39.37 92.78
Capital gains (4) 38.63 46.28
Dividend income 29.01 41.44
Commissions and fee (5) 16.93 27.98
Income from securities (6) 22.01 29.95
Total Income from Operations 1128.81 1447.00
Expenses
Interest expenses 722.76 927.25
Interest tax (7) 27.00 34.25
Depreciation of leased assets 61.09 80.64
Depreciation of other assets 2.13 5.72
Other expenses (net of other income) (8) 19.98 35.41
Total Expenses before Bad Debts 832.96 1083.27
Bad/doubtful debts (9)
Written off 18.67 27.57
Provided for 19.36 16.50
Profit
Profit before tax 257.82 319.66
Provision for tax 41.00 54.95
Profit after tax Per share data (10) 216.82 264.71
Earning per share (11) 87.7 8.8
Dividend per share – –
Weighted Average Shares outstanding in 2.47 30.14
crore (12)

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Notes:
1. Prior to the financial year 20x2, IDCC showed income and expenses net of write-offs and
recoveries in respect of bad debts as opposed to its current practice of disclosing write-offs
separately in the revenue account.
2. Project loan income includes interest, commitment charges and front end fees on project
loans.
3. Financial services income represents income from the leasing, asset credit, deferred credit
and installment sale businesses.
4. Capital gains are stated net of losses on the sale of investments and amounts written-off in
respect of investments (primarily holdings of equity and debenture securities).
5. Includes commissions from underwriting, guarantees and letter of credit activities. Also
includes fees from advisory and consultancy services and custodial and debenture
trusteeship activities.
6. Represents amounts earned primarily on unlent balances on the interbank deposit market.
7. The Income Tax Act provides for a 20.4% tax on interest income. This tax is separate from
corporate income tax.
8. Other expenses primarily include employment and overhead related expenses. Other
income primarily includes rental income from premises leased to subsidiaries, interest on
delayed refund of income tax and profits on the sale of leased assets.
9. Prior to March 20x3, there were no formal guidelines on provisioning norms for
bad/doubtful debts of Financial Institutions in India. Doubtful debts were either charged off
to revenue or a provision was created. Since the financial year 20x3, IDCC has followed the
policy established by the RBI to provide for bad/doubtful debts. Write-off amounts are
stated net of recoveries of amounts previously written-off.
10. Equity shares of face value Rs.100 each were subdivided into 10 shares of face value of
Rs.10 each in February 20x4. Consequently, the profit after tax per share, dividends per
share and weighted average shares outstanding data refer to the Rs.100 face value shares
prior to the financial year 20x4 and Rs.10 face value shares from financial year 20x4
onwards.
11. Does not include up to 3.45 crore shares that may be issued between 20x5 and 20x8 at a
price of Rs.15 per share upon conversion of the outstanding rupee denominated convertible
debt of IDCC. Also does not include up to 2.84 crore shares that may be issued at any time
up to March 20x7 at a price of Rs.239 per share (at an exchange rate of Rs.45 = US $1.00)
upon the conversion of the outstanding dollar denominated convertible debt of IDCC.
Balance Sheet Data
(in Rs. crore, except per share data)
As at 30th September
20x3 20x4
Assets
Loans (1)
Rupee loans 9317.00 11006.50
Foreign currency loans 2634.43 3226.30
Less: Provisions 107.92 155.42
Net loans 11843.51 14077.38
Investments
Equity 845.89 1453.09
Debentures 581.73 1430.52
Others 249.42 279.01

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As at 30th September
20x3 20x4
Current assets (2) 2965.72 3183.16
Leased assets 649.68 1082.48
Other fixed assets 53.87 237.29
Other balances (3) 16.95 14.00
Total assets 17206.77 21756.94
Liabilities
Current liabilities 1033.14 1580.38
Loans
Rupee loans guaranteed by government of India 2863.93 2863.93
Others 6882.17 9870.41
Foreign currency loans guaranteed by government 2748.03 2527.58
of India
Others 1936.84 2465.12
Total liabilities 15464.11 19307.42
Shareholders funds
Equity capital 254.62 301.30
Preference capital — 75.00
Reserves and surplus 1488.04 2073.22
Total 1742.66 2449.52
Total liabilities and shareholders funds 17206.77 21756.94
Notes:
1. Includes project loans, deferred credit and asset credit loans.
2. Principally includes cash and deposits with other banks and interest accrued but not
yet due at period end. Assets and liabilities in foreign currencies are translated into
rupees at the year-end or period-end rates. The differences in exchange arising on
such translation are held in various suspense accounts and included in current assets
or current liabilities, as appropriate.
3. In the financial year 20x3, expenses of Rs.17.93 crore relating to the US $ 200
million 2.5% Convertible Bonds issued in February 20x3 were capitalized and
included in other balances. This amount is being amortized over seven years.
Average Balance Sheets and Interest Rates
The following table shows average balances and interest rates of interest earning assets (excluding
leases and unlent balances) and interest bearing liabilities for the past two financial half years.
Average balances in this table are calculated based on balances at the beginning and end of each
period. Interest expense figures do not include interest tax. Loan fees are included in interest
income.
Six Months Ended 30th September
(in Rs. crore, except %)
20x3 20x4
Average Interest Average Average Interest Average
Balance Rate Balance Rate
Assets
Rupee
Project loans 7828.25 621.88 15.9% 9533.86 773.68 16.2%

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20x3 20x4
Average Interest Average Average Interest Average
Balance Rate Balance Rate
Financial services loans 1105.43 104.58 18.9 1217.26 106.99 17.6
Debentures 537.10 39.37 14.7 1217.49 92.78 15.2
Total rupee loan assets 9470.77 765.83 16.2 11968.62 973.46 16.3
Foreign currency loans 2605.46 144.03 11.1 3115.82 187.41 12.0
Liabilities
Rupee loans 9090.98 575.83 12.7 12061.01 775.75 12.9
Foreign currency loans 4933.32 146.93 6.0 4916.89 151.50 6.2
The following tables set forth certain financial ratios and credit quality data relating to ICICI for
the six months period ended 30th September, 20x3 and 20x4.
Financial Ratios
(in Rs. crore except %)
(Six Months Ended 30th September)
20x3 20x4
Average interest earning assets (2) 11977.99 14937.27
Interest income (3) 909.86 1160.87
Net interest income (4) 160.11 199.36
Gross yield (%) (5) 15.2 15.5
Net interest margin (%) (6) 2.7 2.7
Average cost of loan funds (%) (7) 10.7 11.3
Yield spread (%) (8) 4.5 4.2
Credit risk (9) 0.6 0.6
Net yield spread (10) 3.9 3.6
Profit before tax to:
Average total assets (%) 3.1 3.1
Average shareholders’ capital (%) 205.5 212.2
Average shareholders’ capital and reserves (%) 32.0 28.5
Profit after tax to:
Average total assets (%) 2.6 2.6
Average shareholders’ capital (%) 172.9 175.7
Average shareholders’ capital and reserves (%) 26.9 23.6
Average shareholders’ capital to assets (%) 1.5 1.5
Average shareholders’ capital and reserves to assets (%) 9.7 10.8
Cash dividends declared – –
Dividend pay-out ratio (%) – –
Notes:
1. In the case of a six-month ratio, results are annualized.
2. Interest earning assets consists of project loans, financial services loans and debentures (net
of provisions excluding unlent balances and leases).
3. Interest income consists of income from project loans, financial services loans and
debentures but excludes income from leases and treasury operations. Interest income is
presented without deducting interest tax.

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4. Net interest income consists of interest income for the period minus interest expense for
such period, including interest tax paid. Net interest income figures are understated in all
periods to the extent they reflect the cost of the interest bearing funds used for leases, equity
investments and other non-interest bearing assets such as office premises but not the
income generated from such non-interest earnings assets.
5. Gross yield equals interest income divided by average interest earning assets.
6. Net interest margin represents net interest income divided by average interest earning
assets.
7. Average cost of loan funds is the total interest expense (including interest tax) divided by
average interest bearing liabilities.
8. Yield spread represents the difference between gross yield and average cost of loan funds.
9. Credit risk represents write-offs and provisions charged against income during the
period divided by average interest earning assets.
10. Net yield spread represents yield spread less credit risk.
Case Study 3
Read the case carefully and answer the following questions.
You are provided, hereunder, with an abstract from the prospectus of a public issue of Mohanty
Fabrics Ltd. which opened for subscription on 8th July, 20x1. Some additional information is also
provided towards the end. Based on the information provided as well as your understanding of
public issues and merchant banking activities, you are required to answer the following questions:
1. The abstract makes a mention of minimum subscription of 90% of the issued amount
including the devolvement of underwriters. Subsequently, it also makes a mention of
allotment letters/refund orders:
a. Was it mandatory for the issuer to have a clause with respect to minimum
subscription and underwriting? Explain.
b. Briefly outline some of the key features with respect to underwriters and
underwriting arrangements.
c. State the present requirement with respect to the period of completion of allotment
activity and despatch of refund orders. What is the consequence of non-adherence?

2. The table on Capital Structure provides the details of the present issue as well as the earlier
paid-up capital and the authorized capital.
a. Distinguish between “Shares reserved for firm allotment” and “Shares reserved for
preferential allotment”.
b. Discuss the regulatory issues with respect to “firm allotment” as well as
“preferential allotment”.
c. i. Calculate the promoters’ contribution in the post-issue capital.
ii. Is it adequate as per the regulatory requirements? Explain.
iii. Does it endanger the minimum requirements of net offer to the public?
Explain.
iv. What is the minimum size of application for promoters’ contribution and
when should the contribution be brought into the company?
3. The terms of payment for issue give details of the amount of payment and the mode of
payment.
a. Is there any change in requirement with respect to the minimum application size by
the resident Indian Public? If yes, state the requirement and the reasons for the
change.

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b. Enumerate the essential features and guidelines for the usage of “stockinvest” as a
mode of payment for share application.
4. Are the issuer and the merchant bankers to the issue correct in making the issue at par?
Explain fully after considering the value of the share in terms of the
i. P/E approach
ii. Book value approach
iii. Dividend capitalization approach.
5. Briefly enumerate the key internal risk factors and the management’s perception of internal
risk factors that would have formed a part of the disclosure in the prospectus of this public
issue. What is the other category of risk factors that should form a part of the prospectus
and what does it usually pertain to?
Public Issue of 3,53,90,000 Equity Shares of Rs.10 each for cash at par aggregating Rs.3539
lakh
I. GENERAL INFORMATION
Corporate Status
Mohanty Fabrics Ltd. was incorporated on November 27, 19x5 as a Public Limited
Company under certificate of incorporation issued by Registrar of Companies, New Delhi
and obtained certificate of commencement of business on 8th January, 19x6.
Acknowledgement Card
The company has obtained the Acknowledgement Card vide letter December 13, 19x8 from
the Securities & Exchange Board of India (SEBI).
Authority for the Present Issue
Authorization of the Shareholders of the Company under Section 81(1-A) of the Companies
Act, 1956 has been obtained for this Issue by a special resolution passed at the
Extraordinary General Meeting of the Company, held on July 19, 19x8.
Listing
Applications have been made to the Stock Exchanges at Delhi (the Regional Stock
Exchange), Mumbai and UP as well as NSE for permission to deal in and for an official
quotation of the equity shares being issued in terms of this prospectus.
Minimum Subscription
If the Company does not receive the minimum subscription of 90% of the issued amount
including devolvement of underwriters within 60 days from the date of closure of the issue,
the Company shall forthwith refund the entire subscription amount received. For a delay
beyond 78 days, from the opening of the issue, the Company and the Directors of the
Company shall be jointly and severely liable to repay the amount due by way of refund
with interest @ 15% p.a.
Allotment Letters/refund Orders
The Company shall ensure that the allotment letters/refund orders marked “Account Payee”
are issued within a period of 10 weeks from the closure of the issue. The Company shall
also ensure despatch of refund orders/unused stockinvests of value above Rs.1500 and
share certificate by Registered Post only. Refund orders of value up to Rs.1,500 will be
despatched under the Certificate of Posting. Adequate funds for the purpose will be made
available to the Registrar.
II. CAPITAL STRUCTURE
(Rs.)
SHARE CAPITAL NOMINAL VALUE
A. AUTHORIZED CAPITAL
9,00,00,000 Equity Shares of Rs.10 each 90,00,00,000
B. ISSUED, SUBSCRIBED & PAID UP CAPITAL
70 Equity Shares of Rs.10 each 700

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SHARE CAPITAL NOMINAL VALUE

C. PRESENT ISSUE
7,38,80,000 Equity Shares of Rs.10 each for cash at par 73,88,00,000
D. OUT OF THE PRESENT ISSUE
3,84,90,000 Equity Shares of Rs.10 each for cash at par
reserved for firm allotment to the promoters, their friends,
relatives and associates 38,49,00,000
E. NOW OFFERED THROUGH PROSPECTUS
3,53,90,000 Equity Shares of Rs.10 each for cash at par 35,39,00,000
F. OUT OF WHICH
i. 43,90,000 Equity Shares of Rs.10 each for cash at par
are reserved for preferential allotment to NRIs/Persons
of Indian origin residing abroad/OCBs and Foreign
Institutional Investors on competitive basis 4,39,00,000
ii. 60,00,000 Equity Shares of Rs.10 each for cash at par 6,00,00,000
are reserved for preferential allotment to Indian
Financial Institutions and Banks on competitive basis
30,00,000 Equity Shares of Rs.10 each for cash at par 3,00,00,000
iii. are reserved for preferential allotment to Indian Mutual
Funds on competitive basis
G. NET OFFER TO RESIDENT INDIAN PUBLIC
2,20,00,000 Equity Shares of Rs.10 for cash at par 22,00,00,000
H PAID-UP CAPITAL AFTER THE PRESENT ISSUE
7,38,80,070 Equity Shares of Rs.10 each 73,88,00,700
III. TERMS OF THE PRESENT ISSUE
Rights of Equity Shareholders
The Equity Shares being issued are subject to the terms of this Prospectus, the Application
Form and the Memorandum and Articles of Association of the Company, the provisions of
the Act and other stipulations, if any, made by appropriate authorities.
Ranking
The Equity Shares now being offered shall rank pari passu with the existing equity shares
of the Company in all respects save and except that the holders of the equity shares now
offered will be entitled to dividend, if any, from the respective date of allotment and in
proportion to the amount paid-up thereon and pro rata for the period during which such
capital is paid-up.
Terms of Payment by Indian Public
On Application : Rs.5
On Allotment : Rs.5
PROCEDURE FOR APPLICATION
By Resident Indian Public
1. Applications must be made only:
i. On the prescribed Application Form and completed in full in BLOCK
LETTERS in ENGLISH in accordance with the instructions contained in the
Application Form and are liable to be rejected if not so made.
ii. In single or joint names (not more than three).
iii. For a minimum of 500 equity shares and in multiples of 100 equity shares
thereafter.

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2. Application Forms duly completed as per the instructions contained therein together
with Cash/Cheque/Bank Draft/Stockinvest for the amount payable on application at
the rate prescribed should be lodged before the closure of Subscription List with the
Bankers to the Issue at their designated branches mentioned in the Application Form
and NOT to the Company or the Lead Managers, Co-Managers or Registrars to the
Issue. Applications not made so are liable to be rejected.
3. Payments should be made in cash or by cheque/bank draft/stockinvest drawn on any
bank (including a co-operative bank) which is situated at and is a member or sub-
member of the Banker’s Clearing House located at the center where the application
is submitted.
IV. PARTICULARS OF THE ISSUE
Objects of the Issue
The Company is setting up a 100% EOU for the manufacture of wide width cotton
sheetings and premium shirtings with an installed capacity of 25,200 spindles, 120
shuttleless looms (96 Airjet loom from Picanol, Belgium and 24 Projectile loom from
Sulzer, Switzerland) with necessary processing facilities.
The objects of the present issue are:
i. To raise a part of the finance required for setting up the project
ii. To meet the expenses of the issue and other incidental expenses
iii. To list the equity shares of the Company on the Stock Exchange(s).
Cost of Project
MFL’s project was appraised by IDBI in March 20x1 for the purpose of sanction of Foreign
Currency loans equivalent to Rs.4,700 lakh. The cost of the project was assessed at
Rs.14,350 lakh and the project was expected to commence commercial operations from
October 20x2.
A mid-term review of the project was taken up by IDBI in June 20x2 when the estimated
cost of the project was assessed at Rs.16,698 lakh. Out of the overall increase in the cost of
Rs.2,348 lakh, an amount of Rs.1,305 lakh is notional (due to foreign exchange rate
fluctuation) and the balance amount of Rs.1,043 lakh is accounted for by increase in the
cost of civil construction, miscellaneous fixed assets and preliminary and pre-operative
expenses. The plant was expected to go on stream in January 20x3. However, there was a
delay of three months in project implementation and the commercial production is now
expected to commence in April 20x3. Consequent increase in pre-operative
expenses/interest during the construction period of about Rs.250 lakh is proposed to be met
out of the contingency provision and hence the project is expected to be implemented
within the cost estimates.
The details of the cost of the project, estimated at Rs.16,698 lakh, are as under:
(Rs. lakh)
Land and Site Development 291
Buildings 1169
Plant and Machinery
– Imported 8932
– Indigenous 1395
Misc. Fixed Assets
– Imported 1305
– Indigenous 1631
Preliminary and Pre-operative Expenses 1270
Provision for contingencies 303
Margin Money for Working Capital 402
Total 16698

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Means of Finance
The cost of the project is proposed to be financed in the following manner:
(Rs. lakh)
Share Capital
– Promoters 3849
– Public Issue 3539 7388
Term Loan - Forex Loan
– IDBI 6005
– SBI 3290
9295
State Capital Subsidy 15
Total 16698
The foreign currency term loans have been tied-up with IDBI and SBI against their letter
dated 26/6/20x1 and dated 9/11/20x1 respectively.
The Company has already made application to State Govt. of Uttar Pradesh for sanction of
capital subsidy of Rs.15 lakh. In case the subsidy is not made available to the Company, it
proposes to arrange unsecured loans to meet the shortfall.
Up to 31st January, 20x3 the Company had incurred an expenditure of Rs.14,402 lakh
comprising Rs.266 lakh on land and site development, Rs.1,173 lakh on building and
advance to contractors and building materials, Rs.10,619 lakh on imported machinery,
Rs.731 lakh on misc. fixed assets, Rs.417 lakh on indigenous machinery and Rs.1,196 lakh
on security deposits, preliminary and pre-operative expenses, etc. The expenditure incurred
till date has been financed through the promoter’s equity/share application money of
Rs.3,850 lakh, FI loans of Rs.9,799 lakh (IDBI Rs.6,089 lakh and SBI Rs.3,710 lakh), and
balance Rs.528 lakh by way of unsecured loans and Rs.225 lakh from sundry creditors and
interest on deposits.
Working Capital
Working capital requirements have been calculated based on 2.5 months’ requirement of
raw materials, 3 months’ consumable stores/spares and 1 month’s finished goods. The
working capital requirement in the first full year of operation (20x3-20x4) is estimated at
Rs.1893 lakh which would be met through bank borrowings to the extent of Rs.1,491 lakh,
the balance of Rs.402 lakh has been provided in the project cost as margin money for
working capital. The Company has already approached SBI (its regular banker) for sanction of
working capital finance and is confident of obtaining the sanction at an early date.
Schedule of Implementation
PFL’s civil construction work is at an advanced stage of completion. All major imported
plant and machinery have been shipped and most of them have already arrived at the site;
the remaining are expected to reach the site by March 20x3. Orders for most of the
indigenous equipment have been placed and the same have started arriving at the site.
Erection of equipment have commenced from September 20x2. After installation of
plant and machinery and trial runs, the commercial production is expected to commence
by April 20x3.
The expected delay of about 3 months in implementation of the project as compared to the
projections made by IDBI in its revised appraisal was mainly due to delay in receipt of
imported machinery. Consequent increase in pre-operative expenses/interest of about
Rs.250 lakh during the construction period is proposed to be met through the contingency
provision. The company has incurred/committed substantial expenditure on the project.
Keeping in view the progress made on the project, the cost is expected to be contained
within the estimates. The management is reasonably confident of completing the project
within the revised schedule i.e. by April 20x3.

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Profitability
As per the appraisal done by IDBI in June 20x2, the abstract of projected financial
performance is as follows:
(Rs. lakh)
20x2 20x3 20x4
Year Ending March 31st
Expected Sales 7574 8584 9089
Other Income 142 161 170
Total Cost of Production 4367 4932 5224
Interest 1038 1041 930
Depreciation 1359 1371 1382
Preliminary Expenses written-off 42 42 42
Dividend (%) 8 10 15
Reserves and Surplus 452 1071 1642
V. The Company has not made any public/rights issue of capital since its incorporation.
The particulars pertaining to issue of capital by other listed companies in the group which
have made any public issue of capital in the last three years preceding the date of this
prospectus are as follows:
Mohanty Spinning and Weaving Mills Ltd.
Year of Issue 19x9
Type of Issue Rights Issue
Amount of Issue 23,53,948 PCDs of Rs.50 each for cash at par aggregating
Rs.11,76,97,400
Date of Closure 27.10.19x9
Objects of the To meet the initial expenditure relating to expansion project for
Issue installing spindles for manufacturing synthetic blended yarn
Rate of Dividend 19x9-20x0 – 25%
Paid 20x0-x1 – 25%
Promises vs.
Performance
(Rs. lakh)
Particulars 19x9-20x0 20x0-x1
Turnover PAT EPS Turnover PAT EPS
Projected 6728 657 20.53 6867 548 9.87
Actual 7437 434 13.50 9454 533 9.34
Mohanty Acrylon Ltd.
Year of Issue 19x9
Type of Issue Rights Issue
Amount of Issue 1,81,40,000 Equity Shares of Rs.10 each for cash at par
aggregating Rs.18,14,00,000
Date of Closure 15.11.19x9
Objects of the Issue To finance the expansion project by increasing the capacity
of acrylic fibers from 15,000 tpa to 18,000 tpa and also to
meet the working capital requirement
Rate of Dividend Paid 20x0-x1 - nil
20x1-x2 - nil

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Promises vs. Performance

(Rs. lakh)
Particulars 20x0-x1 20x1-x2
Turnover PAT EPS Turnover PAT EPS
Projected 16,114 781 1.52 16,873 14.91 2.35
Actual 14,023 (661) – 15,198 (231) –
The company had projected an income of Rs.16,873 lakh and PAT of Rs.1,491 lakh for the
year 20x1-x2 while the actual income was Rs.15,198 lakh and the Company incurred a loss
of Rs.231 lakh. Acrylic fiber industry as a whole is passing through a difficult time due to
competition from imports and also due to a steep rise in the prices of raw materials in the
international market, which resulted in an increase in cost of production.
Additional Information
1. The company may be placed in the industry titled as “Textiles – Composite/Cotton/
Blended/Fabric”.
2. The P/E ratios for the industry reported in capital market dated March 25, 20x3 are
as below:
i. Highest P/E 13.9
ii. Lowest P/E 4.0
iii. Composite P/E 9.4
3. It is expected that the company would be in a position to give a dividend at the rate
of 25% for the year ended 31st March, 20x3 at which the rate of dividend will
stabilize for the future period.
4. 364-day T-Bills rates (proxy for risk-free rate) are approximately 9% and the risk
premium per unit of risk is estimated to be 10%. The company’s beta is estimated at
1.30.
5. The company has chosen to avail the benefits u/s 10B of the Income Tax Act, 1961
with effect from the first year of operations itself.
Case Study 4
Read the case carefully and answer the following questions.
1. Calculate the price at which the company can issue shares to raise funds for financing the
project. Give justifications which should include justifications required as per the existing
SEBI guidelines. For justifying the premium, the funds raised by equity can be assumed to
be Rs.500 lakh.
2. Give qualitative reasons for the issue price arrived at (1) above.
3. If the company expects an increase of 80% in its earnings before interest and taxes and the
shareholders accept a dilution in EPS by 30%, calculate the debt-equity ratio for the funds
required for expansion. Assume that of the total funds required, Rs.315 can be sourced by
internal accruals and that equity is priced at the amount arrived at in (1) above.
4. State the various ways by which the company can raise equity funds. Discuss the pros and
cons of each method.
5. State whether investment can be made in such a company highlighting the risk factors
involved.
State assumptions, if any.
History and Business of the company:
Hi-Tech Enterprises Limited was incorporated as a private limited company during 19x1 and was
converted into a public limited company during 19x5.
Hi-tech, promoted by Shri Mohan Reddy and his associates, was incorporated as a Private Limited
Company on August 28, 19x1 under the name of Hi-Tech Enterprises Private Ltd., with the
objective of creating facilities for software development and its export thereof to global markets.
The Company commenced commercial operations in September 19x2.

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IDBI sanctioned start-up assistance of Rs.97 lakh under the Venture Capital Scheme in 19x1 for
the Company’s first project (costing Rs.122 lakh), envisaging creation of facilities for conversion
of paper based drawings into a Computer Aided Design and Drafting (CADD) and Geographical
Information System (GIS) formats and for developing other software packages. The project was
successfully completed in September 19x2. IDBI converted a portion of its loan amounting to
Rs.15 lakh into equity in 19x4. The company obtained a second loan of Rs.100 lakh from IDBI for
expansion of its facilities (the scheme costing Rs.150 lakh) in 19x4, which was successfully
completed in January 19x5. Having stabilized its operations and gaining a stable foothold in the
export market, Hi-Tech is now embarking on an expansion plan envisaging: (i) entry into
engineering consultancy for 3D modelling, (ii) expansion (by over 60%) of its CAD/GIS
conversion Capacity and (iii) doubling of capacity for handling Software projects and product
development.
Hi-Tech shares a fully functional 128 KBPS Satellite Link, provided by STP, Hyderabad and has
established its own home page on its World Wide Web Server on the INTERNET.
Identified Niche Areas and Product-Mix
Hi-Tech has well identified niche areas for software development in tune with its relative expertise
and skill. The basic thrust areas are: (i) Computer Aided Design and Drafting (CADD) and (ii)
Geographic Information System (GIS). The Company undertakes software development as well as
offers ‘Software Services’ in the above two selected areas.
Projects:
The projects Hi-Tech undertakes are under DOS, Windows and UNIX environments. Projects
executed included implementing OLÉ 2 functionally in CADKEY for Windows, enhancing the
functionality of CK Architect using CODe (CADKEY Object Developer) and developing a
Universal Post Processor for Cutting Edge Technologies, USA.
Recognized as ‘R&D’ Unit by Ministry of Science & Technology, Govt. of India:
Hi-Tech is a recognized ‘R&D Unit’ by the Department of Scientific & Industrial Research,
Ministry of Science & Technology, Government of India – which allows the Company the option
to write off the entire amount spent on R&D for IT purposes.
ISO 9000 Certification:
Hi-Tech was given the ISO 9002 certificate by BVQI, London for its CADD/GIS conversion
services. The Company has applied and is confident of obtaining the ISO 9001 certification for
`Software Development’ by June 20x2.
The Company exports it services/products mainly to USA, Europe, Japan, Australia and South-
East Asia, mainly through its Strategic Alliance partners located in USA, Germany, Australia and
Belgium. Hi-Tech has been getting regular orders from clients in UK, Malaysia and Singapore.
Promoters:
Hi-Tech is promoted by Shri BVR Mohan Reddy, Shri K Rajan Babu both technically qualified
computer professionals, and Smt. B Sucharitha (wife of Shri Mohan Reddy) Shri Mohan Reddy
(aged 46 years) has over twenty years of engineering and management experience. He was
awarded “Entrepreneur of the year” by Hyderabad Management Association for the year 1996.
Shri Reddy has two degrees in masters, one in Management Engineering from the University of
Michigan, Ann Arbor, USA (in 1977), the other in Industrial Engineering from the Indian Institute
of Technology, Kanpur (in 1975). His basic graduation was in Mechanical Engineering from
Andhra University (in 1971).
Shri Reddy started his career with the DCM Group in 1974 as a senior management trainee, was
with MICRO BOSCH (the German auto part giant) for three years as senior systems officer
(1977 to 1980) and with HCL (now the Hewlett Packard joint venture in India) as Regional
Manager (1980 to 1982). Within a short period Shri Reddy graduated from Management Trainee
to Regional Manager. Shri Mohan Reddy joined OMC Computers initially as Marketing Manager
(in 1982) and grew to be General Manager, President and then became the Managing Director of
OMC. Shri Reddy left OMC in June 1992.

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Shri Reddy was the President of Electronics Industries Association of Andhra Pradesh (ELIAP)
for two years (1990 and 1991) and has been the President of Hyderabad Software Exporters
Association (HYSEA) since 1993. He was also on the board of AP Electronics Development
Corporation in 1985.
Shri Rajan Babu (44 years) is an Engineering graduate from Osmania University (1974).
Smt. Sucharitha (44 years) is a post-graduate in Chemistry from Shri Venkateshwara University,
Tirupathi (in 1973). She has 3 years experience of working in computers/systems in Bhavani &
Co., Hyderabad, from 1988 till she became a promoter-director in Hi-Tech.
The Financial Highlights of the Company are as follows:
The profits of the company for the period 19x1-20x2 are set out hereunder after making
adjustments
(Rupees in lakh)
Particulars 31/03/x2 31/03/x1 31/03/x0
(estimated)
TOTAL INCOME 502.29 274.81 127.90
EXPENDITURE
Employees Remuneration & Benefits 103.04 57.96 34.07
Processing 153.99 94.58 46.32
Depreciation 26.70 13.43 8.02
Financial charges 24.77 16.41 11.21
Royalty 25.04 7.62 3.00
TOTAL 333.54 190.00 102.62
Net Profit for the year 168.75 84.81 25.28
Less: Provision for taxes 5.30 NIL 1.00
Profit after tax 163.45 84.81 24.28
Assets and Liabilities of the company as on 31st March 20x0, 31st March, 20x1 and 31st March,
20x2 (estimated) are set out below:
(Rs. lakh)
Particulars 31-03-x2 31-03-x1 31-03-x0
(estimated)
Fixed Assets
Gross Block 276.49 139.21 75.29
Less: Depreciation 50.73 24.23 10.80
Net Block 225.76 114.98 64.49
Subtotal (a) 225.76 114.98 64.49
INVESTMENT (b)
Add: Current Assets Loans and Advances: 277.78 201.60 108.40
Total (A) a + b 503.54 316.58 172.89
Less: Current Liabilities and Provisions
Current Liabilities 48.51 36.68 17.63
Provisions 5.30 Nil 1.40
Total (B) 53.81 36.58 19.03

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 Part IV

Particulars 31-03-x2 31-03-x1 31-03-x0

(estimated)
Net Tangible Assets (A–B) 449.73 280.00 153.93
Miscellaneous Expenditure (To the extent not 0.00 0.07 0.07
written off or adjusted)
Gross worth (Total Assets) 449.73 280.07 153.93
Represented by:
Authorized Share Capital 300.00 100.00 50.00
Issued, Subscribed & Paid-up 150.00 75.00 25.00
(Equity shares of Rs.10 each)
Reserves and Surplus 173.70 85.80 35.93
Loan Funds:
Secured Loans IDBI Venture Capital Fund - 1 50.76 64.04 93.00
Secured Loans IDBI Venture Capital Fund - 2 75.00 51.00 —
SBH/GTBL Packing Credit 0.27 4.23 —
Total 449.73 280.07 153.93
Notes:
1. The Company adopts the accrual concept in the preparation of accounts.
2. Assets and Liabilities are recorded at historical cost to the company. The costs are not
adjusted to reflect the changing value in the purchasing power of money.
3. Depreciation on fixed assets has been charged on the Straight Line Method in the manner
and at the rates prescribed under the Companies Act.
The Company has proposed to:
a. Set-up new facilities for handling Engineering Consultancy-3D modeling.
b. Enhance the capacity for software development (projects) from 3,88,500 hrs. per annum to
6,25,500 hrs. per annum.
c. Double the capacity for product development (software/data products) from 24,000 hrs. per
annum to 48,000 hrs. per annum.
The aggregate requirement for the expansion scheme is estimated at Rs.1,250 lakh, a broad break-
up of which is given below:
Cost of the Project
(Rs. lakh)
Particulars Cost
Land and Buildings 266
Plant and Machinery:
– Imported 297
– Indigenous 1
Software:
– Imported 158
– Indigenous 154
Miscellaneous Fixed Assets 238
Public Issue Expenses 50
Provision for Contingencies 53
Working capital Requirements 33
Total 1250

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Location:
The company’s present facilities are located at:
i. Ameerpet, Hyderabad - where the company has an area of 5044 sq.ft. taken on rental basis
from the Software Technological Park, Hyderabad. The current rental charges are @
Rs.13.70 per sq.ft.
ii. Punjagutta, Hyderabad - where the company has taken 6,878 sq.ft. (plinth area), from Smt. B
Sucharitha, the whole-time Director of the Company, on a monthly rent of Rs.50,000
(Rupees fifty thousand only). In addition, the Company was required to make an interest free
security deposit of Rs.3 lakh with the Lessor (being equivalent to six months rent). The
initial lease is for a period of 3 years, with the option for the Company to renew the lease
agreement for another period of 3 years, subject to a 20% increase in rent.
The additional facilities envisaged under the expansion scheme will initially be installed in
the 3rd floor of the Company’s premises at Punjagutta, where about 2,000 Sq.ft. of area is
available. The Company proposes to construct a seven storied building in an one acre plot
allotted to it by Andhra Pradesh Industrial Infrastructure Corporation Ltd. (APIIC) at
Madhapur Village near Jubilee Hills, at the outskirts of Hyderabad and shift all activities to
the new premises. Under the Allotment scheme a total land measuring 4840 sq. yards (1
acre) has been allotted to the company for a price of Rs.62.05 lakh. As per the scheme the
land will be developed by APIIC with metal roads, water supply assistance, telephone
connections, power connections, street lights, etc. The implementation is in progress.
Building and Civil Works:
The company envisages construction of a seven storied (including normal as well as stilts floor)
building, with about 50,000 Sq.ft. area. The building would be of RCC construction and would be
fully air-conditioned and furnished. The company has appointed KSA Consultants Pvt. Ltd.
(KSA), Hyderabad as architects and civil engineers. The company has taken possession of the land
from APIIC on February 5, 20x1. The company would shortly apply for obtaining the necessary
approvals for construction and is confident of obtaining the same well in time as per schedule.
Temporary Facilities and Shifting to New Premises
The company proposes to initially install its facilities at its existing sites and then shift them to its
new premises, once the construction is over. The same workstations (proposed under the scheme) are
initially proposed to be installed in the existing facilities and then are to be shifted to the new
premises. The cost of shifting will be very marginal and no special provision is required for the same.
Technology
For the CAD/GIS conversion services, Hi-Tech follows a unique process developed by it. This
`heads-up’ Interactive approach was developed and systematically refined based on the expertise
build-up over the years. This approach helps to maintain high accuracy levels (of 99.5% and
above) at predictable and manageable costs. The emphasis is on the process and extensive use of
software tools developed in-house to increase productivity and meet quality norms.
Utilities
The present contracted demand is 100 KVA at the Company’s private STP at Gayathri Hills. In
addition, a DG set of 35 KVA has been installed. UPS facility of capacity of 17 KVA has also
been provided. The peak load is 60 KVA. The additional requirement would be about 35 KVA
which can be taken care of with the existing contracted demand.
At its STP, Ameerpet, the contracted load is 60 KVA. The company has a share of 35 KVA out of
the 250 KVA DG set capacity installed at the STP by the Government. The Company has installed
the UPS system of capacity of 26 KVA. No addition to the capacity is envisaged.
The power requirement at the new premises, envisaged at Madhapur would be 500 KVA
(including additional miscellaneous facilities and future expansion), which is proposed to be met
from APSEB supply to the STP. Provision has been made to install a diesel generating set of 125
KVA capacity to take care of the power requirements in case of power failure. An uninterrupted
power supply systems of 50 KVA rating is proposed to be procured to take care of any tripping.

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The Company is yet to make arrangements to obtain sanction of power for its proposed new unit at
Madhapur. However, as per the project implementation schedule, full commercial operations
would commence at its existing sites, where it has enough sanctioned power limits.
Human Resources
The existing manpower and the future requirements are as under:
Existing Additional Total Requirements
Managerial Cadre 29 16 45
CAD/GIS Engineers, Software Engineers/ 274 193 467
Executives/Programmers
Adm. Staff & others 4 3 7
Total 307 212 519
Hi-Tech’s management is fully alive to the problem of turnover of skilled manpower in the
Information Technology Industry. In additional to having an on-going recruitment plan, based on
the turnover in the Company, Hi-tech proposes to tackle this problem by giving relatively high
compensation (based on productivity), opportunity to work in the latest technologies (with on-line
services through the dedicated lines) and providing a challenging and encouraging work
environment.
Environmental Aspects
The company falls under the non-polluting industry category and the software development
process does not involve generation of any effluents. However, the company would be required to
obtain formal clearance from the State Pollution Control Board of Andhra Pradesh. The company
has applied to the AP State Pollution Control Board for the necessary approvals and is confident of
obtaining the same in due course.
Implementation Schedule
As per the implementation schedule it is expected to complete the project and start commercial
operations at Madhapur by October, 20x2.
Assumptions:
1. Financial charges include interest on the existing debt.
2. Industry average P/E for medium/small computer software companies is 6.8.

Case Study 5
Read the case carefully and answer the following questions.
1. Justify the pricing of the share as per Malegam Committee Report.
2. Delineate a set of highlights and risk factors for this issue.
3. MCS Ltd. was appointed as Registrar to the Issue. What do you think was the role of MCS Ltd.
in this issue?
4. You are appointed as a consultant by the company to assist in its IPO. Discuss the
regulatory framework that you would keep in mind while designing the advertisement campaign.
5. Based on the forecasted figures, compute the market adjusted returns and state whether
issue is underpriced or overpriced. Give the implications of the same.
Public issue of 12,50,000 equity shares of Rs.10 each for cash at a premium of Rs.45 per share
aggregating Rs.6,87,50,000.

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Existing Capital Structure of the Company

(Amount in Rs.)
Share Capital Nominal Value Aggregate Value
A. Authorized capital
1,00,00,000 Equity shares of Rs.10 each 10,00,00,000
50,00,000 Preference shares of Rs.10 each 5,00,00,000
B. Issued subscribed and fully paid-up
37,50,000 Equity shares of Rs.10 each 3,75,00,000
C. Present issue to the public in terms of this
prospectus
12,50,000 Equity shares of Rs.10 each for cash at 1,25,00,000 6,87,50,000
a premium of Rs.45 per share to the public
(including NRIs/OCBs)
D. Paid-up capital after the present issue
50,00,000 Equity shares of Rs.10 each 5,00,00,000
E. Share premium account
Before the issue Nil
After the issue 5,62,50,000
Notes:
1. Bonus Shares
The members of the Company, vide a special resolution at the Company’s Annual General
Meeting held on 26th April, 20x1, authorized the Board to capitalize a sum of
Rs.1,25,00,000 towards issue of 12,50,000 equity shares to be allotted to the existing
shareholders in the proportion of 1 bonus equity share for every 2 existing equity shares.
The Board vide a special resolution dated 28th April, 20x1, capitalized a sum of
Rs.1,25,00,000 towards issue of 12,50,000 equity shares. Thus, the present issued,
subscribed and paid-up capital stands at 37,50,000 equity shares of Rs.10 each.
2. Shares issued for consideration other than cash
No shares have been issued for consideration other than cash except the bonus shares on
28th April, 20x1 as detailed in Note 1 above.
Particulars of the Issue
Objects of the present Issue:
The present offer of equity shares is being made to:
i. Expand its software development center at Mumbai, and to purchase as well as upgrade its
hardware and software
ii. Invest in subsidiaries in the UK, Germany and USA to support its marketing activities.
iii. Augment the long-term working capital resources of the Company.
iv. Meet the expenses of the Issue.
v. List the Company shares on the stock exchanges.

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 Part IV

Cost of the project and means of finance

The cost of the project and the means of finance as estimated by the Company are given below:
(Rs. in lakh)
Cost of the Project
Expansion of software development center
– Deposit for Premises 25.00
– Purchase of Hardware 75.96
– Purchase of Software 30.00
– Miscellaneous Fixed Assets 69.00 199.96
Investment in Overseas Wholly Owned Subsidiaries
– Investment in subsidiary in the UK 99.40
– Investment in subsidiary in Germany 50.16
– Investment in subsidiary in the US 91.16 240.72
Long-term working capital resources of the Company 233.43
Expenses of the issue and listing of the Company’s shares 46.00
Contingencies 41.57
Total 761.68
Means of Finance (Rs. in lakh)
Present Issue of Equity 687.50
Internal Accruals 74.18
Total 761.68
Notes: Any increase in the cost of the project is proposed to be met from the internal accruals of
the Company. The expenditure incurred on the project till 25th June, 20x1 has been Rs.14.75 lakh
and has been met from the internal accruals of the Company. The total project cost of Rs.761.68
lakh is proposed to be incurred in the financial year ending 31st March, 20x2.
Schedule of Implementation
The schedule of implementation as per the company’s estimates and the current status is as
follows:
Activity Completion date Current status
Expansion of software August, 20x1 MOU for availing use of the expanded premises
development center has been signed and possession taken.
Purchase of hardware September, 20x1 Quotations have been invited from vendors.
and software
Investment in the UK September, 20x1 RBI approval for setting up the subsidiary has
subsidiary been received on 19th June, 20x1.
Investment in German November, 20x1 RBI approval for setting up the subsidiary has
subsidiary been received on 19th June, 20x1.
Investment in the US March, 20x2 An application for RBI approval for setting up
subsidiary the subsidiary has been made.

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PRESENT BUSINESS AND MAIN OBJECTS

Brief History
The Company was incorporated as a private limited company by the name of Amex Computers
and Services Private Limited on 26th September, 19x3 in the state of Maharashtra. The Company
was converted into a public limited company vide a special resolution dated 31st March, 19x7 and
the name was changed to Amex Information Technologies Limited. The certificate consequent to
change in name and conversion was issued by the Registrar of Companies, Mumbai on 21st April,
19x7. The company was originally promoted by Mr. Ashok Ranade and his family members.
There was very little business activity in the Company till August, 19x7 when the present
promoter group acquired the controlling interest and tookover the management of the Company.
The present promoters consist of three professionals, Mr. G.S. Chandrashekar, Mr. Sharad Gupta
and Mr. Aniket Jathar. Mr. Sharad Gupta brings with him skills in marketing of IT related
products and services. Mr. Aniket Jathar brings with him the experience of software development.
Mr. Chandrashekar has extensive prior experience in the field of finance. The Company started
with a focus on on-site services and year 20x2 compliance related projects. This tool has been
modified to carry out Impact Analysis for Euro-Conversion related projects. In the past one year, it
has widened its scope of activities to the areas of re-engineering migration, data warehousing, e-
commerce (web enabling and NET dynamics) and client server development.
The Company has grown from 37 employees in September, 19x9 to 80 employees in March, 20x1.
Total income of the Company increased from Rs.173.54 lakh in the Financial Year 20x0 to Rs.848.66
lakh in the Financial Year 20x1. The Company generated export income to the extent of Rs.795.66
lakh in the Financial Year 20x1 as against Rs.173.54 lakh in the Financial Year 20x0. A substantial
portion of this revenue came from the UK market, as also from the Netherlands and Germany.
Present Business
The company was incorporated with the objectives of carrying out the business of developing,
designing, manufacturing, processing and assembling products allied to computer hardware and
software in and outside India. Present activities of the company can be broadly divided into On-
site consulting services and Off-shore project execution.
On-site Consulting Services: Several of the company’s software consultants are engaged in
providing on-site consultation to customers in Europe. Consultation ranges from the IBM
mainframe to client-server platforms. Application areas converted include re-engineering,
migration, data warehousing and product development. The Company’s overseas on-site activity is
also marketed by Profund International Management Consulting-Germany, Oakwood Technical
Services Limited UK & Softlines (UK) Limited. Through these arrangements, the Company’s
professionals have been placed in various organizations. The Company plans to build on all these
arrangements by starting three subsidiary companies, in the UK, Germany and USA. It plans to put
together a marketing team to develop business potential in Europe and USA.
Off-shore Project Execution: The Company has successfully carried out in 20x2 compliance
projects with the help of its automated compliance tool TRYST. This tool has also been modified
to carry out the Impact Analysis for Euro-conversion related projects. A plot project for the same
is also underway. The company is currently working on the following tools which aim to automate
parts of the software development process such as TRYST, GRAFTERM and DAD.
The five main clients of the Company during the financial year ended 31st March, 20x1 were
Oakwood Technical Services Limited – UK, Profund International Management Consulting –
Germany, Softlines (UK) Limited, Streamlines – Netherlands & ACS Consulting – USA. They
contributed 83% of the total income for the year. The Company wishes to leverage the expertise
and the association that it has developed through its network valued-added project implementation,
rather than standard software outsourcing. This will be done directly for the same set of clients
where the Company’s professionals currently work.
Quality Procedures and Guidelines: The company has developed Total Quality System based
on ISO 9000 guidelines and procedures with a view of achieving this certification in the near
future. By utilizing quality management techniques, the software development team can solve
problems, improve and manage the process, resolve out of control conditions and take effective
steps for constant improvement.

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Human Resource Policy: Participation by consensus is the key success factor. The company,
therefore, invests in its people to build up high quality human assets. Staff is carefully selected,
intensively trained and appropriate growth paths are charted out for future advancement. Special
emphasis is placed on industry relevant skills and quality assurance. To achieve excellence in these
areas, the company has formal training and development plans for employees. The company also
plans to offer ESOP to its employees.
Financial Highlights
The key financial indicators of the company based on the audited accounts are given below:
Statement of Profit and Loss
(Rs. in lakh)
1.4.20x0 1.10.19x9 1.4.19x8 1.4.19x7 1.4.19x6
to to to to to
Particulars 1.3.20x1 31.3.20x0 30.9.19x9 31.3.19x8 31.3.19x7
(12m) (6m) (18m) (12m) (12m)
Software development
– On-site 704.54 173.54 33.17 – –
– Off-shore 91.12 – – – –
– Domestic 53.00 – 61.75 38.07 5.97
A. Total Sales 848.66 173.54 94.92 38.07 5.97
Y2K related revenue included in 123.11 32.71 1.79 – –
above
B. Other income from 0.00 0.00 0.00 0.00 0.00
operations
a. Total income 848.66 173.54 94.92 38.07 5.97
Expenditure
Cost of goods sold 0.00 0.00 0.00 0.00 0.00
Interest and finance charges 5.48 1.21 1.12 0.08 0.00
Lease Rental Charges 22.30 7.13 1.96 0.00 0.00
b. Total expenditure 27.78 8.34 3.08 0.08 0.00
c. Operating income 820.88 165.20 91.84 37.99 5.97
Operating expenses
Employee cost/on-site 502.46 109.71 35.24 18.27 3.02
expenses
Administrative expenses 64.20 28.42 34.69 13.59 2.76
Depreciation 26.84 2.33 2.87 0.05 0.00
Preliminary expenses 1.25 0.62 1.71 0.01 0.01
written off
Miscellaneous expenses 0.00 0.00 0.00 0.00 0.00
written off
d. Total operating expenses 594.75 141.08 74.51 31.92 5.79
e. Profit from operations 226.13 24.12 17.33 6.07 0.18
f. Other income 2.03 1.17 0.62 0.08 0.05
g. Net profit before tax 228.16 25.29 17.95 6.15 0.23
h. Taxation 5.00 1.50 0.44 2.60 0.14
i. Profit after tax 223.16 23.79 17.51 3.55 0.09
Dividend rate 7.5% 7.5% Nil 10% 15%
j. Dividend 18.62 7.46 0.00 1.62 0.00
k. Corporate dividend tax 1.86 0.75 0.00 0.00 0.00
l. Transfer to general reserve 190.00 1.90 1.09 0.00 0.00
Profit and Loss B/F 32.21 18.53 2.11 0.18 0.09
m. Balance transferred to 44.89 32.21 18.53 2.11 0.18
balance sheet

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Statement of Assets and Liabilities

1.4.20x0 1.10.19x9 1.4.19 x 8 1.4.19x7 1.4.19x6
to to to to to
Particulars
31.3.20x1 31.3.20x 0 30.9.19x 9 31.3.19x8 31.3.19x 7
(12m) (6m) (18m) (12m) (12m)
Assets
Fixed assets
Gross block 147.72 108.23 90.96 7.76 0.08
Accumulated depreciation 32.10 5.26 2.93 0.05 0.01
Net block (I) 115.62 102.97 88.03 7.71 0.07
Investment (II) 0.00 55.39 54.89 5.20 0.00
Current assets, loans and advances
Inventory 0.00 0.00 0.00 0.00 0.00
Sundry debtors 246.23 59.73 76.16 36.45 0.00
Other current assets 117.51 21.46 17.68 11.17 0.79
Loans and advances 29.83 26.21 18.37 29.95 0.02
Total (III) 393.57 107.40 112.21 77.57 0.81
A: (I) + (II) + (III) 509.19 265.76 255.13 90.48 0.88
Less: Liabilities
Loan fund
Secured 2.19 20.59 24.79 2.05 0.00
Unsecured 0.00 0.00 0.00 0.00 0.17
Total (IV) 2.19 20.59 24.79 2.05 0.17
Current liabilities and provisions (V) 28.00 15.45 10.00 6.77 0.29
B: (IV + V) 30.19 36.04 34.79 8.82 0.46
Net assets (A – B) 479.00 229.72 220.34 81.66 0.42
Represented By
Equity capital 250.00 178.93 99.02 80.09 0.30
Share application money 0.00 25.73 112.46 1.00 0.00
Reserves and surplus (Free reserves) 237.90 35.21 19.63 2.12 0.19
Total 487.90 239.87 231.11 83.21 0.49
Less: Miscellaneous expenditure 8.90 10.15 10.77 1.55 0.07
Total (Net Worth) 479.00 229.72 220.34 81.66 0.42
Management Discussion and Analysis of Results of the Company for the last Three
Accounting Periods
Total income of the company increased from Rs.173.54 lakh in the financial year 20x0 to
Rs.848.66 lakh in the financial year 20x1 registering an increase of 144%. During the same period
the net profit of the company increased from Rs.23.79 lakh to Rs.223.16 lakh, a growth of 369%.
The company generated export income to the extent of the Rs.795.66 lakh (94% of revenues) in
the Financial Year 20x1 as against Rs.173.54 lakh in the Financial Year 20x0. However, these
growth rates of total income and net profit have been achieved due to the fact that the initial size of
the company’s operations were comparatively small. These growth rates are likely to decline in the
future. The company consolidated its presence in the European markets and increased the number
of consultants from 22 in September, 19x9 to 67 in March, 20x1. It was also accompanied by
successful execution of off-shore projects. The total income of the company increased from
Rs.94.92 lakh in the financial year 19x9 to Rs.173.54 lakh in the financial year 20x0, registering
an increase of 448%. During the same period the net profit of the company increased from
Rs.17.51 lakh to Rs.23.79 lakh, a growth of 307%. The expenditure of the company (excluding

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taxation) increased from Rs.77.59 lakh in the financial year 19x9 to Rs.149.43 lakh in the financial
year 20x0 and Rs.622.53 lakh in the financial year 20x1. The company competes with similar
other software services companies on its strengths which include its successful track record,
professionally qualified and experienced personnel and their available skills. There have been no
unusual or infrequent events or transactions during the past accounting periods of three years. The
company’s business of software development is not seasonal. No significant general economic
changes have taken place in the past three accounting periods to materially affect the operations or
profitability of the company. No significant economic change is likely to materially affect the
income from continuing operations. No material changes in the future relationship between costs
and revenues are known as on date. No new product or entry into a new business segment has
been publicly announced since the date of the last financial statements. The five main clients of the
company during the financial year ended 31st March, 20x1 were Oakwood Technical Services
Limited – UK, Profund International Management Consulting – Germany, Softlines (UK) Limited,
Streamlines – Netherlands and ACS Consulting – USA. They contributed 83% of the total income
for the year. There were no special events, trends or any uncertainties that at any time adversely
affected the income from continuing operations. The management does not anticipate any adverse
changes taking place in the future also. Future changes in revenue are expected to arise primarily
from the company’s increased volume of activity.
Profitability forecast for financial year ending 31st March, 20x2
A forecast of operations and profit for the year ended 31st March, 20x2 along with the major
assumptions as estimated by the company and certified by K. P. Joshi and Company, the Auditors
of the company, to be arithmetically accurate and in accordance with the assumptions are:
Particulars (Rs. in lakh)
Sales and other income 1,598.44
Employee cost/On-site expenses 942.78
Administrative and Other expenses 87.92
Interest and financial charges 22.20
Miscellaneous expenses written off 8.75
Depreciation 40.04
Profit before tax 496.75
Tax 4.53
Profit after tax 492.22
Assumptions
The benefits from expansion and diversification project are expected to accrue during the second
half of the financial year. The revenue for on-site and off-shore services has been assumed on the
basis of 160 hours per man month working. It has also been assumed that there are 25 working
days in a month. Sales overheads are taken at the rate of 3% of revenue. Administrative overheads
are taken at the rate of 2% of the net revenue. Depreciation on fixed assets has been charged on
straight line method at the rates specified in the Companies Act, 1956. Revenue from on-site staff
has been taken for 11 months, whereas salary and allowance is taken for 12 months. Exchange
Rate for UK Pound is taken at Rs.70. Exchange rate for US Dollar is taken at Rs.42. Exchange rate
for Euro is taken at Rs.43. Tax has been calculated taking into consideration 80 HHE benefits
under Income Tax Act.
Company, management, the promoters and their background
The Promoters of Company and their brief background is outlined below: Mr. G S Chandrashekar,
Managing Director of the company, aged 45 years, is a Chartered Accountant, and has over 18
years experience in finance. Between 1977-88, he was with the Apte group of companies and his
last assignment was as Vice President (Finance) of Lakshmi Vishnu Textiles Limited. Before
joining the company, between 1989-1995, in his capacity as a Financial Consultant, he
implemented projects on turnkey basis for Simplex Mills Limited, Neha Proteins Limited and
Bagade India Engineering Limited. He has also handled a large software-exports project for
Twinstar Software Exports Limited, on a turnkey basis, including setting up of centers, marketing

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tie-ups, selection of hardware and software vendors and appointment of personnel. Mr. Sharad
Gupta, Director-Marketing, aged 43 years, B.Sc, MA with a Diploma in Marketing and Sales, has
over 15 years experience in Marketing and Sales of Computer Hardware and Software. He has
held marketing positions in companies like Birla Consultancy and Software Services Limited,
National Electronics Company Limited, Jumbo Electronics Limited, Datamatics Limited and Blue
Star Limited (Hewlett Packard, Motorola and Software Export Division). He has extensive
experience in international marketing of software, managing Indian operations, setting up
marketing teams, and has successfully developed business in the Far East, Middle East, Europe
and USA. Mr. Aniket Jathar, Director-Technical aged 36 years, with a Post-Graduate Diploma in
Software Technology and Computing Techniques from NCSDCT, has over 9 years experience in
the software development business. He was with OMC Computers Limited and then with Neo
Computers Private Limited before joining the company. He has been instrumental in the development
of the Impact Analysis and Conversion tool that is used for the software exports projects contracted
to the company. He oversees the training and development of the software professionals employed
by the company.
FUTURE BUSINESS STRATEGY
Business Streams
The five main business streams in the future would be:
Client-Server Development: The Company’s personnel have been trained to execute projects
using well-defined methodologies and quality procedures. With strong project management skills
and over 80 man-years of experience in the Company, it can undertake a variety of large and complex
client server developments right from system study to implementation.
IT Support for European Monetary Union (EMU): The impact on the IT systems due to the
single Euro-currency will be driven by the business decisions to be taken by the organization and
the respective country’s participation in the EMU. The company has developed a tool that detects
the currency field in a module and hence assists in EMU problem. The company’s services
include: Analysis of existing system to understand current business processes, Impact Analysis of
affected systems in view of the proposed changes, re-coding test suite design, test data generation
and implementation.
E-commerce Application Development: E-commerce activity is expected to exceed US$349
billion by the year 20x2. Business on the NET is booming and destroying old habits and creating
new opportunities. Keeping this in mind, the company has developed skills that can be provided to
end-users at competitive costs.
Impact Analysis and Conversion Tool: This is a tool that has been developed by the company.
The Y2K problem essentially revolves around locating all the date-fields throughout the length of
the source code (normally a few million lines per program). The Impact Analysis tool simplifies
the activity and reduces the time taken to modify the program and reduces possible oversights. The
company has successfully executed projects using this tool and has received repeat orders for the
same.
On-site Development: These are the current on-site activities that are being carried out by the
company. The company can provide personnel with any or all of the following skill set: Oracle,
Developer 2000, Designer 2000, Sybase, Powerbuilder, Visual C++, Visual Basic, Java,
Networking.
Competition: The company competes with other software services companies on its strengths
which include, successful track record, professionally qualified and experienced personnel and
their skills.
Growth Strategy
The company has consciously looked at the European market to begin with, instead of the US
where large numbers of Indian software companies operate focusing mainly on on-site consulting.
Having established itself in the European market, the company is now focusing on the following:
Direct contact with the end user: The company plans to start fully owned susidiaries in the UK,
Germany and USA with marketing and support staff, which will focus on off-shore projects and
direct contracting with end-users resulting in a high credibility of the company, enhancing its
marketing abilities for projects and on-site development activities.

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Increasing geographic reach: By establishing subsidiaries in the UK and Germany, markets in

Belgium, the Netherlands, France, Austria and Switzerland would be directly accessible to the
company.
New markets: Japan is the second largest IT market after the US. The company is taking the
services of a software language translator to overcome the language barrier and enter this market. The
US remains the largest market and it is still growing. New technologies evolve mainly out of the
US and hence the market cannot be ignored. The emphasis of the US subsidiary will be on off-
shore projects through strategic alliances.
Increase off-shore development: The company started its operation with major dependence on
on-site consulting, which gave consistent revenues and margins. Since then, the company has
successfully implemented off-shore projects and proposes to emphasize on the same in the future.
Focus on high technology areas: The increasing and fast growing web based applications offer
tremendous opportunities. Object technologies being the paradigm for the next generation software
development, the company will invest in high technology areas like Distributed Object
Management using CORBA and DCOM. Component programming and legacy system integration
using object encapsulation will also be the focus.
Presence in domestic market: The company will increase its presence in the growing domestic
market by enhancing the skill set of its professionals in domain specific applications at low risk.
The company is developing a banking product and an interactive telephony product that it
proposes to sell in the domestic market.
Note:
1. The highest P/E ratio in the software industry is 121.7 and the lowest is 0.3. The average
industry P/E is 25.1.
2. Use annualized EPS for all the computations.
Assume the sensex at the time of issue as 4,750 and at the end of March, 20x0 as 5,460.
Case Study 6
Read the case carefully and answer the following questions.
1. What are the conditions imposed by SEBI for a company to be eligible to tap the market
with an IPO at premium?
2. How many Lead Managers, Co-Managers and Advisors can be appointed for this issue?
3. Justify the premium on this issue as per the Malegam Committee recommendations. State
clearly both the qualitative and quantitative factors.
4. Draw a list of highlights and risk factors for this issue.
5. According to the SEBI guidelines state the minimum application by public for such an
issue.
6. a. What would be the public holding after the issue is successfully completed? Will it be
meeting the listing requirements as specified by SEBI?
b. State the formalities associated with listing and give its advantages.
7. Analysts feel that this is an underpriced issue. State the implications of the same.
Public Issue of 4,00,00,000 Shares of Rs.10 each at a Premium of Rs.35 per share aggregating
Rs.180,00,00,000 during April, 20x0.
Objects of the Offer
1. To comply with the license condition stipulated by the RBI that the bank shall have 60% of
its equity held by the public. Further dilution would take place in subsequent tranches.
2. To augment the net worth of the bank for meeting future capital adequacy requirements.
3. To get the bank shares listed on the stock exchanges.
Brief History of the Bank
The Bank was incorporated on 31st January, 19x6 as a private bank. The Bank commenced
commercial operations on 12th April, 19x6.

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As on 31.03.20x0, the bank was the largest private sector bank in terms of assets, deposits and net
profits. Further the Bank was ranked as `Best Bank’ by the Financial Express Survey among 86
nationalized, foreign and private sector banks.
Overview of the Bank’s Business
The Bank has a network of 20 fully computerized and automated branches covering 10 states and
2 Union Territories. All Branches are connected through the satellite to a Central Database
offering the facilities of `anywhere banking’ and instant funds transfer.
The bank has a deposit base of Rs.3093.10 cr. The Bank’s Certificate of Deposit Program has been
rated PR1+ by CARE for the last 3 consecutive years.
The total staff strength is 294. According to the Financial Express survey the bank has been ranked
No.1 in terms of business per employee and No.3 in terms of operating profit per employee.
Income Recognition and Loan Provisioning
Particulars Amount in Crore
Standard Assets 1887.64
Sub-standard Assets 46.79
Doubtful Assets 1.98
Loss Assets —
Total Assets 1936.41
Provisions as per RBI norms 8.75
Net Advances 1927.66
Net Non Performing Assets 40.02
NPAs to Net Advances 2.08%
Capital Adequacy Position of the Bank
(Rs. in crore)
Particulars 31.03.19x8 31.03.19x9 31.03.20x0
Risk Weighted Assets 488.28 1279.62 2165.91
Capital 161.67 232.77 279.46
Capital Adequacy Ratio 33.11% 18.19% 12.90%
Credit Deposit Ratio
Particulars Global Bank Industry
19x7-x8 72.03% 54.69%
19x8-x9 79.39% 58.31%
19x9-20x0 62.32% 54.91%
Estimated Profit Forecast for 20x0-x1
Particulars Amount in Crore
Interest Income 585.25
Other Income 146.31
Total Income 731.56
Interest Expended 449.18
Operating Expenses 79.58
Provisions & Contingencies 99.40
Total Expenses 628.16
Net Profit 103.40

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Financial Performance for the Last Three Years

(Rs. in crore)
Particulars 31.03.19x8 31.03.19x9 31.03.20x0
Interest Income 61.53 191.22 409.30
Other Income 18.11 36.55 81.87
Total Income 79.64 227.77 491.17
Interest Expense 37.14 134.20 310.07
Operating Expense 9.23 27.51 56.15
Total Expenses 46.37 161.71 366.22
Operating Profit 33.27 66.06 124.95
Provisions & Contingency 11.44 20.44 51.63
Net Profit 21.83 45.62 73.32
Share Capital 100.00 120.00 120.00
Reserves & Surplus 6.83 111.34 159.46
Net worth 106.83 231.34 279.46
Deposits 649.89 1412.23 3093.10
Advances 500.54 1121.19 1927.65
Investments 188.04 357.50 1054.54
Other Information
Industry P/E Ratio for Private Sector Banks
1. Average P/E ratio 7.8
2. Highest P/E ratio 35.8
3. Lowest P/E ratio 2.6

Case Study 7
Read the case carefully and answer the following questions.
1. Design a suitable instrument for XYZ Ltd. to mobilize funds from the public. The
instrument designed should meet the constraints given. Give reasons wherever necessary.
2. Determine the cost of the above instrument to XYZ Ltd.
3. What are the important areas focussed by a credit rating agency in assigning rating to a debt
instrument?
4. What is the role and responsibility of a debenture trustee in case of a debt issue?
5. The CEO has informed you that the company would like to offer the instrument designed
by you in demateralized form.
a. Explain the concept of dematerialization of securities.
b. What are the various benefits of dematerialization to the investors?
c. Is it mandatory to give the option of rematerilization to the investors?
Make suitable assumptions wherever necessary and state them clearly.
XYZ Company Limited (XYZ) is a profit making dividend-paying listed company engaged in
manufacture of synthetic ropes. It has technical collaboration with a major foreign company for its
existing product range. The company registered a sales turnover of Rs.5200 lakh and a net profit of
Rs.2089 lakh for the year ended March 31, 20x1.

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XYZ has taken up an expansion project to increase the capacities of existing products, in technical
and financial collaboration with the foreign company. The project was estimated to cost Rs.19000
lakh. The means of financing includes term loans of Rs.6500 lakh and Rs.2500 lakh from Indian
promoters, Rs.3500 lakh from the foreign collaborator in the form of equity, Rs.1500 lakh in the
form of internal accruals, and the balance Rs.5000 lakh from the public.
Performance
The financial performance of the company for the last five years is as follows:
(Rs. lakh)
Year ended March 31 19x7 19x8 19x9 20x0 20x1
Sales 400 700 825 2000 5200
PBIDT 125 180 190 875 2484
Financial Charges 30 30 15 120 300
Depreciation 15 18 18 40 95
PBT 80 132 157 715 2089
Tax 5 1 2 0 0
PAT 75 131 155 715 2089
Share capital 43 85 85 460 460
Reserves & surplus 116 239 375 1883 3382
Dividend (%) 10 12.50 16 18 30
Shareholding Pattern and price movements
The shareholding pattern of XYZ’s existing Share Capital of Rs.460 lakh is as follows:
Holding
Promoters 46.39%
FIIs & Public 53.61%
The price movement of the scrip on the Mumbai Stock Exchange since it is listed in July, 19x8 is
as under:
Share Price (in Rupees)
Month/Year High Low Average
19x9 (Average) 115.0 40.0 77.50
April, 20x0 115.0 85.0 100.00
May, 20x0 97.5 85.0 91.25
June, 20x0 100.0 90.0 95.00
July, 20x0 110.0 92.5 101.25
August, 20x0 90.0 82.5 86.25
September, 20x0 110.0 85.0 97.50
October, 20x0 113.0 89.0 101.00
November, 20x0 102.0 97.0 99.50
December, 20x0 138.0 97.0 117.50
January, 20x1 166.0 133.0 149.50
February, 20x1 204.0 143.0 173.50
March, 20x1 153.0 148.0 150.50
April, 20x1 150.0 101.0 125.50
May, 20x1 141.0 102.0 121.50
June, 20x1 125.0 114.0 119.50
July, 20x1 138.0 118.0 128.00
August, 20x1 135.0 118.0 126.50
September, 20x1 172.0 130.0 151.00

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 Part IV

The scrip is currently being quoted at Rs.109 at a P/E multiple of 2.4 times the EPS of 20x0-x1.
ABC Company Ltd. is the only other player in the market engaged in manufacture of ropes similar
to that of XYZ. For the year ending March 31, 20x1, ABC posted a turnover of Rs.120 crore and a
net profit of Rs.12.2 crore on an equity capital of Rs.20 crore. The scrip is being discounted at 5.9
times and currently quoted at Rs.36.
Future Profitability of XYZ
For the project
Year Ended March 31 20x3 (6 months) 20x4 20x5
Capacity Utilization (%) 60.00 70.00 80.00
Sales 2860.00 6674.00 7627.00
PBIDT 1193.00 2763.00 3144.00
G P Margin (%) 41.71 41.40 41.22
For the Company as a whole
Year Ended March 31 20x2 20x3 20x4 20x5
Sales 5591 8451 12265 13218
PBIDT 2298 3484 5046 5418
Interest 384 801 1171 922
Depreciation 163 1031 1898 1898
PAT 1485 1308 1800 2443
Implementation
The new project of XYZ is expected to commence operations by September end, 20x2.
Constraints in designing the instrument to mobilize funds from public:
• Straight equity issue is ruled out because of:
• bearish market conditions in the equity market, natural resistance to premium issues
• low pricing of equity is not acceptable to promoters
• dilution in equity would immediately affect the bottom line of the company, while the
project would generate cash flows only from October, 20x2.
Pure debt issue cannot be made as:
• The project cannot absorb interest expense before commencement of commercial production.
• Further leveraging the capital structure is not acceptable to financial institutions.
Additional Information
Research Reports by leading Investment Banks suggest that the market is expected to improve
significantly from the second quarter of 20x2.
Case Study 8
Read the case carefully and answer the following questions.
1. Compute the YTM/realized yield for the following bonds:
i. Encash bond assuming the investor opts for early redemption at the end of 5 years
and 6 months from the date of allotment.
ii. Money multiplier bond – Option III
iii. Tax saving bond – Option I. Assume the investor avails the benefit under Section 88
of the Income Tax Act, 1961.
iv. Tax saving bond – Option III:
a. Assume the investor is not availing the benefit under Section 54EC
b. Assume the entire investment is made out of the net sale proceeds of a long-
term asset and 60% of the investment is the capital gains realized on the sale of
the asset.

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2. Explain, with reasons, the types of investors to whom the regular income bond and the
money multiplier bond would appeal.
3. Explain, in detail, the concept of market making.
4. What are the dimensions involved while designing innovative financial products by
financial engineering?
5. Is it mandatory for ICICI to pay interest on the application money as mentioned in the case?
Give reasons.
6. Discuss the steps required to create a vibrant debt market in India.
Clearly state your assumptions.
ICICI has made a public issue of unsecured redeemable bonds in the nature of debentures
aggregating Rs.400 crore with a right to retain oversubscription up to Rs.400 crore.
TERMS OF THE ISSUE:
ENCASH BOND
Face Value : Rs.5000
Redemption : At face value i.e. Rs.5,000 at the end of 7 years from the Deemed Date of
Allotment.
Interest : Interest will be payable annually at the following rates:

Years 1st 2nd 3rd 4th 5th 6th 7th

Applicable rate of interest for 11.00 12.00 13.50 15.00 16.00 17.00 18.00
respective years (%)
Early Redemption at the option of the Bondholders (Encash Facility)
An original individual allottee has the option of Early Redemption of the Bonds (‘Early
Redemption’) at any time after the expiry of 12 months from the Deemed Date of Allotment till
one month prior to the Redemption Date (‘Relevant Period’) at any of the branches of the ICICI
Banking Corporation Limited.
Payment on Early Redemption
An investor who exercises the option of Early Redemption during Relevant Period, will receive the
face value of the bond by way of cheque/pay order, etc. on presentation of duly discharged Bond
Certificate to the Specified Branch.
In case the bondholder exercises the option of Early Redemption of the Bond during the Relevant
Period, the interest for the broken period (i.e. from the time of payment of interest for the previous
year till the date of receipt of Bond Certificate by specified branch or such person at such address
as may be notified by ICICI from time to time) will be paid to the bondholder by ICICI.
TAX SAVING BOND
Investors can avail rebate u/s 88 or tax benefits u/s 54EC of the Income Tax Act, 1961, by
investing in bonds issued by a public financial institution for the purpose of deploying these funds
towards infrastructure projects.
The Central Board of Direct Taxes, Department of Revenue, Ministry of Finance, Government of
India has, vide its notification nos. 10278 and 10279 dated March 4, 1997, declared the bonds
issued by ICICI as specified assets for the purposes of Sections 54EC of the Income Tax Act,
1961 and vide its notification F No.178/94/97-ITA-I dated August 10, 1998 declared the Tax
Saving Bond Option I and Option II as eligible security for the purposes of Section 88 of the
Income Tax Act, 1961.
Investors desirous of availing rebate u/s 88 or tax benefits u/s 54EC of the Income Tax Act, 1961
from payment of tax on capital gains can invest in the relevant option of this bond.
The investor may choose any of the following options in respect of subscription for Tax Saving
Bond.

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Option I II III
Tax Benefit under Sec. 88 88 54EC
Issue Price (Rs.) 5,000 5,000 5,000
Face Value (Rs.) 5,000 7,350 5,000
Redemption Period 3 years 3 years 3 months 7 years
Interest (%) (Payable annually) 12.50 @ Zero Coupon Bond 13.00
The bonds are redeemed at face value.
REGULAR INCOME BOND
Face Value : Rs.5,000
Redemption : At Face Value
The investors can choose any of the following three options in respect of payment of interest:
Option I II III
Minimum Application (Rs.) 15,000 10,000 5,000
Redemption Period (years) 5 5 5
Interest (%) 13.00 13.25 13.75
Interest Payable Monthly Half-Yearly Annually
MONEY MULTIPLIER BOND (in the nature of Deep Discount Bond)
Each Money Multiplier Bond in the nature of Deep Discount Bond will have different face values
under each option and will be issued at a discounted price of Rs. 4000 each.
Minimum Application: One Bond
The investors can choose any of the following options (as per the table below) in respect of the
Money Multiplier Bond.
Option I II III
Issue Price (Rs.) 4,000 4,000 4,000
Face Value/ Redemption Value (Rs.) 8,000 16,000 1,00,000
Redemption Period 5 years 4 months 10 years 7 months 24 years 5 months
Payment of Interest on Encash Bond and Options I, III and IV of Tax Saving Bond: Interest
will be paid on June 30 each year. The first interest payment will be made on June 30, 20x1 for the
period commencing from the Deemed Date of Allotment and the last interest payment will be
made at the time of Redemption of the Bond on a prorata basis.
Interest on Application Money: Interest on Application Money @ 5.00 percent p.a. on the
amount allotted for the period commencing from the 3rd day after the date of deposit of
application form with the bankers to the issue till a day prior to the Deemed Date of Allotment.
Such interest will be paid for the period commencing from the third day after the date of lodgment
of the Application Form at the bank branches listed in the Application Form till a day prior to the
Deemed Date of Allotment. The date of receipt of the Application Form as given by the bank
branch will be considered as final. An investor should not deduct the interest on application money
receivable by him from the amount payable on application. However, in case interest on
application money is less than or equal to Rs.25 then the same would be paid along with the first
interest payment/redemption, depending upon the instrument chosen, along with appropriate
interest. Investors applying through stockinvest will not be entitled to any interest on application
money. No interest on application money will be paid on the amount refunded, if any.
Market Making: ICICI is making arrangements for market making of these bonds.
Deemed Date of Allotment: The Deemed Date of Allotment for the issue has been fixed as 30
days from the date of closure of the issue or date of utilization of proceeds, whichever is earlier.
All benefits relating to the bonds will be available to the investors from the Deemed Date of
Allotment. The actual allotment may occur on a date other than the Deemed Date of Allotment.
Market Lot: The market lot will be one Bond (‘Market Lot’).
Ignore the time lag between the application date and allotment date.
Assume the deemed date of allotment to be January 1, 20x1 and the tax on interest in the hands of
the investors as nil.
403