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Question Paper

Investment Banking and Financial Services-I (261) : April 2006


Section A : Basic Concepts (30 Marks)
• This section consists of questions with serial number 1 - 30.
• Answer all questions.
• Each question carries one mark.
• Maximum time for answering Section A is 30 Minutes.

< Answer >


1. Which of the following statements are true?
I. The purchaser of interest-only portion of the STRIP invests in the security with a yield potential
of high-coupon collateral.
II. The purchaser of principal-only portion of STRIP expects the interest rates would continue fall
and the borrower of the mortgage loan would resort to large-scale prepayments.
III. Both interest-only securities and principal-only securities are neutral to the changes in interest
rates.
IV. The return to the investors of interest-only security and principal-only securities move in the
same direction.
(a) Both (I) and (II) above
(b) Both (II) and (IV) above
(c) (I), (II) and (III) above
(d) (II), (III) and (IV) above
(e) All (I), (II), (III), and (IV) above.
< Answer >
2. A net lease where the title of the asset passes to the lessee upon exercising a purchase option or
payment of guaranteed residual is called
(a) Sale and leaseback
(b) Close-ended lease
(c) Leveraged lease
(d) Cross-border lease
(e) Open-ended lease.
< Answer >
3. In India, under SEBI regulations ‘venture capital undertaking’ means a domestic company,
I. Whose shares are listed on a recognized stock exchange.
II. Which is engaged in the business of providing services, production or manufacture of articles or
things.
III. Whose activities do not include the activities of negative lists provided by Central Government.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
4. Which of the following is/are true with respect to differential shares?
I. The differential shares are a class of shares that carry varying voting rights with fluctuating rates
of dividend.
II. The issue of differential shares acts as a take over defense for the company.
III. Mostly, the companies utilize this route as an aid to maximize the wealth of the shareholders.

(a) Only (I) above


(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) All (I), (II) and (III) above.
< Answer >
5. Which of the following CDs carry both fixed and floating interest rates?
(a) Asian Dollar CDs
(b) Installment CDs
(c) Rising Rate CDs
(d) Thrift CDs
(e) Yankee CDs.
< Answer >
6. Which of the following is not true for LYONS?
(a) This is a zero coupon bond, which is convertible into the common stock of the issuer
(b) The issuer gets the tax advantage even if he is not paying any interest till maturity
(c) If the investor of such securities choose to convert, he will get all accrued and unpaid part of the
interest
(d) By issuing such an instrument, the company earns a lump sum in the initial period, for which it
does not have to meet immediate out flow of interest
(e) Issuance of this stock helps the issuer to take advantage of convertible debt without too much
dilution of common stock.
< Answer >
7. A loan that can be extended after a pre-set period is called
(a) Term loan
(b) Revolving credit facility
(c) Evergreen facility
(d) Back-stop facility
(e) Swingline.
< Answer >
8. Which of the following is/are not the objective(s) of International Organization of Security
Commissions?
I. Cooperating and promoting high standards of regulation in order to maintain just, efficient and
sound markets.
II. Exchanging information on their respective experiences in order to promote the development of
international markets.
III. Providing mutual assistance to promote the integrity of the markets.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
9. The Takeover Code under SEBI’s regulatory purview is triggered when the acquirer obtains
(a) 10% equity stake in a company
(b) 15% equity stake in a company
(c) 20% equity stake in a company
(d) 25% equity stake in a company
(e) 33% equity stake in a company.
< Answer >
10. Which of the following political risks are covered by Export Credit and Guarantee Corporation?
I. War, civil war, revolution or civil disturbance in the buyer’s country.
II. Cancellation of valid license or new import restrictions.
III. Default or insolvency of any agent of exporter or of the collecting bank.
IV. Loss occurring outside India due to any other reasons that are not insured.
(a) Both (I) and (II) above
(b) Both (II) and (III) above
(c) (I), (II) and (III) above
(d) (I), (II) and (IV) above
(e) All (I), (II), (III) and (IV) above.
< Answer >
11. NZ is a US based company. It wants to raise funds from India through Indian Depository Receipts.
What is the profitability requirement for NZ according to SEBI Act, 1992?
(a) It has been making profits for the last three years preceding to issue and has been declaring
dividend of not less than five percent each year for the said period
(b) It has been making profits for the last three years preceding to issue and has been declaring
dividend of not less than ten percent each year for the said period
(c) It has been making profits for the last five years preceding to issue and has been declaring
dividend of not less than five percent each year for the said period
(d) It has been making profits for the last five years preceding to issue and has been declaring
dividend of not less than ten percent each year for the said period
(e) It has been making profits for the last five years preceding to issue and has been declaring
dividend of not less than fifteen percent each year for the said period.
< Answer >
12. Which of the following is not true with respect to private placement?
(a) Unlike the public issue market, an existing company is not required to have a dividend track
record for three years
(b) This route is available for the listed companies only
(c) Private placement deals can be successfully closed in 4 to 6 weeks, hence it is faster mean to
raise funds
(d) In private placement, there is greater flexibility in working out the terms of issue
(e) The issue expenses in case of private placement is as low as 2 percent of the total issue amount
as compared to 10 to 12 percent in case of public issue.
< Answer >
13. Which of the following is not true with respect to bonus issue according to SEBI guidelines?
(a) The bonus issue is made out of free reserves built out of genuine profits or share premium
collected in cash only
(b) Bonus shares cannot be issued out of revaluation reserves and they cannot be capitalized
(c) The bonus issue is not made unless the partly-paid shares are made fully paid
(d) A company which announces its bonus issue must implement the proposal within a period of
three months from the date of such approval
(e) Issue of bonus shares after any public/right issue is subject to the condition that no bonus issue
shall be made which will dilute the value of rights of the holder of debenture, convertible fully or
partly.
< Answer >
14. Parker Ltd. wants to issue the CPs of 15 months of maturity. The discount rate used to issue the CPs is
I. The prevailing market rate of CP.
II. As per the credit rating achieved.
III. As per the discretion of the company.
IV. The company cannot issue the CPs.
(a) Only (II) above
(b) Only (III) above
(c) Only (IV) above
(d) (I), (II) and (III) above
(e) All (I), (II), (III) and (IV) above.
< Answer >
15. Following is the data pertaining to a finance company
Tier-1(% of total assets) 6.98%
Tier-2(% of total assets) 4.66%
Risk Weighted Assets(% of total assets) 76.87%
The total assets of the company stands to Rs.250 crores. The Capital Adequacy Ratio of the company
is
(a) 11.64% (b) 12.14% (c) 15.14% (d) 20.75% (e)
30.75%.
< Answer >
16. Under advance factoring arrangement, India Factors Limited (IFL) has agreed to advance a sum of Rs.
15 lakh for 90 days against the receivables of XYZ Limited. The advance carries the interest of 16%
p.a. compounded quarterly and the factor commission is 2% of the value of factored receivables.
Interest is collected in arrear and commission is collected upfront. Total receivables of the XYZ
Limited are Rs.18,75,000.
What is the annualized cost of funds made available to XYZ Limited?
(a) 16.00% (b) 16.77% (c) 17.44% (d) 17.79% (e) 18.00%.
< Answer >
17. Consider the following data regarding a traditional loan?
Tenure of loan : 10 years
Rate of Interest : 12% p.a.
Loan amount : Rs.10,00,000
Payment pattern : Equated monthly installments
The principal amount repaid in the first installment is
(a) Rs.8,993 (b) Rs.7,500 (c) Rs.4,347 (d) Rs.12,500 (e) Rs.13,164.
< Answer >
18. In which of the following lease agreement has a third party, a lender, to it?
(a) Back to back short term lease
(b) Leveraged lease
(c) Operating lease
(d) Full service lease
(e) Sale and lease back.
< Answer >
19. Consider the following data relating to a manufacturing company:
Cost of leased asset : Rs.25 lakh
Rate of depreciation : 25%
Fixed asset turnover ratio :2
Sales for the year : Rs.150 lakh
Instead of leasing if, the company had purchased the asset, its fixed asset turnover ratio would have
been
(a) 1.00 (b) 1.15 (c) 1.25 (d) 1.50 (e) 2.00.
< Answer >
20. A company has issued Pass Through Certificates (PTCs) backed by a pool of property receivables
aggregating to Rs.315.86 lakh. The equated monthly payment to be made to PTC holder are as
follows:
During the first 12 months : Rs.16 lakh p.m.
During the next 12 months : Rs.12 lakh p.m.
During the next 6 months : Rs.8 lakh p.m.
Calculate the promised rate of return to the investor.
(a) 18.56% (b) 17.56% (c) 16.56% (d) 19.56%
(e) Data is insufficient.
< Answer >
21. Which of the following is true for break even lease rental?
(a) A large upfront payments decrease the break even rental
(b) A higher tax relevant rate of depreciation increases the break even rental
(c) A longer primary lease period increases the break even rental
(d) Higher cost of capital increases the break even rental
(e) A higher net salvage value increases the break even rental.
< Answer >
22. Mr. Shah has deposited Rs.2,00,000 with an NBFC at the interest of 11.5% p.a. with the maturity of
36 months. After 17 months he wants to withdraw the deposit. The interest will be paid to Mr. Shah at
the rate of
(a) 10% p.a. (b) 10.5% p.a. (c) 11% p.a. (d) 11.5% p.a.
(e) No interest will be paid to him.
< Answer >
23. Which of the following is/are true for Advance Factoring?
I. Advance factoring alters the current ratio of the firm.
II. This arrangement results in the creation of current liability.
III. It simply rearranges the current assets by replacing receivables with cash and factor dues.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) All (I), (II) and (III) above.
< Answer >
24. In which lease transaction, the leasing company invests in the equipment by borrowing a large chunk
of investment with full recourse to the lessee and without any recourse to it?
(a) Leveraged lease
(b) Single investor lease
(c) Tripartite lease
(d) Bipartite lease
(e) Sale and lease back.
< Answer >
25. Greenland finance company has the total assets of Rs. 10 crore and net owned funds are Rs.2 crore.
The maximum amount it can borrow is
(a) Rs.4 crore (b) Rs.10 crore (c) Rs.12 crore
(d) Rs.15 crore (e) Rs.20 crore.
< Answer >
26. Which clause of the lease agreement entitles the lessor to terminate the agreement and be indemnified
by the lessee for all expenses incurred on account of the action of the lessee?
(a) Description clause
(b) Equipment delivery clause
(c) Ownership clause
(d) Surrender clause
(e) Exemption clause.
< Answer >
27. Which of the following statements is true with respect to Real Estate Investment Trusts (REIT)?
(a) The most prominent form of lending by REITs is the construction/developmental lending
(b) To retain their special tax status, REITs have to distribute 50% of their income to shareholders
(c) REITs are not allowed to raise finance through debt as they are equity investment vehicles
(d) Indirect equity investments in REITs by investor usually lack liquidity
(e) According to the federal laws, REIT can only be infinite life trusts.
< Answer >
28. Which of the following statements is false regarding REPOs?
(a) REPO is a combination of spot and forward transaction
(b) In a REPO both cash and security get simultaneously exchanged
(c) The backward leg of the transaction provides the fundamental basis for determining the REPO-
interest rate
(d) REPO serves as a collateralized fixed-rate loan for a short period
(e) REPO market can be used for hedging risks with an advantage over the forward market.
< Answer >
29. Which arrangement is designed to protect both the borrower and the lender against volatile interest
rates in real estate financing?
(a) Gap loans
(b) Bow ties
(c) Direct joint ventures
(d) Direct development and syndication
(e) Mini-perms.
< Answer >
30. A fixed deposit with an NBFC cannot be withdrawn within
(a) 2 months from its acceptance
(b) 3 months from its acceptance
(c) 4 months from its acceptance
(d) 6 months from its acceptance
(e) 9 months from its acceptance.

END OF SECTION A
Section B : Problems (50 Marks)
• This section consists of questions with serial number 1 – 5.
• Answer all questions.
• Marks are indicated against each question.
• Detailed workings should form part of your answer.
• Do not spend more than 110 - 120 minutes on Section B.

1. Following is the details related to the customers of Priya Bank:


(Amount Rs.)
Name of customer Saving Account Current Account Fixed deposits
Branch-1 Branch-2 Branch-1 Branch-2 Branch-1 Branch-2
Mr. Vrajesh 15,000 15,000 – – 5,000 55,000
Ms. Reshmi 25,000 5,000 2,500 – – 37,000
Mr. Biswajit – – – – 1,10,000 1,10,000
Mr. Jignesh 18,000 – – 23,000 54,000 –
Mr. Nishith – 17,500 – 5,500 – 65,000
Mr. Raju 44,500 – 5,500 – 17,000 7,000
Mr. Amit 3,500 8,500 5,000 5,000 – 85,000
Mr. Vinod – 6,800 – 93,200 – –
Mr. Amar 23,000 8,000 12,000 9,000 7,500 22,000
Following is the details related to the customers of Divya Bank:
(Amount Rs.)
Name of customer Saving Account Current Account Fixed deposits
Branch-1 Branch-2 Branch-1 Branch-2 Branch-1 Branch-2
Mr. Vrajesh 25,000 4,000 – 9,000 35,000 45,000
Ms. Reshmi – 32,000 8,000 – 12,000 36,000
Mr. Biswajit 21,000 7,500 9,000 14,800 – 23,000
Mr. Jignesh 14,000 – – – 65,000 –
Mr. Dhaval 52,000 25,000 – 27,500 1,00,000 50,000
Mr. Hitesh 2,500 7,500 12,500 – – 32,000
Mr. Dipen 18,500 19,000 5,000 10,000 19,000 9,000
Ms. Purvi 23,000 12,000 – – – –
Mr. Narendra – 26,500 14,500 13,500 10,000 8,000
You are required to
a.Compute the semi annual insurance premium payable by Priya Bank for the total deposits accepted above.
b. Compute the semi annual insurance premium payable by Divya Bank for the total deposits accepted
above.
c.Compute the extent to which Mr.Vrajesh’s total deposits at various banks are insured.
d. ist, which deposits the Deposit Insurance and Credit Guarantee Corporation (DICGC), insures and which
it does not.
As per the guideline given by DICGC, premium paid by the banks to insure deposits is 10 paise per Rs.100 p.a.
(3 + 3 + 1 + 2 = 9 marks) < Answer >
2. Pushti Ltd. had a turnover of Rs.750 lakhs in 2005-2006 and expects an increase of 25% in the next year. The
credit term of Pushti Ltd. is 1/10 net 30 days but it has been observed that none of the customers pay within the ten
days and avail the early discount. As per the records, on an average only 75% of the customers pay within 30 days,
20% of the customers pay within 45 days and rest of the customers pay within 60 days. 1.5% of the total sales
turns as bad debts.
Pushti Ltd. avails short-term finance from PVS Finance Ltd for funding 35% of receivables at 20% p.a. 30% of
receivables from DPS Finance at 22% p.a. The post-tax cost of funds of Pushti Ltd. is 17.50%. The administrative
expenses for credit recovery are Rs.1.5 lakhs.
PVS has given an offer of non-recourse factoring service to Pushti Ltd., the terms of which are as follows:
Discount charge 22%
Commission 2.5%
Advance Payment 80% of factored receivables
Agreed payment time 27 days

Alternatively, the company can change its credit term to 2/10 net 45. The company expects that due to this change
25% of the customers will avail discount and out of the remaining 75% will pay within 30 days, 20% will pay
within 45 days and rest will pay within 60 days. The company will also increase the administrative expenses for
credit recovery to 2 lakhs, as a result of this bad debts will come down to 1.00% of the total sales, rest of things are
expected to remain same.
The variable cost to sales ratio of Pushti Ltd. is 0.65 and the tax rate applicable to the company is 30%.
As a financial analyst you are required to
a. Compute the minimum increase in the sales to make factoring a viable option.
b. Advise Pushti Ltd. in selection of the alternatives whether it should remain with the same policy, adopt
factoring or go for new policy. The company has the policy to appraise the alternatives on the basis of cost to
sales ratio associated with various alternatives. Assume that the sales will remain at break-even level for
factoring option.
(Clearly state your assumptions.)
(7 + 6 = 13 marks) < Answer >
3. Goodwear Ltd. (GL), a Mumbai based textile manufacturer, following is the relevant information:
Sales turnover : Rs. 800 crore
Net profit margin : 12%
GL is contemplating to sale and lease back an asset purchased two years back by raising a term loan carrying an
interest rate of 15% p.a. The current book value of the asset is Rs.75 lakh and it still has an economic life of four
years. The asset can be depreciated for the calculation of Income Tax at the rate of 30% and is expected to have a
salvage value of Rs.15 lakh at the end of its economic life. The marginal tax rate of the firm is 35%. Its debt to
equity ratio is 0.7:1 and the cost of equity is 20%.
GL has approached Gujarat Leasing Ltd.(GLL) for a sale and lease back arrangement. GLL has agreed for the
same. The lease rentals are Rs.25 ptpm payable quarterly in arrears for a period of four years. The cost of capital
for GLL is 13% and it is in the tax bracket of 30%.
You are required to calculate the maximum purchase price of the asset which, GLL can pay and state whether the
sale price is acceptable to GL or not. Show all the relevant calculations.
(11 marks) < Answer >
4. Consider the following information with respect to MKS Projects Limited.
Particulars Rs.
Equity capital: 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
a. Calculate 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
point (a) above.
c. Calculate the change in wealth of a shareholder who owns 1000 shares in MKS Projects Limited.
i. If he sells his rights
ii. If he allows his rights to expire.
(2 + 2 + 2 = 6 marks) < Answer >
5. Franklin Venture Fund is a leading venture capital fund. The fund invests in untested projects; it also provides
mezzanine financing to the companies, which are planning public offering of their equity. The time horizon of all
the investments made by this fund is one year.
The fund has received an investment proposal from Windenergy Ltd. The company is an existing profit making
company involved in the non-conventional energy generation projects. The management of the company is at the
opinion that this sector has a huge growth potential and has very good prospects for profit. Therefore they propose
to increase its capacity by 50%. And they have furnished the fund requirement of Rs.75 crore to the finance
department of the company.
Following are the information furnished by the finance department of the Windenergy Ltd. for Franklin Venture
Fund:
The current EPS of the company is Rs.15
Growth in EPS (%) Probability
0 0.10
10 0.20
20 0.25
30 0.30
40 0.15

P/E Ratio Probability


11 0.25
12 0.30
15 0.35
18 0.10
The target return on any investment made by Franklin Venture Fund is 45%. The Fund has the policy to invest in
any proposal only if the probability of achieving the target return is 75%.
You are required to find the price at which Franklin Venture Fund should invest in the Windenergy Ltd.
(Clearly state your assumptions.)
(11 marks) < Answer >
END OF SECTION B

Section C : Applied Theory (20 Marks)


• This section consists of questions with serial number 6 - 7.
• Answer all questions.
• Marks are indicated against each question.
• Do not spend more than 25 -30 minutes on section C.

6. With the increase in the average purchasing power among the Urban Indians, demand for cars are increasing and
hence the car financing schemes. Many players are operating in this market and competition is increasing with
each passing day. Onus always is lying now on giving some attractive scheme to lure the customers. Can you
discuss some of the latest car financing schemes currently available in the Indian market?
(10 marks) < Answer >
7. With the ever increasing dynamism in the market, new and new instruments and mechanisms are coming into play
in the retail debt market in India. Discuss the broad trends in the retail debt markets in India and the different
investment products available for retail participation.
(10 marks) < Answer >
END OF SECTION C

END OF QUESTION PAPER

Suggested Answers
Investment Banking and Financial Services-I (261) : April
2006
Section A : Basic Concepts
1. Answer: (a) < TOP >

Reason: The following statements are true:


The purchaser of interest-only portion of the STRIP invests in the
security with a yield potential of high-coupon collateral.
The purchaser of principal-only portion of STRIP expects the
interest rates would continue fall and the borrower of the mortgage
loan would resort to large-scale prepayments.
Both interest-only security and principal-only security have large
impact associated with a small change in interest rates.
The return to the investors of Interest only security and Principal
only securities move in the opposite direction.
Hence (a) is the correct answer.
2. Answer: (e) < TOP >

Reason: A net lease, where the title of the asset passes to the lessee upon
exercising a purchase option or payment of guaranteed residual is
called open-ended lease.
Hence (e) is the correct answer.
3. Answer: (d) < TOP >

Reason: In India, under SEBI regulations ‘ venture capital undertaking’


means a domestic company
Whose shares are not listed on a recognized stock exchange.
Which is engaged in the business of providing services, production
or manufacture of article or things.
Whose activities do not include the activities of negative lists
provided by Central Government.
Hence (d) is the correct answer.
4. Answer: (d) < TOP >

Reason: The following are true with respect to differential shares:


The differential shares are a class of shares that carry varying
voting rights with fluctuating rates of dividend.
The issue of differential shares acts as a take over defense the
company.
Mostly, the companies utilize this route as a precautionary
measure and not as an aid to maximize the wealth of the
shareholders.
Hence (d) is the correct answer.
5. Answer: (a) < TOP >

Reason: Asian Dollar CDs carry both fixed and floating interest rates.
Hence (a) is the correct answer.
6. Answer: (c) < TOP >

Reason: If the investor of such securities choose to convert, he will have to


forgo all accrued and unpaid part of the interest. All other
statements are correct.
Hence (c) is the correct answer.
7. Answer: (c) < TOP >

Reason: A loan that can be extended after a pre-set period is called


Evergreen facility
Hence (c) is the correct answer.
8. Answer: (b) < TOP >

Reason: Following are the objectives of International Organization of


Security Commissions:
Cooperate and promote high standards of regulation in order to
maintain just, efficient and sound markets.
Exchange information on their respective experiences in order to
promote the development of domestic markets.
Provide mutual assistance to promote the integrity of the markets.
Hence (b) is the correct answer.
9. Answer: (b) < TOP >

Reason: The Takeover Code under SEBI’s regulatory preview is triggered


when the acquirer obtains 15% equity stake in a company.
Hence (b) is the correct answer.
10. Answer: (d) < TOP >

Reason: Default or insolvency of any agent of exporter or the collecting


bank is the risk which is not covered by ECGC.
Hence (d) is the correct answer.
11. Answer: (d) < TOP >

Reason: The company who wants to raise funds through IDR, has been
making profits for the last five years preceding to issue and has
been declaring dividend of not less than ten percent each year for
the said period.
Hence (d) is the correct answer.
12. Answer: (b) < TOP >

Reason: The private placement route is also available for the unlisted
companies. All other options are correct for private placement.
Hence (b) is the correct answer.
13. Answer: (d) < TOP >

Reason: A company which announces its bonus issue must implement the
proposal within a period of six months from the date of such
approval. All other statements are correct.
Hence (d) is the correct answer.
14. Answer: (c) < TOP >

Reason: Commercial Paper has the maximum maturity of one year.


Therefore the company cannot issue the CP for 15 months.
Hence (c) is the correct answer.
15. Answer : (c) < TOP >

Reason : Tier I capital = 250 × 0.0698 = 17.45


Tier II capital = 250 × 0.0466 = 11.65
Risk weighted assets = 250 × 0.7687 = 192.175
CAR = (17.45+11.65)/192.175
= 15.14%
16. Answer : (c) < TOP >

Reason : Advance provided 15.00 lakhs


Less: commission 0.375 lakhs
Rs.14.625 lakhs
Discount charge 0.600 lakhs
Effective rate per quarter : 0.60/14.625 = 4.10%
Annualized rate = [(1.041)4 – 1] × 100 = 17.44%.
Hence (c) is the correct answer.
17. Answer : (c) < TOP >

10, 00, 000


= Rs.14, 347
Reason : EMI = PVIFA 1%,120

Interest content in the first installment = 10,00,000


0.12
×
12 =Rs.10,000
Principal part = 14,347 – 10,000 = Rs.4347
18. Answer : (b) < TOP >

Reason : Leveraged lease has the third party attached, a lender , to it.
19. Answer : (d) < TOP >

Reason : Fixed asset turnover ratio = 2


2 = Sales/Fixed Assets
Let fixed assets be ‘x’
2 = 150/x
x = Rs.75 lakh
If the asset is bought , Fixed Assets = Rs.100 lakh
FA turnover = 150/100 = 1.5
20. Answer: (d) < TOP >

Reason: Define Im as the monthly rate of return implied by the cash flow
stream.
315.86 = 16 × PVIFA (Im,12) + [12 × PVIFA(Im,12)
× PVIF(Im,12)] +[ 8 × PVIFA(Im,6 ) × PVIF(Im,24)]
The equation is satisfied by Im = 1.5% (By trial and error)
Annualized return is :
I = (1+Im)12 –1
= (1.015)12 – 1
= 19.56%
Hence (d) is the correct answer.
21. Answer: (d) < TOP >

Reason: - A large upfront payment increases the break even rental.


- A higher tax relevant rate of depreciation decreases the break
even rental.
- A longer primary lease period decreases the break even rental.
- Higher cost of capital increases the break even rental.
- A higher net salvage value decreases the break even rental.
Hence (d) is the correct answer.
< TOP >
22. Answer: (b)
Reason: A fixed deposit with a NBFC cannot be withdrawn within 3
months from its acceptance. Subsequent to 3 month period deposit
is withdrawn after 12 months but before the date of maturity is
eligible for interest at the rate which is one percent point less than
the contracted date.
Therefore Mr. Shah will receive the interest @ of 11.5-1 = 10.5%.
Hence (b) is the correct answer.
< TOP >
23. Answer: (c)
Reason: Following are true for advance factoring:
Advance factoring does not alter the current ratio of the firm.
This arrangement does not result in the creation of current liability.
It simply rearranges the current assets by replacing receivables
with cash and factor dues.
Hence (c) is the correct answer.
24. Answer: (a) < TOP >

Reason: In Leveraged lease transaction, the leasing company invests in the


equipment by borrowing a large chunk of investment with full
recourse to the lessee and without any recourse to it.
Hence (a) is the correct answer.
25. Answer: (e) < TOP >

Reason: The finance company cannot borrow more than ten times its net
owned funds.
Hence (e) is the correct answer.
26. Answer: (b) < TOP >

Reason: Equipment delivery clause of the lessee agreement entitles the


lessor to terminate the agreement and be indemnified by the lessee
for all expenses incurred on account of the action of the lessee.
Hence (b) is the correct answer.
27. Answer: (a) < TOP >

Reason : The most prominent form of lending by REITs is the


construction/developmental lending. To retain their special tax
status, REITs have to distribute 95% of their income to
shareholders. There can be mortgage REITs. Indirect equity
investments in REITs by investor are highly liquid. REIT can be
infinite life trusts or finite life. Hence only (a) is true.
28. Answer : (c) < TOP >

Reason : By definition REPO – short for repurchase of securities. Following


are the features of REPO:
REPO is a combination of spot and forward transaction
In a REPO both cash and security get simultaneously exchanged
The forward leg of the transaction provides the fundamental basis
for determining the REPO-interest rate
REPO serves as a collateralized fixed-rate loan for a short period
REPO market can be used for hedging risks with an advantage
over the forward market.
Hence (c) is the correct answer.
29. Answer : (b) < TOP >

Reason: A bow tie is designed to protect both the borrower and the lender
against volatile interest rates.
30. Answer : (b) < TOP >

Reason : A fixed deposit with a NBFC cannot be withdrawn within 3


months from its acceptance.
Hence (b) is the correct answer.
Section B : Problems
1. I. Client wise total deposits with Priya Bank:
Maximum
Name of customer Total Deposits
insured amount
Mr. Vrajesh 90,000 90,000
Ms. Reshmi 69,500 69,500
Mr. Biswajit 2,20,000 1,00,000
Mr. Jignesh 95,000 95,000
Mr. Nishith 88,000 88,000
Mr. Raju 74,000 74,000
Mr. Amit 1,07,000 1,00,000
Mr. Vinod 1,00,000 1,00,000
Mr. Amar 72,500 72,500
Total 7,89,000
Therefore, the insurance premium paid by the bank = 7,89,000 × 0.0005
= Rs.394.5
II. Client wise total deposits with Divya Bank:
Name of customer Total Deposits Maximum insured amount
Mr. Vrajesh 1,18,000 1,00,000
Ms. Reshmi 88,000 88,000
Mr. Biswajit 75,300 75,300
Mr. Jignesh 79,000 79,000
Mr. Dhaval 25,4500 1,00,000
Mr. Hitesh 54,500 54,500
Mr. Dipen 80,500 80,500
Ms. Purvi 35,000 35,000
Mr. Narendra 72,500 72,500
Total 6,84,800
Therefore, the insurance premium paid by the bank = 6,84,800 × 0.0005
=Rs.342.40
III. The maximum amount that is insured at each bank is Rs.1,00,000.
Hence, the insured deposits of Mr. Vrajesh is
Priya Bank : 90,000
Divya Bank : 1,00,000
Total Rs.1,90,000 against the total deposits of Rs.2,08,000.
IV. The DICGC insures all deposits such as savings, fixed, current, recurring, etc. deposits except the following
types of deposits
(i) Deposits of foreign Governments
(ii) Deposits of Central/State Governments
(iii) Inter-bank deposits
(iv) Deposits of the State Land Development Banks with the State co-operative bank
(v) Any amount due on account of and deposit received outside India
(vi) Any amount, which has been specifically exempted by the corporation with the previous approval of
Reserve Bank of India.
< TOP >
2.
Cost of In-house Management
Sales prediction = 750 × 1.25 937.50
Average collection period = (0.75 × 30)+(0.20 × 45)+(0.05 × 60) 34.50 days
Cost of owned funds:
Pre-tax cost = 17.50/0.70 = 25%
Therefore,
Cost = 937.50 × (34.50/365) × 0.35 × 0.25 7.75
Cost of funds from PVS Finance Ltd:
937.5 × (34.50/365) × 0.35 × 0.20 6.20
Cost of funds from DPS Finance Ltd:
937.5 × (34.50/365) × 0.30 × 0.22 5.85
Administrative expenses 1.50
Bad debts = 937.5 × 0.015 14.06
Total cost 35.36
Alternative I.
Benefits associated with factoring:
Suppose, increase in the sales because of factoring service is ‘S’
Therefore the incremental contribution will be 0.35S.
The company will save the above mentioned costs if, it goes for factoring service.
Hence, the benefit is Rs. 35.36+0.35S lakh.
Cost associated with factoring:
New sales 937.5+S
Discount charge = (937.5+S) × (27/365) × 0.80 × 0.22 12.19+0.013S
Commission = (937.5+S) × 0.025 23.44+0.025S
Cost of own funds = (937.5+S) × (27/365) × 0.20 × 0.25 3.47+0.0037S
Total cost 39.10+0.0417S
Now, the minimum increase in the sales
39.10+0.0417S = 35.36+0.35S
S = Rs.12.13 lakh.
Therefore the minimum sales should be Rs.949.63 to make factoring option viable.
The total cost factoring = Rs.39.61 lakh.
Alternative II
In-house Management as per new credit term:
Discount = 937.50 × 0.25 × 0.02 4.69
Average collection period
= 0.25 × 10+0.75[0.75 × 30+0.20 × 45+0.05 × 60] 28.38 days
Cost of owned funds
937.50 × (28.38/365) × 0.35 × 0.25 6.37
Cost of funds from PVS Finance Ltd:
937.5 × (28.38/365) × 0.35 × 0.20 5.10
Cost of funds from DPS Finance Ltd:
937.5 × (28.38/365) × 0.33 × 0.22 4.81
Administrative expenses 2.00
Bad debts = 937.5 × 0.01 9.38
Total cost 32.35
Comparison among the alternatives on the basis of cost to sales:
In-house Management Factoring In-house Management with new credit term
35.36/937.50 39.61/949.63 32.35/937.50
=3.77% =4.17% =3.45%
Hence, the company is advised to go for In-house management with new credit term because it has the lowest cost
associated with it.
< TOP >
3. Let the sales price be Rs.x lakhs.
GLL (Lessor) point of view
A. Initial investment = Rs.x lakhs
B. PV of lease rentals = 0.025 × 12 × i/i4 × xPVIFA(13,4) = Rs.0.93xlakhs
C. PV of tax on LR = 0.025 × 12 × 2.9744x × 0.3 = Rs.0.27x lakhs
D. Depreciation tax shield:
(Rs. lakhs)
Year Depreciation PVIF @ 13% PV
1 22.5 0.8850 19.91
2 15.75 0.7831 12.33
3 11.03 0.6930 7.64
4 7.72 0.6133 4.73
44.62
PV of DTS = 44.62 × 0.3 = Rs.13.39 lakhs
E. PV of net salvage value = 15 PVIF(13,4)
= 15 × 0.6133 = Rs.9.20 lakhs
The sale price is the value of ‘x’ in the equation of net cash flow to lessor = 0
–A + B – C + D + E = 0
–x + 0.93x – 0.27x +13.39 + 9.20 = 0
x = Rs.66.44 lakh.
GL (Lessee) point of view
A. Let initial outflow be Rs.y lakhs
B. PV of LR payable = 0.025 × 12 × i/i4 × yPVIFA(15,4) = Rs.0.90y lakhs
COC = [15 × 0.65 × 0.7/1.7] + [20 × 1/1.7] = 15.78%
C. PV of tax shield on LR = 0.025 × 12 × yPVIFA(15.78,4) × 0.35 = Rs.0.30y lakh
D. PV of DTS:
(Rs. lakhs)
Year Depreciation PVIF @ 15.78% PV
1 22.5 0.8637 19.43
2 15.75 0.746 11.75
3 11.03 0.6443 7.10
4 7.72 0.5565 4.29
42.58
PV of DTS = 42.58 × 0.35 = Rs.14.90 lakhs.
E. According to Suggested Framework, the amount displaced is assumed to be equal to the PV of lease rentals.
Effective annual installment = 0.90y/2.855
= Rs.0.315y lakhs
(Rs. lakhs)
Principal Effective Annual Actual Adjusted
Year Loan o/s Interest
Content Rental Rental Interest
1 0.900y 0.135 y 0.180 y 0.315 y 0.300 y 0.120 y
2 0.720 y 0.108 y 0.207 y 0.315 y 0.300 y 0.093 y
3 0.513 y 0.077 y 0.238 y 0.315 y 0.300 y 0.062 y
4 0.275 y 0.041 y 0.274 y 0.315 y 0.300 y 0.026 y
PV of interest tax shield = [0.120 y PVIF(15.78,1) + 0.093 y PVIF(15.78,2) + 0.062 y PVIF(15.78,3) +
0.026 y PVIF(15.78,4)] × 0.35
= 0.2274y × 0.35
= Rs.0.08y lakhs

F. PV of net salvage value = 15 × 0.5565


= Rs.8.35 lakhs
The minimum acceptable price will be the value of ‘y’ in the equation NAL = 0
NAL = A– B + C – D – E – F
0 = y – 0.90y + 0.30y – 14.90 – 0.08y – 8.35
y = Rs.72.66 lakhs.
As the minimum acceptable price to GL is higher than the maximum payable by GLL, lease deal can not be
struck.
< TOP >
4. a. Market price per share = Rs.20
Earnings per share = Rs.4
Subscription price = 20% below the existing market price
= Rs.16
30, 00, 000
Number of right shares = 16
= 1,87,500
Rights ratio
Existing shares = 10,00,000
Number of additional equity shares proposed to be issued as rights shares = 1,87,500
3 rights shares for every 16 shares held.
Dilution in EPS:
EPS = Rs.4
PAT PAT
= 4=
EPS = 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
NP0 + S
= 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 × 20 ⎞ + 16
⎜ ⎟
⎝3 ⎠ = Rs.19.37 = Rs.19.37
⎛ 16 + 1⎞
⎜ ⎟
= ⎝3 ⎠
Market price 19.37
= = 5.47
P/E ratio = EPS 3.54
c. i. If a shareholder who owns 1000 shares sells his rights.
Market value of original shareholding @ Rs.20 = 1000 × 20 = 20,000

P0 − S
Value realized from the sale of rights R = N + 1

20 − 16
= 0.6315
⎛ 16 + 1⎞
⎜ ⎟
= ⎝ 3 ⎠
1000 × 0.6315 = 631.57
Post-rights market value of the holding 1000 × 19.37 = 19,370.00
20,001.57
ii.
If he allows his rights to expire
Current market value of the investment = 20,000
Market value after the rights issue @ 1,000 × 19.37 = 19,370
Change in Wealth = 630
< TOP >

5.

Growth in EPS Probability Probability Joint


EPS P/E Ratio Price
(%) EPS P/E Probability

0 15 11 165.00 0.1 0.25 0.025


0 15 12 180.00 0.1 0.3 0.03
0 15 15 225.00 0.1 0.35 0.035
0 15 18 270.00 0.1 0.1 0.01
10 16.5 11 181.50 0.2 0.25 0.05
10 16.5 12 198.00 0.2 0.3 0.06
10 16.5 15 247.50 0.2 0.35 0.07
10 16.5 18 297.00 0.2 0.1 0.02
20 16.8 11 184.80 0.25 0.25 0.0625
20 16.8 12 201.60 0.25 0.3 0.075
20 16.8 15 252.00 0.25 0.35 0.0875
20 16.8 18 302.40 0.25 0.1 0.025
30 19.5 11 214.50 0.3 0.25 0.075
30 19.5 12 234.00 0.3 0.3 0.09
30 19.5 15 292.50 0.3 0.35 0.105
30 19.5 18 351.00 0.3 0.1 0.03
40 21 11 231.00 0.15 0.25 0.0375
40 21 12 252.00 0.15 0.3 0.045
40 21 15 315.00 0.15 0.35 0.0525
40 21 18 378.00 0.15 0.1 0.015
4972.80
Average price 248.64

(Price –Avg. Price) (Price – Average Price)2 (Price – Average Price)2 × Prob.
2
-83.64 6995.65 174.89
-68.64 4711.45 141.34
-23.64 558.85 19.56
21.36 456.25 4.56
-67.14 4507.78 225.39
-50.64 2564.41 153.86
-1.14 1.30 0.09
48.36 2338.69 46.77
-63.84 4075.55 254.72
-47.04 2212.76 165.96
3.36 11.29 0.99
53.76 2890.14 72.25
-34.14 1165.54 87.42
-14.64 214.33 19.29
43.86 1923.70 201.99
102.36 10477.57 314.33
-17.64 311.17 11.67
3.36 11.29 0.51
66.36 4403.65 231.19
129.36 16734.01 251.01
2377.79
Standard deviation 48.76
The probability required to achieve the target return should be more than 75%.
Let ‘x’ be the divestment price
Value of Z should be – 0.67
x -μ
≥ − 0.67
Z= σ
x − 248.64
≥ − 0.67
48.76
x ≥ 215.97
Target return ≥ 45%
215.97 − P
≥ 0.45
i.e. P
P ≤148.94.
Hence, Franklin Venture Fund should invest at the rate of 148.94 per share.
< TOP >

Section C: Applied Theory


6. The different car schemes available are:
Margin Money Scheme: Margin Money scheme is the most popular of all car finance schemes. The finance
offered is based on the total value of the car. The amount financed can vary from 90% of the car value to 70%, as
per the financier's eligibility criteria. The balance amount has to be paid by the customer as margin amount or
down payment. Interest is charged only on the amount financed. The repayment of the loan is made by EMls at the
end of each month through post-dated cheques, which are collected at the time of signing the contract. Both, banks
and finance companies (NBFCs) offer this scheme.
One Advance Installment Scheme: This is a variation of the Margin Money scheme where the financier collects
an additional Installment in the form of the first month’s EMI along with the margin / down payment. The scheme
has become a standard scheme, with most financiers pushing it as their favorite. The balance EMls are paid at the
start of subsequent months through post-dated cheques.
Multiple Advance Installment Scheme: The financier finances the full amount, i.e.,100% of the car’s value. 3, 4,
5, 6 or even more EMIs are paid upfront (advance EMIs) depending upon the finance tenure. The balance EMIs
are paid at the start of subsequent months. The repayment ends earlier than the finance tenure, corresponding to
the number of installments that have been paid in advance.
Security Deposit Scheme: Under this scheme, you get 100% of the car’s value as the finance amount, on keeping
a security deposit with the financier. The security deposit may vary from 15% to 35% of the finance amount. The
security deposit earns an interest, simple or compound, throughout the finance tenure. One EMI is to be paid
initially and the balance EMIs are paid at the start of subsequent months by post-dated cheques. The security
deposit, along With this interest earned on the deposit, is refunded to the customer at the end of finance tenure.
Customized Schemes - Staggered Installments: Most financiers are offering savvy schemes to lure salaried
employees, who have more or less a structured career growth and can plan their cash flows well in advance. The
finance schemes are tailored to suit individual requirements. A yuppie executive can get a scheme that matches his
career path and increasing salary. Installments can be lower at the beginning and can gradually increase towards
the end of the finance tenure. Schemes are also possible for higher initial payments, which reduce in amount
towards the latter part of the finance tenure, thus decreasing the finance burden. The scheme is very suitable for
customers who have a lump sum amount in hand today, and who want a comfortable repayment pattern for the
future. The companies also keep bringing out new schemes and change existing schemes on a regular basis.
< TOP >

7. Traditionally, fixed deposits of companies used to be the biggest avenue for retail investors. Within this category,
it was the deposits of finance companies (NBFCs) which were most popular with investors and mobilizers alike -
with investors because of the higher interest rates offered (typically 1-2% higher and additional incentives like
gold coin etc.) and with mobilizers because of the high commissions. In South India, nidhi companies benefit and
chit funds were quite popular due to the high returns offered.
The last 3 years have been times of dramatic upheaval in the retail debt market. The key events relate to defaults
by many of the issuers especially the finance companies and the benefit companies. Prominent default cases
include the CRB group of companies, Lloyds Finance, and most recently the Kuber group of companies. The
market was also rocked by the US 64 problem when for a brief period of time investors were scared and
withdrawing money from the scheme.
The reasons for default by manufacturing companies are related to the overall decline in profitability due to
increased competition, dumping of imports, sharp fall in commodity prices and general slowdown in the economy.
The reasons for defaults in finance companies are related to their investments. Most NBFCs had invested in real
estate (either directly or builder financing), stock market, promoter funding and other illiquid investments. In
addition, they had invested in 100% depreciation leases (often fictitious sale and leaseback transactions) to obtain
tax shields. They witnessed widespread defaults in their lending portfolio, huge losses in investment portfolio and
often were disallowed tax shields by the income tax authorities. In the wake of credit problems, the RBI came
down heavily on these companies and investors stopped investing in their FD’s, which further aggravated their
liquidity crisis. Ironically, the loss of business and the losses they faced resulted in their so-called tax shield being
irrelevant.
All these resulted in a huge flight to safety. This can be seen from the increase in popularity of institutional bond
issues (i.e ICICI “Safety Bonds” and lOBI “Flexi Bonds”) and the sharp increase in the collection of Government
sponsored small savings schemes and postal schemes (In FY 99, small savings collections were about Rs.320bn as
against about Rs.91bn 5 years ago). While it is difficult to obtain data to support the feeling that nationalized
banks have also received larger amounts of money, empirical experience on the ground does point towards that
trend.
Despite the US 64 problem and the consequent loss of image suffered by UTI, it continued to' collect large
quantum of funds from retail investors. Many retail investors thought that the UTI was the lesser evil especially
after the Finance minister and a host of government officials came out openly in support of UTI.
Apart from UTI, private sector mutual funds also witnessed substantial increase in collections albeit from low
bases. We expect the prominence of mutual funds to increase due to the tax concessions given for mutual fund
investing in the Finance Bill for 1999.
It must be noted that there are few tradable instruments available for investment by retail investors. Most of the
available products are different kinds of schemes that are largely illiquid. The different investment products
available for retail participation are listed below:
• Products from banks
• Fixed/term deposits
• Recurring deposits
• Savings deposits
• Contributory and Voluntary provident fund
• Small savings schemes of government
• Public Provident Fund (PPF) scheme
• Tax free Relief Bonds
• Small savings schemes from Department of Posts
• National Savings Scheme (NSS)
• National Savings Certificates (NSC)
• Postal fixed deposits
• Indira Vikas Patra
• Kisan Vikas Patra
• Savings oriented life insurance schemes
• Company fixed deposits
• Bonds of development financial institutions
• Debentures of private sector companies
• Debentures of infrastructure companies
• Debentures of state government backed entities
• Unit Trust of India
• Unit Scheme 64 (US 64)
• Guaranteed return monthly income schemes
• Income/bond funds
• Other Mutual funds
• Guaranteed return monthly income schemes
• Income/bond funds
• Mutual benefit companies
• Nidhi companies
• Collective schemes (plantation/livestock etc.)
< TOP >

< TOP OF THE DOCUMENT >


Question Paper
Investment Banking and Financial Services-I (261): October 2006
Section A : Basic Concepts (30 Marks)
• This section consists of questions with serial number 1 - 30.
• Answer all questions.
• Each question carries one mark.
• Maximum time for answering Section A is 30 Minutes.

< Answer >


1. Which of the following is not a variable of Economic Risks for sovereign risk rating purpose?
(a) Resource endowments and degree of diversification
(b) Public sector fiscal balances
(c) Living standards, income and wealth distribution
(d) Public debt and interest burden
(e) Trends in price inflation.
A Moonshot is < Answer >
2.
(a) A stock that is favorite among the traders
(b) An IPO that makes disproportionately large gains in the stock price on the first day of trading
(c) A situation where the activity in a market is unusually low due to the anticipation of a crisis by the
investors
(d) A stock which has the largest market capitalization in the stock exchange on a particular day
(e) A stock whose bid price is equal to the ask price.
Which of the following risks is not covered by Export Credit and Guarantee Corporation (ECGC)? < Answer >
3.
(a) Insolvency of the buyer
(b) Cancellation of valid import license
(c) Causes inherent in the nature of the goods
(d) War, civil war, revolution or civil disturbances in the buyer’s country
(e) Failure of the buyer to make the payment within a specified period.
< Answer >
4. Which of the following is/are true with respect to detachable equity coupons/warrants?
I. Detachable equity coupons/warrants issued by the companies entitle the holder to buy a stated number of
equity shares of the issuing company at a stated price at any time during the initial defined period.
II. Detachable equity coupons/warrants can be issued with non-convertible debentures or with any other debt or
equity instruments.
III. The warrants attached to the instruments cannot be traded as individual securities.
(a) Only (I) above
(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
5. Which of the following is/are not true with respect to Multi-currency loans?
I. Multi-currency loans are loans denominated in one currency with an option to borrow in one or more other
currencies.
II. Multi-currency loans are being increasingly used as businesses attempt to take advantage of growing
economies.
III. Multi-currency loans are framed to eliminate currency risk.
(a) Only (II) above
(b) Only (III) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
6. Which of the following securities are eligible for Repo transaction?
I. Government of India bonds in demat form.
II. Treasury bills in demat form.
III. PSU bonds in demat form.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
7. Which of the following statements is/are true with respect to interest rate risk to the lenders?
I. In an administered rate scenario, the scope to manage this risk is very low.
II. Cost based pricing of the loan can protect the lenders against this risk.
III. Credit risk is invariably reflected in the interest rate risk.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) Both (I) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
8. Which of the following is not true for treasury bills?
(a) Treasury bills are raised to meet the short-term requirements of Government
(b) Treasury bills enable the RBI to perform open market operations
(c) Investors prefer treasury bills because of high liquidity and assured return
(d) Treasury bills are eligible for meeting CRR requirements
(e) Treasury bills are issued at discount and redeemed at par.
< Answer >
9. Which of the following is/are true with respect to switch deals?
I. Switch deals involve simultaneous purchasing and selling of different securities by a person.
II. This is used to change the composition of portfolio without significant costs.
III. Generally, this facility is used by the RBI to increase or decrease the money supply in the system.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) All (I), (II) and (III) above.
< Answer >
10. Which of the following defaults may be charged under Minor Defaults?
I. Publication of information in the advertisement and other printed matter that does not confirm with the
prospectus.
II. Violation of government regulations on advertisement on capital issue.
III. Non disclosure to SEBI of allocation of responsibilities to the lead manager before the opening of the issue.
IV. Investors grievances not handled properly.
(a) Only (I) above
(b) Only (III) above
(c) Both (I) and (II) above
(d) Both (III) and (IV) above
(e) (I), (II) and (IV) above.
< Answer >
11. Which of the following is/are true with respect to the guidelines for stock buy-back, issued by SEBI?
I. The company shall not issue any shares including by way of bonus shares till the date of closure of the offer
made under the stock repurchase program.
II. The company shall not withdraw the offer to buy-back after the draft letter of the offer is filed with the board.
III. The company can buy-back the locked-in shares and non-transferable shares by passing the resolution in board
meeting.
(a) Only (I) above
(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
12. Which of the following is not true for LYONS?
(a) This is a zero coupon bond, which is convertible into the common stock of the issuer
(b) The issuer gets the tax advantage even if he is not paying any interest till maturity
(c) If the investor of such securities choose to convert, he will get all accrued and unpaid part of the interest
(d) By issuing such an instrument, the company earns a lump sum in the initial period, for which it does not
have to meet immediate out flow of interest
(e) Issuance of this stock helps the issuer to take advantage of convertible debt without too much dilution of
common stock.
< Answer >
13. The insurance premium paid on the deposits accepted by the bank is to be paid by the banks at
(a) The end of January and July
(b) The end of March and September
(c) The end of April and October
(d) The end of May and November
(e) The end of June and December.
< Answer >
14. For public deposits the issuing company is required to maintain the liquid asset for the deposits maturing before
31st March next. The amount should be deposited or invested before 30th April. For this purpose
the permitted investment(s) is/are
I. Deposits held with any Indian bank, free from any lien.
II. Unencumbered securities of central or state government.
III. Unencumbered securities approved by Indian Trust Act,1882.
IV. Unencumbered bonds issued by HDFC.
(a) Only (II) above
(b) Only (III) above
(c) Both (II) and (IV) above
(d) (II), (III) and (IV) above
(e) All (I), (II), (III) and (IV) above.
< Answer >
15. The Executive Committee of International Organization of Security Commissions consist of
(a) 12 members
(b) 14 members
(c) 15 members
(d) 18 members
(e) 19 members.
< Answer >
16. Which of the following guideline(s) issued by the RBI is/are correct for bank participation in equipment leasing?
I. A commercial bank can undertake directly the business of equipment leasing and hire purchase.
II. The bank can also set up a subsidiary to transact the business of equipment leasing and hire purchase and such
other activities incidental thereto where, the bank must not hold less than 51% of the paid up share capital of
the subsidiary.
III. Investment of a bank in the share capital of its subsidiary company (engaged in equipment leasing) together
with the investment of the bank in the share capital of other companies carrying on the business of equipment
leasing cannot in the aggregate exceed 10% of its paid up share capital and reserves.
(a) Only (III) above
(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
17. A company has issued Pass Through Certificates (PTCs) backed by a pool of property receivables aggregating to
Rs.315.86 lakh. The equated monthly payment to be made to PTC holder are as follows:
During the first 12 months : Rs. 16 lakh p.m.
During the next 12 months : Rs. 12 lakh p.m.
During the next 6 months : Rs. 8 lakh p.m.
The promised rate of return to the investor is
(a) 18.56%
(b) 17.56%
(c) 16.56%
(d) 19.56%
(e) 20.56%.
< Answer >
18. Which of the following is a short-term loan extended at the time of completion of project to provide a bridge finance
until the developer can obtain financing of a more permanent nature?
(a) Gap loans
(b) Bow ties
(c) Direct joint ventures
(d) Direct development and syndication
(e) Mini-perms.
< Answer >
19. Mr. Prashant has the accumulated saving of Rs. 72,000 for five years with NHB. He requires a loan for a new
accommodation, which is of 842 square feet. What will be the maximum amount of loan disbursed to him under
Home Loan Account Scheme?
(a) Rs.72,000
(b) Rs.1,08,000
(c) Rs.1,44,000
(d) Rs.2,16,000
(e) Rs.2,88,000.
< Answer >
20. Which of the following is considered as an asset under Wealth Tax Act?
(a) Residential house for residential purpose or allotted by a company to its officers for residence whose gross
annual salary is less than Rs. 5,00,000 p.a.
(b) House held as stock-in-trade
(c) House used for own business or profession
(d) A let out house property for 100 days in the previous year
(e) A commercial complex.
< Answer >
21. A fixed deposit with an NBFC cannot be withdrawn within
(a) 2 months from its acceptance
(b) 3 months from its acceptance
(c) 4 months from its acceptance
(d) 6 months from its acceptance
(e) 9 months from its acceptance.
< Answer >
22. Which of the following is/are not true regarding the difference between venture capital and bought out deal?
I. Participation in management of VC undertaking is high in case of VCF where as it is low in case of bough out
deals.
II. Exit from the investments takes 7 to 10 years in case of venture capital, while in case of bough out deals exit is
done immediately after the expiry of lock in period.
III. Regulations on venture capital investments are very high as compared to bought out deals.
(a) Only (III) above
(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
23. Which of the following is/are not true for back-to-back short term lease contract?
I. Under this arrangement, a series of renewable leases are structured such that the total duration of short-term
leases equate to the maximum of economic life of the asset.
II. This arrangement has the characteristics of both the finance lease and operating lease.
III. Under this arrangement, each short-term lease is a cancelable lease.
(a) Only (III) above
(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
24. Under advance factoring arrangement India Factors Limited (IFL) has agreed to advance a sum of Rs. 15 lakh for 90
days against the receivables of XYZ Limited. The advance carries the interest rate of 16% p.a. compounded
quarterly and the factor commission is 2% of the value of factored receivables. Interest and commission are
collected upfront. Total receivables of the XYZ Limited are Rs.18,75,000.
What is the annualized cost of funds made available to XYZ Limited?
(a) 16.00%
(b) 16.75%
(c) 16.98%
(d) 17.75%
(e) 18.25%.
< Answer >
25. Every NBFC accepting fixed deposits has to maintain a set of registers in respect of all deposits. These registers
should be kept at the registered office of the company and should be maintained for next
(a) 5 calendar years following the financial year
(b) 7 calendar years following the financial year
(c) 8 calendar years following the financial year
(d) 10 calendar years following the financial year
(e) 12 calendar years following the financial year.
< Answer >
26. Expert Ltd. is a leasing company. Following are the relevant information for a lease transaction undertaken by it:
Lease rental receivable for the next five years : 2.25 cr.
Lease rental receivable over the lease term : 3.25 cr.
Cost of leased equipments : 2.75 cr.
Net owned funds : 11.00 cr.
The amount drawn as cash credit for this transaction from the bank is
(a) Rs.1.90 crore
(b) Rs.1.83 crore
(c) Rs.1.53 crore
(d) Rs.1.43 crore
(e) Rs.1.33 crore.
< Answer >
27. A net lease where the title of the asset passes to the lessee upon exercising a purchase option or payment of
guaranteed residual is called
(a) Sale and leaseback
(b) Close-ended lease
(c) Leveraged lease
(d) Cross-border lease
(e) Open-ended lease.
< Answer >
28. Which of the following are the salient features of a capital lease?
I. This lease is non-cancelable for a specified period usually referred to primary period.
II. This lease is fully amortized over the primary lease period.
III. In this lease, the lessor is responsible for repairs, maintenance and insurance of the asset.
IV. The risk of obsolescence is shifted from lessor to lessee.
(a) Both (I) and (III) above
(b) Both (II) and (III) above
(c) (I), (II) and (IV) above
(d) (II), (III) and (IV) above
(e) All (I), (II), (III), and (IV) above.
< Answer >
29. Following is the information pertaining to a lease transaction:
Initial cost : Rs.60 lakh
Lease quote : Rs.444/Rs.1,000 payable annually
PV of lease rentals : Rs.58.87 lakh
Lease term : 3 years
Cost of debt : 17%
Cost of capital : 12%
What will be the principal amount to be paid at the end of third year as per the displaced debt amortization schedule
in a lease?
(a) Rs.16.46 lakh
(b) Rs.19.46 lakh
(c) Rs.20.81 lakh
(d) Rs.22.78 lakh
(e) Rs.24.58 lakh.
< Answer >
30. Jain Financial Services Ltd. (JFSL) has recently structured a six year leveraged lease transaction involving an
investment cost of Rs.150 crore with itself as the equity participant and Syndicate Bank as the loan participant
funding the investment in the ratio of 1:4. The loan carries an effective rate of interest of 14% and is to be repaid in
the six equated annual installments. The gross yield of JFSL is 20% per annum. The amount of loan repayment to
Syndicate bank at the end of every year for such a lease transaction is
(a) Rs.34.83 crore
(b) Rs.35.41 crore
(c) Rs.30.86 crore
(d) Rs.34.55 crore
(e) Rs.35.86 crore.

END OF SECTION A
Section B : Problems (50 Marks)
• This section consists of questions with serial number 1 – 5.
• Answer all questions.
• Marks are indicated against each question.
• Detailed workings should form part of your answer.
• Do not spend more than 110 - 120 minutes on Section B.

< Answer >


1 Mr. Vrajesh, the finance manager of Excellent Financial Services Ltd., seeks your advice on how to
classify the prospective lessees into ‘good’ and ‘bad’ categories. He believes that the two most
important ratios helpful in discriminating between the ‘good’ and the ‘bad’ categories are
i. Current Ratio (CR)
ii. Return on Equity (RoE)
Mr. Vrajesh provides you with the following data relating to 12 accounts
Good customers Bad customers
Client Client
CR ROE (%) CR ROE (%)
number number
1 1.90 17 7 1.10 12
2 2.00 19 8 1.30 -2
3 1.80 22 9 1.20 10
4 2.30 25 10 1.70 9
5 2.10 12 11 1.50 8
6 1.90 13 12 1.00 11
You are required to determine the discriminant function that can be used for segregating the good and
bad categories.
(10 marks)
Mobilis Computech Ltd. (MCL), Bangalore, is planning to invest in some state of art equipments as a < Answer >
2
part of its expansion plan. The equipment will cost Rs.200 lakh exclusive of central or sales tax and will
have an economic life of five years. The company can purchase the equipment from a local vendor.
Given the huge amount of investment, the company is thinking of leasing the equipment from Shah
Financial Services (SFS) of Ahmedabad.
SFS uses the gross yield on investment as the basis of pricing its investments. The gross yield on five
year lease investment is 1.4% over the pre-tax cost of funds. The cost of debt and equity for SFS are 15
%( pre-tax) and 21% respectively. The company maintains the debt to equity ratio of 3:1. The marginal
tax rate applicable to the company is 35% and the applicable surcharge is 10%. Applicable sales tax is
10%. SFS collects 1% of investment cost as front ended management fees and incurs 0.5% as initial
direct cost. The applicable rate of depreciation for the equipment is 22%. Expected salvage value of the
equipment at the end of fifth year will be 5% of the cost of equipment. The finance manager of MCL has
asked you to calculate
a. The lease rental payable to SFS in arrears for the first year if the rentals are stepped up by 10% per
annum, so that it will meet the gross yield requirement.
b. The viability of leasing option if, MCL has the post-tax required return of 18% and cost of debt is
15%. The company is under the tax bracket of 30%. (Use BHW model).
(4 + 6 = 10 marks)

< Answer >


3 On September 30, 2006 Arvee Denim has come out with an issue of 12% partially convertible debenture
of Rs.100 each at par to finance its acquisition plan with an expected amount of Rs.10 crore. The
convertible part of the debenture (Part A) of Rs.50 will be converted into 1 equity shares of Rs.10 each
at a premium of Rs.40 each after 36 months from the date of allotment. The non-convertible portion of
debenture (Part B) of Rs.50 will be redeemed after 6 years. Interest will be paid semi-annually.
Additional information and projections are as follows:
March March March March March
Year (ending)
2005 2006 2007 2008 2009
EPS 2.00 2.45 3.10 4.68 5.30
Bonus 2:7 2:7

Month (2009) April May June July August September October November

Average P/E
ratio (expected) 10.23 10.45 10.10 10.54 11.63 12.00 11.49 11.21

Dynamic Finance Limited (DFL) is planning to subscribe to the issue to deploy its cash surplus. As
finance officer of DFL you are required to advise DFL whether to subscribe to the above issue or not.
The required rate of return of DFL is 18% p.a. compounded semi-annually.
(For the purpose of calculation of P/E, the average of the ratio for 6 months prior to the conversion date
shall apply)
(8 marks)
< Answer >
4 Software industry is at boom in India. Considering this a young group has decided to expand their
company to an IT park namely ‘Softscience City Pvt. Ltd’. The estimated cost of the full project will be
Rs.25 crore. This investment will be required at the beginning of the financial year 2007-08.The group is
able to invest Rs.12.5 crore as equity in the project. The equity will have the face value of Rs.10 each.
For the remaining portion of investment they have proposed IDFC Private Equity Ltd. The group has
given two investment options to IDFC Private Equity Ltd.
i. Straight equity investment.
ii. Fully convertible Debentures. These debentures will carry the coupon rate of 15% and will have
the share of 10% of the profit before taxes until they are converted. These debentures will be
converted into equity at the end of 4 years at the P/E multiple of 10 on the average earning per
share of the first four years. If there is any loss in any year, that negative earnings and that year,
both will be excluded for averaging.
Considering above two options IDFC Private Equity Ltd. has shown its interest for investment with the
time horizon of 6 years. It is expected that IDFC Private Equity Ltd. will exit at the trailing P/E of 14
through the route of IPO.
The company proposes to maintain a dividend payout ratio of 10% for all 6 years.
The expected EBIT for the company is as follows:

Probability 0.2 0.6 0.2


Year Amount (Rs. in crore)
2007-08 1.00 1.25 1.50
2008-09 2.25 2.75 3.00
2009-10 5.00 6.00 7.00
2010-11 8.25 9.25 10.00
2011-12 12.50 14.00 15.25
2012 -13 16.00 16.50 17.00
Recently the Finance Minister of India has declared that after the financial year 2008-09 IT parks will
not be given any tax benefits and after that the company will fall under the tax bracket of 30%.Currently
the company is not required to pay any taxes.
Being the financial analyst of IDFC Private Equity Ltd. you are required to select the investment
option, if the IDFC Private Equity Ltd. has the required rate of return of 30%.
(14 marks)
< Answer >
5 During past one year, following companies came out with IPOs. The initial offer price and Current
Market Price (CMP) of one share and number of shares offered by these companies are given below:
Offer No. of shares Value of
CMP
Company price offered index at the
(in Rs.)
(in Rs.) (in lakh) time of offer
Prime Focus Ltd. 417 284.00 100.00 3177.50
Deccan Aviation Ltd. 148 83.20 245.46 3388.90
Unity Infraprojects Ltd. 675 432.50 34.43 3246.90
Gangotri textile Ltd. 41 36.35 134.00 3388.90
Patel Engineering Ltd. 440 308.45 106.00 3634.25
RPL 60 63.55 4500.00 3345.50
Lokesh Machines Ltd. 140 138.25 30.00 3454.80
Opto Circuit Ltd. 270 352.95 40.00 3402.55
Inox Leisure Ltd. 120 132.00 165.00 2982.75
BOB Ltd. 230 194.30 710.00 2833.10
Punj Lloyd Ltd. 700 718.00 91.72 2812.30
PVR Cinema Ltd. 225 231.00 74.00 2706.70
Triveni Engineering Ltd. 48 73.15 500.00 2620.05
H T Media Ltd. 530 391.30 69.95 2367.80
Yes Bank Ltd. 45 78.00 700.00 2254.50
The current value of index is 3050.30. You are required to calculate the wealth relative and comment
on the same.
(8 marks)
END OF SECTION B

Section C : Applied Theory (20 Marks)


• This section consists of questions with serial number 6 - 7.
• Answer all questions.
• Marks are indicated against each question.
• Do not spend more than 25 -30 minutes on section C.

State government ratings include those in the public domain such as ratings of state government < Answer >
6
guaranteed borrowings by State Electricity Boards, Irrigation Corporations and Road
Development Corporations and one time credit assessments undertaken at the specific request of
investors and entrepreneurs setting up infrastructure projects in different states. With more state
governments accessing the debt market for infrastructure and treasury requirements credit rating
has become an important consideration in lending and investment decisions. Being a financial
analyst which factors will you consider to rate the State Governments?
(10 marks)
Information Technology (IT) plays vital role in the development of the financial service industry. < Answer >
7
Explain how IT is helpful to the financial service industry and also discuss the key IT challenges
faced by the financial services industry today?
(10 marks)
END OF SECTION C

END OF QUESTION PAPER

Suggested Answers
Investment Banking and Financial Services-I (261): October
2006
Section A : Basic Concepts
1. Answer : (c) < TOP >

Reason : Following are the variables of Economic Risks for sovereign risk rating purposes:
• Resource endowments, degree of diversification
• Public sector fiscal balances
• Public debt and interest burden
• Trends in price inflation.
Living standards, income and wealth distribution is a variable of Political Risk for sovereign risk rating
purposes. Hence (c) is the correct answer.
2. Answer : (b) < TOP >

Reason : Moonshot is the term used to describe a situation where the IPO makes disproportionately large gains
in the stock price on the first day of trading. The price of the IPO skyrockets over double or triple in
value on the first day of its trading. The term is also used to describe any stock that makes incredibly
large price leaps during the trading session. In the context of the question, (b) is the correct answer.
3. Answer: (c) < TOP >

Reason: Risks arising due to causes inherent in the nature of the goods are not covered by ECGC. All other
risks are covered by ECGC. Hence (c) is the answer.

4. Answer: (b) < TOP >

Reason: The warrants attached to the instruments can be traded freely as individual security.
Hence (b) is the correct answer.
5. Answer: (b) < TOP >

Reason: Certain currency risks are inherent in the multi-currency loans. Multi-currency loans to some
extent represent a natural expansion of Euro dollar loans.
Hence (b) is the correct answer.
6. Answer: (e) < TOP >

Reason: All the mentioned securities are eligible for Repo transaction. Hence (e) is the correct answer.
7. Answer: (d) < TOP >

Reason : In an administered rate scenario, the scope to manage this risk is very low as regulator fixes the interest
rates leaving little to manage. Hence (I) is true. Cost based pricing of the loan cannot protect the
lenders against this risk since in the increasing rate scenario, the cost of loans tend to go up. Hence (II)
is not true. Credit risk is invariably reflected in the interest rate risk as in an increasing rate scenario;
the default rate tends to go up. Hence (III) is also true. Therefore (d) is the correct answer.
8. Answer: (d) < TOP >

Reason: Treasury bills are eligible for SLR. All other options are correct.
Hence (d) is the correct answer.
9. Answer : (d) < TOP >

Reason: Switch deals do not have any impact on the money supply. Hence statement III is incorrect and (d) is
the correct answer.
10. Answer : (e) < TOP >

Reason: Non disclosure to SEBI of allocation of responsibilities to the lead manager before the opening of the
issue is a general default. All other statements are correct for minor defaults.
Hence (e) is the correct answer.
11. Answer : (b) < TOP >

Reason: The company shall not buy-back the locked-in shares and non-transferable shares till the shares
become transferable as per SEBI guideline. All other statements are correct.
Hence (b) is the correct answer.
12. Answer : (c) < TOP >

Reason: If the investor of such securities choose to convert, he will have to forgo all accrued and unpaid part of
the interest. All other statements are correct.
Hence (c) is the correct answer.
13. Answer : (e) < TOP >

Reason: The premium paid on the deposits accepted by the bank is to paid by the banks at the end of June and
December.
Hence (e) is the correct answer.
14. Answer : (d) < TOP >

Reason: For public deposits the issuing company is required to maintain the liquid asset for the deposits
maturing before 31st March next. The amount should be deposited or invested before 30th April. For
this purpose the permitted investment are
Deposits held with a schedule bank, free from any lien.
Unencumbered securities of central or state government.
Unencumbered securities approved by Indian trust act.
Unencumbered bonds issued by HDFC.
Hence (d) is the correct answer.
15. Answer: (e) < TOP >

Reason: The Executive Committee of International Organization of Security Commissions consists of 19


members.
Hence (e) is the correct answer.
16. Answer : (e) < TOP >

Reason: All the statements regarding bank participation in equipment leasing are correct.
Hence (e) is the correct answer.
17. Answer : (d) < TOP >

Reason: Define Im as the monthly rate of return implied by the cash flow stream.
315.86 = 16*PVIFA (Im,12) + [12 * PVIFA(Im,12) *PVIF(Im,12)] +[ 8 * PVIFA(Im,6 )
*PVIF(Im,24)]
The equation is satisfied by Im = 1.5% (By trial and error)
Annualized return is :
I = (1+Im)12 –1
= (1.015)12 – 1
= 19.56%
Hence (d) is the correct answer.
18. Answer : (e) < TOP >

Reason: Mini-perms is a short-term loan extended at the time of completion of project to provide a bridge
finance until the developer can obtain financing of a more permanent nature.
Hence (e) is the correct answer.
19. Answer : (d) < TOP >

Reason: Under Home loan account scheme the maximum amount of loan that can be disbursed is as follows:
Built up area Maximum amount of loan
Up to 430 sq. ft four times of amount saved
Up to 860 sq. ft three times of amount saved
Exceeding 860 sq. ft two times of amount saved
Therefore loan to Mr. P = 72000 * 3
= Rs. 2,16,000.
Hence (d) is the correct answer.
20. Answer : (d) < TOP >

Reason: A let out hose property for a minimum of 300 days in the previous year is not considered as an asset
under Wealth Tax Act. Therefore a let out house property for 100 days in the previous year is
considered as an asset.
Hence (d) is the correct answer.
21. Answer : (b) < TOP >

Reason: A fixed deposit with a NBFC cannot be withdrawn within 3 months from its acceptance.
Hence (b) is the correct answer.
< TOP >
22. Answer : (a)
Reason: Regulations on venture capital investments are low as compared to bought out deals. All other
differences are correct.
Hence (a) is the correct answer.
< TOP >
23. Answer : (a)
Reason: This arrangement resembles a finance lease in the sense that each short-term lease is a non-cancelable
lease. Hence statement III is wrong and alternative (a) is the answer.
24. Answer : (e) < TOP >

Reason:
Rs. lakhs
Advance provided 15.000
Less: Commission 0.375
14.625
Less: Discount charge 0.600
Funds made available 14.025
Effective rate per quarter : 0.6/14.025 = 4.28%
Annualized rate = [(1.0428)4 – 1] * 100 = 18.25%.
Hence (e) is the correct answer.
25. Answer : (c) < TOP >

Reason: Every NBFC accepting fixed deposits has to maintain a set of registers in respect of all deposits. These
registers should be kept at the registered office of the company and should be maintained for next 8
calendar years following the financial year.
26. Answer : (d) < TOP >

Reason: 0.75*[LR(5) / LR(T)] * C


=0.75* 2.25/3.25 * 2.75
= Rs.1.43 cr
Hence (d) is the correct answer.
27. Answer : (e) < TOP >

Reason: A net lease, where the title of the asset passes to the lessee upon exercising a purchase option or
payment of guaranteed residual is called open-ended lease.
Hence (e) is the correct answer.
28. Answer : (c) < TOP >

Reason: Capital lease is also known as finance lease. The salient features are as follows:
These lease is non-cancelable for a specified period usually referred as primary period.
This lease is fully amortized over the primary lease period.
In this lease, the lessee is responsible for repairs, maintenance and insurance of the asset.
The risk of obsolescence is shifted from lessor to lessee.
Hence (c) is the correct answer.
29. Answer : (d) < TOP >

(Rs. lakhs)
Year Loan o/s in the beginning Interest content Capital content Rental
1 58.87 10.01 16.63 26.64
2 42.24 7.18 19.46 26.64
3 22.78 3.87 22.78 26.64
Hence (d) is the correct answer.
30. Answer : (c) < TOP >

Reason : Loan amount = 0.8×150 = 120 crore


Equity contribution = 30 crore
120
= Rs.30.86 crore
Equated annual installment = PVIFA(14%, 6) .
Hence (c) is the correct answer.
Section B : Problems
1. Let the following notations be used : < TOP >
X : Current ratio
Y : RoE
The discriminant function is :
Zi = a Xi + bYi
Client No. Xi Yi (Xi - X ) (Yi - Y ) (Xi - X )2 (Yi - Y )2 (Xi - X ) (Yi - Y )
1 1.90 17 0.25 4 0.0625 16 1
2 2.00 19 0.35 6 0.1225 36 2.1
3 1.80 22 0.15 9 0.0225 81 1.35
4 2.30 25 0.65 12 0.4225 144 7.8
5 2.10 12 0.45 -1 0.2025 1 -0.45
6 1.90 13 0.25 0 0.0625 0 0
7 1.10 12 -0.55 -1 0.3025 1 0.55
8 1.30 -2 -0.35 -15 0.1225 225 5.25
9 1.20 10 -0.45 -3 0.2025 9 1.35
10 1.70 9 0.05 -4 0.0025 16 -0.20
11 1.50 8 -0.15 -5 0.0225 25 0.75
12 1.00 11 -0.65 -2 0.4225 4 1.30
19.8 156 1.97 558 20.80

∑X i
=
19.8 ∑Y i
=
156
X = n 12 = 1.65 Y = n 12 = 13

∑X 1
=
12 ∑Y 1
=
108
X1 = n1 6 = 2.00 Y1 = n1 6 = 18

∑X 2
=
7.8 ∑Y 2
=
48
X2 = n2 6 = 1.30 Y2 = n2 6 =8

dx = X1 − X 2 = 0.70 dy = Y1 − Y2 = 10
1 1
σ X 2 = n −1
∑ ( Xi −X)2 = 11 x1.97 = 0.1791
1 1
σ Y 2 = n −1
∑ ( Yi − Y)2 = 11 x 558 = 50.727
1 1
σ XY
∑ (X i − X) (Yi Y ) = x 20.80 = 1.891
= n −1 11

σ Y 2 .d x − σ XY .d Y (50.727 x 0.70) − (1.891x10) 16.5989


= =
a = σ X
2
. σ Y
2
− σ XY
2
(0.1791 x 50.727) − (1.891) 2
5.509 = 3.013

σ X 2 .d Y − σ XY .d X (0.1791x10) − (1.891x 0.70) 0.4673


= = = 0.085
b = σ X
2
. σ Y
2
− σ XY
2
(0.1791 x 50.727) − (1.891) 2
5.5093
∴ The discriminant function is:
Zi = 3.013 Xi + 0.085Yi.
< TOP >
2. a. Required gross yield = Pre-tax cost of funds + 1.4%
Pre-tax cost of debt = 15%
Cost of equity = 21%
Applicable tax rate = 0.35(1.10) = 0.385
1 3
× 21 +
× 15(1 − 0.385)
Marginal cost of capital = 4 4 = 12.17%
Pre-tax cost of capital = 12.17/ (1-0.385) = 19.79%
Required gross yield = 19.79 + 1.4 = 21.19%
Assuming an investment of Rs.1000,
Management fees 0.01(1000) = Rs.10
Initial direct cost 0.005(1000) = Rs.5
If the lease rental receivable in the first year is given as ‘x’ and it is stepped up by 10% each year, the rentals to be
charged for 5 year period will be,
10 + xPVIF( 21.19,1) + 1.1xPVIF( 21.19,2) + (1.1) xPVIF( 21.19,3) + (1.1) xPVIF( 21.19,4) + (1.1) xPVIF( 21.19,5)
2 3 4

=1005
10+3.43x = 1005
x = Rs.290 (approximately)
b. In case of a lease, sales tax of 10% will be applicable. Hence the value of the equipment will be Rs 200(1.10) =
Rs.220.
Using BHW model
FA(L) = PV of loan payments – PV of lease payment
PV of loan payments = Rs.220
PV of lease payments =
63.8PVIF(15,1) + 70.18PVIF(15,2 ) + 77.20PVIF(15,3) + 84.92PVIF(15, 4 ) + 93.41PVIF(15,5 )
=Rs.254.29 lakh
PV of management fees = 220(0.01) = Rs.2.2 lakh
Hence FA(L) = 220-254.29-2.2 = (-) Rs.36.49
OA(L) = PV of lease related tax shields – PV of loan related tax shields – PV of residual value
PV of lease rentals
Year Lease Rentals PV @18%
1 63.80 54.07
2 70.18 50.40
3 77.20 46.99
4 84.92 43.80
5 93.41 40.83
Total 236.09
PV of tax shield on lease rentals = 236.09(0.3)
= Rs.70.83 lakh

Debt service charge = 220 = Rs.65.63 lakh


PVIFA (15,5)
Repayment schedule
Year Loan outstanding Debt service charge Interest content Capital content
1 220 65.63 33.00 32.63
2 187.37 65.63 28.11 37.52
3 149.85 65.63 22.48 43.15
4 106.69 65.63 16.00 49.63
5 57.07 65.63 8.56 57.07
PV of loan related tax shield
Year Interest content Depreciation Tax shield PV
1 33.00 48.40 24.42 20.69
2 28.11 37.75 19.76 14.19
3 22.48 29.45 15.58 9.48
4 16.00 22.97 11.69 6.03
5 8.56 17.92 7.94 3.47
Total 53.86
PV of residual value = 220(0.05)/(1.18)5 = Rs.4.81 lakh
OA(L) = 70.83 – 53.86 – 4.81
= Rs.12.16lakh
Now, FA(L) +OA(L) = -36.49 +12.16
= (-)Rs24.33 lakh
Hence, lease option should be rejected.
< TOP >
3. a. PV of interest payments
6 PVIFA (9%,6) + 3PVIFA(9%,6) PVIF(9%,6) = Rs.34.94
b. Bonus adjusted EPS
Year (ending) March March March March March
2005 2006 2007 2008 2009
EPS 2.00 2.45 3.10 6.02 8.76
4
Rate of growth implicit = 2.00(1+g) = 8.76, g = 44.67%
Projected EPS in September 2009
= 8.76(1+0.4476/2) =Rs.10.72
Average P/E ratio between April.2009 and September 2009
= (10.23+10.45+10.10+10.54+11.63+12)/6 = 10.825
Therefore projected market price of share after 36 months = 10.72 ×10.825 = Rs.116.04
PV of this market price = 116.04 × PVIF (9%,6) = Rs.69.19
c. PV of non-convertible portion redeemed after 7 years
= 50PVIF (9%, 12) = Rs.17.78
Intrinsic worth of the share = (A) + (B) + (C) = 34.94+69.19+17.78= Rs.121.91
DFL should invest, as intrinsic worth is more than the issue price.
< TOP >
4. The expected EBIT for the next six years is as follows
(Rs. crore)
2007-08 1.25
2008-09 2.70
2009-10 6.00
2010-11 9.20
2011-12 13.95
2012 -13 16.50
a. Straight equity investment of Rs.12.5 crore
(Rs. in lakh)
EBIT EAT Dividend inflow to IDFC
2007-08 125 125.0 6.25
2008-09 270 270.0 13.50
2009-10 600 420.0 21.00
2010-11 920 644.0 32.20
2011-12 1395 976.5 48.83
2012 -13 1650 1155 57.75
EPS for the 6th year
=1155/250
=4.62
Hence the per share inflow from IPO will be Rs.64.68
The NPV of the equity investment by IDFC
(Rs. in lakh)
Cash flow PV @ 30%
Initial Outflow (1250) (1250)
2007-08 6.25 4.81
2008-09 13.50 7.99
2009-10 21.00 9.56
2010-11 32.20 11.27
2011-12 48.83 13.15
2012 -13 57.75 11.96
Inflow through IPO 8085.00 1675.02
NPV 483.76
b. Investment in FCD by IDFC
Debentures are converted after 4 years therefore EPS for 4 years will be
Year EBIT Interest EBT 10% contribution Tax EAT EPS
2007-08 125 187.5 (62.5) – – – –
2008-09 270 187.5 82.5 8.25 – 74.25 0.594
2009-10 600 187.5 412.5 41.25 111.37 259.88 2.079
2010-11 920 187.5 732.5 73.25 197.78 461.47 3.692
Conversion price of FCD at the end of 4 years is calculated as follows:
Average EPS for first 4 years = (0.594+2.079+3.692)/3 = 2.12
Conversion price of FCD = 2.12* 10 = Rs.21.22
No. shares to be issued = 58.906or 59 lakh shares
Now, the EPS at the end of 6th year = 1155/(125+59)=6.28
Therefore the per share inflow from IPO will be Rs.87.92
The NPV of the debt investment by IDFC is calculated as follows:
Cash flow Cash flow through Cash flow Total PV @
through participation through inflow 30%
interest in EBT dividend
Initial – – – (1250) (1250)
Outflow
2007-08 187.50 – – 187.50 144.23
2008-09 187.50 8.25 – 195.75 115.83
2009-10 187.50 41.25 – 228.75 104.12
2010-11 187.50 73.25 – 260.75 91.30
2011-12 – – 31.33 31.33 8.44
2012 -13 – – 37.05 37.05 7.68
Inflow – – – 5187.28 1074.68
through IPO
NPV 296.28
As the NPV from the option of equity investment is higher than the option of FCDs, IDFC Private Equity should
invest in the option of equity investment.
< TOP >
5. To calculate the wealth relative we have to find the returns on the IPOs for the past one year and return on the market
index as follows:
Offer No. of shares Value of index at Return on
Company CMP Returns
price offered in lakh the time of offer index
Prime Focus Ltd 417 284 100 3177.5 -31.89 -4.00
Deccan Aviation 148 83.2 245.46 3388.9 -43.78 -9.99
Ltd.
Unity 675 432.5 34.43 3246.9 -35.93 -6.06
Infraprojects Ltd.
Gangotri textile 41 36.35 134 3388.9 -11.34 -9.99
Ltd.
Patel Engineering 440 308.45 106 3634.25 -29.90 -16.07
Ltd.
RPL 60 63.55 4500 3345.5 5.92 -8.82
Lokesh Machines 140 138.25 30 3454.8 -1.25 -11.71
Ltd.
Opto Circuit Ltd. 270 352.95 40 3402.55 30.72 -10.35
Inox Leisure Ltd. 120 132 165 2982.75 10.00 2.26
BOB Ltd. 230 194.3 710 2833.1 -15.52 7.67
Punj Lloyd Ltd. 700 718 91.72 2812.3 2.57 8.46
PVR Cinema Ltd. 225 231 74 2706.7 2.67 12.69
Triveni 48 73.15 500 2620.05 52.40 16.42
Engineering Ltd.
H T Media Ltd. 530 391.3 69.95 2367.8 -26.17 28.82
Yes Bank Ltd 45 78 700 2254.5 73.33 35.30
Total -18.18 34.64
n

1 + 1/ N ∑ rit
i =1
n

1 + 1/ N ∑ rmt
Wealth realtive can found out by the formulae = i =1

Where N = number of IPO in the sample


rit = Returns on the IPO
rmt = Returns on the market
1 + 1 / 15 ( −18.18)

= 1 + 1 / 15 (34.64) = -0.064. Wealth relative is less than 1. Hence IPOs have underperformed the market.

Section C: Applied Theory


< TOP >
6. We can assess the credit quality of the state government on the basis of following factors:
Economic Risk
The overall objective of Economic Risk Assessment is to provide a means of evaluating a state’s economic
strength and weakness. In general terms, where its strength outweighs its weakness it will present low economic
risk and where its weakness outweighs its strength it will present relatively higher economic risk.
Economic Structure
A state’s economic structure is of fundamental importance to its financial strength, debt carrying capacity and
future prospects. Key factors:
• Economic and Social Infrastructure
• Per Capita Income
• Natural Resource Endowments
• Employment Growth & Quality of Workforce
• Economic Policies
Demographics & Social Infrastructure
Traditional demographic indicators such as per-capita income, poverty levels, degree of urbanization, literacy
rates, vital-statistics, employment rate etc. are very important to be analyzed.
Economic Infrastructure
Infrastructure availability examined includes the following:
• Power
• Irrigation
• Transport
• Communication
Industrialization
The level of industrial activity and their nature have significant impact on the economic development of a state.
For instance primary industrial activity such as mining and metals are particularly susceptible to economic
downturns as compared to high technology industries, which offer more value-added products.
Banking
The availability of good banking infrastructure enables the growth of savings and investment within the state
and the availability of credit to facilitate economic activity.
Agriculture
Agriculture is important as it lays the foundation for secondary and tertiary sector growth and is therefore an
active determinant of tax revenues and future economic potential.
• Crops Cultivated
• Cropped and Irrigated areas
• Usage of farm inputs
• Productivity indicators
Political Risk
The objective of political risk assessment is to provide a means of evaluating the political stability of state
governments on a comparable basis. And it has a catalytic impact on the state’s economic development.
Financial Risk
State Government Finances
Here we should analyze Revenue Performance, Expenditure Management, Dependency of Revenues,
Dependence on External Resources, Deficit Position, Debt Profile including guarantees issued and other
contingent liabilities, and Performance of state PSEs and SPV’s promoted by the state government.
Revenue Performance
Typically, revenue sources may be classified under four heads:
• Own tax revenue
• Own non-tax revenue
• Share in the divisible pool of central taxes
• Grants from the centre
Expenditure Management
Here we would be concerned about proper targeting of subsidies, collection of correct user charges on non-merit
subsidies, mechanisms in place to identify wasteful expenditure, willingness shown by the government in
controlling or weeding out wasteful expenditure and commitment shown by the government to stay within the
budgeted expenditure.
Revenue Deficit
Well managed state governments are those that not only are in a position to meet their revenue expenditure from
their revenue receipts but also generate a revenue surplus to meet capital expenditure. Capital expenditure
creates assets such as infrastructure that enhance future revenue generation potential of the state government by
encouraging economic activity.
Other factors which are to be considered are
• Debt Profile
• Liquidity Support
• Performance of State Public Sector Enterprises
7. The financial services sector today is characterized by globalization, consolidation and convergence. In this < TOP >
scenario, technology is a major driving force for achieving competitive advantage through cost reductions and
creation of new business opportunities. Technology is creating more efficient enterprises, enabling new ways of
reaching customers through new delivery channels and smoothly links once-disparate business practices.
The key IT challenges faced by the Financial Services industry today are:
• Preserving investments in old systems while leveraging new technologies to drive down transactions
costs, expand and improve customer service
• Integrating enterprise wide disparate systems to gain operational efficiencies
• Substantially reducing time for deployment of new systems
• Reducing IT costs and obtaining better ROIs for new investments in the long-term
• Straight Through Processing
While the technological possibilities of IT may be unlimited, their applications and adoption in India need a
conscious approach towards Business Process Reengineering of existing practices and procedures to take the
fullest advantage of IT. Continuous training & skill upgradation of human resources assume critical importance
towards absorption of new technologies.
The elimination of manual records, the introduction of electronic fund transfer, ATMs etc. raise the important
issue of security and integrity of data. This includes issues relating to confidentiality of information, preventing
data corruption and prevention of fraud. Appropriate technologies for encryption of data for secured transaction,
regular & multiple backups, extensive use of passwords and other forms of authorization would need to be
adopted.
For paperless and electronic financial transactions in India, a host of legal aspects need to be looked into. As in
case of EFT, a cheque is not required to be presented physically for making payment as per the current practice.
Also the legal liabilities of banks and customers in case of loss of ATM cards, ATM frauds etc. are not quite
understood in the present system. The adoption of new technologies would warrant a thorough review of the
system towards changed legal stipulations.
Finally, the most important aspect of costs involved and benefits expected need a closer scrutiny. Expenditure
on IT has always not been in tune with the returns envisaged. The American example of spending US $ 100
billion on IT applications in financial services during 1970-80 has been a pointer. With 100 per cent more
expenditure on IT per worker, it increased productivity by only 0.7 per cent per year. Hence, proper
implementation program and technology management aspects assume much importance.

< TOP OF THE DOCUMENT >


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Question Paper
Investment Banking and Financial Services-I (261): July 2006
Section A : Basic Concepts (30 Marks)
· This section consists of questions with serial number 1 - 30.
· Answer all questions.
· Each question carries one mark.
· Maximum time for answering Section A is 30 Minutes.

< Answer >


1. Financial markets have witnessed remarkable changes in the nature of transactions, the types of
participants, the magnitude of operations and various different characteristics. And depending on the
differing requirements various sub-markets have developed. With respect to these sub-markets, which
of the following is not true?
(a) The capital market is aimed at financing the long term investment and the transaction taking
place in this market will be for periods over a year
(b) The money market is a wholesale debt market for a low risk, highly liquid short term
instruments having the maturity ranging from one month to a year
(c) The forex market deals with the multicurrency requirements which are met by the exchange of
currencies
(d) Credit market is a place where banks, FIs and NBFCs purvey loans to corporates and
individuals
(e) The Reserve Bank of India is the regulator of the money market.
< Answer >
2. Apart from ensuring appropriate liquidity, investors should also consider the risk present in the money
market instruments. Which of the following is/are the risks associated with the money market
instruments?
I. Market risk.
II. Reinvestment risk.
III. Default risk.
IV. Currency risk.
(a) Only (I) above
(b) Only (III) above
(c) Both (II) and (III) above
(d) Both (II) and (IV) above
(e) All (I), (II), (III) and (IV) above.
< Answer >
3. To promote the investment activity in the Government Securities market, several countries have
adopted licensed Primary Dealers (PDs) as important intermediary in the market. Which of the
following is not true with respect to the PDs?
(a) They are responsible for meeting the minimum bidding requirement
(b) They are responsible for giving two-way quotes
(c) They are responsible for providing information of the market activity to the central bank
(d) They have an important role to play in the development of secondary market for the
Government Securities
(e) The specific objective of PDs is to promote retail investment.
< Answer >
4. International Organization of Securities Commissions (IOSCO) meet every year at an annual
conference to discuss important issues relating to international securities and futures market. In
addition, IOSCO functions through the committee system. Which of the following is not true with
respect to the various committees?
(a) The main purpose of President’s Committee is to achieve the objectives of IOSCO and meets
once in a year

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(b) The Executive Committee consists of 19 members and it looks after the day-to-day functioning
of the organization and strives to attain the objectives
(c) The Technical Committee consisting of 16 members, addresses major regulatory issues and
generates practical responses to these concerns
(d) The Emerging Market Committee endeavors the promotion and development of efficient
securities and futures market in developed countries
(e) The SRO Consultative Committee is constituted by the affiliate members of IOSCO and
enables SROs to provide constructive and substantial inputs to the regulatory initiatives of the
organization.
< Answer >
5. 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 third party. The reasons for divestitures are varied. Which of the
following may not be the reason for the planned divestiture?
(a) Strategic decisions to exit from a certain industry
(b) Poor business fit with the other company
(c) Severe competition
(d) Technological factors
(e) Increase in margins.
< Answer >
6. In case of Book Built issues, the minimum period for which bidding will be open is 3 working days.
The maximum period for which bidding will be open and the maximum number of days by which it
can be extended in case of a revision in the price band are
(a) 6 days and 2 days respectively
(b) 6 days and 3 days respectively
(c) 7 days and 2 days respectively
(d) 7 days and 3 days respectively
(e) 10 days and 4 days respectively.
< Answer >
7. Consider the following data of Spice Air Ltd.
Paid-up equity capital (10,00,000 shares of Rs.10 each) Rs.1,00,00,000
Retained earnings Rs.2,00,00,000
Earning power 20%
Interest Rs. 20,00,000
Total assets Rs.7,00,00,000
The tax rate applicable to the company is 35%. The P/E ratio of the company is 10. The company
proposes for a right issue of 2,00,000 shares at the subscription price of Rs.20. The value per share after
the right issue is expected to be
(a) Rs.63.33
(b) Rs.66.33
(c) Rs.68.33
(d) Rs.72.00
(e) Rs.73.67.
< Answer >
8. 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. Which of the following is the feature of private placement?
(a) There are high entry barriers for the private placement market
(b) There is no need for registration of the offer document with SEBI
(c) The terms of the issue can not be negotiated between the issuers and the investors
(d) The transaction costs are very high
(e) Credit rating is mandatory in case of debt instruments.
< Answer >
9. A practical framework for Indian companies to acquire companies abroad, necessitates that Indian
companies be given a potent currency of comparable rights both in India and abroad. An ideal
mechanism would be Indian Depository Shares (IDSs). The significant advantages of IDSs is/are
I. Reduces the number of available potential targets, both in terms of quality and strategic fit.
II. Provide an engine for high velocity growth by increasing the flexibility to the merged/combined

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company’s capital structure.


III. Maintain the competitiveness of Indian bourses as a preferred/necessary destination among global
stock markets for international listing.
IV. Provide Indian investors an opportunity to participate in the growth of world class Indian
companies.

(a) Only (II) above


(b) Only (III) above
(c) Both (I) and (III) above
(d) (II), (III) and (IV) above
(e) All (I), (II), (III) and (IV) above.
< Answer >
10. The instrument which provides the investor the option to convert the paper into flat interest paying
instrument at the end of particular period, is known as
(a) Mismatch FRNs
(b) Mini-max FRNs
(c) Flip-flop FRNs
(d) Capped FRNs
(e) VRN-structured FRNs.
< Answer >
11. Which of the following is not the constituent of the international reserve?
(a) Special Drawing Rights
(b) Official holding of gold
(c) Foreign exchange
(d) Long term international financing
(e) Reserve position in the IMF.
< Answer >
12. Which of the following is/are not true with respect to repo rates?
I. If the current yield is lower than repo rate, capital gain will occur due to adjustment in repurchase
price.
II. Adjustment in price at the repurchase stage is not required, if both repo rate and coupon interest
rate are equal.
III. The required rate is found by calculating the sale and repurchase prices after adjusting the accrued
rate of interest.

(a) Only (I) above


(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) All (I), (II) and (III) above.
< Answer >
13. Which of the following are the guarantees issued by insurance companies?
I. Guarantees extended to non-financial contracts.
II. Guarantee on behalf of the hire purchase companies to banks and other institutions.
III. Guarantees to cover deferred payments to suppliers of equipments and bankers.
IV. Guarantees to cover short-term loans from banks.

(a) Both (I) and (II) above


(b) Both (II) and (III) above
(c) Both (III) and (IV) above
(d) (I), (II) and (III) above
(e) All (I), (II), (III) and (IV) above.
< Answer >
14. Which of the following political risks are covered by Export Credit and Guarantee Corporation?
I. War, civil war, revolution or civil disturbance in the buyer’s country.
II. Cancellation of valid license or new import restrictions.
III. Default or insolvency of any agent of exporter or of the collecting bank.
IV. Loss occurring outside India due to any other reasons that are not insured.

(a) Both (I) and (II) above

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(b) Both (II) and (III) above


(c) (I), (II) and (IV) above
(d) (I), (II) and (III) above
(e) All (I), (II), (III) and (IV) above.
< Answer >
15. Which loan is designed to be drawn only as the last resort?
(a) Term loan
(b) Revolving credit facility
(c) Evergreen facility
(d) Back-stop facility
(e) Swingline.
< Answer >
16. Which of the following guideline(s) issued by the RBI is/are correct for bank participation in
equipment leasing?
I. A commercial bank can undertake directly the business of equipment leasing and hire purchase.
II. The bank can also set up a subsidiary to transact the business of equipment leasing and hire
purchase and such other activities incidental thereto where, the bank must not hold less than 51%
of the paid up share capital of the subsidiary.
III. Investment of a bank in the share capital of its subsidiary company together with the investment
of the bank in the share capital of other companies carrying on the business of equipment leasing
cannot in the aggregate exceed 10% of its paid up share capital and reserves.

(a) Only (III) above


(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
17. Which of the following is/are true with regard to Mortgage Pass-through Securities (MPS)?
I. In MPS, the holder has the proportionate interest according to the securities held in cash flow
generated from the pool.
II. When the security is sold it is to be considered as sale of asset.
III. The MPS promise that the cash flow from the underlying mortgages would be passed through to
the holder of the security in the form of annual payments of interest and principal.
(a) Only (I) above
(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
18. Which of the following features is/are not true for master agreement for factoring?
I. The client gives an undertaking to sell its receivables and factor agrees to purchase the same
subject to the terms and conditions mentioned in the agreement.
II. The client does not take responsibility to settle problems of disputes, damages and deductions
relating to the bills assigned to the factor.
III. The time frame for the agreement and the mode of termination are specified.

(a) Only (II) above


(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
19. Which of the following conditions an NBFC shall fulfill before accepting the deposits?
I. It should have been in existence for at least three years.
II. It should not have overdue deposits, except those unclaimed.
III. It should be a profit making company.
IV. It should obtain minimum rating of B (if issued by CRISIL or ICRA) or BB (if issued by CARE).

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(a) Both (I) and (II) above


(b) Both (II) and (III) above
(c) Both (II) and (IV) above
(d) Both (III) and (IV) above
(e) All (I), (II), (III) and (IV) above.
< Answer >
20. Which of the following is/are not true with respect to Residual Value Insurance (RVI)?
I. RVI coverts the product risk into payables.
II. The cost of RVI is the premium payable to the underwriter or the insurance company.
III. The disadvantage buying of RVI is that it increases the cost to lessor therefore it becomes difficult
to offer lease on competitive rates.
(a) Only (III) above
(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
21. A finance lease where the executory costs incurred in relation to the leased asset like insurance, repair
etc. are paid by the lessee is called
(a) Sale and leaseback
(b) Leveraged lease
(c) Cross-border lease
(d) Net lease
(e) Open-ended lease.
< Answer >
22. Which of the following statements are true?
I. The purchaser of interest-only portion of the Separate Tranche Interest and Principal (STRIP)
invests in the security with a yield potential of high-coupon collateral.
II. The purchaser of principal-only portion of STRIP expects the interest rates would continue to fall
and the borrower of the mortgage loan would resort to large-scale prepayments.
III. Both interest-only securities and principal-only securities are neutral to the changes in interest
rates.
IV. The return to the investors of Interest only security and Principal only securities move in the same
direction.

(a) Both (I) and (II) above


(b) Both (II) and (IV) above
(c) (I), (II) and (III) above
(d) (II), (III) and (IV) above
(e) All (I), (II), (III) and (IV) above.
< Answer >
23. Consider the following:
PV of lease rentals : Rs.58.87 lakh
Lease term : 3 years
Cost of debt : 17%
Cost of capital : 21%
What will be the installment size for the debt displaced, according to suggested framework for lease
evaluation?
(a) Rs.22.67 lakh
(b) Rs.23.10 lakh
(c) Rs.24.86 lakh
(d) Rs.26.64 lakh
(e) Rs.28.69 lakh.
< Answer >
24. Lycos Ltd. has recently leased an equipment costing Rs.400 lakh on the following terms:
Lease Term : 5 years
Lease Rentals : Rs.300/Rs.1,000 per annum payable annually in arrears.
The incremental borrowing rate for Lycos Ltd. is 18% per annum. The present value of minimum lease

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payments as a percentage of fair market value of the equipment is


(a) 100%
(b) 85%
(c) 75%
(d) 94%
(e) 90%.
< Answer >
25. There can be different forms of factoring agreements. Which of the following factoring agreements was
developed by the American factors primarily to help their importers/ distributors involved in executing
import orders on behalf of their customers?
(a) American factoring
(b) Cross-border factoring
(c) Supplier guarantee factoring
(d) Old line factoring
(e) Bank participation factoring.
< Answer >
26. Which of the following is false regarding Loan-to-Value ratio (LTV)?
(a) LTV is used by the lenders to indicate the percentage of down payment required by them
(b) Over passage of time, as mortgage balance declines the LTV increases

(c) High LTV are quoted in times of lower interest rates and easy market conditions
(d) High LTV are quoted only for newer and readily marketable properties
(e) An LTV of 90% means that the borrower would have to make a down payment of 10% of the
value of the property.
< Answer >
27. Which of the following is/are true with respect to finite-life Real Estate Investment Trust?
I. These trusts have specific life spans, between 3 and 10 years.
II. At the end of the specified life time the trust must be liquidated.
III.The finite life is intended to reduce the disparity between the market price of the REIT shares and
the underlying value of its real estate assets and thus warding off hostile takeovers.
(a) Only (I) above
(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
28. A finance company can also tap the money market through issue of Commercial Paper (CPs) subject to
the provisions of Non-Baking companies Directions, 1989. Which of the following is not the salient
feature of the issue of CPs by a finance company?
(a) The CPs are issued at discount and redeemed at par
(b) The discount rate is subject to the cap and can not be freely determined by the issuer
(c) The CPs can not have a maturity period of less than 3 months and more than 6 months
(d) The CPs will be in the form of usuance promissory note negotiable by endorsement and delivery
(e) The aggregate amount that can be raised through issue of CPs can not exceed 75% of the
company’s working capital limit fixed by the bankers to the company.
< Answer >
29. There are several strong reasons in favour of leasing over buying but there are some shortcomings
associated with the asset-based financing. Which of the following is/are true with respect to the
shortcomings associated with the asset-based financing?
I. Most of the equipment lease transactions are structured as finance leases, the flexibility of lessee
to disinvest is seriously undetermined.
II. Propelled by the dubious advantage of ‘Off Balance Sheet Financing’ or one firm can afford to
increase its exposure to leasing beyond reasonable limits.
III. In perfectly competitive financial market, the cost of leasing tends to be higher than the cost of
other forms of borrowings.

(a) Only (I) above


(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above

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(e) All (I), (II) and (III) above.


< Answer >
30. Whether a lease is a finance lease or an operating lease depends on the substance of the transaction
rather than its form. Which of the following situations would not normally lead to lease being classified
as finance lease?
(a) The lease transfers the ownership of the assets to the lessee by the end of the lease term
(b) The lessee has the option to purchase the assets at a price which is equal to the fair value at the
date the option becomes exercisable such that, at the inception of lease, it is reasonably certain
that the option will be exercised
(c) The lease term is for the major part of the economic life of the assets even if title is not
transferred
(d) At the inception of the lease the present value of the minimum lease payments amounts to
atleast substantially all of the fair value of the leased asset
(e) The leased asset is of a specialized nature such that only the lessee can use it without major
modifications being made.

END OF SECTION A

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Section B : Problems (50 Marks)


· This section consists of questions with serial number 1 – 6.
· Answer all questions.
· Marks are indicated against each question.
· Detailed workings should form part of your answer.
· Do not spend more than 110 - 120 minutes on Section B.
< Answer >
1. Mr. Vrajesh is holding a silver credit card with PVS Bank. Following is the credit card statement of
Mr. Vrajesh.
Amount Amount
Statement Date 1st April Details 1st May Details
(Rs.) (Rs.)
Transaction 5th April Pizza Hut 1,400 3rd May Domino’s 1900
Date
10th Central 7,500 8th May Republic 1600
April
12th Barista 800 14th May Planet Health 1500
April
20th Pantaloon 1,800 26th May Raymonds 3250
April
24th Westside 5,000 29th May Water World 1750
April
30th Big Bazar 4,500
April
MAD 1,050 MAD ?
TAD 21,000 TAD ?
Cash
Payment Details Date
Payment
Payment in to card account 24th 6,000
May
Payment in to card account 28th 10,000
May
Payment in to card account 30th 4,000
May
MAD is Minimum Amount Due
TAD is Total Amount Due
Following is the information provided by the PVS Bank for the various cards.
Card Payment Due Maximum Interest Free Period Available
Gold 22 days 52 days
Silver 20 days 50 days
Bronze 20 days 50 days
The interest charged by PVS Bank is 2.95% p.m. Late payment charges is 25% of the minimum
amount due, subject to minimum of Rs.250 and maximum of Rs.500. The service tax applicable on
interest charge and late payment charge is 10.2%.
You are required to calculate the interest amount to be paid by Mr. Vrajesh and the Total Amount
Due. (Clearly state your assumptions.)
(9 marks)

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< Answer >


2. Optra Financial Services offers consumer loans for a maximum period of four years. When a
customer seeks a loan, the company provides financing of 80% of the cost of the asset. The
company is well known for providing the loans at competitive rates. Repayment schedule provided
by the company for a loan of Rs.50,000 is as follows:

Loan tenure (in months) 12 24 36 48


Excess EMI (Rs.) charged by the competitors (to be paid in
60 50 40 30
arrears)

Available repayment schedule offered by the competitors for loan of Rs.1,00,000

Loan tenure (in months) 12 24 36 48


EMI (Rs.) (to be paid in arrears) 9,370 5,267 4,061 3,227

The company also charges the processing fees lower by 25 basis points than the competitors. The
processing fee charged by the competitors is 1%.
Mr. Resham Jain, who is a well known stock broker in Ahmedabad, wants to buy a new car
launched by General Motors. The cost of the car is Rs.10,50,000. He wants the loan for the period
of four years. He has analyzed the finance schemes available in the market and selected the scheme
offered by the Optra Financial Services. But still he is not sure of his selection so he has given you
the scheme for further analysis and asked you to:
a. Calculate the flat rate of interest charged on the four year car loan.
b. Calculate the effective rate of interest on the completed transaction if Mr. Resham Jain opts to
prepay by 36th months. Optra Financial Services calculates the interest rebate according to
Rule of 78 method.
(2 + 6 = 8 marks)
< Answer >
3. Mr. Srinivas has taken a loan of Rs.5,00,000 from Angel Housing Finance Ltd., for purchasing an
apartment according to graduated payment mortgage scheme for 10 years.
Terms and conditions of the loan are as follows:
i. Tenure – 10 years
ii. Payment – Monthly
iii. Interest – 12% p.a. compounded monthly
iv. The borrower needs to make graduated monthly payments for 5 years with payments
increasing at a rate of 8% in the second, 7% in third year, 6% in fourth year and at a rate of
5% for the next year and thereafter the payments would be as equated monthly installments.
You are required to draw a payment schedule of the housing loan taken by Mr. Srinivas.
(5 marks)
< Answer >
4. Prime Engineering Ltd. has awarded National Bank a syndication mandate for US $ 600 million, 5
year facility. The bank underwrites US $ 200 million and 4 other Banks underwrite US $ 50 million
each.
The company agrees the following terms:
Tenure 5 years
Repayment Bullet Payment
Spread Payable annually at 100 Basis Points over LIBOR
Facility fee 25 Basis point per annum
Arrangement fee 50 Basis point payable upfront as under:
15 Basis point on amount of loan.
25 Basis point on amount underwritten.
10 Basis point on amount of commitment.
Each underwriter retains US $ 60 million and there are 15 participant banks with US $ 20 million
each.
Collin Bank is appointed Agent Bank with annual fee of US $ 20,000.

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You are required to calculate the


a. Cost of loan facility for Prime Engineering, if LIBOR remains constant at 3.12%.
b. Fees earned by National Bank on this transaction.
(4 + 2 = 6 marks)
Mercator Limited is planning to increase its capacity for an estimated cost of Rs.250 lakh. The < Answer >
5.
liabilities of Mercator as per the balance sheet as at 31st March, 2006 is as follows:
Particulars Rs. in lakh
Paid-up capital (48 lakh shares of Rs.5 each) 240
Reserves and surplus 1200
1,00,000 partly convertible debenture (F.V. Rs.100 each)
100
at the interest rate of 11.5%
Secured loans, at the interest rate of 11.0% 720
Current liabilities 300
Rs.60 of each PCD, which are issued during April 2005, are to be converted in to 4 equity shares at
the premium of Rs.10 in two equal installments. The first conversion will take place on 1st April
2006. The second and final conversion will happen in 1st April 2007. Due to the expansion plan,
the fundamentals of the company are expected to change significantly. The company expects its
cost of equity to be in line with the industry average of 14.25%. However the premium of 75 basis
points is felt necessary to reflect company specific factors. The Earning Power for the company is
19.53%. The company expects to pay 50% of its earnings as dividends. However due to substantial
costs involved in fresh equity issue, it proposes to finance the expansion through right issue during
2006-07. While pricing the issue, it decides to allow maximum dilution of 15% in EPS. Tax rate
applicable to the company is 30%.
You are required to calculate
a. The minimum subscription price of the right shares and the maximum ratio of rights.
b. Change in the wealth of the shareholder who holds 2000 shares of Mercator, if allows his
rights to expire. Assume that the shares are traded at the intrinsic value.
(6 + 2 = 8 marks)

6. Shah Financial Services Limited (SFSL) is a financial service company. It offers lease, hire < Answer >
purchase and bill discounting facilities to its customers. SFSL is well reputed for its
flexibility in structuring the lease rentals.
Under hire purchase plan, the company requires 25% of the cost of assets as down payment
and charges a flat rate of interest of 12%. The installments under the hire purchase plan are
required to be paid monthly in arrear over the period of 4 years. The lease rentals are so
structured so as to earn same IRR (after rounding off to the nearest percentage point) as on
hire deals.
SFSL was approached by Elgi Equipment Limited (EEL) for funding its investments in a
plant worth Rs.500 crore for its expansion program. The estimated life of the plant is 4 years
after which it is expected to have a salvage value of 15% of the cost of the asset. The relevant
rate of depreciation of the plant is 25% on WDV basis. EEL expects to generate a steadily
increasing cash flows and requests SFSL for a stepped up pattern of lease rentals, the
increase in rentals being 12% p.a. over a period of 4 years. The company allocates interest on
SOYD basis and is in the tax bracket of 30%.
Ignore interest tax.
You are required to calculate
a. The lease rentals to be charged by SFSL.
b. The gross yield on the lease transaction.
(10 + 4 = 14 marks)

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END OF SECTION B

Section C : Applied Theory (20 Marks)


· This section consists of questions with serial number 7 - 8.
· Answer all questions.
· Marks are indicated against each question.
· Do not spend more than 25 -30 minutes on section C.
< Answer >
7. One innovation in housing finance sector has been the introduction of ‘floating rate home
loans’. What consideration a customer should seriously look into before choosing ‘floating
rate home loan’ or a ‘fixed rate home loan’? Discuss.
(10 marks)
< Answer >
8. In the public issue of Bartronics India Ltd., the lead manager for the issue is Karvy Investors
Services Ltd., the registrar is Bigshare Services Pvt. Ltd., and the bankers are ICICI Bank
and HDFC Bank. With respect to this, discuss the role of Lead Managers, Registrars and
Bankers as intermediaries to the issue.
(10 marks)
END OF SECTION C

END OF QUESTION PAPER

Suggested Answers
Investment Banking and Financial Services-I (261): July 2006
Section A : Basic Concepts
1. Answer : (b) <
TOP
Reason: The money market is a wholesale debt market for a low risk, highly liquid short term >
instruments having the maturity ranging from a single day to a year.
Hence (b) is the correct answer.
2. Answer : (e) <
TOP
Reason: All are the risk associated with the money market instruments. >
Hence (e) is the correct answer.
3. Answer : (e) <
TOP
Reason: The specific objective of SD is to promote retail investment. All other statements are correct >
for PDs.
Hence (e) is the correct answer.
4. Answer : (d) <
TOP
Reason: The following are true with respect to the committees: >
The main purpose of President’s Committee is to achieve the objectives of IOSCO and meets
once in a year
The Executive Committee consists of 19 members and it looks after the day to day
functioning of the organization and strives to attain the objectives
The Technical Committee consisting of 16 members, addresses major regulatory issues and
generates practicle response to these concerns
The Emerging Market Committee endeavors the promotion and development of efficient
securities and futures market in developing countries
The SRO Consultative Committee is constituted by the affiliate members of IOSCO and
enables SROs to provide constructive and substantial inputs to the regulatory initiatives of the

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organization.
Hence (d) is the correct answer.
5. Answer : (e) <
TOP
Reason: Following may be the reasons for the planned divestiture: >
Strategic decisions to exit from a certain industry
Poor business fit with the other company
Severe competition
Technological factors
Shrinking margins
Continuous losses in a particular line of activity.
Hence (e) is the correct answer.
6. Answer : (d) <
TOP
Reason: In case of Book built issues, the minimum and maximum period for which bidding will be >
open is 3 – 7 working days extendable by 3 days in case of a revision in the price band.
Hence (d) is the correct answer.
7. Answer : (c) <
TOP
Reason: >
Paid-up equity capital (10,00,000 shares of Rs.10 each) Rs.100,00,000
Retained earnings Rs.200,00,000
Earning before interest and taxes: (700,00,000 0.20) Rs.140,00,000
Interest Rs.20,00,000
Profit before tax Rs.120,00,000
Profit after tax Rs.78,00,000
EPS Rs.7.8
Market price per share Rs.78
Number of existing shares required for a rights share 5
(10,00,000/2,00,000)
The value of share after the rights issue:
Rs. 68.33

8. Answer : (b) <


TOP
Reason: The following are the feature of private placement: >
There are low entry barriers for the private placement market
There is no need for registration of the offer document with SEBI
The terms of the issue can be negotiated between the issuers and the investors
The transaction costs are low
Credit rating is optional in case of debt instruments
Hence (b) is the correct answer.
9. Answer : (d) <
TOP
Reason: The significant advantages of IDSs is/are >
Increase the number of available potential targets, both in terms of quality and strategic fit.
Provide an engine for high velocity growth by increasing the flexibility to the
merged/combined company’s capital structure.
Maintain the competitiveness of Indian bourses as a preferred/necessary destination among
global stockmarkets for international listing.
Provide Indian investors an opportunity to participate in the growth of world class Indian
companies.
Hence (d) is the correct answer.

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10. Answer: (c) <


TOP
Reason: The instrument which provides the investor the option to convert the paper in to flat interest >
paying instrument at the end of particular period, is known as Flip-flop FRNs.
Hence (c) is the correct answer.
11. Answer: (d) <
TOP
Reason: Following are the constituent of the international reserve: >
Special Drawing Rights
Official holding of gold
Foreign exchange
Reserve position in the IMF
Hence (d) is the correct answer.
12. Answer: (a) <
TOP
Reason: Following statements are correct with respect to repo rates: >
If the current yield is lower than repo rate capital loss will occur due to adjustment in
repurchase price.
Adjustment in price at the repurchase stage is not required if both repo rate and coupon
interest rate are equal.
The required rate is found by calculating the sale and repurchase prices after adjusting the
accrued rate of interest.
Hence (a) is the correct answer.
13. Answer: (d) <
TOP
Reason: Insurance companies issue guarantees to cover long term loans only, from banks. >
Hence (d) is the correct answer.
14. Answer: (c) <
TOP
Reason: Default or insolvency of any agent of exporter or the collecting bank is the risk which is not >
covered by ECGC.
Hence (c) is the correct answer.
15. Answer: (d) <
TOP
Reason: Back-stop facility is a loan designed to be drawn only as the last resort. This facility protects >
the companies against the liquidity crunch.
Hence (d) is the correct answer.
16. Answer : (e) <
TOP
Reason: The following guidelines issued by the RBI are correct for bank participation in equipment >
leasing:
A commercial bank can undertake directly the business of equipment leasing and hire
purchase.
The bank can also set up a subsidiary to transact the business of equipment leasing and hire
purchase and such other activities incidental thereto where, the bank must not hold less than
51% of the paid up share capital of the subsidiary.
Investment of a bank in the share capital of its subsidiary company together with the
investment of the bank in the share capital of other companies carrying on the business of
equipment leasing cannot in the aggregate exceed 10% of its paid up share capital and
reserves.
Hence (e) is the correct answer.
17. Answer: (b) <
TOP
Reason: The pass through securities promise that the cash flow from the underlying mortgages would >
be passed through to the holder of the security in the form of monthly payments of interest,
principal and payments. All other options are correct.
Hence (b) is the correct answer.

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18. Answer: (a) <


TOP
Reason: The client undertakes responsibility to settle problems of disputes, damages and deductions >
relating to the bills assigned to the factor. All other statements are correct for master
agreement of factoring.
Hence (a) is the correct answer.
19. Answer: (b) <
TOP
Reason: A NBFC shall fulfill the following conditions before accepting the fixed deposits: >
- It should have been in existence for at least two years.
- It should not have overdue deposits, except those unclaimed.
- It should be a profit making company.
- It should obtain minimum rating A (if issued by CRISIL or ICRA) or BBB (if issued by
CARE).
- It should declare that it has complied with the latest guideline concerning acceptance of
fixed deposits by NBFC.
Hence (b) is the correct answer.
20. Answer: (c) <
TOP
Reason: Following are correct for RVI: >

RVI coverts the product risk into receivables.


The cost of RVI is the premium payable to the underwriter or the insurance company.
The obvious advantage of buying of RVI is that the lessor able to offer competitive rates.
Hence (c) is the correct answer.
21. Answer: (d) <
TOP
Reason: A finance lease where the executory costs incurred in relation to the leased asset like >
insurance, repair etc. are paid by the lessee is called Net lease.
Hence (d) is the correct answer.
<
22. Answer: (a) TOP
Reason: The following statements are true: >
The purchaser of interest-only portion of the STRIP invests in the security with a yield
potential of high-coupon collateral.
The purchaser of principal-only portion of STRIP expects the interest rates would continue
fall and the borrower of the mortgage loan would resort to large-scale prepayments.
Both interest-only security and principal-only security have large impact associated with a
small change in interest rates.
The return to the investors of Interest only security and Principal only securities move in the
opposite direction.
Hence (a) is the correct answer.
<
23. Answer: (d) TOP
Reason: PV of lease rentals = Lease Rental * PVIFA(17,3) >
58.87 = LR * 2.210
LR = 26.64
Installment = lease rentals.
Hence (d) is the correct answer.
24. Answer : (d) <
TOP
Reason : Present Value of minimum Lease payments = 400 x 0.3 x PVIFA (18 %,5) >
= 375.24 lakhs
Fair market value = Rs. 400 lakhs
So, Present Value of minimum Lease payments as a percentage of Fair market value =
375.24/400 x 100 = 94 % approx.

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25. Answer : (c) <


TOP
Reason: Supplier guarantee factoring agreements was developed by the American factors primarily to >
help their importers/distributors involved in executing import orders on behalf of their
customers.
Hence (c) is the correct answer.
26. Answer: (b) <
TOP
Reason: Over time, as mortgage balance declines the LTV also declines. So this statement is false and >
all other statements are true. Hence (b) is the correct answer.

27. Answer : (d) <


TOP
Reason: The following are true with respect to finite-life Real Estate Investment Trust: >
These trusts have specific life spans, between 5 and 15 years
At the end of the specified life time the trust must be liquidated
The finite life is intended to reduce the disperity between the market price of the REIT
shares and the underlying value of its real estate assetsand thus warding off hostile takeovers.
Hence (d) is the correct answer.
28. Answer : (b) <
TOP
Reason: The following is not the salient feature of the issue of CPs by a finance company: >
The CPs are issued at discount and redeemed at par.
The discount rate is not subject to any cap and can be freely determined by the issuer
The CPs can not have a maturity period of less than 3 months and more than 6 months
The CPs will be in the form of usuance promissory note negotiable by endorsement and
delievery
The aggregate amount that can be raised through issue of CPs can not exceed 75% of the
company’s working capital limit fixed by the bankers to the company
29. Answer : (b) <
TOP
Reason: The following are true with respect to the shortcomings associated with the asset-based >
financing:
Most of the equipment lease transactions are structured as finance leases, the flexibility of
lessee to disinvest is seriously undetermined.
Propelled by the dubious advasntage of ‘Off Balance Sheet Financing’ or one firm can
afford to increase its exposure to leasing beyond reasonable limits.
In perfectly competitive financial market, the cost of leasing tends to be equal to the cost of
other forms of borrowings.
Hence (b) is the correct answer.
30. Answer : (b) <
TOP
Reason: The following situations would normally lead to lease being classified as finance lease: >
The lease transfers the ownership of the assets to the lessee by the end of the lease term
The lessee has the option to purchase the assets at a price which is expected to be sufficiently
lower than the fair value at the date the option becomes exercisable such that, at the inception
of lease, it is reasonably certain that the option will be exercised
The lease term is for the major part of the economic life of the assets even if title is not
transferred
At the inception of the lease the present value of the minimum lease payments amounts to
atleast substantially all of the fair value of the leased asset.
The leased asset is of a specialized nature such that only the lessee can use it without major
modifications being made.
Hence (b) is the correct answer.

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Section B : Problems
1. Mr. Vrajesh is having silver credit card so, maximum interest free period available is for 50 days. Therefore he
can pay the amount before 20th of May without paying any interest.
Here in this case Mr. Vrajesh has not made the payment due, on time. Therefore he is required to pay the interest
and the late payment charges. Calculation is as follows:

Interest on 1400 for 24 days = = Rs.32.59

Interest on 7500 for 24 days = = Rs.174.58

Interest on 2900 for 4 days = = Rs.11.25

Interest on 800 for 28 days = = Rs.21.72

Interest on 1800 for 28 days = = Rs.48.88

Interest on 5000 for 28 days = = Rs.135.78

Interest on 500 for 2 days = = Rs.0.97

Interest on 4500 for 30 days = =Rs.130.93


Now, for the month May his statement will be generated on 31st.

Interest on 1900 for 28 days = = Rs.29.10

Interest on 1900 for 28 days = = Rs.51.60

Interest on 1600 for 23 days = = Rs.35.69

Interest on 1500 for 17 days = = Rs.24.73

Interest on 3250 for 4 days = = Rs.12.60

Interest on 1750 for 2 days = = Rs.3.39


Late payment charges = 1050 0.25 = Rs.262.5
Total interest payment = Rs.713.81
Service Tax payable @10.2% of interest and late payment charges.
976.31 0.102 = Rs.99.58
Total principal outstanding of last month = Rs.1,000
Fresh purchases during the month May = Rs.10,000

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Hence Total Amount Due = 1,000+10,000+713.81+99.58


= Rs.11,813.39
< TOP >
2. a. Repayment schedule for a loan of Rs.50,000
Loan tenure (in months) 12 24 36 48
EMI (Rs)charged by the competitors
9370 5267 4061 3227
(on the loan amount of Rs.1,00,000)
EMI(Rs) charged by the competitors
4685 2633.5 2030.5 1613.5
(on the loan amount of Rs.50,000)
Less : Excess EMI (Rs)charged by the competitors 60 50 40 30
EMI (Rs) charged by the Optra Financial Service
4625 2583.5 1990.5 1583.5
(to be paid in arrears)
Flat rate of interest is the value of ‘f’ in the following:

f = 13.00%
b. A. Loan Amount = 10,50,000 0.80 = Rs.8,40,000

Installment = = Rs.26,602.8

B. PV of EMIs = 26,602.8
C. Processing fee = 0.0075 8,40,000 = 6,300
Total charge for credit = (26,602.8 48) – 8,40,000 = Rs.4,36,934.4

Interest rebate as per Rule 78 =


= Rs.28,980.34
D. Amount payable on early settlement = (26,602.8 12) – 28,980.34
= 3,19,233.6 – 28,980.34
= Rs. 2,90,253.26

PV of the above = 2,90,253.26


Effective interest rate is the value of ‘i’ in the following:
A–B–C–D=0

8,40,000 – 26,602.8 – 6,300 – 2,90,253.26 =0


At i = 2%, LHS
= 8,40,000 – 6,78,110.58 – 6,300 – 1,42,288.87 = 13,300.55
At i = 1%, LHS
= 8,40,000 – 8,00,943.94 – 6,300 – 2,02,865.25
= –1,70,109.19
By interpolation,

=1.927% p.m.
Now, we will calculate the annualized interest rate, i.e.

–1
=1.25739–1
=25.74% p.a.
< TOP >
st
3. Let the monthly installment in the 1 year be Rs. X

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\ X PVIFA1%12 + X (1.08) PVIFA1%,12 PVIF 1%, 12 + X(1.08) (1.07) PVIFA 1%,12 PVIF 1%,24 + X(1.08)
(1.07)(1.06) PVIFA 1%,12 PVIF 1%,36 + X(1.08) (1.07)(1.06)(1.05) PVIFA 1%,12 PVIF1%,48 + X(1.08)
(1.07)(1.06)(1.05)PVIFA 1%,60 PVIF1%,60 = 5,00,000
\ 11.2551X[1+(1.08 0.8874)+(1.1556 0.7876)+(1.2249 0.6989)+(1.2862 0.620)] + (1.2862X 0.5504
44.955) = 5,00,000
\ 11.2551X[1+0.9584+0.9102+0.8561+0.7974]+31.825X=5,00,000
\ 50.90X+31.83X=5,00,000
\ X=6043.76
Repayment schedule:
Year Graduated monthly payment made(Rs.)
1 6043.76
2 6572.26
3 6984.17
4 7403.22
5-10 7773.38
< TOP >
4. a.
Loan 600
Less: Arrangement fee 3
597

Annual cash flow 24.72


Facility fee 1.5
Agent fee 0.02
Total 26.24
The annual cash flows are as under
Year Cash flow ( million $)
0 +597
1 –26.24
2 –26.24
3 –26.24
4 –26.24
5 –626.24
The cost of loan is value of ‘I’ in the following

By solving the equation we get the value of i=4.49%.


b. Fees earned by the National Bank is as follows:
$ million
15 Basis point on amount of loan i.e. $ 600 million 0.90
25 Basis point on amount underwritten i.e. $ 200 million 0.50
10 Basis point on amount of commitment i.e. $ 60 million 0.06
1.46
Hence, the total fees earned by the National Bank is $ 1.46 million.
< TOP >

5. a. Proposed right issue = Rs.250 lakh


Earning Power = EBIT / Total Asset
0.1953 = EBIT / 2560
EBIT = 2560 ´ 0.1953
= Rs.499.97
Interest on debenture = 70´0.115 = Rs.8.05

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Interest on secured loans = 720´0.11 = Rs.79.20


Therefore, EBT = 499.97 – (8.05 + 79.20)
= Rs.412.72
PAT = 412.72 ´ 0.70 = Rs.288.90
ROE = PAT / Networth
= 288.90/1440
= 20.06%
Growth rate = ROE ´ retention ratio
= 0.2006 ´ 0.5 = 10.03% 10% (approximately)
Current EPS = 288.90/48 =Rs.6.02
Expected EPS = 6.02 ´1.10 = Rs.6.62
EPS after dilution = 6.62´0.85 = Rs.5.63
Number of shares to be issued be X
5.63= 288.90 ´ 1.10 / (52 lakh + X)
X=4.446 lakh shares (approximately)
Minimum subscription price = 250/4.446
= Rs.56.23
Ratio of rights = 52/4.446
= 11.7
b. Current market price: P = E1 (1-b) / (ke –g)
= 6.62´0.5/(0.15 – 0.10)
= Rs.66.20
Current market value of his holding = 2,000 ´ 66.20 = Rs.1,32,400

Ex rights price = + S / N+1 = [(11.7´66.20) +56.23]/12.7 = Rs.65.41


Market value after rights = 2000 ´ 65.41= Rs.1,30,820
Change in wealth = (Rs.1,580)
< TOP >

6. IRR is the required rate on the hire transaction at which NPV (HP) is equal to zero.
– Loan amount + PV of hire rentals – PV of tax on finance charge = 0
A. Loan Amount = 500 0.75 = Rs.375 crore.

Equated monthly installments =


= Rs.11.56 crore

B. PV of hire rentals = 11.56 12

= 138.72
C. Allocation of finance charge:
Total charge for credit = 375 0.12 4 = Rs.180 crore.
(Rs. in crore)
Year SOYD factor Interest
1 510/1176 78.06
2 366/1176 56.02
3 222/1176 33.98
4 78/1176 11.94
PV of tax on finance charge

=[ ] 0.30

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To find out the IRR, NPV (HP) is set equal to zero.


NPV (HP) = 0
–A + B – C = 0

[–375+(138.72 ) –
]=0
At 14%
LHS = –375 + (138.72 2.9137 1.0626) – 42.48
= 12.01
At 16%
LHS = –375 + (138.72 2.7982 1.0714) – 41.18
= –0.3
By interpolation

=15.95%
= 16% (rounded off)
Lease rentals during the first year of the lease term is the value of ‘L’ at which NPV (lease) at 16% = 0
A. Investment cost = Rs.500 crore
B. PV of lease rentals =

= 0.8621L + 0.8323L + 0.8008L + 0.7732L


= Rs.3.2684L crore
C. PV of tax on lease rentals = 3.2684L 0.3 = Rs.0.9805 crore
D. PV of Depreciation Tax Shield:
(Rs. in crore)
Year Depreciation PVIF@16% PV
1 125.00 0.8621 107.76
2 93.75 0.7432 69.67
3 70.31 0.6407 45.05
4 52.73 0.5523 29.12
Total 251.60
PV of DTS = 251.60 0.3 = Rs.75.48 crore
E. PV of net salvage value = 500 0.15 0.5523
= Rs.41.42 crore
NPV (Lease) at 16% = 0
–A + B – C + D + E =0
–500 + 3.2684L – 0.9805 + 75.48 + 41.42 = 0
2.2879L = 383.10
L = Rs.167.45 crore
a. Lease rentals over the period of 4 years are as follows:
(Rs. in crore)
Year 1 167.45
Year 2 187.54
Year 3 210.05
Year 4 235.26
b. Gross yield is the value of ‘i’ in the following:
–A + B + C = 0
A. Investment cost = Rs.500 crore

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B. PV of lease rentals =

C. PV of salvage value = 75
Gross yield is the value of ‘i’ in the following:

–500 + + 75 =0
At 23% LHS = 8.52
At 24% LHS = –1.65
By interpolation

= 23.84%.
<TOP>

Section C: Applied Theory


7. Ideally, loan seekers should opt for a floating rate home loan when it is expected that interest rates will decline
going forward. Fixed rate loans should be preferred when interest rates are expected to rise. But is making a
choice that simple? In today's environment, when there is a lot of talk about rising interest rates, should investors
shun floating rate home loans altogether? Or is there still some merit in this instrument? All said and done, in the
last one year, there was a trend of floating rate home loans being more popular as compared to the fixed rate loan
and as of now, this trend is continuing.
There are three important issues which one needs to consider before opting for one type of a loan over the other.
First, an important determinant of what one should go in for should be the long term expectation of interest rates.
For example, if the loan seeker (or the experts) expect rates to rise for the next one year, but then decline gradually
over the next several years, a floating rate product may be preferable. The other option of going in for a fixed rate
product and then switching at the end of the year will entail costs (there could be a penalty of 1% - 2% of the
outstanding loan amount) and may not make financial sense. Moreover, floating rate home loans do not change
the rate of interest every quarter (even though they may review the rate every quarter). The attraction of a floating
rate home loan is that it does not attract a part prepayment charge. This could appeal to individuals who get lump
sum bonuses which they can use to reduce their loan exposure.
Second, the issue whether fixed rate home loans are actually `fixed rate'. When considering a fixed rate home loan
over a floating rate home loan a strong selling point is that if interest rates were to rise dramatically the loan seeker
will be `protected'. Apparently the reality is somewhat different. It seems that companies that have given out fixed
rate loans can revise their rates upwards in exceptional circumstances (significant rise in interest rates for one). So
if one thinks that rates will remain range bound over the near term and decline over the long term, one is still
better off with a floating rate product.
Third, a fixed rate loan is generally priced higher as compared to a floating rate product. This holds true in the
current environment where the fixed rate loan is at a higher interest rate as compared to a floating rate loan. The
difference is currently about 0.25% to 1.00%. So if one expects that interest rates are likely to move up, but only
to the extent of this differential, then one should ideally be indifferent between the two types of a loan. The
deciding factors then should be when one thinks the rates will increase, and also the long term expectations of
interest rates.
As always, there is no one answer to whether a customer should go in for a floating or a fixed rate home loan. A
person with very little appetite for risk or negative surprises should opt for the fixed rate home loan. But in case
the customer can take on some risk, a floating rate home loan is worth a look.
< TOP >

8. Lead Manager
In the pre-issue process, the Lead Manager (LM) takes up the due diligence of company’s operations/
management/ business plans/ legal etc. Other activities of the LM include drafting and design of Offer documents,
Prospectus, statutory advertisements and memorandum containing salient features of the Prospectus. The BRLMs
shall ensure compliance with stipulated requirements and completion of prescribed formalities with the Stock
Exchanges, RoC and SEBI including finalization of Prospectus and RoC filing. Appointment of other
intermediaries viz., Registrar(s), Printers, Advertising Agency and Bankers to the Offer is also included in the
pre-issue processes. The LM also draws up the various marketing strategies for the issue.

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The post issue activities including management of escrow accounts, coordinate non-institutional allocation,
intimation of allocation and dispatch of refunds to bidders etc are performed by the LM. The post Offer activities
for the Offer will involve essential follow-up steps, which include the finalization of trading and dealing of
instruments and dispatch of certificates and demat of delivery of shares, with the various agencies connected with
the work such as the Registrar(s) to the Offer and Bankers to the Offer and the bank handling refund business. The
merchant banker shall be responsible for ensuring that these agencies fulfill their functions and enable it to
discharge this responsibility through suitable agreements with the Company.
The Registrar
The Registrar finalizes the list of eligible allottees after deleting the invalid applications and ensures that the
corporate action for crediting of shares to the demat accounts of the applicants is done and the dispatch of refund
orders to those applicable are sent. The Lead manager coordinates with the Registrar to ensure follow up so that
that the flow of applications from collecting bank branches, processing of the applications and other matters till
the basis of allotment is finalized, dispatch security certificates and refund orders completed and securities listed.

Bankers to the issue


Bankers to the issue, as the name suggests, carries out all the activities of ensuring that the funds are collected and
transferred to the Escrow accounts. The Lead Merchant Banker shall ensure that Bankers to the Issue are
appointed in all the mandatory collection centers as specified in DIP Guidelines. The LM also ensures follow-up
with bankers to the issue to get quick estimates of collection and advising the issuer about closure of the issue,
based on the correct figures.
< TOP >
< TOP OF THE DOCUMENT >

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Question Paper
Investment Banking and Financial Services-I (261) : January 2007
Section A : Basic Concepts (30 Marks)
• This section consists of questions with serial number 1 - 30.
• Answer all questions.
• Each question carries one mark.
• Maximum time for answering Section A is 30 Minutes.

< Answer >


1. Which of the following is not the characteristic of the perfect market?
(a) All the players in the market have all the information relating to the security
(b) The flow of funds between the markets should be restricted by the Government regulations
(c) The market price of security reflects all the available information
(d) Transparency in the trading mechanism and shorter settlement periods are critical for low
transaction cost
(e) All players in the market are price takers.
< Answer >
2. Which of the following is false with respect to the effects of Open Market Operations (OMO)
conducted by the RBI?
(a) The open market purchase of gilts will ease the liquidity of banks
(b) If the interest rate structure is to be moved upwards, the prices of securities in the OMO can be
set at higher levels thereby signaling an upward movements in interest rates
(c) The effort to cool the interest rate volatility through OMO may some time lead to an interest
differential loss to the RBI
(d) If the PLR is reduced, the CP rate may also come down
(e) Cut in repo rates will result in increase in the call rates and also other term money rates.
< Answer >
3. Which of the following is false with respect to interest rate structure in the Indian money market?
(a) A very tight liquidity position will increase the call rates while excess liquidity will give fairly
low and stable rates
(b) If the liquidity crunch of the banks is passed on to the system, it may lead to high volatility in the
call rates
(c) Call rates under normal liquidity conditions are the cap rate for the term money market
(d) In a volatile call market situation, lending will return high yields and by selling Inter-Bank
Participations, the bank will have more money to play in the call market
(e) The floor rate for CDs is fixed by short term deposit rates and the ceiling for CDs is set by CPs.
< Answer >
4. To enable participation of small level operators in the Liquidity Adjustment Facility (LAF) and also to
add further operational flexibility to the scheme, the minimum bid size for LAF is being reduced to
(a) Rs. 5 crore
(b) Rs. 7 crore
(c) Rs.10 crore
(d) Rs.12 crore
(e) Rs.15 crore.
< Answer >
5. Mr. Shah has deposited of Rs.2,00,000 with Wicro Ltd. for two years at the rate of 12% p.a. If he wants
to withdraw the entire amount at the beginning of 12th month, the amount that will be refunded by the
company to Mr. Shah as per Rule 8(1) of the Companies (Acceptance of Deposits) Rules, 1975, is
(a) Rs.2,24,000
(b) Rs.2,22,333
(c) Rs.2,20,000
(d) Rs.2,18,333
(e) Rs.2,00,000.
< Answer >
6. Any person aggrieved by an order of SEBI can file an appeal petition to the Central Government. Such
appeal has to be filed within 30 days from the date of communication of the order. However, if the
appellant had sufficient cause for not preferring the appeal within 30 days, the Central Government, if
satisfied, may extend the period by further
(a) 3 days
(b) 7 days
(c) 10 days
(d) 14 days
(e) 15 days.
< Answer >
7. Following is the list of various depositors and their deposits with the Lord Bank:
Name of Joint account Saving bank Current Fixed
depositor holder account (Rs.) Account (Rs.) Deposits (Rs.)
Prashant – 7,500 – 1,00,000
Prashant Resham 23,000 45,000 56,000
Srinivas – 5,000 – 95,500
Nandgopal – 10,000 80,000 5,000
Kalyan Anuradha 26,000 56,000 –
Kalyan – 5,000 – 85,000
The half-yearly insurance premium payable by the Lord Bank to insure this deposits as per DICGC
guideline is
(a) Rs.197.50
(b) Rs.200.50
(c) Rs.246.50
(d) Rs.283.50
(e) Rs.298.50.
< Answer >
8. The takeover code is triggered when the acquirer obtains 15% equity stake in a company. The code
makes it mandatory for the acquirer to make a public offer to acquire a further
(a) 5% of equity of the target company
(b) 10% of equity of the target company
(c) 15% of equity of the target company
(d) 20% of equity of the target company
(e) 25% of equity of the target company.
< Answer >
9. Which of the following is false with respect to the registration of the offer document for an IPO?
(a) Seven copies of the draft prospectus have to be filed with SEBI by the lead manager
(b) The lead manager is required to simultaneously file the draft prospectus with all the stock
exchanges where listing is proposed
(c) The lead manager should furnish to the Board, an in-principle approval of the stock exchanges
for listing of the securities within 15 days of filing of the draft offer document with the stock
exchanges
(d) SEBI would make the observation within 21 days from filing the offer document and in case no
observations are received within the stipulated period the offer document is deemed to have been
cleared by SEBI
(e) The draft prospectus filed will be treated as public document.
< Answer >
10. Which of the following is/are false with respect to eligibility of securities for computation of promoter’s
contribution?
I. If promoters of any company issuing securities acquire equity for consideration other than cash
during the preceding three years before filing the offer documents and if it involves revaluation of
assets or capitalization of intangible assets, then such securities are not eligible for computation of
promoter’s contribution.
II. Shares resulting from bonus issue out of revaluation reserve or reserves without accrual of cash
resources are not eligible for computation of promoter’s contribution.
III. In case of public issue by unlisted companies, securities, which have been issued to the promoters
during the preceding one year at a price lower than the price at which equity is being offered to
public, are eligible for computation of promoter’s contribution.
(a) Only (I) above
(b) Only (III) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
11. Which of the following is false with respect to the issue of debentures?
(a) Credit rating is mandatory for any debenture issue where the conversion period exceeds 18
months
(b) Appointment of SEBI registered Debenture Trustee is mandatory if the maturity period of the
instrument exceeds 18 months
(c) Creation of Debenture Redemption Reserve is mandatory if the maturity period of the instrument
exceeds 18 months
(d) In case the non convertible portion of the PCD is to be rolled over, a compulsory option is to be
given to debenture holders to redeem and encash their debentures
(e) No issue of FCDs having conversion period exceeding 18 months can be made unless
conversion is made optional with put and call options.
< Answer >
12. Which of the following is false with respect to the various financial instruments?
(a) Cash pay bonds are simple debt instruments, which pay interest in cash
(b) Secured premium notes are issued at face value and pays interest annually
(c) The term of maturity for the deep discount bond is usually around 20 to 25 years
(d) In third party convertible debt, a warrant is issued with the debt which allows the investor to
subscribe the equity shares of another company
(e) If the investors of zero coupon convertible note choose to convert into the common stock of the
issuer, they have to forgo all accrued and unpaid part of the interest.
< Answer >
13. Which of the following is/are false with respect to GDR?
I. Normally, a typical GDR is denominated in US dollars where as the underlying shares would be
denominated in the local currency of the issuer.
II. GDR may be at the request of investor converted into equity shares by cancellation of GDRs
through intermediation of the local custodian.
III. The sale of underlying shares is done in the domestic market through the depository.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
14. Prime Ltd. wants to roll over its non convertible portion of PCDs. Within how many months prior to the
date of redemption, the company will have to obtain fresh credit rating?
(a) 6 months
(b) 12 months
(c) 15 months
(d) 18 months
(e) 24 months.
< Answer >
15. Demutualization is a

(a) Stock split, which is mutually agreed upon by the shareholders and the management
(b) Mutual decision between the management and the various stakeholders to wind up the company
(c) Share buy-back, mutually agreed between the Institutional investors and the promoters of the
company
(d) Separation of ownership and trading rights of brokers in a stock exchange
(e) Conversion of the debt into equity with the conversion ratio mutually decided between the
debenture holders and the management.
< Answer >
16. Which of the following is/are true with regard to Mortgage Pass-Through Securities?
I. In pass through securities the holder has the proportionate interest according to the securities held
in cash flow generated from the mortgage pool.
II. If it is sold, it is to be considered as an issuance of debt obligations of the originator of the
mortgages.
III. It promises that the cash flow from the underlying mortgages would be passed through to the
holder of the security in the form of monthly payments of interest, principal and prepayments.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
17. Akar Finance Ltd. has the net owned funds amounting to Rs. 5 crore. The maximum amount of
intercorporate deposit, the company can raise, is
(a) Rs. 5.0 crore
(b) Rs. 7.5 crore
(c) Rs. 10.0 crore
(d) Rs. 12.0 crore
(e) Rs. 15.0 crore.
< Answer >
18. Which of the following clauses of the lease agreement stipulates that the lessee shall not sell, assign,
pledge or otherwise encumber lien upon or against the equipment?
(a) Description clause
(b) Period clause
(c) Equipment delivery clause
(d) Ownership clause
(e) Surrender clause.
< Answer >
19. Amar Finance Ltd. has the policy of discounting the L/C backed bills of Rs.1000 of its clients at 20%.
The annual effective rate of interest implied by the bill with a usance period of 90 days is
(a) 22.75%
(b) 23.50%
(c) 24.00%
(d) 25.00%
(e) 25.75%.
< Answer >
20. Which of the following are false with respect to Leveraged Lease Transaction (LLT)?
I. The leveraged lease has the third party called lender attached to it.
II. The debt fund raised by the leasing company is without recourse to the lessee.
III. The trustee to the transaction remits the debt service component of the rental to the lender and the
balance to the lessor.
IV. LLT allows the lessee to claim tax shields on the depreciation.
(a) Both (I) and (III) above
(b) Both (II) and (IV) above
(c) (I), (II) and (III) above
(d) (II), (III) and (IV) above
(e) All (I), (II), (III), and (IV) above.
< Answer >
21. A lease where the relative magnitude of investment involved is quite high, is known as
(a) Capital lease
(b) Sale and leaseback
(c) Swap lease
(d) Big ticket lease
(e) Finance lease.
< Answer >
22. Mr. Pranav is intending to own a house worth of Rs.3,75,000. He is sanctioned 75% of the cost of the
house as loan. The interest rate on loan is 15% and tenure for the same is 20 years. The EMI payable by
him on this loan is
(a) Rs.3,003.47
(b) Rs.3,203.74
(c) Rs.3,530.74
(d) Rs.3,703.47
(e) Rs.3,803.47.
< Answer >
23. Money Market Mutual Fund is a special category of Mutual Fund,
(a) Which provides higher returns to an investor as compared to debt funds
(b) Which provides an investor the choice to invest for medium-term
(c) Where safety level of the investment is high
(d) Where liquidity is inadequate
(e) Which invests mainly in unrated paper to generate high returns.
< Answer >
24. Which of the following CDs carries both fixed and floating interest rates?
(a) Asian Dollar CD
(b) Installment CD
(c) Rising Rate CD
(d) Thrift CD
(e) Yankee CD.
< Answer >
25. If invoice discounting is not confidential in nature, the customers of the client are advised to make
payment directly to the factor. This facility, if offered with a non recourse feature, is known as
(a) Protected invoice discounting
(b) Bulk factoring
(c) Agency factoring
(d) Full factoring
(e) Old line factoring.
< Answer >
26. Consider the following extract of balance sheet of M/s. Patel Ltd. for the year ended March 31, 2006:
Particulars Rs. lakh
Net worth 180
Long term debt 60
Current liabilities 120
Fixed assets 120
Inventory 80
Receivables 180
Cash 20
M/s. Parikh Ltd. has agreed to factor the receivables of M/s. Patel Ltd. and has given an advance of 80
% of receivables. If 50% of the additional cash is utilized to reduce current liabilities, the current ratio
before and after factoring respectively, will be
(a) 1.67; 3.67

(b) 1.67; 4.33


(c) 2.33; 4.33
(d) 2.33; 6.33
(e) 2.33; 1.92.
< Answer >
27. Souvick has taken a consumer loan of Rs.90,000 for a period of 2 years. If the total charge for credit is
Rs.21,600, the flat rate of interest is
(a) 12 % p.a.
(b) 14 % p.a.
(c) 15 % p.a.
(d) 18 % p.a.
(e) 24 % p.a.
< Answer >
28. Which of the following forms of Venture Capital Financing is provided to companies that have
expended their initial capital (often in developing and market testing a prototype) and require funds to
initiate full-scale manufacturing and sales?
(a) Seed Financing
(b) Start-up Financing
(c) First Stage Financing
(d) Mezzanine Financing
(e) Bridge Financing.
< Answer >
29. Which of the following is/are true regarding accounting of a lease transaction in the books of lessor as
per Accounting Standard 19 of the Institute of the Chartered Accountants of India?
I. The lessor must record the finance lease as a receivable in the balance sheet at an amount equal to
the net investment in the lease.
II. The lessor must bifurcate the lease rental into two components - the capital component and the
interest component.
III. The pattern of recognizing the finance income must also reflect the uncertainties associated with
the collectibility of lease rentals, expectations of the future rates of interest, etc. particularly for
long-term leases.
(a) Only (I) above
(b) Only (III) above
(c) Both (I) and (II) above
(d) Both (I) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
30. Which of the following is not an internal credit enhancement technique in respect of securitization?
(a) Over collateralization
(b) Cash collateral
(c) Letter of credit
(d) Credit trenching
(e) Triggered amortization.

END OF SECTION A
Section B : Problems (50 Marks)
• This section consists of questions with serial number 1 – 5.
• Answer all questions.
• Marks are indicated against each question.
• Detailed workings should form part of your answer.
• Do not spend more than 110 - 120 minutes on Section B.

<
1. Mr. Vrajesh is the chairman of India Glass Ltd. which is a subsidiary of US Glass Inc. of US. Mr. Vrajesh is planning to modernize Answer
the bottling plant of the company. For which he will require some CNC machines. Germany is the technological leader in the world >
so; he has decided to buy the equipment form Computech Ltd., Germany. Details of the CNC machines are as follows:
• Cost of the machines is Rs.150 crore
• Life of the machines is 5 years
• Salvage value of the machines after 5 years will be nil.
• The machines are eligible for a tax relevant depreciation of 30% p.a.
Due to unavailability of sufficient funds to acquire the equipment, India Glass Ltd. has proposed to enter in to a cross border lease
agreement with UK based leasing company, Thomas Financial Services (TFS). TFS has agreed to lease the equipment for a period
of 5 years and the rentals will be payable every year in advance. TFS structures its lease transaction to earn 15% and the tax rate
applicable to TFS is 25%. Assume that the lease transaction in UK is treated as a ‘true lease’, in US it is treated as a sale and in
Germany it is treated as an installment sale.
You are required to
a. Determine the lease rentals of India Glass Ltd. to be paid to TFS.
b. Structure a double dip transaction involving the US Glass Inc. in such a way that the lease rentals payable by India Glass Ltd.
is lower than the lease rentals arrived at (a) above and also determine the lease rentals of such double dip transaction.
(Assume that the required rate of return and the effective tax rate of the US Glass Inc. are 15% and 25% respectively and the
company uses SOYD method of allocation of interest and the same pattern of lease rentals payments.)
(3 + 7 = 10 marks)
<
2. Pantaloon Retail Ltd. is proposing to expand its existing ‘Central’ chain of retail super markets in North and South India during the Answer
year 2006-07. It has estimated the cost of expansion to be around Rs.1000 crore. The company is considering the following two >
alternatives for financing the project:
I. Issue of 1 crore equity shares of face value of Rs.10 at a premium of Rs.1340 per share
II. 6-year Floating Rate Notes (FRN) of face value of Rs.5000.
Basis of Interest of FRN:
The rate of interest on these notes would be fixed at a mark up of 1.5% over SBI PLR at the beginning of each year from the
deemed date of allotment. The interest will be calculated on the outstanding principal amount every year. At any time during
the tenure of the bond, interest on these bonds will not be less than 9% or more than 12.25%.
Annual Payment of FRN:
For every Rs.5000 investment, the holder of the FRN would be paid an amount of Rs.1250 at the end of every year for the
first five years from the deemed date of allotment.
The amount of Rs.1250 would comprise of interest on the principal amount outstanding as at the beginning of every year
and part principal redemption. The annual payment will be adjusted first towards interest part and the balance towards
principal.
The last payment comprising principal outstanding and interest payable would be made at the end of year 6 from the date of
allotment.
Future Interest Rate Scenario:
At the time of issue, SBI PLR is 10.25%. Future SBI PLR as predicted by leading market analysts is as follows:

SBI PLR for the year


Scenario Probability 2nd 3rd 4th 5th 6th
1 0.20 10.30% 10.45% 10.70% 10.90% 11.20%
2 0.20 10.45% 10.80% 10.95% 11.25% 11.50%
3 0.40 10.35% 10.50% 10.75% 11.00% 11.25%
4 0.20 10.25% 10.10% 10.00% 9.75% 9.50%

The data from the financial statements of Pantaloon Retail Ltd. for the year 2005-06 is given below:
Particulars Rs. in crore
Equity Capital (Face value: Rs.10) 2000.00
Reserves and Surplus 500.00
Term Loan @ 12% 400.00
EBIT 4300.00
Effective Tax Rate 23%
Dividend 30%
The following estimates are given by the VP Finance of Pantaloon Retail Ltd.:
• EBIT is expected to increase by 30% for the year ended 2006-07
• In future the dividend is expected to increase by 10% p.a.
• Issue expenses in case of equity and FRN would be 2.00% and 0.75% respectively
You are required to recommend the best alternative to fiancé the project based on the cost of funds to the company.
(10 marks)
<
3. Shah Exports Ltd. has proposed to expand its operations for which it requires funds of $5 million, net of issue expenses which Answer
amount to 2% of issue size. It proposed to raise the funds through GDR issue. The EPS of the company for the past few years are as >
follows:
Year 2001 2002 2003 2004 2005 2006
EPS Rs.10.00 Rs.57.50 Rs.64.00 Rs.67.50 Rs.53.45 Rs.56.25

At the end of the year 2002, the company announced a reverse stock split of 5:1. The company announced the bonus issue of one
share for every three shares held at the end of 2005. The current dividend payout ratio of the company is 25% and is expected to
remain same in the future. The past growth rate in dividends is expected to continue indefinitely. Other particulars are as follows:
• Three shares underlie each GDR.
• Underlying shares are priced at 5% discount to the market price.
• Expected exchange rate at the time of GDR issue is Rs.45/$.
• Current risk free rate is 6% and is expected to remain same.
• Beta of the stock is 1.12 and is expected to remain same.
• Risk premium is 9% and is expected to remain same.
You are required to compute
a. The number of GDRs to be issued.
b. The cost of GDRs to the company.
c. Gains/losses to the holder of 100 GDRs, if the company proposes a rights issue after the GDR issue in the ratio of 1:3 at a
subscription price of Rs.200 per share at the end of 2007. Assume the GDR holder exercises the rights and sells his entire
holding at the prevailing GDR price.
Assume the Rs/$ exchange rate at the time of rights issue and sale by GDR holder is Rs.46/$.
(4 + 2 + 4 = 10 marks)
<
4. ABN bank proposes to borrow on 7th January 2007 an amount of Rs.1 crore from B&P bank under repo for a period of 7 days at an Answer
interest rate of 7% p.a. The security for this transaction is CG2016 – 7.6%. The following information is related to the security: >
Interest payments : 7th April and 7th October
Current price of the security : Rs.99.81
On the same day, ABN bank also enters in repurchase transaction for 1 lakh, 182-day Treasury bill with Bank of Karnataka for 14
days at the interest rate of 5% p.a. Following is the information regarding 182-day Treasury bill:
Issue date : 15th December 2006
Maturity date : 14th June 2007
Current price : 96.81
You are required to compute the repurchase price for the CG2016 – 7.6% and 182-day Treasury bill.
(10 marks)
<
5. Aircommand Air Conditioners Ltd (AACL) has furnished the following information pertaining to its credit policy: Answer
• Projected sales >
• Credit policy of the company is 2/10 net 30. It has been observed that 25% of the customers avail the discount. Out
of the remaining, 25% of customers pay within 20 days, 50% of the customers pay within 30 days and the rest pay
within 50 days.
• The bad debts
• Administrative
• AACL has been financing its investments in receivables through a mix of bank finance and long-term unds in the
ratio of 3:1. The effective rate of interest on bank finance is 15% and the cost of long-tern funds is 18%.
The sales executives are responsible for following up collections and on an average spend 25% of their time on collection. The
finance manager of AACL has realized that if the sales executives are relieved from collection responsibilities, the annual sales
would increase by 10%. Therefore the company has approached Rescue Financial Services. Rescue Financial Services has offered
the following two schemes:
Recourse factoring: The factoring agreement provides for an advance payment of 75% of the value of factored receivables.
Advance carries the interest of 14% p.a. and the factoring commission is 1.5% of the value of the factored receivables. Both interest
and commission are collected upfront.
Non-recourse factoring: The factoring agreement provides advance payment of 70% of the value of factored receivables. Advance
carries a rate of interest of 15% p.a. and the factoring commission is 3% of the value of factored receivables. Both interest and
commission are collected upfront.
After the careful analysis of the sales ledger of AACL, Rescue Financial Services agreed to a guaranteed payment period of 30
days. The finance manager of AACL is not sure whether to go for any factoring or to continue with in-house management for the
receivables.
You are required to recommend with calculation to the finance manager of AACL for the selection of the best scheme. (Assume
360 days in a year)
(10 marks)
END OF SECTION B

Section C : Applied Theory (20 Marks)


• This section consists of questions with serial number 6 - 7.
• Answer all questions.
• Marks are indicated against each question.
• Do not spend more than 25 -30 minutes on section C.

< Answer >


6. Building a large consumer credit portfolio is not a difficult task as compared to managing one.
Discuss the credit management function of a consumer credit institution.
(10 marks)
< Answer >
7. Now-a-days, the computer hardware and software are available in the market at cheaper rate. At
the same time, latest network operating system software is available at cheaper rate. This makes it
possible for even the smallest business to take advantage of networking computers and resources
together. However, although the costs of buying outright are low, still the companies are going for
IT and hardware leasing. Explain the reasons as to why the companies are going for IT and
hardware leasing along with the advantages associated with the same.
(10 marks)
END OF SECTION C

END OF QUESTION PAPER


Suggested Answers
Investment Banking and Financial Services-I (261) : January 2007
Section A : Basic Concepts
1. Answer : (b) < TOP >

Reason: Characteristics of perfect market:


All the players in the market have all the information relating to the security and the market price of
security reflects all the available information
The flow of funds within the market and between the market should not be restricted by the
Government regulations
Transaction cost will depend on trading and settlement processes
Transparency in the trading mechanism and shorter settlement periods
All players in the market are price takers.
Hence (b) is the correct answer.
2. Answer : (e) < TOP >

Reason: The open market purchase of gilts will ease the liquidity of banks
If the interest rate structure is to be moved upwards, the prices of securities in the OMO can be set at
higher levels thereby signaling an upward movements in interest rates
The effort to cool the interest rate volatility through OMO may some time lead to an interest differential
loss to the RBI
IF the PLR is reduced , the CP rate may also come down
Cut in repo rates will result in bringing down the call rates and also other term money rates.
Hence (e) is the correct answer.
3. Answer : (c) < TOP >

Reason: A very tight liquidity position will increase the call rates while excess liquidity will give fairly low and
stable rates
If the liquidity crunch of the banks is passed on to the system, it may lead to high volatility in the call
rates
Call rates under normal liquidity conditions are the floor rate for the term money market
In a volatile call market situation, lending will return high yields, and by selling Inter-Bank
Participations, the bank will have more money to play in the call market
The floor rate for CDs is fixed by short term deposit rates and the ceiling for CDs is set by CPs.
Hence (c) is the correct answer.
4. Answer : (a) < TOP >

Reason: To enable participation of small level operators in the Liquidity Adjustment Facility (LAF) and also to
add further operational flexibility to the scheme, the minimum bid size for LAF is being reduced to Rs.5
crore.
Hence (a) is the correct answer.
5. Answer : (d) < TOP >

Reason: Mr. Shah is withdrawing his deposit at the beginning of the 12th month hence he will be given the
interest for 11 months. Now as per Rule 8(1) of the Companies (Acceptance of Deposits) Rules, 1975
he will be given the interest at the rate of 10% because he is withdrawing the amount before one year.
Therefore the interest will be 2,00,000 * 0.10 *11/12 = 18,333 (approx)
Hence the total amount that is to be refunded is 2,00,000 + 18,333 = Rs.2,18,333
Hence (d) is the correct answer.
6. Answer : (e) < TOP >

Reason: Any person aggrieved by an order of SEBI can file an appeal petition to the Central Government. Such
appeal has to be filed within 30 days from the date of communication of the order. If the appellant had
sufficient cause for not preferring the appeal within 30 days, the Central Government may extend the
period by further 15 days.
Hence (e) is the correct answer.
7. Answer : (d) < TOP >

Reason: If a deposit held in a name of a person individually and the same depositor also holds a deposit jointly
with another person then they are treated as two different deposits.
Name of depositor Joint account holder Maximum amount insured
Prashant – 1,00,000
Prashant Resham 1,00,000
Srinivas – 1,00,000
Nandgopal – 95,000
Kalyan Anuradha 82,000
Kalyan – 90,000
Total 5,67,000
Hence the insurance premium payable is 567000*0.05/100 = Rs.283.50
8. Answer : (d) < TOP >

Reason: The takeover code is triggered when the acquirer obtains 15% equity stake in a company. The code
makes it mandatory for the acquirer to make a public offer to acquire a further 20% of equity of the
target company.
Hence (d) is the correct answer.
9. Answer : (a) < TOP >

Reason: Following are true with respect to the registration of the offer document for an IPO:
Ten copies of the draft prospectus have to be filed with SEBI by the lead manager
The lead manager is required to simultaneously file the draft prospectus with all the stock exchanges
where listing is proposed
The lead manager should furnish to the Board, an in-principle approval of the stock exchanges for
listing of the securities within 15 days of filing of the draft offer document with the stock exchanges
SEBI would make the observation within the 21 days from the filing and in case no observations are
received within the stipulated period the offer document is deemed to have been cleared by SEBI
The draft prospectus filed will be treated as public document.
Hence (a) is the correct answer.
10. Answer : (b) < TOP >

Reason: In case of public issue by unlisted companies, securities, which have been issued to the promoters
during the preceding one year, at a price lower than the price at which equity is being offered to public
are not eligible for computation of promoter’s contribution.
All other statements are correct.
Hence (b) is the correct answer.
11. Answer : (e) < TOP >

Reason: Credit rating is mandatory for any debenture issue where the conversion period exceeds 18 months
Appointment of SEBI registered Debenture Trustee is mandatory if the maturity period of the
instrument exceeds 18 months
Creation of Debenture Redemption Reserve is mandatory if the maturity period of the instrument
exceeds 18 months
In case the non convertible portion of the PCD is to be rolled over, as compulsory option is to be given
to debenture holders to redeem and encash their debentures
No issue of FCDs having conversion period exceeding 36 months unless conversion is made optional
with put and call options
Hence (e) is the correct answer.
12. Answer : (b) < TOP >

Reason: Cash pay bonds are simple debt instruments, which pay interest in cash
Secured premium notes are issued at face value and do not carry any interest
The term of maturity for the deep discount bond is usually around 20 to 25 years
In third party convertible debt a warrant is issued with the debt, which allows the investor to subscribe
the equity shares of another company
If the investors of zero coupon convertible note, choose to convert into the common stock of the issuer,
they have to forgo all accrued and unpaid part of the interest.
Hence (b) is the correct answer.
13. Answer : (d) < TOP >

Reason: GDR may be at the request of investor converted into equity shares by cancellation of GDRs through
intermediation of the depository and the sale of underlying shares in the domesticmarket through the
local custodian.
All other statements are correct for GDRs.
Hence (d) is the correct answer.
14. Answer : (a) < TOP >

Reason: If the issuer wants to roll over its non convertible portion of PCDs, he will have to obtain fresh credit
rating within the period of 6 months prior to the date of redemption.
Hence (a) is the correct answer.
15. Answer : (d) < TOP >

Reason : Demutualization is the latest buzzword rocking the stock exchanges all over. This means that securities
exchanges will no longer be owned only by the members of these exchanges as hitherto. They will be
converted into public companies where ownership will be divorced from trading rights of brokers and
securities. Hence (d) is the correct answer.
16. Answer : (c) < TOP >

Reason: When the security is sold it is to be considered as a sale of asset and not as an issuance of debt
obligation of the originator of the mortgages. All other options are correct.
Hence (c) is the correct answer.
17. Answer : (c) < TOP >

Reason: The intercorporate deposits raised by a finance company cannot exceed two times the net owned funds
of it.
Hence (c) is the correct answer.
18. Answer : (d) < TOP >

Reason: Ownership clause of the lessee agreement stipulates that the lessee shall not sell, assign, pledge or
otherwise encumber lien upon or against the equipment.
Hence (d) is the correct answer.
19. Answer : (a) < TOP >

Reason: Discount charges = 1000*0.20*90/360


= Rs.50
Value received by the client Rs.950
Effective rate of interest per quarter = 50/950 * 100
=5.26%.
Effective rate of interest per annum = 1.05264 –1 = 22.75%.
Hence (a) is the correct answer.
20. Answer : (b) < TOP >

Reason: The following are true with respect to leveraged lease transaction:
The leveraged lease has the third party called lender attached to it.
The debt fund raised by the leasing company is with full recourse to the lessee and without any recourse
to the lessor.
The trustee to the transaction remits the debt service component of the rental to the lender and the
balance to the lessor.
Under this transaction the lessor claims tax shields on the depreciation.
Hence (b) is the correct answer.
21. Answer : (d) < TOP >

Reason: A lease where the relative magnitude of investment involved is quite high or very high, is called
Big ticket lease.
Hence (d) is the correct answer.
< TOP >
22. Answer : (d)
Reason: Amount sanctioned is = 3,75,000*0.75
= 2,81,250
2,81, 250 × 0.0125 × [1.0125]
240

EMI= 1.0125240 − 1
= Rs.3,703.47
Hence (d) is the correct answer.
< TOP >
23. Answer : (c)
Reason: MMMFs are a special category of Mutual Funds, where returns are lower since liquidity levels are high.
These provide an investor the choice to invest forshort-term. These invest mainly in high rated paper so
safety levels are quite high. Hence (c) is the correct choice.
24. Answer: (a) < TOP >

Reason: Asian Dollar CDs carry both fixed and floating interest rates.
Hence (a) is the correct answer.
25. Answer : (c) < TOP >

Reason: If invoice discounting is not confidential in nature, the customers of the client are advised to make
payment directly to the factor. This facility when offered with a non-recourse feature is known as
Agency Factoring. Hence (c) is the correct answer.
26. Answer : (c) < TOP >

Reason: On factoring, 80% of receivables is converted into cash. Given that 50% of cash received through
factoring is utilized for reducing current liabilities,
80 + 180 + 20
Pre-factoring current ratio = 120 = 2.33
Changed current assets = 80 +180 x 0.2 + 20 + 180 x 0.8 x 0.5 = Rs.208 lakhs.
Changed current liabilities = 120 – ( 180 x 0.8 x 0.5) = Rs.48 lakhs
208
Hence, post factoring current ratio = 48 = 4.33
Hence, (c) is the answer.
27. Answer : (a) < TOP >

Reason: The total charge for credit is calculated as Loan Amount × Flat rate of interest × number of years.
Hence, in the given question, flat rate of interest = 21600/(90000 × 2) = 12%.
28. Answer : (c) < TOP >

Reason: First Stage Financing is provided to companies that have expended their initial capital (often in
developing and market testing a prototype) and require funds to initiate full scale manufacturing and
sales. Hence (c) is the correct answer.
29. Answer : (e) < TOP >

Reason: All of the following are true regarding accounting of a lease transaction in the books of lessor as per
Accounting Standard 19 of the Institute of the Chartered Accountants of India which states that
i. The lessor must record the finance lease as a receivable in the balance sheet at an amount equal to
the net investment in the lease.
ii. The lessor must bifurcate the lease rental into two components - (i) the capital component; and (ii)
the interest component.
iii. The pattern of recognizing the finance income must also reflect the uncertainties associated with
the collectibility of lease rentals, expectations of the future rates of interest, etc. particularly for
long-term leases.
Hence (e) is the answer.
30. Answer : (c) < TOP >

Reason: Letter of credit is provided by a third party for securitization structures with credit ratings below the
level sought for the issue. Hence, this is an external credit enhancement technique and (c) is the
answer.
Section B : Problems
1 In UK a lease transaction is treated as a true lease (lessor’s angle) < TOP >

Cost of the machines = Rs.150 crore


Let the lease rentals payable by India Glass Ltd. be L crore per annum
PV of lease rentals = LPVIFA(15,5) × 1.15 = Rs.3.8550L crore
PV of tax on lease rentals = LPVIFA(15,5) ×0.25 = Rs.0.8381L crore
PV of depreciation tax shield
Year Depreciation PVIF@15% PV of depreciation
1 45.00 0.8696 39.13
2 31.50 0.7561 23.82
3 22.05 0.6575 14.50
4 15.44 0.5718 8.83
5 10.80 0.4972 5.37
Total 91.64
PV of depreciation tax shield = 91.64 × 0.25 = Rs.22.91 crore
Now, the minimum rentals
–150 + 3.8550L – 0.8381L + 22.91 = 0
3.0169L = 127.09
Hence L = Rs.42.13 crore.
Hence, lease rentals payable annually in advance by India Glass Ltd. to TFS under this transaction is
Rs.42.13 crore.
A double dip transaction can be structured in the following manner:
TFS should lease to US Glass which in turn leases to India Glass because in US a lease transaction is
treated as sale and the depreciation and other benefits would be claimed by lessee. Hence, US parent
company can be made lessee in the lease transaction between US Glass and TFS and the lessor in the
lease transaction between India Glass and US Glass.
In case of the above double-dip lease transaction the cash flows of US Glass would be
Lease rentals payable to TFS – Outflow
Depreciation tax shield benefit – Inflow
Interest tax shield benefit – Inflow
Lease rentals receivable from India Glass – Inflow
Tax on interest portion of lease rentals
receivable from India Glass – Outflow

Let Y be the lease rental receivable annually by US Glass from India Glass at which net cash flow to US
Glass is zero.
PV of lease rentals payable to TFS (outflow) = 42.13 PVIFA (15,5) × 1.15
= Rs.162.41 crore
PV of depreciation tax shield (inflow) = Rs.22.91 crore
Unexpired finance charges = (42.13×5) – 150 = Rs.60.65 crore
Allocation of Unexpired finance charges
Year SOYD factor Interest PVIF@15% PV of interest
1 5/15 20.22 0.8696 17.58
2 4/15 16.17 0.7561 12.23
3 3/15 12.13 0.6575 7.98
4 2/15 8.09 0.5718 4.62
5 1/15 4.04 0.4972 2.01

Total 44.42
PV of interest tax shield (inflow) = 44.42 × 0.25 = Rs.11.11 crore
PV of lease rentals receivable by
US Glass from India Glass (inflow) = Y × PVIFA(15,5) ×1.15
= Rs.3.855Y crore
PV of tax on finance income of US Glass
Unexpired finance charge = 5Y-150
Year SOYD factor Interest PVIF@15% PV of interest
1 5/15 1.6667Y–50 0.8696 1.45Y–43.48
2 4/15 1.3333Y–40 0.7561 1.01Y–30.24
3 3/15 1Y–30 0.6575 0.66Y–19.73
4 2/15 0.6667Y–20 0.5718 0.38Y–11.44
5 1/15 0.3333Y–10 0.4972 0.17Y–4.97

Total 3.66Y–109.86
PV of tax on interest income (outflow) = (3.66Y–109.86) × 0.25
= Rs.0.915Y–27.47 crore
Now,
–162.41 + 22.91 + 11.11 + 3.855Y – (0.915Y–27.47) = 0
Y=Rs.34.33 crore.
Therefore the rentals payable by India Glass to US glass is Rs.34.33 crore which is lower than the rental
payable to TFS if double dip transaction is not undertaken.

2 a. Computation of Cost of Funds under different alternatives for the year 2006-07 < TOP >

DPS = {2000 x 30%}/200 =3


Expected DPS next year (Dl) = 3.30
Growth rate (g) = 10%
Market price (PO) = 1350
Flotation cost (f) = 2%
Cost of equity = {Dl/PO(I-f)} + g = 10.25%
Interest Allocation of FRN
Realized amount per FRN = Rs.5000 x (1 – 0.0075) = 4962.5
Applicable Annual Interest Principal Post tax Total cash
interest rate payment component component interest flow
0.1175 1250 587.5 662.5 452.38 1114.88
0.1184 1250 513.56 736.44 395.44 1131.88
0.1197 1250 431.05 818.95 331.91 1150.86
0.1213 1250 337.47 912.53 259.85 1172.38
0.1225 1250 229.02 1020.98 176.35 1197.32
0.1225 952.55 103.95 848.60 80.04 928.64
Effective cost of the FRN=IRR of the above cash flow = 9.44%.
Hence from the cost of funds to the company point of view, the FRN would be preferred
< TOP >
3 a. Bonus adjusted EPS for the year 2006 is Rs.75
Growth rate in EPS is 50 (1+g)5 = 75
Hence g= 8.45%
Now dividend for the year = 56.25 × 0.25 = Rs.14.06
Dividends next period = 14.06 × 1.0854 = 15.25
Cost of equity can be calculated from CAPM as follows:
RF + β( Rm- RF) =
RF + Risk premium
6% + 9% = 15%
Using perpetual growth rate
Expected domestic price
D1/ ke – g = 15.25/ 0.15 – 0.0845 = Rs. 232.82
Price of 1 GDR = 3 × 232.82× 0.95 = Rs.663.54
Price of 1 GDR in $= 663.54/45 = $14.75.
Number of GDRs to be issued
Amount of GDRs to be issued = $5 million/1- 0.02 = $ 5.10million
Number of GDRs = 5.10/14.75= 3,45,763 (approx)
b. Computation of cost of GDRs
Price of 1 GDR = Rs. 663.54
Expected dividends = 15.25 × 3 = Rs.45.75
Growth rate = 8.45%
Cost of GDR = D1/ P0(1-f) + g = 15.49%
c. Computation of gains/loss to a holder of 100 GDR
Initial Investment =100 × 14.75 = $ 1475
Number of rights = 100 ×1/3 ×3 = 100
Investment in 100 rights = 100 × 200= Rs.20,000 = 20000/46 = $434.78
Total investment = 1475 + 434.78 = $1909.78
15.25(1.0845)
Price of share at the end of 2007 = 0.15 − 0.0845 = Rs.252.50
252.50 × 3 + 200
= Rs.239.38
Ex-rights price = 3 +1
Total value = 400 × 239.38 = Rs.95,752
Total value in dollars = 95,752/46 = $2081.57
Total gains = 2081.57–1909.78 = $171.79.
< TOP >
4 CG2016 – 7.6%
Amount in Rs.
Value of the security 99,81,000.00
Interest for the period
7th Oct. to 6th Jan. i.e. for 90 days 1,90,000.00
Total 1,01,71,000.00
This actual amount borrowed will , therefore be 1,01,71,000.00
Since the contract envisage payment of interest on the borrowing at 7% for 7
days the interest is 1,01,71,000× 0.07 × 7/365 13,654.22
Total amount to be paid by ABN bank to B&P bank 1,01,84,654.22
The price of the buyback of the security will be now worked out as under
Amount to be paid 1,01,84,654.22
th th
Interest for 97 days i.e. from 7 Oct. to 14 Jan. 2,04,777.78
Price of the security 99,79,876.44
182 day Treasury bill
Value of 182 day Treasury bill Rs.96,81,000
Now the interest on the value for 14 days
96,81,000 × 0.05 × 14/365 Rs.18,566.30
Price for the second leg is Rs.96,81,000 + Rs.18,566.30 = Rs.96,99,566.30.

< TOP >


5 Relevant cost for in house management of receivables:
Cash discount
800*0.02*0.25 = Rs.4 lakh
Average collection period =
0.25*10 + 0.75[0.25*20+0.50*30+0.25*50] 27 days (approx)
Cost of bank finance =
800*(3/4)*(27/360)*0.15 = Rs.6.75 lakh
Cost of long term funds =
800*(1/4)*(27/360)*0.18 = Rs.2.70 lakh
Total cost of funds = Rs.9.45 lakh
Bad debts
800*0.05 = Rs.40 lakh
Contribution lost on forgone sale
80*0.25 = Rs.20 lakh
Avoidable cost of sales ledger and administrative and credit monitoring Rs.2 lakh

Total cost of in house management Rs.75.45 lakh.


Relevant cost of Recourse factoring
Factoring commission
880*0.015= Rs.13.20 lakh
Discount charge
880*0.75*0.14*(30/360)= Rs.7.70 lakh
Cost of long term funds
880*0.25*0.18*(30/360)= Rs.3.30 lakh
Bad debt
880*0.05 Rs.44 lakh

Total cost of Recourse factoring = Rs.68.20 lakh


Relevant cost of Non Recourse factoring
Factoring commission
880*0.03 Rs.26.40 lakh
Discount charge
880*0.70*0.15*(30/360)= Rs.7.70 lakh
Cost of long term funds
880*0.30*0.18*(30/360)= Rs.3.96 lakh

Total cost of Recourse factoring = Rs.38.06 lakh


Hence the Non Recourse factoring is recommended.

Section C: Applied Theory

< TOP >


6 Building a large consumer credit portfolio is not a difficult task as compared to managing one. This is
so because ‘managing’ entails evaluating, monitoring and controlling a large number of individual
accounts. Therefore, a consumer credit institution must primarily focus on stream-lining the credit
management function.
Credit Evaluation
The first step in the streamlining process is to define and articulate a clear-cut procedure for evaluating
customers. This is a 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.
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.
Methods of Pre-Screening Borrowers
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 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 the different categories. For example the borrower who gave the most
unfavorable response to each question will have a risk index of 28 and the (smart) borrower who
furnished all favorable responses 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 all loan applicants with a credit-risk index of more than 10 will be rejected.
Bookkeeping and Collection
Managing a consumer credit portfolio effectively requires: (a) a system of bookkeeping that is
accurate; and (b) a collection program that is consistent and persistent. Collection efforts are bound to
deteriorate if the slow-paying accounts cannot be followed up with authority because information is not
up to date.
As far as enhancing the effectiveness of the collection program is concerned, the following guidelines
have been offered by a credit manager:
A good collection practice is to ask for payment when the customer is most likely to pay. The whole
point of a collection letter is to induce payment and must be timed to arrive as near to pay day as
possible.
For accounts which miss the first installment – the first payment – failure, a personal call must be made
immediately. The personal call will at least confirm that the customer still lives at the address and
establish the real reason why the account has not been paid properly.
The person following up an account should not threaten action unless his office intends to take that
action if the account is not paid. The customer will not take the credit department seriously if it does
not mean what it says.
Slow paying accounts with small balances do not justify legal action on economic grounds. In such
cases, the collection of such balances can be achieved by getting the customer to sign a declaration to
pay by say, weekly installments. Of course the last resort is recovering large accounts is legal action.
< TOP >
7 Even with computers and software being relatively cheap to buy, there is still the risk that a new
version of application software will be released just after one has bought. It is also true that application
software, which is often updated by the software manufacturer every two years or so, can make
hardware obsolete in some cases.
While computer manufacturers imply that their machines can be upgraded cost-effectively, the reality
is sometimes rather different.
Taking into account the cost of upgrading hardware and software, leasing becomes a sensible option
for many firms.
Financial benefits of a Computer Fleet finance and management program include:
• Reduced administration costs and more effective use of management time
• Simplified procurement procedures
• Improved balance sheet performance
• Improved audit ability of IT assets and allocation costs
• Return on equipment at the end of its life ceases to be an issue
• More consistent cash flow
• Greatly reduced cost of support through elimination of non-standard hardware

< TOP OF THE DOCUMENT >


Question Paper
Investment Banking and Financial Services-I (261):
April 2007
Section A : Basic Concepts (30 Marks)
• This section consists of questions with serial number
1 - 30.
• Answer all questions.
• Each question carries one mark.
• Maximum time for answering Section A is 30
Minutes.

<
1. Which of the following functions of the financial system ensures a smooth flow of funds from Answ
savings to investments in order to stabilize the economy? er >
(a) Savings function
(b) Policy function
(c) Credit function
(d) Financial function
(e) Investment function.
<
2. Which of the following statements is not true regarding various types of bills of exchange? Answ
(a) Bill which is payable at a specified later date is called a usance bill er >
(b) Bill accepted by the drawee to accommodate the drawer without having received any
consideration is called an accommodation bill
(c) Bill drawn in India and made payable outside India is called a foreign bill
(d) Bill accompanied by the documents of title to goods such as lorry receipt or bill of lading is
called a clean bill
(e) Bill which arises out of supply of goods by manufacturing concerns is called a supply bill.
<
3. Which of the following statements is not true with respect to the lock-in requirements of the Answ
promoters’ contribution? er >
(a) The minimum contribution to be made by promoters’shall be locked-in for a period of three
years
(b) In case the promoters’ contribution in the proposed issue exceeds the minimum specified
contribution, such excess contribution will also attract lock-in period of three years
(c) The lock-in period commences from the date of allotment or from the date of
commencement of commercial production whichever is later
(d) The specification of shares for lock-in will follow reverse chronological order
(e) Shares issued to the promoter at a price lower than the current issue price during the
preceding 12 months period are required to be locked-in for a period of three years.
<
4. A CD that allows the investors to withdraw a certain amount of promised yields on selected yearly Answ
dates is called er >
(a) Installment CD
(b) Thrift CD
(c) Jumbo CD
(d) Declining rate CD
(e) Rising rate CD.
<
5. Which of the following is/are true with respect to credit rating? Answ
er >
I. A credit rating is a professional opinion given after studying all available information at a
particular point of time.
II. There is no privity of contract between an investor and a rating agency and the investor is free
to accept or reject the opinion of the agency.
III. Rating agency compensates the investor who has made an investment relying on the rating and
makes loss on investment.
(a) Only (I) above
(b) Only (III) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
<
6. The instrument which provides the investor the option to convert the paper into flat interest paying Answ
instrument at the end of a particular period, is known as er >
(a) Mismatch FRNs
(b) Mini-max FRNs
(c) Flip-flop FRNs
(d) Capped FRNs
(e) VRN-structured FRNs.
<
7. Green shoe option is an arrangement wherein the issue would be over allotted to the extent of a Answ
maximum of _____% of the issue size. er >
(a) 10
(b) 15
(c) 20
(d) 25
(e) 30.
<
8. In a fixed price issue the issuing company can mention cap on the price band, which should not be Answ
more than ____ of the floor price. er >
(a) 10%
(b) 20%
(c) 25%
(d) 30%
(e) 35%.
<
9. In case of Book Built issues, the minimum period for which bidding will be open is 3 working days. Answ
The maximum period for which bidding will be open and the maximum number of days by which it er >
can be extended in case of a revision in the price band are
(a) 6 days and 2 days respectively
(b) 6 days and 3 days respectively
(c) 7 days and 2 days respectively
(d) 7 days and 3 days respectively
(e) 10 days and 4 days respectively.
<
10 Which of the following statements is not true with respect to the Indian Depository Receipts Answ
. (IDRs)? er >
(a) Through IDRs the Indian investors can own overseas stock
(b) IDRs issued by any company in any financial year shall not exceed 15% of its paid up
capital and free reserves
(c) IDRs shall not be redeemed into underlying equity shares before the expiry of six months
period from the date of the issue of the IDRs
(d) The issuing company shall not have pre-issue debt to equity ratio more than 2:1
(e) The issuing company has been making profits for at least five years preceding the issue and
has been declaring the dividend of not less than 10% each year for the said period.
<
11 Which of the following facilities does the RBI provide to the guilt funds? Answ
. er >
I. The gilt funds are given the facility of transfer of funds from one center to another under the
Remittance Facility Scheme of the RBI.
II. The gilt funds are also given the facility of clearing of cheques arising out of government
securities transactions, tendered at the RBI counters.
III. Gilt funds are given the facility to access the call money market as borrowers.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
<
12 Which of the following is not true with respect to deposit insurance provided by DICGC? Answ
. er >
(a) The deposit will have an insurance cover for the actual amount of the deposit subject to a
maximum of Rs.1,00,000
(b) For this purpose the deposits of a depositor at different branches are clubbed together
(c) Individual deposits and joint deposits held by a person are clubbed together for this purpose
(d) The premium payable for the insurance is at the rate of 5 paise per half year for every
hundred rupees
(e) The premium is paid at the end of December and June.
<
13 An adjustment made for offsetting the market risk to save the borrower or the lender from the Answ
. transaction price movements in a repo transaction, is called er >
(a) Haircut
(b) Hairoff
(c) Hairon
(d) Hair adjustment
(e) Centric adjustment.
<
14 Which of the following is not true with respect to repo? Answ
. er >
(a) The amount of activity in the repo market will increase the turnover of the money market,
resulting in an enhanced liquidity and depth in the market
(b) As a tool of financing the repo would cause an increase in the turnover in the debt market
(c) Repo enables the traders to take convenient positions to go short or long in the market,
which results in incresed activity of the debt market
(d) Institutions and corporates see repo as an expensive way of financing
(e) Repo is also useful to the Central Bank in the way they can use them as a part of their open
market operations.
<
15 Which of the following is not true with respect to 364-Day T-Bills? Answ
. er >
(a) The RBI does not discount these bills
(b) The RBI does not participate in the auction of these bills
(c) Auction of these bills takes place every fortnight
(d) The auction amount of a bill is conveyed 3 days before the date of auction
(e) The yield on these bills can be used as a benchmark for determining the interest rate of
floating rate bonds.
<
16 Which of the following is/are not true with respect to Shibosai Bonds? Answ
. er >
I. These are privately placed bonds issued in the Japanese markets.
II. The qualifying criteria are stringent for this bond as compared to Samurai or Euro Yen bonds.
III. These bonds are offered to a different market segment that consists of institutional investors
including banks.
IV. The eligibility criteria, amount, maturity and redemption as well as the coupon rate and issue
price all are governed by Japan’s Ministry of Finance guidelines.
(a) Only (II) above
(b) Only (III) above
(c) Both (I) and (III) above
(d) (I), (II) and (III) above
(e) All (I), (II), (III) and (IV) above.
<
17 Belgian Dentist is the term used to describe Answ
. er >
(a) The institutional investors who make market specific investment
(b) The institutional investors who make market and industry specific investment
(c) The institutional investors who make time specific investment
(d) The lenders who are mainly the banks in case of Euroloans
(e) The high net worth individuals who subscribe to the equity of the corporates in case of
GDRs.
<
18 A lease which does not provide a purchase option to the lessee at the end of the lease period and the Answ
. asset reverts back to the lessor is called er >
(a) Walk away lease
(b) Wet lease
(c) Big ticket lease
(d) Master lease
(e) Lease line.
<
19 Which of the following is true for break even lease rental from the view point of lessee? Answ
. er >
(a) A large upfront payments decreases the break even rental
(b) A higher tax relevant rate of depreciation increases the break even rental
(c) A longer primary lease period increases the break even rental
(d) Higher cost of capital increases the break even rental
(e) A higher net salvage value increases the break even rental.
<
20 Under which of the following types of factoring, the factor purchases the receivables on the Answ
. condition that the loss arising on account of irrecoverable receivables will be born by the client? er >
(a) Recourse factoring
(b) Non-recourse factoring
(c) Maturity factoring
(d) Advance factoring
(e) Full factoring.
<
21 Which of the following is not the functions of a factor? Answ
. er >
(a) Sales ledger administration
(b) Credit protection
(c) Long term funding
(d) Advisory services
(e) Collection.
<
22 Mr. Prashant has accumulated savings of Rs.83,000 for five years with NHB. He requires a loan for Answ
. a new accommodation, which is of 862 square feet. What will be the maximum amount of loan er >
disbursed to him under Home loan account scheme?
(a) Rs. 83,000
(b) Rs. 1,66,000
(c) Rs. 2,49,000
(d) Rs. 3,32,000
(e) Rs. 4,15,000.
<
23 Which of the following statements is/are not true? Answ
. er >
I. For investors seeking low exposure to interest rate risk, the shorter tranche CMOs are best
suited.
II. The shorter tranches must be retired before longer tranches receive principal payments.
III. The shorter tranches have a form of call protection.
IV. For the long term investors who want to avoid reinvestment risk, the longer tranche CMOs are
ideal investment vehicles.
(a) Only (I) above
(b) Only (III) above
(c) Both (I) and (III) above
(d) (I), (II) and (III) above
(e) All (I), (II), (III) and (IV) above.
<
24 Ms. Riddhi is intending to own a house worth Rs.3,75,000. She is sanctioned 75% of the cost of the Answ
. house as loan. The interest rate on loan is 15% and tenure for the same is 20 years. The EMI er >
payable by her is
(a) Rs.3,003.47
(b) Rs.3,203.74
(c) Rs.3,530.74
(d) Rs.3,703.47
(e) Rs.3,803.47.
<
25 A leasing company which is formed as a subsidiary of a manufacturing company for leasing the Answ
. products of the parent company, is called er >
(a) Captive leasing company
(b) Common leasing company
(c) Formal leasing company
(d) Extended leasing company
(e) Integrated leasing company.
<
26 I-Let Ltd. is a leasing company. Following are the relevant information for a lease transaction Answ
. undertaken by the company: er >
Lease rental receivable for the next five years : Rs.2.50 crore
Lease rental receivable over the lease term : Rs.3.50 crore
Cost of leased equipments : Rs.2.75 crore
Net owned funds : Rs.11.00 crore
The amount drawn as cash credit for this transaction from the bank is
(a) Rs.1.90 crore
(b) Rs.1.83 crore
(c) Rs.1.53 crore
(d) Rs.1.47 crore
(e) Rs.1.33 crore.
<
27 Which of the following is not true with respect to drawing refinance assistance by the companies Answ
. from NHB? er >
(a) The companies should be registered with NHB to carry on the business of housing finance
(b) The companies should be providing long term finance for construction / purchase / repair /
upgradation of housing units
(c) The companies should invest at least 75% of capital employed in the form of long term
housing finance
(d) The companies should have net owned fund of at least Rs.20 crore
(e) The companies should have net non-performing assets not more than 5% of the net
advances.
<
28 A company has issued Pass Through Certificates (PTCs) backed by a pool of property receivables Answ
. aggregating to Rs.350.00 lakh. The equated monthly payments to be made to PTC holder are as er >
follows:
During the first 12 months : Rs. 18 lakh p.m.
During the next 12 months : Rs. 14 lakh p.m.
During the next 6 months : Rs. 10 lakh p.m.
Calculate the promised rate of return to the investor.
(a) 15.56%
(b) 17.66%
(c) 24.16%
(d) 29.33%
(e) 34.33%
<
29 Which of the following statements is true with respect to Real Estate Investment Trusts (REITs)? Answ
. er >
(a) The most prominent form of lending by REITs is the construction/developmental lending
(b) To retain their special tax status, REITs have to distribute 50% of their income to
shareholders
(c) REITs are not allowed to raise finance through debt as they are equity investment vehicles
(d) Indirect equity investments in REITs by investor usually lack liquidity
(e) According to the federal laws, REITs can only be infinite life trusts.
<
30 I-Lend Finance Limited has the policy of discounting the L/C backed bills of its clients at the rate of Answ
. 18% p.a., when the value of a bill is Rs.1000. er >

The annual effective rate of interest implied by the above bill with a usance period of 90 days is
(a) 18.00%
(b) 20.21%
(c) 22.75%
(d) 23.50%
(e) 24.00%.
END OF SECTION A

Section B : Problems (50 Marks)


• This section consists of questions with serial number 1 – 5.
• Answer all questions.
• Marks are indicated against each question.
• Detailed workings should form part of your answer.
• Do not spend more than 110 - 120 minutes on Section B.
< Answer >
1. Consider the following information with respect to Teledata Info Limited (TIL).
Particulars Rs.
Equity capital: Issued and fully paid
(50,00,000 shares of Rs.10 each) 5,00,00,000
Reserves & surplus 8,00,00,000
Long-term debt 2,50,00,000
Market price per share Rs.45
Earnings per share Rs.9
Effective corporate tax rate 33%
Out of the total long-term debt of Rs.2,50,00,000 the company wishes to redeem a loan of Rs.1,00,00,000
carrying an interest rate of 10% by making a rights issue.
You are required to
a. Calculate 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
part (a) above.
c. Calculate the change in wealth of a shareholder who owns 1000 shares in TIL.
i. If he sells his rights
ii. If he allows his rights to expire.
(4 + 2 + 2 = 8 marks)
< Answer >
2. The commitment for aggregative bidding for Government Securities and T-bills of six Primary Dealers are as
under:

Particulars P Q R S T U
T-Bills 4000 3200 4800 3000 3600 4400
Government
4800 3200 4000 3600 2600 4000
Securities

The details of bids tendered are as follows:


Particulars P Q R S T U
T-Bills 3600 4000 4800 3200 3200 4000
Government
6000 4000 3200 4000 3000 4000
Securities

The details of the bids accepted are as follows:


Particulars P Q R S T U
T-Bills 1200 1600 2400 800 1200 1400
Government
2000 1000 1200 2000 1600 2000
Securities

You are required to


a. Compute the required level of successful bidding in T-Bills and Government Securities for each of the
Dealers.
b. Tabulate which of the Dealers have adhered to the aggregative bidding commitment and achieved the
required level of successful bidding.
(4 + 4 = 8 marks)
< Answer >
3. Vrajesh Engineering (VE) wants to use some high cost Computer Numerical Control (CNC) machines costing
Rs.300 lakh for complete automation of all its manufacturing. This automation would help the company to
achieve 100% capacity utilization from the current 75% level. Given the uncertainties associated with the CNC
machine market, the Vice President (Technical) believes that the useful life of the CNC machines is a
stochastic (random) variable with the following probability distribution:

Useful Life (in years) 3.0 4.0 5.0 6.0


Probability 0.4 0.3 0.2 0.1
After reviewing the above probability distribution, the Vice President (Finance) is considering the options of
purchasing the CNC or taking the same on lease.
For purchase option the company has approached Cen Bank. Cen Bank is willing to provide loan up to 75% of
the total cost of the machine at an interest rate of 16% p.a. for the period of five years. The loan will be repaid
in five equal annual installments.
Genext Financial Services (GFS) is a leasing company with offerings ranging from leasing of CNC machines
to various automation equipments. GFS’s portfolio includes operating and finance leases, variety of acquisition
strategies for multi-vendor/multi-technology solutions, utility structures and lifecycle asset management. GFS
has come up with the following lease proposal for VE.
A finance lease under which, the lessee will have to pay a rental of Rs.425/Rs.1000 a year for a non-cancelable
period of five years. After five years, the lease can be renewed for another three years on a yearly basis at a
rental of Rs.30/Rs.1000 per year. The lease rentals are payable annually in arrears.
The following information is provided by the VP (Finance) of VE:
• The capital costs of similar high technology CNC machines have been escalating at the rate of 10% p.a.
over the last 3 years.
• The ratio of cost of used CNC machine to cost of new CNC machine is expected to be 0.25 after 3
years.
• The net realizable value of the CNC machines by the end of year 4 will be negligible.
• The lease rentals for the second lease term should be projected assuming a pre-tax return of 25%.
• The cash flow projections reveal that the investment in the new CNC machines will result in an
incremental EBDIT of Rs.190 lakh in 1st year, Rs.210 lakh in 2nd year and Rs.250 lakh p.a. from 3rd year
to 6th year.
• The tax relevant rate of depreciation is 25%.
• Marginal rate of tax (including surcharge) is 35%.
• Post tax required rate of return is 18% p.a.
You are required to suggest the VP (Finance) of VE the alternative which will make more commercial sense.
(Use Weingartner’s Model for lease evaluation.)
(14 marks)

< Answer >


4. Now a days automobile industry has become very competitive and the players are coming out with new
schemes frequently. Maruti Motors is planning to come up with an attractive scheme for their new diesel
model. The price of the same is Rs.5,00,000. As per the scheme 75% of the value of the car will be provided as
loan. The customer will have to pay the token payment of Re.1 and the remaining amount will be repaid in 18
monthly equated installments (payable in arrear). The installment is Rs.22,868 p.m. The VP (Finance) of the
company is analyzing this scheme and has asked you to
a. Compute the effective rate of interest and the nominal rate of interest implied by the scheme and advise
whether this scheme will be effective to grab the customers if the competitors are offering the effective
rate of 14% p.a.
b. Develop the repayment schedule clearly distinguishing the capital component and interest component.
(4 + 6 = 10 marks)
st
5. Given below is the balance sheet of Black Ltd. as on 31 March, 07. The company intends to avail factoring < Answer >
service from a factoring company White Ltd. which keeps a margin of 20%. Yes Bank is also willing to finance
the receivables on a similar margin by providing bank overdraft.
Balance sheet as on 31st March, 2007
Liabilities Rs. in lakh Assets Rs. in lakh
Net worth 180 Fixed assets 120
Long-term debt 60 Inventory 100
Current liabilities 180 Receivables 180
Cash 20
420 420
You are required to
a. Find out the impact of advance factoring and bank overdraft on the current ratio of the Black Ltd. and recast
the balance sheet.
b. Recast the balance sheet, if Black Ltd. utilizes the additional cash received through factoring or bank
overdraft to reduce its current liabilities by Rs.70 lakh and also calculate the current ratio.
c. Comment on the impact on current ratio in (a) and (b) above.
(3 + 4 + 3 = 10 marks)
END OF
SECTION B

Section C : Applied Theory (20 Marks)


• This section consists of questions with serial number 6 - 7.
• Answer all questions.
• Marks are indicated against each question.
• Do not spend more than 25 -30 minutes on section C.
< Answer >
6. Globalization brings the entire world onto a single stage. The world’s largest retail enterprises seek globalization in
the retail industry and are continuously striving to make their presence global. Many countries including China,
Brazil, Thailand and Singapore have opened their retail sector to foreign players and are reaping benefits of it. Now
India is the next destination. With reference to this describe the need of FDI in the development of retail sector in
India. Also discus the benefits associated with the entry of FDI in the retail sector of India.
(10 marks)
< Answer >
7. Describe future flow securitization. What are the advantages of this kind of securitization? Also enumerate the
various risk associated with future flow securitization.
(10 marks)

END OF
SECTION C

END OF QUESTION
PAPER

Suggested Answers
Investment Banking and Financial Services-I (261): April 2007
Section A : Basic Concepts
1. Answer : (b) < TOP >

Reason: Policy function of a financial system ensures smooth flow of funds from
savings to investments in order to stabilize the economy. Hence,
alternative (b) is answer. Savings function ensures mobilization of
savings to provide a potentially profitable and low risk outlet. Credit
function ensures the savings transform into the necessary credit for
investment and spending purposes.
Hence, option (b) is the correct answer.
2. Answer : (d) < TOP >

Reason: Bill which is accompanied by documents of title to goods such as


railway receipt/lorry receipt/bill of lading is called a documentary bill.
Bill which is not accompanied by any such documents of title of goods
is called a clean bill. Therefore, statement (d) is false.
Hence, option (d) is the correct answer.
3. Answer : (b) < TOP >

Reason: The following statements is true with respect to the lock-in requirements
of the promoters’ contribution:
• The minimum promoters’ contribution shall be locked-in for a
period of three year
• In case the promoters’ contribution in the proposed issue exceeds
the minimum specified contribution, such excess contribution will
also attract lock-in period of one years
• The lock-in period commences from the date of allotment or from
the date of commencement of commercial production whichever is
later
• The specification of shares for lock-in will follow reverse
chronological order
• Shares issued to the promoter at a price lower than the current issue
price during the preceding 12 month period are required to be
locked-in for a period of three years.
Hence (b) is the correct answer.
4. Answer : (e) < TOP >

Reason: A Rising Rate CD allows the investor to withdraw a certain amount of


promised yields on selected yearly dates. Hence (e) is the answer.
5. Answer : (c) < TOP >

Reason: The following are true with respect to the credit rating:
• A credit rating is a professional opinion given after studying all
available information at a particular point of time.
• There is no privity of contract between an investor and a rating
agency and the investor is free to accept or reject the opinion of the
agency.
• Rating agency does not compensate the investor who has made an
investment relying on the rating and makes loss on investment.
Hence (c) is the correct answer.
6. Answer : (c) < TOP >

Reason: The instrument which provides the investor the option to convert the
paper in to flat interest paying instrument at the end of particular period,
is known as Flip-flop FRNs.
Hence (c) is the correct answer.
7. Answer : (b) < TOP >

Reason: Green shoe option is an arrangement wherein the issue would be over
allotted to the extent of a maximum of 15 % of the issue size.
Hence (b) is the correct answer.
8. Answer : (b) < TOP >

Reason: In a fixed price issue the issuing company can mention cap on the price
band, which should not be more than 20% of the floor price.
Hence (b) is the correct answer.
9. Answer : (d) < TOP >

Reason: In case of Book built issues, the minimum and maximum period for
which bidding will be open is 3 – 7 working days extendable by 3 days
in case of a revision in the price band.
Hence (d) is the correct answer.
10. Answer : (c) < TOP >

Reason: Through IDRs the Indian investors can own overseas stock.
IDRs issued by any company in any financial year shall not exceed 15%
of its paid up capital and free reserves.
IDRs shall not be redeemed in to underlying equity shares before the
expiry of one year period from the date of the issue of the IDRs
The issuing company shall not have the pre-issue debt to equity ratio
more than 2:1
The issuing company has been making profits for at least five years
preceding the issue and has been declaring the dividend of not less than
10% each year for the said period.
Hence (c) is the correct answer.
11. Answer : (c) < TOP >

Reason: The following facilities the RBI provides to the guilt funds:
• The gilt funds are given the facility of transfer of funds from one
center to another under the Remittance Facility Scheme of the
Reserve Bank.
• The gilt funds are also given the facility of clearing of cheques
arising out of government securities transactions, tendered at the
Reserve Bank counters.
• Gilt funds can access the call money market as lenders.
Hence (c) is the correct answer.
12. Answer : (c) < TOP >

Reason: The following is true with respect to deposit insurance provided by


DICGC:
• The deposit will have an insurance cover for the actual amount of
the deposit subject to a maximum of Rs.1,00,000
• For this purpose the deposits of a depositor at different branches
are clubbed together
• Individual deposits and joint deposits are treated separately for this
purpose
• The premium payable for the insurance is at the rate of 5 paise per
half year for every hundred rupees
• The premium is paid at the end of December and June.
13. Answer : (a) < TOP >

Reason: The haircut is an adjustment made for offsetting the market risk to save
the borrower or the lender for transaction price movements in a repo
transaction.
Hence (a) is the correct answer.
14. Answer : (d) < TOP >

Reason: Following statements are true with respect to repos:


• The amount of activity in the repo market will increase the
turnover of the money market, resulting in the enhanced liquidity
and depth in the market
• As a tool of financing the repos would cause an increase in the
turnover in the debt market
• Repos enable the traders to take convenient positions to go short
and or long in the market and the activity of the debt market
increases
• Institutions and corporates see repos an inexpensive way of
financing and can borrow and invest at market rates
• Repos are also useful to the Central Bank in the way they can use
them as apart of their open market operations.
Hence (d) is the correct answer.
15. Answer : (d) < TOP >

Reason: The following are true with respect to 364-Day T-Bills:


• The RBI does not discount these bills
• The RBI does not participate in the auction of these bills
• Auction of these bills takes place every fortnight
• The auction amount of a bill is not conveyed before the date of
auction
• The yield on these bills can be used as a benchmark for
determining the interest rate of floating bonds.
Hence (d) is the correct answer.
16. Answer : (a) < TOP >

Reason: Following are true with respect to Shibosai Bonds:


• These are the privately placed bonds issued in the Japanese
markets.
• The qualifying criteria are less stringent for this bond as compared
to Samurai or Euro Yen bonds.
• These bonds are offered to a different market segment that consists
of institutional investors including banks
• The eligibility criteria, amount, maturity and redemption as well as
the coupon rate issue price all are governed by Japan’s Ministry of
Finance (MoF) guidelines
• In terms of eligibility, MoF has classified various borrowers into
three groups in accordance with the rating.
Hence (a) is the correct answer.
17. Answer : (e) < TOP >

Reason: Belgian Dentist is the term used to describe the high net worth
individuals who subscribe to the equity of the corporates in case of
GDR.
Hence (e) is the correct answer.
18. Answer : (a) < TOP >

Reason: A lease which does not provide a purchase option to the lessee at the end
of the lease period and the asset reverts back to the lessee is called Walk
away lease
Hence (a) is the correct answer.
19. Answer : (d) < TOP >

Reason: - A large upfront payment increases the break even rental.


- A higher tax relevant rate of depreciation decreases the break even
rental.
- A longer primary lease period decreases the break even rental.
- Higher cost of capital increases the break even rental.
- A higher net salvage value decreases the break even rental.
Hence (d) is the correct answer.
20. Answer : (a) < TOP >

Reason: Under recourse factoring, the factor purchases the receivables on the
condition that the loss arising on account of irrecoverable receivables
will be born by client.
Hence (a) is the correct answer.
21. Answer : (c) < TOP >

Reason: The following are the functions of the factor:


- Sales ledger administration
- Credit protection
- Short term funding
- Advisory services
- Collection
Hence (c) is the correct answer
< TOP >
22. Answer : (b)
Reason: Under Home loan account scheme the maximum amount of loan that
can be disbursed is as follows:
Built up area Maximum amount of loan
Up to 430 sq. ft Four times of amount saved
Up to 860 sq. ft Three times of amount saved
Exceeding 860 sq. ft Two times of amount saved
Therefore loan to Mr. P = 83000 * 2
= Rs. 1,66,000.
Hence (b) is the correct answer.
< TOP >
23. Answer : (b)
Reason: The following statements are true:
• For investors seeking low exposure to interest rate risk, the shorter
tranche CMOs are best suited.
• The shorter tranches must be retired before longer tranches.
• The longer tranches have a form of call protection.
• The long term investors who want to avoid reinvestment risk, the
longer tranche CMOs are ideal investment vehicles.
Hence (b) is the correct answer.
24. Answer : (d) < TOP >

Reason: Amount sanctioned is = 3,75,000*0.75


= 2,81,250

2, 81, 250 × 0.0125 × [1.0125]


240

1.0125 − 1
240
EMI= = Rs.3,703.47
Hence (d) is the correct answer.
25. Answer : (a) < TOP >

Reason: A leasing company which is formed as a subsidiary of a manufacturing


company for leasing the products of the parent company, is called
Captive leasing company
Hence (a) is the correct answer.
26. Answer : (d) < TOP >

Reason: 0.75*[LR(5) / LR(T)] * C


= 0.75* 2.5/3.5 * 2.75
= Rs.1.47 cr
Hence (d) is the correct answer.
27. Answer : (d) < TOP >

Reason: To draw refinance from NHB, the companies should


- Be registered with NHB to carry on the business of housing finance
- Provide long term finance for
Construction/purchase/repair/upgradation of housing units
- Invest at least 75% of capital employed in the form of long term
housing finance
- Have net owned fund of at least Rs.10 crore
- Have net non-performing assets not more than 5% of the net
advances
Hence (d) is the correct answer.
28. Answer : (c) < TOP >

Reason: Define Im as the monthly rate of return implied by the cash flow stream.
350 = 18*PVIFA (Im,12) + [14 * PVIFA(Im,12) *PVIF(Im,12)] +[ 10 *
PVIFA(Im,6 ) *PVIF(Im,24)]
The equation is satisfied by Im = 1.82 % (By trial and error)
Annualized return is :
I = (1+Im)12 –1
= (1.0182)12 – 1
= 24.16%
Hence (c) is the correct answer
29. Answer: (a) < TOP >

Reason : The most prominent form of lending by REITs is the


construction/developmental lending. To retain their special tax status,
REITs have to distribute 95% of their income to shareholders. There can
be mortgage REITs. Indirect equity investments in REITs by investor
are highly liquid. REIT can be infinite life trusts or finite life. Hence
only (a) is true.
30. Answer : (b) < TOP >

Reason: Discount charges = 1000×0.18×90/360


= Rs.45
Value received by the client Rs.955
Effective rate of interest per quarter = 45/955 × 100
= 4.71%.
Effective rate of interest per annum = 1.04714 –1 = 20.21%.
Hence (b) is the correct answer.

Section B : Problems
1. a. Market price per share = Rs.45 < TOP >

Earnings per share = Rs.9


Subscription price = 20% below the existing market price
= Rs.36
1, 00, 00, 000
Number of right shares = 36
= 2,77,778
Rights ratio
Existing shares = 50,00,000
Number of additional equity shares proposed to be issued as rights shares = 2,77,778
1 rights shares for every 18 shares held.
Dilution in EPS:
EPS = Rs.9
PAT PAT
= 9=
EPS = No. of shares 50, 00, 000
PAT = 4,50,00,000
Effect of rights issue on EPS
PAT = 4,50,00,000
PBT = 6,71,64,179
Add: Interest saved as a result of redemption of loan = 10,00,000
6,81,64,179
Less: 33% Tax = 2,24,94,179
4,56,70,000
PAT

EPS = Number of shares


4,56,70,000
= Rs.8.65
= 50, 00, 000 + 2, 77, 778
b. Ex-rights price of the share
NP0 + S
= N +1
N = Number of existing shares required for a rights share
P0 = Cum-rights market price per share
S = Subscription price at which rights shares are issued.
(18 × 45 ) + 36
= Rs.44.53
= (18 + 1)
Market price 44.53
== 5.14
P/E ratio = EPS 8.65
c. i. If a shareholder who owns 1000 shares sells his rights.
Market value of original shareholding @ Rs.45 = 1000 × 45 = 45,000
P0 − S
Value realized from the sale of rights R = N + 1
45 − 36
= 0.4737
= (18 + 1)

1000 × 0.4737 = 473.70


Post-rights market value of the holding 1000 × 44.53 = 44,530.00
45,003.70
ii.
If he allows his rights to expire
Current market value of the investment = 45,000
Market value after the rights issue @ 1,000 × 44.53 = 44,530
Change in Wealth = (470)
2. a. Success rate to be maintained by Primary Dealers in Government Securities = 33.33% < TOP >

Success rate to be maintained by Primary Dealers in T-Bills= 40%


Required amount of successful bids
T-Bills 1600 1280 1920 1200 1440 1760
Government Securities 1600 1067 1333 1200 867 1333
b.
T-Bills
Adherence
to
Bids Adherence to Bids successful
Particulars Tendered Commitment commitement Accepted Commitment bids
P 3600 4000 N 1200 1600 N
Q 4000 3200 Y 1600 1280 Y
R 4800 4800 Y 2400 1920 Y
S 3200 3000 Y 800 1200 N
T 3200 3600 N 1200 1440 N
U 4000 4400 N 1400 1760 N

Government Securities
Adherence
to
Bids Adherence to Bids successful
Particulars Tendered Commitment commitement Accepted Commitment bids
P 6000 4800 Y 2000 1600 Y
Q 4000 3200 Y 1000 1067 N
R 3200 4000 N 1200 1333 N
S 4000 3600 Y 2000 1200 Y
T 3000 2600 Y 1600 867 Y
U 4000 4000 Y 2000 1333 Y
3. Alternative (A): Purchase the Equipment < TOP >

The net present value of this option will be as follows:


The present value of EBDIT (1-T) depends upon the value of N.
For N = 3,
P.V. [EBDIT (1-T)] @ K=18%
= [190(1-0.35)×0.8475] + [210(1-0.35)×0.7182] + [250(1– 0.35)×0.6086]
= Rs. 301.59Lakh
For N = 4,
P.V. [EBDIT (1-T)] @ K=18%
= Rs. 385.41Lakh
For N = 5,
P.V. [EBDIT (1-T)] @ K=18%
= Rs. 456.44 Lakh
For N = 6,
P.V. [EBDIT (1-T)] @ K=18%
= Rs. 516.63 Lakh
P.V. Tax Shield on Depreciation @ K=18% and N=3 is equal to
[(75×0.8475) + (56.25×0.7182) + (42.19×0.6086)] × 0.35
= Rs. 45.37 Lakh
P.V. Tax Shield on Depreciation @ K=18% and N=4 is equal to
= Rs.51.08 Lakh
P.V. Tax Shield on Depreciation @ K=18% and N=5 is equal to
= Rs.54.71 Lakh
P.V. Tax Shield on Depreciation @ K=18% and N=6 is equal to
= Rs.57.02 Lakh
Since the salvage value of the equipment is insignificant beyond the third year, we will assume that it
will be retained and the full Depreciation Tax shelter available under the Income Tax act will be
claimed.
Salvage value of the equipment after three years
= 300(1.10) 3 × 0.25
= Rs. 99.83 Lakh
P.V. of the salvage value realizable after three years
= (99.83 ×0.6086)
= Rs. 60.76 Lakh
Net salvage value at the end of years four, five and six is taken to be insignificant.
Loan amount = 300×0.75 = Rs.225 lakh
Now the equated annual installment = 225/3.2743 = Rs.68.72 lakh
Loan repayment schedule:
Year Amount o/s at the Rate of Interest Capital Installment
beginning of the year interest component component
1 225.00 0.16 36.00 32.72 68.72
2 192.28 0.16 30.76 37.96 68.72
3 154.32 0.16 24.69 44.03 68.72
4 110.30 0.16 17.65 51.07 68.72
5 59.22 0.16 9.48 59.24 68.72
Present value of interest payments:
Interest component P/V factor @18% P/V
36.00 0.8475 30.51
30.76 0.7182 22.10
24.69 0.6086 15.03
17.65 0.5158 9.10
9.48 0.4371 4.14
Total Rs.80.88 lakh
Present value of interest tax shield:
= 80.88 ×0.35 = Rs.28.30 lakh
For different values of N, the values of NPV (P) will be as follows:
P.V. P.V. Tax P.V. Tax P.V.
P.V. of interest Initial NPV
N [EBDIT Shield Shield (Net salvage
payment Investment (P)
(1-T)] on Dep. on interest value)
3 301.59 45.37 80.88 28.30 60.76 300 55.14
4 385.41 51.08 80.88 28.30 0 300 83.91
5 456.44 54.71 80.88 28.30 0 300 158.57
6 516.63 57.02 80.88 28.30 0 300 221.07
Expected NPV (P) = (55.14×0.4) + (83.91×0.3) + (158.57×0.2) + (221.07×0.1)
= Rs.101.05 lakh.
Alternative (B): Finance Lease
NPV (FL)
= P.V. [EBDIT (1-T)] - P.V. (Lease Rental) + P.V. (Tax Shield on Lease Rental)
P.V. of lease rentals during the primary period at K=18%
= (300×0.425) PVIFA (18,5)
= Rs.398.72 Lakh
P.V. of lease rentals during the secondary period
= (300×0.030) PVIF (18,6)
= Rs.3.33 Lakh
P.V. of Tax Shield on Lease Rental during the primary period
= 398.72×0.35
= Rs.139.55 Lakh
P.V. of Tax Shield on Lease Rental during the secondary period
= 3.33×0.35
= Rs.1.17 Lakh
For different values of N, the values of NPV (FL) will be as follows:
N P.V. [EBDIT P.V. P.V. NPV
(1-T)] (Lease Rental) (Tax Shield on Lease Rental) (FL)
3 301.59 398.72 139.55 42.42
4 385.41 398.72 139.55 126.24
5 456.44 398.72 139.55 197.27
6 516.63 402.05 140.72 255.30
Expected NPV (FL)
= (42.42×0.4) + (126.24×0.3) + (197.27×0.2) + (255.3×0.1)
= Rs.119.82 lakh.
Since the NPV of the leasing option is higher, this option should be selected to make commercial sense.
4. Loan amount = 5,00,000×0.75 = 3,75,000 < TOP >

Define ‘k’ the effective rate of interest per month. The value of k can be obtained as follows:
22,868 PVIFA (k,18) = 3,75,000
PVIFA (k,18) = 16.3985
From the table,
k = 1% (approximately)
i. The effective rate is,
= (1+0.01)12 – 1
=12.68%.
Since the effective rate offered by the scheme is lower than the peers, it is advisable to go for this
scheme.
The nominal rate is,
= 0.01 × 12
= 12%.
ii. The repayment schedule will be as follows:
Month Amount O/S Interest component Capital component Installment
1 375000.00 3750.00 19118.00 22868
2 355882.00 3558.82 19309.18 22868
3 336572.82 3365.73 19502.27 22868
4 317070.55 3170.71 19697.29 22868
5 297373.25 2973.73 19894.27 22868
6 277478.99 2774.79 20093.21 22868
7 257385.78 2573.86 20294.14 22868
8 237091.63 2370.92 20497.08 22868
9 216594.55 2165.95 20702.05 22868
10 195892.50 1958.92 20909.08 22868
11 174983.42 1749.83 21118.17 22868
12 153865.25 1538.65 21329.35 22868
13 132535.91 1325.36 21542.64 22868
14 110993.27 1109.93 21758.07 22868
15 89235.20 892.35 21975.65 22868
16 67259.55 672.60 22195.40 22868
17 45064.15 450.64 22417.36 22868
18 22646.79 221.21 22646.79 22868
5. a. Advance factoring < TOP >
st
Balance sheet as on 31 March, 2007
Liabilities Rs. in lakh Assets Rs. in lakh
Net worth 180 Fixed assets 120
Long-term debt 60 Inventory 100
Current liabilities 180 Factoring reserves* 36
Cash 164
420 420
* Factoring reserves = 180*0.2 = Rs.36 lakh
Current ratio (before) = 300/180 = 1.67
Current ratio (after) = 300/180 = 1.67
Bank overdraft
Balance sheet as on 31st March, 2007
Liabilities Rs. in lakh Assets Rs. in lakh
Net worth 180 Fixed assets 120
Long-term debt 60 Inventory 100
Current liabilities 180 Receivables 180
Bank overdraft 144 Cash* 164
564 564
* Opening balance + bank overdraft
= 20+144 = Rs.164 lakh
Current ratio (after) = 1.37
b. Advance factoring
Balance sheet as on 31st March, 2007
Liabilities Rs. in lakh Assets Rs. in lakh
Net worth 180 Fixed assets 120
Long-term debt 60 Inventory 100
Current liabilities 110 Factoring reserves 36
Cash* 94
350 350
* Cash = opening balance + factoring receipt – repayment
= 20+144-70 = Rs.94 lakh
Current ratio = 230/110 = 2.09
Bank overdraft
Balance sheet as on 31st March, 2007
Liabilities Rs. in lakh Assets Rs. in lakh
Net worth 180 Fixed assets 120
Long-term debt 60 Inventory 100
Current liabilities 110 Receivables 180
Bank overdraft 144 Cash* 94
494 494
* Cash = opening balance + bank overdraft – repayment = 20+144-70 = Rs.94 lakh
Current ratio = 374/254 = 1.47
c. Due to 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, we can say that the use of factoring facility
improves the liquidity of the firm.
If the factoring facility is used to payout the current liability, the current ratio is increased to 2.09
which says that the liquidity position has further increased. If overdraft is used then also the current
ratio increases to 1.47 but the factoring option strengthens the liquidity position of the company as
compared to the overdraft facility.

Section C: Applied Theory


6. Though Indian retail sector is emerging as one of the most dynamic and fast growing industries with < TOP >
several domestic players taking interest in the retail market, the sector could not develop more because
of the lack of infrastructure and complex Government rules as it would develop with proper
infrastructure. The sector needs heavy initial investment, having a long gestation period. Present data
says that most of the popular brands, which were established in previous years, have yet to taste success.
So there is always a fear of losing capital. Domestic corporates without modern retail technical know-
how do not want to take risk. Allowing FDI in the sector would definitely help in this regard. It would
bring a huge amount of capital, for which India needs to develop its infrastructure and create additional
jobs. This should be the prime concern of Indian policy makers.
India can expect a lot of benefits out of the FDI in Indian retail bandwagon. Categorically, retail sector
can generate huge employment opportunities. In developed countries like the US, this sector employs
12% of its total workforce; whereas, the Indian retail sector employees only 6 to 7% of its workforce.
This is because of the lack of organized retail sector. The market share of organized retail sector in India
is only 2%; whereas, in the US it is 80%, in Thailand it is 40% and in China it is 20%. A modern
organized retail sector can create more than 2 million jobs directly in India within the next five to six
years. According to an estimate of Cygnus Research Center, the retail industry requires more than
115,000 skilled workers to support its growth in years to come. Even the Planning Commission also
hinted that the retail sector is a potential sector for employment generation. Table 2 shows a slow growth
rate of Employment in wholesale and retail sector.
India can expect a sudden growth in the agricultural sector as the retail sector will create more demand
for the agricultural products like fresh and processed fruits. Farmers and dairy farms will benefit the
most with this development. The retail giants can bring better managerial skills and IT-friendly services,
would be facilitated to cut cost and minimize the wastages. They can develop food processing industries
and cold storage, which require huge amount of capital.
Organized players focus on efficient supply chain and target complete saturation of the market where
they are established. Market intermediaries may be omitted. There may be a direct contact between the
farmer or the producer and the market. Farmers will get a good return on their product and the consumer
will also get a better quality with affordable price.
FDI could see an improvement in the lifestyle of the people, particularly the middle class, and the long-
term impact of such a move will be seen in the growth of a number of small and medium-size
entrepreneurs as in the real estate sector. The tax revenue for the government could also increase with
this development.

7. Future flow securitization raises funds based on expected future flows that are still to be generated. < TOP >
These are classified as into two types: long term contract receivables and future cash flows. Term off
take agreements for the supply of goods or services are examples of former. In this, the volume is
generally prefixed, but price of receivables may be variable. Future cash flows are not only subject to
price variations but also to variations in volume. Examples are ticket receivables, telecom receivables
etc. in this a base case for the receivables are generally presumed. The base case cash flows are
progressively reduced over time.
Advantages:
• There will be lesser cost of funds to the borrower due to higher credit rating.
• It is also possible to have a diversified source of funding.
• Even when credit is tight due to adverse market conditions, these transactions can ensure sufficient
funds raising due to their being of quality.
• These can extend the tenure of financing available to the borrower.
Risks associated are:
• Performance risks: these transactions rely on future cash flows to repay investors. Therefore the
borrower needs to be continuously monitored and reviewed throughout the tenure of transaction. In
case a borrower becomes insolvent, no creditor would be able to make claims against the
receivables sold to investor.
• Generation risks: This relates to the sustained generation of the receivables at certain levels from
the host of factors outside the control of the borrower, e.g. anticipated reserves may not materialize
or seasonal variation in the anticipated level of receivables may occur.
• Price risks and off- take risks: These refers to likely price variations or the concerns that the
obligors in the future ceases buying or reduce their purchasing level of goods or services from the
seller
< TOP OF THE DOCUMENT >
Suggested Answers with Examiner's Feedback

Question Paper
Investment Banking and Financial Services - I (MSF2K1) : July 2007
Section A : Basic Concepts (30 Marks)

• This section consists of questions with serial number 1 - 30.


• Answer all questions.
• Each question carries one mark.
• Maximum time for answering Section A is 30 Minutes.

1. Which of the following statements is not true with respect to the Government dated securities? < Answer >

(a) These are medium to long term Government securities


(b) These securities carry a coupon rate
(c)Since these securities are long term instruments, they are part of the long term debt market
(d) These instruments set a benchmark for long term interest rates
(e) Being Government securities, these dated securities have high liquidity.
2. Which of the following statements is not true? < Answer >

(a) The floor rate for CDs is fixed by the short term deposit rates
(b) The ceiling rate for CDs is set by CPs
(c) The PLR will set the cap for CPs
(d) The minimum rate for the bills of exchange is set by call rates
(e) The maximum rate for the bills of exchange is set by CD rates.
3. Which of the following risks is not covered by the Export Credit and Guarantee Corporation? < Answer >

(a) Insolvency of the buyer


(b) Failure of the buyer to make the payments within a specified period
(c) War, civil war, revolution or civil disturbances in the buyer’s country
(d) Fluctuations in the exchange rate for a payment scheduled within 12 months
(e)Additional freight or insurance charges that result due to interruption or diversion of voyage outside
India, which can not be recovered from the buyer.
4. Which of the following departments of SEBI is responsible for new investment products, market surveillance and < Answer >
insider trading?
(a) Primary market department
(b) Secondary market department
(c) Institutional investment department
(d) Investigation department
(e) Legal department.
5. Issues below ______ in size can not be listed on regular stock exchanges and are permitted to be listed only on < Answer >
OTCEI.
(a) Rs. 5 crore
(b) Rs. 7 crore
(c) Rs.10 crore
(d) Rs.20 crore
(e) Rs.25 crore.
6. Which of the following securities is/are not eligible for computation of promoter’s contribution? < Answer >

I. If the promoters of any company issuing securities acquire equity for consideration other than cash during
the preceding three years before filing the offer documents and if it involves revaluation of assets or
capitalization of intangible assets.
II. Shares resulting from bonus issue out of revaluation reserves.
III. In case of public issue by unlisted companies, securities which have been issued to the promoters during
the preceding one year, at a price lower than the price at which equity is being offered to public and the
difference between these prices has been brought by the promoters.
(a) Only (I) above
(b) Only (III) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
7. There are certain issue related advertisements which have to be released statutorily. Before how many days of the < Answer >
opening of the issue, issue announcement advertisement has to be released?
(a) 7 days
(b) 10 days
(c) 14 days

http://www.icfai.org/suggested/MSF2K1-0707.htm (1 of 17)09/Jul/07 2:37:40 PM


Suggested Answers with Examiner's Feedback

(d) 20 days
(e) 21 days.
8. Which of the following is/are true with respect to Secured Premium Notes (SPNs)? < Answer >

I. SPNs are issued at face value and do not carry any interest.
II. SPNs are redeemed by repayment in series of installments at a premium over face value.
III. SPNs may be issued with detachable warrants.
IV. The charge for SPNs may be created by pledge, hypothecation and mortgage on the assets of the issuing
company.
(a) Only (I) above
(b) Only (III) above
(c) Both (I) and (III) above
(d) (I), (II) and (III) above
(e) All (I), (II), (III) and (IV) above.
9. Which of the following statements is not true with respect to auction rated debt? < Answer >

(a)These are fully redeemable non-convertible short term debentures, secured by specific movable and non-
movable assets of the company
(b)These debentures are redeemed at regular intervals and then reauctioned
(c)These debentures help the company to get long term funds at short term rates
(d)These instruments are privately placed at competitive bids
(e)These instruments are compulsorily rated and the minimum rating required is of investment grade.
10. Which of the following statements is not true with respect to Medium-Term Notes (MTNs)? < Answer >

(a)MTNs are defined as the sequentially issued floating interest securities which have a maturity of over
one year
(b)A typical MTN program enables an issuer to issue Euro notes for different maturities for over one year
up to the desired level of maturity
(c)MTNs are conceived as non-underwritten facilities
(d)A Global MTN is issued world wide by tapping Euro as well as the US markets under the same program
(e)Spreads paid on MTNs depend on credit ratings, treasury yield curve and the familiarity of the issuers
among the investors.
11. Consider the following data of Go To Air Ltd. < Answer >

Paid-up equity capital (10,00,000 shares of Rs.10 each) Rs.1,00,00,000


Retained earnings Rs.2,00,00,000
Earning power 20%
Interest Rs. 20,00,000
Total assets Rs.7,00,00,000
The tax rate applicable to the company is 40%. The P/E ratio of the company is 10. The company proposes for a right
issue of 2,00,000 shares at the subscription price of Rs.20. The per shares value after the right issue is expected to be
(a) Rs.63.33
(b) Rs.66.33
(c) Rs.69.33
(d) Rs.72.00
(e) Rs.73.67.
12. Apart from ensuring appropriate liquidity, investors should also consider the risk present in the money market < Answer >
instruments. Which of the following is/are the risks associated with the money market instruments?
I. Market risk.
II. Reinvestment risk.
III. Default risk.
IV. Inflation risk.
(a) Only (I) above
(b) Only (III) above
(c) Both (II) and (III) above
(d) Both (II) and (IV) above
(e) All (I), (II), (III) and (IV) above.
13. Which of the following is/are true with respect to switch deals? < Answer >

I. Switch deals involve simultaneous purchasing and selling of different securities.


II. This is used to change the composition of portfolio without significant costs.
III. Generally, this facility is used by the RBI to increase or decrease the money supply in the system.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) All (I), (II) and (III) above.
14. Which of the following is/are not true with respect to repo rates? < Answer >

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I. Adjustment in price at the repurchase stage is not required, if both repo rate and coupon interest rate are
equal.
II. If the current yield is lower than repo rate, capital gain will occur due to adjustment in repurchase price.
III. The required rate is found by calculating the sale and repurchase prices after adjusting the accrued rate of
interest.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) All (I), (II) and (III) above.
15. Following are the details of different types of deposits held by different clients with Dena Bank: < Answer >

(Amount Rs.)
Name of client Saving Account Current Account Fixed deposits
Mr. Shyam 15,000 0 75,000
Ms. Ghanshyam 25,000 12,500 37,000
Mr. Radheshyam 10,000 0 1,00,000
Mr. Ram 18,000 23,000 54,000
Mr. Rajaram 0 11,000 0
Mr. Ram and Mr. Ghanshyam 95,000 51,000 0
(joint account)
Mr. Ram and Mr. Rajaram 55,000 46,000 0
(joint account)
What is the semi annual insurance premium payable by the bank to insure deposits accepted from the customers
above?
(a) Rs. 57.05
(b) Rs. 285.25
(c) Rs. 570.50
(d) Rs.1,141.00
(e) Rs.1,426.25.
16. Which of the following is not true with respect to Mortgage Pass-Through Securities? < Answer >

(a)The most active issuers of mortgage pass through securities are the mortgage originators such as savings
and loan associations, commercial banks and mortgage companies
(b)The cash flows from a pass through security will generally be higher as compared to cash flows from a
mortgage directly financed by the investor, if the elements of servicing fees and prepayments are not
there
(c)In pass through securities the holder of the security has a proportionate interest in each cash flow
generated in the pool
(d)When pass through securities are sold, it is construed as a sale of asset
(e)Pass through securities promise that the cash flow from the underlying mortgage would be passed
through to the holder of the securities in the form of monthly payments.
17. Which of the following statements are true? < Answer >

I. The purchaser of interest-only portion of the STRIP invests in the security with a yield potential of high-
coupon collateral.
II. The purchaser of principal-only portion of STRIP expects the interest rates would continue to fall and the
borrower of the mortgage loan would resort to large-scale prepayments.
III. Both interest-only securities and principal-only securities are neutral to the changes in interest rates.
IV. The return to the investors of Interest only security and Principal only securities move in the same
direction.
(a) Both (I) and (II) above
(b) Both (II) and (IV) above
(c) (I), (II) and (III) above
(d) (II), (III) and (IV) above
(e) All (I), (II), (III), and (IV) above.
18. Following is the information pertaining to a lease transaction: < Answer >

Lease Quote : Rs.444/Rs.1000 payable annually


Initial cost : Rs.120 lakh
PV of lease rentals : Rs.117.73 lakh
Lease term : 3 years
Cost of debt : 17%
Cost of capital : 14%
What will be the principal amount to be paid at the end of third year as per the displaced debt amortization schedule
in a lease?
(a) Rs.45.54 lakh

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(b) Rs.36.45 lakh


(c) Rs.28.54 lakh
(d) Rs.22.78 lakh
(e) Rs.20.78 lakh.
19. A lease which allows the lessee to exchange equipment in need of major repair with properly working replacement < Answer >
equipment, is called
(a) Temporary lease
(b) Finance lease
(c) Option lease
(d) Swap lease
(e) Open-ended lease.
20. In which of the following stages of venture capital financing, the company may be in the process of organizing or it < Answer >
may already be in the business for one year or less but may not have sold its product commercially?
(a) Seed financing
(b) Start-up financing
(c) First stage financing
(d) Second stage financing
(e) Third stage financing.
21. Which of the following is not true with respect to the Quasi Equity Investment? < Answer >

(a)The quasi equity loans can be linked to the company’s performance and participate significantly only in
the upside
(b)The quasi equity loans can be a loan on which there is a minimum obligation contracted at reasonably
low levels irrespective of performance and an upside sharing component
(c)The quasi equity investment also come with a number of protective covenants like appointment of
nominee, option to convert the loan in to equity shares etc.
(d)The disadvantage with quasi equity is that it involves the cash payout from the investee company during
the growth phase, when the company needs to conserve cash most
(e)From investor’s point of view tracking and accounting the payments and ensuring the accuracy of sales
accounting by the investee company is a point of potential abuse.
22. Which clause of the lease agreement entitles the lessor to terminate the agreement and be indemnified by the lessee < Answer >
for all expenses incurred on account of the action of the lessee?
(a) Description clause
(b) Equipment delivery clause
(c) Ownership clause
(d) Surrender clause
(e) Exemption clause.
23. Which arrangement is designed to protect both the borrower and the lender against volatile interest rates in real estate < Answer >
financing?
(a) Gap loans
(b) Bow ties
(c) Direct joint ventures
(d) Direct development and syndication
(e) Mini-perms.
24. A net lease where the lessee guarantees the residual value is called < Answer >

(a) Master lease


(b) Net-net lease
(c) Operating lease
(d) Skipped lease
(e) Residual lease.
25. A recourse factoring facility where the invoice discounting facility is not confidential in nature and the customers of < Answer >
the client are advised to make payment directly to the factor, this facility is called
(a) Agency factoring
(b) Bulk factoring
(c) Old line factoring
(d) Full factoring
(e) Big ticket factoring.
26. Which of the following is/are not true regarding the difference between venture capital and bought out deal? < Answer >

I. Participation in management of VC undertaking is high in case of VCF where as it is low in case of bough
out deals.
II. Exit from the investments takes 7 to 10 years in case of venture capital, while in case of bough out deals
exit is done immediately after the expiry of lock in period.
III. Regulations on venture capital investments are very high as compared to bought out deals.
(a)Only (III) above
(b)Both (I) and (II) above

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(c)Both (I) and (III) above


(d)Both (II) and (III) above
(e)All (I), (II) and (III) above.
27. Under an advance factoring arrangement, India Factors Limited (IFL) has agreed to advance a sum of Rs.45 lakh for < Answer >
90 days against the receivables of XYZ Limited. The advance carries the interest rate of 14% p.a. compounded
quarterly and the factor commission is 2.5% of the value of factored receivables. Interest and commission are
collected upfront. Total receivables of the XYZ Limited are Rs.58,75,000.
What is the annualized cost of funds made available to XYZ Limited?
(a)15.87%
(b)16.75%
(c)16.98%
(d)17.75%
(e)18.25%.
28. First Leasing Ltd. is proposing to give an equipment for lease, the particulars of which are as follows: < Answer >

Cost of equipment Rs.24 lakh


Monthly rental Rs.20 per thousand
(payable in advance) per month
Duration of lease 7 years
The add-on yield for the First Leasing would be
(a) 10.00%
(b) 9.12%
(c) 9.71%
(d) 9.86%
(e) 9.95%.
29. A borrower wishes to prepay the outstanding amount of loan after the payment of 34th installment. The other < Answer >
particulars about the loan are as follows:
Total credit charge Rs.312
Repayment period 3 years
Total number of installments 36
The interest rebate which he is entitled to get, according to the modified version of Rule of 78 method using the
deferment period of 2 months is
(a) Nil
(b) Re. 1.40
(c) Rs. 3.45
(d) Rs. 5.67
(e) Rs.17.33.

30. Which of the following is/are true with respect to the guidelines for stock buy-back, issued by SEBI? < Answer >

I. The company shall not issue any shares including by way of bonus shares till the date of closure of the
offer made under the stock repurchase program.
II. The company shall not withdraw the offer to buy-back after the draft letter of the offer is filed with the
board.
III. The company can buy-back the locked-in shares and non-transferable shares by passing the resolution in
board meeting.
(a)Only (I) above
(b)Both (I) and (II) above
(c)Both (I) and (III) above
(d)Both (II) and (III) above
(e)All (I), (II) and (III) above.

END OF SECTION A

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Section B : Problems (50 Marks)


• This section consists of questions with serial number 1 – 5.
• Answer all questions.
• Marks are indicated against each question.
• Detailed workings should form part of your answer.
• Do not spend more than 110 - 120 minutes on Section B.

1. Xonix Financial Services offers consumer loans for a maximum period of five years. The company has the policy of providing < Answer >
finance up to 75% of the cost of the asset, which is in line with the competitors. The company is well known for providing
loans at competitive rates. The EMI schedule offered by the competitors for different loan tenures for a loan of Rs.50,000 is as
follows:
Loan tenure (in months) 12 24 36 48 60
EMI (Rs.) (to be paid in arrears) 4583 2526 1823 1479 1275
The following is the information pertaining to the excess EMI charged by the competitors for different loan tenures for a loan
of Rs.10,000:
Loan tenure (in months) 12 24 36 48 60
Excess EMI (Rs.) charged by the competitors
Nil 30 15 10 5
(to be paid in arrears)
The processing fee charged by the competitors is 1%. The processing fee charged by the company is 25 basis points lower than
that by the competitors.
Mr. Vrajesh Shah, who is a well known doctor, wants to buy ‘Spark’ launched by General Motors. The current cost of the car is
Rs.5,50,000. He wants the loan for a period of five years. As he is not familiar with the finance schemes available in the
market, he has approached you for your advice. Being a financial analyst, you are required to:
a. Calculate the flat rate and annual percentage rate charged by Xonix Financial Services on the five year loan.
b. Calculate the effective rate of interest on the completed transaction, if Mr. Vrajesh Shah opts to prepay the entire
loan amount at the end of 36th month after paying 36 installments. Xonix Financial Services calculates the interest rebate
according to Rule of 78 method.
c. Assuming that Mr. Vrajesh Shah avails the loan from competitors and pre payment charge imposed by them is 5%
i. Draw the repayment schedule for the first year.
ii. Calculate the pre-payment charges and effective interest rate on completed transaction that are to be paid by him, if he
prepays the entire loan amount at the end of first year after paying 12 installments.
(2 + 6 + 6 = 14 marks)
2. Shah Tech Ltd. (STL) is contemplating investment in an equipment costing Rs.94 lakh. The company can purchase the < Answer >
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 30% and the tax relevant rate of depreciation is
25%. The salvage value of the equipment after 5 years is negligible. The cost of capital of the company is 18%.
You are required to calculate the net value of the lease and also advise the company whether it should go for leasing or not.
(8 marks)
3. During last four years, following companies came out with IPOs. Following is the per share issue price, last traded price and < Answer >
the value of the index on the listing day:
Issue
LTP Issue Size
Sr. No. Name of the issue Price Range Price Index values
(Rs.) (lakh shares)
(Rs.)
1 Fortis Healthcare Limited 96.70 457.53963 Rs. 92 to Rs. 110 108.00 4079.30
2 Advanta India Limited 815.00 33.80000 Rs. 600 to Rs. 650 640.00 3997.65
3 ICRA Limited 931.95 25.81100 Rs. 275 to Rs. 330 330.00 3917.35
4 Orbit Corporation Limited 223.00 91.00000 Rs. 108 to Rs. 117 110.00 3829.85
5 Abhishek Mills Limited 59.60 41.00000 Rs. 90 to Rs. 100 100.00 3678.90
6 Page Industries Limited 412.80 28.04000 Rs. 360 to Rs. 395 360.00 3608.55
7 Raj Television Network 236.40 35.68250 Rs. 221 to Rs. 257 257.00 3608.55
Limited
8 AMD Metplast Limited 69.50 90.96520 Rs. 65 to Rs. 75 75.00 3678.90

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9 Idea Cellular Limited 116.60 2833.33000 Rs. 65 to Rs. 75 75.00 3718.00


10 Evinix Accessories Limited 95.00 35.00000 Rs. 100 to Rs. 120 120.00 3626.85
11 Mudra Lifestyle Limited 79.45 95.80000 Rs. 75 to Rs. 90 90.00 3718.00
12 Oriental Trimex Limited 22.90 94.00000 Rs. 40 to Rs. 48 48.00 3626.85
13 MindTree Consulting 797.50 55.93300 Rs. 365 to Rs. 425 425.00 3626.85
Limited
14 Broadcast Initiatives Limited 75.80 85.50000 Rs. 100 to Rs. 120 120.00 3626.85
15 Indus Fila Limited 160.10 48.43789 Rs. 170 to Rs. 185 170.00 3761.65
16 Euro Ceramics Limited 142.35 56.21500 Rs. 150 to Rs. 180 165.00 3718.00
17 Indian Bank 127.90 859.50000 Rs. 77 to Rs. 91 91.00 3811.20
18 C & C Constructions 197.00 42.69451 Rs. 270 to Rs. 291 291.00 3942.00
Limited
19 SMS Pharmaceuticals 341.00 25.77000 Rs. 360 to Rs. 380 380.00 3745.30
Limited
20 Power Finance Corp. 149.00 1173.16700 Rs. 73 to Rs. 85 85.00 3938.95
Limited
The current value of the index is 4219.55.
You are required to calculate the wealth relative and comment on the same.
(8 marks)
4. Pitti Ltd. had a turnover of Rs.1000 lakh in 2006-2007 and expects an increase of 20% in the next year. The credit term of Pitti < Answer >
Ltd. is 2/15 net 45 days but it has been observed that none of the customers pays within 15 days and avail the early discount.
As per the records, on an average only 75% of the customers pay within 30 days, 20% of the customers pay within 45 days and
rest of the customers pay on 60th day.
Pitti Ltd. avails short-term finance from PVS Finance Ltd for funding 40% of receivables at 22% p.a. and 40% of receivables
from DPS Finance at 21% p.a. The post-tax cost of funds of Pitti Ltd. is 16.75%. The administrative expenses for credit
recovery are Rs.1.5 lakh. 2% of the total sales turn as bad debts. The default premium charged by the company on late payment
is 3%.
PVS has given an offer of non-recourse factoring service to Pitti Ltd., the terms of which are as follows:

Discount charge 24%


Commission 3%
Advance Payment 75% of factored receivables
Agreed payment time 30 days
Alternatively, the company can change its credit term to 3/10 net 45. Further the company will give 2% discount to the
customer who will pay after 10 days but before 20 days. The company expects that due to this change 30% of the customers
will avail higher discount and will pay within 10 days. 20% of the customers will pay within 20 days. And out of the
remaining, 60% will pay within 30 days, 20% will pay within 45 days and rest will pay on 60th day. The default premium
charged by the company on late payment will be increased to 4%.The company will also increase the administrative expenses
for credit recovery by Rs.2 lakh, as a result of this bad debts will come down to 1% of the total sales, rest of things are expected
to remain same.
The variable cost to sales ratio of Pitti Ltd. is 0.65 and the tax rate applicable to the company is 33%.
As a financial analyst you are required to
a. Compute the minimum increase in the sales to make factoring a viable option.
b. Advise Pitti Ltd. in selection of the alternatives whether it should maintain the same policy, adopt factoring or go
for new policy. The company has the policy to appraise the alternatives on the basis of cost to sales ratio associated with
various alternatives. Assume that the sales will remain at break-even level for factoring option.
(6 + 6 = 12 marks)

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5. On June 30, 2007 Maric Ltd. has come out with an issue of 14% partially convertible debenture of Rs.100 each as a < Answer >
part to finance its acquisition plan with an expected amount of Rs.15 crore. The convertible part of the debenture
(Part A) of Rs.50 will be converted into 1 equity share at a premium of Rs.40 after 36 months from the date of
allotment. Current face value of each share is Rs.10. The non-convertible portion of debenture (Part B) of Rs.50 will
be redeemed after 6 years. Interest will be paid semi-annually.
Gujarat Finance Limited (GFL) is planning to subscribe to the issue to deploy its cash surplus. Since the company is
in FMCG industry, the analyst of GFL is in the opinion that it is better to value the share of the company on the basis
of price to sales and price to earning ratio. He has given equal weights to both the measures to value the share of the
company.
Additional information and projections made by the analyst based on the past performance and the information
provided by the company are as follows:

March March March March March


Year (ending)
2006 2007 2008 2009 2010
EPS (Rs.) 17.00 20.40 12.24 11.75 11.75
Sales per share (Rs.) 340.00 408.00 244.80 235.00 235.04
Stock split – – 2:1 – –
Bonus – – – 1:4 1:5

Month (2010) June


Average P/E ratio (expected) 20.39
Average Price to Sales ratio (expected) 1.01
The required rate of return of GFL is 25% p.a. compounded semi-annually.
You are required to help the analyst in making decision of subscribing or not subscribing the issue.
(8 marks)

END OF SECTION B

Section C : Applied Theory (20 Marks)


• This section consists of questions with serial number 6 - 7.
• Answer all questions.
• Marks are indicated against each question.
• Do not spend more than 25 -30 minutes on section C.

6. In March 2007, SEBI announced mandatory IPO grading, which has been seen positive step for the investors. < Answer >
Discuss whether it is possible to give precise ratings to companies offering equity in the primary markets. Also
explain the parameters on which the IPO of the company can be graded.
(10 marks)
7. The rates of interest on housing loans have consistently moved upwards from the last one year. Discuss the factors < Answer >
to be considered before taking a decision of selecting whether a ‘floating rate home loan’ or a ‘fixed rate home
loan’.
(10 marks)

END OF SECTION C

END OF QUESTION PAPER

Suggested Answers
Investment Banking and Financial Services - I (MSF2K1) : July 2007
Section A : Basic Concepts

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1. Answer : (c) <


TOP
Reason : The following are true with respect to the Government dated securities: >
These are medium to long term Government securities
These securities carry a coupon rate
Inspite of being long term instruments these securities form a part in money market
These instruments set a benchmark for long term interest rates
Being Government securities, these dated securities have high liquidity.
Hence (c) is the correct answer.
2. Answer : (e) <
Reason : The following statements are true: TOP
>
The floor rate for CDs is fixed by the short term deposit rates
The ceiling rate for CDs is set by CPs
The PLR will set the cap for CPs
The minimum rate for the bills of exchange is set by call rates
The maximum rate for the bills of exchange is set by term deposit rates and not by CD.
Hence (e) is the correct answer.
3. Answer : (d) <
Reason : Following are the risks covered by ECGC: TOP
>
Insolvency of the buyer
Failure of the buyer to make the payments within a specified period
War, civil war, revolution or civil disturbances in the buyer’s country
Additional freight or insurance charges that result due to interruption or diversion of voyage
outside India, which can not be recovered from the buyer.
Fluctuations in the exchange rate is the risk which is covered by the ECGC under special
schemes for the payment schedule over a period of 12 months or more up to a maximum of 15
years.
Hence (d) is the correct answer.
4. Answer : (b) <
Reason : Secondary market department of SEBI is responsible for new investment products, TOP
>
market surveillance and insider trading.
Hence (b) is the correct answer.
5. Answer : (a) <
Reason : Issues below Rs.5 crore in size can not be listed on regular stock exchanges and are TOP
>
permitted to be listed only on OTCEI.
Hence (a) is the correct answer.
6. Answer : (c) <
Reason : The following securities are not eligible for computation of promoter’s contribution: TOP
>
If the promoters of any company issuing securities acquire equity for consideration other than
cash during the preceding three years before filing the offer documents and if it involves
revaluation of assets or capitalization of intangible assets.
Shares resulting from bonus issue out of revaluation reserves.
In case of public issue by unlisted companies, securities which have been issued to the
promoters during the preceding one year, at a price lower than the price at which equity is being
offered to public are not eligible for the computation of promoter’s contribution but if the
difference between these prices has been brought by the promoters then these securities are
eligible for the computation for promoter’s contribution.
Hence (c) is the correct answer.
7. Answer : (b) <
Reason : Issue announcement advertisement has to be released 10 days before the opening of TOP
>
the issue.
Hence (b) is the correct answer.
8. Answer : (d) <
Reason : The following are true with respect to Secured Premium Notes (SPNs) TOP
>
SPNs are issued at face value and do not carry any interest.
SPNs are redeemed by repayment in series of installments at a premium over face value.
SPNs may be issued with detachable warrants.
The charge for SPNs may be created by mortgage on all immovable assets of the issuing
company.
Hence (d) is the correct answer.

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9. Answer : (e) <


TOP
Reason : The following statements are true with respect to auction rated debt:
>
These are fully redeemable non-convertible short term debentures, secured by specific movable
and non-movable assets of the company
These debentures are redeemed at regular intervals and then reauctioned
These debentures help the company to get long term funds at short term rates
These instruments are privately placed at competitive bids
This instrument does not require credit rating as the tenure is less than 18 months.
Hence (e) is the correct answer.
10. Answer : (a) <
Reason : The following statements is not true with respect to Medium-Term Notes: TOP
>
MTNs are defined as the sequentially issued fixed interest securities which have a maturity of
over one year
A typical MTN program enables an issuer to issue Euro notes for different maturities fro over
one year up to the desired level of maturity
MTNs are conceived as non-underwritten facilities
A Global MTN is issued world wide by tapping Euro as well as the US markets under the same
program
Spreads paid on MTNs depend on credit ratings, treasury yield curve and the familiarity of the
issuers among the investors.
Hence (a) is the correct answer.
11. Answer : (a) <
Reason : TOP
>
Paid-up equity capital (10,00,000 shares of Rs.10 each) Rs.100,00,000
Retained earnings Rs.200,00,000
Earning before interest and taxes: (700,00,000 0.20) Rs.140,00,000
Interest Rs.20,00,000
Profit before tax Rs.120,00,000
Profit after tax Rs.72,00,000
EPS Rs.7.2
Market price per share Rs.72
Number of existing shares required for a rights share (10,00,000/2,00,000) 5
The value of share after the rights issue:
Rs. 63.33
12. Answer : (e) <
Reason : All are the risk associated with the money market instruments. TOP
>
Hence (e) is the correct answer.
13. Answer : (d) <
Reason : Switch deals involve simultaneous purchasing and selling of different securities. TOP
>
This is used to change the composition of portfolio without significant costs. Switch deals do
not have any impact on the money supply. Hence statement III is incorrect and (d) is the correct
answer.
14. Answer : (b) <
Reason : Following statements are correct with respect to repo rates: TOP
>
If the current yield is lower than repo rate capital loss will occur due to adjustment in repurchase
price.
Adjustment in price at the repurchase stage is not required if both repo rate and coupon interest
rate are equal.
The required rate is found by calculating the sale and repurchase prices after adjusting the
accrued rate of interest.
Hence (b) is the correct answer.
15. Answer : (b) <
Reason : TOP
>
Maximum amount eligible
Name of customer Total Deposit
for insurance
Mr. Shyam 90,000 90,000

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Ms. Ghanshyam 74,500 74,500


Mr. Radheshyam 1,10,000 1,00,000
Mr. Ram 95,000 95,000
Mr. Rajaram 11,000 11,000
Mr. Ram and Mr. Ghanshyam
1,46,000 1,00,000
( joint account)
Mr. Ram and Mr. Rajaram
1,01,000 1,00,000
(joint account)
Total 5,70,500
Therefore, the insurance premium paid
= 5,70,500 * 0.05/100 = Rs.285.25.
Hence (b) is the correct answer.
16. Answer : (b) <
TOP
Reason : The following is are true with respect to Mortgage Pass-Through Securities: >
The most active issuers of mortgage pass through securities are the mortgage originators such as
savings and loan associations, commercial banks and mortgage companies
The cash flows from a pass through security will be exactly equal in magnitude to that of cash
flows from a mortgage directly financed by the investor if the elements of servicing fees and
prepayments are not there
In pass through securities the holder of the security has a proportionate interest in each cash
flow generated in the pool
When pass through securities are sold is construed as a sale of asset
Pass through securities promise that the cash flow from the underlying mortgage would be
passed through to the holder of the securities in the form of monthly payments.
Hence (b) is the correct answer.
17. Answer : (a) <
Reason : The following statements are true: TOP
>
The purchaser of interest-only portion of the STRIP invests in the security with a yield potential
of high-coupon collateral.
The purchaser of principal-only portion of STRIP expects the interest rates would continue fall
and the borrower of the mortgage loan would resort to large-scale prepayments.
Both interest-only security and principal-only security have large impact associated with a small
change in interest rates.
The return to the investors of Interest only security and Principal only securities move in the
opposite direction.
Hence (a) is the correct answer.
18. Answer : (a) <
TOP
Reason : (Rs. lakhs) >
Loan o/s in the
Year Interest content Capital content Rental
beginning
1 117.73 20.01 33.27 53.28
2 84.46 14.36 38.92 53.28
3 45.54 7.74 45.54 53.28
Hence (a) is the correct answer.
19. Answer : (d) <
Reason : Swap lease is a lease which allows the lessee to exchange equipment in need of TOP
major repair with properly working replacement equipment there by enabling the lessee to avoid >
costly maintenance and repair delays
Hence (d) is the correct answer.
20. Answer : (b) <
TOP
Reason : Start-up financing is provided to companies completing product development and >
initial marketing. Company may be in the process of organizing or it may already be in the
business for one year or less but may not have sold its product commercially.
Hence (b) is the correct answer.
21. Answer : (a) <
Reason : The quasi equity loans can be linked entirely to the company’s performance and thus TOP
>
participate totally in the downside and significantly in the upside in a manner agreed upon

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upfront
The quasi equity loans can be a loan on which there is a minimum obligation contracted at
reasonably low levels irrespective of performance and an upside sharing component
The quasi equity investment also come with a number of protective covenants like appointment
of nominee, option to convert the loan in to equity shares etc.
The disadvantage with quasi equity is that, that it involves the cash payout from the investee
company during the growth phase, when the company needs to conserve cash most
From investor’s point of view tracking and accounting the payments and ensuring the accuracy
of sales accounting by the investee company.
Hence (a) is the correct answer.
22. Answer : (b) <
TOP
Reason : Equipment delivery clause of the lessee agreement entitles the lessor to terminate the >
agreement and be indemnified by the lessee for all expenses incurred on account of the action of
the lessee.
Hence (b) is the correct answer.
23. Answer : (b) <
TOP
Reason : A bow tie is designed to protect both the borrower and the lender against volatile >
interest rates.
24. Answer : (b) <
Reason : A net lease where the lessee guarantees the residual value is called Net-net lease TOP
>
Hence (b) is the correct answer.
25. Answer : (b) <
Reason : A recourse factoring facility where the invoice discounting facility is not confidential TOP
in nature and the customers of the client are advised to make payment directly to the factor, this >
facility is called bulk factoring.
Hence (b) is the correct answer.
26. Answer : (a) <
Reason : Regulations on venture capital investments are low as compared to bought out deals. TOP
>
All other differences are correct.
Hence (a) is the correct answer.
27. Answer : (a) <
Reason : Rs. lakh TOP
>
Advance provided 45.000
Less: Commission 1.469
43.531
Less: Discount charge 1.575
Funds made available 41.956
Effective rate per quarter : 1.575/41.956 = 3.75%
Annualized rate = [(1.0375)4 – 1] * 100 = 15.87%.
Hence (a) is the correct answer.
28. Answer : (c) <
Reason : Cost of equipment= Rs.24 lakh TOP
>
Aggregate lease rentals= 0. 020 × 7×12×24=Rs.40.32 lakh
Aggregate interest charged for the lease over the lease period = Rs. (40.32-24) = Rs. 16.32 lakh
Add-on yield = 16.32/7=2.3314, Now (2.33/24) × 100=9.71%. Hence (c) is the correct answer.
29. Answer : (a) <
TOP
Reason : Here t=∝, and when deferment period is either equal to or greater than number of
>
level installment that are not due and outstanding, then no rebate is allowed. Hence (a) is the
correct answer.
30. Answer : (b) <
Reason : The company shall not buy-back the locked-in shares and non-transferable shares till TOP
>
the shares become transferable as per SEBI guideline. All other statements are correct.
Hence (b) is the correct answer.

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Section B : Problems
1 a. < TOP >
Loan tenure (in months) 60
EMI (Rs)charged by the competitors
1275.0
(on the loan amount of Rs.50,000)
EMI(Rs) charged by the competitors
255.0
(on the loan amount of Rs.10,000)
Less : Excess EMI (Rs)charged by the competitors 5.0
EMI (Rs) charged by the Xonix Financial Service
250.0
(to be paid in arrears)
Flat rate of interest is the value of ‘f’ in the following:
f = 10.00%.
APR = 250 PVIFA(k,60) = 10,000
PVIFA(k,60) = 40
Therefore k = 1.486% ( by trial and error)
Therefore APR = (1+0.01486)12–1 = 19.36%
b. A. Loan Amount = 5,50,000 0.75 = Rs.4,12,500
Installment = = Rs.10,312.50
B. PV of EMIs = 10,312.50PVIFA(k,36)
C. Processing fee = 0.0075 4,12,500 = Rs.3,093.75
Total charge for credit = (10,312.50 60) – 4,12,500 = Rs.2,06,250
Interest rebate as per Rule 78 =
= Rs.33,811.48
D. Amount payable on early settlement = (10,312.50 24) – 33,811.48
= Rs.2,13,688.52
PV of the above = 2,13,688.52PVIF(k,36)
Effective interest rate is the value of ‘k’ in the following:
A–B–C–D=0
4,12,500 – 10,312.50PVIFA(k,36) – 3,093.75– 2,13,688.52PVIF(k,36)= 0
Therefore k = 1.55% (by trial and error)
Now, we will calculate the annualized interest rate, i.e.
–1
=1.2027–1
=20.27% p.a.
c. A. Loan amount is 5,50,000 0.75 = Rs.4,12,500
B. Installment size is 1,275/50,000 4,12,500 = 10,518.75
PV of EMI = 10,518.75PVIFA(k,12)
Effective rate of interest applicable is 10,518.75PVIFA(k,60) = 4,12,500
PVIFA(k,60) = 39.2157
k=1.56% (by trial and error)

Repayment schedule for the first year


Opening Interest Capital Outstanding
Month EMI
balance component component capital
1 412500.00 6435.00 4083.75 10518.75 408416.25
2 408416.25 6371.29 4147.46 10518.75 404268.79
3 404268.79 6306.59 4212.16 10518.75 400056.64
4 400056.64 6240.88 4277.87 10518.75 395778.77
5 395778.77 6174.15 4344.60 10518.75 391434.17
6 391434.17 6106.37 4412.38 10518.75 387021.79
7 387021.79 6037.54 4481.21 10518.75 382540.58
8 382540.58 5967.63 4551.12 10518.75 377989.47
9 377989.47 5896.64 4622.11 10518.75 373367.35
10 373367.35 5824.53 4694.22 10518.75 368673.13
11 368673.13 5751.30 4767.45 10518.75 363905.68
12 363905.68 5676.93 4841.82 10518.75 359063.86

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C. The pre-payment charge applicable is 3,59,063.86*0.05 = 17,953.19


PV of pre-payment charge = 17953.19PVIF(k,12)
D. PV of pre-payment = 3,59,063.86 PVIF(k,12)
E. Processing charge paid = 4,12,500*0.01 = Rs.4,125
Effective interest rate is the value of ‘k’ in the following:
A – B – C – D – E= 0
4,12,500 – 10,518.75PVIFA(k,12) – 17953.19PVIF(k,12) –3,59,063.86 PVIF(k,12) – 4,125 = 0
Therefore k = 2% ( by trial and error)
Now, we will calculate the annualized interest rate, i.e.
(1.02)12– 1 = 26.82%

2 A. Initial investment = Rs.94 lakh < TOP >


B. PV of lease payments = 30.55 PVIFA(16.50, 5)
= 3.2365 * 30.55 = Rs.98.88 lakh
C. PV of tax shield on lease payments = 30.55 * 0.30 * PVIFA (18,5)
= 9.165 * 3.1272 = Rs.28.66 lakh
D. PV of depreciation tax shield

Year Depreciation PVIF @ 18% PV

1 23.50 0.8475 19.92

2 17.63 0.7182 12.66

3 13.22 0.6086 8.05

4 9.91 0.5158 5.11

5 7.44 0.4371 3.25

Total 48.99
Therefore tax shield = 48.99 * 0.3 = Rs.14.70 lakh
E. PV of interest tax shield
Amount Interest PVIF @ PV of
Capital
Year of o/s component Lease Rental 18% interest
component
loan @ 16.50%
1
98.88 14.23 16.32 30.55 0.8475 13.83
2
84.65 16.58 13.97 30.55 0.7182 10.03
3
68.06 19.32 11.23 30.55 0.6086 6.83
4
48.74 22.51 8.04 30.55 0.5158 4.15
5
26.23 26.22 4.33 30.55 0.4371 1.89
Total 36.73
Therefore tax shield = 36.73 * 0.30 = Rs.11.02 lakh
Now the net value of lease = A – B + C –D –E
= 94 – 98.88 + 28.66 –14.70 –11.02
= –1.94
Since, the net value of lease is negative leasing is not advisable.

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3 < TOP >

Return Return
Sr. Issue Price Index
Name of the issue LTP from the from the
No. (Rs.) Values
IPO market
1 Fortis Healthcare Limited 96.70 108.00 4079.30 -0.105 0.034
2 Advanta India Limited 815.00 640.00 3997.65 0.273 0.056
3 ICRA Limited 931.95 330.00 3917.35 1.824 0.077
4 Orbit Corporation Limited 223.00 110.00 3829.85 1.027 0.102
5 Abhishek Mills Limited 59.60 100.00 3678.90 -0.404 0.147
6 Page Industries Limited 412.80 360.00 3608.55 0.147 0.169
7 Raj Television
236.40 257.00 3608.55 -0.080 0.169
Network Limited
8 AMD Metplast Limited 69.50 75.00 3678.90 -0.073 0.147
9 Idea Cellular Limited 116.60 75.00 3718.00 0.555 0.135
10 Evinix Accessories Limited 95.00 120.00 3626.85 -0.208 0.163
11 Mudra Lifestyle Limited 79.45 90.00 3718.00 -0.117 0.135
12 Oriental Trimex Limited 22.90 48.00 3626.85 -0.523 0.163
13 MindTree Consulting Limited 797.50 425.00 3626.85 0.876 0.163
14 Broadcast Initiatives Limited 75.80 120.00 3626.85 -0.368 0.163
15 Indus Fila Limited 160.10 170.00 3761.65 -0.058 0.122
16 Euro Ceramics Limited 142.35 165.00 3718.00 -0.137 0.135
17 Indian Bank 127.90 91.00 3811.20 0.405 0.107
18 C & C Constructions Limited 197.00 291.00 3942.00 -0.323 0.070
19 SMS Pharmaceuticals Limited 341.00 380.00 3745.30 -0.103 0.127
20 Power Finance Corp. Limited 149.00 85.00 3938.95 0.753 0.071
Total
3.361 2.457
Wealth relative can found out by the formulae =
Where N = number of IPO in the sample
rit = Returns on the IPO
rmt = Returns on the market
= = 1.04.
A wealth relative greater than 1 indicates that IPOs have outperformed the market in the said period.

4 < TOP >


Cost of In-house Management Rs. in lakh
Sales prediction = 1000 1.20 1200.00
Average collection period = (0.75 30)+(0.20 45)+(0.05 60) 34.50 days
Cost of owned funds:
Pre-tax cost = 16.75/0.67 = 25%
Therefore,
Cost = 1200 (34.50/365) 0.20 0.25 5.67
Cost of funds from PVS Finance Ltd:
1200 (34.50/365) 0.40 0.22 9.98
Cost of funds from DPS Finance Ltd:
1200 (34.50/365) 0.40 0.21 9.53
Administrative expenses 1.50
Bad debts = 1200 0.02 24.00
Income from the default premium:
1200 0.05 0.03 1.8
Total cost 48.88
Alternative I.
Benefits associated with factoring:
Suppose, increase in the sales because of factoring service is ‘S’
Therefore the incremental contribution will be 0.35S.
The company will save the above mentioned costs if, it goes for factoring service.
Hence, the benefit is Rs.48.88+0.35S lakh.
Cost associated with factoring:

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New sales 1200+S


Discount charge = (1200+S) (30/365) 0.75 0.24 17.75+0.015S
Commission = (1200+S) 0.03 36+0.03S
Cost of own funds = (1200+S) (30/365) 0.25 0.25 6.16+0.005S
Total cost 59.91+0.05S
Now, the minimum increase in the sales
59.91+0.05S = 48.88+0.35S
S = Rs.36.77 lakh.
Therefore the minimum sales should be Rs.1236.77 lakh to make factoring option viable.
The total cost factoring = Rs.61.75 lakh.
Alternative II
In-house Management as per new credit term:
Discount:
Customers paying within 10 days : 1200 0.30 0.03 = 10.80
Customers paying within 20 days : 1200 0.20 0.02 = 4.80 15.60
Average collection period
=(0.30 10)+(0.20 20)+0.50[(0.60 30)+(0.20 45)+(0.20 60)] 26.50 days
Cost of owned funds:
1200 (26.50/365) 0.20 0.25 4.36
Cost of funds from PVS Finance Ltd:
1200 (26.50/365) 0.40 0.22 7.67
Cost of funds from DPS Finance Ltd:
1200 (26.50/365) 0.40 0.21 7.32
Administrative expenses 3.50
Bad debts = 1200 0.01 12.00
Income from the default premium:
1200 0.50 0.20 0.04 4.80
Total cost 45.65
Comparison among the alternatives on the basis of cost to sales:
In-house Management Factoring In-house Management with new credit policy
48.88/1200 61.75/1236.77 45.65/1200
=4.07% =4.99% =3.80%
Hence, the company is advised to go for In-house management with new credit policy because it has the lowest
cost associated with it.
< TOP >
5 a. PV of interest payments
7 PVIFA (12.5%,6) + 3.5PVIFA(12.5%,6) PVIF(12.5%,6) = 28.38 + 7.00= Rs.35.38
b. Stock split and Bonus adjusted EPS
Year (ending) March March March March March
2006 2007 2008 2009 2010
EPS 17.00 20.40 24.48 29.38 35.25
Rate of growth implicit = 17.00(1+g)4 = 35.25, g = 20.00%
Projected EPS on June 30, 2010
= 35.25(1+0.20/4) =Rs.37.02
Therefore projected market price of share after 36 months = 20.39× 37.02= Rs.754.84
PV of this market price = 754.84 × PVIF (12.5%,6) = Rs.372.34
Stock split and Bonus adjusted sales
Year (ending) March March March March March
2006 2007 2008 2009 2010
Sales per share 340.00 408.00 489.60 587.50 705.12
Rate of growth implicit = 340.00(1+g)4 = 705.12, g = 20.00%
Projected Sales per share on June 30, 2010
= 705.12(1+0.20/4) =Rs.740.38
Therefore projected market price of share after 36 months = 1.01× 740.38= Rs.747.78
PV of this market price = 747.78× PVIF (12.5%,6) = Rs.368.86
Now the weighted current price is = (372.34*0.5) + (368.86*0.5) = Rs.370.60
c. PV of non-convertible portion redeemed after 6 years
= 50PVIF (12.5%, 12) = Rs.12.17
Intrinsic worth of the share = (A) + (B) + (C)
=35.38+370.60+12.17= Rs.418.15

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GFL should invest, as intrinsic worth is much higher than the issue price.

Section C: Applied Theory


6 Credit rating is a qualitative assessment based on the fundamental strengths of a company which is the < TOP >
most important driver of a company’s performance in the market place over a long period of time. In
case of equity, any errors in valuing the firm are directly mapped on the pricing of equity. Valuation of
any firm is always an improvised task and is merely a reflection of the expectation of cash flows of the
person doing the valuation. Moreover the grading is not a recommendation to buy or sell and does not
comment on the price at all. The grading is to give some sort of indication about the company to invest
and compare it with other companies in that group.
But as ratings are done for promised payments, giving a precise rating to equity instruments is not
feasible.
Following are the parameters on which the IPO of the company can be graded:
• Management strength
• Business prospects
• Financial performance
• Corporate governance practices
• Other issue-related aspects
• Track record of business & financial performance
• Track record of management in managing the business and organization
• Sustainability of business model and ability to adapt
• Future plans / prospects and the ability of the firm to deliver
• Pricing of the IPO
• Evaluating the market-beating potential of the equity
Degree of market concentration in the business, R&D record of the firm etc.
7 Ideally, loan seekers should opt for a floating rate home loan when it is expected that interest rates will < TOP >
decline going forward. Fixed rate loans should be preferred when interest rates are expected to rise. But is
making a choice that simple? In today's environment, when there is a lot of talk about rising interest rates,
should investors shun floating rate home loans altogether? Or is there still some merit in this instrument?
All said and done, in the last one year, there was a trend of floating rate home loans being more popular
as compared to the fixed rate loan and as of now, this trend is continuing.
There are three important issues which one needs to consider before opting for one type of a loan over the
other.
First, an important determinant of what one should go in for should be the long term expectation of
interest rates. For example, if the loan seeker (or the experts) expect rates to rise for the next one year, but
then decline gradually over the next several years, a floating rate product may be preferable. The other
option of going in for a fixed rate product and then switching at the end of the year will entail costs (there
could be a penalty of 1% - 2% of the outstanding loan amount) and may not make financial sense.
Moreover, floating rate home loans do not change the rate of interest every quarter (even though they
may review the rate every quarter). The attraction of a floating rate home loan is that it does not attract a
part prepayment charge. This could appeal to individuals who get lump sum bonuses which they can use
to reduce their loan exposure.
Second, the issue whether fixed rate home loans are actually `fixed rate'. When considering a fixed rate
home loan over a floating rate home loan a strong selling point is that if interest rates were to rise
dramatically the loan seeker will be `protected'. Apparently the reality is somewhat different. It seems
that companies that have given out fixed rate loans can revise their rates upwards in exceptional
circumstances (significant rise in interest rates for one). So if one thinks that rates will remain range
bound over the near term and decline over the long term, one is still better off with a floating rate product.
Third, a fixed rate loan is generally priced higher as compared to a floating rate product. This holds true
in the current environment where the fixed rate loan is at a higher interest rate as compared to a floating
rate loan. So if one expects that interest rates are likely to move up, but only to the extent of this
differential, then one should ideally be indifferent between the two types of a loan. The deciding factors
then should be when one thinks the rates will increase, and also the long term expectations of interest
rates.
As always, there is no one answer to whether a customer should go in for a floating or a fixed rate home
loan. A person with very little appetite for risk or negative surprises should opt for the fixed rate home
loan. But in case the customer can take on some risk, a floating rate home loan is worth a look.

< TOP OF THE DOCUMENT >

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Question Paper
Investment Banking and Financial Services-I (MSF2K1): October 2007
Section A : Basic Concepts (30 Marks)
• This section consists of questions with serial number 1 - 30.
• Answer all questions.
• Each question carries one mark.
• Maximum time for answering Section A is 30 Minutes.

< Answer >


1. Which of the following is false?
(a) The major factor which determines the borrowing rates in the call money market, is the demand supply
condition
(b) If the liquidity crunch of the banks is passed on to the system it may lead to high volatility in call rates
(c) Call rates are under the normal liquidity conditions, are the floor rate for the term money market
(d) The prevailing PLR influence the Inter Bank Participations (IBP) rate since the underlying security is a
loan asset
(e) The banks which have an aggressive approach would prefer to invest in IBPs rather than call money
market.
< Answer >
2. Which of the following bill becomes clean bill immediately after the delivery of the documents?
(a) Documentary bill
(b) Inland bill
(c) D/P bill
(d) D/A bill
(e) Supply bill.
< Answer >
3. The rate at which the RBI rediscounts eligible bills from commercial banks is known as
(a) Bank rate
(b) The SBI hundi rate
(c) Bazaar bill rate
(d) Commercial bank’s bill finance rate
(e) The SBI discount rate.
< Answer >
4. Which of the following is false with respect to repo transactions?
(a) A repo will help the holder of the security to acquire liquidity for a short term without necessarily
liquidating the security
(b) The RBI announces the number of securities eligible for the repo transaction
(c) PSU bonds which are in demat form are eligible for repo transaction
(d) The interest rate on borrowing for the inter bank repo deal is decided by the RBI.
(e) Borrowing under repo is a secured borrowing.
< Answer >
5. Every company accepting public deposits shall file return of deposits with the Registrar of Companies, on or
before
(a) 31st March every year
(b) 30th June every year
(c) 31st July every year
(d) 31st October every year
(e) 31st December every year.
< Answer >
6. Which of the following is false with respect to the insurance of deposits?
(a) The deposit will have a cover of actual amount of deposit subject to a maximum of Rs.1,00,000 for
each depositor irrespective of number and amount of deposits one has with a bank
(b) The premium payable by the depositor for the insurance of the deposits is 5 paise per half year for every
100 rupees
(c) For this purpose all the deposits of a depositor at different branches of the same bank are clubbed
together
(d) Deposits held in the name of a person individually and the same depositor also holds a deposit jointly
with another person then they are treated as two different deposits
(e) The insurance premium is payable at the end of March and October every year.
< Answer >
7. SEBI has instituted a mechanism for redressal of investor grievances related to issue of securities. SEBI has
made it mandatory for all issuers to deposit _____ of the size of the issue as a security with the regional stock
exchange.
(a) 0.50%
(b) 0.75%

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(c) 1.00%
(d) 3.00%
(e) 5.00%.
< Answer >
8. A company has issued Pass Through Certificates (PTCs) backed by a pool of property receivables aggregating
to Rs.315.86 lakh. The equated monthly payment to be made to PTC holder are as follows:
During the first 12 months : Rs. 16 lakh p.m.
During the next 12 months : Rs. 12 lakh p.m.
During the next 6 months : Rs. 8 lakh p.m.
The promised rate of return to the investor is
(a) 19.56%
(b) 18.56%
(c) 17.56%
(d) 16.56%
(e) 15.25%.
< Answer >
9. Registration with SEBI is mandatory to carry the business of investment banking in India. Which of the
following is not correct with respect to the compliance norms to get the registration certificate?
(a) The applicant should be a body corporate
(b) The applicant has at least 5 employees with prior experience in merchant banking
(c) The applicant should have minimum net worth of Rs.5 crore
(d) The associate company, group company or subsidiary of the applying company has not been registered
as investment banker
(e) The applicant should have necessary infrastructure.
< Answer >
10. Which of the following is not the function of the registrar to the issue?
(a) Arrange to collect the application forms from the various collection centers
(b) Screen the invalid application and multiple application
(c) Printing and dispatch of refund orders, allotment advices and share certificates
(d) Redressal of investor grievances
(e) Agree to subscribe a specified number of securities in the event of non-subscription.
< Answer >
11. Which of the following is not correct regarding guideline for the advertisement of an issue?
(a) The advertisement shall not contain any information or language which is extraneous to the prospectus
(b) SEBI approved models, celebrities, fictional characters, landmarks or caricatures can be displayed in the
advertisement
(c) The advertisement should not include any slogans or brand names for the issue except the commercial
brand names of its product
(d) Advertisement stating that the issue is fully subscribed or oversubscribed shall not be issued during the
period when the issue is open for subscription
(e) Announcement about the closing of the issue must be made on the date of closure of the issue.
< Answer >
12. Which of the following financial instrument is issued at a face value and do not carry any interest and are
redeemed by repayment in series of installment?
(a) Cash pay bonds
(b) Installment pay bonds
(c) Secured premium notes
(d) Installment premium notes
(e) Warrants.
< Answer >
13. A leasing company which is formed as a subsidiary of a manufacturing company for leasing the products of the
parent company, is called
(a) Captive leasing company
(b) Common leasing company
(c) Formal leasing company
(d) Extended leasing company
(e) Integrated leasing company.
14. The instrument which provides the investor the option to convert the paper into flat interest paying instrument at < Answer >
the end of a particular period, is known as
(a) Mismatch FRNs
(b) Mini-max FRNs
(c) Flip-flop FRNs
(d) Capped FRNs
(e) VRN-structured FRNs.
< Answer >
15. Which of the following is/are not true regarding the difference between venture capital and bought out deal?
I. Participation in management is high in case of VC where as it is low in case of bought out deals.
II. Exit from the investments takes 7 to 10 years in case of venture capital, while in case of bought out

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deals exit is done immediately after the expiry of lock in period.


III. Regulations on venture capital investments are very high as compared to bought out deals.
(a) Only (III) above
(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
16. Shah Financial Services Ltd. (SFSL) has recently structured a six year leveraged lease transaction involving an
investment cost of Rs.175 crore with itself as the equity participant and Dean Bank as the loan participant
funding the investment in the ratio of 1:4. The loan carries an effective rate of interest of 18% and is to be
repaid in the six equated annual installments. The gross yield of SFSL is 20% per annum. The amount of
equated annual installmet to be repaid to Dean Bank at the end of every year for such a lease transaction is
(a) Rs.40.03 crore
(b) Rs.35.86 crore
(c) Rs.35.41 crore
(d) Rs.34.55 crore
(e) Rs.30.86 crore.
< Answer >
17. Which of the following is true for break even lease rental from the view point of lessee?
(a) A large upfront payments decreases the break even rental
(b) A higher tax relevant rate of depreciation increases the break even rental
(c) A longer primary lease period increases the break even rental
(d) Higher cost of capital increases the break even rental
(e) A higher net salvage value increases the break even rental.
< Answer >
18. Which feature of a construction loan allows the borrower to borrow a medium-term loan from the commercial
bank to pay-off the construction loan taken from the same commercial bank on completion of the construction?
(a) Conventional mortgage
(b) Mini-perm
(c) Direct commercial loan
(d) Bow-ties
(e) Gap loans.
< Answer >
19. Which of the following is not true with respect to auction rated debt?
(a) This is a fully redeemable non-convertible short term debentures
(b) This is secured by specific movable and immovable assets
(c) It is redeemed at regular intervals and then reauctioned
(d) Interest rate for this is determined by the market
(e) Credit rating is mandatory for auction rated debt.
< Answer >
20. There can be different forms of factoring agreements. Which of the following factoring agreements was
developed by the American factors primarily to help their importers/ distributors involved in executing import
orders on behalf of their customers?
(a) American factoring
(b) Cross-border factoring
(c) Supplier guarantee factoring
(d) Old line factoring
(e) Bank participation factoring.
< Answer >
21. Which of the following is/are true with respect to credit rating?
I. A credit rating is a professional opinion given after studying all available information at a particular
point of time.
II. There is no privity of contract between an investor and a rating agency and the investor is free to
accept or reject the opinion of the agency.
III. Rating agency compensates the investor who has made an investment relying on the rating and
makes loss on investment.
(a) Only (I) above
(b) Only (III) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
22. In a book built issue the issuing company can mention cap on the price band, which should not be more than
____ of the floor price.
(a) 10%
(b) 20%
(c) 25%
(d) 30%

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(e) 35%.
< Answer >
23. Mr. Prashant has accumulated savings of Rs.1,82,000 for five years with NHB. He requires a loan for a new
accommodation, which is of 859 square feet. What will be the maximum amount of loan disbursed to him under
Home loan account scheme?
(a) Rs. 83,000
(b) Rs. 1,66,000
(c) Rs. 2,49,000
(d) Rs. 3,64,000
(e) Rs. 5,46,000.
< Answer >
24. Which of the following is/are the correct difference(s) of factoring and forfaiting?
I. In the factoring transaction, the factor does not provide hundred percent finance, on the other hand, a
forfaiting transaction the forfeiter provides hundred percent finance.
II. In a non recourse factoring transaction, the factor participates in the credit granting decision of the
exporter where as in forfaiting transaction, the forfaiter relies on the unconditional and irrevocable
guarantee provided by the availing bank.
III. The forfaiter takes the responsibilities of receivables accounting while, the factor does not assume
any of these responsibilities..
(a) Only (II) above
(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer >
25. DP is a US based company. It wants to raise funds from India through Indian Depository Receipts. What is the
profitability requirement for DP according to SEBI Act, 1992?
(a) It has been making profits for the last three years preceding to issue and has been declaring dividend of
not less than five percent each year for the said period
(b) It has been making profits for the last three years preceding to issue and has been declaring dividend of
not less than ten percent each year for the said period
(c) It has been making profits for the last five years preceding to issue and has been declaring dividend of
not less than five percent each year for the said period
(d) It has been making profits for the last five years preceding to issue and has been declaring dividend of
not less than ten percent each year for the said period
(e) It has been making profits for the last five years preceding to issue and has been declaring dividend of
not less than fifteen percent each year for the said period.
< Answer >
26. Mercator Lines Limited is coming up with a right issue priced at Rs.50 per share. The right is offered in the
ratio of 1 share for every 6 shares held. The shares are currently quoting at Rs.61 in the market. Mr. Vinod is
currently holding 600 shares of the company. The change in the wealth of Mr. Vinod if he allows his right to
expire is
(a) + 942
(b) – 942
(c) + 480
(d) – 480
(e) + 542.
< Answer >
27. A finance company offers a hire purchase plan for its corporate borrowers for the following terms:
Flat rate of interest 10%
Repayment period 3 years
Frequency Monthly in advance
Deposit at the inception of hire agreement 20% of the cost of asset.
The annual percentage rate using approximation formula is
(a) 36.00%
(b) 24.70%
(c) 23.40%
(d) 20.57%
(e) 18.00%.
< Answer >
28. Which of the following is an example of open market?
(a) A bought out deal
(b) A car loan
(c) Public issue of securities
(d) Housing finance
(e) Private placement.
< Answer >

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29. Which of the following CDs carry both fixed and floating interest rates?
(a) Asian Dollar CDs
(b) Installment CDs
(c) Rising Rate CDs
(d) Thrift CDs
(e) Yankee CDs.
< Answer >
30. Consider the following data regarding a traditional loan?
Tenure of loan : 15 years
Rate of Interest : 15% p.a.
Loan amount : Rs.10,00,000
Payment pattern : Equated monthly installments.
The principal amount outstanding after second installment is
(a) Rs.9,96,989.56
(b) Rs.9,96,589.00
(c) Rs.9,63,989.65
(d) Rs.9,12,500.55
(e) Rs.9,13,164.64

END OF SECTION A

Section B : Problems (50 Marks)


• This section consists of questions with serial number 1 – 5.
• Answer all questions.
• Marks are indicated against each question.
• Detailed workings should form part of your answer.
• Do not spend more than 110 - 120 minutes on Section B.

1 Indian power sector is growing rapidly. Considering this Shah group has decided to expand their company ‘Powerful Pvt. Ltd’ < Answer >
in the proposed Gujarat SEZ. The estimated cost of the full project will be Rs.125 crore. This investment will be required at the
beginning of the financial year 2008-09.The group is able to invest Rs.50 crore as equity in the project. The equity will have the
face value of Rs.10 each. The State Bank of India has given its intimation to lend Rs.10 crore in this project for five years at an
interest rate of 10% p.a. and the amount will be repaid in five equal annual installments starting from the end of 1st year.
For remaining Rs.65 crore of investment they have proposed funding options to IDFC Private Equity Ltd. The group has given
two options to IDFC Private Equity Ltd.
i. Straight equity investment.
ii. Fully Convertible Debentures (FCDs). These debentures will carry the coupon rate of 12% and additionally will have
the share of 6% of the profit before taxes until they are converted. These debentures will be converted into equity at the end
of 4 years at the P/E multiple of 11 on the average earning per share of the first four years. If there is any loss in any year,
that year will be excluded for averaging.
Considering above two options IDFC Private Equity Ltd. has shown its interest for investment with the time horizon of 6 years.
It is expected that IDFC Private Equity Ltd. will exit at the trailing P/E of 15 through the IPO route.
The company proposes to maintain a dividend payout ratio of 10% for all 6 years.
The expected EBIT for the company is as follows:
0.2 0.6 0.2
Probability
Year Amount (Rs. in crore)
2008-09 6.00 7.50 9.00
2009-10 13.50 16.5 18.00
2010-11 30.00 36.00 42.00
2011-12 49.50 55.50 60.00
2012-13 75.00 84.00 91.50
2013-14 96.00 99.00 102.00
Recently the Finance Minister of India has declared that after the financial year 2009-10 power companies will not be given any
tax benefits under SEZ and after that the company will fall under the tax bracket of 30%.Currently the company is not required
to pay any taxes. In case the company is not able to pay interest on FCDs, it will have to pay the balance interest with penalty

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on unpaid interest at 15% from the subsequent year’s profit.


If the IDFC Private Equity Ltd. has the required rate of return of 30%, you are required to select the investment option.
(15 marks)
2 Coolcommand Cooling Solutions (CCS) has furnished the following information pertaining to its credit policy: < Answer >

• Projected sales for the next year is Rs.1000 lakh and the gross margin for the company is 22%.
• Credit policy of the company is 2/10 net 30. It has been observed that 25% of the customers avail the discount.
Out of the remaining, 25% of customers pay within 20 days, 50% of the customers pay within 30 days and the rest pay
within 50 days.
• The bad debts amount to 3% of the sales.
• Administrative overheads for credit monitoring are Rs.2 lakh.
• CCS has been financing its investments in receivables through a mix of bank finance and long-term funds in the
ratio of 3:1. The effective rate of interest on bank finance is 16% and the cost of long-tern funds is 20%.
The sales executives are responsible for following up collections and on an average spend 25% of their time on collection. The
finance manager of CCS has realized that if the sales executives are relieved from collection responsibilities, the annual sales
would increase by 10%. Therefore the company has approached Resolve Financial Services. Resolve Financial Services has
offered the following two schemes:
Recourse factoring: The factoring agreement provides for an advance payment of 75% of the value of factored receivables.
Advance carries the interest of 15% p.a. and the factoring commission is 1.5% of the value of the factored receivables. Both
interest and commission are collected upfront.
Non-recourse factoring: The factoring agreement provides advance payment of 70% of the value of factored receivables.
Advance carries a rate of interest of 18% p.a. and the factoring commission is 4% of the value of factored receivables. Both
interest and commission are collected upfront.
After the careful analysis of the sales ledger of CCS, Resolve Financial Services agreed to a guaranteed payment period of 30
days. The finance manager of CCS is not sure whether to go for any factoring or to continue with in-house management for the
receivables.
You are required to recommend with calculation to the finance manager of CCS for the selection of the best scheme. (Assume
360 days in a year)
(8 marks)

3 Prime Infra Ltd. (PIL) is planning to invest in some heavy construction equipments as a part of its expansion plan. The < Answer >
equipment will cost Rs.450 lakh exclusive of central or sales tax and will have an economic life of five years. The company can
purchase the equipment from a local vendor. Given the huge amount of investment, the company is thinking of leasing the
equipment from Tech Financial Services (TFS) of Ahmedabad.
TFS uses the gross yield on investment as the basis of pricing its investments. The gross yield on five year lease investment is
1.41% over the pre-tax cost of funds. The cost of debt and equity for SFS are 15 %( pre-tax) and 21% respectively. The
company maintains the debt to equity ratio of 3:1. The marginal tax rate applicable to the company is 30% and the applicable
surcharge is 10%. Applicable sales tax is 10%. SFS collects 1% of investment cost as front- end management fees and incurs
0.5% as initial direct cost. The applicable rate of depreciation for the equipment is 20%. Expected salvage value of the
equipment at the end of fifth year will be 5% of the cost of equipment. The finance manager of PIL has asked you to calculate
a. The lease rental payable to TFS in arrears for the first year if the rentals are stepped up by 10% per annum, so that it
will meet the gross yield requirement.
b. The viability of leasing option if, PIL has the post-tax required return of 18% and cost of debt is 15%. The company
is under the tax bracket of 30%. (Use BHW model).
(4 + 6 = 10 marks)

4 Harig Exports Ltd. has proposed to expand its operations for which it requires funds of $10 million, net of issue expenses which < Answer >
amount to 2% of issue size. It proposed to raise the funds through GDR issue. The EPS of the company for the past few years
are as follows:
Year 2002 2003 2004 2005 2006 2007
EPS Rs.12.50 Rs.81.85 Rs.105.60 Rs.137.00 Rs.133.60 Rs.167.25
At the end of the year 2003, the company announced a reverse stock split of 5:1. The company announced the bonus issue of 1:3
at the end of 2005. The current dividend payout ratio of the company is 20% and is expected to remain same in the future. The
past growth rate in dividends is expected to continue indefinitely. Other particulars are as follows:
• Three shares underlie each GDR.
• Underlying shares are priced at 5% discount to the market price.
• Expected exchange rate at the time of GDR issue is Rs.40/$.
• Current risk free rate is 7.30% and is expected to remain same.
• Beta of the stock is 1.20 and is expected to remain same.
• Risk premium is 25% and is expected to remain same.
You are required to compute

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a. The number of GDRs to be issued.


b. The cost of GDRs to the company.
c. Gains/losses to the holder of 100 GDRs, if the company proposes a rights issue after the GDR issue in the ratio of 1:3
at a subscription price of Rs.1000 per share at the end of 2008. Assume the GDR holder exercises the rights and sells his
entire holding at the prevailing GDR price.
Assume the Rs/$ exchange rate at the time of rights issue and sale by GDR holder is Rs.40.50/$.
(5 + 2 + 4 = 11 marks)
5 Mr. Vrajesh has taken a loan of Rs.15,00,000 from Diwan Housing Finance Ltd., for purchasing an apartment according to < Answer >
graduated payment mortgage scheme for 10 years.
Terms and conditions of the loan are as follows:
i. Tenure – 10 years
ii. Payment – Monthly
iii. Interest – 12.5% p.a. compounded monthly
iv. The borrower needs to make graduated monthly payments for 5 years with payments increasing at a rate of 8% in the
second and third year and at a rate of 5% for the next 2 years and thereafter the payments would be as equated monthly
installments.
Draw a payment schedule of the housing loan taken by Vrajesh.
(6 marks)
END OF SECTION B

Section C : Applied Theory (20 Marks)


• This section consists of questions with serial number 6 - 7.
• Answer all questions.
• Marks are indicated against each question.
• Do not spend more than 25 -30 minutes on section C.

6 India was amongst the pioneers within Asian nations in leveraging securitization. In India, two sectors < Answer >
are the principal beneficiaries of securitization – banking and infrastructure sector. Explain the benefits
to each sector. Also discuss the factors that hinder the growth of securitization in India
(10 marks)

7 Credit card no doubt is a great innovation but simultaneously the other side of the innovation is the < Answer >
frauds associated with it. Explain the factors to be considered before choosing a credit card.
(10 marks)

END OF SECTION C

END OF QUESTION PAPER

Suggested Answers
Investment Banking and Financial Services-I (MSF2K1): October 2007
Section A : Basic Concepts
1. Answer: (e) < TOP >

Reason: Following statements are correct:


The major factor whicha determines the borrowing rates in the call money market, is the demand supply
condition
If the liquidity crunch of the banks is passed on to the system it may lead to high volatility in call rates
Call rates are under the normal liquidity conditions, are the floor rate for the term money market
The prevailing PLR influence the Inter Bank Participations (IBP) rate
The banks which have an conservative approach, would prefer to invest in IBPs rather than call money market.
Hence (e) is the correct answer.
2. Answer: (d) < TOP >

Reason: The D/A bill becomes clean bill immediately after the delivery of the documents.
Hence (d) is the correct answer.
3. Answer: (a) < TOP >

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Reason: The rate at which the RBI rediscounts eligible bills from commercial banks is known as Bank rate.
Hence (a) is the correct answer.

4. Answer: (d) < TOP >

Reason: Following are true with respect to repo transactions:


A repo will help the holder of the security to acquire liquidity for a short term without necessarily liquidating the
security
The RBI announces the number of securities eligible for the repo transaction
PSU bonds which are in demat form are eligible for repo transaction
The interest rate on borrowing for the inter bank repo deal is mutually decided depending on the term, amount
and the prevailing call money and term money rates.
Borrowing under repo is a secured borrowing.
Hence (d) is the ccorrect answer.
5. Answer: (b) < TOP >

Reason: Every company accepting public deposits shall file return of deposits with the Registrar of
Companies, on or before30th June every year.
Hence (b) is the correct answer.

6. Answer: (e) < TOP >

Reason: Following is true with respect to the insurance of deposits:


The deposit will have a cover of actual amount of deposit subject to a maximum of Rs.1,00,000 for each
depositor irrespective of number and amount of deposits one has with a bank
The premium payable by the banks for the insurance of the deposits is 5 paise per half year for every 100 rupees
For this purpose all the deposits of a depositor at different branches of the same bank are clubbed together
Deposits held in the name of a person individually and the same depositor also holds a deposit jointly with
another person then they are treated as two different deposits
The insurance premium is payable at the end of December and June every year.
Hence (e) is the correct answer.
7. Answer: (c) < TOP >

Reason: SEBI has instituted a mechanism for redressal of investor grievances related to issue of securities.
SEBI has made it mandatory for all issuers to deposit 1% of the size of the issue as a security with the regional
stock exchange.
Hence (c) is the correct answer.
8. Answer : (d) < TOP >

Reason: Define Im as the monthly rate of return implied by the cash flow stream.
315.86 = 16*PVIFA (Im,12) + [12 * PVIFA(Im,12) *PVIF(Im,12)] +[ 8 * PVIFA(Im,6 ) *PVIF(Im,24)]
The equation is satisfied by Im = 1.5% (By trial and error)
Annualized return is :
12
I = (1+Im) –1
12
= (1.015) – 1
= 19.56%
Hence (d) is the correct answer.
9. Answer: (b) < TOP >

Reason: Following are the compliance norms:


The applicant should be a body corporate
The applicant has at least 2 employees with prior experience in merchant banking
The applicant should have minimum net worth of Rs.5 crore
The associate company, group company or subsidiary of the applying company has not been registered as
investment banker
The applicant should have necessary infrastructure.
Hence (b) is the correct answer.
10. Answer: (e) < TOP >

Reason: Agree to subscribe a specified number of securities in the event of non-subscription is the function of
underwriter. Remaining all are the functions of the registrar.
Hence (e) is the correct answer.
11. Answer: (b) < TOP >

Reason: No models, celebrities, fictional characters, landmarks or caricatures shall be displayed in the

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advertisement. Remaining all are the correct guidelines for the advertisement of an issue.
Hence (b) is the correct answer.
12. Answer: (b) < TOP >

Reason: Secured premium notes are issued at a face value and do not carry any interest and are redeemed by
repayment in series of installment.
Hence (b) is the correct answer.
13. Answer : (a) < TOP >

Reason: A leasing company which is formed as a subsidiary of a manufacturing company for leasing the
products of the parent company, is called Captive leasing company
Hence (a) is the correct answer.
14. Answer : (c) < TOP >

Reason: The instrument which provides the investor the option to convert the paper in to flat interest paying
instrument at the end of particular period, is known as Flip-flop FRNs.
Hence (c) is the correct answer.
15. Answer : (a) < TOP >

Reason: Regulations on venture capital investments are low as compared to bought out deals. All other
differences are correct.
Hence (a) is the correct answer.
16. Answer : (a) < TOP >

Reason : Loan amount = 0.8×175 = 140 crore


Equated annual installment = .
Hence (a) is the correct answer.
17. Answer : (d) < TOP >

Reason: - A large upfront payment increases the break even rental.


- A higher tax relevant rate of depreciation decreases the break even rental.
- A longer primary lease period decreases the break even rental.
- Higher cost of capital increases the break even rental.
- A higher net salvage value decreases the break even rental.
Hence (d) is the correct answer.
18. < TOP >
Answer: (b)
Reason: The mini-perm feature of construction loans provided by the commercial banks allows a borrower to
borrow a medium-term loan from the commercial bank to pay-off the construction loan taken from the same
commercial bank on completion of the construction.
Hence, option (b) is the correct answer.
19. Answer : (e) < TOP >

Reason : Credit rating is not required for auction rated debt because the tenure is less than 18 months. All other
options are correct.
Hence (e) is the correct answer.
20. Answer : (c) < TOP >

Reason: Supplier guarantee factoring agreements was developed by the American factors primarily to help
their importers/distributors involved in executing import orders on behalf of their customers.
Hence (c) is the correct answer.
21. Answer : (c) < TOP >

Reason: The following are true with respect to the credit rating:
• A credit rating is a professional opinion given after studying all available information at a particular
point of time.
• There is no privity of contract between an investor and a rating agency and the investor is free to
accept or reject the opinion of the agency.
• Rating agency does not compensate the investor who has made an investment relying on the rating
and makes loss on investment.
Hence (c) is the correct answer.
< TOP >
22. Answer : (b)
Reason: In a fixed price issue the issuing company can mention cap on the price band, which should not be
more than 20% of the floor price.
Hence (b) is the correct answer.

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23. Answer : (e) < TOP >

Reason: Under Home loan account scheme the maximum amount of loan that can be disbursed is as follows:
Built up area Maximum amount of loan
Up to 430 sq. ft Four times of amount saved
Up to 860 sq. ft Three times of amount saved
Exceeding 860 sq. ft Two times of amount saved
Therefore loan to Mr. Prashant = 182000 * 3
= Rs.546000
Hence (e) is the correct answer.
24. Answer : (b) < TOP >

Reason : The factor takes the responsibilities of receivables accounting while, the forfaiter does not assume any
of these responsibilities.
Hence (b) is the correct answer.
25. Answer : (d) < TOP >

Reason : The company, which wants to raise funds through IDR, has been making profits for the last five years
proceeding to issue and has been declaring dividend of not less than ten percent each year for the said period.
Hence (d) is the correct answer.
26. Answer : (b) < TOP >

Reason : Price per share after the right issue =


Current market value for Mr. Vinod = 600*61 = Rs. 36,600
Value of shares after right is expired = 600*59.43 = Rs. 35,658
Therefore reduction in the value of shares = Rs.942
27. Answer : (d) < TOP >

Reason : Annual percentage rate = [n/(n–1)] * 2F


= 36/35 * (10*2)
= 20.57%
Hence (d) is the correct answer.
28. Answer : (c) < TOP >

Reason : A bought out deal, a car loan, housing finance and private placement all are the examples of
negotiated market. Only public issue of securities is the example of open market. Hence option (c) is the correct
answer.
29. Answer: (a) < TOP >

Reason: Asian Dollar CDs carry both fixed and floating interest rates.
Hence (a) is the correct answer.
30. Answer : (a) < TOP >

Reason : EMI =

Interest Capital Capital o/s EMI


Opening balance component

1000000.00 12500.00 1495.87 998504.13 13995.87

998504.13 12481.30 1514.57 996989.56 13995.87


Hence (a) is the correct answer.

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Section B : Problems

1. The expected EBIT for the next six years is as follows < TOP >

(Rs. in lakh)
2008-09 750
2009-10 1620
2010-11 3600
2011-12 5520
2012 -13 8370
2013 - 14 9900
a. Straight equity investment of Rs.65 crore
(Rs. in lakh)
EBIT Interest on EAT EPS Dividend
borrowing inflow to IDFC
2008-09 750 100 650 0.57 37.05
2009-10 1620 80 1540 1.34 87.10
2010-11 3600 60 2478 2.15 139.75
2011-12 5520 40 3836 3.34 217.10
2012 -13 8370 20 5845 5.08 330.20
2013 - 14 9900 – 6930 6.03 391.95
EPS for the 6th year
= 6.03
Hence the per share inflow from IPO will be Rs.90.45
The NPV of the equity investment by IDFC
(Rs. in lakh)
Cash flow PV @ 30%
Initial Outflow (6500) (6500)
2008-09 37.05 28.50
2009-10 87.10 51.54
2010-11 139.75 63.61
2011-12 217.10 76.01
2012 -13 330.20 88.93
2013 - 14 391.95 81.20
Inflow through IPO 58792.50 12180.41
NPV 6070.21
b. Investment in FCD by IDFC
Debentures are converted after 4 years therefore EPS for 4 years will be
Interest
Interest of 6%
Year EBIT on EBT Tax EAT EPS
debenture contribution
Loan
2008-09 750 100 780 –130 – – – –
2009-10 1620 80 780+149.5 610.5 36.63 – 573.87 1.15
2010-11 3600 60 780 2760.0 165.60 778.32 1816.08 3.63
2011-12 5520 40 780 4700.0 282.00 1325.4 3092.60 6.19
Conversion price of FCD at the end of 4 years is calculated as follows:
Average EPS for first 4 years = (1.15+3.63+6.19)/3 = 3.66
Conversion price of FCD = 3.66*11 = Rs.40.22
No. shares to be issued = 161.61 lakh shares approximately
Now, the EPS at the end of 6th year = 6930 / (500 + 161.61) = 10.47
Therefore the per share inflow from IPO will be Rs.157.05
The NPV of the debt investment by IDFC is calculated as follows:
Cash flow Cash flow through Cash flow through Total inflow PV @ 30%
through participation dividend
interest in EBT
Initial Outflow – – – (6500) (6500)
2008-09 780 – – 780.00 600.00
2009-10 813.6 36.68 – 850.28 503.12
2010-11 780 165.60 – 945.60 430.41

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2011-12 780 282.00 – 1062.00 371.84


2012 -13 – – 142.77 142.77 38.45
2013 - 14 – – 169.28 169.28 35.07
Inflow through IPO – – – 25380.85 5258.30
NPV 737.19
As the NPV from the option of equity investment is higher than the option of FCDs, IDFC Private Equity should invest in the equity
of the company.

2. Relevant cost for in house management of receivables: < TOP >

Cash discount
Rs.5 lakh
1000*0.02*0.25 =
Average collection period =
27 days (approx)
0.25*10 + 0.75[0.25*20+0.50*30+0.25*50]
Cost of bank finance =
1000*(3/4)*(27/360)*0.16 = Rs.9 lakh
Cost of long term funds =
1000*(1/4)*(27/360)*0.20 = Rs.3.75 lakh
Total cost of funds = Rs.12.75 lakh
Bad debts
Rs.30 lakh
1000*0.03 =
Contribution lost on forgone sale
Rs.22 lakh
100*0.22 =
Avoidable cost of sales ledger and administrative
Rs.2 lakh
and credit monitoring
Total cost of in house management Rs.71.75 lakh.
Relevant cost of Recourse factoring
Factoring commission Rs.16.5 lakh
1100*0.015=
Discount charge Rs.10.31 lakh
1100*0.75*0.15*(30/360)=
Cost of long term funds Rs.4.58 lakh
1100*0.25*0.20*(30/360)=
Bad debt Rs.33 lakh
1100*0.03
Total cost of Recourse factoring = Rs.64.39 lakh
Relevant cost of Non Recourse factoring
Factoring commission
1100*0.04 Rs.44 lakh
Discount charge
1100*0.70*0.18*(30/360)= Rs.11.55 lakh
Cost of long term funds
1100*0.30*0.20*(30/360)= Rs.5.5 lakh
Total cost of Recourse factoring = Rs.61.05 lakh
Hence the Non Recourse factoring is recommended.
< TOP >
3. a. Required gross yield = Pre-tax cost of funds + 1.41%
Pre-tax cost of debt = 15%
Cost of equity = 21%
Applicable tax rate = 0.30(1.10) = 0.33
Marginal cost of capital =
Pre-tax cost of capital = 12.79/ (1-0.33) = 19.09%
Required gross yield = 19.09 + 1.41 = 20.50%
Assuming an investment of Rs.1000,
Management fees 0.01(1000) = Rs.10
Initial direct cost 0.005(1000) = Rs.5
If the lease rental receivable in the first year is given as ‘x’ and it is stepped up by 10% each year, the rentals to be charged for 5
year period will be,
=1005
10+3.49x = 1005
x = Rs.285.10 (approximately)
b. In case of a lease, sales tax of 10% will be applicable. Hence the value of the equipment will be Rs 450(1.10) = Rs.495.
Using BHW model

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FA(L) = PV of loan payments – PV of lease payment


PV of loan payments = Rs.495
PV of lease payments =
=Rs.562.50 lakh
PV of management fees = 495(0.01) = Rs.4.95 lakh
Hence FA(L) = 495 – 562.48 – 4.95 = (–) Rs.72.43
A(L) = PV of lease related tax shields – PV of loan related tax shields – PV of residual value
PV of lease rentals
Year Lease Rentals PV @18%
1 141.12 119.59
2 155.23 111.48
3 170.76 103.93
4 187.84 96.89
5 206.62 90.32
Total 522.21
PV of tax shield on lease rentals = 522.20(0.3)
= Rs.156.66 lakh
Debt service charge =
Repayment schedule
Year Loan outstanding Debt service charge Interest content Capital content
1 495.00 147.66 74.25 73.41
2 421.59 147.66 63.24 84.42
3 337.17 147.66 50.58 97.08
4 240.08 147.66 36.01 111.65
5 128.44 147.66 19.27 128.39
PV of loan related tax shield
Year Interest content Depreciation Tax shield PV
1 74.25 99.00 51.98 44.05
2 63.24 79.20 42.73 30.69
3 50.58 63.36 34.18 20.80
4 36.01 50.69 26.01 13.42
5 19.27 40.55 17.95 7.85
Total 116.81
PV of residual value = 495(0.05)/(1.18)5 = Rs.10.82 lakh
OA(L) = 156.66 – 116.81 – 10.82
= Rs.29.03 lakh
Now, FA(L) +OA(L) = -72.43 +29.03
= (-)Rs.43.40 lakh
Hence, lease option should be rejected.
< TOP >
4. a. Bonus adjusted EPS for the year 2007 is Rs.223
Growth rate in EPS is 62.5 (1+g)5 = 223
Hence g= 28.97%
Now dividend for the year = 167.25 × 0.20 = Rs.33.45
Dividends next period = 33.45 × 1.2897 = 43.14
Cost of equity can be calculated from CAPM as follows:
RF + β( Rm- RF) =
RF + Risk premium
7.3% + 25% = 32.3%
Using perpetual growth rate
Expected domestic price
D1/ ke – g = 43.14/ 0.323 – 0.2897 = Rs.1295.50

Price of 1 GDR = 3 × 1295.50× 0.95 = Rs.3692.18


Price of 1 GDR in $= 3692.18/40 = $92.30.
Number of GDRs to be issued
Amount of GDRs to be issued = $10 million/1- 0.02 = $ 10.20million
Number of GDRs = 10.20/92.30= 1,10,509 (approx)

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b. Computation of cost of GDRs


Price of 1 GDR = Rs.3692.18
Expected dividends = 43.14 × 3 = Rs.129.42
Growth rate = 28.97%
Cost of GDR = D1/ P0(1-f) + g = 32.55%
c. Computation of gains/loss to a holder of 100 GDR
Initial Investment =100 × 92.30 = $ 9230
Number of rights = 100 ×1/3 ×3 = 100
Investment in 100 rights = 100 × 1000= Rs.1,00,000 = 1,00,000/40.50 = $2469.14
Total investment = 9230 + 2469.14 = $11,699.14
Price of share at the end of 2008 =
Ex-rights price =
Total value = 400 ×1503.10 = Rs.6,01,240
Total value in dollars = 6,01,240/40.50 = $14,845.43
Total gains = 14,845.43–11,699.14= $3146.29

5. Let the monthly installment in the Ist year be Rs.X < TOP >

∴ X PVIFA1.04%12 + X (1.08) PVIFA1.04%,12 PVIF 1.04%, 12 + X(1.08)2 PVIFA1.04%,12 PVIF 1.04%,24 + X(1.08)2 (1.05)
PVIFA1.04%,12 PVIF 1.01%,36 + X(1.08)2 (1.05)2 PVIFA1.04%,12 PVIF1.04%,48 + X(1.08)2 (1.05)2 PVIFA1.04%,60 PVIF1.04%,60
= 15,00,000
11.23X + 10.71X + 10.22X + 9.47X + 8.79X + 30.74X = 15,00,000
81.16X = 15,00,000
X= 18,482 (Approximately)
∴ Monthly installment in the 1st year = Rs.18,482
∴ Monthly installment in the 2nd year = Rs.18,482 (1.08) = Rs.19,960.56
∴ Monthly installment in the 3rd year = Rs.18,482 (1.08)2 = Rs.21,557.40
∴ Monthly installment in the 4th Year = Rs.18,482 (1.08)2 (1.05) = Rs.22,635.28
from 5th year onwards = Rs.18,482 (1.08)2 (1.05)2 = Rs.23,767.04
Repayment schedule
Graduated monthly
Year
payment made (Rs)
1 18,482.00
2 20,349.36
3 21,977.31
4 23,076.17
5-10 24,229.98

Section C: Applied Theory


6. In India, two sectors are the principal beneficiaries of securitization – banking and the infrastructure sector. < TOP >
Let us evaluate the benefits to each sector.
The Banking Sector
Three factors underscore the importance of securitization for the banking sector.
1. Bank credit growing faster than deposits: Indians have been shedding their traditional aversion
to borrowing and banks have aggressively driven a retail credit revolution of sorts—with record
disbursements in Mortgages, Auto Loans, Personal Loans and Credit Card outstanding. As per RBI,
rate of growth in deposits is lagging the rate of growth of Credit5, a trend that is expected to continue.
Thus, banks are expected to struggle to fund the aggressive retail credit expansion from their own
means (deposits) in the near future. To remedy the same, banks may either opt to attract more deposits
by offering higher interest rates on the same, but this would lead to lower margins and lower earnings.
The alternative banks are expected to opt for—is to securitize their existing portfolios, free their
balance sheets, and use proceeds from it to disburse more loans.
2. Banks are capital starved: A majority of Indian banks (especially public sector banks) are
starved of capital and are expected to require Rs.600 bn over the next few years, as per Finance
Minister P Chidambaram. To a certain extent, the per bank burden of their capital enhancement
requirements can be met by securitization.
3. Basel II compliance by 2007: Indian banks would move to Basel II norms by 2007, and with it,
more stringent norms on Capital Adequacy would apply. Banks must sell off their portfolio of bad
loans to Asset Reconstruction Companies (ARCs) to free up their balance sheets and focus on their

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core banking activities. Recent developments like the Government of India’s decision to permit 49%
FDI in ARCs would widen the market and appetite for such loans.
Infrastructure Sector
India’s infrastructure investment needs are huge but financing the same raises several issues such as huge
initial outlays, multiple project risks, unconventional assets (bridges, roads etc.), long gestation period etc.
Additionally, many state-owned service providers like State Electricity Boards (SEBs) etc., are saddled
with huge NPAs—limiting their ability to invest from internal accruals.
Securitization may just be the answer to the issues above as it makes available financing from a larger
pool of investors; enables players specialized in various different aspects of the project to participate,
redistribute risks etc.
For instance, SEBs could securitize their NPAs and generate additional funds available for investments or
road sector projects could be funded via Future Flow Securitization of toll collections etc.
Following are the some factors which hinder the growth of securitization in India:
Small Investor Base
Currently, the market for securitization is rather shallow and shackled by a small investor base. This is
especially true for the market for stressed assets. Currently, banks sell their NPAs to the ARC on the
business side and the same banks end up buying the PTCs on the treasury side. Thus, the risk transfer from
the bank’s balance sheet is often artificial. Greater participation, especially from foreign specialists, is
required.
According to Rajendra Kakkar, CEO of ARCIL, India’s first and only ARC, “We have got a buyer, we
have got a seller, it so happens that the seller is the loan side of the same institutions and buyer is the
treasury side.”
Double Taxation
There are instances of double taxation in the securitization process, which escalate the cost of the structure
and may lend a shade of uncertainty to the process.
Other issues include issues with certain legal provisions, ambiguity regarding the accounting (e.g., in case
of over-collateralization) and inherent poor quality of assets of some banks
7. Factors to be considered before choosing a credit card < TOP >

Credit Card Terms


A credit card is a form of borrowing that often involves charges. Credit terms and conditions affect your
overall cost. So it's wise to compare terms and fees before you agree to open a credit or charge card
account. The following are some important terms to consider that generally must be disclosed in credit card
applications or in solicitations that require no application. You also may want to ask about these terms
when you're shopping for a card.
Annual Percentage Rate
The APR is a measure of the cost of credit, expressed as a yearly rate. It also must be disclosed before you
become obligated on the account and on your account statements.
The card issuer also must disclose the "periodic rate" - the rate applied to your outstanding balance to
figure the finance charge for each billing period.
Some credit card plans allow the issuer to change the APR when interest rates or other economic indicators
-called indexes - change. Because the rate change is linked to the index's performance, these plans are
called "variable rate" programs. Rate changes raise or lower the finance charge on your account. If you're
considering a variable rate card, the issuer must also provide various information that discloses to you:
• that the rate may change; and
• how the rate is determined - which index is used and what additional amount, the "margin," is
added to determine your new rate.
Free Period
Also called a "grace period," a free period lets you avoid finance charges by paying your balance in full
before the due date. Knowing whether a card gives you a free period is especially important if you plan to
pay your account in full each month. Without a free period, the card issuer may impose a finance charge
from the date you use your card or from the date each transaction is posted to your account. If your card
includes a free period, the issuer must mail your bill at least 14 days before the due date so you'll have
enough time to pay.
Annual Fees
Most issuers charge annual membership or participation fees. This fees is also to be considered before
choosing the credit card.
Transaction Fees and Other Charges
A card may include other costs. Some issuers charge a fee if you use the card to get a cash advance, make a
late payment, or exceed your credit limit. Some charge a monthly fee whether or not you use the card.

< TOP OF THE DOCUMENT >

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Question Paper
Investment Banking and Financial Services - I (MSF2K1) : January 2008

Section A : Basic Concepts (30 Marks)

• This section consists of questions with serial number 1 - 30.


• Answer all questions.
• Each question carries one mark.
• Maximum time for answering Section A is 30 Minutes.

<Answer>
1. Export Credit and Guarantee Corporation (ECGC) offer a risk cover for goods which are exported on short-term
credit (credit not extending 180 days) is called
(a) Specific Policy
(b) Standard Policy
(c) Post-shipment Export Credit Guarantee
(d) Small Exporter’s Policy
(e) Export Finance Guarantee.
<Answer>
2. Which of the following is/are true regarding Collateral Mortgage Obligations (CMOs)?
I. CMOs are created to protect the investors from pre-payment risk.
II. Investors seeking low exposure to interest-rate risk prefer longer tranche CMOs.
III. Investors seeking to avoid call and reinvestment risk prefer shorter tranche CMOs.
(a) Only (I) above
(b) Only (III) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
<Answer>
3. A Bank is issuing 9 month CDs worth Rs.100 lakh at a price of Rs.95,78,460. The stamp duty payable is
(a) Rs.50,000 by the subscriber
(b) Rs.50,000 by the issuer
(c) Rs.37,500 by the issuer
(d) Rs.25,000 by the subscriber
(e) Rs.25,000 by the issuer.
<Answer>
4. Which of the following is a private sector security?
(a) Call and Notice Money
(b) Term Money
(c) Participation Certificates
(d) Certificates of Deposit
(e) Factorization Bills.
<Answer>
5. Which of the following statements is true with respect to Real Estate Investment Trusts (REITs)?
(a) To retain their special tax status, REITs have to distribute 50% of their income to shareholders
(b) Indirect equity investments in REITs by investor usually lack liquidity
(c) According to the federal laws, REITs can only be infinite life trusts
(d) The most prominent form of lending by REITs is the construction/developmental lending
(e) REITs are not allowed to raise finance through debt as they are equity investment vehicles.
<Answer>
6. Which of the following forms of factoring is also known as confidential factoring?
(a) Bank participation factoring
(b) Advance factoring
(c) Supplier guarantee factoring
(d) Full factoring
(e) Invoice discounting.
<Answer>
7. RBI issued a tender notification for 91-day treasury bills of Rs.100 each for raising Rs.750 crore.
Mr. Prashant, one of the competitive bidder, has submitted the tender quoting a price of Rs.98.40. If the cut-off
price was determined as Rs.98.24 and the tender of Mr. Prashant was accepted, the yield earned by Mr. Prashant
would be
(a) 6.25%
(b) 6.52%
(c) 6.61%

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(d) 6.75%
(e) 6.95%.
<Answer>
8. Which of the following is/are not true with respect to underwriting of a public issue?
I. Minimum underwriting commitment for the Lead manager to the issue is 5 % of the offer size or Rs.
25 lakhs, whichever is more.
II. Total underwriting commitment of an underwriter cannot be less than 20 times its net worth.
III. Minimum net worth of an underwriter is Rs. 20 lakhs.
IV. Total outstanding underwriting commitment for an underwriter cannot exceed Rs. 25 lakhs.
(a)Only (III) above
(b) Both (I) and (III) above
(c) Both (II) and (IV) above
(d) (I), (III) and (IV) above
(e) (I), (II) and (IV) above.
<Answer>
9. Under bank participation factoring, Hussain Finance Limited has agreed to factor the receivables of Gasket
Limited of Rs.200 lakh and agrees to provide certain proportion of receivables as advance. Diligent Bank has
agreed to finance up to 75% of the factor reserves. If Diligent Bank provides
Rs. 60 lakh, the proportion of receivables financed by Hussain Finance is
(a) 40%
(b) 50%
(c) 60%
(d) 70%
(e) 80%.
<Answer>
10. Which of the following statements is/are true regarding hire purchase?
I. The owner of goods i.e. the hiree or the finance company is required to arrange for a comprehensive
insurance cover.
II. The title to the goods is transferred to the hirer only when the hirer exercises the option to purchase or
on the payment of the last installment.
III. All hire purchase transactions are subject to the sales tax but are not subject to central sales tax.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) of the above.
<Answer>
11. Tristone Ltd. has leased an equipment costing Rs.40 lakhs from Suresh Leases Limited for a period of 4 years at a
lease rental of Rs.320 ptpa payable annually in arrears. The marginal cost of debt and marginal cost of capital of
Tristone Ltd., is 14 percent and 12 percent respectively. If the cost of debt and marginal cost of capital of Suresh
Leases Ltd. is 10 percent and 8 percent respectively, the asset should be capitalized at
(Assume salvage value of the asset is nil).
(a) Rs.37.30 lakhs in the books of Tristone Ltd.
(b) Rs.38.87 lakhs in the books of Tristone Ltd.
(c) Rs.40.00 lakhs in the books of Suresh Leases Limited
(d) Rs.40.00 lakhs in the books of Tristone Ltd.
(e) Rs.44.61 lakhs in the books of Suresh Leases Limited.
<Answer>
12. Pawanhans Ltd. is planning a rights issue of equity shares. The current market price of the share is Rs.40 and the
rights issue can be priced maximum at 80% of the current market price. If the ex-rights price should not fall
below Rs.35, the maximum rights shares the company can offer for every share held is
(a) 0.2
(b) 0.4
(c) 0.6
(d) 0.8
(e) Insufficient information.
<Answer>
13. The risk of obsolescence of old equipments can be hedged by
(a) Swap lease
(b) Indexed lease
(c) Cross border lease
(d) Lease line
(e) Upgrade lease.
<Answer>
14. Gap loan, a form of real estate loan is a
(a)Loan on which the interest charged is generally lower than the prime lending rate
(b)Loan extended to the buyer to cover the difference between the registered value of the property and
actual purchase price

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(c)Loan extended on which additional payment is required to be made to cover the gap between market
interest rate and the ceiling rate agreed upon
(d)Loan extended to the developer to cover the difference between the bank construction loan and the total
cost of the project
(e) Loan extended during the period to help borrower in finding out a suitable lender.
<Answer>
15. Which of the following is/are true regarding REPO transactions?
(a)Non-banking entities holding both current and SGL accounts with RBI, Mumbai can only borrow in the
repo market
(b) It can be issued for a minimum of Rs. 1 crore and in multiples of Rs. 1 crore
(c) The interest rate is decided upon by the issuer of such instruments
(d) Interest rate on REPO is likely to be higher than the prevailing call rate
(e) They represent borrowing of unsecured nature.
<Answer>
16. Consider the following information:
Amount of consumer loan Rs.3,00,000
Repayment period 36 months
Equated monthly installment Rs.9,999
After 21 months, if a borrower opts for early repayment, the interest rebate allowed to the borrower as per rule of
78 method is
(a) Rs.10,804
(b) Rs.10,936
(c) Rs.11,258
(d) Rs.11,492
(e) Rs.11,544.
<Answer>
17. Danley Leasing Ltd. has leased an equipment costing Rs.50 lakh for a period of 5 years at an annual lease rental
of Rs.325 ptpa payable annually in advance. The opportunity cost of debt of the company is 12% and cost of
capital is 15%. If the applicable tax rate is 35%, according to equivalent loan model, the amount of debt that will
be raised in lieu of lease is equal to
(a) Rs.55.26 lakh
(b) Rs.56.49 lakh
(c) Rs.58.20 lakh
(d) Rs.65.61 lakh
(e) Rs.68.46 lakh.
<Answer>
18. Which of the following is true regarding finance and operating leases?
(a)The lessee enjoys the right to terminate the lease at short notice without significant penalty in case of
finance leases
(b)According to FASB, if the present value of lease payments exceed 75 % of the fair market value of the
asset at the inception of the lease, then the lease is termed as finance lease
(c)Operating leases are generally structured for leasing investment-intensive assets
(d)In operating leases, the lease is fully amortized over the lease period
(e)In an operating lease, if the lessee bears the cost of insuring and maintaining, then the lease is referred to
as dry lease.
<Answer>
19. Which of the following statements are true?
I. Both interest-only securities and principal-only securities are neutral to the changes in interest rates.
II. The return to the investors of interest-only security and principal-only securities move in the same
direction.
III. The purchaser of principal-only portion of STRIP expects the interest rates would continue fall and the
borrower of the mortgage loan would resort to large-scale prepayments.
IV. The purchaser of interest-only portion of the STRIP invests in the security with a yield potential of
high-coupon collateral.
(a) Both (I) and (II) above
(b) Both (III) and (IV) above
(c) (I), (II) and (III) above
(d) (II), (III) and (IV) above
(e) All (I), (II), (III), and (IV) above.
<Answer>
20. To promote the investment activity in the Government Securities market, several countries have adopted licensed
Primary Dealers (PDs) as important intermediary in the market. Which of the following is not true with respect
to the PDs?
(a) They are responsible for giving two-way quotes
(b) They are responsible for meeting the minimum bidding requirement
(c) The specific objective of PDs is to promote retail investment
(d) They are responsible for providing information of the market activity to the central bank
(e)They have an important role to play in the development of secondary market for the Government

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Securities.
<Answer>
21. Wesley Inc., is a US based company. It wants to raise funds from India through Indian Depository Receipts. What
is the profitability requirement for Wesley according to SEBI Act, 1992?
(a)It has been making profits for the last five years preceding to issue and has been declaring dividend of
not less than five percent each year for the said period
(b)It has been making profits for the last five years preceding to issue and has been declaring dividend of
not less than fifteen percent each year for the said period
(c)It has been making profits for the last five years preceding to issue and has been declaring dividend of
not less than ten percent each year for the said period
(d)It has been making profits for the last three years preceding to issue and has been declaring dividend of
not less than five percent each year for the said period
(e)It has been making profits for the last three years preceding to issue and has been declaring dividend of
not less than ten percent each year for the said period.
22. In case of Book Built issues, the minimum period for which bidding will be open is 3 working days. The <Answer>
maximum period for which bidding will be open and the maximum number of days by which it can be extended
in case of a revision in the price band are
(a) 7 days and 2 days respectively
(b) 7 days and 3 days respectively
(c) 6 days and 2 days respectively
(d) 6 days and 3 days respectively
(e) 10 days and 4 days respectively.
23. Which of the following statements is/are not true with respect to reservation in the public issues of the company? <Answer>
I. Net offer to the public should not be less than 25% of the post issue equity capital of the company.
II. The reservation for the employees of the company cannot exceed 10% of the total size of the company.
III. Total reservation for all NRIs and OCBs cannot exceed 15% of the post-issue capital as per RBI
guidelines.
IV. The reservation for group shareholders cannot exceed 10% of the total size of the company.
(a) Only (I) above
(b) Only (III) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) Both (III) and (IV) above.
24. The probability of the investment being confiscated is 0.15. If the cash flow when confiscation does not occur is <Answer>
Rs.32 lakh and the discount rate is 11%, then expected cash flow is
(a) Rs. 24.66 lakh
(b) Rs. 45.52 lakh
(c) Rs. 61.84 lakh
(d) Rs. 88.41 lakh
(e) Rs.104.62 lakh.
25. Rao Finance Ltd., a company engaged in hire purchase earns Rs.4,50,000 as interest in the fiscal year 2007-08. <Answer>
The service tax (including surcharge) payable on the interest earned by Rao Finance Ltd. for the fiscal year 2007-
08 is
(a) Rs.42,268
(b) Rs.45,900
(c) Rs.55,620
(d) Rs.56,854
(e) Rs.58,886.
<Answer>
26. Consider the following data relating to a company:
Cost of leased asset : Rs.60 lakh
Rate of depreciation : 20%
Fixed asset turnover ratio : 2.5
Sales for the year : Rs.260 lakh
Instead of leasing if, the company had purchased the asset, its fixed asset turnover ratio would have been
(a) 1.15
(b) 1.45
(c) 1.59
(d) 1.64
(e) 1.82.
<Answer>
27. Which clause of the lease agreement entitles the lessor to terminate the agreement and be indemnified by the
lessee for all expenses incurred on account of the action of the lessee?
(a) Surrender clause
(b) Exemption clause
(c) Ownership clause
(d) Description clause

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(e) Equipment delivery clause.


<Answer>
28. Which of the following is/are not true with respect to Residual Value Insurance (RVI)?
I. The cost of RVI is the premium payable to the underwriter or the insurance company
II. The disadvantage buying of RVI is that it increases the cost to lessor therefore it becomes difficult to
offer lease on competitive rates.
III. RVI coverts the product risk into payables.
(a) Only (III) above
(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
<Answer>
29. Symbolically the valuation exercise in case of venture funding may be represented as follows:
NPV=[(cash/post)]× [PAT×PER)] × k
What does “cash” denote in the above equation?
(a)It denotes the amount of cash being brought into the particular round of financing by the VC investor
(b) It is equal to (Post + pre), where pre is the pre-money valuation of the firm
(c) It denotes the amount of cash in hand possessed by the firm seeking funds
(d) It denotes the cash value of investments of the firm seeking funds
(e) It denotes cash valuation of the firm.
<Answer>
30. Mr. Pratul approaches Axis Bank Ltd. for a loan of Rs. 20,00,000 for a period of 15 years @ 12.5% p.a. The
monthly EMI he has to pay to Axis Bank is (assume interest is compounded monthly)
(a) Rs.20,540
(b) Rs.21,480
(c) Rs.23,465
(d) Rs.24,650
(e) Rs.25,862.

END OF SECTION A

Section B : Problems (50 Marks)


• This section consists of questions with serial number 1 – 5 .
• Answer all questions.
• Marks are indicated against each question.
• Detailed workings should form part of your answer.
• Do not spend more than 110 - 120 minutes on Section B.

1. Sukanth Fabrication Ltd. (SFL) a small scale unit, is contemplating to sale and lease back an asset <Answer>
which was purchased at Rs.50 lakhs three years back by raising a term loan carrying an interest rate of
14% p.a. The remaining useful life of the asset is five years at the end of which it will have a salvage
value of Rs.6 lakhs. The tax relevant rate of depreciation is 25%.
SFL has approached two leasing companies for the same, the details of which are as follows:
Company Lease quote
Alpha Leasing Ltd. (ALL) Rs.20 ptpm payable quarterly in advance over a period of 5
years
Beta Leasing Ltd. (BLL) Rs.18 ptpm payable monthly in arrears over a period of 5
years
Additional Information:
• ALL requires a gross yield of 18% p.a. on this lease transaction. Its cost of capital is
12% and is in the tax bracket of 25%.
• BLL wishes to structure the sale and lease back in such a way that it earns an IRR of 3%
over the cost of capital. Its cost of capital is 12% and is in the tax bracket of 30%.
• SFL follows a debt equity ratio of 2:1. Its cost of equity is 16.4% and it is in the tax
bracket of 30%.
You are required to:

a. Determine the maximum purchase price that ALL can pay for the asset. ( 2 marks)
b. Determine the maximum purchase price that BLL can pay for the asset. ( 6 marks)

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c. Determine, of the two, which lease quote is more favorable to SFL. ( 7 marks)

2. Laxmi Textiles Ltd. proposes to set up a Rs.500 crores Polyester Filament Yarn (PFY) plant in <Answer>
Vadodara. The company is planning an ADR offering and to be listed on NYSE. It proposes to raise
$100 million, net of issue expenses of 5%. The shares will be offered at the domestic market price of
Rs.500 (face value of 1 share is Rs.10). Each ADR will consist of 3 equity shares. The current
exchange rate is $1 = Rs.40. The company paid a dividend of 50% during 2006-2007.

a. You are required to compute


i. The number of ADRs required to be issued.
ii. The cost of ADR to the company if the dividend is expected to grow at 8% p.a.
( 5 marks)

b. Middle-East Fund invests in 25,000 ADRs of the company. At the end of one year the
company issues rights in the ratio of 1:3 (1 new share for every 3 shares held) at a price of
Rs.450 per share. The domestic price before rights issue is Rs.525.
The fund exercises the rights and immediately sells the entire holdings at NYSE. The NYSE
quotes are 5% higher than the rates prevailing on the National Stock Exchange. The exchange
rate is $1 = Rs.38 at the time of the rights issue as well as the divestment.
You are required to compute the gain/loss to Middle-East Fund on this transaction.
( 5 marks)

3. Modi Estate Ltd. has approached a venture capital (VC) company with a proposal to sell <Answer>
25 lakh shares. The performance of the company in the first two years of operation is as under :
Year 1 2
Sales (Rs. Crores) 210 235
Equity (Rs. Crores) (Face value per share: Rs.10) 5 5
Profit after tax (Rs. crores) 30.5 35.8

The sales and the net profit margin are estimated to grow at the historical compounded annual growth
rate.
The target return decided by VC is 40% whereas the probability of achieving the target return should
be at least 90% and the time horizon is 1 year. Modi Estate Ltd., is expected to price its divestment at
the industry P/E ratio.
The industry P/E multiple is expected to be as follows:
P/E multiple Probability
40 0.2
42 0.3
46 0.3
50 0.2

You are required to find out at what price the venture capital company should invest in the shares of
Modi Estate Ltd.

(
10
marks)

4. Konark Packaging Ltd. requires funds to the extent of Rs.100 lakhs for two years. It proposes to raise <Answer>
the funds by issuing Commercial Papers for one year and then roll it over for another year. Its
Investment Banker is of the opinion that as the company is new in the market and it needs to pay an
interest rate of minimum 12% per annum and it has to pay the maximum brokerage charges.
Applicable credit rating charges is 1% of the face value.
You are required to compute the effective cost of funds if the company raises funds through the CPs.

(
7
marks)

5. Sunderam Bank offers traditional and non-traditional mortgage loans for purchase of residential <Answer>
properties. Under Pledged Account Mortgages, it requires the borrower to deposit certain amount in a
savings account. It also required the borrower to make graduated payments, which increase at the rate
of 5% p.a., for the first five years and equated payments thereafter which are equal to the EMIs under
Traditional Mortgage.
Mr. Raghu has approached the bank for a home loan of Rs.15 lakhs for a period of 10 years. Assume
under Pledged Account Mortgages the bank requires Mr. Raghu to make equated monthly payments
of Rs.14,650 during the first year. Assume the payments during a year are equal.

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You are required to:

a. Determine the EMIs and the interest rate if the loan is given under Traditional Mortgage.

(
4
marks)

b. Determine the amount of deposit to be made by the borrower in the pledged savings
account under the Pledged Account Mortgages. Assume the deposit carries an interest of 9% p.
a. compounded monthly and that the balance in the pledged savings account becomes zero at
the end of the fourth year.

(
4
marks)

END OF SECTION B

Section C : Applied Theory (20 Marks)


• This section consists of questions with serial number 6 - 7 .
• Answer all questions.
• Marks are indicated against each question.
• Do not spend more than 25 -30 minutes on Section C.

6. Describe Future flow securitization. What are the advantages of this kind of securitization? Also <Answer>
enumerate the risk associated with Future flow securitization.

(
10
marks)

7. Discuss the factors considered by a credit rating agency while assigning a rating symbol to an <Answer>
instrument.

(
10
marks)
END OF SECTION C

Suggested Answers
Investment Banking and Financial Services - I (MSF2K1) : January 2008
Section A : Basic Concepts
Answer Reason
1. BStandard Policy is a risk cover offered by ECGC which is designed to cover risks <
with respect to goods which are exported on short-term credit not exceeding 180 TOP >
days. So, the correct answer is (b).
2. AThe collateral mortgage obligations takes the same cash flow that a conventional <
pass through security generates and then carves into discrete maturities or trenches. TOP >
Hence, CMOs protect the investors from prepayment risk. As long term loans carry
a higher interest rate risk, the investors preferring to have low exposure to interest
rate risk prefer shorter tranches CMOs and as shorter tranche CMOs receive
principal payment before longer tranches, longer tranches CMOs are preferred by
investors who seek to avoid call and reinvestment risk. Hence, both (II) and (III)
are incorrect and the (I) is true and the answer is (a).
3. C The current rates of stamp duty as paid by the issuer on the face value of <
the CD are as follows: TOP >
Period Stamp Duty (% to face value)
Up to 3 months 0.125
Above 3 months – Up to 6 months 0.250
Above 6 months – Up to 9 months 0.375

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Above 9 months – Up to 12 months 0.500


Therefore for a 9 month CD of Face Value Rs.100 lakhs, the stamp duty payable
by the issuer is 0.375% of Rs.100,00,000 = Rs.37,500. Hence (c) is the right
answer.
4. EFactorization bills comes under private sector securities. All others are interbank <
securities. Hence (e) is the answer. TOP >

5. DThe most prominent form of lending by REITs is the construction/developmental <


lending. To retain their special tax status, REITs have to distribute 95% of their TOP >
income to shareholders. There can be mortgage REITs. Indirect equity investments
in REITs by investor are highly liquid. REIT can be infinite life trusts or finite life.
Hence only (d) is true.
6. EInvoice discounting is also known as confidential factoring. <
TOP >

7. Yield in Treasury Bills = <


B × TOP >
Face value = 100
Price = 98.40
Days to maturity = 91
∴ Yield = = 0.0652
= 6.52%
8. EWith respect to a public issue, the following are true : <
Minimum net worth for an underwriter is Rs. 20 lakhs. TOP >

Minimum underwriting commitment for the Lead manager to the issue is 5 % of


the offer size or Rs. 25 lakhs, whichever is less
Total underwriting commitment of an underwriter cannot exceed 20 times its net
worth.
So, Statement (I), (II) and (IV) are not true. So, the correct answer is (e).
9. CUnder bank participating factoring, a bank contributes to the part of factor reserves. <
In the given case, TOP >
Amount of receivables = Rs.200 Lakhs
Factor reserves to be financed by Diligent bank = Rs. 60 lakhs = 75%
So, the total factor reserves = 60 ÷ 0.75 = Rs.80 lakhs. So, Hussain Finance Ltd.
will provide for Rs. 200 lakhs – Rs. 80 lakhs = Rs. 120 lakhs. So, the proportion of
receivables financed by Hussain Finance Ltd. = 120/200 x 100 = 60%.
10. DIn an hire purchase agreement, the hirer is required to arrange for the <
comprehensive insurance cover. Hence, I is not true. The title to goods is TOP >
transferred to the hirer only when the hirer exercises the option of purchasing the
asset or on the payment of the last installment. Hence, II is true. All hire purchase
transactions are subject to sales-tax but are not subject to Central sales tax. Hence,
III is true. and the answer is (d).
11. AAccording to the new ICAI guidelines, the leased asset should be capitalized in the <
books of lessee at the fair market value or the present value of the minimum TOP >
payments, whichever is lower.
i. Fair Market Value of the equipment – Rs.40 lakhs
ii. Present value of the minimum lease payments for Tristone
Ltd. is:
= × PVIFA
(14,4)
= (40 x 0.32) × 2.914 = 37.2992
= Rs.37.30 lakhs
As the present value of the minimum lease payments is less than the fair market
value, the asset should be capitalized at Rs.37.30 lakhs in Tristone Ltd.
Suresh Leases Ltd. should record the present value of lease rentals as part of
current assets.
12. C Ex-rights price ≥ 35 <
≥ 35 TOP >
≥ 35
40 N ≥ 35 (N + 1) – 32
5N≥3

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N ≥ 3/5 = 0.6
i.e. for every 5 shares held at the most 2 shares is offered as right shares and for
every 1 shares held, a maximum 0.6 share will be offered and the answer is (c).
13. EUpgrade lease provides for automatic exchange of out-model equipment with the <
latest updated version of such equipments. Hence, this type of lease helps in TOP >
hedging the risk of obsolescence.
14. DIn Gap loan, the loan arrangement is as described in alternative (d) and the interest <
charged is generally higher than the prime lending rate. Hence, correct answer is TOP >
(d).
15. BREPOs can be issued for a minimum of Rs. 1 crore and in multiples of Rs. 1 crore. <
It represents borrowing of secured nature. Interest rate on REPO is likely to be TOP >
lower than the prevailing call rate. Non-banking entities holding both current and
SGL accounts with RBI, Mumbai can borrow as well as lend in the repo market .
The interest rate on REPO is mutually decided upon by the issuer and the buyer.
So, the correct answer is (b).
16. A Interest rebate as per rule of 78 = <
Where t is number of installments outstanding = 15, TOP >

n is total number of installments = 36 and


D is total charge for credit = 36 × 9999 – 3,00,000
= Rs.59,964.
∴ Interest rebate =
= Rs.10,804.
17. DAs per the equivalent loan model of lease evaluation, the amount of debt that is <
raised in lieu of debt is considered to be equal to the present value of lease rentals TOP >
computed at the pre-tax cost of debt. In the given case present value of lease rentals
is computed as
0.325 × 50 × PVIFA(12%,5) × 1.12 which is equal to Rs.65.61 lakh.
18. EOption (e) is true because in an operating lease where the lessee bears the costs of <
insuring and maintaining the leased equipment, it is called a ‘dry lease’. Statement TOP >
(a) is false because the lessee enjoys the right to terminate the lease at short notice
without any significant penalty in a operating lease (and not in finance lease).
Statement (b) is not true. According to the FASB definition, if the lease term
exceeds 75% of the useful life of the asset or if the present value of the minimum
lease payments exceeds 90% of the fair market value of the asset at the inception
of the lease, it is termed as finance lease. Statement (c) is not true because finance
leases are structured for leasing investment-intensive assets and operating leases
are generally structured in Sunrise Industries which are characterized by high
degree of technological risk. Statement (d) is not true because in operating leases,
the lease is not fully amortised.
19. BThe following statements are true: <
Both interest-only security and principal-only security have large impact associated TOP >
with a small change in interest rates.
The return to the investors of Interest only security and Principal only securities
move in the opposite direction.
The purchaser of interest-only portion of the STRIP invests in the security with a
yield potential of high-coupon collateral.
The purchaser of principal-only portion of STRIP expects the interest rates would
continue fall and the borrower of the mortgage loan would resort to large-scale
prepayments.
Hence (b) is the correct answer.
20. CThe specific objective of SD is to promote retail investment. All other statements <
are correct for PDs. Hence (c) is the correct answer. TOP >

21. CThe company who wants to raise funds through IDR, has been making profits for <
the last five years preceding to issue and has been declaring dividend of not less TOP >
than ten percent each year for the said period. Hence (c) is the correct answer.
22. BIn case of Book built issues, the minimum and maximum period for which bidding <
will be open is 3 – 7 working days extendable by 3 days in case of a revision in the TOP >
price band. Hence (b) is the correct answer.
23. BTotal reservation for all NRIs and OCBs cannot exceed 10% of the post-issue <
capital as per RBI guidelines. All other statements are true. Hence (b) is the correct TOP >
answer.

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24. EIt can be calculated with help of the formulae i.e. V= CF (1-P)/re +P <
TOP >
V= (32 × 0.85)/(0.11 + 0.15) = Rs.104.62 lakh. Hence the answer is (e).
25. CThe service tax plus surcharge payable on the interest earned by the hire purchase <
companies is 12.36%. Therefore, service tax payable by Rao Finance for the fiscal TOP >
year 2007-08 = 12.36% of Rs.4,50,000 = Rs.55,620. Hence (c) is the correct
answer.
26. CFixed asset turnover ratio = 2.5 <
2.5 = Sales/Fixed Assets TOP >

Fixed Assets = Rs.104 lakh


If the asset is bought , Fixed Assets = Rs.164 lakh
FA turnover = 260/164 = 1.59.
27. EEquipment delivery clause of the lessee agreement entitles the lessor to terminate <
the agreement and be indemnified by the lessee for all expenses incurred on TOP >
account of the action of the lessee. Hence (e) is the correct answer.
28. DFollowing are correct for RVI: <
RVI coverts the product risk into receivables. TOP >

The cost of RVI is the premium payable to the underwriter or the insurance
company.
The obvious advantage of buying of RVI is that the lessor able to offer competitive
rates.
Hence (d) is the correct answer.
29. AIt denotes the amount of cash being brought into the particular round of financing <
by the VC investor. Hence (a) is the correct answer. TOP >

30. DEMI = 1/12[Lr (1+r) n/(1+r) n-1] <


Where L= loan, r= rate of interest and n=period TOP >

EMI = = Rs. 24,650.


Hence (d) is the correct answer.
Section B : Problems
1. a. ALL : Required gross yield is 18% p.a. < TOP >
Let the purchase price be Rs.P lakhs
The maximum purchase price is the value of P at which the following equation is equal to zero.
– P + 0.020 × 12 × P × i/d4 PVIFAi,5 + 6 × PVIFi,5 = 0 at i = 18%

– P + 0.020 × 12 × P × 1.1102 × 3.1272 + 6 × 0.4371 = 0


– P + 0.8332 P + 2.6226 = 0
P = = Rs.15.723 lakhs.
Maximum purchase price of ALL = Rs.15.723 lakhs
b. BLL : Required IRR = 12 + 3 = 15%
At IRR, NPV(lease) = 0
– Initial Investment + PV of lease rentals – PV of tax on lease rentals + PV of DTS + PV of NSV = 0
A. Let initial Investment be Rs.B lakhs
B. PV of lease rentals = 0.018 × 12 × i/i1.067 × PVIFA15,5 × B = 0.7726 B lakhs

C. PV of tax on lease rentals = 0.018 × 12 × B × PVIFA15,5 × 0.3 = 0.2172 B lakhs


D. PV of DTS
WDV at the inception of lease = Rs.21.094 lakhs
Year Depreciation (Rs. lakhs) PV (Rs. lakhs)
1 5.273 4.585
2 3.955 2.990
3 2.966 1.950
4 2.225 1.272
5 1.668 0.829
11.626
PV of DTS = 11.626 × 0.3 = Rs.3.488 lakhs
E. PV of NSV = 6 PVIF15,5 = Rs.2.983 lakhs
–A+B–C+D+E = 0

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– B + 0.7726 B – 0.2172 B + 3.488 + 2.983 = 0


B= = Rs.14.555 lakhs.
c. Of the lease quoted, the lease quote at which NAL is more that will be favourable to lessee.
NAL = Initial Investment – PV of LR + PV of TS on LR – PV of DTS – PV of ITS – PV of NSV
of the factors, the relevant factors for comparison are initial price of sale, present value of lease rentals, PV of tax on lease rentals
and PV of interest tax shields foregone.
Cost of capital of SFL = = 12%
ALL: BLL
Relevant factors of NAL
Rs. in lakhs Rs. in lakhs
A. Initial price of sale 15.723 14.555
B. PV of lease rentals 0.020 × 12 × 15.723 × PVIFA14,5 0.018 × 12 × 14.555 ×
× i/d4 = 14.070 PVIFA14,5 × i/i12 = 11.469
C. PV of tax shield on lease 0.020 × 12 × 15.723 × PVIFA12,5 0.018 × 12 × 14.555 ×
rentals
× 0.3 PVIFA12,5 × 0.3
= 4.081 = 3.40
D. PV of Interest tax shield 3.755 × 0.3 = 1.1265 3.306 × 0.3 = 0.9918
(Note 1)
NAL (apart from depreciation tax
shield and NSV)
= A–B+C–D 4.608 5.494
As the sum of the relevant factors of NAL is more in case of BLL, BLL is more favourable
Note 1: Interest tax shield
Rs. in lakhs
Balance Outstanding Interest @ 14% Principal Portion Adjusted Interest** PV of Adjusted Interest
Year
ALL BLL ALL BLL ALL BLL ALL BLL ALL BLL
1 14.070 11.469 1.970 1.606 2.129 1.735 1.645 1.409 1.469 1.258
2 11.941 9.734 1.672 1.363 2.427 1.978 1.347 1.166 1.074 0.930
3 9.514 7.756 1.332 1.086 2.767 2.255 1.007 0.889 0.717 0.633
4 6.747 5.501 0.945 0.770 3.154 2.571 0.620 0.573 0.394 0.364
5 3.593 2.930 0.503 0.410 3.595 2.931 0.178 0.213 0.101 0.121
** Adjustment Factor:
ALL BLL
Equated Annual Installment 4.099 3.341
Actual annual payment 3.774 3.144
Adjustment factor 0.325 0.197
2. a. i. Domestic market price = Rs.500 < TOP >
Expected domestic price per ADR = 500 x 3
= Rs.1,500
= = $37.5.
Computation of the number of ADRs to be issued:
Amount to be raised =
= $105,263,158.
Number of ADRs to be issued =
= 2,807,017 (Approximate).
ii. Computation of the cost of ADR to the company:
Price of ADR = Rs.1500
Expected dividend = Rs.10 x 3 x 0.54 = Rs.16.2
Growth rate (g) = 8%
Cost of ADR = +g

where D1 = Expected dividend


Po = Price
=g Growth rate
=f Flotation cost of issuing ADR
= + 0.08
= 9.14%
b. Computation of gain/loss to Morgan Stanley Emerging Markets Funds holding 25,000 ADRs.

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Initial investment of the investor = 25,000 x $37.5


= $937,500 ..... (A)
Number of right shares obtainable = 25000 x 3 x 1/3
= 25,000 shares
Investment in 25,000 rights = 25,000 x 450
= Rs.11,250,000
= = $296,053 ....... (B)
Total investment = (A) + (B)
(ignoring time value of money)
=$1,233,553
Ex-right price = = Rs.506.25
ADR price (ex-right) = 506.25 x 3 x 1.05/38 = $41.97
Total divestment value = $(25,000 + 25,000/3)41.97 = $1,399,000
∴ Gain of Middle-East Funds
= $1,399,000 – $1,233,553 = $165,447.
3. < TOP >
Year 1 Year 2
Sales (Rs. crore) 210 235
Number of shares (crore) 05 0.50
PAT (Rs. Crore) 30.5 35.8
EPS (Rs.) 61 71.6
Growth rate of sales = 210 (1+g) = 235
g = 11.90%
Growth rate in profit margin
NPM in year 1 = = 14.52%
NPM in year 2 = = 15.23%
Growth rate in NPM is g in the following:
0.1452 (1 + g) = 0.1523
g = 4.89%
Expected sales in the next year = 235 (1+g) = 235 (1.119) = Rs.262.97 crore
Expected net profit margin = 15.23 (1.0489) = 15.97%
Expected net profit = 262.97 x 0.1597 = Rs.42.0 crore
Expected EPS with increase in equity by 25 lakhs = = Rs.56.
Price at the end of one year follows the following probability distribution:
(Rs.) Probability
56 x 40 = 2240 0.2
56 x 42 = 2352 0.3
56 x 46 = 2576 0.3
56 x 50 = 2800 0.2
Expected price = Rs.2486.40
Standard deviation of price = Rs.199.10
Suppose the VC will invest at Rs. x, then the divestment price should be Rs. (1.4)x.
Probability that the minimum price will be Rs. (1.4)x
= -1.282
or, x = 1593.68
As the probability of earning 40% return is more than 90%, the VC should invest in the company at Rs.1594/share.

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4. < TOP >

Funds required Rs.1,00,00,000


Interest rate per annum 12%
Hence, face value of the CPs = 1,00,00,000 (1.12) Rs.1,12,00,000
Interest obligation in the first year Rs.12,00,000
Brokerage charges payable upfront = 0.10% of face value Rs.11,200
Stamp duty payable upfront = 0.5% of the face value Rs.56,000
Rating charges payable upfront = 1.0% of the face value Rs.1,12,000
(As the company has to pay the maximum brokerage charges, the brokerage charges are payable @
0.10% of FV)
When the CP is rolled over, the Face Value becomes the Issue price at the beginning
of the 2nd year.
Face value at the beginning of the 2nd year = 1,12,00,000 x 1.12 Rs.1,25,44,000
This rollover is treated as a fresh issue and the stamp duties and rating charges would
be incurred again.
Brokerage charges would not be required.
Stamp duty payable at the beginning of the 2nd year = 0.50% of face value Rs.62,720
Rating charges payable at the beginning of the 2nd year = 1.0% of the face value Rs.1,25,440
Cash Flow Chart
Particulars Upfront 1st year 2nd year
Issue Amount 1,00,00,000
Brokerage charges 11,200
Stamp duties 56,000 62,720
Rating charges 1,12,000 1,25,440
Face value redeemed
Net cash flow 98,20,800 –1,88,160 –1,25,44,000
IRR = 13.98 %
Effective cost per annum is the internal rate of return = 13.98%
5. a. First monthly payment under pledged account mortgages loan = Rs.14,650 < TOP >
From the fifth year, the EMI of PAMs are equal to EMIs under Traditional loans. During these five years, the installments increase
at the rate of 5% p.a.
Hence, EMIs from the fifth year under PAMs /EMIs under traditional loan
= 14,650 × (1.05)4 = Rs.17,807
Interest rate under traditional loan is the value of r in the following:
17,807 PVIFAr,120 = Rs.15,00,000
PVIFAr,120 = 84.237
At r = 1%, PVIFA1%,120 = 69.701
At r = 0.5% PVIFA0.5%,120 = 90.073
By interpolation,
r = 0.5% +
= 0.643% p.m. = 8% p.a.
b. The amount to be drawn from savings account will be as follows: (Rs.)
EMI under
Drawings from
Year Traditional EMI under PAM
savings A/c
Mortgage
1 17,807 14,650 3,157
2 17,807 15,383 2,424
3 17,807 16,152 1,655
4 17,807 16,960 847
5-10 17,807 17,807 –
Amount to be deposited in savings account
= 3157 PVIFA0.75%,12 + 2424 PVIFA0.75%,12 PVIF0.75%,12 + 1655 PVIFA0.75%, 12 PVIF0.75%,24 + 847 PVIFA0.75%,12
PVIF0.75%,36
= PVIFA0.75%, 12 [3157 + 2424 PVIF0.75%, 12 + 1655 PVIF0.75%, 24 + 847 PVIF0.75%, 36 ]

= 11.435 [3157 + 2424 × 0.914 + 1655 × 0.836 + 847 × 0.764]


= Rs.84,656.

Section C: Applied Theory

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6. Future flow securitization raises funds based on expected future flows that are still to be generated. These are < TOP >
classified as into two types: long term contract receivables and future cash flows. Term off take agreements for
the supply of goods or services are examples of former. In this, the volume is generally prefixed, but price of
receivables may be variable. Future cash flows are not only subject to price variations but also to variations in
volume. Examples are ticket receivables, telecom receivables etc. in this a base case for the receivables are
generally presumed. The base case cash flows are progressively reduced over time.
Advantages:
(a) There will be lesser cost of funds to the borrower due to higher credit rating.
(b) It is also possible to have a diversified source of funding.
(c) Even when credit is tight due to adverse market conditions, these transactions can ensure sufficient
funds raising due to their being of quality.
(d) These can extend the tenure of financing available to the borrower.
Risks associated are:
(a) Performance risks: these transactions rely on future cash flows to repay investors. Therefore the
borrower needs to be continuously monitored and reviewed throughout the tenure of transaction. In case a
borrower becomes insolvent, no creditor would be able to make claims against the receivables sold to
investor.
(b) Generation risks: This relates to the sustained generation of the receivables at certain levels from the
host of factors outside the control of the borrower, e.g. anticipated reserves may not materialize or seasonal
variation in the anticipated level of receivables may occur.
Price risks and off- take risks: These refers to likely price variations or the concerns that the obligors in the
future ceases buying or reduce their purchasing level of goods or services from the seller.
7. The key parameters taken into account while rating a debt instrument are as follows: < TOP >
I. Industry Evaluation – This involves an evaluation of the following:
• General profile of the industry, major competitors, extent of competition, growth potential and
trend of development both domestic and international.
• Demand and supply position of the product, existing installed and licensed capacities, capacities
in the pipeline.
• Position of import and export, technological developments, price trends, availability, source,
quality and prices of major inputs.
• Government policies and regulations affecting the industry and other major problems and
constraints.
II. Unit Evaluation – This company level evaluation involves an assessment of the following:
• Position of the unit in the industry, market share, competitive edge, major strengths and
weaknesses.
• Product range and quality, market segmentation and seasonality and market, marketing
strategies, channels and network.
• Future program, goals and targets. Product range and portfolio diversification, need, scope and
prospects of diversification and expansion.
• Group/associate company performances, support and synergy.
III. Technical Evaluation – The technical competence of the company is assessed by focusing on the
following:
• Level of technology, operative efficiency of the plant, vintage of the plant and level of
maintenance.
• Need and plan for modernization and debottlenecking.
• Competence and support of technical collaborators, terms of collaboration, royalty and buy-back.
• In-house expertise and expertise for absorption of technology.
• Efforts for skill development and productivity improvement.
• Locational advantages and disadvantages and infrastructural facilities.
• Yield analysis, extent of rejection at different stages including quality complaints by the
customers.
• Protection against hazards and other natural calamities.
IV. Financial Evaluation – The financial strength of the client is assessed by examining the following
aspects:
• Accounting policies, extent of disclosures, inventory valuation, depreciation and other
provisions, revaluation of assets, management of assets and liabilities, asset quality, contingent and off
balance sheet liabilities.
• Auditor’s reports and Director’s report.
• Capitalization trends and policies.
• Cash flow trends and potential, future projections and underlying assumptions in respect of
profitability and liquidity management.

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• Return on capital employed, interest coverage, debt-service coverage and fixed assets coverage.
• Practice of debt servicing, requirement of future debt servicing, major fund commitments and
overall liquidity.
• Financial flexibility, unutilized borrowing potential, standing in the capital market, capability to
raise resources and to absorb debts.
• Working capital management, control over receivables and inventory.
• Budgeting and cost control system.
• Sensitivity to changes in interest rates, tax rates and exchange rates, hedging of risks.
V. Statutory Evaluation – The statutory status of the company will be evaluated in the following manner:
• Compliance status in respect of Government regulations and directives effecting the industry/
unit, position of obtaining approvals and no objection may be necessary.
• Terms of issue, debenture trustees, and trust deeds. Securities and charges created over assets.
• Pending disputes by and against the concern.
• Practices regarding payment of statutory dues.
VI. Management Evaluation – The evaluation of the company’s management will aid in assessing the
willingness of the borrower to repay. The aspects involved in such evaluation are
• Shareholding pattern and controlling interest.
• Composition of the Board of Directors.
• Organizational profile, adequacy and quality of organizational set-up, extent and effectiveness of
delegation.
• Competence and integrity of management and its capability to face crisis.
• Policies and practices regarding recruitment, training, motivation and career planning of
employees.
• Style of management functioning, approach and outlook, organizational culture, employee
morale and industrial relation.
Management information and monitoring system.

< TOP OF THE DOCUMENT >

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Question Paper
Investment Banking and Financial Services – I (MSF2K1) : April 2008

Section A : Basic Concepts (30 Marks)

• This section consists of questions with serial number 1 – 30.


• Answer all questions.
• Each question carries one mark.
• Maximum time for answering Section A is 30 Minutes.

<Answer>
1. For public deposits the issuing company is required to maintain the liquid assets to the extent of a certain
percentage of the deposits maturing during the financial year ending 31st March. For this purpose, the permitted
investment(s) is/are
I. Deposits held with any Indian bank, free from any lien.
II. Unencumbered securities of central or state government.
III. Unencumbered securities approved by Indian Trust Act, 1882.
IV. Unencumbered bonds issued by HDFC.
(a) Only (II) above
(b) Only (III) above
(c) Both (II) and (IV) above
(d) (II), (III) and (IV) above
(e) All (I), (II), (III) and (IV) above.
<Answer>
2. A CD issued by large savings and loan associations which can be covered under the FDIC is called
(a) Installment CD
(b) Thrift CD
(c) Jumbo CD
(d) Declining rate CD
(e) Rising rate CD.
<Answer>
3. Which of the following statements is not true with respect to the lock-in requirements of the promoters’
contribution?
(a) The minimum contribution to be made by promoters’shall be locked-in for a period of three years
(b) In case the promoters’ contribution in the proposed issue exceeds the minimum specified contribution,
such excess contribution will also attract lock-in period of one year
(c) The lock-in period commences from the date of allotment or from the date of commencement of
commercial production whichever is later
(d) Bonus share issued to the promoter out of revaluation reserves during the preceding three accounting
years are required to be lock-in for a period of one year
(e) Shares issued to the promoter at a price lower than the current issue price during the preceding 12
months period are required to be locked-in for a period of three years.
<Answer>
4. Which of the following statements is false regarding different types of leases?
(a) In a leveraged lease transaction, the 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
(b) A leveraged lease transaction entitles the lessor to claim tax shields on depreciation
(c) In a sales-aid lease the equipment supplier catalyzes the lease transaction
(d) In a single investor lease, the debt funds raised by the leasing company are with recourse to the lessee
(e) An upgrade lease is an operating lease which has in-built facilities like up-gradation of the equipment.
<Answer>
5. Which of the following are not true in the context of ‘Credit Rating’?
I. Rating is useful in differentiating credit quality.
II. Rating is a general-purpose evaluation of the issuer.
III. Rating is an isolated function of a credit risk evaluation.
IV. Rating is an extensive audit of the issuing company.
V. Rating reflects borrower’s accountability.
(a) Both (I) and (III) above
(b) Both (II) and (IV) above
(c) (I), (II) and (III) above

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(d) (I), (III) and (V) above


(e) (II), (III), (IV) and (V) above.
<Answer>
6. Blue Fox is coming up with an IPO worth Rs.50 crores. The issue will be underwritten by Goldmine Financial
Services, the lead Merchant Banker. The minimum underwriting commitment of Goldmine in this issue will be
(a) Rs. 25 lakhs
(b) Rs. 50 lakhs
(c) Rs.100 lakhs
(d) Rs.200 lakhs
(e) Rs.250 lakhs.
<Answer>
7. Which of the following is/are not true in the context of real estate investing?
I. Real estate investment is perceived as high-risk investment area.
II. Active management commitment is required to produce high returns.
III. Data concerning the historical returns and risk of the various types of possible real estate investments
is freely available.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
<Answer>
8. Which of the following is not true with regard to Mortgage Backed Securitization and Asset Backed
Securitization?
(a)The former is backed by easily traceable immovable asset whereas the latter is backed by movable
assets, which may not be easily traceable
(b)The former takes into consideration appreciation in the value of assets whereas the latter takes into
consideration depreciation in the value of assets
(c)Legal hassles are relatively less in Asset Backed Securitization
(d)Mortgage Backed Securitization gives high yields to the investors whereas Asset Backed Securitization
gives low yields to the investors
(e) In case of Asset-Backed Securitization, asset need not exist at the time of securitization.
<Answer>
9. Sunder Finance issued a commercial paper with the issue size of Rs.5 crore for a period 3 months. The
maximum brokerage paid would be
(a) Rs.0.125 lakh
(b) Rs.0.500 lakh
(c) Rs.1.000 lakh
(d) Rs.1.125 lakh
(e) Rs.1.500 lakh.
<Answer>
10. The instruments which enables investors to benefit from arbitrage arising on account of differentials in interest
rates for different maturities are known as
(a) Flip-flop FRNs
(b) Rolling rate FRNs
(c) Mini-max FRNs
(d) Capped FRNs
(e) VRN-structured FRNs.
<Answer>
11. Which of the following measures were taken by the Central Government to enhance the level of efficiency of
the Indian Credit Market?
I. Deregulating the interest rate environment.
II. Withdrawing the Government funds as a source of funds to Financial Institutions.
III. Permitting offshore banking.
IV. Setting prudential norms for the intermediaries.
V. Permitting access to overseas funds.
(a) Both (II) and (III) above
(b) (I), (II) and (IV) above
(c) (II), (III) and (V) above
(d) (I), (IV) and (V) above
(e) All (I), (II), (III), (IV) and (V) above.
<Answer>
12. Which of the following is true regarding repo transactions?
(a)A reverse repo is an agreement which involves a sell of security with an undertaking to buyback the

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same security at a predetermined future date and price


(b)A repo transaction is generally done for instruments with long maturities
(c)Provident funds are eligible to participate in repo auctions but are not eligible to participate in a reverse
repo auction
(d)Unlike call loans, repos are secured in nature
(e) RBI enters into reverse repos to suck out liquidity from the system.
<Answer>
13. Which of the following is/are true regarding risk exposure in money market instruments?
I. As the maturity of money market instruments is short, these instruments are not exposed to
reinvestment risk.
II. All the money market instruments including government securities are considered as risk free.
III. Compared to long term securities, money market instruments have minimal inflation risk.
IV. The interest rate risk is minimum in the money market.
(a) Only (I) above
(b) Only (III) above
(c) Both (II) and (IV) above
(d) (I), (II) and (III) above
(e) All (I), (II), (III) and (IV) above.
<Answer>
14. If a bank issued a Certificate of Deposit of face value of Rs.5 lakhs with maturity period of 91 days and at a
discount rate of 9 per cent per annum, the discounted value of the deposit is
(a) Rs.4,89,027
(b) Rs.4,58,716
(c) Rs.4,57,422
(d) Rs.2,85,321
(e) Rs.3,63,750.
<Answer>
15. Under which of the following aspects, factoring differs from bills discounting?
I. In a bill discounting arrangement, the financial intermediary does not assume the responsibilities of
sales ledger administration and collection of debts, which the factor does under the factoring arrangement.
II. Unlike bill discounting, no notice of assignment is provided to the customers of the client under the
factoring arrangement.
III. The bill discounting arrangement is recourse to the client whereas a factoring arrangement can be with
or without recourse.
(a) Only (I) above
(b) Only (III) above
(c) Both (I) and (II) above
(d) Both (I) and (III) above
(e) All (I), (II) and (III) above.
<Answer>
16. Which of the following statements is false regarding facilities given to Primary Dealers (PDs) in the Indian
market?
(a) The PDs are permitted to borrow and lend in the money market
(b) The PDs are provided with Current and SGL accounts
(c) The PDs cannot access finance through REPOs
(d) The PDs can raise funds through commercial papers
(e) The PDs can transfer funds from one center to another under Reserve Bank’s Remittance Facility
Scheme.
<Answer>
17. Manilal Finance Company currently pays interest on the public deposits at the following rates:
Term of deposit Rate of interest (%)
One year 12
Two years 13
Three years 15
Mr. Murtaza, one of the deposit holders with Manilal Finance Company, wants to withdraw his 3 year public
deposit at the end of 9 months from the time of deposit. The maximum interest rate payable to Mr. Murtaza on
his public deposit is
(a) Nil
(b) 10%
(c) 11%
(d) 12%
(e) 13%.
<Answer>
18. Vijay Limited is planning a rights issue of equity shares in the ratio of 1:5. If the current market price of the

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share is Rs.45 and ex-rights price should not fall below Rs.43, subscription price should be more than
(a) Rs.10
(b) Rs.30
(c) Rs.33
(d) Rs.42
(e) Rs.44.
<Answer>
19. If an IPO is under-priced, which of the following can be considered as consequences/implications of the same?
I. The company looses the opportunity to raise more funds.
II. Under pricing would give less returns to the investor.
III Under pricing results in lower net worth on an increased equity.
(a) Only (II) above
(b) Only (III) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
<Answer>
20. Which of the following statements is/are true regarding instruments in the international markets?
I. Foreign bonds are the bonds floated in the domestic market denominated in domestic currency by
non-resident entities.
II. Yen denominated bonds issued in the US are yankee bonds.
III. Euro commercial papers issued with maturity of up to one year are underwritten and secured.
IV. Note Issuance Facilities are underwritten and have maturity of up to one year.
(a) Only (I) above
(b) Only (III) above
(c) Both (II) and (III) above
(d) Both (I) and (IV) above
(e) (I), (III) and (IV) above.
<Answer>
21. Sumeet Industries Limited leased an asset worth Rs.50 lakhs from Nahar Finance Limited for a period of 3 years
at a rate of Rs.115 ptpq. Lease rentals are payable annually in advance. If the marginal cost of debt and tax are
14% and 30% respectively, the amount of debt displaced by lease to Sumeet Industries, according to Bower-
Herringer-Williamson Model is
(a) Rs.61.88 lakhs
(b) Rs.60.89 lakhs
(c) Rs.55.25 lakhs
(d) Rs.53.41 lakhs
(e) Rs.50.00 lakhs.
<Answer>
22. In the context of leasing, “hell or high water” clause is defined as
I. The clause under which the lessee is responsible for repair, maintenance and insurance of the asset.
II. The clause under which the lessee undertakes obligation for the payment of rental regardless of the
condition or the suitability of the asset.
III. The clause under which the risk of obsolescence is shifted from the lessor to the lessee.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (III) above
(e) All (I), (II) and (III) above.
<Answer>
23. Hindustan Factors Ltd. gives an advance of 80% against receivables worth Rs.10,00,000 purchased from Aniket
Ltd. payable after 90 days. The advance carries an interest rate of 17% per annum compounded quarterly and the
factoring commission is 1.8% of the value of factored receivables. Both the interest and commission are
collected up-front. The amount actually made available to Aniket Ltd. is
(a) Rs.7,28,000
(b) Rs.7,48,000
(c) Rs.7,66,000
(d) Rs.7,82,000
(e) Rs.8,00,000.
<Answer>
24. The following data have been extracted from the books of Sun Leasing Limited for the year 2007-08
Particulars Rs. in crore
Equity Share Capital 240.50
Preference Share Capital 140.50

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Share premium 80.00


Capital Reserve (75% of reserve arising out of profit on sale of assets) 60.00
Revaluation Reserve 45.00
Patents 25.00
Loan & advances to Subsidiary Companies 50.50
Deposits with Group Companies 20.55
Calculate the amount of owned fund:
(a) Rs.269.45 crore
(b) Rs.303.50 crore
(c) Rs.340.50 crore
(d) Rs.464.25 crore
(e) Rs.526.00 crore.
<Answer>
25. While evaluating a hire purchase proposal, under which of the following situations, replacement cost is the
appropriate measure of valuation?
I. Realisation value > Economic value > Replacement cost.
II. Economic value > Replacement cost > Realisation value.
III. Economic value > Realisation value > Replacement cost.
IV. Realisation value > Replacement cost > Economic value.
(a) Only (I) above
(b) Only (II) above
(c) Both (II) and (IV) above
(d) (I), (III) and (IV) above
(e) All (I), (II), (III) and (IV) above.
<Answer>
26. Which of the following is/are true regarding the accounting treatment of a hire purchase transaction?
I. Capital content of outstanding hire purchase installments is shown as liability in the books of hirer.
II. Present value of hire purchase installments or cash price of the asset, whichever is minimum, is
capitalized in the books of hirer.
III. Finance income component of hire purchase installments is recorded as current liability in the books
of the finance company.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) Both (I) and (III) above.
<Answer>
27. Which of the following types of guarantees is/are generally issued by the insurance companies?
I. Guarantees extended to financial contracts.
II. Guarantees on behalf of hire purchase companies to banks and other institutions.
III. Guarantees to cover long-term loans from banks.
IV. Guarantees to covered deferred payments to supplier of equipment, to either supplier’s or buyer’s
banker.
(a) Only (I) above
(b) Only (IV) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) (II), (III) and (IV) above.
<Answer>
28. The probability of the firm being confiscated is 0.4. If the discount rate is 8%, then expected cash flow for the
investment of Rs.16 lakh is
(a) Rs.20 lakh
(b) Rs.43 lakh
(c) Rs.45 lakh
(d) Rs.50 lakh
(e) Rs.56 lakh.
<Answer>
29. Under bank participation factoring, Easy Finance Limited has agreed to factor the receivables of Casper
Manufacturers Limited (CML) of Rs.500 lakh and agrees to provide certain proportion of receivables as
advance. Reliable Bank has agreed to finance 80 % of the factor reserves. If Reliable Bank provides Rs. 120
lakh, the proportion of receivables financed by Easy Finance is
(a) 20%
(b) 24%

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(c) 30%
(d) 60%
(e) 70%.
<Answer>
30. Elegant Emeralds have taken a machine worth Rs.10,00,000 in hire purchase from Fabulous Finance Limited at
the following terms:
Rate of interest 14% flat
Repayment period 4 years
Frequency of payment Monthly in arrears
Down payment 25%
If after paying the 30th installment Elegant Emeralds want to repay the loan and purchase the machine, what
interest rebate it can enjoy according to the Rule of 78 method?
(a) Rs.50,000
(b) Rs.56,965
(c) Rs.60,000
(d) Rs.61,071
(e) Rs.62,465.

END OF SECTION A

Section B : Problems (50 Marks)


• This section consists of questions with serial number 1 – 5 .
• Answer all questions.
• Marks are indicated against each question.
• Detailed workings should form part of your answer.
• Do not spend more than 110 - 120 minutes on Section B.

<Answer>
1. SSK has furnished the following information pertaining to its credit policy:
• A projected sale for the next year is Rs.1,500 lakh and the gross
margin for the company is 20%.
• Credit policy of company is 2/15 net 30. It has been observed that 20% of
the customer avail the discount, 20% of customer pay with in 20 days, 50% of the
customer pay with in 30 days and rest pay with in 40 days.
• The bad debts amount to 2% of the sales.
• Administrative overheads for credit monitoring are Rs.1.5 lakh.
• SSK has been financing its investments in receivables through a mix of
bank finance and long-term funds in the ratio of 4:1. The effective rate of interest
on bank finance is 14% and the cost of long-term funds is 18%.
The sales executives are responsible for following up collections and on an average spend 25% of
their time on collection. The finance manager of SSK has realized that if the sales executives are
relieved from collection responsibilities, the annual sales would increase by 5%. Therefore the
company has approached Resolve Financial Services. Resolve Financial Services has offered the
following two schemes:
Recourse factoring: The factoring agreement provides for an advance payment of 80% of the value
of factored receivables. Advance carries the interest of 12% p.a. and the factoring commission is 1.5%
of the value of the factored receivables. Both interest and commission are collected upfront.
Non-recourse factoring: The factoring agreement provides advance payment of 75% of the value of
factored receivables. Advance carries a rate of interest of 15% p.a. and the factoring commission is
3.5% of the value of factored receivables. Both interest and commission are collected upfront.
After the careful analysis of the sales ledger of SSK, Resolve Financial Services agreed to a
guaranteed payment period of 30 days. The finance manager of SSK is not sure whether to go for any
factoring or to continue with in-house management for the receivables.
You are required to recommend with calculation to the finance manager of SSK for the selection of
the best scheme. (Assume 360 days in a year)
( 10 marks)

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<Answer>
2. Milton Telecom Ltd. is a closely held existing profit making company. The company planning to
expand its capacity to meet the growing demand for its product. The cost of the project is estimated at
Rs.50 crore. The project will be financed by term loan of Rs.20 crore and balance through public
issue. The capital and liabilities of Milton Telecom Ltd. as per the balance sheet at the end of year
2007-08 are as follows:
Rs. in lakh
Paid-up capital
(20 lakh shares of Rs.10 each) 200
Reserves & surplus 1400
10% partly convertible debenture 100
( F.V. Rs.100 each)
12% Secured Loans 500
Current liabilities 300
The company appoints Enam Financial Consultants (EFC) as their Merchant Banker. EFC advises
them against tapping the market. Instead they suggest a bought out deal the following terms:
• EFC will buy out the entire issue at current market price, current P/E ratio is 5.
• EFC will offload the shares through an offer for sale at the end of 3 years.
• EFC will be assured an IRR of 24% on their investments. In case of divestment takes
place at a lesser price, the promoter would compensate EFC for differential amount. In case,
EFC offloads at a price which gives them an IRR of over 24%, the surplus would be shared
equally by the promoters and EFC.
The return on assets (ROA) for the company is 18.8%. The EPS is expected to grow by 10% annually
over the next 3 years. The company proposes to declared dividend at 15%, 20%, 25% for the next
three years respectively. The divestment takes place at P/E multiple of 10. Tax rate applicable to the
company is 40%.
Given the information, you are required to calculate:

a. The investment and divestment price of the share for EFC.

(
5
marks)
b. The total post-issue returns to EFC on their investment.

(
6
marks)
<Answer>
3. GPP (India) Ltd., a subsidiary of GPS Co Inc. of US is considering a modernization program for
which it requires some specialized equipments for its bottling plant, the equipments being available in
UK. The cost of machinery is Rs.50 crores. The life of machinery is assumed to be 7 years after which
its salvage value is nil. The machinery is eligible for tax relevant depreciation rate of 25%.
Due to unavailability of sufficient funds to procure the equipments, GPP (India) Ltd., has proposed to
enter into a cross border lease agreement with a UK based leasing company PFS. PFS has agreed to
lease the equipment for a period of 7 years with lease rentals payable annually in advance. PFS
structures it lease transactions to earn a return of 12% and its effective tax rate is 20%.
You are required to:
a. Determine the lease rentals GPP Co (India) Ltd., has to pay to PFS.
( 5 marks)
b. Structure a double dip lease transaction involving the parent company GPS Co Inc. US
in such a way that the lease rentals payable by GPP Co (India) Ltd., is lower than the lease
rentals arrived at (a) above. Determine the lease rentals of such double dip transaction.
Assume:
i. The required rate of return and the effective tax rate of the US and UK companies are
12% and 20% respectively.
ii. SOYD method of allocation of interest and the same pattern of lease rentals payments.
( 8 marks)

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<Answer>
4. Arvind Industries Ltd., entered the capital market with an IPO of Rs.150 cr. Due to the moribund state
of the market, the issue fared badly was undersubscribed. The details of the underwriting and the
procurement of each underwriter is as follows:
(Rs. in crore)
Underwriter Amount Underwritten Amount Procured
JM Morgan Stanley 45 15
DSP Merril Lynch 20 25
Kotak Mahindra Capital Corp. 15 30
Max India 30 10
IDBI 20 0
ICICI Securities 10 0
SBI Capital Market 10 5
In addition to the above, application marked ‘direct’ were for Rs.5 crore and application for Rs.10
crore had no stamp in the underwriter’s column of the application.
You are required to compute the amount of devolvement on each underwriter as per the
current SEBI guidelines.
( 6 marks)
<Answer>
5. Zen Financial Services Ltd., (ZFSL) offers finance to individuals to purchase four wheelers on the
following terms:
i. Deposit of 25% of the cost of the asset should be made at the inception of the
transaction.
ii. 36 EMIs have to be made each at the beginning of every month.
Deposit carries an interest of 12% p.a. compounded monthly and would be repaid on the payment of
the last installment. The company levies a service fee of Rs.2,000 and a prompt payment bonus of
Rs.10 per Rs.10,000 per month on expiry of the repayment period.
You are required to:
a. Calculate the maximum monthly payments to be made by a borrower if his effective cost
of fund is 20% p.a. and cost of the asset is Rs.5 lakhs.
( 5 marks)
b. Calculate the effective interest rate on the completed transaction if the borrower would
like to make the prepayment at the end of 30 months. The company allows the prompt payment
bonus and offers an interest rebate calculated in accordance with the Modified Rule of 78
method with α = 2. Assume the EMIs as obtained in (a) above.
( 5 marks)

END OF SECTION B

Section C : Applied Theory (20 Marks)


• This section consists of questions with serial number 6 - 7 .
• Answer all questions.
• Marks are indicated against each question.
• Do not spend more than 25 - 30 minutes on Section C.

6. The rating services in international markets can be classified into shadow rating and formal rating. In <Answer>
this context, explain these two types of credit rating.

(
10
marks)

7. There is no uniform format for the lease agreement and the clauses included in the agreement vary <Answer>
from one lease agreement to another. What are the contents of the lease agreement that one should
verify before entering into the agreement?

(
10
marks)

END OF SECTION C

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END OF QUESTION PAPER

Suggested Answers
Investment Banking and Financial Services – I (MSF2K1) : April 2008

Section A : Basic Concepts


Answer Reason
1. d For public deposits the issuing company is required to maintain the liquid assets to the extent of certain < TOP >
percentage of the deposits maturing during the financial year ending 31st March. For this purpose, the
permitted investments are
Deposits held with a schedule bank, free from any lien.
Unencumbered securities of central or state government.
Unencumbered securities approved by Indian trust act.
Unencumbered bonds issued by HDFC.
Hence (d) is the correct answer
2. b Thrift CDs are issued by large savings and loan associations. Usually, they are issued in denominations < TOP >
of $100,000 so that they can be covered under the FDIC. Hence (b) is the answer.
3. d The following statements is true with respect to the lock-in requirements of the promoters’ contribution: < TOP >
• The minimum promoters’ contribution shall be locked-in for a period of three year
• In case the promoters’ contribution in the proposed issue exceeds the minimum specified
contribution, such excess contribution will also attract lock-in period of one year
• The lock-in period commences from the date of allotment or from the date of
commencement of commercial production whichever is later
• Bonus share issued to the promoter out of revaluation reserves during the preceding three
accounting years are required to be lock-in for a period of three years
• Shares issued to the promoter at a price lower than the current issue price during the
preceding 12 month period are required to be locked-in for a period of three years.
Hence (d) is the correct answer.
4. d The following statements are correct regarding various types of lease transactions: < TOP >
• In a leveraged lease transaction, the 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
• A leveraged lease transaction entitles the lessor to claim tax shields on depreciation
• In a sales-aid lease the equipment supplier catalyzes the lease transaction
• In a single investor lease, the debt funds raised by the leasing company are without recourse
to the lessee
• An upgrade lease is an operating lease which has in-built facilities like upgradations of the
equipment.
Hence (d) is a false statement and therefore the answer.
5. b Credit rating reflects the borrowers’ accountability, expected capability and inclination to pay interest < TOP >
and principal in a timely manner.
• Rating is an isolated function of a credit risk evaluation.
• Rating is useful in differentiating credit quality.
• Rating will involve issue-specific evaluation.
• Rating is not a general-purpose evaluation of the issuer.
• Rating is not recommendation to buy/sell/hold a security.
• Rating is not an extensive audit of the issuing company.
• Rating is not a one-time assessment of creditworthiness valid over the future life of the
security.
Hence, alternative (b) is answer.
6. a In cases of underwritten issues, the minimum underwriting commitment of the Lead Manager shall be < TOP >
to the extent of 5% of the size of the offer or Rs.25 lakhs, whichever is less.
Issue size of Blue Fox = Rs.5000 lakhs

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Minimum underwriting commitment by Goldmine, the Lead Manager will be the lesser of the two:
• 5% of Rs.5000 lakhs = Rs.250 lakhs
• Rs.25 lakhs.
Hence minimum underwriting commitment by Goldmine shall be Rs.25 lakhs. Therefore (a) is the
correct answer.
7. c Real estate investment is perceived as high-risk investment area because of its’ complicated and < TOP >
unstandardized nature.
Active management commitment is required to produce high returns.
Data concerning the historical returns and risk of the various types of possible real estate investments is
inadequate.
Since statements (I) and (II) are true and statement (III) is false, alternative (c ) is answer.
8. DMortgage Backed Securitization is backed by easily traceable immovable asset whereas Asset Backed < TOP >
Securitization is backed by movable assets, which may not be easily traceable. Mortgage Backed
Securitization takes into consideration appreciation in the value of assets whereas Asset Backed
Securitization takes into consideration depreciation in the value of assets. Legal hassles are relatively
less in Asset Backed Securitization. Mortgage Backed Securitization gives low yields to the investors
whereas Asset Backed Securitization gives high yields to the investors. In case of Asset-Backed
Securitization asset need not exist at the time of securitization but in case of Mortgage Backed
Securitization mortgage has to exist necessarily at the time of securitization. Hence (d) is the answer.
9. AThe maximum brokerage to be payable on a commercial paper issue for a period of 3 months is 0.025% < TOP >
of issue amount. Hence, in the present case, it is 0.125 lakh (5crore × 0.025 %). Hence, alternative (a) is
answer.
10. b Mismatch FRNs also known as rolling rate FRNs have semi-annual interest payments though the actual < TOP >
rate is fixed monthly. This enables investors to benefit from arbitrage arising on account of differentials
in interest rates for different maturities. Hence, alternative (b) is answer.
11. e All the following measures taken by the Central Government endeavors to enhance the level of < TOP >
efficiency of the Indian Credit Market:
• Deregulating the interest rate environment
• Withdrawing the Government funds as a source of funds to Financial Institutions
• Permitting offshore banking
• Setting prudential norms for the intermediaries.
• Permitting access to overseas funds
Hence (e) is the correct answer.
12. d An agreement which involves a sale of security with an undertaking to buy back the same security at a < TOP >
predetermined future date and price is termed as a repo whereas a reverse repo involves a purchase of
security with an undertaking to sell the same. Hence, (a) is not correct. Repo transactions are generally
done for short term and hence (b) is also not correct. Provident funds are not eligible to participate in
the repo auctions and hence (c) is also not correct. When RBI undertakes reverse repos, it purchases the
securities with an undertaking to sell the same and thus increases the liquidity in the money market.
Hence, (e) is also not correct. In a repo transaction, the underlying security is held with the lender of the
funds and hence a repo transaction is considered as a secured transaction whereas the borrowings in the
call money market are unsecured in nature.
13. b All money market instruments though short term in nature are exposed to reinvestment risk i.e., the risk < TOP >
of reinvesting the redeemed funds at a lower rate in case of falling interest rate scenario. Hence, (I) is
not true.
Except for government securities other securities have the probability of default by the borrower in the
repayment of the principal and/or interest. Hence, (II) is not true.
As money market instruments are short term in nature the inflation risk is considered to be minimal as
compared to long term securities. Hence, (III) is true. Generally, interest rate risk is at a higher level in
case of money market instruments. Hence (IV) is not true. Hence, alternative (b) is answer.
14. a Discounted value (DR) = < TOP >
F – Face Value – Rs.5,00,000
I – discount rate – 9%
N – Days to Maturity – 91 days
DR = = Rs.4,89,027.
15. d Factoring differs from bills discounting in the following respects < TOP >

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• In a bill discounting arrangement, the financial intermediary does not assume the
responsibilities of sales ledger administration and collection of debts, which the factor does under
the factoring arrangement. Hence, I is true.
• The bill discounting arrangement is recourse to the client whereas a factoring arrangement
can be with or without recourse. Hence, III is true.
• Unlike factoring, no notice of assignment is provided to the customers of the client under
the bill discounting arrangement. Hence, II is not true.
Hence (d) is the correct answer.
16. c Following are some of rights given to PDs in India: < TOP >
• The PDs are permitted to borrow and lend in the money market.
• The PDs are having access to Current and SGL accounts.
• The PDs can access finance through REPOs.
• The PDs can raise funds through CPs.
• The PDs can transfer funds from one center to another under Reserve Bank’s Remittance
Facility Scheme.
Hence (c) is the false statement. Therefore (c) is the answer.
17. b The interest payable on premature withdrawal of public deposits is as under: < TOP >
More than 3 months but up to 6 months NIL
More than 6 months but up to 1 year Not exceeding 10%
Above one year (12 months) 1% less than the rate of which the company
would have paid if the deposit had been accepted
for the period for which the deposit had actually
run.
Murtaza wants to withdraw his 3 year public deposit at the end of 9 months from the time of deposit.
Therefore interest payable to him by Manilal Finance Company should be 10%. Hence (b) is the correct
answer.
18. c In the given case, ex-rights price should be equal to or more than Rs.43 i.e. < TOP >
[NP0 + S]/[N+1] should be more than or equal to 43, where N is the number of shares required to
subscribe for 1 right share i.e. 5, P0 is the current market price i.e. 45 and S is the Subscription price
per right share.
225 + S ≥ 258
S ≥ 33.
19. c Under pricing of an IPO implies that pricing the share at a price less than what could have been market < TOP >
had paid for that. Naturally in case, an IPO is under priced then, the company looses the opportunity to
raise more funds and also it results in lower net worth on an increased equity. At the same time if an
IPO under priced is evaluated from the investors point of view, then the investor purchases it at a lower
price and can sell it off at a higher price. Hence, under pricing gives a higher return to the investor.
Hence (I) and (III) are true and (II) is false. So (c) is the correct answer.
20. d Foreign bonds are the bonds floated in the domestic market denominated in domestic currency by non- < TOP >
resident entities. US dollar denominated bond issued by foreign borrower in the US bond market called
as Yankee bonds. Euro-commercial paper issued with maturity of upto one year are not underwritten
and are unsecured. Note issuance facilities are underwritten and have maturity of upto one year.
Therefore statements (I) and (IV) are true and statements (II) and (III) are false. Hence (d) is the right
choice.
21. e As the Bower-Herringer-Willaimson model assumes that the debt displaced is equal to the initial < TOP >
investment, the amount of debt displaced in the given transaction is equal to Rs. 50 lakhs.
22. b In the context of leasing, “hell or high water” clause is defined as the clause under which the lessee < TOP >
undertakes obligation for the payment of rental regardless of the condition or the suitability of the asset.
Hence, alternative (b) is answer.
23. b Receivables factored = Rs.10,00,000 × 0.8 = Rs.8,00,000 < TOP >
Less: Interest = 0.17 × 8,00,000 × ¼ = Rs. 34,000
Less: Commission = 0.018 × 10,00,000 = Rs. 18,000
Amount actually received. = Rs.7,48,000
24. c Owned Fund = Equity share capital + Share Premium + capital Reserve (profit from sale of assets) – < TOP >
Intangible Assets

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= 240.50 + 80.00 + (60×.75) – 25


= Rs.340.50 Crore.
25. EIn (I) and (IV), as the realization value exceeds economic value, it appears that the firm should < TOP >
disinvest and therefore RV is the most appropriate measure. But applying the criterion of “loss suffered
on deprivation”, it is clear that the replacement cost is the most appropriate measure. In (II) and (III),
the loss suffered by the firm on deprivation is the replacement cost. Hence replacement cost is the most
appropriate measure under all the situations. Hence (e) is the correct answer.
26. e While accounting for a hire purchase transaction, the hirer capitalizes the asset at the cash purchase < TOP >
price and shows the capital content of the hire installments as a liability. Hence, statement I is true and
statement II is not true. In a hire purchase transaction, at the inception of the transaction, the finance
company records the hire purchase installments receivable as a current asset and finance income
component of these installments as a current liability. Hence statement III is also true.
27. e Insurance companies issue generally four types of guarantees: < TOP >
• Guarantees extended to non-financial contracts
• Guarantees on behalf of hire purchase companies to banks and other institutions
• Guarantees to cover deferred payments to supplier of equipments, to bankers (either to
suppliers or buyers’ bankers)
• Guarantees to cover long-term loans from banks.
Hence (e) is the correct answer.
28. a It can be calculated with help of the formulae i.e. V= CF (1-P)/re +P < TOP >

V= (16×0.6)/(. 08+. 4) = Rs. 20 lakh. Hence the answer is (a).


29. e Under bank participating factoring, a bank contributes to the part of factor reserves. In the given case, < TOP >
Amount of receivables = Rs.500 Lakhs
Factor reserves to be financed by Reliable bank = Rs. 120 lakhs = 80 %
So, the total factor reserves = 120 ÷ 0.80 = Rs.150 lakhs. So, Easy Finance Ltd. will provide for Rs.
500 lakhs – Rs. 150 lakhs = Rs. 350 lakhs. So, the proportion of receivables financed by Easy Finance
Ltd. = 350/500 x 100 = 70 %.
30. d According to the rule of 78 method, interest rebate is calculated as < TOP >
where t = number of installments that are not due and outstanding, n = total number of installments and
D is the total charge for credit.
In the given situation t = 18, n = 48 and D = 1000000 × 0.75 × 0.14 x 4 = Rs.420000 and hence, interest
rebate is equal to Rs.61071. Hence, the correct answer is (d).

Section B : Problems
1. Relevant cost for in house management of receivables: < TOP >
Cash discount
Rs.6 lakh
1500*0.02*0.20 =
Average collection period =
26 days
0.20*15 + 0.20*20 + 0.50*30 + 0.10*40
Cost of bank finance =
1500*(4/5)*(26/360)*0.14 = Rs.12.13 lakh
Cost of long term funds =
1500*(1/5)*(26/360)*0.18 = Rs.3.90 lakh
Total cost of funds = Rs.16.03 lakh
Bad debts
Rs.30 lakh
1500*0.02 =
Contribution lost on forgone sale
Rs.15 lakh
75*0.20 =
Avoidable cost of sales ledger and administrative
Rs.1.5 lakh
and credit monitoring
Total cost of in house management Rs.68.53 lakh.
Relevant cost of Recourse factoring
Factoring commission Rs.23.63 lakh
1575*0.015=
Discount charge Rs.12.60 lakh

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1575*0.80*0.12*(30/360)=
Cost of long term funds Rs.4.73 lakh
1575*0.20*0.18*(30/360)=
Bad debt Rs.31.50 lakh
1575*0.02
Total cost of Recourse factoring = Rs.72.46 lakh
Relevant cost of Non Recourse factoring
Factoring commission
1575*0.035 Rs.55.13 lakh
Discount charge
1575*0.75*0.15*(30/360)= Rs.14.77 lakh
Cost of long term funds
1575*0.25*0.18*(30/360)= Rs.5.91 lakh
Total cost of Recourse factoring = Rs.75.81 lakh
Hence the In house management is recommended.
2. (a) Investment Price: < TOP
Total assets = 200 + 1,400 +100 + 500 +300 = Rs.2500 lakh >
ROA =18.8%
Return on Asset (ROA) = EBIT/ Total Assets
So, EBIT = 2500 × 0.188

= Rs.470 lakh
PAT = (EBIT – interest) (1- t)
= [470 – (100×0.10) – (500×0.12)] (1 – 0.40)
= Rs.240 lakh
Current EPS = 240/20 =12
Current market price = 12 × 5 = Rs.60
Divestment Price:
EPS for 3 years
Year 1 13.20
Year 2 14.52
Year 3 15.97
The divestment takes place at P/E multiple of 10 so price = 15.97 × 10 = Rs.159.70
(b) Required IRR of EFC = 24%
No of share invested by EFC= 30 crore/ 60 = 50 lakh shares
Let the minimum value of divestment be X. thus the cash flow to EFC will be
Year Particulars Rs. in Lakh
0 Investment value –3,000
1 Dividend (50 ×10× 0.15) 75
2 Dividend (50 ×10× 0.20) 100
3 Dividend + Divestment 125 + X
(50 ×10× 0.25) + X
The discounted cash flow @ 24% is
The cash flow to EFC from the divestment would be
The IRR to EFC on their Investment is

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3. (a) In UK, a lease transaction is treated as a true lease < TOP >
A. Cost of equipment = Rs50 crores
Let the lease rentals payable by GPP India be Rs.X crores per annum
B. PV of lease rentals = XPVIFA(12,7) x 1.12 = Rs. 5.112 X Crore
C. PV of tax on lease rentals = XPVIFA(12,7) x 0.20 = Rs.0.913 X Crore
D. PV of Depreciation Tax Shields
Year Depreciation PVIF @ 12% PV of Depreciation
1 12.5 0.8929 11.16
2 9.375 0.7972 7.47
3 7.031 0.7118 5.00
4 5.273 0.6355 3.35
5 3.955 0.5674 2.24
6 2.966 0.5066 1.50
7 2.225 0.4523 1.01
31.73
PV of Depreciation Tax Shields = 31.73 x 20% = Rs 6.346 crore
–A+B–C+D=0
OR, –50 + 5.112X – 0.913X + 6.346 = 0
OR, 4.199X = 43.654
OR, L = Rs.10.396 crore
Hence, lease rentals payable annually in advance by GPP India to PFS under cross border lease transaction is Rs.10.396 crore.

(b) A double dip transaction can be structured in the following manner:


PSF should lease to GPC US which in turn leases to GPP India because in US a lease transaction is treated as sale and
the depreciation and other benefits would be claimed by lessee. Hence, US parent company can be made lessee in the lease
transaction between GPC US and PFS and the lessor in the lease transaction between GPP India and GPC US.
In case of the above double-dip lease transaction the cash flows of GPC US would be
Lease rentals payable to PFS – Outflow
Depreciation tax shield benefit – Inflow
Interest tax shield benefit – Inflow
Lease rentals receivable from GPP India – Inflow
Tax on interest portion of lease rentals receivable from GPP India – Outflow
Let Y be the lease rental receivable annually by GPC US from GPP India at which net cash flow to GPC US is zero.
E. PV of lease rentals payable to PFS = 10.396× PVIFA (12, 7) × 1.12 = Rs. 53.138 cr. 63.9102 Rs.
crore
F. PV of Depreciation Tax Shields = Rs. 6.346 crore
Unexpired Finance Charge = 10.396 × 7 – 50 = Rs.22.772 crore
Allocation of Unexpired Finance Charge
Year SOYD Factor Interest PVIF @ 12% PV of Interest
1 7/28 5.693 0.8929 5.083
2 6/28 4.880 0.7972 3.890
3 5/28 4.066 0.7118 2.894
4 4/28 3.253 0.6355 2.067
5 3/28 2.440 0.5674 1.384
6 2/28 1.627 0.5066 0.824
7 1/28 0.813 0.4523 0.368
16.51
G. PV of Interest Tax Shield = 16.51 × 0.20 = Rs. 3.302 crore
H. PV of lease rentals receivable by GPC US from GPP India = Y × PVIFA (12, 7) × 1.12 = Rs.5.112 Y crore
PV of tax on Finance Income of GPC LR:
Unexpired Finance Charge = 7Y –50

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SOYD
Year Interest PVIF @ 12% PV of Interest
Factor
1 7/28 1.75Y–12.5 0.8929 1.56Y–11.16
2 6/28 1.50Y–10.71 0.7972 1.20Y–8.54
3 5/28 1.25Y–8.93 0.7118 0.89Y–6.36
4 4/28 1.00Y–7.14 0.6355 0.64Y–4.54
5 3/28 0.75Y–5.36 0.5674 0.43Y–3.04
6 2/28 0.50Y–3.57 0.5066 0.25Y–1.81
7 1/28 0.25Y–1.79 0.4523 0.11Y–0.81
5.08Y – 36.26
I. PV of tax on interest income = (5.08Y – 36.26) × 0.20 = Rs1.02Y–7.252 crore
–E+F+G+H–I=0
OR, – 53.138+6.346+3.302+5.112Y–(1.02Y–7.252)=0
OR, –36.238+4.092Y=0
OR, Y = Rs.8.856 crore
Therefore lease rentals payable by GPP India to GPC US is Rs.8.856 crore which is lower than the lease rental payable by
GPP India in the cross border lease transaction between GPP India and PSF.
4. (Rs. in crore) < TOP >
Amount
Underwriter Amount Procured Deficit Surplus
Underwritten
JM Morgan Stanley 45 15 30 –
DSP Merril Lynch 20 25 – 5
Kotak Mahindra Capital Corp. 15 30 – 15
Max India 30 10 20 –
IDBI 20 0 20 –
ICICI Securities 10 0 10 –
SBI Capital Market 10 5 5 –
Total 150 85

Particulars Rs. in Cr.


Excess of amount procured over amount underwritten
DSP Merril Lynch 5
Kotak Mahindra Capital Corp. 15 20
Application marked ‘Direct’ 5
Application without stamp in the underwriter’ column of
the application 10
Total 35… (A)
The ratio in which (A) has to be distributed to the various underwriters is as per the amount underwritten by each underwriter who
is having deficit.
Computation of the devolvement on each underwriter as per the current SEBI guidelines
(Rs. in crore)
Devolvement on each
Amount Ratio Credit given Deficit
Underwriter underwriter
Underwritten (1) (2)=(1)*(A) (3)
(4)=(3)–(2)
JM Morgan Stanley 45 45/115=0.3913 13.70 30 16.30
Max India 30 30/115=0.2609 9.13 20 10.87
IDBI 20 20/115=0.1739 6.09 20 13.91
ICICI Securities 10 10/115=0.087 3.04 10 6.96
SBI Capital Market 10 10/115=0.087 3.04 5 1.96
Total 115 35 50

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5. (a) i. Cost = Rs.5 lakhs < TOP >


ii. Deposit = 5 × 0.25 = Rs.1.25 lakhs
Let Monthly Installment be = Rs.M lakhs
iii. PV of Installments = 12M × i/d12 PVIFA 20%,3 = Rs.27.933M lakhs

iv. Service charge = Rs.0.02 lakhs

Accumulated value of deposit = 1.25 FVIF 1%, 36 = Rs.1.788 lakhs


PV of deposit to be collected at the end = 1.788 PVIF 20%, 3 = Rs.1.035 lakhs
v. Promt payment Bonus = x 10 x 36 = Rs. 0.036 M lakhs
PV of bonus = 0.036M PVIF20%,3 = Rs. 0.021 M lakhs
EMI is ‘M’ in the following:
i – ii – iii – iv + v = 0
= 5 – 1.25 – 27.933M – 0.02 + 1.035 + 0.021 M = 0
∴ M = = Rs.0.17072 lakhs

(b) Total charge for credit = 0.17072 x 36 – 5 = Rs. 1.146 lakhs


Interest rebate as per Modified Rule of 78 = = Rs.0.017 lakhs
Rebate for prompt payment =
Amount payable on early settlement
= 0.1707 x 6 – 0.017 – 0.0051 = Rs.1.0021 lakhs
Accumulated value of deposit by the end of 30 months = 1.25 FVIF1%, 30 = Rs.1.685 lakhs

Monthly effective interest is ‘i’ is the following.


5 – 1.25 – 0.17072 x 12 x PVIFAi,2.5 x – 0.02 – 1.0021 PVIFi,2.5 + 1.685 PVIF i,2.5 = 0
At I= 18% , we get,
5 – 1.25 – (0.17072 x 12 x 1.8825 x 1.095) – 0.02 – (1.0021x 0.661) + (1.685 x 0.661) = 0
= 3.73 – 4.224 – 0.663 + 1.114
= - Rs.0.043 lakhs.
At I = 20%, we get,
5 – 1.25 – (0.17072 x 12 x 1.8303 x 1.1053) – 0.02 – (1.0021x 0.634) + (1.685 x 0.634) = 0
= 3.73 – 4.145 – 0.635 + 1.068
= Rs.0.018 lakhs.
By, interpolation, we get I = 19.41% p.a.
Hence, effective rate of interest on completed transaction, to borrower will be 19.41% p.a

Section C: Applied Theory


6. The rating services in the international markets can be classified into Shadow Rating and Formal Rating. < TOP >
The basic distinction between these two types of ratings is that the shadow rating is an indicative rating and will
give the issuer an idea of its formal rating and suggests if it would be beneficial to go for a formal rating.
Shadow Rating: The issuer will not have to disclose the rating to the public.
The firm can, either independently or with the help of its investment banker, assess its shadow rating by
proceeding in the following manner:
i. After collecting the relevant information, various financial ratios used by rating agencies can be computed.
ii. Identify companies with similar projects having published ratings. The financial ratios of these
companies can be used for comparison.
iii. Apart from these financial ratios, assess the management quality, performance of parent/group
companies.
iv. Give more weightage to those factors/information that have a major impact on the performance of the
company. Based on this also identify the strengths and limitations of the firm.
v. Use the ratings of the industry averages, other companies with similar projects and assign an indicative

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rating.
vi. To this indicative rating apply the sovereign limitations to get the final indicative rating. This rating
should preferably be in the form of a range and not as a specific rating.
Formal Rating: The issuer will have to announce the rating assigned in Formal Rating to the public.
The process involved in formal rating will be more detailed than the shadow rating process, since there will be a need
for more disclosures, and sometimes even plant visits may be involved in it. Further, the shadow rating will not require
any annual fee and meetings. While on the other hand, since formal rating will involve monitoring, there will be an
annual fee for such ratings. In addition to this there will also be annual meetings.
7. Contents of Lease Agreement < TOP >
There is no uniform format for a lease agreement and the clauses included in the agreement vary from one lease
agreement to another. But, by and large, the following clauses are found in most of the lease agreements:
Description Clause provides the description of the lessor, the lessee, the equipment and the location(s) where the
equipment is (are) to be installed. The lessor usually stipulates that the equipment shall not be removed from the
described location without its prior permission. For the sake of easy identification, the lessor may direct the lessee
to affix plates or markings to the equipment indicating the lessor’s interest.
Period Clause specifies the period for which the equipment is leased and the option available to the lessee for
renewing the lease on expiry of the lease term.
Rental Clause specifies the amount of lease rentals to be paid, the periodicity and the mode of such payment. If
the rentals are not evenly spread over the lease term, the rental pattern is given by way of a schedule. This clause
also specifies the initial deposit to be made, and the renal charge that is payable on lease rentals not paid on the
due dates.
Exemption Clause clearly states that the lessee has selected the equipment based on his own judgment and has
not relied on any statements or representations made by the lessor. Through this 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.
Manufacturer’s Warranty Clause entitles the lessee to the benefits of the warranties provided by the
manufacturer/supplier of the equipment. This clause also authorizes the lessee to enforce due performance by the
manufacturer of the equipment for any warranties or performance guarantee relating to the equipment.
Ownership Clause unequivocally 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. This clause also stipulates that the lessee shall not sell, assign, pledge, hypothecate or otherwise
encumber a lien upon or against the equipment.
Equipment Delivery Clause states that the lessee shall be solely responsible for taking delivery and possession
of the leased equipment from the manufacturer/supplier. The clause also specifies that the lessor shall not be
responsible for any loss suffered by the lessee on account of the equipment not being delivered on the due date. If
the lessee cancels the purchase order/contract with the supplier of the equipment or refuses to accept delivery of
the equipment, this clause entitles the lessor to terminate the agreement and be indemnified by the lessee for all
expenses incurred on account of the action of the lessee.
Repairs and Alterations Clause specifies that the lessee at its own cost and expense will keep the equipment in
good repair, condition and working order. While all replacements in the nature of maintenance will be deemed as
part of the equipment, the additions, attachments, and improvements made to the equipment by the lessee (if not
financed by the lessor) will belong to the lessee.
Insurance Clause specifies that the lessee must insure the equipment at its cost and expense for the benefit of and
on behalf of the lessor against all normal risks and risks that are specific to the equipment and to the business of
the lessee where this equipment is used.
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.
Default Clause specifies the events of default and the remedies available to the lessor upon the occurrence of any
such event of default.
Arbitration Clause explains the arbitration procedure to be followed in the event of any dispute, difference or
claim arising out of the lease agreement between the parties to the lease.
Miscellaneous Clause includes provisions such as the lessee’s obligation to submit its audited annual accounts to
the lessor, the lessor’s right to demand additional security in the event of any significant adverse change in the
financial conditions of the lessee, etc. An interest variation clause is also included which provides for varying the
lease rentals in line with the changes in the lending rates of commercial banks.

< TOP OF THE DOCUMENT >

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Question Paper
Investment Banking and Financial Services - I (MSF2K1): July 2008

Section A : Basic Concepts (30 Marks)

• This section consists of questions with serial number 1 - 30.


• Answer all questions.
• Each question carries one mark.
• Maximum time for answering Section A is 30 Minutes.

1. Which of the following is not true with respect to valuation of the investments?
<Answer>

(a) Current investments are to be valued at market value, if it is lower than its cost
(b)Permanent reduction in the value of long term investments determined individually and appropriate
provision must be made for the same
(c) Unquoted shares are always to be valued at break up value of the share
(d)Units of mutual fund are to be valued at lower of cost or the latest NAV declared by the mutual fund
with respect of that scheme
(e) Commercial papers and T-bills are to be valued at carrying cost.
2. Consider the following extract of Pee Cements Ltd., for the year ended March 2008: <Answer>

Particulars (Rs. in crores)


Issued and paid-up capital
1 crore shares of Rs.10 each 10
Reserves:
General reserves 40
Revaluation reserves 8 48
Machinery which was revalued earlier from Rs.15 crores to Rs.20 crores was sold during the year at its revalued amount. Based
on the above, if the company wants to capitalize its reserves, the eligible reserves for bonus issue are
(a) Rs.40 crores
(b) Rs.43 crores
(c) Rs.45 crores
(d) Rs.48 crores
(e) Rs.53 crores.
3. Which of the following is/are not true with respect to credit insurance?
<Answer>

I. Firm can insure its receivables against credit risk and insurance company helps in the collection of receivables.
II. The insurance company specifies the maximum amount it will cover for accounts with a particular credit rating.
III. It is similar to non-recourse factoring in so far as credit protection is concerned.
IV. It is more cost-effective than non recourse factoring for the firms which want protection only against bad debts.
(a) Only (I) above
(b) Both (I) and (IV) above
(c) Both (II) and (III) above
(d) Both (II) and (IV) above
(e) (I), (III) and (IV) above.
4. Which of the following statements is/are true regarding hire purchase?
<Answer>

I. The title to the goods is transferred to the hirer on the payment of the first installment.
II. The hirer has to indemnify the owner against any loss that results from his negligence.
III. Some occasional delays in payment over the hire period do not empower the owner to terminate the contract.
IV. All hire purchase transactions are subject to the sales tax but are not subject to central sales tax.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) (II), (III) and (IV) above
(e) All (I), (II), (III) and (IV) above.
5. In the recent past, there have been innovations in the financial instruments witnessed by the Indian capital market, LYONS is <Answer>
one of the innovative financial instrument. Which of the following is not true with respect to LYONS?
(a) This is a zero coupon bond, which can be converted into common stock
(b) The investor allows to subscribe to the equity share of another company
(c) By issuing such instrument, issuer does not have to meet any immediate outflow of interest
(d) The issuer gets the tax advantages even if he is not paying any interest till maturity
(e) If investors of such security choose to convert, they have to forgo all accrued and unpaid part of interest.

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6. The preliminary prospectus, which has a statement on its cover that the registration statement has not yet become effective, is <Answer>
referred to as a (an)
(a) Registration statement
(b) Standby arrangement
(c) Red herring prospectus
(d) Underwriting syndicate
(e) Due diligence certificate.
7. To promote the investment activity in the Government Securities market, several countries have adopted licensed Primary <Answer>
Dealers (PDs) as important intermediaries in the market. Which of the following is not true with respect to the PDs?
(a) They are responsible for meeting the minimum bidding requirement
(b) They are responsible for giving two-way quotes
(c) They are responsible for providing information of the market activity to the central bank
(d)They have an important role to play in the development of primary market for the Government Securities
(e) In some instances PDs have special rights to different activities in the money market like primary
auctions or some special facilities in market operations.
<Answer>
8. Suntech Ltd., has recently made public issue and the closing date was January 28th 2008. It failed to receive the minimum
subscription amount. As a result, Suntech Ltd., refunded the subscription money collected from the public on March 31st 2008.
The amount refunded should include both the amount due and
(a) Interest @ 6% p.a for 8 days
(b) Interest @ 6% p.a for 63 days
(c) Interest @ 15% p.a for 21 days
(d) Interest @ 15% p.a. for 63 days
(e) Interest @ 20% p.a. for 42 days.
9. Which of the following statements is/are not true regarding to the ‘Auction Rated Debt’?
<Answer>

I. These are fully redeemable non-convertible long-term debentures, secured by specific movable and immovable assets
of the company.
II. The instrument is privately placed at competitive bids.
III. There is no dilution of equity.
IV. The instrument does not require credit rating.
(a) Only (I) above
(b) Only (III) above
(c) Both (II) and (IV) above
(d) (I), (II) and (III) above
(e) (II), (III) and (IV) above.
10. Mr. Smith is the holder of the charge card issued by the City bank. He is not able to make clear differentiation between charge <Answer>
card and credit card because both give the credit to the cardholder. He is assuming that following terms and conditions are
applicable to his charge card. Which of the following is not true with respect to the charge card?
(a) He needs to make payment to the issuer for 100 percent of purchase
(b) Payment period is normally within 30 days of purchase
(c) No interest is charged and there is no extension of payment period
(d) Both annual payment and commission is charged
(e) His spending limit is 5 times of his net income.
11. Which of the following is/are true with respect to the guidelines for stock buy-back, issued by SEBI?
<Answer>

I. The company shall not issue any shares including by way of bonus shares till the date of closure of the offer made
under the stock repurchase program.
II. The company shall not withdraw the offer to buy-back after the draft letter of the offer is filed with the board.
III. The company can buy-back the locked-in shares and non-transferable shares by passing the resolution in board
meeting.
(a) Only (I) above
(b) Both (I) and (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
12. Which of the following statements is/are true with respect to Collateralized Mortgage Obligation (CMOs)?
<Answer>

I. CMOs protect the investors from pre-payment risk.


II. CMOs are considered to have high level of credit quality, because of the quality of the underlying collateral.
III. Longer tranche CMOs are ideal investment for the long term investors who want to avoid call and reinvestment risk.
IV. If any amount is left, it is distributed equally to all the tranches for the payment of principal amount, after paying
interest to them.
(a) Both (I) and (III) above

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(b) Both (II) and (IV) above


(c) Both (III) and (IV) above
(d) (I), (II) and (III) above
(e) All (I), (II), (III) and (IV) above.
13. Which of the following is false with respect to the issue of debentures?
<Answer>

(a) Credit rating is mandatory for any debenture issue where the conversion period exceeds 18 months
(b) Appointment of SEBI registered Debenture Trustee is mandatory if the maturity period of the
instrument exceeds 18 months
(c) Creation of Debenture Redemption Reserve is mandatory if the maturity period of the instrument
exceeds 18 months
(d) In case the non convertible portion of the PCD is to be rolled over, a compulsory option is to be given to
debenture holders to redeem and encash their debentures
(e) No issue of FCDs having conversion period exceeding 18 months can be made unless conversion is
made optional with put and call options.
14. Which of the following is not a variable of Economic Risks for sovereign risk rating purposes?
<Answer>

(a) Resource endowments, degree of diversification


(b) Public sector fiscal balances
(c) Living standards, income and wealth distribution
(d) Public debt and interest burden
(e) Trends in price inflation.
15. Sandhya Ltd., has been working on the development of a new product since last 9 months and now the product is ready for <Answer>
launch. For this, company required Rs.20 lakh for the initial marketing of the product. Yes bank is ready to provide the fund to
the company. This kind of company financing is referred as
(a) Seed Financing
(b) Start-up Financing
(c) First Stage Financing
(d) Mezzanine Financing
(e) Bridge Financing.
16. An adjustment made for offsetting the market risk to save the borrower or the lender from the transaction price movements in a <Answer>
repo transaction, is called
(a) Haircut
(b) Hairoff
(c) Hairon
(d) Hair adjustment
(e) Centric adjustment.
17. Due to boom in the consumer finance market, Centurian bank has entered into the consumer finance segment. Bank has <Answer>
approached the Onida Individual Credit rating Agency (ONICRA) for the assessment of individual credit rating. Which of the
following is not true with respect to individual credit rating agency?
(a) It provides scope to minimize risk of default
(b) It determines the willingness and ability of the borrower to pay
(c) It is relatively easy to rate individual than corporate due to availability of the information
(d) It is easy for a borrower, to get durables or any other products on loan/installment
(e) It is more cost-effective, if the agency has large database.
18. Which of the following statements describe the Gensaki rate? <Answer>

(a) It is the short-term bench mark rate used in Japanese markets


(b) It is the bench mark 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 market
(e) It is the long-term benchmark rate used in British markets.
19. Axis Ltd., has an export order for which it required short term credit for 100 days. Firm wants to cover commercial and political <Answer>
risk under service offered by Export Credit and Guarantee Corporation (ECGC). Which of the following service is suitable to the
firm?
(a) Export Performance Guarantee
(b) Specific Policy
(c) Export Finance Guarantee
(d) Standard Policy
(e)Post-shipment Export Credit Guarantee.
20. There is a lease agreement between Suraj Equipment Ltd., and Chandraj Manufacturing Ltd., where Suraj Equipment Ltd., acts <Answer>
as a lessor and provides the operating know-how, and the related services to Chandraj Manufacturing Ltd., and undertakes the
responsibility of insuring and maintaining the equipment. This type of lease can be defined as

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(a) Hell or high water lease


(b) Dry lease
(c) Capital lease
(d) Full payout lease
(e)Wet lease.
21. Arvind Industries has made an issue of debentures of worth Rs.10 lakhs. The entire issue was underwritten and subscribed by <Answer>
the public. If Global consultant Ltd., has underwritten half of the issue, the commission payable is
(a) Rs. 5,000
(b) Rs.10,000
(c) Rs.20,000
(d) Rs.15,000
(e) Rs.25,000.
22. Which of the following is/are true with respect to mortgage Real Estate Investment Trusts (REITs)?
<Answer>

I. The most predominant form of mortgage lending by REITs is the construction/development lending.
II. The mortgage REITs obtain capital gains whenever there is rise in long term interest rates.
III. It is subject to default risk, interest rate risk and purchasing power risk.
IV. The main source of income for the mortgage REITs is the rentals.
(a)Only (I) above
(b)Both (I) and (III) above
(c)Both (II) and (IV) above
(d)(I), (III) and (IV) above
(e)(II), (III) and (IV) above.
23. US-based credit rating agency ‘FITCH’ has appraised the risk associated with the ‘Bonds’ of a company and opined that there is <Answer>
‘Imminent Default’. The rating given by ‘FITCH’ to the bonds is
(a)B
(b)CCC
(c)CC
(d)C
(e)D.
24. Under bank participation factoring, First Factors Limited has agreed to factor the receivables of Standard Manufacturers Limited <Answer>
(SML) of Rs.500 lakhs and provide an advance of 70 percent of the receivables. ABC Bank has agreed to finance 80% of the
factor reserves. The amount of receivable that SML has to finance from its own funds is
(a) Rs.350 lakhs
(b)Rs.150 lakhs
(c) Rs.120 lakhs
(d) Rs. 50 lakhs
(e)Rs. 30 lakhs.
25. Which of the following is/are not true with respect to call and notice money?
<Answer>

I. Both the call money and notice money serve the general purpose of meeting reserve requirements.
II. In the notice money market, funds are lent for a predetermined maturity period and in call money market there is no
such predetermined maturity period.
III. The reliance of the banks is mostly on the call money rather than notice money, as it raises overnight money.
IV. Maturity period for both the call and notice money markets varies from one day to fourteen days.
(a) Only (II) above
(b) Only (III) above
(c) Both (II) and (IV) above
(d) (I), (III) and (IV) above
(e) (II), (III) and (IV) above.
26. Bharat Cements Limited (BCL) proposed to purchase an equipment costing Rs.40 lakhs inclusive of sales tax of 4 per cent. BCL <Answer>
is considering the alternative of leasing the equipment from Finlease Limited (FL) at annual lease rentals of Rs.30 per thousand
per month. The annual lease rentals payable by BCL are
(a) Rs.13.09 lakhs
(b) Rs.14.40 lakhs
(c) Rs.14.98 lakhs
(d) Rs.15.23 lakhs
(e) Rs.15.84 lakhs.
27. Which of the following is the difference between the issue of ADR Level -I and ADR Level -II? <Answer>

(a) Complying with the US GAAP is necessary in case of ADR Level-II issue, but not required in case of
ADR Level –I
(b) The minimum disclosures have to be made in case of ADR Level-II issue, but substantial disclosures are

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required in case of ADR Level –I


(c) Fresh capital can be raised in case of ADR Level-I, but not permitted in case of ADR Level-II
(d) The company is allowed to be listed in the American Stock Exchange or New York Stock exchange in
case of ADR Level-II issue, but not permitted in case of ADR Level -I
(e) Meeting the listing requirements of the a particular stock exchange is not required in case of ADR Level-
II, but required in case of ADR Level –I.
28. Expert Ltd., is a leasing company. Following are the relevant information for a lease transaction undertaken by it: <Answer>

Lease rental receivable for the next five years : Rs. 2.25 crores
Lease rental receivable over the lease term : Rs. 3.25 crores
Cost of leased equipments : Rs. 2.75 crores
Net owned funds : Rs.11.00 crores
The amount drawn as cash credit for this transaction from the bank is
(a) Rs.1.90 crores
(b) Rs.1.83 crores
(c) Rs.1.53 crores
(d) Rs.1.43 crores
(e) Rs.1.33 crores.
29. Novice Financial Services Ltd., (NFSL) has recently structured a lease transaction involving an asset whose fair market value is <Answer>
Rs.140 crores and has an useful life of 8 years. In which of the following situations, the lease can be classified as finance lease
according to FASB?
I. PV of lease payments is Rs.105 lakhs and the lease term is 5 years.
II. PV of lease payments is Rs.105 lakhs and the lease term is 6 years.
III. PV of lease payments is Rs.126 lakhs and the lease term is 5 years.
(a) Only (II) above
(b) Only (III) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
30. Sadhan Financials Ltd., incorporated under the Companies Act, 1956 engaged in the government securities business for the last <Answer>
few years, is planning to apply for primary dealership business. It has authorized capital of Rs.50 crores out of which Rs.25
crores was issued and paid-up. In additions to this, its balance sheet shows the following balances in various accounts.
Free reserves account : Rs.15 crores
Capital reserves account
Sale of assets : Rs.3 crores
Revaluation of assets : Rs.2 crores
Book value of intangible assets : Rs.1 crore
Accumulated loss balance : Rs.0.5 crore
Is Sadhan Financials Ltd., eligible to apply for primary dealership business?
(a) Yes, it has the paid up capital of Rs.25 crores
(b) No, it has the paid up capital of less than Rs.50 crores
(c) No, it has the net owned funds of less than Rs.50 crores
(d) No, it has accumulated loss balance of more than Rs.0.25 crore
(e) Yes, it has the capital reserves of more then Rs.1 crore arising out of revaluation of assets.

END OF SECTION A

Section B : Problems (50 Marks)


• This section consists of questions with serial number 1 – 6.
• Answer all questions.
• Marks are indicated against each question.
• Detailed workings should form part of your answer.
• Do not spend more than 110 - 120 minutes on Section B.

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<Answer>
1. Magnum Finance Ltd., is a non-banking finance company. The following information pertains to its loans and advances, hire-
purchase receivables and lease assets as on 31.03.2008:
Loans and Advances
(Rs. in lakhs)
Category of loans Amount at the Recovery during Downgraded during Upgraded during
and advances beginning of the year the year (%) the year the year
Standard 3,200 – – –
Sub-standard 408 15 5 8
Doubtful
Upto 1 year 334 12 5 6
1-3 years 296 10 4 4
Above 3 years 225 8 10 2
Loss 180 5 – 2
Hire Purchase Assets turned NPA during the year
(Rs. in lakhs)
Current year Previous year
Total dues 60 50
(Shown as stock in trade in the balance sheet)
Unmatured finance charges 20 15
Original cost of the assets 100 85
Amount realizable 20 15
Accumulated depreciation 60 50
Net book value of hire purchase and lease assets
(Rs. in lakhs)
Overdue for HP Assets Lease Assets
Up to 12 months 70 80
12–24 months 35 40
24–36 months 10 15
More than 36 months 5 10
In the 12–24 months category of HP assets and 24–36 months category of lease assets, amount of Rs.10 lakhs and Rs.5 lakhs
respectively are outstanding for more than 12 months after the due date of the last payment.
You are required to calculate the provision made by the company on the above assets.
( 10 marks)
<Answer>
2. A young group of technocrats decided to set up Intelligent Software Ltd., The estimated project cost is Rs.2 crores. The group is
able to invest only a sum of Rs.100 lakhs as equity at a face value of Rs.2 each. The balance is proposed to be financed through
Venture Capital (VC). The company offers 2 alternative investment packages to the VC firm:
a. Straight equity investment
b. Fully Convertible Debentures. These debentures carry a coupon of 15%. At the end of 3 years, the FCD would be
converted into equity. The conversion would take place at a P/E ratio of 10 on the average Earnings per share (EPS) of the
first three years.
The company plans to tap the capital market with an IPO at the beginning of 6th year. The IPO is expected to be priced at P/E
multiple of 15 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 Payout Ratio of 10% for all the 5 years.
The expected EBIT for the 5 years is:

Ignore Taxes.

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You are required to choose the alternative investment to be made by VC firm if its required rate of return is 12%. Show all the
required calculations.
( 10 marks)
<Answer>
3. Creative Finance Limited (CFL) has signed a lease agreement for an equipment under a Bargain Purchase Option (BPO). The fair
market value of the equipment is Rs.1,40,000 with an expected life of 5 years. The asset is expected to remain with lessee for a
period of 3 years. Each annual lease payment involves Rs.52,000 and the first lease payment commences on January 1, 2008.
The lessor pays Rs.2,000 per year for insurance on the equipment. The lessee can exercise bargain purchase option on December
31, 2010 for Rs.10,000, whereas, the salvage value of the asset is expected to be Rs.1,000 on that day. The lessee’s incremental
borrowing rate is 10%.
Assuming that bargain power option is exercised, you are required to pass necessary entries in the books of CFL according to
IAS:17.
( 8 marks)
<Answer>
4. National Bank offers traditional mortgage loans for purchase of residential properties at an interest rate of 15% p.a. compounded
monthly. It usually charges 0.5% p.a. servicing fee for these type of loans.
Mr. Rohan Verma has approached the bank for a home loan of Rs.100 lakhs for a period of 10 years.
You are required to
a. Determine the equated monthly installments (EMIs) under the traditional mortgage loan.
( 2 marks)
b. Develop the repayment schedule for first 12 months clearly distinguishing the capital component, interest component
and servicing fees.
( 6 marks)
<Answer>
5. The balance sheet of Sheetal Pharma as on March 31, 2008 is as follows:
Amount Amount
Liabilities Assets
(Rs. in crores) (Rs. in crores)
Share Capital Land and
(Face Value Rs.10 each) 20.00 Building 50.00
Reserve & Surplus 160.00 Plant and Machinery 100.00
Debentures 30.00 Misc., Fixed Assets 40.00
Term loan @10% 10.00 Current Assets 40.00
Current Liabilities 10.00
Total 230.00 Total 230.00
The Profit After Tax for 2007-08 is Rs.10 crores. The EPS is targeted to increase by 25% during 2008-09. The market discounts
the share at 20 times its expected earnings.
The Company proposed to set up a bulk formulation plant involving a project outlay of Rs.495 crores. The project is proposed to
be financed by a term loan of Rs.175 crores @ 8% p.a. from ICICI bank, Rs.80 crores through private placement of NCDs
carrying an interest rate of 12%, Rs.40 crores from internal accruals and the balance through 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, 2007. 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 $10 million by issue of 12,50,000 GDRs in March 2007. The paid-up capital of Rs.20 crores
includes 50,00,000 share underlying the GDRs.
You are required to compute:
a. The ratio for issue of rights shares and the pricing of the rights
( 3 marks)
b. The value of the rights
( 1 mark)
c. The gain or loss, in dollars, to a GDR holder who holds 100 GDRs exercise the rights and sells his entire holdings at
the prevailing GDR price. Assume the GDRs are quoting at 20% premium to their domestic price and exchange rate at the
time of rights issue and sale to be Rs.38/$
( 5 marks)

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<Answer>
6. Fish Eye Ltd., has awarded National Bank a syndication mandate for US $ 400 million, 5 year facility. The bank underwrites US
$ 200 million and 4 other Banks underwrite US $ 50 million each.
The company agrees 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 retain.
Each underwriter retains US $ 40 million and there are 10 participant banks with US $ 20 million each.
Collin Bank is appointed as agent Bank with annual fee of US $ 20,000.
You are required to calculate the:
a. Cost of loan facility for Fish Eye Ltd., if LIBOR remains constant at 3.12%.
( 3 marks)
b. Fees earned by National Bank on this transaction.
( 2 marks)

END OF SECTION B

Section C : Applied Theory (20 Marks)


• This section consists of questions with serial number 7 - 8.
• Answer all questions.
• Marks are indicated against each question.
• Do not spend more than 25 -30 minutes on Section C.

7. Private placement as an efficient route for raising capital and profitable avenue for investment makes it acceptable to both the <Answer>
issuers and the investors. Discuss the merits of private placement. ( 10 marks)
8. In international trade transaction, forfaiting is a common form of financing export related receivables. Explain the process of <Answer>
forfaiting and also discuss the cost involved in forfaiting. ( 10 marks)

END OF SECTION C

END OF QUESTION PAPER

Suggested Answers
Investment Banking and Financial Services - I (MSF2K1): July 2008
Section A : Basic Concepts
Answer Reason
1. c Unquoted shares are to be valued at lower of cost or break-up value of the shares. So, option (c) is not true. All other < TOP >
options are true with respect to the valuation of investments.
Hence correct answer is (c).
2. c Bonus can made out of eligible reserves such as general reserve, share premium collected in cash, realized revaluation < TOP >
reserves, etc. In the given case, the entire general reserves and the realized amount of revaluation reserves i.e. Rs. 5
crores can be part of eligible reserves. Hence, 40 + 5 = Rs.45 crores are eligible reserves.
3. a • Firm can insure its receivables against credit risk. While insurance company does not help in the collection of < TOP >
receivables, it settles the claims arising on account of insured amount which have delinquent.
• The insurance company specifies the maximum amount it will cover for accounts with a particular credit
rating.
• Credit insurance is similar to non-recourse factoring in so far as credit protection is concerned.
• Credit insurance is more cost-effective than non recourse factoring for the firms which want protection only
against bad debts.
Hence statement (I) is not true and correct answer is (a).
4. d In a hire purchase agreement, the title to goods is transferred to the hirer only when the hirer exercises the option of < TOP >

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purchasing the asset or on the payment of the last installment. Hence, I is not true. The hire agreement expressly
provides that the hirer has to indemnify the owner for any loss due to the hirer’s negligence. Hence, statement II is true.
Though the payment of the hire rentals on the time agreed is an implied obligation of the hirer some occasional delays in
payment does not empower the owner to terminate the contract. Hence, statement III is also true. All hire purchase
transactions are subject to the sales tax but are not subject to central sales tax. Hence, statement IV is also true.
5. b LYONS is also known as zero coupon convertible note so this is a zero coupon bond, which can be converted into < TOP >
common stock of the issuer. Hence option (a) is true. The investor allows to subscribe to the equity share of issuer
company only, so option (b) is not true. Other option (c), (d) and (e) are true with respect to LYNOS. Hence correct
answer is (b).
6. c A preliminary registration statement that must be filed with the SEBI describing a new issue of stock (IPO) and the < TOP >
prospects of the issuing company is called Red herring prospectus. Hence, alternative (c) is answer.
7. d PDs have an important role to play in the development of secondary market for the Government Securities. All other < TOP >
statements are correct for PDs.
Hence (d) is the correct answer.
8. c If the company does not receive at least 90% of the issued amount including accepted devolvement from underwriters, if < TOP >
any, within 42 days from the date of closing of the issue, the amount of subscription received is required to be refunded.
If there is any delay in the refund of amount collected by more than 8 days, the company and directors of the company
shall be jointly and severally liable to repay the amount due by way of refund with interest @ 15% p.a. for the delayed
period. Since closing date of its issue is 28th January 2008, it completed 42 days by March 10th 2008. Since Suntech
Ltd., refunded amount on 31st March 2008, the delayed period was 21 days, for which it was required to pay the amount
due by way of refund with interest @ 15%p.a. for 21 days. Hence, correct answer is (c).
9. a Auction rated debt are fully redeemable non-convertible short-term debentures, secured by specific movable and < TOP >
immovable assets of the company. There is no dilution of equity. The instrument is privately placed at competitive bids.
It does not require credit rating as the tenure is less than 18 months. Therefore (b), (c), (d) and (e) are true and the
answer is (a).
10. e • The cardholder needs to make payment to the issuer for 100 percent of purchase < TOP >
• payment period is normally within 30 days of purchase
• No interest is charged and there is no extension of payment period
• Both annual payment and commission is charged
• There is no spending limit in case of charge card. In case of credit card, spending limit depends on the
creditworthiness usually 5 times of the net income of individual. So this option is not true.
Hence correct answer is (e).
11. b The company shall not buy-back the locked-in shares and non-transferable shares till the shares become < TOP >
transferable as per SEBI guideline. All other statements are correct.
Hence (b) is the correct answer.
12. d • CMOs protect the investors from pre-payment risk. < TOP >
• CMOs are considered to have high level of credit quality, because of the quality of the underlying collateral.
• Longer tranche CMOs are ideal investment for the long term investors who want to avoid call and
reinvestment risk.
• After paying interest to all the tranches, if any amount left, is used for the payment of principal amount only
one tranche at a time.
Hence correct answer is (d).
13. e Credit rating is mandatory for any debenture issue where the conversion period exceeds 18 months < TOP >
Appointment of SEBI registered Debenture Trustee is mandatory if the maturity period of the instrument exceeds 18
months
Creation of Debenture Redemption Reserve is mandatory if the maturity period of the instrument exceeds 18 months
In case the non convertible portion of the PCD is to be rolled over, as compulsory option is to be given to debenture
holders to redeem and encash their debentures
No issue of FCDs having conversion period exceeding 36 months unless conversion is made optional with put and call
options
Hence (e) is the correct answer.
14. c Following are the variables of Economic Risks for sovereign risk rating purposes: < TOP >
• Resource endowments, degree of diversification
• Public sector fiscal balances
• Public debt and interest burden
• Trends in price inflation.
Living standards, income and wealth distribution is a variable of Political Risk for sovereign risk rating purposes. Hence
(c) is the correct answer.
15. b Seed Financing is a relatively small amount of capital provided to an entrepreneur for product development and market < TOP >
research as well as building of management team and developing a business plan.
Start-up Financing is provided to companies completing product development and initial marketing. These companies
may be in business for a year or less but may have not sold their product commercially.
First stage Financing provided to companies that have expected their initial capital and required fund to initiate full scale
manufacturing and sales.
Mezzanine Financing is provided for major expansion of a company when sales volume is increasing and that is
profitable.
Bridge Financing is needed at times when company plans to go public within six months to a year.

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Hence correct option is (b).


16. a The haircut is an adjustment made for offsetting the market risk to save the borrower or the lender for transaction price < TOP >
movements in a repo transaction.
Hence (a) is the correct answer.
17. c It is relatively easy to rate corporate because of availability of audited balance sheet, market data about suppliers and < TOP >
customers, the industry scenario and the quality of management. So option (c) is not true. Other options are true with
respect to the individual credit rating agency.
Hence correct answer is (c).
18. a Gensaki rate is the short-term bench mark rate used in Japanese markets. < TOP >

19. d Standard Policy is designed to cover risks with respect to goods which are exported on short-term credit not exceeding < TOP >
180 days. The standard policy covers two types of risk namely, commercial risk and political risk. So, the correct answer
is (d).
20. e In an operating lease, the lessor usually provides the operating know-how, suppliers, and related services and also < TOP >
undertakes the responsibility of insuring and maintaining the equipment such operating lease is called as ‘wet lease’.
When in an operating lease, lessee bears the cost of insuring and maintaining the equipment then such lease is called as
‘dry lease’. Other options are types of financial lease where lessee is responsible for repair, maintenance and insurance
of the equipment. Hence, option (e) is answer.
21. a The underwriting commission in case of debentures exceeding Rs.5 lakhs is 1% on the amounts subscribed by public < TOP >
and 2% in case of amounts devolved on the underwriter.
In the given case as the entire amount is underwritten and subscribed by the public, the underwriting commission
payable to XYZ ltd is 1% of half of Rs.10 lakhs
= = Rs.5000.
22. b • The most predominant form of mortgage lending by REITs is the construction/development lending. So, < TOP >
statement (I) is true.
• The mortgage REITs obtain capital gains whenever long term interest rates drop. So, statement (II) is not true.
• It is subject to default risk, interest rate risk and purchasing power risk. So, statement (III) is true.
• The main source of income for the mortgage REITs are the interest earned on mortgages, commitment fees,
commission earned on mortgage purchases. The main source of income for the equity REITs is the rentals. So,
statement (IV) is not true.
Hence correct answer is (b).
23. d Fitch Ratings to bonds are as follows: < TOP >
Highest safety AAA
High safety AA
Good/Medium A
Satisfactory/Low-Medium BBB
Speculative BB
High speculative B
Possibility of Default/Hazardous CCC
Higher Possibility of Default CC
Imminent Default C
Default D
Hence, correct answer is (d).
24. e Under bank participating factoring, a bank contributes to the part of factor reserves. In the given case, < TOP >
Amount of receivables = Rs.500L
Factor reserves = 30% of Rs.500 = Rs.150L
Bank participation = 80% of 150 = 120
Hence, own funds required = 150 – 120 = Rs.30L.
25. a Both call and notice money represent borrowings made for a period of one day up to a fortnight. However, there exists a < TOP >
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 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. 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 single day. Since statements (I), (III) and (IV) are
true and (II) is false, alternative (a) is answer.
26. d As the leasing company is not eligible for the concessional sales tax, the sales tax rate applicable to the lessor is 10% and < TOP >
hence the cost of the asset to the leasing company will be
= 40× 1.1/(1.04) = Rs.42.308 lakhs
The annual lease rentals payable by Bharat cements Limited are
= 0.03 × 12 × 42.308 = Rs.15.23 lakhs.
27. d Complying with the US GAAP is not necessary in case of both the issues. < TOP >
The minimum disclosures have to be made in case of ADR Level-I issue, but substantial disclosures are required in case
of ADR Level –II
Fresh capital can not be raised incase of both the issues. The company is allowed to be listed in the American Stock
Exchange or New York Stock exchange in case of ADR Level-II issue, but not permitted in case of ADR Level –I.

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Meeting the listing requirements of the a particular stock exchange is not required in case of ADR Level-I, but required
in case of ADR Level –II.
Since, alternative (d) is true and is answer.
28. d 0.75*[LR(5) / LR(T)] * C < TOP >

=0.75* 2.25/3.25 * 2.75


= Rs.1.43 cr
Hence (d) is the correct answer.
29. d According to FASB, a lease transaction is classified as a finance lease if one of the conditions stated below is fulfilled: < TOP >
i. Lease term exceeds 75% of the useful life of the asset; or
ii. Present value of lease payments exceeds 90% of the fair market value of the asset.
As statement (II) satisfies the condition (i) and statement (III) satisfies condition (ii) and statement (I) does not satisfy
any, statements (II) and (III) can be classified as finance leases and the answer is (d).
30. c To decide the eligibility criteria, its net owned funds should be computed. < TOP >
Net Owned Funds:
Paid up capital + Free reserves + Capital reserves arising out of sale of assets – Book value of intangibles –
Accumulated loss balance
Rs.25 crore + Rs.15 crore + Rs.3 crore – Rs.1 crore – Rs.0.5 crore = Rs.41.5 crore
The minimum amount of net owned funds required for applying for primary dealership business is Rs.50 crore. Hence,
Sadhan Financial Ltd. is not eligible.

Section B : Problems
1. Loans and advances < TOP >
Nature of asset Opening Increase Decrease Closing % of provision provision
Standard Assets 3200 8 – 3208 0.25 8.02
Sub standard Assets 408 6 8+5+(408*.15)=74.2 339.8 10 33.98
Doubtful Assets
- up to 1 year 334 4+5 5+6+(334*0.12)=51.08 291.92 20 58.38
- 1 to 3 years 296 2+5 4+4+(296*010)=37.6 265.40 30 79.62
- Above 3 years 225 2+4 10+2+(225*0.08)=30 201.00 50 100.50
Loss assets 180 10 2+(180*0.05)=11 179.00 100 179.00
Total 459.50

Additional provisioning
Time period Amount outstanding Rate of provision (%) Amount
Up to 12 months 70 – –
12–24 months 35–10 10 2.5
24–36 months 10 50 5
More than 36 months 5 100 5
Total 12.5
Additional provision on HP assets = 12.5 + 10 = Rs.22.5 lakh
Total provision on HP assets = 20 + 22.5 = Rs.42.5 lakh
Lease assets
Time period Amount outstanding Rate of provision Amount
Up to 12 months 80 – –
12–24 months 40 10 4
24–36 months 15–5 50 5
More than 36 months 10 100 10
Total 19
Provision for lease assets = 19 + 5 = Rs.24 lakh
Total provision = 459.5 + 42.5 + 24 = Rs.526 lakh

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2. The expected EBIT for the 5 years is as follows: (Rs. crore) < TOP >
Year 1 0.24+0.30+0.65 1.19
Year 2 0.28+0.45+0.70 1.43
Year 3 0.32+0.51+0.75 1.58
Year 4 0.34+0.54+0.80 1.68
Year 5 0.40+0.72+1.30 2.42

a. Straight equity investment of Rs.100 lacs by the Venture Capital Firm.


The dividend for the 5 years assuming nil taxes and 10% dividend payout will be as follows:
(Rs. lakhs)
EBIT Dividend Payout Dividend inflow to VCF ( for 50 % share)
Year 1 119 11.9 5.95
Year 2 143 14.3 7.15
Year 3 158 15.8 7.90
Year 4 168 16.8 8.40
Year 5 242 24.2 12.10
The EPS for the 5th year
= [since no taxes]
=
= Rs.2.42
Hence, the divestment price will be Rs.2.42 × 15 = Rs.36.30
Cash inflow to venture capital firm from divestment = Rs.36.30×50 lakh shares = Rs.1,815 lakhs
The NPV of the equity investment by venture capital firm will be:
(Rs. lakhs)
Cash Flow Present Value @12%
Year 0 (100) (100)
Year 1 5.95 5.31
Year 2 7.15 5.70
Year 3 7.90 5.62
Year 4 8.40 5.34
Year 5 12.10+1,815 1036.75
Net present value 958.72
b. Investment in FCDs by venture capital firm:
The EPS for the first 3 years if FCDs of Rs.100 lakhs are issued:
Interest on
EBIT FCDs @ 15% (Rs. in EBT =EAT EPS = EAT ÷ 50
Year
(Rs.in lacs) lacs) (Rs. in lacs) (Rs.)

1 119 15 104 2.08


2 143 15 128 2.56
3 158 15 143 2.86
7.50
Conversion price of an FCD at the end of 3 years is calculated as follows:
Average EPS = 7.50 ÷3 = 2.50
Conversion Price of an FCD = Average EPS × 10
= Rs. 2.50 × 10 = Rs.25
Hence, the FCDs of Rs.100 lacs would be converted into Rs.100 lacs/ Rs.25 = 4,00,000 shares
EPS during the 5th year will be (242 – 0) / (50+4) = Rs.4.48 (approx.)
The divestment price = 4.48 × 15 = Rs.67.20 per share
Cash inflow from divestment = 67.20×4 = Rs.268.80 lakh
The NPV of the debt investment by venture capital firm is calculated as follows:
Present Value @12%
Year Cash Flow
(Rs.)
0 (100) (100)
1 15 13.39
2 15 11.96
3 15 10.68
4 1.24 0.79

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5 1.79+268.80 153.54
Net present value Rs.90.36
As the net present value of equity investment is more than the debt investment, the VC firm should choose the equity alternative.
3. < TOP >
PV of minimum lease payment = (Rs.52,000–Rs.2000*)PVIFA(10%, 3) (1.10) = Rs.1,36,777
PV of bargain purchase = Rs.10,000 PVIF (10%, 3 ) = Rs. 7,513
Rs.1,44,290
* Since the lessor pays the Rs.2,000 a year for insurance, this payment is treated as executory cost and hence excluded from the
calculation of the present value of annual payments.
When the present value of the minimum lease payment exceeds the fair market value of the leased assets, a new rate must be
computed through trial and error method
50,000 PVIFA(r%, 3) (1+r) + 10,000 PVIF(r%, 3) = 1,40,000
r= 13.265% (in Rs.)
Reduction in lease Balance of lease
Year Cash payment Interest expense
obligation obligation
Inception of lease 1,40,000
1/1/2008 50,000 – 50,000 90,000
1/1/2009 50,000 11,939 38,061 51,939
1/1/2010 50,000 6,890 43,110 8,829
31/12/2010 10,000 1,171 8,829 –

Date Particulars 2008 2009 2010


1/1 Lease equipment 1,40,000 – –
To, obligation under lease finance 1,40,000
1/1 Operating expense 2,000 2,000 2,000
Obligation under finance lease 50,000 38,061 43,110
Accrued interest payable 11,939 6,890
To, Cash 52,000 52,000 52,000
12/31 Interest expense 11,939 6,890 1,171
To, Accrued interest payable 11,939 6,890
To, Obligation under finance lease 1,171
12/31 Depreciation expense# 27,800 27,800 27,800
To, Accumulated depreciation 27,800 27,800 27,800
12/31 Obligation under finance lease 10,000
To, Cash 10,000
# Depreciation = (Rs1,40,000–Rs.1,000)/5 years = Rs.27,800
4. a. Let, equated monthly installment (EMI) be Rs.x < TOP >
x PVIFA1.25%,120 = Rs.100,00,000
x =
x = = Rs.1,61,335
∴EMI = Rs.1,61,335

b. The repayment schedule will be as follows:


Repayment schedule
Beginning Monthly Net interest Ending
Servicing Principal
Month mortgage mortgage for mortgage
fees payment
balance payment month* balance
1 100,00,000 1,61,335 1,20,833 4,167 36,335 99,63,665
2 99,63,665 1,61,335 1,20,394 4,152 36,789 99,26,876
3 99,26,876 1,61,335 1,19,950 4,136 37,249 98,89,627
4 98,89,627 1,61,335 1,19,499 4,121 37,715 98,51,912
5 98,51,912 1,61,335 1,19,044 4,105 38,186 98,13,726
6 98,13,726 1,61,335 1,18,582 4,089 38,663 97,75,063
7 97,75,063 1,61,335 1,18,115 4,073 39,147 97,35,916
8 97,35,916 1,61,335 1,17,642 4,057 39,636 96,96,280
9 96,96,280 1,61,335 1,17,163 4,040 40,132 96,56,148
10 96,56,148 1,61,335 1,16,678 4,024 40,633 96,15,515
11 96,15,515 1,61,335 1,16,187 4,007 41,141 95,74,374
12 95,74,374 1,61,335 1,15,690 3,990 41,655 95,32,719
*Net interest for the month = (Beginning mortgage balance*0.0125) – (Beginning mortgage balance*0.0004167)

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5. a. Size of right issue = 495 – (175+80+40) = Rs.200 crore. < TOP >
EPS for 2008-09 = EPS during 2007-08 × 1.25 = (10/2) × 1.25 = Rs.6.25
Current market price = 6.25 × 20 = Rs.125
Pricing of right issue = 125× 0.80 = Rs.100
No. of right shared offered = Rs.200 crore/Rs.100 = 2 crore
As PCDs are converted to equity shares within one year of right issue, the PCD holders are also eligible for right issues in
proportion of their holdings. Thus, the number of shares which are entitled to right share are
Existing equity share 200 lakh
Share arising out of conversion of PCDs 40 lakh
(10,00,000×4) 240 lakh
Right ratio = 200 lakh / 240 lakh = 20/24
The right will be offered in the ratio of 20 shares for every 24 shares held by existing share holders.
b. Value of the rights
Where
is the current market price;
S is the subscription price; and
N is the number of shares required for 1 rights share

c. No of share per GDR =


Issue price of GDR =

Ex-right price of the share =


= Rs.111.36
Share are sold by GDR holder at 20% premium to the market price = 111.36 × 1.2
= Rs.133.63
Number of right shares offered and subscribed by GDR holder holding 100 GDRs

Gain/Loss made by the GDR holder, holding 100 GDRs is calculated as follows:
Purchase cost of 100 GDRs (8 × 100) = $800
Investment in right issue
Total cost = $1,677.18
Sale of GDRs at 20% premium = $2,578.71
Therefore, profit = $901.53
6. a. < TOP >
($ in million)
Loan 400
Less: Arrangement fee (400*0.005) 2
398

Annual cash flow (400*0.0412) 16.48


Facility fee (400*0.0025) 1.0
Agent fee 0.02
Total 17.50
The annual cash flows are as under
Year Cash flow ( million $)
0 +398
1 –17.50
2 –17.50
3 –17.50
4 –17.50
5 –417.50
The cost of loan is value of ‘I’ in the following

By solving the equation we get the value of i=4.49%.


b. Fees earned by the National Bank is as follows:
$ million
15 Basis point on amount of loan i.e. $ 400 million 0.60
25 Basis point on amount underwritten i.e. $ 200 million 0.50
10 Basis point on amount of commitment i.e. $40 million 0.04
1.14
Hence, the total fees earned by the National Bank is $ 1.14 million.

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Section C: Applied Theory


7. Merits of Private Placement < TOP >
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 dividend track record for 3 years nor does a greenfield project 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.
ii. Speed: A private placement deal can be successfully executed 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 and 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 re-negotiate 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 percent of the total issue amount as compared to 10 to
12 percent 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.
8. In international trade transactions, forfaiting is a common form of financing export-related receivables. Under this arrangement: < TOP >

1. The exporter sells the goods to the importer on a deferred payment basis spread over 3-5 years.
2. The importer draws a series of promissory notes in favor of the exporter for the payments to be made inclusive of interest
charges.
3. The promissory notes are availed 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).
4. The exporter sells the avalled notes to a forfaiter (which can be 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.
5. The forfaiter may hold these notes till maturity or sell these notes to groups of investors interested in taking up such high-
yielding unsecured paper.
Costs involved in a transaction of Forfaiting
A transaction of forfaiting involves different types of fees and charges. The fee charged by the forfaiter depends on the relationship
with the exporter, volume of trade and above all the cost of funds of the forfaiter. The fees that come into play during a transaction of
forfaiting fall into three broad categories.
• Commitment Fees: A commitment fee is payable to the forfaiter by the exporter in consideration of the commitment
made by the forfaiter to execute a particular transaction of forfaiting at a particular discount rate and within a specific time. The
commitment fees range between 0.5-1.5 per annum. It is always calculated on the unutilized amount of the forfaiting
transaction. Irrespective of the execution of the export contract, the commitment fees are required to be paid.
• Discount Fees: It is the cost payable on the credit promised under the factoring deal for the total period of credit under
consideration. It is payable by the exporter to the forfaiter. Instead of charging the same separately, the forfaiter deducts it from
the amount it owes to the exporter against the promissory note or bills of exchange, as the case may be. Discount rate is arrived
at based on the London Inter Bank Offered Rate (LIB OR) for the period under consideration. The forfaiter pays the exporter
the money almost instantly, but it has to wait quite some time to recover the same from the importer. During the intervening
period, the adverse movements in the international currency market may wipe out the profits of the forfaiter. So this also
includes the possible loss/gain that can be expected due to changes in the exchange rates in the intervening period.
• Documentation Fees: Documentation fees are generally charged for transactions involving elaborate legal formalities and
complexities and they may not be charged when the legal procedures and the documentation required are low.
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