Question Paper

Treasury & Forex Management (MB351F) : 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. HDFC Bank offers to pay an amount of Rs.10,000 to Mr. Sajad annually for 10 years, if he deposits Rs.60,000
today. The interest rate implied in this scheme is
(a) 10.60%
(b) 11.33%
(c) 12.22%
(d) 13.05%
(e) 14.00%.
2. Alfa Finance is offering a pension scheme for people who are at the age of 40 years. According to the scheme
the individuals who subscribe will have to deposit Rs.15,000 per year for 20 years. Every subscriber will receive
a specific sum at the end of 20th year. In addition to that, he will also receive an annuity of Rs.75,000 per annum
for a period of 25 years, commencing from the beginning of the 21st year. If the depositors wish to earn 11% rate
of return, the minimum amount to be paid by Alfa finance at the end of the 20th year, as the specific sum, is
(a) Rs.2,22,239
(b) Rs.3,31,395
(c) Rs.3,50,000
(d) Rs.4,20,333
(e) Rs.5,00,000.
3. The table below shows financial information about firm F:
Total sales 1,50,000 units
Selling price per unit Rs.22
Fixed Cost Rs.2,92,000
Variable Cost Rs.16
Debt Rs.10,00,000
Equity Rs.30,00,000
Face Value of share Rs.10
Tax rate 43%
Interest rate 12%
What will be Degree of Total Leverage (DTL) of the firm, if the preference dividend is zero?
(a) 0.84
(b) 0.96
(c) 1.84
(d) 2.76
(e) 3.12.
4. The current market price of the firm’s share is Rs.25. It belongs to a risk class for which appropriate
capitalization rate has been estimated to be 8%. A dividend of Rs.4 per share for the current year is expected.
According to Modigliani–Miller hypothesis the market value of the share after one year will be
(a) Rs.21
(b) Rs.23
(c) Rs.25
(d) Rs.27
(e) Rs.29.
5. Which of the following statements is false regarding Internal Rate of Return (IRR)?
(a) It takes into account the time value of money
(b) It is always uniquely defined even in the case of projects having a cash flow stream that consists of one
 or more cash outflows interspersed with cash inflows
(c) It gives misleading results while choosing between mutually exclusive projects that differ significantly in
terms of outlays
(d) It considers the cash flow stream over the entire investment horizon
(e) IRR is the rate of return at which NPV is zero.
6. Which of following statements is/are false about the Audit Committee?
I. It should evaluate the financial reports and policies of the company.
II. It should make assessment of the extent of performance levels of management and staff.
III. It should have an overview of the implementation of the recommendations of internal auditors only.
(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.
7. Which of the following statements is/are false about the credit sales of the company?
I. Credit sales will help the company increase the total sales volume.
II. These sales will always result in the decrease of profit.
III. This facility may help the company to enhance its competitive position.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) Both (II) and (III) above.
8. Consider the following graph:

In the above figure point ‘Q’ represents Economic Order Quantity (EOQ) because
(a) The ordering cost is minimum at this point
(b) The carrying cost is minimum at this point
(c) The ordering cost is maximum at this point
(d) The carrying cost is maximum at this point
(e) The total cost is minimum at this point.
9. Which of the following is/are true regarding aggressive policy for financing current assets?
I. The financing mix will be tilted towards equity.
II. Risk of technical insolvency will be high.
III. The cost of financing will be high.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (III) above
(e) Both (II) and (III) above.
10.The risk free rate is 8% and the market return is 18%. Stock ‘S’ has a beta of 1.2 and is currently selling at
Rs.50. If the expected dividend on stock is Rs.7, the growth rate of the company is
(a) 4%
(b) 5%
 (c) 6%
(d) 7%
(e) 8%.
11.Which of the following factors does not affect the composition of working capital?
(a) Nature of business
(b) Nature of raw material used
(c) Degree of competition in the market
(d) Tax structure of a company
(e) Process technology used.
12.Which of the following is not a relevant factor in an efficient cash management system for a business entity?
(a) Prompt billing and mailing to the customers
(b) Payment of interest on term loans whenever it becomes due
(c) Collection of receivables from branches
(d) Deposit the cheques immediately to the bank on receiving the same from customers
(e) Making a centralized payment system for the suppliers.
13.A short-term usance promissory note issued mostly by large corporations with high credit rating is referred to as
(a) Participation certificate
(b) Certificate of deposit
(c) Gilt edged securities
(d) Letter of credit
(e) Commercial paper.

14.Which of the following is not a principle to determine the costs and benefits of a project?
(a) The cash flows must be determined in incremental terms
(b) All costs and benefits must be measured in terms of cash flows
(c) Interest on long term funds must be excluded from the determination of net cash flows
(d) All accrued revenues and costs must be considered as benefits and costs respectively
(e) Cash flows are to be defined by duly considering the impact of taxes.
15.Which of the following statements is true if the Net Present Value (NPV) of a project is positive?
(a) Internal Rate of Return (IRR) is more than the cost of capital
(b) The pay-back period of the project is less than one year
(c) The discount rate is equal to the risk free rate of return
(d) Benefit cost ratio is less than unity
(e) Accepting the project has an indeterminate effect on shareholders.
16.Investment in shares/debentures by the foreign investors is recorded in which of the following accounts of
Balance Of Payments (BOP) statement?
(a) Monetary movement
(b) Unilateral transfers
(c) Current account
(d) Capital account
(e) Official reserves account.
17.Which of the following theories of International Trade classifies the products/goods in to Labor intensive and
capital intensive segments?
(a) Theory of absolute advantage
(b) Theory of comparative advantage
(c) Imitation – gap theory
(d) Heckscher – Ohlin model
(e) International product life cycle theory.
18.Mr. Suresh wrote a European call option on a stock. The premium was Rs.3 per share and the market price and
exercise price of the share were Rs.39 and Rs.45 respectively. If on expiry date, the price of the share was Rs.42,
the profit/loss to Mr. Suresh was
(a) Re.1
(b) –Rs.2
 (c) –Rs.3
(d) Rs.2
(e) Rs.3.
19.Aditya Industries Ltd., uses the EOQ model to estimate its optimal cash balance for the period under
consideration. The optimal cash balance under this method is Rs.20 Lakhs. Every time the marketable securities
are converted into liquid reserves, a cost of Rs.500 is incurred. If the opportunity cost of funds applicable to the
firm is 10 percent p.a., the annual cash usage rate will be
(a) Rs.26,00,00,000
(b) Rs.32,92,00,308
(c) Rs.35,92,40,008
(d) Rs.40,00,00,000
(e) Rs.47,93,30,803.
20.A currency swap can be viewed as a combination of
I. One spot and one futures contract.
II. One spot and one forward.
III. One futures and one forward.
(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.

21.Which of the following guidelines is/are adhered to while designing an internal control system?
I. A plan to segregate responsibilities based on functions.
II. A system of proper documentation and recording procedures.
III. Formulation of policies and procedures in tune with organization’s short-term goal.
(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.
22.Investment controls deal with
I. Accountability.
II. Dual control custody.
III. Authorization.
IV. Execution.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) Both (II) and (IV) above
(e) All (I), (II), (III) and (IV) above.
23.Which of the following services is offered by Export Credit Guarantee Corporation to cover risks in respect of
goods exported on short-term credit not exceeding more than 180 days?
(a) Standard policy
(b) Small exporter’s policy
(c) Specific policies
(d) Guarantees to bank
(e) Special schemes.
24.An unconditional order in writing usually signed by the exporter and addressed importer ordering him to pay on
demand, or at fixed or determinable future date, the amount specified on it is known as
(a) Bill of landing
(b) Commercial invoice
(c) Consular invoice
(d) Bill of exchange
 (e) Consignment.
25.Which of the following is an equity instrument
(a) Eurobond
(b) Global Depository Receipt
(c) Note Issuance Facility
(d) Foreign Bond
(e) Commercial Paper.
26.Which of the following forms of Purchasing Power Parity is also referred as the Law of One Price?
(a) Absolute form
(b) Relating form
(c) Expectations form
(d) Accounting form
(e) Numerical form.
27.Exports of goods and services are affected by
I. The prevailing exchange rate of the domestic currency.
II. Inflation rate.
III. World prices of a commodity.
IV. Incomes of foreigners.
V. Trade barriers.
(a) (I), (II) and (IV) above
(b) (I), (II) and (V) above
(c) (I), (III) and (IV) above
(d) (I), (II), (III) and (IV) above
(e) All (I), (II), (III), (IV) and (V) above.
28.In which of the following stage(s), sales tax affects a lease transaction?
I. When the asset is purchased by the lessor for the purpose of leasing.
II. When the right to use the asset is transferred to the lessee for a valuable consideration.
III. When the asset is sold by the lessor at the end of the lease period.
(a) 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.
29.Consider the following information relating to Duracell Ltd.:
EBIT Rs.20 crore
Depreciation Rs.3 crore
Interest on debt Rs.3 crore
Annual loan installment Rs.2 crore
Tax rate 35%
The fixed charges coverage ratio of the company is
(a) 2.50
(b) 3.03
(c) 3.78
(d) 4.04
(e) 4.59.
30.Which of the following statements is/are true about the Treasurer?
I. Fund management is an important function of a Treasurer.
II. The treasurer plays a crucial role in maximization of liquidity and profitability of the organization.
III. A treasurer has no role in tax planning.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
 (d) Both (I) and (II) above
(e) Both (I) and (III) above.

END OF SECTION A

Section B : Problems/Caselet (50 Marks)

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

1. Asprin Ltd., is a reputed Pharma company, manufactures drugs for heart diseases. The
company has a following book value capital structure:
(Rs.
Crores)
Equity capital (in shares of Rs.10 each fully paid-up at par) 20
10% Preference capital (in shares of Rs.100 each fully paid-up at par) 2
Retained earnings 25
9% Debentures (of Rs.100 each) 15
15% Term loans 12
The next expected dividend on equity shares per share is Rs.4 and the dividend per share is
expected to grow at the rate of 5%. The market price per share is Rs.45. Preference stock,
redeemable after 10 years, is currently selling at Rs.70 per share. Debentures redeemable after 5
years, are selling at Rs.75 per debenture. The income-tax rate for the company is 45%. You are
required to calculate:
a. Weighted average cost of capital using book value proportions. ( 5 marks)
b. Weighted average cost of capital using market value proportions. ( 5 marks)
2. a. Under recurring deposit scheme of a bank, a fixed sum is deposited every month on or
before the due date opted for 12 to 120 months. The rate of interest applied is 10% p.a.
and compounding is done quarterly.
i. Find the future value of monthly installment of Rs.50 for 12 months.
ii. If the installments are made at the beginning of every month, what will be the future
value? ( 6 marks)
b. Under plan X offered by some life insurance company, if a person is insured for
Rs.20,000 and if he survives the full term, then maturity benefits will be basic sum of
Rs.20,000 assured plus bonus which accrues on the basic sum. The age limit for entering
the policy is 18-50 years. The term of the policy is 20 years and annual premium is
Rs.500. What will be the rate of return on this policy? ( 6 marks)
3. An importer in UK will have to settle an invoice for €1,000,000 after 3 months. He has
collected the following information from his banker:
Spot (€/£) – 1.4145/50
3-months forward – 1.4127/33
3-months interest rates (p.a)
Euro – 4.00% / 4.5%
£ – 4.5% / 5.0%
Which of the following options would you recommend for covering the exposure?
I. Forward market.
II. Money market. ( 10 marks)

Caselet
 Read the caselet carefully and answer the following questions:
4. Explain what are GDRs and ADRs. How they are different from common equity? ( 9 marks)
5. Discuss why FCCBs are the preferred source of international financing for the Indian
companies. ( 9 marks)
Few years ago Global Depository Receipts (GDRs)/American Depository Receipts (ADRs) and
Foreign Currency Convertible Bonds (FCCBs), were mostly unknown abbreviations for Indian
corporate. But the situation has completely changed now; financial market is known to be
interlinked the world. The investors are looking for attractive rate of returns, and companies are
looking for low cost financing compared to domestic market.
Indian financial sector joined the integration process after the financial sector reforms were
initiated in 1991. The inflow and outflow of funds has transformed the way the Indian financial
market functions. Liberalization process led to strong linkage between capital market and forex
market. The process began with liberalizing the investment norms for non-resident Indians,
persons of Indian origin and overseas corporate bodies; under the new policy they were freely
allowed to invest in Indian equities without the prior permission of the Reserve Bank of India.
Further, the Indian corporates were allowed to tap the global market by issue of GDRs, ADRs
and FCCBs. Introduction of advanced technology in terms of screen-based trading system in
foreign stock exchange and Indian stock exchange propped up cross-border investment and
borrowings.
FCCBs are a hybrid instrument issued outside the domestic country that offers option to
investors to convert it into GDR at a predetermined price. The bondholders can enjoy the
regular interest payment and at the same time they can enjoy price appreciation once the bonds
are converted into GDR. Due to warrant attached to the bond, the coupon income is less than
the regular bonds, which leads to low cost for issuers.
As per the current guideline, Indian companies can raise funds in the international market
through the issue of FCCB, but they should have a three years consistent track record of
financial performance. These regulations are not applicable for the company which uses FCCB
for infrastructure projects like power, telecommunication, ports, airports and roads etc.
Issuing company which meets the eligibility norms can issue FCCBs up to US$50 mn under the
automatic route. For issue of FCCB amounting to more than US$50 mn but less than US$100
mn, the company has to take the permission of RBI and for issue of FCCB of more than
US$100 mn and above, prior permission from the Department of Economic Affairs, Ministry of
Finance, Government of India is required.
There is no restriction on issue of FCCBs in terms of frequency and volume but the total
proceeds should conform to external commercial borrowing end use requirements. The issuer is
free to use 25% of the FCCB proceeds for general corporate restructuring.
In August 2005, the government further liberalized the norms for FCCB; according to the new
FCCB norms put in place companies going in for an offering in the domestic market and a
simultaneous or immediate follow on offering through ADR/GDR issues would be exempt
from the requirement of the revised pricing guidelines.
India Inc's overseas fund-raising through bonds, convertibles and equities jumped 60% during
January-September 2005 to US$13.0 bn from US$8.2 bn in the first nine months of 2004. More
interestingly, out of the 25 overseas issues in first half of 2005 that raised an aggregate US$1.7
bn, 24 companies opted for the FCCB route.
Out of the total issue Tata Power raised the highest amount at US$200.0 mn through FCCB
followed by Essar Oil and Tata Chemicals. In 2004 also Tata Motors, a Tata group company
raised US$400.0 mn through FCCB, which is the highest amount raised through FCCB in past
three years.
FCCB is not only beneficial for companies but it also creates a win-win situation for the
investors. FCCB issue not only gives company an international appearance, but also increases
its creditworthiness in the local market and helps the company's stock to re-rate on the bourses.
END OF CASELET

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. Hi-tech Ltd., has excess cash of Rs.20 million. The treasury manager of the company
is looking out various avenues for investing the surplus. State and explain the
different factors and possible ways he should consider for investment. ( 10 marks)
7. If an industry is experiencing a dip in sales and it is believed that the trend is not
likely to reverse in the immediate future. All the manufacturers started offering credit
terms through their dealers. Explain the implications of the policy to the companies. ( 10 marks)
END OF SECTION C

END OF QUESTION PAPER

Suggested Answers
Treasury & Forex Management (MB351F) : July 2008
Section A : Basic Concepts
Answer Reason
1. A PVA = A × PVIFAk ,10 years
60000
or PVIFAk ,10 years = =6
10000
at k = 10%, PVIFA10%,10 years = 6.145
at k = 11%, PVIFAk ,10 years = 5.889
By interpolation:
6.145 − 6
0.1 + 0.01×
6.145 − 5.889
0.1 + 0.01× 0.566
0.1 + 0.00566 = 10.566 = 10.6%
2. B According to the given information subscribers will deposit Rs.15000 for 20 years and
after 20 years scheme will pay Rs.75,000 at the end of every year for 25 years plus Rs.X
at the end of 20 years from now.
The discount rate is 11%.
Therefore the data can be fit into a equation as: 15,000 × FVIFA (11%,20)
= X + 75,000 PVIFA(11%,25)
15,000 × 64.203 = X + 75,000(8.422)
963045 = X + 631650
X = The amount which will be returned = Rs. 331395
3. C
 Turnover of firm = 22 ×150000 = Rs.33, 00, 000
Total Cost = 16 × 150000 + 292000 = Rs.26,92, 000
EBIT = 3300000-26,92,000 = Rs.6,08,000
Interest charges = 1000000 × 0.12 = Rs.1, 20,000
Q( P − V ) 150000(22 − 16)
DOL = = = 1.48
Q ( P − V ) − F 150000(22 − 16) − 292000
EBIT 608000
DFL = (Q prefered dividend is 0) = = 1.245
EBIT − I 608000 − 120000
∴ Combined leverage = 1.48 × 1.245 = 1.84
4. B According MM model:

D1 + P1
P0 =
(1 + k )
e

4 + P1
25 =
1 + 0.08
or P1 = Rs.23
5. B Internal rate of return is the rate at which the present value of inflows is equal to the
present value of cash outflows. Statement (b) is incorrect because when a project has a
cash flow stream that consists of one or more cash outflows interspersed with cash
inflows, it will not have a unique IRR but will have multiple IRRs. Hence option (b) is the
answer. IRR is the return at which NPV = 0. Therefore option (e) is correct. IRR is a
discounted cash flow technique, therefore it takes into account time value of money.
Hence option (a) is correct. Option (d) is also correct as IRR takes into account all the
cash flows arising over the period of investment.
Under the IRR criterion, a project is accepted only if the IRR> the cost of capital
otherwise it is rejected. Hence statement (c) is also correct.
6. C The following are the important objective of audit committee:
• Evaluation of financial reports and policies of the company which are distributed to
shareholders and other parties interested in them.
• Assessment of the extent of performance levels of management and staff.
• Assurance of shareholders that actions of the company are in line with the target and
the company is exercising proper social responsibility.
• Monitoring of solutions to various operational problems.
• Acting as an independent reporting channel for internal audit department.
• To have an overview of the implementation of the recommendations of the internal
and external auditors.
7. B Credit sales help the company to increase total volume of the sales as it may motivate the
buyers to purchase more. It also helps to enhance the competitive position of the company
as due to credit sales market share of the company may increase. In addition to that the
company may increase its profitability by charging higher margins as compared to cash
sales.
8. E The quantity at which the total cost is minimized is known as Economic Order Quantity,
therefore, point ‘Q’ in the figure represents EOQ.
9. B Statement I is not true because in an aggressive financing policy for current assets the
financing mix is tilted more towards short term sources of financing.
Statement II is true because risk of technical insolvency is high in aggressive current asset
financing policy, as the debt servicing obligations are high in the short run.
Statement III is not true because cost of financing is usually low in aggressive current
asset financing policy.
10. C
 D
P=
ks − g
where k s is the rate of return on stock
k s = R f + β ( Rm − R f )
or k s = 0.08 + 1.2(0.18 − 0.08)
or k s = 0.08 + 1.2 × 0.1 = 0.20 = 20%
D 7 10 − 7
∴ g = ks − = 0.20 − = = 0.06 = 6%
P 50 50
11. D Factors affecting the composition of working capital :
• Nature of business
• Nature of raw materials used
• Process technology used
• Nature of finished goods
• Degree of competition in the market.
12. B Whether or not to pay for the outstanding interest on term loans depends on the financial
position of the company and its willingness to pay for the same. A cash management
policy may influence this but this payment is not a part of the cash management policy.
13. E A short-term usance promissory note with a fixed maturity period, issued mostly by
leading reputed, well established large corporations with very high credit rating is referred
to as commercial/corporate paper.
14. D According to the principles followed for the determination of the costs and benefits of a
project, only the cash inflows and outflows are taken as benefits and costs. All revenues
generated from the implementation of the project may not lead to the actual cash inflows
while all expenses to be incurred may not result in actual cash outflows due to the project.
The other statements as mentioned in the other options are correct for determining the
costs and benefits of a project.
15. A If cost of capital is less than IRR of a project, the NPV of the project will be positive.
Similarly, the benefit cost ratio is less than unity indicates the present value of the benefits
is less than the present value of costs at a given cost of capital, thereby making the NPV a
negative one. Similarly, a discount rate is greater than the IRR will make the NPV a
negative one and hence for a project of benefit cost ratio is less than unity. Such a project
will have a positive effect on the wealth of the shareholders, not an indeterminate effect.
16. D Investment in shares/debentures by foreign investments is recorded in capital account of
the Balance of Payments statement.
17. D Heckscher – Ohlin model classifies the products/goods in to labor intensive and capital
intensive.
18. E Since the price of the share at expiry is Rs.42 the buyer of the option will not exercise the
option. Hence, the profit to Mr. Suresh is initial premium received i.e. Rs.3.
19. D As per the EOQ model for determining the optimal cash balance,
Optimal cash balance = [(2 x Annual cash usage x Cost per sale of securities)/Annual
interest rate]1/2
2 FT
or C =
I
squaring both sides we get
2 FT
C2 =
I
C 2 I (2000000) 2 × (0.10)
or T = = = Rs.40, 00, 00, 000
2F 2 × 500
Annual cash usage = Rs.40,00,00,000
20. B A currency swap is a combination of two transactions: one spot and one forward with an
exchange of currencies.
21. D Some of the guidelines which are adhered to while designing an internal control system
are:
• A plan to segregate responsibilities based on functions.
• Allocation of responsibilities between the maintenance of records (by the controller)
and custodianship of cash and other liquid assets (by the treasurer).
• A system for proper documentation and recording procedures.
• Formulation of policies and procedures in tune with the organization’s long-term
goal and a systematic model for implementation of those policies.
• Appointment of suitable personnel whose qualifications, interest and experience are
commensurate with the nature of the job and responsibilities entrusted to them so as
to obtain maximum job enrichment.
22. E The investment controls deal with issues such as:
• Accountability
• Dual controlled custody
• Authorization
• Execution
23. A Standard policy, which is also known as shipment comprehensive risk policy is designed
to cover risks in respect of goods exported on short-term credit not exceeding more than
180 days.
24. D An unconditional order in writing usually signed by the exporter and addressed importer
ordering him to pay on demand, or at fixed or determinable future date, the amount
specified on it is known as
Bill of exchange.
25. B Global Depository Receipt is an equity instrument while Eurobond, Note Issuance
Facility, Foreign Bond and Commercial Paper are debt instruments.
26. A The absolute form of PPP is also known as the law of one price. According to the law of
one price, the exchange rate between two countries currencies is determined by the
respective price levels in the two countries.
27. E Exports of goods and services are affected by
I. The prevailing exchange rate of the domestic currency.
II. Inflation rate.
III. World prices of a commodity.
IV. Incomes of foreigners.
V. Trade barriers.
28. E In all of the following stages, sales tax affects a lease transaction:
• When the asset is purchased by the lessor for the purpose of leasing
• When the right to use the asset is transferred to the lessee for a valuable
consideration
• When the asset is sold by the lessor at the end of the lease period
29. C EBIT + D 20 + 3
LR 2
I+ 3+
Fixed charges coverage ratio = (1 − T ) = (1 − 0 .35) = 3.78
30. D A treasurer has the responsibility of exploring and selecting the best source of finance for
funding long and short -term cash requirements of the business which includes tax
planning. Tresurer plays major role in working capital management, the goal of which is
to maintain a good balance between current assets and current liabilities as per the
requirements of the business. It helps to maintain the optimal cash level. Therefore,
treasurer plays a crucial role in maximization of liquidity and profitability of the
organization by managing the working capital requirements.
Section B : Problems/Caselet
1. Cost of Equity capital and retained earnings:
D 4
Ke/Kr = 1 + g = + 0.05 = 0.1388 13.9%
P0 45
Cost of Preference share capital:
F-P 100 - 70
D+ 10 +
n = 10 13
Kp = = = 0.1529 15.3%
F+P 100 + 70 85
2 2
Cost of Debentures :
F-P 100 - 75
I(1-t) + 9(1-0.45) +
n 5 4.95 + 5 9.95
KD = = = = = 0.1137 = 11.4%
F+P 100 + 75 87.5 87.5
2 2
Cost of term loans :
Kt = 0.15(1-0.45) = 0.0825 = 8.25%
a.
Book value Cost of Weighted average
Source of finance Weight
(Rs. Crore) capital cost
Equity capital 20 0.270 0.1390 0.0375
10% Preference share 2 0.027 0.1530 0.0041
Retained Earnings 25 0.338 0.1390 0.0470
9% Debentures 15 0.203 0.1140 0.0231
15% Term loans 12 0.162 0.0825 0.0134
Total 74 1 0.1251 = 12.51%
b.
Market value Cost of Weighted average
Source of finance Weight
(Rs. Crore) capital cost
Equity capital 90.00 0.785 0.139 0.1091
10% Preference share 1.40 0.012 0.153 0.0018
9% Debentures 11.25 0.098 0.114 0.0112
15% Term loans 12.00 0.105 0.0825 0.0087
Total 114.65 1 0.1308=13.08%
2. a.
 4
 0.1 
Effective rate of interest per annum(r) = 1 +
 4  − 1
4
or r = [1 + 0.025] − 1
4
or r = [1.025] − 1
4
or r = [1.025] − 1 = 0.1038
1/12
∴ rateof interest per month = (1 + r) −1
1/12 1/12
k = (1 + r) − 1 = (1.1038) −1
k = 1.008 − 1 = 0.008
 (1 + k) n − 1 
∴ FVA n = A  
 k 
 (1 + 0.008)12 − 1 
or FVA n = 50  
 0.008 
 (1.1 − 1) 
= 50
or FVA n
 0.008  = 50 × 12.5 = Rs.625
If thepaymentsaremadeat thebegninig, then
FVA n (due) = 50 × (1 + k)FVIFA 0.8%,12months

or FVA n (due) = 50 × 1.008 × 12.5 = Rs.630

b.
FVAn ( due) = A(1 + k ) FVIFAn
orFVAn ( due) = A(1 + k ) FVIFAk ,n

20000 = 500(1 + k ) FVIFAk ,20

(1 + k ) FVIFAk ,20 = 40

If k = 6%
(1 + 0.06) FVIFA6%,20 = x

1.06 × 36.78 = 38.98

If k = 7%
(1 + 0.07) FVIFA7%,20 = y

1.07 × 41 = 43.87
Byinterpolation
 40 − 38.98 
k = 0.06 + 0.01 ×
 43 − 38.98 
or k = 0.06 + 0.0025
or k = 0.06 + 0.0025 = 0.0625 = 6.25%
3. Forward Cover
If the importer uses the forward market, outflow after 3 months will be
 £(1,000,000)/1.4127 = £7,07,864.37 Say £ 707864
Money Market Cover
If the importer uses the money market, he will have to invest today.
∈(1,000,000)/(1 + 0.04/4) = ∈990099.
This necessitates a borrowing in £ to the extent of ∈ 990099/1.4145 = 699963.95 Say £ 699964
After 3 months, the loan repayment inclusive of interest will be
0.05
)
(699964) (1 + 4 = 7,08,713.55
Say £ 708714
In this case forward cover is better.
4. GDRs and ADRs are the depository receipt (DR) is a negotiable certificate issued by a depository bank
which represents the beneficial interest in shares issued by a company. These shares are deposited with a
local custodian appointed by the depository, which issues receipts against the deposit of shares.
GDRs are essentially those instruments which posses a certain number of underlying shares in the
custodial domestic bank of the company. That is, a GDR is a negotiable instrument which represents
publicly traded local-currency-equity share. By law, a GDR is any instrument in the form of depository
receipt or certificate created by the Overseas Depository Bank outside India and issued to non-resident
investors against the issue of ordinary shares or foreign currency convertible bonds of the issuing
company. Usually, a typical GDR is denominated in US dollars whereas the underlying shares would be
denominated in local currency of the issuer. GDRs may be at the request of the investor converted into
equity shares by cancellation of GDRs through the intermediation of the depository and the sale of
underlying shares in the domestic market through the local custodian.
ADR is a dollar denominated negotiable certificate, it represents non-US company’s publicly traded
equity. It was devised in the late 1920s, to help Americans invest in overseas securities and to assist non-
US companies wishing to have their stock traded in the American Markets. ADRs are divided into 3
levels based on the regulation and privilege of each company’s issue.
GDRs and ADRs are considered as common equity of the issuing company and are entitled to dividends
and voting rights since the date of issuance. The company effectively transacts with only one entity – the
Overseas Depository for all the transactions. The voting rights of the shares are exercised by the
Depository as per the understanding between the issuing company and the GDRs and ADRs holders.
5. The driving factor that forced the Indian corporate to tap the foreign market may range from one to
many; but the primary factor is the cheaper source of finance that is available in the developed markets
like the US, UK etc. For example, in September 2005 ICICI bank when raised money at 106 basis points
over London inter-bank offered rate (Libor) for straight debt issues and in November 2005, the IDBI rose
at 145 basis points over the Libor and in September 2005, NTPC 205 basis points raised money at seven-
year US Treasury rate.
Though the company raised money at above rate the real costs of borrowing can be judged after taking
into consideration the premium paid on redemption if bonds are not converted during its lifetime.
Alternatively, the company can save the entire amount of premium if the company's share is lucrative
enough and investor chooses to convert them. In other way FCCBs are the preferred instrument for
raising funds when the stock market is in a rising trend as the conversion price of the FCCB is at a
premium to the current stock price.
In India credit rating is mandatory to raise debt capital from markets, but FCCB does not require any
rating, which is a great opportunity for low rating companies.
Apart from them comparative time to raise money through FCCB is much lesser than time required to
raise money in the Indian market. For example, money can be raised through FCCB in usually one
month whereas in India it takes two to three months to follow the same procedure.
Last but not the least; FCCB has advantages over other modes of finances like ECB in terms of
withholding tax also because of low coupon rate. Further, income remitted in case of FCCB is normally
at the time of redemption only which also reduced the cost of withholding tax.
Though the FCCB proved as low cost source of finance, the risk associated with the instrument cannot be
ignored. Apart from normal risk associated with local bonds, FCCB is exposed to currency risk. So the
potential risk associated with FCCB is the depreciating in rupee, this means more repayment risk as well
as higher interest payment for corporates in case the conversion does not happen.
 Section C: Applied Theory
6. The treasury manager has to consider the following factors for investing the surplus cash.
a. Security: This can be ensured by investing money in securities whose price remains more or
less stable and where a minimum return is guaranteed.
b. Liquidity: This can be ensured by investing money in short-term securities including short-
term fixed deposits with the bank.
c. Yield: Of course, most corporate managers give less emphasis to yield as compared to
security and liquidity of investment. They, therefore, prefer short-term Government securities
for investing surplus cash. However, some corporate managers follow aggressive investment
policies which maximize the yield on their investment.
d. Maturity: Surplus cash is not available for an indefinite period. Hence, it will be advisable to
select securities according to their maturities keeping in view the period for which surplus
cash is available. If such selection is done carefully, the Finance Manager can maximize the
yield as well as maintain the liquidity of investments.
The following are the possible ways of investing:
Cash Balance in the Current Account: This is the highest form of liquid asset a company can
conceive of, but the return provided by it is nil. However, companies maintain approximately four
to five percent of their total assets, on an average, in this form despite no returns.
Keeping Reserve Drawing Power under Cash Credit/Overdraft Arrangement: This form of
liquidity appears to be quite attractive as it can have access to bank borrowing.
Marketable Securities: These are short-term securities of government such as treasury bills and
other gilt-edged securities whose default risk is nil and, for that very reason, the return is low. It is
preferable to ensure the maturity structure of these short-term securities with the likely periods of
excessive cash drain on the part of the company. Then, the transaction costs can be considerably
minimized as early liquidation prior to maturity may result in low return from these assets.
7. The following are the benefits a company accrues when it starts offering credit terms through its
dealers.
i. Total sales will be more in case the company sells goods on credit basis rather than
demanding for immediate cash payment.
ii. The profits will increase not only because of increase in sales but also because of companies
charging a higher margin of profit on credit sales as compared to cash sales.
iii. The company will attract customers in a competitive environment only if it offers better
credit terms than its competitors.
Costs associated with receivables:
a. Additional fund requirement for the company: When a firm maintains receivables, some
of the resources of the firm remain blocked in them because there is a time lag between the
credit sale to the customer and receipt of cash as payment. To the extent that the firm's
resources are blocked in its receivables, it has to arrange additional finance to meet its own
obligations towards creditors and employees, like payments for purchases, salaries and other
production and administration expenses. Whether this additional finance is met from its own
resources or from outside, it involves a cost to the firm in the form of interest (if financed
from outside) or opportunity costs (if internal resources which could have been put in some
other investment).
b. Administrative costs: When the company maintains receivables, additional administrative
expenses will be incurred in the form of salaries to clerks who maintain records of debtors,
expenses on investigating the creditworthiness of debtors, etc.
c. Collection costs: These are the costs the firm has to incur for collection of the amounts at the
appropriate time from the customers.
d. Defaulting costs: When the customers make default in payments, not only the collection
effort is to be increased but the firm may also have to incur losses from bad debts.