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Question Paper

Investment Banking and Financial Services – I : October 2001


Part A : Basic Concepts (30 Points)
• This part consists of questions with serial number 1 - 30.
• Answer all questions.
• Each question carries one point.
• Maximum time for answering Part A is 30 Minutes.

1. A finance lease where the expenses like insurance, repairs, maintenance etc. of the leased
assets are paid by the lessee and lessee also guarantees the residual value is called as
a. Net lease
b. Net - Net lease
c. Wet lease
d. Full payout lease
e. Master lease.
2. Sri Finance offers a hire purchase plan for its corporate borrowers on the following terms :
Flat rate of interest 12%
Repayment period 3 years
Frequency Monthly in advance
Deposit at the inception of hire agreement 20% of the cost of the asset
The annual percentage rate using the approximation formula is
a. 18.0%
b. 19.8%
c. 23.4%
d. 24.7%
e. 36.0%
3. A firm sells on terms 2/12 net 50 days. On an average 30% of the customers pay on the 12th
day and avail the discount. The remaining customers pay on an average in 60 days. The
average collection period of the receivables is
a. 38.6 days
b. 45.0 days
c. 45.6 days
d. 54.0 days
e. 57.0 days
4. Which of the following statements is/are true regarding mortgage backed bonds?
I. These bonds facilitate efficient utilization of eligible collaterals.
II. Mortgages are the collaterals for these bonds.
III. These bonds carry prepayment risk.
a. Only (I) above
b. Only (II) above
c. Only (III) above
d. Both (I) and (II) above
e. Both (I) and (III) above.
5. Which of the following is true with respect to purchases made through a debit card?
a. Payment for the purchases should be made in full at the end of a specified period.
b. Payment for the purchases should be made in full at the end of every month.
c. Only 2.5% - 3% of the amount outstanding at the end of the specified period needs to be
paid at the end of the specified period and the balance is carried over with interest.
d. The amount due is debited to the holder’s bank account when the purchase is made.
e. None of the above.

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6. VFU Financial Services Limited (VFSL) offers consumer credit on the following terms:
Down payment 20%
Flat rate of interest 14%
Payment Quarterly in advance for 3 years.
The equated monthly installments payable by a customer availing finance to purchase an
asset worth Rs.3,00,000 is
a. Rs.28,400
b. Rs.32,000
c. Rs.35,500
d. Rs.40,000
e. Rs.45,000
7. 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.
8. Bharat Cements Limited (BCL) proposed to purchase an equipment costing Rs.40 lakhs
inclusive of sales tax of 4 per cent. BCL is considering the alternative of leasing the
equipment from Finlease Limited (FL) at annual lease rentals of Rs.30 ptpm. 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
9. Which of the following can be termed as a cross-border lease transaction?
I. The lessor and lessee are located in India and the supplier is located in England
II. The lessor and supplier are located in India and the lessee is located in England.
III. The lessee is located in India, lessor is located in England and the supplier is
located in USA.
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.
10. AB Limited leased an asset costing Rs.30 lakhs from XY Finance. The lease rentals are
payable annually in advance for a period of 5 years. If the lease quote is Rs.25 ptpm, add on
yield is
a. 8.00%
b. 8.50%
c. 9.00%
d. 10.00%
e. 12.00%

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11. Assets worth Rs.20,000 of Classic Finance Limited remained doubtful for 2 years. If 50% of
the assets are secured, the provision to be made against these doubtful assets is
a. Rs. 6,000
b. Rs.13,000
c. Rs.16,000
d. Rs.26,000
e. None of the above.
12. Which of the following is\are true regarding invoice discounting?
I. It doesn’t carry the service elements of factoring.
II. It is also called as old-line factoring.
III. It is usually kept confidential
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.
13. Which of the following is\are true regarding pledged account mortgages?
I. They resemble traditional mortgages from the lender’s point of view.
II. The pledged account under this type of mortgage is created by the seller out of his
profits.
III. This type of mortgages are preferred by borrowers who have sufficient cash on
hand, but face cash flow shortage for the first few years.
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.
14. Which of the following is\are true regarding Collateral mortgage obligations?
I. Investors seeking low exposure to interest-rate risk prefer shorter tranche CMOs
II. Investors seeking to avoid call and reinvestment risk prefer longer tranche CMOs.
III. CMOs are created to protect the investors from pre-payment risk.
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.
15. Consider the following data regarding a consumer loan availed by Mr.Srinivas:
Loan amount : Rs.2,00,000
Equated monthly instalment : Rs. 7,120
Repayment period : 36 months
The total charge for credit in the above loan is
a. Rs. 29,120
b. Rs. 56,320
c. Rs.1,14,560
d. Rs.2,56,320
e. Cannot be determined.
16. Which of the following institutions do not have the permission to operate as Primary Dealer?
a. SBI Gilts Limited
b. ICICI Securities & Finance Co. Ltd.
c. PNB Gilts Limited
d. Gilt Securities Trading Corp. Ltd.
e. None of the above.

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17. The minimum size of a certificate of deposit issued to a single investor is
a. Rs.5 lakhs and in multiples of Rs.1 lakh thereafter
b. Rs.1 lakh and in multiples of Rs.1 lakh thereafter
c. Rs.5 lakhs and in multiples of Rs.5 lakhs thereafter
d. Rs.25 lakhs and in multiples of Rs.5 lakhs thereafter
e. Can be any denomination subject to minimum of Rs.5 lakhs
18. A 91-day T-Bill of face value Rs.100 is issued at Rs.98.25. The yield given by the T-Bill is
______ %.
a. 6.124
b. 7.046
c. 7.144
d. 9.825
e. 24.495
19. Which of the following institutions can operate as both a lender and borrower in the
call/notice money market in India?
a. State Bank of India
b. Life Insurance Corporation of India
c. Unit Trust of India
d. Industrial Development Bank of India
e. GIC Mutual Fund.
20. The minimum and maximum tenure permissible for commercial paper is ________ days and
_________ days
a. 15, 90
b. 30, 90
c. 30, 180
d. 15, 364
e. 90, 364.
21. Which of the following statements is/are true with respect to Repo Deals?
I. They help to even out interest rates in the call money market
II. They involve sale of a security with an undertaking to buy the same security at a
predetermined selling price on a predetermined future date
III. They are medium/long term deals
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.
22. Which of the following is/are true regarding government securities?
I. Foreign institutional investors are not allowed to invest in government securities
II. The coupon on these securities is always pre-determined by the Central Bank
III. They are also issued in the form of zero coupon securities.
a. Only (I) above
b. Only (III) above
c. Both (I) and (III) above
d. Both (II) and (III) above
e. All (I), (II) and (III) above.
23. The maximum intra-day trading limit for a broker, as set by SEBI, is
a. 33.33% of the base minimum capital
b. 33.33% of the base minimum capital and additional capital
c. Equal to base minimum capital and additional capital
d. 33.33 times the base minimum capital
e. 33.33 times the base minimum capital and additional capital.
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24. Which of the following is not true about cumulative convertible preference shares (CCPS)?
a. CCPS pays fixed dividend
b. CCPS can be considered as a part of the networth of the company even before its
conversion
c. CCPS helps companies to maintain EPS and increase the leveraging capacity of the
company
d. CCPS cannot be issued with warrants
e. CCPS eventually get converted into equity
25. SEBI reserves the right to direct amendments to the offer documents submitted by Lead
Manager within
a. 14 days
b. 21 days
c. 28 days
d. 30 days
e. there is no time limit prescribed
26. Alpha Ltd. is proposing to issue equity of Rs. 8 crore. The minimum number of shareholders
required as per the listing norms are
a. 2000
b. 4000
c. 6000
d. 8000
e. None of the above
27. Which of the following is/are the conditions attached to safety net/buy back arrangement in a
public issue?
a. It can be offered only to original allottees subject to a maximum of 1000 shares per
allottee
b. The offer should be valid atleast for a period of 6 months from the last date of despatch
of securities
c. It is mandatory for all premium issues
d. Both (a) and (b) above.
e. All (a), (b) and (c) of the above.
28. If the size of a public issue is Rs.150 crores, the number of lead managers that can be
appointed to handle the issue is
a. Maximum of 2
b. Minimum of 2
c. Minimum of 2 and Maximum of 4
d. Maximum of 4
e. No limit and can be finalized with approval from SEBI
29. In case of a composite issue, the maximum gap between the date of closure of rights issue
and the public issue is ________ days.
a. 7
b. 10
c. 14
d. 30
e. 45.

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30. Which of the following conditions should a company fulfill to raise capital through ADR
level -III issue?
a. The company has to comply with the US GAPP
b. The company has to be registered with SEC
c. The company has to comply with listing requirements of AMEX/ NYSE
d. Both (a) and (b) above
e. All (a), (b) and (c) above.

END OF PART A

Part B : Problems (50 Points)


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

1. Three bidders X, Y and Z have responded to a tender notification issued by RBI for 91-day treasury bill for
Rs.300 crores. The bids are as follows :
Bidder Price (Rs.) Amount (Rs. crores)
X 98.35 40
Y 98.45 60
Z 96.60 80
Y 97.80 80
X 98.05 45
X 97.80 40
Z 98.40 50
Y 98.20 20
Z 98.25 25
X 96.90 70
The overall amount quoted through the tender is Rs. 510 crores. Based on the above data regarding the
tenders, you are required to compute
a. The cut off price for acceptance of tender and list of successful bidders with their prices and the
respective approved amounts.
b. If all successful bidders are required to pay a uniform price, compute the weighted average cut off
price payable by all the successful bidders. Also calculate the yield at this price.
(5 + 5 = 10 points)
2. Arvind Industries Limited entered the capital market with an IPO of Rs.60 crores. The shares have a face
value of Rs.10/- each and are issued at a premium of Rs.15/- per share. The details of reservation in the
issue were as follows :
Category Type Amount reserved Amount Subscribed
(Rs. crores) (Rs.crores)
Venture Capital Firm 5 3
Mutual Fund Competitive 10 5
Banks Competitive 15 Nil

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The response to the IPO was as follows :
100 12770
200 9900
400 6550
500 4800
600 3200
900 1670
1000 1300
2000 2250
5000 3300
15000 2000
Based on the above, compute the basis of allotment as per the current SEBI Guideliens.
(12 points)

3. Excel Fabrics Limited (EFL), a textile manufacturer with a sales turnover of Rs.800 lakhs and a net profit
margin of 20% is contemplating to sale and lease back an asset which was purchased two years back by
raising a term loan carrying an interest rate of 16% p.a. The current book value of the asset is Rs.60 lakhs
and it still has a economic life of 4 years. The asset can be depreciated for calculation of income tax at the
rate of 30% and is expected to have a salvage value of Rs.3 lakhs at the end of its economic life. The
marginal tax rate of the firm is 35%. Its debt equity ratio is 1.5:1 and the cost of equity is 22%.
EFL has approached Experts Leasing Limited (ELL) for a sale and lease back arrangement. ELL has
agreed to purchase the asset and lease back to EFL. The lease rentals are Rs.25 ptpm payable monthly in
arrears for a period of 4 years. The cost of capital of ELL is 12% and it is in the tax bracket of 30%.
You are required to calculate the maximum purchase price of the asset, which the leasing company, ELL
can pay and state whether the sale price is acceptable to EFL or not. Show all the necessary calculations.
(14 points)
4. Auto Finance Ltd. (AFL) offers installment facility on purchase of two wheelers from it. It charges a flat
rate of 12% for a repayment period of three years and 2.5% of the amount financed as processing fee. On
prepayments, it allows interest rebate at 4/5th of the rebate according to the SOYD method.
You are required to calculate the effective rate of interest to a customer who buys a vehicle worth
Rs.65,000 for 36 installments but prepays after 24th installment.
(6 points)
5. Zaveri Finance Company (ZFC) offers hire purchase schemes on the following terms :
Down payment 20%
Duration 4 years
Frequency of payment Monthly in arrears.
Mohan Industries Ltd. (MIL) is contemplating an investment of Rs.40 lakhs for purchase of a plant. The
plant attracts a tax relevant depreciation rate of 25% and has a salvage value of 10% of initial cost.
MIL has approached ZFC to avail the above hire purchase plan. ZFC’s cost of capital is 12%. It is in the
tax bracket of 30%. Assume ZFC recognises finance income on the basis of the SOYD method and attracts
an interest tax of 2%.
You are required to determine the minimum flat rate of interest to be charged by ZFC on the above HP
plan.
(8 points)

END OF PART B

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Part C : Applied Theory (20 Points)
• This part consists of questions with serial number 6 - 7.
• Answer all questions.
• Points are indicated against each question.
• Do not spend more than 25 -30 minutes on Part C.

6. Many finance companies have started financing consumer durables in innovative ways to build up credit
portfolio. But managing such a huge credit portfolio is a difficult task. Discuss how a consumer finance
company should effectively manage its portfolio.
(10 points)

7. An important decision that is needed to be taken by an investor, while dematerializing the shares, is the
choosing of the Depository Participant. What are the factors that an investor needs to look into while
selecting his/her Depository Participant?
(10 points)

END OF PART C

END OF QUESTION PAPER

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Suggested Answers
Investment Banking and Financial Services – I : October 2001
Part A : Basic Concepts

1. Answer : (b)
Reason : A finance lease where the executory costs incurred in relation to the leased asset like insurance,
repairs, maintenance etc are paid by the lessee is called as net lease and a net lease where the
lessee guarantees the residual value is called as net-net lease.
2. Answer : (d)
Reason : The approximation formula to find out the annual percentage rate in a hire plan where the rentals
are paid in advance is APR = 2F × N/(N-1)
Where F is the flat rate of interest, n is the total number of installments
= 2 × 0.12 × 36/35 = 24.7%
3. Answer : (c)
Reason : Average collection period = 0.3 × 12 + 0.7 × 60
= 45.6 days
4. Answer : (d)
Reason : A mortgaged backed bond is a collateralized term debt offering. The mortgages are not sold to
the holder of the security but are used only as collateral for the bonds. Hence, statement II is
true. These bonds are overcollaterised so that even if some of the borrowers under the mortgage
have made prepayments well ahead of the maturity of the bonds, there would be sufficient
protection offered to the principal on the date of maturity of bonds. Hence, these bonds do not
carry prepayment risk. As these bonds are overcollaterised they result in inefficient utilization of
the collaterals. Hence, statements I and III are not true.
5. Answer : (d)
Reason : Unlike a credit card, a debit card is a pay now product where the customer’s account with the
issuer is immediately debited to the extent of the value of the transaction. Hence, d is correct.
6. Answer : (a)
Reason : Cost of the asset = Rs.3,00,000
Loan Amount = Rs.3,00,000 × 0.8 = Rs.2,40,000
Equated quarterly installments = (240000 × 0.14 × 3 + 240000)/36 = Rs.28,400
7. Answer : (e)
Reason : As the Bower-Herringer-Willaimson model assumes that the debt displaced is equal to the initial
investment, the amount of debt displaced in the given transaction is equal to Rs. 50 lakhs.
8. Answer : (d)
Reason : As the leasing company is not eligible for the concessional sales tax, the sales tax rate applicable
to the lessor is 10% and hence the cost of the asset to the leasing company will be
= 40/(1.04) × 1.1 = Rs.42.308 lakhs
The annual lease rentals payable by Bharat cements Limited are
= 0.03 × 12 × 42.308 = Rs.15.23 lakhs
9. Answer : (d)
Reason : In an international lease transaction if the lessee and lessor are located in different domiciles the
lease transaction is termed as cross border lease transaction. Hence, the lease transaction given
under statements II and III can be termed as cross border lease transactions.
10. Answer : ()
Reason : The annual lease rentals payable = 0.025 × 12 × 30 = Rs.9 lakhs
The total lease rentals payable = 9 × 5 = Rs.45 lakhs
Total amount of interest included in the lease transaction = 45-30 = Rs.15 lakhs
Annual amount of interest = 15/5 = Rs.3 lakhs
Add on yield, akin to the flat rate of interest is equal to 3/30 × 100 = 10%

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11. Answer : (b)
Reason : In case of unsecured doubtful assets, 100% provisioning must be made to the extent of the
unsecured portion and as assets remained as doubtful for 2 years provisioning is made upto 30%
of the secured portion. Hence, total provision to be made in the given case is
= 100% of Rs.10000 + 30% of Rs.10000 = Rs.13000
12. Answer : (c)
Reason : Invoice discounting a form of factoring is strictly speaking not factoring since it does not carry
the service elements of factoring. In this type of factoring the factor provides pre-payment
against the purchase of the book debts and charges interest for the period spanning the date of
prepayment to the date of collection. This kind of arrangement is usually kept confidential and is
also referred to as confidential factoring. Old line factoring is a factoring arrangement, which
combines the features of the non-recourse and advance recourse factoring and is also referred as
the full factoring. Hence, statements I and III are true.
13. Answer : (c)
Reason : Under this type of mortgages, some portion of the down payment is deposited in the savings
account and the borrower pays the installments, which are lower than those under traditional
mortgages. These installments are increased at a specified percentage for a definite period and
thereafter the installments are paid uniformly. The lender is however, paid equated monthly
installments by drawing the difference between the installment paid by the borrower and the
installment due from the saving account. Hence, this type of mortgage is similar to the
traditional mortgages from the lender point of view. Hence, statement I is true.
If the savings account is created out of the sellers profit it is referred to as Buy down loans and
hence, statement II is not true.
As the borrower is required to deposit at the inception of the agreement and pay installments
which are small in magnitude in the beginning few years and increase for a certain period and
become equal after the specified definite period, these type of mortgages are suitable to the
borrowers who have sufficient cash on hand but face cash flow shortage for the first few years.
Hence, statement III is true.
14. Answer : (e)
Reason : The collateral mortgage obligations takes the same cash flow that a conventional pass through
security generates and then carves into discrete maturities or tranches. 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 tranche 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, all the statements are
true.
15. Answer : (b)
Reason : Total charge for credit = Total amount payable - Loan amount
= 7120 × 36 – 200000
= Rs.56320
16. Answer : (e)
Reason : All the given institutions have the permission to operate as primary dealer in the money market.
17. Answer : (a)
Reason : The minimum size of certificate of deposit is Rs.5 lakhs and are issued in multiples of Rs.1 lakh
thereafter.
18. Answer : (c)
Reason : The yield on a T-Bill is calculated as 100/Price – 1 × 365/maturity of the bill. In the given case
the yield is equal to 100/98.25 – 1 × 365/91
= 7.144%
19. Answer : (a)
Reason : Few participants in the call money market can operate both as lender and borrowers while others
can operate only as lenders. The first category comprises of the banking companies, DFHI, STCI
and primary dealers. In the given case only SBI is allowed to operate as both a lender and a
borrower.

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20. Answer : (d)
Reason : The minimum tenure of the commercial paper is 15 days whereas the maximum tenure is 364
days.
21. Answer : (b)
Reason : A repo is an agreement, which involves a sale of a security with an undertaking to buy-back the
same security on a predetermined future date and price. Repos were introduced by the
Government to manage the excess liquidity in the system and also to even out interest rates in
the call money market. Repos are basically short term instruments. Hence, statements I and II are
true.
22. Answer : (b)
Reason : Foreign institutional investors are also allowed to invest in Government securities. Hence,
statement I is not true. As RBI issues stock through auction also wherein the yield will be
determined on the basis of bids we cannot say that the interest rate is always pre-determined.
Hence, statement II is also not true. As stock is also issued in the form of zero coupon bonds
statement III is true.
23. Answer : (e)
Reason : SEBI has introduced capital adequacy norms for brokers and fixed in addition to the gross
exposure intra-day trading limit of 33 1/3 times the sum of their base minimum capital and
additional capital. Hence, e is correct.
24. Answer : (d)
Reason : Cumulative Convertible Preference Shares are preference shares which are eventually converted
into equity. These carry fixed dividend until conversion. These are considered as part of net
worth and hence increase the leveraging capacity of the company and maintain EPS as these do
not form of equity capital for the calculation of EPS. Further various sweeteners can be attached
to increase the investor attractiveness. Hence, of all the statements d is not correct.
25. Answer : (b)
Reason : SEBI directs amendments for all offer documents within 21 days. In case there is no response
from SEBI within 21 days, the lead managers can assume that the document is cleared and
proceed with the issue formalities.
26. Answer : (b)
Reason : The listing requirement stipulates that there should be at least 5 shareholders for every 1 lakh of
paid up capital. Therefore for Rs.8 crore of capital the minimum number of shareholders
required is 800*5 = 4000.
27. Answer : (c)
Reason : Safety net and buy back facilities are optional and are given by issuer companies to increase the
marketability of the issue and to rope in risk averse investors to subscribe to their issues. These
facilities can be offered to the original allottees only and subject to a maximum of 1000 shares
per allottee. Such type of arrangement is valid only for a period of 6 months.
28. Answer : (d)
Reason : SEBI has stipulated the maximum number of lead managers to be associated with the issue
depending on the issue size. For an issue size from Rs.100 crores to Rs.200 crores the maximum
number of lead managers is 4.
29. Answer : (d)
Reason : According to SEBI guidelines, in a composite issue, the maximum gap between the date of
closure of rights issue and the public issue is 30 days.
30. Answer : (e)
Reason : The companies raising capital through ADR Level III issue has to comply all the requirements
given in the question.

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Part B : Problems

1. a. Arrange the bids in descending order of the price and compute the cumulative amounts to arrive at the
cumulative amount of Rs.300 crores. The corresponding price at this level is the cut off price.
Bidder Price (Rs.) Amount (Rs.crs) Cumulative Amount
(Rs.crs)
Y 98.45 60 60
Z 98.40 50 110
X 98.35 40 150
Z 98.25 25 175
Y 98.20 20 195
X 98.05 45 240
X 97.80 40 280
Y 97.80 80 360
X 96.90 70 430
Z 96.60 80 510
The cut off price is Rs.97.80.
List of successful bidders :
Bidder Price (Rs.) Amount (Rs.crs) Cumulative Amount
(Rs.crs)
Y 98.45 60 60
Z 98.40 50 110
X 98.35 40 150
Z 98.25 25 175
Y 98.20 20 195
X 98.05 45 240
X 97.80 20 260
Y 97.80 40 300
Upto Rs. 98.05, all bids will be accepted fully. For the last 2 bids at Rs.97.80, the shortfall amount of
Rs.60 crores ( 300 - 240) has to be allotted proportionately as follows :
Amount for X = 60 × 40/ (40+80) = 60 × 1/3 = Rs.20 crores
Amount for Y = 60 × 80/ (40+80) = Rs.40 crores
b.
Bidder Price (Rs.) Amount (Rs.crs) Proportion Weighted
(i) (ii) (iii) = price
( ii) / 300 ( i ) × (iii)
y 98.45 60 0.20 19.69
z 98.40 50 0.17 16.73
x 98.35 40 0.13 12.79
z 98.25 25 0.08 7.86
y 98.20 20 0.07 6.87
x 98.05 45 0.15 14.71
x 97.80 20 0.07 6.84
y 97.80 40 0.13 12.71
300 1.00 98.20
Hence all the successful bidders would be required to pay a uniform price of Rs.98.20.
Yield = [ Face value / Price ] – 1 × [ 365/ Days to maturity ]
= {100/98.20} – 1 × {365/91} = 7.35 %

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2. Total number of shares offered in the issue = 60 crs / Rs.25 = 2,40,00,000 shares
Net public offer ( after reservations) = ( 60-30) / Rs.25 = 1,20,00,000 shares
Unsubscribed portion added to net public offer
( 5 crs from Mutual Funds & 15 crs from Banks ) = 20 crs i.e., 80,00,000 shares
It may be noted that the unsubscribed portion of Rs.2 crores by the Venture Capital will have to be brought
in by the promoters and cannot be added to the net public offer as the reservation is on a firm basis.
Hence , net public offer = 1,20,00,000 + 80,00,000 = 2,00,00,000 shares
Oversubscription ratio based on the entire net public offer = 3.2
Oversubscription ratio based on the 50% of the net public offer and applications upto 1000 category = 1.3
As the above is less than the over subscription ratio based on the entire public offer, the basis of allotment
will have to be worked out separately for small investors (i.e., applicants upto 1000 shares). The
oversubscription ratio in this category is 1.3 times.
Accordingly, the basis of allotment would be as under.
Category No. of Total no. of shares Proportionate No. of shares Rounding No. of successful Total no. of shares
(i) applicants applied allocation per applicant off applicants allotted
(ii) (iii) = (i) * (ii) (iv) = (iii) / 1.3 (v) = ( i )/ 1.3 (vi) (vii) = (iv)/ (vi) (viii) = (vi) * (vii)
100 12770 1277000 982308 76.92 100 9823 982300
503* 50300
+1400** 140000
200 9900 1980000 1523077 153.85 200 7615 1523000
400 6550 2620000 2015385 307.69 300 6550 # 1965000
500 4800 2400000 1846154 384.62 400 4615 1846000
600 3200 1920000 1476923 461.54 500 2954 1477000
900 1670 1503000 1156154 692.31 700 1652 1156400
1000 1300 1300000 1000000 769.23 800 1250 1000000
Total 40190 13000000 10000000 34778 10140000
# It may be noted that the number of successful applicants in a category using the above formula should
not exceed the total number of applicants in that particular category. The number of successful applicants
in the category of 400 shares as per the above formula in column (vii) works out to 6718, but it has to be
limited to 6550.
* The excess of 50293 shares is added to the lowest category of 100 shares.
** The excess of shares in the 1000 and above category being adjusted to the 100 category shares.
Allotment to 1000 and above category
The oversubscription ratio in this category is 5.1 times which is computed on 50% of the net offer i.e.
51000000/ 10000000 = 5.1
Category No. of Total no.of shares Proportionate No. of shares Rounding No. of successful Total no.of shares
(i) applicants applied allocation per applicant off applicants allotted
(ii) (iii) = (i) * (ii) (iv) = (iii) / 5.1 (v) = ( i )/ 5.1 (vi) (vii) = (iv)/ (vi) (viii) = (vi) * (vii)
2000 2250 4500000 882353 392.16 400 2206 882400
5000 3300 16500000 3235294 980.39 1000 3235 3235000
15000 2000 30000000 5882353 2941.18 2900 2028 5881200
Total 7550 51000000 10000000 7469 9998600

3. Let the sales price be Rs.x lakhs.


ELL point of view
A. Initial investment = Rs.x lakhs
B. PV of lease rentals = 0.025 × x × 12 × i/i12 × x PVIFA12,4 = Rs.0.96x lakhs
C. PV of tax on LR = 0.025 × x × 12 × 3.037 × 0.3 = Rs.0.27x lakhs
D. Depreciation tax shields:
(According to the Income tax provisions, the actual cost of the asset to the lessor will be the WDV of
the asset to the lessee. The rate at which the lessor has purchased is immaterial for claiming
depreciation).

13
(Rs. lakhs)
Year Depreciation PVIF @ 12% PV
1 18.00 0.893 16.07
2 12.60 0.797 10.04
3 8.82 0.712 6.28
4 6.17 0.636 3.92
36.31
PV of DTS = 36.31 × 0.3 = Rs.10.89 lakhs
E. PV of NSV = 3 PVIF12,4 = 3 × 0.636 = Rs.1.91 lakhs
The sales price is the value of x in the equation of NCF to the lessor = 0
i.e. – A + B – C + D + E = 0
= -x + 0.96x – 0.27x + 10.89 + 1.91 = 0
0.31x = 12.8
x = Rs.41.29 lakhs
∴ The maximum price that ELL can pay for the asset is Rs.41.29 lakhs.
EFL (Lessee) point of view:
A. Initial inflow be Rs.41.29
B. PV of LR payable = 0.025 × 12 × 41.29 × i/i12 PVIFA16,4 = Rs.37.13 lakhs
1.5 1
COC = × 16 × 0.65 + × 22 = 15% (approx.)
2.5 2.5
C. PV of TS on LR = 0.025 × 12 × 41.29 × PVIFA15%,4 × 0.35 = Rs.12.38 lakhs
D. PV of DTS:
(Rs. lakhs)
Year Depreciation PVIF @ 15% PV
1 18.00 0.870 15.66
2 12.60 0.756 9.53
3 8.82 0.658 5.80
4 6.17 0.572 3.53
34.52
PV of DTS = 34.52 × 0.35 = Rs.12.08 lakhs.
E. According to the suggested framework, the amount displaced is assumed to be equal to the PV of
lease rentals.
37.13
Effective annual installment = = Rs.13.27 lakhs.
PVIFA16, 4
(Rs. lakhs)
Effective
Principal Actual Adjusted
Year Loan o/s Interest Annual
content rental interest*
rental
1 37.13 5.94 7.33 13.27 12.387 5.06
2 29.8 4.77 8.50 13.27 12.387 3.89
3 21.30 3.41 9.86 13.27 12.389 0.95
4 11.44 1.83 11.44 13.27 12.387 0.95
* Adjustment factor = 13.27 – 12.39 = 0.88
PV of ITS = [5.06 PVIF15,1 + 3.89 PVIF15,2 + 2.53 PVIF15,3 + 0.95 PVIF15,4] 0.35
= Rs.3.34 lakhs
F. PV of NSV = 3 × 0.572 = Rs.1.72 lakh
NAL = A–B+C–D–E–F
41.29 – 37.13 + 12.38 – 12.08 – 3.34 – 1.72 = - 0.6
As NAL is negative the purchase price is not acceptable. However, as the negative figure is minimal it
can look into proposal again.

14
4. Asset cost = Rs.65,000
65,000 x 0.12 x 3 + 65,000
EM1 = = Rs.2456
36
PV of installments = 2456 PVIFAi,36
Processing fee = 0.025 × 65,000 = 1625
t (t + 1)
Rebate according to SOYD = xD
n (n + 1)
Where,
T = 12
N = 36
D = 23400
12 x 13
Rebate = × 23,400 = Rs.2740
36 x 37
4
Rebate given = × 2740 = Rs.2192.
5
Amount payable on prepayment = 2456 × 12 – 2024
= Rs.27280
Effective installment rate is ‘r’ in the following:
- 65,000 + 2456 PVIFA(i,24) + 1625 + 27280 PVIF(i,24) = 0
i=1%
-63375 + 2456 PVIFA(i,24) + 25180 PVIF(i,24) = 0
-63375 + 2456 × 21.243 + 27280 × 0.788 = 10294
i=2%
-63375 + 2456 × 18.914 + 27280 × 0.622 = Rs.46
∴ i = approximately 2% = (1.02)12 – 1 = 26.8%

5. Amount of loan = 40 × 0.8 = Rs.32 lakhs


Assume that rate of interest = F%
32 x F x 4
Total charge for credit = = 1.28F
100
32 + 1.28F
EMI = = 0.667 + 0.027F
48
PV of hire rentals = (0.667 + 0.027F) × 12 × i/i12 PVIFA12%,4
= (0.667 + 0.027F) 12 x 1.0539 x 3.037
= 25.618 + 1.037F
Interest Allocation
Year SOLD factor Interest Interest tax @ 2% IT on net interest PVIF at 12%
1 510/1176 0.555F 0.011F 0.163F 0.893
2 366/1176 0.398F 0.008F 0.117F 0.797
3 222/1176 0.242F 0.005F 0.071F 0.712
4 78/1176 0.085F 0.002F 0.025F 0.636
PV (Interest tax) = 0.021F
PV (tax on net finance charges) = 0.305F
NPV(of HP) = -32 + 25.618 + 1.037F – 0.305F – 0.021F = 0
0.711F = 6.382
F = 8.98%.

15
Part C: Applied Theory

6. As is often said, 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 streamlining 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 an onerous and difficult task. It is onerous because the number of customers to be credit
rated is quite large. It is difficult because there are no hard data on the past payment record or on the
financial position of the borrower (like the audited financial statements) to judge the willingness and the
ability to repay.
In some countries credit reference bureaus do provide a large part of information required for evaluating
the credit applicant. The typical data stored on the individual file include:
• Record of all registered county court judgements and decrees in the last six years
• Information supplied by other traders with regard to bad debts, slow paying accounts and
repossessions
• Records of bankruptcies and administration orders
• Voters roll information.
Some credit bureaus also file details of all satisfactory credit transactions reported to them by other users.
In the Indian context, there are no credit bureaus to aid the credit granting decision. For the credit
evaluation of an individual borrower, the finance company calls for a copy of the salary certificate and the
name and address of the employer. For the credit evaluation of business entities like sole proprietorships
and partnerships, the finance company looks for the financial statements for the last two years duly
certified by a chartered accountant and the addresses of the bankers with whom the business entity has
credit facility. Thus checking with the employer and the banker seem to be the only way 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. An illustrative questionnaire which can be used for this
purpose is provided in Table 1. The reader can find a number within parentheses appended to each
question. This indicates the percentage of borrowers in that category who subsequently defaulted.
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. In
our 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.
Table 1
Questionnaire for Evaluation of Loan Applicants with Default Rates
1. Do you have a telephone at residence
Yes (0.7)
No (1.0)
2. Do you :
Own your Home (0.7)
Rent a House (2.4)
Rent a Room (6.5)
3. How long have you spent in your present job
Less than 6 months (8.4)
7 to 24 months (3.2)
More than 24 months (0.2)
4. What is your take-home monthly pay 16
4. What is your take-home monthly pay
Less than Rs.2500 (8.8)
Between Rs.2500 to Rs.4500 (3.3)
Above Rs.4500 (0.4)
5. How many are there in your family
One to Two (0.2)
Three to Five (0.7)
More than Five (2.0)
6. For how long do you require the loan
12 months or less (1.3)
More than 12 months (0.8)
The reader must have observed that the method we have employed for separating the sheep from the goats
is conceptually weak because adding up the probabilities the way we did ignores the interactions between
the different factors. As an alternative, we can use the information provided by the questionnaire to identify
the factors relevant for credit rating and combine them using the statistical technique of Multiple
Discriminant Analysis. Suppose we are considering only two such factors, we can also use the graphical
approach. For example, if we regard the take-home pay and the number of months spent on the present job
as two relevant factors then we can define the credit index as follows:
Z = aX1 + bX2
where Z = index of creditworthiness
X1 = take-home monthly income (in rupees)
X2 = number of years spent on the present job.
Based on a sample drawn from the past data (consisting of both defaulters and non-defaulters) we can draw
a scatter diagram as shown in Figure 1.

Figure 1: Scatter Diagram


In this diagram O’s represent the customers who have defaulted and X’s denote the customers who have
paid on time. A visual inspection of the scatter of points reveals that we can draw a discriminating line
intercepting the X1 axis at 3.2 and X2 axis at 2.4 such that the two groups – the defaulters and non-
defaulters – are kept as far apart as possible. The equation is therefore
Z = 3X1 + 4X2
or Index = 3 (Take-home monthly pay in 000s of rupees)
+ 4 (No. of months spent on the current job expressed as fraction of year)
Credit applicants with an index of 9.6 or more will be accepted and applicants with an index of less than
9.6 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.

17
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 in recovering large accounts is legal action.

7. One important basic parameter would be to compare the charges. Naturally, the one which is most cost-
effective would be the most desirable. There are again a few parameters on which costs can be compared.
Some of them are onetime costs while others are recurring ones. Depending upon the volume and
periodicity of transactions by the investor, one can choose the DP. Besides charges, one needs to look at
other parameters too because the quality of service is a key factor. Moreover, as significant sums are
involved, timeliness and turnaround of the service is a key parameter. Decision may be taken after
evaluating the following factors:
Reputation of the Institution: One may look at the reputation of the institution in the market. Whether
the institution is a long-term player and has a long-term vision of his business would be of paraamount
importance. Especially for small time finance companies and merchant bankers that have registered
themselves as DPs. Only those DPs with large volumes would be able to compete since the business is a
cost-sensitive one. If one is not able to attract large volumes, the DP would eventually have to move out.
If your DP has a chance of closing down, it may have attendant problems while transferring the account.
Track Record: The DP’s track record in securities dealing and settlement management would be important
for it to provide an effective service. If a DP is new to the system of stock trading, understanding the finer
points may take a long time for him and in the process, the investor may not get efficient service.
Strength: The strength of DP would be measured by his net worth and capital adequacy. As the investor
would be entrusting his hard-earned money and also share certificates for dematerialization and
rematerialization, the financial strength of DP needs to be given due importance.
Focus: Whether the DP is the main business of the service provider or just another service-like in case of
banks/brokers- should be considered. This would have an impact on the level of service for the customer.
Along with this parameter, one should also look at the track record and reputation in conjunction. If the DP
service is being provided by a bank, the product may be among many of his services and he may not pay
much attention on that activity.
Dedicated Manpower: The investor may look at whether DP has dedicated manpower for the service he
is providing and whether the quantity and quality of the manpower is commensurate with the number of DP
accounts with him. If the staff providing the service is less compared to the volume of business, or is
inadequately trained, then it may reflect on the quality of the business.
Infrastructure: The infrastructure of the DP needs to be given due consideration as lack of it may have a
bearing on the quality of service in the long-term. The willingness of DP to invest further in infrastructure
should also be looked at.
Safety: Whether the DP is a long-term player and whether moneys and securities entrusted to him are safe
in his hands should also be examined.
Hidden Costs: The investor may also pay attention as to whether there are any hidden costs to opening an
account with the depository participant. The DP may prescribe that an investor may have to open a savings
account with a certain minimum balance with it. This would unnecessarily add to the costs.
Convenience and Networking: The branch network of the DP and its location is of great importance. If
the DP allows the investor to approach his account from different branches then it would be a great benefit.
If the DP has good networking with other players or is able to provide services in the area most convenient
to the investor, it would be of great help.
Differentiation on Service and Price: The investor must differentiate between various DPs on parameters
of service and pricing and whether his service is commensurate with its price.
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