Question Paper

Investment Banking and Financial Services – I (261)

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. Which of the following is/are true with respect to commercial paper and certificate of
deposits?
I. Both are issued by corporates
II. Both can be invested by individuals and corporates
III. Both can be bought back by the issuer
IV. A CP can be issued with a minimum size of Rs.5 lakhs and multiples of Rs.1 lakh,
whereas a CD can be issued with a minimum size of Rs.5 lakhs and in multiples of
Rs.5 lakhs

a. Only (II) above

b. Only (IV) above
c. Both (II) and (IV) above
d. (II), (III) and (IV) above
e. All (I), (II), (III), (IV) above.
2. Which of the following model does not assume that lease is a substitute of debt?
a. Weingartner’s Model
b. Equivalent Loan Model
c. Bower-Herringer-Williamson Model
d. Bower Model
e. None of the above.
3. Reshma Rayons Ltd. gives an offer of rights issue to its shareholders on November 24, 2002.
The issue should be open atleast till
a. December 01, 2002
b. December 04, 2002
c. December 09, 2002
d. December 24, 2002
e. January 24, 2003.
4. Standard Cable Company Ltd. recently issued commercial paper for Rs.50 lakhs, which was
rated by ICRA as ‘having adequate safety but any adverse change in business/economic
conditions could hamper the fundamental strength’. The rating given by ICRA was
a. MC
b. MB
c. A4
d. P4
e. A5.
5. ECBs over $20 million raised by 100% Export Oriented Units (EOUs) should have a
minimum average maturity of
a. 3 years
b. 4 years
c. 5 years
d. 6 years
e. 7 years.

1
6. Integrity Financial Services Ltd. is the Registrar to a particular IPO. It has not send the draft
prospectus/offer letter to SEBI before filing with the ROC/Stock Exchange. The penalty
points awarded by SEBI for this default is
a. 1
b. 2
c. 3
d. 4
e. 5.
7. Elegant Emeralds have taken a machine worth Rs.1000000 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 arrear
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.50000
b. Rs.56965
c. Rs.60000
d. Rs.61071
e. Rs.62465.
8. Prudential Factoring Services Ltd. discounts the L/C backed bills of its clients at 25% p.a.
The effective rate of interest per annum of such a bill of usance period 90 days (assuming
360 days a year) is _______ %.
a. 25.00
b. 26.37
c. 26.67
d. 27.44
e. 29.45.
9. Suravi Hotel Groups Public Ltd.’s share of face value Rs.10 is trading at BSE at Rs.350 and
NSE at Rs.360. The General Reserves and the Share Premium Account are Rs.400 crore and
Rs.250 crore respectively. If the total number of outstanding equity shares of the company is
10 lakhs, the maximum possible stock split ratio as per the latest SEBI Guidelines is
a. 1: 4 (4 shares for every one share)
b. 1: 5 (5 shares for every one share)
c. 1: 6 (6 shares for every one share)
d. 1:10 (10 shares for every one share)
e. The maximum possible stock split ratio cannot be computed from the available data.
10. The interest rate in a REPO deal is
a. Specified by RBI in the Monetary Policy.
b. Stipulated time to time by the SBI
c. Mutually decided by BSE and NSE for every month.
d. Mutually negotiated by the buyer and the seller depending on the term, amount and the
prevailing call money and the term money rates
e. Stipulated for every fortnight by SEBI.
11. EXIM Bank is issuing 6 months CDs worth Rs.25 lakh each at a price of Rs.24,86,880. The
stamp duty payable is
a. Rs.3108.60 by the subscriber
b. Rs.3125.00 by the issuer
c. Rs.6217.20 by the subscriber
d. Rs.6250.00 by the issuer
e. Rs.9375.00 by the subscriber.

2
12. 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
13. The maximum amount of brokerage payable for soliciting an 18-month public deposit of
Rs.100000 is
a. Rs.1000
b. Rs.1500
c. Rs.2000
d. Rs.2500
e. No such maximum limit is specified.
14. A Moonshot is
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, that is the bid-ask spread is equal to
zero.
15. In a year, a satellite dealer shall commit to generate outright turnover of Central Government
securities including T-Bills of not less than
a. Rs.0.5 crore
b. Rs.1.0 crore
c. Rs.10.0 crore
d. Rs.25.0 crore
e. Rs.30.0 crore.
16. Which of the following is/are not a features of a finance lease?
a. The lease is not fully amortized
b. The lease is usually cancelled at a short notice
c. The lessor is responsible for the insurance and maintenance of the asset
d. All of the above
e. None of the above.
17. Consider the following data:
Value of asset leased Rs.50 lakhs
Lease rentals Rs.35 ptpm
Lease period 3 years
Payment pattern Payable monthly in advance
The add-on yield on the above transaction is

a. 8.00%
b. 8.33%
c. 8.67%
d. 9.00%
e. 9.33%.

3
18. Which of the following is/are true regarding accounting treatment of a hire purchase
contract?
I. In the books of the finance company, the hire purchase installments receivable is
shown as ‘Stock on Hire’ under current asset
II. In the books of the hirer the capital content of the hire purchase installment is
recorded as a liability
III. In the books of the hirer depreciation is charged on the capital content of the hire
purchase installments.
a. Only (I) above
b. Only (II) above
c. Only (III) above
d. Both (I) and (II) above
e. Both (I) and (III) above.
19. In hire purchase transactions, the service tax payable by the hire purchase companies on the
interest earned is
a. 2.50%
b. 4.50%
c. 5.00%
d. 6.50%
e. 7.50%.
20. Creative Consumer Finance Ltd. is offering a loan of Rs.25000 for 2 years for a monthly
installment of Rs.1200. The effective rate of interest by approximation method is
a. 14.59%
b. 15.20%
c. 16.00%
d. 29.18%
e. 30.40%.
21. The factoring in which a commercial bank participates in the transaction by providing
advance to the client against the reserves maintained by the factor is known as
a. Maturity Factoring
b. Full Factoring
c. Advance factoring
d. Invoice Factoring
e. Bank Participation Factoring.
22. Assertive Finance Ltd. discounts L/C backed bill with a usance period of 60 days at the rate
of 20%. The effective rate of interest is
a. 19.33%
b. 20.00%
c. 20.69%
d. 21.74%
e. 22.57%.
23. Which of the following is/are true regarding factoring and forfaiting?
I. In both factoring and forfaiting advances are medium term in nature
II. Factoring can be structured either as recourse or non-recourse arrangement but
forfaiting can be structured only as non-recourse arrangement
III. Factor does the credit rating of the counter party if required but the forfaiting bank
relies on the credibility of the avalling bank.

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.

4
24. Which of the following expenses are involved in forfaiting?
a. Commitment fees
b. Discount fees
c. Documentation fees
d. Both (a) and (b) above
e. All (a), (b) and (c) above.
25. Which of the following statements is/are false regarding mortgage pass through and
mortgage backed bonds?
a. In mortgage pass throughs use of collateral is more efficient but credit enhancement is
required for private issuers whereas in mortgage backed bonds use of collateral is
inefficient
b. Cash flows in both mortgage pass throughs and mortgage backed bonds are very
predictable and certain
c. Average life of both mortgage pass through and mortgage backed bonds depends on
prepayment experience of underlying mortgages
d. Both (a) and (c) above
e. All (a), (b) and (c) above.
26. A Swap lease is
a. An operating lease with in-built provision for upgradations of the equipment
b. A lease in which the lessor undertakes to replace the leased equipment when it is in
need of major repair with a similar equipment in working condition
c. A lease which provides for automatic exchange of outdated equipment with the latest
updated version of such equipment
d. A lease agreement which provides an option to the lessee for cancelling the lease at
short notice during the lese period and take up another lease with the same lessor
e. None of the above.
27. Which of the following forms of real estate loan is known as Gap Loan?
a. Loan extended to the developer to cover the difference between the bank construction
loan and the total cost of the project
b. Loan on which the interest charged is generally lower than the prime lending rate
c. Loan extended during the gap the borrower is able to find out a suitable lender
d. 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
e. None of the above.
28. Which of the following conditions need(s) to be satisfied by a Housing Finance Company to
get refinance from National Housing Board?
a. The minimum paid up capital of the Housing Finance Company should be Rs.1 crore
b. At least three directors on the board of the Housing Finance Company should be
nominated by banks, financial institutions or National Housing Board
c. At least 75% of the housing loans that are to be granted by the Housing Finance
Company should be long term in nature
d. Both (a) and (c) above
e. All (a), (b) and (c) above.
29. A Hire Purchase or a Leasing Company desiring to accept public deposits should have a
minimum capital adequacy ratio of
a. 8.0%
b. 10.5%
c. 11.0%
d. 12.0%
e. 15.0%.

5
30. 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.

END OF PART A

6
 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. Delicious Food Processing Ltd. is proposing to expand its existing chain of food-joints during the year
2002-03. It has estimated the cost of expansion to be around Rs.100 crore. To finance the project it
considers the following two alternatives:
I. Issue of 2 crore equity shares of face value Rs.10 at a premium of Rs.40 per share
II. Six year floating rate notes of face value Rs.5000.
Details of Floating Rate Note:
Basis of Interest:
The rate of interest on these notes would be fixed at a mark up of 3.5% over the yield on long-dated
Government securities 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 10% or more than 16%.
Annual Payment:
For every Rs.5000 invested, the holder of the FRN would be paid an amount of Rs.1300 at the end of every
year for the first five years from the deemed date of allotment.
The amount of Rs.1300 would comprise 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, the yield on the long-dated Government securities is 11%. The yield pattern on these
bonds as predicted by the leading dealer in Government securities is as follows:
Yield for the year
Scenario Probability
2nd 3rd 4th 5th 6th
1 0.40 11.15% 10.30% 9.20% 7.50% 6.25%
2 0.60 10.00% 8.00% 7.00% 6.00% 5.25%
The data from the financial statements of Delicious Food Processing Ltd. for the year 2001-02 is given below:
Particulars Rs. crore
Equity Capital (Face value: Rs.10) 200.00
Reserves and Surplus 100.00
Term Loan @ 12% 200.00
EBIT 50.50
Effective Tax Rate 23%
Dividend 30%
The following estimates are given by the General Manager Finance of the company:
• EBIT is expected to increase by 35% for the year ended 2002-03
• Dividend is expected to increase by 8% per year
• Issue expenses in case of equity and FRN would be 2.00% and 0.75% respectively
• The P/E ratio of the company is 35.
You are required to
a. Recommend the alternative based on the cost of funds to the company.
b. Evaluate, qualitatively, the FRN of the company with a regular bond with fixed annual payments and
term end redemption. Give your analysis from the company’s point of view.
(8 + 3 = 11 points)
7
2. Sunanda Financial Services Ltd, who are majorly into equipment financing, lease and hire purchase offers
hire purchase scheme on the following terms and conditions:
Down payment 25%
Duration 4 years
Frequency of payment Monthly in arrears
Gavin Iron and Steel Ltd is contemplating an investment of Rs.80 lakhs for purchase of a machinery,
features of which are as follows:
• The machinery attracts a tax relevant depreciation rate of 25%
• The machinery will have a salvage value of 15% of the initial acquisition cost
Gavin has approached Sunanda to avail the hire purchase plan given by them.
The following data is given to you by the Treasury Manager of Sunanda:
• Sunanda’s cost of capital is 10%
• They are in the tax bracket of 30%
• They recognize finance income on the basis of SOYD method
• They attract an interest tax of 2%.
You are required to
a. Determine the minimum flat rate of interest to be charged by Sunanda on the above discussed hire
purchase plan.
b. Show the above hire purchase transaction in the books of Sunanda for the first three years of the HP
term, taking into consideration the same rate of interest as computed in (a).
(7 + 6 = 13 points)
3. Tipsi Co (India) Ltd., a subsidiary of Tipsi 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 Germany,
details of which are given below:
• Cost of the machinery in Indian currency is Rs.60 crore
• Life of the machinery is 6 years
• Salvage value after 6 years is nil
• The machinery is eligible for a tax relevant depreciation of 25%.
Due to unavailability of sufficient funds to procure the equipments Tipsi Co (India) Ltd., has proposed to
enter a cross border lease agreement with a UK based leasing company, Victoria Financial Services.
Victoria has agreed to lease the equipment for a period of 6 years with lease rentals payable in advance.
Victoria structures it lease transactions to earn a return of 10% and its effective tax rate is 20%.
You are required to:
a. Determine the lease rentals Tipsi Co (India) Ltd., has to pay to Victoria.
b. Structure a double dip lease transaction involving the parent company Tipsi Co Inc. US in such a way
that the lease rentals payable by Tipsi 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 10% and
20% respectively
ii. SOYD method of allocation of interest and the same pattern of lease rentals payments.
c. What is the main advantage of a double dip lease transaction?
(4 + 10 + 2 = 16 points)
4. Mr. Gaurav Shivdasani has approached a finance company to get finance to purchase a car worth
Rs.300000. He has opted for a scheme, which carries the following features:
• The loan requires a down payment of Rs.30000 and the tenure of the loan is 10 years
• The loan carries an interest rate of 12% p.a. compounded monthly.
You are required to compute
a. The equated monthly installment Mr. Gaurav has to pay under this scheme.
b. The equated monthly installment if the loan does not require the down payment.
(3 + 1 = 4 points)

8
5. Retreat Hotels Ltd. is a South India based chain of hotels. It has recently opened its first hotel in North
India, a 3 star hotel in Manali, Himachal Pradesh. Retreat Hotels is coming up with different aggressive
marketing strategies to promote this hotel in Manali. In order to tap the middle class market in Delhi, the
General Manager of Retreat Hotels, Manali approaches a finance company in Delhi to design a package so
that one can pay a reasonable affordable monthly amount for 12 months, end of which he or she would be
given a package of a two days and two nights trip to Manali for two persons.
The details of the package designed are as follows:
• The package includes flight fares up and down from Delhi to Simla and Retreat has its own buses from
Simla, which would carry the passengers up and down from Simla to Manali
• The package would include two persons stay in a double bed room in Retreat Hotels for two days and
two nights, each morning breakfast complimentary
• The package would also include 2 days lunch, evening tea or coffee and dinner
• The package would also include two days sight seeing in hotel owned luxury cars.
The following data is given by the General Manager of Retreat Hotels to the finance company:
• The air fare per head up and down from Delhi to Simla as agreed between Indian Airlines and Retreat
Hotels is Rs.3000 per head
• The cost per head for up and down transportation in Retreat buses from Simla to Manali is Rs.150
• The apportioned cost for a double bed room including complimentary breakfast per day for two persons
is Rs.1500
• The cost of per day of lunch, evening tea or coffee and dinner per head is Rs.120 per head
• The cost per head per day for sight seeing in hotel owned luxury cars is Rs.80
• For this package, the General Manager wants to keep a margin of 20% in the transportation provided
exclusively by the hotel, a margin of 40% on the room rental and 60% on the food items.
You are required to compute the amount, which a customer needs to deposit every month for 12 months to
avail this package given by Retreat Hotels. You can make relevant assumptions.
(6 points)

END OF PART B

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. Commercial Papers are very popular and reliable source of high quality short-term borrowings. RBI has
made credit rating compulsory for CPs. Discuss the regulatory requirement and evaluation criteria of CPs.
(10 points)
7. Samanth Aqua Ltd. is currently financing its export-related receivables by availing cross-border factoring
services. It is considering whether `Forfaiting’ would be more advantageous. In this context, explain the
process of forfaiting. Also, state the differences between forfaiting and cross-border factoring.
(10 points)
END OF PART C

END OF QUESTION PAPER

9
 Suggested Answers
Investment Banking and Financial Services – I (261)
Part A : Basic Concepts

1. Answer : (a)
Reason : A CP can be issued by corporates but a CD can be issued only by banks and some permitted
financial institutions. But individuals and corporates can invest in both. A CP can be bought
back by issuer but a CD cannot be bought back by the issuer. A CD can be issued with a
minimum size of Rs.5 lakhs and multiples of Rs.1 lakh, whereas a CP can be issued with a
minimum size of Rs.5 lakhs and in multiples of Rs.5 lakhs. Hence (a) is the correct answer.
2. Answer : (a)
Reason : Of the models, Weingartner’s model does not assume that lease is a substitute of debt.
3. Answer : (d)
Reason : An offer of rights share of a public limited company should be open for 30 days. Reshma Rayons
gives an offer of rights issue to its shareholders on November 24, 2002. The issue should be open
for 30 days from November 24, 2002, i.e. the issue should be open till December 24, 2002.
Hence (d) is the correct answer.
4. Answer : (c)
Reason : For a CP if ICRA rates as ‘having adequate safety but any adverse change in business/economic
conditions could hamper the fundamental strength’, it gives an A4 rating. Therefore, the rating
given by ICRA to the CP issued by Standard Cable Company Ltd. for Rs.50 lakhs, is A4.
Hence (c) is the right answer.
5. Answer : (a)
Reason : As per the Guidelines on Policies and Procedures for External Commercial Borrowing (1999-
2000) 100% EOUs are permitted to raise ECBs at a minimum average maturity of 3 years for
any amount. Therefore, ECBs raised by a 100% Export oriented Units (EOUs) over $20 millions
should have a minimum average maturity of 3 years. Hence (a) is the correct answer.
6. Answer : (a)
Reason : SEBI has prescribed various penalty points for non-compliance of the provisions, contravention
of rules and regulations and wrongdoings. The following are the penalty points awarded for
various types of default:
Types of default Penalty points
General default 1
Minor default 2
Major default 3
Serious default 4
SEBI has categorized various defaults under these four broad heads. Not sending the draft
prospectus/offer letter to SEBI before filing with the ROC/Stock Exchange is categorized as a
General default. Hence the penalty points awarded by SEBI for this default is 1. Therefore, (a) is
the correct answer.
7. Answer : (d)
t ( t + 1)
Reason : According to the rule of 78 method, interest rebate is calculated as xD
n (n + 1)
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).

10
8. Answer : (e)
Reason : The effective rate of interest is calculated as
Discount charge at the rate of 25% per annum (assuming the value of the bill is Rs.100) is
Rs.25 × 90/360 = Rs.6.25
Value received by the client = 100 – 6.25 = Rs.93.75
Effective rate of interest per quarter is 6.25/93.75 × 100 = 6.667%
The effective rate of interest per annum is (1.0667)4 – 1 × 100 = 29.45%
9. Answer : (d)
Reason : As per the latest SEBI Guidelines after the abolition of the par value concept, the face value of a
share can be RE.1 or in multiples of RE.1. Hence if the face value of a share is Rs.10, then it can
be split maximum into 10 shares of face value RE.1 each. Hence the maximum possible stock
split ratio is 1:10 (10 shares for every one share). Therefore (d) is the right answer.
10. Answer : (d)
Reason : The interest rate in a REPO deal is mutually negotiated by the buyer and the seller depending on
the term, amount and the prevailing call money and the term money rates. Therefore (d) is the
right answer.
11. Answer : (d)
Reason : The current rates of stamp duty as paid by the issuer on the face value of the CD are as
follows:
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
Above 9 months – Up to 12 months 0.500
Therefore for a 6 months CD of Face Value Rs.2500000, the stamp duty payable by the issuer is
0.250% of Rs.2500000 = Rs.6250. Hence (d) is the right answer.
12. Answer : (c)
Reason : Under pricing of an IPO implies that pricing the share at a price less than what could have been
market 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.
13. Answer : (b)
Reason : The maximum amount of brokerage payable for soliciting public deposits is as follows:
Tenure of the Deposit Maximum Brokerage (%)
Up to 1 year 1.0
Between 1 and 2 years 1.5
Above 2 years 2.0
Hence for an 18-month public deposit of Rs.100000, the maximum brokerage that can be
payable = 1.5% of Rs.100000 = Rs.1500. Hence (b) is the correct answer.
14. Answer : (b)
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.
15. Answer : (e)
Reason : In a year, a satellite dealer shall commit to generate outright turnover of Central Government
securities including T-Bills of not less than Rs.30 crore. Hence (e) is the right answer.

11
16. Answer : (d)
Reason : All the following – the lease is not fully amortized, the lease is usually cancelled at a short
notice, the lessor is responsible for the insurance and maintenance of the asset are the features of
operating lease and not finance lease. Hence (d) is the correct answer.
17. Answer : (c)
Reason : Initial Investment = Rs.50 lakhs
Aggregate lease rentals payable under the lease during the primary period = 0.035 x 50 x 3 x 12
= Rs.63 lakhs
Aggregate interest charge for the lease = 63 – 50 = Rs.13 lakhs
Average annual interest charge = 13/3 = Rs.4.33333 lakhs
Add-on yield = 4.33333/50 = 0.0867 = 8.67%.
18. Answer : (d)
Reason : In the books of the finance company, the hire purchase installments receivable is shown as a
current asset under the head ‘Stock on Hire’. In the books of the hirer the capital content of the
hire purchase installment is recorded as a liability. In the books of the hirer depreciation is
charged on the cash purchase price of the asset in line with the depreciation pursued by the hirer
with regard to other owned assets. Hence (I) and (II) are true regarding the accounting treatment
of hire purchase agreements. Therefore (d) is the correct answer.
19. Answer : (c)
Reason : From July 16, 2001, Service Tax @ 5% is payable on the interest earned by the hire purchase
companies. Hence (c) is the correct answer.
20. Answer : (a)
Reason : Repayment period = 24 months
Total charge for credit = (1200 x 24) – 25000 = Rs.3800.
3,800 1
Flat rate of interest = × = 7.6%
2 25, 000
Effective rate of interest = 24/25 x 2 x 7.6% = 14.59%.
Hence (a) is the right answer.
21. Answer : (e)
Reason : The factoring in which a commercial bank participates in the transaction by providing an
advance to the client against the reserves maintained by the factor is known as Bank
Participation Factoring. Hence (e) is the correct answer.
22. Answer : (e)
Reason : Let the value of the LC backed bill be Rs.1000.
Discount charge = 1000 x 0.20 x 60/360 = Rs.33.33
Value received by client = 1000 – 33.33 = Rs.966.67
Effective rate of interest for 2 months = 33.33/966.67 = 3.45%
Effective rate of interest per annum = [(1.0345)12/2 – 1] = 22.57%.
Hence (e) is the correct answer.
23. Answer : (d)
Reason : In factoring advances are short-term in nature. Factoring can be structured either as recourse or
non-recourse arrangement but forfaiting can be structured only as non-recourse arrangement.
Factor does the credit rating of the counter party if required but the forfaiting bank relies on the
credibility of the availing bank. Hence (d) is the correct answer.
24. Answer : (e)
Reason : The expenses involved in forfaiting are commitment fees, discount fees and documentation fees.
Hence (e) is the correct answer.

12
25. Answer : (b)
Reason : In mortgage pass throughs use of collateral is more efficient but credit enhancement is required
for private issuers whereas in mortgage backed bonds use of collateral is inefficient. Cash flows
in mortgage pass throughs is relatively uncertain and that of mortgage backed bonds are very
predictable and certain. Average life of both mortgage pass through and mortgage backed bonds
depends on prepayment experience of underlying mortgages.
26. Answer : (b)
Reason : In a swap lease the lessor undertakes to replace the leased equipment when it is in need of major
repair with a similar equipment in working condition.
27. Answer : (a)
Reason : A loan extended to the developer to cover the difference between the bank construction loan and
the total cost of the project is known as Gap Loan. Hence (a) is the correct answer.
28. Answer : (d)
Reason : To get the facility of refinance from NHB a HFC – should have a minimum paid up capital of
Rs.1 crore, at least 2 directors on the board of the Housing Finance Company should be
nominated by banks, financial institutions or National Housing Board and at least 75% of the
housing loans given by the HFC should be long term in nature. Hence (d) is the correct answer.
29. Answer : (e)
Reason : A Hire Purchase or a Leasing Company if accepts public deposits, should have a minimum
capital adequacy ratio of 15%. Hence (e) is the correct answer.
30. Answer : (c)
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.

13
 Part B : Problems

1. a. Computation of Cost of Funds under different alternatives for the year 2002-03
DPS = {200 x 30%}/20 = 3
Expected DPS next year (D1) = 6.48
Growth rate (g) = 8%
Market price (P0) = 50
Flotation cost (f) = 2%
Cost of equity = {D1/P0(1-f)} + g = 21.22%
Interest Allocation of FRN
Year Outstanding Interest rate Interest Principal Annual
Principle Payment
1 5000.00 14.50% 700.00 600.00 1300.00
2 4400.00 13.46% 592.24 707.76 1300.00
3 3692.24 11.92% 440.12 859.88 1300.00
4 2832.36 10.88% 308.16 991.84 1300.00
5 1840.52 10.00% 184.05 1115.95 1300.00
6 724.57 10.00% 72.46 724.57 797.02
Realized amount per FRN = Rs.5000 × (1 – 0.0075) = 4962.5
Cash Flows Upfront Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Amount realized 4962.50
Interest -700.00 -592.24 -440.12 -308.16 -184.05 -72.46
Post Tax Interest = I(1 – 23%) = -539.00 -456.02 -338.89 -237.28 -141.72 -55.79
Principal repaid -600.00 -707.76 -859.88 -991.84 -1115.95 -724.57
Total Cash Flows 4962.50 -1139.00 -1163.78 -1198.77 -1229.12 -1257.67 -780.36
Effective cost of the FRN=IRR of the above cash flow = 9.97%.
Hence from the cost of funds to the company point of view, the FRN would be preferred.

b. Qualitative evaluation of the FRN with Regular Bond from the company point of view
Positive
a. Falling interest rates mean beneficial to the company if FRNs are issued
b. As the principal repayment starts from Year 1, the leverage calculated by D/E starts reducing
from Year 1 itself implying risk is reducing
c. Flexibility to the company during the tenure of the bond to go in for additional debt
d. No one time heavy cash outflow.
Negative
a. Tax shields on principal payments have to be foregone
b. Cash outflow each year would be higher as compared to regular bonds because FRN have
principal and interest repayment.

2. (a) Down payment = 80 × 25% = 20 lakhs

A. Amount of loan = 80 – 20 = 60 lakhs
B. Let the flat rate of interest be x%.
x
60 × × 4 + 60
EMI = 100 = Rs (0.05x + 1.25) lakhs
12 × 4

i
C. PV of hire payment = (0.05x + 1.25) × 12 × PVIFA (10%,4)× 12
i
= (0.05x + 1.25) × 12 × 3.1699 × 1.045 =Rs. (1.9875272x + 49.6881825)
14
 D. Unmatured Finance Charges = 60 × x% × 4 = Rs. 2.4x lakhs

Allocation of Unmatured Finance Charges

Year SOYD Factor Finance Interest tax Net
Income @2% Interest Net Interest Interest tax
(Rs.) (Rs.) (Rs.) (Rs) (Rs.)
1 510/1176 0.433673 1.040816x 0.020816x 1.0200x 0.927272x 0.018924x
2 366/1176 0.311224 0.746939x 0.014939x 0.7320x 0.604959x 0.012346x
3 222/1176 0.188776 0.453061x 0.009061x 0.4440x 0.333584x 0.006808x
4 78/1176 0.066327 0.159184x 0.003184x 0.1560x 0.106550x 0.006189x
1.972365x 0.044267x

E. PV of interest tax = Rs. 0.044267x lakhs

F. PV of income tax on net interest = 1.972365x × 30% = Rs. 0.59171x lakhs
Net Present Value of HP = -A + C –E-F = 0
Implies that –60 + 1.9875273x + 49.6881825 – 0.044267x – 0.59171x = 0
Implies that x = 7.629618 i.e 7.63%

b. Equated monthly instalment = 0.05x + 1.25 = Rs. 1.631 lakhs

Equated yearly payments = 1.631 × 12 = Rs. 19.577 lakhs
Amortization Schedule
Year Instalment (Rs) Interest (Rs.) Capital content (Rs.) Interest tax @ 2% (Rs.)
1 19.577 7.941 11.636 0.1588
2 19.577 5.699 13.878 0.114
3 19.577 3.457 16.12 0.0691
4 19.577 1.214 18.363 0.0273
Total 78.308 60.00
In the books of Sunanda Financial Services Ltd.
Profit and Loss Account
Dr Cr
Particulars Year 1 Year 2 Year 3 Particulars Year 1 Year 2 Year 3
Interest 0.1588 0.114 0.0691 Finance 7.941 5.699 3.457
Tax Income

Balance Sheet
Liabiliti Year 1 Year 2 Year 3 Assets Year 1 Year 2 Year 3
es
Un 10.37 4.671 1.214 Current 58.731 39.154 19.577
matured (5.699+ (3.457 Assets (78.308– (58.731– (39.154–
Finance 3.457+ +1.214) 19.577) 19.577 16.577)
Income 1.214)

15
3. a. In UK, a lease transaction is treated as a true lease
A. Cost of equipment = Rs.60 crores
Let the lease rentals payable by TipsiCo India be Rs.X crores per annum
B. PV of lease rentals = XPVIFA(10,6) x 1.10 = Rs. 4.7908 X Crore
C. PV of tax on lease rentals = XPVIFA(10,6) x 0.20 = Rs.0.8711 X Crore
D. PV of Depreciation Tax Shields
Year Depreciation PVIF @ 10% PV of
Depreciation
1 15.0000 0.909090909 13.63636364
2 11.2500 0.826446281 9.297520661
3 8.4375 0.751314801 6.339218633
4 6.3281 0.683013455 4.322194522
5 4.7461 0.620921323 2.946950811
6 3.5596 0.56447393 2.009284644
38.55153291
PV of Depreciation Tax Shields = 38.5515 x 20% = Rs.7.7103 crore
–A+B–C+D=0
OR, -60 + 4.7908X – 0.8711X + 7.7103 = 0
OR, 3.9197X = 52.2897
OR, L = Rs.13.3402 crore
Hence, lease rentals payable annually in advance by PepsiCo India to Victoria under cross border
lease transaction is Rs.13.3402 crore.
b. A double dip transaction can be structured in the following manner:
Victoria should lease to TipsiCo US which in turn leases to TipsiCo 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 TipsiCo US and
Victoria and the lessor in the lease transaction between TipsiCo India and TipsiCo US.
In case of the above double-dip lease transaction the cash flows of TipsiCo US would be
Lease rentals payable to Victoria – Outflow
Depreciation tax shield benefit – Inflow
Interest tax shield benefit – Inflow
Lease rentals receivable from TipsiCo India – Inflow
Tax on interest portion of lease rentals receivable from TipsiCo India – Outflow
Let Y be the lease rental receivable annually by TipsiCo US from TipsiCo India at which net cash
flow to TipsiCo US is zero.
E. PV of lease rentals payable to Victoria = 13.3402 × PVIFA(10,6) × 1.1 = Rs.
F. PV of Depreciation Tax Shields = 7.7103 Rs. crore
Unexpired Finance Charge = 13.3402 × 6 – 60 = Rs.20.0414 Rs. crore
Allocation of Unexpired Finance Charge
Year SOYD Factor Interest PVIF @ 10% PV of Interest
1 0.285714286 5.726108777 0.909090909 5.2055534
2 0.238095238 4.771757314 0.826446281 3.9436011
3 0.19047619 3.817405851 0.751314801 2.8680735
4 0.142857143 2.863054388 0.683013455 1.9555047
5 0.095238095 1.908702926 0.620921323 1.1851543
6 0.047619048 0.954351463 0.56447393 0.5387065
15.696594

16
 G. PV of Interest Tax Shield = 15.6966 × 0.20 = Rs. 3.1393 Rs. crore
H. PV of lease rentals receivable by TipsiCo US from TipsiCo India = Y × PVIFA(10,6) × 1.1 = Rs
PV of tax on Finance Income of TipsiCo US
Unexpired Finance Charge = 6Y – 60
Year SOYD Interest PVIF @ PV of Interest
Factor 10%
1 0.285714286 1.7143Y – 17.1428 0.909090909 1.5584Y – 15.5844 1.714286 1.55844156
2 0.238095238 1.4286Y – 14.2857 0.826446281 1.1806Y – 11.8064 1.428571 1.18063754
3 0.19047619 1.1429Y – 11.4286 0.751314801 0.8586Y – 8.5865 1.142857 0.85864549
4 0.142857143 0.8572Y – 8.5714 0.683013455 0.5854Y – 5.8544 0.857143 0.5854401
5 0.095238095 0.5714Y – 5.7143 0.620921323 0.3548Y – 3.5481 0.571429 0.35481218
6 0.047619048 0.2857Y – 2.8571 0.56447393 0.1613Y – 1.6128 0.285714 0.16127827
4.6992Y – 46.9926 4.69925514
I. PV of tax on interest income = (4.6992Y – 46.9926) × 0.20 = Rs.(0.9398 – 9.3985)crore 0.93985103
–E+F+G+H–I=0
OR, – 63.9102 + 7.7103 + 3.1393 + 4.7908Y – 0.9398Y + 9.3985 = 0
OR, Y = 11.3379 Rs.Crore
Therefore lease rentals payable by TipsiCo India to Tipsico US is Rs.11.3379 crore which is lower than the
lease rental payable by TipsiCo India in the cross border lease transaction between TipsiCo India and
Victoria.
c. If a UK based lessor leases an equipment to a US based lessee under a finance lease agreement , under
the tax laws of the UK the lease will be treated as a true lease and the UK lesser will claim the
investment related tax shields. Under the tax laws of USA the same transaction will be treated as a
sale and the lessee will be allowed to claim the tax shields. This dual tax benefit (referred to as the
double-dip advantage) reduces the cost of the lease to the lessee without affecting the return to the
lessor. If the lessee is not in a position to absorb these tax shields, the UK lessor can write a lease with
an intermediate lessor in USA who can absorb these tax shields and in turn sub-lease the asset to the
lessee at a lower lease rental. This is the main advantage of double dip lease transactions.

4. a. EMI = (car amount – Down payment)/PVIFA(i/12, nx12)

Where, car amount = Rs.300000
Down payment = Rs. 30000
i = 12%
n = 10 years
PVIFA(1%, 120) = 69.7005
Therefore EMI = 3873.72 Rs.
b. If the loan does not carry any down payment, then the EMI = Loan amount/PVIFA(i/12, nx12)
= 4304.13 Rs.

5. Cost for two persons up and down flight fare from Delhi to Simla = 3000 × 2 = Rs.
(Here the hotel is not keeping any margin)
Revenue wanted by Retreat for up and down transportation from Simla to Delhi = 1.20 × 150 × 2 = Rs.
Revenue wanted by Retreat for two days room rentals and breakfast = 1.40 × 1500 × 2 = Rs.
Revenue wanted by Retreat for 2 days lunch, tea or coffee and dinner for 2 persons
= 1.60 × 2 × 120 × 2 = Rs.768
Revenue wanted by Retreat for 2 days sight seeing for 2 persons = 1.20 × 2 × 80 × 2 = Rs.
Total revenue wanted by Retreat for this package
Let a customer is giving Rs.X per month to avail this package
Let us assume that Rs.X each month is deposited in a recurring deposit giving 8% per annum compounded monthly.
Therefore, interest rate per month = 0.67%
Therefore X x FVIFA(0.67%, 12) = 11712
17
 FVIFA(0.67%, 12) = 12.4499
Therefore, X = 11712/12.4499 = 940.73 i.e. Rs.941
Hence, a customer needs to deposit Rs.941 every month to avail this package of Retreat Hotels after 12
months

Part C: Applied Theory

6. Credit rating is compulsory for issuance of CP, as per the RBI guidelines. The guidelines stipulate the
following:
• The company should obtain the specified credit rating from an agency approved by the RBI for the
purpose.
• Minimum credit rating of either A2 from ICRA, P2 from CRISIL, or Ind D-2 from DCR India.
• The rating so obtained should be current and not more than 2 months old.
Evaluation Criteria for Commercial Paper
Credit Rating Agencies (CRAs), offer their opinion on evaluation of CP, of the issuer’s fundamental credit
quality. The analytical approach is virtually identical to that of rating the debentures or bonds.
The main emphasis in CP rating is liquidity as compared to bond rating.
When the CP matures, the company has to ensure that there is enough balance in the cash credit account for
it to be able to repay the CP, since not all banks may be willing to reinstate cash credit limits.
Another important consideration is the purpose and the pattern of commercial paper since rating will
depend upon these factors. For example, if CP is used to meet reasonable working capital requirements, the
resultant rating could be higher. Credit Rating Agencies, throughout the world, including Standard and Poor
suggest that companies should have alternate source of liquidity to support CP program.
Credit Rating Agencies also look into 100 percent back-up credit support for CP outstanding. This
percentage could be lower for highest credit quality companies. Issuers credit strength and its access to
capital market are also considered by credit rating agencies. Back up finance could be in the form of bank
credit facilities like lines of credit specifically designated for the back up of commercial paper. Back up
arrangements do not allow investors’ confidence to shake up during such developments like bad business
conditions, law suit or litigation, management changes, rating change, because they protect investors’
interest against risk of default under the above circumstances. CRAs verify bank’s commitment in writing,
in this regard. Revolving line of credit may provide flexibility in payback arrangements. Credit back-up
should be arranged from reputed and recognized financial institutions or banks to ensure credit lines
immediately and fully accessible to provide timely repayment of maturing paper. Back up must be
sufficient to provide the appropriate level of coverage for other maturing short-term debts also, along with
commercial paper, which are coinciding for payment with commercial paper maturity. In the U.S.A., CPs
are backed by letters of credit (LOC) from reputed creditworthy banks. Rating for CP is kept under
continuous surveillance under an agreement entered into between the CRA and the issuer. The company
issuing CPs is also under obligation to provide continuous flow of information to CRA. The company
requesting rating for CP should submit all necessary data including the certified copy of resolution of the
commercial paper authorization given by the company’s Board of Directors.
Standard and Poor have distinguished the issuers of CP as private sector companies and public sector
companies. Private sector companies are required to have bank line in support of CP, whereas in case of
public sector sovereign guarantees are more important in addition to bank support, unless they can prove
their liquidity is overwhelming.
In the Indian context, banks are not permitted to sanction standby facilities for repayment of CP. The
company will have to apply afresh for restoration of working capital limits.
Key Ratios for Rating Commercial Paper
Some of the key ratios that are generally looked into, while rating a commercial paper are:
• Pre-tax interest coverage,
• Pre-tax interest and full rental coverage,
• Cash flow/long-term debt (%),
• Cash flow/total debt (%),
18
 • Pre-tax return on average long-term capital employed (%),
• Operating income/sales (%),
• Long-term debt/capitalization (%),
• Total debt/capitalization including short-term debt (%)
• Total liabilities/tangible shareholders’ equity and minority interest (%).
As per S&P’s opinion there is some similarity between CP and bond rating. Minimum credit quality
associated with “A-1” CP rating is equivalent to an “A+” bond rating, “A-1” CP rating has equivalent
bond rating as ‘A’, for ‘A-2’ it is BBB, for “AB” it is BBB–, and for B it is BB+. Weaker the CP rating,
stronger should be the back-up finance in the form of revolving credit arrangements.

7. In international trade transactions, forfaiting is a common form of financing export-related receivables.

Under this arrangement:
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 avalled or guaranteed by a reputed international bank which can also be the
importer’s banker. (An aval is an endorsement on the promissory notes by the guaranteeing bank that
it covers any default of payment by the buyer).
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.
Thus, we find that a forfaiting transaction resembles a cross-border factoring transaction with features of
non-recourse and advance payment. But then the two transactions are not identical. The important
differences are:
1. In a factoring transaction, the factor doesn’t provide hundred percent finance; he maintain a factor
reserve. On the other hand, in a forfaiting transaction the forfaiter discounts the entire value of the
promissory notes.
2. In a non-recourse factoring transaction, the factor participates in the credit-granting decision of the
exporter (the client) whereas in a forfaiting transaction, the forfaiter relies on the unconditional and
irrevocable guarantee provided by the avalling bank. So he is more concerned about the financial
standing of the avalling bank than with the credit standards applied by the exporter.
3. While the factor takes on the responsibilities of receivables accounting, monitoring and collection, the
forfaiter doesn’t assume any of these responsibilities.
4. The factor purchases receivables which are of a short maturity period whereas the fortfaiter buys
bills/promissory notes arising out of deferred credit transactions.

19