Paper: Management of Financial Services

Code: PFS1B

General Instructions:

The Student should submit this assignment in the handwritten form (not in the typed format)
The Student should submit this assignment within the time specified by the exam dept
The student should only use the Rule sheet papers for answering the questions.
The student should attach this assignment paper with the answered papers.
Failure to comply with the above Four instructions would lead to rejection of assignment.

Specific Instructions:

There are four Questions in this assignment. The student should answer all the four questions. Marks allotted 100.
Each Question carries equal marks (25 marks) unless specified explicitly

Question No 1.
a)
Mr. X paid a premium of Rs. 5 per share for a 6 month call option contract (total of Rs
500 for 100) share of Mohana corporation. At the time of purchase Mohana stock was selling for Rs.
57 per share and the exercise price of the call option was Rs. 56.

i)

Determine Xs profit or loss if the price of Mohanas stocks is Rs. 53, when the
option is exercised.
Ans :- (a) Cost of call = 5 premium 100 = 500
Ending value = 500 cost + 0 profit = 500
loss Since the stock price is lower than the exercise price, the option is
worth less.

ii)

Ans :-

What is Xs profit or loss if the price of Mohanas stocks is Rs. 63 when the
option is exercised.

B)Cost of call = .500 Ending value

= .500 + (. 63 .56) x 100
= 500 + 700 Gain
= 200.

iii)

Also calculate the position of seller of Call in both the cases.

b) What is the difference between Future and Options, explain with example.
Ans :- Futures and options represent two of the most common form of "Derivatives". Derivatives
are financial instruments that derive their value from an 'underlying'. The underlying can be a
stock issued by a company, a currency, Gold etc., The derivative instrument can be traded
independently of the underlying asset.

The value of the derivative instrument changes according to the changes in the value of the
underlying.
Derivatives are of two types -- exchange traded and over the counter.
Exchange traded derivatives, as the name signifies are traded through organized exchanges
around the world. These instruments can be bought and sold through these exchanges, just like
the stock market. Some of the common exchange traded derivative instruments are futures and
options.
Over the counter (popularly known as OTC) derivatives are not traded through the exchanges.
They are not standardized and have varied features. Some of the popular OTC instruments are
forwards, swaps, swaptions etc.
Futures
A 'Future' is a contract to buy or sell the underlying asset for a specific price at a pre-determined
time. If you buy a futures contract, it means that you promise to pay the price of the asset at a
specified time. If you sell a future, you effectively make a promise to transfer the asset to the
buyer of the future at a specified price at a particular time. Every futures contract has the
following features:
Buyer
Seller
Price
Expiry
Some of the most popular assets on which futures contracts are available are equity stocks,
indices, commodities and currency.

The difference between the price of the underlying asset in the spot market and the futures
market is called 'Basis'. (As 'spot market' is a market for immediate delivery) The basis is usually
negative, which means that the price of the asset in the futures market is more than the price in
the spot market. This is because of the interest cost, storage cost, insurance premium etc., That is,
if you buy the asset in the spot market, you will be incurring all these expenses, which are not
needed if you buy a futures contract. This condition of basis being negative is called as
'Contango'.
Sometimes it is more profitable to hold the asset in physical form than in the form of futures. For
eg: if you hold equity shares in your account you will receive dividends, whereas if you hold
equity futures you will not be eligible for any dividend.
When these benefits overshadow the expenses associated with the holding of the asset, the basis
becomes positive (i.e., the price of the asset in the spot market is more than in the futures
market). This condition is called 'Backwardation'. Backwardation generally happens if the price
of the asset is expected to fall.
It is common that, as the futures contract approaches maturity, the futures price and the spot price
tend to close in the gap between them ie., the basis slowly becomes zero.
Options
Options contracts are instruments that give the holder of the instrument the right to buy or sell
the underlying asset at a predetermined price. An option can be a 'call' option or a 'put' option.
A call option gives the buyer, the right to buy the asset at a given price. This 'given price' is
called 'strike price'. It should be noted that while the holder of the call option has a right to
demand sale of asset from the seller, the seller has only the obligation and not the right. For eg: if
the buyer wants to buy the asset, the seller has to sell it. He does not have a right.

Similarly a 'put' option gives the buyer a right to sell the asset at the 'strike price' to the buyer.
Here the buyer has the right to sell and the seller has the obligation to buy.
So in any options contract, the right to exercise the option is vested with the buyer of the
contract. The seller of the contract has only the obligation and no right. As the seller of the
contract bears the obligation, he is paid a price called as 'premium'. Therefore the price that is
paid for buying an option contract is called as premium.
The buyer of a call option will not exercise his option (to buy) if, on expiry, the price of the asset
in the spot market is less than the strike price of the call. For eg: A bought a call at a strike price
of Rs 500. On expiry the price of the asset is Rs 450. A will not exercise his call. Because he can
buy the same asset from the market at Rs 450, rather than paying Rs 500 to the seller of the
option.
The buyer of a put option will not exercise his option (to sell) if, on expiry, the price of the asset
in the spot market is more than the strike price of the call. For eg: B bought a put at a strike price
of Rs 600. On expiry the price of the asset is Rs 619. A will not exercise his put option. Because
he can sell the same asset in the market at Rs 619, rather than giving it to the seller of the put
option for Rs 600.
Question No 2
a) What will be the theoretical Market price in the case of following events?
a) A company announced as Bonus issue in the ratio of 3:7 and the price on the last
cum date
was 500. what will be the expected price on the Ex-date.
b) In case a right issue is announced when the price on the cum-date is Rs. 500/- and
the right issue was announced in the ratio of 5:7 and the price of RT issue was 300/- .
what should be the price on the Ex-date.
c) GMR has gone for a stock split when the price on the last cum date was 850/calculate the price on the ex-date split in the ratio of 10:1 shares.

b)

What is the application of SHARE RATIO Vs TREYNOR RATIO in Mutual funds.

Question No 3
(a) The financial data of Excellent paper is as follows:

Paid-up capital ( 4 crore, shares)

Rs. 40 crore
Reserves & Surplus
Rs. 160 crore
Profit after Tax
Rs. 18 crore
The shares of the company are listed and are currently quoting at P/E multiple of 12.
The company has taken up an expansion project at a cost of Rs. 355 crore. It proposes to fund it with a term
loan of Rs. 155 crore, from ICIC, Rs. 80 crore from internal accruals and the balance by a rights issue. The
right will be priced at Rs. 40 per share (Rs. 30 premium).
a.
b.
c.

52.

The value of the rights;

The market capitalization of the company after the rights issue; and
Calculate the value of the share after the rights issue.

The amount to be raised by rights issue = Rs.355 (155 + 80) = Rs.120 crore.
Subscription price/rights share = Rs.40.
No. of right shares on offer = 300,00,000.
Hence ratio of rights is 3 shares for every 4 shares held 3 : 4.
EPS

Rs.4.50
MPS
P/E

12 since
= 12
EPS
Market Price

Rs.54
P S

a. Value of the rights R = 0 N +1

Where,
P0 = Market price before rights issue
S
= Subscription price
N
= Number of shares required for 1 rights share
=
1.33 1

= Rs.6.
Rights

ratio = 0.75

b.

NPo
Market value after the rights issue

+S

N +1

=
=

= Rs.48
No. of shares outstanding after rights issue = Existing + Rights shares
= 4 + 3 = 7 crore
Market capitalization = Ex. Rights price x No. of outstanding shares
= 48 x 7
= Rs.336 crore
c.
NAV per share after the issue:

Paid up capital

Rs.70 cr.

Reserves & surplus:

Existing
Premium on rights issue

160
+ 90

Net worth of the company

No. of shares
NAV per share

(b).

Rs.250cr
ore
Rs.320cr
ore

7 crore
= Rs.45.71

Explain the difference between Bonus issue & Stock split.

Ans :- WHATS THE

DIFFERENCE?

Simply put- A bonus is a free additional share. A stock split is the same share split into two.
Usually companies accumulate its earnings in reserve funds instead of paying it to share-holders
in form of dividend. This accumulated reserve fund is then converted into share-capital and
allotted to share-holders as bonus shares in proportion to their existing holding. So, Share-capital
of the company increases with a concomitant decrease in its Reserve profits. Share-holders get
bonus shares in compensation of dividend.
But when a share is split, say, from Rs 10 denomination to Re 1 denomination, there would
neither be an increase in the share capital nor a concomitant decrease in the reserves of the
company. This is because while in a bonus issue a person having one share of Rs 10 face value
would get another share of the same face value should the company go for a 1:1 bonus what
would happen in a stock split is his one Rs 10 share would now be converted into ten Re 1
shares.

WHY DOES A COMPANY ISSUE BONUS SHARES?

One of the major reasons why companies declare bonus issues is that a higher number of shares
improves float and liquidity and thereby traded volumes of the stock. A lower price also makes
the stock seem more affordable to small retail investors, who might otherwise give it a miss at
high price levels. Another aspect of a bonus issue is that it reflects the confidence of the company
in its ability to service a larger equity base. Thus, bonus issues are said to be a good signaling
mechanism on the companys capacity to deliver future benefits to shareholders in terms of
increased dividend.
Not all is positive with a bonus issue. In some cases, a bonus share ploy is used by companies to
mask flagging performance and to perk up sentiment.

For example, a company has an authorized share capital of Rs. 1,00,000. It has issued
10,000 shares with a face value of Rs. 10 each. Thus, its issued share capital is also Rs.
1,00,000.It has an accumulated reserve of Rs. 10,00,000. It decides to issue bonus shares
in the ratio of 1:1 or 1 for 1 that is, 1 bonus share for each share held. In this case, it
transfers Rs. 1,00,000 from its reserves to its authorized share capital. Thus, its reserves
come down to Rs. 9,00,000, and its authorized share capital increases to Rs.
2,00,000.Using this new share capital of Rs. 1,00,000, the company issues 10,000 new
shares, each having a face value of Rs. 10, and gives a new share the bonus share for
each share held. Its issued share capital also goes up to Rs. 2,00,000.

HOW DOES BONUS SHARE AFFECT INVESTORS?

Immediately, It doesnt affect your investments anyway. Post the bonus, the share price should
fall in proportion to the bonus issue, thereby making no difference to the personal wealth of the
share holder. However, more often than not, a bonus is perceived to be a strong signal given out
by the company and the consequent demand push for the shares causes the price to move up.So,
when stock prices move up in the long run, there will be dramatic increase in the wealth youre
holding.
WHY DOES A COMPANY SPLIT ITS STOCK?

The primary reason is to infuse additional liquidity into the shares by making them more
affordable. It needs to be reiterated here that the shares only appear to be cheaper, though it
makes no difference whether you buy one share for Rs 3,000 or two for Rs1,500 each.
HOW DOES IT AFFECT YOU?
It is like cutting an eight-inch pizza into 12 slices from four slices before. But if you want to buy
the shares of a company which are frightfully expensive, you can now buy them for less. Except
for that , in a stock split, fundamentals about the company does not change, the issued share
capital remains the same, the revenue remains the same, and the profit remain the same too! But,
since the number of shares issued increases, the profit per share (or the Earnings Per Share
EPS) decreases by the same factor.

So, if EPS is Rs. 15 per share for a share having a face value of Rs. 10, after a 10:1 stock
split, the EPS would come down to Rs. 1.5. But since you would be holding 10 shares
now, your share of EPS remains the same: Rs. 1.5 * 10 shares = Rs. 15, which is as
before!

So, if the PE of the stock is 20 in our example, the price would go down from Rs. 300 (EPS of
Rs. 15 * PE 20 = Rs. 300 per share) to Rs. 30 (EPS of Rs. 1.5 * PE 20 = Rs. 30 per share). But
again, since you would be holding 10 shares now, your actual holding remains the same: Rs. 30 *
10 shares = Rs. 300, which is as before!
So, there is absolutely no change anywhere, except for the number of shares traded!
WHY DOES MARKET CHEER STOCK SPLITS?
Stock market interprets a stock split as a statement of confidence by the company it interprets a
split as a signal from the company that it is confident about its future growth. Also, a stock split
increases the number of shares traded in the market, which increases liquidity.These factors are
considered positive, and therefore the market reacts positively!
TAX IMPLICATIONS

Bonus shares- As far as tax is concerned, since no money is paid to acquire bonus shares, these
have to be valued at nil cost while calculating capital gains. The originally acquired shares will
continue to be valued at the price paid at the time of acquisition. An incidental tax planning
benefit is that since the market price of the original shares falls on account of the bonus, there
may arise an opportunity to book a notional loss on the original shares. This is known as bonus
stripping. The Indian Income-Tax Act has introduced measures to curb bonus stripping.
Stock splits As far as the tax implications for stock splits are concerned, well, there arent any.
A stock split, like a bonus issue, is tax neutral. However, when the shares are sold, the capital
gains tax implications are different that what is applicable for bonus issues. Here, the original
cost of the shares also has to be reduced. For instance, if the cost of the 100 shares at Rs 1,500
per share was Rs 1, 50,000, after the split the cost of 500 shares would be reduced to Rs 300 per
share, thereby keeping the total cost constant at Rs 1, 50,000.

Question No 4
A) Define Record date, book closure date, Cum Dividend Date .
Ans :-

Record date :The record date is the cut-off date established by a company in order to determine which
shareholders are eligible to receive a dividend or distribution. The determination of a record date
is required to ascertain who the company's shareholders are as of that date, since the shareholders
of an actively traded stock are continually changing. The shareholders of record as of the record
date will be entitled to receive the dividend or distribution declared by the company. Also known
as the date of record.
Book closure date:The time period when a company will not handle adjustments to the register, or requests to
transfer shares. The book closure date is often used to identify the cut-off date determining which
investors of record will be sent a given dividend payment. The stock of publicly-traded
companies changes hands daily as investors buy and sell shares. Due to this, when a company
declares it will pay a dividend, it must set a specific date when the company will "close" its

shareholder record book and commit to send the dividend to all investors holding shares as of
that date.

Cum Dividend Date

When a buyer of a security is entitled to receive a dividend that has been declared, but not paid.

A) Company declared a dividend of Rs 100 on 3rd August05 Ex dividend date is 16th

August & the record date is 18th august. Date of payment is 30th August. When should
a shareholder Buy a share in order to get the dividend.