IBS535 FM-I (A) / 0805

Semester I Mid Semester (Make Up) Examinations (Class of 2007) IBS535 Financial Management - I Part A
Q. Which of the following is not a function of a finance manager? a. b. c. d. e. Q. Mobilization of funds Deployment of funds. Control over use of funds. Manipulate share price of the company. Maintain a balance between risk and return.

The financial system does not perform the following function: a. b. c. d. e. Channelising savings to users of funds Providing liquidity Payment facility for goods and services received Protection/ reduction of risk Industrial dispute redressal

Q.

The objective of financial management to increase the wealth of the shareholders means to a. b. c. d. e. Increase the physical assets owned by the firm Increase the market value of the shares of the firm Increase the current assets of the firm Increase the cash balance of the company Increase the total number of outstanding shares of the company

Q.

Which is/are the essential feature(s) of a Call Money Market? a. b. c. d. e. Maturity periods of 1-15 days Market determined interest rates Low liquidity High agency costs Both (a) and (b) above

Q.

The difference(s) between Commercial Paper (CP) and Certificate of Deposit (CD) is/are a. b. c. d. e. CP is secured while CD is unsecured CPs can be issued by private sector companies while CDs can be issued by scheduled banks CP is sold at a discount and redeemed at face value whereas for CD the principal and interest are payable upon maturity. Both (b) and (c) above All of (a), (b) and (c) above 1

IBS535 FM-I (A) / 0805 Q. Public debt in the Indian economy is being managed by a. b. c. d. e. Q. SBI on behalf of Government of India Ministry of Finance RBI All nationalized banks and term lending institutions Ministry of Commerce and Trade

Gilt edged securities are the bonds issued by a. b. c. d. e. Big corporates Multinational corporates Global Corporations Central government Financial institutions

Q.

Banks borrow in call money market to a. b. c. d. e. Give loans Invest in high yielding securities Meet the Cash Reserve Ratio (CRR) Meet sudden demand for funds arising due to large payments and remittances Both (c) and (d) above.

Q.

According to the guidelines of Money Market Mutual Funds, the minimum lock in period of an investors investment is a. b. c. d. e. 15 days 30 days 45 days 46 days 60 days

Q.

CRISIL a. b. c. d. e. Rates equity, debentures and fixed deposits Was set up by the Industrial Development Bank of India Gives the highest rating of PI to short-term instruments. Does not consider non-financial factors while valuing a companys securities. None of the above

IBS535 FM-I (A) / 0805 Q. In which of the following types of issue, new securities are offered to the existing shareholders of the company on a pro rata basis? a. b. c. d. e. Q. Public issue Rights issue Bonus issue Private placement Both (b) and (c) above

Which of the following regulations are no more relevant in todays business environment? a. b. c. d. e. Foreign Exchange Regulation Act, 1973. Monopolies and Restrictive Trade Practices Act, 1969 Companies Act, 1956 Income Tax Act, 1961 SEBI Act, 1992

Q.

The nominal rate of interest is equal to a. b. c. d. e. Real Rate + Risk Premium Inflation Real Rate + Risk Premium + Inflation Real Rate - Risk Premium + Inflation Real Rate - Risk Premium Inflation Real Rate

Q.

If P= principal amount, i-= interest rate per annum, m=frequency of compounding per year, n= number of years and A= accumulation at the end of the year n, then which of the following expressions is correct? a. b. c. d. e. A = P(1 + i/n)mn P = A(1 + i/m)mn A = [P(1 + i/m) ]
m n

A = P(1 + i/m) mn None of the above

Q.

Which of the following statements is true? a. b. c. d. e. Increased frequency of compounding reduces the effective rate of interest. According to Rule of 72, the period within which the amount will be doubled can be obtained by dividing 72 by the interest rate and adding 0.35 to the value arrived at. Effective interest rate is always more than or equal to the nominal interest rate. An annuity is a lump sum payment A project is financially viable if the present value of the future cash inflows is positive.

IBS535 FM-I (A) / 0805 Q. A risk-free stock has a beta of a. b. c. d. e. -1 Zero 0.5 1 Infinity

Q.

Which of the following is a specific risk factor? a. b. c. d. e. Market risk Inflation risk Interest rate risk Financial risk None of the above

Q.

Which of the following would reduce the applicability of Capital Asset Pricing Model (CAPM)? a. b. c. d. e. Investors having different time horizons for investments. The presence of high transaction costs in the market The influence of taxes on the choice of assets The different expectations of the investors regarding the risk and return associated with various securities All of the above

Q.

In booming (share) market, the companies are to be selected with Beta () a. b. c. d. e. =0 >1 <1 =1 Beta is not relevant

Q.

YTM is not affected by the a. b. c. d. e. Annual interest payment Discount rate Redemption value Number of years to maturity Current market price of the bond

IBS535 FM-I (A) / 0805 Q. Which of the following statements is correct regarding cash dividends on common stocks? a. b. c. d. e. Q. Dividend payments are guaranteed. Dividends are the only form of return on investment Low dividend yields indicate out of favor stocks Dividend yields are based on current stock price. None of the above

The g in the constant-growth dividend discount model refers to i. ii. iii. a. b. c. d. e. The annual growth rate of dividends The annual growth rate of stock price The annual growth rate of earnings per share Only (i) above Only (ii) above Both (i) and (ii) above Both (i) and (iii) above All of (i), (ii) and (iii) above.

Q.

Which of the following is not true with regard to the multi period valuation model of equity shares? a. b. c. d. e. There is a pre-specified maturity period. The value of an equity share is equal to the present value of its entire dividend stream. The model can be applied to the instances of constant dividends and constant growth in dividends. The model can also be applied in case of variable growth in dividends. The cost of equity of the company can vary from time to time.

Q.

In quarterly compounding, with 10% interest pa, the effective rate of interest is a. b. c. d. e. 10.38% 11% 10.78% 14% inadequate information

Q.

Capital recovery factors is a. b. c. d. e. Inverse of PV interest factor annuity Perpetuity Same as sinking fund factor annuity Given by the formula l/k Same as cumulative interest formula

IBS535 FM-I (A) / 0805 Q. While investing in bonds, the systematic risk involved is a. b. c. d. e. Q. Purchasing power risk Interest rate risk Yield risk Both (a) and (b) above All the above

SML cuts y-axis at a. b. c. d. e. Expected rate of return on the security Expected rate of return on market portfolio Expected rate of inflatiuon Real rate of return on risk free securities Nominal rate of return on risk free securities

Q.

Sytematic risk of asecurity is measured by a. b. c. d. e. Standard Deviation Variance Covariance Beta Correlation coefficient

Q.

Other things being equal, high P/E is a result of a. b. c. d. e. Lower growth rate in dividends Lower dividend yield Reduction in required rate of return of the scrip Lower share price Higher cost of insolvency

Q.

The following is an undiversifiable risk a. b. c. d. e. Business risk Financial risk Credit risk Purchasing power risk Technology risk

IBS535 FM-I (A) / 0805

Part B
Problems, Conceptual Understanding, Analytical Ability and Situational Analysis
1. a. Vision Ltd, an NBFC offers car loans with two schemes. Scheme A offers 10 % discount on Cash Payment. Scheme B asks a down payment of Rs. 18000 and Rs. 4,100 per month for 5 years. If the cost of the car is Rs. 2.5 lakhs and the required rate of return is 9%, which scheme would you choose? (5 marks) b. Given the risk free rate is 12%and the expected return on the market portfolio is 18%. The following are the expected returns for three stocks with their betas: Expected Returns (%) Stock I Stock II Stock III 19 18.5 22 Expected Beta 1.5 0.75 1.4 (5 marks) Suggested Answer: a. PV of cash flows in case of scheme A . = (Rs. 2.5 lakh 2.5 lakh X 10%) = 2.25 lakhs PV of cash flows in scheme B. =18000 + PVIFA (k,60) X 4,100 = [where, k = (1.09)1/12 - 1= 0.0072 i.e., 0.72%] = Rs. 18,000 + (48.581 X Rs. 4,100) =Rs. 18,000 + Rs. 19,9182.10 = Rs. 2,17,182.10 Scheme B should be chosen since PV or cash outflows is less in this scheme comared to scheme A b. Required return on a stock (Ri) = Rf + (Rm Rf) Where, Rf = Risk-free return Rm = Market return Stock I: RI = Required return = 12 + 1.5 (18-12)=21% Since the expected return is only 19%, this stock has been overvalued. Stock II RII = 12+0.75(18-12)=16.5% 7

Comment whether stocks are overvalued or under valued.

IBS535 FM-I (A) / 0805 Since expected return is 18.5%, the stock has been undervalued. Stock III RIII = 12+1.4 (18-12) =20.4% Since expected rate is 22%, this stock has been undervalued. 2. The probability distribution of returns of stock of M/s. ACRO Ltd., and the returns on market are given below: Probability 0.30 0.35 0.15 0.20 Returns of stock of M/s. ACRO Ltd. (in%) 7 8 14 16 Market Returns (in%) 9 5 10 14

The variance associate with the Market returns is 10.6875(%)2. The risk free rate of returns is 6% pa. Determine according to CAPM, the risk premium for the stock of M/s. ACRO Ltd. (8 marks) Suggested Answer: Risk Premium = (Rm R6) Prob 1 0.30 0.35 0.15 0.20 kA 2 7 8 14 16 kA = kA p = 10.20 Cov (kAkm) Var (km) km 3 9 5 10 14 kA = km p = 8.75 P. ((kA - kA)(km - km) P (km - km)2 (kA - kA) 4 -3.2 -2.2 3.8 5.8 (km - km) 5 0.25 -3.75 1.25 5.25

6=4x5 -0.8 8.25 4.75 30.45

7=4x5x1 -0.24 2.8875 0.7125 6.09 9.45

9.45 10.6875 = 0.884

Risk Premium = 0.884 (8.75 6) = 2.73%

IBS535 FM-I (A) / 0805 3. a. Reliance Ltd. Has provided following information. Items Equity share capital (Rs. 20 each) Reserve and surplus 15% Secured Loans 12.5% Unsecured Loans Fixed Assets Investments Operating Profits Tax Rate P/E Ratio Amount (Rs.) 80,00,000 15,00,000 45,00,000 20,00,000 50,00,000 15,00,000 35,00,000 50% 17.5

Calculate the Value Per Equity Share from the above information. (6 marks) b. The Bond of the Charity Company are presently selling at a premium of 8 present against its face value as well as maturity value of Rs. 100. the current yield on these bonds is 8.33%. The coupons are paid yearly. If the bonds are to mature 3 years hence, what should be the annualized yield to an investor of today by the approximation method? (6 marks) Suggested Answer: a. In the given situation, the value of the share can be ascertained on the basis of earnings of the firm and the price-earning multiple as follows: Value = EPSxP/E ratio The P/E ratio is given and the EPS may be ascertained as follows: Operating Profit i.e., EBIT Less: Interest on 15% secured loans Interest on 12.5% unsecured loans Profit before tax (PBT) Tax @50% Profit after tax (PAT) No. of equity shares (Rs. 50,00,000/20) Therefore, EPS(Rs. 12,87,500/4,00,000) = 3.21 Value = EPSxP/E ratio = 3.21x17.5 = Rs. 56.17 35,00,000 6,75,000 2,50,000 25,75,000 12,87,500 12,87,500 4,00,000

IBS535 FM-I (A) / 0805 b. Present market value of the bond is Rs. 108 and the amount of coupon interest to be received annually = Rs. 108X8.33 percent = Rs.8.9964 = Rs.9 Hence, the amount of coupon payments to be received half-yearly = Rs.4.50 and the number of coupons n = 2x3 = 6. So, the approximate half-yearly realized yield to an investor will be I + (F-P)/n (F + p)/2 Rs.4.50+(100-108)/6 (100 + 108) / 2

r=

= 0.03045 = 3.045%

So, the approximate annualized yield to an investor will be = {(1.03045)2-1}x100 = 6.18 percent 4. a. You are considering investing in one of these bonds: Instrument Bond A Bond B Coupon Rate 12% 10% Maturity 10 Yrs 6 Yrs Price / Rs.100 Par Value 70.00 60.00

Your Income Tax is 50% and your Capital Gains Tax is 30%. Capital Gains tax is paid a maturity on the difference between the purchase price and par value. What is your post tax yield to maturity from these bonds? (5 marks) b. The share of certain stock paid a divided of Rs.2.00 last year (D0). The divided is expected to grow at a constant rate of 6% pa. The required rate of return on this stock is considered to be 12%pa. How much should the stock sell now? Assuming that the expected growth rate and the required rate of return remain the same, at what price should the stock sell 2 years hence? (5 marks) Suggested Answer: a. Yield to maturity on bond can be found out rising equation I + (F P) /n (F + P) /2 This is adjusted for capital gains tax affecting the 2nd term on the numerator and also the income tax affecting total returns from the bond as follows: I + {(F P) 0.30 (F P)}/n (F+ P)/2 x 1-T

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IBS535 FM-I (A) / 0805 For Bond A Yield to maturity 12 + [(100 - 70) 0.3 [30]/n 100 + 70 2 12 + 2.1 85 = 8.3 For Bond B Yield to maturity 10 + [(100 - 60) 0.30 (100 60)/n (1 0.5) x 100 + 60 2 0.5 X 10 + (40 12)/6 80 10 + 4.66 80 0.083 (1 0.5)

(0.5)

0.5 X = 0.092 9.2 % p.a.

Post tax returns are bond A & Bond B are 8.3% p.a and 9.2 p.a% respectively. b. The dividend growth model is used here. Po = Do / Ke g Do = 2 D1 = Do (1 + .06) g = 6% p.a. Ke = 12% p.a D1 = d0 (1+0.6) Price Now Rs = D1 / Ke g = 2.12/0.12 0.06 = 35.33 Price at the end of two years P = D4/Ke g = 2 (1 + 0.06)4 / 0.12 0.06 = 42.08 11 = 2 (1 + 0.06) = 2.12 D0 D1 D2 D3 D4

Yr1

Yr1

IBS535 FM-I (A) / 0805 5. What do you mean by derivatives Market? Who can participate as Hedgers, Speculators or arbitrators in this market? (10 marks) Suggested Answer: Will be posted later

Part C Case Analysis / Applied Theory

6. Could a securities intrinsic value differ from the market value? If yes why? (10 marks) Suggested Answer: Yes, the intrinsic and the market value may differ for a security. This will happen because of the following reason: a. b. c. d. e. The yield to maturity for the security may differ. The market capitalization may be different than the intrinsic value The industry whose security is in focus, may have a higher growth rate there fore increasing any firm representing that industrys market value to be high There can be severe information dissymmetry leading to such distortion The market is essentially not perfect, hence the two values will never or seldom be same.

7.

Explain how the environment in which a financial system is interconnected with different markets to bring forth the environment in which a finance manager operates. (10 marks) Suggested Answer: Savers and investors are linked by the financial system which performs the following functions: savings liquidity-payment-risk-policy.

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