1

₹ 

 
 
2

Security Valuation
Study Session 2
QUESTION NO. 1
In December, 2011 AB Co.’s share was sold for ₹ 146 per share. A long term earnings growth rate
of 7.5% is anticipated. AB Co. is expected to pay dividend of ₹ 3.36 per Share.
a) What rate of return an investor can expect to earn assuming that dividends are expected to grow
along with earnings at 7.5% per year in perpetuity?
b) It is expected that AB Co. will earn about 10%on book Equity and shall retain 60% of earnings. In
this case, whether, there would be any change in growth rate and Cost of Equity?
QUESTION NO. 2
Seawell Corporation, a manufacturer of do-it-yourself hardware and housewares, reported earnings
per share of € 2.10 in 2003, on which it paid dividends per share of €0.69. Earnings are expected to
grow 15% a year from 2004 to 2008, during this period the dividend payout ratio is expected to
remain unchanged. After 2008, the earnings growth rate is expected to drop to a stable rate of 6%,
and the payout ratio is expected to increase to 65% of earnings. The firm has a beta of 1.40 currently,
and is expected to have a beta of 1.10 after 2008. The market risk premium is 5.5%. The Treasury
bond rate is 6.25%.
(a) What is the expected price of the stock at the end of 2008?
(b) What is the value of the stock, using the two-stage dividend discount model?
QUESTION NO. 3
SAM Ltd. has just paid a dividend of ₹ 2 per share and it is expected to grow @ 6% p.a. After paying
dividend, the Board declared to take up a project by retaining the next three annual dividends. It is
expected that this project is of same risk as the existing projects.
The results of this project will start coming from the 4th year onward from now. The dividends will then
be ₹ 2.50 per share and will grow @ 7% p.a.
An investor has 1,000 shares in SAM Ltd. and wants a receipt of at least ₹ 2,000 p.a. from this
investment.
Show that the market value of the share is affected by the decision of the Board. Also show as to how
the investor can maintain his target receipt from the investment for first 3 years and improved income
thereafter, given that the cost of capital of the firm is 8%.
QUESTION NO. 4
The current EPS of M/s VEE Ltd. is ₹ 4. The company has shown an extraordinary growth of 40% in its
earnings in the last few year This high growth rate is likely to continue for the next 5 years after which
growth rate in earnings will decline from 40% to 10% during the next 5 years and remain stable at
10% thereafter. The decline in the growth rate during the five year transition period will be equal
and linear. Currently, the company' s pay-out ratio is 10%. It is likely to remain the same for the next
five years and from the beginning of the sixth year till the end of the 10th year, the pay-out will
linearly increase and stabilize at 50% at the end of the 10th year. The post tax cost of capital is 17%
and the PV factors are given below:
Years 1 2 3 4 5 6 7 8 9 10
PVIF 0.855 0.731 0.625 0.534 0.456 0.390 0.333 0.285 0.244 0.209
@17%
You are required to calculate the intrinsic value of the company's stock based on expected dividend.
If the current market price of the stock is ₹ 125, suggest if it is advisable for the investor to invest in
the company's stock or not.

 
   
3

QUESTION NO. 5
Anson Ford, CFA, is analysing the financial statements of Sting's Delicatessen. He has a 2009 income
statement and balance sheet, as well as 2010 income statement & balance sheet (as shown in the
tables below). Assume there will be no sales of long-term assets in 2010. Calculate forecasted free
cash flow to the firm (FCFF) and free cash flow to equity (FCFE) for 2010.
Sting's Income Statement
Income Statement 2010 Forecast 2009 Actual
Sales $300 $250
Cost of goods sold 120 100
Gross profit 180 150
SG&A 35 30
Depreciation 50 40
EBIT 95 80
Interest expense 15 10
Pre-tax earnings 80 70
Taxes (at 30%) 24 21
Net income 56 49
Sting's Balance Sheet
Balance Sheet 2010 Forecast 2009 Actual
Cash $10 $5
Account Receivable 30 15
Inventory 40 30
Current Assets $80 $50
Gross property, plant and equipment 400 300
Accumulated depreciation 190 140
Total Assets $290 $210

Account Payable $20 $20

Short Term Debt 20 10
Current Liabilities $40 $30
Long Term Debt 114 100
Common Stock 50 50
Retained earnings 86 30
Total liabilities and owners’ equity $290 $210

 
 
4

Corporate Valuation
Study Session 3
QUESTION NO. 1
Following information’s are available in respect of XYZ Ltd. which is expected to grow at a higher rate
for 4 years after which growth rate will stabilize at a lower level:
Base year information:
Revenue ₹ 2,000 crores
EBIT ₹ 300 crores
Capital expenditure ₹ 280 crores
Depreciation ₹ 200 crores
Information for high growth and stable growth period are as follows:
High Growth Stable Growth
Growth in Revenue & EBIT 20% 10%
Growth in capital expenditure and 20% Capital Expenditure are offset by
depreciation depreciation
Risk Free Rate 10% 9%
Equity Beta 1.15 1
Market Risk Premium 6% 5%
Pre Tax Cost of debt 13% 12.86%
Debt equity ratio 1:1 2:3
For all time, working capital is 25% of revenue and corporate tax rate is 30%. What is the value of
the firm?
QUESTION NO. 2
Following details are available for X Ltd.
Income Statement for the year ended 31st March, 2018
Particulars Amount
Sales 40,000
Gross Profit 12,000
Administrative Expenses 6,000
Profit Before tax 6,000
Tax @ 30% 1,800
Profit After Tax 4,200
Balance sheet as on 31st March, 2018
Particulars Amount
Fixed Assets 10,000
Current Assets 6,000
Total Assets 16,000
Equity Share Capital 15,000
Sundry Creditors 1,000
Total Liabilities 16,000
The Company is contemplating for new sales strategy as follows :
(i) Sales to grow at 30% per year for next four years.
(ii) Assets turnover ratio, net profit ratio and tax rate will remain the same.
 
   
5

(iii) Depreciation will be 15% of value of net fixed assets at the beginning of the year.
(iv) Required rate of return for the company is 15%
Evaluate the viability of new strategy.
QUESTION NO. 3
Calculate the value of share of Avenger Ltd. from the following information:
Equity capital of company ₹ 1,200 crores
Profit of the company ₹ 300 crores
Par value of share ₹ 40 each
Debt ratio of company 25
Long run growth rate of the company 8%
Beta 0.1; risk free interest rate 8.7%
Market returns 10.3%
Change in working capital per share ₹ 4
Depreciation per share ₹ 40
Capital expenditure per share ₹ 48
QUESTION NO. 4
Rahim Enterprises is a manufacturer and exporter of woollen garments to European countries. Their
business is expanding day by day and in the previous financial year the company has registered a 25%
growth in export business. The company is in the process of considering a new investment project. It is
an all equity financed company with 10,00,000 equity shares of face value of ₹ 50 per share. The current
issue price of this share is ₹ 125 ex-divided. Annual earning are ₹ 25 per share and in the absence of
new investments will remain constant in perpetuity. All earnings are distributed at present. A new
investment is available which will cost ₹ 1,75,00,000 in one year’s time and will produce annual cash
inflows thereafter of ₹ 50,00,000. Analyse the effect of the new project on dividend payments and the
share price.
QUESTION NO. 5
The valuation of Hansel Limited has been done by an investment analyst. Based on an expected free
cash flow of ₹ 54 lakhs for the following year and an expected growth rate of 9 percent, the analyst
has estimated the value of Hansel Limited to be ₹ 1800 lakhs. However, he committed a mistake of
using the book values of debt and equity.
The book value weights employed by the analyst are not known, but you know that Hansel Limited
has a cost of equity of 20 percent and post-tax cost of debt of 10 percent.
The value of equity is thrice its book value, whereas the market value of its debt is nine-tenths of its
book value. What is the correct value of Hansel Ltd?
QUESTION NO. 6
Capital structure of Sun Ltd., as at 31.3.2003 was as under: (₹ in Lacs)
Equity share capital 80
8% Preference share capital 40
12% Debentures 64
Reserves 32
Sun Ltd., earns a profit of ₹ 32 Lacs annually on an average before deduction of income-tax, which
works out to 35%, and interest on debentures.
Normal return on equity shares of companies similarly placed is 9.6% provided:
a) Profit after tax covers fixed interest and fixed dividends at least 3 times.
b) Capital gearing ratio is 0.75.
c) Yield on share is calculated at 50% of profits distributed and at 5% on undistributed profits.

 
 
6

Sun Ltd., has been regularly paying equity dividend of 8%.

Compute the value per equity share of the company, taken
(i) 1 % for every one time of difference for Interest and Fixed Dividend Coverage Ratio,
(ii) 2% for every one time of difference for Capital Gearing Ratio.
QUESTION NO. 7
The directors of Implant Inc. wishes to make an equity issue to finance a $10 m (million) expansion
scheme which has an excepted Net Present Value of $2.2m and to re-finance an existing $6 m 15%
Bonds due for maturity in 5 year’s time. For early redemption of these bonds there is a $3,50,000
penalty charges. The Co. has also obtained approval to suspend these pre-emptive rights and make
a $15 m placement of shares which will be at a price of $0.5 per share. The floatation cost of
issue will be 4% of Gross proceeds. Any surplus funds from issue will be invested in IDRs which is
currently yielding 10% per year.
The Present capital structure of Co. is as under:
’000
Ordinary Share ($1 per share) 7,000
Share Premium 10,500
Free Reserves 25,500
43,000
15% Term Bonds 6,000
11% Debenture (2012-2020) 8,000
57,000
Current share price is $2 per share and debenture price is $ 103 per debenture. Cost of capital of
Co. is 10%. It may be further presumed that stock market is semi-strong form efficient and no
information about the proposed use of funds from the issue has been made available to the public.
You are required to calculate expected share price of company once full details of the placement and
to which the finance is to be put, are announced.
QUESTION NO. 8
You are interested in buying some equity stocks of RK Ltd. The company has 3 divisions operating in
different industries. Division A captures 10% of its industries sales which is forecasted to be ₹ 50 crore
for the industry. Division B and C captures 30% and 2% of their respective industry's sales, which are
expected to be ₹ 20 crore and ₹ 8.5 crore respectively. Division A traditionally had a 5% net income
margin, whereas divisions B and C had 8% and 10% net income margin respectively. RK Ltd. has
3,00,000 shares of equity stock outstanding, which sell at ₹ 250.
The company has not paid dividend since it started its business 10 years ago. However from the market
sources you come to know that RK Ltd. will start paying dividend in 3 years’ time and the pay-out ratio
is 30%. Expecting this dividend, you would like to hold the stock for 5 year. By analysing the past financial
statements, you have determined that RK Ltd.'s required rate of return is 18% and that P/E ratio of 10
for the next year and on ending P/E ratio of 20 at the end of the fifth year are appropriate.
Required:
(i) Would you purchase RK Ltd. equity at this time based on your one year forecast?
(ii) If you expect earnings to grow @ 15% continuously, how much are you willing to pay for the stock
of RK Ltd ?
Ignore taxation.
PV factors are given below :
Years 1 2 3 4 5
PVIF@ 18% 0.847 0.718 0.609 0.516 0.437
QUESTION NO. 9
There are two companies ABC Ltd. and XYZ Ltd. are in same in industry. On order to increase its size
ABC Ltd. made a takeover bid for XYZ Ltd.
 
   
7

Equity beta of ABC and XYZ is 1.2 and 1.05 respectively. Risk Free Rate of Return
is 10% and Market Rate of Return is 16%. The growth rate of earnings after tax of ABC Ltd. in recent
years has been 15% and XYZ’s is 12%. Further both companies had continuously followed constant
dividend policy.
Mr. V, the CEO of ABC requires information about how much premium above the current market
price to offer for XYZ’s shares.
Two suggestions have forwarded by merchant bankers.
(i) Price based on XYZ’s net worth as per B/S, adjusted in light of current value of assets and
estimated after tax profit for the next 5 years.
(ii) Price based on Dividend Valuation Model, using existing growth rate estimates. Summarised
Balance Sheet of both companies is as follows.
(₹ In lacs)
ABC Ltd. XYZ Ltd. ABC Ltd. XYZ Ltd.
Equity Share Capital 2,000 1,000 Land & Building 5,600 1,500
General Reserves 4,000 3,000 Plant & Machinery 7,200 2,800
Share Premium 4,200 2,200
Long Term Loans 5,200 1,000
Current Liabilities Current Assets
Sundry Creditors 2,000 1,100 Accounts Receivable 3,400 2,400
Bank Overdraft 300 100 Stock 3,000 2,100
Tax Payable 1,200 400 Bank/Cash 200 400
Dividend Payable 500 400 - -
19,400 9,200 19,400 9,200
Profit & Loss A/c
(₹ In lacs)
ABC XYZ ABC XYZ
Ltd. Ltd. Ltd. Ltd.
To Net Interest 1,200 220 By Net Profit 7,000 2,550
To Taxation 2,030 820
To Distributable Profit 3,770 1,510 - -
7,000 2,550 7,000 2,550
To Dividend 1,130 760 By Distributable Profit 3,770 1,510
To Balance c/d 2,640 750 - -
3,770 1,510 3,770 1,510
Additional information
(1) ABC Ltd.’s land & building have been recently revalued. XYZ Ltd.’s have not been revalued for 4
years, and during this period the average value of land & building have increased by 25% p.a.
(2) The face value of share of ABC Ltd. is ₹ 10 and of XYZ Ltd. is ₹ 25 per share.
(3) The current market price of shares of ABC Ltd. is ₹ 310 and of XYZ Ltd.’s ₹ 470 per share.
With the help of above data and given information you are required to calculate the premium per
share above XYZ’s current share price by two suggested valuation methods. Discuss which of these
two values should be used for bidding the XYZ’s shares.
QUESTION NO. 10
XY Ltd., a Cement manufacturing Company has hired you as a financial consultant of the company. The
Cement Industry has been very stable for some time and the cement companies SK Ltd. & AS Ltd. are
similar in size and have similar product market mix characteristic. Use comparable method to value the
equity of XY Ltd. In performing analysis, use the following ratios:

 
 
8

(i) Market to book value

(ii) Market to replacement cost
(iii) Market to sales
(iv) Market to Net Income
The following data are available for your analysis:
(Amount in ₹)
SK Ltd. AS Ltd. XY Ltd.
Market Value 450 400
Book Value 400 300 250
Replacement Cost 600 550 500
Sales 550 450 500
Net Income 18 16 14

QUESTION NO. 11
Following is the information of M/s. DY Ltd. for the year ending 31/03/2021:
Particulars
Sales ₹ 1000 Lakh
Operating Expenses Including Interest ₹ 620 Lakh
8% Debentures ₹ 250 Lakh
Equity Share Capital (Face value of ₹ 10 each) ₹ 250 Lakh
Reserves and Surplus ₹ 250 Lakh
Market Value of DY Ltd ₹ 900 Lakh
Corporate Tax Rate 30%
Risk free Rate of Return 7%
Market Rate of Return 12%
Equity Beta 1.4
You are required to-
(i) Calculate Weighted Average Cost of Capital of DY Ltd.
(ii) Calculate Economic Value Added
(iii) Calculate Market Value Added

 
   
9

Mergers, Acquisition & Corporate

Restructuring
Study Session 4
QUESTION NO. 1
XYZ Ltd. wants to purchase ABC Ltd. by exchanging 0.7 of its share for each share of ABC Ltd. Relevant
financial data are as follows :
Equity shares outstanding 1000000 400000
EPS (₹) 40 28
Market price per share (₹) 250 160
a) Illustrate the impact of merger on EPS of both the companies.
b) The management of ABC Ltd. has quoted a share exchange ratio of 1 : 1 for the merger. Assuming
that P/E ratio of XYZ Ltd. will remain unchanged after the merger, what will be the gain from
merger for ABC Ltd.?
c) What will be the gain / loss to shareholders of XYZ Ltd. ?
d) Determine the maximum exchange ratio acceptable to shareholders of XYZ Ltd.
QUESTION NO. 2
R Ltd. and S Ltd. operating in same industry are not experiencing any rapid growth but providing a steady
stream of earnings. R Ltd.'s management is interested in acquisition of S. Ltd. due to its excess plant
capacity. Share of S Ltd. is trading in market at ₹ 3.20 each. Other data relating to S Ltd. is as follows:
Balance Sheet of S Ltd.
Liabilities Amount (₹) Assets Amount (₹)
Current Liabilities 1,59,80,000 Current Assets 2,48,75,000
Long Term Liabilities 1,28,00,000 Other Assets 94,00,000
Reserve & Surplus 2,79,95,000 Property Plants & 3,45,00,000
Share Capital Equipment
(80 Lakhs shares of ₹ 1.5 each) 1,20,00,000
Total 6,87,75,000 Total 6,87,75,000

Particulars R Ltd. (₹) S Ltd. (₹) Combined Entity (₹)

Profit after Tax 86,50,000 49,72,000 1,21,85,000
Residual Net Cash Flows per year 90,10,000 54,87,000 1,85,00,000
Required return on equity 13.75% 13.05% 12.5%
You are required to compute the following:
(i) Minimum price per share S Ltd. should accept from R Ltd.
(ii) Maximum price per share R Ltd. shall be willing to offer to S Ltd.
(iii) Floor Value of per share of S Ltd., whether it shall play any role in decision for its acquisition by R Ltd.
QUESTION NO. 3
The following information relating to the acquiring Company A Ltd. and the target Company B Ltd.
are available. Both the Companies are promoted by Multinational Company, Trident Ltd.
The promoter's holding is 50% and 60% respectively in A Ltd. and B Ltd.:

 
 
10

A Ltd. B Ltd.
Share Capital (₹) 200 Lakhs 100 Lakhs
Free Reserves and Surplus (₹) 800 Lakhs 500 Lakhs
Paid up Value per share (₹) 100 10
Free Float Market Capitalization (₹) 400 Lakhs 128 Lakhs
P/E Ratio (times) 10 4
Trident Ltd. is interested to do justice to the shareholders of both the Companies. For the swap ratio
weights are assigned to different parameters by the Board of Directors as follows:
Book Value: 25%
EPS (Earning per share): 50%
Market Price: 25%
a) What is the swap ratio based on above weights?
b) What is the Book Value, EPS and expected Market price of A Ltd. after acquisition of B Ltd.
(assuming P/E. ratio of A Ltd. remains unchanged and all assets and liabilities of B Ltd. are taken
over at book value).
c) Calculate:
(i) Promoter's revised holding in the A Ltd.
(ii) Free float market capitalization,
(iii) Also calculate No. of Shares, Earning per Share (EPS) and Book Value (B.V.), if after acquisition
of B Ltd., A Ltd. decided to:
1. Issue Bonus shares in the ratio of 1:2; and
2. Split the stock (share) as ₹5 each fully paid
QUESTION NO. 4
Given is the following information:
Day Ltd. Night Ltd.
Net Earnings ₹ 5 crores ₹ 3.5 crores
No. of Equity Shares 10,00,000 7,00,000
The shares of Day Ltd. and Night Ltd. trade at 20 and 15 times their respective P/E ratios.
Day Ltd. considers taking over Night Ltd. By paying ₹ 55 crores considering that the market price of
Night Ltd. reflects its true value. It is considering both the following options:
I. Takeover is funded entirely in cash.
II. Takeover is funded entirely in stock.
You are required to calculate the cost of the takeover and advise Day Ltd. on the best alternative.

QUESTION NO. 5
The following is the Balance-sheet of Grape Fruit Company Ltd as on March 31st 2011.
Liabilities Assets (₹ in lacs)
6 lacs equity shares of ₹100/- each 600 Land & Building 200
2 lacs 14% Preference shares of 200 Plant & Machinery 300
₹100/- each
13% Debentures 200 Furnitures & Fixtures 50
Debenture Interest accrued and 26 Inventory 150
Payable
Loan from Bank 74 Sundry debtors 70
Trade Creditors 340 Cash at Bank 130
Preliminary Expenses 10

 
   
11

Cost of Issue of debentures 5

Profit & Loss A/c 525
1440 1440
The Company did not perform well and has suffered sizable losses during the last few years. However,
it is now felt that the company can be nursed back to health by proper financial restructuring and
consequently the following scheme of reconstruction has been devised:
(i) Equity shares are to be reduced to ₹ 25/- per share, fully paid up;
(ii) Preference shares are to be reduced (with coupon rate of 10%) to equal number of shares of ₹50
each fully paid up.
(iii) Debenture holders have agreed to forego interest accrued to them. Beside this, they have agreed
to accept new debentures carrying a coupon rate of 9%.
(iv) Trade creditors have agreed to forgo 25 per cent of the amount due to them.
(v) The company issues 6 lac of equity shares at ₹25/- each and the entire sum was to be paid on
application. The existing shareholders have agreed to subscribe to the new issue.
(vi) While Land and Building is to be revalued at ₹450 lacs, Plant & Machinery is to be written down
to ₹120 lacs. A provision amounting to ₹15 lacs is to be made for bad and doubtful debts.
You are required to
a) Show the impact of financial restructuring/re-construction
b) Prepare the fresh balance sheet after the reconstructions is completed on the basis of the above
proposals.
QUESTION NO. 6
a) Personal Computer Division of Distress Ltd., a computer hardware manufacturing company has
started facing financial difficulties for the last 2 to 3 years. The management of the division headed
by Mr. Smith is interested in a buyout on 1 April 2013. However, to make this buy-out successful
there is an urgent need to attract substantial funds from venture capitalists.
Ven Cap, a European venture capitalist firm has shown its interest to finance the proposed buy-out.
Distress Ltd. is interested to sell the division for ₹ 180 crore and Mr. Smith is of opinion that an
additional amount of ₹ 85 crore shall be required to make this division viable. The expected financing
pattern shall be as follows:
Source Mode Amount (₹ Crore)
Management Equity Shares of ₹ 10 each 60.00
VenCap VC Equity Shares of ₹ 10 each 22.50
9% Debentures with attached warrant of ₹ 100 each 22.50
8% Loan 160.00
Total 265.00
b) The warrants can be exercised any time after 4 years from now for 10 equity shares @ ₹ 120 per
share.
c) The loan is repayable in one go at the end of 8th year. The debentures are repayable in equal
annual installment consisting of both principal and interest amount over a period of 6 years.
d) Mr. Smith is of view that the proposed dividend shall not be kept more than 12.5% of distributable
profit for the first 4 years. The forecasted EBIT after the proposed buyout is as follows:
Year 2013-14 2014-15 2015-16 2016-17
EBIT (₹ crore) 48 57 68 82
e) Applicable tax rate is 35% and it is expected that it shall remain unchanged at least for 5-6 years. In
order to attract VenCap, Mr. Smith stated that book value of equity shall increase by 20% during
above 4 years. Although, VenCap has shown their interest in investment but are doubtful about the
projections of growth in the value as per projections of Mr. Smith. Further VenCap also demanded
that warrants should be convertible in 18 shares instead of 10 as proposed by Mr. Smith.

 
 
12

f) You are required to determine whether or not the book value of equity is expected to grow by 20%
per year. Further if you have been appointed by Mr. Smith as advisor then whether you would suggest
to accept the demand of VenCap of 18 shares instead of 10 or not.
QUESTION NO. 7
ICL is proposing to take over SVL with an objective to diversify. ICL’s profit after tax (PAT) has grown
@ 18 per cent per annum and SVL’s PAT is grown @ 15 per cent per annum. Both the companies
pay dividend regularly. The summarised Profit & Loss Account of both the companies are as follows:
₹ in Crores
Particulars ICL SVL
Net Sales 4,545 1,500
PBlT 2,980 720
Interest 750 25
Provision for Tax 1,440 445
PAT 790 250
Dividends 235 125

ICL SVL
Fixed Assets
Land & Building (Net) 720 190
Plant & Machinery (Net) 900 350
Furniture & Fixtures (Net) 30 1,650 10 550
Current Assets 775 580
Less: Current Liabilities
Creditors 230 130
Overdrafts 35 10
Provision for Tax 145 50
Provision for dividends 60 470 50 240
Net Assets 1,955 890
Paid up Share Capital (₹ 10 per share) 250 125
Reserves and Surplus 1,050 1,300 660 785
Borrowing 655 105
Capital Employed 1,955 890

Market Price Share (₹) 52 75

ICL’s Land & Buildings are stated at current prices. SVL’s Land & Buildings are revalued three years
ago. There has been an increase of 30 per cent per year in the value of Land & Buildings.
SVL is expected to grow @ 18 per cent each year, after merger.
ICL’s Management wants to determine the premium on the shares over the current market price
which can be paid on the acquisition of SVL. You are required to determine the premium using:
(i) Net Worth adjusted for the current value of Land & Buildings plus the estimated average profit
after tax (PAT) for the next five years.
(ii) The dividend growth formula.
(iii) ICL will push forward which method during the course of negotiations?
Period (t) 1 2 3 4 5
FVIF (30%, t) 1.300 1.690 2.197 2.856 3.713
FVIF (15%, t) 1.15 2.4725 3.9938 5.7424 7.7537

 
   
13

QUESTION NO. 8
B Ltd. wants to acquire S Ltd. and has offered a swap ratio of 2 : 3 (2 shares for every 3 share of S Ltd.)
Following information is available:
Particulars B Ltd. S Ltd.
Profit after tax (in ₹) 21,00,000 4,50,000
Equity shares outstanding (Nos.) 6,00,000 1,80,000
EPS (in ₹) 3.5 2.5
PE Ratio 10 times 7 times
Price quoting per share on BSE before the merger
35 17.5
announcement
Required:
(i) The number of equity shares to be issued by B Ltd. for acquisition of S Ltd.
(ii) What is the EPS of B Ltd. after the acquisition?
(iii) Determine the equivalent earnings per share of S Ltd. and calculate per share gain or loss to
shareholders of S Ltd.
(iv) What is the expected market price per share of B Ltd. after the acquisition, assuming its PE Multiple
remains unchanged?
(v) Determine the market value of the merged firm.
(vi) After the announcement of merger, price of shares of S Ltd. rose by 10% on BSE. Mr. X, an investor,
having 10,000 shares of S Ltd. is having another investment opportunity, which yields annual return
of 14% is seeking your advise whether he needs to offload the shares in the market or accept the
shares from B Ltd.
QUESTION NO. 9
The CEO of a company thinks that shareholders always look for EPS. Therefore he considers
maximization of EPS as his company's objective. His company's current Net Profits are ₹ 80.00 lakhs
and P/E multiple is 10.5. He wants to buy another firm which has current income of ₹ 15.75 lakhs
& P/E multiple of 10.
What is the maximum exchange ratio which the CEO should offer so that he could keep EPS at the
current level, given that the current market price of both the acquirer and the target company are ₹
42 and ₹ 105 respectively?
If the CEO borrows funds at 15% and buys out Target Company by paying cash, how much should
he offer to maintain his EPS? Assume tax rate of 30%.

 
 
14

Mutual Funds
Study Session 5
QUESTION NO. 1
Mr. Y has invested in the three mutual funds (MF) as per the following details:
Particulars MF ‘X’ MF ‘Y’ MF ‘Z’
Amount of Investment (₹) 2,00,000 4,00,000 2,00,000
Net Assets Value (NAV) at the time of purchase (₹) 10.30 10.10 10
Dividend Received up to 31.03.2018 (₹) 6,000 0 5,000
NAV as on 31.03.2018 (₹) 10.25 10 10.20
Effective Yield per annum as on 31.03.2018 (percent) 9.66 -11.66 24.15
Assume 1 Year =365 days
Mr. Y has misplaced the documents of his investment. Held him in finding the date of his original
investment after ascertaining the following:
(i) Number of units in each scheme;
(ii) Total NAV;
(iii) Total Yield; and
(iv) Number of days investment held.
QUESTION NO. 2
Mr. X on 1.7.2000, during the initial offer of some Mutual Fund invested in 10,000 units having face
value of ₹ 10 for each unit. On 31.3.2001 the dividend operated by the MF was 10% and Mr. X found
that his annualized yield was 153.33%. On 31.12.2002, 20% dividend was given. On 31.3.2003 Mr.
X redeemed all his balance of 11,296.11 units when his annualized yield was 73.52 %. What are the
NAVs on 31.3.2001, 31.12.2002 and 31.03.2003?
QUESTION NO. 3
On 1st April, an open ended scheme of mutual fund had 300 lakh units outstanding with Net Assets
Value (NAV) of ₹ 18.75. At the end of April, it issued 6 Lakh units at opening NAV plus 2% load,
adjusted for dividend equalization. At the end of May, 3 Lakh units were repurchased at opening NAV
less 2% exit load adjusted for dividend equalization. At the end of June, 70% of its available income
was distributed.
In respect of April - June quarter, the following additional information are available :
₹ in lakh
Portfolio value appreciation 425.470
Income of April 22.950
Income of May 34.425
Income of June 45.450
You are required to calculate :
a) Income available for distribution;
b) Issue price at the end of April,
c) Repurchase price at the end of May, and
d) Net asset value (NAV) as on 30th June.
QUESTION NO. 4
M/S. Corpus an AMC, on 1.04.2015 has floated two schemes viz. Dividend Plan and Bonus Plan. Mr.
X, an investor has invested in both the schemes. The following details (except the issue price) are
available:
 
   
15

Date Dividend (%) Bonus Ratio NAV

Dividend Plan Bonus Plan
1.04.2015 ? ?
31.12.2016 1 :4 (One unit on 4 units 47 40
held)
31.03.2017 12 48 42
31.03.2018 10 50 39
31.12.2018 1 :5 (One unit on 5 units 46 43
held)
31.03.2019 15 45 42
31.03.2020 - - 49 44
Additional details
Investment (₹) ₹ 9,20,000 ₹ 10,00,000
Average Profit (₹) ₹ 27, 748.60
Average Yield (%) 6.40
You are required to calculate the issue price of both the schemes as on 1.04.2015.
QUESTION NO. 5
Mr. Alex, a practicing Chartered Accountant, can earn a return of 15 percent by investing in equity
shares on his own. He is considering a recently announced equity based mutual fund scheme in which
initial expenses are 6 percent and annual recurring expenses are 2 percent.
(i) How much should the mutual fund earn to provide Mr. Alex a return of 15 percent per annum?
(ii) Mr. Alex's current Annual Professional Income is ₹ 40 Lakhs. His portfolio value is ₹ 50 Lakhs and
now he is spending 10% of his time to manage his portfolio. If he spends this time on profession,
his professional income will go up in same proportion. He is thinking to invest his entire portfolio
into a Multicap Fund, assuming the fund's NAV will grow at 13% per annum (including dividend).
You are requested to advise Mr. Alex, whether he can invest the portfolio into Multicap Funds ? If so,
what is the net financial benefit?
QUESTION NO. 6
Based on the following data, estimate the Net Asset Value (NAV) 1st July 2016 on per unit basis of a
Debt Fund:
Name of Face Purchase Maturity No. of Coupon Date(s) Duration
Security Value Price Date Securities of Bonds
₹ ₹
10.71% 100 104.78 31st March, 100000 31st March 7.3494
GOI 2028 2028
10 % 100 100.00 31st March, 50000 31st March & 5.086
GOI 2023 2023 30th September
9.5 % GOI 100 97.93 31st 40000 30th June & 31st 4.3949
2021 December, December
2021
8.5% 100 91.36 30th June 20000 30th June 6.5205
SGL 2025 2025
Number of Units (₹ 10 face value each): 100000
All securities were purchased at a time when applicable Yield to Maturity (YTM) was 10%. On NAV
date, the required yield increased by 75 basis point and Cash in hand and accrued expenses were ₹
6,72,800 and ₹ 2,37,400 respectively.

 
 
16

Derivatives Analysis & Valuation (Futures)

Study Session 6
QUESTION NO. 1
The NSE-50 Index futures are traded with rupee value being ₹ 100 per index point. On 15th
September, the index closed at 1195, and December futures (last trading day December 15) were
trading at 1225. The historical dividend yield on the index has been 3% per annum and the
borrowing rate was 9.5% per annum.
(i) Determine whether on September 15, the December futures were under priced or overpriced?
(ii) What arbitrage transaction is possible to gain out this mispricing?
(iii) Calculate the gains and losses if the index on 15th December closes at (a) 1260 (b) 1175.
Assume 365 days in a year for your calculations.
QUESTION NO. 2
The Following data relate to A Ltd.’s Portfolio:
Shares X Ltd. Y Ltd. Z Ltd.
No. of Shares (lakh) 6 8 4
Price per share (₹) 1000 1500 500
Beta 1.50 1.30 1.70
The CEO is of opinion that the portfolio is carrying a very high risk as compared to the market risk
and hence interested to reduce the portfolio’s systematic risk to 0.95. Treasury Manager has
suggested two below mentioned alternative strategies:
(i) Dispose off a part of his existing portfolio to acquire risk free securities, or
(ii) Take appropriate position on Nifty Futures, currently trading at 8250 and each Nif ty points
multiplier is ₹ 210.
You are required to:
(a) Interpret the opinion of CEO, whether it is correct or not.
(b) Calculate the existing systematic risk of the portfolio,
(c) Advise the value of risk-free securities to be acquired,
(d) Advise the number of shares of each company to be disposed off,
(e) Advise the position to be taken in Nifty Futures and determine the number of Nifty contracts to
be bought/sold; and
(f) Calculate the new systematic risk of portfolio if the company has taken position in Nifty Futures
and there is 2% rise in Nifty.
Note: Make calculations in ₹ lakh and upto 2 decimal points.
QUESTION NO. 3
A is an investor and having in its Portfolio Shares worth ₹ 1,20,00,000 at current price and Cash ₹
10,00,000. The Beta (β) of Share Portfolio is 1.4. After four months the price of shares dropped by
1.8%.
You are required to determine:
(i) Current Portfolio Beta and
(ii) Portfolio Beta after four months-if A on current date goes for long position on ₹ 1,30,00,000
Nifty futures.
QUESTION NO. 4
Mr. X, is a Senior Portfolio Manager at ABC Asset Management Company. He expects to purchase a
portfolio of shares in 90 days. However he is worried about the expected price increase in shares in
coming day and to hedge against this potential price increase he decides to take a position on a 90-
 
   
17

day forward contract on the Index. The index is currently trading at 2290. Assuming that the
continuously compounded dividend yield is 1.75% and risk free rate of interest is 4.16%, you are
required to determine:
(a) Calculate the justified forward price on this contract.
(b) Suppose after 28 days of the purchase of the contract the index value stands at 2450 then
determine gain/ loss on the above long position.
(c) If at expiration of 90 days the Index Value is 2470 then what will be gain on long position.
Note: Take 365 days in a year and value of e0.005942 = 1.005960, e0.001849 = 1.001851.
QUESTION NO. 5
A company is long on 10 MT of copper @ ₹ 474 per kg (spot) and intends to remains so for the
ensuing quarter. The standard deviation of changes of its spot and future prices are 4% and 6%
respectively, having correlation coefficient of 0.75.
What is its hedge ratio? What is the amount of the copper future it should short to achieve a perfect
hedge?
QUESTION NO. 6
Mr. SG sold five 4-Month Nifty Futures on 1st February 2020 for ₹ 9,00,000. At the time of closing of
trading on the last Thursday of May 2020 (expiry), Index turned out to be 2100. The contract multiplier
is 75.
Based on the above information calculate:
(i) The price of one Future Contract on 1st February 2020.
(ii) Approximate Nifty Sensex on 1st February 2020 if the Price of Future Contract on same date
was theoretically correct. On the same day Risk Free Rate of Interest and Dividend Yield on Index
was 9% and 6% p.a. respectively.
(iii) The maximum Contango/ Backwardation.
(iv) The pay-off of the transaction.
Note: Carry out calculation on month basis.

 
 
18

Derivatives Analysis & Valuation (Options)

Study Session 7
QUESTION NO. 1
Mr. X established the following spread on the Delta Corporation's stock
(i) Purchased one 3-month call option with a premium of ₹ 30 and an exercise price of ₹ 550.
(ii) Purchased one 3-month put option with a premium of ₹ 5 and an exercise price of ₹ 450.
Delta Corporation's stock is currently selling at ₹ 500. Determine profit or loss, if the price of Delta
Corporation’s:
(i) Remains at ₹ 500 after 3 months.
(ii) Falls at ₹ 350 after 3 months.
(iii) Rises to ₹ 600. Assume the size option is 100 shares of Delta Corporation.
QUESTION NO. 2
You as an investor had purchased a 4 month call option on the equity shares of X Ltd. of ₹ 10, of which
the current market price is ₹ 132 and the exercise price ₹ 150. You expect the price to range between ₹
120 to ₹ 190.
The expected share price of X Ltd. and related probability is given below:
Expected Price (₹) 120 140 160 180 190
Probability .05 .20 .50 .10 .15
Compute the following:
a) Expected Share price at the end of 4 months.
b) Value of Call Option at the end of 4 months, if the exercise price prevails.
c) In case the option is held to its maturity, what will be the expected value of the call option?
QUESTION NO. 3
Spot Price is ₹ 60. A One year European Call Option is being quoted in the market at option premium
of ₹ 15 with Exercise Price of ₹ 55. Risk Free Rate of return is 12% p.a.The stock can either rise or fall
after a year. If it can fall by 30% by what percentage (%) can it rise?
QUESTION NO. 4
A two year tree for a share of stock in ABC Ltd., is as follows:

Consider a two years American call option on the stock of ABC Ltd., with a strike price of ₹ 98. The
current price of the stock is ₹ 100. Risk free return is 5 per cent per annum with a continuous
compounding and e0.05 = 1.05127.
 
   
19

Assume two time periods of one year each.

Using the Binomial Model, calculate:
(i) The probability of price moving up and down;
(ii) Expected pay offs at each nodes i.e. N1, N2 and N3 (round off upto 2 decimal points).
QUESTION NO. 5
AB Ltd.'s equity shares are presently selling at a price of ₹ 500 each. An investor is interested in purchasing AB
Ltd.'s shares. The investor expects that there is a 70% chance that the price will go up to ₹ 650 or a 30% chance
that it will go down to ₹ 450, three months from now. There is a call option on the shares of the firm that can
be exercised only at the end of three months at an exercise price of ₹ 550.
Calculate the following:
(i) If the investor wants a perfect hedge, what combination of the share and option should he select ?
(ii) Explain how the investor will be able to maintain identical position regardless of the share price.
(iii) If the risk-free rate of return is 5% for the three months period, what is the value of the option at the
beginning of the period ?
(iv) What is the expected return on the option?
QUESTION NO. 6
From the following data for certain stock, find the value of a call option:
Price of stock now = ₹ 80
Exercise price = ₹ 75
Standard deviation of continuously compounded annual return = 0.40
Maturity period = 6 months
Annual interest rate = 12%
Given
Number of S.D. from Mean, (z) Area of the left or right (one tail)
0.25 0.4013
0.30 0.3821
0.55 0.2912
0.60 0.2743
e 0.12x0.5 = 1.062
In 1.0667 = 0.0646

 
 
20

Foreign Exchange Exposure & Risk

Management
Study Session 8
QUESTION NO. 1
The risk free rate of interest rate in USA is 8% p.a. and in UK is 5% p.a. The spot exchange rate between
US $ and UK £ is 1$ = £ 0.75.
Assuming that is interest is compounded on daily basis then at which forward rate of 2 year there will be
no opportunity for arbitrage.
Further, show how an investor could make risk-less profit, if two year forward price is 1 $
= 0.85 £.
Given e-0. 06 = 0.9418 & e-0.16 = 0.8521, e0.16 = 1.1735, e-0.1 = 0.9048
QUESTION NO. 2
On 1st January 2019 Global Ltd., an exporter entered into a forward contract with BBC Bank to sell
US$ 2,00,000 on 31st March 2019 at ₹ 71.50/$. However, due to the request of the importer, Global
Ltd. received the amount on 28 February 2019. Global Ltd. requested the Bank to take delivery of the
remittance on 2nd March 2019. The Inter- banking rates on 28th February were as follows:
Spot Rate ₹ 71.20/71.25
One month premium 5/10
If Bank agrees to take early delivery then what will be the net inflow to Global Ltd. assuming that the
prevailing prime lending rate is 15%. Assume 365 days in a year.
QUESTION NO. 3
On 10th July, an importer entered into a forward contract with bank for US $ 50,000 due on 10th
September at an exchange rate of ₹ 66.8400. The bank covered its position in the interbank market at
₹ 66.6800.
How the bank would react if the customer requests on 20th September:
(i) to cancel the contract?
(ii) to execute the contract?
(iii) to extend the contract with due date to fall on 10th November?
The exchange rates for US$ in the interbank market were as below:
10th September 20th September
Spot US$1 = 66.1500/1700 65.9600/9900
Spot/September 66.2800/3200 66.1200/1800
Spot/October 66.4100/4300 66.2500/3300
Spot/November 66.5600/6100 66.4000/4900
Exchange margin was 0.1% on buying and selling.
Interest on outlay of funds was 12% p.a.
You are required to show the calculations to:
a) cancel the Contract,
b) execute the Contract, and
c) extend the Contract as above.

 
   
21

QUESTION NO. 4
NP and Co. has imported goods for US $ 7,00,000. The amount is payable after three months. The
company has also exported goods for US $ 4,50,000 and this amount is receivable in two months. For
receivables amount a forward contract is already taken at ₹ 48.90.
The market rates for ₹ and Dollar are as under:
Spot ₹ 48.50/70
Two months 25/30 points
Three months 40/45 points
The company wants to cover the risk and it has two options as under:
a) To cover payables in the forward market and
b) To lag the receivables by one month and cover the risk only for the net amount. No interest for
delaying the receivables is earned. Evaluate both the options if the cost of Rupee Funds is 12%. Which
option is preferable?
QUESTION NO. 5
JKL Ltd., an Indian company has an export exposure of JPY 10,000,000 payable August 31, 2014.
Japanese Yen (JPY) is not directly quoted against Indian Rupee.
The current spot rates are:
INR/US $ ₹ 62.22
JPY/US$ JPY 102.34
It is estimated that Japanese Yen will depreciate to 124 level and Indian Rupee to depreciate against US
$ to ₹ 65.
Forward rates for August 2014 are
INR/US $ ₹ 66.50
JPY/US$ JPY 110.35
Required:
Calculate the expected loss, if the hedging is not done. How the position will change, if the firm takes
forward cover?
If the spot rates on August 31, 2014 are:
INR/US $ ₹ 66.25
JPY/US$ JPY 110.85
Is the decision to take forward cover justified?
QUESTION NO. 6
You have following quotes from Bank A and Bank B :
Bank A Bank B
SPOT USD/CHF 1.4650/55 USD/CHF 1.4653/60
3 months 5/10
6 months 10/15
SPOT GBP/USD 1.7645/60 GBP/ USD 1.7640/50
3 months 25/20
6 months 35/25
Calculate:
a) How much minimum CHF amount you have to pay for 1 Million GBP spot ?
b) Considering the quotes from Bank A only, for GBP/CHF what are the Implied Swap points for Spot
over 3 months?

 
 
22

QUESTION NO. 7
Your bank’s London office has surplus funds to the extent of US$ 500000 for a period of 3 months. The
cost of funds to the bank is 4 % p.a. It proposes to invest these funds in London, New York or Frankfurt
and obtain the best yield, without any exchange risk to the bank. The following rates of interest are
available at the three centres of domestic funds there at for a period of 3 months.
London 5 % p.a.
New York 8 % p.a.
Frankfurt 3% p.a.
The market rates in London for US dollars and EURO are as under:
London on New York
Spot 1.5350/90
1 month 15/18
2 months 30/35
3 months 80/85
London on Frankfurt
Spot 1.8260/90
1 month 60/55
2 months 95/90
3 months 145/140
At which centre, will the investment be made & what will be the net gain (to the nearest pound) to the
bank on the invested funds?
QUESTION NO. 8
DSE Ltd. is an export oriented business in Kolkata. DSE Ltd. invoices in customers currency. Its receipts
of US $ 3,00,000 is due on July 1st, 2019.
Market information as at April 1st 2019
Exchange Rates Currency Futures
US $/₹ US $/₹
Spot 0.0154 April 0.0155 Contract Size = ₹ 6,40,000/-
1 Month Forward 0.0150 July 0.0151
3 Months Forward 0.0147

Initial Margin Interest Rates in India

April ₹ 13,000 9%
July ₹ 24,000 8.50%
On July, the spot rate US $/₹ is 0.0146 and currency future rate is 0.0147 Comment which of the
following methods would be most advantageous for DSE Ltd.
(i) Using forward contract.
(ii) Using currency futures
(iii) Not hedging currency risks.
It may be assumed that variation in margin would be settled on the maturity of the futures contract.
QUESTION NO. 9
Best of Luck Ltd. London will have to make a payment of $ 3,64,897 in six months’ time. The company
is considering the various choices it has in order to hedge its transaction exposure.
Exchange rates:
Spot rate $1.5617-1.5673
Six month forward rate $1.5455-1.5609

 
   
23

Money Market rates:

Borrow (%) Invest (%)

US 6 4.5
UK 7 5.5

Foreign currency option prices (1 unit is £12,500):

Exercise price Call option (March) Put option (March)

$ 1.70 $ 0.037 $ 0.096
By making the appropriate calculations decide which of the following hedging alternatives is the most
attractive to Best of Luck Ltd:
a) Forward market
b) Money market Cover
c) Currency options
QUESTION NO. 10
With the relaxation of investment norms in India in international market upto $ 2,50,000 Mr. X to
hedge himself against the risk of declining Indian economy and weakening of Indian Rupee during last
few year decided to diversify into International Market.
Accordingly, Mr. X invested a sum of ₹ 1.58 crore on 1.1.20x1 in Standard & Poor Index. On 1.1.20x2
Mr. X sold his investment. The other relevant data is given below:
1.1.20x1 1.1.20x2
Index of Stock Market in India 7395 ?
Standard & Poor Index 2028 1919
Exchange Rate 62.00/62.25 67.25/67.50
You are required to:
(i) Determine the return for a US investor.
(ii) Determine return of Mr. X of holding period.
(iii) Determine the value of Index of Stock Market in India as on 1.1.20x2 at which Mr. X would be
indifferent between investment in Standard & Poor Index and Indian Stock Market.
QUESTION NO. 11
A German subsidiary of an US based MNC has to mobilize 100000 Euro's working capital for the next
12 months. It has the following options:
Loan from German Bank : @ 5% p.a.
Loan from US Parent Bank : @ 4% p.a.
Loan from Swiss Bank : @ 3% p.a.
Banks in Germany charge an additional 0.25% p.a. towards loan servicing. Loans from outside Germany
attract withholding tax of 8% on interest payments. If the interest rates given above are market
determined, examine which loan is the most attractive using interest rate differential.
QUESTION NO. 12
You as a dealer in foreign exchange have the following position in Swiss Francs on 31st October, 2009:
Swiss Francs (SF)
Balance in the Nostro A/c Credit 1,00,000
Opening Position Overbought 50,000
Purchased a bill on Zurich 80,000
Sold forward TT 60,000
 
 
24

Forward purchase contract cancelled 30,000

Remitted by TT 75,000
Draft on Zurich cancelled 30,000
What steps would you take, if you are required to maintain a credit Balance of Swiss Francs 30,000 in
the Nostro A/c and keep as overbought position on Swiss Francs 10,000?
QUESTION NO. 13
K Ltd. currently operates from 4 different buildings and wants to consolidate its operations into one
building which is expected to cost ₹ 90 crores. The Board of K Ltd. had approved the above plan and
to fund the above cost, agreed to avail an External Commercial Borrowing (ECB) of GBP 10 m from
G Bank Ltd. on the following conditions:
• The Loan will be availed on 1st April, 2019 with interest payable on half yearly rest.
• Average Loan Maturity life will be 3.4 years with an overall tenure of 5 years.
• Upfront Fee of 1.20%.
• Interest Cost is GBP 6 months LIBOR + Margin of 2.50%.
• The 6 month LIBOR is expected to be 1.05%.
K Ltd. also entered into a GBP-INR hedge at 1 GBP = INR 90 to cover the exposure on account of the
above ECB Loan and the cost of the hedge is coming to 4.00% p.a.
As a Finance Manager, given the above information and taking the 1 GBP = INR 90:
(i) Calculate the overall cost both in percentage and rupee terms on an annual basis.
(ii) What is the cost of hedging in rupee terms?
(iii) If K Ltd. wants to pursue an aggressive approach, what would be the net gain/loss for K Ltd.
if the INR depreciates/appreciates against GBP by 10% at the end of the 5 years assuming
that the loan is repaid in GBP at the end of 5 years?
Ignore time value and taxes and calculate to two decimals.
QUESTION NO. 14
On 1st February 2020, XYZ Ltd. a laptop manufacturer imported a particular type of Memory Chips
from SKH Semiconductor of South Korea. The payment is due in one month from the date of Invoice,
amounting to 1190 Million South Korean Won (SKW). Following Spot Exchange Rates (1st February)
are quoted in two different markets:
USD/ INR 75.00/ 75.50 in Mumbai
USD/ SKW 1190.00/ 1190.75 in New York
Since hedging of Foreign Exchange Risk was part of company’s strategic policy and no contract for
hedging in SKW was available at any in-shore market, it approached an off-shore Non- Deliverable
Forward (NDF) Market for hedging the same risk.
In NDF Market a dealer quoted one-month USD/ SKW at 1190.00/1190.50 for notional amount of
USD 100,000 to be settled at reference rate declared by Bank of Korea.
After 1 month (1st March 2020) the dealer agreed for SKW 1185/ USD as rate for settlement and on
the same day the Spot Rates in the above markets were as follows:
USD/ INR 75.50/ 75.75 in Mumbai
USD/ SKW 1188.00/ 1188.50 in New York
Analyze the position of company under each of the following cases, comparing with Spot Position of
1st February:
(i) Do Nothing.
(ii) Opting for NDF Contract.
Note: Both ₹/ SKW Rate and final payment (to be computed in ₹ Lakh) to be rounded off upto 4
decimal points.

 
   
25

QUESTION NO. 15
A US investor chose to invest in Sensex for a period of one year. The relevant information is given
below.
Size of investment ($) 20,00,000
Spot rate 1year ago (₹/$) 42.50/60
Spot rate now (₹/$) 43.85/90
Sensex 1 year ago 3,256
Senex now 3,765
Inflation in US 5%
Inflation in India 9%
(i) Compute the nominal rate of return to the US investor.
(ii) Compute the real depreciation /appreciation of Rupee.
(iii) What should be the exchange rate if relevant purchasing power parity holds good?
(iv) What will be the real return to an Indian investor in Sensex?
QUESTION NO. 16
M/s. Sky products Ltd., of Mumbai, an exporter of sea foods has submitted a 60 days bill for EUR
5,00,000 drawn under an irrevocable Letter of Credit for negotiation. The company has desired to
keep 50% of the bill amount under the Exchange Earners Foreign Currency Account (EEFC). The rates
for ₹/USD and USD/EUR in inter-bank market are quoted as follows:

₹/ USD USD/EUR
Spot 67.8000 - 67.8100 1.0775 - 1.8000
1 month forward 10/11 Paise 0.20/0.25 Cents
2 months forward 21/22 Paise 0.40/0.45 Cents
3 months forward 32/33 Paise 0.70/0.75 Cents
Transit Period is 20 days. Interest on post shipment credit is 8 % p.a. Exchange Margin is 0.1%. Assume
365 days in a year.
You are required to calculate:
(i) Exchange rate quoted to the company
(ii) Cash inflow to the company
(iii) Interest amount to be paid to bank by the company.
QUESTION NO. 17
You, a foreign exchange dealer of your bank, are informed that your bank has sold a T.T. on Corporation
for Danish Kroner 10,00,000 at the rate of Danish Kroner 1 = ₹ 6.5150, You are required to cover the
transaction either in London or New York market.
The rates on that date are as under:
Mumbai- London ₹ 74.3000 — ₹ 74.3200
Mumbai – New York ₹ 49.2500 — ₹ 49.2625
London- Copenhagen DKK 11.4200 — DKK 11.4350
New York- Copenhagen DKK 07.5670 — DKK 07.5840
In which market will you cover the transaction, London or New York, and what will be the exchange
profit or loss on the transaction? Ignore brokerages.
QUESTION NO. 18
ABC Ltd. of UK has exported goods worth Can $ 5,00,000 receivable in 6 months. The exporter wants to
hedge the receipt in the forward market. The following information is available:
Spot Exchange Rate Can $ 2.5/£
 
 
26

Interest Rate in UK 12%

Interest Rate In Canada 15%
The forward rates truly reflect the interest rates differential. Find out the gain/loss to UK exporter if Can $
spot rates (i) declines 2%, (ii) gains 4% or (iii) remains unchanged over next 6 months.
QUESTION NO. 19
An importer customer of your bank wishes to book a forward contract with your bank on 3rd September
for sale to him of SGD 5,00,000 to be delivered on 30th October.
The spot rates on 3rd September are USD/INR 49.3700/3800 and USD/SGD 1.7058/68. The swap
points are:
USD / INR USD/SGD
Spot/September 0300/0400 1st month forward 48/49
Spot/October 1100/1300 2nd month forward 96/97
Spot/November 1900/2200 3rd month forward 138/140
Spot/December 2700/3100
Spot/January 3500/4000
Calculate the rate to be quoted to the importer by assuming an exchange margin of 5 paisa.

 
   
27

Interest Rate Risk Management

Study Session 9
QUESTION NO. 1
The following market data is available:
Spot USD/JPY 116.00
Deposit rates p.a. USD JPY
3 months 4.50% 0.25%
6 months 5.00% 0.25%
Forward Rate Agreement (FRA) for Yen is Nil.
a) What should be 3 months FRA rate at 3 months forward?
b) The 6 & 12 months LIBORS are 5% & 6.5% respectively.
c) A bank is quoting 6/12 USD FRA at 6.50 - 6.75%. Is any arbitrage opportunity available? Calculate
profit in such case.
QUESTION NO. 2
An Indian company obtains the following quotes (₹/$)
Spot: 35.90/36.10
3 - Months forward rate: 36.00/36.25
6 - Months forward rate: 36.10/36.40
The company needs $ funds for six months. Determine whether the company should borrow in $ or
₹ Interest rates are :
3 - Months interest rate : ₹ : 12%, $ : 6%
6 - Months interest rate : ₹ : 11.50%, $ : 5.5%
Also determine what should be the rate of interest after 3-months to make the company indifferent
between 3-months borrowing and 6-months borrowing in the case of:
(i) Rupee borrowing
(ii) Dollar borrowing
Note: For the purpose of calculation you can take the units of dollar and rupee as 100 each.
QUESTION NO. 3
A Inc. and B Inc. intend to borrow $ 200,000 and $ 200,000 in ¥ respectively for a time horizon of one
year. The prevalent interest rates are as follows:
Company ¥ Loan $ Loan
A Inc 5% 9%
B Inc 8% 10%
The prevalent exchange rate is $1 = ¥120.
They entered in a currency swap under which it is agreed that B Inc will pay A Inc @ 1% over the ¥ Loan
interest rate which the later will have to pay as a result of the agreed currency swap whereas A Inc will
reimburse interest to B Inc only to the extent of 9%. Keeping the exchange rate invariant, quantify the
opportunity gain or loss component of the ultimate outcome, resulting from the designed currency swap.
QUESTION NO. 4
XYZ Inc. having a £ 10 million floating rate loan on July 1, 2013 with resetting of coupon rate every 6
months equal to LIBOR + 50 bp. XYZ is interested in a collar strategy by selling a Floor and buying a
Cap. XYZ buys the 3 years Cap and sell 3 years Floor as per the following details on July 1, 2013:

 
 
28

Notional Principal Amount $ 10 million

Reference Rate 6 months LIBOR
Strike Rate 4% for Floor and 7% for Cap
Premium 0*
*Since Premium paid for Cap = Premium received for Floor
Using the following data you are required to determine:
(i) Effective interest paid out at each reset date,
(ii) The average overall effective rate of interest p.a.
Reset Period LIBOR (%)
31-12-2013 6.00
30-06-2014 7.50
31-12-2014 5.00
30-06-2015 4.00
31-12-2015 3.75
30-06-2016 4.25
QUESTION NO. 5
TMC Holding Ltd. has a portfolio of shares of diversified companies valued at ₹ 400 crore enters into a
swap arrangement with None Bank on the terms that it will get 1.15% quarterly on notional principal of
₹ 400 crore in exchange of return on portfolio which is exactly tracking the Sensex which is presently
21600.
You are required to determine the net payment to be received/ paid at the end of each quarter if Sensex
turns out to be 21860, 21780, 22080 and 21960.
QUESTION NO. 6
The Treasury desk of a global bank incorporated in UK wants to invest GBP 200 million on 1st January,
2019 for a period of 6 months and has the following options:
(1) The Equity Trading desk in Japan wants to invest the entire GBP 200 million in high dividend
yielding Japanese securities that would earn a dividend income of JPY 1,182 million. The
dividends are declared and paid on 29th June. Post dividend, the securities are expected to
quote at a 2% discount. The desk also plans to earn JPY 10 million on a stock borrow lending
activity because of this investment. The securities are to be sold on June 29 with a T+1 settlement
and the amount remitted back to the Treasury in London.
(2) The Fixed Income desk of US proposed to invest the amount in 6 month G-Secs that provides a
return of 5% p.a.
The exchange rates are as follows:
Currency Pair 1-Jan-2019 (Spot) 30-Jun-2019 (Forward)
GBP-JPY 148.0002 150.0000
GBP- USD 1.28000 1.30331
QUESTION NO. 7
IB an Indian firm has its subsidiary in Japan and Zaki a Japanese firm has its subsidiary in India and
face the following interest rates:
Company IB Zaki
INR floating rate BPLR + 0.50% BPLR + 2.50%
JPY (Fixed rate) 2% 2.25%
Zaki wishes to borrow Rupee Loan at a floating rate and IB wishes to borrow JPY at a fixed rate. The
amount of loan required by both the firms is same at the current exchange rate. A financial institution

 
   
29

may arrange a swap and requires 25 basis points as its commission. Gain, if any, is to be shared by
the firms equally.
You are required to find out:
(i) Whether a swap can be arranged which may be beneficial to both the firms?
(ii) What rate of interest will the firms end up paying?

 
 
30

BOND VALUATION
Study Session 10
QUESTION NO. 1
MP Ltd. issued a new series of bonds on January 1,2000. The bonds were sold at par (₹ 1,000), having
a coupon rate 10% p.a. and mature on 31st December, 2015. Coupon payments are made semi-
annually on June 30th and December 31st each year. Assume that you purchased an outstanding MP
Ltd. Bond on 1st March, 2008 when the going interest rate was 12%.
Required:
a) What was the YTM of MP Ltd. Bonds as on January 1, 2000?
b) What amount you should pay to complete the transaction for purchasing the bond on 1st March
2008 ? Of that amount how much should be accrued interest and how much would represent bonds
basic value.
QUESTION NO. 2
XL Ispat Ltd. has made an issue of 14 per cent non-convertible debentures on January 1, 2007. These
debentures have a face value of ₹ 100 and is currently traded in the market at a price of ₹ 90.
Interest on these NCDs will be paid through post-dated cheques dated June 30 and December
31. Interest payments for the first 3 years will be paid in advance through post-dated cheques while for
the last 2 years post-dated cheques will be issued at the third year. The bond is redeemable at par on
December 31, 2011 at the end of 5 years.
Required :
(i) Estimate the current yield and YTM of the bond.
(ii) Calculate the duration of the NCD.
(i) Assuming that intermediate coupon payments are, not available for reinvestment calculate the
realised yield on the NCD.
QUESTION NO. 3
The following data is related to 8.5% Fully Convertible (into Equity shares) Debentures issued by JAC Ltd.
at ₹ 1000.
Market Price of Debenture ₹ 900
Conversion Ratio 30
Straight Value of Debenture ₹ 700
Market Price of Equity share on the date of Conversion ₹ 25
Expected Dividend Per Share ₹1
You are required to calculate:
a) Conversion Value of Debenture
b) Market Conversion Price
c) Conversion Premium per share
d) Ratio of Conversion Premium
e) Premium over Straight Value of Debenture
f) Favourable income differential per share
g) Premium pay back period
QUESTION NO. 4
M/s. Earth Limited has 11% bond worth of ₹ 2 Crores outstanding with 10 years remaining to maturity.
The company is contemplating the issue of a ₹ 2 Crores 10 year bond carrying the coupon rate of 9%
and use the proceeds to liquidate the old bonds.

 
   
31

The unamortized portion of issue cost on the old bonds is ₹ 3 lakhs which can be written off no sooner
the old bonds are called. The company is paying 30% tax and it's after tax cost of debt is 7%. Should
Earth Limited liquidate the old bonds?
You may assume that the issue cost of the new bonds will be ₹ 2.5 lakhs and the call premium is 5%.
QUESTION NO. 5
The following is the Yield structure of AAA rated debenture:
Period (or Maturity) Yield (%)
3 months 8.5%
6 months 9.25
1 year 10.50
2 years 11.25
3 years and above 12.00
a) Based on the expectation theory calculate the implicit one-year forward rates in year 2 and year 3.
b) If the interest rate increases by 50 basis points, what will be the percentage change in the price of
the bond having a maturity of 5 years? Assume that the bond is fairly priced at the moment at ₹
1,000.
QUESTION NO. 6
The following data are available for three bonds A, B and C. These bonds are used by a bond portfolio
manager to fund an outflow scheduled in 6 years. Current yield is 9%. All bonds have face value of ₹100
each and will be redeemed at par. Interest is payable annually.
Bond Maturity (Years) Coupon rate
A 10 10%
B 8 11%
C 5 9%
(i) Calculate the duration of each bond.
(ii) The bond portfolio manager has been asked to keep 45% of the portfolio money in Bond A.
Calculate the percentage amount to be invested in bonds B and C that need to be purchased to
immunise the portfolio.
(iii) After the portfolio has been formulated, an interest rate change occurs, increasing the yield to 11%.
The new duration of these bonds are: Bond A = 7.15 Years, Bond B = 6.03 Years and Bond C =
4.27 years.
Is the portfolio still immunized? Why or why not?
(iv) Determine the new percentage of B and C bonds that are needed to immunize the portfolio. Bond
A remaining at 45% of the portfolio.
Present values be used as follows :
Present Values t1 t2 t3 t4 t5
PVIF0.09, t 0.917 0.842 0.772 0.708 0.650
t6 t7 t8 t9 t10
PVIF0.09, t 0.596 0.547 0.502 0.460 0.4224
QUESTION NO. 7
The following data are available for a bond:
Face Value ₹ 10,000 to be redeemed at par on maturity
Coupon rate 8.5 per cent per annum
Years to Maturity 5 years
Yield to Maturity (YTM) 10 per cent You are required to calculate:
(i) Current market price of the Bond,

 
 
32

(ii) Macaulay’s Duration,

(iii)Volatility of the Bond,
(iv) Convexity of the Bond,
(v) Expected market price, if there is a decrease in the YTM by 200 basis points
(a) By Macaulay’s Duration based estimate
(b) By Intrinsic Value Method.
Given
Years 1 2 3 4 5
PVIF (10%, n) 0.909 0.826 0.751 0.683 0.621
PVIF (8%, n) 0.926 0.857 0.794 0.735 0.681
QUESTION NO. 8
In March 2020, XYZ Bank sold some 7% Interest Rate Futures underlying Notional 7.50% Coupon
Bonds. The exchange provides following details of eligible securities that can be delivered:
Security Quoted Price of Bonds Conversion Factor
7.96 GOI 2023 1037.40 1.0370
6.55 GOI 2025 926.40 0.9060
6.80 GOI 2029 877.50 0.9195
6.85 GOI 2026 972.30 0.9643
8.44 GOI 2027 1146.30 1.1734
8.85 GOI 2028 1201.70 1.2428
Recommend the Security that should be delivered by the XYZ Bank if Future Settlement Price is 1000.
QUESTION NO. 9
ABC Ltd. wants to issue 9% Bonds redeemable in 5 years at its face value of ₹ 1,000 each. The annual
spot yield curve for similar risk class of Bond is as follows:
Year Interest Rate
1 12%
2 11.62%
3 11.33%
4 11.06%
5 10.80%
(i) Evaluate the expected market price of the Bond if it has a Beta value of 1.10 due to its popularity
because of lesser risk.
(ii) Interpret the nature of the above yield curve and reasons for the same.
Note: Use PV Factors upto 4 decimal points and value in ₹ upto 2 decimal points.

 
   
33

Portfolio Management
Study Session 11
QUESTION NO. 1
B Ltd. has been enjoying a substantial net cash inflow and until the surplus funds are needed to meet
tax and dividend payments, and to finance further capital expenditure in several months’ time, they have
been invested in a small portfolio of short - term equity investments. Details of the portfolio, which
consists of shares in four companies, are as follows:
Company No. of Shares Equity Beta M.P.S. (₹) Dividend Yield
Held
D Ltd. 60,000 1.16 4.29 19.5%
E Ltd. 80,000 2.28 2.92 24.0%
F Ltd. 1,00,000 0.90 2.17 17.5%
G Ltd. 1,25,000 1.50 3.14 26.0%
The current market return is 19% per year and the risk free rate is 11% per year.
a) On the basis of the data given, calculate the risk of short-term investment portfolio relative to that of
the market.
b) Recommend with reasons whether B Ltd. should change the composition of its portfolio.
QUESTION NO. 2
There are two Mutual Funds viz. D Mutual Fund Ltd. and K Mutual Fund Ltd. Each having close ended
equity schemes.
NAV as on 31-12-2014 of equity schemes of D Mutual Fund Ltd. is ₹70.71 (consisting 99% equity and
remaining cash balance) and that of K Mutual Fund Ltd. is 62.50 (consisting 96% equity and balance in
cash).
Following is the other information:
Particular Equity Schemes
D Mutual Fund Ltd. K Mutual Fund Ltd.
Sharpe Ratio 2 3.3
Treynor Ratio 15 15
Standard deviation 11.25 5
There is no change in portfolios during the next month and annual average cost is ₹ 3 per unit for the
schemes of both the Mutual Funds.
If Share Market goes down by 5% within a month, calculate expected NAV after a month for the schemes
of both the Mutual Funds.
For calculation, consider 12 months in a year and ignore number of days for particular month.
QUESTION NO. 3
Mr. Abhishek is interested in investing ₹ 2,00,000 for which he is considering following three alternatives:
(i) Invest ₹ 2,00,000 in Mutual Fund X (MFX)
(ii) Invest ₹ 2,00,000 in Mutual Fund Y (MFY)
(iii) Invest ₹ 1,20,000 in Mutual Fund X (MFX) and ₹ 80,000 in Mutual Fund Y (MFY)
Average annual return earned by MFX and MFY is 15% and 14% respectively. Risk free rate of return is
10% and market rate of return is 12%.
Covariance of returns of MFX, MFY and market portfolio Mix are as follow:
MFX MFY Mix
MFX 4.800 4.300 3.370
 
 
34

MFY 4.300 4.250 2.800

Mix 3.370 2.800 3.100
You are required to calculate:
a) Variance of return from MFX, MFY and market return,
b) Portfolio return, beta, portfolio variance and portfolio standard deviation,
c) Expected return, systematic risk and unsystematic risk; and
d) Sharpe ratio, Treynor ratio and Alpha of MFX, MFY and Portfolio Mix
QUESTION NO. 4
Mr. X owns a portfolio with the following characteristics:
Risk Free
Security A Security B
Security
Factor 1 sensitivity 0.80 1.50 0
Factor 2 sensitivity 0.60 1.20 0
Expected Return 15% 20% 10%
It is assumed that security returns are generated by a two factor model.
a) If Mr. X has ₹ 1,00,000 to invest and sells short ₹ 50,000 of security B and purchases ₹ 1,50,000 of
security A what is the sensitivity of Mr. X’s portfolio to the two factors?
b) If Mr. X borrows ₹ 1,00,000 at the risk free rate and invests the amount he borrows along with the
original amount of ₹ 1,00,000 in security A and B in the same proportion as described in part (i),
what is the sensitivity of the portfolio to the two factors?
What is the expected return premium of factor 2?
QUESTION NO. 5
The following information is available for the share of X Ltd. and stock exchange for the last 4 years
Index of Return from Return from
X LTD. Stock Market Funds Govt.
Exchange Securities Securities
Share Price Divided
Yield
Present Year 197 10% 2182 16% 15%
1 Years ago 164.2 12% 1983 15% 15%
2 Years ago 155 8% 1665 16% 16%
3 Years ago 121 10% 1789 10% 14%
4 Years ago 95 10% 1490 18% 15%
With above information available please calculate:
a) Expected Return on X Ltd.’s share.
b) Expected Return on Market Index.
c) Risk Free Rate of Return
d) Beta of X Ltd.

QUESTION NO. 6
Mr. Shyam is holding the following securities:
Particulars of Securities Cost ₹ Dividend Interest ₹ Market Price ₹ Beta
Gold Ltd. 10,000 1,725 9,800 0.60
Silver Ltd. 15,000 1,000 16,200 0.80
Bronze Ltd. 14,000 700 20,000 0.60
GOI Bonds 36,000 3,600 34,500 0.01
 
   
35

Average return of the portfolio is 15.7%. Using Average Beta, Calculate:

a) Expected rate of return in each case, using the Capital Asset Pricing Model (CAPM)
b) Risk free rate of return.
QUESTION NO. 7
The returns and market portfolio for a period of four years are as under:
Year % Return of Stock B % Return on Market Portfolio
1 10 8
2 12 10
3 9 9
4 3 -1
For stock B, you are required to determine:
(i) Characteristic line; and
(ii) The Systematic and Unsystematic risk.
QUESTION NO. 8
Indira has a fund of ₹ 3 lacs which she wants to invest in share market with rebalancing target after every
10 days to start with for a period of one month from now. The present NIFTY is 5326. The minimum
NIFTY within a month can at most be 4793.4. She wants to know as to how she would rebalance her
portfolio under the following situations, according to the theory of Constant Proportion Portfolio
Insurance Policy, using “2” as the multiplier:
1. Immediately to start with.
2. 10 days later-being the 1st day of rebalancing if NIFTY falls to 5122.96.
3. 10 days further from the above date if the NIFTY touches 5539.04.
For the sake of simplicity, assume that the value of her equity component will change in tandem with
that of the NIFTY and the risk free securities in which she is going to invest will have no Beta.
QUESTION NO. 9
The risk free rate of return is 5%. The expected rate of return on the market portfolio is 11%. The
expected rate of growth in dividend of X Ltd. is 8%. The last dividend paid was
₹ 2.00 per share. The beta of X Ltd. equity stock is 1.5.
(i) What is the present price of the equity stock of X Ltd.?
(ii) How would the price change when:
• The inflation premium increases by 3%
• The expected growth rate decreases by 3% and
• The beta decreases to 1.3.

 
 
36

International Financial Management

 
Study Session 12
QUESTION NO. 1
XY Limited is engaged in large retail business in India. It is contemplating for expansion into a country
of Africa by acquiring a group of stores having the same line of operation as that of India. The exchange
rate for the currency of the proposed African country is extremely volatile. Rate of inflation is presently
40% a year. Inflation in India is currently 10% a year. Management of XY Limited expects these rates
likely to continue for the foreseeable future.
Estimated projected cash flows, in real terms, in India as well as African country for the first three years
of the project are as follows:
Year-0 Year-1 Year-2 Year-3
Cash flows in Indian ₹ (000) -50,000 -1,500 -2,000 -2,500
Cash flows in African Rands (000) - 2,00,000 50,000 70,000 90,000
XY Ltd. assumes the year 3 nominal cash flows will continue to be earned each year indefinitely. It
evaluates all investments using nominal cash flows and a nominal discounting rate. The present
exchange rate is African Rand 6 to ₹ 1.
You are required to calculate the net present value of the proposed investment considering the following:
(i) African Rand cash flows are converted into rupees and discounted at a risk adjusted rate.
(ii) All cash flows for these projects will be discounted at a rate of 20% to reflect it’s high risk.
Ignore taxation.
Year - 1 Year - 2 Year - 3
PVIF @ 20% 0.833 0.694 0.579
QUESTION NO. 2
Opus Technologies Ltd., an Indian IT company is planning to make an investment through a wholly
owned subsidiary in a software project in China with a shelf life of two years. The inflation in China is
estimated as 8 percent. Operating cash flows are received at the year end.
For the project an initial investment of Chinese Yuan (CN¥) 30,00,000 will be in a piece of
land. The land will be sold after the completion of project at estimated value of CN¥ 35,00,000. The
project also requires an office complex at cost of CN¥ 15,00,000 payable at the beginning of project.
The complex will be depreciated on straight-line basis over two years to a zero salvage value. This
complex is expected to fetch CN¥ 5,00,000 at the end of project.
The company is planning to raise the required funds through GDR issue in Mauritius. Each GDR will have
5 common equity shares of the company as underlying security which are currently trading at ₹ 200 per
share (Face Value = ₹ 10) in the domestic market. The company has currently paid a dividend of 25%
which is expected to grow at 10% p.a. The total issue cost is estimated to be 1 percent of issue size.
The annual sales is expected to be 10,000 units at the rate of CN¥ 500 per unit. The price of
unit is expected to rise at the rate of inflation. Variable operating costs are 40 percent of
sales. Current Fixed Operating costs is CN¥ 22,00,000 per year which is expected to rise at
the rate of inflation.
The tax rate applicable in China for business income and capital gain is 25 percent and as per GOI Policy
no further tax shall be payable in India. The current spot rate of CN¥ 1 is ₹ 9.50. The nominal interest
rate in India and China is 12% and 10% respectively and the international parity conditions hold.
You are required to :
a) Identify expected future cash flows in China and determine NPV of the project in CN¥.
b) Determine whether Opus Technologies should go for the project or not, assuming that there neither
there is any restriction nor any charges/taxes payable on the transfer of funds from China to India.

 
   
37

QUESTION NO. 3
Equity of KGF Ltd. (KGFL) is ₹ 410 Crores, its debt, is worth ₹ 170 Crores. Printer Division segments value
is attributable to 74%, which has an Asset Beta (βp) of 1.45, balance value is applied on Spares and
Consumables Division, which has an Asset Beta (βsc) of 1.20 KGFL Debt beta (βD) is 0.24.
You are required to calculate:
(i) Equity Beta (βE),
(ii) Ascertain Equity Beta (βE), if KGF Ltd. decides to change its Debt Equity position by raising further
debt and buying back of equity to have its Debt Equity Ratio at 1.90. Assume that the present Debt
Beta (βD1) is 0.35 and any further funds raised by way of Debt will have a Beta (βD2) of 0.40.
(iii) Whether the new Equity Beta (βE) justifies increase in the value of equity on account of leverage?
QUESTION NO. 4
A proposed foreign investment involves creation of a plant with an annual output of 1 million units.
The entire production will be exported at a selling price of USD 10 per unit.
At the current rate of exchange dollar cost of local production equals to USD 6 per unit. Dollar is
expected to decline by 10% or 15%. The change in local cost of production and probability from the
expected current level will be as follows:
Decline in value of USD (%) Reduction in local cost of production Probability
(USD/unit)
0 - 0.4
10 0.30 0.4
15 0.15 Additional reduction 0.2
The plant at the current rate of exchange will have a depreciation of USD 1 million annually. Assume
local Tax rate as 30%.
You are required to find out:
(i) Annual Cash Flow After Tax (CFAT) under all the different scenarios of exchange rate.
(ii) Expected value of CFAT assuming no repatriation of profits.
(iii) Viability of the investment proposal assuming an initial investment of USD 25 million on plant
and working capital with a required rate of return of 11% on investment and on the basis of
CFAT arrived under option (ii). The CFAT will grow @ 3% per annum in perpetuity.

 
 
38

Miscellaneous
 
Study Session 13
QUESTION NO. 1
ABB Ltd. has a surplus cash balance of ₹ 180 lakhs and wants to distribute 50% of it to the equity
shareholders. The company decides to buyback equity shares. The company estimates that its equity
share price after re-purchase is likely to be 15% above the buyback price. if the buyback route is taken.
Other information is as under:
1. Number of equity shares outstanding at present (Face value ₹ 10 each) is ₹ 20 lakhs.
2. The current EPS is ₹ 5.
You are required to calculate the following:
I. The price at which the equity shares can be re-purchased, if market capitalization of the company
should be ₹ 400 lakhs after buy back.
II. Number of equity shares that can be re-purchased.
III. The impact of equity shares re-purchase on the EPS, assuming that the net income remains
unchanged.
QUESTION NO. 2
Telbel Ltd. is considering undertaking a major expansion an immediate cash outlay of ₹ 150 crore. The
Board of Director of company are expecting to generate an additional profit of ₹ 15.30 crore after a
period of one year. Further, it is expected that this additional profit shall grow at the rate of 4% for
indefinite period in future.
Presently, Telbel Ltd. is completely equity financed and has 50 crore shares of ₹10 each. The current
market price of each share is ₹ 22.60 (cum dividend). The company has paid a dividend of ₹ 1.40 per
share in last year. For the last few years dividend is increasing at a compound rate of 6% p.a. and it is
expected to be continued in future also. This growth rate shall not be affected by expansion project in
any way.
Board of Directors are considering following ways of financing the possible expansion:
(1) A right issue on ratio of 1:5 at price of ₹15 per share.
(2) A public issue of shares.
In both cases the dividend shall become payable after one year. You as a Financial Consultant
required to:
(a) Determine whether it is worthwhile to undertake the project or not.
(b) Calculate ex-dividend market price of share if complete expansion is financed from the right issue.
(c) Calculate the number of new equity shares to be issued and at what price assuming that new
shareholders do not suffer any loss after subscribing new shares.
(d) Calculate the total benefit from expansion to existing shareholders under each of two financing
option.
QUESTION NO. 3
From the following particulars, calculate the effective rate of interest p.a. as well as the total cost of funds
to Bhaskar Ltd., which is planning a CP issue:
Issue Price of CP ₹ 97,550
Face Value ₹ 1,00,000
Maturity Period 3 Months Issue Expenses:
Brokerage 0.15% for 3 months
Rating Charges 0.50% p.a
Stamp Duty 0.175% for 3 months

 
   
39

QUESTION NO. 4
AXY Ltd. is able to issue commercial paper of ₹ 50,00,000 every 4 months at a rate of 12.5% p.a. The
cost of placement of commercial paper issue is ₹ 2,500 per issue. AXY Ltd. is required to maintain line
of credit ₹ 1,50,000 in bank balance. The applicable income tax rate for AXY Ltd. is 30%. What is the
cost of funds (after taxes) to AXY Ltd. for commercial paper issue? The maturity of commercial paper is
four months.
QUESTION NO. 5
The closing value of Sensex for the month of October, 2007 is given below:
Date Closing Sensex Value
1.10.07 2800
3.10.07 2780
4.10.07 2795
5.10.07 2830
8.10.07 2760
9.10.07 2790
10.10.07 2880
11.10.07 2960
12.10.07 2990
15.10.07 3200
16.10.07 3300
17.10.07 3450
19.10.07 3360
22.10.07 3290
23.10.07 3360
24.10.07 3340
25.10.07 3290
29.10.07 3240
30.10.07 3140
31.10.07 3260
You are required to test the weak form of efficient market hypothesis by applying the run test at 5% and
10% level of significance.
Following value can be used :
Value of t at 5% is 2.101 at 18 degrees of freedom
Value of t at 10% is 1.734 at 18 degrees of freedom
QUESTION NO. 6
Using the chop-shop approach (or Break-up value approach), assign a value for Cornett GMBH. Whose
stock is currently trading at a total market price of €4 million. For Cornett, the accounting data set forth
three business segments: consumer wholesaling, specialty services, and assorted centers Data for the
firm’s three segments are as follows:
BUSINESS SEGMENT Segment Sales Segment Assets Segment Income
Consumer Wholesaling € 1,500,000 € 750,000 € 100,000
Specialty services € 800,000 € 700,000 € 150,000
Assorted centers € 2,000,000 € 3,000,000 € 600,000
Industry data for “pure-play” firms have been compiled and are summarized as follows:
BUSINESS SEGMENT Capitalization/Sales Capitalization/Assets Capitalization/Op
erating Income
Consumer wholesaling 0.75 0.60 10
Specialty services 1.10 0.90 7
Assorted centers 1.00 0.60 6
 
 
40

QUESTION NO. 7
Mr. X is of the opinion that market has recently shown the Weak Form of Market Efficiency. In order
to test the validity of his impression he has collected the following data relating to the movement of
the SENSEX for the last 20 days.
Days Open High Low Close
1 33470.94 33513.79 33438.03 33453.99
2 33453.64 33478.11 33427.82 33434.83
3 33414.06 33440.29 33397.65 33431.93
4 33434.94 33446.18 33377.78 33383.41
5 33372.92 33380.27 33352.12 33370.93
6 33375.85 33389.49 33331.42 33340.75
7 33340.89 33340.89 33310.95 33330.98
8 33326.84 33340.91 33306.17 33335.08
9 33307.16 33328.22 33296.43 33301.97
10 33298.64 33318.60 33254.28 33259.03
11 33260.04 33228.85 33241.66 33251.53
12 33255.92 33289.46 33249.46 33285.89
13 33288.86 33535.67 33255.98 33329.28
14 33335.00 33346.21 33276.72 33284.17
15 33293.83 33310.86 33278.54 33298.78
16 33300.02 33337.79 33300.02 33325.38
17 33323.36 33356.34 33322.44 33329.95
18 33322.81 33345.98 33317.44 33319.67
19 33317.51 33321.18 33294.19 33302.32
20 33290.86 33324.96 33279.62 33319.61
You are required:
To test the Weak Form of Market Efficiency using Auto-Correlation test, taking time lag of 10 days.
QUESTION NO. 8
Bank A enters into a Repo for 21 days with Bank B in 8% Government of India Bonds 2020 @ 6.10%
for ₹ 5 crore. Assuming that clean price is ₹ 97.30 and initial margin is 1.50% and days of accrued
interest are 240 days (assume 360 days in a year).
Compute:
(i) the dirty price.
(ii) The repayment at maturity.
QUESTION NO. 9
ABC Ltd. is considering a project X, which is normally distributed and has mean return of ₹ 2 crore
with Standard Deviation of ₹ 1.60 crore.
In case ABC Ltd. loses on any project more than ₹ 1.00 crore there will be financial difficulties.
Determine the probability the company will be in financial difficulty.
Given: Standard Normal Distribution Table (Z-Score) providing area between Mean and Z score
Z Score Area Z Score Area
1.85 0.4678 1.88 0.4699
1.86 0.4686 1.89 0.4706
1.87 0.4693

 
   
41

Security Valuation
Study Session 2
SOLUTION 1
(i) According to Dividend Discount Model approach the firm’s expected or required return on equity
is computed as follows:
= 𝑔
Where,
𝐾 = Cost of equity share capital
𝐷 = Expected dividend at the end of year 1
𝑃 = Current market price of the share.
g = Expected growth rate of dividend.
.
Therefore, 𝐾 = 7.5% = 0.0230+0.075=0.098 Or, 𝐾 = 9.80%
(ii) With rate of return on retained earnings (r) 10% and retention ratio (b) 60%, new growth rate
will be as follows:
g = br i.e. = 0.10 x 0.60 = 0.06
Accordingly dividend will also get changed and to calculate this, first we shall calculate previous
retention ratio (b1) and then EPS assuming that rate of return on retained earnings (r) is same.
With previous Growth Rate of 7.5% and r =10% the retention ratio comes out to be: 0.075 =𝑏 X 0.10
𝑏 = 0.75 and payout ratio = 0.25 with 0.25 payout ratio the EPS will be as follows:
3.36
13.44
0.25
With new 0.40 (1 – 0.60) payout ratio the new dividend will be
𝐷 = 13.44 X 0.40 = 5.376
Accordingly new 𝐾 will be
.
𝐾 = +6.0%
or, = 𝐾 9.68%
SOLUTION 2
The expected rate of return on equity after 2008 = 0.0625 + 1.10(0.055) = 12.3% The dividends
from 2003 onwards can be estimated as:
Year 2003 2004 2005 2006 2007 2008 2009
Earnings Per Share (€) 2.1 2.415 2.78 3.19 3.67 4.22 4.48
Dividends Per Share (€) 0.69 0.794 0.913 1.048 1.206 1.387 2.91
a. The price as of 2008 = €2.91/(0.123- 0.06) = €46.19
b. The required rate of return upto 2008 = 0.0625 + 1.4(0.055) = 13.95%.
The dividends upto 2008 are discounted using this rate as follow:
Year PV of Dividend
2004 0.794/1.1395 = 0.70
2005 0.913/(1.1395)2 = 0.70
2006 1.048/(1.1395)3 = 0.70
2007 1.206/(1.1395)4 = 0.72
2008 1.387/(1.1395)5 = 0.72
Total 3.54
The current price = €3.54 + €46.19/(1.1395)5= €27.58.
* Values have been rounded off.

 
 
42

SOLUTION 3
Value of share at present =
.
= = ₹ 106
. .
However, if the Board implement its decision, no dividend would be payable for 3 years and the
dividend for year 4 would be ₹ 2.50 and growing at 7% p.a. The price of the share, in this case, now
would be:
.
𝑃 = = ₹ 198.46
. . .
So, the price of the share is expected to increase from ₹ 106 to ₹198.45 after the announcement of
the project. The investor can take up this situation as follows:
Expected market price after 3 years . ₹ 250.00
. .
Expected market price after 2 years . ₹ 231.00
x
. . .
Expected market price after 1 years . ₹ 214.33
x
. . . ²
In order to maintain his receipt at ₹ 2,000 for first 3 year, he would sell
10 shares in first year @ ₹ 214.33 for ₹ 2,143.30
9 shares in second year @ ₹ 231.48 for ₹ 2,083.32
8 shares in third year @ ₹ 250 for ₹ 2,000.00
At the end of 3rd year, he would be having 973 shares valued @ ₹ 250 each i.e.₹ 2,43,250. On these
973 shares, his dividend income for year 4 would be @ ₹ 2.50 i.e. ₹ 2,432.50.
So, if the project is taken up by the company, the investor would be able to maintain his receipt of at
least ₹ 2,000 for first three years and would be getting increased income thereafter.
SOLUTION 4
(a) Working Notes:
(i) Computation of Growth Rate in Earning and EPS
Year 1 2 3 4 5 6 7 8 9 10
Growth 40% 40% 40% 40% 40% 34% 28% 22% 16% 10%
in
Earning
EPS (₹) 5.60 7.84 10.98 15.37 21.51 28.82 36.89 45.00 52.20 57.42
(ii) Computation of Payout Ratio and Dividend
Year 1 2 3 4 5 6 7 8 9 10
Payout 10% 10% 10% 10% 10% 18% 26% 34% 42% 50%
Ratio
Dividend 0.56 0.78 1.10 1.54 2.15 5.19 9.59 15.30 21.92 28.71
(₹)
(iii) Calculation of PV of Dividend
Year Dividend (₹) PVF PV of Dividend (₹)
1 0.56 0.855 0.48
2 0.78 0.731 0.57
3 1.10 0.625 0.69
4 1.54 0.534 0.82
5 2.15 0.456 0.98
6 5.19 0.390 2.02
 
   
43

7 9.59 0.333 3.19

8 15.30 0.285 4.36
9 21.92 0.244 5.35
10 28.71 0.209 6.00
24.46
. .
TV = ×0.209= ₹ 94.29
. .
Intrinsic Value = ₹ 24.46 + ₹ 94.29 = ₹ 118.75
Since the Intrinsic Value of Equity share is less than current market price, it is not advisable
to invest in the same.
SOLUTION 5

 
 
44

 
   
45

Corporate Valuation
Study Session 3
SOLUTION 1
High growth phase :
𝑘 = 0.10 + 1.15 x 0.06 = 0.169 or 16.9%.
𝑘 = 0.13 x (1-0.3) = 0.091 or 9.1%.
Cost of capital = 0.5 x 0.169 + 0.5 x 0.091 = 0.13 or 13%.
Stable growth phase :
𝑘 = 0.09 + 1.0 x 0.05 = 0.14 or 14%.
𝑘 = 0.1286 x (1 - 0.3) = 0.09 or 9%.
Cost of capital = 0.6 x 0.14 + 0.4 x 0.09 = 0.12 or 12%.
Determination of forecasted Free Cash Flow of the Firm (FCFF)
(₹ in crores)
Yr. 1 Yr. 2 Yr 3 Yr. 4 Terminal
Year
Revenue 2,400 2,880 3,456 4,147.20 4,561.92
EBIT 360 432 518.40 622.08 684.29
EAT 252 302.40 362.88 435.46 479.00
Capital Expenditure 96 115.20 138.24 165.89 -
Less Depreciation
∆ Working Capital 100.00 120.00 144.00 172.80 103.68
Free Cash Flow (FCF) 56.00 67.20 80.64 96.77 375.32
Alternatively, it can also be computed as follows:
(₹in crores)
Yr. 1 Yr. 2 Yr 3 Yr. 4 Terminal
Year
Revenue 2,400 2,880 3,456 4,147.20 4,561.92
EBIT 360 432 518.40 622.08 684.29
EAT 252 302.40 362.88 435.46 479.00
Add: Depreciation 240 288 345.60 414.72 456.19
492 590.40 708.48 850.18 935.19
Less: Capital Exp. 336 403.20 483.84 580.61 456.19
∆ WC 100.00 120.00 144.00 172.80 103.68
56.00 67.20 80.64 96.77 375.32
Present Value (PV) of FCFF during the explicit forecast period is:
FCFF (₹ in crores) PVF @ 13% PV (₹ in crores)
56.00 0.885 49.56
67.20 0.783 52.62
80.64 0.693 55.88
96.77 0.613 ₹59.32
217.38
Terminal Value of Cash Flow
.
= ₹18,766.00Crores
. .
PV of the terminal, value is:
 
 
46

₹18,766.00Crores x = ₹18,766.00Crores x 0.613 = ₹11,503.56 Crores

.
The value of the firm is :
₹ 217.38 Crores + ₹ 11,503.56 Crores = ₹ 11,720.94 Crores
QUESTION 2
Projected Balance Sheet
Year 1 Year 2 Year 3 Year 4 Year 5
Fixed Assets (25% of Sales) 13,000 16,900 21,970 28,561.00 28,561.00
Current Assets (15% of Sales) 7,800 10,140 13,182 17,136.60 17,136.60
Total Assets 20,800 27,040 35,152 45,697.60 45,697.60
Equity (37.5% of sales) 19,500 25,350 32,955 42,841.50 42,841.50
Sundry Creditors (2.5% of Sales) 1,300 1,690 2,197 2,856.10 2,856.10
Total Liabilities 20,800 27,040 35,152 45,697.60 45,697.60
Projected Cash Flows:-
Year 1 Year 2 Year 3 Year 4 Year 5
Sales 52,000 67,600 87,880.00 1,14,244.00 1,14,244.00
PBT (15% of sales) 7,800 10,140 13,182.00 17,136.60 17,136.60
PAT (10.5% of sales) 5,460 7,098 9,227.40 11,995.62 11,995.62
Depreciation 1,500 1,950 2,535.00 3,295.50 4,284.15
Addition to Fixed Assets 4,500 5,850 7,605.00 9,886.50 4,284.15
Increase in Net Current Assets 1,500 1,950 2,535.00 3,295.50 -
Operating cash flow 960 1,248 1,622.40 2,109.12 11,995.62
Projected Cash Flows:-
Present value of Projected Cash Flows:-
Cash Flows PVF at 15% PV
960 0.870 835.20
1248 0.756 943.49
1622.40 0.658 1067.54
2109.12 0.572 1206.42
4,052.65
Residual Value = 11,995.62/0.15 = 79,970.80
Present value of Residual value = 79,970.80 x PVF (15%, 4)
= 79,970.80 x 0.572 = 45,743.30
Total shareholders’ value = 45743.30 + 4052.65 =
49795.95
Pre-strategy value = 4200 / 0.15 = 28,000
 Value of strategy = 49795.95 – 28,000 = 21795.95

SOLUTION 3
₹
(c) No. of Shares = = 30 Crores
₹
₹
EPS = = =₹ 10.00
.
FCFE = Net income – [(1-b) (capex – dep) + (1-b) ( ΔWC )]
FCFE = 10.00 – [(1- 0.25) (48 - 40) + (1 - 0.25) (4)]
= 10.00 – [6.00 + 3.00] = 1.00
Cost of Equity = Rf + ß (Rm – Rf)
= 8.7 + 0.1 (10.3 – 8.7) = 8.86%
. . .
Po = = = =₹ 125.58
. . .

SOLUTION 4
(i) Let us first compute the Cost of Equity ke = = = 20%
(ii) Current Earning = ₹ 25 x 10,00,000 = ₹ 2,50,00,000
 
   
47

The new project can be financed by retaining ₹ 1,75,00,000 of ₹ 2,50,00,000 earning next year,
reducing dividend payment to ₹ 75,00,000 or
, ,
= = ₹ 7.50 per share
, ,
(iii) In the following years, dividend will increase due to the cash generated by the new project.
Dividend per share in year 2 shall be:
, , , ,
= = ₹ 30 per share
, ,
(iv) The new share price can be calculated by finding the Present Value of the revised dividend
payments:
. .
P= + × = ₹ 131.25 per share
. . .

SOLUTION 5
Cost of capital by applying Free Cash Flow to Firm (FCFF) Model is as follows:-
Value of Firm = 𝑉
Where –
𝐹𝐶𝐹𝐹 = Expected FCFF in the year 1
𝐾 = Cost of capital
𝑔 = Growth rate forever
Thus, ₹ 1800 lakhs = ₹ 54 lakhs /(𝐾 𝑔 )
Since g = 9%, then 𝐾 = 12%
Now, let X be the weight of debt and given cost of equity = 20% and cost of debt = 10%,
then 20% (1 – X) + 10% X = 12%
Hence, X = 0.80, so book value weight for debt was 80%
Correct weight should be 60 of equity and 72 of debt.
Cost of capital = Kc = 20%(60/132)+10% (72/132) = 14.5455% and correct firm’s value
= ₹ 54 lakhs/(0.1454 – 0.09) = ₹ 974.73 lakhs.
SOLUTION 6
(a) Calculation of Profit after tax (PAT)
₹
Profit before interest and tax (PBIT) 32,00,000
Less: Debenture interest (₹ 64,00,000 × 7,68,000
12/100)
Profit before tax (PBT) 24,32,000
Less: Tax @ 35% 8,51,200
Profit after tax (PAT) 15,80,800
Less: Preference Dividend
(₹ 40,00,000 × 8/100) 3,20,000
Equity Dividend (₹ 80,00,000 × 8/100) 9,60,000
6,40,000
Retained earnings (Undistributed profit) 6,20,800
Calculation of Interest and Fixed Dividend Coverage
=
, , , , , ,
= 2.16 Times
, , , , , ,

(b) Calculation of Capital Gearing Ratio

Capital Gearing Ratio =
, , , , , , ,
= = 0.93
, , , , , , ,

 
 
48

(c) Calculation of Yield on Equity Shares:

Yield on equity shares is calculated at 50% of profits distributed and 5% on undistributed profits:
₹
50% on distributed profits ( ₹ 6,40,000 × 50/100) 3,20,000
5% on undistributed profits (₹ 6,20,800 × 5/100) 31,040
Yield on equity shares 3,51,040

Yield on equity shares % = 100

, ,
= x100 = 4.39% or, 4.388%
, ,
Calculation of Expected Yield on Equity shares
Note: There is a scope for assumptions regarding the rates (in terms of percentage for every one
time of difference between Sun Ltd. and Industry Average) of risk premium involved with respect
to Interest and Fixed Dividend Coverage and Capital Gearing Ratio. The below solution has been
worked out by assuming the risk premium as:
(i) 1% for every one time of difference for Interest and Fixed Dividend Coverage.
(ii) 2% for every one time of difference for Capital Gearing Ratio.
(a) Interest and fixed dividend coverage of Sun Ltd. is 2.16 times but the industry average
is 3 times. Therefore, risk premium is added to Sun Ltd. Shares @ 1% for every 1 time of
difference.
Risk Premium = 3.00 – 2.16 (1%) = 0.84 (1%) = 0.84%
(b) Capital Gearing ratio of Sun Ltd. is 0.93 but the industry average is 0.75 times.
Therefore,
risk premium is added to Sun Ltd. shares @ 2% for every 1 time of difference.
Risk Premium = (0.75 – 0.93) (2%)
= 0.18 (2%) = 0.36%

(%)
Normal return expected 9.60
Add: Risk premium for low interest and fixed dividend coverage 0.84
Add: Risk premium for high interest gearing ratio 0.36
Value of Equity Share 10.80
.
= x Paid up value of share = 100 = ₹ 40.65
.

SOLUTION 7
In semi-strong form of stock market, the share price should accurately reflect new relevant
information when it is made publicly available including Implant Inc. expansion scheme and
redemption of the term loan.
The existing Market Value $ 2 x 7,000,000 $ 14,000,000
The new investment has an expected NPV $ 2,200,000
Proceeds of New Issue $ 15,000,000
Issue Cost of ($ 600,000)
PV of Benefit of early redemption
Interest of $ 900,000 ($,6,000,000 x 15 %)x 3.791 3,411,900
PV of Repayment in 5 years $ 6,000,000 x 0.621 3,726,000
7,137,900
Redemption Cost Now (6,000,000)
Penalty charges (350,000) 787,900
Expected Total Market value 31,387,900
New No. of shares (30 Million + 7 Million) 37,00,000
Expected Share Price of Company $ 0.848

 
   
49

SOLUTION 8
Working Notes:
Computation of Earning Per Share (EPS)
Particulars Amount (₹)
Margin of Division A (₹ 50 crore x 10% x 5%) 25,00,000
Margin of Division B (₹ 20 crore x 30% x 8%) 48,00,000
Margin of Division C (₹ 8.5 crore x 2% x 10%) 1,70,000
74,70,000
No. of Equity Shares 3,00,000
EPS ₹ 24.90
(i) Market Price based on One Year Forecast
Expected Market Price at the end of the year = ₹ 24.90 x 10 = ₹ 249
PV of the Expected Price = ₹ 249 x 0.847 = ₹ 210.90
I would NOT like to purchase the share as the expected market price of shares is less than its
current price of ₹ 250.
(ii) If Earning is expected to grow @ 15%
Year EPS (₹) Dividend (₹) PVF@18% PV (₹)
1 28.64 --- 0.847 ---
2 32.93 --- 0.718 ---
3 37.87 11.36 0.609 6.92
4 43.55 13.07 0.516 6.74
5 50.08 15.02 0.437 6.56
20.22
. .
Share Price after 5 years = = ₹ 575.77
. .
PV of the Market Price after 5 years = ₹ 575.77 X 0.437 = ₹ 251.61
Total PV of Inflows = ₹ 20.22 + ₹ 251.61 = ₹ 271.83
Thus, the maximum price I would be willing to pay for the share shall be ₹ 271.83.
SOLUTION 9

(a) Net Assets Method

To compute the value of shares as per this method we shall compute the Net Assets.

(i) Value of Land & Building of XYZ Ltd. = ₹ 1,500 lac (1.25)4 = ₹ 3,662.11 lac. Thus, net
asset value will be:
₹
Land & Building 3,662.11 lac
Plant & Machinery 2,800.00 lac
Account Receivable 2,400.00 lac
Stock 2,100.00 lac
Bank/Cash 400.00 lac
11,362.11 lac
Less: Bank Overdraft 100.00 lac
Sundry Creditors 1,100.00 lac
Tax Payable 400.00 lac
Dividend Payable 400.00 lac
Long Term Loan 1,000.00 lac
8362.11 lac
(ii) Estimated profit for next 5 years
= ₹ 1,510 lac (1.12) + ₹ 1,510 lac (1.12)2 + ₹ 1,510 lac (1.12)3 + ₹ 1,510 lac
(1.12)4 + ₹ 1,510 lac (1.12)5
= ₹ 1,691.20 lac + ₹ 1,894.14 lac + ₹ 2,121.44 lac + ₹ 2,376.01 lac +
 
 
50

₹ 2,661.14 lac
= ₹ 10,743.93 lac.
The total yield value= ₹ 8,362.11 lac + ₹ 10,743.93 lac = ₹ 19,106.04 lac
XYZ Ltd.s share’s current market value = ₹ 470 x 40 lacs shares
=₹ 1,88,00,00,000
= ₹ 18,800 lac
The premium is thus ₹ 306.04 lac (₹ 19,106.04 lac – ₹ 18,800 lac) i.e. ₹ 7.65 per share or
1.63% [7.65/470].
This is not a sound basis for valuation as it ignores the time value of money. The premium
of 1.63% above the current market price is very small compared to those achieved in
many real bids.
(b) Dividend Valuation Model
Po= =
₹
Do = = ₹19 per share
Thus D1 = ₹ 19(1+0.12) = ₹ 21.28
Ke using CAPM
Ke = Rf +βj (Rm - Rf) =10% + 1.05(16% - 10%) = 16.3%
₹ . .
P0 = = = ₹ 494.88 per share
. % % . %

The premium is ₹ 24.88 (₹ 494.88 – ₹ 470) i.e. 5.29% above the current market price.
Thus, this method should be used for bidding shares of XYZ Ltd.’s share
Assumptions
• Valuation is based on a constant growth rate and unchanged dividend policy.
• It will be more rational to assess the value of XYZ Ltd. incorporating post merger
synergies.
SOLUTION 10
Estimation of Ratios
Sl. Particulars SK Ltd. AS Ltd. Average
No.
(i) Market to Book Value = =1.125 = =1.333 1.2290
(ii) Market to Replacement Cost = =0.750 = =0.727 0.7385
(iii) Market to Sales = =0.818 = =0.889 0.8535
(iv) Market to Net Income = =25 = =25 25
Application of Ratios to XY Ltd.
Sl. Particulars XY Ltd. (₹) Average Indicative Value of XY Ltd. (₹)
No.
(i) Book Value 250 1.2290 250 x 1.2290 = 307.25
(ii) Replacement Cost 500 0.7385 500 x 0.7385 = 369.25
(iii) Sales 500 0.8535 500 x 0.8535 = 426.75
(iv) Net Income 14 25 14 x 25 = 350.00
Average ₹ 363.31
Value of XY Ltd. according to the comparable method is ₹ 363.31

 
   
51

SOLUTION 11
(i) Weighted Average Cost of Capital of DY Ltd.
Cost of Equity as per CAPM
ke = Rf + β x Market Risk Premium
= 7% + 1.4 x [12% - 7%]
= 7% + 7% = 14%
Cost of Debt kd = 8% (1 – 0.30) = 5.60%
𝐸 𝐷 500 250
WACC ko 𝐾 𝐾 14.00 5.60
𝐸 𝐷 𝐸 𝐷 750 750
= 9.33% + 1.87% = 11.20%

(ii) Economic Value Added (EVA) of DY Ltd.

₹ Lakhs
Sales ₹ 1,000
Operating Expenses (excluding interest) ₹ 620
₹ 20 ₹ 600
₹ 400
Less: Tax @ 30% ₹ 120
Net Operating Profit after Tax (NOPAT) ₹ 280

Calculation of Capital Employed

₹ Lakhs
Equity Share Capital 250
Reserves & Surplus 250
8% Debentures 250
Total Capital Employed 750

EVA = NOPAT – (WACC Total Capital) EVA = ₹ 280 Lakh – 0.1120 ₹ 750 lakhs EVA =
196.00 lakhs

(iii) Determination of Market Value Added (MVA)

₹ Lakh
Market value of Equity Stock [₹ 900 Lakh - ₹ 250 Lakh] 650
Equity Fund [₹ 250 Lakh + ₹ 250 Lakh] 500
Market Value Added 150

Alternatively, it can also be computed as follows:

₹ Lakh
Market value of DY Ltd. 900
Capital employed [₹ 250 Lakh + ₹ 250 Lakh + ₹ 250 Lakh] 750
Market Value Added 150

 
 
52

Mergers, Acquisitions & Corporate

Restructuring
Study Session 4
SOLUTION 1
Working Notes :
(a)
XYZ Ltd. ABC Ltd.
Equity shares outstanding (Nos.) 10,00,000 4,00,000
EPS ₹ 40 ₹ 28
Profit ₹ 400,00,000 ₹ 112,00,000
PE Ratio 6.25 5.71
Market price per share ₹ 250 ₹ 160
(b) EPS after merger
No. of shares to be issued (4,00,000 x 0.70) 2,80,000
Exiting Equity shares outstanding 10,00,000
Equity shares outstanding after merger 12,80,000
Total Profit (₹ 400,00,000 + ₹ 112,00,000) ₹ 512,00,000
EPS ₹ 40
(i) Impact of merger on EPS of both the companies
XYZ Ltd. ABC Ltd.
EPS after Merger ₹ 40 ₹ 28
EPS before Merger ₹ 40 ₹ 28*
Nil Nil
* ₹ 40 x 0.70
(ii) Gain from the Merger if exchange ratio is 1: 1
No. of shares to be issued 4,00,000
Exiting Equity shares outstanding 10,00,000
Equity shares outstanding after merger 14,00,000
Total Profit (₹ 400,00,000 + ₹ 112,00,000) ₹ 512,00,000
EPS ₹ 36.57
Market Price of Share (₹ 36.57 x 6.25) ₹ 228.56
Market Price of Share before Merger ₹ 160.00
Impact (Increase/ Gain) ₹ 68.56
(iii) Gain/ loss from the Merger to the shareholders of XYZ Ltd.
Market Price of Share ₹ 228.56
Market Price of Share before Merger ₹ 250.00
Loss from the merger (per share) ₹ 21.44
(iv) Maximum Exchange Ratio acceptable to XYZ Ltd. shareholders
₹ Lakhs
Market Value of Merged Entity (₹ 228.57 x 1400000) 3199.98
Less: Value acceptable to shareholders of XYZ Ltd. 2500
Value of merged entity available to shareholders of ABC Ltd. Market Price Per 699.98
Share
No. of shares to be issued to the shareholders of ABC Ltd. (lakhs) 250
2.8
Thus maximum ratio of issue shall be 2.80 : 4.00 or 0.70 share of XYZ Ltd. for one share of ABC
Ltd.

 
   
53

SOLUTION 2
(b) (i) Calculation of Minimum price per share S Ltd. should accept from R Ltd.
, ,
Value of S Ltd. = = = ₹ 4,20,45,977
.
, , ,
Value per share of S Ltd. = = ₹ 5.26
, ,
, , ,
Book Value of per share of S Ltd. = = ₹ 4.99 or ₹ 5
, ,
Therefore, the minimum price per share S ltd. should accept from R Ltd. is ₹ 5 (current
book value)
(ii) Calculation of Maximum price per share R Ltd. shall be willing to offer to S Ltd.

, ,
Value of R Ltd. = = = ₹ 6,55,27,273
.
, , ,
Value of Combined entity = = ₹ 14,80,00,000
.
Value of synergy = Value of Combined entity – Individual values of R Ltd. and S Ltd.
= ₹ 14,80,00,000 – (₹ 4,20,45,977 + ₹ 6,55,27,273)
= ₹ 4,04,26,750
Maximum price per share R Ltd. shall be willing to offer to S Ltd. shall be computed as
follows:
.
=
.
, , , , , ,
= = ₹ 10.31
, ,
(iii) Floor value of per share of S Ltd shall be ₹ 3.20 (current market price) and it shall not play
any role in decision for the acquisition of S Ltd. as it is lower than its current book value.
SOLUTION 3
(a)
A Ltd. B Ltd.
Share Capital 200 Lakh 100 Lakh
Free Reserves 800 Lakh 500 Lakh
Total 1000 Lakh 600 Lakh
No. of Shares 2 Lakh 10 Lakh
Book Value per share ₹ 500 ₹ 60
Promoter’s holding 50% 60 %
Non promoter’s holding 50% 40 %
Free Float Market Cap. i.e. relating to Public’s 400 Lakh 128 Lakh
holding
Hence Total market Cap. 800 Lakh 320 Lakh
No. of Shares 2 Lakh 10 Lakh
Market Price ₹ 400 ₹ 32
P/E Ratio 10 4
EPS 40 8
Profits (₹ 2 X 40 lakh) ₹ 80 Lakh -
(₹ 8 X 10 lakh) - ₹ 80 Lakh
Calculation of Swap Ratio
Book Value 1 : 0.12 0.12 x 25% 0.03
EPS 01:00.2 0.20 x 50% 0.1
Market Price 01:00.1 0.08 x 25% 0.02
Total 0.15
Swap ratio is for every one share of Abhishek Ltd., to issue 0.15 shares of Abhiman Ltd. Hence
total no. of shares to be issued.
10 Lakh x 0.15 = 1.50 lakh shares
 
 
54

(b) Book Value, EPS & Market Price

Total No of Shares 2 Lakh + 1.5 Lakh = 3.5 Lakh
Total Capital ₹ 200 Lakh + ₹ 150 Lakh = ₹ 350 Lakh
Reserves ₹ 800 Lakh + ₹ 450 Lakh = ₹ 1,250 Lakh
,
Book Value = ₹ 457.14 per share
.
EPS = =
. . .
= ₹ 45.71
Expected Market Price EPS (₹ 45.71) x P/E Ratio (10) = ₹ 457.10
(c) (1) Promoter’s holding
Promoter’s Revised A Ltd. 50% i.e. 1.00 Lakh shares
Holding B Ltd. 60% i.e. 0.90 Lakh shares
Total 1.90 Lakh shares
Promoter’s % = 1.90/3.50 x 100 = 54.29%
(2) Free Float Market Capitalization
Free Float Market = (3.5 Lakh – 1.9 Lakh) x ₹ 457.10
Capitalization = ₹ 731.36 Lakh
(3) (i) & (ii)
Revised Capital ₹ 350 Lakh + ₹ 175 Lakh = ₹ 525 Lakh
No. of shares before Split (F.V ₹ 100) 5.25 Lakh
No. of Shares after Split (F.V. ₹ 5 ) 5.25 x 20 = 105 Lakh
EPS 160 Lakh / 105 Lakh = 1.523
Book Value Cap. ₹ 525 Lakh + ₹ 1075 Lakh
No. of Shares =105 Lakh
= ₹ 15.238 per share
SOLUTION 4
(a) Working Notes:
Day Ltd. Night Ltd.
Net Earnings ₹ 5 crores ₹ 3.5 crores
No. of Equity Shares 10,00,000 7,00,000
EPS 50 50
P/E 20 times 15 times
MPS ₹ 1000 ₹ 750
Market Value 1,00,00,00,000 52,50,00,000
(i) If takeover is funded by Cash
Since Market Price of Night Ltd. reflects its full value, cost of takeover to Day Ltd is
55 crore – 52.50 crore = ₹ 2.5 crore.
(ii) If the takeover is funded by stock
Number of shares to be issued to Night Ltd.
= ₹ 55 Crore/ ₹ 1000 = 550000 Lakhs
Market Value of Merged Firm = ₹ 1,00,00,00,000 + ₹ 52,50,00,000
= ₹ 1,52,50,00,000 i.e. ₹ 152.50 Crore
Proportion that Night Ltd.’s shareholders get in Day Ltd.’s Capital Structure will be:
.
= 0.3548
.
True Cost of Merger = ₹ 152.50 Crore x 0.3548 – ₹ 55 Crore
= -₹ 0.893 Crore
Since true cost is negative in case of funding from stock, Day Ltd. would better off by funding
the takeover by stock.
SOLUTION 5
Impact of Financial Restructuring
(i) Benefits to Grape Fruit Ltd.
 
   
55

(a) Reduction of liabilities payable

₹ in lakhs
Reduction in equity share capital (6 lakh shares x ₹75 per share) 450
Reduction in preference share capital (2 lakh shares x ₹50 per share) 100
Waiver of outstanding debenture Interest 26
Waiver from trade creditors (₹340 lakhs x 0.25) 85
661
(b) Revaluation of Assets
Appreciation of Land and Building (₹450 lakhs - ₹200 lakhs) 250
Total (A) 911
(ii) Amount of ₹911 lakhs utilized to write off losses, ficticious assets and over- valued
assets.
Writing off profit and loss account 525
Cost of issue of debentures 5
Preliminary expenses 10
Provision for bad and doubtful debts 15
Revaluation of Plant and Machinery 120
(₹300 lakhs – ₹180 lakhs)
Total (B) 675
Capital Reserve (A) – (B) 236
(iii) Balance sheet of Grape Fruit Ltd as at 31st March 2011 (after re-construction)
Liabilities Amount Assets Amount
12 lakhs equity shares of ₹ 25/- 300 Land & Building 450
each
10% Preference shares of ₹ 50/- 100 Plant & Machinery 180
each
Capital Reserve 236 Furnitures & Fixtures 50
9% debentures 200 Inventory 150
Loan from Bank 74 Sundry debtors 70
Trade Creditors 255 Prov. for Doubtful Debts -15 55
Cash-at-Bank (Balancing 280
figure)*
1165 1165
*Opening Balance of ₹130/- lakhs + Sale proceeds from issue of new equity shares ₹150/-
lakhs.
SOLUTION 6
Working Notes
Calculation of Interest Payment on 9% Debentures
PVAF (9%,6) = 4.486
.
Annual Installment = =₹5.0156 crore
.
Year Balance Interest (₹ Installment (₹ Principal Balance (₹
Outstanding (₹ Crore) Crore) Repayment (₹ Crore)
Crore) Crore)
1 22.5000 2.025 5.0156 2.9906 19.5094
2 19.5094 1.756 5.0156 3.2596 16.2498
3 16.2498 1.462 5.0156 3.5536 12.6962
4 12.6962 1.143 5.0156 3.8726 8.8236
Statement showing Value of Equity
Particulars 2013-14 2014-15 2015-16 2016-17
(₹ Crore) (₹ Crore) (₹ Crore) (₹ Crore)
EBIT 48.0000 57.0000 68.0000 82.0000
 
 
56

Interest on 9% Debentures 2.0250 1.7560 1.4620 1.1430

Interest on 8% Loan 12.8000 12.8000 12.8000 12.8000
EBT 33.1750 42.4440 53.7380 68.0570
Tax* @35% 11.6110 14.8550 18.8080 23.8200
EAT 21.5640 27.5890 34.9300 44.2370
Dividend @12.5% of EAT* 2.6955 3.4490 4.3660 5.5300
18.8685 24.1400 30.5640 38.7070
Balance b/f Nil 18.8685 43.0085 73.5725
Balance c/f 18.8685 43.0085 73.5725 112.2795
Share Capital 82.5000 82.5000 82.5000 82.5000
101.3685 125.5085 156.0725 194.7795
*Figures have been rounded off.
In the beginning of 2013-14 equity was ₹ 82.5000crore which has been grown to ₹ 194.7795 over
a period of 4 years. In such case the compounded growth rate shall be as follows:
(194.7795/82.5000)¼ - 1 = 23.96%
This growth rate is slightly higher than 20% as projected by Mr. Smith.
If the condition of VenCap for 18 shares is accepted the expected share holding after 4 years shall be
as follows:
No. of shares held by Management 6.00 crore
No. of shares held by VenCap at the starting stage 2.25 crore
No. of shares held by VenCap after 4 years 4.05 crore
Total holding 6.30 crore
Thus, it is likely that Mr. Smith may not accept this condition of VenCap as this may result in losing
their majority ownership and control to VenCap. Mr. Smith may accept their condition if management
has further opportunity to increase their ownership through other forms.
SOLUTION 7
(i) Computation of Premium (Net Worth Formula):
Amount ₹ in Crores
Total Assets (Fixed assets + Current Assets) = (550 + 580) 1130
Less: Liabilities (Current Liabilities + Borrowings) = (240 + 105) 345
Net Assets Value 785
Current Value of Land after growing for three years @ 30% = 190 X 2.197 417.43
Less: Book Value 190.00
Increase in the Value of land 227.43
Adjusted NAV (785 + 227.43) 1012.43
Current Profit after Tax (@15 % for 5 years i.e. 250 X 7.7537 1938.43
Average Profit for 1 year = 1938.43/5 387.69
Total Value of Firm (1012.43 + 387.69) 1400.12
Total Market Value = No of shares X MPS = 12.50 X 75 937.50
Premium (Total Value – Market Value) 462.62
Premium (%) = 462.62/937.50 * 100 49.35%

(ii) Computation of Premium (Dividend Growth Formula):

Existing Growth Rate 0.15

DPS= 125/12.50 10
MPS 75
Cost of Equity (D1/MP + g) = [(10 X 1.15/75) + 0.15] 0.3033
Expected growth rate after merger 0.18
Expected Market Price = 10 X [1.18 / (0.3033 - 0.18)] 95.70
Premium over current market price (95.70 - 75)/ 75 X 100 27.60%

 
   
57

Alternatively, if given figure of dividend is considered as D1 then Premium over Current Market
Price shall be computed as follows:

Cost of Equity 𝑔 10 0.2833

0.15
75

Expected Growth Rate after Merger 0.18

Expected Market Price 10.00 / (0.2833 – 0.18) 96.81
Premium over Current Market Price (96.81 - 75)/ 75 x 100 29.08%

(iii) During the course of negotiations, ICL will push forward valuation based on Growth Rate Method
as it will lead to least cash outflow.

SOLUTION 8

(i) The number of shares to be issued by B Ltd.:

The Exchange ratio is 2:3

So, new Shares = 1,80,000 x = 1,20,000
shares.

(ii) EPS of B Ltd. after acquisition:

Total (₹ 21,00,000 + ₹ 4,50,000) ₹25,50,000

Earnings
No. of (6,00,000 + 1,20,000) 7,20,000
Shares
EPS (₹ 25,50,000/7,20,000) ₹ 3.5416 or 3.54

(iii) Equivalent EPS of S Ltd. and gain/loss to shareholders:

Equivalent EPS of S Ltd. (₹ 3.54 x ₹ 2.36

)
Less: EPS before merger ₹ 2.50
Loss (₹ 0.14)

(iv) New Market Price of B Ltd. (P/E remaining unchanged):

Present P/E Ratio of B Ltd. 10 times

Expected EPS after merger ₹ 3.54
Expected Market Price (₹3.54 x ₹ 35.40
10)

(v) Market Value of merged firm:

Total number of Shares 7,20,000

Expected Market Price ₹ 35.40
Total value (7,20,000 x 35.40) ₹ 2,54,88,000
(vi)
(1) Equivalent EPS of S Ltd. ₹ 2.36
(2) BSE price per share before merger announcement ₹ 17.50

 
 
58

(3) After the merger announcement 10% increase in price of ₹ 1.75

share
(4) Present Market Price of share (2 + 3) ₹ 19.25
(5) Return on Market Price per share (1/4) 12.26

As Mr. X is having another opportunity to earn 14% and expected return on S Ltd.’s share is
12.26%, it is advisable to offload in market.

 
   
59

Mutual Funds
Study Session 5
SOLUTION 1
(i) Number of Units in each Scheme
MF ‘X’ ₹2,00,000 = 19,417.48
₹10.30
MF ‘Y’ ₹4,00,000 = 39,603.96
₹10.10
MF ‘Z’ ₹2,00,000 = 20,000.00
₹10.00
(ii) Total NAV on 31.03.2018
MF ‘X’ = 19,417.48 x ₹ 10.25 ₹ 1,99,029.17
MF ‘Y’ = 39,603.96 x ₹ 10.00 ₹ 3,96,039.60
MF ‘Z’ = 20,000.00 x ₹ 10.20 ₹ 2,04,000.00
Total ₹ 7,99,068.77
(iii) Total Yield
Capital Yield Dividend Yield Total
MF ‘X’ ₹ 1,99,029.17- ₹ 2,00,000 ₹ 6,000 ₹ 5,029.17
= - ₹ 970.83
MF ‘Y’ ₹ 3,96,039.60 - ₹ 4,00,000 Nil - ₹ 3,960.40
= - ₹ 3,960.40
MF ‘Z’ ₹ 2,04,000 - ₹ 2,00,000 ₹ 5,000 ₹ 9,000.00
= ₹ 4,000
Total ₹ 10,068.77
₹ , .
Total Yield = ×100=1.2586%
₹ , ,
(iv) No. of Days Investment Held
MF ‘X’ MF ‘Y’ MF ‘Z’
Let No. of days be X Y Z
Initial Investment (₹) 2,00,000 4,00,000 2,00,000
Yield (₹) 5,029.17 -3,960.40 9,000.00
Yield (%) 2.5146 -0.9901 4.5
Period of Holding (Days) 365 365 365
2.5146 0.9901 4.5
9.66 11.66 24.15
= 95 Days = 31 Days = 68 Days
Date of Original Investment 26.12.17 28.02.18 22.01.18

SOLUTION 2
Yield for 9 months = (153.33 x 9/12) = 115%
Market value of Investments as on 31.03.2001 = 1,00,000/- + (1,00,000x 115%)
= ₹2,15,000/-
Therefore, NAV as on 31.03.2001 = (2,15,000-10,000)/10,000 = ₹20.50
(NAV would stand reduced to the extent of dividend payout, being (10,000 × 10 × 10%) = ₹10,000)
₹ ,
Since dividend was reinvested by Mr. X, additional units acquired = = 487.80 units
₹ .
Therefore, units as on 31.03.2001 = 10, 000+ 487.80 = 10,487.80
[Alternately, units as on 31.03.2001 = (2,15,000/20.50) = 10,487.80]
Dividend as on 31.12.2002 = 10,487.80 x 10 x 0.2 = ₹20,975.60
Let X be the NAV on 31.12.2002, then number of new units reinvested will be ₹20,975.60/X. Accordingly
11296.11 units shall consist of reinvested units and 10487.80 (as on 31.03.2001). Thus, by way of
equation it can be shown as follows:

 
 
60
.
= 11296.11 = + 10487.80

Therefore, NAV as on 31.12.2002 = 20,975.60/(11,296.11- 10,487.80)

= ₹25.95
NAV as on 31.03.2003 = ₹ 1,00,000 (1+0.7352x33/12)/11296.11
= ₹ 26.75
SOLUTION 3
Calculation of Income available for Distribution
Units (Lakh) Per Unit (₹) Total (₹ In lakh)
Income from April 300 0.0765 22.95
Add: Dividend equalization collected on issue 6 0.0765 0.459
306 0.0765 23.409
Add: Income from May 0.1125 34.425
306 0.189 57.834
Less: Dividend equalization paid on 3 0.189 -0.567
repurchase
303 0.189 57.267
Add: Income from June 0.15 45.45
303 0.339 102.717
Less: Dividend Paid 0.2373 -71.9019
303 0.1017 30.8151
Calculation of Issue Price at the end of April
₹
Opening NAV 18.75
Add: Entry Load 2% of ₹ 18.750 0.375
19.125
Add: Dividend Equalization paid on Issue 0.0765
Price
19.2015
Calculation of Repurchase Price at the end of May
₹
Opening NAV 18.75
Less: Exit Load 2% of ₹ 18.750 -0.375
18.375
Add: Dividend Equalization paid on Issue 0.189
Price
18.564
Closing NAV
₹ (Lakh)
Opening Net Asset Value (₹ 18.75 × 300) 5625.0000
Portfolio Value Appreciation 425.4700
Issue of Fresh Units (6 × 19.2015) 115.2090
Income Received 102.8250
(22.950 + 34.425 + 45.450)
6268.504
Less: Units repurchased (3 × 18.564) -55.692
Income Distributed -71.9019 (-127.5939)
Closing Net Asset Value 6140.9101
Closing Units (300 + 6 – 3) lakh 303 lakh
Closing NAV as on 30th June ₹ 20.2670

 
   
61

SOLUTION 4
(i) Dividend Plan
(a) Average Annual gain over a period of 5 Years 27748.60
(b) Total gain over a period of 5 years (a*5) 138743
(c) Initial Investment 920000
(d) Total value of investment (b+c) 1058743
(e) NAV as on 31.3.2020 49
(f) Number of units at the end of the period as on 31.03.2019 (d/e) 21607

1 2 3 4 = (2*3) 5 6 = 1/ 7
(4+5)*4
Period Units Rate Unit Dividend NAV New Balance Units
held value Units* Pre Dividend
31.03.2019 21607 0.15 10 1.5 45 697 20910
31.03.2018 20910 0.1 10 1 50 410 20500
31.03.2017 20500 0.12 10 1.2 48 500 20000
Issue Price as on 01 04.2015 Investment 920000/ Units purchased 20000 (c/i) = ₹ 46
* Let the units issued be X
X = (Closing Units/NAV + Dividend) x Dividend
(ii) Bonus Plan
(a) Average Yield 0.064
(b) Investment 1000000
(c) Gain over a period of 5 years (a*b*5) 320000
(d) Market Value as on 31.03.2019 (b + c) 1320000
(e) NAV as on 31.03.2020 44
(f) Total units as on 31.03.2020 (d/e) 30000
(g) No of units as on 31.03.2018 Pre bonus = 30000*5/ (5 + 1) 25000
(h) No of units as on 31.12.2016 Pre bonus = 25000*4/ (4 + 1) 20000
(i) Issue Price as on 01.04.2015 Investment 1000000/ Units purchased
20000 (b/h) 50
SOLUTION 5

(i) Personal earnings of Mr. Alex = R1 = 15% Mutual Fund earnings = R2

R2 = × R1+ Recurring expenses(%)

%

= × 15% + 𝟐%
.

= 17.96%

Mutual Fund earnings = 17.96%

(ii) Net financial benefit to Mr. Alex if he invests his portfolio in Fund: Present Income of Mr. Alex

₹ Lakhs
Annual Professional Income (A) 40.00
Portfolio Value 50.00
Income on his Portfolio @ 15% (B) 7.50
Total Income (A) + (B) 47.50

 
 
62

Expected Income of Mr. Alex after investing the Portfolio in Multi-cap Fund:

₹ Lakhs
Annual Professional Income (A) 40.00
Additional Professional Income (B) 4.00
Portfolio Value 50.00
Income on his Portfolio @ 13% (C) 6.50
Total Income (A) + (B) + (C) 50.50

It is advisable to invest in Multi-cap Mutual Funds and devote the time on profession. He will
get net benefit of ₹ 3 Lakhs (₹50.50 - ₹47.50)

SOLUTION 6
Working Notes:

(i) Calculation of Interest Accrued

Name of Security Maturity Date Amount (₹)

10.71% GOI 2028 100 x 100000 x 10.71% x (3/12) 2,67,750
10 % GOI 2023 100 x 50000 x 10.00% x (3/12) 1,25,000
Total 3,92,750

Note: Interests on two remaining securities shall not be considered as last interest was paid on
30.06.2016

(ii) Valuation of Securities

Name of Purchase Duration of Volatility (%) (+)/(-) Total Amount ₹

Security Amount ₹ Bonds
10.71% 1,04,78,000 7.3494 7.3494 - 5,25,053 99,52,947
0.75
GOI 1.10
2028
= 5.0110
10% GOI 50,00,000 5.086 5.086 - 1,81,645 48,18,355
0.75
2023 1.05
= 3.6329
9.5% GOI 39,17,200 4.3949 4.3949 - 1,22,969 37,94,231
0.75
2021 1.05
= 3.1392
8.5% SGL 18,27,200 6.5205 6.5205 - 81,230 17,45,970
0.75
2025 1.10
= 4.4456
2,03,11,503

Calculation of NAV

Particulars ₹ crores
Value of Securities as computed above 2,03,11,503
Cash in hand 6,72,800
Interest accrued 3,92,750
Sub total assets (A) 2,13,77,053
Less: Liabilities 2,37,400
Expenditure accrued
Sub total liabilities (B) 2,37,400
Net Assets Value (A) – (B) 2,11,39,653
No. of units 1,00,000
Net Assets Value per unit (₹ 2,11,39,653/ 1,00,000) ₹ 211.40

 
   
63

Derivatives Analysis & Valuation (Futures)

Study Session 6
SOLUTION 1
(i) Current price of the December Future = ₹ 100 [1195 + 1195 (0.095 - 0.03)× ]
= ₹ 100 [1195 + 19.37]
= ₹ 1,21,437
Since the current market price of December-15 is ₹ 1,22,500 (₹ 100 x 1225) it is overpriced.
(ii) Since the actual future is overpriced, the cash and carry arbitrage is possible i.e. sell the future
contract and borrow to buy the stock.
(iii) September 15
Transaction Cash Flow
Buy (1195 x ₹ 100) = ₹ 1,19,500 worth of Stocks - ₹ 1,19,500.00
Borrow ₹ 1,19,500 @ 9.50% for 91 days + ₹ 1,19,500.00
Sell a Future Contract @ 1225 0
Total 0
(a) If on December 15, the Index closes at 1260
Transaction Cash Flow (₹)
Repay ₹ 1,19,500 @ 9.50% for 91 days - 1,22,330.35
Cancellation of Future Contract (1,22,500 – 1,26,000) - 3,500.00
Sell 1,19,500 worth of Stocks @ 1,260 +1,26,000.00
×1,19,500
Dividend Earned @ 3% + 893.79
×1,19,500×3%
Gain due to Arbitrage + 1,063.44
(b) If on December 15, the Index closes at 1175
Transaction Cash Flow (₹)
Repay ₹ 1,19,500 @ 9.50% for 91 days - 1,22,330.35
Cancellation of Future Contract (1,22,500 – 1,17,500) +5,000.00
Sell 1,19,500 worth of Stocks @ 1,175 + 1,17,500.00
×1,19,500
Dividend Earned @ 3% + 893.79
x 1,19,500 x 3%
Gain due to Arbitrage + 1,063.44

SOLUTION 2

(a) Yes, the apprehension of CEO is correct as the current portfolio is more riskier than market as
the beta (Systematic Risk) of market portfolio is as computed as follows:

Shares No. of Market Price of Per (1) × (2) % to ß (x) Wx

shares Share (2) (₹) (₹ lakhs) total
(lakhs) (1) (w)
X Ltd. 6.00 1000.00 6000.00 0.30 1.50 0.45
Y Ltd. 8.00 1500.00 12000.00 0.60 1.30 0.78
Z Ltd. 4.00 500.00 2000.00 0.10 1.70 0.17
20000.00 1.00 1.40

(b) Since the Beta of existing portfolio is 1.40, the systematic risk of the current portfolio is 1.40.

 
 
64

(c) Required Beta 0.95

Let the proportion of risk-free securities for target beta 0.95 = p

0.95 = 0 × p + 1.40 (1 – p)

p = 0.32 i.e. 32%

Shares to be disposed off to reduce beta (20000 × 32%) ₹ 6,400 lakh and Risk Free securities
to be acquired for the same amount.

(d) Number of shares of each company to be disposed off

Shares % to total Proportionate Market Price No. of Shares

(w) Amount (₹ lakhs) Per Share (₹) (Lakh)
X Ltd. 0.30 1920.00 1000.00 1.92
Y Ltd. 0.60 3840.00 1500.00 2.56
Z Ltd. 0.10 640.00 500.00 1.28

(e) Since, the company is in long position in cash market it shall take short position in Future Market.

Number of Nifty Contract to be sold

. .
= 519 contracts
,

(f) If there is 2% rises in Nifty there will be 2.80%(2%x1.40) rise for portfolio of shares

₹ Lakh
Current Value of Portfolio of Shares 20000
Value of Portfolio after rise 20560
Mark-to-Market Margin paid (8250 × 0.020 × ₹ 210 × 179.83
519)
Value of the portfolio after rise of Nifty 20380.17
% change in value of portfolio (20380.17 – 20000)/ 20000 1.90%
% rise in the value of Nifty 2%
New Systematic Risk (Beta) 0.95
SOLUTION 3

(i) Current portfolio

Current Beta for share = 1.4
Beta for cash =0

Current portfolio beta= x 1.4 + 0 x = 1.2923

(ii) Portfolio beta after 4 months:

Beta for portfolio of shares =

.
1.4 =

Change in value of market portfolio (Index) = (0.018 / 1.4) x 100 = 1.2857

Position taken on 100 lakh Nifty futures : Long
Value of index after 4 months = ₹ 130 lakh x (1.00 - 0.012857)
= ₹ 128.3286 lakh

 
   
65
Mark-to-market paid =₹ 1.6714 lakh
Cash balance after payment of mark-to-market =₹ 8.3286 lakh
Value of portfolio after 4 months =₹ 120 lakh x (1 - 0.018) + ₹ 8.3286 lakh
=₹ 126.1686 lakh
₹ 130 lakh - ₹126.1686 lakh

₹ ₹ .
Change in value of portfolio =
₹

= 2.9472%
Portfolio beta = 0.029472/0.012857
= 2.2923
SOLUTION 4
(a) The Forward Price shall be = S0en(r – y)
Where
S0 = Spot price n = period
r = risk free rate of interest y = dividend yield Accordingly,
Forward Price = 2290 e90/365(0.0416 – 0.0175)
= 2290 e0.005942
= 2290(1.005960)
= 2303.65
(b) Gain/loss on Long Position after 28 days
= 2450 – 2290 e28/365(0.0416 – 0.0175)
= 2450 – 2290 e0.001849
= 2450 – 2290(1.001851)
= 2450 – 2294.24
= 155.76
(c) Gain/loss on Long Position at maturity
= Sn – S0en(r – y)
= 2470.00 – 2303.65
= 166.35
SOLUTION 5
The optional hedge ratio to minimize the variance of Hedger’s position is given by:

H= p

Where
σS = Standard deviation of ΔS
σF = Standard deviation of ΔF
ρ  = coefficient of correlation between ΔS and ΔF
H = Hedge Ratio
ΔS = change in Spot price.
ΔF = change in Future price.
Accordingly
.
H = 0.75 x = 0.5
.
No. of contract to be short = 10 x 0.5 = 5
Amount = 5000 x ₹ 474 = ₹ 23,70,000
SOLUTION 6

(i) The price of one Future Contract

Let X be the Price of Future Contract. Accordingly,

 
 
66
₹ , ,
5=

X (Price of One Future Contract) = ₹ 1,80,000

₹ , ,
(ii) Current Future price of the index = = 2400

Let Y be the current Nifty Index (on 1st February 2020) then

Accordingly, Y + Y (0.09 - 0.06) =2400

and Y = = 2376.24
.

Hence Nifty Index on 1st February 2020 shall be approximately 2376.

(iii) To determine whether the market is in Contango/ Backwardation first we shall compute Basis
as follows:

Basis = Spot Price – Future Price

If Basis is negative the market is said to be in Contango and when it is positive the market is
said to be Backwardation.

Since current Spot Price is 2400 and Nifty Index is 2376, the Basis is negative and hence there
is Contango Market and maximum Contango shall be 24 (2400 – 2376).

(iv) Pay off on the Future transaction shall be [(2400-2100) x 375] =₹ 112500

The Future seller gains if the Spot Price is less than Futures Contract price as position shall be
reversed at same Spot price. Therefore, Mr. SG has gained ₹ 1,12,500/- on the Short position
taken.

 
   
67

Derivatives Analysis & Valuation (Options)

Study Session 7
SOLUTION 1
Total premium paid on purchasing a call and put option
= (₹30 per share × 100) + (₹5 per share × 100).
= 3,000 + 500 = ₹3,500
In this case, X exercises neither the call option nor the put option as both will result in a loss for
him.
Ending value = - ₹3,500 + zero gain = - ₹3,500
i.e Net loss = ₹3,500

Since the price of the stock is below the exercise price of the call, the call will not be exercised. Only
put is valuable and is exercised.
Total premium paid = ₹3,500
Ending value = – ₹3,500 + ₹[(450 – 350) × 100] = – ₹3,500 + ₹10,000 = ₹6,500
Net gain = ₹6,500
In this situation, the put is worthless, since the price of the stock exceeds the put’s exercise price.
Only call option is valuable and is exercised.
Total premium paid = ₹3,500
Ending value = -3,500 +[(600 – 550) × 100]
Net Gain = -3,500 + 5,000 = ₹1,500
SOLUTION 2
(1) Expected Share Price
= ₹120X 0.05 + ₹140X 0.20 + ₹160X 0.50 + ₹180X 0.10 + ₹190X 0.15
= ₹6 + ₹28 + ₹80 + ₹18 + ₹28.50 = ₹160.50
(2) Value of Call Option
= ₹150 - ₹150 = Nil
(3) If the option is held till maturity the expected Value of Call Option
Expected price (X) Value of call (C) Probability (P) CP
₹ 120 0 0.05 0
₹ 140 0 0.20 0
₹ 160 ₹ 10 0.50 ₹5
₹ 180 ₹ 30 0.10 ₹3
₹ 190 ₹ 40 0.15 ₹6
Total ₹ 14
Alternatively, it can also be calculated as follows:
Expected Value of Option
(120 – 150) X 0.1 Not Exercised*
(140 – 150) X 0.2 Not Exercised*
(160 – 150) X 0.5 5
180 – 150) X 0.1 3
(190 – 150) X 0.15 6
14
* If the strike price goes below ₹ 150, option is not exercised at all.

 
 
68

SOLUTION 3
Spot price = 60 [Given] ; Low Price at one year =70% of ₹ 60 = ₹ 42 [Given];
High price (after calculation) = ₹ 81% Increase in price = x100 35%
Working Note:
(1) Maturity Value of Call Probability Expected Value
as on Expiry
X X -55 60 1 .12 42 16.8 (WN-3)
𝑊𝑁 1
𝑋 42
42 0 60 1 .12 42 0
𝑊𝑁 2
𝑋 42
16.8
.
(2) Probability of price Increase (p) = and therefore
.
Probability of price Decrease (1-p) = 1 -
(3) Option Premium after one year =15 (1+.12)1 =16.8
.
Now: (x -55) =16.8 ≥ 25.2 =16.8 ≥ .67 × 55 = 67× -28.14
≥ X – 0.67 X = 28.14 +55 ≥ 33X= 26.86 ≥ X =81.40 ≥ 81 (approx.)
SOLUTION 4

(i) Using the single period model, the probability of price moving up is

. .
P= = = =0.779 say 0.78 i.e. 78%
.

Therefore, the probability of price moving down = 1 - 0.78 = 0.22 i.e. 22%

(ii) Expected pay-off at

Node N2
. . . . .
= = ₹ 14.79
. .

Node N3
. . . .
= = ₹ 3.41
. .

Node N1
. . . . .
= = ₹ 11.69
. .

SOLUTION 5
(i) To compute perfect hedge we shall compute Hedge Ratio (Δ) as follows:
  Δ= = = = 0.50
The investor should purchase 0.50 share for every 1 call option
Or, the investor should purchase 1 share for every 2 Call Option.
(ii) How the investor will be able to maintain his position if he purchase 0.50 share for 1 call option
written.
(a) If price of share goes upto ₹ 650 then value of purchased share will be:
Sale Proceeds of Investment (0.50 x ₹ 650) ₹ 325
Loss on account of Short Position (₹ 650 – ₹ 550) ₹ 100
₹ 225
 
   
69

(b) If price of share comes down to ₹ 450 then value of purchased share will be:
Sale Proceeds of Investment (0.50 x ₹ 450) ₹ 225
(iii) The Value of Option, say, P at the beginning of the period shall be computed as follows:
(₹ 250 – P) 1.05 = ₹ 225
₹ 262.50 – 1.05P = ₹ 225
₹ 37.5 = 1.05P P = ₹ 35.71
(iv) Expected Return on the Option
Expected Option Value = (₹ 650 – ₹ 550) × 0.70 + ₹ 0 × 0.30 = ₹70
.
Expected Rate of Return = ×100 = 96.02%
.

SOLUTION 6
Applying the Black Scholes Formula, Value of the Call option now:
The Formula Value of option = 𝑉 𝑁 𝑑 𝑁 𝑑

𝐼𝑛 𝑆/𝐸 𝑟 𝑡
𝑑
 √𝑡
𝑑 𝑑  √𝑡
Where,
C = Theoretical call premium
S = Current stock price
t = time until option expiration
K = option striking price
r = risk-free interest rate
N = Cumulative standard normal distribution e = exponential term
 = Standard deviation of continuously compounded annual return.
In = natural logarithim
d1
𝐼𝑛 1.0667 0.12 0.08 0.50
0.40 √0.50
. . .
=
.
.
=
.
= 0.5820
d2 = 0.5820 – 0.2828 = 0.2992
N(d1) = N (0.5820)=0.7197
N(d2) = N (0.2992)=0.6176
C= 𝑉 𝑁 𝑑 𝑁 𝑑
= 80 x 0.7197 - ×0.6176
.
= 57.57 – 70.62 x 0.6176
= 57.57 – 43.61
= ₹13.96
Teaching Notes:
Students may please note following important point:
Values of N(d1) and N(d2) have been computed by interpolating the values of areas under respective
numbers of SD from Mean (Z) given in the question.
It may also be possible that in question paper areas under Z may be mentioned otherwise
e.g. Cumulative Area or Area under Two tails. In such situation the areas of the respective Zs given
in the question will be as follows:
Cumulative Area
Number of S.D. from Mean, (z) Cumulative Area
0.25 0.5987
0.30 0.6179
 
 
70

0.55 0.7088
0.60 0.7257
Two tail area
Number of S.D. from Mean, (z) Area of the left and right (two tail)
0.25 0.8026
0.30 0.7642
0.55 0.5823
0.60 0.5485

 
   
71

Foreign Exchange Exposure & Risk

Management
Study Session 8
SOLUTION 1
2 year Forward Rate will be calculated as follows: F = Se ruk rus t
Where F = Forward Rate
S = Spot Rate
rUK = Risk Free Rate in UK
rUS = Risk Free Rate in US
t = Time
Accordingly,
F = 0.75e (0.05 – 0.08)2
= 0.75 х 0.9418
= 0.7064
Thus,
1 US $ = £ 0.7064
If forward rate is 1 US $ = 0.85£ then an arbitrage opportunity exists. Take following steps.
a) Should borrow UK £
b) Buy US $
c) Enter into a short forward contract on US $ Accordingly,
The riskless profit would be
a) Say borrow £ 0.7064e-(0.05)(2) = £ 0.6392 and invest in UK for 2 yea₹
b) Now buy US $ at US $ 1e-(0.08)2 = US $ 0.8521, so that after two year it can be used to close
out the position.
c) After two year the investment in US $ will become US $ 0.8521 e(0.08)(2) = US $ 0.8521 х 1.1735
=
1 US $
d) Sell this US $ for £ 0.85 and repay loan of £ 0.6392 along with interest i.e £ 0.7064. Thus
arbitrage profit will be UK£ 0.85 – UK£ 0.7064 = UK£ 0.1436 say UK£ 0.144
SOLUTION 2
(a) On 28th February 2019 bank would purchase form the exporter US$ 200000 at the agreed rate
i.e. ₹ 71.50/$. However, bank will charge for this early delivery consisting of Swap Difference
and Interest on outlay of funds.
(i) Swap Difference
Bank sells at ₹ 71.20
It buys at ₹ 71.35
Swap loss per US$ ₹ 0.15
Swap loss for $ 200000 is ₹ 30,000
(ii) Interest on Outlay of funds
On February Bank sell $ in Market ₹ 71.20
Bank buys from customer ₹ 71.50
Outlay per US $ ₹ 0.30
Outlay of funds for US$ 200000 ₹ 60,000
Interest of outlay of funds on ₹ 60,000 for 31 days (1st March 2019 to 31st March 2019) at
15% p.a. i.e. ₹ 764
 
 
72

(iii) Charges for early delivery

Swap Loss ₹ 30,000
Interest on Outlay of Funds ₹ 764
₹ 30,764
(iv) Net Inflow to Global Ltd.
Proceed of US $ 200000@₹ 71.50 ₹ 1,43,00,000
Less: Charges for early delivery ₹ 30,764
Net Inflow ₹ 1,42,69,236

SOLUTION 3
In each of the case first the FEADI Rule of Automatic Cancellation shall be applied and customer shall
pay the charges consisted of following:
(a) Exchange Difference
(b) Swap Loss
(c) Interest on Outlay Funds
(a) Exchange Difference
(1) Cancellation Rate:
The forward sale contract shall be cancelled at Spot TT Purchase for $ prevailing on the
date of cancellation as follows:
$/ ₹ Market Buying Rate ₹ 65.9600
Less: Exchange Margin @ 0.10% ₹ 0.0660
₹ 65.8940
Rounded off to ₹ 65.8950
(2) Amount payable on $ 50,000
Bank sells $50,000 @ ₹ 66.8400 ₹ 33,42,000
Bank buys $50,000 @ ₹ 65.8950 ₹ 32,94,750
Amount payable by customer ₹ 47,250
(b) Swap Loss
On 10th September the bank does a swap sale of $ at market buying rate of ₹ 66.1500 and
forward purchase for September at market selling rate of ₹ 66.3200.
Bank buys at ₹ 66.3200
Bank sells at ₹ 66.1500
Amount payable by customer ₹ 0.1700
Swap Loss for $ 50,000 in ₹ = ₹ 8,500
(c) Interest on Outlay of Funds
On 10thSeptember, the bank receives delivery under cover contract at ₹ 66.6800 and sell spot
at ₹ 66.1500.
Bank buys at ₹ 66.6800
Bank sells at ₹ 66.1500
Amount payable by customer ₹ 0.5300
Outlay for $ 50,000 in ₹ 26,500
Interest on ₹ 26,500 @ 12% for 10 days ₹ 87
(d) Total Cost
Cancellation Charges ₹ 47,250.00
Swap Loss ₹ 8,500.00
Interest ₹ 87.00
₹ 55,837.00
(e) New Contract Rate
The contract will be extended at current rate
$/ ₹ Market forward selling Rate for November ₹ 66.4900
Add: Exchange Margin @ 0.10% ₹ 0.0665
₹ 66.5565

 
   
73

Rounded off to ₹ 66.5575

(i) Charges for Cancellation of Contract = ₹ 55,838.00 or ₹ 55,837.00
(ii) Charges for Execution of Contract
Charges for Cancellation of Contract ₹ 55,837.00
Spot Selling US$ 50,000 on 20th September at ₹ ₹ 33,02,750.00
65.9900 + 0.0660 (Exchange Margin) = ₹ 66.0560
rounded to ₹ 66.0550
₹ 33,58,587.00
(iii) Charges for Extension of Contract
Charges for Cancellation of Contract ₹ 55837
New Forward Rate ₹ 66.5575
SOLUTION 4
(A) To cover payable and receivable in forward Market
Amount payable after 3 months $7,00,000
Forward Rate ₹ 48.45
Thus Payable Amount (₹) (A) ₹3,39,15,000
Amount receivable after 2 months $ 4,50,000
Forward Rate ₹ 48.90
Thus Receivable Amount (₹) (B) ₹2,20,05,000
Interest @ 12% p.a. for 1 month (C) ₹2,20,050
Net Amount Payable in (₹) (A) – (B) – (C) ₹1,16,89,950
(B) Assuming that since the forward contract for receivable was already booked it shall be cancelled
if we lag the receivables. Accordingly any profit/ loss on cancellation of contract shall also be
calculated and shall be adjusted as follows:
Amount Payable ($) $7,00,000
Amount receivable after 3 months $4,50,000
Net Amount payable $2,50,000
Applicable Rate ₹ 48.45
Amount payable in (₹) (A) ₹ 1,21,12,500
Profit on cancellation of Forward cost (48.90 – 48.30) × 4,50,000 (B) ₹2,70,000
Thus net amount payable in (₹) (A) + (B) = ₹ 1,18,42,500
Since net payable amount is least in case of first option, hence the company should cover
payable and receivables in forward market.
Note: In the question it has not been clearly mentioned that whether quotes given for 2 and 3
months (in points terms) are premium points or direct quotes. Although above solution is based
on the assumption that these are direct quotes, but students can also consider them as premium
points and solve the question accordingly.
SOLUTION 5
Since the direct quote for ¥ and ₹ is not available it will be calculated by cross exchange rate as
follows:
₹/$ x $/¥ = ₹/¥
62.22/102.34 = 0.6080
Spot rate on date of export 1¥ = ₹ 0.6080
Expected Rate of ¥ for August 2014 = ₹ 0.5242 (₹ 65/¥124)
Forward Rate of ¥ for August 2014 = ₹ 0.6026 (₹ 66.50/¥110.35)

 
 
74

(i) Calculation of expected loss without hedging

Value of export at the time of export (₹ 0.6080 x ¥10,000,000) ₹ 60,80,000
Estimated payment to be received on Aug. 2014 (₹ 0.5242 x
¥10,000,000) ₹ 52,42,000
Loss ₹ 8,38,000
Hedging of loss under Forward Cover
₹ Value of export at the time of export (₹ 0.6080 x ¥10,000,000) Payment ₹ 60,80,000
to be received under Forward Cover (₹ 0.6026 x ¥10,000,000)
Loss ₹ 60,26,000
₹ 54,000
By taking forward cover loss is reduced to ₹ 54,000.
(ii) Actual Rate of ¥ on August 2014 = ₹ 0.5977 (₹ 66.25/¥110.85)
Value of export at the time of export (₹ 0.6080 x ¥10,000,000) Estimated ₹ 60,80,000
payment to be received on Aug. 2014 (₹ 0.5977 x ¥10,000,000)
Loss ₹ 59,77,00
₹ 1,03,000
The decision to take forward cover is still justified.
SOLUTION 6
(i) To Buy 1 Million GBP Spot against CHF
First to Buy USD against CHF at the cheaper rate i.e. from Bank A. 1 USD = CHF 1.4655
Then to Buy GBP against USD at a cheaper rate i.e. from Bank B 1 GBP=USD 1.7650 By applying
chain rule Buying rate would be
1 GBP = 1.7650 * 1.4655 CHF
1 GBP = CHF 2.5866
Amount payable CHF 2.5866 Million or CHF 25,86,600
(ii) Spot rate Bid rate GBP 1 = CHF 1.4650 * 1.7645 = CHF 2.5850
Offer rate GBP 1 = CHF 1.4655 * 1.7660 = CHF 2.5881
GBP / USD 3 months swap points are at discount
Outright 3 Months forward rate GBP 1 = USD 1.7620 / 1.7640
USD / CHF 3 months swap points are at premium
Outright 3 Months forward rate USD 1 = CHF 1.4655 / 1.4665
Hence
Spot rate GBP 1 = CHF 2.5850 / 2.5881
Therefore 3 month swap points are at discount of 28/12.
SOLUTION 7
(i) If investment is made at London
Convert US$ 5,00,000 at Spot Rate (5,00,000/1.5390) £ 3,24,886
Add: £ Interest for 3 months on £ 324,886 @ 5% £ 4,061
£ 3,28,947
Less: Amount Invested $ 5,00,000
Interest accrued thereon $5,000
$ 5,05,000
Equivalent amount of £ required to pay the above sum ($ 5,05,000/1.5430) £ 3,27,285
Arbitrage Profit £ 1,662
(ii) If investment is made at New York
Gain $ 5,00,000 (8% - 4%) x 3/12 $5,000

Equivalent amount in £ 3 months ($ 5,000/ 1.5475) £ 3,231

 
   
75

(iii) If investment is made at Frankfurt

Convert US$ 500,000 at Spot Rate (Cross Rate) 1.8260/1.5390 € 1.19
Euro equivalent US$ 500,000 € 5,93,250
Add: Interest for 3 months @ 3% € 4,449
€ 5,97,699
3 month Forward Rate of selling € (1/1.8150) £ 0.5510
Sell € in Forward Market € 5,97,699 x £ 0.5510 £ 3,29,332
Less: Amounted invested and interest thereon £ 3,27,285
Arbitrage Profit £ 2,047
Since out of three options the maximum profit is in case investment is made in New York. Hence
it should be opted.
SOLUTION 8

(i) Receipts using a forward contract (3,00,000/0.0147) = ₹ 2,04,08,163

(ii) Receipts using currency futures
The number of contracts needed is (3,00,000/0.0151)/6,40,000 = 31.04
say 31
Initial margin payable is 31 x ₹ 24,000 = ₹ 7,44,000
On July 1 Close at 0.0147
Receipts = US$3,00,000/0.0146 = ₹ 2,05,47,945
Variation Margin
= [(0.0151 – 0.0147) x 31 x 640000/-]/0.0146
OR (0.0004x31x 640000)/0.0146 = 7936/0.0146 5,43,562
2,10,91,507
Less: Interest Cost – 7,44,000 x 0.085 x 3/12 15,810
Net Receipts ₹ 2,10,75,697
iii) No hedge
US$ 3,00,000/0.0146 ₹ 2,05,47,945
The most advantageous option would have been to hedge with futures.
SOLUION 9
In the given case, the exchange rates are indirect. These can be converted into direct rates as follows:
Spot rate
1 USD = GBP ---- GBP
. .
1 USD = GBP 0.63804 ---- GBP 0.64033
6 months’ forward rate
1 USD = GBP ---- GBP
. .
1 USD = GBP 0.64066 ---- GBP 0.64704
Payoff in 3 alternatives
(i) Forward Cover
Amount payable USD 3,64,897
Forward rate GBP 0.64704
Payable in GBP 2,36,103
(ii) Money market Cover
Amount payable USD 3,64,897
USD 3,56,867
PV @ 4.5% for 6 months i.e = 0.9779951
.
Spot rate purchase GBP 0.64033
Borrow GBP 3,56,867 × 0.64033 GBP 2,28,512
Interest for 6 months @ 7 % GBP 7,998
Payable after 6 months GBP 2,36,510
 
 
76

(iii) Currency options

Amount payable USD 3,64,897
Unit in Options contract GBP 12,500
Value in USD at strike rate of 1.70 (GBP 12,500 × 1.70) USD 21,250
Number of contracts USD 3,64,897/ USD 21,250 17.17
Exposure covered USD 21,250 × 17 USD 3,61,250
Exposure to be covered by Forward ( USD 3,64,897 - USD 3,61,250) USD 3,647
Options premium 17 × GBP 12,500 × 0.096 USD 20,400
Premium in GBP (USD 20,400 × 0.64033) GBP 13,063
Total payment in currency option
Payment under option (17 × 12,500) GBP 2,12,500
Premium payable GBP 13,063
Payment for forward cover (USD 3,647 × 0.64704) GBP 2,360
GBP 2,27,923
Thus total payment in:
(i) Forward Cover 2,36,103 GBP
(ii) Money Market 2,36,510 GBP
(iii) Currency Option 2,27,923 GBP
The company should take currency option for hedging the risk.
SOLUTION 10
(i) Return of a US Investor
= ×100
= 100 = -5.37%
(ii) Return of Mr. X
Initial Investment (₹) 1.58 Crore
Applicable Exchange Rate on 1.1.20x1 ₹ 62.25
Equivalent US$ US$ 2,53,815.26
Purchase Price of Standard & Poor Index 2028
No. of Standard & Poor Indices Purchased 125.16
Ending Price of Standard & Poor Index 1919
Proceeds realised in US$ on sale of Standard & Poor Index US$ 2,40,182.04
Applicable Exchange Rate on 1.1.20x2 ₹ 67.25
Proceeds realised in INR on sale of Standard & Poor Index ₹ 1,61,52,242
Rate of Return 100
2.23%
(iii) Rate of Return had the amount been invested in India
Initial Investment (₹) 1.58 Crore
Purchase Price of Indian Index 7395
No. of Standard & Poor Indices Purchased 2136.58
Let Ending Price of Indian Index X
Then to be indifferent with return in International Market . .
×100=2.23
.

Price of Indian Index to be indifferent 7559.90 say 7560

SOLUTION 11
Net Cost under each of the Options is as follows:
(i) Loan from German Bank Cost = 5% + 0.25% = 5.25%
(ii) Loan from US Parent Bank
Effective Rate of Interest 4.35%
.
. 0.96%
Premium on US$ 1
.
 
   
77

Net Cost 5.31%

(iii) Loan from Swiss Bank
Effective Rate of Interest 3.26%
.
. 1.94%
Premium on US$ 1
.
Net Cost 5.20%
Thus, loan from Swiss Bank is the best option as the Total Outflow including Interest is Less i.e.
€105200
SOLUTION 12
Exchange Position:
Particulars Purchase Sw. Fcs. Sale Sw. Fcs.
Opening Balance Overbought 50,000
Bill on Zurich 80,000
Forward Sales – TT 60,000
Cancellation of Forward Contract 30,000
TT Sales 75,000
Draft on Zurich cancelled 30,000 —
1,60,000 1,65,000
Closing Balance Oversold 5,000 —
1,65,000 1,65,000
Cash Position (Nostro A/c)
Credit Debit
Opening balance credit 1,00,000 —
TT sales — 75,000
1,00,000 75,000
Closing balance (credit) — 25,000
1,00,000 1,00,000
The Bank has to buy spot TT Sw. Fcs. 5,000 to increase the balance in Nostro account to Sw. Fcs.
30,000.
This would bring down the oversold position on Sw. Fcs. as Nil.
Since the bank requires an overbought position of Sw. Fcs. 10,000, it has to buy forward Sw. Fcs.
10,000.
SOLUTION 13
(i) Calculation of Overall Cost
Upfront Fee (GBP 10 M @ 1.20%) ₹ 1,20,000
Interest Payment (GBP 10 M x 3.55% x 3.4)₹ 12,07,000
Hedging Cost (GBP 10 M x 4% x 3.4) ₹ 13,60,000
Total ₹ 26,87,000
Or ₹ 2.687 million
.
Overall cost in % terms on Annual Basis = x
, , , , , .
.
= x x100
. .

= 8%
.
Overall Cost in Rupee terms@ GBP 1 = ₹ 90 x x 100 =₹ 711.26 lakhs
.
OR
.
Overall cost in % terms on Annual Basis = x
, , , .
.
= x x100
. .
= 7.9%
 
 
78

Overall Cost in Rupee terms@ GBP 1 = 10,000,000 X 7.90% X 90

= ₹ 71,100,000
OR
Calculation of overall cost
Interest & Margin (A) = 3.55%
Hedging cost (B) = 4%
7.55%
Onetime fee = 1.20%
Average loan maturity = 3.4 years
Per annum cost 1.2/3.4 (C) = 0.35%
Annual overall cost in % terms (A+B+C) = 7.9%
Overall Cost in Rupee terms@ GBP 1 = 10,000,000 X 7.90% X 90
= ₹ 71,100,000
(ii) Cost of Hedging in terms of Rupees
₹ 13,60,000 x 90 = ₹ 12,24,00,000 = ₹ 12.24 crores in Total
OR
GBP10,000,000 X 90 X 4% = ₹ 3,60,00,000 on Annual Basis
(iii) If K Ltd. pursues an aggressive approach then Gain/Loss in INR Depreciation/ Appreciation
shall be computed as follows:
(a) If INR depreciates by 10%
Re. loss per GBP = 90 x 10% =₹9
Total Losses GBP10M = ₹ 90 Million
Less: Cost of Hedging = ₹ 36 Million
Net Loss = ₹ 54 million
(b) If INR appreciates by 10%
₹ Gains per GBP = ₹ 90 x 10% =₹9
Total Gain on Repayment of loan = 90 Million
Add: Saving in Cost of Hedging = 36 Million
Net Gain = 126 Million
SOLUTION 14
(i) Do Nothing
We shall compute the cross rates in Spot Market on both days and shall compare the amount
payable in INR on these two days.
On 1st February 2020
Rupee – Dollar selling rate = ₹ 75.50
Dollar – SKW = SKW 1190.00
Rupee – SKW cross rate = ₹ 75.50 / 1190.00
= ₹ 0.0634
Amount payable to Importer as per above rate (1190 Million x ₹ 0.0634) ₹ 754.4600 Lakh On
1st March 2020
Rupee – Dollar selling rate = ₹ 75.75
Dollar – SKW = SKW 1188.00
Rupee – SKW cross rate = ₹ 75.75 / 1188.00
= ₹ 0.0638
Amount payable to Importer as per above rate (1190 Million x ₹ 0.0638) ₹ 759.2200 Lakh Thus,
Exchange Rate Loss = (₹ 759.2200 Lakh - ₹ 754.4600 Lakh) ₹ 4.7600 Lakh

 
   
79

(ii) Hedging in NDF

Since company needs SKW after one month it will take long position in SKW at quoted rate of
SKW 1190/ USD and after one-month it will reverse its position at fixing rate of SKW 1187/USD.
The profit/ loss position will be as follows:
Buy SKW 1190 Million and sell USD (1190 Million/ 1190) USD 1,000,000
Sell SKW 1190 Million and buy USD at Fixing Rate (1190 Million/1185) USD 1,004,219
Profit USD 4,219
Final Position
Amount Payable in Spot Market (as computed earlier) ₹ 759.2200 Lakh
Less : Profit from NDF Market USD 4219 × 75.50 ₹ 3.1853 Lakh
₹ 756.0347 Lakh
Thus, Exchange Rate Loss = (₹ 756.0347 Lakh - ₹ 754.4600 Lakh) ₹ 1.5747 Lakh
Decision: Since Exchange Loss is less in case of NDF same can be opted for.
SOLUTION 15

(i) Nominal rate of return to the US investor

Size of investment ($) 20,00,000

Size of investment (₹) ($ 20,00,000 x 42.50) 8,50,00,000
Sensex at To 3,256
No. of units of Sensex that can be purchased at
To
(₹ 8,50,00,000/3,256) 26,105
Sensex at T1 3,765
Sale of Sensex (26,105 x 3,765) 9,82,85,325
US$ at T1 ₹ 43.90
Equivalent Amount in US$ 22,38,846
Gain in US$ 2,38,846
Nominal rate to US investor 11.94%
(ii) Real Appreciation/Depreciation of Rupee
.
Real Exchange Rate (Buying) = 43.85 = 42.24
.
. .
Real Appreciation of ₹ = x 100 = 0.61%
.

(iii) Exchange rate if relevant purchasing power parity holds

.
Buying Rate = 42.50 = 44.12
.
.
Selling rate = 42.60 = 44.22
.

Exchange rate = 44.12/44.22

(iv) Real return to Indian Investor in Sensex

Nominal Return = x 100 = 15.63%

.
Real return = - 1 = 0.0608 or 6.08%
.

 
 
80

SOLUTION 16

(i) Transit and usance period is 80 days. It will be rounded off to the lower of months and @ months
forward bid rate is to be taken

₹/USD ₹ 67.8000
Add: Premium for 2 months ₹ 0.2100
₹ 68.0100
Less: Exchange margin @ 0.1% ₹ 0.0680
Bid rate for USD ₹ 67.9420
USD/EUR USD 1.0775
Add: Premium USD 0.0040
USD 1.0815
₹/EUR Rate (67.942 x 1.0815) ₹ 73.4793
Amount of Export Bill EUR 5,00,000
Less: EEFC EUR 2,50,000
EUR 2,50,000
Exchange Rate ₹ 73.4793

(ii) Cash Inflow ₹ 1,83,69,825

(iii) Interest for 80 days @ 8% ₹ 3,22,101

SOLUTION 17
Amount realized on selling Danish Kroner 10,00,000 at ₹ 6.5150 per Kroner = ₹ 65,15,000.
Cover at London:
Bank buys Danish Kroner at London at the market selling rate.
Pound sterling required for the purchase (DKK 10,00,000÷DKK 11.4200) = GBP 87,565.67
Bank buys locally GBP 87,565.67 for the above purchase at the market
selling rate of ₹ 74.3200.
The rupee cost will be = ₹ 65,07,88
Profit (₹ 65,15,000 - ₹ 65,07,881) = ₹ 7,119
Cover at New York:
Bank buys Kroners at New York at the market selling rate.
Dollars required for the purchase of Danish Kroner (DKK10,00,000 ÷ 7.5670) = USD
1,32,152.77
Bank buys locally USD 1,32,152.77 for the above purchase at the market
selling rate of ₹ 49.2625.
The rupee cost will be = ₹ 65,10,176.
Profit (₹ 65,15,000 - ₹ 65,10,176) = ₹ 4,824
The transaction would be covered through London which gets the maximum profit of ₹ 7,119 or lower
cover cost at London Market by (₹ 65,10,176 - ₹ 65,07,881) = ₹ 2,295
SOLUTION 18
. .
Forward Rate = = Can$ 2.535/£
.

(i) If spot rate decline by 2%

Spot Rate = Can$ 2.50 x 1.02 = Can$ 2.55/£

 
   
81

£
£ receipt as per Forward Rate (Can $ 5,00,000/ Can$ 1,97,239
2.535)
£ receipt as per Spot Rate (Can $ 5,00,000/ Can$ 2.55) 1,96,078
Gain due to forward contract 1,161

(ii) If spot rate gains by 4%

Spot Rate = Can$ 2.50 x 0.96 = Can$ 2.40/£

£
£ receipt as per Forward Rate (Can $ 5,00,000/ Can$ 1,97,239
2.535)
£ receipt as per Spot Rate (Can $ 5,00,000/ Can$ 2.40) 2,08,333
Loss due to forward contract 11,094
(iii) If spot rate remains unchanged
£
£ receipt as per Forward Rate (Can $ 5,00,000/ Can$ 1,97,239
2.535)
£ receipt as per Spot Rate (Can $ 5,00,000/ Can$ 2.50) 2,00,000
Loss due to forward contract 2,761
SOLUTION 19
USD/ ₹ on 3rd September 49.3800
Swap Point for October 0.1300
49.5100
Add: Exchange Margin 0.0500
49.5600
USD/ SGD on 3rd September 1.7058
Swap Point for 2nd month Forward 0.0096
1.7154
Cross Rate for SGD/ ₹ of 30th October
USD/ ₹ selling rate = ₹ 49.5600
SGD/ ₹ buying rate = SGD 1.7154
SGD/ ₹ cross rate = ₹ 49.5600 / 1.7154
= ₹ 28.8912

 
 
82

Interest Rate Risk Management

Study Session 9
SOLUTION 1
1. 3 Months Interest rate is 4.50% & 6 Months Interest rate is 5% p.a.
Future Value 6 Months from now is a product of Future Value 3 Months now & 3 Months Future
Value from after 3 Months.
(1+0.05*6/12) = (1+0.045*3/12) x (1+i i3,6 *3/12)
i3,6 = [(1+0.05* 6/12) /(1+0.045 *3/12) – 1] *12/3
i.e. 5.44% p.a.
2. 6 Months Interest rate is 5% p.a & 12 Month interest rate is 6.5% p.a.
Future value 12month from now is a product of Future value 6 Months from now and 6 Months
Future value from after 6 Months.
(1+0.065) = (1+0.05*6/12) x (1+ i6,6 *6/12)
i6,6 = [(1+0.065/1.025) – 1] *12/6
6 Months forward 6 month rate is 7.80% p.a.
The Bank is quoting 6/12 USD FRA at 6.50 – 6.75%
Therefore, there is an arbitrage Opportunity of earning interest @ 7.80% p.a. & Paying @
6.75%
Borrow for 6 months, buy an FRA & invest for 12 months
To get $ 1.065 at the end of 12 months for $ 1 invested today
To pay $ 1.060# at the end of 12 months for every $ 1 Borrowed today
Net gain $ 0.005 i.e. risk less profit for every $ borrowed
# (1+0.05/2) (1+.0675/2) = (1.05959) say 1.060
SOLUTION 2
(i) If company borrows in $ then outflow would be as follows:
Let company borrows $ 100 $100.00
Add: Interest for 6 months @ 5.5% $2.75
Amount Repayable after 6 months $102.75
Applicable 6 month forward rate 36.4
Amount of Cash outflow in Indian Rupees ₹ 3,740.10
If company borrows equivalent amount in Indian Rupee, then outflow would be as follows:
Equivalent ₹ amount ₹ 36.10 x 100 ₹ 3,610.00
Add: Interest @11.50% ₹ 207.58
Amount of Cash outflow in Indian Rupees ₹ 3817.58
Since cash outflow is more in ₹ borrowing then borrowing should be made in $.
(ii) (a) Let ‘Ir’ be the interest rate of ₹ borrowing make indifferent between 3 months borrowings
and 6 months borrowing then
(1 + 0.03) (1 + Ir) = (1 + 0.0575)
Ir = 2.67% or 10.68% (on annualized basis)

(b) Let ‘id’ be the interest rate of $ borrowing after 3 months to make indifference
between 3 months borrowings and 6 months borrowings. Then,
(1 + 0.015) (1 + id) = (1 + 0.0275)
id = 1.232% or 4.93% (on annualized basis)

 
   
83

SOLUTION 3
Opportunity gain of A Inc under currency swap Receipt Payment Net
Interest to be remitted to B. Inc in
$ 2,00,000х9%=$18,000 ¥21,60,000
Converted into ($18,000х¥120)
Interest to be received from B. Inc in $ ¥14,40,000 -
converted into Y (6%х$2,00,000 х ¥120)
Interest payable on Y loan - ¥12,00,000
¥14,40,000 ¥33,60,000
Net Payment ¥19,20,000 -

¥33,60,000 ¥33,60,000
$ equivalent paid ¥19,20,000 х(1/¥120) $16,000
Interest payable without swap in $ $18,000
Opportunity gain in $ $ 2,000
Opportunity gain of B inc under currency swap Receipt Payment Net
Interest to be remitted to A. Inc in ($ 2,00,000 х 6%) $12,000
Interest to be received from A. Inc in Y converted into $18,000
$ =¥21,60,000/¥120
Interest payable on $ loan@10% - $20,000

$18,000 $32,000
Net Payment $14,000 -

$32,000 $32,000
Y equivalent paid $14,000 X ¥120 ¥16,80,000
Interest payable without swap in ¥ ¥19,20,000
($2,00,000X¥120X8%)
Opportunity gain in Y ¥ 2,40,000
Alternative Solution
Cash Flows of A Inc
(i) At the time of exchange of principal amount
Transactions Cash Flows
Borrowings $2,00,000 x ¥120 + ¥240,00,000
Swap - ¥240,00,000
Swap +$2,00,000
Net Amount +$2,00,000

(ii) At the time of exchange of principal amount

Transactions Cash Flows
Interest to the lender ¥240,00,000X5% ¥12,00,000
Interest Receipt from B ¥2,00,000X120X6% ¥14,40,000
Inc.
Net Saving (in $) ¥2,40,000/¥120 $2,000
Interest to B Inc. $2,00,000X9% -$18,000
Net Interest Cost -$16,000
A Inc. used $2,00,000 at the net cost of borrowing of $16,000 i.e. 8%. If it had not opted for
swap agreement the borrowing cost would have been 9%. Thus there is saving of 1%.

 
 
84

Cash Flows of B Inc

(i) At the time of exchange of principal amount
Transactions Cash Flows
Borrowings + $2,00,000
Swap - $2,00,000
Swap $2,00,000X¥120 +¥240,00,000
Net Amount +¥240,00,000
(ii) At the time of exchange of principal amount
Transactions Cash Flows
Interest to the lender $2,00,000X10% - $20,000
Interest Receipt from A +$18,000
Inc.
Net Saving (in ¥) -$2,000X¥120 - ¥2,40,000
Interest to A Inc. $2,00,000X6%X¥120 - ¥14,40,000
Net Interest Cost - ¥16,80,000
B Inc. used ¥240,00,000 at the net cost of borrowing of ¥16,80,000 i.e. 7%. If it had not opted
for swap agreement the borrowing cost would have been 8%. Thus there is saving of 1%.
SOLUTION 4
(a) The pay-off of each leg shall be computed as follows:
Cap Receipt
Max {0, [Notional principal x (LIBOR on Reset date – Cap Strike Rate) x
}
Floor Pay-off
Max {0, [Notional principal x (Floor Strike Rate – LIBOR on Reset date) x
}
Statement showing effective interest on each re-set date
Reset Date LIBOR Days Interest Cap Floor Pay- Effective
(%) Payment ($) Receipts off Interest
LIBOR+0.50% ($) ($)
31-12-2013 6.00 184 3,27,671 0 0 3,27,671
30-06-2014 7.50 181 3,96,712 24,795 0 3,71,917
31-12-2014 5.00 184 2,77,260 0 0 2,77,260
30-06-2015 4.00 181 1,98,356 0 0 1,98,356
31-12-2015 3.75 184 1,89,041 0 12,603 2,01,644
30-06-2016 4.25 182 2,36,849 0 0 2,36,849
Total 1096 16,26,094
(b) Average Annual Effective Interest Rate shall be computed as follows:
, ,
×100 = 5.42%
, , ,

SOLUTION 5
Qtrs. Sensex Sensex Amount Fixed Return Net (₹
Return (%) Payable (₹ (Receivable) (₹ Crore) Crore)
Crore)
(1) (2) (3) (4) (5) (5) – (4)
0 21,600 - - - -
1 21,860 1.2037 4.8148 4.6000 - 0.2148
2 21,780 -0.3660 -1.4640 4.6000 6.0640
3 22,080 1.3774 5.5096 4.6000 - 0.9096
4 21,960 -0.5435 -2.1740 4.6000 6.7740
 
   
85

SOLUTION 6
(1) Yield from Investment in Equity Trading Index in Japan
Conversion of GBP 200 million in JPY (148.0002) JPY 29600.04 Million
Dividend Income JPY 1182.00 Million
Stock Lending JPY 10.00 Million
Investment Value at End JPY 29008.0392 Million
Amount available at End JPY 30200.0392 Million
Forward Rate of 30.06.2019 JPY 150/ GBP
Amount to be Remitted back to London Gain = GBP GBP 201.3336 Million
201.3336 – GBP 200 GBP 1.3336 Million
(2) Fixed Income Desk of US
Conversion of GBP 200 million in USD (1.28000) USD 256.00 Million
Add: Interest @ 5% p.a. for 6 months USD 6.40 Million
Amount available at End USD 262.40 Million
Forward Rate of 30.06.2019 USD 1.30331/ GBP
Amount to be Remitted back to London Gain = GBP GBP 201.3335 Million
201.3335 – GBP 200 GBP 1.3335 Million
Decision:
The equivalent amount at the end of 6 months shall be almost same in both the options. The bank
can go for any of the options.
However, from risk perspective, the investment in fixed income desk of US is more beneficial as the
chance of variation in fixed income securities is less as compared to Equity Desk.
SOLUTION 7
Though Company IB has an advantage in both the markets but it has comparative more advantage
in the INR floating-rate market. Company Zaki has a comparative advantage in the JPY fixed interest
rate market.
However, company IB wants to borrow in the JPY fixed interest rate market and company Zaki wants
to borrow in the INR floating-rate market. This gives rise to the swap opportunity.
IB raises INR floating rate at BPLR + 0.50% and Zaki raises JPY at 2.25%
Total Potential Gain = (INR interest differential) - (Yen rate differential)
= (BPLR + 2.50% - BPLR + 0.50%) + (2% - 2.25%) = 1.75%
Less Banker's commission (To be shared equally) = 0.25%
Net gain (To be shared equally: 0.75% each) = 1.50%
(i) Yes, a beneficial swap can be arranged
(ii) Effective cost of borrowing = pays to lenders + pays to other party -receives from other party
+ banker's commission
IB = BPLR + 0.50% +1.125%* - (BPLR + 0.50%) + 0.125% = 1.25%
(* has been arrived as 2% - 0.75% - 0.125%)
Zaki = 2.25% + BPLR + 0.50% - 1.125% + 0.125% = BPLR + 1.75%
Note: Candidates can also present the above Swap arrangement in a different manner. In such case
they should be awarded due marks provided solution be ended up in correct answer.

 
 
86

Bond Valuation
Study Session 10
SOLUTION 1
Since the bonds were sold at par, the original YTM was 10%.
₹
YTM = = = 10%
₹
Price of the bond as on 1st July, 2018 =₹ 50 x 9.712 + ₹ 1,000 х 0.417
=₹ 485.60 + ₹ 417
=₹ 902.60
Total value of the bond on the next =₹ 902.60 +₹50 interest date= ₹952.60
Value of bond at purchase date =₹ 952.60 х /
.
= ₹ 952.60 х 0.9620 (by using excel)
= ₹ 916.40†
The amount to be paid to complete the transaction is ₹916.40. Out of this amount ₹ 16.67 represent
accrued interest* and ₹899.73 represent the bond basic value.
† Alternatively, it can also be calculated as follows:
= ₹ 952.60 х
.

= ₹ 952.60 x
.
= ₹ 915.96
The amount to be paid to complete the transaction is ₹915.96. Out of this amount ₹ 16.67 represent
accrued interest* and ₹899.29 represent the bond basic value.
* Accrued Interest can also be calculated as follows:
Accrued Interest on Bonds = 1,000 x x = 16.67

SOLUTION 2
(i) Current yield = × =0.1555 or 15.55%
YTM can be determined from the following equation
7 × PVIFA (YTM, 10) + 100 × PVIF (YTM, 10) = 90
Let us discount the cash flows using two discount rates 7.50% and 9% as follows:
Year Cash Flows [email protected]% [email protected]% PVF@9% PV@9%
0 -90 1 -90 1 -90
1 7 0.930 6.51 0.917 6.419
2 7 0.865 6.055 0.842 5.894
3 7 0.805 5.635 0.772 5.404
4 7 0.749 5.243 0.708 4.956
5 7 0.697 4.879 0.650 4.550
6 7 0.648 4.536 0.596 4.172
7 7 0.603 4.221 0.547 3.829
8 7 0.561 3.927 0.502 3.514
9 7 0.522 3.654 0.460 3.220
10 107 0.485 51.90 0.422 45.154
6.560 -2.888
Now we use interpolation formula
.
= 7.50% + × 1.50%
. .
.
7.50% + ×1.50% =7.50% + 1.041%
.

 
   
87

YTM = 8.541% say 8.54%

Note: Students can also compute the YTM using rates other than 15% and 18%.
(ii) The duration can be calculated as follows:
Year Cash Flow PVF@ PV @ Proportion of NCD Proportion of NCD
8.54% 8.54% value value × time
1 7 0.921 6.447 0.0717 0.0717
2 7 0.849 5.943 0.0661 0.1322
3 7 0.782 5.474 0.0608 0.1824
4 7 0.721 5.047 0.0561 0.2244
5 7 0.664 4.648 0.0517 0.2585
6 7 0.612 4.284 0.0476 0.2856
7 7 0.563 3.941 0.0438 0.3066
8 7 0.519 3.633 0.0404 0.3232
9 7 0.478 3.346 0.0372 0.3348
10 107 0.441 47.187 0.5246 5.2460
89.95 7.3654
Duration = 7.3654 half years i.e. 3.683 years.
(iii) Realized Yield can be calculated as follows:
=90
1 𝑅 =
/
R= -1= 0.06380 or 6.380% for half yearly and 12.76% annually.

SOLUTION 3
1. Conversion Value of Debenture
= Market Price of one Equity Share × Conversion Ratio = ₹ 25 × 30 = ₹ 750
2. Market Conversion Price
= = = ₹ 30
3. Conversion Premium per share
= Market Conversion Price - Market Price of Equity Share
= ₹ 30 - ₹ 25 = ₹ 5
4. Ratio of Conversion Premium
= = = 20%
5. Premium over Straight Value of Debenture

= –1= – 1 = 28.6%
6. Favourable income differential per share

=
= = ₹ 1.833
7. Premium pay back period
= = 5 1.833 = 2.73 Years

SOLUTION 4
1. Calculation of initial outlay:- ₹ (lakhs)
a. Face Value 200.00
Add : Call premium 10.00
Cost of calling old bonds 210.00
 
 
88

b. Gross proceed of new issue 200.00

Less : Issue costs 2.50
Net proceeds of new issue 197.50
c. Tax savings on call premium and unamortized cost 0.30 (10+3) ₹ 3.90 lakhs
∴ Initial outlay = ₹ 210 lakhs - ₹ 197.50 lakhs - ₹ 3.90 lakhs 8.60 lakhs
2. Calculation of net present value of refunding the bond:- ₹ (lakhs)
Saving in annual interest expenses
[₹ 200 x (0.11 - 0.09)] 4.000
Less:-Tax saving on interest and amortization 0.30 x [4+(3-2.5)/10] 1.215
Annual net cash saving 2.785
PVIFA (7%, 10 years) 7.024
∴ Present value of net annual cash saving ₹ 19.56 lakhs
Less : Initial outlay ₹ 8.61 lakhs
Net present value of refunding the bond ₹ 10.96 lakhs
Decision : The bonds should be refunded
SOLUTION 5
i) Forward Rates for year 2 & years 3:
For year 2: =  (1+0.1050) ( 1+ X) = ( 1+ 0.1125)2 = 12%
. .
For year 3: =  (1 +.1050 )(1+.12) (1+X) = ( 1+1.12)3
. . .
 X = 13.52%
.
ii) Percentage Change in the Price of the Bond: B0 = = 978
.
Therefore, % change in the price of the bond = × 100 = - 2.2%

SOLUTION 6
(a) Calculation of Bond Duration
Bond A
Year Cash flow P.V. @ 9% Proportion of Proportion of
bond value bond value x time
(years)
1 10 0.917 9.17 0.086 0.086
2 10 0.842 8.42 0.079 0.158
3 10 0.772 7.72 0.073 0.219
4 10 0.708 7.08 0.067 0.268
5 10 0.650 6.50 0.061 0.305
6 10 0.596 5.96 0.056 0.336
7 10 0.547 5.47 0.051 0.357
8 10 0.502 5.02 0.047 0.376
9 10 0.460 4.60 0.043 0.387
10 110 0.4224 46.46 0.437 4.370
106.40 1.000 6.862
Duration of the bond is 6.862 years or 6.86 year
Bond B
Year Cash flow P.V. @ 9% Proportion of Proportion of bond
bond value value x time (years)
1 11 0.917 10.087 0.091 0.091
2 11 0.842 9.262 0.083 0.166
3 11 0.772 8.492 0.076 0.228
 
   
89

4 11 0.708 7.788 0.070 0.280

5 11 0.650 7.150 0.064 0.320
6 11 0.596 6.556 0.059 0.354
7 11 0.547 6.017 0.054 0.378
8 111 0.502 55.772 0.502 4.016
111.224 1.000 5.833
Duration of the bond B is 5.833 years or 5.84 years
Bond C
Year Cash P.V. @ 9% Proportion of bond Proportion of bond
flow value value x time (years)
1 9 0.917 8.253 0.082 0.082
2 9 0.842 7.578 0.076 0.152
3 9 0.772 6.948 0.069 0.207
4 9 0.708 6.372 0.064 0.256
5 109 0.650 70.850 0.709 3.545
100.00 1.000 4.242
Duration of the bond C is 4.242 years or 4.24 years
(ii) Amount of Investment required in Bond B and C
Period required to be immunized 6.000 Year
Less: Period covered from Bond A 3.087 Year
To be immunized from B and C 2.913 Year
Let proportion of investment in Bond B and C is b and c respectively then
b + c = 0.55 (1)
5.883b + 4.242c = 2.913 (2)
On solving these equations, the value of b and c comes 0.3534 or 0.3621 and 0.1966 or 0.1879
respectively and accordingly, the % of investment of B and C is 35.34% or 36.21% and 19.66 %
or 18.79% respectively.
(iii) With revised yield the Revised Duration of Bond stands
0.45 x 7.15 + 0.36 x 6.03 + 0.19 x 4.27 = 6.20 year
No portfolio is not immunized as the duration of the portfolio has been increased from 6 years to
6.20 years.
(iv) New percentage of B and C bonds that are needed to immunize the portfolio.
Period required to be immunized 6.0000 Year
Less: Period covered from Bond A 3.2175 Year
To be immunized from B and C 2.7825 Year
Let proportion of investment in Bond B and C is b and c respectively, then
b + c = 0.55
6.03b + 4.27c = 2.7825
b = 0.2466
On solving these equations, the value of b and c comes 0.2466 and 0.3034 respectively and
accordingly, the % of investment of B and C is 24.66% or 25% and 30.34 % or 30.00% respectively.
SOLUTION 7
(i) Current Market Price of Bond
= ₹ 850 (PVIAF 10%, 5) + ₹ 10,000 (PVIF 10%, 5)
= ₹ 850 (3.79) + ₹ 10,000 (0.621) = ₹ 3,221.50 + ₹ 6,210 = ₹ 9,431.5
(ii) Macaulay’s Duration
Year Cash flow P.V. @ 10% Proportion of Proportion of bond
bond value value x time (years)
1 850 0.909 772.65 0.082 0.082
 
 
90

2 850 0.826 702.10 0.074 0.148

3 850 0.751 638.35 0.068 0.204
4 850 0.683 580.55 0.062 0.248
5 10,850 0.621 6,737.85 0.714 3.57
9431.50 1.000 4.252
Duration of the Bond is 4.252 years
(iii) Volatility of Bond
.
Volatility of Bonds = = =3.865
.

(iv) Convexity of Bond

C* x (∆y)2 x100
C* =

Year Cash flow P.V. @ 8% P.V @12%

1 850 0.926 787.10 0.892 758.20
2 850 0.857 728.45 0.797 677.45
3 850 0.794 674.90 0.712 605.20
4 850 0.735 624.75 0.636 540.60
5 10,850 0.681 7388.85 0.567 6,151.95
10204.05 8,733.40
, . . .
C* =
. .

.
= = 9.867
.

Convexity of Bond = 9.867 x 0.02 x 100 = 0.395%

(v) The expected market price if decrease in YTM by 200 basis points.

(A) By Macaulay’s duration-based estimate

= ₹ 9431.50× 2 (3.865/100) = ₹ 729.05

Hence expected market price is ₹ 9431.50 + ₹ 729.05 = ₹ 10,160.55

Hence, the market price will increase.

(B) By Intrinsic Value method

Intrinsic Value at YTM of 10% ₹ 9,431.50

Intrinsic Value at YTM of 8% ₹ 10,204.05
Price increased by ₹ 772.55

Hence, expected market price is ₹ 10,204.05

SOLUTION 8
The XYZ Bank shall choose those CTD (Cheapest-to-Deliver) Bonds from the basket of deliverable
Bonds which gives maximum profit computed as follows:
Profit = Future Settlement Price x Conversion Factor – Quoted Spot Price of Deliverable Bond
Accordingly, the profit of each bond shall be computed as follows:

 
   
91

Security Future Settlement Conversion Quoted Price Profit

Price Factor (4) = (2) x of Bonds
(1) (2) (3) (3) (5) (6)
7.96 GOI 2023 1000 1.0370 1037.00 1037.40 - 0.40
6.55 GOI 2025 1000 0.9060 906.00 926.40 - 20.40
6.80 GOI 2029 1000 0.9195 919.50 877.50 42.00
6.85 GOI 2026 1000 0.9643 964.30 972.30 - 8.00
8.44 GOI 2027 1000 1.1734 1173.40 1146.30 27.10
8.85 GOI 2028 1000 1.2428 1242.80 1201.70 41.10
Since maximum profit to the Bank is in case of 6.80 GOI 2029, same should be opted for.
SOLUTION 9
(i) For finding expected market price first we shall calculate PV Intrinsic Value of Bond as
of Interest + PV of Maturity Value of Bond follows:
Forward rate of interests
1st Year 12%
2nd Year 11.62%
3rd Year 11.33%
4th Year 11.06%
5th Year 10.80%

PV of interest = + + + +
. . . . .

= ₹ 90 x 0.8929 + ₹ 90 x 0.8026 + ₹ 90 x 0.7247 + ₹ 90 x 0.6573 + ₹ 90 x 0.5988

= ₹ 80.36 + ₹ 72.23 + ₹ 65.22 + ₹ 59.16 + ₹ 53.89

= ₹ 330.86

PV of Maturity Value of Bond =

.

= ₹ 1,000 x 0.5988 = ₹ 598.80

Intrinsic value of Bond = ₹ 330.86 + ₹ 598.80 = ₹ 929.66

Expected Price = Intrinsic Value x Beta Value

= ₹ 929.66 x 1.10 = ₹ 1,022.63

(ii) The given yield curve is inverted yield curve.

The main reason for this shape of curve is expectation for forthcoming recession when investors
are more interested in Short-term rates over the long term.

 
 
92

Portfolio Management
Study Session 11
SOLUTION 1 
(i) Computation of Beta of Portfolio
Investmen No. of Marke Market Dividen Dividen Compositio β Weighte
t shares t Price Value d d n d
Yield β
I. 60,000 4.29 2,57,400 19.50% 50,193 0.2339 1.1 0.27
6
II. 80,000 2.92 2,33,600 24.00% 56,064 0.2123 2.2 0.48
8
III. 1,00,00 2.17 2,17,000 17.50% 37,975 0.1972 0.9 0.18
0 0
IV. 1,25,00 3.14 3,92,500 26.00% 1,02,050 0.3566 1.5 0.53
0 0
11,00,50 2,46,28 1.0000 1.46
0 2
, ,
Return of the Portfolio = 0.2238
, ,
Beta of Port Folio 1.46
Market Risk implicit
0.2238 = 0.11 + β× (0.19 – 0.11)
Or, 0.08 β + 0.11 = 0.2238
. .
β= =1.42
.
Market β implicit is 1.42 while the port folio β is 1.46. Thus the portfolio is marginally risky compared
to the market.
(ii) The decision regarding change of composition may be taken by comparing the dividend yield
(given) and the expected return as per CAPM as follows:
Expected return R as per CAPM is:
R = I + (R – I ) ß
For Investment I R = I + (R – I ) ß
= .11 + (.19 - .11) 1.16
= 20.28%
For Investment II R = .11 + (.19 – 11 ) 2.28 = 29.24%
For Investment III, R = .11 + (.19 – 11) .90
= 18.20%
For Investment IV, R = .11 + (.19 - .11 ) 1.50
= 23%
Comparison of dividend yield with the expected return Rs shows that the dividend yields of
investment I, II and III are less than the corresponding Rs,. So, these investments are over-priced and
should be sold by the investor. However, in case of investment IV, the dividend yield is more than the
corresponding Rs, so, XYZ Ltd. should increase its proportion.

 
   
93

SOLUTION 2 
Working Notes:
(i) Decomposition of Funds in Equity and Cash Components
D Mutual Fund K Mutual Fund
Ltd. Ltd.
NAV on 31.12.14 ₹ 70.71 ₹ 62.50
% of Equity 99% 96%
Equity element in NAV ₹ 70 ₹ 60
Cash element in NAV ₹ 0.71 ₹ 2.50
(ii) Calculation of Beta
(a) D Mutual Fund Ltd.
Sharpe Ratio = 2 = =
 .
E(R) - R = 22.50
.
Treynor Ratio = 15 = =
 
 = 22.50/15= 1.50
(b) K Mutual Fund Ltd.
Sharpe Ratio = 3.3 = =

E R R = 16.50
.
Treynor Ratio = 15 = =
 
 = 16.50/15= 1.10
(iii) Decrease in the Value of Equity
D Mutual Fund K Mutual Fund
Ltd. Ltd.
Market goes down by 5.00% 5.00%
Beta 1.50 1.10
Equity component goes 7.50% 5.50%
down
(iv) Balance of Cash after 1 month
D Mutual Fund K Mutual Fund
Ltd. Ltd.
Cash in Hand on 31.12.14 ₹ 0.71 ₹ 2.50
Less: Exp. Per month ₹ 0.25 ₹ 0.25
Balance after 1 month ₹ 0.46 ₹ 2.25
NAV after 1 month
D Mutual Fund K Mutual Fund
Ltd. Ltd.
Value of Equity after 1
month
70 x (1 - 0.075) ₹ 64.75 -
60 x (1 - 0.055) - ₹ 56.70
Cash Balance 0.46 2.25
65.21 58.95
SOLUTION 3
(i) Variance of Returns
,
Cori,j =

Accordingly, for MFX

 
 
94
,
1=
 
  𝜎 = 4.800
Accordingly, for MFY
,
1=
 
  𝜎 = 4.250
Accordingly, for Market Return
,
1=

  𝜎 = 3.100
(ii) Portfolio return, beta, variance and standard deviation
, ,
Weight of MFX in portfolio = =0.60
, ,
,
Weight of MFY in portfolio = =0.40
, ,
Accordingly Portfolio Return
0.60 × 15% + 0.40 × 14% = 14.60%
Beta of each Fund
,
  β   =
.
βX = = 1.087
.
.
  βY = = 0.903
.
Portfolio Beta
0.60 x 1.087 + 0.40 x 0.903 = 1.013
Portfolio Variance
𝜎 𝑊 𝜎 𝑊 𝜎 2𝑤 𝑤 𝐶𝑜𝑣 ,
= (0.60)2 (4.800) + (0.40)2 (4.250) + 2(0.60) (0.40) (4.300)
= 4.472
Or Portfolio Standard Deviation
𝜎 = √4.472 = 2.115
(iii) Expected Return, Systematic and Unsystematic Risk of Portfolio
Portfolio Return = 10% + 1.0134(12% - 10%) = 12.03%
MF X Return = 10% + 1.087(12% - 10%) = 12.17%
MF Y Return = 10% + 0.903(12% - 10%) = 28.06%
Systematic Risk = β2 σ2
Accordingly,
Systematic Risk of MFX = (1.087)2 x 3.10 = 3.663
Systematic Risk of MFY = (0.903)2 x 3.10 = 2.528
Systematic Risk of Portfolio = (1.013)2 x 3.10 = 3.181
Unsystematic Risk = Total Risk - Systematic Risk
Accordingly,
Unsystematic Risk of MFX = 4.80 - 3.663 = 1.137
UnSystematic Risk of MFY = 4.250 - 2.528 = 1.722
UnSystematic Risk of Portfolio = 4.472 - 3.181 = 1.291
(iv) Sharpe and Treynor Ratios and Alpha
Sharpe Ratio
% %
MFX = = 2.282
√ .
% %
MFY = = 1.94
√ .
. % %
Portfolio = = 2.175
.
Treynor Ratio
% %
MFX = = 4.60
.

 
   
95
% %
MFY = = 4.43
.
. % %
Portfolio = = 4.54
.
Alpha
MFX = 15% - 12.17% = 2.83%
MFY = 14% - 11.81% = 2.19%
Portfolio = 14.6% - 12.03% = 2.57%
SOLUTION 4 
(i) Mr. X’s position in the two securities are +1.50 in security A and -0.5 in security B. Hence the
portfolio sensitivities to the two factors:-
b prop. 1 =1.50 x 0.80 + (-0.50 x 1.50) = 0.45
b prop. 2 = 1.50 x 0.60 + (-0.50 x 1.20) = 0.30
(ii) Mr. X’s current position:-
Security A ₹ 3,00,000 / ₹ 1,00,000 = 3
Security B -₹ 1,00,000 / ₹ 1,00,000 = -1
Risk free asset -₹ 100000 / ₹ 100000 = -1
b prop. 1 = 3.0 x 0.80 + (-1 x 1.50) + (- 1 x 0) = 0.90
b prop. 2 = 3.0 x 0.60 + (-1 x 1.20) + (-1 x 0) = 0.60
(iii) Expected Return = Risk Free Rate of Return + Risk Premium Let λ1 and λ2
are the Value Factor 1 and Factor 2 respectively. Accordingly
15 = 10 + 0.80 λ1 + 0.60 λ2
20 = 10 + 1.50 λ1 + 1.20 λ2
On solving equation, the value of λ1 = 0, and Securities A & B shall be as follows:
Security A
Total Return = 15%
Risk Free Return = 10%
Risk Premium = 5%
Security B
Total Return = 20%
Risk Free Return = 10%
Risk Premium = 10%
SOLUTION 5
(i) Expected Return on X Ltd.’s Share
Average % Annual Capital Gain [197÷ 95] ¼ -1 = 0.20 i.e. 20%
% % % % %
Average % dividend yield = = 10%
Therefore, expected return on share of X Ltd. = 20% + 10% = 30%
(ii) Expected Return on Market Index
Average Annual % Capital gain
[2182 ÷ 1490]1/4 - 1 = 0.10 i.e. 10%
% % % % %
Average % of dividend yield = = 15%
Thus, expected return on Market Index = 10% + 15% = 25%
(iii) Return from Central Govt. Securities
% % % % %
= 15%
Thus, Risk Free Rate of Return = R f = 15%
(iv) Beta Value of X Ltd.
E (Rx) = Rf + [E(Rm) – Rf] βx
30 = 15 + [25 – 15] βx
  βx = 1.5 times

 
 
96

SOLUTION 6

Particulars of Securities Cost ₹ Dividend Capital gain

Gold Ltd. 10,000 1,725 -200
Silver Ltd. 15,000 1,000 1,200
Bronz Ltd. 14,000 700 6,000
GOI Bonds 36,000 3,600 -1,500
Total 75,000 7,025 5,500
Expected rate of return on market portfolio
×100

₹ , ₹ ,
= x 100 = 16.7%
₹ ,
Risk free return
. . . .
Average of Betas =
Average of Betas* = 0.50
Average return = Risk free return + Average Betas (Expected return – Risk free return)
15.7 = Risk free return + 0.50 (16.7 – Risk free return)
Risk free return = 14.7%
* Alternatively it can also be calculated through Weighted Average Beta.
Expected Rate of Return for each security is
Rate of Return = Rf + B (Rm – Rf)
Gold Ltd. = 14.7 + 0.6 (16.7 – 14.7) = 15.90%
Silver Ltd. = 14.7 + 0.8 (16.7 – 14.7) = 16.30%
Bronze Ltd. = 14.7 + 0.6 (16.7 – 14.7) = 15.90%
GOI Bonds = 14.7 + 0.01 (16.7 – 14.7) = 14.72%
* Alternatively it can also be computed by using Weighted Average Method.
SOLUTION 7
Characteristic line is given by
 + R
∑
 =
∑
i = y - 
Return on B Return on XY X2
Market (X) (x- x) (x- x)2 (y- y) (y- y)2
(Y)
10 8 80 64 1.50 2.25 1.50 2.25
12 10 120 100 3.50 12.25 3.50 12.25
9 9 81 81 2.50 6.25 0.50 0.25
3 -1 -3 1 -7.50 56.25 -5.50 30.25
34 26 278 246 77.00 45.00
Y = 34 4 = 8.50
X = 26 4 = 6.50
∑ . .
 = = =
∑ .

= = 0.74
 = y - x=8.50 – 0.74 (6.50) = 3.69
Hence the characteristic line is 3.69 + 0.74 (R )

 
   
97
∑
Total Risk of Market = σ 𝑚 = = 19.50(%)
Total Risk of Stock = = 11.25 (%)
Systematic Risk = β σ = 0.74 x 19.25 = 10.54(%)
Unsystematic Risk is = Total Risk – Systematic Risk
= 11.25-10.54 = 0.71(%)
SOLUTION 8 
.
Maximum decline in one month = x 100 = 10%
(1) Immediately to start with
Investment in equity = Multiplier x (Portfolio value – Floor value) = 2 (3,00,000 – 2,70,000) =
₹ 60,000
Indira may invest ₹ 60,000 in equity and balance in risk free securities.
(2) After 10 days
Value of equity = 60,000 x 5122.96/5326 = ₹ 57,713
Value of risk free investment = ₹ 2,40,000
Total value of portfolio = ₹ 2,97,713
Investment in equity = Multiplier x (Portfolio value – Floor value)
= 2 (2,97,713 – 2,70,000) = ₹ 55,426
Revised Portfolio:
Equity = ₹ 55,426
Risk free Securities = ₹ 2,97,713 – ₹ 55,426 = ₹ 2,42,287
(3) After another 10 days
Value of equity = 55,426 x 5539.04/5122.96 = ₹59,928
Value of risk free investment = ₹ 2,42,287
Total value of portfolio = ₹ 3,02,215
Investment in equity = Multiplier x (Portfolio value – Floor value)
= 2 (3,02,215 – 2,70,000) = ₹ 64,430
Revised Portfolio:
Equity = ₹ 64,430
Risk Free Securities = ₹ 3,02,215 –₹64,430 = ₹ 2,37,785
The investor should off-load ₹ 4502 of risk free securities and divert to Equity.
SOLUTION 9 
(i) Equilibrium price of Equity using CAPM
= 5% + 1.5(11% - 5%)
= 5% + 9%= 14%
. . .
P= = = = ₹ 36.00
. . .
(ii) New Equilibrium price of Equity using CAPM (assuming 3% on 5% is inflation increase)
= 5.15% + 1.3(11% - 5.15%)
= 5.15% + 7.61%= 12.76%
. .
P= = = ₹ ₹ 27.06
. .
Alternatively, it can also be computed as follows, assuming it is 3% in addition to 5%
= 8% + 1.3(11% - 8%)
= 8% + 3.9%= 11.9%
. .
P= = = ₹30.43
. .
Alternatively, if all the factors are taken separately then solution of this part will be as follows:

 
 
98

(i) Inflation Premium increase by 3%.

This raises RX to 17%. Hence, new equilibrium price will be:
. .
P= = = ₹ 24
. .
(ii) Expected Growth rate decrease by 3%.
Hence, revised growth rate stand at 5%:
. .
P= = = ₹23.33
. .
(iii) Beta decreases to 1.3.
Hence, revised cost of equity shall be:
= 5% + 1.3(11% - 5%)
= 5% + 7.8%= 12.8%
As a result New Equilibrium price shall be:
. .
P= = = ₹45
. .

 
   
99

International Financial Management

Study Session 12
SOLUTION 1
Calculation of NPV
Year 0 1 2 3
Inflation factor in India 1.00 1.10 1.21 1.331
Inflation factor in Africa 1.00 1.40 1.96 2.744
Exchange Rate (as per IRP) 6.00 7.6364 9.7190 12.3696
Cash Flows in ₹ ’000
Real -50000 -1500 -2000 -2500
Nominal (1) -50000 -1650 -2420 -3327.50
Cash Flows in African Rand
’000
Real -200000 50000 70000 90000
Nominal -200000 70000 137200 246960
In Indian ₹ ’000 (2) -33333 9167 14117 19965
Net Cash Flow in ₹ ‘000 (1)+(2) -83333 7517 11697 16637
PVF@20% 1 0.833 0.694 0.579
PV -83333 6262 8118 9633
NPV of 3 years = -59320 (₹ ‘000)
NPV of Terminal Value = × 0.579 = 48164 ( ₹ ’000)
.
Total NPV of the Project = -59320 (₹ ‘000) + 48164 ( ₹ ’000) = -11156 ( ₹ ’000)
SOLUTION 2
Working Notes:
1. Calculation of Cost of Capital (GDR)
Current Dividend (D0) 2.50
Expected Dividend (D1) 2.75
Net Proceeds (₹ 200 per share – 1%) 198.00
Growth Rate 10.00%
.
K e= +0.10=0.1139 i.e.11.39%
2. Calculation of Expected Exchange Rate as per Interest Rate Parity
Year Expected Rate
1. 1 0.12
9.50 9.67
1 0.10
2. 1 0.12
9.50 9.85
1 0.10
3. Realization on the disposal of Land net of Tax
CN¥
Sale value at the end of project 3500000.00
Cost of Land 3000000.00
Capital Gain 500000.00
Tax paid 125000.00
Amount realized net of tax 3375000.00
4. Realization on the disposal of Office Complex
(CN¥)
Sale value at the end of project 500000.00
 
 
100

WDV 0.00
Capital Gain 500000.00
Tax paid 125000.00
Amount realized net of tax (A) 375000.00
5. Computation of Annual Cash Inflows
Year 1 2
Annual Units 10000 10000
Price per bottle (CN¥) 540.00 583.20
Annual Revenue (CN¥) 5400000.00 5832000.00
Less: Expenses
Variable operating cost (CN¥) 2160000.00 2332800.00
Depreciation (CN¥) 750000.00 750000.00
Fixed Cost per annum (CN¥) 2376000.00 2566080.00
PBT (CN¥) 114000.00 183120.00
Tax on Profit (CN¥) 28500.00 45780.00
Net Profit (CN¥) 85500.00 137340.00
Add: Depreciation (CN¥) 750000.00 750000.00
Cash Flow 835500.00 887340.00
(a) Computation of NPV of the project in CN¥
Year 0 1 2
Initial Investment -4500000.00
Annual Cash Inflows 835500.00 887340.00
Realization on the disposal of Land net of 3375000.00
Tax
Realization on the disposal of Office 375000.00
Complex
Total -4500000.00 835500.00 4637340.00
PVF @11.39% 1.000 0.898 0.806
PV of Cash Flows -4500000.00 750279.00 3737696.00
NPV -12,025
(b) Evaluation of Project from Opus Point of View
(i) Assuming that inflow funds are transferred in the year in which same are generated
i.e. first year and second year.
Year 0 1 2
Cash Flows (CN¥) -4500000.00 835500.00 4637340.00
Exchange Rate (₹/ 9.50 9.67 9.85
CN¥)
Cash Flows (₹) -42750000.00 8079285.00 45677799.00
PVF @ 12% 1.00 0.893 0.797
-42750000.00 7214802.00 36405206.00
NPV 870008.00
(ii) Assuming that inflow funds are transferred at the end of the project i.e. second year
Year 0 2
Cash Flows (CN¥) -4500000.00 5472840.00
Exchange Rate (₹/ 9.50 9.85
CN¥)
Cash Flows (₹) -42750000.00 53907474.00
PVF @ 12% 1.00 0.797
-42750000.00 42964257.00
NPV 214257.00

 
   
101

Though in terms of CN¥ the NPV of the project is negative but in ₹ it has positive NPV due
to weakening of ₹ in comparison of CN¥. Thus Opus can accept the project.
SOLUTION 3
(i) Equity Beta
To calculate Equity Beta first we shall calculate Weighted Average of Asset Beta as follows:
= 1.45 x 0.74 + 1.20 x 0.26
= 1.073 + 0.312 = 1.385
Now we shall compute Equity Beta using the following formula:

𝐄𝐪𝐮𝐢𝐭𝐲 𝐃𝐞𝐛𝐭 𝟏 𝐭𝐚𝐱

βAsset = βEquity × + βDebt ×
𝐄𝐪𝐮𝐢𝐭𝐲 𝐃𝐞𝐛𝐭 𝟏 𝐭𝐚𝐱 𝐄𝐪𝐮𝐢𝐭𝐲 𝐃𝐞𝐛𝐭 𝟏 𝐭𝐚𝐱

1.385= βEquity 𝛽

1.385= βEquity 0.24

βEquity = 1.86
(ii) Equity Beta on change in Capital Structure
Amount of Debt to be raised:
Particulars Value
Total Value of Firm (Equity ₹ 410 cr + Debt ₹ 170 cr) ₹ 580 Cr
Desired Debt Equity Ratio 1.90 : 1.00
Desired Debt Level = Total Value x Debt Ratio ₹ 380 Cr
Debt Ratio +Equity Ratio
Less: Value of Existing Debt (₹ 170 Cr)
Value of Debt to be Raised ₹ 210 Cr
Equity after Repurchase = Total value of Firm – Desired Debt Value
= ₹ 580 Cr – ₹ 380 Cr
= ₹ 200 Cr
Weighted Average Beta of KGFL:
Source of Investment Weight Beta of the Weighted Beta
Finance (₹ Cr) Division
Equity 200 0.345 β(E = X) 0.345x
Debt – 1 170 0.293 0.35 0.103
Debt – 2 210 0.362 0.40 0.145
580 Weighted Average Beta 0.248 + (0.345x)
  βKGFL = 0.248 + 0.345x
1.385 = 0.248 + 0.345x
0.345x = 1.385 – 0.248
X = 1.137/0.345 = 3.296
  βKGFL = 3.296
(iii) Yes, it justifies the increase as it leads to increase in the Value of Equity due to increase in Beta.
SOLUTION 4

(i) Calculation of Annual CFAT

Scenario 1 Scenario 2 Scenario 3

Annual Sales (in units) (A) 10,00,000 10,00,000 10,00,000
US $ US $ US $
Selling price p.u. 10.00 10.00 10.00

 
 
102

Cost p.u. 6.00 5.70 5.55

Profit p.u. (B) 4.00 4.30 4.45
Total Profit (A x B) 40,00,000 43,00,000 44,50,000
Less: Depreciation 10,00,000 9,00,000 8,50,000
PBT 30,00,000 34,00,000 36,00,000
Less: Tax @30% 9,00,000 10,20,000 10,80,000
PAT 21,00,000 23,80,000 25,20,000
Add: Depreciation 10,00,000 9,00,000 8,50,000
Expected CFAT (US$) 31,00,000 32,80,000 33,70,000
(ii) Expected Value of CFAT
= US$ 31,00,000 x 0.4 + US$ 32,80,000 x 0.4 + US$ 33,70,000 x 0.2
= US$ 32,26,000
(iii) Viability of proposal:
Expected CFAT = US $ 32,26,000
Expected Growth Rate = 3%
$ , , .
Expected Value of inflow in perpetuity =
. .
, ,
= = US$ 4,15,34,750
.

US $
Value of Inflows 4,15,34,750
Less: Initial Outlay 2,50,00,000
NPV of project 1,65,34,750

Since NPV is positive, project is viable.

 
   
103

Miscellaneous Topic (Old + New)

Study Session 13
SOLUTION 1
(a) Price At Which the Shares Can Be Repurchased:
Let P be the buyback price decided by Abhishek Ltd.
MPS After Buyback x No. of shares After Buyback = 400,00,000.
 1.15 x P x [Existing Number of Share – Buy Back Share] = 400,00,000
 1.15 x P x [ 20,00,000 – ] = 400,00,000
% , ,
 1.15 x P x [ 20,00,000 – ] = 400,00,000
 P = 21.89
(b) Number of shares to be bought back:
= = 4.11 Lacs (approx)
.
(c) EPS After Buy back :
New Equity Shares i.e Equity Share After Buy back =(20-4.11) lacs = 15.89 lacs
EPS after Buy Back = (5 × 20) / 15.89 = 6.29
SOLUTION 2
Working Notes:
Calculation of Cost of Capital
ke = +g
D1 = ₹1.40
P0 = ₹22.60 – ₹1.40 = ₹21.20
. .
Ke = +0.06 = 13%
.
(a) NPV of the Project
This ke shall be used to value PV of income stream

₹ . ₹ .
V= = = ₹170 crore
. .
PV of Cash Inflows from Expansion Project ₹ l 70 crore
Less: PV of Initial Outlay ₹ l 50 crore
NPV ₹ 20 crore
Since NPV is positive we should accept the project.
(b) By right issue new number of equity shares to be issued shall be:
50 crore (Existing) + 10 crore(Right Issue) = 60 crore
Market Value of Company = PV of existing earnings + PV of earnings from Expansion
₹ . .
= + ₹170 crore
. .
= ₹ 1060 crore + ₹ 170 crore
= ₹ 1230 crore
Price Per Share = ₹ 1230 crore / 60 crore = ₹ 20.50
(c) Let n be the number of new equity shares to be issued then such shares are to be issued at such
price that new shareholders should not suffer any immediate loss after subscribing shares.
Accordingly,
× ₹ 1230 crore = ₹ 150 crore
1230 n = 7500 + 150n
n = 7500/1080 = 6.9444 crore
₹
Issue Price Per Share = =₹21.60
.
 
 
104

or
₹
Ex - Dividend Price Per Share = =₹21.60
.
(d) Benefit from expansion
(i) Right Issue
₹ Crore
Shareholder’s Current Wealth (₹ 22.60 x 50 crore) 1130
Less: ₹ Crore
Value of 60 crore shares @ ₹ 20.50 1230
Cash Dividend Received @ ₹ 1.40 per share on 50 crore 70
shares
Cash paid to subscribe Right Shares (₹15 x 10 crore) (150) 1150
Net Gain 20
or
₹ Crore
Shareholder’s Current Wealth (₹21.20 x 50 crore) 1060
Less: ₹ Crore
Value of 60 crore shares @ ₹ 20.50 1230
Cash paid to subscribe Right Shares (₹ 15 x 10 crore) (150) 1080
Net Gain 20
(ii) Fresh Issue
₹ Crore
Shareholder’s Current Wealth (₹22.60 x 50 crore) 1130
Less: ₹ Crore
Value of existing 50 crore shares @ ₹21.60 1080
Cash Dividend Received @ ₹1.40 per share on 50 crore shares 70 1150
Net Gain 20
or
₹ Crore
Shareholder’s Current Wealth (₹21.20 x 50 crore) 1060
Value of existing 50 crore shares @ ₹21.60 1080
Net Gain 20
SOLUTION 3
Effective Interest = x x 100
Where
F = Face Value
P = Issue Price
, , ,
= x x 100 = 0.025115 x 4 x 100 = 10.046 = 105% p.a.
,
 Effective interest rate = 10.5% p.a.
Cost of Funds to the Company
Effective Interest 10.05%
Brokerage (0.150 x 4) 0.60%
Rating Charge 0.50%
Stamp duty (0.175 x 4) 0.70%
11.85%
 

 
   
105

SOLUTION 4
₹
Issue Price 50,00,000
Less: Interest @ 12.5% for 4 months 2,08,333
Issue Expenses 2,500
Minimum Balance 1,50,000
46,39,167
, ,
Cost of Funds = 𝑥 x 100 = 9.54%
, ,

SOLUTION 5
Date Closing Sign of Price
Sensex Charge
1.10.07 2800
3.10.07 2780 -
4.10.07 2795 +
5.10.07 2830 +
8.10.07 2760 -
9.10.07 2790 +
10.10.07 2880 +
11.10.07 2960 +
12.10.07 2990 +
15.10.07 3200 +
16.10.07 3300 +
17.10.07 3450 +
19.10.07 3360 -
22.10.07 3290 -
23.10.07 3360 +
24.10.07 3340 -
25.10.07 3290 -
29.10.07 3240 -
30.10.07 3140 -
31.10.07 3260 +
Total of sign of price changes (r) = 8
No of Positive changes = n1 = 11
No. of Negative changes = n2 = 8
2𝑛 𝑛
𝜇 1
𝑛 𝑛
2 11 8 176
𝜇 1 1 10.26
11 8 19

2𝑛 𝑛 2𝑛 𝑛 𝑛 𝑛
𝜎^
𝑛 𝑛 𝑛 𝑛 1

2 11 8 2 11 8 11 8 176 157
𝜎^ √4.252 2.06
11 8 11 8 1 19 18
Since too few runs in the case would indicate that the movement of prices is not random. We employ a
two- tailed test the randomness of prices.

 
 
106

Test at 5% level of significance at 18 degrees of freedom using t- table

The lower limit
𝜇 𝑡 𝜎^ 10.26 – 2.101 2.06 = 5.932
Upper limit
𝜇 𝑡 𝜎^ 10.26 + 2.101 2.06 = 14.588
At 10% level of significance at 18 degrees of freedom
Lower limit
= 10.26 – 1.734 × 2.06 = 6.688
Upper limit
= 10.26 + 1.734 × 2.06 = 13.832
As seen r lies between these limits. Hence, the market exhibits weak form of efficiency.
*For a sample of size n, the t distribution will have n-1 degrees of freedom.
SOLUTION 6
Cornett, GMBH. – Break-up valuation
Business Segment Capital-to-Sales Segment Sales Theoretical Values
Consumer wholesaling 0.75 €1,500,000 €1,125,000
Specialty services 1.10 €800,000 €880,000
Assorted centers 1.00 €2,000,000 €2,000,000
Total value €4,005,000
Business Segment Capital-to-Sales Segment Sales Theoretical Values
Consumer wholesaling 0.60 €750,000 €450,000
Specialty services 0.90 €700,000 €630,000
Assorted centers 0.60 €3,000,000 €1,800,000
Total value €2,880,000
Business Segment Capital-to-Sales Segment Sales Theoretical Values
Consumer wholesaling 10.00 €100,000 €1,000,000
Specialty services 7.00 €150,000 €1,050,000
Assorted centers 6.00 €600,000 €3,600,000
Total value €5,650,000
, , , , , ,
Average theoretical value = = 4,178,333.33 say 4,178,000
Average theoretical value of Cornett GMBH. = €4,178,000
SOLUTION 7
Period 1 Closing Prices Change Period 2 Closing Prices Change
1 33453.99 11 33251.53
2 33434.83 -19.16 12 33285.89 34.36
3 33431.93 - 2.90 13 33329.28 43.39
4 33383.41 - 48.52 14 33284.17 - 45.11
5 33370.93 - 12.48 15 33298.78 14.61
6 33340.75 - 30.18 16 33325.38 26.6
7 33330.98 -9.77 17 33329.95 4.57
8 33335.08 4.1 18 33319.67 -10.28
9 33301.97 - 33.11 19 33302.32 -17.35
10 33259.03 - 42.94 20 33319.61 17.29

 
   
107

X Y X2 Y2 XY
-19.16 34.36 367.11 1180.61 -658.34
-2.90 43.39 8.41 1882.69 -125.83
-48.52 -45.11 2354.19 2034.91 2188.74
-12.48 14.61 155.75 213.45 -182.33
-30.18 26.6 910.83 707.56 -802.79
-9.77 4.57 95.45 20.88 -44.65
4.1 -10.28 16.81 105.68 -42.15
-33.11 -17.35 1096.27 301.02 574.46
-42.94 17.29 1843.84 298.94 -742.43
2
 X = -194.96 Y = 68.08  X = 6848.66  Y2 = 6745.74 XY = 164.68
X = - 21.66 Y = 7.56

∑
β= ∑ ̅

. . .
= = 0.624
. .

a = 𝑌 - b 𝑋 = 7.56 – 0.624(-21.66) = 21.08

∑ ∑ . . . . .
𝑟 = ∑
=
. .

𝑟 = 0.164
r = 0.405
There is moderate degree of correlation between the returns of two periods hence it can be concluded
that the market does not show the weak form of efficiency.
SOLUTION 8

(i) Dirty Price

= Clean Price + Interest Accrued

(ii) First Leg (Start Proceed)

= Nominal Value x ×

. .
= ₹ 5,00,00,000 x = ₹ 5,05,45,275

.
Second Leg (Repayment at Maturity) = Start Proceed x(1+ Repo rate × )

= ₹ 5,05,45,275 x (1+0.0610× ) = ₹ 5,07,25,132

 
 
108

SOLUTION 9
For calculating probability of financial difficulty, we shall calculate the area under Normal Curve
corresponding to the Z Score obtained from the following equation (how many SD is away from Mean
Value of financial difficulty):
z=

. .
=
.
= -1.875 say 1.875
Corresponding area from Z Score Table by using interpolation shall be found as follows:
Z Score Area under Normal Curve
1.87 0.4693
1.88 0.4699
0.01 0.0006
.
The corresponding value of 0.005 Z score = 0.005 × = 0.0003
.
Thus the Value of 1.875 shall be = 0.4693 + 0.0003 = 0.4696
Thus the probability the company shall be in financial difficulty is 46.96%.