Institute of Bankers of Sri Lanka

(Established and managed by a Governing Board representing the Central Bank of Sri Lanka, Licensed Banks,
Fellows and Associates under the Institute of Bankers of Sri Lanka (Incorporation) Act No.26 of 1979)

Diploma in Applied Banking & Finance

(DABF)
January 2022 Examination

D 07 - Investment Banking

Question Paper & Suggested Answers

These suggested answers have been compiled by the College of Banking and Finance,
Institute of Bankers of Sri Lanka with the assistance of its resource panel.

Institute of Bankers of Sri Lanka

80A, Elvitigala Mawatha, Colombo 08.
TP : +94112425777
Web : www.ibsl.lk
 Institute of Bankers of Sri Lanka
Diploma in Applied Banking and Finance (DABF)
D 07 - Investment Banking
Examination – January 2022
Suggested Answers
1.

(A)
(i) (d) Reverse repo
(ii) (c) To promote deposits of other entities
(iii) (c) Issue of subordinated debt
(iv) (b) Total return increases
(v) (b) Buy a floating rate security.
(vi) (c) Having executive director as the chairperson.
(vii) (a) Rs. 10,000/-
(viii) (b) Statement 2

(B) (ix) Searching of recurring and predictable patterns based on historical prices,
trading volumes, and other historical data and trade on that.
(x) The prudent investment rule requires a fiduciary to invest trust assets as if they
were her or his own. This managing investor should consider the needs of the
trust's beneficiaries and should avoid investments that are excessively risky. The
prudent investor rule states that the decision-making process must follow certain
guidelines.
2.
(i) Front running

This is a misconduct by a trader or stockbroker who receives information of a large

buy or sell order that is significant enough to affect the market price of that security
and executes a trade prior to the order to benefit from the price movement.

Insider trading
Investor receives material nonpublic information of a company before the company
disseminates the same information to the general public and executes a trade on the
information to benefit personally or to the benefit of the few others.

(ii) When a broker engages in excessive buying and selling (i.e., trading) of securities
in a customer's account without considering the customer's investment goals and
primarily to generate commissions that benefit the broker, the broker may be
engaged in an illegal practice known as churning.
(iii)
Whistleblowing is the term used when a worker passes on information concerning
wrongdoing. We call that “making a disclosure” or “blowing the whistle”.
The wrongdoing will typically (although not necessarily) be something they have
witnessed at work. The mechanism is such that the person who “blows the whistle”
gets the opportunity to secretly inform the relevant authority about the misconduct
he or she suspects that is happening and the relevant department of the entity would
do the initial investigation on the information to verify the concern raised
independently.
 (iv) A conflict of interest arises when a person chooses personal gain over the duties
to an organization in which they are a stakeholder or exploits their position for
personal gain in some way. All corporate board members have fiduciary duties
and a duty of loyalty to the corporations they oversee.
Instances where conflict of interest could occur in an organization

1. When a board of director enters into a transaction with the company where
he has significant influence over the business decision.
2. Self-dealing company shares.
3. Deciding on salaries and perks to the Board members
4. Neglecting the duties as a board of directors over other personal matters.
5. Taking up position in a competitor entity
3.
(i) Once a company selects an Investment Bank (IB), it will help the entity in the
followings.

 Advise the proposed entity on the listing process. This could be on matters
such as corporate governance, listing rules, listing requirement, etc.
 Value the company to be listed to arrive at a listing price. This is the
proposed price that company wishes to offer to the public.
 Assist the listing process with relevant approvals and documentations.
 Promote the company among prospective investors for book building.
 Get the commitment of the investors so the IPO to be a success.
 Assist the company of post IPO process till the listing is completed.

(ii) The best instrument is securitization Paper issue.

This is because;
 Company is having a credit rating of BBB- which is below the listed
debenture guideline as per Colombo Stock Exchange Listing rules.
Therefore, the company will have to look for a credit enhancement to apply
for a listed instrument which will be costly.

 Company is a limited liability company and would be their first listing if

they are to list the debenture even after obtaining a credit rating. First time
listing will be a time-consuming process with approvals.

 Issuing securitized paper would be relatively less time consuming and less
costly process since funds will be placed by an investment banker with its
clients and does not have to comply with listing rules.

 Securitized papers are tradable instruments, therefore irrespective of

unlisted status, still the instrument can be traded.

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(iii)
Once the amount and the tenure of the structure are decided.
 Assigning a portfolio to be transferred to the SPV.
 Create a SPV / trustee and effect the transfer of assets.
 Get the credit rating for the structure of the securitized paper issue.
 Undertake due diligence to check the quality of the transferred assets.
 Placing of securitized papers in the capital market.

(iv)
 Arranger
Arranger is the party who involves in placing the funds to the structure of
the securitization. It is also the responsibility of the arranger to propose an
appropriate structure for the arrangement and get the placements as per the
proposed structure. (Selling the securitized papers to the investors)

 Trustee
The trustee of the trust usually subcontracts the administration and servicing
of the securitized assets back to the originator of the asset pool or a third-
party provider. The main role of trustee is to ensure repayment of the
investor from the collection of receivables (securitized assets)

 Issuer
Issuer is the institute that requires funding. Issue assigns / provides
securities to the securitized papers, replaces securities when those are not
performing and honor the repayment of capital and interest to the structure
on time.

 Investors
These are the parties who invest in securitized papers of the issuer.

 Auditor
Auditor does the due diligence audit of the mortgaged securities and give
their opinion on the quality of the mortgaged assets.

 Rating Agency
Provides rating to the structure of the securitization.

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 4. (i)
Tenure Cash flow discounting factor PV
Y0 -100 1 (100)
Y1 -75 0.909 (68)
Y2 40 0.826 33
Y3 50 0.751 38
Y4 60 0.683 41
Y5 70 0.621 43
NPV (13)
Based on NPV calculation, the net present value of the project is negative.
This indicates the project is not viable to undertake and based on the information
provided you should advice your client not to undertake the project.

(ii)
CAPM = risk Free rate + Beta (market rate – risk free rate)

CAPM = 9.00 % + 1.2 (15.00% - 9.00%)

CAPM = 16.20 %

(iii) Based on the information provided, there are two attractive investments for
Mr. Gureira’s Client; 1) T/bill investment 2) is T/bond investment. Considering the
maturity and the expected rate movement, best investment option out of the two is
T/Bond investment because yields of the bond is expected to dip 5.75% which will
give Mr. Gureira’s Client a substantial capital gain at the end of the 3-year period.
Share market investments will be making losses at the end of the 3 years and due
to that it is not an attractive investment given the current context of the economy.

(iv) Based on the given information, bond yields are expected to move up after 3 years
hence if fixed income securities are selected after 3 years, the yields will be at low
levels and this will make the Government securities returns unattractive. However,
the equity market is expected to give a return of 4% at the end of 5 years. This is
after 3 years of bear market. Therefore, out of the given option, equity market
investment should be the most suited investment for Mr. Gureira’s Client.

5.
(i)

(Cost of Equity*Equity) + (Debt*(cost of debt*(1-t)))

WACC =
(Equity + Debt)

OR

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 (1000*10%) + (600*7% (1-.24))
WACC =
(1000+600)

WACC = 8.25%

(ii)

3*(1+.03)
Price =
(8.25%-3.00%)
Rs. 58.85

(iii) Current market price of the company share = Rs. 60.00

Minimum no of shares to be available for 1 new shares = 3
Market value of existing shares = (3*60) = Rs.180.00
Price of right issue shares = Rs.50.00
Cost of existing shares and right issue shares = 180+50 = 230.00
Ex-right price = 230/4 = Rs.57.50

(iv) Advantages
1. For long term projects where cash inflows are delayed, company does not
have to go through financial stress when rights are issued compared to debt
capital raising.
2. Shareholders have the option to maintain the same ownership via right
issue.
3. Rights are issued at a discounted price to the existing market price. This is
a benefit to the existing shareholders. This helps the company to raise funds
without much difficulty.
4. Right issue is cheaper than public share issue.
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 Disadvantages
1. If rights are not subscribed company may fail to raise expected funding for
their requirement.
2. If the rights are not fully subscribed that could create a negative perception
regarding the company.

6.
(i) Horizontal merger is merging of companies which are in the same business and
industry. Mostly horizontal mergers happen between competitors. Objective of
such merger is achieving economies of scale and expand the market.
Vertical Merger is merger of two companies that provide different supply chain
functions for a common good or service. These types of mergers are expected to
increase the synergies and expected to gain more control over the supply chain of
the business. Another objective is to reduce the cost and increase the efficiency of
the business.

(ii) Staggered Board

Only a portion of the board seats are due for election each year. In this way it takes
longer time to elect enough directors to take majority control of the company
through the board.
Poison Pill
Poison pill is another powerful strategy against hostile takeover. Poison pills allow
existing shareholders the right to purchase additional shares at a discount,
effectively diluting the ownership interest of a new, hostile party.

(iii)
⁎ To revive the financial position of the company.
Many companies sometimes go through financial crunch due to various
reasons and find it difficult to meet with its existing financial liabilities.
In these circumstances, companies consider corporate restructuring to find
solutions to their financial crunch.
* To divest from poor fit units
Sometimes companies identify their existing corporate structure is a poor
fit to the company. In such situations, companies consider divestment of
those units from the existing structure so the rest of the company can be
benefited from it.
* Change in the corporate strategy.
Time to time some companies, given the opportunities in the market, change
their overall corporate strategy for the betterment of the company. In such
circumstances, companies go through corporate restructuring to realign the
company to the new corporate strategy.
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 * Reverse Synergy
Some companies find that some divisions of the company are beneficial as
a standalone unit rather than as a part of the company.

(iv)
* Equity carve-out
New shares are issued for a newly formed legal entity.

* liquidation

Company assets are sold in piece-by-piece basis to derive better value to the
shareholders. This is mostly associated with company bankruptcy.

* Spin off
Existing shareholders receive proportional shares in new company, no
inflow of cash to parent company.
* Split-off
Existing shareholders receive share of the new company in lieu of the shares
of the parent company.

7.
(i) Wash trading
A trader Buys and Sells security at the same time to generate volume and thus
stimulate interest and demand in that security and then sells the security.

(ii) Layering
A legitimate order is placed on one side of the market (this could be either Buy or
Sell) and multiple illegitimate orders are placed on the opposite side to lure
participants to trade in favour of the real order.

(iii) Front running

A trader who is having information of a large buy or sell order that is likely to affect
market price, executes a trade prior to the order to benefit from the price movement.

(iv) Painting the tape

This is where a trader takes the best offer or bid in the market to move the market
price in that direction, then sells at the highest price (if the trader moves the price
up) or buys at the lower price (if the trader moves the price down)

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8.

(i) Briefly explain term Investment Policy Statement.

An investment policy statement (IPS) is a document drafted between a portfolio

manager and a client that outlines general rules for the manager. This statement provides
the general investment goals and objectives of a client and describes the strategies that
the manager should employ to meet these objectives. Specific information on matters
such as asset allocation, risk tolerance, and liquidity requirements are included in an
investment policy statement.

(ii)
1. Liquidity Constraints
2. Time Constraints
3. Tax constraints
4. Legal and regulatory constraints
5. Unique circumstances

(iii)
1. Passive – the portfolio composition does not react to changes in
expectations. Expects the return of the market to be
replicated from the portfolio. Example is index investing.

2. Active – this involves holding a portfolio different from a benchmark

and expecting alpha return from the portfolio.

3. Semi active – it is an indexing approach with controlled used of weights

different from the benchmark.

(iv) Since the inflation is on the rise and also expects to rise in the future, it can be
assumed that interest rate will further go up. Therefore, it is advisable to invest for
short term to get the advantage of the increase in interest rate and then invest in
longer maturity. Hence, the best option would be to invest the maturity in T/bill.

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