AFM CHARTS CA.

DINESH JAIN

ADVANCED FINANCIAL MANAGEMENT

SUMMARY CHARTS (TO BE USED

ALONG WITH CONCEPT BOOK
SECOND/THIRD EDITION)

BY CA. DINESH JAIN

DEDICATED TO MY LOVABLE FATHER

[RAMESH JAIN]

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TABLE OF CONTENTS
Chapter 2 – Risk Management .................................................................................. 3
Chapter 3 – Advanced Capital Budgeting Decisions ............................................ 4
Chapter 4 – Security Analysis .................................................................................. 14
Chapter 5 – Security Valuation................................................................................ 17
Chapter 6 – Portfolio Management ......................................................................... 38
Chapter 8 – Mutual Funds ........................................................................................ 49
Chapter 9 – Derivatives Analysis and Valuation ................................................. 55
Chapter 10 – Foreign Exchange Exposure and Risk Management ................... 69
Chapter 11– International Financial Management .............................................. 86
Chapter 12 – Interest Rate Risk Management ...................................................... 88
Chapter 13 – Business Valuation ............................................................................ 94
Chapter 14 – Mergers, Acquisitions & Corporate Restructuring .................... 103

Disclaimer:
While every effort is taken to avoid errors or omission in this publication, any mistake or
omission that may have crept in, is not intentional. It may be taken note of that neither the
publisher, nor the author, will be responsible for any damage or loss of any kind arising to
any one in any manner on account of such errors or omissions
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Make the most of your concept book while studying. The charts included will serve as a quick
revision tool, especially useful for the day before your exam. To maximize your
understanding, use these charts along with the concept book and ensure you solve all
MCQs provided in it. This structured approach will enhance your conceptual clarity and
help you to solve the questions in the Question Bank.

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Chapter 2 – Risk Management

Value at Risk - Maximum Possible loss in worst case scenario

VAR = Amount invested x Daily SD x No of days x Multiple

Amount SD of Number of days Multiple for

invested Security of VAR confidence level

95% - 1.65 99% - 2.33

Concept 1 – Value at Risk

Conversion of Daily SD into Monthly SD (Let us assume one month has 20

trading days)

Correct Approach Wrong Approach

Monthly SD = Daily SD x 20 Monthly SD = Daily SD x 20

Concept 2 – Daily SD vs Monthly SD vs Annual SD

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Chapter 3 – Advanced Capital Budgeting Decisions

Techniques of Capital
Budgeting

Discounted
Payback Profitability
Payback NPV ARR IRR
Method Index
Method
Introduction to Capital Budgeting
Format for computation of various techniques

Technique Year CF Cum CF PVF DCF CDCF Depreciation PAT

Payback        
Disc Payback        
NPV        
PI        
ARR        
IRR        

Payback Method - Unrecovered CF of Base Year

Payback = Base year +
Time taken to recover CF of Next Year
the initial investment
ignoring the time
value of money Lower the better

Concept 1 – Payback Method

Discounted Payback Unrecovered DCF of Base Year

Method - Time taken Disc Payback = Base year +
DCF of Next Year
to recover the initial
investment
considering the time
value of money Lower the better

Concept 2 – Discounted Payback Method

NPV and PI

NPV = PV of inflows - PV of PV of inflows

PI =
outflows PV of outflows

Higher Positive NPV is

PI > 1 is better
better

Concept 3 and 4 – NPV and Profitability index (or) Benefit cost Ratio (or) Present value Index Method (or)
Desirability Factor

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Accounting Rate of
Return (only technique
based on Profits)

On Initial On Average
Investment Investment

Average PAT Average PAT

Initial Investment Average Investment

Note:
Opening investment + Closing investment
Average investment = ; Closing investment = Salvage value
2
Concept 5 – Accounting Rate of Return

IRR (Rate of return earned by the company) -

This is the discount rate at which NPV of the
cash flows is zero

NPV Positive NPV = 0 NPV Negative

IRR > DR IRR = DR IRR < DR

Concept 6 - IRR
Initial guess rate
Start with an initial
= 2/3 of ARR on
guest rate and
average
compute NPV
investment

Increase DR if NPV is
Steps in positive and reduce
Computation of DR if NPV is negative
IRR
Compute IRR
once one Positive NPV at L1
NPV and L1 + x L2 − L1
NPV at L1 − NPV at L2
Negative NPV is
Computed

Concept 6 - IRR

Cost of capital Specific to the project and not overall cost of

capital of company
Discount rate
Cost of capital can increase or decrease depending on change
in risk of the project. PVF needs to be computed in the same
manner as that of forward rates in bond valuation
Concept 7 – What discount rate to be used for Project Evaluation?

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Depreciation (Non-
cash Item)

Relevant Irrelevant

If the company has tax exemptions or

Because of tax benefit
taxes to be ignored

Concept 8 – Rules for computation of Cash flows

Opportunity cost (Cost of benefit
foregone) - Relevant item

Considered in PBT computation Considered in PAT computation

If given item is pre-tax If given item is post-tax

Concept 8 – Rules for computation of Cash flows

Sunk cost (or) Historical Cost - Irrelevant

Cost of an item which has already Example: Market survey expense, R&D
been incurred (whether paid or not) Costs

Concept 8 – Rules for computation of Cash flows

Overhead cost

Apportioned/ General/
Specific/ Incremental OH
Corporate OH

Irrelevant Relevant

Concept 8 – Rules for computation of Cash flows

Working capital (Money

required for smooth
functioning of operations)

Initial working Decrease in Final recapture

Increase in WC
capital WC of WC

Outflow in Outflow in in- Inflow in in- Inflow in last

year 0 between years between years year
Concept 8 – Rules for computation of Cash flows

Reward Exclusion Principle (ignore reward paid for

providers of capital)

Capital is contributed by equith shareholder, Ignore interest, Preference

preference shareholders and debt holders Dividend and Equity
Dividend
Concept 8 – Rules for computation of Cash flows
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Outflow at start of Capital expenditure

Initial outflow
project and working capital

Steps in In-between Cash Inflows during life CFAT during

computation of cash flows of project project
flows
NSV of machine
One-time inflow on
Terminal Flow and recapture of
project completion
WC
Concept 9 – Steps for computation of Cash flows
Formats:
Step 1: Initial Outflow
Particulars Amount
Capital expenditure (XXX)
Working capital (XXX)
Total outflow (XXX)

Step 2: In-between cash flows:

Particulars Amount
Incremental Revenues XXX
Incremental cost savings XXX
Less: All costs other than depreciation (XXX)
Profit before depreciation and tax (PBDT) XXX
Less: Depreciation (XXX)
Profit before Tax (PBT) XXX
Less: Tax (XXX)
Profit after Tax (PAT) XXX
Add: Depreciation XXX
Cash flow after tax (CFAT) XXX
Add/Less: Increase/decrease in Working capital XXX
Less: Purchase of additional machinery / payment for original machine (XXX)
Revised CFAT XXX

Step 3: Terminal flow:

Particulars Amount
Net salvage value of capital expenditure XXX
Recapture of working capital XXX
Total terminal flow XXX

Different from salvage value (Sale value of

machine)

Net salvage value of Machine

NSV = Sale value + Tax saved on capital loss -

Tax paid on capital gain

Concept 9 – Steps for computation of Cash flows

No capital gain/loss on sale of machine unless the

block is exhausted
Block Assets Method (Method
followed in Income Tax)
Depreciation on incremental value of block = Purchase
price of new machine - sale value of old machine

Concept 9 – Steps for computation of Cash flows

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Any asset purchased at the beginning of the year will

be treated as acquired at the end of the prior year for
Investment decision assumes CF computation
cash flows to happen at end of
year
For example: Asset purchase at beginning of year 5
will be considered as Year 4 outflow
Concept 10 – Asset Purchase at beginning of year
Existing Profit-making Immediate tax saving in the year of
company loss

Treatment of Carry forward loss and set-off in

Loss carry forward
Losses future - less tax payment in future

No carry forward and no No tax saving as loss cannot be

details of existing profit carried forward nor set-off now
Concept 11 – Impact of Losses

Other
concepts

Tax exemption for specific Expenses not paid in the

% of Profits year of incurrence

Take effective tax rate Deduct expenses as Add Back: Amount which was not
= Normal tax rate x (1 per accrual concept to be deducted and deduct amount
- Exemption %) for tax comption which was already paid

Concept 12 and 13 – Tax Exemption for Specific % of Profits and Expenses not paid in the year of
incurrence

Adjust with the cost of Asset

Capital Subsidy
(assumption based)
Not to adjust with cost of asset
Subsidy/Grant
Taxable
Revenue Subsidy
Exempt
Concept 14 – Treatment of Subsidy/Government Grant
Utility value (Attach utility value to every cash flow earned
by the company)

Compute expected utility value for the project = Weighted average of utility
values with probability being the assigned weight

Select the project with higher expected utility value

Concept 15 – Utility Value

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Sell today and compute cash

Compute Cash flow today
flows of machine
Abandonment Decision
(When to sell an existing
machine)
Compute PV of all cash
Continue with machine and
inflows by using the
sell machine at end of life
machine
Note:
• NPV = PV of continuation option – PV of selling today
• If NPV is positive, continue using the machine and If NPV is negative, sell the machine today.
Concept 19 – Abandonment Decision

How to decide on replacement

Compute NPV of replacement decision based on cash flows of replacement decision

Step 1 Outflow = Initial Step 3 Terminal flow =

Step 2 inflow = CFAT of
outflow of new machine - Terminal flow of new
new machine - CFAT of
inflow from sale of old machine - Terminal flow of
old machine
machine today old machine

Concept 20 – Replacement Decision

Type 1 - Deciding whether to
replace an existing machine Follow concept 20
(one-time exercise)

Type 2 - Deciding on optimum Example: Deciding of

Types of Replacement
life of regulary used asset optimum life of Car by a
Decision
(acquired or to be acquired) taxi driver

Type 3 - Deciding the timing of

replacement decision

Concept 21 – Types of Replacement Decision

Type 2 Problem

Let us assume Compute cash flows, NPV/PV of Select the optimum

an asset (car) has outflow and EAB/EAC if machine life as the one which
life of 3 years is purchased and sold in 1 year, 2 has highest EAB or
year and 3 years lowest EAC

Concept 21 – Types of Replacement Decision

Type 3 Problem

Let us assume an Compute cash flows, NPV/PV of outflow Select the

existing asset has and EAB/EAC if machine is replaced alternative with
balance life of 2 years today, a year later or after two years highest EAB or
lowest EAC
Concept 21 – Types of Replacement Decision

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NPV
Projects which generate EAB =
returns PVAF r, life
EAB/EAC (Concept is
used to compare
alternatives which have
different lives) PV of outflow
Projects which has only EAC =
costs PVAF r, life

Concept 18 – Equated Annual Benefit (EAB) or Equated Annual Cost (EAC)

Long-term
Ignore cash flow
funds
between company and Discount at Get Project
approach
equity share-holder, cost of NPV and
(FCFF) -
preference share-holder capital Project IRR
Preferred
Project and debentureholders
Approach
evaluation
approach
Equity
Ignore cash flow Discount at Get equity
shareholders
between company and cost of NPV and
approach
equity-shareholder equity equity IRR
(FCFE)

Concept 16 – FCFF vs FCFE Approach

APV Approach

Compute base NPV of Final NPV = Base

Compute PV of debt Compute PV of
a project assuming it is NPV + PV of debt
financing benefit issue cost
100% equity funded financing benefit
- Issue cost
PV of tax PV of interest saving (lower Discount two as
saving on interest payment as compared pre-tax cost of
interest to normal rate) debt
Concept 17 – Adjusted Present Value Approach

Inflation in capital
budgeting

Types of cash Flows Types of Discount rate

Nominal Real Nominal or Money

Real DR (excludes
(includes (excludes DR (includes
inflation)
inflation) inflation) inflation)

Concept 22 – Inflation in Capital Budgeting

Approach to Inflation in
Capital Budgeting

Real CF to be discounted at
How to adjust How to adjust
Real DR and Money CF to
CF DR
be discounted at Money DR

Nominal cash flows (1 + MDR) = (1 + RDR) x (1 +

= Real cash flows x ሺ1
+ Inflation rateሻn Inflation Rate)

Concept 22 – Inflation in Capital Budgeting

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Expected Value, Standard Deviation

and CV

Risk ሺSDሻ
Expected value = Weighted SD = Deviation from CV =
Return ሺNPVሻ
average of various possible expected value - Computed
CF/NPV with Probabiltiy using format 1 of Porfolio
being assigned weight Management

Concept 23 – Expected Value, Standard Deviation and CV

Dependent CF (Cash flow

Compute SD of every
of succeeding period is Sum of DSD is final
year cash flow and
dependent on previous SD
discount them
period CF) - High Risk
Standard
Deviation
Independent CF (Cash flow
Compute SD of every
of succeeding period is ∑ 𝑑𝑠𝑑 2
year cash flow and 𝑆𝐷 =
independent of previous
discount them
period CF) - Low Risk

Note: Probability of NPV

• Probability of Dependent cash flow NPV = Probability of the cash flow in year 1
• Probability of independent cash flow NPV = ሺProbability of the cash flow in year 1ሻn
Concept 24 – SD for dependent and independent cash flows
Format for Concept 24
DSD
Year SD PVF (SD x PVF) 𝐃𝐒𝐃𝟐

Compute different NPV Followed if question asks

based on cash flows and best case and worst case
take weighted average NPV
Approach for NPV
computation
Compute expected CF of Followed if question asks SD
every year and compute one for dependent and
NPV using expected CF independent Cash Flow

Approach for Expected NPV and SD Computation

RADR

Not to use Different discount

same cost of RADR = Risk-
rate for different RADR = Rf + Risk
capital for free rate +
projects based on risk Index (Normal DR - Rf)
discounting Risk-Premium
of Project
all projects

Concept 25 – Risk-Adjusted Discount Rate

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Certain cash flow
CEF =
Uncertain Cash flow

CEF (How certain/confident are we in Convert uncertain CF into certain

earning a cash flow given in question) - CF using CEF
Certainty will decline with time and
risk of cash flows Discount these cash flows at risk-
free rate and get NPV

RADR and CEF - Low CEF would indicate higher

risk and hence will have higher RADR
Concept 26 – Certainty Equivalent Factor
Impact on NPV due to
change in one factor (SP or
Sensitivity Analysis
cost or life or outflow or
discount rate)
Sensitivity Analysis vs
Scenario Analysis
Impact on NPV due to
Scenario Analysis changes in multiple
factors
Concept 27 – Sensitivity Analysis and Scenario Analysis
Approaches of
sensitivity Analysis

Approach 1 - Impact on NPV for Approach 2 - Find out what percentage change
uniform % change in variable in variable will make the NPV as zero

Factor with maximum fall in NPV is Variable with smallest change making
the most sensitive factor NPV 0 is the most sensitive factor

Fall in NPV Change

% Change in NPV = x 100 % fall in variable = x 100
Old NPV Base

Concept 27 – Sensitivity Analysis

Starts with decision
Value is highest of branches
node (Rectangle)

Chance node (circle) Value is weighted average of

Decision Tree can come in between various branches
(Diagrammatic
representation of a problem
which requires sequential Drawn from left to
decision making) right and valued
from right to left

Use concept of joint Prob of event 1 x Prob of even

probability t2
Concept 28 – Decision Tree

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Simulation (Useful for complex project which has lot of uncertainty - Simulate NPV
computation million times and find out the expected performance and deviation)

Find Based on Discount rate

parameters Create RN Random number to be used is Final NPV =
(no change) table for tables, find value risk-free rate Average of
and variables of various the various
variables using variables for If question gives experiments
(which can probability multiple something else,
change) experiments then we follow the
other rate
Concept 29 – Simulation
Compute NPV of base
project without the option

Do valuation of the option

Option in capital budgeting (Give
with only the cash flows of
a choice to company either to
the option
expand or abandon the project -
Similar to call and put option - Final NPV = Base NPV +
Increases NPV of project) Value of option
Do a project even if base
Decision based on final NPV
NPV is negative but final
on project
NPV is positive

Concept 30 – Option in Capital Budgeting

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Chapter 4 – Security Analysis

Fundamental Analysis No practical Problems

Security Moving average, Breadth Index,

Technical Analysis
Analysis Confidence Index and Relative Strength

Efficient Market
Run Test and Correlation Test
Hypothesis
Introduction

Economy Analysis
Value of share = Intrinsic
Fundamental value = PV of future
Industry Analysis
Analysis dividends = Buy under-
valued and sell over-valued
Company Analysis

Concept 1 – Fundamental Analysis (EIC Analysis)

Purchase or sell History will repeat

Study historical
Technical Analysis decision based on and take buy/sell
price movements
price trends decision
Concept 2 – Technical Analysis

SMA (Average data of the

most recent observations)

5-day SMA is 10-day SMA is Equal weightage is

average of last 5 average of last 10 given to all observations
days prices days prices in SMA
Concept 3 – Simple Moving Averages (SMA)
2
Exponent =
Value of n+1
exponent will be
EMA (Give extra given in question N = Number of
weights to recent days EMA
observations and
less weights to New EMA = [(Previous day EMA x (1 -
earlier observations) Exponent)] + (Latest value x Exponent]
Formula EMA Adjustment =
New EMA =
Exponent x (Today
Previous EMA +/-
value - Previous EMA
EMA Adjustment
value)
Concept 4 – Exponential Moving Averages (EMA)
Format for computation of EMA:
EMA New
Change Adjustment EMA
EMA of (Col 2 - Col (Col 3 x 30-day (Col 3 +
Date Sensex previous day 3) exponent) Col 5)
6 14,522 15,000.00 -478 -29.64 14,970.36
7 14,925 14,970.36 -45.36 -2.81 14,967.55

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Breadth Index

Index that covers No of securities Advanced − No of securities declined

all securities Total Securities traded
traded
Concept 5 – Breadth Index

Confidence Index

How willing are the Yield on high grade bond

investors to take chance in CI =
Yield on low grade bond
the market
Concept 6 – Confidence Index

RSI Index (Relative Strength Index)

Average gain 100

How strong a company is RS = RSI = 100 −
compared to others in market Average loss 1 + RS

Rise more in bull Fall less in bear

market market
Concept 7 – RSI Index
Sign of technical strength = Supports
movement of Dow Jones averages
Breadth Index
Sign of technical weknesses = Does not
Support movement of Dow Jones averages

Rising CI = Bull Market

Confidence
Interpretation
Index
Falling CI = Bear Market

RSI Above 70 = Correction in price

RSI Index
RSI below 30 = Increase in price

Concept 5 to 7 – Interpretation
Efficient Market - Cannot be predicted what
will happen in future
Inefficient market - Can be predicted based
Types of Market Run Test
on past trends

Tests to check market efficiency Serial Correlation Test

Filter rules test

Efficient Market vs Inefficient Market

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Run Test

Step 1 Step 2 Step 3 - Compute Compute

Take Mention number of runs tolerable limit
past price
price change Run is Runs within Runs outside
data coninuous Any sign tolerable limit tolerable limit
every
increase/ in price
day as +
decrease in change is a
or - Efficient Inefficient
price new run
market (weak market
form of
efficiency)
Tolerable Limit Computation: • Upper limit = Mean + (SD x t-value)
𝟐𝒏𝟏𝒏𝟐 • Lower Limit = Mean - (SD x t-value)
𝐂𝐨𝐦𝐩𝐮𝐭𝐞 𝐌𝐞𝐚𝐧 µ𝐫 = +𝟏
𝒏𝟏 + 𝒏𝟐 • t-value is to be computed for given significance level and
𝐂𝐨𝐦𝐩𝐮𝐭𝐞 𝐒𝐃 𝛔𝐫
(n-1) degrees of freedom
ሺ𝑴𝒆𝒂𝒏 − 𝟏ሻሺ𝑴𝒆𝒂𝒏 − 𝟐ሻ
= √
𝒏−𝟏
Concept 8 – Run Test
Data 1 = Jan 2025
Prices
Identify two data for which
correlation is to be tested
Data 2 = Jan 2024
Prices

Auto correlation test

- Absolute change
Correlation Data Measure changes in data
Serial Correlation
test = % change

Correlation closer to
+1 or -1 = Inefficient
market
Calculate correlation coefficient
between two data change
Correlation closer to
0 = Weak form of
efficiency
Concept 9 – Correlation Test

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Chapter 5 – Security Valuation

Security Valuation

Rights Money
Equity Bond Convertible Enterprise
issue and Market
Valuation Valuation Instruments Valuation
Buyback Instruments
Introduction

Walter Model - Price is sum of

Dividend (due to paid out Capital Appreciation (due to

earnings retained earnings)
⬚
⬚
⬚
r
D ሺE − Dሻ
Ke
Ke Ke

Concept 1 - How to Compute Price under Walter’s Model?

Terms Used

D = Dividend R = Return on E = Earnings per Ke = Cost of

per share equity share equity
Total Dividend EAES Investor required
R = IRR
No of shares No of shares return
Opportunity
R = Return on ROE x
EPS x PR cost of capital
retained earnings BVPS
Rate of
Dividend R = Return on capitalization
rate x FV investment
Cost of capital
EAES EPS (100% equity
ሺORሻ company)
Equity BVPS
Equity capitalization
rate
Concept 1 - How to Compute Price under Walter’s Model?

R> Ke (Growing) 0%

Optimum Payout Ratio R = Ke (Normal) Any ratio

R < Ke (Decline) 100%

Concept 15 – Appropriate Dividend Payout Ratio

Compute at a payout ratio

Minimum Possible value per
Limiting value which is opposite of optimum
share
payout ratio

Concept 17 – Limiting Value

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Gordon's Model (Growing

Perpetuity)

D1 D0 x ሺ1 + Gሻ E1 x Payout Ratio
P= P= P=
Ke − G Ke − G Ke − G

Concept 2 - How to value under Gordon’s Model?

Paid out (or) Will pay now
Current year dividend (D0)
(or) Paid last year

Dividend Given (Is Will pay next year (or) end

Next year dividend (D1)
it D0 or D1) of CY

No clarity Assumption to be taken

Concept 2 - How to value under Gordon’s Model?

How to compute Growth Rate

Based on Past Dividends

Based on Earning Ability; History
ROE x Retention ratio

Take First Dividend = PV

EAES Take Last Dividend = FV
ROE =
Amount of equity

FV = PV x FVF r, n
Retained earnings (OR)
RR =
Total Earnings PV = FV x PVF r, n

Concept 6 – How to Compute Growth Rate

Preference given to this as
Past EPS Data EPS reflects real growth of
company
Basis of Growth Rate

Used only if EPS data not

Past DPS Data
there

Concept 7 – Growth Rate Based on EPS vs DPS

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Future value FV = PV x 1 + r n
(Compounding)

Present value FV
PV =
(Discounting) 1+r n

Future value
AA x FVAF (r,n)
Time Value of Money (Annuity)
(Most important concept
of FM) Present value
AA x PVAF (r,n)
(Annuity)

Perpetuity (normal CF1

and growing) Discount rate − Growth Rate

Loan Amount
Loan instalment
Amount PVAF r, n

Concept 8 – Time Value of Money

EAES
Amount of equity

Return on Equity
EPS SC + Reserves − Fictitious Assets
BVPS =
BVPS No of shares

Concept 9 and 10 – How to Compute Return on Equity

Cost of Equity (What equity shareholder
wants) = Required return on equity

Dividend Non-Dividend Based on PE

Paying Paying Company
Company
1
Ke =
K e = R f + Beta x ሺR m − R f ሻ 𝑃𝐸
D1
Ke = +G
P0 − F
Rf = Risk Free Useful if there is
Rate 100% Payout
D1 = Dividend
of Next year
Rm = Market
Return
Po = Issue
price (or CMP
Rm - Rf = Risk
Premium of
F = Floatation market
cost

G = Growth
Rate
Concept 11, 12 and 14 – Computation of Cost of Equity

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Favourable Project Share price will increase by

(Positive NPV) NPV per share
Impact on new Project on
Share price
Adverse Project (Negative Share price will decrease
NPV) by NPV per share

Concept 31 – Impact of New Project on Share Price

Purchase Under-valued AMP < FMP

Decision on
Purchase/Sell
Sell Over-valued AMP > FMP

Concept 32 – Under-valued vs Over-valued Security

How to move from Price on one year to another
year (Can be used for bond valuation/ equity
valuation or any asset valuation) - Modigilani
Miller Approach

P1 = P0 x 1 + K e − D1 P2 = P1 x 1 + K e − D2

Concept 3 – Computation of Price of Different Years (MM Approach of CA Inter)

Company pays Dividend income meets

Dividend Investing
dividend committment
(People want regular
income from shares for
meeting their Do partial sale of shares till
Company stops paying
commitments) company starts paying
dividend
dividend again
Concept 27 – Maintenance of Dividend Income

Holding Period Return (Return

earned by holding shares)

Capital Appreciation P1 − P0 + Dividend ሺD1 ሻ

Return = x 100
Opening price ሺP0 ሻ

Concept 4 – Holding Period Return

Real value of security
Ex-dividend values without accrued
dividend
Ex-dividend (vs) cum-
dividend values
Ex-dividend values +
Always use ex- Cum-dividend values
Dividend Income
dividend values in
any formula
Price falls by the amount of
Relationship DPS post share becoming ex-
dividend
Concept 5– Ex-Dividend vs Cum-Dividend Price

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Required Return of any

security

Risk-Free Rate Risk Premium

Real-rate of return on
Inflation
risk-free security
Note:
• Real-return of any security = Normal return of security – Inflation rate
• Inflation premium forms part of Risk-free Rate and hence any increase in inflation premium
will increase the Risk-free Rate
Concept 33 and 34 – Component of Required Return and Inflation Premium
Step 1 - PV of Compute DPS till
Dividend Growth stability

Value of Share = PV of
Step 2 - Compute price at beginning of
Dividend + PV of sale proceeds
stabilization using Gordon's Formula
of share price on sales

Step 3 - Discount step 1 and step 2 at Ke (or) investor

required return and compute share price
Concept 18 – Step-up Growth Model
DPS of future years
No change in = DPS of earlier
Payout ratio years + Growth
rate
Dividend Estimation
for future period
Estimate EPS of
Change in future years = EPS Future DPS = Future
Payout Ratio of earlier years + EPS x Payout Ratio
Growth rate
Concept 20 – Estimation of Future Dividends

Linear Fall in Growth Higher rate − Lower rate

Number of years of Annual fall in GR =
Rate (Growth rate Number of years of fall
fall given
will stabilitze from
higher number
(example 20%) to
Number of years of Take 1% fall every
lower number
fall not given year
(example 10%)

Concept 19 – Linear Fall in Growth Rate

H Model - Price is sum of

Dividend at normal growth Extra price for higher growth

rate ⬚
⬚
⬚
Transition Period
D0 x ሺ1 + Normal GRሻ D0 x High GR − Normal GR x 2
K e − Normal GR K e − Normal GR

Concept 26 – H Model valuation

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Fair Price = EPS x PE Multiple

PE Multiple can be given in question Not Given

100% Payout BPVS = MPS

1 1
PE = PE =
Ke ROE
Concept 28 – PE Multiple Approach

Earning Growth Model Consider CMP as FMP and

substitute in Gordon Formula

E1
D0 x ሺ1 + Gሻ
Ke − G P1 =
Ke − G
Concept 29 – Earning Growth Model Concept 21 – Implied Growth Rate by CMP
Share price = PV of
Dividend + Sale price of
Bonus issue (one share will shares
become 1.2 or 1.5 shares on
last date) Sale proceeds = Higher
Sale price of shares = Sale
number of shares x Selling
proceeds - Transaction cost
Price
Concept 24 – Impact on Bonus on Terminal value

Max Purchase Price = Fair

No Transaction cost
value per share

Maximum Purchase Price

Fair value
Incurrence of Transaction Max PP =
cost on sale 1 + TC%

Concept 25 – Impact of Transaction Cost on Maximum Purchase Price

US investors are Infosys deposits

Infosys India wants
ready to invest but some 10,000 shares
to raise money from 10 shares = 1 GDR
want to invest in with a custodian
US investors
USD Bank

GDR are issued on Investor invests money Instrument is same

the security of through GDR - Gets regular as equity and cost of
shares and issued in dividend income when GDR = Cost of
USD Infosys declares dividends equity

Formula:
D1
Cost of GDR = +G
P0 − F
Concept 16 – GDR

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Step 1: Take the

Direct formula of
Cost of equity with CMP as outflow of Step 2: Compute
concept 11 cannot
multiple growth the investor dividends till the
be used as Growth
rates assuming we buy it stabilization phase
changes
today

Step 5: Increase DR
Step 3: Take Step 6: Compute
Step 4: Discount if we get positive
terminal value IRR. IRR of investor
above and compute NPV and Decrease
based on perpetuity = Cost of equity of
NPV DR if we get
valuation company
Negative NPV
Concept 13 – Computation of Cost of Equity (Dividend Paying Company with Multiple Growth Rates)
Compute Price without
growth. Take EPS as DPS.
100% Payout ratio
PVGO (Extra Premium paid by company
due to growth in company)
PVGO = CMP - Price
computed above

Concept 22 – Present Value of Growth Opportunities

Free Cash Flow Approach

FCFE1 FCFE = Free cash FCFE = PAT -

P0 = flow of equity Equity funding for net
Ke − G Equity funding capex and working capital
shareholder of next for net capex
year = (Net capex and working
and working capital requirement) x
capital (100% - Debt ratio%)

Concept 30 – Free Cash Flow Approach

Particulars Amount
Sales XXX
Less: Cost of Goods Sold (XXX)
Gross Profit XXX
Less: Operating expenses (Selling and admin expenses) XXX
Operating Profit/EBIT XXX
Less: Interest expenses (Note 1) (XXX)
EBT XXX
Less: Tax (XXX)
EAT XXX
Less: Preference Dividend [Preference capital x Coupon %] (XXX)
Earnings available to equity shareholders XXX
No of equity shares XXX
EPS [EAES/No of equity shares] XXX

Sum of (Respective debt

Problem is silent x Respective interest
rate)
How interest to be
computed?
Problem gives effective Total Debt x Effective
interest rate interest rate %

Concept 35 – Format of Income Statement

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Liquidity Ratios/Short term solvency Ratios

Capital Structure/ Long term Solvency Ratios
Profitability ratios related to sales
Types of Ratios
Coverage Ratios
Profitability ratios related to return on assets/ investments
Profitability ratios from owners point of view
Turnover Ratios
Concept 36 – Important Ratios

CA
Current Ratio CL
Liquidity Ratios (Ability to
repay short-term liabilities) QA
Quick Ratio (or) QA = CA - stock -
Acid Test Ratio CL Prepaid expenses

Concept 36 – Liquidity Ratios

Debt
Debt Ratio Capital Employed

Equity or Networth
Equity Ratio Capital Employed

Debt
Capital Structure (Ability to
Debt to Equity Ratio Equity
repay Long-term Liabilities)

Debt + Preference
Capital Gearing Ratio Equity

Equity
Proprietary Ratio Total Assets

Concept 36 – Capital Structure Ratio/Long Term Solvency Ratio

What is Capital Employed?

Assets Side Liabilities Side

Route Route

CE = Total Assets - CE = ESC + Reserves + PSC +

Fictitious Assets - Long-term debt - Fictitious assets
Current liabilities
Concept 36 – Capital Structure Ratio/Long-Term Solvency

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Interest Coverage EBIT

Ratio Interest

Source of payment PAT

Preference Dividend
Coverage Ratio What are we paying Preference Dividend
Coverage Ratio

EAES
Equity Dividend
Coverage Ratio Equity Dividend

Concept 36 – Coverage Ratio

Profitability
Ratio

Net
COGS Operating
GP Ratio Profit
Ratio Profit Ratio
Ratio

Gross Profit COGS Net Profit EBIT

Sales Sales Sales Sales

Concept 36 – Profitability Ratios related to Sales

Sales
Relevant item
Sales based
Ratios Relevant item can be Total Assets, Fixed Assets,
Current Assets, Working Capital and Capital
Employed

Debtors Turnover Credit Sales

Ratio Debtors
Turnover
Ratios Ratios based Credit Purchases
Creditors
on other Creditors
Turnover Ratio
items

Inventory Turnover COGS

Ratio Stock

Conversion 365
Debtor days =
into days Debtors Turnover Ratio

Concept 36 - Turnover Ratios used to assess effectiveness of usage of resources

EBIT
Pre-tax CE
ROI (or)
ROCE EBIT x 1 − T
Profitability Ratios What is earned
related to Return on Post-tax CE
What is invested
Assets/Investments
EAES
ROE Equity

Concept 36 – Profitability Ratios related to Return on Assets/Investments

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DPS
Dividend Yield x 100
MPS
EPS
Earning Yield x 100
MPS
EAES
Profitability Ratio EPS No of equity shares
related to owners
Equity Dividend
DPS No of equity shares

DPS
Payout Ratio EPS

Concept 36 – Profitability Ratios related to Owners Point of View

Ability to repay the

Fixed Interest and Fixed Dividend fixed interest and fixed PAT + Interest
Coverage Ratio dividends (Preference Interest + Dividend
Dividends)
Concept 37 – Fixed Interest and Fixed Dividend Coverage Ratio

Our ratio is better than Required return of our

Industry company will decline
Impact of Ratios on required return
of our company with help of proxy
company data
Our ratio is weaker Required return of our
than Industry company will increase
Concept 38 – Impact of Adverse/Favourable Ratios on Required Yield

Stock Lending - Lender temporarily lends

the shares of a particular stock to borrower

Borrrower (He does short-sell

Lender (Owner who
and hence wants shares for
has shares and lends it)
delivery

Lending Dividend Guarantee

Profit or loss Lending fees
fees Income charges
on short sell (Expense)
(Income) (Income) (Expense)
Concept 57 – Stock Lending
Offered to existing shareholders at a
price which is lower than CMP

Theoratical Ex-rights Expected price on

price completion of rights issue
Rights Issue
Price at which RE can be
Value of right entitlment
bought or sold in market

Positive/Negative NPV Share price will change by

on RI proceeds the amount of NPV
Formula:
ሺExisting shares x Existing Priceሻ + ሺNew shares x Rights Priceሻ + NPV
Theoretical ex − rights price =
Existing shares + New shares
Value of one right Theoretical ex-rights price – Rights issue price
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Value of one right Value of one right
[per share] Rights Ratio
Concept 40 and 41 and 43 – Theoretical Ex-Rights Price, Value of one Right and Impact of
Positive/Negative NPV on Share Price

Subscribe to Rights issue No impact

Impact of Rights issue on

Sell Rights Entitlement No impact
wealth of Shareholders

Ignore Rights Issue Wealth will decline

Concept 42 – Rights issue and Impact on Wealth

Impact on EPS

PAT may go No of shares will EPS may

down/remain same decline increase/decrease/
remain constant
Interest cost on Loss in interest income on
debt taken will existing Cash equivalents
reduce PAT (if used for buyback) will
reduce PAT
Concept 44 and 45 – Impact on EPS due to Buyback and Buyback funded with debt

Impact on BVPS

Networth will decline by BVPS may increase/

Number of shares
the amount of Buyback decrease or remain
will decline
size same

Concept 46 – Impact of Buyback on BVPS

Face value = Nominal value of Bond

Coupon Rate = Interest rate payable on bond

Basic terms associated

Interest Amount = Face value x Coupon Rate
with Bond

Maturity value = Amount payable on redemption -

taken as par if silent

YTM = Return earned by investor by holding bond

till maturity
Note:
• YTM can also be called as Cost of debt/ Discount rate/ Required return of investor/ Expected
return/ Opportunity cost/ Market rate of interest/ prevailing interest rate of similar bond/
Going rate of interest
Concept 58 – Basic Terms Associated with Bond

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Fair value of Bond

Today value = PV of future cash flows

(Interest and Principal) discounted at P1 = P0 x 1 + K d − I1
investor required rate of return

Half-yearly bond - Half-

Annual Bond - Annual cash
yearly Cash flows at half-
flows at Annual YTM
yearly YTM
Concept 59 – Valuation of Bond and Concept 60 – Half-Yearly Bond

Transaction Cost impact

Revised Yield = Normal Yield x (1 - No of days to break-even

Transaction cost %) Transaction Cost

Transaction cost
x No of days in a year
Normal YTM

Concept 65 – Impact of Transaction cost

Bond quote at par

Coupon Rate = YTM
(meets expectation)
Relationship between
YTM, Coupon Rate and Bond quote at
Bond Price Coupon Rate > YTM premium (exceeds
(This relationship only expectation)
if redemption is at par)
Bond quote at discount
Coupon Rate < YTM (Does not meet
expectations)
Concept 68 - Relationship between YTM, Coupon Rate and Bond Price

Increase in Investor
Decline in Price
expectation
Yield (Investor expectation)
and Price has inverse
relationship
Decrease in Investor
Increase in Price
expectation

Concept 74 – Yield and Price Relationship

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YTM of Bond - More relevant

for a redeemable bond

Method 2 (IRR
Method 1 (Short-cut Method)
Method)

RV − Today price Compute IRR with

Interest income +
Life one positive NPV
RV + Today Price and one Negative
2 NPV

Note:
• Spread of Yield from Comparable Bond = YTM of our Bond – Yield of Comparable Bond
Concept 66 – YTM of Bond
Pre-tax: Use pre-tax cash
flows to compute YTM
Investor
Post-tax: Cash flows to Deduct tax on interest and
compute YTM capital gain
Type of
YTM Inflow on day 0 and outflow
Pre-tax: Use company's pre-
every year and last year
tax cash flows
outflow
Company
Inflow on day 0 and outflow
Post-tax: Use company's
every year and last year
post-tax cash flows
outflow
Note:
• In case of company YTM (basically cost of debt), we should increase Discount rate in case of
Negative NPV and decrease Discount rate in case of Positive NPV (opposite approach of normal
Approach)
Concept 72 – YTM from Company Point of View

Current Yield (More Interest

Ratio of interest to current
relevant for irredeemable CMP
market price
bond)

Concept 73 – Current Yield

Has to be interpreted as change in
investor expectation/Yield/
Discount rate
Increase/decrease in
Yield or interest rates
Exception: Variable bond -
Cannot be taken as change
In this case both discount
in bond coupon rate as they
rate and coupon rate can
dont change during life
change
Concept 69 and 70 – Increase/decrease in interest rates and Variable Bond

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1
Uniform DR PVF of Y2 = 2
1+r
PVF computation for
discounting
(Equity/Bond PVF of Y1
valuation/NPV Forward DR PVF of Y2 =
1 + New DR
computation)
Change in
DR
1
Spot Yield DR PVF of Y2 = 2
1+r

Concept 23 and 61 – Multiple Cost of equity and Step-up/down Discount Rate

Expected Price of Bond Intrinsic value of Bond x Beta

Concept 71 – Expected Price of Bond (Not a Logical Item)

Discount rate for

arriving as issue price

Exception: Company wants to offer higher yield

Investor required return - Multiple
(or) lower yield and hence the same can be taken
other names are as per Concept 58
as DR

Concept 62 – What is to be used as Discount Rate of Bond

Broken Period Bond Valuation Let us assume Bond We need to arrive

(Valuation of Bond on non- pays interest on Mar 31 value of bond on
interest payment dates) and Sep 30 June 1, 2025

Arrive at bond value on the last

Value as on June 1, 2025 =
interest paid date (Apr 1, 2025) =
Value as on Apr 1, 2025 +
PV of future cash flows disconted at
Accrued interest
required return
Concept 64 – Broken Period Bond Valuation

Reinvestment rate given in question (or)

Compute maturity cash take as cost of debt
flow of every year CF by
taking reinvestment rate Reinvestment rate = 0 if intermediate CF
Realized Yield cannot be reinvested
(IRR assuming Compute IRR with one initial
reinvestment outflow and maturity cash
rate) inflow

Computed IRR is called

realized yield

Note:
• Re-invested interest = Maturity value of all cash flows – Normal additional of all cash flows
Concept 75 – Realized Yield

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Reinvestment rate > Realized YTM > Normal

Normal IRR YTM

Normal YTM vs Reinvestment rate = Realized YTM = Normal

Realized YTM Normal IRR YTM

Reinvestment rate < Realized YTM < Normal

Normal IRR YTM
Concept 76 – Relationship between Normal YTM and Realized YTM

Duration

Helps in
How long, on average, it takes to receive the Time period at
computation of
cash flows (interest payments and principal which there is
price change
repayment) of the bond, weighted by the no interest rate
due to change
present value of those cash flow risk
in Yield
Concept 77 – Duration
Format for computation of duration (assuming a 5-year bond)
Year Cash flow PVF @ YTM DCF Weight Year x Weight
1 Interest DCF
Total DCF
2 Interest DCF
Total DCF
3 Interest DCF
Total DCF
4 Interest DCF
Total DCF
5 Interest + Principal DCF
Total DCF
Total Total = Price of Bond 1.000 Duration of bond

For HY bond it
will be HY x
Total of year x weight and
Redeemable
weight column duration answer
Duration of would be in Half-
Bond 1 + YTM years
Irredeemable YTM

Note:
CMP
Annual cash flow of Annuity Bond =
PVAF ሺr, nሻ
Concept 77 – Duration and Concept 63 – Annuity Bond
Helps in finding
out the impact of
Volatility (or) yield change on
Modified Bond price Yield increases
Duration % change = and price will
Duration Volatility x fall
1 + YTM Change in Yield decreases
Yield and price will
increase
Concept 79 and 82 – Volatility (OR) Modified Duration and Volatility and Change in Price

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Duration in Years % price change =

Volatility = Volatility x Change
1 + HY YTM
Volatility of Half- in Annual YTM
Yearly Bond (Two
Approaches to find % price change =
price Change) Duration in HY Volatility x Change
Volatility =
1 + HY YTM in Half-yearly
YTM
Concept 80 – Volatility of Half-yearly Bond

Yield likely to Replace long

Reduce
go up - Price duration bond with
Duration and Duration
will fall short duration Bonds
Churning of
Portfolio Yield likely to Replace short
Increase
go down - Price duration bond with
Duration
will increase long duration Bonds

Concept 81 – Duration and Churning of Portfolio

Time to Lower time to maturity will
Maturity lead to lower duration
Impact of Change in
Coupon Higher coupon will lead to
Variables on Duration
Rate lower duration
of Bond
Yield to Higher YTM will lead to
Maturity lower duration
Concept 78 – Impact of Change in Variables on Duration of Bond

Price will go down

Increase in
interest rate Reinvestment income will
Immunization (effect of
price risk is exactly increase
offset by effect of
reinvestment risk) Price will increase
Decrease in
interest rate Reinvestment income will
decrease
Concept 83 – Immunization

Investor needs Ensure Portfolio

money after 4 Duration as 4
Immunization (Ensure years years
investment horizon to be
equal to Duration of
Bonds) Ensure Portfolio
Fund an outflow
Duration as 6
after 6 years
years
Concept 83 – Immunization

How to decide on Bond Refunding

Compute NPV of Bond Refunding decision based on CF of Bond Refunding

Step 1 Outflow = Outflow of Step 2 inflow = After tax Step 3 Terminal flow =
old bond - inflow of new cost of old bond - after Outflow of old bond -
bond tax cost of new bond outflow of new bond

Concept 84 – Bond Refunding [Same as Concept 20 – Replacement Decision]

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Payment to bond holders Inflow from new bond (inflow)

Cash flows relating to

Cash flow relating to
(outflow) Floatation cost of new bond
Call premium (outflow) (outflow)

new bond
old Bond
Write-off all items relating to old
bond (inflow)
Overlapping interest (Extra
interest paid on old bond) -
Outflow
Tax benefit on overlapping
interest (inflow)
Concept 84 – Bond Refunding
Compute net CF of
Interim saving new bond and net CF Find saving in
every year of old bond as if bond CF every year
Step 2 and has continued
Step 3 CF
Difference in Compute end of year Find saving or
outflow at end outflow at end of life extra outflow of
of life of old and new bond last year
Concept 84 – Bond Refunding

Use after-tax cost of debt given in question

What Discount rate to be
used for computing NPV
If not given, then we need to use after-tax
cost of new debt

Concept 84 – Bond Refunding

CF of Bonds Use CF structure of various bonds

are given and forecast future interest rates
Forward Rates - Forecasting
of future interest rates
Interest rates Use interest rates and forecast
are given future interest rates

Concept 85 – Forward Rates

CF of Bonds are given (Assume

given bonds are fairly valued)

Use one-year Bond Use two-year Bond Use three-year Bond

CF and compute PVF CF and compute PVF CF and compute PVF
of year 1 as of year 2 as of year 3 as
balancing figure balancing figure balancing figure
1 PVF of year 1 PVF of year 2
PVF of Year 1 = PVF of Year 2 = PVF of Year 3 =
Forward Rate of Year 1 FR of Year 2 FR of Year 3
Concept 85 – Forward Rates

FR of year 1
= SR of Year 1
FVF for 2 years
Interest rates are given FR of Year 1 to 2 = −1
FVF for 1 Year

FVF for 3 years

FR of Year 2 to 3 = −1
FVF for 2 Years
Concept 85 – Forward Rates

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Normal Yield Curve (or) Upward Long-term interest >

sloping Yield Curve Short-term interest
Yield Curve (structure Inverted Yield Curve (or) Short-term interest >
of interest rates) Downward Sloping Yield Curve Long-term interest
Long-term interest =
Flat Yield Curve
Short-term interest
Concept 87 – Nature of Yield Curve
Price Computed using Gap between these two
volatility does not match prices can be reduced
Bond Convexity with price computing using convexity and
under PV discounting make estimation more
method accurate
Concept 88 – Bond Convexity

Approach 1: Discounting approach at new YTM

Price computation with Approach 2: Old price + price change due to

change in Yield volatility
Approach 3: Old Price + Price change due to volatility +
Convexity Adjustment (Always to be added)
Note • C = Convexity
Δy = Change in Yield • Convexity adjustment (in Rs.) = C x ሺΔy 2 ሻ x V0
V+ + V− − 2V0
C=
2V0 ሺΔy 2 ሻ
V+ = Price of bond if yield increases by Δy
V− = Price of bond if yield decreases by Δy

Convexity Adjustment in Rs.

Convexity Adjustment ሺ%ሻ = x 100
V0
Concept 88 – Bond Convexity
PV of future cash flow
Redeemable discounted at investor
Preference share required return
valuation PD
Irredeemable Value =
Investor Expectation

Concept 89 – Valuation of Preference Shares

Valuation of Warrants
(Option to purchase (CMP - Exercise Price) x Number of equity
shares at pre-defined shares convertible with one warrant
exercise price)
Concept 90 – Valuation of Warrants

Conversion value (or) Value received if the CMP of share x

Stock Value bond is converted today Conversion Ratio

Concept 47 – Convertible Instruments – Conversion Value

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Per Bond = CMP - Conversion

Value

Conversion CMP in excess Per Bond

Premium (extra of Conversion Per share =
Conversion Ratio
payment made) value

CP
CP % = x 100
CV

Concept 48 – Convertible Instruments – Conversion Premium

Straight Value (or) Intrinsic PV of future cash flows of bond without
value (or) Floor value (or) conversion option discounted at
Minimum Price investor required return
Concept 49 and 55 - Straight value (or) Intrinsic value (or) Floor Value (or) Minimum Price

Per Bond = CMP - Straight

Value

Downside Risk
CMP in excess DR in Rs.
(Potential fall in bond DR % of SV = x 100
of Straight SV
value if conversion
value
does not happen)
DR in Rs.
DR % of CMP = x 100
CMP

Concept 50 – Downside Risk

Conversion Parity Price (OR) Market CMP of Converible Instrument
Conversion Price (OR) Minimum Price for Conversion Ratio
conversion (or) Break-even Price
Concept 51 – Conversion Parity Price

Income per Bond -

Per
(Total income for
Favorable Income Bond
shares x CR)
Differential (Extra Income
in bond as compared to
equity shares) Per Fav income differential per bond
Share Conversion Ratio

Concept 52 - Favourable income differential

CP per bond
Premium Payback period Fav Income differential per bond
(No of years taken to
recover conversion CP per share
premium)
Fav Income differential per share

Concept 53 – Premium Payback Period

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PV of future interest and

Redeemable value
Valuation of
Conversion value into
Convertible
equity on maturity date
Bonds
Redeemable value
(higher of two)
Redeem as debt (Par
value if problem is
silent)
Concept 54 – Valuation of Convertible Bond

Do not opt for

CMP > CPP
Compute conversion
Decision on
Conversion
Conversion
Parity Price Opt for
CMP < CPP
conversion

Concept 56 – Decision on Conversion

Equity + Debt + Minority Interest - Cash

Total
and Cash Equivalents

Enterprise TEV - Market value of non-operating

Operating
Value assets such as investment in associates

Core OEV - Value of non-core assets

Concept 91 – Enterprise Value

EV to EBITDA EV = EBITDA x EV to
Arriving at Multiple EBITDA Multiple
Enterprise
Valuation based
on Multiples EV to Sales EV = Sales x EV to Sales
Multiple Multiple

Concept 92 - Valuation based on EV Multiples

1
Cash Return on Total Investment EV to EBITDA Multiple

Concept 93 – Cash Return on Total Investment

MV − IP 365
Yield of Treasury x x 100
Bill IP No of days

Note:
• Issue price can also be computed using the above formula
Concept 94 and 95 - Yield of Treasury Bill (or) Discount of Commercial Bill (or) Yield of Certificate of
Deposit (or) Yield of commercial Paper

r n
Higher frequency of compounding will ERI = 1 +
n
increase the effective interest cost
N = No of compounding in a year

Concept 96 – Effective Annual Interest on Money Market Instrument

Particulars Calculation Amount
(in lacs)

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Interest cost FV – Amount raised XXX
Cost of placement XXX
Stamp Duty XXX
Issuing and other charges XXX
Rating Charges XXX
Total cost XXX
Net amount raised through CP
Amount raised XXX
Less: Line of credit to be maintained (XXX)
Less: All costs other than interest (note) (XXX)
Effective amount raised XXX
Note:
• Interest should also be subtracted in case there is up-front payment of interest
Total Cost 12
Effective cost of CP ሺpre − taxሻ = x x 100 = XX%
Effective Amount Raised Number of Months
Effective cost of CP ሺpost − taxሻ = Pre − tax cost of CP x ሺ1 − Tax Rateሻ
Concept 97 – Effect of Compensating Balance on Cost of Commercial Paper
Bank A (Need of
Money and has
investment in 12%
GOI Bonds)

Bank B returns 12% Gives this to Bank

GOI Bonds to Bank B as financial
A security

Bank A has
Bank B gives loan
adequate Money
to Bank A at Repo
and transfers
Rate of 5%
Money to Bank B
Bank A continues
to earn interest at
12% but pays
interest at 5%
Concept 98 – Repo Transaction

Clean Price Value without accrued interest

Clean Price and
Dirty Price
Clean Price + Accrued interest (in
Dirty Price
above example it will be 12%)

Concept 98 – Clean Price and Dirty Price

Start Proceeds No of securities x Dirty Price x

(or) First Leg (1 - Initial Margin)
Repo Transaction
Start Proceeds + Interest at
End Proceeds
repo rate (5% in above
(or) Second leg
example)
Concept 98 – Clean Price and Dirty Price

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Chapter 6 – Portfolio Management

Concept of Risk
and Return

Return Risk

Possibility of earning Possibility of

money losing money

SBI Equity = 14.00% SBI Equity = 22.07%

SBI FD = 7.00% SBI FD = 1 to 2%
Concept 1 and 2 – Return of Security and Risk of Security
Formats for Portfolio
Management

Format 1 Format 2 Format 3

Format 1
Probability Return Product Deviation 𝐏𝐝𝟐

Format 2:
Security A Security B
Prob Return Product Deviation 𝑷𝒅 𝟐 Return Product Deviation 𝐏𝐝𝟐 𝐏𝐝𝐚 𝐝𝐛

Format 3:
Return of security (X) Return of market (Y) XY 𝐘𝟐

Computation of Risk and

Return

P1 − P0 + D1 P1 − P0
Return = Return = + DY Risk = pd2
P0 P0

Concept 1 and 2 – Return of Security and Risk of Security

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Co-variance of A
and A is called
variance
COVAB = ∑𝐏𝐝𝐀 𝐝𝐁
Co-variance of A and B =
Co-variance and Beta of A x Beta of B x
Correlation Variance of Market
coefficient
COVAB
Correlation can
COR AB = SD range between -
A SDB
1 to +1
Concept 3 – Computation of Correlation coefficient and Covariance

Healthy eating habits -

Health and organic fooods
will do well and fast food
Fast food chains vs chains will struggle
health and organic
foods brands If there is no shift - Fast
food chains will do well
Diversification or and healthy foods will
Portfolio Creation struggle

Online Retailers vs
Performance will have
Brick and Mortar
negative correlation
Stores
Benefit of Diversification:

Business 1 Business 2 Combined performance

40 -10 15

30 0 15

10 10 10

-10 20 5

-15 40 12.5
Average Return = 11% Average Return = 12% Average Return = 11.50%

SD (Risk) = 21.54% SD (Risk) = 17.20% SD (Risk) = 3.74%

Portfolio Return and

Risk

Portfolio Return = Portfolio Risk = Not weighted average

Weighted average of due to Corrrelation coefficient
individual returns

Two Securities
= 𝑆𝐷1 𝑊1 2 + 𝑆𝐷2 𝑊2 2 + 2𝑆𝐷1 𝑊1 𝑆𝐷2 𝑊2 𝐶𝑂𝑅12

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Concept 4 – Portfolio Return and Portolio Risk
Notion of Dominance -
Security dominates
other security if

Higher return with Higher return with Same return with

lower risk same risk lower risk

A = 10% Ret and A = 10% Ret and A = 10% Ret and

5% Risk 5% Risk 5% Risk
B = 12% Ret and B = 12% Ret and B = 10% Ret and
4% Risk 5% Risk 4% Risk
Concept 5 – Notion of Dominance

Compensation for risk - Extra

return generated due to risk
being taken

Diversified Portfolio (Beta based) Undiversified Portfolio (SD based)

Treynor Ratio Sharpe Ratio

Act Return − Risk Free Return Act Return − Risk free rate
TR = SR =
Beta SD

Concept 6 – Compensation for Risk

Types of Risk

Systematic Risk (or) Unsystematic Risk

Non-diversifiable risk (or) Diversifiable risk

Risk inherent to the market and Risk specific to company and

will impact all companies in the will not impact everyone in the
market industry

GDP Growth/Interest Poor management decision/

Rates/Inflation/Wars Frauds/ Lawsuits/ Competition

Cannot be eliminated Can be eliminated by

by diversification diversification

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Measure of Risk

Standard Deviation
Beta (Systematic Risk)
(Total Risk)

How does security

How much does security return
react to fluctuations in
deviate from its average return?
market?

Considered for undiversified Considered for diversified

portfolio portfolio

Concept 11 – Beta vs Standard Deviation

How to we
measure Beta?

Probability information Probabiity Approx formula

not given information given (not prefered)

Use Format 3 Beta

Use Format 2 Change in Security
=
F3 Change in Market
∑XY − n Mean of X Mean of Y F2
= SDs
∑Y 2 − n Mean of Y Mean of Y = x COR SM
SDm
COVSM
F1 =
VAR M

Concept 9 - Beta

Risk-free Rate (Return on Government

Security)

Interest in Rs.
Multiple Risk-free Rf = Hidden Rf in question
Rates value per Bond

Aggressive Approach = Rf = Security return with 0

Higher Number Beta

Conservative Approach = Rf =
Lower Number

Moderate Approach = Rf =
Average
Concept 7 – Risk-Free Rate

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Risk Premium of Market

Extra return generated Rm − Rf

by market for risk taken

Positive if market return is higher

than risk-free rate

Negative if market return is lower

than Risk-free Rate
Concept 8 – Risk Premium of Market

Portfolio Beta

Weighted average of the Can be altered by Can also be altered with

Beta of individual securities adding/removing borrowing/investment in
securities risk-free security

Concept 15 and 16 – Portfolio Beta and Weights for Target Portfolio Beta
Format for computing Portfolio Beta and weights of Portfolio for target Beta
Security Beta Weight Product

Return
Beta

Fair Fair Beta /Equilibrium Actual

Return/Equilibrium Actual Return Beta Beta
Return
What Beta should a Calculated
What return should What return a security security have for the using
a security give? is actually giving? return it is giving? F1/F2/F3
Act Return
= R f + Fair Beta x R M − R f
Fair Return = R f + Actual Beta x R m − R f

Concept 12 – Concept of Fair/Equilibrium Return and Fair/Equilibrium Beta

Risk of Portfolio Relative to Market

Optimum Risk High Risk Low Risk

Actual Beta = Actual Beta > Fair

Fair Beta Actual beta <
Beta Fair Beta

Concept 13 – Risk of Portfolio Relative to Market

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Decison on Purchase/sell

Purchase Sell

Under-valued Over-valued

Act Return > Fair Return Act Return < Fair Return

Act Price < Fair Price Act Price > Fair Price

Act Beta < Fair Beta Act Beta > Fair Beta
Concept 14 – Decision on Purchase/Sale of Security

Risk-taking ability of the investor

Bull Markets Bear Markets

Markets will go up Markets will go down

Invest in high Beta Stocks Invest in low Beta Stocks

Higher Positive Return Lower Negative Return

Concept 10 – Beta (Bullish vs Bearish Market)

Numerator of F2 of Beta
Systematic Risk
Computation
Systematic Risk and
Unsystematic Risk
(Computation) Unsystematic
risk/Specific SD/ Total Risk - Systematic
Residual Risk/ Random Risk
error

Concept 17 – Systematic Risk and Unsystematic Risk

Formulae
Particulars Variance Approach SD Approach
Total Risk Variance of security SD of security
ሺBeta of security x SD of marketሻ2 Beta of security x SD of market
(or) (or)
Systematic Risk ሺSD of security x COR sm ሻ2 SD of security x COR sm
Unsystematic Risk Total risk - Systematic risk Total risk - Systematic risk

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Portfolio Risk

Markowitz Approach Sharpe Approach (Co-movement of

(Correlation based) security with index)

2 Total Risk (Variance) = Systematic

a+b formula Risk + Unsystematic Risk

Sys Risk of Portfolio = Same

as concept 17 Formula

Unsys Risk of Portfolio = weighted

average of individual USR with W2
being assigned weights
Concept 18 – Portfolio Risk through Markowitz/Sharpe Approach

Co-efficient of Determination

Variance Approach ሺr 2 ሻ SD Approach (r) = This is equal to

correlation coefficient

Sys risk as per variance approach Sys risk as per SD approach

r2 = r=
Total Variance SD

Concept 19 – Co-efficient of Determination

Investment with margin of 60%

Investment in risky portfolio = Borrowing = 60% at risk-free

160% rate
Concept 20 – Investment with margin of XX

Fully Diversified Portfolio

Carries no unsytematic risk

SD = Systematic Risk of Portfolio

Concept 21 – Fully Diversified Portfolio

Components of Return

Return due to Return due to extra risk taken

Return due to sheer skill of
market risk manager

CAPM return for given

Actual Return -
Rm - Rf beta - CAPM return for 1
CAPM Return
Beta
Concept 21 – Components of Return
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Stock Specifc
Characteristic Line
CL = Alpha + Beta x (Return
of Market)

Common for all companies

Characteristic Line, Security Market Line
CML and SML (SML) - CAPM
R f + Beta x R m − R f

Common for all Companies

Capital Market Line
(CML) SDsecurity
Rf + x Rm − Rf
SDmarket

Concept 22 – Characteristic Line, CML and SML

Return earned in excess of

the required return. This is
also know as return due to
sheer skill of portfolio CAPM
manager Approach
How is (Diversified
Alpha Alpha = Actual Return - required
CML Approach
Required Return return
(Undiversified)
calculated
Positive Alpha is strong Characteristc
performance and Line
Negative Alpha indicates
underperformance

Concept 23 – Alpha

Rf and Rm Computation through

two securities SML

Form 2 SML equations

Solve equations to get Risk-
with Beta and return
free rate and Market return
given in question

Concept 24 – Computation of Rm and Rf using two SML Equations

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CAPM is single
factor model and Rf + [Factor 1 x Risk (or) Return
APT is multi-factor premium of Factor 1] + [Factor 2 x Risk
Return model (or) Return premium of Factor 2] +
[Factor 3 x Risk (or) Return Premium of
under APT Factor 3]
Two formulae for
return
computation Rf + [(Expected value – Actual Value of
Factor 1) x beta of Factor 1] + [(Expected
value – Actual value of Factor 2) x Beta of
Factor 2] + [(Expected value – Actual
value of Factor 3) x Beta of Factor 3]

Concept 25 – Arbitrage Pricing Theory

Weighted average of the Beta

Asset side of various assets
Beta (or)
Unlevered Asset Beta of our company =
Beta Asset Beta of Proxy =
Beta (Asset side
Liability Beta of Proxy
Beta = Liability
Side Beta) Weighted average of the Beta
of various liabilities
Liability Side
Beta
Weights for debt would be
taken as Debt x (1 - Tax Rate)
Concept 26 – Beta and Leverages

Asset beta (or)

Used to compute cost
unlevered beta (or)
of capital (WACC)
overall beta
Beta Classification
Equity Beta (or)
Used to compute cost
Levered Beta (or)
of equity
Stock Beta

Concept 26 – Beta and Leverages

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Portfolio Strategies

Buy and Constant Constant Proportion

Hold Mix Policy Portfolio Insurnace
Policy (CPPI)
Rebalancing at every Rebalancing is
No event (Fixed done at every
rebalancing period/Fixed change) event
done
Investment in Floor value =
equity = Total investment -
Multiplier x Maximum % fall
(Total value - in Nifty
Floor value)
Concept 27 – Portfolio Strategies
Var2 − COV12
W1 =
Var1 + Var2 − 2COV12
Two Securities
W2 = 1 − W1

Minimum Risk
Portfolio Three Securities Critical Line Approach

More than Three Sharpe's Optimal Portfolio

Securities Approach

Concept 28 – Minimum Risk Portfolio

Critical Line
Approach (Three
Securities)

Find two portfolios Fit an equation Use the equation and

which are on which links weights find the weights for the
minimum risk of two securities third portfolio with
minimum risk

Weight of Security 1 = a
+ b (weight of security 2)

Concept 28 – Critical Line Approach

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More than
3 Securities

Step 1 - Step 4 - Step 5 -

Step 2 - Step 3 - Maximum cut-
Rank Compute Z
Rearrange Compute off is taken as
securities value and final
in the cut-off final cut-off.
in the weights in
order of point Security with
order of proportion of Z
ranking TR > cut-off
Treynor value
Ratio forms part of
final portfolio

Concept 28 – More than 3 Securities

Format for Computation of Cut-off Point:
Sec TR Beta USR SR SR SR SR SR SR Cur-off
TR x ( ) ∑TR x ሺ ሻ ∑( ) 1 +∑( )
USR USR USR USR USR

Note:
• TR = Treynor Ratio
• USR = Unsystematic Risk
• SR = Systematic Risk = Beta x Beta x Variance of Market
• Cut-off Point =Column 8/Column 10
Z- value computation
Beta
Z value = Excess cutoff x ( )
USR
• Excess cutoff = Treynor Ratio - Cutoff point
Based on credit side of Value of Property = Area
P&L - Sales comparison x Adjusted SP per square
appproach feet

Based on debit side of Area x Construction cost

P&L - Cost Approach per square feet
Real Estate
Valuation Perpetual Income
Based on income (Credit - Value =
Debit) Capitalization rate

PV of cash flows
Based on Cash Flows discounted at required
return
Concep 29 – Real Estate Valuation

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Chapter 8 – Mutual Funds

MF Introduction (Financial
Doctor for Managing Investor
Money)

Sponsor Trustee (Ensures AMC (Manages Investors/

(entity that MF operates in the fund
establishes investments) unit-holders
the best interest
MF and of investors)
gives initial Incurs expenses and
capital) recovers it as part of
Expense ratio
Mutual Fund Introduction
MF Return vs Individual Return (Return to
be earned by MF to give same return which
an investor would get on his own)

Without With Opportunity

Opportunity Cost Cost

Individual Return Do cost benefit analysis

MF Return = + AER
1 − IER to check which is better

Concept 1 and 2 – MF Return vs Individual Return

Return is function of Dividend and Capital
Appreciation for an investor

What I get back − What I give

Return =
What I Give

ሺNAV1 − NAV0 + D1 + CG1 ሻ

Return =
NAV0

Holding Period Return Annual Return

Same Above formula

Formula multipled with (12/m)
as above
Concept 3 – Holding Period Return vs Annual Return

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Period of Holding through Holding period

Return and Annual Return

HPR
Period of Holding = x 365 days or 12 Months
Annual Return

Concept 7 – Period of Holding

Question specifies Do return

that a year consist of computation on
Days or Months 360/365 days number of days
Calculation for Annual
Return
Do computation
No such information
on months basis

Concept 5 – Return Computation – Days vs Months

Note:
• Number of days = Redemption date – Investment date [Consider date of redemption in days calculation
and ignore date of investment in computation]

Dividend Declared by MF
[Dividend Rate x Face value]

Dividend Payout Dividend

Plan Reinvestment Plan

Dividend is re-invested and

Paid in Cash
given extra units

Return computed Closing value − Opening value

using formula of HPR = x 100
Opening value
Concept 3
Concept 8 – Dividend Payout Plan and Dividend Re-investment Plan
Concept 9 – Computation of Closing Units
Dividend Reinvestment Plan:
Dividend
Unit Amount (B) New Total
held (A x Face value x Dividend Reinvestment NAV units units
Date (A) % %) (C) (D= B/C) (A+ D)

Bonus Plan:
Bonus
units
Unit (B = A x Total
held Bonus Bonus units
Date (A) ratio Ratio) (A + B)

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Types of MF Schemes

Open-ended Scheme (Entry Close-ended scheme (entry

and exit at any time) and exit at specified time)

Return computed using Listed in stock market (to

formula of Concept 3 facilitate purchase and sale)

Purchase and sale cannot

happen at NAV

Replace NAV 1 and NAV 0

with adjusted price in formula
Concept 4 – Return for Close-ended Schemes

Taxation Impact

Cost of Acquisition of bonus units STT is not tax deductible expense for
is 0 computing capital gain

Concept 10 – Taxation Impact

Effective Yield

Return computed as Annual Compute return as IRR of the

return through formula ignores investor
Time value of Money and hence
not fully accurate
Day 0 - Outflow of Maturity - Inflow
investor of Investor

Concept 11 – Effective Yield

Collected extra
Front-end Public offer price − NAV
on entry and
Load (or) NAV
hence increases
Entry Load
Load purchase price
in MF Collected on
exit and hence NAV − Redemption Price
Back-end Load
decreases NAV
(or) exit load
redemption
price

Concept 12 – Front-end Load and Back-end Load

Asset and Liabilties

Formula 1
details available
NAV (Fair value per
unit of MF)
Asset and Liabilites
Formula 2
details not available

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Concept 14 and 15 – NAV
Market value of assets − Value of liabilities
Formula 1 NAV =
Number of units
Opening Networth + Items increasing networth − Items reducing networth
Formula 2 NAV =
Opening units + New units issued − Redemptions

Impact of events on NAV

Fresh Purchase/ Redemption Dividend Declaration

No impact as Numerator and NAV falls by the amount of

denominator is impacted Dividend per unit
Concept 16 and 17
Total yield of Investor (Applicable
when an investor is investing in
multiple MF)

Capital Gain of All MF + Dividend of All MF

x 100
Amount invested in all MF

Concept 6 – Total Yield of Investor

No exit Load Exit Immediately

Exit strategy of
under-performing
MF Check proportionate %
loss in return as
Exit Load exist
compared to exit load
and decide
Concept 13 – Exit Load vs Lower Return from MF

Record cash as an
asset if given for
Not possible
NAV computation -
Tracking of cash else ignore it
inflows and
outflows Prepare Cash book
and compute
Possible
closing cash and
consider in NAV
Concept 18 – Cash Balance Computation to Value NAV

Applicable and
Original Shares
will be received
Dividend income
of MF on its
Will not be applicable
investments
Rights in case dividend
shares/Bonus declared before
shares allotment of
bonus/rights shares

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Concept 21 – Dividend Income on Equity Shares

No need to do
Yes dividend equalization
adjustment

MF reports daily Purchase NAV =

NAV Opening NAV + Entry
Load + Dividend
No (Practical equalization per unit
world this option
is not there) Redemption NAV =
Opening NAV - Exit Load
+ Dividend Equalization
per unit
Concept 21 – Impact of Dividend Equalization
Note:
Total income earned
Dividend equalization per unit =
Number of units
Income Let us assume there are three months in the calculation period
Available for
distribution is
computed to Total income
identify the Income per unit =
amount of Number of units of that month
dividends
which can be Income available for distribution = (Month 1 income per unit
distributed + Month 2 income per unit + Month 3 income per unit) x
Closing units
Concept 24 – Income Available for Distribution

Dividends out of realized earnings

Dividends distributed = Realized earnings x Specific %

Realized earnings = Dividend/interest income of MF +

Realized capital gain
Concept 20 – Dividends out of realized earnings

Valuation of Assets

Equity shares Bonds

Closing index value Interest in Rs.

Amount invested x
Index on date of investment Current Yield in %
Concept 19 – Valuation of shares and bonds for NAV computation
Amount incurred by MF such as office expenses, rent, fund management
expenses etc
Expense Ratio
Annual Expense per unit
Expense ratio = x 100
Opening NAV or Closing NAV or Average NAV

Concept 25 – Expense Ratio

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Sharpe Ratio (or)
Undiversified MF Reward to Variability
Ratio
Treynor Ratio (or)
MF Performance
Diversified MF Reward to Volatility
Evaluation
Ratio

Either of them Jensen Alpha

Concept 26, 27, 28 and 29

Formulae
Expected return − Risk free Higher the
Sharpe Ratio =
Standard Deviation better Values can be negative if MF return is
Expected return − Risk free Higher the lower than risk-free return
Treynor Ratio =
Beta better
Alpha = Actual return – Required return as Higher Positive
per CAPM Alpha is Better

Will decline by
Cash component
expense per unit
Break-up of NAV
Will increase or
Equity Component decrease based on
market change

Concept 22 – MF NAV computation – Cash and Equity Component

Note:
• Closing NAV = Cash Component + Equity Component
• Equity Component = Opening Value +/- % change;
• % Change = Beta of Portoflio x Change in Market

Applicable for MF which Computes the amount

Tracking tracks any index. of variation in
error performance as
Example: Nifty Index MF compared to the index
Concept 30 – Tracking error

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Chapter 9 – Derivatives Analysis and Valuation

Spot Market
This gives TCS - Spot
(or) Cash
Spot Price price is 3,786
Market

Types of TCS Feb 27 is

Market 3,789

This gives
Futures TCS Mar 27 is
Actual
Market 3,810
Futures Price

TCS Apr 24 is
3,832

Concept 1 - Futures price vs Spot Price

Types of
Futures Price

Actual Futures Price Fair Futures Price

Price at which futures are quoted in Price at which futures should be

market quoted in market

Any buying or selling or hedging Compute with spot price and a

will be at this price formula
Concept 1 - Futures price vs Spot Price

Normal Formula 1: FFP = Spot price x 1 + r n

compounding
Valuation of
Futures
Continuous Formula 2: FFP = Spot Price x ert
compounding

Concept 2 – Valuation of Futures

No dividend (or)
Formula as above
storage cost

Replace Spot price with

Dividend in Rupees Adjusted Spot Price (SP -
PV of Dividend)
Futures Dividend
valuation Dividend in % Replace r with r - y

Replace spot price with

Storage costs in
Adjusted Spot Price (SP +
Rupees
PV of storage costs)
Storage costs

Storage costs in % Replace r with r + s

Note:
Dividend Income Dividend Income
PV of Dividend Income = rt
ሺorሻ
e ሺ1 + rሻt
Storage costs Storage costs
PV of Storage costs = ሺorሻ
ert ሺ1 + rሻt
Concept 4 – Formula Adjustments

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X X2 X3 Xn
eX = 1 + + + + ⋯+
1! 2! 3! n!

Concept 3 – How to Compute ert values

Variables used in
futures valuation

Risk-free
Spot Time Storage Compounding
Rate of Dividend
Price Period Costs Frequency
Interest
Concept 6 – Format for Computation of Fair Futures Price
CCRFI (or) Daily Compounding (or) e Continuous
power value given in question compounding

One-month interest rate = 12% per Monthly

annum Compounding
What
Compounding Monthly
Interest rate = 0.6% per month
Frequency to Compounding
Take?
Quarterly
Interest rate = 3% per quarter
Compounding

Compounding
No indication
once (n = 1)
Concept 7 – What Compounding Frequency to Take?

Arbitrage Gain = Difference between FFP

and AFP [Higher number - Lower number]

AFP > FFP AFP < FFP

Futures Overvalued Futures undervalued

Sell Futures Buy Futures

Buy Spot Sell Spot

Borrow to buy share Create FD for sale proceeds

Concept 8 - Arbitrage Gain Computation and Strategy

Cost to Carry (Total expenses FFP as per

associated with holding an Formula - Spot
underlying asset till expiry) Price
Concept 10 – Cost to Carry

Same Yield Take the given yield as final yield for

every month valuation

Dividend Yield
Take average yield of futures period.
Different yield For example consider average of April
every month to June for 3-month futures valuation
in March end
Concept 5 – Dividend Yield Computation

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FFP as per question = SP + Cost to

Carry - CY
Future value of
CY
Convenience Yield (Benefit FFP as per question = FFP as per
of holding anything in formula - CY
physical form)
Present value of Discount future value using
CY normal or continuous discounting
Concept 11 – Convenience Yield
Implied Risk-Free Rate Arbitrage gain 12
(Increase in risk-free rate due Normal R f + x 100 x
Spot Price m
to arbitrage)
Concept 9 – Implied Risk-free Rate

Pay cash and

receive share or
Physical product
settlement Deliver share or
Types of product and receive
Settlment for cash
futures No need to
contract deliver or
receive product Current selling
Net Buyer of
price - original
settlement Just settle the futures
buying price
difference in
price Original selling
Seller of
price - Current
futures
buying price

Format 15 – Physical Settlement and Net Settlement

Format for computation of Net Settlement
Date Position Action Ref date Rate
10-Sep-23 Original Position Sell 10-Dec-23 3,200
10-Dec-23 Opposite Position Buy 10-Dec-23 -3,400
-200
Contango (Normal and Futures price >
Negative Basis
Types of upward sloping market) Spot price
Futures
Market Backwardation (Reverse Futures Price <
Positive Basis
sloping market) Spot Price
Basis = Spot Price – Futures Price
Concept 12 – Contango and Backwardation Market

SD of spot
F2 of Beta computation = x Correlation
Beta (Hedge Ratio) - SD of futures
Ratio between spot
position and Index
futures for hedging % Change in share = Beta
Can be used to find %
of Share x % Change in
change in share price
Market
Concept 13 and 14 – Computation of Beta (Hedge Ratio) and Change in Price

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Perfect Hedge Overall Beta of 0

Fully Hedged Overall Beta of 0

Hedging
Target Beta Overall Beta as given in question

Hedging of specific % (Lets say

New Beta = Old Beta - 60%
60%)
Concept 16 (Hedging – Perfect Hedge), Concept 17 (Hedging – Target Beta), Concept 18 (Hedging –
Protection of Specified %)
Format for computation of Amount to be Hedged
Security Beta Weight Product
Portfolio
Index Futures
Overall
Total will not include
Weight column
weight of Futures

Beta of Nifty /Sensex/

Variables in Beta of 1
Index Futures
deciding
Amount to be
Purchase/sale Purchase is positive in weights
Hedged
transaction and sale is negative in weights

No of contracts
Amount to be Weight of
based on Actual
hedged index futures
Futures Price
Note:
Amount to be hedged ሺweight of Index Futuresሻ
No of contracts =
Size of One Contract ሺLot size x 𝐀𝐜𝐭𝐮𝐚𝐥 𝐅𝐮𝐭𝐮𝐫𝐞𝐬 𝐏𝐫𝐢𝐜𝐞ሻ
Concept 19 – Hedging – Size of One Contract
Normal Rate can be CCRFI rate can be
converted into CCRFI rate converted into normal rate
using Natural log values using ert values
Concept 21 – Normal Rate and CCRFI Rate

Investment Reduction in Beta

Changing Beta through

Borrowing Increase in Beta
Risk-free investment
Format remains same as format of
amount to be hedged
Concept 20 – Modification of Portfolio Beta through Risk-Free Investment/Borrowing
Price Goes Up (+) Profit
Long Position (Purchase) (+)
Price Goes Down (-) Loss
Profit or Loss
Computation
Price Goes Up (+) Loss
Short Position (Sell) (-)
Price Goes Down (-) Profit
Concept 22 – Profit/Loss on Different Positions

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Realization will always happen
Realization as per spot rate
at spot rate and not at the
on expiry date
Effective contracted futures rate
Realization
Net settlement in Futures
as per concept 15
Concept 23 – Effective Realization/Payment in Futures
Return from
Asset Swap (Swapping of Nifty %
Net settlement = Return from
return of one asset with
one asset - Return from
swapping of return from
another asset Return from
another Asset)
FD (Fixed %)
Concept 26 – Asset Swap
Value of one
Margin contract x Specific %
Margin deposited at x No of contracts
Initial Margin
(Refundable start of the Daily absolute
deposit with contract change + (3 x
broker for Standard Deviation)
allowing us to Margin to be
take position in Maintenance maintained Specific % of
futures) Margin during the initial margin
contract
Concept 24 – Initial Margin and Maintenance Margin
Actual Margin higher
Excess Amount can be
than Initial Margin
withdrawn
(Amount withdrawable)

Actual Margin lower than Margin has to be

Margin movement maintenance margin replenished back to Initial
(Margin Call) Margin

Actual margin between

Initial and Maintenance No adjustment
Margin
Concept 24 – Initial Margin and Maintenance Margin

Return on Investment in Futures

Return earned
x 100
Amount paid on day 0

Return earned Amount paid on day 0

Margin paid on day 0 + Transaction

Profit - transaction cost
cost paid on day 0
Concept 25 – Return on Investment in Futures

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Right to buy something but not

Call Option
an obligation to buy
Option Contract
Right to sell something but not
Put Option
an obligation to sell
Concept 27 – Option Contract - Basics
Gets the right to Pays Premium
Holder or Buyer
buy or right to sell (Expense)
Parties
Gives the right to Receives Premium
Writer or Seller
buy or right to sell (Income)
Concept 27 – Option Contract - Basics
Call Holder Gets the right to Buy
Call
Call Writer Gives the right to Buy
Parties
Put Holder Gets the right to Sell
Put
Put writer Gives the right to Sell
Concept 27 – Option Contract - Basics
Only Holder can exercise it and if he
Profit for Holder
exercises there will be profit for holder
Option Exercise
If We are writer - In this case also
holder can only decide on exercise and Loss for Writer
we have to pay Holder
Concept 28 – Who Can exercise an Option

Type of Option

American Option European Option

Can be exercised at any Can be exercised on expiry

time before expiry date date
Concept 29 – American vs European Option

Price at which the share (or) Product can be bought

Exercise Price or Strike Price
or sold

Concept 30 – What is Exercise Price?

Option which will be
In the Money Option
exercised by the holder

Status of Option At the Money Option Indifferent (CMP = EP)

Out of the Money Option which will lapse by

Option the holder
Concept 31 – Status of Option

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Price change

Likely to go
Likely to go up
down

Long call (or) Short Put Long Put (or) Short Call

Concept 32 – What action to be taken in Options Market?

Componeent of Option Price (Premium)

Intrinsic value Time value

Real value of option today (Net Premium - Intrinsic

settlment if option is exercised today) value
Concept 33 – Intrinsic Value vs Time Value

Option Utility

Call Option Put Option

To restrict maximum To receive minimum

purchase price selling price
Concept 34 – Call Option vs Put Option Utility

Holder GPO - Premium

Payoff (Profit)
Writer Premium - GPO
Payoff and BEP
Strike Price +
Call
Premium
BEP
Strike Price -
Put
Premium
Concept 35 – Payoff of option and Break-even Price
PCPT

Option Valuation (To Risk Neutral Model

find fair price of Replication
option) Binomial Model
Approach
Black Scholes Model
Concept 37 – Methods of Option Valuation

Share price (or) Adjusted Share

Price
Can be used if
Put Call Parity Theory three out of Put Premium
Share + Put = Call + PV of EP four variables
are available Call Premium

EP discounted at risk-free rate

Note:
• Adjusted Share price [Share price - PV of Dividend] (or)
Share price
• Adjusted share price = Share price x e−yt ሺorሻ ሺ1+yሻ n

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Concept 38 – Put Call Parity Theory

Risk Neutral Model (Can Compute future Take P as Probability for

be used if we have 2 share price using upside price and (1-P) as
Judgement Price) FFP Formula probability for downside price

Future value of option = Weighted Discount future value

average of Intrinsic Value with of option to today by
probability being assigned weight discounting at Rf

Concept 39 – Risk Neutral Model

Binomial Model (2 prices Three month option and

Draw decision tree
but changes can happen change happens every
showing prices at
multiple times in option month (This will lead to 8
different levels
valuation period) Prices (2 x 2 x 2)

Compute upside
Value Decision tree Consider Time Value of
and downside
in reverse order as Money when we move
probability for any
weighted average of from one time period to
one period using
IV of branches another time period
Risk Neutral Model
Concept 40 – Binomial Model (European Option)

IV of immediate
exercise
American Option Can be exercised at Value of any node
(Binomial Mode) any time is hgiher of PV of future
exercise (weighted
average)
Concept 40 – Binomial Model (American Option)

Black Scholes Model

Time to Volatility Risk-free Exercise

Spot Price
expiry (SD) rate Price

No
Call (D) Call (D) Call (D) Call (D)
change

Put (I) Put (D) Put (D) Put (I)

Note:
• D = Direct Relationship; I = Inverse Relationship
Concept 41 – Black Scholes Model
Value of Call = S0 x N d1 − PVEP x N d2

S0 = CMP N d1 = Call Delta

Note:
• Put will be valued using PCPT after valuation of call
Concept 41 – Black Scholes Model

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Current Gap S0
between CMP NL
CMP
and EP
Expected Gap
Item 1 + Item 2 + Item 3 between CMP rt
D1 =
σ 𝑡 and EP

Half of 0.5 x Variance x t

D1 and variance
D2
Current Gap between
CMP and EP

Item 1 + Item 2 − Item 3

D2 = Expected Gap between
σ 𝑡 CMP and EP

Half of Variance

Concept 41 – Black Scholes Model

Positive D1 Prob > 0.50. If not add 0.50 to
Take values values the given values
Normal
distribution from Z table
Negative D1
values of D1 Prob < 0.50
Rules in taking values
and D2 Z values
1- Given
Prob to increase Positive D1
Prob
with increase in
D1 values 0.5 - Given
Negative D1
Prob
Concept 42 – How to Compute N(d1) and N(d2) Values
Replace spot price with Adjusted
Dividend in Rs. Spot Price (Spot Price - PV of
Dividend)
Replace spot price with Adjusted
Spot Price
SP
ASP = yt
e

Impact of Dividend in % Use ASP in

Dividends Item 1

For D1
Computation Replace r with
(one of two r-y
approaches)
Depends on
DY in case of Natural-log
fixed life assets 1 value given in
DY =
such as mine or Life question
patent
Note:
• Present value of Exercise Price will always be discounted at r and not with r-y. This is because
there is no impact of Dividend on EP
Concept 41 – Black Scholes Model

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Market price on expiry

EP prevails on
date would be equal to ATM Option GPO of 0
Maturity Date
Exercise Price
Concept 36 – Exercise Price Prevails on Maturity Date
Concept of Beta is used which
Futures
doesn't change frequently
Hedging of
Portfolio
Concept of Delta is used which
Options
changes frequently
Concept 43 – Delta Hedging

Change in Option Price

Call Option (Positive Delta) Change in share price

Delta N(d1) of BS Model

Put Option (Negative Delta) Call Delta - 1

Concept 43 – Delta Hedging
Delta of 0.4 would
mean 1 call = 0.4 Share Create equation for 2 JP and
Risk-less Hedge compute Rf on maturity date
Portfolio (based
on delta) 0.4 Share - Call =
Discount Rf to today value
Risk-free investment

Substitute today Rf value in today

price and get Call Premium
Concept 44 – Replication Approach of Option Valuation (Sub-Part of Binomial Model)

Company A raises
funds by issuing
shares (underlying
company)

Investor (Protection Bank B - Protection

Buyer) wants seller against risk of
protection against default by receiving
risk of default and premium
hence pays premium

CDS Contract Parties

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Protection buyer -
Pays Premium
Parties Involved
Protection Seller -
Receives Premium

Credit Default Premium Notional Amount x

Swap (Derivative Amount CDS Spread
instrument to
protect against the No default on
No Settlement
risk of default on debt Protection seller will
debt instrument) pay the loss in bond
value. Notional
Cash settlement Amount x (1 -
Recovery Rate)
Default on debt

Deliver default
Physical bonds to protection
Settlement seller and receive
face value of bonds

Note:
• Index CDS Comprises multiple securities; notional amount reduces when constituents default
Concept 45 – Credit Default Swaps
Profit for protection buyer =
Notional Amount x Change in
Increase in CDS Spread spread x Duration
indicates deterioration in
credit quality
Loss for protection buyer in case
CDS Spread of decrease in spread
(Premium)

CDS spread = Prof of

Prob of default (Hazard rate) = 1 -
default x (1 - Recovery
Prob of Survival
rate)
Concept 45 – Credit Default Swaps

Option Greeks

Delta Gamma Theta Rho Vega

Concept 46 – Option Greeks

Measures change Call has Positive Delta and Put has Negative Delta
in option price due
Delta
to change in price
of underlying asset Increase in price of underlying asset: Call Premium
will increase and Put Premium will decrease
Concept 46 – Option Greeks (Delta)

Gamma will be positive for both Call and

Changes in Delta Put Option
due to Changes in
Gamma
Price of
Call delta will increase (More positive)
underlying asset
and Put delta will increase (Lower
negative) with increase in price of asset
Concept 46 – Option Greeks (Gamma)
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Call and Put has negative Theta

Measures change in option
Theta price due to change in
number of days to expiry Both call and put premium will decrease with
one day decrease in time to expiration

Concept 46 – Option Greeks (Theta)

Change in Call and Call has Positive Rho and Put has Negative Rho
Put Premium due to
Rho
change in risk-free Call premium will increase with incresae in Rf and
interest rates Put premium will decrease with increase in Rf
Concept 46 – Option Greeks (Rho)

Call and Put option has Positive Vega

Change in call and
Vega put premium due to
increase in volatility Increase in volatility will lead to increase
in call and put premium
Concept 46 – Option Greeks (Vega)

Chooser Compound
Exotic Options Barrier Option Binary Option
Option Option

Bermuda Lookback
Asian Option Basket Option Spread Option
Option Option

Concept 47 – Exotic Options

Give a choice to the holder to

Chooser To be decided on a specific date
choose the option to be a call
Option during the life of the option
option or Put option
Concept 47 – Chooser Option
Gives a choice to the option
Original option can be a call
Compound holder to buy another call or
option and the second option
Option put option by paying a specific
can be a call or put option
premium
Concept 47 – Compound Option

Contract will get activated only

Barrier Price not reached - no check on
if the price reaches a specific
Option exercise on maturity date
price
Concept 47 – Chooser Option
Specific payoff if the option is
Binary exercised (Not the difference Zero payoff if the option is not
Option between exercise price and exercised
CMP)
Concept 47 – Binary Option

Payoff is computed by comparing the average

Asian
price of the underlying asset during contract
Option
with the strike price

Concept 47 – Asian Option

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Can be exercised on multiple

Bermuda Between American Option and
specific dates (like month end)
Option European Option
during life of contract
Concept 47 – Bermuda Option
Call option and Put option on
Option contract where
Basket basket can be taken where
underlying asset is a portfolio
Options strike price is compared with
of assets
value of portfolio
Concept 47 – Basket Option
Call and Put option on spread
Underlying asset is the
Spread can be taken where strike price
difference in prices of two
Option is compared with the actual
underlying assets
spread in prices of 2 shares
Concept 47 – Spread Option

Strike price of call option =

Strike Price is not pre-decided in Minimum price
Look Back this option and can be taken as the
Option most favorable price during the life
of the contract Strike price of Put option =
Maximum Price
Concept 47 – Look Back Option

CDO needs
ICICI Bank (Has
money to pay
loan book of
ICICI bank
Rs.2,000 Cr)

Returns CDO issues

income to securities to
Gets money
Needs the investor investors
from CDO
money
today

Earns money
on underlying
Transfers loan Book Collects money
Loan book and passes to
to CDO ICICI bank

Concept 48 – CDO

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Cash Flow Transfer of actual loan book to CDO

CDO and receipt of money from CDO

CDO does not raise

money from
Unfunded
investor and issues
CDS
No transfer
of loan but
Synthetic protection
CDO raises full
Types of CDO against Fully
money from investor
CDO default with Funded
through CLN
CDS
CDO raises part
Partially
money from
Funded
investor

Arbitrage CDO invests in Earn higher income on assets

CDO mispriced assets and pay lower cost on liabilities

Concept 48 – CDO

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Chapter 10 – Foreign Exchange Exposure and Risk Management

Price Currency and

Product Currency

Exchange Rate: Rate at which Price currency: First Product currency:

two currencies are exchanged currency in the quote. INR Second currency in the
with each other. Rs.82/USD is in the example of quote. USD in the
the ER between INR and USD INR/USD example of INR/USD
Concept 1 – Price Currency And Product Currency
Direct Quote: Home
Example: INR per USD
Currency per unit of
in India
Foreign Currency.
Direct Quote and
Indirect Quote
Indirect Quote: Foreign
Example: INR per USD
Currency per unit of
in USA
Home Currency
Concept 2 – Direct Quote and Indirect Quote
Two-way Quote [INR 91.50 - 91.90 per USD]

Bid Rate Ask Rate Middle Rate Spread Rate

Rate at Profit of the Spread %

Rate at which Average of bank
which banker sells Bid and Ask (Difference
banker buys product Rate between % of Bid % of Ask
product currency Ask Rate Rate Rate
currency (USD) and Bid
(USD) Rate)
Rs.91.70 0.40 0.40
Rs.91.90 per USD 𝑥 100 𝑥 100
91.50 91.90
Rs.91.50 per USD Rs.0.40 = 0.437% = 0.435%
per USD per USD

Concept 3 – Two-way Quotes

Quote = 67.20 PIPS = 20

Two-way Quote PIPS for Bid is 20 and

= 67.20 - 67.80 Pips for Ask is 80

67.20 - 67.80
Numbers before For the Ask rate number
will be written
two-way quote before decimal is not
as 67.20-80 in
PIPS (Number is same repeated
question
after decimals
in Quote)
Pips numbers Those numbers
are same at bid are not repeated
and ask in Ask rate 12.315 - 70 will be
mentioned as quote
in question
PIPS for Bid is
12.315 - 12.370 315 and Pips for
Ask is 370 70 will be taken as
last two decimals of
the Ask Rate
Concept 4 - PIPS

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Direct quote = Direct quote = Rs.50-51/USD

Rs.50/USD
USD 1 USD 1
BID = ASK =
Indirect quote = Inverse of INR INR INR INR
ASK USD BID USD
Direct Quote = 1/50 = USD
0.02 per INR

USD 1 USD 1
BID = = 0.0196 ASK = = 0.020
INR 51 INR 50
Concept 5 – Direct to Indirect Quote

Quotes Interpretation

1 USD = INR/USD USD/INR USD quote INR quote

Rs.80 80 80 in India = in USA =
80 80

INR 80 INR 80 per INR 80 Interpreted

per USD USD per USD based on INR 80 per INR 80 per
practical USD - USD -
ER and one Interpreted Interpreted
INR cannot based on based on
be 80 USD practical ER practical ER

Concept 14 – Interpretation of Quotes

0.58 INR per 48.94 INR per 54.27 INR per 60.48 INR per 64.73 INR per
JPY NZD AUD CAD SGD

87.47 INR per 90.76 INR per 96.77 INR per 109.98 INR per
USD EUR CHF GBP
Concept 8 – Commonly Used Currencies (will Help in Interpretation of Quotes as per Concept 14)
Cross Rate (Cross Multiplication) to get third
quote using two quotes

One Apple = Rs.10; One Orange = Rs.5 INR per USD = Rs.80; INR per GBP =
Hence ER between Apple and Orange is 2 Rs.100
Oranges per Apple

GBP GBP INR 1

= x = x 80 = 0.80 GBP per USD
Orange Orange INR 1 USD INR USD 100
= x = x 100 = 2
Apple INR Apple 5
A A B A A B
Bid ( ) = Bid ( ) x Bid ( ) Ask ( ) = Ask ( ) x Ask ( )
C B C C B C
Concept 9 – Cross Rates
This would mean we need to find
the rate for INR and hence INR is
Likely rate of one product currency
Likely rate of INR
currency against
against USD
another currency
Hence we should compute USD per
INR rate

Concept 13 – Likely rate of one currency against another currency

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KC = Amount is known in one

Step 1 - Identify currency = 10,00,000 USD (BUY)
known and unknown
component UKC = Amount to be computed in
other currency = ? INR (SELL)

UKC
Step 2 - Write the base UKC = KC x
KC
formula to compute
UKC currency INR
INR = 10,00,000 USD x
USD

Steps to solve Bank will buy at bid rate

Problems
Find what is bank
doing with the Bank will sell at Ask rate
denominator currency
mentioned in Step 2
formula In our examples we are buying
USD (deonominator currency) and
bank is selling it. Hence Ask Rate

INR
INR = 10,00,000 USD x ASK
Step 4 - Expand USD
formula to compute
the amount in UKC Use Concept of Cross Rate to
expand quote if needed

Concept 10 – Steps to solve basic problems (Let us assume we are planning to buy 10,00,000 USD and want
to pay for the same in INR)

Exchange Margin (Extra Profit of Bank]

Profit of Bank = EM is subtracted from bid rate Merchant rate

Ask Rate - Bid (reduced bid rate) and added vs Inter-bank
Rate to ask rate (increased ask rate) rate

MR = Rate for customers IBR = Rate for dealing

= After adding or between bank = No EM to
subtracting EM be considered
Concept 11 – Exchange Margin (EM)

EM Application in cross rates

Apply in one quote

Get final rate doing cross-multiplication Both approach will
while expanding
and apply it on the final rate give same answer
cross rate

Preferably one which has One exception is triangular

INR in quote arbitrage

Concept 11 – Exchange Margin (EM)

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Buying rate = Understood as Banker's buying rate

(BID Rate)
EM on buying rate and selling
rate (different %)
Selling rate = Understood as Banker's selling rate
(ASK Rate)
Concept 11 – Exchange Margin (EM)
EM Application on BID
(INR/USD)

INR/USD rate given is 60- USD/INR rate is given as USD

62 and 1% is EM. We deduct 0.01613-0.01667/INR. Two
it from 60 (BID rate) and we Approaches to Apply EM and both
get INR 59.40/USD will give slight variation in answer

INR 1 INR 1
BID = BID =
USD USD USD
USD ASK
ASK INR INR
1 INR 1 INR
= = BID = 60.00 = = BID
0.01667 USD 0.01667 + 1% USD
= 59.39

Deduct 1% from bid rate In this case we have added

of 60 and get INR to Ask rate (USD/INR) (and
59.40/USD then did conversion
Concept 11 – Exchange Margin (EM)
Doing opposite of original
transaction and computing the
profit/loss in the transaction
If the transaction one was
Cover Transaction purchase of USD; cover
transaction would be sale of USD Should be converted into INR
/Squaring up of if the question has information
position to convert the loss into INR
Profit or loss =
Sale proceeds - Profit or Loss is
Purchase cost computed in non- In case of loss we have to
INR currency. purchase 5,000 USD and
Example: Loss of convert into INR
5,000 USD
In case of profit we will sell
5,000 USD and convert into
INR

Convert 12 – Cover Rate

We normally see what customer is doing
How BID or and what is the bank doing and based on
ASK rate is that we decide the bid BID Rate and ASK
determined Rate
when one For Example SBI is
bank is In this case the banker initiating the initating the transaction
dealing with transaction is considered as customer and SBI buys 10,000
another bank and the other bank is considered as USD. The other bank is
bank for finding BID and ASK Rate selling USD and they
will sell at ASK Rate
Concept 12 – Cover Rate

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Appreciation of (1+HCR) = (1+FCR) x

Foreign Currency (1+Appreciation % of FC)
Return in Foreign
Currency
Depreciation of (1+HCR) = (1+FCR) x (1-
Foreign Currency Depreciation % of FC)

Concept 6 – Return in Foreign Currency (One Way Quote)

Convert all values into single
currency (FC) and compute
Return in Formula cannot be used to return
Foreign compute foreign currency
Currency return Convert all values into single
currency (HC) and compute
return
Concept 7 – Return in Foreign Currency (Two Way Quotes)

Can be used to compute

forward rate if outright
forward rate is not given

Spot rate 60.50 - 60.90. 15/25 will be

Swap points can
interpreted as last two decimals of
Swap Points be in ascending
0.15/0.25. Post addition the forward
[Difference order 15/25
rate is 60.65-61.15
between spot
rate and Spot rate 60.50 - 60.90. 25/15 will be
Swap points can
forward rate] interpreted as last two decimals of
be in descending
0.25/0.15. Post subtraction the forward
order 25/15
rate is 60.25-60.75
Swap premium would mean higher
Swap premium in forward rate and would be added to
descending order spot rate despite the premium in
ascending order
Concept 15 – Swap Points

Appreciation/Depreciation of Price
currency and Product Currency

% is to be
Product Price Computed
computed
Currency Currency % is
for

FR − SR 12 Convert the Bid Ask

x x 100 Rate Rate
SR m quote. Hence
price
currency will
If question become
asks to product
compute on currency and Positive: Negative:
average rate apply same Currency is Currency is
formula appreciating depreciating
Denominator or becoming or becoming
will be expensive cheaper
average of FR
and SR

Concept 17 - Appreciation/Depreciation of Price Currency and Product Currency

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Forward Rate computation using Premium/Discount %

Given for Given for 6-month premium of

Product price 3% would mean
Currency currency direct 3% for 6-month
and not yearly rate
Add Deduct Convert the Apply
Premium discount quote. So that premium % 6-month premium of
% to spot % from price currency and discount 3% per annum would
rate spot rate becomes % now on the mean 3% for year and
product convereted it will become 1.5%
currency quote for 6-months

Concept 18 - Appreciation/Depreciation percentage direct application for Product Currency

Swap Points for Broken Period

Swap points are available Interpolation technique can be used use to find swap points for
for 1 month and 3 1.5 months, 2 months, 2.5 months (basically any period between
months 1 and 3 month)

Concept 16 – Swap Points for Broken Period through Interpolation Technique

1 + R h F1 F1 = Forward Rate
=
1 + R f e0
e0 = Spot Rate

IRPT (Helps in Rh = Price currency risk-free rate (First currency in quote)

forecasting of
Exchange Rate) Rf = Product currency risk-free rate (second currency in Quote)

Rh and Rf should be For 6-month FR we need to

for the period we use proportionate 6-month Rh
compute FR and 6-month Rf
Concept 21 - IRPT
Currency having higher interest
rates will lead to depreciation of Product
that currency Appreciation
IRPT - Link currency has
of Product
with Interest lower interest
Implied differential in currency
Rates interest rates = rate
Appreciation/Depreciation
of product currency Depreciation of Product
Product currency has
currency higher interest
rate
Concept 22 – IRPT – Link with Interest Rates
1 + Ih F1 F1 = Forward Rate
=
1 + I f e0
e0 = Spot Rate

PPT (Helps in Ih = Price currency inflation (First currency in quote)

forecasting of
If = Product currency inflation (second currency in Quote)
Exchange Rate)
Ih and If should be For 6-month FR we need to
for the period we use proportionate 6-month Ih
compute FR and 6-month If

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Concept 23 – PPT/Law of One Price
Space Arbitrage (Buying in one Bank and
selling in other Bank to earn risk-less profit)

ER quoted Buy from Sell to the Profit = Sale

If result is positive,
from the bank bank having proceeds -
then arbitrage
multiple having the the highest Purchase
opportunity exist
banks lowest Ask Bid rate cost
Rate
Concept 24 - Space Arbitrage [Buy in one Market and Sell in another Market]

Space Arbitrage [Direct Quote and Indirect Quote]

Let us assume To check arbitrage opportunity Buy at Compute

Bank A gives we should convert the ER into lowest Ask profit and
INR/JPY ER and common form for both banks Rate and check
Bank B gives [Either INR/JPY or JPY/INR] sell at arbitrage
JPY/INR ER highest Bid opportunity
rate
Concept 25 - Space Arbitrage [Direct Quote and Indirect Quote]

Covered Interest Rate Arbitrage (OR) Time Arbitrage

Compute Fair Forward Rate using IRPT and compare with

Actual Forward Rate

FFR > AFR FFR = AFR FFR < AFR

Borrow in Product currency Borrow in Price currency and

No arbitrage
and invest in price currency invest in Product currency
Concept 26 – Covered Interest Rate Arbitrage
Borrow in price or product currency

Convert the same into other currency

Day 0 Steps
Invest the converted amount

Enter into FC to re-convert this amount into other currency

Arbitrage
Steps
Redeem investment along with interest

Convert this back at forward rate

Maturity Steps
Repay loan with interest

Gain = FD maturity - Loans repaid

Concept 26 – Covered Interest Rate Arbitrage

Option 1 - Borrow in price

currency and invest in
Covered Interest FFR and AFR comparison product currency
Rate Arbirage will not help in deciding
(with two-way arbitrage. Hence trial and
quotes) error method Option 2 - Borrow in
product currency and invest
in price currency
Concept 26 – Covered Interest Rate Arbitrage
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Triangular Arbitrage (Arbitrage with

three exchange quotes)

Let us Find the starting Arbitrage gain

Two ways of rotating
assume currency we have is confirmed if
the USD money and
we have (let us assume ending amount
going back to USD
USD) is higher than
starting amount
USD to USD to
GBP to INR to Exchange
INR to GBP to margin is to
INR INR USD
USD USD applied on
50/USD 80/GBP 1.65/GBP
every quote or
conversion
Concept 27 – Triangular Arbitrage
Forex Risk Management Techniques

Leading Money Currency

Currency Forward Currency
Netting and Market futures &
Invoicing Contract swaps
Lagging Hedge options
Concept 28 – Forex Risk Management Techniques

Currency Invoicing - Elimination of Exchange Risk

Transfers the risk to Export billing Accept Import Insistence of home

counterparty by in INR by billing in INR currency invoicing
doing our home Indian by Indian can lead to loss of
currency invoicing Exporter Importer business
Concept 29 - Currency Invoicing – Elimination of Exchange Risk

Currency Invoicing - Non-elimination of Exchange Rate

Export billing Import billing

If multiple options If multiple options

Bill in exist then bill in most Bill in
appreciating depreciating exist then bill in most
appreciating currency depreciating currency
currency (or) least depreciating currency
(or) least appreciating
currency currency

Concept 30 - Currency Invoicing – Non-elimination but deciding on the currency

Currency invoicing - Let

Conversion can be done
us assume we have
at bid rate (or) ask rate This depends on
done exports of USD
(or) middle rate negotiation between
10,00,000 and want to
(Depends on buyer and seller
convert the same into
assumption)
INR for INR billing

Concept 31 – Currency Invoicing – Conversion of Quote from one currency to another currency

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Option 1 - Lead - Collect money today

or pay money today
Option 2 - Lag - Collect money later
or pay money later Take borrowing
interest rate if
Leading and cash deficit
Option 1 and option 2 Cash
Lagging
flows cannot be compared
due to different time period.
What interest
Hence interest needs to be Take
rate to take
added to option 1 CF to investment
make them comparable to interest rate if
option 2 CF cash surplus
Concept 32 – Leading and Lagging
Company wants to export Importer asked to Financial Impact Item: LC
something - however submit letter of credit given by banker by taking
worried about payment from banker LC commission on day 0
Financial impact item: Interest Importer makes If importer doesn't make payment,
cost on LC commission to be payment of the invoice importer's bank will make payment
considered in our analysis amount on due date and recover from importer
Concept 32 – Leading and Lagging (Letter of Credit)

Netting (Dues receivables are set-off against

dues payables and net amount is settled)

Bilateral Netting Multilateral Netting

Involves two parties Involves more than 2 parties

Needs to be applied first Applied after bilateral Netting

Concept 33 – Netting

Netting in Cash Management

Centralized cash Independent cash

Benefit of netting
management management

Surplus/deficit of each Surplus/deficit of each Difference between net

company in group is netted company is amount on last day
and invested/borrowed at invested/borrowed between option 1 and
corporate level individually option 2

Concept 33 – Utility of Netting in Cash Management

Inflow in FC is higher
Contract to buy than expected inflow if
or sell specific Enter into hedging is not done
Forward
currency at a forward
Contract Outflow in FC is
specified rate on contract if
future date lower than expected
inflow if hedging is
not done
Concept 34 – Forward Contract

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Hedging rate + Upfront Premium +

Payable
Interest on Premium
Cover Rate (effective
payment/realization in FC)
Hedging rate - Upfront Premium -
Receivable
Interest on Premium
Concept 35 – Cover Rate in Forward Contract

Profit or loss in FC [Compare Outflow in no hedge scenario -

Payable
cash flow in FC with the outflow in FC
Notional Cash flow (what
could have been) if hedging Inflow in FC- Inflow in no hedge
was not done] Receivable
scenario
Concept 35 – Cover Rate in Forward Contract

Hedging Compare cash flow at bille date (spot rate)

through FC with cash flow under Forward Contract
Expected Loss
Compare cash flow at bille date (spot rate)
No hedging with cash flow at expected spot rate if
hedging is not done
Concept 36 – Expected Loss with and Without Hedging
S1 - On Due Date

Honour S2 - Before Due Date

S3 - After Due date

S4 - On due date
Closure of
Forward Cancellation S5 - Before due date
Contract
S6 - After due date

S7 - On due date

Extension S8 - Before due date

S9 - After due date

Concept 38 – Closure of Forward Contract
Closure of Forward Contract

S1 - No extra S3, S6 and S4 and S5 - S7 and S8 -

computation and S2 - Refer
S9 - Refer Compute Compute
exchange of Concept
Concept cancellation cancellation
currencies will 39
40 loss loss and enter
happen at agreed into new
rate contract
(effective loss
also to be
computed)
Concept 38 – Closure of Forward Contract
Format for computation of Cancellation Gain or loss:
Date Position Action Reference Date Rate
Original date Original Position Buy (ASK) December 31 -68.00
December 31 Opposite Position Sell (BID) December 31 66.50
December 31 New Position Buy (ASK) March 31 -66.00

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Effective rate (Addition of three rates) -67.50
Loss on cancellation per USD (compare 1 with 2) -68.00 + 66.50 -1.50
Total loss on cancellation -1.50 x 1,00,000 -1,50,000
Effective gain per USD (Compare 1 with 4) -67.50 – (-68.00) 0.50
Total effective gain/loss 0.50 x 1,00,000 50,000
Buy if we are buying the product
Original
currency and sell if we are selling the
Position
product currency

Opposite Opposite of Original Position to compute

Position Profit or loss

Refers to the date for which the contract was

Items impacting Reference
entered. Reference date should remain same
cancellation loss Date
for original position and opposite position

Positive rate if it is sell position and

Rate
Negative rate if it is buy position

Flat Fixed amount to be recovered on

cancellation cancellation. Will be added to
charges cancellation loss
Concept 38 – Closure of Forward Contract

Cancellation Comparison of original rate and opposite

Gain or loss rate
Types of Loss
Effective gain Comparison of original rate with effective
or loss rate (addition of three rates)
Concept 38 – Closure of Forward Contract
Customer Does Not Apppear
on Due Date

Banker (let us FEDAI rules SBI's contract Leads to ER

assume SBI) allow for 3 with another risk for SBI
normally does days Grace bank (ICICI) and hence as
back to back Period to will cancel on per FEDAI
contract to customer (let due date. rules SBI will
ensure he us assume However ABC enter into the
makes fixed ABC Limited) contract still next available
margin. to decide on has grace contract to
performance period protect for the
grace period
Customer ICICI Mar 31 -
Mar 31 -
contract = Contract = Customer
ICICI
Jan 1 to Jan 1 to contract is Apr 30 - Mar 31 to
contract is
Mar 31 Mar 31 still live Next Grace period
cancelled
ICICI - Customer
contract is contract is
taken live
Concept 40 – Forward Contract – Customer does not appear on Due Date
Auto-cancelled on third
day in absence of
When is contract instruction
cancelled in case
of no instructions Even if customer tells to honour
Cancelled on the day
the contract, it will be first
customer gives instruction if
cancelled and then honour will
3 days grace is not over
happen at spot rate
Concept 40 – Forward Contract – Customer does not appear on Due Date

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Date on which customer gives

instruction (or) 3rd day after
Cancellation rate original date
(ER margin to be
computed) Cancellation loss is calculated by
comparing original rate and
cancellation rate
Cancellation loss - Not seperately
Banker loss Comparison of recovered from
Charges for (Due to original rate and customer as it is sub-
S3 (or) S6 swapping of cancellation rate part of effective loss
(or) S9 contract) - No Swap loss -
ER margin to Comparison of Recovered from
be cosidered original rate and customer
effective rate
Interest cost on
Interest cost cancellation loss of bank For 3 days or date
on outlay of (as the recovery of this is of cancellation
funds delayed but SBI has whichever is later
already paid to ICICI)
Note:
In any of the above cases, if there is a profit for the bank, the same may not be passed on to the customer by
the bank

Concept 40 – Forward Contract – Customer does not appear on Due Date

Swap loss of Compare effective rate with original rate

customer and recover the same from customer

Realization at
Honour Before Inflow or outflow computed at spot rate
spot rate
Due Date
(Surprise to the Net outflow for
banker as bank - Interest
Assume customer
performance is charged for the
Interest realization happens
happening number of days
outflow/ at original spot rate
before due date) of early delivery
inflow of (debatable item)
customer and then we sell the Net inflow for
(Not fully USD received in bank - Interest
logical) spot market at spot paid for the
rate number of days
of early delivery
Concept 39 – Honour Before Due Date [Above analysis is for exporter – Opposite will happen for
importer]
Add Interest income (or) interest
Do early honour and
saving from the date of early
compute net inflow
honour to the original due date
as per the above table
and compute total inflow
Lead and Lag
Analysis with Early
honour Do honour as per the original due date and
calculate total inflow

Choose the option which leads to higher inflow

Concept 39 – Lead vs Lag Analysis in relation with honour before due date:

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Saving in outflow
Amount of cash
Time value due to cash
discount x ER on
Time value of Component discount earned on
due date
Money and early payment
Currency
Fluctuation Increase/ decrease
(Payment post
Component Currency in otuflow due to
discount) x [ER on
Flctuation appreciation or
due date - ER on
Component depreciation of
date of payment]
currency
Concept 42 – Time Value and Currency Fluctuation Component
Prepare income statement
Compute Select this if it
if realization happens for
Decision on contribution has better
all currencies at forward
hedging based to sales ratio ratio
rate
on average
contribution to Prepare income statement
Compute Select this if it
sales ratio if realization happens at
contribution has better
expected spot rate for all
to sales ratio ratio
currencies on maturity
Concept 41 - Decision on hedging based on average contribution to sales ratio

Relevant Forward Contract Rate with transit period

Let us assume a bill has due date of 60 days and shipment period
is 20 days. Money will be realized in 80 days

Take forward contract of 2 Interest cost would also be computed in case company
months (80 days rounded off to has taken loan to fund the post-shipment credit
2 months)
[Illogical part]
Interest cost = Bill realized in non-EEFC Account x ER
as per FC date x Rate of interest x (No of days/365)

Concept 37 – Relevant Forward Contract Rate

Take a USD
Money is
Receivable loan on day 0 Convert USD
realized in
of USD which will loan into INR
INR on
1,00,000 mature to USD and create FD
Money maturity date
1,00,000
Market
Hedge Create a USD
Money is
Payable of deposit on day Take INR loan
repaid in INR
USD 0 which will to create USD
on maturity
1,00,000 mature to USD deposit
date
1,00,000
Concept 43 – Money Market Hedge
USD Receivable USD Payable
Liability Amount Asset Amount Liability Amount Asset Amount
Matching USD Debtors USD Creditors USD Matching USD
Loan 97,000 1,00,000 1,00,000 Deposit 98,000
Deposit INR Loan INR
68,50,000 69,40,000
Concept 43 – Money Market Hedge (Balance Sheet Format)

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Profit as per spot rate

Variation in profit
Transaction - Profit as per
due to change in
Exposure expected spot/
exchange rates
forward rate
Types of
Exposure Profit as per spot
Variation in profit rates - revised profits
Operating due to change in as per spot rates (No
exposure operating conditions change in ER but
(SP/ cost/ units) change in
SP/CP/units)
Concept 44 – Transaction Exposure and Operating Exposure

Measures change in Change in units sold =

Price Elasticity of
units sold due to Change in SP x Elasticity
demand
change in selling price of demand
Concept 44 – Transaction Exposure and Operating Exposure

Types of Bank Accounts

Nostro Account Vostro Account Loro Account

Our Account with you Your Account with us Interim account where a
bank remits fund in foreign
currency to another bank
ICICI Bank having USD CITI Bank USA having INR for credit to third bank
account with Citi Bank USA account with ICICI Bank
India
Concept 45 – Types of Bank Accounts

Exchange Position vs Cash Position [Analysis from Banker Point of View]

Measures the extent of risk a bank carries on account of the foreign currency

Cash Position Exchange Position

Reflects the actual foreign currency balance Considers actual balance along with forward
in the bank account purchase or sale of foreign currency
Concept 46 – Exchange Position vs Cash Position
Format for Recording Exchange Position: Format for Recording Cash Position:
Particulars Purchase/Inflow Sales/Outflow Particulars Receipt/Inflow Payment/Outflow

Note: It records all transactions whether cash flow Note: It records all transactions when cash flow
happens or not happens
Purchase of bill, Cancellation of demand draft, spot
purchase, DD Purchase, Purchase of cheques not
Purchase
credited to account, outstanding forward purchases,
Exchange bills purchased in hand but not due for
Position Forward sales, cancellation of forward purchase,
Remittance by TT, Sold forward TT, outstanding
Sale
forward sales, DD issued but not yet presented for
payment
Concept 46 – Exchange Position vs Cash Position

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Spot Purchase, Settlement of earlier

Inflow forward purchase, settlement of earlier
bill purchase
Cash
Position
Spot sales, remittance by TT, settlement
Outflow of earlier forward sales, settlement of
demand draft

Concept 46 – Exchange Position vs Cash Position

Cash First this is to be balanced and we should do spot
Position purchase/sale to get the target balance in cash position
Maintenance
of desired Above transaction to balance cash position will also be
balance recorded in exchange position
Exchange
Position
Now we do forward purchase/sale to get the desired
overbought or oversold position in exchange position
Concept 47 - Exchange Position vs Cash Position – Maintenance of Desired Balance

Currency Futures

Format for number of Exposure currency vs

Format for net settlement
contracts contract currency
Concept 48 – Currency Futures
Format for Number of Contracts Format for computing Net Settlement
Particulars Amount Date Position Action Ref Date Rate
Amount of Exposure Day 0 Original Buy Jan 31 (1.50 USD/GBP)
Size of one contract Jan 31 Opposite Sell Jan 31 1.47 USD/GBP
Number of contracts Profit per GBP 0.02 USD/GBP
Action Taken Profit for 16,000 contracts (0.02 x 62.50 x 16,000) USD 20,000

Net cash flow Payment at spot rate (outflow) (or) receipt at spot rate (inflow)
in futures (or)
NDF (Non- Net settlement (can be inflow (profit) or outflow (loss))
deliverable
Margin money is a refundable deposit and the
Forward Interest on margin
same is returned back. Hence only interest on
contract) money (outflow)
margin money considered as outflow
Concept 48 – Currency Futures
Buy if we are buying the product currency of
the quote [Don't look at import or export and
Buy
decide - just see what is being done with
How to decide product currency]
original position
Sell if we are selling the product currency of the
Sell
quote
Concept 48 – Currency Futures

Exact date if Closest available live

Which contract to
available for contract if exact contract
take for hedging?
hedging is not available

We want to hedge for Mar 15 We cannot take Mar We will take Mar 31 contract
and we have Mar 10, Mar 31 10 contract as it will as the same is the closest
and Apr 30 not be live on Mar 15 available live contract
Concept 48 – Currency Futures

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Call if we are buying the product currency of
the quote [Don't look at import or export and
Call
decide - just see what is being done with
Which option to product currency]
take?
Put if we are selling the product currency of the
Put
quote
Concept 49 – Forex Options

Maximum outflow Max Purchase Price = Strike Rate + Call Premium +

Call
(Call) and Interest on Call Premium
Minimum inflow
(Put) Min Selling Price = Strike Rate - Put Premium -
Put
Interest on Put Premium
Concept 49 – Forex Options
Interest at borrowing rate
Premium is paid on day 0 and (cash deficit)
settlement of option happens on
Why interest on Interest at investment rate
maturity date. Hence interest is
Premium? (Cash surplus)
considered to give effect to
Time Value of Money Ignore if no information on
interest available
Concept 49 – Forex Options
Hedged component - Outflow
at spot rate or strike rate
This happens if we get Can be paid at forward rate
Total Unhedged component
contract in decimals or the future spot rate
outflow
Premium payment

Interest on premium
Note:
• Inflow = Hedged component inflow + Unhedged component inflow – Premium payment – Interest
on premium payment
Concept 49 – Forex Options
Invest the
Identify the amount Residual amount is the net
amount in
Most of currency needed gain and same should be
given
beneficial to get back the converted into common
currencies
investment original surplus + currency. One with max
and get the
currency cost of funds of that gain is the most beneficial
maturity
surplus investment currency
amount
Concept 50 – Investment Decision

Indfferent from return point of view

Same gain in
two currencies Consider risk angle. Investment in fixed income security would be
preferred to investment in equity
Concept 50 – Investment Decision
Bid Rate = 1.998 - 0.002 Realization using actual
Spot rate = 1.996 Exchange
spot rates - Realization
= 1.998 + exposure
using expected spot rates
0.002 Ask Rate = 1.998 + 0.002 risk
(forward rates)
= 2.000
Concept 52 – Other Key Points in Hedging Concept 52 – Other Key Points in Hedging

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Chapter 11– International Financial Management

Issue 1 in International Capital Budgeting = Some cash flows are in INR and
some are in non-INR

Use IRPT or PPT and forecast Convert all cash flows into a single
forward exchanges rates currency using forecasted ER

Concept 1 – Some Cash flows are in INR and some are in non-INR

Issue 2 - What discount rate to use?

INR cash flows at INR discount rate Non-INR cash flows at non-INR discount rate
Concept 2 – INR discount rate vs Non-INR discount rate
Compute risk premium of project and that remains same for
every currency
How to convert
discount rate from
(1+ Risky Rate) = (1 + Risk-free rate) x (1 + Risk Premium)
one currency to
another currency
Use this risk premium in another currency with different Rf
and get risky rate of other currency (discount rate)
Concept 2 – INR discount rate vs Non-INR discount rate

No (Expense of Charged on PAT

Issue 3 - With- company) and reduces CFAT
holding tax (Extra
Eligible for tax
expenditure and
credit Charged on PBT
would reduce
Yes (Not an and the same
inflow of project)
expense of the amount is reduced
company) from normal tax
payable on PBT
Concept 3 – With-holding Tax
With-holding
Lower of DTAA and Applicable with-holding tax rate
tax rate
Concept 4 – With-holding tax Rate
Conversion of NPV of one
Home currency NPV = Foreign currency NPV x Spot Exchange
currency to NPV of
Rate
another currency
Concept 5 – Home currency NPV and Foreign Currency NPV

Exchange Repatriated Consider as inflow

restrictions - cash flows of respective year
Restriction on
Cash flows are
repatriation of usually invested
cash flows from Non- Consider it as
and repatriated at
the project repatriated inflow in the year
end of project
cash flow of repatriation
along with some
interest income
Concept 6 – Impact of Exchange Restrictions

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Weighted average time

Average Loan Total interest expense for
period in which the loan is
Maturity (Similar entire tenor of loan = Loan
being repaid and can be
to Average Due Amount x Average Loan
used for easy computation
Date) maturity x Rate of Interest
of interest expense

Concept 7 – Concept of Average Loan Maturity

Debt x (1 - Tax Rate)

Weight of debt for
computation of liability In International
side beta Consider tax rate of
capital budgeting
the country in
Liability Beta = Asset two countries are
which loan is taken
Beta = Project Beta involved and we
for computing
may have 2
weight of debt
different tax rates

Concept 8 – Project Beta vs Equity Beta

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Chapter 12 – Interest Rate Risk Management

Interest Rate
Options

Interest Rate
Variation in cash flows due to Futures
Interest Rate Risk
changes in interest rates Forward Rate
Agreements

Interest Rate
Swaps
Concept 1 – Interest Rate Risk
Restrict maximum interest
Cap Similar to outflow
Option Call option Exercised if Act interest >
Strike Rate

Provides minimum interest

Floor Similar to income
option Put Option Exercised if Act interest <
Interest Rate Strike Rate
Options
Buy cap option
Collar
option
Sell Floor Options

Cap option for borrower

Interest Rate
Guarantee
Floor option for investor

Concept 2 – Interest Rate Options

Normal option vs Interest Rate Option

Normal Option Interest Rate Option

Strike Rate = Price of share Strike Rate = Interest Rate

Call Put Cap Floor

Concept 3 – Normal Options vs Interest Rate Options
Time
Call Option Amount x x ሺActual Rate − Strike Rateሻ
12
Settlement
Amount
Time
Floor Option Amount x x ሺActual Rate − Strike Rateሻ
12

Note:
• Settlement Amount is inflow for holder and outflow for writer
Concept 4 – Interest Rate Option (Settlement)

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Amount which we
Notional
intend to invest or
Amount
Terms Associated borrow Can be applicable for
with IRO the next period
Date on which
Reset Date
interest is being reset
Can be applicable for
the prior period
Concept 5 – Terms Associated with Interest Rate Options
Format for computation of Interest Outflow:
Reset Base No of Our Interest Premium Cap Floor Total
Date Rate days Borrowing paid Paid Receipt Payment Interest
rate (A) (B) (C) (D) (A+B-
C+D)

𝐓𝐨𝐭𝐚𝐥 𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐏𝐚𝐢𝐝 𝟑𝟔𝟓

𝐄𝐟𝐟𝐞𝐜𝐭𝐢𝐯𝐞 𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐑𝐚𝐭𝐞 = 𝐱 𝐱 𝟏𝟎𝟎
𝐋𝐨𝐚𝐧 𝐀𝐦𝐨𝐮𝐧𝐭 𝐍𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐝𝐚𝐲𝐬 𝐨𝐟 𝐥𝐨𝐚𝐧
Lump-Sum
Premium (One- Notional Amount x Lumpsum Premium %
time Payment)
Option
Premium
Amortized Lumpsum Premium
Premium for every PVAF Fixed rate, No of reset period
reset period
Concept 6 – Option Premium

Contracts in decimals
Used to fix future interest
rate - however final rate Basis Risk
may vary due to issues
with futures Mismatch in futures
settlement period and
loan duration

Interest Rate Interest rate is 7% (100 - 93)

3-month
Futures
futures of Settlement Amount will be
Rs.93 computed by multiplying with
3/12

Interest rate is 4% (100 - 96)

6-month
futures of Settlement amount will be
Rs.96 computed by multplying with
6/12
Concept 7 – Interest Rate Futures
Loan Duration = 6 Months; Need to borrow 50 Crores
How to tackle
mismatch loan Futures settlement period = 3 months
duration and futures
settlement period Loan Period
Position in Futures = Loan Amount x
Futures settlement Period

Concept 7 – Interest Rate Futures

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Step 1: Decide Amount to be Hedged

Amount to be hedged
Step 2: Compute No of Contracts =
Size of one contract
Steps in
IRF
Step 3: Computation of net settlement of IRF. Interest
received on investment - interest paid on borrowing

Step 4: Total Interest = Spot Interest + Net Settlement

Concept 8 – Steps in Interest Rate Futures

Expiry date of Mar 31

Today date: Mar 1, 2025:
3-month Mar futures Setlement amount would be computed
Futures
Settlement by multiplying with 3/12
Period vs
Expiry Date Expiry date of Apr 30
Today date: Mar 1, 2025;
6-Month Apr Futures Setlement amount would be computed
by multiplying with 6/12
Concept 8 - Steps in Interest Rate Futures

Exchange gives list of Inflow = Futures

Net Settlement eligible bonds which seller settlement Price x
(normal aproach) of IRF can buy and deliver to Conversion Factor
IRF the buyer of IRF
Settlement
Outflow = Quoted
Physical price of Bond
settlement (rare Profit of seller of IRF =
approach) Inflow - outflow
CTD bond = One
with max profit

Concept 9 – Cheapest to Deliver Bond (CTD Bond)

Like a forward contract but has net settlement

Forward Rate Borrowing period or lending period =

FRA 6 x 9
Agreement (FRA) Month 6 end to Month 9 end
Borrowing period or lending period =
FRA 3 x 9
End of Month 3 to End of Month 9
Concept 10 – Forward Rate Agreement (FRA)

Step1: Compute M
undiscounted net Contracted rate − Act Rate x Amount x
12
settlement
Steps in
FRA (FRA Step 2: Compute Step 1 Figure
borrower discounted net
(buyer) M
settlement 1 + Act Rate x
12
Step 3: Total interest cost = Interest paid on
spot borrowing + Net settlement
Note:
Total Interest Cost 12
Effective Interest Cost = x x 100
Loan Amount m
Concept 10 – Forward Rate Agreement (Steps for borrower – Opposite steps for lender)

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FVF for 6 Months This will be 3 (M6 - M3)

FRA 3 x 6 −1
FVF for 3 Months month rate and we need to
(Month)
annualize it

FVF for 9 Months This will be 6 (M9 - M3)

FRA Rate FRA 3 x 9 −1
FVF for 3 Months months rate and we need to
Computation (Month)
annualize it

FVF for 3 years This will be 2 (Y3 - Y1) years

FRA 1 x 3 −1
FVF for 1 Year rate and we need to annualize
(Year)
it

Concept 11 – Computation of FRA Rate

FRA Arbitrage (Let us assume we are

analyzing 3 x 6 FRA)

Step 1 - Compute Step 2: Compare FRA 6.50 - 6.75 would

Fair FRA rate as Actual FRA Rate mean deposit rate of 6.50
per Concept 11 with Fair FRA Rate and borrowing rate of 6.75

Actual borrowing Rate is Actual Investment rate is

lower than Fair Rate higher than Fair Rate

Borrow for 3 Months Invest for Invest for 3 Months

Borrow for
at spot rate + Borrow 6 months at spot rate + Invest
6 months
for 3 months at at spot for 3 months at
at spot rate
Actual FRA Rate rate Actual FRA Rate

Concept 12 – FRA and Arbitrage

Borrower Sell
IRF (Profit for buyer if rates
go down)
Investor Buy

Borrower Buy
Borrower/Investor FRA (Profit for buyer if rates
Action go up)
Investor Sell

Pays Fixed
Buyer
IRS (Profit for buyer if rates Rate
go up) Receives
Seller
Fixed Rate
Concept 13 – Borrower/Investor Action
Preferred if interest rates
Fixed Same interest rate during
are likely to increase
Rate tenor of loan
Interest (harden)
Rate Interest rate gets reset Preferred if interest rates
Floating
based on specific are likely to decrease
Rate
benchmark (soften)
Concept 14 (Types of Loans) and Concept 16 (Hardening and Softening of Interest Rates)

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IRS (Helps a borrower to convert fixed loan

into floating loan and vice versa)

Compute total Find ideal Ideal

Two interest of two
borrowers - A combination - combination
combinations One which is best.
Limited and
B Limited - has lower However
Both get A total interest companies
A (Fixed want other
quote of fixed (Floating
Rate) combination -
rate and Rate)
and B Hence we can
floating rate and B
(Floating use IRS in this
from bank (Fixed
Rate) case
Rate)

If companies want
ideal combination -
No scope for IRS

Concept 15 – Interest Rate Swap

Swap Structuring

Split of swap gain in Effective Borrowing

Benefit of Swap specific ratio between Rate for Comp A and
Comp A and Comp B Comp B

Difference in total Original Planned

If problem is silent,
interest of combination Borrowing Rate - Share
then it is split equally
1 and 2 of swap gain
Concept 15 – Interest Rate Swap
Swap Structuring without intermediary
Particulars Amount
1. Pay to banker as per ideal rate 8%
2. Company 1 Receipt from Company 2 (8%)
Receive from Company 2 what was paid to Bank
3. Company 1 Payment to Company 2 T + 0.3%
Pay our effective borrowing rate to the other company
4. Effective borrowing rate T + 0.3%

Swap Structuring with intermediary

Particulars Amount
1. Pay to banker as per ideal rate 8%
2. Company 1 Receipt from swap intermediary (8%)
Receive from swap intermediary what was paid to Bank
3. Company 1 Payment to swap intermediary T + 0.3%
Pay our effective borrowing rate to swap intermediary
4. Effective borrowing rate T + 0.3%

This would mean we can

Expectation Theory Holds
compute future interest rates
Good
using FRA formula

Concept 17 – Expectation Theory

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Locked in Spread = Income - cost

Company A has fixed cost loan and Company A has floating cost loan
floating income investment and fixed income investment

Convert fixed cost loan to floating Convert floating cost loan to fixed
rate loan using IRS rate loan using IRS

Concept 18 – Locked in Spread

Net settlement of fixed rate payer (Buyer of

IRS)= Floating receipt - Fixed Payment

Fixed Rate Payment Floating rate Receipt

(Same interest rate every (Changes every reset
reset period) period)

Same amount paid every No of days

reset period irrespective of Receipt = Amount x FR x
360 or 365
number of days

Computed on Denominator is to be Floating rate can

original amount - taken as 360 if swap have effect of interest
no impact of is valued on 30/360 on interest if interest
interest on interest days basis rate changes -
Considered mostly
in case of daily reset

Concept 19 – Fixed Payment vs Floating Payment [Net settlement computation of fixed rate payer –
opposite would happen for floating rate payer]

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Chapter 13 – Business Valuation

Measures overall company's

performance and management
effectiveness
Economic Value Added= Measure of
economic profit
Return generation in excess of the
cost of capital employed

Concept 1 – Economic Value Added

EBIT x (1 - Tax)
Item 1
EVA NOPAT
Computation = Invested capital =
Item 1 - Item 2 Capital Employed = It
Invested Capital
Item 2 should be based on
x WACC
economic value (or)
replacement cost basis
Concept 1 – Economic Value Added

MV of Firm = MV of equity + MV
of debt + MV of Preference
Market Value Market value of Firm
Added - Book value of Firm
BV of Firm = BV of equity (SC +
Reserves - Fictitious Assets) + BV
of Debt + BV of Preference
Concept 10 – Market value Added

Excess generation No impact on share

Dividend is Paid
EVA by the company price
Dividend per and can be enjoyed
share by equity Share price will
shareholders Dividend not paid increase by EVA
DPS
Concept 5 – EVA Dividend
Cost of equity (Mostly
given in question or
computed using Gordon
WACC (Cost of capital) = Model)
Weighted average cost of
Interest rate x (1 - Tax)
different forms of capital

Cost of debt
Interest x 1 − Tax
x 100
Value of debt

Format:
Source Cost Weight Product
Debt 10% 200 20
Equity 15% 400 60
Total 600 80
Concept 3 – Format for Computation of WACC

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Cost of debt given in question

Can be taken as pre-tax cost of debt (or post-tax cost

of debt

One check can be done before taking assumption

Interest
Compute
Debt

Check if compute number is closer to cost of debt

Yes - Treat given Cost of debt as pre-tax No - Treat given Cost of debt as post-tax

Concept 3 – Format for computation of WACC

PE Multiple of company = PE Multiple of Industry

Adjustment should be based on risk of

company

Risk can be measured through Debt/equity

ratio

High DE = High Risk = Low DE = Low Risk =

Low PE High PE
Concept 8 – PE Multiple Adjustment based on Risk
Increase CY Profit and deduct
depreciation on these items
Advertising, R&D, Staff Training -
Treated like an Asset and not an expense
Increase CE at end of year net of
depreciation

Concept 2 – EVA Adjustments

Add Accounting Depreciation and
deduct Economic Depreciation
Depreciation (We charge accounting
depreciation on book values but we need to
charge economic depreciation on real values) Adjust CE by adding back cumulative
accounting depreciation and deduct
cumulative economic depreciation

Concept 2 – EVA Adjustments

Add back to Profit

Non-Cash expenses (Like Provision for
Bad and Doubtful Debts)
Add Cumulative non-cash
expenses to Capital Employed

Concept 2 – EVA Adjustments

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Add back tax provision charged in P&L

Tax Charge
Deduct cash taxes paid

Concept 2 – EVA Adjustments

Tax Adjustment on EVA Computation

Cash taxes are deducted in NOPAT - However interest is not

subtracted but tax benefit is factored in cash taxes

Three ways of computing NOPAT and giving tax treatment

EBIT - Cash taxes - tax

EBIT x (1 - Tax Rate) PAT + Interest (1 - Tax)
saving lost on interest
Concept 7 – Tax Adjustment on PE Computation

EBIT
EBIT Computation using Financial FL =
Leverage PD
EBT −
1 − Tax

Concept 6 – Computation of EBIT using Financial Leverage

EVA = Excess value generated by the
company for the shareholders

Value of Firm = Present Capital employed +

PV of Future EVA
Concept 9 – Valuation of Firm on basis of EVA

Valuation Approaches

Cash flow Break-up Earnings

Relative FMP based Net assets
based value capitalization
Approach valuation method
valuation Approach method

Valuation Approaches
Free Cash flow to CF belonging to all long-term
Firm (FCFF) money providers
Types of Cash Flow
Free Cash flow to CF belonging only to equity
equity (FCFE) shareholder
Concept 11 – Cash Flow Based Approach of Valuation
FCFF (Preferred Discount at cost
Value of Firm
Approach) of capital
Valuation Approach
Discount at cost
FCFE Value of equity
of equity
Note:
• Approach 1 is preferred Approach and would give us value of Firm
• Value of equity = Value of Firm – Value of Debt
Concept 11 – Cash Flow Based Approach of Valuation

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PAT + Non-cash items + Interest x (1 - Tax) -

FCFF
Capital expenditure - working capital

Types of
Cash Flow FCFF - Interest x (1 - Tax) - Loans repaid + New
loans taken
FCFE
PAT + Non-cash items - Capital expenditure -
working capital - loans repaid + New loans taken

Concept 11 – Cash Flow Based Approach of Valuation

Gross Increase in Gross Add Depreciation and

Capex block deduct gross capex in CF
Types of Capex
Increase in net Deduct only net capex in
Net capex
block CF

Concept 12 – Gross Capex and Net Capex

Working capital

Increase in WC Decrease in WC Be cautious while computing WC

is outflow is inflow change with change in revenue growth

Concept 13 – Working Capital

Outflow in Consideration given
cash and other to liabilities
Initial outflow
Initial outflow of than cash on Sale value of assets
Acquisition - day 0 (except Fixed Assets)
In-between
Treated like a
flow
capital budgeting
problem Terminal
inflow
Concept 22 – Initial outflow of Acquisition (Cost of Acquisition)
Break-up value Approach (used in valuation of multi-business
company);
Value of company = Value of Business A + B +C

Business A Business B Business C

Value using Relevant Value using Relevant Value using Relevant

multiple multiple multiple
Concept 15 – Break-up value Approach
Relative Approach of Valuation (or)
Valuation of Multiple

Value of company = Relevant Basis x

Multiple

Example: Basis is sales and value Example: Basis is PAT and value is
is sales x (MV to sales Multiple) sales x (MV to PAT Multiple)
Concept 14 – Relative Approach of Valuation
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FM PBT = Existing profit + Extra-ordinary loss - extra-ordinary

income - Non-recurring income + Profit from new product

FMP based Future Maintainable PAT = Future Maintainable PBT x (1 - Tax

Valuation Rate)

FMP
Value of business =
Capitalization rate

Concept 16 – Future Maintainable Profits Approach of Valuation

FMP based Alternative Valuation

Compute EPS based on Value per share = EPS x PE

Future Maintainable PAT Multiple
Concept 16 – Future Maintainable Profits Approach of Valuation

Net Assets Method (similar to NAV computation of MF)

Contingent liability -
Compute Realizable value of Compute settlement May or may not
assets value of liabilities crystallize - has to be
assumed if silent
Realizable value of Assets − Settlement value of Liabilities
Value per share =
Number of shares
Concept 17 – Net Assets Method
CR = Given in
FMP Question
Value of company =
Capitalization rate EPS
Earnings CR =
Capitalization Share price
Method Value of company
Value per share =
No of shares

Concept 17 – Earnings Capitalization Method

Residual cash flow
NCF Approach =
Ke − G

SC + Reserves − Fict Assets

BV Approach =
No of shares

Valuation of share
Min Price = Lower of two approaches

Value of merged firm − Pre merger value of AC

Max Price =
No of shares

Floor value = CMP

Concept 18 – Net Cash Flow and Book Value Approach with Floor Value

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S1 - Compute wrong Cash flow

WACC using value Wrong WACC =
Value of firm
given in firm

S2 - Compute wrong weights used in WACC

Impact of wrong
WACC on valuation
S3 - Correct weights and get correct WACC

S4 - Get correct value of Cash flow

CV of firm =
firm Correct WACC

Concept 20 – Wrong WACC and Valuation

EBITDA
EV of company =
Capitalization rate
Earning value of company
and per share earning value
EV of company
Per share earning value =
No of shares

Concept 21 – Computation of Per share earning value (Not a logical item)

Funding required for
growth

% Growth in Funding needed CE= Fixed assets + Current assets -

revenues = % = New capital Operating current liabilities
Growth in employed -
Fixed assets Earlier capital Financial CL like short term
and NWC employed loan will not form part of WC
Concept 23 – Funding Required for Growth
Intrinsic value of
Intrinsic value of Firm + MV of Non-core assets - Value of debt
Equity

Concept 24 – Intrinsic value of equity (using SVA Approach)

Distress Companies - Companies which
are not able to meet fixed commitments

Operating issue Financing issue = Going concern

= Inability to Inability to meet assumption is not
meet fixed costs fixed interest valid

Leads to Cash flow adjusted DR adjusted

lower value downwards upwards

Concept 25 – Valuation of Distress Companies

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Distress Company Valuation

Method 1 = Method 2 = Liquidation Method 3 = Method 4 =

Modified value + Going Concern Adjusted Relative
Discounted Value (OR) DCF Present Value Valuation
Cash flow valuation + Distress Approach Method
Approach Value
Concept 25 – Valuation of Distress Companies
Get values for various Value of company
Approach 1 -
scenarios such as = weighted
Scenario based
optimistic, pessimistic average of various
valuation
and most likely possible values
Valuation

Approach 2 - Cash Adjusted CF = Use adjusted CF

flow adjustment Normal CF x (1 - and value firm as
approach Prob of distress%) PV of adjusted CF

Concept 25 – Modified Discounted Cash Flow Approach

Going concern value = PV of

Multiply with Probability
future cash flows discounted
of Survival
Value is sum of at required return
two parts with
probability weights Liquidation value = Value
Multiply with Probability
realized if company is
of Distress
liquidated today

Concept 25 – Liquidation value + Going Concern Value (OR) DCF Valuation + Distress Value
Value of unlevered
firm = Discounting of
future cash flows at
Value = Value of cost of equity
unlevered firm + Irredeemable debt = Debt x Tax Rate
Tax Benefits - Tax benefits of debt
Bankruptcy Cost Redeemable debt = PV of tax saving at
pre-tax cost of debt

(GC value - Liquidation value) x

Bankruptcy cost
Probability of Distress
Concept 25 – APV Approach
Relative Valuation Approach - same as Concept 14

Value of company = Company is in distress and hence multiple

Relevant Basis x Multiple may have to be adjusted downwards
Concept 25 – Relative Valuation Approach

Valuation of Start-ups

Cost-to- Comparable Scorecard First Venture

Berkus
duplicate Transactions Valuation Chicago Capital
Approach
approach Method Method Method Method
Concept 26 – Valuation of Start-ups

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Value based on 5 success factors (Basic value, Technology,

Execution, Strategic realtionships and consequent sales)

Berkus Attach value to each factor and final value is sum of all
Approach factors

Caps pre-revenue valuation at USD 2 million and post-

revenue valuation at USD 2.5 Million
Concept 26 – Berkus Approach
Cost-to-duplicate Value = Sum of all costs and expenses associated with the
Approach start-up and its product development and physical assets

Concept 26 – Cost-to-duplicate Approach

Value based on comparable
transactions done in recent
Comparable times
Transactions
Method Value of our company = Basis Transaction can be adjusted
x Multiple of comparable upwards or downwards on
transaction the basis of risk
Concept 26 – Comparable Transactions Method
Comparison of our company with
another relevant peer on various
parameters (Team strength, size of
opportunity, product or service,
competitive environment, marketing)
Scorecard Better than peer = Score of
Valuation more than 100%
Put score on every parameter
Method Weaker then peer = Score of
Arrive at weighted average score of less than 100%
different parameters
Final value = Value of peer x
weighted average score
Concept 26 – Scorecard Valuation Method
Get values for various Value of company =
First Chicago
scenarios such as worst-case, weighted average of
Method
Normal-case and Best-case various possible values

Concept 26 – First Chicago Method

PAT x PE Multiple

Estimate the exit value of start- Amount invested x

up Multiple

Discount the exit value to today Based on perpetuity

Venture Capital
by using discount rate. This valuation
Method would be considered as post-
money valuation

Pre-money valuation = Post-

money valuation - Amount
invested today
Concept 26 – Venture Capital Method

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Top-down approach of
Income Approach estimation
(Discount income at
Digital Platforms Ke/WACC) Bottom-up approach of
(Online infrastructure estimation
which facilitates
transactions between
users) - Example - Market Approach EV to EBITDA (OR) Price to
(Valuation by multiples) sales (OR) Price to Book value
Search Engine, Market
Place
Value = Total cost of building
Cost Approach
the platform

Valuation of Digital Platforms

Professional/ Consultancy Firms (Example - CA
Firm)

Value = PV of future cash flows discounted at

required return

Make adjustment based on

KPI

Better KPI Performance = Higher Weaker KPI Performance =

valuation Lower Valuation
Valuation of Professional/Consultancy Firms
Environmental Factors

Social Factors
Impact of ESG
on Valuation
Governance Factors

To adjust these in cash flows or discount rate for valuation

Impact of ESG on Valuation

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Chapter 14 – Mergers, Acquisitions & Corporate Restructuring

Economies of scale,
Operating Synergies
improved market
(Improvement in cash
reach, lower
flow/PAT)
competition
Merger of company with
Financial Synergies
surplus cash with another
Why Merger? (Improvement in Cost of
company having high-
capital/ PE Multiple)
return projects

Empire Building,
Managerial self-interest Stronger
Management Team

Introduction
Concept 1 – Format for doing Merger Analysis
Particulars AC TC Merged company
PAT/EAES XXX XXX XXX
No of equity shares XXX XXX XXX
EPS [PAT/ No of shares] XXX XXX XXX
PE Multiple XXX XXX XXX
MPS [PAT x PE Multiple] XXX XXX XXX
No of equity shares XXX XXX XXX
Market value of firm [MPS x No of shares] XXX XXX XXX
Note:
• AC = Acquiring Company; TC = Target Company
• Market value of firm (real formula) = PAT x PE Multiple

Cash flow/PAT of
merger firm > Sum
of individual
Gain from Merger = companies)
Value of Merged
Arises due to the
Firm - (Pre-merger
following Post-merger
value of AC + Pre-
merger value of TC) PE/Cost of capital is
better than weighted
average of AC and
TC
Concept 2 – Gain from Merger
Cost of Merger (Consideration Paid
to TC)

Net Cost or
Gross Cost
True Cost

Stock offer Cash offer Gross cost - Pre-merger

value of TC
No of shares issued x Cash paid per share x Pre-
Post merger MPS merger No of shares

Concept 3 – Cost of Merger

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Relevant Post-Merger EPS/MPS

For AC For TC

Normal number without Equivalent number = Post merger (EPS or MPS)

adjustment x Exchange Ratio

Concept 9 – Equivalent EPS/MPS

Find out basis of ER

(EPS/MPS/BVPS)

How exchange Adjust base values in case

Write base value as
ratio is company wants to consider
AC:TC
determined? some premium in base value

Switching is not be done in case

Switch those values
basis is on adverse factors such
and take it as ER
as NPA, cost ratio
Concept 7 – How Exchange Ratio is Determined?

Can be (Post-merger MPS - Pre-

Gain/Loss computed at For AC merger MPS) x Pre-merger no
Computation EPS or MPS of shares
for AC and TC level (Do both (Post-merger equivalent MPS -
Shareholders if problem is For TC Pre-merger MPS) x Pre-merger
silent) no of shares

Concept 10 – Gain/loss per share (or) Impact of merger on EPS/MPS

To maintain ER based on Only if no PAT
EPS EPS synergy

ER for
To maintain ER based on Only if no PAT and
maintenance
MPS MPS PE Multiple Synergy
of parameter

To maintain ER based on Only if no

BVPS BVPS revaluation gain

Concept 11 – ER to maintain EPS/MPS/BVPS

Problem is Equal to pre-merger PE Multiple

silent of AC

Weighted PAT of AC x PE of AC + PAT of TC x PE of TC

PE Multiple
average PE PAT of AC + PAT of TC
Post Merger
Multiple
Minimum PE Pre − merger value of AC + TC
Multiple to Post merger PAT
justify merger

Concept 8 – PE Multiple

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Value of merged firm

Approach 1 (commonly used) Approach 2

Pre-merger value of AC + Pre-

Post merger PAT x PE Multiple merger value of TC + Valuation
gain from merger
Concept 8 – Value of Merged Firm
ER at which
Minimum ER (from TC consideration paid is
point of view) equal to pre-merger
value of TC
Exchange Ratio (if
basis not given)
ER at which
Maximum ER (from consideration paid =
AC Point of view) Post-merged value -
Premerger value of AC

Concept 8 – Value of Merged Firm

EG > Cost of
Calculate earning capital =
Opportunity Continue
yield and compare
cost of capital
with Opportunity EG < Cost of
given
cost capital = Sell
Decision on Shares
sale of shares Gain at MPS
Compare pre- level =
Opportunity merger MPS with Continue
cost not given post-merger Loss at MPS
equivalent MPS level = Sell
shares
Concept 27 – Decision on Sale of Shares
Value of Original Shareholders

Post-merger value of AC and TC shareholders

assuming no gain in merger

Value of AC Shareholders Value of TC shareholders

Note 1 Note 1

Concept 13 – Value of Original Shareholders

Note 1
Pre merger value of AC + TC
Value of AC shareholders = ( ) x Shares held by AC shareholders
Pre merger shares of AC + Shares issued to TC
Pre merger value of AC + TC
Value of TC shareholders = ( ) x Shares issued to TC shareholders
Pre merger shares of AC + Shares issued to TC

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Overall Gain = Post-merger value -

(Pre-merger value of AC and TC)

True cost of merger (or) net cost of NPV of merger (or) Gain of AC
merger (or) Gain of TC Shareholders shareholders

Gross Cost - Pre-merger value of AC Total gain - Net cost of merger

Concept 4 – Gain from Merger

Post -merger EPS

Stock Offer Cash Offer (no shares issued to TC)

Post merger PAT PATof AC + PAT of TC − after − tax Interest cost

Shares of AC + Shares issued to TC Shares of AC

Concept 5 and 6 – Post-Merger EPS

Book value per share (Value of Networth divided by

Number of equity shares)

Liabilities Side Assets Side

SC + Reserves − Fictitious assets Total assets − Fictitious assets − CL − Debt − Preference

No of shares No of shares

Concept 16 – Book value per share

Free Float Market Capitalization (Shareholding by non-promoters (or)

Shareholding by Public)

Free-float market capitalization = Overall market capitalization x %

shareholding by non-promoters

Concept 14 – Free Float Market Capitalization

Impact of bonus issue/Split

Increase in no of shares and Overall Market Capitalization will

EPS/MPS/BVPS will go down remain same

Concept 17 – Impact of bonus/Split

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Compute existing cost
of capital as
𝐎𝐯𝐞𝐫𝐚𝐥𝐥 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝𝐬
+𝐆
Value of TC business 𝐄𝐱𝐢𝐬𝐭𝐢𝐧𝐠 𝐯𝐚𝐥𝐮𝐞
Impact of Revision in
will increase in case
Growth rate of Firm Compute revised value
growth rate increases
of business as
𝐎𝐯𝐞𝐫𝐚𝐥𝐥 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝𝐬
𝐄𝐱𝐢𝐬𝐭𝐢𝐧𝐠 𝐊 𝟎 − 𝐍𝐞𝐰 𝐆

Concept 19 – Impact of Revision in Growth rate of Firm

ROE
EPS (ROE x
BVPS)
Price (EPS x PE
BVPS
Multiple)
PE Multiple

Concept 15 – Components of Price

Closer to lower
limit if TC is
Stronger company is one stronger
Final ER
with better PE, Growth,
(Negotiation)
Brand, Cost of capital, ROE Closer to upper
limit if AC is
stronger

Concept 18 – How is final exchange ratio decided in negotiation

Taken as equal to
Real value of
Intrinsic value MPS in absence of
company
information

Concept 20 – Intrinsic value

Adverse parameters are

We should take ER as
Exchange ratio those which an
equal to base values and
based on adverse organization wants to
no switching should be
parameters minimize such as NPA,
done in these cases
Expense Ratio, COGS Ratio

Concept 22 – Exchange Ratio based on adverse parameters

Ratios related to Bank Merger

GNPA in Rupees Networth

GNPA % = x 100 CAR % = x 100
Advances Risk Weighted Assets

Concept 23 – Ratios related to Bank Merger

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Normal Approach
[(PAT of AC of year 0 +
PAT of TC of Year 0) x (1 +
Post-merger growth of
merged firm)] + Synergy
Post Merger PAT of Gain
Next year Retained earnings are
already re-invested Post merger PAT of
Year 2 = [Post-merger
[PAT of AC of year 0 + AC PAT of year 1] x (1 +
Growth Rate] + [PAT of TC Merged company
of year 0 + TC Growth Growth Rate)
Rate] + Synergy Gain

Concept 28 – Post-merger PAT if retained earnings have already been re-invested

Post bonus Number of shares

Promoter Shares held by Promoters
=
shareholding is Desired Promoter shareholding %
reduced to comply
with SEBI Norms and
this is done by giving Number of bonus
Bonus ratio = New shares
free shares only to shares allotted = (Post
allotted to Minority:
minority shareholders bonus number of
Existing shares held by
shares) - Existing
minority
shares

Concept 25 – Bonus issue to reduce Promoter Holding

Fund available for Merger in

case of Cash Consideration

Maximum Debt Maximum New debt Available Total Fund =

Post Merger = = Total debt - cash and Maximum New
Networth x Existing debt of AC cash debt + Cash and
(Debt/Equity) and TC equivalents cash Equivalents

Concept 30 – Fund Available for Merger

Post merger shareholding

Existing shares in AC + Existing shares in TC x ER

Post − merger overall shares

Concept 31 – Post-merger shareholding of a shareholding who has shares both in AC and TC

Distribution of shares to TC shareholders in case of partly

paid shares

Convert partly ER = Shares Allot shares based on

paid shares into alloted: Total this to fully paid and
equivalent fully Fully paid partly paid
paid shares shares shareholders

Concept 29 – Distribution of shares in case of Partly Paid Shares

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Value of debt of Individual debt values

merged firm = Value of is weighted average of
debt of AC + Value of various values at
debt of TC different scenarios
Valuation of debt and
equity of Merged firm Individual Equity
Value of equity of
values is weighted
merged firm = Value of
average of various
equity of AC + Value
values at different
of equity of TC
scenarios

Concept 32 – Valuation of Debt and Equity (Not a Logical Item)

EAES or PAT
ROE =
Amount of equity

ROE = NP Margin x Asset Turnover x

Equity Multiplier

PAT Asset Turnover Assets

NP Margin = Sales Equity Multiplier =
Sales = Equity
Assets

Assets = Debt + Equity

if no information
Concept 24 – ROE as per Dupont Framework

CR = Items increasing
Compute capital
NW - Items decreasing
Reserve
NW
Internal
Reconstruction
Prepare revised
Balance sheet post
reconstruction giving
effect to changes

Concept 19 of Business Valuation Chapter – Internal Reconstruction

Promoters can enjoy allied benefits such as higher

remuneration due to majority shareholding. Hence they
Minimum need to be compensated for the same
consideration for
promoters Value of allied benefits
Minimum Price = Existing MPS +
No of shares held by promoters

Concept 26 – Minimum Consideration for promoters to relinquish Promoter Holding

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