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Mock Test Paper - Series I

FINAL COURSE: GROUP I

PAPER-2 ADVANCED FINANCIAL MANAGEMENT

Time Allowed- 3 hours Maximum Marks-100

1. The question paper comprises two parts, Part I and Part II.
2. Part I comprises Case Scenario based Multiple Choice Questions (MCQs)
3. Part II comprises questions which require descriptive type answers.

PART I - Case Scenario based MCQs (30 Marks)

Part I is compulsory

Write the most appropriate answer to each of the following multiple-choice questions by choosing one of the
four options given. All MCQs are compulsory and carry 2 Marks each.

Case Scenario 1

Case Description:
XYZ Ltd., a manufacturing company, has been operating successfully for over 20 years. The company is
planning to expand its operations and is exploring valuation options. Its financial data includes an EBITDA of
₹100 crores, a market capitalization of ₹800 crores, and outstanding debt of ₹200 crores. The weighted average
cost of capital (WACC) is 10%, and the tax rate is 30%. The company has been growing at a consistent rate of
5% per annum. The management is evaluating methods like DCF, comparable multiples, and asset-based
valuation to assess the fair value of the business.

Questions:

Q1. What is the value of the company using the DCF method with a perpetual growth rate of 5%?

A. ₹1,400 crores
B. ₹2,000 crores
C. ₹1,500 crores
D. ₹1,200 crores

Q2. What is the impact on DCF valuation if WACC increases from 10% to 12%?

A. Increases by 28.57%
B. Decreases by 18.57%
C. Increases by 18.57%
D. Decreases by 28.57%

Q3. Which valuation method is most suitable for asset-intensive companies?

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A. DCF Valuation
B. Market Multiples
C. Asset-Based Valuation
D. Comparable Company Analysis
(3 MCQ X 2 Marks =6 Marks)

Case scenario 2
GreenEarth Energy Solutions Ltd. is a renewable energy company planning to raise ₹50 crore to fund its new solar
energy project. The company plans to borrow funds through a floating-rate loan linked to the 6-month MIBOR
(Mumbai Interbank Offered Rate), currently at 7%. However, with rising interest rate volatility, the company is
concerned about the impact of fluctuating interest rates on its project’s profitability. To mitigate this risk, the
company is exploring interest rate swaps and futures contracts. The company’s CFO, Mr. Aditya, decides to
consult their financial advisor, Ms. Meera, to design an effective interest rate risk management strategy. Based
on her advice, the following options are being evaluated:

1. Interest Rate Swap: Swap the floating rate with a fixed rate of 6.5% for the entire loan period of 3 years.

2. Interest Rate Futures: Use 6-month futures contracts at an implied rate of 6.8% for hedging.

Questions:

Q4. If GreenEarth Energy chooses the interest rate swap, what will be the net annual interest saving (or cost)
compared to the floating rate if MIBOR rises to 8%?

A. ₹25 lakh savings

B. ₹30 lakh savings
C. ₹37.5 lakh savings
D. ₹40 lakh savings

Q5. If GreenEarth uses interest rate futures at an implied rate of 6.8%, what is the effective interest rate the
company will lock in if the actual MIBOR rises to 7.5%?

A. 7.3%
B. 7%
C. 6.8%
D. 6.5%

Q6. Suppose the company partially hedges 60% of the loan amount using swaps and the remaining 40% remains
at a floating rate. If the MIBOR rises to 7.8%, what will be the weighted average cost of interest for GreenEarth
Energy?

A. 7.0%
B. 7.02%
C. 7.1%
D. 7.8%
(3 MCQ X 2 Marks =6Marks)

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Case scenario 3

AgroAce Ltd. is a leading exporter of agricultural commodities, dealing primarily in wheat and soybean. The
company has received an order to supply 10,000 metric tons of wheat to a foreign client at a fixed price of
₹22,500 per metric ton. However, the company is concerned about potential price fluctuations in the
commodities market during the next three months, which might impact its profit margins. To hedge against this
price risk, the CFO, Ms. Nisha, decides to use derivatives. AgroAce Ltd. evaluates two possible strategies:

1. Wheat Futures Contract: Short futures at ₹22,800 per metric ton (standard lot size: 1,000 metric tons).

2. Wheat Options Contract: Buy put options at a strike price of ₹22,500 with a premium of ₹200 per metric ton.

The spot price of wheat is currently ₹22,300 per metric ton. After three months, the spot price of wheat might
rise to ₹23,200 or fall to ₹21,800. AgroAce needs to decide the most suitable strategy.

Questions:

Q7. If AgroAce Ltd. decides to use the futures contract and the price of wheat falls to ₹21,800 per metric ton after
three months, what will be the net impact of the futures position (profit or loss)?

A. ₹10 lakh profit

B. ₹50 lakh profit
C. ₹100 lakh profit
D. ₹90 lakh profit

Q8. If AgroAce Ltd. opts for the put options contract and the price of wheat falls to ₹21,800 per metric ton after
three months, what will be the net benefit from the options contract after accounting for the premium paid?

A. ₹20 lakh net profit

B. ₹50 lakh net profit
C. ₹60 lakh net profit
D. ₹70 lakh net profit

Q9. Assuming the price of wheat rises to ₹23,200 per metric ton after three months, which hedging strategy will
result in better financial performance for AgroAce Ltd.?

A. Futures Contract
B. Options Contract
C. No Hedging
D. Both futures and options perform equally
(3 MCQ X 2 Marks =6 Marks)
Case Scenario 4

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Nova Corporation is evaluating two investment options to diversify its portfolio: preferred stock and
convertible debentures. The details of the securities are as follows:

1. Preferred Stock Details:

- Current Market Price: ₹100
- Annual Dividend: ₹8
- Required Rate of Return: 8%

2. Convertible Debentures Details:

- Face Value: ₹1,000
- Annual Coupon Rate: 10%
- Conversion Ratio: 20 shares per debenture
- Market Price of Equity Shares: ₹50
- Current Market Price of Debenture: ₹1,050

Nova Corporation needs to assess the intrinsic value of these securities and determine which offers a better
investment opportunity.

Questions:
Q10. What is the intrinsic value of the preferred stock?

A. ₹80
B. ₹90
C. ₹100
D. ₹110

Q11. What is the conversion value of the convertible debenture?

A. ₹900
B. ₹1,000
C. ₹1,050
D. ₹1,100

Q12. Based on the intrinsic values, which investment should Nova Corporation choose?

A. Preferred Stock, as it is fairly valued.

B. Convertible Debentures, as they are undervalued.
C. Neither, as both are overvalued.

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D. Both, as both are fairly valued.

(3 MCQ X 2 Marks =6 Marks)

Case Scenario 5

GlobalTech Exports Ltd. is a company based in India that exports electronic components to the USA. The
company is set to receive USD 200,000 in three months. With the recent volatility in exchange rates,
GlobalTech wants to hedge its currency exposure to minimize the risk of adverse currency movements. The
following data is available:

1. Spot Rate: ₹82/USD

2. Forward Rate (3 months): ₹83/USD
3. Call Option: Strike Price = ₹82.50/USD, Premium = ₹0.50/USD
4. Put Option: Strike Price = ₹82/USD, Premium = ₹0.40/USD
5. Expected Spot Rate after 3 months: ₹81/USD or ₹85/USD

GlobalTech is evaluating whether to use a forward contract, options, or leave the exposure unhedged.

Questions

Q13. What is the primary advantage of using currency options over forward contracts for hedging?

A. Guaranteed protection against unfavorable currency movements

B. Unlimited upside potential with downside protection
C. Zero cost of hedging
D. Fixed settlement rate for future transactions

Q14. If GlobalTech chooses the forward contract, what will be the effective value of the USD 200,000 receivable
in INR?

A. ₹16,400,000
B. ₹16,200,000
C. ₹16,600,000
D. ₹16,800,000

Q15. If GlobalTech chooses the call option and the spot rate after 3 months is ₹85/USD, what will be the net
benefit (in INR) from using the call option after accounting for the premium paid?

A. ₹4,60,000
B. ₹4,40,000
C. ₹3,80,000
D. ₹4,00,000
(3 MCQ X 2 Marks =6 Marks)

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PART II – Descriptive Question (70 Marks)

Question No.1 is compulsory.

Attempt any four questions from the rest.

1) (a). Ram holds a portfolio with 10,000 shares of X Ltd. purchased at Rs. 22 per share (Beta = 1.5) and a short position of
5,000 shares of A Ltd. sold at Rs. 40 per share (Beta = 2). He decides to hedge his portfolio by using Nifty futures priced
at Rs. 1,000 each. On the following day, the market conditions change:

- The share price of X Ltd. falls by 2%

- The share price of A Ltd. increases by 3%, and
- Nifty futures drop by 1.5%.

Calculate the overall profit or loss for Ram. (Use the concept of beta to compute the number of futures contracts
required to achieve a complete hedge.)
(6 Marks)

1) (b). Tiger Ltd. Is presently working with an Earning Before Interest and Taxes (EBIT) of Rs. 90 Lacs. Its present
borrowings are as follows:
Rs. In Lacs
12% Term Loan 300

Working Capital Borrowings:

From Bank at 15% 200
Public Deposit at 11% 100

The Sales of the company are growing and to support this, the company proposes to obtain additional borrowing
of Rs. 100 lacs expected to cost 16%. The increase in EBIT is expected to be 15%.
Calculate the change in interest coverage ratio after the additional borrowing is effected and comment on the
arrangement made.
(4 Marks)

1) (c). EXPLAIN briefly the Dow Theory, its components, and its relevance in today's stock market environment.
(4 Marks)

2) (a). An Indian exporting firm, Rohit and Bros., would like to cover itself against a likely depreciation of pound
sterling. The following data is given:

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Receivables of Rohit and Bros : £500,000 Spot

Rate : Rs. 56.00/£
Payment date : 3-months
3-month interest rate : India: 12% per annum; UK: 5% per annum

ADVICE: What should the exporter do to mitigate the risk of currency depreciation?
(6 Marks)

2) (b). The directors of Implant Inc. wish to make an equity issue to finance a $10 m (million) expansion scheme which has
an excepted Net Present Value of $2.2m and to re-finance an existing $6 m 15% Bonds due for maturity in 5 years time.
For early redemption of these bonds there is a $3,50,000 penalty charges. The Co. has also obtained approval to
suspend these pre-emptive rights and make a $15 m placement of shares which will be at a price of $0.5 per share. The
floatation cost of issue will be 4% of Gross proceeds. Any surplus funds from issue will be invested in IDRs which is
currently yielding 10% per year.

The present capital structure of co. Is as under:

Particulars Amount ($000)

Ordinary Share ($1 per share) 7,000
Share Premium 10,500
Free Reserves 25,500
15% Term Bonds 6,000
11% Debenture (2012-2020) 8,000
Total 57,000

Current share price is $2 per share and debenture price is $ 103 per debenture. Cost of capital of Co. is 10%. It may be
further presumed that stock market is semi-strong form efficient and no information about the proposed use of funds
from the issue has been made available to the public. You are required to calculate expected share price of company
once full details of the placement and to which the finance is to be put, are announced.
(4 Marks)

2) (c). VentureY, a newly established e-commerce startup, requires funds to scale its operations and manage its working
capital. However, the founders are hesitant to approach banks for loans due to stringent requirements. They have
approached you for advice on innovative ways to finance their startup. Suggest four innovative funding options
VentureY can consider for financing its operations. Explain how these methods can benefit the startup, considering the
challenges they face in accessing traditional financing.
(4 Marks)

3). (a). Mr. Tamarind intends to invest in equity shares of a company, the value of which depends on various parameters as

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mentioned below:

Factor Beta Expected value (%) Actual value (%)

GNP 1.20 7.70 7.70
Inflation 1.75 5.50 7.00
Interest Rate 1.30 7.75 9.00
Stock Market Index 1.70 10.00 12.00
Industrial Production 1.00 7.00 7.50

The risk-free rate of interest is 9.25%.

CALCULATE the return of the share as per the Arbitrage Pricing Theory (APT).
(6 Marks)

3). (b). ABC Bank has a portfolio of housing loans amounting to Rs. 200 crores. To enhance liquidity, the bank is considering
securitization of these loans. The following details are provided:

1. The loans will be packaged and sold as a pass-through certificate (PTC) to investors.
2. The expected annual cash flows from the loan portfolio are Rs. 30 crores for the next 7 years.
3. The securitization process involves an upfront cost of Rs. 2 crores.
4. The investors require a return of 10% per annum.

You are required to:

(i) Calculate the present value of cash flows from the securitization process.
(ii) Determine the net gain or loss to the bank from the securitization process.
(iii) Briefly discuss one advantage and one risk associated with securitization for the bank.
(4 Marks)

3). (c) The Asset Management Company of the mutual fund (MF) has declared a dividend of 9.98% on the units under the
dividend reinvestment plan for the year ended 31st March 2024. The investors are issued additional units for the
dividend at the rate of closing Net Asset Value (NAV) for the year as per the conditions of the scheme. The closing NAV
was Rs. 24.95 as on 31st March 2024. An investor Mr. X who is having 20,800 units at the year-end has made an
investment in the units before the declaration of the dividend and at the rate of opening NAV plus an entry load of Rs.
0.04. The NAV has appreciated by 25% during the year. Assume the face value of the unit as Rs. 10.00.

CALCULATE:

1. Opening NAV
2. Number of units purchased
3. Original amount of the investment.

OR
M/s. Parker & Co. is contemplating to borrow an amount of INR 60 crores for a period of 3 months in the coming 6

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months' time from now. The current rate of interest is 9% p.a., but it may go up in 6 months' time. The company wants
to hedge itself against the likely increase in interest rate.

The Company's Bankers quoted an FRA (Forward Rate Agreement) at 9.30% p.a.

Requirement:

Determine the final settlement amount if the actual rate of interest after 6 months happens to be:

(i) 9.60% p.a.

(ii) 8.80% p.a.
(4 Marks)

4). (a) A valuation done of an established company by a well-known analyst has estimated a value of Rs. 500 lakhs,
based on the expected free cash flow for next year of Rs. 20 lakhs and an expected growth rate of 5%. While going
through the valuation procedure, you found that the analyst has made the mistake of using the book values of debt
and equity in his calculation. While you do not know the book value weights he used, you have been provided with
the following information:

(i) Company has a cost of equity of 12%.

(ii) After-tax cost of debt is 6%.
(iii) The market value of equity is three times the book value of equity, while the market value of debt is equal to
the book value of debt.

You are required to estimate the correct value of the company.

(6 Marks)

4). (b) A portfolio consists of the following investments:

- Rs. 300 lakhs in shares of DEF Ltd.

- Rs. 200 lakhs in shares of GHI Ltd.

The daily standard deviation of returns for both shares is 1.2%, and the coefficient of correlation between the two
shares is 0.4.

You are required to determine the 10-day 95% Value at Risk (VaR) for this portfolio. Use the Z-score from the Normal
Table at 95% confidence level as 1.645. Show all calculations up to four decimal points.

(4 Marks)

4). (c) A company is evaluating two financing strategies to fund its future projects:

1. A high debt-equity ratio approach to leverage tax savings on interest.

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2. A balanced debt-equity ratio approach to maintain financial stability.

As a financial strategist, explain which strategy the company should adopt, considering the implications on cost of
capital, risk, and shareholder value.
(4 Marks)

5). (a) Yes Ltd. wants to acquire No Ltd., and the cash flows of Yes Ltd. and the merged entity are given below:

Year 1 2 3 4 5
Cash Flow Yes Ltd. (₹ Lakhs) 175 200 320 340 350
Merged Entity 400 450 525 590 620

Earnings would have witnessed a 5% constant growth rate without merger and 6% post-merger owing to economies of
operations after 5 years. The cost of capital is 15%.
The number of shares outstanding in both companies before the merger is the same, and the companies agree to an
exchange ratio of 0.5 shares of Yes Ltd. for each share of No Ltd.

CALCULATE:
(i) The Value of Yes Ltd. before and after merger.
(ii) Value of Acquisition.
(iii) Gain to shareholders of Yes Ltd.
Note: PV factors @15% for years 1-5 are 0.870, 0.756, 0.658, 0.572, 0.497 respectively.
(8 Marks)

5). (b) Following information pertains to a regular income scheme:

Particulars Value (in Crores)

Listed shares at Cost (ex-dividend) 20
Cash in hand 1.23
Bonds and debentures at cost 4.3
Of these, bonds not listed and quoted 1
Other fixed interest securities at cost 4.5
Dividend accrued 0.8
Amount payable on shares 6.32
Expenditure accrued 0.75
Number of units (10 face value) 20 Lacs
Current realizable value of fixed income securities of face value of 100 106.5
The listed shares were purchased when Index was 1000
Present index is 2300
Value of listed bonds and debentures at NAV date 8
There has been a diminution of 20 percent in unlisted bonds and debentures. Other fixed interest securities are at cost.

CALCULATE the NAV on a per unit basis.

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(6 Marks)

6). (a) Following are the estimates of the net cash flows and probability of a new project of M/s X Ltd.:

Particulars Year P = 0.3 P = 0.5 P = 0.2

Initial Investment 0 4,00,000 4,00,000 4,00,000
Estimated net after tax cash inflows per year 1 to 5 1,00,000 1,10,000 120000
Estimated salvage value (after tax) 5 20,000 50,000 60000

The required rate of return from the project is 10%. Find:

(i) The expected NPV of the project.

(ii) The best case and the worst case NPVs.

(iii) The probability of occurrence of the worst case if the cash flows are perfectly dependent over time and
independent over time.

(iv) Standard deviation and coefficient of variation assuming that there are only three streams of cash flow, which are
represented by each column of the table with the given probabilities.

(v) Coefficient of variation of X Ltd. on its average project which is in the range of 0.95 to 1.0. If the coefficient of
variation of the project is found to be less risky than average, 100 basis points are deducted from the Company’s cost
of Capital. Should the project be accepted by X Ltd?
(8 Marks)

6). (b) Mr. A owns a portfolio with the following characteristics:

Security X Security Y Risk Free security

Beta 1.60 1.80 0
Expected Return 15% 16% 7%

(i) If Mr. A has ₹2,00,000 to invest and sells short ₹1,00,000 of security Y and purchases ₹3,00,000 of security X, what is
the sensitivity of Mr. A’s portfolio?
(ii) If Mr. A borrows ₹2,00,000 at the risk-free rate and invests the amount he borrows along with the original amount
of ₹2,00,000 in security X and Y in the same proportion as described in part (i), what is the sensitivity of the portfolio?
(iii) What is the expected market risk premium?
(6 Marks)

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