CA FINAL

STRATEGIC
FINANCIAL
Marathon

MANAGEMENT
Sanjay Saraf Sir

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 Strategic Financial Management – Marathon

Question 1.

Auto Correlation Test

Mr. X is of the opinion that market has recently shown the Weak Form of
Market Efficiency. In order to test the validity of his impression he has
collected the following data relating to the movement of the SENSEX for the last 20
days.

Days Open High Low Close

1 33470.94 33513.79 33438.03 33453.99
2 33453.64 33478.11 33427.82 33434.83
3 33414.06 33440.29 33397.65 33431.93
4 33434.94 33446.18 33377.78 33383.41
5 33372.92 33380.27 33352.12 33370.93
6 33375.85 33389.49 33331.42 33340.75
7 33340.89 33340.89 33310.95 33330.98
8 33326.84 33340.91 33306.17 33335.08
9 33307.16 33328.22 33296.43 33301.97
10 33298.64 33318.60 33254.28 33259.03
11 33260.04 33228.85 33241.66 33251.53
12 33255.92 33289.46 33249.46 33285.89
13 33288.86 33535.67 33255.98 33329.28
14 33335.00 33346.21 33276.72 33284.17
15 33293.83 33310.86 33278.54 33298.78
16 33300.02 33337.79 33300.02 33325.38
17 33323.36 33356.34 33322.44 33329.95
18 33322.81 33345.98 33317.44 33319.67
19 33317.51 33321.18 33294.19 33302.32
20 33290.86 33324.96 33279.62 33319.61

You are required:

To test the Weak Form of Market Efficiency using Auto-Correlation test, taking time
lag of 10 days.

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Answer:

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

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Question 2.

Mutual Fund Dividend Equilisation Sum

On 1st January, 2020, an open ended scheme of mutual fund had outstanding
units of 300 lakhs with a NAV of ` 20.25. At the end of January 2020, it had issued 5
lakhs units at an opening NA V plus a load of 2%, adjusted for dividend equalisation.
At the end of February 2020, it had repurchased 2.5 lakhs units at an opening NAV
less 2% exit load adjusted for dividend equalisation. At the end of March 2020,
it had distributed 70 per cent of its available income.

In respect of January - March quarter, the following additional information is

available:

Value appreciation of the portfolio ` 460 lakhs

Income for January ` 24 lakhs
Income for February ` 36 lakhs
Income for March ` 47 lakhs

You are required to calculate:

i. Income available for distribution

ii. Issue price at the end of January
iii. Repurchase price at the end of February
iv. Closing Value of Net Assets at the end of March.

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Answer:

i. Calculation of Income Available for Distribution

ii. Calculation of Issue Price at the end of January

iii. Calculation of Repurchase Price at the end of February

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iv. Closing NAV at the end of March

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Question 3.

EFR

The Balance Sheet of M/s. Sundry Ltd. as on 31-03-2020 is follows:

(` in lakhs)
Liabilities ` Assets `
Share Capital 300 Fixed Assets 600
Reserves 200 Inventory 500
Long Term Loan 400 Receivables 240
Short Term Loan 300 Cash 60
Payables & Provisions 200
Total 1400 Total 1400

Sales for the year was ` 600 lakhs. The sales are expected to grow by 20% during the
year. The profit margin and dividend pay-out ratio are expected to be 4% and
50% respectively.

The company further desires that during the current year Sales to Short Term Loan
and Payables and Provision should be in the ratio of 4 : 3. Ratio of fixed assets to
Long Term Loans should be 1.5. Debt Equity Ratio should not exceed 1.5.

You are required to determine:

i. The amount of External Fund Requirement (EFR)

ii. The amount to be raised from Short Term, Long Term and Equity funds.

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Answer:

i. External Funds Requirement (EFR):

* As current liabilities shall also be increased proportionately with increase in

sales.

ii. Amount to be raised from different sources with following conditions:

 Sales to short term loans and payables & provisions 4:3
 Ratio of fixed assets to long term loans 1.5
 Debt equity ratio should not exceed 1.5

1. Amount to be raised from short term funds:

2. Amount to be raised from Long term funds:

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3. Amount to be raised from equity funds:

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Question 4.

Forex

M/s. Sky products Ltd., of Mumbai, an exporter of sea foods has submitted a 60 days
bill for EUR 5,00,000 drawn under an irrevocable Letter of Credit for
negotiation. The company has desired to keep 50% of the bill amount under
the Exchange Earners Foreign Currency Account (EEFC). The rates for `/USD and
USD/EUR in inter-bank market are quoted as follows:

`/ USD USD/EUR
Spot 67.8000 - 67.8100 1.0775 - 1.8000
1 month forward 10/11 Paise 0.20/0.25 Cents
2 months forward 21/22 Paise 0.40/0.45 Cents
3 months forward 32/33 Paise 0.70/0.75 Cents

Transit Period is 20 days. Interest on post shipment credit is 8 % p.a. Exchange

Margin is 0.1%. Assume 365 days in a year.

You are required to calculate:

i. Exchange rate quoted to the company

ii. Cash inflow to the company
iii. Interest amount to be paid to bank by the company.

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Answer:

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

ii. Cash Inflow ` 1,83,69,825

iii. Interest for 80 days @ 8% ` 3,22,101

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Question 5.

VAR

On Tuesday morning (before opening of the capital market) an investor, while

going through his bank statement, has observed that an amount of ` 7 lakhs is lying
in his bank account. This amount is available for use from Tuesday till Friday. The
Bank requires a minimum balance of ` 1000 all the time. The investor desires
to make a maximum possible investment where Value at Risk (VaR) should not
exceed the balance lying in his bank account. The standard deviation of market
price of the security is 1.5 per cent per day. The required confidence level is 99 per
cent.

Given

Standard Normal Probabilities

z 0.00 .01 .02 .03 0.04 .05 .06 .07 .08 .09
2.2 .9861 .9864 .9868 .9871 .9875 .9878 .9881 .9884 .9887 .9890
2.3 .9893 .9896 .9998 .9901 .9904 .9906 .9909 .9911 .9913 .9916
2.4 .9918 .9920 .9922 .9923 .9925 .9929 .9931 .9932 .9934 .9936

You are required to determine the maximum possible investment.

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Answer:

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Question 6.

Ratio

AB Industries has Equity Capital of ` 12 Lakhs, total Debt of ` 8 Lakhs, and annual
sales of ` 30 Lakhs. Two mutually exclusive proposals are under consideration
for the next year. The details of the proposals are as under:

Proposal Proposal
Particulars
no. 1 no. 2
Target Assets to Sales Ratio 0.65 0.62
Target Net Profit Margin (%) 4 5
Target Debt Equity Ratio (DER) 2:3 4:1
Target Retention Ratio (of Earnings) (%) 75 -
Annual Dividend (` In Lakhs) - 0.30
New Equity Raised (` in Lakhs) - 1

You are required to calculate sustainable growth rate for both the proposals.

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Answer:

Sustainable Growth Rate under Proposal 1

Sales (Given) ` 30 Lakhs

Total Assets ` 30 Lakhs x 0.65 ` 19.50 Lakhs
Net Profit ` 30 Lakhs x 4% ` 1.20 Lakhs

Sustainable Growth Rate = ROE x Retention Ratio = 3.69% x 0.75 = 2.77%

Sustainable Growth Rate under Proposal 2

New Equity = ` 12 Lakhs + ` 1 Lakh = ` 13 Lakhs
New Debt = ` 13 Lakhs x 4 = ` 52 Lakhs
Total Assets = ` 13 Lakhs + ` 52 Lakhs = ` 65 Lakhs

Sustainable Growth Rate = ROE x Retention Ratio

= 1.613% x 0.943 = 1.52%

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Question 7.

Interest Rate Risk Management

IB an Indian firm has its subsidiary in Japan and Zaki a Japanese firm has its subsidiary
in India and face the following interest rates:

Company IB Zaki
INR floating rate BPLR + 0.50% BPLR + 2.50%
JPY (Fixed rate) 2% 2.25%

Zaki wishes to borrow Rupee Loan at a floating rate and IB wishes to borrow
JPY at a fixed rate. The amount of loan required by both the firms is same at
the current exchange rate. A financial institution may arrange a swap and requires
25 basis points as its commission. Gain, if any, is to be shared by the firms equally.

You are required to find out:

i. Whether a swap can be arranged which may be beneficial to both the firms?
ii. What rate of interest will the firms end up paying?

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Answer:

Though Company IB has an advantage in both the markets but it has comparative
more advantage in the INR floating-rate market. Company Zaki has a comparative
advantage in the JPY fixed interest rate market.

However, company IB wants to borrow in the JPY fixed interest rate market and
company Zaki wants to borrow in the INR floating-rate market. This gives rise
to the swap opportunity.

IB raises INR floating rate at BPLR + 0.50% and Zaki raises JPY at 2.25%
Total Potential Gain = (INR interest differential) - (Yen rate differential)
= (BPLR + 2.50% - BPLR + 0.50%) + (2% - 2.25%) = 1.75%
Less Banker's commission (To be shared equally) = 0.25%

Net gain (To be shared equally: 0.75% each) = 1.50%

i. Yes, a beneficial swap can be arranged

ii. Effective cost of borrowing = pays to lenders + pays to other party -receives
from other party + banker's commission

IB = BPLR + 0.50% +1.125%* - (BPLR + 0.50%) + 0.125% = 1.25%

(* has been arrived as 2% - 0.75% - 0.125%)

Zaki = 2.25% + BPLR + 0.50% - 1.125% + 0.125% = BPLR + 1.75%

Note: Candidates can also present the above Swap arrangement in a different
manner. In such case they should be awarded due marks provided solution be ended
up in correct answer.

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Question 8.

Convexity Part

The following data are available for a bond:

Face Value ` 10,000 to be redeemed at par on maturity

Coupon rate 8.5 per cent per annum
Years to Maturity 5 years
Yield to Maturity (YTM) 10 per cent

You are required to calculate:

i. Current market price of the Bond,

ii. Macaulay’s Duration,
iii. Volatility of the Bond,
iv. Convexity of the Bond,
v. Expected market price, if there is a decrease in the YTM by 200 basis points
a. By Macaulay’s Duration based estimate
b. By Intrinsic Value Method.

Given
Years 1 2 3 4 5
PVIF (10%, n) 0.909 0.826 0.751 0.683 0.621
PVIF (8%, n) 0.926 0.857 0.794 0.735 0.681

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Answer:

i. Current Market Price of Bond

= ` 850 (PVIAF 10%, 5) + ` 10,000 (PVIF 10%, 5)
= ` 850 (3.79) + ` 10,000 (0.621) = ` 3,221.50 + ` 6,210 = ` 9,431.5

ii. Macaulay’s Duration

Duration of the Bond is 4.252 years

iii. Volatility of Bond

iv. Convexity of Bond

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

A. By Macaulay’s duration-based estimate

= ` 9431.50  2 (3.865/100) = ` 729.05

Hence expected market price is ` 9431.50 + ` 729.05 = ` 10,160.55
Hence, the market price will increase.

B. By Intrinsic Value method

Hence, expected market price is ` 10,204.05

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Question 9.

Mutual Fund Reverse Q

M/S. Corpus an AMC, on 1.04.2015 has floated two schemes viz. Dividend
Plan and Bonus Plan. Mr. X, an investor has invested in both the schemes. The
following details (except the issue price) are available:

NAV
Date Dividend (%) Bonus Ratio
Dividend Plan Bonus Plan
1.04.2015 ? ?
31.12.2016 1 :4 (One unit on 4 47 40
units held)
31.03.2017 12 48 42
31.03.2018 10 50 39
31.12.2018 1 :5 (One unit on 5 46 43
units held)
31.03.2019 15 45 42
31.03.2020 - - 49 44

Additional details
Investment (`) ` 9,20,000 ` 10,00,000
Average Profit (`) ` 27, 748.60
Average Yield (%) 6.40

You are required to calculate the issue price of both the schemes as on 1.04.2015.

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Answer:

i. Dividend Plan

a. Average Annual gain over a period of 5 Years 27748.60

b. Total gain over a period of 5 years (a*5) 138743
c. Initial Investment 920000
d. Total value of investment (b+c) 1058743
e. NAV as on 31.3.2020 49
f. Number of units at the end of the period as on 31.03.2019 (d/e) 21607

Issue Price as on 01.04.2015 Investment 920000/ Units purchased 20000 (c/i) =

` 46
* Let the units issued be X
X = (Closing Units/NAV + Dividend) x Dividend

ii. Bonus Plan

a. Average Yield 0.064

b. Investment 1000000
c. Gain over a period of 5 years (a*b*5) 320000
d. Market Value as on 31.03.2019 (b + c) 1320000
e. NAV as on 31.03.2020 44
f. Total units as on 31.03.2020 (d/e) 30000
g. No of units as on 31.03.2018 Pre bonus = 30000*5/ (5 + 1) 25000
h. No of units as on 31.12.2016 Pre bonus = 25000*4/ (4 + 1) 20000
i. Issue Price as on 01.04.2015 Investment 1000000/ Units
purchased 20000 (b/h) 50

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Question 10.

NPV

SS Company is considering the replacement of its existing machine with a new

machine. The Purchase price of the New machine is ` 26 Lakhs and its expected Life
is 8 years. The company follows straight-line method of depreciation on the original
investment (scrap value is not considered for the purpose of depreciation). The other
expenses to be incurred for the New Machine are as under:

i. Installation Charges ` 9,000

ii. Fees paid to the consultant for his advice to buy New Machine ` 6,000.
iii. Additional Working Capital required ` 17,000. (will be released after 8 years)

The written down value of the existing machine is ` 76,000, and its Cash Salvage
Value is ` 12,500. The dismantling of this machine would cost ` 4,500. The
Annual Earnings (before tax but after depreciation) from the New Machine
would amount to ` 3,15,000. Income tax rate is 35%. The Company's required Rate
of Return is 13%.

You are required to advise on the viability of the proposal.

PVIF (13%, 8) = 0.376 PVIFA (13%, 8) = 4.80

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Answer:

Working Note:

1. Computation of Annual Depreciation-

2. Computation of Annual Cash Savings-

3. Tax effect on sale of Old Machine-

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4. Computation of Net Present Value

Decision: Since NPV of the project is negative it is not viable.

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Question 11.

Forex

KGF Bank's Sydney branch has surplus funds of USD $ 7,00,000 for a period of 2
months. Cost of funds to the bank is 6% p.a. They propose to invest these funds in
Sydney, New York or Tokyo and obtain the best yield, without any exchange
risk to the bank. The Following rates of interest are available at the three
centres for investment of domestic funds there for a period of 2 Months.

Sydney 7.5% p.a.

New York 8% p.a.
Tokyo 4% p.a.

The market rates in Australia for US Dollars and Yen are as under:

Sydney on New York:

Spot 0.7100/0.7300
1 Months 10/20
2 Months 25/30

Sydney on Tokyo:

Spot 79.0900/79.2000
1 Months 40/30
2 Months 55/50

At which centre, will the investment be made & what will be the net gain to the bank
on the invested funds?

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Answer:

i. If investment is made at Sydney

ii. If investment is made at New York

Gain $ 7,00,000 (8% - 6%) x 2/12 = $ 2,333.33

Or Equivalent amount in £ 3 months ($ 2,333/ 0.7330) = A$ 3,183

iii. If investment is made at Tokyo

Out of three options the profit is in case of investment is made in New York.
Hence it should be opted.
* Due to conservative outlook.

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Question 12.

Merger & Acquisitions

R Ltd. and S Ltd. operating in same industry are not experiencing any rapid growth
but providing a steady stream of earnings. R Ltd.'s management is interested in
acquisition of S. Ltd. due to its excess plant capacity. Share of S Ltd. is trading in
market at ` 3.20 each. Other data relating to S Ltd. is as follows:

Balance Sheet of S Ltd.

Liabilities Amount (`) Assets Amount (`)

Current Liabilities 1,59,80,000 Current Assets 2,48,75,000
Long Term Liabilities 1,28,00,000 Other Assets 94,00,000
Reserve & Surplus 2,79,95,000 Property Plants & 3,45,00,000
Equipment
Share Capital (80 Lakhs 1,20,00,000
shares of ` 1.5 each)
Total 6,87,75,000 Total 6,87,75,000

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

Profit after Tax 86,50,000 49,72,000 1,21,85,000
Residual Net Cash Flows per year 90,10,000 54,87,000 1,85,00,000
Required return on equity 13.75% 13.05% 12.5%

You are required to compute the following:

i. Minimum price per share S Ltd. should accept from R Ltd.

ii. Maximum price per share R Ltd. shall be willing to offer to S Ltd.
iii. Floor Value of per share of S Ltd., whether it shall play any role in decision for
its acquisition by R Ltd.

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Answer:

i. Calculation of Minimum price per share S Ltd. should accept from R Ltd.

Therefore, the minimum price per share S ltd. should accept from R Ltd. is ` 5
(current book value)

ii. Calculation of Maximum price per share R Ltd. shall be willing to offer to S
Ltd.

Maximum price per share R Ltd. shall be willing to offer to S Ltd. shall be
computed as follows:

iii. Floor value of per share of S Ltd shall be ` 3.20 (current market price) and it
shall not play any role in decision for the acquisition of S Ltd. as it is lower than
its current book value.

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Question 13.

Forex

A German subsidiary of an US based MNC has to mobilize 100000 Euro's working

capital for the next 12 months. It has the following options:

Loan from German Bank : @ 5% p.a.

Loan from US Parent Bank : @ 4% p.a.
Loan from Swiss Bank : @ 3% p.a.

Banks in Germany charge an additional 0.25% p.a. towards loan servicing. Loans
from outside Germany attract withholding tax of 8% on interest payments. If the
interest rates given above are market determined, examine which loan is the
most attractive using interest rate differential.

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Answer :

Net Cost under each of the Options is as follows:

i. Loan from German Bank

Cost = 5% + 0.25% = 5.25%

ii. Loan from US Parent Bank

iii. Loan from Swiss Bank

Thus, loan from Swiss Bank is the best option as the Total Outflow including
Interest is Less i.e. €105200

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Question 14.

Equity Valuation

The current EPS of M/s VEE Ltd. is ` 4. The company has shown an extraordinary
growth of 40% in its earnings in the last few year This high growth rate is likely to
continue for the next 5 years after which growth rate in earnings will decline from
40% to 10% during the next 5 years and remain stable at 10% thereafter. The decline
in the growth rate during the five year transition period will be equal and linear.
Currently, the company' s pay-out ratio is 10%. It is likely to remain the same for the
next five years and from the beginning of the sixth year till the end of the 10th year,
the pay-out will linearly increase and stabilize at 50% at the end of the 10th year. The
post tax cost of capital is 17% and the PV factors are given below:

Years 1 2 3 4 5 6 7 8 9 10
PVIF
0.855 0.731 0.625 0.534 0.456 0.390 0.333 0.285 0.244 0.209
@17%

You are required to calculate the intrinsic value of the company's stock based on
expected dividend. If the current market price of the stock is ` 125, suggest if it is
advisable for the investor to invest in the company's stock or not.

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Answer:

Working Notes:

i. Computation of Growth Rate in Earning and EPS

ii. Computation of Payout Ratio and Dividend

iii. Calculation of PV of Dividend

Since the Intrinsic Value of Equity share is less than current market price, it
is not advisable to invest in the same.

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Question 15.

Portfolio Management

The returns of a portfolio A and market portfolio for the last 12 months are indicated
as follows:

Month Portfolio A Market Portfolio

January - 0.52 0.82
February 2.20 0.04
March 2.17 2.80
April 4.17 1.72
May 2.04 0.27
June 3.00 0.39
July 1.99 1.95
August 4.00 0.64
September -1.38 1.53
October 2.67 2.70
November 3.99 2.52
December 1.86 2.09
Standard Deviation (σ) 1.6223 0.9498

i. You are required to find out the monthly returns attributable to the sheer skill
of the Portfolio Manager.
ii. What part of the monthly return is attributable to the higher risk
assumed by the Portfolio Manager?

Assume that the risk-free rate of return is 12% per annum and the portfolio is
fully diversified.

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Answer:

i. The monthly risk free rate of return = (12%/12) = 1%

Average Portfolio Return (Rp) = 2.1825

Average Portfolio Return (Rm) = 1.4558
Portfolio Risk (σP) = 1.6223
Market Risk (σm) = 0.9498
Since portfolio A is fully diversified then it can be computed with a
portfolio whose beta (β) can be found as follows:

Therefore, portfolio A is comparable to a portfolio whose Beta is 1.708.

Expected monthly returns on such portfolio can be calculated as follows:

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ii. The returns due to higher risk assumed by the portfolio manager
= 1.7785% - 1.4558% = 0.3227% per month

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Question 16.

Mutual Fund

Mr. Alex, a practicing Chartered Accountant, can earn a return of 15 percent by

investing in equity shares on his own. He is considering a recently announced equity
based mutual fund scheme in which initial expenses are 6 percent and annual
recurring expenses are 2 percent.

i. How much should the mutual fund earn to provide Mr. Alex a return of 15
percent per annum?
ii. Mr. Alex's current Annual Professional Income is ` 40 Lakhs. His portfolio
value is ` 50 Lakhs and now he is spending 10% of his time to manage his
portfolio. If he spends this time on profession, his professional income will go
up in same proportion. He is thinking to invest his entire portfolio into a
Multicap Fund, assum ing the fund's NAV will grow at 13% per annum
(including dividend).

You are requested to advise Mr. Alex, whether he can invest the portfolio into
Multicap Funds ? If so, what is the net financial benefit?

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Answer:

i. Personal earnings of Mr. Alex = R1 = 15%

Mutual Fund earnings = R2

Mutual Fund earnings = 17.96%

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

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

It is advisable to invest in Multi-cap Mutual Funds and devote the time on

profession. He will get net benefit of ` 3 Lakhs (`50.50 - `47.50)

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Question 17.

Portfolio Management

Mr. Kapoor owns a portfolio with the following characteristics:

Security X Security Y Security Z

Factor 1 sensitivity 0.75 1.50 0
Factor 2 sensitivity 0.60 1.10 0
Expected Return 15% 20% 10%

It is assumed that security returns are generated by a two factor model.

i. Analyse the sensitivity of Mr. Kapoor's portfolio to the two factors if he
has Rs. 1,00,000 to invest and sells short Rs. 50,000 of security Y and
purchases Rs. 1,50,000 of security X.
ii. Evaluate the sensitivity of the portfolio to the two factors if Mr. Kapoor
borrows Rs. 1,00,000 at the risk free rate and invests the amount he
borrows along with the original amount of Rs. 1,00,000 in security X and Y in
the same proportion as described in part (i).
iii. Determine the expected return premium of factor 2?

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Answer:

i. Mr. Kapoor’s position in the two securities is +1.50 in security X and -0.5 in
security Y. Hence the portfolio sensitivities to the two factors:-
b prop. 1 =1.50 x 0.75 + (-0.50 x 1.50) = 0.375
b prop. 2 = 1.50 x 0.60 + (-0.50 x 1.10) = 0.35

ii. Mr. Kapoor’s current position:

iii. Expected Return = Risk Free Rate of Return + Risk Premium

Let λ1 and λ2 are the Value Factor 1 and Factor 2 respectively.
Accordingly
15 = 10 + 0.75 λ1 + 0.60 λ2
20 = 10 + 1.50 λ1 + 1.10 λ2
On solving equation, the value of λ1 and λ2 comes 6.67 and 0 respectively.
Accordingly, the expected risk premium for the factor 2 shall be Zero and
whatever be the risk the same shall be on account of factor 1.
Alternatively, the risk premium of Securities X & Y can be calculated as follows:
Security X
Total Return = 15%
Risk Free Return = 10%
Risk Premium = 5%
Security Y
Total Return = 20%
Risk Free Return = 10%
Risk Premium = 10%

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Question 18.

Bond Valuation

The following data are available for three bonds A, B and C. These bonds are
used by a bond portfolio manager to fund an outflow scheduled in 6 years.
Current yield is 9%. All bonds have face value of Rs.100 each and will be
redeemed at par. Interest is payable annually.

Bond Maturity (Years) Coupon rate

A 10 10%
B 8 11%
C 5 9%

i. Calculate the duration of each bond.

ii. Advise the percentage amount to bond portfolio manager to be invested in
bonds B and C to immunise the portfolio and he has been asked to keep
45% of the portfolio money in Bond A.
iii. Evaluate whether the portfolio is still immunized if after the portfolio has
been formulated, an interest rate change occurs, increasing the yield to
11%. The new duration of bonds are:
Bond A = 7.15 Years, Bond B = 6.03 Years and Bond C = 4.27 years.
iv. Advise the new percentage of B and C bonds that are needed to
immunize the portfolio. Bond A remaining at 45% of the portfolio.

Present values be used as follows :

Present
t1 t2 t3 t4 t5
Values
PVIF0.09, t 0.917 0.842 0.772 0.708 0.650

Present
t6 t7 t8 t9 t10
Values
PVIF0.09, t 0.596 0.547 0.502 0.460 0.4224

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Answer:

i. Calculation of Bond Duration

Bond A

Duration of the bond is 6.862 years or 6.86 year

Bond B

Duration of the bond B is 5.833 years or 5.84 years

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Bond C

Duration of the bond C is 4.242 years or 4.24 years

ii. Amount of Investment required in Bond B and C

Period required to be immunized 6.000 Year

Less: Period covered from Bond A 3.087 Year
To be immunized from B and C 2.913 Year
Let proportion of investment in Bond B and C is b and c respectively then
b + c = 0.55 (1)
5.883b + 4.242c = 2.913 (2)
On solving these equations, the value of b and c comes 0.3534 or
0.3621 and 0.1966 or 0.1879 respectively and accordingly, the % of
investment of B and C is 35.34% or 36.21% and 19.66 % or 18.79%
respectively.

iii. With revised yield the Revised Duration of Bond stands

0.45 x 7.15 + 0.36 x 6.03 + 0.19 x 4.27 = 6.20 year
No portfolio is not immunized as the duration of the portfolio has been
increased from 6 years to 6.20 years.

iv. New percentage of B and C bonds that are needed to immunize the portfolio.
Period required to be immunized 6.0000 Year
Less: Period covered from Bond A 3.2175 Year
To be immunized from B and C 2.7825 Year

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Let proportion of investment in Bond B and C is b and c respectively,

then b + c = 0.55
6.03b + 4.27c = 2.7825
b = 0.2466
On solving these equations, the value of b and c comes 0.2466 and 0.3034
respectively and accordingly, the % of investment of B and C is 24.66% or
25% and 30.34 % or 30.00% respectively.

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Question 19.

Interest Rate Risk Management

Derivative Bank entered into a swap arrangement on a principal of ` 10 crores

and agreed to receive MIBOR overnight floating rate for a fixed payment on
the principal. The swap was entered into on Monday, 19th August, 2019 and was
to commence on 20th August, 2019 and run for a period of 7 days.
Respective MIBOR rates for Tuesday to Monday were:
8.15%, 7.98%, 7.95%, 8.12%, 8.15%, 7.75%.
If Fixed Rate of Interest is 8%, then evaluate
i. the nature of this Swap arrangement.
ii. the Net Settlement amount.

Notes:
1. Sunday is Holiday.
2. Work in rounded rupees and avoid decimal working.
3. Consider 365 days in a year.

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Answer:

i. The given swap arrangement is Plain Vanilla Overnight Index Swap (OIS).

ii. To compute the Net Settlement amount we shall compute Interest as

per floating rate as follows:

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Question 20.

Nostro

You as a dealer in foreign exchange have the following position in GBP on 31 st

October, 2019:

GBP
Balance in the Nostro A/c Credit 2,00,000
Opening Position Overbought 1,00,000
Purchased a bill on London 1,60,000
Sold forward TT 1,20,000
Forward purchase contract cancelled 60,000
Remitted by TT 1,50,000
Draft on London cancelled 60,000

Decide the steps would you take, if you are required to maintain a credit Balance of
GBP 65,000 in the Nostro A/c and keep as oversold position on GBP 20,000?

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Answer:

Exchange Position:

Cash Position (Nostro A/c)

The Bank has to buy spot TT GBP 15,000 to increase the balance in Nostro account to
GBP 65,000. This would bring the overbought position on GBP to 5,000.
Since the bank requires an oversold position of GBP 20,000, it has to sell forward GBP
25,000.

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Question 21.

Mutual Fund

Mr. Y has invested in the three mutual funds (MF) as per the following details:

Particulars MF ‘X’ MF ‘Y’ MF ‘Z’

Amount of Investment (`) 2,00,000 4,00,000 2,00,000
Net Assets Value (NAV) at the time of purchase (`) 10.30 10.10 10
Dividend Received up to 31.03.2018 (`) 6,000 0 5,000
NAV as on 31.03.2018 (`) 10.25 10 10.20
Effective Yield per annum as on 31.03.2018 9.66 -11.66 24.15
(percent)
Assume 1 Year = 365 days
Mr. Y has misplaced the documents of his investment. Help him in finding the date of
his original investment after ascertaining the following:
i. Number of units in each scheme;
ii. Total NAV;
iii. Total Yield; and
iv. Number of days investment held.

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Answer:

i. Number of Units in each Scheme

ii. Total NAV on 31.03.2018

iii. Total Yield

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iv. No. of Days Investment Held

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Question 22.

Types of Risk

TRC Cables Ltd. (an Indian Company) is in the business of manufacturing Electrical
Cables and Data Cables including Fiber Optics cables. While mainly it exports
the manufactured cables to other countries it has also established its
production facilities at some African countries’ due availability of raw material
and cheap labour there. Some of the major raw material such as copper,
aluminum and other non-ferrous metals are also imported from foreign countries.
Hence overall TRC has frequent receipts and expenditure items denominated in Non-
INR currencies.

Though TRC make use of Long-Term Debts and Equity to meet its long term fund
requirements but to finance its operations it make use of short-term financial
instruments such as Commercial Papers, Bank Credit and Term Loans from the banks
etc. If any surplus cash is left with TRC it is invested in interest yielding securities.
Recently due to stiff competition from its competitors TRC has relaxed its policy for
granting credit and to manage receivables it has formed a separate credit
division.

Further to hedge itself against the various risk it has entered into various OTC
Derivatives Contracts settled outside the Exchange.

Required:
Evaluate the major risks to which TRC Ltd. is exposed to.

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Answer:

Following are main categories of risks to which TRC Cables is exposed to:

i. Financial Risks: TRC is exposed to following financial risks:

1. Currency Risk: Since most of the Receipts and Payments of TRC are
denominated in Non-INR currencies it is exposed to Currency Risk.
2. Commodity Risk: As major constituents of production of TRC are
commodities such copper, aluminum etc. it is subject to Commodity Risk.
3. Interest Rate Risk: As TRC borrows and invest money in short-term
instruments it is exposed to Interest Rate Risk.
4. Counter Party Risk: Due to relaxation of norms for granting credits
certainly the receivable amount must have increased resulting in increased
in Credit Risk.
5. Liquidity Risk: Since for short-term funding requirements TRC is using
Commercial Papers etc. they are exposed to Liquidity Risk as in time of need
if funds are not available from these sources then securities shall be sold at
discounted price.
6. Political Risk: As TRC is operating in various other countries it is also
exposed to Political Risks such as Restriction on Conversion of local
earnings into foreign currency, restrictions on remittance etc.
ii. Settlement Risk: The use of OTC Derivatives by TRC also expose it to the
settlement risk as the parties with whom it has entered into the contract may
not honor the same.

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Question 23.

Commodity

A company is long on 10 MT of copper @ ` 534 per kg (spot) and intends to remain

so for the ensuing quarter. The variance of change in its spot and future prices
are 16% and 36% respectively, having correlation coefficient of 0.75. The contract
size of one contract is 1,000 kgs.

Required:

i. Calculate the Optimal Hedge Ratio for perfect hedging in Future Market.
ii. Advice the position to be taken in Future Market for perfect hedging.
iii. Determine the number and the amount of the copper futures to achieve a
perfect hedge.

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Answer:

i. The optional hedge ratio to minimize the variance of Hedger’s position is given
by:

Where
σS= Standard deviation of ΔS (Change in Spot Prices)
σF=Standard deviation of ΔF (Change in Future Prices)
ρ= coefficient of correlation between ΔS and ΔF
H= Hedge Ratio
ΔS = change in Spot price.
ΔF= change in Future price.

Accordingly
Standard deviation of ΔS = √16% = 4% and
Standard deviation of ΔF = √36% = 6% and

ii. Since the company is long position in Spot (Cash) Market it shall take Short
Position in Future Market.

iii. Since contact size of one contract is 1,000 Kg, the

Amount = 5000 x ` 534 = ` 26,70,000

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Question 24.

Portfolio Management

Mr. Abhishek is interested in investing ` 2,00,000 for which he is considering

following three alternatives:

i. Invest ` 2,00,000 in Mutual Fund X (MFX)

ii. Invest ` 2,00,000 in Mutual Fund Y (MFY)
iii. Invest ` 1,20,000 in Mutual Fund X (MFX) and ` 80,000 in Mutual Fund Y (MFY)

Average annual return earned by MFX and MFY is 15% and 14% respectively. Risk
free rate of return is 10% and market rate of return is 12%.

Covariance of returns of MFX, MFY and market portfolio Mix are as follow:

You are required to calculate:

i. variance of return from MFX, MFY and market return,

ii. portfolio return, beta, portfolio variance and portfolio standard deviation,
iii. expected return, systematic risk and unsystematic risk; and
iv. Sharpe ratio, Treynor ratio and Alpha of MFX, MFY and Portfolio Mix

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Answer:

i. Variance of Returns

ii. Portfolio return, beta, variance and standard deviation

Accordingly Portfolio Return

0.60 × 15% + 0.40 × 14% = 14.60%

Beta of each Fund

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Portfolio Beta
0.60 x 1.087 + 0.40 x 0.903 = 1.013

Portfolio Variance

iii. Expected Return, Systematic and Unsystematic Risk of Portfolio

Portfolio Return = 10% + 1.013 (12% - 10%) = 12.03%

MF X Return = 10% + 1.087(12% - 10%) = 12.17%
MF Y Return = 10% + 0.903(12% - 10%) = 11.81%

Systematic Risk = β2 σ2

Accordingly,
Systematic Risk of MFX = (1.087)2 x 3.10 = 3.663
Systematic Risk of MFY = (0.903)2 x 3.10 = 2.528
Systematic Risk of Portfolio = (1.013)2 x 3.10 = 3.181
Unsystematic Risk = Total Risk – Systematic Risk
Accordingly,
Unsystematic Risk of MFX = 4.80 – 3.663 = 1.137
Unsystematic Risk of MFY = 4.250 – 2.528 = 1.722
Unsystematic Risk of Portfolio = 4.472 – 3.181 = 1.291

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iv. Sharpe and Treynor Ratios and Alpha

Sharpe Ratio

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Question 25.

Mutual Fund

There are two Mutual Funds viz. D Mutual Fund Ltd. and K Mutual Fund Ltd. Each
having close ended equity schemes.

NAV as on 31-12-2019 of equity schemes of D Mutual Fund Ltd. is ` 70.71

(consisting 99% equity and remaining cash balance) and that of K Mutual Fund
Ltd. is 62.50 (consisting 96% equity and balance in cash).

Following is the other information:

Equity Schemes
Particular
D Mutual Fund Ltd. K Mutual Fund Ltd.
Sharpe Ratio 2 3.3
Treynor Ratio 15 15
Standard deviation 11.25 5

There is no change in portfolios during the next month and annual average
cost is ` 3 per unit for the schemes of both the Mutual Funds.

If Share Market goes down by 5% within a month, calculate expected NAV after a
month for the schemes of both the Mutual Funds.

For calculation, consider 12 months in a year and ignore number of days fo r

particular month.

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Answer:

Working Notes:

i. Decomposition of Funds in Equity and Cash Components

ii. Calculation of Beta

iii. Decrease in the Value of Equity

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iv. Balance of Cash after 1 month

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Question 26.

International Financial Management

Suppose you are a treasurer of XYZ plc in the UK. XYZ have two overseas subsidiaries,
one is based in Amsterdam and another in Switzerland. The surplus position of funds
in hand is as follows which it does not need for the next three months but will be
needed at the end of that period (91 days).

Holding Company £ 150,000

Swiss Subsidiary CHF 1,996,154
Dutch Subsidiary € 1,450,000

Exchange Rate as on date are as follows:

Spot Rate (€) £0.6858 - 0.6869

91 day Pts 0.0037 0.0040
Spot Rate (£) CHF 2.3295 - 2.3326
91 day Pts 0.0242 0.0228

91-Day Interest rates on p.a. basis on the Deposits in Money Market are as follows:

Amount of Currency £ € CHF

0 – 200,000 1.00 0.25 Nil
200,001 – 1,000,000 2.00 1.50 0.25
1,000,001 – 2,000,000 4.00 2.00 0.50
Over 2,000,000 5.38 3.00 1.00

You have been approached by your banker wherein the above-mentioned

surplus was lying, requesting you to swap the surplus lying with other two
subsidiaries and place them in deposit with them.

Determine the minimum interest rate per annuam (upto 3 decimal points) that
should be offered by the bank to your organization so that your organization is ready
to undertake such swap arrangement.

Note: Consider 360 days a year.

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Answer:

XYZ plc shall be ready to undertake this swap arrangement only if it receives the
interest on the surplus funds if invested on individual basis as follows:

Swap to Sterling

Thus, the minimum rate that should be offered is 4.023%.

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Question 27.

Interest Rate Risk Management

Two companies ABC Ltd. and XYZ Ltd. approach the DEF Bank for FRA (Forward Rate
Agreement). They want to borrow a sum of ` 100 crores after 2 years for a
period of 1 year. Bank has calculated Yield Curve of both companies as follows:

Year XYZ Ltd. ABC Ltd.*

1 3.86 4.12
2 4.20 5.48
3 4.48 5.78

*The difference in yield curve is due to the lower credit rating of ABC Ltd.
compared to XYZ Ltd.

i. You are required to calculate the rate of interest DEF Bank would quote under
2V3 FRA, using the company’s yield information as quoted above.
ii. Suppose bank offers Interest Rate Guarantee for a premium of 0.1% of the
amount of loan, you are required to calculate the interest payable by XYZ Ltd. if
interest rate in 2 years turns out to be
a. 4.50%
b. 5.50%

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Answer:

i. DEF Bank will fix interest rate for 2V3 FRA after 2 years as follows:

ii.

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Question 28.

Interest Rate Risk Management

Espaces plc is consumer electronics wholesaler. The business of the firm is

highly seasonal in nature. In 6 months of a year, firm has a huge cash deposits and
especially near Christmas time and other 6 months firm cash crunch, leading to
borrowing of money to cover up its exposures for running the business.

It is expected that firm shall borrow a sum of £25 million for the entire
period of slack season in about 3 months.

The banker of the firm has given the following quotations for Forward Rate
Agreement (FRA):

Spot 5.50% - 5.75%

3 × 6 FRA 5.59% - 5.82%
3 × 9 FRA 5.64% - 5.94%

3-month £50,000 future contract maturing in a period of 3 months is quoted at

94.15.

You are required to:

a. Advise the position to be taken in Future Market by the firm to hedge its
interest rate risk and demonstrate how 3 months Future contract shall be
useful for the firm, if later interest rate turns out to be (i) 4.5% and (ii) 6.5%
b. Evaluate whether the interest cost to Espace plc shall be less had it adopted
the route of FRA instead of Future Contract.

Note:- Ignore the time value of money in settlement amount for future contract.

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Answer:

a.
i. Since firm is a borrower it will like to off-set interest cost by profit
on Future Contract. Accordingly, if interest rate rises it will gain hence it
should sell interest rate futures.

ii. The final outcome in the given two scenarios shall be as follows:

b. No, the interest cost shall not be less for Espace plc had it taken the route of
FRA, as the 3 x 9 FRA contract are available at 5.64% – 5.94% i.e. borrowing
rate of 5.94%. Hence, the interest cost under this option shall be nearby by
5.94% which is more than interest rate under Future contract rate of 5.85%.

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Question 29.

Forex

Telereal Trillium, a UK Company is in the process of negotiating an order amounting

€5.5 million with a large German retailer on 6 month’s credit. If successful, this will
be first time for Telereal Trillium has exported goods into the highly competitive
German Market. The Telereal Trillium is considering following 3 alternatives for
managing the transaction risk before the order is finalized.

i. Mr. Grand, the Marketing head has suggested that in order to remove
transaction risk completely Telereal Trillium should invoice the German
firm in Sterling using the current €/£ average spot rate to calculate the
invoice amount.

ii. Mr. John, CE is doubtful about Mr. Grand’s proposal and suggested an alter
native of invoicing the German firm in € and using a forward exchange contract
to hedge the transaction risk.

iii. Ms. Royce, CFO is agreed with the proposal of Mr. John to invoice the German
first in €, but she is of opinion that Telereal Trillium should use sufficient 6
month sterling future contracts (to the nearest whole number) to hedge the
transaction risk.

Following data is available

Spot Rate € 1.1980 - €1.1990/£

6 months forward points 0.60 – 0.55 Euro Cents.
6 month future contract is currently trading at € 1.1943/£
6 month future contract size is £70,500
After 6 month Spot rate and future rate € 1.1873/£

You are required to

a. Advise the alternative you consider to be most appropriate.

b. Interpret the proposal of Mr. Grand from non-financial point of view.

Note: Calculate (to the nearest £) the £ receipt.

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Answer:

a. (i) Receipt under three proposals

Proposal of option (ii) is preferable because the option (i) & (iii)
produces least receipts.

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b. Further, in case of proposal (i) there must be a doubt as to whether this

would be acceptable to German firm as it is described as a competitive market
and Telereal Trillium is moving into it first time.

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Question 30.

Mutual Fund

The following particulars relating to S Fund Schemes:

Particulars Value ` in Crores

1. Investment in Shares (at cost)
a. Pharmaceuticals companies 158
b. Construction Industries 62
c. Service Sector Companies 112
d. IT Companies 68
e. Real Estate Companies 20
2. Investment in Bonds (Fixed Income)
a. Listed Bonds (8000, 14% Bonds of ` 15,000 each) 24
b. Unlisted Bonds 14
3. No. of Units outstanding (crores) 8.4
4. Expenses Payable 7
5. Cash and Cash equivalents 3
6. Market expectations on listed bonds 8.842%

The fund has incurred the following expenses:

Consultancy and Management fees ` 520 Lakhs

Office Expenses ` 180 Lakhs
Advertisement Expenses ` 48 Lakhs

Particulars relating to each sector are as follows:

Sector Index on Purchase date Index on Valuation date

Pharmaceutical companies 300 500
Construction Industries 275 490
Service Sector Companies 285 500
IT Companies 270 515
Real Estate Companies 265 440

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Required:

i. Calculate the Net Asset Value of the fund

ii. Calculate the Net Asset Value per unit
iii. Determine the Net return (Annualized), if the period of consideration is 4
years, and the fund has distributed ` 2 per unit per year as cash dividend
during the same period.

Note: Calculate figure in ` Crore upto 3 decimal points.

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Answer:

i. Calculation of NAV of the Fund

ii. NAV of the Fund per Unit

NAV of the Fund ` 781.209 crore

Number of Units 8.40 crore
NAV Per Unit (` 781.209 crore/ 8.40 crore) ` 93.00

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iii. Net Return

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Question 31.

Bond Valuation

In March 2020, XYZ Bank sold some 7% Interest Rate Futures underlying
Notional 7.50% Coupon Bonds. The exchange provides following details of
eligible securities that can be delivered:

Security Quoted Price of Bonds Conversion Factor

7.96 GOI 2023 1037.40 1.0370
6.55 GOI 2025 926.40 0.9060
6.80 GOI 2029 877.50 0.9195
6.85 GOI 2026 972.30 0.9643
8.44 GOI 2027 1146.30 1.1734
8.85 GOI 2028 1201.70 1.2428

Recommend the Security that should be delivered by the XYZ Bank if Future
Settlement Price is 1000.

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Answer:

The XYZ Bank shall choose those CTD (Cheapest-to-Deliver) Bonds from the
basket of deliverable Bonds which gives maximum profit computed as follows:

Profit = Future Settlement Price x Conversion Factor – Quoted Spot Price of

Deliverable Bond

Accordingly, the profit of each bond shall be computed as follows:

Since maximum profit to the Bank is in case of 6.80 GOI 2029, same should be opted
for.

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Question 32.

Derivatives

Mr. Dayal is interested in purchasing equity shares of ABC Ltd. which are
currently selling at Rs. 600 each. He expects that price of share may go upto Rs.
780 or may go down to Rs. 480 in three months. The chances of occurring such
variations are 60% and 40% respectively. A call option on the shares of ABC Ltd.
can be exercised at the end of three months with a strike price of Rs. 630.

i. Advise what combination of share and option should Mr. Dayal select if he
wants a perfect hedge?
ii. Evaluate the value of option today (the risk free rate is 10% p.a.)?
iii. Interpret the expected rate of return on the option?

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Answer:

i. To compute perfect hedge we shall compute Hedge Ratio (Δ) as follows:

Mr. Dayal should purchase 0.50 share for every 1 call option.

ii. Value of Option today

If price of share comes out to be Rs.780 then value of purchased share will be:
Sale Proceeds of Investment (0.50 x Rs. 780) Rs. 390
Loss on account of Short Position (Rs. 780 – Rs. 630) Rs. 150
Rs. 240

If price of share comes out to be Rs. 480 then value of purchased share will be:
Sale Proceeds of Investment (0.50 x Rs. 480) Rs. 240

Accordingly, Premium say P shall be computed as follows:

(Rs. 300 – P) 1.025 = Rs. 240
P = Rs.65.85

iii. Expected Return on the Option

Expected Option Value = (Rs. 780 – Rs. 630) × 0.60 + Rs. 0 × 0.40 = Rs. 90

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Question 33.

EMH

The closing value of Sensex for the month of October, 2007 is given below :

Date Closing Sensex Value

1.10.07 2800
3.10.07 2780
4.10.07 2795
5.10.07 2830
8.10.07 2760
9.10.07 2790
10.10.07 2880
11.10.07 2960
12.10.07 2990
15.10.07 3200
16.10.07 3300
17.10.07 3450
19.10.07 3360
22.10.07 3290
23.10.07 3360
24.10.07 3340
25.10.07 3290
29.10.07 3240
30.10.07 3140
31.10.07 3260

With the help of above data evaluate the weak form of efficient market hypothesis
by applying the run test at 5% and 10% level of significance.

Following value can be used:

Value of t at 5% is 2.101 at 18 degrees of freedom

Value of t at 10% is 1.734 at 18 degrees of freedom

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Answer:

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Since too few runs in the case would indicate that the movement of prices is
not random. We employ a two- tailed test the randomness of prices.

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

The lower limit

As seen r lies between these limits. Hence, the market exhibits weak form of
efficiency.

*For a sample of size n, the t distribution will have n-1 degrees of freedom.

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Question 34.

VAR

ABC Ltd. is considering a project X, which is normally distributed and has mean return
of Rs. 2 crore with Standard Deviation of Rs. 1.60 crore.

In case ABC Ltd. loses on any project more than Rs. 1.00 crore there will be financial
difficulties. Determine the probability the company will be in financial difficulty.

Given: Standard Normal Distribution Table (Z-Score) providing area between Mean
and Z score

Z Score Area
1.85 0.4678
1.86 0.4686
1.87 0.4693
1.88 0.4699
1.89 0.4706

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Answer:

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

Corresponding area from Z Score Table by using interpolation shall be found as

follows:

Thus the Value of 1.875 shall be = 0.4693 + 0.0003 = 0.4696

Thus the probability the company shall be in financial difficulty is 46.96%.

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Question 35.

Forex

On 1st February 2020, XYZ Ltd. a laptop manufacturer imported a particular

type of Memory Chips from SKH Semiconductor of South Korea. The payment is due
in one month from the date of Invoice, amounting to 1190 Million South Korean Won
(SKW). Following Spot Exchange Rates (1st February) are quoted in two different
markets:

USD/ INR 75.00/ 75.50 in Mumbai

USD/ SKW 1190.00/ 1190.75 in New York

Since hedging of Foreign Exchange Risk was part of company’s strategic policy and no
contract for hedging in SKW was available at any in-shore market, it
approached an off-shore Non- Deliverable Forward (NDF) Market for hedging the
same risk.

In NDF Market a dealer quoted one-month USD/ SKW at 1190.00/1190.50 for

notional amount of USD 100,000 to be settled at reference rate declared by Bank of
Korea.

After 1 month (1st March 2020) the dealer agreed for SKW 1185/ USD as rate for
settlement and on the same day the Spot Rates in the above markets were as
follows:

USD/ INR 75.50/ 75.75 in Mumbai

USD/ SKW 1188.00/ 1188.50 in New York

Analyze the position of company under each of the following cases, comparing with
Spot Position of 1st February:

i. Do Nothing.
ii. Opting for NDF Contract.

Note: Both Rs./ SKW Rate and final payment (to be computed in Rs. Lakh) to
be rounded off upto 4 decimal points.

Sanjay Saraf Sir 84 | P a g e

 Strategic Financial Management – Marathon

Answer:

i. Do Nothing

We shall compute the cross rates in Spot Market on both days and shall
compare the amount payable in INR on these two days.

On 1st February 2020

Rupee – Dollar selling rate = Rs. 75.50
Dollar – SKW = SKW 1190.00
Rupee – SKW cross rate = Rs. 75.50 / 1190.00
= Rs. 0.0634

Amount payable to Importer as per above rate (1190 Million x Rs. 0.0634) Rs.
754.4600 Lakh

On 1st March 2020 Rupee – Dollar selling rate = Rs. 75.75

Dollar – SKW = SKW 1188.00
Rupee – SKW cross rate = Rs. 75.75 / 1188.00
= Rs. 0.0638

Amount payable to Importer as per above rate (1190 Million x Rs. 0.0638) Rs.
759.2200 Lakh
Thus, Exchange Rate Loss = (Rs. 759.2200 Lakh - Rs. 754.4600 Lakh) Rs. 4.7600
Lakh

ii. Hedging in NDF

Since company needs SKW after one month it will take long position in SKW at
quoted rate of SKW 1190/ USD and after one-month it will reverse its
position at fixing rate of SKW 1187/USD. The profit/ loss position will be as
follows:

Sanjay Saraf Sir 85 | P a g e

 Strategic Financial Management – Marathon

Final Position

Thus, Exchange Rate Loss = (Rs. 756.0347 Lakh - Rs. 754.4600 Lakh) Rs. 1.5747
Lakh

Decision: Since Exchange Loss is less in case of NDF same can be opted for.

Sanjay Saraf Sir 86 | P a g e