PAPER – 2: STRATEGIC FINANCIAL MANAGEMENT

QUESTIONS
Project Planning and Capital Budgeting
1. 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
2. Airborne Ltd. wants to take advantage of a new government scheme of connecting smaller
towns and wants to purchase one-turboprop airplane at a cost of ` 5 crores. It has obtained
permission to fly on 4 sectors.
The company had provided the following estimates of its costs and revenues. The cost of
capital is 16% and the company depreciates its assets over a period of 25 years on a
straight-line basis. Currently it is operating in a 30% tax regime and under the new
government scheme it enjoys a 100% tax waiver for the first 3 years.
 Passenger Capacity of the aircraft: 60 passengers
 Expected Operational Capacity: 80%
 Per aircraft no. of trips on a daily basis: 4
Amount in (`)
Average realization per passenger 2,000
Annual Cost of Manpower 2,50,00,000
Airport handling charges - Fixed per day 10,000
Annual Repairs and Maintenance 5,00,00,000
Daily Operating Costs 75,000

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 76 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

The costs with the exception of Airport handling charges are expected to increase 10%
year on year and the Operational Capacity would go up to 90% from Year 3.
The certainty of achieving the projected cash flows in the first five years are 0.8, 0.9, 0.75,
0.7 and 0.7 and PV at 16% are 0.862, 0.743, 0.641,0.552, 0.476 respectively.
Advise the management on the feasibility of the project, assuming the aircraft operates on
all the 365 days in a year.
Leasing Decisions
3. Robust Tech, an IT company had purchased printers 5 years ago which are due for
replacement. The cost of the printers was ` 75,00,000 and the company depreciates these
class of assets on a straight-line basis for 10 years. The printers are expected to realize
` 7,50,000.
There is a proposal to replace all the printers in the company and as a Finance Manager;
you are presented with the following alternatives:
Proposal 1: Purchase a new Class of sophisticated network printers at a cost of
` 1,00,00,000 which would be depreciated over a period of 5 years and expected to realize
` 10,00,000 at the end. The purchase could either be funded through a loan at 14%
repayable in 5 equal annual installments at the end of the year. PVAF at 14% for 5 years
is 3.433
OR
Proposal 2: Help Printers Ltd. had submitted a proposal to take over the existing printers
and provide on rent the new class of sophisticated network printers for the next 5 years at
an annual rental of ` 18,00,000 payable at the end of the year with a clause to increase
the rentals by ` 2,00,000 on an annual basis.
You are required to suggest the best alternative to the management assuming the
company's income tax rate is 50% and discount rate is 7%.
You may ignore realization of scrap value and their short term capital gains/loss under both
the options.
Year 1 2 3 4 5
PV@7 % 0.935 0.873 0.816 0.763 0.713
Dividend Decisions
4. The following information is given for QB Ltd.
Earning per share ` 12
Dividend per share ` 3
Cost of capital 18%

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 77

Internal Rate of Return on investment 22%

Retention Ratio 75%
Calculate the market price per share using
(i) Gordon’s formula
(ii) Walter’s formula
5. In December, 2019 AB Co.'s share was sold for ` 146 per share. A long term earnings
growth rate of 7.5% is anticipated. AB Co. is expected to pay dividend of ` 3.36 per share.
(i) What rate of return an investor can expect to earn assuming that dividends are
expected to grow along with earnings at 7.5% per year in perpetuity?
(ii) It is expected that AB Co. will earn about 10% on book Equity and shall retain 60% of
earnings. In this case, whether, there would be any change in growth rate and cost of
Equity?
Indian Capital Market
6. Mr. SG sold five 4-Month Nifty Futures on 1 st February 2020 for ` 9,00,000. At the time of
closing of trading on the last Thursday of May 2020 (expiry), Index turned out to be 2100.
The contract multiplier is 75.
Based on the above information calculate:
(i) The price of one Future Contract on 1 st February 2020.
(ii) Approximate Nifty Sensex on 1 st February 2020 if the Price of Future Contract on
same date was theoretically correct. On the same day Risk Free Rate of Interest and
Dividend Yield on Index was 9% and 6% p.a. respectively.
(iii) The maximum Contango/ Backwardation.
(iv) The pay-off of the transaction.
Note: Carry out calculation on month basis.
7. A Rice Trader has planned to sell 22000 kg of Rice after 3 months from now. The spot
price of the Rice is ` 60 per kg and 3 months Future on the same is trading at ` 59 per kg.
Size of the contract is 1000 kg. The price is expected to fall as low as ` 56 per kg, 3 months
hence.
Required:
(i) to interpret the position of trader in the Cash Market.
(ii) to advise the trader the trader should take in Future Market to mitigate its risk of
reduced profit.

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 78 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

(iii) to demonstrate effective realized price for its sale if he decides to make use of future
market and after 3 months, spot price is ` 57 per kg and future contract price for
closing the contract is ` 58 per kg.
8. 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%
Security Analysis and Valuation
9. Today being 1st January 2019, Ram is considering to purchase an outstanding Corporate
Bond having a face value of ` 1,000 that was issued on 1st January 2017 which has 9.5%
Annual Coupon and 20 years of original maturity (i.e. maturing on 31st December 2027).
Since the bond was issued, the interest rates have been on downside and it is now selling
at a premium of ` 125.75 per bond.
Determine the prevailing interest on the similar type of Bonds if it is held till the maturity
which shall be at Par.
PV Factors:

1 2 3 4 5 6 7 8 9
6% 0.943 0.890 0.840 0.792 0.747 0.705 0.665 0.627 0.592
8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 79

10. The following data is available for NNTC bond:

Face value: ` 1000
Coupon rate: 7.50%
Years to maturity: 8 years
Redemption Value: ` 1000
YTM: 8%
Calculate:
(i) The current market price, duration and volatility of the bond.
(ii) The expected market price if there is a decrease in required yield by 50 bps.
Portfolio Theory
11. A study by a Mutual fund has revealed the following data in respect of three securities:
Security σ (%) Correlation with
Index, Pm
A 20 0.60
B 18 0.95
C 12 0.75
The standard deviation of market portfolio (BSE Sensex) is observed to be 15%.
(i) What is the sensitivity of returns of each stock with respect to the market?
(ii) What are the covariances among the various stocks?
(iii) What would be the risk of portfolio consisting of all the three stocks equally?
(iv) What is the beta of the portfolio consisting of equal investment in each stock?
(v) What is the total, systematic and unsystematic risk of the portfolio in (iv) ?
12. 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%.

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 80 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

Covariance of returns of MFX, MFY and market portfolio Mix are as follow:
MFX MFY Mix
MFX 4.800 4.300 3.370
MFY 4.300 4.250 2.800
Mix 3.370 2.800 3.100
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
Financial Services
13. AC Co. Ltd. has a turnover of ` 1600 Lakhs and is expecting growth of
17.90% for the next year. Average credit period is 100 days. The Bad Debt losses are
about 1.50% on sales. The administrative cost for collecting receivables is ` 8,00,000. The
AC Co. Ltd. decides to make use of Factoring Services by FS Ltd. on terms as under:
(i) that the factor will charge commission of 1.75%.
(ii) 15% Risk with recourse and
(iii) Pay an advance on receivables to AC Co. Ltd. at 14% p.a. interest after withholding
10% as reserve.
You are required to calculate the effective cost of factoring to AC Co. Ltd. for the year.
Show amount in Lakhs of ` with two decimal points. Assume 360 days in a year.
Mutual Fund
14. 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

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 81

There is no change in portfolios during the next month and annual average cost is ` 3 per
unit for the schemes of both the Mutual Funds.
If Share Market goes down by 5% within a month, calculate expected NAV after a month
for the schemes of both the Mutual Funds.
For calculation, consider 12 months in a year and ignore number of days for particular
month.
International Financial Management
15. 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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 82 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

Foreign Exchange Exposure and Risk Management

16. Citi Bank quotes JPY/ USD 105.00 -106.50 and Honk Kong Bank quotes USD/JPY 0.0090
- 0.0093.
(a) Are these quotes identical if not then how they are different.
(b) Is there a possibility of arbitrage?
(c) If there is an arbitrage opportunity, then show how would you make profit from the
given quotation in both cases if you are having JPY 1,00,000 or US$ 1,000.
17. (a) Given:
US$ 1 = ¥ 107.31
£1 = US$ 1.26
A$ 1 = US$ 0.70
(i) Calculate the cross rate for Pound in Yen terms
(ii) Calculate the cross rate for Australian Dollar in Yen terms
(iii) Calculate the cross rate for Pounds in Australian Dollar terms
(b) The current spot exchange rate is $1.35/£ and the three-month forward rate is
$1.30/£. According to your analysis of the exchange rate, you are quite confident that
the spot exchange rate will be $1.32/£ after 3 months.
(i) Suppose you want to speculate in the forward market then what course of action
would be required and what is the expected dollar Profit (Loss) from this
speculation?
(ii) What would be your Profit (Loss) in Dollar terms on the position taken as per
your speculation if the spot exchange rate turns out to be $1.26/£.
Assume that you would like to buy or sell £1,000,000.
Merger, Acquisition & Restructuring
18. Following information is given in respect of WXY Ltd., which is expected to grow at a rate
of 20% p.a. for the next three years, after which the growth rate will stabilize at 8% p.a.
normal level, in perpetuity.
For the year ended March 31, 2014
Revenues ` 7,500 Crores
Cost of Goods Sold (COGS) ` 3,000 Crores
Operating Expenses ` 2,250 Crores
Capital Expenditure ` 750 Crores
Depreciation (included in Operating Expenses) ` 600 Crores

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 83

During high growth period, revenues & Earnings before Interest & Tax (EBIT) will grow at
20% p.a. and capital expenditure net of depreciation will grow at 15% p.a. From year 4
onwards, i.e. normal growth period revenues and EBIT will grow at 8% p.a. and incremental
capital expenditure will be offset by the depreciation. During both high growth & normal
growth period, net working capital requirement will be 25% of revenues.
The Weighted Average Cost of Capital (WACC) of WXY Ltd. is 15%.
Corporate Income Tax rate will be 30%.
Required:
Estimate the value of WXY Ltd. using Free Cash Flows to Firm (FCFF) & WACC
methodology.
The PVIF @ 15 % for the three years are as below:
Year t1 t2 t3
PVIF 0.8696 0.7561 0.6575
19. The following is the Balance-sheet of Grape Fruit Company Ltd as at March 31 st , 2019.
Liabilities (` in lakhs) Assets (` in lakhs)
Equity shares of ` 100 each 600 Land and Building 200
14% preference shares of 200 Plant and Machinery 300
` 100/- each
13% Debentures 200 Furniture and Fixtures 50
Debenture interest accrued 26 Inventory 150
and payable
Loan from bank 74 Sundry debtors 70
Trade creditors 340 Cash at bank 130
Preliminary expenses 10
Cost of issue of 5
debentures
Profit and Loss account 525
1440 1440
The Company did not perform well and has suffered sizable losses during the last few
years. However, it is felt that the company could be nursed back to health by proper
financial restructuring. Consequently the following scheme of reconstruction has been
drawn up :
(i) Equity shares are to be reduced to ` 25/- per share, fully paid up;

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 84 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

(ii) Preference shares are to be reduced (with coupon rate of 10%) to equal number of
shares of ` 50 each, fully paid up.
(iii) Debenture holders have agreed to forgo the accrued interest due to them. In the
future, the rate of interest on debentures is to be reduced to 9 percent.
(iv) Trade creditors will forego 25 percent of the amount due to them.
(v) The company issues 6 lakh of equity shares at ` 25 each and the entire sum was to
be paid on application. The entire amount was fully subscribed by promoters.
(vi) Land and Building was to be revalued at ` 450 lakhs, Plant and Machinery was to be
written down by ` 120 lakhs and a provision of `15 lakhs had to be made for bad and
doubtful debts.
Required:
(i) Show the impact of financial restructuring on the company’s activities.
(ii) Prepare the fresh balance sheet after the reconstructions is completed on the basis
of the above proposals.
Theoretical Questions
20. Write short notes on:
(a) Key decisions that fall within the scope of financial strategy
(b) Market Indicators for Technical Analysis
(c) Difference between Forward Contract and Future Contract
(d) Limitations of Social Cost Benefit Analysis
(e) Manner of purchase of Assets by Asset Reconstruction Companies

SUGGESTED ANSWERS/HINTS

1. Working Notes:
a. Computation of Annual Depreciation-
Particulars `
Purchase Price 26,00,000
Add: 1. Installation Charges 9,000
2. Fees Paid to Consultant for Advice 6,000
Total Cost of New Machine 26,15,000
Useful Life 8 Years
Annual Depreciation (Total Cost/No. of Years) 3,26,875

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 85

b. Computation of Annual Cash Savings-

Particulars `
Annual Earnings 3,15,000
Less-Tax @35% 1,10,250
Earning after Tax 2,04,750
Add-Depreciation on New Machine 3,26,875
Annual Cash Savings 5,31,625
c. Tax effect on sale of Old Machine-
Particulars `
Proceeds of Sale 12,500
Less- Cost of Removal 4,500
Net Proceeds 8,000
Less: WDV 76,000
Net Loss due to Sale 68,000
Tax savings due to Loss on Sale @35% 23,800
Total Cash Inflow due to Sale (` 8,000+` 23,800) 31,800
Computation of Net Present Value
Particulars Period Cash Flow PVF PV
(`) @13% (`)
(a) Annual Cash inflow after Tax 1-8 5,31,625 4.8 25,51,800
(b) Net Salvage Value of Existing 0 31,800 1.0 31,800
Machine
(c) Working Capital Realized 8 17,000 0.376 6,392
Present Value of Cash Inflows 25,89,992
Less: 1. Initial Investment 0 26,15,000 1.0 26,15,000
2. Initial Working Capital 0 17,000 1.0 17,000
NPV of the Proposal (42,008)
Decision: Since NPV of the project is negative it is not viable.
2. Working Notes:
` 5,00,00,000
(i) Depreciation = = ` 20,00,000 Per Annum
25

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 86 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

(ii) Realization from Passenger

Year 1 Year 2 Year 3 Year 4 Year 5
Passenger Capacity 60 60 60 60 60
Exp. Operational 80% 80% 90% 90% 90%
Capacity
No. of Trips per Day 4 4 4 4 4
Average Realization 2,000 2,000 2,000 2,000 2,000
Per Passenger (`)
No. of Days 365 365 365 365 365
Realizations (`) 14,01,60,000 14,01,60,000 15,76,80,000 15,76,80,000 15,76,80,000

(iii) Statement Showing Cost (`)

Year 1 Year 2 Year 3 Year 4 Year 5
Annual Cost of 2,50,00,000 2,75,00,000 3,02,50,000 3,32,75,000 3,66,02,500
Manpower
Airport Handling 36,50,000 36,50,000 36,50,000 36,50,000 36,50,000
Charges
Annual Repair & 5,00,00,000 5,50,00,000 6,05,00,000 6,65,50,000 7,32,05,000
Maintenance
Daily Operating 2,73,75,000 3,01,12,500 3,31,23,750 3,64,36,125 4,00,79,738
Exp.
Total 10,60,25,000 11,62,62,500 12,75,23,750 13,99,11,125 15,35,37,238

(iv) Statement Showing NPV (Amount in `)

Year 1 Year 2 Year 3 Year 4 Year 5
Realizations 14,01,60,000 14,01,60,000 15,76,80,000 15,76,80,000 15,76,80,000
Cost of Operations 10,60,25,000 11,62,62,500 12,75,23,750 13,99,11,125 15,35,37,238
Depreciation 20,00,000 20,00,000 20,00,000 20,00,000 20,00,000
Profit Before Tax 3,21,35,000 2,18,97,500 2,81,56,250 1,57,68,875 21,42,762
Less: Tax ---- --- --- 47,30,663 6,42,829
Profit after Tax 3,21,35,000 2,18,97,500 2,81,56,250 1,10,38,212 14,99,933
Add: Depreciation 20,00,000 20,00,000 20,00,000 20,00,000 20,00,000
3,41,35,000 2,38,97,500 3,01,56,250 1,30,38,212 34,99,933
CE Factor 0.8 0.9 0.75 0.70 0.70
Certain Cash Flow 2,73,08,000 2,15,07,750 2,26,17,188 91,26,748 24,49,953
PVF@16% 0.862 0.743 0.641 0.552 0.476
PV of Cash Inflow 2,35,39,496 1,59,80,258 1,44,97,618 50,37,965 11,66,178
Total PV of Cash Inflow 6,02,21,515

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 87

PV of Cash Ouflow 5,00,00,000

NPV 1,02,21,515
Since NPV is positive Airborne Ltd. should accept the project.
3. Proposal 1
The loan amount is repayable together with the interest at the rate of 14% on loan amount
and is repayable in equal installments at the end of each year. The PVAF at the rate of
14% for 5 years is 3.433, the amount payable will be

Annual Payment = ` 100,00,000 = ` 29,12,904 (rounded)

3.433
Schedule of Debt Repayment
End of Total Payment Interest Principal Principal Amount
Year ` ` ` Outstanding
`
1 29,12,904 14,00,000 15,12,904 84,87,096
2 29,12,904 11,88,193 17,24,711 67,62,385
3 29,12,904 9,46,734 19,66,170 47,96,215
4 29,12,904 6,71,470 22,41,434 25,54,781
5 29,12,904 3,58,123* 25,54,781 ------
* Balancing Figure
Schedule of Cash Outflows: Debt Alternative (Amount in `)
(1) (2) (3) (4) (3) + (4) (5) (6) (7) (8)
End Debt Interest Dep Tax Cash PV PV
of Payment Shield outflows factors
year [(3) + (4)] (2) – (5) @ 7%
0.50
1 29,12,904 14,00,000 18,00,000 32,00,000 16,00,000 13,12,904 0.935 12,27,565
2 29,12,904 11,88,193 18,00,000 29,88,193 14,94,097 14,18,807 0.873 12,38,619
3 29,12,904 9,46,734 18,00,000 27,46,734 13,73,367 15,39,537 0.816 12,56,262
4 29,12,904 6,71,470 18,00,000 24,71,470 12,35,735 16,77,169 0.763 12,79,680
5 29,12,904 3,58,123 18,00,000 21,58,123 10,79,062 18,33,842 0.713 13,07,529
63,09,655

Total present value of Outflows = ` 63,09,655

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 88 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

Proposal 2
(1) (2) (3) (4) (5) (6)
End of Lease Tax Cash outflows PV factors PV
year Rent Shield (2) – (3) @ 7%
1 18,00,000 9,00,000 9,00,000 0.935 8,41,500
2 20,00,000 10,00,000 10,00,000 0.873 8,73,000
3 22,00,000 11,00,000 11,00,000 0.816 8,97,600
4 24,00,000 12,00,000 12,00,000 0.763 9,15,600
5 26,00,000 13,00,000 13,00,000 0.713 9,26,900
44,54,600
Since PV of outflows is lower in the Leasing option, Robust Tech should go for leasing
option to acquire printer.
4. (i) Gordon’s Formula
EPS - Div idend Per Share ` 12 - ` 3
Retention Ratio = = = 0.75 i.e. 75%
EPS ` 12

E(1  b)
P0 =
K  br
P0 = Present value of Market price per share
E = Earnings per share
K = Cost of Capital
b = Retention Ratio (%)
r = IRR
br = Growth Rate
12(1- 0.75)
P0 =
0.18 - (0.75 × 0.22)
3
= = ` 200
0.18 - 0.165

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 89

(ii) Walter’s Formula

Ra
D (E - D)
Rc
Vc =
Rc

Vc = Market Price
D = Dividend per share
Ra = IRR
Rc = Cost of Capital
E = Earnings per share
0.22
`3 (` 12 -` 3)
= 0.18
0.18
` 3 `11
= = ` 77.77
0.18
5. (i) According to Dividend Discount Model approach the firm’s expected or required return
on equity is computed as follows:
D1
e 
K  g
P0

Where,
Ke = Cost of equity share capital
D1 = Expected dividend at the end of year 1
P0 = Current market price of the share.
g = Expected growth rate of dividend.
3.36
Therefore, K e   7.5%
146
= 0.0230 +0.075 = 0.098
Or, Ke = 9.80%

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 90 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

(ii) With rate of return on retained earnings (r) 10% and retention ratio (b) 60%, new
growth rate will be as follows:
G = br i.e.
= 0.10 X 0.60 = 0.06
Accordingly dividend will also get changed and to calculate this, first we shall
calculate previous retention ratio (b1) and then EPS assuming that rate of return on
retained earnings (r) is same.
With previous Growth Rate of 7.5% and r =10% the retention ratio comes out to be:
0.075 = b1 X 0.10
b1 = 0.75 and payout ratio = 0.25
With 0.25 payout ratio the EPS will be as follows:
3.36
= 13.44
0.25
With new 0.40 (1 – 0.60) payout ratio the new dividend will be
D1 = 13.44 X 0.40 = 5.376
Accordingly new Ke will be
5.376
Ke   6.0%
146
or, Ke = 9.68%
Alternatively
EPS with 6% growth rate instead of 7.5%.
1.06
13.44× = 13.25
1.075
With new 0.40 (1 – 0.60) payout ratio the new dividend will be
D1 = 13.25 X 0.40 = 5.30
Accordingly new Ke will be
5.30
Ke   6.0%
146
or, Ke = 9.63%

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 91

6. (i) The price of one Future Contract

Let X be the Price of Future Contract. Accordingly,
Rs. 9,00,000
5=
X

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

Rs. 1,80,000
(ii) Current Future price of the index = = 2400
75
Let Y be the current Nifty Index (on 1 st February 2020) then
4
Accordingly, Y + Y (0.09 - 0.06) = 2400
12
2400
and Y = = 2376.24
1.01
Hence Nifty Index on 1st February 2020 shall be approximately 2376.
(iii) To determine whether the market is in Contango/ Backwardation first we shall
compute Basis as follows:
Basis = Spot Price – Future Price
If Basis is negative the market is said to be in Contango and when it is positive the
market is said to be Backwardation.
Since current Spot Price is 2400 and Nifty Index is 2376, the Basis is negative and
hence there is Contango Market and maximum Contango shall be 24 (2400 – 2376).
(iv) Pay off on the Future transaction shall be [(2400-2100) x 375] ` 112500
The Future seller gains if the Spot Price is less than Futures Contract price as position
shall be reversed at same Spot price. Therefore, Mr. SG has gained Rs. 1,12,500/-
on the Short position taken.
7. (i) Since trader has planned to sell after 3 months now it implies, he is in Long Position
in Cash or Spot Market.
(ii) Since the trader is in Long Position in Cash Market, he can mitigate its risk of reduced
profit by hedging his position by selling Rice Futures i.e. Short Position in Future
Market.

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 92 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

(iii) The gain on futures contract

= (` 59 – ` 58) x 22,000 kg. = ` 22,000
Revenue from the sale of Rice
= 22,000 x ` 57 = ` 12,54,000
Total Cash Flow = ` 12,54,000 + ` 22,000 = ` 12,76,000
` 12,76,000
Cash Flow per kg. of Rice = = ` 58
22,000
8. (i) DEF Bank will fix interest rate for 2V3 FRA after 2 years as follows:
XYZ Ltd.
(1+r) (1+0.0420) 2 = (1+0.0448) 3
(1+r) (1.0420) 2 = (1.0448) 3
r = 5.04%
Bank will quote 5.04% for a 2V3 FRA.
ABC Ltd.
(1+r) (1+0.0548) 2 = (1+0.0578) 3
(1+r) (1.0548) 2 = (1.0578) 3
r = 6.38%
Bank will quote 6.38% for a 2V3 FRA.
(ii)
4.50% - Allow to Lapse 5.50%-Exercise
Interest ` 100 crores X 4.50% ` 4.50 crores -
` 100 crores X 5.04% - ` 5.04 crores
Premium (Cost ` 100 crores X 0.1% ` 0.10 crores ` 0.10 crores
of Option)
4.60 crores 5.14 crores
9. To determine the prevailing rate of interest for the similar type of Bonds we shall compute
the YTM of this Bond using IRR method as follows:
M = ` 1000
Interest = ` 95 (0.095 x ` 1000)

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 93

n = 9 years
V0 = ` 1125.75 (` 1,000 + ` 125.75)
YTM can be determined from the following equation
` 95 × PVIFA (YTM, 9) + ` 1000 × PVIF (YTM, 9) = ` 1125.75
Let us discount the cash flows using two discount rates 8% and 10% as follows:
Year Cash Flows PVF@6% PV@6% PVF@8% PV@8%
0 -1125.75 1 -1125.75 1 -1125.75
1 95 0.943 89.59 0.926 87.97
2 95 0.890 84.55 0.857 81.42
3 95 0.840 79.80 0.794 75.43
4 95 0.792 75.24 0.735 69.83
5 95 0.747 70.97 0.681 64.70
6 95 0.705 66.98 0.630 59.85
7 95 0.665 63.18 0.583 55.39
8 95 0.627 59.57 0.540 51.30
9 1095 0.592 648.24 0.500 547.50
112.37 -32.36
Now we use interpolation formula
112.37
6.00% +  2.00%
112.37 - (- 32.36)

112.37
6.00% +  2.00% = 6.00% + 1.553%
144.73
YTM = 7.553% say 7.55%
Thus, prevailing interest rate on similar type of Bonds shall be approx. 7.55%.
10. (i) Current Market Price of Bond shall be computed as follows:
Year Cash Flows PVF@ 8% PV@8%
1 75 0.926 69.45
2 75 0.857 64.28
3 75 0.794 59.55
4 75 0.735 55.13

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 94 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

5 75 0.681 51.08
6 75 0.630 47.25
7 75 0.583 43.73
8 1075 0.540 580.50
970.97
Thus, the current market price of the Bond shall be ` 970.97.
Alternatively, using the Short-cut method the Market Price of Bond can also be
computed as follows:
Interest+(Discount/Premium)/ Years to maturity
(Face Value + market Value)/2
Let market price be X
0.08 = 75 + (1000-X)/8
(1000+X)/2
Thus, Value of X i.e. the price of Bond shall be ` 969.70
For the duration of the bond, we have to see the future cash flow and discount them as
follows:
Year CF PV@8% DCF Proportion Prop* Time (Yrs)
1 75 0.926 69.45 0.071 0.071
2 75 0.857 64.28 0.066 0.132
3 75 0.794 59.55 0.061 0.183
4 75 0.735 55.13 0.057 0.228
5 75 0.681 51.08 0.053 0.265
6 75 0.630 47.25 0.049 0.294
7 75 0.583 43.73 0.045 0.315
8 1075 0.540 580.50 0.598 4.784
Total 970.97 1.000 6.272
Volatility of the bond= Duration / (1+ Yield) = 6.272/1.08 = 5.81
(ii) If there is decrease in required yield by 50 bps the expected market price of the Bond
shall be increased by:
= ` 970.97  0.50 (5.81/100) = ` 28.21
Hence expected market price is ` 970.97 + ` 28.21 = ` 999.18

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 95

Alternatively, this portion using Bond Price as per Short-cut method can also be
computed as follows:
= ` 969.70  0.50 (5.81/100) = ` 28.17
then the market price will be = ` 969.70 + ` 28.17 = ` 997.87
11. (i) Sensitivity of each stock with market is given by its beta.
Standard deviation of market Index = 15%
Variance of market Index = 0.0225
Beta of stocks = σ i r/ σ m
A = 20 × 0.60/15 = 0.80
B = 18 × 0.95/15 = 1.14
C = 12 × 0.75/15 = 0.60
(ii) Covariance between any 2 stocks = β1β 2 σ 2m
Covariance matrix
Stock/Beta 0.80 1.14 0.60
A 400.000 205.200 108.000
B 205.200 324.000 153.900
C 108.000 153.900 144.000
(iii) Total risk of the equally weighted portfolio (Variance) = 400(1/3) 2 + 324(1/3) 2 +
144(1/3) 2 + 2 (205.20)(1/3) 2 + 2(108.0)(1/3) 2 + 2(153.900) (1/3) 2 = 200.244
0.80  1.14  0.60
(iv) β of equally weighted portfolio = β p =  β i/N =
3
= 0.8467
(v) Systematic Risk β P2 σ m2 = (0.8467) 2 (15) 2 =161.303
Unsystematic Risk = Total Risk – Systematic Risk
= 200.244 – 161.303 = 38.941
12. (i) Variance of Returns
Cov (i, j)
Cor i,j =
σ iσ j

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 96 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

Accordingly, for MFX

Cov (X, X)
1=
σXσX

σ 2X = 4.800
Accordingly, for MFY
Cov (Y, Y)
1=
σYσY

σ 2Y = 4.250
Accordingly, for Market Return
Cov (M,M)
1=
σMσM

σ M2 = 3.100
(ii) Portfolio return, beta, variance and standard deviation
1,20,000
Weight of MFX in portfolio = =0.60
2,00,000
80,000
Weight of MFY in portfolio = =0.40
2,00,000
Accordingly Portfolio Return
0.60 × 15% + 0.40 × 14% = 14.60%
Beta of each Fund
Cov Fund,Market
β
Variance of Market
3.370
β  = 1.087
X 3.100
2.800
β  = 0.903
Y 3.100
Portfolio Beta
0.60 x 1.087 + 0.40 x 0.903 = 1.013

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 97

Portfolio Variance
σ 2XY = w 2X σ 2X + w 2Y σ 2Y + 2 w X w YCov X,Y
= (0.60)2 (4.800) + (0.40)2 (4.250) + 2(0.60) (0.40) (4.300)
= 4.472
Or Portfolio Standard Deviation

σ XY = 4.472 = 2.115
(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 = β 2σ2

Accordingly,
Systematic Risk of MFX = (1.087) 2 x 3.10 = 3.663
Systematic Risk of MFY = (0.903) 2 x 3.10 = 2.528
Systematic Risk of Portfolio = (1.013) 2 x 3.10 = 3.181
Unsystematic Risk = Total Risk – Systematic Risk
Accordingly,
Unsystematic Risk of MFX = 4.80 – 3.663 = 1.137
Unsystematic Risk of MFY = 4.250 – 2.528 = 1.722
Unsystematic Risk of Portfolio = 4.472 – 3.181 = 1.291
(iv) Sharpe and Treynor Ratios and Alpha
Sharpe Ratio
15% - 10%
MFX = = 2.282
4.800
14% - 10%
MFY = = 1.94
4.250

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 98 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

14.6% - 10%
Portfolio = = 2.175
2.115
Treynor Ratio
15% - 10%
MFX = = 4.60
1.087
14% - 10%
MFY = = 4.43
0.903
14.6%  10%
Portfolio = = 4.54
1.013
Alpha
MFX = 15% - 12.17% = 2.83%
MFY = 14% - 11.81% = 2.19%
Portfolio = 14.6% - 12.03% = 2.57%
13. Expected Turnover = ` 1600 lakhs + ` 286.40 = ` 1886.40 lakhs
` in Lacs ` in Lacs
Advance to be given:
Debtors `1886.40 lakhs x 100/360 524.00
Less: 10% withholding 52.40
471.60
Less: Commission 1.75% 9.17
Net payment 462.43
Less: Interest @14% for 100 days on ` 462.43 lacs 17.98
444.45

Calculation of Average Cost:

Total Commission `1886.40 lakhs x 1.75% 33.01
Total Interest ` 17.98 lacs x 360/100 64.73
97.74
Less: Admin. Cost 8.00
Saving in Bad Debts (`1886.40 lacs x 1.50% x 85%) 24.05 32.05
65.69
Effective Cost of Factoring = 65.69/444.45 x 100 14.78%

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 99

14. Working Notes:

(i) Decomposition of Funds in Equity and Cash Components
D Mutual Fund Ltd. K Mutual Fund Ltd.
NAV on 31.12.19 ` 70.71 ` 62.50
% of Equity 99% 96%
Equity element in NAV ` 70 ` 60
Cash element in NAV ` 0.71 ` 2.50
(ii) Calculation of Beta
(a) D Mutual Fund Ltd.
E(R) - R f E(R) - Rf
Sharpe Ratio = 2 = =
σD 11.25
E(R) - Rf = 22.50
E(R) - R f 22.50
Treynor Ratio = 15 = =
βD βD
βD = 22.50/15= 1.50
(b) K Mutual Fund Ltd.
E(R) - R f E(R) - Rf
Sharpe Ratio = 3.3 = =
σK 5
E(R) - Rf = 16.50
E(R) - R f 16.50
Treynor Ratio = 15 = =
βK βK
βK = 16.50/15= 1.10
(iii) Decrease in the Value of Equity
D Mutual Fund Ltd. K Mutual Fund Ltd.
Market goes down by 5.00% 5.00%
Beta 1.50 1.10
Equity component goes down 7.50% 5.50%
(iv) Balance of Cash after 1 month
D Mutual Fund Ltd. K Mutual Fund Ltd.
Cash in Hand on 31.12.19 ` 0.71 ` 2.50
Less: Exp. Per month ` 0.25 ` 0.25
Balance after 1 month ` 0.46 ` 2.25

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 100 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

NAV after 1 month

D Mutual Fund Ltd. K Mutual Fund Ltd.

Value of Equity after 1 month
70 x (1 - 0.075) ` 64.75 -
60 x (1 - 0.055) - ` 56.70
Cash Balance 0.46 2.25
65.21 58.95
15. 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:
Interest Amt. after 91 days Conversion in £
Holland
€ 1,450,000 x 0.02 x £1,004,829.42
91/360 = € 7,330.56 € 1,457,330.56 (1,457,330.56 x 0.6895)
Switzerland
CHF 1,996,154 x 0.005 x £865,303.02
91 / 360 = CHF 2,522.92 CHF 1,998,676.92 (1,998,676.92÷2.3098)
UK
£ 150,000 x 0.01 x
91/360 = £ 379.17 £ 150,379.17 £ 150,379.17
Total GBP at 91 days £ 2,020,511.61
Swap to Sterling
Sell € 1,450,000 (Spot at 0.6858) buy £ £ 994,410.00
Sell CHF 1,996,154 (Spot at 2.3326) buy £ £ 855,763.53
Independent GBP amount £ 150,000.00
£ 2,000,173.53
Amount accrued on Individual Basis (Principal + Interest) £ 2,020,511.61
Interest Required £ 20,338.08
Required Interest Rate on Per Annuam Basis 4.023%
20,338.08 360
× ×100
2,000,173.53 91

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

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 101

16. (a) No, while Citi Bank’s quote is a Direct Quote for JPY (i.e. for Japan) the Hong Kong
Bank quote is a Direct Quote for USD (i.e. for USA).
(b) Since Citi Bank quote imply USD/ JPY 0.0094 - 0.0095 and both rates exceed those
offered by Hong Kong Bank, there is an arbitrage opportunity.
Alternatively, it can also be said that Hong Kong Bank quote imply JPY/ USD 107.53
– 111.11 and both rates exceed quote by Citi Bank, there is an arbitrage opportunity.
(c) Let us how arbitrage profit can be made.
(i) Covert US$ 1,000 into JPY by buying from Hong Kong Bank JPY 1,07,530

Sell these JPY to Citi Bank at JPY/ USD 106.50 and convert in US$ US$ 1009.67

Thus, arbitrage gain (US$ 1009.67 - US$ 1000.00) US$ 9.67

(ii) Covert JPY 1,00,000 into USD by buying from Citi Bank at JPY/ USD 106.50
US$ 938.97

Sell these US$ to Hong Kong Bank at JPY/ USD 107.53 and convert in U S$
JPY 100967.44
Thus, arbitrage gain (JPY 1,00,967.44 - JPY 1,00,000) JPY 967.44
17. (a) (i) Calculate the cross rate for Pounds in Yen terms
1£ = ? ¥
US$1 = ¥ 107.31
£ 1 = US$ 1.26
¥ $ ¥
× =
$ £ £
¥
= 107.31 x 1.26
£
£1 = ¥ 135.21
(ii) Calculate the cross rate for Australian Dollar in Yen terms
A$1 = ¥ ?
US$1 = ¥ 107.31
A$ 1 = US$ 0.70
¥ $ ¥
× =
$ A$ A$

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 102 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

¥
= 107.31 x 0.70
A$
A$ 1 = ¥ 75.12
(iii) Calculate the cross rate for Pounds in Australian Dollar terms
₤ 1 = A$ ?
A$1 = US$ 0.70
US $ 1 = A$ 1.4286
£1 = US$1.26
A$ $ A$
× =
$ £ £
A$
= 1.4286 x 1.26 = 1.80
£
£ 1 = A$ 1.80
(b) (i) If you believe the spot exchange rate will be $ 1.32/£ in three months, you should
buy £ 1,000,000 forward for $1.30/£ and sell at $ 1.32/£ 3 months hence.
Your expected profit will be: £1,000,000 x ($1.32 - $1.30) = $20,000
(ii) If the spot exchange rate turns out to be $1.26/£ in three months, your loss from
the long position in Forward Market will be: -
£ 1,000,000 x ($ 1.26 - $1.30) = $ 40,000
18. Determination of forecasted Free Cash Flow of the Firm (FCFF) (` in crores)
Yr. 1 Yr. 2 Yr 3 Terminal Year
Revenue 9000.00 10800.00 12960.00 13996.80
COGS 3600.00 4320.00 5184.00 5598.72
Operating Expenses 1980.00* 2376.00 2851.20 3079.30
Depreciation 720.00 864.00 1036.80 1119.74
EBIT 2700.00 3240.00 3888.00 4199.04
Tax @30% 810.00 972.00 1166.40 1259.71
EAT 1890.00 2268.00 2721.60 2939.33
Capital Exp. – Dep. 172.50 198.38 228.13 -
∆ Working Capital 375.00 450.00 540.00 259.20
Free Cash Flow (FCF) 1342.50 1619.62 1953.47 2680.13
* Excluding Depreciation.

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 103

Present Value (PV) of FCFF during the explicit forecast period is:
FCFF (` in crores) PVF @ 15% PV (` in crores)
1342.50 0.8696 1167.44
1619.62 0.7561 1224.59
1953.47 0.6575 1284.41
3676.44
PV of the terminal, value is:
2680.13 1
x = ` 38287.57 Crore x 0.6575 = ` 25174.08 Crore
0.15 - 0.08 (1.15)3

The value of the firm is :

` 3676.44 Crores + ` 25174.08 Crores = ` 28,850.52 Crores
19. (a) Impact of Financial Restructuring
(i) Benefits to Grape Fruit Ltd.
(1) Reduction of liabilities payable
` in lakhs
Reduction in equity share capital (6 lakh shares x `75 per 450
share)
Reduction in preference share capital (2 lakh shares x `50 per 100
share)
Waiver of outstanding debenture Interest 26
Waiver from trade creditors (`340 lakhs x 0.25) 85
661
(2) Revaluation of Assets
Appreciation of Land and Building (`450 lakhs - `200 lakhs) 250
Total (X) 911
(ii) Amount of ` 911 lakhs utilized to write off losses, fictious assets and over-valued
assets.
Writing off profit and loss account 525
Cost of issue of debentures 5
Preliminary expenses 10
Provision for bad and doubtful debts 15
Revaluation of Plant and Machinery 120
(`300 lakhs – `180 lakhs)

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 104 FINAL (OLD) EXAMINATION: NOVEMBER, 2020

Total (Y) 675

Capital Reserve (X) – (Y) 236
(b) Balance sheet of Grape Fruit Ltd as at 31 st March 2019 (after re-construction)
(` in lakhs)
Liabilities Amount Assets Amount
12 lakhs equity shares of 300 Land & Building 450
` 25/- each
10% Preference shares of 100 Plant & Machinery 180
` 50/- each
Capital Reserve 236 Furnitures & Fixtures 50
9% Debentures 200 Inventory 150
Loan from Bank 74 Sundry debtors 70
Trade Creditors 255 Prov. for Doubtful Debts -15 55
Cash-at-Bank (Balancing 280
figure)*
1165 1165
*Opening Balance of `130/- lakhs + Sale proceeds from issue of new equity shares
`150/- lakhs.
20. (a) The key decisions falling within the scope of financial strategy are as follows:
1. Financing decisions: These decisions deal with the mode of financing or mix
of equity capital and debt capital.
2. Investment decisions: These decisions involve the profitable utilization of
firm's funds especially in long-term projects (capital projects). Since the future
benefits associated with such projects are not known with certainty, investment
decisions necessarily involve risk. The projects are therefore evaluated in
relation to their expected return and risk.
3. Dividend decisions: These decisions determine the division of earnings
between payments to shareholders and reinvestment in the company.
4. Portfolio decisions: These decisions involve evaluation of investments based
on their contribution to the aggregate performance of the entire corporation
rather than on the isolated characteristics of the investments themselves.

(b) The various market indicators are as follows:

(i) Breadth Index: It is an index that covers all securities traded. It is computed by
dividing the net advances or declines in the market by the number of issues

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traded. The breadth index either supports or contradicts the movement of the
Dow Jones Averages. If it supports the movement of the Dow Jones Averages,
this is considered sign of technical strength and if it does not support the
averages, it is a sign of technical weakness i.e. a sign that the market will move
in a direction opposite to the Dow Jones Averages. The breadth index is an
addition to the Dow Theory and the movement of the Dow Jones Averages.
(ii) Volume of Transactions: The volume of shares traded in the market provides
useful clues on how the market would behave in the near future. A rising
index/price with increasing volume would signal buy behaviour because the
situation reflects an unsatisfied demand in the market. Similarly, a falling market
with increasing volume signals a bear market and the prices would be expected
to fall further. A rising market with decreasing volume indicates a bull market
while a falling market with dwindling volume indicates a bear market. Thus, the
volume concept is best used with another market indicator, such as the Dow
Theory.
(iii) Confidence Index: It is supposed to reveal how willing the investors are to take
a chance in the market. It is the ratio of high-grade bond yields to low-grade
bond yields. It is used by market analysts as a method of trading or timing the
purchase and sale of stock, and also, as a forecasting device to determine the
turning points of the market. A rising confidence index is expected to precede a
rising stock market, and a fall in the index is expected to precede a drop in stock
prices. A fall in the confidence index represents the fact that low-grade bond
yields are rising faster or falling more slowly than high grade yields. The
confidence index is usually, but not always a leading indicator of the market.
Therefore, it should be used in conjunction with other market indicators.
(iv) Relative Strength Analysis: The relative strength concept suggests that the
prices of some securities rise relatively faster in a bull market or decline more
slowly in a bear market than other securities i.e. some securities exhibit relative
strength. Investors will earn higher returns by investing in securities which have
demonstrated relative strength in the past because the relative strength of a
security tends to remain undiminished over time.
Relative strength can be measured in several ways. Calculating rates of return
and classifying those securities with historically high average returns as
securities with high relative strength is one of them. Even ratios like security
relative to its industry and security relative to the entire market can also be used
to detect relative strength in a security or an industry.
(v) Odd - Lot Theory: This theory is a contrary - opinion theory. It assumes that the
average person is usually wrong and that a wise course of action is to pursue
strategies contrary to popular opinion. The odd-lot theory is used primarily to
predict tops in bull markets, but also to predict reversals in individual securities.

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(c) Difference between forward and future contract is as follows:

S. Features Forward Futures
No.
1. Trading Forward contracts are traded on Futures Contracts are traded
personal basis or on telephone in a competitive arena.
or otherwise.
2. Size of Forward contracts are Futures contracts are
Contract individually tailored and have no standardized in terms of
standardized size. quantity or amount as the
case may be.
3. Organized Forward contracts are traded in Futures contracts are traded
exchanges an over the counter market. on organized exchanges with
a designated physical
location.
4. Settlement Forward contracts settlement Futures contracts settlements
takes place on the date agreed are made daily via.
upon between the parties. Exchange’s clearing house.
5. Delivery Forward contracts may be Futures contracts delivery
date delivered on the dates agreed dates are fixed on cyclical
upon and in terms of actual basis and hardly takes place.
delivery. However, it does not mean
that there is no actual
delivery.
6. Transaction Cost of forward contracts is Futures contracts entail
costs based on bid – ask spread. brokerage fees for buy and
sell orders.
7. Marking to Forward contracts are not Futures contracts are subject
market subject to marking to market to marking to market in which
the loss on profit is debited or
credited in the margin
account on daily basis due to
change in price.
8. Margins Margins are not required in In futures contracts every
forward contract. participants is subject to
maintain margin as decided
by the exchange authorities.
9. Credit risk In forward contract, credit risk is In futures contracts the
born by each party and, transaction is a two way
therefore, every party has to transaction, hence the parties
bother for the creditworthiness. need not to bother for the risk.

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(d) Limitations of Social Cost Benefit Analysis are as follows:

(i) Successful application depends upon reasonable accuracy and dependability of
the underlying forecasts as well as assessment of intangibles.
(ii) Technique does not indicate whether given project evaluated on socio-economic
considerations is best choice to reach national goals or whether same resources
if employed in another project would yield better results.
(iii) Cost of evaluation by such technique could be enormous for smaller projects.
(iv) Social Cost Benefit Analysis takes into consideration those aspects of social
costs and benefits which can be quantified. Other aspects like happiness,
satisfaction, aesthetic pleasure, better quality of life cannot be quantified.
(e) The Asset Reconstruction Companies purchase assets in the following manner and
the whole process is closely monitored by the banking regulator:
(i) Raising Funds - Asset Reconstruction Companies are allowed to raise funds
from Qualified Institutional Buyers only in order to make payment to buy
discounted debts from banks. They raise fund through the issue of security
receipts to QIB’s. The security receipt gives the QIB a right, title or interest in
the financial asset that is brought by the ARC. ARC’s also issues debt
instruments or even sells equity to raise funds. Further, they have to take a
special precaution that retail investors are excluded from it. The reason is that
ARC’s are highly risky and only QIB’s are able to withstand such risk in case of
a loss.
(ii) Partnership Method – Many times, ARC’s do not directly buy debts from the
banks. They remain on the banks books. And, the bank hires the ARC to do the
debt recovery process. Whatever revenue generated is divided between banks
and ARC in a predetermined manner.

© The Institute of Chartered Accountants of India