Suggested Answers to Question —AFM

FINAL EXAMINATION
GROUP III
(SYLLABUS 2008)

SUGGESTED ANSWERS TO QUESTIONS

JUNE 2013

Paper- 12 : FINANCIAL MANAGEMENT & INTERNATIONAL FINANCE

Time Allowed : 3 Hours Full Marks : 100

The figures in the margin on the right side indicate full marks. Please
(i) Answer all bits of a question at one place.
(ii) Open a new page for answer to a new question.
(iii) T ick the question number answered on the front sheet of the answer-book.
Answer Question No. 1 from Part A which is compulsory and any five questions from Part B.

PART - A (25 Marks)

1. (a) In each of the cases given below, one out of four answers is correct. Indicate the correct
answer (= 1 mark) and give workings/reasons briefly in support of your answer (= 1 mark) :
(i) What is the opportunity cost of not taking a discount, when the credit terms are 2/20 net 45?
Assume 1 year = 360 days
(A) 24.9%
(B) 29.4%
(C) 22.9%
(D) 29.2%
(ii) E Limited has earnings before interest and taxes (EBIT) of ` 10 million at a cost of 7%., Cost
of equity is 12.5%. Ignore taxes. What is the overall cost of capital?
(A) 11.26%
(B) 11.62%
(C) 16.12%
(D) 12.61%

(iii) S Limited earns ` 6 per share, has capitalisation rate of 10% and has a return on
investment at the rate of 20%. According to Walter’s model, what should be the price
per share at 30% dividend payout ratio?
(A) `120
(B) `102
(C) `112
(D) `106

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(iv) On January 1, 2012, X Limited’s begining inventory was `4,00,000. During 2012, Ltd.
purchased `19,00,000 of additional inventory. On December 31, 2012, X Ltd.’s
ending inventory was `5,00,000. What is X Ltd.’s operating cycle in 2012, if it is
assumed that the average collection period is 42 days?
(1 year =36 days).
(A) 123.3 days
(B) 132.3 days
(C) 126.3 days
(D) 133.3 days

(v) From the following, what is the amount of sales of A Ltd.? Financial Leverage —
3:1; Interest—`200; Operating Leverage — 4 : 1; Variable Cost as a % of sales —
66.67%.
(A) `3,600
(B) `6,300
(C) `6,030
(D) `3,060

(vi) The dollar is currently trading at `40. If rupee depreciates by 10%, what will be the
spot rate?
(A) `0.0525
(B) `0.0552
(C) `0.0225
(D) `0.0522

(vii) If the following rates are prevailing: Euro/$ : 1.1916/1.1925 and $/£ : 1.42/1.47 what
will be the corss rate between Euro/Pound?
(A) 1.6921/1.750
(B) 1.7530/1.6921
(C) 1.6921/1.1925
(D) 1.7530/1.1916 [2x7 = 14 marks]

(b) State if each of the following sentences is T (= true) or F (= false) : [1x9 = 9 marks]

(i) Basic lease period refers to the period during which the lease is irrevocable.
(ii) LIBOR for treasury bill rate is the example of basis swaps.
(iii) Provision for taxation is an external source of financing.
(iv) TRIPS are the international agreement on intellectual property rights.
(v) The ROE of an unlevered firm is higher than the ROE of a levered firm, when the ROI
is lower than the cost of debt.
(vi) If IRR is less than the firm’s cost of capital, the project should be rejected.
(vii) There is no need for calculating separate cost for retained earnings, when cost
of equity capital is calculated on the basis of the market value of equity shares.
(viii) In CAPM, systematic risk is the risk that can not be eliminated by
diversification, it being common to all firms.
(ix) Interest rate swap is an exchange of interest payments between two parties.

(c) Match the descriptions to the ‘Four kinds of Float’ with reference to management of
cash:
Descriptions:

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(i) The time when a cheque is being processed by pst office, Messanger service
or other means of delivery.
(ii) The time required to sort, record and deposit the cheque after it has been
received by the company.
(iii) The time from the deposit of cheque to the crediting of funds in the seller’s
account.
(iv) The time between the sale and the mailing of the invoice.
Four kinds of Float—Management of cash:
(A) Billing Float
(B) Banking processing Float
(C) Cheque processing Float
(D) Mailing Float
Note: Your answer may be of the form:
Description No…..Capital letter of the alternative indicating kind of float. [½×4=2 marks]

Answer 1.
(a) (i) (B) 29.4%

discount percent 360

Opportunity cost = x
100 discount percent N

2 360
= x = 29.4%
98 25

(ii) (A) 11.26%

EBI T- 1 `10,000,000 - 1,400,000

Market Value of equity(S) = =
ke 0.125
= `68,800,000
Total value of Firm(V) = S+ D = `68,800,000 + `20,000,000
= `88,800,000

EBIT- 1 `10,000,000
Overall cost of capital (K0) = = = 11.26%
V ` 88,800,000

(iii) (B) `102

r 0.20
D (E D) 1.80 (6 1.80)
Ke 0.10
Market Value of share (P) = = = `102
Ke 0.10

(iv) (D) 133.3 days

Cost of goods sold = `(4,00,000 + 1,900,000 – 500,000)

= `1,800,000

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`1,800,000
Inventory turnover = =4
` 450,000
365
Average age of Inventory = = 91.3 days
4
Operating cycle = Average age inventory + Average Collection Period
= 91.3 = 42 = 133.3 days

(v) (A) `3,600

EBI T 3
Financial Leverage = =
EBI T 1
EBIT = 3EBT
EBIT – 200 = EBT
EBIT = 3[EBIT – 200] EBIT = `300

S V 4
Operating Leverage =
EBIT 1
S – V = 4 EBIT = 4X300 = 1200
(100 – 66.67%)S = 1200
Sales = 1200 = `3600
1
33 %
3
(vi) (C) `0.0225
Re quote : Re.1 = $1/40 = 0.25
If rupee depreciates by 10%, then = 0.025 – 0.0025 = `0.0225

(vii) (A) 1.6921/1.7530

Bid (Euro/£) = Bid (Euro/$) x Bid ($/£)
Bid rate for ε /£ = 1.1916 x 1.42 = 1.6921
Ask rate for ε/£ = 1.1925 x 1.47 = 1.7530
Quote as ε/£ = 1.6921/1.7530

(b)
(i) True
(ii) True
(iii) False
(iv) True
(v) True
(vi) True
(vii) True
(viii) True
(ix) True
(x)
(c)
(i) D= Mailing Float
(ii) C = Cheque Processing Float
(iii) B = Banking Processing Float
(iv) A = Billing Float

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PART - B (75 Marks for any five questions)

2. (a) AMRITAM Ltd. has a total sales of ` 3.2 crores and its average collection period is
90 days. The past experience indicates that bad debts losses are 1.5% on sales. The
expenditure incurred by the firm in administering its receivable collection efforts is `
5,00,000. A factor is prepared to buy the firm’s receivables by charging 2% commission.
The factor will pay advance on receivables to the firm at an interest rate of 18% per
annum after withholding 10% as reserve. Assume 360 days in a year. Calculate the
effective cost of factoring to the firm. [10]

(b) State the main features of venture capital. [5]

Answer 2.
(a)
Particulars `
90
Average level of receivables = `3.2 crores x
360 80,00,000
2
Factoring commission = `80 lakhs x
100 1,60,000
Factoring reserve = `80 lakhs x 10% 8,00,000
Amount available for advance = `[80- (1.6 +8)] lakhs 70,40,000
Factor will deduct his interest @ 18%
`70.4 lakhs x 18 x90
= = `3,16,800
100 x360
Advance to be paid = `(70,40,000 – 3,16,800) 67,23,200
Annual cost of factoring to the firm:
360 6,40,000
Factoring commission = `1,60,000 x
90
360
Interest charges = `3,16,800 x 12,67,200
90

Total 19,07,200
Firm’s saving on taking factoring service:
Cost of credit administration saved 5,00,000
1. 5
Cost of Bad debts = `3.20Cr. x avoided
100 4,80,000
Total 9,80,000

Net cost to the firm = `(19,07,200 – 9,80,000) = `9,27,200

Net cos t `9,27,200
Effective rate of interest to the firm = x100
Advanceto pay `67,23,200
= 13.79%

(b) Main features of venture capital are:

(i) High degree of risk : An investment in a highly risk project with the objective of
earning a high rate of return.
(ii) Equity participation : An actual or potential equity participation to make
capital gain by selling the share once the project becomes profitable.
(iii) Long- term investment : It takes a long period to encash the investment in
securities made by venture capitalists.
(iv) Participation in management : Takes an active interest in management than
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of a traditional lender or banker. “venture capital combines the qualities of

banker, stock market investor and entrepreneur in one.”
(v) Management buying : are funds provided to enable an outside group of
managers to buy an existing company.
(vi) Management buyouts : Venture capital institutions provide funds to enable the
current operating management/investors to acquire existing product line/
business.

3. (a) VEDAVYAS Ltd. is considering two mutually exclusive projects M and project N.
The Finance Director thinks that the project with higher NPV should be chosen, whereas the
Managing Director thinks that the one with the higher IRR should be undertaken, especially
as both projects have the same initial outlay and length of life. The company anticipates a
cot of capital of 10% and the net after-tax cash flow of the projects are as follows:

Year 0 1 2 3 4 5
Cash flows (`)
Project M (4,00,000) 70,000 1,60,000 1,80,000 1,50,000 40,000
Project N (4,00,000) 4,36,000 20,000 20,000 8,000 6,000

You are required to:

(i) Calculate the NPV and IRR of each project.
(ii) State with reasons, which project you would recommended.
(iii) Explain the inconsistency in the ranking of the two projects.
Present value Table is given :
Year 0 1 2 3 4 5

PVIF at 10% 1.000 0.909 0.826 0.751 0.683 0.621

PVIF at 20% 1.000 0.833 0.694 0.579 0.482 0.402

(3+4)+2+1=10]
(b) As an executive of a lending institution, what factors should you critically evaluate
with respect to a large industrial project, from the perspectives of environmental and
economic viability? [5]

Answer 3.
(a) (i) Calculation of NPV and IRR

NPV of Project M:
year Cash Flows Discount factor Discounted Discount factor Discounted
(`) (10%) Values(`) (20%) Values (`)
0 (4,00,000) 1.000 (4,00,000) 1.000 (4,00,000)
1 70,000 0.909 63,630 0.833 58,310
2 1,60,000 0.826 1,32,160 0.694 1,11,040
3 1,80,000 0.751 1,35,180 0.579 1,04,220
4 1,50,000 0.683 1,02,450 0.482 72,300
5 40,000 0.621 24,840 0.402 16,080
NPV 58,260 (38,050)

IRR of Project M:
At 20%, NPV is (-) 38,050 and at 10% NPV is 58,260
58260 58260
IRR = 10 + x10 = 10 + x10 = 10 + 6.05 = 16.05%
58260 38050 96310
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NPV of Project N:
year Cash Flows Discount factor Discounted Discount factor Discounted
(`) (10%) Values(`) (20%) Values (`)
0 (4,00,000) 1.000 (4,00,000) 1.000 (4,00,000)
1 4,36,000 0.909 3,96,324 0.833 3,63,188
2 20,000 0.826 16,520 0.694 13,880
3 20,000 0.751 15,020 0.579 11,580
4 8,000 0.683 5,464 0.482 3,856
5 6,000 0.621 3,726 0.402 2,412
NPV 37,054 (5,084)

IRR of Project M:
At 20%, NPV = (-) 5,084 and at 10% NPV = 37,054
37054 37054
IRR = 10 + x10 = 10 + x10 = 10 + 8.79% = 18.79%
37054 5084 42138
(ii) Both the projects are acceptable because they generate the positive NVP at the
company’s cost of capital at 10%. However, the company will have to select
PROJECT M because it has higher NPV. If the company follows IRR method, then
PROJECT N should be selected because of higher internal rate of return (IRR). But
when NPV and IRR give contradictory results, a project with higher NPV is generally
preferred because of higher return in absolute terms. Hence, Project M should be
selected.
(iii) The inconsistency in the ranking of the projects arises because of the difference in
the pattern of the cash flows. Project M’s major cash flow occur mainly in the
middle three years whereas project N generated the major cash flow in the first
year itself.

(b) Factors to consider to consider for critical evaluation of a large industrial projects,
from the perspectives of environmental and economic viability are:
(i) Employment potential.
(ii) Utilisation of domestically available raw material and other facilities.
(iii) Development of industrially backward areas as per government policy.
(iv) Effect of the project on the environment with particular emphasis on the
pollution of water and air to be caused by it.
(v) Arrangements for effective disposal of effluent as per government policy.
(vi) Energy conservation devices, etc. employed for the project.
Other economic factors that influence the final approval of a particular project
are:
Internal Rate of return (IRR) and Domestic resources Cost (DRC)

4. (a) M/s Circuit Manufacturing Corporation (CMC) furnishes the following information:
Total Sales : 1,45,000 units
Selling price per unit : ` 23
Fixed Cost : ` 2,80,000
Variable Cost : ` 17 per unit
Debt : ` 10,00,000 @ 11% interest rate
Equity : ` 20,00,000
Face Value of each share : `10
Tax rate applicable : 45%
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You are required to work out the following:

(i) By what amount the firm’s sales have to come down, so that the Earnings
Before Taxes is equal to zero?
(ii) If Earnings Before Interest & Taxes (EBIT) double, what is the new level of
Earning BeforeTaxes (EBT)?

(iii) What will be the degree of operating, financial and combined leverage?
(iv) If the asset turnover of the industry is 0.75, does the firm have a high or
low degree of asset turnover? [3+2+3+2=10]

(b) What are the basic financial decisions? How do they involve risk-return trade off? [5]

Answer 4.
(a)
(i) Turn of the firm = `23 x 145000 = `33,35,000
Total cost = `17 x 145000 + `280000 = `27,45,000
EBIT = `(33,35000 – 27,45,000) = `5,90,000
Interest Charges = `10,00,000 x 0.11 = `1,10,000
If the earning before taxes is equal to Zero,
EBIT should be equal to interest charges.
Let this happen at a sales level of X units.
Profit function (EBIT) = (SP – VC)X – FC;
Then, `(23-17) X - `2,80,000 = `1,10,000
` 3,90,000
Or, X = = 65,000 Units
`6
Re quired EBIT FC 110000 280000
Or, Sales required = = = 65000 Units.
Contribution per unit 6

Therefore, the sales should come down by (145000 – 65000) or 80000 units,
or by (`80,000 x `23) or `18,40,000, so that EBT is equal to Zero.
(ii) If EBIT doubles, the new level of EBIT would be equal to `(2 x 5,90,000)=
`11,80,000
New level of EBT = EBIT – 1 = `11,80,000 - `1,10,000 = `10,70,000
(iii) Degree of operating leverage –
Q(SP VC) 145000(23 17)
= = = 1.475
Q(SP VC) F 145000(23 17) 280000
EBIT
Degree of financial leverage is
EBIT 1
590000
Hence, DFL = = 1.23
590000 110000
Combined leverage = DOL x DFL = 1.475 x 1.23 = 1.814
(iv) Turnover of the firm = `23 x 145000 = `3335000
Total sales 3335000
The asset turnover of the firm is = = 1.11
Total assets (1000000 2000000 )

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Since, the asset turnover of the industry is 0.75, the firm is considered to have a
high degree of asset turnover.(It is assumed that the firm has no other liabilities.
Therefore, Total Asset = debt + Equity).

(b) (i) Investment Decision: Concerned with the selection of assets (fixed and current) in
which funds will be invested by a firm – Long-term investment decision is known as capital
budgeting and short-term investment decision (current assets) is identified as working
capital management – Proper trade – off between liquidity and profitability.
(ii) Financing decision: Concerned with capital structure of firm – trade off between risk
and return by maintaining a proper balance between debt and equity capital.
(iii) Dividend Decision: Concerned with the distribution of profits of firm to the share
holders. It will depend upon the preference of the shareholders, investment opportunities
available within the firm and opportunities for future expansion of the firm.

5. (a) Determine the working capital requirements on cash cost basis from the following
partculars:

Annual Budget for Amount (` in lakh)

Raw Materials 720
Supplies and Components 240
Manpower Expenses 480
Factory Expenses (including depreciation ` 10 130
lakhs)
Administration Expenses 180
Sales 2380

You are given the following additional information:

(i) Stock-levels planned : Raw materials— 30 days; supplies and components— 90
days.
(ii) 50 per cent of the sales are for cash; for the remaining, 20 days credit is normal.
(iii) Finished goods are held in stock for a period of 7 days before they are released for
sale and are valued at factory cost.
(iv) Goods remain in process for 5 days. Materials & components are supplied in the
beginning and expenses are incurred evenly.
(v) The company enjoys 30 days credit facilities on 20 per cent of the purchases.
(vi) Cash and Bank balances had been planned to be kept at the rate of half month’s
budgeted expenses [Assume 360 days in a year]. [10]

(b) Discuss the important factors that affect the dividend policy of a firm. [5]

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Answer 5.

(a) Statement showing the requirements of working capital (in lakhs):

Particulars `
A. Current Assets
30
Stock of Raw materials = 720 x
360 60.00
90
Stock of supplies & components = 240 x 60.00
360

Stock of WIP
5
RM = 720 x x100% 10.00
360
5 3.33
Supplies = 240 x x100%
360
5 3.33
Wages = 480 x x 50%
360
5
F. expenses = 120 x x50%
360 0.84
17.50
7
Stock of Finished Goods = (720 + 240+480+120) x 30.33
360

Debtors:
Cost of goods produced
(720 +240+480+120)
(+) Op. F. Stock 1560
(-) Cl. F. Stock 30.33
(+) Office expenses (30.33)
180
1740

Cost of credit Sales 50

1740 x
100
20
870 x 48.33
15 360
Cash in hand (480+120+180)x
360
32.50
Total Current Assets 248.66

Particulars `
B. Current Liabilities
Creditors for raw materials 20 30
720 x x
100 360 12.00
20 30
Creditors for supplies and componet 240 x x 4.00
100 360
Total current liabilities 16.00
C. Net Working Capital (A-B) 232.66

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(b) Factors determining the Dividend policy of a company

(a) Cash flow situation of the company based on its current and future
needs of funds.
(b) Expectation of shareholders and performance by similar industries.
(c) Constraints in payment of Dividend, Legal requirements
(d) Investment opportunities available to the company and its benefits
vis-a-vis funding requirement
(e) Trends in capital market
(f) Ownership pattern of the company.

6. (a) The following quotes are available.

Spot ($/Euro) 0.8385/0.8391
3-m swap points 20/30
Spot ($/Pound) 1.4548/1.4554
3-m swap points 35/25
Find the 3-m (€/£) outright forward rates: [5]
(b) Compute a call option price by applying the Black-Scholes Option Pricing
model on the following values:
Strike price = ` 45
Time remaining to expiration = 183 days
Current stock price = ` 47
Expected price volatility = standard deviation of the stock’s return = 0.25
Risk free rate = 10%
Given : N (0.6172) = 0.7315 and N (0.4404) = 0.6702. [5]

(c) What is swaps? Explain its necessity. Also state financial benefits created by swap
transactions. [5]

Answer 6.

(a) Given $/Є = 0.8385 / 0.8391 3M fwd = 0.8405 / 0.8421

(Swap points ascending order add to find forward rates)
$/£= 1.4548/1.4554 3M fwd = 1.4513 / 1.4529
(Swap points descending order deduct to find forward rates)
To find Є /£ (3M outright forward rates)
Bid (Є/£) = Bid ( Є /$) x Bid ($/£)
We do not have a quote of Є /$, instead we have $/ Є.
Bid (Є /£) = l/Ask($/Є) x Bid($/£)
Substituting the values,
Bid rate for Є /£= 1/0.8421 x 1.4513 = 1.7234

Similarly Ask (Є /£) = 1/Bid($/Є) x Ask($/£)

= 1/0.8405x1.4529 = 1.7286

3M outright forward rates (Є /£) = 1.7234 / 1.7286

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(b) Applying the Black - Scholes formula:

Px
Vc= Ps[Nd1- [Nd2 ]
e (RF)(T)
In[47/45] [0.10 0.5(0.25) 2 ]0.5
d1
0.25 0.5

d2 = 0.6172 – 0.25 √0.5 = 0.4404

Then, C = 47(0.7315) – 45(e-(0.10)(0.5))(0.6702)
= `5.69
(c) Swaps Exchange of one obligation with another -- Financial swaps are funding technique,
which permit a borrower to access one market and exchange the liability for another market /
instrument - exchange one type of risk with another.
Necessity –
1. Difference in borrowers and investors preference and market access
2. Low cost device
3. Market saturation
4. Differences in financial norms followed by different countries.

Financial Benefits Created by Swap Transactions

o The Theory of Comparative Advantage
o Information asymmetries.

7. (a) Considering the following quotes.

Spot (Euro/Pound) = 1.6543/1.6557
Spot (Pound/NZ$) = 0.2786/0.2800
(i) Calculate the % spread on the Euro/Pound Rate
(ii) Calculate the % spread on the Pound/NZ$ Rate
(iii) The maximum possible % spread on the cross rate between the Euro and the NZ$.
[1+1+3=5]

(b) A company operating in JAPAN has today effected sales to an Indian company, the payment
being due 3 months from the date of invoice. The invoice amount is 108 lakhs yen (¥). At today’s
spot rate, it is equivalent to `30 lakhs. It is anticipated that the exchange rate will decline by
10% over the 3 months period and in order to protect the yen (¥) payments, the importer proposes
to take appropriate action in the foreign exchange market. The 3 months forward rate is presently
quoted as 3.3 yen per rupee. You are required to calculate the expected loss and to show how it
can be hedged by a forward contract. [5]
(c) Explain the major functions and features of WTO and GATT. [5]

Answer 7.
1.6557 1.6543
(a) (i) The % spread on Euro/Pound = x100 = 0.085%
1.6543
0.2800 0.2786
(ii) % Spread on the Pound/NZ$ = x100 = 0.50%
0.2786
(iii) The maximum possible % spread on the cross rate between Є & NZ$
To find out cross rate first
Given Spot (Euro/Pound) = 1.6543 / 1.6557
Spot (Pound/NZ$) = 0.2786 / 0.2800
Spot (Euro/NZ$) = 0.2786 x 1.6543 / 0.2800x1.6557

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= 0.4609 / 0.4636
0.4636 0.4609
The maximum % spread on Euro/ NZ$ = X100 = 0.59%
0.4609

(b) Spot rate of Re.1 against ¥ = 108 Lakhs ¥ / `30 lakhs = 3.6 ¥
3 months forward rate of Re.1 against ¥ = 3.3¥
Anticipated decline in Exchange rate = 10%
Expected Spot Rate after 3 months = ¥(3.6-10% of 3.6) per Re.
= ¥(3.6-0.36) = ¥3.24 per Re.

Particulars `(in Lakhs)

Present cost of ¥108 lakhs 30
Cost after 3 months = ¥ 108/¥3.24 33.33
Expected Exchange Loss 3.33
If the expected exchange rate risk is hedged by a
Forward Contract:
Present Cost 30
Cost after 3 months if Forward Contract is taken
¥108 Lakhs/¥3.3 32.73
Expected Loss 2.73

If the exchange rate risk is not covered with forward contract, the expected exchange loss is
`3.33 lakhs. This could be reduced to `2.73 lakhs if it is covered with Forward Contract. Hence,
taking Forward Contract is suggested.

(c) Functions of WTO/GATT:

1. Administering its trade agreements
2. Being a forum for trade negotiations
3. Monitoring national trade polices
4. Providing technical assistance and training for developing countries
5. Cooperating with other international organisations.

Major features of WTO and GATT :

1. Formed in' 1995 - 152 member states
2. Designed to supervise and liberalise international trade
3. Deals with rules of trade between nations at a global level
4. Responsible for negotiating and implementing new trade agreement
5. Governed by a Ministerial Conference.

8. Write short notes on (any three) :

(a) Foreign Currency Convertible Bonds (FCCBs);
(b) Money Market Hedge;
(c) Trading Blocks;
(d) Factors which discourage FDIs in India. 5 x 3 =15

Answer 8.
(a) Foreign Currency Convertible Bonds (FCCBs): They mean bonds issued in accordance
with relevant scheme and subscribed by a non-resident in foreign currency and convertible into
depository receipts or ordinary shares of the issuing company in any manner, either in whole or in
part, on the basis of any equity-related warrants attached to debt instruments. A company
seeking to issue FCCBs should have consistent track record of good performance for 3 years.

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Suggested Answers to Question —AFM

FCCBs are unsecured; carry a fixed rate of interest and an option for conversion into as fixed
number of equity shares of the issuer company. Interest on redemption price (if conversion
option is not exercised) is payable in Dollars. Interest rates are very low by Indian domestic
standards.
FCCB has been popular with issuers. Local debt markets can be restrictive with comparatively
short maturities and high interest rates. On the other hand, a straight equity may cause a dilution
in earnings, and certainly dilutions in control, which many shareholders, especially major family
shareholders, would find unacceptable. Foreign investors also prefer FCCBs because of dollar-
denominated servicing, the conversion option and the arbitrage opportunities presented by
conversion of FCCBs into equity at discount on prevailing market-price in India. The major
drawbacks are that the issuing company cannot plan capital structure as it is not assured of
conversion of FCCBs. In addition, FCCBs would result in creation of external debt for the country,
as there would be foreign exchange outflow from the country, if conversion option is not
exercised by the investors.
Some other regulations are: (i) Interest payment on bond, until the conversion option is
exercised, shall be subjected to TDS; (ii) Conversion of FCCBs into shares shall not give rise to
capital gain in India; and (iii) Transfer of FCCBs shall not give rise to capital gain in India.

(b) Money Market Hedge is of two types: (i) hedging payables, and (ii) hedging receivables.
Hedging payables involve the following steps:
Borrow funds in home currency; Use them to purchase the foreign currency; Invest the foreign
currency for the period after which the foreign currency payable due; Use the proceeds to make
the payment; Repay the borrowed amount together with interest. Hedging receivable involves
the following steps:
Borrow funds in the foreign currency for the period after which the receivable is due; The
amount to be borrowed should be equal to the amount of the receivable as discounted by the
prevailing rate of interest; Convert the borrowed am ount into home currency and use it till
the receivable arrives; and if the home currency funds cannot be used gainfully in the enterprise
itself, invest them to earn interest.

(c) A trading block is a preferential economic arrangement between a group of countries

that reduces the intra-regional barriers to trade in goods, services, investment an capital. There
are more than 50 such arrangements at the present time. There are five major forms of economic
cooperation among different countries; free trade areas, customs unions, common markets,
economic unions and political unions.

The North American Free Trade Agreement (NAFTA) among USA, Canada and Mexico is example
of free trade areas where member countries remove all trade barriers among themselves.

(d) Factors that discourage FDTs in India

High rates of taxation

Lack of Infrastructure facilities
Favouritism in the selection of investment
Complicated legal framework of rules regulations procedures for FDI into India
Lack of transparency

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