PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT

Question No.1 is compulsory.

Candidates are also required to answer any four from the remaining five questions.
Working notes should form part of the respective answer.
Question 1
(a) Alfa Ltd. wants to acquire Beta Ltd. and has offered a swap ratio of 1 : 2 (0.5 shares for
every one share of Beta Ltd.). Following information is provided:
Alfa Ltd. Beta Ltd.
Profit after tax (`) 18,00,000 3,60,000
Equity shares outstanding (Nos.) 6,00,000 1,80,000
EPS (`) 3 2
PE Ratio 10 times 7 times
Market price per share ( `) 30 14
(i) You are required to determine:
(a) the number of equity shares to be issued by Alfa Ltd. for acquisition of Beta
Ltd.
(b) the EPS of Alfa Ltd. after the acquisition.
(c) the equivalent earnings per share of Beta Ltd.
(d) the expected market price per share of Alfa Ltd.* after the acquisition, if PE
increases to 12 times.
(e) the market value of the merged firm.
(ii) If you are the shareholder of Beta Ltd and holding 100 shares, will you be interested
to sell your stake ? Why? (8 Marks)
* Mistakenly got typed as A Ltd.
(b) Mantra Ltd. is planning to buy Alay Ltd. Following information is given in respect of Alay
Ltd. which is expected to grow at a rate of 18% p.a. for the next three years, after which
the growth rate will stabilize at 8% p.a. normal level, in perpetuity:
Particulars For the year ended March 31, 2022
Revenues ` 6,800 Crores
Cost Of Goods Sold (COGS) ` 2,800 Crores
Operating Expenses ` 2,100 Crores
Capital Expenditure ` 750 Crores
Depreciation (included in Operating Exp.) ` 600 Crores

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 2 FINAL EXAMINATION: NOVEMBER, 2022

During high growth period, Revenues & Earnings Before Interest & Tax (EBIT) will grow
at 18% p.a. and capital expenditure net of depreciation will grow at 12% p.a. From
4th year 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.
Corporate Income Tax rate is 30%.
The Weighted Average Cost of Capital (WACC) for both the companies is 15%.
You are required to estimate the value of Alay Ltd. using Free Cash Flows to Firm
(FCFF) & WACC methodology.
The PVIF for the three years are as below:
Year t1 t2 t3
PVIF @ 15% 0.870 0.756 0.658
(8 Marks)
(c) Briefly explain Asset and Liability Management (ALM). (4 Marks)
Answer
(a) (i) (a) The number of shares to be issued by Alfa Ltd.:
The Exchange ratio is 0.5
So, new Shares = 1,80,000 x 0.5 = 90,000 shares.
(b) EPS of Alfa Ltd. after acquisition:
Total Earnings (` 18,00,000 + ` 3,60,000) ` 21,60,000
No. of Shares (6,00,000 + 90,000) 6,90,000
EPS (` 21,60,000)/6,90,000) ` 3.13
(c) Equivalent EPS of Beta Ltd.:
No. of new Shares 0.5
EPS ` 3.13
Equivalent EPS (` 3.13 x 0.5) ` 1.57 or ` 1.56
(d) New Market Price of Alfa Ltd. (P/E = 12):
Revised P/E Ratio of Alfa Ltd. 12 times
Expected EPS after merger ` 3.13
Expected Market Price (` 3.13 x 12) ` 37.56
(e) Market Value of merged firm:
Total number of Shares 6,90,000

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 3

Expected Market Price ` 37.56

Total value (6,90,000 x 37.56) ` 2,59,16,400
(ii) Present market Value of share of Beta Ltd. (100 x ` 14) ` 1,400
Revised market price of each share of Alfa Ltd. after Merger ` 37.56
Equivalent No. of Alfa Ltd. share in exchange of Beta Ltd. (0.50 x 100) 50
Equivalent Value of Alfa Ltd. share in exchange of Beta Ltd. ` 1,878
(100x 0.50 x ` 37.56)
Increase in Market Value (` 1,878 - ` 1,400) ` 478
No, I am not agreed to sell the stake as there is increase in market value.
(b) Determination of forecasted Free Cash Flow of the Firm (FCFF) (` in crores)
Yr. 1 Yr. 2 Yr. 3 Terminal Year
Revenue 8,024.00 9,468.32 11,172.62 12,066.43
COGS 3,304.00 3,898.72 4,600.49 4,968.53
Operating Expenses* 1,770.00 2,088.60 2,464.55 2,661.71
(*Excluding Depreciation)
Depreciation 708.00 835.44 985.82 1,064.68
EBIT 2,242.00 2,645.56 3,121.76 3,371.51
Tax @30% 672.60 793.67 936.53 1,011.45
EAT 1,569.40 1,851.89 2,185.23 2,360.06
Capital Exp. – Dep. 168.00 188.16 210.74 -----
∆ Working Capital 306.00 361.08 426.07 223.45
Free Cash Flow (FCF) 1,095.40 1,302.65 1,548.42 2,136.61
Terminal value is:
2136.61
= ` 30,523 Crore
0.15 − 0.08
Present Value (PV) of FCFF:

FCFF (` in crores) PVF @ 15% PV (` in crores)

1,095.40 0.870 953.00
1,302.65 0.756 984.80
1,548.42 0.658 1,018.86
30,523 0.658 20,084.13
23,040.79

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 4 FINAL EXAMINATION: NOVEMBER, 2022

The value of the firm is ` 23,040.79 Crores

Note: The answer may vary due to rounding off difference.
(c) Asset-Liability Management (ALM) is one of the important tools of risk management in
commercial banks of India. Indian banking industry is exposed to a number of risks
prevailing in the market such as market risk, financial risk, interest rate risk etc. Th e net
income of the banks is very sensitive to these factors or risks.
ALM is a comprehensive and dynamic framework for measuring, monitoring and
managing the market risk of a bank. It is the management of structure of Balance Sheet
(liabilities and assets) in such a way that the net earnings from interest are maximized
within the overall risk preference (present and future) of the institutions. The ALM
functions extend to liquidly risk management, management of market risk, trading risk
management, funding and capital planning and profit planning and growth projection.
Banks and other financial institutions provide services which expose them to various
kinds of risks like credit risk, interest risk, and liquidity risk. Asset liability management is
an approach that provides institutions with protection that makes such risk acceptable.
Asset-liability management models enable institutions to measure and monitor risk, and
provide suitable strategies for their management.
It is therefore appropriate for institutions (banks, finance companies, leasing companies,
insurance companies, and others) to focus on asset-liability management when they face
financial risks of different types. Asset-liability management includes not only a
formalization of this understanding, but also a way to quantify and manage these risks.
In a sense, the various aspects of balance sheet management deal with planning as well
as direction and control of the levels, changes and mixes of assets, liabilities, and capital.
Question 2
(a) MNO Ltd., a company based in India, manufactures very high quality mode rn furniture
and sells them to a small number of retail outlets in India and Nepal. It is facing tough
competition. Recent studies on marketability of product have clearly indicated that the
customers are now more interested in variety and choice rather than exclusivity and
exceptional quality. Since the cost of quality wood in India is very high, the company is
reviewing the proposal for import of wood in bulk from Nepalese supplier.
The estimate of net India ( `) and Nepalese Currency (NC) cash flow in nominal terms for
this proposal is shown below:
Net cash flow (in Millions)
Years NC India (`)
0 —38 0
1 1.8 1.9
2 3.2 3.5
3 4.1 4.4

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 5

4 5.4 5.8
5 6.5 6.9
The following information is relevant :
(1) MNO Ltd. evaluates all investment by using a discount rate of 11% p.a. All
Nepalese customers are invoiced in NC. NC cash flows are converted to Indian ` at
the forward rate and discounted at the Indian rate.
(2) Inflation rate in Nepal and India are expected to be 11% and 10% p.a. respectively.
(3) The current exchange rate is ` 1 = NC 1.65
You are required to calculate Net Present value of the proposal. (8 Marks)
(b) The following 2-way quotes appear in the foreign exchange market:
Spot 2-months spread
`/US $ 74.00/74.25 1.00/1.25
(i) You are required to calculate:
(a) 2 months forward rates.
(b) How many US dollars should the firm sell to get ` 10 lakhs in the spot market
and after 2 months?
(c) How many Rupees is the firm required to pay to obtain US $ 80,000 in the spot
market and after 2 months?
(ii) Assume the firm has US $ 27,600 in current account earning no interest. ROI on
Rupee investment is 10% p.a. Should the firm encash the US $ now or after 2
months? (8 Marks)
(c) Explain various methods of hedging of interest rate risk. (4 Marks)
Answer
(a) Working Notes:
(i) Computation of Forward Rates
End of Year NC NC/`
1  (1+0.11) 
NC 1.65 x   1.665
 (1+0.10) 
2  (1+0.11) 
NC 1.665 x   1.680
 (1+0.10) 
3  (1+0.11) 
NC 1.680 x   1.695
 (1+0.10) 

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 6 FINAL EXAMINATION: NOVEMBER, 2022

4  (1+0.11) 
NC 1.695 x   1.710
 (1+0.10) 
5  (1+0.11) 
NC 1.710 x   1.726
 (1+0.10) 

(ii) NC Cash Flows converted in Indian Rupees

Year NC (Million) Conversion Rate ` (Million)
0 -38.00 1.650 -23.03
1 1.80 1.665 1.081
2 3.20 1.680 1.905
3 4.10 1.695 2.419
4 5.40 1.710 3.158
5 6.50 1.726 3.766
Net Present Value
Year Cash Flow in Cash Flow in Total PVF PV
India Nepal Cash Flow @ 11%
0 --- -23.030 -23.030 1.000 -23.030
1 1.900 1.081 2.981 0.901 2.686
2 3.500 1.905 5.405 0.812 4.389
3 4.400 2.419 6.819 0.731 4.985
4 5.800 3.158 8.958 0.659 5.903
5 6.900 3.766 10.666 0.593 6.325
1.258

(b) (i) (a) Two Month Forward Rates:

Buying Rate ` 74.00 + ` 1.00 = ` 75.00
Selling Rate ` 74.25 + ` 1.25 = ` 75.50
(b) (1) To get ` 10 lakh at Spot Market the firm should sell
= ` 10,00,000/ ` 74.00 = US $ 13,513.51
(2) To get ` 10 lakh after 2 month the firm should sell
= ` 10,00,000/ ` 75.00 = US $ 13,333.33
(c) (1) Rupees required to obtain US $ 80,000 in Spot Market:
US $ 80,000 × ` 74.25 = ` 59,40,000

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(2) Rupees required to obtain US $ 80,000 after 2 months:

US $ 80,000 × ` 75.50 = ` 60,40,000
(ii) If US$ are converted in ` now and get invested in India, then fund position after 2
months will be as follows:
US$ 27,600 × ` 74.00 ` 20,42,400
ROI @ 10% p.a. for 2 month ` 34,040
Amount after 2 months ` 20,76,440
If US$ are converted after 2 month, then fund position will be:
$ 27,600 × ` 75.00 = ` 20,70,000
Thus, it is better to get converted US$ into ` now and get them invested in India.
Alternatively, this sub part can also be answered as follows:
Computation of Annual Premium on US $ = (1.00/74.00) × (12/2) × 100 = 8.108% or
8.11%
Since, the premium on US $ in lesser than ROI on Indian `, it is better to convert
US $ in Indian ` now and get them invested in India.
(c) Methods of Hedging of Interest Rate Risk can be broadly divided into following two
categories:
(A) Traditional Methods: These methods can further be classified in following
categories:
(i) Asset and Liability Management (ALM): ALM is a comprehensive and
dynamic framework for measuring, monitoring and managing the market risk of
a bank. It is the management of structure of Balance Sheet (liabilities and
assets) in such a way that the net earnings from interest are maximized within
the overall risk preference (present and future) of the institutions.
(ii) Forward Rate Agreement (FRA): Normally it is used by banks to fix interest
costs on anticipated future deposits or interest revenues on variable-rate loans
indexed to Benchmark Interest Rate e.g. LIBOR, MIBOR etc. A bank that sells
an FRA agrees to pay the buyer the increased interest cost on some "notional"
principal amount if Reference Rate of some specified maturity is above a
stipulated "Forward Interest Rate" on the contract maturity or settlement date.
Conversely, the buyer agrees to pay the seller any decrease in interest cost if
Reference Rate fall below the forward rate.
(B) Modern Methods: These methods can further be classified in following categories:
(i) Interest Rate Futures (IRF): An interest rate future is a contract between the

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 8 FINAL EXAMINATION: NOVEMBER, 2022

buyer and seller agreeing to the future delivery of any interest-bearing asset.
The interest rate future allows the buyer and seller to lock in the price of the
interest-bearing asset for a future date.
(ii) Interest Rate Options (IRO): Also known as Interest Rate Guarantee (IRG) as
option is a right not an obligation and acts as insurance by allowing businesses
to protect themselves against adverse interest rate movements while allowing
them to benefit from favourable movements.
It should be noted that the IRO is basically a series of FRAs which are
exercisable at predetermined bench marked interest rates on each period say
3 months, 6 months etc.
(iii) Interest Rate Swaps: In an interest rate swap, the parties to the agreement,
termed the swap counterparties, agree to exchange payments indexed to two
different interest rates. Total payments are determined by the specified
notional principal amount of the swap, which is never actually exchanged.
(iv) Swaptions: An interest rate swaption is simply an option on an interest rate
swap. It gives the holder the right but not the obligation to enter into an interest
rate swap at a specific date in the future, at a particular fixed rate and for a
specified term.
Question 3
(a) Details about long term portfolio of shares of an investor is as below:
Shares No. of shares (Lakh) Market Price per share Beta
K Ltd. 6 250 1.4
L Ltd. 8 375 1.2
M Ltd. 4 125 1.6
The investor thinks that the risk of portfolio is very high and wants to reduce the portfolio
beta to 0.91.
He is considering below mentioned alternative strategies:
(i) Dispose a part of his existing portfolio to acquire risk free securities, or
(ii) Take appropriate position on Nifty Futures which are currently traded at 16250 and
each Nifty points is worth `100.
You are required to determine:
(i) portfolio beta,
(ii) the value of risk-free securities to be acquired,
(iii) the number of shares of each company to be disposed off,

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(iv) the number of Nifty contracts to be bought/sold,

(v) the value of portfolio beta for 1% rise in Nifty. (8 Marks)
(b) Ms. Sreenidhi is learning the portfolio management techniques and wants to test one of
the techniques she has developed on KIFS Equity Fund and compare the gains and
losses from the technique with those from a passive buy and hold strategy.
The KIFS Equity Fund consists of equities only and the ending NAVs of the fund she
constructed for the last 10 months are given below:
Month Ending NAV (`/unit)
Jan-22 100
Feb-22 78
Mar-22 92
Apr-22 86
May-22 102
Jun-22 98
Jul-22 100
Aug-22 102
Sep-22 118
Oct-22 120
Assume
(i) Sreenidhi had invested a notional amount of ` 5 lakhs equally in the equity fund and
a conservative portfolio (of bonds) in the beginning of January 2022 and the total
portfolio was being rebalanced each time the NAV of the fund increased or
decreased by 15% compared to the NAV of previous month.
(ii) There is no income earned from the conservative portfolio during the period.
(iii) There is no taxation and entry/exit loads.
You are required to determine:
(i) Value of the portfolio for each level of NAV following the Constant Ratio Plan.
(ii) Whether there are any errors in the technique developed by Sreenidhi? If so briefly
explain. (8 Marks)
(c) Write a short note on Money Market Hedging. (4 Marks)

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Answer
(a)
Shares No. of shares Market Price (1)× (2) % to ß (x) w*x
(lakhs) (1) of Per Share (` lakhs) total
(2) (w)

K Ltd. 6.00 250.00 1,500.00 0.30 1.40 0.42

L Ltd. 8.00 375.00 3,000.00 0.60 1.20 0.72
M Ltd. 4.00 125.00 500.00 0.10 1.60 0.16
5,000.00 1.00 1.30
(i) Portfolio beta 1.30
(ii) Required Beta 0.91
Let the proportion of risk free securities for target beta 0.91 = p
0.91 = 0 × p + 1.30 (1 – p)
p = 0.30 i.e. 30%
Shares to be disposed off to reduce beta (5000 × 30%) ` 1,500 lakh and Risk Free
securities to be acquired.
(iii) Number of shares of each company to be disposed off
Shares % to Proportionate Market Price No. of Shares to be
total (w) Amount (` lakhs) Per Share disposed off
(a) (b) (Lakh) (a/b)
K Ltd. 0.30 450.00 250.00 1.80
L Ltd. 0.60 900.00 375.00 2.40
M Ltd. 0.10 150.00 125.00 1.20
(iv) Number of Nifty Contract to be sold
(1.30 - 0.91) × 5000 lakh
= 120 contracts
16,250 × 100

(v) 1% rises in Nifty is accompanied by 1% x 1.30 i.e. 1.30% rise for portfolio of shares
` Lakh
Current Value of Portfolio of Shares 5,000
Value of Portfolio after rise 5,065
Mark-to-Market Margin paid (16250 × 0.01 × ` 100 × 120) 19.50
Value of the portfolio after rise of Nifty 5,045.50

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% change in value of portfolio (5,045.50 – 5,000)/ 5,000 0.91%

% rise in the value of Nifty 1%
Beta 0.91

(b) (i) Constant Ratio Plan:

Stock Value of Value of Total value Revaluation Total No.
Portfolio Conservative aggressive of Constant Action of units in
NAV Portfolio Portfolio Ratio Plan aggressive
(`) (`) (`) (`) portfolio
100 2,50,000.00 2,50,000.00 5,00,000.00 - 2500
78 2,50,000.00 1,95,000.00 4,45,000.00 - 2500
2,22,500.00 2,22,500.00 4,45,000.00 Buy 352.56 2852.56
units
92 2,22,500.00 2,62,435.52 4,84,935.52 - 2852.56
2,42,467.76 2,42,467.76 4,84,935.52 Sell 217.04 2635.52
units
86 2,42,467.76 2,26,654.72 4,69,122.48 - 2635.52
102 2,42,467.76 2,68,823.04 5,11,290.80 - 2635.52
2,55,645.40 2,55,646.40 5,11,290.80 Sell 129.19 2506.33
units
98 2,55,645.40 2,45,620.34 5,01,265.74 - 2506.33
100 2,55,645.40 2,50,633.00 5,06,278.40 - 2506.33
102 2,55,645.40 2,55,645.66 5,11,291.06 - 2506.33
118 2,55,645.40 2,95,746.94 5,51,392.34 - 2506.33
2,75,696.17 2,75,696.17 5,51,392.34 Sell 169.92 2336.41
units
120 2,75,696.17 2,80,369.20 5,56,065.37 - 2336.41
Hence, the ending value of the mechanical strategy is ` 5,56,065.37 and buy & hold
strategy is (`2,50,000+ 2,500 X `120 = `5,50,000)
(ii) Though the value of portfolio as per technique is lesser than Buy & Hold Strategy
but there is no error as if market has been bearish then the value of much lesser
under Buy & Hold Strategy.
(c) At its simplest, a money market hedge is an agreement to exchange a certain amount of
one currency for a fixed amount of another currency, at a particular date. For example,
suppose a business owner in India expects to receive 1 Million USD in six months. This
Owner could create an agreement now (today) to exchange 1Million USD for INR at
roughly the current exchange rate. Thus, if the USD dropped in value by the time the

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business owner got the payment, he would still be able to exchange the payment for the
original quantity of U.S. dollars specified.
Advantages of Money Market Hedging
(i) Fixes the future rate, thus eliminating downside risk exposure.
(ii) Flexibility with regard to the amount to be covered.
(iii) Money market hedges may be feasible as a way of hedging for currencies where
forward contracts are not available.
Disadvantages of Money Market Hedging
(i) More complicated to organize than a forward contract.
(ii) Fixes the future rate - no opportunity to benefit from favorable movements in
exchange rates.
Question 4
(a) Following is the information related to three mutual funds:
Year MF-A MF-B MF-C
2020 10% 5% 14%
2021 8% 10% 10%
2022 12% 8% 18%
Correlation between market and mutual fund:
MF-A MF-B MF-C
Correlation with market 0.45 0.25 0.65
Variance of the market is 9% and rate of return of government bond is 7%.
You are required to Rank the Mutual fund using Sharpe’s ratio and Treynor’s ratio.
(8 Marks)
(b) M/s. Siri Ltd. Has a surplus amount of ` 3 crores to invest and has shortlisted the
following equity shares:
Company Beta
S Ltd. 1.6
K Ltd. 1
P Ltd. -0.3
D Ltd. 2
C Ltd. 0.6

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Required:
(i) If M/s. Siri Ltd. invests an equal amount in all securities, what is the beta of the
portfolio?
(ii) If M/s. Siri Ltd. invests 15% of its investment in S Ltd., 15% in P Ltd., 10% in C Ltd.
and the balance in equal amount in the other two securities, what is the beta of the
portfolio?
(iii) If the expected return of market portfolio is 12% at a beta factor of 1.0, what will be
the portfolios expected return in both the situations given above?
(iv) If the Company changes its policy to invest in any 3 securities with a minimum of
20% in each of these 3 securities to diversify risk, you are requested to advi se the
company to have a right mix of securities to maximize the return in the following two
scenarios and also calculate the expected return:
(1) Bull Phase: Expected Market returns 10%
(2) Bear Phase: Expected Market returns — 5% (8 Marks)
(c) What are the features of Securitization? (4 Marks)
Answer
(a) (i) Calculation of Standard Deviation of Funds
Year MF-A Dev. Dev.2 MF-B Dev. Dev.2 MF-C De Dev.2
(%) (%) (%) v.
2020 10 - - 5 -2.67 7.13 14 - -
2021 8 -2 4 10 2.33 5.43 10 -4 16
2022 12 2 4 8 0.33 0.11 18 4 16
30 8 23 12.67 42 32
Avg. Var. Avg. Var. Avg. Var.
= 30/3 = 8/3 = 23/3 12.67/3 = 32/3 =
= 10 = 2.67 = 7.67 = 4.22 42/3 10.67
σA = σB = 2.05 = 14 σC =
1.63 3.27

(ii) Calculation of Beta of MFs

r σM σi Var. of Market βi
MF-A 0.45 3 1.63 9 0.244
MF-B 0.25 3 2.05 9 0.171
MF-C 0.65 3 3.27 9 0.709

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Reward to Variability (Sharpe Ratio)

Mutual Rp Rf Rp – Rf σp Reward to Ranking
Fund Variability
MF-A 10.00 7.00 3.00 1.63 1.84 2
MF-B 7.67 7.00 0.67 2.05 0.33 3
MF-C 14.00 7.00 7.00 3.27 2.14 1
Reward to Volatility (Treynor Ratio)
Mutual Rp Rf Rp – Rf βp Reward to Ranking
Fund Volatility
MF-A 10.00 7.00 3.00 0.244 12.30 1
MF-B 7.67 7.00 0.67 0.171 3.92 3
MF-C 14.00 7.00 7.00 0.709 9.87 2

(b) (i) Beta of the Portfolio

Investment Beta (β) Investment Weighted
(` Lakhs) Investment
S Ltd. 1.6 60 96
K Ltd. 1.0 60 60
P Ltd. -0.3 60 -18
D Ltd. 2.0 60 120
C Ltd. 0.6 60 36
300 294
294 lakh
βP = = 0.98
300lakh
Alternatively, it can also be computed as follows:
1 1 1 1 1
1.6 × + 1.0 × + (-0.30) × +2× + 0.6 × = 0.98
5 5 5 5 5
(ii) With varied percentages of investments portfolio beta is calculated as follows:
Investment Beta (β) Investment Weighted Investment
(` Lakhs)
S Ltd. 1.6 45 72
K Ltd. 1.0 90 90
P Ltd. -0.3 45 -13.50
D Ltd. 2.0 90 180

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C Ltd. 0.6 30 18
300 346.50
346.50
Beta = = 1.155
300
(iii) Expected return of the portfolio with pattern of investment as in case (i) = 12% ×
0.98 i.e. 11.76%
Expected Return with pattern of investment as in case (ii) = 12% × 1.155 i.e.,
13.86%.
(iv) (1) Securities to be selected during Bull Phase Expected Market returns 10%
As it is bull Market Higher Beta stocks should be selected.
Shares % to be Beta (β) Investment Weighted
invested Investment
S Ltd. 20 1.6 60,00,000 96,00,000
K Ltd. 20 1 60,00,000 60,00,000
P Ltd. 0 -0.3 - -
D Ltd. 60 2 1,80,00,000 3,60,00,000
C Ltd. 0 0.6 - -
100 3,00,00,000 5,16,00,000
Portfolio or Weighted Beta (β) (5,16,00,000/ 3,00,00,000) 1.72
Portfolio Beta (β) 1.72
Market Return 10%
Expected Return 17.20%

(2) Securities to be selected During Bear Phase Expected Market returns – 5%

As it is bear market Lower Beta stocks should be selected
Shares % to be invested Beta (β) Investment Weighted
Investment
S Ltd. 0 1.6 - -
K Ltd. 20 1 60,00,000 60,00,000
P Ltd. 60 -0.3 1,80,00,000 -54,00,000
D Ltd. 0 2 - -
C Ltd. 20 0.6 60,00,000 36,00,000
100 3,00,00,000 42,00,000

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 16 FINAL EXAMINATION: NOVEMBER, 2022

Portfolio or Weighted Beta (β) (42,00,000/ 3,00,00,000) 0.14

Portfolio Beta (β) 0.14
Market Return -5%
Expected Return -0.70%
(c) The securitization has the following features:
(i) Creation of Financial Instruments – The process of securities can be viewed as
process of creation of additional financial product of securities in market backed by
collaterals.
(ii) Bundling and Unbundling – When all the assets are combined in one pool it is
bundling and when these are broken into instruments of fixed denomination it is
unbundling.
(iii) Tool of Risk Management – In case of assets are securitized on non-recourse
basis, then securitization process acts as risk management as the risk of default is
shifted.
(iv) Structured Finance – In the process of securitization, financial instruments are
tailor structured to meet the risk return trade of profile of investor, and hence, these
securitized instruments are considered as best examples of structured finance.
(v) Trenching – Portfolio of different receivable or loan or asset are split into several
parts based on risk and return they carry called ‘Tranche’. Each Trench carries a
different level of risk and return.
(vi) Homogeneity – Under each tranche the securities issued are of homogenous
nature and even meant for small investors who can afford to invest in small
amounts.
Question 5
(a) Following is the information related to return on shares of three different companies :
Years A Ltd. B Ltd. C Ltd.
2018 2% 3% 5%
2019 6% 8% 7%
2020 13% 14% 15%
2021 7% 9% 11%
Required:
(i) Construct maximum number of portfolio and its return, if each portfolio consists of
any two Company's shares in proportion of 65% and 35% and suggest which
portfolio provides highest return.

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 17

(ii) Calculate portfolio return and beta (β), if Mr. X invests ` 65,000 in A Ltd. having
beta (β) of 0.45; ` 20,000 in B Ltd. having beta (β) of 1.15 and ` 15,000 in C Ltd.
having beta (β) of 1.8. (8 Marks)
(b) The following information was extracted from the books of M/s Murugan Ltd.:
Face Value of Bond ` 1000
Coupon Interest Rate 8.5%
Time Period of Maturity Remaining 4 Years
Interest Payment Annual, at the end of the year
Principal Repayment At the end of the Bond maturity
Conversion Ratio 30
(Number of shares per Bond)
Current Market Price per Share ` 55
Market Price of Convertible Bond ` 1725
It can issue plain bonds without conversion option at an Interest rate of 10.5%.
Year t1 t2 t3 t4
[email protected]% 0.905 0.819 0.741 0.671
Based on the above data, you are requested to calculate:
(i) Straight value of bonds
(ii) Conversion Value of Bond
(iii) Conversion Premium
(iv) Percentage of Down Turn Risk
(v) Conversion Parity Price (8 Marks)
(c) What do you mean by Bootstrapping? Explain the method of Trade Credit used by the
startup firms in bootstrapping. (4 Marks)
Answer
(a) Calculation of Average Return
Year A Ltd. B Ltd. C Ltd.
2018 2% 3% 5%
2019 6% 8% 7%
2020 13% 14% 15%
2021 7% 9% 11%
Sum 28% 34% 38%
Average 7% 8.50% 9.50%

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 18 FINAL EXAMINATION: NOVEMBER, 2022

(i) (1) Combination 1 - 65% in A Ltd. & 35% B Ltd.

Return = 7% × 0.65 + 8.50% × 0.35 = 4.55% + 2.975% = 7.525% or 7.53%
(2) Combination 2 – 65% in B Ltd. & 35% in C Ltd.
Return = 8.50% × 0.65 + 9.50% × 0.35 = 5.525% + 3.325% = 8.85%
(3) Combination 3 – 65% in C Ltd. & 35% in A Ltd.
Return = 0.65 × 9.50% + 0.35 × 7.00% = 6.175% + 2.45% = 8.625% or 8.63%
(4) Combination 4 – 65% in A Ltd. & 35% in C Ltd.
Return = 0.65 × 7% + 0.35 × 9.50% = 4.55% + 3.325% = 7.875% or 7.88%
(5) Combination 5 – 35% in A Ltd. & 65% in B Ltd.
Return = 0.35 × 7% + 0.65 × 8.50% = 2.45% + 5.525% = 7.975% or 7.98%
(6) Combination 6 – 35% in B Ltd. & 65% in C Ltd.
Return = 0.35 × 8.50% + 0.65 × 9.50% = 2.975% + 6.175% = 9.15%
Since maximum return is under Combination - 6 i.e. 65% investment in C Ltd. and
35% in B Ltd. hence it should be opted for.
(ii) Calculation of Return and Beta of Portfolio
65,000 20,000 15,000
Return of Portfolio = 7% × + 8.50% × + 9.50% ×
1,00,000 1,00,000 1,00,000
= 7.675%
65,000 20,000 15,000
Beta of Portfolio = 0.45 × + 1.15 × + 1.80 × =
1,00,000 1,00,000 1,00,000
0.7925 or 0.79
(b) (i) Straight Value of Bond
= ` 85 x 0.905 + ` 85 x 0.819 + ` 85 x 0.741 + ` 1085 x 0.671
= ` 76.93 + ` 69.62 + ` 62.99 + ` 728.04 = ` 937.56
(ii) Conversion rate is 30 shares per bond. Market price of share ` 55
Conversion Value 30 x ` 55 = ` 1,650
(iii) Conversion Premium
Market Pr ice − Conversion Value
 100
Conversion Value
`1725 − ` 1650
100 = 4.55%
` 1650

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 19

Alternatively, it can also be computed on Per Share/ Bond basis as follows:

` 1725 − ` 1650
= ` 2.50 Per Share or ` 1725 - ` 55 x 30 = ` 75
` 30
` 1725 − ` 937.50
(iv) 100 = 0.84 or 84%
` 937.50
` 1725 − ` 937.50
or 100 = 0.4565 or 45.65%
` 1725
This ratio gives the percentage price decline experienced by the bond if the stock
becomes worthless.
(v) Conversion Parity Price
Bond Price
No. of Shares on Conversion

` 1725
= ` 57.50
30
(c) An individual is said to be boot strapping when he or she attempts to found and build a
company from personal finances or from the operating revenues of the new company.
Trade Credit - When a person is starting his business, suppliers are reluctant to give
trade credit. They will insist on payment of their goods supplied either by cash or by
credit card. However, a way out in this situation is to prepare a well -crafted financial plan.
The next step is to pay a visit to the supplier’s office. If the business organization is
small, the owner can be directly contacted. On the other hand, if it is a big firm, the Chief
Financial Officer can be contacted and convinced about the financial plan.
Communication skills are important here. The financial plan has to be shown. The owner
or the financial officer has to be explained about the business and the need to get the
first order on credit in order to launch the venture. The owner or financial officer may give
half the order on credit and balance on delivery. The trick here is to get the goods
shipped and sell them before paying to them. One can also borrow to pay for the good
sold but there is interest cost also. So trade credit is one of the most important way to
reduce the amount of working capital one needs. This is especially true in retail
operations.
Question 6
(a) Mr. X wants to invest ` 1,00,000 in the 7 years 8% bonds in the market (Face Value
` 100) which were issued 2 years ago.
(i) You are requested to advise him what is the maximum price for bonds to be paid in
the following scenarios:

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 20 FINAL EXAMINATION: NOVEMBER, 2022

(1) If Mr. X is expecting minimum 9% return on the bonds

(2) If Mr. X is expecting minimum 7% return on the bonds
(3) If the present rate of similar bonds issued is 8.25%
(4) If the present rate of similar bonds issued is 7.75%
(ii) If the bonds are available at par and 1% is the transaction cost, what is the effective
yield?
(iii) Find the number of days required to breakeven transaction cost if the bonds are
available at par and 2% is the transaction cost. (8 Marks)
(b) (i) What is sustainable growth rate?.
(ii) What makes an Organization Sustainable?
(iii) Mr. X has submitted the following data:
Particulars (` ) in Lakhs
Total Assets 250
Total Liabilities 220
Net Income 12
Dividend Paid 4.5
Sales 100
Mr. X wants to know to what extent sales can be increased without going for
additional borrowings by using Sustainable Growth Rate (SGR) concept? (8 Marks)
(c) Write a short note on Venture Capital Fund.
OR
What are the applications of Value At Risk (VAR) ? (4 Marks)
Answer
(a) (i) The maximum price to be paid for Bond
(1) To have a return of 9% return on Bond.
8
= ` 100 × = ` 88.89
9
Alternative Answer
8 8 8 8 108
= + + + +
(1.09) (1.09) (1.09) (1.09) (1.09)5
1 2 3 4

= ` 7.34 + ` 6.73 + ` 6.18 + ` 5.67 + `70.19 = ` 96.11

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 21

(2) To have a return of 7% return on Bond.

8
= ` 100 × = ` 114.29
7
Alternative Answer
8 8 8 8 108
= + + + +
1 2 3 4
(1.07) (1.07) (1.07) (1.07) (1.07)5
= ` 7.48 + ` 6.99 + ` 6.53 + ` 6.10 + ` 77.00 = ` 104.10
(3) If present rate of similar bond issued is 8.25%
8 8 8 8 108
= 1
+ 2
+ 3
+ 4
+
(1.0825) (1.0825) (1.0825) (1.0825) (1.0825)5
= ` 7.39 + ` 6.83 + ` 6.31 + ` 5.83 + ` 72.66 = ` 99.02
Alternative Answer
8
= ` 100 × = ` 96.97
8.25
(4) If present rate of similar bond issued is 7.75%
8 8 8 8 108
= 1
+ 2
+ 3
+ 4
+
(1.0775) (1.0775) (1.0775) (1.0775) (1.0775)5
= ` 7.42 + ` 6.89 + ` 6.39 + ` 5.94 + ` 74.36
= ` 101.00
Alternative Answer
8
= ` 100 × = ` 103.23
7.75
8
(ii) Effective yield if transaction cost is 1% = ×100 = 7.92
101
(iii) No. of Days required for break even
2% × 1,00,000 2,000
= = = 90 days
8% 22.22
1,00,000 ×
360

Alternatively, if 365 days used in Calculation then answer will be as follows:

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 22 FINAL EXAMINATION: NOVEMBER, 2022

2% × 1,00,000 2,000
= = = 91.24 days say 91 days
8% 21.92
1,00,000 ×
365

(b) (i) The sustainable growth rate is a measure of how much a firm can grow without
borrowing more money. After the firm has passed this rate, it must borrow funds
from another source to facilitate growth.
(ii) In order to be sustainable, an organisation must:
• have a clear strategic direction;
• be able to scan its environment or context to identify opportunities for its work;
• be able to attract, manage and retain competent staff;
• have an adequate administrative and financial infrastructure;
• be able to demonstrate its effectiveness and impact in order to leverage further
resources; and
• get community support for, and involvement in its work.
(iii)
SI. No Particulars Amount in ` Lakhs
(a) Total Assets 250.00
(b) Total Liabilities 220.00
(c) Net Income 12.00
(d) Dividend Paid 4.50
(e) Sales 100.00
(f) Equity (a) – (b) 30.00
(g) Return on Equity (ROE) (c) /(f) 40.00%
(h) Dividend pay-out Ratio (d) /(c) 37.50%
(i) SGR [g x (1-h)] 25.00%*
(j) Additional Sales can be achieved without 25.00
further borrowings (e) × (i)
(k) Maximum sales can be achieved without 125.00
further borrowings (e) + (j)
* Alternatively, it can also be computed as follows:
g(1 − h)
SGR = = 33.33% and then Additional Sales shall be ` 33.33 Lakhs and
1 − [g(1 − h)]
Maximum Sales can be achieved without further borrowings shall be ` 133.33
Lakhs

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 23

(c) Venture Capital Fund means investment vehicle that manage funds of investors seeking
to invest in startup firms and small businesses with exceptional growth potential. Venture
capital is money provided by professionals who alongside management invest in young,
rapidly growing companies that have the potential to develop into significant economic
contributors.
Venture Capitalists generally
• Finance new and rapidly growing companies
• Purchase equity securities
• Assist in the development of new products or services
• Add value to the company through active participation.
OR
VAR can be applied
a. to measure the maximum possible loss on any portfolio or a trading position.
b. as a benchmark for performance measurement of any operation or trading.
c. to fix limits for individuals dealing in front office of a treasury department.
d. to enable the management to decide the trading strategies.
e. as a tool for Asset and Liability Management especially in banks.

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