PAPER – 2: STRATEGIC FINANCIAL MANAGEMENT

QUESTIONS
Security Valuation
1. XL Ispat Ltd. has made an issue of 14 per cent non-convertible debentures on January 1,
2007. These debentures have a face value of ` 100 and is currently traded in the market
at a price of ` 90.
Interest on these NCDs will be paid through post-dated cheques dated June 30 and
December 31. Interest payments for the first 3 years will be paid in advance through post-
dated cheques while for the last 2 years post-dated cheques will be issued at the third
year. The bond is redeemable at par on December 31, 2011 at the end of 5 years.
Required:
(i) CALCULATE the current yield and YTM of the bond.
(ii) CALCULATE the duration of the NCD.
(iii) CALCULATE the realized yield on the NCD assuming that intermediate coupon
payments are, not available for reinvestment calculate.
2. SAM Ltd. has just paid a dividend of ` 2 per share and it is expected to grow @ 6% p.a.
After paying dividend, the Board declared to take up a project by retaining the next three
annual dividends. It is expected that this project is of same risk as the existing projects.
The results of this project will start coming from the 4th year onward from now. The
dividends will then be ` 2.50 per share and will grow @ 7% p.a.
An investor has 1,000 shares in SAM Ltd. and wants a receipt of at least ` 2,000 p.a. from
this investment.
Required:
(i) EVALUATE whether the market value of the share is affected by the decision of the
Board.
(ii) RECOMMEND how the investor can maintain his target receipt from the investment
for first 3 years and improved income thereafter, given that the cost of capital of the
firm is 8%.
Portfolio Management
3. Expected returns on two stocks for particular market returns are given in the following
table:
Market Return Aggressive Defensive
7% 4% 9%
25% 40% 18%

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 34 FINAL (NEW) EXAMINATION: MAY, 2018

CALCULATE:
(i) The Betas of the two stocks.
(ii) Expected return of each stock, if the market return is equally likely to be 7% or 25%.
(iii) The Security Market Line (SML), if the risk free rate is 7.5% and market return is
equally likely to be 7% or 25%.
(iv) The Alphas of the two stocks.
4. Following are the details of a portfolio consisting of three shares:
Share Portfolio weight Beta Expected return in % Total variance
A 0.20 0.40 14 0.015
B 0.50 0.50 15 0.025
C 0.30 1.10 21 0.100
Standard Deviation of Market Portfolio Returns = 10%
You are given the following additional data:
Covariance (A, B) = 0.030
Covariance (A, C) = 0.020
Covariance (B, C) = 0.040
CALCULATE:
(i) The Portfolio Beta
(ii) Residual variance of each of the three shares
(iii) Portfolio variance using Sharpe Index Model
(iv) Portfolio variance (on the basis of modern portfolio theory given by Markowitz)
Mutual Funds
5. Sun Moon Mutual Fund (Approved Mutual Fund) sponsored open-ended equity oriented
scheme “Chanakya Opportunity Fund”. There were three plans viz. ‘A’ – Dividend Re-
investment Plan, ‘B’ – Bonus Plan & ‘C’ – Growth Plan.
At the time of Initial Public Offer on 1.4.2009, Mr. Anand, Mr. Bacchan & Mrs. Charu, three
investors invested ` 1,00,000 each & chosen ‘B’, ‘C’ & ‘A’ Plan respectively.
The History of the Fund is as follows:
Date Dividend % Bonus Ratio Net Asset Value per Unit (F.V. ` 10)
Plan A Plan B Plan C
28.07.2013 20 30.70 31.40 33.42

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 35

31.03.2014 70 5:4 58.42 31.05 70.05

31.10.2017 40 42.18 25.02 56.15
15.03.2018 25 46.45 29.10 64.28
31.03.2018 1:3 42.18 20.05 60.12
24.03.2019 40 1:4 48.10 19.95 72.40
31.07.2019 53.75 22.98 82.07
On 31st July 2019 all three investors redeemed all the balance units.
CALCULATE:
(i) Annual rate of return of Mrs. Charu who has invested in ‘A’ – Dividend Re-investment
Plan.
(ii) Annual rate of return of Mr. Anand who has invested in ‘B’ – Bonus Plan.
(iii) Annual rate of return of Mr. Bacchan who has invested ‘C’ – Growth Plan.
Assumptions:
1. Long-term Capital Gain is exempt from Income tax.
2. Short-term Capital Gain is subject to 10% Income tax.
3. Security Transaction Tax 0.2 per cent only on sale/redemption of units.
4. Ignore Education Cess
Derivative Analysis and Valuation
6. The following market data is available:
Spot USD/JPY 116.00
Deposit rates p.a. USD JPY
3 months 4.50% 0.25%
6 months 5.00% 0.25%
Forward Rate Agreement (FRA) for Yen is Nil.
Required:
(i) CALCULATE 3 months FRA rate at 3 months forward?
(ii) RECOMMEND arbitrage strategy, when 6 & 12 months LIBORS are 5% & 6.5%
respectively and X Ltd. bank is quoting 6/12 USD FRA at 6.50 – 6.75%.?
7. TMC Holding Ltd. has a portfolio of shares of diversified companies valued at ` 400 crore
enters into a swap arrangement with None Bank on the terms that it will get 1.15% quarterly
on notional principal of ` 400 crore in exchange of return on portfolio which is exactly
tracking the Sensex which is presently 21600.

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 36 FINAL (NEW) EXAMINATION: MAY, 2018

CALCULATE the net payment to be received/ paid at the end of each quarter if Sensex
turns out to be 21,860, 21,780, 22,080 and 21,960.
Foreign Exchange Exposure and Risk Management
8. An importer booked a forward contract with his bank on 10 th April for USD 2,00,000 due on
10th June @ ` 64.4000. The bank covered its position in the market at ` 64.2800.
The exchange rates for dollar in the interbank market on 10 th June and 20th June were:
10th June 20th June
Spot USD 1= ` 63.8000/8200 ` 63.6800/7200
Spot/June ` 63.9200/9500 ` 63.8000/8500
July ` 64.0500/0900 ` 63.9300/9900
August ` 64.3000/3500 ` 64.1800/2500
September ` 64.6000/6600 ` 64.4800/5600
Exchange Margin 0.10% and interest on outlay of funds @ 12%. The importer requested
on 20th June for extension of contract with due date on 10 th August.
Rates rounded to 4 decimal in multiples of 0.0025.
On 10th June, Bank Swaps by selling spot and buying one month forward.
CALCULATE:
(i) Cancellation rate
(ii) Amount payable on $ 2,00,000
(iii) Swap loss
(iv) Interest on outlay of funds, if any
(v) New contract rate
(vi) Total Cost
9. Your bank’s London office has surplus funds to the extent of USD 5,00,000/- for a period
of 3 months. The cost of the funds to the bank is 4% p.a. It proposes to invest these funds
in London, New York or Frankfurt and obtain the best yield, without any exchange risk to
the bank. The following rates of interest are available at the three centres for investment
of domestic funds there at for a period of 3 months.
London 5 % p.a.
New York 8% p.a.
Frankfurt 3% p.a.

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 37

The market rates in London for US dollars and Euro are as under:
London on New York
Spot 1.5350/90
1 month 15/18
2 month 30/35
3 months 80/85
London on Frankfurt
Spot 1.8260/90
1 month 60/55
2 month 95/90
3 month 145/140
RECOMMEND at which centre, the investment to be made & what will be the net gain (to
the nearest pound) to the bank on the invested funds?
International Financial Management
10. A foreign based company is planning to set up a software development unit in India.
Software developed at the Indian unit will be bought back by the foreign parent company
at a transfer price of US $10 millions. The unit will remain in existence in India for one year;
the software is expected to get developed within this time frame.
The foreign based company will be subject to corporate tax of 30 per cent and a withholding
tax of 10 per cent in India and will not be eligible for tax credit. The software developed will
be sold in the international market for US $ 12.0 millions. Other estimates are as follows:
Rent for fully furnished unit with necessary hardware in India ` 20,00,000
Man power cost (80 software professional will be working for 10 ` 540 per man hour
hours each day)
Administrative and other costs ` 16,20,000
The rupee-dollar rate is `65/$.
ADVISE the foreign company on the financial viability of the project.
Assumption: 365 days in a year.
Interest Rate Risk Management
11. Electraspace is consumer electronics wholesaler. The business of the firm is highly
seasonal in nature. In 6 months of a year, firm has a huge cash deposits and especially
near Christmas time and other 6 months firm cash crunch, leading to borrowing of money
to cover up its exposures for running the business.

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 38 FINAL (NEW) EXAMINATION: MAY, 2018

It is expected that firm shall borrow a sum of €50 million for the entire period of slack
season in about 3 months.
A Bank has given the following quotations:
Spot 5.50% - 5.75%
3 × 6 FRA 5.59% - 5.82%
3 × 9 FRA 5.64% - 5.94%
3 month €50,000 future contract maturing in a period of 3 months is quoted at 94.15
(5.85%).
ADVISE:
(i) How a FRA, shall be useful if the actual interest rate after 3 months turnout to be:
(a) 4.5% (b) 6.5%
(ii) How 3 months Future contract shall be useful for company if interest rate turns out as
mentioned in part (a) above.
Corporate Valuation
12. BRS Inc deals in computer and IT hardwares and peripherals. The expected revenue for
the next 8 years is as follows:
Years Sales Revenue ($ Million)
1 8
2 10
3 15
4 22
5 30
6 26
7 23
8 20
Summarized financial position as on 31 March 2012 was as follows:
$ Million
Liabilities Amount Assets Amount
Equity Stocks 12 Fixed Assets (Net) 17
12% Bonds 8 Current Assets 3
20 20

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 39

Additional Information:
(a) Its variable expenses is 40% of sales revenue and fixed operating expenses (cash)
are estimated to be as follows:
Period Amount ($ Million)
1- 4 years 1.6
5-8 years 2
(b) An additional advertisement and sales promotion campaign shall be launched
requiring expenditure as per following details:
Period Amount ($ Million)
1 year 0.50
2-3 years 1.50
4-6 years 3.00
7-8 years 1.00
(c) Fixed assets are subject to depreciation at 15% as per WDV method.
(d) The company has planned additional capital expenditures (in the beginning of each
year) for the coming 8 years as follows:
Period Amount ($ Million)
1 0.50
2 0.80
3 2.00
4 2.50
5 3.50
6 2.50
7 1.50
8 1.00
(e) Investment in Working Capital is estimated to be 20% of Revenue.
(f) Applicable tax rate for the company is 30%.
(g) Cost of Equity is estimated to be 16%.
(h) The Free Cash Flow of the firm is expected to grow at 5% per annum after 8 years.
CALCULATE:
(i) Value of Firm
(ii) Value of Equity

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 40 FINAL (NEW) EXAMINATION: MAY, 2018

Mergers, Acquisitions and Corporate Restructuring

13. T Ltd. and E Ltd. are in the same industry. The former is in negotiation for acquisition of
the latter. Important information about the two companies as per their latest financial
statements is given below:
T Ltd. E Ltd.
` 10 Equity shares outstanding 12 Lakhs 6 Lakhs
Debt:
10% Debentures (` Lakhs) 580 --
12.5% Institutional Loan (` Lakhs) -- 240
Earning before interest, depreciation and tax (EBIDAT) (` Lakhs) 400.86 115.71
Market Price/share (`) 220.00 110.00
T Ltd. plans to offer a price for E Ltd., business as a whole which will be 7 times EBIDAT
reduced by outstanding debt, to be discharged by own shares at market price.
E Ltd. is planning to seek one share in T Ltd. for every 2 shares in E Ltd. based on the
market price. Tax rate for the two companies may be assumed as 30%.
CALCULATE the following under both alternatives - T Ltd.'s offer and E Ltd.'s plan:
(i) Net consideration payable.
(ii) No. of shares to be issued by T Ltd.
(iii) EPS of T Ltd. after acquisition.
(iv) Expected market price per share of T Ltd. after acquisition.
Note: Calculations (except EPS) may be rounded off to 2 decimals in lakhs
Theoretical Questions
14. DISTINGUISH between:
(a) Banking and Non-Banking financial institutions
(b) Primary participants and secondary participants in securitization
(c) Islamic Finance and Conventional Finance
15. (a) DESCRIBE Value at Risk and its application.
(b) EXPLAIN the concept of Bootstrapping and describe the various methods of
bootstrapping used by start ups.
(c) DESCRIBE the guidelines for SME listing and its benefits.

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 41

SUGGESTED ANSWERS/HINTS

` 7 12
1. (i) Current yield = × = 0.1555 or 15.55%
` 90 6
YTM can be determined from the following equation
7 × PVIFA (YTM, 10) + 100 × PVIF (YTM, 10) = 90
Let us discount the cash flows using two discount rates 7.50% and 9% as follows:
Year Cash Flows [email protected]% [email protected]% PVF@9% PV@9%
0 -90 1 -90 1 -90
1 7 0.930 6.51 0.917 6.419
2 7 0.865 6.055 0.842 5.894
3 7 0.805 5.635 0.772 5.404
4 7 0.749 5.243 0.708 4.956
5 7 0.697 4.879 0.650 4.550
6 7 0.648 4.536 0.596 4.172
7 7 0.603 4.221 0.547 3.829
8 7 0.561 3.927 0.502 3.514
9 7 0.522 3.654 0.460 3.220
10 107 0.485 51.90 0.422 45.154
6.560 -2.888
Now we use interpolation formula
6.560
7.50% + × 1.50%
6.560-(-2.888)
6.560
7.50% + × 1.50% =7.50% + 1.041%
9.448
YTM = 8.541% say 8.54%
Note: Students can also compute the YTM using rates other than 15% and 18%.
(ii) The duration can be calculated as follows:
Year Cash PVF@ PV @ Proportion of Proportion of
Flow 8.54% 8.54% NCD value NCD value × time
1 7 0.921 6.447 0.0717 0.0717
2 7 0.849 5.943 0.0661 0.1322

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 42 FINAL (NEW) EXAMINATION: MAY, 2018

3 7 0.782 5.474 0.0608 0.1824

4 7 0.721 5.047 0.0561 0.2244
5 7 0.664 4.648 0.0517 0.2585
6 7 0.612 4.284 0.0476 0.2856
7 7 0.563 3.941 0.0438 0.3066
8 7 0.519 3.633 0.0404 0.3232
9 7 0.478 3.346 0.0372 0.3348
10 107 0.441 47.187 0.5246 5.2460
89.95 7.3654
Duration = 7.3654 half years i.e. 3.683 years.
(iii) Realized Yield can be calculated as follows:
(7 × 10) + 100
= 90
(1 + R)10
170
(1 + R)10 =
90
1/10
 170 
R=   - 1 = 0.06380 or 6.380% for half yearly and 12.76% annually.
 90 
D1
2. (i) Value of share at present =
ke − g

2(1.06)
= = ` 106
0.08 − 0.06
However, if the Board implement its decision, no dividend would be payable for 3
years and the dividend for year 4 would be ` 2.50 and growing at 7% p.a. The price
of the share, in this case, now would be:
2.50 1
P0 = × = ` 198.46
0.08 − 0.07 (1 + 0.08)3
So, the price of the share is expected to increase from ` 106 to ` 198.45 after the
announcement of the project. The investor can take up this situation as follows:
Expected market price after 3 years 2.50 ` 250.00
=
0.08 − 0.07

© The Institute of Chartered Accountants of India

 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 43

Expected market price after 2 years 2.50 1 ` 231.48

×
0.08 − 0.07 (1 + 0.08)
Expected market price after 1 years 2.50 1 ` 214.33
×
0.08 − 0.07 (1 + 0.08) 2

(ii) In order to maintain his receipt at ` 2,000 for first 3 year, he would sell
10 shares in first year @ ` 214.33 for ` 2,143.30
9 shares in second year @ ` 231.48 for ` 2,083.32
8 shares in third year @ ` 250 for ` 2,000.00
At the end of 3rd year, he would be having 973 shares valued @ ` 250 each i.e.
` 2,43,250. On these 973 shares, his dividend income for year 4 would be @ ` 2.50
i.e. ` 2,432.50.
Thus, if the project is taken up by the company, the investor would be able to maintain
his receipt of at least ` 2,000 for first three years and would be getting increased
income thereafter.
3. (i) The Betas of two stocks:
Aggressive stock - 40% - 4%/25% - 7% = 2
Defensive stock - 18% - 9%/25% - 7% = 0.50
Alternatively, it can also be solved by using the Characteristic Line Relationship as
follows:
Rs = α + βRm
Where
α = Alpha
β = Beta
Rm= Market Return
For Aggressive Stock
4% = α + β(7%)
40% = α + β(25%)
36% = β(18%)
β=2
For Defensive Stock
9% = α + β(7%)

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 44 FINAL (NEW) EXAMINATION: MAY, 2018

18% = α + β(25%)
9% = β(18%)
β =0.50
(ii) Expected returns of the two stocks:-
Aggressive stock - 0.5 x 4% + 0.5 x 40% = 22%
Defensive stock - 0.5 x 9% + 0.5 x 18% = 13.5%
(iii) Expected return of market portfolio = 0.5 x 7% + 0.5% x 25% = 16%
∴ Market risk prem. = 16% - 7.5% = 8.5%
∴ SML is, required return = 7.5% + βi 8.5%
(iv) Rs = α + βRm
For Aggressive Stock
22% = αA + 2(16%)
αA = -10%
For Defensive Stock
13.5% = αD + 0.50(16%)
αD = 5.5%
4. (i) Portfolio Beta
0.20 x 0.40 + 0.50 x 0.50 + 0.30 x 1.10 = 0.66
(ii) Residual Variance
To determine Residual Variance first of all we shall compute the Systematic Risk as
follows:
β2A × σ M
2
= (0.40)2(0.01) = 0.0016

βB2 × σ M
2
= (0.50)2(0.01) = 0.0025

β2C × σ M
2
= (1.10)2(0.01) = 0.0121
Residual Variance
A 0.015 – 0.0016 = 0.0134
B 0.025 – 0.0025 = 0.0225
C 0.100 – 0.0121 = 0.0879
(iii) Portfolio variance using Sharpe Index Model
Systematic Variance of Portfolio = (0.10)2 x (0.66)2 = 0.004356

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 45

Unsystematic Variance of Portfolio = 0.0134 x (0.20)2 + 0.0225 x (0.50)2 + 0.0879 x

(0.30)2 = 0.014072
Total Variance = 0.004356 + 0.014072 = 0.018428
(iv) Portfolio variance on the basis of Markowitz Theory
2
= (wA x wAx σ A ) + (wA x wBxCovAB) + (wA x wCxCovAC) + (wB x wAxCovAB) + (wB x wBx
σ B2 ) + (wB x wCxCovBC) + (wC x wAxCovCA) + (wC x wBxCovCB) + (wC x wCx σ 2c )
= (0.20 x 0.20 x 0.015) + (0.20 x 0.50 x 0.030) + (0.20 x 0.30 x 0.020) + (0.20 x 0.50
x 0.030) + (0.50 x 0.50 x 0.025) + (0.50 x 0.30 x 0.040) + (0.30 x 0.20 x 0.020) + (0.30
x 0.50 x 0.040) + (0.30 x 0.30 x 0.10)
= 0.0006 + 0.0030 + 0.0012 + 0.0030 + 0.00625 + 0.0060 + 0.0012 + 0.0060 + 0.0090
= 0.0363
5. (i) Return of Mrs. Charu invested in Plan A (Dividend Reinvestment)
(Amount in ` )
Date Investment Dividend Dividend Re- NAV Units Closing
payout invested Unit
(%) (Closing Balance
Units X Face ∑ Units
value of ‘10
X Dividend
Payout %)
01.04.2009 1,00,000.00 10.00 10,000.00 10,000.00
28.07.2013 20 20,000.00 30.70 651.47 10,651.47
31.03.2014 70 74,560.29 58.42 1,276.28 11,927.75
31.10.2017 40 47,711.00 42.18 1,131.13 13,058.88
15.03.2018 25 32,647.20 46.45 702.85 13,761.73
24.03.2019 40 55,046.92 48.10 1,144.43 14,906.16
Redemption value 14,906.16 × 53.75 8,01,206.10
Less: Security Transaction Tax (STT) is 0.2% 1,602.41
Net amount received 7,99,603.69
Less: Short term capital gain tax @ 10% on 1,144.43 (53.64* – 634
48.10≈) = 6,340
Net of tax 7,98,969.69
Less: Investment 1,00,000.00
6,98,969.69

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 46 FINAL (NEW) EXAMINATION: MAY, 2018

*(53.75 – STT @ 0.2%) ≈ This value can also be taken as zero

6,98,969.69 12
Annual average return (%) × × 100 = 67.64 %
1,00,000 124
(ii) Return of Mr. Anand invested in Plan B – (Bonus)
(Amount in `)
Date Units Bonus units Total Balance NAV per unit
01.04.2009 10,000 10,000 10
31.03.2014 12,500 22,500 31.05
31.03.2018 7,500 30,000 20.05
24.03.2019 7,500 37,500 19.95
Redemption value 37,500 × 22.98 8,61,750.00
Less: Security Transaction Tax (STT) is 0.2% 1,723.50
Net amount received 8,60,026.50
Less: Short term capital gain tax @ 10%
7,500 × (22.93† – 19.95) = 22,350 2,235.00
Net of tax 8,57,791.50
Less: Investment 1,00,000.00
Net gain 7,57,791.50
†(22.98 – STT @ 0.2%)
7,57,791.50 12
Annual average return (%) × × 100 = 73.33 %
1,00,000 124
(iii) Return of Mr. Bacchan invested in Plan C – (Growth)
Particulars (Amount in `)
Redemption value 10,000 × 82.07 8,20,700.00
Less: Security Transaction Tax (S.T.T) is .2% 1,641.40
Net amount received 8,19,058.60
Less: Short term capital gain tax @ 10% 0.00
Net of tax 8,19,058.60
Less: Investment 1,00,000.00
Net gain 7,19,058.60
7,19,058 12
Annual average return (%) × × 100 = 69.59 %
1,00,000 124

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 47

Note: Alternatively, figure of * and † can be taken as without net of Tax because, as
per Proviso 5 of Section 48 of IT Act, no deduction of STT shall be allowed in
computation of Capital Gain.
6. (i) 3 Months Interest rate is 4.50% & 6 Months Interest rate is 5% p.a.
Future Value 6 Months from now is a product of Future Value 3 Months now & 3
Months
Future Value from after 3 Months.
(1+0.05*6/12) = (1+0.045*3/12) x (1+i3,6 *3/12)
i3,6 = [(1+0.05* 6/12) /(1+0.045 *3/12) – 1] *12/3
i.e. 5.44% p.a.
(ii) To find arbitrage opportunity first we shall find out the 6 Months forward 6 month rate
as follows:
(1+0.065) = (1+0.05*6/12) x (1+i6,6 *6/12)
i6,6 = [(1+0.065/1.025) – 1] *12/6
6 Months forward 6 month rate is 7.80% p.a.
The Bank is quoting 6/12 USD FRA at 6.50 – 6.75%
Therefore, there is an arbitrage Opportunity of earning interest @ 7.80% p.a. & Paying
@ 6.75%
Strategy: Borrow for 6 months, buy an FRA & invest for 12 months
To get $ 1.065 at the end of 12 months for $ 1 invested today
To pay$ 1.060# at the end of 12 months for every $ 1 Borrowed today
Net gain $ 0.005 i.e. risk less profit for every $ borrowed
# (1+0.05/2) (1+.0675/2) = (1.05959) say 1.060
7.
Qtrs. Sensex Sensex Return (%) Amount Payable Fixed Return Net (`
(` Crore) (Receivable) Crore)
(` Crore)
(1) (2) (3) (4) (5) (5) – (4)
0 21,600 - - - -
1 21,860 1.2037 4.8148 4.6000 - 0.2148
2 21,780 -0.3660 -1.4640 4.6000 6.0640
3 22,080 1.3774 5.5096 4.6000 - 0.9096
4 21,960 -0.5435 -2.1740 4.6000 6.7740

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 48 FINAL (NEW) EXAMINATION: MAY, 2018

8. (i) Cancellation Rate:

The forward sale contract shall be cancelled at Spot TT Purchase for $ prevailing on
the date of cancellation as follows:
$/ ` Market Buying Rate ` 63.6800
Less: Exchange Margin @ 0.10% ` 0.0636
` 63.6163
Rounded off to ` 63.6175
(ii) Amount payable on $ 2,00,000
Bank sells $2,00,000 @ ` 64.4000 ` 1,28,80,000
Bank buys $2,00,000 @ ` 63.6163 ` 1,27,23,260
Amount payable by customer ` 1,56,740
(iii) Swap Loss
On 10th June the bank does a swap sale of $ at market buying rate of ` 63.8300 and
forward purchase for June at market selling rate of ` 63.9500.
Bank buys at ` 63.9500
Bank sells at ` 63.8000
Amount payable by customer ` 0.1500
Swap Loss for $ 2,00,000 in ` = ` 30,000
(iv) Interest on Outlay of Funds
On 10thApril, the bank receives delivery under cover contract at ` 64.2800 and sell
spot at ` 63.8000.
Bank buys at ` 64.2800
Bank sells at ` 63.8000
Amount payable by customer ` 0.4800
Outlay for $ 2,00,000 in ` 96,000
Interest on ` 96,000 @ 12% for 10 days ` 320
(v) New Contract Rate
The contract will be extended at current rate
$/ ` Market forward selling Rate for August ` 64.2500
Add: Exchange Margin @ 0.10% ` 0.0643
` 64.3143

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 49

Rounded off to ` 64.3150

(vi) Total Cost
Cancellation Charges ` 1,56,740.00
Swap Loss ` 30,000.00
Interest ` 320.00
` 1,87,060.00
9. To determine the centre of investment by bank except New York (in whose currency the
surplus is available) Arbitrage Profit for remaining two centres shall be computed as
follows:
(a) If investment is made at London
Convert US$ 5,00,000 at Spot Rate (5,00,000/1.5390) = £ 3,24,886
Add: £ Interest for 3 months on £ 324,886 @ 5% =£ 4,061
= £ 3,28,947
Less: Amount Invested $ 5,00,000
Interest accrued thereon $ 5,000
= $ 5,05,000
Equivalent amount of £ required to pay the
above sum ($ 5,05,000/1.5430) = £ 3,27,285
Arbitrage Profit =£ 1,662
(b) If investment is made at New York
Gain $ 5,00,000 (8% - 4%) x 3/12 = $ 5,000
Equivalent amount in £ 3 months ($ 5,000/ 1.5475) £ 3,231
(c) If investment is made at Frankfurt
Convert US$ 500,000 at Spot Rate (Cross Rate) 1.8260/1.5390 = € 1.1865
Euro equivalent US$ 500,000 = € 5,93,250
Add: Interest for 3 months @ 3% =€ 4,449
= € 5,97,699
3 month Forward Rate of selling € (1/1.8150) = £ 0.5510
Sell € in Forward Market € 5,97,699 x £ 0.5510 = £ 3,29,332
Less: Amounted invested and interest thereon = £ 3,27,285
Arbitrage Profit = £ 2,047

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 50 FINAL (NEW) EXAMINATION: MAY, 2018

Recommendation: Since out of three options the maximum profit is in case

investment is made in New York. Hence it shall be opted and arbitrage gain would be
£3,231.
10. Proforma profit and loss account of the Indian software development unit
` `
Revenue 65,00,00,000
Less: Costs:
Rent 20,00,000
Manpower (`540 x 80 x 10 x 365) 15,76,80,000
Administrative and other costs 16,20,000 16,13,00,000
Earnings before tax 48,87,00,000
Less: Tax 14,66,10,000
Earnings after tax 34,20,90,000
Less: Withholding tax 3,42,09,000
Repatriation amount (in rupees) 30,78,81,000
Repatriation amount (in dollars) $4.7366 million

Advise: The cost of development software in India for the foreign based company is $5.3
million. As the USA based Company is expected to sell the software in the international
market at $12.0 million, it is advised to develop the software in India.
11. (i) By entering into an FRA, firm shall effectively lock in interest rate for a specified future
in the given it is 6 months. Since, the period of 6 months is starting in 3 months, the
firm shall opt for 3 × 9 FRA locking borrowing rate at 5.94%.
In the given scenarios, the net outcome shall be as follows:
If the rate turns out to be If the rate turns out to be
4.50% 6.50%
FRA Rate 5.94% 5.94%
Actual Interest Rate 4.50% 6.50%
Loss/ (Gain) 1.44% (0.56%)
FRA Payment / (Receipts) €50 m × 1.44% × ½ = €50m × 0.56% × ½ =
€360,000 (€140,000)
Interest after 6 months on = €50m × 4.5% × ½ = € 50m × 6.5% × ½
€50 Million at actual rates = €1,125,000 = €1,625,000
Net Out Flow € 1,485,000 €1,485,000

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Thus, by entering into FRA, the firm has committed itself to a rate of 5.94% shown as
follows:
€ 1,485,000 12
×100 × = 5.94%
€ 50,000,000 6
(ii) Since firm is a borrower it will like to off-set interest cost by profit on Future Contract.
Accordingly, if interest rate rises it will gain hence it should sell interest rate futures.
Amount of Borrowing Duration of Loan
No. of Contracts = ×
Contract Size 3 months
€ 50,000,000 6
= × = 2000 Contracts
€ 50,000 3
The final outcome in the given two scenarios shall be as follows:
If the interest rate If the interest rate
turns out to be 4.5% turns out to be 6.5%
Future Course Action:
Sell to open 94.15 94.15
Buy to close 95.50 (100 - 4.5) 93.50 (100 - 6.5)
Loss/ (Gain) 1.35% (0.65%)
Cash Payment (Receipt) for €50,000×2000× €50,000×2000×0.65%
Future Settlement 1.35%×3/12 × 3/12
= €337,500 = (€162,500)
Interest for 6 months on €50 €50 million × 4.5% × ½ €50 million × 6.5% × ½
million at actual rates = €11,25,000 = €16,25,000
€1,462,500 €1,462,500
Thus, the firm locked itself in interest rate of 5.85% shown as follows:
€ 1,462,500 12
× 100 × = 5.85%
€ 50,000,000 6
12. Working Notes:
(a) Determination of Weighted Average Cost of Capital
Sources of Cost (%) Proportions Weights Weighted
funds Cost
Equity Stock 16 12/20 0.60 9.60
12% Bonds 12%(1-0.30) = 8.40 8/20 0.40 3.36
12.96 say 13

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(b) Schedule of Depreciation

$ Million
Year Opening Balance Addition during Total Depreciation @
of Fixed Assets the year 15%

1 17.00 0.50 17.50 2.63

2 14.87 0.80 15.67 2.35
3 13.32 2.00 15.32 2.30
4 13.02 2.50 15.52 2.33
5 13.19 3.50 16.69 2.50
6 14.19 2.50 16.69 2.50
7 14.19 1.50 15.69 2.35
8 13.34 1.00 14.34 2.15
(c) Determination of Investment
$ Million
Investment Required Existing Additional
Year For Capital CA (20% of Investment Investment
Total in CA required
Expenditure Revenue)
1 0.50 1.60 2.10 3.00 0.00
2 0.80 2.00 2.80 2.50* 0.30
3 2.00 3.00 5.00 2.00** 3.00
4 2.50 4.40 6.90 3.00 3.90
5 3.50 6.00 9.50 4.40 5.10
6 2.50 5.20 7.70 6.00 1.70
7 1.50 4.60 6.10 5.20 0.90
8 1.00 4.00 5.00 4.60 0.40
* Balance of CA in Year 1 ($3 Million) – Capital Expenditure in Year 1($ 0.50 Million)
** Similarly balance of CA in Year 2 ($2.80) – Capital Expenditure in Year 2($ 0.80
Million)
(d) Determination of Present Value of Cash Inflows
$ Million
Years
Particulars
1 2 3 4 5 6 7 8
Revenue (A) 8.00 10.00 15.00 22.00 30.00 26.00 23.00 20.00

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Less: Expenses
Variable Costs 3.20 4.00 6.00 8.80 12.00 10.40 9.20 8.00
Fixed cash operating
cost 1.60 1.60 1.60 1.60 2.00 2.00 2.00 2.00
Advertisement Cost 0.50 1.50 1.50 3.00 3.00 3.00 1.00 1.00
Depreciation 2.63 2.35 2.30 2.33 2.50 2.50 2.35 2.15
Total Expenses (B) 7.93 9.45 11.40 15.73 19.50 17.90 14.55 13.15
EBIT (C) = (A) - (B) 0.07 0.55 3.60 6.27 10.50 8.10 8.45 6.85
Less: Taxes@30% (D) 0.02 0.16 1.08 1.88 3.15 2.43 2.53 2.06
NOPAT (E) = (C) - (D) 0.05 0.39 2.52 4.39 7.35 5.67 5.92 4.79
Gross Cash Flow (F) =
(E) + Dep 2.68 2.74 4.82 6.72 9.85 8.17 8.27 6.94
Less: Investment in
Capital Assets
plus Current Assets (G) 0 0.30 3.00 3.90 5.10 1.70 0.90 0.40
Free Cash Flow (H) =
(F) - (G) 2.68 2.44 1.82 2.82 4.75 6.47 7.37 6.54
PVF@13% (I) 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376
PV (H)(I) 2.371 1.911 1.261 1.729 2.579 3.106 3.132 2.46

Total present value = $ 18.549 million

(e) Determination of Present Value of Continuing Value (CV)
FCF9 $6.54 million(1.05) $6.867million
CV = = = = $85.8375 million
k-g 0.13 - 0.05 0.08
Present Value of Continuing Value (CV) = $85.8376 million X PVF13%,8 = $85.96875
million X 0.376 = $32.2749 million
(i) Value of Firm
$ Million
Present Value of cash flow during explicit period 18.5490
Present Value of Continuing Value 32.2749
Total Value 50.8239

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 54 FINAL (NEW) EXAMINATION: MAY, 2018

(ii) Value of Equity

$ Million
Total Value of Firm 50.8239
Less: Value of Debt 8.0000
Value of Equity 42.8239
13. As per T Ltd.’s Offer
` in lakhs
(i) Net Consideration Payable
7 times EBIDAT, i.e. 7 x ` 115.71 lakh 809.97
Less: Debt 240.00
569.97
(ii) No. of shares to be issued by T Ltd
` 569.97 lakh/` 220 (rounded off) (Nos.) 2,59,000
(iii) EPS of T Ltd after acquisition
Total EBIDT (` 400.86 lakh + ` 115.71 lakh) 516.57
Less: Interest (` 58 lakh + ` 30 lakh) 88.00
428.57
Less: 30% Tax 128.57
Total earnings (NPAT) 300.00

Total no. of shares outstanding 14.59 lakh

(12 lakh + 2.59 lakh)
EPS (` 300 lakh/ 14.59 lakh) ` 20.56
(iv) Expected Market Price:
` in lakhs
Pre-acquisition P/E multiple:
EBIDAT 400.86
10
Less: Interest ( 580 X ) 58.00
100
342.86
Less: 30% Tax 102.86
240.00

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No. of shares (lakhs) 12.00

EPS ` 20.00
220
Hence, PE multiple 11
20
Expected market price after acquisition (` 20.56 x 11) ` 226.16
As per E Ltd’s Plan
` in lakhs
(i) Net consideration payable
6 lakhs shares x ` 110 660
(ii) No. of shares to be issued by T Ltd
` 660 lakhs ÷ ` 220 3 lakh
(iii) EPS of T Ltd after Acquisition
NPAT (as per earlier calculations) 300.00
Total no. of shares outstanding (12 lakhs + 3 lakhs) 15 lakh
Earning Per Share (EPS) ` 300 lakh/15 lakh ` 20.00
(iv) Expected Market Price (` 20 x 11) 220.00

14. (a) Distinction between Banking and Non-Banking financial institutions

Basis for Non-Banking
Banking Institutions
comparison Institutions
Meaning Bank is a financial intermediary Non-banking institutions
which provides banking services to are basically company
general people. And it requires a form of organization that
bank license for that. provides banking services
to people without holding
a banking license.
Transaction Banks provide transaction services The non-banking
Services like providing overdraft facility, institutions do not provide
issue of cheque books, travelers any transaction services.
cheque, demand draft, transfer of
funds, etc.
Money Bank deposits constitute a major The money supply of the
supply part of the national money supply. nonbanking institutions is
small.
Credit Banks create credit. Non-banking institutions
creation do not create credit.

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Compliance Banks are required to comply with Non-banking institutions

some of the legal requirements like are not required to comply
Cash Reserve Ratio (CRR), with these legal
Statutory Liquidity Ratio and requirements.
Capital Adequacy Ratio (CAR).
Demand They are not accepted. They are accepted.
Deposit
Payment and Contains an integral part of the Not a part of the system.
settlement system.
system
(b) Distinction between Primary Participants and Secondary Participants in
securitization
Primary Participants: Primary Participants are main parties to this process. The
primary participants in the process of securitization are as follows:
(i) Originator: It is the initiator of deal or can be termed as securitizer. It is an entity
which sells the assets lying in its books and receives the funds generated
through the sale of such assets.
(ii) Special Purpose Vehicle: Also, called SPV is created for the purpose of
executing the deal. Since issuer originator transfers all rights in assets to SPV,
it holds the legal title of these assets. It is created especially for the purpose of
securitization only and normally could be in form of a company, a firm, a society
or a trust.
(iii) The Investors: Investors are the buyers of securitized papers which may be an
individual, an institutional investor such as mutual funds, provident funds,
insurance companies, mutual funds, Financial Institutions etc.
Secondary Participants
Besides, the primary participants, other parties involved into the securitization
process are as follows:
(i) Obligors: Actually they are the main source of the whole securitization process.
They are the parties who owe money to the firm and are assets in the Balance
Sheet of Originator.
(ii) Rating Agency: Since the securitization is based on the pools of assets rather
than the originators, the assets have to be assessed in terms of its credit quality
and credit support available and that is where the credit rating agencies come.
(iii) Receiving and Paying Agent (RPA): Also, called Servicer or Administrator, it
collects the payment due from obligor(s) and passes it to SPV. It also follow up

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with defaulting borrower and if required initiate appropriate legal action against
them.
(iv) Agent or Trustee: Trustees are appointed to oversee that all parties to the deal
perform in the true spirit of terms of agreement. Normally, it takes care of interest
of investors who acquires the securities.
(v) Credit Enhancer: Since investors in securitized instruments are directly
exposed to performance of the underlying and sometime may have limited or no
recourse to the originator, they seek additional comfort in the form of credit
enhancement. In other words, they require credit rating of issued securities
which also empowers marketability of the securities.
Originator itself or a third party say a bank may provide an additional comfort
called Credit Enhancer. While originator provides his comfort in the form of over
collateralization or cash collateral, the third party provides it in form of letter of
credit or surety bonds.
(vi) Structurer: It brings together the originator, investors, credit enhancers and
other parties to the deal of securitization. Normally, these are investment
bankers also called arranger of the deal. It ensures that deal meets all legal,
regulatory, accounting and tax laws requirements.
(c) Distinction between Islamic Finance and Conventional Finance
How Islamic Finance is different from Conventional Finance
Major differences between Islamic finance and other form of finance (Conventional
Finance) are as follows:
Basis Islamic Finance Conventional Finance
Promotion Islamic Finance promotes just, Based on commercial
fair and balanced society. objectives and interest must
Hence, interest is prohibited. be paid irrespective of
outcome of business.
Ethical framework Structured on ethical and No such framework.
moral framework of Sharia.
Verses from the holy Quran
and tradition from As-Sunnah
are two divine guidance.
Speculation The financial transactions No such restrictions.
should be free from the
element of uncertainty
(Gharar) and gambling (Maisir)
Unlawful Goods Islamic Finance must not be There are no such
and Services involved in any transactions restrictions.

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not involve trade not allowed

as per Islamic principles such
as alcohol, armaments, pork
and other socially detrimental
products.

15. (a) VAR is a measure of risk of investment. Given the normal market condition in a set of
period, say, one day it estimates how much an investment might lose. This investment
can be a portfolio, capital investment or foreign exchange etc., VAR answers two
basic questions -
(i) What is worst case scenario?
(ii) What will be loss?
It was first applied in 1922 in New York Stock Exchange, entered the financial world
in 1990s and become world’s most widely used measure of financial risk.
Features of VAR
Following are main features of VAR
(i) Components of Calculations: VAR calculation is based on following three
components :
(a) Time Period
(b) Confidence Level – Generally 95% and 99%
(c) Loss in percentage or in amount
(ii) Statistical Method: It is a type of statistical tool based on Standard Deviation.
(iii) Time Horizon: VAR can be applied for different time horizons say one day, one
week, one month and so on.
(iv) Probability: Assuming the values are normally attributed, probability of maximum
loss can be predicted.
(v) Control Risk: Risk can be controlled by selling limits for maximum loss.
(vi) Z Score: Z Score indicates how many standard Deviations is away from Mean
value of a population. When it is multiplied with Standard Deviation it provides
VAR.
Application of VAR
VAR can be applied
(i) to measure the maximum possible loss on any portfolio or a trading position.
(ii) as a benchmark for performance measurement of any operation or trading.
(iii) to fix limits for individuals dealing in front office of a treasury department.

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(iv) to enable the management to decide the trading strategies.

(v) as a tool for Asset and Liability Management especially in banks.
(b) 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.
A common mistake made by most founders is that they make unnecessary expenses
towards marketing, offices and equipment they cannot really afford. So, it is true that
more money at the inception of a business leads to complacency and wasteful
expenditure. On the other hand, investment by startups from their own savings leads
to cautious approach. It curbs wasteful expenditures and enable the promoter to be
on their toes all the time.
Methods: Here are some of the methods in which a startup firm can bootstrap:
(i) 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.
(ii) Factoring: This is a financing method where accounts receivable of a business
organization is sold to a commercial finance company to raise capital. The factor
then got hold of the accounts receivable of a business organization and assumes
the task of collecting the receivables as well as doing what would've been the
paperwork. Factoring can be performed on a non-notification basis. It means
customers may not be told that their accounts have been sold.
(iii) Leasing: Another popular method of bootstrapping is to take the equipment on
lease rather than purchasing it. It will reduce the capital cost and also help
lessee (person who take the asset on lease) to claim tax exemption. So, it is
better to a take a photocopy machine, an automobile or a van on lease to avoid
paying out lump sum money which is not at all feasible for a startup organization.
(c) Guidelines for SME Listing
(i) Capital: The post issue face value capital should not exceed ` Twenty-five
crores.
(ii) Trading lot size
 The minimum application and trading lot size shall not be less than
` 1,00,000/-.

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 The minimum depth shall be ` 1,00,000/- and at any point of time it shall not
be less than ` 1,00,000/-.
 The investors holding with less than ` 1,00,000/- shall be allowed to offer their
holding to the Market Maker in one lot.
 However in functionality the market lot will be subject to revival after a
stipulated time.
(iii) Participants: The existing Members of the Exchange shall be eligible to
participate in SME Platform.
(iv) Underwriting: The issues shall be 100% underwritten and Merchant Bankers
shall underwrite 15% in their own account.
Benefits of Listing in SME
(i) Easy access to Capital: BSE SME provides an avenue to raise capital through
equity infusion for growth oriented SME’s.
(ii) Enhanced Visibility and Prestige: The SME’s benefit by greater credibility and
enhanced financial status leading to demand in the company’s shares and
higher valuation of the company.
(iii) Encourages Growth of SMEs: Equity financing provides growth opportunities like
expansion, mergers and acquisitions thus being a cost effective and tax efficient
mode.
(iv) Ensures Tax Benefits: In case of listed securities Short Term Gains Tax is 15%
and there is absolutely no Long Term Capital Gains Tax.
(v) Enables Liquidity for Shareholders: Equity financing enables liquidity for
shareholders provides growth opportunities like expansion, mergers and
acquisitions, thus being a cost effective and tax efficient mode.
(vi) Equity financing through Venture Capital: Provides an incentive for Venture
Capital Funds by creating an Exit Route and thus reducing their lock in period.
(vii) Efficient Risk Distribution: Capital Markets ensure that the capital flows to its
best uses and those riskier activities with higher payoffs are funded.
(viii) Employee Incentives: Employee Stock Options ensures stronger employee
commitment, participation and recruitment incentive.

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 PAPER – 2: STRATEGIC FINANCIAL MANAGEMENT
QUESTIONS
Security Valuation
1. ABC Limited’s shares are currently selling at ` 13 per share. There are 10,00,000 shares
outstanding. The firm is planning to raise ` 20 lakhs to Finance a new project.
(i) CALCULATE the ex-right price of shares and the value of a right, if the firm offers one
right share for every two shares held.
(ii) CALCULATE the ex-right price of shares and the value of a right, if the firm offers one
right share for every four shares held.
(iii) ANALYSE how does the shareholders’ wealth change from (i) to (ii) above and right
issue increases shareholders’ wealth?
2. Piyush Loonker and Associates presently pay a dividend of Re. 1.00 per share and has a
share price of ` 20.00.
(i) CALCULATE the firm’s expected or required return on equity using a dividend -
discount model approach if this dividend were expected to grow at a rate of 12% per
annum forever.
(ii) CALCULATE the firm’s expected, or required, return on equity if instead of this situation
in part (i), suppose that the dividends were expected to grow at a rate of 20% per
annum for 5 years and 10% per year thereafter.
Portfolio Management
3. Mr. FedUp wants to invest an amount of ` 520 lakhs and had approached his Portfolio
Manager. The Portfolio Manager had advised Mr. FedUp to invest in the following manner:
Security Moderate Better Good Very Good Best
Amount (in ` Lakhs) 60 80 100 120 160
Beta 0.5 1.00 0.80 1.20 1.50
ADVISE Mr. FedUp in regard to the following, using Capital Asset Pricing Methodology:
(i) Expected return on the portfolio, if the Government Securities are at 8% and the
NIFTY is yielding 10%.
(ii) Replacing Security 'Better' with NIFTY.
4. The following are the data on five mutual funds:
Fund Return Standard Deviation Beta
A 15 7 1.25
B 18 10 0.75

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 2 FINAL (NEW) EXAMINATION: NOVEMBER, 2018

C 14 5 1.40
D 12 6 0.98
E 16 9 1.50
CALCULATE Reward to Volatility Ratio and rank this portfolio using:
 Sharpe method and
 Treynor's method
assuming the risk free rate is 6%.
Mutual Fund
5. Following information is related to XYZ Regular Income Fund:
Particulars ` Crores
Listed shares at Cost (ex-dividend) 20
Cash in hand 1.23
Bonds and debentures at cost 4.3
Of these, bonds not listed and quoted 1
Other fixed interest securities at cost 4.5
Dividend accrued 0.8
Amount payable on shares 6.32
Expenditure accrued 0.75
Number of units (` 10 face value) 20 lacs
Current realizable value of fixed income securities of face value of ` 100 106.5
The listed shares were purchased when Index was 1,000
Present index is 2,300
Value of listed bonds and debentures at NAV date 8
CALCULATE the NAV of scheme on per unit basis if there has been a diminution of 20%
in unlisted bonds and debentures and Other fixed interest securities are valued at cost.
Derivatives
6. Ram holding shares of Reliance Industries Ltd. which is currently selling at ` 1000. He is
expecting that this price will further fall due to lower than expected level of profits to be
announced after one month. As on following option contract are available in Reliance
Share.
Strike Price (`) Option Premium (`)
1030 Call 40

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 3

1010 Call 35
1000 Call 30
990 Put 35
970 Put 20
950 Put 8
930 Put 5
Ram is interested in selling his stock holding as he cannot afford to lose more than 5% of
its value.
RECOMMEND a hedging strategy with option and show how his position will be protected.
7. Laxman buys 10,000 shares of X Ltd. at a price of ` 22 per share whose beta value is 1.5
and sells 5,000 shares of A Ltd. at a price of ` 40 per share having a beta value of 2. He
obtains a complete hedge by Nifty futures at ` 1,000 each. He closes out his position at
the closing price of the next day when the share of X Ltd. dropped by 2%, share of A Ltd.
appreciated by 3% and Nifty futures dropped by 1.5%.
CALCULATE the overall profit/loss to Ram?
Foreign Exchange Exposure and Risk Management
8. On January 28, 2017 an importer customer requested a Bank to remit Singapore Dollar
(SGD) 2,500,000 under an irrevocable Letter of Credit (LC). However, due to unavoidable
factors, the Bank could effect the remittances only on February 4, 201 7. The inter-bank
market rates were as follows:
January 28, 2017 February 4, 2017
US$ 1= ` 45.85/45.90 ` 45.91/45.97
GBP £ 1 = US$ 1.7840/1.7850 US$ 1.7765/1.7775
GBP £ 1 = SGD 3.1575/3.1590 SGD 3. 1380/3.1390
The Bank wishes to retain an exchange margin of 0.125%
ANALYZE whether the customer stand to gain or lose due to the delay. (Note: Calculate
the rate in multiples of 0.0001)
9. Place the following strategies by different persons in the Exposure Management Strategies
Matrix.
Strategy 1: Kuljeet a wholesaler of imported items imports toys from China to sell them in
the domestic market to retailers. Being a sole trader, he is always so much involved in the
promotion of his trade in domestic market and negotiation with foreign supplier that he
never pays attention to hedge his payable in foreign currency and leaves his position
unhedged.

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Strategy 2: Moni, is in the business of exporting and importing brasswares to USA and
European countries. In order to capture the market he invoices the customers in their home
currency. Lavi enters into forward contracts to sell the foreign exchange only if he expects
some profit out of it other-wise he leaves his position open.
Strategy 3: TSC Ltd. is in the business of software development. The company has both
receivables and payables in foreign currency. The Treasury Manager of TSC Ltd. not only
enters into forward contracts to hedge the exposure but carries out cancellation and
extension of forward contracts on regular basis to earn profit out of the same. As a result
management has started looking Treasury Department as Profit Centre.
Strategy 4: DNB Publishers Ltd. in addition to publishing books are also in the business of
importing and exporting of books. As a matter of policy the movement company invoices the
customer or receives invoice from the supplier immediately covers its position in the Forward
or Future markets and hence never leave the exposure open even for a single day.
International Financial Management
10. A multinational company is planning to set up a subsidiary company in India (where hitherto
it was exporting) in view of growing demand for its product and competition from other
MNCs. The initial project cost (consisting of Plant and Machinery including installation) is
estimated to be US$ 500 million. The net working capital requirements are estimated at
US$ 50 million. The company follows straight line method of depreciation. Presently, the
company is exporting two million units every year at a unit price of US$ 80, its variable
cost per unit being US$ 40.
The Chief Financial Officer has estimated the following operating cost and other data in
respect of proposed project:
(i) Variable operating cost will be US $ 20 per unit of production;
(ii) Additional cash fixed cost will be US $ 30 million p.a. and project's share of allocated
fixed cost will be US $ 3 million p.a. based on principle of ability to share;
(iii) Production capacity of the proposed project in India will be 5 million units;
(iv) Expected useful life of the proposed plant is five years with no salvage value;
(v) Existing working capital investment for production & sale of two million units through
exports was US $ 15 million;
(vi) Export of the product in the coming year will decrease to 1.5 million units in case the
company does not open subsidiary company in India, in view of the presence of
competing MNCs that are in the process of setting up their subsidiaries in India;
(vii) Applicable Corporate Income Tax rate is 35%, and
(viii) Required rate of return for such project is 12%.

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 5

CALCULATE the Net Present Value (NPV) of the proposed project in India, assuming that:
(a) there will be no variation in the exchange rate of two currencies and
(b) all profits will be repatriated, as there will be no withholding tax.
Present Value Interest Factors (PVIF) @ 12% for five years is as below:
Year 1 2 3 4 5
PVIF 0.8929 0.7972 0.7118 0.6355 0.5674
Interest Rate Risk Management
11. M/s. Parker & Co. is contemplating to borrow an amount of `60 crores for a Period of 3
months in the coming 6 month's time from now. The current rate of interest is 9% p.a., but
it may go up in 6 month’s time. The company wants to hedge itself against the likely
increase in interest rate.
The Company's Bankers quoted an FRA (Forward Rate Agreement) at 9.30%p.a.
EVALUATE the effect of FRA and actual rate of interest cost to the company, if the actual
rate of interest after 6 months happens to be (i) 9.60% p.a. and (ii) 8.80% p.a.?
Corporate Valuation
12. Eagle Ltd. reported a profit of ` 77 lakhs after 30% tax for the financial year 2016-17. An
analysis of the accounts revealed that the income included extraordinary items of ` 8 lakhs
and an extraordinary loss of ` 10 lakhs. The existing operations, except for the
extraordinary items, are expected to continue in the future. In addition, the results of the
launch of a new product are expected to be as follows:
` In lakhs
Sales 70
Material costs 20
Labour costs 12
Fixed costs 10
You are required to:
(i) CALCULATE the value of the business, given that the capitalization rate is 14%.
(ii) CALCULATE the market price per equity share, assuming Eagle Ltd.‘s share capital
being comprised of 1,00,000 13% preference shares of ` 100 each and 50,00,000
equity shares of ` 10 each and the P/E ratio being 10 times.
Mergers, Acquisitions and Corporate Restructuring
13. Yes Ltd. wants to acquire No Ltd. and the cash flows of Yes Ltd. and the merged entity are
given below:

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 6 FINAL (NEW) EXAMINATION: NOVEMBER, 2018

(` In lakhs)
Year 1 2 3 4 5
Yes Ltd. 175 200 320 340 350
Merged Entity 400 450 525 590 620
Earnings would have witnessed 5% constant growth rate without merger and 6% with
merger on account of economies of operations after 5 years in each case. The cost of
capital is 15%.
The number of shares outstanding in both the companies before the merger is the same
and the companies agree to an exchange ratio of 0.5 shares of Yes Ltd. for each share of
No Ltd.
CALCULATE:
(i) The Value of Yes Ltd. before and after merger.
(ii) Value of Acquisition and
(iii) Gain to shareholders of Yes Ltd.
Note: PV factor at 15% for years 1-5 are 0.870, 0.756; 0.658, 0.572, 0.497 respectively.
Theoretical Questions
14. (a) EXPLAIN the key elements of a well-functioning financial system.
(b) DESCRIBE the various parameters to identity the currency risk.
(c) EXPLAIN the challenges to Efficient Market Theory.
15. (a) DESCRIBE the constituents of International Financial Centers (IFC)
(b) EXPLAIN Startup India Initiative
(c) LIST the ways to arrange finance for Small and Medium Enterprises.

SUGGESTED ANSWERS/HINTS

1. (i) Number of shares to be issued: 5,00,000

Subscription price ` 20,00,000 / 5,00,000 = ` 4
` 1,30,00,000  ` 20,00,000
Ex-right Pr ice   ` 10
15,00,000
` 10 - ` 4
Value of r ight   3
2
Or = ` 10 – ` 4 = ` 6

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 7

(ii) Subscription price ` 20,00,000 / 2,50,000 = ` 8

` 1,30,00,000  ` 20,00,000
Ex-right Pr ice   ` 12
12,50,000
` 12  ` 8
Value of r ight   ` 1.
4
Or = ` 12 – ` 8 = ` 4
(iii) The effect of right issue on wealth of Shareholder’s wealth who is holding, say 100
shares.
(a) When firm offers one share for two shares held.
Value of Shares after right issue (150 X ` 10) ` 1,500
Less: Amount paid to acquire right shares (50X`4) ` 200
`1,300
(b) When firm offers one share for every four shares held.
Value of Shares after right issue (125 X ` 12) ` 1,500
Less: Amount paid to acquire right shares (25X`8) ` 200
`1,300
(c) Wealth of Shareholders before Right Issue `1,300
Thus, there will be no change in the wealth of shareholders from (i) and (ii).
2. (i) Firm’s Expected or Required Return on Equity
According to Dividend discount model approach the firm’s expected or required return
on equity is computed as follows:
D1
Ke  g
P0
Where,
Ke = Cost of equity share capital or (Firm’s expected or required
return on 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.
Now, D1 = D0 (1 + g) or ` 1 (1 + 0.12) or ` 1.12, P0 = ` 20 and g = 12% per annum
` 1.12
Therefore, K e   12%
` 20

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 8 FINAL (NEW) EXAMINATION: NOVEMBER, 2018

Or, K e = ` 17.6%
(ii) Firm’s Expected or Required Return on Equity
(If dividends were expected to grow at a rate of 20% per annum for 5 years and 10%
per year thereafter)
Since in this situation if dividends are expected to grow at a super normal growth rate
gs, for n years and thereafter, at a normal, perpetual growth rate of g n beginning in
the year n + 1, then the cost of equity can be determined by using the following
formula:

n
Div 0 (1+ gs ) t Div n + 1 1
P0 = ∑ (1+ K e ) t
+ ×
K e - gn (1+ K e )n
t =1

Where,
gs = Rate of growth in earlier years.
gn = Rate of constant growth in later years.
P0 = Discounted value of dividend stream.
Ke = Firm’s expected, required return on equity (cost of equity
capital).
Now,
gs = 20% for 5 years, g n = 10%
Therefore,

n
t
P0 = ∑ D0(1(1++K0.20)
)t
+
Div 5 + 1
×
1
K e - 0.10 (1+ K e ) t
t =1 e

1.20 1.44 1.73 2.07 2.49 2.49 (1  0.10) 1

0P 1  2  3  4  5   5
(1  K
e) (1  K
e) (1  K
e) (1  K
e) (1  K
e)
K
e- 0.10 (1  K
e)

or P 0 = ` 1.20 (PVF 1, K e) + ` 1.44 (PVF 2, K e) + ` 1.73 (PVF 3 , K e ) + ` 2.07

Rs. 2.74 (PVF5 , K e )
(PVF 4, K e) + ` 2.49 (PVF 5 , K e) +
K e - 0.10

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 9

By trial and error we are required to find out K e

Now, assume K e = 18% then we will have
P0 = ` 1.20 (0.8475) + ` 1.44 (0.7182) + ` 1.73 (0.6086) + ` 2.07 (0.5158) + `
1
2.49 (0.4371) + ` 2.74 (0.4371) 
0.18 - 0.10
= ` 1.017 + ` 1.034 + ` 1.053 + ` 1.068 + ` 1.09 + ` 14.97
= ` 20.23
Since the present value of dividend stream is more than required it indicates that Ke
is greater than 18%.
Now, assume K e = 19% we will have
P0 = ` 1.20 (0.8403) + ` 1.44 (0.7061) + ` 1.73 (0.5934) + ` 2.07 (0.4986) + `
1
2.49 (0.4190) + ` 2.74 (0.4190) 
0.19 - 0.10
= ` 1.008 + ` 1.017 + ` 1.026+ ` 1.032 + ` 1.043 + ` 12.76
= ` 17.89
Since the market price of share (expected value of dividend stream) is ` 20.
Therefore, the discount rate is closer to 18% than it is to 19%, we can get the exact
rate by interpolation by using the following formula:
NPV at LR
K e = LR + × Δr
NPV at LR - NPV at HR
Where,
LR = Lower Rate
NPV at LR = Present value of share at LR
NPV at HR = Present value of share at Higher Rate
r = Difference in rates
(` 20.23 ` 20)
K e  18%   1%
R` 20.23  ` 17.89
` 0.23
18%   1%
`2.34
= 18% + 0.10% = 18.10%
Therefore, the firm’s expected, or required, return on equity is 18.10%. At this rate
the present discounted value of dividend stream is equal to the market price of the
share.

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 10 FINAL (NEW) EXAMINATION: NOVEMBER, 2018

3. (i) Computation of Expected Return from Portfolio

Security Beta Expected Return (r) Amount Weights wr
(β) as per CAPM (` Lakhs) (w)
Moderate 0.50 8%+0.50(10% - 8%) = 9% 60 0.115 1.035
Better 1.00 8%+1.00(10% - 8%) = 10% 80 0.154 1.540
Good 0.80 8%+0.80(10% - 8%) = 9.60% 100 0.192 1.843
Very Good 1.20 8%+1.20(10% - 8%) = 10.40% 120 0.231 2.402
Best 1.50 8%+1.50(10% - 8%) = 11% 160 0.308 3.388
Total 520 1 10.208
Thus Expected Return from Portfolio 10.208% say 10.21%.
Alternatively, it can be computed as follows:
60 80 100 120 160
Average β = 0.50 x + 1.00 x + 0.80 x + 1.20 x + 1.50 x = 1.104
520 520 520 520 520
As per CAPM
= 0.08 + 1.104(0.10 – 0.08) = 0.10208 i.e. 10.208%
(ii) As computed above the expected return from Better is 10% same as from Nifty, hence
there will be no difference even if the replacement of security is made. The main logic
behind this neutrality is that the beta of security ‘Better’ is 1 which clearly indicates
that this security shall yield same return as market return.
4. Sharpe Ratio S = (Rp – Rf)/σp
Treynor Ratio T = (Rp – Rf)/βp
Where,
Rp = Return on Fund
Rf = Risk-free rate
σp = Standard deviation of Fund
βp = Beta of Fund
Reward to Variability (Sharpe Ratio)
Mutual Rp Rf Rp – Rf σp Reward to Ranking
Fund Variability
A 15 6 9 7 1.285 2
B 18 6 12 10 1.20 3
C 14 6 8 5 1.60 1

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 11

D 12 6 6 6 1.00 5
E 16 6 10 9 1.11 4

Reward to Volatility (Treynor Ratio)

Mutual Rp Rf Rp – Rf βp Reward to Ranking
Fund Volatility
A 15 6 9 1.25 7.2 2
B 18 6 12 0.75 16 1
C 14 6 8 1.40 5.71 5
D 12 6 6 0.98 6.12 4
E 16 6 10 1.50 6.67 3
5.
Particulars Adjusted Values
` crores
Equity Shares 46.00
Cash in hand 1.23
Bonds and debentures not listed 0.80
Bonds and debentures listed 8.00
Dividends accrued 0.80
Fixed income securities 4.50
Sub total assets (A) 61.33
Less: Liabilities
Amount payable on shares 6.32
Expenditure accrued 0.75
Sub total liabilities (B) 7.07
Net Assets Value (A) – (B) 54.26
No. of units 20,00,000
Net Assets Value per unit (` 54.26 crore / 20,00,000) ` 271.30
6. Instead of selling the stock of Reliance Ltd., Ram must cover his Risk by buying or long
position in Put Option with appropriate strike price. Since Ram’s risk appetite is 5%, the
most suitable strike price in Put Option shall be ` 950 (` 1000 – 5% of ` 1000). If Ram
does so, the overall position will be as follows:

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 12 FINAL (NEW) EXAMINATION: NOVEMBER, 2018

Spot Price after 1 month Stock Value Put Payoff Initial Cash Flow Total
S < 950 S 950 – S -8 942 - S
S > 950 S - -8 S–8
Thus, from the above, it can be seen that the value of holding of Ram shall never be less
than ` 942 as Put Option will compensate for loss below spot price of ` 950. However, this
strategy will involve a cost of ` 8.
7. No. of the Future Contract to be obtained to get a complete hedge
10000 ×`22 × 1.5 - 5000 × ` 40 × 2
=
`1000
`3,30,000 - `4,00,000
= = 70 contracts
`1000
Thus, by purchasing 70 Nifty future contracts to be long to obtain a complete hedge.
Cash Outlay
= 10000 x ` 22 – 5000 x ` 40 + 70 x ` 1,000
= ` 2,20,000 – ` 2,00,000 + ` 70,000 = ` 90,000
Cash Inflow at Close Out
= 10000 x ` 22 x 0.98 – 5000 x ` 40 x 1.03 + 70 x ` 1,000 x 0.985
= ` 2,15,600 – ` 2,06,000 + ` 68,950 = ` 78,550
Gain/ Loss
= ` 78,550 – ` 90,000 = - ` 11,450 (Loss)
8. On January 28, 2017 the importer customer requested to remit SGD 25 lakhs.
To consider sell rate for the bank:
US $ = `45.90
Pound 1 = US$ 1.7850
Pound 1 = SGD 3.1575
` 45.90 * 1.7850
Therefore, SGD 1 =
SGD 3.1575
SGD 1 = `25.9482
Add: Exchange margin (0.125%) ` 0.0324
` 25.9806
On February 4, 2017 the rates are

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 13

US $ = ` 45.97
Pound 1 = US$ 1.7775
Pound 1 = SGD 3.1380
` 45.97 * 1.7775
Therefore, SGD 1 =
SGD 3.1380
SGD 1 = ` 26.0394
Add: Exchange margin (0.125%) ` 0.0325
` 26.0719
Hence, loss to the importer
= SGD 25,00,000 (` 26.0719 – ` 25.9806) = ` 2,28,250
9. Strategy 1: This strategy is covered by High Risk: Low Reward category and worst as it
leaves all exposures unhedged. Although this strategy does not involve any time and effort,
it carries high risk.
Strategy 2: This strategy covers Low Risk: Reasonable reward category as the exposure
is covered wherever there is anticipated profit otherwise it is left.
Strategy 3: This strategy is covered by High Risk: High Reward category as to earn profit,
cancellations and extensions are carried out. Although this strategy leads to high gains but
it is also accompanied by high risk.
Strategy 4: This strategy is covered by Low Risk : Low Reward category as company plays
a very safe game.
Diagrammatically all these strategies can be depicted as follows:
High Risk

Low Strategy 1 Strategy 3 High

Reward Reward
Strategy 4 Strategy 2
Low Risk

10. Financial Analysis whether to set up the manufacturing units in India or not may be carried
using NPV technique as follows:
I. Incremental Cash Outflows
$ Million
Cost of Plant and Machinery 500.00
Working Capital 50.00
Release of existing Working Capital (15.00)
535.00

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 14 FINAL (NEW) EXAMINATION: NOVEMBER, 2018

II. Incremental Cash Inflow after Tax (CFAT)

(a) Generated by investment in India for 5 years
$ Million
Sales Revenue (5 Million x $80) 400.00
Less: Costs
Variable Cost (5 Million x $20) 100.00
Fixed Cost 30.00
Depreciation ($500Million/5) 100.00
EBIT 170.00
Taxes@35% 59.50
EAT 110.50
Add: Depreciation 100.00
CFAT (1-5 years) 210.50
Cash flow at the end of the 5 years (Release of Working Capital) 35.00
(b) Cash generation by exports
$ Million
Sales Revenue (1.5 Million x $80) 120.00
Less: Variable Cost (1.5 Million x $40) 60.00
Contribution before tax 60.00
Tax@35% 21.00
CFAT (1-5 years) 39.00
(c) Additional CFAT attributable to Foreign Investment
$ Million
Through setting up subsidiary in India 210.50
Through Exports in India 39.00
CFAT (1-5 years) 171.50
III. Determination of NPV
Year CFAT ($ Million) PVF@12% PV($ Million)
1-5 171.50 3.6048 618.2232
5 35 0.5674 19.8590
638.0822
Less: Initial Outflow 535.0000
103.0822
Since NPV is positive the proposal should be accepted.

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11. Final settlement amount shall be computed by using formula:

(N)(RR- FR)(dtm/DY)
=
[1+ RR(dtm/DY)]
Where,
N = the notional principal amount of the agreement;
RR = Reference Rate for the maturity specified by the contract prevailing on the
contract settlement date;
FR = Agreed-upon Forward Rate; and
dtm = maturity of the forward rate, specified in days (FRA Days)
DY = Day count basis applicable to money market transactions which could be 360 or
365 days.
Accordingly,
If actual rate of interest after 6 months happens to be 9.60%
(` 60crore) (0.096- 0.093) (3/12)
=
[1 + 0.096(3/12)]
(` 60crore)(0.00075)
= = ` 4,39,453
1.024
Thus, banker will pay Parker & Co. a sum of ` 4,39,453
If actual rate of interest after 6 months happens to be 8.80%
(` 60crore) (0.088- 0.093) (3/12)
=
[1 + 0.088(3/12)]
(` 60crore) (-0.00125)
= = - ` 7,33,855
1.022
Thus Parker & Co. will pay banker a sum of ` 7,33,855
Actual Rate 9.60% 8.80%
Interest payable
` 60 crore x 0.096 x 3/12 (` 1,44,00,000)
` 60 crore x 0.088 x 3/12 (` 1,32,00,000)
Compensation Receivable:
` 60 crore x (0.096 – 0.093) x 3/12 ` 4,50,000

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 16 FINAL (NEW) EXAMINATION: NOVEMBER, 2018

Compensation Payable:
` 60 crore x (0.088 – 0.093) x 3/12 (` 7,50,000)
Interest Cost to Company (In `) ` 1,39,50,000 ` 1,39,50,000
Annual Interest Cost to Company (In %) 9.30% 9.30%
(` 1,39,50,000/ ` 60crore) x 12/3

12. (i) Computation of Business Value

(` Lakhs)
77 110
Profit before tax
1  0.30
Less: Extraordinary income (8)
Add: Extraordinary losses 10
112
Profit from new product (` Lakhs)
Sales 70
Less: Material costs 20
Labour costs 12
Fixed costs 10 (42) 28
140.00
Less: Taxes @30% 42.00
Future Maintainable Profit after taxes 98.00
Relevant Capitalisation Factor 0.14
Value of Business (`98/0.14) 700
(ii) Computation of Market Price of Equity Share
Future maintainable profits (After Tax) ` 98,00,000
Less: Preference share dividends 1,00,000 shares of ` 100 @ 13% ` 13,00,000
Earnings available for Equity Shareholders ` 85,00,000
No. of Equity Shares 50,00,000
` 85,00,000 ` 1.70
Earning per share = =
50,00,000
PE ratio 10
Market price per share ` 17

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13. (i) Working Notes:

Present Value of Cash Flows (CF) upto 5 years
Year CF of Yes PVF PV of CF CF of Merged PV of CF of
End Ltd. @15% Entity Merged
Entity
(` lakhs) (` lakhs) (` lakhs) (` lakhs)
1 175 0.870 152.25 400 348.00
2 200 0.756 151.20 450 340.20
3 320 0.658 210.56 525 345.45
4 340 0.572 194.48 590 337.48
5 350 0.497 173.95 620 308.14
882.44 1679.27
PV of Cash Flows of Yes Ltd. after the forecast period
CF5 (1  g) 350(1  0.05) 367.50
TV5 = = = = ` 3675 lakhs
Ke  g 0.15  0.05 0.10

PV of TV5 = ` 3675 lakhs x 0.497 = ` 1826.475 lakhs

PV of Cash Flows of Merged Entity after the forecast period
CF5 (1  g) 620(1  0.06) 657.20
TV5 = = = = ` 7302.22 lakhs
Ke  g 0.15  0.06 0.09

PV of TV5 = ` 7302.22 lakhs x 0.497 = ` 3629.20 lakhs

Value of Yes Ltd.
Before merger (` lakhs) After merger (` lakhs)
PV of CF (1-5 years) 882.440 1679.27
Add: PV of TV 5 1826.475 3629.20
2708.915 5308.47
(ii) Value of Acquisition
= Value of Merged Entity – Value of Yes Ltd.
= ` 5308.47 lakhs – ` 2708.915 lakhs = ` 2599.555 lakhs
(iii) Gain to Shareholders of Yes Ltd.
1
Share of Yes Ltd. in merged entity = ` 5308.47 lakhs x = ` 3538.98 lakhs
1.5

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 18 FINAL (NEW) EXAMINATION: NOVEMBER, 2018

Gain to shareholder = Share of Yes Ltd. in merged entity – Value of Yes Ltd. before
merger
= `3538.98 lakhs - `2708.915 = `830.065 lakhs
14. (a) Key elements of a well-functioning financial system are explained as below:
(i) A strong legal and regulatory environment – Capital market is regulated by
SEBI which acts a watchdog of the securities market. This has been ensured
through the passing of SEBI Act, Securities Contract Regulation Act and
numerous SEBI rules, regulations and guidelines. Likewise money market and
foreign exchange market is regulated by RBI and this has been ensured through
various provisions of the RBI Act, Foreign Exchange Management Act etc. Thus,
a strong legal system protects the rights and interests of investors and acts as
a most important element of a sound financial system.
(ii) Stable money – Money is an important part of an economy. Frequent
fluctuations and depreciations in the value of money lead to financial crises and
restrict the economic growth.
(iii) Sound public finances and public debt management – Sound public finances
means setting and controlling public expenditures and increase revenues to fund
these expenditures efficiently. Public debt management is the process of
establishing and executing a strategy for managing the government's debt in
order to raise the required amount of funding. It also includes developing and
maintaining an efficient market for government securities.
(iv) A central bank – A central bank supervises and regulates the operations of the
banking system. It acts as a banker to the banks and government, manager of
money market and foreign exchange market and also lender of the last resort.
The monetary policy of the Central Bank is used to keep the pace of economic
growth on a higher path.
(v) Sound banking system – A well-functioning financial system must have large
variety of banks both in the private and public sector having both domestic and
international operations with an ability to withstand adverse national and
international events. They perform varied functions such as operating the
payment and clearing system, and foreign exchange market. Banks also
undertake credit risk analysis and assess the expected risk and return of a
project before giving any loan for a proposed project.
(vi) Information System – All the participants in the financial system requires
information at some stage or the other. Proper information disclosure practices
form basis of a sound financial system for e.g. the corporates has to disclose
their financial performance in the financial statements. Similarly, at the time of
initial public offering, the companies have to disclose a host of information
disclosing their financial health and efficiency.

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(vii) Well functioning securities market – A securities market facilitates the

issuance of both equity and debt. An efficient securities market helps in the
deployment of funds raised through the capital market to the required sections
of the economy, lowering the cost of capital for the firms, enhancing liquidity and
attracting foreign investment.
(b) Just like interest rate risk the currency risk is dependent on the Government action
and economic development. Some of the parameters to identity the currency risk are
as follows:
(1) Government Action: The Government action of any country has visual impact
in its currency. For example, the UK Govt. decision to divorce from European
Union i.e. Brexit brought the pound to its lowest since 1980’s.
(2) Nominal Interest Rate: As per interest rate parity (IRP) the currency exchange
rate depends on the nominal interest of that country.
(3) Inflation Rate: Purchasing power parity theory discussed in later chapters
impact the value of currency.
(4) Natural Calamities: Any natural calamity can have negative impact.
(5) War, Coup, Rebellion etc.: All these actions can have far reaching impact on
currency’s exchange rates.
(6) Change of Government: The change of government and its attitude towards
foreign investment also helps to identify the currency risk.
(c) Challenges to the Efficient Market Theory
(i) Information inadequacy – Information is neither freely available nor rapidly
transmitted to all participants in the stock market. There is a calculated attempt
by many companies to circulate misinformation.
(ii) Limited information processing capabilities – Human information processing
capabilities are sharply limited. According to Herbert Simon every human
organism lives in an environment which generates millions of new bits of
information every second but the bottle necks of the perceptual apparatus does
not admit more than thousand bits per seconds and possibly much less.
David Dreman maintained that under conditions of anxiety and uncertainty, with
a vast interacting information grid, the market can become a giant.
(iii) Irrational Behaviour – It is generally believed that investors’ rationality will
ensure a close correspondence between market prices and intrinsic values. But
in practice this is not true. J. M. Keynes argued that all sorts of consideration
enter into the market valuation which is in no way relevant to the prospective
yield. This was confirmed by L. C. Gupta who found that the market evaluation
processes work haphazardly almost like a blind man firing a gun. The market

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 20 FINAL (NEW) EXAMINATION: NOVEMBER, 2018

seems to function largely on hit or miss tactics rather than on the basis of
informed beliefs about the long term prospects of individual enterprises.
(iv) Monopolistic Influence – A market is regarded as highly competitive. No single
buyer or seller is supposed to have undue influence over prices. In practice,
powerful institutions and big operators wield grate influence over the market.
The monopolistic power enjoyed by them diminishes the competitiveness of the
market.
15. (a) Although there are many constituents for IFC but some of the important constituent
are as follows:
(i) Highly developed Infrastructure: A leading edge infrastructure is prerequisite for
creating a platform to offer internationally completive financial services.
(ii) Stable Political Environment: Destabilized political environment brings country
risk investment by foreign nationals. Hence, to accelerate foreign participation
in growth of financial center, stable political environment is prerequisite.
(iii) Strategic Location: The geographical location of the finance center should be
strategic such as near to airport, seaport and should have friendly weather.
(iv) Quality Life: The quality of life at the center showed be good as center retains
highly paid professional from own country as well from outside.
(v) Rationale Regulatory Framework: Rationale legal regulatory framework is
another prerequisite of international finance center as it should be fair and
transparent.
(vi) Sustainable Economy: The economy should be sustainable and should possess
capacity to absorb all the shocks as it will boost investors’ confidence.
(b) Startup India scheme was initiated by the Government of India on 16 th of January,
2016. The definition of startup was provided which is applicable only in case of
Government Schemes. Startup means an entity, incorporated or registered in India:
❖ Not prior to five years,
❖ With annual turnover not exceeding r` 25 crore in any preceding financial
year, and
❖ Working towards innovation, development, deployment or commercialization of
new products, processes or services driven by technology or intellectual
property.
Provided that such entity is not formed by splitting up, or reconstruction, of a business
already in existence. Provided also that an entity shall cease to be a Startup if its
turnover for the previous financial years has exceeded ` 25 crore or it has completed
5 years from the date of incorporation/ registration. Provided further that a Startup

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 21

shall be eligible for tax benefits only after it has obtained certification from the Inter -
Ministerial Board, setup for such purpose.
(c) The need for finance can be classified into following types:
- Long and medium term loans
- Short term or working capital requirements
- Risk Capital
- Seed Capital/Marginal Money
- Bridge loans
Financial assistance in India for MSME units is available from a variety of institutions.
The important ones are:
(i) Commercial/Regional Rural/Co-operative Banks.
(ii) SIDBI: Small Industries Development Bank of India (refinance and direct
lending)
(iii) SFCs/SIDCs: State Financial Corporations (e.g. Delhi Financial
Corporation)/State Industrial Development Corporations.
Long and medium term loans are provided by SFCs, SIDBI and SIDCs. Banks also
finance term loans. This type of financing is needed to fund purchase of land,
construction of factory building/shed and for purchase of machinery and equipment.
The short-term loans are required for working capital requirements, which fund the
purchase of raw materials and consumables, payment of wages and other immediate
manufacturing and administrative expenses. Such loans are generally available from
commercial banks. The commercial banks also sanction composite loan comprising
of working capital and term loan up to a loan limit of ` 1 crore.

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