CA FINAL

ADVANCE FINANCIAL MANAGEMENT

Full Test-1

SOLUTION

(TOTAL MARKS 100)

Ans-1 – A
No of shares to be sold = 5,000 x 30% = 1,500 shares
Shares held post sale = 5,000 – 1,500 = 3,500 shares

Ans-2 - C Computation of interest:

Particulars
Amount
Nov 30 – Bank will buy from customer = (-75.40)
Nov 30 – Bank will sell at spot rate to some other Bank = 75.22
Outflow for banker = 0.18
Total outflow for banker (1,00,000 x 0.18) = 18,000
Interest cost to be recovered (18,000 x 18% x 31/365) = 275
Hence customer will pay Rs.275 to Bank

Ans-3 - b Fair FRA rate is 8.00%. This would mean that arbitrage is possible if we can borrow
at rate lower than 8.00% (or) invest at rate higher than 8.00%. In this case we will be able to
invest at FRA rate of 10.50%. Hence Arbitrage is possible by doing the following:
Borrow for 12 months at 9% per annum and invest for 6 months at 9.60% and balance 6
months at actual FRA rate of 10.50%

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Ans- 4 – A Capital gearing= Debt + Preference / ESC + Reserves= 100+200 / 50+100=2 Times
Gearing of company is 1.25 times higher than that of industry. The company is riskier than
industry and hence will need higher return. Higher gearing of 1.25 times will be
compensated by higher return of 2.50 % (1.25 x 2) and hence the required return of
company A is 12.50%

Ans-5 – C Probability of earning 24,000 in year 2 = Probability of earning 50,000 in year 1 x

Probability of earning 24,000 in year 2
Probability = 40% x 20% = 8.00%

(2×5=10 Marks)

Ans-6 - a. Bullish signal indicating a potential uptrend in the stock.

Ans-7 – D, +0.25
Correlation coefficient = Co−variance of security A and B / SD of A x SD of B= 0.0200 / 0.40 𝑥
0.20 = +0.25

Ans-8 – B
The funds are undiversified and hence we should do ranking as per Sharpe Ratio. It is better
to have higher Sharpe Ratio. Hence the ranking as per Sharpe Ratio is B, A and C

Ans-9 – C
Minimum compensation for promoters = Value of shares held (16,00,000) + Value of excess
remuneration (15,00,000) = Rs.31,00,000
Minimum price per share = 31,00,000 / 40,000 shares = Rs.77.50 per share

Ans-10 – C
Value of merged firm = 540 lacs + 90 lacs + 45 lacs = Rs.675 lacs
Post−merger price= 675 lacs / 30 lacs + 6 lacs = Rs.18.75 per share

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Consideration paid=6 lacs x 18.75=Rs.112.50 lacs
(2×5=10 Marks)

Ans-11 : D) Financial planning for corporate entities results in financial decision-making,

measures like ratio analysis, and evaluation of corporate performance.

Reason: "Outcomes of the financial planning are the financial objectives, financial decision-
making and financial measures for the evaluation of the corporate performance." Option D
accurately represents this outcome by indicating that financial planning for corporations
involves making financial decisions, utilizing measures like ratio analysis and cash flow
analysis, and evaluating the overall corporate performance based on the established
financial objectives. This aligns with the passage's description of financial planning's impact
on corporate entities.

Ans-12 : C) The maximum possible loss the portfolio might experience over the next week
with 95% confidence.

Reason: In the context of VAR analysis, the calculated value of ₹500,000 represents the
maximum possible loss that the portfolio might experience over the next week with a
confidence level of 95%. This means that there is a 95% probability that the portfolio's
losses will not exceed ₹500,000 within the specified time horizon. VAR helps financial
professionals like Kamleshwara assess the potential downside risk of an investment or
portfolio, providing a measure of risk management and decision-making.

Ans- 13 : A
NPV of base project = 28,00,000 – 35,00,000 = -7,00,000
NPV of real option = 20,00,000 – 11,00,000 = 9,00,000

Hence NPV of the project before is -7,00,000 and after the option is Rs.2,00,000 [-7,00,000 +
9,00,000]

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Ans-14 : D
Return under APT = Risk-free rate + [Factor 1 Beta x Risk premium] + [Factor 2 Beta x Risk
premium]

Return under APT = 3% + [-1.20 x 2%] + [0.80 x 3%] = 3.00%

Ans-15 : B

Hedge Funds utilize leverage and derivatives extensively to amplify returns and manage risk,
whereas traditional mutual funds and index funds do not engage in such advanced
strategies

Ans-16 : D
Amount paid by Axis Bank = Default amount x (1 – Recovery rate)

Amount paid by Axis Bank = 10,00,000 x (1 – 25%) = Rs.7,50,000

Ans-17 : A) Rohan can conclude that USD is at a premium and EUR is at a discount. The
premium for USD is 18.18% and the discount for EUR is 16.61%.

Reason: Based on the information provided, when the forward rate for USD/INR is greater
than the spot rate, it implies that USD is at a premium against INR. On the other hand, when
the forward rate for EUR/INR is less than the spot rate, it suggests that EUR is at a discount
against INR. The calculation of the premium or discount in percentage terms can be done
using the formula:

Premium/Discount = Forward Rate - Spot Rate / Spot Rate x 12/6. For USD/INR:
Premium/Discount = 60 – 55/55 x 12/6 = 18.18%

For EUR/INR: Given that the forward rate for EUR/INR is less than the spot rate, it implies
that EUR is at a discount. The calculation can be done similarly to find the discount
percentage. So, option A is the correct answer.

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Ans-18 : C) An Interest Rate Collar involves the purchase of a Cap and the simultaneous sale
of a Floor to limit exposure to interest rate fluctuations on the high side.

Reason: An Interest Rate Collar is a hedging strategy that combines the purchase of a Cap
Option (which protects against interest rate increases) with the simultaneous sale of a Floor
Option (which compensates the buyer for decreases in interest rates). The Collar effectively
locks the buyer into a bounded floating interest rate that is protected on the high side by
the Cap and on the low side by the sold Floor.

Ans-19 : A) MVA is solely concerned with historical financial metrics, while SVA incorporates
future earnings and investment opportunities into its analysis.

Reason: MVA is primarily based on historical financial metrics, specifically the difference
between the current market value and invested capital. It reflects the market's perception
of a company's past performance. In contrast, SVA goes beyond historical figures and
considers future earnings, cash flows, and investment opportunities to assess the potential
for value creation. SVA focuses on the future potential of a company, making it distinct from
MVA.

Ans-20 : A
Gain for A Limited = Post-merger MPS - Pre-merger MPS = 150 - 100 = Rs.50

Gain for B Limited = Equivalent MPS - Pre-merger MPS = 300 - 200 = Rs.100
(1×10=10 Marks)

Descriptive Answers

Ans-1. (a) The Investor should take the decision to buy, hold or sell the shares on the basis
of change in price and rate of return.

Existing rate of return = + Beta ( – )

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= 1296 + 1.3 (596) = 18.5%

Revised rate of return

= 10% + 1.4 (4%) = 15.60%

Price of share (original)

= = = =Rs.34.42

Price of share (Revised)

= = = =Rs.31.10

The current market price of share is Rs. 40. It is higher in comparison to current equilibrium
price of Rs. 34.42 and revised equity price of Rs. 31.10. Under this situation investor should
sell the share.

(6 Marks)

Ans-1. (b) Calculation of units purchased

Particulars ‘A’ ‘B’ ‘C’

Date of Investment (x) 1,00,000 2,00,000 2,00,000

NAV at entry date (y) 10.30 10.00 10.10

No. of units (x/y) 9,708.74 20,000 19,801.98

Calculation of effective yield

Particulars ‘A’ ‘B’ ‘C’

Closing NAV (31-3-2016) 10.25 10.15 10.00

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NAV at entry date 10.30 10.00 10.10

Increase (Decrease) in NAV (Rs.) (0.05) 0.15 (0.10)

Units purchased 9,708.74 20,000 19,801.98

Total increase (Decrease in NAV) (485.44) 3000 (1,980.20)

(+) Dividend received (Rs.) 2,850 4,500 Nil

Total Yield (Rs.) 2,364.56 7,500 (1,980.20)

Effective Yields (%) 2.365% 3.75% (0.99%)

Holding Periods ( ) ( ) ( )

Holding Periods (No. of days) 152 60 31

Effective Yields (%) (Annualised) 5.679% 22.813% (11.657%)

( ) ( ) ( )

Note: While calculating number of days, the date of investment is taken into account.

(4 Marks)

Ans-1. (c) No organization can run an existing business and promote a new expansion
project without a suitable internally mobilized financial base or both i.e. internally and
externally mobilized financial base.

Sources of finance and capital structure are the most important dimensions of a strategic
plan.

The generation of funds may arise out of ownership capital and or borrowed capital. A
company may issue equity shares and/or preference shares for mobilizing ownership capital
and debentures to raise borrowed capital. Public deposits, for a fixed time period, have also

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become a major source of short and medium term finance. Organizations may offer higher
rates of interest than banking institutions to attract investors and raise fund. The overdraft,
cash credits, bill discounting, bank loan and trade credit are the other sources of short term
finance.

Along with the mobilization of funds, policy makers should decide on the capital structure to
indicate the desired mix of equity capital and debt capital. There are some norms for debt
equity ratio which need to be followed for minimizing the risks of excessive loans. For
instance, in case of public sector organizations, the norm is 1:1 ratio and for private sector
firms, the norm is 2:1 ratio. However this ratio in its ideal form varies from industry to
industry. For capital intensive industries, the proportion of debt to equity is much higher.

Another important dimension of strategic management and financial policy interface is the
investment and fund allocation decisions. A planner has to frame policies for regulating
investments in fixed assets and for restraining of current assets.

(4 Marks)

Ans-2.(a)

Conclusion: The market is bullish. The market is likely to remain bullish for short-term to
medium term. On the basis of this indicator (EMA), the investors/ brokers can take long
position.

(6 Marks)

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Ans-2. (b)

Net issue size $ 1Million

Issue Expenses 1.5%

Gross Issue $ 1.01523 million

Domestic market price of the share Rs. 1080

No. of shares under each GDR priced @ 5@ below market price 3

Expected exchange rate (1 USD) Rs.69

Issue price per GDR= Rs. ( 1065.25 ) =Rs.3035.96 i.e, $ 44

3036/69

(a) Number of GDR to be issued

= =23073.40

(b) Cost of GDR to Supreme Ltd.

Dividend Per GDR (D) = ₹ 30 × 3= ₹ 90

Net Proceeds Per GDR = ₹ 3036 × 0.985 = ₹ 2990.46

= = +0.070=0.03009+0.07=0.10009=10% (approx)

(4 Marks)

Ans-2. (c) 1. Calculation of NAV at the end of month:

r=

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=

=Net Asset Value at time period t-1

= = Income at time period t

= = Capital Gain distribution at time prd. t

Given Annual Return = 15%

Monthly Return (r) = 1.25%

Income (I t) = Re. 0.50

Capital Gain (CG t) = Re. 0.32

= =Rs.65.78

0.0125=

0. 82 = – Rs. 64.96

= Rs. 65.782

2. There is no change in NAV.

(4 Marks)

Ans-3. (a) (i) IM has overall strong position and hence is in a comparative advantageous
position in both rates. However, it has a comparative advantage in floating-rate market.

The differential between the U.S. dollar floating rates is 2.00% per annum, and the
differential between the JPY fixed rates is 0.25% per annum. The difference between the
differentials is 1.75% per annum. The total potential gain to all parties from the swap is
therefore 1.75% per annum, or 175 basis points. If the financial intermediary requires 75
basis points, each of IM and JI can be made 50 basis points better off.

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(ii) Since the Net Benefit of 100 Basis Points to be shared equally among IM and JI interest
rate for them shall be as follows:

IM

Borrowing from Market LIBOR + 0.5%

Less: Benefit from Swap 0.5%

Net Interest LIBOR

JI

Borrowing from Market 4.25%

Less: Benefit from Swap 0.5%

Net Interest 3.75%

(10 Marks)

Ans-3.(b) If an organization desires to be sustainable then it 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 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.

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The organization must take the following steps in ensuring its stability:

Step 1: Define objectives. The organization must be aware about its priorities and
objectives and try to achieve these objectives and ensure stability there-after. These
objectives can be related to target payout ratio, optimal capital structure without raising
funds through issue of new equity shares or market share and level of sales.

Step 2: Identify the variables and the variants. These variables generally are, net profit
margin, asset turnover ratio, financial leverage ratio, dividend payout and retention ratio,
asset to beginning of period equity ratio. Incremental growth strategy, profit strategy and
pause strategy are variants that need to be defined.

Step 3: Analyze any change in variables and its impact on sustainability of the organization
and take appropriate action wherever required. If a firm is mature then it has actual growth
rate that is less than SGR model. The management’s principal objective is finding productive
uses for the cash flows that exist in excess of their needs.

Comment: Since the asset to equity ratio in the beginning is constant and the firm’s only
source of new equity is retained earnings, sales and assets cannot grow any faster than the
retained earnings plus the additional debt that the retained earnings can support. The
sustainable growth rate is consistent with the observed evidence that most corporations are
reluctant to issue new equity. If, however, the firm is willing to issue additional equity, there
is in principle no financial constraint on its growth rate.

(4 Marks)

OR

Ans-3.(b) The participants in the process of securitization are Primary Participants and
Secondary Participants.

The primary participants in the process of securitization are as follows:

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  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. The originator transfers both legal as well as beneficial interest to
the Special Purpose Vehicle (SPV).
 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. The main
objective of creating SPV to remove the asset from the Balance Sheet of Originator.
Since, SPV makes an upfront payment to the originator, it holds the key position in
the overall process of securitization. Further, it also issues the securities (called Asset
Based Securities or Mortgage Based Securities) to the inves-tors.
 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. Since, they acquire a
participating in the total pool of assets/receivable, they receive their money back in
the form of interest and principal as per the terms agree.

(4 Marks)

Ans-4. (a) Total premium paid on purchasing both the call and put option on 100 shares

= (₹ 30 per share × 100) + (₹ 5 per share × 100).

= 3,000 + 500 = ₹ 3,500

(i) As the price of share remains at ₹ 500, X will exercise neither the call option nor the put
option. The total premium will be lost and there will be no gain on call or put option.

Therefore, Net loss = ₹ 3,500

(ii) Since the price of the stock is ₹ 350, which is below the exercise price of the call, the call
will not be exercised. Only put is worth exercising.

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Total premium paid = ₹ 3,500

Value at the time of expiry = -₹ 3,500 + ₹ *{450 – 350} × 100]

= – ₹ 3,500 + ₹ 10,000 = ₹ 6,500

Net gain = ₹ 6,500

(iii) In this situation, the put is worthless, since the price of the stock is Rs. 600 and is above
the exercise price of the put but, call will be profitable and is exercised.

Total premium paid = ₹ 3,500

Value at the time of expiry = – 3,500 + [(600 – 550) × 100]

Net Gain = – 3,500 + 5,000 = ₹ 1,500

(6 Marks)

Ans-4. (b) (a) Shares to be issued by Elrond Limited:

= No. of shares in Doom Ltd. ₹ Exchange Ratio

= 10 Lakhs ₹ 0.5 = 5 Lakh Shares

(b) Percentage holding of shareholders of Doom Ltd. in Elrond Limited:

= [latex]\frac{5 \text { lakh }}{20 \text { lakh }+5 \text { lakh }}\) i.e. 20%

(c) The value of Elrond Ltd. after merger:

= (₹ 50 × 20 lakh) + (₹ 25 × 10 lakh) + ₹ 200 lakh

= ₹ 1,000 lakh + ₹ 250 lakh + ₹ 200 lakh = ₹ 1,450 lakh

Value for shareholders of Doom Ltd. = ₹ 1,450 × 20% = ₹ 290 lakhs

(d) True Cost of Merger will be:

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= ₹ 290 lakhs – ₹ 250 lakhs = ₹ 40 lakhs

(4 Marks)

Ans-4. (c) A type of convertible bond issued in a currency different than the issuer's
domestic currency. In other words, the money being raised by the issuing company is in the
form of a foreign currency. A convertible bond is a mix between a debt and equity
instrument. It acts like a bond by making regular coupon and principal payments, but these
bonds also give the bondholder the option to convert the bond into stock.

These types of bonds are attractive to both investors and issuers. The investors receive the
safety of guaranteed payments on the bond and are also able to take advantage of any large
price appreciation in the company's stock. (Bondholders take advantage of this appreciation
by means of warrants attached to the bonds, which are activated when the price of the
stock reaches a certain point.) Due to the equity side of the bond, which adds value, the
coupon payments on the bond are lower for the company, thereby reducing its debt-
financing costs.

Advantages of FCCBs

(i) The convertible bond gives the investor the flexibility to convert the bond into equity at a
price or redeem the bond at the end of a specified period, normally three years if the price
of the share has not met his expectations.

(ii) Companies prefer bonds as it leads to delayed dilution of equity and allows company to
avoid any current dilution in earnings per share that a further issuance of equity would
cause.

(iii) FCCBs are easily marketable as investors enjoy the option of conversion into equity
resulting into capital appreciation. Further investor is assured of a minimum fixed interest
earnings.

(4 Marks)

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Ans-5.(a) (i) Expected return of the stock A and B

E (A) = (10 + 16)/2 = 13%

E (B) = (12 + 18)/2 = 15

(ii) Standard deviation of return from each stock.

Stock A:

𝑥 ̅

Variance = 0.5 (10 – + 0.5 (16 – =9

Standard deviation = √9 = 3%

Stock B:

Variance = 0.5 (12 – + 0.5 (18 – =9

Standard deviation = 3%

(iii) Covariance of stocks A and B

̅̅̅̅̅̅̅̅̅̅̅̅̅
̅
Covariance =

=0.5 (10 – 13) (12 – 15) + 0.5 (16 – 13) (18 – 15) = 9

(iv) Correlation of coefficient

= = =1

(v) Portfolio Risk

Portfolio Variance

= =WA2σA2 + WB2σB2 + 2WAWBσAσBr

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 √

(6 Marks)

Ans-5. (b) P.V. of dividend stream and sales proceeds

Year Dividend/sale PVF (12%) PV (Rs.)

1 ₹ 20 0.893 17.86

2 ₹ 20 0.797 15.94

3 ₹ 20 0.712 14.24

4 ₹ 24 0.636 15.26

5 ₹ 24 0.567 13.61

6 ₹ 24 0.507 12.17

7 ₹ 24 0.452 10.85

7 ₹ 1,026 (₹ 900 × 1.2 × 0.95) 0.452 463.75

LESS: Cost of share (₹ 500 × ₹ 563.68

1.05)
₹ 525.00

Net gain Rs. 38.68

Since Mr. A is gaining ₹ 38.68 per share, he should buy the share.

Maximum price: Mr. A should be ready to pay is ₹ 563.68 which will include incidental
expenses. So the maximum price should be ₹ 563.68 × (100/105), which comes at ₹ 536.84

(6 Marks)

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Ans-6. (a)

Cash outflow (Rs. lakhs)

Cost of the machine (new) 4.00

Less: Sale value of old machine (0.90)

3.10

Incremental Depreciation (Rs. lakhs)

Year WDV Depreciation (@ 10%)

1 3.1000 0.3100

2 2.7900 0.2790

3 2.5110 0.2511

4 2.2599 0.2260

5 2.0339 0.2034

Statement Showing Incremental Cash flows and CFAT associated with Replacement of Old
Machine with a New Machine (Rs. lakhs)

Particulars Year 1 Year 2 Year 3 Year 4 Total

Savings in manufacturing cost 1.0000 1.0000 1.0000 1.0000 1.0000

Less: Incremental depreciation 0.3100 0.2790 0.2511 0.2260 0.2034

Incremental taxable income 0.6900 0.7210 0.7489 0.7740 0.7966

Less: Tax @ 50% 0.3450 0.3605 0.3744 0.3870 0.3983

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Incremental earning after tax (EAT) 0.3450 0.3605 0.3744 0.3870 0.3983

CFAT (EAT + Depreciation) 0.6550 0.6395 0.6256 0.6130 0.6017

Add : Salvage value - - - - 2.5000

Total Incremental CFAT 0.6550 0.6395 0.6256 0.6130 3.1017 5.6348

Less : Cash outflows 3.1000

Incremental net cash flows 2.5348

Suggestion - In view of positive incremental net cash flows, it is suggested to replace the
existing machine.

(6 Marks)

Ans-6.(b) (i) Calculation of Maximum price

The present value of future inflows (comprising both interest as well as redemption value)
discounted at 13% is the maximum price the investor would be ready to pay.

Annual Interest (I) = Rs. 100 × = Rs. 11

Redemption Value (RV) = Rs. 100

Maturity Period (n) = 3 Years

Accordingly, Present value of future inflows can be calculated as

= ₹ 11 × + ₹ 100

= ₹ 11 × 2.361 + ₹ 100 × 0.693

= ₹ 25.97 + 69.30

= ₹ 95.27

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The maximum price that the investor is ready to pay is Rs. 95.27.

(ii) Calculation of yield

It may be noted that the price of bond and yield/return are inversely related. The fair value
is Rs. 95.28 at 13% yield. It means, if the bond is selling at higher than this fair value at Rs.
97.60, the return will be less than 13%.

Let us find out approximate yield:

= 0.1194 or 11.94%

The present value of future inflows (comprising both interest as well as Value at 12%

= ₹ 11 × PVIFA(12%3) + 100 × PVIF(12% 3)

= ₹ 11 × 2.402 + ₹ 100 × 0.712

= ₹ 26.42 + ₹ 71.20

= ₹ 97.62

This value is almost equal to the price of ₹ 97.60. Therefore, the YTM of the bond would be
12%.

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