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 GETTING THE MOST FROM THIS BOOK
A QUICK GUIDE

1 INITIAL READING
After your initial reading of a
particular chapter in your
study material, go through the
questions in our 3, 5, and 11
attempt’s compilations,
focusing on the chapter
you've just covered. Make
note of challenging questions
for later reference.

2
FIRST REVISION
During your first revision, revisit the marked questions.
If you still can't answer them, highlight them in red and
review the related concepts to improve your
understanding. This process helps you to grasp the key
concepts and address your weak points

3 KEEP GOING WITH THE

REVISIONS
Repeat the reading and revision process
as often as possible before your exams.
Each iteration will enhance your
confidence and knowledge.

4 EXAMINERS COMMENTS
Pay attention to the examiner's comments in
our compilations, as they highlight common
mistakes. Learning from these errors will
help you avoid them in your exams
 Frequently Asked Ques琀椀ons
1. Why RTP’s, MTP’s and PYP’s?
RTP’s, MTP’s, and PYP’s are extremely important to ensure that you reproduce ICAI language.
These ques琀椀ons train you to understand what is important and what is expected of you.
At least 41% of ques琀椀ons* are asked from previous RTP’s, MTP’s and PYP’s.

2. What is included?
In this compiler, all ques琀椀ons from the last 3, 5 or 11 a琀琀empts depending on the one you have
selected will be available. There will be references to the marks and the a琀琀empt from which
they were asked. Iden琀椀cal or similar ques琀椀ons have been removed and references for both
a琀琀empts are men琀椀oned.

3. What is the bene昀椀t of Chapter-wise?

We have categorized each and every ques琀椀on from all Old RTPs, MTP’s, and PYP’s into
chapters. This means that you don't have to wait un琀椀l you've completed your en琀椀re syllabus
to tackle an RTP, MTP, or past paper. You can start solving these ques琀椀ons to check your
conceptual clarity right a昀琀er 昀椀nishing a par琀椀cular chapter.

4. What does amended for the latest a琀琀empt mean?

When we reviewed all the ques琀椀ons from the past 11 a琀琀empts of RTP, MTP, and PYP’S, we
didn't just segregate them Chapterwise; we also updated them to re昀氀ect the latest provisions.
All the answers provided in the compila琀椀on are applicable for the May 2024 examina琀椀on. So,
there's no need to stress about outdated or incorrect informa琀椀on.

5. How are Old RTP’s, MTP’s & PYP’s bene昀椀cial for me?
All old RTPs, MTPs, and PYPs have been organized according to the new syllabus issued by ICAI.
This means that if a speci昀椀c chapter from the old scheme is not included in the new scheme,
it has been omi琀琀ed. If a par琀椀cular chapter in the new scheme is based on concepts from two
or more chapters in the old scheme, it has been adapted to align with how the chapter should
be in the new scheme. If a chapter is only par琀椀ally included in the new scheme, the ques琀椀ons
related to those speci昀椀c concepts are only included in the corresponding chapter of the new
scheme. A comprehensive reconcilia琀椀on of the chapters between the new scheme and the old
scheme is provided on the following page.

6. What if a new a琀琀empt is added post my purchase?

If you have purchased materials for the May 2024 a琀琀empt, you will receive a 昀椀le with the
ques琀椀ons segregated Chapterwise speci昀椀cally for that a琀琀empt.

7. What does N/A mean?

It could mean any of the following:
1. No ques琀椀ons from that chapter have been included in the selected a琀琀empts.
2. The chapter is newly introduced, and as a result, no ques琀椀ons have been previously asked
in RTP’s, MTP’s, or PYP’s.

*This is on an average based on the last 11 a琀琀empts

 Financial Management & Strategic Management
Reconciliation of chapters of the new scheme (May’24) with old course
New Chapter Name as per New Syllabus Old Old Chapter Name
Chapter Chapter
No. No.
Section A: Financial Management
1 Scope and Objectives of Financial 1 Scope and Objectives of Financial
Management Management
2 Types of Financing 2 Types of Financing
3 Financial Analysis and Planning – Ratio 3 Financial Analysis and Planning –
Analysis Ratio Analysis
4 Cost of Capital 4 Cost of Capital
5 Financing Decisions – Capital Structure 5 Financing Decisions – Capital
Structure
6 Financing Decisions – Leverages 6 Financing Decisions – Leverages
MODULE 2
7 Investment Decisions 7 Investment Decisions
8 Dividend Decision 9 Dividend Decision
9 Management of Working Capital
9.1 Introduction to Working Capital 10.1 Introduction to Working Capital
Management Management
9.2 Treasury and Cash Management 10.2 Treasury and Cash Management
9.3 Management of Inventory 10.3 Management of Inventory
9.4 Management of Receivables 10.4 Management of Receivables
9.5 Management of Payables (Creditors) 10.5 Management of Payables
(Creditors)
9.6 Financing of Working Capital 10.6 Financing of Working Capital

Section B: Strategic Management

1 Introduction to Strategic Management 6,8 Introduction to Strategic
Management & Strategic
Management Process
2 Strategic Analysis: External Environment 7,10 Dynamics of Competitive Strategy
& Business Level Strategies
3 Strategic Analysis: Internal Environment 7,10,11 Dynamics of Competitive Strategy,
Business & Functional Level
Strategies
4 Strategic Choices 9 Corporate Level Strategies
5 Strategy Implementation and Evaluation 8,12,13 Strategic Management Process,
Organisation & Strategic
Leadership and Strategy
Implementation & Control
 Table of Contents
Sr. Particulars Page Number
No
Financial Management
1 Scope and Objectives of Financial Management 1.1 – 1.9
2 Types of Financing 2.1 – 2.13
3 Financial Analysis and Planning – Ratio Analysis 3.1 – 3.51
4 Cost of Capital 4.1 – 4.41
5 Financing Decisions – Capital Structure 5.1 – 5.37
6 Financing Decisions – Leverages 6.1 – 6.42
7 Investment Decisions 7.1 – 7.61
8 Dividend Decision 8.1 – 8.25
9.1 Introduction to Working Capital Management 9.1-1 – 9.1-32
9.2 Treasury and Cash Management 9.2-1 – 9.2-13
9.3 Management of Inventory 9.3-1
9.4 Management of Receivables 9.4-1 – 9.4-14
9.5 Management of Payables (Creditors) 9.5-1
9.6 Financing of Working Capital 9.6-1 – 9.6-3
Strategic Management
1 Introduction to Strategic Management 1.1 – 1.23
2 Strategic Analysis: External Environment 2.1 – 2.15
3 Strategic Analysis: Internal Environment 3.1 – 3.24
4 Strategic Choices 4.1 – 4.30
5 Strategy Implementation and Evaluation 5.1 – 5.37
6 Case Scenarios 6.1 – 6.29

21 MTPs: March’18, April’18, Aug’18, Oct’18, May’19, April’19, Oct’19,

May’20, Oct’20, March’21, April’21, Oct ’21, Nov ’21, March
’22, April ’22, Sep ’22, Oct ’22, March ’23, April '23, Sep ’23 &
Oct ‘23
11 PYPs: May’18, Nov’18, May’19, Nov’19, Nov’20, Jan’21, July ’21, Dec
’21, May’22, Nov ’22, May ‘23
12 RTPs: May’18, Nov’18, May’19, Nov’19, May’20, Nov’20, May’21, Nov
’21, May ’22, Nov ’22, May ’23, Nov ‘23
 1.1

Chapter 1
Scope & Objectives of Financial Management

Question 1
STATE Agency Cost. DISCUSS The Ways to Reduce the Effect of It. (MTP 4 Marks, Aug918)
OR
DISCUSS Agency Problem and Agency Cost. [MTP 4 Marks, Oct920, MTP 4 Marks March 923, MTP 4 Marks
Apr921, MTP 5 Marks April 923, RTP Nov 20, May922 & Nov 823)
Answer 1
Agency Cost: In a sole proprietorship firm, partnership etc., owners participate in management but in
corporate, owners are not active in management so, there is a separation between owner/ shareholders and
managers. In theory managers should act in the best interest of shareholders however in reality, managers
may try to maximize their individual goal like salary, perks etc., so there is a principal-agent relationship
between managers and owners, which is known as Agency Problem. In a nutshell, Agency Problem is the
chances that managers may place personal goals ahead of the goal of owners. Agency Problem leads to Agency
Cost. Agency cost is the additional cost borne by the shareholders to monitor the manager and control their
behavior so as to maximize shareholder9s wealth. Generally, Agency Costs are of four types (I) monitoring (ii)
bonding (iii) opportunity (iv) structuring
Addressing the agency problem
The agency problem arises if manager9s interests are not aligned to the interests of the debt lender and
equity investors. The agency problem of debt lender would be addressed by imposing negative covenants
i.e. the managers cannot borrow beyond a point. This is one of the most important concepts of modern day
finance and the application of this would be applied in the Credit Risk Management of Bank, Fund Raising,
Valuing distressed companies.
Agency problem between the managers and shareholders can be addressed if the interests of the managers
are aligned to the interests of the share- holders. It is easier said than done.

However, following efforts have been made to address these issues:

(A) Managerial compensation is linked to profit of the company to some extent and also with the long
term objectives of the company.
(B) Employee is also designed to address the issue with the underlying assumption that maximisation of
the stock price is the objective of the investors.
(C) Effecting monitoring can be done.

Question 2
EXPLAIN as to how the wealth maximization objective is superior to the profit maximization objective What
is the cost of these sources? [MTP 4 Marks, March919]
Answer 2
A firm9s financial management may often have the following as their objectives:

(i) The maximization of firm9s profit.

(ii) The maximization of firm9s value / wealth.
The maximization of profit is often considered as an implied objective of a firm. To achieve the aforesaid
objective various type of financing decisions may be taken. Options resulting into maximization of profit may
be selected by the firm9s decision makers. They even sometime may adopt policies yielding exorbitant profits
in short run which may prove to be unhealthy for the growth, survival and overall interests of the firm. The
profit of the firm in this case is measured in terms of its total accounting profit available to its shareholders.
The value/wealth of a firm is defined as the market price of the firm9s stock. The market price of a firm9s stock
Chapter 1 Scope & Objectives of Financial Management
 1.2

represents the focal judgment of all market participants as to what the value of the particular firm is. It takes
into account present and prospective future earnings per share, the timing and risk of these earnings, the
dividend policy of the firm and many other factors that bear upon the market price of the stock.
The value maximization objective of a firm is superior to its profit maximization objective due to following
reasons.
1. The value maximization objective of a firm considers all future cash flows, dividends, earning per share,
risk of a decision etc. whereas profit maximization objective does not consider the effect of EPS, dividend
paid or any other returns to shareholders or the wealth of the shareholder.
2. A firm that wishes to maximize the shareholder9s wealth may pay regular dividends whereas a firm with
the objective of profit maximization may refrain from dividend payment to its shareholders.
3. Shareholders would prefer an increase in the firm9s wealth against its generation of increasing
flow of profits.
4. The market price of a share reflects the shareholders expected return, considering the long- term
prospects of the firm, reflects the differences in timings of the returns, considers risk and recognizes the
importance of distribution of returns.
The maximization of a firm9s value as reflected in the market price of a share is viewed as a proper goal of a
firm. The profit maximization can be considered as a part of the wealth maximization strategy.

Question 3
DISCUSS the Inter relationship between investment, financing and dividend decisions. (MTP 4 Marks,
Oct919]
OR
DISCUSS the three major decisions taken by a finance manager to maximize the wealth of shareholders.
(MTP 4 Marks, Oct918)
OR
BRIEFLY explain the three finance function decisions. [MTP 4 Marks, Oct921, RTP Nov 919, RTP May919, PYP
3 Marks Nov919)
OR
What are the two main aspects of the Finance Function? (PYP 2 Marks, May 918, Old & New SM)
Answer 3
Inter-relationship between Investment, Financing and Dividend Decisions: The finance functions are divided
into three major decisions, viz., investment, financing and dividend decisions. It is correct to say that these
decisions are inter-related because the underlying objective of these three decisions is the same, i.e.
maximization of shareholders9 wealth. Since investment, financing and dividend decisions are all interrelated,
one has to consider the joint impact of these decisions on the market price of the company9s shares and these
decisions should also be solved jointly. The decision to invest in a new project needs the finance for the
investment. The financing decision, in turn, is influenced by and influences dividend decision because retained
earnings used in internal financing deprive shareholders of their dividends. An efficient financial management
can ensure optimal joint decisions. This is possible by evaluating each decision in relation to its effect on the
shareholders9 wealth.
The above three decisions are briefly examined below in the light of their inter-relationship and to see how
they can help in maximizing the shareholders9 wealth i.e. market price of the company9s shares.
Investment decision: The investment of long term funds is made after a careful assessment of the various
projects through capital budgeting and uncertainty analysis. However, only that investment proposal is to be
accepted which is expected to yield at least so much return as is adequate to meet its cost of financing. This
have an influence on the profitability of the company and ultimately on its wealth.
Financing decision: Funds can be raised from various sources. Each source of funds involves different issues.
The finance manager has to maintain a proper balance between long-term and short-term funds. With the
total volume of long-term funds, he has to ensure a proper mix of loan funds and owner9s funds. The optimum
financing mix will increase return to equity shareholders and thus maximize their wealth.
Dividend decision: The finance manager is also concerned with the decision to pay or declare dividend. He
Chapter 1 Scope & Objectives of Financial Management
 1.3

assists the top management in deciding as to what portion of the profit should be paid to the shareholders by
way of dividends and what portion should be retained in the business. An optimal dividend pay-out ratio
maximizes shareholders9 wealth.
The above discussion makes it clear that investment, financing and dividend decisions are interrelated and are
to be taken jointly keeping in view their joint effect on the shareholders9 wealth.

EXAMINERS9 COMMENTS ON THE PERFORMANCE OF EXAMINEES:

This was a theoretical question based on explanation of three finance functions decision. Only
a handful number of examinees attempted the question, but performance observed was
above average.

Question 4
DISCUSS the advantages and disadvantages of Wealth maximization principle. (MTP 4 Marks, March921,
PYP 2 Marks May922)
Answer 4
Advantages and disadvantages of Wealth maximization principle.
Advantages:
(i) Emphasizes the long term gains
(ii) Recognizes risk or uncertainty
(iii) Recognizes the timing of returns
(iv) Considers shareholders9 return.
Disadvantages:
(i) Offers no clear relationship between financial decisions and share price.
(ii) Can lead to management anxiety and frustration.

Question 5
WRITE two main objectives of Financial Management. [MTP 2 Marks, Oct921, PYP 2 Marks Nov 918)
Answer 5
Two main objectives of Financial Management
Profit Maximization
It has traditionally been argued that the primary objective of a company is to earn profit; hence the objective
of financial management is also profit maximization. This implies that the finance manager has to make his
decisions in a manner so that the profits of the concern are maximized. Each alternative, therefore, is to be
seen as to whether or not it gives maximum profit.
Wealth / Value Maximization
We will first like to define what is Wealth / Value Maximization Model. Shareholders wealth are the result of
cost benefit analysis adjusted with their timing and risk i.e. time value of money.
So, Wealth = Present Value of benefits 3 Present Value of Costs
It is important that benefits measured by the finance manager are in terms of cash flow. Finance manager
should emphasis on Cash flow for investment or financing decisions not on Accounting profit. The shareholder
value maximization model holds that the primary goal of the firm is to maximize its market value and implies
that business decisions should seek to increase the net present value of the economic profits of the firm.

Question 6
A finance executive of an organisation plays an important role in the company9s goals, policies, and financial
success. WHAT his responsibilities include? (MTP 4 Marks Sep922)
Answer 6
A finance executive of an organisation plays an important role in the company9s goals,policies, and financial
success. His responsibilities include:
(i) Financial analysis and planning: Determining the proper amount of funds to employ in the firm, i.e. designating
Chapter 1 Scope & Objectives of Financial Management
 1.4

the size of the firm and its rate of growth.

(ii) Investment decisions: The efficient allocation of funds to specific assets.
(iii) Financing and capital structure decisions: Raising funds on favourable terms as possible i.e. determining the
composition of liabilities.
(iv) Management of financial resources (such as working capital).
(v) Risk management: Protecting assets.

Question 7
EXPLAIN Financial Distress and explain its relationship with Insolvency. (MTP 4 Marks, March918)
OR
8Financial distress is a position where Cash inflows of a firm are inadequate to meet all its current
obligations.9 Based on above mentioned context, EXPLAIN Financial Distress along with Insolvency. [MTP 4
Marks March 22]
Answer 7
There are various factors like price of the product/ service, demand, price of inputs e.g. raw material, Labour
etc., which is to be managed by an organization on a continuous basis. Proportion of debt also needs to be
managed by an organization very delicately. Higher debt requires higher interest and if the cash inflow is not
sufficient then it will put lot of pressure to the organization. Both short term and long term creditors will put
stress to the firm. If all the above factors are not well managed by the firm, it can create situation known as
distress, so financial distress is a position where Cash inflows of a firm are inadequate to meet all its current
obligations.
Now if distress continues for a long period of time, firm may have to sell its asset, even many times at a lower
price. Further when revenue is inadequate to revive the situation, firm will not be able to meet its obligations
and become insolvent. So, insolvency basically means inability of a firm to repay various debts and is a result
of continuous financial distress.

Question 8
DISTINGUISH between Profit maximisation vis-a-vis wealth maximization. (MTP 5 Marks April 923)
OR
8Profit maximisation is not the sole objective of a company. It is at best a limited objective. If profit is given
undue importance, a number of problems can arise.9 DISCUSS four of such problems. (RTP May 22, RTP May
21)
OR
EXPLAIN <Wealth maximisation= and <Profit maximisation= objectives of financial management (Old & New
SM)
Answer 8
It has traditionally been argued that the primary objective of a company is to earn profit; hence the
objective of financial management is also profit maximisation. This implies that the finance manager has to
make his decisions in a manner so that the profits of the concern are maximised. Each alternative,
therefore, is to be seen as to whether or not it gives maximum profit.
However, profit maximisation cannot be the sole objective of a company. It is at best a limited objective. If
profit is given undue importance, a number of problems can arise. Some of these have been discussed
below:
(i) The term profit is vague. It does not clarify what exactly it means. It conveys a different meaning to
different people. For example, profit may be in short term or long term period; it may be total profit
or rate of profit etc.
(ii) Profit maximisation has to be attempted with a realisation of risks involved. There is a direct
relationship between risk and profit. Many risky propositions yield high profit. Higher the risk, higher
Chapter 1 Scope & Objectives of Financial Management
 1.5

is the possibility of profits. If profit maximisation is the only goal, then risk factor is altogether ignored.
This implies that finance manager will accept highly risky proposals also, if they give high profits. In
practice, however, risk is very important consideration and has to be balanced with the profit
objective.
(iii) Profit maximisation as an objective does not take into account the time pattern of returns. Proposal A
may give a higher amount of profits as compared to proposal B, yet if the returns of proposal A begin
to flow say 10 years later, proposal B may be preferred which may have lower overall profit but the
returns flow is more early and quick.
(iv) Profit maximisation as an objective is too narrow. It fails to take into account the social considerations
as also the obligations to various interests of workers, consumers, society, as well as ethical trade
practices. If these factors are ignored, a company cannot survive for long. Profit maximization at the
cost of social and moral obligations is a short sighted policy.
Wealth / Value Maximisation
We will first like to define what is Wealth / Value Maximization Model. Shareholders wealth are the result
of cost benefit analysis adjusted with their timing and risk i.e. time value of money.

So, It is important that benefits measured by the finance manager are in terms of cash flow. Finance
manager should emphasis on Cash flow for investment or financing decisions not on Accounting profit. The
shareholder value maximization model holds that the primary goal of the firm is to maximize its market
value and implies that business decisions should seek to inc rease the net present value of the economic
profits of the firm. So for measuring and maximising shareholders wealth finance manager should follow:
A) Cash Flow approach not Accounting Profit
B) Cost benefit analysis
C) Application of time value of money.
How do we measure the value/wealth of a firm?
According to Van Horne, <Value of a firm is represented by the market price of the company's common stock.
The market price of a firm's stock represents the focal judgment of all market participants as to what the value
of the particular firm is. It takes into account present and prospective future earnings per share, the timing
and risk of these earnings, the dividend policy of the firm and many other factors that bear upon the market
price of the stock. The mark et price serves as a performance index or report card of the firm's progress. It
indicates how well management is doing on behalf of stockholder9s=.
Why Wealth Maximization Works? Before we answer this question it is important to first understand and know
what other goals a business enterprise may have. Some of the other goals a business enterprise may follow
are:-
A) Achieving a higher growth rate
B) Attaining a larger market share
C) Gaining leadership in the market in terms of products and technology
D) Promoting employee welfare
E) Increasing customer satisfaction
F) Improving community life, supporting education and research, solving societal problems, etc.
Though, the above goals are important but the primary goal remains to be wealth maximization, as it is critical
for the very existence of the business enterprise. If this goal is not met, public/institutions would lose
confidence in the enterprise and will not invest further in the growth of the organization. If the growth of the
Chapter 1 Scope & Objectives of Financial Management
 1.6

organization is restricted than the other goals like community welfare will not get fulfilled.
Conflicts in Profit vs. Value maximisation principle
In any company, the management is the decision taking authority. As a normal tendency the management
may pursue its own personal goals (profit maximization). But in an organization where there is a significant
outside participation (shareholding, lenders etc.), the management may not be able to exclusively pursue its
personal goals due to the constant supervision of the various stakeholders of the company-employees,
creditors, customers, government, etc.
Every entity associated with the company will evaluate the performance of the management from the
fulfilment of its own objective. The survival of the management will be threatened if the objective of any of
the entities remains unfulfilled.
The wealth maximization objective is generally in accord with the interests of the various groups such as
owners, employees, creditors and society, and thus, it may be consistent with the management objective of
survival.
Owing to limitation (timing, social consideration etc.) in profit maximization, in today9s real world situations
which is uncertain and multi-period in nature, wealth maximization is a better objective. Where the time
period is short and degree of uncertainty is not great, wealth maximization and profit maximization amount
to essentially the same.
The table below highlights some of the advantages and disadvantages of both profit maximization and wealth
maximization goals:-
Goal Objective Advantages Disadvantages
Profit Large amount (i) Easy to calculate (i) Emphasizes the short
Maximization of profits profits term gains
(ii) Easy to (ii) Ignores risk or
determine the link uncertainty
between financial (iii) Ignores the timing of
decisions and returns
profits. (iv) Requires immediate
resources.
Shareholders Highest market (i) Emphasizes the long (i) Offers no clear
Wealth value of shares. term gains relationship between
Maximisation (ii) Recognises risk or financial decisions and
uncertainty share price.
(iii) Recognises the (ii) Can lead to management
timing of returns anxiety and frustration.
(iv) Considers
shareholders9
return.
Example: Profit maximization can be achieved in the short term at the expense of the long term goal, that
is, wealth maximization. For example, a costly investment may experience losses in the short term but yield
substantial profits in the long term. Also, a firm that wants to show a short term profit may, for example,
postpone major repairs or replacement, although such postponement is likely to hurt its long term
profitability.

Question 9
<The profit maximization is not an operationally feasible criterion. DISCUSS (RTP May 918, Nov 918 & May920)
Answer 9
Chapter 1 Scope & Objectives of Financial Management
 1.7

<The profit maximization is not an operationally feasible criterion.= This statement is true because Profit
maximization can be a short-term objective for any organization and cannot be its sole objective. Profit
maximization fails to serve as an operational criterion for maximizing the owner's economic welfare. It fails to
provide an operationally feasible measure for ranking alternative courses of action in terms of their economic
efficiency. It suffers from the following limitations:
(a) Vague term: The definition of the term profit is ambiguous. Does it mean short term or long term profit? Does
it refer to profit before or after tax? Total profit or profit per share?
(b) Timing of Return: The profit maximization objective does not make distinction between returns received in
different time periods. It gives no consideration to the time value of money, and values benefits received today
and benefits received after a period as the same.
(c) It ignores the risk factor.
(d) The term maximization is also vague

Question 10
Functions of Finance Manager. (RTP May 919)
Answer 10
Functions of Finance Manager
The Finance Manager9s main objective is to manage funds in such a way so as to ensure their optimum
utilization and their procurement in a manner that the risk, cost and control considerations are properly
balanced in a given situation. To achieve these objectives the Finance Manager performs the following
functions:
(i) Estimating the requirement of Funds: Both for long-term purposes i.e. investment in fixed assets and for
short-term i.e. for working capital. Forecasting the requirements of funds involves the use of techniques of
budgetary control and long-range planning.
(ii) Decision regarding Capital Structure: Once the requirement of funds has been estimated, a decision regarding
various sources from which these funds would be raised has to be taken. A proper balance has to be made
between the loan funds and own funds. He has to ensure that he raises sufficient long term funds to finance
fixed assets and other long term investments and to provide for the needs of working capital.
(iii) Investment Decision: The investment of funds, in a project has to be made after careful assessment of various
projects through capital budgeting. Assets management policies are to be laid down regarding various items
of current assets. For e.g. receivable in coordination with sales manager, inventory in coordination with
production manager.
(iv) Dividend decision: The finance manager is concerned with the decision as to how much to retain and what
portion to pay as dividend depending on the company9s policy. Trend of earnings, trend of share market prices,
requirement of funds for future growth, cash flow situation etc., are to be considered.
(v) Evaluating financial performance: A finance manager has to constantly review the financial performance of
the various units of organisation generally in terms of ROI Such a review helps the management in seeing how
the funds have been utilised in various divisions and what can be done to improve it.
(vi) Financial negotiation: The finance manager plays a very important role in carrying out negotiations with the
financial institutions, banks and public depositors for raising of funds on favourable terms.
(vii) Cash management: The finance manager lays down the cash management and cash disbursement policies
with a view to supply adequate funds to all units of organisation and to ensure that there is no excessive cash.
(viii) Keeping touch with stock exchange: Finance manager is required to analyse major trends in stock market and
their impact on the price of the company share.

Question 11

Chapter 1 Scope & Objectives of Financial Management

 1.8

DISCUSS the points that demonstrates the Importance of good financial management. (RTP Nov 921, PYP 4
Marks Jan921)
Answer 11
Points that demonstrate the "Importance of good financial management":
÷ Taking care not to over-invest in fixed assets
÷ Balancing cash-outflow with cash-inflows
÷ Ensuring that there is a sufficient level of short-term working capital
÷ Setting sales revenue targets that will deliver growth
÷ Increasing gross profit by setting the correct pricing for products or services
÷ Controlling the level of general and administrative expenses by finding more cost-efficient ways of
running the day-to-day business operations, and
÷ Tax planning that will minimize the taxes a business has to pay.

Question 12
List out the steps to be followed by the manager to measure and maximize the Shareholder's Wealth?
(PYP 2 Marks, July921)
Answer 12
For measuring and maximizing shareholders9 wealth, manager should follow:
÷ Cash Flow approach not Accounting Profit
÷ Cost benefit analysis
÷ Application of time value of money.

EXAMINERS9 COMMENTS ON THE PERFORMANCE OF EXAMINEES:

This theoretical question required the examinees to list out the steps to measure and maximize
shareholder9s wealth. Very few examinees attempted the question and below average performance
was observed.

Question 13
List out the role of Chief Financial Officer in today's World. (PYP 4 Marks, Nov920)
OR
What are the roles of Finance Executive in Modem World? (PYP 2 Marks, May918)
Answer 13
Role of Chief Financial Officer (CFO) in Today9s World: Today, the role of chief financial officer, or CFO, is
no longer confined to accounting, financial reporting and risk management. It9s about being a strategic
business partner of the chief executive officer, or CEO. Some of the role of a CFO in today9s world are as
follows-
÷ Budgeting
÷ Forecasting
÷ Managing M&As
÷ Profitability analysis (for example, by customer or product)
÷ Pricing analysis
÷ Decisions about outsourcing
÷ Overseeing the IT function.
÷ Overseeing the HR function.
÷ Strategic planning (sometimes overseeing this function).
÷ Regulatory compliance.
÷ Risk management
Chapter 1 Scope & Objectives of Financial Management
 1.9

Question 14
Explain in brief the phases of the evolution of financial management. (PYP 2 Marks Dec 921)
Answer 14
Evolution of Financial Management: Financial management evolved gradually over the past 50 years. The
evolution of financial management is divided into three phases. Financial Management evolved as a
separate field of study at the beginning of the century.
The three stages of its evolution are:
The Traditional Phase: During this phase, financial management was considered necessary only during
occasional events such as takeovers, mergers, expansion, liquidation, etc. Also, when taking financial
decisions in the organization, the needs of outsiders (investment bankers, people who lend money to the
business and other such people) to the business was kept in mind.
The Transitional Phase: During this phase, the day-to-day problems that financial managers faced were
given importance. The general problems related to funds analysis, planning and control were given more
attention in this phase.
The Modern Phase: Modern phase is still going on. The scope of financial management has greatly increased
now. It is important to carry out financial analysis for a company. This analysis helps in decision making.
During this phase, many theories have been developed regarding efficient markets, capital budgeting,
option pricing, valuation models and also in several other important fields in financial management. Here,
financial management is viewed as a supportive and facilitative function, not only for top management but
for all levels of management.

Chapter 1 Scope & Objectives of Financial Management

 2.1

Chapter 2
Types of Financing
Question 1
EXPLAIN the importance of trade credit and accruals as source of short-term finance. DISCUSS the cost of
these sources?. (MTP 4 Marks, Aug918)
Answer 1
Trade credit and accruals as source of short-term finance like working capital refers to credit facility given by
suppliers of goods during the normal course of trade. It is a short term source of finance. Micro small and
medium enterprises (MSMEs) in particular are heavily dependent on this source for financing their working
capital needs. The major advantages of trade credit are easy availability, flexibility and informality.
There can be an argument that trade credit is a cost free source of finance. But it is not. It involves implicit
cost. The supplier extending trade credit incurs cost in the form of opportunity cost of funds invested in trade
receivables. Generally, the supplier passes on these costs to the buyer by increasing the price of the goods or
alternatively by not extending cash discount facility.

Question 2
DESCRIBE Bridge Finance. (MTP 4 Marks, April919)
OR
Briefly DESCRIBE bridge finance. [MTP 2 Marks, Nov921, RTP May 918)
Answer 2
Bridge finance refers, normally, to loans taken by the business, usually from commercial banks for a short
period, pending disbursement of term loans by financial institutions, normally it takes time for the financial
institution to finalize procedures of creation of security, tie-up participation with other institutions etc. even
though a positive appraisal of the project has been made. However, once the loans are approved in principle,
firms in order not to lose further time in starting their projects arrange for bridge finance. Such temporary
loan is normally repaid out of the proceeds of the principal term loans. It is secured by hypothecation of
moveable assets, personal guarantees and demand promissory notes. Generally, rate of interest on bridge
finance is higher as compared with that on term loans.

Question 3
EXPLAIN the limitations of Leasing? (MTP 4 Marks, April919, PYP 2 Marks, May 919)
Answer 3
Limitations are:
The lease rentals become payable soon after the acquisition of assets and no moratorium period is permissible
as in case of term loans from financial institutions. The lease arrangement may, therefore, not be suitable for
setting up of the new projects as it would entail cash outflows even before the project comes into operation.
1) The leased assets are purchased by the lessor who is the owner of equipment. The seller9s warranties for
satisfactory operation of the leased assets may sometimes not be available to lessee.
2) Lessor generally obtains credit facilities from banks etc. to purchase the leased equipment which are
subject to hypothecation charge in favor of the bank. Default in payment by the lessor may sometimes
result in seizure of assets by banks causing loss to the lessee.
3) Lease financing has a very high cost of interest as compared to interest charged on term loans by financial
institutions/banks.
Despite all these disadvantages, the flexibility and simplicity offered by lease finance is bound to make it
popular. Lease operations will find increasing use in the near future.

Question 4
What is debt securitization? EXPLAIN the basics of debt securitization process. (MTP 4 Marks, Oct919 &
March 923, RTP May 919, RTP May 920, PYP 4 Marks, May 919, RTP May923)
Answer 4
Debt Securitization: It is a method of recycling of funds. It is especially beneficial to financial intermediaries

Chapter 2 Types of Financing

 2.2

to support the lending volumes. Assets generating steady cash flows are packaged together and against this
asset pool, market securities can be issued, e.g. housing finance, auto loans, and credit card receivables.
Process of Debt Securitization
(i) The origination function 3 A borrower seeks a loan from a finance company, bank, HDFC. The credit
worthiness of borrower is evaluated and contract is entered into with repayment schedule structured
over the life of the loan.
(ii) The pooling function 3 Similar loans on receivables are clubbed together to create an underlying pool of
assets. The pool is transferred in favor of Special Purpose Vehicle (SPV), which acts as a trustee for
investors.
(iii) The securitization function 3 SPV will structure and issue securities on the basis of asset pool. The
securities carry a coupon and expected maturity which can be asset-based/mortgage based. These are
generally sold to investors through merchant bankers. Investors are 3 pension funds, mutual funds,
insurance funds.
The process of securitization is generally without recourse i.e. investors bear the credit risk and issuer is
under an obligation to pay to investors only if the cash flows are received by him from the collateral. The
benefits to the originator are that assets are shifted off the balance sheet, thus giving the originator
recourse to off-balance sheet funding.

Question 5
EXPLAIN in short the term Letter of Credit. [MTP 4 Marks, May920 & Sep 823]
Answer 5
Letter of Credit: It is an arrangement by which the issuing bank on the instructions of a customer or on its
own behalf undertakes to pay or accept or negotiate or authorizes another bank to do so against stipulated
documents subject to compliance with specified terms and conditions.

Question 6
DISCUSS in brief the characteristics of Debentures. (MTP 4 Marks, March921)
Answer 6
Characteristics of Debentures are as follows:
÷ Normally, debentures are issued on the basis of a debenture trust deed which lists the terms and
conditions on which the debentures are floated.
÷ Debentures are either secured or unsecured.
÷ May or may not be listed on the stock exchange.
÷ The cost of capital raised through debentures is quite low since the interest payable on debentures can
be charged as an expense before tax.
÷ From the investors' point of view, debentures offer a more attractive prospect than the preference shares
since interest on debentures is payable whether or not the company makes profits.
÷ Debentures are thus instruments for raising long-term debt capital.
÷ The period of maturity normally varies from 3 to 10 years and may also increase for projects having high
gestation period.

Question 7
DEFINE Secured Premium Notes. (MTP 2 Marks, March921 & March 923, Old & New SM)
Answer 7
Secured Premium Notes: Secured Premium Notes is issued along with a detachable warrant and is
redeemable after a notified period of say 4 to 7 years. The conversion of detachable warrant into equity shares
will have to be done within time period notified by the company.

Question 8
DEFINE Masala bond. (MTP 2 Marks, March921, PYP 2 Marks May 918)
Answer 8
Chapter 2 Types of Financing
 2.3

Masala bond: Masala (means spice) bond is an Indian name used for Rupee denominated bond that Indian
corporate borrowers can sell to investors in overseas markets. These bonds are issued outside India but
denominated in Indian Rupees. NTPC raised Rest. 2,000 crores via masala bonds for its capital expenditure in
the year 2016.

Question 9
DEFINE Debt Securitization. (MTP 2 Marks, April921)
Answer 9
Debt Securitization is a process in which illiquid assets are pooled into marketable securities that can be sold
to investors. The process leads to the creation of financial instruments that represent ownership interest in,
or are secured by a segregated income producing asset or pool of assets. These assets are generally secured
by personal or real property such as automobiles, real estate, or equipment loans but in some cases are
unsecured.

Question 8
BRIEF out any four types of Preference shares along with its feature. [MTP 4 Marks, Nov921]
Answer 8
Sl. No. Type of Preference Shares Salient Features
1 Cumulative Arrear Dividend will accumulate.
2 Non-cumulative No right to arrear dividend.
3 Redeemable Redemption should be done.
4 Participating Can participate in the surplus which remains
after payment to equity shareholders.
5 Non- Participating Cannot participate in the surplus after payment
of fixed rate of Dividend.
6 Convertible Option of converting into equity Shares.

Question 9
EXPLAIN any four types of Packing Credit. [MTP 4 Marks, Nov921, Mar922, & Oct 923 Old & New SM)
Answer 9
(i) Clean packing credit: This is an advance made available to an exporter only on production of a firm
export order or a letter of credit without exercising any charge or control over raw material or finished
goods. It is a clean type of export advance. Each proposal is weighed according to particular
requirements of the trade and credit worthiness of the exporter. A suitable margin has to be maintained.
Also, Export Credit Guarantee Corporation (ECGC) cover should be obtained by the bank.
(ii) Packing credit against hypothecation of goods: Export finance is made available on certain terms and
conditions where the exporter has pledge able interest and the goods are hypothecated to the bank as
security with stipulated margin. At the time of utilizing the advance, the exporter is required to submit,
along with the firm export order or letter of credit relative stock statements and thereafter continue
submitting them every fortnight and/or whenever there is any movement in stocks.
(iii) Packing credit against pledge of goods: Export finance is made available on certain terms and conditions
where the exportable finished goods are pledged to the banks with approved clearing agents who will
ship the same from time to time as required by the exporter. The possession of the goods so pledged
lies with the bank and is kept under its lock and key.
(iv) E.C.G.C. guarantee: Any loan given to an exporter for the manufacture, processing, purchasing, or
packing of goods meant for export against a firm order qualifies for the packing credit guarantee issued
by Export Credit Guarantee Corporation.
(v) Forward exchange contract: Another requirement of packing credit facility is that if the export bill is to
be drawn in a foreign currency, the exporter should enter into a forward exchange contact with the
Chapter 2 Types of Financing
 2.4

bank, thereby avoiding risk involved in a possible change in the rate of exchange.

Question 10
EXPLAIN: Callable bonds and Puttable bonds. (MTP 2 Marks, Nov 921 & March 922, PYP 2 Marks Jan921)
Answer 10
(i) Callable bonds: A callable bond has a call option which gives the issuer the right to redeem the bond
before maturity at a predetermined price known as the call price (Generally at a premium).
(ii) Puttable bonds: Puttable bonds give the investor a put option (i.e. the right to sell the bond) back to the
company before maturity.

Question 11
STATE in brief four features of Samurai Bond. [MTP 2 Marks March 22, RTP Nov922)
Answer 11
Features of Samurai Bond:
÷ Samurai bonds are denominated in Japanese Yen JPY
÷ Issued in Tokyo
÷ Issuer Non- Japanese Company
÷ Regulations: Japanese
÷ Purpose: Access of capital available in Japanese market
÷ Issue proceeds can be used to fund Japanese operation
÷ Issue proceeds can be used to fund a company9s local opportunities.
÷ It can also be used to hedge foreign exchange risk

Question 12
DISCUSS in briefly any two long term sources of finance for a partnership firm. (MTP 4 Marks April 22)
Answer 12
The two sources of long-term finance for a partnership firm are as follows:
Loans from Commercial Banks: Commercial banks provide long term loans for the purpose of expansion
or setting up of new units. Their repayment is usually scheduled over a long period of time. The liquidity
of such loans is said to depend on the anticipated income of the borrowers.
As part of the long term funding for a partnership firm, the banks also fund the long term working capital
requirement (it is also called WCTL i.e. working capital term loan).
Lease financing: Leasing is a general contract between the owner and user of the asset over a specified
period of time. The asset is purchased initially by the lessor (leasing company) and thereafter leased to
the user (lessee firm) which pays a specified rent at periodical intervals. Thus, leasing is an alternative to
the purchase of an asset out of own or borrowed funds. Moreover, lease finance can be arranged much
faster as compared to term loans from financial institutions.

Question 13
WHAT is the meaning of Venture Capital Financing. STATE some characteristics of it. [MTP 4 Marks Sep922)
Answer 13
Venture Capital Financing: The venture capital financing refers to financing of new high risky venture promoted
by qualified entrepreneurs who lack experience and funds to give shape to their ideas. In broad sense, under
venture capital financing, venture capitalist make investment to purchase equity or debt securities from
inexperienced entrepreneurs who undertake highly risky ventures with potential to succeed in future.
Chapter 2 Types of Financing
 2.5

Some of the characteristics of Venture Capital financing are:

ø It is basically an equity finance in new companies.
ø It can be viewed as a long-term investment in growth-oriented small/medium firms.
ø Apart from providing funds, the investor also provides support in form of sales strategy, business networking
and management expertise, enabling the growth of the entrepreneur.

Question 14
BRIEF OUT certain sources of finance- Inter Corporate Deposits and Certificate of Deposit. (MTP 2 Marks Sep922)
Answer 14
Inter Corporate Deposits: The companies can borrow funds for a short period, say 6 months, from other companies
which have surplus liquidity. The rate of interest on inter corporate deposits varies depending upon the amount
involved and the time period.
Certificate of Deposit (CD): The certificate of deposit is a document of title similar to a time deposit receipt
issued by a bank except that there is no prescribed interest rate on s uch funds.
The main advantage of CD is that banker is not required to encash the deposit before maturity period and
the investor is assured of liquidity because he can sell the CD in secondary market

Question 15
STATE in brief four features of Plain Vanilla Bond. (MTP 2 Marks Sep922)
Answer 15
Features of Plain Vanilla Bond:
÷ The issuer would pay the principal amount along with the interest rate.
÷ This type of bond would not have any options.
÷ This bond can be issued in the form of discounted bond or can be issued in the form of coupon bearing bond.

Question 16
Write a short note on seed capital assistance. (MTP 2 Marks Oct922)
Answer 16
Seed Capital Assistance: The seed capital assistance has been designed by IDBI for professionally or technically
qualified entrepreneurs. All the projects eligible for financial assistance from IDBI, directly or indirectly through
refinance are eligible under the scheme. The project cost should not exceed ¹ 2 crores and the maximum assistance
under the project will be restricted to 50% of the required promoter9s contribution or ¹ 15 lacs whichever is lower.
The seed capital assistance is interest free but carries a security charge of one percent per annum for the first five
years and an increasing rate thereafter

Question 17
EXPLAIN in brief the features of Commercial Papers. [MTP 4 Marks Oct922, Oct920, Apr921, & Oct 923 Old & New
SM)
Answer 17
Commercial Paper: A Commercial Paper is an unsecured money market instrument issued in the form of a
promissory note. The Reserve Bank of India introduced the commercial paper scheme in the year 1989 with a view
to enabling highly rated corporate borrowers to diversify their sources of short- term borrowings and to provide an
additional instrument to investors. Subsequently, in addition to the Corporate, Primary Dealers and All India Financial
Institutions have also been allowed to issue Commercial Papers. Commercial papers are issued in denominations of
¹ 5 lakhs or multiples thereof and the interest rate is generally linked to the yield on the one-year government bond.
All eligible issuers are required to get the credit rating from Credit Rating Information Services of India Ltd, (CRISIL),
or the Investment Information and Credit Rating Agency of India Ltd (ICRA) or the Credit Analysis and Research Ltd
(CARE) or the FITCH Ratings India Pvt. Ltd or any such other credit rating agency as is specified by the Reserve Bank

Chapter 2 Types of Financing

 2.6

of India.

Question 18
BRIEFLY describe the financial needs of a business. [MTP 2 Marks, Oct921]
Answer 18
Financial Needs of a Business: Business enterprises need funds to meet their different types of
requirements. All the financial needs of a business may be grouped into the following three categories-
Long-term financial needs: Such needs generally refer to those requirements of funds which are for a period
exceeding 5-10 years. All investments in plant, machinery, land, buildings, etc., are considered as long-term
financial needs.
Medium- term financial needs: Such requirements refer to those funds which are required for a period
exceeding one year but not exceeding 5 years.
Short- term financial needs: Such type of financial needs arises to finance current assets such as stock,
debtors, cash, etc. Investment in these assets is known as meeting of working capital requirements of the
concern for a period not exceeding one year.

Question 19
EXPLAIN the followings:
(a) Floating Rate Bonds
(b) Packing Credit. (RTP May 818)
Answer 19
(a) Floating Rate Bonds: These are the bonds where the interest rate is not fixed and is allowed to float
depending upon the market conditions. These are ideal instruments which can be resorted to by the
issuers to hedge themselves against the volatility in the interest rates. They have become more popular
as a money market instrument and have been successfully issued by financial institutions like IDBI, ICICI
etc.
(b) Packing Credit: Packing credit is an advance made available by banks to an exporter. Any exporter, having
at hand a firm export order placed with him by his foreign buyer on an irrevocable letter of credit opened
in his favour, can approach a bank for availing of packing credit. An advance so taken by an exporter is
required to be liquidated within 180 days from the date of its commencement by negotiation of export
bills or receipt of export proceeds in an approved manner. Thus Packing Credit is essentially a short-term
advance.

Question 20
EXPLAIN the difference between Financial Lease and Operating Lease. (RTP Nov 918 & Nov 820)
OR
Under financial lease, lessee bears the risk of obsolescence; while under operating lease, lessor bears the
risk of obsolescence. In view of this, you are required to COMPARE the financial lease and operating
lease. (RTP Nov922)
Answer 20
Difference between Financial Lease and Operating Lease
Financial Lease Operating Lease
1. The risk and reward incident to ownership The lessee is only provided the use of the asset
are passed on to the lessee. The lessor only for a certain time. Risk incident to ownership
remains the legal owner of the asset. belong wholly to the lessor.
2. The lessee bears the risk of obsolescence. The lessor bears the risk of
obsolescence.

Chapter 2 Types of Financing

 2.7

3. The lessor is interested in his rentals and not As the lessor does not have difficulty in leasing
in the asset. He must get his principal back the same asset to other willing lessor, the
along with interest. Therefore, the lease is lease is kept cancelable by the lessor.
non- cancellable by either party.
4. The lessor enters into the transaction only as Usually, the lessor bears cost of repairs,
financier. He does not bear the cost of maintenance or operations.
repairs, maintenance or operations.
5. The lease is usually full payout, that is, the The lease is usually non-payout, since the
single lease repays the cost of the asset lessor expects to lease the same asset over
together with the interest. and over again to several users.

Question 21
DISCUSS the advantages and disadvantages of raising funds by issue of preference shares. (RTP May 921)
Answer 21
Advantages and disadvantages of raising funds by issue of preference shares Advantages
(i) No dilution in EPS on enlarged capital base 3 On the other hand if equity shares are issued it reduces
EPS, thus affecting the market perception about the company.
(ii) There is also the advantage of leverage as it bears a fixed charge (because companies are required
to pay a fixed rate of dividend in case of issue of preference shares). Non-payment of preference
dividends does not force a company into liquidity.

(iii) There is no risk of takeover as the preference shareholders do not have voting rights except where
dividend payment are in arrears.
(iv) The preference dividends are fixed and pre-decided. Hence preference shareholders cannot
participate in surplus profits as the ordinary shareholders can except in case of participating
preference shareholders.
(v) Preference capital can be redeemed after a specified period.
Disadvantages
(i) One of the major disadvantages of preference shares is that preference dividend is not tax deductible
and so does not provide a tax shield to the company. Hence, preference shares are costlier to the
company than debt e.g. debenture.
(ii) Preference dividends are cumulative in nature. This means that if in a particular year preference
dividends are not paid they shall be accumulated and paid later. Also, if these dividends are not paid,
no dividend can be paid to ordinary shareholders. The non-payment of dividend to ordinary
shareholders could seriously impair the reputation of the concerned company.

Question 22
EXPLAIN some common methods of Venture capital financing. (RTP Nov 921, PYP 4 Marks,Nov 920)
Answer 22
Some common methods of venture capital financing are as follows:
(i) Equity financing: The venture capital undertakings generally require funds for a longer period but may
not be able to provide returns to the investors during the initial stages. Therefore, the venture capital
finance is generally provided by way of equity share capital. The equity contribution of venture capital
firm does not exceed 49% of the total equity capital of venture capital undertakings so that the effective
control and ownership remains with the entrepreneur.
(ii) Conditional loan: A conditional loan is repayable in the form of a royalty after the venture is able to
generate sales. No interest is paid on such loans. In India venture capital financiers charge royalty
ranging between 2 and 15 per cent; actual rate depends on other factors of the venture such as gestation
Chapter 2 Types of Financing
 2.8

period, cash flow patterns, risk and other factors of the enterprise. Some Venture capital financiers give
a choice to the enterprise of paying a high rate of interest (which could be well above 20 per cent)
instead of royalty on sales once it becomes commercially sound.
(iii) Income note: It is a hybrid security which combines the features of both conventional loan and
conditional loan. The entrepreneur has to pay both interest and royalty on sales but at substantially low
rates. IDBI9s VCF provides funding equal to 80 3 87.50% of the projects cost for commercial application
of indigenous technology.
(iv) Participating debenture: Such security carries charges in three phases 4 in the start-up phase no
interest is charged, next stage a low rate of interest is charged up to a particular level of operation, after
that, a high rate of interest is required to be paid.

Question 23
HIGHLIGHT the similarities and differences between Samurai Bond and Bull Dog Bond. (RTP May 23)
Answer 23
Samurai Bond ÷ Samurai bonds are denominated in Japanese Yen JPY
÷ Issued in Tokyo
÷ Issuer Non- Japanese Company
÷ Regulations: Japanese
÷ Purpose: Access of capital available in Japanese market
÷ Issue proceeds can be used to fund Japanese operation
÷ Issue proceeds can be used to fund a company9s local
opportunities.
÷ It can also be used to hedge foreign exchange risk
Bulldog Bond ÷ It is denominated in Bulldog Pound Sterling/Great Britain Pound (GBP)
÷ Issued in London
÷ Issuer Non- UK Company
÷ Regulations: Great Britain
÷ Purpose: Access of capital available in UK market
÷ Issue proceeds can be used to fund UK operation
÷ Issue proceeds can be used to fund a company9s local opportunities

Question 24
DESCRIBE the inter relationship between investing, financing, and dividend decisions. (RTP Nov 923)
Answer 24
Inter-relationship between Investment, Financing and Dividend Decisions

The finance functions are divided into three major decisions, viz., investment, financing, and dividend
decisions. It is correct to say that these decisions are inter - related because the underlying objective of
these three decisions is the same, i.e., maximisation of shareholders9 wealth. Since investment, financing
and dividend decisions are all interrelated, one must consider the joint impact of these decisions on the
market price of the company9s shares and these decisions should also be solved jointly. The decision to
invest in a new project needs the finance for the investment. The financing decision, in turn, is influenced
by and influences dividend decision because retained earnings used in internal financing deprive
shareholders of their dividends. An efficient financial management can ensure optimal joint decisions.
This is possible by evaluating each decision in relation to its effect on the shareholders9 wealth.
The above three decisions are briefly examined below in the light of their inter - relationship and to see
how they can help in maximising the shareholders9 wealth i.e., market price of the company9s shares.

Chapter 2 Types of Financing

 2.9

Investment decision: The investment of long-term funds is made after a careful assessment of the various
projects through capital budgeting and uncertainty analysis. However, only that investment proposal is to
be accepted which is expected to yield at least so much return as is adequate to meet its cost of financing.
This has an influence on the profitability of the company and ultimately on its wealth.
Financing decision: Funds can be raised from various sources. Each source of funds involves different
issues. The finance manager must maintain a proper balance between long-term and short-term funds.
With the total volume of long-term funds, he must ensure a proper mix of loan funds and owner9s funds.
The optimum f inancing mix will increase return to equity shareholders and thus maximise their wealth.
Dividend decision: The finance manager is also concerned with the decision to pay or declare dividend.
He assists the top management in deciding as to what portion of the profit should be paid to the
shareholders by way of dividends and what portion should be retained in the business. An optimal
dividend pay-out ratio maximises shareholders9 wealth.
The above discussion makes it clear that investment, financing, and dividend decisions are interrelated
and are to be taken jointly keeping in view their joint effect on the shareholders9 wealth.

Question 25
STATE the meaning of debt securitization (RTP Nov 923)
Answer 25
Debt Securitisation: It is a method of recycling of funds. It is especially beneficial to financial
intermediaries to support the lending volumes. Assets generating steady cash flows are packaged
together and against this asset pool, market securities can be issued, e.g., housing finance, auto loans,
and credit card receivables.
Process of Debt Securitisation
(i) The origination function 3 A borrower seeks a loan from a finance company, bank. The credit
worthiness of borrower is evaluated, and contract is entered into with repayment schedule
structured over the life of the loan.
(ii) The pooling function 3 Similar loans on receivables are clubbed together to create an underlying pool
of assets. The pool is transferred in favour of Special purpose Vehicle (SPV), which acts as a trustee
for investors.
(iii) The securitisation function 3 SPV will structure, and issue securities based on asset pool. The
securities carry a coupon and expected maturity which can be asset-based/mortgage based. These
are generally sold to investors through merchant bankers. Investors are 3 pension funds, mutual
funds, insurance funds.

Question 26
Explain in brief the forms of Post Shipment Finance. (PYP 4 Marks, July921)
Answer 26
Post-shipment Finance: It takes the following forms:
a. Purchase/discounting of documentary export bills: Finance is provided to exporters by purchasing
export bills drawn payable at sight or by discounting since export bills covering confirmed sales and
backed by documents including documents of the title of goods such as bill of lading, post parcel
receipts, or air consignment notes.
b. E.C.G.C. Guarantee: Post-shipment finance, given to an exporter by a bank through purchase,
negotiation or discount of an export bill against an order, qualifies for post- shipment export credit
guarantee. It is necessary, however, that exporters should obtain a shipment or contracts risk policy of
E.C.G.C. Banks insist on the exporters to take a contracts shipment (comprehensive risks) policy
Chapter 2 Types of Financing
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covering both political and commercial risks. The Corporation, on acceptance of the policy, will fix
credit limits for individual exporters and the Corporation9s liability will be limited to the extent of the
limit so fixed for the exporter concerned irrespective of the amount of the policy.
c. Advance against export bills sent for collection: Finance is provided by banks to exporters by way of
advance against export bills forwarded through them for collection, taking into account the
creditworthiness of the party, nature of goods exported, since, standing of drawee, etc.
d. Advance against duty draw backs, cash subsidy, etc.: To finance export losses sustained by exporters,
bank advance against duty draw-back, cash subsidy, etc., receivable by them against export
performance. Such advances are of clean nature; hence necessary precaution should be exercised.

Question 27
Briefly describe any four sources of short-term finance. (PYP 4 Marks.Nov919)
OR
What are the sources of short term financial requirement of the company? (PYP 4 Marks, May918)
Answer 27
Sources of Short Term Finance: There are various sources available to meet short- term needs of
finance. The different sources are discussed below-
(i) Trade Credit: It represents credit granted by suppliers of goods, etc., as an incident of sale. The usual
duration of such credit is 15 to 90 days. It generates automatically in the course of business and is
common to almost all business operations. It can be in the form of an 'open account' or 'bills payable'.
(ii) Accrued Expenses and Deferred Income: Accrued expenses represent liabilities which a company has
to pay for the services which it has already received like
wages, taxes, interest and dividends. Such expenses arise out of the day-to-day activities of the
company and hence represent a spontaneous source of finance.
Deferred Income: These are the amounts received by a company in lieu of goods and services to be
provided in the future. Since these receipts increases a company9s liquidity, they are also considered
to be an important sources of short- term finance.
(iii) Advances from Customers: Manufacturers and contractors engaged in producing or constructing costly
goods involving considerable length of manufacturing or construction time usually demand advance
money from their customers at the time of accepting their orders for executing their contracts or
supplying the goods. This is a cost free source of finance and really useful.
(iv) Commercial Paper: A Commercial Paper is an unsecured money market instrument issued in the form
of a promissory note. The Reserve Bank of India introduced the commercial paper scheme in the year
1989 with a view to enabling highly rated corporate borrowers to diversify their sources of short-term
borrowings and to provide an additional instrument to investors.
(v) Treasury Bills: Treasury bills are a class of Central Government Securities. Treasury bills, commonly
referred to as T-Bills are issued by Government of India to meet short term borrowing requirements
with maturities ranging between 14 to 364 days.
(vi) Certificates of Deposit (CD): A certificate of deposit (CD) is basically a savings certificate with a fixed
maturity date of not less than 15 days up to a maximum of one year.
(vii) Bank Advances: Banks receive deposits from public for different periods at varying rates of interest.
These funds are invested and lent in such a manner that when required, they may be called back.
Lending results in gross revenues out of which costs, such as interest on deposits, administrative costs,
etc., are met and a reasonable profit is made. A bank's lending policy is not merely profit motivated but
has to also keep in mind the socio- economic development of the country. Some of the facilities
provided by banks are Short Term Loans, Overdraft, Cash Credits, Advances against goods, Bills
Purchased/Discounted.
(viii) Financing of Export Trade by Banks: Exports play an important role in accelerating the economic
growth of developing countries like India. Of the several factors influencing export growth, credit is a
very important factor which enables exporters in efficiently executing their export orders. The
commercial banks provide short-term export finance mainly by way of pre and post-shipment credit.

Chapter 2 Types of Financing

 2.11

Export finance is granted in Rupees as well as in foreign currency.

(ix) Inter Corporate Deposits: The companies can borrow funds for a short period say 6 months from other
companies which have surplus liquidity. The rate of interest on
inter corporate deposits varies depending upon the amount involved and time period.
(x) Certificate of Deposit (CD): The certificate of deposit is a document of title similar to a time deposit
receipt issued by a bank except that there is no prescribed interest rate on such funds.
The main advantage of CD is that banker is not required to encase the deposit before maturity period
and the investor is assured of liquidity because he can sell the CD in secondary market.
(xi) Public Deposits: Public deposits are very important source of short-term and medium term finances
particularly due to credit squeeze by the Reserve Bank of India. A company can accept public deposits
subject to the stipulations of Reserve Bank of India from time to time maximum up to 35 per cent of its
paid up capital and reserves, from the public and shareholders. These deposits may be accepted for a
period of six months to three years. Public deposits are unsecured loans; they should not be used for
acquiring fixed assets since they are to be repaid within a period of 3 years. These are mainly used to
finance working capital requirements.

Question 28
Explain in brief following Financial Instruments:
(i) Euro Bonds
(ii) Floating Rate Notes
(iii) Euro Commercial paper
(iv) Fully Hedged Bond (PYP 4 Marks, Nov918)
Answer 28
i. Euro bonds: Euro bonds are debt instruments which are not denominated in the currency of the
country in which they are issued. E.g. a Yen note floated in Germany.
ii. Floating Rate Notes: Floating Rate Notes: are issued up to seven years9 maturity. Interest rates are
adjusted to reflect the prevailing exchange rates. They provide cheaper money than foreign loans.
iii. Euro Commercial Paper(ECP): ECPs are short term money market instruments. They are for
maturities less than one year. They are usually designated in US Dollars.
iv. Fully Hedged Bond: In foreign bonds, the risk of currency fluctuations exists. Fully hedged bonds
eliminate the risk by selling in forward markets the entire stream of principal and interest payments.

Question 29
Discuss the Advantages of Leasing. (PYP 4 Marks, Nov918)
Answer 29
i. Lease may low cost alternative: Leasing is alternative to purchasing. As the lessee is to make a series
of payments for using an asset, a lease arrangement is similar to a debt contract. The benefit of lease
is based on a comparison between leasing and buying an asset. Many lessees find lease more
attractive because of low cost.
ii. Tax benefit: In certain cases, tax benefit of depreciation available for owning an asset may be less
than that available for lease payment
iii. Working capital conservation: When a firm buy an equipment by borrowing from a bank (or financial
institution), they never provide 100% financing. But in case of lease one gets normally 100%
financing. This enables conservation of working capital.
iv. Preservation of Debt Capacity: So, operating lease does not matter in computing debt equity ratio.
This enables the lessee to go for debt financing more easily. The access to and ability of a firm to get
debt financing is called debt capacity (also, reserve debt capacity).
v. Obsolescence and Disposal: After purchase of leased asset there may be technological obsolescence
of the asset. That means a technologically upgraded asset with better capacity may come into
existence after purchase. To retain competitive advantage, the lessee as user may have to go for the
upgraded asset.
Chapter 2 Types of Financing
 2.12

Question 30
Write short notes on Bridge Finance and Clean Packing Credit. (PYP 4 Marks Dec 821)
Answer 30
Bridge Finance: Bridge finance refers to loans taken by a company normally from commercial banks for a
short period because of pending disbursement of loans sanctioned by financial institutions. Though it is of
short-term nature but since it is an important step in the facilitation of long-term loan, therefore it is being
discussed along with the long term sources of funds. Normally, it takes time for financial institutions to
disburse loans to companies. However, once the loans are approved by the term lending institutions,
companies, in order not to lose further time in starting their projects, arrange short term loans from
commercial banks. The bridge loans are repaid/ adjusted out of the term loans as and when disbursed by
the concerned institutions. Bridge loans are normally secured by hypothecating movable assets, personal
guarantees and demand promissory notes. Generally, the rate of interest on bridge finance is higher as
compared with that on term loans.
Clean packing credit: This is an advance made available to an exporter only on production of a firm export
order or a letter of credit without exercising any charge or control over raw material or finished goods. It is
a clean type of export advance. Each proposal is weighed according to particular requirements of the trade
and credit worthiness of the exporter. A suitable margin has to be maintained. Also, Export Credit Guarantee
Corporation (ECGC) cover should be obtained by the bank.

Question 31
Distinguish between American Depository Receipts and Global Depository Receipts. (PYP 2 Marks
May922)
Answer 31
Distinguish Between American Depository Receipts and Global Depository Receipts:

American Depository Receipts Global Depository Receipts

Meaning It is a negotiable instrument which is It is a negotiable instrument which is
issued by US bank, which represent issued by the international depository
the nazon-US Company stock that is bank that represent the foreign
being traded in US stock Exchange company9s stock trading world-wide.
Issued where In the US domestic capital market. European capital market.
Listed in In the American Stock Exchange In the Non-US Stock Exchange
Relevance Foreign companies are able to trade Foreign companies can trade in
in the US Stock Market. any country9s stock market other
than that of the US.
Alternatively:
American Depository Receipts (ADRs): These are securities offered by non-US companies who want to list
on any of the US exchange. Each ADR represents a certain number of a company's regular shares. ADRs
allow US investors to buy shares of these companies without the costs of investing directly in a foreign
stock exchange.

Global Depository Receipts (GDRs): These are negotiable certificates held in the bank of one country
representing a specific number of shares of a stock traded on the exchange of another country. These
financial instruments are used by companies to raise capital in either dollars or Euros. These are mainly
traded in European countries and particularly in London.

Question 32
These bonds are issued by non-US Banks and non-US corporations in US. What this bond is called and
what are the other features of this Bond? (PYP 4 Marks Nov 822)

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 2.13

Answer 32
The Bond is called as Yankee Bond. Features of the bond:
÷ These bonds are denominated in Dollars
÷ Bonds are to be registered in SEC (Securities and Exchange Commission)
÷ Bonds are issued in tranches
÷ Time taken can be up to 14 weeks

Question 33
List out the conditions, framed by SEBI, which a company needs to fulfil in order to issue of bonus shares.
(PYP 4 Marks May 823)
Answer 33
To issue Bonus shares, a Company needs to fulfill all the conditions given by Securities Exchange Board of
India (SEBI):
(i) As per SEBI, the bonus shares are issued not in lieu of cash dividends.
(ii) A bonus issue should be authorized by Article of Association (AOA) and not to be declared unless all
partly paid-up shares have been converted into fully paid-up shares.
(iii) The Company should not have defaulted on re-payment of loan, interest, and any statutory dues.
(iv) Bonus shares are to be issued only from share premium and free reserves and not from capital reserve
on account of fixed assets revaluation.

Question 34
Discuss features of Secured Premium Notes. (PYP 2 Marks May 823)
Answer 34
Features of Secured Premium Notes:
" SPN instruments are issued with a detachable warrant.
" These instruments are redeemable after a notified period of say 4 to 7 years.
" No interest is paid during the lock in period.
" The conversion of detachable warrant into equity shares will have to be done within time period notified
by the company.

Chapter 2 Types of Financing