SFM MQP Merged

FINAL EXAMINATION SET 1
MODEL QUESTION PAPER TERM – JUNE 2023

PAPER - 14
STRATEGIC FINANCIAL MANAGEMNT
Time Allowed: 3 Hours Full Marks: 100
The figures in the margin on the right side indicate full marks.
Where considered necessary, suitable assumptions may be made and
clearly indicated in the answer.
Question No. 1 and 8 are compulsory; Answer any four from Question No. 2, 3, 4, 5, 6 & 7.
SECTION - A
1. (a) Choose the correct alternative. Provide Justification for your answer. 1 Mark
is allotted for the correct choice and 1 mark for the justification. [2 × 10 =20]
(i) An investor buys a call option contract for a premium of ` 150. The exercise
price is ` 15 and the current market price of the share is ` 12. If the share
price after three months reaches ` 20, what is the profit made by the option
holder on exercising the option? Contract is for 100 shares. Ignore the
transaction charges.
a. ` 300
b. ` 350
c. ` 400
d. ` 450
(ii) The declining market is called bear market because of the __________.
Provide a justification.
a. Long hibernation period of bears
b. Traditional usage
c. Fur coat of the bears
d. Attacking manner of bears
(iii) An investor has three alternatives of varying investment values. The data
available for each of these alternatives are given below:
Alternative Expected Return (%) Standard Deviation of Return
I 23 8.00
II 20 9.50
III 18 5.00
Which alternative would be the best if coefficient of variation is used?
a. Alternative I
b. Alternative II
c. Alternative III
d. None of the above
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Directorate of Studies, The Institute of Cost Accountants of India
PAPER - 14
(iv) The strike price and the current stock price of a European put option are `
1,000 and ` 925 respectively. What is its theoretical minimum price after 6
months, if the risk-free rate of interest is 5% p.a.?
a. `50.3053
b. `50.2056
c. `51.2125
d. `52.4125
(v) If ROA is 0.20 and leverage factor is 1.5, the ROE of the company is
a. 0.25
b. 0.30
c. 0.45
d. 0.50
(vi) According to the stock market psychology
a. Investors forget the past
b. History repeats itself
c. More faith is placed in predictions of the future
d. Both (A) and (B)
(vii) The concept of securitisation is associated with ___________. Provide
justification for your selection.
a. Capital market
b. Money market
c. Debt market
d. Foreign exchange market
(viii) __________ is/are a private arrangement between lending banks and a
borrower. Provide justification for your selection.
a. Club loan
b. Multiple component facility
c. Syndicated Euro credit
d. All of the above
(ix) Which of the following is not an assumption of perfect capital market? Why?
a. No transaction cost
b. No taxes
c. Information is available to all
(x) Hedging through 'currency of invoicing' results in ___________. Why?
a. The exporter covering forex exposure
b. The importer covering forex exposure
c. Both exporter and importer covering forex exposure
d. Either exporter or importer covering forex exposure
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SECTION - B
2. (a) PQR Ltd. has a capital budget of ` 20,000,000 for the year. From the following
information relating to six independent proposals, recommend the projects to be
selected if (i) the projects are divisible and (ii) projects are indivisible in order to
maximise the NPV.
Proposal Investment (`) NPV (`)
I 8,500,000 5,000,000
II 3,500,000 2,600,000
III 6,000,000 2,000,000
IV 4,000,000 2,500,000
V 6,000,000 5,000,000
VI 8,000,000 (2,500,000)
(b) XY Manufacturing Ltd. desires to acquire a diesel generating machine set costing
` 40 lakh which has an economic life of 10 years at the end of which the asset is
not expected to have any residual value. The company is considering two
alternatives: (A) taking the machine on lease (B) purchasing the asset outright by
raising a loan. Lease payments are equal annual amounts and have to be made in
advance and the lessor requires the asset to be completely amortized over its useful
period. The loan carries an interest 16% p.a. The loan has to be paid in 10 equal
annual instalments becoming due at the beginning of the first year. Average rate of
income tax is 50%. It is expected that the operating costs would remain the same
under either method. The company allows straight line method of depreciation and
the same is accepted for tax purposes.
Assume tax benefits at the end of the respective years and for end of year zero, tax
benefit may be considered at the end of the first year. Use 8% discount rate for p.v.
factors. Prepare a statement showing discounted values of annual cash flows to the
nearest rupee under alternative (B), only for end of years 0 to 2 and year 10. What
should be the maximum annual lease rental for which the lease option may be
preferred if you are given that the present value under the loan option is `
26,57,029? The present value of an annuity of one Rupee:
Year 8%
1 to 9 6.247
1 to 10 6.71
Present value of Rupee one at 8%
Year 0 1 2 3 4 5 6 7 8 9 10
PV 1.00 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463
[7 + 9 = 16]
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3. (a) Delta Corporation is considering an investment in one of following two mutually
exclusive proposals:
Project A: requiring initial outlay of ` 1,80,000.
Project B: requiring initial outlay of ` 1,60,000.
The certainty equivalent approach is employed in evaluating risky investment. The

current yield on treasury bill is 5% and the company uses this as riskless rate.
Expected values of net cash inflow with their respective certainty equivalents are:
Project A Project B
Year
Cash in flow Certainty Equivalents Cash in flow Certainty Equivalents
1 92,000 0.8 92,000 0.9
2 1,02,000 0.7 92,000 0.8
3 1,12,000 0.5 1,02,000 0.6
Analyse the above information to determine the following:

(i) Which Project should be acceptable to the Company?
(ii) Which Project is riskier and why? Explain.
(iii) If the company uses the risk adjusted discount rate method, which project
would be discounted with higher rate?
(b) Briefly discuss the components of digital finance. [10 + 6 = 16]
4. (a) (i) Discuss the key determinants of price-earnings multiple.
(ii) A company has an EPS of `10 for the current year and a DPS of `4. The
earnings growth rate during the past four years was 4% and earnings are
expected to grow at 2% a year in the long run. Currently the shares of the
company are trading at 7 times its earnings. If the required rate of return is
14%, compute an estimate of the P/E ratio. Also calculate the long run growth
rate implied by the current P/E ratio.
(b) A mutual fund has an NAV of ` 12.50 per unit at the beginning of the year. At the
end of the year the NAV increases to ` 13.40. In the meanwhile, the Fund distributes
` 1.55 as dividend. Calculate the fund's rate of return during the year. Assuming
that the investor had 240 units and that the distributions have been reinvested at an
average NAV of ` 12.80, find out the rate of return. [(6 + 5) + 5 = 16]
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5. (a) The returns on Stock PQ and market portfolio for a period of 4 years are as follows:
Year Return on PQ (%) Return on Market portfolio (%)
1 12 8
2 15 12
3 11 11
4 2 (-)4
You may opt to use the following additional information:
Particulars PQ Market
Mean Return (%) 10 6.75
Standard Deviation (%) 4.84 6.38
Covariance of stock with market = 29.75
You are required the determine the Characteristic Line for Stock PQ. Find the
expected return on PQ when market return improves to 5% in year 5 or decreases
to - 8% in the 5th year.
(b) The following particulars are furnished about three mutual funds scheme A, B and
C.
Particulars Scheme A Scheme B Scheme C
Dividend Distributed ` l.60 - ` 1.15
Capital Appreciation ` 2.77 ` 3.33 ` 1.79
Opening NAV ` 30 ` 25.15 ` 21.50
Beta 1.40 1.10 1.35
Analyse the performance of the schemes based on Jensen's Alpha, if government

of India Bonds carry an interest rate of 6.64% and the NIFTY has increased by
12%. [8 + 8 = 16]
6. (a) The following data relates to DCB Ltd.'s share prices:

Current Price Per Share ` 180
Price per share in the futures Market - 6 months ` 200
Money can be borrowed from the market at 12% p.a.
Analyse, on the basis of your calculation of the theoretical minimum price of 6
months-Futures contract, whether there exists any arbitrage opportunity.
(b) The equity share of ABC Ltd., is quoted at ` 210. A 3-month call option is available
at a premium of ` 6 per share and a 3-month put option is available at a premium
of ` 5 per share. Ascertain the net pay-offs to the option holder of a call option and
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PAPER - 14
a put option if (i) The strike price in both cases is ` 220 and (ii) The share price on
the exercise days is ` 200, 210 220, 230 and 240. On the expiry day for what
threshold values of share price will each option holder be in the money? [8+8 = 16]
7. (a) What do you mean by ADR? Discuss its advantages and limitations.
(b) X Ltd. has imported goods from USA worth US $ 10 million and it requires 90
days to make the payment. The USA supplier has offered a 60 days interest free
credit period and for additional credit for 30 days interest is to be charged at 8%
per annum. (Consider 360 days p.a.)
The banker of X Ltd. Offers a 30 days loan at 10% per annum and its quotes for
foreign exchange are as follows:
Spot 1 US $ ` 64.50
60 days forward rate for 1 US $ ` 65.10
90 days forward rate for 1 US $ ` 65.50
You are required to evaluate the following options:
(i) Pay the USA supplier in 60 days or
(ii) Avail the supplier's offer of 90 days' credit. Advise X Ltd. accordingly.
[8 + 8 = 16]
SECTION - C
8. Zenith Power. Ltd. is considering a proposal to replace one of its machines. In this
connection, the following information is available:
The existing machine was purchased 3 years ago for ` 20 Lakh. It was depreciated 20
per cent per annum on reducing balance basis. It has remaining useful life of 5 years, but
its maintenance cost is expected to increase by ` 1 Lakh per year from the end of sixth
year of its installation. Its present realizable value is ` 12 Lakh. The company has several
machines having 20% depreciation.
The new machine costs `30 Lakh and is subject to the same rate and basis of depreciation.
On sale after 5 years, it is expected to realize `18 Lakh. With the new machine, the annual
pre-tax operating costs (excluding depreciation) are expected to decrease by `2 Lakh. In
addition, the machine would increase productivity on account of which net pre-tax
revenues would increase by `3 Lakh annually (reckoned at year end). The tax rate
applicable to the company is 40% and the cost of capital is 10 per cent.
Advise the company on the choice of the machine from a financial perspective on the
basis of NPV.
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PV Factors (10%)
Year 1 2 3 4 5
PV Factor 0.909 0.826 0.751 0.683 0.621
Present an incremental analysis of using the existing machine versus replacing the
machine with a new one. Present annual discounted cash flows in your answers with
separate calculation showing annual discounted cash flows on account of incremental
depreciation without netting off capital asset outflows or inflows. Calculations are to be
presented to the nearest rupee. P.V. factors with above decimal places should be used.
[16]
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MODEL ANSWERS TERM – JUNE 2023
PAPER - 14
SECTION - A
1. (a)
Sl. Answer Justification
No.
(i) (b) When share price reaches to ` 20 per share, the profit will be
= (20 – 15) × 100 – 150
= ` 350
So, the correct option is (b)
(ii) (d) The bear market phenomenon is thought to get its name from
the way in which a bear attacks its prey—swiping its paws
downward. This is why markets with declining stock prices are
called bear markets.
So, the correct option is (d)
(iii) (c) The Co-efficient of Variation is the ratio of standard deviation
to mean.
Alternative Expected Standard Co-efficient
Return (%) Deviation of of Variation
Return (%)
I 23 8 0.35
II 20 9.5 0.48
III 18 5 0.28
Alternative III is the best as its co-efficient of variation is the
lowest.
So, the correct option is (c)
(iv) (a) Theoretical minimum price
= [Present Value of Strike Price – Current Stock Price]
= [1,000 × e-rt) – 925
= [1,000 / e0.05 × 0.5] – 925
= [1,000 / e0.025] – 925
= [1000/1.02532] - 925
= 975.3053 - 925
=50.3053
So, the correct option is (a)
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PAPER - 14
(v) (b) ROE = ROA x Leverage factor = 0.20 x 1.5 = 0.30
(vi) (b) Financial history is replete with boom-bust cycles and
repetition of these cycles makes one believe that history repeats
itself.
(vii) (c) Securitization is an act of conversion of loans into debt
instruments The process of taking an illiquid group of assets or
an individual asset through financial engineering and changing
it into a security is called securitization.
So, the correct option is (c)
(viii) (a) The club loan is a private arrangement between lending banks
and a borrower. Conventionally, the entry into Euromarkets for
a funding deal is well-publicized. When the loan amounts are
small and parties familiar with each other, lending banks form
a club and advance a loan.
So, the correct option is (a)
(ix) (d) A perfect capital market assumes information availability to all
market participants, absence of transaction cost and taxes.
(x) (d) A very simple way of eliminating the transaction exposure is
to invoice all receivables and payables in the domestic
currency. However, only one of the parties involved can hedge
itself in this manner. It will still leave the other party exposed
as it will be dealing in a foreign currency.
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SECTION - B
2. (a) (i) If the projects are divisible

Projects are ranked according to PI and arranged in descending order.
Proposal Investment NPV PV of Inflows PI Rank
(`) (`) (`)
I 85,00,000 50,00,000 1,35,00,000 1.59 4
II 35,00,000 26,00,000 61,00,000 1.74 2
III 60,00,000 20,00,000 80,00,000 1.33 5
IV 40,00,000 25,00,000 65,00,000 1.63 3
V 60,00,000 50,00,000 1,10,00,000 1.83 1
Projects are selected based on their ranking up to the availability of fund.
Proposal Investment (`) Cumulative Investment (`)
V 60,00,000 60,00,000
II 35,00,000 95,00,000
IV 40,00,000 1,35,00,000
I 85,00,000 2,20,00,000
III 60,00,000 2,80,00,000
Only ` 65,00,000 can be invested in project I.
NPV of the project = 65/85×50,00,000 = ` 38,23,529
So, the selected projects are V, II, IV and part of I.
(ii) If the projects are indivisible (by trial-and-error method)

Feasible Sets Investments (`) NPV (`)
V, II, I 1,80,00,000 1,26,00,000
V, IV, I 1,85,00,000 1,25,00,000
V, II, IV, III 1,95,00,000 1,21,00,000
I, II, IV 1,60,00,000 1,01,00,000
V, IV, III 1,60,00,000 95,00,000
The combination of projects V, II and I provides the maximum NPV and
hence may be undertaken.
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(b) Schedule of Debt Payment

Year Loan Loan at the Interest on Principal Principal
end Instalment beginning of the loan (Col. 3 x Repayment Outstanding at the
year 0.16) (Col.2 - end of the year
Col.4) (Col.3 - Col.5)
` ` ` ` `
1 2 3 4 5 6
0 7,13,394 40,00,000 0 7,13,394 32,86,606
1 7,13,394 32,86,606 5,25,857 1,87,537 30,99,069
2 7,13,394 30,99,069 4,95,851 2,17,543 28,81,526
10 7,13,394 6,14,994 98,400 6,14,994 0
(7,13,394/1.16)
Annual instalment of Loan = `40,00,000 / 5.607 (PV factor making payment in 0
year =Factor for cash flow at time 0 + Annuity factor for 9 years at 16% = 1 +
4.607) = ` 7,13,394
PV of Cash Outflows under Buying Alternative

Depreciation = 40,00,000 / 10 = 4,00,000
Year Loan Tax Advantage Net Cash PV factor Total PV
End Instalment On On Outflows at after
Interest Depreciation tax cost
(0.5) (0.5)
` ` ` ` ` `
1 2 3 4 5 6 7
0 7,13,394 0 - 7,13,394 1.000 7,13,394
1 7,13,394 2,62,928 2,00,000 2,50,465 0.926 2,31,931
2 7,13,394 2,47,926 2,00,000 2,65,468 0.857 2,27,506
10 0 0 2,00,000 (2,00,000) 0.463 (92,600)
Let x be the equal annual lease rental (L.R).

P.V. of L.R. = PV for year 0 + PV for yrs 1-9 - PV for year 10
= (x)×1 + (x-0.5x) × 6.247- (0.5x) × 0.463
= 1x + 3.1235x-0.2315x
= 3.892x
Lease will be preferred if 3.892x < 26,57,029, i.e., x < ` 6,82,690
So, the maximum lease rental should be `6,82,689.
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3. (a) Determination of NPV
Project-A
Year Cash inflow Certainty Adjusted cash in P.V. Factor Total P.V.
(`) equivalent flow (`) @ 5% (`)
1 92,000 0.8 73,600 0.9524 70,097
2 1,02,000 0.7 71,400 0.9070 64,760
3 1,12,000 0.5 56,000 0.8638 48,373
1,83,230
NPV= ` ( 1,83,230-1,80,000) = ` 3,230
Project B
Year Cash inflow Certainty Adjusted cash in P.V. Factor Total P.V.
(`) equivalent flow (`) @ 5% (`)
1 92,000 0.9 82,800 0.9524 78,859
2 92,000 0.8 73,600 0.9070 66,755
3 1,02,000 0.6 61,200 0.8638 52,865
1,98,479
NPV = ` (1,98,479 – 1,60,000) = `38,479
(i) Project B should be preferred as its NPV is greater.
(ii) Project A is riskier because its certainty equivalent is lower.
(iii) Project A being riskier would be discounted with higher rate.
(b) The components of digital finance ecosystem include the following.
1. Digital Infrastructure: Digital infrastructure refers to the digital
technologies that bring together and interconnect physical and virtual
technologies such as computer, storage, network, applications etc. to provide
the foundation for an organisation’s digital operations. The components of
digital infrastructure are as follows-
(i) Internet
(ii) Mobile telecom and digital communication suites, including
applications
(iii) Data centers and networks
(iv) Enterprise portals, platforms, systems, and software
(v) Cloud services:
(vi) Operational security, user identity and data encryption
(vii) APIs and integrations
2. Digital Money: digital money is largely interpreted as digital currency issued
by the central bank of a country and is essentially a digital version of cash
that can be stored and transferred using an internet or mobile application. It
is also known as Central Bank Digital Currency (CBDC)
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3. Digital Assets: A digital asset is anything that is stored digitally and is
uniquely identifiable that the owner can use to realize value. In other words,
a digital asset is anything that exists only in digital form and comes with a
distinct usage right. Data that do not possess that right are not considered.
Types of digital assets include, but are not exclusive to: photography, logos,
illustrations, animations, audio-visual media, presentations, spreadsheets,
digital paintings, word documents, electronic mails, websites, and a
multitude of other digital formats and their respective metadata. In addition
to above, digital assets may also include Non-Fungible Tokens, Private
Cryptocurrency, Stablecoins which are immensely popular in today’s digital
age.
4. Digital Financial Services: Digital Financial Services (DFS) are financial
services (e.g., payments, remittances, and credit) accessed and delivered
through digital channels, including via mobile devices. These encompass
established instruments (e.g., debit and credit cards) offered primarily by
banks, as well as new solutions built on cloud computing, digital platforms,
and distributed ledger technologies (DLT), spanning mobile payments, and
peer-to-peer (P2P) applications.
4. (a) (i) The P/E ratio can be derived from the dividend discount model which is the
foundation of valuation for common stocks.
As per the constant growth version of dividend discount model. The value
of a stock or
P = D1/ (k – g)
Dividing both sides of the equation by expected earnings E1, we get,
𝐷1 /𝐸1
P / E1 = 𝑘−𝑔
If the growth rate is assumed to depend on the return on equity (ROE), then
g = ROE (1 – D1/E1)
𝐷1 /𝐸1
Then, P / E1 = 𝐷
𝑘−𝑅𝑂𝐸(1− 1 )
𝐸1
Thus, P/E ratio depends on the dividend payout, discount rate and return on
equity.
The following relationship should hold, other things being equal:
 The higher the expected payout ratio, the higher the P/E ratio.
 The higher the expected growth rate (g), the higher the P/E ratio.
 The higher the required rate of return (k), the lower the P/E ratio.
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(ii) EPS current year = `4.00; expected growth rate = 2%; required rate of return = 14%
𝐷0 (1+𝑔) 4 (1+0.02)
We know that, P0 = = = `34
𝑘−𝑔 0.14−0.02
P/E ratio = Price/ EPS = 34/10 = 3.4
𝐷0 (1+𝑔)
Again, P0 = 𝑘−𝑔
𝐷0 /𝐸 ×(1+𝑔)
P0/E = 𝑘−𝑔
4/10 (1+𝑔)
or, 7 =
0.14−𝑔
Solving for ‘g’ we get, g = 0.078378 = 7.84%
So, implied growth rate is 7.84%.
(b) Return for the year (all changes on a per unit basis)
Change in price (13.40 - 12.50) ` 0.90
Dividend received ` 1.55
Total Return ` 2.45
Holding Period Return = 2.45 / 12.50 × 100 = 19.6%
(ii) When all distributions are reinvested into additional units of the fund (at NAV of
`12.80).
Dividend per unit = ` 1.55
Total receipt from 240 units = 1.55 × 240 = ` 372
Additional unit acquired ` 372 / ` 12.80 = 29.06 Units
Value of (240 + 29.06) = 269.06 units held at end of year = 269.06×13.40 = ` 3,605.40
Price paid for 240 units at beginning of year = 240 units ×12.50= ` 3,000
Holding period return would be = (3605.40 - 3000) / 3000 = 20.18%
5. (a) Characteristics line

y= α + βx
y= Mean return (stock PQ), x= mean return (market)
10=α+0.73 (6.75)
α =5.0725
y=5.0725+0.73x
So, the characteristic line is y=5.0725+0.73x
Now, If x=5
y=5.0725+3.65
y=8.7225
or, y=8.72%
Similarly, If x=(-) 8
y=5.0725+0.73(-8)
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y=5.0725-5.84
y=(-)0.767% y=(-)0.77%
(b) Calculation for ranking based on Jensen’s alpha

Particulars Scheme A Scheme B Scheme C
Dividend Distributed `1.60 - `1.15
Add : Capital Appreciation `2.77 `3.33 `1.79
Total Return (A) `4.37 `3.33 `2.94
Opening NAV (B) `30 `25.15 `21.50
Actual Return (C)=(A)÷(B)×100 14.57% 13.24% 13.67%
Beta (D) 1.40 1.10 1.35
Expected Return under CAPM 14.14% 12.54% 13.88%
[E=(RP)][E]=RF + BP × (RM – [6.64+1.40×(12 [6.64+1.10×(12- [(6.64+1.35×(12
RF)] - 6.64)] 6.64)] -6.64)]
Jensen's Alpha (C)-(E) 0.43% 0.70% =(0.21%)
(14.57-14.14) (13.24-12.54) (13.67-13.88)
Ranking II I III
Schemes A and B have outperformed the market portfolio (Nifty) whereas scheme
C has underperformed in comparison with the NIFTY.
6. (a) (i) Theoretical Future Price

Particulars Value
6 months future price `200
Current Stock Price (Sx) `180
Borrowing Rate (r) 12% or 0.12
Time (in years) 6/12 = 0.5 year
Theoretical Future Price (Fx) = Sx × ert
180 × e0.12 × 0.5
180 × e0.06
180 x 1.06184 = `191.13
Since the Theoretical Future Price is less than the Expected Future Price, the
recommended action would be to sell in the future market.
(ii) Cash flows to gain from Arbitrage opportunity:
Activity Flow: Enter into a future contract to sell shares at the rate of ` 200 on
expiry date, sell the shares at the 6 months future rate of ` 200, pay the amount of
borrowing together with interest. ` 180 × e0.12 × 0.5 = ` 191.13
Net gain = 200 – 191.13=`8.87
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(b) Net pay-off [call option]

Spot price Exercise Value of call Action Option Net Pay off
on Expiry Price [Maximum of premium [call holder]
Date (SPE) (EP) (SPE-EP),0]
1 2 3 4 5 6=3-5
200 220 200-220=-20--------0 Lapse 6 0-6=-6
210 220 210-220= -10-------0 Lapse 6 0-6=-6
220 220 220-220=0----------0 Lapse 6 0-6=-6
230 220 230-220=10-------10 Exercise 6 10-6=4
240 220 240-220=20-------20 Exercise 6 20-6=14
Net pay off [put option]

Spot price Exercise Value of call Action Option Net Pay off
on Expiry price [Maximum of premium [call holder]
Date(SPE) (EP) (EP-SPE),0]
1 2 3 4 5 6=3-5
200 220 220-200=20 Exercise 5 15
210 220 220-210=10 Exercise 5 5
220 220 220-220=0 Lapse 5 -5
230 220 220-230= -10-----0 Lapse 5 -5
240 220 220-240= -20-----0 Lapse 5 -5
Option is gainfully exercised by (or in the money)
(i) For call option holder, share price is more than ` 226
(ii) For put option holder, share price is less than ` 215
7. (a) An American Depositary Receipt (ADR) is a certificate that represent shares of a

foreign stock owned and issued by a U.S. bank. The foreign shares are usually held
in custody overseas, but the certificates trade in the U.S. Through this system, a
large number of foreign-based companies are actively traded on one of the three
major U.S. equity markets (the NYSE, AMEX or Nasdaq).
Advantages of ADRs: ADRs provide the following advantages -
(i) Access to Large Capital.
(ii) Access to Foreign Exchange.
(iii) No Change in the Shareholding / voting pattern.
(iv) Increased recognition for the Company internationally by bankers,
customers, etc.
(v) No Exchange Rate risk since the Company pays interest and dividends in
Indian Rupees.
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Limitations of ADRs:
(i) High cost of Issue.
(ii) Requirement as to large size of issue.
(iii) Stringent compliance requirements.
(b) (i) Payment to supplier in 60 days

If the payment is made to supplier in 60 Days, the ` 65.10
applicable forward rate for 1 US$
Payment due US$ 1,00,00,000
Outflow in rupees (US$ 1,00,00,000 × ` 65.10) ` 65,10,00,000
Add: Interest on Loan for 30 days @10% p.a. ` 54,25,000
Total Outflow ` 65,64,25,000
(ii) Payment to supplier in 90 days

Amount Payable US$ 1,00,00,000
Add: Interest on Credit Period for 30 days @ 8% p.a. US$ 66,667
Total Outflow in US$ US$ 1,00,66,667
Applicable forward for 1 US$ ` 65.50
Total Outflow (US$ 1,00,66,667 × ` 65.50) ` 65,93,66,689
Comment: It is better to select alternative (i) as it entails lower cash flows.
SECTION - C
8.
Existing Machine (Amount in `)
Cost 20,00,000
Depreciation 20%, year 1 4,00,000
16,00,000
WDV 12,80,000
WDV at Y0 = 10,24,000
Base for incremental depreciation

Cost of New Machine 30,00,000
Less: WDV of existing machine 10,24,000
Difference 19,76,000
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PAPER - 14
Depreciation at end of the Year

PV Disc. Values
Year 1 3,95,200 0.909 3,59,237
Year 2 3,16,160 0.826 2,61,148
Year 3 2,52,928 0.751 1,89,949
Year 4 2,02,342 0.683 1,38,200
Year 5 1,61,874 0.621 1,00,524
10,49,058
Tax Shield 40% 4,19,623
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Expenses (1,00,000) (1,00,000) (1,00,000)
Revenue 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000
Net Revenue 3,00,000 3,00,000 2,00,000 2,00,000 2,00,000
Net Revenue after Tax 1,80,000 1,80,000 1,20,000 1,20,000 1,20,000
Cost of New Machine (30,00,000)
Resale – old Machine 12,00,000
Resale – New Machine 18,00,000
Cash Flows other than (18,00,000) 1,80,000 1,80,000 1,20,000 1,20,000 19,20,000
Depreciation
PV Factor 1 0.909 0.826 0.751 0.683 0.621
Discount Annual C/F (18,00,000) 1,63,620 1,48,680 90,120 81,960 11,92,320
(1,23,300)
PV of Cash Flows (Other than Depreciation) (1,23,300)

Depreciation Impact + 4,19,623
Net Impact + 2,96,323
Hence it is beneficial to go in for the new machine.
11
PAPER - 14
SECTION - A
1. (a) Choose the correct alternative. Provide Justification for your answer. 1 Mark
is allotted for the correct choice and 1 mark for the justification. [2 × 10 =20]
(i) In Porter’s structural analysis, which of the following is not considered as an
entry barrier? Why?
a. Product differentiation
b. Switching costs
c. Capital requirements
d. Low value addition
(ii) Which of the following is not a apart of financial risk? Why?
a. Operational risk
b. Market risk
c. Credit risk
d. Liquidity risk
(iii) Which of the following is not a type of Euro Notes? Why?
a. Commercial Papers
b. Note Issuance Facility
c. Medium Term Notes
d. Short Term Notes
(iv) The type of lease that includes a third party, a lender, is called __________.
Why?
a. Sale and leaseback
b. Leverage lease
c. Direct lease arrangement
d. Operating lease
(v) DCL measures the relationship between
a. EPS and EAT
b. EPS and P/E
c. EPS and EBIT
d. EPS and Sales
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PAPER - 14
(vi) A six-month forward contract on a stock that does not pay dividend is
available at `340. The risk-free interest rate is 12% p.a. continuously
compounded. Calculate the forward price.
a. ` 359.051
b. ` 361.012
c. ` 363.217
d. ` 364.119
(vii) A project with an initial investment of `50 lakh and life of 10 years generates
Cash Flow After Tax (CFAT) of `10 lakh per annum. Calculate Payback
Reciprocal.
a. 15%
b. 18%
c. 20%
d. 22%
(viii) The return on market portfolio is 14%. The last dividend of share A was `2
and the dividend and earnings have a constant growth rate of 5% p.a. The
beta of the share is 2 and the intrinsic value of the share is `12.35. Find the
risk-free return.
a. 5%
b. 6%
c. 7%
d. 8%
(ix) It was observed that in a certain month, 6 out of 10 leading indicators have
moved up as compared to 4 indicators in the previous month. The diffusion
index for the month was
a. 20%
b. 40%
c. 60%
d. 80%
(x) An Indian Company is planning to invest in the US. The annual rates of
inflation are 8% in India and 3% in USA. If the spot rate is currently `
78.50/$, what spot rate can you expect after 5 years, assuming the inflation
rates will remain the same over 5 years?
a. ` 88.89
b. ` 94.95
c. ` 99.50
d. ` 86.10
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PAPER - 14
SECTION - B
2. (a) Q Ltd. has two projects under consideration, A and B, each costing `60 lacs. The
projects are mutually exclusive. The life of Project A is four years and of Project B
is three years. The salvage value is zero for both the projects. Depreciation is
charged uniformly for A over four years and 100% depreciation is available for B
at the end of the first year. The tax rate is 40% and the hurdle rate for cash flow
evaluation is 15%. The cash inflows before tax for A and B are given below:
(Figs. ` lacs)
At the end of the year Project A Project B
1 30 25
2 55 60
3 60 65
4 25 Nil
Find the NPV of A and B. Comment on your preference. Is the NPV the most
appropriate measure for your decision? Why? (Use PV factors up to 3 decimal
points, show annual discounted cash flows for each project in ` lacs, up to two
decimal places.)
(b) Describe various types of securities issued by a SPV in securitization transactions.
[9 + 7 = 16]
3. (a) A firm has an investment proposal, requiring an outlay of ` 40,000. The investment
proposal is expected to have 2 years' economic life with no salvage value. In year
1, there is a 0.4 probability that cash inflow after tax will be ` 25,000 and 0.6
probability that cash inflow after tax will be ` 30,000. The probabilities assigned
to cash inflows after tax for the year 2 are as follows:
The Cash inflow year 1 ` 25,000 ` 30,000
The Cash inflow year 2 Probability Probability
` 12,000 0.2 ` 20,000 0.4
` 16,000 0.3 ` 25,000 0.5
` 25,000 0.5 ` 30,000 0.1
The Firm uses a 12% discount rate for this type of investment.
(i) Tabulate the NPVs for each path of the decision free (diagram not essential)
(ii) What net present value will the project yield if the worst outcome is realized?
What is the probability of occurrence of this NPV.
(iii) What will be the best outcome and the probability of that occurrence?
(12% Discount factor for 1 year is 0.8929 and for 2 year is 0.7972)
(b) Write a short note on: Non-Fungible Tokens (NFTs). [10 + 6 = 16]
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PAPER - 14
4. (a) (i) XY Ltd. is expected to pay a dividend of ` 8.00 at the end of first year, a
dividend of ` 14.00 at the end of second year, a dividend of ` 22.00 at the
end of third year. from fourth year onwards, the dividends are expected to
grow at a constant growth rate of 4%. if the required rate of return is 14%,
compute the value of the stock.
(ii) A ` 100 par value bond bears a coupon rate of 14 percent and matures after
five years. Interest is payable semi-annually. Compute the value of the bond
if the required rate of return is 16 percent.
(b) A Mutual Fund made an issue of 10,00,000 units of ` 10 each on 01.01.2016. No

entry load was charged. It made the following investments after incurring initial
expenses of ` 2 lacs.
Particulars `
50,000 Equity Shares of ` 100 each @ ` 160 80,00,000
7% Government Securities 8,00,000
9% Debentures (unlisted) of ` 100 each 5,00,000
10% Debentures (Listed) of ` 100 each 5,00,000
Total 98,00,000
During the year, dividends of ` 12,00,000 were received on equity shares, interest
on all types of debt securities was received as and when due. At the end of the year,
equity shares and 10% debentures are quoted at 175% and 90% of their respective
face values. Other investments are quoted at par. (i) Find out the Net Asset Value
(NAV) per unit given that the operating expenses during the year amounted to `
5,00,000. (ii) Also find out the NAV, if the Mutual Fund had distributed a dividend
of ` 0.90 per unit during the year to the unit holders. [(4 + 4) + 8 = 16]
5. (a) A holds the following portfolio:

Share/Bond Beta Initial Price Dividend Market price at the end of year
A Ltd. 0.9 30 3 60
B Ltd. 0.8 40 3 70
C Ltd. 0.6 50 2 150
G Bonds 0.01 1000 140 1010
Risk Free return is 14%
Calculate:
(i) The expected rate of return on his portfolio using Capital Asset Pricing
(CAPM)
(ii) The average return of his portfolio.
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PAPER - 14
(b) Four investors, A, B, C and D have invested equal amounts of money in different
combinations of funds as per their risk appetite. A has fully invested in Money
Multiplier Funds, B has invested 50% in Money Multiplier and 50% in Balanced
Growth Funds, C has invested 80% in Balanced Growth Funds and 20% in Safe
Money Funds and D has fully invested in a fund that exactly replicates the market
portfolio. The following information is given:
Fund Type Return for the year (%) Beta Factor
Money Multiplier (100% Equity) 24.00 1.8
Balanced Growth Funds (50% Equity 17.5 1.3
and 50% Debt)
Safe Money (20% Equity and 80% Debt) 13.00 0.75
The market return is 16% and the risk-free rate is 8%. Analyse the above
information and rank the investors’ rewards using Treynor’s measure.
[8 + 8 = 16]
6. (a) Briefly illustrate various steps in a risk management process.
(b) A owns a portfolio in three stocks as detailed below:

Stock No. of shares Price `/share Beta
X 4,00,000 400 1.1
Y 8,00,000 300 1.2
Z 12,00,000 100 1.3
The NSE-Midcap 100 is at 28,000 and futures price is 28,560. Assume that the
index factor is 100. Advise A on the use stock index futures to
(i) decrease the portfolio β to 0.8;
(ii) increase the portfolio β to 1.5 ; and
determine the number of contracts of stock index futures to be bought or sold in
each case. [7 + 9 = 16]
7. (a) (i) Compare and contrast ADR and GDR.

(ii) An Indian exporter has sold handicraft items to an American business house.
The exporter will be receiving US dollar 1 lakh in 90 days. Premium for a
dollar put option with a strike price of ` 81.00 and a 90 days settlement is `
1. The exporter anticipates the spot rate after 90 days to be ` 79.50. Analyse
the benefit of the exporter if it hedges its account receivable in the options
market.
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PAPER - 14
(b) A company operating in USA has on 1st September 2022 invoiced sales in $ to an
Indian company, the payment being due on 1st December 2022. The invoice
amount is $ 13,750. At spot rate on 1/9/2022 it is equivalent to ` 10,18,875. The 3
months forward rate is presently quoted at $ 0.01340 per rupee. The importer wants
to hedge half his exposure by a forward contract. Advise the company on hedging
transaction by forward contract. Substantiate your advice through calculation of the
pay outs and the net gain or loss due to hedging if the spot rates are as follows on
1st December 2022.
(i) $ 0.01338
(ii) $ 0.01352
Present your calculation using `/$ up to two decimal places. Ignore transaction
cost. [(4 + 4) + 8 = 16]
SECTION - C
8. Y, a British firm with a US subsidiary, seeks to refinance some of its existing British
pound debt to include floating rate obligations. The best floating rate it can obtain in
London is LIBOR + 2.0%. Its current debts are as follows:
US$ 10 million owed to CT Bank at 9.5% (fixed annually); and
£ 5 million owed to MD Bank at 9.5% (fixed) annually.
HRS Company wishes to finance exports to Britain with £3 million of pound

denominated fixed rate debt for six months. HRS is unable to obtain a fixed interest rate
in London for less than 13.5% interest because of its lack of credit history in the UK.
However, Lloyds Bank is willing to extend a floating rate British pound loan at LIBOR
+ 2%. HRS, however, cannot afford to pay more than 12%. Assume that Y is in a strong
bargaining position and can negotiate the best deal possible, but HRS will not pay over
12%. Assume further that transaction costs are 0.5% and exchange rates are stable.
Advise whether Y and HRS can help each another by an interest rate swap. In case the
swap deal is workable, determine the amount of gains for Y, HRS and the Swap Dealer.
Create a diagrammatic representation of the effective post-swap interest rates of each
party. Explain the diagram with needful narratives. Also show the effective interest rates
for each party over the six months period of the swap.
[16]
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PAPER - 14
SECTION - A
1. (a)
Sl. Answer Justification
No.
(i) (d) Low value addition does not create any barrier for the new entrants
rather it provides the space for them in the market.
So, the correct option is (d).
(ii) (a) Operational risk is a part of business risk and hence not a part of
financial risk. So, the correct option is (a).
(iii) (d) Euro notes are of three types – Commercial Papers, Note Issuance
Facilities and Medium Term Notes.
(iv) (b) Leveraged lease refers to a lease agreement wherein the lessor
acquires an asset partially financed by the financial institutions and
lease out the same to the lessee for the agreed lease payments.
(v) (d) DCL = % change in EPS/% change in sales
So, So, the correct option is (d)
(vi) (b) The Forward Price (F) = 340 ×e6/12×0.l2 = 340 × 1.0618 = `361.012
So, the correct option is (b).
(vii) (c) Payback Reciprocal = ` 10 lakh ÷ `50 lakh = 1/5 or 20%
So, the correct option is (c).
(viii) (b) Intrinsic value of a share = D1/(Ke – g) = 2.1/ (Ke – 0.05) = 12.35
or, Ke = 0.05 + 2.1/12.35 = 22%
E(R) = Rf + β (Rm - Rf) = Rf (1 - β) + βRm
22% = Rf (-1) + 2 × 14% ,
or, Rf = 6%
So, the correct option is (b).
(ix) (c) The diffusion index = 6/10 = 60% So, the correct option is (c).
(x) (c) F = S x [(1 + rA)n/ (1+ rB)n];
or, F(`/$) = 78.50 x [1 + 0.08)5 / (1+ 0.03)5]
= 78.50 x 1.267455 = `99.50
So, the correct option is (c).
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PAPER - 14
SECTION - B
2. (a) (i) Project A

End of Year 0 1 2 3 4
Cash Outflow -(60)
Cash inflows 30 55 60 25
Cash inflows after tax 18 33 36 15
Depreciation tax shield 6 6 6 6
Effective cash flows after tax 24 39 42 21
and depreciation shield
PV factor 1.0 0.870 0.756 0.658 0.572
PV of Cash inflows 20.88 29.48 27.64 12.01
Total of PV of inflows 90.01
PV of outflows -(60.00)
NPV +30.01
Project B
End of Year 0 1 2 3 4
Cash Outflow -(60)
Cash inflows 25 60 65
Cash inflows after tax 15 36 39
Depreciation tax shield 24
Effective cash flows after tax and 39 36 39
depreciation shield
PV factor 1.0 0.870 0.756 0.658 0.572
PV of Cash inflows 33.93 27.22 25.66
Total of PV of inflows 86.81
PV of outflows -(60.00)
NPV +26.81
NPV of Project A is higher, but the project lives are unequal. 12 lacs of A's PV in
the 4 years has been in favour of A compared to B. Hence, choice based on NPV is
not appropriate.
Equal annual inflows of A = 90.01/2.856 = 31.52 (PV Annuity 15%, 4 years =
2.856)
Equal annual cash inflows of B = 86.81 / 2.284 = 38.00 (PV Annuity 15%, 3 years
= 2.284) Since B yields higher equated annual inflows, B is the better choice. This
measure is appropriate for projects with unequal lives.
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PAPER - 14
(b) Different type of securities issued by the special purpose vehicle (SPV) in securitization
transactions are as follows:
a. Pass Through Certificates: In case of a pass-through certificate, payments to
investors depend upon the cash flow from the assets backing such certificates. That
is to say, as and when cash (principal and interest) is received from the original
borrower by the SPV, it is passed on to the holders of certificates at regular intervals
and the entire principal is returned with the retirement of the assets packed in the
pool.
b. Pay Through Certificates: Pay through certificates has a multiple maturity structure
depending upon the maturity pattern of underlying assets. Thus, the SPV can issue
two or three different types of securities with different maturity patterns like short
term, medium term and long term. Thus, these have a greater flexibility with
varying maturity pattern needed by the investors.
c. Preferred Stock Certificates: These are issued by a subsidiary company against the
trade debts and consumer receivables of its parent company. In other words,
subsidiary companies buy the trade debts and receivables of parent companies to
enjoy liquidity. Generally, these stocks are backed by guarantees given by highly
rated merchant banks and hence they are also attractive from the investor’s point of
view. These instruments are generally short term in nature.
d. Asset Backed Commercial Papers: This type of structure is mostly prevalent in
mortgage-backed securities. Under this the SPV purchases portfolio of mortgages
from different sources (various lending institution) and they are combined into a
single group on the basis of interest rate, maturity dates and underlying collaterals.
They are then transferred to a Trust which in turn issued mortgage-backed
certificate to the investors. These are also of short term in nature.
e. Interest Only Certificates: In case of these certificates, payments are made to
investors only from the interest incomes earned from the assets securitized.
f. Principal Only Certificates: As the very name suggest payment are made to the
investors only from the repayment of principal by the original borrower. These
certificates enable speculative dealings since the speculators know well that the
interest rate movements would affect the bond value immediately. When interest
rate increases, the bond value will decline and vice-versa.
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PAPER - 14
3. (a) (i) The net present value of each path at 12% discount rate is given below:
Path Cash inflow year cash inflow year Total cash NPV
1*discount factor year 1 2*discount factor year 2 inflow outflow
1 ` 25000*.8929=22323 12000*.7972=9566 31889 40000 -8111
2 ` 25000*.8929=22323 16000*.7972=12755 35078 40000 -4922
3 ` 25000*.8929=22323 25000*.7972=19930 42253 40000 2253
4 `30000*.8929=26787 20000*.7972=15944 42731 40000 2731
5 `30000*.8929=26787 25000*.7972=19930 46717 40000 6717
6 `30000*.8929=26787 30000*.7972=23916 50703 40000 10703
Statement showing Expected Net Present Value

Path NPV @12% Joint probability Expected NPV
1 -8111 0.08 -648.88
2 -4922 0.12 -590.64
3 2253 0.2 450.60
4 2731 0.24 655.44
5 6717 0.3 2015.1
6 10703 0.06 642.18
2523.8
(ii) If the worst outcome is realized, the Net Present Value which the project will yield
is ` 8111(negative). The probability of occurrence of this NPV is 8%
(iii) The best outcome will be path 6 when NPV is higher i.e., `10703(positive). The
probability of occurrence of this NPV is 6%
(b) Non-fungible tokens (NFTs) are cryptographic assets on a blockchain with unique
identification codes and metadata that distinguish them from each other. Unlike
cryptocurrencies (which are fungible as each unit of cryptocurrency represent same value
and characteristics), these are non-fungible as each NFT is unique. Non-fungible tokens
can digitally represent any asset, including online-only assets like digital artwork and real
assets such as real estate. Today, however, much of the current market for NFTs is
centered around collectibles, such as digital artwork, sports cards, and rarities. Perhaps
the most hyped space is NBA Top Shot, a place to collect non-fungible tokenized NBA
moments in digital card form. Some of these cards have sold for millions of dollars.
Recently, Twitter's (TWTR) Jack Dorsey tweeted a link to a tokenized version of the first
tweet ever, in which he wrote: "just setting up my twttr." The NFT version of the first-
ever tweet sold for more than $2.9 million.
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PAPER - 14
NFTs are created through a process called ‘asset tokenization’. Asset tokenization is the
process by which an issuer creates digital tokens on a distributed ledger or blockchain
(Ethereum being most popular), which represent either digital or physical assets.
NFTs can be bought and sold in NFT marketplace such as Rarible, OpenSea, Foundation.
However, to buy NFTs from this marketplace, one will require a wallet and need to fund
it. In most of the platforms wallets are required to be funded by cryptocurrencies and the
widely accepted cryptocurrency in this context is the Ethereum.
4. (a) (i)
𝑫 𝟏 𝑫𝟐 𝑫𝟑 𝑫 (𝟏+𝒈)
𝟑
P = (𝟏+𝒌) + (𝟏+𝒌)𝟐 + (𝟏+𝒌)𝟑 + (𝟏+𝒌)𝟑 (𝒌−𝒈)
= 8/1.14 + 14/(1.14)2 + 22/(1.14)3 + 22.88/[(1.14)3×(0.14 – 0.04)]

= `187.08
Therefore, the price of the share is `187.08 through DDM (dividend discount
model).
(ii) In this case the number of half-yearly periods is 10, the half-yearly interest payment
is ` 7, and the discount rate applicable to a half-yearly period is 8 percent. Hence,
the value of the bond is:
V = 7 PVIFA (8%, 10) + 100 PVIF (8%, 10)
= 7 PVIFA (8%, 10) + 100 PVIF (8%, 10)
= 7 (6.710) + 100 (0.463)
= 46.97 + 46.30
= Rs 93.27
(b) Given the total initial investments is `98,00,000, out of the issue proceeds of
`1,00,00,000. Therefore. the balance of ` 2,00,000 is considered as Issue Expenses.
Computation of Closing Net Asset Value
Opening Capital Closing Income (`)
Particulars value of Appreciation value of
Investments (`) investments
(`) (`)
Equity Shares 80,00,000 7,50,000 87,50,000 12,00,000
7% Govt. Securities 8,00,000 NIL 8,00,000 56,000
9% Debentures (Unlisted) 5,00,000 NIL 5,00,000 45,000
10% Debentures(Listed) 5,00,000 (-)50,000 4,50,000 50,000
Total 98,00,000 7,00,000 1,05,00,000 13,51,000
Less: operating expenses during the period (5,00,000)
Net Income 8,51,000
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Net Fund Balance = ` (1,05,00,000+8,51,000) 1,13,51,000
Less: Dividend = (10,00,000 × 0.90) (9,00,000)
Net Fund Balance (after Dividend) 1,04,51,000
NAV(Before considering Dividends) `1,13,51,000 ÷ 10,00,000 11.35
NAV(After Dividends) ` 1,04,51,000 ÷ 10,00,000 10.45
5. (a) (i) Expected rate of return

Total Investment (`) Dividend (`) Capital Gain (`)
A Ltd. 30 3 30
B Ltd. 40 3 30
C Ltd. 50 2 100
GOI Bonds 1000 140 10
1120 148 170
Expected Return on Market Portfolio = (148 + 170)/1120 = 28.39%
CAPM, E (RP) = RF + β [E (RM) – RF]

A Ltd. 14+0.9(28.39-14) = 14+12.95 =26.95%
B Ltd. 14+0.8(28.39-14) = 14+11.51 =25.51%
C Ltd. 14+0.6(28.39-14) = 14+8.63 =22.63%
GOI Bonds 14+0.01(28.39-14) =14+0.14 =14.14%
(ii) Average Return of Portfolio = (26.95+25.51+22.63+14.14)/4 = 22.31%

Alternatively, (0.9+0.8+0.6+0.01)/ 4 = 2.31/4 = 0.5775
14 + 0.5775 (28.39 – 14) = 14 + 8.31 = 22.31%.
(b)
DETAILS A B C D
Risk free return 8 8 8 8
Fund invested 100% money 50% MM and 80% balanced Market
multiplier 50% balanced growth and 20%
growth safe money
Beta 1.80 0.5 × 1.3 + 0.5 × 0.8 × 1.3 + 0.2 1.00
1.8 = 1.55 × 0.75 = 1.19
Return on 24 0.5 × 24 + 0.5 × 0.8 × 17.5 + 0.2 16
portfolio 17.5 = 20.75 × 13 = 16.6
Treynor’s ratio = (24-8)/1.8 (20.75-8)/ 1.55 (16.6 - 8)/1.19 (16-8) / 1
(Rp-Rf)/β = 8.89 =8.23 =7.23 =8
Rank 1 2 4 3
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6. (a) A generic approach towards risk management must include the following steps:
(i) Setting the Objectives:
Determination of objectives is essential step in the risk management. The objective
may be to protect/enhance profits or to develop competitive advantage. The
objectives must be decided by the management and in this process company’s risk
tolerance must be taken into account.
(ii) Identification of Risk
The next step in the risk management process is identification of risk. Every firm
faces different types of risks - based on its organizational structure, nature of
business, the economic conditions, social and political factors, the status of the
industry it operates. Any risk needs to be identified initially and then categorized as
per its nature and character.
(iii) Measurement and Prioritization of Risk
Once the risks are identified, they need to be evaluated for ascertaining their
significance. The significance of a particular risk depends upon the size of the loss
(expected severity of consequences) that it may result in, and the probability of the
occurrence of such loss (or, expected frequency). On the basis of these two factors,
various risks faced by a company need to be classified as critical risks, important
risks and not-so-important risks. This may be termed as risk prioritization. The
severity is measured by using various risk measures.
(iv) Development of Strategy
Strategy setting is an important task in managing risk, as it sets a direction for the
business as a whole. A strategy is essentially an action plan, which specifies the
nature of risk to be managed and the timing. It also specifies the tools, techniques
and instruments that can be used to manage these risks. Besides, it also deals with
tax and legal problems.
Responses to risk generally fall into the following categories:
Risk avoidance: action is taken to halt the activities giving rise to risk, such as a
product line, a geographical market or a whole business unit.
Risk reduction: action is taken to mitigate the risk of likelihood or impact or both,
generally via internal controls.
Risk sharing or transfer: action is taken to transfer a portion of the risk through
insurance, outsourcing or hedging.
Risk acceptance: no action is taken to affect likelihood or impact.
(v) Implementation of Strategy
Once the policies and strategies are in place, they need to be implemented for
actually managing the risks; where actual execution of risk management takes
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PAPER - 14
place. This includes finding the best deal in case of risk transfer, providing for
contingencies - in case of risk retention, designing and implementing risk control
programs, etc. It also includes eyeing for operational details, like the back-office
work, to ensure compliance controls.
(vi) Monitoring Risk
Risk monitoring is the last major element of risk management - but certainly not
the least important. The function of risk management needs to be reviewed
periodically, depending on the costs involved.
Risk management is a process or cycle which works continuously and in a repetitive
manner. After monitoring the risk, the process of risk identification is done because
risk keeps on changing its form as various new requirements come periodically.
(b) Computation of existing portfolio beta:

Stock Market value of stock (` in lakh) Proportion Beta of the stock Weighted beta
X 1600 4/13 1.1 0.34
Y 2400 6/13 1.2 0.55
Z 1200 3/13 1.3 0.30
Total 5200 1.19
Value per futures contract = Index price per contract × Lot size per futures contract =
28,000 × 100 = `28,00,000.
(i) To reduce portfolio beta to 0.8, the manager should sell index futures contract.
Portfolio value = `5200 lakh
Value per futures contract = Index price per contract × Lot size per futures contract
= 28,000 × 100 = `28,00,000
Beta of the existing portfolio =1.19
Desired beta of the new portfolio = 0.8
No. of contracts to be sold
= Portfolio Value × (Beta of the portfolio-Desired Value of Beta)/Value of the
futures Contract Number of Contracts = 5,200 lakhs × (1.19-0.8)/28 lakh =72.42,
say 73 contracts.
(ii) To increase the portfolio beta to 1.5 the manager should buy index futures contract.
Portfolio value = `5200 lakh
Value per futures contract = Index price per contract × Lot size per futures contract
= 28,000 × 100 = `28,00,000
Beta of the existing portfolio = 1.9
Desired beta of the new portfolio = 1.5
No. of contracts to be bought = 5,200 lakhs × (1.5-1.19)/28lakh = 57.57, say 58
contracts.
8
PAPER - 14
7. (a) (i) An American Depositary Receipt (ADR) is a certificate that represent shares of a
foreign stock owned and issued by a U.S. bank. The foreign shares are usually held
in custody overseas, but the certificates trade in the U.S. Through this system, a
large number of foreign-based companies are actively traded on one of the three
major U.S. equity markets (the NYSE, AMEX or Nasdaq).
These are a class of investment which allows international investors to own shares
in foreign companies where the foreign market is hard to access for the retail
investor, and without having to worry about foreign currencies and tax treatments.
Global Depository Receipts are issued by international investments banks as
certificates (the GDR) which represents the foreign shares but which can be traded
on the local stock exchange. For example, a UK investor may be able to buy shares
in a Vietnamese company via a GDR issued by a UK investment bank. The GDR
will be denominated in GB Pounds and will be tradable on the London Stock
Exchange. The investment bank takes care of currency exchange, foreign taxes etc.
and pays dividends on the GDR in GB Pounds.
(ii)
Option Put
Strike price `81 per US $
Premium ` 1 per US $
Settlement (expiration) rate ` 79.50
Benefit from Put option = Max [(Strike rate – Expiration rate),0] – Premium
= Max [(` 81 per US $ - ` 79.50 per US $), 0] – ` 1 per US $
= ` (1.50 – ` 1) per US $ = ` 0.50 per US $
Here, if the exporter remains un-hedged, it will receive = [` 79.50 per US $ x US $
1,00,000) = ` 79,50,000
But with hedging using Put Option, the exporter receives at the end of 90 days =
[(` 81 x US $ 1,00,000) – (` 1 x US $ 1,00,000)] = ` 80,00,000
Gain = ` 50,000
OR Gain = (71 – 69.50) – 1 = 1.5 – 1 = 0.5 `/$
1,00,000$ x 0.5 = 50,000 `
As there is benefit in owing the Put, so the Exporter should hedge using the Put
Option.
9
PAPER - 14
(b) The importer will loss if the $ appreciates, as is indicated by the forward rate/ Spot rate
on 1/9/2022= 74.10 `/$ (Since, `10,18,875/$13,750)
3m forward rate = 1/0.01340 = 74.63
Hence by a forward contract, he will ask his banker to sell him at ` 74.63, 3 months later,
irrespective of what happens to the spot rate on 1st Dec.
(i) On Dec 1st, if the sport rate increases to 74.74 (i.e., 1/0.01338),
Half of his exposure is hedged.
His pay-out will be on 1st Dec, 13750/2 × 74.74+13750/2 × 74.63
i.e., 6875 × 74.40 + 6875 × 74.63 = 513838 + 513081 = 10,26,919.
If he had not gone for the Forward contract, he would have paid 13750 x 74.74=
10,27,675
By forward contract, the net gain is 1027675– 1026919 = 757
Or
He can still buy from his bank at 74.63. He saves `0.11 per $ by hedging
i.e., 0.11x6875= 757
(ii) If the exchange rate falls to 73.96 (i.e., 1/0.01352) on 1st December,
His pay out on 1/12 will be 6875 x 73.96 + 6875 x 74.63
i.e., he will pay 508475 + 513081 = 1021556
If not gone for forward contract, he would have paid 13750 x 73.96 = 10,16,950
By forward contract the net loss = 1021556 – 1016950 = `4,606
Or
He will lose due to the forward contract to the extent of 6875 x (74.63 – 73.96) =
`4,606 Since the forward rate was indicting a premium, the importer would only go
for forward purchase agreement from the bank. If the actual spot rate goes in a
different direction, then the forward contract will not result in hedging and will
instead create loss.
8. (a)
Particulars Cost of Funds Y and HRS
Objective Fixed Rate Floating Rate
Y Floating 9.5% p.a. LIBOR +2%
HRS Fixed 13.5% p.a. LIBOR +2%
Differential in absolute terms 4% 0
The differential between two markets = 4% - 0% = 4%.
A total of 4% needs to be shared between Y, HRS and Swap Dealer.
10
PAPER - 14
Since HRS cannot pay more than 12% as against the fixed rate funding of 13.5%, it
requires 1.5% benefit out of 4%. Commission to swap dealer is 0.5%. so, benefit to Y
=4% - 1.5% - 0.5% = 2%.
The swap can therefore be structured as follows:
Firm Paid to Swap Received from Paid to Net Cost Savings

Dealer Swap Dealer Market
Y LIBOR 9.50% 9.50% LIBOR LIBOR+2% - LIBOR = 2%
HRS 10% LIBOR 12% 12% 13.5% - 12% = 1.5%
Y gets floating rate funds at LIBOR as against LIBOR +2%, thereby getting advantage
of 2% HRS gets fixed rate funds at 13.5%, there by getting advantage of 1.5%.
Finally Swap Dealer get commission of 0.5%.
Schematic Diagram
Effective interest rates: If HRS is able to negotiate such that its total outflow is 12%,
Commission will be borne by Y.
Hence, effective interest rate for Y = LIBOR
HRS = 12%
Alternatively, Y = LIBOR + 2% - 2.25% = LIBOR – 0.25%
HRS = 12% (Fixed) + 0.25% (Commission) = 12.25% (Fixed).
11
FINAL EXAMINATION SET - 1
MODEL ANSWER TERM – DECEMBER 2023
PAPER – 14 SYLLABUS 2022
STRATEGIC FINANCIAL MANAGEMENT
SECTION – A
1. Choose the correct alternative. [15 x 2 =30]
(i) Which of the following techniques is the most suitable, when NPV and IRR lead to inconsistent
ranking due to life disparity between two or more projects?
a. Modified Net Present Value.
b. Modified Internal Rate of Return.
c. Uniform Annual Equivalent Cost/Benefit.
d. Discounted Payback Period.
(ii) The Profitability Index of a project is 1.28 and its cost of investment is ₹ 2,50,000. The NPV of the
project is ___________.
a. ₹ 75,000
b. ₹80,000
c. ₹ 70,000
d. ₹ 65,000
(iii) The following information is available with respect to Project X:

NPV Estimate (₹) 30,000 60,000 1,20,000 1,50,000
Probability 0.1 0.4 0.4 0.1
The expected NPV will be _____________
a. ₹ 1,00,000
b. ₹75,000
c. ₹90,000
d. ₹1,20,000
(iv) The major advantage of leasing is that it _________.

a. provides flexible financing
b. provides lower payments
c. avoids risks of obsolescence.
d. All of the above
(v) It was observed that in a certain month, 6 out of 10 leading indicators and moved up as compared
to 4 indicators in the previous month. The diffusion index for the months was:
a. 20%
b. 40%
c. 60%
d. 80%
1
(vi) Bond volatility is inversely related to:

a. Term to maturity
b. Yield to maturity
c. Coupon rate
d. Both (b) and (c)
(vii) Mr. X expects 20% return from his investment. The dividend from the stock is ₹2.0 and the
present price is ₹50. What should be the future price of the stock?
a. ₹ 56.39
b. ₹ 58.00
c. ₹ 60.00
d. ₹ 62.30
(viii) According to the constant growth model, the next year’s dividend is ₹2.00, required rate of return is
15% and the growth rate is 10%, the market price would be:
a. ₹ 50
b. ₹45
c. ₹ 40
d. ₹ 48
(ix) Which among the following increases the NAV of a mutual fund scheme?
a. Value of investments
b. Receivables
c. Accrued income
d. All of (a), (b) and (c)
(x) A portfolio comprises two securities and the expected return on them is 12% and 16% respectively.
Determine return of portfolio if first security constitutes 40% of total portfolio.
a. 12.4%
b. 13.4%
c. 14.4%
d. 15.4%
(xi) Plain vanilla interest rate swaps involved:

a. Fixed to fixed rate swap
b. Fixed to floating rate swap
c. Floating to floating rate swap
d. Currency swap
(xii) An investor writes a three-month put on the stock of an oil company at an exercise price of ₹275 per
share at a premium of ₹34. If the expiration date price is ₹280, calculate the gain/loss of put writer.
a. ₹5
b. (̶) ₹5
c. ₹34
2
(xiii) The 6-month forward rate for US dollar against Rupee is quoted as ₹49.50 as opposed to a spot
price of ₹48.85. The forward premium on US dollar is:
a. 1.50 %
b. 3.08 %
c. 3.05 %
d. None of the above.
(xiv) The sterling is trading at $1.6400 today. Inflation U.K. is 3.8% and that in U.S.A. is 2.9%. What
would be the spot rate ($/£) after 2 years?
a. $1.6117
b. $1.615
c. $1.625
(xv) Sharpe’s measure of the portfolio performance is based on:

a. Systematic risk of the portfolio
b. Unsystematic risk of the portfolio
c. Total risk of the portfolio
d. Market risk of the portfolio
Answer:
(i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) (xi) (xii) (xiii) (xiv) (xv)
c c c d c d b c d c b c b a c
SECTION – B
(Answer any five questions out of seven questions given. Each question carries 14 Marks)
2. (a) Nine Gems Ltd. has just installed Machine – R at a cost of `2,00,000. The machine has a five-year
life with no residual value. The annual volume of production is estimated at 1,50,000 units, which
can be sold at `6 per unit. Annual operating costs are estimated at `2,00,000 (excluding
depreciation) at this output level. Fixed costs are estimated at `3 per unit for the same level of
production.
Nine Gems Ltd. has just come across another model called Machine – S capable of giving the same
output at an annual operating cost of `1,80,000 (exclusive of depreciation). There will be no change
in fixed costs. Capital cost of this machine is `2,50,000 and the estimated life is for five years with
nil residual value.
The company has an offer for sale of Machine – R at `1,00,000, but the cost of dismantling and
removal will amount to `30,000. As the company has not yet commenced operations, it wants to
sell Machine – R and purchase Machine –S.
Nine Gems Ltd. will be a zero-tax company for seven years in view of several incentives and
allowances available. The cost of capital may be assumed at 15%. P.V. factors for five years are as
follows:
3
Year P.V. Factors
1 0.8696
2 0.7561
3 0.6575
4 0.5717
5 0.4972
(i) Advise whether the company should opt for the replacement.
(ii) Suggest if there be any change in your view, if Machine-R has not been installed but the
company is in the process of selecting one or the other machine?
Support your view with necessary workings. [7]
(b) Fair finance, a leasing company, has been approached by a prospective customer intending to
acquire a machine whose Cash Down price is ₹3 crores. The customer, in order to leverage his tax
position, has requested a quote for a three-year lease with rentals payable at the end of each year
but in a diminishing manner such that they are in the ratio of 3: 2: 1. Depreciation can be assumed
to be on straight line basis and Fair Finance’s marginal tax rate is 35%. The target rate of return for
Fair Finance on the transaction is 12%.
Calculate the lease rents to be quoted for the lease for three years. [7]
Answer:
(a) (i) Replacement of Machine – R:
Incremental cash out flow

Particulars ` `
Cash outflow on Machine – S 2,50,000
Less: Sale value of Machine – R 1,00,000
Less: Cost of dismantling and removal 30,000 70,000
Net outflow 1,80,000
Incremental cash flow from Machine –S
Annual cash flow from Machine – S 2,70,000
[(1,50,000×`6)–(1,50,000× `3) – 1,80,000]
Annual cash flow from Machine – R 2,50,000
[(1,50,000×`6)– (1,50,000×`3) – 2,00,000]
Net incremental cash in flow 20,000
Present value of incremental cash inflows = `20,000 × (0.8696 + 0.7561 + 0.6575 + 0.5717 + 0.4972)
= `20,000 × 3.3523
= `67,046
NPV of Machine – S = `67,046 – `1,80,000 = (–) `1,12,954.
`2,00,000 spent on Machine – R is a sunk cost and hence it is not relevant for deciding the
replacement.
Decision: Since Net present value of Machine –S is in the negative, replacement is not advised.
If the company is in the process of selecting one of the two machines, the decision is to be made
on the basis of independent evaluation of two machines by comparing their Net present values.
4
(ii) Independent evaluation of Machine– R and Machine –S
Particulars Machine– R Machine– S

Units produced 1,50,000 1,50,000
Selling price per unit (`) 6 6
Sale value 9,00,000 9,00,000
Less: Operating Cost (exclusive of depreciation) 2,00,000 1,80,000
Contribution 7,00,000 7,20,000
Less: Fixed cost 4,50,000 4,50,000
Annual Cash flow 2,50,000 2,70,000
Present value of cash flows for 5 years 8,38,075 9,05,121
Cash outflow 2,00,000 2,50,000
Net Present Value 6,38,075 6,55,121
As the NPV of Cash in flow of Machine-S is higher than that of Machine-R, the choice should fall
on Machine-S.
Note: As the company is a zero tax company for seven years (Machine life in both cases is only for
five years), depreciation and the tax effect on the same are not relevant for consideration.
(b) Capital sum to be placed under Lease

Particulars ` in
lakhs
Cash Down price of machine 300.00
Less: PV of depreciation tax shield [100 × 0.35 × PVIFA (12%, 3 years) = 35 × 84.06
2.4018]
215.94
If the normal annual lease rent per annum is x, then cash flow will be:
Year Post-tax cash flow P.V. of post-tax cash flow
1 3x × (1 – .35) = 1.95x 1.95 × (1/1.12) = 1.7411x
2 2x × (1 – .35) = 1.3x 1.30 × [(1/(1.12)2] = 1.0364x
3 x × (1 – .35) = 0.65x 0.65 × [1/(1.12)3] = 0.4626x
= 3.2401x
Therefore 3.2401 x = 215.94

or, x = `66.6409 lakhs
Year-wise rentals are as follows: (` in lakhs)
Year 1 3 × 66.6409 lakhs 199.9227
Year 2 2 × 66.6409 lakhs 133.2818
Year 3 1 × 66.6409 lakhs 66.6409
3. (a) A firm has an investment proposal, requiring an outlay of ₹80,000. The investment proposal is
expected to have two years economic life with no salvage value. In year 1, there is a 0.4 probability
5
that cash inflow after tax will be ₹50,000 and 0.6 probability that cash inflow after tax will be
₹60,000. The probability assigned to cash inflow after tax for the year 2 are as follows:
The cash inflow year 1 ₹ 50,000 ₹60,000
The cash inflow year 2 Probability Probability
₹ 24,000 0.2 ₹ 40,000 0.4
₹ 32,000 0.3 ₹ 50,000 0.5
₹ 44,000 0.5 ₹ 60,000 0.1
The firm uses 8% discount rate for this type of investment.

Required:
(i) Develop a decision tree for the proposed investment project and calculate the expected net
present value (NPV).
(ii) Calculate net present value will the project yield, if worst outcome is realized and also
calculate the probability of occurrence of this NPV.
(iii) Suggest what will be the best outcome and the probability of that occurrence?
(iv) Recommend whether the project be accepted.
(Note: 8% discount factor 1 year 0.9259; 2 year 0.8573) [7]
(b) Consider the equity share of India Incorporated

D0 = Current dividend per share `3.00
n = Duration of the period of super normal growth = 5 years
ga = Growth rate during the period of super normal growth = 25%
gn = Normal growth rate after super normal growth period is over = 7%
k = Investor’s required rate of return = 14%
Calculate the price of the Equity Share under Multiple Growth Rate Model. [7]
Answer:
(a) The decision tree diagram is presented in the chart, identifying various paths and outcomes, and the
computation of various paths/outcomes and NPV of each path are presented in the following tables:
(i) The Net Present Value (NPV) of each path at 8% discount rate is given below:
6
The Net Present Value (NPV) of each path at 8% discount rate is given below:
Path Year 1 Cash Flows Year 2 Cash Flows Total Cash Cash NPV
(`) (`) Inflows (PV) Outflows (`)
(`) (`)
1 50,000×.9259 = 46,295 24,000×.8573 = 20,575 66,870 80,000 (-) 13,130
2 50,000×.9259 = 46,295 32,000×.8573 = 27,434 73,729 80,000 (-) 6,271
3 50,000×.9259 = 46,295 44,000×.8573 = 37,721 84,016 80,000 4,016
4 60,000×.9259 = 55,554 40,000×.8573 = 34,292 89,846 80,000 9,846
5 60,000×.9259 = 55,554 50,000×.8573 = 42,865 98,419 80,000 18,419
6 60,000×.9259 = 55,554 60,000×.8573 = 51,438 1,06,992 80,000 26,992
Statement showing Expected Net Present Value

Path NPV (`) Joint Probability Expected NPV (`)
1 (-) 13,130 0.08 (-)1,050.40
2 (-) 6,271 0.12 (-)752.52
3 4,016 0.20 803.20
4 9,846 0.24 2,363.04
5 18,419 0.30 5,525.70
6 26,992 0.06 1,619.52
8,508.54
Conclusions:
(i) If the worst outcome is realized the project will yield NPV of (-) `13,130. The probability of
occurrence of this NPV is 8% and a loss of (-) ` 1,050.40 (path 1).
(ii) The best outcome will be path 5 when the NPV is at `18,419. The probability of occurrence of
this NPV is 30% and an expected profit of `5,525.70.
(iii) The project should be accepted because the expected NPV is positive at `8,508.54 based on
joint probability.
7
(b) The following are the steps involved:
Step I. Dividend stream during super normal growth period.

D1 = `3.00 (1.25); D2 = `3.00 (1.25)2, D3 = `3.00 (1.25)3
D4 = `3.00(1.25)4 and D5 =`3.00(1.25)5
The present value of the above stream of dividends is
2 3 4 5
3.00 (1.25) 3.00 (1.25) 3.00 (1.25) 3.00 (1.25) 3.00 (1.25)
+ + + +
(1.14) 2 3 4 5
(1.14) (1.14) (1.14) (1.14)
= ` (3.29 + 3.61 + 3.96 + 4.34 + 4.76)
= ` 19.96
Step II. The price of the shares at the end of 5 years, applying the constant growth model at that
point of time will be
D D (1  g ) 3.00 (1.25) 5 (1.07)

P5 = 6 = 5 n = = `140
k-g k -g 0.14 - 0.07
n
`140
Discounted value of this price = = ` 72.71
5
(1.14)
Step III. The sum of Steps I and II is
`19.96 + `72.71 = `92.67
4. (a) AB Ltd. is expected to pay a dividend of ₹4.00 at the end of first year, a dividend of ₹7.00 at the
end of second year, a dividend of ₹11.00 at the end of 3rd year. From 4th year onwards, the dividends
are expected to grow at a constant growth rate of 4%. If the required rate of return is 14%, compute
the present value of the stock. [7]
(b) Four friends S, T, U, and V have invested equivalent amount of money in four different funds in
tune with their attitude to risk, S prefers to play aggressive and is keen on equity-funds, T is
moderately aggressive with a desire to invest upto 50% of his funds in Equity, whereas U does not
invest anything beyond 20% in Equity. V, however, relies more on movement of market, and prefers
any fund which replicates the market portfolio.
Their investment particulars, returns therefrom and Beta of the fund are given below —
Fund Invested Return for the year Beta Factor
Money Multiplier Fund (100% Equity) 23.50% 1.80
Balanced Growth Fund (50% Equity - 50% Debt) 16.50% 1.25
Safe Money Fund (20% Equity and 80% Debt Funds) 12.50% 0.60
8
If the Market Return was 16% and the Risk Free Return is measured at 7%, suggest which of the
four friends were rewarded better per unit of risk taken? [7]
Answer:
D D D D (1  g )
(a) P0 = 1 + 2 + 3 + 3
(1  k) (1  k) 2 (1  k) 3 (1  k) 3 ( k  g )
Substituting these values:

4 7 11 11.44
P0 = + + +
(1.14) 2 3 3
(1.14) (1.14) (1.14) (0.14  0.04)
= 3.509 + 5.39 + 7.415 + 77.22
= ` 93.54
Therefore, the price of the share is ` 93.54 through DDM (dividend discount model)
(b)
Particulars S T U V
Risk Free Return [RF] 7% 7% 7% 7%
Fund Invested Money Balanced Growth Safe Money Market
Multiplier Fund Fund Fund Portfolio
Beta of the Portfolio [βP] 1.80 1.25 0.60 1.00
Return on Portfolio [RP] 23.50% 16.50% 12.50% 16.00%
Treynor Measure [(RP-RF) ÷ βP] 9.17 7.60 9.17 9.00
[23.50–7] ÷1.80 [16.50–7] ÷ 1.25 [12.50–7] ÷ 0.60 [16–7] ÷ 1
Ranking 1 3 1 2
Evaluation: Both S and U have earned the same Reward per unit of risk taken, which is more than
the Market Reward to Risk of 9.00
5. (a) The beta coefficient of M Ltd. is 1.40. The company has been maintaining 8% rate of growth in
dividends and earnings. The last dividend paid was `4.00 per share. Return on government
securities is 12% and return on market portfolio is 18%. The current market price of the share of M
Ltd. Is `32.00. Calculate be the equilibrium price per share of M Ltd. [7]
(b) From the following information, ascertain the risk of the portfolio — [7]
Securities Standard Deviation Proportion in Portfolio
A 8% 0.30
B 12% 0.50
C 6% 0.20
Correlation Co-efficient
AB = 0.50
9
AC = - 0.40
BC = + 0.75
Answer:
(a) Required rate of return as per CAPM = Rf + (Rm - Rf) × βi = 12 + (18-12) × 1.40 = 20.40%.
Equilibrium price D1 = 4 × (1+0.08) = 4 × 1.08 = ` 4.32 and G = 0.08 [E.P. = Equilibrium price].
Expected return = [D1/E.P.] + g or 20.40 = 4.32/E.P. + 0.08

or (0.2040 - 0.08) E.P. = 4.32
or 0.124 E.P. = 4.32
or E.P. = 4.32 / 0.124
or `34.84.
or equilibrium price = `34.84
(b) Formula Approach (Alternative 1)
(i) Basic Values of Factors for Determination of Portfolio Risk
Standard Deviation of Security A σA 8%

Standard Deviation of Security B σB 12%
Standard Deviation of Security C σC 6%
Correlation co-efficient of Securities A and B 0.50
Correlation co-efficient of Securities A and C -0.40
Correlation co-efficient of Securities B and C 0.75
Weight of Security A WA 0.30
Weight of Security B WB 0.50
Weight of Security C WC 0.20
(ii) Computation of Portfolio Risk (σABC)

2 2 2 2 2 2
= (σ A × WA ) + (σ B × WB ) + (σ C × WC ) + 2(σ A × WA  σ B × WB   AB )  2(σ A × WA  σ C × WC   AC )  2(σ B × WB  σ C × WC   BC )
2 2 2 2 2 2
= (8  0.3 ) + (12 × 0.5 ) + (6 × 0.2 ) + (2 × 8 × 0.3 × 12 × 0.5 × 0.5) + (2 × 8 × 0.3 × 6 × 0.2 × (-0.4)) + (2 × 12 × 0.5 × 6 × 0.2 × 0.75)
= (64 × 0.09) + (144 × 0.25) + (36 × 0.04) + (14.4) + (-2.304) + (10.8)
= 5.76 + 36 + 1.44 + 14.4 - 2.304 + 10.8

= 66.096
= 8.13%
Formula Approach (Alternative 1)
10
(i) Basic Values of Factors for Determination of Portfolio Risk
Variance of Security A σA2 82 = 64

Variance of Security B σB2 122 = 144
Variance of Security C σC2 62 = 36
Covariance of Securities A and B [PAB× σA× σB] COVAB 0.50 × 8 × 12 =48
Covariance of Securities A and C [PAC× σA× σC] COVAC - 0.40 × 8 × 6 = - 19.2
Covariance of Securities B and C [PBC× σB× σC] COVBC 0.75 × 12 × 6 = 54
Weight of Security A WA 0.30
Weight of Security B WB 0.50
Weight of Security C WC 0.20
(c) Matrix
Securities A B C
Weights 0.30 0.50 0.20
WA WB WC
A 0.30 64 48 -19.2
WA (σA2) (CovAB) (CovAC)
B 0.50 48 144 54
WB (COVAB) (σA2) (CovBC)
C 0.20 -19.2 54 36
WC (CovAC) (CovBC) (σC2)
Computation of Portfolio Variance (σABC2)

Description Computation Product
(W×W×Cov) or (W×W×σ2)
1 WA× WA× (σA2) 0.30 × 0.30 × 64 5.76
2 WA×WB×COVAB 0.30 × 0.50 × 48 7.20
3 WA× WC× COVAC 0.30 × 0.20 × (19.2) (1.15)
4 WB× WA× COVAB 0.50 × 0.30 × 48 7.20
5 WB× WB× (σB2) 0.50 × 0.50 × 144 36
6 WB × WC × COVBC 0.50 × 0.20 × 54 5.40
7 WC × WA × COVAC 0.20 × 0.30 × (19.2) (1.15)
8 WC × WB × COVBC 0.20 × 0.50 × 54 5.40
9 WC× WC× (σC2) 0.20 × 0.20 × 36 1.44
Variance of the Portfolio (σABC) 66.10
Standard Deviation (Risk) of the Portfolio (σABC) 8.13%
11
6. (a) Given the following information
BSE Index 50,000
Value of Portfolio ₹1,01,00,000
Risk Free Interest Rate 9% p.a.
Dividend Yield on Index 6% p.a.
Beta of Portfolio 2.0
We assume that a futures contract on the BSE index with 4 months maturity is used to hedge the
value of portfolio over next 3 months. One future contract is for delivery of 50 times the index.
Based on the information, calculate:
(i) Price of future contract,
(ii) The gain on short futures position if index turns out to be 45,000 in 3 months [7]
(b) Calculate the price of a European put option on a non-dividend-paying stock when the stock price
is ₹ 69, the strike price is ₹ 70, the risk-free interest rate is 5% per annum, the volatility is 35% per
annum, and the time to maturity is six months. [7]
Answer:
(a) (i) Computation of price of Futures Contract

Securities of R Ltd.
Spot price [Sx] `50,000
Dividend yield Expected [Y] 6% or 0.06
Tenor / Time period [t] in Years 4 Months or 0.3333 Year
Risk Free interest Rate [r] 9% or 0.09
Price of Futures Contract [TFPx] TFPx = Sx×e(r-y)×t (0.09 - 0.06) × 0.3333
= `50,000 × e
0.03×0.3333
= ` 50,000 × e
= `50,000 × e 0.01
= `50,000 × 1.0101
= `50,505
Therefore, price of the Futures Contract is `50,505 or `50,500 (Approx)
(ii) Gain on short Futures Position

Computation of No. of Contracts to be entered into:
Particulars Value
Portfolio Value `1,01,00,000
4-Month’s futures Price per Unit of BSE Index `50,500
No. of Units per BSE Index Futures Contract 50
Value per BSE Index futures Contract [50 Units × 50,500 per unit] `25,25,000
No. of Contract to be entered [Portfolio Value × Beta of Portfolio w.r.t Index 8 Contracts
÷ Value per BSE Index futures Contract] = [`1,01,00,000 × 2.0 ÷
`25,25,000]
Computation of Gain on Short Futures Position
12
Particulars Value
Position SELL
Contracted Sale Price per Unit of BSE Index `50,500
Less: Index Position in 3-Months `45,000
Gain per Unit of BSE Index Future `5,500
No. of Units per Contract 50
Gain per Contract [`5,500 × 50 Units] `2,75,500
No. of Contract entered into 8
Total Gain [8 Contracts × `2,75,000 per contract] `22,00,000
Total Gain on Short Futures Position in 3 Months is `22,00,000.
(b) In this case,

S0 = 69, K = 70, r = 0.05, σ = 0.35 and T = 0.5
2
In(69 / 70) + (0.05 + 0.35 /2) × 0.5
d1 = = 0.166
0.35 0.5
d2 = d1 ̶ 0.35√0.5 = ̶ 0.0809
The price of the European put is
70e-0.05 × 0.5 N(0.0809) ̶ 69 N (-0.1666)
= 70e-0.05 × 0.5 × 0.5323 ̶ 69 × 0.4338
= 6.40.
7. (a) On 25th March 2023, a customer requested his bank to remit DG 12,50,000 to Netherlands in
payment of import of diamonds under an irrevocable LC. However due to bank strikes, the bank
could affect the remittance only on 2nd April 2023. The inter-bank market rates were as follows:
Date 25.03.2023 02.04.2023
Bombay [$ / `100] 2.2873 - 2.2962 2.3063 - 2.3159
London [US$/Pound] 1.9120 -1.9135 1.9050 - 1.9070
DG /Pound 4.1125 - 4.1140 4.0120 - 4.0130
The bank wishes to retain an exchange margin of 0.25%. Calculate how much does the customer
stand to gain or lose due to the delay? [7]
(b) Exchange rate between Rupee and Swiss franc is ₹33/SFr at the reference period and the forward
rate is found to be ₹33.40/SFr after 9 months. Nine-month interest rate on Rupee is 8% p.a.
Recommend what should have been corresponding interest rate on Swiss franc. Show that interest
rate differential is equal to forward premium or discount. [7]
Answer:
(a) 1. Determination of Rupee Value of DG 1 on 25.03.2021
13
Process: Buy US $ at Ask Rate at Bombay = > Buy Pound (using US $) at Ask Rate at London
= > Sell Pound at Bid Rate for DG
Therefore, ` / DG = Ask Rate at Bombay (for Purchase of Dollar) × Ask Rate for Pound at
London (for Purchase of Pound) × Bid Rate for DG (for conversion of
Pound into DG)
= 100/2.2873 × 1.9135 × (1/4.1125)
= `20.34 per DG
2. Determination of Rupee Value of DG 1 on 02.04.2021

Process: Buy US $ at Ask Rate at Bombay = > Buy Pound (using US $) at Ask Rate at London
= > Sell Pound at Bid Rate for DG
Therefore, `/DG = Ask Rate at Bombay (for Purchase of Dollar) × Ask Rate for Pound at
London (for Purchase of Pound) × Bid Rate for DG (for conversion of
Pound into DG)
= 100/2.3063 × 1.9070 × (1/ 4.0120)
= `20.61 per DG
3. Loss because of Delay

a) Loss without considering Banker’s Margin (Extra Money payable by the Company)
= Amount Payable × (Exchange Rate on the date of a ctual payment – Exchange
Rate on the date on which payable)
= DG 12,50,000 × (`20.61 – `20.34)
= `3,37,500
b) Banker’s Margin on Loss
= `3,37,500 × 0.25%
= ` 844
c) Total Loss to the Company
= `3,37,500 + `844
= `3,38,344
(b) Given, e0 = `33/SFr

f1 = `33.40/SFr
Interest rate in home country (India) = rh = 8% p.a. (for 9 months)
Interest rate in foreign country (USA) = rf = x% p.a. (for 9 months)
1  rh
Since, as per IPR, = f = e0
1  rf
9
1  0.08 
Conditionally, 33.40 = 33 × 12
9
1 X
12
or, x = 0.063 or 6.3%
14
So, the interest rate on Swiss franc is 6.3% p.a.
9 9
r  rf 0.08   0.063 
Interest rate differential = h = 12 12 = 1.21%
1  rf 9
1  0.063 
12
f -e
Forward Premium or discount = 1 0 = (33.40 – 33.00)/33.00 = 1.21%
e
0
So, interest rate differential is equal to forward premium or discount.
8. (a) Prepare a short note on Digital Infra Structure. [5]

(b) Discuss who can invest in participatory notes. [5]
(c) Discuss the benefits of Securitization. [4]
Answer:
(a) Digital infrastructure refers to the digital technologies that bring together and interconnect physical
and virtual technologies such as computer, storage, network, applications etc. to provide the
foundation for an organisation’s digital operations. Businesses use this foundation to re-architect
their services for global digital delivery and to access the ecosystems and capabilities they need to
rapidly build products and services and deliver them at scale.
Components of digital infrastructure include:

1) Internet: The Internet is the global system of interconnected computer networks that uses the
Internet protocol suite (TCP/IP) to communicate between networks and devices. It is a
network of networks that consists of private, public, academic, business, and government
networks of local to global scope, linked by a broad array of electronic, wireless, and optical
networking technologies. The Internet carries a vast range of information resources and
services, such as the inter-linked hypertext documents and applications of the World Wide
Web (WWW), electronic mail, telephony, and file sharing. Internet acts as the prime enabler
or connecting force that integrates the digital world including digital finance.
2) Mobile telecom and digital communication suites, including applications: These
components connect various organisations to a common network and enables
communication for digital transactions.
3) Data centers and networks: A data center is a physical facility that organisations use to
house their critical applications and data. A data center’s design is based on a network of
computing and storage resources that enable the delivery of shared applications and data.
The key components of a data center design include routers, switches, firewalls, storage
systems, servers, and application-delivery controllers.
4) Enterprise portals, platforms, systems, and software: An enterprise portal, also known as an
enterprise information portal (EIP), is a framework for integrating information, people and
processes across organizational boundaries in a manner similar to the more general web
portals. Enterprise portals provide a secure unified access point, often in the form of a web-
based user interface, and are designed to aggregate and personalize information through
application-specific portlets. The portal integrated with required systems and applications
15
delivers the required service.
5) Cloud services: The term “cloud services” refers to a wide range of services delivered on
demand to companies and customers over the internet. These services are designed to
provide easy, affordable access to applications and resources, without the need for internal
infrastructure or hardware. These are infrastructure, platforms, or software that are hosted
by third-party providers and made available to users through the internet. Cloud services
can be of three types – (i) Infrastructure-as-a-service (IaaS) where the cloud service provider
manages the infrastructure for the firm through an internet connection; (ii) Platforms-as-a-
Service (PaaS) where the hardware and an application-software platform are provided and
managed by an outside cloud service provider, but the user handles the apps running on top
of the platform and the data the app relies on and (iii) Software- as-a-Solution (SaaS) where
the service provider delivers a software application—which the cloud service provider
manages—to its users.
6) Operational security, user identity and data encryption: Operational security is a security
and risk management process that prevents sensitive information from getting into the
wrong hands. It applies specific authentication process to verify user identity and also
systems and software to ensure data encryption apart form advanced data security through
antivirus and antimalware.
7) APIs and integrations: An application programming interface (API) is a messenger that
processes request and ensures seamless functioning of enterprise systems. An API
integration is the connection between two or more applications, via their APIs, that lets
those systems exchange data. API integrations power processes throughout many high-
performing businesses that keep data in sync, enhance productivity, and drive revenue.
The above elements are the generic components of a digital infrastructure. In addition, digital
finance infrastructure will include the digital payment system infrastructure of the country,
blockchain enabled distributed ledger system under a broader Decentralized Finance (DeFi)
system.
(b) Following entities are eligible to invest in Participatory Notes:
(i) Any entity incorporated in a jurisdiction that requires filing of constitutional and/or other
documents with a registrar of companies or comparable regulatory agency or body under the
applicable companies’ legislation in that jurisdiction;
(ii) Any entity that is regulated, authorized or supervised by a central bank, such as the Bank of
England, the Federal Reserve, the Hong Kong Monetary Authority, the Monetary Authority of
Singapore or any other similar body provided that the entity must not only be authorized but
also be regulated by the aforesaid regulatory bodies;
(iii) Any entity that is regulated, authorized or supervised by securities or futures commission,
such as the Financial Services Authority (UK), the Securities and Exchange Commission,
the Commodities Futures Trading Commission, the Securities and Futures Commission
(Hong Kong or Taiwan), Australia Securities and Investments Commission (Australia) or other
securities or futures authority or commission in any country, state or territory;
(iv) Any entity that is a member of securities or futures exchanges such as the New York Stock
Exchange (Sub- account), London Stock Exchange (UK), Tokyo Stock Exchange (Japan),
16
NASD (Sub-account) or other similar self-regulatory securities or futures authority or
commission within any country, state or territory provided that the aforesaid organisations
which are in the nature of self-regulatory organisations are ultimately accountable to the
respective securities / financial market regulators.
(v) Any individual or entity (such as fund, trust, collective investment scheme, Investment
Company or limited partnership) whose investment advisory function is managed by an
entity satisfying the criteria of (a), (b), (c) or (d) above.
(c) The driving force behind securitization has been the need for banks to realize value from the assets
they hold on their balance sheet. Typically, these assets are residential mortgages, corporate loans,
and retail loans such as credit card loans. A financial institution securitizes part of its balance sheet
for three main reasons:
a. Funding the assets that it owns

b. Balance sheet capital management
c. Risk management and credit risk transfer.
These are discussed below.
a. Funding the assets that is owns

Banks can use securitization to (1) support rapid asset growth, (2) diversify their funding mix and
reduce cost of funding, and (3) reduce maturity mismatches. Banks aim to optimize their funding
between a mix of retail, interbank, and wholesale sources. Securitization is a prime component in
this mix. Securitization also helps a bank to reduce its funding costs. This is because the
securitization process separates the credit rating of the originating institution from the credit rating
of the issued notes. Typically, most of the notes issued by special purpose vehicles (SPVs) will be
more highly rated than the bonds issued by the originating bank directly. Finally, bank often funds
long-term assets, such as residential mortgages, with short-asset liabilities, such as bank account
deposits or interbank funding. This funding “gap” can be mitigated via securitization, as the
originating bank receives funding from the sale of the assets, and the economic maturity of the
issued notes frequently matches that of the assets.
b. Balance sheet capital management

Banks use securitization to improve balance sheet capital management. Securitization provides (1)
regulatory capital relief, in some cases (depending on the form of the transaction), (2) “economic”
capital relief, and (3) diversified sources of funding.
c. Risk Management and Credit risk transfer

Once assets have been securitized, the credit risk exposure on these assets for the originating bank
is reduced considerably. This is because assets have been sold to the SPV. Securitization can also
be used to remove nonperforming assets from banks’ balance sheets. This will remove credit risk as
well as a potentially negative sentiment from the balance sheet apart from freeing up regulatory
capital as before. Further, if any of the securitized NPA starts performing again, or there is a
recovery value obtained from defaulted assets, the originator will receive any surplus profit made
by the SPV.
17
Securitization is beneficial from the view point of investors also. The potential attractions include:
a. Ability to diversify into sectors of exposure that might not be available in the regular bond
markets (for example, residential mortgages or project finance loans).
b. Access to different (and sometimes superior) risk-reward profiles.
c. Access to sectors that are otherwise not open to them.
18
SECTION – A (Compulsory)
I. Choose the correct option: [15 x 2 =30]
(i) The IRR of a project is 10%. If the annual cash flow after tax is ₹1,30,000 and project duration is 4
years, whatis the initial investment in the project?
(a) `4,10,000
(b) `4,12,100
(c) `3,90,000
(d) `4,05,000
(ii) Which of the following is/are not true regarding the risk adjusted investment appraisal techniques?
i. In the certainty equivalent method, if there is high degree of correlation between the
cashflows for the entire project life the certainty equivalent coefficient is taken as one for all
the years.
ii. In sensitivity analysis, the impact of the changes in one or more variables on the criterion of
merit isstudied.
iii. Simulation does not produce an optimal solution but the user of the technique has to generate
all possible combinations of conditions and constraints to choose the optimal solution.
(a) Only (ii) above.
(b) Only (iii) above.
(c) Both (i) and (ii) above
(d) Both (i) and (iii) above
(iii) Given, expected value of profit without perfect information = `1,600 and expected value of perfect
information =`300, then expected value of profit with perfect information will be .
(a) `1,300
(b) `1,900
(c) `950
(d) None of the above
(iv) The type of lease that includes a third party, a lender, is called as which of the following?
(a) Sale and lease back
(b) Leveraged Lease
(c) Direct leasing arrangement
(d) Operating lease
(v) The current price is `100, the required rate of return is 20% and the dividend paid `3.00 on a
share of`10 face value. What is the expected growth rate?
(a) 15%
(b) 16%
(c) 18%
(d) 17%
1
(vi) In the bull market:
(a) The stock prices are increasing
(b) Each peak is higher than the previous peak
(c) Each bottom is higher than the previous bottom
(d) Both (b) and (c)
(vii) Mr. X expects 20% return from his investment. The dividend fromthe stock is `2.0 and the present
price is `50. What should be the future price of the stock?
(a) `56.39
(b) `58.00
(c) `60.00
(d) `62.30
(viii) Yield to maturity is same as:

(a) NPV
(b) IRR
(c) Geometric mean
(d) Both (b) and (c)
(ix) If opening units 1,25,000 Units subscribe 2,00,000, Units redeem 50,000 then Closing units?
(a) 3,25,000 units
(b) 2,75,000 units
(c) 3,75,000 units
(d) 2,50,000 units
(x) A portfolio comprises two securities and the expected return on them is 12% and 16% respectively.
Determine return of portfolio if first security constitutes 40% of total portfolio.
(a) 12.4%
(b) 13.4%
(c) 14.4%
(d) 15.4%
(xi) An investor buys 100 shares of a sugar mill at `210 per share and at the same time writes a September
250 call at a premium of `20 per share. If the expiration date price is `280, calculate the net gain/loss.
(a) `20
(b) `40
(c) `60
(xii) With respect to capital market theory, the average beta of all assets in the market is:
(a) Less than 1.0.
(b) Equal to 1.0
(c) Greater than 1.0.
(d) None
2
(xiii) The United States Dollar is selling in India at `45.20. If the interest rate for a 6-months borrowing in
India is 10% and the corresponding rate in USA is 4%, what would be the rate of forward
premium/(discount)?
(a) 5.93 %
(b) 5.88 %
(c) (5.17%)
(d) (5.52%)
(xiv) Plain vanilla interest rate swaps involved:

(a) Fixed to fixed rate swap
(b) Fixed to floating rate swap
(c) Floating to floating rate swap
(d) Currency swap
(xv) The portfolio’s risk premium is 12% and the standard deviation of market and the portfolio are
4 and 3, respectively. The fund’s beta value is 1.5. The Treynor index is:
(a) 3.0
(b) 8.0
(c) 4.0
(d) 12
SECTION – B
(Answer any 5 questions out of 7 questions given. Each question carries 14 marks.)
[5 x 14 = 70]
2. (a) X Ltd. an existing profit-making company, is planning to introduce a new product with a projected
life of 8 years. Initial equipment cost will be `120 lakhs and additional equipment costing `10 lakhs
will be needed at the beginning of third year. At the end of the 8 years, the original equipment will
have resale value equivalent to the cost of removal, but the additional equipment would be sold for
`1 lakhs. Working Capital of `15 lakhs will be needed. The 100% capacity of the plant is of 4,00,000
units per annum, but the production and sales- volume expected are as under:
Year Capacity in percentage
1 20
2 30
3-5 75
6-8 50
A sale price of `100 per unit with a profit-volume ratio of 60% is likely to be obtained. Fixed
Operating Cash Cost are likely to be `16 lakhs per annum. In addition to this the advertisement
expenditure will have to be incurred as under:
Year 1 2 3-5 6-8
Expenditure in ` lakhs each year 30 15 10 4
The company is subject to 40% tax, straight-line method of depreciation, (permissible for tax
purposes also) and taking 15% as appropriate after-tax Cost of Capital, should the project be
accepted? [7]
3
(b) Beta Ltd is considering the acquisition of a personal computer costing `50,000. The effective life
of the computer is expected to be five years. The company plans to acquire the same either by
borrowing `50,000 from its bankers at 15% interest p.a. or on lease. The company wishes to know
the lease rentals to be paid annually, which match the loan option. The following further information
is provided to you:
a) The principal amount of loan will be paid in five annual equal instalments.
b) Interest, lease rentals, principal repayment are to be paid on the last day of each year.
c) The full cost of the computer will be written off over the effective life of computer on a
straight-line basis and the same will be allowed for tax purposes
d) The company’s effective tax rate is 40% and the after-tax cost of capital is 9%
e) The computer will be sold for `1,700 at the end of the 5th Year. The commission on such
sales is 9% on the sale value.
You are required to compute the annual lease rentals payable by Beta Ltd, which will result in
indifference to the loan option. [7]
3. (a) A company is considering two mutually exclusive projects X and Y. Project X costs `3,00,000 and
Project Y `3,60,000. You have been given below the net present value, probability distribution for
each project:
Project X Project Y
NPV Estimate (`) Probability NPV Estimate (`) Probability
30,000 0.1 30,000 0.2
60,000 0.4 60,000 0.3
1,20,000 0.4 1,20,000 0.3
1,50,000 0.1 1,50,000 0.2
Compute the expected net present value of Projects X and Y.

(i) Compute the risk attached to each project i.e., Standard Deviation of each probability
distribution.
(ii) Which project do you consider riskier and why?
(iii) Compute the profitability index of each project. [7]
(b) The rates of return on the Security of company S and Market Portfolio for 10 periods are given below:
Year 1 2 3 4 5 6 7 8 9 10
Return on Security S (%) 20 22 25 21 18 -5 17 19 -7 20
Return on Market Portfolio 22 20 18 16 20 8 -6 5 6 11
i. Compute the beta of Security S?
ii. Determine the Characteristic Line for Security S?
iii. Analyse the Systematic and Unsystematic Risk of Security S? [7]
4. (a) For the first four years, India Incorporated is assumed to grow at a rate of 10%. After four years, the
growth rate of dividend is assumed to decline linearly to 6 percent. After 7 years, it is assumed to
grow at a rate of 6% infinitely. The next year dividend is `2.00 per share and the required rate of
return is 14%. Find the value of the stock. [7]
4
(b) There are two mutual funds viz. X mutual fund and Y mutual fund. Each having closed-ended equity
schemes. NAV as on 31-12-2022 of equity schemes of X mutual fund is `70.71 (consisting 99%
equity and remaining cash balance) and that of Y mutual fund is `62.50 (consisting 96% equity and
balance in cash).
Following is the other information:
Particulars Equity Schemes
X Mutual Fund Y Mutual Fund
Sharpe ratio 2 3.3
Treynor ratio 5 15
Standard deviation 11.25 5
There is no change in portfolios during the next months and annual average cost is `3 per unit for the
schemes of both the mutual funds. For calculation, consider 12 months in a year and ignore number of
days for particular month. Calculate NAV after one month if the market goes down by 5%. [7]
5. (a) Subho has invested in four securities M, N, O and P, the particulars of which are as follows —
Security M N O P
Amount Invested (`) 1,25,000 1,50,000 80,000 1,45,000
Beta (β) 0.60 1.50 0.90 1.30
If RBI Bonds carries an interest rate of 8% and NIFTY yields 14%, compute the expected return on
portfolio. If investment in Security O is replaced by investment in RBI Bonds, what corresponding
change will be there in Portfolio Beta and expected return? [7]
(b) Based on the data provided below, compute and compare the performance of the portfolios
using the Jensen model of the differential return.
Portfolio Realized Return on Portfolio
Portfolio (%) (β)
1 14.5 1.2
2 9.5 0.8
3 18.0 1.4
Return on market portfolio, Rm = 12%
Risk-free rate of interest = 6% [7]
6. (a) Decide which position on the index future gives a speculator, a complete hedge against the following
transitions:
(i) The share of Yes Limited is going to rise. He has a long position on the cash market of `100
Lakhs on the Yes Limited. The beta of the Yes Limited is 1.25.
(ii) The share of No Limited is going to depreciate. He has a short position on the cash market
of `50 Lakhs on the No Limited. The beta of the No Limited is 0.90.
(iii) The share of Fair Limited is going to stagnant. He has short position on the cash market of
`40 Lakhs of the Fair Limited. The beta of the Fair Limited is 0.75. [7]
5
(b) A put and a call option each have an expiration date 6 months hence and an exercise price `9. The
interest rate for the 6 month period is 3 percent.
(a) If the put has a market price of `2 and share is worth `10 per share, compute the value of the
call.
(b) If the put has a market price of `2 and the call `4. determine the value of the share per share.
If the call has a market value of `5 and market price of the share is `12 per share what is the value of
the put? [7]
7. (a) Following are the details of cash inflows and outflows in foreign currency denominations of M Co.,
an Indian export firm, which have no foreign subsidiaries —
Currency Inflow Outflow Spot rate Forward rate
US $ 4,00,00,000 2,00,00,000 48.01 48.82
French Franc (F Fr) 2,00,00,000 80,00,000 7.45 8.12
UK £ 3,00,00,000 2,00,00,000 75.57 75.98
Japanese Yen 1,50,00,000 2,50,00,000 3.20 2.40
(a) Determine the net exposure of each foreign currency in terms of Rupees.
(b) Are any of the exposure positions off-setting to some extent? [7]
(b) Following are the USD/INR spot and 3-month forward quotes available. Which currency is in forward
premium or discount? Calculate the annualised forward premium or discount.
Spot rate, USD/INR: `75.42/50
3-month swap points: 20/30 [7]
8. Short Notes on:

(a) Advantages of Digital Financial Services. [5]
(b) Participatory Notes. [5]
(c) Sale and Lease back. [4]
6
Answer to MTP_Final_Syllabus 2016_Jun2023_Set1
Paper 14 - Strategic Financial Management
DoS, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 1
Paper 14 - Strategic Financial Management
Full Marks: 100 Time Allowed: 3 Hours
This paper contains two sections A and B. Section A is compulsory and contains question
No.1 for 20 marks. Section B contains question Nos. 2 to 8, each carrying 16 marks.
Answer any five questions from Section B.
Section – A [20 Marks]
1. Choose the correct option among four alternative answer. (1 mark for correct choice,
1mark for justification.) [10×2= 20]
(i) If the risk free rate of interest (Rf) is 10%, and expected return on market
portfolio (Rm) is 15%, ascertain expected return of the portfolio if portfolio beta
is 0.30.
(a) 10.5%
(b) 11.5%
(c) 12.5%
(d) 13.5%
(ii) There are two projects, Project A & B. From the given data please. Suggest
which project will be selected?
Project A Project B
Investment 5000000 7500000
Net Cash Inflow 6250000 9150000
K = 10%
(a) Project A
(b) Project B
(c) A & B both
(iii) Consider the following quotes: Spot (Euro/Pound) = 1.3904 — 1.3908 Spot
(Pound/NZ $) = 0.5020 — 0.5040 What will be the possible % spread on the
cross rate between Euro and NZ $?
(a) 0.40
(b) 0.39
(c) 0.41
(d) 0.43
(iv) The spot price of securities of X Ltd. is ₹160. With no dividend and no carrying
cost, compute the theoretical forward price of the securities for 1 month. You
may assume a risk free interest rate of 9% p.a.
(a) ₹160
(b) ₹162.75
(c) ₹161.20
(d) ₹159.20
(v) A mutual Fund had a Net Asset Value (NAV) of ₹72 at the beginning of the
year. During the year, a sum of ₹6 was distributed as Dividend besides ₹ 4 as
Capital Gain distributions. At the end of the year, NAV was ₹ 84. Total return for
the year is:
(a) 30.56%
(b) 31.56%
(c) 40.56%
(d) 41.56%
(vi) Sales unit 2,000 2,800

Selling price per unit ₹ 10 ₹ 10
EPS ₹ 9.60 ₹ 38.40
What is the Degree of Combined Leverage?
(a) 6.5
(b) 5.6
(c) 7.5
(d) 5.7
(vii) The following details relate to an investment proposal of XYZ Ltd. Investment
outlay — ₹ 100 lakhs Lease Rentals are payable at ₹180 per ₹1,000 Term of
lease — 8 years Cost of capital—12% What is the present value of lease rentals,
if lease rentals are payable at the end of the year? [Given PV factors at 12%
for years (1-8) is 4.9676.
(a) ₹ 98,14,680
(b) ₹ 89,41,680
(c) ₹ 94,18,860
(d) ₹ 96,84,190
(viii) A company has obtained quotes from two different manufacturers for an
equipment.
The details are as follows:
Product Cost (Million) Estimated life (years) Make X 4.50 10
Make Y 6.00 15
Ignoring operation and maintenance cost, which one would be cheaper? The
company’s cost of capital is 10%.
[Given: PVIFA (10%, 10 years) = 6.1446 and PVIFA (10%, 15 years) = 7.6061]
(a) Make X will be cheaper
(b) Make Y will be cheaper
(c) Cost will be the same
(ix) The capital structure of a company is as under:

300000 Equity shares of ₹10 each
32000, 12% Preference shares of ₹100 each
General Reserve ₹15,00,000
Securities Premium Account ₹5,00,000
25000, 14% Fully Secured Debentures of ₹100 each Term Loan of ₹13,00,000.
Based on these, the leverage of the company is:
(a) 60.22%
(b) 58.33%
(c) 55.21%
(d) 62.10%
(x) The spot Value of Nifty is 4430. An investor bought a one-month Nifty for 4410
call option for a premium of ₹12. The option is:
(a) In the money
(b) At the money
(c) Out of the money
(d) Insufficient data.
Answer:
(i) - (b)
Rule for determining Expected Return on Portfolio under CAPM Under Capital Asset Pricing
Model (CAPM),Rp = Rf + (β × (Rm - Rf) Notation Particulars Value Rp Expected Return on
Portfolio To be computed Rf Risk Free Rate of Interest/ Return 10% β Portfolio Beta 0.30 Rm
Expected Return on Market Portfolio 15% Computation of Expected Return on Portfolio
Expected Return on Portfolio, Rp= Rf + β × (Rm - Rf) = 10% + 0.30(15%-10%)=11.5%
(ii) - (b)
At first, NPV and IRR of the projects are calculated and it has been found that,NPVA < NPVB
, IRRA > IRRB .The above results indicate that there is a conflict in ranking of the projects
under NPV and IRR. Such conflict is mainly due to the difference in the initial investment of
the projects and it can be resolved using incremental approach as follows. Differential
Cash Outflows = 25,00,000, Differential Net Cash Inflows = 29,00,000 We know that IRR is the
discount rate at which Present Value of Cash Inflows are equal to the Present Value of
Cash Outflows.
So, 25,00,000 = 29,00,000 / (1+ r)1
Or, 1 + r = 29,00,000 / 25,00,000 Or, r = 1.16 – 1 = 0.16
IRR (r) of the differential cash flows = 16%, which is greater than Cost of Capital (k).
Therefore, Project with higher non-discounted cash inflows, i.e., Project B would be
selected.
(iii) - (d)
0.43 The % spread on Cross rate between the Euro and NZ $. Let us find out the Cross rate
first. SPOT (Euro / NZ $) = (0.5020 × 1.3904) : (0.5040 × 1.3908) = 0.6980 : 0.7010 So, % Spread
on Euro to NZ $ = [(0/7010 – 0.6980) / 0.6980] × 100 = 0.4298 = 0.43.
(iv) - (c)
Theoretical forward price of security of X Ltd. [Fx] = Sx × e rt = ₹160 × e 0.09 × 0.0833

= ₹160 × e 0.0075
= ₹160 × 1.007528
= ₹161.20
(v) – (a)
84  72  6  4
= 30.56%
72
(vi) - (c) ₹7.5 Degree of Combined leverage
=∆EPS/EPS /∆ Sales/Sales  (38.40 - 9.60)/9.60÷(28,000 -20,000)/20,000

=3/0.4
=₹7.5
(vii) - (b) ₹89,41,680
P. V. of lease rentals = ₹18 lakhs × PVI FA (12%, 8)

= ₹18 lakhs × 4.9676
= ₹89,41,680
(viii) - (a) Make X will be cheaper
Make X
Purchase cost = ₹ 4.50 million
Equivalent annual cost = 4.50/6.1446 = ₹ 0.73235 million
Make Y
Purchase cost = ₹ 6.00 million
Equivalent annual cost = 6.00/7.6061 = ₹0.78884 million
Therefore, equivalent annual cost of make X is lower than make Y, make X is
suggested to purchase.
(ix) - (b) 58.33%
a. Fixed Income Funds= ₹(32,00,000 + 25,00,000 +13,00,000)

b. Equity Funds= ₹(30,00,000 +15,00,000 + 5,00,000)
Leverage=a/ (a + b) = ₹70,00,000/₹120,00,000 =58.33%
(x) - (a) In the money Spot Value > Exercise Price/Strike Value=> In the money ₹4430>₹4410
Section – B
Answer any five questions. [16×5= 80]
2. (a) M Ltd. is attempting to decide whether or not to invest in a project that requires
an initial outlay of ₹ 4 lakhs. The cash flows of the project are known to be made
up of two parts, one of which varies independently over time and the other one
which display perfect positive correlation. The cash flows of the six-year life of
the project are
(₹) (₹)
Perfectly Correlated Independent Component
Components
Year Mean Standard Mean Standard
Deviation Deviation
1 40,000 4,400 42000 4000
2 50,000 4,500 50000 4400
3 48,000 3,000 50000 4800
4 48,000 3,200 50000 4000
5 55,000 4,000 52000 4000
6 60,000 4,000 52000 3600
(i) Find out the expected value of the NPV and its standard deviation, using a discount
rate of 10%
(ii) Also find the probability that the project will be successful, i.e. P (NPV > 0) and state
the assumptions under which this probability can be determined. [12]
(b) A manager is lying to decide which of the three mutually exclusive projects to undertake.
Each of the projects could lead to varying net profits which are classified as outcomes I
II III. Manager has constructed the following pay –off table or matrix (a conditional profit
tables):
Project I II III
A 50,000 65,000 80,000
B 70,000 60,000 75,000
C 90,000 80,000 55,000
Probability 0.25 0.50 0.25
Which project should be undertaken? [4]
Answer:
(a)
Calculation of NPV
Year Mean (Perfectly Mean (Independent Expected PV factor @ Present value

correlated component) Value 10%
component)
(1) (2) (3) (4) = (2) + (3) (5) (6)=(4)X(5)
1 40,000 42,000 82,000 0.909 74,538
2 50,000 50,000 1,00,000 0.826 82,600
3 48,000 50,000 98,000 0.751 73,598
4 48,000 50,000 98,000 0.683 66,934
5 55,000 52,000 1,07,000 0.621 66,447
6 60,000 52,000 1,12,000 0.564 63,168
4,27,285
Less: Cash outflow 4,00,000
Expected Net Present Value 27,285
Calculation of Standard Deviation for Perfectly Correlated Components

Year Standard Deviation PV factor @ 10% Present Value
1 4,400 0.909 3,999.6
2 4,500 0.826 3,717.0
3 3,000 0.751 2,253.0
4 3,200 0.683 2185.6
5 4,000 0.621 2484.0
6 4,000 0.564 2256.0
16895.2
Standard Deviation = Variance2 = (16.895.2)2 = 285447783

calculation of variance for independent components
Year (1) Standard Deviation PV Factor @ 10% Present Value (Present Value)2 (5)
(2) (3) (4)=(2)X(3)
1 4,000 0.909 3,636.0 1,32,20,496
2 4,400 0.826 3,634.4 1,32,08,863
3 4,800 0.751 3,604.8 1,29,94,583
4 4,000 0.683 2,732.0 74,63,824√
5 4,000 0.621 2,484.0 61,70,256
6 3,600 0.564 2,030.4 41,22,524
Variance = 5,71,80,546
Variance of the Project

= Variance of Perfectly Correlated Components + Variance of Independent Components
= (16,895.2)2 + ₹5,71,80,546 = ₹28,54,47,783 + ₹5,71,80,546
= ₹ 34,26,28,329
Standard Deviation (σ) = 342628329 =18,510
(ii) P (NPV≥ 0) = P (z ≥ 0−27285 ) = P (z ≥ -1.47)

= 0.5+0.4292(from normal table)
= 0.9292
Hence, the probability that the project will be successful is 92.92%. The assumption made
under which this probability can be determined is that the cash flows follow normal
distribution with mean (M) is 27,285 and standard deviation (a) is 18,510 as calculated above.
(b) If the project with higher EV pf profit were chosen, this would be project C
Outcome Probability Project A EV Project B EV Project C EV
I 0.25 12500 17500 22500
II 0.50 32500 30000 40000
III 0.25 20000 18750 13750
1.00 65000 66250 76250
However, If the maximum criteria were applied, the assessment would be as follows:
Project Selected The worst outcome that could Profit (₹)

happen
A I 50000
B II 60000
C III 55000
Analysis: By choosing B, we are ‘guaranteed’ a profit of at least ₹60,000, which is more than
we would get from project A or C if the worst outcome were to occur for them . The decision
would therefore be to choose project B.
MTP_Final_Syllabus 2016_Jun2023_Set1
3. (a) Mr. Z has invested in the three mutual funds as per the following details:
Particulars MF X MF Y MF Z
Amount of investment 2,00,000 4,00,000 2,00,000
Net assets value (NAV) at the time of 10.30 10.10 10.00
purchase (₹)
Dividend received up to 31.03.2023 6,000 NIL 5,000
NAV as on 31/03/2023 10.25 10.00 10.20
Effective yield p.a. as on 31/03/2023 9.66 11.66 24.15
Assume 1 year =365 days

Mr. Z has misplaced the documents of his investment. Help him in finding of his original
investment after ascertaining the following:
(i) Numbers of units in each scheme,
(ii) Total net present value,
(iii) Total yield,
(iv) Number of days of investment held. [10]
(b) Sovereign Investments have floated an Equity Based Fund Scheme called “A – Cube”,
the funds of which will be invested only in stocks and Bonds of Infrastructure and
Construction Companies.60% of the Fund Value is invested in Companies engaged
Commercial Construction Services and the other 40% in companies engaged in
developing Residential Colonies /Townships. Average Beta of Return from development
of residential Townships is measured at 1.9 and that from commercial construction is
measured at 1.4. The Benchmark Index yields 11.20% return and RBI Bonds carry an
interest rate of 4.25 %.
Ascertain Jensen’s Alpha from the following monthly particulars relating to “A- cube “.
Opening NAV for January was ₹ 17.75
Month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Closing 18.60 17.80 18.20 18.00 17.80 16.8 17.20 17.80 17.90 18.10 18.80 18.5
NAV 0 0
Dividend 0.75 1.20
payment
[6]
Answer:
(a) (i) Number of units in each scheme
2,000,00
MF X-------------→₹ 10.30 = 19,417.48
4,00,000
MF Y------------→ ₹ 10.10 = 39,603.96
2,00,000
MF Z-------------→ ₹ 10.00 = 20,000.00
(ii) Total NAV as on 31/03/2023
MF X-------------→ 19,417.48 x ₹ 10.25 = ₹ 1,99,029.17

MF Y------------→ 39,603.96 x ₹ 10.00 = ₹ 3,96,039.60
MF Z-------------→ 20,000.00 x ₹10.20 = ₹ 2,04,000.00
(iii) Total yield
Name of Mutual Capital Yield Dividend Total

Funds Yield
MF X ₹1,99,029.17-₹ 2,00,000 = ₹ 970.83 ₹ 6,000 ₹5029.17
MF Y ₹ 3,96,039.60- ₹4,00,000 = ₹ 3960.40 NIL - ₹3960.40
MF Z ₹ 2,04,000-₹ 2,00,000= ₹ 4000 ₹ 5,000 ₹ 9,000
Total ₹10,068.00
10068.77
Total Yield =  100 = 1.2586%
8,00,000
(iv) No. of days’ investment was held
Particulars MF X MF Y MF Z
Let numbers of days be X Y Z
Initial investment 2,00,000 4,00,000 2,00,000
Yield (₹) 5029.17 -3960.40 9000
Yield (%) 2.5146 -0.9901 4.5
Period of holding (days) 2.5146 0.9901 4.5

 365  365 = 31  365
9.66 11.66 24.15
= 95 days days = 68 days
Date of original investment 26.12.22 28.02.23 22.01.23
(b) Computation of Return on “ A-Cube “ Scheme
Months Op. NAV Clg NAV Dividend Total Return Return%

₹ ₹ Distributed ₹
₹
1 2 3 4 5=(4)+(3)-(2) 6=(5)÷(2)x 100
Jan 17.75 18.60 0.85 4.79%
Feb 18.60 17.80 0.75 (0.05) (0.27%)
Mar 17.80 18.20 --- 0.40 2.25%
Apr 18.20 18.00 --- (0.20) (1.10%)
May 18.00 17.80 --- (0.20) (1.11%)
Jun 17.80 16.80 1.20 0.20 1.12%
Jul 16.80 17.20 --- 0.40 2.38%
Aug 17.20 17.80 --- 0.60 3.49%
Sep 17.80 17.90 --- 0.10 0.56%
Oct 17.90 18.10 ---- 0.20 1.12%
Nov 18.10 18.80 ---- 0.70 3.87%
Dec 18.80 18.50 --- (0.30) (1.60%)
Total 214.75 215.50 1.95 2.70 15.50%

therefore, Actual Return from “A-Cube” Scheme is [RA-Cube] 15.50%
2. Computation of Jensen’s Alpha
Beta “A-Cube” β A-Cube CAPM Return [E(R A-Cube)] Jensen’s Alpha(α)

Weighted Average Beta =Rf+ [β A-Cube x (Rm – Rf)] = Actual return – Expected
= 60% x 1.40 + 40% x 1.90 = 4.25%+ [1.60 x (11.20%- Return
= 0.84+0.76 4.25%)] = RA-Cube Less E(RA-Cube)]
=15.37% = 15.50% - 15.37%
= 1.60
= 0.13%
Evaluation: Since Jensen’s Alpha is positive, it has exceeded the expectations

outperformed the market portfolio
4. (a) Mahadev Real Estate Ltd invested at the beginning of year 1 in certain Equity Shares
as below:
Name of the Company No. of Shares Cost (₹)

M ltd 1,000 ( ₹ 100 each) 2,00,000
N ltd 500 (₹ 10 each) 1,50,000
in Year 1, 10% dividend was paid out by M Ltd., and 30% Dividend paid out by N LTD. At
the end of 1 Year, market quotation showed a value of ₹ 220 and ₹ 290 per share for M Ltd.
N Ltd respectively.
At the beginning of year 2, Investment advisors indicate –
(a) that the Dividend from M Ltd. and N Ltd. for the Year 2 are likely to be 20% and 35%
respectively and
(b) that the probabilities of market quotations at the end of Year 2 are as below:
Probability Price Per Share of M Ltd. Price per Share of N Ltd.

0.2 220 290
0.5 250 310
0.3 280 330
(i) Calculate the average Return from the Portfolio for the Year 1
(ii) Calculate the expected Average Return from the portfolio for the year 2, and
(iii) Advise Mahadev Real Estate Ltd of the comparative risk in the two Investment by
Calculation the Standard Deviation in each case. [10]
(b) Return on portfolios, W and L for the past 4 years are—
Year 1 2 3 4
Portfolio W 12.00% 12.50% 11.50% 13%
Portfolio L 15.00% 11.25% 13.50% 11.00%
Beta factor of the two portfolios are 1.3 and 1.2 respectively. If the market Portfolio fetches
12 % return and RBI bonds. Which are considered risk free, yield 5 % return which of the
above two portfolios will an investor prefer? [6]
DoS, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page
10
Answer:
(a)
1. Calculation of Closing MPS and Total Return for Year 1
Emps = expected market price per share
Gain = Closing MPS less Opening MPS,
DIV = Dividend
Yield = Div+Gain
M LTD.
Prob. Clg. Opg. Gain. Div. Yield MPS x Prob.
0.2 220 220 0 20 20 44
0.5 250 220 30 20 50 125
0.3 280 220 60 20 80 84
EMPS=253
N LTD
Prob. Clg. Opg. Gain. Div. Yield MPS x Prob.
0.2 290 290 0 3.5 3.5 58
0.5 310 290 20 3.5 23.5 155
0.3 330 290 40 3.5 43.5 99
EMPS=312
2. Calculation of return on portfolio
Particulars For Year 1 For Year 2

M Ltd. N Ltd. M Ltd. N Ltd.
Opening 200 300 220 290
Market
Price (P0)
Clg/Exp. 220 290 253 312
Market
Price(P1)
Return= 10  (220 - 200) 3  (290 - 300) 20  (253 - 220) 3.5  (312 - 290)
Div(P1-P0 ) 200 300 220 290
P0
3. Computation of Standard Deviation

Rm = Return from M LTD.
Dm = Deviation of M LTD.
Rn = Return from N LTD.
Dn = Deviation of N LTD.
Prob (P) M Ltd. N Ltd.

Rm Rf x P
Dm = R m - D m2 P x D m2 Rn Rf x P Dn = Rn -53 Dn 2 P x Dn2
53
0.2 20 4 -33 1089 217.80 3.5 0.70 -22 484 96.80
0.5 50 25 -3 9 4.50 23.5 11.75 -2 4 2.00
0.3 80 24 27 729 218.70 43.5 13.05 18 324 97.20
53 Variance of M LTD 441.00 25.50 Variance of N LTD 196.00
Standard deviation = √𝑃𝐷2 =√441 21 Standard deviation = √𝑃𝐷2 =√196 14
Comment: Shares of M LTD is riskier as its Standard Deviation is more than the Standard
Deviation of N LTD.
11
(b)
1. Computation of expected Rate of return under CAPM
E(Rx) RF+βx×(RM – RF) i.e expected return on portfolio
Risk Free Return RF 5% i.e Treasury bills
Return On Market Portfolio 12% given
Expected Return on Portfolio W Portfolio L

Beta factor 1.3 1.2
expected Return 5%+1.3×(12%-5%) 5%+1.2×(12%-5%)
=14.10% =13.40%
2. Computation of Alpha Factors

year Portfolio W Portfolio L
Actual Abnormal Return[ARW] Actual Abnormal Return [ARL]
Return Return
(1) (2) (3)=(2) – E (RW) (4) (5) = (4) – E (RL)
1 12.00% 12.00% - 14.10% = (2.10%) 15.00% 15.00% - 14.10% = 0.9%

2 12.50% 12.50% - 14.10% = (1.60%) 11.25% 11.25%-14.10%= (2.85%)
3 11.50% 11.50% - 14.10% = (2.60%) 13.50% 13.50% - 14.10% =(0.6%)
4 13.00% 13.00% - 14.10% = (1.10%) 11.00% 11.00%- 14.10%=(3.10%)
(7.40)% (5.65%)
Alpha Factor:
Portfolio W = ∑ 𝐴𝑅𝑊 ÷ n = (7.40%)÷ 4 Years =(1.85)
Portfolio L = ∑ 𝐴𝑅𝐿 ÷ n = (5.65%) ÷ 4 Years = (1.41)
3. Expected Return adjusted for Alpha

Alpha adjusted return = Return under CAPM+α
Portfolio W = E(RW)+α = 14.10% - 1.85% = 12.25%
Portfolio L = E(RL) +α = 13.40% - 1.41% = 11.99%
Alpha for Security W is higher than L ,indicating its better performance relative to L. Hence ,an
investor should prefer Portfolio W.
5. (a) Compute the theoretical forward price of the following securities:
Securities P ltd Q ltd R ltd

Spot price ₹ 4,500 ₹ 350 ₹ 900
Dividend Expected ₹ 50 ₹ 20 ₹ 50
Dividend Receivable in 2 months 3 months 4 months
6 month’s futures contract rate ₹ 4650 ₹ 360 ₹ 900
12
You may assume a Risk Free Interest Rate of 9% p. a. What is the course of action to
benefit from futures contract? Is there any arbitrage? [8]
(b) XYZ Ltd. shares are presently quoted at ₹100. The 3 Month Call Option carries a premium
of ₹15 for an Exercise Price of ₹120 and a 3 Month’s put option carries a premium of ₹20
for a strike price ₹120.
If the spot price on the expiry date is in the range of ₹90 to ₹160 with an interval of ₹5,
calculate Net Pay-Off along with graph for both call option and put option from the option
buyer’s perspective and option writer’s perspective. [8]
Answer:
(a)
Particulars P LTD Q LTD R LTD

Spot Price [Sx] ₹ 4,500 ₹ 350 ₹ 900
Dividend Expected [Df] ₹ 50 ₹ 20 ₹ 50
Dividend Receivable in [t] 2 months 3 months 4 months
6 month’s futures contract rate ₹ 4650 ₹ 360 ₹ 900
Particulars P LTD Q LTD R LTD

Present value of dividend DF x e-rt or DF÷ ert DF x e-rt or DF÷ ert DF x e-rt or DF÷ ert
[Dp]
= ₹ 50 x e-0.09x0.1667 = ₹ 20 x e-0.09x0.25 =₹ 50 x e-0.09x0.3333
= ₹ 50 x e-0.015 = ₹ 20 x e-0.0225 =₹ 50 x e-0.03
= ₹ 50 x 0.9851 = ₹ 20 x 0.9775 = ₹ 50 x 0.9704
= ₹ 49.255 = ₹ 19.555 = ₹ 48.52

Adjusted spot price = Sx - = ₹ 4500- ₹ 49.255 =₹ 350- ₹ 19.555 =₹ 900- ₹ 48.520
Dp
=₹ 4,450.744 = ₹ 330.445 = ₹ 851.48
Theoretical forward Price = ₹ 330.445 x e0.09x0.50 ₹ 851.48 x e0.09x0.50
[TFPx] ₹4,450.745xe0.09x0.50
= SAdj x ert =₹ 330.445 x e0.045 =₹ 851.48 x e0.045
= 6 months future contract = ₹ 4,450.745 x
rate[AFPx] e0.045 = ₹ 345.645 = ₹ 890.648
[TFPx] Vs [AFPx] = ₹ 4,650 AFPx is Higher AFPx is Higher

Valuation in Futures Market Overvalued Overvalued
Recommended Action AFPx is lower Buy Spot. Sell Future Buy Spot. Sell
Undervalued Future
Sell Spot. Buy
Future
Conclusion: Since the theoretical Forward Price is different from the Stock Price, Arbitrage
exits in all the three cases.
13
(b) Calculation of Net Payoff of Call Option Buyer and Writer
Call Option
Spot Exercise Price Gross Premium Action Net Payoff Net Payoff
Price (₹) Payoff (Long/Buyer) (Short/Seller)
90 120 0 15 Lapse (15) 15
95 120 0 15 Lapse (15) 15
100 120 0 15 Lapse (15) 15
105 120 0 15 Lapse (15) 15
110 120 0 15 Lapse (15) 15
115 120 0 15 Lapse (15) 15
120 120 0 15 Lapse (15) 15
125 120 5 15 Exercise (10) 10
130 120 10 15 Exercise (5) 5
135 120 15 15 Exercise 0 0
140 120 20 15 Exercise 5 (5)
145 120 25 15 Exercise 10 (10)
150 120 30 15 Exercise 15 (15)
155 120 35 15 Exercise 20 (20)
160 120 40 15 Exercise 25 (25)
Put Option
Spot Price Exercise Gross Premium Action Net Payoff Net Payoff
Price (₹) Payoff (Long/Buyer) (Short/Seller)
90 120 30 20 Exercise 10 (10)
95 120 25 20 Exercise 5 (5)
100 120 20 20 Exercise 0 0
105 120 15 20 Exercise (5) 5
110 120 10 20 Exercise (10) 10
115 120 5 20 Exercise (15) 15
120 120 0 20 Lapse (20) 20
125 120 (5) 20 Lapse (20) 20
130 120 (10) 20 Lapse (20) 20
135 120 (15) 20 Lapse (20) 20
140 120 (20) 20 Lapse (20) 20
145 120 (25) 20 Lapse (20) 20
150 120 (30) 20 Lapse (20) 20
155 120 (35) 20 Lapse (20) 20
160 120 (40) 20 Lapse (20) 20
6. (a) X Ltd. an Indian company has a payable of US$ 1,00,000 due in 3 months. The
company is considering to cover the payable through the following alternatives:
i) Forward contract,
ii) Money market
iii) Option
14
The following information is available with the company: Exchange rate:
Spot ₹/$45.50/45.55 3
m- Forward 45.90/46.00
Interest Rate (%): Per annum

US 4.5/5.0 (Deposit/Borrow)
India 10.0/11.0 (Deposit/Borrow)
Call option on $ with a strike price of ₹46 is available at a premium of ₹ 0.10/$. Put option on
$ with a strike price of ₹ 46.00 is available with a premium of ₹ 0.05/$.
Treasury department of the company forecasted the future spot rate after 3 months to be:
Spot rate after 3-m Probability
₹ 45.60/$ 0.10
₹ 46.00/$ 0.60
₹ 46.40/$ 0.30
You are required to suggest the best alternative of hedging. [8]
(b) A firm is contemplating import of a consignment from USA for a value of USD 10,000. It
requires 90 days to make payment. Supplier has offered 60 days’ interest–free credit and is
willing to offer additional 30 days’ credit at an interest rate of 6% per annum. the Bankers of
the firm offer a short loan for days at 9 % per annum. Bankers quotation for Foreign exchange
is
(a) Spot 1 USD = ₹ 46.00,
(b) 60 days forward 1 USD = ₹ 46.20,
(c) 90 days for ward 1 USD = ₹ 46.35.
You are required to advice the firm as to whether it should—

(i) Pay the supplier in 60 days or
(ii) Avail the suppliers offer of 90 days’ credit. [8]
Answer:
(a) : Exchange rate ₹/$
Spot 45.50 / 45.55
3-m Forward 45.90 / 46.00
3-m Interest Rate %
US 4.5 / 5.0
India 10.00 / 11.00
i. Forward Hedge: After 3-m, outflow of ₹ for the month is ₹(1,00,000×46.00) = 46,00,000
ii. Money Market: The firm should borrow ₹ and convert it into $ at the spot rate. Then
the $ proceeds for 3 –m to be invested and the payable will be settled at maturity
out of the $ investment.
Therefore, $ to be invested to get $ 1,00,000 3-m hence is:
1,00,000 = $98,887.52
To get $ 98,887.52 the amount of₹ required is = (98,887.52×45.55) = ₹ 45,04,326.54.
So, the firm has to borrow a sum of ₹ 45,04,326.54.
15
Hence, rupee repayment after 3-m is=₹ 45,04,326.54×1 + 0.11=₹46,28,195.52
iii. Option Hedge: Since the firm has a $ liability, it should go long on call $ option. That
means the firm will buy $ call option with a strike price of ₹ 46.00 at a premium
of ₹ 0.10/$.
So, total premium paid is ₹ (1,00,000×0.10)= ₹ 10,000.
Possible spot rate after 3- Whether to exercise Total ₹ outflow Probability

m (₹/$) Option
45.60 No 45,70,000 0.10
46.00 No 46,10,000 0.60
46.40 Yes 46,00,000 0.30
Expected rupee outflow after 3 month is -

= ₹(45,70,000×0.10)+ ₹(46,10,000×0.60)+₹ (46,10,000×0.30)
= ₹46,06,000.
The firm can also go short on the put option, that is sell $ put option with a strike price of
₹ 46.00 at a premium of ₹0.05/$. Total premium received is ₹ (1,00,000×0.05)= ₹ 5,000
(b) Cash Outflows under the two options are—
Particulars Alternative 1 Alternative 2

(i)Supplier’s Credit 60 days NIL interest 90 days 30 days Credit @ 6
% p.a.
(ii) Bank Loan 30 days @ 9% p.a. NA
(iii) Amount in USD 10,000 10,000+(interest) 50 = 10,050

[see pt. (vi)]
(iv) Application forward rate 46.20 46.35
(v) Amount in ₹ [(c)x(d)] 4,62,000 4,65,818

1
(vi)Interest 10,000 x 9 % 1/12=
4,62,000 x 9% x 12 =
₹ 3,465 USD 50
(Vii) Total Cash Outflow
[(e)+(f)] ₹ 4,65,465 ₹ 4,65,818
conclusion: Alternative 1 is better because of lower cash outflow.
7. (a) XYZ. Ltd. is considering the possibility of purchasing a multipurpose machine which
cost ₹ 10 lakhs. The machine has an expected life of 5 years. The machine generates ₹ 6
lakhs per year before depreciation and tax, and the management wishes to dispose the
machine at the end of 5 years which will fetch ₹ 1 lakh. The depreciation allowable for the
machine is 25% on written down value and the company's tax rate is 50%. The company
approached a NBFC for a five-year lease for financing the asset which quoted a rate of
₹ 28 per thousand per month. The company wants you to evaluate the proposal with
purchase option.
16
The cost of capital of the company is 12% and for lease option it wants you to consider a
discount rate of 16%. [8]
(b) An investor estimates return on shares in two different companies under four different
scenarios as under:
Scenario Probability of its Return on Security A Return on Security

happening (%) B (%)
I 0.2 12 10
II 0.4 16 20
III 0.3 18 25
IV 0.1 25 30
You are required to:

(i) Calculate Expected rate of return if the investor invests all his funds in Security A
alone or in Security B alone.
(ii) Determine the preferred security based on return.
(iii) Ascertain the risk associated with each of the security.
(iv) If the investor invests 40% in Security A and 60% in Security B, what is the expected
return and the associated risk. [8]
Answer:
(a)
Evaluation of Purchase Option

(₹ in lakhs)
Particulars 0 1 2 3 4 5
Initial outlay (10) - - - - -
Operating Profit 6.00 6.00 6.00 6.00 6.00
Less : Depreciation 2.50 1.88 1.40 1.06 0.79
Profit before tax 3.50 4.12 4.60 4.94 5.21
Less : Tax (a.1 50% 1.75 2.06 2.30 2.47 2.60
Profit after tax 1.75 2.06 2.30 2.47 2.61
Add : Depreciation 2.50 1.88 1.40 1.06 0.79
Salvage value of - - 1.00
machine
Net cash Inflow 4.25 3.94 3.70 3.53 4.40
Present value factor @ 1.00 0.893 0.797 0.712 0.636 0.567
12%
Present values (10) 3.80 3.14 2.63 2.25 2.49
Therefore, ₹ (3.80+3.14+2.63+2.25+2.49-10) = ₹ 4.31
17
Net present value of the purchase option is ₹ 431000
(₹ in Lakhs)
Particulars 1 2 3 4 5
Operating profit 6.00 6.00 6.00 6.00 6.00
Less ; Lease rent 3.36 3.36 3.36 3.36 3.36
Profit before tax 2.64 2.64 2.64 2.64 2.64
Tax @ 50% 1.32 1.32 1.32 1.32 1.32
Profit after tax 1.32 1.32 1.32 1.32 1.32
Discount factor @ 16% 0.862 0.743 0.641 0.552 0.476
Present values 1.14 0.98 0.85 0.73 0.63
Therefore, ₹ (1.14+0.98+0.85+0.73+0.63) = ₹ 4.33
The net present value of lease option is ₹ 4,33,000.
Suggestion: From the analysis of the above we can observe that NPV of lease option is more
than that of purchase option. Hence, lease of machine is recommended.
(b) P= probability, RA = Return of A, RB = Return of B,DA= Deviation of A (RA-ERA),DB= Deviation of

B (RB-ERB),PRA=Probability x RA, ERA= Expected Return from A i.e. mean ,PDP2= Probability x
Deviation of portfolio
(i) Expected Return from Security A & Security B
Scenario Probability Return (%) Expected Return Deviation (D) Deviation square Variance
(P) RA (%) = PRA from (DA2) PDA2
Mean
DA
(1) (2) (3) (4)= (2)*(3) 5=(3)- Σ (4)] (6)=[(3)- Σ (4)]2 6=(2)*(5)
I 0.2 12 2.4 -4.7 22.09 4.418
II 0.4 16 6.4 -0.7 0.49 0.196
III 0.3 18 5.4 1.3 1.69 0.507
IV 0.1 25 2.5 8.3 68.89 6.889
ERA 71 16.7 A2 12.01
Scenario Probability Return Expected Deviation (D) Deviation Variance

(P) (%) Return (%) = from square PDB2
RB PRB Mean (DB2)
DB
(1) (2) (3) (4)= (2)*(3) 5=(3)- Σ (4)] (5)=[(3)- Σ 6=(2)*(5)
(4)]2
I 0.2 10 2.0 -10.5 110.25 22.05
II 0.4 20 8.0 -0.5 0.25 0.1
III 0.3 25 7.5 4.5 20.25 6.075
IV 0.1 30 3.0 9.5 90.25 9.025
ERB 85 20.5 B2 37.25
18
Expected return on Security A=16.7%
Risk on Security A (σ) = √𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒= 12.01 =3.465
Expected return on Security B=20.5%
Risk on Security B (σ) = √𝑉𝑎𝑟𝑎𝑖𝑛𝑐𝑒= √37.25=6.103
(ii) Preferred Security: Based on return alone, Security B is preferable since it has a higher
return at 20.5 %
(iii) Determination of Portfolio Risk :
Standard Deviation of Security A A is 3.465 %

Standard Deviation of Security A B is 6.103 %
Covariance between Security A & B
Scenario Probability Deviation from Deviation from Deviation Covariance

(P) Mean for Mean for Product
A(%) B (%) COVAB
DB D A x DB
DA
(1) (2) (3) (4) (5) (6)=(2)*(5)
I 0.2 -4.7 -10.5 49.35 9.87
II 0.4 -0.7 -0.5 0.35 0.14
III 0.3 1.3 4.5 5.85 1.755
IV 0.1 8.3 9.5 78.85 7.885
COVAB 19.65
Correlation Co-efficient of A and B
COVAB 19.65
PAB =
 A B = 3.465  6.103 =0.9292
Risk of portfolio i.e. standard deviation of Portfolio A and B [40% and 60% Ratio] (σ) A and B=
3.465 2
  
 0.402  6.1032  0.602  2  0.92923.465  0.40  6.103  0.60 
= 1.921  13.408  9.431
= 24.76 = 4.975%
Risk Return:= 40% of Return on A+60% Return on B
=(0.40 x 16.7+0.60 x 20.5)
= 6.68+12.3
=18.98
19
8. Write short notes on any four of the following: [4×4=16]
(a) Optionally Convertible Debentures(OCD) and its advantages.

(b) Four exchange of India.
(c) Credit risks and its types.
(d) Sources of Foreign Currency.
(e) Major main functions and activities of RBI.
Answer:
(a) These are the debentures that include the option to get converted into equity. The investor
has the option to either convert these debentures into shares at price decided by the issuer/
agreed upon at the time of issue.
Advanteges of OCD:
(1) Issuer-
(i) dependence of financial institution is reduced because of the inherent option for
conversion.
(ii) It is possible to maintain Equity Price at a high level, by issuing odd-lot s hares
consequent to convertion of the debentures , and hence lower floating stocks.
(2) Investor:
(i) investor gets assured interest during gestation periods of the project, and start
receiving dividends once the project is functional and they choose to convert
debentures.
(ii) The investment is secured against the assets of the company , as against company
deposits which are unsecured.
(iii) there is a possibility of capital gain associated with conversion, which compensates
for the lower interest rate a debentures.
(3) Government:
(i) Debentures helped in mobilizing significant resources from the public and help in
spreading the equity investors , thereby reducing the pressure on financial institutions
for their resources.
(ii) By making suitable tax amendments, benefits are extended to promote these
instruments to:
A. safe guard the funds of Financial Institutions.
B. Encouraging more equity participation, which will also require a higher
compliance under Corporate Laws, whereby organizations can be monitored
more effectively.
(b) The four exchanges of India are -
(1) National Multi Commodity Exchange of India Ltd.(NMCEIL):

The NMCE is the first demutualized electronic commodity exchange of India granted the
National Exchange of Govt. of India and operational since 26 th Nov. 2002.The head of of
it is located in Ahemedabad.There are various commodity trades on NMCE platform
including Agro and non-Agro commodities.Promoters of NMCE are CWC,NAFED,GAICL
etc.
20
(2) National Commodity & Derivatives Exchange Limited (NCDEX):

NCDEX is a public limited company incorporated on April 23 2003 under the companies
Act ,1956.It obtained its certificated for commencement of business on may 9 ,2003. It
has commenced its operation on December 15 2003.It is professionally managed online
multi commodity exchange promoted by ICICI Bank Limited, LIC, NABARD and NSE.
(3) Multi – Commodity Exhange of India Limited (MCX): MCX Inaugurated in November 2003
by Shree Mukesh Ambani, Chairman & managing director ,Reliance Industries Ltd.MCX
offers futures trading in the following commodity categories , Agri commodity, bullion
cOmmodity, Metal- Ferrous & Non – Ferrus , Pulses , Oils & Oilseeds , Energy , Plantation
,Spices and other soft commodity.Key shareholders of MCX are financial Technologies
(india) Ltd., State bank of Saurashtra,SbI Life Insurance Co. Ltd. Union Bank of India, Bank
of India, Bank of Boroda, Canara bank ,Corporation Bank. Etc
(4) Indian Commodity Exchange Ltd.( ICEL): It is latest commodity exchange of India started
Function from 27 Nov , 09 . It is a Screen based on-line derivatives exchange for
commodities and has established a reliable, time- tested and a transparent trading
platform.It is also in the process of putting in palce robust assaying and warehousing
facilities in order to facilitate deliveries. It is jointly Ne promoted by Reliance exchange
next infrastructures limitedand MMTC limited, India bulls Financial Services Ltd.KRIBHCO,
Indian Potash Ltd., and IDFC among others ,as its partners.
(c) Credit Risk & Its types: Credit risk refers to the risk that an obligor will default, either willfully or
due to incapacity on any type of debt by failing to make payments which it is obligated to
do.The risk is primarily that of the lender and includes lost principal and interest, disruption to
cash flows and increased collection costs.
Credit risk can be classified in the following way:
(i) Credit default risk: The risk of loss arising from a debtor being unlikely to pay its loan
obligations in full or the debtor is more than 90 days past due on any material credit
obligation; default risk may impact all credit sensitive transactions, including loans,
securities and derivatives.
(ii) Counterparty risk: The risk of loss arising from nonperformance of counterparty in trading
activities such as buying and selling of commodities, securities, derivatives and foreign
exchange transactions. If inability to perform contractual obligations in such trading
activities is communicated before the settlement date of the transaction, then
counterparty risk is in the form of pre-settlement risk, while if one of the counterparty
defaults on its obligations on the settlement date, the counterparty risk is in the form of
settlement risk.
(iii) Concentration risk: The risk associated with any single exposure or group of exposures
with the potential to produce large enough losses to threaten a lender ‘s core operations.
It may arise in the form of single name concentration or industry concentration.
(iv) Country risk: The risk of loss arising from sovereign state freezing foreign currency
payments (transfer/ conversion risk) or when it defaults on its obligations (sovereign risk).
(d) Sources of Foreign Currency: The major sources for raising foreign currency finances are as
follows:
1. Foreign currency term loan for meeting the foreign currency expenditures towards import
of plant, machinery, payment of foreign technical knowhow fees.
2. Export Credit scheme like export agencies finance exports of capital goods and related
technical services.
3. External Commercial Borrowings (ECB) include, raising finance from international markets
for plant and machinery imports.
4. Euro Issues: subscription can come from any part of the world by various forms like
depository receipts mechanism, foreign Currency /Euro Convertibles Issues, debt Route.
21
(e) The major Functions and activities of RBI: The Reserve Bank is the umbrella network for
numerous activities, all related to the nation’s financial sector, encompassing and extending
beyond the functions of a typical central bank. This section provides an overview of our
primary activities:
Monetary Authority→ The main objectives of monetary
Issuer of Currency
Banker and Debt Manager to Government
Banker to Banks
Regular of the Banking System
Manager of Foreign Exchange
Maintaining Financial Stability
Regulator and Supervisor of the Payment and settlement Systems
Developmental Role
22
Answer to MTP_Final_Syllabus 2016_Dec2023_Set1
PAPER 14 - STRATEGIC FINANCIAL

MANAGEMENT
Dos, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 1
PAPER 14 - STRATEGIC FINANCIAL MANAGEMENT
Full Marks: 100 Time allowed: 3 hours
Answer Question No. 1 which is compulsory and carries 20 marks and any five from
Questions No. 2 to 8.
Section – A
1. Choose the correct option among four alternative answer. (1 mark for correct choice,
1 mark for justification.) [10 ×2 = 10]
(i) You are a forex dealer in India. Rates of rupee and Euro in the international
market are US $ 0.01962905 and US $ 1.335603 respectively. What will be
your direct quote of € (euro) to your customer?
a. ₹ 69.5900
b. ₹ 68.0420
c. ₹ 65.1010
d. ₹ 70.905
(ii) Marison Ltd. is planning to invest in USA. The rates of inflation are 8 % in
India and 3 % in USA. If spot rate is currently ₹46.50/$, what spot rate can
the company expect after 5 years?
a. ₹57.93/$
b. ₹58.94/$
c. ₹59.00/$
d. ₹59/.13/$
(iii) The Beta co-efficient of equity stock of ECOBOARD LTD. Is 1.6. The risk
free rate of return is 12% and the required rate of return is 18% on the
market portfolio. If dividend expected during coming year is ₹2.50 and the
growth rate of dividend and earnings is 8%, at what price the stock of
ECOBOARD ltd. Can be sold (based on CAPM)?
a. ₹18.38
b. ₹15.60
c. ₹12.50
(iv) The spot USD/Yen=190 Yen and one year forward rate of USD/Yen =210Yen
The prime rate in US is 15%. What should be Japanese prime rate be?
a. 20.11%
b. 25.22%
c. 27.11%
d. 29.55%
(v) Which of the following investment avenues has the least risk associated with
it?
a. Corporate fixed deposits
b. Deposits in commercial banks
c. Public Provident Fund
d. Non-convertible zero coupon bond.
(vi) Consider the following data:

Rate of inflation=5.1%
Beta=0.85
Real rate of return=4.2%
Market return=12.6%
The risk premium for the above security will be:
a. 2.5%
b. 2.65%
c. 2.805%
d. 2.95%
(vii) Covariance between a stock and a market index and variance of market index
are 33.56 and 19.15 respectively. The Beta of stock is:
a. 1.55
b. 1.75
c. 1.85
d. 1.95
(viii) The face value of a 364-day T-Bill is ₹100. If purchase price is ₹86, then the
yield on such a bill is
a. 12.5%
b. 13.36%
c. 16.32%
d. 16.56%
(ix) A company has obtained quotes from two different manufacturers for an
equipment. The details are as follows:
Product Cost (Million) Estimated life (years)
Make X 4.50 10
Make Y 6.00 15
Ignoring operation and maintenance cost, which one would be cheaper? The
company’s cost of capital is 10%.
[Given: PVIFA (10%, 10 years) = 6.1446 and PVIFA (10%, 15 years) = 7.6061]
a. Make X will be cheaper
b. Make Y will be cheaper
c. Cost will be the same
(x) The stock of ABC Ltd sells for ₹ 240. The present value of exercise price and
value of call option are ₹217.40 and ₹39.60 respectively. What is the value of
put option?
a. ₹ 16.50
b. ₹ 22.00
c. ₹ 17.00
d. ₹ 18.00
Answer:
(i) — (B).
₹68.0420: ₹ /US $ = 1/0.01962905 = ₹50.9449
Now, US $ /€ = 1.335603
Therefore, the direct quote of €in India will be —
₹/€=₹/$ x $/€=₹50.9449 × 1.335603 = ₹68.0420
(ii) — (B).
₹58.94/$ E(₹/$) = 46.50 x [(1.08)5/(1.03)5
= 46.5(1.08/1.03)5
= 46.50 x1.267455
= ₹58.94
Hence, expected rate is ₹58.94/$
(iii) — (A).
Expected return (By CAPM) Re=Rf+β(Rm-Rf)
=12%+1.6(18%-12%)
=12%+9.6%
=21.6%
Price of stock (Dividend growth formula) Re
= D1/P0+g
= 0.216 =2.50/P0+0.08
= 0.216-.08 =2.50/P0
= 0.136=2.50/P0
P0 = 2.50/0.136 = ₹18.38
(iv) — (C).
From Interest Rate parity - (¥210/$)/(¥190/$)=(1+i¥)/1.15
Or, i¥=27.11%
(v) — (C).
Public Provident Fund (PPF).
PPF Account can be opened in a Head Post Office or branch of SBI or subsidiaries.
The rate of interest on these accounts is determined by Central Government.
(vi) — (C).
Risk free return= Real rate of return + Rate of inflation
= 5.1+4.2
= 9.3
Risk Premium = β(Rm-Rf)
= 0.85(12.6-9.3)
= 2.805
(vii) — (B).
Β = Covs m/Variance m =33.56/19.15=1.75
(viii) — (C).
[₹(100-86)/₹86]x365/364x100 =16.32%
(ix) — (A).
Make X Purchase cost = ₹4.50 million
Make Y Purchase cost = ₹6.00 million
Therefore, equivalent annual cost of make X is lower than make Y, make X is
suggested to purchase.
(x) — (C).
Value of put option = Value of Call option + PV of exercise price – Stock price
= ₹ (39.60+217.40-240) = ₹17.
Section - B
Answer any five questions from question nos. 2 to 8. Each question carries 16 marks.
2. (a) X Ltd. an existing profit making company, is planning to introduce a new

product with a projected life of 8 years’ initial equipment cost will be ₹120 lakhs
and additional equipment costing ₹10 lakhs will be needed at the beginning of third
year. At the end of the 8 years, the original equipment will have resale value
equivalent to the cost of removal, but the additional equipment would be sold for
₹ 1 lakhs. Working Capital of ₹15 lakhs will be needed. The 100% capacity of the
plant is of 4,00,000 units per annum, but the production and sales volume expected
are as under:
Year Capacity in percentage

1 20
2 30
3-5 75
6-8 50
A sale price at of ₹100 per unit with a profit volume ratio of 60% is likely to be
obtained. Fixed Operating Cash Cost are likely to be ₹16 lakhs per annum. In
addition to this the advertisement expenditure will have to be incurred as under:
Year 1 2 3-5 6-8

Expenditure in ₹ in Lakhs each year 30 15 10 4
The company is subject to 40% tax. Assuming straight-line method of depreciation

is permitted under tax laws and taking 15% as appropriate after tax Cost of Capital,
should the project be accepted? [10]
(b) Determine the risk adjusted net present value of the following projects:
A B C
Net cash outlays (`) 1,00,000 1,20,000 2,10,000
Project life 5 years 5 years 5 years

Annual cash inflow (`) 30,000 42,000 70,000
Coefficient of variation 0.4 0.8 1.2
The company selects the risk-adjusted rate of discount on the basis of the coefficient
of variation:
Coefficient of Risk adjusted Present value factor 1 to 5 years at risk
variation rate of discount adjusted rate of discount
0.0 10% 3.791
0.4 12% 3.605
0.8 14% 3.433
1.2 16% 3.274
1.6 18% 3.127
2.0 22% 2.864
More than 2.0 25% 2.689
[6]
Answer :
2. (a) Computation of initial cash outlay

(` in lakhs)
Equipment Cost (0) 120
Working Capital (0) 15
135
Calculation of Cash Inflows:
Year 1 2 3-5 6-8
Sales in units 80,000 1,20,000 3,00,000 2,00,000
Contribution @ ₹60 p.u. 48,00,000 72,00,000 1,80,00,000 1,20,00,000
Fixed cost 16,00,000 16,00,000 16,00,000 16,00,000
Advertisement 30,00,000 15,00,000 10,00,000 4,00,000
Depreciation 15,00,000 15,00,000 16,50,000 16,50,000
Profit/(loss) (13,00,000) 26,00,000 1,37,50,000 83,50,000
Tax @ 40% Nil 10,40,000 55,00,000 33,40,000
Profit/(loss) after tax (13,00,000) 15,60,000 82,50,000 50,10,000
Add: Depreciation 15,00,000 15,00,000 16,50,000 16,50,000
Cash Inflow 2,00,000 30,60,000 99,00,000 66,60,000
Computation of PV of CIF
Year PV Factor @
CIF
15%
₹ ₹
1 2,00,000 0.8696 1,73,920

2 30,60,000 0.7561 23,13,666
3 99,00,000 0.6575 65,09,250
4 99,00,000 0.5718 56,60,820
5 99,00,000 0.4972 49,22,280
6 66,60,000 0.4323 28,79,118
7 66,60,000 0.3759 25,03,494
8 66,60,000 0.3269 21,77,154
WC 15,00,000 0.3269 4,90,350
SV (1,00,000) 0.3269 (32,690)
2,75,97,362
PV of COF0 1,35,00,000
Additional Investment = ₹ 10,00,000 × 0.7561 7,56,100
NPV 1,33,41,262
Recommendation: Accept the project in view of positive NPV.

2. (b)
Statement showing the determination of the risk adjusted net present value
Projects Net cash Coefficient Risk Annual PV Discounted Net
outlays of adjusted cash factor 1- cash present
variation discount inflow 5 years at inflow value
rate risk
adjusted
rate of
discount
₹ ₹ ₹ ₹ ₹
(i) (ii) (iii) (iv) (v) (vi) (vii) (viii) =
=(v) x (vi) (vii) - (ii)
A 1,00,000 0.4 12% 30,000 3,605 1,08,150 8,150
B 1,20,000 0.8 14% 42,000 3,433 1,44,186 24,186
C 2,10,000 1.20 16% 70,000 3,274 2,29,180 19,180
3. (a) A mutual fund made an issue of 800000 units of ₹10 each on 01.04.2022. No entry
load was charged. It made the following investments after meeting its issue expenses.
Particulars ₹
40,000 Equity Shares of ₹100 @ ₹160 64,00,000
At par:
8% Government Securities 6,40,000
9% Debentures (unlisted) 4,00,000
10% Debentures (listed) 4,00,000
78,40,000
During the year, dividend of ₹9,60,000 was received on equity shares. Interest on all
types of debt securities was received as and when due. At the end of the year on
31.03.2023, equity shares and 10% debentures were quoted at 175% and 90% of the
respective par value. Other investments were at par. The operating expenses during
the year amounted to ₹4,00,000.
(i) Find out the Net Assets Value (NAV) per unit at the end of the year.
(ii) Find out the NAV if the Mutual Fund had distributed a dividend of ₹0.90 per
unit during the year to the unit holders. [8]
(b) Following information is available regarding four Mutual Funds:

Mutual Fund Return (%) Standard Diviation (σ) Beta (β)
A 12 15 0.80
B 16 22 0.76
C 21 37 1.15
D 13 24 1.32
Risk free rate of return is 10% and face value is `100 each.
Evaluate the performance of these Mutual Funds using Sharpe Ratio and
Treynor's Ratio. Comment on the evaluation after ranking the Funds. [8]
Answer:
3. (a) Computation of closing net asset value
Given the total initial investment ₹ 78,40,000 out of issue proceeds of ₹80,00,000 therefore
balance of ₹1,60,000 is considered as issue expenses.
Particulars Opening value Capital Closing value Income
of investment Appreciation of investment ₹
₹ ₹ ₹
40000 Equity of ₹100 each 64,00,000 6,00,000 70,00,000 9,60,000
at ₹160
8% Government securities 6,40,000 Nil 6,40,000 51,200
9% Debentures (Unlisted) 4,00,000 Nil 4,00,000 36,000
10% Debentures (Listed) 4,00,000 - 40,000 3,60,000 40,000

Total 78,40,000 5,60,000 84,00,000 10,87,200
Total Income = ₹ 10,87,200

Less: Opening Expenses during the period = ₹ 4,00,000
Net Income ₹ 6,87,200
Net Fund Balance ₹84,00,000 + ₹6,87,200 = ₹ 90,87,200
Less: Dividend = ₹7,20,000 (8,00,000 × 0.90) = ₹ 7,20,000
Net Fund balance (after dividend) = ₹ 83,67,200
Net Asset Value (before considering dividend) = ₹ 90,87,200
Net Asset Value(before considering dividend) [₹90,87,200 ÷ 800000]= ₹ 11.36
Net Asset Value (After dividend) [₹83,67,200 ÷ 800000] = ₹ 10.46
Note: Closing market price of the investment have been quoted at a percentage of the face
value (Assumption)
3. (b) Sharpe Ratio = (Rp- Rf)/σp; and Treynor's Ratio = (Rp- Rf)/βP.
Where RP = return on Portfolio Rf
= Risk-free return
σp = Standard deviation of portfolio
βP = Beta of portfolio
Mutual Under Sharpe's method Ranking Under Treynor's Ranking

Fund method
A (12 - 10) / 15 = 0.133 3 (12 -10 )/0.80 = 2.5 3
B (16-10)/22 = 0.27 2 (16 - 1 0 ) / 0.76 = 7.89 2
C (21 -10)/ 37 = 0.30 1 (21 - 1 0 ) / 1.15 = 1
9.57
D (13 -10)/24 = 0.125 4 (13 -10 )/1.32 = 2.27 4
Rank in both methods is same. This indicates that all the Mutual Funds seem to be
reasonably well diversified.
4. (a) An investor is interested to construct a portfolio of securities ALFA and GAMA.

He has collected the following information about the proposed investment:
ALFA GAMA
Expected return 20% 25%
σ 12% 16%
Co-efficient of Correlation (r) between ALFA and GAMA is 0.16.
He wants to constitute only 5 portfolios of ALFA and GAMA as follows:
(1) All funds invested in ALFA.
(2) 50% of funds in ALFA and 50% in GAMA.
(5) All funds invested in GAMA.
You are required to calculate:

(A) Expected return under different portfolios.
(B) Risk factor associated with these portfolios.
(C) Which portfolio is best from the view-point of risk?
(D) Which portfolio is best from the view-point of return? [8]
(b) A portfolio manager has the following four stocks in his portfolio:
Security No. of shares Market Price per share β = Beta
(`)
VSL 10,000 50 0.9 1.0
CSL 5,000 20 1.5
SML 8,000 25 1.2
APL 2,000 200
Compute the following:
(i) Portfolio Beta (β).
(ii) If the Portfolio Manager seeks to reduce the Beta to 0.8, how much Risk-
free investment should he bring in?
(iii) If the Portfolio Manager seeks to increase the Beta to 1.2, how much
Risk-Free investment should he bring in? [8]
Answer:
4. (a) (A) Expected return under different portfolios

Portfolio (1): 1 x 0.20 + 0 x 0.25 = 20%
Portfolio (2): 0.5 x 0.20 + 0.5 x 0.25 = 22.50%
Portfolio (3): 0.75 x 0.20 + 0.25 x 0.25 = 21.25%
Portfolio (4): 0.25 x 0.20 + 0.75 x 0.25 = 23.75%
Portfolio (5): 0 x 0.20 + 1 x 0.25 = 25%.
(B) Risk factor associated with different Portfolios –

Portfolio (i) = [(σa2 × Wa 2) + (σc2 × Wc 2) + 2 (σa × Wa × σc × Wc × ac)]1/2,
where a= ALFA and c = GAMA.
= [(122 × 12) + (162 ×0 2) + 2 × 1 2 ×1 × 1 6 ×0 × 0. 1 6 ]1/2 = (144)1/2 =12%.
Similarly, Portfolio (ii) = (115.36)1/2 = 10.74%.
Portfolio (iii) = (108.52)1/2 = 10.42%
Portfolio (iv) = (164.52)1/2 = 12.83%
Portfolio (v) = (256)1/2 = 16%.
(C) The best portfolio from the viewpoint of Risk is one which has least risk factor;
i.e., 10.42%, i.e., Portfolio (iii) = 75% fund in ALFA and 25% fund in GAMA.
(D) The best portfolio from the view-point of Return is one which has best return,
i.e., 25%, i.e., Portfolio (v) = 100% fund in GAMA.
4.(b) (i) Computation of Portfolio Beta

Security No. of MPS (`) Market Value of Beta Product
Shares held investments
[1] [2] [3] [4] [5] [6] = [5] × [4]
VSL 10,000 50 5,00,000 0.9 4,50,000
CSL 5,000 20 1,00,000 1.0 1,00,000
SML 8,000 25 2,00,000 1.5 3,00,000
APL 2,000 200 4,00,000 1.2 4,80,000
12,00,000 13,30,000
Therefore, portfolio beta = 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 = 13,30,000/12,00,000 = 1.108
𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒
(ii) Reduce Beta to 0.8

Beta can be reduced replacing High Beta stocks in the portfolio with Risk Free
investments, which carry a Beta of Zero.
Security Beta Proportion (Amt. Invested) Product
Risk Free Investments 0 x 0
Risky Securities 1.108 1-x 1.108 – 1.108x
1 1.108 – 1.108x
1.108  1.108 x
Therefore, Portfolio Beta = Product ÷ Amount Invested = = 0.8
1
Therefore, 1.108x = 1.108 – 0.8 ⇒ 1.108x = 0.308 ⇒ x = 0.278 or 27.8% for Risk Free
Investments and 72.2% for Risky Investments. Therefore, amount to be invested in Risk
Free Investments is as follows –
(a) Alternative One – Overall Portfolio value is retained at `12,00,000:

Amount to be invested in Risk Free Investments = 27.8% of `12, 00,000 = `3, 33,600
[= value of Risky Investments sold, and replaced by Risk Free Investments]. Therefore,
Risky Investments will constitute `8, 66,400 (comprising the four securities in the
existing ratio)
(b) Alternative Two – Overall Portfolio value is increased:
 Therefore, existing Risky Investments will not be disturbed. Therefore, investments in

Risky Securities will be ₹12, 00,000 (constituting 72.2%)
 Amount of new Risk Free Investments = 1272.2,00,000% ×27.8% = ₹4, 62,050.
(i) Increase Portfolio Beta to 1.2
Increase in portfolio Beta can be done by replacing Low Beta securities with High Beta
securities. Since, it has to be done using Risk Free Securities; amount can be borrowed at
Risk Free rate and invested in Risk Securities:
Security Beta Proportion (Amt. Product

Invested)
Risk Free Investments 0 x 0
Risky Securities 1.108 1-x 1.108 – 1.108x
1 1.108 – 1.108x
1.108  1.108 x
Therefore, portfolio Beta = Product ÷ Amount Invested = = 1.2
1
Therefore, 1.108x = 1.108 – 1.2 ⇒ 1.108x = - 0.092 ⇒ x = - 0.083 or 8.3% for Risk Free
Borrowings. Therefore, and 108.3% of existing portfolio value to be Invested in Risky
Securities.
Therefore, Amount of Risk Free Borrowings = `12, 00,000 × 8.3% = 99,600 to be borrowed
at Risk Free rate and Invested in Risky securities in the same proportion as existing.
5. (a) The following table shows interest rates and exchange rates for the US Dollar
and French Franc. The spot exchange rate is 7.05 Francs per Dollar. Complete the
missing entries:
3 months 6 months 1 year
Euro-dollar interest rate (Annual) 11.5% 12.25% ?
Euro-franc interest rate (Annual) 19.5% ? 20%
Forward Francs per dollar ? ? 7.52
Forward discount on Franc (% per year) ? (6.3%) ?
[10]
(b) Suppose a dealer Rupam quotes ‘All-in-cost’ for a generic swap at 8% against
six month LIBOR flat. If the notional principal amount of swap is ₹5,00,000,
(i) Calculate Semi-Annual fixed payment.
(ii) Find the first floating rate payment for (i) above if the six-month period
from the effective date of swap to the settlement date comprises 183 days
and that the corresponding LIBOR was 6% on the effective date of
swap.
(iii) In (ii) above, if settlement is on ‘Net’ basis, how much the fixed rate
payer would pay to the floating rate payer? Generic swap is based on
30/360 days’ basis. [6]
Answer:
5.(a)
Particulars 3 Months 6 Months 1 Year

Euro Dollar interest rate [Annual] 11.5% 12.25% 12.50%
Euro Franc interest rate [Annual] 19.5% 18.94% 20.00%
Forward Francs per Dollar 7.1871 7.2721 7.52
Forward Discount on Franc [per cent per (7.78%) (6.3%) (6.67%)
year]
Working notes:
1. Spot rate 1$ =7.05 Francs;
2. 3 Months forward: (for $ 1)
= Spot rate x [(1 + Francs interest rate for 3 months) / (1 + Euro dollar interest rate for 3
months)]
= 7.05 Francs x [(1 + 19.5% / 4) / (1 + 11.5% / 4)] = Fr. 7.1871. [Interest rate parity
method]
3. Forward Discount rate [3 months]

= [(Forward rate - Spot rate) / Spot rate] x 100 x 12 / (no. of months’ forward rate)
= [(7.1871 - 7.05) / 7.05] x 100 x (12 / 3) = 7.78%. [Annualised]
4. 6 months’ Forward rate:

= Spot rate x [1 + (Discount rate x No. of months forward /12)] = Fr.7.05 x [1 + (6.3% x
6/12)] = Fr. 7.2721.
5. Franc interest rate [6 months] = Assuming Franc interest rate = X, applying the same
in Interest Rate Parity Formula for determining Forward Rate - Forward Rate
= Franc Spot rate x [(1 + Francs interest rate for 6 months) / (1 + Euro Dollar interest rate
for 6 months)]
Fr. 7.2721 = Fr. 7.05 x (1 + X/2) / (1 + 12.25% / 2); or, Fr. 7.2721 = Fr. 7.05 x (1 + X/2) /
(1 + 6.125%); or, X = 18.94%.
6. Euro Interest Rate [1 year] = Assuming Euro interest rate = X, applying the same in
interest rate parity formula for determining Forward Rate — Forward Rate
= Franc Spot rate x [(1 + Francs Interest Rate for 1 year) / (1 + Euro Dollar interest rate
for 1 year)]
Fr. 7.52 = Fr. 7.05 x [(1 + 20%) / (1 + X); Or, X = 12.50%.
7. Forward Discount Rate

= [Forward rate - Spot rate] / [Spot rate x 100 x 12 / (no. of months’ forward)] = [(7.52 -
7.05) / 7.05] x 100 x [12 / 12 months] = 0.0667 = 6.67%.
5.(b) Computation of Factors

Factor Notation Value
Notional Principal P 5,00,000
Time N 180 days
All in Cost Rate R 0.08
(1) Computation of Semi Annual Fixed Rate Payment

Semi-Annual Fixed Rate Payment = P x (N ÷ 360) x R
= 5,00,000 x (180 ÷ 360) x 0.08
= 5,00,000 x 0.5 x 0.08 = `20,000
(2) Computation of Floating Rate Payment
Floating Rate Payment = P x (N ÷ 360) x LIBOR
Where N = Period from the effective date of SWAP to the date of Settlement
= 5,00,000 x (183 ÷ 360) x 0.06
= 5,00,000 x (0.5083) x 0.06 = `15,250.
(3) Computation of Net Amount
Net Amount to be paid by the Person Requiring Fixed Rate Payment = Fixed Rate
Payment Less Floating Rating Payment = ₹20,000 - ₹15,250 = ₹4,750.
6. (a) The following two-way quotes appear in the Foreign Exchange Market:
Spot 2 months forward
` / US $ ` 46.00 / 46.25 ` 47.00 / 47.50
Required:
(i) How many US Dollars should a firm sell to get ₹ 25 lakhs after 2
months?
(ii) How many Rupees is the firm required to pay so as to obtain US $
2,00,000 in the spot market?
(iii) Assume that the firm has US $ 69,000 in current account earning
interest. ROI on Rupee investment is 10% per annum. Should the firm
encash the US $ now or 2 months later? [6]
(b) Bharat’s subsidiary in India, Emami, procures most of its soaps from a
Japanese company. Because of the shortage of working capital in India,
payment terms for the Indian importers are typically 180 days or more.
Emami wishes to hedge an 8.5 million Japanese Yen payable. Although
options are not available on the Indian Rupee (`), forward rates are available
against the Yen. Additionally, a common practice in India is, for companies’
like Emami, to work with a currency agent who will, in this case, lock in the
current spot exchange for a 4.85% fee. Using the following data, recommend
a hedging strategy.
Spot rate, USD/JPY yen 120.60/$
Spot rate, USD/INR `47.75/$
180-day forward rate, JPY/INR `0.4166/yen
Expected spot exchange rate in 180 days `0.3846/yen
180-day yen investment rate 1.5%
180-day rupee investment rate 8.0%
Cost of capital 12.0% [10]
Answer:
6.(a)
(i) US $ required to get ` 25 Lakhs after 2 months at the rate of ` 47.00 per $.
Hence, ` 25,00,000 / ` 47.00 = US $ 53191.489.
(ii) ` required to get US $ 2,00,000 now at the rate of ` 46.25 per $. Hence, US
$ 2,00,000 x ` 46.25 = ` 92,50,000.
(iii) Encashing US $ 69,000 Now Vs. 2 months later
Proceeds if we can encash in open market $ 69,000 x ` 46.00
= ` 31,74,000. Opportunity gain = 31,74, 000 x (10 /100) x (2 /12)
= `52,900.
Likely sum at end of 2 months =` 32,26,900.
Proceeds if we can encash by Forward rate: $ 69,000 x ` 47.00
= ` 32,43,000.
It is better to encash the proceeds after 2 months and get opportunity gain.
ALTERNATIVE SOLUTION: Part (iii) only.

Evaluation of investment in Rupee:
Forward Premium (for Bid rates)
= [(Forward rate ` 47 - Spot rate ` 46)/ Spot rate ` 46] x (12 months / 2
months) x 100. = 13.04%.
Observation and conclusion: Annualised forward premium for Bid rates
(13.04%) is greater than the Annual return on investment in Rupees (10%).
Therefore, the firm should not encash its US $ balance now. It should sell the
US $ in the forward market and encash them two months later.
6.(b)
180 – day account payable, Japanese Yen 8500000

Spot rate, Yen/$ 120.60
Spot rate, Rupee/$ 47.75
Implied (calculated) spot rate Yen/ Rupee (120.60/47.75) 2.5257
180 – day Forward rate: Yen/ Rupee 2.4000
Expected spot rate in 180 – days Yen/Rupee 2.6000
180 – day Indian Rupee investing rate 8.00%
180 – day Japanese yen investing rate 1.50%
Currency Agent’s exchanges rate fee 4.80%
Emami’s cost capital 12.00%
HEDGING ALTERNATIVES:
1. REMAIN UNCOVERED Rate Yen per Amount

Rupee (₹)
Settling Account 2.5257
Payable in 180 – days at spot rate.
*If spot rate in 180- days is same as current (8500000/2.5257) 3365464.34 Risky
spot
*If spot rate in 180 – days is same as 2.4000 3541666.67 Risky
Forward rate
[8500000/2.4000]
* if spot rate in 180 – days is expected 2.600 3269230.77 Risky
Spot rate
[8500000/2.6000]
2. BUY JAPANESE YEN FORWARD

180 DAYS
Settlement amount at forward rate. 2.400 3541666.67 Certain
[8500000/2.400]
3. MONEY MARKET HEDGE:
Principle Account Payable: Yen 8500000
Discount factor for year
Investing Rate for 180 days 0.99256
(1/1.0075)
Principle needed to meet Yen 8436760.00
Account payable in 180 – days:
(8500000 x 0.99256)
Current spot rate Yen per rupee
2.5257
Indian Rupee Current amount: ₹3340365.05
[8436760/2.5257]
Emami WACC carry – forward Factor for 180 days: 1.0600
FUTURE VALUE OF MONEY MARKET HEDGE:₹3540786.95 certain
4. INDIAN CURRENCY AGENT HEDGE:
Principle Account Payable Yen 8500000
Current spot rate Yen per rupee 2.5257
Current account payable (8500000/2.5257) ₹3365403.65 (A)
Plus: Agent’s Fees (4.85%) ₹163222.08

Emami’s WACC
Carry – forward factor for 180 days on fee ₹173015.40 (B)
(163222.08 x 1.06)
Total ₹3538419.05
Certain.
EVALUATION ALTER NATIVES:
Hedging through currency agents is the best alternative hedging strategy if risk
avoidance is the objective.
7. (a) Nava Ratna Ltd. has just installed MACHINE R at a cost of ` 2,00,000. This
machine has 5 years’ life with no residual value. The annual volume of production
is estimated at 1,50,000 units, which can be sold at ` 6 per unit. Annual operating
costs are estimated at ` 2,00,000 (excluding depreciation) at this output level. Fixed
costs are estimated at ` 3 per unit for the same level of production.
The company has just come across another model called MACHINE S,
capable of giving the same output at an annual operating costs of `1,80,000
(excluding depreciation). There will be no change in fixed costs. Capital cost
of this machine is ` 2,50,000 and the estimated life is 5 years with no residual
value.
The company has an offer for sale of MACHINE R at `1,00,000. But the cost
of dismantling and removal will amount to ` 30,000. As the company has not
yet commenced operation, it wants to sell MACHINE R and purchase
MACHINE S.
Nava Ratna Ltd. will be a zero-tax company for 7 years in view of several
incentives and allowances available. The cost of capital may be assumed as
14%.
Required:
(i) Advise the company whether it should opt for replacement.
(ii) What would be your advice, if MACHINE R has not been installed but
the company is in the process of selecting one or the other machine?
[Given: PVIF for 1-5 years = 0.877, 0.769, 0.675, 0.592, 0.519] [10]
(b) A stock costing `120 pays no dividends. The possible prices that the Stock might
sell for at the end of the year with the respective probabilities are given below.
Compute the Expected Return and its standard Deviation.
Price 115 120 125 130 135 140
Probability 0.1 0.1 0.2 0.3 0.2 0.1
[6]
Answer:
7.(a)
Replacement of Machine R: Incremental cash
outflow:
Cash outflow of Machine S ₹ 2,50,000
Less: Sale value of Machine R (` 1,00,000 - 30,000) ₹ 70,000
Net outflow ₹1,80,000
Incremental cash flow from Machine S:

Annual cash flow from Machine S:
[(1,50,000 x 6) – 1,80,000 - (1,50,000 x 3)] Annual cash ₹2,70,000
flow from Machine R:
[(1,50,000 x 6) - 2.00.000 - (1,50,000 x 3)] ₹2,50,000
Net inflow ₹ 20,000
Present value of Incremental cash inflow:
= 20,000 x (0.877 + 0.769 + 0.675 + 0.592 + 0.519)
= ₹ 68,640
NPV of Machine S = 68,640 - 1,80,000 = ₹ (-) 1,11,360.
[₹ 2,00,000 spent on Machine R is a sunk cost and hence it is not relevant for deciding
the replacement]
Decision: NPV of Machine S is NEGATIVE. Replacement is not advised. If it selects one of
the two, independent NPV is to be calculated for this decision.
Independent evaluation of Machine R & Machine S: All in `

Particulars Machine R Machine S
Units produced 1,50,000 1,50,000
Selling Price @ ` 6 9,00,000 9,00,000
Less: Operating cost (Exclusive of depreciation) 2,00,000 1,80,000
Contribution 7,00,000 7,20,000
Less: Fixed cost 4,50,000 4,50,000
Annual cash flow 2,50,000 2,70,000
PV of cash flows for 5 years, i.e., [Sum of PVIF for
14%, 5] 8,58,000
3.432 x 2,50,000 9,26,640
3.432 x 2,70,000 2,00,000 2,50,000
Cash out flow
NPV 6,58,000 6,76,640
Decision: Choose Machine S as NPV of S is higher than that of R.
7.(b)
Price Return Probability Expected D D2 P x D2
(R)= (P) Return =
` 120 (P x R) R
-P -
R
115 (5) 0.1 (0.5) (13.5) 182.25 18.225
120 0 0.1 0.0 (8.5) 72.25 7.225
125 5 0.2 1.0 (3.5) 12.25 2.450
130 10 0.3 3.0 1.5 2.25 0.675
135 15 0.2 3.0 6.5 42.25 8.450
140 20 0.1 2.0 11.5 132.25 13.225
Total R = 8.5 50.250
Expected Return on Security = ` 8.5
Risk of Security = σ = Variance = 50.25 = ` 7.09
8. Answer any 4 questions out of 5 questions. [4x4=16]
(a) The advantages of OCDs (Optionally Convertible Debentures) to investor

(b) Characteristics of Commodity Exchange in India
(c) Types of Credit risk.
(d) Discuss the regulatory role of RBI
(e) Put-Call Parity Theory.
Answer :
8.(a) The advantages of OCDs (Optionally Convertible Debentures) to investor:

Optionally Convertible Debentures (OCDs) are the debentures that include the option to
get converted into equity. The investor has the option to either convert these debentures
into shares at price decided by the issuer/agreed upon at the time of issue.
Advantages of OCD are:

(a) From Issuer
(i) Quasi-Equity: Dependence of Financial Institutions is reduced because of the
inherent option for conversion (i.e. since these are converted into equity, they
need not be repaid in the near future.)
(ii) High Equity Line: It is possible to maintain Equity Price at a high level, by issuing
odd-lot shares consequent to conversion of the debentures, and hence lower
floating stocks.
(iii) Dispensing Ownership: Optionally Convertible Debentures enable to achieve
wide dispersal of equity ownership in small lots pursuant to conversion.
(iv) Marketability: The marketability of the issue will become significantly easier, and
issue expenses can be expected to come down with the amounts raised becoming
more.
(b) Investor
(i) Assured Interest: Investor gets assured interest during gestation periods of the
project, and starts receiving dividends once the project is functional and they
choose to convert their debentures. Thereby, it brings down the effective
gestation period at the investor ‘s end to zero.
(ii) Secured Investment: The investment is secured against the assets of the
Company, as against Company deposits which are unsecured.
(iii) Capital Gains: There is a possibility of Capital Gains associated with
conversion, which compensates for the lower interest rate on debentures.
(c) Government
(i) Debentures helped in mobilizing significant resources from the public and help
in spreading the Equity Investors, thereby reducing the pressure on Financial
Institutions (which are managed by Government) for their resources.
(ii) By making suitable tax amendments, benefits are extended to promote these
instruments, to safeguard the funds of Financial Institutions and encouraging
more equity participation, which will also require a higher compliance under
Corporate Laws, whereby organisations can be monitored more effectively.
8. (b) Characteristics of Commodity Exchange in India: The basic characteristics of

commodity exchange in India are:
(i) The units are inter-changeable and no value adding processes are performed on
them. This allows the units to be traded on exchanges without prior inspection.
(ii) Every commodity has a unique supply factor and as they are produced
―naturally.
(iii) Commodities are subject to cycles in demand from both intermediate players and
end users. High prices usually lead to a boost in resource investments causing
excess supply in the future which eventually pushes down commodity prices.
(iv) The commodities from different groups may be negatively correlated at a point
of time. For example, the prices of wheat and aluminium can move in the opposite
direction as they are affected by a different set of factors.
(v) There is a positive correlation between commodity prices and growth measures,
although there may be a significant lag between a pickup in industrial production
and commodity prices.
(vi) A positive correlation is often seen between commodities and inflation indicators.
In particular, commodities tend to react to an early stage of inflation as raw
material price appreciation generally tends to precede, and quite often exceed
consumer price inflation growth. While true over the very long term, the
relationship between inflation and commodity prices has been considerably
weaker over the last 10 years, which has been characterized by disinflation/low
inflation.
The above characteristics may not be true for all commodities taken individually;
however, they are true for diversified indices of industrial commodities and agricultural
commodities.
8. (c) Types of Credit risk: Credit risk can be classified in the following way:
(i) Credit default risk: The risk of loss arising from a debtor being unlikely to pay its
loan obligations in full or the debtor is more than 90 days past due on any material
credit obligation; default risk may impact all credit sensitive transactions,
including loans, securities and derivatives.
(ii) Counterparty risk: The risk of loss arising from non-performance of counterparty
in trading activities such as buying and selling of commodities, securities,
derivatives and foreign exchange transactions. If inability to perform contractual
obligations in such trading activities is communicated before the settlement date
of the transaction, then counterparty risk is in the form of pre-settlement risk,
while if one of the counterparty defaults on its obligations on the settlement date,
the counterparty risk is in the form of settlement risk.
(iii) Concentration risk: The risk associated with any single exposure or group of
exposures with the potential to produce large enough losses to threaten a lender
‘s core operations. It may arise in the form of single name concentration or
industry concentration.
(iv) Country risk: The risk of loss arising from sovereign state freezing foreign
currency payments (transfer/ conversion risk) or when it defaults on its
obligations (sovereign risk).
8. (d) The regulatory role of RBI: As the nation’s financial regulator, the reserve bank
of India handles a range of activities, including:
1. Licencing
2. Prescribing capital requirements
3. Monitoring Governance
4. Setting prudential regulations to ensure solvency and liquidity of the banks
5. Prescribing lending to certain priority sectors of the economy
6. Setting appropriate regulatory norms related to income regulation, asset
classification, provisioning investment valuation, exposure limits and the like
7. Initiating new regulation
8. (e) Put-Call Parity Theory: Put-call parity states that the simultaneous purchase and sale
of a European call and put option of the same class (same underlying asset, strike price,
and expiration date) is identical to buying the underlying asset right now. The inverse of
this relationship would also be true.
The term "put-call" parity refers to a principle that defines the relationship between the
price of European put and call options of the same class. Put simply, this concept
highlights the consistencies of these same classes. Put and call options must have the
same underlying asset, strike price, and expiration date in order to be in the same class.
The put-call parity, which only applies to European options, can be determined by a set
equation.
Put-call parity shows the relationship that has to exist between European put and call
options that have the same underlying asset, expiration, and strike prices.
This concept says the price of a call option implies a certain fair price for the
corresponding put option with the same strike price and expiration and vice versa.
Put-call parity doesn't apply to American options because you can exercise them before
the expiry date.
If the put-call parity is violated, then arbitrage opportunities arise.
You can determine the put-call party by using the formula C + PV(x) = P + S.
As noted above, the put-call parity is a concept that applies to European options. These
options are of the same class, meaning they have the underlying asset, strike price, and
expiration date. As such, the principle doesn't apply to American options, which can be
exercised at any time before the expiration date.
Put-call parity states that simultaneously holding a short European put and long European
call of the same class will deliver the same return as holding one forward contract on the
same underlying asset, with the same expiration, and a forward price equal to the option's
strike price.
If the prices of the put and call options diverge so that this relationship does not hold, an
arbitrage opportunity exists. This means that sophisticated traders can theoretically earn
a risk-free profit. Such opportunities are uncommon and short-lived in liquid markets.

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FINAL EXAMINATION SET 1

MODEL QUESTION PAPER TERM – JUNE 2023

The certainty equivalent approach is employed in evaluating risky investment. The

Analyse the above information to determine the following:

(b) Briefly discuss the components of digital finance. [10 + 6 = 16]

4. (a) (i) Discuss the key determinants of price-earnings multiple.

Analyse the performance of the schemes based on Jensen's Alpha, if government

6. (a) The following data relates to DCB Ltd.'s share prices:

2. (a) (i) If the projects are divisible

(ii) If the projects are indivisible (by trial-and-error method)

(b) Schedule of Debt Payment

PV of Cash Outflows under Buying Alternative

Let x be the equal annual lease rental (L.R).

5. (a) Characteristics line

(b) Calculation for ranking based on Jensen’s alpha

6. (a) (i) Theoretical Future Price

(b) Net pay-off [call option]

Net pay off [put option]

7. (a) An American Depositary Receipt (ADR) is a certificate that represent shares of a

(b) (i) Payment to supplier in 60 days

(ii) Payment to supplier in 90 days

Base for incremental depreciation

Depreciation at end of the Year

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

PV of Cash Flows (Other than Depreciation) (1,23,300)

(b) A Mutual Fund made an issue of 10,00,000 units of ` 10 each on 01.01.2016. No

5. (a) A holds the following portfolio:

6. (a) Briefly illustrate various steps in a risk management process.

(b) A owns a portfolio in three stocks as detailed below:

7. (a) (i) Compare and contrast ADR and GDR.

HRS Company wishes to finance exports to Britain with £3 million of pound

2. (a) (i) Project A

Statement showing Expected Net Present Value

= 8/1.14 + 14/(1.14)2 + 22/(1.14)3 + 22.88/[(1.14)3×(0.14 – 0.04)]

5. (a) (i) Expected rate of return

CAPM, E (RP) = RF + β [E (RM) – RF]

(ii) Average Return of Portfolio = (26.95+25.51+22.63+14.14)/4 = 22.31%

(b) Computation of existing portfolio beta:

The swap can therefore be structured as follows:

Firm Paid to Swap Received from Paid to Net Cost Savings

Finally Swap Dealer get commission of 0.5%.

1. Choose the correct alternative. [15 x 2 =30]

(iii) The following information is available with respect to Project X:

(iv) The major advantage of leasing is that it _________.

(vi) Bond volatility is inversely related to:

(xi) Plain vanilla interest rate swaps involved:

(xv) Sharpe’s measure of the portfolio performance is based on:

(a) (i) Replacement of Machine – R:

Incremental cash out flow

(ii) Independent evaluation of Machine– R and Machine –S

Particulars Machine– R Machine– S

(b) Capital sum to be placed under Lease

Therefore 3.2401 x = 215.94

The firm uses 8% discount rate for this type of investment.

(b) Consider the equity share of India Incorporated

Statement showing Expected Net Present Value

(b) The following are the steps involved:

Step I. Dividend stream during super normal growth period.

D D (1  g ) 3.00 (1.25) 5 (1.07)