MANAGEMENT OF BANKS AND FINANCIAL INSTITUTIONS (MBFI)

MID-TERM EXAMINATION, PGPM, 2019-21 (TERM IV)

FACULTY: S. VEENA IYER
MAX MARKS: 50
Date & Time: 30th July 2020 (10.15 am)
MAX TIME: 3 HRS
This is an open-book, open-material exam. Students should have all required material either in
hard copy format or downloaded on to their computers. Students are not allowed to access any
Internet links and sites.
The question paper comes with an accompanying Excel file that has space marked out for each
question and its sub-parts. Please use this Excel file to answer all questions. Save it as Roll
no._Name.xlsx and upload to submit.
Please answer to the point. Spend more time thinking than writing. Marks are for content and not
length. Finally, no copy-pasting from anywhere, especially the articles provided here. Answer in
your own words – your understanding of the concepts should come out clearly.

I. Below are the abridged financials of SBI AMC Ltd. and two mutual funds from their stable –
Fund 1 and Fund 2. All figures are in Rs. crore.

SBI AMC
Balance Sheet Mar-18 Mar-17 Revenue Statement FY2017-18
Shareholder funds 102 77 Revenues 127
Non-curr. liabilities 4 1 Expenses 77
Current liabilities 23 20 Taxes 17
Total liabilities 129 98 PAT 33
Non-current assets 58 50
Current assets 71 48
Total assets 129 98
   
Fund 1
Balance Sheet Mar-18 Mar-17 Revenue Statement FY2017-18
Unit capital 31 34 Interest & Dividends 22
Profit on sale/ redemption of
Reserves & Surplus 233 230 investments 190
Current Liabilities 26 5 Other income 1
Total liabilities 290 269 Total revenues 213
Loss on mark-to-market of
Investments 248 252 investments 180
Deposits 4 2 Management fees 2
Current assets 38 15 Commission to agents 3
Total assets 290 269 Other operating expenses 2
Total expenses 187
Surplus/ deficit for the year 26
 Fund 2
Balance Sheet Mar-18 Mar-17 Revenue Statement FY2017-18
Unit capital 155 143 Interest & Dividends 30
Profit on sale/ redemption of
Reserves & Surplus 2002 1636 investments 137
Current Liabilities 135 95 Other income 0
Total liabilities 2292 1874 Total revenues 167
Loss on mark-to-market of
Investments 2033 1750 investments 16
Deposits 1 9 Management fees 9
Current assets 258 115 Commission to agents 5
Total assets 2292 1874 Other operating expenses 2
Total expenses 32
Surplus/ deficit for the year 135

a. Conduct Du-Pont analysis for all the entities such that financial leverage in all the breakdowns is
kept at 1. Further, for the funds, adjust all net unrealized gains/losses against revenues rather
than as part of expenses. (5)
b. How does the ROE of the AMC and its components compare with that of the funds? Provide
business model related explanations for your numbers. (5)
c. Compute the TER of each of the two funds using only their ROE components that you have
calculated in part a. Interpret all the metrics of the funds that you have computed, using AMC
language and comment on their nature and relative performance assuming that the average
return on the benchmark index during the year was 8% p.a. (6)

II. Provided below are projections by the managers of a PE fund that they are about to launch.
They anticipate the life of the fund to be eight years and the projections are as under (all
figures in $ millions):

Year Drawdown Net income accruing to the fund Distributions to partners

1 80 0 0
2 50 0 0
3 30 50 50
4 45 75 75
5 35 80 80
6 35 90 90
7 ‘A’ 90 90
8 90 ‘B’
‘A’: The partners hope to raise $300m in the first year as the first and final close of the fund.
They project that they will be able to deploy all funds raised by the end of the 7 th year.
‘B’: All remaining investments of the fund will be liquidated by the end of the 8 th year and
proceeds distributed. The managers do not foresee any loss in liquidating the investments.
 1. Management fees of 2% will be charged on committed capital for three years after
which it will be charged at 1% of the NAV at the start of the year.
2. Earnings of the fund to be distributed between the Limited Partners (LPs) and General
Partners (GPs) such that:
a. 100% to all partners until all the partners have received an amount equal to the capital
contributed
b. 100% to limited partners until the limited partners have received an aggregate amount
equal to an 8% cumulative internal rate of return, compounded annually, on the
outstanding balance of partners’ capital contributions
c. 100% to the GP until the GP has received 20% of the all aggregate amount allocated to
the general and limited partners pursuant to clauses 2a, 2b and 2c
d. Thereafter, 80% to the LPs and 20% to the GP.

You are required to:

1. Draw up the waterfall schedule for distribution of surplus between the LPs and GPs. Compute
the IRR for the LPs and the NPV for both parties at 8% p.a. hurdle rate. (10)
2. The ‘Distributions’ column in the projections above has been drawn up under pressure from
their LPs who believe that the maximum capital distribution should be restricted to the income
accruing to the fund in any year. The GPs however, want to front-load the payments as that
shows a better picture of their capability and performance to prospective investors. Their
argument is that since there is no change in the projected earnings of the fund, it shouldn’t
matter how the pie is distributed across time. And not to mention that it will improve the IRR for
the LPs too! They propose the following distribution.

Year 1 2 3 4 5 6 7 8
Distribution
($mm) 50 120 100 200 100 0 0 ‘B’

In such a case, the fund will need to resort to short term borrowing to manage liquidity. The net
income will be a negative $5 million for Y1 and Y2 and 75% of earlier projected earnings for
every year starting Y3 owing to interest expenses.
a. Make required changes to your model to effect the above changes. (4)
b. Recommend if the LPs should go for this deal or not. (6)

c. By suggesting the alternative distribution pattern, are the GPs reneging on their fiduciary
responsibility towards the LPs? Are they being unethical? (4)

III. Below are excerpts from the article “How kidnapping insurance keeps a lid on ransom
inflation”, published in The Economist in May 2018. Read the article and answer the
questions that follow in not more than 50 words each.
IN THE early 1970s, leftist guerrillas in Argentina discovered a lucrative new way to make
money: kidnap millionaires. Panicking firms would agree to huge ransoms, more concerned
with freeing their executives than driving down the fee. That was not just bad for businesses. It
also became a textbook case of how poor negotiating can send future ransoms rocketing and
attract new entrants to the kidnapping trade.
One reason it marked a high point is the spread of kidnapping-and-ransom (K&R) insurance.
This is involved in a minority of the $0.5bn-1.5bn thought to be paid out in ransoms each year,
but the share is growing. Around three-quarters of Fortune 500 companies pay to cover some
employees. Insurers reimburse the ransom and, at least as importantly, provide seasoned “crisis
management” experts to help with negotiations. The best can get a ransom down to 10% of the
initial demand. They can also calm criminals who may consider harming hostages to induce
distraught relatives to pay up. In kidnappings motivated by money, a hostage’s risk of death
during negotiations is 9% without K&R insurance, but just 2% with it, according to Anja
Shortland, who is writing a book about kidnapping insurance. Kidnappers rarely know if a victim
is insured.
Even without blood spilled, kidnappings ruin lives. Victims are often traumatised. A ransom can
wreck a family’s finances. Kidnappings also keep companies and charities out of places in need
of investment and help. K&R insurance has evolved to lessen these harms. Coverage includes
legal liability for companies and counselling for survivors. Many rich families in countries such
as Nigeria and the Philippines also take out coverage. However, employees with K&R insurance
are forbidden from finding out they have it, for fear of encouraging more kidnapping if word
gets out. Insurance is usually invalidated if its existence is confirmed.
On a sunny day in Mexico City, Carlos Seoane of Seoane Consulting Group, a crisis-management
firm, recalls how his hands shook the first time he listened in on a negotiation as a trainee.
Some 116 kidnappings later, that no longer happens, he says: “Now I am made of ice.” Mexico’s
kidnappers once targeted the ultra-rich. In recent years the trade has “democratised” to strike
the middle class too, he says.

a. From your understanding of the business of insurance, would you say that offering K&R
insurance makes business sense? Justify your answer. (5)
b. What kind of business risks does offering such insurance carry for the insurers? How do they
seem to be mitigating them, based on the information given in the article? (5)